Colony Credit Real Estate, Inc.
Q3 2018 Earnings Call Transcript

Published: 6 Nov 2018

[Operator:]

Greeting, and welcome to Colony Credit Real Estate Third 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, Investor Relations.

[Lasse Glassen:]

Good morning everyone, and welcome to Colony Credit Real Estate Inc's third 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, and Frank Saracino, Managing Director, are 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, November 6, 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 conference call to discuss our third quarter results. I'll provide a brief overview of our recent financial and operational highlights, along with an update on our key management priorities as we wrap up the current year and look ahead to 2019. Our CFO, Sujan Patel, will then discuss the details of our third quarter financial performance, including specifics on our deployment activity, investment portfolio, balance sheet, and liquidity position. Overall, I'm pleased with the continued development of our business strategy as a public company. During the quarter, we were extremely successful in deploying our available liquidity into our targeted assets, which grow our investment portfolio to $5.2 billion, an increase of over 20% since going public in February. At the same time, we continued to make good progress in our efforts to recycle capital by locating out of lower yielding and non-core assets and other strategic asset resolution to enhance the core earnings power of the portfolio. Our business continues to build momentum, and I'm looking forward to a strong finish to the year. Turning to our financial and operational results, during the third quarter we reported a GAAP net loss of $52.7 million, or $0.42 per share, and core earnings of $38.8 million, or $0.30 per share. Excluding a $6.9 million of loss, the mark-to-market adjustments are non-core real estate private equity investment. We generated core earnings of $45.7 million, or $0.35 per share, up 13% from $0.31 last quarter. Notwithstanding the impact of the mark-to-market adjustments on our real estate private equity interest, we made good progress during the third quarter and growing our core earnings. However, the core earnings we are reporting today does not include the full quarter impact of approximately $810 million of capital deployed during the third quarter, an additional $356 million of capital already deployed subsequent to the third quarter, as well as an additional $252 million of capital debt has already been committed or allocated to be committed during the fourth quarter. This recent investment activity will have significant impact on core earnings in the quarters ahead. As of the end of the third quarter, CLNC had approximately $5.5 billion in total at share assets, which includes a diversified season mix of loans, preferred equity, CMBS, net lease real estate and other non-core assets. Over the last three quarters, we further diversified and optimized the overall portfolio mix. For example, we have increased exposure to office and industrial assets from a combined 41% of our portfolio at the end of the first quarter to 53% at the end of the third quarter. At the same time, we have reduced exposure to hospitality and retail assets from 39% as of the first quarter to 31% at the end of Q3. Further, we have increased our exposure to Europe where we believe the current real estate and interest rate cycle lags the U.S. We have made three investments in Europe to date and have increased our exposure to 9% of our total portfolio as of September 30. Finally, we have substantially increased our exposure to triple net leased assets, which now comprise 25% of our portfolio. We like the long duration, stable cash flows, and potential upside appreciation of these investments. And as of September 30, the weighted average remaining lease term on our triple net lease portfolio was 9.5 years. Turning to our balance sheet, we continue to possess considerable liquidity which today totaled a $189 million between cash on hand and availability under our corporate revolving credit facility. In addition to this, we have capacity residing within our under levered existing asset base which could potentially generate approximately $375 million of additional liquidity from identified financing and asset resolution. During the third quarter, we began tapping into this embedded asset level leveraged capacity which Sujan will discuss in more detail in his remarks. Ultimately, we remain confident in our ability to deploy our available and embedded liquidity and accretive investments 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 July, August, and September. Subsequent to quarter end, we also declared a $0.145 per share dividend for the month of October and November. Our dividend has remained consistent at this level since our formation and represents an annualized dividend of $1.74 per share. This reflects a very attractive current annualized dividend yield of over 8%. Turning to the economy, the U.S. macroeconomic conditions remain healthy as overall demand for real estate remained strong. Employment rates are the highest levels in nearly 50 years and corporate profits remain robust. The U.S. economy is growing nicely albeit slightly slower than earlier in the year. Markets remain unsettled by tariffs and trade rhetoric and all eyes are on the Fed which is likely to continue tightening. However, from our perspective, the investment landscape remains favorable and is well aligned with Colony Credit Real Estate's diversified and flexible investment mandate which we believe allows us to achieve our targeted risk adjusted returns throughout various points of the economic and real estate cycle. With respect to commercial real estate in general, values have been relatively stable that vary across property sector. We continue to be bullish on rental housing in particular affordable housing and on the industrial sector while we remain cautious around retail and hospitality. We are seeing attractive opportunities in construction financing where increased scrutiny and regulatory pressures on traditional bank lenders have created a unique opportunity for non-regulated lenders like Colony Credit Real Estate to generate strong return. Our ability to source, price and execute new transactions across multiple asset classes and property type is a key competitive advantage that we believe will continue to differentiate feel and see in the marketplace over the long term. From a geographic standpoint, in the U.S., we are focused on markets and stock markets with strong growth potential, favorable supply-demand fundamentals and high barrier to entry. We are also seeing compelling opportunities in Europe where we believe there is less competitive pressures and where the current cycle is likely several years behind the U.S. Our sponsor, Colony Capital, possess a long investment track record, significant investment management infrastructure, and best-in-class deal sourcing capabilities in Europe. Through the third quarter 2018, we completed two European investments totally a combined $382 million which represents 9% of our existing portfolio. Subsequent to quarter end, we made a third investment in a European mixed use development project. Two of our three investments have been in Dublin, which is one of the fastest growing economies in Europe, has exceptional real estate fundamentals and is also a market where Colony franchise has vast experience. Before turning the call over to Sujan, I would like to provide an update of our top priorities for 2018 that we articulated earlier in the year and the progress that we have made to date. First, we remain highly focused on the development of our liquidity into targeted asset classes to grow our investment portfolio, and we are very pleased by the pace of our investment activity. Year-to-date, we have allocated $2.2 billion of capital for investments that have closed or are in advanced stages of execution. 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're achieving across our recent investments. Additionally, we're very focused on the asset management of our portfolio. I am pleased with our enhanced asset mix and continued geographic diversification, particularly with respect to our recent European investments. Over the longer-term, we will focus efforts on rotating out of certain non-core and lower yielding assets, including our real estate private equity interest and opportunistic asset sales of our non-core owned real estate. Subsequent to the end of the third quarter, we sold our largest non-core-owned real estate asset by book value for a total sales price of $177 million. We anticipate additional strategic asset resolutions and monetizations in the near future. Finally, we remain focused on increasing our return on equity by moderately increasing leverage. To this end, during the quarter, our debt to asset ratio increased during the quarter to 42%, from 35% at the end of the second quarter. As we successfully execute these priorities, we're confident in the long-term outlook for CLNC, and in our ability to continue to accretively grow earnings. And now, I'll turn the call over to Sujan Patel for a more detailed explanation of our third quarter operational and financial results.

