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Executives

Andrew Backman - SVP of IR and Marketing

Jay Sugerman - Chairman and CEO

David DiStaso - CAO

Analysts

Don Fandetti - Citigroup

Michael Kim - CRT

James Shanahan - Wells Fargo

Joshua Barber - Stifel Nicolaus

iStar Financial Inc. (SFI) Q2 2010 Earnings Call August 3, 2010 10:00 AM ET

Operator

Good day and welcome to iStar Financial Second Quarter 2010 Earnings Conference Call. (Operator Instructions), as a reminder today's conference is being recorded. At this time for opening remarks and introductions, I would now 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 Rochelle and good morning everyone. Thank you for joining us today to review, iStar Financial's Second Quarter 2010 earnings report. With me today are Jay Sugerman, Chairman and Chief Executive Officer; and David DiStaso our Chief Accounting Officer.

This morning’s call is being webcast on our website 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 164196.

Before I turn the call over to Jay, I would like to remind everyone that statements in this earnings call, which are not historical fact's, will be forward-looking. iStar Financial's 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 obligation 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, our second quarter was another one of hard work and steady progress on a number of fronts, offset by a less than robust macro economy challenging asset workouts and a continued need to realign asset and liability maturities more appropriately.

We made good progress in our ongoing efforts to create a stronger balance sheet and a more flexible operating profile, with the closing of a $1.35 billion sale of a diversified portfolio credit tenant lease asset.

The sale in conjunction with continued loan repayments from borrowers, individual asset sales and fewer funding commitments allowed us to pay down debt, reduce leverage, solidify book value and improve many of our operating metrics.

Progress on the asset side was more mix, with the macro economic pause, we saw in the latter parts of the second quarter slowing some of the asset resolutions we expected following the first quarter.

Our real estate capital markets continue to recover, we remain cautions on a speed at which values uncertain of our more difficult assets will recover and many asset resolutions will continue to take material amounts of time and effort with less than certain outcomes.

Let me touch quickly on the second quarter results. Earnings continued to be impacted by increased provisions and continued high levels of non-performing assets, partially offset by gains on debt repurchases.

Adjusted earnings per share were negative $0.89 per share, primarily due to provisions that remain stubbornly high. Leverage came down nicely as we repaid almost $1.8 billion in debt and increased our book value by several $100 million. Tangible net worth, UAUD and other operating metrics all improved as well.

And our operating profile continued to be solid with repayments easily exceeding funding and unrestricted cash at quarter end in excess of $0.5 billion. However, the debt maturities in 2011 and 2012 remain an obvious concern that we are focused on. And I’ll give a brief update on that after Dave gives you all the numbers. Dave.

Dave DiStaso

Thanks Jay and good morning everyone. I’ll begin by discussing our financial results for the second quarter before moving to credit quality and liquidity. For the quarter we reported net income of $212 million or $2.27 per common share. Earnings this quarter included $250 million gain associated with our previously announced portfolio sale of 32 corporate tenant lease, or CTL properties.

Adjusted earnings, which excludes gains from the portfolio sale and other discontinued operations was a loss of $83 million for the quarter, or a loss of $0.89 cents per common share.

Revenues for the second quarter were $137 million versus $193 million for the same period last year. The year-over-year decrease is primarily due to a reduction of interest income, as a result of performing loans moving to non-performing status and to a lesser extent of smaller asset base resulting from loan repayments and sales.

Net investment income for the quarter was $130 million versus $276 million for the second quarter 2009. The year-over-year decrease is primarily due to smaller gains associated with the early extinguishment of debt as well as the lower interest income I previously mentioned somewhat offset by a decrease in interest expense and increased earnings from equity method investments.

You may recall that in the second quarter last year we completed a bond exchange that generated $108 million of net gains upon closing of the transaction. During the second quarter we funded a $131 million under preexisting commitments in addition as part of the CTL portfolio sale we provided a $106 million mezzanine loan to the buyer, of which $25 million was repaid subsequent to quarter end.

During the quarter we received $1.3 billion of proceeds from the CTL portfolio sale, $592 million in gross proceeds from loan repayments and loan sales and we generated a $144 million of proceeds from OREO as well as other CTL sales.

