Blackstone Mortgage Trust Inc (BXMT) 2005 Q1 法說會逐字稿

Welcome to the Capital Trust first-quarter 2005 results conference call. Before we begin please be advised that the forward-looking statements expressed in today's call are subject to certain risks and uncertainties including, but not limited to -- the continued performance, new origination volume and the rate of repayment of the Company's and its fund loan and investment portfolio; the continue maturity and satisfaction of the Company's portfolio assets; as well as other risks contained in the Company's latest Form 10-K and Form 10-Q filings with the Securities and Exchange Commission. The Company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events.

There will be a Q&A session following the conclusion of this presentation. At that time I will provide instructions for submitting a question to management. I will now turn the call over to John Klopp, CEO of Capital Trust. Go ahead, sir.

Good morning, everyone. Thanks for joining us and for your continuing interest in Capital Trust. Sorry we're starting a little bit late; we had a little technical difficulty there. You almost missed the opening disclaimer which I'm sure would have disappointed everybody.

Last night we reported our results for the period ended March 31, 2005 and filed our 10-Q. A very busy quarter once again and a very good start to our year. GAAP net income was $9.2 million or $0.60 per share fully diluted, slightly down from 9.5 million in Q4 when we had some fairly significant non-cash, nonrecurring items and roughly triple our earnings from last year's first quarter. Brian will give you the details on the financials in just a moment.

Our business can be boiled down to three essential ingredients -- originating new investment opportunities, managing our risk exposure and efficiently financing our assets. When we get it right the combination allows us to produce steady, growing streams of current income for our shareholders and investors which we believe is CT's primary mission. On all three fronts we had significant success in the first quarter of 2005.

In an admittedly tough origination environment we closed 206 million of new investments for the balance sheet plus another 166 million for Fund III. We also had a number of payoffs during the quarter and unfortunately the payoffs came early and the originations came relatively late. So pure timing cut into our net interest income somewhat. Overall we're pleased with our production numbers for the first quarter and our pipeline for the second quarter is very strong.

For the balance sheet, our focus continued to be on lower risk B Notes which carry lower credit spreads but, when leveraged efficiently, produce great risk-adjusted ROEs. At a point in the cycle when everyone seems to be worried about frothy (ph) valuations and rising interest rates we've purposely dialed down our risk profile and the results are clear -- on new originations average loan to value is lower, debt service coverage is higher, and with the exception of that one old $3 million loan that we spoke about on our last conference call, 100% of our assets in all of our portfolios are performing.

Efficient leverage is the third key ingredient and we're very pleased with the execution that we accomplished on our second CDO in mid-March. Designed to be a compliment to our first CDO last summer, this one allows us to finance higher grade collateral on an extremely cost-effective basis. With an investment grade advance rate of 88.5% at a cost of LIBOR plus 49 basis points, this new financing drives our ability to pursue lower risk assets while still achieving our return targets.

CDOs have dramatically transformed the way we finance our business. Compared to just a year ago when virtually all of our debt took the form of fairly short-term mark to market recourse credit facilities, today 83% of our liabilities are term matched, non market for market CDOs and the Company has no recourse debt on its balance sheet. At the same time, the all in cost of our liabilities has decreased from 4.9% to 4.2% while average LIBOR has increased 150 basis points.

If you added in the subordinated debentures the decrease in our cost of liabilities is even more impressive, moving from 6.5% a year ago to 4.2% in the first quarter of '05. In addition to driving down the cost of our capital, increased leverage capacity means increased liquidity and at March 31st CT has over 100 million of available liquidity to make new investments. As the year unfolds our job is to deploy that capital into accretive investments.

In the first quarter we also received our first incentive management fee payments from CT Mezzanine Partners II, roughly four years after the fund made its initial investments. As Fund II continues to wind down additional incentive management fees will be collected. We believe that our investment management business is an important component of Capital Trust's business model, allowing us to leverage our equity capital and our platform to create a steady stream of co-investment income, base management fee and, over time, incentive management fees. The investment period of Fund II expires this summer and we're currently hard at work designing our next offer.

The proof is in the pudding -- sorry, I couldn't help myself. And we increased our dividend again in the first quarter from $0.50 per share to $0.55. As we always say on these calls, we will continue to assess our payout as the year progresses and will set our dividend at a level that we feel is comfortably sustainable. Without further adieux, I'll plus it to Brian to go through the financials in greater detail.

Thank you, John, and good morning, everyone. Since John has discussed the highlights for the quarter I'll get right into the numbers. First, the balance sheet. At quarter end total assets topped $1 billion, increasing 14% from the 878 million at December 31, 2004. The primary drivers of the increase were new loan originations of over $200 million. Offsetting these increases were loan amortization and repayments totaling $77 million.

In March we issued our second CDO secured by $337.8 million of B Notes, Mezzanine loans and CMBS. This financing is designed to allow us to originate lower risk business at lower spreads and create attractive returns on equity. In the CDOs transaction the Company sold $298.9 million of floating-rate investment grade notes with a weighted average coupon of LIBOR plus 49 basis points or LIBOR plus 70 basis points when the amortization of all fees and expenses is included. The structure is termed and index matched non mark to market, non recourse and provides for a five-year reinvestment period that allows the principal proceeds from repayments of collateral assets to be reinvested in qualifying replacement assets.

