Ladder Capital Corp

NYSE:LADR

Earnings Call Transcript 2018-Q4

[Operator]

Good afternoon and welcome to the Ladder Capital Corp’s Earnings Call for the Fourth Quarter of 2018. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, today’s call is being recorded.

At this time, I would like to turn the conference over to Ladder’s Chief Compliance Officer and Senior Regulatory Counsel, Ms. Michelle Wallach. Please go ahead Ms. Wallach.

[Michelle Wallach]

Thank you and good afternoon everyone. I'd like to welcome you to Ladder Capital Corp.'s earnings call for the fourth quarter and year ended December 31, 2018. With me this afternoon are Brian Harris, the company's Chief Executive Officer; and Marc Fox, the company's Chief Financial Officer.

This afternoon, we released our financial results for the quarter and year ended December 31, 2018. The earnings release is available in the Investor Relations section of the company's website and our quarterly report on Form 10-Q will be filed with the SEC this week.

Before the call begins, I'd like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements. I refer you to Ladder Capital Corp.'s 2018 Form 10-K for a more detailed discussion of the risk factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Accordingly, you're cautioned not to place undue reliance on these forward-looking statements. The company undertakes no duty to update any forward-looking statements that may be made during the course of this call.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. The company's presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP, are contained in our earnings release.

With that, I'll turn the call over to our Chief Executive Officer, Brian Harris.

[Brian Harris, CEO]

Thank you, Michelle. Today, I'll walk through some earnings data for the fourth quarter as well as the full year 2018 results. I'll then note some interesting changes in investment preferences that took place in the fourth quarter and how we see the year ahead shaping up. In the fourth quarter, Ladder produced core earnings, a non-GAAP measure of $52.5 million or $0.45 per share. This resulted in an after tax core return on average equity of 12.9%. For the full-year 2018, we had core earnings of $230.1 million or $2.03 per share and after tax core return on average equity of 14.9%.

We were particularly pleased with our performance this year as core earnings per share increased by 31.8% versus 2017. Our un-depreciated book value increased by 5.1% during the year to $15.34 per share, after announcing two increases to our quarterly cash dividend during the year. Our multi-product model served us well in 2018, as our real estate portfolio accounted for 24% of net investment income, while our balance sheet loan inventory contributed to another 61% of net investment income to core earnings.

You may recall that in our last earnings call, we voiced some concerns about general market complacency and overly hawkish Federal Reserve Bank Chairman and our view that volatility was likely to pick up as we progress into year end. The volatility witnessed in December 2018 was expected and produced an excellent opportunity to make high-quality investments in securities as ramp in redemptions caused the forced selling of many very safe liquid securities, particularly CLOs and short duration CMBS. As we are prone to due, during periods of high volatility, we purchased a relatively large amount of securities in the quarter, totaling $468.3 million. We purchased these assets at a discount to par and they have a weighted average maturity of less than three years.

We match funded many of these purchases by borrowing $288 million from the Federal Home Loan Bank at an average fixed rate of 2.89%, with an average maturity of two years. We've continued to purchase securities into the first quarter of 2019, adding an additional $187 million over the first two months thus far this year. While we were acquiring securities, we were also witnessing compression of credit spreads in our balance sheet lending business, further shifting our focus away from loan origination and towards securities acquisition.

During the fourth quarter, we received loan payoff in our bridge loan portfolio of $730.9 million, roughly three times what we would normally expect in a quarter. While we could have held on to many of these loans by simply matching the terms of the refinancing lender, the terms being offered usually with higher proceeds at lower rates didn't seem to offer the right risk reward relationship, so we collected our payoff with our exit fees and reallocated our capital into what we felt was a better value proposition for our shareholders.

We did originate 237.9 million in balance sheet loans in the quarter with a weighted average interest rate of 7.75% and we also originated 182 million of first mortgage loans held for securitization. During the fourth quarter, we also participated in three securitizations, all completed before the volatility in December. We contributed $364.8 million of loans earning $7 million.

I'm pleased to report that we have also contributed $170 million of loans to a securitization in the first quarter of 2019, however, that securitization has not settled yet. We've seen a slowdown in the pace of repayments of our balance sheet loans receiving just 55 million in payoffs at this point in the quarter. This is probably the result of widening of credit spreads in the CLO market and the volatility seen in world markets in December.

While we embarked on an aggressive plan in 2016 to originate more floating rate bridge loans, anticipating higher rates after building upon our loan inventory, quarter after quarter, the fourth quarter of 2018 mark the first time in over two years that our inventory of balance sheet loans fell quarter over quarter. At the end of 2018, we still own $3.3 billion of balance sheet loans, but for the first time in years, our inventory of securities increased by 44% in the quarter, ending the year at 1.41 billion. This illustrates how flexible and nimble our investment platform is able to pivot quickly into different product types as changing market conditions produce different investment opportunities

As we move ahead into 2019, I would like to note that while we seem to have witnessed a V shaped recovery from December 2018 into February of 2019, interest rates still have not returned to where they were in November of 2018. The yield on the 10-year US Treasury is still about 50 basis points lower than it was in November. While many may chalk that up to more recent said commentary that expresses patients when raising interest rates, we would also note that the two-year rate is inverted against the five-year Treasury rates and the yield curve is still quite flat. And this makes us more cautious about what we think lies ahead in the US economy.

