ACRES Commercial Realty Corp. (ACR) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q1, 2016 Resource Capital Corp. Earnings. 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] I would like to remind everyone, that this call is being recorded. I would now like to turn the conference over to your host Jonathan Cohen, President and CEO of Resource Capital Corp. You may begin.

Thank you. Thank you for joining the Resource Capital Corp. earnings conference call for the first quarter ended March 31, 2016. 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 in the forms 8-K, 10-Q and 10-K, and in particular, Item 1A in 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. Furthermore, certain non-GAAP financial measures will be discussed on this conference call. Our presentations of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with Generally Accepted Accounting Principles can be accessed through our filings with the SEC at www.sec.gov. And with that, I’ll turn it back to Jonathan.

Thank you, Purvi. First a few highlights from the quarter ended March 31, 2016. Adjusted funds from operations, AFFO was $0.47 per share-diluted. Since inception of the common stock repurchase program in August, we repurchased nearly 8% of our outstanding common shares through March 31, 2016. Net interest income increased $1.6 million, or 7%, as compared to the three months ended March 31, 2015. RSO, the company liquidated its investment in RREF CDO 2006-1, a commercial real estate CRE, CDO on April 25, 2015 and received the remaining collateral of $66.3 million in exchange for its remaining interest after paying off the CDO debt. GAAP net income allocable to common shares was $0.31 per share-diluted. Adjusted for the residential mortgage servicing rights mark-to-market, it would have been $0.39 per share. Economic book value was 17.73, and we paid a dividend of $0.42. With those highlights out of the way, I will now introduce my colleagues. With me today are Dave Bloom, Head of Real Estate; David Bryant, our Chief Financial Officer; and Purvi Kamdar, our Director of Investor Relations. Earning from our core commercial real estate business were strong this quarter, and we expect them to be stronger respectively. We also saw a good performance in Northport, our middle market corporate credit business. We continue to see stable credit statistics, exemplifying the result of prune lending through rigorous underwritings Our existing tern financing facilities in CRE securitizations give us certainty in our financing sources at attractive spreads and we see the markets re-price risk across all sectors. During the first quarter, we had nearly $50 million of CRE loan originations, including funding of obligations of existing loans as we focus on liquidating and refinancing properties and position the company for solid originations. We expect our originations to be in the range of $400 million to $600 million for 2016, mostly taking place in the latter half of the year. As we have stated previously, we have been committed to repurchasing our security. Since the inception of our buyback program through the end of the first quarter, we have repurchased almost $37 million of our security. The company repurchased over $33 million of its common stock, which represents approximately 8% outstanding common shares. We have also bought back approximately 3.5% of our outstanding Preferred B shares. In the quarter, we saw significant opportunities to generate yield for our shareholders via our share repurchase plans and executed on common share repurchase that were accretive to book value by $0.13. We look forward to continuing this in 2016 if those opportunities present themselves. Accordingly on March 15th, our board authorized a repurchase plan of up to an additional $50 million of the company's outstanding securities. During our last call, we stated that we would begin to recycle capital from our legacy CRE, CDOs and bank loans CDOs over the next year. Last week we called and liquidated our investment in RREF CDO 2006-1, our first CRE, CDO, which closed in August of 2006 and had $345 million of assets at closing. We received the remaining collateral of $66 million in exchange of our equity interest after paying off the CDO debt. I want to note that this securitization which invested just before the beginning of the great financial crisis paid every bond, in full and on time. It never failed in interest coverage or over collateralization debt. We think that’s a remarkable achievement for a transaction with vintage and we are proud of that. As we have previously indicated, we believe that Northport, our middle market lending business is ultimately non-optimized by being a REIT subsidiary even though the business continues to perform very well and we are proud of our – its profitable growth, it gained [ph] just in over 2 years. In the fourth quarter, Northport received $105 million of repayments, which resulted in $2.6 million of prepayment fees providing capital for us to recycle into our business. As we focus on reallocating our capital to our CRE lending business, Northports assets were reduced from $376 million to $322 million during the quarter and we anticipate further reduction. We are exploring several options in which we can get at a better structure outside of a REIT and expect to have clarity on this in the near future. When we do so, the capital currently allocated to Northport will be redeployed into our core CRE business. I also want to update you on our residential mortgage business, Primary Capital Mortgage or PCM. In March and April PCM operated profitably, except that we were required to mark as – our mortgage servicing rights to market and that we took a $2.5 million non-cash reserve. The MSRs are continuing to provide volatility to our financial statements and we will review our strategy with respect to them. While this operating segment impacted our net income for the quarter, it has achieved operating profitability and we think it will contribute to net income going forward. Please note that between dividends and share repurchases, we returned over $29 million to our shareholders in 2016 quarter one. We remain steadfast in our commitment to maximizing shareholder value. We are reiterating our guidance of at least $2.65 per share of AFFO and at least $1.50 per share of GAAP net income. 