Centerline Holding Company Q2 2008 Earnings Call Transcript

Centerline Holding Company (CHC)

Q2 2008 Earnings Call

August 7, 2008 10:00 am ET

Executives

Marc D. Schnitzer - President, Chief Executive Officer, Managing Trustee

Robert L. Levy - Chief Financial Officer

Analysts

Howard Blum - UBS Financial Services

Manny Pearlman - Liberation Investments

Presentation

Operator

Welcome to the Centerline Holding Company second quarter earnings conference call. (Operator Instructions) The company’s press release and supplemental financial package were issued this morning.

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

Centerline Holding Company urges you to review its Form 10K and 10Q on file with the Securities and Exchange Commission for a discussion of such factors and uncertainties and the risks related to an investment in the company. Centerline Holding Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained in the press release, supplemental financial package or today’s call to reflect any change in the company’s expectations with regard thereto or change in events, conditions or circumstances on which any such statement is based.

With us today from the company are Marc Schnitzer, Chief Executive Officer and President, and Rob Levy, Chief Financial Officer. At this time I would like to turn the call over to Mr. Marc Schnitzer.

Marc D. Schnitzer

We want to thank you for joining us for our second quarter 2008 earnings call. I hope you’ve all had a chance to review our earnings release by now.

I’d like to emphasize two main points this morning. First, our stock performance does not reflect our business performance which continues to be solid. Second, we are committed to delivering long-term shareholder value by increasing our assets under management and ensuring their continued performance.

What I will address in this call are the current limitations in our various businesses and the opportunities. After I discuss what those are, Rob Levy our CFO will go over the [inaudible].

First I would like to take a moment to explain our business model since the beginning of 2008. Centerline is a real estate focused alternative asset manager. Alternative asset management involves managing assets on behalf of third parties in exchange for contracted fees and other income. Traditional asset managers manage portfolios for a contracted fee based on the amount of the assets without regard to the performance of the assets. Alternative asset managers apply investment strategies with the goal of delivering investment performance measured by how well the assets perform. Our growth is based on increasing our revenues and assets under management and delivering superior performance for our investors. We now have over $14.2 billion of assets under management.

Because we started in the affordable housing industry 35 years ago and transitioned to alternative asset management over the past few years, over $9 billion of the assets we manage comprise low income housing tax credit equity funds. The major portion of tax credit fund fees are paid up front when the fund closes with a modest asset management fee over the 15-year holding period and generally are not based on fund performance.

As we grow assets under management in our other fund products, we will develop greater reward opportunity for superior performance.

Our overall message this quarter is a stronger reiteration of our message last quarter. The market remains volatile and challenging. We cannot predict when the credit crisis will end. We can only say that we believe it will end. And we believe that our company is sufficiently strong to continue our business growth through the downturn. We will continue to evaluate and adjust our cost structure as necessary to ensure that it reflects our business expectations.

The credit quality of our assets is strong. As of June 30 we were the named special servicer for $117 billion of commercial real estate loans with only about 10% on our watch list. Of that 10% only $302 million was delinquent as of June 30 representing just 26 basis points on the portfolio. While we expect delinquencies to rise modestly in the CMBS funds we manage for our investors, we are still well below the industry average of 49 basis points.

Both our fund and loan portfolios contribute earnings we can count on, revenue streams that are contractual and recurring in nature. We believe that there is value in the equity of our company and value in the future of our company regardless of what our stock price may be from day-to-day. There is a psychology to the stock market we cannot escape. Bad news drives many investors to sell, and selling or buying drives asset valuation. We believe our stock price is driven more by broader market issues than by our individual business performance, the real value of our company or its future prospects.

At the end of last year we took defensive action to withstand the market turbulence we anticipated this year when we delevered our balance sheet through the resecuritization of our bond portfolio with Freddie Mac.

In the second quarter of this year, we took decisive action to increase our assets under management by forming an agreement with Nomura Credit & Capital to act as collateral manager of two CDOs comprising over $1.7 billion of commercial real estate loans, all reviewed and approved by Centerline. The equity interest in these CDOs valued at $270 million as well as below investment grade securities are owned by [Cress] an investment fund we manage. With the CDO agreement we added a seasoned team of 14 real estate professionals from Nomura to manage the new assets. We also continued to manage loans worth over $0.75 billion for Nomura that remain on its balance sheet.

