HF
#Thank you, <UNK>.
Good evening everyone and welcome to HFF's second quarter 2015 earnings conference call.
Overall, we are very pleased with the firm's performance in the second quarter of 2015 and the first six months of the year.
Based on our results, which <UNK> <UNK> will review in detail, we believe the commercial real estate industry continues to embrace the Company's team-oriented approach in executing capital markets transactions thereby affirming HFF's strategic plan and it's unwavering adherence to its core cultural guiding principles.
Revenues in the second quarter of 2015 grew approximately 31.9% year-over-year.
HFF's operating income increased 42.7% as operating margins expanded to 20.6% during the second quarter of 2015, an increase of 160 basis points compared to the same period in the prior year.
As we continue to invest in our business, evident in 11.1% increase in total headcount over the past 12 months, our revenue and operating performance are consistent with our philosophy of measured, sustainable and profitable growth.
Additionally, our revenue per producer during the first half of 2015 totaled $767,000, an 18.5% increase over $647,000 achieved in the same time period of 2014, which we consider a testament to the firm's team-oriented culture and the efficiencies obtained from the synergies between and among the firm's business lines and property verticals.
The commercial real estate industry as an asset class remains in favor with investors.
Additionally, the composition of ownership is becoming increasingly institutional, contributing to HFF's attractive position as an intermediary.
This is best illustrated by the following points: First, [effective in] third quarter of 2016, commercial real estate will be re-categorized from the broader financial sector and become a standalone category as the 11th Global Industry Classification Standard or GICS trading vertical.
While the private market has long recognized commercial real estate as a valid asset class, this globally recognized designation of firm's commercial real estate has earned its place among the investment portfolio of the public sector as well.
For reference, the CRE industry's returns as compared to competing asset classes are set forth on slide 15.
HFF believes the emergence of CRE as a core investment holding ensures the industry will continue to benefit from consistent annual allocations of capital and that investing in the asset class is necessary in order to attain a well-balanced diversified investment portfolio.
Domestic institutional investors who are active in the private commercial real estate market have in the past been consistently underinvested in commercial real estate.
As shown on slide 16, actual investment in the asset class is approximately 90 basis points below target as a percentage of AUM.
Furthermore, as expected, these institutions are poised to further increase target allocations in the near future.
Additionally, sovereign wealth funds are electing to invest in commercial real estate as a reduced exposure to public equities in private equity as shown on slide 17.
As evidence of my previous statements and as illustrated on slide 18, the institutional investor participation in the private commercial real estate market continues a multi-year increase in 2015.
Capital managed by institutional investors in real estate, measured by assets held within open-end and closed-end funds has increased 40% and 77%, respectively since the prior peak suggesting both increased demand for the asset class in a larger denominator of assets, which should be a positive relative to future transaction volume.
Finally, the economic and social unrest in many parts of the globe appears to be increasing the flow of foreign capital into the US with commercial real estate being a beneficiary of this inflow of capital as shown on slides 19 and 20.
In fact, preliminary estimates of foreign investment in domestic commercial real estate assets totaled approximately $47.4 billion during the first six months of the year, exceeding the 2014 full year total by nearly 15%.
In our opinion, these trends suggest ample equity capital is poised to deploy in the commercial real estate barring any external events that would be detrimental to the US economy in large.
Supporting this view as reported by RCA in transaction volumes during the second quarter of 2015 totaled $117.7 billion, an increase of 23.7% over 2014 and $254.2 billion during the first six months of 2015, a 36.2% increase over 2014 as illustrated on slide 21.
The aforementioned increases in AUM for both the closed-end and open-ended fund markets suggest the market has the potential to sustain current transaction levels.
Of particular note is the transaction volume likely to emerge from the closed-end fund market in the near future.
As illustrated on slide 22, the average hold period for 64% of participants in the closed-end fund market is less than five years in duration due to the value add objectives and underlying compensation structures of these funds.
Finally, as shown on slide 23, the $1.4 trillion of maturing CRE loans should serve as a catalyst for investment sales or refinancing transactions.
However, the competition to extend these loan maturities will be intense given the liquidity in the US banking industry and the need for earning assets on balance sheet.
