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Executives

Jason Fooks – Vice President of Investor Relations & Marketing

Jay Sugarman – Chairman of the Board & Chief Executive Officer

David DiStaso – Chief Financial Officer

Analyst

Michael Kim – CRT Capital Group

Joshua Barber – Stifel Nicolaus & Company, Inc.

Amanda Lynam – Goldman Sachs

[Jonathan Fleman – Numerist Securities]

iStar Financial, Inc. (SFI) F2Q12 Earnings Call July 27, 2012 10:00 AM ET

Operator

Welcome to iStar Financial’s second quarter 2012 earnings conference call. (Operator Instructions) As a reminder, today’s conference is being recorded. At this time for opening remarks and introductions I’d like to turn the conference over to Jason Fooks, Vice President of Investor Relations and Marketing.

Jason Fooks

Thank you for joining us today to review iStar Financial’s second quarter 2012 earnings report. With me today are Jay Sugarman, Chairman and Chief Executive Officer and David DiStaso, our Chief Financial Officer. This morning’s call is being webcast on our website at www.iStarFinancial.com in the investor relations section. There will be a replay of the call beginning at 12:30 PM Eastern Time today. The dial in for the replay is 1-800-475-6701 with a confirmation code of 254611.

Before I turn the call over to Jay, I’d like to remind everyone that statements in this earnings call that are not historical facts will be forward-looking. iStar Financial’s actual results may differ materially from these forward-looking statements and the risk factors that could cause these differences are detailed in our SEC reports. In addition, as stated more fully in our SEC reports, iStar disclaims any intent or obligation to update these forward-looking statements except as expressly required by law.

Now, I’d like to turn the call over to iStar’s Chairman and CEO, Jay Sugarman.

Jay Sugarman

During the second quarter we delivered on two of our main objectives: continuing to pay down significant amounts of debt; and accessing the unsecured markets for the new issue while continuing to work on the portfolio. Successful sales in the net lease and residential portfolio were offset by increased provisions in Europe and impairments of vacant office assets that are proving difficult to release to single tenants.

We continue to make slow progress in transitioning non-earning assets into a position where they can be more productive but this remains a key challenge as we move forward. Our earnings reflected these trends with a net loss of just under $60 million. For the quarter excluding primarily depreciation and provisions impairments, adjusted net income for the quarter was closer to breakeven coming in at a $2 million loss or a little under $0.02 a share.

Liquidities remain solid with sales, repayments, and our return to the unsecured market enabling us to end the quarter with over $700 million in cash and in good shape to repay our remaining 2012 debt maturities. Repayment of our two secured facilities have both exceeded projections and as a result each of the 2011 and 2012 secured facilities have delevered nicely.

With respect to the asset side of the balance sheet we continue to evaluate opportunities to deploy capital in the portfolio while simultaneously looking to take advantage of the strong bid for many of our assets when it makes since. But standing on the availability and cost of our capital, we should be able to ramp up our investment activity once our leverage levels reach our long term target levels.

With that quick update, let me turn it over to Dave for more of the details.

David DiStaso

I’ll begin by discussing our financial results for the second quarter 2012 before moving to investment activity and credit quality and I’ll end with an update on liquidity. For the quarter we reported a net loss of $59 million or a loss of $0.70 per diluted common share compared to a net loss of $36 million or $0.38 per diluted common share for the second quarter 2011. Results in the prior year included the benefit of $26 million of interest income associated with the favorable resolutions of two NPLs.

The year-over-year decrease was also due to lower revenue from a smaller overall asset base and higher provisions for loan losses and impairments. This was partially offset by increased gains from discontinued operations and income from sales of residential property as well as a reduction in general administrative costs.

Adjusted income for the quarter was approximately breakeven with the loss of $1 million compared to a loss of $2 million for the same quarter last year. Adjusted income represents net income calculated in accordance with GAAP prior to the effects of depreciation, long loss provisions and impairments, stock based compensations, and gains on our early extinguishment of debt, all of which are non-cash items.

