Colony Financial's (CLNY) CEO Richard Saltzman on Q2 2014 Results - Earnings Call Transcript

| About: Colony NorthStar, (CLNS)

Colony Financial (CLNY) Q2 2014 Earnings Call August 6, 2014 10:00 AM ET


Lasse Glassen -

Richard B. Saltzman - Chief Executive Officer, President and Director

Darren J. Tangen - Chief Financial Officer, Principal Accounting Officer, Chief Operating Officer and Treasurer


Eric Jansen Beardsley - Goldman Sachs Group Inc., Research Division

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division


Greetings, and welcome to the Colony Financial, Inc. Second Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Lasse Glassen of Addo Communications. Thank you. You may begin.

Lasse Glassen

Good morning, everyone, and welcome to Colony Financial, Inc.'s Second Quarter 2014 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 your 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 upon management's current expectations and are subject to risks, 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 is as of today, August 6, 2014, 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 in 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.

And now I'd like to turn the call over to Richard Saltzman, Chief Executive Officer of Colony Financial. Richard?

Richard B. Saltzman

Thank you, Lasse, and welcome, everyone, to our second quarter 2014 earnings call. I'm very pleased to report core earnings for the second quarter of $42.1 million or $0.46 per share, which is a 57% increase from last quarter of $26.8 million or $0.33 per share. Our results once again demonstrated the power, reach and scalability of the Colony Capital platform and our ability to deploy capital effectively and efficiently around the globe. In fact, we achieved record capital deployment again this past quarter of approximately $725 million. And through just 7 months in 2014, we have now invested and committed to invest more than $1.4 billion, which is equal to our former record annual deployment during the entire year of 2013. To fund this activity, we raised approximately $1.2 billion of net proceeds year-to-date through common equity, preferred equity and convertible debt offerings. So we are quickly and effectively putting this capital to work.

In the United States, we generally continue to see improvement in the overall economy and commercial real estate markets. While yield compression has been ubiquitous across financial assets, demand fundamentals in most property sectors and geographies continue to improve against the backdrop of very limited new supply. This translates to a very favorable environment to make new investments in our targeted strategies and we are also taking advantage of current market conditions to harvest gains across our investment portfolio.

For example, since our inception in 2009, we have now fully or partially realized on 22 transactions in the U.S. that have averaged an internal rate of return of 21%. When we include the additional 4 full and partial realizations from Europe since our inception, the average internal rate of return is 20%. A great performance, particularly given our limited use of financial leverage.

Now in contrast to the U.S., Europe remains several years behind the United States in terms of dealing with legacy financial issues and finding a path to a more natural economic growth. Our European team is currently pursuing a deal pipeline that typically involves some form of distress or market dislocation and includes REO and loan acquisitions, recapitalizations and rescue financing opportunities. European investments made up 9% of our investment portfolio at the beginning of 2014. And since then, 35% of our $1.4 billion of deployment year-to-date has been in Europe. Our current portfolio is approximately 20% weighted towards Europe and we expect this to continue to trend higher.

So with that backdrop, I'd like to drill down on some of the specific opportunities we're pursuing. In the U.S., we continue to execute a hybrid return strategy that combines investments with both current yield and capital appreciation potential. For example, we are investing in first mortgages by way of origination and acquisition and financing these loans with matched term, nonrecourse, asset-level debt to provide a foundation of stable current yield, while elsewhere, we are investing deeper in the cap stack, either through preferred equity or common equity via triple net lease transactions or equity platform investments, which will provide a component of current yield and potential upside through capital appreciation.

An example of a current yield strategy is our Transitional Commercial Real Estate Lending business. Darren Tangen will provide more details on the progress of this business shortly. But this platform fits very well with our view of the improving commercial real estate markets. We are financing borrowers who need capital to pursue an interim value add or stabilization strategy and who are prepared to pay a higher interest rate in order to obtain a more flexible floating rate short-term debt solution.

We also just acquired a $272 million performing loan portfolio from Fannie Mae. The portfolio was composed of 237 first mortgage loans with an average loan balance of $1.1 million, a weighted average coupon of 6% and is collateralized primarily by multifamily assets diversified across 43 states with the largest concentration in California. We expect to leverage this investment with nonrecourse, matched term financing in the near term to achieve a double-digit current yield. At the other end of the spectrum, we recently completed 2 triple net lease transactions for a combined $32 million, which have a blended cap rate of 12%. Further, we continue to evaluate numerous other equity and platform investments.

