Alesco Financial Inc. Q2 2008 Earnings Call Transcript

Alesco Financial Inc. (AFN)

Q2 2008 Earnings Call

August 6, 2008 10:00 am ET

Executives

James J. McEntee, III - President, Chief Executive Officer & Director

John J. Longino - Chief Financial Officer & Treasurer

Analysts

[Jack Ruben – DB Capital]

Jason Arnold – RBC Capital Markets

Kevin Mullen – RBC Capital Markets

Phil Dumas – Geode Capital

[Harry Zelnick – Private Investor]

[Robert Kyle – CSCM, Inc.]

Jeff Miller – JMG Capital

Arthur Burns – Deltek Associates

[Joseph Vagda - Private Investor]

Marc Berger – MKB Associates

[Robert Knapp – Ironside]

Allen Goldstein – Wachovia

Presentation

Operator

Welcome to Alesco Financial Inc. 2^nd quarter 2008 earnings conference call.

Before we begin Alesco Financial would like to remind everyone that information provided in its earnings release and during this call contains forward-looking statements which involve a number of risks and uncertainties. Alesco Financial cautions readers that any forward-looking information is not a guarantee of future performance and that actual results could differ materially from those contained or implied in the forward-looking information. Factors that may affect future results are contained in Alesco Financial’s filings with the SEC which are available at the SEC’s website at www.SEC.gov. (Operator Instructions)

I would now like to turn the call over to Jay McEntee, President and CEO.

James J. McEntee, III

Good morning everyone and thank you for joining us. Also representing the company with me today is John Longino, our Chief Financial Officer as well as several other members of the company’s management team. Today I would like to provide a brief update on the current business model and planned future strategy for Alesco Financial. Next I’ll provide an overview of our financial position and asset performance through the end of the second quarter of 2008, then I will hand it over to John Longino who will provide more details on our results for the second quarter.

As previously discussed a special committee of our Board of Directors has been investigating various strategic options and alternatives. We have considered a number of alternatives one of which was endorsed by management and the Committee. However we have not been able to effectuate this transaction on terms that we believe are in the best interests of shareholders. As a result we are continuing to consider a variety of transactions that may be available to us as well as reviewing a number of very attractive investment opportunities that exist right now. Although the turmoil in the financial services marketplace has had adverse consequences on us the fact is that it has also created many opportunities and we are considering several of them at the present time.

I will now provide a brief overview of our financial position and asset performance through the end of the second quarter of 2008. Our unrestricted cash balance increased to approximately $136 million during the quarter and remains at $120 million today after having paid the $15 million Q2 08 cash dividend on July 10^th. In addition we continue to have no short term recourse financing. Cash and liquidity positions remain very strong for our company. Significantly during the quarter after considerable effort and negotiation we completed a transaction which enabled us to realize gains on all of our open CDS positions by selling the subsidiary which held those positions to a third party. We view this as an important transaction for Alesco as we closed out our CDS positions in a very positive way and removed any counterparty and market risk related to the cash earned on these positions. Overall our cumulative net profit on our CDS positions has been approximately $90 million.

An item which has been discussed in some detail on recent calls is the ongoing viability of the Kleros Real Estate deals and their ability to provide re-qualifying income and assets. KRE III was liquidated during the quarter. However the remaining three KRE deals continue to generate re-qualifying income. Moreover we have now generated sufficient re-qualifying income for 2008 such that even if all three of the remaining deals were to liquidate we should be able to maintain REIT status to at least the end of 2008 without having to purchase significant additional re-qualifying assets. However management and the Board will continue to evaluate the advantages and disadvantages of Alesco continuing to operate as a REIT versus moving to a PTP or C Corp structure.

With respect to the bank portfolio we continue to experience significant challenges most notably the seizure of IndyMac Bank Corp by the OTS. The seizure of IndyMac resulted in AFN recording a tax loss of $86 million. While we have had no additional bank deferrals or defaults since then we continue to expect to see an increase in the number of problem banks being placed on the FDIC’s watch list and ultimately in bank deferrals and defaults as compared to historical levels. As of June 30 the aggregate principal amount of trust preferred securities in deferral was $282 million representing approximately 5.5% of AFN’s consolidated trust preferred securities portfolio and an aggregate of $4.5 million in quarterly interest payments to the eight CDOs in which AFN invests.

AFN’s proportionate share of the interest income is approximately $3.1 million or $0.05 per diluted common share per quarter. These deferrals resulted in overcollateralization failures in six of our eight TruPS CDOs. We currently expect three of the six affected CDOs to cure overcollateralization failures and recommence making equity distributions within three to six quarters while the other three may not cure from anywhere from 20 to 35 quarters. These estimates could change if there are additional deferrals. We continue to see no material credit issues in our insurance TruPS portfolio comprising $1.1 billion of our total assets and our middle market loan portfolio comprising $853 million of our total assets is also performing well.

With respect to the middle market loan business as of June 30 we had $170 million of middle market loan assets on a warehouse facility secured by $40 million of cash from AFN. This warehouse facility expires in May of 2009. The warehouse line is non-recourse to AFN beyond posted cash equity. It is not subject to margin calls and AFN has no liability with respect to this line beyond the posted cash collateral. We continue to believe that the middle market loans that have been acquired through our [inaudible] platform will provide an attractive return on investment for Alesco. The average borrower in our portfolio comprises .76% of the entire portfolio. Approximately 90% of our loans are senior secured first lien loans made to companies in over 30 different industry sectors.

