iStar Financial's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.20.14 | About: iStar Inc. (STAR)

iStar Financial Inc. (NYSE:STAR)

Q4 2013 Earnings Conference Call

February 20, 2014 10:00 AM ET

Executives

Jason Fooks – VP, IR and Marketing

Jay Sugarman – Chairman and CEO

David DiStaso – CFO

Analysts

Michael Kim – CRT Capital Group

Jade Rahmani – KBW

Operator

Ladies and gentlemen, thank you for standing by. And welcome to iStar Financial’s Fourth Quarter in Fiscal Year 2013 Earnings Conference Call. (Operator Instructions).

As a reminder, today’s conference is being recorded. At this time for opening remarks and introductions, I’d like to turn the conference over to Mr. Jason Fooks, Vice President of Investor Relations and Marketing. Please go ahead.

Jason Fooks

Thank you, John, and good morning, everyone. Thank you for joining us today to review iStar Financial’s fourth quarter and fiscal year 2013 earnings report. With me today are Jay Sugarman, Chairman and Chief Executive Officer; and David DiStaso, our Chief Financial Officer.

This morning’s call is being webcast on our website at istarfinancial.com in the Investor Relations section. There will be a replay of the call beginning at 12:30 p.m. Eastern Time today. The dial-in for the replay is 1800-475-6701 with a confirmation code of 319108.

Before I turn the call over to Jay, I’d like to remind everyone that statements in this earnings call which are not historical facts will be forward-looking. iStar Financial’s actual results may differ materially from these forward-looking statements and the risk factors that could cause these differences are detailed in our SEC reports.

In addition, as stated more fully in our SEC reports, iStar disclaims any intent or obligation to update these forward-looking statements except as expressly required by law.

Now, I’d like to turn the call over to iStar’s Chairman and CEO, Jay Sugarman. Jay?

Jay Sugarman

Thanks, Jason. And thanks to those of you joining us this morning. Our fourth quarter saw a continued signs of steady progress we’ve been making on many front. Our investment activity was solid with over $200 million in fundings in the quarter and another approximately $200 million in early January.

Our capital strength continued to grow with lower cost refinancing and ongoing deleveraging enabling us to sit at the low end of our leveraged target with overall debt cost well below prior quarters.

We reenergized our net lease business by partnering with a sovereign wealth fund giving us more clout on larger transactions and the ability to maintain diversity in our portfolio.

And while we’re still working hard to get overall earnings back to full profitability, we are pleased with the finance, net lease and operating property segments all showed profitable metrics for the quarter and for the year.

With several land developments expected to come on line in 2014, we should be able to reduce the historical losses in that segment and start seeing some level of return on the capital we’ve invested there over the past several years.

Let me do a brief overview of our various business lines. In real estate finance, increased investment activity helped put some of our large cash balances to work. Where transactions in Chicago and New York City accounting for the bulk of the activity, and the January closing the large development loan in Times Square giving us further momentum.

Segment profit increased to $10.8 million from $5.9 million last quarter, and to $23.5 million for the year versus $11.1 million last year.

In net lease, the big news is obviously the closing of our $500 million joint venture with a sovereign wealth fund. Combining our long standing track record as the leader in the net lease industry, with the increased financial strength our partner provides, we expect our net lease team to be able to cast their net further and wider and with an increased ability to tackle larger transactions.

In fact, we closed on the first transaction for that venture in December, a $94 million investment, backed by a 12-year investment grade lease in a top notch location with future development potential.

Segment profit was $9.8 million for the quarter, an increase from $8.6 million last quarter, while full year was $38.2 million versus $59.2 million in the prior year.

Profit in the operating portfolio was below last quarter primarily due to a gain from the sale of a commercial property last quarter, and some year-end cost items.

Segment profit was $5.5 million versus $17.5 million last quarter, and $73.4 million for the full year, versus $10.7 million last year.

Lastly, the land team is beginning to gain approvals and beginning construction on several projects which we highlighted in the press release.

