Wednesday, April 22, 2020

Ladder Capital: Internally Managed mREIT, No CRE CLO Debt

In the previous post I sung the praises of the use of non-recourse secured debt for Colony Capital (CLNY), here I'm going to do the same but for the use of unsecured/non-CLO debt at Ladder Capital (LADR), a commercial credit/mortgage REIT with an $830MM market cap.  Ladder has been punished alongside their commercial mREIT peers and currently trades at approximately 50% of 12/31 book value (which will almost certainly will come down), the recovery won't be overnight, but Ladder is well positioned to survive the corona crisis and provides a safer (not safe) way to play the rebound in the mortgage REITs for the following reasons:
  1. Ladder is an internally managed REIT with significant insider ownership and management seems to run the company as owners versus as a fee revenue stream.
  2. Senior secured portfolio -- in particular their CMBS portfolio is predominantly AAA (which the Fed recently announced is eligible for TALF financing) versus many of their peers who play in the BBB to B space and have had trouble with margin calls.
  3. Unsecured and term repurchase financing gives Ladder the opportunity to work with their borrowers on modifications without getting cash flows shut off like they would in a CRE CLO or face margin calls as they would in short term repo.
Quick overview of Ladder Capital, they were founded shortly following the last market crisis in 2009 (and listed in 2014) by the former UBS real estate team, that team is still largely together today and as a group own 11% of the company.  Ladder primarily plays in four areas of CRE finance: 1) transitional whole loans held for investment; 2) stabilized whole loans to be sold into CMBS (hopefully recognizing a gain on sale); 3) CMBS held for investment; 4) single tenant net lease properties; and then they do have a small sleeve of other operational properties partially the result of any foreclosures on the whole loan portfolio.  They portray themselves as having a strong credit culture and that seems to have played out in the last several years, prior to the coronavirus crisis, they've only had one realized loss on a loan, and unlike other mortgage REITs they don't have any legacy issues or at least don't play the trick of segmenting a core and legacy portfolio when things don't go as planned.

Roughly half of their assets fall into the first and second category, commercial real estate loans that Ladder originates themselves either on transitional properties (meaning a developer is re-positioning the property in some way) for their own balance sheet or on stabilized properties which Ladder will originate to distribute via the CMBS market.  Many if not most of the transitional variety will require some kind of forbearance or modification, construction crews may or might not be working, and certainly any up leasing activity or the time to rent stabilization where the property could be refinanced with longer term financing is pushed out.  The CMBS conduit market is already showing early signs of thawing, and on their Q4 call, Ladder mentioned having a fairly small amount of loans "trapped" in their warehouse awaiting to be sold into the CMBS market.  Here's their slide on their loan portfolio as of January:
As you can see, about 25% of the portfolio is exposed to the highest risk retail and hospitality sectors.  Given their middle market lean, the hospitality portfolio tends to be more weighted towards self service than convention hotels or resort destinations that may take longer to recover.  I tend to think most of these mortgage REITs have similar assets, capital is a bit of a commodity, but possibly Ladder is more conservative than some others.

The right side of the balance sheet is where I think Ladder is more interesting than others -- many commercial mREITs finance their transitional loan portfolios through CRE collateralized loan obligations ("CRE CLOs") where the loans are pledged to an off balance sheet SPV which then issues notes to fund the SPV's purchase of the loans.  The notes will be issued in various tranches depending on investor risk tolerance with the sponsor (the mREIT) of the CLO retaining the junior bonds and equity.  If the underlying collateral doesn't perform, there are asset coverage tests in place to divert cash flows from the junior note holders to pay the senior note holders and protect their position in the transaction.  In the years following the financial crisis, the asset coverage test thresholds are paper thin to the point where one or two modified loans in the portfolio will trip the diversion of cash flows away from the mREIT to pay down the senior note holders.  In practice, what often happens is if one of the underlying loans is in default or requires modification, the mREIT will purchase the loan from the CLO at face value and work it out off to the side as to not jeopardize their cash flow lower down the payment waterfall.  However, in the current environment where there will be many defaulted or modified loans, it might be difficult or just not possible due to margin calls elsewhere in an mREIT's balance sheet to purchase the non-performing loans from the CLO and thus shutting off cash flows.

