Colony Financial Management Discusses Q3 2013 Results - Earnings Call Transcript

| About: Colony NorthStar, (CLNS)

Colony Financial (CLNY) Q3 2013 Earnings Call November 8, 2013 10:00 AM ET


Lasse Glassen - Senior Vice President of Financial Relations Board Division

Richard B. Saltzman - Chief Executive Officer, President and Director

Darren J. Tangen - Chief Financial Officer, Principal Accounting Officer, Chief Operating Officer and Treasurer


Daniel K. Altscher - FBR Capital Markets & Co., Research Division

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division


Greetings, and welcome to the Colony Financial Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Lasse Glassen of Addo Communications. Thank you, Mr. Glassen. You may begin.

Lasse Glassen

Good morning, everyone, and welcome to Colony Financial, Inc.'s Third Quarter 2013 Earnings Conference Call. With us today are the company's Chief Executive Officer, Richard Saltzman; and Chief Operating Officer and Chief Financial Officer, Darren Tangen. Neale Redington, the company's Chief Accounting Officer, is also on hand to answer questions.

Before I turn the call over to them, please note that on this call, certain information presented contains forward-looking statements. These statements are based on management's current expectation and are subject to risks and uncertainties and assumptions. Potential risks and uncertainties that could cause the company's business and financial results to differ materially from these forward-looking statements are described in the company's periodic reports filed with the SEC from time to time. All information discussed on this call is as of today, November 8th, 2013, and Colony Financial does not intend and undertakes no duty to update future events or circumstances.

In addition, certain of the financial information presented in this call represents non-GAAP financial measures. The company's earnings release, which was released yesterday afternoon and is available on the company's website, presents reconciliations to the appropriate GAAP measure and an explanation as to why the company believes such non-GAAP financial measures are useful to investors.

And now, I'd like to turn the call over to Richard Saltzman, Chief Executive Officer of Colony Financial. Richard?

Richard B. Saltzman

Thank you, Lasse, and welcome, everyone, to our third quarter 2013 earnings call. As a reminder, we did pre-release our third quarter earnings in connection with our equity offering last week. And our more detailed earnings release was issued last evening, which included several significant and exciting updates we'd like to share with you on this call.

As reported last week, our third quarter results were great. Quarter earnings were $0.39 per share, which, again, covered our $0.35 per share dividend, notwithstanding our significant $550 million investment in Colony American Homes that only contributed about $0.01 of core earnings in the third quarter. The vast majority of our core earnings production this quarter came from our debt portfolio, which continues to perform well ahead of underwriting in the aggregate, despite the limited use of financial leverage.

Moreover, Colony American Homes did move from a small core loss in the second quarter, to a small positive core earnings contribution in the third quarter, and we expect this positive trend to continue into 2014. Combined with a growing concentration of other debt and equity investments in the Colony Financial portfolio, we are very optimistic about our 2014 core earnings outlook.

In addition to continued asset management success as being realized across our investment portfolio, we've had 15 full and partial investments since the beginning of 2012, generating an aggregate 20% internal rate of return and 1.5x equity multiple. We see a significant ramp up of deal flow in all of our debt and equity strategies. Investment volume has increased to more than $550 million since July 1, including a large European loan portfolio acquisition and our first credit tenant leaseback.

On the loan acquisition front, our business is thriving, both domestically here in the U.S. and in Europe. In the United States, we recently acquired loan portfolios from 2 separate government agencies. A portfolio of 100% performing loans from Freddie Mac and our 9th portfolio of commercial real estate loans from the FDIC. The Freddie portfolio is comprised of 27 loans primarily collateralized by multifamily assets with the balance a combination of student housing and seniors housing collateral. The portfolio is currently unlevered. However, it is expected be financed with non-recourse financing in the near future and the targeted levered equity return is in excess of 13%.

In addition, we also recently consummated a structure transaction with the FDIC to acquire a portfolio of $415 million performing and non-performing loans, with an aggregate unpaid principal balance of $199 million, consisting of substantially all first mortgage recourse commercial real estate and acquisition, development and construction loans.

Now I mentioned on our last call, that we were finally seeing some market activity in Continental Europe, as banks get more serious about disposing troubled legacy assets. I'm delighted to report that our European team just secured the acquisition of a large first mortgage loan portfolio, secured by institutional quality office in retail assets in Spain through a European bank. These loans are payment current but overleveraged, what we typically referred to as sub-performing loans. Because of these credit characteristics, we were able to acquire these loans at a significant discount to par, and Colony Financial has invested $145 million in this transaction, prior to any potential financings or co-investment.

