Colony Capital, Inc.
Q1 2013 Earnings Call Transcript

Published: 7 May 2013

[Operator:]

Greetings. Welcome to the Colony Financial Incorporated First Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Lasse Glassen, for Addo Communications. Thank you, Mr. Glassen, you may now begin.

[Lasse Glassen:]

Good morning, everyone, and welcome to Colony Financial Inc.'s first quarter 2013 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 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, May 7, 2013, and Colony Financial does not intend and undertakes no duty to update future events or circumstances. In addition, certain of the financial information presented in this call represents 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 appropriate GAAP measures and an expiration of why the company believes such non-GAAP financial measures are useful to investors. And now, it's my pleasure 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 first quarter 2013 earnings conference call. After a terrific 2012, we're off to a promising start in 2013. In just 2 months since our last call, we have invested and committed to approximately $235 million of new investments, which, combined with the investments and commitments in the first 2 months of the year, amount to more than $725 million of investments year-to-date. This is composed of $295 million of additional commitment to Colony American Homes for an aggregate commitment of $550 million, approximately $380 million in 6 new loan originations and $50 million in a single-loan purchase and a separate loan portfolio acquisition. We are pleased with this level of investment activity and our near-term deal flow prospects appear similarly robust. We are also very satisfied with how these new investments complement our portfolio's overall diversification and risk-adjusted return profile. That said, I'd like to note that of the $725 million of investment activity, we have invested approximately $430 million to date and expect to fund the remaining commitments by the end of the second quarter. Further, our successful capital raising activities in the last 2 quarters have significantly increased our share count, thus retarding first quarter earnings due to the drag from uninvested capital. As such, we don't expect our per share earnings to fully reflect the contribution from these new investments until the second half of this year. Another factor contributing to a temporary drag on earnings is our substantial investment in Colony American Homes. As we explained on our last call, our share of earnings from the single-family homes platform will not be meaningful until the company slows its current acquisition pace and operating results begin to normalize. Separately, Colony American Homes, Inc, the majority interest holder of the Operating Partnership in which Colony Financial has an investment, filed a registration statement on Form S-11 last week with the SEC for a proposed initial public offering of its shares of common stock. This filing unfortunately means we are now in a quiet period and are very limited in what we can say about our investment in Colony American Homes outside of what is otherwise disclosed in the S-11. As such, I am unable to provide much of an update to the information I had provided than the last call, other than a few summary statistics from the S-11 filing and my hope is to provide a more detailed update during our next earnings call. At present, Colony Financial has committed to invest $550 million in single-family homes for rent or roughly 35% of the Colony Financial portfolio. To date, $443 million has been funded with $107 million remaining balance expected to be called by the end of the second quarter. Including Colony Financial's commitment, the Colony American Homes Operating Partnership has now raised total commitments of approximately $2.2 billion in the aggregate, of which approximately $1.9 billion has been called. As of April 21, 2013, Colony American Homes owned over 9,500 homes in 8 states and as of March 31, 2013, the most recent reported data in the S-11, the occupancy of homes owned for 180 days or longer was 86% and the overall portfolio occupancy was 55%. Now speaking of IPOs, it was also announced yesterday that