Description

BXMT is a considered the preeminent real estate lending platform in the space and has historically traded at a premium to book (1.1x-1.2x book very typical for the name); currently it trades at a meaningful (but not amazing) discount of at a P/B of ~0.87x.

My thesis is similar to the write up of other investments that have worked out for me, BKEPP, MMLP bonds, NYMT preferreds. 

I find this a confusing and difficult moment in markets. An inverted yield curve can play tricks with the mind and make near dated yields look very attractive for floating rate paper, and what would normally be attractive paper looks "meh" compared to the front end of the curve. However, I believe the assumption of rate cuts in the 10 year is most likely factoring in a recession that does not seem to be priced in for a large portion of the equity universe.

I like the opportunity I see with BXMT to earn a 9% yield with optionality to drive to a double digit yield  PARTICULARLY if the fed cuts rates. I believe even in a recessionary environment; where most of the other ideas I look at would drop in value due to an economic contraction, I feel BXMT would outperform. 

Most of my ideas that tend to have better risk adjusted returns have a credit angle and this one is no different. I recommend buying the BXMT 5.5 of 27 @87.5 which is a 9% yield to worst.

There have been writeups about BXMT in the past; but to keep it simple they are a bridge lender focused on real estate plays where the property is being repositioned to prepare for long term financing off what is (hopefully) a higher level of NOI. As per the chart below it has a well diversified portfolio of over 200 loans representing over $24bb of value.  These are large loans, to credible sponsors for core real estate investments with a weighted average life of <4 years.

Looking at the above chart; I would think the “scariest” sector for most is probably office; which makes up the biggest slice @ 41% off the collateral pool. I parsed through their loans and approximately 25% of their loans or over half of their office book is from pre covid (which I will say kicked off in earnest in March 2020). I find that a scary number honestly and bigger than I would have liked. The other 16% I would think is underwritten with a remote workforce concern built into valuation; however no-one saw covid coming in 2019 so I consider those earlier loans to be concerning (albeit their risk rating scale internally holds most of them as normal risk as opposed to risk of impairment). If one assumes all of those loans on pre-covid office on average take a 25% hickey (OUCH!); That would wipe out a third of book value! That would imply an approximate 50% drop in value from their original underwritten levels.

That scariest asset class/vintage on their books would then be gone, and while it isn’t small; it is certainly what is keeping me away from being excited about the equity but wouldn’t come close to impairing the bonds.

 The chart below gives you an idea how to think about recoveries at a very high level.

The analysis prepared shows a 52% LTV from initial underwriting needed across the entire portfolio and a loss of nearly 20% on each loan on a stabilized basis before any value is lost versus a par recovery on the converts. This analysis is further ignoring several key risk mitigants for what would be a stronger recovery than the above modeled case:

1. While I did give value to the cash currently on balance sheet at a par level; there is a strong possibility of continued cash generation in the case of a default (which is not a base case) and most likely the dividend would be shut off well in advance allowing cash to build pre-petition.

2. The above analysis treats all debt as senior to the convertible bonds; this isn’t factual but is done for shorthand and conservatism; over $4 billion of the liabilities are segregated into at least 8 separate non cross collateralized, non mark to market asset/liability funded pools. In the case of an eventual liquidation some pools might provide recovery, and others may have a significant loss, this means that in reality 20% of the above liabilities would have to be run individually but the above is a worst case scenario. 

3. If at some point things start to head south; some of the financings will most likely disallow cash distributions which will further turbo down senior liabilities that sit in front of the convert, this is a risk to the equity but in my opinion not a net negative for the bonds. 

4. New loans are being done at lower a LTV. The most recent quarter's loans were done @ a 58% implied LTV (with 0% being done in office). This is a lower LTV off of what is most likely backed up cap rates. As time progresses and as certain loans repay (hopefully some from that earlier office risk bucket!); the capital will hopefully be cycled into higher yielding and safer instruments. Time in this case is your friend as newer originations should lead to higher credit quality and yes while there is a <4 year average life; repayments will most likely meaningfully slow down as transaction volume slows. Hopefully if the fed settles, and volatility in yields normalizes bid/ask spread for transactions can tighten some.

Thinking about this in a very boring way; BXMT has always been the blue chip of the sector. Almost everyone would have been excited 9-12 months ago to put a portion of their portfolio into core quality real estate picked by Blackstone at 75% of Blackstone's entry which was at ⅔ of their anticipated valuation and get paid 9%+ to do it. I bet that happens again in the next few years; bonds appreciate and you end up getting a nice double digit yield; and if not I feel the downside is well protected and you get a 9% annualized return as I don’t believe core real estate will drop 50%+ during this resetting of asset prices. 

Catalyst

1) Fed pausing on increasing rates

2) Issuance of junior capital (maybe a preferred)

3) Meaningful repayment on pre-covid office loan portfolio