Colony Credit Real Estate, Inc.
Q2 2018 Earnings Call Transcript

Published: 7 Aug 2018

[Operator:]

Greeting, and welcome to the Colony Credit Real Estate Second 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. It is now my pleasure to introduce your host, Lasse Glassen with Addo Investor Relations. Thank you, Mr. Glassen. You may begin.

[Lasse Glassen:]

Good morning, everyone. And welcome to Colony Credit Real Estate Inc’s Second Quarter 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, Sujan Patel. Neale Redington, the Company's Chief Accounting Officer, 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, August 7, 2018, 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 morning and is available on the Company's Web site, 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. I want to thank everyone for joining Colony Credit Real Estate second quarter earnings conference call. I’ll provide a brief overview of our recent financial and operational highlights, along with an update on our key management priorities for the second half of the year. Our CFO, Sujan Patel, will then discuss the details of our second quarter financial performance, including specific on our deployment activity, investment portfolio, balance sheet and liquidity position. Before jumping into comments about our second quarter financial performance, there are a few company announcements that I’d like to make. First, in connection with our sponsor's name change, The Colony Capital Inc. Our Board of Directors similarly authorized the changing of our name to Colony Credit Real Estate Inc. effective June 25th. Second, I am also pleased to report that Colony Credit Real Estate was added to the U.S. small-cap Russell 2000 Index during the Index’s of the annual reconstitution on June 25th. As a result, trading volume and support in our stock has increased significantly since our addition was made public on June 8th. Becoming a member of the Russell 2000 affirms the breath of the business we have established and the great result for CLNC shareholders. Now, let's turn to our financial and operational results for the second quarter. Overall, it was a productive quarter for the Company, particularly on the new deployment front, as we continue to focus on one of our primary corporate objectives, which has been to invest our excess liquidity. During the second quarter, we reported GAAP net income of $16 million or $0.12 per share and core earnings of $40.3 million or $0.31 per share. As will be further discussed during the call, due to a number of factors, we believe these results do not reflect CLNC’s normalized core earnings run rate. Most notably, their earnings we are reporting today do not include the full impact of approximately $460 million of capital deployed during the second quarter, and additional $380 million of capital already deployed subsequent to the second quarter, not to mention an additional $475 million of capital that is already been committed or allocated to be committed during the third quarter. This deployment will have significant positive impact on core earnings in future quarters, which Sujan will discuss in more details shortly. As of today, our portfolio has approximately $5 million in total at share asset, which includes a diversified and seasoned mix of loans, preferred equity, CMBS, net lease real estate and other non-core assets. Moreover, our balance sheet continues to posses considerable liquidity, which today totals $419 million between cash on hand and availability under our corporate revolving credit facility. This does not include leverage capacity that resides within our under-levered assets, which could generate $350 million or more of additional liquidity. Ultimately, we remain confident in our ability to deploy our available liquidity in our targeted asset classes, and continue to drive earnings growth in future period. During the quarter, we declared and paid a monthly cash dividend of $0.145 per common share for the month of April, May and June. Subsequent to quarter end, we also declared $0.145 per share dividend for the month of July and August. Our dividend has remained consistent at this level since our formation, and represents an annualized dividend of $1.74 per share. Based on yesterday's closing stock price, this reflects a very attractive current annualized yield of over 8%. Turning to the economy. U.S. macro economic conditions are quite healthy with regard to demand for real estate, employment figures and solid corporate profit. From our advantage point, the investment landscape remains favorable and is well aligned with Colony Credit Real Estate diversified and flexible investment mandate, which we believe allows us to achieve attractive risk-adjusted returns throughout various points of the economic and real estate cycles. Within the commercial real estate sector, market fundamentals including property level operating income, supply demand dynamics and continued capital markets liquidity, have driven sustained support for robust valuation and overall transaction volumes. Our ability to source, price, and execute new transactions across asset classes, geographies and property types, is a key competitive advantage that we believe will continue to differentiate CLNC in the marketplace over the long-term. As we evaluate you transactions, we typically favor markets and sub-markets with strong growth potential, favorable supply demand fundamentals and higher barriers to entry. As we’ll discuss shortly, we’re also seeing compelling opportunities in Europe where we believe there is less competitive pressures and we believe the current cycle is several years behind the U.S. The county franchise enjoys a decade-long investment track record, significant investment management infrastructure and best-in-class deal sourcing capabilities in Europe. As always across all markets, we are committed to transactions with strong sponsors that have a track record of executing successful business plan and that has structures that provide meaningful downside protection for our investment. In terms of property types, we continue to believe strongly in for rent housing, office, industrial hospitality. Although under the right circumstances, we can be a creative capital partner for other asset classes as well. We are very pleased by the pace of our recent investment activity where our affiliation with Colony Capital continues to provide significant competitive advantages with respect to the sourcing and underwriting synergies that clearly differentiate Colony Credit in the marketplace. Year-to-date, we have allocated $1.6 billion of capital for investments that have closed or in advanced stages of execution, including our first allocation to European investment, which total approximately $400 million. 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 yield we are achieving across our recent investment. Looking ahead to the second half of the year, our current pipeline remains very robust and includes over $1 billion of actionable transactions. Based upon this pipeline and our recent pace of deployment, we expect to be able to invest our current available liquidity and accretive transactions by the end of the year. And now, I’ll turn the call over to Sujan for a more detailed explanation of our second quarter operational and financial results.

