Q3 2014 Eurocastle Investment Ltd Earnings Call
Nov 06, 2014 AM EST
ECT.AS - Eurocastle Investment Ltd
Q3 2014 Eurocastle Investment Ltd Earnings Call
Nov 06, 2014 / 01:00PM GMT
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Corporate Participants
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* Olga Zakharchenko
Fortress Investment Group LLC - IR
* Francesco Colasanti
Fortress Investment Group LLC - MD
* Oliver Goodrich
Eurocastle Investment Limited - Co-CFO
* Scott Berry
Eurocastle Investment Limited - Co-CFO
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Conference Call Participants
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* Ismadi Ismail
- Analyst
* Michael Mackey
Kingdon Capital Management - Analyst
* Edmond Safra
EMS Capital - Analyst
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Presentation
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Operator [1]
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Good morning. My name is Jackie and I will be your conference operator today. At this time I would like to welcome everyone to the Eurocastle third quarter 2014 earnings call. (Operator Instructions) I would now like to turn the call over to Olga Zakharchenko to begin.
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Olga Zakharchenko, Fortress Investment Group LLC - IR [2]
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Thank you, Jackie, and good afternoon, everyone. I would like to welcome you to Eurocastle's third quarter 2014 earnings call. Joining us today are Francesco Colasanti, Managing Director at Fortress and Eurocastle's Co-CFOs, Oliver Goodrich and Scott Berry.
For the duration of this call, we will be referencing the presentation that we've posted on our website under the Investor Relations section, which we hope you will find helpful. We would like to remind everyone that this call is being recorded and the replay number is on our website.
This call is also available via webcast on our website as well. I would like to point out that statements, opinions and beliefs communicated today which are not certainly historical facts may in fact be forward-looking statements. We encourage you to read the forward-looking disclaimer at the front of our presentation. With that, I would like to turn it over to Francesco Colasanti.
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Francesco Colasanti, Fortress Investment Group LLC - MD [3]
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Thank you, Olga, and welcome, everyone, to Eurocastle's third quarter 2014 earnings call.
As Olga mentioned, for the duration of this call, we will be referencing a presentation that we've posted on our website. As you listen to today's comments and go through our material, I want you to keep in mind that we essentially view our business as two segments; one is a legacy business and the second one is our new investment strategy focused on the Italian NPL and opportunistic real estate investments.
The strategy around our legacy investment is to accelerate the recoveries on these assets, while generating the maximum return for our shareholders. We've continued to do that through the course of this year.
Our new business is where we are placing a great deal of focus on making new investments with a high rate of return. This includes our investments in Italian distressed debt and real estate. I'll discuss portions of each segment in more detail [throughout] my remarks.
But let me start with a few positive highlights on our new Italian investment. As you can see on page 2 of the presentation, so far we invested or committed to invest EUR71 million or 68% of the equity we raised in May last year. Of that amount, EUR59 million has been invested generating EUR16 million of cash to date with a remaining NAV of EUR54 million.
So now I'll discuss our recent investment activity in more detail. If you turn to page 3 of the presentation you can see that since Q2, we closed on the first two real estate conversion projects, funding EUR12.6 million of a total expected investment of EUR15.4 million. And we did through an Italian real estate fund.
As mentioned on the previous earnings call, we launched a series of anticipated NPL transactions with an Italian banking group to acquire small pools of non-performing loans from regional corporate banks on an ongoing basis. So far we have closed on four small pools investing EUR500,000 and we are evaluating another three pools of a similar nature that will be closed by year end.
In addition to that, we are committed to invest over EUR11 million to acquire approximately 50% share in the units of an Italian closed-end real estate fund under distressed circumstances.
In terms of pipeline, we are currently evaluating Italian NPLs with a gross book value of over EUR8 billion, of which approximately EUR3.6 billion gross book value is under exclusivity or we are acting as a sole bidder.
In addition to that, we are analyzing real estate opportunities that represent an estimated total investment of up to EUR200 million to be shared with other [Fortress entities].
So I'll give you more color on the NPL pipeline in just a moment, but first let's turn to page 5. So, as I mentioned before, Eurocastle businesses are split between new investments and legacy investments.
So subtracting the new investments and corporate cash from the current market cap of EUR222 million, the legacy business is valued at approximately EUR63 million or 51% to the current NAV.
As you can see on page 7, Eurocastle invested or committed approximately EUR71 million since the capital raise in the new strategy.
The investments are expected to generate a profit of EUR41 million with an average IRR of approximately 24%.
So let's now talk about what is driving the investment opportunity.
