Wednesday, April 22, 2020

Ladder Capital: Internally Managed mREIT, No CRE CLO Debt

In the previous post I sung the praises of the use of non-recourse secured debt for Colony Capital (CLNY), here I'm going to do the same but for the use of unsecured/non-CLO debt at Ladder Capital (LADR), a commercial credit/mortgage REIT with an $830MM market cap.  Ladder has been punished alongside their commercial mREIT peers and currently trades at approximately 50% of 12/31 book value (which will almost certainly will come down), the recovery won't be overnight, but Ladder is well positioned to survive the corona crisis and provides a safer (not safe) way to play the rebound in the mortgage REITs for the following reasons:
  1. Ladder is an internally managed REIT with significant insider ownership and management seems to run the company as owners versus as a fee revenue stream.
  2. Senior secured portfolio -- in particular their CMBS portfolio is predominantly AAA (which the Fed recently announced is eligible for TALF financing) versus many of their peers who play in the BBB to B space and have had trouble with margin calls.
  3. Unsecured and term repurchase financing gives Ladder the opportunity to work with their borrowers on modifications without getting cash flows shut off like they would in a CRE CLO or face margin calls as they would in short term repo.
Quick overview of Ladder Capital, they were founded shortly following the last market crisis in 2009 (and listed in 2014) by the former UBS real estate team, that team is still largely together today and as a group own 11% of the company.  Ladder primarily plays in four areas of CRE finance: 1) transitional whole loans held for investment; 2) stabilized whole loans to be sold into CMBS (hopefully recognizing a gain on sale); 3) CMBS held for investment; 4) single tenant net lease properties; and then they do have a small sleeve of other operational properties partially the result of any foreclosures on the whole loan portfolio.  They portray themselves as having a strong credit culture and that seems to have played out in the last several years, prior to the coronavirus crisis, they've only had one realized loss on a loan, and unlike other mortgage REITs they don't have any legacy issues or at least don't play the trick of segmenting a core and legacy portfolio when things don't go as planned.

Roughly half of their assets fall into the first and second category, commercial real estate loans that Ladder originates themselves either on transitional properties (meaning a developer is re-positioning the property in some way) for their own balance sheet or on stabilized properties which Ladder will originate to distribute via the CMBS market.  Many if not most of the transitional variety will require some kind of forbearance or modification, construction crews may or might not be working, and certainly any up leasing activity or the time to rent stabilization where the property could be refinanced with longer term financing is pushed out.  The CMBS conduit market is already showing early signs of thawing, and on their Q4 call, Ladder mentioned having a fairly small amount of loans "trapped" in their warehouse awaiting to be sold into the CMBS market.  Here's their slide on their loan portfolio as of January:
As you can see, about 25% of the portfolio is exposed to the highest risk retail and hospitality sectors.  Given their middle market lean, the hospitality portfolio tends to be more weighted towards self service than convention hotels or resort destinations that may take longer to recover.  I tend to think most of these mortgage REITs have similar assets, capital is a bit of a commodity, but possibly Ladder is more conservative than some others.

The right side of the balance sheet is where I think Ladder is more interesting than others -- many commercial mREITs finance their transitional loan portfolios through CRE collateralized loan obligations ("CRE CLOs") where the loans are pledged to an off balance sheet SPV which then issues notes to fund the SPV's purchase of the loans.  The notes will be issued in various tranches depending on investor risk tolerance with the sponsor (the mREIT) of the CLO retaining the junior bonds and equity.  If the underlying collateral doesn't perform, there are asset coverage tests in place to divert cash flows from the junior note holders to pay the senior note holders and protect their position in the transaction.  In the years following the financial crisis, the asset coverage test thresholds are paper thin to the point where one or two modified loans in the portfolio will trip the diversion of cash flows away from the mREIT to pay down the senior note holders.  In practice, what often happens is if one of the underlying loans is in default or requires modification, the mREIT will purchase the loan from the CLO at face value and work it out off to the side as to not jeopardize their cash flow lower down the payment waterfall.  However, in the current environment where there will be many defaulted or modified loans, it might be difficult or just not possible due to margin calls elsewhere in an mREIT's balance sheet to purchase the non-performing loans from the CLO and thus shutting off cash flows.

