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Executives

Jeff Cirillo – VP

Joe Robert – Chairman and CEO

Mark Weiss – President

Keith Belcher – Head, CMBS Group

Mike McGillis – VP, CFO and Treasurer

Analysts

James Axelrod [ph]

Andrew Schiff – Zirkin-Cutler Investments

Paul Burgess [ph] – Cornerstone Asset Management

Lewis Feldman – Wells Capital Management

Rob Schwartzberg – Compass Point

JER Investors Trust Inc. (JRT) Q4 2008 Earnings Call Transcript March 3, 2009 10:00 AM ET

Operator

Ladies and gentlemen, welcome to the fourth quarter 2008 JER Investors Trust earnings conference call. My name is Tanya, and I will be your coordinator for today. At this time, all participants are in 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. Jeff Cirillo, Vice President. Mr. Cirillo, please proceed.

Jeff Cirillo

Thank you and good morning, everyone. This presentation will include statements that constitute forward looking statements, including with regard to the company's revenues and earnings per share, the anticipated effects of today's announcements and the Company's growth.

Wherever possible, the Company has identified these forward looking statements by words such as anticipates, believes, intends, estimates, expects, projects and similar phrases. These forward-looking statements are based upon assumptions the company believes are reasonable and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Because such statements inherently involve risks and uncertainties, actual future results may differ materially from those expressed or implied by such forward looking statements. Factors that can cause or contribute to such differences include but are not limited to changes in economic conditions generally and the real estate and bond market specifically; legislative and regulatory changes; the availability of capital; our ability to obtain future financing arrangements; changes in interest rates and interest rate spreads; changes in generally accepted accounting principals; market trends; policies and rules applicable to REIT; the application and interpretation of the rules and regulations of the Investment Company Act; the subjectivity inherent in any weighted analysis underlying the company's assumptions and estimates with respect to the future; and other risks detailed in the company's periodic filings with the securities and exchange commission.

The company cannot predict what factors may arise or how such factors may cause its results to differ materially from those contained in any forward looking statements. Such statements speak only of the date on which those statements were made. The Company undertakes no obligation to update these statements with revisions or changes after the date of this call.

In addition, this presentation includes non-GAAP financial measures in accordance with Regulation G, a presentation of the most directly comparable measures calculate in accordance with GAAP, as well as the reconciliation of the differences between such measures are available on the company's website at www.JER.com. With that, I would now like to introduce Joe Robert, Chairman and CEO.

Joe Robert

Good morning, and thank you for participating on this morning's conference call to discuss the fourth quarter and full year '08 results for JER Investors Trust. As I usually do, let me introduce the management team that's with me on the conference call today. We have Mark Weiss, our President; Keith Belcher, Head of our CMBS Group; and Mike McGillis, our CFO.

Now, with respect to the environment we are operating in, as everyone is painfully aware, the market continues to deteriorate. This ongoing decline is evidenced in the generally economy, in the stock, and the credit markets as well. Transactions in the real estate market are virtually non-existent. Most owners of real estate like us are working to asset management, protect value in what they currently own, and almost all sales are in one way or another, tend to be forced sales.

We, like all of you, are hopeful that the revamped TARP program and the TALF program will help the credit markets in general and commercial real estate specifically. We're hopeful that the steps that the government is taking, the policy initiatives that are being implemented will mitigate to some degree this continued decline and hopefully, at some point, maybe towards the end of this year, beginning of '10, that we begin to – we begin to climb out of this recession.

Now having said that, we're not waiting for the tooth fairy to come. I think we're realistic about where we are. We're optimistic about the opportunities that the future will bring and actually that are here right now and from our perspective, we are all, at this point, possibilitarians in the sense that we are looking at what opportunities are there and how we capitalize on them, and how we best position this company to come out of this mess, and to succeed and outperform our peers.

The liquidity crisis has hit our company like many others in the financial services industry. We paid down approximately $250 million of repo borrowings since the end of '07 and, as Mark will explain, the remaining repo balance has been reduced to $14 million, currently.