In Europe, our team continues to find very interesting opportunities, many of which are relationship-driven and/or proprietary in nature. Case in point, we teamed up with the largest shareholder of a publicly listed REIT in France to finance a tender offer for the entire company, which we believe was trading at a significant discount to underlying net asset value. Based upon our relationship and ability to quickly assess a pretty complex situation, Colony Financial and a related Colony-managed private fund originated $175 million loan with a high current coupon and a participation in the equity. Although the tender offer was ultimately withdrawn due to a higher rival bid, we earned approximately $3 million in interest, fees and expected equity profit participation over a very short time period.

Subsequent to quarter end, we also made 3 additional European investments totaling $106 million. The largest is a 50% share of an GBP 80.3 million subperforming loan acquired from a German financial institution at 70% of the outstanding principal balance. The loan is secured by 13 commercial real estate assets throughout the U.K., which include office, industrial and retail properties constituting approximately 780,000 square feet. The other 2 deals are first mortgage rescue financing on a luxury hotel portfolio in France and a participating first mortgage loan origination on a Dublin office development site that was acquired out of receivership by a third-party group. Together, these loans will earn us a blended current yield of 12%.

I'd like to finish my comments with an update on our largest investment, Colony American Homes, otherwise known as CAH. As of last week, the portfolio had approximately 17,600 homes, up from approximately 16,200 as of March 31, 2014. And the current average cost basis, including renovations, is approximately $182,000 per home. In July, CAH signed more than 1,000 leases, the highest monthly leasing performance to date and we continue to see strong leasing momentum, resulting in a 78% total portfolio occupancy as of last week with strong improvement from 70% as of March 31, 2014, and 76% as of June 30. A corporate priority has been the internalization of CAH's property management function. As of today, property management is now fully internalized with the exception of 1 market, Denver, which only represents about 6% of our portfolio.

During our call last quarter, I reported on CAH's inaugural securitization completed in early April. And just 2 months later in June, CAH completed a second securitization with even better terms. The latter deal is backed by income generated from approximately 3,700 single-family rental homes for proceeds of $560 million and a blended rate of LIBOR plus 1.74% for a fully extended 5-year term. This represents a meaningful improvement over the first securitization, which was consummated at LIBOR plus 1.78% but with a LIBOR floor of 25 basis points. With the completion of the second securitization, Colony American Homes now has over $1 billion of liquidity between cash on hand and undrawn capacity on its credit facility to either make additional acquisitions or originate loans to other third-party owners of single-family homes for rent to its wholly-owned subsidiary, Colony American Finance, otherwise known as CAF now.

During the second quarter, CAH built out the infrastructure of the Colony American Finance business and now has a $1 billion plus pipeline of loan origination leads. We believe that CAF is an attractive business on its own based upon its high current income and risk-reward profile. But it is also an extraordinary complement to CAH. CAH is able to seamlessly underwrite collateral based upon information already in its possession and simultaneously creates a potential pipeline of future property acquisitions. Last but not least, as the business ramps, CAH will have a more diversified revenue stream, which should add value to the platform and enhance its appeal to the public markets. In summary, we expect the solid performance demonstrated during the first half of the year to continue through the remainder of 2014. But before turning it over to Darren, I have one additional comment.

In May, Colony Financial received a proposal from Colony Capital, the owner of the company's manager, regarding a potential transaction for an internalization of the management of company's current business and the contribution to the company of certain other material assets and rights of Colony Capital. The proposal envisions continuity of the senior management of Colony Financial and that the consideration would be paid in common equity of Colony Financial. A special committee of Colony Financial's Board of Directors consisting of independent and disinterested directors has been formed and together with its advisors is reviewing the proposals. It is important to note that any such internalization transaction will be subject to approval of Colony Financial's stockholders. And there is no assurance that the company will pursue or continue to pursue this opportunity or that this opportunity will be consummated. At this point, we appreciate your understanding that we cannot comment further on this matter.

And now I'll turn the call over to Darren Tangen, our COO and CFO, for a more detailed summary of our second quarter financial results.

Darren J. Tangen

Thank you, Richard. Again we are happy to report core earnings in the second quarter of $42.1 million or $0.46 per share. We have deployed approximately $1.4 billion of capital year-to-date, approximately 1/3 of which has been in Europe and which covers all 3 core strategies of loan acquisitions, new originations and equity investments. Second quarter net income was $32.1 million or $0.35 per share. The $0.11 per share difference between net income and core earnings is composed of approximately $0.02 of noncash equity compensation expense and $0.09 of depreciation expense resulting from our interest in our various equity investments, including Colony American Homes. Book value per share at June 30, 2014, was $18.97, $0.01 lower than our book value per share at March 31, 2014. Fair value per share increased from $21.20 as of March 31, 2014, to $21.39 as of June 30, 2014. We also paid a common dividend of $0.36 per share in the second quarter and just declared a $0.36 per share common dividend for the third quarter.

