Roger Cozzi – CEO
John Roche – CFO
Tim O'Connor – President
David Fick – Stifel Nicolaus
Omotayo Okusanya – UBS
Gramercy Capital Corporation (GKK) Q4 2008 Earnings Call Transcript March 12, 2009 2:00 PM ET
Thank you everyone for joining us and welcome to the Gramercy Capital Corporation’s fourth quarter and full year 2008 earnings results conference call. This conference is being recorded. (Operator instructions)
At this time, the Company would like to remind the listeners that during the call management may make forward-looking statements. Actual results may differ from predictions that management may make today. Additional information regarding the factors that could cause such differences appear in the MD&A section of the Company’s Form 10-K and other reports filed with the Securities and Exchange Commission.
Also, during today’s conference, the Company may discuss non-GAAP financial measures as defined by the SEC Regulation G. The GAAP financial measures most directly comparable to each non-GAAP financial measure discussed and the reconciliation of the differences between each non-GAAP financial measure and the comparable GAAP financial measure can be found on the Company’s website at www.gkk.com by selecting the press release regarding the Company’s second [ph] quarter earnings.
Before turning the call over to Roger Cozzi, Chief Executive Officer of Gramercy Capital Corp., we would like to ask those of you participating in the Q&A portion of the call to please limit your questions to two per person. Thank you. Go ahead, Mr. Cozzi.
Thank you and good afternoon everyone. I am joined today by Tim O'Connor, our new President and of course John Roche, and Bob Foley, whom you all know.
Before I begin, I wanted to take a moment to thank Marc Holliday and Andrew Mathias. Marc and Andrew have worked continuously with me during the first quarter as CEO to ensure a smooth transition to a new day-to-day management team at Gramercy and pursuant to our consulting agreement with – Marc and Andrew will continue to provide insight and assistance through most of the remainder of the year.
This has been especially important given the extraordinary stress placed on Gramercy and our competitors in the specialty finance sector, the continued deterioration of the economy and the ongoing softening of the commercial and residential real estate markets.
During this call, we will outline some of our achievements during a difficult and in many respects unprecedented macroeconomic environment, discuss our fourth quarter results, and highlight our operating strategy for 2009. We will also describe for you some of the risks and obstacles that we face in operating a commercial real estate finance and property investment company in a turbulent and weakening economy.
Before I get into specifics, I just wanted to say that I am extraordinarily pleased with our accomplishments this quarter in the face of a volatile and rapidly deteriorating economy. We were able to increase liquidity, remain in compliance with all of our covenants, and pay down debt. These are extraordinary feats in perhaps one of the most difficult operating environments that many of us have seen in our careers. Let’s get started.
On our third quarter call, I outlined four goals. One, continue to fill key positions in Gramercy’s management team. Two, determine an asset management strategy for each of the assets in Gramercy Realty and Gramercy Finance. Three, aggressively manage our loan portfolio and pursue asset dispositions. And four, proactively maximize liquidity to create operating flexibility.
First and foremost, let’s focus on some of our management changes. I am pleased to welcome Tim O'Connor who joined us in November as Gramercy’s President. Tim and I know each other very well and have worked together in the past for over 10 years at iStar Financial. Tim’s extensive asset management, property management, and loan servicing experience made him a wonderful addition to Gramercy’s team.
In addition, we have named Ed Matey our General Counsel, Michael Kavourias, our Chief Legal Officer, and John Clarke [ph], as our Chief Accounting Officer.
Finally, after largely completing the acquisition and integration of AFR, our CFO, John Roche, will be leaving the Company. Our search for a new CFO is well under way and we hope to announce John’s replacement soon. I personally wanted to thank John for all of his hard work and wish him well in his new endeavors.
Second, we reviewed each of the investments in Gramercy Finance and the largest assets in Gramercy Realty and determined the strategy for each investment. During our review of the assets in the Finance portfolio, we assessed the operating expertise and financial wherewithal of each of our borrowers to determine the optimal resolutions strategy when a loan matures.
In situations where the borrower provides operating or financial resources, we attempted to secure pay-downs or additional guarantees in connection with the negotiated loan extension. Specifically, from October 1st, 2008, to today, we completed modifications and extensions on eight loans totaling approximately $333 million and secured $39 million in pay-downs, additional guarantees, and reserves in connection with those deals. Overall, in 2008 through today, these numbers increased to approximately $510 million with incremental pay-downs, guarantees, and reserves totaling $65 million.
