Resource Capital Corp. (NYSE:RSO)
Q3 2011 Earnings Call
November 3, 2011 8:30 a.m. ET
Jonathan Cohen – President and CEO
Purvi Kamdar – Director, IR
David Bloom – SVP, Real Estate Lending
David Bryant – CFO
Christopher Allen – SVP, Commercial Real Estate
(Brian Gonnic – Sin Vest)
Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 Resource Capital Corp. Earnings Conference Call. My name is Kim, and I will be your coordinator for today. At this time, all participants are in a listen-mode. We will conduct a question-and-answer session at the end of today’s conference.(Operator instructions).
As a reminder, this call is being recorded.
I will now turn the conference over your host for today’s call, Mr. Jonathan Cohen, President and CEO. Please proceed, Mr. Cohen.
Thank you for joining the Resource Capital Corp conference call for the third quarter ended September 30, 2011. 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 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 these contained in the forward-looking statements. These risks and uncertainties are discussed in the company’s report filed with the SEC including its reports on forms 8-K, 10-Q and 10-K, and in particular item 1-A on the form 10-K report under the title Risk Factors. Listeners are cautioned not to place undue reliance on 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.
Thank you Purvi. First a few highlights. Our GAAP net income was $14.9 million or $0.20 per share diluted, and $37.3 million or $0.54 per share diluted for the three and nine months ended September 30, 2011, respectively. Compared to 14.1 million or $0.27 and 28.8 million or $0.64 per share diluted for the three and nine months ended September 30, 2010, respectively.
Funds from operations for the three and nine months ended September 30, 2011 was $16.2 million or $0.22 per-share diluted and 40.2 million or $0.59 per share diluted respectively.
Total revenues increased by $4.3 million or 22% and $17.1 million or 35% compared to the three and nine month ended September 30, 2011 respectively. We paid a dividend of $0.25 per common share for the quarter or 19.2 million in the aggregate on October 27, 2011 to stockholders of record as of September 30, 2011.
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; David Bryant, our Chief Financial Officer; and Purvi Kamdar, our Director of Investor Relations.
Resource Capital saw another quarter of growth, lower credit provisions and good cash flow. We were also very active in terms of moving forward with our plans, reaching important goals and strategic objectives.
We continue to build our investment portfolio while paring some older and riskier real estate positions. In fact, we originated close to $40 million of real estate whole-loans for the quarter and into October, and are in the process of closing even more.
In this same timeframe, we purchased approximately $15 million in real estate equity investments, distressed and value add. And we opportunistically converted two loans with close to $35 million outstanding into equity ownership. We sold some positions and received over $13 million of cash from repayments this quarter.
Consistent with our goal to strengthen our assets, our commercial real estate portfolio is now approximately 84% whole loans as compared to 66% a year ago. A very active quarter and one that is positioning us to obtain our goal.
You will hear us talking about funds from operations as an alternative measure to look at our earnings. This change is necessary due to – is necessary as we have begun a strategy of selectively acquiring distress and value-added properties.
This strategy will mean that we will have far more depreciation run through our income statement and FFO, or Funds from Operations, will back this out so an investor can have a clear perspective on how we are doing. This is another strategy to build long-term book value through appreciated investments, while maintaining strong cash flow and a high dividend.
So far, in my opinion, we have excelled in this strategy.
In total we own properties with approximately 10 to $15 million in equity, and expect returns in excess of 18%, including 5 to 10% cash-on-cash returns in the first year growing. We have done this through joint ventures as well as directly through our management company.
Credit generally continued to improve and our provisions for loan loss has decreased significantly, nearly 70% from the prior year. We believe the credit environment is still improving for real estate, but we are certainly aware of the weaker macro situation.
While credit on our legacy loans continues to improve, this part of our asset base has decreased due to the growth of our business.
Dave Bloom will tell you in a few minutes about our newly originated loans as well as our CMBS bond strategy that’s worked quite well so far. Then I will speak about the seller performance in our bank loan portfolio as well as Apidos VIII, our newly-issued term financing for over $350 million of new loans. We’ve also completed recently a term financing for our leasing portfolio, as held in our joint venture with our joint venture affiliate.
We are very are focused on growing our business and eager to complete the investment of $177 million of cash that remained on our balance sheet as of September 30, 2011. This number, although still big, has decreased significantly from almost 236 million at June 30, 2011. And we expect this number to decrease even more significantly within the next few months.
Some shareholders have recently asked me about the timeframe for investing the remaining 177 million of cash, and why we didn’t see that number drop even more this quarter. It’s a good question and one that I want to address.
