NorthStar Realty Finance Corp. Q4 2007 Earnings Call Transcript

| About: Colony NorthStar, (CLNS)

NorthStar Realty Finance (NRF) Q4 2007 Earnings Call February 28, 2008 12:00 PM ET


Richard J. McCready - Executive Vice President and Chief Operating Officer

David T. Hamamoto - Chairman, President and Chief Executive Officer

Andrew C. Richardson - Executive Vice President, Chief Financial Officer and Treasurer

Jean-Michel Wasterlain – Chief Investment Officer and Executive Vice President


Douglas Harter - Credit Suisse

Bill [Inaudible] – TCF Financial

James Shanahan – Wachovia

James [T- inaudible] – Wachovia Securities

Dean [inaudible] – Lehman Brothers

David Fick – Stifel Nicolaus

[John O’Hagen] - Raymond James


Welcome to the NorthStar Realty Finance fourth quarter and full year 2007 conference call. (Operator Instructions) I would now like to turn the conference over to Mr. Richard McCready, Chief Operating Officer of NorthStar Realty Finance.

Richard J. McCready

Welcome to NorthStar’s fourth quarter and full year 2007 earnings call.

Before the call begins, I’d like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

Refer you to the company’s filings made with the SEC for a more detailed discussion of the risks factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. I should add that the company undertakes no duty to update any forward-looking statements that may be made in the course of this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call.

Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with generally accepted accounting principles. Reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with Generally Accepted Accounting Principle can be accessed through our filings with the SEC at

With that, I’m going to turn the call over to our Chairman and Chief Executive Officer, David Hamamoto.

David T. Hamamoto

First, let me welcome everyone to the call. In addition to Rick, our COO; I’m joined today by Andy Richardson, our CFO; Mich Wasterlain, head of our Real Estate Securities Investment business; Dan Gilbert, head of our Real Estate Debt business; Dan Raffe, head of our Net Lease Investment business; and Al Tylis, our General Counsel.

As you see in our results published this morning, NorthStar delivered solid results for 2007 in the face of what most people would acknowledge are some of the most difficult capital market conditions in memory.

2007 was an extraordinary year which began with very liquid credit market conditions continued high level of transaction volume in the commercial real estate industry, the greatest amount of competitors in memory.

And $1 billion corporate market with acknowledgement, yes, the residential markets have probably peaked and brought industry opinion that there would likely be issues in that sector but that those problems would largely be isolated to mostly just the residential sector. A sector we have never operated in and intentionally avoided.

As we moved into the second quarter in the summer, rapidly declining residential market conditions quickly and broadly infected other markets resulting in ever-decreasing liquidity and greater risk premiums in the corporate and secured credit markets.

Today, we are operating in a market that has been severely dislocated. There’s virtually no liquidity and very little transaction volume. And for the first time, virtually every major banking institution is dealing with their own severe liquidity and capitalization issues.

I’m going to highlight many of the things we did well in 2007 to prepare NorthStar for the difficult market. And also discuss our approach for 2008 to successfully operate through this period so that when transaction volume increases, NorthStar will be well positioned to reap the opportunities available from a less competitive landscape and more attractive pricing.

I’m also going to again highlight some key facts about NorthStar, so that those who have not followed our company closely can differentiate NorthStar from other companies who are also more broadly grouped into the refinance sector.

First, let me lay out some facts. NorthStar is not in the single family residential housing mortgage or development business, and we have no direct exposure to subprime or any residential mortgages. Our focus is on the commercial real estate sector an area that has generally not experienced the overbuilding and poor lending standards we have seen in the residential sector.

Second, we have three business lines which generate stable and diversified cash flows including over $1.2 billion of owned net lease real estate properties under which our corporate tenants are obligated to make a lease payment to us for the next ten years on average.

Third, a majority of our assets are match-funded with very cheap liabilities, so we have minimal exposure to mismatched maturity. Also, over $4 billion of our CDOs which are essentially secured, non-recourse term debt financing have reinvestment rights.

This means when an asset finance by that debt repays, we don’t have to retire the debt, but can reinvest the repayment proceeds in an environment such as we’re in right now, where spreads are much wider than when we originated the assets that are repaid. Thereby increasing the returns we earn on the reinvested capital.

We also have never had a negative rating action on our debt. And during the past six months, several classes of our debt have either been upgraded or had their ratings reaffirmed. Finally, our credit track record to date has been best in class. While we expect credit conditions to get more difficult in 2008, we have no non-performers or delinquencies across our asset base.

