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Crexus Investment (NYSE:CXS)

Q2 2012 Earnings Call

August 02, 2012 11:00 am ET

Executives

Kevin Riordan - Chairman, Chief Executive Officer and President

Daniel Wickey - Chief Financial Officer, Principal Accounting Officer and Secretary

Robert M. Karner - Global Head of Debt Investments

Rose-Marie Lyght - Executive Vice President and Co-Head of Portfolio Management

Robert Restrick - Chief Operating Officer and Executive Vice President

Analysts

Jason Arnold - RBC Capital Markets, LLC, Research Division

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

Douglas Harter - Crédit Suisse AG, Research Division

Steven C. Delaney - JMP Securities LLC, Research Division

Gabriel J. Poggi - FBR Capital Markets & Co., Research Division

Operator

Good morning, and welcome to the Second Quarter Earnings Call for the CreXus Investment Corp. At this time, I would like to inform you that this conference is being recorded. [Operator Instructions]

This earnings call may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements which are based on various assumptions, some of which are beyond our control, may be identified by reference to a future period or periods or by use of forward-looking terminology, such as may, will, believe, expect, anticipate, continue or similar terms or variations on those terms or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, our business and strategy; our projected financial and operating results; our ability to obtain and maintain financing arrangements and the terms of such arrangements; general volatility of the securities markets and commercial real estate in which we invest; the implementation, timing and impact of and changes to various government programs affecting the capital markets and the economy; our expected investments; changes in the value of our investments and in the assets securing our investments; interest rate mismatches between our assets and our borrowings used to fund such assets; changes in interest rates and mortgage prepayment rates; risks relating to our counterparties; rates of default or decreased recovery rates on our investments; the degree to which our hedging strategies may or may not protect us from interest rate volatility; impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters; availability of investment opportunities in real estate-related and other securities; availability of qualified personnel; estimates relating to our ability to make distributions to our stockholders in the future; the amount of commercial mortgage loans requiring refinancing; the amount of debt financing from lenders; the volume of short-term loan extensions; the demand for new capital to replace maturing loans; our understanding of our competition; and market trends in our industry, interest rates, the debt securities markets or the general economy. For a discussion of the risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see Risk Factors in our most recent annual report on Form 10-K and all subsequent quarterly reports on Form 10-Q. We do not undertake and specifically disclaim any obligation to publicly release the result of any revisions, which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

I will now turn the conference over to Mr. Kevin Riordan, President and Chief Executive Officer. Please proceed, sir.

Kevin Riordan

Thank you, operator. Good morning, and welcome to the earnings call for CreXus Investment Corp. for the second quarter 2012. I'm Kevin Riordan, President and CEO of CreXus. In addition to our CFO, Dan Wickey, joining me on the call today are the senior members of CreXus management team. I want to begin the call with a few comments on the quarter and the markets in general, and Dan will run through our results. After which, our team will be happy to discuss anything in our release or quarterly supplement.

This quarter, we continue to make new investments and optimize our portfolio. We closed approximately $150 million of subordinate debt investments near the end of the quarter. We sold 2 hotels for approximately $10.5 million for a total gain of approximately $1.8 million. We also continue to implement our strategy to originate whole loans and sell the senior component of the loan while retaining the higher yielding junior piece. Specifically, we sold a $50 million senior position and retained a $30 million subordinate note with a coupon of 11.6%.

As can be seen in our quarterly supplement, our investing activity has enabled us to push out the maturity profile while increasing the return over the last 6 months. This takes some time, but you can see that we have increased the coupon by over 300 basis points while maturities are extended by more than a year.

So now looking at the portfolio at quarter end, we have an unlevered debt book of approximately $700 million yielding north of 11%, with a weighted average LTV of 70%. We also have real estate investments of approximately $70 million yielding 10% utilizing a modest amount of nonrecourse leverage. In light of the options available to investors, we think CreXus provides a very compelling investment opportunity.