We have restructured one of our two core business groups the commercial real estate group into two divisions, commercial and CMBS products and agency lending products, enabling us to designate specialized expertise toward these two product lines.

Our agency products division is having a great year. In the second quarter we generated over $324 million of first mortgage loans on behalf of Fannie Mae and Freddie Mac amounting to $557 million of loan volume for the first half of the year compared to $434 million for the first half of 2007. With conduit lending all but nonexistent in the current market, our agency lending business has made up the difference. We expect volume in 2008 to significantly exceed our total of $962 million for 2007.

Our other core business is affordable housing managed by the Affordable Housing Group. The tax credit equity side of the affordable housing industry remains impacted by the withdrawal of several large traditional investors from the market including Fannie Mae and Freddie Mac. Accordingly we have adjusted our anticipated fund raising volume downward to $660 million for the year as compared to $1.2 billion completed last year.

The good news is that while certain investors have reduced their activity, we have seen many new investors enter the market in 2008 due to increased yields. In addition, our fees on completed deals have increased from recent levels as fewer firms compete for the tax credits.

The recently passed Housing and Economic Recovery Act of 2008 contains numerous provisions designed to enhance the value and efficiency of low income housing tax credits. We believe that these provisions will help reinvigorate investor demand for affordable housing tax credit funds during the balance of 2008 and onward.

Our direct tax exempt bond origination business remains dormant due more to market liquidity issues than deals in need of tax exempt financing which further contributes to the strength of our agency business as deal flow has shifted towards agency lending.

As I mentioned earlier, the portfolio management group which handles the special servicing for our $117 billion CMBS portfolio maintains the excellent credit quality of those assets and our loan defaults are still well below the rest of the industry.

Our fourth business group credit risk products continues to pursue two business lines, investments and syndicated corporate loans and through Centerline Financial LLC AAA rated credit support for affordable housing, debt and equity transactions.

Before I turn this call over to Rob, I’d like to reiterate the two main points I started with. Our stock performance does not reflect our business performance, and we are committed to delivering long-term shareholder value by increasing our assets under management and ensuring their continued strong performance.

Thank you, and I’ll turn it over to Rob Levy our CFO.

Robert L. Levy

Before I begin I would like to remind you that all the earnings, revenue and other financial numbers that I’m going to discuss in this morning’s conference call have been adjusted to exclude consolidated partnerships. Please refer to the as adjusted column on the income statement and balance sheet of our quarterly supplemental posted on our website for additional details.

First, I’d like to update you on our balance sheet and our liquidity position. Second, I will talk about our operating cash flows and our shareholders’ equity. And then I’ll go into detail on our financial highlights including our earnings, revenues and expenses for the second quarter of 2008.

We continue to be focused on further deleveraging Centerline’s balance sheet while maintaining adequate levels of liquidity to fund ongoing operations. As a result of our continued term loan amortization at June 30, 2008 we had $473 million of debt outstanding equating to a 25.2% ratio of debt to total assets as compared to 25.8% at December 31. This includes $320 million in debt associated with our term loan and revolver with the remainder from asset specific borrowings. We expect our debt to total assets ratio to continue to decline into the low 20s by year end as we further delever.

Now let’s talk about the company’s upcoming capital commitments. During August our syndicated corporate debt warehouse line will be paid off from the sale of the associated assets on the balance sheet. As of June 30 we had $17 million outstanding on that facility. In addition, on August 31 we have a $33 million payment due on our term loan bringing it down to $75 million. In the fourth quarter we will be required to pay off the remaining $75 million of our term loan and refinance our commercial real estate repurchase facility which had $31 million outstanding as of June 30.

To meet these obligations we expect to utilize a combination of operating cash flow, existing liquidity in our other facilities, execution of new facilities, strategic asset sales such as our syndicated corporate debt, and certain bonds on the balance sheet as well as the monetization of the Freddie Mac B certificates. Management believes that we will be able to meet these obligations while maintaining a level of liquidity that will allow us to effectively run our current operations.

