NorthStar Realty Finance CEO Discusses Q4 2010 Results - Earnings Call Transcript

| About: Colony NorthStar, (CLNS)

NorthStar Realty Finance Corporation (NRF) Q4 2010 Earnings Call February 24, 2011 2:00 PM ET


Al Tylis – COO and General Counsel

David Hamamoto – Chairman and CEO

Andy Richardson – EVP, CFO and Treasurer

Dan Gilbert – EVP and Chief Investment Officer


Joshua Barber – Stifel Nicolaus


Ladies and gentlemen, thank you for standing by and welcome to the NorthStar Realty Finance Q4 and full year 2010 results conference call. (Operator Instructions) This conference is being recorded today, Thursday, February 24th, 2011. And I would now like to turn the call over to Mr. Al Tylis, Chief Operating Officer and Counsel for NorthStar Realty. Please go ahead, sir.

Al Tylis

Thank you very much. Welcome to NorthStar’s Q4 and full year 2010 quarterly conference call. Before the call begins I’d like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company’s filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The company undertakes no duty to update any forward-looking statements that may be made in the course of this call.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with generally accepted accounting principles. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with generally accepted accounting principles can be access through our fillings with the SEC at

With that I’m now going to turn the call over to our Chairman and Chief Executive Officer David Hamamoto. David?

David Hamamoto

Thanks, Al, and thanks everyone for joining us. In addition to Al I’m joined today by Andy Richardson, our CFO, and Dan Gilbert, our CIO. Commercial real estate markets ended 2010 on a more optimistic tone than we have seen in the past several years. A year ago we said that two positive things needed to occur for commercial real estate to improve: first, the lending and securitization markets must recover so that reasonably priced debt capital is available to investors; and second, business expansion and employment growth must accelerate to improve real estate cash flows.

As we enter 2011 economic indicators are slowly improving and it appears as though the debt markets are well on their way to recovery. Approximately $10 billion of securitizations were completed in 2010 and the industry experts are projecting $40 billion to $50 billion of new securitizations for 2011. This pales to the over $150 billion annual volume in 2005 through 2009 but is quickly approaching levels more commonly seen prior to 2005.

Cost of debt capital has also steadily decreased as market liquidity returned during 2010. For example, credit spreads on AAA CMBS, which typically comprise the largest buying class in a securitization, decreased by approximately 260 basis points during 2010. Also, values of some real estate properties such as apartments and hotels, whose revenues would most immediately benefit from an economic recovery, have not only stabilized but increased during 2010. Real estate buyers are paying good prices for well-located real estate in high-constrained markets such as New York City and Washington, D.C. Investors appear to be attracted to real estate for current yields as an inflation hedge and in anticipation of appreciation from accelerating economic growth.

(Inaudible) business expansion continues to be the missing ingredient to a solid real estate recovery. With the exception of the hotel and apartment sectors, most properties have not been able to meaningfully increase cash flows because base demand remains soft. Many properties outside of major metropolitan areas continue to suffer the effects of the recession, and consequently, most private real estate investors still cannot access capital to repay maturing debt.

We think 2011 will be a transition year for real estate credit performance, with market default rates stabilizing and possibly decreasing modestly by the end of the year. We anticipate that within our own portfolio, credit management will continue to be challenging, but increasing market liquidity should provide more options that were unavailable the past few years such as loan or collateral sales and borrower recapitalization.

During 2010, improving markets conditions allowed us to sell eight loans for $147 million of proceeds compared to no loan sales during 2009. We also received $270 million from loan repayments in 2010 compared to $106 million in 2009. Operationally, during 2010 we implemented several strategies that should position NorthStar well to compete and invest in what we believe is the beginning of a recovery in commercial real estate.

First, we increased our balance sheet flexibility by retiring over $300 million of recourse debt and we now have virtually no bank debt outstanding. Second, we acquired a $1 billion real estate loan CDO for which we have already recovered our invested capital and which we believe there is the potential to generate over time a return that is multiple to our investment. Third, we substantially completed the build out of our non-traded REIT distribution platform and began to raise equity for NorthStar-sponsored REITs in that market. During 2010 we raised more capital in this market than any other new sponsor in 2009 and 2010.

Next month we will be listed as an approved commercial mortgage special servicer by Standard & Poor’s. We believe obtaining this designation will provide access to further fee-based asset management activities within our own CMBS portfolio as well as from third parties. Our scalable asset management platform, team of seasoned commercial real estate professionals, and experience in mortgage workouts should be value added to others and also open up new opportunities within our own CMBS portfolio not previously available to us.

Going forward into 2011 and beyond, our goal is to become a leading sponsor of commercial real estate fixed income products in the non-traded REIT and more broadly, the alternative investment sector. Our experience indicates there is a scarcity of and demand for real estate fixed income exposure by these investors. We also see opportunities to take advantage of what we believe is market mis-pricing of our own CDO liability. Selective purchases of our issued debt could provide good returns and be accretive to our common booked equity.

