Resource Capital's CEO Discusses Q3 2012 Results - Earnings Call Transcript

Oct.31.12 | About: Resource Capital (RSO)

Resource Capital Corporation (NYSE:RSO)

Q3 2012 Earnings Call

October 31, 2012, 8:30 a.m. ET


Jonathan Cohen - President and CEO

David Bloom - SVP - Real Estate

David Bryant – CFO

Purvi Kamdar - IR


29.54 Steve Delaney – JMP Securities

Zachary Tanenbaum – MLV


Good day, ladies and gentlemen, and welcome to the quarter three, 2012 Resource Capital Corp earnings conference call. My name’s Dave, I’ll be your operator for today.

At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I’d like to turn the call over to Mr. Jonathan Cohen, President and CEO. Please proceed, sir.

Jonathan Cohen – President, CEO

Thank you. Thank you for joining the Resource Capital Corp conference call for the third quarter ended September 30th, 2012. 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.

Purvi Kamdar – Director of Investor Relations

Thank you, Jonathan. When used in this conference call, the words believes, anticipates, expect and similar expressions are intended to be taken as 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 reports filed with the SEC, including its reports on Form 8-K, 10-Q and 10-K. And in particular, Item 1-A on the Form 10-K report under the tile, Risk Factors. Listed is a caution not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.

This is a precaution 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.

Jonathan Cohen

Thank you, Purvi. First, a few highlights.

Adjusted funds from operations or AFFO for the three months ended September 30th, 2012, were $0.26 per share diluted. We paid a dividend of $0.20 per common share for the quarter on October 26th, 2012 to stockholders of record as of September 28th, 2012. Our book value increased to $5.51 per share this quarter from $5.38 as of December 31st, 2011 and $5.44 as of June 30th, 2012.

Our GAAP net income for the three months ended September 30th, 2012 was $18.2 million or $0.20 per share diluted as compared to $14.9 million or $0.20 per share diluted for the three months ended September 30th, 2011.

Total operating revenues increased by $3 million or 13% and $11.7 million or 18% as compared to the three and nine months ended September 30th, 2011.

Cash on hand was $169.5 million at September 30th, 2012.

With those highlights out of the way, I will not 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.

In my opinion, the third quarter was another terrific quarter for Resource Capital. We achieved what every company in our sector would like to achieve. First, we paid a sizeable cash dividend. Second, we covered that dividend by a margin of 30% or said a different way, we earned 130% of what we distributed as a dividend. Third, while paying the sizable dividend, we also increased book value, and while doing all of this, we raised additional common capital at 110% of book value per common share to diversify and grow our already solid portfolio.

On top of the common capital raise, we also raised relatively cheap capital for ourselves by issuing over $40 million of preferred stock with an average coupon of approximately 8.35%.

While this is the morning before Halloween, trust me when I say that this is no masquerade.

Our credit quality was good. We kept our debt levels relatively low. And opportunities to expand the franchise and the company remain ever present.

Our liquidity remains excellent and we had approximately $170 million of cash including $113 million of unrestricted cash as of September 30th even after making considerable investments during the quarter.

You may notice that our cash has declined significantly from over $235 million last June. This reflects meaningful new investment activity, which has helped fuel growth in operating revenue. The cash, of course, is also increased due to the common stock and preferred offerings, which allowed us to grow our portfolio, diversify it, and increase book value through accretive offerings.

Our portfolio of loans continued to perform well. During 2012, we have grown our real estate loan portfolio by over $150 million net. We expect this trend to continue as we continue to find good opportunities to lend money against good real estate. We have greatly strived to grow our origination channel in real estate and we believe that the investments we have made in our team and systems will start to pay off.

While our portfolio stayed constant for the quarter due to repayments from a legacy $28 million loan, legacy meaning made before the crisis, and another $6.5 million loan made in 2011, we underwrote and funded a series of, in my opinion, very attractive loans. We are picking up pace and expect this portfolio to grow tremendously in the next few quarters, net of payoffs. Dave Bloom will elaborate on this in the real estate portfolio momentarily.

