Acres Commercial Realty Corp (ACR) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Q3 2017 Resource Capital Corp. Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the call over to Ms. Purvi Kamdar. Ma'am, you may begin.

Thank you. Thank you for joining the Resource Capital Corp. Earnings Conference Call for the Third Quarter ended September 30, 2017. I'm Purvi Kamdar, Director of Investor Relations. As we begin, I would like to remind you that certain statements made on the course of this call are not based on historical information and may constitute forward-looking statements. When used in this call, the words believe, anticipate, expect 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 based on management's current expectations and beliefs and are subject to a number of trends, risks and uncertainties that 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 Form 8-K, 10-Q and 10-K, and in particular, the Risk Factors section of our Form 10-K. 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 presentation of this information is not intended to be considered in isolation or as a substitute to 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 Accounted Principles can be accessed through our filings with the SEC at www.sec.gov. I would like to now turn the call over to Andrew Farkas, Chairman of RSO, for opening remarks.

Thank you, Purvi. Good morning, everybody. With me today are: Bob Lieber, who is the CEO of RSO; Matt Stern, President of RSO; Dave Bryant, CFO of RSO; and Paul Hughson, Head of Commercial Real Estate Lending at RSO. It's been approximately 1 year since we laid out our vision for RSO and announced our strategic plan. We're are on track to achieve that vision, and I'm pleased to provide an update on our progress. We have sold $296 million of the $480 million or 62% of the assets deemed noncore under the strategic plan, the proceeds of $325 million through September 30, 2017. We have refocused RSO's operations towards commercial real estate debt. This includes revitalizing the company's commercial real estate lending platform through expanding RSO's opportunity set by adding C-III's expertise in CMBS investing. We deployed $265 million of capital in the commercial real estate loans and CMBS bonds in the third quarter. To give some context for our loan origination efforts this year, we originated $371 million of commercial real estate loans through September 30, 2017, which is over 150% greater than the loan origination volume for the comparable period in 2016. And just after the close of the third quarter, RSO acquired its first CMBS B-Piece comprising a higher-yielding below-investment grade and unrated tranches on a CMBS trust, which further demonstrates the expansion of RSO's investment capabilities as a result of its new manager. We've also begun the process of addressing RSO's cost for capital at both the asset level and the corporate level, with a favorable pricing of our CLL and the recent issuance of 4.5% coupon convertible notes. While we acknowledge there is further work to do, our progress thus far speaks to the level of commitment C-III has made to transforming RSO into a first-class REIT. With that, I'll turn it over to our CEO, Bob Lieber.

Well, thank you, Andrew, and good morning, everybody. For the third quarter, RSO had GAAP earnings of $0.41 per share and had core earnings, excluding a onetime charge of $8.5 million related to the extinguishment of debt in connection with our convertible notes offering, of a negative $0.09 per share. Dave Bryant will walk through the details of our earnings, but I'd like to highlight a few key items. Sale of LEAF contributed $36.6 million to net earnings. This transaction is excluded from our reported core earnings as it relates to one of the businesses that is a part of the strategic plan. The issuance of our new convertible notes and the repurchase of our 6% and 8% converts led to a GAAP charge of $10.4 million. Importantly, this transaction lowers our cash cost to capital going forward and extends our debt majority schedule and was executed under very favorable market conditions.

Core earnings are improving, but continue to be impacted by the amount of capital we have that still needs to be deployed into commercial real estate from our noncore investments. We expect core earnings to turn positive in 2018, but the pace of earnings growth still remains uncertain. As we have mentioned previously, one of the largest hurdles we face in managing the businesses is anticipating the proceeds from the strategic planned asset sales and the maturities from our existing commercial real estate loan book. For example, the loans originated in 2014 and 2015, 2 of RSO's strongest origination years, are now approaching their initial maturities. Our origination team continues to increase origination volumes, but asset sales like the LEAF transactions create lumpy cash flows, which we need to deploy expeditiously -- as expeditiously as possible while still maintaining our strict focus on credit quality. Our CMBS investment supplement are CRE commercial real estate origination efforts to deploy proceeds profitably as the lumpy cash inflows occur. Our earnings visibility improves. As earnings visibility improves over the course of 2018, we will continue to discuss the dividend policy with our Board and update you as appropriate. As Andrew mentioned in his opening comments, during the quarter, we capitalized on favorable market conditions to issue the 4.5% convertible notes. The majority of the proceeds were used to acquire some of the most expensive components of our capital structure, including the 8% and 6% outstanding convertible notes.

