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CapLease, Inc (NYSE:LSE)

Q3 2007 Earnings Call

November 7, 2007 11:00 am ET

Executives

Brad Cohen - Investor Relations

Paul McDowell - Chief Executive Officer

Shawn Seale - Chief Financial Officer

Analysts

Sheila McGrath - KBW

Ambika Goel - Citigroup

Will Marks - JMP Securities

Jeff Donnelly - Wachovia

Merrill Ross - FBR

David Fick - Stifel Nicolaus

Charles Richard - Zammer

Bob Gasson - Alphine Fund

Operator

Good morning and welcome to the CapLease Third Quarter 2007Earnings Conference Call (Operator Instructions).

It is now my pleasure to turn the floor over to your hostMr. Brad Cohen, Investor Relations. Please go ahead sir.

Brad Cohen

Thank you very much, operator. Today, I would like to remindeveryone that part of our discussion this morning will include guidance andother forward-looking statements, and these statements does not guarantees thefuture performance and, therefore, undue reliance should not be placed on them.

We refer all of you to CapLease's third quarter 2007earnings release in filings with the Securities and Exchange Commission for amore detailed discussion of important factors that could cause actual resultsto differ materially from those contained in the company's forward-lookingstatements. The company disclaims any obligation to update its forward-lookingstatements.

Also during the call today, the company will be discussingfunds from operations or FFO, which is a non-GAAP financial measures. Pleasesee the company's press release for reconciliation of FFO to net income to mostdirectly comparable GAAP measure.

It is now my pleasure to turn the call over to CapLease's,Chief Executive Officer, Mr. Paul McDowell. Paul?

Paul McDowell

Thank you very much, Brad, and good morning everyone. Withme on the call today is my partner, Shawn Seale, who is our Chief FinancialOfficer. This morning CapLease announced its results for the third quarter of2007 highlighted by revenue of $46.6 million and FFO of $0.29 per share both arecord for us.

This represents growth of 51% and 32% respectively, from thethird quarter of 2006 and our third quarter FFO per share results were withinour prior guidance range. It will be no surprise to anyone listening to thiscall that is an understatement to say the third quarter presented a challengingoperating environment for many real estate market participants includingCapLease.

The markets continue to be unsettled in the fourth quarterthough current conditions are somewhat better than they were in August.Fortunately, CapLease has a solid portfolio of properties nearly all of whichhave investment grade tenants and a long-term fixed rate financing inside atattractive pricing that largely insulates us for this conditions.

This transparent corporate credit back, commercial realestate portfolio continues to perform flawlessly and has no exposure to anyresidential assets. Our strong portfolio along with the actions we took in thethird quarter and the beginning of the fourth quarter provide a solid ball workto our shareholders against the wild swings we have seen in the credit markets.Even so, we have felt some modest impact of this credit markets.

As a management team we've been together for a long time andwe do know how important it is not only to react, but also to anticipatepotential issues when the markets go through rapid change. As a second quarterrundown and the third begin we noted our conditions in the credit markets weredeteriorating and that’s a pricing of liabilities would getting increasinglydifficult to forecast.

We reacted to this tell-tell signs in two ways. First, weimmediately curtailed our asset acquisition activity. It makes no sense to tryand purchase long-term net lease property when it is not clear how and at whatprice those properties can be financed. Accordingly, and quite deliberately weadded no new net lease properties in the third quarter. Second we turned ourattention and energy to making our balance sheet even stronger.

We rapidly completed a previously negotiated first mortgagefinancing on the three net lease properties we bought neoteric cap transactionearlier in the year and use the proceed to completely retire the existingbridge financing we had in place for that deal. We put in place a three-year$30 million revolving credit facility, secured by the factory mutual propertyin Johnston Road Island, which is otherwise unencumbered

The facility is available as a general line of credit forany cooperate purpose. In August as the credit markets fall out accelerated, wesuccessfully completed the routine renewal of our warehouse line for anotheryear. As expected we extended our core borrowing capacity of $250 million untilAugust 2008 with the accordion feature of $500 million of capacity extended untilwe complete our long term financing of the assets on the line.

In October, we accessed the capital market to add additionallong term capital to the balance sheet reduced our Warehouse balance andprovide us with enhance flexibility to take immediate advantage of growthopportunities when they arise.