I do want to mention that the revenues from our real estate CDO's as noted on schedule two of this press release continue to grow. For example, we received cash distributions of $22.3 million in the nine months ended September 30th, 2012 from these two real estate CDOs versus $22.4 million for the entire year of 2011; a great achievement by the team.

Our syndicated bank loan portfolio continued to perform well. Credit improved substantially across the company. This trend has continued over the last few quarters. Our leasing joint venture, LEAF, continues to grow and improve its portfolio. We expect that venture to turn profitable later this year. We expect it sometime in November or December on a monthly basis.

We continue to be excited about its prospects. We also continue to explore additional opportunities to diversify and invest capital to provide current return, long-term growth and do so with good risk management.

The growth in our business has been exciting. As compared to the quarter ending September 30th, 2011, this quarter we recorded revenues of $26.5 million versus $23.4 million a year ago. This trend will continue; a tremendous achievement given the steadfastness of our debt to equity levels.

In addition, the revenue growth came from both the real estate loan segment as well as the syndicated loan side of the business.

Now, I will ask Dave Bloom, our head of Real Estate, to review our real estate activities.

David Bloom – SVP – Real Estate

Thanks very much, Jonathan.

Resource Capital Corp's commercial mortgage and CMBS portfolio has a current balance of approximately $894 million in a diverse and granular pool. RSO's commercial mortgage portfolio is comprised of 48 individual loans with an aggregate committed balance of approximately $717 million.

The underlying collateral base continues to be geographically diverse, spread across the major asset categories with a portfolio breakdown of 33% multi-family, 15% office, 21% hotel, 18% retail, and 13% other such as research and development and mixed use. The portfolio was in components as follows; 87% whole loans, 10% mezzanine loans, and 3% B-notes.

Through the third quarter of 2012, RSO has originated new debt positions with an aggregate balance of $115.4 million at a weighted average starting coupon on a floating rate basis of 6.9% including origination fees.

During the third quarter of 2012 through today, we closed three new self-originated whole loans totaling $34.9 million with four more loans totaling another $51 million in process. In addition, we have terms on eight more loans totaling approximately $154 million in active negotiation.

While we see many lending opportunities, we continue to be keenly focused and aware of credit, value, and deal structure. And although we are lending on lightly transitional properties, we're only doing loans with day-one cash flow coverage and meaningful sponsor equity.

With our two structured finance vehicles, our CDOs totaling $845 million having been fully deployed at the expiration of their respective reinvestment periods, we not utilize a $150 million term financing facility that we put in place with Wells Fargo Bank earlier this year. As I've said on previous calls, the Wells Fargo term facility is specifically designed to fund our long-established bridge lending business. The addition to the leverage from the term facility greatly increased net interest margins with leverage yields of new loans targeted between 13% and 18%, which will increase the return on equity and overall profitability of RSOs, real estate, direct origination platform.

Our existing financing facility has a revolving period prior to match funding loans that remain financed. And we will seek to increase our existing facility as well as line up additional prudent leverage as we continue to grow our commercial mortgage portfolio.

In addition, we are actively exploring long-term securitized financing options to more efficiently match fund our commercial mortgage portfolio.

We are still underwriting a consistent forward pipeline of $250 …


Please stand by.

David Bloom

Hello, did we lose our conference line? Operator. Hello.

We are still underwriting a consistent forward pipeline of $250 million on average. And are seeing ample opportunities to make the loans secured by strong real estate to well capitalized sponsors.

That said, while overall sale and financing volumes continue to increase as commercial real estate fundamentals improve and additional markets recover, we have noted that acquisitions and refinancings are taking longer to come to fruition as a bit as disparity returned in healthier markets with sellers feeling slightly stronger about holding pricing levels and terms and buyers and borrowers looking to price to perfection. As a result, certain fully-negotiated applications for new loans need to be refreshed as acquisition terms change over time or uphold altogether as certain deals are cancelled.