In regard to HFF, our investment sale transaction volumes for the second quarter of 2015 totaled $8.2 billion, an increase of 20.1% over 2014 and $13.8 million in the first half of 2015, an increase of 19.7% over 2014.
When adjusting for one large investment sale transaction, which closed during the second quarter of 2014, the second-quarter growth rate increases to 43.8% and the first half growth rate increases to 32.6%.
As is illustrated on slide 24, HFF's investment sale transaction volume for the full year of 2014 increased 70% from 2007 as compared to a decrease of 26% for the industry.
Furthermore, HFF's investment sale transaction volume for the full year 2014 represented an increase of 187% from 2006, while the industry showed a decrease of 1% for the same period.
Turning to our debt placement volume, transactions for the first half of 2015 totaled $17.7 billion as compared to $11.2 billion in the first half of 2014, equating to an increase of 56.9%.
As illustrated on slide 25, HFF's debt placement volume for the full year 2014 increased 37% from 2007 as compared to a decrease of 25% for the industry.
Furthermore, HFF's debt placement volume for the full year of 2014 representing an increase of 45% from 2006 while the industry showed a decrease of 2% for the same period.
While we are pleased with our growth in transaction volume over the last several years, we are mindful the industry has largely recovered from the trough of 2009 financial crisis relative to historical metrics.
Therefore we believe future growth will be dependent on the ability of HFF to continue to differentiate and build out it's platform [in a] consolidating industry.
In regard to pricing, it is widely believed that capitalization rate compression and multiple expansion have run their course as the market is currently pricing at or slightly above the long-term average spreads of cap rates above both the 10-year and the BBB corporate bond benchmarks, illustrated on slides 28 and 29.
Therefore, most investors are keenly focused on fundamentals such as leasing velocity, run rates and occupancy increases.
In terms of a potential impact on price from rising interest rates, most investors have incorporated same into their respective underwriting models on each purchase and have also completed various sensitivities in determining the impact to total return over the whole period.
As illustrated on slide 30, in terms of geographic market preference, we expect the long-term trend of migrating up the risk curve at this point in cycle to continue as investors seek total return for a portion of their commercial real estate investment portfolio in markets outside of traditional gateway cities.
Additionally, investors are increasingly focused on corporate relocation trends, long-term employment population shifts and the velocity of trades in a given market, meaning the liquidity of a market, in determining allocations to a given geography.
In summary, we believe there is ample availability of capital in both the debt and equity markets to sustain a reasonable foundation for real estate transaction volumes.
Perhaps, more importantly, we are encouraged by the transparency of discussions regarding obvious potential risk to asset level pricing and the associated underwriting of same.
However, we are always mindful of both domestic and global macroeconomic events, which could dramatically and negatively impact both the volume and pricing levels of real estate.
Commercial real estate in effect houses of the US economy and therefore its health is directly correlated to US economic health primarily defined as US job growth.
I would like to thank the HFF team that generated our second quarter results, as those results are directly attributable to the efforts of this incredibly talented group of individuals.
And with that let me turn the call over to <UNK>.
Thank you, <UNK>.
The information I will discuss today is also set forth on slides 33 through 44.
Beginning on slide 33, during the second quarter, our revenue was $125 million, which is up 31.9%, principally due to the 37.8% increase in transaction volume.
The increase in transaction volumes is led by 64.1% increase in debt transaction volume and 20.1% increase in our investment sales transaction volumes.
We produced solid and improving operating margins and continue to maintain healthy levels of liquidity.
In addition, we continue to operate a highly diversified and fully integrated capital market services platform as it relates to both consumers and providers of capital.
For the first six months of 2015, no one client represented more than 1.7% of our capital market services revenue and the combined fees of our top 10 clients represented 12.2% of our cash market services revenue.
Turning to slide 34 and 35, as previously mentioned, revenue for the quarter was up 31.9%.
For the six months of 2015, revenue was $219.3 million, which represents a year-over-year increase of $48.4 million or 28.4%.
The growth in revenue for the six months was driven by 35.7% increase in transaction volumes with debt volume up 56.9% and investment sales volume up 19.7% year-over-year.
