Specialized lenders known as mortgage real estate investment trusts occupy a prominent place on the commercial real estate industry's list of casualties.
Since rising interest rates began to weigh on real estate borrowers in early 2022, shares of two mortgage REITs — Starwood Property Trust and Blackstone Mortgage Trust — have fallen 15% and 35%, respectively.
Mortgage REITs have been the focus of Raymond James' Steven Rose, who on Wednesday published a study on how these REITs are building reserves for potential loan losses. December-quarter results for most of the 15 companies he follows show they built up reserves based on their outlook for the economy and rising interest rates.
The biggest reserve builders are the REITs with the highest percentages of office loans: Granite Point Mortgage Trust, Ares Commercial Real Estate and Blackstone Mortgage. This shouldn't come as a surprise to anyone.
Firms that specialize in apartment loans, such as ACRES Commercial Realty and Franklin BSP Realty Trust, have smaller reserves.
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Accounting rules require lenders to add reserves to address problems with specific loans, but also to add reserves based on how similar loans have performed for themselves and the industry, as well as their general view of the economy. Increasing reserves is a noncash expense and reduces earnings.
Starwood and Blackstone are two of the largest mortgage REITs. Blackstone Mortgage has come under more scrutiny than other REITs because it puts more than a third of its loans into office space. At last count, about 15% of its freely trading shares were short.
Rose's report contrasts Blackstone's reserves with those of Starwood.
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At Blackstone Mortgage, reserves have doubled since the second half of 2022, to a level equivalent to 2.25% of committed loans. At Starwood, reserves have tripled over the same period, to 1.7% of committed loans.
Most of Blackstone's increase in loss reserves was for specific bad loans. General reserves, which are based on the company's portfolio and view of the economy, have remained roughly flat.
The REIT said in its December-quarter earnings report that it had increased special reserves for three troubled loans and hopes to remove four loans from the reserves this quarter through sales or foreclosure. Blackstone said it keeps its liquidity near record levels.
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“BXMT weathered a challenging 2023 with results that highlight the resilience of our business,” CEO Katie Keenan said on a conference call Feb. 14. “We reported record interest income and distributable earnings, generating $3.05 per share for the year and covering our dividend by 123%.” The $2.48 per share dividend more than offset a $1.10 reduction in the REIT's book value due to an increase in reserves, she added.
By contrast, very little of Starwood's reserves reflect problems with specific loans. Nearly all of the company's reserves are drawn from commercial real estate lending and general caution about the economy.
That's not to say Starwood hasn't had problems with certain loans: On its most recent earnings call, the REIT discussed several properties it has acquired through foreclosures, which accounting rules don't include in reserves.
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When you combine the company's reserves with the value of its acquired properties, Starwood's reserves are actually conservatively estimated to be equal to 3% of its loan portfolio, Chief Financial Officer Lina Panilee said on the REIT's earnings call on Feb. 22.
Still, the December reserve figures show Blackstone Mortgage is tackling identifiable problem loans. Starwood's reserves point to general caution, and the company is already writing off troubled loans.
Contact Bill Alpert at william.alpert@barrons.com.