RAIT Financial Trust Q3 2008 Earnings Call Transcript

| About: RAIT Financial (RAS)

RAIT Financial Trust (NYSE:RAS)

Q3 2008 Earnings Call

November 5, 2008 9:30 am ET


Daniel Cohen – Chief Executive Officer

Jack Salmon – Chief Financial Officer

Scott Schaeffer - President


David Fick – Stifel Nicolaus

Jason Arnold – RBC Capital Markets

Joshua Barber – Stifel Nicolaus


Welcome to the third quarter 2008 RAIT Financial Trust earnings conference call. (Operator Instructions) I would now like to turn the presentation over to host Mr. [Andres Vershloff], Director of Corporate Communications.

[Andres Vershloff]

Thank you for joining us today to review RAIT Financial Trust's third quarter 2008 financial results. On the call with me today are Daniel Cohen, Chief Executive Officer, Betsy Cohen, Chairman of the Board, Schaeffer, President and Jack Salmon, Chief Financial Officer.

This morning's call is being webcast on our web site at www.raitft.com. There will be a replay of the call available via webcast on our web site until approximately 11:00 am. ET today. The dial in for the replay is 888-286-8010 with the confirmation code 85629845.

Before I turn the call over to Daniel, I would like to remind everyone that there may be forward-looking statements made during this call. These forward-looking statements reflect RAIT's current views with respect to future events and financial performance. Actual results could differ substantially and materially from what RAIT has projected. Such statements are made in good faith pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Please refer to RAIT's press release and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations. Participants may discuss non-GAAP financial measures in this call. A copy of RAIT's press release containing financial information, other statistical information and a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure is attached to RAIT's most recent report on 8-K available at RAIT's web site, www.raitft.com under investor relations. RAIT's other SEC filings are also available through this link.

RAIT does not undertake to update forward-looking statements in this call or with respect to matters described herein except as may be required by law. Now I'd like to turn the call over to RAIT's CEO, Daniel Cohen.

Daniel Cohen

Thank you for being with us this morning during what continues to be an extremely challenging and volatile environment. After some brief remarks I will ask Jack to deliver his financial report after which we will open up the call for questions.

We continue to face unprecedented market conditions which continued to deteriorate during the quarter. However, I'd like to point out our continuing cash flow which was in line with our previous quarter. As we all know, several large financial institutions have failed, the credit markets froze, the economy many believe has entered a recession, and the stock market is extremely volatile. It's really not a lot of fun out there but we do continue to generate cash flow and that is what we are focused on.

The real estate markets can be described as weak. We've all witnessed the unprecedented government intervention attempts to try to stabilize the financial system from what former Fed Chairman Allan Greenspan recently characterized the credit tsunami.

I, like what other CEO's have said, is recessionary market conditions are very concerning to all of us, and we look forward to the time when volatility subsides, markets stabilize and the economic cycle begins to turn.

This is a point that RAIT will reach because of our aggressive managing of our liquidity and I and Jack will speak about on this call. We expect to participate in a market recovery and have positioned ourselves to take advantage of opportunities once the market begins to recover, and opportunities begin to appear.

Until the market recovers and gets to real investment opportunities we are vigorously and we think effectively managing our portfolio to maximize our cash flow. We've been managing the effects of the global credit crisis by working diligently to stay ahead of financing risk by stabilizing our liquidity position and by working with our borrowers.

Over the past 15 months, we've eliminated our exposure to short term repurchase debt, which in this environment comes with a high degree of uncertainty and counterparty risk. No good things have come of short term leverage for many months. Since June of 2007, we have repaid approximately $1 billion in short term repurchase debt.

This last quarter marks an important point for RAIT as we have refinanced the final $27.5 million of exposure in the third quarter to a longer term facility which reduced the uncertainly surrounding our short term liquidity position. By completing this financing, we successfully turned out our short term purchase agreements and removed the risk of margin calls without the need to sell our assets at fire sale prices.

