RAIT Financial Trust Q4 2007 Earnings Call Transcript

| About: RAIT Financial (RAS)

RAIT Financial Trust (NYSE:RAS)

Q4 2007 Earnings Call

February 28, 2008 3:00 pm ET


Andres Viroslav - Investor Relations

Daniel Gideon Cohen - Chief Executive Officer

Jack E. Salmon - Chief Financial Officer and Treasurer

Scott F. Schaeffer – Co-President

Betsy Z. Cohen - Chairman


Andrew Wessel - JP Morgan

David Fick - Stifel Nicolaus

Jason Arnold - RBC Capital Markets

Jason Deleeuw - Piper Jaffray


Welcome to the Q4 2007 RAIT Financial Trust earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today, Mr. Andres Viroslav, Vice President and Director of Corporate Communications.

Andres Viroslav

Good afternoon to everyone, thank you for joining us today to review RAIT Financial Trust’s fourth quarter and fiscal 2007 financial results. On the call with me today are Daniel Cohen, Chief Executive Officer; Betsy Cohen, Chairman of the Board; and Jack Salmon, our Chief Financial Officer.

This afternoon’s call is being webcast on our website at raitft.com. There will be a replay of the call available via a webcast on our website, and telephonically beginning at approximately 5:00 pm Eastern Time today. The dialing for the replay is 888-286-8010, with the conformation code of 85751563.

Before I turn the call over to Daniel, 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 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 would like to turn the call over to RAIT’s CEO, Daniel Cohen.

Daniel Gideon Cohen

Thank all of you for being with us this afternoon. Obviously, the second half of 2007 was a difficult time for many companies, almost all companies in the financial sector. The closure of the capital markets and lack of liquidity overall has led to unprecedented re-pricing of risks in debt and equity financing.

As Jack will go over, from our tangible book today to tangible book as of December 31 to tangible book as of January 1 if you only look at the assets, you really don’t get a full picture of the value of the matched book that we have and we have to continue to generate our earnings. Our underlying borrowers however suffered substantial stress as well as valuation of the assets that we hold.

Our fourth quarter results or book value and economic book attested this to the non-cash charges, charges which have not affected our cash flow. However, the company continues to generate substantial cash flow. It generated $0.47 per share this quarter of adjusted earnings and continue to generate cash flow, which is, we detailed in our press release and will further detail on our 10-K.

We expect to be $214.3 million of gross cash flow this year, before servicing our convertible debt and our preferred equity and our overhead expenses. This provides cash flow ample to pay our dividend. We feel that these are important performance measures for investors to review, as well as our REIT taxable income, since the company refers to them when considering our common dividend levels.

We also reported our economic book value at the end of the quarter of $10.52 per share. This included the negative value attributed to effective hedges as interest rates declined over the quarter, as well as approximately $196 million of net temporary impairments in our available-for-sale securities portfolio during the fourth quarter.

We believe economic book values is a valuable measure for shareholders, as it facilities evaluation of us, without the effect of unrealized losses on investments in excess of our value at risk. But of course, it does incorporate the negative impact of hedges, which are effective hedges against which we match our assets and our liabilities.

Now looking forward, during 2008, we will focus on delivering cash flow and cash flow results, and growing our businesses of working with third parties and commercial banks to fund new loan growth.

We also expect to see fee income continue over the year and joint ventures on the development of funds to take advantage of dislocation in the marketplace. We are starting to see good opportunities now out there and continued opportunities to fund loans.

To accomplish this, we are executing on the following. In the near term, we are maintaining our balance sheet and growing our fee income. Origination efforts are geared towards our domestic commercial real estate lending platform, which currently generates more than 55% or $119 million of the annualized gross cash flow.

We continue to lend in Europe with approximately $528 million of available capital to lend at the European real estate related assets as of December 31, 2007. We currently manage $1.7 billion of real estate related collateral in Europe, which generates approximately $13.6 million of gross cash flow for us.

We expect to continue to earn new origination fees and incremental asset and management fees as these available funds are invested. We have not experienced any significant impairment in this portfolio.

In today’s market environment, these securitization techniques to finance structured assets, is simply not an option. We are quickly reverting to life without access to these sophisticated debt capital market techniques. Specifically, we have and expect to finance our commercial real estate lending pipeline through commercial real estate loan repayments in our existing portfolios.

