NorthStar Realty Finance's CEO Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 2.13 | About: NorthStar Realty (NRF)

NorthStar Realty Finance Corp. (NYSE:NRF)

Q2 2013 Earnings Conference Call

August 2, 2013 10:00 AM ET

Executives

Albert Tylis - President

David Hamamoto - Chairman and CEO

Debra Hess - CFO

Daniel Gilbert - COO, Chief Investment Officer and CEO, NorthStar Realty Asset Management, LLC

Analysts

Steven DeLaney - JMP Securities

Daniel Altscher - FBR

Stephen Laws - Deutsche Bank

Matthew Howlett - UBS

Bose George - KBW

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the NorthStar Realty Finance Second Quarter 2013 Conference Call Results. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session, and instructions will be provided at that time. (Operator Instructions). I would like to remind everyone that this conference call is being recorded today, August 2, 2013.

I will now like to turn the conference over to Mr. Al Tylis, President of NorthStar Realty Finance Corp. Please go ahead sir.

Albert Tylis

Thank you very much. Welcome to NorthStar's second 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 thank you everyone for joining us this morning. In addition to Al, I am joined today by Dan Gilbert, our Chief Investment and Operating Officer; Debra Hess, our CFO; and Ron Lieberman, our EVP and General Counsel.

From a macro perspective, the economic recovery in the U.S. continues slowly with modest GDP growth during the first half of the year. The Federal Reserve recently announced potentially taking steps to take further stimulus efforts, which have been in place for the last few years, and have provided a foundation for the current low interest rate environment. As a result, interest rates have been increasing with the 10-year treasury currently at 2.6%, up from 1.8% as of the beginning of the year.

In terms of commercial real estate, fundamentals continue to improve. There is still limited supply growth in most markets, and we continue to see positive trends overall. In the commercial real estate capital market, liquidity also continues to gradually improve, despite the recent increase in interest rates. The first half of 2013, there has been $40 billion of non-agency CMBS issuance, compared to $17 billion during the first six months of 2012. Additionally, full year 2013 projection are currently at approximately $65 billion to $70 billion, compared to $45 billion during 2012.

2013 continues to be a year of strong growth and transformation for NorthStar. We have consistently deployed capital across a broad range of commercial real estate investment, generating strong expected risk adjusted return. Our focus remains on increasing our debt, and creating durable cash flows, through utilizing our broad and established commercial real estate platform, which as of today, includes over 145 professionals, devoted exclusively to NorthStar.

The strength and flexibility of our platform has been evidenced by the approximately $3.4 billion of diverse investments, that we and our non-traded REIT NorthStar Income have committed to year-to-date.

We recently announced our eighth consecutive quarterly increase to our common stock dividend, representing a 100% increase since we began increasing our dividend two years ago. As a result of our consistent and substantial CAD growth, our payout ratio, in relation to our CAD, has actually declined, even with these substantial dividend increases, and now stands at levels more consistent with traditional equity REIT, which traded significantly lower dividend yields. Going forward, we will continue to seek to prudently balance dividend distribution, with retaining cash flow to deploy into accretive investment opportunities.

Our asset management business continues to be an integral driver of our growth. We recently reached a significant milestone. The completion of the primary offering of our first $1.1 billion non-traded REIT, NorthStar income. This successful offering is a testament to our platform, and our efforts over the last few years, to build a top notch captive broker-dealer.

We look forward to continuing this momentum with our additional $2.75 billion of non-traded REIT products in the market, NorthStar Healthcare, and NorthStar Income II.

Over the past 30 days, we have executed selling agreements to several large financial advisory firms for NorthStar Healthcare, and now have a selling group covering more than 46,000 registered representatives, including our top selling firms from NorthStar Income.

While the impact of these new selling agreements will take a little bit of time to realize, we anticipate the capital raising pace for NorthStar Healthcare and NorthStar Income II to significantly pick up momentum in the second half of this year, and into next year. We are confident that we will exceed our initial goal of over $700 million of capital raised in 2013, and expect capital raising in 2014 to be even stronger than 2013.

I will turn the call over to Al, who will further discuss our business strategy. Al?

Albert Tylis

Thanks David. During the second quarter, we closed $1.4 billion of investments, including $443 million of invested equity. Subsequent to the second quarter, we committed to $778 million of investments, including $444 million of invested equity.

Our 2013 investments are projected to generate a weighted average return on equity of greater than 17%. Additionally, on behalf of NorthStar Income during the second quarter, we made $298 million of investments, and subsequent to the end of the second quarter, we committed an additional $233 million of investments.