Based on principal repayments and asset sales associated with the Fremont portfolio during the quarter the A-participation interest was reduced by $116 million down to $135 million at the end of the second quarter.

Let me turn to the portfolio and credit quality, at the end of the second quarter our total portfolio had a book value of $11.3 billion. Our remaining unfunded commitments for the total portfolio were $532 million at the end of the second quarter of which we expect to fund just under $200 million.

Our total portfolio was comprised of $7.3 billion of loans and other lending investments. In addition we had $2.2 billion of corporate tenant lease assets, $891 million of OREO assets, $642 million of real estate held for investment and $211 million of other investments.

77% of our portfolio is comprised of first mortgages, senior loans and corporate tenant lease assets. Our total condo exposure was $2.7 billion at the end of the quarter versus $3.1 billion last quarter.

Our total land exposure remained flat quarter-over-quarter at $1.9 billion. The land exposure was comprised of $1.3 billion of loans and $624 million of owned real estate. At the end of the second quarter, 63 assets representing $3 billion or 39.9% of managed loan value were non-performing loans or NPLs. This compares to 72 assets representing $3.5 billion or 42.3% last quarter.

Managed loan value refers to iStar's carrying value of loans, gross of specific reserves and the remaining $135 million of Fremont A-participation interest. Our NPL's continue to be primarily land and condo related assets. Land assets represents 29% of our NPL's, while condo assets make up 26%.

At the end of the quarter, the performing loan watch list included 14 assets representing $1 billion or 13.8% of managed loan value. This compares to 12 assets representing $674 million or 8.1% last quarter. Let me now turn to our Other Real Estate Owned or OREO's and real estate held for investment during the quarter we took title to 9 properties which had an aggregate managed loan value of $385 million prior to foreclosure. This resulted in a $147 million of charge-offs against our loan loss reserves. We received net proceeds of $74 million associated with OREO asset sales including unit sales and recorded $12 million of additional impairments on the total OREO portfolio.

At the end of the quarter our OREO and real estate held for investment assets totaled $1.5 billion compared to $1.4 billion at the end of last quarter. Of these assets, $891 million were classified as OREO and considered held for sale. Based on our current intention to market the assets and sell them in the near term. The remaining $642 million of assets are considered investment properties and are classified as real estate held for investment based on our current intention and ability to hold them for a longer period of time.

Let me move onto reserves. At the end of the second quarter, we recorded a $109 million of additional provisions versus $90 million in the prior quarter. While we've seen provisions trend significantly lower from last year as we have said before the rate at which they may continue to do so is uncertain and we can see quarterly fluctuations as we did this quarter.

The main driver behind the quarter-over-quarter increase related to one asset in our corporate loan portfolio which as a result of recent restructuring discussions conducted during the second quarter warranted significant incremental reserves. At the end of the quarter our reserves totaled $1.2 billion, consisting of $1 billion of asset specific reserves and a $174 million of general reserves. Our reserves represent 15.9% of total managed loans.

Let me review our covenants. For our secured bank credit facilities, our tangible net worth was approximately $1.8 billion at the end of the second quarter, above our $1.5 billion requirement.

Our fixed charge coverage calculated on a trailing 12 month basis was 2.1 times at quarter end, which is above the 1 time requirement. And our Unencumbered Assets Unsecured Debt or UAUD ratio was approximately 1.5 times at quarter end, exceeding our 1.2 times requirement. For both our unsecured and secured bonds our fixed charge coverage ratio was 2.1 times, and our UAUD ratio was approximately 1.5 times.

Finally, let me conclude with a discussion of liquidity. We ended the quarter with $532 million of unrestricted cash versus $641 million at the end of the prior quarter. During the quarter we repaid approximately $1.8 billion of debt, specifically we fully repaid a $948 million term loan [collaterized], primarily by assets in the CTL portfolio we sold.

We repaid our $129 million unsecured bond that matured in April, and we paid down $161 million of other outstanding indebtedness. In addition we redeemed $282 million par value of our 8% secured notes due March 2011, and 10% secured notes due June 14, and repurchased $235 million of senior unsecured notes at a discount. As a result, we recorded a $70 million net gain on the early extinguishment of debt for the quarter.

