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Executives

Marc Holliday – President, Chief Executive & Officer

John B. Roche – Chief Financial Officer

Robert R. Foley – Chief Operating Officer

David Sean Brown

Analysts

Richard B. Shane, Jr. - Jefferies & Company, Inc.

[Tao Akusanja]

Donald Fandetti - Citigroup SmithBarney

David Fick – Stifel Nicolaus

Stephen Laws - Deutsche Bank Securities, Inc.

[Douglas Harter] - Credit Suisse

Jim Shanahan - Wachovia Capital Markets, LLC

[John Guinney] - Stifel Nicolaus & Company

Gramercy Capital Corp. (GKK) Q2 2008 Earnings Call July 24, 2008 2:00 PM ET

Operator

Welcome to the Gramercy Capital Corporation second quarter 2008 earnings results conference call. (Operator Instructions)

At this time, the company would like to remind the listeners that during the call management may make forward-looking statements. Actual results may differ from predictions that management may make today. Additional information regarding the factors that could cause such differences appear in the MD&A section of the company’s Form 10Q and other reports filed with the Securities & Exchange Commission.

Also, during today’s conference the company may discuss non-GAAP financial measures as is defined by SEC Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure discussed and the reconciliation of differences between each non-GAAP financial measure and the comparable GAAP financial measure can be found on the company’s website at www.gkk.com by selecting the press release regarding the company’s second quarter earnings.

Before turning the call over to Mr. Marc Holliday, President and Chief Financial Officer of Gramercy Capital Corporation, we would like to ask those of you participating in the Q&A portion of the call to please limit your questions to two per person.

Marc Holliday

Last night, Gramercy released its earnings for the second quarter. The release contains highlights of Gramercy’s achievements as we embark on a new strategy for the company in response to very difficult market conditions while positioning ourselves to take advantage of new market opportunities. Clearly, the most important event for the company in the past three months was the successful closing of the acquisition by merger of American Financial Realty Trust on April 1st. This transaction was successfully completed under very challenging market conditions thanks in no small part to Gramercy’s and AFR’s employees who worked to get this transaction closed and then to ensure a smooth transition in post closing integration. The merger has transformed GKK from a niche specialty finance REIT to a diversified REIT with a majority of its assets in real property, becoming the third largest diversified REIT measured by enterprise value in the Morgan Stanley REIT Index.

One of the main benefits of the AFR acquisition was the obtaining of $225 million per annum of in place net operating income with longer duration and less volatility than Gramercy’s loan investment portfolio. I’m pleased to report that the NOI achieved during GKK’s first quarter of ownership exceeded our underwriting and we have commenced efforts to further enhance GKK’s yield through asset dispositions, leasing of vacant space, and restructuring of existing lease arrangements.

In the public setting, Gramercy now has a new peer group and operating platform which we provided with greater ability to attract capital, broaden its opportunity set, create synergies between business lines and strengthen its strategic ties to SL Green. In connection with Gramercy’s transformation and in response to deteriorating market conditions, Gramercy is implementing other strategic initiatives to monetize assets and increase corporate capacity to strengthen our balance sheet and to take advantage of opportunities within our existing asset base and de novo investments. We intend to accomplish this through loan payments, sales and syndications, asset sales and joint ventures with the objective of increasing cash and reducing indebtedness to approximately 75% of total assets. We would expect to reinvest this cash in the significant opportunities that exist within our portfolio and arising out of what should develop to be the most target rich environments for new investments we have seen in the past 10 years.

Examples of external opportunities include acquisitions of bank properties from higher grade financial institutions looking to shed real estate and raise cash and future GKK CDO bond buybacks, high grade CMBS purchases and new high yield loan originations. Examples of internal opportunities consist of restructuring and extending selected loans to generate higher profits and leasing up a portion of the 2.5 million square feet of existing vacancy. The market is valuing our portfolio today at approximately 40% of book value. We obviously see more value in our portfolio and it will be our job to start realizing some of that spread through maximizing our efforts on internal activity.

In addition to our plan to reduce overall leverage, we have also embarked on a path of eliminating or extending all final debt maturities beyond 2010. Towards this objective we have reduced the Wachovia repo facility balance from a 12 month high of $361 million to just $79 million currently outstanding and yesterday announced that this debt has been extended to a final maturity date that is three years out. Similarly, we have reduced the Goldman repo facility from a 12 month high of $193 million to just $14 million today. Further, the $95 million Deutsche Bank facility originated in connection with the AFR transaction will be paid down to approximately $70 million upon the closing of the announced sale yesterday of Wachovia Tower for $36 million, with the balance of the Deutsche facility intended to be termed out through a refinancing which we are now initiating. Our largest indebtedness obligations consisting of our three CDOs totaling $3.1 billion have terms ranging from seven to nine years remaining and they’re non-recourse, non-mark-to-market financings with much embedded value. Much of the investment opportunity I alluded to earlier can be financed via the reinvestment mechanisms in the CDOs over the next two to four years of reinvestment period.

Another strategic objective initiated last summer is to preemptively mitigate risks in the loan portfolio. We’ve been doing this in a number of ways: first, shrinking the loan portfolio from a high of $2.95 billion in 2007 to $2.4 billion today, restructuring over $200 million of loans to maintain a return to performing status, enforcing loan provisions to obtain payoffs, paydowns and loan rebalancings, reducing future funding commitments from a high last year of $385 million in 2007 to just $101 million today, sales and syndication of loan assets and foreclosing loan collateral where GKK can create or monetize value.

Within Gramercy Realty, near term risks are largely mitigated by the relatively modest amount of near term contractual lease explorations over the next two years. There is increasing scrutiny on the credit of tenants in our portfolio; however currently nine out of 107 of GKK’s top tenants by square footage, which comprise almost 75% of the revenue stream, have senior obligations rated A or better by the major rating agencies. The one that doesn’t is a very minor tenant with only 100,000 or 200,000 square feet of space; it is just unrated.

