Fortress Investment Group LLC Q2 2008 Earnings Call Transcript

Fortress Investment Group LLC (FIG)

Q2 2008 Earnings Call

August 7, 2008 10:00 am ET

Executives

Lilly Donohue – Investor Relations

Wes Edens - Chairman and CEO

Dan Bass - Chief Financial Officer

Pete Briger - Co-President and Head of Hybrid Hedge Fund Business

Mike Novogratz - President and Head of Liquid Market Hedge Fund Business

Randy Nardone - Chief Operating Officer

Analysts

Roger Freeman - Lehman Brothers

Marc Irizarry - Goldman Sachs

Robert Lee - Keefe, Bruyette & Woods

Roger Smith - Fox-Pitt Kelton

Daniel Fannon - Jefferies & Co.

Presentation

Operator

Welcome everyone to the Fortress second quarter earnings conference call. (Operator Instructions) Ms. Donohue, you may begin your conference.

Lilly Donohue

Thanks, Amanda. Good morning, everyone. I just want to welcome all of you to our second quarter earnings conference call. Here with me today is Wes Edens, our Chairman and CEO, Dan Bass, our Chief Financial Officer, Pete Briger, President and Head of our Hybrid Hedge Fund business, Mike Novogratz, President and Head of our Liquid Market Hedge Fund business, and Randy Nardone, our Chief Operating Officer.

Just before I turn the call over to Wes, I want to point out that statements today which are not historical facts may be forward-looking statements. Our actual results may differ materially from the estimate or expectations in any forward-looking statements. These statements represent our belief regarding events that, by their nature, are uncertain and outside of our control. I would encourage you to review the forward-looking statements disclaimer in our quarterly earnings release, including a recommendation, obviously, to review the risk factors that are in our annual quarterly reports that are filed with the SEC.

With that, I'll turn it over to Wes Edens. Wes?

Wes Edens

Right. Thanks, Lilly, and welcome, everyone. We've got lots of things to cover this morning. It's certainly been a very interesting first half of the year.

The markets, as everyone knows, continue to be very volatile and challenged, in particular here in the United States. And while this is the type of environment that creates tremendous opportunity, it's also very demanding with respect to liquidity and performance of existing investments.

As a firm, at Fortress our priorities are focused on performance of what we own, sourcing new investments and capital formation, in exactly that order. The team here has done a terrific job on financing our investments around the firm. In the Private Equity business alone, in the past 12 months we have successfully completed over 50 different financings totaling approximately $12 billion, all at reasonable rates and terms.

The notion that the financing markets are shut is simply not true. There continues to be pockets of dislocation in the credit markets, but for the most part, so long as you're financing real assets at reasonable leverage, we have found the markets to be highly functional. In the past year we've financed ships, airplanes, railroads, real estate, and many other types of assets at comparable leverage with only modestly higher debt costs than the pre-credit crisis world.

We've also continued to have good operating performance in virtually all of our investment businesses, and while the current economic environment continues to be challenging, our core businesses have had very good assets under management growth this year.

The tone of the market has been a more constructive one of late. There's still a very active debate regarding the state of housing in the United States and, until that path is finally clear, we believe that it will continue to be a choppy environment for both the debt and equity markets.

In general, we have been and we continue to be very active pursuing some of the many significant opportunities in the mortgage and financial services space. Thus far this year across the firm we've made in excess of $6 billion in various credit-related investments and have significant dry powder to pursue new investments in the sector.

In addition, we believe there will eventually be many opportunities in the distressed credit and restructurings markets on the corporate side. This is an area in which we've had a particular expertise having been as a group among the most active and successful distressed investors in prior credit crunches. But for the most part we believe  I believe - that the bulk of those types of opportunities are likely to come about in 2009 and even in 2010.

Given the uncertainty in the markets, with the exception of the credit and financial services situations which I just mentioned, we're in no rush to put new investments on the books as we feel like there's going to be better opportunities in the future in many cases.

Given the current opportunities, though, we're very focused on capital formation and fundraising across the firm to be well positioned to take advantage of this, and we've had a significant amount of success thus far in the year. In the second quarter we raised gross third-party capital of $2.8 billion across the existing businesses. Since July 1 we raised an additional $1.9 billion of gross third-party capital, brining year-to-date capital formation to a total of $7.5 billion.

We have several new initiatives across the firm this year. We launched a commodity hedge fund in January that through the end of the second quarter has about $908 million in assets and through the end of July has grown to approximately $1 billion.

In addition, we recently raised capital for what we think will be a series of mortgage opportunity funds. After the latest close in July, the funds totaled approximately $935 million in equity. And also in the credit space we have a private equity style fund that invests in other types of credit-sensitive assets that we expect to be approximately $2.5 billion in total and we have commitments of about $1.9 billion thus far.

And lastly, we've just begun the process of organizing our next main private equity fund, Fund VI, ahead of first close last week of approximately half a billion dollars.

Let's talk about the results. For the quarter, pre-tax distributable earnings was $58 million. Pre-tax DE for second quarter of 2007 was $143 million, so our quarterly earnings declined year-over-year. It was a slow quarter earnings wise, as for the most part we earned only base management fees. And although we haven't earned any significant performance fees thus far this year, we still have five months left and have some significant irons in the fire.