As of today we have approximately $50 million of total liquidity on the balance sheet including non-restricted cash and availability on our corporate revolver.

One other balance sheet item we should note is the significant decline in shareholders’ equity during 2008. This decline was primarily due to a decline in the marks on CMBS investments held by the funds we manage resulting in significant unrealized losses at the fund level. Our GAAP equity has been negatively impacted by approximately $260 million in 2008 due to these marks. We continue to believe these losses are temporary as we have the intent and ability to hold these investments to maturity.

In addition, most of these investments are term financed within their funds. As you know we are required to consolidate these funds on our balance sheet. As the marks on these investments declined to a level where equity at the funds was below zero, we were required to absorb 100% of excess valuation declines in our shareholders’ equity. You can see the impact in our supplemental on page 6 by comparing the as reported and as adjusted amounts which primarily reflects the unrealized losses on the investments in our consolidated partnership absorbed by us due to our consolidation of the funds.

Even if the losses were to ultimately be realized by the funds, we would absorb a smaller amount than currently impacting our balance sheet equating to the portion of the losses corresponding to our co-investment amount which is typically 5%.

Let me now turn to operating cash flows. Year-to-date through June 30, 2008 we generated positive operating cash flow of $3.6 million. Even in a very difficult market with significantly reduced new business activity, our company remains cash flow positive. This is primarily due to the ongoing fees generated through our asset management and servicing operations, through our co-investments in our funds, our investments in the Freddie Mac B piece, and other on-balance sheet assets.

We continually analyze our operations to understand our cash position and our ongoing liquidity. Our analysis shows that even if we originate significantly reduced business volume through the remainder of 2008, our company remains cash flow positive.

Now I’d like to discuss our results of operations. With regard to our adjusted earnings per share for the three months ended June 30, 2008 Centerline reported a loss of $0.14 per share. Adjusted net loss excluding certain non-cash items was $0.18 per share. The primary drivers of the non-cash items are detailed on page 5 of our second quarter supplemental financial package.

Our earnings were lower than anticipated this quarter primarily due to reduced business volume as a result of the unfavorable market conditions and impairment charges of $13.4 million as a result of an updated valuation of our Freddie Mac B piece and $4.1 million of impairments for tax exempt bonds not included in last year’s resecuritization transaction.

Centerline’s revenues were down in the second quarter versus the same period last year but in line with the first quarter of 2008 which is a more relevant comparison due to the impact of the bond resecuritization in December 2007.

Total expenses were down significantly in the second quarter from previous quarters.

Interest expense declined 78.8% for the second quarter versus the comparable period in 2007 and 77.1% versus the first quarter of 2008. The decline in interest expense reflects the lower amount of average debt outstanding as a result of the December resecuritization and lower levels of corporate debt. The second quarter decrease also reflects non-cash income of over $15 million from the change in value of free-standing derivatives. If we adjust the 2008 first and second quarter interest expense numbers for the impact of free-standing derivatives, interest expense is comparable quarter-to-quarter.

Similarly general and administrative expenses were consistent in the first and second quarters of 2008 at about $43 million.

Before I open the call to questions, I would like to reiterate that we temporarily discontinued giving earnings guidance due to the unprecedented market volatility. We will resume giving earnings guidance only after the market stabilizes so that we can give a more reliable earnings projection.

At this point I would like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Howard Blum - UBS Financial Services.

Howard Blum - UBS Financial Services

Last conference call I asked a question about whether your projections included the continuation of dividend payments and you said that the model did anticipate that. Has that changed? I know you did reduce the amount of the dividend after the conference call last time but does the model that you’re using and the free cash flow you’re projecting still allow you to anticipate continued dividends?

Robert L. Levy

Our current model does assume that we continue to pay dividends but I think as we noted in the past that it is of course in the hands of the Board to make that decision. But yes our current model does assume a dividend level.

Operator

Our next question comes from Manny Pearlman - Liberation Investments.