We are pleased with the ongoing progress and operating performance at Colony American Homes with portfolio occupancy and net operating income continuing to improve. Second quarter core earnings contribution from Colony American Homes was $500,000, basically level with the first quarter. Core earnings contribution would have been approximately $1 million higher if not for some extraordinary items recognized in the quarter. Colony American Homes also had a substantial amount of cash on hand during the second quarter from its 2 securitizations. And so we expect to see more meaningful earnings contributions from CAH in the second half of 2014 as that cash is deployed and the other operating metrics of the business continue to trend positively.

We were also active in the capital markets during the past couple of months. In June, we raised approximately $250 million through the reopening of an existing convertible debt issue and a new Series B preferred equity issue. And given our heightened level of year-to-date investment activity and robust deal pipeline, we followed that up last month with a $380 million common equity offering, which was the highest-priced offering since our inception. This offering was accretive to our book value and fair value per share and we expect this capital to be fully deployed during the third quarter. This capital-raising activity also positions us well from a liquidity standpoint for the balance of the year. To put this in perspective, if our second half investment activity matches the first half performance of $1.3 billion, we will have sufficient liquidity from recent capital raises, near-term investment level financing and revolver availability to fund these prospective investments.

At the investment level, we completed a highly accretive securitized financing in our Transitional Commercial Real Estate Lending Platform early in the second quarter that provided $126 million of proceeds on a matched term, nonrecourse basis at a weighted average coupon of LIBOR plus 1.78% on $190 million of contributed loans. The average loan-to-value of the contributed loans was 70%. And as such, we effectively hold a subordinate tranche with first dollar risk starting at 46% of collateral value and last dollar risk ending at 70% of collateral value. The thick, low-leverage position and affiliated loans held outside the trust, which totaled $79 million in the aggregate, yield an attractive blended rate of LIBOR plus 14%. Since this first securitization, the transitional lending platform has continued to be productive, having originated 8 additional loans totaling $175 million with another $264 million in the process of closing in the next few weeks, which would mean our next financing could be more than double the size of the first one. As I mentioned last quarter, we maintain our expectation to originate approximately $750 million to $1 billion of loans under this program in 2014 and considerably higher volumes in 2015 and beyond when a significant quantity of commercial property loans begin to mature.

On the asset management front, I'd like to provide an update on our performance across our various investment strategies as of the end of the second quarter. Loan acquisitions make up approximately 31% of the portfolio, half of which is performing and subperforming loans, which are all performing at or better than underwriting on average. The other half is represented by our small balance loan portfolios, which included more nonperforming loans at the time of acquisition and often requires various workout resolutions managed through our captive Asset Management Company or AMC. We continue to experience strong performance from our seasoned small balance loan portfolios during the second quarter. We currently own an interest in 22 seasoned small balance loan portfolios that we acquired at an average purchase price of $0.59 on the dollar. We have resolved approximately 41% of the unpaid principal balance as of June 30, 2014. And total collections on these resolved loans averaged 1.4x our purchase price basis. Trailing 12-month weighted average current yield for the remaining loans in these portfolios as of June 30 was 7% despite approximately 46% of the loans being nonperforming.

Turning to our book of originations, which represents approximately 39% of our total portfolio at quarter end. These positions sit between an average first dollar loan-to-value of 22% and average last dollar loan-to-value of 73% and yield 11% on a blended basis, a very attractive risk-reward profile. The balance of our portfolio, approximately 30%, falls under the equity or equity linked category and includes our positions in Colony American Homes, the multifamily portfolio preferred equity, the select service hotel portfolio and several smaller loan-to-own and triple net lease assets.

All in all, it was an excellent quarter for Colony Financial. We are now well situated to finish 2014 strongly. And with this momentum and other significant potential events on the horizon, prospects for 2015 look equally bright. That concludes our prepared remarks. And we would now like to open up the call to questions-and-answers segment. Operator?

Question-and-Answer Session


[Operator Instructions] Our first question is from Eric Beardsley of Goldman Sachs.