Operating income grew $7.7 million or by 42.7% to $25.7 million in the second quarter of 2015 compared to the same period last year.
For the first six months of 2015, operating income improved $15.1 million.
The increase in operating income for the quarter and six month period was primarily attributable to the growth in revenues.
The increases were partially by increases in compensation related and other operating expenses including performance based compensation.
Compensation-related expenses for the quarter and the six month period were impacted by an increase of approximately $600,000 and $1.3 million, respectively in contractual performance-based incentives for accrued transaction professionals.
The operating income for the first six months of 2015 was also impacted by $2.1 million reduction in non-cash stock compensation expense.
Operating margin for the second quarter of 2015 was 20.6% compared to the operating margin of 19% for the second quarter of 2014.
Operating margin for the first six months of 2015 expanded 400 basis points to 16.8%, as compared to 12.8% for the same period in 2014.
The increase is primarily due to the growth in revenues and improved operating leverage.
The Company's adjusted EBITDA for the second quarter of 2015 was $35.3 million, an increase of $12.2 million or 52.7% when compared to the second quarter of 2014.
For the first six months of 2015, adjusted EBITDA was $53.2 million, an increase of $18.2 million or 52.1%.
The increase in adjusted EBITDA for both the quarter and six month period was driven by growth in operating income as well as an increase in securitization and other agency related income.
Adjusted EBITDA margins for the quarter and the six month period increased by approximately 390 basis points and 370 basis points, respectively.
This margin improvement is due to the increase in securitization and other agency-related income of $3.8 million and $4.8 million for the quarter and the six month periods, respectively, as well as from the growth in operating income.
Cost of services as a percentage of revenue was 57.3% in the first six months of 2015 compared to 58.2% in the same period of 2014, 90 basis point improvement is primarily attributable to the fixed cost component being spread over the higher revenue base and is evidence that our cost increase as relative to growth in personnel is commensurate with our revenue increase.
Operating, administrative and other expenses were up approximately $6.7 million or 14.6% in the first six months of 2015 when compared to the same periods in 2014.
This increase is primarily due to the increased compensation-related expenses and other operating expenses due to higher transactional activity offset by the $2.1 million reduction in non-cash stock compensation expense.
Also, as shown on slide 34 and 35, interest and other income increased $6.2 million in the second quarter, which is attributable to higher income from the initial recording of mortgage servicing rights of $2.4 million and an increase of $3.8 million in securitization and other agency related income.
For the first six months of 2015, interest and other income increased $8.9 million, which is primarily due to an increase of $4 million from the initial recording of mortgage servicing rights and an increase of $4.9 million in securitization and other agency related income.
We have seen significant improvement in our Freddie Mac originations beginning in the second half of 2014 and continuing through the first six months of 2015.
The Company's Freddie Mac originations for the first six months of 2015 were approximately $3 billion, which is an increase of $2.5 billion or nearly 470% over the originations in the same period in 2014.
Given the robust financing volumes by Freddie Mac in the first half of 2015, we remain uncertain as to whether Freddie Mac can continue this pace of financings for the remainder of 2015.
The Company's effective tax rate for the first six months of 2015 was approximately 40%.
Earnings per share on a fully diluted basis increased 66.7% from $0.33 to $0.55 for the second quarter of 2015, and we had an increase of 86% from $0.43 to $0.80 for the first six months of 2015.
Slides 36 to 38 relate to the balance sheet and liquidity.
Our cash balance at June 30 of 2015 was $169.3 million, compared to $232.1 million at December 31, 2014, representing a decrease of $62.7 million.
The principal portion of this change is related to the $67.8 million special dividend payment made on February 13, 2015.
During the first six months of 2015, the Company generated $24 million in cash from operating activities excluding $15.1 million decrease in client advances.
The Company's use of cash is typically related to the limited working capital needs during the year and the payment of taxes.
The Company has virtually no corporate level debt to service other than that related to our Freddie Mac business which is offset with the mortgage note receivable.
On slide 36, I would like to point out that on our balance sheet as of June 30, 2015, we had $449.1 million of outstanding borrowings on 19 loans under our warehouse credit facilities to support our Freddie Mac multi-family business and we also had a corresponding asset recorded in the same amount for the related mortgage notes receivable.
