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NorthStar Realty Finance Corp. (NYSE:NRF)

Q1 2013 Earnings Call

May 3, 2013 9:00 am ET

Executives

Al Tylis – President

David Hamamoto – Chairman and Chief Executive Officer

Debra Hess – Chief Financial Officer

Analysts

Stephen Laws – Deutsche Bank

Steve Delaney – JMP Securities

Joshua Barber – Stifel Nicolaus

Operator

Good day, ladies and gentlemen and thank you for standing by. Welcome to the NorthStar Realty Finance First Quarter 2013 Conference Call Results. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator instructions)

This conference is being recorded today May 3, 2013. I would now like to turn the conference over to Al Tylis, President of NorthStar Realty Finance Corp. Please go ahead, sir.

Al Tylis

Thank you very much. Welcome to NorthStar's first quarter 2013 earnings conference call. Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements.

These statements are based on management's current expectations and beliefs, and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

I refer you to the company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The company undertakes no duty to update any forward-looking statements that may be made in the course of this call.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with Generally Accepted Accounting Principles can be accessed through our filings with the SEC at www.sec.gov.

With that, I am now going to turn the call over to our Chairman and Chief Executive Officer, David Hamamoto. David?

David Hamamoto

Thanks Al and thanks everyone for joining us. In addition to Al, I am joined today by Dan Gilbert, our CIO and COO; Debra Hess, our CFO; and Ron Lieberman, our General Counsel. On a macro level the US economy continues to recover slowly, as economic indicators remain mixed, and lingering policy in Eurozone debt issues persist. However we continue to see positive trends in commercial real estate fundamentals, such as improving demand drivers, relatively limited supply growth in most markets.

Liquidity also continues to improve in the commercial real estate market evidenced by strong demand for new issued CMBS issuance. During the first quarter of 2013, there was approximately $22 billion of new CMBS issuance, the biggest quarterly total since 2007, and full-year projections are currently estimated at more than $70 billion, which is up from $45 billion in 2012. As we move through 2013, we continue to leverage our broad and sophisticated commercial real estate platform to make accretive investments that further diversify our investment base and cash flows, while continuing to grow our asset management business. Year-to-date we successfully closed $1.6 billion of investments for NorthStar, deploying $677 million of equity capital at a weighted average current yield significantly in excess of our cost of capital.

Due to our continued increase in cash flow, we recently announced our seventh consecutive quarterly increase to our common stock dividend representing a 90% increase over this period. This quarter we introduced a new operating metric, cash available for distribution, or CAD. We believe this metric is a very good indicator for our cash earnings and will enhance investor visibility into our operating performance. Furthermore, CAD has become a prominent metric that we utilize in evaluating our quarterly dividend.

While our CAD per share for the first quarter was comfortably in excess of our dividend, we expect CAD per share in the coming quarters to be higher given that we deployed a substantial amount of equity in the second half of the first quarter and at the beginning of the second quarter. Going forward, we will continue to seek to prudently balance distribution with retaining cash flow for accretive investments.

We are well positioned to maintain our momentum with a robust pipeline of compelling and diverse investment opportunities across commercial real estate. We remain focused on expanding our ownership of hard assets, particularly given the aggressive dynamics of the CMBS and agency financing market, which allow us to lock in long-term, low-cost non-recourse financing that results in significant [cash-on-cash] yield with potential appreciation.

Our loan origination team is focused on leveraging our broad expertise and relationship to drive our core loan origination business and to be a value-added capital provider with the ability to offer specialized capital solutions to borrowers. In addition, we continue to seek opportunistic investments in commercial real estate such as our recent acquisition of limited partnership interest in real estate private equity funds. This acquisition has already outperformed our expectation, and we believe that there could be meaningful additional opportunities in this sector.

We also continue to grow our asset management business, as demonstrated by the accelerated capital raising pace of our non-traded REIT business over the last several months. We continue to execute selling agreements for our second non-traded REIT, NorthStar Healthcare Income. We are seeking to have our third non-traded REIT, NorthStar Real Estate Income II declared effective shortly, which will have a commercial real estate debt focus, similar to our first non-traded vehicle, NorthStar Income.

