ACRES Commercial Realty Corp. (ACR) Q3 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Resource Capital Corp., Q3 2016 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 be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Andrew Farkas, Chairman of Resource Capital Corp. You may begin.

Thank you and good morning. Thank you for joining the Resource Capital Corp., earnings conference call for the third quarter ended September 30, 2016. This is Andrew Farkas, Chairman of Resource Capital Corp., also sometimes referred to as RSO for its ticker symbol. With me today are Bob Lieber, the new CEO of Resource Capital Corp.; David Bryant, the CFO; David Bloom, Head of Real Estate at RSO; and Purvi Kamdar, our Director of Investor Relations. Before we begin, Purvi is going to read the Safe Harbor statement. Purvi?

Thank you, Andrew. 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 the 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. Furthermore, certain non-GAAP financial measures will be discussed on this conference call. Our presentation 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 the 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 Andrew.

Thank you, Purvi. As many of you know on September 8, 2016 C-III Capital Partners of which I am the Chief Executive Officer acquired Resource America the parent company of RSO’s external manager. To give you a little bit background on C-III. We are fully integrated real estate services and investment management company that I founded in 2010. C-III is also led by six other principles the team that has worked together for over 20 years each capitalizing on distressed opportunities in the commercial real estate states. Some of those opportunities were executed while operating Insignia Financial Group which I founded and to which I served as Chairman and CEO from 1990 to 2003. Insignia grew to become one of the largest real estate owner operators in the United States with over 350,000 multifamily residential housing units and over 200 million square feet of commercial real estate space across the U.S., UK, Europe, Asia and South America. C-III is a commercial real estate platform which has grown significantly since inception is extremely complementary to RSO’s primary investment strategies. C-III is an active commercial real estate lender having originated over $5 billion of loans in the last six years alone and an active CMBS investor having acquired bonds in CMBS trust with over $350 billion of underlying commercial real estate loans. C-IIIs platform also includes the following real estate businesses, which create important synergies throughout the family of C-III companies. First the top performing institutional investment management business with $4 billion of assets under management. Also one of the largest CMBS special services in the United States responsible for $70 billion of commercial mortgages. A multifamily residential property manager with approximately 60,000 apartment units under management. The largest network of owner operated commercial real estate brokerage firms with more than 6,700 local market experts on the ground. A leading online platform for commercial property and note investment sales and capital markets transactions that is close over $1.7 trillion in real estate asset and loan sales since inception and the largest only report company in the country. The granular level information obtained from our platform along with our real estate experience and expertise gives us the unique ability to identify and thoroughly underwrite investment opportunities in almost every market in the United States which is the core of how we plan to evaluate investment opportunities and build value for RSO and its shareholders. We understand RSO’s historical performance has been disappointing and frustrating for investors. Our team has experienced successfully repositioning companies or replacing management teams, stabilizing operations and creating investment strategies that grow bottom line earnings and shareholder value. We are confident in our ability to execute that plan which are about to walk through in detail and which will put RSO on a path for sustainable results and growth well into the future. With that, I'll turn this over to our CEO, Bob Lieber to provide some detail around our plan. Bob?

