Colony Credit Real Estate, Inc.

Good afternoon, and welcome to Colony Credit Real Estate Inc.' s third 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.Speakers on the call today are the company's President and Chief Executive Officer, Kevin Traenkle; and Chief Financial Officer, Neale Redington.

Chief Accounting Officer, Frank Saracino, and General Counsel, David Palame are also on the line to answer questions.Before I hand the call over to management, 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 could cause the company's business and financial results to differ materially for a discussion of some of these risk and uncertainties that could affect results please see the risk factors section of our most recent 10-K and other forward-looking statements in the company's current and periodic reports filed with the SEC from time-to-time. All information discussed on this call is as of today, November 7, 2019, and the company does not intend and undertake 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, portfolio bifurcation plan and supplemental presentation, which was released this afternoon and is available on the company's website. Because that's 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?

Thank you, Lasse. And thank you all for joining today's call covering Colony Credit Real Estate 2019 third quarter results, as well as other significant events taking place at the company.

As an adjunct to our prepared comments, I would also like to draw your attention to our portfolio bifurcation plan and supplemental financial report, which are available on our website.On the call today we will refer to those materials which we will provide incremental details beyond today's remarks. Neale Redington, our CFO will discuss the details of our third quarter financial performance, including specifics on our earnings growth, deployment activity, investment portfolio, balance sheet and liquidity position.Our press release issued this afternoon reported third quarter results and also announced a major milestone in our strategy to rotate out of legacy investments in order to address the dislocation between our current trading price and the net asset value of our portfolio.

My comments today will focus on the strategic update, which includes a definitive one time bifurcation of our balance sheet into: one, a core portfolio comprised of senior loans, mezzanine loans, preferred equity, commercial real estate debt securities and net lease real estate, which together have been our target asset since inception.And two, a legacy non-strategic portfolio, consisting of operationally intensive owned real estate, all retail and certain other legacy loans originated prior to the formation of CLNC, all of which are inconsistent with our go forward core business.The segmentation of our balance sheet is the result of an exhaustive strategic reassessment of our business, performed in conjunction with our external financial advisors, third party real estate valuation experts and property diligence consultants. As part of this process, many of our investment level business plans have been amended and reflect our conviction in our core business strategy, focusing on our core business and taking impairments as a result of accelerating legacy non-strategic portfolio dispositions.Following the third quarter accounting related charges that Neil will discuss in more detail, we now believe our reported September 30, underappreciated book value per share of $17.77 more closely represents our current fair market value or net asset value of our company.

Also, as a result of this process, we have reduced our monthly dividend to $0.10 per share, or $1.20 per share on an annual basis, which is fully supported by the current in place core earnings of our core portfolio of $1.28 per share.Our legacy non-strategic portfolio will be liquidated in an orderly fashion and the resulting available proceeds will be reinvested to grow our core earnings, which will come solely from our core portfolio and further support the dividends. Said differently, we expect to be able to internally generate capital to grow our core earnings within our core portfolio in the near-term without the need to access the external capital markets for equity.Additionally, we will provide in depth investment by investment disclosure providing incremental transparency into the intrinsic value of our assets.

We believe this level of disclosure will be useful to investors as they form their own view on the net asset value of both the core and legacy non-strategic portfolios.Management with the full support of the Board of Directors believes this strategy put CLNC on the best path forward to increase investor support and grow our core business to ultimately enhance shareholder value.To provide a better perspective on the strategic direction we are pursuing, it is important to understand how the company was created. On January 31, 2018 CLNC was formed through the combination of three portfolios, and listed on the New York Stock Exchange on February 1, 2018.

The combination created significant scale, with approximately $5 billion in total asset value across over 150 discrete investments. However, the combined portfolio also carried over approximately $1 billion of investments that were not core to Colony Credit's investment strategy.Much has been accomplished since our formation just 20 months.

A key priority has been the deployment of available capital into our core target investment strategy. We've invested or committed to invest over $3.7 billion, including approximately $1.6 billion year-to-date.

Over the short period capital deployment efforts have contributed to over a 20% increase in total annualized earnings, excluding gains and losses since our first full quarter of operations.In addition, our balance sheet remains prudently leveraged. Our debt to equity ratio is 1.4 times or 56% debt to assets, which remains below the average of our peer group, providing room to continue to invest and grow our core earnings.