Adjusted EBITDA for the second quarter was $107 million compared to $103 million for the same period last year. The year-over-year improvement was due to increased gains from discontinued operations and income from sales of residential property as well as a reduction in general and administrative costs partially offset by lower revenue from a smaller asset base.

As we previously announced, during the quarter we issued $275 million of 9% senior unsecured notes due 2017. Proceeds from the new issuance will be used to refinance unsecured debt maturing in 2012. During the second quarter we retired a total of $640 million of debt, specifically we repaid $90 million of our 5.5% senior unsecured notes due June 2012 and repurchased $192 million of our senior convertible notes due October 2012 at a small discount.

We also repaid $226 million on the A1 tranche of our 2011 secured credit facility bringing the balance to $646 million and repaid $81 million on the A1 tranche of our 2012 secured credit facility bringing that balance down to $329 million. As a result, we have satisfied all minimum amortization requirements on the A1 tranche of the 2011 facility prior to its maturity and effectively met the minimum cumulative amortization of $82 million required by June 30, 2013 for the A1 tranche of the 2012 facility. Finally, we repaid a $51 million loan secured by a pool of net lease assets that we sold during the quarter which I will discuss further shortly.

Our leverage decreased to 2.5 times from 2.7 times at the end of the first quarter and our weighted average effective cost of debt for the quarter was 6.5%. During the quarter we also repurchased approximately 800,000 shares of our common stock at a net average price of $5.69 per share. At the end of the quarter we still had remaining authority to repurchase up to 16 million of shares under our share repurchase program.

At the end of the quarter we had $770 million of cash including cash reserved for repayment of debt. During the second quarter we generated a total of $555 million of proceeds from our portfolio comprised of $186 million of principle repayments, $117 million from sales of OREO assets, $136 million from sales of net lease assets, $57 million from loan sales, and $59 million from other investments. In addition, we funded $40 million of investments and capital expenditures during the quarter.

Let me now turn to the portfolio and credit quality. At the end of the second quarter our total portfolio had a carrying value of $6.3 billion gross of general reserves. This was comprised of approximately $2.4 billion of loans and other lending investments, $1.6 billion of net lease assets, $2 billion of owned real estate, and $428 million of other investments. At the end of this quarter our $1.7 billion of performing loans and other lending investments had a weighted average LTV of 74% and a maturity of approximately three years.

The performing loans consisted of 51% floating rate loans that generated a weighted average effective yield of 6.7% for the quarter and 49% fixed rate loans that generated a weighted average effective yield of 8.6 for the quarter. The weighted average risk rating of our performing loans was 3.16 at the end of the quarter, an improvement from 3.27 at the end of the prior quarter. Included in our performing loans were $75 million of watch list loans, a decrease from $170 million last quarter.

At the end of the second quarter our non-performing loans or NPLs had a carrying value of $639 million net of $491 million of specific reserves. This is a decrease from $663 million net of $477 million of specific reserves at the end of the prior quarter. Our NPLs consisted primarily of 31% land, 21% retail assets, 15% hotel assets, 13% apartment residential, and 12% of entertainment leisure.

Our $1.6 billion of net lease assets which are recorded net of $342 million of accumulated depreciation were 91% leased with a weighted average remaining lease term of over 12 years. They had a weighted average risk rating of 2.70 versus 2.63 in the prior quarter. During the quarter we sold a portfolio of 12 net lease assets for $130 million in net proceeds and recorded a gain of $25 million on the transaction. Certain of the properties were subject to a $51 million secured term loan that was repaid in full at closing with a portion of the net sale proceeds.

For the quarter our occupied net lease assets generated a weighted average effective yield of 9.3% while our total net lease portfolio generated a weighted average effective yield of 8.4%. During the quarter we recorded $6 million of impairments within our net lease portfolio.

