Acres Commercial Realty Corp (ACR) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter 2018 Exantas Capital Corp. Earnings Conference call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference Mr. Andy Carr, Head of Investor Relations. Sir, you may begin.

Good morning, and thank you for joining our call today. Before we begin, I would like to remind everyone that certain statements made in the course of this call are not based on historical information, and may constitute forward-looking statement. When used in this conference call, the words believe, 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 based on management's current expectations and beliefs and are subject to a number of trends, risk and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. These risk and uncertainties are discussed in the company's reports filed with the SEC, including its reports on Forms 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 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 are contained in our earnings release for the past quarter.

I will now turn it over to the Chairman of Exantas Capital Corp, Andrew Farkas for opening remarks.

Thank you, Andy. Good morning, everyone. Thanks for joining the call. With me today are Bob Lieber, our CEO, Matt Stern, our President; Dave Bryant, our CFO; Paul Hughson, our Head of Commercial Real Estate Lending; and of course, Andy Carr, Head of Investor Relations from whom you've already heard.

Since we announced the rebranding of the company in May of this year, the trajectory of our earnings has continued to increase as our core investment portfolio grows.

Over $1 billion of new transitional commercial real estate loan origination and CMBS investment activity in the last 12 months is driving the continued net growth of the investment portfolio. The acceleration of core earnings resulting from the core portfolio growth has supported another anticipated increase in our dividend to $0.175 per share for the fourth quarter, which we'll recommend to the board for approval when we meet at the end of the fourth quarter. This will be the third consecutive increase in our quarterly dividend, which has increased from $0.05 per share established from the announced strategic plan in November 2016. That's over a 300% increase during that period of time.

With the strategic plan successfully behind us, the company's operations are less complicated, thus making the potential earnings power of the company easier for shareholders to understand.

I'm pleased with the results of the third quarter and the prospects for additional quarter earnings growth. We look forward to reporting those results to you on our future calls.

With that, I'll turn it over to our CEO, Bob Lieber.

Thank you, Andrew, and good morning, everybody. For the third quarter of 2018 adjusted core earnings increased to $0.24 per common share, up from $0.20 a share in the second quarter and up from $0.03 a share in the first quarter.

As Andrew mentioned, the positive trajectory on adjusted core earnings is a reflection of the growth in the company's investment portfolio, which grew by over $100 million during the third quarter and almost $350 million during the 9 months ended September 30, 2018. This is net of payoffs, paydowns and sales. This growth in our investment portfolio and the stability of our pipelines, despite a competitive investing environment, is driven by several factors: The first of which is that real estate transaction volume remain strong, creating lending opportunities and from a macro perspective, commercial real estate has generally continued to perform well as operating fundamentals across property types and desirable domestic markets are driven by the strength of the local U.S. economy; secondly, our ability to capture our share of lending opportunities, this is a function of Exantas' increasing presence in the marketplace and extensive lending relationships as evidenced by many repeat borrowers and the relationships are supplemented by lending relationships derived from C-III's large commercial real estate platform and its management team; the third is leveraging C-III's core competency and investing in commercial mortgage-backed securities, which provides longer duration assets and enhances the diversification of the company's balance sheet.

As we continue to move forwards towards full deployment and execute on our business plan, we expect core earnings to continue to increase. We anticipate substantially achieving full deployment in the second half of 2019, and our efforts to outpace the payoffs in 2019 will be bolstered by a significantly lower principal balance of loans, which are expected to pay off in 2019 as compared to 2018.

Once fully deployed, the annual earnings of the profile is expected to be consistent with the illustrative core earnings profile presented on Page 12 of our August 2018 Investor Presentation.

As you heard Andrew mention, we believe our near-term earnings outlook works and anticipate a third consecutive increase in the quarterly dividend to $0.175 per share for the fourth quarter.

We carefully consider both book value as well as core earnings when making dividend recommendations to the board and as core earnings visibility continues to improve, we will continue to evaluate dividend policy and discuss regularly with our board.

In fact, looking at the balance sheet, book value increased for the second consecutive quarter to $14.23 per share at the end of the third quarter, which is up from $14.09 in the second quarter and $13.92 at the end of the first quarter of 2018. The increase in book value for this quarter is attributed mainly to, number one, net income of $0.19 per share, and additional unrealized gains of $0.08 per share from marking our CMBS portfolio and related swaps to the market, and it's been offset by the payment of our $0.15 per share dividend in the third quarter. As we look ahead to 2019, we are optimistic about the growth potential.

