ACRES Commercial Realty Corp. (ACR) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2017 Resource Capital Corp. Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Ms. Purvi Kamdar, Director of Investor Relations. Ma'am, please go ahead.

Thank you, and thank you for joining the Resource Capital Corp. earnings conference call for the second quarter ended June 30, 2017. I'm Purvi Kamdar, Director of Investor Relations. When used in this conference call, the words believe, anticipate, expect 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. 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 to 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.com. Let me now turn it over to the Chairman of RSO, Andrew Farkas, for opening remarks.

Thank you, Purvi. Hello, everybody. Thanks for dialing in. With me today are Bob Lieber, who is CEO of RSO; Matt Stern, President; Dave Bryant, our CFO; Paul Hughson, who is Head of Debt and Equity Principal Investing for C-III; and obviously, myself. I'm very proud to announce today that we've divested more than half in dollar terms of the non-core assets as part of our strategic plan. As I mentioned last quarter, we're beginning to play offense and deploy realized dispositions proceeds into the investment strategies where C-III has both a successful track record and a platform that provides competitive advantages. Though there's still considerable work to be done, we're confident that we have implemented the appropriate strategy to achieve our stated objective of stabilizing and growing the value of RSO. We look forward to the evolution of this company in the quarters ahead. And I'll make some closing comments once we've heard detail from the operating guys who run the operating businesses. With that, I'll turn it over to our CEO, Bob Lieber. Bob?

Thank you, Andrew, and good morning, everybody. This quarter marks a very important milestone for Resource Capital Corp. as we have sold a significant portion of our non-core assets at attractive levels, including some in excess of book value. Our efforts to execute the strategic plan resulted in several key events so far. First, we resolved our largest held-for-sale commercial real estate loan at close to par, which was greater than our carrying value. This loan was originated back in 2007 and was no longer accretive due to several modifications made since its origination. We have now resolved our 2 largest held-for-sale commercial real estate loans in 2017. Second, we sold the operating platform of a residential mortgage business. We received proceeds of $2.6 million at closing, and we retained meaningful financial assets, which we can now begin the process of unwinding. Our goal is to have this unwind completed by year-end. Third, we sold our passive Pearlmark limited partnership investment for $16.2 million, and eliminated a remaining $33 million commitment to the fund. And lastly, subsequent to the second quarter end, we sold Resource Capital Corp.'s equity interest in LEAF Commercial Capital, our small ticket equipment leasing business, and received proceeds of $84.3 million, well in excess of our carrying value. The results of these transactions totaled approximately $170 million of proceeds. We have previously stated that the sales of the commercial real estate loans and operating businesses are complicated transactions and that the timing and the proceeds realized would be unpredictable. We're proud of not only the value achieved in these transactions but also the timeframe in which they were achieved, given our 12 to 18-month targeted timeframe. The resolutions of Primary Capital, Pearlmark and LEAF are significant steps in our process. To note, Primary Capital had losses of $11 million in 2016, including $29 million of G&A. LEAF, an equipment leasing business where we had $43 million of equity tied up since 2011, has had no cash earnings. And Pearlmark was a passive limited partnership investment with a $50 million commitment. While there's still more to be done, we believe we have taken a meaningful amount of the risk off the table in regard to the execution of our strategic plan. The vast majority of these proceeds have been received within the last 40 days, and will enhance the liquidity available to grow our loan origination business. We are now better positioned to meet our objective of restoring origination volumes to 2015 levels. We will continue to leverage C-III's platform to enhance origination and underwriting efforts while maintaining our high credit standards. Our origination, underwriting and credit focus allowed us to close a $377 million commercial real estate securitization in July, with our notes pricing at the tightest level of any post-crisis commercial real estate CLO. This securitization closed after quarter end and its impact will therefore be reflected in our third quarter financial statements. Also, during the second quarter, we purchased $15 million in commercial mortgage-backed securities. C-III's teams monitors the CMBS market very closely and has a unique ability to identify attractive CMBS investment opportunities. The market is currently trading fairly tightly, but we have been able to opportunistically source attractive trades and are confident our CMBS book will continue to grow. I want to reiterate that while we're encouraged about the progress of our portfolio transformation as well as the opportunities that lie ahead, we remain pragmatic about what is required to improve the long-term consistency of returns for RSO. We remain committed to working through the disposition of our remaining non-core assets in an expeditious yet prudent manner as well as exercising strict credit discipline for future originations. We are keenly focused on preserving and maximizing shareholder value. Next, I'll hand the call over to Matt Stern, who was appointed President of RSO in May. Matt has been a key member of the C-III team since 2010 having previously worked in investment banking, and has brought a wealth of corporate finance, transactional and business development expertise to his new role here at RSO. Matt?

