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Executives

Richard McCready – EVP and COO

David Hamamoto – Chairman, President, CEO

Andrew Richardson – EVP, CFO and Treasurer

Analysts

Douglas Harter – Credit Suisse

Stephen Laws – Deutsche Bank

Lee Cooperman – Omega Advisors

David Fick – Stifel Nicolaus

Jeff Miller – JMG Capital

Matt Goldfarb – GSO Capital

Jeffrey Talbert – Wesley Capital

Phil Wilhelm [ph] – Stark Investments

NorthStar Realty Finance Corp. (NRF) Q2 2008 Earnings Call Transcript August 7, 2008 10:00 AM ET

Operator

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the NorthStar Realty Finance second quarter 2008 earnings conference call. During today’s presentation all parties will be in a listen-mode. (Operator instructions) This conference is being recorded today Thursday, August 7, 2008. At this time I'll like to turn the conference over to Richard McCready, Chief Operating Officer, please go ahead sir.

Richard McCready

Thank you very much. Welcome to NorthStar’s second quarter 2008 earnings call. Before the call begins I'd like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements.

These statements are based on management’s current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company’s filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

I should add that the company undertakes no duty to update any forward-looking statements that may be made in the course of this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with generally accepted accounting principals.

Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with generally accepted accounting principles can be accesses through our fillings with the SEC at www.sec.gov. With that, I'm going to turn over the call to our Chairman and Chief Executive Officer, David Hamamoto. David.

David Hamamoto

Thanks Rick and thanks everyone for joining us this morning. In addition to Rick McCready, our COO, I'm joined today by Andy Richardson, CFO, Dan Gilbert and Dan Raffe, both EVPs, and heads of our investments businesses and Al Tylis, our General Counsel.

Today NorthStar announced very solid results for the second, a quarter in which we saw continuation of the market challenges we have discussed in the past several earnings calls and during the many investor conferences in which we participate. Despite positive momentum in the financial sector and credit market in May, weaker than expected results, and additional large write-off from the banking sector.

All-time high commodity prices and weakening consumer demand combined to reverse many of the gains. Since our last call credit spreads have generally widen and the overall residential sector news continues to be negative. In fact, market consensus today now fees no recovery in single family housing until 2010 at the earliest. Credit and liquidity remain scarce and we continued to remain cautious in our outlook for the remainder of 2008 and into 2009.

Within commercial real estate finance we are now starting to see the market differentiate between those companies who have effectively managed liquidity and credit and those with real issues. Since the beginning of this credit prices in 2007 the management team at NorthStar has diligently and continuously emphasized caution in investing capital at the expense of near-term earnings solution, managing liquidity by aggressively raising capital when available while working hard to reduce nondiscretionary future funding commitments, and reducing mark-to-market risk and extending debt maturities.

As a result of our approach NorthStar’s balance sheet as well positioned for this market with very little debt maturing until the middle of 2010 and strong liquidity of $295 million includes of the July 9, recapitalization of our healthcare net lease portfolio. Our credit track record continues to be one of the best in the sector. While we aren’t immune to the current week market conditions we still have no non-performers in our portfolio.

Our focused on direct organization rather than purchasing loans structured by a Wall Street Firm, and our early investment in a strong an experienced portfolio management platform has served as well. Andy will go into credit and more detail later, but since 2006 we directly originated and structured 78% of our real estate loans and focus primarily on first mortgage origination. This allowed NorthStar to secure a more senior position in the capital structure and also to obtained better covenants and other protection.

In fact, 53% of our self-originated loans have some form of recourse to the borrowers, compared to no recourse in most Wall Street structured loans. Also we didn’t participate in the large widely syndicated top of the market financing, such as the subsequent acquisitions of the ELP portfolio our extended stay hotels and others. We just didn’t think we were getting paid for the poor structure, lack of control and credit risk inherent in these transactions.

We also avoided the weaker residential condo market and have no condo loans in Florida, Las Vegas, or Phoenix. If fact, residential condo loans represents just 1.9% of our total assets under management and 90% of these loans are located in Manhattan at an average fully funded basis of $616 per square foot. Finally we have always emphasis that most of our loans represent acquisition financing as opposed to refinancing. As a result, the real cash equity was put into the transaction and our reported loan to values represent loan to cost.

We believe those LTVs are much more reliable indicators of risk than LTVs drive from value imply by refinancing to where the borrower is taking equity out of the deal. Also in 2006 we began investing significantly in our Dallas based portfolio management team led by Bob Riggs, who has 20 years of experience in managing commercial real estate equity in debt assets. The team now totals 15 individuals who average 15 years of experience in managing commercial real estate. This in-depth experience means they are senior people who have operated through several real estate cycles.

They leverage the work of third party servicing and surveillance organizations in proactively managing our assets. I can’t emphasize enough the importance of a strong portfolio management team in mitigating risk and preserving capital in time like these. During bull markets, easy to under investment portfolio management, but NorthStar prudently build that area early and we are now reaching the benefits the outstanding performance.