And with that, I'd like to turn it over to Matt for some more details.

Thank you, Bob, and good morning, everyone. I'd like to begin by taking a closer look at this quarter's origination activity. As September 30, 2018, our commercial real estate loan portfolio was comprised of $1.5 billion of floating rate, self-originated whole loans, which grew by $69 million during the third quarter as new loan originations exceeded payoffs and paydowns.

Our commercial real estate loan origination team continues to see quality lending opportunities resulting in a strong deal pipeline, which is further enhanced by the C-III platform.

In the third quarter, the company originated $245 million of CRE loans with a weighted average spread of 343 basis points over 30-day LIBOR.

As summarized on Page 2 of our earnings release, despite some spread compression during the quarter from market competition, the weighted average unlevered yield of new originations has been largely unchanged over the last 12 months.

The weighted average spread for loans originated during the third quarter of 2018 was 76 basis points tighter than the weighted average spread for loans originated during the same period a year ago.

Similarly, the weighted average spread of XAN's entire CRE whole loan portfolio compressed 62 basis points when comparing the portfolio at September 30, 2018, to the portfolio at September 30, 2017. However, this spread compression has been substantially mitigated, as we have reduced the spread on our cost to funds by 50 basis points over the last 12 months. And as a floating rate lender, we benefit from the rise in LIBOR, which has increased by 103 basis points during the same 12-month period.

During the third quarter, we continued to diversify the company's portfolio by investing in CMBS, where we see attractive investment opportunities that offer duration. At September 30, 2018, our $395 million CMBS portfolio at par was comprised of $218 million of floating rate bonds and $177 million of fixed-rate bonds, which we have hedged.

During the third quarter, we acquired $48 million in face amount of CMBS bonds. Similar to the loan asset class, CMBS yields have compressed while we continue to selectively invest and remain focused on credit quality, we have also been presented with opportunities to sell and have done so opportunistically to realize quality gains on our CMBS investments.

Based on loan commitments and CMBS investments closed through September 30 of 2018, plus the company's current pipeline, we expect total volume for 2018 to exceed our 2017 guidance of $1 billion, which we provided in March of this year during our fourth quarter 2017 earnings call.

Following the end of the quarter, we improved the terms of our asset level financings through a new warehouse facility with J.P.Morgan. This provides several benefits for the company, not only is the new facility structured with attractive terms and flexibility but J.P. Morgan is another firm that is also highly regarded for its CLO structuring and market execution capabilities. As CLO financing is an important and attractive financing source for the company, we are pleased to add another highly regarded financing and structuring partner.

Finally, turning to the strategic plan. We have concluded that for one of our remaining assets, a longer holding period and an additional funding commitment will be advisable over the next few quarters in order to maximize proceeds.

The delay in exiting this investment is unfortunate. However, we believe this path is the best course of action to maximize proceeds, and we will therefore pursue this path accordingly.

We are pleased with the continued progress and growth of core earnings and book value this quarter, and look forward to discussing future progress in the quarters to come.

With that, I'd like to turn it over to Dave Bryant to discuss our financials.

Thank you, Matt. Good morning. Our GAAP net income allocable to common shares for the 3 months ended September 30, 2018, was $6 million or $0.19 per share.

Core earnings for Q3 2018 was $5.2 million or $0.17 per common share and adjusted core earnings were $7.6 million or $0.24 per common share.

We saw a growth of $1 million or approximately 8% in our net interest income for Q3 2018 as compared to the second quarter of 2018 and had an increase of $4.4 million or approximately 43% over the third quarter of 2017.

Free items are driving these increases in interest income. First is the incremental net asset growth in our core investment platform. The net growth in the par value of core earning assets was $347 million or 22%, and $422 million or 28% for the 9 months and trailing 12 months ended September 30, 2018, respectively.

As of September 30, 2018, match funded and floating rate CRE and CMBS assets at par comprise 89% of the core investment portfolio, totaling $1.9 billion. Second is the lowering of our cost of capital on our asset base and corporate financing. Although, we have seen a decrease in the spread on our self-originated CRE loans from 419 basis points for the third quarter of 2017 to 343 basis points during Q3 '18, a decline of a 76 basis points. At the same time, as Matt indicated, we have seen LIBOR increase 103 basis points. Concurrently, we have improved our financing spread from 212 basis points at September 30, 2017, as compared to 162 basis points at September 30, 2018, a decrease of 50 basis points. This decrease is a result of several factors: one, the cost-effective issuance of our 2017 and 2018 CLOs; two, the unwinding of our 2015 CLOs and payoff of related outstanding borrowings with higher cost; and three, negotiating lower interest rates on our CRE warehouse facilities; third, is the accretive benefit to equity from rising LIBOR on our floating rate, core CRE credit investments. In fact, we estimate that if LIBOR were to increase prospectively by 100 basis points. Our annual core earnings would also increase by approximately $6 million per year or $0.19 per share.