Eric Jansen Beardsley - Goldman Sachs Group Inc., Research Division

I just wondered if you could just provide an update on the strategy for Colony American Homes as you look out either at selling it, IPO or spinoff?

Richard B. Saltzman

Sure. So I think, as we've mentioned previously, it is definitely our intent to take Colony American Homes public. And we're really working through the checklist of items that we view as necessary and appropriate to get that accomplished here pretty quickly. Our expectation is within the next 12 months, this is likely to occur. And as you just pointed out, there are a variety of different ways that we could get Colony American Homes public once we have completed the checklist that I just referred to. So the first, of course, would be just through a traditional IPO-type roadshow and offering. But certainly, we will also consider potentially doing a spinoff out of Colony Financial itself, which is similar to what a different group did in order to get themselves public. And then last but not least, there are various M&A possibilities, which could be another way to back-door and get the Colony American Homes business public. So we don't have a bias one way or the other. We're all about maximizing shareholder value. And all 3 of these different types of executions are under consideration as we complete our comprehensive kind of checking the box on the checklist of what it takes to really get that business public and appropriately valued.

Eric Jansen Beardsley - Goldman Sachs Group Inc., Research Division

Are there any metrics that you need to see in terms of the operations, whether it be occupancy or current yield on the portfolio before you do that? Or do you feel like it's in a good place now if you are able to move it?

Richard B. Saltzman

Well, I think it's already in a good place. I mean, the occupancy is now, as we just reported, up to 78%. Our expectation is that occupancy is going to continue to ramp up. We talked about the internalization of the property management functions, which is well on its way and now almost complete. We talked about getting the Colony American Finance business subsidiary organized and up and running. And now that's well on its way. There are a few other things that we want to also do before all is said and done. But we're working 24/7 on all of these different fronts to basically position ourselves to go public as quickly as possible through one of those mechanisms.

Eric Jansen Beardsley - Goldman Sachs Group Inc., Research Division

Okay, great. And then just lastly, as you look out at the opportunities to invest over the next few months, how do you see the mix between transitional lending and more equity investments developing? And ideally, where would you like that mix to be longer term?

Richard B. Saltzman

Yes. Look, I think we're a little bit agnostic about it, to be candid. And we have a little bit here in the U.S. right now, I guess, what you would describe as a barbell approach, which is more current yield being generated from the transitional lending and other activity that we're doing in the mortgage space as versus what we continue to want to do in the equity space because we are much more comfortable and confident about the improving fundamentals, where we want to invest in equity platforms and more triple net lease opportunities and other special situations that we come across from time-to-time. Both of these types of opportunities are for very high total returns. One is much more focused just on the current yield, whereas the other is focused on kind of a blend of more modest current yield but more back-end appreciation potential. And we're seeing lots of opportunities in both categories. And that's just the U.S. leg to our stool. I mean, I think our expectation currently is that probably 50% or maybe even a little bit more of our origination activity or new investment activity will come from Europe, which is much more in the distressed category, kind of harkening back to what we've been doing here in the U.S. over the last several years, where it's either loan acquisitions or rescue capital opportunities. The lending environment in Europe is still pretty scattered, to say the least, just in terms of the capacity of the traditional institution. So we're able to find niches and nooks and crannies where we can originate right at the top of the caps-back in terms of first mortgages at very attractive yields.


[Operator Instructions] Our next question is from Jade Rahmani from KBW.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

In the single-family business, I think you mentioned several one-time items. Can you just provide some color on that?

Darren J. Tangen

Yes. Sure, Jade. There was about $1 million in terms of what Colony Financial's pro rate share of that -- those unusual items. And it really related to 2 things. There was an impairment taken on some noncore assets that were held for sale, and then there was also an unrealized loss or a mark-to-market loss on a hedging instrument that related to one of the securitized financings.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. Your core earnings exceeded the dividend materially. I just want to see if you could give any color on what REIT taxable income was. And if core earnings remain on this level of trajectory, would you expect a special dividend would be required at year end?