Thanks, Bob, and good morning, everyone. I'm excited to be involved in the day-to-day operations at Resource Capital Corp., and I'm pleased with the recent success we have had with the execution of our strategic plan. I'd like to begin by providing further detail on the strategic plans and would point everyone to Schedule III of our press release. Since the announcement of the strategic plan, through June 30, 2017, we have realized proceeds of over $196 million, including the LEAF transaction, which closed this week. We have realized proceeds of $281 million from the investments targeted for disposition. Including the LEAF transaction, we have remaining identified assets with a book value of $198 million, including $18 million of cash at our PCM subsidiary. As Bob mentioned, we monetized our largest held for sale CRE loan and recorded a $5.6 million GAAP gain. The $67.5 million loan was written down to $61.4 million in the third quarter of 2016, based on a third-party appraised value, and we successfully exited our position for $67 million during the second quarter. This loan resolution, which followed our successful resolution of another held for sale CRE loan in the first quarter of this year, is further evidence of the asset management and loan workout capabilities of our combined platform. During the quarter, we also closed on the sale of our residential mortgage lending business, Primary Capital Mortgage. I would like to point out that this transaction consisted of the sale of the PCM operating platform, which includes the rights to PCM's pipeline, trademarks, sales team, capital leases and certain other assets. It is important to note that RSO retained nearly all of PCM's financial assets, including loans held for sale, loans that were in process, mortgage servicing rights and cash. While we cannot speak to our expected proceeds upon sale, the book value of PCM's retained net assets is $42 million as of June 30, 2017. We have begun the process of liquidating these retained assets and anticipate incurring net additional costs and expenses while running off this business to be approximately $6 million to $8 million. We hope to have this process substantially completed by the end of this year. It is important to note that given its completion subsequent to quarter end, the LEAF transaction is not reflected in Schedule III of our press release. As Bob mentioned, we have received $84.3 million of cash proceeds for the sale of our interest in LEAF Commercial Capital, for which RSO had an investment carrying basis of $43.2 million as of June 30, 2017. Turning to the origination side of the business. We are beginning to see consistent deal flow and believe our marketing efforts, initiated in the middle of the first quarter of this year, are beginning to materialize. To that end, we expect third quarter loan origination volume to be between $150 million and $175 million, and expect volume for the second half of the year to be over $350 million. Historically, our CRE loan origination volumes have trended higher in the second half of the year, and we are optimistic as our pipeline is steadily growing after restarting our originations push earlier this year. It remains a very competitive market, but we believe opportunities to deploy our capital into attractively yielding investment opportunities still exist, and our platform and relationships allow us to compete effectively. That said, we will continue to exercise the credit discipline that is the foundation of C-III's platform, and our management team's track record. Finally, one of the next phases of this strategic plan is to identify expense savings within our business. For 2016, total G&A, including management fees, was approximately $62 million. Of the $62 million, $32 million came from businesses and non-core investments targeted for disposal in conjunction with the strategic plan, and another $4 million came from items transitory or one-time in nature. We will continue to evaluate opportunities to reduce the costs of running our business, and feel the simplification of our business from executing the strategic plan will allow us to make significant progress to that end. I would like to point out that our decision to move certain assets to held for sale was informed in part by the all-in return on equity of each respective business or investment. Businesses like PCM carry high levels of G&A that were widely discussed in the investment community. And certain assets, such as underperforming CRE loans required ongoing modifications and litigation associated with them, generating legal fees and third-party costs that were not apparent on the income statement. We anticipate at the conclusion of this strategic plan that our annual run rate G&A expense should be $25 million to $27 million, or a $36 million reduction from the $62 million of G&A incurred in 2016. This figure excludes all legal, banker and other one-time expenses associated with disposing non-CRE assets and executing our strategic plan. In conclusion, with the success we have achieved in monetizing non-core assets, we are now focusing more of our attention on originating assets and evaluating opportunities to improve core earnings. I will now ask Dave Bryant, our CFO, to discuss our second quarter financials. Dave?

