Resource Capital Corp. (NYSE:RSO)
Q3 2008 Earnings Conference Call
November 06, 2008; 8:30 am ET
Jonathan Cohen - President, Chief Executive Officer
David Bryant - Chief Financial Officer
Purvi Kamdar - Director of Investor Relations
David Bloom - Senior Vice President of Real Estate Lending
Douglas Harter - Credit Suisse
Good day, ladies and gentlemen and welcome to the third quarter 2008 Resource Capital Corp. Earnings Conference Call. My name is Channelle, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator Instructions)
As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Mr. Jonathan Cohen, President and CEO of Resource Capital Corp. Please proceed.
Thank you, Channelle. Thank you for joining the Resource Capital Corp. conference call for the third quarter of fiscal 2008. I am Jonathan Cohen, President and CEO of Resource Capital Corp. Before I begin, I would like to ask Purvi Kamdar, our Director of Investor Relations, to read the Safe Harbor statement.
Thank you. When used in this conference call, the words “believed” “anticipate” “expects” and similar expressions are intended to identify forward-looking statements. Although the company believes that these forward-looking statements are based on reasonable assumptions, such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from these contained in the forward-looking statements. These risks and uncertainties are discussed in the company’s reports filed with the SEC, including its reports on Forms 8-K, 10-Q and 10-K, and in particular item one on the Form 10-K report and under the title risk factors.
Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as the date hereof. The company undertakes no obligation to update any of these forward-looking statements and with that, I’ll turn it back to Jonathan.
Thank you, Purvi; first for a few highlights. For the quarter ended September 30, 2008, Resource Capital reported adjusted net income, a non-GAAP measure that excludes the effect of certain non-cash charges and non-operating capital transactions, of $11.1 million or $0.44 per share diluted.
For the quarter ended September 30, 2008, Resource Capital reported REIT taxable income of $9.4 million or $0.38 per share diluted, as compared to $10.9 million, or $0.44 per share diluted, for the quarter ended September 30th, 2007, a decrease of $1.5 million or 14%.
We declared and paid a dividend of $0.39 for the third quarter ended September 30, 2008, and have affirmed our guidance for the fourth quarter ending December 31, 2008, for $0.37 to $0.39. This range of dividends implies an approximate yield of 34% on the current stock price, which seems to us, at least, to be quite substantial.
Our economic book value, a non-GAAP measure, was $10.92 per common share as of September 30th, 2008. Our GAAP book value per common share was $9.45 as of September 30th, 2008. The difference between GAAP and economic book value is mostly comprised of swap and hedging marks and negative marks on our commercial mortgage-backed securities.
You may notice that our GAAP book value is within 5% of last quarter’s book value, even after reserving for future losses and writing off the one real estate loan. The drop in book value was mostly a result of the increase in general loss reserves on our commercial loan portfolio and the sale of a commercial real estate loan for a modest discount after the quarter ended, actually this week. These reserves and the distribution of $0.39 to our shareholders led to the decrease.
We’re comfortable with our balance sheet as most assets are match-funded. As of October 31, 2008, we have recourse at the company level to only $180,000; yes $180,000, of short-term repurchase agreements that are guaranteed by the company, secured by the way, by a face value of $4 million of assets. This is down from $4.6 million as of June 30th, 2008 and we have over $12.8 million in cash and availability on our corporate credit line. This is after paying our most recent dividend of approximately $10 million.
With those highlights out of the way, I will now introduce my colleagues and then proceed to dive deeper into the company, its performance and the drivers for a successful fourth quarter of 2008. With me today are Dave Bloom, Senior Vice President in charge of Real Estate Lending, and Dave Bryant, our Chief Financial Officer.
As a company, we remain very, very focused during this quarter. Conditions worsened considerably for all credit markets and for real estate specifically and that continued obviously into October and early November. I believe that we have found ourselves in a good spot, for the most part, and that has been a function of good real estate investing and avoiding the most risky asset classes during what is now called “the bubble”.
We continue to see good stability within our portfolio. This view was recently affirmed, as late as yesterday and earlier in the month, by Fitch on both of our CDOs which finance our commercial real estate. Even using a different model and new loss assumptions, we have been affirmed across all classes. We consider this affirmation of our credit quality to be significant external validation of the quality of our commercial real estate portfolio.
Transaction volumes in the commercial real estate and commercial finance area were extremely low during the quarter and we saw ourselves using all pay-downs to move assets from our low-leverage facility, which is paying facility, which is non-recourse to the company, but has extremely low advance rates into the CDOs.