Finally since March 31, we accomplished two of our major capital raising and recycling initiative and made selective opportunistic investments in several parts of our business where we saw interesting opportunities. On the capital front we raised approximately $170 million of net proceeds the capital markets transaction involving our net lease portfolio.

First in June our subsidiary that holds NorthStar’s core net lease portfolio, which is comprised primarily of suburban office and industrial properties, sold $80 million of five-year unsecured notes bearing interest at 11.5% which are exchangeable into NorthStar’s common stock at an exchange price of $12. This transaction was marketed confidentially and was a creative way to access capital on the different market by allowing investors to underwrite a discreet portfolio of commercial real estate asset subject to long-term net leases.

Then in early July we closed on the sale of a $100 million of preferred stock in the Wakefield healthcare net lease venture. The preferred equity is convertible into an approximate 42% common interest in the venture at our cost basis in the asset. As many of you know we have been working towards to this monetization for several quarters. The deal unlocked approximately $90 million of capital for NorthStar which was formerly earning a 12% ROE.

The transaction closed after June 30, to the $90 million of cash we have received is therefore not included in our quarter end balance sheet. During the second quarter we deployed approximately $58 million of net equity capital in areas where we think there is very good risk return. First we continue to see opportunities and buying securities at deep discounts from motivated sellers.

We purchase $35 million of highly rated investment great securities issued by our own CDOs at an average discount to part of 40% to yield an approximate 18% ROE. This represents some of the most senior securities in NorthStar capital structure and likely are the most exceptional risk returns today. These purchases also validate our recurring values of the debt and demonstrate the attractiveness to the issuer of its cheap cost, flexibility, and long-term nature.

On the lending front, we have made two new loans during the quarter one of the loans was an opportunistic investment and which we bought at a significant discount at part mezzanine loan having $44 million based amount on a CBD trophy office asset having a well regarded institutional equity sponsor. The financial institution seller also provided 75% leveraged term financing enabling NorthStar to underwrite an ROE north of 20% during the life of the loan.

Going forward we think there will be more discounted loan purchase opportunity as bank continue to de-leverage there balance sheet by disclosing of assets and enticing buyers with attractive seller financing. Finally, during the quarter we made our first investment in LandCap. The Joint venture in which we are equal partners with Goldman Sachs Whitehall Funds and whose purpose is to make opportunistic investments in the distressed residential sector.

To set up this venture with Goldman Sachs nearly a year ago in which time the partners hired the management team with extensive experience in the home builder industry. Since that time the venture has evaluated over $1.5 billion of investment opportunities that has been exceptionally patient in deploying capital. Second quarter investment was an $11 million acquisition fully entitled land for residential development. Even the values in single-family housing continue to fall we believe there were opportunities to underwrite high 20% to 30% unleveraged return investment assuming that 3 to 4 year holding period and continued short-term price erosion.

On the private capital management front we still hope to have a first closing on our real estate debt fund later this year is a very difficult environment for new managers to the pension fund and endowment world to get allocation. We’re hopeful that our investors will look to our public track record and transparency to being a public company manager provides to them.

In conclusion and before I turn the call over to Andy we’re pleased with NorthStar’s ability to navigate in difficult market to date and we continue to remain very caution in our outlook for the remainder of 2008 into 2009. I believe NorthStar is well positioned to take advantage of the market stress to make some exceptional investments and we will remain very focused on managing credit risk and liquidity.

Now I would like to turn the call over to Andrew.

Andrew Richardson

Thanks David. I will start off with our second quarter earnings results then discuss credit and liquidity before we open the call up for questions. The second quarter our GAAP loss inclusive of FAS 159 adjustments was a negative $18.5 million or $0.30 per share, FFO for the quarter was $24.9 million or $0.35 per share inclusive of the one time cost of issuing the $80 million of exchangeable senior notes during the quarter. Exclusive of these one time issuance cost FFO was $0.43 per share.

We elected the fair value of these notes consistent with our treatment of 7.25% senior notes we issued last year. If we elected the use of historical cost method, the issuance cost would have been capitalized and amortized in the earnings over five years. We invested approximately $89 million of equity capital during the second quarter and received approximately $31 million of equity capital from loan repayments. We delivered an 18.4% return on average GAAP book equity for the second quarter excluding G&A and the notes issuance cost.

Net interest income which is interest rental and advisory fee revenues less interest expense, property operating costs and asset management fees stayed flat from the first quarter at $40 million. Prepayment penalties and other income totaled about $4 million this quarter approximately $3 million higher than the first quarter. The increase was principally due to the sales of an equity participation interest in one of our collateral properties.

