Colony Credit Real Estate, Inc.
Q4 2019 Earnings Call Transcript

Published: 28 Feb 2020

[Operator:]

Greetings, and welcome to the Colony Credit Real Estate, Inc. Fourth Quarter and Full Year 2019 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded.I would now turn the conference over to your host, Jason Terry, Investor Relations.

[Jason Terry:]

Good afternoon, and welcome to Colony Credit Real Estate, Inc.'s fourth quarter and full year 2019 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, Kevin Traenkle; Chief Financial Officer, Neale Redington; and General Counsel, David Palamé; Chief Accounting Officer, Frank Saracino is also on the line to answer questions.Before I hand the call over to management, 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. For a discussion of some of these risks that could affect results, please see the Risk Factors section of our most recent 10-K and other forward-looking statements in the company’s current and periodic reports filed with the SEC from time to time. All information discussed on this call is as of today, February 27, 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 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, Jason, and I want to thank everyone for joining today’s conference call covering Colony Credit Real Estate's 2019 fourth quarter and full year results.But before we begin our official presentation and now that the portfolio bifurcation plan has been successfully implemented and the company is well positioned for growth all of which you will hear by shortly, I wanted to announce that I would be stepping down my position as the President and CEO of Colony Credit effective February 29. Andy Witt, the Managing Director and our Chief Operating Officer of Global Credit Colony Capital has been appointed Interim Chief Executive Officer and President effective February 29.Over the last 12 years, Andy has played a pivotal role in building Colony Capital Credit business and has a deep understanding of our company. With Andy’s capable leadership, I am confident that the company is well positioned to continue executing on legacy non-strategic asset resolution and growing the company's core portfolio.With that, I'd like to now give a brief overview of the company's 2019 highlights, including an update on the portfolio bifurcation plan announced last quarter and then cover the key management priorities for the coming year. Neale Redington, our CFO will then discuss the details of our fourth quarter and the full year financial performance, including specifics on our deployment activity, investment portfolio, balance sheet and liquidity position.The fourth quarter wrapped up a productive and pivotal year for Colony Credit Real Estate, where we made significant progress executing our strategic initiative. Most importantly we announced the portfolio bifurcation plan in November, which was the major milestone in our overall business strategy and prioritize rotating out of our legacy non-strategic investment in order to address the dislocation between our current trading price, and the net asset value of the portfolio and ultimately drive shareholder value. We are pleased with our early progress and the sales activity on the legacy non-strategic or LNS portfolio.We announced the portfolio bifurcation plan in November of last year and as a reminder this plan included a one-time separation of our balance sheet into one, a $4.5 billion core portfolio and two a discrete 54 assets $1 billion of legacy non-strategic portfolio which consisted of operationally intensive owned real estate, and all of our retail exposure and certain other legacy loans originated prior to the formation of the CLNC, all of which are inconsistent with our go-forward core business, which will primarily focus on senior mortgages, mezzanine loans and net leased real estate.Overall I’m pleased with the early success in executing the portfolio bifurcation plan, since announcing the plan in November, we have sold seven legacy non-strategic assets for approximately $43 million of gross sales proceeds representing approximately $10 million gain and a 29% premium to their GAAP book net value.In addition six more assets are now under contract for approximately $126 million of growth sale proceeds which would provide the anticipated gain of approximately $27 million and a 58% premium to GAAP net book value.Furthermore 27 assets with a GAAP net book value of $228 million are now listed for sale or are loans that are expected to payoff in the near future. Altogether this represents approximately 75% of the LNS portfolio that is resolved or in active phases of resolution.Our overarching objective is to liquidate the LNS portfolio in an orderly fashion and reinvest the resulting available proceeds to grow our Core Portfolio’s underappreciated book value and the company's core earnings. As evidence of this, our Core Portfolio underappreciated book value per share increased from $13.96 in the third quarter to $14.40 in the fourth quarter primarily as a result of the LNS sales proceeds being redeployed into Core Portfolio during the quarter.These recently completed sales coupled with several in execution transactions suggest that the book value of the LNS assets were supportable. This also highlights our prudent approach at resolving these assets where we remain highly focused on maximizing proceeds from all dispositions with no need or intention to buy or sell any asset.Turning to deployment, we remain very active in 2019 having committed over $1.6 billion of total capital across 27 investments, primarily in multifamily, and office senior loan. Since inception in early 2018, we have committed approximately $3.8 billion of total capital across 65 investments to our Core Portfolio that are 100% performing and have a blended current ROE of 12%. This successful deployment has helped us to achieve a 14% year-over-year increase in total company earnings and over a 20% increase in total investments assets since inception.Turning to our balance sheet improvement, we significantly improved our capital structure during the year culminating with the successful $1 billion managed CLO execution in the fourth quarter. We were pleased with the closing of our first CLO demonstrating the strength of our loan origination business, investor relationship and ability to access the capital market.The transaction accretively replaced $770 million of recourse repo debt with non-recourse CLO financing at a lower cost of fund. In addition, we developed 17 new institutional investor relationship across six classes of offered notes. We believe the managed nature of the transaction exemplifies institutional investor confidence in the management team.Finally, we substantially reduced our risk profile and improved the earnings quality of our portfolio throughout the year through the resolution of approximately $350 million of asset sales including $140 million of private equity secondary interest, $76 million of retail loan resolution, $40 million of CMBS fee piece sales and approximately $100 million of other non-core asset sales.In 2019, we concentrated our origination efforts primarily on senior mortgages, which represented over 87% of our total deployment. Approximately 78% of our total deployment occurred in multi-family and office asset classes with a focus on market with strong fundamentals and demographics. We expect to continue this investment pattern in 2020, focusing our investment activity in coastal market, as well as other markets demonstrating a combination of job growth, affordability and positive in-migration.With that, I'd like to switch gears and discuss the key management priorities as we head into 2020. First, we will continue to work with sense of urgency to prudently resolve assets in the LNS portfolio. Thanks to efforts in the fourth quarter, we had momentum heading into 2020 with approximately 75% of the LNS portfolio either sold, under contract or listed or sale. More importantly these proceeds will provide an engine of growth for our core business.Next, we are highly focused on the deployment of our liquidity into targeted asset classes to grow our core portfolio. We remain confident in our ability to continue to source transactions with an investment level return on equity in the low-double-digit. Third, structure and liquidity position, and we’ll continue to explore accretive debt alternatives while maintaining prudent leverage ratio.And finally with a simplified business plan and good progress on our LNS sales we will look at significantly increase our investor visibility with goals of expanding institutional ownership and equity research analyst coverage of real estate. Ultimately I’m confidence in our ability to execute our priorities in 2020 and expect to be goals of these initiatives will allow us to close the gap between the current share price and book value and position Colony credit real estate for long-term success.With that, I'll now turn the call over the Neale Redington for a more detailed explanation of the fourth quarter and full year operational and financial results.