Let me now turn to our owned real estate portfolio. At the end of the quarter we had $722 million of OREO assets. OREO assets are considered held for sale based on our current intention to market the assets and sell them in the near term. Additionally, $1.3 billion of assets were classified as real estate held for investment, based on our current intention and ability to hold them for a longer period of time.

During the quarter we took titles to properties with a carrying value of $45 million. For the quarter our owned real estate portfolio generated $28 million of combined revenue and gains from condo sales offset by $22 million of expenses. In addition, we funded $19 million of capital expenditures.

Let me move on to reserves. We recorded a $27 million provision for loan losses in the second quarter versus $18 million last quarter. At the end of the quarter our reserves total $564 million consisting of $507 million of asset specific reserves and $57 million of general reserves. Our reserves represent 20% of the total gross carrying value of the loans. This compares to loan loss reserves of $567 million or 18% at the end of the prior quarter.

Finally, let me concluded with a discussion on our liquidity. As I mentioned before we ended the quarter with $707 million of cash including cash reserved for debt repayment and have approximately $465 million of remaining convertible note due in October which fulfills all of our unsecured debt maturities until June 2013. Other expected uses of cash for the remainder of 2012 include approximately $30 million of loan and investment funding and approximately $90 million of capital expenditures that we expect to invest in our owned real estate portfolio.

With that, let me turn it back to Jay.

Jay Sugarman

Let me just finish by saying as we continue to streamline the portfolio in coming quarters we’re going to need to find ways to optimize each of our business lines and to begin focusing on how to make our costs of funds more competitive. A lot of works been done but there’s a lot more to do. Let’s go ahead and open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Kim – CRT Capital Group.

Michael Kim – CRT Capital Group

I have a question on the other real estate owned category, residential unit sales were a lot higher than what you were forecasting. Can you describe where the demand is coming from? Are you seeing more demand by investors, or retirees, or are there certain projects within the portfolio that are having better absorption rates, or a project that just came online? Are there any comments you can provide there?

Jay Sugarman

It was a pretty strong quarter for that part of the portfolio. It is a combination of a couple of projects where redesign efforts came to fruition. We were actually selling almost a brand new product into the marketplace where obviously there hasn’t been much new in a couple of these markets. Good solid strength down in Miami continues, we actually saw very good results in our project in Vegas this quarter. New York continues to be reasonably strong. So we had a number of projects where we were pleasantly surprised by the demand side and it’s our view that low interest rates have a very direct correlation on the residential side of the marketplace and we’re starting to see the impact of that combined with the fact that we did bring a couple of projects back to market with a very new and interesting concept that the market seems to have liked.

Michael Kim – CRT Capital Group

How should we think about the remaining residential unit sales? Is there a number of remaining units or kind of average sales prices that you could provide us? Or, even a sense of the current – I guess the month’s supply not the current sales rate?

Jay Sugarman

Again, I always give you the caution that extrapolating from a single set of numbers is tricky but rough numbers you can think about 15,000 units. Second quarter we sold probably in the order of 300 but if you’re looking for kind of what is the run out period, we think more like eight quarters so I’d probably caution you from just doing the division and say eight quarter run for the remainder of the portfolio will probably take care of the significant majority of everything that is left.

Michael Kim – CRT Capital Group

Just moving to the real estate held for investment portfolio and just thinking about the residential land, is there a dollar amount of land that’s kind of fully entitled and doesn’t require any more investment?

Jay Sugarman

Unfortunately, I think land is always going to require investment. Sometimes it’s into infrastructure, sometimes it’s into future phases, sometimes it’s simply a function of redesigning entitlements that are already there. The projects are, with just one or two exceptions, fully entitled the question is are those the right entitlements for the market we see going forward. Unfortunately, you never get to sit back and say okay, “I made it across the bridge and now I can rest.” Particularly in these multiphase vaster playing communities.