Recycling capital and revolving debt capacity with our current real estate securitizations and reinvesting proceeds from paybacks at higher rates with low cost long-term sources of funding. We are expanding our commercial bank lines of credit and our commercial bank line partners, I will talk about this briefly in a second, and we are continuing to sell senior participations in loans that we originate as well as continue to develop sources of joint venture capital.

Now, we have closed on a number of these sources over the fourth quarter and really into the first quarter of this year and we expect to expand these sources as our origination network can be used to take advantage of the dislocations today in today’s real estate environment.

Now, when we have reduced, we will expand our asset origination for third parties and maintaining our balance sheet and trying to redeploy capital into higher yielding assets. At the same time, we are maintaining our balance sheet and reducing our exposure to short-term repurchase financing. We have done that by $74 million in the fourth quarter, with the year-end balance of the short-term repurchased financing of a $138 million.

This represents reduction of more than $1 billion since December 31 of 2006. We are focusing on reducing our remaining exposure and we expect to manage that balance down even further during 2008.

Though, we expect to generate approximately $58 million of gross cash flow from our domestic TruPS assets under management, we’ve stopped originating new domestic TruPS. This is in turn led to cutting back personnel that previously were responsible for originating this asset class. This severance does affect our financial results, and we will continue to reduce. Since that showed up in our fourth quarter financial results, we are continuing to reduce our expenses where it might be appropriate.

Subsequent to December 31, I will point out; we’ve originated approximately $125 million of new commercial real estate loans and finance the majority of the transactions by the sale of senior participations to banking relationships and institutional investors. We have closed on approximately $150 million of assets in Europe since then as well.

I will give you an example of the kind of business that we are seeing. We made a $70 million loan against the property in New York City with the rate of LIBOR plus 375 in a floor of 835. The loan-to-value was substantially below what we have been seeing in the previous quarter approximately less than 70%. The loan was funded primarily with the sale of senior participations to three participants.

We expect the fully funded IRR to be above 40% and we earned fee income. We invested only about $4 million of our own capital. These types of opportunities will continue to be there. We will also pursue opportunities that we see through our bank partners and we expect today’s environment to be fruitful to deploy our capital when it becomes available in permanent funding vehicles on balance sheet and in combination with third parties.

This has been a challenging market over the last nine months and we believe it will continue to be challenging going forward. We will make sure that we maintain adequate liquidity and we won’t be overextending ourselves. However, we do believe that we are beginning to see openings that can be turned into opportunities. On the origination side, we are seeing a beginning of steady demand for our very high quality commercial lending opportunities with favorable pricing.

Before I turn the call over to Jack, I would just like to emphasize although the current market liquidity environment is very difficult, our existing portfolio is solidly generating cash flow and we expect to continue to do so.

We believe that we have addressed the key risks in our portfolio with adequate liquidity and though, we are currently in a defensive posture in terms of new asset origination, we believe we are building new relationships and taking the appropriate steps to position and grow the company over the medium and long term.

On that note, I would like to turn the call over to Jack to go through the financial results and provide some more details on our quarterly and year-end 2007 results.

Jack E. Salmon

I am going to review our fourth quarter and year-end 2007 financial results. This will provide you with an additional insight to the changes in our investment portfolio that Daniel just described as well as describe any resulting effects on our adjusted earnings and dividends.

First on the financial results in the fourth quarter, total revenue for the quarter was $35.7 million, which was less than the third quarter revenue of $56 million. This decline reflects payment defaults in our domestic TruPS portfolio, an increase in non-performing loans, primarily in the TruPS portfolio, a $5 million increase in our loan loss reserves, a $13.4 million decrease in the value of our non-hedged derivatives, and a $6.5 million reduction in fees and other income.

During the quarter, we disposed of assets in our securities portfolios at a loss of just under a $100 million, which was offset by gains of $117 million upon the partial disposition and deconsolidation of two of our Taberna CDOs. This thereby, permanently removed these assets and their related liabilities from our consolidated balance sheet.

We adjusted the carrying values of certain TruPS and other securities for other than temporary impairment charges of approximately $93 million. We charged off $5.6 million of certain intangible assets and the entire amount of goodwill which was $75.6 million.

These non-cash asset impairments totaled $174.5 million contributing significantly to our $183.5 million net loss for the quarter. The asset impairments for the whole year totaled $517 million, causing a net loss of $379 million after taking in account minority interest.

