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RAIT Financial Trust (NYSE:RAS)

Q1 2009 Earnings Call Transcript

May 6, 2009 10:00 am ET

Executives

Andres Viroslav – VP and Director of Corporate Communications

Scott Schaeffer – CEO

Jack Salmon – CFO and Treasurer

Raphael Licht – COO and Secretary

Analysts

Gabe Poggi – FBR

David Fick – Stifel Nicolaus

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2009 RAIT Financial Trust earnings conference call. My name is Francine and I will be your coordinator for today. At this time all participants are in a listen only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions) As a remainder, this conference is being recorded for replay purposes.

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. Please proceed, sir.

Andres Viroslav

Thank you, Francine and good morning to everyone. Thank you for joining us today to review RAIT Financial Trust’s first quarter 2009 financial results. On the call with me today are Scott Schaffer, Chief Executive Officer; 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 via webcast on our website and telephonically beginning at approximately 1:00 p.m. Eastern Time today. The dial-in for the replay is 888-286-8010 with a confirmation code of 51124748.

Before I turn the call over to Scott, 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 to 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, 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 the call over to RAIT’s Chief Executive Officer, Scott Schaeffer. Scott?

Scott Schaeffer

Thank you very much, Andres, and thank all of you for being with us this morning as we present RAIT's first quarter 2009 results. After some brief remarks, I will ask Jack to deliver his financial report, after which we will open the call up for questions.

The negative credit cycle continued during the first quarter and although we believe a market recovery will prevail, underlying fundamentals have yet to improve. Asset values generally remain under stress and refinancing opportunities are scarce. We remain focused on preserving the level of cash flow generated by our portfolios and maximizing the ultimate recovery value of our assets over time.

I’d like to highlight the following results. First is earnings. Our portfolio generated adjusted earnings of $0.27 per share for the quarter although we incurred a $2.22 per share GAAP loss. This loss was caused primarily by mark-to-market valuations adjustments in our Trust preferred securities portfolio and continued additions to our provision for losses associated with our commercial real estate and residential mortgage portfolios. The losses were reduced by gains realized due to the extinguishment of outstanding debt at considerable discount.

Second is cash flow. During the quarter, our portfolios generated gross cash flow of $30.5 million as compared to $38.5 million for the first quarter of 2008. The majority of the gross cash flow of approximately $24 million or 78% came from our commercial real estate portfolio and senior management fees we earned from assets under management. As previously communicated, the primary cause of the diminishing in gross cash flow occurred subsequent to December 31st, 2008, when our consolidated securitization, Taberna VIII and Taberna IX failed their respective over collateralization test.

However, we continued to generate free cash flow and comply with the over collateralization and interest coverage test in both of our commercial real estate securitization, such that all debt and residual equity interest in those transactions continued to receive monthly distribution. Our portfolios, including our residential mortgage portfolio, domestic TruPS portfolio, and European portfolio, excluding senior management fees, generated approximately $6.7 million or 22% of gross cash flow.

Third is dividend. As announced in today’s release and primarily driven by our interest in optimizing our corporate flexibility, the Board and management decided to review and determine the common dividend, if any, when the full year or REIT taxable income is available. The Board and management, all of whom are investors in RAIT, took this action in light of the uncertainty in estimating annual financial results on a quarterly basis caused by the market conditions and credit environment. The Board will continue its review and determination of the preferred dividends on a quarterly basis.

As a reminder, to qualify as a REIT we are required to make distributions to preferred and common shareholders an amount at least equal to 90% of our annual REIT taxable income. Ongoing market conditions on our portfolios will impact these decisions as we continue to manage our business towards a market recovery.

Fourth is credit. During the quarter, the market environment continued to impact the credit performance of our portfolios. We took non-cash mark-to-market valuation adjustments on our Trust preferred securities portfolio and continued the provisioning for potential losses in our commercial real estate and residential portfolios.

In order to maximize recovery of asset value over the long term we chose to convert 11 commercial real estate loans into owned properties during the first quarter. Subsequent to quarter-end, we completed the conversion of an additional seven loans. Depending on market conditions, this tactic may continue for the remainder of 2009. As always, we continue to explore all options including assets sales, repositioning and other alternatives in order to maximize cash flow and recovery value.