During the second quarter, we committed to our second acquisition of limited partnership interest of real estate private equity funds. In this transaction, we committed to acquire limited partnership interest, and up to 25 real estate private equity funds, with an aggregate reported NAV of approximately $925 million as of September 30, 2012. These fund interest have seen a 14% annualized NAV increase through December 31, 2012, which goes to our benefit, given that we are purchasing these interest at the September 30, 2012 NAVs.

Similar to our first investment in real estate, private equity fund interest, the structural enhancements associated with this transaction, creates in our view, one of the best risk return profiles available today in commercial real estate. We brought Goldman Sachs Asset Management into the second transaction, and we have received inquiries from multiple institutional investors that have shown a high degree of interest in pursuing a partnership with us on leased or similar future investment opportunities.

To that end, we are exploring bringing in additional institutional partners and/or third party discretionary capital for these types of transactions, to potentially grow our asset management business, and enhance our returns through earning management and other fees.

On the loan origination front, we continue to be active and year-to-date we have completed $775 million of loan originations for us and NorthStar Income. We have an experienced and proven origination platform, with a strong market reputation, and the ability to provide sizeable and specialized capital solutions for borrowers. As we have said in the past, our diversified business allows us to be nimble and allocate capital for the most favorable portions of commercial real estate capital structures.

During the first half of this year, while rates were at all time lows, we acquired $1.3 billion of real estate and locked-in primarily 10-year fixed rate, non-recourse and non mark-to-market financing, with interest rates of approximately 4%. In a rising interest rate environment, we see very interesting opportunities originating from floating rate loans, and securitizing those loans, where we effectively retain a floating rate interest in securitization. We believe that our securitization expertise and credibility with bondholders is critical, as the securitization markets continue to improve.

Overall, we are making significant progress in building a more diverse, less cyclical and higher multiple business, as evidenced by many of our recent accomplishments, including the diversity of our cash flows and our dividend payout ratio relative to CAD, which was a second quarter on an annualized basis, with approximately 74%.

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

Debra Hess

Thanks Al, and good morning everyone. I'd like to take a few minutes to discuss our CAD results in the second quarter, and our overall portfolio. As you saw in this morning's press release, we reported CAD for the second quarter of 2013, of $57 million or $0.27 per share, compared to $39 million or $0.21 per share in the prior quarter. As discussed previously, we believe CAD is a very good indicator of our operating performance, and is an important factor when evaluating our dividend.

Looking at our investment portfolio as of June 30, we had $2.8 billion of commercial real estate debt investment. A majority of our 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 June 30, we did not have any non-performing loans.

During the second quarter 2013, we had no provision for loan losses, and as of June 30th, our loan loss reserve was $133 million or approximately 6% of total loans relating to 10 loans with a carrying value of $155 million.

With respect to our securities, almost all are financed in CDOs, and we continue to evaluate opportunities in the portfolio. During the second quarter, the liquidation of CDO II resulted in the deconsolidation of approximately $135 million of assets, and $65 million of third party liabilities.

Throughout the year, through sales and repayments, we have been unlocking capital and we are strategically reinvested in our repurchased CDO bonds. In total, excluding the liquidation of CDO-II, we have received approximately $130 million of proceeds, which provides us a source of additional liquidity, that we can recycle as new investments.

Our commercial real estate assets continue to perform well, and generate stable cash flows. During 2013 year-to-date, we have grown this portfolio, with the acquisitions of our second manufactured housing community portfolio, 12 multifamily properties, and two healthcare properties.

As of today, our real estate portfolio totals $2.6 billion, and is comprised of $1.2 billion of manufactured housing communities; $638 million of healthcare properties, which are predominantly assisted living facilities; $401 million of net leased properties, and $370 million of multifamily portfolio.

As David mentioned, we are continuing to see exciting investment opportunities, and as of today, we have approximately $220 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

(Operator Instructions). And your first question comes from the line of Mr. Steven DeLaney from JMP Securities. Please go ahead.

Steven DeLaney - JMP Securities

Good morning everyone, thanks for taking my question. Our equity investors are just overly consumed now with interest rate fears or uncertainty, and I just wondered if -- since you are in this market day in and day out, have you seen any impact yet from this 80 basis point rise in rates that Dave had alluded to, most of which of course comes in, I guess March/April. Have you seen an impact, either on transaction activity, cap rates, loan pricing, sort of in the real CRE equity market? How are CRE equity investors and sponsors thinking about interest rates?

