RAIT Financial Trust's CEO Discusses Q3 2011 Results - Earnings Call Transcript

| About: RAIT Financial (RAS)

RAIT Financial Trust (NYSE:RAS)

Q3 2011 Earnings Call

October 28, 2011 9:30 AM ET

Executives

Andres Viroslav – IR

Scott Schaeffer – CEO

Jack Salmon – CFO

Analysts

Gabe Poggi – FBR

Amy DeBone – Compass Point Research & Trading

Brian Gonick – Senvest

Operator

Good day ladies and gentlemen and welcome to the Third Quarter RAIT Financial Trust Earnings Conference Call. My name is Jeff and I will be your coordinator for today. At this time, all participants are in a listen-only mode. Later we will facilitate a question-and-answer session (Operator Instructions). As reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today Mr. Andres Viroslav, Director of Corporate Communications. And, you have the floor, sir.

Andres Viroslav

Thank you, Jeff and good morning to everyone. Thank you for joining us today to review RAIT Financial Trust’s third quarter 2011 financial results. On the call with me today are Scott Schaeffer, RAIT’s Chief Executive Officer; and Jack Salmon, RAIT’s Chief Financial 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 12:30 PM Eastern Time today. The dial-in for the replay is 888-286-8010, with a confirmation code of 52503337.

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 releases 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, www.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’d 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 joining us this morning as we present RAIT’s third quarter 2011 results. It’s been a busy quarter. We are pleased to report our fourth consecutive quarter of positive operating income as well $0.23 per share of AFFO which is supported our quarterly common dividend of $0.06 per share.

During the quarter, RAIT’s total revenue increased, our rent income increase, property NOI increased and our occupancy in our own portfolio continues to increase, while our provision for losses and non-accrual loans decreased. Jack will discuss our operating results in more details shortly.

We’ve made significant progress towards reaching our main goals for 2011. Since the end of the second quarter, we retired and were extended $104 million of RAIT’s recourse debt through multiple transactions. These transactions strengthened RAIT’s balance sheet and cash flows by eliminating our highest cost recourse debt and substantially reducing the recourse debt that matures or can be redeemed within the next four years. To be clear, as of today, we have less than $5 million in total debt obligations that are redeemed bulk or mature prior to October 2015.

In addition, we completed the sale of $61 million of loans into a third party CMBS securitization and entered into a $100 million facility with the money center bank to warehouse new CMBS eligible loans which we will originate for sale into future CMBS securitizations. The CMBS business is a natural extension of our core, bridge and mezzanine lending platforms.

Also, we have $91 million of lending capacity within our existing CRE securitizations and a healthy pipeline of new bridge and mezzanine loans.

And finally, at Independence Realty Trust, we continue to make progress. So, we are limited on what we can say because Independence has an offering in the market. We recently executed our first selling agreement with an independent broker dealer.

At this point, I would like to turn the call over to Jack to run through the details. Jack?

Jack Salmon

Thank you, Scott and good morning. The financial highlights for the quarter ended September 30, improved the following. Our GAAP net loss of $21.2 million which was primarily caused by $35 million of net changes in the fair value of our financial instruments this quarter, second, operating income of $4.1 million as compared to an operating loss of $8.4 million last year for the third quarter. And third $8.9 million or $0.23 per common share of adjusted funds from operations, which is an increase of $0.32 per share over the third quarter last year, we have generated positive operating income now for four consecutive quarters. Moreover, the $0.23 of AFFO this quarter represents our fourth consecutive increase in quarterly AFFO.

I’d now like to summarize some of the operating income trends which continued to improve as follows. Our total revenue has increased with rental revenue of $23.6 million, up 28% over the $18.4 million for the third quarter last year. .Rents grew by approximately $1.5 million compared to the second quarter of 2011, a link quarter with half the increase arising in our office in retail portfolio and the balance in our multifamily portfolio. Now after deducting real estate operating expenses of $14.5 million, we generated $9.1 million of net operating income from our own properties, a link quarterly increase of approximately 8%.