We focused our time on credit analysis and re-underwriting, decreasing short-term recourse liabilities, which effectively we have zero, close to zero now, and setting the company up to continue to produce a very solid dividend. At the same time, we prepared ourselves for the next few quarters with no rebound or market increases in the credit market.
Our overall adjusted net income and REIT taxable income statistics, as mentioned earlier were somewhat satisfying given the environment, and we believe that these types of numbers will continue to be realized for the foreseeable future.
I would like to reiterate that our portfolio continues to perform solidly. We believe that we have a few more quarters, and I’ve said this in the past, to allow the real estate finance markets to start up again before we see our borrowers become overtaxed. We believe that the remainder of 2008 and 2009 will continue to be very difficult for refinancing real estate other than multi-family.
We anticipate gradual easing in liquidity and the ability for refinancing in late 2009. Although this quarter saw generally good credit, we took the opportunity to add to the general reserve for our bank loans and to sell a commercial real estate loan at a modest discount after the quarter and we reserved against that loss. We intend to buy other assets hopefully at steeper discounts with better credit with over 18 million of net proceeds.
Interestingly, we made a conscious decision to sell the loan for a modest discount, even though the building more than collateralized the loan. We did this because of the vast opportunity to invest a wider range and at better loan-to-values in other assets. I believe we will more than make up this modest discount and this will be a good transaction for us.
As for the bank loans, we looked at the company’s commercial bank loans, we looked at the companies that we have lent to and took reserves against any loan that we felt was secured by a company that may have, and I underline “may have” liquidity issues within three to six months. We then applied a conservative recovery rate for the loan. We reviewed our entire portfolio while doing this calculation. Now, I will ask Dave Bloom to walk through our commercial real estate portfolio.
Thanks very much, Jonathan. RCC’s commercial mortgage portfolio has a current committed balance of approximately $834 million, across a diverse and granular pool of 50 separate loans. Our portfolio of commercial mortgage positions is in components as follows: 65% whole loans, 24% mezzanine loans and 11% B-notes.
The collateral base underlying the portfolio continues to be diversified across the major asset categories in geographically diverse markets. With a portfolio breakdown of 31% multifamily, 23% office, 26% hotel, 14% retail and 6% others, such as flex office or self-storage.
Credit across the portfolio remains strong with a majority of the properties performing well above our pro forma underwriting and ahead of schedule. While recent LIBOR fluctuations have had an unsettling effect on any number of investment portfolios, well over half of our commercial loan portfolio consists of self-originated whole mortgage loans can benefit significantly from LIBOR floors of approximately 4.5% that we structured into the loans.
Our current LIBOR floors are more than 250 basis points above where LIBOR closed yesterday. A particular note regarding credit quality is the fact that we always stress property cash flows at both our imposed LIBOR floor and the cap that we make the borrowers buy. Our commercial mortgage portfolio continues to be current with no defaults and no non-performing loans.
As I’ve discussed on previous calls, during this period of lower transaction volumes, our primary efforts have focused on asset management activities. We continue to utilize our direct lines of communication with borrowers and have taken this opportunity to bolster our routine asset management functions, which include monthly re-underwriting of property cash flows, monitoring the progress of capital expenditures, leasing and other upgrade plans.
Over the better part of the last year, each of the senior members of the RCC commercial mortgage team have had numerous in-person meetings with borrowers and multiple property tours, which have validated original loan underwritings and continue to confirm the strength of the markets in which we have investments. We continue to be pleased with the performance of the portfolio and can report that the majority of the asset-specific business plans have been implemented by our borrowers and their plans for value creation have been largely realized.
As the credit markets continue to heal, we anticipate significant pay-offs in our self-originated whole-loan portfolio as borrowers sell or recapitalize their already completed properties. Monthly asset management reviews and risk ratings continue to evidence strength in the portfolio and we continue to see either completed asset plans or significant progress towards the borrower’s plan for value creation at the individual property and portfolio levels.
In the few instances where we have seen borrowers falling short of targets, we have been proactive in our approach and have worked with them to understand and address issues facing their asset plans. To be clear, we are current on all of our loans and have not had to enter workout discussions in any of our positions. That said, in three instances, we have made minor modifications to loans in exchange for significant additional structural enhancements and exit fees.
The lack of liquidity in the market is an issue for shorter-term bridge loans, but we are not in any situations with bullet maturities looming. To the contrary, despite a lack of liquidity for mega transactions, we are still seeing a tremendous amount of activity across our portfolio and we still receive regular inquiries from borrowers about loan payoff details in anticipation of transactions that they are considering.
