Diving Into Blackstone Mortgage’s Portfolio Reveals 2024 Is Darker Than It Seems (BXMT)

Blackstone Mortgage Belief (NYSE:BXMT) is likely one of the largest and most revered Mortgage REITs. It’s externally managed by a subsidiary of Blackstone. BXMT offers short-term transitional floating fee loans to debtors for properties which might be being are being renovated, are beneath development, or not stabilized on account of present or recognized vacancies. These are a few of the riskiest loans in industrial actual property. Thus far, BXMT’s reported monetary outcomes have proven little proof of the misery that’s occurring in Industrial Actual Property usually and is being mentioned by banks on their earnings calls. This led me to a destructive outlook on BXMT.

On December 6^th Muddy Waters printed a brief report on Blackstone Mortgage Belief titled Right here Comes the Cliff. The report targeted on BXMT’s borrower’s use of rate of interest swaps/caps which had, to a point, insulated them from the unprecedented rise in SOFR. As these swaps/caps expired, the report reasoned the debtors could be pressured to default on their loans, which might set off a liquidity disaster for BXMT, given its restricted borrowing capability and unfunded commitments. Because the evaluation, in my view, accurately factors out primarily based on a consultant pattern of BXMT’s loans 70% -75% of their “US mortgage guide is unable to service its debt absent fee swaps.” (It doesn’t impression the mathematics, however administration accurately factors out their debtors use caps not swaps.) The report spooked the market. BXMT’s inventory fell 8% on the day the report was issued. Over the following month, BXMT’s inventory worth mainly recovered (after adjusting for the dividend ex-date) as Jerome Powell indicated the Fed was prone to lower charges in 2024, and administration launched a truth sheet, which counters Muddy Water’s evaluation. A deep dive into BXMT’s accounting, mortgage portfolio, debt covenants, and supervisor’s incentive construction, nevertheless, reveals that even with some aid from decrease charges, BXMT’s earnings and dividend are nonetheless very a lot in danger in 2024 in my view.

Background

BXMT advantages from each its total scale as a REIT with over $24 billion in belongings and its entry to data and alternatives by means of its affiliation with Blackstone. BXMT presents itself to buyers as a high-yield however low-risk alternative on account of its deal with floating-rate senior loans. This implies if a borrower runs into bother, BXMT can have first declare on a property.

On condition that BXMT lends cash primarily to well-known sponsors for initiatives in main markets, they argue the possibility of defaults are low and their floating fee loans shield them from rate of interest threat as properly. Traditionally, BXMT’s charge-offs have been nearly zero; at the moment, 95% of their loans are performing. (BXMT Truth Sheet, December 11, 2023)

Because the industrial actual property surroundings has turn into tougher on account of rising rates of interest, the Work From Residence (WFH) development, and growing crime in sure areas, BXMT has maintained that its loans are largely protected against these points on account of their senior place within the capital stack, minimal publicity to class B commodity workplace, the top quality of their debtors, their debtors’ continued willingness to place fairness into their initiatives, the floating charges on each its belongings and liabilities, and the absence of mark-to-market phrases by itself financing.

Whereas these arguments ring true on a portfolio degree, I imagine lots of BXMT’s loans have a big threat of turning into impaired within the coming quarters. In my view, BXMT has not adequately reserved for these loans. I anticipate it’ll quickly turn into troublesome for BXMT and its auditors to keep up its low ranges of reserves because the freeze on transactions within the workplace sector thaws (offering new decrease benchmarks) and gross sales happen at valuations that mirror the brand new leasing and rate of interest realities. I feel BXMT’s 4Q23 outcomes could embody an impairment associated to the phrases of the 3-year extension on its $291 million mortgage secured by One South Wacker. On December 14^th, a few of the phrases of the extension turned public, together with BXMT’s dedication to lend a further $46 million. This implies BXMT’s mortgage on the workplace property is 15% greater than the sponsor paid for the constructing in 2018. I think different workplace loans that will result in elevated reserves and impairments within the close to future embody the $336 million mortgage on the Woolworth Constructing in NYC and a $229 million mortgage on an workplace constructing in San Francisco. I imagine two lodge loans in San Francisco with a mixed stability of $345 million are additionally liable to impairments. One in all them is the Hyatt Regency SOMA. On January 4^th, 2024, the Actual Deal reported the proprietor of the Hyatt Regency SOMA did not make their balloon fee of $261 million. Brokers estimate the property is value solely $54 million at the moment, implying BXMT is over $200 million of losses on the mortgage.

In Europe, BXMT’s $600 million mortgage secured by the legacy poisonous actual property belongings of Banco Fashionable, a failed Spanish lender, appears to be transferring towards an impairment, in my view, as Santander, who at the moment owns a 49% curiosity within the loans, not too long ago marked down their fairness by 62%. On account of BXMT’s very restricted disclosures on its mortgage portfolio, I really feel buyers can solely belief administration’s assurances that its loans are doing significantly better than these of different comparable actual property lenders within the present surroundings. I anticipate that when BXMT reviews its full-year 2023 numbers, that are audited by Deloitte & Touche LLP, versus the 3Q23 numbers, that are merely reviewed, it’s seemingly the outcomes will embody impairments of a number of giant loans. If loans are impaired, it will impression BXMT’s earnings going ahead as they will’t acknowledge revenue on impaired loans.

Whereas BXMT’s personal financing doesn’t have mark-to-market phrases, it does include covenants primarily based on reported GAAP outcomes, that are impacted by impairments and charge-offs. My calculations suggest that BXMT is already very near violating the Fastened Cost Protection covenant of 1.4x on their very own debt on account of growing SOFR.

