Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) of Blackstone Mortgage Trust, Inc. (BXMT) at 'BB'.

The Rating Outlook has been revised to Negative from Stable. Fitch has also affirmed BXMT's secured debt and senior unsecured debt ratings at 'BB' and 'BB-', respectively.

Key Rating Drivers

The revision of the Outlook reflects BXMT's ongoing credit quality deterioration, which Fitch expects to continue given the firm's elevated exposure to office commercial real estate (CRE). The Negative Outlook also reflects earnings pressure from the rise in credit provisions and non-accrual loans and the expectation that cash earnings will likely be adversely impacted by realized credit losses during 2024 as the firm resolves problem loans. Finally, the Outlook revision considers BXMT's relatively weaker funding profile and Fitch's view that this could persist over time.

BXMT's rating could be downgraded if it experiences further credit quality weakening such that the ratio of impaired loans to gross loans remains elevated compared to that of peers, especially if meaningful credit losses are realized. Further, the rating could be downgraded if the firm is unable to address funding needs in a cost-effective manner over the rating time horizon.

BXMT's ratings remain supported by its affiliation with Blackstone Inc. (Blackstone; A+/Stable) and its affiliate manager, BXMT Advisors L.L.C., which provide the firm with investment and asset management resources, risk management tools, and bank relationships as part of one of the largest global real estate platforms. The rating also reflects BXMT's solid liquidity profile in the context of its near-term corporate debt maturities.

Rating constraints include BXMT's narrow focus on the commercial real estate (CRE) market, with concentrated exposures to office against the backdrop of challenging real estate trends; a predominantly secured funding profile and the distribution requirements associated with being a mortgage real estate investment trust (mREIT).

BXMT's ratio of impaired loans to gross loans (based on book value) was 7.9% at Dec. 31, 2023 (4Q23) up from 3.7% the year prior due to the internal downgrade of multiple loans, primarily tied to the office portfolio. Another 11.5% of loans were risk-rated '4' (on a scale of 1 to 5 with 1 having the lowest risk and 5 the highest risk) at 4Q23. These are loans that the firm believes have a potential risk of loss of principal due to challenged collateral values.

While a portion of the '4' rated loans may be resolved over the near-term, Fitch believes BXMT's elevated exposure to office properties, representing 36% of net loans at YE 2023, will remain a headwind to asset quality metrics and earnings for some time, especially with the continuation of elevated interest rates. Partially mitigating these concerns is the firm's meaningful reserve against existing impaired loans, its historical focus on higher-quality buildings in locations with solid demographics, and its asset management capabilities through the broader Blackstone platform.

BXMT's GAAP profitability declined modestly during 2023 reflecting elevated credit provisioning offset by stronger spread revenue from higher rates. BXMT's pre-tax ROA was 1.0% in 2023 compared with a four-year average (2019-2022) of 1.3%, which was within Fitch's 'bb' category earnings benchmark range of 1.0%-2.5% for balance sheet heavy finance and leasing companies with a sector risk operating environment (SROE) score in the 'bbb' category. Fitch believes further migration of '4'-rated loans to impaired ('5'-rated) could keep provisioning levels elevated throughout 2024, pressuring returns while net interest income could be adversely impacted by higher levels of non-accruing loans.

BXMT's leverage (gross debt-to-tangible equity including, non-recourse funding comprised of CLO liabilities) was 4.4x at 4Q23; higher than rated peers and within Fitch's 'bb' category benchmark range of 4x-7x for balance sheet heavy finance and leasing companies with a SROE score in the 'bbb' category. BXMT targets net leverage below 4.0x, excluding non-recourse and off-balance sheet debt net of unrestricted cash. On this basis, leverage was 3.7x at 4Q23. Fitch expects leverage to remain elevated compared to peers but below the firm's target throughout 2024, although a continued muted lending environment could allow for modest de-leveraging as assets are resolved.

BXMT's unsecured funding profile is weak relative to peers, representing less than 2% of on-balance-sheet debt at 4Q23, which was within Fitch's 'b' category benchmark range of 0%-10% for balance sheet heavy finance and leasing companies. The firm has historically relied on secured bank financing facilities, non-recourse securitizations and the secured Term Loan B market for funding, which it accessed multiple times during 2022. Given the sectoral challenges BXMT is experiencing, Fitch doesn't expect it to be able to enhance its funding flexibility over the near term through access to the unsecured debt markets.

As a REIT, BXMT is required to distribute at least 90% of its annual net taxable income to shareholders, which constrains the firm's ability to build equity and Fitch's assessment of its liquidity. At 4Q23, the company had $350 million of cash and equivalents and $1.3 billion of borrowing capacity on its funding lines, which Fitch believes is sufficient to address funding needs, including loan funding commitments in the near term.

Fitch also notes that BXMT's debt facilities have no capital markets mark-to-market attributes, are match -funded and are over-collateralized with commitments from lenders such that the $1.3 billion of borrowing capacity at 4Q23 is readily available. Still, while the firm does not have any corporate debt maturities until 2026 when $1.3 billion of its Term Loan B comes due, sector headwinds could put pressure on its ability to cost-effectively refinance this debt.

As the firm did not realize any losses during 2023, distributable earnings remained sufficient to cover its dividend. However, given high levels of problem credits, Fitch expects BXMT to realize losses during 2024 which would weigh on dividend coverage. Should realized losses persist and weaken cash earnings coverage of the dividend, Fitch would expect management to cut the dividend in order to preserve on-balance-sheet liquidity.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Further deterioration in credit performance whereby impaired and nonperforming loans remain elevated compared to peers even as problem loans are resolved and meaningful credit losses are realized, adversely impacting cash earnings;

An Inability to maintain sufficient liquidity relative debt maturities, unfunded commitments and margin call potential associated with collateral loan nonperformance or material credit deterioration;

A sustained increase in Fitch-calculated leverage above 5.0x and/or a sustained increase in company-calculated leverage above 4.0x; and/or

A sustained reduction in pre-tax ROA at or below 1.0%;

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Given current macroeconomic conditions as well as sector headwinds related to commercial real estate, near-term positive rating action is considered unlikely. The Negative Outlook could be revised to Stable if BXMT is able to resolve problem loans without a meaningful impact to cash earnings such that pre-tax ROA and/or distributable earnings ROA remain in-line with historical performance. Over the longer-term, the following could lead to positive rating actions:

Sustained increase in the proportion of unsecured debt at or above 25% of total debt;

Measured and appropriately risk-adjusted diversification into other CRE asset classes or expansion of business model; and/or

Sustained decrease in Fitch-calculated leverage at-or-below 4.0x.

DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS

The rating on the secured debt is equalized with the Long-Term IDR, indicating Fitch's expectation for average recovery prospects. The rating on the unsecured debt is notched down from BXMT's Long-Term IDR, and reflects the predominantly secured funding mix and the limited size of the unencumbered asset pool, which suggests below average recovery prospects in a stressed scenario.

DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES

The secured and unsecured debt ratings are primarily linked to changes in the Long-Term IDR and would be expected to move in tandem. However, a material change in the funding mix or collateral pool for each class of debt could result in the ratings being notched up or down from the IDR depending on how recovery prospects are impacted.

ADJUSTMENTS

The Standalone Credit Profile (SCP) has been assigned in line with the implied SCP.

The Business Profile score has been assigned below the implied score due to the following adjustment reason: Business model (negative).

The Asset Quality score has been assigned below the implied score due to the following adjustment reason: Historical and Future Metrics (negative).

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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