Regardless of this timing phenomenon that we noted in the last two quarters, the number of year-end transactions has picked up dramatically in the last 30 to 45 days.

In addition, we see deal flow for our traditional floating rate bridge loans continuing to broaden as more than $1 trillion of scheduled maturities are reached over the next three years. And the capacity of established balance sheet lenders, especially those who focus on loans between $10 and $30 million in size like RSO, not being able to accommodate the vast opportunities that continue to develop.

We remain optimistic about meeting and we're exceeding prior peak level production levels of approximately $600 million of new loans per year as we continue to grow our well-established national origination platform and add new loan programs to our existing product offerings.

Credit across the portfolio continues to trend in a positive direction with improving metrics across all asset classes. The majority of the properties securing our loans are continuing to realize improved cash flow on a quarter-over-quarter basis. And the entire portfolio remains performing with no defaults. As assets are recapitalized or sold and paid off, the few legacy positions that require extra asset management attention grows smaller each quarter. And we remain extremely focused on the ultimate resolution of the limited number of situations.

In our other commercial real estate activities, RSOs CMBS portfolio is now approximately $177 million in the aggregate. We continue to utilize our CMBS credit facility with Wells Fargo Bank and an additional CMBS repurchase facility to buy highly-rated CMBS bonds and deploy meaningful amounts of capital in Triple-A investments or very healthy risk adjusted returns exceeding 15%.

In addition to our whole loan origination and CMBS bond activities, we continue to take advantage of opportunities to own properties. This quarter, RSO converted a whole loan on a well-located, four-diamond hotel and spa to an equity position. RSO's primary equity portfolio now consists of five properties, three multi-family properties totaling 1,154 units, one 30,000-square-foot office building, and one hotel. All of which are performing at or above budget.

Also, RSO, along with an institutional partner, owns a portfolio of 17 non-performing loans in distressed multi-family properties. These assets, acquired at substantial discounts, are –currently represent a total investment of approximately $136 million. RSO participates in up to 25% of the profits as these investments are realized and has already booked gains from the resolution of some of the venture's assets.

RSO will continue to invest in both value add and distressed real estate transactions that provide opportunities for significant value creation and capital appreciation.

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

Jonathan Cohen

Thanks, Dave. Now I will also review our syndicated bank loan portfolio.

Resource Capital's syndicated bank loan portfolio has a carrying value of approximately $1.1 billion at amortized cost. Overall, I believe that our portfolio has remained in excellent condition and little has changed since last quarter.

As of September 30th, 2012, we have specific reserves of $2.1 million and general reserves of $3 million as compared to specific reserves of $2.1 million and general reserves of $3.1 million for the second quarter. We continue to forecast a very benign outlook in corporate credit for the next year or two.

The default rate for the last 12 months was 0.43% or less than 1/2 a percent. Great job by Gretchen Bergstresser and her team. This has been a terrific business line for Resource Capital and we will continue to allocate capital to it.

In addition to our portfolio of syndicated bank loans, we also collect management fees from our acquisition of the right to manage five other CLOs. During the nine months ended September 30th, 2012, we received $5.4 million in fees. This has been a very good transaction.

I also want to mention that we lowered our investment in investments trading securities from $44.2 million to $25.8 million after we bought distressed CLOs, subordinate tranches starting in 2010. We sold much of this in the 9/30 quarter. We realized returns during that period far in excess of 50% compounded per year; a great transaction by our team.

I just wanted to thank our employees who were involved for such an amazing investment returns once again.