Thanks, Andrew. Good morning. My name is Bob Lieber. We are very excited to introduce our plan and vision for Resource Capital Corporation. We and C-III view RSO is a great opportunity for investors to participate in commercial real estate debt investments under our direction. We've been at the helm here a little over eight weeks now and have been carrying out an extensive review of RSO. This has included in-depth valuation of each of the various business lines, operating businesses and investments on RSO’s balance sheet. We recognized RSO has been a difficult commercial mortgage REIT for the market to understand and the financial results have not been what you want them to be. Key issues that we've identified have been brought up time and time again from analysts, investors alike include. There are too many unconnected business lines several of which were outside of the CRE mandate. Dividends exceed earnings, AFFO as a measure of sustainable operating performance may not be appropriate and leverage and the cost of debt is an excess of that of our peers. We and C-III hear you loud and clear. So what is our plan? Our plan candidly is to simplify the Company and make it more understandable for investors and improve the transparency of RSO’s performance. We're going to do this by disposing of underperforming assets, divesting non-core businesses and investing solely in CRE asset that produce consistent recurring cash flows and pay dividends out of earnings and not just out of cash that’s on the balance sheet. And we began our process started by evaluating the CRE loan portfolio for credit impairments and establishing estimated fair value adjustments for assets and businesses we intend to monetize, as well as to determine the impact of the strategy on our deferred tax asset. The financial impact of the result of this process is a $51.6 million GAAP lost for the third quarter and an anticipated write-down to fourth quarter earnings of $11 million to $14 million. The fourth quarter write-downs are comprised in the following items; $7 million to $9 million will be associated with moving certain legacy real estate loans to held for sale status. These are loans that have underperformed the business plan and the risk weighted return is no longer attractive. And additional $3 million to $4 million is related to reclassify the businesses that we intend to exit as held for sale. It is important to note that we are not required to exit these businesses and will not unless we receive a purchase price in line with our expectations. Additionally $1 million is due to reclassify middle market lending of the discontinued operation as we no longer plan on allocating capital to originating or acquiring syndicated corporate bank loans. We plan on letting this portfolio run off naturally over the next year and will be opportunistic sellers to the extent we can realize proceeds around book value. We understand that these losses are painful to investors and C-III shares in that pain as we own approximately 714,000 shares of RSO. However, we are confident that this change in direction will benefit all shareholders in the future. To summarize, our strategy is to prudently divest non-core and underperforming assets which account for nearly $0.5 billion or 22% of our book asset value. And as we realize the proceeds from the maturity and sales, we will deploy incremental capital into our CRE lending and CMBS acquisition business. We believe this is the right path as the current RSO CRE debt team is very capable of deploying capital and now will be able to leverage C-IIIs expertise in that platform of additional real estate resources. Keep in mind that this process will not happen overnight. We are very committed to a long-term strategy in a space we know extremely well. But we expect that the past ahead maybe a bit bumpy particularly in 2017 as we execute our plan, we’re optimistic that the fruits of our labor will begin to materialize in 2018. As a result of the revised strategy and the new management team we are formally withdrawing 2016 AFFO guidance and we will be updating dividend guidance as well. We want to position RSO for long-term success. The recipe for this success includes stabilizing earnings and growing book value. Up until now RSO has paid dividends which were a significant return of capital. In fact, over the past three years only 22% of the dividends paid have been a return on capital as opposed to return of capital. We believe the dividend should be a return on capital and not just a return of investment dollars. Therefore, for the fourth quarter we intend to pay a dividend of $0.05 per share. We expect the dividend will remain at $0.05 per share for 2017 which we believe will be a transition year. Once we are able to generate consistent earnings, we expect to establish a dividend policy based on a sustainable earnings model for the Company. With RSO trading at a significant discount of the book value, we believe is imperative to stabilize book value and pay dividends in line with earnings. We hope this gives shareholders confidence the dividend they are receiving will have consistent earnings coverage as we go forward. Lastly to improve transparency, we will no longer report adjusted funds from operations and will begin to report core earnings in the fourth quarter which we believe will more clearly demonstrate the dividend coverage. Now let I provided our future plans for RSO, I will ask Dave Bryant, our CFO to discuss third quarter results.

