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Executives

Andres Viroslav – VP, Director, Corporate Communications

Scott Schaeffer – CEO

Jim Sebra – CFO

Analysts

Gabe Poggi – FBR

Jason Stewart – Compass Point

Brian Gonick – Sunvest

RAIT Financial Trust (RAS) Q2 2012 Earnings Call July 26, 2012 9:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the Second Quarter 2012 RAIT Financial Trust Earnings Conference Call. My name is Ann and I will be your coordinator for today’s call.

As a reminder, this conference is being recorded for replay purposed. At this time all participants are in listen-only mode. If you require assistance at any time during the call, please press star followed by zero and an operator will be very happy to assist you.

We will be facilitating a question-and-answer session following the presentation. I would now like to turn the presentation over to your host for today’s call, Mr. Andres Viroslav, Vice President, Director, Corporate Communications. Please proceed, sir.

Andres Viroslav

Thanks and good morning to everyone. Thank you for joining us today to our RAIT Financial Trust second quarter 2012 financial results. On the call with me today are Scott Schaeffer, Chief Executive Officer and Jim Sebra, RAIT’s Chief Financial Officer.

This morning call is being webcast on our website at www.raitft.com. There will be a replay of the call available via webcast on our website and telephonically beginning at approximately 11.00 am Eastern Time today. The dial in for the replay is 888-286-8010 with a confirmation code of 431-317-37.

Before I turn the call over to Scott, I would like to remind everyone that there may be forward-looking statements made in this call. These forward-looking statements reflect RAIT’s current views with respect to future events and financial performance.

Actual results could differ substantially and materially from what RAIT has projected. Such statements are made in good faith pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Please refer to RAIT’s press releases and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations.

Participants may discuss non-GAAP financial measures in this call. A copy of RAIT’s press release containing financial information, other statistical information and a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure is attached to RAIT’s most recent current report on Form 8-K available at RAIT’s website, www.raitft.com under Investor Relations.

RAIT’s other SEC filings are also available through this link. RAIT does not undertake to update forward-looking statements in this call or with respect to matters described herein, except as may be required by law.

Now, I’d like to turn the call over to RAIT’s Chief Executive Officer, Scott Schaeffer. Scott?

Scott Schaeffer

Thanks, Andres. And thank you all for joining our call today. We are pleased to report solid results for the second quarter as we benefit from growth in both our loan book and owned-real estate portfolios.

AFFO rose to $0.25 per share, an increase of $0.04 per share on the linked quarter basis. Operating income increased to 6.4 million or 92% from the first quarter and the balance sheet remains stable.

We’ve had strong loan originations during the first half of the year. As expected we funded over 170 million of new loans during the quarter and 243 million during the first six months of the year.

We redeployed all loan repayments received during the quarter and expect to receive minimal loan repayments during the second half of 2012.

Interest income improved and should continue to rise in the third quarter as we receive a full quarter of interest income on newly funded loan. At this point, all available funds in RAIT’s CRE CDO too [ph] have been deployed and the reinvestment period has ended.

Our CMBS loan business is ramping nicely. During the quarter we closed and funded 32 million of small balanced CMBS loans and contributed loans into two recent securitizations.

Our warehousing agreements with two banking partners enable us to continually close and associate CMBS loans into their securitization. Having multiple securitizations partner shortens the holding period of our loans thereby increasing the turnover of our capital and reducing our overall risk.

The CMBS pipeline continues to grow as we add to our origination team and looking forward, we expect to be selling loans every quarter. Our portfolio of directly held real estate also continues to improve.

Rental income as well as occupancy and NOI had increased as we raised rents, lease additional office and retail space also as property operating expenses remains stable and actually declines slightly during the second quarter.

Multi-family properties remain our favorite property type in this environment and represent the majority of our directly owned portfolio. We remained focused on growing the NOI of the entire portfolio which will increase cash flow and the value of rates equity investment in these properties.

With that overview I’d like to turn the call over to Jim. Jim?

Jim Sebra

Thank you, Scott. The key drivers of our second quarter 2012 financial performance were as follows. First, asset growth, during the second quarter, we had growth loan production of 170 million and pay off totaling 86 million resulting a net loan growth of 84 million.

This loan growth was the primary contributor to the increase of our interest income of $800,000 on the linked quarter basis. We expect that our interest income will increase in the third quarter as the loans responded in the second quarter have been outstanding for a full quarter.

Second, asset performance, regarding our loan portfolio, three items of note. First we converted two loans totaling 25 million to own real estate, one property at a 229,000 square foot, 79% occupied office tower at St. Paul, Minnesota and the other property is a 64,000 square foot, 87% occupied retail center located in Ralf Rapp Texas [ph] just north of Austen.

