Colony Capital, Inc.
Q3 2012 Earnings Call Transcript

Published: 7 Nov 2012

[Operator:]

Greetings, and welcome to the Colony Financial, Inc. Third Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Lasse Glassen, with Addo Communications. Thank you. Mr. Glassen, you may begin.

[Lasse Glassen:]

Good morning, everyone, and welcome to Colony Financial, Inc.'s Third Quarter 2012 Earnings Conference Call. With us today are the company's Chief Executive Officer, Richard Saltzman; and Chief Operating Officer and Chief Financial Officer, Darren Tangen. Kevin Traenkle, the company's Chief Investment Officer; and Neale Redington, the company's Chief Accounting Officer, are also on hand to answer any 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 expectation 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, 2012, and Colony Financial does not intend or undertakes no duty to update future events or circumstances. In addition, certain of the financial information presented in this call contains non-GAAP financial measures. The company's earnings release, which was released last night 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 Richard Saltzman, Chief Executive Officer of Colony Financial. Richard?

[Richard B. Saltzman:]

Thank you, Lasse, and welcome, everyone, to our third quarter earnings call. We had another productive quarter and won acquisitions by deploying an aggregate of $157 million across all 3 lines of business

[Darren J. Tangen:]

Thank you, Richard. Third quarter 2012 Core Earnings were $12.5 million or $0.36 per basic and diluted share, and net income was $10.5 million or $0.30 per basic and diluted share. Of note, Core Earnings and net income in the third quarter of 2012 were inclusive of approximately $0.05 per share and $0.06 per share, respectively, of combined bankruptcy and related transaction expenses associated with our Hotel Portfolio investment and loss from CSFR, our single-family home rental investment, which is still in a start-up phase, as Richard mentioned. More specifically, our investment in CSFR produced a relatively small loss of $1 million in the third quarter. The loss reflects

[Operator:]

[Operator Instructions] Our first question is from the line of Zach Tanenbaum with MLV.

[Zachary Tanenbaum:]

Can you remind us just the total amount of capital that's been raised at CSFR inclusive of your upsized investment?

[Richard B. Saltzman:]

Well, it's an ongoing process. We continue to raise money privately and we had an initial closing where Colony Financial represented $150 million of CSFR. The aggregate capital raised at that time was approximately $525 million. And -- but we continue to raise money privately in addition to the incremental investment that we're making now from Colony Financial. We're really not at liberty to disclose though exactly what's happening with respect to that capital raise.

[Zachary Tanenbaum:]

Okay. And then to date, has that vehicle utilized any leverage? And if so or if not, what form could leverage take for that vehicle going forward?

[Darren J. Tangen:]

Hey, Zach, it's Darren here. So thus far, all the homes that we've purchased have been bought just purely with equity. We do anticipate putting some leverage into the business, probably by the end of the year. And I believe, at this point, the type of leverage we'll likely take on initially will be some kind of term revolving credit facility. That will probably be the first iteration. We're also watching the development of the securitization markets to finance the business as well. It's a little bit premature at this point, but I think once there's a little more operating history to the business, we think that's going to be a very efficient way to finance single-family homes for rent in the future.

[Zachary Tanenbaum:]

Great. Just on the -- you mentioned good progress in terms of realization of gains in some of your higher yielding investments. Going forward, do you have a target in terms of the amount of capital recycling we could see maybe for the full year next year in terms of realization of those gains? Just thinking about the amount of capital you could potentially be redeploying into new investments.

[Darren J. Tangen:]

Well, let me maybe just back up. Earlier this year in 2012, I think we had set a range of between $50 million to $100 million of our portfolio that we expected to recycle. And I think when we finish up this year, we're going to end up being considerably higher than that, probably almost double that initial range. I think as we look into 2013, it's probably a fair assumption that we'll be in a -- maybe not quite as high of a recycling as we had in 2012, but I do think sort of $100 million to $150 million of the portfolio could turn and there'll be, hopefully, gains associated with that and a return of capital that we'll be reinvesting into new deals.

