Acres Commercial Realty Corp (ACR) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Resource Capital Corp Fourth Quarter and Fiscal Year Ended December 31, 2006 Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the call over to Mr. Jonathan Cohen, CEO and President. Please proceed.

Thank you and welcome to the fourth quarter and year end fiscal 2006 conference call for Resource Capital Corp. I am Jonathan Cohen, CEO and President of Resource Capital. And before I begin I will take a moment to read the Safe Harbor statement. 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 certainties which could have caused 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 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. Again, thanks for joining us. 2006 was a year of transformation and growth for our company. As we focus on building a premiere platform for the origination and investment in commercial real estate debt and commercial loans.

I think if you look at the numbers and specifically the shift from commercial real estate mezzanine loans to whole loans, you will agree that the origination platform is growing and our investment in it has been fruitful. I am very pleased with the growth and acceptance of our platform, both by the equity markets where we completed a follow-on offering for net proceeds of $130 million in late December, as well as by the real estate community where we originated over $235 million of loans in the fourth quarter.

As we continue to grow throughout the year, we continue to grow our dividends, which was $0.38 per share in the fourth quarter, before the dilution of the late December offering. We anticipate this share in continuing as we proceed to add origination staff and underwriters. We feel internally like 2007 will be our year as we are set to increase our return on equity and hence dividends throughout the year because of first -- because of first, our ability to deploy capital in the self originated commercial real estate mortgages.

Second, our ability to match fund our assets with long term liabilities. This especially helps the [inaudible] widen without significant credit events. And third, our ability to originate and manage commercial loan companies and corporations. And fourth, our conservative credit underwriting and monitoring abilities. In all four areas, I believe we are doing a good job. In our press release, released yesterday evening, we gave guidance through our dividends for the fiscal year ending December 31, 2007, with a range of $1.65 to $1.80. We are truly seeing our commercial real estate platform coming into its own.

This is not only exemplified by good credit in underwriting, we currently are very satisfied by all loans in our commercial real estate portfolio, but also by our ability to originate investments ourselves and in the process, charge origination fees, exit fees, extension fees and have the borrower pay for all costs and set aside substantial reserve for debt service coverage. We have also proved that where we originate higher LTV loans we are able to get substantial guarantees from extremely established and well-funded players.

Now, I will ask Dave Bloom to review our commercial real estate portfolio.

Thanks, Jonathan. As of today, our portfolio of closed commercial mortgage loans and loans in the process of closing, stand at approximately $900 million and breaks down into components as follows. 52% whole loans, 23% B notes, and 25% mezzanine loans. We continue to see very strong credit characteristics in our transactions, and have a forward origination pipeline of between $200 million and $250 million per quarter.

Our collateral base continues to be diversified across the major asset categories with a portfolio breakdown as follows. 31% multi family, 26% in office, 23% in hotel, 12% retail, and 8% in other, such as self storage. Resource real estate funding continues to focus on our whole loan direct origination capabilities.

As we have proven with prior transactions, we realized the premium to market pricing for directly originated collateral. A function that we are uniquely set up to accommodate based on the existing infrastructure that supports Resource Real Estate's nationwide investment platforms in both debt and equity. Our strong focus on directly originated loans continues to drive a shift in our mix of collateral.

Our current portfolio is almost evenly split between self-originated whole loans, and subordinate debt positions that we have acquired in partnership with Wall Street and middle market banks. While a snapshot of our forward pipeline demonstrates the mixed shifts much more clearly with approximately 60 to 75% of new collateral all being directly originated whole loans.

Our direct origination platform operates on a nationwide basis, and is of significant note to our business model. Our self-originated whole loans are typically structured with origination and exit fees, and the borrower is responsible for all costs associated with t he transactions.

In addition, many of our whole loans are structured to provide elements of borrower recourse and other credit enhancements. In general, our whole loans provide considerable boost to ROE and we will continue to see increased returns from our commercial mortgage portfolio, as existing subordinate debt positions are repaid and more whole loans added.

