Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Crexus Investment (NYSE:CXS)

Q3 2012 Earnings Call

November 06, 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

Robert Restrick - Chief Operating Officer and Executive Vice President

Analysts

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

Jason Arnold - RBC Capital Markets, LLC, Research Division

Douglas Harter - Crédit Suisse AG, Research Division

Stephen Laws - Deutsche Bank AG, Research Division

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

Operator

Good morning, and welcome to the Third Quarter Earnings Call for 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 third quarter of 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.

We'll have some prepared remarks and then we'll open the call up for questions. Before we begin, I want to thank all who have offered such warm condolences for Mike Farrell. He was a colleague, mentor and friend. It is an honor to work within the Annaly family of companies that his vision and wisdom helped to create and grow. Again, on behalf of the CreXus team, thank you. Our thoughts go out to those affected by Hurricane Sandy also.

During the quarter, we closed approximately $125 million of portfolio investments, including $20 million of subordinated debt investments and a preferred equity investment of approximately $40 million. The mezzanine loans were on a portfolio of suburban office buildings and the preferred investment was on a multifamily portfolio. We also provided 2 home loan financings totaling $65 million, the first secured by a bulk distribution warehouse and the second by a retail facility. As we have indicated and successfully executed in the past, it is our objective to recycle the senior parts of the capital structure by selling a lower levered A note to enhance shareholder returns by retaining the higher-yielding subordinate piece. We continue to be actively engaged in those efforts.

We continue to demonstrate our ability to maintain duration in our portfolio while providing an attractive risk adjusted return. Compared to the second quarter, we increased our debt and preferred equity holdings by 14% or $95 million and raised the portfolio coupon by 20 basis points, yet the last dollar leverage increased by only 2%. This was accomplished despite the fact that we had a lower leveraged senior mortgage payoff. It is worth noting that the senior mortgage that paid off was the last remaining unmodified position from the Barclays portfolio, a repayment of a $30 million first mortgage secured by a hotel in Los Angeles. More details on the portfolio activity during the quarter can be found in our quarterly supplement, which I hope everyone has had chance to review. It's up on our website at www.crexusinvestment.com.

I just want to highlight a few other points. Clearly, QE3 has had an impact across the entire spectrum of fixed income assets. The Federal Reserve has pushed down rates of return as part of QE3, and this policy has pushed investors to hunt for return into other asset classes. Credit spreads has tightened across the board and our industry has been no exception, with CMBS clearly benefiting from enhanced market liquidity. As we remarked in our quarterly market commentary, analysts' forecast for mortgage originations and securities issuance have been revised higher. We stand to benefit from this surge as Wall Street origination should facilitate acquisition activity across the board. In this environment, we have built a high credit quality portfolio with 0 portfolio level leverage and what we believe are stable long-term cash flows. Our portfolio is comprised of debt and preferred investments with a weighted average yield of 10.5% and a weighted average maturity of close to 5 years, as well as a real estate portfolio with a net equity yield of 11.28%. We have dry powder and other means to optimize the portfolio to increase shareholder returns.

There continue to be attractive opportunities for capital deployment. Although our current pipeline is active and sizable, in light of the current interest rate and policy climate, we have maintained a disciplined approach to investing. Our focus, as always, is to continue to generate the highest achievable risk adjusted returns for our shareholders. 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 September 30, 2012, of $22.6 million or $0.30 per average share available to common shareholders. We declared a dividend for the period of $0.32 per share, producing an annualized dividend yield of 11.84% based on the September 30 closing price of $10.81 per share. Our book value at September 30 was $11.93 per share. We added one loan to our watch list, primarily as a result of a small decline in debt service coverage. We remain highly confident, however, of the viability of the asset. At September 30, 2012, the weighted average yield on our debt and preferred equity investment portfolio was 10.29%, and the net equity yield on the real estate investment portfolio was 11.28%. The accretion of discount on the Company's loan and preferred equity portfolio, which is a component of interest income, for the quarter ended September 30, 2012, was $8 million. The total net discount remaining at September 30, 2012, is $7.9 million.