I feel sooner or later this might drive BXMT to promote loans at inopportune occasions.

I feel long-term buyers must be much more involved by administration’s tendency to lend further capital to initiatives the place, in my view, the capital helps stave off a charge-off or impairment within the short-term, however could result in larger losses on troubled belongings sooner or later. Thus far, administration has been pushing out the maturities on loans which might be in bother. Within the third quarter, in addition they agreed to lend a further $50 million to the Falchi Constructing which has already been impaired, which means the mortgage is at excessive threat of not being repaid, in line with the auditors, Deloitte & Touche, when there was no obligation to supply further capital.

Whereas disclosed within the 10Q, this $50 million further dedication was not mentioned on the 3Q23 earnings name. As talked about above, BXMT can be loaning a further $46 million to the troubled One South Wacker property. In my view, lending further capital to initiatives that appear to be removed from stabilized and have been impaired with out a proof for buyers on an earnings name must be troubling to shareholders. Whereas I imagine these actions can delay impairments/charge-offs, within the short-run, I feel within the long-run they could destroy shareholder worth by elevating the losses if a mortgage defaults. It must be identified that impairments and charge-offs scale back the motivation price acquired by the exterior supervisor, Blackstone.

BXMT is an externally managed REIT, which implies it has no staff. Its funding choices are made by staff of its supervisor, a Blackstone subsidiary.

The supervisor is paid a Base Administration price primarily based on fairness in addition to an Incentive Payment that equals 20% of BXMT’s “Core Earnings” over a 7% return on fairness. Core Earnings embody curiosity revenue, even when the revenue is generated from a mortgage the place BXMT is paying itself from an curiosity reserve that was arrange when the mortgage was funded, i.e., a development mortgage. (Second Amended and Restated Administration Settlement filed with the SEC on October 28^th, 2014.) Solely when an asset is impaired does BXMT cease recognizing revenue on mortgage funds. Which means each time an asset is impaired, the exterior supervisor stops receiving 20% of the acknowledged revenue recorded from that asset. Moreover, provided that Core Earnings consists of realized positive factors and losses, if BXMT does acknowledge any losses (charge-offs versus reserves), it’ll price the supervisor (Blackstone) 20% of the realized losses. BXMT’s Danger Components talk about a few of the potential points associated to the motivation price.

My math signifies the motivation price might be larger if impairments and charge-offs are delayed as each scale back Core Earnings. As mentioned within the Danger Issue above from the 10K, the motivation price is elevated by investments in dangerous loans with larger yields. On this context, I feel it’s fascinating to notice that BXMT continued to make loans with comparatively high-interest charges secured by workplace properties in 2021 (BMXT Mortgage Portfolio Element 3Q23), properly after Blackstone had made it clear it had diminished its publicity to workplace. At the moment, Blackstone’s actual property portfolio is 2% workplace properties versus 36% for BXMT. (BXMT Supplemental Monetary Disclosure, p.8) As early as the top of 2020, Blackstone had diminished workplace to five% of its whole portfolio. (WSJ Jan 19, 2021.) Apparently, a number of of BXMT’s current impairments have been from workplace loans that have been made in 2021. Many of those loans carried outsized spreads once they have been originated. It’s fascinating to notice, for loans which have solely been watch-listed versus impaired BXMT continues to be paying Blackstone an elevated incentive price as a result of excessive unfold.

To me, it seems that BXMT’s administration group hesitated to acknowledge the challenges going through any of its loans. As of 3Q22, BXMT had solely impaired one mortgage, a lodge asset in NYC. The difficulty within the workplace sector was already well-known. Over the following 4 quarters, BXMT’s portfolio of loans has seen its performing loans drop from 99% to 95%, and it has slowly impaired extra loans. Nonetheless, I imagine the constructing of the Present Anticipated Credit score Loss (CECL) reserve and the impairment of loans nonetheless considerably trailed the realities of the market. On every quarterly convention name in 2023, the administration group has stated they’re adequately reserving for losses, solely to be pressured to extend the reserve within the following quarter because the efficiency of the portfolio continues to deteriorate. Under is a quote from the CFO on 1Q23 Earnings Name.

In distinction, many banks have tried to get in entrance of weaknesses of their industrial mortgage guide by taking a lot bigger impairments than BXMT has performed up to now. I imagine in 2024, it’ll turn into inconceivable for buyers to look previous BXMT’s issues. Not solely do I feel growing reserves and impairments will impression buyers’ view of BXMT’s stability on account of reported guide worth falling and dividend protection eroding, however they could additionally journey BXMT’s covenants, placing the dividend in danger.

The Calculation of BXMT’s Present Anticipated Credit score Loss and Relative Measurement

BXMT’s financials embody an adjustment for CECL as required by ASU 2016-13 to mirror the danger of loss. The Audit Opinion Letter in BXMT’s 10-Okay lists two Vital Audit Issues. Each of them relate to the CECL.

As described above, the auditors primarily depend on administration to information them on the valuations supporting the calculation of the CECL. It seems many of the auditor’s focus in reviewing the CECL is on testing the valuation mannequin and guaranteeing they might comply with hyperlinks to the exterior sources to assist administration’s assumptions. For my part, few auditors could be able to problem a administration group’s estimates, particularly on belongings like workplace properties the place there have been nearly no current information factors on account of an absence of transactions on the finish of final 12 months.

As proven beneath, BXMT has reserved $477 million for mortgage losses.

