Colony Credit Real Estate, Inc.
Q2 2020 Earnings Call Transcript

Published: 7 Aug 2020

[Operator:]

Welcome to the Colony Credit Real Estate Incorporated Second Quarter 2020 Earnings Call. [Operator Instructions] I will now turn the conference over to your host, David Palame, General Counsel. Thank you. You may begin.

[David Palame:]

Good afternoon and welcome to Colony Credit Real Estate Inc second quarter 2020 earnings conference call. We will refer to Colony Credit Real Estate Inc as CLNC, Colony Credit Real Estate, Colony Credit or the company throughout this call. Speaking on the call today are the company's President and Chief Executive Officer, Mike Mazzei; Chief Operating Officer, Andy Witt and Chief Financial Officer, Neale Redington, Chief Accounting Officer, Frank Saracino is also on the line to answer questions. Before I hand the call over, 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 could cause the company's business and financial results to differ materially, including the potential adverse effect of the current pandemic of the novel coronavirus or COVID-19. For a discussion of risks that could affect results, please see the Risk Factors section of our most recent 10-K and first quarter 2020 10-Q and other risk factors and forward-looking statements in the company's current and periodic reports filed with the SEC from time to time, cautioning that an interpretation of many of the risks should be heightened as a result of the ongoing and numerous adverse impacts of the COVID-19 pandemic. All information discussed on this call is as of today, August 6, 2020 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 reconciliations to the appropriate GAAP measures 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 Mike Mazzei, President and Chief Executive Officer of Colony Credit Real Estate. Mike?

[Mike Mazzei:]