[Neale Redington:]

Thank you, Kevin. Good afternoon, everyone.Before discussing fourth quarter and full financial year results, I want to draw your attention to our supplemental financial report which is available on our website includes additional information on each of our business segments in addition to a description of how we define core earnings.This definition excluded from core earnings gains, losses and impairments of real estate including unconsolidated joint ventures to preferred equity investments but will include provision for loan losses. Further core earnings will come solely from our core portfolio, while we will report legacy non-strategic earnings separately.Similar to last quarter we're providing asset by asset details for all of our holdings and as supplemental financial report as well as Form 10-K which will be filed shortly. We believe this added transparency will help investors and research analysts better understand our company and the value of our assets given the additional data it provides on our two business segments. We believe delineating our investments between core and legacy non-strategic portfolios creates clarity around the core mission.Further we believe it will facilitate a greater understanding of our company and the value embedded within its assets, for the fourth quarter CLNC’s Core Portfolio reported GAAP net income of $30.3 million or $0.23 per share and core earnings of $43 million or $0.33 per share. In addition, the company’s Legacy, Non-Strategic Portfolio generated GAAP net of $3.7 million or $0.03 per share and LNS earnings of $5.3 million or $0.04 per shareFor the fiscal year 2019, we reported core portfolio GAAP net income of $75.4 million or $0.57 per share and core earnings of $169 million or $1.29 per share. During the fourth quarter we paid a monthly cash dividend of $0.145 per common share for the month of October and a monthly cash dividend of $0.10 per common share for months of November and December.In addition we declared a $0.10 per share monthly cash dividend for the month of January and February of this year, our annual dividend per share of $1.20 is more than fully covered at 108% percent of full year 2019 core earnings.Turning now to deployment, we allocated and initially funded $123 million and $77 million of capital respectively during the fourth quarter, the deployment activity consisted of one senior loan and one mezzanine loan both within the United States and with an expected blended return on equity of over 12%. These two investments are collateralized by multi-family and mixed use propertiesFor the fiscal year 2019 we successfully allocated an initially funded approximately $1.6 billion and $1.2 billion of capital respectively across 27 investments to our core portfolio. These investments carry an expected blended return on equity with over 12% and the mix of these allocations is approximately 87% senior loans, 12% mezzanine loans and 1% other. All of these investments are in the US with a little over 80% spread about evenly between the West and Northeast areas of the country.Property type mix is approximately 39% multifamily, 39% office, 12% of the mixed use, 7% industrial and 3% hotel. Overall we saw fully diversified and prudent deployment activity for the year was in line with our overall investment strategy. Additional portfolio activities for the quarter included one full loan repayment to $17 million of gross proceeds along with full partial repayments totaling $27 million of gross proceeds.There are a total of six sales during the quarter, five LNS portfolio sales of $22 million of net proceeds at a 63% premium to GAAP net book value and one core portfolio of hotel asset for $474 million which is under contract during the third quarter and sold for a slight premium to get net book value.Turning to our core portfolio; as Kevin mentioned undepreciated book value stands at approximately $1.9 billion dollars or $14.40 per share, up from $13.96 per share in this third quarter.Our loan book continues to be the largest segment with the current value of approximately $2.9 billion at year-end. Blended - leverage yield on our loan book is approximately 7.7% with an average loan size of $52 million. Furthermore, the loan portfolio remains well diversified in terms of size, collateral, type and geography.Moving to CRE debt securities within our core portfolio, our portfolio has a carrying value of $363 million a quarter-end and predominantly consists of investment grade-rated securities. As we've mentioned before, our CRE