Click on to enlarge

BXMT 3Q23 10Q

The $463.4 million quantity represents BXMT’s anticipated losses on present loans, whereas the $477.0 million determine consists of anticipated losses on unfunded commitments. Administration encourages buyers to deal with the $477.0 million quantity as that’s the solely quantity they disclose of their monetary complement. Nonetheless, in my view, when calculating their reserve relative to their present loans, the $463.4 million, which is disclosed on the stability sheet, is the suitable metric. As of 3Q23, their CECL on present loans represents 1.95% of their loans receivable. As some extent of comparability, Wells Fargo has a reserve of two.5% for its industrial actual property portfolio as of 3Q23. Nonetheless, for its workplace properties related to its Industrial Funding Banking (CIB) Group, the reserve is 10.8%. (Wells Fargo 3Q23 Monetary Outcomes Presentation, p. 6) The CIB Group focuses on transitional loans which might be much like BXMT’s transitional loans. If BXMT reserved 10.8% of the guide worth of its workplace loans, its reserve could be $922 million or nearly double its reserve for all of its belongings. Whereas I don’t imagine Wells Fargo’s (CIB) workplace loans are an ideal analogy for BXMT’s workplace loans, as a few of Wells Fargo’s loans could have been issued to drive enterprise in different areas like Funding Banking advisory assignments, I feel they are going to be a lot nearer to BXMT’s transitional loans than remainder of Wells Fargo’s actual property mortgage guide.

BXMT’s small reserve relies on the Weighted Common Maturity Technique, a.ok.a the WARM technique. Whereas this mannequin could also be acceptable for the accountants, I feel it seemingly drastically understates the extent of impairments that BXMT will ultimately want to acknowledge. The inputs BXMT makes use of within the mannequin are primarily based on CMBS loans from 1999-2022. (BXMT 2022 10-Okay, p. 82) In my view, BXMT’s transitional and growth loans bear little resemblance to the usual CMBS loans on stabilized belongings of the final twenty years. Moreover, rates of interest have by no means elevated as shortly as they did in the course of the earlier two years. Most significantly, society has modified in unprecedented methods for the reason that pandemic. As Wells Fargo acknowledged on their convention name, value determinations are nonetheless catching as much as the brand new actuality for workplace properties, and buyers ought to count on to see additional write-downs as extra transactions shut.

On condition that actual property and workplace properties, specifically, are a small portion of Wells Fargo’s total mortgage portfolio, I feel it’s in all probability simpler for them to be candid concerning the course of the market. Wells Fargo’s 10.8% reserve appears a lot nearer to what different information sources point out for market ache. It is usually fascinating to notice that identical to Blackstone, Wells Fargo has not seen any important losses but. Nonetheless, Wells Fargo acknowledges that losses are seemingly within the comparatively close to future. In distinction, BXMT presents the truth that 95% of its loans are performing as proof that its portfolio is in good condition. In 3Q22 99% of BXMT loans have been performing.

Improvement and Transitional Loans – Why 95% Present Pay Ought to Not Reassure Buyers

BXMT’s short-term floating fee loans with outsized spreads are designed for debtors who’re both creating an asset from the bottom up, are making important investments to renovate or develop a property, or are addressing a big emptiness or recognized move-out. A borrower with a steady asset would discover higher charges and long run by working with an insurance coverage firm or going to the CMBS market. A few of BXMT’s largest loans embody a $1.1 billion development mortgage for the Spiral, Pfizer’s not too long ago accomplished headquarters in New York Metropolis, a $851 million mortgage for Blackstone’s acquisition of Crown Resorts, a troubled Australian On line casino operator, a $668 million development mortgage for Second Century, Time Warner’s new headquarters in Burbank. BXMT has additionally originated quite a few development loans for residence developments. Since properties don’t have any money circulate when they’re beneath development or restricted money circulate throughout transitional intervals, lenders will sometimes arrange an curiosity reserve with the mortgage that may be drawn on to pay the lender till the asset offers ample money circulate. I think given that the majority of BXMT’s loans seemingly have curiosity reserves in place, even when an proprietor had cashflow points or a growth’s stabilized valuation was lower than the mortgage, it will be proven as present on their funds. I feel BXMT would merely use the curiosity reserve to pay themselves. Whereas BXMT doesn’t launch data on whether or not the money circulate from a property covers the mortgage funds, reviews on their CLOs present a window on some properties.

As proven above, a number of of BXMT’s bigger loans aren’t overlaying their debt service. These loans, nevertheless, are thought of performing by BXMT as an curiosity reserve is probably going being drawn on to make the funds.

Whereas BXMT’s truth sheet says 99.7% of curiosity revenue was paid present, I think it is a perform of the curiosity reserve. Whereas technically, utilizing an curiosity reserve to remain present on a mortgage isn’t utilizing a PIK characteristic, the idea is identical: a lender is including to the stability of the mortgage to which helps maintain a borrower present. I imagine the challenges for a mortgage with an curiosity reserve will solely turn into obvious when a mortgage matures/an curiosity cap expires, or an proprietor is required to place fairness into the property.

BXMT CECL Reserve Rose in Each Quarter in 2023

All through 2023, BXMT’s administration stated that they have been adequately reserving for future losses and have been already incorporating anticipated occasions for 2024. Because of this, I feel some buyers are inclined to mannequin their earnings with out future reserves and impairments. Reviewing their convention calls for the reason that starting of the 12 months exhibits a remarkably constant message as reserves steadily elevated. The message is all the time: now now we have captured all the danger. They by no means level out that they had the identical message the prior quarter.