Ladder had previously issued two CRE CLOs but wound those vehicles up in October and is currently out of that market.  Instead, Ladders funds its loans through a combination of unsecured bonds where they are a BB credit and through term repurchase facilities.  In their term repurchase facilities, they've always stressed in their filings that they've always kept a cushion available to allow them to meet margin calls in a cashless manner.  Neither have the feature of a CLO where cash flow of the underlying assets is completely shut off and may allow Ladder some breathing room in working through modifications with borrowers.  Here's from p74 of the 10-K, they've received margin calls and met them thus far (at least what's been disclosed), many mREITs tout their total available credit capacity but I think that's less meaningful than the borrowing capacity on their currently pledged assets.
Committed Loan Facilities
We are parties to multiple committed loan repurchase agreement facilities, totaling $1.8 billion of credit capacity. As of December 31, 2019, the Company had $702.3 million of borrowings outstanding, with an additional $1.0 billion of committed financing available. Assets pledged as collateral under these facilities are generally limited to first mortgage whole mortgage loans, mezzanine loans and certain interests in such first mortgage and mezzanine loans. Our repurchase facilities include covenants covering net worth requirements, minimum liquidity levels, and maximum debt/equity ratios.
We have the option to extend some of our existing facilities subject to a number of customary conditions. The lenders have sole discretion with respect to the inclusion of collateral in these facilities, to determine the market value of the collateral on a daily basis, and, if the estimated market value of the included collateral declines, the lenders have the right to require additional collateral or a full and/or partial repayment of the facilities (margin call), sufficient to rebalance the facilities. Typically, the lender establishes a maximum percentage of the collateral asset’s market value that can be borrowed. We often borrow at a lower percentage of the collateral asset’s value than the maximum leaving us with excess borrowing capacity that can be drawn upon at a later date and/or applied against future margin calls so that they can be satisfied on a cashless basis.
Committed Securities Repurchase Facility
We are a party to a term master repurchase agreement with a major U.S. banking institution for CMBS, totaling $400.0 million of credit capacity. As we do in the case of borrowings under committed loan facilities, we often borrow at a lower percentage of the collateral asset’s value than the maximum leaving us with excess borrowing capacity that can be drawn upon a later date and/or applied against future margin calls so that they can be satisfied on a cashless basis. As of December 31, 2019, the Company had $42.8 million borrowings outstanding, with an additional $357.2 million of committed financing available.
Uncommitted Securities Repurchase Facilities
We are party to multiple master repurchase agreements with several counterparties to finance our investments in CMBS and U.S. Agency Securities. The securities that served as collateral for these borrowings are highly liquid and marketable assets that are typically of relatively short duration. As we do in the case of other secured borrowings, we often borrow at a lower percentage of the collateral asset’s value than the maximum leaving us with excess borrowing capacity that can be drawn upon a later date and/or applied against future margin calls so that they can be satisfied on a cashless basis.
The other issue many mREITs are having is with their CMBS portfolios, mREITs like XAN or CLNC tend to buy CMBS in the BBB-B rating range or simply unrated, Ladder is predominately in the AAA and AA rated tranches of CMBS and as a result have significant credit enhancement via subordination.  While the pricing of AAA CMBS did drop, the Fed recently announced an expansion of the TALF program in which they'll provide financing on AAA CMBS issued prior to 3/23/2020.  In a bit of a departure from the other assets classes they're willing to finance, CMBS will only be legacy versus only new issuance.  I take this two different ways, 1) the Fed wants to stabilize CMBS prices today; 2) they're not concerned with needing to provide support for new issuance to resume like they are in other ABS markets.  Both are good for Ladder as a CMBS investor and as a loan originator to the CMBS market and it seems to be having its intended result, take the iShares CMBS ETF for example (tracks investment grade CMBS), it has recovered its losses and is up on the year.

Since I started drafting this post, Ladder put out an additional "business update" press release that is becoming all to regular for public companies these days.  In it they outline how they have $600MM of cash after some maturities on their loan portfolio plus they sold assets at 96 cents on the dollar and they have $2.3B of unencumbered assets.  Should be sufficient to get them through the crisis?  The dividend is roughly 20% at $1.34/year, that'll almost certainly get cut/suspended and could provide an attractive opportunity if any remaining yield pigs remain holders.  I like the management here and think we will see most if not all CRE CLOs fail their coverage tests (might be more opportunities once that happens), my sense is Ladder should trade for somewhere in the 75-80% of 12/31 book value range, no science behind it, but I see little risk that they'll be forced to liquidate at fire sale prices or have their cash flows shut off due to asset coverage test failures.