General and administrative expenses excluding non-cash stock based compensation increased approximately $2.5 million from the first quarter to $8.6 million. Accounting and auditing fees decreased $1.2 million from the first quarter and cash compensation cost were $800,000 lower than the first quarter. Our first quarter auditing fees were traditionally higher than the other quarter’s due to the preparation of our annual audited financial statements and decreased compensation cost results from lower staffing levels which are more appropriate from the current environment.

In early may we completed a recapitalization of our corporate lending joint venture formally known as Monroe. We briefly described the transaction during the last quarter’s call our second quarter balance sheet and income statement reflect the completion of this transaction. Recall that we had $800 million of credit facilities during this year with a combined outstanding balance of $423 million at March 31st backed by a 140 corporate loan investments.

Due to disruptions in the asset backed lending markets there was no reasonable prospect for completing the CLO transaction to repay the debt at maturity. We therefore partnered with an institutional investor with middle-market lending experience, do invested approximately $87 million of cash equities into the venture and NorthStar’s subordinated a significant portion of it’s existing equity investment to a mid-teens preferred returns to the new capital.

The lender agreed to reduce the outstanding debt balance by $46 million and term out the remaining debt in the form of a private CLO. The lender also permitted the venture to sell up to 25% of the existing loans and to reinvest the proceeds into new loans having much wider markets to spread. In the second quarter the venture sold 58 of the old loans at a $19 million realized loss the NorthStar carrying value. NorthStar recorded $46 million gains on debt reduction and $19 million realized loss from sales of loans and reduced this investment in the venture by $27 million.

The recapitalization resulted in zero net P&L impact in NorthStar and no net increase in NorthStar’s carrying value in the venture after recapitalization. NorthStar also contributed all of its corporate CLO equity investments into the new venture. These investments had a $44 million of carrying value at March 31st. Going forward we’re using the equity method of accounting for investment in the venture, so our net investments totaling $82 million at June 30th, we’ve recorded a equity and joint ventures in our balance sheet.

We also elected FAS 159 fair value option for our investment in new venture which is consistent with our partners accounting treatments. As a result approximately $33 million of mark-to-market loss as previously recorded in OCI in prior periods were reversed and recorded through unrealized losses in the P&L of the quarter. We are no longer including the underlying loan assets in our AUM numbers. During the quarter net mark-to-market adjustments reduced NorthStar’s book value by approximately $4 million. Our GAAP book values as of June 30th, was $12.23 per share. The earnings release contains a detailed reconciliation between our first and second quarter book value.

Our annualized second quarter dividend of $1.44 represents in a 11.8% return on book value as of June 30th. On the investment front as David indicated we’re seeing pockets of opportunity across our businesses. One of the most compelling investment areas are discounted purchases of our own CDO debt. This debt represents the most senior portion of NorthStar’s capital structure. During the second quarter we deployed approximately $14 million of equity capital and acquired $35 million face amount of our issued CDO notes having credit ratings ranging from AA to BBB flat at an average of 40% discount base.

At these levels the purchase price implies an approximately 18% ROE on our equity investments. The purchase price also represents of $7 million discount through our carrying value at the beginning of this debt of the year so we’ve recognized a net realized gains for that amount. Not only to thee purchases representing good ROE opportunities for NorthStar but they are also very efficient in terms of resources because we own the underlying collateral so there is no need for additional underwriting to make the investments.

Significant discounts of which we are able to acquire these securities in the open market also validates the carrying value to the liabilities in our financial statement. During the second quarter we also invested $16 million of equity into the NorthStar real estate security fund increasing our interest of 45%. The average credit rating of our portfolio remains BBB flat and we have no non-performing securities. At June 30th, exclusive of the securities, we managing the security funds we’d approximately $1.5 million of CMBS securities under our management in our REIT of which 82% were issued prior to 2006.

During the second quarter we made a $6 million equity investment into the LandCap venture and we made no new net lease investments. On the credit side our asset base is performing well in this difficult environment. This portfolio entirely diversified with an average real estate loan balance of just $16 million and an average securities balance of $5 million. We believe this diversification strategy has help to mitigate the risk to any individual credit situation will have a material impact on NorthStar. Senior management devote significant time on activity managing portfolio credit situation and Dallas-based asset management organization has been proactive and identifying issues before they could become significant problem.

NorthStar has no non-performing asset for delinquency of schedule interest or principal payments across our commercial real estate lending and securities portfolio as of June 30th. And I am going to discuss portfolio credit to provide some color on how we view the asset base. Simply we break our investments into three major categories owned net leased real estate assets; commercial real estate securities and commercial real estate loans.

Starting with the owned real estate we have approximately $1.3 billion of real estate assets based on un-depreciated book values that are subject to long-term net leases, having a weighted average remaining term of nine years. These assets are fully leased as of June 30th and our tenants are paying according to their respective lease terms. These assets generate steady long-term cash flows from corporate U.S. Government and healthcare related tenants.