In an over subscribe transactions we issued $75 million of7.5% convertible senior notes due 2000, 27. We used $26.3 million of theproceeds from the notes to reduced interest expense by paying down some of ourhigher cost warehouse debt and another $15 million to repurchase shares of ourcommon stock at the closing of the offering in part to offset customary hedgingactivity by note buyers.

The remaining proceeds provide us with additional cashliquidity and are expected to be used at new high quality long-term assets toour portfolio. As we moved to the forth quarter, our focused is on the longterm financing of the existing assets under our warehouse lines.

In July and August, we and other market participants beliefthat the CDO market would return relatively quickly for financing high qualitylong-term assets, we no longer belief that to be the case.

Compared to many other market participants who relied solelyupon the structure markets and CDO markets for financing, we have a variety ofcost effective long term financing options. Our loan assets are transparent andare extremely high credit quality, are not likely to face interruptions to cashflow and for the most parts significantly amortized over their expected term.

Accordingly, these assets have very attractive financingcharacteristics, and we have found in appetite away from the structure marketsfor lending against our investment portfolio on a long term fixed rate non-markto market basis.

We are actively pursuing these opportunities. We’re makingsignificant progress and hope to get a financing completed in the reasonablynear term that we cannot provide complete assurance today about the timing ofthe successful transaction.

A small, but important part of our business model is basedon our ability to finance the debt assets we own on a long-term basis. Over our12-year history, we have issued net lease CMBS, financed installed home loansand small structured loan pools and we’ve issued one CDO.

We believe the structure real estate finance markets willresume as a vital and liquid market before too long. However, cap lease withour knowledge and high quality assets is not dependent on any one financingstrategy, and we will adapt our approach as necessary to access to thosesections of the market that will give us lowest cost of debt on the bestavailable terms.

The real estate finance market is changing. It’s not goingaway. As for our current pipeline, we continue to see a steady flow of highquality property acquisition in mortgage opportunities. The flow oftransactions that we’re seeing has picked up recently as property sellers areslowly returning to the market as the new pricing reality is beginning to setin.

While we have seen some improvement in cap rates,particularly when compared to where the benchmark 10-year treasury is trading.In general, they still are not currently at levels that are attractive to usfrom a historical prospective, in light of financing cost uncertainty.

We believe property prices may adjust further once thefinancing markets stabilize. Though in general, investment grade, net lease caprates have less volatility than those in the broader real estate markets.

Given current conditions, we expect our new investment payswill remain slow for the remainder of 2007, though we have the balance sheetand the liquidity to take advantage of attractive opportunities as they arise.

And while we need some additional visibility in the marketsbefore we can comment more specifically, we anticipate that there will bematerial improvement in conditions and our ability to add new assets in 2008 asrelative financing cost come down.

It is worth noting briefly that while financing cost hadcurrently risen that this phenomenon has no impact on our existing own propertyportfolio. In annualizing the 62 properties encompassing more than 10 millionsquare feet that we own it is too simplistic to just look at CAP rate as thesole measure of value of that portfolio.

Instead, the value of our property cash flows need to bemeasured against the advantages long term fixed rate financing we have inplace. That locked in financing gives us very strong returns on our investedequity dollars that are not affected by current market trends.

We don’t know when the weak and broader real estate marketswill return to normal, but we do know that CapLease's dividend yield of morethan 8% is the highest of our peer group. Further, that dividend is only 78% ofour expected 2007 FFO and is fully covered by our existing investment gradeportfolio on a cash basis and that coverage is expected to grow meaningfully in2008.

While our projected annual per share FFO is also expected torise, compared to full year 2007 even if we don’t add another asset. Inclosing, the third quarter revealed the strength of our business model and thedeep experience of your management team. In the phase of a severe marketdislocation, our high quality long-term portfolio continued to perform asexpected generating record quarterly results.

Our recent actions have further strengthened our liquidityand balance sheet and we remain confident in our ability to weather any furthermarket downturns and are in a solid position to resume our steady growth inassets when condition warrant.

I’ll now turn the call over to Shawn.

Shawn Seale

Thank you Paul and good morning everyone. As Paul indicated,we reported record third quarter 2007 FFO results within the range of ourpreviously announced guidance. FFO was $13.3 million or $0.29 per share and netloss to common shareholders was $105,000 or rounded to $0.0 per share.