William Lyon Homes has launched its IPO roadshow. As previously disclosed, Colony Financial indirectly owns 2.4 million shares of Class A common stock of William Lyon Homes, prior to the planned 1-for-8.25 share reverse stock split and approximately 291,000 shares following the reverse split. This stock was received as consideration for an earlier land sale transaction. On the basis of the reverse stock split, William Lyon Homes stated in its filing that it expects the initial public offering price will be between $22 and $24 per share as compared to our like cost basis of $8.66 per share. And now, a few comments and thoughts on our other lines of business, Loan Acquisitions and New Originations, which are thriving too. On the Loan Acquisition front, we have completed 1 large first mortgage acquisition and 1 first mortgage portfolio acquisition from a commercial bank so far this year. We currently are underwriting 2 additional commercial bank portfolios and are increasingly starting to see some interesting loan portfolio acquisition opportunities emerge from Continental Europe. The European banks appear to be getting more serious about selling some of their problem legacy loan assets and we are well positioned to capitalize on this opportunity through our substantial existing infrastructure in Europe. We are also seeing some interesting loan to own and recapitalization opportunities arising in Japan. Recent open market transactions by the BOJ, combined with improving commercial real estate fundamentals and a very accretive real estate financing environment, have created some interesting high-yielding loan acquisitions and REO opportunities involving institutional quality assets. We have also demonstrated a significant flow of interesting loan origination opportunities, having invested and committed to approximately $380 million of such transactions to date in 2013. Within this category, we continue to pursue first mortgages on transitional assets, B-notes and mezzanine loans. One of our very significant competitive advantages in the origination business is our ability to commit to fund a large portion of the capital stack as a part of a larger overall financing commitment. For example, we recently committed to a multi-hundred million dollar mezzanine loan on a $1 billion-plus overall refinancing, which enabled us to control an attractive position with a 13% yield to maturity. Also within the loan origination category, we are currently originating first mortgages for a potential CLO securitization later this year. The CLO is a highly attractive way to finance first mortgages on a matched term, nonrecourse basis, generating expected returns north of 12% on retained interest. We are also seeing some interesting loan origination opportunities in certain markets in Europe where commercial real estate debt capital markets remain largely in a state of dislocation. Now before turning it over to Darren, I'd like to provide some additional thoughts on our overall progression. First off, we more than doubled the size of the company last year and now have a $2 billion balance sheet. Secondly, despite investing roughly 1/3 of our capital in Colony American Homes, a rapidly growing, newer business with enormous potential, but a noncontributor to core earnings in the near to intermediate term, we are very confident of the ability to support our current $1.40 per share annualized dividend level from core earnings in 2013. Investments already committed to and funded this current quarter will complete the transition to a sustainable core earnings run rate that supports this distribution level. In addition, a very robust pipeline of deals and opportunities that can be funded primarily with incremental modest leverage on a match term basis, will enhance this dynamic in 2014 and beyond. Last but not least, the volume of platform and other more outsized value-added opportunities is increasing exponentially against the backdrop of an ever improving fundamental and credit environment where size is a critical competitive advantage. We have never been more excited about our future. And with that, I'll turn the call over to Darren Tangen, our COO and CFO, for a more detailed summary of our first quarter financial results.