Thank you, David. Welcome to our second quarter earnings call. This is also my second call since joining the company on April 1. On behalf of CLNC team, I would like to start by wishing everyone well in these uncertain times. The best possible outcomes will be achieved, through hard work, focus and cooperation. Our CLNC employees are doing this every day. We continue to work safely from remote locations. Our operational systems, financial controls, technology and communication, continue to work seamlessly. We are confident, that we can continue to work productively until we can safely return to the workplace. During our second quarter and through today, we have been extremely active. On the first quarter earnings call, we highlighted our key areas of focus, including asset and liability management with an emphasis on increased borrower and tenant interactions. We also maintained frequent communication with our banking counterparties. In addition, I stated that maintaining and enhancing liquidity, will remain the top priority. Given the substantial unknown and persistence of COVID-19, we felt the need to act decisively by setting in motion multiple initiatives, which included the sales and financing of certain core assets. We put multiple irons in the fire, because of the uncertainty and timing, sequencing and probability of success with any of these initiatives. We carefully weighed the value of retaining certain assets, long term versus the benefits and costs associated with generating incremental liquidity to support the CLNC balance sheet during COVID-19. To this end, we have completed a number of initiatives. The results of which have doubled our liquidity, which currently stands at $525 million. We have also reduced total borrowings, since March 31 by over $600 million from $3.2 billion to $2.6 billion. These core asset sales included CMBS securities, hotel and preferred equity loans as well as owned real estate. This involves the sale of three core portfolio assets, during the second quarter ended June 30 and subsequent to quarter end. In addition, we entered an agreement to sell an equity investment on an industrial portfolio and have separately agreed to sales terms on another equity investment. Both of these transactions are expected to close in the coming months. Also, included in this liquidity initiative was the closing of a non-recourse asset level financing with Goldman Sachs. Andy will discuss this transaction in more detail. While there has been a reduction in book value and earnings associated with these transactions, we are confident that we are taking the necessary steps to further protect the balance sheet, given the persistence of COVID-19. The effort put forth by the CLNC team and the execution of these initiatives have provided meaningful results. In addition to generating substantial liquidity, we have also reduced our repo financing and other debt exposures. Since March 31, we have reduced our CMBS securities repo from $197 million to $38 million. We have substantially eliminated concerns over CMBS margin calls. Additionally, we have reduced our loan warehouse lines and we have also paid down our bank revolver in full. As I discussed on the last earnings call, we have been working very closely with our bank counterparties. Our decisive actions to monetize assets, increase liquidity and reduce debt have been well received by our lenders. Maintaining credibility with our bank counterparties is critical. We look forward to their continued support, as we seek to do new business and rebuild earnings. Now, I would like to turn to an overview of our portfolio. As I've said, we are working very closely with our borrowers and tenants. Every asset and sponsor situation is unique. There is no playbook for pandemic-related solutions. However, the key is to maintain frequent communication. Allow me to provide some details on interest collections for our loan portfolio. On a total company basis, 99% of cash interest payments expected in July, have been paid. Of this, there were some loans which required some form of partial modification of their existing loan reserves, as well as some loans where borrowers have come out of pocket to support their equity. This is a cash collection figure and excludes PIK loans. Turning now to our owned real estate assets, inclusive of legacy non-strategic, we have experienced rent collections of 94% throughout the second quarter and July. We are pleased to note that since our last reporting, several of our tenants that were previously unable to pay rent have since come current. CLNC also remains current on all investment level borrowings on our owned real estate. Separately, I would like to highlight a loan that was placed on non-accrual and has also incurred a write-down during this quarter. This is a mezzanine and preferred equity construction loan for a Los Angeles mixed-use development CLNC's share of the combined unpaid principal balance totals $190 million. The write-down on the loan this quarter was $89 million. The development project has experienced overruns due to both construction costs and time delays. We have been working closely with the senior lender and the borrower to arrange outside capital in an effort to fund anticipated budget shortfalls. The situation remains very fluid. Therefore, our write-down considers various outcome scenarios including a successful third-party capital raise, as well as the possibility the senior lender could ultimately foreclose in the event, outside capital is not sourced. For additional information, please refer to the details provided on this loan in both our first quarter and second quarter Form 10-Q. In closing, CLNC has made significant progress during the second quarter in fortifying its balance sheet. As previously stated, the commitment to generate liquidity was weighed against reductions in shareholder equity and near-term earnings. These initiatives, along with our dividend suspension in April were necessary steps to protect the balance sheet and maintain flexibility. Once uncertainties associated with COVID-19 are behind us, we look forward to redeploying this capital to rebuild earnings. To this end, we have been engaged with the markets to stay apprised of new loan activities. At this time, transactions in both asset sales and lending continue to remain low and highly selective. Going forward, as we redeploy capital, our focus will be on senior mortgages. With that, I would like to turn the call over to our Chief Operating Officer Andy Witt. Andy?

[Andrew Witt:]

Thank you, Mike, and good afternoon everyone. As previously highlighted, the focus of this past quarter and subsequently has been asset and liability management and continuing to build liquidity to address pressures related to COVID-19, and the eventual shift towards future opportunities. Highlights of these activities since last reporting are as follows

[Neale Redington:]

