ACRES Commercial Realty Corp. (ACR) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Resource Capital Corp. Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Jonathan Cohen, President and CEO. You may begin.

Thank you. And thank you for joining the Resource Capital Corp. earnings conference call for the third quarter ended September 30, 2015. I am Jonathan Cohen, President and CEO of Resource Capital Corp. Before I begin, I would like to ask Purvi Kamdar, our Director of Investor Relations to read the Safe Harbor Statement.

Thank you, Jonathan. When used in this conference call the words believes, anticipates, expects, and similar expressions are intended to identify forward-looking statements. Although, the Company believes that these forward-looking statements are based on reasonable assumptions, such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those contained in the forward-looking statements. These risks and uncertainties are discussed in the Company’s reports filed with the SEC including its reports on forms 8-K, 10-Q and 10-K, and in particular, Item 1A on the Form 10-K report under the title Risk Factors. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to update any of these forward-looking statements. And with that, I’ll turn it back to Jonathan.

Thank you, Purvi. Resource Capital’s core loan portfolio continued to perform well during the quarter ended September 30, 2015. But overall earnings and AFFO were negatively impacted by two non-core assets. First, our earnings in AFFO were dragged down by start-up loads and market turbulence experienced by our investment in Primary Capital, our residential mortgage subsidiary. We believe that these losses, approximately $3 million for the quarter should decline in the fourth quarter as we should be back to breakeven by the first quarter of 2016. Second our earnings and AFFO were impacted by a reversal of foreign exchange currency losses of $2.1 million that we experienced in the sale of piece of CLO equity. Other than these charges, the portfolio performed well. For the third quarter, AFFO was $0.44 per common share and GAAP net income was $0.21 per common share. Without these charges, it would have been -- it would have approximated $0.60. Now some highlights, we bought back almost $25 million of common stock since mid-August or close to 6% of the outstanding shares from the start date of the repurchase program. Our book value was $17.95 per share, slightly lower than it was at June 30th. We originated approximately $148 million of commercial real estate loans and we ended the quarter with over $128 million of liquidity. We believe that we have a huge opportunity in front of us as the stock continues to trade at approximately 75% of book value. Based on the current situation, we anticipate purchasing additional corporate stock, both common and preferred during the remainder of 2015 and purchasing at least $40 million more in 2016. Make no mistake; we think that our shares are deeply discounted. While we have not and will not manage our Company for the stock price, the stock price does create some new realities. When we can utilize capital to repurchase our stock at a return on equity that exceeds the ROE, we can achieve another investment, we feel that we our compelled to repurchase as much as we can within confines of the security laws governing stock buybacks and also by business realities. Accordingly, we expect to complete the $50 million buyback that we have already announced. And if our securities remain “on sale”, we will initiate another buyback if authorized by our Board of Directors. The reality is that we have a very good business. The ROE that we can generate on newly originated commercial real estate transitional loan is in that mid to upper teens. Our middle market corporate loan business Northport Capital generates almost 14% ROE before taxes. These are good returns. We must continue to originate loans in order to maintain our market presence and to meet the expectations of a loyal borrower base that has generated considerable repeat business. However, based on the realities of the higher ROE that we can get back -- that we can get by buying back stock, we may slow that growth, if we have the opportunity to buy our stock at large discounts to book value. In that gain, as we’ve discussed in the second quarter earnings call, we do have some assets that are generating some optimal recurring returns on equity we are working to sell, finance or otherwise improve those returns but we will not enter into a transaction that may improve current returns at the expense of total returns. Last quarter, we discussed Northport, our middle market lender and our evaluation of how to proceed with what has been a good business that we grew from nothing over the last few years. Northport has a portfolio of loans of about $345 million and about a $190 million of equities invested in it. Northport’s primary competition for the loans it buys our business development corporations or BDCs. At one point, we had strongly considered spinning off Northport as a BDC to our shareholders, which would have had significant tax benefit by moving the business out of the taxable REIT subsidiary. However, the current trading of BDCs is as poor as that of mortgage REITs and we have concluded that spinning off Northport would not benefit our shareholders. We think with the current market volatility and discounts to book value of BDCs having two smaller entities would not enhance value and might impact liquidity. Therefore that is currently not our plan. We are evaluating alternatives on how to maximize value of Northport. We believe that Northport has franchise value and we want to preserve that for all of our shareholders, if at all possible. With the goal of balancing continued development of our core business and maximizing ROE; we are carefully working on our budgets and plans for 2016 and are currently projecting at least $2.65 of AFFO and at least a $1.60 of GAAP net income. That results in AFFO to FFO to book equity ratio of 15%, GAAP net income to book equity is about 9%. As we reduce our share counts, these metrics grew measurably. Now, I will ask Dave Bloom to review our real estate activities.