David Hamamoto

Yes Steve, hey it's David.

Steven DeLaney - JMP Securities

Hi David.

David Hamamoto

I think certainly not in cap rates, and as you know, cap rates are determined by a lot of factors, but I think the rise in the 10-year really hasn't impacted cap rates. That might have to do with the fact that people are anticipating more growth or the credit spread over cap rates, over treasuries, are still at highs relative to -- at other points in the cycle.

I think there is probably some impact on the fixed rate financing market, because of reduced coverage, but with the floating rate market, we are seeing that that is actually becoming more active, as the fixed rate market is more expensive, and particularly, if you factor in the poor LIBOR curve, where there is not a lot of expectation, that has increased floating rate, while we are actually seeing people rather take more towards floating rate financing, which plays well to us, because that has typically been the sweet spot in terms of where we do the bulk of our business.

Steven DeLaney - JMP Securities

That's clearly a better fit for a REIT balance sheet, especially with the involving net financing. And that (inaudible) into my question to Al. Al, you sounded more positive about the senior loan market than I have heard you in several months, or sometimes we have been together, and I am just curious, Dave has just mentioned, maybe our guidance would have gone to the conduit route, looking for fixed rate. We are saying okay, I will just go with the transitional loan, go with the flow or -- what's behind -- forgive me for being presumptuous, but I definitely detected, personally a more positive view there on the loan market, and is it more this rotation of borrowers and your pricing power there, or is it also for the evolving sort of CLO-CMBS structures that are making sort of the levered returns look better? Appreciate any color you could give me there?

Albert Tylis

I think your intuition there, Steve, is probably right. And I think it's consistent with what we just talked about, and I think what we have discussed. I know there are occasions, which is when rates were at historic lows, and you could really lock those in for an extended period of time, and you could earn double digit current yields on high quality real estate and cash flows with upside, relative to making floating rate loans in that lower interest rate environment, on a risk return basis, all else being equal, we definitely did our share of acquiring those hard assets and locking in that.

So you (inaudible), where you continue -- have gone up, and I think the assumption is it will likely continue to go up. I think that favors that floating rate lending business of ours, which has been a bread and butter business of ours from the get-go from the IPO, and I think our -- you look at our track record and the credit performance of our team, locking most of which has been intact since we went public nine years ago.

I think it's certainly an area where you will see us deploy more capital and think, particularly in a rising rate environment, it's quite attractive. And as you know, when we originate loans, they are floating rate for the most part, and we finance them with floating rate, either facilities, and ultimately securitizations and our retained interest as floating rate instruments. As rates will go up, that will help our interest income and help our overall CAD.

Steven DeLaney - JMP Securities

The five loans for $200 million in the second quarter, was the majority of that floating rate LIBOR index?

Albert Tylis

All but one of the loans was floating rate.

Steven DeLaney - JMP Securities

And what -- I know this, every loan is priced based on the quality and each one is a unique story, but what would sort of be the range on your bridge loans, sort of the range of your spread over LIBOR that you are looking at, in terms of your initial pricing?

David Hamamoto

I think we are averaging around 400 to 500 over.

Steven DeLaney - JMP Securities

Okay. Thanks so much for the comments this morning. Appreciate it. Good quarter.

Operator

The next question will come from the line of Mr. Daniel Altscher from FBR. Please go ahead sir.

Daniel Altscher - FBR

Hey thanks. Good morning. Thanks for taking my call. As I look forward to 3Q, as we are talking about CAD on a run rate basis, I am kind of struggling not to get somewhere close to around $0.30 or higher, such as you throw in New Jersey, and looks like some incremental CAD or realized discount accretion there on the CAD. So is that directionally on track with I guess the plan that you guys are thinking about, for the rest of this year?

Albert Tylis

Yeah Dan, I think you are generally right, the numbers for this quarter do not reflect the New Jersey transaction. So certainly, on a run rate basis, we think the CAD number would be higher than what it is for the second quarter.

Daniel Altscher - FBR

Okay, great. Then also on the private equity transactions. I guess for the first deal, I appreciate you giving the break out and the balance sheet and cash flow statements, specifically for the private equity, but looks like maybe -- there is maybe a write up to maybe $300 million or so. Is that reflective of the disclosure in the press release that showed that the NAV had about 11% annualized growth for that first deal?

