Resource Capital Corp., (NYSE:RSO)
Q2 2010 Earnings Call
August 3, 2010 8:30 a.m. ET
Jonathan Cohen – Chief Executive Officer, President, Director, and Chairman of Investment Committee
David Bryant – Chief Financial Officer, Chief Accounting Officer, Sr. Vice President, and Treasurer
David Bloom – Sr. Vice President of Real Estate Investments
Purvi Kamdar – Director of Investor Relations
Gabriel Poggi – FBR Capital Markets
Good day, ladies and gentlemen, and welcome to the Q2 2010 Resource Cap Corp. earnings conference call. My name is Michelle and I will be your operator for today. (Operator instructions.) As a reminder, this conference is being recorded for replay purposes.
I will now turn the presentation over to your host for today’s conference, Mr. Jonathan Cohen, President and CEO of Resource Capital Corp. Please proceed.
Thank you for joining the Resource Capital Corp conference call for the Q2 of 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, Jonathan. 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 reasonable assumptions, such statements are subject to certain risks and uncertainties, which can cause actual results to differ materially from those 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 8K, 10Q, and 10K, and in particular item #1 on the Form 10K report under the title “Risk Factors.” Investors are cautioned not to place undue reliance on these forward looking statements, which speak only of the date hereof. The company undertakes no obligations to update any of these forward-looking statements.
And with that I will turn it back over.
Thank you, Purvi. First, for a few highlights. For the three and six months ended June 30th, 2010, we had net income of $0.30 and $0.36 per share diluted respectively, and for the three and six months ended June 30th, 2010, we had retaxable income of $0.30 and $0.55 per share diluted respectively.
We announced a dividend of $0.25 per common share for the quarter ended June 30th, 2010, or $12.8 million in aggregate paid on July 27th, 2010, to stockholders of record as of June 30th, 2010. GAAP booked value was $5.92 per common share as of June 30th, 2010.
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; and David Bryant, our Chief Financial Officer; as well as Purvi Kamdar, our Director of Investor Relations.
The Q2 of 2010 was marked by many positive events, including first we completed a public offering of 8,625,000 shares with net proceeds of approximately $42.8 million. Second, we repurchased $36.1 million par value of our real estate CDO debt at a discount of 45%. Of note, since the quarter end we’ve purchased $20 million par value of our CDO debt at a discount of 31%. These were the AAA’s.
Third, we deployed by mid July, including commitments, most of the capital from our public offering. Fourth we saw our watch list, or impaired list as laid forth in our press release each quarter and today, drop to 6.5% of our portfolio from 9.5% one year ago, a marked improvement in credit. And fifth, we purchased a large portfolio of leases and loans with term financing, with estimated GAAP returns of 18%.
We are excited about where the balance sheet ended this quarter, specifically as it relates to our real estate finance portfolios, which saw leverage fall to a meager 1.7 times. While we continue to build our cash position as our investment update press release indicated a week or so ago, we have started to deploy that cash and will continue to do so. This deployment’s high rates, especially inside the CDOs, will augment our already-growing net interest margin, which grew by over $3 million in the Q2 of 2010 when compared to the Q2 of 2009.
Now to the CDO bond buybacks. Including $20 million of debt we purchased in mid-July, we have now purchased approximately $137 million of our debt back. During 2010 we have purchased approximately $76.4 million at a blended discount of about 38%. This includes $20 million of notes that we bought in July for a gain of $6.25 million, or $0.12 per share. Most of these notes were originally rated AAA through A. While we continue to see debt purchase opportunities and believe we will buy another $20 million to $30 million of debt over the next few months, we are dedicated to growing our interest margin and increasing our gains in our investment portfolio through discount purchases.
This has been most obvious in our commercial finance and syndicated bank loan portfolios where our net spread over LIBOR has increased from 252 basis points as of June, 2009, to 270 basis points as of June, 2010. As I said last quarter we believe we can add between $0.12 to $0.20 of net operating income by putting the cash currently in our structured vehicles as well as some unrestricted cash to work both in terms of continuing to buy back our debt as well as with new investments. We have started to see this, and by September this improvement should be very evident in our earning power.
Most importantly we earned more than our dividend through $0.30 of net income and $0.30 of retaxable income. We did this with over $2.50 of cash on our balance sheet and no short term debt.