The weighted average spread on the current commercial mortgage portfolio is approximately LIBOR plus 285. As I've noted, the majority of our mortgage portfolio consists of whole loans, which go from the first dollar of debt through, between, say 75 or 85% of the property's cost. While a smaller portion of the portfolio represents lower leverage subordinate debt positions.

During the ramp period for our second commercial real estate CDO, which is scheduled to price in April, the commercial mortgage portfolio is financed on term warehouse financing facilities at a cost of approximately LIBOR plus 125, with average advance in excess of 80%. We expect the cost of liabilities to drop significantly when we execute CDO2 early next quarter.

I'd like to briefly provide an example of a transaction that closed last quarter, which I believe to be emblematic of our lending style and the asset quality in which we back. In late December we originated a whole loan for acquisition financing to back a prominent national hotel management company, and a multi billion-dollar fund in their purchase of a destination resort and spa located on 75 contiguous acres.

The hotel has 244 rooms as well as a full service spa, meeting facilities, and the premier functions base in the market that it serves. Our whole loan funded the acquisition of the property, and also includes future advance provisions to fund capital improvements at the property, as the new owners undertake renovations of rooms and common areas at the hotel.

Our whole loan represents a total commitment of 75% of the loan to cost, and bears interest at LIBOR plus 250. In addition, this loan as with the majority of our whole loans [set] origination fees and other fees that have a positive impact on the overall return at our investment in this transaction. In general, our portfolio of closed deficit positions is performing extremely well, and we continue to see a full forward pipeline with strong credit characteristics in both pricing and structure that are inline with our expectations.

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

Thank you, Dave. On the commercial corporate side of our business we continue to see good credit and have issued two match funded vehicles, which allow us to actively invest in the commercial bank loan market with extremely cheap liabilities. Portfolio statistics are as follows; we have $614 million of bank loans, encompassing over 30 industries. Our top holdings by industry are in healthcare, diversified, broadcasting, chemicals, plastics and rubber.

All of our loans are not only performing, but we have a positive mark on the portfolio. As of the end of the quarter, our asset -- our average loan asset yield 2.34% over LIBOR, and our liabilities are costing us 46 basis points over LIBOR. On our leasing portfolio, small business portfolio all of our assets are performing, and the average yield is 8.576 and our liabilities are costing us 6.33.

As for our ABS, asset backed securities portfolio, where we have limited exposure, a total of 27 million of maximum exposure for our company, there has been a lot of stress in the global markets regarding subprime credit originated mostly in 2006 and 2007. Although we constantly are worried about deterioration, we are generally pleased to report that our portfolio is performing well and benefits from its mostly investment grade ratings.

In addition, most of the ABS bonds were originated in 2004 and up through mid 2005, and benefited from the rise in house price appreciation during those periods. In addition, our bonds benefited from the very rapid prepayment rate that occurred during '04, '05 and '06 as people sought mortgages elsewhere. This protects our principal.

We have reviewed the portfolio after the latest remittance reports, which detailed a credit statistic of the underlying mortgages and our bonds, which consist of prime, midprime and subprime mortgages, as well as loans, small business loans, etc. And we believe that we have aggregated a portfolio with which we are very comfortable at this time.

Of course no one is perfect, and therefore our team is constantly monitoring those bonds that we worry about most. The portfolio benefits from our team's abhorrence of the new types of loans originated in 2006 and 2007. We tried, to the best of our ability, to avoid these types of loans. We will continue to monitor with the same diligence we would otherwise, and we continue to expect the same losses that we would normally conservatively project.

In providing our guidance today, for 2007 dividends. We are cognizant of reserving room for error due to the macro-housing environment. We have a total of $27 million of maximum exposure to this portfolio. It is our only residential mortgage exposure in the REIT. We are excited about where we are going here in 2007, and look forward to continuing to build our company and grow our dividends.