Thank you, Randy, and good afternoon everyone. Before discussing our second quarter results, I'd like to underscore a few items that will be included in our Form 10-Q filing tomorrow. Similar to last quarter, we will provide an update about why COVID-19 has most impacted our balance sheet and liquidity and we will provide tables identifying our hotel property loans as well as mezzanine loans and preferred equity. There's also further information about July interest and rent receipts. Furthermore, I would like to draw your attention to our supplemental financial report, which is available on our website. It includes additional information on each of our business segments, in addition for a description of how we define core earnings. And finally, we continue to provide asset by asset details for our core portfolio in our supplemental financial report as well as all holdings in our Form 10-Q. With that, let's turn to our second quarter results. CLNC reported total company GAAP net loss of $227.1 million or $1.77 per share and Core Earnings loss of $230.5 million or $1.75 per share. Excluding provisions for loan losses and further fair-value adjustments and realized losses, second quarter core earnings of $35 million or $0.26 per share. The company reported a GAAP book value of $1.7 billion or $13.06 per share as an undepreciated book value of $1.9 billion of $14.43 per share. As previously disclosed, due to the volatility and unprecedented market conditions arising from the pandemic, we concluded that it is prudent and in the best interest of the company to conserve available liquidity, and on April 17, we suspended the company's monthly cash dividend beginning with the monthly period ending April 30, 2020. The Board will evaluate dividends in future periods based on customary considerations. That being said, the company continues to monitor its taxable income or ensure that the company meets the minimum distribution requirements to maintain its status as a REIT for year-end 2020. In terms of deployments, the company has not completed any new investment so far in 2020 with one exception where the company provided a $19 million senior mortgage to support the acquisition by a new buyer of our non-performing hotel asset in Minnesota. As Mike and Andy have already described, the detrimental impact of COVID-19 on certain assets resulted in incremental impairments and asset sales losses are $185 million or $1.41 per share. Most substantially from the LA mixed use development. Core portfolio undepreciated book value now stands at approximately $1.7 billion or $13.13 per share. Our loan book continues to be the largest segment with a carrying value of approximately $2.5 billion dollars at quarter end, the blended unlevered yield on our loan book is approximately 6.3% with an average loan size of $49 million. Furthermore, the loan portfolio remains well diversified in terms of size, collateral type and geography. Moving to our balance sheet, our total share assets stood at approximately $4.7 billion as of June 30, 2020. Our debt to assets ratio was 60% at the end of the quarter and our current liquidity stands at approximately $525 million between cash on hand and availability under our revolving credit facility. The use of our revolving credit facility will continue to be a source of liquidity for the foreseeable future. During the second quarter, we renegotiated terms revolver with our bank syndicate and these terms included a reduction in the facility size to $450 million from $560 million, a reduction in tangible net worth requirement and certain restrictions on dividends, stock repurchases and the type of new investments we can make. We believe that this new arrangement will allow us the liquidity and flexibility we need to manage our business in the near term. As Andy mentioned, during the quarter, we completed a non-recourse financing arrangement with a non-controlling interest in a portfolio of five underlying company investment interests. This transaction generated $170 million of net proceeds, net of approximately $30 million in pay downs under the company's corporate credit facility and resulted in a reallocation from shareholder equity to non-controlling interest of $70million. Turning to risk ratings, we increased our risk ratings in Q1 for a number of assets because of COVID-19 concerns and we are maintaining the same approach in Q2 given the current environment. As such, our overall risk rating at the end of the second quarter stood at 3.9 compared to 3.1 at the end of 2019 still reflecting the increased risk resulting from continuing uncertainty related to COVID-19. That concludes our prepared remarks. And with that let's open up the call for questions. Operator?

[Operator:]

[Operator Instructions] Our first question is from Stephen Laws with Raymond James.

[Stephen Laws:]

Mike, you guys accomplished a lot of three months, so I know it's a difficult time and I think four months on the job, so accomplished a lot. Congratulations on that, can you give me some color additionally, on the legacy nonstrategic asset portfolio, it looks like from the last two supplements about $120 million decline in Q2 with $569 million - $570 million left. How do we think about that from a timing is a $100 million a quarter a good run rate, is going to be lumpier than that. I know you've identified some things in Q3, are there going to be some assets that may stick around on the LNS side for a while?

[Mike Mazzei:]

Stephen, thank you for joining the call and the question. Yes, we've been very active over these past three months, with five or six, seven initiatives going on. With regard to LNS that continues to remain a focus, it's getting smaller we've made some headway resolving some assets this quarter and we'll continue to do that. That's a focus of ours it's not going to subside. We shifted a lot of focus to the overall portfolio for liquidity purposes, but we have not taken our focus on LNS and we'd like to reduce that LNS where one day, we could just if we have a tail left on it, we'll just consolidate it back into the rest, because from a reporting standpoint, it may become a nuisance at some point, but we are very focused on continuing to do that as the market permits, and evaluations change and we see the ability to sell an LNS assets in the context of the market, it makes sense. We're not looking to hold and nurture that portfolio, we're looking to execute on it at reasonable prices, so we'll continue to do that.