Debra Hess

Dan, I am not sure. We didn't have a write-up. What we do is, we take our initial capital as invested. We increase them for any future fundings, decrease it for any distributions we receive, and then we book our, call it level yield on top of that. So we didn't have actually any book-up during the quarter. The increase in NAV that we do disclose in the table, that is really more for information purposes. We are trying to show you how the portfolio, the underlying portfolio has performed, vis-à-vis where we bought it, and in the case of the first deal, effective June 30, 2012.

Daniel Altscher - FBR

Okay, great. That makes sense. Just one final one. You have obviously been very successful on the LTE interest for private equity, and I think probably getting a lot of credibility, and for instance, credibility to the space. But have others recognized this also, and have you seen an increase in competition for other players that are may be not hedge funds and private equity as they can, maybe participating in, but other maybe non-bank lenders or more traditional asset managers that might be looking to either be competitors, or perhaps even partners with you, on new deals?

David Hamamoto

As Al said, we are -- the two transactions that we have done, has clearly made us the leader in the real estate secondary space, and so we have gotten a lot of inquiries, dialog from potential sellers, and as Al said, dialog from a lot of institutions who would be interested in giving us money to execute the strategy further, and we are certainly entertaining, taking on some money in order to grow the asset management business and our fees off of that money, and we think that it will, at least for the next year, be a very interesting place to continue to play. We have gotten calls from other people that haven't historically been in this space, but I don't think that we have seen any of those players actually do anything.

So right now, I think the competition, particularly for larger deals is still relatively limited.

Daniel Altscher - FBR

Thanks for the commentary David, and a very nice quarter everyone.

Operator

Your next question will come from the line of Mr. Stephen Laws from Deutsche Bank. Please go ahead.

Stephen Laws - Deutsche Bank

Congratulations on a great quarter, and thanks for taking my question. But first, I kind of just wanted to hit on one item, the transaction costs in the jump, is that related to the debt offerings during the quarter, or is it due diligence work, and kind of how should we think about that on a go forward basis?

Debra Hess

Stephen, hey it's Debra. How are you? Basically when you actually buy real estate, you have to record it under GAAP as an expense. So you are not going to see anything on a recurring basis. So to the extent we have bought real property, you are going to find any costs associated with that will be an expense in your GAAP income statement.

Stephen Laws - Deutsche Bank

Okay great. That's helpful as we look forward. Then a little, and I apologize if I missed this, but the non-listed REIT, on the healthcare side. As we ramp that up, and it looks like you guys did acquire some assisted living facilities during the quarter. But I guess first, were there any co-investments from the healthcare non-listed REIT there, and as we go forward, should we expect to see more similar transactions with co-investments between NorthStar and the non-listed REITs in more healthcare type assets, or will this really be more focused on investments outside, without the co-investment from NorthStar?

Daniel Gilbert

Steve, it's Dan Gilbert. On the healthcare non-traded REIT, one of the benefits of that being sponsored by the traded company, is the ability to identify certain assets, and invest in those assets, and raising capital into that non-traded company, that non-listed company. And what does for the non-listed company, is it allows for fixed investment like capital, (inaudible) distribution coverage and identifiable assets, which the market offers. So in our first transaction, that's what we did. We made a loan and that's the purchase side of the non-traded REIT and you will see in the future, some assets that will be identified to the non-traded REIT, but by the traded company, in event of raising capital.

Stephen Laws - Deutsche Bank

Okay. That's helpful color there. I guess, with the raising capital approach, you guys -- year-to-date have done a common deal on some exchangeables, some preferred stock offerings. How do you guys think about your capital structure with the mix of capital, and maybe is there a target you look at, is it not really driven by mix, but more kind of market conditions, at the time you need to raise additional capital. Can you may be give us some color there, as far as how you think about addressing needs for additional capital?

David Hamamoto

I think a lot of it is determined by pricing at the time, and which market we think is most attractive. But I think overall, as we said before, the goal is to run a much more [equitized] balance sheet, and so directionally, that's what you will continue to see.

Stephen Laws - Deutsche Bank

Okay. Great. Well thanks for taking my questions, and again, congratulations on a very nice quarter.

Operator

(Operator Instructions). Your next question comes from the line of Mr. Matthew Howlett from UBS. Please go ahead.

Matthew Howlett - UBS

Thanks for taking my question. Just a bigger picture question. I mean, in terms of, David, what you said in the opening comments regarding -- you could have clearly paid a bigger dividend in the second quarter than you did in lowering the payout ratio to something that's more commensurate with the property REIT. As NorthStar transforms into these property verticals, you are growing the asset management fee. I mean, what else could you do to get your cost of capital more in line with sort of the (inaudible) you guys, given your expertise, your ability to acquire assets seem superior to really most people in the space, you have the platform.