BXMT’s Key Assumptions in Defending it CECL

BXMT’s CEO started the REIT’s 1Q23 convention name by discussing its CECL and the advantages of being a senior lender in unsure occasions.

Whereas in combination BXMT could have a 36% margin of security, I feel this margin is not going to cease it from seeing important impairments if solely a few bigger loans run into points. BXMT lends on properties with a variety of potential outcomes on account of growth, lease-up and market threat. If 80% of the properties BXMT lends towards develop their money flows and repay their loans, however the different 20% of the loans default, given BXMT’s leverage, I imagine buyers would endure important losses. Profitable loans are repaid, and their additional margin of security doesn’t shield the lender from points with their watch-list loans.

On the identical name, BXMT highlighted that it has reserves of over 20% towards its workplace loans that it considers impaired or prone to be uncovered to a loss.

Whereas BXMT’s math is appropriate {that a} 50% discount in asset worth ought to result in a 20% impression on a senior lender, historical past exhibits lenders often get better a lot much less.

Even when an asset is bought for 50% of its authentic worth, the senior lender finally ends up bearing all the bills related to the sale, authorized bills and the price of the receiver. As proven above, over the past 12 months lenders have sometimes recovered lower than 50% when loans default. Whereas there isn’t a good historic information on transitional loans like BXMT originates, it’s seemingly, in my view, given their threat profile, recoveries might be even decrease. Merely transferring BXMT’s reserve from 20% to 50% of its impaired loans would greater than double its reserve.

Afterward the 1Q23 earnings name, the CFO defended the appropriateness of their reserve by citing a SOX grievance course of for figuring out the CECL calculation.

As anybody concerned in actual property by means of the Monetary Disaster can attest, having a SOX grievance mannequin, whereas good for accounting functions, ought to do little to guarantee buyers about valuations. A bunch of economic establishments and actual property lending platforms didn’t have an issue accounting or in any other case till they did.

As talked about above, in 1Q23, the CEO stated 7% of the portfolio was watch-listed or impaired workplace. By 2Q23, it was as much as 10%, as described by the CEO on the earnings name.

Measurement of BXMT’s Workplace Publicity

On the 2Q23 earnings name, BXMT administration talked about a number of occasions that 10% of the general portfolio is watch-listed or impaired workplace properties. For a portfolio of $24.0 billion, this implies that they had $2.4 billion of impaired or watched checklist workplace out of a complete of $8.6 billion of workplace publicity. Given the WFH development’s impression on the workplace sector, which might be mentioned later, along with larger rates of interest, it’s arduous for me to think about that lower than a 3rd of the short-term loans that BXMT underwrote have a possible for loss. Moreover, primarily based on BXMT’s disclosure, it’s troublesome to inform how they classify a few of the loans on mixed-use initiatives like Colony Sq. in Atlanta or Business Metropolis in Brooklyn. It’s doable their workplace publicity could be a number of billion {dollars} larger if these mixed-use initiatives have been included.

By the 3Q23 earnings name, impaired or watch-listed workplace loans have been as much as 40% of the overall workplace portfolio. Moreover, in the course of the quarter, there have been impairments of workplace loans that have been Class A belongings. (Mortgage Portfolio Particulars Chart in BXMT 3Q23 10Q/488 Almaden Blvd.) Quite a few the impaired belongings had been given a threat score of three on 12/31/22. (See Chart Under) This implies they weren’t even on the watchlist at first of the 12 months. To me, this means how shortly the basics of the workplace mortgage portfolio are deteriorating and/or administration’s tendency to solely impair a mortgage when a borrower stops paying curiosity and principal. It’s arduous for me to know how workplace properties in San Francisco and San Jose weren’t on the watch checklist at first of the 12 months.

For the reason that starting of the 12 months, administration has indicated on its convention calls that the one loans the place they’re prone to see impairments are within the workplace sector. From my perspective, BXMT’s disclosure suggests there could also be points with different property sectors as they’ve watch-listed/impaired loans backed by resorts in addition to a $600 million mortgage secured by the poisonous legacy belongings of Banco Fashionable, which was acquired by Santander at regulators urging. On condition that this leaves much less of the CECL for workplace properties, I feel it makes the overall CECL estimates appear nonetheless extra unrealistic. The chart beneath exhibits BXMT’s watch-listed (4) and impaired (5) belongings together with their score at first of the 12 months.

As proven beneath, for loans topic to the WARM technique within the US, excluding the impaired loans, BXMT solely has a reserve of 0.48% of the overall loans receivable. This equates to $69 million. I really feel this quantity appears implausibly low. Assuming the identical fee of reserves (23%) as for BXMT’s present impaired belongings, merely transferring certainly one of BXMT’s bigger watch-listed belongings to impaired in 4Q23 would equal the complete reserve for the U.S. loans that aren’t at the moment impaired. As might be mentioned later, I imagine lots of BXMT’s 4 rated loans, together with a few of the bigger ones, would look like prone to be impaired within the coming quarters.

1. Consists of Loans the place the WARM mannequin isn’t relevant. Over 70% of the Distinctive Loans Receivable Steadiness contains loans to an Australian On line casino Operator and to a Blackstone/Santander Joint Enterprise that holds the poisonous legacy actual property belongings of Banco Fashionable.