In terms of our cash obligations for the remainder of 2010 we have $130 million unsecured bond maturity in December. In addition, we’re currently expect a net use of cash of approximately $300 million, which includes funding remaining loan commitments, other investments as well as CTL, OREO and real estate held for investment expenses.

These uses exclude any potential amortization payments on our first-lien bank line. We are considering our options with respect to the September 30, $500 million amortization payment.

If we don’t make the payment we will direct proceeds from repayments and sales of collateral to pay down the first-lien bank line's $500 million in accordance with the terms of the first-lien loan agreement. With that let me turn it back to Jay. Jay?

Jay Sugarman

Thanks Dave, so our list of priorities hasn’t changed much over the past several quarters reduced debt, protect book value, shrink the size of the company to more manageable levels.

We’ve made good progress on all those fronts. To give you some sense of what it's taken to do that in the past 12 quarters we have repaid over $8 billion in debt and we funded over $8 billion throughout the portfolio.

Now that's put us in a better position to begin negotiating an extension of our debt maturities and our goal is to better align them with our asset maturity profile. At this point, ideas are being shared between us and our bank group on how we would like to begin doing that, but there is no guarantee we will successful in finding a solution.

But we do hope our debt and equity holders will continue to support us as we try to protect value for all our stakeholders.

With that let’s open it up for questions, operator?

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Don Fandetti, Citigroup. Please go ahead.

Don Fandetti - Citigroup

I was wondering if I guess Jay is there a roadmap to the other side for you. It's my first question and then secondly what criteria do you think the banks would look at to determine whether or not they would work with you?

Jay Sugerman

I think as I said the roadmap for us at least to this point has been to reduce debt, protect the book value, shrink the company. We have kept in tact what we think are still very powerful investment platform, continued to see opportunities in our own portfolio where we have deployed new and additional capital. Obviously once we are able to access appropriately price capital from the capital markets I think the macro opportunities quite large.

But right now the biggest opportunity and where our focus needs to be, is really to maximize the value of our existing $10 billion plus one. So I think we are going to keep our eyes focused on that. With respect to the second question, I guess the five most important things to say when you are asking for some sort of extension from a lender is one, don’t need anymore money as I mentioned in my remarks, repayments are exceeding funding by wide margins, so we don’t need anymore money.

You want to tell them, you are going to pay them off in full. I think we spent the last two years working very hard to demonstrate that there is lots of equity value in this company. And we have put ourselves in a position where I think certainly our bank group feels like they will be paid in full.

We don’t need them to lower our rates, that’s always a tough decision we face it often times our borrowers will say I need a lower rate that’s always difficult. As a lender we don’t need that. We don’t need them to accrue interest we will continue to pay them currently. We have plenty of money to do that.

And we are going to improve their security, its one of the things we always look for in situations where we have to extend is how are you making my position better?

If you look at those 5 things we don’t need any more money, we are going to pay our creditors in full, we don’t need to lower the rate. We don’t need them to accrue interest. We are going to improve security, at least from a extension stand point, those are good things to have in your back pocket and I think we have spent the last 8, 12 quarters really trying to put ourselves in a position where we can ask something that we think is a regular way conversation that happens everyday, not something that’s done on the drafts and not something that’s a crisis mode and that’s how we’d like to handle it.

We continue to work on our standalone business plan but obviously as we've said many times aligning assets liability profiles really will maximize value for everybody.

Don Fandetti - Citigroup

And just another question I may have missed this, but as you look out I mean there is not a tremendous amount of commercial real estate loan acquiring and As you look out, I mean there is not a tremendous amount of commercial real estate loan acquiring and originating opportunities now. When do you think that tipping point occurs where just transaction velocity opportunities open up for the business is general?

Jay Sugerman

I think there actually are plenty of opportunities out there. I think surprisingly there is just a lot of money chasing them in a more normal environment, I think there has been quite a bit of dollar volume available but it seems like in mid cycle, there is a lot more capital chasing real estate because of the yield, because of the potential upside and relative to a 0% interest rate environment.