Interest expense has decreased by 5.6% compared to the same quarter last year as we continued to reduce our debt outstanding and I’ll cover that more in a minute. Compensation expense of $6.9 million includes approximately $1.2 million of non-recurring severance costs during the quarter, which if excluded would reflect comp expense running approximately 17% below the comparable period last year and also on the year-to-date basis

The provision for loan losses has decreased significantly over the last four quarters. If we combine those quarters, they total $5.9 million compared to the $10.8 million of third quarter charges alone in 2010.

Our total non-performance loans are now at $91 million down from a $143 million at September 30, 2010. And they represent approximately 8.6% of the unpaid principle balance in the CRE loan portfolio. There were no new loans converted in the real estate this quarter, and as a result, our reserves represent 55% of our current non performing balance, compared to 51% a year ago after charged-off approximately $2 million of loans against the reserve this quarter.

During the third quarter, we repurchased $15 million of our CRE CDO debt securities at a discount this resulted in a gain on debt extinguishment of approximately $10.5 million. And we also sold other debt securities, this quarter we generated a $1.5 million gain on sales. The continuing volatility and interest rates has caused about $35 million change in the fair value of our financial instruments. As long term interest rates fell to record low levels, witnessed by the 10 year treasury rate recently falling below 200 basis points. And certain of our financial declined in value, although interest rate has be cross grow significantly.

The recent changes in our debt capital structure had corollary effect on increase in the fair value of rates, corporate, junior subordinate debt obligations by $18 million. These pricing movements directly impacted the $21 million GAAP net loss.

I’d like to address some of the debt capital then specifically. RAIT has improved in debt capital structure significantly repaying high cost debt and short term debt which will reduce the interest carrying costs for the next four years. Only $4.5 million of recourse debt obligations may arise during this four year time period. And our next scheduled debt maturity of significance relates to $19 million of the junior subordinated notes due in October 2015.

And by extending our debt maturities, we’ve created a window of opportunity of opportunity for RAIT to generate incremental cash flows and raise capital for new investments, to invest in our CRE lending business and direct ownership of real estate.

On the six and seven days, convertible debt, we began the quarter with $38.8 million outstanding. Subsequent to quarter end, we repurchased approximately $34.3 million with the remaining balance still subject to an April 2012 put option. Our other recourse debt has also been updated.

Secured banks and credit facilities at the end of June had about 19.7 outstanding. We have renewed our secured bank credit facility by repaying $9 million of principle and many of the terms of the remaining $10.5 million outstanding to improve the following. A lower interest rate of LIBOR plus 275% which will include monthly principle amortization, and thereby extending the overall maturity date to December 2016, five years out.

Our senior secured notes were $43 million at June 30, were prepaid in there entirely. These are the 12.5% senior secured notes that were due at April 2014. We also repaid a $7 million real estate loan that had a September 2013 maturity date.

I’d now like to summarize the recent debt exchange transaction. As previously announced in October, RAIT entered to an exchange transaction whereby we issued a new series of senior secured notes, aggregating $100 million. In exchange for a portfolio of senior RAIT bonds, CMBS debt securities and other real estate related debt instruments.

All the exchange financial instruments were discounted to an equivalent current fair market value of approximately $80 million, essentially equating the effective interest cost from the debt issued to the effective earned on the portfolio, such that no gain or loss is occurred.

RAIT will make interest payments at a weighted average rate of 7% and the new notes will mature over an average period of 6.5 years. The new notes are secured CRE CDO debt instruments which RAIT owns in CRE I and CRE II. And by pledging these debt securities versus selling them today, we believe that RAIT had retained ownership of the collateral and can expect to receive higher recovery value in the future as the CRE CDOs paid down their debt over time.