The difference between FFO and GAAP earnings consistedprimarily of depreciation and amortization expense of approximately $13.4million. Total revenues for the quarter were $46.6 million, up 51% from $30.9million in the comparable period in 2006.

At quarter end, our overall portfolio was largely unchangedfrom June 30 with over $2.1 billion in real estate and investment assets ofwhich about 78% are owned properties. Our diverse property portfolio includes62 properties across 26 states leased to 33 different tenants and it exceeds 10million square feet.

One of the unique characteristics of the portfolio thattruly differentiates CapLease is the credit quality of our tenants, which isexceptionally high. The weighted average underlying Standard & Poor'stenant credit rating on our owned properties is single A.

In addition to our largest tenant, which is the U.S.government our tenant base is for the most part made up of large publiclytraded cooperation and this provides a very high level of transparency in termsof our investment. We believe that the quality of our real estate portfolio isunmatched in the Nestle space.

During the quarter, we renewed our warehouse facility, whichis our primary short-term borrowing facility for another year during August. Werepaid in full the EntreCap bridge facility in July and we retired the existing$41.6 million mortgage debt on the Kroger properties.

Our Nestle properties were refinanced in July with five yearmortgage notes totaling approximately $147 million an obvious amount wefinanced $117 million with an external first mortgage loan at an effectiveinterest rate of 5.65%. The remaining $30 million of inter-company notes areexpected to be financed through a structured financing or term loan withsimilar characteristics.

The factoring mutual property now secures a new $30 million,three-year revolving credit agreement, which means ten years to support futureinvestment activities and to generate liquidity as necessary. We will payinterest on these borrowings at one-month LIBOR plus 125 basis points.

As of today there have been no advances under this facility.The Qwest properties have been refinanced with $23 million of borrowings on ourwarehouse line with interest payable at one month LIBOR plus 70 basis points.We do not intend to refinance the debt on the Travelers property at this time.

Overall, our portfolio leverage stood at approximately 78%at September 30. We believe our leverage is conservative given the assetquality and long-term nature of our assets and the long-term in place financingwe have against them.

As of September 30, approximately 80% of our overallportfolio is financed with long-term match funded non mark-to-market etcetera,including 88% of our owned property portfolio. Our cost and the terms of thesefinancings of these assets are not and will not be impacted by the currentconditions in the credit markets.

At September 30, the company had $10.2 million of cash andcash equivalents plus about $9.8 million in cash held inside the CDO pendingreinvestment.

We had $1.6 billion in net real estate investments, $267million in loan investments, and $205 million in various net lease securitiesincluding CMBS. Overall, total assets were $2.1 billion.

On the liability side at September 30, we had $387 millionof debt outstanding under our warehouse line, $986 million of long-term fixedrate mortgage debt on individual property investments and $268 million financedunder our fixed rate CDO.

To give a quick snapshot of where we are after the closingof our recent convert as of today we have approximately $30 million of cash andcash equivalents and $7 million inside of our CDO pending reinvestment. We haveno outstanding borrowing under the revolver and roughly $360 millionoutstanding under the warehouse. The carry value of the asset in the warehouseis about $460 million.

While representing only 10% of our total assets, let me saya few things about our securities portfolio. Each quarter we routinelydetermine the fair market value of our securities available for sale. In thethird quarter we had a decline in the value of these securities as a result ofthe generally wider credit spread that have foreboded the broad market.

We believe that these value declines are temporaryparticularly when compared with our expected holding period. The changes invalue are not the result of a decline in the performance or credit quality ofthe security classes for the collateral that supports these classes and;therefore, consistent with prevailing accounting standards we recorded thesechanges in value as a component of other comprehensive income on our balancesheet.

We do not currently expect any change in the cash flow fromthese securities that we own or losses in the underlying collateral and weintend to hold the securities for a sufficient time to allow for a fullrecovery in value. G&A for the quarter was up 547,000 from the prior yearperiod; primarily due to the addition of two senior personnel late in 2006 andhigher legal fees. A significant piece of which was related to the EntreCapdebt repayment.

G&A was as budgeted and is not expected to growmaterially in the fourth quarter. Today our G&A is only 6.7% of revenues,which we believe compares very favorably with some of the most respected rigsin the market place and we still have significant room to scale our operatingplatform.

