NorthStar Realty Finance Management Presents at dbAccess 2013 Global Financial Services Investor Conference (Transcript)

Jun. 4.13 | About: NorthStar Realty (NRF)

NorthStar Realty Finance. (NYSE:NRF)

dbAccess 2013 Global Financial Services Investor Conference

June 04, 2013, 02:50 PM ET

Executives

Albert Tylis – President

Debra Hess – Chief Financial Officer

Analysts

Stephen Laws – Deutsche Bank

Stephen Laws – Deutsche Bank

Thanks for joining us today. I’m Stephen Laws, Mortgage REIT Analyst for Deutsche Bank excited to have NorthStar Realty Finance with us today. On my left Al Tylis with NorthStar and then Debra Hess, the CFO as well here to discuss the company and update investors on the recent activity.

I do have bi-rating on the stock $1.7 billion market cap as of earlier this week and excited to get an update Al and Debra. So I think we are going to just launch into a fire set chat and they have some slides that we will use as supplemental materials as we discuss the company. So with that, Al maybe why don't you give us 60 seconds just kind of an overview of the company. The three or four primary business lines.

Al Tylis

Sure.

Stephen Laws – Deutsche Bank

What the portfolio consist of today?

Al Tylis

Sure, as Stephen mentioned. We are about $1.7 billion market cap company. We are diversified commercial real estate and asset management company. We are a commercial real estate lender. We own about $2.5 billion of commercial real estate hard assets manufactured housing, triple net lease, real estate and health care related real estate.

We also have our own asset management business. We are internally adviced, which is different than many mortgage REITs or asset management business in order to the benefit of all shareholders. We created our own broker-dealer. We've raised nearly a $1 billion of capital that we manage on a fee basis and then lastly is more of an opportunistic investor and commercial real estate related assets.

Stephen Laws – Deutsche Bank

Great. Let me maybe go through each of the businesses and touch base on what you're seeing today relative opportunities in each. So maybe start with, I guess what most think of is more traditional business NorthStar has been and the commercial real estate debt investing. How is your increase in size changed your targeted investment size there, maybe talk to the securitization markets and opportunities you have put on recourse financing behind those assets?

Al Tylis

Sure. Yes as Stephen mentioned historically NorthStar started as a mortgage origination firm. I think our credit track record has been unparalleled in the commercial and mortgage REITs space. Our performance through the credit crisis has been again we certainly like anybody else made our fair share of mistakes, but certainly did better than any of our competitors by a wide margin and the bread and butter business for us is direct mortgage origination having the larger scale that we have now has allowed us to look at opportunities and be even more creative in our financing solutions for (inaudible) we recently did, a $255 million mortgage on the Milford Hotel here in Times Square and retail component of the hotel.

And I think we were not the commodity based lender. We do not compete in broker-driven business. We find that, if you're that lender and you're providing the cheapest capital that works until at some point eventually it doesn't, and for us it's always been about relationships, it's been about using our rolodex, it's about creating constructive, thoughtful, financing solutions, value added solutions for our borrowers and I think the Milford was a good example, where you had a great asset and maybe the best hotel submarket in the country.

You had a complicated capital structure, a borrower looking for a mortgage, a mezzanine loan. There is also a retail component in Times Square that they own, that's part of the hotel and they're potentially looking at scenario where they would need four separate lenders mortgage on each, the hotel, the retail as well as the mezzanine positions on both. And we came up a with a constructive solution, where we took the entire capital structure and as part of being a lender, we are also 35% owners of the asset with Highgate Hotels, which is one of the prominent hotel operators in the city.

So that was a good example of being able to use our balance sheet to create a great fixed income for NorthStar and which is the mortgage, but also the opportunity to own a trophy asset in a great hotel market, that we think has substantial upside. And Stephen also mentioned the securitization markets. We did the first securitization in the commercial mortgage REIT space at the end of the last year, since the credit crisis.