[Sujan Patel:]

Thank you, Kevin and good morning everyone. I am happy to speak with you all today on our second quarter 2018 earnings call. As I’m going over financial results for the quarter, I want to draw your attention to our supplemental financial report, which is available on our Web site. We believe this supplement will help investors and research analyst understand our Company better, given the granular data it provides on each of our business segments. For the second quarter, CLNC reported GAAP net income of $16 million or $0.12 per share and core earnings of $40.3 million or $0.41 per share. As Kevin noted, these results do not fully reflect the run rate earnings of our portfolio due to the timing of investment closings. During the second quarter, we invested $460 million of capital. To-date in the third quarter, we have already invested an additional $380 million of capital with another $475 million allocated, but not yet funded to existing and identified investments. Together, these investments have a weighted average expected levered current yield of approximately 11% and total IRR of approximately 13%. Once fully deployed, this investment activity is expected to contribute approximately $0.05 per share to future quarterly core earnings on a run rate basis, net of any expected repayments and any anticipate draws under our corporate revolving credit facility. We continue to maintain our historic dividend rate of $0.145 per common share per month or $1.74 per share on an annualized basis, and we remain focused on maximizing product deployment from all of our available liquidity sources. As Kevin mentioned, our balance sheet has considerable dry powder, totaled $419 million between cash on hand and availability under our corporate revolving credit facility. This does not include additional embedded leverage capacity at many of our assets, which we expect to generate an additional $350 million of liquidity. We expect to deploy this available liquidity over the coming quarters and further increase our run rate earnings as we execute on our business plan and enhance our dividend coverage. Overall, we are comfortable with our current dividend and we are confident we will be fully covered on a fully invested steady-state basis. We’re also exploring several additional strategies, including non-core asset monetizations and investment recapitalizations, which could contribute positively to our run rate earnings. One example of this includes the potential modification and/or restructuring of $261 million unlevered first mortgage and mezzanine investment secured by Ney York City Hotel, which is now on non-accrual status and negatively impacting CLNC’s quarterly core earnings by approximately $0.03 per share. Ultimately, we believe this asset performance will improve as the Ney York City hospitality market emerges from recent oversupply issues. Through the first six months of this year, the asset is already seeing positive top and bottom line growth, and 2018 projected NOI has increased approximately 70% from the beginning of the year. On the investment side, as Kevin noted, we had a very productive quarter. During the second quarter, we allocated an initially funded $592 million and $460 million of capital respectively, including six senior loans totaling $440 million, one mezzanine and one preferred equity investment, totaling $130 million and four CMBS bonds totaling $22 million. Subsequent to quarter end, we allocated and initially funded $855 million and $380 million of capital respectively, including two net lease investments totaling $620 million, including one property in Europe, two senior loans totaling $160 million, one European preferred equity investment, totaling $70 million and two CMBS bonds totaling $6 million. Taking into account second quarter deployments and all subsequent events, year-to-date, we have allocated over $1.6 billion of total capital to new investments. The mix of these allocations is approximately 47% senior loans, 38% net leased, 10% preferred equity, 3% mezzanine loans and 2% CMBS. Turning to our in place portfolio. Our loan book at quarter end stood at $2.6 billion and continues to be the largest segment within our portfolio. Over 97% of our senior loan portfolio on approximately 72% of total loan portfolio is floating rate and thus positively exposed to increases in LIBOR. Our tipple-net lease portfolio had an un-depreciated carrying value of $691million as of June 30th and consists primarily of industrial and office properties. We view the net lease segment of the core business of CLNC. And as previously mentioned, subsequent to quarter end, we closed on or committed to two new net lease transactions totaling $620 million of capital. These assets provide long-duration stable cash flows for our portfolio with the potential of capital appreciation. And pro forma for these new acquisitions our weighted average lease term remaining has increased from 3.8 years to over nine years. Moving to CRE debt securities. Our portfolio had $342 million of carrying value at quarter end and is predominantly investment grade. We continue to source CMBS bonds that meet our underwriting criteria, including non-rated B-piece opportunities. In addition to generating attractive yields, our CRE debt securities portfolio provides CLNC with liquidity options within our investment portfolio and access to efficient borrowings. Turning to our non-core assets. We have mentioned this before but it repeating this quarter. These assets were contributed as part of the merger with two legacy non-traded REITs and are not part of our long-term target asset classes. That said, these assets are performing with stable cash flows and we will look to opportunistically exit these investments while maximize value for shareholders. Within our non-core assets, the other real estate has an un-depreciated carrying value of $762 million. This portfolio consists of predominantly office, multifamily and student housing properties and it’s financed with long-term non-recourse asset level financing. Our other non-core holding consists of our interest in real the private equity funds with the total carrying value of $241 million at quarter end. The weighted average life of this portfolio is approximately 1.2 years. And as these positions liquidated in the near-term, we plan to redeploy the excess liquidity into our higher yielding targeted asset classes. During the quarter, our PE interest contributed approximately $3 million to core earnings or at 4.8% yield on average carrying value, which was the below our expectations for the second quarter and was driven largely by timing delays and asset realization events in the underlying funds in which we own interest. Since the difference is largely timing related, we expect to make up the shortfall in later periods. Moving on to our balance sheet. As of June 30th, our total at share assets was approximately $5 billion with the total at share debt balance of $1.7 billion. Our debt to assets ratio was 35% at the end of the quarter, which is significantly lower than our peer and our expected long-term target. Despite the uptick in leverage this quarter, we still have an under-leveraged capital structure and we can realize on significant embedded growth opportunities by optimizing the right side of our balance sheet. As discussed, our current liquidity stands at approximately $419 million between cash on hand and availability under our revolving credit facility. Inclusive of a new 250 facility, we have $2 billion in total master repurchase facilities and our current access borrowing capacity of $1.3 billion provides ample liquidity to fund our senior loan originations pipeline. While not stabilized on a run rate basis, the second quarter of 2018 represents our first full earnings quarter. Significant work remains ahead for the rest of 2018. However, we are pleased with our overall performance, particularly on the capital deployment front, which will be additive to our future quarters’ earnings. We look forward to continuing to expand our portfolio with attractive opportunities. And based on our strong pipeline, we feel we are well positioned to achieve our operational goals and strategic objectives for the year. I’d like to thank you all for your time today. And we’ll now ask the operator to please open the line for questions.