The yields on our assets in our industry continue to look attractive so I think that certainly the supply of opportunities is there, it's just not as robust as the demand for them. It feels like stuff is starting to shake loose, Don I will tell you that as we see the large holders of commercial real estate begin to write them down to trading levels as apposed to what they might view as intrinsic long-term value, you’ll see more and more trades take place.

And it’s always a difficult thing to sell something below what you think is intrinsic long-term value is. But in many cases for an institution, a bank, somebody who has got a lot of different parts of the machine, if they can get out without a loss and they can redeploy that capital and they can demonstrate progress, I think they’re going to do that.

And I think we’re starting to see marks reach the point where people are saying I’d like to shrink down the book, I’d like to take a lower profile, I’d like to be able to do some new deals. And to do that we have to start seeing velocity. And I think the capital demand from a wide range of investors is where it’s just the price point haven’t been quite attractive enough.

But as people get comfortable that rates are not going up anytime soon, I think the relative attractiveness of the yields in real estate will start to stand out.

Operator

Next question comes from the line of Michael Kim, CRT. Please go ahead.

Michael Kim - CRT

Jay in terms of the loan portfolio just kind of curious, how much was actually scheduled to be repaid during the quarter and the breakdown of how much was actually transferred to nonperforming status from the scheduled repayments?

Jay Sugarman

I don’t have that number at my fingertips; maybe you can follow-up with Andy afterwards and he can give you some more detail.

Michael Kim - CRT

And my follow-up question just the news on the LNR recapitalization, just wondering what your stake in this equity investment was? And was it a net use of cash from iStar’s perspective?

Jay Sugarman

Yes, as you might have seen in our 8-K filing it had a bunch of different pieces to it. We were a large senior creditor, a large junior creditor. We received about half of our senior credit paid down as part of the transaction so we retained about a $50 million stake in the senior credit.

We received $50 million repayment on our senior credit. We converted our $100 junior position into equity and we invested $100 million of new equity so we come out of this with really two pieces of paper around the $50 million first-lien and about a quarter of company's equity.

Michael Kim - CRT

And do you expect this to be a big contributor more of a long term investment obviously but is there any short term impact from something like this?

Jay Sugerman

No, I think it was a strategic decision that there are only four or five major players in that sector LNR being the largest and with some of the most industry leading statistics in their ability to workout assets and in the environment we find ourselves in. We think that could be an attractive place, we’ve seen a lot of very high profile investors chasing this space. We were in the space, we decided that making an additional investment with some other high profile investors could lead to some pretty interesting opportunities but at this point we made a single investment decision based on the prospects of the company with or without our participation, and we thought with our participation was the right decision.

Michael Kim - CRT

And my last question just real quickly on the Fremont portfolio, how is that trending and do you expect to have this fully repaid by the end of the third quarter just the A-participation?

Jay Sugerman

It’s a variable; some of it is outside of our control. Obviously faster we sell assets in the Fremont portfolio the faster that piece of paper would go away. We do still have some funding commitments under Fremont loans.

So it can go down and also can go up a little bit. We certainly think that overtime that is going to pay-off and 100% of the proceeds of that portfolio will be available to us. But right now we don’t have exact visibility but it's paying down every quarter and the natural run-off yields like about $20 million a month. But that excludes sales which are obviously in our discretion.

Operator

Next question comes from the line of James Shanahan of Wells Fargo. Please go ahead.

James Shanahan - Wells Fargo

Most of my questions have been asked and answered. I did have one remaining question however. The increase in watch list assets that occurred that in the second quarter offset the improvement in NPA's but I am more curious if you could discuss these assets in detail and you know with the motivation from moving them to the watch list at this stage in the cycle, did something change with these properties, was it lumpy. Any detail there would be helpful, thank you.

Jay Sugerman

I guess I would personally say I was disappointed in a number of these assets showing up this quarter in the way they did. They are characterized by large assets major markets and I am talking really about the three or four that make up the bulk of the change.

But each one had a borrower who ran out of money, each one had a large mezzanine lender who decided not to fund additional capital, each one had a cost overrun that we wish would have been avoided.

And I think our view is given that they are in good markets, we are placed with the decision on how that moves forward, that’s why they are on the watch list.