Today, 14 of these loans or $323 million have been purchased by Freddie Mac.
I would like to make a few comments regarding our production volume and operational measurements, which can be found on slides 40 to 42.
As noted on slides 40 and 41, our production volume increased by 37.8% or $5.3 billion for the second quarter of 2015 and $8.8 billion or 35.7% for the first six months of 2015.
The total number of transactions grew by 31% or 130 in the second quarter of 2015 and 262 or 34.4% for the first six months of 2015.
The Company's loan servicing portfolio grew by $9.4 billion or 26.6%, when compared to the second quarter of 2014.
Slide 42 provides a historical summary of our headcount and also shows the second quarter comparison to the same period in 2014.
Total headcount and number of transaction professionals as of June 30, 2015 were up 11.1% and 7.1%, respectively year-over-year.
We have increased the total number of transaction professionals by 127 or 79.9% since the beginning of 2010.
Slide 43 provides a summary of certain production and operational measures.
The revenue per transaction professional was up approximately 18.5% for the first six months of 2015, and up 11% to $1.688 million from $1.521 million for the trailing 12 months, which is evidence of the productivity gains achieved by the Company.
In summary, we are extremely pleased with the Company's operating and financial performance for the second quarter and first six months of 2015.
We achieved improved operating margins and continue to make strategic investments in our business consistent with our growth strategy.
We continue to believe that we have been very efficient and strategic as it relates to our management of expenses and that any incremental increase should have minimal impact to our bottom line results on a full year-over-year comparative basis provided the market continues to expand and we continue to experience revenue growth consistent with the investments made in our business.
I would now like to turn the call back over to <UNK>.
<UNK>.
Thank you, <UNK>.
As we look further into 2015, we think it's important to convey the firm's strategic plan remains unchanged from previous years in terms of continuing to build out the Company's platform to ensure the HFF offices domiciled in major markets in the US have a full complement of our existing business lines and property vertical specialties.
Further, our future growth will continue to be premised on our core guiding principles, which we believe significantly differentiate HFF in the real estate industry.
These core guiding principles are briefly described as follows: First is our client-centric business model which avoids business lines or product services that directly compete with the business interests of our clients, such as investment management, landlord and tenant representation and/or property asset management practices.
Our capital markets professionals appreciate this lack of conflict of interest with their clientele.
Second is our player coach leadership style whereby the firm's leadership mentors our transactional professionals through being engaged in generating revenue for the firm by actively originating and executing real estate transactions.
Our transactional professionals prefer to be led and mentored through transactional deal flow versus managed in a corporate context.
Third is our pay-for-performance compensation structure, which aligns the interests of HFF's leaderships, leadership with the performance of the firm through our profit participation and omnibus compensation plans.
To further illustrate this point and as you know from our previous filings, effective January 1, 2015, we amended our office and firm profit participation plans as well as the executive bonus plan to allocate a higher percentage of the annual awards to equity which will vest over a subsequent three-year period.
Fourth is maintaining an owner mentality versus an employee mentality, which is illustrated by the fact that HFF employees own more than 14% of the outstanding Class A shares of HFF.
Highlighting the importance of our adherence to an owner mentality is the firm's granting of 750,000 shares in 2014 and an additional 250,000 shares in February 2015 to our leadership team and transaction professionals based on value added metrics which vest over a five-year period.
Our fifth guiding principle is risk mitigation.
Company has virtually no corporate level debt to service and we continue to maintain significant cash balances to fund our working capital needs, our future growth and to mitigate downside risks as occurred in 2008 and 2009.
Once we have met these needs and has sufficient capital reserve to not only survive but thrive in a down market, the Company led by the Board of Directors always looks at all options regarding the highest and best use of its capital.
Over the recent past, this has been illustrated by returning capital to shareholders on three previous occasions in 2012 and 2014 and recently in February of 2015 in the form of special dividends totaling $192.3 million or $5.15 per share over the last 31 months.
The sixth guiding principle is maintenance of our partnership mentality whereby the governing body of HFF, its executive committee, is elected by the firm's leadership team, which is comprised of 57 individuals who run the firm's 22 offices, it's business lines and it's property type verticals.