In addition given the low cost of the debt in the structures holding these loans as repayments occur we expect to be able to replace existing loans with those of similar credit quality but with wider spreads. Going forward we remain positive about this business for both the mid and long term.

I will now turn the call over to John Longino, our Chief Financial Officer who will discuss the company’s financial results.

John J. Longino

For the second quarter of 2008 Alesco Financial reported a GAAP net loss of $81.2 million or $1.36 per diluted share based on 59.5 million weighted average shares outstanding as compared to GAAP net income of $84.9 million or $1.43 per diluted share based on 59.4 million weighted average shares outstanding for the first quarter. As I indicated on last quarter’s earnings call while the adoption of FAS 159 as of January 1^st, 2008 should significantly reduce the erratic swings previously recorded in our earnings and stockholder’s equity, there may continue to be volatility in our GAAP earnings each quarter related to changes in the fair values of assets and liabilities as these adjustments while largely correlative may not completely offset. To this end the GAAP net loss for the three months ended June 30, 2008 includes $44.7 million of non-cash net losses resulting from fair value adjustments on financial instruments net of minority interest allocations while GAAP net income for the three months ended March 31^st includes $72.7 million of non-cash net gains.

We have not reported adjusted earnings this quarter because it would include significant positive non-cash net interest income from the six CDOs that have failed overcollateralization tests and would not include realized tax losses on defaulted securities. Therefore it is not a meaningful measure of performance for the quarter. Also the realized IndyMac and KRE losses will significantly offset the non-cash income in determining our re-taxable income for the year. Net investment income which includes the amount earned by minority interest holders and excludes interest rate swap expense was $28 million for $0.47 per diluted share for the second quarter as compared to $26.5 million or $0.45 per diluted share in the first quarter. Net investment income for the second quarter net of interest rate swap expense was generated from the following sources, TruPS $17.2 million or $0.29 per share; middle market loans $4.7 million or $0.08 per share; residential mortgages was actually a loss of $5.1 million or $0.09 per share; and the Kleros Real Estate deals $2.2 million or $0.04 per share.

Also included in net investment income is interest expense of $3.9 million or $0.07 per share related to our $190 million of recourse indebtedness. Net investment income for the residential mortgage loan asset class and the leverage loans asset class include approximately $5.6 million and $2.3 million respectively of provisions for loan losses recorded during the three months ended June 30. Related party management compensation which is primarily asset management fees paid by the underlying CDOs declined to $4.2 million in the second quarter as compared to $4.7 million in the first quarter due to asset management fees being reduced as a result of deferring and defaulting securities in our TruPS CDOs. General and administrative costs for the second quarter remained flat with the first quarter at approximately $3.5 million.

As of June 30 our investment portfolio totaled approximately $6 billion including $3.2 billion of TruPS and subordinated debentures, $925 million in mortgage backed securities, $962 million in residential mortgages and $853 million of leveraged loans. Of the $5.8 billion of debt on our balance sheet at June 30 only $190 million is recourse to AFN consisting of $140 million of convertible bonds issued during the second quarter of 2007 and $50 million of TruPS debt. The $5.6 billion of non-recourse indebtedness consists of $4.4 million of CDO notes payable, $889 million of securitized mortgage debt, $222 million of trust preferred obligations and $131 million warehouse indebtedness.

GAAP book value at June 30 was $203.4 million or $3.41 per diluted share based on 59.6 million shares outstanding as compared to $258.1 million or $4.34 per share based on 49.5 million shares outstanding as of March 31^st. Given our adoption of FAS 159 book value determined in accordance with GAAP now reflects changes in the fair value of the assets and liabilities associated with our TruPS and MBS related instruments. Therefore we no longer believe that adjusted book value is a useful alternative measure for investors to consider.

At this point I’d like to turn the call back to Jay McEntee.

James J. McEntee, III

As previously discussed the realized tax losses that we have experienced during 2008 including those resulting from the failure of IndyMac are expected to significantly offset or eliminate our taxable income for the 2008 year precluding the requirement for additional dividend distributions to satisfy REIT requirements this year. Decisions regarding future dividends will continue to consider projections regarding our taxable income and are subject to the review and approval by our Board of Directors. The failure of IndyMac is indicative of the stress that the banking sector is under at the current time and is likely to be under for the foreseeable future. IndyMac’s failure has significantly impacted our portfolio, however as a result of our strong liquidity position we continue to believe that we have the ability to be patient and to manage through these difficult times.

Also we may not have yet seen the end of worsening conditions or the bottom of this market but we do believe there are solid investment opportunities available to us today and we intend to pursue these opportunities vigorously.

I would now like to ask the Operator to open the floor for questions.

Question-And-Answer Session

Operator

(Operator Instructions) Questions will be taken order received. As a reminder replay access code is 55802183 available for 15 days. Your first call comes from [Jack Ruben – DB Capital].

[Jack Ruben – DB Capital]

I’ve been studying AFN, I’ve been a shareholder for quite some time and I saw in there that there’s a trigger within your $140 million of convertible notes and within those notes is a trigger that if the control of AFN were to change outside of Cowen & Company that those notes would be due immediately. I was just wondering what was the purpose of putting that clause in there? It seems like it protects Cowen & Company but is not in the best interest of the shareholders.

