Colony Financial Inc (NYSE:CLNY)
Q4 2013 Earnings Conference Call
February 21, 2014 10:00 am ET
Lasse Glassen - Addo Communications, Inc.
Richard Saltzman - Chief Executive Officer, President and Director
Darren Tangen - Chief Operating Officer and Chief Financial Officer
Jade Rahmani - KBW
Greetings, and welcome to the Colony Financial Incorporated Fourth Quarter and Full Year 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (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.
Good morning, everyone, and welcome to Colony Financial, Inc.'s Fourth Quarter and Full Year 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. Kevin Traenkle, the company's Chief Investment Officer and Neale Redington, the company's Chief Accounting Officer, are also on hand to answer questions.
Before I hand 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 today is as of today, February 21, 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 of why the company believes such non-GAAP financial measures are useful to investors.
Now, I would like to turn the call over to Richard Saltzman, Chief Executive Officer of Colony Financial. Richard?
Thank you, Lasse, and welcome everyone to our fourth quarter and full year 2013 earnings call. We are very pleased with our fourth quarter results, capping an end to a record year for Colony Financial in many respects.
The fourth quarter was particularly robust in terms of heightened investment activity and financial performance across our portfolio, and if the activity from the most quarter and the first two months of 2014, are any indicator of the future, this will be another great year for Colony Financial, that will also happen to include our fifth anniversary as a public company.
Before I review our outlook for 2014, I would like to take a moment to reflect upon our 2013 accomplishments and how that provides a foundation for an even more successful 2014.
One year ago, we indicated that Colony Financial had achieved the scale to access the capital markets more efficiently and was finally operating on all cylinders with respect to leverage the Colony Capital platform to optimize both, capital deployment and asset management successes.
Since the beginning of 2013 through today, we had record capital deployment of approximately $1.5 billion, almost doubling the size of our balance sheet. This capital deployment activity was broadly distributed across our three primary investment strategies. $359 million in six loan and loan portfolio acquisitions involving approximately 540 loans, $558 million in 16 new originations and $541 million in equity oriented investments, including $295 million in our single-family homes for rent platform, Colony American Homes, otherwise known as CAH.
Last year, we also talked about the improving U.S. economy and commercial real estate fundamentals and accordingly our desire to increase our exposure to equity and equity equity-linked investments in the U.S. market.
Since the end of 2012, we increased our concentration of equity and equity-linked investments from 33% of our portfolio to more than 40% today. For example, we made our first triple net credit tenant lease investment for $123 million, which is an office campus occupied by a single-A-rated tenant.
We purchased these two Class-A buildings, which were built 2008 and 2009 at a 7.5% cap rate and approximate 20% discount to replacement cost. This investment was subsequently financed with an $88 million tenure fixed-rate first mortgage and now generates a cash-on-cash yield of 13%.
In 2013, we also increased our European portfolio exposure from 3% to 9%, following the acquisition of a large first mortgage loan portfolio, secured by his usual quality office and retail assets in Spain from the European bank. These loans are payment-current, but over leveraged, what we typically refer to as sub-performing loans. Because of these credit characteristics, we were able to acquire these loans at a very significant discount to par and Colony Financial invested $143 million in this transaction.
Notwithstanding the growth of our balance sheet during 2013, our results have been excellent 2013 core earnings increased more than 60% year-over-year to $97 million, or $1.45 per basic share, fully covering the aggregate 2013 dividends of a $1.40 per share.
As a reminder, because we did not expect meaningful core earnings contributions from CAH, until its portfolio is closer to stabilization, we deliberately capped our investment in CAH at $550 million, in order to more easily sustain and eventually grow our dividend. In fact, the percentage of our total portfolio investment in CAH has gradually been coming down.
Last year, our CAH investment averaged 28%, and today it is actually closer to 25%. CAH's core earnings contribution to Colony Financial ended up effectively breakeven for 2013, which means that the rest of our investment portfolio had outsized performance from a core earnings standpoint. Over the course of 2013, we also increased our fair value per share by 7% from $19.35 to what we currently reported at year-end $20.78 per share.
Our asset management teams have done a tremendous job managing our loan portfolios in order to optimize returns. We have stated from the beginning that we are a total return investor and the Colony Financial investment portfolio has been constructed to generate both, current yield and capital appreciation.
Since the beginning of 2013, we had 11 full and partial investment realizations, generating an average of 19% internal rate of return and a 1.6 times equity multiple, representing $185 million of aggregate cost basis.