We continue to be somewhat concerned about slowing global economy, trade wars with China, emerging talk of future tax policies that don't seem to support growth, a possible hard Brexit, and growing tensions with Russia. And while we feel that the economy is stable, we think real estate valuations and by extension, cash flows may have peaked. We will be taking a slightly more cautious approach to lending on transitional loans that require execution and timing in a slowing economy. We don't think we've seen the last the volatility witnessed in December and we will try to position ourselves to exploit investment opportunities that invariably present themselves when liquidity is thin and sellers are forced to sell high-quality assets to meet redemption demands that tend to occur during periods of illiquidity.

I'll wrap up now by saying how happy I am with the performance of 2018 of the company. I'd like to thank our employees and our investors who supported us throughout the year. We look forward to 2019 confident that we're well positioned for the year ahead.

I'll now turn you over to Marc Fox.

[Marc Fox, CFO]

Thank you, Brian. I will now review Ladder Capital’s financial results for the quarter and year ended December 31, 2018. In the fourth quarter of 2018, Ladder generated core earnings of $52.5 million, resulting in core EPS of $0. 45 and an after tax return on average equity of 12.9%. The 2018 calendar year core earnings totaled $230.1 million compared to $178.8 million for the year ended 12/31/17. 2018 core EPS was $2.03 per share compared to $1.54 per share earned in 2017. After tax ROAE for 2018 of 14.9% surpassed 2017 performance of 11.5%.

Ladder’s net interest income from loans and securities investments and net rental income from real estate investments total $226.9 million in 2018 and was about 25% higher than $181 million earned in 2017. Increases in recurring sources of income have been an ongoing trend since Ladder’s IPO in 2014, has allowed us to judiciously increase our quarterly cash dividend rate six times over the course of four years, most recently in the fourth quarter of 2018.

On a GAAP basis, Ladder generated net income before taxes of $27.8 million in the fourth quarter and $228.3 million for the year ended 12/31/18. The largest GAAP to core earnings adjustment in the fourth quarter related to the timing of the recognition of hedge results that coincide with the realization of gains and losses on a disposition of hedged assets. In the fourth quarter, Ladder originated a total of $419.9 million of loans bringing total loan origination to $2.8 billion.

Ladder’s balance sheet loan origination succeeded conduit loan origination 2018 for the first time since inception. At the end of 2018, balance sheet loans totaled $3.3 billion and the conduit loan balance stood at $182.4 million. Also during the fourth quarter, Ladder reported income from three securitization transactions to which Ladder contributed $364.8 million of principal balance of loan held for sale, generating $7 million of securitization gains.

For the 2018 calendar year, Ladder securitized a total of 103 loans with a total principal balance of $1.3 billion in nine securitization transactions, generating a total of $30 million of securitization gains. Finally, during the fourth quarter of 2018, Ladder made $7.2 million of net lease and other equity investments, resulting in total net leased and other equity investments of $122.7 million in 2018. Ladder also received $5.5 million of net proceeds from sales of condominium real estate in the fourth quarter, bringing total proceeds from the sales of real estate to $218.7 million for the year

Turning to key balance sheet and investment activity metrics, as of December 31, 2018, 96% of our debt investments were senior secured including first mortgage loans and commercial mortgage backed securities secured by first mortgage loans which is consistent with the senior secured focus of the company. Senior secured assets plus cash comprised 76.3% of our total asset base. Total assets stood at $6.27 billion, which is 4.1% higher than at the end of 2017. Total unencumbered investments including cash were $2.1 billion at year end and unsecured debt outstanding stood at $1.2 billion, reflecting an unencumbered asset to unsecured debt ratio of 1.79 times.

The weighted average loan to value ratio of the commercial real estate loans on our balance sheet at December 31, 2018, was approximately 68% in line with prior quarters. The most meaningful fourth quarter changes to the asset side of the balance sheet were in the securities and balance sheet loan portfolios. During the fourth quarter, the securities portfolio increased by $431.8 million instead of $1.41 billion at year end. Ladder responded to the spread widening and general volatility and the fixed income markets by purchasing more securities in three months than the company had acquired in the preceding year.

At the end of the year, the key risk metrics of this portfolio remains in line with historic norms as 80.9% of the securities portfolio was comprised of securities rated triple A or backed by the US government agency, and the weighted average duration was 29 months, which compares to 30 months at 9/30/18 and 36 months a year prior. Also, during the quarter, Ladder received $730.9 million of balance sheet loan repayments more than offsetting $237.9 million of balance sheet loan originations during the quarter. The net result was a $3.3 billion December 31, 2018 balance sheet loan portfolio versus a $3.8 billion portfolio at the end of the prior quarter. The weighted average spread to LIBOR, the floating rate loans in the portfolio was 556 basis points at year end compared to 563 basis points at 9/30/18.