James J. McEntee, III

The provision is in there not because AFN or Cowen asked for it. It was a market, I think is, a market based provision that you’ll tend to find in converts for externally managed companies of our size. There are a number of them out there, you can go out there and take a look. But it was at RBC’s insistence that that provision go in there, not at ours.

[Jack Ruben – DB Capital]

Secondly on the CDOs, is there any more detail you can provide as far as which of the TruPS CDOs is busted, how close the two remaining are to going over the edge? You obviously have purposely not provided information, if you could please tell us why you’re not providing that information.

John J. Longino

No, we’re not actually purposely not providing information about how the deals work. I do think we’ve suffered a number of deferrals throughout all of the transactions and all of the Alesco Trust Preferred deals are either in OC failure or hovering around. So additional bank deferrals will continue to have a shut off of the cash flow from those transactions. But I don’t think it’s fair to say we’re trying to hide that from anyone. The deferrals have a negative impact on these structures.

[Jack Ruben – DB Capital]

Can you tell us specifically which CDOs are still cash flowing?

John J. Longino

Right now Alesco 11 and 17 continue to cash flow.

Operator

Your next call comes from Jason Arnold – RBC Capital Markets.

Jason Arnold – RBC Capital Markets

Quick question on your expectations for cash earnings going forward? I know that you guys have consolidated net interest income that you will be reporting given some of the GAAP rules, but I’m curious about cash earnings and maybe specifically cash earnings on TruPS that you would expect to see going forward assuming that Alesco 11 and 17 still are cash flowing?

John J. Longino

With respect to the current deals that are OC tests, that’s an impact of $8 million per quarter negative on our cash flow. The other assets are continuing to provide, if you looked at the net investment income that approximates cash other than the deals that are in the OC trigger. So it’s about $8 million per quarter. Now if some of those deals come back then we get more cash. If the other two deals that are currently flowing were to trip then it’s about $2 million more that could go based on those other two deals.

Jason Arnold – RBC Capital Markets

I was wondering if you could also, I think you mentioned that you were looking for about $86 million of losses on IndyMac. Is that inclusive of, and I don’t know but you can maybe update me, does that include some of the additional TruPS deferrals and maybe losses expected there or is that exclusively IndyMac? To what degree would you expect taxable earnings to be offset? Would it be, I know you said through the end of 2008 it would be beyond at this point or was that just a rough estimate?

James J. McEntee, III

There’s a number of factors there but with respect to the $85 million first of all, that is the realized tax loss specifically related to IndyMac and that’s our share effectively across all the deals that IndyMac was in. Then there are other tax losses relative to other investments that we had that have gone bad but then there’s also various gains as you know for CDS positions, etc. So there’s a lot of factors that are going to impact or could impact re-taxable income through the end of the year and into 2009. Depending upon what we do over the next several months, there could be positive impact or negative impact on our re-taxable - what is currently a re-taxable loss.

Jason Arnold – RBC Capital Markets

Actually on that note perhaps you could give us a little bit more color on what you would expect to have to pay out on a tax basis on the gains on the credit default swaps?

James J. McEntee, III

You mean what we might have to distribute to shareholders under the REIT rules?

Jason Arnold – RBC Capital Markets

No, I guess since it’s a gain, assumably you have to pay a tax on it, right?

John J. Longino

No, the way that we actually triggered those gains is by selling the entity and it was in such a manner that we are able to use losses available to us. We had capital gains respectively on that transaction and we have capital losses available to us to offset those gains basically.

Jason Arnold – RBC Capital Markets

So the net impact, I guess I was just curious on a gross basis what you would have paid out.

John J. Longino

If we look at the $90 million total gain cumulatively as Jay mentioned earlier, effectively $60 million of that was realized, if you will as part of the transaction that we just did this quarter. $30 million had already been realized or recognized in re-taxable income, some last year, some early this year and you can look at that portion as being at least considered in whether or not it’s a REIT distribution. But there may again be other losses to offset that.

Jason Arnold – RBC Capital Markets

To what degree you can, can you give us a little bit of an update on, you mentioned briefly looking at some of the different structures that you could really flow into. Maybe you could give us an idea of where you’re leaning in terms of PTP or a C Corp or a liquidating trust perhaps?

James J. McEntee, III

Jason, we don’t have a leaning or an idea to lay out at this point. What we’re presented with by virtue of the IndyMac tax loss is really enhanced optionality meaning that clearly we believe that it’s fairly straightforward to maintain REIT status through 08 and we don’t have mandatory additional distributions. We may make additional distributions but they’re not required for REIT status and as a result we will have the free option to consider this issue into next year. I think that’s a valuable option for us to have. I think the structural alternatives present good opportunities for us and it may that be that by the time we get to having to make a decision we have engaged in a transaction or a resetting of the business model that makes maintaining REIT status not only easy but appropriate. Keeping that optionality for us I think is important. That being said, standing where we stand today there would be significant challenges for us to maintain REIT status beyond the 2008 year. Shareholders should understand and expect that this issue is not, we haven’t made a decision. We’re not foreclosed from D reading next year. It’s something that is very relevant to us and we’re focused on it.

Jason Arnold – RBC Capital Markets

Last question, you had mentioned that there are some interesting investment opportunities out there. Maybe could you give us a little flavor for what those are?

