Centerline Holding Co. Q1 2008 Earnings Call Transcript

Centerline Holding Co. (CHC)

Q1 2008 Earnings Call

May 08, 2008 10:00 am ET

Executives

Marc Schnitzer - President and CEO

Rob Levy - CFO

John Kelly - CAO

Analysts

Nicole Jacoby - Liberation Investments

Howard Bloom - UBS

Donald Hutchinson - Safe Harbor

Presentation

Operator

Good day, and welcome to Centerline Holding Company's first quarter Earnings Call. Today's call is being recorded. The company's press release and supplemental financial package were issued this morning.

We would like to remind you that certain statements in this morning's press release, supplemental financial package and today's conference may constitute forward-looking statements within the meaning of the Safe Harbor provisions for the Private Securities Legislation Reform Act of 1995. These statements are based on management's current expectations and beliefs and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward looking statements.

Such forward looking statements speak only as of the date of the press release, supplemental financial package and today's conference call. Centerline Holding Company urges you to review its Forms 10-K and 10-Q on file with the Securities Exchange Commission for a discussion of such factors and uncertainties and risks related to an investment in the company.

Centerline Holding Company expressly disclaims obligation or undertaking to release publicly any updates or revisions to any forward looking statements contained in the press release, supplemental financial package or today's call to reflect any change in the company's expectations with regard thereto or change in events, conditions or circumstances on which any statement is based.

With us today from the company are Marc Schnitzer, Chief Executive Officer and President, and Rob Levy, Chief Financial Officer.

At this time I'd like to turn the call over to Mark Schnitzer. Please go ahead, sir.

Marc Schnitzer

(Audio Break) weather the storm. We have access to capital, we are low leveraged and on the buy side, we have assembled a strong deal pipeline for those areas of our business where we have capital to deploy.

Credit quality in our investment funds remains stable and in certain funds we continue to outperform the broader market. Following our bond securitization with Freddie Mac at the end of 2007, we eliminated most of our interest rate and funding risk that we had on the balance sheet.

While our reported financial results in the first quarter are not indicative of the health or overall performance of the company, I would like to point out that this is the first quarter following our transformation to an alternative asset manager, that we are using a GAAP-based earnings metric to measure our financial performance, rather than a cash flow based metric. And, as noted is in the press release we issued this morning, there are a series of non cash items that impacted our adjusted earnings per share. If you adjust for the non-cash items, our adjusted earnings per share for the first quarter would have been slightly below our initial projections last quarter, although some of the EPS decline is attributable to the general decline in business volume due to market conditions. Rob, will get into the details of the numbers but I wanted to address this up front with all of you.

Though the market remains highly volatile, we have seen some signs of stability in the past few weeks. Specifically in the CMBS market, even those spreads on the CMBX index remain extremely wide. They have come in quite substantially since the end of March.

Our biggest challenge remains the evolving status of many of the large financial institutions that play a significant role in our day-to-day operations. We rely on these institutions to extend credit to us and to invest in the funds that we manage. Many of them continue to scale back their commercial real estate lending and investing, which has hampered our ability to grow at the pace we projected. In response, we have been working diligently to identify new institutional relationships and to broaden our existing relationships with financial partners that are still active in our markets.

Now, I will address the outlook for our two core businesses which are affordable housing and commercial real estate. The affordable housing equity market has experienced a repricing since the beginning of the year, predominately driven by the withdrawal of traditional investors such as Fannie Mae and Freddie Mac. Less capital flowing into that market has caused investor yield expectations to rise, and because of that we have noticed renewed interest from several investors that have not participated in the market during the past few years.

On the buy side, developer expectations are coming into line with shifting yields, and we are adding to an already solid pipeline of deals. Many of our competitors ended 2007 with quite a lot of unsold inventory, and we find that there are fewer firms competing for the new deals. We expect we will complete less volume in our affordable housing equity businesses this year. However on the positive side, we do anticipate margins in that business will be wider than we originally budgeted.

With respect to our direct tax-exempt bond business, the market remains dormant due to the continued unrest in the tender option bond market. While there is no shortage of deals that need tax exempt financing, liquidity in this market has been nonexistent or cost prohibitive since we completed our bond securitization with Freddie Mac at the end of last year. Unless conditions change, we expect to complete very few direct tax-exempt bond originations in 2008 and anticipate that most of the deal flow will shift to our agency business.

