Resource Capital Corp. (NYSE:RSO)
Q1 2010 Earnings Call
May 4, 2010 8:30am ET
Jonathan Cohen - President & Chief Executive Officer
David Bloom - Senior Vice President of Real Estate Lending
David Bryant - Chief Financial Officer
Purvi Kamdar - Director of Investor Relations
Steve Delaney - JMP Securities
Good day ladies and gentlemen, and welcome to the first quarter 2010 Resource Capital Corp. earnings conference call. My name is Josh, and I’ll be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)
I’d now like to turn the presentation over to our host for today’s call, the President and CEO of Resource Capital Corp., Jonathan Cohen; you may proceed Sir
Thank you for joining the Resource Capital Corp. conference call for the first quarter 2010. I am Jonathan Cohen, President and CEO of Resource Capital Corp. Before I begin, I would like to ask Purvi Kamdar, our Director of Investor Relations, to read the Safe Harbor statement.
Thank you. When used in this conference call, the words believe, anticipate, expect, and similar expressions are intended to identify forward-looking statements. Although the company believes that these forward-looking statements are based on such reasonable assumptions, such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from these contained in the forward-looking statements.
These risks and uncertainties are discussed in the company’s reports filed with the SEC, including its reports on Forms 8-K, 10-Q and 10-K, and in particular, Item 1, on the Form 10-K reported under the title Risk Factors. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The company undertakes no obligation to update any of these forward-looking statements.
With that, I will turn it back to Jonathan.
Thank you Purvi. First a few highlights. Net operating income for the three months ended March 31, 2010 was $10 million or $0.26 per share diluted, as compared to $10.2 million or $0.42 per share diluted for the three months ended March 31, 2009.
We announced a dividend of $0.25 per common share for the quarter ended March 31, 2010, or $10.1 million in aggregate paid on April 27, 2010 to stockholders of record as of March 31, 2010. Our economic book value, a non-GAAP measure, was $8.30 per share as of March 31, 2010, and our GAAP book value was $5.98 per common share.
With those highlights out of the way I will now introduce my colleagues. With me today are David Bloom, Senior Vice President in charge of Real Estate Lending; David Bryant, our Chief Financial Officer; as well as Purvi Kamdar, our Director of Investor Relations.
The first quarter of 2010 was marked by our continued buildup of cash; over $109 million as of March 31, 2010. Our continued deleveraging so after adjusting for our cash balances our net debt to equity ratio is 4.7 times, and our real estate portfolio is under two times leveraged, and we continue to build in a significant pipeline of potential new investments.
Including $26.6 million of debt we purchased in early April, we have now bought approximately $107.4 million of our debt. While we continue to see debt purchase opportunities and believe we will buy another $30 million to $50 million of debt over the next few months, we are also looking forward to investing some of the $109 million in cash that we’ve accumulate.
In fact, our pipeline on the corporate side has grown significantly, and we believe we can add between $0.12 and $0.20 of net operating income by putting this cash to work, both in terms of buy back of debt, as well as with new investments. We are regularly seeing opportunities to invest unlevered at 8% to 12% rates in investments that we originated. With a little leverage the returns can be significant.
Most importantly, we earned our dividend through our $0.26 of net operating income and cash flow. We did this with over $2.50 of cash of our balance sheets and no short-term debt. Our credit, other than one real estate loan in particular remains stable. We are seeing tremendous liquidity returning to our borrowers, both on the corporate side where the high yield market continues to bloom, and on the real estate side of our business, where our borrowers are willing to now invest equity to refinance.
The CMBS market has come back for better quality properties, and the mezzanine market is now functioning again. We are very comfortable with our portfolio and are pleased with our GAAP purchases throughout 2009 and 2010. Now it is time to add appropriate investments and add to our bottom line. With all this being said, I reiterate our $1 cash dividend guidance for 2010.
Now let’s discuss our debt purchase program, our deleveraging efforts and our book value. During 2010, we have purchased approximately $47 million of notes at a blended discount of about 37%. This includes $26.6 million that we bought in April for a gain of $10.5 or $0.25 per share. Most of these notes were originally rated AAA to A. We continue to speak to sellers and have a rise of approximately $30 million to $50 million of additional bonds at prices between $0.20 and $0.70 on the dollar. We will only buy these at the right price.
Although, we always believe in patience obviously investors across the globe have become much more constructive on real estate generally, and more positive about Resource Capital’s portfolio specifically. It is of course a good and a bad fact.
