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Executives

Bill Powell – President and CEO

Craig Laurie – CFO and Treasurer

Jon Tyras – VP, General Counsel and Secretary

Analysts

Jim Shanahan – Wachovia

Klaus Von Stutterheim – Deutsche Bank

Neil Bryan [ph]

Gary Clark [ph]

Crystal River Capital, Inc. (CRZ) Q3 2008 Earnings Call Transcript November 3, 2008 4:30 PM ET

Operator

Good day everyone, and welcome to the Crystal River Capital Third Quarter 2008 Earnings Conference Call. My name is Jason, and I will be the coordinator for today's presentation.

Before we begin, I would like to point out that some of the statements made in this conference call may be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933 that involves risks, uncertainties, and assumptions with respect to Crystal River, including some statements concerning the transactions described on this conference call, future results, projected sector returns, plans, goals, credit market conditions, and other events that have not yet occurred.

For a description of factors that may cause Crystal River's actual results to differ from those expressed in these forward-looking statements, please refer to Crystal River's 2007 Form 10-K, the second quarter 2008 Form 10-Q report, and its other reports filed with SEC, which are available on Crystal River's website, and the third quarter 2008 Form 10-Q report, which Crystal River expects to file with the SEC by 5:30 PM on Monday, November 10. Please refer to Crystal River’s earning release which is available on their website www.crystalriverreit.com for a reconciliation of any non-GAAP financial measures used during this call.

With that, I will now turn the call over to Bill Powell, Crystal River's President and Chief Executive Officer. Please go ahead, sir.

Bill Powell

Good afternoon, everyone, and thank you for joining us to review Crystal River’s Third quarter results.

With me today are Craig Laurie, our chief financial officer, and Jon Tyras, our Vice President and General Counsel. We will begin by making a few remarks about the current market environment and providing a recap on the plans and objectives we set out earlier this year and the progress that we made towards them in strengthening our financial position. I’ll then hand the call over to Craig, who will walk you through our financials in more detail.

As we all are aware, adverse market conditions have persisted and actually worsened in recent months. At the moment, there is virtually no even the liquidity for the type of securities that are in Crystal River’s current portfolio. There is also limited liquidity for the commercial real estate loan product that are in our portfolio. This limited liquidity manifests itself in the extremely low market value that are now being attached to many of the assets that are in the portfolio, which results in a reported GAAP equity position at September 30 that is close to zero. We do not believe that this tells the whole story or accurately represents the underlying position and cost factors of the company, and I would like to make several comments about these positions.

First you’ll recall that in our second quarter earnings conference call, we communicated our goal of reducing our short term. Our view was then as it is now that as a result of the changed credit environment, long-term assets should be either matched with long-term debt or debt rate [ph]. We witnessed this extreme volatility in asset value provides further support for our decision to reduce debt and we are pleased that we’ve made process towards this goal in the third quarter.

Second, it is our view that in order to run a business effectively in the face of such volatility and illiquidity, our fundamental focus needs to be on maximizing the current and expected cash flows of our assets. We have done just that and during the third quarter we generated approximately $8 million in cash flow from operations. Of this amount, $2.5 million was used to pay the third quarter dividend, with the rest being used to reduce liability.

During the fourth quarter of 2008, we expect to show continued progress with our short-term debt reduction efforts. We remain convinced that the actions taken by the Board and the company to reduce the dividend beginning in the second quarter which has enabled Crystal River to retain excess cash flow will greatly benefit shareholder value in the future. By using the excess cash flow to reduce liability together with selectively selling certain assets in a controlled manner, we are removing the risk that are associated with short term debt and are allowing the company’s assets to produce their return for stockholders without a material event risk that short term debt has placed on the company.