Now, let me discuss our guidance. We’re affirming our fullyear 2007 guidance, estimating FFO to be the in the range of $1.1 to a $1.3 pershare and earnings per share in the range of minus $0.15 to minus $0.13 pershare.

These numbers equate to guidance following the fourthquarter of 2007. That’s affordably in the range of $0.26 to $0.28 per share,and earnings per share to be in the range of minus $0.04 to minus $0.02. Ourguidance included the impact of the convertible note offering we completed inOctober and does not include any material impact from gain on sale activity.

We compute our FFO based on the NAREIT definition. Thedifferences between FFO and earnings per share are add-backs for depreciationand amortization on our real estate properties and minority interest on ouroperating partnership units.

FFO includes the deduction for stock-based compensationexpense, which was $0.08 per share in 2006 and is estimated to be roughly $0.04per share in 2007.

However, in analyzing the earnings power of the Company, webelieve that it is appropriate to adjust FFO to add back the stock-basedcompensation since it impacts reported FFO by both lowering the FFO andincreasing the share count.

For the fourth quarter of 2007 we expect stock basedcompensation expense to be approximately $1.001per share. Finally the straight-linerent adjustment for the third quarter was a negative $4.6 million over the next12 months straight-line rent adjustment is expected to be approximately anegative $6.7 million as we previously discussed the adjustment is secured fromquarter-to-quarter due to certain property leases, which pay rent, semiannually rather than monthly.

I'll now turn the call back to Paul for some final comments.

Paul McDowell

Thanks Shawn. CapLease had a very solid year-to-date by anymeasure, despite the issues in the broader markets. We are a significantlylarger company than we were in the comparable period just a year ago. Ourequity base grew by 25%, our asset base by 44%, our revenue by 51% and pershare FFO by 32%.

We have prudently taken the steps necessary to solidify ourcapital structure and strengthen our balance sheet particularly in light ofmarket conditions. Our business model and the strategy to finance that businessis proven having added on average $545 million of assets per year, during thethree short year, we've been public.

Our assets are primarily lead to investment grade tenantsand are performing as expected. We have one of the highest dividends in ourpeer group and that dividend is covered by our existing asset base and that coveragewill increase meaningfully in 2008.

This experienced management team has a build a company thatassembled a stable high quality asset base that supports our ’s stable dividendand has meaningful growth prospects in the years ahead.

We are now ready to answer any questions that you may have.Operator, please open the phone line.

Question-and-Answer Session

Operator

(Operator Instructions) We have our first question fromSheila McGrath, KBW.

Sheila McGrath - KBW

Good morning, Paul. I was wondering if you could talk aboutopportunities on the debt side right now versus property acquisitions and howyou view that?

Paul McDowell

Sure. I think Sheila, when you see market go through thetypes of events we've been seeing over the past several months. You see a veryrapid change in the pricing associated with debt transaction and a much slowerchange in the pricing associated with property acquisition. Accordingly we’veseen some more attractive debt opportunities than we’ve had, then we’ve seenover the past several years.

But we've been cautious in pursuing those opportunitiesgiven the continuing uncertainty. Cap rates have the tendency to lagsignificantly changes in market conditions. We are currently seeing that, investmentgrade cap rates have got significantly less volatility, than you might see inthe broader real estate market.

So, you'll see sort of cap rates have remained reasonablystable to trending up wards slightly given in the current market and we expectthat will continue as debt market settle down.

Sheila McGrath - KBW

Okay. And on the financing that you alluded to and do youthink that would be possible to get that wrapped up before year-end?

Paul McDowell

I am not going to speculate for you Sheila. Lets state weare focused very intently on getting those assets financed on a long-termbasis.

Sheila McGrath - KBW

Okay. Thank you.

Operator

We’ll go next to Jonathan Litt, Citigroup.

Ambika Goel - Citigroup

Hi, this is Ambika for John. Can you comment on thisperspective alternative financing, what the rates are and what kind ofstructures. I know that you’re considering several different options. But justto give us a feel of what these other options are, that would be great?

Paul McDowell

Sure Ambika. I am not going to comment necessarily on therate, beyond saying that we expect that, ones the financing is completed willhave an acceptable return on equities for the finance, finance, for the assetsfinanced. So we're comfortable with the rates that were talking marketparticipants about.

