RAIT Financial Trust Q4 2008 Earnings Call Transcript

| About: RAIT Financial (RAS)

RAIT Financial Trust (NYSE:RAS)

Q4 2008 Earnings Call

February 26, 2009


Scott F. Schaeffer – Chief Executive Officer and President

Jack E. Salmon – Chief Financial Officer

Andres Virsoslav – Vice President and Director of Corporate Communications

Betsy Cohen – Chairman of the Board


Davis Chiaverini – BMO Capital Markets


Ladies and gentlemen, welcome to the fourth quarter 2008 RAIT Financial Trust earnings conference call. My name is Tonya and I will be your coordinator for today. All participants are in a listen only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator Instructions)

I would now like to turn the presentation over to your host for today’s call, Mr. Andres Viroslav, Vice President and Director of Corporate Communications. Sir, please proceed.

Andres Viroslav

Thank you, Tonya and good morning to everyone. Thank you for joining us today to review RAIT Financial Trust’s fourth quarter and fiscal 2008 financial results. On the call with me today are Scott Schaffer, Chief Executive Officer, Betsy Cohen, Chairman of the Board, Jack Salmon, Chief Financial Officer, and Raphael Licht, our Chief Operating Officer.

This morning’s call is being webcast on our website at www.raitft.com. There will be a replay of the call available for webcast on our website and telephonically beginning at approximately 1 p.m. Eastern time today. The dial-in for the replay is 888-286-8010 with a confirmation code of 82111440.

Before I turn the call over to Betsy, I would like to remind everyone that there may be forward-looking statements made in this call. These forward-looking statements reflect RAIT’s current views with respect to future events and financial performance.

Actual results could differ substantially and materially from what RAIT has projected. Such statements are made in good faith pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

Please refer to RAIT’s press release and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations. Participants may discuss non-GAAP financial measures in this call.

A copy of RAIT’s press release containing financial information, other statistical information and a reconciliation of non-GAAP financial measures and the most directly comparable GAAP financial measure is attached to RAIT’s most recent current report on form 8-K available at RAIT’s website, www.raitft.com under Investor Relations.

RAIT’s other SEC filings are also available through this link. RAIT does not undertake to update forward-looking statements in this call or with respect to matters described herein except, as may be required by law. Now, I would like to turn to the call over to RAIT’s Chairman, Betsy Cohen. Betsy?

Betsy Cohen

Thank you, Andres, and again welcome to all of you on the call. I just wanted to take the opportunity to review the recent resignation of Daniel Cohen. As CEO of RAIT, Daniel gone on to be the CEO of another company which he was Chairman.

We’re very fortunate though at RAIT to have what we think of as a deep bench and to have colleagues from which to draw leaders who have been with us over a long period of time.

And to have a very relevant experience to today’s market. Scott Schaffer who has become our CEO was active in the distress debt markets of the early 1990s, has over time not only had acquisition experience in that area but certainly substantial commercial real estate work out experience, and indeed was a part of the RAIT team which prior to the advent of available securitization in our marketplace allowed us to grow, develop and succeed with a very sound CRE platform.

Raphael Licht who has moved from the position of General Counsel to that of Chief Operating Officer, again brings with him, long experience in the securitization field from both the legal and negotiating perspective. And understanding of our business platform which we will enable us, I think, to operate even more effectively.

With that, I’m going to turn the call over to Scott Schaffer.

Scott Schaffer

Thank you very much, Betsy. And thank of all you for being with us this morning as we present RAIT’s 2008 results and our current business strategy. After some brief remarks, I will ask Jack to deliver his financial report. After which, we will open the call up for questions.

I think it is very clear to everyone how challenging the market has become. So I’m not going to spend time describing what we all can experience by turning on the TV, reading the newspaper, or watching volatility in the stock market. Simply put, RAIT faces macroeconomic, recessionary market conditions as the deleveraging process continues without signs as to when the economy will recover.

Unfortunately, we have no control over these conditions. However, we can determine how RAIT responds and manages through this difficult period in order to maximize available cash flow, build assets, and provide returns to our shareholders.

Today, we have adequate cash flow and liquidity to meet our debt maturities and an existing commercial real estate platform which is positioned to take advantage of opportunities in the distressed commercial real estate debt market.

We recently hired a former managing director of a large financial institution with extensive CMBS experience to support us in this initiative. As detailed in our earnings release, we generated $0.33 and a $1.84 per share of adjusted earnings for the quarter and yearend at December 31, 2008. Our portfolios generated gross cash flow of $174 million for the yearend at December 31, 2008, as compared to $214 million in 2007.