As expected, without material incentive income earned in the second quarter, our Fund Management business generated $75 million of pre-tax DE.

Assets under management grew 23% year-over-year from $28.6 billion at the end of the second quarter last year to $35 billion at the end of this quarter this year. We track assets under management closely because it does measure the amount of capital we earn management fees on. Our gross management fee revenues for the quarter were $150 million compared to $118 million a year ago or a 27% year-over-year increase.

As I said before, I like to think that distributable earnings provide the best scorecard of how the firm has performed looking backwards in time, and that AUM provides the platform to generate DE in the future. Our business here at Fortress is a high-margin business. Historically, through a combination of management fees and private equity and hedge fund performance fees, we earn about 4% on AUM and bring about half or 2% of that to the bottom line.

A portion of this, of course, is performance fees and we need to perform in order to earn them. These are markets that are better for making new investments than harvesting existing ones, but with markets more functional now, there's still five months left of the year to generate material fees.

Now let's talk about the performance of each business, starting with the Hedge Funds. Hedge Funds at Fortress total approximately $18.1 billion, just over half, 52% of our AUM. Our Hedge Funds in the aggregate performed generally in line with the indices, with Macro underperforming, Commodities outperforming, and Hybrid very much in line, but we did not accomplish what we expected in terms of profitability for the funds in the second quarter.

All of our hedge funds are generally flat to modestly down for the second quarter on an absolute basis. The hedge fund space overall had a pretty tough second quarter. For example, the CSFB/Tremont Hedge Fund Index for all funds showed an average increase of 59 basis points in the second quarter and HFR's fund weighted average composite index showed an average decline of a negative 1.06. Not bad returns when compared to S&P returns, but just on an absolute basis, flat to negative returns for the year.

Liquids is made up of $8.8 billion in our Macro fund and $908 million in the Fortress Commodities Fund. Global Macro had negative 2.07 gross and negative 2.55 net returns for the three months ended June 30, and then negative 1.82 gross and negative 2.76 net returns for the first six months of 2008. For the month of July the Global Macro had estimated negative 1.63 and negative 1.82% returns.

Global Macro had net inflows of $0.4 billion for the second quarter and $1.2 billion to date. Commodities had a 10.63% gross and 8.11% net returns for the three months ended June 30th. And year-to-date is 12.33% gross and 9.01% net for the first six months of 2008.

For the month of July the Commodities had a negative 2.85% gross and a negative 3.02% returns. That's obviously had very good returns for the year, and given the volatility in the markets in the past 30 days in particular, they've had a tremendous performance through difficult times.

Our Commodities Fund is a prime example of the type of growth that we think the Macro Fund can generate for the firm by helping to foster new fund initiatives in areas we believe have substantial amounts of promise. We are currently evaluating two segments of the Liquids business in this regard, and think over time this will generate a number of high-quality growth opportunities for our business.

Hybrid is made of $6.6 billion in the [Onshore] Special Ops Fund and $1.8 billion in the Fortress Partners Fund. For the three months ended June 30, the Special Ops Onshore Fund had 1.44% gross positive returns and 0.94% net returns, and for the six months to date ended June 30, the Onshore Fund was 0.35% gross and negative 65 basis points net. Special Ops had net inflows of $45 million for the quarter and $452 million year to date.

You know, flat performance for a credit business like the Hybrid business is a heroic performance in an environment like this. It speaks volumes to the discipline and the capabilities of this group, and having already dealt with many of the challenges of owning a portfolio in a market like this, this area is perhaps our best prepared to take immediate advantage of the numerous opportunities in credit. While other players are talking about setting up groups or hiring people in this area, we currently have over 250 people working full-time in the credit space here at Fortress, have just closed another several billion dollars in capital, and are voraciously focused on the opportunities in front of us.

For the month of July the Hybrid funds are currently estimated to be slightly negative, but the valuation process has not yet been completed.

Private Equity in the second quarter, we were very focused on liquidity and financings in each of our underlying portfolio companies. As I mentioned, since this time last year we've completed about $12 billion in financings at these companies. The businesses have all performed fairly well thus far this year. In the economic slowdown in the U.S. has certainly had an impact, but we feel good about where the companies are positioned and financed at this time. I very much like our portfolio and expect it will produce excellent results in the years to come.

We have between and $2 and $3 billion invested in a handful of industries, including the largest investment, I believe, in the U.S. in senior housing, where we operate approximately 850 buildings, large investments in transportation, in particular rail in the United States, where we own and manage over 8,000 miles of track, and also have a very significant investment in apartments in Germany. We own approximately 200,000 apartments spread throughout the country. All three sectors have very favorable long-term demographic profiles and have continued to generate very substantial organic growth, even in these challenged times.

We believe that these investments and the others in the funds over time will generate substantial returns for the funds.

With the continued deleverage in the financial markets, we expect to see a number of high quality investment opportunities as the year plays out. With regard to new investments, for the moment we are solely focused on the value that we see in the credit assets and we'll continue to add to our investment portfolios as we see opportunities. Our overall perspective is that this is going to be a very good time to buy assets for the foreseeable future and that one of the principal challenges is how best to finance assets on a stable long-term basis.

