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BRSP BrightSpire Capital

Participants
Lasse Glassen ADDO, Investor Relations
Kevin Traenkle President and Chief Executive Officer
Neale Redington Chief Financial Officer
Stephen Laws Raymond James
Call transcript
Operator

Greeting, and welcome to Colony Credit Real Estate Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation [Operator Instructions].

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Lasse Glassen, Managing Director of Investor Relations. Thank you.

You may begin.

Lasse Glassen

Good afternoon everyone, and welcome to Colony Credit Real Estate Inc's fourth quarter and full year 2018 earnings conference call.

We will refer the Colony Credit Real Estate, Inc. as CLNC, Colony Credit Real Estate, or the Company, throughout this call. With us today are the Company's President and Chief Executive Officer, Kevin Traenkle; and Chief Financial Officer, Neale Redington; Chief Accounting Officer, and Frank Saracino is also on the line to answer questions.

Before I hand the call over to them, please note that on this call, certain information presented contains forward-looking statements. These statements are based on management's current expectations and are subject to risks, uncertainties, and assumptions. Potential risks and uncertainties that could cause the company's business and financial results to differ materially from these forward-looking statements are described in the company's periodic reports filed with the SEC from time-to-time. All information discussed on this call is as of today, February 28, 2019, and the company does not intend and undertakes no duty to update for future events or circumstances.

In addition, certain financial information presented on this call represents non-GAAP financial measures. The company's earnings release and supplemental presentation, which was released this afternoon and is available on the company's website, presents reconciliation to the appropriate GAAP measure and an explanation of why the company believes such non-GAAP financial measures are useful to investors. And now, I'd like to turn the call over to Kevin Traenkle, President and Chief Executive Officer of Colony Credit Real Estate. Kevin?

Kevin Traenkle

Thank you, Lasse. And I want to thank everyone for joining Colony Credit Real Estate's conference call to discuss the company's 2018 fourth quarter and full year results. I'll provide a brief overview of our 2018 highlights including our portfolio rationalization strategy, as well as cover our other key management priorities for 2019.

Our CFO, Neale Redington will then discuss the details of her fourth quarter and full year financial performance including specifics on our deployment activity, investment portfolio, balance sheet and liquidity position. The fourth quarter wrapped up a transformative year for Colony Credit Real Estate in which we successfully completed our tri-party merger and listing on the New York Stock Exchange on February 1st, 2018. Since our formation, we have been incredibly active on the new origination front having committed over $2billion of gross capital and growing our investment portfolio by over 20% to $5.2 billion.

Asset growth has been balanced through a diversity of deals across investment type, collateral types and geography.

As we expanded into Europe and de-risked our portfolios exposure to retail and hospitality. Most notably, our investment in portfolio management teams embarked upon a comprehensive portfolio rationalization strategy, which will increase the earnings and overall yields on our capital.

We are currently in the process of divesting certain inherited investments which include non core assets and investments that have experienced recent credit events and are meaningfully low or no yielding.

Specifically, we come to the portfolio and identified assets where rationalization and redeployment will lead to an accretive, higher yielding returns on equity. The strategy also identified refinancing opportunities which will take advantage of the current credit market and mine additional investable capital in our portfolio. When Q - e discusses our financial and operational results, you will note that our portfolio rationalization strategy may have generated short-term pain, but it's important to realize that this is the quickest path towards long -term earnings growth.

While these proactive activities impacted our fourth quarter results, we believe these impairments are now behind us and our go forward strategy is the best direction for Colony Credit Real Estate to level-set, efficiently execute our business plan, quickly resolve the identified investment and redeploy capital into higher yielding assets that will enhance core innings in 2019.

Before turning the call over to Neale, I'd like to provide a brief update on the top priorities that we articulated earlier in the year and the progress we have made on them during 2018.

First, I'm very pleased with our success in deploying liquidity into targeted asset classes to grow and further diversify our investment portfolio.

