Resource Capital Corporation (NYSE:RSO) Q2 2016 Results Earnings Conference Call August 2, 2016 8:30 AM ET
Purvi Kamdar - Director of Investor Relations
Jonathan Cohen - President and Chief Executive Officer
David Bryant - Chief Financial Officer
David Bloom - Senior Vice President-Real Estate Investments
Steve Delaney - JMP Securities
Jade Rahmani - KBW
Good day, ladies and gentlemen, and welcome to the Resource Capital Corporation's Second Quarter, 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, today's conference is being recorded.
I would now like to introduce your host for today's conference, Mr. Jonathan Cohen, President and Chief Executive Officer of Resource Capital Corp. Sir, please go ahead.
Thank you. Thank you for joining the Resource Capital Corp. earnings conference call for the second quarter ended June 30, 2016. 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, Jon. 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 those 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 the forms 8-K, 10-Q and 10-K, and in particular, Item 1A 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.
Furthermore, certain non-GAAP financial measures will be discussed on this conference call. Our presentations of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with the Generally Accepted Accounting Principles can be accessed through our filings with the SEC at www.sec.gov.
And with that, I’ll turn it back to Jonathan.
Thank you, Purvi. First a few highlights from the quarter ended June 30, 2016. RSO yesterday made significant progress in its previously announced strategy to clarify its business model and focus on the core real estate lending business. We entered into an agreement with to sell approximately 80% of the portfolio of Northport, the middle market direct origination leading business to a third-party joint venture for $247 million. The remaining loans are assets we will hold but which can be used to generate liquidity if necessary. This transaction will generate immediate liquidity of $102 million for ourselves.
Adjusted funds from operations AFFO were $0.48 per share diluted. Adding back the charges resulting from the Northport transaction AFFO would have been a very healthy $0.75 per share diluted.
RSO liquidated its investment in RREF CDO 2006-1, a commercial real estate CRE CDO on April 25, 2016 and received the remaining collateral of $66.3 million in exchange for its remaining interest after paying off the CDO debt.
Due to the Northport transaction, GAAP net loss allocable to common shares were negative $0.05 per share-diluted. Economic book value was $17.11 per share and we paid a dividend of $0.42 per share.
With those highlights out of the way, I will now introduce my colleagues. With me are Dave Dave Bloom, Head of Real Estate; Dave Bryant, our CFO; and Purvi Kamdar, our Director of Investor Relations.
Earnings from our core commercial real estate were strong this quarter and we expect them to be stronger prospectively. We continue to see stable credit statistics in our commercial real estate loan portfolio, exemplifying the result of prudent lending through rigorous underwritings. Our existing tern financing facilities in CRE securitizations give us certainty in our financing sources at attractive spreads as we see the markets re-price risk across all sectors.
During the second quarter, we focused on liquidating and refinancing properties and positioning the company for solid originations and thus temporarily slowed CRE loan originations. We expect our CRE loan originations to pick up considerably in the second half of 2016 and we will be adding high-quality assets as we deploy capital generated from the Northport transaction.
As we have previously stated – as we have stated on previous calls, we believe Northport, our middle market lending business was ultimately not optimized by being a re-subsidiary even though the business has performed very well. We saw an opportunity to clarify our business and increase the company's equity allocation to real estate to over 75% with a goal of at least 90% and to generate substantial liquidity.
To that effect, RSO entered into a purchase agreement to sell Northport to a third-party JV for $247 million. The transactions with nearly all of the direct origination middle-market loans with a par balance of $257 million in the assumption of the J.P. Morgan senior secure revolving credit facility for net proceeds of approximately $102 million.
RSO will retain the broad based indicated middle market loans with a current market value of $51.2 million and one direct origination middle market loan with a net carrying value of $13.9 million. We are currently holding these assets as they continue to produce income, but they are generally marketable and we could generate additional liquidity if necessary.
RSO recorded an $8.2 million after-tax loss on the sale. The sale of Northport is significant to Resource Capital Corp in many regards. First, it generates over $100 million of equity that can be used to increase commercial real estate originations which continue to generate mid teens returns.
