STORE Capital Corp (STOR) 2015 Q3 法說會逐字稿

Good day and welcome to the STORE Capital third-quarter 2015 earnings conference call.

(Operator Instructions)

Please note, this event is begin recorded. I would now like to turn the conference over to Moira Conlon, Investor Relations for STORE Capital. Please go ahead.

Thank you Kari. And welcome to all of you who have joined us for today's call to discuss STORE Capital's third-quarter 2015 financial results. Our earnings release, which we issued this morning along with a packet of supplemental information is available on our investor website at ir.storecapital.com under news and market data quarterly results.

I am here today with Chris Volk, President and Chief Executive Officer of STORE Capital; Cathy Long, Chief Financial Officer, and Mary Fedewa, Executive Vice President of Acquisitions. On today's call management will provide prepared remarks and then we will open the call up to your questions.

Before we begin, I would like to remind you that comments on today's call will include forward-looking statements. Forward-looking statements can be identified by the use of the words such as estimate, anticipate, expect, believe, and intend, may, will, should, seek, approximate, or plan or the negative of these words and purchases, or similar words and phrases.

Forward-looking statements by their nature involve estimates, projections, goals, forecasts and assumptions, and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in our forward-looking statements. These forward-looking statements speak only as of the date of this conference call. And should not be relied up as predictions of future events.

STORE Capital expressly disclaims any obligation or undertaking to update or revise any forward-looking statements made today, to reflect any change in STORE Capital's expectations, with regard thereto, or any other changes in events, conditions, or circumstances around any such statement is based. Except as required by law. Please refer to our SEC filings on our investor relations website for additional information.

With that I would now like to turn the call over to Chris Volk. Chris, please go ahead.

Thanks Mora. And good morning everyone. And welcome to STORE Capital's third-quarter 2015 earnings call. With me today are Cathy Long, our CFO and Mary Fedewa, our Executive Vice President of Acquisitions.

As you've all seen from our press-release today, 2015 is taking shape to realize operating results well-above our initial expectations. A year ago today, as we were preparing to introduce our company to the public equity markets, we felt we could commit to 2015 investment activity, net of any asset sales, of approximately $750 million. Over the past year we have steadily raised this amount. And today believe we will close out the year with a record net annual investment activity approximating $1.1 billion.

We believed that we would be able to realize an average lease rate of approximately 8%. And we will do this. We believe that our average fixed-rate term borrowings cost, a new term debt this year would be 5%. And we will realize weighted average borrowing costs materially less. With some of the best investments spreads in the 35 year history of our leadership team.

Vacancies and property management costs that we initially budgeted for have come in lower than we estimated. Operating costs have come in approximately what we initially expected. But the most meaningful variance for the year has been the timing of our investment activity.

Record investment activity in the second quarter, increased to predicted weighted-days outstanding of 2015 investments. We added to this with a positive variance in the third quarter. With record third-quarter investment activity. Again, more heavily weighted to the front half of the quarter than we expected.

Altogether, these investments, financing and operational achievements have allowed us to steadily raise our guidance for AFFO per share. Initial guidance of $1.33 to $1.39 in March this year, was gradually raised to a range of $1.38 to $1.42 last quarter. And that increase guidance, together with our outlook on 2016, let our board to approve an 8% dividend increase, which was paid in October. Today, with about a month and a half remaining in 2015, we're happy to announce a meaningful increase for our 2015 AFFO guidance to $1.45 and $1.47 per share.

In the third quarter, we generated approximately $263 million worth of investments, which in turn, set a new record of nearly $950 million of investments for the first nine months of the year. For the year, about 30% of the investments we have made in profit center real estate, have been with the existing STORE customers.

During the third quarter, our average investment transaction continued to approximate $8 million, with 32 transactions. And very importantly, we added 14 new customers, concluding the quarter with a total of 288 customers, providing our shareholders with an extremely granular portfolio of net leased assets.

Most important of all, is what this signifies. STORE has absolutely struck a cord with our target customer base providing needed long-term capital solutions that are a clear improvement to our customer's alternatives. By the end of 2015, we will have organically grown our portfolio to about $4 billion. And we will get there by filling capital needs from our large and growing customer base for efficient long-term capital solutions.

In the process, we will have created a diversified portfolio of predominantly investment-grade net lease contracts, backed by a portfolio of profit center real estate that today is delivering for both our shareholders and customers in equal measure.

So here are a few statistics for the first quarter. Our weighted average lease rate for investments made during the third quarter stood at just over 7.8%. Year-to-date the weighted average lease rate for 2015 stands at about 8.15%. The average annual contractual lease escalation on our new investments approximated 1.8%.

The weighted average primary lease term for our new investments was approximately 17 years. The median new investment tenant credit rating profile was BA1. The median new investment contract rating which is our STORE score was A1.

Our average new investment was made approximately 92% of replacement cost. 78% of the multi-unit investments we made during the quarter were subject to master leases. And finally, all the assets we acquired during the quarter will deliver us unit level financial statements.

All together, our portfolio performance during the third quarter was strong. And we closed the quarter with an occupancy rate of 99.8%. Earlier in the year we experience five vacancies from a single for-profit college tenant.