It was effectively astatic CMBS deal. We are going to be in the market in the next couple of weeks on a new securitization and that will likely have more flexibility, and in other deal you’ll see something more like that allows for reinvestment when loans—underlying loans pay off as well as has dollars available securitization to ramp up the securitization that can be used to make new investment and I think our ability to do the securitization and sell the underlying bonds. I think is a testament to the credit track record and performance of the company, since it went public in 2004.

Stephen Laws – Deutsche Bank

As far as the deal sizes, Debra now you guys see there. Do you expect going forward more to be larger size like we saw with Milford? Do you still see opportunities in kind of the maybe $10 million to $30 million or $10 million to $40 million loan size, where you operate with a smaller balance sheet? How do you think about your pipeline for an investment standpoint going forward?

Al Tylis

It's a good question; I think you'll see us do everything in terms of size. I think the benefit we are seeing in some of the larger transactions is the level of competition. I think, while there is no shortage of people with dollars to invest in commercial real estate debt. I think in the higher dollar volumes, there is less completion and but at the same time. We do look at this a little; you take a step back and say okay well $2 trillion of commercial mortgage loans coming due next six years.

There is a healthier CMBS market, but not quite where it was and you have other regional banks and others who have not, who are not lending quite the way they use to, in commercial real estate and I think for us as a proven lender with a real team. We have a 130 people as you know within the organization. We have, we think there is a broader longer-term opportunity to fill what will inevitably be a refinancing gap for borrowers.

Stephen Laws – Deutsche Bank

Great. I guess moving to the second business line that I think about four and one that you had for quite a while as well in triple net lease assets. Until six months ago or so was primarily or was entirely more [ph] interesting today given where you're able to get financing on those properties.

Al Tylis

Sure. I think manufactured housing for those of you not familiar with it is, it’s an incredibly durable, sticky, long-term, low-risk fee stream and I know there is lots made about the single family rental market. To me this is the opposite of that, where it’s a proven durable, high cash flow streaming wallets, not the prettiest asset class there is. It's been proven, it's sustainable, it's durable, it increases steadily overtime. It's a – you're not going to get rich fast on it, but you will get rich and maybe slowly.

And I think the overall financing environment even today with the increase in rates that we have seen, very much lends itself to owning manufactured housing assets. And I will give you the example of how we actually got into the business. It was a relationship of ours that came to us and asked us to do a mezzanine loan behind first mortgage on a, that was a $300 million manufactured housing portfolio and the credit was great.

I mean there is, we felt like there was limited risk certainly to a mezzanine position, but we looked at it and said, if we do a mezzanine loan which behind the CMBS first mortgage today, probably prices in the high single-digit maybe 10% area. We looked at it and said, you the owner because the CMBS market is so aggressive in its pricing. You're going to make a 15 current yield on an extremely stable asset class for 10 years.

And we ended up working with our relationship, who was one of the largest private owner. Actually the largest private owner and operator of manufactured housing communities in the country and said look, why don't we buy this together, we won't do the mezzanine loan, but we will just buy this with you and let's look at other opportunities, where we can use with 4%, 10-year fix straight, non-recourse, non-market debt and we and our operating partner earning at mid-teens, cash on cash going in yield and we think there is upside to those cash flows.

So I think that's an example of kind of what we do in terms of we are not just the lender, we are not just an owner. There is clearly and a risk return basis, owning these assets that are again low turnover, high margin businesses with low CapEx. You want to own those, that's the better place in the capital structure and we could have lent and would have made 10%, that would have been just fine, but instead now we own it, we are making 15% and we think there is upside to it.

And I think that's the one of the nice things about what we do in our ability to move up and down capital structures at the appropriate times and the appropriate asset classes.

Stephen Laws – Deutsche Bank

Do you think the growth from the segment will come from additional manufactured housing opportunities? Are there things you're seeing on healthcare or I guess commercial or multifamily there that, you find attractive and what's the endgame? Is this is going to be a permanent business segment for NorthStar or are there opportunities as you get scale in each of, in this business segment, where maybe you do something else with this portfolio?