So starting from page 8, I'd like to give you an overview on one of the most significant topics for our business; the ECB Comprehensive Assessment.
So, on October 26 the ECB published the results of almost a year-long comprehensive assessment of 130 European banks.
The goal of the comprehensive assessment was to determine the quality of the assets on banks' balance sheets, known as Asset Quality Review, or AQR, and the resilience of banks' balance sheet under two scenarios as of December 31, 2013.
So the scenarios have been performed using different assumptions by the ECB. There was a Baseline Test which assumed normal economic conditions under -- until December 2016, at a core Tier 1 ratio threshold of 8%.
And the Adverse Test that was made [updating] deteriorating economic conditions until December 2016, against a core Tier 1 ratio threshold of 5.5%.
The comprehensive assessment resulted in total capital shortfall for the banks of EUR24.6 billion among the top 25 European banks.
Those banks that failed the test now have until November 10 to submit a new capital plan, after which they will have six months and nine months to cover shortfalls under Baseline and Adverse Test, respectively.
Out of the 19 countries inspected, Italian banks have recorded the biggest capital shortfall of EUR9.7 billion out of the total of EUR24.6 billion. Nine of the 15 inspected Italian banks failed the Adverse Test.
So, while seven out of the nine banks already managed to cover the shortfall primarily through capital-raising activity and conversion of existing convertible bonds, since December last year, two of Italy's major banks had a combined material shortfall of EUR2.9 billion that is still uncovered.
In addition to covering the major capital shortfalls, the banks are being forced by the ECB to reduce asset valuation by approximately EUR12 billion which, in my opinion, will contribute to narrowing the gap between the bid and ask price on the NPLs.
And, in addition, it's important to note that the Asset Quality Review was a static exercise, analyzing the banks' financial position as of December 31, 2013.
We estimated that since then approximately [70%] of the reduction in valuations has been provisioned, and we expect that additional provisions will have to be made due to the negative trends of the Italian economy since the beginning of 2014, taking into account the same guidelines stated by the AQR.
So now let's spend a minute talking about the NPL business. So if you turn to page 10 I would like you to -- to remind everyone on this call that the level of NPLs on Italian banks' balance sheets, back in May 2013 when we repositioned Eurocastle strategy, was EUR136 billion.
As you can see in line with our provision forecast, the NPL inventory has reached EUR172 billion at the end of Q3 2014. I think this will grow even more over the next few quarters and could reach EUR200 billion which is approximately 5 times higher the NPL stock back in 2008.
So with that let me give you some color on how Eurocastle plans to benefit from the current market dynamic in Italy.
The banks with lower capital ratios will need to recapitalize or sell non-core assets in order to bolster their balance sheets.
This, in my opinion, together with the smaller gap between the bid and ask price will trigger a third big wave on NPL sales.
A significant deal flow is expected to accelerate by year-end with a peak in 2015 and 2016. I think the Italian banks may sell up to EUR5 billion to EUR10 billion by the end of 2014, and over EUR50 billion to EUR100 billion over the next two, three years.
So despite the provisioning that has taken place this year, the flow of new deals has been pretty slow, primarily due to the wait for the completion of the ECB Comprehensive Assessment.
But now that the results are strongly affecting the bank's balance sheet, we think that the NPLs will be provisioned correctly and this will help to accelerate the sale.
It is for the reason just described that we believe that investing in non-performing loans in Italy is the most actionable opportunity we have.
We think that ECT is uniquely positioned to take advantage of the most actionable opportunity in Italy.
Our main competitive advantage is our exclusive partnership with Italfondiario, the largest non-bank NPL service in Italy, with majority-owned by affiliates of our manager, Fortress Investment Group.
Italfondiario continues to serve not only as a servicing partner but also adds great value when sourcing and underwriting new deals.
I believe that adding a strong partnership with a servicing platform like Italfondiario is a key to investing in Italy.
In addition, we are also leveraging the expertise of our manager in Italy. Fortress has been one of the largest investor in the Italian NPL market for over a decade, and has a strong team of professional with experience in sourcing investment opportunities and have a long-term relationship with the [senior manager] of top Italian banks.
Fortress and Italfondiario relationships often help us to receive exclusivity or the status of a sole bidder on many deals that we're bidding on.
So, now if you turn to page 11 I will dive a little deeper into where we are today with respect to our Italian loan investments.
So, as I mentioned before, our investments in Italian loans continue to outperform expectations. To date, we have invested EUR24.9 million (sic - see slide 11, "EUR24.5 million") to acquire nine pools of loans with combined GBV of approximately EUR4.2 billion.