Now, I’d like to address our CRE loan portfolios and relating hedging strategies. Our $1.1 billion CRE loan portfolio has continued to perform well. You may recall at the end of the second quarter, we had approximately $32 million of availability for funding new loans in these structures. And during the third quarter, we funded $22.1 million of new loans and received $77.9 million of additional loan repayments. So, currently we have approximately $90 million of funding capacity for new loans. We expect to see increased loan production as loan repayments continue to occur and we are managing our origination pipeline accordingly.

The two CRE loan securitizations CRE I and II, continue to meet in all their IC and OC requirements. And as for the recent payment cycle, the most stringent OC test was at 123.7 versus a trigger of $116.2 in CRE I, and at $119.1 versus a trigger of $111.7 in CRE II.

Now I’d like to discuss our hedging. Currently, we have approximately $715 million of interest rate hedges outstanding to protect the CRE I and CRE II from adverse interest rate movements. From inception, five years ago, we hedged the projected amount of floating rate debt that was exposed to a potential mismatch with our fixed rate assets in the structures by entering in two hedging contracts that slopped the floating rate interest to a fixed rate.

These hedge contracts amortized down overtime based upon on our original estimates of the expected loan repayment cycles. And as we approach the fifth year anniversary of our initial funding, approximately $100 billion of hedges will be fully amortized next month. We do not need to replace these hedges since we have successfully reinvested fixed rate loans that have been repaid with new floating rate loans. And the reduction in interest rate costs for the $100 million of expiring hedges will save approximately $400,000 a month beginning in December. And these savings will float through to our net income and our AFFO.

Given to the ongoing volatility of the both short-term and long-term interest rates, we will continue to consider other hedging strategies as necessary for new loans including the CMBS loans, although no assurance can be made that such strategies will eliminate volatility in our reported debt results.

Our two subordinate debt securitizations are meeting our IC and OC test requirements and are paying our senior management fees after which all remaining cash flow continues to be redirected to pay down the senior most debt in those structures.

Finally, our real estate owned portfolio. We currently own 48 properties with an aggregate balance of $849 million as of September 30. A year ago, we owned 47 properties with a balance of $818 million. The year-to-date rental income under this portfolio increased to $67.1 million for the first nine months of this year in comparison to $52.2 million for the same period last year, which is a 28% improvement.

The primary drivers of this $15 million increase or increases in average occupancy and rental rate increases are as follows and I’ll go by property type. The multifamily portfolio currently has an occupancy rate of 89.8% compared to 84.6% a year ago, and as average reflective rents of 688 per unit. The office portfolio has a current occupancy of 68.5% compared to 52.5% a year ago. And it currently has an effect of ravish rent of $18.93 per square foot.

And the retail portfolio has a current occupancy of 68.9% compared to 57.7% a year ago, with an average effect of rent of $8.65 per square foot. But on an overall basis, total occupancy is currently averaging 84.5% compared to 74.8% hoping to drive these results.

And with that, I’ll return the call to Scott.

Scott Schaeffer

Thanks Jack. At this time, operator, I think would like to open the call up for questions.

Question-and-Answer Session

Operator

Thank you very much. (Operator Instructions). Our first question comes from the line of Gabe Poggi with FBR. Please proceed.

Gabe Poggi – FBR

Hey, good morning guys, congratulations on a nice third quarter.

Scott Schaeffer

Hi Gabe.

Jack Salmon

Thanks Gabe.

Gabe Poggi – FBR

I wanted to get a little color kind of on the – from a macro perspective so to speak. Scott, where are you guys floating new loans and what I’m trying to ask is I want to get an idea of your spread pick up relative to the loans you have in the CDOs that are getting repaid and where you can go reallocate that capital today, kind of what that delta is so to speak?

Scott Schaeffer

Yes Gabe, we’re quoting new loans on the bridge business, at LIBOR plus 500 with a floor of seven. And those are typically in the 75% LTB range.

Gabe Poggi – FBR

Okay. And then my….

Jack Salmon

Excuse me, with a point in and a point out as well.

Gabe Poggi – FBR

Okay. How does that compared just to how does that compare relatively speaking that what you’d you know, I don’t want to say legacy but stuff that’s already in the CDO or the paper that’s getting repaid?