And while it will continue to take time to extract value out of this portfolio, it feels good to start seeing some of the projects beginning to gain momentum and head into production.

We’ll have more to talk about in this portfolio throughout the year, but for now, the quarterly drag remains stiff with segment loss this quarter, $22.6 million, versus $19.1 million last quarter, and a loss of $75.5 million for the full year, versus $80.8 million last year.

Let me turn it over to Dave now to review the numbers for the quarter in more detail. Dave?

David DiStaso

Thanks, Jay, and good morning, everyone. Let me begin by discussing our financial results for the fourth quarter, and full year 2013 as well as capital markets activities, before moving on to discuss investments and the performance of our business segments.

For the quarter, our adjusted income was a loss of $19 million, or $0.23 per common share, compared to a loss of $23 million or $0.28 per common share for the same quarter last year.

One of the main drivers in improvement in adjusted loss, was a $22 million decrease in interest expense resulting from lower debt levels, combined with our ability to refinance outstanding debt at lower rates dropping period.

Also, the fourth quarter of 2012 included $23 million of cash underwriting and prepayment fees associated with our bank facility refinancing and note issuances.

These items were partially offset by lower earnings from equity method investments. As our prior year period included $24 million associated with LNR which was sold earlier this year.

In addition, our strong pace of condominium sales and certain luxury projects have approached sellout, reducing our overall inventory and resulting in $13 million less income from sales of residential properties compared to the prior year.

Our net loss allocable to common shareholders for the quarter, was $58 million, or $0.68 per diluted common share compared to a loss of $87 million or $1.04 per diluted common share for the same period last year.

In addition to the drivers I mentioned before, the year-over-year improvement, was the result of a $12 million reduction in our provisions, impairments and loss on transfer to venture.

The prior period also included $12 million of non-cash loss on early extinguishment of debt associated with refinancing transactions.

For the full year 2013, we reported an adjusted loss of $22 million, or $0.26 per diluted common share compared to a loss of $54 million, or $0.64 per diluted common share in 2012.

The improvement was driven by several factors including a reduction in interest expense of $89 million as our debt balance decreased by over $1 billion, and our weighted average cost of debt, declined approximately 60 basis points, as a result of several refinancing transactions.

In addition, operating lease income increased by $18 million, due to additions to our operating properties portfolio as well as releasing activities while gains recorded on the sale of our condominium asset increased by $23 million above the prior year.

This was partially offset by a $25 million decrease in interest income due to a smaller overall loan portfolio, and $61 million less of earnings from equity method investments primarily as a result of the sale of LNR as well as the sellout of our Paramount Bay condominium venture.

During the fourth quarter, we issued at par, $200 million of 1.5% convertible senior notes, due November 2016 which convert into shares of our common stock, an initial conversion price of $17.29.

We use the net proceeds from this offering, along with cash on hand, to redeem the remaining $201 million of our 5.7% senior unsecured notes due March 2014, and to pay a $2 million prepayment fee.

Concurrent with this offering, we also repurchased $1.7 million shares of our common stock with cash on hand at the prevailing market price of $12.35 per share.

At December 31, 2013, we had $29 million remaining under our share repurchase program. Additionally, we repaid $97 million on our 2013 secured credit facility during the quarter, bringing the remaining balance to $1.4 billion at the end of the quarter.

We also repaid $8 million on our 2012 secured credit facility bringing that remaining balance to $432 million at year end.

Overall in 2013, we closed five capital markets transactions including re-pricing our larger secured credit facility issuing several series of unsecured and convertible notes to reduce our cost of debt and extend our maturity profile and as well as raising convertible preferred equity to provide us additional growth capital.

As a result of these transactions, our weighted average cost of debt for the fourth quarter, improved to 5.7%, from 6.5% for the same period last year.

In addition, we reduced our leverage to 2 times, at December 31, 2013 down from 2.5 times at the end of 2012 and at the low end of our target range of 2 times to 2.5 times.