[Stephen Laws:]

Right. And then switching...

[Mike Mazzei:]

Go ahead.

[Stephen Laws:]

I was just going to - switching to the core portfolio. I think there were some asset sales there, is that likely to continue and then on the core side I know Neale mentioned some things around the holiday, but also it has some limitations with regards to dividends, the new investments and other things. What metrics should we be watching as far as getting the balance sheet on the core side position the way you'd like; it is the liquidity, is it reducing certain concentrations, is it a leverage metric, what is - what do you think are the best metrics to watch as far as tracking the positioning of the core portfolio?

[Mike Mazzei:]

Very good question. It is somewhat dynamic. So, let me just hit the asset sales first on the core side. We have nothing else such active, other than the two equity investments that are under contract for agreement for sale that we said would come in the coming months. We'll continue to work on the LNS and we will continue to whittle down the CMBS transactions or the CMBS securities going forward, on a selective basis. The motivations have been different for each one, for the CMBS, the motivation was to wasn't really liquidity - it was really reducing exposure to CMBS repo which we took down from $197 million on March 31 to $38 million and we extended that repo out. And the goal there - and we also removed the hedge and the losses there are some somewhat of a realization of a big chunk of them a realization of unrealized losses that we had and we've marked the rest of the portfolio accordingly and we removed the hedges. So, that was less about liquidity more about just reducing the CMBS exposure and CMBS securities aren't really something that we'll be looking at as a - as a product line for investments going forward. The rest of the assets that we've sold and targeted were a combination of assets that were rated Risk 5 rating. We had a hotel loan and we had two preferred equity loans that closed; one during the quarter, two subsequent to the quarter. And one of the preferred equities really was a reversal of the CEC, we basically transacted where it was marked for CECL. With regard to the hotel, we quite frankly we had three large hotel loans in California, we want to reduce our exposure there, and we looked at the ones that performed weakest pre-COVID and a number of things that also weighed in on it as to why we transacted there. So, there were a combination of things and in some areas, we saw that with regard to some of the equity, there is lower internal leverage against that - albeit it is external leverage, but lower internal leverage, so we are able to get more bang for the buck, if you will, in terms of raising liquidity. So, those are the things, and priority was to raise liquidity and stabilize the balance sheet, so earnings there is a cost and the cost associated with that and this is where it gets a little bit dynamic and you can go through the supplement and figure out which assets moved and how much CMBS has come down, but yes, the cost was - there was some book value cost and there were some earnings cost. And so we look to rebuild earnings and so, the reason why it's dynamic, and I'm being long-winded here, but you'll be able to see the earnings will come down in the next quarter as these assets come off and then the two equity sales in the maybe third and fourth quarter, but also we're sitting on a large amount of liquidity. And then the question is, when do we start redeploying that liquidity, and so you might start seeing us doing that later in the year as we get more visibility and so then you'd have to put somewhat - some form of rate of return on that on that liquidity that we have which is circa $0.5 billion dollars and we'll know more about that as we progress through the third quarter to see how much of that liquidity, if any, we need to use to defend the balance sheet.

[Stephen Laws:]

You've predicted my next call and as well, so I appreciate the color on the timing about potentially shifting the new investments and thoughts around that. Last question really more, I guess, big picture, but I'd love for you to tie down to your portfolio in the CLNC exposure. The office market big discussion is central business district vertical office got under significant pressure, and go the other way and see the need for more square foot per employee. Can you talk about your thoughts on the office markets from a macro level and then from a CLNC portfolio, what is the exposure? Is it primarily Central Business District, is it more kind of satellite type offices or less debt that might even be more attractive post COVID. Can you give us your thoughts around that please?