Turning to the WAMU property situation, there is no update from the last quarter. In January we posted $26 million of cash collaterals to secure a bond, thereby allowing us to continue to pursue all avenues available to us to resolve the matter in our favor. I’d like to now turn the call over to Andy Richardson. Andy?

Andy Richardson

Thanks, David. For the Q4 our GAAP net loss inclusive of negative $302 million of non-cash marked to market adjustments was $258 million or $3.33 a share. AFFO for the Q4 of 2010 was $40 million or $0.48 per share. We invested approximately $2 million of equity capital and received approximately $97 million of net loan sales and repayment proceeds during the Q4. Q4 net investment income, which is interest (inaudible) and advisory fee revenues less interest expense, swap interest expense, property operating costs and asset management fees, was $75 million compared to $51 million in the Q3 of 2010. The increase was principally due to $24 million from accelerated amortization of discounts relating to loans for which we received repayments in the Q4 greater than their carrying values.

For the full year 2010 our GAAP net loss inclusive of negative $441 million of non-cash marked to market adjustments, was $396 million or $5.17 per share. AFFO for the full year 2010 was $52 million or $0.62 per share. We invested approximately $30 million of equity capital and received approximately $418 million of net loan sales and repayment proceeds during 2010.

Net investment income was $178 million for 2010 compared to $105 million in 2009. The increase was principally due to $36 million of net interest margin and $24 million of accelerated discount amortization from the Cap Source CDO; $10 million of income related to the consolidation of four NorthStar CDOs previously off balance sheet; the acquisition of NorthStar CDO 9; and the purchase of higher-yielding security, which is partially offset by a lower yield from our legacy loan portfolio, approximately $4 million of interest savings from the early repayment of $304 million of bank debt in June, 2010; and $7 million of higher corporate interest expense, principally to the expiration of a floating interest rate swap in late 2009.

General and administrative expenses for 2010 excluding non-cash stock-based compensation totaled approximately $72 million, which is approximately $22 million higher than the prior year due primarily to a $7 million investment in our broker-dealer subsidiary, $3 million relating to the internalization of our healthcare management team, $4 million related to the separation agreement with our former Chief Operating Officer, $3 million related to the WAMU litigation, and approximately $1 million of costs related to the acquisition of the Capital Source CDO.

Realized gains totaled a net $36 million for the Q4 compared to $27 million for the Q3 of 2010. Decreasing credit spreads once again allowed us to generate gains from our securities portfolio during the Q4. As usual, we must caution that we cannot predict the amount, if any, and timing of realized gains that may be generated from our portfolio. This type of income is dependent on many factors including several factors outside of our control, such as market credit spreads and general market conditions. Our $97 million of repayment and sale proceeds in the Q4 includes $39 million of proceeds from three loan sales which had an aggregate $36 million net booked value when sold.

At December 31, and exclusive of the Capital Source loan, we had four non-performing loans, or NPLs, totaling $65 million and having a $26 million booked value net of loan loss reserves. Including the Cap Source loans acquired in the Q3 of 2010, at the end of the year we had 13 NPLs, having an aggregate $50 million booked value and a $258 million principal balance.

The Q4 loan loss provision totaled $32 million, an $11 million decrease from the Q3 of 2010. Loan loss reserves totaled $197 million as of December 31, or approximately 11.3% of the $1.8 billion NorthStar legacy portfolio exclusive of the Cap Source loan. At December 31, the performing Cap Source loan had a $927 million outstanding principal balance and $268 million booked value, representing a 71% discount to contractual amounts due at maturity. NorthStar’s credit provisioning and reserve levels are based on the best information available to us, however we’re continuing to work through a number of assets whose outcomes are difficult to predict.

As of December 31, our net leased portfolio consist of $1.1 billion of healthcare, office, industrial, and retail properties. The overall portfolio was 89% leased at year-end with an approximate seven-year weighted average remaining lease term. Our $3.3 billion commercial real estate securities portfolio had a weighted average rating of B/B2 as of December 31, down from B+/B1 at September 30. We believe that a vast majority of negative ratings actions that we had been anticipating and discussing on our quarterly earnings calls the last two years have finally been made. It appears that the rating actions reflect a higher degree of conservatism and future performance expectations by the agencies. The ratings may not necessarily be indicative of current performance and the vast majority of NorthStar’s CMBS securities are current and paying according their contractual terms. However, further economic deterioration or a disruption in the capital market would negatively impact our portfolio.