These loans were current on their interest but were in maturity default. We incurred the gain on these transactions as the value of the real estate exceeded our loan basis.

Second, our non-accrual loans increased to – due to an $80 million that became delinquent during the second quarter. We expect full recovery from this loan at the property value as it is today exceeds our outstanding loan balance.

Non accruals ended the quarter at 74 million or 6.9% of our outstanding loan balance. At the quarter end, we maintained teary loan [inaudible] of approximately 35 million which were added with the cover anticipated loan losses in the future.

Lastly our CRE CDOs continue to perform with good coverage in their OC and IC test. With regards to our own real estate portfolios we continue to see improvement in the key measures of their performance, occupancy and rental rates.

Our portfolio occupancy has increased 85% as of June 30th, up from 83% as of June 30th, 2011. This improvement along with rental rate gains has increased rental income by approximately $700,000 on a linked quarter basis.

Real estate operating expenses was out 300,000 in the second quarter as compared to last quarter. As a result, the net operating income at our own properties increased to 12 million this quarter. That is a $1 million increase since last quarter at a $4 million increase since the second quarter of 2011.

To further highlight the improvement in our own real estate performance, let’s look at our multi-family assets which represent approximately 60% of our own real estate portfolio. The improvement in their occupancy and performance is even more dramatic.

Since the second quarter of 2011, occupancy in our multi-family business has increased to 91% up from 88%. Average rental rates have increased to $695 per month up from $673 per month in the second quarter of 2011.

Net operating income from the multi-family properties with 7.5 million this quarter up 41% since the second quarter of 2011.

Our business activities had contributed to an improvement of our reported AFFO 12 million and $0.25 per diluted share during the second quarter. As to pick it up [ph] on our press release, our AFFO has increased year over year and on a linked quarter basis.

Revenue is higher in the second quarter as compared to last quarter driven by our asset growth and improved performance at our own properties. Overall expenses were down predominantly driven by lower real estate operating expenses and lower compensation expenses. Interest expense was lower this quarter as compared to the first quarter.

For the remainder of 2012, we expect additional interest savings of approximately $300,000 for third quarter from RAIT CRE CDO head as they continue to burn off according to their original term. We’ve listed our earlier office space sublease and accrued a of $1.5 million loss in other expense on a future sublease. As a result, our rent expense will be reduced going forward as well.

We do report a GAAP net loss for the second quarter of $7 million or $0.14 for the diluted share. The GAAP net loss was attributable to continue negative changes in the fair value of our various financial instruments.

Please remember, the changes in the fair value of our financial instrument relate to our consolidated Taberna securitizations and our non-cash. As such, our presentation and discussion of FFO about is more than decade of our financial performance.

Finally, let’s discuss some key statistics with respect to our balance sheet, book value, and capital available. During the second quarter, we introduced adjusted book value or ABV to help investors understand management field book value. Scheduled, too, of our cash release provide a reconciliation between our GAAP book value and our ABV. Our ABV was $6.56 as June 30 of 2012 and our GAAP book value was $13.52.

From a capital perspective, we ended the quarter with $275 million of capital available for investment. Our capital consists of $44 million of cash on hand and the unused portion of our warehouse lines totally $231 million as of June 30.

Scott, this concludes our financial report.

Scott Schaeffer

Thanks, Jim. We’ve been productive with the capital that we raised in our March offering. We invested approximately $30 million of the proceeds into our core lending business, $15 million went into a bridge loan, and the balance was invested in the seven CMBS loans.

The annualized return on this invested capital is approximately 31%. The CMBS business is a volume business where we will turn our invested capital multiple times per year as we originate and secure tight CMBS loans, recover our invested capital and invest it again.

Going forward, our bridge loan business will be funded through bank participation program. As you know, many regional banks and insurance companies are having difficulty originating small well-positioned good yielding loan.

Our program provides these banks and insurance companies with senior loan participation of 50% to 60% LPV that will result in the mid- to high-teens return to rate on a retain subordinate loan investment. We are in effect creating small mezzanine loans for our balance sheet.

As we do this, we’re looking to the past as we had success with this type of program during our CRE CDO period and expect to have success in the future.

I think at this time operator, we’d like to open the call for questions.

Question-and-Answer Session

Operator

Okay. (Operator Instructions) And our first question comes from the line a Gabe Poggi with FBR. Please proceed.

Gabe Poggi – FBR

Hi, good morning, guys.

Scott Schaeffer

Hi, Gabe.

Jim Sebra

Good morning.

Gabe Poggi – FBR

A very nice job in the quarter, and thank you so much for the clarity on the adjusted book value. It’s really helpful. Just a couple of quick questions, Scott, I think I asked you this every quarter but I’m going to ask it again, can you just give us an update based on the compression across the curve?