[Darren J. Tangen:]

Thank you, Richard. First quarter 2013 Core Earnings were $17 million or $0.27 per basic and diluted share and net income was $14.1 million or $0.22 per basic and diluted share. The $0.05 per share difference between net income and core earnings is composed of $0.02 of noncash equity compensation expense and $0.03 of depreciation expense resulting from our interest in single-family homes and our hotel portfolio. Both book value and fair value per share increased during the quarter. Book value per share increased from $18.30 as of December 31, 2012, to $18.58 as of March 31, 2013. Fair value per share increased from $19.35 as of December 31, 2012, to $19.66 as of March 31, 2013. With respect to our first quarter earnings, our share of loss from Colony American Homes was $1.1 million on a GAAP basis and break-even on a core earnings basis, consistent with the fourth quarter of 2012. As Richard mentioned, our first quarter earnings were also impacted by uninvested capital during the period, which should be fully deployed by the end of the second quarter and contributing earnings during the final 2 quarters of the year. We also expect our equity investment in the hotel portfolio, formally known as the Jameson Inns portfolio, to produce stronger earnings in the second half of the year as the benefits from our recent management restructuring and rebranding begin to take hold in what is also typically the stronger seasonal quarters for the business. We also expect the continuation of asset management successes in 2013 from loan payoffs and loan resolutions across our various loan portfolios. Within our seasoned, small balanced loan portfolios, which include 15 investments with a total book value of $236 million and an average purchase price of $0.52 on the dollar, we have resolved approximately 32% of the unpaid principal balance as of March 31, 2013, and total collections on these resolved loans average 1.4x our purchase price basis, consistent with year-end. Trailing 12-month weighted average current yield for the remaining loans in these portfolios as of March 31, 2013 was 8%, also consistent with year-end. And as we've mentioned previously, 5 of our 8 FDIC loan acquisition portfolios have either paid off or fully deceased [ph] their acquisition debt and are now distributing cash to the equity. Regarding capital markets activity, total capital raised year-to-date from a common stock offering and the convertible notes offerings totaled approximately $426 million, all of which have been spoken for in terms of deployment and we expect to have invested all of our capital, including the availability under our $175 million credit facility by the end of the second quarter. And as I've mentioned previously, we are in the midst of at least doubling the size of our credit facility and intend to have that completed by the end of the second quarter as well. Additional liquidity is also expected from several investment level financings, A-note sales and loan payoffs, which all combined should provide sufficient runway in the near-term for our considerable investment pipeline. I'd like to spend a minute on our recent $200 million convertible debt issuance. From the outset, we have communicated a general conservatism towards permanent recourse leverage on Colony Financial's balance sheet, and this philosophical approach to debt continues to hold true today. However, with the $1.5 billion total equity capitalization currently, very limited leverage overall and improving economic and real estate fundamentals, we felt it was appropriate to introduce a prudent amount of leverage to the corporate balance sheet through an equity-linked, longer maturity date, unsecured debt security. While most of the convertible debt issuances in our peer group have been done with a 5-year term, we ultimately decided to issue a longer dated 10-year security and we were pleased with the 5% coupon and up 10% conversion premium. We have demands for much more than $200 million, but we wanted to balance the quantity of new capital and expected deployment timing so that near-term earnings disruption was limited. This issuance should be accretive to shareholders upon full deployment of the capital and furthermore, we believe that this capital markets transaction exposed our company to a new universe of investors, which should be beneficial to us in the future. As we have always maintained, Colony Financial is a premier real estate financing investment company dedicated to delivering a diversified total return in the form of current earnings and capital appreciation. 2013 is shaping up to be a transformative year for Colony Financial, marked by a significantly larger balance sheet with approximately $2 billion of assets today, the ongoing ramp up and exciting changes afoot for Colony American Homes, and the increasing opportunities to harvest gains in our legacy investment portfolio such as William Lyon Homes and our FDIC loan portfolios, which bode very well for more significant earnings growth in 2014 and beyond. That concludes our prepared remarks and we'd like to now open the call up to Q&A. Operator?

[Operator:]

[Operator Instructions] Our first question is from the line of Jade Rahmani of KBW.

[Jade J. Rahmani:]

I was wondering if you could comment on the size of the investment pipeline and put it into context in terms of the value of deals you're seeing, whether the average deal size is increasing and sort of the volume that you're seeing on a week or monthly basis and what your expected win rate is. Just basically, the size of the investment pipeline and how you see it in context.

[Richard B. Saltzman:]

Jade, it's Richard. Yes. Pipeline generally is increasing and deals really of all sort, both here in the U.S. as well as outside the U.S. and I would say it's really in all flavors, which is to say that some deals consist of small loan balanced portfolios like we bought historically from the FDIC. But now, increasingly, we're buying, we're looking at from the banks here in the U.S. On the other hand, I mean, I think outside of the U.S., we're probably seeing more larger balance portfolios and transactions that we might pursue. And in the new originations space, again, I think it's kind of all flavors, but with a tendency for us of focus maybe on some of the larger opportunities where size is a competitive advantage as we just cited in the prepared remarks that we delivered. So with that as just a backdrop, I'm going to maybe turn it over to Kevin Traenkle, our CIO, just for a little bit more granularity.

[Kevin P. Traenkle:]

Yes, Jade, as Richard mentioned, the pipeline is huge. We have well over $2 billion of deals that we are actively negotiating term sheets right now. I don't remember a time where we've had that much in the shop, all at one time. There's different types of deals that we're looking at, as Richard alluded to, several large portfolios, debt that we're underwriting right now, several large loan originations on portfolios of assets that we're also underwriting. I would say that the pipeline's never been bigger.

