ACRES Commercial Realty Corp. (ACR) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2018 Exantas Capital Corp. 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 introduce you host to today's conference Mr. Andy Karr, Head of Investor Relations. Sir, you may begin.

Good morning and thank you joining our call today. Before we begin, I would like to remind everyone that certain statements made in the course of this call are not based on historical information, and may constitute forward-looking statements. When used in this conference call, the words believe 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 based on management's current expectations and beliefs and are subject to a number of trends, risks and uncertainties that 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 Form 8-K, 10-Q and 10-K and, in particular, the Risk Factors section of our Form 10-K. 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 are contained in our earnings release for the past quarter. I would now turn it over to the Chairman of Exantas Capital Corp., Andrew Farkas, for opening remarks.

Thank you, Andy. Good morning, everyone. Thanks for joining the call. With me today are Bob Lieber, our CEO; Matt Stern, our President; Dave Bryant, our CFO; Paul Hughson, our Head of Commercial Real Estate Lending; and of course Andy Karr, Head of Investor Relations, from whom you've already heard. Since we announced three brand of the company in May of this year, a trajectory of our earnings has continued to increase at our core investment portfolio gross. Over $1 billion of new transitional commercial real estate loan origination and CMBS investment activity in last 12 months is driving the continued net growth of the investment portfolio. The acceleration of core earnings resulting from - sorry - of the core portfolio growth has supported another anticipated increase in our dividend to $0.175 per share in the fourth quarter which will recommend to the Board for approval when immediately end of the fourth quarter. This would be the third consecutive increase in our quarterly dividend which is increase from $0.5 per share established when we announced strategic plan in November 2016. That's overly 300% increase during that period of time. When the strategic plan is behind us, the Company's operations always complicated, thus making the potential earnings power of the Company easier for shareholders to understand. I am pleased with the results in the third quarter and the prospects for additional quarter earnings growth. We look forward to reporting those results to you on our future calls. With that I will turn it over to our CEO, Bob Lieber.

Thank you, Andrew, and good morning, everybody. For the third quarter of 2018, adjusted core earnings increased to $0.24 per common share, up from $0.20 a share in the second quarter and up from $0.03 a share in the first quarter. As Andrew mentioned, the positive trajectory and adjusted core earnings is a reflection of the growth from the Company's investment portfolio, which group by over 100 million during the third quarter and almost 350 million during the nine months ended September 30, 2018. This is net of payoffs, pay downs and sales. This growth in our investment portfolio and the stability of our pipeline, despite a competitive investing environment is driven by several factors. The first of which is a real estate transaction volume remained strong, creating lending opportunities, and from a macro perspective, commercial real estate is generally continue to perform well, as operating fundamentals across property types and desirable domestic markets are driven by the strength of the local U.S. economy. Secondly, our ability to capture our share lending opportunities. This is a function of XAN's increasing presence in the marketplace, an extensive lending relationships as evidenced by many repeat borrowers and the relationships are supplemented by lending relationships derived from C-III's large commercial real estate platform and its management team. The third is leveraging C-II's core competency in investing in commercial mortgage backed securities, which provides longer duration assets enhances the diversification of the Company's balance sheet. As we continue to move forward towards full deployment and execute on our business plan, we expect core earnings to continue to increase. We anticipate substantially achieving full deployment in the second half of 2019 and referenced outpace the payouts in 2019 will be bolstered by a significantly lower principal balance of loans, which were expected to pay off in 2019 as compared to 2018. Once fully deployed, the annual earnings of the profile was expected to be consistent with the core earnings profile presented on Page 12 of our August 2018 Investor Presentation. As you heard Andrew mentioned, we believe our near term earnings outlook were anticipated third consecutive increase in the quarterly dividend to $0.725 per share for the fourth quarter. We carefully consider book value as well as core earnings were making dividend recommendations to the board and as core earnings visibility continues to improve, we will continue to evaluate different policy and discuss regularly with our board. In fact looking at the balance sheet, book value increased for the second consecutive quarter to $14.23 per share at the end of the third quarter, which is up from $14.09 in the second quarter and $13.92 at the end of the first quarter of 2018. The increase in book value for this quarter is attributed mainly to number one, net income of $0.19 per share, an additional unrealized gains of $0.08 per share from marking our CMBS portfolio and related swaps to the market and it's been offset by the payment of our $0.15 per share dividend in the third quarter. As we look ahead to 2019, we're optimistic about the growth potential. And with that I'd like to turn it over to Matt for some more details.