Disclosure: I own shares of LADR

Friday, April 10, 2020

Colony Capital: Preferred Stock, Non-Recourse Debt, Complex Mix of Assets

Colony Capital (CLNY) is a real estate private equity manager and real estate investment company that today fashions itself as a leader in the digital infrastructure sector.  However, it's mostly a complex mess of assets that have been left behind as the company has pivoted strategic directions several times, only to reclassify the old businesses as "legacy" hoping investors forget about them.  But the complexity and random assortment of assets might be beneficial to company today as its not reliant on one asset type (i.e., agency mortgages) or one funding source (i.e., repo agreements) that could subject the company to repeated margin calls and put them out of business completely.  The common stock might be worthwhile as a call option, but due to that complexity, I have a hard time valuing it in any credible way I'm willing to share, instead, the preferred stock seems cheap based on the unencumbered assets and is unlikely to be impaired through this crisis.

CLNY is the creation of Tom Barrack, he's a long time real estate investor and close friend of Donald Trump who is known for speaking at the 2016 Republican National Convention and more recently writing a blog post asking for a bailout of the commercial mortgage market.  Commercial mortgage REITs have recovered quite a bit in the last week or so, but prior to that they were hit with margin calls as the value of their CMBS assets fell and started a chain reaction of forced selling creating more forced selling as prices dropped.  CLNY is not a mortgage REIT, but is the external manager for one in Colony Credit Real Estate (CLNC) and CLNY owns 36% of CLNC's equity, but CLNY and its preferred stock declined alongside the commercial mREITs anyway.

CLNY's current strategy is to "focus on building the leading digital real estate provider and funding source for the occupancy, infrastructure, equity and credit needs of the world's mobile communications and data-driven companies."  They started down this path last July by purchasing Digital Bridge Holdings, a private equity firm that managed six separately capitalized digit real estate companies and a $4B fund it co-raised with CLNY, Digital Colony Partners Fund (which recently acquired ZAYO).  Along with Digital Bridge came a new management team that is slated to take over CLNY on 7/1 and move Tom Barrack to Executive Chairman.  This might be the right strategy, the tower and data storage REITs all trade at rich valuations, if CLNY can fully pivot maybe they'll get some of the benefit of that premium, but most of the value here is in the legacy assets.

Let's start with CLNY's capital structure as of 12/31/19:
CLNY's Q4 Supplemental
CLNY has a fair amount of liquidity following the sale of their light industrial warehouse assets to Blackstone in December and the sale of their equity interest in RXR Realty in February, leaving them with $520MM in cash as of the end of February, plus their undrawn credit facility.  All but $931MM of debt is non-recourse, and then a portion of the non-recourse debt is third party that CLNY consolidates on their balance sheet.

Their main assets are majority interests in two large portfolios (essentially REITs in their own right), one in an assortment of healthcare assets (but mostly senior housing and skilled nursing) and the other in select-service and extended stay hotels with brands associated with either Hilton or Marriott.  Both asset sleeves refinanced their debt in 2019 and pushed out maturities to 2024 and 2026, I haven't spent much time on the covenants, but the debt is non-recourse and under a worst case scenario, CLNY could mail back the keys to the lenders.  In hospitality, I do tend to think extended stay is performing better than other segments (still long some STAY) as its more of a residential replacement than true travel and then select service might recover sooner than destination resorts or convention heavy locations.  But again, non-recourse, a blow up in either or both would be a scary headline but wouldn't take down the entire enterprise, for the below, just going to assume both portfolios are zeroes.

The remaining assets are an interesting grab bag, cynically, it seems like CLNY was used as a way for Tom Barrack to invest with friends or in vanity projects whether it made sense for a public REIT or not:

1) Investment Management Business
When CLNY (originally CLNS) was formed in the three way merger with NSAM and NRF, I figured CLNY wanted to be the next Brookfield Asset Management (BAM), they would mostly be an asset management company and then would have "YieldCos" they would manage and partially own.  They've sort of done that, just not executed as well.  But with the acquisition of the digital business, they have a considerable management company arm that is essentially unencumbered and generates approximately $160MM a year in base fee revenue.
They have started down the path of internalizing the management at CLNC which they'll likely receive additional shares as consideration once the commercial mortgage market settles down a bit.  If you put a 35% margin on $160MM and give it a 10x multiple (just a swag), that's a $560MM business plus the non-wholly owned management companies listed above.  One of which is an interesting venture with Sam Zell (partnering with friends, not sure it fits in a public REIT vehicle), Alpine Energy, that is investing in distressed oil and gas like California Resources (CRC).  As mentioned earlier, they also monetized their investment in RXR Realty for $179MM, which implies a similar valuation I'm placing on the four wholly owned segments.