Thank you, Matt. Our GAAP net income allocable to common shares for the three months ended June 30, 2017 was $2.5 million or $0.08 per common share. And our GAAP net income for the 6 months ended June 30th was $5.2 million or $0.17 per share. Our net income for the second quarter includes the following non-core activity: a realized gain of $5.6 million on our largest held for sale real estate loan; realized gains of $1.8 million on the sale of two commercial finance securities; a net loss of $5 million incurred in our residential mortgage lending segment, which includes $4.2 million of net cost related to the sale of PCM's origination platform and a net loss of the $345,000 on the disposition of our investment in a mezzanine debt fund. At June 30th, our GAAP book value per share was $14.12, a slight decrease compared to $14.16 at March 31st. The quarterly decrease in book value can be attributed to the following: net income of $0.08 per share, plus an increase of $0.02 to additional paid in capital, net of a diluted impact of shares vested that is offset by a common dividend payout of $0.05 per share and a reclassification from other comprehensive income of $0.09 per share to the income statement from disposed commercial finance assets. On a stand-alone basis, we expect the positive impact from our sale of our investment in LEAF Commercial Capital on common share book value to be approximately $1 per share, net of tax adjustments in the third quarter. We reiterate the dividend guidance of an annual rate of $0.20 per common share for 2017. We report core earnings as a measure to evaluate our operating performance. We also report a segment view of the core earnings calculation that allows investors to gauge the progress of our strategic plan as we transition to a more focused commercial real estate debt investment platform. We had a net loss to core earnings of $0.10 per share in Q2 2017, unchanged from Q1. We see the loan pipeline increasing in volume and additional opportunities to invest in CMBS, which will ultimately be accretive to core earnings. Our three most recent securitizations that closed in 2014 and 2015 are subject only to over collateralization tests, which we have comfortably passed. Our securitizations continue to perform well and produce reliable cash flow. Our newest securitizations, RSO 2017-CRE5 closed in July. And we paid our term facilities down by $195.5 million. The investment profile of this securitization is comprised of $376.7 million of floating rate loans at a weighted average spread of 1 month LIBOR plus 4.94%. Typical loan origination fees of 1% add 0.33% per annum over a normal 3 year initial term. This securitization has note obligations of $251.5 million at a weighted average cost of one month LIBOR plus 1.03%. And we amortized the deferred debt costs of approximately $4 million over 42 months. Our $1.3 billion commercial real estate portfolio is substantially all floating rate self-originated whole loans. We have total capacity of $650 million on our commercial real estate term facilities and have approximately $439 million available as of July 31. During the three months ended June 30, we closed 4 new loans -- real estate loans, and a total commitment of $84.7 million at an average loan balance of $21.2 million. In August, we expect to liquidate our commercial real estate securitization that was originated in August 2014. Upon liquidation, we will receive proceeds of $25.6 million and the remaining loan collateral of $93 million. Notably, we were able to unwind the 2013 and 2014 CLOs from start to finish in 36 months. We had every loan in these securitizations make every interest payment on time and no holders will be paid in full, which is a credit to our loan structuring and asset management teams. Our universal shelf registration filed in May 2014 reached its expiration after 3 years, so we filed a new shelf in May 2017 that became effective in June. Our GAAP leverage stands at 1.7 times, down from 1.9 at December 31, 2016. The decline was a result of net pay downs of $140.2 million on our borrowings and other liabilities, offset by a nominal increase of our book equity of $1.1 million. We remain focused on the execution of the strategic plan. We believe that we have ample liquidity to fund the business on a going-forward basis and have over $282 million on hand at July 31, 2017. We expect to deploy this liquidity judiciously in risk-adjusted, higher-yielding commercial real estate debt and debt securities. With that, I'll hand the call back to Andrew Farkas.

Andrew?

Hello? I was muted. I apologize. Thanks again, Dave. Thanks for joining the call, everybody. We're pleased with the progress we've made with our strategic plan. While we've made meaningful strides, we'd like to point out, there's still significant work to be done in the disposition of the remaining $200 million of non-core assets. Originally, we stated that we believe there would be a 12 to 18-month process, and to that end, we recognize that our results will remain choppy until the plan is complete. That said, we are ahead of our plan, both in terms of timing and proceeds. To summarize, we've now exited all the non-core operating platforms targeted for divestiture, Primary Capital mortgage, LEAF Commercial Capital and Pearlmark. We monetized our two largest held for sale commercial real estate loans at a premium to carry value and we're making great strides to redeploy capital, by restoring loan origination volumes and ramping up CMBS investing, both of which are at core capacities at C-III and at RSO. We're optimistic we'll continue to make progress now and well through the end of the year and into the future. With that, I'll open up the call to any questions any of our shareholders may have.

[Operator Instructions] Our first question comes from the line of Ben Zucker with JMP Securities. Your line is open. Please go ahead.