Thank you, Bob, and good morning, everyone. I'd like to begin by taking a closer look at this quarter's origination activity. At September 30, 2018, our commercial real estate loan portfolio which comprised of 1.5 billion of floating rate, self-originated whole loans, which grew by 69 million during the third quarter as new loan origination exceeded payoffs and pay downs. Our commercial real estate loan origination team continue to see quality lending opportunities was resulting in a strong deal pipeline, which is further enhanced by the CC-III platform. In the third quarter, the Company originated 245 million of CRE with a weighted average spread of 343 basis points over 30-day LIBOR. As summarized on page two of our earnings release, despite some spread compression during the quarter from market competition, the weighted average unlettered yield of new originations has been largely unchanged over the last 12 months. The weighted average spread for loans originated during the third quarter of 2018 was 76 basis points tighter than the weighted average spread for loans originated during the same period a year ago. Similarly, the weighted average spread of XAN's entire CRE whole loan portfolio compress its future basis points when comparing the portfolio at September 30, 2018 to the portfolio at September 30, 2017. However this spread compression has been substantially mitigated as we have reduced the spread on our cost of funds by 50 basis points over the last 12 months. And as the floating rate lender, we benefit from the rise in LIBOR which has increased by 103 basis point during the same 12 month period. During the third quarter, we continue to diversify the Company's portfolio by investing in CMBS, where we see attractive investment opportunities that offer duration. At September 30, 2018, our $395 million CMBS portfolio at par was comprised of $218 million of floating rate bonds and $177 million of fixed rate bonds, which we have hedged. During the third quarter, we acquired 48 million in base amount of CMBS bombs. Similar to the loan asset class, CMBS yields have compressed, while we continue to selectively invest and remain focused on credit quality. We have also been presented with opportunity to sell and have done so opportunistically to realize quality gains on our CMBS investments. Based on loan commitments and CMBS investments close through September 30, 2018 plus the Company's current pipeline, we expect total volume for 2018 to exceed our 2018 guidance of $1 billion, which we provided in March of this year during our fourth quarter 2017 earnings call. Following the end of the quarter, we improve the terms of our asset level financing through a new warehouse facility with J.P. Morgan. This provides several benefits for the company. Not only it's the new facility structure with attractive terms and flexibility, but J.P. Morgan is another firm that is also highly regarded for its CLO structuring and market execution capabilities. As CLO financing is an important and attractive financing source for the company, we are pleased to add another highly regarded financing and structure partner. Finally, turning to the strategic plan. We have concluded that for one of our remaining assets in longer holding period and an additional funding commitment will be advisable over the next few quarters in order to match up - to delay in exiting this investment is unfortunate. However, we believe this path is the best course of action to maximize proceeds and we will therefore pursuit this path accordingly. We are pleased with the continued progress in growth of the core earnings and book value this quarter and look forward discussing future progress in the quarters to come. With that I'd like to turn it over to Dave Bryant to discuss our financials.