From a credit perspective, as you'll hear from Keith, our special servicing portfolio represents approximately 2% of our total first-loss, CMBS collateral pool balance of approximately $48 billion. While still a relatively small number compared to the residential markets, we are monitoring our portfolio carefully and making adjustments to our loss reserves as appropriate. Not withstanding the current market, we do see opportunities, as I suggested earlier, and Mark will talk about an equity offering that we announced this morning.

Now, before I turn the call over to Mark, let me talk about another topic. The topic is me, as any of you who looked at some of the filings, including one I think that went out this morning, or yesterday, I was discovered to – several weeks ago to have brain cancer. I underwent surgery on the 12th of February at the National Institute of Health here in Bethesda, Maryland.

Actually I underwent two surgeries, I'm now under treatment. I have come back to work full time. I am fully up to speed. I hope not to miss a beat as I go through the – go through the treatment. I've given everybody here a – will give everybody here a cattle prodder, so if I start to slow down they'll nudge me a little bit but I don't thing that's going to be a problem. So I'm back running at full speed. And with that, I will turn it over to Mark.

Mark Weiss

Thanks, Joe. I wish I could say that things have improved since our last earnings call, but I can't. Liquidity for commercial real estate is almost non-existent today. Most of the securitized lenders have dramatically reduced or eliminated their staff, and most of the on balance sheet lenders are dealing with maturity extensions, which are limiting their appetite for new originations.

We are also seeing stress in our existing portfolio. As Keith will talk about shortly, the assets in our special servicing portfolio have approximately doubled since our last earnings call. While the assets are from all geographies and asset classes, we are seeing a significant concentration of retail and multi-family loans as a percent of the total special servicing portfolio, relative to our overall CMBS collateral pool.

With regard to liquidity, as of today, we have only $14.1 million in repo exposure remaining. This was accomplished through the meeting of margin calls, sale of assets, and the termination of our right of repurchase on three assets with Goldman Sachs. The remaining repo debt will be amortized down by $750,000 a month, beginning in March with the remaining $8 million due in December.

Our remaining debt exposure is through CDO I and CDO II, which are both nonrecourse obligations of JRT. In order to further manage our liquidity, we took the step of paying 90% of our fourth quarter and full year dividend in stock, and given the size of our dividend relative to our cash balances, we thought it was prudent to avail ourselves of the option to pay the maximum amount in stock.

Now, let's turn to loan maturities. On the non-CMBS real estate loan front, we had only one loan maturity before November of 2010. That loan came due in early February and concurrent with the principal pay down and other modifications, that loan was extended until a maximum final maturity date of February 2011.

As mentioned on previous calls, approximately 1% of the loans underlying our first-loss CMBS securities come due in 2009. The majority of these are in the second half of this year and in cases where the borrower is unable to refinance, we do have the option of loan extensions. Finally, with regard to asset management, I will turn it over to Keith Belcher, Head of our CMBS Investments, to review the state of our special servicing portfolio and provide more information on the increase in our loan reserves. Keith?

Keith Belcher

Thanks Mark, and I'll be consistent with our prior earnings calls and we'll cover four things regarding the CMBS portfolio. First, I'll review the actual loss experience relative to the underlying loans in the pools that we have first-loss exposure on. Second, I'll talk about our current special servicing portfolio and the trends we're seeing. Third, I'll address the CMBS delinquency rate and our loss projections going forward. And finally, I'll talk about the bond downgrades that have occurred.

So with regard to the actual CMBS losses, for the 21 pools that we purchased the first-loss pieces on between 2004 and 2007, those pools had a beginning total principal balance of approximately $48 billion – excuse me, approximately $50 billion initially, $48 billion currently. To date, we've had very few realized loan losses with only a little over $3 million in actual loan losses in comparison to our original underwriting, where we had projected to have had $37 million through December 30, 2008.

Despite the favorable variance to date, we do expect losses to accelerate in 2009 as we've experienced a substantial increase in the special servicing portfolio, which has grown from $304 million at the end of September 2008 to $713 million at year end, and $982 million at the end of February. From a percentage standpoint, the present balance of the special servicing portfolio represents approximately 2% of the current total pool balance.