We are vigorously and I think effectively managing and servicing our investment portfolios with a focus on cash flow. In order to understand where our business is today, it’s important to understand that the majority of our gross cash flow, approximately 55% came from our commercial real estate portfolio during 2008. We built our commercial real estate portfolio over 10 years and we feel it is a strong foundation that will support RAIT’s future.

Our other portfolios including our residential mortgage portfolio, domestic TruPS portfolio, and our European portfolio also generate significantly cash flow. Our ability to earn positive investment income on our investments in these portfolios is highly dependent on the overall economy and particularly its affect on our borrowers’ liquidity.

In this environment we’ve experienced lower asset originations than anticipated and accordingly, fewer new fee generating opportunities in our commercial real estate business. These fee incoming producing opportunities become available as loan repayments are received.

During 2008, we received $180 million in loan repayments and originated $232 million in new loans. Since long-term financing for commercial real estate properties is not readily available, some loans in our portfolio have been modified and/or extended. Our commercial real estate portfolio is weighted towards multifamily properties where Fannie and Freddie continue to provide liquidity and support albeit on more conservative terms.

These agencies provide a potential source of financing for some of our borrowers though much depends on how the recession impacts the operations of these properties going forward. Financing further commercial property types remain scarce since banks are hesitant to lend and the securitization market for commercial real estate assets remains frozen.

We are hopeful the Treasury Department will include commercial real estate in 2009 TAF program and make it available soon. The inclusion of commercial real estate could provide much needed liquidity to all commercial real estate property types.

During the fourth quarter we experienced an increase in a nonperforming loans in our commercial real estate and residential mortgage portfolios and in turn have adjusted our allowance for losses accordingly.

At yearend our allowance for losses in our commercial real estate and residential loan portfolios totaled $172 million. Our TruPS portfolio which is mark to market quarterly continues to devalue on a fair basis due mainly to market conditions and additional issuer default.

However, we continue to earn over $20 million per year in senior collateral management fees. We’ve adapted quickly to the market and are well prepared to manage assets that are in transition via workouts. Commercial loan workouts are not new to RAIT. We have extensive workout experience within our ranks.

For instance, as Betsy mentioned, prior to joining RAIT in October 2000, I spent eight years buying and ultimately working out nonperforming loans from the RTC and others. Additionally, many members of our executive team have managed through numerous real estate cycles both good and bad. We’ve been a provider of commercial real estate debt instruments since 1998 and we have insights and knowledge on how to create value during the workout process.

Our underwriting process looked at credit from the perspective of what if we had to be comfortable one day only in the real estate. Today we assess our nonperforming loans taking senior debt terms and asset specific issues into consideration. And in many instances, have decided to take direct ownership of the property rather than selling into a distress market.

During 2008, we converted 10 loans totaling $237 million into real estate equity. We expect this trend to continue through 2009. We will explore all options available to us from the familiar vantage point of being an owner of real estate including asset sales, repositioning, and other strategical alternatives to maximize returns and recovery value for our shareholders.

For more than 18 months, we’ve been working diligently to stay ahead of the financing risks by stabilizing our liquidity position. During 2008, we eliminated our exposure to short-term repurchase debt which in this environment causes a high degree of uncertainty and counterparty risks.

I would like investors to note that only $33 million of our total debt matures during 2009 for which we expect to have adequate liquidity. Though we have seen a decline in gross cash flow generated from our investment portfolios we feel that our operating cash flow and other liquidity resources are adequate to sustain our operation, provide capital for the repurchase of our debt.

We believe that retiring debt at a significant discount is a good use of available cash especially when coupled with the new IRS ruling which allows for the deferral of result in gains. It’s an opportune time to purchase further debt buy backs.

We will also continue to seek and develop alternative financing sources while focusing on enhancing our liquidity. As previously announced in January 2009, dividends will be determined by our Board after each quarter end. So management and the Board can review the results and the status of our REIT taxable income.

As a reminder to qualify as a REIT we are required to make distributions to shareholders in the amount at least equal to 90% of annual REIT taxable income. The Board will also consider the composition of any common dividends declared including the option of paying a portion in cash and the balance in additional common shares.

Market conditions will significantly impact these decisions as we continue to manage our business for the long-term benefit of shareholders. With that, I’d like to turn the call over to Jack to review our fourth quarter and fiscal 2008 financial results.

Jack E. Salmon

Thank you, Scott. Given the extent of the financial information included in our press release, I will briefly summarize our 2008 financial results and focus on three aspects of our year including the following; our credit performance, the cash flow trends in our business, and our capital resources and liquidity.