Book value at the end of the third quarter was $14.91 per share, which is an increase from the $14.12 per share at the end of the second quarter. Today, we will provide a reconciliation of this change. And similar to core earnings, book value should be expected to fluctuate as we complete the execution of the strategic plan and divest or resolve the remaining assets, and book value could decline from future monetizations. That said, when we announced the strategic plan a year ago, the strategic plan assets represented 25% of RSO's total asset value at that time, and we are pleased that the monetizations in the aggregate have been greater than the book value at that time.

Finally, as it relates to the third quarter hurricane activity, not only does RSO have commercial real estate loans secured by properties in Houston and throughout Florida, but also the broader C-III organization has employees and owns or manages properties in these areas as well. Our thoughts and prayers go out to our employees, the residents and their respective families who were impacted by the hurricanes. And C-III, on behalf of our broader organization, is proud to support them with financial aid and other assistance. Dave Bryant will go into further detail in his remarks, but simply put, all of our loans that are collateralized by properties in Houston and Florida, our current and business interruption insurance is in place for the foreseeable future. With that, I'd like to turn call over to Matt.

Thank you, Bob, and hello, everyone. Expanding on some of the items Bob highlighted, I'd like to begin with our origination and investment activity. For the third quarter, we originated $158 million of transitional CRE loans, with a weighted average spread of 419 basis points over a 30-day LIBOR. We also deployed $107 million into CMBS bonds, with targeted returns in the low double digits. Our CRE loan origination team continues to see improved deal flow, and we are confident that our quarterly originations will continue to grow despite lower industry-wide CRE acquisition volume. We still believe second half 2017 CRE loan originations will be approximately $350 million. That said, we continue to be focused on credit quality and will remain disciplined in our approach.

We are able to pursue a more opportunistic approach on the CMBS side and continue to selectively find value throughout the capital stock, including in bonds rated BBB and lower. Here, we are able to leverage C-III's platform and its expertise in underwriting and by earning higher-yielding CMBS. Subsequent to quarter-end, RSO acquired its first CMBS B-Piece. C-III has a respected track record as a B-Piece buyer, and this acquisition further demonstrates how C-III can prudently expand RSO's opportunity set. We target low to mid-teen returns in our B-Piece investments and believe this investment will provide a yield in that range.

The second item I would like to address is the successful issuance of $144 million of senior convertible notes. These notes carry a 4.5% coupon, have a 5-year maturity and an initial conversion ratio equivalent of $12.78 per share. With favorable conditions in the convertible debt market, we were able to issue the 4.5% notes and retire $79 million of our 8% notes and $45 million of our 6% notes. The repurchase of our 8% and 6% notes and the deal costs associated with the new issuance reduced our third quarter net income by $0.33 per share. While the initial conversion price is beneath our current book value, it is also approximately 25% higher than our current trading price. And the issuance also has several important benefits for the company. First, it lowers our cash cost of capital at a time when the market for a transitional CRE lending is increasingly competitive. We do not want to reach for yield in this credit environment. And therefore, having a lower cost of capital allows us to continue to grow our origination platform competitively and creatively. Second, we thought it was prudent to extend the company's debt maturity profile at a time when the convertible market and available terms are quite favorable to issuers as opposed to when the company could be forced to complete a transaction. Lastly, during this period of transition, RSO received a vote of confidence from the capital markets with the completion of our most recent CLO and the issuance of these notes at yields which both greatly improved the company's all-in cost of funding.

Finally, turning to Schedule 3 of our press release. We have less than 1/3 of the initial $480 million balance of strategic planned assets remaining on our books and have achieved aggregate proceeds in excess of our book value. As discussed earlier, the sale of LEAF closed this quarter, generating $84.3 million in pretax proceeds compared to a carrying amount of $43.2 million. We received 2 par payoffs in our middle-market lending loan book, reducing the balance of middle-market loans outstanding to $29 million. We also continue to make progress in unwinding our commercial finance book, which consists primarily of CLO equity positions. We only have $3.5 million remaining in this asset class, and have recognized proceeds in line with our book value. I would just like to add that our investments in unconsolidated entities also consist of similar assets. Our initial guidance for substantially exiting assets identified in this strategic plan over an 18-month period remains on track. With that, I would like to turn it over to Dave Bryant to discuss our financials.