[Sujan Patel:]

Thank you, Kevin, and good morning everyone. In discussing our 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 analysts understand our company better given the additional data it provides on each of our business segments. For the third quarter, CLNC reported a GAAP net loss of $52.7 million or $0.42 per share, and core earnings of $38.8 million or $0.30 per share. Third quarter net income and core earnings included a $6.9 million loss related to mark-to-market adjustments on our real estate private equity investments related to net asset value markdown and delayed cash flow projections by certain underlying fund sponsors. Excluding the $6.9 million loss, third quarter core earnings would total $45.7 million or $0.35 per share. During the third quarter, we invested $810 million of capital. To date, in the fourth quarter, we have already invested an additional $356 million of capital, with another $252 million allocated but not yet funded to existing and identified investments. Together, these investments have a weighted average expected return on equity of approximately 12%, the full benefits of which will be realized in our core earnings beginning in 2019, with further upside in subsequent years as well. We continue to maintain and are comfortable with our current dividend rate of $0.145 per common share per month or $1.74 per share on an annualized basis. And we are confident it will be covered on a steady state basis during 2019. Today, the company has access to $189 million between cash on hand and availability under our corporate revolving credit facility, with an additional $1.2 billion in excess master repurchase facility capacity, including $300 million of incremental capacity which closed subsequent to quarter end. In addition, we have up to approximately $375 million of potential liquidity from identified financing and asset resolutions on our existing portfolio, several of which initiatives are in progress. We expect to deploy this available liquidity over the coming quarters and further increase our core earnings as we execute on our business plan and enhance our dividend coverage. We also continue to explore several strategies to generate incremental liquidity, including low-yielding and non-core asset monetization and investment recapitalization, which will contribute positively to our core earnings. To that end, as Kevin mentioned, subsequent to third quarter, we sold our two largest non-core-owned real estate portfolio by book value for a total sales price of $177 million. We expect to redeploy the net sales proceeds into identified higher-yielding investments to increase our go-forward core earnings. As mentioned on our last call, we are working through the restructuring of four loans secured by a New York City hotel, which is on nonaccrual status and negatively impacting CLNC's core earnings by approximately $0.03 per share per quarter. We continue to work through this asset resolution. However, during the quarter, discussions with the borrower did not progress as anticipated, which has led us to explore additional options for resolution. We've prepared a weighted average probability analysis of potential outcomes, which included a recapitalization and earlier than expected receipt and sale of the collateral. Based on this analysis, we recorded a $35 million provision for loan losses for the four loans secured by this hotel. As New York City hotel room additions are beginning to be absorbed, we continue to be New York City lodging market recovery looking ahead to 2019 and 2020. And the 2018 forecasted NOI for this particular hotel is up approximately 70% from its initial 2018 budget. Regarding our ongoing non-core asset monetizations and resolutions, during the quarter, we recorded an at-share $25 million impairment on two owned student housing properties and one triple net leased retail property. This resulted from recent developments including, among other things, the potential monetization of these assets earlier than expected, as well as recent rent reductions. Ultimately, we believe this allows us to move forward faster with our business plan of selling lower yielding non-core-owned real estate assets, and redeploying this capital into higher yielding target investments. On the investment side, as Kevin noted, we have a very productive quarter. During the quarter we allocated an initially funded $841 million and $810 million of capital respectively, including two net leased transactions totaling $619 million, four senior loans totaling $172 million, seven CMBS bonds totaling $25 