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RAIT Financial Trust (NYSE:RAS)

Q4 2011 Earnings Call

February 9, 2012 09:30 a.m. ET

Executives

Scott F. Schaeffer – CEO

Jack E. Salmon – CFO & Treasurer

Andres Viroslav – Director of Corporate Communications

Analysts

Gabe Poggi – FBR

Amy DeBone – Compass Point Research & Trading

Brian Gonick – Senvest

Operator

Good day ladies and gentlemen and welcome to the Fourth Quarter 2011 RAIT Financial Trust Earnings Conference Call. My name is Jasmine and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator Instructions) As reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today’s conference to Mr. Andres Viroslav, Director of Corporate Communications, you may proceed.

Andres Viroslav

Thank you, Jasmine and good morning to everyone. Thank you for joining us today to review RAIT Financial Trust’s fourth quarter and fiscal 2011 financial results. On the call with me today are Scott Schaeffer, 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 11:30 AM Eastern Time today. The dial-in for the replay is 888-286-8010, with a confirmation code of 88426369.

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 2011 results. It’s for the productive quarter and year for RAIT. We are pleased to our fifth consecutive quarter of positive operating income and AFFO of $0.30 per share.

In January RAIT paid its third consecutive regularly quarterly common dividend of $0.06 per share. In the fourth quarter, we received approximately $80 million in loan repayments, we ended the year with approximately $110 million of lending capacity available to reinvest into our core loan products such bridge loans and mezzanine loans and we have $250 million of line capacity to finance our CMBS eligible loans.

During the quarter we sold $61 million of CMBS loans to a third-party securitization which resulted in the gain of $2.9 million. We also recently hired an experienced loan originator and two new underwriters to speed our origination efforts and our pipeline of lending opportunities continues to grow, it currently totals approximately $500 million.

Credit quality within our loan book remains stable as credit costs have remained low and we’ve continued to see reductions in the number of loans on non-accrual. In our directly owned real estate portfolio we’ve experienced growth in both rental income, property net operating income driven by higher rental rates mainly in our multifamily portfolio while coupled with lower property operating costs.

Our multifamily property manager, Jupiter Communities has been increasing rental rates within the stabilized multifamily properties in the portfolio, which results in a slight reduction in occupancy rate, but higher net operating income. We expect to see our occupancy rates increase during the year once the market digests these higher rental rates. And Jack will discuss our operating results in more detail shortly.

We reached our debt reduction goals for 2011, during the year we refinanced or paid off $250 million of RAIT’s recourse debt to multiple transactions and as of today we’ve less than $3.6 million in recourse debt obligations that are redeemable or mature prior to October 2015.

And finally, I’d like to comment about RAIT’s common dividend. RAIT generated $30 million in depreciation cost in 2011 and ended the year with $52 million of NOLs. For re-compliance purposes we’re not required to pay a dividend, however, the improvements in both our balance sheet and operating results along with the slowing improving macroeconomic environment gives us confidence that market challenges rate previously faced are now behind us and the potential for growth is in front of us. We believe shareholders should benefit from these improvements.

At this point, I’d like to turn the call over to Jack to provide more details on our results. Jack?

Jack Salmon

Thank you, Scott. The financial highlights for the quarter ended December 31, include a GAAP net loss of $15.6 million primarily caused by $20 million of net changes in the fair value of our liability financial instruments. Operating income of $4.3 million is compared to $1.9 million last quarter or the fourth quarter of 2010 and adjusted funds from operations of $12 million was $0.30 per common share. This is an increase of $0.14 per share over the fourth quarter last year. We’ve generated positive operating income and quarterly increases in AFFO for five consecutive quarters.

I’d now like to comment on our operating income trends which continue to improve as follows. We have rental revenue of $24.8 million this quarter which is up over 23% from $20.2 million in the fourth quarter last year. Rents grew by $1.2 million compared to the third quarter 2011 mostly as result of rate increases which more than offset slightly low occupancy levels at year end.

After deducting real estate operating expenses of $14.3 million we generated $10.5 million of net operating income from our own properties, a link quarter increase of 16% or $1.4 million of additional property NOI.