This approach to governance reinforces our team partnership culture and significantly differentiates the firm from the industry at large.
Finally, our seventh core guiding principle is the maintenance of the firm's value-add philosophy, which permeates every aspect of the HFF culture.
Our leadership positions, compensation awards and executive appointments are based on long-held value-add principles which were developed internally or communicated to all employees.
The ability of HFF to continue to differentiate and build out its platform in a consolidating industry as well as continued expansions in real estate history at large remains the primary focus of management.
We believe these guiding principles allow the firm to recruit and retain best-in-class industry professionals.
[Every single] statement as illustrated on slide [22], since the beginning of 2010, the Company has increased its headcount by 382, representing a 101.6% increase and we have grown our total transaction professionals by under 127 representing a 79.9% increase.
We have accomplished this profitably and at a measured pace.
HFF remains committed to protecting its culture via an unwavering adherence to its deliberative hiring practices.
Operator, I would now like to turn the call over to questions from our callers.
Well, let me first start off by saying, <UNK>, as you know, we don't give guidance.
So to speak to expectations of what that means for the second half, we cannot do that.
However, what I can tell you and it's obvious that the Freddie Mac volumes were up for a lot of the seller services in the first half of the year and they were rumored to hit their mandated caps before the end of the year.
So, they made some adjustments relative to the definition of what falls under the cap to try to ease some of that, but I think just given the robust nature, I think everyone would be uncertain as to whether or not that can continue in the second half.
So, I think we're just highlighting the fact that it was extremely robust in the first half, the mandated cap issue has been out there.
So I think it's just prudent to remain cautious about what that second half will bring.
For us, as you know, we have relationships with a lot of other lending sources, so Freddie Mac is not the only lending source for us from a multi-housing perspective.
Secondly, as it relates to the Freddie Mac ancillary income on our financial statements, it's primarily done in the other income line where we report securitization comp and gain on sale whenever we securitize those loans and as I've mentioned on previous calls, a lot of that is ---+ has a lag effect as it relates to when it rolls through our financials.
So, we originated loans, close it with Freddie and maybe a quarter or two before the impact comes into our financials when that loan gets securitized.
So, we saw that effect negatively in 2014, as our volumes decreased in 2013 into the first half of 2014.
We're seeing the pick up here this year from the volume increases in the second half of 2014 in the first half of 2015.
So, even if Freddie Mac originations decrease, I'm not sure what that impact will be in our second half on interest and other income, because of this lag effect.
Absolutely not, <UNK>.
Again to <UNK>'s point, we're extremely diverse in our debt relationships and if you look at the results of the firm from a debt perspective in 2014, when you had a little different scenario from the agencies, the fact remains that the vast majority of debt providers in the US are underallocated to multi-housing and any time that you see a shifting in agency demand or otherwise, you have ample sources of capital looking for multi-housing product in the US.
So, diversification is a key point that I would mention there.
And then just one follow-up, <UNK>.
As you know, we don't control the timing of any of the securitizations that occur.
So, even if we build up the originations and has a lot of loans that could potentially be securitized and we can earn additional other income from that, we don't control the timing of that.
So, how that falls out and impacts our financial statements is out of our control.
<UNK>, as I mentioned, I appreciate the question and as I mentioned on our first quarter call, we saw no diminishing in our results in Texas and that continues to remain the same.
Yes, I think it's a good question, <UNK>.
I think, market share is a hard number to track.
We gave you indications of that in the slide deck that we've shown you primarily using MBA and RCA data, and I would also say that financial results [tend to trump] volume on that.
But I think you will see some trends that emerge in the marketplace.
One is consolidating industries or M&A activity would have an effect on market share on a relative basis and I think in a bull market such as what we're in now, you do have all boats rise on a rising tide, and I believe that you have some headcount and timing components that will also be affecting market share for intermediaries across the board.
So, you do have a changing landscape in a changing industry relative to those three primary topics relative to HFF.
So, M&A timing and headcount have to take a look at that.
But, again, from our perspective, we're pleased at both our volumes and our financial performance year-to-date.