Thank you, Matt, and good morning. Our GAAP net income allocable to common shares for the 3 months ended September 30, 2017, was $12.6 million or $0.41 per share and our GAAP net income for the 9 months ended September 30 was $17.8 million or $0.57 per share. Our net income for the third quarter includes the following significant activity: a realized gain of $41.1 million on the sale of our investment in LEAF Commercial Capital for approximately $36.6 million net of taxes. We also had an extinguishment of debt of $10.4 million related to repurchase of $45 million of our 6% convertible notes and $79 million of our 8% convertible notes in conjunction with the issuance of $143.8 million or 4.5% convertible notes, which become due in 2022, and a net loss of $7.1 million from Primary Capital Mortgage, a discontinued operation that we are winding down.

At September 30, 2017, our GAAP book value per share was $14.91, an increase from $14.12 at June 30. The quarterly increase in book value can be attributed to the following: net income of $0.41 per share, plus an increase of $0.46 per share related to the conversion option value ascribed to our 4.5% convertible note issuance, which will be amortized to interest expense over the term of the notes; a net increase of $0.03 to other comprehensive income from mark-to-market adjustments, and that was offset by a decrease of $0.05 per share from the acquisition of a partnership interest with a deficit balance into stockholders equity; and a net decrease of $0.01 to additional paid-in capital inclusive of the impact of shares vested; and finally a common dividend payout of $0.05 per share.

We use core earnings as a financial measure to evaluate our operating performance. We provide a segment view of our core earnings calculation in the press release that allows investors to gauge the progress of our strategic plan as we transition to a more focused share REIT debt investment platform. We had a net loss in core earnings of $0.36 per share in the third quarter of 2017, which includes a onetime charge of $8.5 million or $0.27 from the retirement of convertible notes. Excluding this onetime charge, our core earnings for the period would be a net loss of $0.09 per share as compared to a net loss of $0.10 per share for the second quarter of 2017. The related new issuance of 4.5% convertible notes will provide cash interest savings of approximately $600,000 each quarter or $2.4 million per annum, which will enhance the core earnings run rate going forward.

Turning to originations. We see the loan pipeline increasing in volume, with additional opportunities to invest in CMBS which will soon be accretive to core earnings. We deployed a significant amount of liquidity in the third quarter with new share REIT debt investments of $265 million, composed of $158 million of new commercial real estate loans and $107 million of CMBS purchases at cost. And we expect we will benefit from the full impact of these investments in the fourth quarter. As Andrew mentioned in his opening remarks, year-to-date CRE loan origination activity is up 154% as compared to the same 9-month period in 2016. In addition, through September, we have purchased CMBS bonds with a cost basis of $122 million as compared to $4 million during the same period in 2016, a significant increase.

Our $1.3 billion commercial real estate portfolio is substantially all floating rate self-originated home loans. We have total capacity of $650 million on our commercial real estate term facilities, and have approximately $380 million available as of October 31, 2017. Our 3 newest commercial real estate securitizations are subject only to over-collateralization tests which we have comfortably passed. Our securitizations continue to perform well and produce reliable cash flow. We anticipate that at least one of the 2 securitizations issued in 2015 will liquidate during 2018, which is on an approximate 36-months CLO lifespan similar to our recently liquidated 2013 and 2014 deals.

In light of the aforementioned weather events in Texas and Florida, I wanted to provide a brief summary of the impact on our loan collateral. With respect to Hurricane Harvey, we had 2 loans on properties in greater Houston, one of which sustained minor water damage to about 10% of the apartment units, and it is in the process of being fully repaired. With respect to Hurricane Irma, RSO has a number of loans on assets throughout Florida, all of which came through without any significant damage. In addition to all other required insurance as determined by our independent insurance consultants, we also require our borrowers to carry business interruption insurance, generally, for a period of 12 to 18 months of potential downtime. It should be noted that all of the loans collateralized by properties in Houston and Florida are current with respect to debt service payments and all required monthly impounds after the hurricanes.