From a liquidity standpoint, the total capacity under our master repurchase facility stands at approximately $2.3 billion, up from $1.2 billion at inception and which has drawn $825 million today.Last month, we closed our first CLL securitization totalling $1 billion, which demonstrates the strength of our loan origination business. Institutional investor demand for the CLO was strong and shows the market’s receptivity to our company.

While much has been accomplished, we experienced operating performance deterioration in certain legacy non-strategic positions, which resulted in a series of impairments over the previous reporting period. This provides even more reason to segment these assets away from our core portfolio.Today, we are announcing a clear transformation story.

Delineating our investments between core and legacy non-strategic portfolios create clarity around the core mission. Furthermore, we believe it will along with enhanced disclosure facilitate a greater understanding of our company and the value embedded within its assets.Our core portfolio totals $4.5 billion of total at share assets or 82% of our total portfolio today.

The core portfolio has an underappreciated and GAAP net book value of $13.96 and $13.39 per share respectively, with year-to-date annualized core earnings of $1.28 per share. The implied net core earnings yield of our core portfolio is 9.5% on GAAP net book value.

The legacy non-strategic portfolio totals $1 billion of additional at share assets or 18% of the total portfolio.Incremental the core portfolio value the legacy non-strategic portfolio has underappreciated and GAAP net book value of $3.81 per share and $3.16 per share respectively. Furthermore, the legacy non-strategic portfolio is cash flow positive and is fully self-financed.

This means we do not have to inject cash flow from our core portfolio to execute the legacy non-strategic portfolio business plans, but it also means that the legacy non-strategic portfolio generates positive cash flow to be redeployed into our core portfolio on a current basis.As of the third quarter 2019, the legacy non-strategic portfolio had year-to-date annualized earnings of $0.26 per share, which provides further support to the year-to-date annualized core earnings of $1.28 per share, and together meaningful coverage on our dividend.In conclusion, with this bifurcation of our assets, our key priorities will be focused on growth of the core portfolio and expanding core portfolio earnings with a concurrent disposition of legacy non-strategic portfolio assets. Our annual dividend is now fully covered by sustainable earnings from our core portfolio.

Available proceeds from legacy non-strategic portfolio asset sales will be redeployed in our core portfolio providing an engine of growth for our core business.The bifurcation of our assets, and the enhanced disclosure provides a foundation for shareholders to better understand our company. Showing earnings contribution from each segment supported by detailed investment by -- investment disclosure, which is now available in our filings.I am confident in our team's ability to execute this transition who have led a successful investment and financing programs since inception, and opportunistically resolved certain non-core assets to-date.

We expect the road ahead will reflect results that close the gap between the current trading price and the company's book value.With that, I'll now turn the call over to Neale Redington for a more detailed explanation of our third quarter operational and financial results.

Thank you, Kevin, and good afternoon, everyone. As usual, I would refer everyone to please look at our supplemental financial report that was filed earlier today, includes plenty of new details regarding our financial operations and also describe some changes we've made to our core earnings definition.This definition will exclude from core earnings, gains, losses and impairments on real estate, including unconsolidated joint ventures and preferred equity investments.

But will include provisions for loan losses. Further core earnings will come solely from our core portfolio, while we will report legacy non-strategic earnings separately.Also, as Kevin highlighted, today's announcement includes the benefit of added transparency and disclosure to investors.

In addition to the portfolio bifurcation presentation and supplemental presentation, which are posted on our website, we will be providing asset by asset details followed by holdings in our Form 10-Q, which will be filed shortly.We believe this added transparency will help investors and research analysts to better understand our company and the value of our assets given the additional data it provides on our two business segments.CLNC's core portfolio reported a third quarter GAAP net loss of $1.5 million, or $0.01 per share and core earnings are $44.7 million or $0.34 per share. In addition, the company's legacy non-strategic portfolio generated legacy non-strategic earnings excluding losses of $6.9 million or $0.05 per share.Our reduced annual dividend per share of $1.20 is more than fully covered at a 107% of year-to-date annualized core earnings of $1.28 per share from our core portfolio.

Legacy non-strategic earnings provides additional coverage for the dividend and other liquidity requirements.Now, I'd like to take a moment to discuss the impairments taken during the third quarter of 2019. First, as Kevin mentioned, as part of our overall portfolio bifurcation strategy, we're accelerating the pace at which we divest our legacy non-strategic assets.

