12% Yield! Blackstone Mortgage Trust Is Cheap For A Reason (NYSE:BXMT)

Introduction

It’s time to discuss one of the best mortgage real estate investment trusts, or mREITs on the market. That company is Blackstone Mortgage Trust, Inc. (NYSE:BXMT), a company with terrific total returns that has been a cornerstone of countless income-focused portfolios.

Over the past ten years, BXMT shares have returned 100%, including reinvested dividends. This beats the VanEck Mortgage REIT Income ETF (MORT) by a huge margin. Excluding dividends, the return was negative 16%, which isn’t bad in an industry where the average stock has lost close to half of its value.

Needless to say, I would only buy any mortgage stock if I were highly dependent on income. Investors looking for more consistent growth should avoid this 12%-yielding mortgage REIT – or pretty much any stock with a yield that high.

Anyway, the reason I’m writing this article isn’t to state the obvious.

I’m writing this article for two reasons.

• I want to know what this multi-billion dollar mortgage REIT can tell us about the economy, especially in light of a severe deterioration in growth and rate-related headwinds on demand.
• I will assess the attractiveness of this ultra-high-yield REIT and explain how I would deal with the company behind the BXMT ticker.

So, let’s get to it!

The High-Yielding Mortgage Giant

BXMT has paid a quarterly dividend of $0.62 per share. This translates to a current annualized yield of 11.6%.

This dividend is backed by a huge mortgage portfolio, which brings me to the essential question for new investors: What’s BXMT?

BXMT is a real estate finance firm that specializes in originating senior loans secured by commercial real estate across North America, Europe, and Australia.

Its biggest market is the U.S. Sunbelt, the Northeast, and the West, with major overseas exposure in the U.K.

Its largest collateral is U.S. office real estate, multifamily real estate, hospitality assets, and non-U.S. office assets. I’m not at all a fan of this, as office real estate might be the worst place to be right now, but more on that later.

BXMT is externally managed by BXMT Advisors LLC, which is a subsidiary of the mighty asset manager Blackstone (BX), the world’s largest alternative asset manager.

The management team benefits from Blackstone’s extensive global real estate group, consisting of 787 professionals. This takes away some of the risks when it comes to having office collateral. I’m not saying BX is immune, but given its expertise, the risk of BX getting involved in poor risk/reward deals is somewhat subdued. Again, macroeconomic factors are still important, just less severe when backed by a team of Blackstone professionals.

Thanks to its expertise and capabilities, the company utilizes various financing options to maintain liquidity and execute its business plan, including secured debt, securitizations, asset-specific financings, and corporate term loans.

Macroeconomic Headwinds

Yes, BXMT has one of the best management teams on the market. No, this does not mean it’s immune to macroeconomic headwinds. Even the best cook cannot prepare a good meal if his ingredients go bad, which is the best comparison I can come up with right now.

The economy is not in a great spot. We’re dealing with vicious headwinds from rising rates and slower economic growth. The cherry on top is sticky inflation, keeping the Fed from coming to the rescue. What a mess.

As a result, bankruptcies in the U.S. are outpacing prior years by a margin so big that it makes me a bit uncomfortable.

The same goes for delinquency rates on auto loans, credit cards, and even mortgages. While mortgage delinquency rates are still at pre-pandemic levels, the trend is going in the wrong direction.

This is hurting mortgage bonds as well.

As reported by Bloomberg at the end of last month (emphasis added):

Credit ratings were cut on the highest number of commercial mortgage-backed securities in “recent memory” last week, according to strategists at Bank of America Corp.

The tally of downgrades last week hit 121 tranches from 40 deals, according to the bank. Many were tied to Fitch Ratings’ ongoing review of the CMBS bond market as the ratings company downgraded or warned of underperforming offices, retail locations and hospitality properties or portfolios. So far in September, BofA has spotted 188 bond downgrades and just 15 upgrades.

This has also hurt the stock price of BXMT, which is currently 22% below its 5-year-high. This includes dividends.

