Colony Credit Real Estate, Inc. (CLNC) Q1 2019 Earnings Call Transcript

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Colony Credit Real Estate, Inc. (BRSP -1.39%)
Q1 2019 Earnings Call
May. 08, 2019, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greeting, and welcome to Colony Credit Real Estate first-quarter 2019 earnings conference call. [Operator instructions]. Please note that this conference is being recorded. I would now like to turn the conference over to your host, Lasse Glassen, managing director of investor relations.

Thank you, sir. You may begin.

Lasse Glassen -- Managing Director of Investor Relations

Good afternoon, everyone, and welcome to Colony Credit Real Estate Inc.'s first-quarter 2019 earnings conference call. We will refer the Colony Credit Real Estate, Inc. as CLNC, Colony Credit Real Estate, or the Company, throughout this call. With us today are the company's president and chief executive officer, Kevin Traenkle; and Chief Financial Officer Neale Redington.

Chief Accounting Officer Frank Saracino, is also on the line to answer questions. Before I hand the call over to them, please note that on this call, certain information presented contains forward-looking statements. These statements are based on management's current expectations and are subject to risks, uncertainties, and assumptions. Potential risks and uncertainties that could cause the company's business and financial results to differ materially from these forward-looking statements are described in the company's periodic reports filed with the SEC from time to time.

All information discussed on this call is as of today, May 8, 2019, and the company does not intend and undertakes no duty to update for future events or circumstances. In addition, certain financial information presented on this call represents non-GAAP financial measures. The company's earnings release and supplemental presentation, which was released this afternoon and is available on the company's website, presents reconciliations to the appropriate GAAP measure and an explanation of why the company believes such non-GAAP financial measures are useful to investors. And now, I'd like to turn the call over to Kevin Traenkle, president and chief executive officer of Colony Credit Real Estate.

Kevin?

Kevin Traenkle -- President and Chief Executive Officer

Thank you, Lasse, and thanks to everyone for joining Colony Credit Real Estate's conference call to discuss the company's 2019 first-quarter results. I will provide a brief overview of our first-quarter highlights, including early results of low-yielding asset monetizations that we outlined last quarter, as well as an update on other key management priorities for 2019. Neale Redington, our CFO, will discuss the details of our first-quarter financial performance, including specifics on our deployment activity, investment portfolio, balance sheet and liquidity position. Colony Credit Real Estate is off to a good start in 2019, highlighted by early success in our portfolio rationalization strategy and the expansion of core earnings.

Most notably, during the quarter, we made meaningful progress in our efforts to recycle capital from non-core and non-yielding assets, highlighted by the sale of approximately 90% of our interest in real estate private equity funds. We also continued to steadily deploy our available liquidity into our targeted assets at an approximate 12% blended return on equity. We continue to grow and diversify the portfolio across collateral type and geography, while increasing our core earnings. Furthermore, we have several prospective investments in late stages of execution in addition to a very robust originations pipeline.

In all, I believe the quarter represents our strong execution capabilities to resolve legacy non-core investments and to reshape our portfolio and see tangible improvements in the company's performance. Turning to our financial and operational results, during the first quarter, we reported GAAP net income of $14.9 million, or $0.11 per diluted share and core earnings of $11.8 million, or $0.09 per diluted share. Excluding realized losses, which Neale will describe shortly, we generated core earnings of $49.3 million, or $0.38 per diluted share, which is up 15% from $0.33 last quarter. On the strategic front, I'm very pleased with the early success of our comprehensive portfolio rationalization strategy, which is focused on divesting certain inherited non-core and low-yielding assets.

The overarching objective of this effort is to increase the core earnings of our portfolio and overall yield on our capital by redeploying proceeds from such asset sales into investments that will lead to substantially accretive returns on equity. To this end, the aggregate sales price of the real estate private equity interest mentioned earlier will return approximately $142 million and is in line with our carrying value. To date, we have received approximately $63 million in proceeds, with a substantial portion of the remaining $79 million in proceeds anticipated to be received during the second quarter. As these private equity interest did not meaningfully contribute to the company's 2018 core earnings, the reinvestment of these proceeds into our targeted assets will be highly accretive to earnings.