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

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Jade Rahmani of KBW.

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

Can you comment on your current cash position? At what level of cash would you expect the company's capital fully deployed and over what time period do you expect to get there? You did indicate you're taking a disciplined approach to investing.

Daniel Wickey

Well, currently, our cash position is $105 million, but you should take into consideration that we had a $25 million dividend paid out in the middle of October. So we're roughly $80 million.

Kevin Riordan

We have about $80 million to invest, and I think I'm going to throw it over to Bob Karner to give you a little flavor for what we see in the pipeline and what's actionable right now in the market out there.

Robert M. Karner

I mean, currently right now, I mean, in our active pipeline, we're looking at approximately $1 billion of transactions. In most cases, that's the full debt set, but it would result in CreXus' potentially funding net of approximately $500 million. So we're definitely seeing a robust pipeline far in excess of the capacity of our balance sheet. So we -- I mean, we continue to see strong flows in commercial mortgage originations, first mortgages, mezzanine loans and even in preferred equity. That certainly has not let up.

Kevin Riordan

So we're getting to a point there, Jade, where we are getting to be fully invested. And with that, there are means and opportunities out there to recycle capital.

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

Okay. And of the $80 million, what's the minimum amount of cash you'd need to hold to run the business?

Kevin Riordan

Probably keep like -- we do have some real estate we own so there's maybe some capital expenditures, maybe $10 million, $20 million on...

Daniel Wickey

That's the maximum at this point, correct? Even looking at future fundings on current commitments in place, yes.

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

Okay. And then the schedule of investments in your supplemental indicates your first maturity is a $13 million condo loan in December 2013. I was wondering is there any significant other repayment activity you'd expect in 2013? And also, do all of your investments have prepayment penalties?

Kevin Riordan

We -- the December '13, actually, that's kind of an interesting situation. As you can see in the supplement that's disclosed, it's on non-accrual status because of an enforcement action occurring with a relation of the borrower of that property. We feel that we're very well-secured and collateralized by that particular loan, and there's active discussions going on around the situation to basically come up with a resolution, which would entail paying us off. So looking at the maturity at December '13 and what we understand going on around that property, I would expect to actually get that paid off sooner than later. With respect to your second question, we have a number of call protection structures built into the loans. Some, we have hard lockout. Generally, if you do a floating rate loan, the first 12 months is hard lockout. And then after that, you would have to prepay. You can prepay, but there would be some kind of yield maintenance or penalty attached to that prepayment.

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

Okay. And beyond the condo loan, you don't expect any other 2013 prepayments? And if there were any, there would be a yield maintenance or a penalty?

Kevin Riordan

Correct.

Operator

The next question comes from Jason Arnold of RBC Capital Markets.

Jason Arnold - RBC Capital Markets, LLC, Research Division

It sounds like your pipeline is looking quite good. I'm just curious if you could comment on what segments of the market in particular you're seeing as attractive. Is it more whole loan, more the mezz side, more the private equity? Where do you see kind of most attractive opportunities right now?

Robert M. Karner

I'm not sure that we necessarily differentiate today between opportunities in the whole loan space versus the mezzanine space. We think we're seeing attractive opportunities in both. We are seeing on the margin more opportunities on the whole loan side, which we think is attractive, the ability to originate 0% to 75% loan-to-value opportunities. And we like them because there's such a strong demand today for the A note or the lower-leveraged first mortgage you can cut off of that whole loan from, a, from the banks, number one, because again as they continue to repair their balance sheets, they're looking to increase their exposure to commercial mortgages versus decrease; and b, we're starting to see more robust activity in the CMBS space and looking at and originating their potential securitizing floating rate, lower-levered first mortgages. So we think that's a real opportunity today, but we continue to see a relatively robust pipeline in the pure mezzanine, and to a lesser extent, the preferred equity space as well.

Jason Arnold - RBC Capital Markets, LLC, Research Division

Okay, great. And then just one other quick follow-up. On the $8 million roughly of discount left you're accreting in your investment portfolio, I was just curious if you'd remind us kind of how we should expect that to play out in the fourth quarter and then into 2013. Is that kind of weighted towards one end or the other? There.