We believe that when you adjust our book value for our activities since the quarter ended, we probably have another $0.25 to $0.35 or more of book value that is not reflected in the quarter end figure of approximately $6 per share. In addition, we have over $30 million or over $0.75 per share of unrecorded discount in our syndicated loan portfolio that will be accreted over the next three to five years.
Our leverage loan assets also improved. Moving from an approximate $79 weighted average price at June 30, 2009, to $92 at March 31, 2010. We have continued to see price appreciation this quarter, as the portfolio has move to an approximate value of $870 million. This improvement has lead to our ability to increase our cushion to our over-collateralization test, as well as to upgrade the quality of our loan book.
As mentioned above, we have over $30 million of discount to accrete over the next few years. This is a thanks to the very opportunistic work of Gresham Berg Shasar and the entire [Afades team]. We are looking to take advantage of opportunities in this space, and of course as term financing returns to the CLO market, we will take advantage of lower cost liabilities as we did in the last cycle.
As for real estate, although we had decided to exit one loan, which we will sell at a loss, the reasons have more to do with technical, zoning and political forces than the real estate crises. As I mentioned on the last call, we now see borrowers who see some light at the end of the tunnel, and if lenders are willing to work with them [Inaudible] hold onto their properties. They no longer seem to think they are catching a falling knife.
While the property and CMBS market still seems to be improving, we did take impairments and reserves totally in $15 million, including $1 million added to our general reserves.
Now I will ask Dave Bloom to comment on the real estate side of our business.
Thank you Jonathan. Resource Capital Corp.’s commercial mortgage portfolio as a current committed balance was approximately $760 million across the granular pool for 43 separate loans. Our portfolio of commercial mortgage positions is in components as follows: 63% whole loans, 26% mezzanine loans, and 11% B-notes.
The collateral base underlying the portfolio continued to be spread across the major asset categories in geographically diverse markets, with a portfolio breakdown of 25% multi-family, 24% office, 32% hotel, 12% retail, and 7% other, such as flex office, industrial or self-storage.
We have had one $7 million multi-family loan comprised of three buildings that was involved in a contested foreclosure process. However, in recent weeks we have reached a settlement with the borrower that will give us title to two buildings, and payoff the third for $2.5 million. The settlement agreement has been fully executed and is now awaiting court approval, which should be forthcoming shortly. Even a distressed valuation of the assets exceeded our outstanding loan balance, so we remain confident about the ultimate recovery of principle on this loan.
In addition to the one to five multi-family loan that has now been settled, we continue to have a $10.5 million mezzanine loan in default, that has not paid principal any interest since January. There have been extensive settlement negotiations with the borrower, other mezzanine participants, and the special servicer, and there is a concessional settlement agreement that has been preliminarily agreed to by the parties.
The cash flow from the properties [expecting] the loan covers debt service, but through a technicality, cash flow is been trapped at the senior lender. As part of the settlement, the borrower will be committing fresh equity to the deal, and our position will be brought current. In addition, current appraisals for the properties securing the loan show a loan base to be well below the value of the properties. So again, we are confident about the ultimate recovery of principle in this position.
With the exception of the loans I highlighted, our portfolio commercial real estate loans continues to be current. Market fundamentals for commercial real estate tend to lag behind other sectors of the economy, and while we have seen improvement in many of our portfolio properties we remain concerned about the impact of the weak economy in some situation.
We have modified a number of loans across the portfolio and in every instance are our goal is to work with the borrower to provide adequate time to see the business plan through, and reach a capital that will payoff of the loan.
Parts of our portfolio continue to face a choppy market, but we remain fully engaged and continue to benefit from a deep bench of experienced real estate professionals as we push forward to stabilization.
The real estate debt market is being soft and we have seen both sale and financing activity picking up. Since many of the assets specific business plans have been implant by our borrowers, the plans for value equation had been realized. As transaction volumes continue to pick up, we anticipate payoffs across our portfolio.
As the debt markets continue to heal, we are seeing a significant increase in refinancing activity from banks, insurance companies, and especially from reconstituted CMBS programs.
The debt capital markets are returning, and we are again seeing situations where multiple lenders are competing for the same loans. The flow of refinanced capital is obviously a positive sign for the market in general, and for our portfolio in specific, as we see a number of our portfolio properties renting for takeout financings.