In line with this strategy today, we announced a fourth quarter dividend of $0.10 per share which continue to believe is an appropriate run rate in lieu of stated objectives in prevailing market conditions. Thus far in 2008, we have made significant progress in our deleveraging efforts. The sale of our agency mortgage backed securities portfolio in the first quarter was an important first step as it reduced our outstanding repurchased debt to $22 million from $1.3 billion. At September 30, 2008, our short term debt consisting of repurchase agreement debt and debt under our secured revolving credit facility totaled approximately $50 million, which is down significantly from $457 million at March 31 and $1.3 billion at December 31, 2007.

Lastly before I turn it over to Craig, I would like to briefly mention the credit performance of our investment portfolio. During the third quarter, we had no new nonperforming loans in our commercial real estate debt portfolio. In our CMBS portfolio, our weighted average delinquency rate was 0.59 of 1% which is down slightly from the second quarter, and our prime residential portfolio had a weighted average delinquency rate of 6.62% which is up from 5.82 as reported in the second quarter.

I would now like to turn it over to Craig Laurie, our chief financial officer, who will address some of the specifics of the quarter.

Craig Laurie

Thank you, Bill. I will begin with a review of our balance sheet followed by a discussion of our earnings for the quarter. Our total assets at the end of the third quarter totaled approximately $590 million. Included in this total was $454 million investment portfolio, with commercial real estate and direct real estate loans accounting for over half of the portfolio and securities comprising the remainder.

About 73% of the securities portfolios is owned in our two CDO structure. Commercial real estate totaled $230 million at the end of the quarter and consisted of three high quality office buildings that are 100% leased on a triple net basis to JP Morgan Chase. Real estate loans totaled $31 million at September 30 after we successfully sold $27 million of home loans that we designated as available for sale during the second quarter.

We recorded an additional $4.4 million loan loss allowance against our construction loan in Portland, Oregon. Also as previously announced, our $9.6 million investment in the Birchwood Acres construction loan matured during the third quarter of 2008. The investment which paid off at par had a floating rate coupon of LIBOR plus 3.1%. The proceeds from the sale and the loan repayment were used to repay debt.

The composition of our CMBS portfolio was unchanged during the quarter, but the carrying values reduced to $159 million. We recorded approximately $85 million for the write down due to both increased spread widening in the CMBS market during the quarter and a reduction in expected cash flows from some of the advances in the first class CMBS portfolio.

The composition of the RMBS portfolio which totaled $33 million or at least 7% of the investment portfolio with sub prime accounting for only 2% was largely unchanged during the quarter. However, we did receive approximately $1.5 million in principal pay downs during the quarter, as well as recorded further write-downs of approximately $21 million.

Turning to the liability side of the balance sheet, during the third quarter, the company continued its focus on reducing leverage by paying down two purchase agreement debt of $8 million at the end of the quarter down from $22 million at the end of the second quarter and down from $409 million at the end of the first quarter. The outstanding debt under the secured revolving credit facility was relatively unchanged at $41 million. At this time, the company’s short-term borrowings is still approximately $50 million. These debt repayments were funded from free cash flows and the repayment of maturity of the $10 million construction loan in Florida.

In terms of the financial results for the third quarter of 2008, operating earnings for the third quarter totaled $13.9 million or $0.56 per share compared to $16.6 million or $0.67 per share for the second quarter of 2008. The GAAP net loss for the three months ended September 30, 2008, totaled $56.7 million or $2.28 per share compared with a net loss of $75.5 million or $3.04 per share for the second quarter of 2008.

The primary contributors to the third quarter of 2008 net loss were impairment charges of mark to market adjustments totaling $59.2 million. Of the total charge, $32.3 million was attributed to impairment charges and net mark to market adjustments on our assets and liabilities within our two CDOs and $26.9 million was attributed to impairment charges and mark to market adjustments on assets held indirectly.

That concludes my comments on the financial results. I’ll hand it back to Bill for a few final comments after which we’ll be happy to take any questions that you may have.

Bill Powell

Thanks, Craig. In conclusion, we remain committed to the execution of the strategy we have outlined, namely to create and preserve liquidity for Crystal River. Despite the still very tough operating environment, we believe we have made and will continue to make solid progress towards our goal of reducing short-term debt, deleveraging the company and strengthening our overall financial position.