As of today, those vacancies have planned resolutions with our recent agreement to sell the last remaining property. In the end, we will have sold three of the five asset the leased the remaining two. And all five by the way, will continue to be uses education facilities.

In total, the recovery rate will be almost 90%. This is a nice result, but it's also important to keep in mind our gains on select property sales through the third quarter, averaged 10% after transaction costs. You should think of this as a negative default rate, or an added form of recovery that virtually eliminates losses arising from our five-store vacancy.

With the five locations resolved, vacancies at the end of the third quarter were nominal. Always keep in mind that vacancies are a part of the business we're in. We budgeted for them at the beginning of this year, and concluded the third quarter modestly under budget.

Cathy Long will provide you with our initial guidance for 2016, which will also presume a level of tenant non-performance. As always, what is important to us is building a portfolio having margin for error. The ability to realize margins for error in embedded in lease rates, generally in excess of the auction marketplace, portfolio centered in contracts we deem to be investment grade, assets purchased for less than their cost to replace, assets having rent per square foot supported by the local marketplace, and an extremely high level of portfolio diversity.

You will see from our supplemental disclosure on our website that the health of our overall portfolio continues to be very sound. The median tenant credit risk remained at about BA1, and we deem approximately three fourths of our contracts to be of investment grade quality.

Turning to our financial position, we concluded the quarter with a run rate funded debt to EBITDA of 6.3 times. While having accumulated more than $1.35 billion in unencumbered assets, or approximately 35% of our under appreciated balance sheet. The expansion of our pool of unencumbered assets led us to the implementation of an unsecured credit line just over a year ago.

Then, during this past quarter, we modified, extended, reduced the cost of, an increase the availability on that line of credit with the help of the of our bank syndicate. Part of the modification was designed to enable us to issue unsecured term note offerings, should we elect to do so.

With the credit facility enhancements complete, we pursuer an investment grade corporate credit rating. Today's we announced that STORE has received a BBB minus credit rating from Fitch Ratings. This makes STORE amongst the very few equity REITS today, that have both a highly rated debt conduit, while also being, in our own right an investment grade company. Having done this, we will proceed with an inaugural private placement issuance of unsecured term notes that might be complete as soon as the fourth quarter.

Here, it is important to give in mind the aim. We remain committed to our an initial master funding ABS strategy, which has been a consistent supplier of flexible and attractively priced borrowings, since we pioneered the strategy 2005. The use of unsecured term borrowings, if completed via initial private placement offering, may not realize at the outset savings to our current A plus rated conduit.

However, we do expect that having two sources of investment-grade term borrowings will ultimately reduce our cost to capital. While also providing important term borrowing diversity. So, our expected forthcoming unsecured term note issuance will be an important start down this path, and towards a complementary commitment to an unsecured term debt borrowing strategy, that will serve to greatly benefit our shareholders and customers.

As I stated on our last quarterly conference call, STORES leverage and level of unencumbered assets are highly favorable, relative to our more than 20 year history of running public REITS. Likewise, our investment spreads this year have been the highest, our contractual profile lease escalations are the highest, our portfolio diversity is the highest, and our dividend payout ratio the lowest, relative to anytime in our past. Add this to the opportunities we see for new investments, and we could really not be more excited about the growth path ahead of us.

Now on that growth note, I'd like to turn the call over to Mary Fedewa.

Thank you Chris, and good morning everyone. As Chris mentioned, we had another strong quarter in acquisitions, resulting from working directly with our customers, creating long-term contracts, focusing on master leases with annual escalations. And I am pleased to report that the momentum we've experienced this entire year, has extended into the fourth quarter. Including what we expect to close today, we have funded slightly over $1 billion in growth acquisitions year to date.

As Chris mentioned, our lease rates for the third quarter was over 7.8%. As we've said before, this is a flow business, and the lease rates can fluctuate on a quarterly basis. We still expect an overall 8% average lease rate for 2015.

The properties we've acquired since September 30, and the properties currently in our closing pipeline, continue to meet our investment criteria. They are predominantly in service industries with strong STORE scores, that are consistent with investment-grade tenants.

Now turning to the market. During the third quarter, cap rate compression continued in the marketplace. However, STORE's cap rate spread over the marketplace, remained consistent. Driven primarily by our direct origination approach, and our ability to provide innovative solutions to our customers.

Our pipeline of investment opportunities remains robust. As we continue to focus on generating organic growth through our brick by brick approach. We're excited about the final two months of 2015, and look forward to another year of strong growth ahead in 2016.

With that, I will turn the call to Cathy to talk about operating results and 2016 guidance.

Thank you Mary. I'll begin my remarks today with an overview of the result of our third quarter ended September 30, 2015. Next, I will discuss our balance sheet and capital structure. Followed by a discussion of our updated guidance for 2015, and the guidance we introduced today for 2016. Unless otherwise noted, all comparisons refer to year-over-year periods.

So starting with the income statement, total revenues increased 47% to $74.8 million for the quarter. Primarily attributable to our continued portfolio growth, which generated additional rental revenues and interest income. This also marks an increase of 9% from last quarter's revenues of $68.9 million.