As part of our monitoring and asset management, we have refined our commercial real estate loan general reserve policy. Effective September 30, we are now using 5 loan main categories, with loans rated as 1 having the highest credit quality and loans rated as 5 as having the lowest credit quality. The implementation of the policy refinement did not yield a significant shift in allowances provided from our previous approach. I wanted to highlight the asset shift in our balance sheet as a result of this strategic plan implementation. While our total assets have declined by $228 million since September 30, 2016, the composition of our total assets at September 30, 2017, is now comprised of approximately 90% commercial real estate in divestments, combined with cash earmarked for our new CRE investments. The decrease in total assets over the past year is primarily from: the net reduction in core assets included in the strategic plan of $331 million; net payoffs of CRE loans and changes in other assets of $169 million, offset by a net increase in CMBS of $104 million; and a net increase in liquidity of $168 million. We expect our total assets to increase as we finalize the execution of the strategic plan and deploy the proceeds in new commercial real estate debt investments with a market standard use of leverage. We received $128 million of proceeds and saw our net book value of the remaining strategic plan assets decrease by $93 million during the quarter, including a $23 million decrease in our investment in Primary Capital Mortgage from $42 million to $19 million. With the vast majority of Primary Capital's remaining financial assets under contract for sale, it is notable that PCM's net book value includes $5 million of cash on the balance sheet. The winding down of this former operating business over the next few months represents a significant milestone in our strategic plan.

Our GAAP leverage stands at 1.6x, down from 1.9x at December 31 of 2016. The decline was a result of net pay downs of $151 million on our borrowings and other liabilities and an increase in our common book equity of $26 million. We remain focused on the execution of the strategic plan. We believe that we have ample liquidity to fund the business on a going-forward basis, with over $185 million on hand as of October 31. We expect to deploy this liquidity judiciously in commercial real estate debt and debt securities that produce strong risk-adjusted returns. And with that, I'll ask the operator to open up the call to any questions.

(Operator Instructions) And our first question comes from the line of Jessica Levi-Ribner from B. Riley FBR.

This is Tim for Jessica. So you guys reiterated your second half '17 origination guidance, so we have a pretty good idea about what to expect next quarter. But I was hoping you guys could size your pipeline for us and give any type of update on originations, fundings or payments that have been received so far in the quarter.

Sorry, what's the question? You want to go what the pipeline looks like going forward and what we've paid off in that quarter?

Yes, so just -- if you could help just size your forward pipeline for us. And then any updates so far in the fourth quarter on originations and repayments so far?

Okay. I will turn that last part over to Paul Hughson, who runs our debt investment business, to comment on the pipeline.

I mean, I think the fourth -- I think the pipeline is fairly consistent with what Matt articulated a little bit earlier in terms of what we're looking to close in the fourth quarter. The time horizon for most loans is plus or minus 60 days from the time the application is returned until the time the loan ultimately closes. So the loans that have the applications returns to date are likely in the number that Matt said a little bit earlier. And then the loans that we are working on in excess of that will likely be more likely first quarter closings than fourth quarter closings.

Okay. And the yield on new originations has come down a little bit. I was just hoping you could talk about kind of the competitive landscape, the asset types and geographies you're seeing the most competition, those you're seeing the most opportunity as well.

Yes, I think that -- I think Matt said earlier that the spread on the new originations was likely just a little bit south of 4 20 over LIBOR. I think we continue to see opportunity in value-add apartments, which historically been a strength for RSO's origination infrastructure. I think spreads have compressed a bit on that, although we still like the risk-adjusted returns available in that product type. We've been able to supplement the origination of the traditional RSO originators with certain of the clients that have been historic C-III clients, and bringing certain other asset classes into the mix that perhaps RSO had not historically focused on that have a fair amount of cash flow stability and reasonable returns. And I'm talking about manufactured housing as well as sales storage. So we continue to see opportunities in the apartment sector and the manufactured housing sector and the storage sector. I think historically, RSO has done a lot of lending in the Texas markets, Houston, Dallas predominantly as well as places like Austin and San Antonio. And then throughout California, we do have an origination infrastructure with presence in California. We continue to like those markets, although we've expanded -- given the C-III platform, we've expanded some of that focus on the East Coast, and continue to look at that opportunities in Florida and throughout the Carolinas and the Sun Belt. So I think it's not too -- the places that we like to lend in RSO are not too terribly dissimilar from the places we like to invest in equity from the C-III side. And we look kind of up and down the West Coast throughout the Southwest and the Carolinas at the East Coast, with less of a focus in the Midwest.

(Operator Instructions) And our next question comes from the line of Steve Delaney from JMP Securities.