Our net income for the third quarter of $0.19 per common share includes several noncore adjustments that resulted from the implementation of the strategic plan, an annual reserve -- I'm sorry, an incremental reserve of $1.6 million on a legacy CRE loan held for sale.

Other income of $400,000 from noncore assets and net income of $400,000 from discontinued operations. These noncore adjustments net to a loss of $800,000 or $0.03 per share this quarter.

Core earnings for the 3 months ended September 30, 2018 were $0.17 per share. After adjusting for a realized loss on a 2013 vintage commercial real estate loan that was impaired and reserved for during Q4 2016, our adjusted core earnings for Q3 2018 were $0.24 per share. The transformation and simplification of our balance sheet has yielded increased core net interest income, lowered operating costs and continues to benefit our common shareholders.

Our GAAP debt-to-equity ratio rose to 2.5x from 2.4x at June 30. The increase in leverage ratio results from a net increase of $103 million on our asset level borrowings offset by a net increase on our equities of $4 million.

We now have total warehouse capacity of over $900 million on our commercial real estate term facilities including the new facility we closed in October.

During Q3 2018, we redeemed both of our CLO issuances from 2015, which was essentially cash neutral after certain loans paid off in due course. We targeted online and recycling of capital from our existing CLOs, as a key component of our financing and reinvestment strategy, the liquidation of these vintage CLOs enabled us to efficiently recycle capital via natural loan payoffs. Secondly, financing of return on collateral on our existing term to release. And third, with respect to legacy loans selling assets in accordance with our strategic plan. In each case, we have utilized recycled capital to either invest in our core investment portfolio or reduced our corporate cost of capital, such as the redemption of our preferred stock earlier this year. As we look forward to the fourth quarter of 2018, our 6% convertible senior notes mature in early December, and we plan to pay these off with available liquidity. The payoff of the 6% convertible senior notes will eliminate $4.2 million of cash interest expense or approximately $0.13 per share a year, beginning in 2019.

With that, I'll turn the call back to Bob for any final comments.

This is Andrew Farkas. Bob, you don't mind, I'm going to hijack this for just 1 minute or 2.

I'm sorry?

Chairman's prerogative.

Thank you. So I just want to point out that this story is a story of promises kept. Several years ago when we entered this as a new manager, we made a series of representations with regards to specific plans that we had to right size this enterprise, return it to focus on commercial real estate lending, terminate various different types of businesses that were not core to what it was and the business must be doing, and basically take that capital and redeploy it to both growth our book value and earnings. Every single one of those steps has been properly and successfully implemented. The growth in earnings has taken place. The improvement of book value has taken place. I expect to continue to see our implementation of this program as we go forward. I'd like to commend my team for the work they have done and the success that they've had.

And with that now, Bob, I will turn it back to you.

Thanks, Andrew. And Dave, thanks to you as well. Just a couple of takeaways just to reiterate what Andrew said, we're on track to achieve what we laid out to do 2 years ago. Growth for the core investment portfolio has led to an acceleration in adjusted core earnings to $0.24 per share for this quarter. And the dividend is followed by increasing for 3 consecutive quarters to $0.175 per share that we'll be recommending to the board for approval in the fourth quarter. We look forward to updating all of you on the continued progress and discussing the results of our investment efforts on future calls and/or meetings we may have with you.

With that, I'll ask the operator to open up to any calls or questions you might have.

(Operator Instructions) Our first question comes from Ben Zucker with BTIG.

Congrats on the dividend raise. I imagine it's easier to deploy proceeds in capital into the CMBS business and that certainly helps reduce immediate cash drags. But I'm just curious where are you seeing the best incremental relative returns in the market right now between the senior bridge loan product and CMBS? And could you also follow up with providing some color on the type of CMBS investments you made in 3Q '18?