First from a financial results standpoint. We reported GAAP net loss of $506 million in the fourth quarter and $443 million or $7.03 per common share for the full year. These losses were caused primarily by $552 million of fair value adjustments to our TruPS portfolio, $67 million of asset impairment charges including write-offs of intangible assets, and $163 million of provisions for loan losses during the year.

These noncash adjustments are added back to our adjusted earnings resulting in a $116 million or a $1.84 per share of adjusted earnings for the year. Management has implemented cost containment measures during 2008 that resulted in reducing compensation and G&A expenses by over 26% compared to 2007.

We repaid $148 million of recourse debt during 2008 thereby lowering from $711 million to $563 million. Our remaining $5.6 billion of debt is nonrecourse to rate. We will continue to seek additional reductions of these items during 2009.

Adjusted earnings provides an alternative non-GAAP performance measure. By comparison, during 2008 we generated estimated REIT taxable income of $94 million and thereby paid tom (ph) distributions of $108 million and preferred distributions of $13 million to our shareholders.

Turning to our cash flows. The press release contains a summary of the cash flows by product – by portfolio for each of the quarters and year to date in ’08 compared to ’07. Our first and most significant portfolios are commercial real estate.

It is our primary investment portfolio with over $2.2 billion of assets under management which generated $95 million of gross cash flows during the year representing 55% of the total.

During 2008, we originated $232 million in new loans primarily by recycling the capital from $108 million in repayments of existing loans within our CRE portfolio. All of our funding commitments in terms of future funding commitments are in our existing CRE securitizations are fully funded with restricted cash. In addition, the restricted cash at December 31, 2008, includes approximately $44 million of excess funding capacity available to finance new loans in our CRE CDOs.

All of our existing bank lines of credit totaling $90 million are up for renewal over the next year. And we have $33 million of expected principle repayment obligations during 2009. Although we expect to renew or expand this source of financing, we need to maintain sufficient liquidity and capital to meet these obligations as they mature over time.

During the fourth quarter our nonaccrual loans increased to $186 million, approximately 7.7% of the CRE portfolio, up from $146 million as of September 30, 2008. We also increased our CRE loan loss reserves to $118 million, an increase of $71 million during the quarter.

This increase in nonperforming loans and the recording of these additional reserves led to decreases in that interest margin, lower adjusted earnings, and the resulting $3.8 million reduction in CRE cash flow for the fourth quarter.

As we continue to pursue ways of improving of overall recovery and repayments on these loans, we may experience further temporary reductions in net interest margin and cash flow. Our second portfolio’s are residential mortgage backed securities.

As of December 31, 2008, we owned approximately $3.6 billion of securitized residential mortgage loans.

The residual cash flows we received generated $19.5 million of cash flow in 2008. With reductions occurring each quarter due to normal prepayment and the declining credit performance. The economic crisis worsened during the fourth quarter and the credit quality has deteriorated as we’ve experienced increase delinquencies into 2009.

The total nonaccrual loans in the residential portfolio were $231 million at December 31, 2008, representing approximately 6.4% of the total portfolio. We recorded $54 million of loan loss reserves and increased to $35 million since September 30, 2008. This portfolio remains in runoffs. We continue to expect reduced cash flows from repayments and credit deterioration during 2009.

Our third portfolio is our European portfolio comprised of approximately $1.9 billion of debt securities which generated $14 million of gross cash flow during 2008 or approximately 8% of our total for the year.

During the fourth quarter, we experienced additional credit defaults in certain over collateralization or OC test failures that resulting in the redirection of cash flows to pay down the senior debt currencies in our most recent European securitization.

These defaults resulted in the fourth quarter decline in cash flow which we expect to continue in 2009. And information about all of our securitization credit performance statistics in terms of the OC test will be included in our form 10-K for each of our CDOs.

Our fourth portfolio is our corporate domestic TruPS portfolio. In this portfolio we own $4.1 billion of securitized investments that are carried at a fair value of $1.9 billion in our financial statement. The portfolio generated approximately 25% of our quarterly gross cash flow during 2008.

We’ve experienced increasing payment and coveted defaults in the portfolios during and into 2009. Based upon the most recent payment cycle which was completed in January, all of our consolidated TruPS portfolios are now experiencing cash flow declines such that cash receipts are being utilized to pay down the highest rated debt tranches after paying the administrative costs and expenses, including our senior collateral management fees.