Al Tylis

I think, it is easy to probably tell, we love the manufactured housing space. So we will continue to look for opportunities and we are CMA, it's highly fragmented. There is something along the lines of $4 million of these manufactured housing rental pad sites across the country and EOS [ph] was the largest public REIT I believe they owned less than $200,000 of those nearby far the largest.

So I think it remains in industry that's very mom-and-pop owned, where there is an opportunity for further consolidation. We would like to help here, based our second non-traded REIT as you know is healthcare, real estate focused. We recently made a healthcare acquisition. I think, that's us. We have a team, we like this space longer term, the dynamics there. So we could expect to see us grow that and I think, you know it's a question, we get frequently which is you have these various business at the same time, if there comes a point in time where any one of them is large enough and to be able to standalone and we are not getting the credit that I think we deserve and I think this is actually one place, where I would like to turn to those slides.

So here, if you look at this slide. What we try to show here is, you take our cash flow projections for this year and you kind of say, okay where are they coming from. So 43% of them were actually coming from essentially real estate, 19% of them are from our legacy portfolio, 22% from our new loan originations or loans we've originated the last three years, and then 16% from asset management fees. And then the reasonable minds can disagree on what the appropriate yield is, but we kind of put of range of what we think and equity reach to trade out and asset manager or legacy REITs, new REITs.

And if you apply our cash flows to any one of these to the appropriate yield for those particular assets. You get to a level, we are trading on a nine yield today. We are right around the nine yield, with a dividend that's been increasing for seven quarters in a row in a growth vehicle. All right, we are not just the dividend play, we've been a growth vehicle for some time now and there feels, there ought to be some material multiple expansion within our business and at some point, if that doesn't happen.

We are aligned with the shareholders, right we are internally managed. We would look to spin off, one or more of these components to be able to extract the appropriate value.

Stephen Laws – Deutsche Bank

That's a great segue, into the asset management business I think, which my opinion undervalued not reflected in the book value of the company. I think a lot of people forget that, when they look at comp tables. Saw extremely strong growth in April over $100 million of growth, but can you talk about the traction you're seeing there. You mentioned the second fund that's healthcare focused. I know you've got a third fund that's going to be the CRE debt two.

Al Tylis

In May, I would expect us to continue that pace into June and where as you know we've it's taken a long time to build this out. We have 50 people in our broker-dealer. We've spent almost four years now, building out our own broker-dealer. It's not been an easy process, but we have material traction at this point. We have a brand that's recognized. We are one of the top sponsors in the space.

We are doing what we said, we are going to do. We are originating loans, that's covering the dividend and it's exciting for us. The idea of raising over $100 million every month, where you're leveraging the people and earning every dollar just goes bottom line to the shareholders and without risking capital. It's a pretty powerful tool for us and I think, as much as we can continue to grow it and we have a second billion dollar vehicle that we just started selling, we have a third that's $1.5 billion that is effective with the SEC and we will start selling as soon as the first one reaches its $1.1 billion target.

Then we should probably expect this time, the fourth vehicle at some point during the year and you know as long as we can do it responsibly and be good for do share this to the non-listed REIT shareholders. We would love to continue to scale this business and so it’s a huge priority for us.

Stephen Laws – Deutsche Bank

I think you probably just answered my question given your comments on May growth and expectations for June, but I've been asked a couple of times last month. How does the volatility in the mortgage REIT equities impact what you're doing on the non-listed REIT? Obviously it's your pace of growth is pretty steady, but what do you hear back from the field from your people out there selling those funds, what are they saying as far as the target audiences reactions to what we're seeing in the equity market?

Al Tylis

Yes, I think so far there haven't been any change in the pace and I actually, it's hard to tell what if any impact, my sense is there won't be any impact, it's largely a senses. It might marginally help.