Looking further forward, once we have sufficiently reduced short term debt and delevered the company, thus underpinning its financial strength, we believe the Crystal River will be well placed to take advantage of the growing number of high quality and significantly undervalued investment opportunities appearing in the market and available only to those that have access to liquidity.

I recently received an e-mail from an investor who asked on today’s call have you answered the question on whether Crystal River is a viable company? I would answer that question by reiterating that one of our top priorities in strengthening our financial position is to reduce the company’s short-term debt. Given the prevailing conditions in the credit market, our view was and remains that our long-term assets should either be matched with long-term debt or on debt free. The company’s is taking clear action top sufficiently reduce all of its short-term liability.

By removing the inherent liquidity related risks associated with short-term debt, the company’s assets can be used to produce appropriate returns for stockholders, without the material risks that a short-term debt burden places on the company, particularly in a tightened credit environment. Further our dividend is at a level which in our view is an appropriate run rate given current market conditions. With a dividend coverage ratio of more than three to one, the company generated approximately $8 million in cash flow from operating activities during the third quarter of 2008. This cash was used to pay the quarterly dividend of approximately $2.5 million, and the remainder being used to further pay down liabilities, in line with our stated strategy. We expect to show continued progress during the fourth quarter of 2008.

I have also been asked to comment on the status of our New York Stock Exchange listing. There are two criteria which may impact Crystal River and its NYSE listing. The first is an NYSE regulation that requires listed companies to have minimum average stock price of $1.00 for any 30 days trailing period. Failure of this condition typically results receiving a notice from NYSE of noncompliance and requires the company to come into compliance within the next six months. The second criteria is an NYSE regulation that requires listed REITs to have a minimum average market cap of $25 million for any 30 days trailing period. Failure of this condition typically results in a company being delisted and moved to the OTC bulletin board.

Crystal River has not received formal notice of either of these criteria failures from the NYSE. However, we are monitoring our stock price closely. In the event that we receive a formal notice from the NYSE, we will issue an announcement to investors and we remain vigilant about reviewing the best available options to ensure that our investors have access to a liquid marketplace to trade our shares.

And with that I would like to hand it back to the operator and open the call up for your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions). We’ll go first to Jim Shanahan with Wachovia.

Jim Shanahan – Wachovia

Thank you, good afternoon. What is the current cost basis and carrying value after associated reserves for the Portland loan?

Craig Laurie

Sure. This is Craig, Jim. The current value actually is $4.4 million, this quarter is $2.7 million.

Jim Shanahan – Wachovia

I am sorry. So what is the total reserve that you’re holding against that loan now, I don’t have the number?

Craig Laurie

That’s around – I mean it’s $14.9 million to $2.7 million.

Jim Shanahan – Wachovia

Okay, thank you. And then I guess a general question, I think it was back in end May after the first quarter call. There was some commentary originally about what’s the long term strategy was for the business, and I think a lot of that was under review. Are you prepared to comment at this point about what you think that you can do about the stock price, what your interest is, and either growing equity capital base, retiring shares, growing the portfolio, anything generally about what you the company might look like in six months or twelve months?

Bill Powell

It’s Bill. Yes, I’d say that strategy for the company, we remain being extremely focused on strengthening its financial position, and our plan on that is reducing our short-term liability and actively managing the each and every one of our assets to maximize the cash flow. And we think in a market like this that by staying focused on these very discreet goals and objectives that shareholder value will be best served in the long run (inaudible).

Craig Laurie

The original book value is 14.6 with a reserve of 11.9 to get to the 2.7.

Jim Shanahan – Wachovia

2.7. Okay, thanks. Okay. I guess the follow question then, the strategy is to manage assets to maximize cash flow and continue to reduce liabilities. What are potential pit falls there, what are the potential covenants that could be the violated, that would say lead to a liquidation event of certain assets, and how is the company’s positioned relative to covenants and CDO triggers, et cetera?