We are beginning to see a number of opportunities to originate new loans at post price evaluations, premium spreads and optimal structure. There are hundreds of millions of dollars of loans coming sue, and none of the debt providers to address the total refinanced demand. In addition, there are numerous discounted payoff situations, each needing financing at a new and much lower basis.
RCC benefits from our focus and expertise in loans between $10 million and $20 million, and even though there are a number of capital sources in the market to make new loans, the vast majority are looking to make much larger loans. Our direct origination platform operates on a nationwide basis and has a significant electro business model.
We are not dependent on the CMBS market or a secondary loan trading market, because we originate our own loans. Our self-originated whole loans are structured with origination and access fees, and many of our loans are structured to provide elements of borrowed recourse of our credit enhancements.
We have fully established origination capabilities and infrastructure, and we have kept our team in place. As the DFO continues to build, we are uniquely positioned to take advantage of select opportunities for well structured transactions and premium spreads in today’s market, and to match our production levels with our existing financing facilities and capital availability. We will benefit from loan repayments as we reinvest higher yielding assets into our long-term loss and financing vehicles.
With that, I’ll turn it back to Jonathan and I’ll join for Q-and-A at the end of the call.
Thank you Dave. I will now give you some statistics on our corporate bank loan portfolio. As I stated earlier, we have syndicated bank loans with an approximate value of $870 million, encompassing over 30 industries. Our top industries are healthcare 12.5%, diversified 8.9%, broadcasting and entertainment 8.9%, chemicals 5.9%, and printing and publishing 5%. At the end of December our average loan asset yield 2.7% over LIBOR and our liabilities are costing us 47 basis points over LIBOR.
Now I will ask Dave Bryant, our Chief Financial Officer to walk us through our financials.
Thank you Jonathan. Our estimated REIT taxable income for the first quarter 2010 was $9.3 million or $0.24 per common share. Our board declared a cash dividend for the first quarter of $0.25 per common share.
At March 31, 2010, RCC’s investment portfolio was financed with approximately $1.5 billion of total indebtedness that included $1.47 billion of CDO senior notes, $51.5 million sourced from our unsecured junior subordinated debentures related to our two TRUPs issuances in 2006. We ended the period with $239.6 million in book equity.
RCCs borrowings of $1.5 billion had a weighted average interest rate of 1.02% at March 31, a reflection of continuing very low LIBOR. Consistent with our stated philosophy of maximizing match funding, our investment portfolio is now completely match funded by long-term borrowings, thus we have no short-term debt.
Of note, we continue to pass all of the critical interest coverage and over-collateralization tests in our two real estate CDOs and three bank loan CLOs. Each of the structures continue to perform and generate stable cash flow to RCC year-to-date in 2010. The real estate CDOs produced over $7 million, and bank loan CLOs generated over $5.2 million of cash flow in the first quarter of 2010 respectively to the REIT.
Of note, as of April 30th we have an access of $90 million in reinvestable cash comprised of approximately $40 million, and over $50 million in our bank loan and real estate deals respectively. This cash is available for reinvestment in the CLOs and CDOs to build collateral and strengthen our positions in each structure.
For example, during the quarter ended March 31, we brought investment grade CMBS of $7.7 million, applied for a weighted average price of $64.27. The resulting discount of $2.8 million improved the collateralization in our real estate CDOs, and these CMBS purchases provided a cash-and-cash yield of approximately 9%.
We consider leverage ratio from two positions; our economic book value after adjusting for unrealized losses in our CMBS portfolio, unrealized losses from our cash flow hedges, and including appreciating income from discounts on our bank loans is $8.30 per common share at March 31.
Our leverage based on economic book value is 4.6 times. When we consider our two TRUPs issuances which have a remaining term of 26 years as equity, we see our leverage drop to 3.8 times.
Focusing on commercial real estate, we delevered 2.3 times on our real estate CDOs a year ago on March 31. After giving effect to the debt repurchases of 2009, the additional purchases in the first quarter of 2010, we ended the quarter 2.1 times levered. After taking into account the bonds we purchased in April for 2010, we see our real estate leverage drop down to 1.8. We are now very close to reducing the real estate leverage to the 1.7 times target level that we discussed in our December 2009 common stock offering road show.
Our GAAP book value per common share was $5.98 at March 31, as compared to $6.26 at December 31, 2009. This quarter the decrease in the GAAP book value of $0.28 is primarily due to the increase of provision for loan losses that Jon mentioned with respect to the CRE loan portfolio. At March 31 our equity is allocated as follows: Commercial real estate loans and CMBS 74.6%, Commercial bank loans 22.5%, and direct financing leases and notes of 2.9%.