[Jade J. Rahmani:]

Okay. Specifically on the $175 million mezzanine loan on the whole hotel portfolio, I wanted to find out if this is a new origination that was unrelated to any of your prior investments and also if Colony Financial was the sole mezzanine lender or if there's a co-participation with any of the Colony funds?

[Darren J. Tangen:]

Jade, it's Darren here and I'll take that one. This particular refinancing is a transaction that we've not had any prior history with, so it is a new transaction for Colony. It is a refinancing of a legacy capital stack for this particular portfolio. And to answer your second question, Colony Financial will be joining other Colony-managed vehicles and some other co-investors to complete that transaction.

[Jade J. Rahmani:]

Okay. So in other words, it's the sourcing of that loan and the overall pipeline is still through the Colony funds and we should expect the co-participation structure of your investments to continue?

[Richard B. Saltzman:]

Generally, yes. So Colony, the manager in effect, is sourcing all of these transactions that we end up investing in. And for the most part, that we'll continue to be sharing with other Colony-managed vehicles. In certain circumstances, depending on opportunity set, type of transaction, regulatory considerations, that sort of thing, Colony Financial may be the 100% participant as we have been in the past. But on the one mezzanine loan that's being referenced, we're a joint venture partner with other Colony-managed funds.

[Operator:]

Our next question is coming from the line of Dan Altscher of FBR.

[Daniel K. Altscher:]

I have a question that I think you guys sort of alluded to that you have a lot of -- we're seeing some amount of repayment coming, loan payouts coming and some I guess, availability on the credit facility. Can you just give us a sense of kind of quantitatively what -- how much that might that be or how much dry powder you think is coming onboard or is going to be available to fund the robust pipeline?

[Darren J. Tangen:]

Yes, Dan. Darren here, and I'll take that one. I mean, payoffs are coming through a couple of forms. I mean one, our pro active resolutions that we're pursuing in some of the loan acquisition portfolios that we've done, so this is the FDIC portfolios and the non-FDIC portfolios. And typically, we're the catalyst or we're the ones who were triggering those payoffs and resolutions through our asset management company. In the origination part of the book, we do have some positions there where we do expect to have some payoffs as well. And if we think about all of that in the aggregate, I think earlier in the year, we had suggested that we could have $100 million to $150 million over the course of the year of payoffs and distributions from these loan portfolios. I'd say sitting here today, that was probably a little on the low side. It could end up being more like $150 million to $200 million over the course of the year. So it could produce some pretty meaningful liquidity for us. The other thing that, again, I think we alluded to in our remarks, is we've got 3 different loan portfolios that we've been in the process of putting some nonrecourse matched term financing on. And in doing so, really through commercial bank market, and that's where you can go and get 50% to 60% leverage at a pricing of sort of LIBOR plus mid to high 300s. Again, on a matched term, nonrecourse basis on a portfolio of loans that we've acquired. So that's another source of liquidity that we are expecting here in the near term.

[Daniel K. Altscher:]

Got it. That makes a lot of sense. And I guess without getting too much into details, for the loans that are being paid off by -- that have been paid off, do you think the yields that you're seeing on new opportunities in the pipeline are equal or better to what's being wound down?

[Darren J. Tangen:]

As a general matter, they're equivalent. But what I would say is I think, we've moved from a couple of years ago, being consistently at the top of the capital stack to many more situations where we're in more of a subordinate position and/or in no circumstances, where we continue to be at the top of the capital stack, either more off the run asset classes or alternatively, transitional situations where -- there's some more complicated part to the story as opposed to a plain vanilla credit. Because frankly, plain vanilla credit prices very efficiently and those kind of yields are really not of interest to us.

[Richard B. Saltzman:]

And then, Dan, on the domestic loan acquisition side of the business, whereas in 2009 and '10, we were largely acquiring those portfolios without the use of leverage. As I was just highlighting, there's very attractive match term nonrecourse financing available today to buy these loan portfolios. So I think what is different today versus a couple of years ago for that business is that we will utilize a prudent amount of leverage, meaning 50% to 60%, when we are acquiring those particular types of assets.