At present, our European team is pursuing a robust and diversified pipeline throughout the continent, including loan originations, loan acquisitions, REO purchases and triple net lease opportunities, typically involving some form of seller or asset distress, and we expect to add more exposure to well underwritten European investments in the near future.

Moving on, loan origination activity continues to turn [ph] around several lending platforms we recently formed, and bespoke lending opportunities around more complicated credits and off-the-run asset classes. On our last call, we introduced 2 new platforms that target lending to transitional assets. One focus is on general commercial real estate and the other on multifamily. Both programs offer floating rate loans to borrowers for relatively short terms, typically 2 to 3 years, and will use low-cost, nonrecourse, match term financing to generate targeted 11% to 15% ROEs.

In connection with the commercial platform, we've already closed or have term sheets issued on 11 loans totaling $160 million and are negotiating $150 million warehouse line to aggregate more loans for an ultimate floating rate securitization. Based upon current market conditions, we expect equity returns to be well in excess of 12%. Furthermore, the multifamily platform has built a substantial loan pipeline as well, closed its first 2 loans totaling $114 million, secured $150 million non-recourse credit facility and is targeting equity returns in excess of 11%.

Increasingly, we are also focused on equity-oriented investments, as the distress cycle in the U.S. winds down and real improvement in the underlying economy takes hold. As an example, we just contracted to acquire $125 million office campus occupied by a single-A-rated tenant under a triple net lease. And while this deal is not expected to close for another month or so, preliminary debt quotes indicate an initial cash-on-cash yield in excess of 13%.

Lastly, I'd like to provide an update on the operational progress and results from the Colony American Homes business, which represents our single largest investment. To manage the Homes portfolio, we have built a substantial organization composed of more than 1,000 dedicated employees, including both full-time equivalents and affiliate relationships, who are deployed across 3 main functional areas: acquisitions, renovations and leasing and property management. As of last week, Colony American Homes owned approximately 14,500 homes, up from approximately 12,200 as of June 30, with a diversified national footprint across 9 states, including Arizona, California, Colorado, Delaware, Florida, Georgia, Nevada, Pennsylvania and Texas. The current average cost basis across the Colony American Homes portfolio is approximately $178,000 per home, which we also believe represents a substantial discount to replacement cost and is expected to generate a net yield at the asset level, including renovation costs of approximately 6% on average.

On average, across all of our own homes, renovation spend per home is approximately $20,000. As of last week, the overall portfolio was 61% leased, up significantly from 49% leased as of June 30, 2013. The improvement in portfolio occupancy is the result of a deliberate strategy to slow acquisition activity, in order to focus on improved operational performance, including higher renovation throughput and leasing productivity [ph].

During the third quarter, Colony American Homes averaged approximately 1,000 renovations and 900 new leases per month. This compares to 900 and 650 respectively in the second quarter. Acquisitions averaged approximately 600 homes per month for the third quarter, as compared to 1,400 homes per month in the second quarter. Another Colony American Homes milestone during the third quarter was the closing on a $500 million credit facility, and it is expected the company will upsize this facility to more than $1 billion by year end.

Colony American Homes also began closing loan originations via a new lending program that other owners of single-family homes for rent and this loan portfolio, once scaled, can also be financed via securitization in the future. Speaking of securitization, there is exciting news for the single-family home for in-asset class. The first securitization closed this week and the execution was simply superb. Loan proceeds were approximately 75% loan-to-value or around 88% loan-to-acquisition cost, and the all-in pricing was LIBOR plus 166 basis points, for a fully extended 5-year term. The Colony American Homes management team is actively working towards our own securitized financing, which we hope to complete in early 2014.

All in all, this is a great time for our business. Terrific current results, lots of acquisition activity across our various business lines and geographies, all leading to a very bright future ahead for Colony Financial.

And with that, I'd like to now turn the call over to Darren Tangen, our COO and CFO, for a more detailed summary of our third quarter financial results.