Ladder had previously issued two CRE CLOs but wound those vehicles up in October and is currently out of that market.  Instead, Ladders funds its loans through a combination of unsecured bonds where they are a BB credit and through term repurchase facilities.  In their term repurchase facilities, they've always stressed in their filings that they've always kept a cushion available to allow them to meet margin calls in a cashless manner.  Neither have the feature of a CLO where cash flow of the underlying assets is completely shut off and may allow Ladder some breathing room in working through modifications with borrowers.  Here's from p74 of the 10-K, they've received margin calls and met them thus far (at least what's been disclosed), many mREITs tout their total available credit capacity but I think that's less meaningful than the borrowing capacity on their currently pledged assets.
Committed Loan Facilities
We are parties to multiple committed loan repurchase agreement facilities, totaling $1.8 billion of credit capacity. As of December 31, 2019, the Company had $702.3 million of borrowings outstanding, with an additional $1.0 billion of committed financing available. Assets pledged as collateral under these facilities are generally limited to first mortgage whole mortgage loans, mezzanine loans and certain interests in such first mortgage and mezzanine loans. Our repurchase facilities include covenants covering net worth requirements, minimum liquidity levels, and maximum debt/equity ratios.
We have the option to extend some of our existing facilities subject to a number of customary conditions. The lenders have sole discretion with respect to the inclusion of collateral in these facilities, to determine the market value of the collateral on a daily basis, and, if the estimated market value of the included collateral declines, the lenders have the right to require additional collateral or a full and/or partial repayment of the facilities (margin call), sufficient to rebalance the facilities. Typically, the lender establishes a maximum percentage of the collateral asset’s market value that can be borrowed. We often borrow at a lower percentage of the collateral asset’s value than the maximum leaving us with excess borrowing capacity that can be drawn upon at a later date and/or applied against future margin calls so that they can be satisfied on a cashless basis.
Committed Securities Repurchase Facility
We are a party to a term master repurchase agreement with a major U.S. banking institution for CMBS, totaling $400.0 million of credit capacity. As we do in the case of borrowings under committed loan facilities, we often borrow at a lower percentage of the collateral asset’s value than the maximum leaving us with excess borrowing capacity that can be drawn upon a later date and/or applied against future margin calls so that they can be satisfied on a cashless basis. As of December 31, 2019, the Company had $42.8 million borrowings outstanding, with an additional $357.2 million of committed financing available.
Uncommitted Securities Repurchase Facilities
We are party to multiple master repurchase agreements with several counterparties to finance our investments in CMBS and U.S. Agency Securities. The securities that served as collateral for these borrowings are highly liquid and marketable assets that are typically of relatively short duration. As we do in the case of other secured borrowings, we often borrow at a lower percentage of the collateral asset’s value than the maximum leaving us with excess borrowing capacity that can be drawn upon a later date and/or applied against future margin calls so that they can be satisfied on a cashless basis.
The other issue many mREITs are having is with their CMBS portfolios, mREITs like XAN or CLNC tend to buy CMBS in the BBB-B rating range or simply unrated, Ladder is predominately in the AAA and AA rated tranches of CMBS and as a result have significant credit enhancement via subordination.  While the pricing of AAA CMBS did drop, the Fed recently announced an expansion of the TALF program in which they'll provide financing on AAA CMBS issued prior to 3/23/2020.  In a bit of a departure from the other assets classes they're willing to finance, CMBS will only be legacy versus only new issuance.  I take this two different ways, 1) the Fed wants to stabilize CMBS prices today; 2) they're not concerned with needing to provide support for new issuance to resume like they are in other ABS markets.  Both are good for Ladder as a CMBS investor and as a loan originator to the CMBS market and it seems to be having its intended result, take the iShares CMBS ETF for example (tracks investment grade CMBS), it has recovered its losses and is up on the year.

Since I started drafting this post, Ladder put out an additional "business update" press release that is becoming all to regular for public companies these days.  In it they outline how they have $600MM of cash after some maturities on their loan portfolio plus they sold assets at 96 cents on the dollar and they have $2.3B of unencumbered assets.  Should be sufficient to get them through the crisis?  The dividend is roughly 20% at $1.34/year, that'll almost certainly get cut/suspended and could provide an attractive opportunity if any remaining yield pigs remain holders.  I like the management here and think we will see most if not all CRE CLOs fail their coverage tests (might be more opportunities once that happens), my sense is Ladder should trade for somewhere in the 75-80% of 12/31 book value range, no science behind it, but I see little risk that they'll be forced to liquidate at fire sale prices or have their cash flows shut off due to asset coverage test failures.

Disclosure: I own shares of LADR

17 comments:

  1. Interesting idea. Thanks. Is there a breakdown somewhere of their physical real estate owned? how much is office/retail/res/hospitality

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    1. It's only about 5% of assets.