Focusing on the performance of the existing loan investments made in 2013 and 2014, we received already EUR15.9 million of cash flow versus our initial underwriting of EUR11.9 million for the same period, representing approximately 65% of the invested amount.
The target IRR has increased significantly as compared to the underwriting IRR, and we are very pleased with these results.
As you can see on page 12, I'd like to say that the potential areas for investments in Italy continue to be very significant, and in line with our strategy.
We are currently in the exclusivity, or acting as a sole bidder, on portfolio with a combined gross book value of approximately EUR3.6 billion, and have a solid long-term pipeline of over EUR8 billion of gross book value. We think that some of these deals will close by year end.
And I think that we could deploy a significant amount of equity in the next few quarters, and depending on capital needs, we might approach the market for new equity, in the near future.
In the meantime, Eurocastle is also actively involved in pursuing opportunistic investments in Italian real estate sector, and other opportunities in the Italian receivables. For those categories, we have a pipeline of almost [EUR300 million].
So you see on page 13, we expect to generate between EUR90 million and EUR160 million from the legacy business, over an average life of 1 to 2.5 years.
The amount that will be collected will depend on the economy, the evolution of the German real estate market, and the success of certain asset management sales and refinancing activities.
In conclusion, we feel very positive about the investments made so far in the new Italian strategy. We are confident that we are very well positioned to take advantage of a large NPL market in Italy that is now waking up after a few years of inactivity.
The results of the comprehensive assessment will play in our favor, by forcing banks to provision against the loans more accurately, and generate a solid pipeline with strong returns for our investors.
In addition to that, we are leveraging our experience in the Italian real estate market, where we see opportunities to make investments with attractive returns.
Finally, I will add that we feel very confident that we'll be able to monetize our legacy real estate portfolio ahead of schedule.
And with that I will turn it to our co-CFOs, Oliver Goodrich and Scott Berry, who will take you through our financials in more detail. Oliver?
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Oliver Goodrich, Eurocastle Investment Limited - Co-CFO [4]
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Thank you, Francesco, and welcome, everyone. As Francesco just mentioned, we see significant opportunity to generate large cash flows from our legacy business and have become increasingly focused on accelerating these recoveries, which could then be redeployed into the Company's new investment strategy at higher returns.
Let me take you through the mechanics of the cash flow scenarios, laid out on slide 13.
Our legacy portfolio is made up of EUR1.4 billion in assets, with a finance of EUR1.3 billion of debt. These assets are contained in both the commercial real estate and other debt portfolios.
Just to reiterate Francesco's earlier comment, over the next few years we believe that we will be able to generate between EUR90 million to EUR160 million of cash flows from these remaining assets.
This expected range equates to about EUR2.76 to EUR4.90 per share. The majority of this is expected to be generated from commercial real estate in the form of levered cash flows, fees and sales [cash] from asset disposals.
To date, in 2014, we've already realized EUR34 million of cash from our legacy assets. And approximately EUR23 million of this was received in the first quarter for the sale of securities within the debt business.
We are now extremely focused on realizing cash flows from the commercial real estate assets, on an accelerated basis, and are actively working on a sale of three portfolios which, if successful, could generate a significant portion of the expected cash flows to Eurocastle over the next year.
So we're making good progress in our goals, in converting these legacy assets into cash, and expect to continue to do so in 2015.
With that, I'd like to turn it over to Scott Berry who will take you through our second quarter financial results.
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Scott Berry, Eurocastle Investment Limited - Co-CFO [5]
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Thank you, Oliver, and welcome, everyone. I will now spend a few minutes reviewing the financial highlights set out in slide 4 of the presentation.
The adjusted NAV for the quarter was EUR8.85 per share. As in previous periods, the adjusted NAV adds back the negative net asset value within the non-recourse Mars Floating portfolio.
Compared to the last quarter, this is a decline of EUR0.15 per share, mainly due to transaction costs and sales, and CapEx on German commercial real estate assets.
Excluding Mars Floating, normalized FFO in Q3 was EUR1.7 million or EUR0.05 per share.
Assuming we invest the net corporate cash, of EUR101 million, at a 16% return, quarterly normalized FFO would increase by EUR0.12, to EUR0.17 per share, on an illustrated basis.
Finally, let me discuss our dividend. On October 31, Eurocastle paid a dividend of EUR0.125 per share, for the third quarter. This implies that our stock is currently trading at a dividend yield of over 7% as of yesterday's closing price.
We have now paid out EUR0.625 per share, since we simplified our capital structure, and raised additional equity last year. On an absolute basis, this is now over EUR20 million of cash distributed to our investors, over 18 months.
