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Resource Capital Corp. (NYSE:RSO)

Q2 2014 Results Earnings Conference Call

August 6, 2014 8:30 AM ET

Executives

Jonathan Cohen - President and CEO

Purvi Kamdar - Vice President, Investor Relations

Dave Bloom - Head, Real Estate

Dave Bryant - Chief Financial Officer

Analysts

Jade Rahmani - KBW

Lee Cooperman - Omega Advisors

Richard Eckert - MLV & Company

Matthew Stolzar - Pyrrho Capital

Operator

Good day, ladies and gentlemen. And welcome to the Q2 2014 Resource Capital Corp. Earnings Conference Call. My name is Darren, and I am your event manager. At this time, all participants are in listen-only mode. We’ll conduct a Q&A session towards the end of the conference. (Operator Instructions)

As a reminder, this call is being recorded for replay purposes. And now I would like to turn the call over to Jonathan Cohen, President and CEO. Please proceed, sir.

Jonathan Cohen

Thank you. And thank you for joining the Resource Capital Corp. earnings conference call for the second quarter ended June 30, 2014. I am Jonathan Cohen, President and CEO of Resource Capital Corp. Before I begin, I would like to ask Purvi Kamdar, our Vice President of Investor Relations to read the Safe Harbor Statement.

Purvi Kamdar

Thank you, Jonathan. When used in this conference call the words believes, anticipates, expects, 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 could 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 8-K, 10-Q and 10-K, and in particular Item 1A on the Form 10-K report under the title Risk Factors.

Listeners are cautioned not to place undue reliance on any of 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.

And with that, I’ll turn it back to Jonathan.

Jonathan Cohen

Thank you, Purvi. First a few highlights from the quarter. Adjusted funds from operations were $0.19 per share. During the quarter we funded $181 million of new commercial real estate loans. These loans will have future funding of $33 million, thereby totaling $214 million of new loan commitments. This is 138% increase as compared to $90 million in the same quarter last year and an 83% increase over our first quarter production.

On July 30, RSO successfully completed a $354 million commercial real estate securitization, in which we issued term notes in the amount of $235 million to outside investors at a weighted average spread of 1.29% and on which we expect to earn a return of equity in excess of 15%.

On June 10, RSO completed the issuance of its new 8.625% Series C Preferred Stock demand was strong and we issued 4.8 million shares of our new Preferred Stock for net proceeds of over $116 million. We, of course, paid a dividend of $0.20 for the quarter.

With those highlights out of the way, I will now introduce my colleagues. With me today are Dave Bloom, Head of Real Estate; Dave Bryant, our Chief Financial Officer; and Purvi Kamdar, our Vice President of Investor Relations.

In the second quarter, we earned $0.19 of adjusted funds from operations, closely matching our dividend of $0.20. Our book value was $5.24 having earned $0.11 this quarter, as compared to $0.05 earned in the similar quarter in 2013.

We are making progress bridging the gap between AFFO and net income. We expect this gap to continue to close as we put proceeds from our perpetual preferred deal to work and continue to leverage our balance sheet to appropriate levels.

Our real estate team has done in my opinion a tremendous job of both growing the commercial real estate, business and getting access to the securitization market, a substantially lower spread than have been previously seen in this market.

During this quarter we closed commercial real estate loans with commitments of $214 million, 83% increase over last quarter, where we originated $170 million of loans. Our ability to access the securitization markets and secure low rate, term financing has enabled us to continue to generate solid midteens return on equity on our CRE lending.

Our most recent securitization closed last week and our weighted average cost of funds, I said before with LIBOR + 129 basis points, an excellent execution that reflects we believe the market positive view on our asset quality.

We are well on our way to completing our goal of $600 million to $700 million of commercial real estate loans originated for 2014 with almost $300 million funded in the first six months and future funding commitments on those loans of nearly $42 million.

We have funded almost $500 million during the 12 months ended June 30, 2014 with future funding commitments of over $48 million. This is tremendous growth and we plan on sequentially growing origination during the year.

As I stated on last quarter's conference call, we anticipated using the investment cycle to better leverage our balance sheet to appropriate and reasonable levels. Our access to the real estate securitization market for the second time in eight months gives us the ability to do so.

