Washington corporate finance company Allied Capital Corp. sold its commercial real estate securities portfolio to a Canadian pension fund company yesterday for $976 million.
The portfolio, made up of securities backed by commercial real estate loans, equals about a quarter of Allied's total assets. Allied plans to use the money from the sale to repay debt and for its main business -- financing the growth of mid-size private companies.
Allied plans to book a $216 million gain on the portfolio sale to a subsidiary of Caisse de Depot et Placement du Quebec, a company that manages more than $85 billion in assets for Canadian public pension funds.
Allied's real estate investing involved commercial mortgage-backed securities and investments in pools of loans on office buildings or other commercial and multifamily properties. Allied specialized in non-investment grade, or "junk bond," pieces of these pools. Its portfolio had a fair market value of $714 million on March 31.
Allied, which entered the business in 1998, became one of a handful of companies that dominated the specialty. But Allied chief executive William L. Walton said an increasing number of investment funds have followed it into non-investment-grade real estate debt. To achieve the necessary returns to stay competitive, Allied would have had to increase the borrowing, or leverage, on the portfolio, he said. But because Allied is a business development company -- a highly regulated form of financial firm with strict leverage limits -- Allied last year began considering a sale.
Also, Walton said, Allied found it could get a good price.
"In a way, it's like the classic case of our private equity cycle," Walton said, referring to the investments Allied makes in mid-size private companies. "When we've done as much as we can with an asset, we monetize it."
Allied employs about 35 people in the real estate business. Allied Chief Operating Officer Joan M. Sweeney said some of those employees may be hired by Caisse, and others may leave the company. She said the company hopes John M. Scheurer, who heads Allied real estate operations and has been with the company since 1991, will stay. Walton said Allied "is carefully assessing how and when we want to invest in real estate."
Walton said the $216 million gain from selling the real estate securities portfolio will allow the company to keep its dividend stable over the next few quarters and to enlarge its $2.4 billion portfolio of private company investments without having to sell new shares in the stock market, which can dilute the value of existing shares.
Separately, Allied said its first-quarter earnings were up, mostly because of a wide swing in unrealized investment gains. Allied had a profit of $119.6 million (88 cents a share) in the first quarter of this year, compared with $20.3 million (15 cents) in the corresponding period last year.
Allied's net investment income, a key profitability measure that subtracts overhead expenses from investment portfolio income, dropped substantially, to $38.8 million from $44.5 million. The biggest factor in the drop was $12 million in legal and other fees Allied spent to respond to a civil inquiry by the Securities and Exchange Commission and a federal criminal investigation, both involving how Allied has valued its largest investment, its 94 percent ownership of a large New York small-business lender. The investigations are continuing.
"The only negative in there is the money we had to spend on lawyers," Walton said of the quarter. "Fortunately, we're profitable enough to absorb these expenses. But it's a big number. We're hopeful that's going to go down in the future."