James J. McEntee, III

I think there are a number of things happening in the places that we have our core competency, the trust preferred arena as well as in the middle market loan business and for that matter in the ABS business there are a number of opportunities to participate in what I would characterize the forced liquidation of portfolios is I think some of it once in a lifetime opportunity for investors and it’s something we’re very, very focused on and studying hard and looking at some specific opportunities there which if we resolve to proceed with them will be announcing in due course. But I think to be a player in the financial services sector, particularly in the parts of it that we have played in and to understand both the structures and the securities that we’ve been putting together for several years now, is valuable and there is clearly some opportunity for us and for others obviously and we’re very focused on thinking through how to take advantage of those opportunities.

Operator

Your next question comes from Kevin Mullen - RBC Capital Markets.

Kevin Mullen – RBC Capital Markets

I was wondering, someone had asked earlier a question about the convertible debt. I noticed that [Ray Financial] earlier in the week announced that they bought back some of their convertible debt at what looks like a pretty attractive price and I was wondering if you had thought about this? To me it looks like an attractive use of capital.

Ray

Sure, we think about the full panoply of options open to us for using cash. I think we’ve had this conversation now every quarter going back to four quarters where we’ve looked at and walked people through how we think about stock buy back. Our stock’s extremely cheap right now obviously we think and I think there are opportunities on the convert side as well. We constantly think about it and consider it. I think it’s fair to point out that those who have been listening to me over the past year realize that I think cash in this environment is extremely valuable and so parting with it is difficult for me to do. But we do think about those things and look at it. We watch the trading and all this stuff and it’s something that is talked about regularly internally but we’ve not bought back any of that convert.

Kevin Mullen – RBC Capital Markets

Do you have any thoughts on why Ray Financial decided to do this now or did it just look too attractive to them to pass up?

James J. McEntee, III

You really should ask them that, I don’t have any idea what the thinking is there.

Operator

Your next call comes from Phil Dumas – Geode Capital.

Phil Dumas – Geode Capital

Most of my questions have been answered, but which of the alternatives John was taken off the table by the Board? Can you guys elaborate on that?

James J. McEntee, III

We really don’t think it’s appropriate for us to lay out what exactly it is that we had studied hard and focused on. I don’t want to start down that path. It was something that all of thought was a good transaction but we couldn’t get it done at levels that we thought made sense for the company.

John J. Longino

It wasn’t really an alternative that’s been closed by the way. It was a specific transaction. It’s not like we’ve said there’s one course of action we will not pursue.

Phil Dumas – Geode Capital

It involved the entire company or did it involve a piece of the portfolio? Can you elaborate on that at all?

James J. McEntee, III

Frankly I just prefer not to elaborate on it.

Operator

Your next question comes from [Harry Zelnick – Private Investor].

[Harry Zelnick – Private Investor]

On a previous announcement or conference, and I don’t recall which, several quarters ago, you pointed out that you had enough capital and enough liquidity to pay a $0.25 per quarter payout, I believe. If my facts are wrong please correct me. Obviously circumstances have changed so on the other hand people that have bought your stock many of them bought it for that fat dividend at the time. Without the dividend, many of us are in a bad situation and given the fact that you see all these opportunities out there, I can understand your reluctance to pay out that which is not necessary. On the other hand, can you address the fact that before you made these suggestions that cash was going to be available and it seem to me that you’re basically hurting a whole class of investors that are looking for that dividend income. Regardless of the effect upon the company, that’s what they look for.

James J. McEntee, III

Harry, I’m sympathetic to your view. I do believe you’ve accurately stated, maybe not precisely, but you’ve accurately stated the gist of what I communicated on prior calls which is that the company does have the cash to support continued payment of the $0.25 dividend. The difference between the prior quarter and today of course is IndyMac having been affected in particular and more generally the impact on the financial services sector that we lend into but specifically at IndyMac it has a very significant impact on us in terms of on a short term basis it shuts off much of the cash flow that supports the dividend that we have been paying. That being said, the company does have the cash to continue to distribute to shareholders and I do not want to foreclose the notion that that might happen and we may continue to do that. I don’t think the general proposition returning capital to shareholders which is effectively what we would be doing, but returning capital to shareholders in the form of a dividend is probably not sound policy.

We have to examine the alternative uses that we have for cash and for sure we’re not going to use that cash unless we think we can do so in very meaningfully accretive ways. At the moment we are leaving all options open. I do think I’ve been trying to communicate to people for some period of time now that given how rocky our sector is and you don’t have to look at our company to realize that, but there are hundreds of companies and hundreds of billions of dollars of losses that have been realized in this sector. You don’t have to look too far to realize that the cash flow associated with these investments is being threatened and we shouldn’t be adhering to a dividend policy just to adhere to a dividend policy. It’s a general proposition, dividends should reflect earnings of the company and when the earnings of the company aren’t going to be there for 2008 to support continued payment of that dividend in 2008. Again that decision’s not been made. It is among the options that we will look at at the end of the quarter and make a decision.

We’re very sympathetic, Harry, with your position. We do know that shareholders purchased our stock because their interested in dividend payments. We totally get it and are as disappointed as you are in the position that we’re in and are doing out best to dig out of it. But I can’t commit to you that that dividend will be there in Q3.

[Harry Zelnick – Private Investor]

I understand that. My follow up question then is what about the shorts that are out there as a means of shaking them loose and perhaps getting some better pricing on your stock. If you continue to pay the dividend it becomes difficult for the shorts to hold the position.

