Blackstone Mortgage Trust: Red Flags For This 14% Yielder (Rating Downgrade) (NYSE:BXMT)

The stock of Blackstone Mortgage Trust, Inc. (NYSE:BXMT) did not react well to the mortgage trust’s first quarter earnings in which the company showed that it swung to a net loss amid loan problems in the office category: BXMT declined 4.6% on Thursday and may see additional selling pressure in the short term.

An increase in the current expected credit loss reserve affected the company’s distributable earnings by $0.32 per share in 1Q24, which caused a dip of the dividend coverage ratio below 100%.

However, on an adjusted basis, Blackstone Mortgage Trust’s covered its dividend at a ratio of 105%, but the risk to the dividend has definitely increased.

I think passive income investors need to tread more carefully here amid growing loan losses, and I am modifying my stock classification accordingly.

My Rating History

In March 2024, before the company’s first quarter earnings, I rated Blackstone Mortgage Trust as a Buy because of a big discount to book value which I felt was exaggerated despite some loan issues creeping up in the trust’s loan portfolio in the fourth quarter. Obviously, the increase in loan reserves has been bigger than I anticipated, suggesting that I overestimated the overall quality of Blackstone Mortgage Trust’s loans.

Because of the increase in reserves, I am modifying my classification for Blackstone Mortgage Trust stock from Buy to Hold.

Portfolio Review And Higher Expected Credit Losses

Blackstone Mortgage Trust is a leading REIT that originates mortgage loans and keeps the loans on its balance sheet. The trust collects recurring interest income from these loans and uses it to pay shareholders a regular, quarterly dividend.

At the end of the first quarter, Blackstone Mortgage Trust owned a $21.1B portfolio, including 173 senior loans that was collateralized by different forms of real estate. Blackstone Mortgage Trust’s portfolio consisted mainly of loans in the office and multi-family sectors. Offices, which have struggled to keep tenants amid a rise in hybrid work arrangements, which in turn has pressured rents, accounted for 36% of the trust’s real estate exposure as of March 31, 2024.

Due to some borrowers experiencing payment issues, leading to a higher number of impaired loans, Blackstone Mortgage Trust was forced to increase the value of its current expected credit reserve (‘CECL’), a reserve account that lowers earnings, by $234.9 million in 1Q24 which brought the total CECL reserve to $766 million as of March 31, 2023.

The jump in the CECL reserve reflected a net increase of $174 million QoQ. Further charge-offs are, given the large size of the office portfolio, a distinct possibility in 2024.

The increase in the CECL reserve primarily related to seven new impaired loans, and the trust had a total $602.6 million in asset-specific CECL reserves (representing 17 loans) as of the end of 1Q24.

Management is taking a prudent approach here and increasing its credit loss reserve, but it is likely that we are going to see incremental additions to this reserve account moving forward, particularly because U.S. offices are over-represented in Blackstone Mortgage Trust’s portfolio.

Loan Troubles Starting To Affect Dividend Coverage

Because of the loan problems emanating from the office portfolio, Blackstone Mortgage Trust suffered a $0.32 per share non-recurring drop in its first quarter distributable earnings. The trust earned $0.33 per share after charge-offs and $0.65 per share, which means, unfortunately, that on an unadjusted distributable earnings basis, Blackstone Mortgage Trust earned only 53% of its dividend pay-out in the first quarter.

On an adjusted basis, Blackstone Mortgage Trust covered 105% of its present dividend pay-out ($0.62 per share) with distributable earnings. On a full-year basis, Blackstone Mortgage Trust earned 117% of its dividend which means that even though the trust’s dividend coverage deteriorated in the first quarter again, the dividend has still been fairly well covered, at least so far.

Discount To BV May Be Deserved

The market is obviously concerned about the underlying credit quality of Blackstone Mortgage Trust’s office loan portfolio, which is reflected in the discount to book value that BXMT is selling at.

Presently, the mortgage trust is selling for a 25% discount to book value, suggesting that the market is increasingly concerned about the sustainability of the trust’s dividend as well.

Taking into account the rise in the credit reserve as well as the lower dividend coverage ratio, I’d apply a 15% discount (previously 5-10%) to Blackstone Mortgage Trust’s ex-CECL reserve book value of $23.83 which implies an intrinsic value of $20.25 per share.

I think a 15% discount (my personal assumption) applied to book value improves my margin of safety in a market that is seeing substantial weakness in one of BXMT’s major investment categories, U.S. offices. I raise my applied discount here because of the trust’s negative CECL reserve trend and in order to account for the possibility of deteriorating dividend coverage moving forward.

Ladder Capital (LADR) is selling for an 8% discount to book value, primarily because the mortgage trust has only 16% of its assets exposed to the office market. Blackstone Mortgage Trust’s large exposure to the struggling office market is now starting to hurt the trust as well as the stock outlook.

Starwood Property Trust, Inc. (STWD) has an even higher book value multiple of 0.98x, primarily because the portfolio has been performing well, STWD is more broadly positioned by owning real estate and a servicing business and the company only had 10% of its portfolio invested in the U.S. office sector (as of March 2024).

What Passive Income Investors Need To Consider

Blackstone Mortgage Trust has incremental charge-off risk with other office loans in the portfolio if borrowers continue to get into trouble, or if the trust decides to sell loans at a loss in order to get them off its balance sheet.

The trust had $7.5 billion in net loan exposure in the first quarter, in the U.S. office category alone, and the reserve trend is pointing upwards. Thus, investors must anticipate that new impaired loans will appear moving forward.

The inflation trajectory here is also key because rising consumer prices will tempt the central bank to take the foot off the gas pedal when it comes to short-term interest rate cuts. I anticipate the central bank to lower short-term rates in the latter half of the year, which should take some financial stress off borrowers that are on the hook for floating-rate loans in the office market. Lower short-term rates are thus generally favorable for the U.S. office sector.

Furthermore, an increase in loan charge-offs could push Blackstone Mortgage Trust’s dividend coverage ratio below 100% and then the dividend might get cut.

My Conclusion

Blackstone Mortgage Trust swung to a big net loss in the first quarter thanks to underwhelming loan performance in the office segment, which caused the company to report a substantial increase in its CECL reserve.

As a consequence, Blackstone Mortgage Trust reported only $0.33 per share in distributable earnings for the first quarter, which was not sufficient to back the dividend. On an adjusted level, the dividend was covered by distributable earnings, however, but the safety margin for the dividend has further eroded in 1Q24.

If the charge-off issue gets worse moving forward, which passive income investors unfortunately must anticipate, the dividend could indeed be on the chopping block in 2024.