And finally, liquidity. We continue to generate positive free cash flow. We ended the quarter with $41 million of cash and $32 million of recourse bank debt that is scheduled to mature in 2009. We are in active discussions with these lenders to extend our current relationships. Anticipating an expected decline in our gross cash flow as previously communicated, we implemented cost saving initiatives, which have reduced both general and administrative cost as well as compensation expense by 15% as compared to the three months ended December 31st, 2008.

We continue to focus on ways to reduce overhead. Our operating cash flow appears adequate to sustain our operations and provide funds for the repurchase of our debt as appropriate. We continue to believe that retiring debt at a significant discount is a viable use of available corporate cash. During the quarter we purchased $39.5 million of our debt and realized $35.2 million in gains during the quarter. We will continue to consider similar types of purchases in the future to the extent that we have free available cash flow.

And with that overview, I would like to turn the call over to Jack to go through the first quarter 2009 financial results. Jack?

Jack Salmon

Thank you, Scott. I am going to present the financial aspects for the first quarter and during my comments I will focus on three things. First of all, explain the significant variations in our reported results this quarter. Secondly, describing the impacts of the credit changes that have occurred [ph] and those that impact our earnings and cash flows. And third, summarizing the key variables that affect our estimated 2009 REIT taxable income based on events that have occurred during the first quarter.

In reviewing our first quarter financial highlights, I will first focus on balance sheet variations. The total assets decreased by approximately $350 million during the quarter due to the following reasons. During the first quarter, we converted $195 million of loans, including $81 million of previously nonperforming loans, into investments in real estate, and recorded adjustments to the carrying basis of these investments of $48.2 million. These were recorded against the previously known allowances for loan losses. The net assets transferred reduced our previous CRE loan portfolio and correspondingly increased our investments in real estate to a total of $511 million.

Second, we had a $108 million reduction in the residential mortgage portfolio due to scheduled normal prepayments. And associated with this is a $94 million reduction in the mass funded related mortgage backed securities debt.

Third, we had a $191 million decrease caused by the mark-to-market adjustments to the Trust portfolio, particularly offset by a $91 million change in fair value of the related debt, nonrecourse debt and hedges.

And finally, we increased the provision for loan losses by $119 million, including $61 million in our commercial real estate portfolio and $58 million in our residential mortgage portfolio, which I will comment on further in a few minutes. As a result of this, cash and cash equivalents increased $27 million to $41 million by March 31st, 2009.

Our recourse debt obligations decreased by $19 million during the quarter as result of principal amortization and debt repurchases. We generated $35.2 million of gains and debt extinguishments in a series of transactions at a cash cost of approximately $4.6 million. This represents an average cost of 12% of the related par amount of debt.

Total liabilities decreased by $200 million and total equity, which now includes our non-controlling interest, decreased by $150 million compared with the year-end 2008.

I would like to take a moment to note that we adopted or applied various new accounting principles during the quarter, including FAS 141R, FAS 160, and FSP No. APB 14-1. These accounting standards require the application of these principles in our previously issued financial statements. Accordingly, you will note in the press release we are presenting all of our historical comparative financial information on an “as revised” basis.

FAS 141R requires treating the loans that were converted into real estate as if they were acquisitions of a business, therefore applying them at fair value.

FAS 160 results in us reclassifying amounts previously reported as minority interest as a separate component within the equity section now known as non-controlling interest.

FSP 14-1 required us to separate the intrinsic equity value of the convertible debt instruments issued in 2007 as bifurcated debt and equity components and to treat the resulting debt discount that was computed as a charge to interest expense up until and through the first option put date of April, 2012. The reported balance of the debt outstanding is shown net of this discount for all periods.

Turning to our operations, major variations included the following. Our investment interest income was $151 million, representing approximately an 18% decrease from the $185 million in the comparable quarter in 2008. This is due primarily to loans that have gone on a non-accrual basis during that intervening year. Total revenue of $61 million includes net interest margin of $48 million, a decrease of approximately 10% compared to the comparable quarter in the prior year plus rental income of $10 million and fee income of $3 million.