The answer is quite straightforward. The last quarter saw incredible turbulence in this global stock and debt markets. And we chose to slow down our origination and look for better real estate loans at wider spreads. We’ve been able to execute on this strategy, albeit at a slower pace and expected. We also saw some repayments in the quarter that obviously needed to net out. I believe we will be fairly fully invested by the end of the first quarter of 2011.
The company is in pretty good position to be in. The company is in a pretty good position; very little short-term recourse debt, lots of free cash flow to invest and grow our revenues and profits, improving credit environment with rising real estate prices underlying our loans, and $0.22 of funds from operations as a starting point.
Our focus in the last several quarters on paring back legacy assets and deploying capital into new loans and investments has paid off. We are in a strong position. Going forward, we will focus on further expanding our real estate lending operations, continue to seek opportunistic equity positions in real estate, finding new investment in syndicated bank loans, and building franchise value at our commercial finance business lease.
Now I will ask Dave Bloom, to review our real estate activities. Dave.
Thanks, Jonathon. Resource Capital Corps commercial mortgage portfolio has a current committed balance of approximately $694 million, and a granular pool of 42 individual loans. The collateral base underlying the portfolio, continues to be spread across the major asset categories, in geographically diverse markets with a portfolio breakdown of 40% multifamily, 10% office, 24% hotel, 14% retail, and 13% other such as mixed use or self-storage.
Since we have been actively originating new loans, which started late in 2010, and has been intermittent through 2011 while we through periods of price discovery, we have closed, or are closing 12 new loans with an aggregate balance of approximately $151 million with a weighted average coupon of 7.22%.
When you take into account the typical 1% origination fee, which is accreted into income over the initial two-year term of the loans, our starting coupon is 7.72% on a floating-rate basis overall LIBOR floor.
Our portfolio of commercial mortgage positions is in components as follows; 84% whole loans, 12% mezzanine loans, and 4% B-notes.
We continue to benefit from an increasing percentage of whole loan positions in our portfolio, having gained another 4% this quarter, which represents a year-over-year increase of 18% from 66% as of September 30, 2010 to the 84% we have in portfolio today. This mix shift is the result of our origination of new whole loans, and the sell or payoff of legacy subordinate debt dispositions.
On September 20, the reinvestment period for the first of our two term financing facilities closed, and the $345 million vehicle was fully invested at that time. We still have restricted cash in our second term financing facility, which is $500 million in size, and we have a robust forward pipeline and look to be fully invested well in advanced of the closing of that reinvestment period, which ends in June of 2012. We are currently negotiating new term financing facilities that fuel future lending activity, and that will be structured to match fund on the loans that we originate.
With regard to overall credit and performance of our loans, we note improving metrics across the portfolio with the majority of the properties securing our loans, realizing improved cash flow on a year-over-year basis, and continuing to trend in an upward direction.
We are impressed with the resilience of our loan portfolio and pleased to see the majority of asset-specific business plans are back on track, and progressing towards the realization of borrower’s plans for value creation.
The CMBS new origination loan market has pulled back substantially from earlier this year, and the uncertainty that both borrowers and lenders feel in CMBS execution has created additional opportunities for RSO to make high-quality, high-coupon floating rate loans, in situations where borrowers may have otherwise considered permanent financing.
In addition, tighter CMBS standards, higher pricing, lower proceeds on a going-forward basis, greatly broadens the pool of properties that will seek the floating rate bridge loans that we specialize in.
The retreat of the CMBS lenders is certainly a positive for RSO’s lending platform. As we originate loans for our balance sheet and are not dependent on CMBS for a secondary loan trading market. We currently see approximately $250 million of new loan request each week, and as a result we have a strong forward pipeline of new transactions, and will continue to convert select opportunities to loans for our portfolio.
Sales and financing activity has definitely continued to increase as select markets stabilize. Despite the pullback in the CMBS market that I noted, there has been a significant increase in lending activity by banks, insurance companies, in addition to well-established portfolio lenders such as RSO.
RSO benefits from our focus and expertise in directly-originating floating-rate loans on lightly-transitional properties between 10 and $25 million. Even though there are a number of capital sources in the market to make new loans, there are relatively few market participants focused on floating-rate loans for the middle market.
Our nationwide direct origination platform continues to be the driver of our business model. As has been noted before, our self-originated whole loans are typically structured with origination and exit fees, and the borrower’s responsible for all cost associated with the transaction. In addition, many of our whole loans are structured to derive elements of borrower recourse and other credit enhancements.