With respect to 2007, you go back and listen to our earnings calls during the year, and even in late 2006, we consistently said that we were being defensive in what was first a very competitive market. In that market, our strategy was to focus on safer first-mortgage investments and to go long liability and raise cheap corporate capital.

During 2007, we raised $439 million of corporate equity and debt, including $190 million of perpetual preferred equity, $72 million of trust-preferred securities, and $173 million of convertible notes.

On the investment side, we focused on directly originating safer first-mortgage loans, often times sacrificing yield for safety. For 2007, approximately 84% of our loan commitments were self-originated and 75% were first mortgages.

We also allocated approximately $161 million of equity capital to our net lease healthcare business, an industry experiencing positive growth characteristics and largely insulated from deteriorating macro economic conditions. This sector is viewed by the market as defensive, and as a result, healthcare [refi] attracted in multiple, averaging over 12 times FFO and dividend yields averaging 6%.

Next, when we saw the clouds gathering on the horizon, we intentionally slowed new investment activity, focused on preserving capital, dedicated resources from our investment teams and portfolio management, and syndicated $135 million of loans to increase liquidity and to reduce future funding obligations.

During 2007, we received $566 million of loan repayments of which 63% were prepayments more than three months in advance of their contractual maturity. We also raised private capital allowing us to move nearly $1 billion of securities investments off our balance sheet into a fund vehicle, reducing our financial statement volatility and enabling us to more effectively hedge many of these positions.

Just this past quarter, we converted a substantial amount of warehouse capacity into a $600 million, three-year term loan, match funding assets previously financed on a short term basis and eliminating mark-to-market risks relating to interest rate spread changes.

Liquidity remains strong. We finished the year with $352 million of liquidity on hand which includes $154 million of unrestricted cash, $98 million of un-invested cash in our secured term financing and $100 million of un-drawn capacity on our unsecured credit facility. We also had $732 million un-drawn on our secured credit facilities.

This quarter NorthStar again delivered solid financial results in rapidly worsening market conditions and for the year, excluding the third quarter one-time item, generated AFFO per share of $1.57, an increase of 19% over $1.32 in 2006. We also paid $1.44 of dividends relating to 2007 representing a 12% increase over ‘06.

For the fourth quarter, we generated AFFO of $0.39 per share. We generated this level of AFFO while maintaining significantly more liquidity than we had historically.

We deployed a limited amount of equity during the quarter. Only $39 million growth including fundings from prior period commitments, in order to preserve our liquidity for more interesting investment opportunities we expect to see in the future. For the fourth quarter, we committed and funded just $89 million in new investments and received $213 million of proceeds from repayment, payoffs and sales for net funded investment volume of negative $124 million.

For the fourth quarter, we generated a weighted average return on book equity of 24% post-G&A, and 34% pre-G&A. In this market, we’re pleased to have had a net return of capital during the fourth quarter. Our goal is to make good investment decisions which will generate excess returns for the risks we are taking. We will not deploy capital for the sake of growth, and our belief in the fourth quarter was that risk based pricing would become more attractive and assets cheaper, which is indeed what has occurred into 2008.

As we move through the first quarter of this year, market conditions have continued to get worse and transaction volumes remain low. Generally, buyers and sellers are still trying to discover a pricing level acceptable to both parties, and we aren’t yet seeing banks and others willing to sell loans at compelling levels.

Our management team has been through many business cycles and the lack of transaction volume due to the wide [bit spread] is reminiscent of 1990. However, eventually in 1991, the RTC became a catalyst for establishing market clearing prices in the ensuing four years where some of the best value plays in recent real estate history. I was one of the first and most active buyers of nonperforming loans from the RTC during that period of time.

We will continue to be prudent and patient with our capital as we are more focused on growing long term franchise value than on the short term solution from holding large cash balances and reserves. We are confident that very attractive investment opportunities will present themselves in 2008, and we are well positioned to capitalize on them with existing balance sheet liquidity, and investment partners who value our expertise.

Assets under management total $7.4 billion as of year-end ‘07 and consist of a highly diversified portfolio of primarily long-term net lease properties, commercial real estate first mortgages and subordinate loans, and investment grade commercial real estate security. We believe that commercial real estate values will continue to decline in ‘08 and if liquidity remains scarce will further pressure real estate owners.