In addition, we remain focused on taking proactive steps with regard to the restructuring of loans secured by a New York City Hotel. This restructuring is a key part of our overall portfolio rationalization strategy, as these loans remain on non-accrual status and therefore are not currently contributing anything to core earnings. While this process is ongoing, we do not have further updates to report at this time. However, once this restructuring is completed and our capital begins generating revenue, we believe our core earnings will benefit significantly.

To further assist our deployment initiatives, subsequent to the end of the quarter, we completed amendments on two of our master repurchase facilities to allow for European investments denominated in euros and British pounds, concurrent with a $200 million aggregate upsize. This brings our total master repurchase capacity to approximately $2.3 billion, with more than $1.2 billion currently available. Along with the upsize capacity, these amendments helped to facilitate our investment strategy to further diversify our portfolio geographically into euro. As you may recall, during the second-half of last year, we made substantial investments in Europe and European investments comprised approximately 11% of our total portfolio as of March 31, 2019.

We will continue to benefit from the global infrastructure and best-in-class deal sourcing capabilities of our sponsor, Colony Capital, as we evaluate new opportunities in the U.S., as well as Europe. Before turning the call over to Neale, I would like to provide a brief update on our key management priorities for 2019. First, we remain highly focused on the deployment of our liquidity into targeted asset classes to grow our portfolio and we expect the pace of our investment activity to pickup as the year progresses. We remain confident in our ability to continue to source transactions with an investment level return on equity in the low double-digit, which is consistent with the yields we are achieving across our recent investments.

While executing our portfolio rationalization strategy and deployment goals, we expect to generate a core earnings run rate that covers our dividend by year-end 2019. Through continued execution of our strategic initiatives, we are confident in the long-term outlook for CLNC and our ability to narrow this current trading discount to book value and build long-term shareholder value. And now, I'll turn the call over to Neale Redington for a more detailed explanation of our first-quarter operational and financial results.

Neale Redington -- Chief Financial Officer

Thank you, Kevin, and good afternoon, everybody. As we discussed our first-quarter financial results, I want to draw your attention to our supplemental financial report, which is available on our website. We believe this supplemental will help investors and research analysts understand the company better, given the additional data it provides on each of our business segments. CLNC reported first-quarter GAAP net income of $14.9 million, or $0.11 per common share and core earnings of $11.8 million, or $0.09 per diluted share.

Core earnings, excluding realized losses during the quarter was $49.3 million, or $0.38 per diluted share. After adjusting for realized losses and other one-time first-quarter items, run rate core earnings for the first quarter was $0.36 per diluted share, which represents 83% coverage of our current dividend. As a reminder, reported core earnings excludes the impact from impairment of real estate and provision for loan losses until a realization event occurs. In the fourth quarter of 2018, we proactively recorded a $35.5 million loan loss provision in anticipation of a mezzanine loan foreclosure that occurred in the first quarter.

So because of this timing difference, the provision reduced GAAP net income during the fourth quarter and reduced reported core earnings during this first quarter. This timing issue will probably recur in the future as we execute on the portfolio rationalization strategy communicated last quarter. Turning to deployments., our first-quarter activity was solid and we allocated and initially funded $278 million and $225 million of capital, respectively, across eight senior mortgage loans. All of the deployment activity for the quarter was within the United States, with 43% of the capital allocated in the West, 24% in the Northeast, 23% in the Southeast and 10% in the Southwest.

In addition, so far in the second quarter, we have initially funded an additional $184 million of capital, the full benefits of which we realized in our core earnings in coming quarters. During the first quarter, we paid a monthly cash dividend of $0.145 per common share for the month of January, February and March 2019, and we have declared a $0.145 per share dividend for the months of April and May. Our dividend has remained consistent at this level since our formation and represents an annualized dividend of $1.74 per share, and this reflects a very attractive current annualized yield of approximately 11%. Looking at our in-place investment portfolio, our loan book continues to be the largest segment within our portfolio with a carrying value of $2.7 billion at quarter end, 50% to the total portfolio.