Now, our rental income is increasing as we take on more owned real estate. However, our fee income has declined due to the curtailment of subordinated management fees from our CDOs under the current credit conditions and reduced loan production.

During the first quarter, we increased the provision for loan losses by $119 million. This is a result of general declines in the U.S. economy and the related credit environment impacting the two portfolios upon which we book loan reserves, the CRE portfolio and the residential portfolio during the first quarter. We charged off $65 million of loans against our allowance for loan loss reserves, resulting in a net increase of $54 million in reserves and a total allowance for loan losses on the two portfolios of $226 million at March 31st, 2009.

During the quarter, we designated two investments for disposition, which are reported as discontinued operations. Now, after the recording the gains on the extinguishment of debt and the fair value mark-to-market adjustments I described, both of which have no effect on cash flow, we are reporting the net loss of $144.2 million or $2.22 loss per common share.

I would now like to comment more (inaudible) on credit performance during the quarter in our four primary portfolios. First and foremost, our CRE portfolio. We own $2.3 billion of CRE loans and direct real estate investments at March 31st, 2009. There is a $177 million of nonperforming loans that are on a nonaccrual basis. This represents 35 loans and approximately 7.6% of the portfolio. Against this, we have $126 million of loan loss reserves recorded at March 31st, 2009.

It is important to note that our delinquencies decreased in the CRE portfolio during the quarter from $206 million at year-end 12/31/08 to $158 million at March 31st, ’09. This reflects the changes we have been making in improving our performance.

Through April, 2009, both of our CRE CDOs are meeting all required interest coverage and over collateralization tests necessary for normal monthly distribution of cash flows. We received $20.3 million of gross cash flow overall during the quarter related to all of CRE investments in the portfolio.

Second portfolio is our residential portfolio. We own a $3.5 billion securitized portfolio of residential loans. Approximately 11% of the loans are now reporting as delinquent. This is up from 8.4% at year-end 12/31/08. This represents $387 million of total loans balance outstanding. Delinquencies have increased by 27% during the quarter leading to a net increase in loan loss reserve of $45 million on this portfolio. We recorded approximately $100 million of related loan loss reserves on this portfolio as of the end of the quarter. And virtually all of the cash flow, approximately $4.5 million during the quarter, is being used to repay existing indebtedness.

Third portfolio is our European portfolio. We own a minority interest in two European CDOs, which we manage and do not consolidate. There are currently seven defaulted issuers, which results in our returns being limited in the quarter to $500,000 of yield and $1.2 million of management fees, both senior and subordinated, during the first quarter.

The fourth portfolio is our Trust portfolio. We own a portfolio of subordinate debt and other investment securities that are carried under a fair value method of $1.8 billion at March 31st, 2009. Defaults are increasing compared to 2008 in all of the Taberna securitizations. This now causes all of the quarterly interest collections to be redirected to pay down senior debt positions versus paying us in our residual interest. We do, however, continue to receive our senior management fees. As previously reported, the expected deterioration has resulted in the redirection of cash flow in Taberna VIII and IX as well during the quarter.

During the quarter we received quarterly senior management fees of $2.7 million and approximately $1.1 million of investment returns for a total of $3.8 million in gross cash flow through March 31st, 2009.

The next topic I would like to cover briefly is our liquidity capital resources. As Scott said, during the quarter we generated gross cash flow of approximately $30.5 million from operations and in addition approximately $23 million from our investment activities. After meeting our cash operating expenses of approximately $19.6 million we used $17 million to repurchase or pay down and repay existing debt. We paid preferred dividends of $3.4 million and we increased our available cash by $13.5 million. We ended the quarter with $41 million of immediately available liquidity.

The last topic I would like to cover is our REIT taxable income and the key determinants that we are looking at in making those estimates. As a REIT, we are required to make distributions of at least of 90% of our annual REIT taxable income. Many factors affect the determination of REIT taxable income, both in terms of timing of recognition, and estimates of the certain income and expense items. Now, given the volatility of the markets in which we operate it is likely that taxable income will be different from financial reporting under GAAP.

