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Resource Capital Corp. (NYSE:RSO)

Q1 2009 Earnings Call

May 6, 2009 8:30 am ET

Executives

Jonathan Cohen - President and Chief Executive Officer

Dave Bryant - Chief Financial Officer

Dave Bloom - Senior Vice President of Real Estate Investments

Purvi Kamdar - Director of Investor Relations

Analysts

Gabe Poggi - FBR

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2009 Resource Capital Corp. Earnings Call. My name is Dan, and I’ll be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct 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 call over to your host for today’s call, Mr. Jonathan Cohen, President and CEO. Please proceed.

Jonathan Cohen

Thank you. Thank you for joining the Resource Capital Corp. conference call for the first quarter of 2009. I am Jonathan Cohen, President and CEO of Resource Capital.

Before I begin, I would like to ask Purvi Kamdar, our Director of Investor Relations, to read the Safe Harbor statement.

Purvi Kamdar

Thank you, Jonathan. When used in this conference call, the words, ‘believes’, ‘anticipates’, ‘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 Form 8-K, 10-Q and 10-K, and in particular, Item 1 on the Form 10-K report 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.

Jonathan Cohen

Thank you, Purvi. First, a few highlights.

For the quarter ended March 31, 2009, Resource Capital reported net operating income of 10.2 million or $0.42 per share diluted. RCC reported REIT taxable income, a non-GAAP measure, of 6.1 million or $0.25 per share diluted for the first quarter ended March 31, 2009 as compared to 12.1 million or $0.48 per share diluted for the first quarter ended March 31, 2008, a decrease of 6 million or 49%. This decrease was mostly due to the timing of tax losses, and Dave Bryant, our Chief Financial Officer, later in this call will explain this phenomena.

We declared and paid a dividend of $0.30 per common share for the quarter ended March 31, 2009, 7.5 million in aggregate, which was paid on April 28, 2009 to stockholders of record as of March 31, 2009.

Our economic book value, a non-GAAP measure, was $9.74 per common share, and our GAAP book value was $6.81 per common share, both as of March 31, 2009.

Given the economic environment, we determined that we should take a substantial provision of $5 million on a specific loan in our commercial real estate portfolio, where we decided to terminate a loan participation agreement. As for syndicated bank loans, as we have always done each quarter, we looked at the companies that we had lent to, and took reserves against any loan that we felt the borrower may have liquidity issues within three to six months. We then applied a very conservative recovery rate for the loan. We reviewed our entire portfolio using this methodology. As a result, we increased our bank loan allowances by 2.9 million.

We also sold 10 bank loan positions for a loss of $9 million in an effort to manage rating agency downgrades in our three CLOs. Our team is doing a great job and we are very happy with their performance. In addition, we wrote off the one remaining ABS bond that that we still owed, although it was on our books for virtually nothing. In doing so, we reported a GAAP net loss for the quarter ended March 31, 2009 of $0.50 per share.

We continued to benefit from our lack of short-term liabilities, decent cash position and liquidity, our match-funded assets and liabilities, and our good underwriting and asset management. Of course, this is a terrible environment, but we are doing whatever we can to protect our cash flow.

With those highlights out of the way, I will now introduce my colleagues. With me today are David Bloom, Senior Vice President in charge of Real Estate Lending and David Bryant, our Chief Financial Officer as well as Purvi Kamdar, our Director of Investor Relations.

The economic environment has been very difficult, and during the first quarter, got worse, substantially worse, for commercial real estate. We are working hard, and continue to benefit from the fact that we have virtually no recourse to any liabilities and no short-term maturities. And therefore, have the luxury of working to build cash from deleveraging, maintaining our cash for our CDOs and CLOs, and focusing on value. We are confident in our portfolio, and are resolute in mining the portfolio for ultimate value.

As I have said in previous quarters, we are determined to make a meaningful cash dividend this quarter. We continue to see relative outperformance within our real estate portfolio. This being said, the challenges increase as values decline and borrowers tire. Transaction volumes in the commercial real estate and commercial finance area were again very low during the quarter. As you will see from our press release, we did not originate any loans, and we continue to deleverage our portfolio. We believe this to be the smart thing to do. We focused our time on credit analysis and re-underwriting, decreasing short-term recourse liabilities, and setting the Company up to continue to produce a solid dividend.