The good news is that lower short term interest rates will improve coverage and provide some support to cap rate. Our portfolio had minimal exposure to the weaker property asset classes, such as residential condominiums. In fact, condo loans represent just 2.8% of our balance sheet assets, and 97% of our condo exposure is in New York City with an average last dollar exposure of $674 per square foot.

Our senior management team and portfolio management group continue to aggressively identify borrowers and properties that may become stressed. We proactively managed the portfolio to identify potential issues well in advance so that we can work with borrowers to sell or refinance their collateral, even in return for discounted prepayment penalties or to obtain additional credit enhancement in advance of problems.

We have weekly risk management meetings to discuss and review ongoing credit management issues and on a quarterly basis perform a comprehensive asset by asset review of the portfolio, review our loan basis relative to where we think the underlying collateral value could be sold and determine whether any need for reserve is warranted.

Our watch list totals just $58 million and requires significant ongoing management attention. But we feel good about our loan basis and structure in each of these situations. Our portfolio has continued to generate strong performance and we have no delinquencies or non-performers across our asset base.

Finally, before I turn it over to Andy to go through our earnings, I want to review the status of some of the strategic initiatives we’ve discussed in the past. The two primary initiatives are first, to raise private capital to fund a majority of the equity needed for our new investment activity and the second initiative involves recycling equity capital from our lower ROE net lease investments to have available to reinvest at much higher ROEs in this market.

On the private capital raising front progress has been slower than we expected, principally because of the ever increasingly difficult market decision. We have discussions ongoing with many potential investors for our real estate debt fund, but we don’t expect a closing earlier than the second quarter.

On the net lease side for the last several months, we have been actively pursuing opportunities to recapitalize our net lease healthcare portfolio and maintain a management fee income stream from ongoing involvement with the assets.

More recently, we’ve expanded the scope of monetization options to include a sale of the portfolio, and have hired an investment bank to pursue a sale or recapitalization. There generally is a scarcity of large healthcare real estate portfolios for sale. And we believe that the scale and quality of our portfolio presents an attractive opportunity for investors in the sector.

Cost of capital in that sector remains relatively low. We currently believe there’s up to a dollar per share of book value gain embedded in that portfolio and we hope to have a sale transaction completed by midyear. A sale should generate well over $200 million of equity capital for NorthStar. These assets generate about a 12% ROE, and we should be able to accretively reinvest this capital in much higher yielding opportunities later this year.

Now I’d like to turn the call over to Andy Richardson who will give you more color on our results for the quarter.

Andrew C. Richardson

Thank you for joining us this afternoon. In addition to reviewing our earnings results, credit and liquidity, I will also briefly review highlights from each of our business lines.

For the fourth quarter, our net income was $5.3 million or $0.09 per share, AFFO for the quarter was $26.4 million or $0.39 per share. We invested $39 million of equity capital during the quarter and received approximately $74 million of equity capital from loan repayment and syndication.

We delivered a 34.1% ROE for the fourth quarter excluding G&A. NorthStar also generated strong ROEs in each of its business lines.

Net interest income, which is interest rental and advisory fee revenues less interest expense, property operating costs and asset management fees decreased $1.1 million to $41 million. The decrease was principally caused by slightly lower assets under management during the fourth quarter, the early October payoff of a $42 million mezzanine loan on a New York City asset which had a LIBOR plus 13% interest rate and higher borrowing cost.

In the fourth quarter, we replaced approximately $560 million of short-term borrowing, based on the September 30 balances with a three-year term loan costing approximately 75 basis points more than the debt it replaced.

The decrease was slightly offset by approximately $1.8 million of origination fees, which were accelerated due to prepayment. Prepayment penalties and other income were about $1 million for the quarter down $700,000 from $1.7 million in the third quarter.

General and administrative expenses excluding $4.2 million of non-cash stock based compensation decreased approximately $940,000 from the third quarter, to $9.5 million and represented approximately 8.6% of our revenues for the fourth quarter, down from 9.3% in the third quarter and consistent with our goal for the high single digits.

During the fourth quarter, we closed on two acquisitions in our net lease portfolio, totaling approximately $46 million. We invested approximately $15 million of equity capital on our net lease business.

Total un-depreciated cost basis of our net lease office, industrial and retail assets totaled $549 million and were financed with non-recoursed mortgage debt totaling $397 million. And our own healthcare related net lease assets totaled $721 million and were financed with $515 million of non-recoursed mortgage debt at year-end.

