2023-04-08 08:00:00 ET
Summary
- The market often hyperventilates on things that don't matter.
- The commercial real estate story is unfortunately not exaggerated and the stresses are very real.
- Blackstone Mortgage Trust sports a 14% yield and appears to be a discounted play on the situation.
- We tell you why we are not touching it.
Blackstone Mortgage Trust Inc. ( BXMT ) is the second largest commercial mortgage REIT after Starwood Property Trust Inc. ( STWD ). The REIT has legions of fans, thanks to the Blackstone pedigree and wide diversification you can get with the name. Based on the most recent presentation an investment in BXMT got you access 13 US states, UK, Sweden, Ireland and Australia.
That is quite the diversification and you can see the relative proportions better in the chart below.
BXMT Q4-2022 Presentation
Of course, the key question on everyone's mind is how badly are they are going to take a hit on their office segment. Well, that part makes up 40% of the loans and the 18% in hospitality should not be completely ignored either, going into a possible recession.
BXMT Q4-2022 Presentation
So let's take a look at this as a whole and see if we can make a long case for this.
The Setup
BXMT has a fairly large portfolio with total assets close to $27 billion. The terms are solid with the 64% loan to value providing solid first line buffer.
Recent collections have been strong, despite most loans being of a floating nature. This has translated into solid distributable income for Blackstone with a 116% full year distribution coverage.
In fact, Blackstone has grown its distributable income quite sharply over the last 2 years and this is attributable to the rise in the SOFR.
The origination and repayment metrics are also fascinating. New originations have been done with a far larger spread to SOFR than the whole portfolio. Note that this is shown as a "spread" (plus 549 basis points vs 376 basis points).
The fascinating aspect is that BXMT is doing far more loans for industrial assets and getting such a huge spread relative to its old portfolio which was weighted towards office. This appears to be positive for future returns (higher yield from safer assets). It also reflects the deep distress in the current market for commercial real estate loans in general. One more interesting aspect of the slide above is that repayments continue to be high in the office segment. So the weightings of originations to repayments are firmly pushing the riskiest segment, office, down over time. This has to be conscious decision by management and the impact of this can be seen by examining where office stood at the end of Q4-2020.
BXMT Q4-2020 Presentation
The Risks & Rewards
Whenever examining any mortgage REIT, the first thing you need to pay attention to is the leverage. There is a reason that mortgage REITs have collectively produced to 2.47% annual total returns including distributions over the past 20 years. That reason is they frequently blow up as leverage amplifies the downside. In the case of BXMT there is pretty high levels of leverage with total equity to assets is 5.57X.
Since this is a mortgage REIT (not an equity REIT), we can take this leverage at face value. Here, GAAP accounting fairly represents the value of assets. The 5.57X is high and here is Ares Commercial Real Estate ( ACRE ) sporting a 3.37X on the same metric.
Yes, BXMT is the bigger name and has possibly better access to capital, but those two extra turns of leverage should get your gooses bumped and spines tingled. Additionally, while the CECL reserve looks good, it is less than 1.5% of total loans.
BXMT Q4-2022 Presentation
Moving on to the valuation, we see that the stock has discounted some grizzly outcomes already. It is trading at 33% discount to value of equity.
That discount has pushed up the yield to over 14%. One interesting aspect is that the yield this time has decoupled a bit from the US high yield CCC spread. This tells us that the distress being experienced here is pretty unique and not related to a generalized recession scare. We can see this distress in the CMBS market as well.
ICE Data
Note how BXMT topped and its yield bottomed right around fourth quarter of 2022, alongside the spreads shown above. There are some significant stresses here that will get worse with a recession. Nonetheless at least at this point you are getting a good yield and a big discount to tangible book to wade into these troubled waters.
Verdict
BXMT has close to $20 billion of liabilities and paid just $711 million in interest last year ( 10-K Link ).
BXMT Q4-2022 10-K
One reason for that extremely low rate is because there is a lot of floating debt which was just beginning to reset in 2022. Interest expense in 2023 will be far higher. This by itself is not an issue as BXMT's assets also produce higher yields in response to higher rates. The real problem is that all of BXMT's debt was placed during far happier times. Currently BXMT's notes have yields in double digits.
These are not 30 year bonds either. They mature in less than 4 years. If you replace those yields to maturity on BXMT's current debt structure, you won't have money left to pay the electricity bill, forget about dividends. The March 2027 maturity has a 1.4% higher yield than those maturing just 2 months earlier. These are convertible notes with a conversion price of $36.27, something we are sure no one is thinking about today.
The January 2027 senior secured notes reflect as SEC 144A but we were able to place orders on Interactive Brokers ( IBKR ) at below market (as a test) for these.
The January 2027 bonds are pretty solid despite the very high levels of leverage. The reason is that these are rather well protected from several buffers. The main buffer is that the loan to value protects against downside in most loans that go bad. The first 35% of downside is the problem of the person taking the loan. The second buffer comes from the fact that most of the debt is secured debt. The offset here is that most assets are also pledged as collateral and unencumbered assets remain low. There is a minimal threshold that is required to be maintained, but this amount could protect against a severe downside in the notes.
The covenants under our Senior Secured Notes require us to maintain a total debt to total assets ratio, as defined in the agreements, of not greater than 83.33% and, in certain circumstances, a total unencumbered assets to total unsecured indebtedness ratio, as defined in the agreements, of 1.20 or greater. As of December 31, 2022 and December 31, 2021, we were in compliance with these covenants.
Source: BXMT 10-K
Overall, we think the notes pay well for the risks and this is a security we are interested in at the right price. We will give a pass to the equity at this point in the cycle and focus on capital preservation.
For further details see:
Blackstone Mortgage: 14% Yield, But Why Mess With The Equity