As I have stated on previous calls, the timing of acquisitions during the year can have a meaningful impact on our results of operations for that year. Our record level of acquisitions volume for the first nine months of this year, has driven us to outperform our revenue projections. Allowing us to increase the 2015 guidance that Chris mentioned earlier on this call.

By the end of our third quarter this year, we have grown our portfolio to $3.7 billion. Representing 1246 property locations, up from $2.5 billion in gross investment amount, representing 850 property locations at September 30 a year ago. This is a 47% net increase in the size of our portfolio in the past 12 months. And a 33% increase in the size of our portfolio since the beginning of this year. Our portfolios base rent and interest on an annualized basis, was approximately $312 million at September 30, as compared to an annualized $238 million on the portfolio that was in place at the beginning of the year.

As Chris discussed, the weighted average going in lease rate for real estate investments acquired during the third quarter, was just over 7.8%. Slightly lower than the 8% weighted-average rate we expect for the year. Total expenses for the third quarter increased 30% to $52.4 million. Compared to $40.2 million a year ago.

Again, most of the expense increase relates to the growth of the portfolio, with more than half of the increase in total expenses due to higher depreciation and amortization expense during the quarter. Interest expense increased about 12%, to $21.4 million for the quarter. From $19.1 million a year ago, primarily due to an increase in long-term borrowings used to partially fund the acquisition of properties added to our portfolio.

The long term debt we've added in the past 12 months includes the April 2015 issuance of $365 million of STORE Master Funding, A plus rated net leased mortgage notes, which we reported earlier this year, and a minor amount of traditional mortgage debt. Interest expense was also impacted by lower weighted average interest rate on both our long-term debt and our credit facility in 2015, as compared to 2014.

Property costs increased to $471,000 for the third quarter of 2015. At the end of our third quarter we had very few properties that were not under lease. And we have no scheduled lease maturities through the end of next year. While we do expect to incur some property-level costs from time to time, when we have vacant or underperforming properties, we don't expect property costs to be significant.

G&A expenses increased to just over $7 million for the quarter, from $5 million a year ago. Primarily due to the growth of our portfolio and related staff additions, along with the increased cost associated with being a public company, since our IPO a year ago this month.

As we continue to grow, we focus on managing our costs. Despite the addition of the regulatory and governance costs associated with being a public company, G&A expense, as a percentage of portfolio assets decreased slightly from last year. Net income increased to $23 million for the quarter, or $0.18 per basic and diluted share. Compared to $10.8 million or $0.13 per basic and diluted share for the year ago period.

The increase in net income was primarily driven by the additional rental revenues and interest income, generated by the growth in our real estate investment portfolio. Our net income for the third quarter also included a gain of about $700,000 on the sale of three properties. In comparison, net income for the third quarter of 2014 included a gain of about $100,000 on the sale of two properties.

AFFO increased by 66%, to $48.6 million, or $0.38 per basic and diluted share. Compared to AFFO of $29.3 million, or $0.35 per basic and diluted share in the third quarter of last year. This is also a 14% increase from last quarter's AFFO of $42.8 million, or $0.36 per basic and diluted share, which highlights our consistent sequential growth.

Again, the increase in AFFO was primarily driven by the revenue generated by our portfolio growth. Partially offset by the increase in the interest expense related to borrowings associated with the acquisition volume. And the higher operating expense to support our growth.

For the third quarter of 2015, we declared a regular quarterly cash dividend of $0.27 per common share to our stockholders on AFFO per share of $0.38. Our low dividend payout ratio provides a level of free cash flow that can be used for additional real estate acquisitions. The third quarter dividend was paid on October 15, and on an annualized basis represents $1.08 per common share. An increase of 8% over our previous annualized dividend.

Now, I will provide an update on the balance sheet and capital structure. Towards the end of the third quarter, we expanded our unsecured credit facility from $300 million to $400 million. And increased the accordion feature from $200 million to $400 million. For a total maximum borrowing capacity of $800 million.

The amended credit facility now matures in September 2019. And includes a one-year extension option, subject to certain conditions. As of September 30 we had $192 million of borrowings outstanding on this credit facility. Along with a pool of unencumbered assets aggregating over $1.3 billion.

As we previously reported, the credit facility bears interest at a rate that varies depending on our overall leverage level. Based on our leverage ratio in effect as of September 30, 2015, the rate on our credit facility was one month LIBOR plus 1.35%.

Our total debt outstanding at September 30, was $1.83 billion. We measure leverage using the ratio of adjusted debt to EBITDA. Because of our high rate of growth, we look at this ratio on a run rate basis. Using estimated run rate EBITDA. Based on our real estate portfolio of $3.7 billion at September 30, we estimate that our leverage ratio on a run rate adjusted debt to EBITDA basis, was approximately 6.3 times.

Going into the fourth quarter, we had unrestricted cash and cash equivalents on our balance sheet totaling $29 million. And over $200 million available on our unsecured credit facility.

As Chris mentioned, with our newly announced investment grade rating, we could expect to issue our first privately placed senior unsecured notes as early as the fourth quarter. The proceeds of which, would be used to pay down the amounts then outstanding on our credit facility.

At that point, virtually all of our borrowings would consist of long-term fixed rate debt, with [well-laddered] maturities. This is consistent with our aim to minimize our exposure to floating-rate debt, by minimizing the time between acquisition of our real estate, and the ultimate financing of the real estate with long term fixed rate debit. Thereby locking in the spread for as long as is economically feasible.