Thank you, Matt. Good morning. Our GAAP net income allocable to common shares for the three months ended September 30, 2018 was 6 million or $0.19. Core earnings for Q3 2018 was 5.2 million or $0.17 per share common share and adjusted core earnings was 7.6 million or $0.24 per common share. We saw growth of 1 million or approximately 8% in our net interest income for Q2 2018 as compared to the second quarter of 2018 and had an increase of 4.4 million or proximately 43% over the third quarter of 2017. Three items are driving these increases in interest income. First is the incremental net asset growth in our core investment partner. In that growth in the par value of core earning assets was 347 million or 22% and 422 million or 28% for the nine months and trailing 12 months ended September 30, 2018 respectably. As of September 30, 2018, match funded and floating rate CRE and CMBS assets at par comprised of 89% of the core investment portfolio totaling 1.9 billion. Second is the lowering of our cost of capital when our asset based incorporates financing. Although we have seen a decrease in the spread on our self-originated CRE loans, 419 basis points for the third quarter of 2017 to 343 basis points during Q3 '18, a decline of 76 basis points, at the same time as Matt indicated, we have seen LIBOR increased to 103 basis points. Concurrently, we have improved our financing spread from 212 basis points at September 30 of 2017 as compared to 162 basis points at September 30, 2018, a decrease of 50 basis points. This decrease as a result of several factors. One, the course of factored issuance of our 2017 to 2018 CLOs. Two, the unwinding of our 2015 CLOs and payoff of related outstanding borrowings with higher costs. And three, negotiating lower interest rates on our CRE warehouse facilities. Third is the accretive benefit to equity from rising LIBOR on our floating rate core CRE credit investments. In fact, we estimate that LIBOR were to increase prospectively by 100 basis points, are annual core earnings would also increase by our proximately 6 million per year or $0.19 per share. Our net income for the third quarter of $0.19 per common share includes several non-core adjustments that resulted from the implementation of the strategic plan. And annual reserve - I'm sorry - an incremental reserve of 1.6 million on a legacy CRE loan held for sale, other income of 100,000 from non-core assets and net income of 400,000 from discontinued operations. These non-core adjustments net to a loss of 800,000 or $0.03 per share this quarter. Core earnings for the three months ended September 30, 2018 were $0.17 per share. After adjusting for our realized loss on a 2013 vintage commercial real estate load that was impaired and reserved for going Q4 2016, our adjusted core earnings for Q3 2018 were $0.24 per share. The transformation and simplification of our balance sheet as yielded increased core net interest income, lower operating costs and continues to benefit our common shareholders. Are GAAP debt-to-equity ratio rose to 2.5 times from 2.4 times at June 30. The increase in leverage ratio results from a net increase of 103 million on our asset levels borrowings offset by a net increase in our equity of 4 million. We now have total warehouse capacity of over 900 million on our commercial real estate term facilities, including the new facility we closed in October. During Q3, 2018, we redeemed both of our CLO issuances from 2015, which was essentially cash neutral after certain loans paid off in due course. In targeted on line and recycling of capital from our existing CLOs is a key component of our financing and reinvestment strategy. The liquidation of these evented CLOs unable us to efficiently recycle capital via natural loan payoffs. Secondly, financing of return collateral on our existing term priorities. And third, with respect to legacy loans, selling assets in accordance with our strategic plan. In each case, we have utilized recycled capital to either invest in our core investment portfolio or reduced our corporate cost of capital such as the redemption of our preferred stock earlier this year. As we look forward to the fourth quarter of 2018, our 6% convertible senior nerves mature in early December and we plan to pay these are off with available liquidity. The payoff of 6% convertible senior notes will eliminate 4.2 million of cash interest expense, where approximately $0.13 per share a year, beginning in 2019. With that, I'll turn the call back to Bob for any final comments.

This is Andrew Farkas. Bob, you don't mind, I'm going to highjack this for just a minute or two. So I just want to point out that this story, as a story of promises kept. Several years ago when we entered this as a new manager, we made a series of representations with regard to specific plans that we had to right size this as enterprise, we turn it to a focus on commercial real estate lending, terminate waste and types of businesses that were not core to what it was business must be doing and basically take that capital and redeploy it to both grow our book value and our earnings. Every single one of those steps have been properly and successfully implemented. The growth in earnings has taken place. The improvement in book value has taken place. I expect to continue to see our implementation of this program as we go forward. I like to commend my team for the work they have done, the success they have had. With that now Bob, I will turn it back to you.

Thanks, Andrew. And David, thanks to you as well. Just a couple of takeaway just to reiterate what Andrew said, we're on track to achieve what we laid out to do two years ago, growth of the core investment portfolio is let to an acceleration and adjusted core earnings of $0.24 per share for this quarter and the dividend is followed by increasing for three consecutive quarters to $0.175 per share that will be recommended to board for approval in the fourth quarter. We look forward updating all of you on the continued progress and discussing the results of our investment efforts on future calls and our meetings we may have with you. With that, I'll ask the operator to open up to any calls for questions you might have.

Thank you. [Operator Instructions] Our first question comes from Ben Zucker with BTIG. Your line is now open.

Good morning, everyone. Thanks for taking my questions and congrats on the dividend rise. I imagine it's easier to deploy proceeds and capital into CMBS business and that certainly helps reduce immediate cash drags. But I'm just curious where are you seeing the best incremental relative returns in the market right now between the senior bridge loan product and CMBS and could you also follow-up with providing some color on the type of CMBS investments you made in 3Q, 2018?