This is why Scott mentioned as a result, we are generating quarterly cash flows of approximately $5 million on these portfolios consisting of primarily senior collateral management fees. During 2008, we recorded net fair value adjustments of $552 million of which $206 million was allocated to (inaudible) interest.

These net fair value adjustments included a reduction in assets of $1.7 billion, a $395 million increase in the value of hedging derivatives, and a decrease in the fair value of our CDO debt of $1.6 billion.

The volatility of interest rates and credit spreads continues to reflect the international monetary and credit conditions. And may continue to rode our net equity value in the future. Now, it is important to note that our hedging contracts are funded directly by the securitization entities and do not require any additional cash collateral by RAIT.

At December 31, 2008, approximately $457 million of our unpaid principal TruPS and subordinate debt securities were on a nonaccrual status which resulted in a lower net interest margin and cash flow for the portfolios.

We continue to seek remedies and other means of restructuring the underlying collateral so as to improve the overall recovery in future periods. However, we are unable to determine whether we would be able to sustain the cash flows at these present levels within each of the (inaudible) transactions.

Finally, I’d like to just comment briefly on our capital events, its sources and uses of liquidity going forward. During 2008, in a series of a transactions we repurchased approximately $70 million of our debt instruments including convertible debt, trust preferred financing securities, and securitized debt in our CDO structures.

These debt repurchases were all at significantly discount prices enabling us to reduce the debt service cost going forward. We also recognized $42 million of gains associated with these transactions in 2008. We expect to continue to assess market opportunities to repurchase our debt obligations into 2009 at these distressed levels.

Moreover as Scott mentioned, the ability to defer the tax consequences from cancellation of debt makes this opportunity a key objective. So to summarize from a financial statement performance, our credit performance across all of our investment types may result in reduced net interest margin, adjusted earnings, and cash flows in the future.

However, we have adequate funding capacity within our CRE business to replenish assets as they mature or are sold. We are generating significant cash flow and adjusted earnings from all of our portfolios and paying dividends in accordance with our estimated REIT taxable income for the full year.

Now, I’d like to return the presentation back to Scott.

Scott Schaffer

Thanks, Jack. Before I open the call up for questions, I would like to comment the challenges we see for 2009. We will continue to focus on the following; managing our investment portfolios to reposition nonperforming assets and maximize cash flows; to take advantage of our CRE platform to invest in the distressed CRE debt market; to reduce our leverage through additional purchases of our debt; right size the business and cost structure to match today’s operating environment and develop new financing sources to maintain and increase our adjusted earnings and REIT taxable income.

We believe these are the appropriate steps to position RAIT for long-term growth. We will continue to focus on managing the credit risks inherent in our existing portfolios to maximize recovery and generate cash flow to improve our financial performance.

That concludes our prepared remarks. Tonya would you please open the line up for questions.

Question-and-Answer Session


Thank you. Ladies and gentlemen, (Operator Instructions). Your first question will come from the line of Davis Chiaverini with BMO Capital Markets. Please proceed.

Davis Chiaverini – BMO Capital Markets

Hey guys. A couple of questions. The first one is did you calculate what economic book value was for the quarter?

Jack E. Salmon

Dave, we did not. Given the events of the year, the economic book value is not as meaningful in our opinion and we’re not presenting it on a go forward basis. The book value is approximately $14 per share. You’ll see that in the 10-K.

Davis Chiaverini – BMO Capital Markets

Okay. And you mentioned about having $33 million of maturities in ’09. I assume that’s the recourse to REIT, those debt maturities.

Jack E. Salmon

All the $33 million represents recourse debt. That’s correct.

Davis Chiaverini – BMO Capital Markets

Okay and what about for 2010? Do you have a figure for how much is coming due then?

Jack E. Salmon

The number’s approximately $75 to $80 million in 2010 and then there are no maturities the next year and we’re into longer term of maturities. The 10-K will have the disclosures.

Davis Chiaverini – BMO Capital Markets

Okay. And you feel comfortable about having adequate cash flow to cover the maturities this year?

Jack E. Salmon

Yes, we do.

Davis Chiaverini – BMO Capital Markets

Okay, great. All right, that’s all I had. Thanks.

Scott Schaffer

Thanks, Dave.


Again, ladies and gentlemen, (Operator Instructions). Again ladies and gentlemen, (Operator Instructions).

Scott Schaffer

Well, I guess we’re finished. Thanks to everyone for joining us and we look forward to talking to you in three months time to discuss our first quarter earnings results. Thank you.


Ladies and gentlemen, thank you for your participation in today’s call. This concludes the presentation. You may now disconnect and have a great day.

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