Thank you, Jonathan. Resource Capital Corp.’s committed commercial mortgage and CMBS portfolio has a current balance in excess of $1.98 billion in a diverse and granular pool. RSO’s commercial mortgage portfolios comprised of 91 individual loans with an aggregate committed balance of approximately $1.8 billion and is comprised of 99% self-originated whole loans and 1% mezzanine and B notes. The underlying collateral base securing RSO’s commercial mortgage portfolio continues to be spread across the major asset categories in geographically varied markets with the portfolio breakdown of 47% multifamily, 19% office, 16% hotel, 16% retail and 2% other such as R&D or mixed use deals. During the third quarter of 2015, RSO closed new loans with commitments totaling $148 million. And since the end of the third quarter, we have closed new loans with commitments totaling approximately $117 million and have another $129 million of new loans in the process of closing. As of today, RSO’s aggregate new loan production activity for 2015 stands at approximately $735 million across 36 individual first mortgage loans. Our origination pipeline remains full and continues to grow, while we still remain keenly focused on credit metrics and overall market and sponsor quality and diversity. We current have to over $300 million of new lending opportunities underwritten, quoted and under negotiation with approximately $300 million of additional opportunities in active underwriting and structuring. In August, we successfully closed RSO 2015-CRE4, our fourth CRE CLO in 20 months. Since RSO’s first CRE CLO in late December of 2013, we have term financed over $1.5 billion of collateral through these transaction at a weighted average cost of LIBOR plus 170 and weighted average leverage of 76%. We anticipate RSO’s weighted average annual yield on retained equity in our CLOs to be between 15% and 18%. In September, we entered into a new $250 million term financing facility with Morgan Stanley, which again demonstrated RSO’s ability to access flexible credit to support our continued growth. The new credit facility brings our total capacity of term financing facilities to $650 million which will be utilized to aggregate collateral while we continually prepare to access the CRE CLO market on a regular basis, as has been our practice. Having recognized peak production levels in our origination efforts, our primary focus remains as always on credit. Our core lending philosophy still places the ultimate premium on asset quality, location and business plans with a significant focus on sponsor, experience and financial strength. Through the application of strict valuation, cash flow metrics and conservative growth and access assumptions, RSO continues to build a strong portfolio and has ready access to term financing through our facilities with our commercial banking partners, as well as in the CRE CLO market where RSO deals have been met with broad acceptance. We remain cautiously optimistic about fundamentals but are constantly studying markets and asset classes and remain on the lookout from markets or transactions that we feel are outpacing normal sustainable growth. This quarter, I am again pleased to report the entire commercial real estate portfolio is performing with no defaults. The positive performance of our portfolio is a daily reminder that validates the credit first approach to lending and selectivity we apply to markets, asset classes and sponsors in our origination process. With that, I will turn it back to Jonathan and rejoin for Q&A at the end of the call. Thank you.

Thank you, Dave. Now I will ask Dave Bryant, our Chief Financial Officer to discuss our financials.

