Blackstone Mortgage: Still Priced For Doom And Gloom

Blackstone Mortgage Trust, Inc. (NYSE:BXMT) holders have suffered at the hands of sellers since BXMT topped out in November 2021. Despite being externally managed by a subsidiary of the world's leading alternative asset manager, Blackstone (BX), its exposure to office properties has led to significant uncertainty.

Management didn't believe it was justified for the market to use a "broad-brush" approach, as seen in BXMT's hammering. At the company's April earnings conference, CEO Katie Keenan stressed that a book value per share multiple of 0.64x "implies an over 90% impairment on all foreign-vibrated office loans, effectively a full principal loss on first mortgage loans."

The valuation dislocation has since improved, as dip buyers helped to defend the steep selloff in March. Accordingly, based on price performance and total return basis, BXMT has clawed back most of its March 2023 losses attributed to the shock due to the regional banking crisis.

However, while the crisis has subsided somewhat, BXMT's valuations remain highly depressed, in line with the broad undervaluation in the real estate sector. As a result, the sector has failed to participate in the overall market recovery, which saw S&P 500 (SPX) (SPY) notched highs last seen in April 2022. In contrast, Vanguard Real Estate Index Fund ETF Shares (VNQ) remains in the doldrums, mired at levels last seen in April 2023.

There were concerns raised at Blackstone Mortgage Trust's Q1 earnings conference that management attempted to address. However, the crux remains whether its credit loss reserve is sufficient to manage the ongoing crisis in office properties.

While management highlighted its confidence that its CECL reserve was prudent, it also acknowledged the uncertainties holders must be aware of when deciding whether to add more exposure. Keenan stressed that it's "possible to see more reserves over time." She added that the "environment is dynamic, reserves have been raised significantly in recent quarters, but future changes are uncertain." As such, I believe investors must take a more prudent approach with BXMT, reflecting a significant discount against its historical valuation average to assess its risk/reward profile.

Management indicated that its lower reserve levels compared to the regional banks were predicated on a reasonable basis. The company stressed that its "more granular" approach to determining the level of reserves is more appropriate for Blackstone Mortgage Trust than the "macroeconomic statistical models" adopted by banks. Therefore, management believes it offers them more clarity over their loss modeling.

Given their scale and pedigree, I don't doubt Blackstone's expertise in commercial properties. However, in a highly uncertain environment where risks could escalate if the macroeconomic conditions worsen, Blackstone's pedigree might not be sufficient to mitigate the challenges. Furthermore, management acknowledged that "future changes are uncertain," necessitating investors to reflect "worst-case scenarios" in BXMT's valuation before dip buyers could have the confidence to return.

Hence, I believe the critical question facing investors is whether BXMT's price action and valuation reflect such a scenario analysis.

As seen above, BXMT's price action indicated the worst selloff since the waterfall decline triggered by the COVID pandemic in early 2020.

I don't expect such a rapid mean-reversion recovery from BXMT this time, given the Fed's still hawkish stance. Despite that, BXMT remains well-primed to benefit from a well-battered valuation that reached its bottom in April. At 6x its forward distributable earnings, it is below the two standard deviation zone under BXMT's 10Y valuation average. In other words, it reached highly attractive zones in April.

While BXMT's valuation has recovered somewhat, it's still only 7.5x, well below its 10Y average of 12.2x. However, as highlighted, I don't expect buyers to re-rate BXMT much further upward in the near term to reflect significant risks over commercial real estate properties, coupled with its reserves modeling.

Hence, investors looking to add more exposure need to be very patient while riding out the volatility in the near term. However, the risk/reward is appealing, and I assessed that steep pullbacks should be capitalized, given the significant undervaluation zones that were robustly defended in April and May.

Rating: Buy.

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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