On the financing side, as of 12/31/18, Ladder had $3.9 billion of adjusted debt outstanding and committed financing availability of $2.6 billion for additional investments. At December 31, 2018, debt was comprised of $1.17 billion of unsecured bond that outstanding maturing in 2021, 2022, and 2025; $743.9 million of long-term non-recourse mortgage debt financing, our real estate holdings; and $601.5 million of non-recourse CLO debt. When combined with $1.64 billion of permanent equity and $176.7 million of other liabilities, $4.3 billion or 69% of Ladder’s capital base is comprised of equity, unsecured debt and non-recourse non-mark-to-market debt.

At quarter end, we had $1.3 billion of FHLB borrowings with a 2.46 year weighted average maturity and an average cost of 2.55%. But at the end of the year, Ladder further diversified its funding sources entering into a new financing agreement with another major bank that is new to Ladder to finance both first mortgage and mezzanine loans. This new facility provides $100 million of committed availability and this agreement expands our access to loan repurchase financing to a [indiscernible]. In November, Ladder also successfully accessed the equity market for the first time since our 2014 IPO. We issued 5.8 million shares of class A common stock in an underwritten primary public offering, resulting in total gross proceeds of approximately $100 million.

The shares were issued at a price reflecting a 24% premium over GAAP book value and a 12% premium over underappreciated book value. Ladder’s year end undepreciated book value was $15.34 per share, up from $15.25 at 9/30 and up from $14.60 at the end of 2017. Finally, in the fourth quarter, Ladder paid a $0.57 per share dividend, including $0.34 in cash and $0.23 in shares of class A common stock. The $0.34 per share cash dividend reflected a 4% increase in the quarterly cash dividend rate, the sixth increase in four years. Dividends in 2018 totaled $1.535 per share of Class A common stock with a cash dividend payout ratio of 64.3%.

Ladder’s equity base grew to $1.64 billion at year end reflecting an increase of $155.5 million or 10% in 2018, which resulted from strong 2018 performance in the form of $230.1 million of core earnings, the $100 million primary equity issuance in November, Ladder’s continued adherence to a conservative dividend payout ratio, supported by a base of growing recurring earnings and the election to pay a $0.23 per share portion of the 2018 dividends in stock instead of cash, thus retaining approximately $25 million of equity.

In the meantime, our asset base increased by 4.1% resulting in 2018 year end adjustable average of 2.34 times, the lowest leverage level since 2014. The result of all this is that Ladder entered 2019 with over $500 million of available liquidity that can be used to take advantage of the opportunity cited when we issued equity in November. Applying modest leverage to this available funding could result in $1 billion to $1.5 billion of additional investment assets on Ladder’s balance sheet over time.

So, summing up, in the fourth quarter of 2018, Ladder generated $52.5 million of core earnings, $0.45 per share of core EPS, resulting in a core after tax ROAE of 12.9% bringing 2018 core earnings of $230.1 million or $2.03 per share of core EPS. We originated $419.9 million of loans and securitized $364.8 million of fixed rate loans resulting in $7 million of net securitization gains. We issued 5.8 million shares a class A common stock in our first underwritten Primary Public Offering since the 2014 IPO, resulting in total gross proceeds of approximately $100 million and we paid a $0.57 per share dividend, bringing total 2018 dividends to $1.535 per share of class A common stock in 2018.

At this point, it's time to open the line for questions and answers.

[Operator]

[Operator Instructions] Our first question comes from the line of Steve DeLaney with JMP Securities.

[Steve DeLaney, JMP Securities]

Obviously, a great report. One thing you missed though, you didn't say anything about your stock being up 35% since the end of 2017. And that was sort of at the top of my list. So congrats on that. Seriously, the other thing you didn't talk about is any recent real estate investments. Recently had the chance to be with one of your peers who also like you makes opportunistic investments and they were really talking down the ability to put any capital to work this year, just because of hot prices. And Brian, I’d appreciate your outlook on that as far as whether you, you obviously told us what you think about CMBS, but I was just curious if you think you'll still be able to find any special sets because the real estate investment has really created a lot of value over the last couple of years. Thanks.

[Brian Harris, CEO]

Sure. Thanks, Steve and thanks for pointing out our recent success, I hope that's not the curse of the announcer. But, I would say that we were not active in the real estate space for acquisitions in the quarter. We haven't been terribly active in the first quarter either, and it isn't -- that's not really our core business. As you know, we're always [indiscernible]. And we think that there will be some opportunities, but I think there's -- the answer to the question is twofold.

One, I think things are very expensive and there's a lot of capital around and two, I think that we're probably a little more picky, given our view of the economy over the next couple of years. And it isn't that we think it's going to be bad necessarily. We just don't think it's going to be better. So we think that you would have to make a real estate investment today based on cash flows today, rather than managing better or raising rents later on.

So we think the opportunity set for real estate as an asset class is not as strong today, however, owning real estate through the debt door in the next couple of years might be a much more interesting proposition.

[Steve DeLaney, JMP Securities]

Got it. And you commented on the loan spreads and being tighter, almost sounds like to me, even though CMBS spreads have come back and CLOs, everything seems to be somewhat back to normal. I mean, we've seen your execution on your CMBS, you did with Wells last week, it almost feels that securities might continue to be a bigger percentage this year. Just curious if you would care to comment on that. And we had the volatility in 4Q, but it almost sounds like on a relative basis, we could see you continue to grow that book.