You’re moving from one piece to the next and a lot of the work still lies ahead of us on a number of these projects so capital will continue to go into them. We will start seeing money come back from more and more of those projects so the balance will be a little better but I wouldn’t want to tell you there isn’t more money going in on any of these because I think in almost every case we’re continuing to either refine or reinvest in those projects.

Michael Kim – CRT Capital Group

My last question just on loan repayments through the remainder of the year, do you have visibility on the amount of expected loan repayments to occur by year end? Understanding that you exceeded the near term minimum amortization requirements under the 2011/2012 tranche A1 bank debt, what portion of anticipated loan repayments for this year do you expect will pay down bank debt versus available for liquidity on hand?

Jay Sugarman

Obviously if the loan is inside the ’11 or ’12 facility all of those proceeds will go to pay down the facility further and since a significant portion of the loan is both in those two facilities a lot of the loan repayments are going to be amortizing the facility. On the other side of the ledger there are a number of condominium and other types of assets outside the secured facility that will generate liquidity well so that’s where we pick up kind of the excess liquidity that gives us a chance to think about where to deploy in effect unrestricted capital.

Operator

Your next question comes from Joshua Barber – Stifel Nicolaus & Company, Inc.

Joshua Barber – Stifel Nicolaus & Company, Inc.

You mentioned the low loss reserve had to do with higher European losses and I know that you mentioned that with your watch list assets uptick last quarter. Can you remind us what your total exposure there is both gross and net and how that’s divided up between junior and senior positions?

Jay Sugarman

Here’s the way to think about it, we’re under $200 million on a currency adjusted net basis which is how we think about it. We have a couple of positions over there that we feel quite good about and we have a couple of positions that candidly on the financial metrics we would feel quite good about but given what’s going on in the refinance and senior bank debt markets I’m not sure whether those markets are even functioning at this point. Those are the ones we’ve had to take a closer look at, those are the ones we’re concerned about that have popped up on the watch list and in our own internal management.

We do have probably from a senior standpoint and we’re just thinking about Europe at this point not other international, only a couple of positions are going to be senior in the capital stacks. Probably 25% of that book, the rest are in some way subordinated whether through a senior loan or to some sort of first lean corporate type debt.

Joshua Barber – Stifel Nicolaus & Company, Inc.

When it comes to the second half 2012 resolutions it looks like the total amount of properties that you took title to in the second quarter started slowing. I know that can move around from quarter-to-quarter but as you’re going into the second half of this year what do you think the outlook is for just overall NPL resolutions?

Jay Sugarman

It’s difficult, a couple of those are litigation situations where it is truly impossible to predict. They just consistently prove slower than we think they should. We do have a couple of assets that have matured where we know borrowers are unlikely to support the property or make the cap ex requirements that we’re telling them they need to, to get an extension out of us. We will be prepared to take those kinds of assets back.

So that portfolio continues to wind its way through. We are making progress and we will take back assets if it makes sense to but I just hesitate to tell you we have a good crystal ball on those because we don’t. We know in the second half of the year we have one or two meaningful assets we’ll take back and beyond that we’ll see how it goes.

Joshua Barber – Stifel Nicolaus & Company, Inc.

When it comes to your impairments on the CPL portfolio, I know you mentioned it had to be more office leasing, a) can I assume that’s similar to the impairment that you took last quarter on that portfolio? And b) the statistics you gave on that about the 12 years weighted average leasing and 91% leased, is that including those assets that were sold during the quarter and the ones that have been impaired?

Jay Sugarman

Let’s talk about net lease for a second. Obviously, the majority of the book is under long term leases, single tenant, strong, stable, predictable cash flows. We’ve had a segment of that market as tenants have rolled out of 10, and 15, and in some cases 20 year leases. We’ve got to go back into that market and make a decision, are we going to wait for that one new single tenant that the property is the right one for? Typically, that requires us to make some meaningful expenditures to reposition it for today’s market versus when the lease was sign 10, 15, 20 years ago.