Interest income was $30.8 million down by $2.8 million from the third quarter of 2011, as I see every loan portfolio experience some timing differences between when loans are repaid and the funding of new loans. And as Scott indicated, we expect to deploy our available funds during first quarter at higher interest spreads which will restore or interest income levels.

Interest expense of $21.3 million decreased by $1.2 million compared to the fourth quarter last year and by over $7 million for the year as a whole, as we achieved significant reductions in our total debt outstanding.

Compensation expense of $4.8 million was $2.2 million lower than the fourth quarter of 2010 and ran at a rate of 16% low on a year-over-year basis. Our provision for loan losses has decreased significantly during 2011 with a total provision this year of $3.9 million as compared to $38.3 million for the last year due to the significant improvements in non-performing loans this year.

Our total non-accrual loans were $54 million down from a $122 million at year end December 31, 2010 representing 5.7% of the unpaid principal balance in the CRE loan portfolio. The current reserves represent 75% of our remaining non-performing loans compared to 51% coverage of our non-performing loans a year ago.

The continuing volatility and interest rates has caused us $75 million net decrease in the changed fair value of our financial expense contributing to a $51 million GAAP loss for 2011. The change resulted from three components. First, improvements of $19 million in the fair value of our investments in securities, second, offset by a $35 million pricing upticks in the fair value of our debt obligations and third, $59 million increases in the fair value of our interest rate hedges as long term interest rates fell to relatively low levels that last year.

It is important to note that although these fair value changes affect of our reported GAAP earnings, there is no cash or economic impact on our operating business since the CDO debt is non recourse to rate.

Next, I’d like to talk about our investments in our assets under management. Our CRE loan portfolio has approximately billion dollars in loans, which is primarily financed by CRE CDOs I and II.

CRE I reached the end of a three investment period in November last year. RAIT owns approximately $244 million of the total capital structure including all of the $200 million of double B debt and residual equity. All future principal repayments were amortized to debt in order seniority and at December 31, there were $90 million of defaulted loans in this portfolio. CRE I is meeting all of its IC and OC covenant requirements with the most stringent overcollateralization test currently at 127.4% versus a requirement of 116.2%.

CRE II continues to receive loan repayments that could be re-invested in new loan originations through June of 2012. RAIT loans $247 million of the total capital structure including all the $141 million of double B debt and residual equity. At December 31, there is one $4 million defaulted mezzanine loan in this portfolio, so CRE II is meeting all of its IC and OC tests with the most stringent OC test currently at 119.1% versus requirement of 111.7%.

During the fourth quarter, we received $80 million of loan repayments rating the total for the year to $206 million. We also funded $25 million of new loan and a $104 million of new loans for the whole year.

Next, our debt securities portfolio, the total investment in the two consolidates to burn the CDOs is $320 million, which represents both preferred equity and various loans of debt positions that we own. Approximately 75% of the investments are in the form of TruPS and TruPS related receivables issued by corporate real estate companies. The typical TruPS instrument is a secured corporate borrowing with a 30-year maturity and a five year no call provision that prevented prepayments.

Now beginning in 2012, the no call provision starts to expire and the corporate borrowers will have the options to prepay these instruments. Given that historically low interest rate environment in comparison to when the collateral was originated five years ago together with strengthening corporate balance sheets, we expect some of the Trust borrowers will elect like to prepay their loans. We will use those proceeds to repay the most senior tranches of the non-recourse debt in these securitizations.

And although we continue to receive our quarterly senior management fees, all remaining cash flow from interest proceeds is being further directed to pay down the most senior debt each quarter.

In subordinated A, we owned $40 million of lower trans debt and $93 million of the double B and preferred equity positions. At year end subordinated A had over $80 million of restricted cash which is now reduced to pay down the senior debt tranches in 2012 to approximately $260 million from an original balance of $375 million.

If the TruPs issue has exercised the prepayment options it will accelerate prepayments of TAs non-recourse liabilities which are carry of less than par and there will be incremental non-cash charge to GAAP earnings as a result. TA currently has six defaulted investment securities with an unpaid balance of $54 million and as a result it’s failing of its OC and IC interest coverage tests. In T9, we owned $89 million of lower tranche debt and $97 million of the double B in preferred equity positions.