million, and two preferred equity investments totaling $24 million. Subsequent to quarter end, we allocated and initially funded $620 million and $356 million of capital respectively, which includes five senior loans totaling $501 million, two mezzanine loans totaling $75 million, and two preferred equity investments totaling $14 million. Taking into account third quarter deployments and all subsequent events, year-to-date, we have allocated over $2.2 billion of total capital to new investments. The mix of these allocations is approximately 57% senior loans, 29% net lease, 6% preferred equity, 5% mezzanine loans, and 3% CMBS. Approximately 75% of these investments are in the U.S., and 25% in Europe. The property type mix is approximately 43% office, 23% hospitality, 15% industrial, 10% multifamily, and 10% mixed use. Turning to our in place portfolio, our loan book continues to be largest segment within our portfolio, with a carrying value of $2.5 billion at quarter end. Over 93% of our senior loan portfolio and approximately 69% of our total loan portfolio is floating rate, and thus positively exposed to increases in LIBOR. In fact, a hundred basis points increase in one-month U.S. LIBOR would increase annual interest income on our loan portfolio by approximately $7 million or $0.05 per share. Our triple net lease portfolio has an un-depreciated carrying value of $1.3 billion as of September 30th, and consists primarily of industrial and office properties. We view the net lease segment as a core business of CLNC. The weighted average lease term on our portfolio is approximately 9.5 years, providing long duration and stable cash flows with the potential for capital appreciation. Moving to CRE debt securities, our portfolio has a carrying value of $373 million 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 borrowing. Within our non-core assets, the other real estate segment, which predominantly consists of operating real estate, had an un-depreciated carrying value of $878 million as of quarter end. This was up slightly from the last quarter as a result of taking receipt of collateral on two hotel loans during the quarter. In each of these cases, we believe taking ownership of the best alternative, given Colony's proven expertise and relationships within the lodging sector. And we continue to work through monetization strategies for these two assets. In addition, as previously mentioned, subsequent to quarter end we completed the sale of the largest non-core asset within this segment. Our other non-core holdings consist of our LT interest in real estate private equity funds with a total carrying value of $210 million at quarter end, net of a $6.9 million unrealized loss and mark-to-market adjustment during the quarter. Given our passive secondary interest in these funds, forecasting go-forward earnings proves difficult due to the volatility and timing of cash flow distribution. We continue to monitor these positions closely, and expect a substantial portion of this investment to self-liquidate over the next two years. Moving on to our balance sheet, our total at share assets grew up approximately 11% since June 30th, to approximately $5.5 billion as of September 30th, with the total at share net balance of $2.3 billion. Our debt to assets ratio was 42% at the end of the quarter, which remains lower than our peer group and our expected long-term target. Despite the uptick in leverage this quarter, we still have an underleveraged 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 $190 million between cash on hand and availability under revolving credit facility. In addition, we have excess master repurchase facility capacity of $1.2 billion, including $300 million of new capacity which closed subsequent to the third quarter. Since the end of the second quarter, we have executed on asset-level financings and dispositions which have generated approximately $130 million of proceeds to CLNC. In addition, we believe we still have the potential to generate approximately $375 million of proceeds from additional asset resolutions and financings identified on our existing asset base, which we expect to execute on over the coming quarters. While not stabilized on a run rate basis, overall we are pleased with our performance so far this year. We look forward to updating you on our progress on future calls as we continue to monetize our lower yielding assets and deploy additional liquidity into higher yielding target investments. I'd like to thank you for your time today, and will now as the operator to please open the line for questions.

