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Executives

Andrew Backman - SVP, IR and Marketing

Jay Sugarman - Chairman and CEO

Jim Burns - CFO

Analysts

David Fick - Stifel Nicolaus

Jim Shanahan - Wells Fargo

Ian Goltra - Forward Management

iStar Financial Inc. (SFI) Q4 2009 Earnings Call Transcript February 17, 2010 10:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the iStar Financial’s fourth quarter and fiscal year 2009 earnings conference call. (Operator instructions) As a reminder, today’s conference is being recorded.

At this time for opening remarks and introductions, I would like to turn the conference over to iStar Financial’s Senior Vice President of Investor Relations and Marketing, Mr Andrew Backman. Please go ahead sir.

Andrew Backman

Thank you, John and good morning everyone. Thank you for joining us today to review iStar Financial’s fourth quarter and fiscal year 2009 earnings report. With me today are Jay Sugarman, our Chairman and Chief Executive Officer; and Jim Burns, our Chief Financial Officer. This morning’s call is being webcast on our Web site at istarfinancial.com in the Investor Relations section. There will be a replay of the call beginning at 12:30 pm Eastern Time today. The dial-in for the replay is 1-800-475-6701 with a confirmation code of 145462.

Before I turn the call over to Jay, I would like to remind everyone that statements in this earnings call, which are not historical facts will be forward looking. iStar Financials actual results may differ materially from these forward-looking statements and the risk factors that could cause these differences are detailed in our SEC reports. In addition, as stated more fully in our SEC reports, iStar disclaims any intent or obligations to update these forward-looking statements except as expressly required by law.

Now, I’d like to turn the call over to iStar’s Chairman and CEO, Jay Sugarman. Jay?

Jay Sugarman

Thanks Andy. 2009 was a very difficult year for iStar. Despite a lot of hard work, it seemed like we were climbing an ever-steepening hill. Asset impairment and negative surprises were large, painful and ongoing.

The final quarter provided some positive signs of stabilization and high quality in cash flowing assets. The transitional assets remained out of favor and sellable only at meaningful discounts to normalized value. Market fundamentals continue to be weak in most areas and the macro economy remains fragile though on steadier ground than early last year.

Our fourth quarter and year-end results reflected much of the second (inaudible) backdrop. Fourth quarter earnings were weak with provisions for loan losses driving a large adjusted loss totalling $1.47 per diluted share. And while slightly better than the third quarter, elevated losses have continued as we grind down the portfolio, we tried to work down both the left and right side of the balance sheet. Unfortunately, 2010 will likely be more of the same though we do think we have made progress in 2009 in reducing some of the flash points in the portfolio.

While painful taking out lumps on certain assets and continued pay downs on various performing loans have enabled us to meet our funding obligations through the end of last year and should position us to meet remaining funding obligations and debt maturities through the first half of 2010. In addition, we will continue to explore the sales of the mix of both high quality assets and some lesser quality assets to prepare for future maturities and position the company to approach our banks regarding 2011 maturities.

With respect to credit quality, as pay downs of good assets continue, the remaining asset portfolio will be made up of a higher and higher proportion of (inaudible) loans that will take longer to work out and monetize. As a result, our credit stats continue to look very poor. All we can do is continue to work these problem assets out and re-align the firm’s resources accordingly.

Now, with that brief overview, let me turn it over to Jim. Jim?

Jim Burns

Thanks Jay and good morning everyone. Let me start with our earnings results for the fourth quarter and the full year before moving to credit and liquidity.

For the quarter, we reported an adjusted loss of $142 million or $1.47 per common share. Results this quarter included $216 million of additional loan loss provisions and $65 million of impairments related to OREOs, CTLs and other assets. Partially offsetting these loans were $100 million of gains associated with the retirement of debt at a discount.

Revenues for the fourth quarter were $200 million versus $287 million for the fourth quarter of 2008. The year-over-year decrease is primarily due to a reduction of interest income as a result of an increase in non-performing assets including NPLs and OREOs as well as an overall smaller asset base. Net investment income for the quarter was $192 million versus $432 million for the fourth quarter 2008. The year-over-year decrease is primarily due to a smaller gain associated with the early extinguishment of debt as well as the lower interest income I just mentioned somewhat offset by lower interest expense.