Thank you, Bob. Our GAAP net loss eligible to common shares for the three months ended September 30 was $51.6 million or $1.69 per share. Our GAAP net loss for the three months ended September 30, 2016 includes four significant line items. First, and other than temporary impairment on securities available for sale and intangible assets of $25.3 million most of which is related to collateral in the legacy commercial real estate portfolio that underlies a securitization issued in 2007. Our security interest in that vehicle is supported by 12 CMBS positions and seven commercial real estate loans. As part of our ongoing credit evaluation of our investments, we obtained third-party appraisals with six of the loan collateral properties. The other loan value is supported by an agreement of sale on the real estate collateral. As a result of these appraisals, two assets, the first a property located in Tucson, Arizona and second a property located in Phoenix, Arizona each had assessed values below our loan basis causing a collective impairment charge to the cash flows of the securitization and thus loss recognition bias of $20.7 million. The impairment charge reflects the credit impact of the fair value of the security given the results of the appraised property values. The charge was calculated by comparing the previous projected cash flows of the security to the revised cash flows which included the results of the properties appraised. Second, provisions for two loan losses of $8.1 million were also related to the after mentioned real estate appraisals, a) on a property located in Studio City, California that had been previously supported by contract per sale, and b) on the same property in Tucson, Arizona where we had mezzanine tranche portion of the whole loan held outside the securitization. That loan was previously supported by a broker’s opinion of value that assumes certain concessions and assumptions which are no longer consistent with the going forward strategic plan of RSO. The total credit impairment for real estate positions was $28.8 million for this period. We also experienced an additional loss of $9.6 million to the third item on a previously impaired middle market loan that went into the fall during the quarter, which had us update a third-party valuation as of September 30 that is captured in net realized and unrealized losses in other income expense. In the last several weeks and upon making the decision to exit non-real estate businesses that were funded primarily in taxable REIT subsidiaries, we reevaluated our deferred tax asset and recognized a net breakdown of $12.3 million during the period. This is reflected in income tax expense. Collectively these four items make up the bulk of our net loss during the third quarter. As Bob discussed RSO’s Board approved the framework of a plan to exit several underperforming non-commercial real estate businesses and legacy commercial real estate loans. In the fourth quarter we will reclassify certain of our non-real estate investments as discontinued operations and a life settlement contract investment and several legacy commercial real estate loans as held for sale. The impairments in Q4 ranging from $11 million to $14 million estimate recoverable fair value of the associated assets and liabilities of these held for sale investments. We ended September 30, 2016 with GAAP book value per share of $14.71 down from $17.63 at December 31, 2015. We had a net loss of $1.42 per share and had a $0.55 decline due to the deconsolidation adjustments. We paid dividends of the $1.26 per share, including $0.42 for the September quarter. This was offset by an accretive benefit of $0.15 per share from share repurchases and $0.31 from marks on securities and interest rate hedges. The balance is the expense associated with restricted stock that vested. Our three most recent real estate securitizations are subject only to over collateralization tests, which we have comfortably passed. The structured finance vehicles continued to perform well and produce reliable cash flow. We have total capacity of $650 million on our commercial real estate term facilities and availability of approximately $312 million as of September 30. Further substantially all of our commercial real estate portfolios comprised of self originated whole loans. Our leverage decreased to 1.9 times at September 30, as compared to 2.3 times at December 31, 2015. Most of this decline in leverage is due to the disposition of the middle market portfolio and legacy real estate CDO’s deconsolidated in the first quarter. With regard to commercial real estate leverage we ended Q3 2016 at 2.2 times on our entire portfolio, including cash earmarked for the new real estate loan originations. We remain focused on getting our total commercial real estate equity allocation increased to a minimum of 90% and plan to achieve this goal after we exit the non-core businesses and of course redeploy the capital into commercial real estate. As of September 30, 2016. We had 73% of our equity allocated to commercial real estate and commercial real estate related investments. Adjusted funds from operations or AFFO for the quarter was $12.9 million, $0.42 per common share. In determining AFFO for the third quarter there were several non-cash adjustments that netted to approximately $64.5 million. These non-cash items include provisions, asset impairments and unrealized mark-to-market adjustments that totaled $44.4 million, evaluation reserve with deferred tax assets of $12.3 million and amortization of deferred cost of $4.4 million and also share based compensation and other adjustments that combine to $3.4 million. However, as Bob indicated beginning with our fourth quarter reporting. We will no longer use AFFO as our measure of operating performance and we will move to a core earnings metric. 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. We continue to anticipate recycling capital from our remaining legacy bank loan CLO and legacy real estate CDO over the next year. Each of which is expected to provide a substantial cash either upon liquidation or monetization of the underlying collateral. Coupled with the $115 million of unrestricted cash on hand as of September 30, we have respectable liquidity available as we head towards the final months of 2016. We expect to deploy this liquidity judiciously in risk adjusted higher yielding real estate and CMBS investments, which will happen over the next year. Our selective re-use of the recycled capital will help us grow our real estate portfolio and improve earnings quality with our complete focus on credit quality. With that, I’ll hand the call back to CEO and President of Resource Capital Bob Lieber.