That shortened hold period resulted in impairments to a number of operating real estate and preferred equity investments.As a result, we recorded $258 million of impairments on owned real estate and preferred equity investments during the quarter. Additionally, we have recorded provisions for loan losses of $127 million during the quarter related to deteriorating credit metrics on loans primarily in the retail sector, and one hospitality asset.

These write-downs of $385 million result in a GAAP book value of $16.55 per share or $17.77 un-depreciated book value.Turning to deployment, we had an active third quarter in which we allocated and initially funded $486 million and $362 million of capital respectively. The deployment activity for the quarter consisted of seven senior loans and three mezzanine loans all within United States.

The property type mix is approximately 32% office, 24% industrial, 18% mixed use, 17% multifamily and 9% hotel.The third quarter deployment had a weighted average return on equity of 12% and an underwritten IRR of 13%. During the third quarter, we paid a monthly cash dividend of $0.0145 per common share for the month of July, August and September 2019.

And we have declared $0.0145 per share dividend for the month of October. Kevin mentioned in his remarks as part of our portfolio bifurcation strategy, we've reduced our dividend to $0.10 per share per November and December or $1.20 per share annualized, which is fully covered by our core earnings.Looking at our core portfolio, our loan book continues to be the largest segment, for the carrying value of approximately $2.8 billion at quarter end.

The unlevered yield on our loan book is 7.8%, with an average loan size of $52 million. Furthermore, the loan portfolio remains well diversified in terms of size, collateral type and geography.Moving to CRE debt securities, our portfolio had a carrying value of $367 million at quarter end and the majority is investment grade rated.

In addition to generating attractive yields, our CRE's debt securities portfolios provide CLMC with additional liquidity options within our investment portfolio and access to efficient borrowing.Net lease real estate comprises 26% of the core portfolio and had a carrying value of $1.1 billion at the end of the third quarter. This portfolio consists primarily of industrial and office properties, with a high-single digits weighted average return on equity and a weighted average lease term of 9.6 years.

The net lease assets for core business for CLNC providing long-term stable cash flows with a potential for capital appreciation.Turning to our legacy non-strategic portfolio, this segment is predominantly composed of operationally intensive owned real estate, all retail and certain other legacy loans originated prior to the formation of CLNC with total at share assets of $1 billion as of quarter end. This value reflects the impacts of impairments taken during the quarter, due primarily to accelerated anticipated sales dates.Moving to our total balance sheet, our total at share asset stood approximately $5.6 billion as of September 30, 2019.

Our debt to assets ratio was 56% at the end of the quarter and our current liquidity stands at approximately $304 million between cash on hand and availability under our revolving credit facility.Subsequent to the end of the quarter, we closed $1 billion manage commercial real estate collateralized loan obligation. The CRE CLO accretively financed interest in 21 floating rate mortgage loans secured by 39 properties, with an 83.5% initial advance rate at a weighted average coupon at issuance of LIBOR plus 1.59% before transaction costs.The loan collateral includes multifamily, office and hospitality properties across 10 states in the District of Columbia, and features a two year reinvestment period.

Overall, we were extremely pleased with the outcome, which demonstrates the strengths of our loan origination business, capital markets capabilities and investor relationships.With a lower cost of funds, higher advanced rate and managed reinvestment structure, the CRE CLO fortifies the company's capital structure, improves the return on equity on our retained interest and allow CLNC to continue to expand its core business. As part of our enhanced disclosures, we've also introduced risk ratings on all loans in our core portfolio.

Importantly on senior loans, mezzanine loans and preferred equity investments to provide more detail regarding the credit and risk profile of our core business.Our overall risk rating at quarter end is 3.1, in line with our conservative policy and critical process that starts all originations with a 3 rating. Therefore, our overall rating is indicative of the performance of our investments and underlying collateral, operating in line with our business plans.In closing, with today's announcement, we are focused on executing our deployment strategy, and growing our core portfolio, while continuing our portfolio rationalization activities within our legacy non-strategic portfolio.

Overtime, we expect to see book value of our core portfolio and core earnings increase as a result of the reduced dividends, contributions from operations and accretively deploying sales proceeds from the legacy non-strategic portfolio.I'd like to thank you for your time today. And will turn the call back to Kevin for a moment.