Since quarter end, we have closed $125 million of new investments. We closed 2 subordinate debt investments totaling $60 million that will earn north of 11%, with a weighted maturity of 6.5 years. We also closed 2 senior mortgages totaling $65 million with a coupon of approximately 6.5%. We are obviously pleased with the risk return profile of the sub debt positions.

We're in the process of optimizing the capital structure of the senior loans where CreXus may retain the subordinate debt at our targeted asset yields. You saw that in the quarterly activity where we sold $50 million senior note. Timing for these transactions cannot be certain though. In addition, the amount of our remaining available cash is affected by the timing of borrower repayments.

So let me summarize our quarterly activity and our recent closings. We've closed $275 million in the last 60 days. $210 million is in sub debt earning 11.25% and $65 million in senior debt. Also, we didn't close the $50 million A note until the end of May, so Q3 will be the first full quarter that we will realize the contribution from the retained note. We continue to see compelling opportunities across the capital stack and we're not only generating new business but repeat business as well.

On the property side, fundamentals are generally improving. New supplies anemic for most property types in markets. The capital markets are open to real estate, and the asset class looks cheap relative to the cost of debt. Investors continue to search for yield. But the markets are competitive. The attractive relative yield on commercial real estate both debt and equity have created strong demand. We continue to partner with portfolio lenders. Risk guidelines remain constrained. Our investment offers that additional layer of protection they need to facilitate business.

With that, Dan Wickey, our CFO, will now take you through our results.

Daniel Wickey

Good morning. CreXus reported GAAP earnings for the quarter ended June 30, 2012, of $14.4 million or $0.19 per average share available to common shareholders. We declared a dividend for the period of $0.27 per share, producing an annualized dividend yield of 10.62% based on the June 30 closing price of $10.17 per share. Our book value at June 30 was $11.96 per share.

As part of our strategy to opportunistically sell the hotels, 2 were sold resulting in the gain of $1.8 million. As Kevin indicated, CreXus had no recourse leverage at June 30. The leverage that we did have was associated with our net lease portfolio.

Our investment portfolio was approximately $750 million, comprised primarily of first mortgage commercial loans and mezzanine loans. Our real estate investments includes warehouses and the hotel portfolio acquired in the first quarter, the deed in lieu transaction. At June 30, 2012, our weighted average yield on debt investments for the portfolio was 11.27%.

At this time, I would like to turn the call back over to the moderator, and we will be happy to answer any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Jason Arnold of RBC Capital.

Jason Arnold - RBC Capital Markets, LLC, Research Division

I'm just curious, first, you can give a little bit more color on the mix of the $125 million of new investments made subsequent to quarter end, and kind of what segments of the series base and the loan market that you find particularly compellingly attractive right here?

Kevin Riordan

Sure, Jason. I'll give you what the mix was and then Bob Karner will talk about what he sees out in the market. Of the sub debt, the $60 million that we did in the sub debt, $20 million was in office and $40 million was in multifamily. And then on the senior debt of $65 million, $46 million was in industrial and $18 million was in retail. So we have a nice variety of asset classes there.

Robert M. Karner

Yes. This is Bob Karner. We like the fact that we think we're getting better diversification in our portfolio, we're getting more exposure to warehouse space, more exposure to multifamily, and that's good in building out a diversified portfolio. And going forward, we are seeing more bulk distribution or warehouse opportunities on the margin. We're seeing more multifamily opportunities as well. We highlighted on the last call that we continue to be the beneficiary of repeat business, repeat both via senior lenders that we've done financing packages, financings with before, as well as borrowers that we've done business with before. And hopefully, that will continue.

Jason Arnold - RBC Capital Markets, LLC, Research Division

Great. Okay. And then you, of course, put some good money to work here since quarter end. But I was just curious, I know you've used the MBS market in the past, as kind of 4 months [indiscernible] investing on the CMBS side, and then more as a temporary investment tool on the Agency side. So I know that an origination activity can kind of be lumpy. But I was just curious as to your thoughts on utilizing that space as kind of a filler again as you kind of get pre-pays or repayments coming through the Barclays portfolio.