Now to credit. This quarter we took the opportunity to sell or agree to sell (after the quarter) a real estate mezzanine loan and a real estate B-note, both purchased in 2006 with a total balance of $43 million at a discount of 15%. Other than that we only had $1.5 million of credit reserves, which in my opinion is a very good trend. We did this because we believed that we could redeploy the cash at much higher rates while eradicating more exposure and binary exposure to pre-financial crisis real estate.
Under the same path of thinking, we impaired two originally-rated BBB legacy CMBS bonds, one of which was purchased in 2006, the other which was purchased in 2007. This was just other comprehensive loss which we ran through our P&L. In other words, this was already in our booked value for the most part. We replaced those with higher-rated bonds at a steep discount and we were very happy to make this trade.
Our credit otherwise remains stable and improving. We are seeing liquidity returning to our borrowers, both on the corporate side where high yield markets continue to bloom, and on the real estate side of the business where our borrowers are willing to now invest equity to refinance. The CMBS market has come back for better quality properties, and believe it or not, the mezzanine market is now functioning.
We are very comfortable with our portfolio, are pleased with our debt purchases throughout 2009 and 2010. Now it is time to add appropriate investments and add to our bottom line. With all this being said we reiterate once again our $0.25 quarterly cash dividend guidance throughout 2010.
Our leveraged loan assets also improved - these are our syndicated bank loans - moving from an approximate $79 weighted average price at June 30th, 2009, to $96 at June 30th, 2010. What a rally. We have continued to see price appreciation this quarter as the portfolio has moved to an approximate amortized cost of $914 million. This improvement has led to our ability to increase our cushion to our over-collateralization tests as well as to upgrade the quality of our loan book.
As mentioned above we have over $30 million of discounts to accrete over the next few years, thanks to the very opportunistic work of Gretchen Bergstresser and the entire Apidos team. We are looking forward to taking advantage of opportunities in this space and of course the term financing returns (a.k.a the CLO market) we will take advantage of lower cost liabilities as we did during the last cycle.
Now I will ask Dave Bloom to comment on the real estate side of the business.
Thanks, Jonathan. Resource Capital Corp’s commercial mortgage portfolio has a current committed balance of approximately $692 million across a granular pool of 42 separate loans. Our portfolio of commercial mortgage positions is in components as follows: 65% whole loans, 27% mezzanine loans, and 8% B-notes. The collateral base underlying the portfolio continues to be spread across the major asset categories in geographically-diverse markets with a portfolio breakdown of 26% multi-family, 22% office, 33% hotel, 12% retail, and 7% other, such as industrial, self-storage, and flexed office.
We have had a $7 million multi-family loan comprised of three buildings in default. The loan has been settled and approved by the court. For the terms of the settlement we will be receiving title to two of the buildings and a payoff of $2.5 million for a release of the third building. The settlement is expected to close within the next month and we remain confident about our recovery of principal in this situation.
We continue to have a $10.5 million mezzanine loan in default that has not paid principal and interest since January. There have been extensive settlement negotiations with the borrower and other mezzanine participants and a special servicer, and terms have been reached for a settlement. The settlement needs to be documented but by its terms the borrower will be committing fresh equity to the deal and our position will be brought current. The cash flow from the properties securing the loan covers debt service, but through a technicality cash flow is being trapped at the senior lender. Current appraisals for the properties securing the loan show our loan basis to be well below the value of the properties so we are confident about the ultimate recovery of principal in this position.
In addition to the multi-family loan that has been settled and the mezzanine loan position that is being worked out, we had a $5 million senior mezzanine on a three-building office portfolio go into default in the Q2. The portfolio lost its largest tenant, and a special servicer projects the loss at the first mortgage level. As a result of the facts we allocated $5 million from general reserves for this position, the full amount of our loan.
With the exception of the loans I have highlighted our portfolio of commercial real estate loans continues to be current. We have seen both sale and financing transaction volumes increase and liquidity returning to the market, and we are beginning to experience payoffs in our portfolio.
The parts of our portfolio continue to face a difficult market but we remain fully engaged and continue to benefit from a deep bench of experienced real estate professionals as we push forward to overall stabilization. We have modified a number of loans across the portfolio, and in every instance our goal was to work with the borrower to provide adequate time to see their business plan through and to reach a capital event that will pay off our loan.
As the debt markets continue to heal, we’re 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’re seeing situations again 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 ready for take-out refinancings.