James J. McEntee, III

I understand and as I’ve said on prior calls I can’t allow my corporate finance policy to evolve based upon what shorts do. If you’ve listened to these calls, for some period of time now when the stock was at $6 people were making the same argument and beating me over the head to buy back stock at that level, to address the short position. I just don’t think it sound policy for me to pay a dividend or buy back stock or buy back the convert because of what the shorts are doing to me. I think in due course they’ll take care of themselves.

Operator

Your next call comes from Robert Kyle – CSCM, Inc.

Robert Kyle – CSCM, Inc.

Question regarding the management fee that’s payable to Cowen & Company and before I finish I’d just like to observe that clearly the amount of assets under management have obviously dropped due to market defaults, deterioration value, so forth. Is the management fee payable to Cowen market asset based or should some consideration be given to the fact that the net value of the asset being managed is considerably less than it was say two years ago? It would seem to me that something like this needs to be addressed. If you could go into a little bit, John.

John J. Longino

The way that the management fee structure works at AFN as it does for most of the externally managed REITs is a little bit convoluted and requires some effort to get your arms around, but the base management fee for the REIT management agreement is based upon the equity in the company and that equity is adjusted as there, in this case, in negative ways. There’s also an incentive fee based upon returns in the company that are realized. You see you start with what I would call a very common marketplace REIT management fee structure but then you look to the underlying CDOs that have been invested in. In this case, take the Alesco CDOs where you have inside of those CDOs management fees to Cowen for managing the CDO. The aggregate of those fees offsets dollar for dollar any management fee that might be due under the REIT management fee. We have, I don’t have the exact numbers in front of me, but from a substantive standpoint the offset has been complete so that there’s been no management fee paid under the REIT management fee.

I answered your question by explaining that the REIT management fee does up or in this case down based upon the equity of the company but if you look at the CDO management fee that overcomes the REIT management fee for the time being. The CDO management fees themselves have different metrics. Typically the fee is divided up into two pieces, one being a senior fee and that senior fee is a function of the assets that are held inside that structure and as the assets default, the denominator, if you will, used to calculate that fee is reduced and then part of the fee is also what we refer to as a subordinated management fee and that fee is dependent upon cash flows being available to distribute to equity holders in those CDOs so those subordinate fees are by and large being cut off as well. I can’t answer your question in a very straightforward fashion but for sure I can tell you that the cash flow to Cowen, the management fee is being realized by Cowen, are being materially reduced as a result of the credit performance of the portfolios.

Robert Kyle – CSCM, Inc.

It looks like it was reduced by about $200,000 against the prior year quarter and was up by about $2.2 million for the six months. It’s just very hard for me to get my arms around that, but whatever.

John J. Longino

That actually is the fees inside of the CDOs that have declined by $500,000 quarter-over-quarter and that’s where you’re measuring the asset management. Quarter-over-quarter, that’s not to say what the impact will be now that the CDOs turned off.

Robert Kyle – CSCM, Inc.

You haven’t seen the impact on the fee of IndyMac. You’ll see that next quarter.

John J. Longino

That’ll be in the third quarter.

Operator

Your next question comes from Jeff Miller – JMG Capital.

Jeff Miller – JMG Capital

I just was trying to understand the liquidity position currently. It looks like last quarter you had $130 million of unrestricted cash prior to paying out the dividend, you had about $87 million of restricted cash so stated with I think some of your CDOs. Then this quarter on your release you’ve got $136 million of cash, $120 million after backing out the dividend and $88 million of restricted cash. Where does the realized gain from your CDS portfolio that you sold? Is that part of the $136 million?

John J. Longino

It is, yes. Yes, it’s part of what’s now $120 million. That transaction is closed out. From an accounting perspective it’s partially closed out previously and we were realizing cash that was unrestricted cash but it was unrestricted from an accounting perspective. Technically it was subject to claw back.

Jeff Miller – JMG Capital

So last quarter that was in that unrestricted cash number?

John J. Longino

That’s correct. The $120 million unrestricted after dividends really hasn’t changed. The issue is that we paid a $15 million dividend in the second quarter and effectively we generated about the same $15 million of cash between earnings as well as a couple other asset sales.

Jeff Miller – JMG Capital

So is it safe to say then going forward, you were basically kind of break even then in terms of cash position quarter-over-quarter but is that expected then to obviously drop now that IndyMac has been seized and the cash flows from that have stopped?

John J. Longino

It depends on how you look at it. We still expect to have positive cash flow coming off of our investments after debt service and G&A, etc. It depends upon whether we spend any money on anything else, whether it’s dividends or buy backs or whatever else we do.

Operator

Your next question comes from Arthur Burns – Deltek Associates.

Arthur Burns – Deltek Associates

Gentlemen I know it’s been tough for you to run a company that’s involved in a marketplace that’s deteriorated but we as shareholders have also clearly suffered fairly dramatically from a $10 high to where we are today and I think you owe it to us who have a decision to make, do we continue to go with McEntee & Co. and the Cowens about rebuilding this thing or do we take our 90% loss from the top and go do something else. I think you’ve got to lay out without giving details, it’s not important that you tell us what deal you missed and the magnitude of that deal, but I do think you owe us a game plan going forward. I know you’ve been involved simply riding the ship but you made the comment you think the stock is cheap, you’ve got liquidity, IndyMac is a big problem, we know that, but that’s now in the past. What can you do to make this a $3 stock or a $5 stock a year from now, two years from now, five years from now and I think you owe it to us instead of hiding behind I can’t tell you this, I can’t tell you that about what your game plan is to rebuild this thing. I think you have failed to do that and I think you owe it to us.