The question at this point is how much BXMT is suffering. If the company is doing just fine, buying a 12% yield may be very attractive for income-focused investors.

How’s BMXT Doing?

When it comes to dividend safety, that has been taken care of.

In the second quarter, the company achieved distributable earnings per share of $0.79, marking an 18% year-over-year increase and covering its dividend by 127%.

This achievement was accompanied by a reduction in leverage and a growth in liquidity to a record $1.8 billion. Furthermore, the book value remained stable as retained earnings offset the reserve build.

Despite challenges in the office sector, BXMT benefited from positive trends in the broader capital markets. They collected $1.5 billion in repayments, indicating the refinanceability of their loans and the liquidity of their collateral assets.

This included over $350 million of office loans.

They also capitalized on opportunities by selling two loans at essentially par value.

While the office sector remains challenging, the company’s diverse portfolio, which includes nearly 200 loans, helped mitigate risks. They successfully upgraded eight loans, including two from a rating of 4 to 3, thanks to cash flow recovery and significant sponsor paydowns. The average weighted risk rating remained at 2.9x, despite an increase in rating 5 loans since early 2022.

In terms of credit, BXMT increased its CECL (Current Expected Credit Losses) reserve by $28 million during the quarter, though this did not impact distributable earnings.

The company’s CECL reserve now includes a new asset-specific reserve on a 5-rated loan, bringing the total specific reserves to $214 million, which represents approximately 20% of the related loan balance and suggests a 50% decline in underlying real estate value from origination.

Moreover, the general reserve increased by $11 million to $166 million, double the reserve level from the same period in the previous year.

Overall, BXMT maintains a strong credit position, with 96% of its portfolio performing, which is down from 99% when 1M SOFR rates were less than 1% (it’s north of 5% now).

While the direction of credit quality is a reason to worry, BXMT is not yet in a bad spot.

With regard to dividend coverage, BXMT remains in a very good spot when it comes to its own financial health.

Over the past year, the company retained nearly $120 million of distributable earnings, bolstering liquidity and reducing leverage while adapting to changing market conditions.

They maintain a low-cost liability structure with no corporate debt maturities until 2026, which is buying the company a lot of time.

Hence, BXMT believes it is well-positioned to manage a wide range of economic outcomes, with the optionality to capitalize on unique opportunities while prioritizing capital preservation and attractive dividends for investors.

Valuation

If the economy were in a better spot, I would probably be screaming Buy BXMT from the rooftops. BXMT is trading at 80% of its tangible book value. It usually trades close to 110%.

Having said that, if the economy were in better shape, BXMT wouldn’t be trading at these levels.

The market is clearly telling us it doesn’t trust mortgage companies, regardless of how well they are managed.

I agree with that.

Hence, my message is straightforward.

I like BXMT. It’s a great mortgage company. If I were looking for mortgage income, I would probably be a buyer of this REIT.

However, my belief is that the economy is in a very tough spot, and although I am a buyer of quality stocks on weakness (I have zero shorts), I cannot make the case that the time is right to buy mortgage REITs.

Again, please feel free to disagree with me, but given the trends in credit markets that I witness, I think we might get better buying opportunities down the road.

Takeaway

Blackstone Mortgage Trust offers an enticing 11.6% annualized yield and boasts a robust management team backed by the industry giant Blackstone.

However, in these turbulent economic times, even the best-prepared companies face challenges. Rising rates, slower growth, and credit market concerns have taken a toll on BXMT’s stock price, currently 22% below its 5-year-high.

The company’s dividend safety appears intact, with distributable earnings covering it by 127% in the last quarter. They have also bolstered liquidity and diversified their portfolio, mitigating some risks.

While BXMT is an attractive mortgage REIT, I believe that the current economic uncertainties warrant caution.

For those seeking mortgage income, it’s worth considering, but I can’t help but think that better buying opportunities may emerge in the future as credit market trends continue to evolve.