Thank you, Neale. There is one more topic of business that I would like to mention.

The company's independent directors recently received a non-binding letter from Colony Capital that seeks to explore the possible internalization of the management of CLNC and the transfer of Colony Capital global credit management business to CLNC. Key components of such a transaction may include internalizing Colony's commercial real estate credit management business, extinguishing the company's management contracts, and taking on management of Colony credit funds and related co-investment vehicles, several of which are co-invested with the company in some of its core investments.

The letter has also been filed publicly by Colony Capital on schedule 13-D.Importantly, management's continuing commitment to CLNC’s business, stated bifurcation plan and continuing growth or unwavering regardless of the outcome of any internalization discussions. There is no further information we can provide at this time regarding the possible internalization and as directed by legal counsel, we're not in a position to respond to any questions related to the letter.I'd like now to ask the operator open the floor for questions regarding our bifurcation plan and quarterly results.

Hi, good afternoon, Kevin and Neale. A lot to process in an hour but first off, just wanted to state it's good to see these little -- a lot more disclosure on these assets and appreciate you providing separate financials for each of the two buckets.

I think that will be very helpful analyzing your portfolio. With that said kind of thinking about the core portfolio first.

If we, for a second, put aside the potential reallocation of capital as you monetize the legacy assets, but think just to the core portfolio, I think leverage was 1.4 times in the deck. What kind of investment capacity does that leave you just as far as where your target leverage is for the core portfolio, considering the assets that now comprise that portfolio?

So, yes, on the leverage, I think in both portfolios we’re relatively under leveraged relative to our peers. So I think we have room on the leverage side, to continue to move that up.

We still have liquidity to deploy. Obviously, everything that we have been doing and everything that we will be doing will be within the core portfolio.In addition to the liquidity at hand as either cash that we have available or availability under our revolver, we have a lot of capacity under our repo facilities that we can add.

And in addition to all that, as we monetize the legacy, non-strategic portfolio of assets, those net proceeds will be funnelled back into our core portfolio and provide even more liquidity to continue on with our core business.So we have a lot of liquidity coming from a lot of different places and a lot of capacity to continue on with the core business.

So, maybe in an effort to quantify that the one core can go to maybe say somewhere around two and then over a period of time, you'll pick up I believe I saw roughly $400 million, give or take that will be reinvested into core assets.

So that's right. It's going to depend on the mix between the senior assets that or the senior loans that we do and mezzanine and preferred equity or the triple net lease assets.

But yes, if -- we've been more focused on the senior mortgages. And if, what we've been doing in the recent past continues into the future, those numbers are generally correct.

Right, and then, so with the legacy monetization, I know you're trying to accelerate this. What kind of timeline should we think about?

Is this something that will be accomplished over the next five quarters by year end next year or are you comfortable giving maybe a rough guess at how much can be maybe resolved by year end next year? How should we think about the timeline of asset monetization from legacy portfolio?

Yes, I mean, we want to be cautiously optimistic in terms of projections on the timings. But through this like portfolio reassessment and going through every single business plan, we basically have accelerated the disposition dates to occur as soon as practically possible.

So in some cases, we're actually in discussions with brokerage firms right now to get a lot of these assets lifted ASAP. Actually some are on the market right now to be sold.Some of the assets, there's still some value add work that needs to be done, some lease up some TIs leasing commissions that need to be paid and invested in those assets.

But the models show a significant majority of those assets to be liquidated over the next 12 to 24 months. There are some assets that are going to take, a little bit longer, but the significant majority within 24 months.

Looking at the core portfolio, again, I appreciate all the additional disclosure. Noticed one loan 25 looks like a four rated hotel has an extended maturity about two months from now January of 2020.

So can you maybe give us an update on any discussions you've had with that borrower? Do you expect it to pay off?

I wanted to ask about that one. Is it a near-term maturity on a full rate loan?

Yes, I can address that one, Stephen. So it is it is a small performing senior loan on a hotel in Bloomington in Minnesota.

We move this to a four rating because the hotel management company just issued a quality assurance default to the owner because they have recently listed for sale. So there is an expected closing probably in Q1 of 2020 that would intend to pay off the loan.