For the full year, we allocated approximately $2.2 billion of capital for investment. We remain confident in our ability to continue to source transactions with an investment level return on equity in the low double digits, which is consistent with the yields we are achieving across our recent investment.

Our US origination pipeline is robust.

As I have noted before, we continue to see compelling opportunities in Europe, where we believe there is less competitive pressure and where the current cycle appears to be several years behind the US.

We will continue to benefit from the global infrastructure investment class deal sourcing capabilities of Colony Capital as we evaluate new investment opportunities in 2019. By executing our portfolio rationalization strategy and achieving our anticipated redeployment pace with new investment, we expect to generate core earnings run rate that fully covers our dividend by the year-end 2019.

Additionally, we made good progress on the asset management front of our portfolio. I am pleased with the enhanced asset mix and ongoing geographic diversification.

As I alluded to earlier, our near-term focus is to rotate out of identified lower yielding and non core or credit impaired legacy assets including several resolutions anticipated coming in the coming month.

We expect the redeployment of capital into our higher yielding pipeline will have a meaningful impact to our go forward core earning.

Finally, we remain focused on increasing our return on equity by moderately increasing leverage. To this end during the year our debt to assets increased positively from 33% at the end of the first quarter to 46% at year end. We remain on pace to achieve our targeted debt to assets of 50% to 55% during 2019, which still remains lower than our peer group.

As we successfully execute on our strategic initiatives, we are confident in our ability to continue narrowing the trading discount to current book value and accretively grow the company. And now I'll turn the call over to Neale Redington for a more detailed explanation of our fourth quarter and year-end operational and financial results.

Neale Redington

Thank you, Kevin and good afternoon, everyone.

As we discuss our fourth-quarter financial results, I want to draw your attention to our supplemental financial report which is available on our website. We believe this supplement will help investors and research analysts better understand our company given the additional data it provides on each of our business segments.

For the fourth quarter CLNC reported a GAAP net loss of $127.1 million or $1.00 per share and negative core earnings of $37.3 million or $0.29 per share. Fourth quarter net income and core earnings included one, $69.7 million of realized losses from mark-to-market adjustments and tax expenses on our real estate private equity investments. And two, $10.2 million of realized losses from the sale of property and resolutions of loans.

Excluding these combined losses totaling approximately $80 million, fourth quarter core earnings was $42.6 million, or $0.33 per diluted share.

For the fiscal year 2018, we reported a GAAP net loss of $168.5 million, or $1.41 per diluted share and core earnings of $86.1 million, or $0.70 per diluted share.

Excluding realized net losses 2018 core earnings was $175.8 million or $1.42 per share. Subsequent to the end of the quarter, our Board re-approved our initial $300 million stock repurchase program through March 2020. We believe the current share price is not indicative of CLNC's long-term intrinsic value.

We will continue to evaluate repurchasing shares as part of our overall capital allocation strategy, including where the return on equity is at least consistent with our new investment pipeline.

Turning to our liquidity. The company currently has access to $278 million between cash on hand and availability under a corporate revolving credit facility. We successfully upsized a corporate revolving credit facility from $400 million to $560 million providing us with additional capacity for new investments.

In addition, during the quarter we successfully closed on a new $300 million master repurchase facility, which brings our total master repurchase facility capacity to $2.1 billion across six banking relationship. I would now like to take a moment to discuss the impairments taken during the fourth quarter 2018.

First as Kevin mentioned, as part of our overall portfolio rationalization strategy, we are accelerating the sale of our real estate private equity secondary interest.

As a result of recent price discovery from this ongoing process, during the fourth quarter, we reported a mark- to- market adjustment of $35 million as well as a $35 million write-off of a related deferred tax asset, both of which impacted our reported core earnings. We still aim to utilize this deferred tax assets to offset potential future capital gains on our investment portfolio.

