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Executives

Andres Viroslav - VP

Scott Schaeffer - CEO

Jim Sebra - CFO

Analysts

Gabe Poggi - FBR

Brian Gonick - Sunvest

John Evans - Edmund Wade and Partners

RAIT Financial Trust (RAS) Q3 2012 Earnings Call October 25, 2012 9:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the Q3 2012 RAIT Financial Trust Earnings Conference Call. My name is Catherine and I will be your operator for today.

At this time all participants are in listen-only mode. We will be conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Andres Viroslav, Vice President. Please proceed sir.

Andres Viroslav

Thank you Catherine and good morning to everyone. Thank you for joining us today to review RAIT Financial Trust third quarter 2012 financial results. On the call with me today are Scott Schaeffer, Chief Executive Officer and Jim Sebra, RAIT’s Chief Financial Officer.

This morning’s call is being webcast on our website at www.raitft.com. There will be a replay of the call available via webcast on our website and telephonically beginning at approximately 11.00 AM Eastern Time today. The dial in for the replay is 888-286-8010 with a confirmation code of 337-322-73

Before I turn the call over to Scott, I would like to remind everyone that there may be forward-looking statements made in this call. These forward-looking statements reflect RAIT’s current views with respect to future events and financial performance.

Actual results could differ substantially and materially from what RAIT has projected. Such statements are made in good faith pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Please refer to RAIT’s press release and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations.

Participants may discuss non-GAAP financial measures in this call. A copy of RAIT’s press release containing financial information, other statistical information and a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure is attached to RAIT’s most recent current report on Form 8-K available at RAIT’s website, www.raitft.com under Investor Relations.

RAIT’s other SEC filings are also available through this link. RAIT does not undertake to update forward-looking statements in this call or with respect to matter described herein, except as may be required by law.

Now, I’d like to turn the call over to RAIT’s Chief Executive Officer, Scott Schaeffer. Scott?

Scott Schaeffer

Thanks Andres and thanks to all of you for joining our call today. We are pleased to report another strong quarter at RAIT. The hard work and effort we’ve put forward focusing on our core business is clearly paying off. Revenues increased across all three categories this quarter, interest income, rental income and fee income all increased driven primarily by the expansion of our core lending businesses and continued growth of our rental revenue. Operating expenses as a whole remained flat during the quarter resulting in a 57% increase in operating income on a linked quarter basis.

As discussed on previous calls, our interest expense continues to declines as hedged burn off. We remain match funded because we are increasing the number of floating rate loans in the portfolio and as a result, we don't need to replace the interest rate hedges when they expire. We saved $300,000 in the third quarter and expect to save an additional $250,000 in the fourth quarter as existing hedges burn off. We estimate an additional $3 million in hedge cost savings during 2013.

The bottom line impact of these results is that AFFO rose to $0.30 per share and operating income jumped to 9.4 million for the third quarter. These increases were directly attributable to the progress we made originating and securitizing CMBS loans from receiving a full quarter of interest income on the loans we funded during the second quarter and from further reductions in interest expense. As a result of this progress, RAIT’s board recently announced our second quarterly common dividend increase of 2012.we remain focused on delivering a consisting and steadily growing dividend to RAIT shareholders as we continue to accretably deploy capital into our core businesses.

Jim will go through the numbers shortly, but I’d like to take a moment to discuss the recently announced $100 million capital commitment from Almanac Realty Investors. We recognized the need to identify a new capital to help us continue the positive forward momentum in our lending businesses. We've made good progress towards obtaining this capital. We secured two warehouse facilities to fund our CMBS lending initiatives and we're actively exploring other similar initiatives for our bridge lending businesses. We have also begun to partner with banks who are interested in participating in our pipeline of bridge loans. As previously reported, Almanac Realty committed to purchase $100 million of newly issued securities. We are excited to have this relationship with such a well-respected and capable partners Almanac. The commitment is structured so that RAIT can draw funds as needed, over two year periods so that the capital isn't dilutive to earnings. We will use the proceeds to fund all of our lending businesses and fully expect this capital to be accretive to our common shareholders as we close themselves CMBS loans and close and lever bridge loans.

When we deploy capital in our lending businesses, we target returns in excess of 20% well in excess of the 7.5% current cost of the Almanac capital. At this point, I’d like to turn the call over to Jim to go through the financial results. Jim?

Jim Sebra

Thank you Scott. The third quarter was a good quarter for RAIT. AFFO increased 30% to $0.30 per diluted share up from $0.23 in the third quarter of 2011. Let`s spend a little time on the numbers and the drivers of our business.