We are now a leader in the securitization market and have access to $450 million of financing after paying down our commercial real estate term facilities at the close of our second CRE CLO with a continued focus on future securitizations.

Since the end of the quarter, the company has closed or has received the application in the process of closing seven commercial real estate loans totaling $185 million. The company has an ongoing pipeline of new CRE loan opportunities in various stages of negotiation.

During the second quarter we reach the milestone of holding $1 billion portfolio of CRE loans, 92% of which are whole loans. During the second quarter of 2014 Resource Capital Corp. made over $291 million of high -- high quality diversified investments in both commercial real estate and commercial finance.

Our commercial finance pipeline is focused on the middle market corporate segment and our origination machine is just getting going. We have over $40 million in our pipeline and expect to fund at least $100 million more by the end of the year.

We have always invested a portion of our capital to the corporate loan space and we have successfully transitioned to the middle market lending emphasis. Our middle market lending business called Northport Capital is growing and is deployed $160 million of capital.

We have a full team in place to grow this business meaningfully. The company also made approximately $46 million of new investments during the second quarter of 2014 in one of the remaining leverage loan vehicle Apidos Cinco, which had a return of equity of over 40% in 2013.

This redeployed all -- nearly all available capital before the reinvest period and closed in May, taking advantage of the low cost of financing to provide significant returns to the shareholders.

We continue to seek opportunities to generate solid returns of quality credit related products to supplement our commercial real estate lending business. As this portfolio grows it should add a boost to our earnings and our AFFO.

Our credit quality continues to be very solid. Our real estate watch-list is shrinking. We currently maintain the general reserve of $4 million. This is in line with our recent charge-off history and reflects our strong focus on originating commercial real estate loans with strong credit profile. Even as we are increasing origination capacity, our primary focus remains credit quality.

Now, I will ask Dave Bloom to review our real estate activities.

Dave Bloom

Thanks, Jonathan. Resource Capital Corp.’s committed commercial mortgage and CMBS portfolio has a current balance in excess of $1.3 billion in a diverse and granular pool. RSO's commercial mortgage portfolios comprised of 65 individual loans, with an aggregate committed balance of approximately $1.1 billion and is comprised of 92% self-originated whole loans, 7% mezzanine loans and 1% B-notes.

The underlying collateral base continues to be spread across the major asset categories and geographically diverse markets with the portfolio breakdown of 38% multi-family, 20% office, 16% hotel, 18% retail and 8% other, such as mixed use deals.

During the second quarter of 2014, RSO closed new loans with commitments totaling approximately $214 million bringing total new loan origination for the first and second quarters of 2014 to $330.7 million. On a trailing 12-month basis RSO's aggregate loan originations volume is $518.1 million.

Since the beginning of the third quarter, we have closed new whole loans with commitments totaling $40.5 million, bringing 2014 originations to-date to $371.2 million, as compare to total annual productions for 2013 of $348.2 millions.

In addition, we’re in the process of closing additional new loans with an aggregate committed balance of approximately $144.8 million, provided that everything in process closes, RSO's new production for 2014 will stand at $516 million, that’s just one month into the third quarter. So, as Jonathan mentioned, RSO is well on its way to meeting our target annual production of between $600 million and $700 million of new originations.

As we look at our forward pipeline it remains strong, with new loan originations totaling $137.8 million under application and final negotiation and an additional $450 million of new lending opportunities either quoted or past preliminary screening and deep into underwriting.

With the closing last week of RSO 2014-CRE2 our second securitization, our term lines of credit were cleared, which provides us with $450 million of borrowing capacity, that we will again utilize while we’re aggregating collateral for our next securitization.

In addition to financing new loan originations, we will also utilize our lines of credit to leveraged approximate $44.4 million of future funding obligations that remain outstanding on the loans contributed to our recent securitization.

Optimal match funding of our loans and maximum returns on invested equity will be realized when we again access the commercial real estate securitization market, which we anticipate doing more frequently based on the velocity of our new originations.

In addition, although, the average call protection of the loans and RSO 2014-CRE2 is a very healthy 16 months, a new structural feature in our recent securitization is the ability to contribute funded future commitments in the event of prepayments of any other loans in the securitization during their initial term, which in all the one case is three years.