[Mike Mazzei:]

So, let me for us to give you the CLNC answer. We do not come to work, thinking about big MSA, CBD issues. We - COVID knows no boundaries, and so we come to work thinking about our hotel assets and thinking about every asset at the asset level, but certainly hotel exposure is one that we're watching very carefully hence why we sold one of hotel loans rated risk rating five. You see us moving our risk ratings on our loans and we think that this is reasonable and realistic because of an over-riding effect of COVID-19 on underlying asset business plans, albeit whether they're transitional assets or even - or hotels where there was no transition or refurbishment or repositioning of the asset, but the RevPAR is at an all-time low. So, it's affected our risk rankings and our thinking around that, and we're looking at every asset regardless of where it sits. We don't really have any CBD, MSA type exposure that comes to mind. We have in New York City we have some self-storage in multiple sites in the boroughs, and we moved the risk rating on that loan a little bit higher because while the NOI was up, it was a little bit behind budget. But quite frankly, an asset like that given the trends you may see a turn around there where the - we have a lot of increase in NOI, because there is a trend of people leaving the city, when their leases are up on the resi apartments - they may not renew, they may move home, in some cases with family outside and you may see some increased use of self-storage. So, we also have some suburban office exposure outside of New York City in Connecticut - while there's inquiry going on nothing active yet, but that could benefit. So, no real exposure that we're thinking of generally. I do acknowledge the trend of folks that are leaving larger cities seeking as the expression in New York was bridge and tunnel and people are saying that, that's, that's fine. We want to be a bridge and tunnel, we want to get out of the city, and that's a trend we're seeing and we saw the Governor of New York make a plea, yesterday for residents to come back. So we acknowledge that, that trend overriding is there. But then, we would also say, outside of the city anywhere whether it's student housing, for instance, in any state what's going on at that college campus. So, we think that at the end of the day what we need is we need - we certainly need a vaccine for obvious reasons to protect us, but we need a re-opening plan, and I think a opening plan, no matter where the jurisdiction is going to help and that's the thing we're focused on most - what are the government going to do around regional and state and city re-openings.

[Stephen Laws:]

Appreciate those comments and certainly looks like you guys are taking action to get the portfolio to the other side of this, so look forward to continued updates. Thanks Mike.

[Operator:]

Our next question is from Randy Binner with B.Riley.

[Randy Binner:]

So, I guess I'll start with CMBS, so the repo financing against it is down to $38 million. I'm sorry there is a lot of detail in the call, but if I missed it, I apologize. Did you just say what the actual overall exposure for - should being below CMBS is down to - it was at $270 million at 1Q 2020, what is that number now from an exposure perspective?

[Mike Mazzei:]

I don't know - Neale, do you have that number?

[Neale Redington:]

We'll get that for you.

[Mike Mazzei:]

I'll give you the market value number. The goal there was we took it down by 27 line items to about 24, so it will become much more manageable for us, so it was a substantial reduction in that regard, we did three larger trades toward the end of May and the beginning of June when we saw CMBS pricing was improving. We also removed the hedges on the duration hedges on the CMBS, because quite frankly, they really weren't correlated anymore - all the CMBS were trading on a dollar price basis and albeit while CMBS has improved, and pricing certainly at the higher AAA level down the stat, the mezzanine BBB, BB area has improved, but we're still trading on a almost on an appointment basis, based on the underlying loan delinquencies and things like that. So, we've gotten the position down to a much more manageable size and we certainly by taking that repo down from $197 million to $38 million, we were basically trying to take off the table, any discussions or concerns about CMBS margin calls going forward.

[Randy Binner:]

Okay. I understood.

[Neale Redington:]

Randy just to describe some of the details for you. The principal values for the face on the CMBS is about $285 million, and we're carrying that on about half of that $0.50 on the dollar. So our carrying value is $142 million gross and as Mike mentioned, we've got the repo debt against it, so our net carrying value is $103 million.