[Brian Harris, CEO]

I think that's accurate. I can tell you that December, you have to be moving quickly to take advantage of opportunities like that. And thankfully, we were able to do that. We had plenty of dry powder. And I think that has continued into January and February. I think that we've purchased another $190 million worth of securities in January and February to date. So that would probably get us up to around close to $600 million in the last four months or five months. That's a lot for us. We are buying things on the short end, mainly because we don't want to be hedging interest rates with all of the cash flow and with a flat yield curve, that gets a little bit difficult.

So you want to be in the two year area, two and three year and that's where we've concentrated our efforts. I would say though, if you took a look at almost any financial instrument, it was really a V shaped recovery, right? It went down in December. And then right back up into February. But there are a couple of salient differences. I don't think the CLO market has come back all the way. And the reason for that is, I think the CLO market is, it's not broadly distributed.

The CLO paper is really in the hands of a few money managers that are capable of understanding what goes into those things. And frankly, I think it's a very attractive buy, but it was bid pretty tightly I would say into June and July of last year where I thought it was a little too aggressive. So we do like that right now. We are active purchasers of CLO AAA and AA paper. We think it's relatively cheap, especially when compared to making LIBOR based loans at relatively tight spreads late in the cycle. And so we will continue to do that as long as that opportunity presents itself.

And as far as -- the rest of the business just feels okay. We're originating loans, maybe not at the pace we're originating at when we felt a little more comfortable with where we were in the cycle. But there's still plenty of opportunities. I think one of the reasons we allocated some capital to securities, it was just a better value trade. But I also think that we're a little cautious about lending money to people now at higher loan amounts, at tighter spreads and attempting to get paid back in two to three years where we might be in a bit of a downturn.

So we're very selective right now about who we're lending money to. And we're very selective about what rates we’ll charge to lend that money out to people. And it does seem like many of our competitors and peers are a little bit more aggressive in the space than we are. I owe that to the flexibility of our model where we can easily shift over to securitization in the conduit business as well as buying securities. So if we can buy the AAA paper from a CLO of a competitor, at 130 and 140 DM, which we were doing in December, that looks like a better value proposition then LIBOR plus 300 on loans.

[Operator]

Our next question comes from the line of Jade Rahmani with KBW.

[Jade Rahmani, KBW]

Brian, I wanted to ask if you could share your thoughts on the co-working business model, seems to have taken the leasing market by storm and accounts for as much as, I don't know, something like a third of leasing activity. If you look at the commercial real estate brokers, they're reporting leasing volumes growth of north of 20% year-on-year and it's clear that the office sector for traditional occupiers is not growing lease occupancy at that rate. So wanted to find out what do you think about that?

[Brian Harris, CEO]

Sure. I'm not an expert on it, first of all, but it's clearly the [indiscernible] of the office buildings taking place. And I do agree that a lot of office tenants are not renewing at nearly the sizes and space that they used to. So there, you do have to adapt. And I do think that, especially for new companies, it's a very attractive feature, because you don't have all of the, you have assistance really in moving into these companies. So that makes sense. And I think the idea behind the WeWorks of the world and names like that is, you put 10 accounts into a building, you really hope two or three of them expand greatly and stay in the building. I don't know if that's a business plan, but that's what I think they're doing, but as far as a lender always cautious when you see space in a headline being leased by a company that's new and oftentimes not making money, that always concerns me a little bit.

So you have to dig into the financials of that company and to see who's guaranteeing that lease that they're signing because effectively what they're doing is they're master leasing real estate and that's fine. If it's a strong enough company, but if it's an LLC that just has nothing but that space and the cash flows associated with it, I would be very cautious around relying too heavily on that. But as a business model, and as technology makes some real estate obsolete and other real estate more portable, I think it's fine idea. Like most good ideas, they get a little overdone and I would suspect that when the largest tenant in a city like New York is a temporary space seller to smaller companies, yeah, I would flash caution at that.

[Jade Rahmani, KBW]

Can you give an update on both credit migration in the quarter, didn't look like there's any notable change in the loss provision. So I assume credit was stable in the quarter, but also on the couple of credit issues you've experienced, what the status update is on those loans?

[Brian Harris, CEO]

I would say credit, any credit problems bubbling up are very similar to the ones that we've seen before. I think credit problems are occurring, in particular in operating businesses like hotels and also in non-cash flowing businesses that are being repositioned. So if you have a construction loan outstanding and there's no cash flow, let's say, I don't know, call it $100 million loan and if it's out there at a given rate, if you need another year, that's a very expensive proposition, because you have to put up a full year of interest reserves and when you've got LIBOR at 2.5 instead of 50 where it was 2.5 years ago, that's quite a bit more. But as I said, I think it's mostly biting into the equity ROEs at this point and not necessarily causing debt problems.

Having said that, I do think that limited service hotels are probably overbuilt. I think that the hotel business as a whole is doing fine. But I do think it is -- there are reminders out there that operating businesses are not all real estate. So during the quarter, in the fourth quarter, we actually did have a situation on some hotels in Texas that we thought we were going to foreclose on it, we began to make moves in that direction.