As we have discussed on past conference calls, our strategic goal is to continue leveraging our deep organization and wholly owned broker dealer to create new vehicles and products, including exploring additional distribution channels, where we can create long-term and stable key streams for our shareholders.

I now like to turn the call back over to Al. Al?

Al Tylis

Thanks David. Year-to-date we have closed on the acquisition of 45 limited partnership interest in real estate private equity funds in connection with our previously announced transaction. The final acquisition price was based on the private equity fund’s aggregate reported NAV of approximately $789 million at June 30, 2012.

We have already seen substantial realization (inaudible) and reported NAV growth. For the funds that were reported in 2012 year-end financials, reported NAV has grown approximately 7% on a weighted average basis from June 30, 2012 through December 31, 2012. The tables in our earnings release provide additional detail regarding this investment and the underlying real estate asset.

In early April of this year we acquired our second portfolio of manufactured housing communities for $865 million. We expect to earn an initial current return of 14% on our invested equity. As of today we own over 1.1 billion of manufactured housing communities containing approximately 25,000 pad rental sites. As we have said in the past this is an asset class that has historically demonstrated stable cash flows, steady rental growth, very low turnover rates and minimal capital expenditures. We will continue to seek opportunities to grow our portfolio.

In addition, we have acquired select properties in the multi-family sector with strong operating partners and what we believe are attractive risk-adjusted returns. We are able to take advantage of aggressive non-recourse senior loan financing in these transactions, and expect to generate a current yield of approximately 14% with potential upside.

We also continue to actively originate loans, and year-to-date we have completed $400 million of loan originations for us in NorthStar Income. Given the magnitude of the commercial real estate loans coming due in the next several years, we believe the opportunity to buy debt financing continue to be significant, particularly for lenders like us that can also provide sizeable and specialized capital solutions.

This type of value-added financing builds long-term relationships with borrowers, while providing us attractive risk-adjusted returns compared to more commoditized loans. An example of this is the recently announced closing of the loan on the Milford Plaza hotel in Times Square. We provided the sponsor with a creative one-stop financing solution that filled their needs while providing us with an attractive current return, which maybe enhanced in the securitization in a 35% ownership interest in a hotel, and retail component of the hotel, one of the strongest hotel submarkets in the market.

We believe that these types of differentiated lending opportunities will continue to be available through our deep relationships with credibility in the commercial real estate space.

Turning to our asset management business, year-to-date we made $337 million of investments on behalf of NorthStar Income. During the first quarter of 2013, NorthStar Income raised $179 million and we continue to see acceleration in our capital raising pace as we approach the end of the $1.1 billion target for July.

As of today we have $887 million raised, which includes $108 million during the month of April alone. Based on our current fees and the projected growth of our non-traded REIT business for 2013, we remain on target to generate over $40 million of net fees in our asset management business this year. Because we're an internally managed REIT our shareholders are the direct beneficiaries of this high multiple business that does not require significant capital investment.

In summary, we are making significant progress on our long-term objectives of creating a more diversified, less cyclical and higher multiple business, and we will continue diversifying our asset base and cash flows by deploying capital in investments across the commercial real estate spectrum that we feel will provide the most attractive risk adjusted returns for our shareholders.

I'd like to now turn the call over to Debra, who will review our financial results for the first quarter of 2013. Debra?

Debra Hess

Thanks, Al, and good morning, everyone. I would like to take a few minutes to discuss our CAD results for the quarter and our overall portfolio. As you saw in today's press release, we reported a CAD metric, which reflects the cash flows for distribution as presented in our corporate presentation for the past several quarters.

CAD for the first quarter totaled $36 million, or $0.21 per share, which as David mentioned, does not fully reflect all of the investments we have made in the past several months. Also as David discussed, we believe this is a good indicator of our operating performance and CAD is an important factor when evaluating our dividend.

As to our investment portfolio, as of March 31, we had $2.5 billion of commercial real estate debt investments, a majority of these debt investments are first mortgage loans that were directly originated by us and we have seen the credit trends in our underlying portfolio continue to improve steadily.