Thank you, Dave. And just to reiterate for the fourth quarter we intend to pay a divided of $0.05 per share and we expect the dividend will remain at $0.05 per share per quarter for all of 2016 which again we believe will be a transition year. I believe that many of you will have questions and remind you that we've only been in this for a little over two months. We're still in the process of refining the strategies and approach that are most prudent for our stakeholders. And we want to be more thoughtful on our approach to answering the questions and concerns you will have. So we will be planning to have an Investor Day once we've made some additional progress with our plan. We believe in are very excited about the prospects for RSO and C-IIIs ability to contribute to RSO’s profitable growth and we're committed to maximizing shareholder value by streamlining and simplifying the Company, monetizing these legacy business lines and assets and deploying capital into commercial real estate debt and CMBS. We believe this plan will allow us produce sustainable earnings and pay out a consisted dividend. I want to thank each of you for joining the call today. We appreciate your support and patience as we work to improve the quality and the consistency of RSO’s performance. And with that, I will open up the call to a few questions.

Thank you. [Operator Instructions] And our first question comes from Jade Rahmani with KBW. Your line is open.

Hi. This is actually Ryan Tomasello for Jade. Thanks for taking my questions this morning. Just in terms of the expected dividend, what level of core profitability does that new dividend imply for 2017? I realize you mentioned it would be a transitional year. Should we assume a lower payout ratio on expected core earnings in 2017? For example, do you expect any anticipated losses to shield you from having to payout 100% of earnings?

Ryan that is a great question and one we wrestle with a great deal here. We expect that 2017 is going to be a bumpy year and we may not have any REIT taxable income for calendar year 2017. We think it’s important to pay a dividend, but the dividend that we're paying is not one that’s targeted to a specific level of core earnings for 2017. The timing of the resolution of the monetization of these different assets and the redeployment of that capital into our business plan as you can all imagine is uncertain and we expect that again 2017 will be lumpy and we're optimistic that 2018 will be in a better path to report a core earnings metric to the market.

And then just taking a high-level view of the strategic plan, can you provide us a summary of the non-core business lines that you would ideally like to exit the amount of equity invested in each and the capital that you would expect to potentially generate from sales, if you are able to execute them at prices that meet your internal valuation.

Well I want to be very careful about putting targets on what we're going to sell and when we're going to sell it for. We have as I mentioned about 22% of the Company's asset book value within these non-core businesses and loans and we're going to look to monetize these at the best price we possibly can and not break out any specific allocations that we have to date any of those specific businesses. We don't want to prejudice our ability to sell assets for the highest value we can, but we actually go to the market to seek business.

And then would it be reasonable to assume any declines in G&A as these sales take place over the next year? Could you lay out what core G&A is for the CRE lending business in particular?

I think those are the kinds of things that we're going to talk more about on an Investor Day. It’s a little early for us to make those estimates today. A lot of these businesses as you’ve identified are embedded in your question carry a level of G&A associated with it. That if we’re successful in divesting and when we're able to successful divesting, should reduce overall G&A cost of the Company, but the details of that are things that we're still digging through today.

Okay, and just regarding the market overall. Can you characterize what you're seeing in terms of borrower sentiment quarter-over-quarter, year-over-year, and highlight any trends in loan spreads? And then just on credit quality, notwithstanding the legacy CRE book, which took some of the impairments and provisions in the quarter, how has credit migrated in the newer assets?

Well I think that overall we look at the market and think that the advantages to the lenders today, there is a lot of maturing debt out there that needs to get refinanced in 2016, 2017, 2018 and we see plenty of that from the position that we sit in see at C-III, the actual spreads and the volatility of the market. The credit we think is getting better, credit spreads and things like that, we’ll see how it goes as it plays out.

Great. Thanks for taking my questions.

Thank you, Ryan.

Our next question comes from Steve DeLaney with JMP Securities. Your line is open.

Thank you, and good morning everyone and welcome to the C-III team. I'm curious, there was a lot to talk about in the press release, obviously, but I didn't pick up a lot of commentary about third quarter lending activity or current pipeline. Could you just comment on whether you are, today, actively lending through the RSO platform?

We are actively in the market searching for lending opportunities there. This is the spigot that you can't just turn on one day and immediately see loans originated the next day. We’ve got a little over $350 million of loan originations so far through third quarter of 2016. We have an active book that we're working today with lots of activity going on there, but it's too early to commit what we're going to end up for all of 2016.

Got it. And the focus will – should we assume the focus will remain on senior floating rate loans, transitional loans?