As Scott discussed, all three categories of our revenue were up on a linked quarter basis. Interest income grew by $1.6 million or 6% quarter to quarter as year-to-date loan production reached $285 million of which $31 for the [Audio Disturbance] and are seeing occupancy increases in our office and retail properties. Lastly, seeing other income is up 73% or $1.5 million as a result of our securitizing $36 million of CMBS conduit loans resulting in $2.1 million of profit that is included as part of fee and other income.

With respect to our expenses, most expenses are in line with our expectations and historical levels. A couple items as note. First, interest expense is down sequentially due to lower hedge costs in our CRE CDOs of $300,000 and lower interest cost on $25 million of subordinated debt that flipped from a fixed rate to a floating rate of interest during the third quarter. We expect that our CRE hedge cost will decline by an additional $250,000 in the fourth quarter as compared to the third quarter. For the full year of 2013, we are expecting additional savings in our interest rate hedge cost associated with our CRE CDOs of approximately $3 million as these hedges continue to burn off or amortize.

Second, property operating expenses increased by $800,000 as the two properties we acquired in May 2012 were owned for a full quarter. Property NOI was $12.2 million for the third quarter while NOI increased by $100,000 on a linked quarter basis, it has increased by $3.1 million since the third quarter of 2011 or a 34% increase. That increase equates to $12 million of additional NOI on an annual basis.

Combined compensation and administrative expenses are consistent as a percentage of revenue and are running at approximately 16%. We expect some modest increase in these expenses as we continue to hire the personnel necessary to grow our business.

From a credit standpoint, we continue to see stability in our loan portfolio. Non-accrual loans decreased slightly to $70 million or 6.8% of our portfolio. We continue to maintain loan loss reserves at approximately 47% of our non-accrual loan and believe that we are adequately reserved for any potential future losses.

We reported a GAAP net loss for the third quarter of $18.4 million or $0.37 per diluted share. As with the prior quarters, the GAAP net loss was attributable to continued negative changes in the fair value of our various financial instruments.

Please remember that the changes in the fair value of our financial instruments relates to our consolidated (inaudible) securitizations and our non-cash. As such, we believe that our presentation and discussion of AFFO is more indicative of our financial performance.

As of September 30th, we continue to maintain good liquidity on capital available for investment. We ended the quarter with $40 million of cash on hand and $291 million of capital available for investment. As Scott mentioned, in October of 2012, we closed on a $100 million capital commitment from (inaudible) Almanac Realty and as such, our capital available for investment has increased to $391 million.

During 2012, we introduced adjusted book value or ABV to help investor’s management’s view book value. Scheduled two of our press release, reconciles our GAAP book value to ABV. Our ABV at September 30th was $6.65.

Finally, in September, we declared a dividend of $0.09 per common share. This declaration represented a second increase in our common dividend during 2012 or a 50% increase since last year.

Scott this concludes the financial report. Back to you.

Scott Schaeffer

Thanks Jim. Operator at this time, I think we want to open up the call for questions.

Question-and-Answer Session

Operator

Thank you Scott. (Operator Instructions). And your first question comes from the line of Gabe Poggi from FBR. Please proceed.

Gabe Poggi - FBR

A few questions. Scott I was hoping you could provide a little more color around the program, the bank participation program. I noted that in the 2Q conference call and you mentioned today you are working on some things, is there any incremental color you have there would be helpful. Second question is, you guys are obviously having a lot of success in the CMBS market contributing loans to conduits. Can you give me a sense of if you’re working with the kind of diversity of different conduits or you have kind of one or two key relationships there because obviously the CMBS market is opened back up materially here in the back half of the year.

And then lastly Jim, you may have said this and if you did I apologize, can you just give me the breakout of the 391 million now of capital available between cash and lines etcetera just so I have the different buckets to where that 391 is

Scott Schaeffer

I'll start with the CMBS question. The two warehouse lines that we have are with one is with Barclays and one is with Citi and we have been securitizing loans through their programs. We like that strategy because it appears at least for the time being that they are each coming to the market with deals every other month, so it allows us to have good velocity in turning our loans. We’re not carrying them on our balance sheet for very long. But so far, it’s just those two partners and those are the partners that provide the warehousing to us.

As far as the bank program goes, we have been working to establish relationships with the banks who would participate with us on the bridge lending. I am sure you recognize that banks are hungry for loans. We've had good success. We have five or six banks that have expressed a strong interest in doing this program with us. It's now incumbent upon us to generate the loans that they will participate and of course the second quarter we were slightly, the third quarter we were slightly capital constrained because we were fully invested through our CDOs at the end of the second quarter and the new capital that we discussed for that moment that didn’t come in until the very beginning of the fourth quarter.