Darren J. Tangen

Thank you, Richard. Third quarter 2013 core earnings were $25.7 million, or $0.39 per basic share, and net income was $21.1 million or $0.32 per basic share. The $0.07 per share difference between net income and core earnings is composed of approximately $0.02 of non-cash equity compensation expense and $0.05 per share of depreciation expense, resulting from our interests in single-family homes and our hotel portfolio. Book value per share was $18.53 at September 30, 2013, down slightly from $18.58 at June 30, 2013. However, fair value per share increased from $19.91 as of June 30 to $20.36 as of September 30, 2013. Also, we paid the dividend of $0.35 per share for the third quarter, consistent with the prior quarter.

With respect to our third quarter earnings, our share of loss from Colony American Homes was $1.6 million on a GAAP basis or approximately $0.02 per share. However, as Richard indicated, core earnings from our interest in Colony American Homes, which adds back depreciation, was positive $1 million or $0.01 per share. Considering the fact that Colony American Homes is just beginning to turn profitable on a core earnings basis and represented approximately 30% of our portfolio in the third quarter, core earnings of $0.39 per share was a very good result, reflecting the strong performance of our other investments. And we think it's an attractive way to participate in the upside of Colony American Homes, with an attractive current dividend from Colony Financials' other various debt and equity portfolio investments.

Furthermore, continued improvement in Colony American Homes' operating and financial performance in 2014, in addition to a larger portfolio concentration of other high-yielding debt and equity investments within Colony Financial, in fact, Colony American Homes represents closer to 25% of our portfolio after accounting for all the investment activity announced since the end of the third quarter, should set the stage for Colony Financial's 2014 core earnings to exceed 2013 levels.

On the asset management front, I'd like to provide a few performance statistics across our various investment strategies as of the end of the third quarter. Loan acquisitions were approximately 37% of the portfolio and the majority of this category is represented by our small balance loan portfolios. We had continued strong performance from our seasoned small balance loan portfolios during the third quarter. We currently own an interest in 18 seasoned small balance loan portfolios that we acquired at an average purchase price of $0.53 on the dollar. We have resolved approximately 36% of the unpaid principal balance as of September 30, 2013, and total collections on these resolved loans averaged 1.4x our purchase price basis.

Trailing 12-month weighted average current yield for the remaining loans in these portfolios, as of September 30, was 9%. And for our 8 seasoned FDIC loan portfolio acquisitions, 7 have paid off or fully deceased their acquisition debt and are distributing cash to us.

Turning to our book of new originations, which represents a approximately 28% of our total portfolio, these positions sit between an average first dollar loan-to-value of 30% and average last dollar loan-to-value of 71%, and yields 11% on a blended basis, a very attractive yield, given this risk profile.

The balance of our portfolio falls under the equity category and is currently dominated by our position in Colony American Homes. Approximately 40% of our overall portfolio is now represented by direct equity or equity-linked investments. And as we've mentioned in the past, we expect this figure to increase in future quarters. We also expect our European exposure to increase from our current 2% to closer to the 9% pro forma for the just announced Spanish loan portfolio acquisition, and there could be additional European investments in the near future, as mentioned by Richard.

Our capital deployment has been robust throughout 2013, but particularly active in the last couple of months. In order to take advantage of these investment opportunities, we proactively raised approximately $200 million of common equity last week. The deal size also happened to correspond with the amounts outstanding under our credit facility at that time, which was also approximately $200 million. However, Colony Financial has also been active in the debt capital markets in 2013, issuing $200 million of 10-year convertible debt in April at a 5% coupon and closing our new $360 million corporate credit facility in August on significantly improved terms and pricing. And we are currently speaking to several banks about a possible upsizing of our credit facility by approximately $40 million to $50 million. We are also in the documentation process for a new $150 million warehouse credit facility for our floating-rate securitization loan origination program, which should be closed by year end.

At the investment level, we are actively pursuing non-recourse, match term financing on the loan portfolio recently acquired from Freddie Mac, the Spanish loan portfolio and the pending Midwest triple net lease office campus acquisition. We also intend to take advantage of the securitization markets for our floating-rate loan origination platform. And Colony American Homes will also look to issue a securitized financing in 2014.

From Colony Financial's perspective, these corporate-level and investment-level debt executions, plus availability under our credit facility should provide approximately $400 million of liquidity in the near term, plus we estimate we could have approximately $250 million to $350 million of repayments and other distributions during 2014 that would add to our liquidity next year.

Given all of this, we feel extremely well positioned to take advantage of our considerable pipeline of deals and to utilize the debt capital markets to execute some highly accretive financings, all of which should benefit our earnings production for next year.