James J. McEntee, III

I appreciate your comments and I’m sympathetic with the position you’re in and it is about the choice and the company has suffered greatly by virtue of the sector that we’re playing in I think. My real concern, I’m not trying to hide anything. There are a number of things that we can do and I’ll go through some of those at eye level. But what I’m trying not to do is point to one or point to another and then build expectations in shareholders that we’re going to proceed down a particular path and then as we try to go down that path, the terms and conditions under which execution of that plan require are not acceptable to me or to the Board or to the rest of management and then suddenly while we think it’s a good idea we think the fact that it’s too expensive precludes us from doing it and then suddenly everyone has this expectation that we’re going to do A, B and C and we don’t do it and it’s just not a productive exercise.

Arthur Burns – Deltek Associates

You people have an expertise now in an area that’s been trashed and I see these people who bought the Merrill Lynch portfolio at $0.22 financed to the tune of 75%. It would seem to me that that is in a smaller scale, an area that you people could think about doing. But just by telling us that you’re thinking about that can help us to decide whether we want to stand pat and see if this thing can be rebuilt or if we should just take our losses and go do something else. And I think just giving us some idea of what you’re thinking as opposed to sort of downplaying all of what the Board is thinking and so on about the future. I think we’re not getting a big enough picture.

James J. McEntee, III

That’s fair and I will affirm for you that what you’ve laid out is frankly part of or one of the exact things that we are thinking about which is to say that there are opportunities across structured finance that are I think very compelling opportunities if you look within the sectors that we know best which again are the trust preferred arena and the middle market loan sectors. I think within those there are particularly good opportunities. The trust preferred sector is one that’s not surprisingly getting hammered as all of you can see and there is much forced selling going on and probably more that’s about to go on and we think it’s an opportunity for us.

Now executing on that opportunity is never easy and there are a number of uncertainties along that path that we will have to overcome but certainly doing something along those lines is potentially quite valuable to us. There are other things as well, internalizing management for the company is something that we’ve considered and will continue to consider, focusing more on the loan sector is something that I think presents some opportunities today but not without risks. On the one hand lenders today can be incredibly choosy in the borrowers that they choose, very different than it was 18 months ago. One of the reasons why we were unsuccessful in growing the loan platform in the ways that we had originally projected that we would do.

Arthur Burns – Deltek Associates

Spreads got too narrow I’m sure.

James J. McEntee, III

Spreads got narrow and there was too much money flying around so you started seeing covenant free loans and things that just made us very uncomfortable. Now it’s paying dividends in the sense that the deals that we did do seem to be performing quite well. I think the economic conditions will affect that portfolio but we seem to be working through it well but I think today those conditions are on their head. You can get very wide spreads, you can get any covenant you want and you can be very choosy with respect to the borrowers that are out there. The problem of course is you can’t get financing for those loans, so you’ve got to put a lot of equity to work. All of these things need to be balanced in order to choose the right path or paths for moving forward but you certainly pointed to an arena that absolutely is one that we’re quite focused on and we have not as I mentioned I think on the last call, we spent most of last year making sure that the ship didn’t tip over and we achieved that certainly not free of problems but the ship did not turn over and we’ve been focused for the better part of this year on looking at these different alternatives and have gone down the path on a couple but it’s important that all the terms are terms that are good for the company, not most of the terms but all of the terms.

It’s not necessarily easy to achieve that, we’re working hard to do it. I’m very confident we will but we are going to go forward in a judicious manner and make sure that we do maximize shareholder value and not just do something to satisfy those that are beating me over the head to act. It is important to act and we do want to act and there are things that we can do but it’s quite important that we cover all the bases when we do so.

Arthur Burns – Deltek Associates

Agreed 100% and the only advice that I would give you is encourage us a little more as beaten down shareholders that there are opportunities out there and that you think you might be able to take advantage of them.

James J. McEntee, III

We absolutely feel that way. You haven’t seen anybody running away form the opportunities here. We have stayed focused and are working hard to try and realize them.

Operator

Your next calls from [Joseph Vagda - Private Investor].

[Joseph Vagda - Private Investor]

I have a quick question about the CDOs that take years to recover. Which one are those?

James J. McEntee, III

The transaction is Alesco 14 and 15 are the ones that we project will take the longest.

[Joseph Vagda - Private Investor]

Are we going to get the names of the various banks in the CDOs?

James J. McEntee, III

I review this in every call, it’s problematic to start selectively listing these things but we can list the banks with respect to which we have an issue and are focused and obviously IndyMac was one of those that we had listed. But from a materiality standpoint IndyMac and E*Trade were the largest exposures that we had and I think we’ve been pretty good about getting those names out.

[Joseph Vagda - Private Investor]

No, I don’t think so. That’s two out of 320 and I went to the shareholder meeting and I was told that this would be made more public at this point, at least that we would know which banks would be above 1%. So we’re not going to get those names?

James J. McEntee, III

No, I think at the shareholder’s meeting what I told you was we would be revisit the question. We have been revisiting the question.

[Joseph Vagda - Private Investor]

So the question now means that we’re not going to get them?

James J. McEntee, III

We’re not prepared to reveal on a selective basis these names.