Thank you, Jonathan. Resource Capital Corp. declared and paid a cash dividend for the third quarter ended September 30, 2015, $0.64 per common share. Our adjusted funds from operations or AFFO for the quarter $14.6 million was $0.44 per common share. Determining AFFO for the third quarter, there were several non-cash adjustments that netted to approximately $5.2 million and cash adjustments of $2.6 million. The non-cash adjustments are primarily attributable to the amortization of deferred debt issuance costs and issuance discounts on our convertible notes. All per share amounts stated take into account the one-for-four reverse stock split, effective on August 31st, as though were in full effect for all periods presented for comparison purposes. During the period, we closed RCC 2015-CRE4, our newish $312.9 million real estate securitization backed by 19 commercial mortgages which issued approximately $224 million of non-recourse floating rate notes at a weighted average cost of LIBOR plus 171 basis points. In past, all of the interest coverage and overcollateralization tests in each of our securitizations that require such tests including two legacy real estate CDOs and one remain back loan CLO. Our three most recent securitizations are subject only to overcollateralization tests, which we have passed. Each of these structured vehicles did very well and produced healthy cash flow to us in Q3. One of our legacy bank loan CLOs liquidated in Q2 from which we received an additional $5.2 million in Q3, which brought the total to $12.8 million return to us in 2015. This CLO capital will combine with other recycled CLO capital from earlier in 2015 brings CLO cash return to $42.6 million, which of course we are deploying into our real estate lending platform and to a lesser extent, our middle market loan platform. We now have capacity of $650 million on our real estate term facilities after we entered into a new $250 million facility with Morgan Stanley, during the period. We saw that new whole loan production in our -- from our commercial real estate originators continue in Q3, totaling $489 million year-to-date and $791 million on a trailing 12 months basis. This is providing us with certain benefits. First, we have a strong track record with a credit quality on our originated real estate loans which comprise 99% of our current real estate loan portfolio. Second, we have weighted average LIBOR floors of 49 basis points on $1.5 billion of loans, of which $1.3 billion were funded in our four most recent real estate securitizations that have remaining terms two to five years. This means that incremental increases in LIBOR do not have materially negative effect on earnings. In fact, as LIBOR increases more than 50 basis points, it becomes accretive to our earnings. In Q3, we booked provisions for loan losses of $1 million. Virtually all this charge is a result of increased provisions on our commercial finance and middle market areas which added to impaired positions on an oil [ph] credit held in each segment. We ended the period with $42.1 million in commercial real estate allowances, $1.1 million in commercial finance allowances, and $4.1 million in middle market allowances. In terms of delinquencies, only two bank loans in our commercial finance segment or $474,000 is delinquent out of a portfolio of a $153 million, about 31 basis points. All but one of our middle market loans are current out of a portfolio of approximately $350 million and all 89 of our real estate loans totaling $1.7 billion are current with respect to debt service payments due. Our leverage increased modestly to 2.2 times at September 30th. When we treat our TruPS issuances which have a remaining term of approximately 21 years as equity, our leverage is 2 times. With regard to real estate leverage, we ended Q3 at 2.5 times on our entire real estate portfolio including cash earmarked for new loan originations. We continue to focus on getting our real estate equity allocation increased to over 75%. Lastly, our weighted average cost of capital from all sources of capital was 6.05% as of September 30th. We ended September 30, 2015 with GAAP book value per share of $17.95 down from $18.24 per share at June 30th. We had earnings of $0.21 and saw an accretive benefit of $0.20 per share from our share repurchase plan which of course began during the third quarter. Of course we paid dividends of $0.64 per share and lost $0.04 due to declines in securities that are mark-to-market and $0.02 from a combination of miscellaneous items. Of note, with respect to the securities buyback program, we have funded nearly half of the $50 million authorized by the RSO Board. In October and early November, we have purchased over 720,000 common shares at a weighted average price of $13.05 and this additional activity is approximately $0.11 accretive to book value since September 30th. Our real estate lending platform is in gear and remains centered on underwriting and originating high quality credit combined with a conservative use of leverage. We look forward to further implementing the stock buyback plan in Q4 as we continue to trade below book value on common and preferred stock. We have relatively low leverage, are substantially match funded with non-recourse floating rate term financing on the vast majority of our lending platform. Our selective use of recycled capital is helping us to modestly grow the real estate platform, improve earnings quality and continue with the utmost on credit. With that, my formal remarks are completed. And I hand the call back to Jonathan Cohen for questions.