In our commercial real estate group, the agency lending business continues to be an area of opportunity. We originated over $230 million of loans on behalf of Fannie Mae and Freddie Mac in the first quarter, including an $80 million loan for Fannie Mae, our largest single Fannie Mae DUS loan to date. Since the conduit market currently is not a feasible option, Fannie and Freddie remain the best financing sources for multi family properties. While we have significantly scaled back our expectations for conduit lending this year, we expect our agency lending will increase substantially over last year's volume.

With very few new CMBS issues coming to market, we have reduced our projections for acquiring subordinate CMBS in 2008. We have also reduced our expectations for equity to be closed into our opportunity fund doing during 2008. While we continue to receive positive feedback from our marketing efforts, we expect to raise less than our full original target of $1 billion prior to the end of this year.

Credit quality in our CMBS portfolio remains very strong, with delinquency still at historically low levels in the first quarter. As of March 31, 2008, Centerline was the main special servicer on a portfolio of $117.2 billion of CMBS. Only $254 million was delinquent as of that date, representing just 22 basis points on the portfolio. This is highly favorable when compared to the industry average of 47 basis points as reported by Trek, and can be taken as a validation of the strength of our buy watch fixed strategy.

Given the realities of the current market, we believe the best way to deliver long-term shareholder value is to carefully conserve our capital and take the actions necessary to ensure the continued performance of the assets we manage. While we have scaled back our business expectations in 2008, we are confident of our ability to endure the current market volatility.

Now, I'd like to turn things over to Rob Levy, our CFO, who will go over the financial information from our earnings release. Thank you.

Rob Levy

Thanks Marc, and good morning everyone. Before I review our financial highlights, I'd like to remind you that all of the earnings revenue and expense numbers that I'm going to discuss in this speech have been adjusted to exclude consolidated partnerships. Please refer to the "as adjusted" column on the income statement and balance sheet of our quarterly supplemental for additional details.

With regard to our adjusted earnings per share for the three months ended March 31, 2008, Centerline reported adjusted EPS excluding non-cash items of negative $0.08 as compared to $0.11 for the three months ended March 31, 2007. As Mark mentioned in his remarks, there were several non-cash items that impacted our adjusted EPS this quarter, which I'd like to review in detail.

As has always been the case, our operations include non-cash expense items, some of which will never require the use of cash such a share based compensation and some of which are driven by economic factors, such as fair value fluctuations of interest rate swaps. Therefore, in order to present a clearer picture of the company's operations, we felt it was important to isolate these items and report adjusted EPS excluding their impact. The primary drivers of the non-cash items are detailed on page five of our quarterly supplemental financial package.

The non-cash items impacting adjusted EPS totalled $0.60 per share in the first quarter. They include $0.12 of non-cash losses which relate to marks on interest rate derivatives, $0.12 of losses in relation to impairments on balance sheet assets, $0.03 of equity losses in an affiliate which represents our share of operating losses resulting from our ownership interest in American Mortgage, $0.10 of losses for transactions in the first quarter of 2008 that were associated with our Freddie Mac bond securitization in December 2007.

In addition, we recorded $0.23 of non-cash charges to shareholders' equity related to the accounting treatment for the change in terms of most of our Community Reinvestment Act shares, the effect of which reduces the earnings per share without reducing that income. These changes to the CRA shares were also made in connection with our Freddie Mac bond securitization. The change in terms of the Community Reinvestment Act preferred shares also affects the calculation of EPS, in that the shares are now redeemable and are therefore no longer included in the weighted average share count.

Even after we exclude these items, our adjusted EPS was still lower than anticipated this quarter, primarily due to a decline in business volume as a result of the increased market volatility. Other factors weighing negatively on our first quarter earnings include a decline in our escrow earnings from our loan servicing business, due to the rapid decline in short term interest rates, and a tax provision in 2008 versus a recorded tax benefit in 2007.

Centerline's revenues were down in the first quarter versus the same period last year, but much of that was expected due to the re securitization of the bond portfolio in December. Partially offsetting that was a substantial decline in interest expense in the quarter, as a significant portion of secured and unsecured debt was paid off in December.