Is there any change in where you guys can put out money from a bridge lending perspective and kind of where you’re putting money out today relative to a quarter or two quarters ago?

Scott Schaeffer

Gabe, there’s not been any compression I should say. As you can tell from our release, we had a very active period for bridge loans. We have a strong pipeline looking forward. Loans are being funded and the live work plus 550- to 600-range with floors between 6 and 6.5 depending on the leverage and the property type and location.

And that’s what we’ve seen for the last six months or so. So we’re not seeing any compression whatsoever.

Gabe Poggi – FBR

How competitive is that market? I know you guys, as you mentioned in your prepared remark, prior to your CDO days, you guys had a niche business with a significant rolodex in that area and I assume you guys still had that rolodex.

How competitive is that business right now just in terms of the scarcity of lenders even just across the board, as you mentioned, banks unwilling to go into market? How competitive is it for other specialty financed names so to speak?

Scott Schaeffer

It’s competitive at the larger levels but we’re still – rates focus has always been on smaller loans and that’s where we stay in the middle-market so to speak. If you’re looking at a loan or if we’re looking at the loan in the $25 million to $30 million range, there’s a lot of competition.

But in the $7 million to $10 million, $12 million range, there’s not nearly as much and that’s where we’re focusing our efforts. That’s what we’ve always done. We think it builds a more granular portfolio which just gives [ph] to safety going forward. And that’s our bread and butter and we’re sticking to it.

Gabe Poggi – FBR

Got you. That’s helpful. One more question if I may. How do you guys think about kind of on a go forward basis, you reported $0.25 of AFFO this quarter, it’s more indicative of kind of the cash on cash return at rate relative to the $0.08 payout?

Scott Schaeffer

Good question Gabe.

Gabe Poggi – FBR

I’m not pressing. It just – kind of thinking out overtime, you obviously have built in a lot of cushion which is a good thing.

Scott Schaeffer

We have and rates come through a period of real turmoil. We are confident and comfortable at the $0.08 level. Obviously, we discussed it with our board every quarter. The operations continue to improve and we believe going forward that there’s no reason they won’t improve even more.

We’ve stated that the $0.08 – that we will not distribute less than $0.08 or that we don’t intend to distribute less than $0.08. I am hopeful that as our AFFO and cash flow improve going forward that the board will authorize higher dividends. But at this point, it’s reviewed on a quarterly basis and the company’s results, the market, everything is taken into consideration.

And as we’ve said, we don’t intend to lower it from $0.08 but we will continue to review it. And again, hopefully, the board will recognize as results increase or improve that we should be increasing the dividend.

Gabe Poggi – FBR

Great. Thanks so much. Nice job, guys.

Scott Schaeffer

Thank you.

Operator

And our next question comes from the line of Jason Stewart with Compass Point. Please proceed.

Jason Stewart – Compass Point

Hi, good morning.

Jim Sebra

Hi Jason.

Scott Schaeffer

Good morning.

Jason Stewart – Compass Point

On the $275 million of capital available for investment, how do you think about breaking that between the opportunities in CMBS, bridge, mezz?

Scott Schaeffer

Of $275 million that we did in the first six months of the year – I’m sorry. Were you talking about the production or the – or the capital available?

Jason Stewart – Compass Point

The capital available. Just thinking about how you would like to allocate it going forward.

Scott Schaeffer

Well, it’s largely allocated through the two warehouse lines for CMBS production. That’s 250 – there are 230 million of the available cash or capital.

Jason Stewart – Compass Point

And I guess if you had a bank signed and you saw an opportunity there, would you shift some of the non-CMBS capital to fund those ones or would you think about getting a different warehouse plan? How would we think about that business being funded on a go forward basis?

Scott Schaeffer

The way we’re going forward is that we have the warehouse lines for the CMBS business and the participation program or a syndication effort, if you will, will be for the bridge business. We don’t like to leverage mezz [ph] because it’s inherently leveraged already.

So, the bridge business will be funded by selling senior pieces of the loans off to – again, as I said to various banks and smaller insurance companies. That in itself is similar to what we would be doing with the warehouse line.

Jason Stewart – Compass Point

Okay. And are we close – are you close to signing a bank on the participation side? How is that process going?

Scott Schaeffer

We have a number of banks that we are working with and actively showing deals to and we are confident that if we want to move forward because of the credit profile of the opportunity that works for us that the bank will be there to fund alongside of.

Jason Stewart – Compass Point

Okay. And is the board thinking about the fact that that is – the mezz piece if it is participation with the bank on the senior side that you don’t want to leverage. Is the board thinking that the retained capital that would be used for that asset?

Is that one of the reasons the board is not thinking…

Scott Schaeffer

Yes.