The unlevered yield on our loan book is 8.2%, with approximately 88% of our senior loans being floating rate. With an average loan size of $36 million, the portfolio remains well-diversified in terms of size, collateral type and geography. Net lease real estate comprises 25% of the portfolio and has an undepreciated carrying value of $1.3 billion as of March 31, 2019. This portfolio consists primarily of industrial and office properties with high single digits weighted average return on equity and a weighted average lease term of 9.2 years.

We view the net lease segment as a core business of CLNC providing long-term stable cash flows with a potential for capital appreciation. Moving to CRE debt securities, our portfolio had a carrying value of $384 million at quarter end, and the majority is investment-grade rated. In addition to generating attractive yields and poised for growth, our CRE debt securities portfolio also provides CLNC with additional liquidity options within our investment portfolio and access to efficient borrowing. Turning to our other real estate segment, this segment is predominantly cash flow and operating real estate, with a carrying value of $796 million as of quarter end.

This increased since the fourth quarter predominantly due to the previously discussed foreclosure of mezzanine loan collateralized by diversified portfolio of U.S. properties to a single borrower. In addition, non-core holdings of real estate private equity funds, which have a total carrying value of $102 million at quarter end reduced from $161 million in the prior quarter from distributions and our ongoing sales closing process. Moving to our balance sheet, our total at share assets stood at approximately $5.5 billion as of March 31, 2019.

Our debt to assets ratio was 46% at the end of the quarter and is lower than our expected long-term target of 50% to 55%. Our current liquidity stands at approximately $346 million between cash on hand and availability under our revolving credit facility, which will be enhanced as we continue to monetize our private equity secondary positions and other certain lower-yielding assets. We're also quite pleased with the recent amendments for us to master repurchase facilities to allow for European investments and the $200 million upsize, bringing the total capacity to $2.3 billion. To turn section in early 2018, we have been diligently walking on our deployment and portfolio rationalization strategies, and we're pleased that our first-quarter results were tangible representation of our work.

CLNC is gathering momentum and we remain confident that we can build on our first-quarter success during the remainder of 2019 and beyond. We look forward to updating you on our progress in future calls, as we continues to execute plan and for our shareholder value. I'd like to thank you for your time today. We'll now ask the operator to please open the line for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] One moment please while we poll for questions. Our first question comes from the line of Stephen Laws with Raymond James. Please proceed with your question.

Stephen Laws -- Raymond James -- Analyst

Good afternoon, Kevin and Neale. Thanks for taking my question.

Kevin Traenkle -- President and Chief Executive Officer

Hi, Stephen, thanks.

Neale Redington -- Chief Financial Officer

Hi, Stephen.

Stephen Laws -- Raymond James -- Analyst

Yes. I got to hit on the big one first. Congratulations on the sale of the majority or almost entirety of the private equity interest. But I guess, can you comment on the remaining 10%? Do you have a buyer identified? Will that simply runoff? Can you talk about why you kept what you did and what the likely outcome is for that?

Kevin Traenkle -- President and Chief Executive Officer

Yes, sure. So that interest is actually within a joint venture and we're actually speaking with our partner right now about picking our way to liquidate that position. All the other interests were wholly owned. They were fairly liquid.

We got good attractive prices for those. So it's almost 90% everything that we did, so it's around 10% of what we have remaining. And even that, we don't think that there is a long life left there, so, it's not going to be around that much longer even if you don't sell it today.

Stephen Laws -- Raymond James -- Analyst

Yes. OK. Great. Well, that makes sense and actually you've got some partners there.

Neale, I want to make sure I heard you correctly. I know I think backing out some $0.38 was the core earnings this quarter backing up the large charge make sense as related to PE sale. But I think in your prepared remarks, you may have made a comment that run rate core EPS was $0.36. I guess, is that accurate at $0.36 what we should consider kind of the base line that we grow from is capitals deployed and new investments are originated?