Turning to adjusted earnings, the net loss of $379 million for all of 2007 compares to $67 million of net income a year-ago. The asset impairment charges I described and other non-cash items were added back to determining our adjusted earnings of $28.6 million or $0.47 a share for the fourth quarter and a $166.9 million or $2.75 per share for the full year in 2007. This compares to adjusted earnings of $0.49 for the fourth quarter of 2006 and $2.54 for all of 2006.

For your benefit, a reconciliation of our GAAP net income to adjusted earnings is attached in the Schedule 2 to the press release.

Turning to dividends, our adjusted earnings that I just described corresponds to the most recently quarter dividend of $0.46 per common share that was paid on January 14, 2008. On an annualized basis, we generated $2.75 of adjusted earnings per share in 2007 and declared dividends of $2.56 per common share. Our investments in our portfolios have changed significantly as a result of the activities in the last half of 2007. And as I described, we’ve taken asset impairments in several of the portfolios, which I will now describe.

Turning first to our most important portfolio, our commercial real estate mortgage portfolio, we have a total of $2.2 billion of investments in the commercial real estate and asset portfolio, of which, $1.3 billion was originated during 2007 compared to a generation of $1.0 billion during 2006. The growth in this portfolio has been significant, although, it was primarily done in the first nine months of the year.

The CRE investments include approximately $42 million in non-performing loans at the end of the year representing just under 2% of the total portfolio. The portfolios are generating returns on our $791 million of invested capital at a rate of over 15% on an annualized basis.

Our second portfolio was our residential mortgage loan portfolio. This represents a portfolio of approximately $4.1 billion of securitized residential mortgages, which is decreased by approximately a $100 million in September 30, 2007 based on the normal repayments of the underlying mortgages. These are high-grade adjustable rate mortgages, which continue to demonstrate good credit performance with delinquencies over on the over 60-day measure, equal to just under 1.8% of the portfolio.

We have reserves for residential loan losses of approximately $11.8 million at year-end and while you are returning 8.6% return on approximately $245 million of residual interest in these securitized assets.

Our third portfolio is our domestic TruPS portfolio. This portfolio has just under $6.2 billion of assets under management at year end. Our invested capital of the TruPS portfolio is currently at $241 million as of December 31, and earns a blended yield of approximately 17%. This portfolio has had the most significant effect on the asset impairments. So, let me take a minute to describe that.

All of our available-for-sale securities are mark-to-market from a credit perspective. So, their estimated fair value is recorded at the end of each quarter. Whenever our estimated fair value signifies that impairment has occurred, we also assess whether or not the impairment is temporary or permanent in nature. Any permanent asset impairment is recorded as a charge to earnings based on these estimates, based on our estimate of the magnitude of probable loss, offset by the expected recovery for each asset.

As of January 30th, 2008, our most recent payment cycle, we experienced a total of seven payment defaults by individual issuers with a consolidated balance of $236 million, of which $156 million is our non-accrual status at year-end. Another three issuers also are in covenant default, but made their payments as scheduled. These issuers represent the majority of the TruPS portfolio that had permanent impairment charges during the second half of 2007.

Under current market conditions, caused by incremental temporary mark-to-market adjustments, we have reported $196 million in changes in fair value through other comprehensive income on our available-for-sale securities portfolio during the fourth quarter. And through the year ended 2007, for the whole year, we recorded approximately $350 million of net accumulative temporary charges through the OCI adjustment to shareholders’ equity.

Our fourth portfolio is our European portfolio. During the third quarter of 2007, we formed our second European-based subordinated debt portfolio, which will ultimately hold approximately €900 million of securities, when the capital is fully deployed later this year.

During 2007, we funded approximately $800 million of assets in the two European portfolios we managed. And in 12/31/07, we still had $516 million of cash available to fund the remaining investments in these two transactions. We funded on our own basis 50.6 million of invested capital in our portfolios. Based on this investment, we expect to generate management fees, origination fees, and returns on our investments.

The total European assets under management at December 31 of approximately $1.7 billion are expected to generate $13.6 million of net investment income and $+7.4 million in asset management fees on an annualized basis.

I would next like to turn to liquidity and capital resources. RAIT has approximately $1.4 billion of invested capital on the $14.3 billion of assets under management at 12/31/07. These assets are generating $214.3 million of annualized gross cash flow.

Now from this gross cash flow, we use it to deduct and pay for $40 million of corporate level interest, approximately $38 million of cash compensation and G&A, $13.4 million of preferred dividend requirements, and the resulting net cash flows together with our financing cash flows enable us to repay debt, invest in new assets and pay our common dividends.