[Daniel K. Altscher:]

Got it. And I'll just try to sneak in a quick housekeeping question. If you could just kind of give us what do you think the drag was on earnings from the Single-Family Rental business this quarter?

[Darren J. Tangen:]

Well from a quarter earnings standpoint, 0 basically. Because I think we said it was breakeven and from a GAAP earnings standpoint, it was about $1 million.

[Daniel K. Altscher:]

Perfect, that was what I was looking for.

[Richard B. Saltzman:]

And just also to put that in the context, Dan, I mean, that roughly 1/3 of our portfolio, right, that was not contributing any core earnings.

[Operator:]

Our next question comes from the line of Steve Delaney of JMP Securities.

[Steven C. Delaney:]

I wanted to ask you about your CLO. I mean, we are seeing some -- a little more liquidity and better terms there and I was just curious if you were thinking about a more -- one of the more flexible structures, say a floating rate structures that might have a replenishment period for a couple of years, is that the type of thing you had in mind?

[Richard B. Saltzman:]

It is, Steve. I mean, there's really sort of 2 variations of that. There's the static CLOs where you don't have that reinvestment capability and then the managed CLOs and it's really more of the latter is the structure that I think we're contemplating at this time.

[Steven C. Delaney:]

Yes, I mean, I guess you might have a little higher spread over LIBOR there, but it would seem if you're talking about 2- to 3-year transitional loans, it seems you can extend the life such that the thing doesn't delever so fast.

[Richard B. Saltzman:]

That's correct, yes.

[Steven C. Delaney:]

And my other question is I guess, up at the 60,000-foot level. As I was looking through your press release last night, and Richard, I guess maybe this is -- since you've got all the years of experience in real estate, maybe this is a good one for you to take. Something struck me. I was reading through your loan activity in the first quarter and I'm sitting here focused on Florida and I saw some irony in my mind that I saw the word development in here 2 or 3 times respect to new loans and then I see a loan where a performing first mortgage retail asset in Florida that you can buy that at 78% of UPB and on the same token, you're seeing new out-of-the-ground projects that you're comfortable lending on. So I guess I'm curious if that's -- there's some commentary hidden in there about the nature of certain markets and is this just a case where real estate markets by definition are local in nature, as opposed to just general?

[Richard B. Saltzman:]

Yes. Look, I think to some degree, you're answering your own question there with your latter comments. I think real estate markets are definitely local and if you look around the country right now, we're only really beginning to see the start of recovery, right? I mean, I think, from a real estate perspective, the last kind of 3, 4, 5 years has really been more about trying to find the bottom and trying to clear the air with respect to the uncertainty and the confusion that was kind of hanging over all of us as a result of the financial crisis. Now, we're beginning to see the seeds of recovery and frankly, it's very uneven as you look across the country. So there are a few select major markets where new development can make sense, given the economic environment, despite the fact that it's still kind of 2 steps forward, 1 step back, and there's a lot of headwinds out there. And certainly in Florida, the Miami market, which has been spurred by Latin America, it's one of those markets where you can justify new construction on a residential side, believe it or not, despite how terrible it was at the beginning of the financial crisis. And then if you look at other markets, like where we bought that particular loan that you were referencing, which is in Orlando, there's still opportunities based on existing distress. So it's a little bit a tale of 2 cities out there, very uneven across the country and again, I think from a visibility standpoint, we're only at the beginning of the up cycle.

[Steven C. Delaney:]

There's a message in there that waterfront is always a nice little plus in real estate. I was curious though, as you -- since we are -- I have noticed the more development activity and we're seeing it with some others too. This is certainly not just Colony, we're seeing it in Manhattan as well. But what would you normally -- when you structure these loans, they're obviously very attractive, 14%, 15% type of yields. What are you looking for as you position your first lien, what type of target LTV range and how much hard equity are you looking at from these developers?