Another important goal for the company is the successful integration of the AFR platform into a new and reorganized Gramercy. This integration effort is being undertaken largely by John Roche and Bob Foley and is well underway in just the first three and a half months. Bob and John will later discuss our progress in building out the platform. In addition, the company is also contemplating a possible internalization of the GKK manager or a modification of the existing management agreement. We are considering internalization because to have management in house is consistent with the progression of GKK and because we believe it could conserve cash for the company. Both companies have committees made up of independent directors looking at this. No decisions have been made yet to proceed and anything that does happen would obviously have to be acceptable to both parties. If the committees determine not to internalize at this time then it’s possible that with 18 months remaining the management agreement could be modified and extended.

Consistent with all of these strategies and goals I’ve enumerated just now, the directors of Gramercy intend to evaluate the dividend policy in the third quarter for possible reduction. As John will expand on momentarily, the AFR properties provide substantial depreciation shield to increase retained earnings while complying with REIT distribution requirements. Recall that this was one of our stated reasons for pursuing this transaction as retained earnings is by far the company’s cheapest and most efficient form of capital in today’s market. While the directors have not yet discussed any specific dividend level for the third quarter, I would hope that the dividend would be fixed at a level to bring its yield in line with other diversified or hybrid or other non-mortgage finance REITs. Given the scarcity of capital, management and the board feel that recycling cash within the company to execute on the opportunities in this market is in the best interest of shareholders.

With that, let me turn it over to John who will run through the results of the second quarter.

John Roche

FFO for the quarter was $32.9 million or $0.64 per diluted share. This is the first quarter reflecting the AFR acquisition completed April 1st. Property operations exceeded our underwriting for the transaction. We continue to make significant headway on the integration and execution of the business plan. During the quarter, we generated net income of $10.1 million or $0.20 per diluted share as compared to net income of $20 million or $0.73 per diluted share in the second quarter 2007. The current quarter reflects $22.5 million of depreciation expense or $0.44 per diluted share as compared to $1.1 million or $0.04 per diluted share in the 2007 quarter. Total revenues for the quarter increased to $202.1 million as compared to $78.3 million in the first quarter of 2007. Rental revenue and expense reimbursements aggregated $116.3 million for the quarter and an increase of $114.4 million compared to $1.9 million in the second quarter of 2007. This increase is directly rated to the AFR acquisition. Gains on sales and other income increased $19.1 million to $22.8 million for the quarter from $3.6 million in the prior year quarter.

Gains during the quarter included $17.6 million on the repurchase of GKK CDO bonds. Offsetting these increases was lower investment income of $63 million versus $72.8 million in the prior year. This decline was primarily attributable to lower LIBOR, a decline in the balance of loans and lending investments and higher levels of non-performing loans and REO assets in 2008. Operating expenses for the acquired AFR portfolio totaled $51.6 million during the quarter versus zero in the prior year. Management fees, including incentive fees, totaled $11.7 million for the quarter up $2.5 million from $9.2 million in the second quarter of 2007. This resulted from higher based management fees related to the equity raises in the third and fourth quarter of 2007 and the AFR acquisition offset by lower incentive management fees. MG&A expense was $4.1 million in both periods, reflecting the cost cutting initiatives implemented simultaneous with the AFR closing.

While we are still building out the platform, the benefits of scale efficiencies we are working toward are evident. Assets increased 91% percent during the quarter while MG&A was flat and MG&A combined with management fees increased less than 8%. Interest expense totaled $77.8 million and $39.2 million during the second quarter of 2008 and 2007 respectively. This increase reflects the $2.5 billion of additional debt incurred in connection with the AFR transaction, which included $1.3 billion of existing mortgage debt at an average rate of 5.68% and $1.25 billion of debt originated in connection with the transaction at an average interest rate of 6.5%. During the quarter, we recognized a provision for loan losses of $23.2 million as compared to $2.9 million in the prior year quarter and $8 million for the first quarter of 2008. The additional provision brought our reserve for loan losses to $35.4 million as of the end of the second quarter.

Our balance sheet has significantly changed with the completion of the acquisition including the addition of approximately $4 billion of assets including: $3 billion of real estate assets; $412 million of costs associated with in place leases; $221 million of real estate held for sale; and $329 million of other assets. Our loans and other lending investments decreased by approximately $230 million, primarily due to loan repayments of $133 million. An additional $75 million of the decrease was attributable to a loan investment outstanding to AFR prior to the acquisition. Subsequent to the acquisition, the loan was eliminated in the consolidation as an intercompany transaction. No loan investments were directly originated or acquired during the quarter. Our investment activity included the repurchase of $37.8 million of CRE CDO bonds previously issued by Gramercy and the purchase of $20 million of investment grade CMDS. The CMDS is reflected as an increase in assets. The repurchase bonds are not retired but are reflected on Gramercy’s balance sheet as a reduction in the amount of CDO bonds outstanding at quarter end. Assets held for sale June 30 totaled $365 million which is comprised of the remaining real estate held for sale in connection with the acquisition and $221 million of loan investments and real estate owned of $144.1 million.

On the real estate side, as previously noted, we assumed $1.3 billion of existing mortgage debt and issued and refinanced debt totally $1.25 billion in connection with the transaction. We have also recorded a liability of $746 million of below market leases and approximately $215 million of other liabilities. We continue to limit use of our two secured credit facilities with only $95 million outstanding under these facilities at quarter end, a decrease of $72 million from the prior quarter. Borrowing’s under our secured credit facility with $75 million. Derivative instruments improved significantly from the prior quarter to a net liability of $63 million as compared to $116 million in the prior quarter. The improvement increased book value by approximately $1.03 as compared to the prior quarter. To address exposure to interest rates we use a variety of plain vanilla derivative products such as interest rate swaps, caps, collars and floors. As effective hedges, the mark-to-market adjustments are reflected on our balance sheet in other comprehensive income.

Our shareholders equity at June 30, 2008 increased to approximately $1.1 billion or $21.78 per share due primarily to the issuance of approximately 15.6 million shares of common stock at a price per share of $22.36 in connection with the AFR acquisition. The real estate assets recorded on our June 30 balance sheet in connection with the acquisition reflect preliminary purchase price adjustments, which may differ from the actual purchase price allocations as more information becomes available in certain intangible assets and liabilities. Accounting rules generally provide for one year from the date of acquisition to finalize the purchase price allocations.