Second, we recorded $77 million of provisions for loan losses during the quarter related to four separate borrowers. I'd like to remind everyone as noted in our public disclosure, the reported core earnings excludes the impact of impairment of real estate and provision for loan losses until a realization event occurs. Therefore, reported fourth-quarter core earnings exclude these losses taken through GAAP net income this quarter.

So some specifics on the loan loss provision.

As Kevin mentioned, earlier Colony Credit is taking proactive steps to rotate out of certain legacy underperforming and/ or non core investment. In our call last quarter, we mentioned that we were working through the restructuring of four loans to give it by a New York City Hotel, which remain on non accrual status and are impacting our quarterly core earnings by approximately $0.04 per share.

As part of our ongoing resolution efforts, during the fourth quarter the borrower entered into a listing agreement with a real-estate brokerage firm, and as a result we believe the sale of the underlying collateral and repayment of the four loans is the most likely outcome.

As such during the fourth quarter, we recorded an additional provision for loan loss on these four related New York hospitality loans to reflect the estimated proceeds to be received from the borrower following the sale.

As New York City hotel room additions are being absorbed, we continue to be optimistic on the New York City lodging market recovery and the ability to exit this recent credit impaired asset.

Next, in January 2019, we completed foreclosure on a portfolio of senior and mezzanine loans collateralized by 28 properties to a single borrower.

During the fourth quarter, we recorded an impairment to reflect the estimated fair value of collateral, which included a provision for loan loss associated with protected advances paid by us on the borrower's behalf during 2018.

We are moving forward on these assets with a robust asset management plan to improve operating performance and have engaged new property managers, working under the diligent oversight of our portfolio management team.

We also expect to thoughtfully finance and/or dispose of certain assets within the portfolio in order to maximize value and go forward with earnings.

Finally, during the fourth quarter, two separate borrowers on three of our regional more loans notified us of the potential loss of anchor tenants.

Following this notification, we concluded that the foreclosure or sale of the underlying collateral and repayment of each of these loans is the most likely outcome.

As such we recorded a provision for loan lost for these loans.

While the impairments and their impact on our operating results for this quarter were meaningful, we believe they are comprehensive and complete and that we are now well-positioned to move forward with our business plan.

Turning to deployment.

Our fourth quarter was once again a productive quarter.

Specifically, we allocated and initially funded $561 million and $531 million of capital during the fourth quarter, including five senior loans totaling $486 million including a $163 million investment in Dublin. And two mezzanine loans for $75 million. Total expected return on equity for these fourth quarter investments is approximately 14%.

In addition, in the first quarter to date, we've already deployed an additional $199 million of capital. The full benefits of which will be realized in our core earnings in the coming quarters.

We expect that brief this recent deployment of approximately $730 million, coupled with the redeployment of capital from the portfolio rationalization strategy that Kevin previously discussed, will allow us to achieve our projected run rate dividend coverage during 2019.

For the fiscal year 2018, we successfully allocated approximately $2.2 billion in capital, and funded $2 billion across 38 individual investments.

Our average transaction size exceeded $50 million with an expected weighted average return on equity of 12%. The mix of these investments is approximately 58% senior loans; 28% net lease; 6% mezzanine loans; 5% preferred equity and 3% CMBS. Approximately 74% of these investments are in the US and 26% in Europe. The property type makes it approximately 40% office, 23% hospitality, 13% industrial, 11% multifamily and 13% mixed-use. We increased our office and industrial exposure from 41% of our portfolio at the end of the first quarter to 53% at year-end.

While at the same time, we reduced our exposure to hospitality of retail assets from 39% to 29%.

Taken together, this exemplifies the breath and execution capabilities of Colony's origination platform.

Looking at our in-place investment portfolio, our loan book continues to be the largest segment within our portfolio for the carrying value of $2.8 billion at quarter end. Over 85% of our senior loan portfolio and approximately 65% of our total loan portfolio is floating rate, and thus we see accretive returns despite the increases in LIBOR. With an average loan size of $36 million, the portfolio remains well diversified across collateral type and geography.