It is hard to even say, given the stock price and the general environment, but we are proud to be one of the few companies still in business in this space that is still producing decent amounts of free and discretionary cash flow. We do believe that a huge opportunity looms for Resource Capital, and those able to focus on the core abilities of their platform. With the demise of commercial banks and CMBS, our business, that of whole loan lending for cash flowing assets, is very attractive. Now that we have effectively deleveraged and have no short-term obligations, we are poised to take all repayments when they come and reinvest into new loans and incredibly attractive spreads. We believe we can achieve equity-like returns and do so with safety.

Now, I will ask Dave Bloom to walk through our commercial real estate portfolio.

Dave Bloom

Thanks, Jonathan. RCC’s commercial mortgage portfolio has a current committed balance of approximately $820 million across a diverse and granular pool of 46 separate loans. Our portfolio of commercial mortgage positions is in components as follows: 66% whole loans, 24% mezzanine loans, and 10% B-notes.

The collateral base underlying the portfolios continues to be diversified across the major asset categories in geographically diverse markets, with a portfolio breakdown of 32% multifamily, 21% office, 27% hotel, 14% retail, and 6% others such as industrial, self-storage, and flex office.

After the termination of the loan participation agreement that Jonathan mentioned, our commercial mortgage portfolio continues to be current with the exception of one $7 million multifamily loan that is less than 30 days delinquent. We are in discussions with the borrower of the one small delinquent loan, and feel quite comfortable about a full recovery, because even a distressed valuation of the asset exceed their outstanding loan balance.

Despite the current low level of delinquencies in our portfolio, 85 basis points, we remain extremely concerned about market fundamentals in general and the impact of a weak economy on our portfolio. We continue to be in regular direct communication with our borrowers and have bolstered routine asset management functions, which include monthly re-underwriting of property cash flows, monitoring the progress of capital expenditures, leasing and other upgrade plans, as well as stressing loan exit scenarios based on current property values.

As you have repeatedly heard from me in previous calls, during this period of lower transaction volumes, our primary efforts have focused on asset management activities.

While we have not had payment defaults which have resulted in non-performing loan situations, we have had borrowers who were delayed in the lease up or repositioning of assets, and we have made modifications to their loans to carry them through this period. In exchange for modifications, we are receiving additional exit fees and other structural enhancements to loans.

In a few instances, where we have seen borrowers missing targets, we have been proactive in our approach, and have worked with borrowers to understand and address issues facing their asset plans.

To be clear, we are current on our loans, but for the delinquency I mentioned, and we are willing to work with borrowers who demonstrate a commitment to their properties, and are in need of assistance based on underlying property issues.

In instances where borrowers don’t meet extensions or future advance hurdles, but are able to demonstrate that their asset-specific business plans remain viable, we continue to do what we can to make accommodations that allow the borrowers to pursue completion of their business plans. That said, we require evidence for a borrower’s continued commitment and the best evidence in this regard is a fresh equity infusion to the property by the borrower.

As I’ve mentioned, relief from extension hurdles or covenants is accompanied by structural enhancements to the loan such as elements of recourse or tighter cash management protocols, as well as increased spread and additional or increased extension and exit fees.

Credit across the portfolio remains generally stable, but these are times that have never been witnessed before. So we are extremely cautious and watching each and every one of our loan positions with heightened scrutiny and considering all possible stress scenarios.

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 loans and benefit significantly from LIBOR floors that we structured into our positions.

About 50% of our total commercial mortgage portfolio carries LIBOR floors of approximately 4.5% or almost 400 basis points above where LIBOR has closed recently.

The fact that we have structured our loans with floors gives us additional room to maneuver in situations where borrowers are under pressure. We have the ability to lower the floor, while maintaining or even increasing spread, which can have a significant impact on current cash flow from portfolio properties. In these instances, we are also requiring significant structural enhancements to the loan, as well as increased fees to make up for any interest margin that we are foregoing in the shorter term.

The senior members of the RCC commercial mortgage team have continued with multiple in-person meetings with borrowers and property tours, which allows us ample opportunities to get out in front of anything that might be burdening a loan position.