As for the Realty portfolio, Gramercy’s dedicated dispositions team has done a fabulous job in continuing to sell assets in what has been a very challenging sales environment. In the fourth quarter, we sold 46 assets for aggregate proceeds of $65.1 million. Overall, in 2008, the team sold 103 of the 151 properties designated at the merger as held-for-sale, generating $313 million of gross proceeds. In addition, the team closed on 43 properties not previously identified as held-for-sale, generating an additional $131 million of gross proceeds.
This trend has continued in the first quarter as we recently announced the closing of the sale of 55 Corporate, which generate approximately $17 million in net cash and a reduction in the Company’s mortgage debt of $94.5 million.
On the leasing front, we signed new leases totaling 60,000 rentable square feet that commenced during the fourth quarter, resulting in year-end occupancy of 88.7%, an increase of 100 basis points from the 87.7% reported in the prior quarter. We continue to evaluate proactively extending and modifying leases to improve the stability of the Realty portfolio, including the Dana portfolio, which is one of our larger investments that is fully leased to Banc of America.
For assets in our core Gramercy Realty portfolio, we are prudently managing capital and leasing expenditures to ensure that we are meeting our requirements as landlord while generating an appropriate return for additional money invested in the portfolio.
Lastly, we have taken several steps to maximize our operating flexibility. We increased unrestricted cash on our balance sheet from $95.2 million to $136.8 million, and retained $98 million in restricted cash in our three CDOs as of December 31st, 2008. We restructured our trust preferred securities, which will generate in excess of $32 million in savings over the next three years.
During the fourth quarter, we repaid $93.8 million in Company debt and have subsequently reduced the balances of both our Goldman repo facility and our Wachovia credit facility in the first quarter. We have reduced our unfunded commitments to $69.8 million. On the investment side, we have been very cautious.
In the fourth quarter, we only made three loan investments and purchased $20 million of CMBS other than existing commitments and repurchasing our own securities. Other than discounted super senior AAA CMBS, we have not yet seen meaningful volumes of distressed investment opportunities. We continue to believe that purchasing super senior AAA CMBS and repurchasing our own securities at significant discounts are some of the most attractive investments that we can make with our capital. As a result, we purchased $55 million of investment-grade CDO bonds, thereby generating gains of $43.9 million in the fourth quarter.
Despite the progress we have made and the achievement outlined above, I remain concerned about the continued deterioration of the U.S. and world economies. I am specifically focused on escalating unemployment and plummeting consumer confidence and the resulting impact on demand in the commercial real estate sector.
Given the structure and term of leases in commercial properties other than hotels, the negative impact on commercial real estate values lags any softening in the economy. The deteriorating economy and scarcity of capital has resulted in Gramercy taking $47.8 million in loan loss reserves in the fourth quarter. This trend may continue if the stimulus package and the government’s fiscal policy does not stabilize the economy and trigger a return of liquidity to the financial system.
I am cautiously optimistic that the government’s stimulus packages will eventually release pressure on tenants and borrower. However, my sense is that this may not occur until some time in 2010.
Let’s talk about 2009. Our operating objectives for 2009 are relatively straightforward. One, retain operating flexibility. Two, preserve liquidity. And three, operate efficiently. Our first objective is to retain operating flexibility. While we are currently in covenant compliance in our debt facilities, we are very close on certain of our covenants. We intend to continue to work closely with our lenders and in that spirit we have hired Goldman Sachs and Barclays Capital to assist us in the modification and restructuring of several of our borrowing arrangements.
In addition, we are close on our over collateralization covenants in our CDOs, which can have an impact on the cash flow the Company receives from the CDOs, which is a material amount of the operating cash generated by the Company on a quarterly basis.
Second, we will preserve liquidity by A, continuing to prudently dispose off assets, B, significantly reducing controllable corporate G&A, C, rationalizing property operating expenses and D, curtailing our investments and initially focusing on buying back our own debt securities at a discount.
Finally, in difficult markets, it is crucial to operate as efficiently as possible. Later in the call, Tim will briefly outline the action steps we have taken to optimize how Gramercy manages its business on a daily basis.
Now, I would like to turn the call over to John Roche, our Chief Financial Officer, to review the financials and operating results. John?
Thanks, Roger. FFO for the fourth quarter was $35.9 million as compared to $24 million in the comparable prior year quarter. On a fully diluted per share basis, FFO was $0.69 in both periods. For 2008, FFO was $123.5 million or $2.61 per fully diluted share as compared to $89.1 million or $3.03 per diluted share in the prior year. Fourth quarter and 2008 full year results include the impact for the AFR acquisition completed April 1st.