Manny Pearlman - Liberation Investments

Can you walk us through the amortization on your term loan I believe that’s existing, and maybe a little bit more color on some of your larger on-balance sheet assets like the B piece from the Freddie Mac deal and what kind of valuations are on our books currently?

Robert L. Levy

The amortization on the term loan, we have a $33 million required payment on August 31, we have a $25 million required payment on October 31, and then we have a $50 million payment at year end, at the one year anniversary of the execution of the facility.

Manny Pearlman - Liberation Investments

At the end of that period will that extinguish the term loan?

Robert L. Levy

Yes, that would because that would pay it down to zero.

Manny Pearlman - Liberation Investments

Are you anticipating just trying to amortize it out or are you anticipating trying to refinance it?

Robert L. Levy

We are currently anticipating through asset sales and through financings against existing assets on the balance sheet to pay it down to zero at year end.

Manny Pearlman - Liberation Investments

And you anticipate being able to do that currently?

Robert L. Levy

That is our current anticipation.

Manny Pearlman - Liberation Investments

Could you talk a little bit about some of the, like the Freddie Mac B piece, some of the larger assets that may be on your books that you could either use to finance against or sell?

Robert L. Levy

There are a number of bonds on the balance sheet which we are in the market to sell as of today. In fact we anticipate something happening relatively shortly on a couple of those bonds with proceeds in the $22 million range. We also have as you mentioned the B certificates which we currently value at just north of $200 million. We are in the market with various parties to either finance that or sell a portion of it. We are at this point probably the best way to put it is relatively confident that one of those executions are available to us and will come to fruition. But certainly in this market place there’s always a risk to execution. We have some very interested parties and are moving forward on that front. Thos are probably the two largest pieces as far as assets go and as far as proceeds from assets sales or financings to pay down the term loan.

Manny Pearlman - Liberation Investments

In regard to the Freddie Mac B piece, have you had data available to you that are able to track how the loans that you had sold or securitized with Freddie Mac are performing? Are they performing in line with what you thought or has there been any denigration of that?

Robert L. Levy

Actually Manny, since we are both the primary and special servicer still for the whole portfolio we are as familiar with them as we ever were. And in fact the performance is somewhat better than we had projected. You may recall that at the time of the transaction we set aside a stabilization escrow of approximately $125 million that on a quarterly basis is released to us predicated on the performance of the properties with respect to construction completion and stabilization. And over the course of the first two quarters the releases from that escrow have been ahead of our projections. So the stabilized projects continue to maintain their occupancies and the non-stabilized properties are actually behaving slightly ahead of projections.

Manny Pearlman - Liberation Investments

How much is left in that escrow?

Robert L. Levy

Let me just add to that. The escrow was originally funded to about $126 million. We have released to date about $36 million.

Marc D. Schnitzer

We have about $90 million still in the escrow.

Manny Pearlman - Liberation Investments

Is there an out date upon which it would get fully released?

Marc D. Schnitzer

Five years.

Robert L. Levy

Yes. Over a five-year period. And I should have added when you were asking about repayment of the term loan that the proceeds from that through the remainder of this year will also be used to pay down the term facility.

Marc D. Schnitzer

The proceeds from those releases.

Manny Pearlman - Liberation Investments

So in theory we have on our books about $290 million of assets just related to the Freddie Mac transaction, meaning the B piece is $200 and $90 million of the escrow, is that correct?

Robert L. Levy

That’s correct.

Manny Pearlman - Liberation Investments

And then how much is the actual term debt that’s left? I’m sorry, I didn’t add up all those numbers as you went through them.

Robert L. Levy

It’s $108 million and change. $108.5 million.

Manny Pearlman - Liberation Investments

Just from those assets alone we probably have in excess, assuming everything’s correctly marked on our balance sheet, about $180 million of equity just there alone?

Robert L. Levy

That’s correct.

Operator

Ladies and Gentlemen, that does conclude today’s question session.

Marc D. Schnitzer

We’d just like to say thank you to everyone for your continued interest, and we’ll keep working as hard as we can, and talk to you next quarter. Thank you.

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