As detailed in our earnings release during the third quarter, we generated $0.46 per share of adjusted earnings supported by $44.3 million of gross cash flow. Our portfolios are generating cash flow and net investment income. However, they are not immune to credit issues. We have experienced an increased in non-performing loans in our commercial real estate and residential mortgage portfolios, and in turn, have adjusted our allowances for losses accordingly.

Our TruPS portfolio was mark to market quarterly has devalued as have many fixed income assets. On a fair value basis, mainly due to market conditions as well as additional issuer defaults, our investments into Taberna Eight and Nine continue to cash flow and our entire investment in these deals is not subject to any short term borrowing.

Today, we are focused on proactively managing credit issues in our $14.3 billion of assets under management in order to maximize recovering cash flow. Jack will provide further portfolio details in his financial report.

We do continue lending in the commercial real estate market through our origination platform where we have long term committed capital available and our securitizations, line of credit capacity and institutional capital looking to partner the loans we originate. During the third quarter, we originated $47 million of commercial real estate loans and received $57 million in loan repayments.

Obviously, we are approaching the market gingerly. The credit crises has slowed transaction volume and new fee generating opportunities which are predicated on the pace and amount of loan repayments we receive. The crisis has also made it more challenging for our borrowers to find suitable longer term financing for their commercial real estate projects.

However, Fanny and Freddie continue to lend against multi-family properties in this market which represents approximately 52% of our commercial real estate portfolio. Liquidity for other commercial property types remains scarce. Banks are hesitant to lend and the securitization markets for commercial real estate assets are frozen.

In this environment, we continue to review investment opportunities within our capital structure most aggressively. With that, I'd like to turn the call over to Jack to review the third quarter results as well as review the credit performance of our domestic and European portfolios.

Jack Salmon

I will comment on three aspects of our third quarter financial results. They are; credit performance, cash flow trends in our portfolios, and the capital transactions that we have looked at and continue to look at heading into the fourth quarter.

First of all, from a financial results oversight, our reported GAAP net loss of $181.7 million was primarily caused by a non-cash fair value adjustment to our TruPS portfolio and an impairment charge to write off certain intangible assets. Neither of these reduced our adjusted earnings or cash flow.

On a cumulative basis through September 30, '08, we generated $62.9 million of GAAP net income or $1.01 per diluted share and $94.9 million of adjusted earnings or $1.52 per share. The adjusted earnings of $0.46 for the third quarter does reflect non accrual income impacts for certain underperforming loans that occurred during the quarter. We continue to monitor the ongoing effects of credit performance as we continue to finance these assets for the long term returns for our shareholders.

My comments on our portfolios which follow will reflect the cash flows that we displayed in the earnings press release and they list the cash flows by portfolio on a quarter to quarter basis and year to date for September 30.

Our first portfolio is our commercial real estate portfolio. It is our primary investment portfolio with over $2.1 billion of assets under management which generates $23.1 million of gross cash flows representing over 52% of our current cash flow. During the quarter, we originated $47 million in new loans and we've originated $186 million of loans year to date.

The primary source of funding for these loans continues to be loan repayments within the portfolio which were $57 million during the quarter and $141 million year to date, while we continue to seek JV and other forms of financing for new loans.

At September 30, we had approximately $92 million of funding capacity comprised of $55.6 million of availability in our CRCDO's in a revolver capacity and $36.5 million from our secured bank facilities. These are all dedicated to growing the commercial real estate portfolio.

During the quarter, our non accrual loans increased to $146 million which represents 6% of the portfolio. This is up from $42 million at June 30. We also increased our loan loss reserve during the quarter to $46.3 million, an increase of $7.8 million.

As we continue to pursue ways of improving our overall recovery, and repayment on our loans, we experienced temporary reductions in net interest margin and cash flow. Approximately 73% of our underperforming loans are first mortgages hence we believe our reserves are adequate for the ultimate of our portfolio.

Our second portfolio is our residential mortgage backed securities. As of September 30, we owned approximately $3.7 billion of high grade residential mortgage loans all of which have been securitized with retained interest investment on our part of $235 million.