These results are remarkably consistent with 2012, when we had 10 full and partial investment realizations generating an aggregate 19% internal rate of return and 1.5 times equity multiple, representing $140 million of aggregate cost basis.
In terms of capital markets' activity since the beginning of 2013, we raised aggregate net proceeds of approximately $1.3 billion, primarily through two follow-on equity offerings, totaling approximately $500 million, two convertible debt offerings of approximately $400 million, incremental capacity of $250 million under our corporate credit facility and a new $150 million credit facility, the warehouse our transitional commercial real estate mortgage originations.
We were particularly pleased with the execution of our most recent convertible debt issued last month, achieving a [3 in 7%, 8%'s] coupon and a conversion premium of 12.5% on a new seven-year issue. Evidence in our view that the capital markets increasingly recognized the strong credit quality of our investment portfolio and our low leverage balance sheet.
Looking ahead, the prospects for 2014 appear even brighter than 2013. Our North American and European acquisition and asset management teams are extremely busy and the portfolio results continue to be very compelling.
In the first two months of 2014, we have deployed or committed to deploy up to $188 million of capital and our pipeline of new investment opportunities remains robust across all three major investment strategies, including very healthy deal flow emanating from Europe.
European banks are clearly becoming more serious about disposing troubled legacy assets, evidenced by several large loan portfolios now on the market. We are also sourcing more opportunities to provide rescue capital to borrowers pursuing recapitalizations, a prevalent scenario in Europe where lenders tend to favor more consensual resolution strategies with their troubled borrowers.
As a reminder, Colony has a sizable longstanding platform based in Europe, and we are currently underwriting a substantial pipeline of transactions across the continent. We are also making excellent progress with our Transitional commercial, real estate, lending platform. We have now closed 9 loans with three additional loans expected to close shortly and have just closed a new $150 million warehouse facility, with a two-year terms of financial loans.
We expect this platform to accelerate its origination volume in 2014 and are currently underwriting to an excess of the 13% return on equity based upon our contemplated permanent financing execution.
We also recently teamed up with an unaffiliated party to soon acquire and REO property involving a resort hotel in a Hawaii. The property will be acquired from the former lender who had foreclosed following the loan default by the previous owners.
We have committed to fund sufficient capital to close the transaction on an unlevered basis, however we expect to secure mortgage financing concurrent with the shortly after closing, which will then leave our investment in the form of both, mezzanine debt and equity.
Finally, I would like to provide an update on the Colony American Homes business. As of last week Colony American Homes portfolio had approximately 15,300 homes, up from approximately 14,100 as of September 30th, with a diversified national footprint across nine states.
The current average cost basis across the Colony American Homes' portfolio was approximately $178,000 per home, which we 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. Across the entire owned home portfolio, renovation spending per home is slightly above $20,000.
As of last week, the overall portfolio was 66% occupied, up from 57% occupied as of September 30, 2013. Among other key initiatives, management has been surgically focused on improving operational performance, including faster renovation completions and higher leasing productivity.
During the fourth quarter, Colony American Homes averaged approximately 800 renovations and 730 leases per month, while acquisitions averaged approximately 330 homes per month.
I would also like to provide some color on the admittedly small sample set of lease rollovers that CAH has now experienced within its portfolio. On average, tenant turnover has been approximately 30% across expiring leases, and of the lease renewals, rental increases have averaged between 3% to 4%, without trying to maximize rent from conventional yield optimization techniques. This turnover rate bodes well for the average expected tenure of CAH's tenants.
Separately, CAH has also been calling homes within its portfolio that were not a good long-term strategic fit. Today, CAH has sold approximately 250 homes at an average gross sale price of 117% of our basis, including renovation expense. This is another positive sign for the underlying value of CAH's portfolio.
On the capital side of the business, CAH successfully upsized its $500 million credit facility to 1.2 billion. As mentioned during our last call, the first securitization in the single-family rental space was completed at the end of last year, which generated financing proceeds for the issuer equal to 75% loan-to-value for approximately 88% loan-to-cost, with an all-in pricing of approximately 2% for a fully extended five-year term.
This is obviously very attractively priced debt capital and the Colony American Homes management team is actively analyzing various financing solutions, including securitization for its own purposes.
Colony American Homes also began closing loan origination via new lending program to other owners of single-family homes for rent and this loan portfolio once scaled could be financed via securitization in the future. We view this platform as a highly attractive and complementary business to CAH's core business, due to which potential current income profile, lead generation for future home acquisitions and CAH's ability in seamlessly underwrite the collateral in credit.