James Shanahan - Wells Fargo

Okay great your anticipation then that may be watch list assets have stabilized at this level or do you think there is a possibility for another large increase?

Jay Sugerman

Look as the portfolio shrinks here, we are hoping that both NPL's and watch list become a smaller and smaller subset of the portfolio and I think for the most part, that is true and I would also say some of these assets that remain in our portfolio are quite large and when something goes sideways as you can see some variability, it wasn’t the number of loans obviously this quarter, that changed dramatically but the dollar amounts were fairly large.

I think that’s still the issue and I think I have mentioned that on a couple of past calls as you've got these assets to have uncertain outcomes. Some certainly in the first quarter went very well, quite better than we expected. I would say in the second quarter with the economy pausing we saw a few that actually didn’t expect to have these issues with. But, something we are dealing with everyday and have dealt with everyday. I think we continue to think we are able to protect value when we need to and when these surprises happen we will go to work to try to protect it.

Operator

Next question from the line of Joshua Barber, Stifel Nicolaus. Please go ahead.

Joshua Barber - Stifel Nicolaus

Your $300 million that you referenced for remaining cash uses, does that include the $100 million that you invested in LNR?

Jay Sugerman

Yes it does

Joshua Barber - Stifel Nicolaus

In reference to your watch list assets and everything else that got added to the either NPL or watch list can you talk about how many of those assets have funding commitments associated with them?

Jay Sugerman

At this point most of the funding commitments have burned off but as I said when you have a construction project that has issues, somebody has got to fund it. The borrower choosers not to and the mezzanine chooses not to. Somebody is going to, and at the end of the day we need to do so to protect our value, we will do that. I won't say that those are very large numbers in the grand scheme of things, so.

Operator

Thank you and next question from the line of [Robbie Beller of BlackRock]. Please go ahead.

Unidentified Analyst

I was wondering if you could just most of my questions have been asked and answered but I was wondering if you could just elaborate a little bit more on NPL sales or loan sales during the quarter, and in terms of what kind of recoveries you got on those?

Jay Sugerman

We’ve got plenty of NPL's, we are trying to fairly judiciously pair that down, failed it on some of these put place that prices we thought were appropriate given the marketplace. I think probably the most disappointing was the sale we did in DC, of a very high quality project that stumbled during construction.

We recovered probably $0.65 to $0.70 on that. I think if we had been willing to hold it we might have done a little better, but we had a participant, we looked at the challenges moving forward and we decided together that it was the right time to sell. We recovered $0.100 on a couple of the deals as well, and some of the CTL's we sold, obviously we sold at a very sizable (inaudible).

So, again I think it’s not a question of being forced to sell anything. We are judiciously pairing that portfolio down when borrowers reach a price point that we think is acceptable, or third parties reach a price point that we think is acceptable.

But, we’re trying to be thoughtful about it and this was not a big sales order. We had the CTL deal in the market; we wanted to see if that would close first. So we did not actively push to pair down the portfolio because we thought the CTL deal would do that for us. As we move forward we will continue to look at that list and try to get it down.

Operator

Okay, and your last question comes from the line of (inaudible)

Unidentified Analyst

Can you just clarify how much of the provision in the quarter for LNR?

Jay Sugerman

The fairly large provision, we had taken a quite a large general reserve. We ended then converting that to an even larger specific reserve and reserving out the general reserve but it made up in almost half the impairments for the quarter.

Unidentified Analyst

So the provision went down excluding LNR link quarter?

David DiStaso

Yes, general reserves went down approximately $16 million for the quarter without this provision quarter-over-quarter the total provision would have decreased from prior quarter.

Unidentified Analyst

Right, the provision on the income statement would have decreased linked quarter.

Operator

And back to you Mr. Backman

Andrew Backman

Well thank you everybody for joining us. If you still have any additional questions on today’s earnings call as always please feel free to contacting here directly in New York. Rochelle would you please give the conference replay instructions one more time? Thank you.

Operator

Certainly. And ladies and gentlemen this conference will be made available for replay after 12.30 pm today until August 17, at midnight. You may access AT&T executive playback service at any time by dialing 1800-475-6701 entering the access code 164196. International participants dial 1320-365-3844 and again that access is 164196. And that does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.

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