Neale Redington -- Chief Financial Officer

That's right. For Q1, that should be the base line. So you're correct and just a quick recap of what you heard is fairly simple as you spelled out. $0.38 was reported and then we had about $0.02 that were risking our tax and G&A areas that were a little no quite at run rate.

So we had a bit of a tax benefit and our G&A was slightly below where we expect we end up in terms of run rate. So that why throwing it back a little bit from $0.38 to $0.36.

Stephen Laws -- Raymond James -- Analyst

OK. Great. $0.36 was right, that's kind of a bump where I had in the model running right now. So that's certainly good to hear.

Kind of thinking about what caused that to go down. Can you maybe spend a few minutes, Kevin, talking about the remaining non-core assets? I know last quarter you spent a lot of time talking about kind of acceleration of the monetization of those. But with the PE largely gone now, can you talk about non-core assets, either debt investment or operating real estate that you view as non-core? And kind of where you are maybe in the process of monetizing that and your outlook on timing of how we think the remaining non-core asset should wind down, would be great?

Kevin Traenkle -- President and Chief Executive Officer

Yes, absolutely. And first and foremost, we are focused on those non-core assets at our low-yielding and no yielding. So, as I mentioned earlier, those are private equity interest. They actually generated no earnings for us in 2018, yet, we we're carrying them on our book for $160 million.

So, obviously, it's a big anchor around our net. So that was our number one priority to monetize that, to repatriate that capital and then put that capital back out to work. And then in subsequent quarters, you will see the result of that through increased earnings. So then we're just kind of going down to the other assets that are falling through that category that are low-yielding that aren't hitting our bogies in terms of returns on equity.

We're in process on a couple of those bigger positions right now. We hope in the coming quarter or so that we'll be able to kind of announce some good news on those as well. And then, there are some of those kind of non-core positions that are generating some decent yields right now. We'll be opportunistic in terms of when we sell them.

We don't want to buyer sell them just for the sake of buyer selling them. They're not for us long term, but to the extent that they're attractive real estate generating good yields right now. We'll wait and for the right buyer at the right price and liquidate those. But the biggest of those pending positions are either sold like a private equity interest or in the process of being sold with a couple of others, the big lower-yielding positions in that non-core category.

Stephen Laws -- Raymond James -- Analyst

Great. And you think the majority of the non-core stuff looks like, it would be addressed this year -- sorry, if I missed that, but I have one or two that linger, but kind of the timeframe --

Kevin Traenkle -- President and Chief Executive Officer

Yes. So definitely, the majority of the low and no yielding of the non-core will be addressed this year. Absolutely.

Stephen Laws -- Raymond James -- Analyst

Yes.

Kevin Traenkle -- President and Chief Executive Officer

The other non-core, which is yielding, I think, we're just going to be a little bit more opportunistic and make sure that we're getting the right price. We don't have a sale date. We're exploring ways to kind of maximize our exit. As you know, we are still sitting on a lot of liquidity right now.

So, once we start getting closer to deploying all the capital and cash that we have at hand right now, we'll visit some of that sell dates of those other assets. But by the end of this year, definitely all the lower no yielding non-core assets will be addressed.

Stephen Laws -- Raymond James -- Analyst

Great. Thinking about the balance sheet and book value pretty stable this quarter, few writedowns last year. But can you talk about your confidence around the current book value, or are there any problem loans or problem assets that you're watching closely and you're concerned about? Or kind of any update on how we should think about additional risks that remain in the portfolio?

Neale Redington -- Chief Financial Officer

Yes. So we do rank all of our assets and we do have watchlist assets. There are certain sectors in asset classes right now that are performing better in certain classes, asset classes and sectors that aren't performing so well. One of the asset classes that we're paying particular attention to is our retail exposure.

Another reason why we've been looking to kind of riddle that down, we did a pretty good job this quarter kind of ridding ourselves and letting that retail kind of exposure you burn off. We're not too eager to increase that. The bar is pretty high there. But in a lot of places across the U.S., the ability to refinance retail assets is not what it used to be.