Daniel Wickey

It's -- I would pretty much straight-line it throughout the maturities. There's no real weighting at this point.

Operator

Our next question comes from Erica Fencil of Credit Suisse.

Douglas Harter - Crédit Suisse AG, Research Division

This is actually Doug Harter from Credit Suisse. I was hoping you could help remind us, when you're looking at that senior debt position, how much of that do you think you could kind of sell off and to be able to recycle into subordinate debt or new investments?

Robert Restrick

This is Bob Restrick. We -- generally, rule of thumb would be anywhere between 50%, 55% to 65%, depending on what the ultimate leverage is on the individual whole loan and what your exit is. So whether it's a -- if it's a one-off individual sale, you might get a higher leverage sale of 65%. If you're going to pool it and aggregate it and securitize it, it'd be kind of a lower cutoff.

Douglas Harter - Crédit Suisse AG, Research Division

Great. So that's helpful. And can you also give us an update on how you guys are thinking about leverage, putting some leverage against your loan portfolio today?

Robert Restrick

Sure. This is Bob again. We sort of have a 2-pronged strategy, if you will, on how we can tackle that business and we're in discussions with several banks on approaching that, which is kind of separating that, the financing alternatives, into sort of 2 buckets. One would be the mezzanine portfolio and the other would be on first mortgages. And both of those, similarly, is some sort of short-term, maybe a couple of year financing facilities that would allow us to aggregate or hold, in the case of the mezz's positions, to ultimately exit into some securitized form or a private transaction where we would be able to match up with non-recourse term funding effectively on a senior portion. So it's sort of a 2-step process to getting to ultimate financing alternatives.

Douglas Harter - Crédit Suisse AG, Research Division

And then, I guess, are you feeling more comfortable with that sort of term financing? Market is coming back at attractive enough levels to consider that?

Robert Restrick

Yes. I mean, absolutely. I mean, just as an example, in the floating rate, securitized market is always a smaller segment of the larger fixed-rate. When people say conduit, they generally mean fixed-rate deals. But the floating rate market has been slowly coming back, and in fact, we finally saw a transaction a couple of weeks ago, which was a securitization of full-debt stack floating rate deals, and that met with great demand. I think the execution, on a weighted basis, on the investment-grade portion affects the way you would sell away, was around 165 basis points or so over LIBOR. And that's very attractive. That's -- so it's sort of like the trade in that context is it's a little lower leveraged at a much tighter spread as opposed to, say, a warehouse facility, which might be more leveraged but a higher pay rate.

Operator

[Operator Instructions] Our next question comes from Stephen Laws of Deutsche Bank.

Stephen Laws - Deutsche Bank AG, Research Division

First off, congrats on a very solid quarter. I was very impressed with the portfolio growth and origination volume. Sounds like the pipeline is really attractive as well. A lot of my questions has been hit on, but I was wondering if you could maybe just take a -- spend a moment discussing the pipeline and maybe how that pipeline has changed today versus 6 months ago. Kind of how much of yields come down or has your positioning improved? Kind of what the competitive market is out there as you're looking to continuing to put the last bit of cash to work.

Robert M. Karner

Sure. Hey, Stephen. It's Bob Karner. I mean, listen. We'd experienced yield compression in this sector, in this market, as we have across all sectors almost across the globe, right? You can't escape it. Generally, I would've framed it as, if we were looking at mezzanine opportunities in the 11% to 12% range earlier in the year, frankly, it's closer to 10% to 11% today. With the off chance you find an outlier that you get comfortable with, then maybe just north of 11%. The subordinate debt space is little, if you will, stickier than the first mortgage space. I mean if 10-year treasury is tightened by 20 basis points in the context of 1 day, we don't see 20 basis points of tightening in the subordinate debt space. The first mortgage space is probably, on the margin, more efficient. So they're more volatile in terms of pricing relative to treasuries. But we've been more -- and that's on the fixed rate side. We've been more focused on origin whole loan debt fixed on a floating rate basis. And so you don't see, again, as much volatility here just based on where LIBOR has been over the recent past. So we continue to see good opportunities and we think is attractive pricing. Again, we've got a portfolio today that's yielding approximately 10.25% with no portfolio-wide leverage. And we did that at a very, very attractive proposition. And if you look at the portfolio today, it's approximately 50% to 72% loan-to-value in terms of outcatch detach. We think that's a very attractive risk return.