This is an innovative structure that was introduced to the market for the first time in our securitization and is a benefit to both investors in the securitization and RSO by keeping the weighted average life of the deal as close to the stated term as possible.

We are seeing borrowers achieving their asset specific business plans on or often times ahead of pro forma. So as we look at the timing of the drawdown of future funding commitments, we anticipate the majority of these amounts will be drawn within the next nine to 12 months if not sooner.

We also note improving credit metrics across all asset classes represented in our commercial real estate portfolio. The majority of the properties securing our loans are continuing to realize improved cash flow with borrowers plans for value creation well on track. I’m once, again, pleased to report that the entire commercial real estate loan portfolio is performing with no defaults.

With that, I'll turn it back to Jonathan and rejoin you for Q&A at the end of the call.

Jonathan Cohen

Thank you, Dave. Now I will ask Dave Bryant, our Chief Financial Officer to discuss our financials.

Dave Bryant

Thank you, Jonathan. Resource Capital Corp. declared and paid a cash dividend for the second quarter of $0.20 per common share. Our adjusted funds from operations or AFFO for the quarter was $24 million or $0.19 per common share diluted.

Determining AFFO for the second quarter, there were several non-cash adjustments that led to approximately $6.1 million and cash adjustments of $7 million, of which $3.1 million comes from the recognition of cash gains on the extinguishment of debt and $3.9 million from realized gains on the sale of real estate.

We passed all of the interest coverage and over collateralization tests in our securitizations. Each of these financing structures performed well and generated strong cash flow to us in Q2 2014.

We ended the quarter with approximately $320 million of real estate loan collateral posted on our term facilities. And when we closed our second real estate securitization since late 2013, we were able to fully pay off our real estate term facilities, thereby providing plenty of runway for our real estate loan pipeline that will fuel our expected growth.

In the second quarter 2014, we saw a net increase of $782,000 in provisions for loan losses. There was $700,000 provision on the loan related to leasing fund that we took a preemptive write-down on, $60,000 on real estate loans and $26,000 on residential mortgage loans held for investment which was offset by a small decrease in provisions of $5000 on bank loans.

We ended the period with $5.8 million in real estate allowances, $668,000 in bank loan allowances and $700,000 allowance on other commercial finance loans. Overall real estate credit has been excellent and I continue to characterize our bank loan portfolio credit as very benign.

Only one bank loan for $1.6 million is delinquent out of a portfolio of $765 million and again all of our real estate loans totaling $1,00,043,000 are current. Our leverage stands at 1.7 times at June 30. When we treat our TruPs issuances which have a remaining term of approximately 22 years as equity, our leverage is 1.6 times.

With regard to real estate leverage, we ended Q2 at 1.5 times levered on our entire portfolio which includes cash earmarked for new real estate loan originations. Overall leverage came in at 1.7 times from for June 30th and the end of 2013. We saw changes in the components of leverage.

Net borrowings from our real estate term facilities increased and that helped fund our real estate loan origination business. We also had increased borrowings from consolidation of the Moselle CLO and to a lesser extent from borrowings for our mortgage-backed securities. These increases to leverage were partially offset by pay downs and runoff of CLO and CRE debt.

In terms of equity, we had $116 million of net proceeds from our Series C preferred stock issuance in June, augmented by $22.3 million through our active market preferred stock program and $14.6 million from our common stock dividend reinvestment plan. Overall our weighted average effective cost on net proceeds from all three series of preferred stock is 8.76% and efficient cost of capital for RSO.

In terms of liquidity, after paying the second quarter common and preferred stock dividends in late July, we have $156.3 million of unrestricted cash at the end of July, with several additional real estate loans and middle-market loan originations in process intended to invest this equity.

We ended June 30th with a GAAP book value per share of $5.24. At June 30th, our equity is allocated as follows, commercial real estate loans and CMBS 68%, commercial finance 31% and 1% in other investments.

With that, my prepared remarks are completed and I’ll turn the call back to Jonathan Cohen.