The net lease asset class of the financing asset class, it’sbeen around for a long time. And there are a large number of institutionalplayers like Life Insurance Company’s and Pension Funds who have got long-termassets who for many years have finance long-term net leased properties andthese are the exact types of institutions to which we use to when we had gainon sale activity, we use to sale our net leased loans too.

So we know, who the market participants are. We know thatthey like this asset class. Many were talking them about potentially financingit on a long-term basis with on a pool long-term fix rate financing.

Ambika Goel - Citigroup

No. Before I think you were talking about on all in ratearound the 6% range with that, is that the same kind of range who runs withthis potential financing?

Paul McDowell

Yeah. I’m not sure we’re going to comment. I’m not going tocomment exactly on that. Just Ambika, just to say we’re not surprised ordishearten by the rates we’re looking at.

Ambika Goel - Citigroup

Okay. So could we assume that’s its higher than theirprevious rates of what you expected to get in the CDO market?

Paul McDowell

Well, I mean credit spreads are wider than they were sixmonths ago. I think, we would expect some increase in debt financing costversus where the market was six months ago.

Ambika Goel - Citigroup

Okay. That’s great. And then just going back to your currentcapacity under your various lines of credit, what is that could you kind ofreview the different pieces?

Paul McDowell

We have warehouse facility, which currently is $360 millionagainst an asset base of roughly 460.

Shawn Seale

If total capacity there is 500 Ambika.

Ambika Goel - Citigroup

Okay.

Paul McDowell

We got capacity there of 500 until we get the assets thatare there financed away. And we have $30 million underline revolver facility.And we have cash on the balance sheet of roughly $30 million and $7 million inCyber, CDO.

Ambika Goel - Citigroup

Okay. And then just going back to the $500 million how muchis drawn on that?

Paul McDowell

360.

Ambika Goel - Citigroup

360. Okay. Great. Thank you.

Operator

We’ll go next to Will Marks, JMP Securities.

Will Marks - JMP Securities

Thank you. I have one question just as it relate, I miss thebeginning part of your call. But I seen you hadn’t comment it, any thought onthe Grama C deal and how that ties into valuations or your business in general?

Paul McDowell

Well, I mean I think Grama C buying AFR. We haven’t done thedue diligence on AFR but on the surface, it’s certainly looks to me like GramaC has gotten a very strong transaction, particularly for the component ofassets in AFR that are long-term in nature. I think there is a lot ofcomplexity at AFR that’s going to take Grama C, sometime to unwind. But ingeneral, it looks like they got a really strong transaction.

Shawn Seale

I think you also have to dig in and I wouldn’t take it facevalue what the kind of chatter is from that transaction in terms of where caprates are. It’s never as simple as people like to pay that. I can tellanecdotally, we still see a lot of transactions in the volume being a largetransactions we market on the net leased side being done at vary attractive caprates. Meaning it’s not at all easy to by properties still in this environment.

Paul McDowell

With very large component I think Grama C said in their callvery large component of their cap rate assumptions with respect to A4 assets isdependent upon then selling quite a number of their asset today of our holesand lowering the basis on the properties they keep. So with respect to what wesee in the marketplace, we see investment rate, cap rates, and remainingreasonable stable and a lot of activity and demand for properties continuing onthe purchase side.

Will Marks - JMP Securities

Okay. Great. That’s very helpful. Thank you.

Operator

We’ll go next to Jeff Donnelly, Wachovia.

Jeff Donnelly - Wachovia

Good morning guys. I guess as the follow up to that couldyou mentioned you do or did not do due diligence on AFR, why didn’t you guysconsider looking at American venture?

Paul McDowell

That’s a complicated. That’s a little bit of complicatedquestion. We share Chairman with AFR and that always provide presents wellsomeway as you think that should make life easier. Because of the potentialconflict of interest or where we see parent conflict of interest.

We are focused on growing CapLease, organically fromasset-by-asset basis and didn’t think that it was we don’t have a largeproperty management arm here, a very large component what AFR does is propertymanagement, selling of assets that’s our various expertise.

Jeff Donnelly - Wachovia

Okay. And I apologies like really. I have to priorconference call earlier then expected so I might have missed some early comments.But if I could pin you down maybe a little bit on ’08, I guess, I was curiousare thinking about investment activity for next year? I mean, do you expect youwill be increasingly active as the year progresses or what sign do you guyslooking forward to help you make the decision when the public trigger on newinvestments?