Since the postponement of the Colony American Homes' IPO in June of 2013, the CAH management team has been operationally focused with particular attention to the internalization of the property management functions, renovations, leasing and information technology.
When CAH likely re-approaches the public markets, we are confident that the additional scale and operational maturity, debt capital markets executions and other key structural changes to the business, including the potential internalization of management, will significantly improve the likelihood of consummating a successful public offering at an appropriate valuation.
In conclusion, 2013 was a phenomenal year in terms of portfolio growth and performance, and we expected that 2014 will provide more of the same, albeit with new engines of growth such as Europe and more opportunistic equity related investments in platforms.
Now I will turn the call over Darren Tangen, our COO and CFO, for a more detailed summary of our fourth quarter financial results.
Thank you, Richard. Fourth quarter 2013 core earnings were $30.3 million or $0.42 per basic share and net income was $24.9 million or $0.34 per basic share. The $0.07 per share difference between net income and core earnings is composed of approximately $0.01 of non-cash equity compensation expense and $0.06 of depreciation expense, primarily resulting from our interest in Colony American Homes and our hotel portfolio.
Book value per share increased from $18.53 as of September 30 2013 to $18.72 as of December 31, 2013. Fair value per share increased from $20.36 as of September 30, 2013 to $20.78 as of December, 31. Also, we paid a dividend of $0.35 per share for the fourth quarter consistent with the previous three quarters in 2013.
With respect to our fourth quarter earnings, our share of loss from Colony American Homes was $2.7 million on a GAAP basis or approximately $0.04 per basic share. However, core earnings from our interest in Colony American Homes, which adds back depreciation, were marginally positive for the second consecutive quarter.
For the entire 2013 year, core earnings from CAH were basically breakeven, in line with the outlook I presented one year ago when we had suggested the rapid home portfolio growth of Colony American Homes, would lead to a GAAP loss for 2013, but turn positive on a core earnings basis by the end of the year.
CAH's financial results should continue to improve over the course of 2014, as a result of continued improvement in overall portfolio occupancy and other operational efficiencies being achieved.
Going back to the quarterly results, total core earnings of $0.42 per basic share, which was also net of approximately $0.02 per share one-time transaction expenses, highlights the strong core earnings performance of our portfolio ex-Colony American Homes.
Colony American Homes represented approximately 26% of our portfolio in the fourth quarter, yet only contributed slightly above breakeven core earnings. Looking ahead, and given the prospect of a stronger financial performance from CAH in 2014, in addition to the expectation that CAH will represent an increasingly smaller percentage of Colony Financials' overall portfolio as we add new investments. We continue to expect that Colony Financials' 2014 core earnings should easily exceed 2013 levels, adjusting for any significant one-time transaction expenses.
A quick comment on transaction expenses, as we migrate to a higher volume of both, loan portfolio acquisitions and equity oriented investments, we may recognize one-time transaction expenses associated with a particular investment in the period of acquisition.
For example, in January 2014, we formed Spanish domiciled entities to acquire formal title to the recently announced Spanish commercial loan portfolio acquisition, which triggered a transfer tax of $3.8 million to us, or approximately $0.05 per share that will be recognized in the first quarter of 2014. This type of expense recognition could create some lumpiness in our results for the foreseeable future depending upon our level of acquisition activity.
On the asset-management front, I would like to provide a few performance statistics across our various investment strategies as of the end of the fourth quarter. Loan acquisitions were approximately 33% of the portfolio, half of which is represented by our small balance loan portfolios.
We had continued strong performance from our seasoned small balance loan portfolios during the fourth quarter. We currently own an interest in 20 seasoned small balance loan portfolios that we acquired at an average purchase price of $0.54 on the $1. We have resolved approximately 38% of the unpaid principal balance as of December 31, 2013 and total collections on these resolved loans averaged 1.4 times our purchase price basis.
Trailing 12-month weighted average current yield for the remaining loans in these portfolios as of December 31, 2013 was 8% and for our eighth seasoned FDIC loan portfolio acquisitions that all initially had full cash sweep acquisition financing, all eight of those portfolios have now paid off or fully defused their debt and are distributing cash to us.
Turning to our book of new origination, which represents approximately 30% of our total portfolio, these positions sit between an average first dollars loan-to-value of 29% and average last dollar loan-to-value of 73% and yield 11% on a blended basis, a very attractive yield given this risk profile.