However, also due to the fact that there's a lot of capital in the world right now and Texas is doing very well, we did get paid off in full before it ultimately turned into a problem. That went round trip in the fourth quarter. That became a conversation, became a difficult conversation and then it became a payoff in the beginning of December. So I would say credit is stable, but showing signs of distress on anything that needs to be extended, where the borrower was not particularly well capitalized.

The other situations we've had, as you know, We wave an office building that we're now part of on reserve in Wilmington, Delaware and not much change there. It's been a little bit too soon. I think given the way we restructured that, that whole capital stack and the other one was a Food Emporium on Broadway here in Manhattan that is in bankruptcy still, it is still 100% occupied by Bed Bath & Beyond credit for a long term lease. I don't understand why it's in bankruptcy. But it is still -- but it is not of a particular concern to us.

We're under receivership, we’re receiving cash flow payments, and we're just really waiting for that to sort itself out through the bankruptcy system.

[Jade Rahmani, KBW]

You mentioned securities purchases to date and you mentioned loan repayments to date. What about bridge loan and conduit originations in the first quarter thus far?

[Brian Harris, CEO]

Let me take a quick look. I've got a pretty good idea of that. Yeah, the other panel.

[Michelle Wallach]

Yeah, I can tell you. Right now, we look on pace more towards on average time for us, I would say we're expecting to do 500 million to 650 million, broken roughly 50-50, maybe a slightly heavier balance towards balance sheet. But I think you can see -- you can expect to see a more regular quarter from us.

[Brian Harris, CEO]

And I would tell you so far, in the first two months, we have closed, I don't have the breakout between bridge and conduit, but we have closed $334 million worth of loans so far.

[Marc Fox, CFO]

Yeah. 190 million of balance sheet loans.

[Operator]

Our next question comes from the line of Stephen Laws with Raymond James.

[Stephen Laws, Raymond James]

Following up on the last answer was to Jade's question, can you maybe talk a little bit about the differences in how you think about the underwriting or the volumes for the loans that you plan to put into the conduit versus those you put into the -- on the balance sheet and I guess maybe start with that?

[Brian Harris, CEO]

Same underwriting process, there's no difference, same people here underwrite both categories and obviously one of them has more cash flows than others. So one of them, you might have to have a little bit better predictive ability as opposed to this fully stabilized assets that go into the conduit, but against the conduit model, you’re really underwriting for rating agency guideline and kind of there's a little bit of variation around it, but not that much.

Whereas the balance sheet business, you can overlook certain things that maybe a rating agency wouldn't or you can also decide to penalize an item more than the rating agency would. So, we're cautious on all of our loans and we use the same process, but I would tell you that today as opposed to a couple of years ago, in the bridge loan business, we are not underwriting the expectation of higher cash flows over the next 12 to 24 months.

We're underwriting stability and if not possibly down cash flows. So we don't necessarily think things are going to get better. And then in a transitional loan, I think we have to live in a world where first of all, interest rates might go up, we think they won't, but they might. And if they do that LIBOR cap only helps until you get to the maturity date. And then it has to be refinanced. So you have to think a little bit more, there's a lot more liquidity in the world.

So you can take a little bit more risk, I think, in the execution, because if a borrower does execute 75% of his business plan, he can probably refinance you even though he hasn't got all the cash flow straightened out. But if that liquidity dries up on the refinance pipeline, then you'd have to -- you're in an extension conversation where you're going to ask a borrower to write a check with additional equity, given $730 million in payoffs in the fourth quarter and I'll tell you December didn't get a lot of payoffs because it was such a volatile quarter.

So that was a hell of a lot of payoffs in that quarter, relative to our existence to date. Having said that, I think December put a real hole in that CLO model, because spreads did widen out quite a bit. And as a result of that, and as I said, we're only -- we've only received $55 million in payoffs so far in the first quarter. So I wouldn't draw too much conclusion from any one quarter, but we are underwriting cautiously going forward on bridge loans as well as conduit loans.

[Stephen Laws, Raymond James]

And switching gears to the CMBS side, how big could you envision that portfolio getting? I mean, if the environment stays like it is or was for January and February, we continue to add to the CMBS basket, will that reach 2 billion in CMBS, will it go higher, kind of, how do you think about your portfolio mix moving through the year, given the current market environment?

[Brian Harris, CEO]

I try not to put a calendar into the answer. I would tell you our desire to do our next transaction oftentimes leads to securities during periods of high volatility. And we happen to see that in December. I think we'll see it again, but I don't quote on this mark, you might be able to help. I believe we had a CMBS portfolio of over $3 billion at one point.

[Marc Fox, CFO]

Yeah, we were approaching $3 billion. Yes.

[Brian Harris, CEO]

So to me again, when you make a loan, you really own the AAA, the AA, the A and the BBB minus and everything else that goes into a normal securitization. So it isn't, I don't differentiate too much between loans and securities. What securities do is they provide you with a degree of safety and a degree of liquidity and so when you can buy very short term, high quality assets that are easily financed, easily sold, and they produce levered returns in the 8% to 9% area, that might very well be a better short term investment than making loans that yield an 11% levered, because those loans are not that liquid. And so we always, sometimes it may not be intuitive, but we might take a little bit less in yield to live a little bit more safely.