As of March 31, we did not have any non-performing loans. Loan loss reserves totaled $153 million or approximately 7% of loans related to 11 loans with a carrying value of $189 million. With respect to our securities, almost all are financed in CDOs, and we continue to evaluate opportunities in the portfolio. One such opportunity is the ability to unwind CDO share. We owned $71 million of CDO II bonds that we repurchased at significant discounts to par. By unwinding the CDO, we expect to realize predominantly all of this discount, as well as generate a return of our return investment, which can be deployed accretively.

Our commercial real estate assets continue to perform well and generate stable cash flows. During 2013, we grew this portfolio with the acquisitions of our second manufactured housing communities’ portfolio and seven multi-family properties. As of today, our real estate portfolio totals $2.4 billion and is comprised of $401 million of net lease properties, $574 million of healthcare properties, $1.2 billion of manufactured housing communities’ portfolio, and 212 million multi-family portfolios. As David mentioned, we continue to see exciting investment opportunities, and as of today we have approximately $284 million of unrestricted cash.

This concludes our prepared remarks for today. Now let's open up the call for questions. Operator?

Question-and-Answer Session

Operator

Thank you, ma'am. Our first question is from the line of Stephen Laws with Deutsche Bank. Please go ahead.

Stephen Laws – Deutsch Bank

Hi, thanks for taking my questions. Congratulations on a nice quarter and good portfolio growth. Can you maybe give us little color about how CAD has trended from last year into this year, I know in David’s prepared remarks you commented on some late quarter investments that should help drive some growth there. And then secondly, you know the acceleration we saw in asset management business during April, is that a pace that you guys expect to continue, or is there more business days, where there some other things going on there that we’re not going to continue to see 100 million, and then thirdly kind of as you look at opportunities across the different business segments, is there one or two that you find more attractive, others that are simply looking at things on a deal by deal basis to make sure of (inaudible) to deploy capital?

Al Tylis

Hi, Stephen, it is Al. We will take those questions one at a time. I think in terms of how CAD has trended, in our corporate presentation, you may have seen the bar chart that we have used and we showed a number for what would have been equivalent of CAD in that whole presentation, which was $0.74 for 2012.

I think that gives you a sense of where we were last year and out of this $0.21 for the first quarter, it now reflects substantial amount of investments that we have made over the last month or two. And in terms of your question about the asset management growth, yes, we are certainly seeing the pace accelerate. We have another couple of hundred million dollars to go on this offering, and we would certainly expect to continue to see very strong demand as we close out the initial offering, and we will be launching – we launched our second product and hopefully will launch our third product shortly thereafter.

David Hamamoto

Stephen, your third question was about where we want – where we find the most attractive opportunities, which segments that was in.

Stephen Laws – Deutsche Bank

Yes.

David Hamamoto

Is that right?

Stephen Laws – Deutsche Bank

Yes. As you look out there, one or two segments that are more compelling, or is it simply an investment by investment basis that you are looking at required internal capital?

David Hamamoto

Yes. I think we’re opportunistic, and I think within the various fields that we are doing, you can see that one of the things that we focus on is obviously generating current yields, but I think we are also looking for situations where we can also participate in the upside of the real estate, and I think where that comes in in a particular transaction really depends on the liquidity and the different components of the market, and we are obviously trying to play in areas where there is less competition, and where our expertise can add value in terms of creating opportunities that have attractive risk adjusted returns.

So you know it just depends. We are comfortable in a big complicated loan on a New York City asset as we described on Milford, where we have got a great operator and actually behind us, and we create attractive piece of paper that we can securitize the senior on. And then in addition to the coupon, we have got a significant equity participation. But on the other hand, in some of the other real estate that we are buying, we find the equity component more compelling.

So, for instance, in the manufactured housing business, where cash flows are a lot less volatile, and where the CMBS market is particularly aggressive at financing those assets on a non-recourse long-term basis, in those situations we allow the equity play. And again we have got an operating partner that we feel can manage the portfolio and create incremental upside.

So, I think we will play all across the sector, and we talked about the limited partnership transaction, and we are very happy with that. As a result early on looked very compelling, and again less competition in that sector and an ability to underwrite that gives us a competitive advantage. So I would say we will continue to play all across the capital side.