Let me now turn to investment activity in our real estate and loan portfolios. We invested $218 million during the fourth quarter, including $159 million of new investment originations committed during the quarter.

We’ve been ramping up our origination activity, and over the past nine months, including January 2014, we have closed approximately $750 million of new investments, and financing commitments.

We generated $164 million of proceeds from our portfolio this quarter, which included $78 million from repayments and sales of loans in our real estate finance portfolio, $49 million from sales of operating properties, and $37 million in proceeds across other segments.

After giving effect to the investment funding and venture contribution we made in January 2014, we had approximately $400 million of cash, which we used primarily to fund future investment activity.

At December 31, 2013 our total portfolio had a carrying value of $5.2 billion, gross of $425 million of accumulated depreciation and $29 million of general loan loss reserves.

Let me discuss each of our four business segments. Our real estate finance portfolio totaled $1.4 billion at the end of the quarter. This includes approximately $1.2 billion of performing loans that had a weighted average LTV of 72% and a weighted average maturity of just under three years.

They were comprised of $619 million of first mortgages, or senior loans, and $576 million of mezzanine or subordinated debt. The performing loans generated a weighted average effective yield for the quarter, of 8%.

At the end of the quarter, we had $204 million of NPLs, a reduction of 60% from the $503 million of NPLs we had at the end of last year.

Our remaining NPLs are mainly comprised of 38% entertainment leisure, 37% land, and 13% retail.

For the quarter, we recorded 100,000 of loan loss provisions compared to a provision of $29 million for the fourth quarter of 2012.

For the full year, our loan loss provision was 5.5 million, a significant reduction from 82 million of provisions recorded in 2012. Our total reserve for loan losses at the end of 2013, was $377 million, consisting of $348 million of asset specific reserves, and $29 million of general reserves.

We expect that the rate of provisions and the level of NPLs will continue to fluctuate.

Now, let me provide a brief update on certain key metrics relating to our net lease portfolio. At the end of the quarter, we had $1.7 billion of net lease assets, gross of $339 million of accumulated depreciation.

Our net lease portfolio totaled 20 million square feet across 33 states. This portfolio was 94% leased at the end of the quarter with a weighted average remaining lease term of 12 years. For the quarter, our total net lease portfolio generated an unleveraged weighted average effective yield of 7.5%.

Next, I’ll turn to our operating properties portfolio. Our operating properties totaled $965 million, gross of $82 million of accumulated depreciation. The portfolio was comprised of $742 million of commercial and $223 million of residential real estate properties. Over the past year we sold $270 million of residential assets and $92 million of commercial properties which resulted in $101 million of gains. We saw a net reduction in this portfolio by approximately $200 million from a balance of $1.2 billion at the end of last year.

The commercial properties represent a diverse pool of real estate assets across a broad range of geographies and property types, such as office, retail and hotel properties. They generated $30 million of revenue offset by $21 million of expenses during the quarter.

At the end of the quarter, we had $135 million of stabilized commercial operating properties. These properties were 85% leased, resulting in an 8.3% unleveraged weighted average effective yield for the quarter.

The remaining $607 million of operating properties are transitional real estate properties that were 57% leased and generated a 2.7% unleveraged weighted average effective yield for the quarter. We are continuing to actively lease these properties to maximize their value. During the quarter, we executed commercial operating property leases covering approximately 170,000 square feet.

The residential operating properties were comprised of 615 condominium units remaining in inventory at the end of the quarter. These units are generally located in projects characterized as luxury buildings in major cities throughout the United States. During the quarter, we sold 88 condos for $47 million in proceeds, resulting in $14 million of income, offset by $4 million of expense and a $6 million impairment.

That brings me to our land portfolio. At the end of the quarter, our land portfolio totaled $965 million and included 11 master planned communities, 10 infill land parcels and six waterfront land parcels. Master planned communities generally represent large-scale residential projects that we plan to entitle, plan and develop.