RSO benefits from our focus and expertise in directly originating loans between $10 million and $25 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. We have an extensive pipeline of deals and are looking to convert select opportunities to loans in our portfolio.
We are actively sourcing new deals and are seeing opportunities to originate new loans at post-crisis valuations, premium spreads, and optimal structure. There are hundreds of millions of dollars of loans coming due and not enough debt providers to address the total refinance demand. In addition, there are numerous discounted payoffs and REO situations, each needing financing at a new and much lower basis.
We have a fully established origination asset management and servicing teams and infrastructure in place. As deal flow continues to build we are uniquely positioned to take advantage of opportunities for well-structured transactions at premium spreads in today’s market and to match our production levels with our existing financing facilities and capital availability.
Our direct origination platform operates on a nationwide basis and is of significant note to our business model. We are not dependent on a CMBS or secondary loan trading market because we originate our own loans. Our self-originated whole loans are structured with origination and exit fees, and many of our loans are structured to provide elements of borrower recourse and other credit enhancements. We will benefit from loan repayments as we reinvest well-structured, higher yielding assets into our long-term, locked in financing vehicles.
With that, I’ll turn the call back to Jonathan and rejoin you for Q&A at the end of the call.
Thanks, Dave. I will now give you some statistics on our corporate bank loan portfolio. As I stated earlier we have syndicated bank loans of approximately $914 million in amortized costs encompassing over 30 industries. Our top industries now are healthcare (12%), diversified (9%), broadcasting and entertainment (7.5%), chemicals (5%), and printing and publishing (5%). As of the end of June our average loan asset yields 270 basis points over LIBOR and our liabilities are still costing us 47 basis points over LIBOR.
Now I will ask Dave Bryant, our Chief Financial Officer, to walk us through the financials.
Thank you, Jonathan. Our estimated retaxable income for the Q2 2010 was $13.4 million or $0.30 per common share. Our Board declared a cash dividend for the Q1 of $0.25 per common share, for a total of $12.8 million. This brings our year-to-date results to $22.7 million of retaxable income, all of which has been paid out as a dividend.
At January 30th, 2010, RCC’s investment portfolio was financed with approximately $1.6 billion of indebtedness, that included $1.3 billion of CDO senior notes, approximately $110 million of leased equipment backed securitized notes, and $51.5 million sourced from our two trust issuances in 2006. We ended the period with $301.8 million in booked equity and RCC’s borrowings of $1.6 billion had a weighted average interest rate of 1.43% at June 30th, 2010, a continuation of low LIBOR.
Consistent with our stated philosophy of maximizing match funding, our investment portfolio is completely match funded by long-term borrowings and thus we have no short-term borrowings. We continue to pass all of the critical 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 CRE CDOs produced over $13.1 million and bank loan CLOs generated over $10.6 million cash in the six months ended June 30th, 2010 for the re.
Of note, as of July 31st, 2010, we have in excess of $103 million in invsetable cash, comprised of $21 million and $82 million in our bank loans and real estate deals respectively. This cash is available for reinvestment in our CLOs and CDOs to build collateral, generate returns, and strengthen our positions in each structure.
As an example, during the six months ended June 30th we bought an investment grade CMBS, $15.2 million at par, for a weighted average price of $68.30. The resulting discount of $4.8 million improved the collateralization in our CRE CDOs and the CMBS purchases provided a cash-on-cash yield of approximately 8.3%. We also have committed over $20 million of CDO capital to fund first mortgage commercial real estate loans originated by our manager. We expect these loans to close in Q3.
Our leverage is 5.3 times. When we consider our trust issuances which have a remaining term of 26 years as equity we see our leverage drop to 4.4 times. Focusing on commercial real estate, we were levered 2.3 times on our CRE CDOs at December 31st, 2009, and after giving effect to the debt repurchases in the six months ended June 30th, we ended the Q2 1.7 times levered as John mentioned on our CRE portfolio. After taking into account the $20 million bond purchase in July, CRE leverage dropped down to 1.6 times. This improves upon the projection from our December, 2009, common stock offering when we had targeted CRE leverage to the 1.7 times level.
Our GAAP booked value per common share was $5.92 at June 30th as compared to $5.98 at March 31st. Our Q2 gains on debt extinguishments exceeded the dilutive effect of our common stock offering in May, 2010. However, necessary increases in our provisions for loan losses and asset impairments offset this impact and caused our booked value to decrease slightly. The increase in loan provisions was to a large extent - $7 million of the $7.9 million, or $0.14 per share – the direct result of our decision to sell a B-note and mezzanine loan position after quarter end, each for approximately 85% of face value. These sales reduced our exposure to commercial real estate loans other than to our self-originated whole loans.