[Operator:]

Our next question is from the line of Joshua Barber with Stifel, Nicolaus.

[Joshua A. Barber:]

I'm wondering if you guys could talk -- you mentioned on the Fannie Mae deal that you bought, it had a similar deal -- had a similar structure to that of the FDIC. Can you elaborate on that a little bit? Does that mean there's fully amortizing debt or hold back liabilities on that? Or is it just that you're getting some non-recourse financing from Fannie with a somewhat different structure?

[Richard B. Saltzman:]

It's not something that we can comment on directly, unfortunately. But the substance is that it's not a structured purchase money financing like in the FDIC, but it is a structured incentive arrangement, which creates equivalent economics and equivalent incentives vis-à-vis our managing, if you will, on behalf of Fannie and ourselves' portfolio. But we're not at liberty, unfortunately, to disclose the details of it.

[Joshua A. Barber:]

Okay. So it wouldn't be like a full cash flow sweep for the first couple of years, but there would be some promote, so to speak, for the federal government?

[Richard B. Saltzman:]

There's no cash flow sweep to the extent that we put up capital. We're certainly earning a healthy return on that capital and then, if anything, the incentives work in the other direction for our benefit.

[Joshua A. Barber:]

Okay. You guys seem to be able to find a number of good distressed portfolios and I understand that at least one of the portfolios that you bought are estimated to buy from the Maiden Lane asset, but can you talk about who else is selling those portfolios today, especially domestically in that 75% or less of par? Are you seeing either increased competition or a lot less selling from banks today?

[Kevin P. Traenkle:]

This is Kevin Traenkle. We still have a pretty healthy pipeline of portfolios of the loans that we're currently underwriting. Fourth quarter, in particular, is substantially higher than what we were looking at in the third quarter, but that usually does happen. A lot of financial institutions and banks at the end of the year try to clean up their balance sheet. So there's a bit of seasonality with NPL portfolios. But we still are seeing banks that are getting more and more healthy in this environment, who are able to kind of take write-downs on their portfolios. I would say that that's probably accelerating, the volume of banks who are able to sell. So the pipeline's pretty robust. The European market, we are still monitoring. However, we haven't seen as much open up there yet, but we do think that that's just a matter of time, and there will be some quite good investment opportunities over time.

[Richard B. Saltzman:]

So I mean, the constituencies that are -- I mean, it's really all of the same constituencies, including the U.S. government through the FDIC, who's actively marketing a portfolio this quarter. It's banks, insurance companies, specialty finance companies, and hopefully, over the long run, European banks, as Kevin was just referencing. But it's really all the same sources. There's still plenty more to go in terms of over-leveraged loans that basically need to be cleared out of bank balance sheets and the like and really unglued, in terms of the frozen nature of the real estate in the over-leveraged properties that still exist in the market today. Just from a competitive standpoint, Josh, I think you were asking about competition. For sure, there's a fair amount of competition in the market for this kind of product. I think we're still able to underwrite to the returns that we've been producing consistently since our inception, to be totally fair about that. I think, against the backdrop of a more stable and generally speaking, although spotty, modestly improving economy, typically, you have to dip down the capital stock a little bit perhaps in terms of taking a little bit of incremental credit risk and/or potentially sell off A notes or obtain leverage. In some modest fashion, that might get you back to the mid-teen rates of return that we're typically underwriting to. So competition is out there for sure, but notwithstanding the competition, we're still confident we're able to get the yields, albeit maybe taking either a little bit more credit risk or putting on a modest amount of leverage or, in some cases, maybe a tiny amount of both.

[Joshua A. Barber:]

That's really helpful. Two quick questions on, just a follow-up, A, on the Jameson portfolio. I guess once that comes out of bankruptcy and you completed that whole reorganizational plan, again, assuming it's gets a boost by the bankruptcy court, is that an asset that you'd want to hold onto longer term after you repositioned it, just as part of Colony's overall strategy? And second, what is the remaining UPB on the term and loan portfolio after you got the fourth quarter payoff?