The residual cash flows generated approximately $4.8 million of cash flow for the quarter similar to the first two quarters of the year. This is subject to normal prepayments and the credit performance of the underlying assets and in general, the credit has deteriorated as we experience increased delinquencies in the September/October time frame.

Total non accrual loans at September 30 were $170 million, representing 4.6% of our portfolio and we have recorded $19.5 million of loan loss reserves, an increase of $2.5 million during this quarter.

Our third portfolio is a managed portfolio. These assets are primarily off balance sheet and we manage $1.9 billion Euro portfolio of debt related securities generating $4.3 million of cash flow in the form of management fees and residual equity returns during quarter three representing about 10% of our total cash flow for the quarter.

During the third quarter, we experienced our first credit by two issuers of these portfolios with an additional two issuers considered at risk of default in the future. As a result, we expect to receive our collateral management fees and equity returns from our first European securitization but only the senior collateral management fees from the more recent securitization on a go forward basis. These defaults will reduce our expected cash flows by approximately $2 million per quarter beginning in the fourth quarter.

In order to complete our second European transaction, we did pay down approximately $120 million Euros of various debt contracts in lieu of originating additional assets. We are expecting notification about confirmation in the near future on this transaction.

Our fourth portfolio is our corporate and domestic trust portfolio. We own approximately $4.1 billion of securitized debt investments that are recorded at fair value of approximately $2.5 billion at September 30. This is after reflecting the fair value adjustments on both the assets and the underlying debt instruments. We manage an additional $2 billion of assets in this portfolio.

The portfolio generated $12 million or 27% of our gross cash flow for the quarter. During the third quarter we experienced $102 million increase in payment defaults and certain incremental covenant defaults in the portfolio. This resulted in recording net fair value adjustments of $302 million during the quarter of which $118 million was allocated to minority interests.

These net fair value adjustments include reductions in assets of $540 million offset by net debt revaluation gains and hedging adjustments of $238 million. At September 30, '08 approximately $475 million of the unpaid principal of our TruPS debt securities were on a non accrual status which results in lower net interest margin and cash flow from the portfolio.

As of October 31, 2008 we had one additional issuer who has defaulted. However, it's important to note the total number of issuers and payment default were in bankruptcy condition have remained consistent with the results of August 2008 during periods through October.

We continue to seek remedies and other means of restructuring this underlying collateral so as to improve the overall recovery in future periods. For example, during quarter three, we changed the collateral in one of the Taberna eight transactions that resulted in recovery of approximately $2.5 million of deferred subordinated management fees and cash flow from our residual interest which had been deferred beginning in quarter two.

Now we are unable to determine whether the number and range of issuers seeking alternative repayment terms will enable us to sustain the cash flows at these present levels within each of the Taberna transactions.

Turning to our capital events. As Daniel mentioned, we are managing our business to maintain stability and liquidity. In that that light, we completed the transaction of financing out our short term repurchase debt to remove the uncertainty of margin calls and be able to plan for future capital requirements without that as an overhang, although we did pay a higher coupon to obtain this certainty and control over our financing sources.

We also continue to evaluate potential redemption of debt issued by RAS in various structures in our corporate structure. We are paying our fourth common dividend this year in December which represents a total of $1.73 per share paid to the common shares during the year, and our quarterly preferred dividends, with the fourth dividend being paid on December 31, 2008.

To summarize where we stand at the end of the quarter, we have new capital availability which is dependent on factors outside of our control, primarily the global capital markets. We do have adequate financing capacity within our existing CRE business to replenish the assets as they mature, or roll over or are sold.

Our future CRE investments will include direct ownership of real estate and loans as we have done in our origination business historically. The credit performance across all of our investment portfolios may result in reduced net interest margin and cash flows in the future. However, we believe that our loan loss reserves are adequate to dispose of the underperforming assets at our current carrying values.

Accordingly, we believe we are generating significant cash flow and adjusted earnings and paying dividends in accordance with our estimated pre-tax requirements for the year.