So it's something that we're paying attention to. Our retail exposure for the most part, loans are performing, but as we get closer to the maturity date, it's something that we're going to pay attention to, not a huge part of the book, but something that we do focus on pretty extensively.

Stephen Laws -- Raymond James -- Analyst

Great. I appreciate that. And last question, I think, I have asked this in most quarters. But the stocks at a 30% discount, your cash flow liquidity looks like earnings certainly are building off a pretty attractive day, I guess, of 36-year and you've got mummy going to work, they'll surely generating the returns.

So an update just on your thoughts and how the firm thinks about stock repurchases, your debt at stock I believe around 70% of your book value. You mentioned putting return money to work, I think, in Q1 is 12% ROE. But how do you weigh the pros and cons of repurchasing stock at such a big discount that would be accretive to book and earnings and provide confidence to shareholders with opportunities you're seeing to deploy capital and the new investments? And kind of what's the pros and cons that you guys look at internally you're buying back stock versus not doing so?

Kevin Traenkle -- President and Chief Executive Officer

Yes. It's a great question. It's something that internally, we discuss and debate constantly. I wish I can give you just a simple formula and a simple number.

It really is a multi-vary equation with many things going on. If you saw our pipeline, which we think is pretty robust with a lot of interesting transactions with a lot of good yields, low risk, we'd love to kind of put our balance sheet to work in those investments, in those assets that we think longer-term doing that will be better for the longer-term benefit of the company and long-term shareholder value. Obviously, if the stock gets too low, we have the authority to do it and it's something that we will do. Yes, just right now based upon what we are seeing, we think it's a better investment to deploy into our pipeline.

I guess, on the other side if we start seeing, the landscape getting rate competitive and yields and spreads going well below, where we think that they are to be, investing in our own stock would be a great investment and it's something that we can do on outside as well. But just kind of building out our models, based upon where we can deploy the capital, how big our investment pipeline is, the yields that we can deploy the capital and kind of looking over the next several quarters and not just this month or next quarter in terms of where we would be in earnings, in dividend coverage and everything like that, we just think it's still a better place to deploy the capital into our business, into our pipeline.

Stephen Laws -- Raymond James -- Analyst

I appreciate the colors there. And actually, I do have one more question, you made me think off in your comments there. But dividend coverage, looking my model, how you guys are doing right about in line with the dividend in Q4, so reaching coverage by year end. I mean, given what you put up in Q1 36 base line, I think I'm almost $500 million of origination year to date.

Do you guys still comfortable with dividend coverage at some point this year, or any comments around that?

Kevin Traenkle -- President and Chief Executive Officer

Yes, we do. So yes, we're going in the right direction. I mean, we are growing earnings quarter over quarter. We're putting out capital at attractive rates that will only kind of continue that progression.

So, our models also show us covering the dividend on a run rate basis by the end of the year. I mean, absent anything extraordinary, that happens on a macro basis, just based upon our business and where we think we're going to deploy the capital. We've got a lot of deals that are in execution right now. We have a lot of others that are in the hopper, lot of relationships we're working on, we think that will hit that by the end of the year.

Stephen Laws -- Raymond James -- Analyst

Fantastic one, but certainly good to hear and I appreciate the guide or the comments there. So thanks for taking my questions. I appreciate it.

Kevin Traenkle -- President and Chief Executive Officer

Yes. Thanks, Stephen.

Operator

Since there are no further questions left in the queue, I would like to turn the call back over to management for closing remarks.

Kevin Traenkle -- President and Chief Executive Officer

All right. Well, on behalf of the entire team at Colony Credit Real Estate, we thank you for dialing in today, and look forward to updating you on our progress when we report our second-quarter results in early August. Thank you.

Operator

[Operator signoff]

Duration: 29 minutes

Call participants:

Lasse Glassen -- Managing Director of Investor Relations

Kevin Traenkle -- President and Chief Executive Officer

Neale Redington -- Chief Financial Officer

Stephen Laws -- Raymond James -- Analyst

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