[Operator:]

Thank you. We will now be conducting a question-and-answer session [Operator Instructions]. Our first question comes from the line of Steve Delaney with JMP Securities. Please proceed with your question.

[Steve Delaney:]

Kevin, I was wondering if you could provide a little color on the large European net lease transaction that you closed in the quarter.

[Kevin Traenkle:]

So the net lease transaction is an office complex, I mean, it’s headquarter for a major European multinational corporation. It provides all the things that we’re looking for in our net leased investments, long-term lease stable cash flows. It actually came with financing that’s in place at pretty attractive rate, so our levered cash on cash yields are pretty attractive. So down the center of the net for our net lease investment strategy.

[Steve Delaney:]

Which country is it based in, and what was the size of that investment?

[Kevin Traenkle:]

It was in Norway, and the ultimate size $330 million.

[Steve Delaney:]

And when you do these larger net lease transactions, what type of -- do you have to step up lease that’s somewhat indexed to inflation to protect you there?

[Kevin Traenkle:]

So every lease is a little bit different. But in this particular lease, we do have that built into this lease term where we get, on an annual basis, get reset for an inflation in platter but all the leases are a little bit different but this one we do have that.

[Steve Delaney:]

And Sujan one for you. You had a nice pop in un-depreciated tangible book value that’s went up from 23.45 that we had at March 23.80. From a GAAP standpoint, you obviously under-earned the dividend, so you could comment a little bit on what was driving the increase fair value marks incremental depreciation. How did we get to 23.80?

[Sujan Patel:]

I think right now your numbers have the deferred tax asset deducted from it, and which is why I think you were showing a lower number. And if I were to deduct that from our 23.80, it goes down by about $0.20.