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 $1.85 billion and a granular and diverse pool. RSO’s commercial mortgage portfolio is a 100% self-originated and is comprised of 88 individual whole loans with an aggregate committed balance of approximately $1.8 billion. The underlying collateral base securing RSO’s commercial mortgage portfolio is in geographically varied markets with loans secured by asset in major used categories. The portfolio is broken down as follows, 42% multifamily, 21% office, 21% retail, 15% hotel and 1% other such as mixed used properties. Since the start of 2016, we closed $56.1 million of new loans. Over the trailing 12 months ending March 31, RSO originated $642 million of new loans, inclusive of commitments for future fundings across 35 separate positions. On our last call, I explained that in the fourth quarter of last year, although we remained in the market, we pulled back on originations due to what we felt to be a significant mis-pricing of risk in our long established bridge lending business. We continue to take measured approach to new originations as the market has been recalibrating. During the first quarter we were focused on increasing equity for new loans through liquidating lower leverage, legacy securitization, which allow us to originate new loans at our mid-teens return targets. As Jonathan mentioned, in late April, RSO liquidated our 2006 securitization, received our equity interest in approximately $66 million of collateral that is in the process of being optimally financed. This will free up equity to invest in new loans, as well as increase return on the existing collateral during its short remaining duration. RSOs 2007 securitization is also being prepared for liquidation, and as with the liquidation of the 2006 transaction through the proper re-leveraging we will again optimize returns of any remaining collateral unlock equity that will be used for no originations. In general, CMBS markets still remains volatile, and as I have stated in the past, while we do not originate any long-term fixed rate loans for the securitization market, CRE, CLO pricing tends to track the broader CMBS market. As CMBS markets continue to firm, we contemplate our return to the CRE, CLO market. RSO has been the most prolific issue of CRE, CLOs and has termed financed approximately $1.5 billion of collateral in four separate transactions from December 2013 through August of 2015. The RSO deals were well received by the market and have had a total of 38 separate institutional investors that participated in our CRE CLO transactions. As this market continues to return, we will again access it to efficiently term finance our new loan production. As I have previously noted, RSO is not dependent on capita market taxes in the CRE CLO market. We have great deal of capacity on our term facilities with our commercial banking partners. To that end, I am pleased to report that we are in the process of documenting a new $400 million five year term financing facility with Wells Fargo, which will replace the Wells facility that we have had in place since early 2012. We are again actively building a forward pipeline of new loan opportunities and look forward to returning to a normalized pace of originations, ramping up through the second quarter. We currently anticipate 2016 origination volume to be between $400 and $600 million. We have remained active through the recent retrenchment and are seeing new lending opportunities increasing week-by-week. As banks are pulling back in overall direct balance sheet lending, and with the absence of floating rate CMBS option, RSO is well positioned as bridge lending platform with over 10 years of history and in excess of $3.5 billion of loans closed. The wall of maturities from 2006 and 2007 CMBS loans will surely drive transaction volume for the next few years. As many assets will trade to value add buyers. In addition, the uncertain execution in the CMBS market is driving many owners with high quality stabilized properties away from long-term financing and towards short term financing with certainty of execution. Real estate fundamentals have remained largely in check and we see an increasing demand for our core floating rate bridge loan program. At this point, we feel the market is clearly moving towards us. With markets fundamentals playing in our favor, and the proven ability to term finance our loans in either CRE CLOs or on facilities provided by our commercial banking partners, as RSO continues to allocate more capital to the core CRE platform, we are optimistic about growing net interest margins and overall profitability in a meaningful way. Our primary focus remains as always on credit. Our core lending philosophy places the ultimate premium on asset quality, location and business plan with significant focus on sponsor experience and financial strength. Once again this quarter RSOs commercial real estate loan portfolio is performing with no defaults. With that, I'll turn it back to Jonathan and rejoin you for Q&A at the end of the call. Thank you.