Covenant Stress – On account of rising SOFR

Whereas growing SOFR will make it troublesome for a lot of of BXMT’s debtors to increase their loans when their swaps/caps expire, as mentioned at size within the Muddy Waters’ Report, I feel it poses a extra speedy risk to BXMT as a result of Fastened Cost Protection covenant (FCC) for its secured lending facility. BXMT is required to have an FCC of 1.4x. (BXMT 3Q23 10Q p. 30) Because of the denominator impact, as illustrated beneath, rising charges make this covenant far more onerous. The tables beneath present the impression of rising SOFR on FCC on BXMT’s secured debt portfolio. The primary situation exhibits protection primarily based on SOFR at 0.42% – the typical SOFR flooring for the portfolio, which is probably going indicative of SOFR ranges when loans have been originated. The second situation exhibits protection with at the moment’s SOFR fee. Merely growing SOFR to at the moment’s charges reduces protection from a snug 2.6x to a comparatively tight 1.8x.

My calculations for covenants are primarily based on EBITDA calculated with GAAP numbers. The above evaluation doesn’t account for gadgets like G&A, administration and incentive charges or GAAP changes just like the impression of impaired loans the place BXMT can not acknowledge revenue. Working the covenant check as required per BXMT’s Mortgage Paperwork (Filed with SEC on October 26, 2022) on a trailing twelve-month foundation exhibits protection of 1.52x. My calculations are beneath.

Nonetheless, primarily based simply on 3Q numbers, my calculations recommend the protection goes right down to a really slim 1.43x versus the requirement of 1.4x. As quarters early within the 12 months when SOFR was decrease drop out of the trailing 4 quarters, I imagine the stress on this covenant will proceed to extend. Moreover, the impression of not recognizing the $7.2 million of curiosity revenue on the loans that have been impaired within the 3^rd quarter (BXMT 3Q23 10Q p. 23) can even scale back BXMT’s FCC. The chart beneath exhibits the FCC for 3Q23, adjusting for revenue that may not be acknowledged on account of belongings being impaired on the finish of the quarter and eradicating the one-time good thing about BXMT recognizing a achieve on its debt extinguishment.

My math signifies if there are further impairments within the fourth quarter, the chance of a covenant breach early subsequent 12 months will increase.

Buyers ought to take into account that third-quarter EBITDA was elevated by a one-time achieve related to a debt repurchase. Within the third quarter, BXMT repurchased $33.4 million of debt with an rate of interest of three.75% for 85 cents on the greenback. (BXMT 3Q23 10Q p.33) This implies BXMT is shopping for again its debt at a present yield of 4.4% with an IRR within the mid-teens. From an accounting perspective, BXMT acknowledges the achieve within the present quarter, however they might want to exchange 3.75% debt with debt from their secured amenities, which have a median Web Curiosity Margin of 1.80%. Contemplating SOFR is at 5.32%, this implies BXMT is buying and selling a present yield of 4.4% for 7.12%, which I imagine will stress earnings in future intervals.

Extensions – Sponsors Contribute their Charges, BXMT Commits Virtually $100 Million to Troubled Tasks

On BXMT’s earnings calls (see Earnings Name quote from Background Part) and of their Truth Sheet, they cite sponsors’ willingness to place fairness into initiatives as proof that buyers don’t want to fret about future impairments or charge-offs. My view of the small print of those extensions suggests sponsors could get better their new investments by means of administration and growth charges, whereas BXMT is committing giant portions of further capital even on initiatives which have been impaired as they’re seen, by the auditor, as being at excessive threat of not being repaid. It must be famous that these preparations enable BXMT to delay charge-offs, which might impression Core Earnings.

Falchi Constructing

In 2016, Blackstone offered Savana a $200 million mortgage to fund the acquisition of the Falchi Constructing, a 733,000 sqft. workplace constructing in Sunnyside/Lengthy Island Metropolis Queens that was in-built 1922. Savana is a well-respected sponsor that traditionally has targeted on repositioning older workplace buildings round NYC. Savana proceeded to speculate $35 million within the property for upgrades, and many others. Nonetheless, as a result of leasing market, the property seems to have a emptiness fee of over 37%. The general emptiness fee for Class A Workplace within the Lengthy Island Metropolis submarket was 43% at YE 2022 and rents have been down 7% from the prior 12 months, in line with Cushman & Wakefield. Associated Fund Administration and BentallGreenOak additionally purchased properties close to the Falchi Constructing in 2016 and had the same technique to Savana for retenanting the properties. In February of 2023, Associated and BentalGreenOak walked away from the properties and gave the keys again to their lender. BXMT did impair its mortgage on the Falchi constructing in 4Q22, and it seems that Savana additionally gave up on their property because it was bought to Madison Capital in August. On condition that BXMT was not repaid, clearly, Madison Capital assumed the mortgage.

Madison Capital is now targeted on remodeling this workplace property into an industrial property. I feel this technique appears extraordinarily dangerous. Multistory industrial properties are a really uncommon idea within the US. I imagine it’ll even be an awfully complicated course of to work round or purchase out the prevailing workplace tenants. Moreover, in my view, it’s seemingly a lot of the $35 million that was spent on renovations to draw workplace tenants might be of little use to industrial tenants.