Yes, I think there's -- we see tremendous value in the transitional lending business. As you know what we've been focusing on is likely transitional loans. We think the market for that remains robust, we think the ability to finance those both in the capital markets and with the warehouse providers is good today. As it relates to CMBS, what we've been focused on really revolves around -- we bought a fair amount of Freddie Mac bonds supported to the guarantee portion, so the Bs and Cs in the Freddie bonds. We've also bought a number of single-asset, single-borrower deals where we see value. So I think we've been pretty well focused at, what would you say, 75-25, plus or minus, whole loans-CMBS for the year. And my expectation is the balance may shift plus or minus 5 points one way or the other, but that's pretty much the tax intake.

And that seems to be in keeping with, I think, the equity allocation model you guys presented earlier in the year? Talking about CRE loan origination volumes, they've steadily increased throughout the year, which is always nice to see. What does that market feel like right now? Have you seen any change in recent borrower behavior now that rates are a bit higher? We've also heard a peer say that spreads might be starting to bottom out in some of their markets, and I'm wondering if you are seeing that too?

I think there is a little bit of natural floor on origination spreads, just given where the capital markets financing alternatives are, both from warehouse providers and from the CLO market. That said, the market remains competitive, although I think we've been able to leverage the C-III platform to enhance the legacy Exantas origination capability, which is the reason why we've been able to grow volume quarter-over-quarter. I think we're -- we feel pretty good as to where we stand. Our expectation is that our capture rate will continue to increase. But as you know, the market remains a pretty competitive market.

That's definitely helpful. And I guess lastly for me. Can you talk about that legacy CRE loan that you cited in your prepared remarks? I think you mentioned that you're investing or advancing more proceeds to the borrower, any color you could give would be great around that specific asset? What kind of property, the borrower property type, the business plan going on there, timeline to resolution? Just any kind of insight would be helpful.

Yes, it's more of an operational and capital investment in order to advance the asset to the point where we think we can realize the best resolution, obviously we're in the process of working through that, so giving real specifics is a challenge at this point in time. But we've evaluated a variety of paths, and we feel as though a little bit of operational capital into the asset is the most prudent thing to maximize the recovery.

Appreciate that. Well, that's it for me guys. Andrew, I hear you on your story about promises kept. And Dave, thanks for including the interest-rate sensitivity to higher LIBOR. I believe that's the first time you guys have provided that, and it's definitely a helpful stat. So thank you, both.

You're welcome, Ben.

Our next question comes from Stephen Laws with Raymond James.

Echoing Ben's comments, congratulations on an another dividend increase. Following up, Matt, on the legacy assets identified as part of the strategic plan, any -- I may have missed this, but can you quantify the loan that you've been discussing versus the other assets that are identified and maybe looking at the other basket, how should we think about timeline or resolution? I know some of the stuff may have a longer life, but what are your thoughts on the remaining assets?

Sure. If you refer to Schedule III in the press release, you'll get a little bit of a breakdown of it. We've discussed the $28.3 million, which are a couple of other loans that we continue to work through. We expect them to resolve themselves over the next couple of quarters, potentially one of them in short order. And then the balance of them are just some cash, et cetera, that resolve in one of the legacy businesses and then the loan that we've spoken about. So I think we're down really to quite a small component of the aggregate capital, starting at close to $0.5 billion and south of $50 million at this point in time. But I would expect, it'll take a couple of quarters to resolve the balance of them and get that down to zero.

Great. Yes, certainly a lot of progress having addressed 95% of it over the last 2 years. When we look at the investment portfolio seeing good origination volumes, can you talk a little bit about the sourcing for those? Are these repeat borrowers? Or what's driving the sourcing there? And then as a follow-up, are there any other asset classes, such as net lease or anything else that you've identified as part of your core investment strategy going forward? But have yet to really make any investments there that we should think about as we look to next year?

So in terms of lending, I would say that a fair amount of our business does derive from the customers, both on the intermediary side as well on the sponsor side. We've also made a number of our traditional C-III clients, clients of Exantas, on a go-forward basis. As it relates to the different product types away from the traditional -- slightly transitional first mortgage lending as well as CMBS, we have -- we've got a preferred equity deal, we have more kind of on the horizon. We've done mezzanine deals and we need to look at those. As you mentioned, we have identified net lease, I think for all the net-leased opportunities that we've seen over the last quarter, we weren't comfortable with the return profile of those investments, that's not to say we don't continually evaluate that. I think that will be a product over time that we add to the arsenal. But to date, we've not seen an opportunity that meets our return expectations given the inherent risk of the product.