[Randy Binner:]

So, the $103 million net carrying value and that was equivalent to the $270 million in first quarter and we can take that offline. But, I think I'm just interested in quantifying the kind of…

[Mike Mazzei:]

Yes. And I think what we can to help you with Randy is that we had some unrealized loss that was converted to realized loss and so we can go through with that with you in more detail.

[Randy Binner:]

And then kind of similar question for the - just on the senior loans. So the - just on repo, your overall repo is down from $3.2 million to $2.6 million, I think that's what you said.

[Mike Mazzei:]

Our overall net debt was reduced from $3.2 million down to $600 million - I think about $100 million of that - $110 million of that was on the loan repo, I think about $160 million of that was CMBS and about the balance of that was the pay-down on the line - the revolver.

[Randy Binner:]

$340 million, yes. Okay. So the repo against loans is that $110 million number?

[Mike Mazzei:]

I think it's $110 million, $112 million to be exact.

[Randy Binner:]

Okay. Got it. And then...

[Mike Mazzei:]

The next thing is $331 million.

[Randy Binner:]

Clearly making a lot of progress in cleaning up the balance sheet. But I guess on the risk rankings, just kind of looking at the sub and then listening to your comment is the score - is the score lower or higher in the risk ranking, if - I haven't been able to put all these numbers in spreadsheet yet, but is your kind of average or median score higher now than it was in the first quarter?

[Mike Mazzei:]

It's modestly higher by attempt I think,. I just commented that generally we moved from something that was in the lower three overall to the higher threes and that is largely just - the backdrop of that is largely COVID related and you look at hotel assets and you say there are extremely low occupancies everywhere and we're just trying to act reasonably and what we thought was accurate there in terms of a reflection of what we think the overall impact on COVID will be and certainly the persistence. Now, when will we change that, we want to see most of all, for everyone's welfare a vaccine and more therapeutics, that's an obvious, but also we want to see more economic reopening and plans around how to effectuate that all those other things are in process. I think that plan around more economic opening will have the biggest impact on asset performance.

[Randy Binner:]

Okay. So shifting - sorry go ahead Neale.

[Neale Redington:]

Sorry Randy. I mean, just to expand on Mike's point, it's $3.1 million as of the end of 2019 and then moved it to $3.8 million as of 3/31 and is $3.9 million as Mike mentioned, it just ratcheted up a little bit. I will point out to that three of those loans that were risk ranked 5 were resolved subsequent to quarter and subsequent to Q2, and so that will be one thing down just because those are going away. And then as Mike has mentioned, to the extent there are other improvements that will come along as well, but just Stephen pro forma from the deals that we've done in the last few weeks, that will be coming down

[Randy Binner:]

And then I just had one more, just on the top 25 liquidity. Can we, just break that out maybe into a couple of buckets, one, how much is from the revolver, two how much, if I understood it correct came from the preferred financing in the 5 properties, and then if there is other main buckets. Just kind of understand where that liquidity lies?

[Neale Redington:]

Randy I'm not sure I can answer it that way, but just specifically the revolver is close to $200 million of that and then the remainder is cash on hand. But if you're asking about all the other ins and outs, I'm not sure that would be terribly helpful to say one over the other because we had the Fed finance, we had sales, we then had pay downs on the borrowing base on the revolver. So there is a lot of different moving parts as you might imagine so I think it's better just more to focus on the components that are remaining.

[Randy Binner:]

The $325 cash on hand at the end of the quarter?

[Neale Redington:]

That's right. Okay, I'll leave it there. Thank you.

[Operator:]

Ladies and gentlemen, we have reached the end of the question and answer session, and are out of time for today's call, I will now turn the call back to Mike Mazzei for closing remarks.

[Mike Mazzei:]

Thank you very much. Thank you for your support and for joining us on today's call. We look forward to updating you on our third quarter results in early November. Thank you and stay safe.

[Operator:]

This concludes today's conference. Thank you for your participation, you may disconnect your lines at this time.