During 2007, we made significant progress on our goal to reduce our exposure to short-term debt, mostly comprised of repurchase agreements with major investment banks. Since December 31 of ‘06, in just one-year time, we have repaid approximately $1 billion of short-term in debt, through a combination of asset sales, term debt financings, cash flow from operations and the available cash resources we have as a company.

During the fourth quarter, we repaid $74 million of repo capacity, thereby reducing our balances at year-end to $138.8 million. This repo debt finances our residual interest in our residential mortgage portfolios and temporary holdings of debt securities in recent CDO transactions.

The other debt in our balance sheet at December 31 is comprised of $710 million of bank and non-CDO-based debt, including the short-term repos, $50 million of long-term TruPS issued by us, approximately $100 million in secured bank debt under committed commercial bank lines of credit that still have approximately $66 million of capacity today, and also our $425 million of convertible debt.

We have limited our use of warehouse facilities in the last four months in light of the depressed capital markets and the need to get vendor approvals on any new issuers and the availability of permanent funding alternatives. We continue to maintain adequate liquidity through these capital sources together with new capital we expect to raise through the anticipated senior bank participations as Daniel described, institutional capital providers, and equity sources.

The last item I would like to cover is our economic book value per share. We are in an interesting time in the financial REIT sector, and economic book value is an important non-GAAP alternative measure that management uses in evaluating our performance. The economic book value reflects the adjustments of tangible book value of adding back losses, which we have identified and recorded in excess of the maximum potential loss that we could derive upon ultimate disposition of our assets.

And this is due to the non-recourse and match-funded nature of our liabilities in our securitizations. For example, upon the disposition of the underlying collateral, RAIT may realize in accounting gains under GAAP, as we recover the negative basis that we have been forced to record on the asset impairment and asset valuation changes.

This situation occurred during the fourth quarter as I mentioned earlier. We sold off a significant portion of two of our investments in the Taberna II and Taberna V residual interest. This triggered a $117 million gain reflecting the recovery of our negative GAAP basis in these transactions during the quarter.

At December 31st, ‘07, our economic book value stands at $10.52 per share, as reflected on Schedule 1 in the press release.

The new event beginning in 2008 is that we have adopted the provisions of FAS 159 regarding fair value accounting. Under this accounting standard, we will record the fair value of CDO debt associated with the Taberna programs. The projected effect on book value and tangible book value will be the increase of $1 billion or $16.50 per share.

In the future, all changes in fair value of these selected assets and liabilities will be recorded in earnings. And as a result, the management has estimated that there will be no significant changes to raise economic book value as of January 1, 2008, since we would not be able to expect any specific gains on sale of assets until they are sold or the effects of repaying debt until it is liquidated.

We will begin the first quarter in 2008 with a book value at approximately $22.35 per common share. Other information is available on our 10-K, which will be filed tomorrow and the press release information filed prior to this call.

And this concludes my financial report.

Daniel Gideon Cohen

I think that the change in book value represents the continuing cash flow of $215 million of gross cash flow that we generate from what we do on a regular basis. Of course, in this environment, we have to have a defensive stance.

But we are working hard to marshal resources, so without further deploying capital and maintaining the most liquid and least dependence on short-term liabilities that we can, continuing to repay those short-term liabilities and looking to take advantage of the environment that we have around us, grow our businesses in such a way, so that we can generate fee income and we have generated a lot of fee income as you will see and as Jack has stated in 2007. And look to generate substantial cash from fee income in 2008.

And so on that note, I will ask the operator to ask for questions now.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Andrew Wessel - JP Morgan.

Andrew Wessel - JP Morgan

I’ll start with the domestic TruPS portfolio. So, you said there is $241 million of investment capital, we see that in the press release. But as of January 30, there was $236 million of those domestic TruPS borrowers in default. Is that correct?

Daniel Gideon Cohen

The 241 million is our residual, Andrew, with an asset base of about $6.2 billion. And in the $6.2 billion, there is about $236 million of non-performing assets at year-end. So, it’s a little bit over 2%, 3%.

Jack E. Salmon

In the Portfolios 8 and 9, we don’t have any non-performing assets. So, where we have over $200 million of our invested capital, the 1.1 billion of invested capital, we have no non-performing assets.