Jason Stewart – Compass Point

Okay.

Scott Schaeffer

Yes. And again, it’s – these are small – these will be small, individual interest. Again, if we’re doing an $8 million loan and we’re selling all 60% of it, you’re talking about $3 million of retained interest. So, we can – we can do a fair amount of that with the capital that we have available.

Jason Stewart – Compass Point

That makes perfect sense. And then if you could just give us some color on the CMBS business and the pipeline. It looked like – as is usual in this environment, some transactions slip quarter to quarter.

But I think before you had talked about a $60 million-ish pipeline that was close to closing and if I can add it up, we still have some more that might be closing in the third quarter, is that right?

Scott Schaeffer

Yes, we do. We have a very active pipeline. We closed number – it was 32 million in the second quarter. There’s been some closing since and we have a very strong pipeline going forward. That business is ramping nicely as I indicated.

Jason Stewart – Compass Point

And last question and I’ll jump out. Is the gain on sale margin – I mean, there’s obviously eight points, it seems like it was an anomaly which is great. It’s a good anomaly to have.

On a go forward basis, consistently, what should we be thinking about in terms of margin there?

Scott Schaeffer

On the CMBS business, what we’re seeing is 2.5 to 3 points on the total loan of which we have 25% of that loan is our – is our capital and the other 75% is the warehouse line. So, on our equity, you can multiply that by three so you’re looking at a 10 point business – or 9 to 10 point business.

Jason Stewart – Compass Point

On equity, okay. Great. Great quarter and thank you for the disclosure and taking all the questions, I appreciate it.

Scott Schaeffer

Thank you.

Operator

And our next question comes from the line of Brian Gonick with Sunvest. Please proceed.

Brian Gonick – Sunvest

Good morning. It’s a great quarter.

Scott Schaeffer

Hi Brian.

Brian Gonick – Sunvest

Hi. On the restrictive cash, it looks like $100 million now. Is that all – so how much of that is potentially re-investable into – I know the re-investment period is over. But I thought that there were some extension possibilities still even though the re-investment period was over.

Scott Schaeffer

The re-investment period has ended and of the restricted cash, there’s between $50 million and $60 million that is being held for future funding commitments within existing loan. So, that is not interest earning capital at the moment but as we fund it, it will be.

Brian Gonick – Sunvest

And over what period of time does that happen?

Scott Schaeffer

I would – I would – if – it depends obviously on the borrower because these are for improvements being made to properties and how quickly the borrowers get that done but I would guess within a year.

Brian Gonick – Sunvest

Okay. And on the interest expense, I know you had some hedges rolling off, is there any way you can quantify how much that will continue here and how much has already rolled off? What sort of savings?

Jim Sebra

Sure. I mean, we’re going to – this is Jim. We’re going to have about $300,000 of savings per quarter in the third quarter and the fourth quarter of 2012 from the roll off of the hedges.

Brian Gonick – Sunvest

And how about – anything in the next year?

Jim Sebra

There are some next year. I don’t have the number handy but there are certainly some continued rolled back next year as well.

Brian Gonick – Sunvest

Okay. Listen, we’d like to see that the AFFO and the cash flow is going forward and you had put out in a investor presentation recently your expectations for cash flows this year and next. Has that changed at all?

Jim Sebra

We’re still tracking with those productions.

Brian Gonick – Sunvest

Great. And in light of that and sort of following up on the question asked earlier, we think the dividend payout ratio is low and we think that it would be sending a very good signal if you were to increase that even though – however modest that might be sequentially each quarter as your cash flow goes higher to support that.

Scott Schaeffer

We hear you Brian. And we understand that and as I said to Gabe that we will be reviewing it on a quarterly basis with our board. And we’re comfortable with the payout ratio where it is relative to AFFO. So, as AFFO increases, I think it’s fair to assume that the dividend will increase along with it.

Brian Gonick – Sunvest

Right. And when is the next time that you meet to determine the dividend?

Scott Schaeffer

We meet on a quarterly basis. It’s every quarter.

Brian Gonick – Sunvest

And so, when do you expect that the next dividend announcement date would be?

Scott Schaeffer

Well, usually, it – later of the – late in the second or early in the third month of each quarter.

Brian Gonick – Sunvest

Great. Okay. Thanks, guys.

Scott Schaeffer

You’re welcome.

Operator

Ladies and gentlemen, with no further questions, this concludes today’s question and answer session. I would now like to turn the call back over to Mr. Scott Schaeffer for closing remarks.

Scott Schaeffer

Once again, thank you for joining us today and we look forward to speaking with you again after the end of our third quarter. Thanks.

Operator

Ladies and gentlemen, we thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect. Have a good day.

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