In terms of the loans in special servicing, out of the total CMBS B-piece portfolio of approximately 3500 loans, again with a balance of approximately $48 billion at the end of February, we had 86 loans in special servicing totaling $982 million. Of those 86 loans, 21 totaling $238 million are current, 59 loans totaling $703 million are delinquent and six loans totaling $41 million have been foreclosed.

In terms of the collateral trends, as Mark indicated, the special servicing portfolio is most heavily weighted toward retail as 37% of the balance is collateralized by retail. Multifamily is second with 35% of the portfolio collateralized by multifamily. I mentioned last time that we had not yet had a large amount of hotel defaults, and while we have had a few more recently, the percentage of hotel loans totals – in special servicing totals about 5%, which is pretty proportional to the overall pool.

With declining travel, however, we do expect to see the percentage of hotel delinquencies increase. Given the overall increase in the special servicing portfolio and based on the concerns over the general economy, we previously increased our CMBS loan loss assumptions in the third quarter by $201 million with an additional increase of $101 million in the fourth quarter, so that the total loss assumption has been increased to $964 million, as of the end of the year.

In addition to the loss amount increase, we've also accelerated the timing of the loss assumptions, so that approximately 44% of the losses are projected to occur in 2009 and 2010. The increase in the loss assumption and the timing impact has been modeled into the CMBS cash flow projections. One last comment on the portfolio before I turn it back over to Mark, is that we've seen an acceleration of the rating agency downgrades across the sector, in particular in early February, Moody's published a report indicating their intent to complete a review of the 2008 through – excuse me, 2006 through 2008 transactions with the exception – with the expectation of consistent downgrades.

They have subsequently downgraded several of our deals, and collectively we've had bonds downgraded on 15 of our 21 B-piece transactions and three of our five transactions, where we own the bonds above the first-loss positions. Those downgrades have ranged from single notch downgrades to downgrades of four or five notches. And now back to Mark.

Mark Weiss

Thanks, Keith. I have said before and reiterate this point again. We continue to aggressively manage our portfolio. We think experienced asset managers like JER will have significant value in times like these. As part of our dedication to asset management, we've continued to add experienced staff in our special service as the flow of loan transfers increases. With that, let me turn it over to our CFO, Mike McGillis. Mike?

Mike McGillis

Thanks Mark, and good morning. Let me start by reviewing our balance sheet. GAAP requires that we retrospectively restate earnings per share for our 1-for-10 reverse stock split that occurred on February 20, 2009. However, under GAAP we're precluded from retrospectively restating earnings for common share for our stock dividend paid on January 30, 2009, as a portion of this dividend was paid in cash.

Management believes that it's meaningful to investors to disclose the retrospective effect of both, the 1-for-10 reserve stock split as well s the stock dividend. Accordingly, we are presenting the non-GAAP measure, earnings per adjusted diluted common share in this release. See a reconciliation of earnings per common share calculated under [ph] GAAP to earnings per ADCS at the end of this press release.

Our GAAP shareholders equity is $46.4 million or $9.29 per adjusted diluted common share as of 12/31/08 compared to $222 million or $86 per adjusted diluted common share as of September 30, 2008. The decline is primarily due to the GAAP net loss during the quarter and declaration of our fourth quarter dividend.

At December 31, 2008, we have total assets of approximately $435 million. Our cash balance was $9.5 million and included $1.1 million in restricted cash. As discussed by Mark, due primarily to repayment borrowings of $2.5 million, swap termination costs of $3.3 million and our Q4 2008 dividend payment, our unrestricted cash position at February 28, 2009 was approximately $2.7 million.

Our primary asset class continues to be CMBS. At year end, CMBS represented $223 million in fair value or 51% of total assets. During the fourth quarter, we recorded unrealized losses of $118 million on our CDO related CMBS, and a $33 million impairment charge on our non-CDO related CMBS. At December 31, 2008, the GAAP yield on our CMBS portfolio is approximately 36% on a weighted average loss adjusted basis on a cost basis of approximately $221 million.