The tables contained in the supplemental information section of the earnings release shows the status of the CDO coverage tests. If we were to fail any of these test cash flows from the respective financing would be temporarily diverted from NorthStar to repay senior debt until the sales desk is back in compliance. Credit ratings downgrades on the CMBS collaterals backing our CDOs can negatively impact OC tests if downgrades reach certain levels, even if the security is fully performing. Typically a CDO can have a maximum amount of CCC-rated securities before OC deteriorates.

Preserving cash flow has consistently been a priority in managing our CDO financing, and we have in the past been able to invest in discounted securities to create a cushion, but it is difficult to preserve OC for the three security CDOs in which we no longer have reinvestment rights. At December 31, CDO 2 for which we have no reinvestment rights, was failing its OC tests, as was the Capital Source CDO.

Consolidated assets totaled $5.2 billion at December 31, unchanged from September 30. For the Q4 2010 NorthStar’s booked value decreased by approximately $278 million from September 30th to $12.41 per share. The earnings release contains a detailed reconciliation between our Q3 and Q4 2010 booked value. Lightening market credit spreads continued to increase the value of our liabilities for which we elected Badge 159, resulting in a $482 million decrease to booked value from the Q4. If all unrealized marked to market adjustments, non-cash credit loss reserves, and accumulated depreciation were excluded, booked value would be $7.96 per share at December 31, an increase of $0.38 from September 31 due primarily to the repurchase of issued debt at discounts to par.

NorthStar had approximately $240 million in total liquidity at December 31, comprised of $125 million of unrestricted cash and $116 million of uninvested cash in our CDOs. We currently have approximately $3 million of nondiscretionary future funding for future unrestricted cash need relating to loans and we have no corporate debt maturities until June, 2012.

This concludes our prepared remarks for the day. Now let’s open the call for questions. Operator?

Question-and-Answer Session


Ladies and gentlemen, at this time we will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Joshua Barber with Stifel Nicolaus. Please go ahead.

Joshua Barber – Stifel Nicolaus

Hi, good afternoon. I was wondering if you could tell us how long the reinvestment periods on the rest of your CDOs are, just given the significant amount of restricted cash that you still have.

Andy Richardson

Hey, Josh, it’s Andy. I don’t have the expiration periods in front of me, but the ones that are remaining have between a year and a year and a half remaining on them.

Dan Gilbert

Yeah, Josh, I think the CDO 6 is this summer, CDO 8 is about a year after that; CDO 7 is this summer as well and CDO 9 is well over a year after that as well.

Joshua Barber – Stifel Nicolaus

Okay. Do you have any–

Dan Gilbert

Sorry Josh, and the Cap Source CDO is about a year away.

Joshua Barber – Stifel Nicolaus

Okay. Do you have any funding commitments that are still related to the Cap Source CDO?

Dan Gilbert

Nothing outside of the transaction itself.

Joshua Barber – Stifel Nicolaus

Okay. And I know that you referenced before the funds raising for the private vehicles, but of late your share price has certainly had a really nice appreciation here. How do you think about raising capital over the next year and striking that balance I guess between raising it on your balance sheet itself and sponsoring other vehicles? And at what point would you look to start growing the balance sheet again?

David Hamamoto

Yeah, Josh, I think it’s always a tradeoff between the opportunities and the returns they generate and sort of what price we can raise capital at. But I think we see a lot of great investment opportunities in the market, and to the extent we can raise capital at the right price and thought that we could invest it accretively it would be something that we would look to take advantage of.

Joshua Barber – Stifel Nicolaus

Do you think there are more Cap Source CDOs out there or would the investments that you’re looking at today be more on the direct loans side or securities, or maybe even direct real estate?

David Hamamoto

Yeah, I think clearly the Cap Source CDO investment was a big homerun for us and it’s something that we continue to focus on because we think we’re uniquely positioned to buy commercial real estate CDOs. They’re hard to find. We’ve looked at number of them and we certainly will continue to try and find other opportunities like that. But I think similarly in the direct real estate and investment market, or the acquisition of our own CDO bonds, there are a number of areas where we think we can put capital to work at attractive prices.

Joshua Barber – Stifel Nicolaus

Great. One last question: the CMBS that you sold, the realized gains this quarter, can you give us a sense of what price on the dollar those were sold at?

Dan Gilbert

I think it sort of ranges all over the map depending on what we sold, but I think Andy, you can probably get that to him.

Andy Richardson

I can get that to you offline, Josh. I don’t have that in front of me right now.

Joshua Barber – Stifel Nicolaus

Perfect. Well thank you very much, guys.


Thank you. (Operator Instructions). At this time I would like to turn the conference back to management for closing comments.

David Hamamoto

Thank you, everyone, for joining the call and for your support, and we’ll speak to you next quarter.


Ladies and gentlemen, this does conclude our conference for today. If you would like to listen to a replay of today’s conference please dial 303-590-3030 or 1-800-406-7325 with an access code of 4406812#. We thank you for your participation and at this time you may now disconnect.

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