[Darren J. Tangen:]

So on the Jameson portfolio, Josh, I think we would like to -- I think we're going to want to see and allow to gestate some of the changes that we put in place there, both from a balance sheet perspective as well as operationally. So I think it's going to take a little bit of time for us to see that stabilize and to create the value that we're hoping to create before we would look to exit that portfolio. Of course, we'll continue to monitor various exit alternatives, and if something attractive presents itself, we'll pursue it. But I think that ones probably going to take a little bit of time for that to materialize. As it relates to the German portfolio that we had the one asset sell, maybe Richard, do you want to...

[Richard B. Saltzman:]

Sure. So just to remind everybody, we've actually acquired now 5 German loan portfolios. Now the particular one that this asset was sold from is the largest of the 5 and the total investment that Colony made in that portfolio was on the order of about $65 million of which Colony Financial is a 50% participant. And so we will still own substantially most of that portfolio pro forma for the sale and again the investment that Colony Financial had was roughly on the order of between $30 million and $35 million. I don't remember the precise amount.

[Joshua A. Barber:]

The UPB was huge. I mean, it's $300 million.

[Richard B. Saltzman:]

UPB, yes, I think that portfolio was bought at about 10 or 11 cents on the dollar, somewhere in that vicinity.

[Operator:]

Our next question is from the line of Jade Rahmani of KBW.

[Jade J. Rahmani:]

Can you comment on the investment pipeline, excluding single-family, and how it's changed maybe the last couple of quarters? Do you expect investment activity to continue to run in the, on a gross basis, $150 million range on a quarterly basis for the foreseeable future?

[Richard B. Saltzman:]

Yes, I think Kevin described what the pipeline looks like with respect to secondary sales, but we also have quite a robust pipeline in terms of new origination opportunities. And I would say that, easily, we should be able to meet and/or exceed what we've been doing in the past in terms of putting on new assets each quarter. Activity is quite good.

[Jade J. Rahmani:]

Okay. And then just with respect to asset sales, longer-term maturities and repayments, can you just indicate for the overall portfolio what the weighted average duration is?

[Darren J. Tangen:]

The weighted average duration is between 3 to 4 years at this point, Jade, and so -- and I think initially, we have been sort of suggesting that the duration on the book was sort of 4 to 5 years but obviously, there's been some seasoning in the portfolio, but we're down between 3 and 4 at this point in time.

[Jade J. Rahmani:]

Okay. And regarding near-term potential repayments, is the William Lyon Home, to the extent they're able to issue debt and to repay that, is that the largest investment that could repay?

[Darren J. Tangen:]

Correct. At this point in time, that's the largest investment that we have that could repay in the near term, meaning in the next quarter.

[Jade J. Rahmani:]

Okay. Do you have any idea whether you think it's definitely a 4Q event or...

[Darren J. Tangen:]

At this point, we'd say that it's highly probable.

[Jade J. Rahmani:]

Okay. And just lastly, I was wondering if you could provide any credit metrics on the portfolio. We get a lot of questions on this and given that you're participating in joint ventures, I was wondering if you could provide any color on the percentage of the portfolio that's nonperforming. On the performing assets, any indication of debt service coverage or just the overall LTV on the portfolio and how those metrics have been trending?

[Darren J. Tangen:]

Sure. Well, maybe what I could just quickly mention is where we are with some of our small balance loan portfolios and these are some metrics that we've highlighted previously. And in terms of loan resolutions within those portfolios, I think we've mentioned before that we've been recovering approximately 1.5x our purchase price basis on most loan resolutions. And that metric continues to hold consistent through the end of the third quarter. And if we look at the -- again, the small balance loan portfolios, we're currently generating about a 9% current yield against that portfolio and roughly 2/3 of those portfolios are nonperforming or sub-performing loans and only 1/3 is performing. So that 9% current yield is being generated from the 1/3 of the portfolio that is still performing. And then, of course, to the extent that we're continuing to generate a 1.5 multiple on those nonperforming loans within the portfolio, that should be accretive to that 9% current yield.

