Blackstone Mortgage Trust And The Blueprint

| About: Blackstone Mortgage (BXMT)
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Summary

BXMT is the blueprint for how to build a commercial mortgage REIT.

The company trades at the highest valuation in the sector, so it would be unwise to assign any bullish ratings.

The dividend looks solid. I see cuts as very unlikely. BXMT is likely to either sustain the dividend or give it a slight boost after rates moved higher.

There are two areas where I would like to see BXMT make modifications. Both are issues with how they report the numbers rather than changing the business.

My interest in BXMT is driven by my interest and position in RSO.

Blackstone Mortgage Trust (NYSE:BXMT) is a larger commercial mortgage REIT. That doesn't mean large compared to most corporations, but a market capitalization between $2.5 and $3 billion is pretty big for mortgage REITs. The REIT has done something remarkable during 2016, they have traded at a premium to book value. While most mortgage REITs are trading at discounts, the commercial mortgage REIT subsector has received far higher valuations (using price to book). Even within this niche, BXMT has performed very well. The company offers a much lower dividend yield than the residential mortgage REITs, but it offers investors a pool of assets that create higher income streams when rates move higher. The way BXMT structures their portfolio results in an increase in net interest income if rates go up. That makes them a very interesting mortgage REIT because it means they can be a hedge of sorts against holding other mortgage REITs.

Valuations

The first thing that has to come up when analyzing BXMT is their valuation. As an analyst focusing on REITs and with most of that coverage going to mortgage REITs, I have to point out that BXMT has a rich valuation. Despite finding the business intriguing, I haven't been able to recommend the stock because it has consistently been too expensive. At the same time, I don't want to use short ratings on a stock unless I can identify a clear flaw in their business that should create a material downside in the near future. The price on BXMT is high, but there are no glaring flaws so there is no case for a bearish rating.

As an analyst, this can be a dreadful situation because it means a stream of neutral ratings. Some analysts will mark it as a buy or sell, but I don't see sufficient evidence that the price movements on BXMT can be predicted reliably. That is saying a great deal, since I regularly predict price movements (or relative movements using multiple stocks) with an incredible record of success.

The following chart, borrowed from my " Quick and Dirty mREIT Discounts" series shows the price to trailing book value (from Q3 2016) ratios across the sector:

BXMT was trading at a premium to trailing book value of about 14% while the broader industry was running about a 10% discount.

Dividend

This is one area where I can weigh in with conviction. I think a cut in the dividend is very unlikely. The odds of the current dividend being maintained (or increased) is at least 85% in my estimate. The increase in rates lately should bode well for their net interest income in the near future, so an increase in the amount of a couple cents per share is not unreasonable. The company trades above book value by a material amount, so if they find more opportunities to make profitable loans, they have access to additional financing through issuing common stock. Since it would be issued at a significant premium to book value, it would automatically increase book value per share. That means each share would represent a larger amount of net assets. The increase would be small since BXMT is far too large to suddenly double their share count without a huge deal in place, but it would still be accretive.

A Couple Things I Would Like to Change

There isn't much to dislike about BXMT, but I do dislike two things. One is their calculation of Core EPS. They add stock-based compensation expense back, but there is no economic reason for doing so from the perspective of the common shareholder. For a bond holder, that presentation would make sense since the bond holder would want to know more about the cash flow. For the stock investor, it is still a cost regardless of how it is paid.

The other area that I would love to see in both presentations and quarterly filings is more discussion of their provisions for loan losses. In their 10-Q the words "Provision for Loan Loss" come up precisely twice. Both times are on page 8:

" Loans Receivable and Provision for Loan Losses

We originate and purchase commercial real estate debt and related instruments generally to be held as long-term investments at amortized cost. We are required to periodically evaluate each of these loans for possible impairment. Impairment is indicated when it is deemed probable that we will not be able to collect all amounts due to us pursuant to the contractual terms of the loan. If a loan is determined to be impaired, we write down the loan through a charge to the provision for loan losses. Impairment of these loans, which are collateral dependent, is measured by comparing the estimated fair value of the underlying collateral, less costs to sell, to the book value of the respective loan. These valuations require significant judgments, which include assumptions regarding capitalization rates, leasing, creditworthiness of major tenants, occupancy rates, availability of financing, exit plan, loan sponsorship, actions of other lenders, and other factors deemed necessary by our Manager. Actual losses, if any, could ultimately differ from these estimates."

While that may sound a little "lawyer-ish", it is a standard description and it is a reasonable accounting strategy. The downside is that I would love to see an entry labeled "provision for loan loss" on the statements. How big is the account on the balance sheet? How much accrues each quarter? Is the provision taken before we reach the "gross interest income" line? I have not asked management, because they could not legally answer. The answer would be material non-public information. I would love to see them begin reporting it in their quarterly statements and presentations. Then it would be material public information.

Please Don't Mistake This for Being Bearish

I'm talking about two areas where I believe BXMT could improve. There are few companies that don't have at least two areas where they could improve. Many have far more than two areas. Further, with the exception of the provisions for loan losses, BXMT offers accounting values that are both detailed (in the 10-Q) and clear. In my next piece on BXMT, I'll go over the things I do like. There are some really great factors about BXMT I would love to address. In my view, BXMT is providing a blueprint for how a commercial mortgage REIT should operate. It isn't perfect, but it is still a very good blueprint.

Why I'm Suddenly Interested in BXMT

I'm not taking an interest in BXMT because the investment prospects of their own stock. I'm interested because I'm heavily invested in Resource Capital Corporation (NYSE:RSO). I started buying shares of RSO after their stock collapsed following the earnings release and I would like to see their business redesigned to function as a smaller version of BXMT. While BXMT trades at a material premium to trailing book value (somewhere around 14%), RSO trades at a discount of around 42%. If BXMT is the blueprint and RSO is able to make that transition , then I would expect RSO to soar. To determine if that is a reasonable possibility, it helps to analyze the blueprint.

My view on RSO is very heavily bullish. The huge discounts combined with the potential to restructure their business to more closely resemble BXMT gives the play great upside. No rating applied to BXMT, but I'll reiterate the buy rating on RSO.

Want to know when REITs go on sale? Consider joining The Mortgage REIT Forum. For the cost of one lunch per month, you can get access to the research I'm using for managing my own investments. On average, I publish about 3 subscription articles per week. One is for calculating new estimated book value for several mortgage REITs and finding the current discounts to those estimates. Another covers the preferred shares for each mortgage REIT that has preferred shares. The third is used to either preview articles I'm working on for the public or to provide real-time updates on liquidity failures where prices for a small number of securities detached from other similar stocks. The most notable recent alert was when Resource Capital Corporation went on sale.

Disclosure: I am/we are long RSO, RSO-B.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. Tipranks: Assign buy rating to RSO. No rating to BXMT.