Bill Powell

I’ll answer that two ways. The first way would be in regards to the CDO and I think as we talked about before, we have two CDOs, 2005 CDO and the 2006 CDO. The 2005 CDO has triggers that require – there’s a trigger for failure for cash flow and it would otherwise go to the subordinate classes of the CDO, the classes that Crystal River owns. That cash flow gets diverted to pay senior liabilities of the CDO. And as we talked about in the second quarter conference call, we are failing some of those triggers, and there is cash flow that is being diverted to delever the CDO. We do not have the risk of a catastrophic failure of the CDO that would require a selling of those securities into the marketplace as others have and people have seen in the market. About the 2006 CDO, we do not have any triggers. It is structured as a static ReREMIC and it simply flows through the cash flow.

Now the second part of your question I think was asking about covenants within the company. If you look at our debt position, we are down to only approximately $8 million of repo debt, which is a very low number, and something that the company can certainly handle paying off, and our line – secured financing lines from Brookfield, the $42 million [ph]. And Craig might want to speak to the covenants on that, but we are not at risk of any sort of failure at this point.

Craig Laurie

Actually I’ll pass it to Jon.

Bill Powell

Okay. Jon, shoot.

Jon Tyras

Yes, Jim. It is Jon. In terms of our short-term debt, we worked with Brookfield and our repo counter parties to amend the covenants that was previously in place. We paid some lower agri level [ph] that reflects the current spread environment. It allows us to be very sensitive to covenants reaches, and more particular proactive approach to them with all of our lenders. As of September 30, we were in compliance with all of our covenants on our short-term debt. We do have two credit default swaps outstanding, and we are working with the counter party on those credit default swaps, to kind of waiver them with the covenants (inaudible) the two transactions. Those CDOs have a notional amount or maximum exposure of $20 million. And as of September 30, 2008, we have closed approximately $19.5 million in collateral against those two trades.

Jim Shanahan – Wachovia

Okay. And one more management related question, Craig I understand your responsibilities now have been expanded into management of another – Brookfield vehicle. What does that mean for Crystal River and is it just a situation where there is limited investment activity going on at Crystal River, you just have the capacity to do more, or is this first half in a transition of your responsibility fully to the other company?

Craig Laurie

Jim, this is Craig. No, I’d say I am obviously fully committed to Crystal River and I would anticipate that I’ll continue on in my role. This is an additional responsibility to what I already have.

Jim Shanahan – Wachovia

Thank you

Operator

We will go next to Klaus Von Stutterheim with Deutsche Bank.

Klaus Von Stutterheim – Deutsche Bank

Yes, hi. Nice progress on reducing the leverage. The question that I have given that your – let me ask it differently, you are saying that once you’ve got your assets and liabilities matched, you want to participate in the opportunities in the depressed market, and I am sort of curious where would the capital resources come from to do that? I guess that’s the question.

Bill Powell

Okay, so that’s a fair question. At this point, we are generating decent amount of cash flow over and above, and so there is a scenario that in the future once the debt has been reduced to an appropriate level, that that excess cash flow that is coming into this company could be used to make new investments.

Klaus Von Stutterheim – Deutsche Bank

Okay. When do you think that might happen? When you think you are going to be able to at the point where you’ve got your assets and liabilities matched, enough reserves to take care of contingencies? And would the amount that’s left from cash flow minus the dividend be meaningful enough to make investments that would be meaningful to book value, and eventually the stock price?

Bill Powell

So, there’s two questions there. The first was what kind of timing do we think, and the second was is the excess cash flow large enough to be meaningful. I will take the second one first. I think it could be meaningful, and especially looking at the financial statements of the company, which we released earlier, and looking at where the stock’s been trading, in all honesty, small amounts of money are meaningful here. The other – the first part of your question was timing. I am a little reluctant to put a hard…

Klaus Von Stutterheim – Deutsche Bank

No, don’t – I know you can’t do that.