[Operator:]

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Stephen Laws from Raymond James. Please proceed with your question.

[Stephen Laws:]

Hi, good morning. Appreciate you taking my questions. Sujan, wanted to maybe talk about, I guess, start off with the new investment, seems like certainly a skew towards net lease, the senior mortgage portfolio, senior loan investment portfolio actually declined sequentially. Is that due to competition on the loan side? Is it due to something specific with regards to duration or the sourcing you're seeing on the net lease? But can you maybe talk about the mix of new investment activity we saw over the last couple of months?

[Sujan Patel:]

Sure. Yes, good morning. Stephen. I'd say, more than anything, it's a function of opportunity we seeing, which is not reflective necessarily of any kind of strategic shift. I think from the onset we were interested in increase our net lease exposure. We like the duration within the portfolio. And I think we mentioned, those deals, we're going to tend to focus on larger transactions within that lease just from an efficiency of capital deployment and resource. So, I think you're going to see that shift quarter-to-quarter. And I think just if you look back at the activity from the last quarter we had a large transaction -- or two rather, in this space, so.

[Stephen Laws:]

Great. And then I guess on the European side, what's really driving the opportunity there? I know there's other vehicles under Colony's management that invest in Europe on the net lease side. Any co-investments there, any conflicts of interest, or kind of what's driving the sourcing opportunities on Europe?

[Kevin Traenkle:]

Yes, Stephen, this is Kevin. As you know, we have a big presence in Europe, Colony Capital, that is. We've been operating there for a couple of decades now. And so I think we have some really good reach over there and some access to fantastic transactions. So as we see interesting opportunities that kind of fit the mandate for CLNC we are going to pursue them. These couple of transactions in particular, I guess they're a little bit opportunistic in that we were at the right time at the right place, and they really kind of fit in with what we were doing. We like the yields that we're seeing over there. All things considered, if you kind of compare it kind of similar types of transactions in Europe compared to the ones that you're seeing over in the U.S., there seems to be a little bit less competition, so I think we're getting higher yields for the same amount of risk that we're taking. So we definitely like that. A few markets in particular kind of stand out for us, Dublin in particular. That's been one where we've been investing in heavily over the last five or six years, at Colony Capital. The fundamentals are really strong. I mean the vacancy rates or Class A office space is in the low single-digits. The demand for more space is kind of through the roof. So it's markets like that where we're kind of focusing a little bit more looking for opportunities for our strategy. So, Europe I think it's going to be kind of a nice addition to what we are doing here in the States, so little bit of a diversifier by geographies, little bit of a diversifier by types of investments that we're doing. While at the same time, kind of producing some pretty interesting yields for us. So we definitely like Europe.

[Stephen Laws:]

Great, I appreciate the color on that, Kevin. Thinking about the non-core assets, can you give us any details on the sales at quarter-end, what was the sale price versus your carrying value, will there be a gain, just kind [technical difficulty] how to think about any changes to book value that would take place as you guys continue to recycle capital and monetize the non-core asset portfolio?

[Sujan Patel:]

Sure. As we mentioned the growth price was 177 million, and close subsequent to 930 net of cost, relating to transaction, we expect small gain from a GAAP perspective and most likely a small loss from a Colony's perspective, but it's right in line overall with where we've been carrying it. More importantly, we can redeploy that capital, and it's been identified already going to higher yielding deals.

[Stephen Laws:]

Great. And anything that -- I know you have a working of quite a bit on this, but what do we do to accelerate the non-core sales, I mean, are there any other assets you have identified near-term that you think you can monetize there? How do you really -- what's your thought-process behind selling those assets quickly versus holding them longer term for maybe a slightly better sale price, you know, how do you weigh the tradeoff of that?