Now, turning to real estate loans. We ended the quarter with ten loans held for investment, totaling $274 million in cost basis, net of premiums and discounts, which we carry on our balance sheet a fair value of $190 million or 44% of total assets. All of these loans are financed by CDO II. During the three months ended December 31, 2008, we sold one real estate loan and consensually terminated the right to repurchase three real estate loans, all of which were previously classified as held for sale, with a face amount of $235 million, and an unamortized cost basis of $232 million for $140 million.

Proceeds from these transactions were used to repay the repurchase agreement with Goldman Sachs. We recorded a $72 million realized loss in connection with the sale of these loans. Finally, with respect to debt and other liabilities, we ended the quarter with total liabilities of $388 million, consisting of $212 million of CDO notes payable at fair value, which had a corresponding face amount of $975 million, $16 million of repo borrowings, $60 million of junior subordinated debentures, $92 million of interest rate swap liabilities at fair value, $2.3 million of dividends payable, and $6.8 million in miscellaneous trade payables and accrued interest payable.

As noted in last week's 8-K filing, CDO II tripped its over collateralization coverage test for February 2009 and as a result, approximately $2.2 million of monthly cash distributions that would have otherwise come to JRT were redirected to repay senior notes payable issued by CDO II. Currently in compliance with all other material requirements of the applicable loan documents related to our CDOs and repurchase agreements, as well as, it is related to our interest rate swaps.

With respect to the statement of operations, in comparing our fourth quarter 2008 results versus third quarter of 2008 results, Q4 2008 AFFO was $8.5 million or $1.71 per adjusted diluted common share, compared to $8.5 million or one point – or $1.72 per adjusted diluted common share for Q3 2008. At the back of the earnings release is reconciliation between GAAP net income and AFFO. With respect to our GAAP net loss of $181 million or $36.48 per adjusted diluted common share, for the fourth quarter, it was primarily the result of other losses net of $183 million.

In our earnings release is a table, which breaks down the composition of the $183 million of other losses during the fourth quarter of 2008. In summary, other losses net were primarily due to net changes in the fair value of CDO related financial assets and liabilities, which resulted in an unrealized loss net of $97 million, net changes in the fair value of assets and liabilities held outside of our CDOs, and realized losses on sales of real estate loans and termination of interest rate swaps resulted in aggregate net losses of $82 million, which consisted primarily of realized losses on real estate loans, net of reversal of prior period unrealized losses of $38 million, non-CDO CMBS impairment charges of $33 million and unrealized losses on interest rate swaps of $8.8 million.

The non-CDO CMBS impairment charge of $33 million includes $19 million due to declines in projected net present values of future cash flows on certain of our CMBS investments, and $14 million of other than temporary impairment charges. The decline in projected cash flows is primarily a result of the increases in projected losses on our CMBS collateral, as Keith discussed previously. Now, let me turn it back over to Mark. Mark?

Mark Weiss

Thanks, Mike. Now, let me talk to you about our proactive approach we're taking to try to take advantage of some of the market dislocation we are seeing on CMBS securities. We announced this morning the intent to raise approximately $150 million in a common equity offering. The net proceeds from this offering will primarily be used to invest in senior investment grade tranches of commercial mortgage backed securities.

We also intend to use approximately $15.6 million of the net proceeds to repurchase all of our outstanding trust preferred securities with an aggregate liquidation amount of $60 million, contingent upon the completion of this offering. As this is a new offering into a marketing period, I am prohibited from taking any questions on this proposed offering. With that, operator, let's go to questions. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) And your first question will come from the line of James Axelrod [ph].

James Axelrod

My question has to do with the cash portion of the dividend, was that required that you pay that percentage in cash?

Joe Robert

Yes, under the – under the new rules that came out as a result of the various economic stimulus packages, we had to pay a minimum of 10% of that dividend in cash and that is what – we met that minimum requirement.

James Axelrod

Thank you.

Operator

(Operator instructions). Your next question will come from the line of Andrew Schiff with Zirkin-Cutler Investments. Please proceed.