For the full year 2009, we reported an adjusted loss of $689 million or $6.88 per common share. Results for the year included $1.3 billion of loan loss provisions, $141 million of impairments, and $547 million of gains associated with retirement of debt including a one-time gain of $108 million we recorded upon completion of our bond exchange earlier in the year. Given the required accounting treatment, we still have approximately $228 million of unamortized gains associated with this exchange which we will amortize against interest expense over the life of the 2011 and 2014 secured notes.

Net investment income for the year was $911 million versus $966 million last year. Revenues for the year were $893 million versus $1.4 billion for the prior year. Again, the primary drivers of the decrease were the reduction of interest income as a result of an increase in non-performing assets including NPLs and OREOs as well as an overall smaller asset base. At the end of the fourth quarter our leverage, defined as book debt net of unrestricted cash divided by the sum of book equity accumulated depreciation and loan loss reserves, was 2.9 times unchanged from the prior quarter.

During the fourth quarter, we funded a total of $253 million under pre-existing commitments, we received $673 million in gross proceeds from loan repayment and loan sales versus $586 million received last quarter, and we generated $104 million of proceeds from OREO and CTL sales. Based on principal repayments and assets sales associated with the Fremont portfolio during the quarter, the A-participation interest was reduced by $200 million to $473 million at the end of the fourth quarter. As you know, 17% of all proceeds from principal repayments and asset sales associated with the Fremont portfolio go to reduce the A-participation until it is paid off. After that, iStar will retain a 100% of all proceeds received.

Our remaining unfunded commitments for the total portfolio were $840 million at the end of the fourth quarter of which we expect to fund approximately $540 million, $198 million of our unfunded commitments relate to Fremont portfolio of which we expect to fund about $71 million.

Let me turn to the portfolio and credit quality. At the end of the fourth quarter, our total portfolio on a managed asset basis was $14.5 billion. As a reminder, when we talk about managed bases, we mean iStar’s carrying value of loans, gross of specific reserves and the A-participation interest outstanding on Fremont portfolio assets. Our total portfolio was comprised of $9.6 billion of loans and other lending investments, $3.5 billion of corporate tenant lease assets, $839 million of other real estate owned, $426 million of real estate held for investment, as well as $192 million of other investments. 84% of our portfolio is comprised of first mortgages, senior loans, and corporate tenant lease assets.

The loan portfolio had an average loan to value of 85%, and on a managed basis, this comprised of $7 billion of iStar loans and lending investments, and $2.6 billion of Fremont loans. The average loan to value for all performing loans was 76% at the end of the quarter. Our total condo loan exposure was $3.5 billion versus $4.2 billion last quarter. Completed condo construction loans represented $2 billion, in progress condo construction loans represented $1.2 billion, and condo conversion loans were approximately $300 million. Our total land loan portfolio was approximately $1.9 billion at the end of the quarter, down slightly from $2.2 billion at the end of last quarter due to a number of loans being moved to our OREO and real estate held for investment portfolios.

At the end of the fourth quarter, 81 assets representing $4.2 billion or 45% of managed loan value were NPL. This compares to 85 assets representing $4.4 billion or 42% of managed loan value last quarter. At the end of the quarter, 22 assets representing approximately $700 million of managed asset value were in foreclosure. Our NPLs continue to be primarily land and condo related assets. Land assets represent 30% of our NPLs, new condo construction assets make up 28%, and condo conversions make up 2%. On the performing loan watch list at the end of the quarter were 14 assets representing $718 million or 8% of managed loan value. This compares to 26 assets representing $1.2 billion or 11% of managed loan value last quarter.

Let me turn to OREOs and real estate held for investment. During the quarter, we took title to 12 properties, which had an aggregate gross loan value of $675 million prior to foreclosure, resulting in $211 million of charge-offs against our loan loss reserves. We received net proceeds of $98 million associated with the sale of OREO assets and recorded $42 million of additional impairments on the OREO portfolio, At the end of the quarter, our OREO and real estate held for investment assets totalled $1.3 billion. Of these assets, $839 million were classified as OREO considered held for sale based on our current intention to market the assets and sell them in the near term. The remaining $423 million, the largest component of which is land, are considered investment properties and are classified as real estate held for investment based on our current intention and our ability to hold them for longer period of time.