Jonathan Cohen

Thank you, Dave, and Dave. With that, before I open the call for questions, I want to reiterate our guidance of approximately $0.40 of AFFO for the next six months. We also reiterate our dividend guidance of $0.20 per quarter during 2014.

With that, I will open the call for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from the line of Jade Rahmani from KBW. Your line is open. Please go ahead.

Jade Rahmani - KBW

Good morning and thanks for taking the question. Can you provide some color on the types of loans you’re originating and can you give a sense for the range of yields and other credit metrics, LTVs that service coverage ratios, specifically how those trended over the past quarter?

Jonathan Cohen

Sure. Dave Bloom can handle that.

Dave Bloom

We are still making loans that have positive cash flow. We are looking at debt service coverage going in, sort of, at a minimum of about 1, 2. I think at this point, we’re still maintaining a weighted average starting coupon of around 5% as we blend all of our production together, which is very consistent with where we've been and where we were in our last -- in our last securitization.

Jade Rahmani - KBW

And what’s the range around that 5%?

Jonathan Cohen

This is Jon. I mean for multi-family, lower levered that we love that rounds out a nice securitization, it would be in mid 4% to 4.75%.

Jade Rahmani - KBW

And what would be at the high end?

Jonathan Cohen

The high end probably would be 6.5% to 7% and that would be in still relatively low levered, that might be in retail hotel situation or office situation with lease-up component.

Jade Rahmani - KBW

Okay. Are you still seeing around 50% of your originations from existing borrowers?

Jonathan Cohen

I would say that number probably is about a third only because -- it's a third to 50%. It depends how you really look at it in terms of number of loans or total dollars. Some of the bigger loans that we made recently have been to borrowers that are either new or have borrowed long time ago. We didn’t see them repeat. They may have borrowed in another form or another PE fund that they worked at.

Jade Rahmani - KBW

Okay. And just over the last couple of weeks, have you seen any -- has any other volatility in the market led to higher loan yields or the loan market hasn’t had much reaction?

Jonathan Cohen

No, I wouldn’t say the loan market in this case, I would say in the middle market lending corporate side, we have seen a little bit of that but not in the real estate side.

Jade Rahmani - KBW

Okay. Additionally, on the CLOs that you’re issuing, is the typical duration about 16 months or which I think you cited or is it a little longer than that?

Jonathan Cohen

No. I apologize if I confused you with the comment. The average call protection though is 16 months. For the AAAs, the weighted average life is 2.88 years. But these loans -- term finance of these loans go five years then the bonds go five years.

Jade Rahmani - KBW

Right. But when they pay -- when loan repayments are received, they pay off the senior securities of these structured deleverages?

Jonathan Cohen

Right. That’s right. Although, we have a very good mechanism as Dave Bloom and his team put into the deal, which allows us to take future funding commitments and essentially put them back into the deal that we lever the transaction.

Jade Rahmani - KBW

Okay. Just lastly on the North Port and corporate lending opportunity, how much flexibility is there under the REIT rules to grow those businesses? Can you talk about like how much capital you would expect to continue to allocate?

Jonathan Cohen

We don’t really -- I mean it’s opportunistic at this point, but we have a lot of flexibility if we want it.

Jade Rahmani - KBW

Okay. Thanks a lot.

Jonathan Cohen

Thank you.

Operator

Thank you. And next question is from the line of Lee Cooperman from Omega Advisors.

Lee Cooperman - Omega Advisors

Thank you and good morning. Jonathan, east wards, we of course paid a $0.20 dividend. I don’t think that the dividend commitments for 2014 is meaningful in itself because of the history. In 2009, we paid $1.15, 2010 and ‘11, we paid $1. We’re currently paying $0.80. Our AFFO from recurring operations is less than dividend. So I have a simple question. When do you expect and do you expect income AFFO from recurring activities to cover distribution?

Jonathan Cohen

Yes. We’ve been right around that level. The last two or three quarters $0.19 to $0.20. We’d like to see it go higher because there always are a portion of our gains that always have been maybe 10% to 15%, have always been from one-time activities, that’s just the portion of our business. So we’d like to see that higher to feel very comfortable with the dividend there.

Obviously, we’re under incredible pressure from the market in terms of keeping with our desire to keep credit quality very high and not make silly loan, while being aggressively deploying capital and focused on not maintaining that dividend.