We also managed $2.9 billion base of commercial real estate securities for the REIT of which $627 million are consolidated and $2.3 billion our accounted for an half balance sheet financing. The average credit rating of these securities is an investment grade BBB flat and as I said 82% were issued in 2005 or prior.

All of the securities are current and paying according to the contractual terms and credit performance of commercial real estate loans, underlying CMBS securities remains very strong across the sector, with most recent most the delinquency rates remaining steady and low relative to the historical level. The delinquency rates underlying our securities are consistent with the market experience. We mark our securities to market each quarter and the portfolio has decreased in value as market credits spreads have widened. However, nearly all of our securities are financed to maturity in CDO term financing.

So we not only have the intent, but also the ability to hold these assets to maturity. We closely monitor underlying collateral performance and credit support levels relating to our securities investments and believe there are currently our no credit issues with any of our securities investments. We do have one security investment with the $21 million principal amount that has been on our watch list since last year.

The asset is on the list due to credit support deterioration resulting from underlying credit with exposure to the weakening housing sector. We underwrote this investment, which had AA rating at the time of issue to withstand sever stress from credit deterioration in the minority portion of the underlying collateral having exposure to the housing market.

Since last year credit support levels have stabilized and the bond still has an investment credit rating. We continue to monitor the security due to the REIT housing market. If we were to experience the material deterioration in credit quality of an investment we cannot take a credit loss provision like we can with loans. We must take an impairment charge when it becomes probable we will not collect contractual amounts when due.

Nevertheless our portfolio is fully performing delinquencies of underlying collateral remain very low and the investment grade average rating remains steady. This brings us to the $2.1 billion of funded commercial real estate loans. We had no non-performers or delinquencies at June 30th. We do believe that our focus on sales structure and directly originated loan over last several years has resulted in fundamentally stronger, structural protections and credit enhancement than was available from Wall Street structure products.

We control all of our direct originated investments, which means we have direct dialogue with the customer and have decision making authority when administering the loan and negotiating any changes to loan term. Over 43% of our loans in total as some sort of recourse obligation to the sponsor usually debt service reserve replenishment obligation, funded reserves and replenishment obligations totaled $135 million at the end of the quarter.

Now going to the watch list, recall that this is our highly monitored asset list and not an NPL list. In fact all of our watch list loans are current and since 2007 we have successfully resolved $67 million of watch list asset without a loss of principal. We added one loans to the watch list this quarter, a $13 million mezzanine loan on a multi-family property located in Atlanta.

The property is underperforming at least our projections and the borrowers coming out of pocket to fund recourse interest replenishment obligation. Also we’ve recently signed a firm comment with a significant non-refundable deposits, which will enable a well capitalized National Multi-Family owner and developer to acquire the two San Antonio properties backed by an $19.5 million first mortgage loan they have been on the watch list since third quarter of 2007. Upon closing the new sponsor will inject $2.5 million of fresh cash equity into the properties and assume our first mortgage loan. As a result we have removed the asset from our watch list. Our watch list now totaled $89 million down $7.1 million from the first quarter of 2008.

We also took a $2.5 million credit loss provision in the second quarter against two loans on the watch list, $2 million was attributable to an $11million mezzanine loan on a limited services hotel portfolio and $500,000 relates to a $18 million first mortgage loan on a multi-family property in South Florida, a $11 million mezzanine loan has an accrual rate of 21.5% and a cash pay rate of 11.3%. We will no longer accrued the non-cash interest portion of the loan until we become comfortable at the underlying collateral value can support further increases in our loan basis. Again our watch lists assets continue to pay contractual interest amount and therefore continue to perform. We publish this list so that our investors can understand the pool of assets to which we divert a high level of resources in order to preserve our capital.

On the right side of balance sheet we have very limited exposure to near-term debt maturity. We are in renewal discussions with JP Morgan relating to the $350 million secured credit facility we have with them for commercial real estate loans. We have just $47 million of outstanding under this facility at June 30th and the credit facility can be extended for two additional one year period.

JP Morgan has been consolidating Bear Stearns’s as commercial real estate business in those lending area and bank has been actively involved in discussions with us, but it has been delayed – in processing our extension request. Given market conditions we understand that JP Morgan may seek to change some terms under the facility and we plan to working with them to extend the facility under near terms they are jointly attracted to them and to us.

Our next significant final debt maturity does not occur until the second half of 2010. At June 30th consolidate asset totaled $4.2 billion down form $4.6 billion last quarter due principally to the deconsolidation of $870 million of corporate loan assets and the Monroe recapitalization.

On the liquidity in capital markets front at quarter end and pro forma for the July 9th closing of the Wakefield recapitalization we had $227 million of unrestricted cash and $68 million of un-invested cash in our CDO secured term financing for aggregate liquidity of $295 million. As part of the senior note issuance we terminated the $100 million unsecured facility, which had (inaudible) remaining.