Paul McDowell

Well, to answer the first part of our question. Yes, in factyes, we expect to be active in 2008 in adding institutional assets for thebalance sheet. The key triggers that we look for is going to be thestabilization, doesn’t necessary have to be at a particular level. We just needto see the stabilization of financing cost so that we then understand what ourcost of debt capital is going to be as against to the property purchase priceunless we got out and pursue them in the marketplace.

We start some scientist stabilization in September and earlyOctober that is obviously changed somewhat over the past several weeks as we gointo this latest round of credit markets ups and downs. But we expect as 2008progresses that the financing market will settle, we’ll understand wherefinancing cost are and we are in good strong position from a balance sheetperspective once that occurs to start adding assets.

Jeff Donnelly - Wachovia

I’m curious maybe it is a little bit broader then how I seebut what step you feel need to transpire, I guess in order to further thecredit markets to stabilize or clear and re-establish, is ready for credit?

Paul McDowell

I wish, I knew, I think, that obviously what’s going on nowis there is a lot of concern about mark-to-market with respect to residentialassets on a lot of very large market balance sheets. I think, one stockresidential uncertainty starts to clear through the market place and we get aclear sense of where the economy is going. You’ll see the markets stabilize andthe demand return to financing a real estate asset.

Jeff Donnelly - Wachovia

And just two last questions. Assuming the other net lease companiesout there have raised I guess relative to there historical activity substantialquantities of debt and equity capital of past 90 days. Is there a hefty volumeof transaction opportunities in the market today with an attractive pricing ordo you think that’s more precautionary on their part. And I guess what’s yourattitude towards reducing financial average at this juncture?

Paul McDowell

Well, I think it’s a little bit of, I think we will look atit, the same way to some degree that other market expense as well, it’s not, Iwould say at this moment in time the environment for purchasinginvestment-grade, net-lease properties is not particularly favorable giving theuncertainty surrounding financing cost.

But this uncertainties amounting financing cost can clearrapidly. So it make sense to have that cash on the balance sheet then to beable to take advantage of market condition when they do improve that’s exactlythe position we’re in.

With respect to financial leverage, we expect our financialleverage. If we do nothing, our financial leverage will trend down as ourunderlying fixed rate debt amortized, remember we have very steeply amortizingdebt on the properties that we owned.

So as that debt amortizes our financial leverage by its verynature comes down. And with investment-grade set of asset we’re comfortablewith the current leverage where it is and we would expect that we wouldmodestly de-leverage over the next several years.

Jeff Donnelly - Wachovia

And just last on our margin-buying portfolio, any change indelinquencies or default experience since the prior quarter?

Paul McDowell

No. It was our zero and it continues to zero in terms ofdelinquencies and default. And is expected to remain zero.

Jeff Donnelly - Wachovia

Hi, great. Thanks guys.

Operator

We will go next to Merrill Ross, FBR.

Merrill Ross - FBR

Hi, I think the questions basically being asked andanswered. I was just going to ask whether it takes to get off to side line particularly,if you feel you need to arrange this terms financing before you come back intothe market in ’08 but I believe you and to through that Shawn take another shotat?

Shawn Seale

No, I think we pretty much answered it now. We’ll get theterm financing; although, I would add one caveat and that is say, if we see avery attractive financing opportunity now we are well position to takeadvantage of it and we will do so.

Merrill Ross - FBR

Unlike if you guys, some seller financing that wasnon-marginal and recourse etcetera?

Shawn Seale

Where you could buy, that’s right, whether we have capacityin our warehouse facility. We have cash in the balance sheet. You can alwaysbuy a property with debt in place. So, there are variety of options. It’s justa question of making sure you get the right transaction in this marketplace.

Obviously, once we have completed the term financing of theassets in the warehouse line that will open us up more greatly than we aretoday. So, we’re in a position to execute our transaction today, if we see onethat’s attractive.

Merrill Ross - FBR

Great. Thank you.

Operator

We’ll go next to David Fick, Stifel Nicolaus.

David Fick - Stifel Nicolaus

Good morning. I don’t know that you really address thebusiness model question here, I think we are going to sort of a 100-year eventscenario and you say that financing conditions can clear rapidly, I think it’syour exact words. But how could you be so sure? Number one.