There are two obvious sources of leverage that are attractive in this regard - banks and insurance companies. We have beefed up our already significant investment capabilities in both these areas with a couple of high-profile experienced people and expect we'll find great opportunities in the months to come, much like we found in similar periods in the past.

Just a word on performance. You know, I hate to have to respond to some of the negative statements that were made in the past few days regarding the performance of our private equity fund, but I feel like it's appropriate to give a few facts in order to give both our shareholders and investors an accurate assessment of the performance of the funds to date.

We raised our first fund here at Fortress in 1999, and since then we've raised a total of five main funds which, including sidecar funds, total approximately $14.08 billion in capital. The first four funds are fully invested and have been for some time. Fund V is approximately two-thirds invested and is expected to be fully invested later this year. We have a handful of funds that hold single investments as well, but our main fund's the primary vehicle through which we invest in private equity and thus give the clearest view as to our investment performance.

If you look at the results of the funds that are already invested, which are the first four funds and sidecars, inception to date on the $8.85 billion in capital in those funds, the weighted average net return on a marked-to-market as of the end of July is 11.1% net. Included in those results are a handful of meaningful public companies that currently trade at substantial discounts to the NAV of the underlying assets.

One of the beauties of our brand of private equity is that unlike a private equity investment in a sportswear company or an auto company, for example, in our business if at the end of the day you can't close the gap between the market value of a public company and NAV, you always have the option of selling out the assets on an asset-by-asset basis, which we've done in several cases. If you assume that the public investments in these funds are liquidated at the estimated NAV rather than the current public price, the return to date is approximately 16% net. Furthermore, if you assume, as we do, that these investments will be held to maturity and the value of the companies will grow, as we expect them to, our projected return will be about 28% gross and approximately 2.6 times net multiples on the invested capital.

To give some context to these numbers, a good reference is Cambridge Associates. They compile data in the private equity space by vintage year. When you compare our results versus the relevant universe of the funds, the result is very favorable. We benchmark our funds to the same vintage index of funds, i.e., the 1999 vintage of funds for our Fund I, 2002 for our Fund II, etc., and using marked-to-market results, our funds to date have returned approximately 11%, as I said, or 16% assuming we liquidated our public investments at NAV; 16% compares to an average result using the Cambridge cohorts of approximately 9.3%, not quite double the industry average, but a healthy spread to it.

Marked-to-market for private equity is a funny notion, not just for us but for the whole industry. These are investments that are intended to be held patiently for significant periods of time, and thus looking at them as a snapshot to assess their value is a challenging process. In the end, the final proof is in the ultimate performance. We've had excellent performance from our mature funds going back to our BlackRock days in 1995, and we fully expect that all of our core funds have a very good chance of producing the 20% plus net returns and 2 times investors' money that we tell investors our goal is to deliver to them.

One other comment I'd like to make is that when you look at our history as investors, we've generated good results across a number of economic cycles, but in particular we've done our best work in distressed times. Our 2002 vintage fund, which is Fund II, which was invested during the last significant market dislocation, to date is at returns at just over 40%. Again, when compared to the 31 funds totaling approximately $20 billion that Cambridge track from this cohort, the average return of all those funds from the period was about 25%, and of the 31 funds they track from this vintage, only four of those funds have had higher returns than our cohort has to date.

Distressed and dislocated markets are where we make our mark historically, and given the current market conditions, we're very confident this will prove a very fruitful environment for us.

We have a very well-diversified business here at Fortress, with 38 funds and many different strategies. These are difficult markets for this most part. It's markets like this that we thrive in. I think it was John Templeton that said that it is best to buy in times of maximum pessimism and sell at times of maximum optimism. If that's true, it certainly looks like we're headed into a pretty good investment environment.

So with that, let me turn it over to Dan to review our financial results in detail. Dan?

Dan Bass

Thanks, Wes, and good morning, everyone. As Wes described, Fortress second quarter results were similar to our first quarter as we continue to grow, make investments, and raise new funds across all our businesses. Let me now provide you with some more information about our financial results.

First, our GAAP results. In the second quarter we had a GAAP net loss of $55 million, which is consistent with the loss we had in the second quarter of last year. If we exclude the principal's agreement compensation, a noncash item, the GAAP net loss in the second quarter was a total of $345,000. As mentioned in previous quarters, the principal agreement will be shown as an expense on our GAAP income statement for the first five years from our IPO. This charge represents a $950 million a year, $237 million a quarter non-cash charge which has no impact on our capital and requires no obligation on the part of the company to deliver cash or any securities.

As we previously stated, we feel distributable earnings or DE is the most meaningful way to measure our company's performance. Pre-tax DE for the second quarter was $58 million, down 59%, versus $143 million for the second quarter last year and flat versus the $58 million in the first quarter of 2008 despite an impairment charge of $10 million in the quarter in our Principal Investment segment.

As a reminder, as we look at DE, there are two main elements - Fund Management DE consisting of segment revenues and expenses and performance of our Principal Investments segment.