That concludes our prepared remarks, and we would now like to open the call up to Q&A. Operator?

Question-and-Answer Session


[Operator Instructions] Our first question comes from Dan Altscher with FBR.

Daniel K. Altscher - FBR Capital Markets & Co., Research Division

Question, as we kind of think about 2014 a little bit more conceptually at this point, I'll say, a lot of good things going on, as we think about core earnings from quarter [ph]. But if you can give -- maybe give us all like a priority list of how you think about what is contributing the most to the outlook for '14 being better? Is it homes, is it securitization, the new investments, whatever? How can we think about that?

Richard B. Saltzman

Thanks, Dan. I think it's really all aspects of our business. So as we just cited in our prepared remarks, the existing portfolio has matured and is really contributing, both current income and capital gain, as a function of the appreciation and residual value that we have in many of the positions that we put on over the last couple of years. But in addition, the new acquisitions and new platforms that we've been establishing are beginning to kick in as well and establish some pretty significant contributions to our core earnings. And, of course, we're delighted that this past quarter, Colony American Homes finally went from being a slight negative to now a slight positive, where the trajectory, again, given stabilization of that business and the stabilization of the portfolio, is only going to produce better results in our opinion. So it's really no one factor. It's really a combination of kind of all of the legs to our stool that are contributing to this. And then, of course, on the acquisition side, in addition to what I just cited, some of these opportunities that we're now looking at in Europe, we think are going to be accretive to our results as well.

Daniel K. Altscher - FBR Capital Markets & Co., Research Division

Okay, great, yes. So it sounds like is that all the legs of the stool, and maybe a couple of extra legs in there. You know, and just thinking about that also, as we roll forward to the dividend. And I'm sure this is the question you don't want to have to answer, but how do we think about maybe dividend trajectory, as well as core earnings power? Seems to look like it's going to exceed the $0.35 quarterly run rate.

Richard B. Saltzman

Well, look, I think for the moment, we're very content to be able to cover what we've been paying out as a regular way dividend, which has been $0.35 a quarter, $1.40 a year. If you recall, at the end of last year, actually, our results from a taxable income standpoint, exceeded that level. So therefore, we had to pay out a special distribution, a special dividend as well. But we want to be prudent here and not get ahead of ourselves. So I think, for the moment, we're very comfortable kind of keeping the dividend where it is. And should our results really start to kick in very meaningfully above those levels, of course, we'll be looking at a possible increase.

Daniel K. Altscher - FBR Capital Markets & Co., Research Division

Okay. Yes, I mean, even if it doesn't increase, it still then would presumably accrete the book value, so I guess shareholders get it either way. And then just also, you sounded particularly bullish on Europe, probably maybe a little bit more bullish than in the last couple of quarters. What's changed there beyond maybe having a bigger presence on your part or more feet on the ground, but what fundamentally has changed about Europe? We've heard about private equity getting a little bit more interested in the region. Is it just a -- great contrarian play, or fundamentals really improving there, or is it just lack of bank financing?

Richard B. Saltzman

Well, look, we've been anxiously awaiting for the opportunity to materialize in Europe now, for several years. And, of course, as an organization, Colony has had boots on the ground since the mid-1990s in Europe. So we have a very substantial, formidable team in many of the major markets in Continental Europe, basically, ready to go. And it's been frustrating, to date, that Europe has really lagged behind the U.S. in terms of dealing with the bubble and the credit crisis, and, of course, they were very focused on just the euro itself. But now that, seemingly, that issue is kind of behind the sovereigns. I think there is a lot more pressure on the banking institutions to kind of clean up their balance sheets and their positions that are fraught with a lot of non-performing and sub-performing loans, kind of consistent with what we saw in the U.S. just a few years back. So maybe it's delayed from the standpoint of Europe kind of being 3 to 4 years behind the U.S. But we're delighted to finally see that pressure occurring, and the banks really starting to deal with some of their problems. And, therefore, we're quite optimistic about our deal flow on a go-forward basis here over the next year or 2.


[Operator Instructions] Our next question comes from Jade Rahmani with KBW.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

I was wondering, can you review your current investment capacity? What's the current cash on hand and available debt capacity, not including the securitization potential that you mentioned? And also, how do you prioritize upsizing of your credit facility, as well as [ph] doing securitization with potential equity or other capital raises to fund incremental origination?