Now turning to our guidance for 2015, as Chris discussed, we are raising and narrowing our AFFO per share guidance from our previous range of $1.38 to $1.42, to a new range of $1.45 to $1 47. We're increasing our acquisition volume guidance to $1.1 billion. And I should point out that this is our volume expectation, net of anticipated property sales. Including sales totaling $32 million in original acquisition cost completed so far this year through yesterday.

We still expect our weighted average cap rate on new acquisitions to be at about 8% for the year. And regarding leverage, we continue to target a run rate debt to EBITDA level of between 6 and 7 times. And G&A costs are expected to be between $29 million and $30 million for 2015. Including commissions and non-cash equity compensation. As we have mentioned before, we expect G&A costs, as a percentage of our portfolio assets, to trend lower over time due to our scalable platform.

Now turning to our guidance for 2016, we currently expect 2016 AFFO per share of $1.59 to $1.63, based on projected annual real estate acquisition volume of approximately $750 million. As we have seen so far in 2015, AFFO per share, in any period, is particularly sensitive to the timing of acquisitions during that period. The timing of acquisitions for 2016 is expected to be spread throughout the year, though weighted towards the end of each quarter.

Our AFFO guidance is based on a weighted average cap rate on new acquisitions of 7.75%. Our AFFO per share guidance for 2016 equates to anticipated net income of $0.74 to $0.77 per share. Plus $0.76 to $0.77 per share of expected real estate depreciation and amortization. Plus, approximately $0.$0.09 per share related to non-cash items and real estate transaction costs.

We continue to target a run rate fund to debt to EBITDA ratio in the range of 6 to7 times, or roughly 45% to 50% leverage on the gross cost of our portfolio. Interest cost on new long-term debt for 2016, is estimated based on a weighted average interest rate of 5%. And finally, G&A costs are expected to be between $32 million and $34 million for 2016, including commissions and non-cash equity compensation.

This concludes my prepared remarks. I will now turn the call back to Chris.

Thank you Cathy. I have a few remarks to make before turning this call over to questions.

First, as always I invite you to tour our website and download our packet of supplemental information, which contains market-leading portfolio disclosure. Second, upon introducing STORE into the public equity markets a year ago, we're bringing for a terrific growth company that just happens to also be a REIT. For STORE, the major portion of our growth, will be delivered from external growth, which is the ability to realize AFFO per share accretion, through new investments that are enabled by new equity issuances.

Having seen the power of external growth over the past 30 years, we have high confidence in this dependability. What 2015 has demonstrated is, the power of accelerated investment timing, which has contributed materially to our REIT AFFO per share guidance for the year.

With our revised guidance today, the bottom end of our 2015 AFFO per share range increased approximately 5%. And the top end of the range increased by 3.5%, which is a percentage change not far off from the annual AFFO per share growth rates for many REITs.

As we look to 2016, the level of growth we realize will likewise be dependent upon the amount of our investment activities that can be accelerated to have an impact on 2016 versus 2017. But either way, external growth is a powerful and dependable force, as we've seen over many years.

Now, at STORE we've compounded this external growth with the best internal growth prospects of any net lease REIT we've ever run. Our average annual contractual lease escalation approximates 1.7%, which is the highest of any company we've ever operated. And likely stands amongst the highest of any net lease REIT.

At the same time with a dividend at $0.27 per quarter, our payout ratio today, stands at under 74%. Relative to the 2000 midpoint AFFO guidance. And at approximately 67% of our 2016 midpoint AFFO guidance. This is amongst the lowest dividend payout ratios of any net lease REIT. And is the lowest pay-out that we've ever experienced since we first introduced our first public net lease company in 1994.

We estimate that combining the ability to reinvest surplus cash, with favorable tenant lease escalations improves internal AFFO per share growth prospects to between 3% and 4% annually. As we have often stated, there can be no better tonic for uncertain interest rate times then growth and a well-protected dividend.

And with that, I would like to turn the call over to the operator for any questions.

(Operator Instructions)

Vikram Malhotra, Morgan Stanley.

Hi, guys, this is Landon on for Vikram. Congrats on the quarter and 2016 outlook. I just wanted to ask about the new debt rating, and maybe how that figures into your thought process as, previously, you guys had indicated that the master funding conduit was pretty much sufficient for your needs. And maybe how you expect the trade-off between those two sources to trend going forward.

Sure, Landon. This is Chris and I will start. I should also introduce -- or say that I'm surrounded by the full leadership -- the full complement of our senior leadership team. So if questions are moved to other people that will be great. We decided that, given the level of unencumbered assets that we had, we had an opportunity to have a level of financial diversity that we didn't have before. So we have -- we, obviously, love and are very attached to STORE Master Funding. We're one of the few net lease REITS, or any type of REIT that has multiple sources -- and certainly, in net lease space, multiple sources of debt for the kinds of product that we do. And so, whereas it's very easy to become very dependent on the unsecured market as your sole vehicle, we have been able to show that the ABS space is really good and offers us a lot of the same flexibility that we would have in the unsecured debt side.