We look forward to steady new loan origination while maintaining the credit quality, structure, pricing and diversity of our current portfolio, and meaningful growing our net interest margins and overall profitability.
As a value add strategy to our focus on new whole loan production, in 2009 we began buying investment grade CMBS bonds at a significant discount to PAR. Our CMBS bond portfolio is also diverse in granular, with no single position exceeding $5 million. In addition to our dedicated loan origination and asset management teams, we have a CMBS team lead by Joan Sapinsley that underwrites every bond purchase and then re-underwrites each individual position in our CMBS portfolio on a quarterly basis, and carefully monitors pricing moves on a daily basis.
In 2009, we purchased $54.8 million of bonds, and in 2010 we purchased another $37.8 million. When prices rallied earlier this year, we opportunistically sold $23 million of bonds, and realized a $3.5 million gain. We are well positioned to take advantage of future rallies in the CMBS space, and will continue to opportunistically trade positions for gains, as market moves dictate.
Since the beginning of 2011, we have been very active buying highly rated CMBS for our structured finance vehicles, as well on a $100 million line of credit that we have with Wells Fargo Bank. Through the third quarter of this year, we have purchased $24.5 million of bonds for our structured finance vehicles, and another $51.6 million for our Wells Fargo facility, for a total aggregate new investments and CMBS bonds of $76.1 million.
The Wells Fargo facility provides us an opportunity to deploy meaningful amounts of capital into a space where we have a well-established team, and to earn returns between 12 and 15% in AAA investments.
In addition to our whole loan origination and CMBS bond activities, as Jonathon mentioned, we are also seeking to take advantage of good opportunities to own properties. In the second quarter, we converted two properties with an aggregate loan balance of approximately $35 million to equity. Also in the second quarter, we made two opportunistic purchases. In one, RSO teamed with an established institutional partner to acquire a distressed note secured by 494-unit apartment complex at a substantial discount.
We will receive a 10% share of the profits and are also entitled to a 25% promoted interest over a stated hurtle. In the other, RSO acted alone and acquired a 504 unit value add multifamily apartment complex for $18.6 million. In this instance, RSO acted alone and will recognize all of the capital appreciation itself.
Since bringing all four properties into portfolio, they have now been successfully transferred to our asset management group, and are performing ahead of Pro Forma and exceeding budget expectations. These properties are solid long-term holds with great potential for capital appreciation over time.
We are still targeting 15 to 25% returns for these properties, but early performance shows the potential for returns well above original underwriting. RSO will continue to look for real estate purchases that provide strong current cash flow characteristics and the possibility of significant value creation and profitability.
With that, I’ll turn back to John, and rejoin you for Q&A at the end.
Thanks, Dave. Now I’d like to review our investment in the commercial finance. In January, we transformed our previous investment into a new one, and now we own our interest through a joint venture we formed with LEAF Financial and Guggenheim Securities. Since then, LEAF has made great progress in building it’s vendor programs and making high-quality leases. It just completed its first securitization rated by Moody’s, which was widely distributed. These are good accomplishments in just a few months, and we look forward to even more progress in future periods.
Now I will also review our syndicated bank loan portfolio. Resource Capital’s bank loan portfolio has a carrying value of approximately $1.1 billion and approximately 1.13 billion in PAR value.
For the most recent quarter, the bank loan portfolio, the CLOs that the company owns, produced interest income 23% higher than during the second quarter of 2010. The CLOs have now produced annualized equity returns of 26% since inception.
Overall, in my opinion, our portfolios remain in excellent condition, and little has changed since last quarter. As of September 30, 2011, we have specific reserves of 166,000, and general reserves of 3.3 million, as compared to specific reserves of 136,000 and general reserves of 3.4 million for the second quarter.
We continue to forecast a very, very benign outlook in corporate credit for the next two years. There were zero loan defaults in June, July, and August, and only one small one in September. Currently, the Apidos last 12-month default rate is zero.
All of our deals have increasing amounts of principal cushion, versus last quarter and a year ago. As we mentioned last quarter, Resource Capital asset management also entitled to earn fees, to the fees are earned from managing five bank loan portfolios, which we managed for other investors.
Since the deal closed in February of this year, we are in track to receive what we estimate to be approximately $33 million over the next several years. We have received 7.8 million of fees to date, roughly $100,000 below our projections of variance of 1%.
Very excitedly, on October 13, Resource Capital invested in $15 million in a CLO VIII, Apidos CLO VIII, a $350 million new issue cash flow CLO along with other outside equity investors. We expect to achieve gross returns between 16 and 20%.