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

Thank you, Jonathan. I'll now walk you through some financial highlights for the fiscal year ended December 31, 2006. The company increased its book value per common share at December 31, 2006 by $0.87 per share to 13.33, as compared to $12.46 at December 31, 2005, a 7% increase.

This is based on total stockholders equity of $317.6 million at the year-end 2006, and $195.3 million at December 31, 2005, and total shares outstanding of approximately $23.8 million and $15.7 million at December 31, 2006 and December 31, 2005 respectively. Our board declared a regular dividend of $0.38 per common share, and a special dividend of $0.05 per common share, or a total of $7.7 million for the quarter ended December 31, 2006.

For the fiscal year ended December 31, 2006, we have declared dividends of approximately $26.5 million or $1.49 per common share on our 17.8 million shares outstanding, which is prior to the December follow on offering. And have estimated REIT taxable income at $27.9 million or $1.57 per common share, based on the same number of shares. This equates to an approximately payout ratio of 95% of our 2006 estimated REIT taxable income.

At December 31, 2006, our equity is allocated as follows. Commercial real estate loans 77%, commercial bank loans 14%, ABS 7% and direct financing leases and notes of about 2%. At December 31, 2006, RCC's investment portfolio was further financed with approximately $1.5 billion of total indebtedness, and included the following. 1.2 billion of CDO senior notes, 120.5 million of repurchase agreements, 84.7 million outstanding under a secured term facility.

We also sourced about 51.5 million from our unsecured junior subordinated debentures related to our two Trups issuances, our first in May and second in September 2006. After accounting for our follow-on offering in December, we ended the period with $317.6 million in book equity. At December 31, 2006, the approximately 1.5 billion in RCC borrowings has a weighted average interest rate of 6.07%.

A little bit about leverage ratio. We consider leverage ratio from two standpoints. On a book basis our leverage is approximately 4.6 times. When we consider our Trups issuances, which have a remaining term of nearly 30 years as equity, we see our leverage on a net book basis drop to 3.8 times.

A little bit about recently capital events.. We further strengthened our balance sheet after year end with the January closing of the underwriters over allotment option, which was granted in connection with the December follow-on offering and exercised by our underwriters for an additional 650,000 shares, that generated net proceeds of 10.1 million after the underwriting discount.

In addition, we received through February 28th of '07, warrant exercises for approximately 274,000 shares, at $15 per share, that yielded proceeds of 4.1 million. Options to exercise warrants were 1,294,000 shares for potential proceeds of 19.5 million will remain outstanding until January 13, 2009.

With that, my formal remarks are completed, and I'll turn t he call back over to Jonathan Cohen.

Thank you, very much, Dave and Dave. And with that, we'll open the floor for any questions from our investors.

[OPERATOR INSTRUCTIONS]

Your first question comes from the line of Andrew Wessel from JPMorgan. Please proceed.

Hey guys, good morning.

Hi Andrew, how you doing?

Good, good, hanging in there. I have a -- I guess one question that's technical and the other one is kind of more general one. Going back to the breakout that you gave of the forward pipeline, you had the $900 million, is that -- that's what's currently enclosing what you're looking to close? Is that right? Is that the definition?

No, that's currently in closing and closed.

Okay, currently in closing and closed, so that's the 52% whole loans.

Yes.

Okay, and then the 60 to 75% directly originated whole loans is kind of what you see in the pipeline going forward?

Yes, I mean as we've said over the last six months. We've been moving our business and of course we go where the going's good.

Sure.

And right now, we really are seeing a lot of traction in the marketplace. We're finding our niches, we're finding the loans and properties and sponsors that we like, and so over the next 6 months that's really what it looks like.

Great. And has a good chunk of that come from the west coast team that you added --?

We continue -- it does come from the west coast team and -- but the west coast team has been added to. And we're continuing adding people and underwriters and originators, and of course we have originators also in New York.

Great. Okay, and the other question I have is about, just the course of real estate CDO market in general. I mean I think there's been a lot of talk about -- you've heard people saying the cash CDO market is basically closed.