Our second largest segment remains our triple net lease portfolio with an un-depreciated carrying value of $1.3 billion as of December 31st, 2018. This portfolio consists primarily of industrial and office properties with a high single digits weighted average return on equity and a weighted average lease term of 9.3 years. We view net lease statement as a core business of CLNC providing long duration and stable cash flows with a potential for capital appreciation.

Moving to CRE debt securities.

Our portfolio had a carrying value of $371 million at quarter end. And is predominantly investment grade rated.

In addition to generating attractive yields and poised for growth, our CRE debt securities portfolio also provides CLNC with additional liquidity options within our investment portfolio and access to efficient borrowing.

Turning to our other real estate segment, which predominantly consists of cash flowing operating real estate, we've brought our exposure down from 24% to 16%. This segment had an underappreciated carrying value of $715 million as of quarter end. This declined by over a $160 million in the third quarter.

As a result of the sale of our largest non core office portfolio during the fourth quarter.

In addition, non core holdings in real estate private equity fund had a total carrying value of $161 million at quarter end, net of the $35 million mark- to- market adjustment recognized during the quarter.

Given our passive secondary interest in these funds and the volatility and timing of cash flows, we are now exploring sales and other strategic alternatives for these interests.

Moving on to our balance sheet.

Our total share assets stand at approximately $5.5 billion at year-end 2018.

Our debt to assets ratio increased to 46% at the end of the quarter, but still remains lower than our peer group and our expected long-term target of 50% to 55%.

As mentioned earlier, our current liquidity stands at approximately $278 million between cash on hand and availability under our revolving credit facility. Overall, we are optimistic as we look towards 2019. We've accomplished a lot during 2018 and we look forward to updating you on our progress on future calls as we continue to monetize certain lower yielding and non core legacy assets and deploy additional liquidity into higher yielding targeted investments.

Our portfolio rationalization and resolution strategy is well defined. And our pipeline and new investment execution should follow the successes about 2018 investment activity. I'd like to thank you for your time today. I will now ask the operator to please open the line for question.

Operator

[Operator Instructions] Our first question comes from the line of Stephen Laws with Raymond James. Please proceed with your question.

StephenLaws

Hi, good afternoon. Kevin, I guess maybe start with the real estate private equity interest. I guess there's a small mark in Q3 and then obviously took a bigger impairment this quarter. Can you talk about the process of selling that those assets, but I think if I remember correctly from when the initial investments were made, they're fairly complex, but can you talk about the interest you may --you're possibly seeing and if you're unable to sell that at a price you find attractive kind of what's the game plan from there. How should we think about it running off and potential for additional write-downs if it's not sold?

KevinTraenkle

Yes, Stephen. And thanks for joining us and thanks for the question. Yes for sure I mean, yes, the real estate private equity interests as you may know they don't fit well into a public company. Their earnings are a little bit lumpy; they're hard to predict.

So we thought it was in the best interest just to kind of clean up some of the noise around the quarter-to-quarter kind of mark-to-markets that we're seeing is just to sell the portfolio. And in fact, it is for sale right now. We've have a lot of interest. There are a number of parties that have been in the data room and yes we think it's going to trade at a number that it will be acceptable to us. And I think is going to be able to kind of repatriate a lot of capital that we'll be able to redeploy into much higher yielding assets. And we'll put this behind us and we'll be much better off for it.

StephenLaws

Appreciate the color there. And I guess bigger picture on the whole portfolio. Q3 we had a New York hospitality and then some operating real estate took an impairment, and couple of issues in Q4. What kind of confidence do you guys have after reviewing the portfolio? The last three are really six months, the things are marked correctly especially with the new accelerated plan to address the non-core assets.

So how do we think about the risk for additional write -downs from here on the existing portfolio?

KevinTraenkle

Yes, no, so the risks are very low. We've gone through the portfolio pretty extensively kind of asset by asset, loan by loan.