As I’ve noted before, the majority of our borrowers are IRR-driven investors who look to sell properties when they are done with their value-added plans. With business plans complete at the property level, our borrowers are likely to sell rather than hold out for the last dollar and there are numerous cash buyers still very active in the markets where we have concentrated our lending efforts.
While this shift in our business model to a portfolio of self-originated whole loans was implemented over two years ago, we do still have 35% of our commercial mortgage portfolio comprised of subordinate debt positions, the majority of which are 2005 and early 2006 vintage. Our subordinate debt portfolio has an average loan-to-value ratio of approximately 70% and an average debt service ratio in excess of $1.75. These are well-seasoned loans with premiere sponsors and as the capital markets continue to improve, we anticipate a wave of pay-offs in our subordinate debt portfolio as well.
Having fully built out our national origination platform, we remain uniquely positioned to take advantage of select opportunities for well-structured transactions at premium spreads in today’s market and to match our production levels with our existing financing facilities. We will certainly benefit from loan repayments as we reinvest higher yielding assets into our long-term locked-in financing vehicles. With that, I’ll turn it back to Jonathan and rejoin you for Q&A at the end of the call. Thanks.
Thanks, Dave. Well, before I ask Dave Bryant, our CFO, to walk us through the financials, I’ll just give you some statistics on our bank loan portfolio. From the bank loan side, we have $942 million of bank loans encompassing over 30 industries. Our top industries are healthcare 11%, diversified 9%, printing 5.9%, chemicals 5.9%, and broadcasting and entertainment 5.5% approximately. As of the end of September, our average loan asset yields 2.28% over LIBOR, and our liabilities are costing us approximately 47 BPs, basis points, over LIBOR.
We’ve been able to buy loans at a substantial discount over the last several months and continue to see widening here on the asset side. Now, I will ask Dave Bryant, our CFO, to walk us through the financials.
Thank you, Jonathan. I’ll now briefly cover our financial highlights for the quarter ended September 30, 2008. Our estimated REIT taxable income for the third quarter was $9.4 million, or $0.38 per common share. For the third quarter in 2008, our board declared a dividend of $0.39 per common share or a total of $9.9 million. This brings our year-to-date results to $30.9 million of REIT taxable income or $1.24 per common share with an associated dividend of $1.21 per share for a payout ratio of approximately 97%.
At September 30th, RCC’s investment portfolio was financed with approximately $1.7 billion of total indebtedness and included $1.5 billion of CDO senior notes, $99.9 million outstanding under a secured term facility, $60.5 million in a three-year, non-recourse commercial real estate repurchase facility, and 360,000 in other repurchase agreements. We have also $51.5 million sourced from our unsecured junior subordinated debentures related to our two TruPS issuances in 2006.
We ended the period with $239.1 million in book equity. RCC’s borrowings of $1.7 billion had a weighted average interest rate of 3.79% at September 30, 2008. Our investment portfolio is 91% match funded by long-term borrowings and 9% from term borrowings, with a weighted average remaining life of 18 months with additional extension options beyond that timeframe.
Of note, with respect to our real estate structure financings in particular, we are comfortably passing the critical interest coverage and over-collateralization tests in our two real estate CDOs. Both of these real estate CDO structures continue to perform and generate stable cash flow to RCC.
Since quarter-end, our non-recourse commercial real estate repurchase facility has been paid down to $58.5 million, with approximately $116.6 million in collateral pledged against that facility for a very conservative advance rate of approximately 50%.
We consider leverage ratio from two positions. As Jon noted earlier, our economic book value after adjusting for unrealized losses in our CMBS portfolio and unrealized losses from our cash flow hedges is $10.92 per common share at September 30. Our leverage based on our economic book value is 6.3 times. When we consider our TruPS issuances, which have a remaining term of 28 years as equity, we see our leverage drop to 5.2 times.
Our GAAP book value per common share was $9.45 at September 30th,as compared to $9.90 at June 30th. As Jon indicated, this third quarter decrease in GAAP book value of $0.45 is primarily due to provisions for losses of approximately $11 million on our loan and lease portfolio. At September 30, 2008, our equity is allocated as follows. Commercial real estate loans and CMBS 73%, commercial bank loans 25%, and direct financing leases and notes of 2%.