Secondly, we are making great strides in simplifying our business model to more strongly emphasize our primary commercial real estate focus as we have indicated in our strategic plan. Also one thing to note, if there was an offer to sales associated provisions are caused, AFFO for the quarter would have been $0.75.
As we have reiterated in the past, we have been committed to repurchasing our security. Since the inception of our buyback program through the end of the second quarter, we have repurchased almost $38 million of our security. The company repurchased approximately $34 million of common stock which represents approximately 8% of the outstanding common shares. We have also bought back approximately 3.4% of our outstanding preferred B shares.
During the first six months of 2016 we saw significant opportunities to generate yield for our shareholders via our share repurchase plan and executed on common share repurchases that were accretive to book value by $0.15.
We were not able to continue repurchasing stock during the second quarter as the Northport transaction came to fruition. We look forward to continuing this in 2016 as these opportunities present themselves.
During our last call, we stated that we would begin to recycle capital from our legacy CRE CDOs and bank loan CDOs over the next year. In April we called and liquidated our investment in RREF CDO 2006-1. We have one remaining legacy CRE CDO that we think will be called over the next 18 months and one remaining bank loan CLO that should be called over the next six to nine months.
In addition, we are expecting our CRE securitization CRE note 2013 which closed in December 13, 2013 to naturally liquidating quarter four 2016 as the remaining collateral pays down into our equity notes and return cash and assets.
CRE note 2013 performed extremely well, paid every interest payments to the note order, has not had one loan miss an interest payment or even delayed on a payment and there were zero credit costs to date on the securitization.
I also want to update our investors on the residential mortgage business, primary capital mortgage or PCM. In the second quarter, PCM generated an operating profit, but since we were required to mark our mortgage servicing rights to market they declined in value with the dramatic fluctuations in 10-year U.S. treasuries.
We recorded a $2.3 million non-cash reserve against these MSRs. The MSRs are continuing to provide volatility to our financial statements and we are actively reviewing our strategy with respect to them. But the PCM has reached operating profitability.
Please note that between dividends and share repurchases we returned over $45 million to our shareholders to date in 2016. We remain steadfast in our commitment to maximizing shareholder value.
Now, I will ask Dave Bloom to review our real estate activities. Dave?
Thank you, Jon. Resource Capital Corp.'s commitment commercial mortgage in CMBS portfolio has a current balance of approximately $1.73 billion in a diverse and granular pool. RSO's commercial mortgage portfolio is comprised of 80 individual positions with an aggregate balance of approximately $1.6 billion. The portfolio consists of 79 self originated whole loans and one mezzanine loan of only $7.3 million secured by a residential and retail property and this was just Lincoln Square section of Manhattan. This mezzanine loan will be paying off imminently.
The underlying collateral base, securing RSO's commercial mortgage portfolio, is in geographically varied markets with loans secured by assets and major use categories. The portfolio was broken down as follows; 38% multifamily, 23% retail, 21% office, 16% hotel, and 2% other, such as mixed-use properties.
Since the start of 2016 we have closed $59.6 million of new loans. As Jonathan noted, through the second quarter of 2016 RSO has been focused on positioning the company for strong future growth in our commercial mortgage business. Our origination efforts are again fully ramped and the immediate liquidity generated from the Northport transaction will be put to work in our core commercial real estate business.
RSO presently has $68.2 million of new originations in various stages of documentation for closing with a pipeline of approximately $450 million of additional new loan opportunities in various stages of negotiation or underwriting. Our pipeline continues to grow and we feel well-positioned to return to or exceed prior origination level as we deploy capital from other businesses into the commercial real estate space and fully optimize our financing structures.
With that, I'll turn it back to Jonathan and rejoin for Q&A at the end of the call. Thank you.
Thanks Dave Bloom. Now, I will ask Dave Bryant, our Chief Financial Officer to discuss our financials.
Thank you, Jonathan. Resource Capital Corp declared cash dividend for the second quarter of $0.42 per common share. Our adjusted funds from operations or AFFO for the quarter was $14.5 million or $0.48 per common share, a payout ratio of 88%. In determining AFFO for the second quarter there were several non-cash adjustments that netted to approximately $9.8 million.