We currently have entitlements of these projects for more than 25,000 lots. Our infill and waterfront parcels are currently entitled for 6,000 residential units and select projects include commercial, retail and office space.

The projects in the portfolio are well diversified with our largest exposures in California, the New York Metro area, Florida, and several markets in the mid-Atlantic and Southwest regions. During the quarter, we invested $16 million in our land portfolio through capital expenditures and sold one bulk land asset in Hawaii for $15 million, recognizing a nominal gain.

At the end of the quarter, we had five land projects in production, 11 in development, and 11 in the predevelopment phase.

As Jay just discussed, and as we highlighted in our earnings release, we have made important headway on our land properties by partnering with both National and Regional Home Builders and entering at the several strategic ventures.

We plan to continue those efforts in 2014 and are poised to accelerate development activities and capital investment in our land portfolio with the objective of further enhancing their value.

We look forward to updating you on our efforts and results this year.

With that, let me turn it back to Jay. Jay?

Jay Sugarman

Thanks Dave. And I hope you can see we continue to be busy on all fronts. And as Dave said, we look forward to providing additional information and spotlighting various projects and investment as they come to fruition throughout this year. So let’s go ahead and open it up for questions, Operator.

Question-and-Answer Session

Operator

Certainly. Ladies and Gentlemen, today’s question-and-answer session will be conducted electronically. (Operator Instructions) We will take as many questions as time permits and proceed in the order that you signal us. (Operator Instructions) We’ll pause for just a moment to assemble the roster.

And the first one from Michael Kim with CRT Capital Group. Please go ahead.

Michael Kim – CRT Capital Group

Hi. Good morning. Thanks for taking my question. Nice quarter and I really appreciate the disclosure of the progress being made with specific assets in the portfolio.

Jay, I guess my first question, I was just wondering if you could discuss the net lease venture with the sovereign wealth fund in more detail on several fronts. Yes, know you’ll own about 52 percent of the venture but, you know, how much cash did iStar contribute to the venture? Can you provide any specifics on the promoted management fee targeted yields for the venture or any sort of like ramp up of assets being contributed?

And I guess the ultimate strategy of the venture, will you target net lease assets with investment grade tenants or kind of the split between development versus acquisition of stabilized assets and will there be an opportunity for iStar to actually contribute some of your own transitional properties to the venture as well?

Jay Sugarman

Hey, Michael, thanks. The ventures really intended to give us a little more flexibility about where we can go in the net lease market. As you know, we struggled a little bit with some of the frothiness in that market and we still see some opportunities that are either too concentrated or too big for us.

So we have been looking for the right partner for quite a while. I think we’ve got a great partner now, very interested in the net lease business in our capabilities there, pretty freeform. I think the first deal was an investment grade deal – it had a little piece of future development opportunity attached to it that’s kind of in our wheel house.

The returns are nice and solid given that where senior debt is pricing these days. So I think from a return standpoint, we’re certainly looking to put money out in low to mid-teens, long term stable duration assets on a modestly levered basis.

The partner is paying us some management fee and promote – I won’t go into too many details there but I think it’s a great relationship for us long term not just in net lease business but it also gives us a partner who’s quite interested and allow the other fronts that we’re looking at actively, so we hope it’s a relationship that grows and builds and certainly the net lease is going to be the core of it. But we’re hoping it has the potential to expand in lots of other directions as well.

Michael Kim – CRT Capital Group

Right. I appreciate that. And I guess shifting to the land side, with the venture with KB Home to jointly develop the first phase with Spring Mountain Ranch, and I guess could you describe that venture in a little bit more detail and if it could be applicable to other master planned communities that you own. I guess how many lots on the first phase or the timing of development or even the economics of that venture? Is it more of a rolling lot option contract?

I guess how should we think about this in terms of the structure and could that be applied to the other projects you have in portfolio?