<UNK>, it's a great question and thank you for asking it.
As we stated on the first quarter call, we are ---+ we think the market is very constructive.
We think it is measured in its standards.
You could argue that there are some relaxing and some interest only periods and various other components, but in terms of LTVs and other underwriting metrics in the debt space and a full transparency of risks, it is very, very different than in the 2006, 2007 timeframe and we believe overall that the vast majority of the lending providers or the GAAP providers in the debt space in the US remain very measured, very thoughtful, very constructive in how they're underwriting the business.
But also make the same statement on the equity front.
So, again, you're looking at, again, relative to an 2006 timeframe, which is the most comparable period based on transactional volume, there are stark differences in the underwriting in today's market versus what was occurring in 2006, 2007, much more to the conservative.
And ultimately, what is happening is the underwriting metrics and the underwriting assumptions that both debt participants and equity participants are utilizing ---+ are we think very reasonable and measured based upon historical standards of growth and essentially are just accepting lower returns in the equity market and are highly mindful of loss histories that occurred in 2008 or 2009.
So, overall, we remain very ---+ we think the market in general remains well positioned in terms of its underwriting metrics utilizing to achieve book values and loan to value pricing in both the equity and the debt markets.
That's a long period of time for me to say ever.
I would say this, there are ---+ it appears that there has been no memory loss from 2008, 2009 with the participants in the marketplace.
One may disagree with what a buyer may buy a building for on a basis play or a lender may lend on a given assignment.
However, when you look at the overall I guess metrics of the industry and what we're seeing and how they're underwriting, there is full transparency of the risk and all participants know exactly the risk they are taking with multiple sensitivities on multiple metrics when they make a loan or they make a purchase, vastly different from 2006, 2007 when there was a certain naivety in the market, which we just don't see today.
There is an extreme importance placed on risk and it dominates conversations in virtually every award that we're involved with.
Peter, I would not read too much into that.
As you know, there is quite substantial timing differences in quarter-to-quarter.
So, on that particular statistic, what I would suggest is we just wait for a year-end comparative and take a look at it on that basis.
In terms of the competition for talent, there's always incredibly good competition for talent, it's no different now than it has been in the past out there.
So, that remains a constant.
We don't break that out and disclose in terms of specifics on property types, but we've seen no real discernible difference if you look at the national data across the board in terms of product property verticals, and I'm assuming you're talking about office versus multi-housing and others.
I think it's fairly consistent, <UNK>.
Again, I would not ---+ no discernible change there.
Been very consistent and what I would call normalized, <UNK>.
I will just take the moment those since you asked a question to reiterate that one of the key growth initiatives of the firm is the build out of our platform, which has really not changed since we went public and for that matter for the last 15 years.
So, strategically, it is an incredibly important growth initiative for HFF to continue to build out each one of its offices with complete complement of its business lines and property verticals.
And as you know, we do [that] a little differently than some.
We just do it one brick at a time and one person at a time, but it is an incredibly important initiative for the firm.
As you can imagine, that's a pretty significant increase in the servicing portfolio, given the fact that you continue to have run-off of that portfolio each quarter as well.
So, we're pretty impressed with it.
It really ties back to the debt business overall.
Yes, Freddie is a piece of that and certainly when you look at the footnote disclosure, you'll see in the queue relative to the MSR's that kind of goes somewhat ---+ it goes somewhat directionally in play with the increase in the servicing portfolio where it's coming from, but it's the three tranches we have under our MSR portfolio.
We have the Freddie Mac business but life insurance companies represent a significant portion of our servicing portfolio and with the debt business up at the levels it was in the quarter and year-to-date, it's just driving the servicing portfolio up.
So, it really goes hand-in-hand with what we've seen in the debt transaction volumes.
As far as what we see looking out is, as you know, we don't give guidance on that, but certainly you can follow the pattern over time that it relates to the increase in the production on the debt side.
From our perspective, obviously, the mix of the portfolio changes to a certain extent as you said as an impact, but I think overall, individually, we haven't seen any discernible difference on the individual tranches if you will.
Thank you, everyone for joining us today and I hope that you can join us again for our third quarter 2015 call.
Thank you.