The most senior tranches in non-recourse debt in T9 have been paid down to approximately $298 million from the original of $375 million primarily from collateral repayments and redirected net interest proceeds. Similar to G9, any trust prepayments will have a course by the noncash charge to GAAP earnings upon the repayment of T9’s non-recourse debt. G9 currently has 15 defaulted investment securities with an nonpaid balance of approximately $128 million and as a result it is failing all the OC and IC coverage tests.

Turning to our own real estate, we own 56 properties with an aggregate balance of $892 million at year end with 62% of it in multifamily, 25% in office and 13% in retail and other asset types. A year ago we owned 47 properties for the balance of $839 million. Our 2011 total rental income was $92 million in comparison to $72 million last year which is a 26% increase. Now the primary drivers of this increase in addition to new properties owned are improvements in average occupancy and higher effective renovates as follows.

In the multifamily portfolio occupancy at the year end was 88.5% up from 85.5% a year ago and effective average rents were $681 per unit compared to $664 per unit a year ago. In the office portfolio occupancy is 69.2% up from 67.8% last year and effective average rents were $20.85 per square foot compared to $18 per square foot in 2010. In the retail portfolio occupancy is now at 68% compared to 58.8% a year ago with effective rents at $9.73 per square foot compared to rents of $9.40 a year ago. Overall, our occupancy is at 83.6% compared to 79.2% in 2010.

We’ve improved our debt capital structure significantly during 2011 by refinancing or repaying $250 million of short-term high cost and most of the recourse debt. Overall, these changes have the net effect to reducing our interest carrying costs for the next four years. At year end there are $77 million of remaining hedge obligations in CRE I and II and $95 million remaining hedge obligations to burn 8 and 9.

We expect scheduled reductions in our interest rate hedges as the securitizations begin to unwind. As the hedges are amortized further in 2012, we expect to derive annualized interest expense savings of approximately $5 million as a result of AFFO and cash flow to rate.

During the quarter we had $38.8 million of our six and seven A’s convertible debt outstanding which is now $3.6 million subject to an April 2012 put option. In October we prepaid the entire $43 million of the 12.5% senior secured notes that previous had an April 2014 maturity date. And during the fourth quarter we borrowed 1726 million on a non-recourse basis at a loan-to-value ratio of 65% for a multifamily property owned by IRT. This financing was provided through Fannie Mae at a fixed interest rate of 3.7%.

We ended the year with $30 million of available cash and cash equivalents and we’ve $239 of restricted cash balances including the following. A $152 million in CRE I and II, which are set aside for funding existing and future loan commitments, $84 million into burn 8, 9 which is used to pay down the senior debt tranches and no securitizations in 2012 and $43 million borrowers escrows for real estate taxes, insurance and debt serves reserves in our CRE loan portfolio that concludes my remarks.

Scott Schaeffer

Thank you, Jack. Much has changed at rate over the past year, so I think it’s important to summarize how we see the company today and how we see the company going forward. RAIT is a vertically integrated real estate company focused primarily on lending, investing and managing commercial real estate assets.

Today we have two primarily portfolios, $996 million portfolio of commercial real estate loans and an $891 million portfolio of directly owned real estate. These portfolios are largely secured by cash flow in multifamily, small office and neighborhood retail properties. Our internal capabilities include loan originations, property acquisitions, asset management, due diligence, underwriting, legal, loan servicing and property management. These integrated disciplines allow us to manage and service our existing portfolios as well as source, underwriting close new opportunities.

Looking forward our plan is to capitalize on RAIT’s existing scalable platform and focus on the origination of bridge, mezzanine and CMBS loans. We’ve a awesome pipeline of opportunities and expect to close approximately $100 million of new loans during this first quarter of 2012. Our current plan is to fund new bridge and mezz loan production through our existing securitization capacity and to fund our CMBS pipeline through our new Barclays Capital and Citibank warehouse facilities. We are also actively pursuing alternative ways to expand and finance the origination platform going forward.

Our plan also includes growing our portfolio of multifamily properties, utilizing our sponsorship of a non-traded REIT, independent reality trust or IRT. We’ve recently begun the capital raising stage at IRT and are happy to report that we’re in the final stage of the due diligence with two independent broker dealers representing more than 12,500 advisors. In addition, eight independent broker dealer firm, so there are over 11,000 advisors have began their due diligence on IRT.