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

David Bryant - CFO

Thank you, Jonathan. RSO’s Board declared a cash dividend for the third quarter of $0.20 per common share or approximately 19.9 million in the aggregate. Our adjusted funds from operations were, AFFO was 23 million for the third quarter, or $0.26 per common share diluted. AFFO was impacted by several non-cash adjustments, totaling 4.2 million, and to a lesser extent, cash items of approximately 425,000. This represents an AFFO payout ratio of approximately 86%, and demonstrates our ability to cover the dividend from operating cash flow.

I would also like to point out that included in our AFFO our realized gains from sales in the trading portfolio that Jon just mentioned, where we monetized significant valuation improvement in that portfolio. The realized gains in that portfolio were 6.2 million before associated income taxes of 3.1 million and other expenses of 600,000. Thus, even if we renewed those gains, net of those associated expenses of 2.5 million were approximately $0.03 per common share from AFFO we’d still have AFFO of $0.23 per common share.

We continue to pass all the critical interest coverage and overcollateralization tests in our two real estate CDOs and four bank loans CLOs through September of 2012. Each of these structured financings performed well and continues to generate stable or even improving cash flow to us in 2012.

The CRE CDOs produced over 22.3 million and bank loan CLOs generated approximately 24.5 million of cash flow during the nine months ended September 30th. This compares favorably to the same period in 2011 when they generated 15.1 million, and 20.1 million from CRE and bank loans respectively. This reflects both improved credit, as well as our ability to deploy restricted cash balances.

As of September 30th we have an excess of 54.8 million of restrictive cash in these structures, comprised of approximately 54 million and 800,000 in our bank loans and real estate deals respectively. Of these balances, 15.7 million is available for reinvestment in two of our CLOs, which we expect will provide very attractive spreads over the cost of the associated debt, which is a very low weighted average rate of 1.61%. The CRE restricted cash balances are now designated to repay the senior notes on two real estate CDOs, as the reinvestment period on those CDOs has expired.

Note that we own a meaningful amount of these senior notes, so that as underlying CDO collateral pays off, principal will be returned to us and become unrestricted cash available for reinvestment at which should be higher returns on equity.

Of the Q3 provisions for loan losses of approximately 1.4 million, 366,000 is related to bank loans and 1 million for real estate loans.

Regarding our bank loan portfolio, we slightly increased reserves for positions sold at losses and decreased our general reserves as we see modestly improving credit conditions in the balance of that portfolio.

On our real estate loans, 494,000 was added to reserves for a previously impaired whole loan, and 511,000 was added to reserves for a loan subject to a modification agreement, for which we provided protective advances on the collateral held in our CDOs.

Overall, I continue to characterize our credit as stable to improving, and as Dave Bloom cited, all of our CRE loans are current and keep on performing.

Our leverage ratio stands at a very modest 2.9 times at September 30th. When we treat our [inaudible] issuances which have a remaining term of over 24 years as equity, our leverage is 2.6 times.

Focusing on real estate leverage, we end Q, 2012, a very conservative 1.3 times levered on the entire real estate portfolio. Our leverage continued to decrease from December 31st, 2011, primarily due to pay downs and runoff of CLO and CDO debt, as well as equity raised in a common stock offering in September. Also, capital from our dividend reinvestment program and improvements in mark-to-market indications on our available-for-sale securities portfolio, as well as two preferred stock offerings.

As part of our capital markets efforts, we began selling preferred shares in June through an [inaudible]-market program and have sold approximately 411,000 shares at a weighted average price of $24.25 per share for net proceeds of 9.8 million through September 30th. Overall our weighted average effective cost on net proceeds of both series of preferred stock outstanding is 8.66%.

In terms of liquidity, after paying the third quarter common stock dividend last Friday, we have a total of 174 million, comprised of 99 million of unrestricted cash and 75 million of restricted cash. We ended the September 2012 quarter with GAAP book value per share of 5.51 up from 5.44 at June 30th. The $0.07 change resulted primarily from improved mark-to-market valuations on a combination of our available for sale CMBS and ABS portfolios, and from the net proceeds generated by an accretive common stock offering.