      See page 33 of their investor presentation, chunky stuff is an office portfolio in Richmond and student housing at UCSB:
      http://ir.laddercapital.com/Cache/IRCache/322dc8f3-20a9-71a1-6617-cc003ea59a68.PDF?O=PDF&T=&Y=&D=&FID=322dc8f3-20a9-71a1-6617-cc003ea59a68&iid=4422251

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  2. Why now? As ripple effects continue to spread outwards in the commercial real estate market, I would think we are in the beginning stages of seeing dominoes fall. Sure there's other mREITs with way worse debt instruments and derivatives exposure, but that doesn't make Ladder immune to the fallout. IMO wait 6 months and see if thesis still holds.

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    1. That's fair, I sort of said that as well, wait for the dividend cut, etc. Maybe it is just a better watchlist add.

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  3. They have a covenant on the bonds of 1.2x unencumbered asset / unsecured debt. The latest announcement suggests they are sitting right on the covenant...seems like they'd rather raise liquidity than increase unencumbered assets.

    I'm not sure about this trading at 80% of pre covid NAV. Hair cutting their hotel and retail exposure and a couple of other duds would take NAV down 15-20%

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    1. Thanks for the color on the covenant. Admittedly maybe I'm a little early on this one but going through some of the commercial mortgage REITs, these guys seem best positioned to weather the storm. Worth watching if the sector takes another 30% dip.

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  4. FYI, dunno if you saw, but XAN had cured its defaults as of Apr 19. A long way to go on this, but that's good news...

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    1. I did, CMBS market has recovered a bit, I do like XAN but sort of waiting for the shoe to drop on their CRE CLO financing. At first I thought the fact that they just issued a deal in early March was a good thing, but there hasn't been any amortization on the senior notes, a couple of those loans go to special servicing and cash flows get shut off unless they can buy them out of the deal. But its near the top of my list, does remind me of some successful CRE CDO CMBS from the last crisis.

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    2. I agree that that might be a real opportunity if/when it happens, as people with no patience for waterfalls sell and move on. I did take a nibble of this and a few things that might go much lower in short order, just because the hydrant is blasting cash every which way at the moment. I am sort of pricing things in my mind with base, upside, downside and bizarro cases.

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  5. Interesting call this afternoon. These guys seem blushingly bullish today as compared to the rest of the world. And strangely, Brian Harris is usually right on Macro calls. Thanks for the writeup.

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    1. It was almost a defiant tone? Yeah, worried about a little hubris here as we don't know how the situation will play out. But I did enjoy Brian's discussion on CRE CLOs towards the end of the call (more from a AAA buyer perspective) and how many of the traditional ones will shutoff payments to the mezz and equity in the coming months.

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    2. Loved the call - one of my go tos in times of stress. Had a different interpretation though.

      His actions are hardly bullish - they are very cautious and justifiably so. He's keeping $830m of cash not earning a spread during a target rich environment (with no indication that he wants to put it to work). And that is despite cost of funding at Ladder increasing rapidly (FHLB sunset + Goldman/Koch @ 7% + $750m more unsecured). It will probably be a 20% earnings drag so this will have medium term ROE impact. He just doesn't know what the world looks like on re-opening and with little financing by banks, there's no point in trying to be a hero. All very sensible.

      Think Ladder provides some interesting opps.

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  6. What do you make of this?
    https://www.propublica.org/article/whistleblower-wall-street-has-engaged-in-widespread-manipulation-of-mortgage-funds

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    1. I tend to think most of these pieces about structured finance are overstated, fighting the last war sort of thinking. This one in particular seems to have similarities to controversies around EBITDA addbacks in the leverage finance world, EBITDA isn't necessarily EBITDA for reported leverage ratios, etc. LADR didn't have a lot of fixed rate loans that were stuck in a warehouse ready to be securitized, so unless there are put back provisions in these deals, guessing they're pretty safe other than from a reputational perspective. The AAA stuff they hold on balance sheet, should have enough subordination in just about any scenario.

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  7. What is your price target for this stock?

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  8. A number of the original partnership interests recently converted their Class B shares to the publicly traded class A shares. To me, it would seem like they'd want to convert these shares to class A when they want to sell their shares or at least have the option to sell those shares and monetize their partnership interest. Any idea why a bunch of management would have recently converted? Perhaps my logic is wrong on this and there's some tax or other reason why they'd be converting at $7/share instead of $17/share a few months ago.

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    ReplyDelete