By the same token, the ABS space, in terms of numbers, it's just not as big as the unsecured debt market. So, what we're doing is basically broadening our scope to include complementary unsecured offerings so that we can basically jointly access both these marketplaces -- the ABS market being one such market place, where we are a very seasoned issuer, and then the unsecured marketplace being a place where the sheer amount of volume is much greater and the level of efficiency is extremely high. And, together, I think both of those will serve to give us both capital flexibility and ability to have extremely prudent leverage strategies. And, at the same time, be able to lower our cost to capital relative to many companies.

Okay. And is it safe to assume that the initial pricing will be relatively close between the two sources going forward? The unsecured maybe then to become a more attractive from the pricing standpoint?

Yes, I would say initially -- it's too early to say exactly where our -- I don't want to predict today on the phone, where our initial unsecured debt transaction is going to come in at. It wouldn't be appropriate to do that. But I would say that, if it comes in higher than the ABS market, that's feasible. So, this is not a contest. So we are not sitting there trying to bench one off the other per se. But I can say, over time, it bears note that the unsecured debt market's very efficient. So, for example, if you look at a realty income who has a BBB+ rating, their rating is essentially three notches south of our A+ rating on the ABS side. And yet the cost of debt they issue on BBB+ unsecured is well inside of the ABS marketplace. So, the unsecured marketplace is complementary and just highly efficient, because it's so liquid.

Okay. And will you guys be pursuing a second rating from one of the other agencies?

I think over time that would be expected, yes.

Okay. But no timeline on that or when you plan to (multiple speakers)?

No timeline for that.

Okay. And then, just really quickly on the acquisition front. Just wanted to understand the cap rate guidance for next year. It seems to imply a little bit of -- is it compression or is it mix that's driving that? And maybe what you're seeing in general on that front.

This is Mary. I would say that we have seen some compression, and our spread over the marketplace, as I mentioned, has remained consistent. Our quarter -- third quarter was [7.83%]; it's not a trend, it's just a quarter. But we've seen a quarter in the high [7%s], and I think we want to be prudent in thinking about next year. And I think that you may see cap rates go down a little bit more, and so we want to be -- that's where we think that we -- where it would be prudent for us to be next year.

(Multiple speakers). Great.

Landon, I would say, likewise for the $750 million off of acquisitions. When investors are investing in our stock, as I said in my prepared remarks, external growth is an incredibly dependable mover of AFFO per share. So then the question is, how dependable is it? I think $750 million is dependable. I think for us to sit there and say we'll do a $1.1 billion next year, you can't do it. We don't have visibility, we are in a flow business. And we wouldn't expect to be that aggressive. So, if it's up to Mary, obviously we'll do more than $750 million for next year. We certainly did more than $750 million this year. We will have to just play it by ear. And, the lead time of these transactions is long and the size of these transactions is very small. So it's a very granular, organically driven portfolio that's hard to get a lot of vision on in November, more than a year from the estimate date.

Okay. That's very helpful. I will let others take a whack at it.

Craig Mailman, KeyBanc.

Hi, guys. Maybe just following up on the unsecured debt question there. Chris, your comments about the ABS market and the size. Did you guys recently look to go to the ABS market? And there was something there that you didn't see? Or that you didn't like?

No. What we're doing is -- had we gone to the ABS market, we keep up with it all the time. If we wanted to go to the ABS market, we would've gone and we would've issued debt. So, the ABS market has certainly been open. I don't have to tell you all, you know the marketplace has been sort of choppy relative to the first half of the year. So the second half has been a little bit choppy. But, absolutely, the ABS market has been open. We could have accessed it if we wanted to. This is something we've given a lot of thought to and it's pretty strategic.

And how do you guys weigh the benefits of the master funding, where it's asset recourse versus recourse, and the pricing there versus going unsecured and shifting the recourse onto you guys from the asset level? Versus the savings that you may also get down the line on pricing unsecureds?

Yes, I think --well, first of all, from a strategic perspective, you're going to see us do several things. We have availed ourselves, historically, very little of the CMBS market. But we may do so from time to time, if we have large discrete assets, where we want asset level recourse and we don't want to have corporate recourse. The ABS marketplace is efficient because it gives us 70% leverage to an A rating. And so, the reason we have so much in unencumbered collateral, is because the Company's leveraged less than 50%, but the ABS market allows us to go to 70% to an A+ rating, which is incredible. So it's a very efficient marketplace.

And so then, if you layer on to that and the unsecured credit and you say, well what's the difference between STORE versus, let's say, some company that's just unsecured credit rated? Well if the company's unsecured credit rated and they don't have the ABS market, obviously, they can't ham and egg. They don't have two sources of capital. There's no way for them to refinance their assets, other than the unsecured debt marketplace. So it's important to make that distinction. The second thing is that the ABS market and the unsecured market do not always move in tandem. And, from an efficiency perspective, it is important to make that distinction.

The third is that because the ABS market allows a better leverage and more efficient leverage, then what's feasible for us is still to maintain a slightly higher leverage profile than, let's say a REIT that's solely unsecured. And, therefore, not have to use preferred stock or other very expensive types of leverage to be able to fund ourselves. And, in doing that, we can lower our cost to capital. And yet maintain an incredibly high level of unencumbered assets to unsecured debt coverage ratio. And unencumbered fixed charge coverage ratio relative to anybody else.