At September 30th, our equity is allocated as follows: Commercial real estate loans and CMBS 70%, commercial finance 28%, and 2% in other investments. With that, my formal remarks are completed and I turn the call back to Jonathan Cohen.

Jonathan Cohen – President and CEO

Thanks, Dave Bryant. And now with that I open the call for any questions.

Question-and-Answer Session


(Operator instructions). Please stand by for your first question, which comes from Steve Delaney at JMP Securities. Please go ahead.

Steve Delaney – JMP Securities

Good morning, and congratulations on a strong quarter.

Jonathan Cohen – President, CEO

Thanks, Steve.

Steve Delaney – JMP Securities

I guess this is addressed to David Bloom. David, you ran through the pipeline in some detail and I apologize, I was writing as fast as I could, but couldn’t quite keep up. I believe you said, and correct me if I’m wrong here, that you continue to look at a long-term forward pipeline of about $250 million in potential fundings. But could you tighten it down maybe for the next two quarters, say for fourth quarter of 2012 and first quarter of ’13 and give us, you know, a tighter sense for which you really expect to see in closings for the next two quarters?

David Bloom – SVP, Real Estate

Well, sure, Steve. I mean, you know, as I noted, there’s a lot of moving parts, but as far as deals in process for the fourth quarter, it’s another 51 million.

Steve Delaney – JMP Securities

How many loans was that?

David Bloom – SVP, Real Estate

That’s four.

Steve Delaney – JMP Securities

Four loans for about 51, okay.

David Bloom – SVP, Real Estate

And you know, I – past being pro [inaudible] because we continue to ramp, you know, I’m saying, you know, 50 again in the first quarter.

Steve Delaney – JMP Securities

Okay, very good. Okay, so the 50 million kind of…

Jonathan Cohen – President, CEO

Steve, this is Jonathan. Obviously you know that, you know, it’s a lumpy business. Sometimes these loans can take, you know, three weeks, six weeks, eight weeks to close, you know, because you’re waiting for the transaction to close as well. So – and sometimes they can be 24 million and the next one 7 million, so you know, obviously for our investment portfolio, the sooner the better because we have the cash and we like the – so we’ve got to do 75 million in the second quarter and you know, if – 25 in the – 75 in the last quarter and 25 in the next quarter. Of course, we don’t want to do 25, but you get the point, that you know, we’re on all cylinders but we’re not going – no matter what we do here, we’re not going to move our underwriting standards and so we’re being very particular.

Steve Delaney – JMP Securities

Okay. And your loan yield with fees would indicate maybe an average loan coupon of something in the 6.5 range. Have you guys seen, you know, has the volumes picked up? We’re seeing spreads tighten, you know, in all the sort of institutional qualities like the CMBS and insurance company loans. Are you seeing any pricing pressure in your segment of the market?

Jonathan Cohen – President, CEO

You know, I would say that if you want to remain as conservative as we are and really be underwriting what we think is institutional level properties, things that we actually like, you’re going to see some tightening. At the same point, the returns, given our leverage ratios on our line and where we borrow, you know, are in the 15, 16% range typically.

Steve Delaney – JMP Securities

So the – in terms of the loans that we’ve seen, the 50 million per quarter maybe over the next two quarters, what would you estimate the range of coupons on that 100 million might be?

Jonathan Cohen – President, CEO

Well, I would still probably say right around what we’ve been underwriting, but I would say we underwrote a lot of multi-families during the last six months, nine months. Now we’re seeing an opportunity to do other asset classes so it may be the same but you know, not in what we consider to be the safest of all classes.

Steve Delaney – JMP Securities

Okay. And then the final question I have, Jonathan, there’s been a couple of announcements, two or three in the last couple of weeks about these permanent financings. A couple of people call them CLOs, one person called theirs a CMBS. I guess that’s just a fine point in structure, but could you comment maybe as to, you know, beyond the obvious non-recourse permanent financing aspect of that, do you see actually a funding cost advantage versus your Wells Fargo line and do you think it’s possible that you’ll actually enhance your ROE on the equity if you can put in one of those structures?