With that, I'd like to turn the presentation back to Daniel

Daniel Cohen

Before I open up the call for questions, I would like to comment on the challenges we see for the remainder of 2008 and into 2009, and really, reiterate what we will continue to focus on. Our challenge is, and our focus will be to generate adjusted earnings, originate new risk adjusted good performing assets with the securitizations and funds that we have dedicated for those in earning fees, enhancing our cash flow from our investment portfolio, repositioning our non-performing assets.

We believe these are the appropriate steps to position RIAT in the near term for long term growth. We will continue to focus on managing the credit risks that are in our existing portfolio. Now that we believe that we have eliminated liquidity risks so we can maximize recovery, generate cash flow and improve adjusted earnings to improve our financial performance.

Thank you very much and we'll open up the line for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from David Fick – Stifel Nicolaus.

David Fick – Stifel Nicolaus

Can you comment about any potential impact from FAS 140 and 1046 and whether it would affect your credit line covenants and ratios?

Daniel Cohen

We're looking at those changes. Our credit lines basically have no covenants that were in difficulty of tripping at this point so we're in compliance for quarter three, and we'll continue to look at that as we get to year end.

David Fick – Stifel Nicolaus

Your dividend policy, you haven't paid a dividend for the third quarter. Can you comment on where you stand going forward?

Jack Salmon

We have paid three dividends year to date of $0.46 and we have declared a dividend of $0.35 for the fourth quarter which will be paid in December, totally $1.73. That's our dividend payment for this year.

David Fick – Stifel Nicolaus

What is your view on the forward dividend?

Daniel Cohen

We've taken a policy especially in this environment of waiting until the end of each quarter to make a dividend announcement and we're going to continue that policy. Additionally, we look primarily to our cash flow and to our adjusted earnings as indicative of the dividend we will declare and the Board considers that as well as pre-taxable income.

David Fick – Stifel Nicolaus

The Taberna CDO's, the October default, can you just review for us what CDO's are cash flow and which ones aren't at this point? You have CDO 8 or 9, what's the status?

Jack Salmon

First of all, we have nine Taberna CDO's. Two of them are managed CDO's at this time, meaning that we are basically not controlling. Another CDO is not consolidated because we own less than a controlling interest so those are three of the CDO's.

Of the nine, seven of them are in some level of impairments such that the residual returns below event the BBB level are not flowing, and the cash flow from those instruments are paying the senior debt down on an amortizing basis.

Taberna Eight and Nine are performing CDO's such that we are receiving our senior collateral management fees, our subordinated collateral management fees and our equity residual return in both Taberna Eight and Nine. As I mentioned in my comments, during the quarter we were able to rehabilitate Taberna Eight which had lost its subordinated management fees for a time period in quarter two. That resumed paying the subordinated management fees in August and through October we are also on a performing basis in Taberna Eight and Nine.

David Fick – Stifel Nicolaus

What is your assumption going forward on those? Are you assuming that at some point you will lose the cash flow there?

Jack Salmon

Well no. We are heavily dependent on the significant stress that our issuers are suffering under this credit market so quarter to quarter, we assess based on payments that have occurred. As I mentioned, we have reached the point where the payment defaults are fairly static from August through October. That's no guarantee that they will be static in the future. We have no idea of the number of issuers that could face uncertainties in the future which will then affect us.


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

Jason Arnold – RBC Capital Markets

I was wondering if you could give us your 30 to 59 day delinquency total. You gave us the 60 days plus.

Daniel Cohen

The details will be in our Q that will be filed later this week. I think we gave you our non accrual loans in the CRE portfolio which again is $146 million and in the residential portfolio it's $170 million which would include those delinquencies.

Jason Arnold – RBC Capital Markets

Can you give us any color on what you're seeing on CRE side in particular in the last month or two months from a performance perspective?

Daniel Cohen

In generally, we have been aggressively interacting with the borrowers. Probably because of the nature of our business, we were hit relatively early on by the change in credit conditions so I don't think we've seen any real changes over the last month.