Net income to common shareholders was $9.4 million or $0.18 per fully diluted share and $23.2 million or $0.67 per full diluted share in the fourth quarter of 2008 and 2007, respectively.
For the year, net income to common shareholders was $50 million or $1.06 per fully diluted share as compared to net income of $155 million or $5.28 per fully diluted share in 2007. The current quarter reflects $25.4 million of depreciation expense or $0.49 per fully diluted share as compared to $1 million or $0.03 per fully diluted share in the same 2007 quarter.
The year-over-year net income reflects an increase of $66.8 million or $1.41 per fully diluted share of depreciation expense resulting from the AFR acquisition in 2008. The 2007 full year results include a gain of $73.2 million or $2.49 per fully diluted share on the sale of One Madison Avenue.
Rental revenue and expense reimbursement aggregated $105.6 million and $4.1 million for the fourth quarter and $332.4 million and $10.2 million for the years ended 2008 and 2007, respectively.
Operating expenses for the Realty portfolio totaled $43 million during the quarter and $138.5 million for all of 2008. Operating expenses was zero in both prior year periods. The increase in rental revenues and operating expenses in 2008 are directly attributable to the acquisition of AFR in April 2008.
Offsetting these increases was lower investment income of $59.5 million in the fourth quarter versus $79.1 million in the fourth quarter of 2007. For the year, investment income was $254.8 million, a 14.4% decline from the $297.7 million recorded in the prior year. This decline was primarily attributable to lower levels of LIBOR, a shrinking loan portfolio, and higher levels of nonperforming loans.
Interest expense totaled $72.7 million and $49.9 million during the fourth quarters of 2008 and 2007, respectively. This increase reflects the $2.5 billion of additional debt incurred in connection with the AFR transaction, which included $1.3 billion existing mortgage debt at an average rate of 5.68% and $1.25 billion of debt originated in connection with the transaction at an average interest rate of 6.5%.
Management fees totaled $6 million for the quarter as compared to $6.5 million in the fourth quarter of 2007. For the year, management fees was $30.3 million and $22.7 million in 2008 and 2007, respectively. The increased fees are a result of the increased book equity of the Company, offset by a reduction in fees resulting from the restructured management agreement in the third quarter of this year.
During the quarter, we recaptured $2.8 million of incentive fees recognized as expense in the first half of the year as a result of an agreement with our external manger as compared to $2.8 million expense recorded in the fourth quarter of the prior year. Incentive fees for the full year were $2.4 million and $32.2 million in 2008 and 2007, respectively.
In addition to the $2.8 million of cash, the Company also received $1.9 million shares of GKK stock as a result of the agreement. These shares were canceled upon receipt, reducing the common shares outstanding of the Company.
MG&A expense was $5.6 million and $2.5 million for the fourth quarter of 2008 and 2007, respectively. For the year, MG&A expense was $17.6 million as compared to $13.6 million in the prior year. Increased costs for both the quarter and the year reflect the larger asset base resulting from the AFR transaction in addition to increased legal cost incurred in connection with nonperforming loans. During the fourth quarter, these higher costs were partially offset by the reversal of deferred compensation cost associated with the resignation of certain executives.
Provision for loan losses were $47.8 million in the fourth quarter and $97.9 million for 2008 as compared to $2.8 million and $9.4 million in the comparable prior year periods. The additional provision recorded in the fourth quarter brought our reserve for loan losses to $89 million as of the end of 2008 in connection with 13 loans. The increase in the provision reflects the worsening operating performance in the CRE sector and general lack of availability of debt and equity in the capital markets to support sales or refinancing.
Fourth quarter investment activity included the repurchase of $55 million of CRE CDO bonds previously issued by Gramercy, which generated $43.9 million of gains on the early extinguishment of debt as compared to $3.8 million in the prior year quarter.
Full year of 2008 results reflect the repurchase of $127.3 million of GKK CDO bonds generating $77.2 million of gains compared to $3.8 million in the prior year. The repurchased bonds are not retired, but are reflected on Gramercy’s balance sheet as a reduction in the amount of CDO bonds outstanding at quarter-end.
We originated $52.2 million of first mortgage loans and a $5 million mezzanine loan during the quarter.
We ended 2008 with liquidity of approximately $235 million, including $137 million of cash and cash equivalents, and $98 million of restricted cash and or CDOs. During 2009, we have totaled scheduled debt maturities of approximately $76 million, including a single property mortgage of approximately $54 million maturing in July and the remaining $22 million representing principal amortization on existing mortgage debt.