In our 10-Q, interest expense does not appear to decline much which is counter intuitive. This is because embedded in the reported income expense for the quarter is about $9 million of expense for changes in the fair value of derivatives.

Going forward, our expenses should reflect the impact of our recently announced workforce reductions. In the second quarter, we reduced our workforce by approximately 8% and our executive management team adopted salary decreases of 10%. G&A was already down by just under $13 million or 22 % in the first quarter versus the same period last year. We would expect the first quarter G&A to be a good run rate for the remainder of the year.

At this point, I would like to discuss our balance sheet and our liquidity. As noted previously, we are working to significantly de lever Centerline's balance sheet. At March 31, 2008 we had $616 million of debt outstanding, equating to a 29% ratio of debt to total assets. That includes about $340 million in debt associated with our term loan and revolver, with the remainder coming from asset specific borrowings. This is in sharp contrast to our debts total asset ratio of 60% as of September 30, 2007. We expect that percentage to continue to drop into the mid to low 20's by year end, as we pay down our term debt. As of March 31, 2008, Centerline had $157 million in cash and cash equivalents. As of today we have about $44 million of unrestricted liquidity.

Finally, before I open the call to questions, I would like to discuss our earnings guidance. At this time, we have decided to temporarily discontinue giving guidance. Given the unprecedented market volatility we think the best course of action right now is to resume giving earnings guidance only after the market stabilizes and we can give a more reliable earnings projection.

At this point, we would like to open the call to questions.

Questions-and-Answers Session

Operator

Thank you. (Operator Instructions) And we'll take our first question from Nicole Jacoby with Liberation Investments.

Nicole Jacoby - Liberation Investments

Hi, how are you?

Marc Schnitzer

Good morning, Nicole.

Nicole Jacoby - Liberation Investments

Good morning. I wanted to know, Rob, if you could just walk through again, how is it that you can have positive adjusted net income excluding non cash items and negative EPS? Could you walk through that again?

Rob Levy

We have negative adjusted EPS.

Nicole Jacoby - Liberation Investments

Right. The related number is negative.

Rob Levy

Correct, so, I'm not sure I understand your question. The first quarter we have negative adjusted EPS, after non-cash charges of negative $0.08.

Nicole Jacoby - Liberation Investments

Right. And not the per share number but the adjusted net income excluding that non-cash items was $1.08 million, right?

John Kelly

This is John Kelly, the Chief Accounting Officer. The adjusted net income excluding the non-cash items then factors into an EPS calculation where we have to subtract preferred dividends, subtract dividends on redeemable securities, and subtract the fair value adjustment related to the conversion of those shares to redeemable securities. There is an illustration of the earnings per share calculation on page eight of the supplemental that shows those items that factor into the calculation.

Nicole Jacoby - Liberation Investments

Okay. It's just my computer's having a hard time downloading the file, it's so big. All right, so the so this isn't that number that's presented is not as applicable to common, there is some further adjustment before it turns into EPS?

John Kelly

That's right, because it's more of a GAAP EPS calculation. Net income is then reduced by any preferred dividends and any charges to equity related to preferred dividends, which is essentially what the charge for the redeemable securities represents.

Nicole Jacoby - Liberation Investments

Okay. All right, thank you. The next question is, can you walk through again what your new guidance is for the amount of capital raised for the different areas? Long in sorry, the low income tax credit funds and the CMBS funds for '08?

Marc Schnitzer

We didn't detail that but broadly, we have amended our projection for growth in assets under management this year to be 10% over where we were at the end of last year.

Nicole Jacoby - Liberation Investments

Okay. And, so when you gave guidance, the more specific guidance of, for example I think it was $1 billion of low income housing tax credit funds and I forget how much of CMBS. What percentage increase of assets under management was it then?

Marc Schnitzer

Well, I believe we were suggesting somewhere between $2 billion and $3 billion at the end of last year. And at the end of last year we had something like $11.5 billion under management, we now about $12 billion under management. So overall, our current projection would be to increase assets under management by somewhere between $1.2 billion to $1.5 billion.

Nicole Jacoby - Liberation Investments

Okay. And but you're not breaking out under which, which is low income housing tax credit and which is CMBS?

Marc Schnitzer

We haven't broken that down at this point, but we would expect the low income housing tax credit to be just under $1 billion, maybe $900 million, and the balance to be within commercial real estate.