Yes. On the lending side, yes, we expect that we will be adding to the CMBS portfolio as we go forward to the balance of the year and going forward as a part of our business plan as well, Steve.

Thank you, okay. Could you just talk a little more about the decision just say the – up top. I mean the concept of simplification, focus, transparency, all extremely important and we all totally buy-in on that from your end. Specifically, though, the decision to position the CDO 2007-1. I mean that's CMBS; it's CRE loans. It's nothing in there that you guys don't work with every day. Just curious about the decision to kind of deconsolidate that, get the retained equity interest there? Just get off the books and move on? If you could share any thoughts there as to why not hold it and work it out yourself?

Well, the CDO and buys a lot of different assets in positions as you know note some of those assets are lower earning assets and we think the way the CDO and the waterfall works the return on equity is now what we hope to be able to achieve as we go forward. So we want to unlock that value and free the capitals that we can use to redeploy the lending business as we go forward.

So it's really one of these things of delevering and trap cash, is that kind of the way you view it?

Exactly. The ROE is more attractive at formation, but as you get longer into the life of the CDO, the ROE on the positions we have is perhaps lower than we want as we’d say

Got it. And we've certainly seen that across the industry with the legacy companies. And one final thing, if I could, and maybe this is too detailed, and you're not ready to talk about it, but like the concept of core. There's always been a lot of noise in AFFO. Are there one or two items – I'm just looking at your AFFO reconciliation in press release? Can you point us to one or two items that are included in this $12.9 million of AFFO that you would not look to include under a core calculation. I'm just trying to get to $0.42 of AFFO to a core figure that maybe is more in line with where you set your going forward dividend rate? Thanks.

I think that when we have our Investor Day we’ll walk you through what our proposed core earnings metric is going to be and what gets excluded and what gets included. There are lots of components to add. There is share compensation. There's debt costs that are realized differently, so we’ll walk through that to come up with a metric that we think measures what the performance of the business is.

Okay. Well thank you for the comments this morning.

Thanks Steve.

Our next question comes from Jessica Levi-Ribner with FBR & Company. Your line is open.

Hi guys. This is actually Tim Hayes for Jessica. What are your guys' priority now between preserving capital, growing originations, deleveraging the balance sheet? How do you guys prioritize those initiatives? Then also where does stock buyback now fit into the equation, with the stock looking to open at a meaningful discount to book value?

As we sit here today we don't have any plans to continue with the stock buyback. We've invested I think a little over $35 million under the $50 million we were authorized to do initially, but we don't currently have any plans to buyback stock again using capitals that we want to use to deploy to growing the business. And our first objective is to get the origination business going, so that we can generate more earnings as we go forward and then monetize our way out of the different businesses as prudently and financially and physically as we possibly can. So I hope that answers your question with the priorities, but there's a lot of things to do, we’ve just been getting our arms around it today, but the timing of the monetization of these assets is something we're going to monitor closely, but it's really about taking the capital that we have and deploying this profitably as we can through the balance of 2016 and 2017.

Got it. And then just on a relative basis getting – once you're able to get through divesting everything that you want to divest and redeploy that capital into your core business segment, what is earning – do you expect that will be accretive to earnings power, obviously you guys are kind of shifting around how you're looking at profitability, but should we expect on a relative basis that it's accretive to earnings?

Absolutely. Or we would be doing it.

Fair enough. Thanks guys.

Thanks Tim. End of Q&A

And I'm showing no further questions. I would now like to turn the call back to Andrew Farkas for any further remarks.

I would like to thank everybody for dialing in. As you can see we've spent a tremendous amount of time over a very short period to develop the strategy here to take this operation forward and create the real estate investment trust of which you can be proud that is profitable, predictable and as it consistently growing dividend. We're also focused on growing our book value by building the commercial real estate investment portfolio and as you heard from Bob divesting of certain non-core businesses as prudently and quickly as we possibly can. C-III and the principles of C-III have a tremendous amount of experience in fixing things like this. We're extremely optimistic that we can do that here and expect to do that over the course of the balance of this year and through 2017, so in 2018 we could start seeing the results of that which we’re speaking today. With that, I think we'll stay so long for now and then expect to hear from us shortly including about the Investor Day that Bob spoke about. Thanks for dialing in.