Andrew Schiff – Zirkin-Cutler Investments

Hi, guys. Who owns – these trust preferred securities are not public, correct? Or I can’t find a –

Joe Robert

Yes, that is correct.

Andrew Schiff – Zirkin-Cutler Investments

Okay, who owns them? I mean was this something you offered at some point – and actually, do you know who owns them at this point?

Mike McGillis

We obviously do, but we can't disclose that on this call.

Andrew Schiff – Zirkin-Cutler Investments

Okay, it's just a little or perhaps more than a little disconcerting to hear about this equity raise given the current number of shares outstanding, what's happened to market cap and then to hear that these trust preferreds are going to be taken out at that level. I mean you can understand why we might have more than a question or two about what you're proposing.

Joe Robert

Yes, I mean, as we mentioned, we're buying them back at – subject to the successful completion of the equity offering at a substantial discount, the 15.6 million relative to the $60 million amount.

Andrew Schiff – Zirkin-Cutler Investments

Yes, you're basically restarting the company, it looks like, which I guess in today's environment, with a pot of cash, isn't such a bad idea. It's just really too bad for the shareholders that have been there since the very beginning. Okay, I guess, we'll just continue to wait. Thank you.

Operator

And your next question will come from the line of Paul Burgess [ph] with Cornerstone Asset Management. Please, proceed.

Paul Burgess – Cornerstone Asset Management

Yes, hi, Joe. I was just wondering if you could add a little bit more in terms about your own physical condition going forward and prognosis. Does it look pretty good for you for the long term?

Joe Robert

Well, there's always the proverbial bus out there, so I look both ways when I cross the street. I'll be undergoing treatment, which should start in a couple weeks for – that will last probably through till – through April. The only real restrictions on me are that I can't get on an airplane and travel anywhere, probably until May.

But other than that, I'm at the absolute best place in the world at the National Cancer Institute, which is part of the National Institute of Health, for treatment. And the prognosis is good, and I'm up and ready for the fight. I feel good and I'm – I may be – I just turned 57, I guess, about a week ago, and so I'm optimistic. So are my doctors.

Paul Burgess – Cornerstone Asset Management

Good. Good. That's all I had.

Joe Robert

Okay.

Operator

And your next question will come from the line of Lewis Feldman with Wells Capital Management. Please proceed.

Lewis Feldman – Wells Capital Management

Good morning, gentlemen. Can you give a little bit more color in terms of what you are seeing in the commercial real estates? Are you seeing defaults? Are you seeing trouble with people being able to refinance when their loans mature? Is there just – I mean certainly there's a lack of liquidity, but is there just simply an unwillingness on the parts of what had traditionally been the alternatives to step up to do it and can you give a little bit more on where you think you see the opportunities?

Mike McGillis

Sure. Yes, I mean it's – in terms of – and Keith can jump in as well, clearly in terms of maturities, that's sort of the big watchword right now, and you're seeing an awful lot of lenders right now dealing and dealing responsibly with their borrowers, and as loans mature, obviously they always have a decision whether to foreclose or extend, and you're certainly seeing a lot of people extending right now. And the problem with that, from a new liquidity perspective, is by doing these extensions, there's obviously not a lot of new capital or new availability of capital at those lenders to put out.

They – obviously people assume when you get repayments you can then put that money to use again, but if you're out there extending in the marketplace, that leaves a limited amount of ability for new transactions. And obviously, we have not seen the securitized market come back in any way, shape or form yet. Most of the Wall Street lenders and the typical securitized lenders are really sitting on their hands at the moment just watching and waiting and seeing what's going on with the CMBS market, because it just does not – the rates that they would have to charge today just don't make a lot of sense for an awful lot of borrowers today. With that, I'll let Keith continue on the conversation.

Keith Belcher

Sure, Lewis, I think as we addressed in our comments, we have seen an increase in the flow of delinquencies coming into special servicing. We're not unique in that regard. In fact, across the sector in the November, December, January time frame, you saw increasing delinquencies. Clearly that was a result of the decline in the economy. When you see such things as Circuit City failing, and other retailers failing, that has an impact at the retail collateral level. So we're seeing real economic events filter through.