For my part BXMT will settle for many of the Falchi Constructing industrial conversion threat. Madison Capital is barely required to contribute $2 million in reserves to the undertaking. BXMT has agreed to supply one other $50 million, to permit curiosity to be paid-in-kind (PIK) versus being paid in money, and to increase the maturity date from December 2023 to June 2028 (BXMT 10Q 3Q23 p. 26) BXMT typically cites sponsor new fairness commitments as proof that its sponsors are dedicated to their initiatives. Nonetheless, primarily based on my math it appears seemingly the sponsors will greater than get better their fairness by means of asset administration and growth charges. For a undertaking just like the Falchi Constructing, the asset administration price might simply be 1% of the worth of the undertaking yearly, and the event charges may very well be 5% of no matter is spent. This implies Madison might obtain $2 million yearly in asset administration charges and one other $2.5 million in growth charges, assuming the $50 million BXMT is lending to the undertaking funds the transformation to an industrial property. Given the brand new rate of interest on the mortgage is SOFR plus 10.5% (10Q 3Q23 p. 70), I imagine it’s unlikely that Madison thinks it’ll see a return on its fairness. I feel they’re seemingly concerned within the undertaking merely for the price revenue and doubtlessly to be taught extra about multistory industrial initiatives on BXMT’s dime. Lastly, buyers must keep in mind that BXMT won’t be able to acknowledge any revenue on this incremental $50 million because the mortgage is already impaired. I imagine within the short-term, nevertheless, offering the $50 million will enhance BXMT’s reported outcomes and core earnings by stopping a charge-off. I think within the long-term, it might result in a bigger cost of as BXMT will enhance the dimensions of its mortgage to the undertaking.

One South Wacker

BXMT offered a mortgage to 601W Corporations to buy One South Wacker in 2018. The mortgage coated 70% of the $310 million acquisition worth and offered a further $93 million to fund enhancements and the lease-up of recognized vacancies within the property. On account of the pandemic, the lease-up of the property has been a lot slower than anticipated. The property had a Trailing Twelve-Month Debt Service Protection Ratio of 0.80x as of March 2023. Primarily based on the unique mortgage paperwork, the absolutely prolonged maturity date was in December 2023. Regardless of not too long ago signing a lease that may carry occupancy within the constructing as much as 80%, I think the property was not in a state the place it might have been bought or refinanced; as such, BXMT prolonged the maturity to 2026 and agreed to lend one other $46 million to the undertaking. Whereas the sponsor. on this case, did conform to contribute $21 million, as mentioned above, I feel it’s seemingly that on a undertaking of this dimension, they may recoup this fairness by means of charges. BXMT is now dedicated to lending as much as $356 million towards an workplace property that bought in 2018 for $310 million. Given that the majority market contributors suppose the value for workplace properties has fallen, not risen, over the past 5 years, in my view, it appears seemingly that BXMT might be required to impair this mortgage. If this happens, BXMT must cease recognizing one other $9 million yearly in revenue primarily based on the all-in-yield and mortgage stability within the 3Q23 Mortgage Portfolio Particulars from the 10Q.

One other $84 million mortgage is described on web page 26 of BXMT’s 10Q for 3Q23, the place BXMT agreed to an extension in return for the sponsors contributing $2 million. Administration, throughout their convention calls and of their Truth Sheet indicated there are quite a few situations of sponsors contributing capital to initiatives in change for extensions. I feel if the small print of those extensions have been disclosed, it will be obvious in lots of of those instances the charges for the sponsors will seemingly exceed their fairness contribution. I feel the sponsors’ contribution must be seen as a rational enterprise determination to keep up or enhance price revenue, not a vote of confidence in a undertaking. (I think the charges are sometimes paid with the undrawn cash on the BXMT mortgage.) As with the Falchi Constructing, on a number of of those loans with extensions, I imagine the rate of interest is simply too excessive for an fairness investor to count on a return on their funding.

Potential 4Q23 Impairments

When BXMT reviews its 4Q23 outcomes, they are going to be audited by Deloitte & Touche, as an alternative of merely reviewed. Whereas the auditors will little question have some deference for administration’s actual property expertise, as mentioned above, I imagine they may need to cowl themselves in the case of the CECL calculation. On condition that they didn’t push again on administration’s assumption sufficient final 12 months, I think they may seemingly take a extra conservative method this 12 months. Moreover, in contrast to final 12 months, extra workplace transactions have closed and supply steering on new pricing within the workplace market. I imagine this might result in a notable enhance in impaired properties with 4Q outcomes. Under are a few initiatives that I really feel are seemingly liable to impairment when auditors start digging into assumptions on valuations.

Woolworth Constructing, New York Metropolis, $336 million mortgage, Maturity – 5/1/2025

The collateral for this mortgage is an workplace property constructed in 1913. Lots of the tenants which might be within the property have been there for greater than 20 years. When their leases expire, I feel they may seemingly search for extra fashionable house. The mortgage has already had its maturity date prolonged a number of occasions. BXMT agreed to decrease the rate of interest on the mortgage by 0.6% with its most up-to-date extension. (BXMT Mortgage Portfolio Particulars 3Q23 10Q and 2022 10k) I feel the auditors will seemingly see this together with the general NYC workplace market, and conclude this mortgage must be impaired.

Workplace Property, San Francisco, $229 million mortgage, Maturity – 11/9/2025

This mortgage was originated in September of 2021. As of 12/31/2022, it was nonetheless rated a 3, not even watch-listed. In 2Q23, the maturity on the mortgage was prolonged from 4/9/2023 by nineteen months, and the rate of interest was dropped by 2.74%; BXMT fastened the speed and allowed a portion of the curiosity to be paid in sort (PIK) (BXMT 10Q 3Q23 ) Whereas the mortgage is at the moment watch-listed, an impairment is probably going, in my view, as extra workplace property gross sales happen in San Francisco. In keeping with CBRE, the San Francisco workplace market has a emptiness fee of over 35% versus 5% earlier than the pandemic. For the final a number of years, this has frozen the transaction market, so it has been troublesome to discern the brand new market clearing worth of buildings. Because the Actual Deal reviews, a small variety of San Francisco workplace buildings have traded in current months, and it seems costs have dropped about 75%.