So to your question is, do we get these $2 billion? I don't see it getting to $2 billion unless there's another few bouts of volatility, but if there was a 60 day bout of volatility and all you had to do is watch the TV today and you realize there's plenty of things that can cause that. That number could go to 3 billion.

[Operator]

Our next question comes from the line of Tim Hayes with FBR.

[Tim Hayes, FBR]

Hey, good evening, everyone. Brian, appreciate your comments on credit quality earlier, but I just wanted to pick on credit a little bit more directly. Do you anticipate a pickup in provisions and or losses in your portfolio this year? And how does the Fed commentary or your view of rates play in to this view?

[Brian Harris, CEO]

I'm sorry, Tim. I didn't hear that. Can you repeat that?

[Tim Hayes, FBR]

Yeah, sure. No, I was just – just kind of wanted to pick on credit a little bit more directly. Just wondering if you expect provisions to increase this year and/or losses in the portfolio and then just maybe how your view around rates plays into that?

[Brian Harris, CEO]

I think that there will be more stress. Again, I personally think the fed’s next move is down, not up. I know that’s an unusual comment, but it isn't because I see anything in particular that's problematic in our portfolio. I see things in the economy that are problematic. And again, I think that there may be just a little bit too much liquidity right now chasing CPU transaction. So there might be a little bit of over leverage in the principal column, construction loans is typically something that might get into trouble. But those don't often show up until a couple years ago by, because they have interest reserves right now. So I would answer the question by saying, I don't think that we will see less difficulty in our portfolio or real estate in general, but I don't think we're going to see any unusual increases in it either. So the loan underwriting that have been done over the last few years, that reasonably saying, there's reasonable equity in these transactions. So I think that you could easily see some maturity defaults or some restructuring without necessarily seeing a loss associated with it.

[Tim Hayes, FBR]

And then, the gain on sale margin on the conduit transactions in 4Q was pretty low compared to historical level and just wondering directionally if you expect the margin to improve on the 1Q19 transaction and to be more in line with historical levels?

[Brian Harris, CEO]

Okay. The first securitization we did, I can't get into too much detail, because it hasn’t settled. However, I can tell you that in the fourth quarter and I'll go back even till June, from June of 2018 through December, credit spreads widened almost every month. So every securitization we did in the second half of the year, we may have made money, we did make money on all of them and we were -- they were profitable, but they were not as profitable as we had hoped they would be. And I think we made around 1.9% in the fourth quarter and we were in three securitizations and all three of them in my opinion didn't do very well.

But again, that's why you build in a bigger margin because you can absorb some spread widening, while you're out there in the market. Going into the first quarter, we do see flows of funds, and they're in the 7 to 10 year intermediate bond area. There's a lot of flows going into those funds. So that tells me that a lot of investors are not afraid of the Fed raising rates, and they're not afraid to buy longer paper, even though there's a flat yield curve.

In addition to that, the insurance companies with their fresh allocations have arrived in January. They generally like to get through their allocations before the summer. And so this is a seasonally aggressive period for lenders. There's a lot of competition in the first and second quarters, tends to lighten up a little bit in the second half of the year, really after July 4. So it's a little hard for me to say what I think profit margins will be.

I do think that there is a lack of supply, loan demand is not terribly strong. But I do think that the flat yield curve fear has left the market at least for the near term. So I -- and I'll also give you a little factoid in that the January -- the securitization we did in 2019 obviously was loans that were closed before ’19. Interest rates on the 10 year fell dramatically and they have not returned to where they were.

So the 10 year interest rate on the US Treasury is about 50 basis points lower today than it was back in November. And so when low -- when rates fall dramatically like that, that's usually good for us, even though it does invite more competition, but that would be in a high loan demand market, which December was not, but on the other hand, we have floors in our loans and when you have floors in your loans as you're closing them, your spreads are effectively widening which should create he wider profit margins.

[Tim Hayes, FBR]

Got it? Okay. And so putting that kind of altogether, do you see Ladder taking share this year in the conduit market or obviously you've expressed a lot of caution and more volatility, so just given kind of the trends you're seeing now, how would you say volumes look like this year versus last year?

[Brian Harris, CEO]

Yeah. Volume is not a concern of ours. It’s profitability that we search for. So I would say I can only really look out a quarter, I will tell you, I like the conduit business right now. I think we're going to do more of it now than we did in the past recently. Margins seem acceptable, there seems to be good supply and demand going on there, partners are easy to find, BP’s buyers are aggressive. So there's plenty of reasons why I like that business.

And honestly, in the last two years, this is probably as optimistic as I've been on that business. And that's probably the good part of when you see, in 2016, we embarked on an aggressive campaign to add balance sheet loans that were LIBOR based floaters onto our balance sheet, adding and adding and adding, in anticipation the Fed raising rates, and they did exactly what we had hoped they would do.

Today, if you fear that they might go down in rates, I think you have to think of the other side of that coin too. If you liked making those loans when LIBOR was going up, maybe the definition of slowing it down a little bit, if you think they're going down is a concern, especially in the late cycle. So on a relative value basis, last year, I told you, we loved real estate and we loved bridge loans. I would tell you this year, we like real estate, we love the conduit business, and we especially love securities during volatile times.