So it does appear -- heard your comments about 62% done. But focusing on the $122 million of remaining assets held for sale, is there anything else other than those loans held for sale that we should -- that remains under the umbrella of the strategic plan, any unconsolidated joint ventures or anything of that nature? Or are we just looking at these loans?

I think if you to turn to Schedule 3 in the press release, it will bifurcate for you some of the component parts. Specifically, we have about half of the remaining assets are in legacy CRE loans that we targeted for divestiture. In many cases, that was yield-based as opposed to it being noncore from an investment type. The middle market loans that we spoke about or the remaining balance is down to $29 million. And then we have the balance of PCM, which we spoke about, and then some other smaller investments in commercial finance, as I talked about in my comments. So the vast majority of that is concentrated in commercial real estate loans and middle market and then just the balance of PCM, which we're in the process of divesting.

Exactly. And that made a -- you had a big recovery in PCM in the third quarter it appeared so. As we hear your comments and look at what you have left, I think someone mentioned 18 months as far as the actual sort of the endgame on the strategic plan. So if we were to look out to sort of mid-2018, would it be your hope that you would be substantially completed and moving forward with a clean balance sheet at that point in time?

Steve, it's very hard to time these things, as you well know. We would anticipate that we'd be well through the strategic plan by the end of 2018. We really start this in place in March. And we talk about 18 months in there, so that's kind of time frame we still would -- our expectation is to be through this by 2018, whether that's the middle, the third quarter, we just don't have enough visibility yet to know that. We like the pace and the path and the direction that we are taking.

Yes, certainly we see the progress for sure. Talking about the -- switching over to the new CMBS activity that we saw in this quarter, and not at all surprised giving the expertise to C-III in that area. But the $115 million of investment-grade -- in grade investments, when we think about investment-grade CMBS, should we see those as sort of a placeholder given your high liquidity? Or do you think that investment-grade CMBS might be a permanent part of the forward strategy along with the B-Pieces that you will be doing?

Yes. If you look at our CMBS portfolio today, we have some legacy highly-rated CMBS that we've held on balance sheet. But the investments about which we're speaking, many of them are in BBB or lower in the capital stack. And so while some are low investment grade, this is a slightly different portfolio than the one that RSO has traditionally held, and we think meets the various criteria for RSO, including yield, but also diversification and gives us a little extra duration in our assets.

Okay, that's helpful to understand. So not really -- it sounds like it's a little more really a credit investment than a highly levered investment with your -- if you're going to be below the BBB -- BBB or down. Should we think of it that way?

Yes, I think I wouldn't exclude opinion depending upon what's happening where we think risk-adjusted returns are about moving up and down the capital stack. But you are correct that most of the investments here have tended to be in the BBB and BB level.

Okay, that's helpful. And just my last question. Despite the $115 million in CMBS, you still had a huge cash position at October 31, $185 million. And I'm just curious in addition to playing offense with investing and lending, would you consider using some of this liquidity to call or redeem some of your high cost 8.5 percent-or-so preferred stock?

We are always looking at ways to improve the profitability of the business and looking at all the components of the balance sheet. So that's something we continue to consider.

And I'm showing no further questions at this time. I would now like to turn the call back to Mr. Andrew Farkas, Chairman of RSO, for any closing remarks.

We'd like to thank everybody for continuing to follow the progress that we're making in RSO. We began this plan in earnest, as Bob said, in March really of this year. I think that the progress that has been made in every category that we addressed, we first started to articulate what the strategic plan would be, it's considerable. In fact, we're probably a little ahead of where we would've liked to have been at this point. We've also addressed the company's cost of capital by redeeming the 8% to preferred and converts and sort of reducing that cost to 4.5%, while there's still others outstanding, of course, getting people to do that is certainly a case-by-case negotiation with those who are holders. We've liquidated a lot of the noncore assets. We've commenced deploying the liquidity associated with debt liquidations and put it out into commercial real estate loans and CMBS that are consistent with the yield objectives that the organization has. So in my personal opinion, we are well on our way to getting to where we want to be. We appreciate the support that the shareholders have shown and the patience you've shown as we continue to make progress. And we look forward to being able to show you more during 2018 as we continue to complete the plan. I think that's all I have to say. Thank you for calling in. And we look forward to speaking to you next time.

Thank you, everybody.

Ladies and gentlemen, thank you for participating in today's conference call. This does conclude the program. You may all disconnect. Everyone, have a great day.