Let me move on to reserves and impairments. During the fourth quarter, we took $216 million of additional provisions versus $346 million of provisions in the third quarter and $435 million in the second quarter. While we have seen provisions trend lower over the past couple of quarters, the rate at which they continue to do so is uncertain. At the end of the quarter, our reserves totalled $1.4 billion consisting of $1.2 billion of asset specific reserves and $175 million of general reserves. Our reserves represent 15% of total managed loans and 29% of total non-performing loans and watch list assets combined.

Okay, let me review our covenants. First we continued the incompliance with all of our bank and bond covenants and our intent is to continue to take the appropriate actions to maintain compliance with all of our covenants going forward. For our secured bank credit facilities, our tangible network was approximately $1.7 billion at the end of the fourth quarter above our $1.5 billion requirement. Our fixed charge coverage calculated on a trailing 12-month basis was 2.4 times at quarter end, which is above the one-time requirement and our unencumbered assets on secured debt or UAUD ratio was 1.4 times at quarter end exceeding our 1.2 times requirement. For both our unsecured and secured bonds, our fixed charge coverage ratio was 2.3 times and our UAUD ratio was 1.4 times. As a reminder, the fixed charge coverage ratio covenant requirement is 1.5 times and the UAUD maintenance requirement is 1.2 times.

Now, let us move to liquidity. We ended the year with $225 million of unrestricted cash. Since the end of December, we completed several asset sales as well as had some assets repaid including the highly publicized rate loan where we received approximately $199 million or 95% of the par value of the loan. Cash available at year end as well as the proceeds from recent asset sales and repayments will be used to pay our approximately $300 million of March and April bond maturities and help offset our other full-year 2010 obligations, which include $430 million of unfunded commitments of which we expect to fund approximately $300 million by the end of June, and $250 million of December bond maturities. In addition as outlined in our public filings, if we do not pay down our first-lien [ph] facility by $500 million in September, then any proceeds from principal repayments or asset sales associated with the collateral securing that facility will be applied to pay down that facility by up to $500 million.

As we have said in the past, we will continue to work to meet our funding obligations utilizing a combination of cash, credit facilities and asset sales. With that, let me turn it back to Jay. Jay?

Jay Sugarman

Thanks Jim. Lastly I hope 2009 would be a transition year setting us back on course. That did not happen as some borrowers we believe would work aggressively to recover value and protect our position, instead threw in the towel, walked away from their investment or worse actively blocked and impeded our value to recover proceeds due to iStar. It will now be up to us in many cases to find a way to extract value from these assets, and we hope to be able to shore many of these assets and put them back on solid ground.

The bigger question is how do we get iStar back on solid footing. And given sufficient time, we believe we can create significant value for shareholders from the existing portfolio. Gaining time and creating a long enough runway to be able to maximize asset values will continue to be our key focus in 2010. But execution on the left side of the balance sheet will be very sensitive to execution on the right side of the balance sheet. On the right side, we need to work down our leverage, protect book value, stay within convent guidelines, and find ways to meet debt maturities and funding commitments. This is the same fine line we have been walking for sometime now. We expect to continue to have little margin available [ph] in our execution. However with funding commitments mostly coming to an end over the next 12 months, our main focus can now be on meeting our future debt maturity. We will obviously keep you updated throughout the year on how we plan to do that.

With that, let us go ahead and open it up for questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We will go to Joshua Barber with Stifel Nicolaus. Please go ahead.

David Fick - Stifel Nicolaus

Hi this is Dave Fick for Joshua Barber. Two quick questions, the loan sales in the quarter of $129 million, what percentage of par, original par were those sales done on average?

Jim Burns

Move on David. David, what is your second question?

David Fick - Stifel Nicolaus

Your 8-K filing last week, you indicated that you had offers to sell roughly 40% of your CTL portfolio, first of all is this the one collateralizing the capital loan and what kind of cap rate indicators you are seeing and what sort of what is your strategy around selling those loans, I am sorry the CTL assets considering they are some of your more stable assets in the portfolio?

Jim Burns

We have been over the last two years looking for opportunities to monetize the assets. We do believe the market for strong stable assets is actually quite attractive right now given the dearth of very long life and very stable cash flow assets that are actually available in the marketplace, lot of capital out there that we think needs to find a home given the low treasury interest rate environment it finds itself in, and we think the sales leaseback product is one of the more attractive ones out there and for those who do not want to take near term macro economic or real estate risk. It is not to say we are going to do anything there David. Our view right now is, we are exploring the opportunity as a result of a number of inbound calls. We do think that values could approach levels that would be attractive to us, but we will obviously know that relatively soon and make a decision going forward.