And number two, this term financing event that you areworking on you really not willing to discuss pricing, but is there a riskadjusted spread there and are you really locking in, you know on a mass fundedbasis, sufficiently did that becomes the new business model?

Paul McDowell

The answers if we, when and if we get the term financingcompleted, we will have done exactly that data. We will have got attractivefinancing on a long-term fixed rate basis.

David Fick - Stifel Nicolaus

And is something that you can replicate and if need be itcan become a new business model and…

Paul McDowell

Absolutely.

David Fick - Stifel Nicolaus

All right.

Paul McDowell

Absolutely.

David Fick - Stifel Nicolaus

So, you are not depending on the recovery in the debtmarkets because you don’t know what’s going to happen, we had a good session?

Paul McDowell

Yeah, when we are not depending up on David, we are notdepending up on recovery in one specific sector of the debt market, right. So,some markets participants, their entire business model is build aroundaggregating assets and issuing collateral like debt obligations, that is notour business model.

So, the decline or if you will the demise of the CDO market,does not have a negative long-term impact on our ability to finance the assetsthat we put on our balance sheet, in fact most of our financing is just planevanilla first mortgage loans on the properties that we buy.

Where I talk about the financing market clearing, I will bequick to recognize that leverage levels and spreads are not going to rapidlyretreat their steps to where they were in April and March.

However, right now, as you know the CMBS markets are notfunctioning normally that versus normal origination, there is not normalpricing. I think that once the CMBS market.

And broader real phase finance markets understand where thelong-term financing is for those assets you’ll see those markets stabilize andget some pricing, that is reflective of the underlying risks and that’s rightnow, I don’t think anyone knows what the underlying risks is, and so you areseeing lots of volatility, that’s what I mean by stabilization.

David Fick - Stifel Nicolaus

And that’s why I think people are skeptical about the termfinancing approach and you got right now in your mortgage portfolio a bigspread, I’m sorry, in your mortgage liability a big spread between the mortgageconstant and the interest rate.

And so, you got to have a cash flow spread to have abusiness modeling works too and I guess what you’re is in this term deal, youare going to have both a sufficient cash flow spread and an earnings spreadthat you think is logical?

Paul McDowell

Yes.

David Fick - Stifel Nicolaus

Okay. The converts that you just issued, what is theaccounting going to be there and how does the pending change in accountingeffects you?

Paul McDowell

We expect David, the proposed accounting change will go intoeffect for 2008 meaning there portion of our convert will be treated as equityand effectively increased our interest expense.

Assuming that it happens think about 3.5% increase tointerest expense for 2008 versus not treating it that way. We’ve assumed that,that going to effect and that will be subject to that accounting convention.

David Fick - Stifel Nicolaus

Okay. And then, I’m a little confused on change in guidancebecause their explanation is for LIBOR shift, the LIBOR is down lower than itwas in August?

Paul McDowell

Well, let me be a transparent I can be with David, becauseit’s obviously very important. The expected yearly results that we have feltthe impact from as compared to when we put out the original guidance of 105 to108 in the spring, we’re impacted by a spike in LIBOR.

So that since moderated, but remember with our warehouselines reset, they reset month-to-month, so that had some negative impact on uswhen LIBOR went up.

We had delay in the permanent financing of the assets, thatwe sledded for CDO, is now looking to be delayed and looking for anotherlong-term financing exit. We had somewhat less investment volume then weexpected in the spring. And there is of course an impact from the convert.

Now the convert was added to us additional liquidity in cashto take advantage of market opportunities. So, it has a near term impact, butwe think it’s a long-term positive.

So the point is David there, that we don’t meant to implythat the only impact what that the results of LIBOR movement, we recognize as aLIBOR spike guard that has now come back, but it just sort of variety of smallthings that added up to a couple of sudden change in our yearly expectation.

David Fick - Stifel Nicolaus

That’s reasonable. Thank you.

Operator

We’ll go next to Charles Richard, Zammer (ph).

Charles Richard - Zammer

Good morning gentlemen. Could you. I have a couple ofquestions the evaluation of company versus the stock prices, which is steadythree quarters. And my numbers, it looks like you’re trading for just overeight times FFO, north of 9% dividend yield.