[Kevin Traenkle:]

Yes, Stephen, so all things around the table, I mean it's something that we look at constantly in terms of where can we kind of accretively deploy our capital, whether it's holding it in our existing investments or turning around and putting it to work in new ones. So, on each of these investments that we have in our non-core assets, it's going to be event-driven, circumstances you're going to dictate what decisions that we make. There is no list or there is no mandate in terms of assets that are for sale right now. And we will confidently kind of be reviewing what's the opportunities are for us to deploy capital, while at the same time kind of looking at everything in the portfolio and you know, if it makes sense to dispose something to deploy into something new. That's one we will do it, but not a specific plan. I think we are going to continue to be opportunistic when this happen. And we are going to look at scenarios that are accretive to the earnings of the company. And that's how we're going to kind of go forward with that part of the portfolio.

[Stephen Laws:]

Great. And one last question, just -- you know, the stocks are off little today and looks like we are now trading at about 17% discount -- 30 book value, can you update us on your thoughts around the stock repurchase. I think if I remember correctly, there is one authorized, but I don't think you've utilized any of it, and really how you view repurchasing your own stock versus the new investment opportunity you see out there, and do you have the liquidity to potentially both of those? Thanks.

[Kevin Traenkle:]

Yes. So we do have liquidity to do those things, and as I mentioned before, just like any investment that we are making, whether it's buying back shares or deploying it into new opportunities, it's something that we consider and we do way our options. We do track the stock price and see where that is trading, and also make sense to buy back shares we will do it at the time. I think right now and you can see by the pace of deployment and all the activity that we've had and the great yields that we are getting on the capital we are putting to work, it would not be as accretive to buy back shares as it would be to continue to march forward with our investment strategy, so given where we are today there's no immediate intend to buy back shares, but it's something that's it on the table and it's something that we can execute it if we needed to but no plans to do that right now.

[Stephen Laws:]

Great. Well, thanks for the comments, Kevin. I appreciate you taking my questions.

[Kevin Traenkle:]

Thank you.

[Operator:]

Our next question comes from the line of Steve Delaney with JMP Securities. Please proceed with your question.

[Steve Delaney:]

Good morning, Kevin and Sujan. How are you?

[Kevin Traenkle:]

Good morning.

[Sujan Patel:]

Good, Steve. Thank you.

[Steve Delaney:]

Good. Yes, I was going to go straight to the non-core asset as well but Stephen's discussion with you covered that pretty well, so just -- so that I fully understand the 20% and ORE and REP. I mean, that is all targeted to be disposed of, but the other roughly $4 billion of assets by -- you are looking at those as whether there is a specific loan you might sell, but as a class, if you will, you are continuing to consider those to be core assets. Is that correct?

[Sujan Patel:]

Yes. Hi, it's Sujan. That's correct. So the 20% is the -- effectively the other owned real-estate, which is primarily operating real-estate and the private equity interest you are correct in that assumption.

[Steve Delaney:]

And the other thing I heard was it like new capital as it becomes available from dispositions, et cetera, would be targeted to a combination of senior loans and net lease that's where you are going with your new capital. So those are over Gosh, almost 60% now, but we should expect those to continue to grow and the other three categories to be present, but not currently areas where you are looking to drive a lot of capital, is that correct?

[Sujan Patel:]

Well, no. We should probably clarify that for you. The target investments going forward as part of our strategy or the senior loans, the mezzanine loans preferred equity, CMBS and the net lease, so what we are really rotating out of is the operating real-estate and the runoff of the private equity interest and we are redeploying in all of those categories I mentioned.

[Steve Delaney:]

Okay. So all five of those buckets are areas where you would actively invest, if you see the right opportunity. So I was incorrect in saying that you are going to over or only really emphasize senior loans in P&L is what I'm hearing now -- everything, all of those five are on the table as options.

[Kevin Traenkle:]

Yes, commercial real-estate credit. Exactly.

[Steve Delaney:]

Got it. Yes, that fits the bill. Okay. Well, thank you for the clarification and the comments and good luck in the fourth quarter.

[Sujan Patel:]

Thanks, Steve.

[Kevin Traenkle:]

Thanks, Steve.

[Operator:]

Ladies and gentlemen, we have reached the end of the question-and-answer session and I would like to turn the call back to management for closing remarks.

[Kevin Traenkle:]

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

[Operator:]

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