Our focus has been on a number of lower yielding assets that we have on the books. And we kind of just looked at the opportunity that we have to kind of increase the yield that those assets was redeploying the capital we can get if we sold them. And it came to the conclusion that it's -- better just to sell those and kind of redeploy that capital into our pipeline, which is very robust.

So we took a big long, hard look and everything in the portfolio and everything that we have, we're generally happy with the yield that we're getting. These handfuls of assets where we realized these impairments we did so and we thought it was in the best interest for a long-term kind of earnings and growth potential for the firm. The assets that we're going to put up for sale and we are confident that we'll be able to get very attractive prices likely kind of clear these trades in the coming months here. And kind of really focus on our pipeline going forward.

StephenLaws

Great and that's a good segue to my next question really thinks more about the growth especially getting things to ramp. I believe in your prepared you said you expected core earnings to cover the dividend I believe by year-end. Please correct me on that if I'm wrong, but when you look at your options for new investment, looks like senior loans have been active. Is that really where you see the most growth taking place this year when you kind of look at the landscape today. How do you see the mix of assets with capital being deployed this year as you grow the portfolio?

KevinTraenkle

Yes.

So within the credit space and where we kind of classify ourselves as the credit REIT.

So we do invest a little bit more up and down the capital stack which is a good thing because we're always kind of picking and choosing where we're finding the best risk adjusted yield.

We have been seeing a lot of very attractive loan origination, whole loan origination. Therefore, we've been executing those at a pretty good pace.

If you look at our pipeline going forward, I think that the majority of our investments in our pipeline are also whole loan origination.

So we like the risk adjusted yields that we're seeing in that space. We'll continue to look at little bit more opportunistically some triple net lease transactions when they come up in the right space at the right yields with the right credit. Mezzanine investments are always something that we're looking at as well, but I'd say whole loan originations are probably the majority of what's in our pipeline going forward.

NealeRedington

And, Stephen, just to answer your question specific to dividend coverage and core earnings, yes, we did say that we intend to pay the dividend coverage by the end of 2019. And we have a good pathway to get there through these deployments that Kevin just described.

StephenLaws

Great, appreciate you confirming that. Last question and I asked this last quarter as well, but you reauthorized or I guess extended the share repurchase authorization.

Let me talk about how management's think about the opportunity to buy back stock as the valuation levels we've seen versus the benefits of a larger balance sheet and the opportunities you're seeing deployed capital and new investments as opposed to stock buybacks and just the pros and cons and how you think about the decision there?

KevinTraenkle

Yes.

So it's not a linear decision and there are many variables that go into that equation. Yes but I guess fundamentally we kind of start with the opportunities that we're seeing in terms of putting capital to work.

We are very pleased where we're putting capital work and all of 2018 the weighted average yield on all of our investments on over $2 billion of investments; it was over 12% in the fourth quarter alone. It was even higher than that.

So when we look at the ability to kind of put capital to work at those yields versus buying back shares which you also rightly point out does kind of shrink the balance sheet a little bit. When we kind of put it all together, it doesn't make sense right now to buy back shares although things do change. That the pipeline, our robust pipeline that we have right now is that kind of takes us out over the next 90 days plus or minus.

So we're feeling good about that. If the market should change and spread should tighten pretty considerably and the rates that we can get on the loans are originating changed, it's something that will always revisit and look at, but right now we're pretty happy with putting the capital to work into our pipeline. End of Q&A

Operator

Since there are no further questions left in the queue. I would like to turn the call back over to management for closing remarks.

Kevin Traenkle

All right. Well, I just wanted to thank everyone for your support and joining us on today's call. On behalf of the entire team here at Colony Credit Real Estate, we thank you for dialing in today. And we look forward to updating you on our progress when we report our first quarter results in early May. Thank you.

Operator

This concludes today's teleconference.

You may now disconnect your lines at this time. Thank you for your participation.