Richard B. Saltzman

Well, let me comment first and Darren will correct me where I'm off course. Right now, we don't really have visibility on our taxable income. It's a very complex set of numbers that you have to basically compute at year end. So while we could guess at it, we don't really, to be completely honest, have good visibility yet on what exactly our taxable income will be, even though we, as a matter of policy, try to target our dividend to what that taxable income level will be, so we can maintain our REIT status. And simultaneously, we try to make sure that we can continue to be highly confident in the recurring nature of our regular way dividend. And if, in fact, we generate more taxable income at the end of the year, then what that regular way dividend has been, then we'll pay a special dividend. So look, our business continues to improve, ramp, where we're experiencing a lot of good results both in terms of the regular way and some of the capital gains that we're able to realize. So I think we're cautiously optimistic that over time, we're going to be able to increase our dividend from a regular way standpoint, although I'm not really prepared to comment on when that's going to occur. And right now, when you look at our first half results, I think we're comfortably kind of doing exactly what I just described. And we think that will continue in the second half of the year, but it's a little early to comment on whether we're going to be increasing the dividend, paying a special dividend. I think you're going to have to be a little patient with us on that.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. Regarding the nature of the investments you're doing, it seemed that there was some decline in the average loan size or the average investment size. I'm not sure if that was just OpEx or the way I read the press release. Is that correct?

Richard B. Saltzman

I don't think so. I mean, look, we have, since our inception, had a focus on smaller loan-type opportunities. All of those original deals that we were buying from the FDIC and some of the smaller community and regional banks that were under immense distress and pressure, those typically were small balance. On the other hand, we also have a core competency, an expertise in terms of the larger loan balance-type transactions as well, albeit that occurs not with the same regularity as maybe the volumes that you can buy in the small balance area. But we feel very comfortable our asset management team, which has been working through literally thousands of these smaller loan balance portfolios, this is just a continuation of that effort. So we're very comfortable. We don't really focus too much on what the blend is, how many million-dollar loans we've done versus how many $50 million loans we've done at the end of the day. We just try to do as much in both categories as we can, where it's meeting our return thresholds and our risk management protocols.

Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. Turning to the real property side of the equation, I think for several quarters, you've now mentioned willingness to invest in equity platforms. I was hoping you could just provide some color on what you mean by that. And additionally, on the triple net investments, I think the cap rates stand out as, at least in my sense, as outliers relative to the market. So if you could provide any color on why the cap rate is so high.

Richard B. Saltzman

Sure. So look, I think in terms of the platforms, these are highly complex transactions and typically require a fairly lengthy lead time to negotiate and consummate. And I wish I could be a little bit more specific in terms of kind of new things that we think we're going to be able to announce here shortly. But suffice it to say, we've got a couple of these that we're working furiously on to try to get to the finish line, where you're going to own a very substantial portion of the company, meaning the operating platform, in addition to actually owning the assets. So by virtue of owning the operating company in addition to the assets, it's our view you're going to get a much enhanced rate of return for basically the same risk. And that's why we're so focused and so interested at this point in the cycle in trying to initiate and establish a few of these platforms. It's just like we did with Colony American Homes, which of course, was a Colony-initiated effort. We're interested in either doing that on other Colony-initiated efforts and/or doing it with best-in-class third-party management teams that may be focused on a particular sector strategy or a particular geography. So again sooner rather than later, we're going to get to the finish line on a few of these and we're going to have some good news to report, I believe, in terms of what they are. We're not in a position yet to report on that. But with a little bit of luck, as I said, sooner rather than later. On the net lease front, it's a very competitive space, which I think you're kind of alluding to. And as a result, we're focused in more niche-y type opportunities, where the competition is much more limited and the air is thinner. So that could fall into a couple of different types of categories. It could fall into situations where maybe it's not a long-dated lease and/or where the credit is not as obvious and it's more of a hybrid-type opportunity, where it's kind of a combination of a credit-dated lease as well as a fundamental real estate opportunity of some sort, should the credit go awry or go sideways for some reason. So certainly, we focus on those types of opportunities. Then we focus on some smaller opportunities that might again be less obvious, like these deals that we announced, where one was an office property that basically got converted to a school and where again the credit isn't necessarily as obvious. But on the other hand, we actually believe that if there were a problem with the school credit over time, we could convert the property back into an office property because it's a very vibrant office market in that area. Not everybody who's in the credit lease space can necessarily look at it through that type of lens. The other thing I would comment on is we also have a global footprint that we can benefit from. So we are definitely looking at some credit net lease opportunities outside the United States, which we think are very interesting and where again the competition seems to be thinner.


[Operator Instructions] There are no more questions at this time. I'd like to turn it back to management for any closing remarks.

Richard B. Saltzman

Well, I'd just like to say again, thanks, everybody, for joining us this morning in August. We appreciate your continued support. And it's been a great first half of the year for us and we expect more of the same going forward. So we look forward to reporting hopefully more good news in ensuing quarters. Thanks again.


This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.

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