Nicole Jacoby - Liberation Investments

Okay, great. The origination fees related to the new low income housing tax credit rates, are those in line with, on a percentage basis, with what you been doing?

Marc Schnitzer

Yes, yes they are. And in fact we see the ability to increase those fees over the course of this year.

Nicole Jacoby - Liberation Investments

How is that?

Marc Schnitzer

Really because what's gone on in that market is that the marketplace has gone through a pretty significant withdrawal of equity from the market and the two largest investors which were Fannie Mae and Freddie Mac have essentially stepped out of the market for the least the current time. And then a couple of the other larger investors such as Citibank and some of the others have at least scaled back what they're doing. So, the effect of that has been to cause yields to go up, and the price that we and others pay developers for the tax credits to go down. So, where yields are today, and with a few competitors out of the marketplace, we are able to acquire tax credits, acquire interests in properties and price them at a level where we can recover some of the ground we lost in our margins over the past couple of years when there was far more pressure with more capital coming into the market.

Nicole Jacoby - Liberation Investments

Okay, thank you. What about, looking at going back to the CMBS funds for a minute, over the $1.4 billion, $1.5 billion that's listed in the table, how much of that, of the existing equity are we actually paid on in the management fees? Are we paid on the whole thing or a portion of it?

Rob Levy

A portion of it. The in our first fund we have just under $600 million. In our second fund, we just over $500 million and that's really what we're getting paid on today. The first fund, all the equity capital, has been returned to those investors and the only thing we're receiving from the first fund is our share of co-investments and then promotes or incentive management fees.

Nicole Jacoby - Liberation Investments

Okay. And, was there I'm not sure if I caught this, was there any money raised in the commercial, in the CMBS during the quarter?

Marc Schnitzer

In the first quarter nothing was closed.

Nicole Jacoby - Liberation Investments

Okay. All right, so I was asking about guidance you already. As far as the servicing portfolio goes, the primary servicing, is the servicing fee approximately the same rate that you've been experiencing on the new?

Marc Schnitzer

Yeah, that has not moved and that again is laid out in our supplemental. On page 20 you'll see that for the entire portfolio we're still at around 8.5 basis points, which is consistent with where we have been.

Nicole Jacoby - Liberation Investments

Yeah, I'm still rebooting my computer from trying to download. So, I haven't been able to look through the supplemental beyond the first couple pages. So, can you talk a little about your projection for your capitalization at year end also? What you said you are expecting to be about 25% debt to CAP?

Rob Levy

Right. So, the major changes that should occur throughout the year are primarily the pay down of the term facility. Currently, we have $135 million outstanding, with the anticipation that it gets paid down to zero by year end.

Nicole Jacoby - Liberation Investments

Okay. And so what does that imply for the balance of other debt outstanding?

Rob Levy

The balance of other debt outstanding should remain somewhat, the balance of debt outstanding beyond that is warehouse facilities that we used to originate Fannie Mae or Freddie Mac loans, and that type of product. The rest of, so that kind of goes up and down as we originate product and then sell either to Fannie Mae or Freddie Mac or when we use our corporate revolver to buy properties for our tax credit syndication funds. So, those numbers kind of go up and down on a daily basis depending on if we acquired assets for those funds or for those executions or after we've sold the assets. So, from a corporate standpoint the real issue or the real target is our corporate revolver and the term loan. That will have the impact on the term loan which should be paid down by the $135 million.

Nicole Jacoby - Liberation Investments

Okay, you are right. And I guess my last question is about the credit enhancement revenue. Where, or how much in fees did you earn in the quarter in credit enhancement?

Rob Levy

Hold on one second; I have it here. In fees and credit risk products we received about just over $1 million of credit intermediation fees in the first quarter.

Nicole Jacoby - Liberation Investments

Okay. And would you expect that to be a good run rate for the year? Or is that low? Is it high?

Marc Schnitzer

No, that should come up because certainly a significant percentage of the affordable housing transactions that we're contemplating this year will be with credit enhancement, and so certainly, through Centerline Financial, and so those fees should certainly increase throughout the year.

Nicole Jacoby - Liberation Investments

Okay. Thanks very much, guys.