In our real estate lending business, we made just one loan commitment. Our first mortgage totaling $10 million and funded $78 million of loans, including prior period commitments during the fourth quarter. We had $200 million of loan repayments and asset sales during the fourth quarter, and our syndication activities also reduced future funding commitments by $77 million.

From a credit standpoint the overall first dollar weighted average loan to value increased 2.3 percentage points to 25.4% during the fourth quarter from 23.1% of September 30 and the last dollar LTV decreased to 79.8% from 81% during the quarter. Since September 30, Fitch affirmed the ratings on all classes of notes of N-Star VI and VIII, two of our secured term financing totaling $1.5 billion.

Turning to the real estate securities business, NorthStar and our securities fund invested $27 million in seven real estate security transactions during the quarter. A 100% of our volume consisted of investment grade commercial real estate securities backed by commercial real estate. Our weighted average credit rating for fourth quarter investments was BBB+.

During the quarter, the fund also entered into hedges having a net notional amount of $407 million. Our portfolio as a whole continues to be in a very safe part of the credit spectrum with an average credit rating of BBB flat across the portfolio.

During the quarter, we had 12 upgrades, totaling $60 million and 9 downgrades totaling $103 million. NorthStar has historically targeted more seasons commercial real estate securities especially in CMBS and our securities investment business. At December 31, exclusive of assets we managed in the securities fund we had approximately $1.5 billion of CMBS securities under management in our wreath, of which 84% were issued prior to 2006.

In the back of our earnings release, we further disclosed the distribution of our portfolio by vintage, asset type and credit rating. We have always been focused on the investment credit part of the credit spectrum and believe that the credit quality of the seasoned and diversified portfolio is very strong.

Our ROEs in this business in particular have been dramatically impacted by mark-to-market adjustments we would make. Excluding a $140 million of cumulative mark-to-market adjustments on our securities and interest rate swap associated with this business, ROE was 27% at December 31.

This quarter in our earnings release, we again included a reconciliation of our book value from the beginning of the most recent quarter to the end of December. We also calculated un-depreciated book value, which excludes accumulative real estate depreciation and amortization from our long-term net lease asset.

And it’s pro forma for this quarter for preliminary estimate of adopting the fair value option for certain financial assets and liabilities consistent with FAS 159, which NorthStar will adopt in its first quarter 2008 financial statement.

At December 31, our un-depreciated book value per share, pro forma for this FAS 159 estimate was $11 and depreciated unadjusted GAAP book value was $5.70 per share. Our pre-G&A ROE based on average book equity was 34.1% for the fourth quarter, and we generated a 23.8% ROE, based on average book equity including G&A.

Since the second quarter of 2007, our book value has been negatively impacted by the mismatched accounting for our securities assets, compared to the accounting for related liabilities. While our assets were written down, the related match funded debt which was issued in very attractive spreads was carried at historical costs rather than also being written down to partially offset asset decline.

Mark-to-market adjustments resulted in a book value decrease of about $2.07 for the fourth quarter of 2007. To give an example of the perverse impact of accounting, our only on balance sheet securities term financing N-Star VII matched funds approximately $550 million face value of securities with $511 million of investment grade notes having a weighted average coupon of LIBOR plus 34 basis points.

There are no delinquent or non-performing assets in this deal. This financing is 100% non-recourse to NorthStar and we retained a non-investment grade note as our retained equity in the transaction implying a $39 million cost basis. Because the financing is non-recoursed, we could never lose more than $39 million of capital.

However, because of the accounting at year-end we carried the deal at a negative $75 million carrying value. This means that we could give away our investment and get a $75 million increase in book value, clearly absurd.

The current return on our $39 million equity investment is 25%, which we believe supports its value implying a fair value that’s about $114 million or $1.70 a share increased over current book.

Fortunately, FAS 159 fair value option enables us the one-time right to determine effective January 1 of 2008 which financial assets and liabilities we would mark-to-market allowing us to potentially recoup an enormous amount of lost book value from the old accounting methodology.

The ultimate impact will also depend on fair value at March 31, 2008, however, based on preliminary marks on our N-Star secured term financing liabilities, exchangeable notes and trust-preferred securities at year end, the increase in book value that these liabilities were mark-to-market could be greater than $4 per share.

From a balance sheet perspective, consolidated assets totaled $4.8 billion down from $4.9 billion last quarter. The decrease was principally caused by the previously discussed mark-to-market adjustments on our real estate securities, which we accounted for as available for sale. Total on balance sheet leverage at December 31 increased to 82% compared to 81% at September 30, principally due to the mark-to-market and senior debt to total assets was 76% at December 31.