So that's the model at Ladder, right. We rotate around the wheel on the products and we are -- we have moved and the reason I don't want to give you a volume estimate or participation estimate for a full year is we can turn on the dime. And so, we can be buying securities and focusing on the conduit business for 90 days and then show up with $1 billion worth of bridge loans.

[Tim Hayes, FBR]

That makes a lot of sense. Appreciate the comments around that. And then just one more from me, real estate operating expenses were down a decent amount quarter-over-quarter, just wondering what accounted for the drop with the balance of the portfolio being relatively flat?

[Marc Fox, CFO]

Yeah. That had to do with a combination of things, the accounting that’s surrounding our condominium investments has changed with respect to the consolidation of the HOAs that are involved and also what you see is also the aftermath of us selling the Lafayette property last year.

[Operator]

Our next question comes from the line of Rich Shane with JP Morgan.

[Rich Shane, JP Morgan]

I'll try to keep it quick. Look, I think the, you’ve done a good job describing sort of the transition in terms of where you want to deploy capital. I just want to make sure I understand the securities, the transition towards securities two-fold. One is Brian, is it fair to say that when you looked at execution on the stuff you were selling, you realized it was just simply a better time to be a buyer. And that's -- that drives that inflection?

[Brian Harris, CEO]

Categorically no. The execution was fine. The only mistake we made was, we didn't have enough of them. However, it's a very easy transaction to invest hundreds of millions of dollars in a very short period of time, while the whole world is a seller. So we just took advantage of that reason, because they were simply cheap. I wouldn't say this was us not liking another investment. It was really the -- it was more that the product called CUSIP got attractive. It wasn't that the rest of the world got less attractive.

When I look at our products right now, bridge loans, real estate conduit and CUSIPs, I will tell you all of them are on. I like every one of those products right now. I think that the only expression you're hearing from me on the bridge loan portfolio is competition has heated up. There's a lot of capital chasing it. Credit spreads are tightening into a market where they might -- maybe should be widening and I'm a little concerned about that and if you think that LIBOR is going to fall as opposed to rise, you can exit that in one quarter. You have to start thinking about that years in advance.

I don't want to signal to you that we're not originating bridge loans because I’d suspect in the first quarter, you'll see a resumption of our net add on the balance sheet portfolio because we're not experiencing a lot of payoffs, but we are writing plenty of loans, but we are a little more cautious in that area.

[Rich Shane, JP Morgan]

And again, you indicated that the conduit business -- you expect the conduit business to rebound in the first quarter. I am curious. So is the way to look at this, the attractiveness of the securities was a function of being able to deploy capital into larger chunks more quickly and into diversified pools with short durations. Is that what made it compelling?

[Brian Harris, CEO]

Yes, we don't. There's much less insurance being paid to hedge interest rates on a short security. There's less airplane time and analysis when you're buying AAAs. And all you had to really do was look at the inflows and outflows and you could see through redemptions, one of the benefits of this cycle where there's a lot of passive investing. What happens is, you just see forced redemption going on. It used to be hedge funds, you would see a lot of volatility, and you'd make a few calls around town and find out what hedge fund was having a problem.

Now, it's an ETF usually. And so when we're buying a whole lot of CLO types AAA bonds, there's not that many people that own them. So, one of my originators said to me, who's selling those things? They look very cheap. And I said, it's the people that just bought them because they're only two years old. And they said, well, why would they sell them? And the answer is because they have to, they're taking redemptions in their funds.

And so, we really like moment like that. Anytime we see a volatility spike, we take a look and we ask a very basic question, is this a credit problem, or is this a liquidity problem? And that looked like a liquidity problem to us if we ever saw one.

[Rich Shane, JP Morgan]

So it was much more of a tactical call than the strategic call.

[Brian Harris, CEO]

It was an opportunistic call. Yes.

[Rich Shane, JP Morgan]

Okay.

[Operator]

[Operator Instructions] Our next question comes from the line of [indiscernible]

[Unidentified Analyst]

You raised capital to equity sales, which of course stayed with management stake, and you raised that for some opportunistic things that were out in the marketplace. I'm just wondering after you raise that capital and leverage it, if you feel like you’ve expanded at all now, in terms of where you thought those opportunities were going to be?

[Brian Harris, CEO]

We have a reasonable amount of dry powder. We don't think that that December situation is necessarily over. We take our cue from the inverted five year and two year as potentially problems ahead and some of the rhetoric coming out of Washington right now. So we think that there will be some other opportunities and we did raise that small amount of capital, really as a hybrid almost as I mentioned in the original call that when I was talking about the quarter, we thought rates were low and we borrowed fixed rate fundings from the Federal Home Loan Bank of over $280 million.

And we originally started by simply buying securities to hold that, so that that there was no drag effects or no J curve on those funds that we had borrowed, because it is secured borrowing, but we borrowed the other $100 million for a few reasons. One is we felt like we unpacked, I think we even said it on the third quarter call that we thought we'd be buying securities because we thought volatility would be increasing and we did not have to wait long until it happen. Have we expanded all of it? Well, we took 700 million in payoffs also. So the original plan of the $100 million that we borrowed coupled with the borrowings at the Federal Home Loan Bank, yes, we've expanded that. However, with $730 million in payoffs on the bridge loan portfolio, we have some cash around. But we will – it may take a quarter, but I don't think it'll be too hard. There's plenty of opportunities right now.