The tax laws also provide certain elective methods, which determine the nature, such as capital versus ordinary treatment, and the timing such as the current year or deferred to future years of both income and deductible items. For example, during the first quarter, we charged off $65 million of loans that will result in ordinary tax deductions in 2009. We have triggered certain debt extinguishment gains that may deferred for several year before they are elected to be recognized in REIT taxable income.

As a result, we are reporting estimated REIT taxable losses for the quarter of over $30 million. There can be no assurance that this estimated REIT taxable loss will be typical results [ph] for the future quarters or for the year as a whole. Therefore, we will monitor events throughout the year and continue to refine our estimate of REIT taxable income after these future events occur. Future distributions to preferred and common shareholders are dependant upon the results of this analysis and will be determined at such time.

To summarize, I think that we are working towards renewing our existing credit facilities and seeking to extend and expand our capital resources. We are continuing to reposition our CRE portfolios that will result in the following changes – transforming certain loans into owned real estate to re-energize our returns, refinancing loans with near term maturities to generate fees and positive spread yields, and enhancing and protecting our existing core CRE portfolio returns to produce recurring cash flow.

This completes the financial report and I would like to return the call back to Scott.

Scott Schaeffer

Thank you, Jack. Francine, I think at this point we’d like to open the call up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Gabe Poggi – FBR. Please proceed.

Gabe Poggi – FBR

Good morning, guys, how are you doing?

Scott Schaeffer

Good morning, Gabe.

Jack Salmon

Good morning, Gabe.

Gabe Poggi – FBR

I don’t know if you mentioned this, Scott, and if you did I am sorry, did you guys provide a maturity recourse debt maturity schedule updated for ’09, ‘10, ’11? I think you had said $33 million due this year. I was wondering to see if that had changed at all because you guys said you paid down $17 million, so – then you got $16 million left in ’09.

Scott Schaeffer

What we – the $17 million, Gabe, represents both normally scheduled maturities and also purchases. So –

Gabe Poggi – FBR

Got you, okay.

Scott Schaeffer

Things that were not scheduled to paid yet in 2009.

Gabe Poggi – FBR

So, what’s the ’09 current, what left?

Scott Schaeffer

It is – it’s relatively small, Gabe, it’s $32 million of bank lines that are maturing this year.

Gabe Poggi – FBR

Got you.

Scott Schaeffer

Working with them, in active discussions regarding extension. We don’t have any news to report at this time.

Gabe Poggi – FBR

Okay. And that kind of leads to my next question is how have things kind of picked up – discussions in that regard and the market has had a left yet, but just from a fundamental basis, have you guys seen any change in anything 03/31 and now you said that you are in compliance in your CDO tests, but has there been any – anything from a fundamental on the ground difference with discussions as things gotten more positive? Are there more – the new word is green shoots [ph], et cetera, have you seen anything like that?

Scott Schaeffer

I am sorry, I am laughing at the green shoots –

Gabe Poggi – FBR

Oh well, I laugh at it all the time and that’s – it’s ridiculous.

Scott Schaeffer

Not much has changed since 03/31 as far as how that portfolio is performing. It’s kind of what we’ve experienced prior to 03/31, so things aren’t getting appreciably better, they are not getting appreciably worse either. One good thing is that these bank lenders are actively discussing extensions with us rather than a year ago they would have just –

Gabe Poggi – FBR

Right, okay.

Scott Schaeffer

So, we are hopeful that we are headed in the right direction.

Gabe Poggi – FBR

Okay. Thanks a lot guys.

Scott Schaeffer

Sure.

Operator

Our next question comes from the line of David Fick of Stifel Nicolaus. Please proceed.

David Fick – Stifel Nicolaus

Good morning.

Scott Schaeffer

Good morning, David.

Jack Salmon

Good morning, David.

David Fick – Stifel Nicolaus

You’ve got about $0.5 million in REO, little over $0.5 million, it was up about 135 this quarter. It may be the least of your problems right now, but can you just kind of review where you are with that and in specific the $22 million of land, how much have you written it down, and what kind of reserves do you have against this?