Credit quality once again remains strong for the quarter, we had no losses, no assets are delinquent or non-performing and we therefore did not take a loan loss provision this quarter based on the performance and solid collateral value coverage to our loan basis. NorthStar continues to have no direct exposure to the single family mortgage and housing market.

As we stated last quarter, we believe that the difficult financing market and weaker macro economic conditions over the next year will create more challenging conditions for commercial real estate. While we do not believe that specific reserve on our loan portfolio of 117 real estate loans are warranted at this time, we will be especially diligent and proactive in protecting our capital in this market.

Our portfolio management group rigorously monitors our asset base to identify potential issues in advance of a problem developing and is in active dialogue with our borrowers to monitor the impact weaker real estate market values and macro economic conditions are having on our collateral properties.

NorthStar each quarter also performs a comprehensive credit review of its assets under management and conduct weekly portfolio management review sessions to review ongoing credit management initiatives. We do maintain an internal watch list of assets that require intensive management and monitoring.

Last quarter, we had two real estate loans and one security aggregating $46 million or just 1% of our total assets. One of the loans, a $5 million mezzanine loan, paid off in early January. We also added one $17 million first mortgage on a multi-family property based in south Florida to our watch list this quarter. Lease of the property has been slower and the borrower is under financial stress.

We believe there is excess underlying collateral coverage to our basis and that no reserves are required at this time, but these assets are on our $58 million watch list at year-end due to the management attention required. We declared a $0.36 per share fourth quarter dividend in January, and our payout ratio is approximately 92%.

On the right side of the balance sheet, over 87% of our debt liabilities are long term in nature and we have very little exposure to near-term maturity. We do have a consolidated credit facility with our partner in the Monroe Capital middle-market corporate lending business that matures on March 31 this year.

The facility had $374 million of outstandings at year-end. Finances $367 million of assets based on GAAP value and is non-recoursed to NorthStar. We are working with our partner and the lender to potentially recapitalize and/or extend the facility. However, if there is no resolution and the lender decides to liquidate the loans on March 31, NorthStar’s total exposure is just $16 million.

On the liquidity and capital markets front at quarter end, we had $154 million of unrestricted cash, $100 million of un-drawn equity liquidity on our credit facilities and $98 million of un-invested cash in our end source secured term financing for aggregate liquidity of $352 million. The repayments we received this quarter and the $33 million we received after quarter end showed that our borrowers continued to be able to either refinance or sell their properties in these difficult capital market conditions.

In conclusion, we are pleased with NorthStar’s solid credit and financial performance in a very disruptive market. Our balance sheet is solid and we are managing the company for more difficult conditions in 2008. Our priorities are risk management, managing liquidity and being patient with our capital.

And with that, let’s open it up for questions.

Question-and-Answer Session


(Operator Instructions) Our first question is from the line of Douglas Harter - Credit Suisse.

Douglas Harter - Credit Suisse

Dave, you said that on the net lease healthcare portfolio that you see about $1 per share book value gain there. Is that over and above the fair value number that you gave?

David T. Hamamoto

No, that’s over depreciated.

Douglas Harter - Credit Suisse

So that would be included in the FAS 159?

David T. Hamamoto

Some of it is. No, the real estate is not mark-to-market. FAS 159 is just for financial assets and liabilities.

Douglas Harter - Credit Suisse

So the real estate could be over and above that?

David T. Hamamoto


Douglas Harter - Credit Suisse

And can you just talk about any other debt maturities that you have in 2008?

David T. Hamamoto

The one I talked about is the nearest term debt maturity. We also have another facility in the Monroe venture that matures on end of July. At least that’s the initial maturity date. That facility has two extension options, I believe, but it’s at the option of the lender.

And also, our JPMorgan facility that basically finances real estate lending investments, the one-year anniversary is also, I think, at the beginning of August, and that is expendable, I believe, so long as we’re in compliance with that facility for an additional two one-year periods.

Douglas Harter - Credit Suisse

So that would be expendable at your option assuming you’re still in compliance?

David T. Hamamoto



Our next question comes from the line of Bill [Inaudible] – TCF Financial.

Bill [Inaudible] – TCF Financial

You made a comment how you have not experience any defaults currently. I’d like to know, is that just as of the reporting period or as of today?