As to liquidity, while the April 1 closing of AFR was a significant use of cash during the period we ended the quarter with approximately $100 million of cash and cash equivalents, including $44 million in Gramercy’s three CDLs. Availability under our unsecure credit facility was approximately $100 million and unused capacity under our secure borrowing facilities was approximately $733 million as of June 30. Subsequent to quarter end, we entered into a new three year term in revolving credit facility with Wachovia, which limits our exposure to mark-to-market risks. Specifically, we entered into a $115.7 million term facility for existing assets and a $100 million revolving facility for new opportunities. In connection with this agreement, we reduced our capacity from $733 million at June 30 to $470 million today in line with our current expectations for utilization.

As to integration and staffing, since the acquisition we have initiated a variety of steps to integrate the two organizations and take advantage of the skill sets of both. We have also added senior management to take day-to-day responsibility to ensure these initiatives happen. Bob will touch on the operating changes but I would like to address a couple of these projects currently underway. On the systems side, we have spent a significant amount of time preparing for the integration of the IT platforms in both organizations. During the third quarter, we will complete this task and be on one system for all of GKK by September 30th. For anyone who has gone through this process, it has been an enormous commitment on both a cost and time basis but we believe that it will enable us to operate significantly more efficiently going forward. We have also created a more robust budgeting control group to support the various operating groups in the company. This includes a [diamodeling] capability utilizing both internal and external resources and a number of analysts monitoring day-to-day results and projections to ensure that we have an accurate and timely picture of our realty and finance operations. While I’ve only mentioned two of the initiatives underway, the combination of better systems and a more robust analytical and budgeting capability, combined with the increased operating capabilities that Bob will discuss, will enable GKK to weather the current environment and capitalize on the opportunities going forward.

I will now turn it over to Bob to discuss operations.

Robert Foley

Creating value in our Gramercy Realty and Gramercy Finance businesses requires intensive, integrated asset management with a focus on quality people, accurate and timely information, setting the right priorities, generating operating efficiencies and exercising good risk management. Getting all of this right produces improved investment performance and a useful feedback loop that will help us make better and quicker buy, sell or hold decisions. In both businesses, realty and finance, our operating philosophy is always to be disciplined, analytical and assertive.

During the second quarter this year, we strengthened our realty and finance platforms in many ways. In Gramercy Realty, our focus was on integrating previously Balkanized disciplines by building from the ground up a brand new asset management function, which is actually quite common in commercial real estate businesses but didn’t previously exist at AFR. It’s an integrated, interdisciplinary approach and it’s remarkably but unsurprisingly similar to the highly effective approached used by SL Green.

In our first 90 days, we recruited several highly experienced real estate executives to direct this effort led by Michael Berman, who joined us and has more than 20 years of experience in commercial real estate asset management and leasing. Around them, Michael is building internal teams to integrate the following functions: leasing, property management, construction and property operations, property level finance, and tenant relationship management. Michael has recruited several senior asset managers, he’s retasked some of our new colleagues, formerly with AFR, and he’s recruited and continues to recruit leasing directors and business analysts to round out his team. Each senior asset manager is responsible for a sizeable portfolio generally based on geography or property type. He or she has ultimate and direct responsibility and accountability for the performance of his or her portfolio and that performance is carefully measured.

Their collective mandate is to execute the first phase of the business plan we articulated last November when we announced the AFR merger agreement and it includes the continued disposition of non-core properties, the lease up of existing vacancies and expected future vacancies, improved relations with our largest tenants and the preparation and execution of detailed business plans for each of our properties. It’s a large undertaking and it can not be accomplished overnight but in our first 90 days we’ve made significant progress on the strength of our approach, the quality of our people that we’re applying to the task, and our collective experience.

On the Gramercy Finance side, we’ve added four experienced real estate finance professionals to our existing loan servicing and asset management team, which now numbers 12 professionals here in New York City and in Los Angeles. That in turn has allowed us to reduce the number of loan positions per person to an average of around six and we believe that’s appropriate given the tough capital markets conditions that we and our borrowers face today.

On the Gramercy Finance side, at June 30th our loan portfolio totaled about $2.32 billion down $230 million from prior quarter, as John explained. Classification by property type was largely unchanged with CBD and suburban office properties leading the way at 40%. By form of investment, first mortgages remained at about 67% of the loan portfolio with the remainder comprised primarily of mezzanine loans and B notes. Repayments during the quarter were $133 million, almost in line with our first quarter repayments of $142 largely the result of aggressive loan management, spur borrowers to refinance or sell assets securing our loans. Those loan payoffs have continued into the third quarter with over $40 million thus far in July. These loan repayments create fresh liquidity for opportunistic reinvestment, especially for the bulk of our loans which are financed in our CDOs that, as Marc explained earlier, have reinvestment periods that extend from 2010 through 2012.

All capital markets, including the commercial real estate capital markets are experiencing challenging market conditions I haven’t seen since the very early 1990s. Illiquidity is posing challenges to the sale or refinancing of conventional properties with decent operating performance and strong institutional sponsorship. In response, during the first half of this year our loan servicing and asset management team successfully completed loan modifications involving seven loans representing slightly more $200 million of unpaid principal balance. These are typically anticipatory modifications based upon the strength of the sponsor, involve quality assets with good asset coverage and involve appropriate concessions and economic investments by the borrower and its sponsors. A typical modification might include a significant principal paydown, a rebalancing of capital reserves within the loan, a fee to Gramercy Finance, an increase of interest rate, and an extension of the loan maturity date.

Let me turn to non-performing loans. At quarter end, Gramercy Finance had five non-performing loans with an aggregate carrying value of $205 million. All of that increase is attributable to loans classified as sub-performing at March 31st. Make no mistake; we are displeased with these results. They reflect not only the difficult market conditions in which we operate but they also reflect investment decisions we’d like to have back if we could, but we can’t. However, we do know from our collective experience reaching back to the 1980s that the prospects for maximum recovery are enhanced by the aggressive use of all the rights and remedies available to us as primarily a secured lender. The use of loan resolution strategies as objective as maximum recovery may cause the classification as non-performing loans of loans that might otherwise remain performing if different strategies were employed, but we remain aggressive.