So we have been busy building up a pipeline but of course we didn’t want to get out ahead of ourselves because we are still going to need you know 25% or 30% equity for each of these loans that we fund under this program. But now that we have the capital it's full speed ahead and again we are very pleased with the response we received from the banks that we are working with.

Gabe Poggi - FBR

Before you entered the question Scott can I follow-up on that real quick, can you just give me I think I ask this every quarter but can you, the world is obviously changing rapidly quarter to quarter, QE3 is now implemented, have you guys seen any major delta between where you guys can originate those bridge loans or kind of just take a step back. What has the ROE profile changed either in the CMBS world, what you guys are doing there that velocity turnover or where you guys can put out bridge money.

Scott Schaeffer

No we really haven’t seen much of a change, it's still, there is a very healthy spread and on the bridge product you know as we all know that we are doing smaller, floating rate loans. We are still seeing pricing in the 6.5% to 7% range, you know for these assets that have a modest amount of transition associated with them and the banks are you know in the 3.5% range. So there is a good healthy spread and which all equates to a 20% give or take yield on our residual subordinated piece and on the CMBS side, spreads have come in little bit on the origination side but it's because the spreads have come in you know on the securitization pricing as well and so we are seeing similar margins and again we are playing in smaller loans where there is just less competition and that allows us maybe to have slightly better margins than would be available if we were playing in a larger loan area with more competition.

Jim Sebra

And gave on the capital available for investments is 391 million, it's made up of about $41 million of cash at the end of the quarter, 250 million available on the warehouse line and a 100 million capital commitment from Almanac. Let me just add one thing there Gabe which is that we securitized the most recent pool of loans right near the end of the third quarter and that’s why the lines were all paid back.

Operator

Thank you. Your next question comes from the line of (inaudible). Please go ahead.

Unidentified Analyst

Just in terms of the Almanac investment after completing the first drawn down on that capital, do you expect deploy those proceeds fairly quickly by the end of the year, meaning you where their target investments that you had lined up before you drew down those proceeds.

Scott Schaeffer

Yes absolutely, there is targeted investments that we have lined up to deploy before the third week of November and that’s why we drew the money. Again this was structured so that we wouldn’t be sitting on capital that would be dilutive to our common shareholders, so we drew it so that we knew we had it and we are in the process of closing loans using that capital.

Unidentified Analyst

Great and then going forward if it's safe to assume future drawdowns will be then used to match fund investments as they come along.

Scott Schaeffer

Yes that’s the program.

Unidentified Analyst

Switching gears a little bit on the multi-family occupancy was down a 100 basis points sequentially, any color on that, you mentioned you’re trying to push around some more, in that asset class, did occupancy take a hit because of those rent increases.

Scott Schaeffer

We are pushing rents and that’s all that’s always a balance between pushing rents and occupancy. So we do think that had some effect on the slight decline in occupancy. However the third quarter seasonally is typically a little softer than the other three quarters of the year. So we are not at all alarmed about it, there is still a strong demand for multi-family properties and notwithstanding the uptick in home ownership, from what we have seen that really has impacted the A-Plus properties and ours are mostly B-Plus to A-minus and we expect occupancies to remain strong in the 90% and then we still believe we will be able to push rents are going forward.

Unidentified Analyst

Great and then finally just on the CMBS securitization loans, as Gabe mentioned that the new issue markets picked up a little bit and you guys have talked about your large pipeline of those deals. Are you comfortable kind of you did 36 million of securitization on the third quarter, is that a good run-rate going forward? You mentioned kind of Barclays and Citi are kind of alternating a deal a quarter, what do you think it's a good run-rate in terms of your securitization volume targets on a quarter basis.

Scott Schaeffer

I think we are still ramping and we are still relatively new entrant to this field and that the run-rate should be three times that going forward for the year 2013.

Operator

Thank you. The next question comes from the line of Brian Gonick from Sunvest. Please go ahead Brian.

Brian Gonick - Sunvest

So if you made 2 million in change on 36 million of you sold is that kind of point level is going to be substantial for a while do you think?

Scott Schaeffer

Well you know the market adjust daily Brian. There was some tightening of spreads on the issuance side, the securitization side during the third quarter and we benefited from that because we were securitizing loans that had been originated prior to that period. However we still believe that in the space that we play that we are in a 3 to 4 point area and you lever that you know three times you get to the 10%-12% gains on each loan. So that’s kind of where we think it will stay for a while and again it's because we are doing smaller loans but there is less competition.

Brian Gonick - Sunvest

Can you talk about little bit about IRT and how things are going there and what are your expectations for next year?