Scott Schaeffer

It’s significantly higher. The paper that is being repaid on the bridge loans typically, the loans were originated in late 2005, 2006 and into 2007, and the market was much tighter. So, you know, at that time we were doing loans of LIBOR plus 250 with floors in the 5% range. So, at a minimum, some of them didn’t even have floors of the loans that we were paying off. So, there we have a significant pick up. But even on the loans it had floors we’re picking up a couple of hundred basis points.

Gabe Poggi – FBR

Got you. Okay, that’s helpful. And then, Jack, I don’t know if you mentioned this earlier or if I just got call I was writing things down. Can you talk about any details about the CMBS facility, what you can or cannot put on there, if there are any restrictions, what the cost is etcetera?

Jack Salmon

Sure. It’s a new facility a $100 million of capacity, the cost of funds is LIBOR plus 250. And it is meant to be used for new originations. So, we will be going to the market creating new CMBS loans for ultimate securitization into the secondary market.

Gabe Poggi – FBR

Is there any LTV restriction?

Jack Salmon

We can fund up to 75% loan to value.

Gabe Poggi – FBR

Okay.

Jack Salmon

And again, it’s confirming to what the market ought to be look like in terms of the CMBS 2.0 type of loan.

Gabe Poggi – FBR

Right, right, okay.

Scott Schaeffer

And Gabe, let me add if I may that there are no non-usage fees which was important to us because everyone recognizes that the CMBS market today is somewhat choppy after what we went through with S&P in July and then with, you know, spreads and interest rate volatility in August and September. So, it’s important to us to have a facility that is not going to cost us a lot while we were, you know, waiting for the market to settle down.

Gabe Poggi – FBR

Okay. That leaves me to my last question. Has anything, you know, over the tone in the markets have obviously gotten better in the last, call it, two weeks, three weeks maybe, maybe that three weeks is stretching it. But have you seen anything anecdotally in broad CMBS win that gives you a reason to believe that maybe the, I won’t say, the default that we had, the free so to speak in the third quarter maybe melting a bit, though I’m just curious, I don’t, I’m just.

Scott Schaeffer

Yes, yes, we are. We’re seeing a lot of opportunities. Borrowers are still a little leery of CMBS loans because of what happened in the summer. But we’re seeing a lot of opportunities, we had what I would view is a very good strong pipeline meeting as recently as yesterday. And we’re putting our quotes. You know, a lot of it will depend on you know, the closings to come up and how the next securitization is accepted in the market.

Gabe Poggi – FBR

Right.

Scott Schaeffer

And no, we really won’t know, you know, that the fall is really over until that happens.

Gabe Poggi – FBR

One last follow up on those kind of let’s call it 75 LTV CMBS loans, what are you guys quoting ballpark there?

Scott Schaeffer

You mean, as far as spread?

Gabe Poggi – FBR

Yeah.

Scott Schaeffer

400 over the corresponding.

Gabe Poggi – FBR

Got you, okay. Perfect. Thank you so much guys. Congratulations.

Scott Schaeffer

Thanks Gabe.

Jack Salmon

Thank you.

Operator

Our next question comes from the line of Amy DeBone with Compass Point Research & Trading. Please proceed.

Amy DeBone – Compass Point Research & Trading

Good morning. Thank you for taking my questions.

Scott Schaeffer

Hi Amy.

Amy DeBone – Compass Point Research & Trading

Hi. Can you give any progress on I know that you said that there is an offering outstanding that you can’t say much. But can you give any progress on Independence Realty?

Scott Schaeffer

Well, as I’m sure you are aware the SEC and spend are low as I was talking about the deal when they are offering materials, they have their wealth there. But I will tell you that we are on schedule. We always thought that we would have our first selling agreement signed in the fourth quarter which is where we’re at. And we’re looking forward to a very active 2012.