We initially hired two people to support this IRT initiative. The Vice President of Acquisitions, who will focus on sourcing multifamily acquisitions and our broker dealer subsidiary independent realty securities hired an Executive Vice President and Director of Business Development to assist with the capital raise. We do the non-traded REIT industry as an area where RAIT can utilize its expertise and capabilities to build an attractive cash flowing portfolio for IRT shareholders while generating recurring fee income for RAIT shareholders.

Operator at this time, I think we should open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question will come from the line of Gabe Poggi with FBR, you may proceed.

Gabe Poggi – FBR

Hi, good morning guys, nice job in the fourth quarter. Scott, I kind of had a high level question, kind of as you look at in the 2012, you guys mentioned you have $110 million of approximate available financing for re-investment in bridge and mezzanine loans, $250 million in the CMBS side, of those two businesses where do you think the opportunities best kind of rate now. The CMBS side of things or bridge/mezz investing?

Scott Schaeffer

Gabe, I think there is opportunities in both areas, however, I will tell you that our pipeline of bridge and mezz opportunities is growing more quickly and is larger than the pipeline for CMBS, right now it’s about $300 million for bridge and mezz and slightly under $200 million for CMBS. CMBS had, what we are seeing has had a slow start, the hiccup in the fourth quarter of 2011, but there are lot of maturities coming down the pike, performance in the real estate sector is better. So, we do see a lot of opportunity there, but to answer your question today there is more opportunity in the bridge and mezz space.

Gabe Poggi – FBR

Can you just remind me where you guys are rating those bridge/mezz loans from a spread perspective?

Scott Schaeffer

Bridge loans are in the 450 to 500 over with floors, the floating rate with floors of 6.5 to 7 point in and point out. Mezz is really anywhere from 10 to 13 depending on the location and where you are in the capital stat.

Gabe Poggi – FBR

Okay, great that’s helpful, thanks guys.

Operator

Your next question will come from the line of Amy DeBone with Compass Point Research & Trading please proceed.

Amy DeBone – Compass Point Research & Trading

Hi, good morning, congrats on a great quarter.

Scott Schaeffer

Thanks Amy.

Amy DeBone – Compass Point Research & Trading

Can you talk a little bit about what are the decline in commercial loan portfolio and how to think about the run rate going forward, are new originations expect to ramp up going forward compared to this quarter or what are you seeing there?

Scott Schaeffer

The decline is on a quarter-over-quarter basis is solely due to repayments where we were carrying at the end of the year a fair amount of cash because loans prepaid in the fourth quarter and there’s a timing difference. It takes us a little bit of time, it’s actually originating close new loans to get that money out. We’ve always been very conscious of matching up our available funds to our pipeline so we don’t want to be ahead of ourselves and have funding obligations until we know that cash is available. So, the cash comes in it takes us a couple of months to get it back out and we had a fair amount of repayments at the end of the fourth quarter.

Amy DeBone – Compass Point Research & Trading

Okay, great. And were there any loan conversions completed this quarter?

Scott Schaeffer

Yes Amy. We had two loans that were converted into real estate for the quarter approximately $60 million of value.

Amy DeBone – Compass Point Research & Trading

Okay and then last question what showed the increase in the OC margin and CRE CDO I?

Jack Salmon

Well, we’re happy to report that lot of nonperforming loans has decreased significantly during the last quarter. So, were down to $19 million of defaulted loans that helps improve the overall tests.

Amy DeBone – Compass Point Research & Trading

Okay, so they are just filtering there, okay great that was very helpful. Thank you.

Operator

Your next question comes from the line of Brian Gonick with Senvest, please proceed.

Brian Gonick – Senvest

Hi, good morning.

Scott Schaeffer

Hi

Brian Gonick – Senvest

So, with the $100 million of loans that you’ve in the pipeline expect to close this quarter will those all be essentially reinvestments in REIT II?

Scott Schaeffer

Yes, there is a couple of CMBS loans, small CMBS loans in that amount. But about $85 million of it is REIT II.

Brian Gonick – Senvest

So, when you look at the pipeline of $500 million the $300 million would be I presume lot of that would be reinvestment in REIT II, is that right?

Jack Salmon

Yes. Now recognize that you don’t always close 100% of your pipeline.

Brian Gonick – Senvest

Of course.