And the reason I say that, I've had some people asked us that today and kind of had this odd look on their face, when I say that but the reason I think, it can help is the investors by the non-traded REITs are one of the reasons. I think one of the primary reasons, as their focus on not having the volatility that they now see on the screens for real estate product and I think, I'm not seeing the stock trade up, one day down, one day the market's up.

I think it's more of a fixed income like product, where our average ticket size is little less than $40,000, they give you $40,000. There's a promised coupon, if we do our job, they get their coupon and then they get their money back and I think increased volatility can actually be helpful, but I think my sense is on the margin. It's not on impact.

Debra Hess

Actually it's also in our corporate presentation on our website. We actually showed, the past few years. What the capital raising has been and if you look back to 2007, 2008. You'll see that in fact they did actually raise a significant amount of capital even during those years. So I do say, that this year it's been historically an $8 billion to $10 billion a year business.

We think that could be on track for maybe even $15 billion this year and I think what's nice about that it is a reasonably new entrant in the market. We're just been in sponsoring within a last few years, within the first year we moved up into a top 10 spot in terms of a sponsor and now we are hovering around the fifth or sixth spot and what's important about that is the top 10 sponsors tend to raise call 75% of the capital in the space.

And so I think that what we have done is by building this business, person by person and really putting the effort into it. We've really demonstrated our ability to be in this space for the long-term and generate this significant cash flow stream without any material equity at risk.

Stephen Laws – Deutsche Bank

And following up on the question, I had about triple net lease, but I think you said 40, 45 employees of the 130 in NorthStar target. When do we need to try to unlock the value for this very attractive recurring cash flow business that really had to feel like you get a lot of credit in your public stock price, but can you talk about what your view is there over the next couple of years, as this continues to grows from I believe $35 million to $40 million of cash flow this year to, the way I expect close to $100 million of cash flow some time by year end '15, on annualized basis.

So what do you really looking at is your bogey for how to address this business issue going forward?

Al Tylis

No, I think Stephen you're hitting through the nail in head in terms of so we're thinking about and it's definitely a little more art than science in terms of, is it getting credit, if not would you, do you spin it off and I think for us, an important consideration in any spin off would be, is it big enough, important enough as a standalone vehicle to attract institutional investors to have interest from analysts.

The overall, making sure it's not the world doesn’t need another $200 million vehicle I think, having critical mass in that vehicle and I think, we'll get a $100 million of free cash flow, with any reasonable permanent fee stream like multiple. It's clearly big enough right and so I think, it's something we'll continue to evaluate and see how it progresses.

I think the other thing that we actually don't want to spend a lot of time on is, the broker-dealer itself and we have 50 people in the broker-dealer. There's a the name escapes me but, American Realty Capital has a broker-dealer that it's on the road, so looking to IPO at this point and they're actually as I understand getting a pretty significant multiple on just the broker-dealer and now putting aside the asset manager business, which is what we're talking about.

Our broker-dealer itself is going to have value and be making money in the years to come and if you look through our corporate presentation. Actually not even something we spent much time describing value too but you could see if you have it real.

Stephen Laws – Deutsche Bank

I think of is more special situations but, obviously the JV private equity investment started generating cash flows, expect a very attractive returns there. Can you talk any update there, what opportunities Debra maybe do you see to do other similar type of investments and then also kind of special situations bucket? I think of your CDO debt repurchases, where are those priced today, are they more opportunist, by more is it more a function of maybe winding down some CDOs and realizing some of the gains and value there. So maybe talk about some special situation segment opportunities.

Al Tylis

Sure. I think the transaction we did both limited partnership interest last December, when we signed it up. I think in and most people would agree is, it was one of the more interesting, more compelling transaction. Certainly in a risk return basis that we've ever done and lot of our investors have asked us, was this is a one-off grade transaction or is it something that can be replicated, is there a broader opportunity to buy these secondary real estate private equity fund interest and I think you know about probably six months ago or when we first did it, my answer was candidly, I have no idea.