Park Central Resort (Hyatt Regency SOMA), San Francisco, $261 million mortgage, Maturity – 12/9/2024

In 2018, Highgate Motels bought the Park Central San Francisco for $315 million. On the time, Income Per Obtainable Room (RevPAR) in San Francisco was rising at 13.3% yearly., in line with Smith Journey Analysis (STR). As proven beneath, San Francisco is the one main metropolis within the nation the place RevPAR is considerably beneath 2019 ranges, in line with STR.

Because of the difficult working surroundings, a number of main San Francisco resorts have defaulted on their mortgages and returned the keys to the lenders. Given the timing of Highgate’s funding and the lodge’s location in SOMA, which has seen a big uptick in crime and homelessness for the reason that pandemic, I feel it’s unlikely they may have the ability to promote the property or refinance the mortgage.

On January 4^th, the Actual Deal reported that Highgate did not make its balloon fee. On condition that BXMT’s Mortgage Portfolio Element within the 3Q23 10Q exhibits a last maturity date of 12/9/24, I think Highgate was not keen to incur the expense of an extension, which seemingly required paying an extension price and placing a brand new rate of interest cap in place. I don’t suppose that is shocking, provided that, in line with an area dealer, the estimated worth of the property is now $54 million. I imagine the dearth of fee will drive BXMT to impair the asset with 4Q23 outcomes, which can result in a $50+ million impairment, assuming an impairment of 20%+ of the mortgage stability. The impairment can even trigger BXMT to cease recognizing one other $8.0 million in revenue yearly going ahead, primarily based on the dimensions of the mortgage and the all-in yield. (Mortgage Portfolio Element 3Q23 10Q.) Moreover, if the dealer’s valuation is correct, within the subsequent couple of quarters, I imagine BXMT may very well be charging-off over $200 million, earlier than accounting for bills. This equates to $1.16 per share or 50% of consensus EPS for 2024.

Challenge Quasar, Diversified Spain, $600 million mortgage, Maturity – March 15, 2026

In March 2018, Blackstone purchased a 51% curiosity in €10 billion of poisonous belongings from Santander, a Spanish Lender. (Santander inherited these belongings as a part of its acquisition of Banco Fashionable, which was inspired by regulators within the aftermath of the monetary disaster.) The construction allowed Santander to deconsolidate the belongings with out exhibiting a achieve or loss. Blackstone and Santander used €7.3 of debt to finance the three way partnership. BXMT offered €1 billion of this debt. The unique maturity date was March 15^th, 2023. It has been prolonged by three years to 2026. Through the years, it seems as if Blackstone and Santander have tried to promote belongings from the enterprise. In 2020, they even provided to reimburse patrons as much as 10% for any losses they incurred on belongings they bought. That very same 12 months, Santander diminished the worth of its stake within the JV by 40%. Extra not too long ago, in June of 2023, the JV was contemplating promoting a portfolio of $2.2 billion of lodge loans. In August of 2023, Santander wrote down the worth of their fairness funding in undertaking Quasar by a further 62%, and it now stands at €155 million, or $170.5 million. This implies they worth the fairness within the undertaking, together with Blackstone’s stake, at €316 million. Whereas asset gross sales have repaid a few of the authentic debt, BXMT nonetheless has €567 million excellent. As proven beneath, the implied leverage for the enterprise is now at 93%.

It’s arduous for me to think about an auditor agreeing that there’s not a excessive threat of default for a portfolio with leverage of 93%. A small change within the assumptions on the worth of the belongings might result in a big impairment on the debt. In my expertise, typically occasions with a lot of these portfolios the place there’s a mixture of belongings and a plan to promote them over time with the intent of ultimately paying off the debt, the belongings which might be simple to promote above appraised worth are bought first. The asset supervisor initially seems good as a result of they’re exceeding expectations. Over time, the portfolio is left with hard-to-sell belongings that may commerce for costs properly beneath their appraised worth. I feel it’s seemingly that Challenge Quasar, after 5 years and numerous asset gross sales, is left with difficult-to-sell properties with unreasonably excessive value determinations. I imagine that is in all probability why this mortgage was watch-listed by BXMT. Given the age of most of BXMT’s “distinctive loans,” it’s possible that just about all the $46 million in reserves for distinctive loans (BXMT 3Q23 10Q, p.23) ones the place the WARM mannequin isn’t applicable, are devoted to this mortgage. Nonetheless, if this mortgage went from watch-listed to impaired, I feel the impression on BXMT’s financials could be important. BXMT would not have the ability to acknowledge the $20 million of revenue it data from this mortgage yearly. (Primarily based on yield from 3Q23 10Q Mortgage Portfolio Particulars)

Different properties may very well be Impaired

Along with the properties listed above, I feel a plethora of workplace and lodge properties look susceptible to impairments within the close to time period, together with a number of workplace properties in New York, Washington DC and the Bay Space and one other lodge in San Francisco. Moreover, there’s a $700 million mixed-used undertaking during which is beneath development in Austin the place there isn’t a preleasing on the workplace portion of the undertaking.

At the moment, Impaired Tasks May See Their CECL Improve and Be Hit With Cost-Offs

I imagine a number of BXMT loans which might be already impaired may even see their reserves enhance with the year-end audit. Whereas this is not going to impression BXMT’s revenue or EBITDA, because it already doesn’t acknowledge revenue on these loans, it’ll additional erode BXMT’s guide worth, which BXMT and its analysts typically cite to assist its valuation.