Bill Powell

I can just let you know that we are very active right now in trying to achieve that objective of reducing the liability.

Klaus Von Stutterheim – Deutsche Bank

All right, that is fine. Thanks.

Operator

We will go next to Neil Bryan, a private investor

Neil Bryan

How are you guys doing? Hello?

Bill Powell

Yes, we are here.

Neil Bryan

Can you hear me?

Bill Powell

Yes, we can.

Neil Bryan

My question was about you know as a REIT you have to disperse 90% of your taxable income, correct?

Bill Powell

That’s correct.

Neil Bryan

And I think it is $0.10 a share. The way you’re going you’re going to have an excess of taxable income, correct?

Craig Laurie

No, if you’re interested – this is Craig. In 2008 as we talked about – announced, we had a press release, but our estimated street re-taxable income at the end of nine months is $0.42, and that would be versus an expectation of $1.18 in distribution. So we would have over distributed. At this point in time, I think for this year, we had $0.68 in the first quarter, then $0.30 the second, then $0.10. So we have distributed in $1.08 just $0.42 for the nine months.

Neil Bryan

So you are on target with the 90% then?

Craig Laurie

Yes, we would have over distributed – we would have distributed more than the taxable income.

Neil Bryan

Okay. Thank you.

Operator

(Operator instructions). We will go next to Gary Clark [ph], private investor

Gary Clark

Yes, I have a follow-up question on the last one, and that is, does that carry over (inaudible) or not? In other words, obviously for this year as you say you’ve actually over distributed but does that mean that by next year you can under distribute and still meet VI [ph], or would – if you make $0.90 next year and only distribute $0.40, would you have to give us $0.50 at the end of 2009, or how does that work?

Craig Laurie

Yes, this is Craig. Unfortunately the over distribution is treated as a return of capital for tax purposes. It doesn’t get carried forward to the next year.

Gary Clark

So if your taxable income next year is $0.90 for instance, you would have to pay out 90% of that to maintain your REIT status, is that correct?

Craig Laurie

That’s correct.

Gary Clark

And I presume you don’t have any projection yet on taxable income for 2009?

Craig Laurie

That is also correct.

Gary Clark

And would that be, do you plan to make any predictions, say for next quarterly report, or the report after that on that, or is it almost like a month to month where you really can’t make any even projections out like General Electric does for the year ahead or anything?

Bill Powell

This is Bill. We don’t formally publish NAV or earnings guidance. But you will notice that in the earnings release, we do put out a weighted average yield versus the major asset sectors. And so what the weighted average yield represents is for each of our asset, we have a detailed cash flow projection, and that detailed cash flow projection stresses the yield relative to the market value of that asset is the weighted average yield. And so it is possible using the 10-Q and the earnings release to approximate what the earnings may be in any given year. But I will get in there that that’s sort of an economic cash flow earnings, and REIT taxable income can be an animal of its own. But if you just try to approximate the future earnings power of the company, there is material enough in the disclosure to help you do that.

Gary Clark

Okay. Can you – so I don’t have to do that, can you give me what that is computing as to the run rate for future years? Again that is a prediction I understand under the Private Securities Act and all that, I don’t want you to get into that situation, but just simply so I don’t have to the do the math since you guys…

Bill Powell

It’s a complicated analysis and what I can tell is that we show as our risk adjusted loss yield for our for our CMBS portfolio, our prime portfolio, and our sub prime portfolio, and then we do not show ongoing run rate for the company as a whole. So unfortunately I think you do have to do the math.

Gary Clark

I can. One other question and that is from the standpoint of dealing with the stock price situation, are you considering a reverse split, is that among the options. I realize you’re not going to tell us what option, but is that among the options that obviously does exist to maintain your listing?

Bill Powell

All I can say is that we are evaluating all options available at this point.