I think there is - we see tremendous value in the traditional lending business. As you know what we've been focusing on is likely transitional loans. We think the market of that remains robust. We think the ability to finance those both in the capital markets and with the warehouse providers is good today. As it relates to CMBS, what we've been focused on really revolves around a fair amount of three bonds coordinate to the guarantee portion, so the B's and C's in the pretty bonds, we've also got a number of single asset, single borrower deals where we see value. So I think we've been pretty well focused and I would just say 75, 25 plus or minus alone CMBS for the year. In my expectation is the balance may shift plus or minus 5 points one way or the other, but that's pretty much we can take.

And that seems to be in keeping with I think the equity allocation model you guys presented earlier in the year. Talking about CRE loan origination volumes, they've steadily increased throughout the year which is always nice to see. What is that market feel like right now? Have you seen any change in recent borrower behavior now that rates are a bit higher? We've also heard a peer say that spreads might be starting to bottom out in some of their markets and I'm wondering if you're seeing that too.

I think there is a little bit of an natural floor on origination spreads just given where the capital markets financing alternatives are, both from warehouse providers and from the CLO market. That said, the market remains competitive, although I think we've been able to leverage the C-III platforms to enhance the legacy examples origination capability, which is the reason why we've been able to grow volume on quarter-over-quarter. I think we feel pretty good as to where we stand on our expectation is that our capture rate will continue to increase, but as you know the market remains at pretty comparative market.

That's definitely helpful. And I guess lastly for me. Can you talk about that legacy CRE loan that you cited in your prepared remarks? I think you mentioned that you're investing for advancing more proceeds to the borrower. Any color you could give would be great around that specific asset, what kind of property, the borrower property type, the business plan going on there, timelines or resolution, just any kind of insight would be helpful?

Yeah, it's more of an operational and capital investment in order to advance the assets of the point where we think we can realize the best resolution. Obviously, we're in the process of working through that. So giving real specifics is a challenge at this point in time. But we've evaluated a variety of paths and we feel as though a little bit of operational capital into the asset is the most prudent thing to maximize the recovery.

Appreciate that, Matt. Well that's it for me guys. Andrew, I hear you on your story about promises kept and Dave thanks for including the interest rate sensitive to higher LIBOR, I believe that's the first time you guys have provided that and it's definitely helpful stats, so thank you both.

Thank you.

Thank you. Our next question comes from Steven Laws with Raymond James. Your line is now open.

Hi. Thank you. And that going Ben's comments, congratulations for another dividend increase. Following-up, Matt on the legacy assets identified was part of strategic planning. Any - I maybe have missed this but can you quantify the loan that you've been discussing versus the other assets they're identified and maybe to looking at the other basket, how should we think about timeline to resolution, I know some of the stuff may have a longer life, but what are your thoughts on the remaining assets?

Sure. If you refer the scheduled three in the press release, you get a little bit of a breakdown of it. We've discussed a $28.3 million which are a couple of other loans that we continue to work through. We'd expect them to resolve themselves over the next couple of quarters potentially one of them in short order and then the balance of them are just some cash et cetera that resolving one of the legacy businesses and then the loan that we've spoken about. So I think we're down really to acquire the small component of the aggregate capital starting here close to $0.5 billion and south of $50 million at this point in time. But I would expect it will take a couple of quarters to resolve the balance of them and get that down to zero.

Great, yeah, certainly a lot of progress having addressed 95% over the last two years. When we look at the investment portfolio, same good origination volumes, can you talk a little bit about the sourcing for those or are these repeat borrowers or what's driving the sourcing there? And then a follow-up, are there any other asset classes such as net lease or anything else that you've identified as part of your core investment strategy going forward but have yet to really make any investment there that we should think about as we look to next year.

So in terms of lending, I would say that the fair amount of our business does the right from the customers both on the intermediary side, as well on the sponsor side. We've also made a number of our traditional C-III clients, examples on a group four basis. As it relates to the different product types away from the traditional slightly transitional first mortgage lending as well as CMBS, we have - we done a preferred equity deal, we have more kind of on the horizon, we've done Mezzanine deals and we will continue to look at those. As you mentioned, we have identified net lease. I think for all the net least opportunities that we've seen over the last quarter, we were comfortable with the return profile of those investments as we say we don't continually evaluate that. I think that will be a product over time and that we add to it, but today, we've not seen an opportunity that meets our return expectations given the risk.

Great, I appreciate the color. My last question is just really seasonality, as we look to both the election and year-end with regards to originations and repayments, is there any seasonality we should think about is as we look at our model people trying to you know originate loans prior to yearend or pushing off decisions until post-election or anything like that we need to consider?