These non-cash items include amortization of deferred costs, notably the acceleration of $2.6 million from the middle market revolving credit facility and discounts on our convertible senior notes. Also evaluation reserve on our residential mortgage originators mortgage servicing rights portfolio and adjustments for share-based compensation.
We had cash adjustments to AFFO of $6.3 million. The cash gain on debt extinguishment is from a legacy real estate CDO that was liquidated during the quarter. The genesis of these gains are from notes that we purchased from 2008 to 2012 at substantial discounts to par. As the non-cash gains were not realized through AFFO at the time those notes were purchased we are now recognizing these gains as cash is received.
After recognizing the cash gains in Q2 $15.1 million of gains remain. We expect that this will be realized proportionately as the remaining collateral pays off or pays down. Of note, and as Jonathan mentioned, our other real estate legacy CDO namely RREF 2007 is expected to mature over the next 18 months and likewise this CDO has $13.8 million of deferred gains that will be realized ratably as we see the collateral liquidated.
As of January 1, we deconsolidated our 2006 and 2007 real estate CDOs as well as Apidos Cinco. In April 2016 we liquidated the 2006 CDO as previously mentioned. As a result, we now reflect those 2006 loan assets on our books at fair value. With respect to 2007 CDO and Apidos Cinco we continue to hold those investments as available-for-sale securities at fair value and record income on a net effective yield basis.
We passed all of the interest coverage and over collateralization tests in each of our securitization that requires such tests including deconsolidated legacy real estate CDOs and a remaining bank loan CLO. Our three most recent real estate securitizations are subject only to over collateralization tests which we have comfortably passed. These structured finance vehicles continue to perform well and produce reliable cash flow.
We have a total capacity of $650 million on our commercial real estate term facilities and availability of $367.4 million as of June 30. We see that substantially all of our commercial real estate portfolio is comprised of self originated whole loans. We have weighted average LIBOR flows of $0.28% on $1.4 billion of loans of which $947 million are in our floor real estate securitizations and have remaining terms ranging from one to four years and a weighted average of $0.28%. The result of having these floors in relation to where rates stand today, means that any potential incremental increases in LIBOR will be accretive to our earnings on our equity investment.
In Q2 we bought provisions for loan losses of $12.1 million comprised of $9 million related to the Northport sales, $3.5 million on a specific provision related to the retained middle market loan and a miscellaneous recovery of approximately $400,000 related to a previously reserved position.
In terms of delinquencies all of our middle market loans are current and each of our commercial real estate senior whole loans are current with respect to debt service payments due from our borrowers.
Our leveraged is 2.0 times at June 30, 2016 as compared to 2.3 times at December 31. Most of this decline in leverage is due to the CDOs deconsolidated and principal paydowns on other CDO. When we treat our TruPS issuances which have a remaining term of approximately 20 years as equity our leverage is 1.8 times.
With regard to real estate leverage, we ended Q2 at 2.35 times when the entire portfolio including cash earmarked for new real estate loan originations. We remain focused on getting our total real estate equity allocation increased to a minimum of 75%. Overall, our weighted average cost of capital held corporately based on book value was 8.82% at June 30.
We ended the June quarter with GAAP book value per share of 1663 down from 1763 at December 31. We had earnings of $0.27 so our accretive benefit of $0.15 per share from the share repurchase plan. We paid dividends of $0.84 per share and have $0.55 temporary decline due to the deconsolidation adjustments, picked up $.12 from our marks on securities and interest rate hedges and the balance of $0.15 is the cost investing and expenses associated with restricted stock. Economic book value of 17 $0.11 per share and this metric provides our investors with an economic basis as we expect to recover our investments in those the deconsolidated CDO vehicles.
We have relatively low leverage and our substantially match bonded with nonrecourse floating-rate term financing on the vast majority of our platform. In addition to the liquidation of our first real estate securitization in April, we anticipate recycling capital from our remaining legacy CRE CDO and legacy bank loan CLO over the next six to 18 months each of which will provide a substantial cash upon liquidation.