David T. Hamamoto

I think we said in our press release that through the end of the day yesterday. And so far, this afternoon, there’s nothing that I’m aware of that’s occurred.


Our next question comes from the line of James Shanahan - Wachovia.

James Shanahan - Wachovia

I’d like some clarification on the net lease. I just want to make sure I have this right. You’re proposing potentially selling the healthcare net lease portfolio, which you had indicated was a $721 million cost basis, financed with $515 million. This is the portfolio that you’re selling, not the entire portfolio?

David T. Hamamoto


James Shanahan - Wachovia

So you’re not announcing plans here to exit the net lease business?

David T. Hamamoto

No, this is specifically on the healthcare portfolio.

James Shanahan - Wachovia

Will you continue to operate? Will you look for new opportunities in the healthcare business or will you dissolve the healthcare portion of the strategy?

David T. Hamamoto

At this point, we’re exploring two possibilities and it’s going to come down to what the best economics are. One would be an outright sale of the healthcare portfolio, and the other would be a recap with the cheaper capital source, in which instance, we would stay in the business.

I think, and I said it in the script, but very simply, if healthcare REITs are trading at 6% dividend yield and we see 20% return opportunities in our core lending business, it doesn’t really make sense for us to have a ton of our capital allocated to the healthcare sector. So, in one form or another, what we’re going to do is monetize the healthcare assets and redeploy them into higher yielding opportunities in our core business.

James Shanahan - Wachovia

Are you aware of any other healthcare net lease portfolios or large investments that are in the market or being shopped right now?

David T. Hamamoto

There was just a deal that was done by one of the healthcare REITs on a medical office building portfolio that traded at a 61 cap rate that I think was in the billion dollar range. But I think it’s pretty unique to find this kind of scale and part of our strategy when we went into this was that we knew there was an aggregation premium created by buying in smaller size and creating scale.

And the preliminary feedback from the market is that there’s significant interest in this portfolio from a wide variety of investors both public healthcare REITs as well as private equity sponsors. And I think one of the reasons there’s so much interest is that we have a bunch of long-term assumable debt on the assets and financing is probably one of the more difficult things in today’s market.

So the fact that there’s financing available on the portfolio is also making it a much more attractive investment opportunity for people with equity capital.

James Shanahan - Wachovia

You feel you’re able to extract a premium on your equity position in that portfolio because of the situation with the debt?

David T. Hamamoto


James Shanahan - Wachovia

On credit, kind of high level here, I’ve always thought that you don’t really have credit issues necessarily associated with your net lease investments and sub-debt is kind of a smaller portion of the overall strategy. And so I thought that that kind of skewed your credit metrics more favorably given that even in the universe CMBS aren’t really generating very significant delinquencies or credit issues.

But they are rising and the fact that you continue to have zero delinquencies and credit issues associated with CMBS is really remarkable. And I’m wondering is it just a vintage issue or what are the drivers for the credit performance that continues to be stellar in spite of a deteriorating condition in that segment?

David T. Hamamoto

I think it’s a combination of things. And as I said, I think one of the drivers was that we were very afraid of how frothy the market was. And so in viewing the market and figuring out how to be active in it when it was so frothy, we basically had a pretty simple strategy, which is to try and create the most defensive assets, i.e. first mortgages with lower loan to values, and effectively over-finance those assets by basically going long liabilities.

So if you look at our balance sheet, I think our loans average two years, 2.2 years remaining in terms of duration, but we have over $5 billion of really long term cheap liabilities. So that was the way that we played the market and so, number one, it was being defensive and effectively creating return through the cheap financing that was available.

I think as part of that defensive strategy, as it related to CMBS, the bulk of what we did were earlier vintage, where you had more subordination requirements from the agencies and better underwriting, and so I think that’s a part of it.

And then I think also one thing that’s important to note is that we underwrite both our loans as well as any of our CMBS securities, really on an asset-by-asset basis. And so that there is a bottom-up approach to our investing, so that we do asset level review as opposed to somebody who is more of a statistical buyer with less real estate experience.

And I think the combination of all of those things is obviously played out very well in this credit environment. And as we said, we think conditions are getting more difficult and we have to stay ahead of issues, but I think by and large, the reason we’re going to have less losses is because of all those reasons I mentioned.

James Shanahan - Wachovia

On credit, if, per Andy’s discussion, if there were an increase in loss provisions related to, say for example, the sub debt business, this looks right into the accounting. You’ve never had loss provisions, so that’s why I need help. Is this an add-back for AFFO on the provision side and does it only really impact AFFO if there’s a charge-off.