The balance of our portfolio or approximately 40% is made up of equity or equity-linked investments, including our positions in Colony American Homes, the multifamily portfolio preferred equity, the select service hotel portfolio and several other smaller loan to own assets. As Richard noted, we expect the percentage of equity and equity-linked investments in our portfolio to increase.
We also expect our European exposure to increase from our current 9% given the significant pipeline of European investments we are currently underwriting. I also wanted to address capital market's activity and liquidity. As you know from our last call, we raised approximately $200 million of common equity during the fourth quarter to take advantage of the significant opportunities we were pursuing at that time.
Subsequent to the fourth quarter, we also raised another $230 million of seven-year convertible debt, which was primarily used to repay amounts outstanding under our $420 million corporate credit facility.
Lastly, we just closed on a new $150 million warehouse credit facility for a transitional commercial real estate loan origination program which is currently undrawn. Advances under this facility will bear interest ranging from LIBOR plus the spread of 225 basis points to 250 basis points. Between our two credit facilities, we now have access to over $500 million of liquidity, which will give us much more flexibility to manage our business going forward.
That said our philosophy towards leverage remains unchanged. We will continue to focus on deal level, nonrecourse, match term financing, locking in an accretive favorable spread for our leverage investments and limit the amount of corporate balance sheet leverage. We intend to utilize our corporate credit facilities as a bridge to more permanent capital, and over the longer term we anticipate our convertible debt issues will ultimately convert to equity.
In summary, a great quarter and year for Colony Financial and we are well poised and determined to build upon this momentum in 2014.
That concludes our prepared remarks and we would now like to open the call up to Q&A. Operator?
Thank you. At this time, we will be conducting a question and answer session. (Operator Instructions) Our first question first question comes from Jade Rahmani with KBW. Please proceed with your question.
Jade Rahmani - KBW
Thanks for taking the questions. Just on the investment capacity and capital, can you comment on current cash on hand?
Yes. What I would say about that, Jade, is really we've got the majority of the availability under our credit facilities available to us, so not a lot of cash on hand, but obviously a lot of credit available to fund future deal flow.
Yes, but we are not into the credit facilities right now to be clear.
Jade Rahmani - KBW
Okay. With respect to the trade-offs between the various options on capital raises. I mean, you alluded to eventually you foresee the converts becoming coming equity, but is that how you look at convertible insurance? Do you view it as equity or does that count as leverage in your mind?
Well, until it converts it's counts as leverage. I think, what we are seeing now is a kind of adverse as a general matter to a corporate leverage and much more comfortable with deal related leverage, non-recourse match term, you know et cetera. Therefore while for sure the converts or leverage in kind of the near to intermediate-term. We are cautiously optimistic that over time our share price will hopefully elevate to a level where the converts will convert into common equity and that's why we prefer doing that type of financing from a corporate perspective as let's say is versus more plain-vanilla debt.
Jade Rahmani - KBW
Okay. Great. In terms of the investment pipeline, could you characterize for us the volume and flow of deals you are seeing and how they split amongst the various categories of investment strategies. Whether it would be home loans, whether it'd be mezzanine preferred equity and also REO property, and also if you could provide target yields and some of the other types of characteristics you are seeing.
Okay. I mean, I'm not sure will give you complete transparency on the dollar amounts. I mean, suffice it to say that I would say in every one of the categories that we pursue, there is at least $1 billion or more of opportunity that we are currently examining and analyzing and underwriting. Some of the categories multiple billions of dollars of opportunity, so you know it's hard to predict exactly what's going to land and what isn't as is always the case in connection with the types of transactions that we pursue, but we are still as a general matter underwriting to the same levels that we been underwriting to from the beginning which is kind of mid-teens equity returns and you know if there was a range there. It's probably kind of 10% on the low end for certain types of transactions and kind of 15+ percent on high end for other types of transactions.
Jade Rahmani - KBW
Okay. Historically you have co-invested in joint venture structures Colony Capital and I think the split in ownership percentage has gradually increased toward around 50%. Also, the multifamily JV investment I think is with an unaffiliated sponsor, so could you just speak to the co-invest strategy and if you expect that to continue to encompass the majority of your investments or is it the case that as you get bigger, you'll be doing more wholly-owned investments?
Well, I think there's a couple of levels of answers to that question. At the beginning, when we were a much smaller company, we were only entitled to a third interest in situations where there was overlap with Colony Capital led private funds that were investing in similar types of assets and that changed once that initial private fun and completely exhausted its capital availability (Inaudible) to 50-50. That's number one.