That’s why on the schedule that we included in the press release, you can see on invested capital in the in the deals Taberna I through Taberna VII, we have a total of about $35 million of invested capital that we view as productive capital, not true, because in fact, we have a very short-term horizon in terms of looking at this invested capital as having value, a longer-term horizon relative to our expectation that we will actually get cash flow back in future years but not in current periods.

Andrew Wessel - JP Morgan

So, there is a chance then in those CDOs we do have the large amount of defaults that could cause a further write-down in the near term?

Daniel Gideon Cohen

The CDOs where we do have defaults should not; we don’t expect any write-downs in the near future, if I understood the question.

Andrew Wessel - JP Morgan

On the commercial real estate side, of the $26.4 million of loss reserves, how much is allocated to the commercial loans versus residential?

Jack E. Salmon

It’s approximately $14 million on the commercial loans and $11.5 million on the residential portfolio.

Andrew Wessel - JP Morgan

And is that $14 million all against the $42 million of MPLs or is that against the broader base of loans?

Jack E. Salmon

Essentially against the $42 million.

Andrew Wessel - JP Morgan

Are you seeing in your portfolio any trend in terms of, is it mezz loans that’s causing you the most of problems, is it a specific asset class, is it geography or is it all kind of spread out?

Daniel Gideon Cohen

We really only have five loans that are causing the problems and there’s one loan that is causing more problem than rest of them. But besides that, it’s really reflective of one loan that is causing a problem and then smaller reserves among a variety of things that are transitioning with very specific issues. The issues are so specific and idiosyncratic, one of our non-performing loans has a borrower who was to be incarcerated until he got hit by a car and that’s on our watch list.

And I’m just saying, just as an example, it’s idiosyncratic. We don’t see any overall trends in the portfolio of our commercial real estate borrowers being charged with crimes and then they are hit by a car.

Andrew Wessel - JP Morgan

In terms of the make up, what is the balance or do you have any kind of conversion of construction loan outstanding?

Daniel Gideon Cohen

No, we have loans against income producing property in general and the loans that we have outstanding are not for conversion to condominiums or anything like that, but for transitioning properties in general.

Andrew Wessel - JP Morgan

So those would be probably more in your mezz category.

Daniel Gideon Cohen

No, on both mezz and the senior loan category, we don’t have condo conversion. That’s not been an area that we specialize in. We are actually looking now at opportunities in the brooking condos, impact rentals, re-apartment opportunities that should present themselves where you have cash flow.

Andrew Wessel - JP Morgan

From an analyst perspective, I think in the Q, you did a good job breaking out a lot of other parts of the portfolio. But just in terms of the commercial real estate portfolio, there’s not a lot of color.

And I know that you did go into a lot detail about fairly broad portfolio, but I think it probably would be helpful if we could see more and may be we will in the K, kind of description about the commercial real estate portfolio, because in the past, obviously that hadn’t been a concern, and now more investors are looking away from your TruPS portfolio to the commercial real estate basically to get some transparency there?

Daniel Gideon Cohen

If I might just add into it, the loans that we have made have what I would consider to be cosmetic fix up components to them, if anything. And so, really no construction loans at all.

Andrew Wessel - JP Morgan

So, just for the new commercial loans you are originating, so the strategies has been or at least for that one you described, originate loans and you are putting relatively little capital into them, because of the fact that you are simultaneously syndicating off senior interest to other investors, so you hold basically the B note of the senior loans. Is that correct?

Daniel Gideon Cohen

We take the loan we syndicate off, the A piece and then we actually syndicate off the B piece as well. We do have certain needs to put to maintain a portfolio, and obviously we want to have the highest yielding assets in our portfolio, but at the same time, we are to a certain extent IRR-driven, in the best IRRs, when you don’t have your capital involved.

So, our viewpoint is that in 2008, we will have a building year for this business as the capital markets change. The funding sources in terms of CDOs are not going to exceed our CRE CDOs going forward. It’s questionable whether 2008 will have CMBS available. And I think I am being generous in terms of saying that.

That having been said, like other marketplaces, our portfolio which is heavily geared towards apartment and multifamily is like the conforming borrower, in that they have access to funding provided by Fannie and Freddie, and as rates go down, that funding becomes very attractive to the owners of our properties, which is good because that allows us to have a substantial repayment.

It’s really in that area where we’ve gone out and we’ve tried to work with borrowers to have them refinance into Fannie or Freddie programs. So, we expect to have substantial repositioning of our portfolio as well as situations that there will be an opportunity to recycle our capital. And we’ll be looking for the best opportunity.