[Unidentified Analyst]

And then just curious in terms of playing off what you said, in terms of kind of things are extensive, there's a lot of capital available [Technical Difficulty] has played into the way you're looking in the marketplace?

[Brian Harris, CEO]

Well, the marketplace of net lease, I think, is a difficult place to say you're going to add a whole lot in right now. And the main reason being your cost of funds has dramatically increased relative to where the cap rates are on many of those things that are selling. You do have the Amazon effect taking place with some of those retailers. I would argue that rather than talking about the net lease space, I'd rather talk about the Dollar General space. And Dollar General is one of our favorite companies right now. And there's a lot of reasons why we prefer to buy Dollar Generals.

One is that there are hundreds of them, and you can be rather selective around where you want to buy them. Two is that trying to word it delicately, the Dollar General customer is not necessarily the Amazon Prime customer. So -- and they're oftentimes in less populated areas, so less likely to be trafficked by the big retailers that are mostly shrinking as opposed to expanding into areas like that.

And another thing that we like to do is Dollar General has been around for a long time. And what the Dollar General is doing is they're moving out of a lot of their inline stores and moving right across the street into standalone source. And we like that because we know that they know their customer. So they wouldn't be making that move unless they understood they could support it.

And lastly, there is a high barrier to entry to buying Dollar Generals, because the average Dollar General costs about $1.4 million. So by the time you get through with appraisers and engineers and environmental and lawyers, you can get through a pretty big legal bill on a $1.4 million asset. So if we were buying one of them, I wouldn't do it. But when you buy 100 of them, that's a very attractive proposition because you do get them at a slightly wider cap rate because of the expense factor that goes with it. We don't absorb quite the expenses that other people do.

[Unidentified Analyst]

Right. And I appreciate that and I feel the same way you do about Dollar General for all those same reasons. I've looked at the Dollar General portfolio pretty extensively and it's pretty wise. Just my last question is, you saw a loan book run off and then the need to redeploy that capital. I’m just wondering if we enter an environment where despite what's happened in the first quarter where you hadn't really had a loan book run off, but if we get into future quarters where you’re having a loan book runoff, just kind of wondering how you guys have thought about replacing that, and if you say rotating into other areas, if you feel like -- if and when the loan book runs off, will you be able to rotate into these other areas to keep your core growth going?

[Brian Harris, CEO]

Well, we think we will be able to, but that doesn't mean we will be able to. We don't determine those opportunities. Those are determined by the market, but there's always other things we can do. One, we can give it back to our shareholders if we feel like it -- but if we're – last year, we developed during a year where cash was considered the best investment where bonds were down, stocks were down, we delivered a 14.9 ROE. When we’re delivering an ROE like that or even we tend to shoot for, as we've said many times 9% to 10% without anything fancy going on, but if we can make a double digit return on equity, and we can do that rather easily from what I can tell at this point anyway, if it continues like this, as long as we can do that, we'll just keep investing and rotating around our product mix. However, if for some reason it got to the point where we didn't think we could deliver a return like that, we would probably opt to start giving money back to shareholders rather than trying to fund loans that didn't cover our dividend.

[Unidentified Analyst]

Okay. Appreciate the conservatism you guys are bringing into the marketplace because we're not really seeing that in too many other areas.

[Operator]

Our final question comes from the line of Jade Rahmani with KBW.

[Jade Rahmani, KBW]

Just wanted to ask your thoughts on the New York City condo market, how much of a concern is the oversupply right now and the decline in demand, do you anticipate it to result in distressed projects? And could that be an opportunity for Ladder?

[Brian Harris, CEO]

That’s an interesting question. I don't know how it will be more negative on it than we are. We are not comfortable with New York City condos as an investment right now, it doesn't mean they won't become a very attractive investment. In fact, one thing that could change our mind very quickly is if the state and local tax deduction were restored, and we think it might be or if it was even raised to 30,000 instead of 10,000, we think that that event alone has really caused a big problem in the space and that could be easily reversed.

So I don't know if I call that a market condition or a legal condition, but it is problematic for sure. And that's where I am very concerned, I think, about residential housing. Let's not talk about New York City condos. Let's talk about New York, New Jersey, Connecticut and California. Because I think that there are many factors at work right now in those states that would cause me to be very concerned about any form of positive view towards residential property values.

[Operator]

This concludes our question-and-answer session. And I would like to turn the call back over to Brian Harris, the company's Chief Executive Officer.

[Brian Harris, CEO]

Thanks everybody for getting on the call and staying up with us tonight. We'll be back on a call in the not too distant future because of -- and the first quarter coming up. So thanks again for supporting us in a good year and listening to us today. And if you have questions, as always, feel free to dial in directly to us. Thanks again.

[Operator]

This concludes today's teleconference. You may now disconnect your lines at this time. We thank you for your participation and have a wonderful day.