We were especially glad to be able to price this transaction, close this transaction during a period of heightened volatility in the market. We are very pleased about the performance and look forward to continued results in the bank loan portfolio.
Now I will ask Dave Bryant, our Chief Financial Officer to discuss our financials.
Thank you, Jonathon. RSO’s board declared a cash dividend for the third quarter of $0.25 per common share. Our estimated REIT taxable income for the third quarter 2011 was 5.3 million or $0.27 per common share diluted. REIT taxable income in the third quarter was impacted by several non-cash tax adjustments, totally 10.8 million and reduced REIT income by $0.15 per-share without affecting our liquidity and ability to pay the $0.25 dividend for the eighth consecutive quarter.
Also, given our new investments in real estate equity, by both acquisition and by conversion of debt-to-equity, we are moving two funds from operations or FFO, as an alternate operating performance measure, since we now have, as John mentioned, significant real property depreciation expense in our statement of operations.
Our FFO for the three and nine month periods were $0.22 per-share and $0.59 per-share respectively, thus this FFO metric gets us to a similar result as REIT taxable income after adjusting REIT income for the non-cash deductions this quarter.
We continue to pass all of the critical interest coverage and over collateralization test in our two real estate CDOs and four-bank loan CLOs through October. As a reminder, the overcollateralization and interest coverage test in each of our real estate CDOs was improved by our cancelation of some previously repurchased bonds in June of 2011.
We also repurchased 10 million of our CRE CDO bonds, for a discount of nearly $0.40 on the dollar, this quarter. Each of this structured financing performed and generated stable cash flow to RCC in the third quarter. The real estate CDOs produced over 15 million and bank loan CLOs generated over 20 million of cash flow during the nine months ended September 30.
Of note, as of the end of the quarter, we have in excess of 144 million of restricted cash in these structures, comprised of about 49 million in the CLOs and 95 million in our real estate deals. This cash, is available for reinvestment to generate very attractive spreads over the cost of associated debt, and to potentially add collateral to each structure.
Of our provisions for loan losses of 1.2 million, 800,000 is related to bank loans, and 400,000 for real estate loans. On our bank loan portfolio, we increased our reserves by 800,000 with virtually all of it related to loan sales during the quarter, sold for credit reasons.
On our real estate loans, 400,000 was added for a previously impaired whole loan. Overall, I continue to characterize our credit as stable to improving, and notably, all of our 42 real estate loans, both legacy and newly underwritten are performing.
Our leverage is 3.6 times. When we treat our trust issuances which have a remaining term of 25 years, and new [inaudible] as equity, our leverage is 3.1 times. Focusing on real estate, we began 2010 approximately 2.3 times LIBOR on our real estate CDOs. After giving effect to the debt repurchases throughout 2010 and 2011, we end September quarter conservative 1.5 times LIBOR on our real estate portfolio.
Our GAAP book value per-share was 566 at September 30, down from 584 at June 30. The $0.18 change in Q3 resulted from reduced mark-to-market adjustments on our CMBS portfolio of $0.11 per-share, the quarterly dividend of $0.25 less earnings of $0.20 per-share for $0.05 reduction, and $0.02 per-share dilution from a restricted stock issuance.
At September 30, our equity is allocated as follows, commercial real estate loans and CMBS is 65%, commercial finance 30%, and 5% in other investments.
With that, my formal remarks are completed, and I’ll turn the call back to Jonathon Cohen.
Thank you. Before we take any questions, I wanted to just answer one or two questions that came to us from shareholders. One shareholder asked what we’ll take for book value per-share to start increasing. Obviously you can hear from our comments today that we continue to move more and more of the portfolio into assets that although high yielding, or yielding, come with appreciation. For instance, our investment in the commercial finance since we leave where we get a 10% coupon, but have 48% of the upside. That can grow book value. The same with our investment in distress and value added properties. Where we’re getting a good cash flow, but really we’re looking for appreciation. It’s instances like that where we can start to grow book value.
Also obviously, we’ve negatively affected probably by 18 to $0.25. I don’t have the exact number, by the mark-to-market and CMBS over the last two quarters, two or three quarters. And obviously we fill like these are money good bonds and so we’re looking forward to taking back into book value the marks on the CMBS and other finance, structured finance securities that fell during these last two quarters, with significant hurt book value.