Moreover, for a few of these belongings, I count on its auditor, Deloitte & Touche, to find out that it’s practically sure that the quantities due is not going to be collected, main BXMT to lastly cost off a portion of the principal. These charge-offs will circulate by means of its Distributable Earnings Calculation, which BXMT makes use of to justify its present dividend degree.

Park Central Resort, New York Metropolis, $286 million, Maturity – 8/9/2025

In November of 2018, BXMT loaned Highgate $250 million for the acquisition of the Park Central Resort in New York Metropolis. The mortgage allowed Highgate to borrow as much as $291 million and carried a fee of LIBOR plus 2.83%. (2018 10-Okay) The mortgage, together with extensions, matured in December of 2023. In 2Q20, as a result of impression of COVID-19, BXMT took a reserve towards this mortgage for $54.9 million (impairment quantity by particular person loans was disclosed in BXMT’s 2020 10K) and began accounting for it utilizing the cost-recovery technique. Which means revenue accrual on this mortgage was suspended, and no revenue is recorded. Any funds that BXMT receives from this mortgage are handled as a discount to principal. As of 12/31/22, the rate of interest on this mortgage had been diminished to 2.35%, however the stability on the mortgage had not come down. The implication is that the lodge has not been in a position to make any curiosity or principal funds. In its 3Q22 10Q, BXMT disclosed its reserve on the mortgage was nonetheless $54.9 million. BXMT additionally disclosed a couple of particulars on the way it calculated the reserve. I feel the important thing assumption appears completely unrealistic at the moment or in 3Q22. BXMT assumed an exit capitalization fee of 4.5%. This implies a purchaser would count on a 4.5% yield on the lodge’s internet working revenue. I suppose this assumption could have been practical when the mortgage was impaired in 2Q20, and the 10-year treasury was yielding 0.67%. At the moment, with the 10-year yielding 4.05%, I imagine this assumption appears very aggressive. Along with not making any funds on the excellent mortgage stability, the asset seems to be deteriorating primarily based on on-line opinions. Lots of the opinions on Journey Advisor complain about worn and stained carpets, previous fixtures, and damaged elevators.

It feels like it’s now normal follow on the lodge for company to attend in lengthy traces to make use of the service elevator to get to their rooms. The speed on this mortgage is now at SOFR + 7.9%, which I imagine is probably going a default fee and signifies the homeowners aren’t cooperating with BXMT. I think it’s seemingly that the sponsor sees no hope of paying off the mortgage and has determined to not contribute capital for capex. I imagine when the auditors overview this asset at year-end, it’s seemingly that they may require a bigger reserve and maybe drive a charge-off.

Workplace Property, Washington DC, $209 Million, Maturity – 5/9/2024

In April of 2021, BXMT originated an workplace mortgage in Washington, DC for $209 million. In keeping with CBRE, the DC Market has not recovered from COVID-19 as many authorities staff proceed to do business from home, and companies all through the town shrink their actual property footprint. In keeping with CBRE, the emptiness fee was 20.9% on the finish of the three^rd quarter, up over 6% from the top of 2019. In keeping with Costar, given that the majority Federal Companies are solely utilizing 25% of their house, the scenario within the DC workplace market is prone to worsen. Whereas giant workplace transactions have been nearly non-existent within the DC market for the reason that pandemic, not too long ago, there have been a few foreclosures gross sales that I imagine could set a brand new benchmark for the market. I imagine it will likely be arduous for BXMT’s auditors to disregard these transactions at year-end. 2100 M Avenue, close to Dupont Circle, was bought for 55% of the mortgage’s worth. Much more troubling, 1201 Connecticut Avenue, mainly proper at Dupont Circle, was bought at a foreclosures public sale for lower than a 3rd of its mortgage worth.

Conclusion

I feel over the past couple of years BXMT outcomes and inventory worth have been insulated from the altering panorama of business actual property. I imagine 2024 is prone to be the 12 months when it turns into inconceivable for auditors, lenders and buyers to disregard the weak spot in BXMT’s mortgage guide. The 12 months is starting with a missed balloon fee on a $260 million lodge mortgage in San Francisco. Over the course of the following couple of months, there are quite a few different workplace and lodge loans the place I think the homeowners could cease making funds or miss balloon funds. If this involves move, I imagine it’ll in all probability result in additional impairments which can scale back BXMT’s revenue because it can not acknowledge revenue on impaired loans. I feel additionally it is doable that BXMT and its auditors will start to view sure loans as uncollectable, which can result in charge-offs, which can hit earnings and dividend protection and ultimately might result in a discount within the dividend.

Danger to Shorting BXMT

It is crucial for readers to know that regardless of the issues I imagine BXMT faces on account of weak spot in its mortgage guide, the inventory may be very unstable. This implies any variety of issues might trigger the inventory worth to spike briefly. A brief vendor with out ample capital may very well be pressured to liquidate their place at a loss on this situation. It’s simple to ascertain circumstances the place there aren’t any impairments or charge-offs introduced with 4Q outcomes and the inventory strikes up sharply. Moreover, BXMT will seemingly proceed to pay its dividend within the close to future. Not solely does the dividend signify a value to a brief vendor, I imagine the dividend will put a flooring on the inventory worth for a while as there’ll all the time be buyers who’re looking for yield. In different phrases, I imagine somebody shorting BXMT must have the endurance and capital to attend till the market has a transparent and knowledgeable view of BXMT’s mortgage guide.