John J. Longino

Frankly I think your experience here, if you look at the other companies that participate similarly in this sector and in similar sectors, we’re not unique here. You’ll find that across the board, it’s just in a public company context to start doing one off names and then not being able to do the private names because we have NDAs. It’s just not that simple a thing.

[Joseph Vagda - Private Investor]

You have TruPS within you portfolio that you can deploy to repair those CDOs that have been broken?

James J. McEntee, III

One of the options that may be open to us, the structural issues surrounding these CDOs are not always straightforward, but one of the issues or opportunities may be to take some of the trust preferreds that we have in our own portfolio and contribute them to the CDOs that are failing in order to reinvigorate the cash flow from those deals. There are a couple of issues associated with that. One is it may be good money after bad if there’s continued deterioration in that sector and that’s been the main driver behind my reluctance to pursue this strategy. The second thing is we’re not 100% owner of the equity in those deals so if you turn around and make that contribution you may in effect be making a gift to the other equity holders. You automatically lose some percentage, typically 40% of what you’re contributing. But as the dust begins to settle I would prefer to see another full quarter before I’m prepared to say whether or not things have finally settled out or not. But once that happens then I think it might be worth devoting more assets to fixing some of these transactions and that’s one way to go about doing it.

[Joseph Vagda - Private Investor]

And there’s $29 million in TruPS right now?

James J. McEntee, III

Yes.

John J. Longino

We’ve actually [inaudible]. We sold off that one piece.

James J. McEntee, III

We’re down to $20 million. That’s part of the liquid cash.

[Joseph Vagda - Private Investor]

That’s part of the restricted cash or unrestricted cash?

John J. Longino

Selling some of the TruPS we held on our balance sheet generated some of the cash that offset the fact that we paid a $15 million cash dividend but we didn’t have $15 million in cash earnings this month.

[Joseph Vagda - Private Investor]

One last thing, Alesco 10 is the biggest CDO that we have and how long is that one going to take if no other TruPS defer until that one cash flow is positive again?

John J. Longino

That’s kind of in the middle of the ones that we have. It’ll be several years.

Operator

Your next question comes from Marc Berger – MKB Associates.

Marc Berger – MKB Associates

Can you tell us on a going forward basis now what is let’s say for third and fourth quarter your monthly cash flow going forward versus your taxable income going forward in terms of cents per share?

James J. McEntee, III

Taxable income is of course an annual calculation, not quarterly and because of the IndyMac loss we expect the taxable income for the year to be not positive or marginally positive. From a cash flow perspective given the OC triggers that we’ve hit pre-doing something else. In other words, absent a dividend, absent a stock buy back, convert buy back, investment in other activities, we expect the company to be marginally cash flow positive. Net, net, all in it’ll be cash flow positive.

Marc Berger – MKB Associates

So now if you go and buy back some of your debt, that would pick up, it would certainly help the book value. It would also increase your taxable income and therefore allow you to continue to pay REIT income towards or for the rest of this year. Is that a consideration?

James J. McEntee, III

Certainly buying back the convert at a discount would have a positive impact on book value. it would also have a positive impact on cash flow because we no longer are servicing that portion of the convert that we buy back. The notion of it creating re-taxable income to allow a dividend, I don’t know if we would get there or not, depending on the magnitude and the price. But the ability to pay a dividend is not really a question. We have the ability to pay a dividend. The question is whether it’s sound corporate policy at this point, not funds ability.

Marc Berger – MKB Associates

You mentioned that adjusted book value is no longer a good measure of value. Could you tell us what we would be a good measure of value and what you would value this company at?

John J. Longino

Marc, I think what we said was in the release that we were putting an adjusted book value calculation together in the past because GAAP only allowed us to show one side of the fair value and that was the asset side. Now that GAAP allows us to mark the assets and the liabilities to fair value GAAP is as good a measure as there is out there. Any measurement is going to give you some flaw and adjusted book value analysis at this point may or may not include some of the deferrals and you determine whether they are or they’re not going to end up being losses. That’s the conjecture that we can’t make at this point and shouldn’t make. You’re left with the GAAP book value as an investor and that’s really the only place you can look at this point.

Marc Berger – MKB Associates

What is the GAAP book value?

John J. Longino

The GAAP book value is $3.41 a share.

Marc Berger – MKB Associates

You said looking for opportunities the cash that you have available for those opportunities obviously is the cash that’s sitting in the bank. Is it also part of the warehouse facilities that you have as well?

John J. Longino

I’m not sure that we’re following your question, but we have cash available for using for purposes that we think are appropriate of $120 million. The restricted cash amount which would include things inside our CDOs and other places that we don’t have free access to it but it’s available to be deployed for very specific things would not be available to us to do something outside of what’s contemplated inside that particular structure. Let me just clarify, the first loss that we have on our warehouse of $40 million on the Wachovia facility, that actually shows up in our loan line, it’s not actually for accounting purposes, it’s not really cash, it’s part of our loan portfolio.

Marc Berger – MKB Associates

So the warehouse facilities that you have available again is specified to what you can use that for?

James J. McEntee, III

Yes, the only warehouse that we have available to us today is the middle market loan warehouse. So that warehouse can house additional middle market loans only.

Marc Berger – MKB Associates

Obviously that would be an area that you’d probably want to pursue?