Marc Schnitzer

Thanks, Nicole.

Operator

Thank you. And we'll go on to [Howard Bloom] with UBS.

Howard Bloom - UBS

Good morning.

Marc Schnitzer

Good morning, Howard.

Howard Bloom - UBS

How are you? With the hunkering down mentality that I think is probably what we're hearing and probably well advised in the pay down of debt, what are the implications for the continuation of dividends for the balance of this year?

Marc Schnitzer

The next time that we'll consider the dividend will be at our June board meeting, and clearly the board will make a decision. We are not in a position right now where we are going to recommend any change to the dividend policy that we stated. But that will be decided finally in June at the board meeting.

Howard Bloom - UBS

So in other words your internal models anticipate getting down to those debt level based on current conditions with the continuation of the policy?

Marc Schnitzer

With respect to models? Yes, based on current conditions.

Howard Bloom - UBS

Okay. Thank you very much.

Operator

Thank you. (Operator Instructions) And we'll take Mr. [Donald Hutchinson with Safe Harbor].

Donald Hutchinson - Safe Harbor

I'm curious regarding the amount of activity in the low income tax credit syndication. Are there a good number of ready buyers for these instruments? And if so, you mentioned that there seems to be a discount between what they used to be worth, six, nine months ago or whatever and what they're worth today. Could you comment on that, please?

Marc Schnitzer

Certainly. So, the answer to your first question is, yes. There are a good number of investors in that market who are very active. I did mention that Fannie Mae and Freddie Mac and one or two others have either scaled back their investments or exited the market, and the withdrawal of that capital has caused yields to come up. And as yields have come up, and at the same time as we all know Treasury rates have come down, other investors who have been in and out of the market based on economic conditions over the years, have come back into the market. So, the trend in that business over the past few years had been ever decreasing yields to investors and many investors, who are really looking at this purely as an economic investment, exited the market. A number of those folks are coming back into the market and these are people that we've managed capital for years, and they've taken the place, or at least partly partially taken the place of some of the others that have exited. And to give you a sense for how pricing has adjusted in the market, probably about, I'd say, 12 months ago, a little over 12 months ago, the yield levels for a typical multi investor fund in that market without a credit enhancement were somewhere between 4.5% and 5%. Currently, the market for a similar product is something like 6.5%. So, we've seen a pretty significant increased and fortunately, many transactions are still feasible at those levels. And we're still finding a lot of interest from investors. It's actually a fairly healthy development for the market.

Donald Hutchinson - Safe Harbor

How does that translate in terms of the amount of difference in proceeds that the investors would be making for the same amount of tax credits?

Marc Schnitzer

Well, for the same amount of tax credits, they would be investing a little bit less money.

Donald Hutchinson - Safe Harbor

I'm asking you. I want to turn this around backwards. So you've got this expressed in terms of yield to the investor. Can you express this in terms of proceeds to the seller?

Marc Schnitzer

Sure, in very, very rough numbers. Say, a year or so ago, a developer who was selling a dollar of tax credits might get $0.90 to $0.95 on the dollar for all the credits he or she was selling. Today, selling a dollar of tax credits might yield $0.80 on the dollar.

Donald Hutchinson - Safe Harbor

Have you seen any change or movement in that market and all, and do you forecast that there might be anything different?

Marc Schnitzer

Well, it has changed significantly. It's comedown over $0.10 on the dollar of credits over the course of the past year. It seems to have…

Donald Hutchinson - Safe Harbor

I'm thinking of like, from here forward.

Marc Schnitzer

Yeah, I would say at this point it seems to have stabilized and to the extent that it decreases going forward, I don't think the decrease will be nearly as substantial, as what we witnessed over the past 12 months because there seems to be a good amount of capital in the market and I think the market is close to reaching equilibrium at this point.

Donald Hutchinson - Safe Harbor

Thank you.

Marc Schnitzer

Thank you.

Operator

Thank you. And this does conclude our question and answer session. I'd like to turn the conference back over to the gentlemen for any final or closing remarks.

Marc Schnitzer

We'd just like to thank everyone for calling in, and we look forward to speaking to everyone again at our next earnings conference call in three months. Thank you, and have a good day.

Operator

Thank you. And this does conclude today's presentation. We thank you for your participation and have a great afternoon.

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