Fund Management DE for the second quarter was $75 million, which was a 42% decrease versus the second quarter last year but a 6% increase versus the first quarter this year. Management fees for the second quarter were $150 million, up 27% from $118 million for the second quarter last year. This was due, as Wes mentioned, to a 23% increase in AUM to $35.1 billion at the end of the quarter. This increase was a result of our continued focus on ability to raise capital across all of our segments.

Our segment incentive income for the second quarter was $15 million, down from $165 million in the second quarter of 2007 largely due to no realization events in Private Equity and lower returns on our hedge funds. Our segment expenses were $90 million for the second quarter, a decrease of 41% versus the second quarter of 2007. This decrease was predominantly due to a 76% drop in profit sharing compensation, which is in line with our decline in incentive income.

Our operating margin from Fund Management activities for the second quarter was 45% versus 46% for the second quarter last year and versus 40% for the first quarter this year. The improvement between the first and second quarter this year was primarily due to lower compensation expenses as a percentage of revenue.

Now I'll drill down to discuss Fund Management DE on a segment basis.

Private Equity, including the Castles, generated Fund Management DE of $36 million for the quarter versus $41 million in the second quarter last year. Management fees for the second quarter were $57 million, an increase of 19% versus second quarter last year, primarily due to a 20% growth in AUM to $17 billion. There were no realizations in our Private Equity funds in the quarter or in the second quarter last year, thus we earned no incentive income in either period.

Fund Management DE for the Liquid Hedge Fund segment was $30 million for the second quarter versus $75 million for the same period last year. Management fees for the second quarter were $57 million, up 50% versus last year, mainly due to a 31% growth in AUM to $9.7 billion. Our newly formed Fortress Commodities Fund, included in the Liquid Hedge Fund segment, had a net return to investment of approximately 8% for the quarter and generated $6 million in Fund Management DE during the second quarter. In addition, expenses for the Liquid Hedge Fund business were down 46% to $41 million for the second quarter, again due to lower profit sharing expenses.

Our Global Macro Fund, which earned incentive in the second quarter last year, did not earn any incentive in this period.

Our Hybrid segment generated $9 million of Fund Management DE in the second quarter versus $18 million for the second quarter of 2007. Management fees were $36 million, up 13%, due mainly to the 20% growth in assets. In addition, expenses were down 46%, again due to lower profit sharing expenses.

With respect to our Principal Investments segment, we had a loss of $17 million for the quarter versus a gain of $13 million in the same quarter last year. The $17 million loss was mainly made up a previously mentioned $10 million impairment charge we took for DE on our investment in the shares of Newcastle and $8 million of net interest expense.

As it relates to taxes on a DE basis, due to the fact that we have generated lower levels of incentive income this year we expect our tax rate to be within the range of 25% to almost 30% for the year.

Now let me turn to AUM and capital raise to discuss them in more detail. As I mentioned previously, AUM for the second quarter was $35.1 billion, up 3% from $34.2 billion from the previous quarter but up 23% from $28.6 a year ago. Third-party capital raises in all of our segments had contributed to the growth and on a year-to-date basis as of today we've raised $7.5 billion gross, of which $2.8 billion was raised during the second quarter. During the second quarter we raised $1.8 billion in private equity and $1 billion in our Hedge Fund businesses. However, it's important to note that certain of these capital raises, in particular from our private equity style funds, do not generate management fees until the capital is deployed.

In the soft market environment, we've demonstrated improvements in our results compared to the first quarter, in particular through overall management of our expenses along with raising and deploying capital in areas of the market where we see opportunities for investments.

And now I will turn it back to Wes for a few closing comments.

Wes Edens

Great. Thanks, Dan. I just wanted to say a few words on the dividend.

You know, our dividend policy to date has been to pay out a substantial amount of our earnings in the form of dividends. To date thus far this year we've paid out $0.225 per quarter, and we have our next scheduled dividend that will be paid out in the month of September. And although not final, we are considering reducing our dividend to be consistent with how some of the other companies in the sector have done, so instead of base dividend at a rate which approximates our net earnings based on management fees, which on an annual basis now would be about $0.50, and then evaluate at the end of the year what to do based upon actual results.

We haven't decided conclusively one way or the other what to do on this issue, but I know it's a question in many of the investors' minds and I just wanted to make sure that I addressed it right now.

So with that, Lilly?

Lilly Donohue

Amanda, if we could turn it to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Roger Freeman - Lehman Brothers.

Roger Freeman - Lehman Brothers

I guess just first on the $1.8 billion in Private Equity funds raised this quarter, was this to fund deals that were closing or what is this, new commitments?

Wes Edens

The $1.8 billion is from a handful of different funds. It runs across the different credit businesses as well as in Private Equity, which is actually in the month of July. So the $1.8 billion was for the quarter. The bulk of it really is in Pet's area, in the Fortress credit funds and in the different mortgage funds.

Roger Freeman - Lehman Brothers

And so this is the stuff that's joint ventured between the Hybrid and the Private Equity?

Wes Edens

No, about $900 million of it is. It's joint ventured between ourselves and the guys upstairs in the Macro business, which is really the mortgage funds. Pete's fund, the Fortress Credit Opportunities Fund, that's the $1.9 billion that we have in commitments that we've captured $2.5 billion that we referenced earlier. That's the other part of that, Roger.