Well, I don't know that we can speak directly to the impact of the election. Traditionally, the fourth quarter has been a strong one and our existing pipeline is representative of that trend. We do expect to see continued strong origination volume into the quarter. And as mentioned in our comments that would be our expectation that we would maintain strong originations and that the repayment profile imbedded in our existing portfolio will wane over the next year relative to what we've seen over the last 12 months, which would allow us in the aggregate to continue to achieve aggregate net deployment for the portfolio and that's really the primary contributor to what we anticipate to be continued core earnings growth.

Great. Thanks for color. I appreciate you taking my questions.

Thank you.

Thank you. [Operator Instructions] Our next question comes from Jade Rahmani with KBW. Your line is now open.

Good morning. This is actually Ryan Tomasello for Jade. Thanks for taking the question guys. Just in terms of the 245 million of originations in the quarter, maybe you can just give us a bit of color in terms of the types of those loans maybe the property type, size and geography? And then as a follow-up to that, you know what property types in market you currently see as most attractive areas to lend?

Sure. So the 245 million for the quarter were - was a levered in separate loan, so the average was about 22 million. There's a bit of range there in terms of actual deal size, but on average it was about 22. 54% of them were multi-family, 7 of the 11 deals were multi-family and then we saw a smattering in hospitality, office et cetera to round that out. So a little bit more diversity than the existing portfolio, as you know we've been substantially weighted toward multi-family and that continues to be a large representation, we did pick up a little bit of incremental diversity this quarter.

And in terms of the repayments in the quarter, can you say or quantify what amount of those represented early prepayment rather than scheduled maturities? And then as a follow-up to that you know one of the comments we've heard from some other players in the market is existing borrowers requesting greater proceeds or a lower cost on existing loans given the amount competition and liquidity in this space, was wondering if you've seen that at all in your portfolio?

I don't know right now. Yeah, I have to confess on the repayments for the quarter whether or not they were specific maturities or expedited prepayment, I just don't know offhand if something that we can take a look at/

Okay, that's fine. And then just in terms of the follow-up you know if you're seeing any bars come to you in advance so the maturity of a loan and requesting are the greater procedures or lower spread on the loan just given the amount of competition for refinancing in the space?

It's not so much commented it before, maturity it's really coming here after the expiration of all call protection of the loan. And I would say and this is a little bit of a generalization. Borrowers like tighter spreads and more proceeds and commercial real estate on our operators are not shy about asking. So if the market opportunity exists, our refinancing at a lower spread away, we will likely get that inquiry and have the ability either to do it ourselves or decide that the - you know the price is too dear for us.

Okay, yeah, that's good color. Sorry, go ahead.

That's it.

And just one more if I can. In terms of the rate environment just given the forecasted rate creases off in the fed over the next year that the market is dissipating. Maybe you can say what level of LIBOR you expect rates to start actually impacting these bar business plans and if you require your borrowers to purchase interest rate caps on their loans?

All of our loans, interest rate caps we do and, I don't think that the rate increases that are talked about over the you know over the course of the next 12 months are going to have a dramatic impact on borrower activity. What rate volatility tends to do oftentimes is it makes borrowers loans cooperates. So it affects the fixed rate market more than it affects the floating rate market, because when you have a light transitional or even a moderate transitional business plan, the idea of locking in fixed rate financing before the value add has been completed, is not consistent with the business plan of these borrowers. So the borrowers who are looking at value add type transactions, almost definitionally we need to borrow floating rate. And I am old and I've been around long enough to know that when you know rates were not - you know you only needed 9% to make a deal work. And if you only get a single digit mortgage rate, you could make a deal. Rates, you know if you look historically, rates are still pretty normal. So if LIBOR goes up 25, 50, 75 basis points, we'll have some impact, yes, we'll have some impact. So I think it will have a dramatic impact on our business, I tend to think so.

Thanks for taking the questions.

Thank you. I'm not showing any further questions at this time. I would now like to turn the call over to Andrew Farkas for any further remarks.

Thanks everybody for calling in. We hope to continue to provide this type of news as we continue to move forward. We are optimistic about this business plan. We're optimistic about the enterprise. And we have no reason to believe it will not continue to deliver the kinds of results you come to expect from us. Thanks for taking the time. Again thanks to the crew here, who have done great job and we'll talk to you next quarter.

Thank you.

Thanks everyone.

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