I mean, NorthStar has been transforming the last 10 years, the other restructurings that you could do, are there other things that you could do to get your cost of capital down, as opposed to just lowering your payout ratio?

David Hamamoto

I think the main thing is continuing to educate people, so they understand that the company is not a pure mortgage REIT, and I think as the asset management fee income becomes more significant, as the equity real estate ownership has become more significant, all of those back, kind of support what we have been saying, which is this is a much more diversified business, and as a result, we should trade at a lower yield, and I think it has continued education, and continuing to execute on the strategy.

The other thing that we continue to reiterate, but at least currently, seems to be lost in the market, is the difference that we think should exist between internally managed companies and advise companies, and the fact that we are internally managed, and are building franchise value and everything we do, we do exclusively in this vehicle, and we are compensated with stock, and we are completely aligned with shareholders.

We believe over time, that -- that's ultimately going to drive to a lower yield than some of these big asset management firms who have a mortgage REIT as part of their overall business, and to a certain extent, are not as aligned with shareholders.

Matthew Howlett - UBS

Got you. That makes a lot of sense. In terms of (inaudible) corporate restructuring spends like that, so we may consider. But let me zero-in on one, on business line, the manufactured housing space, which you guys have grown tremendously in the last year, and the returns look very attractive. If I look at -- (inaudible) trade at sort of 5% yields or so forth. First, what do you see in that vertical, are you happy with your partner, are you looking to make additional acquisitions, and would you consider may be potentially spinning that business out at some point, would that be something the company would consider?

David Hamamoto

Yeah, I think in terms of what you talked about, getting value for (inaudible), its ultimately, as you are pounding the table and educating people, it's not translating into the appropriate value. To the extent we have adequate scale in these businesses, spin-offs are always a possibility and we reference the -- spinning out the asset manager at some point as a possibility, but similarly that could happen in manufactured housing. Particularly, because that's a space that doesn't really -- isn't overcrowded in terms of the number of pure play manufactured housing REITs that are out there. We are very happy with our partner, we will continue to look for incremental add on opportunities, but with $1.2 billion of assets, we have got a critical mass, and now we can add assets, either on a one-off basis, or focusing on some of the larger portfolios that are out there.

Matthew Howlett - UBS

Okay. We will continue to watch that sector. Then just switching back to the loan side. I haven't seen a securitization from you guys, since late last year, and though there has been some widening of the AAA market, post the (inaudible) renews and business and new deals in the market, what are you seeing -- in terms of executing that side of the business, is the AAA market back to a point where that wouldn't sort of -- (inaudible) spiral, make the economics work, or do things need to still sort of shakeout here?

David Hamamoto

Yeah, you know we have been the leader in the floating rate securitization market, and I think we will continue overall, as part of our strategy, to utilize that method of enhancing. So it’s the loans that we currently have for the most part are pretty much mass-funded today, but we will look to securitize at some point, and it's really figuring out, when the opportune time is.

Matthew Howlett - UBS

Great. Thanks David.

Operator

Your next question will comes from the line of Mr. Bose George from KBW. Please go ahead.

Bose George - KBW

Good morning. Just had a quick follow-up to that earlier question on the CRE yields. I mean, are there fees that we should add as well, because I was just trying to do the math to get to that 13% return?

Debra Hess

Bose, I am sorry, the yields on which asset?

Bose George - KBW

On the CRE loans? Like just to get to the 13% return, I was just wondering, kind of fees we should add as well, to get to the total return?

Albert Tylis

We usually have origination fees and exit fees.

Bose George - KBW

Okay. So if I just do the reverse math, basically that's how I get the difference between the yield and the leverage, and then getting to the 13%?

Albert Tylis

Yes.

Bose George - KBW

Great. Thanks.

Operator

Ladies and gentlemen, this now concludes the Q&A session for us today. I would like to remind you, that the replay for this conference will be available as of 12 PM Eastern Time today through August 9, 2013 at midnight. You may access the replay system at anytime by dialing 1800-406-7325, or locally at 303-590-3030, and by entering access code of 4630509. Again, those numbers are 1800-406-7325, or 303-590-3030, and entering access code of 4630509.

That does conclude our conference call for today. We thank you for participating. You may now disconnect your lines.

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