Amy DeBone – Compass Point Research & Trading

Great. And can you explain what drove the improvement in the OC test for RAIT II this quarter?

Scott Schaeffer

Sure. There is only one default loan in CRE II same as it was I think towards the end of last quarter, its $4 million of this loan. So, the credit side is very strong. And I think from recycling of capital, loans that are going in probably of a slightly higher interest factored to them. So, we’re getting better results on the interest coverage test.

Amy DeBone – Compass Point Research & Trading

Okay, great. And will the debt exchange that was done in October impact the OC cushion at all or the corresponding CDO?

Scott Schaeffer

Yes. It will impact it slightly. But I will tell you that there is lots of way to go before it would be corrected.

Amy DeBone – Compass Point Research & Trading

Okay.

Jack Salmon

It impacts it positively.

Amy DeBone – Compass Point Research & Trading

Great.

Jack Salmon

Both the interest coverage and the OC test but not to the point where it’s cured or anything.

Amy DeBone – Compass Point Research & Trading

Okay. And then, RAIT 1 reinvestment NDA comes next month. Is there anything you can do to maintain the OC cushion after the reinvestment mandate is over aside from loan conversions? And then, in addition to that, do you see any more loan conversions coming from the RAIT 1 portfolio?

Scott Schaeffer

Well, at this time, we’re managing the portfolio we believe appropriately. I will tell you that that portfolio has a higher percentage of mezz loans and subordinated debt positions than our second portfolio, which means that those loans do not pay off as frequently especially because of the turmoil that we’re just going through for the past few years. It’s much harder for borrowers to refinance to a level to retire that type of subordinated debt. So, while, you know, those loans that we’re carrying or performing which is why we still have the cushion within the OC test. We don’t anticipate those paying off any time soon, which is a good thing. But we will continue to manage the portfolio as appropriate.

Amy DeBone – Compass Point Research & Trading

Okay, great. That’s all my questions. Congratulations on a good quarter.

Scott Schaeffer

Thank you.

Jack Salmon

Thank you Amy.

Operator

Our next question comes from the line of Brian Gonick with Senvest. Please proceed.

Brian Gonick – Senvest

Hi, good morning. If you look at all the non-recurring items, the severance, the hedges that are going to save on interest expense. What do you kind of look at your adjusted FFO being kind of normalized after, you know, after taking those things into consideration?

Scott Schaeffer

Well, you hit two of them on the head Brian, the comp just owns the non-recurring item because related some severance. And our run rate has been pretty consistent on comp throughout the year other than that item if the third quarter. The hedge, the hedge savings on just the next to occur amortized hedge will be about $1.2 a quarter, $400,000 a month. And that will be continuous, you know, because that isn’t being replaced, it doesn’t need to be replaced.

Brian Gonick – Senvest

Right. And then, if we factored in reinvestment and better spreads, I mean, it looks to me like you’re approaching $0.30 per share in adjusted FFO. So, I’m wondering now that you’ve resolved really all the debt maturity issues have you given a thought to buying back stock, given as trading is like four times AFFO?

Scott Schaeffer

Yes, we have given thought to that. And currently I will tell you that we discussed it every quarter with our board. And up until now we have always been focused as you can tell within our – to payback our debt with the repayments and maturities that were coming to in the short term. So, we will continue to discuss it. And as cash permits, if the stock price is still trading at what values or levels that we believe are well below real value. I think the board would have a positive reaction going forward.

Brian Gonick – Senvest

Great thank you.

Operator

Ladies and gentlemen, that will conclude the question and answer portion of our event. I’d now like to turn the conference back over to Mr. Scott Schaeffer for closing remarks.

Scott Schaeffer

Thanks Jeff. As a final thought, I just liked to say that 2011 has been a successful year for RAIT. We’ve now turned the corner, our near term debt maturities are behind us. We have new agreements and relationships in place to grow the business. And we are well positioned to take advantage of opportunities in the market. Thanks for joining us. We look forward to speaking with you again next quarter.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. And have a wonderful day.

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