[Richard B. Saltzman:]

Sure, Steve. Let me try to take that. I think what we're looking for in those instances is a meaningful equity contribution from the sponsors. So from a leverage standpoint, I think we don't want to get up much higher than 60%, 65%. And again, we want to see a meaningful slug of equity coming in from the borrower, from the sponsor. And then usually, with the way we are structuring these loans is, with a shorter term to really bridge to the more permanent construction financing and equity capitalization to begin that vertical construction and then ideally, what we'll do is we'll take an option on whether we want to roll some or all of our capital into the capitalization of the vertical construction. So that's usually the way we're approaching these kind of deals in this market right now.

[Operator:]

[Operator Instructions] Our next question is from the line of Jason Arnold of RBC Capital Markets.

[Jason Arnold:]

I guess just as you shift your growth focus from single-family toward the loan acquisition origination activities, I was wondering if you could speak to the segments of the market that are particularly intriguing to you right now, maybe by asset type or segment on the capital structure, both on the domestic side. And then as you mentioned, seeing opportunities internationally, maybe some commentary there would be useful.

[Richard B. Saltzman:]

Okay. Well, first of all, this was really the beginnings of Colony Financial, we're in the loan acquisition side. And then kind of second stage, we expanded to loan originations as transactions and volumes really started to accelerate. And so really, the most recent investments that we've been making are in the single-family home for rent space. So yes, on the one hand, we ramped that up very quickly and it now equates to 35% of our balance sheet and we're certainly at a pause state given the S-11 filing and in effect, only investing capital incrementally at the margin back in the original 2 spaces that we were invested in. But to come back to your specific question, first of all, we're agnostic to property type. Generally speaking, geography, there might be a few places that we wouldn't want to invest in. But we're agnostic with respect to property type as long as the risk reward trade-off is incredibly compelling. And so, initially, we were focused on top of the capital stack transactions and as I was saying in an answer to an earlier question, I would say generally speaking, particularly on the origination side, we've been moving to more subordinate financings, more transitional assets, more off-the-run asset classes, that sort of thing. But I think in terms of loan acquisitions, that's still generally first mortgage positions. Again, FDIC is probably coming to its end, in terms of those divestitures from having taken over banks. On the other hand, we're seeing a lot more in the way of volume from financial institutions, which did survive the crisis who are now starting to deal with their own balance sheet considerations and issues. And then as you migrate outside the United States, we seem to be more at the same phase or stage where we were here in the U.S. just a few short years ago, so back at the beginning, where we're seeing a lot more first mortgage type opportunity, REO opportunity. So depending on where you are in the world, you're at a different stage or phase of coming through the crisis, the U.S. being, let's say, more in the middle towards the end where we're now really seeing good visibility on recovery, albeit somewhat uneven around the country, as I mentioned earlier. And then in places like Europe, just the beginning of really dealing with the financial problems that the banks have and maybe a somewhat similar opportunity in Japan as we referenced. So hopefully, that adequately addresses, Jason, your questions but that's kind of a tour around the globe.

[Jason Arnold:]

That's great. So I mean, I think the lower end of the capital structure then probably is -- it's probably where your focus is domestically, just to kind of paraphrase what you're saying. And then probably, the upper end is maybe more interesting in Europe at this point in time?

[Richard B. Saltzman:]

Yes. I think that's fair. I think if anything, we're migrating in the U.S. to more equity, right? I mean, whether it’s the investment in the single-family for rent platform, which is pure equity or whether it was the hotel portfolio that we foreclosed on, which is now in an equity investment for us, some of the preferred equity deals that we've originated more recently and we're looking at other kind of interesting equity opportunities. So I think on the one hand, yes, people look at us and say we're a mortgage REIT, but on the other hand, I mean, I think if you look at our exposure, more than 40% already is in equities.

[Operator:]

Ladies and gentlemen, we have reached the end of our question-and-answer session for today. We will now be turning the floor back to management for closing comments.

[Richard B. Saltzman:]

Okay. Well, thanks, everyone, for joining us today. As always, we appreciate your support and we look forward to speaking with you again in a few short months. Have a good day.

[Operator:]

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