Today, I feel much better that there really is a broader opportunity and I say that because there are the amount of enquiries we are getting both from people who own, fund interest as well as people who saw what we did larger financial institutions, who I think would like to partner with us on these types of transactions. I think, my sense is there really a broader really interesting opportunity and it's a kind of perfect asset class for us because it involves real deep credit work, it involves complicated structures understanding, lots of different commercial real estate assets and different markets, understanding manager motivations, timing of assets and that kind of thing.

And then, there is just a limited universe of buyers. There is – it's not a natural fit for real estate private equity funds won't get approved by other real estate private equity funds, when they buy they interest, hedge funds won't get approved by others. I think, we are not viewed necessarily as competitive to real estate private equity funds, but we are more their lending relationship often time. So I think there it has a lot of the characteristics we like and I do feel pretty confident that there is a broader opportunity to make additional investments.

And then I think on the CDO's I mean where we are, we liquidated one of our CDO's recently. I think there's a way to recycle capital. We definitely are looking at the CDO's, our bonds, our structures and particularly like our CDO like our CDO two, the one we liquidated nobody I don't think anybody really subscribed residual value, we didn't have much equity in the first place, we bought a lot of bonds back at $0.50 on a $1. Recovered $0.99 on the $1 and I think those kinds of opportunities, we want to continue certainly to explore.

Stephen Laws – Deutsche Bank

Great, I guess I'll ask one more question and maybe open it up say probably, if there's any, but I want to hit on the internal management structure. I think that makes you guys unique versus most of the mortgage REITs out there. Can you talk about maybe what drives your capital deployment decisions especially given how, internally managed you guys maybe or incentivize more ROE focus and suppose to assets under management and then coupled with that, when you see market volatility like today? Do you ever consider repurchasing stock or is it really a situation where the opportunity available in your various business segments is more attractive than maybe your short-term decision to repurchase stock?

Al Tylis

Sorry, I just I clicked on that slide in and this is our little attempt to kind of clause our humor here, but we've built, if you just think about externally managed REITs that manage other funds. I mean that's what this is non-trader REIT is, it's a fund. It's like a fund and we've now created a fee stream that's worth today hundreds of millions of dollars and obviously more as we continue to grow it, that's going directly for shareholders benefits and again if we were externally managed, management would be getting the benefits of these fee streams.

I think, we've always talked about the importance of being internally managed. The importance of being aligned with the shareholders and maybe that's been a reason we outperformed the externally managed REITs since we've been in public, but we never had something as stark as this to point to, where you could look out and say okay here's real dollars that would be otherwise going out to door, that are going directly for benefit shareholders.

And then in terms of capital deployment raising, buying back capital structures. We are 100% aligned, right so our focus is simply. How do we get the stock higher, both today, tomorrow and long-term? We are long-term investors in the company, we all are owners of stock, we're focused on creating the most long-term value that we can in the stock. So that may mean in the past we've bought back portions of our capital structure that may mean raising capital to make awfully compelling investments someday.

Right and that's what we have done when we did the limited partnership deal last December. So I think from a shareholder’s standpoint, our structure is extremely aligned and our interest the portion. What goes into the equation of capital raising, repurchasing capital and making investments, now making investments has, is the same equations I think anybody here in the audience would go through because we're shareholders like everybody else.

Debra Hess

I think one other thing, I would just add on the internally managed. I think one thing that gets lost some times is, we have a full robust organization. We have a 130 people, we have an investment team. We have a loan origination team and we have real estate team, we have an asset management team. We have four offices around the country legal, compliance, etc. and so it's very different than an external manager to where you've got some people that are allocating their time to vehicle as oppose to 130 people that are spending 100% of their time and making money for the NRF shareholders. And I think at that point gets lost a little bit as well.

Al Tylis

It's a great point Debra. And Debra should know because she used to be the CFO of an external mortgage REITs as well. She might be talking from experience.

Stephen Laws – Deutsche Bank

Well great, I think that's a great point Debra.