I would say that in previous periods, the senior loans seemed to us to be the best opportunities, because the yield on loan-to-value is very flat. But today, the yields on the first dollar in are still relatively reasonable if you can get it. And it’s really even in lower loan-to-value from the mezzanine side that we think that we’ve great opportunities. So, we hope to reposition substantial portions of our portfolio over this year and increase our cash flow in that way.


Your next question comes from the line of David Fick - Stifel Nicolaus.

David Fick - Stifel Nicolaus

Can you comment just briefly, I was a little bit confused Daniel by your comments that I think I heard you say that you expect to have to return to the old repo-funding model and yet you have been working on reducing your repo exposure, which obviously is smart to do in a liquidity.

Daniel Gideon Cohen

David, maybe I could just answer that. The old RAIT funding model, RAIT, I think that just so that we will make sure the transcript reflects that accurately. And I apologize if I slurred my words together.

David Fick - Stifel Nicolaus

Well, maybe I misheard it. Where do you currently in terms of your forward look see your net asset growth or run-off going over the next couple of quarters and the balance of the year? Will you be able to redeploy the capital?

Daniel Gideon Cohen

Yes. I think that we will be able to redeploy the capital and let me go through this. We have capital. We have funding sources that are CDOs that are available for reinvestment over the long periods of time. And we expect to have pay downs within those CDOs, which we’ll be able to redeploy. As I said to Andrew, we think that the majority of those pay downs will be out of the multifamily sector.

And that’s something that we’re expecting because that’s the commercial real estate market that has the best opportunity to refinance with the availability of Fannie Mae and Freddie Mac’s multifamily lending programs. And we’ll see other repayments sporadically in idiosyncratic assets, where assets are sold or refinanced even, and as people get their bearing on what they are doing in terms of the financing sources that you saw more traditionally, I wouldn’t say life insurance companies today, but really commercial banks more than anything else.

So, we do see the ability to reposition those assets. What we have over the last couple of quarters, we’ve been seeing good demand. We’ve been managing our pipeline in that we are redeploying our assets, so, where we could have great opportunities, we think. And we are looking to build our relationships with commercial banks, with pension funds, with institutional investors. We currently have some of those that we are partnering with on assets. But we expect to develop that over the next year.

David Fick - Stifel Nicolaus

Along those lines, some of your CDOs or bonds, high-grade CDO bonds are trading at sort of ridicules pricing, and I am wondering if maybe you might think about deploying some of your newer CDO capacity into repurchasing those bonds at a large discount?

Daniel Gideon Cohen

Well, we don’t have the capacity there are two things. In general, I don’t that we would be looking to repurchase a lot of our CDO debt, because that’s something that might be done opportunistically but not programmatically. And the second thing is, is that it doesn’t fit into our other CDOs. So, our CDOs don’t contain any CDO debt. Our commercial real estate CDOs contains investments in commercial real estate.

David Fick - Stifel Nicolaus

I am a little bit confused, I am an old accountant, but I don’t get the spread between your expected roughly $22 GAAP book value and your economic book value of $11. What is the primary spread there?

Jack E. Salmon

David, the most significant aspect of 159 for us is that we’ll be able to re-price the CDO debt, which has been carried at its original cost, and then it was issued over the last two years at a relatively low value. That adjustment is contributing significantly to the whole adjustment of 16.57 we just described. And the benefit of that on a go forward basis is there will be better parity between changes in values on the assets which we have taken through either earnings or OCI over the last.

David Fick - Stifel Nicolaus

I get that side of it, but why is that non-economic?

Jack E. Salmon

Well, we are not liquidating the debt today. So, if you write in a check for $3.5 billion, you can buy down our debt, which is where it’s priced in the market.

Daniel Gideon Cohen

And it’s to a certain extent it reflects that, and this is my understanding, is that it reflects the fact that to a certain extent it is economic, but when we define economic book value, we took a definition which was really the amount of capital that was deployed less the charge that we took beyond the average capital. So, that’s why the economic book value differs somewhat from the tangible book value.

David Fick - Stifel Nicolaus

Lastly, your dividend policy going forward I know it’s very difficult to subject, but if you could just talk about some of the considerations that you are facing right now and give a little bit of where the thought process is as to what you might do in the next dividend and beyond?