2) Colony Credit Real Estate (CLNC)
CLNC is mostly a commercial mortgage REIT but does own some net lease properties and other assets, it's suffered like the rest of the sector, but has generally limited CMBS exposure at under 7% of assets, recently closed a CRE CLO which termed out much of its debt, and has been current thus far on any margin calls.  Interestingly, I've only seen margin calls on RMBS or CMBS and not whole loans, whole loans are likely harder to price or more negotiable, might be worth focusing on mREITs with more whole loan exposure than to securitized products.
At Thursday's ~$5 close, CLNC has a market cap of approximately $665MM, trading at about 30% of the last reported book value (likely coming down).  But a 36% ownership at today's depressed prices is still worth $240MM to CLNY, plus the management fee contract but we're including that in the investment management business above.  They do account for their stake in CLNC via the equity method, so its grossly overstated at the moment compared to CLNC's market value, meaning an accounting impairment is likely on the way.  CLNY's long term plan with CLNC is to sell their position down over time once it is trading more inline with book value.  CLNC is interesting in its own right and might deserve a separate post, but for the purposes of CLNY let's say it survives and leave it here.

2) Other equity and debt portfolio
Here's the grab bag of other assets that includes some directly held real estate (sometimes the result of a foreclosure), their $186MM investment in DataBank which is one of the six companies that Digital Bridge manages, a stake in Albertson's which might be one of the few large companies to conduct an IPO this year (can't think of a better year for a grocery store to come public again), and all their co-investments in institutional funds they manage.

This sleeve is valued at $1.8B on the balance sheet and CLNY pre-corona intended to monetize $300-$500MM of assets this year.  That'll likely change, but even putting a significant haircut on the assets, let's say they're worth 30% less in this environment, making the net equity worth ~$900MM, that's probably overly punitive as a lot of this is at cost in their financials, but the exercise is to see how much value is left for the preferred assuming an extended crisis.

This modified SOTP is too severe, but just illustrating that I think the preferred stock is still money-good versus a trading price in the $16-17 range.
At Thursday's close, you also have about $1.2B in CLNY market cap beneath the preferred shares.  There are plenty of investment opportunities with more juice but here you don't have to worry about how much of the portfolio has been liquidated due to repo margin calls.  The preferred stock (there are 4 series, generally the same, some more liquid than others) has about 50% upside to $25 plus any dividends collected along the way as we wait for things to normalize.

Disclosure: I own shares of CLNY Preferred Series G

Wednesday, April 1, 2020

Watchlist: GLPI and Penn National Gaming

There are a number of interesting situations and potential bargains out in the markets today, I typically don't write on companies where I don't own the shares, but for the next few months (however long we're all stuck at home) I might try to push out a few more posts on ideas where I've done some work on but don't own for one reason or another (limited cash), but want to be ready to take advantage of further declines.

One such situation is Gaming and Leisure Properties Inc (GLPI) which is the 2013 REIT spin of Penn National Gaming (PENN), PENN is now the largest operator of regional casinos in the United States and rents most of their properties from GLPI, they're still attached at the hip 7 years later.  GLPI was the first of the triple-net lease gaming REITs that now also includes VICI Properties (VICI) and MGM Growth Properties (MGP); GLPI owns the real estate of 40+ casinos and leases them back to casino operators who pay all the maintenance, taxes, insurance and other property level costs of the property.  The leases are typically structured as master leases and are functionally senior to the traditional debt as their physical casinos are critical to the operation of the business (although mobile will increase in share going forward).  In addition to the triple-net lease business, GLPI owns and operates two casinos due to tax rules at the time of the spin requiring an active business, one in Louisiana and the other in Maryland, both under PENN's Hollywood brand.  Their leases are primarily with PENN, around 80%, they did previously diversify by doing a PropCo/OpCo transaction with Pinnacle Entertainment (PNK) in 2016, but PENN ended up buying PNK in 2018 causing GLPI's tenant concentration to revert back.  GLPI also has Elderado (ERI) as a tenant from when GLPI paired with ERI in the acquisition of Tropicana Entertainment (TPCA), Boyd Gaming (BYD) due to forced divestitures from the PNK tie-up, and Casino Queen (smaller distressed player) on the rent roll.