Could you explain the thoughts about why you wouldn’t takeone or two of your assets at least to the Federal government or there’ssomebody else in a long-term basis and place them with foreign investor who cantake advantage to achieve dollar.

You kind of prove to the world of the shareholders that thevolume that inherent in portfolio and take the proceeds that maybe pay downsome debt and then rest of proceeds you can buyback share your shares. You certaincan buying the assets. I’m virtually short that the same kind of valuationlevels that your stock is trading at?

Shawn Seale

Well, we could in fact do exactly as you say, right. Youcould sell from assets or joint venture some assets. That is something that wehave and/or and continuously consider. With respect adding additional assets,we have the capital inflate to add assets or in general on an average basis, wesee returns on equity on the existing portfolio, which we’ve said before in thelow-teens. So we could certainly add accretive assets today, now we standingwhere our share price is?

Charles Richard - Zammer

I guess…

Shawn Seale

Those are good idea. If you say if you get…

Paul McDowell

Charles does are exactly types of things we discuss hereroutinely.

Charles Richard - Zammer

Okay. Well, I guess, let me add a couple more things. Iguess, I’m a little confused on the fixation for growth, for growth sake, Imean, we always have to kind of look at the share price and what shareholderreturns are, we’re less than the IPO. This is kind of something, which isgrowth is probably better for management and it’s been for shareholders.

My thought, if you don’t want to dramatically change yourbalance sheet and you restructure your company, it just take $120 millionassets or $130 million asset to sell it, issue a press release and say, we soldit for 6.5 or 7% cap rate, we took the proceeds that we’re going to use mostlikely to buyback share.

So people can actually do the math and say there’s no waythis company should sell for $8.75 with the 9.25% yield with the quality oftenants with the term that you have and the whole package. It such too cheapand I think just selling one property with the stronger were press release,kind of waken up some folks to what’s happening?

Paul McDowell

Like we said, with that type of advice we alreadyconsidering, while we can’t control the stock price. We agree there’s asignificant disconnect with the value. We’re creating compare to the stock. Andlet me just comment very specially on the first thing you’ve said, we are notout for growth merely for growth sake.

When we add additional assets the fundamental test we alwaystry to meet, just to make sure that, that assets is accretive to ourshareholders. If you look at our year-over-year results, you’ll see exactlythat.

Charles Richard - Zammer

Okay. Well, hopefully maybe there is some things you can doin the future that will demonstrate to the market and to the world of thediscount going on here on CapLease. Thank you.

Paul McDowell

Thank you.

Operator

(Operator Instructions) We’ll go next to Bob Gasson, AlphineFund (ph).

Bob Gasson - Alphine Fund

Good morning. A quick question. Shawn mentioned aboutstraight-line rent being lumpy I thought you gave a number of $6.7 million forthe next 12 months. The annual fourth quarter number 6.7 and that’s going to belumpy within that or what does the 6.7 represent?

Shawn Seale

Yes, hi Bob that is the forward number from September 30 orOctober 1st forward. So, its negative $6.7 million and it will some quarterswill be positive adjustment as we received those semi-annual rent and anotherquarters will be negative like this quarter was. The 2008 estimates, is about$6.1 million negative. So its $6 million to $7 million right now.

Bob Gasson - Alphine Fund

Okay. And what’s the, if we’re really going to CAD numberfor distribution, what is the amortization or the principal amortization ondebt? How much more does it take that cash available for distribution down?

Shawn Seale

Right, I don’t have that figure in front of me, but I’lltell you that most people do not include principal amortization in the CADnumber.

Bob Gasson - Alphine Fund

I understand. I’m just. But it’s certainly as relevantnumber than what the clearance is on how much you can pay to shareholder?

Shawn Seale

Yes, it absolutely is. I agree with you.

Bob Gasson - Alphine Fund

Okay. So, I could get that outline from you?

Shawn Seale

Yes.

Bob Gasson - Alphine Fund

Thank you.

Operator

We have no further question in the queue at this time. I’llturn the conference over to Mr. Paul McDowell for additional or closingremarks.

Paul McDowell

Thank you everyone. We appreciate your time today and yourvaluable questions and we look forward to speaking with you again when wereport our fourth quarter results.

Operator

That concludes today’s conference call. You may disconnectat this time. We do appreciate your participation.

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Source: CapLease Q3 2007 Earnings Call Transcript

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