Jay Sugarman

Good question. I think the truth is, each one of these is bespoke, depends on the market, depends on the property, depends on our business plan. This is a large property in Riverside.

It’s over – I think it’s about 1,400 units. It works from some low elevations up into some hills where it’s reasonably costly. So we’re having to put in quite a bit of infrastructure and given the size of the community, we wanted to make sure it kicks off correctly and certainly with the kind of velocity that will make future phases more valuable to us on a MCV basis.

So as we looked around KB, it’s probably the best partner we could have found. The structure of the deal – they really met the two criteria we had, as one, they were willing to put capital in, side-by-side with us, and two, they provided for a profit participation.

So we think the California market is one that is turned. We’re actually seeing some pretty good activity across even some of the Inland Empire market like Riverside. So we want to play and keep our foot in the game but we are very cognizant that velocity is a killer if you don’t get it right. And so KB is somebody who we think has done it right again and again in those local markets and we wanted them in our team.

So the way we’ll structure these deals is going to be a little different. This one has a lot of upfront infrastructure. So having a capital partner is important. In a lot of our other JVs, we don’t need any capital partner. I’m going to be – much more about expertise and there will be much less upfront investment for hopefully a longer term payout.

So this one is a little bit unusual, but again the goal is to find the right partner in lots of different markets. You’ll see us talk about deals in other markets throughout the year where there’s a lot less capital equation and much more just getting the right partners who can steer the ship, and we’ll probably be paying them some sort to promote in lieu of getting their capital.

So each one is going to be different Michael, I think this one is the right kind of structure for this community. It comes to us about a third of the lots.

Michael Kim – CRT Capital Group

Okay.

Jay Sugarman

They have quite a bit of money up but there’s no forced take down.

Michael Kim – CRT Capital Group

I see.

Jay Sugarman

We think they think it’s a very attractive community. They’re putting their money where their mouth is. We think they are in a position to help us build a very good entry to the rest of the community. And we look forward to working with them on a number of things both in this project and elsewhere.

So I don’t want you to think there’s any single template, there isn’t.

Michael Kim – CRT Capital Group

Yes.

Jay Sugarman

Each one is really a pretty sensitive mix between what our needs are and what our partners needs are. But you will see us use the structure more often throughout the year.

Michael Kim – CRT Capital Group

Okay.

Jay Sugarman

In some cases it’s a value maximization game for us. We just want to extract the most profit we can. In other words, we’re just trying to increase velocity and get our money back. So sometimes you’ll see us try to get a very large participation, in other cases we don’t think the returns are going to be that interesting. We’re just trying to get our capital back so we can redeploy it.

Michael Kim – CRT Capital Group

Understood. I appreciate all the color and keep up the good work. Thanks.

Jay Sugarman

Thanks, Michael.

Operator

(Operator Instructions). And we’ll go to Jade Rahmani with KBW. Please go ahead.

Jade Rahmani – KBW

Good morning, and thanks for taking the question. On the investment pipeline, can you discuss what you’re seeing in terms of opportunities and also competition? Any color on yields, the LTVs and deal types would be helpful.

Jay Sugarman

Yes. I think the market is pretty active both on the supply and the demand side. I think there’s no shortage of capital. But it seems like it’s really splitting into the commodity parts of the business which we certainly can’t compete in and don’t – we choose not to compete in. But there’s a big gulf between that business and some of the more entrepreneurial developers and borrowers out there who need sort of bespoke customer tailored financing.

As we said in the past we are gravitating to larger deals. We certainly see the competitive landscape much thinner up there. The Black Stones and the Star [ph] guys we partnered with in the past, we certainly see them. But that’s an L plus 700 and above market. And to do that in size requires a lot of in-house capabilities and talent and experience. And there just aren’t that many players who can reach up into those areas.