I think, since you were closing off your remarks talking about the disposition progress, I was wondering if you could offer maybe any new or updated timeline for the divestment of the remaining held for sale assets? I mean, you guys have done a great job, so far, monetizing these, especially some of the less liquid assets like the business lines that you mentioned. And now that we're just a little bit through the process, I was wondering if you could give maybe like a tighter range for where you see this playing out in maybe 2018 or something?

I think, we are going to stay with our plan we discussed initially. This is going to be a 12 to 18-month process. We're into it now about nine months, so about halfway through there. We have disposed of what we would consider the riskiest part of those assets we have. Those are operating businesses that we weren't in control of. And we now have assets that we can monetize as and when we see fit to realize value. So how that's going to play out is going to be a function of timing and use of cash and what we think we can achieve on those prices and we still kind of stay within the timeframe that we outlined nine months ago.

And I think, I saw you guys have like $100 million of cash at quarter end, and based on some of the subsequent divestments, I would assume that cash balance has only grown from there. So I was just wondering, how quickly do you think you can start turning to offense and put this money to work? How much demand are you seeing for your core loan product right now, kind of outside of what you gave as your just origination guidance, just a more general feel for the market? And then, maybe about the CMBS that you're also targeting, if that's kind of more the AAA product as a yield play, more of a BPs pre and post risk retention kind of securities?

This is Matt Stern speaking. First, to your first question around liquidity, you're correct about $100 million. And then, I think, at the back end of Dave's comment, he touched on the current loan balance, which includes the proceeds for many of the most recent divestitures. In terms of capital deployment, there is a lot of activity remaining in our core business on the lending side and we've seen that pick up from a pipeline perspective materially, as our marketing and activity in the market has increased. We've begun deploying capital on the CMBS side. Traditionally, we've invested in AAAs from a legacy perspective. But more lately, it's been more between BBB's and south. We'll continue to evaluate opportunities across the board in the CMBS space to get yields on a risk-adjusted basis that work. But we think it will take a little bit of time to deploy all the capital. We want to do it prudently and we're kind of legging our way into our asset base over time.

That was very clear. And then, just lastly, I wanted to ask about your floating rate CLO. I mean, the execution seems really good there. And we noticed that you guys got a little bit of a lower advance rate, but that also played out in a lower weighted average costs. One of your peers recently did a similar transaction. I think, they got an advanced rate over 80% with a cost of maybe 45 basis points higher. So I'm just kind of wondering if you guys could just discuss or talk about how you think about the CLO market? Why your securitizations might be structured this way while others might go a different route, if this specific deal has any replenishment features, or will your future deals be similar in structure to this? Any kind of color around that would be very helpful.

You pointed out from a financing perspective, and there, typically, you would see something in the 75% to 80% range. We're certainly very pleased with the execution that we have. One opportunity that is available to us is to finance our retained notes in connection with that transaction, which could increase leverage and provide financing still at very attractive levels, and that's something that we're very much evaluating.

And our next question comes from the line of George Bahamondes with Deutsche Bank. Your line is open. Please go ahead.

I know there's quite a bit of work to do still as you guys transition, but I just wanted to ask a question on the core business. Just want to revisit this. Can you provide some high-level target metrics for your floating rate senior whole loan strategy? Maybe including average loan size, spreads to LIBOR, LTVs, duration? Maybe an example of a loan that you guys have done recently that's in the pipeline? You don't have to get too specific, but I just want to get a general sense of what this looks like?

So the floating rate product is generally 75% to 80% leverage, but the coupons are today, probably LIBOR plus 375 to LIBOR plus 475 or 500. They generally are three year loans with two, one year extensions. Average loan size is probably in the low 20s. Forward pipeline is probably as robust as I've seen it since we've taken over management. So we're encouraged on a go forward basis around that business.

And that does conclude today's Q&A session. And I would like to turn the conference back over to Andrew Farkas for any closing remarks.

Well, thank you again to everybody on the phone call. We appreciate your patience. We appreciate your support. We hope that you are satisfied with the progress that we have made and are as optimistic as we are with regards to the implementation of the balance of the strategic plan and our ability to continue to deploy capital and build the core business to have the business in which you can be proud. We're generating the types of returns that one would expect to see in a first rate mortgage REIT. I want to thank all the members of management for everything that's been achieved over the course of the last quarter, and we look forward to speaking to you next quarter where we hope we have similar or even stronger results. Thanks everybody for calling in.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone, have a great day.