James J. McEntee, III

It is an area that we want to pursue. The caveat that I would put on that is the way that the marketplace is functioning or not functioning at the moment, it’s not so clear what you do with those assets ultimately. We have a belief about what we do but not proof of it. So the inability to get term financing for holding those assets makes it difficult to acquire those assets at this time.

Operator

Your next call comes from [Robert Knapp – Ironside].

[Robert Knapp – Ironside]

The remittance reports for the TruPS portfolios, are they publicly available?

James J. McEntee, III

No.

[Robert Knapp – Ironside]

Who’s the servicer?

James J. McEntee, III

There are different trustees for that. Wells is the largest I believe but we use all the service providers.

[Robert Knapp – Ironside]

Because if I go to Wells Fargo and their trustee page and I sign in and register I can typically get the remittance reports for anything that they’re an agent for.

James J. McEntee, III

I don’t think so.

[Robert Knapp – Ironside]

I want to complement you guys for taking these calls and staying on forever because they often run past an hour. But you haven’t really gone around to see shareholders either. Is there any way in the future with some of the strategic directions you’re considering that you’re going to go actually see shareholders?

James J. McEntee, III

Yes, sure. I think my intention would be when we do finally resolve the direction that we’re going to take absolutely would intend to go out and try to demonstrate the viability of that plan to folks. That being said, frankly we’re always available and we’re always traveling. So regardless of where you are if you want to see us we’re there at some point in the not so distant future.

[Robert Knapp – Ironside]

Maybe I’ll follow up with you on that. Given the situation it would send a pretty strong signal to the market if some of the insiders were buying in here. I can read the proxy statements. I realize that you do already own a lot of shares, but I would have thought if you really believed what was going on, you would be stepping in and buying hundreds of thousands of shares at these kind of prices.

James J. McEntee, III

Yes, I think people always like to see management buy shares and it’s something that we think about and you may see that in the future.

[Robert Knapp – Ironside]

The last issue on the dividend, I actually just wanted to comment because you have many different constituencies and I’m a constituency that would like you to focus on tax efficiency. You have a large number of possible buyers or holders of your stocks are people who could go and try to buy the equity tranches of distressed CDOs and you know the issue there. if people go and look at doing that and depending on the asset class and what you’re buying and whether it’s really an equity tranche or it’s just one of the middle tranches that subordinate it into triple As but the prices can be anywhere from $0.05 to $0.20 and the yields are 30% to 40%, sort of like the dividend yield on Alesco and the issue with going and doing that of course is that your typical buyers pays 35% income tax on that coupon. So the real power of Alesco as a structure are the tax losses you have. I know dividends are nice and a headline dividend yield of 30% is very seductive but it’s incredibly tax inefficient. So I know you have any constituencies and other people will present good arguments for doing other things, but I just wanted to make sure on the call somebody puts in an argument for you to maximize the after-tax power of the tax losses that you have in your account.

James J. McEntee, III

We get that and I think what you see with respect to the execution on the closing out of the CDS portfolio is somewhat demonstrative of our sensitivity and the appropriateness of thinking through what actions we take with the tax man in mind as well as with other factors. You point out correctly that there are a lot of constituencies and you have convert holders, you have common shareholders who are very focused on dividend yields, common shareholders are very focused on value and the like and I think our job as managers is to make sure we think through the appropriate needs of all constituencies and do our best and we can only put our finger down on one spot. Hopefully everyone will be mildly unhappy but mildly happy so that would be a victory I think for us.

[Robert Knapp – Ironside]

Despite the share price and the way the converts are trading, it doesn’t look to me like you’re in the range of insolvency and so I just would remind you that you don’t really care about the converts, they’re debt and they’re going to be debt unless something really incredible happens. So your priority is to the shareholders and maximizing their return. Your fiduciary duty at least is to the shareholders and maximizing their return.

James J. McEntee, III

You absolutely are correct in how you articulate the standard. In fairness to how I sort of get out of bed in the morning, I do think about all the constituencies but where my legal loyalties lie and I think I’ve moved forward with that in mind.

[Robert Knapp – Ironside]

The last thing about the dividend and that is and constituencies, the last caller pointed out you do have a real expertise here that a lot of people don’t have and equity tranches, there;’ various things trading, the Merrill Lynch transaction is a good example. For people like me who were in early, bought in later but are still on a mark-to-market basis dreadfully under water, there should be ways if the portfolio is still generating cash for you to be able to go out there and earn returns far, far in excess of what any of your basic shareholders can earn themselves. Typically in my life as an investor I’m always telling shareholders to give me the money back, this is like the one time in ten I’m saying if the opportunities are there and you can do it so that the gains you earned are not taxed anywhere in the structure and potentially the cash flow that you generate and give back to us could be non-tax dividends. I just would encourage you to do that for everyone.

James J. McEntee, III

We’ve got it, thanks.

Operator

Your final question comes from Allen Goldstein – Wachovia.

Allen Goldstein – Wachovia

I don’t know if you had brought this up before or not, but what would you handicap the possibilities of some share buy backs?

James J. McEntee, III

I wouldn’t be handicapping that. We’ve been talking about this every quarter for over a year now and it’s very much on our minds, it’s something we think a lot about and consider all the time and we do have a very significant authorization out there that allows us to do it if we want to. It’s something we might do but I can’t handicap it for you.

I believe that concludes the calls. Thank you everyone for your interest in our company.

Operator

Thank you for your participation in today’s conference. This concludes the presentation.

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