Roger Freeman - Lehman Brothers

So as you think about private equity and the Private Equity segment going forward and this Fund VI your raising and if I'm just trying to put your comments together about where you see opportunity, it sounds like you're staying really focused on credit from a Private Equity standpoint. And you're mentioning banks and insurance companies. Is that sort of where we'd be thinking you'd put money to work?

And on the bank front, are you thinking regional banks and do you need some of the ownership caps lifted to really be able to execute on that strategy?

Wes Edens

Yes, you know, we have as a firm have historically done a lot of work on the credit side, obviously. And there hasn't been a distressed market since the 2001-2002 period, but that's obviously changed quite a bit. We think that the financial services space and the credit markets are not only interesting but could be really historic in terms of the opportunities set in front of us.

The credit stuff, as I said, we've invested over $6 billion in credit-related assets thus far this year across the firm in a variety of different places. That is only going - likely to accelerate with Pete's fund and other initiatives we've got around here. And in the private equity sector I'm very, very focused on the providers of leverage, you know, the banks and the insurance companies. I think of the two, the insurance company space is something that is more interesting for a variety of reasons right now.

But the banking sector is something. Again, back in the time of the RTC we were very active in the whole bank and finance sector. I think it's likely that there will be tremendous opportunities that exist there. I still think that on balance it's a little bit early on the bank side. You know, obviously since our last quarterly call there's been a handful of banks that have been taken over. There's many more others that are on the watch list. We know that there's a lot of companies that need additional capital. It's not specific to regionals or small banks or big banks.

I think that the financial system overall still needs a fair bit of repair on the capital side and that as time passes I think that the opportunities there are going to be tremendous.

Roger Freeman - Lehman Brothers

And then on the $6 billion of funds that you've put to work in the credit space, can you just give us sort of maybe some at least rough breakdown on asset classes? We know funds you've raised around mortgage, resi, you know, they've been leveraged loans. How does that sort of break down so far?

Pete Briger

The two areas that we think are most interesting right now, one is obviously mortgage finance broadly defined. Certainly sentiment in the world is negative in almost every corner and, as Wes said, we like to be investors when the perception of risk is absolutely at the most extreme. So I would say broadly defined mortgage finance securities, whole loans and all the derivatives associated with all of those different businesses.

The second one is direct new extension of credit. While the loans on banks and investment banks' balance sheets have certainly gotten more interesting, they're not as interesting as new extension of credit in the marketplace. We can craft much better investments with better covenants, better pricing, etc.

So those have been our two areas of focus. We think the corporate distressed market and the commercial real estate market are not yet baked, not yet really interesting enough broadly defined to be investing in whole hog, although there are individual opportunities out there that we have pursued.

Roger Freeman - Lehman Brothers

And just in the resi space, where do you feel the market is there right now? You'd already put some money to work earlier in the year. There's reports that the fund's down fairly meaningfully. Do you think you were early based on your analysis of residential performance? Are we near bottoming at this point, do you think?

Pete Briger

Well, if you just use the liquid indexes as a proxy, at the beginning of the year the ABX Indexes, the tripleA side, were still in the 80s and even low 90s. That dropped down to really the low 70s at the time of all the liquidation of the telecom stuff. It then kind of bottomed out at the middle of March at the Bear Stearns crisis. Then from the period of middle of March to the middle of May you had the markets get better a little bit every day, and so they went from really the low 60s to the mid 60s to the mid 80s in some cases. And then from the middle of May until about 10 days ago, it seemed like every day the entire credit sector went down.

And so we made investments across all those different periods and for the most part the markets are lower than where we made a lot of those investments, but the investments we made in those specific funds that you asked about, Roger, are long-term locked up funds. They're designed to accept a lot of market volatility and so it's the ultimate performance of the assets that will dictate the returns of that fund.

And I do feel that the risk/reward relationship of those securities is tremendous. I think it's actually at a place where, you know, you think about in the RTC days, we bought many, many billions of dollars of loans in the 60s and 70s and 80s, and now you're buying tripleA securities with 30%, 40% credit support in the 40s, 50s and 60s. It seems like a tremendous environment for us and something that we're still very focused on.

Wes Edens

A couple points. One is we do expect the residential markets in many respects to continue to deteriorate for some time, but the prices reflect a significant amount of deterioration, both with respect to real estate prices and with respect to defaults.

One thing I would mention, though, is when I was in Asia investing in distressed debt across Asia at the time of the Asia crisis, the early investments that we made when we were competing in auctions, there was the biggest spread between the winner and the second place, what we call the cover in the business. And the same was true in the RTC days in the early 90s. The winning bid might be substantially higher than the number two bid in some of these auctions.

And I can tell you almost uniformly those early investments were the best investments. And I wouldn't say as a rule necessarily that the biggest cover denotes the best investment, but when markets are stressed out and capital flows are very stagnant, there is a big differential.

So pricing, while it's important and certainly you can price almost everything today, pricing is important to look at but what really you need to focus on are the underlying trends relative to your pro forma expectations. And at least from our perspective, our expectations on the underlying assets, the assets have actually performed better than our expectations.