Lee Cooperman - Omega Advisors

I know but that’s my question, based upon your internal budgets, do you expect to see…

Jonathan Cohen

We’re there now, I mean, we’re there at $0.19 to $0.20. We expect to be there and try to grow that a little bit from here on AFFO.

Lee Cooperman - Omega Advisors

So you believe that you’ll be able to maintain the distribution beyond 2014?

Jonathan Cohen

That’s what we believe now, but I’m always very cautious (indiscernible), yes.

Lee Cooperman - Omega Advisors

And secondly, if you could go through the arithmetic of raising capital at let say, $5.50 a share, take away your underwriting discount. What could you do with that money today that would be accretive to the distribution as oppose to presenting a risk to the distribution?

Jonathan Cohen

We have not done an offering for common stock. We’ve been issuing preferred stock at 5% -- I mean at 8.5%, which where we think, we can make money given our securitization at -- that we just completed at a 15% ROE. Our last securitization was north to 20%. So we’ve been basically focused on preferred stock. We did do a convertible, convertible in the high sixes, which we did nine month -- a year ago. You all quit -- we have not done an offering.

Lee Cooperman - Omega Advisors

Right. Okay. Thank you.

Jonathan Cohen

Thank you.

Operator

Thank you. Your next question is from the line of Richard Eckert from MLV & Company. Thank you.

Richard Eckert - MLV & Company

Hey, thanks for taking my call. Couple of quick questions. The first is there is a gain on the sale of real estate, was that from the Florida Resort property?

Jonathan Cohen

It was…

Dave Bloom

Rick, it was.

Richard Eckert - MLV & Company

Okay. And second, for the second quarter in a row your capital allocation to commercial real estate has been around 70%, which seems a little low to me, isn’t it generally in the 80% to 85% range. I mean I know you plan on being opportunistic but it seems like the allocation to real estate, commercial real estate is somewhat low?

Jonathan Cohen

Yes. We will see that get back up to about 80% within the next six to nine months. It just a matter of us, we had $58 million of payoffs. We had properties we sold, so that number came down a little bit.

Richard Eckert - MLV & Company

Thank you.

Operator

Thank you. Your next question is from the line of Matthew Stolzar from Pyrrho Capital. Please go ahead.

Matthew Stolzar - Pyrrho Capital

Hey guys.

Jonathan Cohen

Hi, Matthew.

Matthew Stolzar - Pyrrho Capital

Can you walk us through the gain on extinguishment of debt? And how do you think about or sort of just what that gain was from and how we should think about those going-forward?

Jonathan Cohen

That gain was from previous buybacks of bonds that went into GAAP income, but was not taken into AFFOs as a gain that those gains are taken in AFFO and we actually receive the cash from the sales of bonds or from the repayment of loans underlying those securitization. So it’s really -- it’s a little bit lumpy here and there, but as these things speed up and the old securitizations are paid down, we expected that to be probably an ongoing AFFO add back probably for the next couple of quarters.

Matthew Stolzar - Pyrrho Capital

Okay. And in terms of your leverage, where are you, would you say in terms of the progress of levering off the balance sheet? And how do you ultimately look at running this from a leverage perspective?

Jonathan Cohen

On the commercial real estate side, we’re looking at, probably somewhere in the 70% to 75% as where we’re comfortable, which would imply a little less than three times. On the corporate lending side, its really more one-to-one business. I think then on top of that we’re comfortable having another half a turn to or so of corporate leverage on top of that.

Matthew Stolzar - Pyrrho Capital

So when we think about sort of what your sources of capital will be going forward, I guess, how do you think about making that decision?

Jonathan Cohen

I would look at it that we will probably be able to grow our balance sheet by another somewhat $600 million to $1 billion on the leverage standpoint.

Matthew Stolzar - Pyrrho Capital

Got it. Thank you, guys.

Operator

Thank you. We have no further questions. So I’d like to turn the call back to Jonathan Cohen for closing remarks.

Jonathan Cohen

Well, we thank you very much for your support, both this quarter and many of you over the years. And we continue to make progress and we’re looking forward to reporting next quarter. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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