While we remain in compliance with all our debt covenants, including our credit facilities and CDOs, we have engaged financial advisors to assist the Company in restructuring our debt facilities to create further flexibility in dealing with the current economic conditions.
On January 23rd, 2009, the Company entered into a single asset master repurchase facility with JPMorgan Chase Bank. This facility has an 18-month term and LIBOR plus 175 basis point pricing.
On January 30th, 2009, the Company announced that it has exchanged $150 million of its trust preferred securities for $150 million of newly issued unsecured junior subordinated notes. The new notes bear a fixed interest rate of 50 bps per annum for the period commencing January 30, 2009, and ending January 29, 2012, and a fixed interest rate of 7.5% per annum thereafter through maturity on June 30, 2035. The exchange of these notes will reduce our cash requirements by approximately $10.7 million annually during the first three years although we are accruing at an effective rate of 6.65% through maturity in accordance with GAAP.
I will now turn the call over to Tim.
Thanks, John. As the newest member of the Gramercy senior management team, let me take a minute to briefly describe my background. I have worked in the construction and real estate business for the past 30 years. I actually grew up in the equity side of the business in positions where I represented ownership and operated commercial real estate assets of all property types. I spent the last 10 years of my career as a Chief Operating Officer of iStar Financial where I was responsible for asset management and servicing of both the company’s structured finance and lease portfolios.
As Roger indicated earlier, in these challenging times, we are very focused on finding and implementing the most efficient ways to manage Gramercy’s business. During the fourth quarter, we continued to strength our Realty platform. At this point, the integration of AFR is largely complete. The final piece of the integration is the ongoing rationalization of internal processes, which should result in a reduction of our controllable G&A expenses.
As has been stated on prior calls, our objective in Realty has been on unifying what were previously siloed [ph] disciplines into an integrated asset management function. Again, the goal is to create an efficient, inter-disciplinary model that delivers superior service to our tenants. In this past quarter, we reorganized all of the major functions to include leasing, property management, project management, accounting, and lease administration into regional asset management teams. Each region is now run by a senior asset manager. That asset manager is responsible and accountable for everything within his regional portfolio.
On the leasing front, we continue to focus on the 10 largest existing vacancies in our portfolio. These opportunities total approximately 828,000 second quarter in 10 separate properties. We have established detailed plans and engaged top tier brokerage firms, but, as Roger mentioned earlier, we do expect 2009 to be a very challenging year in which to lease space.
We have made considerable progress in lowering property level expenses by instituting a more rigorous budgeting process, aggressively re-bidding contracts, pooling contracts to achieve economies of scale, developing more accurate billing practices, and consistently enforcing lease provisions. Year-over-year controllable operating expenses on a same-store basis – and we define controllable operating expenses as all operating expenses except real estate taxes and utilities – are expected to down over 10% in 2009 from 2007 levels.
Another important initiative is the restructuring of the Dana portfolio lease. As you may know, this is a multi-property portfolio leased to the Banc of America. Here, we are in active discussions with Banc of America about a range of alternatives to rework the existing the agreement for their benefit and ours.
Finally, as roger highlighted earlier, Gramercy dedicated dispositions teams has done a remarkable job in a very difficult sales environment. Markets allowing, we are projecting to continue to be an active seller of properties through 2009.
With that, let me turn it back to Roger for some closing comments.
Thanks, Tim. To summarize, despite the worsening economic conditions, we will continue to focus on preserving liquidity, maximizing flexibility, and aggressively managing our portfolio. Everyone at Gramercy has been working very hard and is committed to working diligently on operating our business as efficiently as possible in the face of an extraordinarily difficult operating environment.
With that, why don’t we open it up for questions? Operator?
(Operator instructions) And your first question comes from the line of David Fick with Stifel Nicolaus. Please proceed.
David Fick – Stifel Nicolaus
Good afternoon. Can you address your investment strategy in terms of buying back the CDO bonds, given your capital needs and your ongoing negotiations with your lenders? Why wouldn’t you be reserving that or retire debt at this point?
Well, let me take that, David. Yes, sure, we – here is how we think about it. I mean, frankly, if you look at where our CDO bonds are trading, and you take into account – despite the fact that the CDO bonds obviously have a long term to them, I mean in some of these instances, depending upon the class of bonds each of the CDOs, you are in effect retiring $5 of debt for $1 of cash. So, from our standpoint, it looks like a really attractive investment. And so we looked at it and said despite the need to preserve liquidity, it makes sense to use some of our precious liquidity in that manner.