So you’ll see us play up there. We are still seeing pretty good deal flow out of our existing customer base. So you’ll see us continue and try to work that. But I would say it’s just – it’s an active market. There’s a pretty big shift going on as banks get ready for Basel III. Try to put themselves in the best position. They are seeding parts of the market to folks like us. But they’re being pretty strong and pretty aggressive on the parts of the market they do like. So you’ve got to dance away from that capital and find where your strengths are and we think we’re starting to see where we can play and generate some pretty interesting returns.

Jade Rahmani – KBW

Thanks. Could you elaborate on your expectations around capital deployment? Do you view the pace of announced investment activity as sustainable and do you expect to fund incremental opportunities solely from cash on hand and cash generation or would you anticipate accessing the capital markets for growth capital?

Jay Sugarman

Yes. Look I think that from a pacing stand point $100 million to $200 million a quarter is very doable and probably can be self-financed. But if we get up to the upper end of that range and don’t do some things on the existing portfolio in terms of monetization, there is an opportunity to look to the markets to fund even more incremental growth. But I think we’re going to let the opportunity set in the market guide us. If we see great opportunities that are valuable to the company, we’ll try to ramp up originations and then look inside our own portfolio for that capital and if it’s even beyond that, then we could certainly go to the outside world.

Right now though, I’d say $200 million per quarter probably that would stretch our internal resources. So if it gets much above that, we’ll certainly be thinking about alternatives. You know this land equation is a big one for us. How much money do we want to commit to that versus harvesting? If the returns are good we’re going to keep investing in that portfolio. And I think that’s one of the big question marks later in the year is how much do we take off the table versus how much do we redeploy inside that business line. And that will probably govern some of our thinking.

Jade Rahmani – KBW

That’s helpful. Just on the land book, I have just two questions. One is a clarification I think in the way you described the land projects. This quarter you disclosed five projects in production, 11 in development and 11 in pre-development, totaling 27 where – which is different from last quarter’s six in production, 12 in development and 8 in pre-development for a total of 26. So could you explain that change? And then also just more broadly if there’s anything you’re seeing on the housing market or land market that changed how you think about the outlook for that business?

David DiStaso

In relation to the land projects, there were some changes quarter-over-quarter. Notably we sold the project Kula [ph] in Hawaii which was in production. So that was sold during the quarter. And also as Jay mentioned Spring Mountain Ranch was broken into two. Phase one with our development activities was segregated into one piece. And phases two and three which are not yet in production were moved to a separate category. So you’ll see some shuffling amongst categories as things play out with the land portfolio.

Jade Rahmani – KBW

Okay, great. And just a follow up on the outlook for the housing and land market.

Jay Sugarman

You know what’s interesting to us is, the numbers came in pretty weak this quarter. We just think every quarter that supplies based constrained is going to be a good quarter down the road. Rates have come in a little bit. So I think from an affordability stand point, people are still nervous about how far and how fast. We’re not seeing a ton of impact from that. A little bit of a slowdown in certain markets that moved really fast as people adjust to the new pricing level. But affordability is still pretty good from a historical stand point. Rates are very good from a historical stand point, supplies constrain from both the historical and recent history stand point.

So I think other than a demand shock, we still see upward lift across most of the markets we’re in. Certainly Southern California is one we’re thinking that’s going to be quite good for us, Southern Florida good for us. We’ll see what happens in the macro economy throughout the year. But as long as there’s no big shocks, we think the trend is certainly still positive.

Jade Rahmani – KBW

Great. Thank you very much.

David DiStaso

Thanks, Jade.

Operator

And Mr. Fooks, there are no further questions in queue.

Jason Fooks

Thanks, John, and thanks everyone for joining us this morning. If you should have any additional questions on today’s earnings release, please feel free to contact me directly. John, would you please give the conference call replay instructions once again? Thanks.

Operator

Certainly. And ladies and gentlemen, the replay starts at 12.30 p.m. Eastern time and will last until March 6th at midnight. You may access the replay at any time by dialing 800-475-6701, the access code is 319108. That number again, 800-475-6701, the access code 319108. That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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