Operator

Your next question comes from Marc Irizarry - Goldman Sachs.

Marc Irizarry - Goldman Sachs

Hey, Wes, a question for you on the Private Equity funds on the '04 and I guess '06 vintage, so maybe Fund IV and Fund V. Can you talk about the industries and the holding on the private side, the industries that you're invested in in those funds? Can you talk a little bit about the cap structures as well, and then just what you see for the outlook for sort of marked-to-market improvement in those businesses or operating improvements in those businesses?

Wes Edens

Yes. Just off the top of my head, I think that the largest four investments that we've got in these most recent vintage funds would be the following:

We have a very large investment in Florida East Coast, which is a railroad and real estate business.

We have very substantial transportation investments, both in the shipping and ship container business, and then in particular in railroads. I think we're the largest owner of short-line railroads in the United States.

I think the largest investment we've made to date is kind of the private counterparty to Brookdale. It's a private company called Holiday Retirement. It's the kind of three-star equivalent of the five-star Brookdale model that we invested in about a year and a half go.

And then lastly, I guess, the other large investment would be Interwest, which is a collection of both a ski business, a real estate business, travel and leisure business, etc.

Starting at the top, Florida East Coast railway, I think, may prove over time to be one of the best investments that we've ever made. It's an investment that we have many, many different ways of profiting. The railroad business itself, this is a single line railroad that runs from Jacksonville to Miami. Given the transportation needs of the state of Florida, we think it is an incredible asset. And even given the economic slowdown in the state, we've continued to have very, very good operating results there. We think that the right of way is something which is incredibly valuable.

And the real estate portfolio in this case, primarily it's about two-thirds industrial properties, it's about onethird commercial office buildings, 90% plus occupied. We own about 6,000 acres of land, 3,000 of which is entitled to be built on. The guy that runs that business as our partner is a fellow named Armando Codina, who is a highly regarded partner and really has been a tremendous person for us to work with thus far.

And I think when we add up all the different pieces of that business over the years, that is likely to be something which is very, very substantial and we're very excited about that.

You know, the railroad business, there's been a lot written about the railroad. It's on the front cover of Barrons here I guess just last week. Our experience in the railroad business has been tremendous. The overall aggregate shippings are down in line with kind of an economic slowdown. I think in our numbers we're 5% or 6% or 7%, you know, year-over-year declines in shipping traffic. With that, I think net cash flow is up 16%, 17% organically. So the pricing power in that industry is terrific, and we think for a whole variety of reasons we've got a long ways to go. We've accumulated a very substantial position there. That's a large private position.

I did mention, Marc, that we had refinanced a good chunk of that recently. We're in the process of doing the last piece of that now. And with that I'd say that, across the board, our capital structure in these businesses averages about 55% leverage, so I don't want to be flippant about the leverage stuff. As I've said, we've done a tremendous amount of good work over the last year, $12 billion plus of financings, 50 different transactions. Each one has had its own challenges and issues, but they've all gotten done at reasonable prices and yields, and I think that we're going to continue to have good success there.

The Holiday stuff, we actually had an earnings report this morning on Brookdale. I think the market has responded appropriately to that. That business also is a pretty good proxy for what's happening in the housing markets, and we have seen really positive inflow results in those businesses for the first time in the last couple of years. You know, people need to sell their houses in some cases in order to move into those facilities so, on a very, very kind of granular basis, it can give you a great snapshot of how those different industries are going.

Interwest is a company we bought a couple of years ago. It's a business that has been probably our best performance as a management team in terms of turning around and cost cutting and restructuring that. We've hired a completely new management team there. [Tobia Polido], who runs a lot of our stuff here on the operations side, has spent a considerable amount of his life out in Vancouver over the last couple of years. I think that the same-store EBITDA on the ski business is up about $100 million from the time that we bought it, so obviously a good chunk of that is cost cutting and rationalizations. And we've just done, we think, a heroic job there.

The real estate portfolios that we own there we think have incredible value in the long term, and we are not highly financed. We paid about $3.5 billion for all that stuff and we've got about $1 billion and change in debt in total, so we have got a modest amount of leverage against the entire portfolio, and that's what it is.

So those are the four biggest holdings. There's other material ones, but those are the four biggest ones, Marc.

Marc Irizarry - Goldman Sachs

And then in terms of capital raising, even on the private equity side of the business, are you seeing any change in LPs interest in putting money to work in private equity right now, particularly given it sounds like you're going to do more distressed investing, but maybe the opportunities are still a bit too far out there. What are you seeing in terms of LP interest for raise [inaudible] private equity?

Wes Edens

Well, it's similar to the comments that I saw from some of the calls yesterday. I think that the LP universe, along with every other human being, has been shocked and is somewhat on their heels in terms of what's happened to the market over the last year. It has been, at least by my measure, the most disruptive bad market that we have ever been a part of. There are bad markets that can be very constructive and have great opportunities and there are bad markets that are destructive, and this certainly falls in the latter category at least to date, where it just seems like everything that you touch seems to be worth a little bit less the next day.