Rose-Marie Lyght

Jason, this is Rose. Obviously, we will always continue to look at all the different markets and the different opportunities within those markets, so we would never say never that the agency stays [indiscernible] where we would look to put if we saw some relative values that made sense. But to your point, we are seeing a good amount of investment opportunities in the commercial real estate environment and in those opportunities. And if you listen to the analyst call earlier this morning, we're not looking -- I'm not necessarily looking to go into agencies and take the risk of having to sell in 2, 3 months because I have a credit commercial opportunity that is providing better risk-adjusted return. So we're not going to be in and out of the market like that for the agencies. And with the pipeline that we have in the commercial space right now, we feel comfortable that putting the rest of the money to work will be easily done in that space.

Operator

And the next question is from Jade Rahmani of KBW.

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

Given the investment activity you cited, can you give a sense for what percentage invested you currently are if you include those closings? And also, at what level of cash would you consider the company's capital fully deployed?

Kevin Riordan

Yes, well, just running through the cash numbers starting with the year end balance. We've got and the closing we've just had through the end of July, we have approximately $65 million of uninvested cash at the moment. Again, we're always subject to potential repayments so that cash number can move around. I like to get -- it's a question of investing the money, but also what we're targeting is getting subordinate debt. So we can get fully invested by doing first mortgages but they're going to be a coupon sort of in the 6.5% area which I just told you the 2 first mortgages we did. We're not going to own those 6.5% similar to the way we didn't own that hotel deal at 6.75%. We're going to look to recycle the senior piece and then hold the junior piece, so that timing of that money is a bit uncertain. But the goal is, for us, always to get fully deployed and then circle back, recycle the A note back into sub debt investments.

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

And what's your sense of -- or is there any sort of emerging regularity to the pace at which you're able to do that refinancing or do the sell the seniors, retain the sub piece?

Robert Restrick

It's Bob Restrick. In my experience, there's never been a whole lot of real regularity. It's always very opportunistic because of all the different parties, whether on the borrower side, you have people leasing up their properties, looking to either lock in long-term financing or to sell them. And then on the financing side, with a lot of partners that we did the A notes, whether it's an insurance company whose I think after the year, they hit their bogeys, and they're not putting more money out or there's more demand at the bank to put out more money, it just takes a lot of time if we get all the right parties in line to REIT, put our first mortgage on and then also to identify the right A note guide. So it's not really regular but we try and manage it as tightly as we can.

Robert M. Karner

And this is Bob Karner. We continue to see more in incremental demand from banks who have either repaired their balance sheet or in the process repairing their balance sheet that are now looking for more assets to put on. To the extent that these institutions are funding themselves to close to 0%, LIBOR plus 200 to 300 is very attracted to them. It's also very attractive to us that we can execute an A note in that basis if we're doing the whole loan in the context of 6% to 6.5%.

Kevin Riordan

And just one last thing, it's really, really helpful to get repeat relationships going with these A notes. And for example, we had financed a first mortgage, if you will, back at year-end, and we sold $15 million of that senior piece and retained $10 million with the financial institution. That note was subsequently repaid in full. You saw that the second quarter activity when the $10 million was repaid. We have now sold that A note that I've described earlier, $50 million, we sold that into the same institution. So that does help a bit and that increases the velocity of trying to do that type of business.

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

Okay, that's helpful. Secondly, regarding the remaining discount accretion, what's the pace of the remaining income recognition of that? And are you still expecting 100% of that $20 million discount to be recognized?

Kevin Riordan

Basically, we -- that is going to be accreted over the life of the loans. We are only expecting what -- we can't predict what payoffs are going to be happening. So as of June 30, that is a good number.

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

Okay. But the pace quarter-over-quarter did decline, so just from a modeling perspective, just trying understand what kind of run rate to assume going forward, I guess, without any other information this quarter's run rate would be the best guess we could make at this point. Is that fair?