debt securities has an attractive yield and provides the company with additional liquidity options within our investment portfolio, as well as access to efficient borrowing alternatives.Also within our core portfolio, net lease real estate comprises 25% of the core portfolio and had a carrying value of $1.1 billion at the end of the fourth quarter. This portfolio consists of industrial and office properties, with a weighted average least of 9.4 years. The net leased assets are core to our investment strategy due to the long term stable cash flows they provide, in addition to the potential for capital appreciation.As part of our in-house disclosures, which were implemented in the third quarter, we introduced risk ratings on online and within our core portfolio in order to provide more detail regarding the credit and risk profile of our core business.Our overall risk rating at year end remains at 3.1, consistent with prior quarter with one line moving from a 3 to a 4 rating. That loan is mixed use mezzanine loans located in San Rafael, California and the increase was based on a change in the borrowers exit strategy from individual residential home sales to a bulk sale approach. The borrower is still planning to repay Colony at maturity in June 2020 and we will continue to monitor this position, we'll update you in future courses.Turning to our legacy non-strategic portfolio; this segment is predominantly composed of operationally intensive owned real estate, all retail and certain other legacy loans originated prior to the formation of CLNC. Total GAAP net book value for this portfolio stands at approximately $359 million or $2.73 per share.As Kevin mentioned earlier, we closes the $1 billion of managed commercial real estate collateralized loan obligation during the fourth quarter which are critically financed interest in 21 floating rate mortgage loan secured by 39 properties with 83.5 initial advance rate on a weighted average coupon at issuance of LIBOR plus 1.59% before transaction costs. The loan collateral includes multifamily, office and hospitality properties across 10 states in the District of Columbia and features a two-year reinvestment period.The CRE CLO bolstered the company’s capital structure improve the return on equity on retained interest and is a direct result of the investor relationships we have fostered, our origination teams’ execution capabilities and capital markets capabilities.Moving to our balance sheet, our added total share assets stood at approximately $5.6 billion as of December 31, 2019. Our debt to assets ratio was 57% at the end of the quarter and our current liquidity stands at approximately $378 million between cash on hand and availability under our revolving credit facility.Lastly I would like to comment on the current expected credit losses or CECL accounting standard which was adopted by the company on January 1, 2020 based on our portfolio size and composition as of December 31, 2019 we expect to record…….Lastly I would like to comment on the current expected credit losses or CECL accounting standard which was adopted by the company on January 1, 2020. Based on our portfolio size and composition as of December 31, 2019 we expect to record a day one CECL reserve of approximately $23 million which will have an approximately $0.18 impact to our January 1, 2020 book value per share.The CECL reserve will modulate in future periods through an adjustment to net income as our portfolio expands or contracts. The credit quality and risk attributes of our loans improve or decline. Our overall market conditions strengthen or weaken. We will continue to provide further disclosure of ongoing reserve impacts due to CECL in the Q1, 2020 earnings conference call.In closing 2019 was a transformational year for CLNC as we undertook significant actions to focus our ongoing effort on growing our core portfolio while rationalizing assets within our legacy non-strategic portfolio. The fourth quarter results are demonstration of the efficacy of our business strategy. Looking forward to 2020, we expect the core portfolio to see more stabilized performance with increased core earnings as a result of reinvesting capital from LNS resolutions into core assets.Before handing our call over to our General Counsel, David Palamé, I would like to thank Kevin both personally and on behalf of the team for his leadership and friendship and to recognize his tireless efforts to bring our strategy to fruition over the last two years. Thank you, Kevin, and we wish you the best of luck. David?