Jonathan Cohen – President, CEO

Yeah, I mean, I think you’re right, Steve, that you know, at some point, depending on how much you want to borrow, you’re going to find an advantage to go to the [inaudible] market. It’s not there yet, at the same leverage ratio we can borrow from Wells Fargo on the line, but the permanent aspect of it is very attractive and we’re seeing those spreads on the Triple-A and the – even coming down to the Double-A on new-issue [inaudible] CRE-CDO-looking structures being very comparable to where we’re borrowing. All that being said, there haven’t been very many [inaudible] different, you know, it’s hard to tell what’s in each deal, so you know, when we prepare ourselves, which we will be preparing in the next three to six months to do something more permanently, you know, we’re very hopeful that rates will be even lower and this will be a very accretive transaction for us.

Steve Delaney – JMP Securities

It seems like you got the flexibility with the availability on the Wells line and your other liquidity to kind of let that market evolve and you know, you only get one shot at locking up your loan collaterals so maybe this opportunity to just kind of watch that market tighten up…

Jonathan Cohen – President, CEO

Yeah, we’re going to watch, but it definitely is coming and I think it’s coming our way.

Steve Delaney – JMP Securities

Okay, very good. Thank you for the comments.

Jonathan Cohen – President, CEO

Thanks, Steve.


Thank you. The next question comes from the line of Zachary Tanenbaum at MLV. Please go ahead.

Zachary Tanenbaum – MLV

Thanks. Good morning, everyone.

Jonathan Cohen – President, CEO

Good morning, Zach.

Zachary Tanenbaum – MLV

I just wanted to ask, and I think I might have missed some of this earlier. The 9.8 million gain on investment securities trading in the quarter, can you give us the breakout of what was in that? And I think Dave Bryant, you walked through some math around some expenses associated with it, so can you just maybe just give a little more color on that?

Jonathan Cohen – President, CEO

Sure. Dave Bryant can do that.

David Bryant - CFO

Okay, Jon. So of the 9.8 million, Zach, the breakdown that I gave was that 6.2 million of that had been realized. So we actually sold and monetized some of those significant gains in the portfolio. The expenses associated with the 6.2 million of realized gains were income taxes and other expenses of – combined of about 3.7 million, so the net was about 2.5.

And the point I was making is that when you take out the 2.5 from adjusted FFO, we’re still at $0.23 a share. So of the balance of the 9.8 million, the other 3.6 was marks won in that trading portfolio, which of course, are going through the income statement, and won securities that we continue to hold.

Zachary Tanenbaum – MLV

Got it. And those realized gains were on some CLO debt that you had bought? Is that right?

Jonathan Cohen – President, CEO

Yeah, we had made an concerted effort, I mentioned it, Zach, in the end of my comments of buying distressed subordinate CLOs, you know, starting really in the early 2010 period and we really just made a tremendous amount of money, the market was red hot and we – even though we could have kept earning on them, we determined to sell them and realize the gains and so you’ll see that our investment trading securities, which is where those fall, have fallen from 44 to about 25 million, probably going to be a little bit flat for a little bit as we find new opportunities.

Zachary Tanenbaum – MLV

Great. Thanks a lot. That’s helpful.

Jonathan Cohen – President, CEO

Thank you.


Sir, you have no further questions at this time. (Operator Instructions). We have no further questions, sir.

Jonathan Cohen – President, CEO

All right. I want to thank everybody for listening and those of you who read the transcript, I want to thank you for your support. We’re available for any questions from anybody, so let us know. Have a good day.


Thank you very much. I would like to apologize sincerely for the technical difficulties at my end and once again, thank you for participating. You may now disconnect.

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