Future funding relating to our real estate loan represents our only non-discretionary funding commitments. Recall that all future funding on loans that are financed in our CDOs will be funded a 100% within the CDO by revolving class of notes, which means that there is no cash requirement for NorthStar. About $443 million future funding requirements at June 30th, $233 million will be funded in our CDOs. We are responsible for the un-financed portion of loans that are collateral outside of our CDOs for our term loans and credit facility. At the quarter end we modified a loan further reducing the future funding requirements by $29 million.

Currently, we expect just $8 million of cash requirements for the un-financed amounts through the reminder of 2008 and $62 million of un-financed amounts for 2009. This concludes our prepared remarks today. NorthStar had a productive quarter on the investment credit and liquidity front. We found interesting opportunities continued our strong credit performance and raised a $160 million of cash – a $170 million of cash proceeds of cost of fund, which we can accretively put the work for our shareholders.

Our balance sheet and liquidity are solid and we are one of the best position companies in the commercial real estate finance space to take advantage of the unique opportunities presented by this market. So, as a recap for the quarter let’s open it up for questions. Operator?

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) And our first questions from the line Douglas Harter with Credit Suisse. Please go ahead.

Douglas Harter – Credit Suisse

Thanks, can you talk about the maturities that are you have in the loan portfolio coming in 2008 and 2009?

Richard McCready

Yes. Doug I will take it and try at that first and David add in his comments the initial maturities and we discloses in our Q’s every quarter, but the initial maturities for ’08 are about $391 million, but most of those loans have extension option and if you assume that everybody qualify for an extension extent, there is less then a million dollars of maturities for the rest of the year, but I will tell you that we’re working on high probability payoffs for the reminder of the year that could be in the $125 million to $150 million range. We have already received over $11 million this quarter and we have a payoff notice that’s we feel pretty good about that will be getting another $30 million back by the middle of this month. And of course next years initial maturities are $580 million of which all but about $105 million of that could be extended.

Douglas Harter – Credit Suisse

All right thanks and then obviously – sitting with a fair amount of cash on the unrestricted cash right now. Can you talk about, what is the level of you feel comfortable holding, given the environment and how much of that you would feel comfortable putting to work over the next couple of quarters?

Richard McCready

Yes, I think that we are as I said, we are starting to make investments and we are starting to see very attractive opportunities, and feel that we can make north that 20% return without taking undue credit risks, and so I think a good part of that $295 million we’ll get put to work over the balance of the year, my sense is that will probably run a liquidity level somewhere between $50 million and a $100 million.

Douglas Harter – Credit Suisse

Great. Thank you.

Operator

Thank you. Our next question comes from the line of Stephen Laws, with Deutsche Bank. Please go ahead.

Stephen Laws – Deutsche Bank

Yes, hi. Thanks for the detail on the portfolio during the prepared remarks, and can you maybe expand on that a little bit David as far as you put that roughly $200 million to work over the balance of the year? You commented specifically about buying back senior collectives of your CDOs? Are there any other specific investments where you’re looking to deploy that capital given today's environment?

David Hamamoto

Yes, I mean I would put it into different bucket. One is the deal that we talked where we’re buying dealer paper at a discount with seller financing, obviously that’s the power of that is the attractive financing that sellers are prepared to provide through term, which helps drive return. There is some paper that’s inside that we’re not comfortable with the credit, but we are seeing select opportunities where we will continue to buy selectively at discounts from the Street. I think the other two major areas are the LandCap venture which we have set up with Whitehall, where we’re seeing a tone of supply and not a lot of qualified buyers, so that it’s a very interesting niche for us.

Particularly, because some of the sellers want to stay in and participate in the upside and therefore the management team that we’ve built at the LandCap, has the expertise of both working out and reselling lots provides us with a pretty strong competitive advantage, and I would see as being more active in that venture over the balance of the year, and then lastly, we’re focused on the restructuring business.

I think there is about a $50 billion of CMBS coming due this year, obviously a lot of those are getting extended, but there are many situations whereas part of the restructuring that there is new capital that’s required, which we think sits safely at a LTV level where we like the credit, and we can charge very attractive return by participating in those restructuring. So, I would love to see opportunities in 203 categories.

Stephen Laws – Deutsche Bank

Great, and maybe can you take a second and expanding in the LandCap? I mean it’s been a year I guess since you announced the JV with Goldman Sacs Whitehall? Can you maybe refresh our memories on how that structure, with those opportunities are there and how NorthStar drives those income from that point?

David Hamamoto

Sure. The venture is a 50-50 venture with Whitehall, we’re straight up partners. We have both allocated a $175 million of capital, but that those investment decisions are fully discretionary. So, we and Whitehall both have to agree in order for an investment to be made. The prior year we spent really building the team, and we understand that the residential land business is a very, very complicated asset class to understand and not withstanding our and Whitehall’s long history of making real estate investments, we felt that building that specific expertise and a management team was what was really going to get us comfortable in order to start pulling the trigger in that sector, and so we’ve assembled a team of 12 guys, professionals coming out of the homebuilding industry, who have extensive experience in all of the entitlement construction zoning issues associated with land.