With that, I'd like to hand the call over to the moderator for the question-and-answer session.
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Questions and Answers
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Operator [1]
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(Operator Instructions) [Ismadi Ismail].
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Ismadi Ismail, - Analyst [2]
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I have two questions and the first one is actually on net asset value, and the second one is on the 16% IRR rate, on the invested cash flow.
Starting with the net asset value; I noted that the -- it's fallen from the FY13 year end figure of EUR328 million, to EUR289 million at the end of the third quarter.
Our question is, is this expected to continue, as the asset sales in Germany continue? Or would you expect this to stabilize or increase going forward?
And my second question is, based on your current negotiations, do you still remain confident in achieving the 16% return rate on investing the net corporate cash of EUR101 million?
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Oliver Goodrich, Eurocastle Investment Limited - Co-CFO [3]
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Hi, I'll take it, it's Oliver. I think from a value -- you've mentioned a decline in NAV over the year. Yes, you are right, it does primarily relate to our real estate assets.
I think the risk is -- it's been a reflection of declining lease terms in the retail portfolios, together with some [over rent] in the Drive portfolio, primarily. So there will be some continued decline in these portfolios until lease terms are negotiated or a renewal secured, should that be the case.
But what I will say is that we're talking about accelerating recoveries on the real estate business, currently. So that involves -- we're looking to monetize portfolios, so we wouldn't obviously consider to do that considerably away from net asset value, but obviously note the fact that assets carried on our balance sheet don't account for transaction costs on sales.
So I guess what I'm saying is that there is a continued run off, and it may be driven by certain leasing events, particularly in the Drive portfolio, but at the same time, we are -- we do think it's a good time now, and we are working and exploring selling potential assets and we wouldn't want to do that significantly below net asset value.
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Francesco Colasanti, Fortress Investment Group LLC - MD [4]
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So I'll take the second question. I feel confident that the investments that we'll be making using the existing cash, will be done at 16%.
All the investments we're looking at are mid to high teens. So other investments will not -- we're not looking at.
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Ismadi Ismail, - Analyst [5]
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Thank you.
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Operator [6]
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Michael Mackey.
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Michael Mackey, Kingdon Capital Management - Analyst [7]
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A question on the legacy assets, which you guys have mentioned a couple times on the call, that you're in discussions to accelerate the recovery. I think you mentioned three portfolios, and I know some of them, obviously at this point have more debt than equity.
So if I think about the three portfolios, and the projection for cash flows, of anywhere from EUR85 million to EUR135 million, is this -- the three portfolios you're talking about, is that a lion's share of it?
And, I guess, if you can give us a little bit more color around potentially the timing.
And if in fact you are successful, I know Francesco you made comments about potentially needing equity in the near future, if a deal were to happen, if you were able to bring in proceeds from these sales and obviously make the Company much simpler without the legacy assets, would you use that cash instead of raising, obviously, down here below NAV?
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Francesco Colasanti, Fortress Investment Group LLC - MD [8]
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Thanks for the question. So let me give you some more details on the legacy assets.
The team in Germany, together with us here in Italy and London, we are working very hard to monetize the existing investments. In fact, we currently have a process to sell the Wave portfolio. We received multiple offers and we think that we can execute in a reasonable timeframe, the sale of that portfolio.
We also received an offer to buy the Retail portfolio, and the numbers look pretty attractive for us. It's a good indication. They're doing the diligence, and we will see if this completes. But I'm confident that this could work.
And the other thing is, we are monetizing -- we're selling now the last assets of the Mars Fixed portfolio with -- that will generate significant cash for us.
So for all these three portfolios, we don't have binding commitments yet, but we saw the market interested in those portfolios, in those assets, and definitely we think that there will be something to do with them in the near future.
So, even though we don't have binding commitments, we think that it's possible now, with the current market conditions, to monetize those investments, at a value that is attractive for us.
For the use of cash, I would say, definitely. So as long as the -- that's the goal of the Company. So the goal of the Company is to monetize the legacy assets that are not generating high enough return for our shareholders, and deploy the capital in more attractive business opportunities.
So that's what we will do. As soon as the cash we -- will be received from the legacy assets, we'll deploy in new investments in the new strategy of the Company. That would be the goal.
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Michael Mackey, Kingdon Capital Management - Analyst [9]
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And I guess, Francesco, as it relates -- I mean obviously, there's a timing issue as that happens and I know you're under -- obviously, you guys have commented you're in exclusivity period. Should you be able to come to terms and I don't know how long that -- if you can give us some sense of how long that exclusivity period lasts for and the timing of that.