So, if you think about it -- if you start doing the math, relative to where we are going to be, relative to other unsecured issuers, because we have master funding, it's a huge complement to the unsecured note issuers. Because it's like lending money to a pool of (inaudible) worth of unencumbered assets, and having a guarantee of $90 million worth of free cash flow, flowing off from master funding, and having massive unencumbered asset coverage relative to a REIT that would have solely an unsecured debt rating.

All right. That's helpful. And then, on guidance, Cathy, can you break down the $0.09 between non-cash G&A transaction costs and whatever other non-cash items may be in there?

Yes, I don't have that with me. But it's predominantly going to be the -- equity comp is probably the main item. And transaction costs will be very small.

Okay. Then, just lastly. Sounds like the pipeline is robust year. Of the $750 million you guys are putting in guidance for next year, how much of that is in the pipe now that just may fall from 2015 into 2016? Versus spec opportunities you guys may need to source?

I would say, today, it is maybe $100 million. But keep in mind that's same as last year. You always have a pipeline, you have some momentum going into the beginning of the year.

Great. Thank you.

Todd Stender, Wells Fargo.

Thanks. Maybe to start with you, Mary, if you don't mind. You talked about investment spreads remaining wide. Is that over a blended cost of capital? Does that include an equity component?

Go ahead, Chris.

At the spread, I was talking about the marketplace cap rate to our cap rate, Todd. That we remain consistent. We're still seeing substantial spread over the market auction marketplace to the cap rate we are able to create through our direct origination model. As you know, as we're calling directly on customers and creating our own contracts, we're getting a premium in the marketplace. And that's the spread I was referring to.

Okay, not over your cost of capital.

Yes, so, Todd, think about it this way. Let's say we are at $775 million, hypothetically. And let's say that your cost of debt is $5 million. Obviously we would like to be higher than $775 million, we'd like to have our cost of debt lower than $5 million. But, you know you can't tell. And everybody is worried about rates moving up. So, I think if I'm you I'm going to model at of 5% debt rate. Why not? So, basically, what you've got then, is you've got a 2.75% spread, right? To your cost of debt.

Now, in addition to that, keep in mind that your lease escalators -- and we didn't give you predictions on lease escalators. But I would tell you that our lease escalators have been incredibly stable since we opened our doors here. So, it's around 1.7%. So, you could basically take the 2.75% spread, and add another 1.75 -- 1.7% on to that for a constant growth formula, to get a gross spread, as it were. And, if you were to assume, hypothetically, a long-run cost of equity capital for equity REIT investors, we should blow through that.

The amount of margin for error we have here is a lot. And it's in everything we do. It's from the way we buy assets at a positive spread, as Cathy -- as Mary mentioned, to the marketplace. It's in terms of buying assets below their replacement cost. And it's in making lease rates and returns, that we hope to exceed our cost to capital. So we don't ever find ourselves being worth less than what we cost to create.

Do you guys provide a spread -- an investment spread over your blended cost of capital? Do you have something that does factor in what you're equity cost was?

Well, look, what I've seen a lot of people do is use AFFO yields for their cost of equity capital. I have never felt my AFFO yields were a cost of equity capital. So, we're booking15-year leases. And our average lease trend this quarter was 17 years. So, if you're asking what my cost of capital is over 17 years, I'm going to go to the entire equity markets over a 17-year period of time, and say, I think it's probably 8. Maybe it's 9. So, you take 9 and 5. And you blend that, and you see what your return is over that. And I think, by the way, every REIT should do that. Because you can't just look at your AFFO yield on any given day.

Great. That's helpful Chris. And how about just -- you gave us the average cap rate for the quarter. How about the range of cap rates? Maybe a low and a high?

I would say the range probably the lowest would be [7.30%] and the highest would be [certain mid-8%s].

Okay. That's helpful. And then, you kind of touched on this, whether maybe new unsecured -- potential new unsecured offering would have a higher coupon than your ABS funded program. At what point do you not do the unsecured? Is there a basis-point spread where you say, all right, let's just stay with our master funding program just based on coupon alone?

I am sure there is. We are going to decide whether we're going to hit that. But, again, what you're going to do -- if we do a private placement deal, we're going to get dinged because it's a private placement deal. If we do our first unsecured deal, you tend to have a first issuance notice -- a first issuance impact. So, when we did our first master funding transaction it came in at [5.95%]. That was in 2012. So interests rates weren't materially different from where they are today.

I don't expect it to be anywhere near that. But just pointing out to you, that today -- obviously for the first part of this year, our cost of master funding was 4.06%. So you have to take the long-run view on the cost of debt capital. And today, when I look at that 5.95% debt, it's great because when it matures I hope I can refinance it for less. So, it's less risky for investors, and we are locking in spreads. What we didn't want to do is load up on floating-rate debt, just to have a bunch of unencumbered assets. So that we could wait around to do an unsecured debt deal. I would rather match funds [stuff] at a rate where I'm giving you an honest phone number that's locked in -- it's locked and loaded, and it's turned out.

And in matched funding would this be closer to a 10-year maturity?