Kevin Riordan

Yes, that's a fair assumption.

Operator

And the next question is from Douglas Harter of Crédit Suisse.

Douglas Harter - Crédit Suisse AG, Research Division

And then just to get a sense as to portfolio repayments, would you characterize -- outside of the senior, the A note sale, would you characterize this as kind of a heavy prepayment quarter, normal? Just to get some expectation for sort of net portfolio growth going forward.

Kevin Riordan

I can't place a description on it exactly, Doug, to be frank with you. A lot of the properties -- a lot of the transactions we do have, if you will, a business side behind the property itself. In other words, the borrower, we've done transactions with borrowers who have taken on a property, which has a lease sub component to create valuation. So how successfully it is and the timing of that success would dictate the ultimate resolution of what would occur to the property and, therefore, how we will get repaid. And another example is some of the borrowers have acquired properties again with the lease up component to it or a value creation component, if you will. And their goal is to sell off and dispose the properties as opportunistically that makes sense for them. Again, I can't really control that. We build flexibility, we built prepayment protections and so forth around the instruments that we do, but it's very difficult to model prepayments. I mean, we have the absolute -- the only thing we have disclosed, if you will, on Slide 12 of the supplement is to fully extended maturities of the loans themselves.

Robert M. Karner

Yes. This is Bob Karner. To follow on to Kevin's point, as you can see, we began the year with a weighted average maturity of 3.3 years, we spent the past 6 months if you will kind of extend in that portfolio, pushing the maturities out in terms of refi and longer-term, longer-dated assets. So today, that weighted average maturity is 4.74 years. So I think on the margin, if anything, we're extending that maturity schedule and reducing debt paydown schedule from -- on a quarter-by-quarter basis.

Robert Restrick

I think just a follow-up on that, this is Bob Restrick, we also structure most of our loans with some form of call protection, so that we just experienced one last quarter the apartment portfolio in New York City paid off $50 million. We weren't expecting that to come back, but it did, and we got a 5-point penalty for that as well. So even when you have large penalties, people still pay off because there's other motivations going on at the borrower level.

Douglas Harter - Crédit Suisse AG, Research Division

Great. And then sort of given the investment activity quarter-to-date you're getting closer to sort of using up your cash balance. Can you just refresh our -- refresh us on your thoughts on whether you would use any form of financing or leverage, I mean, on the portfolio?

Kevin Riordan

Sure. I think we say this all the time, but we're always looking at the possibility of getting some form of financing in place, especially as we get to a point where we're more long-term fully invested. We have still an ongoing dialogue with several providers of debt and we keep evaluating that. So it's just trying to optimize our overall portfolio in terms of reselling these A notes and then also trying to find a good -- it's a balance of trying to find something that's flexible as opposed to locking in some monthly repo that you would have to -- that you get caught on the wrong side of.

Operator

[Operator Instructions] And our next question is from Steve Delaney of JMP Securities.

Steven C. Delaney - JMP Securities LLC, Research Division

Just a couple of miscellaneous things. Kevin, when you described the new originations in the pipeline, you use the term sub debt. And is that analogous to what we've also referred to as mezzanine loans?

Kevin Riordan

That's correct.

Steven C. Delaney - JMP Securities LLC, Research Division

Okay, good. I don't know if there was some nuance in the legal structure or the instrument or something that would [indiscernible] kind of make a distinction.

Kevin Riordan

And it also can include preferred equity and B notes.

Steven C. Delaney - JMP Securities LLC, Research Division

Okay, great. Yes, I know something -- sometimes you get preferred rather than the actual debt loan. And I apologize, but I missed your first quarter call. And when I was going through this release last night, I was a little confused about it. Can you just, very briefly, update me on the nature of why you had discontinued operations in the first quarter and, of course, an ongoing impact? Does this have something to do with these hotels you're referring to?