Coupled with the $102 million of proceeds from the Northport transaction, we expect to have ample liquidity on hand as we head toward the balance of 2016. We will deploy this pretty judiciously in higher yielding investments. Our selective reuse of the recycled capital will help us grow our real estate portfolio and improve core earnings quality with our complete focus on credit quality.
With that, I'll hand the call back to Jonathan Cohen.
Thanks Dave. We are implementing our strategy also, and as always maintained what I believe is a consistent focus on credit quality, high underwriting standards, vigilant management of our investments. Our leverage remains low and we have an experienced dedicated management team that will carefully monitor our risk while continuing to look forward to paying this meaningful these dividends.
As announced on May 22, Resource America Inc., the company's external manager, has agreed to be acquired by C-III Capital Partners LLC, C-III a leading commercial real estate services company. As part of the transaction, our core commercial real estate team will remain in place.
Upon closing of the acquisition of Resource America, I will no longer be the officer, director of Resource Capital Corp. Andrew L. Farkas and Jeffrey P. Cohen, Executive Managing Director of C-III, will be appointed to RSO's Board of Directors and it is anticipated that Robert C. Lieber, Executive Managing Director of C-III, will succeed me as the Chief Executive Officer of RSO.
I believe that C-III is a stellar organization and will work very well with outstanding origination and asset management teams that will be continuing. We thank you for your continued support.
And with that I will open up the call to any questions. Operator?
[Operator Instructions] Our first question comes from the line of Steve Delaney with JMP Securities. Your line is now open.
Good morning everyone and thanks for taking the question. $102 million coming in realistically how long will it take to deploy that and I’ve heard your comments that the focus will be on the Senior CRE portfolio, so how long to deploy and what would be the incremental growth in CRE loans based on that $102 million once it was deployed? Thanks.
Thanks Steve. Dave Bloom or Dave Bryant, would you like to take that?
I’ll take that Jon. Hi Steve, its Dave Bloom.
We – as I mentioned, we've got a very full pipeline with about $70 million slated to close imminently starting next week and through the end of August and back with about that pace I think for the few months that we can see beyond. So I would anticipate it being put to work very rapidly.
So realistically by the end of this year you could have that capital deployed?
Yes, this is Jonathan, I think that the capital will be deployed in the next five months, but obviously some of the loans will come on later in the quarter in Q4. So the real impact and kind of stabilized version of our company having redeployed that company will be kind of first seen in the end of the fourth quarter or first quarter.
Got it. And so the portfolio, the senior loan portfolios are just under $1.5 billion I guess currently. Would this support something on the order of another $400 million of loans if we were to assume like three to one…?
Steve, I would say that’s right. We also have a lot of other capital as we mentioned, being recycled through for instance is the CRE 2013 securitization is now going to started to pay off the equity notes. So we’ve seen some math would be leveraging as we’ve seen things pay off in this very nice credit environment. And so, I think that you'll see the overall portfolio grow by more than $400 million and that should be very helpful to 2017.
Understood. And switching over to PCM, Jon you mentioned that you're thinking through your strategies there. I guess two parts to the question. What is the amount of RSO’s equity exposure/investment in PCM at this time?
I think it’s in the mid-30s equity investment.
Okay, got it.
And then, oh wait and I just want to clarify that includes all MSR, which could be sold readily.
Exactly. So that's about a dollar – right it is about a dollar a share. I'm trying to get some sense of the magnitude of in a worst case scenario, which I'm not necessarily predicting or suggesting, but just a frame it’s helpful to know kind of what that is now. Now just…
No, no, I just want to mention though Steve, that if you talk with the team there we’ve seen incredible business generation there, platform building, profitability now, I think that they think it's worth well in excess of that.
Interesting, okay that's helpful. And you care your MSRs, I believe in the intangibles line on the balance sheet, Dave Bryant I want to - could you could you tell us how much, what the caring value of the MSRs is in that $26.7 million of total intangibles?
I'm sorry Steve, say that again please?