And some people are saying well, that's more kind of the -- just from added ABS deals, and then others are saying well, its just banks being skittish and they actually are kind of -- all new players in the space are kind of our of luck, and that if we really want to get a cash CDO done right now, its difficult.

I guess my first question is, what do you see in general in the commercial real estate CDO market and then, taking that information, how has that effected you, if at all?

Of course whenever the global credit markets are rocked you're not -- nobody is spared. So -- but I think that my own view is, and we're [lining] up, we're talking to agencies and talking to investors, we've got a great track record and we're moving forward. We haven't heard anything in the market where people are shelving deals or doing anything like that. People are getting deals done and there seems to be a good bid for it.

I do think that you'll see some of the subordinate tranches of the CDO that we finance widen a little bit, because of general contagion in the marketplace. And therefore, I would expect liabilities to be a little bit wider for us that they might have been three months ago.

Great. Great. Thank you, very much. I appreciate it.

Thank you.

Your next question comes from the line of Don Fandetti from Citigroup. Please proceed.

Hi, good morning, everyone.

Hi, Don. How are you doing?

Doing okay. Just wanted to sort of dig in a little bit on the subprime or ABS assets. What percentage of your equity today is in subprime or midprime?

Well, the total exposure for the company is $27 million to an ABS portfolio, of which probably about half of which is subprime, midprime.

Okay, so --

But that doesn't mean that its -- some of that's AA, A, BBB plus, BBB, etc.

Okay, so what you're saying is the $27 million is the total roughly par amount of ABS securities that have some type of subprime, midprime.

No, -- the 27 million is our equity exposure.

Okay. that's your equity exposure.

Yes, so --

Okay.

And we were happy to go through that with you, but we feel very - comfortable at this point. Like if we looked at this relatively to how our bonds are performing from 2004, they benefited a lot from a lot of different things that went on in the marketplace. And of course we're not picking the average bonds, we're picking the bonds that didn't have a lot of those characteristics.

Okay. And Jonathan, what is your appetite to step back into that asset class?

It's not high. And that's been recognized at the REIT by the fact that we mostly got out of residential mortgages six months ago, but of course you cant just get out of a CDO, we have to wait for the call period or have it run down.

Okay. And then just to clarify --

That's our only exposure.

Got you. Okay. And just to clarify, it looks like your percentage of your equity in commercial real estate is significantly higher than your bank loans. And I understand there's different leverage, but it looks like -- unless I'm looking at the wrong numbers, your bank loans are roughly equal to your commercial real estate loans. And I was just curious if there's that much of a leverage difference.

Yes, I mean bank loans tend to be between eight and 11 times leveraged depending on the vehicle, and those vehicles are locked up, and to -- as I said, our average spread is LIBOR plus 235, and our liabilities are LIBOR plus 46.

Okay.

And we own those for a long time. So that's a very good financing vehicle for us. And, obviously, our real estate is only levered two to three times right now, and that's why you get a global kind of company wide leverage of four times ish.

So, you're only leveraging your real estate two to three times right now?

When it will ultimately get to 3.8 to four times on the real estate, but we're still in the ramp mode.

Okay, but you're saying you get a -- like 80% advance rates on your warehouse lines.

No, we get about -- yes, probably about 75 to 80% advance rate.

Okay. So how do you get to sort of two to three times leverage?

No, because right now we have cash from the offering.

Okay.

So, as of December we took a lot of cash in in December, so we paid down a lot of our lines.

Got you.

I'm saying eventually we will get back to that 3.8 to four times on the real estate. But as a company as a whole right now, we're four times, but the growth in the company will be as we reinvest and get up to five times as a company, or 5.5.

Got you.

Where we were before.

Great. And just in terms of your payout ratio. Do you see your company sort of migrating towards a lower payout ratio just to run a more conservative business? We've seen other companies doing that after they're public for a period of time.