Yes. I mean, what we're going to do is -- when you say -- you can't match fund a REIT. You can't match fund any REIT. And you certainly can't match fund a net lease REIT. Because, even though our lease term this quarter was 17 years, the leases will invariably renew. So, what you're trying to do is match fund your cash flows. Since our payout ratio is pretty low, we are starting to have a pretty large piece of free cash flow every year, which can be effectively used to pay back debt. And then you're buying new assets. And so you're immunizing your cash flows. And you are trying to match fund your cash flow streams. So what we are doing, at this point, is filling in gaps in our maturity schedule so that we are having a good ladder. And that's just what's important to us at this point.

Great. Thanks, Chris. And just finally, most of the REITS across all the property types that we cover are talking about increasing asset sale programs. Your disposition volumes have been fairly modest. You have a really low payout ratio, so a very well-covered dividend. Asset pricing is favorable. How are you looking at asset sales? I guess maybe in the near term? And maybe into next year as you look at your budget?

Well, I mean, in terms of where we are priced today. We are priced at or above where we can sell the asset. So let's say it's a push. It's just not really worth for us to sell a bunch of assets today. I mean, I think it's a long run for a short jump for you guys. And it's not going to do our shareholders the best good. I mean, creating a diversified portfolio has way more value. So, when we're selling off assets, it's going to average 1% to 1.5% of the portfolio every year. And Cathy is giving you the estimates for next year. It's a net number, and we're assuming were going to sell off 1% to 1.5% of the portfolio.

The 1% to 1.5% of the portfolio we sell will be a view on our strategic holdings. And what we would like to keep over the long term. So -- and what we're willing to part with. It's not an effort for us to just maximize gains and flip out assets. It is a very strategic thought process. It happens every single month, at our asset management portfolio meeting and we just go through this stuff.

And as I said on the call earlier, the fact is that we have been generating gains on this because -- which isn't surprising, because we're booking assets, as Mary noted, above the broader auction marketplace. So there is room in there to be able to book some gains. And the gains, we don't get any credit for them from an AFFO perspective. But they are like a negative default rate. And, [as I said], you can get the gains. And so they help to lessen portfolio volatility. And that's how we look at it.

Okay. Thank you.

Sure.

[Ian Gall], SunTrust.

Thank you for taking my question. My first question is, this past quarter you didn't disclose the expected default frequency. Should we expect that to be similar to the prior quarter?

This is Chris. I saw that Vikram -- not Vikram, I saw that [Ketan] had that on his deal this morning. And I was thinking, okay, I am going to get asked this question. So, every quarter we are going to modify our disclosure. And generally we've added disclosure so we haven't reduced disclosure. But when you get into the expected default rate numbers, and you get into the number of 0.87 or some decimal point, it sounds so precise and it just bothered me.

So, when you talk about the percentage of the portfolio that is investment grade, last quarter it showed it was 78% investment grade -- or 78 point something. It might've had a decimal point. And even on the quarterly slides, if you looked at our quarterly investor presentation, I've always said it's approximately three-quarters, or approximately 75% of the portfolio. Because, if you are doing this, when you run the financial statements -- the tenant financial statements through a Moody's RiskCalc, it is incredibly volatile. It can move from quarter to quarter. We have tenants moving in and out of investment-grade ratings, or in and out of from a Ba2 to a Ba1, or a Ba2 to Ba3. And so, I tend to take the long-run approach on this stuff. And I didn't want people to sit there and go, okay this moved down 10 [picks] so should I be worried?

So the answer is, about three-quarters of our portfolio is still investment grade. We had a slight gravitation downward from investment grade status versus last quarter. And most -- a big chunk of that is attributable to the methodology with which we are calculating it. Some, related to a couple of speed bumps that a couple of our customers had. But, those are not speed bumps that we're worried about. So, we are here, three-quarters, and the portfolio is doing fine.

Okay. So it's safe to assume it hasn't materially changed then? Is that correct?

No.

Okay. And then, my second question is, do you have a sense of Oaktree's plans on selling parts of their estate? Either next quarter or next year?

I don't. All I will say to you is that Oaktree will subordinate their need, and they don't really have a need to sell. So they'll subordinate any desire they have to sell -- or thought they had to sell, to our desire to grow, so long as we can grow accretively, which we have certainly been able to do that on an AFFO-per-share basis. So, if you're looking at roughly a 10% AFFO-per-share growth at the midpoint for next year, that's something that I think Oaktree is really encouraged by. I think that, like any other private equity holder, they will look to exit out over time. But I think that they will be incredibly disciplined about it. And they will do it in concert with us. So, after that, I can't give you any guidance.

Okay. Thank you.

Paul Adornato, BMO Capital Markets.

Thanks, good morning. Wanted to ask about the third-quarter activity, as well as looking forward to the pipeline for 2015, in terms of the mix of acquisitions. You typically say about 80% is directly sourced, versus 20% out in the market. Is that what happened in the third quarter? And what is the outlook for next year?

Yes, Paul. This is Mary, and that's exactly what happened. Same outlook for next year.

Okay. And what are you seeing in terms of behavior of your customers? Any change based on their outlook for their -- for the macro economy? And what sectors are hot or not at this point?