David T. Hamamoto

It’s included in AFFO. It’ll be a deduct.


Our next question is from the line of James [T- inaudible] – Wachovia Securities.

James [T- inaudible] – Wachovia Securities

Mr. Richardson, you were talking about some adjustments going to be made using the SFAS 159 that could increase book value as much as $4 per share in the first quarter. Will that be increasing the diluted book value or the non-depreciated?

Andrew C. Richardson

It would be an increase to GAAP book value. So it would actually show up on our financial statements in equity. It’s effectively we have a lot of liabilities that were issued at very attractive rates, in fact our secured term financing that’s on our balance sheet, I think we have about a $1.7 billion of outstanding.

The average coupon on those long-term liabilities is LIBOR plus 50 basis points. So when you mark those to market, they basically will be traded an enormous discount for that. Those happened in the first quarter is rather than carrying them at historical costs or pay, they will be written down to market and that adjustment will actually be part of equity.

Richard J. McCready

In fact in the earnings release, the last page of the earnings release, there is actually a specific reconciliation between current GAAP book and how you get to the $11 a share.

James [T- inaudible] – Wachovia Securities

And then the last question, any kind of guidance for 2008 on the dividend policy?

David T. Hamamoto

It’s our policy not to give guidance. But we did a pretty good job of more than covering the last year’s dividend and as we said, we’ve held more cash, we anticipate redeploying the Wakefield capital and more creative transactions. So, I think you should run your models, but we feel very good about how that company is positioned.


Our next question is from the line of Dean [inaudible] – Lehman Brothers.

Dean [inaudible] – Lehman Brothers

As you meet with potential investors, how would you characterize their appetite for both investing in the real estate debt and the securities funds and what’s the timing for when they are willing to commit capital?

David T. Hamamoto

I think the reception from investors in terms of the concept has been very high. And I think there are a number of investors in the market who see the debt base as being particularly attractive from a risk-adjusted value perspective. So I think there is a lot of capital looking to get into the space.

I think the difficulty is, a number of those, the pension fund and endowment tend to take longer to invest in two things. One, what’s considered a first time fund, so that’s the hurdle; and then two, also go through the whole thesis about effectively moving from what was traditionally pure private equity into more of a debt oriented opportunity.

So I think those two things are what is slowing down the process, but I think, overall, the amount of money that think they’re going to be very attractive buying opportunities is pretty significant. And to that end, we will continue to market the fund and raise it.

But we have also been approached by a number of institutions that have liquidity about investing with us in opportunities because they don’t have the expertise and the infrastructure, and the deal flow that we have so to the extent that we do see interesting opportunities. I think there are one off transactions that we can do with institutional investors where we can promote them and participate in scale.

Dean [inaudible] – Lehman Brothers

Would that be similar to syndicating loans or would this be setting up?

David T. Hamamoto

No, it’s what more like setting up a partnership with somebody. There’s a couple hundred million dollars of equity required; maybe we put up 20% of it, and the investor would put up the balance, and we get some sort of the carried interest for finding the deal and managing the transaction.


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

David Fick - Stifel Nicolaus

Jean, can you talk about the long-term capital plan. Everything you’ve discussed so far is sort of one time sources selling interest and so forth, in addition to the venture fund approach. But I presume you don’t see that as a permanent, sole source of forward capital once these one time recycling items burn off.

How do you see this industry being structured, and specifically your forward view of where you’re going to be a year or so out for capital access?

Jean-Michel Wasterlain

What we have said David is that rather than being a pure balance sheet funder, we believe that it is prudent and a better business model to have multiple sources of equity capital. And I think that that model is still something that we very much believe in.

And so I think what we will do prospectively is to fund transactions both on balance sheet, but also take the opportunity to use some of our balance sheet capital and invest it in various funds, when there’s private capital available for those funds. So that the fees and the carried interest associated with that private money can benefit our shareholders.

And so, I think you’ll see a combination of capital raising both on balance sheet in a private fund format. And we’ve even explored the possibility of other managed vehicles that could potentially even be public prospectively.

David Fick - Stifel Nicolaus

I guess it’s fair to say that you’re at least for the time being planning to run your business without the traditional collateralization structure being available or recovering?

David T. Hamamoto

Yeah. I think it’s safe to say that I don’t know what’s traditional.