Daniel Gideon Cohen

Well, I think that we are going to be looking to our cash flow and our adjusted earnings. I think I was very clear at the beginning of the earnings call that we looked to our adjusted earnings and our cash flow primarily and secondarily through our re-taxable income, in terms of looking to what dividends that we are going to payout, and we expect that that cash flow should continue at the same levels that it has been previously.

So, therefore, we would expect and as much as that cash flow continues and our expected cash flow comes in that we will pay the dividends that we have paid previously.


Your next question comes from the line of Jason Arnold - RBC Capital Markets.

Jason Arnold - RBC Capital Markets

Just a question about commercial credit performance expectations, could you share with us your views particularly on the mezzanine side of your book?

Daniel Gideon Cohen

Our views on the mezzanine side of our book, each one of our loans is an individual loan. There are, we have 168 loans with an amortized cost of $544 million in our mezzanine loan portfolio, and as we said our non-performing loans represents a small percentage of our overall loan portfolio of $2.2 billion or not, but in normal handful of loans that are idiosyncratic.

So, we do see more stress to a certain extent, but not tremendous amount of stress because we’ve been, our mezzanine loans are not investments in condo conversions rather non-income producing properties. They really are based backed by almost entirely income producing properties, multi-family, office, retail and 5.6% other, and diversified across a number of geographic regions.

Jason Arnold - RBC Capital Markets

Going forward, now that we are kind of seeing some economic weakness, I would assume that of course the MPAs will potentially rise but do you have any thoughts on what you will do with reserving, anything like that, any view going forward or are you just kind of take it as it comes.

Daniel Gideon Cohen

Well, I am going to ask Scott Schaeffer who is here with us. The question is he would not because he was not answering the question directly. The question really was do we have any overall policy, and do you see any overall trend in our mezzanine loan book and do we believe that we should be doing anything in terms of our financial statements, in terms of general trends and we see non-performing loans, obviously, we don’t see non-performing loans.

Scott F. Schaeffer

No. The majority of the mezzanine loans on our book were originated prior to 2007, even before the last half of 2006. So, these mezzanine loans are largely seasoned and they have all been performing and as Daniel pointed out, they are all secured by cash flowing assets.

Jason Arnold - RBC Capital Markets

Another question about the residual interest there, on the reported value of the retained interest like REIT 1 and REIT 2, is that just purely the investment there or is there any computed expectation for losses or anything like that built in?

Jack E. Salmon

Yes. Basically, our residual interest we retained, this is really financing transactions for us on our commercial portfolio, so we retained up to 20% of the capital stack in both of those transactions, as well as, we have approximately $350 million of loans that are balance sheet, that are basically direct funded off our corporate structure, so both in our CRE transactions and our balance sheet loans the $790 million reflects the cash and equity we have at work. And supportively, the loans that are on the book.

Jason Arnold - RBC Capital Markets

What I am trying to get at is there is no, you haven’t said okay, well, we expect losses of say 2% or something like that in the value.

Jack E. Salmon

We don’t book our reserves on a formulaic basis in that portfolio. It is basically specific identification of known and expected losses on an asset-by-asset basis. We look at it very carefully month-to-month and review our adequacy of our loan loss reserve on a quarterly basis, specific identification method.

Jason Arnold - RBC Capital Markets

One other question on Europe 1 and 2, there is some CMBS and some other assets that would be market-to-market. Do you have any market valuation triggers in the deals that would potentially cut-off cash flows there or is that not the case in those deals?

Scott Schaeffer

Yes, two things, those securities are very small in the deals, but definitely we don’t have any market value triggers at all in any of our deals.

Jason Arnold - RBC Capital Markets

I think you have said that you sold assets for somewhere a little less than $100 million, loss. What exactly was sold?

Scott Schaeffer

We sold some securities, and we also sold interest in our two of our Taberna CDOs and by selling off those interest, we sold-off the significant portion what we held previously such that we no longer would consolidate those two transactions. And because those transactions had incurred significant losses from the date of sale the act of selling them have the effect if reversing the negative basis associated with those losses and reporting a gain in the fourth quarter

Jason Arnold - RBC Capital Markets

This is kind of referring to the previous question; you will continue reporting the economic book value, as well in addition to the FAS 159 book value, correct?

Jack E. Salmon



Your next question comes from the line of Jason Deleeuw - Piper Jaffray.