Kevin Riordan

That's exactly it, yes. The hotels being held for available for sale, we classified the income as discontinued operations.

Steven C. Delaney - JMP Securities LLC, Research Division

Okay. So you took a deed in lieu and then you actually had the property held for sale, and it's working through, so I guess...

Kevin Riordan

That included [ph] the sales we had in Q2 for the $10.8 million.

Steven C. Delaney - JMP Securities LLC, Research Division

Yes. Okay, very good. I mean, it looks like year-to-date, obviously, there's -- I mean, even though it was something you had to take back, it looks like you've had a $3 million positive impact earnings year-to-date from that activity.

Kevin Riordan

That's right. And I'll also tell you that you take over properties via deed in lieu, Steve, as you're aware, it's not always a perfect hand-off. We went in there, we utilized Prism Hotels out of Dallas, Texas to take over the management of the hotels, and they've done a very good job increasing the RevPAR of the assets themselves and improving the net income. And looking at what they've done and projecting it back out, we anticipate seeing a cash on cash yield from these assets in the low double digits that'll basically mirror what we're doing up in the sub debt space itself.

Robert M. Karner

And then that's an unlevered yield.

Steven C. Delaney - JMP Securities LLC, Research Division

Okay, great. And then my last thing, I'm trying to get a handle on, obviously, you maintained your dividend this quarter at $0.27 against $0.19 of EPS. It's a fairly wide excess of the dividend over current earnings. And obviously, we've got some GAAP tax differences, but I couldn't really identify anything significant in the second quarter income statement like provision for loan loss or something that would be a GAAP charge but not a current charge for tax. I mean, is there anything you can share with me just to help me understand the difference there? Is there something I'm missing in the second quarter, or did you simply have sort of some carryover excess taxable earnings coming into the quarter that helped support the dividend?

Kevin Riordan

It's more of a timing difference, as you had said, between the GAAP and tax. There was slight carryover just for when we declared a dividend as to where it possibly pays off. So we did have some excess due to that.

Steven C. Delaney - JMP Securities LLC, Research Division

But you also -- you're also are suggesting -- so you had a little excess but just in the nuance of the line items, you're -- are you -- am I hearing you say that also, your taxable EPS for 2Q was higher than your GAAP $0.19?

Kevin Riordan

That is correct.

Steven C. Delaney - JMP Securities LLC, Research Division

Okay. So a combination, okay.

Operator

And the next question is from Gabe Poggi of FBR.

Gabriel J. Poggi - FBR Capital Markets & Co., Research Division

Two very quick questions. The $275 million you guys have done kind of in the last 60 days, can you give us a ballpark on the LTV there? I know it's more heavily weighted to sub debt, but is it just kind of -- does it mirror what you guys have in the supplemental?

Kevin Riordan

It absolutely does. It's -- the interesting -- on the coverage side, it is about 1.4x, which is the coverage for sub debt portfolio, so coverage wise. The LTV of the senior debt was at 70% and the LTV of the sub debt was at 80%.

Gabriel J. Poggi - FBR Capital Markets & Co., Research Division

Perfect. And then one other quick question, you mentioned you did $65 million of firsts that you're going to kind of look to recycle. Trying to think about, you guys are looking to kind of maybe awfully $40 million of that $65 million. I'm just trying to think of additional capital that could come back to you over the next, I don't know, take a timeframe, 60, 90 days if someone, if you do something kind of $40 million of that $65 million will probably go out the door and then you can recycle it?

Kevin Riordan

As a good rule of thumb, it's generally 75% of the first mortgage is area where we target it to redeploy.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Riordan for closing remarks.

Kevin Riordan

Thank you, operator, and thank you, everybody, for listening to our earnings call for the quarter ended June 2012. We look forward to speaking to you again at the conclusion of Q3 2012.

Operator

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing (877) 344-7529 or (412) 317-0088, with an ID number of 10016749. This concludes our conference for today. Thank you for participating, and have a nice day. All parties may now disconnect.

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