Scott Schaeffer

We've not seen any real changes and what we're experiencing I believe is consistent with what others in our space are experiencing. There has been some softness and some slower pay in some retail rents, but again retail is a minor portion of our portfolio. 52% are multi-family. We're not seeing any significant change in that portfolio or that portion of the portfolio.

The economy is one that is struggling as we all know and the small non credit tenants that are in office and in the retail spaces are the ones where we're seeing impacted the most.

Jason Arnold – RBC Capital Markets

I recall that you have some exposure in CRE One to a development in Florida that one of the big lease holders and I know that the terms were coming up for renegotiation, have you heard anything on that?

Daniel Cohen

No. There's been no change.

Jason Arnold – RBC Capital Markets

On the terms of the refinance of the repo, could you give us a little more color there please?

Jack Salmon

We filed an 8-Q awhile ago that went through a lot of color.

Jason Arnold – RBC Capital Markets

Can you review what the terms are for us please?

Daniel Cohen

Generally we borrowed $27.5 million up to a two year term securitized by two sub portfolios, primarily secured by our residual residential mortgage backed securities portfolio and a small portion of our CRE bond. The coupon on the instrument is 13% and has certain other terms that would make us look at credit performance underlying assets for accelerating the repayment terms. So we view it as something that has given us term financing for up to two years and given us the ability to manage our cash flow on a more predicable basis going forward.

There are also $250,000 in warrants which are currently out of the money.

Jason Arnold – RBC Capital Markets

On the credit side of things, where would things need to go or to what degree would it need to worsen to trip some of those covenants on the line there?

Daniel Cohen

The covenants do not get tripped by the credit performance so the line will not be pulled based on those types of actions. Its submitted financing secured by our residual interests and the underwriting was such that we were able to get $27.5 million of proceeds against those assets for up to two years.


Your next question comes from David Fick – Stifel Nicolaus.

David Fick – Stifel Nicolaus

If I look at your financials looking at Page 12, the distribution is declared per common share shows zero for the third quarter. It looks like you're going to pay four dividends but four this year, you declared a dividend but was it applicable to the third quarter or not? Your financials seem to indicate not.

Jack Salmon

Just to clarify again. We did declare that dividend after the quarter end as Daniel suggested. Our Board reviews the results for the whole quarter and make a determination. That dividend would be $0.35 that I mentioned earlier which would be total dividends paid this year of $1.73. If you look in the earnings release, we have adjusted earnings of $94.9 million through 9/30 and we have paid dividends of about $85.5 million through 9/30.

Joshua Barber – Stifel Nicolaus

I'm just trying to confirm, the dividend that was paid in January of this year was the dividend that was applicable to the fourth quarter or the dividend that was applicable to the third quarter? I'm just confused by your income statement because you're indicating that through September 30, you've only paid declared dividends of $0.46?

Jack Salmon

The confusion is we've paid four dividends so are this quarter. We've decided that in the current environment that the wisest solution our Board has decided is to wait until after the end of the quarter to make a determination based upon the results of the quarter. So in the first quarter, any dividend will be based upon the results of the fourth quarter of this year.


There are no further questions. I would like to turn the call over to Mr. Daniel Cohen for closing remarks.

Daniel Cohen

I think that my closing remarks is to thank everybody for participating in the call. To reiterate, we've been aggressively managing our liquidity meaning that we're willing to pay interest rates that are relatively high to give us certainty in this environment. I think that has been a good thing because even the largest financial institutions have found themselves threatened with collapse on the basis of short term liquidity.

So therefore, we've prudently moved forward. We've measured our ability to move forward as a company by the amount of liquidity that we have in excess of short term repo lines, so therefore today, we obviously, if we have any money in the bank it's in excess of short term repo lines.

We've been able to replenish our cash nicely over the time since the quarter has ended so I think that we're starting to see ourselves being able to be positioned to move forward nicely and start to look at opportunities first in our capital structure and then later in the world if the world continues to develop.

So thank you very much for participating with us and we will talk to you next quarter.

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