A little background on some of our NPLs. We have a cross-collateralized first mortgage loan on two full service hotels in Florida. In our assessment, the principal cause of this status is a weak sponsor, which filed for bankruptcy in late May. The sponsor has reported that it has obtained almost $10 million of fresh capital subordinate to our first mortgage position with which to restabilize and rebrand. The properties are currently managed under contract by a well regarded national hotel management company. Nonetheless, we are pursuing our legal claims against the collateral and separate legal claims against the loan guarantor since both loans are recourse to the sponsor. Accordingly, no loan loss reserve has been recorded. We also hold a majority interest in a first mortgage loan secured by a shopping center. The sponsors here do have substantial cash investment in the project. They completed the bulk of the physical redevelopment called for by its business plan but they haven’t finished the lease up. The borrower is pursuing an equity recap and potentially a refinancing of the existing loan. Nonetheless, we are pursuing a foreclosure action scheduled for later this year and separately we’re pursuing enforcement of guarantees from individuals who have personally guaranteed this loan. Here again, no loan loss reserve has been recorded.

We also hold interests in a broadly syndicated second lien and third lien financing secured by residential land in southern California. Marc and I discussed this investment with you on several occasions, including last December at our annual investor meeting in New York City. This is a broadly syndicated secured financing to what had been one of California’s leading private residential land developers. Lehman Brothers was the money partner and the borrower, a co-lender, and the administrative and syndication agent for the financing, which in the aggregate approached $400 million. Currently, Gramercy is spearheading negotiations on behalf of itself and the other subordinate lenders with the senior lender group to conclude a restructuring that would provide time for the housing markets to recover and for the entire lending syndicate to maximize its recovery. Simultaneously, the senior lenders are exercising their default remedies, which include a pending foreclosure action. During the second quarter, we recorded an additional reserve of $7.3 million against this loan to fully reserve our exposure on the third lien and an additional $10.6 million reserve to reduce our exposure to the second lien to roughly $34 million, which we will attempt to recover based on current valuations and I can assure you we will continue to carefully monitor value and recoverability in response to changing market conditions.

As we do with all of our investments, whether successful or challenged, we carefully evaluate what we did well and what we did poorly and we’ve done so on the SunCal transaction. I personally recall the last pronounced housing correction in the early 1990s, which was severe in its own right and from which California began to recover by the mid 1990s. Although we underwrote our investment in SunCal anticipating a correction in the housing market, we did not anticipate the suddenness or the ferocity of this cycle’s housing correction nor did we fully anticipate the virtual shutdown of the residential mortgage market throughout the United States. In addition, we overestimated the benefit to the transaction of Lehman Brothers varied involvement in the deal. In fact, what we had originally assessed as a solid commitment by the borrower and its sponsors that would benefit all the lenders in the transaction has turned out or become an absence of financial commitment that has hurt the transaction and its lenders.

Sub-performing loans; at the end of the quarter, Gramercy had two loans secured by office buildings classified as sub-performing. They had an aggregate carrying value of $34.7 million. Subsequent to quarter end, we sold the first lost interest in one of the two loans that reduced our exposure to approximately $16 million in what we believe is an adequately covered senior position. We incurred a loss of $3.1 million on that sale, which was fully reserved at quarter end. In addition to creating liquidity, rebalancing our loan portfolio, and shedding future funding commitments, which Marc described earlier, loan sales and syndications can also serve as an important risk mitigation tool which was exhibited here. We expect to continue to utilize our deep relationships in the capital markets to manage our loan portfolio as best we can. John touched earlier on the loan loss reserve. At the end of the quarter it was $35.4 million against approximately 10 positions. The gross provision was $23.2 million and that relates primarily to the increase in the provision against the SunCal exposure which I previously described. We do believe our reserves are appropriate but should challenging conditions in the capital markets continue and/or should the general economy continue to slow we may record additional provisions in the future.

REO; Gramercy foreclosed on two properties during the second quarter with a combined carrying value of roughly $31.6 million. For one of the properties, a formalized sales process is well underway and we expect a satisfactory resolution before the end of the year. For the other, we are evaluating alternative strategies with our current co-owner and former majority 60% co-lender.

Let me turn for a few moments to Gramercy Realty. Summary statistics for the composition of our realty portfolio at quarter end are on page 4 of the earnings release. Marc commented earlier that more than 70% of our existing tenants carry senior unsecured debt ratings of A or better. Additionally the weighted average remaining term of our lease portfolio is a bit longer than 11 years and in fact less than 3.5% of the base revenue in our realty portfolio relates to scheduled leased expirees through the end of 2009. The basis of classification that you see in that table for our portfolio among core, value add and held-for-sale remains unchanged since we announced the acquisition last November. However improved asset management, our planned dispositions, and some selective joint ventures in sales will result in some migration among these classifications over time. For example, in the second quarter we sold six properties that were not previously classified as held-for-sale and that is disclosed in the press release.

Gramercy’s dedicated acquisitions and dispositions team has done a great job through June 30 of this year. They’ve sold 68 properties for an aggregate sales price of $265 million. You may recall our target for year-end 2008 is 151 properties and $367 million so you can see we’ve made strong progress against our objective especially since an additional $49.5 million is already under contract to close and we have additional sales transactions in the pipeline.

Other current initiatives on the realty portfolio include the sale of our vacant bank branch portfolio which is going to occur in transactions that will involve in some instances only one property, in other instances a small pool of properties, and potentially some fairly large-scale transactions. We have one transaction that we’ve initiated involving a very large portfolio of office properties northwards of 20.

On the leasing front, current initiatives include several things. First, we’ve identified the 10 largest existing vacancies in our portfolio. They total about 799,000 square feet in 10 separate properties. We have established detailed leasing plans for each of those vacancies which Michael Berman’s leasing and asset management team will execute, frequently using the assistance of third-party leasing brokers that we’ve specifically identified and selected in each market.