The opportunity is really to buy either lots or finance lots, or buy non-reforming loan from banks who have significant inventory, and our focus has been on the finished lot products where over a three to four year period we can liquidate the investments, and for the most part, we are underwriting near-term for the deterioration and both housing prices and lot values, and not withstanding those relatively conservative assumptions we can generate the 20% to 30% un-leverage return on those investments.

So, we see it as a sector that requires a specific expertise, we see the supply of those on the sales side to be very significant and much more significant than the capital that’s lined up to take advantage of the opportunity. So, we think it will work out quite well although we’ve still as I said earlier, are somewhat bearish on what's happening in the residential market, and that’s part of the reason why the $1.5 billion of investments that we’ve evaluated in LandCap over the last year, we’ve really having some been able to make a lot of investments, but we just had good outspread with the sellers on those valuation.

Stephen Laws – Deutsche Bank

Great, thanks for the description. I appreciate you taking my questions.

Operator

Thank you. Our next question is from the line of Lee Cooperman, with Omega Advisors. Pleas go ahead.

Lee Cooperman – Omega Advisors

Thank you. It was kind of talked around, but I want see if you could get a little bit more specific. In your desire to build liquidity, which is fully understandably, you’ve done a great job I might add. We really have a drag on our results, because we’re sitting on $295 million of cash earning X paying out Y with a big negative spread that you mentioned it your cash liquidity to be somewhere between $50 million to $100 million, which means you put $200 million out.

I’m curious as you look at what you’re currently earning on your cash versus what’s paying? What do you think you can earn in the way of spread on that $200 million? I’m kind of thinking, we could pick up a spread of 600 basis point, because where that we seems reasonable as $12 million or 70 million shares, basically it’s a $0.50 to $0.60 increase in our run rate of earnings, as you deploy that money. Is that a realistic way of looking at or too optimistic or what?

David Hamamoto

Well I think Lee, the way that we look at it is, between the preferred and the convertible, the average coupon was around 11% and so if we can reinvest at 20, there is a nine point spread on that $200 million.

Lee Cooperman – Omega Advisors

Better yet. Its $18 million on 70 million shares right, so it’s a lot of money relative to present dividend. It was suggested that dividend rate which is attractive now would have been sustained, if not enhanced over the year or two?

David Hamamoto

I’m surprised you’ve focused on dividend Lee, you’ve never talked about that before.

Lee Cooperman – Omega Advisors

I appreciate your sense of humor. Thank you very much, good luck. You’ve done a very good job.

Operator

Thank you. Our next question is from the line of David Fick, with Stifel Nicolaus. Please go ahead.

David Fick – Stifel Nicolaus

Yes, can you help us with the spread between your EPS that’s been enhanced by the first quarter debt markups and your taxable income at this stage? Where do you think you’re going to come out against your dividend at the end of the year?

Richard McCready

We still think we’re going to be over distributed, because we have a pretty significant depreciation tax shield.

David Fick – Stifel Nicolaus

You got about a 30% return on capital last year?

Richard McCready

Yes, I know you always hear that’s in complicated, but I still think that there is plenty of cushion.

David Fick – Stifel Nicolaus

Okay, plenty of cushion before you must increase…

Richard McCready

Exactly.

David Fick – Stifel Nicolaus

Right exactly. Your $43.9 million in other income was pretty high. I present that included a $7.1 million in gains from the CDO bond buyback?

Richard McCready

I’m sorry well, how much did you say with the other income was there, Dave?

David Fick – Stifel Nicolaus

I’m sorry 3.9.

Richard McCready

Yes, 3…

David Fick – Stifel Nicolaus

I misspoke.

Richard McCready

3.9 were just from the sale of our participation interest, and we had $7.19 million gain from buying back to debt.

David Fick – Stifel Nicolaus

Well, where is that?

Richard McCready

The 7.1 is in realized gains and losses.

David Fick – Stifel Nicolaus

Okay, we get it. Okay. The mezzanine loan on the extended stay properties in land, can you talk about recourse there and what is the outlook for that asset, a little bit in more detail?

Richard McCready

I’ll take a shot at it David, can add, it’s seven limited service properties plus land that there is no recourse number one, no recourse that we are counting on getting put it that way, and the original business plan was to further develop properties. We have changed that plan, or our borrower has changed that plan given the current environment and so, they are actively marketing that the land parcels that they have and the hotels are performing very well because of the concept that it’s a limited service concept, but it’s RevPAR or is it average daily rate is well below the other limited service competitors in the market.