But because of this additional paper that the hotel company had issued that's why we've moved it to a four and we continue to move to monitor that situation.

Appreciate the color there. Subsequent events the hotel sell that I belief that had a gap recurring value of $72 million.

Is that also the sale price? Have you disclosed the sale price?

Or can you provide any color on that hotel sale?

So we are very close to selling that and we do expect to recover the carrying value from that sale.

That’s good. I think I've asked about this every call, but I want to touch on the stock buyback.

I think authorization still in place, given the new un-depreciated book value stock closed today at a 20% discount we'll see how it reacts tomorrow. But can you talk about the appetite or willingness to consider a stock repurchase given the valuation and given significant amount of liquidity and you've got plenty of room there from a leverage and available capital standpoint.

Yes, sure. So it's something that, we track and we analyze on a real time basis.

However, we would strongly consider repurchasing stock. Now given through -- given the reset that we're going through and the revaluation and the reassessment of the portfolio, it's something that we will strongly consider.

Good, seems like a positive step there in the thought process around the buyback. And lastly, and Kevin, I know, you specifically kind of said not to ask about this, but on the internalization, timing, how should we think about that?

Is it a next year event, kind of how long is the review process going to play out? And, I'll hold off and ask any specifics around numbers, but I'm curious about kind of how we should think about the timing of that review process?

Yes. So the Board of Directors, they have set up an independent committee, that special committee is also has its own independent financial advisors and legal advisors who are going to be working through that.

And, there's really nothing more to say at this time with regards to timing or anything else.

Fair enough. I thought I at least ask.

Well, that's all I have for now. I'm sure I'll be back later with more, but appreciate you taking my questions.

Thanks, Stephen.

Thank you, Stephen.

Hi. Just a few follow ups to that line of questioning, what yield expectation do you expect for money put to work in the core business?

Yes, so in the in the core business, I mean, we've been running north of 12 on the $3.7 billion that we've invested since going public, we have been north of a 12. There has been some slight spread compression recently that we've seen throughout the marketplace, with the execution of the CLO that we just consummated, which we got very attractive financing rates at very attractive, advanced rates.

Even with the question in the marketplace, we actually think that we're going to be able to continue to reach those targeted returns, call it in 11% kind of plus range on ROEs.So, what we're kind of -- we're happy with the business, we're happy with our financing our assets, and there's no reason to believe that we don't think that we can get those 11% plus ROEs on our core business.

Okay. And those are levered return, correct?

Those are levered returns.

And then just on the CLOs, is that a continued strategy we should expect on the core book or is the -- the first one was large so is that it for a while or could there be more?

There certainly will be more, we will incorporate CLO executions as part of our base business and our base strategy going forward. This CLO, in particular, it is a managed CLO so we do have the ability to replace any collateral that pays off within the first two years.

But, CLO executions will be something that we will do from time to time as part of our financing repertoire.

The last one I have is just on the non-core earnings in the kind of the 12 to 24 month plan. I mean, how should we potentially plan for that to be part of the dividend coverage going forward.

I know that we have to have our own models and you have a process going on. But would it be most conservative to assume that there's no ongoing contribution from the non-core?

We -- that is frankly, why we are differentiating between core earnings from the core portfolio versus the legacy non-strategic earnings from that part of the portfolio, Randy. So as I think Kevin and I both mentioned, the dividend coverage is really focused on the core earnings that we're generating.

So the $1.20 is covered by the year-to-date annualized number of $1.28. So that's, frankly, what we're more focused on.We do expect over time that that will grow from a number of factors including the legacy non-strategic.

And as Kevin said, over the next 12 to 24 months, we should expect that the majority of those assets will be moved over to core. But frankly, we would prefer to be more focused on the core earning side of things.

I'd like to add one other thing just on that portfolio and just so everyone knows, it is self-sufficient, it’s cash flow positive. It doesn't require capital coming from the core portfolio to execute its business plan.

And even though we don't want people to focus on the legacy non-strategic earnings, it is additive.

Okay, understood. That's all I have.

Thank you.

Thank you, Randy.

Thank you, Randy.

Great. Well, I want to thank everyone for your continuing support and for joining us on today's call.

On behalf of the entire team at Colony Credit Real Estate, we thank you for dialing in today. And we look forward to updating you on our progress when we report 2019 results early next year.

Thank you.