The second alternative is to break it up into a multi tenant building. A third is to simply sell it and let someone else deal with it. We’ve looked at a number of the vacant assets as we came out of the down turn to see whether it was the downturn that was causing the problem or whether they were simply not being competitive for the type of single tenant situations that are in the marketplace. In those cases where we no longer think we’re going to land the big single tenant that’s going to fill the entire building we’re taking a much harder look at the alternatives and deciding where we’re going with particularly some of these assets that are not things that we think are going to be in the core portfolio long term.

Where appropriate, it’s certainly less efficient to run a multi tenant building and it’s probably even going to be a bigger hit if we have to turn around and sell without making the cap ex improvements. But, that may be the right decision. As we talk about streamlining the portfolio, where do we want management’s attention span, where do I want my asset manager’s focused, some of these assets just don’t make sense anymore so they’ll either be moved into the operating portfolio and be treated like multi tenant assets or we’re going to sell them and move on.

Joshua Barber – Stifel Nicolaus & Company, Inc.

Last question, share buybacks it looks like you guys did about $800,000 during the quarter. What’s your outlook I guess going into the second half of the year? It looks like liquidity continues to improve and the share price still has done pretty well this year but still pretty low in absolute terms. How are you thinking about share repurchases at the current level?

Jay Sugarman

I think the first order of business has been to get our leverage down but at the same time we think a number of securities in our capital structure are attractive from the debt, to the preferred, to the common. We will continue to look at the relative valuation among those components and make good use of any excess liquidity we have. Last quarter we certainly so an opportunity in the shares. I would expect us to continue to have some amount of excess liquidity to deploy and common stock buyback is still part of that thinking.

Operator

Your next question comes from Amanda Lynam – Goldman Sachs.

Amanda Lynam – Goldman Sachs

I was just hoping you could address your preference for addressing the 2013 unsecured maturities? Would you work to issue a convert or is your preference unsecured or another secured financing?

Jay Sugarman

Look, we think it’s going to be a combination of cash on hand from the continued streamlining of the portfolio plus access to the capital markets in one way, shape, or form. Certainly a combination of secured and unsecured is probably the preferred way. We want to continue to make progress back into the unsecured side of the world but we also need to keep our cost of funds competitive and the secured side may provide a way to finance a portion of the refinancing.

As you know, the first maturity is in June, the second one is October, and there is a very small tag piece in December. We think we’ve got plenty of runway and time to make use of the capital markets and figure out how much internal capital is appropriate to generate. So it will be a combination of all three is my guess. With respect to the capital market piece, I wouldn’t expect it to be all secured or all unsecured, we’ll probably use a combination.

Just lastly on converts, we still don’t see a good place to take advantage of the markets on the convert side but if that were to open up to us we might think about that but right now it’s not on our radar.

Operator

(Operator Instructions) Your next question comes from [Jonathan Fleman – Numerist Securities].

[Jonathan Fleman – Numerist Securities]

Just a couple questions from this end and I was a little late to the call so I apologize if you answered them, but in terms of the [inaudible] assets that were sold did you give any color on what those assets were specifically?

Jay Sugarman

No, but I can tell you they came out of our [Auto Star] book primarily. They were done in the eight range on a cap rate basis. We have deemphasized the [Auto Star] piece of our business as we focus more on our core strategies. They were very good assets, a good fit for the ultimate buyer so it was a trade we think had positive characteristics for us and for them.

[Jonathan Fleman – Numerist Securities]

Then you guys had also called out the reduction in the watch list assets during the quarter. Any color that you can provide around the situation? Was that Europe related, is that do you think a longer term positive as reflected in that reduction? I’m just kind of curious what you’re seeing with respect to that there?

Jay Sugarman

That migration really was around an asset that had a maturity date and a borrower who has consistently supported the asset but it’s got a reasonably meaningful cap ex requirements going forward. We weren’t sure whether the borrower would take those on. It doesn’t look like those will so we’ll move that to NPL and ultimately my guess is we’ll be the owner of the asset. It is a cash flowing asset but as I said it does need a strong commitment behind it to continue generating decent cap rates through our basis so it looks like we’re going to be taking on that responsibility.