Kevin Riordan

Stephen, it's Kevin. And the other thing which we've commented on in the past, and I've actually written this in the commentary, is that as the Street becomes more active, the Street is a better facilitator to help acquisitions happen. And when that happens, there is generally -- sometimes, mezzanine or subordinate debt required. So the Street has gotten more active. We've seen that with the compression of spreads. We've seen increased issuance. And by the way, the 2 transactions that we did in the sub debt space, the mezzanine loan on the portfolio of office buildings was an acquisition that we participated in, and then also, the preferred equity investment on the portfolio of multifamily was an acquisition that we participated in. So that's what creates more velocity, if you will, in the transaction space and allows us to see more opportunities.

Stephen Laws - Deutsche Bank AG, Research Division

Great. And I guess, one follow-up, kind of stay on the larger picture. As we think about the regulatory landscape out there and regulated financials, are there 1 or 2 things you guys are watching closely that could change the competitive landscape and make regulated financials more aggressive in the asset classes you're targeting? Is it a situation where you guys have positioned yourself where you're more of a complement to the positions that the regulated financials want to take because of the credit piece you're willing to hold? Can you maybe just talk about how the landscape may change as we get some clarity on the regulatory -- regulated financials over the next [indiscernible] the 12 to 36 months?

Kevin Riordan

You know the structure of the company, right? It is not regulated, it's not rated. It is a -- as Mike Farrell always said, it's a risk depository. And therefore, what we always focus on and what we try to really keep in touch with in all the type of co-origination efforts that we do with senior lenders is to really focus upon where their risk cutoff or their risk profile is. So if I think about the landscape and I think about my co-lending partners, if you will, my co-lending lenders, then I'm thinking about where their risk is, and then us, as a risk depository, is a natural complement to work with them.

Daniel Wickey

Yes, as we think of Dodd-Frank and Basel III and the other regulations that are coming through the pipeline, I mean, we really like the fact that we're a non-bank bank.

Kevin Riordan

Yes.

Operator

The next question comes from Gabe Poggi of FBR.

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

A quick question regarding your remaining discount accretion. I'm just trying to get a sense of how you guys think about the kind of core or recurring earnings power of the portfolio now that you only have $8 million of accretion left. What I'm really trying to get to is kind of what do you think the earnings power of the portfolio is relative to the current $0.32 payout kind of on a go forward basis and acknowledging that you have $80 million of cash on balance sheet and, Kevin, you said maybe $60-odd million of that goes out the door this quarter? That's what I'm trying to get my head around.

Kevin Riordan

Hey, Gabe. It's Kevin. A couple of things. On the payout and on the earnings capability, I mean, in the supplement, we've got Slide 13 and we got 2 things going on there, right? We've got a maturity profile that we're expanding, we continue to try to expand that, and also, we've been pushing the weighted average coupon of the portfolio. And all the detail of the coupon is enclosed in the supplement also. And then you -- that's just the invested part. And then there's the uninvested part, which is the $80 million, which Bob Karner talked to at length about investing a significant component of that and what we're looking at. And then finally, taking what small rounds of first mortgages we have left and then optimizing that.

Daniel Wickey

Yes, I think we're replacing that accretion with coupon.

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

Got you. Okay. Okay, that's the way I'm thinking about it. I just want to make sure that kind of at a $12 book, give or take, if it's a 10% business, you're in the ballpark from a recurring standpoint kind of over time as that transition happens.

Daniel Wickey

Yes, yes, exactly.

Operator

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

Kevin Riordan

Thank you, operator. We look forward to speaking with you again in the very near future. Thank you, everybody, have a good holiday.

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 10019912. This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Crexus Investment Management Discusses Q3 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts