Crystal River Capital, Inc. Q1 2008 Earnings Call Transcript

Crystal River Capital, Inc (CRZ)

Q1 2008 Earnings Call

May, 13 2008 9:00 am ET

Executives

Bruce K. Robertson - Chairman of the Board

Clifford Lai - President and Chief Executive Officer

Craig Laurie - Chief Financial Officer and Treasurer

William Powell - President and Chief Executive Officer

Analysts

Rolf Ruben - Merrill Corp

Jim Shanahan - Wachovia

(Thomas Wallstrom) - Private Investor

(Amit Anand) - Axial Capital

Glenn (Crockmall) - Weather Gauge Advisory LLC.

Ronald Redfield - Redfield Blonsky

Barry Kellman - Knott Partners

Presentation

Operator

Please standby, we are about to begin. Good day everyone and welcome to the Crystal River Capital First Quarter 2008 Earnings Conference Call. My name is Stacy, and I will be the coordinator for today’s presentation.

Before we being I would like to point out that statements made during this call that are not historical may be deemed forward-looking statements. Actual results may differ materially from those indicated by forward-looking statements due to a variety of risks and uncertainties, which are disclosed in Crystal Rivers most recent Form 10-K including under the heading “Risk Factors” and the updated version of risk factors that appear as Exhibit 99.1 to Crystal Rivers first quarter Form 10-Q, which is being filed with the SEC and is available on Crystal Rivers website.

Forward-looking statements speak only as of the date of this call and Crystal River undertakes no duty to update them.

With that, I will now turn the call over to Bruce Robertson, Chairman of Crystal Rivers Board of Directors. Please go ahead sir.

Bruce K. Robertson - Chairman of the Board

Good morning and thank you everyone for joining the call this morning. As detailed in yesterday’s press release Crystal Rivers Board of Directors has appointed William Powell, as its new President, Chief Executive Officer effective today. Bill joins us from his former position as co-head of Brookfield Real Estate Finance Funds Group and he has over 20 year of commercial debt structured finance and commercial real estate equity markets experience.

The Crystal River has benefitted tremendously from corporate life structured finance expertise most recently Clifford help stabilize Crystal River financial position amidst, you know, one of the most challenging credit market conditions experienced in recent history. At the same time both Clifford and the Board believe that due to the changed market environment builds wide range in commercial real estate background will be a better fit for Crystal River.

I would now like to hand the call over to Clifford Lai. Cliff?

Clifford Lai - President and Chief Executive Officer

I want to say a couple of words before I turn over to Craig and then over to Bill. You know, as most of know it’s been a very challenging environment for Crystal River over the last year, and the stress did continue into the latest quarter. We hear as the firm continued to have a very cautious outlook for the markets for the remainder of the year and last quarter, as we have mentioned, we took very proactive steps to deleverage the balance sheet, and very dramatically reduced the liquidity risk from the company.

But at this point, in the company life cycle, we had the balance sheet delevered, the credit markets remaining very tight, financing at some point will return, but only two select sectors. And one of the components of the company’s strategies, which will of that purchasing mortgage-backed securities and financing them in either the repo or the CDO market just, you know, is probably not available there in the future. So, I think, you know, as Bruce said, it’s a very appropriate time to review the company’s strategy in light of all these factors. Bill Powell brings a broad range of experience in both the securities and the commercial real estate markets. And you know, I think it will be a great addition to Crystal River team and I look forward to working with him as a Board member of the company. Craig?

Craig Laurie - Chief Financial Officer and Treasurer

Thank you, Cliff. I will begin by walking through the key portfolio highlights for the first quarter and I will provide a brief summary of our financial results.

As previously disclosed, we sold our $1.2 billion Agency Mortgage-Backed Securities portfolio as well as our real estate finance fund investment following which we expect our future distribution to be less than previous distribution. As these assets contributed approximately half of our estimated REIT taxable income of $0.63 per share for the quarter ended March 31^st, 2008.

With the asset sales we reduced the borrowings under our funding facility to less than $40 million drawn and significantly lowered our repurchase debt outstanding from 1.3 billion at the end of the year to 28 million after the trade settled made April. Following this settlement 95.5% of our debt was term funded and our debt to equity ratio significantly improved to 5 from 1.

In terms of the financial results for the first quarter of 2008 operating earnings increased to $20.1 million or $0.81 per share compared to $17.9 million or $0.72 per share for the fourth quarter of 2007, while the GAAP net loss for the three months ended March 31^st, 2008 totaled $137.7 million or $5.56 per share. The primary contributor to the first quarter 2008 net loss was a $100 million impairment charge and mark-to-market adjustment including $67 million on our non-securitized assets and $33 million of impairment charges and net mark-to-market adjustments on our securitized assets and liabilities.

As discussed during our last call effective January 1^st, 2008 we adopted FAS 159 and made an election to carry both the assets and liabilities of our two CDO entities at their fair value. As a result, all unrealized gains and losses may be available for sale securities held within our CDOs, and the corresponding CDO liabilities, and swaps previously designated as a hedge are now being recorded directly into earnings. With the adoption of this standard, the company had a one-time cumulative effective balance sheet adjustment of $181 million at January 1^st 2008.

Additionally, during the quarter, we recorded realized and unrealized losses on a derivative to $43 million. Approximately, 10 million of the derivative loss was attributable to the 2008 portion of the realized loss resulting from the closed out credit default swaps while the remainder has come predominantly as a result of reclassification adjustment, mark-to-market adjustments and realized losses on our interest rate swaps.

We also recorded a $9.1 million loan loss allowance on our real estate loan. 2.5 million of this total was a further allowance against the previously impaired construction loan discussed last quarter to reflect the worsening economic climate in that region. The remaining allowances are mark-to-market adjustment resulting from the reclassification of our $107 million of our real estate loans designated held for sale this quarter.

That concludes my comments on the financial results. I will be happy to take any questions at the end of the call. I would now like to turn the call over to Bill Powell.

William Powell - President and Chief Executive Officer

I would just like to say that I am very pleased to be appointed as the new CEO of Crystal River. And I would like to thank Cliff for all his hard work and efforts over the past several years in what has been a very challenging environment.

I am very pleased to say that Cliff will be remaining on the Board and will offer insights and guidance. I am looking forward to working with Craig and his team and with our Board of Directors as well as working to create value for our shareholders.

As Craig had mentioned the real estate finance market is still dislocated and delinquent. Although the commercial real estate market has continued to perform very well from a credit perspective, it is our view that the credit aspect of the market will need to be carefully monitored and managed over the near term.

So it is in this environment the liquidity and uncertainty but Crystal River took the very necessary and positive steps in the first quarter of 2008 to significantly deleverage its portfolio. This deleveraging was the first step in ensuring that Crystal River will be better positioned in the current environment and be able to successfully weather current and future market condition. The near term goal for the company will be to remain cautious and conservative and an emphasis we place more on trading and preserving available liquidity.

We will be proactive however in identifying potential risks in the portfolio and will be continually monitoring market conditions to evaluate positive steps and opportunities for the company.

We would now like to open the call for questions. So, I will turn it back to the operator.

Question-And-Answer Session

Operator

Thank you. (Operator Instructions). We will go first to Rolf Ruben with Merrill Corp.

Rolf Ruben

Yes, one of your competitors CapitalSource has bought the deposits of a savings and loan, there was a little bit of trouble and they have of forming an Industrial Bank and they are going to use the deposit as a funding source going forward. Would you guys consider that as an option for you know, future funding.

William Powell

Rolf this is Bill Powell. We sold that transaction as well, and it is a very interesting transaction for CapitalSource. You know, we are going to be doing a lot of work when coming up with a strategic plan for Crystal River and we are not going to rule out sort of any alternatives and certainly that would be something we would look at. So I appreciate you bringing it to our attention.

Operator

Anything further Mr. Ruben?

Rolf Ruben

No.

Operator

Thank you. [Operator Instructions]. We will go next to Jim Shanahan with Wachovia.

Jim Shanahan

Yes, I am curious about a couple of developments in the quarter and the first of all the decision to take throughout 2008 base management fees in the form of stock. What was the primary reason for that is, is it designed to sort of cash flow, is it designed to a line interest with shareholders and a little more background there please?

William Powell

Yes, Jim it’s Bill. The company asks the management to take the dealing stock really to just the measure to preserve liquidity. You know, liquidity was very crucial to preserve going back over the past 10 months and it was really nothing more than that.

Jim Shanahan

Okay.

William Powell

Obviously, this is something that will be reviewed every quarter between the manager and the Board.

Jim Shanahan

So, it’s not necessarily throughout 2008 that will continue?

William Powell

That’s correct.

Jim Shanahan

And, Mr. Powell, my question I guess, there is so many changes to your certainly the deleveraging and the balance sheet obviously was a lot bigger and I am just kind of curious where you would – what it means for us as shareholders and investors and analysts, where do you think, you will see off and you are likely to take the direction of the investment strategy here given your background and where do you see the market refinancing?

William Powell

Okay, okay. So, that’s a good question, Jim, I appreciate that. And before I talk too much about the business plan, I just want to stress how valuable it has been for the company to do to delevering actions in the first quarter because we removing all that financial risks from the company that that gives us the ability to create a strategic future for Crystal River. That will be based on the merits of the future business plans and I just want to be very careful I make sure, I make this point clearly, because as opposed to a business plan whose objective is solely to de-risk or delever the company we have already done that. And so what business plan we settle one for the future it will be very attractive, it will be blessed by the Board, and it will be a business plan that is dependent to save the company or to delever the company, if you follow me. So, as I said earlier, I mean, at this time though we are still being very cautious and conservative. We will be – we will be taking steps to preserve the company’s liquidity. We are also going to be working very hard coming out with the value franchisee for the company. But, at this point, no decisions have been made and it’s pretty mature to talk about what that plan could be like.

Jim Shanahan

Is there a possibility that Crystal River could be raising capital to take advantage of market opportunities?

William Powell

I would ever say to that is, I would say that most alternatives for the company do involve raising capital. I mean, obviously not all but most do. And once again essentially have the leverage and we should, I think we have to do capital pursuant to the value trading plan as opposed to a compensating plan and I think that’s something that would be attractive to our shareholders.

Jim Shanahan

Okay, one more quick and maybe this for Craig. We're tinkering with the model last night Craig and we’re wondering if you are thinking about this the right way. When you write down the value of certain of your investments CMBS and non-agency RMBS and you are carrying them at book yield. And first question is, does that include your assumption for credit loss on the go forward basis and part two, is that an appropriate yield for us to use versus the fair value of those asset to estimate what the earnings power is for the assets in there written down form?

Craig Laurie

Sure Jim his is Craig. So in terms the first questions those view include our current loss assumption. And the second part of that question is assuming those loss assumption that is what we expect that yields to be on the bond, in terms of your question.

Jim Shanahan

Would you do the same analysis with your CDO liabilities and would we want to back in to just estimate with funding cost side, it was on the original size of the notes and calculates that into the reduced fair value of those liabilities to come up with the same interest expense?

Craig Laurie

In terms of, there is really two parts to that question. For the first part, all the securities as well as within the CDO and outside the CDO as well as CDO liabilities are marked to market. Those marked-to-market are from predominantly from third-parties. Only 1% of our portfolio has been marked to model, so everything else we did it from independent pricing service or a dealer. So that's really separate in part. In terms of the actual interest expense on the CDO liabilities they have obviously, they have been close in the 10-Q as wells as the 10-K as well as the hedge rate. If I can give you to hedge rate…

Jim Shanahan

No I think I found them here. But is your suggestion we should use the hedge annual rates which I assume are fixed here than, and apply that to the original balance of the notes to get a run rate for interest expense?

Craig Laurie

Yes, that’s correct.

Jim Shanahan

Okay, I have kind of started to do that. I think that the press release yesterday might have suggested that the run rate for re0-taxable income might be half, what it was or at least I got some early feedback from some investors and I think there is maybe a little more earnings power than that. Was it your intention to send the message to the street that the dividend could be cut by a measure of half because the agency RMBS book contributed half to re-taxable earnings?

William Powell

This is Bill, just getting in to talking about the dividend I just want to be clear that everyone understands that dividend is determined by the board after taking into consideration the company’s earnings, the cash flow, liquidity, capital requirements among other factors. And so, that being said, I don’t think it was our intention to conduct a message either a very positive or very negative. I think it was our intention simply to report what happened in the first quarter and the how material those response were relative to the first quarter earnings. And I think Craig can add some details behind that which I if you can share where the agencies and the investment in the North Sea finance fund equated to approximately 50% on the taxable earnings for the first quarter.

Craig Laurie

Jim actually go through the math if you wanted just for the, I think everybody on the call as well. So, as Bill said what we reported in the press release was what actually happened in the first quarter and as Bill said the Board will consider a lot of different factors on setting a dividend. But in terms of the actual what happened in the first quarter, the agency, there is obviously some math for everybody. So the actual asset on the agencies was about $1.2 billion at an average coupon of 5.3% that equals to $56 million. So liability which at the time has an advanced rate of 97%, I mean, everybody knows that advanced rate come downs substantially to probably 93% in some case 90%, by the time t is 97 that equates to $1.2 billion as well as 3.2% which is about $39 million, at least in net investment income $27 million on a 12 month period roughly divide by $6.8 million. The real estate investment fund had an book value of $36 million with a cash flow expectation of 10% which is 3.6 million, it was financed to 100% at LIBOR plus 250. So that is all in rate of 5.7 times to 36 equals $2.1 million which is $1.6 million net investment income for 12 months or 0.4 for the year for a quarter, so that totaled $10.2 million which divides 24.7 million shares and roughly $0.29 of the total $0.63 or 46% of the tax flowing customer.

Jim Shanahan

Okay. Thank you.

Operator

And we will go next to (Thomas Wallstrom) a Private Investor.

Thomas Wallstrom

Good morning Tyras. I wanted you to talk just a little bit further about the impact on the dividend and your planning for the future, there is a look like its on the table to cut the dividend or eliminated at all?

William Powell

This is Bill, I will try to answer your question, and I don’t want to repeat you know what I said earlier about, dividend is the decision of the board, and so, when they determined the dividend they look at what prudent and appropriate given all of the consideration. So it’s not like a – it our intention to cut the dividend or to eliminate the dividend is merely our intention to get out there, the operating earnings of the company. And as Craig just walk through they are – the operating earnings of the company for the first quarter has the agency securities not been there and has the investment and development finance are not been there would have been about half. And so, I really think about how we can say about the future dividend at this point.

Thomas Wallstrom

Okay thank you. Now looking at things like risks and impairments on that in the present quarter you’re already one and half months into the second quarter and probably have a feeling for some of these kinds of things. Are we’re going to have any bad news out of this quarter also?

Craig Laurie

In terms of the, this is Craig. In terms of the impairments from marked-to-market if you look at – the book value is $5.37 and what that equates to its historic cost for real estate assets, but the securities are marked-to-market. If you actually look at the lift we have moved since quarter end and to your question specifically. This embedded spread or the index spreads have tightened, but the cash market has been relatively flat. So the – to kind of estimate where things what I’ve said today, its roughly at the same level there were at March 31st to right on 537.

Thomas Wallstrom

Okay. And also you have initiated they group program, can you tell me where the series will come from is that going to be both on the open market or you going to have an issue?

Craig Laurie

Yeah, this is Craig again. It could be a combination about the one that have planned a lot other that become a newly issued shares and treasure when they buy, make any purchase on the market place.

Thomas Wallstrom

Okay, I see that the stock is trading as low as lower $7 this morning and I wondered if your folk should be in the market today and pickup some?

William Powell

This is Bill. Regarding the share buyback today we have purchased approximately 300,000 shares. But at this point, we think it’s important for the companies to preserve cash and liquidity just in light of market condition and so, going back to my earlier statements and it is our outlook to remain cautious and conservative in the near term.

Thomas Wallstrom

Okay, thank you.

Operator

Thank you. [Operator Instructions]. We will go next to (Amit Anand) with Axial Capital.

Amit Anand

Hi good morning. I was wondering if you could give us an update on the covenants for your first CDO and whether there are any other rating agency downgrades have effected your position with respect to the CDO?

William Powell

Okay thanks this is Bill again. As you know we have two CDO’s. The first CDO has what I will call l triggers and the second CDO has no trigger. The way the triggers are designed they don’t work off the ratings of the CDO liabilities and so, the triggered effect the cash flow waterfall of the CDO and it completely blind to the rating of the of the CDO it’s a – the ratings downgrade of the CDO bond has no impact on that. Now just to further elaborate obviously, the ratings of the underlying bond within the CDO are impacted or due impact the triggers and this is something that we ,monitor very closely and carefully. And, at present time we are in compliance with all the triggers and the cash flow waterfall in that CDO is not been authored pursuant to any downgrades of ours.

Amit Anand

That’s great. And as you model out the securities within the CDOs, are you comfortable that they will continue to pay the cash out for the foreseeable future?

Craig Laurie

So it’s a good question and it depends upon your future assumptions on credit and prepays with some of the bonds that are in the CDO. But I want to point out that we – our manager has the ability to remove assets from the CDO that we have been to be credit risk. And so, the reason we’ve monitored the CDOs so carefully is that we would be – we want to be in a position that simply catching the – represent liquidity of course, and we would have the ability to transfer out of the CDO bonds that – that’s our potentially going to call chipping the desk, no not saying we’re definitely going to do that, I am not saying that we are always have the liquidity to do that, but as the collateral manager for CDO as most collateral managers for CDO which is whatever our main functions is.

Amit Anand

Yep. And then with respect to you know I saw the reserve that you took for the condo loans, are there any other loans on that you’ve invested in that are maybe on your watch list or that you’re watching carefully, that maybe we should be expect the reserves on for the rest of the year?

Craig Laurie

When we look at our loan portfolio, there are no other loans that we do as at risk, and I will just elaborate a little bit about credit generally. When we look at the CMBS portfolio credit has continue to perform well. When we look at our portfolio as a whole, the weighted average delinquency for that portfolio is 0.63 of 1%. Coincidentally there is a large database provider for CMBS industry and they’re current showing a market wide delinquency of the same number 0.63%, and in that I should be clear on defining delinquency of anything that 60 days or greater the delinquency. So I would say that we are in part with the market. So if you drill down just a little bit more and look at the market wide credit statics and say how the cohort of 2005, 2006 2007 performing, once again market wise 2005 is 0.36, 2006 is 0.50, and 2007 hasn’t enough to be meaningful. So if you look at those two statics, I would say that within our portfolio we’re equal to the market and we’re slightly worse than the cohorts of ’05 or ’06, but its really too early to draw any meaningful conclusions from that. And then on the residential side, our crime t portfolio we current has 3.87% in delinquencies, and on the sub prime we have 27% delinquencies, but I will just further add that the market value of those securities are down around 26 or 20 dollar price. So I can agree the market pricing that we had has been fully incorporate the expected losses that will come from those delinquencies.

Amit Anand

Got it. Great and then my final question as part of your business plan review whether you’ve given any thought to the corporate structure, the new entity you will be in, and specifically have you given any though deviating the company?

William Powell

Yes, its Bill again,. Just on the matter of the read, I just want to – I would like to say that we are weak compliances at this moment when we go to business planning process, of course, we would look at all alternatives, which would naturally include the possibility of the reading, but at this time we have no intention to read.

Amit Anand

Alright thank you very much.

Operator

We’ll go next to Glenn (Crockmall) with Weather Gauge Advisory LLC. Hello Mr. Krochmal, your line is open. Please check your mute button.

Glenn Crockmall

Yeah, my question was answered by the last person’s last question.

Operator

Okay, we’ll move next Ronald Redfield with Redfield, Blonsky.

Ronald Redfield

Hi, good morning. Can you please explain your quarter transactions and future pending transaction with Brookfield Real Estate fund, Brookfield Asset Management and any other related entities please?

William Powell

Yeah, let me start its Bill. First of all when we start talking about Brookfield Asset Management, used to get out there, Brookfield Asset Management does on 10% - approximately 10% of the shares at Crystal River. And they’ve been a great sponsor. They provide and support information and over the past 10 months they provided a secured bank facility that was extremely difficult to gather, it would’ve been extremely difficulty to get in the market front. So, they are a great sponsor. And now, to answer your question specifically, the – in the first quarter Crystal River did its investment in Brookfield Sponsored Fund and Crystal River did so simply to raise liquidity and in time when Crystal River needed to raise some liquidity. As far as going forward, in the business plan – we have no specific plan to buy or sell from Brookfield, although we – we certainly have plans that we want to take advantage of the knowledge stage within Brookfield and also hopefully to take advantage – or not valid to take advantage, but to get the benefit of Brookfield’s capital base.

Ronald Redfield

And how about Brookfield Real Estate services?

William Powell

I am assuming you’d like taking about the manager of the REIT?

Ronald Redfield

Yeah. I must have mistaken. BREF?

William Powell

BREF is the BREF. Brookfield Real Estate Finance Fund, and that’s real estate fund, it is managed by Brookfield and that is the finance fund, by the way that Crystal River has $36 million investment.

Ronald Redfield

Is that the fund you sold this quarter?

William Powell

Yes, it is.

Ronald Redfield

Okay thanks.

Operator

And we will next to Barry Kellman with Knott Partners.

Barry Kellman

Yes good morning, thanks for taking my call. Just a couple of questions. You know, its not directly associated with your business, but can you maybe talk about what you see happening with CDO managers that, you know, what kind of cause on cash are you seeing running through that segment of the marketplace?

William Powell

It’s Bill again. It’s interesting, you know, I mean, generally speaking, we still are seeing capital, we treat from the commercial mortgage finance market. We see capital still retrieving from, you know, what was the CDO market which includes the portion of say, CDO market. But, you know, most CDOs were structured so that one flavor done than they were in effect term finance and so as this thing from the SIVs or some of the other vehicles in the market that have gotten a lot of press, you know, most of the CDOs were structured such that the CDO by the asset, issue the liability and then the waterfall which will simply takes the cash flow from those assets and pay the liabilities and if there is anything left at the end of the day it will pay out to equity. And so, in that contact there is not sort of pressure against these CDO collateral managers for say. I am not sure if I answered your question, but if you could, let me know.

Barry Kellman

No, no, no you did, I mean, like one other thing is, I guess one other question is that we’ve been struggling with, as CDO managed its cash end from their investor pool, you know, they are buying a lots a lot of synthetic not necessarily with cash underlying. And we’re trying to figure out if they’re getting cash calls.

Craig Laurie

For the cash that is supporting the synthetic position?

Barry Kellman

Yeah.

Craig Laurie

I would say that is definitely not, nothing with business, that’s not the – that’s not the way (Inaudible) CDos, and actually I am not sure the answer to the question.

Barry Kellman

The other thing – the other question I guess I have is as an opinion everybody has got one, I mean do you have any thoughts as to why there is such a disparity between the cash market and synthetic market?

William Powell

Yeah I think just generally speaking the synthetic market was set up as a way for people to, I mean, to hedge their risk or make their one way debt, and there was no natural party to take a long time of that and so, we’ve got people that were hedging therefore they were going sure and you had lot of people that were betting and they were going short, and they kept on piling on each other and here was no one on the long side to sort of start of stop the spread widening this is my observation on it.

Barry Kellman

Alright. And maybe if you can just reiterate, this is my last question, I mean, where do you want to drive the business over the next 12 to 18 months?

Clifford Lai

It’s a good question and it’s a question that’s come up a couple of times already and its difficult to answer at this time. I can tell you that we are working very hard to come up with the strategy for Crystal River that creates value for the shareholders, but at this time it’s just premature to talk any more about it.

Barry Kellman

Alright I appreciate you guys taking the time out. Thank you very much.

Operator

Thank you we will next to Jim Shanahan with Wachovia.

Jim Shanahan

Thanks for taking my follow-up I appreciate it. Just quickly, can you estimate what you think your cash position will be following the closing of the pending transaction?

Craig Laurie

Jim its Craig, you mean, pending after the agency mortgage-backed opportunities were all sold.

Jim Shanahan

That’s right.

Craig J. Laurie

All those trades settled in late April. And probably the better way to answer it, if you think of cash as kind of being fungible with the funding lines. The funding was paid down to below $40 million and because currently our pay down is about $22 million.

Jim Shanahan

Thank you.

Operator

Thank you. And, ladies and gentlemen that will conclude today’s question-and-answer session and today’s Crystal River Capital first quarter 2008 conference call. We thank you for your participation and you may now disconnect.

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