As always, thank you, Dave Bloom. Now I will ask Dave Bryant, our CFO to discuss the financials.

Thank you, Jonathan. Resource Capital Corp. declared and paid a cash dividend for the first quarter of $0.42 per common share. Our adjusted funds from operations or AFFO for the quarter was $14.7 million or $0.47 per common share, a payout ratio of 89%. In determining AFFO for the first quarter, there were several non-cash adjustments that netted to approximately $5 million. These non-cash items included amortization of deferred cost and discounts from our convertible senior notes, valuation reserves on residential mortgage origination, mortgage servicing rights and adjustments related to share based compensation. The deconsolidation of our two legacy real estate CDOs RREF 2006 and RREF 2007 and our one remaining bank loan CDO Apidos Cinco resulted in a reclassification of the assets. Interest rate swaps, and debt held at December 31, to what is essentially a net amount representing available for sale securities held in each CDO. Accordingly, we recorded the required adjustments for estimated fair value through retained earnings and we'll record income on a net effective yield basis on these investments going forward. We passed all of the interest coverage and over collateralization tests in each of our securitizations that required these tests, including the deconsolidated real estate CDOs and remaining bank loan CLO. Our three most recent securitizations in - one in 2014 and two in 2015 are subject only to over collateralization tests, which we have comfortably passed. These structured finance vehicles again performed well and produced healthy cash flow to us in the first quarter. We now have total capacity of $650 million on our real estate term facilities and availability of $392 million as of March 31. We see that our commercial real estate portfolio is now comprised of 100% self-originated whole loans and this core business is providing us with several benefits. We have a strong track record with the credit quality, one are originated real estate loans. We also have weighted average LIBOR floors of 27 basis points on $1.4 billion of loans of which $1 billion are in our four real estate securitizations and have terms remaining from 1 to 4.5 years, and weighted average floor of 0.9%. This means that any potential increases in LIBOR will be accretive to our earnings. In Q1, we booked provisions for loan losses of 37,000. We ended the period with $1.5 million in commercial real estate allowances and $2.7 million in middle market loan allowances. In terms of delinquencies all of our $322 million middle market loans are current and as Dave Bloom mentioned each of our real estate loans are current with respect to debt service payments due from our borrowers. Our leverage decreased to two times at March 31 from 2.3 times at December 31, 2015. Most of this decline and leverage is due to the deconsolidation previously discussed. When we treat our TruPS issuances which have a remaining term of approximately 20 years, as equity leverage is 1.8 times. With regard to real estate leverage, we ended Q1 at 2.4 times on our entire portfolio, including cash earmarked for new real estate loan originations. We remain focused on getting our real estate equity allocation increased to a minimum of 75%. Overall, our weighted average cost of capital from all sources was 5.53% at March 31. We ended the March 31 quarter with a GAAP book value per share of $17.12, down from $17.63 at December 31. We had earnings of $0.31 and saw an accretive benefit of $0.13 per share from the share repurchase plan. We paid dividends of $0.42 per share and had a $0.55 reduction due to the deconsolidation adjustments, which we consider temporary and picked up $0.02 from marks on securities and interest rate hedges. Economic book value as Jon mentioned is 17.73 per share and this metric serves to provide our investors with economic basis, as we expect to again substantially recover our investments in these deconsolidated vehicles. Inefficient to the common shares we purchased during a period, we repurchased RSO Preferred Series B preferred stock during Q1, which provided a $0.05 benefit to common share earnings as we retired those shares. We look forward to continuing to implement the stock buyback plan in 2016 as liquidity allows us and as we continue to trade well below book value on our common and preferred stock. We have relatively low leverage and are substantially match funded with non-recourse floating rate, term financing on the vast majority of our lending platform. In addition to the liquidation of our initial real estate securitization from 2006, we also anticipate recycling capital from our remaining legacy real estate CDO in 2007 and a legacy bank loan CLO, which should happen over the next 12 months, each of these will provide us substantial cash on our liquidation. We can deploy these proceeds in higher return on equity investments, as these legacy financings have been substantially delevered. Our selective re-use of the recycle capital will help us cautiously grow our real estate portfolio, improve core earnings quality, along with the utmost focus on credit. With that my formal remarks are completed. And I'll turn the call back to Jonathan Cohen.

Thank you, Dave. In summary, we are pleased with where we are and continue to maintain a consistent focus on credit quality, high underwriting standards and vigilant management of our investments. Our leverage remains low, and we have an experienced and dedicated management team that will carefully monitor our risk, while continuing to look forward to a stable dividend. We thank you for your continued support. And with that I will open up the call to any questions.

Thank you. [Operator Instructions] And our first question comes from the line of Steve Delaney from JMP Securities. Your line is now open.

Thanks. Good morning, everyone. And congratulations on the progress in the first quarter, really nice…

Thank you, Steve…

Covered by AFFO. I was struck the - your comments about projected origination volume of 400 to 600 after what was a slower start to the year. And I am just curious if you guys were trying or you're looking out to the second half of the year and you are seeing scheduled maturities and are you some how trying to match the flow of your origination pipeline against the actual pay-offs that you have coming in later in the year?

Thanks, Steve. Good question. We're really doing two things in my opinion and Dave Bloom can add whatever to this. One is that we are moving dollars from non-CRE allocation, primarily from Northport over to CRE. So we're timing that and we expect that to pace in quickly here and in the next two to three, four months, and we'll be redeploying those dollars into earning assets at that point, as well as by the way into stock buyback and other things. The second thing is that, we have old CRE, CDOs like 2006 and 2007 in various properties that are on our book that are more in legacy side, as well as even creeping up to 2013 CDO where these things are starting to mature and those deals will be called eventually just like 2006, those dollars are a lot and our low levered and lower earning. So we'll be able to redeploy that into new higher levered earning assets in the current market. So as we see that, we see a lot happening in the back half for this year. Dave, you want to add to that?

Got it…

Yes, I don’t really think I have much to add to Jon, other than, we really do see great lending fundamentals as banks are pulling back, the floating rate CMBS market is essentially non-existent. And quite frankly, as people are now just going to begin ramping risk retention compliant, long-term CMBS deals, there is just going to be I think a whole lot more people who want to let that shake out over the next 18 to 24 months and are going to be looking for shorter term solutions, as we tend to offer.

Thanks, Dave. And Jon on the Northport - on the middle market portfolio, could you give us rough estimate if you were just able to let's just say, theoretically, you were able to sell that portfolio, pay-off any financing, approximately how much capital could come back from that portfolio to be redirected into CRE lending?

Well, I mean, it’s a lot of capital, its – the total amount of capital is probably at 100 and…

$175 million, $180 million…

It’s down in total, if we saw at the whole…

Okay. So about $175 million…

Yes, and that’s about the amount that we would expect…

Okay. And that’s essentially – yes, and that’s the majority of the 30% allocation, you are 70% in CRE now, and it seems like that would be the vast majority of the…

Yes, exactly, and over time that would move us very close to our goal.

Got it. Okay. That’s helpful…

And I just want to add, while the market may think BDCs or whatever are trading in low book values, there is an incredible desire on behalf of institutional and other owners to own the middle market loans, specifically that we originated. And so we're quite excited about the value of them.

It’s funny, Jon, I mean, how the private markets are valuing assets versus the public market is in terms of…

It’s very different.

Public equity versus real money, feed to entirely different attitudes about the same asset. Just one other thing, because I think its important long-term. So we know about what's happened with CMBS, and the spreads and that’s obviously has to have some spillover impact I assume on your floating rate, CRE CLO deals. Over the last one [ph] in August, how far away are we, I guess the extreme is could you do a deal today and just not like the pricing or would you say, you know, funding would not at any price probably not available. Where are we in, you know when do you get back to what would feel like normal? Thanks.

Steve, I can say just to reverse enquiry, we could fill a book [ph]

Okay.

As you know these things tend to ratchet in, they boil out quickly, the ratchet it in a little more slowly. But AAAs have certainly come back to levels that are where we'd seen them in the past. Our BBB tranche is very small. So again, it’s something we evaluate regularly, but do look forward to accessing that market again.

And then definitely is desired, I would say globally from our investors who buy our bonds, to continue to buy our bonds. But you know, at a lower levels they still want to be paid for them and I think we're already starting to see that as ratchet in. So we also have long-term term facilities were re in no pressure to do anything. So we'll just weight it out. Although, I think you might see that if the market opens up we go sooner than later.

Well, guys, good progress in the first quarter. And thanks for your comments.

Thank you, Steve.

Thanks, Steve.

Thank you. And the next question comes from the line of Jade Rahmani with KBW. Your line is now open.

Thanks. You mentioned - thanks for pulling back. Can you quantify the magnitude to which you are seeing this? And I guess, because it make you increasingly cautious about where we are in the cycle or do you think this is just driven by bank concentration risk in CRE and also as you've seen much of an impact on loan spreads as a result?

Let me try to answer them in order. Banks are pulling back certainly in our space where we would run up against banks on a regular basis. They would be obviously a lower leverage option. We have not that much above them. As there are a number of banking regulations out there, we did see in 2015 banks put on a tremendous amount of direct lending obligations and have noted a pull-back and there is certainly regulatory pressure for them to stay that way. There are many, many banks with lots of Tier 1 capital are far better off going in - you know, doing lines, then doing direct lending at a certain point. They are absolutely not going out of the market. But we don’t see them being as aggressive. I think that’s a fairly standard theme and there is been lots written and lots of talk about that. As far as spreads, there is – we're never going to price through the market, but we have pricing power that had been eroding. We were never the low cost provider, but to the extent that we look back at our sort of weighted average spreads in 2014, a little above 5, which was I think frankly high or on the higher side and we were happy to do it, right, LIBOR that was the spread. We see things – we absolutely see things going, you know, loans are more expensive and borrowers who had been adjusting to it, as I said as the markets recalibrating, certainly if closed and the need to refinance is driving business our way, we feel very optimistic about the future and our positioning.

Do you have any concerns that the bank pulled back and tightness in CMBS could lead to a liquidity crunch in the market or it’s not nearly of that magnitude at this point?

It’s not nearly of that magnitude. I mean, there is clearly – look, there is lots of things going on. There is CMBS risk retention issues, there is sort of – there is bank lending caps. But if you look at the balance sheets of the extremely large banks, they are enormous and they are very, very healthy. We tend to play in the $10 million to $40 million space on a floating rate basis, that is not where they can deploy. So quite frankly we again, in our specialized space we really give you it as an opportunity.

And just the loan repayments moderated sequentially, was that due to timing or was that just lumpiness, or as a couple of other commercial mortgage REITs have noted, they did see the volatility in the market impact the pace of loan repayment?

This is Jonathan, I think for us that was mostly just timing and we expect for instance a decent amount of repayments coming forward and we'll turn our machine back on to replace that. And - but for us I don’t think it was the volatility of the CMBS market.

And just lastly, in terms of credit quality in the portfolio, it seems stable sequentially, did you see any indications of deterioration or are there any pockets of concentration in your portfolio that you have concerns?

No, there aren’t. We feel and again we do this quarterly, obviously as opposed every quarter. Things are performing well, ahead of plan and we still see sort of active – an active sales market, an active refinancing market. We are largely in multifamily now, which is - there are still lots of capital chasing it. So we feel – we don’t feel concerned about any of it and we've been through a lot to get to that point.

Thanks for taking my questions.

Thanks, Jade.

Thank you. [Operator Instructions] Our next question comes from Jessica Levi-Ribner from FBR Capital Markets. Your line is now open.

Good morning, guys. Thank you so much for taking my questions.

Good morning.

Morning.

Just one question on your Northport segment, is there - I know you talked about finding a more optimal kind of structure for TBN [ph] is there any timeline for that or is that just something that you work on?

Well, you can see that overall portfolio is shrunk by 15%, 20% over the quarter. There some very active market there, companies have been sold, reified, et cetera. So there is lots of opportunities to shrink the broker base on that. But in terms of a bigger situation that moved us more quickly, as I said in my comments, stay tuned in the near future we'll be updating you.

All right. Thank you very much. And the rest of my questions have been asked and answered.

All right. Thanks, Jessica.

Thank you.

And I am showing no further questions. I would now like to turn the call back over to Jonathan Cohen for any further remarks.

Thank you very much and we look forward to continuing to build the company and speaking with you next quarter.