Having said that, the investors with us, the investors that invest in private equity, know that the best time to invest is when it feels the worst and the opposite is also true. And I think that given the opportunities that we see out there, we have found and will continue to find ample capital to pursue them.

There are a number of very specific initiatives that we've got this year, but we are virtually uniformly focused on the financial services and credit spaces right now. I think there will be lots and lots of other kinds of things to do and, when the markets are more fully priced, you need to be more creative and more broad reaching in terms of the kinds of things you consider and the industries and the businesses you look at. In times like this, there should be a tremendous amount of money made just by being right about very, very basic blocking and tackling in the financial services. It's complex. There's lot of issues around it. But it's something that we are obviously very, very focused on.

Marc Irizarry - Goldman Sachs

And then, notwithstanding that, you're still raising capital. Would you care to size the most recent vintage PE fund?

And then also it looks like you're halfway to your target of $15 billion in terms of capital raises to maybe $20 billion. Where do you think that stands? Does that maybe get pushed off a little bit more in 2009 perhaps, given the environment?

Wes Edens

I'm reading these single words that my General Counsel just put in front of me, which says "No." So I think that unfortunately we can't comment about private funds that are being raised, unfortunately.

We have, as we told you before, we had our goals in terms of what we hoped to raise in capital for the year. Historically we've raised about $11 billion a year for the last number of years. We're $7.5 billion into it through the first seven months. And I do think that capital will flow to opportunities and we think that there's lots of opportunities out there.

So I'm optimistic about it, but I just can't be more specific.

Operator

Your next question comes from Robert Lee - Keefe, Bruyette & Woods.

Robert Lee - Keefe, Bruyette & Woods

Wes, could you maybe give us a sense of, aside from the Private Equity Fund VI, some of the terms or capital lockups in some of the recent capital raises? Are we looking at three, five-year lockups and a typical kind of fee structure?

Wes Edens

Well, the private equity funds are as you'd expect them to be. They're very consistent with the rest of the industry, so kind of 10 to 12-year terms with 3 to 4-year investment periods. The private equity fund that Pete just raised, is in the process of raising, on the credit side is 10 years as well. The mortgage ops fund itself that we raised earlier this year is also 3-year capital with the possibility to extend it. So those are all long-term funds.

The credit ops core fund, the special opportunities fund, has got annual redemption features, but it's got, consistent with the types of things it invests in, it's got the ability to extend that callability to capital to make sure that we don't get short called in capital in that fund. It's a very well-structured fund.

And then in Mike's fund - about half of the capital, Mike, what is it, about a third?

Mike Novogratz

A third is in 3-year money.

Wes Edens

A third of it is 3-year money and two-thirds of it is the capital. So that's really the shortest equity duration of all the things we've got. That's the way the liquid markets are. But we've got a decent chunk of that that has migrated to longer-term capital as well.

Robert Lee - Keefe, Bruyette & Woods

And just in terms of the mortgage ops and credit ops, kind of general fee structure in terms of management fee? I assume it's the normal kind of 20% carry, but are there kind of return hurdles or anything in those?

Wes Edens

Yes, for the mortgage ops that Pete just raised it's 1.5 and 20, right, Pete?

For the securities business that we've really co-authored between myself and Mike, that is just 1 and 10, but that's a single-purpose enterprise that's just looking at securities. That's the lowest fee structure of anything that we've done here on the active investment side.

The other funds are exactly as you'd expect. I think Mike's core fund is 2 and 20, 3 and 25 on another chunk of it. The private equity funds average about 1.15, I think, off the top of my head, in terms of management fee and then 20% of the upside.

Robert Lee - Keefe, Bruyette & Woods

And I'm just curious, in the special opportunities fund I know you had some dry powder from leverage you could tap. Could you just maybe size what that is for us again? I seem to recall it's a couple of billion.

Wes Edens

It is still significant. I think that we view that as a proprietary piece of information, so I'd rather not go into specific [inaudible].

Operator

Your next question comes from Roger Smith - Fox-Pitt Kelton.

Roger Smith - Fox-Pitt Kelton

I know you can't talk about raising the public funds but can you just help me understand where you would be in the process of a new type of private equity fund, meaning that it was my understanding that you needed to have 75% of the commitments of your prior fund in place before you could raise a new fund. And with $1.5 billion of uncommitted, does that mean that you are not yet at the point where you can go out and market a new fund, or am I looking at that incorrectly?

Wes Edens

No, we can market a fund and we have done some marketing to date. That's why we had the first closing here, I guess, a week or so ago. That fund we have not yet turned on because we still have a significant amount of capital in Fund V and we're certainly evaluating a lot of different things. I think I said earlier my expectation would be that we will fully invest that this year. That's not a certainty but it's my expectation based on what's out there. And then when that fund is fully invested we will then turn on Fund VI, and we certainly expect Fund VI to be a substantially larger fund at the end of the day. But that's the process. And we can't really comment exactly what our expectations are or why we're still marketing that.

Roger Smith - Fox-Pitt Kelton

I just wanted to understand if that process of Fund VI already is well under way on the marketing side, and once you're fully deployed we wouldn't think that that's the starting point of going out and marketing it.