Great, I appreciate the color on that. My last question is just really seasonality, as we look to -- either the -- both the election and year-end with regards to originations and repayments, is there any seasonality we should think about, as we look at our model, people trying to originate loans prior to year-end or pushing off decisions until post-election or anything like that we need to consider?

Well, I don't know that we can speak directly to the impact of the election. Traditionally, the fourth quarter has been a strong one and our existing pipeline is representative of that trend. We do expect to see continued strong origination volume into the quarter. And as mentioned in our comments, it would be our expectation that we would maintain strong originations and that the repayment profile embedded in our existing portfolio will wane over the next year, relative to what we've seen over the last 12 months, which would allow us in the aggregate to continue to achieve aggregate net deployment for the portfolio and that's really the primary contributor to what we anticipate to be continued core earnings growth.

(Operator Instructions) Our next question comes from Jade Rahmani with KBW.

This is actually Ryan Tomasello on for Jade. Just in terms of the $245 million of originations in the quarter, maybe you can just give us a bit of color in terms -- and the types of those loans, maybe the property type, size and geography. And then as a follow-up to that what property types and markets you currently see as most attractive areas to lend?

Sure. So the $245 million for the quarter were -- it was 11 separate loans, so the average was about $22 million. There's a bit of range there in terms of actual deal size. But on average, it was about $22 million, 54% of them were multifamily, 7 of the 11 deals were multifamily. And then we saw a smattering in hospitality, office, et cetera, to round that out. So a little bit more diversity than the existing portfolio. As you know, we've been substantially weighted toward multifamily and while it continues to be a large representation, we did pick up a little bit of incremental diversity this quarter.

And in terms of the repayments in the quarter, can you say or quantify, what amount of those represented early prepayments rather than scheduled maturities? And then as a follow-up to that, one of the comments we've heard from some other players in the market is existing borrowers were requesting greater proceeds or a lower cost on existing loans given the amount of competition in liquidity in this space, was wondering if you've seen that at all in your portfolio?

I have to confess on the repayments for the quarter, whether or not they were specific maturities or expedited prepayment, I just don't know offhand, it's something that we can take a look at.

Okay, that's fine. And then just in terms of the follow-up, if you're seeing any borrowers come to you in advance of maturity of a loan and requesting either greater proceeds or a lower spread on the loan, just given the amount of competition for refinancings in the space?

It's not so much coming to you before maturity, it's really coming to you after the expiration of the call protection of the loan. And I would say -- and this is a little bit of a generalization, borrowers like tighter spreads and more proceeds, and commercial real estate owner operators are not shy about asking for this. So if the market opportunity exists for refinancing at a lower spread away, we will likely get that inquiry and have the ability either to do it ourselves or decide that the price is too dear for us to do that.

Yes, that's good color. Sorry, go ahead.

No, that's it.

And just one more, if I can. In terms of the reenvironment, just given the forecast and rate increases from the Fed over the next year that the market is anticipating, maybe you can say what level of LIBOR you expect rates to start actually impacting these borrower business trends? And if you require your borrowers to purchase interest rate caps on their loans.

All of our loans have interest rate caps, we do. I don't think that the rate increases that are talked about over the course of the next 12 months are going to have a dramatic impact on borrower activity. What rate volatility tends to do often times because it makes borrowers to lock rates. So it affects the fixed rate market more than it affects the floating rate market, because when you have a light transitional or even a moderate transitional business plan, the idea of locking in fixed rates financing before the value add has been completed, is not consistent with the business plan of these borrowers. So the borrowers were looking at value-add type transactions almost definitionally need to borrow floating rate. And I'm old, and I've been around long enough to know that when rates were not -- you only need a 9% to make a deal work and if you can only get a single-digit mortgage rate, you could make yield. Rates -- if you look historically, rates are still pretty darn low. So if LIBOR goes up 25, 50, 75 basis points, will it have some impact? Yes, it will have some impact. Do we think it will have a dramatic impact on our business? I tend to think not.

I'm not showing any further questions at this time. I would now like to turn the call over to Andrew Farkas for any further remarks.

Thanks, everybody, for calling in. We hope to continue to provide this type of news as we continue to move forward. We are optimistic about this business plan. We're optimistic about the enterprise. And we have no reason to believe, we will not continue to deliver the kinds of results you've come to expect from us. Thanks for taking the time. Again, thanks to the crew here, who've done such a great job, and we'll talk to you next quarter.

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