David Fick - Stifel Nicolaus

Can you say anything about what kinds of yields you are seeing in that marketplace?

Jim Burns

Yes, I think the last two trades that have gone down on a sale leaseback basis that we monitor very closely, the best was about 7.5 cap on a suburban Princeton office building leased to a large pharma company. 7.5 cap is probably close to or just behind where that would have traded probably two or three years ago. We have seen some industrial stuff trade in the high 7, and we have seen some second-tier properties trading in the low 8. So, we think there is a strong bid for assets that, at least in the near term, people are not having to guess where the economy is going or where the real estate market is going. We think really high caliber assets like some of the ones in our portfolio should be attractively priced at both of the benchmarks.

David Fick - Stifel Nicolaus

These sales would not affect if they occur your changeable net worth calculation but they would affect your liquidity obviously and I am sure that is behind your call here.

Jim Burns

To the extent they are game, they would impact tangible network.

David Fick - Stifel Nicolaus

Okay, thanks.

Jim Burns

David, just getting back to you on your first question, the loan assets that we sold in the first quarter, I am sorry in the fourth quarter, we realized just a hair under 90% recovery on those assets.

David Fick - Stifel Nicolaus

Well, that is very strong. Okay, great, thank you.

Jim Burns

Thanks David. Next question John?

Operator

(Operator instructions) We will go to the line of Jim Shanahan with Wells Fargo. Please go ahead.

Jim Shanahan - Wells Fargo

This is Jim Shanahan. Good morning, everyone. The question that I have is the company has continued to obviously to see opportunities that require outstanding debt and retire the debt for gains. However I am guessing here that the largest gain potential is not likely to be with the near term maturities, it is just to make sure, I wanted to verify, is any of the debt that was retired in the fourth quarter, is any of that the March or April maturities that we have been discussing?

Jim Burns

Yes, as I mentioned in my talk, our March and April debt maturities now are down to about $300 million. So, we did repurchase some of those in the fourth quarter.

Jim Shanahan - Wells Fargo

(inaudible) in this has commented two other earnings conference calls going on, so regarding the other liquidity, did you provide an update Jim of the liquidity position today and the outlook for the repayment of those debt maturities as scheduled?

Jim Burns

No, we talked about where we were at the end of the quarter. We have had some repayments and some asset sales thus far already this year and that included we did get back almost $200 million on our great position which got a fair amount of publicity. So, we now have the $300 million of March and April that we expect to repay in March and April. We think in the first half of the year, we have got about $300 million of unfunded commitments that we need to meet, and then in the second half of the year, probably another $130 million of unfunded commitments mostly related to construction loans. Our December 2010, unsecured bond which we had also being buying back a little bit back of is now down to $250 million. And in September of this year, as part of our first-lien bank line credit facility, if we do not make a $500 payment, it is not a mandatory repayment but if we do not pay it down by $500 million repayments of principal in any asset sales of the collateral that is in that pool goes to pay down the banks until they receive the $500 million pay down there. So that is kind of where we are.

Jim Shanahan - Wells Fargo

Thank you for that review.

Jim Burns

Thanks Jim. John?

Operator

I think we have time for one more question that will be from the line of Ian Goltra with Forward Management. Please go ahead.

Ian Goltra - Forward Management

Good morning Jay. Of the $4.2 billion of NPLs currently, how many of those are maturity defaults or what dollar amount of maturity defaults versus non-payment of P&I [ph] is occurring?

Jim Burns

You know, I do not have the exact amount but it is mostly maturity defaults. We have got three buckets, we have got maturity defaults, we have things being delinquent by 90 days, interest being delinquent from 90 days, and then we also have assets where we think the borrowers no longer making an effort to repay the loan and it is a vast, vast majority of those assets that are NPL are maturity defaults.

Ian Goltra - Forward Management

In which case you are receiving P&I on an ongoing basis?

Jim Burns

In most cases in the maturity defaults, we are not receiving interests either. Some cases, it will go NPL before maturity if someone stops paying interest but no, for the cases if there is a maturity default, not always but in most cases there is no more interest to be paid either.