Unidentified Analyst

Just going back to to some of the parts page, in those four buckets does one of those include the CDO realized discounts?

Al Tylis

No, it doesn't.

Unidentified Analyst

And so from the some of the parts perspective that sort of 50 of your 350 of growth cash. A quarter of your CAD, how should we think about that obviously there is 380 embedded value in those, but how should we think about that cash flow overtime and what would you do with the proceed?

Al Tylis

I think you're seeing the realized discounts probably coming in at a pace. We've given the 5.7 years as a weighted average life for realizing all those discounts and when we liquidated CDO, when we sell bonds. We monetize that discount quicker, so our goal is generally to accelerate that to the extent reasonably possible and now again, we also own bonds and CDOs that are backed by loans that we originated.

Those CDO's won't be liquidated, right there where there is we think substantial residual recoveries in those and they have very healthy long-term cash flows, that we have no interest in getting rid of versus the CDO we liquidated. We were earning $200,000 of fees per year. So we have to evaluate kind of where we are, what we own, what we are receiving in those transactions.

Unidentified Analyst

The last two weeks have not been kind to mortgage REITs. I think it's basically the steepening yield curve, your balance sheet I think has about $2 billion of floating rate liabilities, so you try to match with floating rate assets. The other $3 billion, can you give us any kind of sense of interest rate risk in per 1% rise in interest rate?

Al Tylis

Sure. So I'm going to, so this is our CAD for the year. So there's a $0.95 projection for midpoint free cash flow, effectively cash available for distribution for the year. If the 10-year treasury went up 100 basis points that 95 when we redo the slide will be 95 again. We are indifferent to changes in the 10-year treasury on LIBOR. There are some marginal incremental impact, but we are talking $0.01 or $0.02 maybe and I think maybe longer term. When we originate loans, we are doing floating rate loans, financed with floating rate liabilities and let's say, when we did securitization, where we financed two-thirds of the capital structure with selling bonds we retained one-third that one-third is floating rate itself.

So to extend LIBOR were to go up, after we did the securitization that actually is our retained interest is essentially floating rate instrument. So the – we are largely indifferent to both changes in shorter term as well as longer term interest rates and I think there clearly has been an overall sell off in certainly our stock and I think REIT related stocks in general and I think one, because I think there's an expectation of the cap rates will somehow automatically move and I think we've been talking to some folks today.

There is a recent Deutsche Bank report that came out that actually had something that was particular interesting, which is if you look at the cap rates across the countries are blended cap rates today across all asset classes across the country, looking where the 10-year is, that spread today is around 500 basis points.

The historic spread of unlevered returns on commercial real estate, the cap rates and treasuries is less than 400 basis points. Right so in other words, you could have a 100 basis point increase in the 10-year and you'd still end up only back historic spreads between the 10-year and where cap rates are today. So I think there is a little bit of a fewer grease Stephen. But I think there is a little bit of disconnect in some of the selling of the REIT.

And you kind of couple all this with, the overall dynamics in commercial real estate. You still have muted supply, increasing demand and while rates have ticked up, they're 2%, you can still finance incredibly cheap long term non-recourse buying commercial real estate assets. I think what we’ve seen in the market has been, in my sense it is going to reverse fairly quickly because there is pretty strong forces I think behind commercial real estate and then I think also just the context of which rates are to increase.

Right if you think they're just going to increase a couple 100 basis points, without any underlying economic growth, that's one thing. If you think there is some embedded strength in the economy, maybe inflation who knows, those are good things for commercial real estate, they're going to be positive, you're able to reset rents. You're able to charge more for healthcare.

I mean there is underlying things that would go presumably go along with an increased rate environment as well.

Stephen Laws – Deutsche Bank

Great, well I think that does it for our 35 minutes today. Al and Debra thank you both for joining us today. I appreciate.

Al Tylis

Thanks, Stephen.

Debra Hess

Thanks, Stephen.

Question-and-Answer Session

[No Q&A session for this event]

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