We continue to face a unique and very challenging market, but we remain fully engaged and continue to benefit from a deep bench of experienced real estate professionals as we navigate forward through stretches of uncharted territory. Despite tough market conditions, we are working through issues well in advance and we are doing the best job we can in managing our portfolio.

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-add plans. With business plans [inaudible] 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 active in the markets where we have concentrated our lending efforts.

The real estate debt markets remain frozen but many of the asset-specific plans have been implemented by our borrowers and their plans for value creation realized. As the credit markets thaw, we would anticipate payoffs across the portfolio.

Having built out our direct origination capabilities and fully established our platform, we are uniquely positioned to take advantage of select opportunities, well-structured transactions at premium spreads in today’s market, and to match our production levels with our existing financing facilities. We will 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.

Jonathan Cohen

Thanks, Dave. I will now give you some statistics on our corporate bank loan portfolio. We have 962 million of bank loans encompassing over 30 industries. Our top industries are healthcare, diversified, broadcasting and entertainment, printing and publishing, and chemicals. As of the end of March, our average loan asset yields 2.48% over LIBOR, and our liabilities are costing us 47 basis points over LIBOR.

We’ve been able to buy loans at a substantial discount over the last several quarters and continue to see widening here on assets side.

Now, I will ask Dave Bryant, our CFO, to walk us through the financials.

Dave Bryant

Thank you, Jonathan. Our estimated REIT taxable income for the first quarter of 2009 was 6.1 million or $0.25 per common share. REIT taxable income includes losses on bank loans of approximately 4 million realized for tax purposes and sold during the March 2009 quarter. Please note that these bank loan losses had already been provided for at the year-end 2008 for GAAP purposes.

We also had a non-recurring transaction in the 2008 quarter from the gain on extinguishment of debt where we bought a CDO note payable at a discount of approximately 1.8 million. This gain of 1.8 million, coupled with the bank loan tax losses of 4 million, accounts for the bulk of the $6 million decline in REIT income from Q1 ‘08 to Q1 ‘09. For the first quarter in 2009 our Board declared a dividend of $0.30 per common share for total outlay of 7.5 million.

At March 31, 2009, RCC’s investment portfolio was financed with approximately 1.7 billion of total indebtedness and included 1.5 billion of CDO senior notes, 88.7 million of outstanding under a secured term facility, 16 million in a three-year non-recourse commercial real estate repurchase facility, and a mere 36,000 in other repurchase agreements. In addition, we have 51.5 million sourced from our unsecured junior subordinated debentures related to our two TruPS issuances in 2006.

We ended the period with 169.5 million in book equity. RCC’s borrowings of 1.7 billion had a weighted average interest rate of 1.79% at March 31st, a reflection of very low LIBOR in today’s market. Consistent with our stated philosophy of maximizing match-funding, our investment portfolio was 92% match-funded by long-term borrowings, and 7% from term borrowings, with a remaining life of 12 months, with some remaining extension options.

Our non-recourse commercial real estate purchase facility now is now down to 16 million with approximately 43 million in collateral pledged against that facility for a modest advance rate of approximately 37%.

We continue to pass the critical interest coverage and over-collateralization tests in our two real estate CDOs and three bank loan CLOs. Each of these five structures continued to perform and generate stable cash flow to RCC year-to-date in 2009.

Please note, we’ve added a new disclosure to our release regarding the specifics of these critical tests and our cash distributions and that we will update this quarterly.

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 9.74 per common share at March 31, 2009. Our leverage based on economic book value is 7.0 times. When we consider our TruPS issuances, which have a remaining term of 28 years as equity, we see our leverage drop to 5.6 times.

Our GAAP book value per common share was 6.81 at March 31, 2009 as compared to 7.35 at December 31, 2008. This first quarter decrease in GAAP book value of $0.54 is primarily due to the additional provisions for losses of $8 million on our loan and lease portfolio as well as the $9 million related to the losses on the sales of bank loans that Jon mentioned. This combined with a decrease of value of our mark-to-market securities of 9 million offset by an improvement in the value of our cash flow hedges of 8.8 million since December 31st, accounts for most of that change.

At March 31, 2009, our equity is allocated as follows: commercial real estate loans and CMBS, 72%; commercial bank loans, 25%; and direct financing leases and notes of 3%.