Jack Salmon

Yes, just to be clear, David, I think what you are referring to is our – in the earnings release we have at March 31st, the nonperforming loans are $177 million on our commercial portfolio and the – I think the other number you are referring to must be the residential loans are $315 million.

David Fick – Stifel Nicolaus

I am looking at the REO line item, which went up $135 million.

Jack Salmon

$500 million

David Fick – Stifel Nicolaus

510–

Scott Schaeffer

Well, first of all, David, it’s not – it is real estate owned, it’s not all the – all properties that have been converted from loans into owned real estate. Some of it was direct real estate purchases. We have and we continue to make a determination on each loan whether or not it’s appropriate to sell the assets when it gets into trouble. And as you know, as loan assets get into trouble for a number of reasons, it’s not always performance, some times it’s borrower related. And we make the determination whether it’s better to take the property back and hold it rather than just sell it immediately. And that’s what you are seeing is the increase quarter-over-quarter is relative to situations where we’ve made the determination that we would – the Company will realize a higher return not selling the asset today, but taking it back, holding it through this period, and selling it at some point in the future.

David Fick – Stifel Nicolaus

Okay, great. We’ve been watching a bunch of transactions covering the equity REITS and watching the other TruPS issuers, folks like Cap Trust, Gramercy, Newcastle, where you guys have been involved in restructuring your TruPS and you are taking very low current cash run rate going forward. Are these in deals where you already are not cash flowing so there is now additional reserves or disclosure and what it’s – how are they impacting your OC and IC triggers I guess is the bottom line.

Raphael Licht

This is Raphael Licht. Without commenting on any specific transaction, as Jack reported, the CDO performance is what it is. The OC tests were they have been triggered, we are not receiving residual cash flows. And individual exchange transactions or revisions of terms have not had an impact on that today.

David Fick – Stifel Nicolaus

Okay. Can you discuss what your motivation in general is without being specific from making these kinds of deals assuming you have either no equity or no cash flow in them at this point?

Raphael Licht

Yes, we are the collateral manager engaged as the investment advisor to represent the best interest of all noteholders in all of our CDOs.

David Fick – Stifel Nicolaus

Have you done them in other sectors beyond what I might see in the equity REIT or commercial finance REIT space?

Raphael Licht

Yes, we have.

David Fick – Stifel Nicolaus

How many in total would you say you’ve restructured.

Raphael Licht

I don’t have the exact number, but I can get it for you after the call.

David Fick – Stifel Nicolaus

Okay, thanks. And then lastly, the effective cash flows in either of the two remaining cash flowing – are there any in any of the two remaining cash flowing CDOs?

Raphael Licht

No, we – as I mentioned, all of our commercial real estate securitizations are fully complying and all cash flow levels are being distributed on a monthly basis. We are earning our management fees and our equity – we are the equity in those transactions or getting our full equity returns.

David Fick – Stifel Nicolaus

I am sorry, I am sure it’s me, I am just confused. But you do have non cash flowing CDOs at this point, which had failed their tests, and –

Raphael Licht

What?

David Fick – Stifel Nicolaus

I believe there is eight of them. And I am just wondering are all of these TruPS exposures in those or are they – or there are also some in the remaining two cash flowing CDOs.

Raphael Licht

All of the Taberna CDOs are now in a position where they are redirecting the cash flow to pay the senior level debt. So all the Taberna transactions are – we are basically now receiving just a senior management fees –

David Fick – Stifel Nicolaus

Okay, (inaudible) clarify this. Thank you.

Raphael Licht

Our two commercial real estate, they are purely commercial real estate assets and no securitizations.

David Fick – Stifel Nicolaus

Right, okay.

Raphael Licht

And they are performing.

David Fick – Stifel Nicolaus

Alright. Thanks a lot guys.

Scott Schaeffer

Thank you, David.

Jack Salmon

Thanks, David.

Operator

Ladies and gentlemen, that concludes the question-and-answer portion of the presentation. I would now like to turn the call back over to Mr. Scott Schaeffer.

Scott Schaeffer

Well, thank you for joining us today. As always, if you have any continuing questions, feel free to call Andres Viroslav, and we look forward to joining and presenting to you three months in the future, our next quarter. Thanks again.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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