Obviously, Penn National is in a considerable amount of distress with coronavirus and social distancing, they have closed all of their casinos and furloughed much of their employee base for an indefinite amount of time.  PENN is highly levered, their annual rent is significant at ~$900MM/ year (plus another $105MM in interest on regular debt), with $820MM of that going to GLPI, PENN is current on rent through the April payment, but would be unable to manage through this crisis without some forbearance or risk being restructured which would be disastrous for both GLPI and PENN.  This past Friday, GLPI and PENN entered into a unique transaction:
  • PENN will be free delivering the Tropicana Las Vegas property and operations to GLPI, plus the land under their Hollywood Morgantown development that is scheduled to open around year end for $337MM in credits to be applied to the May, June, July, August, October, and a partial payment towards their November rent.
  • PENN will then lease back the Tropicana Las Vegas from GLPI for $1/year and continue to run the operations and maintain the property.
  • GLPI will engage in a sale process over the next 2 years to sell both the real estate and operations of the Tropicana Las Vegas in order to recoup the rent credits.  $307MM of the $337MM in rent credit is to be assigned to the Tropicana. If the property sells for more than $307MM then the excess would be split with PENN, 25% of the excess would go to GLPI if it sold in the first 12 months, and there would be a 50/50 split in year two, beyond year 2 GLPI would get 100%.  PENN had been rumored to have gotten inbound bids in the $700MM range as recently as this past January for the property, but those buyers are likely long gone.  PENN did purchase the Tropicana for $360MM in 2015 providing some assurance that the property is worth more than the rent credit GLPI is receiving (assuming Vegas isn't permanently impaired by the coronavirus).
  • PENN additionally agreed to exercise their 5 year extensions on their master leases and entered into an option to purchase the operations in 2021 of one of GLPI's owned and operated casino, Hollywood Perryville (MD), for $31MM and enter into a $7.8MM annual lease for the property.
No one will confuse the Tropicana with a high end casino like the Wynn or Bellagio, but it is 35 acres and over 1400 rooms on one of the busiest corners on the strip.  Another tired casino in much worse location, Circus Circus, was just purchased for $825MM by Phil Ruffin in January.  Again, the world has changed, but if things return to any reasonable normalcy, GLPI should eventually get their deferred rent paid via the sale of the Tropicana.  And then PENN gains itself some breathing room with the rent credits at least into the fall, if they can open up the majority of their casinos sometime in the summer, they're likely to survive, if social distancing lasts deep into the third quarter or early fourth quarter it is likely game over.  PENN might be able to raise additional cash by selling their distributed gaming business or other non-casino related assets, but following moving the Tropicana over to GLPI, essentially all their properties are leased.

But how does GLPI itself navigate the remainder of 2020?  GLPI has $5.7B of debt and pays out approximately $600MM in annual dividends to shareholders.  Below is a quick analysis on GLPI's liquidity and ability to pay their dividend.  Both Boyd and Elderado (at least pre-CZR deal) have a stronger liquidity position than PENN, but let's assume both receive similar rent forbearance arrangements and then GLPI's operating casinos are a net cash drag on the year.
As always, I'm sure I've made a few mistakes in the above, so feel free to pick it apart, but it appears that GLPI could be in a position to continue its $2.80/share dividend, which is an 11% yield at today's $25/share price. 

A lot depends on when PENN can reopen their casinos and how receptive people are to returning to gambling following both a health crisis and for many people an economic one.  Regional casinos like PENN's might hold up better than destination ones as they rely on regular customers and focus on slot machines (~93% of their gambling revenue) versus convention business travelers or high rollers.  PENN is also making an aggressive move into sports gambling with their $163MM investment for a 36% stake in sports and pop culture media company Barstool Sports in February.  Barstool has an army of loyal followers, they're truly marketing experts, and Barstool personalities pumped up the stock in the weeks following the acquisition and before coronavirus realities set in for the company.  The plan is to rebrand PENN's sports betting operation to Barstool and launch an online sports betting app, where legal, in August ahead of the NFL season.  With sports essentially cancelled for the near term, that's another blow to PENN's plans, any delay to the NFL season would be particularly painful given their investment in Barstool.

Back to GLPI, original 2020 guidance was for $1.05B in EBITDA on about an $11B enterprise value, or 10.5x, in simpler times these gaming REITs trade at 13-15x EBITDA, 14x a normalized 2021 EBITDA would make GLPI a ~$42 stock versus $25 today.  In a dream scenario, there might be an extra $1/share in the Tropicana if sold for $700MM in year two, but that feels unlikely today.  There are certainly stocks with higher upside in this market, but once the smoke clears on PENN's casinos reopening, GLPI should re-rate pretty quickly once the disaster scenario of getting the keys in the mail is off the table.  Whereas PENN clearly has more upside, but may take longer and is more exposed to how quickly the economy recovers.  Why don't I own GLPI or PENN?  Not 100% confident the dividend remains at GLPI, if its cut, might actually be the buying opportunity as other investors sell if you believe in the long term durability of their leases.  Others thoughts welcome.

Disclosure: No current position as of posting