Focusing on liquidity, I’ll give a recap of our sources and uses of funds year-to-date for 2009. We sourced and used approximately 38.6 million during the three months ended March 31. Our major categories of sources include: from loan repayments of 17.1 million; net operating income of 10.1 million; repayments within our leasing portfolio, 7.5 million; and from cash on hand of 3.9 million, for total sources of 38.6 million.

Our major uses during the three months were: losses on investments of 14.3 million; a net reduction in our borrowings of 8.1 million; distributions of 7.5 million; CDO reinvestments of 4.4 million; repurchases of common stock of 2.8 million and working capital of 1.5 million, for total uses of 38.6 million.

With that, my formal remarks are completed and I’ll turn the call back to Jonathan Cohen.

Jonathan Cohen

Thanks, Dave. Again, as I said last quarter, management’s recommendation is that unlike other REITs in our sector which have paid out stock as part of their dividend or their entire dividend, our intention is to pay dividend in cash at least in the near future. Of course, this is subject to the Board’s approval. We have fine liquidity and we’ll continue to build cash and position ourselves defensively to protect our book value and our cash flow.

Thanks for participating in the call. Now, I will open the call for questions if there are any.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from the line of Gabe Poggi from FBR. Please proceed.

Gabe Poggi - FBR

Good. Hey, can you give us an update kind of on credit from quarter end to-date? I mean the market has rallied significantly. I believe there hasn’t been a fundamental change but in underlying CRE performance, but just wanted to hear from you guys is kind of March 31st to now how things have performed? Are you seeing the same green shoot, so to speak, that people are talking about? And then also, what are your thoughts kind of on the TALF extension to five years, thoughts on just -on TALF and potential impact to the CRE market?

Jonathan Cohen

On the first question, we’re seeing the same credit we mentioned every credit that I think that we’ve identified that has any issues. We are about to do a transaction which changes around a few of the CRE loans which will be a great enhancement I think to our CRE, CDO test, and we’re just continuing to try to work with the structures.

On the credit side, no we haven’t seen any deterioration in our borrowers since the end of the quarter. Just to clarify something, on the commercial bank loan side, we are not continuing to see widening on the assets side. The last month, month-and-a-half has seen incredible move up in prices as was I think documented in the New York Times and the Wall Street Journal today.

Loans have rallied considerably as our portfolio and we continue to look at that as an opportunity both as loans that we have move up to be able to sell them and to build par within our structures. Gretchen Bergstresser and the team are doing phenomenally well, and we’re actually mentioned by a major investment bank as having the lowest defaults of any CLO or loan manager out there. So, we’re quite proud of what we’re doing on that side of the house as well as on the real estate house where they’re really working incredibly hard with borrowers. Each situation is different.

But I would say, generally speaking, we continue to have a cautiously optimistic view of our portfolio and nothing has changed since the end of the quarter.

As far the TALF is concerned, we do think over time that will be a great savior of one of the ways that the CMBS world will be saved. Unfortunately, new originations of CMBS will be very difficult to occur without banks and other players spending nine months to a year, aggregating portfolios. But certainly, this is a great help to us.

We think it helps our borrowers long-term. But we also see it as a great opportunity with the lack of lending that’s out there, as we don’t have any short-term liabilities to be able to take money within the CDOs that we have and be able to redeploy that at incredible spreads when we’re borrowing for the next five years or so at incredibly low rates.

Gabe Poggi - FBR

Got you. One other quick follow-up on, you mentioned about how on the bank loan side, there has been incredible tightening recently. Has there been a lot of volume in that market or is it lot of secondary volume? Are people beginning to move? Is paper moving more freely or has it just been a tightening just a better bid of paper?

Jonathan Cohen

My understanding is that there has been decent volume, especially in the flow names and in the bigger loans.

Gabe Poggi - FBR

Right.

Jonathan Cohen

But I’d have to really look into whether or not our portfolio is moving up due to lack of volume and tightening. But of course, I would say on the way down that was probably due to lack of trading not people selling.

Operator

[Operator Instructions]. At this time, there are no further questions in queue. I would now like to turn the call back over to Mr. Cohen for closing remarks.

Jonathan Cohen

Once again, we appreciate your support and we’re working very hard here to try to build this company in a difficult market. Thanks again for your support.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Resource Capital Corp. Q1 2009 Earnings Call Transcript
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