So obviously, the potential to potentially raise equity and how you guys feel about how you get -- I assume you would only raise equity with a deal in hand and, obviously, market it as such, knowing the stock obviously doesn't have a tremendous amount of liquidity, I'm not sure that the price on the screen is really a reference point.
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Francesco Colasanti, Fortress Investment Group LLC - MD [10]
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Yes, well, first of all, the EUR3.6 billion referred to four portfolios where we are exclusive or we are the sole bidder. But you're totally right, we'll raise capital only if we have a deal on our hand and so if we are sure that we're going to close the deal. We're not going to raise additional capital on a speculative basis right now.
So what -- the timing may not be the same, by the way, because really it's a negotiation, but it might be that certain cash that is needed to close the deals that we have under exclusivity right now, should be paid earlier than the monetization that we will have on the legacy real estate assets.
So really it's both -- in both circumstances we're under negotiation, so we are trying to expedite this resolution of the legacy, but at the same time, once we have agreed the terms for the assets under exclusivity, then they may not be the same -- the timing may not be aligned. So we have some discrepancy that we will need to manage.
But what I can tell you, and I can confirm you, that if we would be able to generate the cash from the legacy assets, then it will definitely be deployed in the deals that we will be acquiring.
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Michael Mackey, Kingdon Capital Management - Analyst [11]
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Thank you, Francesco.
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Operator [12]
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[Jordan Celeste]
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Edmond Safra, EMS Capital - Analyst [13]
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Hi, it's actually Edmond Safra. A couple of my questions were answered. I guess, just focusing on the new business in the NPL, your partner, Prelios they -- yesterday they made an announcement where they suggest that they are pretty confident that the deal which you are under exclusivity will materialize. Can you give us a little bit more certainty on that or you prefer to remain a little bit more cautious?
And number two is just a small item. As an indication, where is the shares that you bought at a discount for the closed end Italian real estate fund, where do they trade currently? I know you bought it around 36.5% discount. Thank you.
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Francesco Colasanti, Fortress Investment Group LLC - MD [14]
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So let me answer the two questions. On the first one, Prelios can make all the statements that they deem appropriate. What I think is that we are under severe confidentiality obligation with the seller. We cannot disclose the terms of that agreement.
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Edmond Safra, EMS Capital - Analyst [15]
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Okay.
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Francesco Colasanti, Fortress Investment Group LLC - MD [16]
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What I can tell you is that we are under exclusivity and we are negotiating a deal. As soon as we know that a deal will close, in case it will close, we will be making a public announcement and so we will let you know.
So at the moment, it's very difficult for us to give you more information on that deal because it involves listed companies and there's a severe confidentiality agreement obligation that we have undertook. So that's -- undertaken. So that's the situation.
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Edmond Safra, EMS Capital - Analyst [17]
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And what's the timing there, roughly, when you will know? Is it another month? Is it another three months?
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Francesco Colasanti, Fortress Investment Group LLC - MD [18]
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Well, it really depends because we are in the negotiation phase and it could take a month, it could take four months. There are certain authorities that need to approve it. So it will -- it may take time and we may not be able to control all the timing of this deal.
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Edmond Safra, EMS Capital - Analyst [19]
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Okay.
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Francesco Colasanti, Fortress Investment Group LLC - MD [20]
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And the second question that you asked is actually, if you look at the presentation, it's page number 7. When you want to see the numbers of the fund that we bought, that Eurocastle bought, it's in the investments prior to Q3 2014 that you can see here.
The fund is trading at the same level that Eurocastle made the investment.
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Edmond Safra, EMS Capital - Analyst [21]
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Okay. And you're tracking the performance underlying and you're satisfied with it?
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Francesco Colasanti, Fortress Investment Group LLC - MD [22]
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As we track with the performance of all our investments, that specific fund is listed so the people at Eurocastle that are responsible for that investment are tracking the investments with public information made available by the company that managed it.
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Edmond Safra, EMS Capital - Analyst [23]
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Okay, thank you.
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Operator [24]
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(Operator Instructions) And at this time, it appears we have no further questions so I'd like to turn the floor back over to management for any additional or closing remarks.
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Francesco Colasanti, Fortress Investment Group LLC - MD [25]
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Well, I would like to thank you for your time, thank you for your questions. And on behalf of everyone at Eurocastle, we thank you for your continuous support and look forward to updating you again in March. Thank you very much.
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Operator [26]
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Thank you. This concludes today's conference call. You may now disconnect.
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