That being said, the level in special servicing and the delinquency levels at 2% or under are still remarkably low compared to the residential market experience, and in the context of the overall market, the delinquencies are actually relatively low. From a forecast standpoint, as we commented, we do see an increase going forward. We model for those increases and we perform surveillance, updating our loss assumptions and that's taken into account in the current cash flows.

Lewis Feldman – Wells Capital Management

Isn't it true, though, on a historical basis, and I'm not talking of the last five, seven years, but going back 15, 20 years, the 2% is still relatively low on an average basis, is that correct?

Keith Belcher

That's correct. In peak times, we've seen delinquency levels historically for instance the 1985, '86 vintages that had cumulative default levels significantly higher. Keep in mind that the 2% is a point in time. There will be cumulative defaults over the years in these pools that certainly exceed that.

Lewis Feldman – Wells Capital Management

Are you – in terms of the – in terms of the borrowers, in terms of the commercial real estate, are you actually – are you seeing real stress both on your individual loans as well as in the pools on the part of borrowers?

Keith Belcher

We are seeing property cash flows decline, and it's not an across the board event, it's – as I indicated, it's the Circuit City failures, its an office tenant moving out of a building in a particular submarket. It is not consistent 5%, 10% decline in net operating income across the collateral portfolio.

Lewis Feldman – Wells Capital Management

Okay, I'll step back. Thank you.

Operator

And your next question will come from the line of Rob Schwartzberg with Compass Point. Please, proceed.

Rob Schwartzberg – Compass Point

Good morning, gentlemen. I had a theoretical question regarding the offering. In previous discussions with management, I thought that there was an obstacle to repurchasing securities, because of the gain and how the gain would be treated and whether or not any dividend would have to be paid. Can you sort of speak hypothetically to that, that if you complete the offering and you repurchase trust preferreds, how would you pay the gain or – that's question one, and then I have a follow up question.

Mike McGillis

Sure, there are a couple things that have happened with respect to the gain, and there are – there are a couple of options as a result of changes in the REIT rules, the ability to pay stock dividends is one way to handle the treatment of the COD income, resulting from the buy back of debt. There's another treatment that came out of the recent economic stimulus package, which allows deferral of recognition or cancellation of debt income for a period of five years. And then you'd recognize that ratably over a five-year period of time subsequent to that. So, it does provide a deferral mechanism for those gains and based on our discussions with counsel, we believe we're eligible to treat gains in that fashion.

Rob Schwartzberg – Compass Point

Well, that kind of goes to my second question, which is you wouldn't then pay a dividend in shares after just issuing a relatively large number of shares relative to the stock price. Did the company explore or are you considering at all any sort of high-yield offering, because it seems like the debt markets are more receptive right now than the equity markets.

Mark Weiss

Listen, we clearly look at all opportunities right now. While the credit fall out is coming, but it's coming very slowly. We haven't seen, certainly for companies in our space, an awful lot of debt, whether it's high yield or other. And as Mike said, in terms of the COD income, that's actually a very attractive way to buy back debt and to defer the income for a significant period of time. But listen, we examine all capital alternatives at all time, particularly in this difficult capital markets environment.

Rob Schwartzberg – Compass Point

Right, right. I'm not sure you're seeing too many equity offerings either, but anyway I hope it all works out for you.

Mark Weiss

Thank you.

Rob Schwartzberg – Compass Point

Thanks, bye-bye.

Operator

There are no further questions at this time. This concludes our question-and-answer session. I would now like to turn the call over to Mr. Joe Robert for closing remarks.

Joe Robert

Well, I want to thank everybody for participating in this call. I want to let everyone know that we are working feverishly as hard as we possibly can to maximize the recovery of the capital that was entrusted to us and the investments that we have in our portfolio. As I suggested as well, we see significant opportunity out there. We have to be realistic about where we were, where we are. I think we've done quite a good job of balancing our balance sheet through an unbelievable crisis, particularly relative to our peers, and I'm optimistic that the future holds opportunities that frankly we haven't seen for a long time. With that, I will close.

Operator

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

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