Thank you, Dave, both Dave. We remain, as a company, very focused and committed to our mission to achieve attractive prudently generated returns for our shareholders while preserving our capital. Over the past 10 years, we have earned a reputation as a dependable and responsible lender and have been able to pay strong distributions to our shareholders. And with that, I will open the call for any questions if there are any.

Thank you. [Operator Instructions] Our first question comes from Jade Rahmani [ph] of KBW. Your line is now open.

Hi, this is actually Ryan Tomasello on for Jade. Thanks for taking my questions. I was wondering if you could provide us with your thoughts on the current state of the commercial real estate cycle including your thoughts on current lending standards. Have you been seeing any indication of lenders compromising on structure and/or term?

Sure, thanks Ryan. This is Dave Bloom. Yes, we certainly see lenders out there who are fighting hard for deals and that’s -- we always fight hard for deals but have remained, as I said, keenly focused on overall metrics as it relates to specific assets, markets in general and most importantly the sponsors and the equity going into the deals. We have not given on structure. And it’s sort of a breakdown of where our yields have been, keeping our structure the same, our spreads have remained relatively constant through our last two CLOs, the February and August deals that we were at 497. And we still continue to pace in a strong way. We are getting our share. We have been in the market for a long time and are as I said cautiously optimistic about fundamentals but there are just certain places we won’t adopt.

And then just moving on, you spent a lot of time talking about the Board’s decision to continue the active share repurchases. Can you just provide a bit more color on liquidity position of the Company and how management thinks about capital availability and access to the capital markets overall?

I don’t think we have much access to the capital markets given that we would never sell stock here, we’re a buyer of our stock, a preferred stock and our common stock and we have access to the capital markets in terms of securitization where we just finished a very probably -- in our opinion the best execution on the Street in terms of liability management there. But just in terms of liquidity, we have decent liquidity, we don’t have tremendous liquidity. So, we are continuing to buy back our shares. We bought back $25 million already over the last few months. We expect to buy more before the end of the year and continue to additional, as I said, into 2016 with up to at least $40 million more of repurchases. A lot of that liquidity comes from order deals that are now paying off from 2008, ‘07, ‘09, ‘10, ‘12 even and instead of we reinvesting that into growing our portfolios tremendously as we have in the past, we look at it that we’re going to modestly grow our commercial real estate book, post runoff, shrink other books or keep books at the same level of the portfolios that are there and any loose assets that are not achieving their correct ROEs will be sold and used to get a better ROE by buying back our shares. So in combination of all those aspects, we feel that we have a very good liquidity going into 2016 and we should be able to accomplish a lot in 2016 in terms of buyback, in terms of our portfolios and our business and of course, in terms of dividends.

And then just moving on, I think a large question on everyone’s mind is the Board thoughts on the current dividend and moving forward into 2016. What are the Board’s thoughts on the current dividend relative to underlying core earnings of the Company which would appear to be below your AFFO metric, given the various add backs for gains and amortization of debt issuance costs that flow through that number, any color would be helpful.

I can’t speak for the Board and I won’t. I know they’re constantly thinking of this issue. But the question really that looms I think in their mind is you are going to earn AFFO of over your dividend next year, would you rather be paying a very large dividend or using more of that capital to buy back shares. And I think that that’s the only question that’s how do we return that money to shareholders, I think is only question that is on their mind.

And then just lastly, digging into the 255 AFFO, you cited for next year, can you give a bit more detail on what you see as driving that as far as with the pace of originations, primary capital mortgage coming profitable and any other drivers to that 255 number that you see?