Stephen Laws – Deutsche Bank

Well, I appreciate the color there, and one last if I may, you know, the JV private equity investments that you guys referenced, I know generates some cash flows there I think was $8 million of income maybe and $30 million of return of capital, I maybe incorrect there, but can you talk I think that was back since June 30, can you talk about what type of cash flows we should expect to see on a quarterly basis, or is this something more lumpy and a little bit difficult to give visibility into?

Debra Hess

Hi, Stephen. I think that while the underlying cash flows will be a little lumpy, because the booking is based on an effective yield, what you are going to see is sort of a smooth recognition of both income and cash flow that will approximate that as we go forward.

Stephen Laws – Deutsche Bank

Great. Thanks Debra, thanks Al, and David, you guys have a good day. I appreciate it.

Al Tylis

Thanks.

David Hamamoto

Thanks David.

Operator

Thank you and our next question is from the line of (inaudible). Please go ahead.

Unidentified Analyst

Hi, thanks, Good morning everyone. Just want to ask a question on the liquidation of the CDO, one, I guess, are you thinking about any sort of gain that can be recognized there, I guess like formerly in terms of you know income statement around that, and then you know, also is there any loss of income that is material, probably not from the management fees that are thrown of there, or any interest that was being earned on the bonds that you own there.

Al Tylis

Yes, Dan. I think I will let Debra speak to what the accounting gain maybe. I think the purpose of this is to really have an economic realization on bonds that we bought at pretty deep discounts that can now recover close to par. So that – there the purpose is to realize that event and also be able to redeploy the capital at much more lucrative levels relative to the distributions we are receiving now, which is essentially just our management fee, which is about $200,000 a year.

So it is pretty de minimis what we are giving up, and be able to take that capital and be able to redeploy it accretively, as well as lock in substantial economic gain is the purpose of that transaction.

Debra Hess

Yes, I mean there may be an accounting gain as a result of unwinding the CDO, but really because the way we own the CDO bonds and their limited consolidation we are not actually getting the benefit of interest income on those underlying bonds for the realization of those bonds through our income statement. So in fact this will actually be much better for us going forward.

Unidentified Analyst

Got you, and then also I just want to ask about this new transaction in Milford, thanks for the details on the returns on equity, but can you give us a little detail on maybe underlying – what the actual rate of the yields were like the senior piece and what the mid piece set forth in some of the terms around that.

Al Tylis

Yes, I think that transaction again was great for us in that it was a top operator that we had a long-term relationship with that we think is one of the best operators in New York City in [high]. And I think that that submarket in Times Square we find very compelling. So, we looked at financing so that we could be comfortable with our bases, and we feel very good about that. The renovation that they have done is incredible, and the amount of traffic and the rates they were getting there when the lobby was still under construction was very compelling, and the lobby is now completed and we think there will continue to be increases in that underlying NOI. And again, a private equity sponsor that we like retaining equity in there was also a very compelling aspect of that financing.

Unidentified Analyst

Okay, and just one more if I may, just from the JV and limited partnerships, just correct this, it looks like in the income statement that 8.3 million equity in earnings of unconsolidated [subs] is that the income that was generated, but they were actually asking more return of capital that flowed through the cash flow statement there, is that correct?

Debra Hess

That is correct.

Unidentified Analyst

Okay. Thank you.

Operator

Thank you, and our next question is from the line of Steve Delaney with JMP Securities. Please go ahead.

Steve Delaney – JMP Securities

Hi, good morning everyone, and congrats to a great start to the year. I believe when you initially announced the private equity transaction, I believe there were 50 or 51 total funds, can you comment on you have closed 45, are the other five or six still viable, and if so when do you expect to put that additional equity out?

Debra Hess

Yes, I mean there has been a couple of that went in and a couple that went out. There is a handful more that we are looking to close in the second quarter.

Steve Delaney – JMP Securities

Okay, very good. And Debra on the CAD versus AFFO, we will obviously dig in and do a side-by-side and try to identify the pieces, but the $0.03 difference between 21 and 18 between CAD and AFFO, is there one, can you point me to one big item, or one or two items that might make up that $0.03, or is it just too many little things?