Scott Schaeffer

We close about 30% of it.

Brian Gonick – Senvest

And remind me, how much is maturing this year in REIT II?

Scott Schaeffer

I don’t have that number off hand that’s something that we’ll be happy to get together for you and provide you after the call.

Brian Gonick – Senvest

What you think is the amount of CMBS loans that you can sort of produce on a quarterly basis and do you think that some of the source of those loans might come out of your, out of RET I & II?

Scott Schaeffer

We think, comfortably that we’ll do once we fully ramp it up to $75 million a quarter that’s really where at this point I’m comfortable so that we don’t get out and again ahead of ourselves and we think that with the lines that we have in place with about $75 million will then contribute it and then do it again and we are hoping to turn it each quarter. We have had and will continue to have opportunities within RAIT’s existing bridge portfolio. We are in constant contact with all of our borrowers and they are well aware of the fact that we can provide permanent financing when they seek it. So, the answer to that question is yes, some of them will come from our existing bridge pipeline.

Brian Gonick – Senvest

Got it, great. So, turning now to the real estate you own on the multifamily side, your occupancy levels have been fairly consistent in the high 80s where do you think you can get that this year when you look at sort of public apartment reach, they’ve much higher occupancy levels?

Scott Schaeffer

Well we remember that this portfolio is not totally stable at this point. So, our stabilized properties are in the low to mid 90s and actually some of them are in high 90s which I feel that those ranks should be pushed further brining occupancy down a little bit. But, we think on a stable basis that this portfolio will also be in the low to mid 90s like the other multifamily REIT.

Brian Gonick – Senvest

So how long does that process take do you think?

Jack Salmon

Its really a negative process running, it’s got alluded, I mean we are looking at rank growth across all the properties in our portfolio and as you achieve that rank growth you may have sacrificed little bit of occupancy then you rebuild the occupancy and you’ve got locked in for the next twelve months and its really a negative process that we’ve monitor it, week to week literally in terms of what rank goes for putting into the marketplace.

Brian Gonick – Senvest

But, would you expect that by the end of this year, you would exit the year at a higher occupancy level than you are today?

Scott Schaeffer

Most likely, because I think, we have a lot of rent growth in the last six months of last year so we will start seeing this stability in this year.

Brian Gonick – Senvest

Great, on the $5 million of interest expense savings you referenced for 2012 relative to 2011, how much of that did we see in Q4?

Jack Salmon

It’s a very small portion of that had occurred in the fourth quarter of 2011.

Brian Gonick – Senvest

Okay.

Scott Schaeffer

It’s $100 million and probably it’s 5 less than $100 million.

Brian Gonick – Senvest

Okay. You said the $7 million of total or 5?

Jack Salmon

Are you talking about the forward savings or –?

Brian Gonick – Senvest

Yes, the forward savings and I thought you said that it would be $5 million of interest expense savings in 2012?

Scott Schaeffer

I thought you are asking about the interest expense we have in 2011.

Brian Gonick – Senvest

No, no, no.

Scott Schaeffer

For 2012 that savings will occur as the hedge obligations are paid down sequentially over the year, so the first quarter will be smallest and the last quarter will be the largest.

Brian Gonick – Senvest

Okay but that will be over the course of this year and there was none of that happened in Q4?

Scott Schaeffer

I think we had a couple of $100,000 of affect in the fourth quarter.

Brian Gonick – Senvest

Okay. How much CDO fee income did you recognize in cash that you did not recognize on the income statement with lasting consolidation?

Scott Schaeffer

Well probably, you are taking about the management fee?

Brian Gonick – Senvest

Yes

Scott Schaeffer

It’s probably about $500,000 to $600,000 on a quarterly basis.

Brian Gonick – Senvest

Can you reason why you wouldn’t flow that into AFFO?

Scott Schaeffer

We don’t spec out as we reconcile it different so we were earning it, we’re just not reporting it because it’s get eliminated in consolidation.

Brian Gonick – Senvest

Right, okay, great. That finishes my questions. Thank you.

Operator

And at this time we have no further question, I would like to turn the call over to Mr. Scott Schaeffer for closing remarks.

Scott Schaeffer

Well thanks everyone for joining us today. We look forward to 2012 and speaking to you next quarter. Thank you.

Operator

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

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