Yes Dave, I'm trying to find out in you care your MSRs on your balance sheet I believe you have them included in the intangibles line. Could you tell us with the fair value, the carrying value of the MSRs at June 30 was?
It’s approximately $22 million, Steve.
Okay, so the bulk of that intangibles is the MSRs. Okay, I think that – I think that covers it, Jon and in fact this…
Just to add to that Steve, the cumulated reserve on these MSRs is about $5.4 million.
That’s the non-cash fair value marks that you've made?
Right, that we made, a little bit at the end of last year and then in the first and second quarter of this year.
Okay very good. But the $22 million is the net of those reserves?
Net, that is net.
Understood, okay thank you. Well thank you, that's all the questions I have and Jon if in fact this the timing of the direct [ph] sale is September, October if in fact this is your last call as CEO of RSO, we want to – we’ve enjoyed working with you, we want to wish you all the best for the future. Thank you.
Thank Steve, I appreciate it.
Our next question comes from the line of Jade Rahmani with KBW. Your line is now open.
Thank you very much. Just stepping back for a second, not sure if you're able to, but I’d appreciate if you could offer any highlights - high level thoughts on what C-III may bring to the table with respect to RSO?
We're really not at liberty to speak about C-III or the merger, but their reputation speaks for itself and they are a tremendous firm with Andrew Farkas and his team, Jeff Cohen et cetera, have tremendous reputation for building incredibly valuable public and private franchises. And so, and they are deep in the mortgage and mortgage bond business. So I think with our team will bring tremendous value to RSO shareholders as well as in growing the resource platform. So we really are limited to say much more.
Okay, I appreciate that. Just regarding the market overall, can you characterize what you're seeing in terms of borrower sentiment quarter-over-quarter and also highlight any trends in loan spreads?
Dave Bloom, you want to take that?
Sure, thanks Jade. We've actually – we have seen transaction volume pick up. I think that borrowers feel a general firming in the market. We see banks backing away, even the regional banks that had been more aggressive. So we actually feel the market coming to us, which is a good position for us to be in now.
Yes, spreads remain competitive, but on a levered basis we're still looking at in mid teens business. So I think that we are very active. We – when we are this active, we tend to get our share of quality deals. We do stay up credit and that's what we will continue to do. But we do look forward to deploying the additional capital in a prudent, but expeditious way.
Thanks. And are you seeing any flow from upcoming or pending CMBS debt maturities and recapitalization transactions?
We are. I mean there's certainly the wall of maturity is that you can see in any number of Fitch books and analyst reports. We are absolutely seeing that. We are taking advantage of well located transactions, while the CMBS market in general is in a state of disarray as risk retention, compliant pools continue to be ramped. There are, quite frankly, borrowers who are waiting that out, waiting for a little bit more stability, certainty of course.
Those people are coming to us as well and obviously as tenure deals roll, this seasons [ph] has been enormously expensive, they are paid off and sold and there are value add opportunities there as well. So we really see it coming from a number of different places and feel that there is a nice convergence of events that open up the market for bridge loans in a fairly unique way at this time.
And just lastly, any credit, how does the added credit migrate in the quarter, any movement in the watch list of risk ratings?
There wasn’t a move in this quarter now.
Thanks for taking my questions.
Thank you, Jade.
We have a followup question from the line of Steve Delaney with JMP Securities. Your line is now open.
Yes, thank you. Apologies for that, I should have asked this earlier, but you have not made any comments about your previously established guidance of 265 that was given on the first quarter earnings call. Is there anything that you can say about your guidance are you leaving that in place or does that needs to be updated?
No, I think that we are leaving that in place in terms of our dedication of the $0.42 dividend and I think that as the new management comes in, I think that they will provide their own guidance. We usually provide guidance for 2017 some time at the end of – I think sometime in November which I think will continue.
Okay. Thanks for clarifying that.
And I'm showing no further questions in queue at this time. I would like to turn the call back to Mr. Cohen for closing remarks.
I greatly appreciate you listening to our call and investing in our business and we look forward to speaking with you in the near future. So thank you.
Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program and you may now disconnect. Everyone, have a great day.
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