Yes, I mean just to give you a sense, and I think I said this on the -- in my comments, but of course, I said a lot in my comments so --. When we give guidance to $1.65 to $1.80, we there have credit loss provisions, we have holdbacks, we probably stated -- last year was 95% of taxable REIT income, but probably more like 90% than 92%.

Okay. All right. And just wanted to just go back to the loan that I think David highlighted during his prepared remarks. I was just curious how you got involved in that deal, if you could just tell us a little bit about the -- was it a competitive transaction, and how did you win that transaction?

Sure, that was actually not a competitive transaction. That was a relationship deal. That was something that -- it was a sponsor that we know well.

Okay.

It was a follow-on transaction with that group. So it's -- that's how we've done a number of --.

We've -- this is Jonathan. We've had a numerous - as I've said to m any people, the size of our company -- we need eight to ten or 15 good borrowers that we like. We like their strategies, we like their asset management skills. We don't need 100.

Got you.

And this is one of those people, and we've got a few, we're probably up to four or five or six.

Okay.

And our job is to grow that, and we're investing heavily to do so.

Great. And if I could just ask one modeling question. On the 200 to 250 million of commercial real estate growth per quarter, is that net or is that before pre-payments?

I think that we think that that's net. We're still very -- only because we're still very early in our process. So, and we don't have that -- although we do have some prepayments, they tend not to be overwhelming like you see at some other companies that have been doing this a longer time.

Got you. And on your bank loan portfolio, have you seen any repricings at all or --?

We've seen repricings, but we typically play in the very, very strong credits, and they tend to have come out pretty cheaply anyway. And we're not seeing anything damaging to our portfolio.

Got you. And just --

I mean other words, we're seeing it fluctuate, I think I said it was LIBOR plus 234, it might be LIBOR plus 232 now, and it's a diversified portfolio.

Okay great. Thank you, very much.

Thanks, Don.

Your next question comes from the line of Bob Napoli from Piper Jaffray. Please proceed.

Hello, guys, this is actually [Jason Dalue] calling in for Bob.

Hi, [Jay], how are you doing?

I'm doing fine, thanks. I was just sort of wondering if you could characterize just the competition you're seeing for commercial real estate loans. I mean obviously you're seeing some good opportunities in the whole loans. If you could just kind of compare the -- what we're seeing in whole loans to the B notes in the mez debt, and then just also kind of what you see now compared to maybe a quarter ago.

I would say that -- we really focused on the whole loans. And I keep reminding people, we're a fairly small company, so we can take our picks of where we ant to play on the B note in the mez portfolio. But as you'll see, we originated 40 million of mez, and 48 million of B notes, and 116 million of whole loans.

And as Dave said, that's going to shift to 60 to 75% whole loan, because quite frankly the B notes are competitive and up -- I think there's going to be some pricing pressure on those guys to give more spread to the marketplace, which we're seeing already. But -- its competitive there, and we try to only do the ones where we can put away 13, 14% return levered without worrying very much about it.

And, I would say, that on the whole loans, we have our niche and as our guys in our sort of quarterly meeting told me -- we have our relationships, and its competitive, but the type of stuff that we're doing with guys who want to buy real estate and do transition properties, they just want to know that you're there, you're closing, you're going to relate to them, you're going to be more of a community banker for them.

So they don't want to pop out because they get 20 basis points lower across the street, they want to know that they're going to do five loans with you over five years, or three years, or two years. So, it's competitive but we're finding great opportunities.

Have you been seeing more players moving into the whole loans?

Certainly, you see more players, but it's a large country and we haven't seen very much impact. We usually -- I mean people talk about other names in the marketplace, but oddly enough when we're competing its not repetitively with one player.

Okay, that's helpful. And if you could just try to give me your thoughts on the commercial real estate credit outlook, and what you guys are seeing and if has anything changed in the last quarter or so?

Quite frankly, no. But I mean -- people are obviously talking about that, and we haven't seen anything either in our portfolio or in our borrowers etc.