Going into the detail, here’s a recap of our sources and uses of funds, to-date days in 2010. We sourced and used approximately $87 million during the three months ended March 31.
Our major categories of sources include unrestricted cash $24.3 million, borrower repayments of $22.9 million, dividend reinvestment plan proceeds of $18 million, net operating income of $10 million, gains on debt extinguishments of $6.6 million, working capital of $3.8 million, and finally margin collateral return of $0.6 million, with the total sources of $87.2 million.
Our major uses during the three months were a net reduction in our borrowings $20.2 million, provisions for loan losses $15.2 million, CLO reinvestments of $15.1 million, dividend paid $10.1 million, new loans of $10 million, purchases of equipment leases and notes $9.4 million, purchase of CMBS $6.8 million, and an investment in our real estate joint venture of $0.4 million, with total uses of $87.2 million.
With that my formal remarks are completed, and I’ll turn the call back to Jonathan Cohen.
Thanks Dave. Again, as I said last quarter and the quarters before, management reiterates our $1 dividend guidance and believe that we can start from here to grow book value with debt buybacks and other means. Our liquidity has increased and we will continue to build cash and position ourselves effectively, although we are starting to invest and put that cash to work to add to the bottom line.
Thanks for participating in our call, and now I’ll open the call for any questions.
(Operator Instructions) Your first question comes from Steve Delaney - JMP Securities.
Steve Delaney – JMP Securities
I was little unclear. Dave was good enough to address the two problem commercial real estate loans, the $7 million multi-family, and the $10.5 million. So I guess Jon I was unclear given the resolutions that were described there; can you help me understand that $15 million provision in the quarter and exactly what loan that provision was made for, because it sounded like other than $1 million that went to general…
Yes, sorry about that. The two loans that Dave described, where there was the issue we are expecting a full payback and are about to finalize agreements on those. So those are sort of by next quarter hopefully in the good bucket, and not in the bad bucket. They are broken with that bucket for a quarter or two quarters or three quarters.
The new loan which we basically had determined that we were going to get out of, really is a loan in California and that’s the bulk of this entirety of the reserve that we took, and it had to do with a very complicated zoning issue with a short term stay and long term stay as to in California, so that’s a separate loan.
But I just want to make the point; it’s a very singular event that has really nothing to do unfortunately with the credit crises or like with the underwriting or the zoning change by the City of Los Angeles on zoning change, but zoning confusion I would say among California, LA and others that just made it untenable for us to spend the time to work through that loan.
Steve Delaney – JMP Securities
Okay. So your $14 million you would say, pretty much it fully covers your exposure there. You are just kind of done with that one?
Steve Delaney – JMP Securities
Okay, I mean looking forward to the opportunities, which I think now that you’ve clearly survived and taken advantage of the debt opportunities, which is kind of exciting to be I’m sure for all of you with your platform to be back, to doing the business you were created to do. Can you talk a little more specifically about the types of new loans that we likely to see over the next couple of quarters; would these be more mezz loans?
No, these would be whole loans; on a traditional business whole loans going up to 75% probably as where we were before to where we are now. We are negotiating certain lines of credit that we’ll enter into, but primarily we think in some cases we’ll be selling the first to CMBS and in some cases retain them as, but we will be originating all of those loans, and having significant control over the properties. These will be kind of anywhere from 8% to 10% unlevered with some sort of participation.
Steve Delaney – JMP Securities
And you think some of them might confirm to conduit guidelines.
Yes, we’ll be working to confirm at least while we underwrite it, the ability to sell off an AP as to conduit.
Steve Delaney – JMP Securities
So 75%, you might keep 15%, 20% in a B-note?
Yes, something like that, although it’s still very fluid. The time in which they reopen the CMBS, they need people on the ground, they need loans and diversities, and so it’s an excellent opportunity for us to retain a certain part of it as a gain, and also hold onto the risk that we like.
Steve Delaney – JMP Securities
And that little bit of leverage to kind of get your, to boost you at times, you’ve mentioned bank lines of credit, so you’ll try to work up some kind of a term line with the bank for that portfolio.
(Operator Instructions) And at this time we are showing no further questions available. Jonathan Cohen, you may proceed.
Well, thank you very much. We look forward to speaking with you next quarter. Thank you.
Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect. Have a great day.
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