Shedding rights; many of you are aware of the shedding rights that exist in certain of the leases that we have with our financial services tenants. We’re using our newly-built asset management platform to plan ahead for this shedding in space by our larger tenants because by planning ahead we can generate positive results that allow us to create cash flow and value. For example, we expect 957,000 square feet to potentially divert to Gramercy prior to the end of 2009. But of that 370,000 square feet has been or will soon be sublet to tenants and will generate annual rental revenue in excess of $8 million. And we’ve already begun leasing and disposition plans for the remaining space, a full year ahead of time.

Another important initiative is the [Dana] portfolio a multi-property portfolio leased to the Bank of America. Here we’re well underway in terms of studying the properties in the individual markets and continuing our discussions with our tenant, the Bank of America, about a range of potential reworkings of the existing agreement for their benefit and ours.

Marc Holliday

We are taking steps in response to the current environment and the opportunities available to Gramercy as a result of the AFR transaction. These steps are consistent with our vision for Gramercy when we launched the AFR transaction and will result in the formation of a new Gramercy. Implementing this new strategy in the current climate is very challenging but as you have heard on today’s call we are making headway on several fronts, notwithstanding a near complete shutdown of the commercial real estate financing system with no abatement in sight.

These market forces have put enormous pressure on our current earnings causing us to lower our guidance for the second half of the year. We are decreasing our earnings projections primarily due to an increase in nonperforming loans, additions to the provisions for possible loan losses, higher incremental borrowing costs associated with term-out of the Wachovia loan, and an intended delivering of the loan portfolio. The cumulative effect of these factors will reduce projected earnings in Q3 and Q4 to a midpoint of approximately $0.50 per quarter based on projected additional losses of $25 million for the remainder of the year which is just a projection based on current market environment. We are extremely disappointed in having to revise guidance in this manner, however I can assure you that we are meeting these challenges head on and doing everything possible to protect Gramercy’s collateral positions even at the expense of current earnings because we believe this is the best way to mitigate problem loans and refocus on taking advantage of new opportunities.

With that, Operator, we’d be happy to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Richard B. Shane, Jr. - Jefferies & Company, Inc.

Richard B. Shane, Jr. - Jefferies & Company, Inc.

Historically there really hasn’t been a big difference I assume between FFO and taxable income but I want to make sure with the CDO repurchase being such a big contributor to the FFO this quarter that there’s not some nuance there that we’re missing. Can you explain that please?

John B. Roche

The CDO gains are taxable but as a function of the AFR acquisition and the amount of depreciation generated by the real estate portfolio. We have a significant amount of shelter in excess of the gains generated.

Richard B. Shane, Jr. - Jefferies & Company, Inc.

Given the investment opportunities that you’re looking at and the stock trading below half of book value, what about authorizing a repurchase or more importantly why not SL Green take a look at buying the whole company? I mean you’re trading at half of NAD or less.

Marc Holliday

I don’t think the company’s made any kind of decision to solicit any buyers in that regard. The opportunities I was referring to are mostly internal opportunities which we would describe as the lower hanging proof in that regard, clearly leasing up a substantial portion of the 2.5 million square feet all of which would be additive to the current NOI that I referred to earlier, $225 million, is probably one of our big focuses. Buying back CDO bonds where we think the price warrants it, we don’t always think it does and what can we do and we think that has been a very good use of capital for us particularly when some of those yields have approached anywhere between high teens to 20%. There’s also very efficient financing we get within the CDOs where we can originate new mortgages at much higher spreads than in the past and also put in AAA or subordinate AAA CMDS bonds where we have Joe Romano and his team cherry pick through different bond classes. We try to stay at the very highest levels in efficiently financing the CDOs. So that’s been a good strategy so our approach at trying to close that gap between where we trade and the book value, that’s over double where we trade currently. We think we can do relatively efficiently internally with some external opportunities as well. And I think that’s the course we’re focusing on right now.

Richard B. Shane, Jr. - Jefferies & Company, Inc.

It is interesting because essentially you’re buying the CDO debt, it’s slightly above $0.50 on the dollar at least by the way I do the math, and you’re equity which theoretically should have a lot more upside because historically you’ve traded at a pretty good premium to par is even cheaper than that. You have the liquidity apparently to do that. Why not go after the equity?

Marc Holliday

Just to be clear, I didn’t say we wouldn’t buy our equity and recognize we’ve only been trading at this level for maybe a couple of weeks, so I wouldn’t infer anything from a couple of weeks of history. Clearly at Green there is an announced buy-back program and Green has taken advantage of that when the stock was trading at levels that were deemed to be advantageous for the buy-back. And I’m not saying that’s not something we wouldn’t consider at Gramercy, we just haven’t done it yet and we in addition think that the bond buy-backs are good business. One’s not exclusive of the other.

Robert R. Foley

And it also helps to delever the company which is one of the stated intentions that Marc mentioned to take the leverage down a little bit so shrinking the equity base at this point in the game might not be the highest and best use of capital.

Marc Holliday

To buy back the stock would be the exact opposite.

Richard B. Shane, Jr. - Jefferies & Company, Inc.

But on the other hand you’re buying assets that by your calculations at $0.45 on the dollar which that tends to be a pretty good investment. The other question I have is what are the key underline assumptions to the $0.50 per quarter guidance for the back half of the year particularly loss guidance and what type of provision you would be taking as well?

Marc Holliday

The lowest guidance I gave earlier, the $25 million over the balance of the year which is not tied to any particular assets but more just in line with what we’re looking at as a group of assets that we could have to reserve for if market conditions don’t improve. So that’s the guidance and one to more material assumptions. There are a lot of assumptions that go into that.

Robert R. Foley

I think that’s the primary one and probably the significant difference on a go forward for the remaining six months.

Richard B. Shane, Jr. - Jefferies & Company, Inc.

That makes sense and I agree with you that’s the primary one. That’s where I want to dive in a little bit deeper. Given that and given where the allowance is currently, are you assuming an incremental, you’re describing $25 million of losses, are you describing $25 million more provision or do you believe that the provision’s going to be less than the $25 million of losses?

Robert R. Foley

Midpoint that Marc alluded to assumes incrementally $25 million of additional provision for loan losses.

Operator

Our next question comes from [Tao Akusanja].