Darren J. Tangen

So Jade, it's Darren, let me try to tackle that. I mean, I think I cited in my prepared remarks that we have approximately $400 million of liquidity. And the lion's share of that is through availability under our corporate credit facility. But it also assumes a couple of investment level financings that we're actively pursuing. And, in fact, fairly advanced stages on closing those investment level financing. So I think we've got pretty good clarity on our liquidity picture today. And that's what that $400 million number is that I cited. As to securitizations, that's really more of a 2014 event to be candid. And to the extent that we're pursuing those kind of financings, that could be incremental liquidity.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And of the $433 million of originations post the quarter, what percentage of that has actually fund?

Darren J. Tangen

Of that amount, as of today, all but $125 million will have funded.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. A broader question. When we look at the portfolio changes going on and the introduction of additional equity investments beyond the single-family, what do you look at as the optimal mix of that versus the equity investments? Is it 50-50, or something similar to what you currently have?

Richard B. Saltzman

Jade, let me try to tackle that one, it's Richard, and thanks for joining us this morning. Look, we don't have a set formula here. I think our view is we want to be agnostic to formulas. We really want to be opportunistic. And we're going for the best returns that we can find, subject to taking, what we believe, is reasonably prudent risk. And the reality in the United States today is, versus some of the comments I was just making about Europe, is that distress is pretty much disappearing. It's still there, of course, in the single-family space, that's why we're still optimistic about Colony American Home. But in the commercial space, things are tightening. The real economy is improving. Absorption is taking place, albeit very slowly, because the real economy is only improving slowly. And therefore, as we've indicated over the course of the last several quarters, we're moving down the caps back to take advantage of the improving credit conditions, including looking at equity. And the equity investments would include even equity platforms, like Colony American Homes, whether Colony-sponsored or maybe other best-in-class third party management groups that we might choose to get them. So we think this is the beginning of the real cycle. And this is where you can make outsized returns in equity. And at the same time, we're still very sanguine about the level of returns that we can generate in some of these newer lending platforms, because, frankly, given some of the regulation through Dodd-Frank and the like, the traditional lending institutions are being kind of put into a straight jacket with respect to, maybe, some of the traditional lending opportunities that they used to pursue. So that's why were also sanguine about that. But there's really no formula, in terms of what we think the appropriate mix is. But if we had to forecast, I think, the equity part of our portfolio, over time, is going to increase.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Great. And just on the single family side, you noted you're pursuing a securitization. Players in the space have typically talked the leverage ratios of 34% to 40% similar to multifamily. However, I think you noted the advanced rate on the invitation homes deal of 75% on market value and nearly 90% on cost, which thereby allows the monetization of home price appreciation. Do you guys view this as a game changer for the sector? And also can you comment on the potential originations on the finance side of the business that you're just dating to provide loans to the single-family, smaller and mid-market operators?

Richard B. Saltzman

Sure, no. The securitization is definitely a game changer, in terms of the institutionalization of the asset class. And it's really only available for those of us who have scale, which fortunately, as we've discussed in previous calls, a limited number of groups. And we can now take advantage of substantially leveraging the mature part of our portfolio on the one hand. But on the other hand, we still also want to be mindful as you suggest relative to the multifamily piece, that we'd still like to go to public, all things being equal. And recognizing that public markets typically want to see more conservative leverage, we would try to balance what's encumbered, which might be very substantially leveraged versus what's unencumbered to have an appropriate balance in mix, when and if, we do decide to go public. So that means maybe more like a one-to-one type of number, 50%, plus or minus. And then on the lending platform, we have started to make loans. We've actually closed several loans. And there's just an opportunity for us to basically earn again outsized returns from smaller to mid-sized borrowers, who really don't have the critical mass to be able to do a securitization and do the kinds of financings that we are, from credit lines and the like. And I think it accomplishes a couple of things. On the one hand, we earn outsized returns. We'd be able to securitize against that and have very high ROEs. And then, in addition, perhaps, we also create for the future, somewhat of a captive pipeline of acquisitions that we can also take advantage of down the road.


There are no further questions in queue at this time. I would like to turn the call over back to management for closing comments.

Richard B. Saltzman

Okay. Well, again, everyone, thank you for joining us. We couldn't be more delighted with our results. And we appreciate your continued confidence in us as a company and a management team. So thank you very much. We look forward to speaking with you again in a few months.


Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.

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