[Jade J. Rahmani:]

Okay. And as a percentage of your total portfolio, what percentage is the small balance loan portfolios?

[Darren J. Tangen:]

So as of the end of the third quarter, everything that's in the universe is a metrics, I was just quoting that, represents about $240 million of book value or roughly 26% of our overall investment portfolio. So it represents a meaningful percentage of our overall investment portfolio.

[Operator:]

Our next question is from the line of Ken Bruce with Bank of America.

[Kyle Rhoades:]

This is actually Kyle Rhoades on behalf of Ken Bruce. I just -- I was wondering if you could give us a little color on the capital allocation decision between the single-family rental homes and your more traditional, either purchased or secondary debt, type investment. It seems that the single-family home with the 6% to 7% current yield is likely going to be lower than the current yield on debt investments, so maybe you can just give us a little color about that capital allocation decision.

[Richard B. Saltzman:]

Sure. I mean, from the beginning, our strategy has been to pursue opportunities coming out of this very severe financial cycle that we've all been living through on the real estate side, including both the commercial sector as well as the residential sector. And it started off for sure primarily through purchases of loan portfolios in the secondary market, both the government and then subsequently for institutions directly. Then increasingly, we were starting to originate new loans also with very high yields as things started to improve, assets started to unfreeze and new financing was basically possible. As we saw the single-family distress evolve and all of a sudden it was clear that there was an opportunity to actually buy vacant homes and rent them, and we could accumulate that in very large scale size and the amount of distress in the single-family market really dwarfed, in this particular cycle, the magnitude of the distress in the commercial market. We decided to dip our toes in the water, if you will, and now maybe we're going further in terms of putting the foot in and maybe the whole leg. But I think it's consistent with trying to pursue total returns that really are kind of mid-teens or higher in distressed parts of the real estate market emanating from the financial crisis. We really have 3 legs to the stool. So it's secondary purchases alone, it's new originations alone and now it's owning single-family homes for rent. And given the incremental $75 million that we just committed to the homes platform, we're now at approximately 20% of our assets. We're certainly very comfortable taking that higher, maybe even to a level of as much as 1/3, consistent again with having kind of 3 legs to the stool. So I think, for now, somewhere between maybe 20% and 1/3 of our assets. As we see things unfold and we see the performance that we're able to generate in the homes portfolio relative to what we're doing in the other parts of our business, we'll make a decision somewhere within that range is kind of our best estimate today.

[Kyle Rhoades:]

Okay, great. That's very helpful. And also, on that single-family home portfolio, can you clarify some of the numbers that you provided on occupancy? I've got essentially 4,200 homes purchased. What percentage of those are leased currently?

[Richard B. Saltzman:]

60%.

[Kyle Rhoades:]

So 60%.

[Richard B. Saltzman:]

Correct.

[Kyle Rhoades:]

And that's running at about 200 homes a month of new leases?

[Richard B. Saltzman:]

Well, the most recent month, almost 300 homes that we leased.

[Kyle Rhoades:]

Almost 300 in October.

[Richard B. Saltzman:]

Yes, and it's been increasing exponentially. As we've been getting more heavily invested in the business and as we have figured out exactly how to renovate these properties quickly and then get them leased up fairly quickly.

[Operator:]

We have reached the end of our allotted time for question-and-answers today. I'll turn the floor back to management for closing comments.

[Richard B. Saltzman:]

Okay, great. Thanks, everyone, for joining us this morning. It was another really good quarter for Colony Financial. We know we had some noise around the ramp-up of our single-family rental investment platform but we actually expect, as we increase our investment in that platform, for results to stabilize sometime during calendar year 2013. Also, we had some noise in connection with the bankruptcy and hopefully, the emergence from bankruptcy for the Hotel Loan portfolio during Q4. But notwithstanding all of that, we think we had a really good quarter, and we appreciate your interest and support and look forward to speaking with you about our year end and Q4 results on our next call. Thank you very much.

[Operator:]

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