Scott Schaeffer

Things are going slow, we are continuing to sign up broker dealers, there is clearly some head wins in the industry as a whole, you know there has been drum beat of negative news which has affected us and many others but we still believe that we have a viable a program and a good strategy and we are moving forward. We have only been at the signing up of broker dealers process for a year and again if you look back at other groups that have been successful in this space it's always takes two years plus until you really start to see the volume increase.

Again we believe in the program, we are sticking with it, we are doing it in a way that we believe is cost effective, so tis not really hurting rates bottom-line but it's slower than what we had hoped for.

Brian Gonick - Sunvest

In your investor presentation you provide some 2012 and 2013 expectations for cash flow and I think one of the key assumptions in that presentation is that there was no incremental capital put to work. Now that you got this 100 million facility from Almanac as well as the warehouse lines. Are you going to adjust what you’re thinking is for 2013 now?

Scott Schaeffer

We will and that will included in the next version of the presentation that I will come out in a couple of weeks.

Brian Gonick - Sunvest

Is there any way you can tell us sort of an apples to apples basis, what the Q3 cash flow per share?

Jim Sebra

Sure I mean the cash flow per share that’s you know that would be increasing the amount of related to the amount of dividend that we are declaring here was kind of give or take roughly $0.14, $0.15 a share because as we all know the earnings of the (inaudible) securitization is used to delever that portfolio or delever that debt. So the cash flow per common share would be closer to $0.14, $0.15.

Brian Gonick - Sunvest

And what does that kind of imply given the range you have got for 2012 of $0.48 to $0.63 in the last presentation. What did that imply for Q4? What’s the range on Q4 cash flow per share?

Jim Sebra

We expect Q4 to be in the same range.

Brian Gonick - Sunvest

So comparable to Q3.

Jim Sebra

Comparable to Q3, correct.

Brian Gonick - Sunvest

So you’re paying out $0.09 on say $0.15 roughly 60% as a payout ratio. Is that ratio you know sort of what we expect to continue to payout and cash flow goes higher therefore our dividend will go higher?

Jim Sebra

Yes that’s a fair assumption Brian and I will tell you that as we put the new capital to work I expect the cash flow to increase. So the fourth quarter you know we’re only three weeks into it, we haven’t closed any loans yet in the fourth quarter although the pipeline is very full of signed up deals and they will start closing I think as early as late next week right through the end of the year, so I would not be surprised at all for the cash flow for the fourth quarter is slightly ahead of where we were for the fourth quarter.

Brian Gonick - Sunvest

So looking at what you’re previously had for 2013, the mid-point of the range is about $0.95 and given that we have more capital to put to work now let’s say you make a buck in cash flow, paid out 60% ratio that would imply $0.60 dividend next year.

Jim Sebra

Yes it would.

Operator

Thank you. Your next question comes from the line of John Evans from Edmund Wade and Partners. Please proceed.

John Evans - Edmund Wade and Partners

Can you just talk a little bit about I guess your thoughts of leverage overtime and how much leverage that you think, what’s the leverage ratio that you’re comfortable with and potentially when you need more equity, can you help us understand that?

Scott Schaeffer

Well on the loans that we are originating for sale, the leverage that we are using there is 75%. On the loans that we are holding on our balance sheet, the bridge loans because the pricing is a little bit more advantages. We are targeting 50% leverage and on the bank participation program the way that shapes out is that we would for example we would originate a 75% loan, let’s say just for the math, let’s say a 70% loan and if the bank comes in and buys 70% of our loan there is 50% leverage against the property which is where they want to be and then we would be left with a subordinated debt piece that is 30% of the loan.

John Evans - Edmund Wade and Partners

Yeah got it and then makes a lot of sense and then the last question I have for you relative to the convert, if it goes through the strike can you, is there like if it trades above the stride for so many days do you have the ability to force conversion or can you not do that until ’16 because obviously that changes your leverage ratio if that turns to equity.

Scott Schaeffer

I believe that we cannot, that it goes until ’16 but we can confirm that and get back to you.

Operator

Thank you. I would now like to turn the call over to Scott Schaeffer for closing remarks.

Scott Schaeffer

Well thank you. In summary I just want to say that RAIT is a full service real estate company with the scalable platform that supports commercial real estate lending and direct commercial real estate ownership. We believe that these asset classes are complimentary and provide a balanced approach to investing in commercial real estate and we remain focused on growth and we will put our capital to work across all of these business lines.

We look forward to sharing our progress with you next quarter and thanks for joining our call today and for your continued interest in RAIT.

Operator

Thank you for joining in today’s conference. This concludes the presentation. You may now disconnect and have a good day.

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