So, the outlook for that loan is going to be dependent on two things. One, the value that’s are going to realize on the land for selling and two, if the hotel continue to stabilize and so, right now we thing the $2 million reserve against the basis is a good number based on what we see today, but it’s going to be dependent on realizing proceeds from the land and I think we have reasonable assumptions there and then also the hotels continuing to stabilize.

David Fick – Stifel Nicolaus

Okay and then lastly, can you detail your land exposure out of that?

Richard McCready

I think we have about $87 million of land loans, of which a majority of that is located in the New York area.

David Fick – Stifel Nicolaus

And what types of properties.

Richard McCready

Mixed use properties, one small hotel parcel.

David Fick – Stifel Nicolaus

And no residential at all?

Richard McCready

The residential, we’ve categorized in the condo and as I said David most of our condo is Manhattan and the average basis is 611 a foot, so we feel very good about our condo exposure.

David Hamamoto

These are all first mortgage loan.

David Fick – Stifel Nicolaus

Nice quarter, thank you.

Operator

Thank you. Our next question is from the line of Jeff Miller with JMG Capital. Please go ahead.

Jeff Miller – JMG Capital

Hi, guys. Nice quarter. I just had some questions about, you got a 700 convert out there that’s trading around 71 right now. So, it’s seems like it’s the return on investment there buying that back is even above your 20% or so, have you guys thought about doing that as one of your reinvestment.

Richard McCready

Obviously, we look at all of our securities as a potential investment opportunity and I think that what we’ve seen today is the ability to earn 18% on that the senior bonds in our CDOs is the best risk return out there and there is not a huge amount of volume with that level, but we are obviously the best buyer and when we see some of these restructured credit funds liquidating and having to be a forced seller. We’ve been able to buy these bonds at a very attractive level and the ratings are BBB to AA on the $35 million at we put to work at 18%. So, clearly that is a more attractive investment opportunity then the preferred at 71.

Jeff Miller – JMG Capital

Okay, understood. I think you guys have a shelf registration out there for equity, is that something that you guys are contemplating..

Richard McCready

We have the shelf out there just so that we can be, a better way of saying, opportunistic in issuing equity when the price seems attractive to us.

Jeff Miller – JMG Capital

Right. I mean obviously, the stock price is suppressed now, but so that’s just something that’s not even on the table.

Richard McCready

Not with $295 million of liquidity, but I think as we see investment opportunities in 20% to 30% range, we’re hoping we’ve start to get some of the credits for our performance to these multiple expansion.

Jeff Miller – JMG Capital

Understood and just to clarify, I think David you mentioned that your $58 million of capital deployed in Q2 and you kind of went through the bond, I think it was $38 million of bond securities at deep discount and then two new loans and then one investment in LandCap for a $11 million, and then Andy you said that $89 million of equity was capitalize deployed during the quarter. Can you just walk me through those numbers again?

Andrew Richardson

Yes, sure. The $89 is really is about $13 million for our bond buyback, $6 million in the LandCap, $16 million into our security fund.

Jeff Miller – JMG Capital

Okay.

Andrew Richardson

And the remainder was in the lending business.

Jeff Miller – JMG Capital

Okay. Alright, thanks a lot.

Operator

Thank you. Our next question is from the line of Matt Goldfarb with GSO Capital. Please go ahead.

Matt Goldfarb – GSO Capital

Hey guys, nice job on a quarter. Can you just briefly discuss the extent, to which debt service requirements are supporting what might otherwise be regarded just nonperforming assets and debt service reserves?

David Hamamoto

What would be supporting nonperforming assets, I think as Andy said we have about a $135 million of reserves and I think it’s important to understand the business model that we had for our leading and our typical customer was either a private developer or real estate opportunity fund that was buying a lot of assets that a business associated with them. So, we did a lot of things that had a lease up component to it or some sort of value-add component, whereas I said these high quality sponsors had real cash in the deal. So, of our average LTV of 79%, there is 21% real cash in these deals and the reason that the reserved number is so high at a $135 million is that these assets contemplated a period where they didn’t cover.

One of the reasons, why we’re having more payoffs than are contractually required is that the business plan are getting, Matt and people are selling assets or refinancing with higher coverage. Some of the statistic that I can give you and we tracked very carefully in our portfolio management effort is, how are these assets doing relative to business plan and a little over 75% of the assets are meeting or exceeding business plan and then we have a subset of the assets that are slightly behind from a lease up perspective, but suffice it to say that we believe that other than the assets that are on our watch list the assets are all performing and well perform overtime.

Matt Goldfarb – GSO Capital

It’s very helpful, thanks a lot.

Richard McCready

And just to add of those assets that David mentioned that that are not performing at pro forma 97% of those have some level of recourse related to those assets whether it’s direct recourse or interest replenishment.

David Hamamoto

As I said 43% of our loan portfolio has some level of recourse.

Matt Goldfarb – GSO Capital

Thanks guys.

Operator

Thank you. Our next question is from the line of Jeffrey Talbert with Wesley Capital. Please go ahead.