It’s actually 265, I think that -- and we actually think to be higher than that. Just if you take the current quarter, we were around $0.60 before the market sort of moved what we were doing at primary capital in terms of originations and mark-to-market stuff as well as that one foreign exchange loss, the core portfolio is throwing off around $0.60 now. And obviously as we buy back shares, that number goes up. And because the share cushion not created the book value but created earnings, so you’re layering our shares. And then we do have growth in our commercial real estate book, we put on a lot of loans over the last quarter. We expect to put on a lot of loans in this fourth quarter that we are scheduled to close. We expect that modest I think 10% growth on a $1.7 billion or $1.8 billion portfolio next year. So, you just have a larger portfolio and we’re taking alder equity that’s invested in lower ROE situations and either buying back shares or which of course is immediately accretive or putting it back into commercial real estate at higher levels, all that combined is what drives AFFO to where we expect it to be.

Our next question comes from Richard Eckert of Lahde Capital Management. Your line is now open.

Actually the question is for Dave Bloom. According to your press release, you’ve originated a little less than $500 million in commercial real estate loans this year. Are you still expecting to lend somewhere between $800 million and $950 million in total originations for 2016?

Certainly there, we’re close. And based on the pipeline that we have, we are very comfortable with that. As we move forward, we will evaluate. But we are being selective; we are holding our credit standards playing our game. So, I think that to that extent, not chasing the market, continuing to trade on our repeat business, our strong reputation in the market and just keeping the generally prudent lending standards. Yes, I still feel very comfortable that we’ll be there or close.

Richard, this is Jonathan, I want to remind that that’s up considerably over the last few years. And of course during the period of low stock price here where we have optionality to allocate our capital, to buyback among other things, we’re looking at liquidity all the time. So, it’s not just about growth, it’s about how can we make the best return here.

I understand that, I am just trying to think from a modeling purpose. Is it realistic to build in the expectation of at least approximately $300 million for the fourth quarter when you’ve averaged just a little over 160 for the first three?

Well, my experience has been the fourth quarter is seasonally the largest contributor to asset growth, that’s what everyone wants to close on. I think you’ll see a nice fourth quarter here.

[Operator Instructions] Our next question comes from Lee Cooper of Omega Advisors. Your line is now open.

Thank you. It’s really not a question, more just an observation. I heard you comment Jonathan about dividend. I just give you a word of advice, people own the stock because of the dividend; the stock has been an enormous disappointment since the IPO. The direction of the dividend has been kind of going consistently down. So, I would not be an aggressive buyer of the stock which you are, if you thought that the dividend was not secure due to buy at a lower price or the only argument I would do for the buyback in the face of the dividend possibilities is that we thought we would liquidate the Company and return the book value to the shareholders. So I want to make that clear. My view is if you’re contemplating a dividend reduction, I’ll be very cautious in buying back stock or should buy it cheaper. If you thought there was a chance that the Board of Directors would vote to return the minor shareholders and liquidate the Company and buying back stock at discounted book value will make a lot of sense. People own this because of the income flow.

Thank you, Lee.

[Operator Instructions] We have a follow-up question from Jade Rahmani of KBW. Your line is now open.

Hey, Ryan.

Thanks guys for taking my follow-up. A quick technical question, as far as modeling purposes, can you give any color on how much more of the debt extinguishment gains you might expect to be flowing through AFFO in the near-term?

It’s really depending on how quickly loans pay-off and those deals on line, Ryan, but we do have a decent amount of that modeled in for next year. And I think that when we give a little more color, we typically -- Jon gave some minimal guidance in terms of GAAP net income and AFFO; he typically gave little more detail around that towards the end of the year. I think we can provide that…

We can only provide that at the end of December, early January which we will do. But I would just add that if my numbering had lot of gains at AFFO from extinguishment of debt, it probably -- the AFFO number would have been north of $3, much north of $3. So, we don’t really include very much of that in the guidance that I am giving you.

And I am showing no further questions in the queue. I’ll now like to turn the call back to Jonathan Cohen for any further remarks.

I really don’t have any other remarks. But thank you for joining the call. And we appreciate your ongoing support during this rough period for Resource Capital. Thank you.

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone, have a good day.