[David Palamé:]

Thank you, Neale. Before moving onto the Q&A portion of the call, I would like to discuss the special committee review process. As previously announced during the fourth quarter, Colony Credit Real Estate’s independent Directors received the letter from Colony Capital proposing to explore the possible internalization of the management of CLNC and the transfer of Colony Capital’s credit management through CLNC.In response, our Board of Directors formed a special committee consisting exclusively of independent and disinterested Directors that explore this internalization proposal as well as other strategic alternative. The special committee has engaged both an independent financial adviser and legal adviser to assist pending 22.38 their review. As a further update, Colony Capital publicly reported today that it plans to take action necessary to enter into an agreement with CLNC and/or one or more third-party with respect to disposition of Colony Capital’s management agreement with CLNC.Subject to the company’s consent whether in the form of an internalization of management, a sale of Colony Capital’s management agreement with CLNC or similar transaction the effect of which is to dispose of Colony Capital’s management agreement with CLNC. The scope of any such transaction is focused on Colony Capital’s management agreement with CLNC and not Colony Capital’s private credit investment management platform and associated private credit interest.Please refer to our earnings release and soon to be filed 10-K for further disclosure regarding these matters. With respect to the process, we will not be addressing any questions on these matters on the call or otherwise at this time.With that, we will open the line for questions limited only to our fourth quarter and full year results. Operator?

[Operator:]

Thank you. Our question’s today comes from Randy Binner of B. Riley FBR. Please proceed with your question.

[Randy Binner:]

Yes thank you. Just wanted say Kevin it’s been good to work with your and best of luck on your next professional endeavor.

[Kevin Traenkle:]

Thank you, Randy.

[Randy Binner:]

Yes, you bet. I'm going to try to talk out just the fourth quarter results, but I guess - that the potential for a buyback is still listed in the press release you didn’t discuss it on the call. But I mean how would you think of allocating capital to a buyback relative to other investment opportunities considering you're trading at 70% all-in book and implying in earnings yield of buying back the stock risk free that I think rivals what you're doing in the portfolio. Can you kind of walk us through how you think of that capital allocation decision?

[Kevin Traenkle:]

So Randy you're right. We didn't disclose that, so the Board has authorized or extended the authorization for a buyback. And we have considered that in the past and I think we've discussed that on calls previously in terms of comparing that to our investment opportunities and we think that there are still some very compelling investment opportunities out there in terms of making loans and some good pipeline.And beyond that, I would just say because we're in the process, we do have a blackout. So, it really hasn't been on the table because of - that blackout.

[Randy Binner:]

Okay. And then, I wanted to go back to the comments around sales proceeds in the legacy book and how I think you outlined this in the press release to that you're transacting and expect the transact above book value. But the $228 million you mentioned in the script that - is that simply just the real estate that you have all real estate available for sale and legacy is there - there's more for sale than that. Correct?

[Neale Redington:]

That's right, Randy. And perhaps this is helpful. The last page of the press release has a listing of the LNS resolutions. So, we've got sold under contract and then there is a expected one - powerful listed for sale. So, that's the 2.28 where you see the net carrying value is the combination of the expected loan payoff and listed for sale. And then there's another group that is preparing for sale. So, not currently listed and we'll be looking at in the future. But, you could also see associated with that the gross carrying value. So, we've described that net of any associated debt

[Randy Binner:]

Understood, okay that's helpful. And then the first quarter the macroeconomic environment an environment in commercial real estate was supportive. And there has been a little bit of a change in the market, expectations to rescue this week. Are you seeing - anything different in your negotiations or day activities in light of what’s going and in the broader market?

[Neale Redington:]

Well, as you say, it’s really been over the last - this last week, where we've seen a heightened view on the risk of coronavirus and perhaps other topics, but mainly coronavirus. We are monitoring that and in terms of day-to-day conversations, I haven't really had a substantial shift over the last couple of days with potential borrowers. But in terms of our overall business approach, now we're monitoring this very carefully.We’re obviously focused on our exposure to potential in this area, which would probably be around the hospitality industry about 14% of that book is focused in that area. But as I think, we've described here in the past with our core loan book. We have a very strong sponsors involved in those deals, and we have a decent amount of equity subordination in those deals.So we feel comfortable in terms of potential to withstand some blips that may come through this. Other sides of it, to think about just longer term - just what happens to the economy which then has knock on impacts on interest rates obviously. So, we’re thinking about that, but I think still little too early to change our strategy around it.

[Randy Binner:]

Right, and then, the last question is you kind of broader the property in the other income line was significantly better - than our map was there anything unusually good in that line in the quarter?

[Kevin Traenkle:]

I don't think so. We can double check that. And we do have our 10-K release coming out, which will have sort of MD&A explanations there Randy, but we can see if there is any better explanation for movements, but I think it was consistent with what we'd anticipated.

[Operator:]

Thank you so much. We have reached the end of the question-and-answer session. This will conclude today's conference. You may disconnect your lines of this time. We appreciate your participation and have a great evening.