[Jonathan Fleman – Numerist Securities]

What is your guy’s outlook on a fundamental perspective in terms of longer term monetization of that asset?

Jay Sugarman

It’s probably too early to tell. We’ve got to get our hands around exactly where – we might have a difference in opinion versus our borrower on what can be done. We don’t own the asset yet so I can’t really speak to that.

[Jonathan Fleman – Numerist Securities]

It sounds like this was not a surprise in terms of kind of thinking that it was okay and now an expectation that you’re going to take ownership of it? Or was it a surprise?

Jay Sugarman

It was a little bit of a surprise. I think a difference of opinion internally about the borrower’s motivation. It’s seen strong support in the past and so for whatever reason I think we’ve come to the end of the line on that one and rather than continue as a lender it probably makes more sense now to put ourselves in control.

[Jonathan Fleman – Numerist Securities]

You had mentioned you can change or look at ways to reduce your cost of capital going forward. Can you at this time amplify your thoughts there in terms of ways that you would look to go about doing that?

Jay Sugarman

I think there’s a couple of things, one as we said obviously just delivering the portfolio is a big part of that strategy. I think retiring all of the 2013 maturities will have a material impact on how people perceive our maturity profile. I think consistent accelerated amortization in the secured facilities should give people comfort that there’s lots of liquidity in those books. So we’re hoping a combination of all of those things while we continue to try and transition some of the non-GAAP contributing assets into a more positive position, if all those things can come together in a marketplace that has the kind of interest rate environment we see today and a little more stability in the macroeconomic environment, we would expect the whole complex to trade a little bit better. But each of those pieces needs to continue to move forward and we still have quite a bit of work ahead of us before we reach our target leverage levels.

[Jonathan Fleman – Numerist Securities]

Then just lastly, you’ve talked a little bit about kind of the RHI portfolio and some of the initiatives there. I’m just wondering if you can kind of provide your most recent thoughts on that portfolio understanding that it’s very idiosyncratic in nature. I saw that it looks like you guys had taken title to a project in Virginia, Magnolia Green, several years ago and it looked like a piece of home construction on that project had picked up recently. I’m just wondering if you can comment on that, are there any other success stories in terms of builder interest or otherwise in the RHI portfolio?

Jay Sugarman

On RHI I think the land component is a pretty big component so it’s probably worth touching on that. Home builder indices and confidence surveys are all really strong. As I said earlier, there is a direct correlation between low interest rates on housing and we see that and feel that strongly in certain markets and where we’ve gotten our hands on assets and been able to deploy capital wise, good things have been happening. You mentioned Magnolia Green, a top selling community in the Richmond area, but it’s a multiphase project, it has thousands of units.

You’ve got to have a vision that builds from today towards all the future phasing, how you place that infrastructure, what amenities. It’s a big effort. We’ve got probably a dozen to 18 people now working on our land group all focused on delivering value. Some places it’s happening quicker than others. As I mentioned earlier in the call every step seems to require capital so it’s not something that we don’t pay rigorous attention to but in most cases we think deploying that capital into that sector is very attractive.

We would look to modify some of those assets, we would look to find ways to supplement the capital resources for that portfolio, but we are going to optimize that business line as best we can and think about all different alternatives for it. So nothing to report at this point but it’s certainly a focus of ours.

Operator

Mr. Fooks, we have no further questions.

Jason Fooks

Thank you everyone for joining us this morning. If you should have any additional questions on today’s earnings release, please feel free to contact me directly. Operator, will you please give the conference call replay instructions once again?

Operator

Ladies and gentlemen this conference replay starts today at 12:30 pm Eastern, will last until August 10th at Midnight. You may access the replay at any time by dialing 800-475-6701 and entering the access code 254611. That number again 800-475-6701 and the code 254611. That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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