[Tao Akusanja]

I wanted to talk a little bit about the CDO financing that you have in place and just the ability to continue to take advantage of that on a going forward basis. For example, could you talk a little bit about your ability to swap out loans that may not be performing or any concerns you may have about meeting of the collateralization test and things of that nature?

Robert R. Foley

With respect to the CDOs just to recap, we have three. We did one in each of the summers of 2005, 2006, 2007. The first two were $1 billion each. The last one we did last summer is for $1.1 billion. The first two have full reinvestment periods for five years so the deal that was done in the summer of 05, that reinvestment period extends through the summer of 2010, the 06 deal through 2011, the 07 deal for those of you who are familiar with them that deal we used to finance the bulk of our AAA rated CMBS inventory for term and that’s about $750 million and then the remaining $350 million or so is used to finance loans. And so there is a reinvestment ability for up to five years with respect to that $350 million amount. The actual operation of it is subject to what are called collateral qualification tests which are basically covenants that have to do with property type, form of investment, and compliance with other covenants which I’ll touch on in a moment. We can reinvest those proceeds as people pay us off. We monitor the covenants very carefully and are in compliance and are comfortable with our compliance with those deals.

[Tao Akusanja]

In regards to AFR and the ability to generate lease-up on the under leased portion of that portfolio, how are you finding that process at this point just given the challenge in environment for banks in general?

Marc Holliday

Let me speak to that first. David Sean Brown is here with us and he’s also very involved in helping direct deal. Michael unfortunately is not here right now. Our portfolio’s comprised of both office and branches. Speaking first to the office, it’s really market dependent. As I said we’ve been building an asset management infrastructure including leasing. We have already had some success. You saw some of the smaller deals that we did in the second quarter of the year, our first quarter of ownership. We have already begun to attack some of these larger vacancies. They’re in large urban markets, Chicago, some of the Eastern markets, so we actually have some pretty good traction especially in Chicago right now interestingly. So the answer is it’s not an easy leasing market. We generally have pretty serviceable space. I will tell you the principal issue in many instances is we just weren’t doing it. To be blunt, it was not a priority of the former management team of what is now Gramercy Realty and that’s why we’ve been building an asset management infrastructure and hiring people with the right expertise to make it happen.

Operator

Our next question comes from Donald Fandetti – Citigroup SmithBarney.

Donald Fandetti – Citigroup SmithBarney

Marc, I guess a broader question, you mentioned that there’s been a complete shutdown in the CRE finance market. I wanted to get your perspective on how this plays out. I mean obviously that plays a pretty dark scenario for CRE values and I just wanted to get your thoughts on that, where we’re headed.

Marc Holliday

I think there’s a lot of ways you can look at that. On the one hand there’s very little new liquidity of any size for big transactions. On the flip side I think that as we do within Gramercy, if we think the sponsorship is right and the collateral is right, we’re restructuring loans where appropriate and we’re also taking back collateral where appropriate and I think for certain sponsors like Gramercy, debt is available. So when I make that statement I’m talking just generally, but we just re-upped three years with Wachovia with $100 million of a future funding facility as long as that term-out of our existing, we still have our facilities in place with Goldman, and I think the best thing is those lenders with the mechanisms like we have in the CDOs where we can replace product as it does pay off, we’ve been replacing at much higher yields and that’s basically in place as Bob said for two to four years. So I think if you have those tools in the arsenal then you can continue to conduct business, but clearly the pay offs we’re getting from people right now, they’re having to equify, rebalance, come out of pocket, in order to pay down their exposures to levels where they can get financing at not conventional levels but unconventionally low levels. Some sponsors can do that; some can’t. If we feel it’s appropriate, we’ll step in and restructure and if not, then we exercise revenues. So the system is not going to work well for the next certainly throughout 2009 but with that said, there are ways of making it work and that’s what we’re doing and we’re trying to get ahead of the curve where we can and get through things where we can. I think we’ve been a little more diligent than most in if we don’t think it’s the best result for the asset is to restructure or defer, then we’ll take it and we’ve been doing that or at least we’ve been pursuing our remedies. And it’s resulted in a lot of restructuring but it’s also resulted in some REO.

Donald Fandetti - Citigroup - Smith Barney

On the internalization potential, obviously the company’s delevering and the earnings are going down. How do you expect to look at that in terms of the buy-in I think it’s on a trailing fees 12 months but I could be wrong?

Marc Holliday

In terms of the buy-in?

Donald Fandetti - Citigroup - Smith Barney

Well, let’s say you internalize I think the formula, correct me if I’m wrong, is based on trailing fees that are paid out.

Marc Holliday

There’s a determination fee which is formulaic if it were to be terminated but that contract has some time to go. If there’s internalization, it would be a negotiated process between the two independent boards. It’s not gotten to that level. There’s been no offers made or received but we’re clearly studying it as well as studying for each company what a modification of the agreement would look like. So I think both potentials are on the table and the buy-in prices you referred to would have to be something that both company’s thought were in their best interests for there to be a deal. If not, there would probably be some kind of modification to the management agreement and that process is underway. But there’s a recognition that in either case the commitment by SL Green, the continuity of senior management where Green is in place would have to be a function either way of an internalization or the modified agreement until permanent management’s in place. But we’ve always said when the company was big enough and had enough resources at critical mass to support its own internal structure that we would look at it closely and we feel that with the AFR transaction it’s the right time to do so. The question is it the right time in the market to do so. That’s a question the committees will have to address.

Operator

Our next question comes from David Fick – Stifel Nicolaus.

David Fick – Stifel Nicolaus

I’d like to just step back for a minute and talk a little bit about your loan portfolio and how we got to where we are. You guys have been pretty specific about your comfort with your portfolio analysis in prior quarters and have expressed a fair amount of confidence in your underwriting and in your current valuations and yet this quarter’s mess is largely coming out of that side of the business for old Gramercy business. That’s a bit baffling honestly as an analyst looking at this. And you really give some management credibility and I’d like you to address that. I heard Bob’s comment in saying you’re sorry that it went that way and you wish you could get some of these things back, but how do we believe today that it’s another - you’ve given some guidance for the rest of the year in terms of potential additional charge offs - shouldn’t we be assuming that there are substantial additional unknown rocks that are going to be turned over here that’ll be presenting more downside in that portfolio based on this performance?