Jeffrey Talbert – Wesley Capital

Hi, good morning and thanks for taking my questions. First question is on Monroe, you indicated, I think you had about $82 million…

Richard McCready

Can you speak up we can’t hear you, Jeffrey.

Jeffrey Talbert – Wesley Capital

Let me pick up the phone, is that better?

Richard McCready

Yes.

Jeffrey Talbert – Wesley Capital

You indicated with respect to Monroe that you had about $82 million pro forma for the new infusion of capital. Could you give me a sense please what the asset and total liabilities are of the enterprise pro forma for that investment? I’m trying to get a sense of where that 82 is in the capital spend?

Andrew Richardson

Yes, let me just go through that quickly. There is about, with new equity capital in the deal.

Jeffrey Talbert – Wesley Capital

Yes.

Andrew Richardson

There is about a $160 million of equity in the transaction and I think there is about $330 million of underlying debt, but I think that an important number here and that’s you can just look at that is the fact that we contributed about $43 million cost of third party CLO equity into the venture as well, so that already pre-levered if you will.

Jeffrey Talbert – Wesley Capital

Got it. So, the assets just simplistically would be about 490, you’ve about 330 of debt, 160 of equity. The 160 equity is approximately 87 of new money from the new investor that’s preferred and you’re subordinate for that. I’m just trying to get a sense of how the capital spend is?

Andrew Richardson

These are not all of our equity, but a majority of our equity is subordinate to a preferred return about half and I think that the important thing on the debt that term financing with no mark-to-market.

Jeffrey Talbert – Wesley Capital

Got it. Second question just quickly, the loan to values of first and last dollar of 26.6 and 79.7 that’s at origination and I assume that’s based on the original evaluations?

Richard McCready

It reflects the downward revision of assets that are underperforming…

Jeffrey Talbert – Wesley Capital

Okay.

Richard McCready

But, I can’t recall any upward revisions on value.

David Hamamoto

Basically, it’s lower of cost to market.

Jeffrey Talbert – Wesley Capital

Could you indicate that what percentage, if any over 90%, just I have a sense of that please?

Richard McCready

I would characterize and I don’t have the exact number in front of me, but all of our watch list assets are over 90%.

Jeffrey Talbert – Wesley Capital

Okay. Are there any others?

Richard McCready

There might be a couple of others, but I would be surprised if it was more than a couple.

Jeffrey Talbert – Wesley Capital

That that’s good to hear. One more quick question if I may, please. On subsequent events you indicate the Wakefield Capital Investments 10.5% preferred yield. What’s the, I don’t want to saw EBITDA number, but I guess the equivalent of AFFO number on that portfolio its net lease, so I assume whatever AFFO is pretty much net-net? What’s your net return on investment capital at this point on that portfolio? I’m trying to get a sense of leverage?

Richard McCready

As I said it was 12 pre, the transaction.

Jeffrey Talbert – Wesley Capital

Okay.

Richard McCready

So, if you just factor in the leverage from at 10.5, I think our remaining equity is probably earning 13.5 or 14.

Jeffrey Talbert – Wesley Capital

Got it. That’s exactly what I was trying to figure out. Thank you very much and good luck this quarter. I appreciate it.

Richard McCready

Thank you.

Operator

Thank you. Our next question comes from the line of Phil Wilhelm [ph] with Stark Investments. Please go ahead.

Phil Wilhelm – Stark Investments

Hey, guys. I had a question relating to your loan extensions within your existing portfolio. Are they tracking above the expectations, do you track them, do you track them as a percentage of the portfolio and just any other additional information on the refinancing market and your expectations with respect to the loans that are being extended?

Richard McCready

Yes, I think that the thing is really surprised us Phil, is the amount of repayments that we’re getting. I mean, I think we’re running the business assuming that everybody is going to extend to the absolute last face that they can and so we’re planning our liquidity assuming everyone extends till that…

Phil Wilhelm – Stark Investments

Right.

Richard McCready

As long as they can, but as Andy said, I think this year, we could have up to $200 million of repayments for the year and that’s all voluntary and so, I think again that ties into the comment that I made before about the nature of our asset and the fact that these are transitional asset when values created as part of the business plan, there is still an ability to refinance or sell at a profit, which is what’s driving those early repayments.

Phil Wilhelm – Stark Investments

Okay that answers my question. Thank you.

Operator

Thank you. (Operator instructions) And at this time, there are no additional questions. I would like to turn it back to management for any closing remarks.

Richard McCready

No. Thank you very much.

Operator

Thank you, ladies and gentlemen. This concludes our conference for today. AT&T would like to thank you for your participation. If you would like to listen to a replay of today’s conference please dial 1-800-405-2236 or 303-590-3000 using the access code of 11117035. Thank you very much and have a pleasant day.

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Source: NorthStar Realty Finance Corp. Q2 2008 Earnings Call Transcript
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