Debra Hess

No, I mean the bigger differences are one, realized gains are in AFFO, you have got reserves in AFFO, both of which are not in CAD. AFFO does not have the realized discount on the CDO bonds, CAD does. And the last one is there is some accretion on assets that sit in CDOs that is in AFFO that is not in CAD.

Steve Delaney – JMP Securities

Okay, that is helpful, and I will follow up with you on that. I guess the last thing I would like to know, I mean, you are very active on both direct real estate, equity investments and CRE loans, I mean if we include the manufactured housing too, it looks like you know almost $400 million of equity invested year-to-date, you know, at March you had $280 million of cash on the balance sheet. Can you comment on how you guys see your dry powder now based on your current capitalization dry powder for additional investments including your credit facilities?

Al Tylis

Yes, Steve, the 284 is the number now, not at quarter end.

Steve Delaney – JMP Securities

Excuse me, thank you.

Al Tylis

Yes, just to clarify that and Steve, we always run with somewhat of a healthy cushion, but we clearly have a fair amount of dry powder to be able to take advantage of some of the particularly interesting investments (inaudible).

Steve Delaney – JMP Securities

All right, very good. I appreciate it.

Operator

Thank you, and our final question is from the line of Josh Barber with Stifel Nicolaus. Please go ahead.

Joshua Barber – Stifel Nicolaus

Hi, thanks. Good morning. Most of my questions have already been asked and answered, just a couple of quick ones, can you tell us how much cash today is available at the non-traded REIT?

Al Tylis

There is about $200 million right now of cash that is not invested in our non-traded REIT.

Joshua Barber – Stifel Nicolaus

Okay, and the credit line is still available for that – was there something drawn on that?

Al Tylis

Part of it was drawn in connection with the Milford financing, and there was one other asset that was financed with it, but a fair amount of it still remains.

Joshua Barber – Stifel Nicolaus

Okay, can you talk also about the apartment acquisitions, I understand some of those where – a couple of them were in Memphis, couple of them were in Atlanta, could you talk about some of the other stock markets that you guys are getting into with those acquisitions?

Al Tylis

Yes, the portfolio we bought is primarily southeast and the markets, these were well located. Again we have an operating partner that we really like, and the yields out of the box were very compelling because of the cheap financing, sub 4% fixed rate, and so I think we feel like we were generating a very attractive current return, but we think there are some things that our partner can do in terms of operating performance which we think will help drive yield further up over time?

Joshua Barber – Stifel Nicolaus

And it is one operating partner for all the different acquisitions

Al Tylis

Now we have two.

Joshua Barber – Stifel Nicolaus

Okay, and I guess it has been asked in some different forms so far, but looking out forward, I guess, where are you seeing the best opportunities I guess on a purely unlevered side and then maybe on a levered basis, will that continue to be in manufactured housing, in debt, in apartments, in some special situations, or is it some combination of all four today?

Al Tylis

Yes, I think, you know, one of the strengths I think we have is that we understand all components of the capital structure, and so we are able to make judgments about where the best risk-adjusted returns are. I think a couple of quarters ago we commented on how the equity investment in manufactured housing was really created by some one coming in from (inaudible), and thus effectively looking at the equity and feeling that was a more attractive place to participate.

So I think a lot of what we will do is evaluate it on a case-by-case basis, but ultimately I see us with a pretty diversified approach to where we put capital to work, whether it is straight loans, or equity, and I think the deal flow just in terms of the size has really ramped up. We took down $255 million position at Milford. I think playing in that size is something that makes us more unique, particularly on assets that are transitional. So, we will continue to play across the various sectors and feel very good about the deal pipeline right now.

Joshua Barber – Stifel Nicolaus

Great, thank you very much.

Operator

Thank you. Ladies and gentlemen, this concludes our conference for today. If you would like to listen to a replay of today’s call, it will be available for one week by dialing 303-590-3030 or 1800-406-7325 with the access code of 4615468. We thank you for your participation, you may now disconnect.

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