Gary Clark

Are you determined then, is that a high priority for you, and as you’ve indicated, shouldn’t high priorities as opposed to, which the highest priority is liquidity rather than earnings or dividends. Similarly where on the priority list is stockholder benefit, does the listing come high priority or just something you obviously prefer to keep, but you are not going to sacrifice others priorities to meet it?

Bill Powell

Well, I see the priorities as – obviously, it’s a very high priority for us.

Gary Clark

It is high priority.

Bill Powell

Absolutely. Yes, I see all the priorities of the company as been exclusive onto themselves. I don’t see them as competing with each other for attention or time or importance. Just to make a technical point, you are referring to – if we did, if any company did a reverse stock rise, that would only enable them to remedy more of the covenant failures – not a covenant failures, but one of the rule failures from the NYSE, which is that your stocks cannot trade below $1 on a 30 day weighted average trailing basis.

Gary Clark

Right, it doesn’t do anything about these, and that’s capitalization…

Bill Powell

That is correct, that is correct.

Gary Clark

What possible remedies can exist on that I can’t even imagine what you do there. I don’t suppose you would sell more capital, which you say you can’t do in this market. Can you give us any list of what companies can do or have done say just historically to meet that second requirement? I wasn’t aware of that second requirement exactly.

Bill Powell

No, I think the second requirement is there is no easy fix to the second requirement.

Gary Clark

No easy fix to the second requirement. And one other question, and that is, from the standpoint of the areas that you may go into, I gather that on a long term basis, because know that the new CEO did state I think two quarterly meetings ago when he came in that one thing he said he was going to buy some stock and he did (inaudible) and the question of whether or not you are going to try to constitute any commercial and especially European as opposed to going back into if not sub prime at least prime American residential, in other words you have at least some focus areas that you are thinking ahead of. I’d hope your long term planning will at least go over that, that’s commercial versus residential and American versus European on Asian?

Bill Powell

But I have already answered that by saying that there is nothing more important right now than what we are working now within the company and focusing in on the existing portfolio and the existing financial structure and strengthening the financial basis of the company. I am really not prepared to comment beyond that.

Gary Clark

So perhaps the future quarterly things, you have more information on that, if and when the liquidity problems go off, but just one another question. I know I am hogging this, but just one another thing I really need to ask, and that is, you stated in the release which I have been reading the few minutes it was posted and then this conversation that things haven’t really gotten any better now. This bailout and all those other stuff, are you saying none of this is helping at all, or just isn’t helping very much or what ?

Bill Powell

I would say that it is not helping, yes. I would say that we are cautiously optimistic that the various governmental programs will help to provide stable housing prices, and will help to provide getting capital flowing to the commercial real estate debt markets again. Keep in mind that the month of August – the month of October was extremely difficult from a credit market perspective, somewhat unprecedented, and we are only on November 3 right now. And so it’ll definitely take some time for some of the re-liquefication of the markets to take place.

Gary Clark

Are you saying when we meet again in January, you may be a little more optimistic? I was a little surprised actually at totally pessimistic report that sounded like – this is pessimistic as it was doing six months ago as far as far as the macro picture. You don’t seem to be any more optimistic than you were six months ago, and if that’s realistic I appreciate that of course. On the other hand, with a billion dollars, trillion dollars thrown in, do you think that should allow you to be a little more optimistic at least on a macro plus some commentary on your own plans?

Bill Powell

Yes, I could say that we will be very open with our shareholders and at the appropriate time we will communicate what we see and how we see it.

Gary Clark

I guess that’s all I can ask now. Thank you.

Bill Powell

Okay, thank you.

Operator

And at this time we have no further questions. So I’d like to turn the conference back over to Mr. Powell for any additional or closing remarks.

Bill Powell

Thank you. I just wanted to thank everybody for joining us today for the third quarter conference call of Crystal River Capital and we look forward to speaking with you again in the future.

Operator

This does conclude today’s teleconference. You may now disconnect and thank you for your participation.

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