With the market focus on liquidity, I’ll now provide a summary of our sources and uses of funds year-to-date for 2008. We sourced and used approximately $125.2 million during the nine months ended September 30. Our major categories of sources include: from cash available for reinvestment, $46.4 million; from investment portfolio principal repayments, $36.5 million; from the sale of a CMBS position, $10 million; and from adjusted net income of $32.3 million for total sources of $125.2 million.
Our major uses during the nine months were: for settlement on CRE loans and future fundings, $24.8 million; for net acquisitions of bank loans and leases, $11.9 million; for a net reduction in our borrowings of $51 million; for distributions of $30.8 million; for working capital of $0.6 million; and the remaining amount to increase our cash balance by $6.1 million for total uses of $125.2 million. With that, our formal remarks are completed and I’ll turn the call back to Jonathan Cohen.
Thank you very much and at this time, I think we’ll open the phone lines for questions. Channelle.
(Operator Instructions) Your first question comes from Douglas Harter - Credit Suisse.
Douglas Harter - Credit Suisse
I wonder if you could just clarify something. You said that you were comfortably passing the covenants in the CRE CDOs. Can you just talk about just where you stand on the covenants in the bank loan CDOs?
Yes, we’re also comfortably passing those as well.
Douglas Harter - Credit Suisse
Great and can you just talk about, sort of with the cash and as you get to the extent that there are any more pay-downs, how are you viewing stock repurchase, debt repurchase, versus new originations of loans?
Well, I think that we’ve been in a mode of deleveraging the company significantly as a factor of our dollars invested versus the debt that we have and we’ve been doing this primarily using payoffs that have been on our bank line at Natixis where we receive, this is called one-to-one 50% leverage, where we’re already carrying liabilities in our CDOs at, let’s say, 75% leverage points. We’ve been moving them, as we’ve gotten pay-downs into CDO; we’ve been moving loans off of Natixis into the CDO, and then using the excess cash that we’re getting back for liquidity and other corporate activities.
We also have paid down a significant amount of, not significant given the environment, but tens of millions of dollars of what used to be recourse repurchase agreements that we also paid down to virtually zero and our goal is to move all of the things into these vehicles and then to start building cash reserves and cash to both work with our existing portfolio, so that we’re a very strong lender, not a weak lender, as well as looking for various opportunities for stock and bond repurchase, as well as keeping our CDOs fully financed and fully loaded with assets; because obviously we’ve borrowed that money for a term amount. So we have to use it.
So we’re in the mode now of really freeing up what we think is $20 million, $30 million, $40 million, $50 million of equity, which is trapped outside the CDOs in a low-leverage structure and once we have that done and everything into the CDOs over the next three, four, five months, we’re hopeful we could accomplish a lot of that. We then will be in the mode of buying back stock and/or bonds, but my inclination would be, since I believe in the portfolio, to be a buyer of the stock, unless the bonds are so ridiculously cheap that you’d be a fool to walk away from it.
Douglas Harter - Credit Suisse
I guess if you could just talk about where the cash that you have available in the CDOs right now, which CDOs, is that CRE CDOs, bank loan CLOs?
Yes, we have cash available actually and after the quarter changed around a little bit, but I’ll just tell you where we are now, which is that we have cash available in all of the CDOs and CLOs. You can only use those within the CRE, the CDOs. You can’t extract the cash from the CDOs and use that to buy back bonds or buy back.
Douglas Harter - Credit Suisse
Correct, but I guess you still have the term facility outstanding.
Douglas Harter - Credit Suisse
What sort of prevents that from going down quicker to the extent that you have cash in the CDOs?
No, no. If we have cash in the CDOs, we’re currently; I should have taken that one-step further, Doug. We took an early payoff on a loan in order to basically free up a lot more cash and now we’re moving a lot of stuff off of the Natixis line into the CDOs and that will happen over the next week or two.
Douglas Harter - Credit Suisse
So we would expect that 58.5 numbers to fall.
Yes, it would go down significantly and that will free up cash and let us be, not only a stronger lender, but also an exploiter of the situation for our benefit, although we’ve had good credit, and we have continued to have good metrics on the CDOs and all the things that we’ve said and been a little bit boring, thank God, but now, I think we’re going to move, over the next few months as we feel stronger based on this plan to basically start to exploit that.
(Operator Instructions) and there are no further questions. I would now like to turn the call back over to Jonathan Cohen.
Well, thank you very much and we’re looking forward to continuing to deliver a very solid dividend and a good balance sheet in building this company going forward. So thank you very much.
Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have an excellent, excellent day.
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