David Fick – Stifel Nicolaus
Okay, great, we do get that math and (inaudible) it’s a great investment. I am just wondering in this sort of age of survival – anyhow, can you address – do you know at this point what your taxable income was for ’08 and do you have any thought about your’09 taxable income and a need to make a distribution?
David, we did go through and again a decision to not declare a dividend in 4Q. 4Q is done with the – on the basis that we have already met our 2008 dividend requirements. For 2009, again, there is two parts to that question. One is, we have done projections, but at the same time, as you are probably aware, in connection with the Trust’s restructuring, we have committed to not pay a preferred or common dividend except for as required to maintain our REIT status. That decision will be made later in 2009.
David Fick – Stifel Nicolaus
Okay. In terms of clarifying your 2010 debt maturities, you got $1.1 billion scheduled, but the Goldman Citi Mezzanine is in a key facility or extendable until 2011, isn’t that correct, and if so what would cause them to be final this year?
They are extendable and again we have that right as long as we are not in default. And I believe there may be a small fee associated with it.
David Fick – Stifel Nicolaus
Well, the Goldman – the mezz – the mortgage, the key facility, in addition to the Wachovia facility.
All of which we can extend.
David Fick – Stifel Nicolaus
Okay great. And then two final questions. Can you comment on your position in Stuy Town, where you are in the stack and what options you might have in terms of control and do you have a reserve there?
Yes, sure. As it relates to Stuy Town, I’d rather not get into talking about individual investments on a going forward basis. We are in the mezzanine stack, we are in the M10 and M11 positions in the stack. As it relates to how the asset is performing, the asset obviously, there continues to be a significant amount of reserves that exist in the structure. We – it depends on the projections in terms of where you think reserves will come out, but estimates range from anywhere towards the end of this year to the first quarter of next year in terms of how long the reserves last on Stuy Town.
David Fick – Stifel Nicolaus
Okay. And then lastly, you’ve addressed a lot of your structural issues and what you are doing to staff up and deal with your portfolio. Can you just talk a little bit more about your processes internalization and where you stand in terms of the separation from SL Green?
Sure. As it relates to the internalization, I mean we have largely transitioned each of the – both the services and the people in terms of the functionality of the internalization. We obviously also have negotiated a significant reduction in terms of the fees associated that got paid to the manager. And so from a – both an economic perspective and from a day-to-day function perspective, we have largely completed a significant portion of that transition. As part of our negotiation with the banks, the banks have reasonable approval rights over the internalization and we also have to complete and finalize the negotiations with Green, which obviously involves the independent committees of both parties.
David Fick – Stifel Nicolaus
Any idea on the timing there?
I would like to believe that the timing of completing the internalization will be sometime within the next quarter. Some of that ties into the overall discussions that we have with the banks and how that integrates into the overall discussions with the banks.
David Fick – Stifel Nicolaus
Your next question comes from the line of Omotayo Okusanya with UBS. Please proceed.
Omotayo Okusanya – UBS
Yes, good afternoon, just two questions. In regards to the Dana portfolios is there any more detail you can give about what kind of alternatives you guys are looking at to restructure that so that it’s a win-win both for you and as well as with your bank?
Yes, we are talking with them about a couple of options that would effectively rewrite the lease, to turn the lease into a long term commitment for certain properties in the portfolio and then in exchange for that perhaps selling some of the assets in the portfolio to them.
Omotayo Okusanya – UBS
Okay. That’s helpful. And then the second thing, just in regards to the financial advisors you are working with, of the back of David’s question, I mean maybe you can expand the repo line and as well as the key bank line of credit. Kind of what else you guys imagining you may want to do, when you kind of (inaudible) maturities?
Yes, the – as we pointed out, we are in compliance; we are tight on our covenants as everybody in our sector is. We are in discussions, not necessarily specifically as it relates to extension, although that would be a partial result of the discussions, but also to create additional flexibility as it relates to the covenants and enable us to accelerate some of the restructuring things that we are contemplating.
Omotayo Okusanya – UBS
Okay. That makes sense to me. Alright. Best of luck.
No further questions are there?
And we do have no further questions at this time. I would like to turn the call back over to Mr. Roger Cozzi, Chief Executive Officer of Gramercy Capital Corp.
Alright, well, thank you everyone. We look forward to seeing you next quarter and hopefully we’ll continue to show positive news. Thanks.
Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.
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