Jason Deleeuw - Piper Jaffray

On the Taberna 8 and 9, CDOs still have a lot of invested capital in those and I just want to make sure I heard you correctly, you said there were no non-performing assets in those CDOs. And if that’s the case, then what is it about those CDOs that differ from the other ones is it simply you just don’t have as much homebuilder and mortgage REIT exposure or are there some other factors there?

Daniel Gideon Cohen

I think that what you said is basically correct, and that they were the, if you remember the change in the mortgage market it was happened relatively late. And so we have less than different mortgage exposure in those CDOs. And I think that’s the basic differential and mostly these are CDOs that were ramped up between the second quarter of 2007 and currently over the fourth quarter.

And therefore, we were fortunate enough not to have companies that hit the mortgage in home building collapse that happened quite precipitously that seems to be on the same levels as anything which happened in last 100 years. Fortunately, that event had already started to happen when we are ramping up those two CDOs.

Jason Deleeuw - Piper Jaffray

In Europe are you originating any TruPS in Europe or is it just commercial real estate?

Daniel Gideon Cohen

We are not TruPS, but long-dated securities, subordinated debentures to real estate companies in Europe. And those long-dated debentures are to the types of equity type in residential, non-construction companies that have strong cash flows and very strong balance sheet. On top of that, I’d say somewhat more sanguine and less leveraged real estate environment in Europe.

Jason Deleeuw - Piper Jaffray

I know there has been a lot to talk about the outlook for commercial real estate credit, and just in the press, and in the industry there is a lot of concern as to where credit is going. We are coming off of historical lows in terms of some of the best credit performance in history for commercial real estate.

If you could talk about what your view is over the next year and if there has been any significant change in the last quarter on your view for commercial real estate credit. And, what are the major risks as it relates to your portfolio? Is it simply the risk of rising unemployment because you got a large multi-family loans or is it also falling prices, inability for borrowers to refinance?

What are I know you talked that some of them you can still do with Fannie and Freddie, but could you just kind of give your broader outlook on commercial real estate credit?

Daniel Gideon Cohen

Yeah. I think we are cautious in terms of commercial real estate credit in general. We think there are opportunities today in terms of looking at managing a portfolio of assets. We think the opportunities today are that there is less capital out there, and the opportunity should be great as we, as they become available to us to write even safer situations.

Our belief has always been and Scott is here with me and Betsy is also here. And our belief has always been that when you invest in income producing properties that is the safest area of growth. Obviously, we have risks from rising, unemployment source in multi-family portfolio obviously that’s a negative.

Today you’ve been seeing better development of multi-family statistics for a whole variety of reasons. But things are somewhat idiosyncratic. We have basic property types 75%, 80% of our properties are multi-family and office and other 20% is retail, we don’t have exposure to hotels or and we don’t have exposure to condo projects.

And hopefully, over 2006 and 2007 we focused mostly on senior lending rather than mezzanine lending. And it was driven by the same philosophy I think that drove us to believe that the trust prefers were good investments to make because they were based on cash flows from companies.

We didn’t see the complete change of the securitization environment and the overexpansion of the home building industries. And we believe that we have an asset producing cash flow that that is where you can have the best lending opportunities. We are cautious, and I think our overall perspective on commercial real estate is cautious. I wouldn’t say it’s negative, I would say it’s cautious.

Scott F. Schaeffer

I completely agree with you. I think the stress that you see in the marketplace today is really somewhat limited to development loans, land loans, condo conversion projects, and for income producing properties that the types that we are collateralized with, the fundamentals are still fine.

Betsy Z. Cohen

I would only add that you have to remember that our real estate loans as Scott and Daniel described them, are all in matched-funded and matched-duration vehicles. So, they are protected against the pressure of having to sell at any given moment a particular property, and that structure is one that is protective of the value of the properties, as well as anything.

So, I think that we feel that, we have always an opportunity to originate loans going forward that are underwritten within the context of having less ability to refinance, less ability to sell on a whim and that’s a good thing, but the current portfolio has a duration protection on the liability side.

Jason Deleeuw - Piper Jaffray

I believe you said there were some severance charges for this quarter in the comp expense could you quantify that.

Jack E. Salmon

It’s approximately 2.5 million.


At this time there are no further questions in queue. I would like to turn the conference back over to Daniel Cohen for closing comments.

Daniel Gideon Cohen

I think our closing comments are thank you very much for joining us today. And we look forward to speaking to you at the next quarterly conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!