Wes Edens

It's not.

Roger Smith - Fox-Pitt Kelton

And then on the Newcastle, it was a write down on an impairment of $10 million. Really, what caused that impairment and then what's the potential that's left there in the Newcastle investment right now?

Dan Bass

The impairment was really the amount of time the investment traded below our cost and the amount of recovery that it needs to get. It's an other than temporary impairment. Right now our remaining basis is around $6 million in that Newcastle investment.

Roger Smith - Fox-Pitt Kelton

And then I guess lastly, just on the dividend here, if we talk about the sustainability of the current dividend, how long do you think, if you decided not to change the policy that you discussed earlier, how long - should management fee earnings be the only earnings that come into play, how long do you think we could keep the current dividend in place?

Wes Edens

Well, the current dividend - again, just to kind of restate it - the current dividend was intended to be our best guess at the beginning of the year for what a normalized set of returns would be. It's not a normalized year in terms of realizations and the like. We think that the right thing to do is to consider reducing it to something, which is very noble, which is what's your earnings on management fees.

Again, just walking through what we just did, most of our management fees, the vast majority of them, in fact, are very noble. They're very locked and very long-term. So establishing a dividend at that level, we think, is something which is an easy thing to do.

What the incremental over that would be is just a function of performance. And, you know, we still have five months left in the year and we still have aspirations to have great performance in a number of these businesses this year, and that's why we're not making a definitive statement about this now. We're going to sit down with our Board and talk about it in September. We mentioned it to these guys and had a conversation about it with them earlier this week, but it's something we'll consider in due course.

And really my objective is to be as transparent and as clear with people as possible and so, lest there be some kind of general concern about whether we're going to pay a dividend or how it works or whatnot, I thought it would be reasonable just to tell you look, certainly in terms of, like, establishing it at or around management fees, which is roughly the $0.50 number for the year, that's a very basic thing, and then just evaluating the incremental to that, what we do with the money.

Roger Smith - Fox-Pitt Kelton

And then just on the credit funds, is there any particular area that you are more focused on in this market or that you see bigger dislocation? I guess what I'm really asking is are you looking at like the hybrid ARM products or are you looking at pick-a-pay or an option ARM? Is there anything that's more attractive in this environment in your perspective?

Pete Briger

Well, I think that there definitely are certain areas that we are more focused on than others, but obviously we'd rather keep that to ourselves until we've finished investing.

Wes Edens

It's fair to say [inaudible] the residential space, then it's quite a bit more compelling in the commercial stuff right now, right?

Pete Briger

Yes.

Wes Edens

For the most part? I mean, there's obviously individuals -

Pete Briger

For the most part. And from our perspective, you know, we tend to like the worst situations, the highest perception of risk. The pricing generally tends to overshoot the actual performance. So you can bet where things actually look the absolute worst is where we'll focus.

Roger Smith - Fox-Pitt Kelton

And then I would have thought that you would have had some incentive income potentially on the sale of the GM building. Did that sort of net numbers out in the quarter for the funds?

Dan Bass

Obviously, we had a very favorable outcome there, which we expected. But there's still some - the way that that fund works is it needs to be resolved in its entirety for us to actually create the performance fee, which we will create. So that is not reflected in the first half's numbers.

Operator

Your next question comes from Daniel Fannon - Jefferies & Co.

Daniel Fannon - Jefferies & Co.

Can you talk about your backlog for transactions? You talked about potentially deploying the rest of Fund V by the end of the year. Is this something where you're looking at and just kind of monitoring the insurance kind of financial space or are there things that you're actively a little bit more closer in terms of investing in?

Wes Edens

We're very, very actively looking at a bunch of situations. And without being specific, some of them are public companies, obviously. It's something which I think is actionable and I think that we'll have some success here. I'd be disappointed if we don't between now and the end of the year. Obviously, each one of these deals is a binary event, but given what we see, the opportunity set, I think that there's a very, very good opportunity to deploy capital right now in that sector.

Daniel Fannon - Jefferies & Co.

And then are there any financings that are coming due in terms of your current portfolio over the next kind of 6 to 12 months that are large or that are kind of looming out there right now?

Wes Edens

The only one that we've got that's on the horizon really is Interwest which, you know, thankfully we have both low leverage in the business as well as actually terrific operating results. So we're in the process of [inaudible] in the market with that. That's something that matures this fall.

The bulk of the stuff that we have done over the last year has been preventative. It's been things that we have kind of proactively sought to extend maturities and the like. And so the portfolio is incredibly well financed really across all of our portfolio companies. We've got some individual mortgage financing stuff that we have done both in the U.S. as well as in Germany. There's a handful of different things. The only significant piece of finance that is out there in total is, on the Private Equity side, is really Interwest, and that's something that we feel like in due course is going to be fine because it's a great company, it's got great assets and it's low leveraged.

Operator

At this time, we have reached the end of our allotted time for questions. I would now like to turn the conference over to Ms. Donohue for any closing remarks.

Lilly Donohue

Great. Thanks, everyone, for joining us and we look forward to talking to you next quarter. Any follow up, please don't hesitate to call. Thanks, again. Bye bye.

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