You know, there are great opportunities in the marketplace to buy back our own CDO debt, and it’s a balance between taking advantage of those opportunities at the right prices. We did this quarter, where we bought approximately, I think, $10 million of CDO bonds, opportunistically. We will continue to look at them; we’re looking at one now. So obviously that’s a good way to grow book value, but you do it by putting cash out for a very low return, in terms of cash-on-cash going forward. So we’re fairly conservative of that as we’re trying to maintain our dividend and move forward and grow.
With that, I just wanted to say we’re very excited to reap the benefits of all these new opportunities, the closing of our CLO, the closing of our securitization, the buying of [inaudible] opportunities. We’re looking forward to putting the $177 million of cash to work. And even taking advantage of more opportunities. And I think we’ve already started to do this, and we look forward to sharing more results for you in future periods.
With that, I will open the call for any questions.
(Operator instructions). Your first question comes from the line of (Brian Gonnic with Sin Vest). Please proceed.
(Brian Gonnic – Sin Vest)
Hi. Good morning.
(Brian Gonnic – Sin Vest)
So on the 177 million of cash to be invested, what’s your latest thinking on what kind of rate you could get on that cash? What kind of returns?
Well, it really breaks down into two categories. One is $28 million, which is unrestricted cash and Dave Bryant will correct me if I get the numbers wrong. And approximately $150 million of restricted cash that are inside, mostly inside the real estate CDOs, although some in the TLOs as of September 30th.
And I would say just on average in the real estate loans, as Dave put forth, we’re looking for returns around 8% on newly-issued loans. And so I would say around 8% on the unrestricted portion, maybe for the touch of things that are in the CLOs, around 6%. And on the restricted portion, we’re looking for 15 to 18% returns.
(Brian Gonnic – Sin Vest)
So when you factor in whatever that blended overall return might be, let’s say it’s 8%, right, on 177 million…
Well, it’s probably more like, you know, 10% or something like that.
(Brian Gonnic – Sin Vest)
Okay, 10%, so that’s $17 million, right?
That’s $0.20-plus a share, yeah.
(Brian Gonnic – Sin Vest)
Right. And you said, I didn’t catch it when you said on the call when you expect to have this deployed, by the end of Q2 you said?
No, by the end of Q1.
(Brian Gonnic – Sin Vest)
End of Q1. Great. On the real estate owned, presumably, that was over the course of the quarter that you…
Hey, Brian, I don’t mean to interrupt you. I want to point out that other than the 177 million, we have probably about 50 to $60 million of loans that during the crisis we dropped the floors on those loans to help the borrowers. We expect to have those loans either repaid, be worked out and put that money out at higher rates than it’s currently earning.
So one of the things we’re doing in addition to the 177 million, not just on the real estate side, but across the board, is optimizing our cash and our cash investments, most of which, you know, has been optimized, but probably somewhere around 100 million, 200 million. There’s stuff that’s floating out there that’s not really earning us very much and it comes from legacy investments, restructuring from the old-time pre – or doing the financial crisis. And obviously, we need to get that to start earning more significantly.
(Brian Gonnic – Sin Vest)
Right, right. So 100 million to 200 million, or is it closer to 100?
My guess is – I’ll get back to you on that, but it probably is 100 to 150 probably.
(Brian Gonnic – Sin Vest)
Okay. On the real estate owned, what is the run rate on the rental, you know, the NOI out of those properties?
I don’t really have that on me right now. I’m happy to provide it to you, but I would just say right now we’ve really bucketed in two categories; one is, we have a joint venture with VARTA Group and there we’re doing, you know, kind of discounted or defaulted loans and we’ve had a good track record of turning them into 15 to 30% type returns. And so there you might not have a lot of NOI, but you’re looking to turn it around quickly, solve the problems and sell it within a year, or two or three. And that’s a very small portion of what we do. The bigger portion is in value-add multi-families where you’re probably getting a, you know, with 60% leverage or something like that. You’re probably getting somewhere around an 8% return, cash on cash, the first year.
But with the trends that are involved in multi-family right now, we feel like we can turn around and either grow the cash flow significantly the second year or/and sell it eventually. And we’re looking for returns somewhere between 17 and 20% there.
(Brian Gonnic – Sin Vest)
With like a two-year horizon you think?
(Brian Gonnic – Sin Vest)
Okay, great. All right, thanks guys. Great quarter.
(Operator Instructions). There is no further questions at this time.
Thank you very much and we look forward to speaking with you next quarter, and please call either myself, or anybody on the team, Purvi Kamdar, with any questions that you would like to be answered directly. Thank you.
This concludes today’s conference. Thank you for your participation. You may now disconnect and have a great day.
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