Number two, depending on where we are in the cycle for capital raising from a private standpoint, there may or may not be capital available in those funds, so if there isn't any capital available you may see even in a situation where we have a fun prospectively that might invest in the same type of asset you might see Colony Capital invest 100%. Okay?
Then further to your point, as we have grown as a public company and diversified somewhat our investment strategies to include new equity categories like triple net lease and alike. These are categories that are outside of the domain of any of the private funds that we are currently managing that invest in the distressed credit space and kind of other special situations, so therefore the net lease deal that we did is 100% owned by Colony Financial, so the answer is not quite as precise as I know you'd like to hear in terms of it being a smorgasbord of the different constructs depending upon what is, but as a general matter Colony Financial and the deals that invests in the Colony Capital sponsors typically gets at least 50%...
Jade Rahmani - KBW
Okay. Thanks. The color is helpful. Just on single-family side, the occupancy rate for 4Q two versus 3Q was the more modest change than what you saw on the prior quarter attributable to seasonality or anything else that you would like to speak to. I know it's improved to 66% as of February.
Yes. Look, I think we were quite pleased with - I mean, it's a seasonality in the business for sure, but you know as a general matter I think the improvement that we saw in the occupancy was kind of as forecasted and we expect that these trends will continue you know for the foreseeable future of particularly in light of the fact that now are leasing pace exceeds our acquisition pace at the margin, so the leasing fundamentals continue to be very robust.
Frankly, surpassing our initial expectations as to how strong the rental market might be in the single-family for rent space. That aggregate number of homes that are rented in the United States is now up to $15 million, having grown from $12 million at the beginning of the financial crisis and this seems to be becoming a regular part of - it was always a regularly part of the landscape to begin with, even a 12 million, but it's certainly very accepted in the marketplace as an alternative and for larger family units probably the preferred alternative.
Jade Rahmani - KBW
Great. Thanks very much. I will get back in the queue.
Okay. Thank you, Jade.
(Operator Instructions) We have a have a follow-up question from Jade Rahmani with KBW. Please proceed with your question.
Jade Rahmani - KBW
Thanks a lot. Just one other follow-up on the single-family side, the finance subsidiary that you mentioned can you talk to if any loans have closed so far what the volume is that you are thinking in terms of originations for the year?
Yes. I mean, very few loans and close debate and it's really just getting started that business, so it's kind of in the embryonic stages, but with a little bit of luck, the volumes will be quite robust and it's hard to exactly predict given that there were still literally in the first inning, so I'm going to be hesitant to kind of give you an actual projection of the volume, but we are cautiously optimistic that this will the hundreds of millions of dollars initially if not larger than that over time.
Jade Rahmani - KBW
Great. Actually an investor emailed me something. Some investors would like to know if you would consider a tracking stock for Colony American Homes or some kind of no structural alternatives that would be similar to a spin-off.
Sure. Well, I mean, look, I think that the simple answer to that question for the moment is, every day we debate various alternatives and different strategies that you know we can pursue for Colony American Homes in terms of capital formation and in terms of capital contract, including spinoff.
Frankly, we hadn't thought of a tracking stack, so interesting idea. We'll add that to the number of different things that we do analyze, but it's all out there. We are not blind to what's happening in the markets, we are in fact we try to keep both, eyes wide open with respect to what's happening in the market.
As I said, we are trying to balance what we are doing from an operational perspective in terms of trying to grow the business and get all of the operational efficiencies that we think should be there albeit we are still very much at the early stages of the learning curve, combined with the most efficient capital market executions and we are trying to kind of balance all of these different considerations in terms of what our approach is, what path we ultimately end up on, but the good news is, this is a high-quality problem to have that there were all of these different choices available to us.
Notwithstanding, we are still private, and frankly able to build the business in a way that we think is optimal without necessarily the total (Inaudible) what the public markets might otherwise look for, for the moment.
Eventually again, I think I said in my opening comments that we still hope to be a public company and that's probably sooner rather than later I know, but we just have to be mindful of all the different variables as we try to balance what we are trying to accomplish in terms of value maximization.
Jade Rahmani - KBW
Great. Thanks. I appreciate the answer.
Okay. Thanks, Jade.
(Operator Instructions) There no further questions.
Okay. Well, just to wrap up, we appreciate everybody's support as always and thank you for listening and participating in this call. Again, we are very proud of what we accomplished in '13 and really feel great about the future here in '14 and beyond, so appreciate it again. Thanks for joining us this morning.
This concludes today's teleconference. You may disconnect your lines at this time and have a great day.
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