[Steve Delaney:]

Okay, that's my bad on not having apples-to-apples there. I guess my last question would be, Kevin, you were suggesting that the goals for the second half of year is to get you -- have yourself largely fully deployed without the incremental cap, which you have available by the end of the year. At that point, would you expect based on the return on that deployment. Do you think that you would be at full coverage of the current dividend with core earnings by the time you get through the fourth quarter or at least not asking for guidance, but would that be a reasonable goal for you and expectation for investors?

[Kevin Traenkle:]

I think if we just deploy the current cash that we have on hand today and to our credit lines and some of the cash that we have, we’d be close by the end of the year. But I think what we’ll have to do to get the full coverage, we’ll probably have to leverage up some of our other assets that are un-levered. So which will happens through the first and second quarter of the following years to get up to the full dividend cost of coverage.

[Steve Delaney:]

So maybe -- realistically maybe a mid-2019 would be more realistic to make sure -- to be have confidence that you would have done all the deployment and the engineering, if you will, to fully cover?

[Kevin Traenkle:]

Yes, I think that’s about right. Plus or minus mid-2019 after we have fully deployed all the liquidity plus levered up the balance sheet the way that we want to get it delivered up. Our projections are showing around that time that’s when we’ll be fully covering our dividend.

[Operator:]

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

[Stephen Laws:]

Sujan, I guess a quick follow-up, I think it was in your comments you mentioned earnings -- core earnings would benefit by $0.05. Was that in reference to the full quarter impact of the 2Q new investments, as well as the new investments subsequent to quarter end? Or exactly what did the $0.05 improvement earnings really to?

[Sujan Patel:]

So that’s correct, so that’s the full impact of the second quarter, as well as the subsequent transactions that we referenced in third quarter year-to-date. And that’s -- one clarification, that a net number, net of repayments as well.

[Stephen Laws:]

Touching base and really following up on Steve's last question about capital deployment, and in relation to the non-core assets and the other real estate equity. Is there a plan, as far as how you're looking to monetize those investments and reallocate capital? Is it something that will get more focused once you have the available liquidity deployed by the end of the year? Obviously, the real estate assets are generating positive cash flow and solid occupancy. So can you maybe comment about a timeline or how we should expect that capital to be reallocated over the next 18 months?

[Kevin Traenkle:]

So we are focused on deploying the immediate liquidity at hand. But as soon that’s done I think we’re going to start turning to some of these other assets that might be fine investments, stable investments but just yielding something a little bit lower than what our business model is suggesting. So once we’re fully deployed, I think we’re going to start turning a little bit more to these other assets. That said, we are selling some of these non-core assets, as we speak. We’re doing it on an opportunistic basis. If we’re getting great prices, we’re pulling the trigger and executing them. But by no means are we in buy or sale mode just trying to get them off our balance sheet to generate even more liquidity while we’re putting out our cash right now.

[Stephen Laws:]

And then my last question really on the PE assets and duration I think 1.2 years, about five quarters remaining. Sujan, I think you mentioned in your prepared remarks that the contribution this quarter was a little below expectations. Although, its timing related so that should even out. Is there an income number we should expect that rolls through over the next five quarters as far as our model? Or how should we think about PE interest maturing over the next five quarters the income contributions from that?

[Sujan Patel:]

As I think we have spoken about before, I mean, these are good investments but tough in a yield oriented vehicle, which is why we’ve identified it as non-core. So there is some volatility quarter-to-quarter in how we account for the income from that investment. And the 1.2 years, that’s a weighted average. So please keep in mind that there will be some assets that payoff beyond that date. We identified the 5% yield in our -- approximately 5% in our remarks, because that's clearly low relative to where we are able to redeploy. But if you look back at the prior quarter, we generated a low double digits return on those investments as well. So it's a little bit for all the quarter-to-quarter and market is more of a straight-line basis. The market rates, people require those interests that are in the low double-digit return. But we’re more focused on the cash we receive each quarter and how we account from them.

[Stephen Laws:]

And a follow up, that’s a good point on the weighted -- if average -- is there a maturity -- what's the curve on the maturity of those funds look like around that 1.2 weighted average? Is it mostly at the tail or what's the maturity for that?

[Sujan Patel:]

Yes, it’s a lot -- most of it occurs next year and then there is a small portion that’s got a little bit longer tail.

[Operator:]

There are no further questions. I’d like to hand the call back to management for closing comments.

[Kevin Traenkle:]

On behalf of the entire team at Colony Credit Real Estate, we thank you for dialing in today. We look forward to updating you on our progress when we report our third quarter results in early November. Thank you.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.