So, to answer your first question on interest rates and the macro economy, and so forth. No, we haven't seen much change with the customers. There will be a very long-term lag for us as interest rates do move around, with our customers. And remember, we're out there creating contracts and creating business with our customers. So we have the opportunity to ask for the cap rate. And ask to get paid for the value we are adding. So from that perspective, we will continue to do that. And your second part of your question, again? Sorry.

What sectors are hot?

Sectors are hot. That's an interesting question. Because we are a financing profit center real estate, we have the opportunity to look at all sectors, Paul. And look at all industries that have profits that are real estate. And that's what we're interested in. So we're not sector specific, and we are not moving into different sectors. We are looking at a global profit center, interest -- or profit center real estate.

I wish we were big enough to be statistically significant. But when you're doing $300 million or $400 million worth of stuff in a quarter, you can't really make any heads or tails out of any macro moves by sector. And, this quarter, we were obviously involved with a lot of different industries. And, frankly, most of the industries that we do, and most of the tenants that we have, aren't going gangbusters top line. The coverages tend to be sort of stable. They tend to gravitate towards around the middle.

We have not been making this with any assumption that the economy is going to catch fire, or that there's any hot sector. And also, to be honest with you, stay away from some of the hot sectors. Because -- sometimes the hottest sectors are the ones that have the most risk attendant to them. Because you have fewer players and less competitive maturity out there. So, we tend to do fairly seasoned industries with companies that have been in there for a long time and lots of them.

Great. And just one more. I think FASB approved changes in lease accounting. Was wondering if you think this might impact at all the net lease or sale-leaseback to markets?

Yes, so the answer to that is -- the short answer is, no. Because a lease is not a debt substitute, it never has been a debt substitute. So, if you look at anything that's on our website, or anything we've written about, or any sales presentations we have made, whether something is on balance sheet or off balance sheet is kind of irrelevant to us. Because what you are doing is, you're giving somebody a form of capital that has a lower payment constant than any other long-term capital.

It has a tendency to be more flexible than any other long-term source of capital. And it tends to be a substitute for both debt that they would otherwise have to take from a financial institution, and the equity they would have to deploy, which comes at a higher cost. So that is how this is solved. Now, when you change the accounting rules, which had been debated for --

years.

Yes, like last decade or something like that

Yes. Maybe more.

I would say -- and you are an analyst, Paul. So I would say that I don't think that the current lease accounting is perfect. But, I find that the current lease accounting is very understandable. Because when you read the financial statements of any company, you can see on the back, in the footnotes, exactly what their lease obligations are. And you know, as an accountant, for example, that if a movie theater company leases all their real estate, or if an airplane company leases all of its planes, it will continue to lease real estate, and continue to lease planes, long after those leases mature.

So, the notion of present valuing individual contracts is kind of a ridiculous notion. Because it doesn't really come into play in terms of what the long-term results are likely to be for the company. So I think that the current lease accounting, while imperfect, I tend to like it. Because I can look at and say, here's a charge to expenses. This is the charge, and that charge is probably going to keep on happening for a long time, irrespective of when the leases mature because they are going to get new assets, new airplanes to lease, or they are going to get new movie theaters to put on.

If you make these changes, what's going to happen is it's going to put into play a lot of judgment on the part of the auditors, and perhaps other valuation professionals, where they are going to have to discount back present values, and they're going to debate how much of that lease stream is equity versus how much of it is debt substitute, right? So this is what comes into play, as to how much you actually capitalize. And so, what will happen potentially is there will be greater demand for things like tenant-purchase options, which today, tenants don't get purchase options, because it's viewed as continuing involvement under a net lease. So it will be in a on-balance-sheet transaction with a purchase option.

So, if you looked to us for our first public company at FFCA, and when FAS 13 was still in effect but FAS 98 was not there yet, we were able to get off purchase options like water. Not that many people took them, but we gave them out. Today, we give out purchase options very little. I think if the lease accounting changes, that will happen.

There may be a greater push to shorter-term leases. Because, if people are having to capitalize the lease obligations, then there'll be an incentive on the part of accountants and companies' management to want to have -- present value as little of that as the can. So, if you give somebody $1 million, rather than capitalizing $800,000 as debt, they would rather capitalize $500,000. So, there will be more frictional discussions about that which may also take place. So accounting shouldn't drive finance, but it does a little bit. And it does today -- in FAS 13 it does a little bit. And it will do if they change it.

Thanks for that. Very thoughtful answer.

Any time. One last comment, Paul. Is that, you may have companies that today, like a McDonald's, for example, didn't say they would spend their real estate. But, hypothetically, if everybody has to capitalize leases anyway, today they can't actually do leasebacks and sublease to their tenants, because it would be continuing involvement. If they changed the accounting rules, they will be tempted to potentially do sale-leasebacks on all their properties because they'll get big proceeds. And it might be efficient and today that would be off the table. So there would be interesting things that could happen.

Great. Thank you.

(Operator Instructions)

I'm seeing no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Chris Volk for any closing remarks.

I have nothing further to add. But thank you very much for joining us. We look forward to our next quarterly conference call. And for those of you who are going to be at NAREIT next week, we look forward to seeing you. So thank you very much. Bye bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a good day.