At June 30th, our equity is allocated as follows: commercial real estate loans and CMBS, 78%; commercial bank loans, 19%; leases and notes of 2%; and structured notes of 1%.
When we review our operating performance and trends it helps to look at an adjusted NOI metric. We had two notable transactions in the Q2, which are currently classified as other revenue, that we wanted to highlight on our call. First we had investment gains from selling securities of $2.5 million. Secondly, as noted in the investing update from July 23rd we realized a nice gain on a real estate joint venture which we had entered into in the Q4 of 2009. We sold an interest in a multi-family property at a gain to the company of over $750,000.
These Q2 gains, when added to NOI of $7.3 million and before deducting the incentive fee which was not incurred in the 2009 period yields an adjusted NOI of $13.6 million, or approximately $0.31 per share for the 2010 period, versus $9.5 million in the 2009 period. This adjusted NOI metric and positive performance trend gives us comfort in reiterating our $0.25 quarterly dividend guidance for the balance of 2010.
Last, here is a recap of our sources and uses of funds year-to-date for 2010. We sourced and used approximately $296 million during the six months ended June 30th. Our major categories or sources include issuances of equipment-backed securitized notes, $111.3 million; common stock offerings proceeds of $42.8 million; borrower repayments of $41.2 million; dividend reinvestment plan proceeds of $32.5 million; gains on debt extinguishment, $23 million; net operating income of $18 million; unrestricted cash, $13.4 million; working capital, $8.9 million; gains on sales of securities, $2.9 million; gains from property sale in a real estate joint venture, $1.7 million; and margin collateral returned of $1.1 million. These are the total sources of $295.8 million.
Our major uses during the six months were purchases of equipment leases and notes, $117.6 million; a net reduction in our borrowings of $56.3 million; an increase in invsetable cash of $24.6 million; provision for loan losses of $23.3 million; CLO reinvestments of $22.8 million; dividends paid, also of $22.8 million; related party loans of $10 million; asset impairments on CMBS of $6.1 million; structured note investments of $5 million; purchase of CMBS $4.9 million; additional investment in our real estate joint venture of $1.5 million; and finally loan commitments funded of $0.9 million. Total uses are $295.8 million.
With that my formal presentation is completed and I’ll turn the call back to Jonathan.
Thank you, Dave and Dave. Our basic strategy continues to be to position ourselves defensively to protect our booked value and even build booked value, and certainly to protect our cash flow and build our cash flow so that one day we can not only have a $0.25 dividend but look to grow it. Thanks for participating in our call. Now I will open the call up for any questions.
(Operator instructions.) Your first question comes from Gabe Poggi of SBR Capital Markets. Please proceed.
Gabriel Poggi – FBR Capital Markets
Hey, good morning, guys.
Good morning, Gabe. How are ya?
Gabriel Poggi – FBR Capital Markets
Good, how are you? Two quick questions: the $36 million of debt you bought back in Q2, you guys may have said this, I may have missed it. Where in the stack were they? Were they AAA’s? You guys said the stuff post quarter-end were AAA’s.
No, they were above A, kind of A, AA.
Gabriel Poggi – FBR Capital Markets
Okay. And then do you guys have any commentary on the asset maturity side of things, an outlook out into 2011? How much you guys have coming due from an asset side, how much you’re going to have to work with borrowers in 2011?
We’ve been really working with borrowers so I think that we’re not overly concerned about that. And where we haven’t we’re hearing actually that they’re looking to refinance us. We’ve had numerous people come in the last, let’s call it eight weeks and tell us they’re not looking for an extension; they’re going to pay us off.
Gabriel Poggi – FBR Capital Markets
Okay, great. Thanks.
It’s sort of becoming a new world, Gabe.
Gabriel Poggi – FBR Capital Markets
That’s a good thing. Alright, that’s all I had. Thanks, guys.
(Operator instructions.) If there are no further questions I would now like to turn the call back over to management for closing remarks.
Well, we thank you very much for participating in our call and thank you for your support and encouragement during the financial crisis and afterwards, and we look forward to I think continuing to perform as we have. Thank you.
Thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect. Have a great day.
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