David Fick - Stifel Nicolaus

Well, CDO.

David T. Hamamoto

Certainly what had been traditional for us is not going to exist for a long time and I think that’s something that we want to make sure that our shareholders understand is that $5 billion of cheap liabilities that we have that have reinvestment rights are really something of significant value and probably won’t be reproducible for a long period of time.

And so those will continue to be a huge source of value for our shareholders, there’s short-term assets pay off and we can reinvest in those debt structures. I think in terms of new business beyond refilling the existing CDOs, we are looking at some new financing structures and I think part of what will develop as the market starts to become more liquid again is different structures that the rating agencies will endorse probably will go back to more of a static transaction.

But if you think about what we’re really doing, which is effectively just leveraging our loan portfolio, it should be more financable than the CMBS deal because at least in our transaction we’re holding the risk piece and we’re servicing it and so we won’t have the reinvestment rights that we had in the CDO, but I think there will be some sort of securitized market that re-emerges but something that was much more akin to what was happening I think in the late ‘90s than what was happening at the top of the market.

David Fick - Stifel Nicolaus

You said you don’t have any issues in your current loan portfolio Have you had any negotiated extension to this stage?

David T. Hamamoto

We had two loans, the one with the watch list loan, the $5 million that repaid. That had an initial maturity in early October. We were the mezz lender there. We and the senior lender gave them an extension and they paid us default interest to get it refinanced, and it repaid, I think the first week of January, which is what we expected.

And there was another first mortgage loan that we had that it was a similar situation, we had a lot of coverage and we gave them, I think it was a couple of months extension with a much higher interest rate and they also paid us off. But other than that, we have not had any situations where we’ve reduced rates or we’ve basically extended a loan to prolong a problem or defer a problem.

David Fick - Stifel Nicolaus

What is your forward view on the rating agency outlook for net upgrade, downgrade on CMBS portfolios similar to yours?

Jean-Michel Wasterlain

I think when you look at the performance of CMBS in terms of the delinquency and underlying deals they are remarkably stable and still near the historic load, however, when you look at the environment of rating industry they’re operating in I think that it’s truly the mind-set of the range is very different going into 2008. And I think that they’re mind-set currently is much more apt to downgrade and kind of take an early action on downgrade as opposes to upgrade.

So while I don’t think that you’re going to see a large number of downgrades in the near term, because credit performance just wouldn’t justify that. I do think that if problems start to pop up, they’ll be much quicker to pull the trigger than they would have in the past.


Our next question comes from the line of [John O’Hagen] - Raymond James.

[John O’Hagen] - Raymond James

I’d just like to know the validity of the dividend going forward, is it stable?

David T. Hamamoto

We typically have not given guidance, and I think the only guidance that I can give is that the dividend that we paid in ‘07 was very well covered, and that was with us holding higher cash balances, that reinvesting in our CDOs should be more accretive as we put assets back into the vehicles, and that the sale of the Wakefield portfolio and reinvestment should also be accretive as a result of selling lower yielding healthcare assets.

And investing in our core business, which we believe is sort of a 20% investment opportunity. And so we feel very well positioned for 2008 in light of the difficulties and the credit markets.


Our next question is a follow-up question from the line of David Fick.

David Fick - Stifel Nicolaus

But we’re hearing and seeing some of your colleagues looking at buying their own CDO paper back, some of the higher investment grade stuff at huge discounts which would seem to be and putting that stuff into their existing subsequent CDOs, at 100 cents on the dollar and creating some real net cash that way. Is it something you’re considering?

David T. Hamamoto

And if you look at the purchases and the open market, I’ve been an active buyer of the stocks, and that’s why I’m as concerned about the dividend as everyone. I like getting that dividend too. But we have as a management team we’re very invested in the company.

And in terms of how do we use our capital most accretively, I think there are some interesting opportunities as it relates to some of our CDO paper, and this tends to come from people who need to liquidate a portfolio for reasons unrelated to the credit.

And the CDO bid just because of the fear and actually the real credit losses that have occurred in some of the asset backed CDOs is such that there are some extremely attractive investment opportunities in credit that we think is money good. So, it is an area that we’ve looked at. And I think we’ll probably participate in the coming year.


Ladies and gentlemen that does conclude our question and answer session. I will turn the call back over to management for closing remarks.

David T. Hamamoto

No closing remarks, we just appreciate everyone’s continued support and we’ll talk to you in a few months. Thank you.

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