Okay. And then lastly, just on the CMBS, what are you see in for spreads there? I guess mostly recently given kind of what's been going on. And I know you guys increasing your investments a little bit there last quarter, but --

I would say that we -- I would say two things, one is we were very excited when for one or two days last week the BBB minus spread blew out by like 20, 30 basis points; just because we're buyers, and we haven't bought very much. So we were kind of excited by that. But as soon as we started to like even think about bidding, they were coming back in.

Okay.

So, I think that -- as of yesterday, I don't know what happened yesterday but -- because we were working on our presentation here, spreads were snapping back, [CMBS] was also snapping back pretty hard.

But basically it's on your radar screen. But --

Sure and we would like -- I mean, just quite frankly for everybody, we would like wider spreads. We want to be paid more, we own liabilities, right? So if we do a good job with our credit, we get prepaid and if I own liabilities for instance in the bank loan market of 46 over, I'd rather get paid 330, not 230. So, we're a fan of widening spreads.

All right. Thank you, very much.

Thank you.

[OPERATOR INSTRUCTIONS]

Your next question comes from the line of Douglas Harter from Credit Suisse. Please proceed.

Thanks. Just --

Hi, Douglas.

Hi, Jonathan. Just to sort of touch on that last point about wider spreads, what do you think it will take for spreads to widen? Is a little bit of widening in the CDO market going to cause that, or will competitive pressure sort of keep that from happening?

Well, as I said before, if you look at the one or two portfolios that we're ramping now, which are commercial real estate and commercial bank loan portfolios. I believe that liability just makes a lot of sense, will be a little bit wider than they were six months ago, three months ago, when we come to the market so the people on the bottom part of that structure, the BBB get paid a little bit more money. That would just be logical to me. I don't know that.

Right.

But as far as -- we own 1 billion, 200 million dollars of liabilities. When something prepays me at 250, I actually want to get paid more on the next asset to take the same risk. So, if I can get paid 350 because things widen out, I'm going to make a hell of a lot more money?

Where are those spreads today? Can you reinvest prepays today at wider spreads?

No, we haven't seen that.

Okay. And then sort of an unrelated question. Can you talk about the difference in profitability of that -- of the whole loans that you're originating, versus the loans you're buying?

Sure, I'd be happy to. I mean if you made a loan from LIBOR, from zero to 75%, you charged 250 over, I think that was one of the examples, maybe David gave. You're getting paid from 0% LPV, to 40% LPV, where you're really not taking a lot of risks, but you're still making 250 over on a AAA, AA type risk for the property at that level.

And so when you add in -- these are typically two to five year loans, you add in two years and then they start paying extensions. When you add in a point for origination, half a point or a point for exit, where the borrowers are paying the cost of the loan in a [dos] and due diligence.

You really end up with something that's more like, over a two year period, LIBOR plus 350, where you're -- if you break it up and say that you have from zero to 40% is AAA, you're getting paid 250 on the AAA, or lets just even allocate it and say you're getting paid 100, which is still wide of the AAA market.

When you look at the risk that you're taking for putting your money from 60 to 75%, you're actually getting paid LIBOR plus 1000 something. Which is a very good rate to get paid for that, when you add in all the fees. And then, when you put leverage to it and we just had one prepay, when this happen over a year and a half period of time, you really do -- can make 20, 30% type returns.

So, as the portfolio moves from sort of 50% to the forward pipeline of being 60, 65% you would expect -- so you expect a pretty big improvement on the profitability there?

Yes, I mean that's why we gave guidance from 1.65 to 1.80, because we don't really know -- we're not going to make loans just for the sake of making loans and have a mix for the sake of having a mix. We're only going to make the good loans. So if it turns out to be 75% whole loans, I think you'll see us at the high end of that dividend range.

Great. Thank you.

Thank you.

And there are no further questions at this time. I would now like to turn the call back over to management for closing remarks.

Thank you, very much. And again thank you for your continued support in the marketplace.

Thank you for your participation in today's conference. The concludes the presentation. You may now disconnect. Good day.