Jay Sugarman

I want to be careful there. I think most of the NPLs are impaired assets, they are not simply passage of time issues. It is actually a credit issue.

Ian Goltra - Forward Management

Okay. And then lastly the reserve at roughly $0.33 on a dollar relative to the NPLs, are you guys using fairly draconian assumptions at this point or can you talk to a minute about sort of your qualitative assessment of loans and the risk ratings and where you are with – I assume there is varying shades of grey here relative to those NPLs, and just kind of where you are in terms of draconian versus say fair value assumptions?

Jay Sugarman

Yes, we are spending a lot of time on that, Ian. I guess, the number that gets tossed out in the world is 40% decline in value as the baseline. In our experience, I would break that down for you and tell you for high quality, strong, stable, cash flowing assets, it is probably 0 to maybe as much as 20%. If it is high quality but the cash flows are somewhat transitional or second-tier assets with somewhat stable cash flows, I would say you probably lost 20% to 40% of value. If it is high quality and it has got no cash flow or negative cash flow, particularly in the hospitality area, or you have got second-tier assets with cash flows and transitions, you are probably down 40%, 50% even 60%. And then if you are second-tier assets really with negative or no cash flow, you can be down as much as 60% to 80%.

So I think the 40% base line is an interesting number but as we look through the portfolio and try to assess real value diminution, a lot of it comes down to an assessment of where it is in that sort of cycle of cash flows and qualitative issues with respect to the real estate. We think the 33% number while interesting, hard to generalize from each individual asset, could be from very little reserves to very, very, very significant reserves. The average just happens to be kind of in the 33% range, which if you think values on average have fallen 40% and we were at kind of 65% or 70% of initial value feels adequate, but I will tell you there are probably about 50 high data assets in the portfolio. We guess it is very difficult to make an assessment of the outcome. It is almost binary. So we are making judgment calls on how things are going to fall out and again I think we have gone several steps beneath the surface to try to analyze exactly what we think outcomes will be, severities will be, and see the end result but I would caution you that it is a very granular approach.

Ian Goltra - Forward Management

In a dollar value sense, those significant assets represent what percent of the total NPLs?

Jay Sugarman

Not just NPLs it is --

Ian Goltra - Forward Management

Across the board.

Jay Sugarman

It is 10% of the total number of assets, it is more than that on the dollar amount.

Ian Goltra - Forward Management

Okay.

Jay Sugarman

We think fundamentally, we have to break it down for you, we look at value and say if a borrower paid more than the replacement cost in the last three years, that money is lost and never coming back. It is pretty easy to assess those. I think where replacement costs have changed, the borrower paid replacement costs, we lent against then current replacement costs, we think those numbers are down 10% to 20%. Most cases, we are probably fine. Borrowers probably lost the money but we are probably fine. I think the loss of leverage on some of these deals is impacting value. We think time may heal some of that but it clearly will not heal all of it. And then we think fundamentals have weakened. There has simply been a flat out reduction in cash flow particularly in hospitality, retail, and even for multi-family but we think that is something that actually will come back as the economy comes back. So, we look at those factors and we try to decide where is value been permanently diminished versus where things that with the passage of time may be recovered and that is how we are trying to assess both severities and the timeframe in which we will recover our basics.

Ian Goltra - Forward Management

Then lastly, shifting gears, you had a small impairment of $22 million against the CTL portfolio, do you think it is a particular event or is it just market conditions? Can you articulate what is it that caused that?

Jay Sugarman

Yes, we had a transaction we thought was going to close last year on a parcel of land in California. The zoning did not happen and so there is more work to be done there before that value can be realized. Based on GAAP, we had to take that impairment.

Ian Goltra - Forward Management

Thank you.

Operator

I will turn it back to you, Mr Backman.

Andrew Backman

Great. Thank you John. Thank you Jay, Jim and everybody for joining us this morning. As always, if you have any additional questions on today’s earnings release, please feel free to contact me directly here in New York.

John, would you go ahead and give the conference call replay instructions once again, thank you.

Operator

Certainly. Ladies and gentlemen, this replay will end March 5 at midnight. You can access the replay at anytime by dialing 800-475-6701 and entering the access code 145462. The number again, 800-475-6701 and entering the access code 145462. That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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