Marc Holliday

A lot of questions, let me address one that you asked as it relates to credibility. I actually think if you look back to June of last year and listen and look at what we were saying, we’ve been saying for a year now that this is a very tough market. We stopped originating loans essentially June of 2007 because we said we didn’t like the tea leaves out there and we thought the market was deteriorating. We talked about SunCal in December specifically and on prior calls which is probably our biggest exposure right now. That made up the bulk of the loan loss reserves as Andrew points out, so in terms of sentiment I don’t think we’ve been ebullient on the past two or three conference calls in terms of market condition, the effect it was having on loan portfolios generally, the market generally, our complete shift in strategy which we started about six months ago, nine months ago, syndicating and selling down our loan exposures, future funding commitments, reducing our repo warehouse line exposures, and talking about the tough times in the market. So I think on that one point, I would disagree with you a little bit. I think we’ve been up front with people about our views on the market and the potential impact on the portfolio.

As it relates to your second question as to, maybe you want to restate it, how do we know what you’re telling us now there are no more rocks to be turned over? And to the contrary, we’re actually projecting or predicting or estimating if you will that there will be some more potential losses in Q3 and Q4. We were actually getting out ahead of that by estimating a certain amount. If you’re asking is that the right amount or will it be higher or lower? That is really going to be market dependent. We can only estimate what’s in front of us based on our discussions with borrowers, the problems their having or not having, and the lenders we’re dealing with on refinancing or not dealing with, and we make a projection that we think is good as of this moment, but as we roll forward we’ll just have to take it quarter by quarter and see.

David Fick – Stifel Nicolaus

My second question is also a two-parter. Your disclosures at the SL Green level have always been among the best in the industry. AFR’s disclosures with respect to their portfolio were also quite strong, I think roughly 35 to 40 pages every quarter. This quarter you kick out a nine-page press release and we see nothing in terms of portfolio detail. Is this just a transitional issue, number one? Number two, how do we get to your cash NOI and [inaudible] based on what you provided or will you be providing more information there?

John B. Roche

We are actively working on the supplemental and would anticipate to have one for the third quarter. Indeed we had put most of it together and it is based upon the prior AFR supplemental and you should expect to have one for 3Q.

David Fick – Stifel Nicolaus

But there will not be or you don’t anticipate putting anything out in the next week or days that will help us out?

John B. Roche

We’ll look at that. Truth be told, David, we have been working towards a whole variety things. It’s been a pretty active quarter. There will be additional disclosure in the Q and we’d like to believe that will answer many of your questions.

David Fick – Stifel Nicolaus

Just one detail there, the FAS 141 adjustment in rents was?

John B. Roche

The FAS 141 was about $13 million. But I will point out that we have a negative straight line adjustment in there in excess of $9 million. [Inaudible]

Marc Holliday

So in answering one of the questions I heard David ask as it relates to cash, if you’re trying to sell for cash, the cash increment was only $4 million or $5 million.

John B. Roche

It would be closer to $4 million.

Operator

Our next question comes from Stephen Laws - Deutsche Bank Securities, Inc.

Stephen Laws - Deutsche Bank Securities, Inc.

Can you talk about the timing as far as internalization of management? Is this something you all look to evaluate from both sides and make a decision on quickly or is it something that could linger for some time as a long negotiation occurs?

Marc Holliday

I don’t know what you’re view of quickly is. I mean I think this isn’t something that is going to take, they’re going to make a career out of evaluating. I think that by third quarter I would hope to have some color one way or the other on the next call as to whether, in which direction everyone thinks makes the most sense at that time. Maybe before that, I don’t think it would be after that. So certainly within the next quarter I think there’s be some light shed on that.

Stephen Laws - Deutsche Bank Securities, Inc.

Just talk a little bit more about the decisions on the AFR portfolio. It seems like you’ve got a larger number of properties still remaining in held-for-sale but for the most part the gross proceeds balance of those sold is I think at 78% of what you’ve targeted. Can you talk about the timing? When you look to have those sales completed? Are you pleased with how fast those are going to date? And maybe just a little color overall on how you selected those properties that you’re looking to sell.

David Sean Brown

I think we’re a little slower than we had hoped initially just transitioning from the [Ampar] guys running the process to our team running it. I think we’re pretty well through and have pretty good clarity as to where we’re going to end up. There are a bunch of sales right now that are in the hopper and under contract that should put us pretty close to the 90% through what we expected to be and the last 10% we’re actively exploring different venues to sell them through. But the actual dollar amount isn’t that large so I think by the end of next quarter or a little later we should be pretty much through the vast majority of it.

Marc Holliday

If you recall Steve this portfolio originally of $367 million is considered to be in the aggregate the toughest of the properties AFR had to sell. And the fact that David says we are or are soon to be at 90% of the way through the toughest means that last 10% is the toughest of the toughest and that’s I guess about $30 to $35 million or so of remaining product. So it’s a relatively, it’s a very, very small dollar amount that remains. It could be very, very hard to sell. We are looking at all these different avenues and vehicles for getting it sold and hitting the numbers that we’ve pegged to receive for these properties. But in the same sense that’s not going to drive the boat in terms of the strategic objectives we talked about earlier. To get the kind of scale and size that we’re talking about, we’re going to be looking much more at, David why don’t you talk about some of the other briefly portfolios we’re looking at.

David Sean Brown

We’re looking at trying to bring some money in through a couple of joint ventures in some of the larger assets we have and some of the larger pools we have with Bank of America and Wachovia which have attractive long-term debt in place and have long-term leases that we think they’re a strong market for with a good cash yield. So we’re going to actively look to bring partners in on assets like that and other large office buildings and strong CBDs that have good [inaudible].

Operator

Our next question comes from Douglas Harter - Credit Suisse.

Douglas Harter - Credit Suisse

I was wondering if you could talk about the covenants you have on the credit facilities and the repurchase agreement and where you stand relative to those?

John B. Roche

We as you might imagine monitor them closely both as it relates to our projections and obviously for the quarter and we are in compliance with all.

Douglas Harter - Credit Suisse

On any of those facilities, are there any cross default triggers or anything or are they all independent?

John B. Roche

There are cross default triggers as it relates to some of the unsecured facilities and I would include in that Key and [inaudible] I’m going to say that virtually all of them are identical.

Douglas Harter - Credit Suisse

But do those facilities impact any of the CDOs or any of the AFR assets?

John B. Roche

Again, property level mortgages have property level covenants and the CDOs again have their own covenants so each of these are monitored individually and in aggregate.

Operator

Our next question comes from Jim Shanahan - Wachovia Capital Markets, LLC.

Jim Shanahan - Wachovia Capital Markets, LLC

The $205 million of nonperforming loans calculate roughly 9.4% of the category in the balance sheet to which I think that applies, talking 9.5% of loans and other lending investments. Where does management think that will peak, what percentage, and what would be the timing for that? I mean, put it in your perspective and where you think we are in the cycle? Does this peak at year end 08? Is it more like year end 09? What your thoughts are there.

Andrew Mathias

Our hope is that obviously we do anticipate further issues within the loan portfolio based on our guidance, but we are also actively resolving loans that are currently either sub-performing or nonperforming and our goal is always to try and maintain a constant number; in other words, resolve situations so that we have both time and focus to tackle new situations. It’s tough to project exactly the timing of resolutions and how quickly we’ll be able to get loans hustled off of the sub and nonperforming lists. It just depends on the kind of resolution strategies we’re pursuing there. So certainly internal capacity for both by number of loans and by principal balance to be tackling more situations as part of the infrastructure we’ve built over the last 12 months. However we have shown an ability as Bob went through to resolve situations both from pay offs and through restructuring. So for example, the hotel loan where the sponsors raised almost $10 million of new subordinate capital, there’s a shot we may get that loan restructured and put back to performing status so that would come off of that list.

Marc Holliday

I would also add to that, a large part of our book, I’m going to hazard to say 40% or so, is New York City assets which are holding up by far the best and actually there’s a fair amount of liquidity available in Manhattan and in New York City. So my comments earlier about the lack of liquidity, that’s generally in most of these secondary markets or even in the case of California some primary markets. But in Manhattan there’s not only debt liquidity but there’s equity liquidity, there are trades, Green’s refinancing, others are refinancing, so the fact that 40% or so, I’ll try to get you an exact number in a second, is New York City means that our universe of potential problems we think is limited to a smaller pool of assets, some of which we’ve dealt with already and some of which we are dealing with. So that in some sense makes us emboldened that we can work our way through this over the next four to six quarters and hopefully restructure as much of this as we can into a cell as much as we can in order to be redeploying into new opportunities which is what we want to do and where we’re going to make the money going forward. So it’s no coincidence that all of the REO and/or nonperforming loans are not Northeast located loans. That’s not a coincidence because that is where the problems are. 45% of our book of business is secured by collateral in the Northeast.

Jim Shanahan - Wachovia Capital Markets, LLC

I’d like to ask a follow up. Can you discuss what you think the recent trends have been with regard to the use of extension options by borrowers and how the use of extension options impacts your credit metrics and how that might be the case in the future? And when a borrow extends, is there a re-underwriting that occurs to get a sense for if the project has deteriorated at the margin and is that a consideration when you look at appropriateness of your loss reserves?

Marc Holliday

I would say typically our extension options do have tests attached to them, whether it’s a measure of property cash flow, whether it’s a measure of loan-to-value, whether it’s requiring borrowers to rebalance certain reserves so it’s a debt service reserve or carry reserves, most of our extension options the majority we did structure with tests so that they’re not purely as of right and it does give us an ability to make a determination and have a conversation and decide to try and take a position with respect to an extension option. And I would say we’re doing that across the portfolio. I think we take those extension options as opportunities to fully re-underwrite the properties and some of the loan restructures that we’ve completed to date have been on loans with extension options. Just because we have tests and conditionality with respect to those options, it gives us a hook to go in and do restructurings.

Operator

Our last question comes from John Guinney - Stifel Nicolaus & Company.

John Guinney - Stifel Nicolaus & Company

This is an AFR question for you just to clarify. Marc, you said $225 million of core what I’m assuming is cash in OI. Is that roughly attributable to about $3 billion portfolio?

Marc Holliday

That is attributable to about less than $3 billion, about $2.9 billion.

John Guinney - Stifel Nicolaus & Company

Of that $225 million is $40 million the Dana portfolio?

Marc Holliday

Well there are adjustments as John mentioned both ways. Dana has been reduced from $40 million to a straight line adjustment of less. We do have a negative straight line number in our numbers as a function of primarily the Dana portfolio.

John B. Roche

Let me clarify it. If you take your $65 million of NOI per this press release and annualize it, that comes to about $260 million but Marc had mentioned $225 million of cash NOI, so I’m assuming that $225 million of cash in OI includes $40 million for the Dana portfolio.

John Guinney - Stifel Nicolaus & Company

That $65 million, does that include other rental revenues from other non-A par properties?

John B. Roche

The legacy portfolio, which again in the prior year was less than $2 million.

John Guinney - Stifel Nicolaus & Company

Just dealing with the AFR portfolio, does the $225 million include a full $40 million for Dana?

Marc Holliday

Yes as adjusted for the straight line.

John Guinney - Stifel Nicolaus & Company

Which is a reverse negative straight line?

Marc Holliday

Negative straight line, yes.

John Guinney - Stifel Nicolaus & Company

John, if I heard you right, by the next quarter you’re going to use the best practices of SL Green and the best practices of AFR to get a supplemental package that’s state-of-the-art in the industry?

John B. Roche

We are working diligently on and indeed many of the AFR people who put together their supplemental are I would like to believe listening to this call and have one very close.

Robert R. Foley

We actually got Greg Hughes involved who can get it done in an afternoon?

John B. Roche

I’ll take him up on it.

Marc Holliday

Again thank you for joining us. There were a lot of listeners today. For those that are still with us, I appreciate your time and the questions and we’ll hopefully be able to come back in the next quarter with progress on the initiatives that we set out on the phone today. Thank you.

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Source: Gramercy Capital Corp. Q2 2008 Earnings Call Transcript
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