With our second CDO issuance we have restructured the manner in which we finance our business. Proceeds from the CDO financing were used to pay down outstanding borrowings on the Company's credit and repurchase facilities. As of March 31, 2005 we had no recourse borrowings and 83% of our debt is in the form of CDOs. We plan to continue to use CDOs in the future to efficiently finance existing assets and new business. We also continue to achieve reduced spreads on our existing credit facility and repurchase obligations allowing us to further reduce the cost of our borrowings.

Turning to the income statement, we reported net income of $9.2 million for the quarter ended March 31st, more than a 200% increase over the 3 million reported for the same period in the prior year. On a per-share basis net income of $0.60 per share for the first quarter of this year represents an increase of $0.14 over the first quarter of 2004. The major drivers of this increase were higher levels of interest income -- net interest income from an increase in average interest-earning assets and reductions in financing costs plus the receipt of the incentive management fees from Fund II.

The issuance of our two CDOs allowed us to finance our significant asset growth while still maintaining a high level of liquidity. Average interest-earning assets increased from $385 million in the first quarter of 2004 to $822 million in the first quarter of 2005. As credit spreads in the market continue to tighten and we focus our balance sheet more on Senior B Notes, the average rate on our interest-earning assets decreased 1.8% year-over-year from 9.4% in the first quarter of 2004 to 7.6% in the first quarter of 2005.

Utilizing the two CDO financings, converting the subordinated debentures to common stock and negotiating reduced spreads on other debt, we were able to reduce the average rate paid on our interest-bearing liabilities including the subordinated debentures by 35% from 6.5% in the first quarter of 2004 to 4.2% in the first quarter of 2005.

Other revenues increased by $4 million from $2.5 million for the three months ended March 31, 2004 to $6.5 million for the three months ended March 31, 2005. This increase is primarily due to the receipt of incentive management fees from Fund II of $6.2 million during the first quarter of 2005. In connection with this receipt the general partner of Fund II expensed a portion of the cost that had capitalized when it formed Fund II.

This expensing decreased CT's equity investment by approximately $1 million. In addition, the Company recorded the effects of the incentive management fee payment on its limited and general partner co-investment in Fund II as a reduction in the Company's equity investment of approximately $850,000. Also during the quarter, management fees and co-investment income from Fund II decreased due to lower levels of investments in 2005 as the fund winds down.

Other income statement effects of the receipt of the incentive management fees included a contractual payment to employees of 25% of the related incentive management fees or $1.6 million which is included in G&A, and the recording of $1.7 million of income tax expense related to the receipt which was through our taxable REIT subsidiary. The net effect of the receipt on incentive management fees -- of the incentive management fee received was a $1.1 million increase to net income.

Comparing this quarter to last quarter, interest income was up 304,000 due to an increase in average earning assets which increased from 775 million in the fourth quarter to 822 million in the first quarter of this year and an increase in average LIBOR offset by a decrease in the average spreads as we continue to originate lower risk assets. Furthermore, virtually all 200 million of the new loan originations occurred at the end of the quarter and will have full impact in future quarters.

Comparing this quarter to last quarter interest expense increased primarily due to increases in LIBOR offset by the new CDO financing which occurred late in the quarter and will generate additional savings in future periods. We remain committed to maintaining an asset liability match -- asset liability mix which minimizes the negative effects of changes in interest rates on our future results.

In the current interest rate environment we are maintaining a net positive floating-rate exposure on our balance sheet with $174 million more floating-rate assets than floating-rate liabilities. Based upon assets, liabilities and hedges in place at March 31st, and taking into account floors and some (indiscernible) on some of the loans receivable, each increase in LIBOR of 100 basis points would increase annual net income by approximately $1.8 million.

As a result of the new investment activity in the first quarter our debt-to-equity ratio increased during the quarter from 1.7 to 1 at December 31, 2004 to 2.1 to 1 at March 31, 2005. As we continue to utilize existing liquidity to fund our investment activity we expect our debt-to-equity ratio will increase further.

Our liquidity position remains very strong and we currently have approximately $115.9 million of liquidity including cash on hand and available borrowings under our committed credit facilities. We believe that this level of liquidity is more than adequate to find our near-term requirements including originations of new loans and investments for our balance sheet. In March we declared a dividend of $0.55 per share, up $0.05 or 10% from the $0.50 of the previous quarter payable to holders of record on March 31st. The dividend was paid on April 15th.

Our book value, $20.78 at March 31st, includes 196,000 shares representing in the money options in addition to the 15.1 million shares outstanding at that time. This compares with the $20.79 reported at December 31st which included 174,000 shares of in the money options in addition to the 15.1 million shares outstanding at that time. That wraps it up for the financials and at this point I'll turn it back to John.

I guess we'll open it up for any and all questions please.

(OPERATOR INSTRUCTIONS). Don Destino, JMP Securities.

A couple of questions. One, John, can you talk about -- Brian mentioned what happens to earnings with a 100 basis point increase to LIBOR. Can you talk about how increases to short-term rates affect credit and how you can manage that or feel comparable that your floating rate -- that coverage ratios are going to hold up in a high rate environment?

Sure. We're going to do them one at a time. It's a very good question because looking at the impact of increasing short rates on our income statement in a vacuum can be dangerous. But we feel very comfortable about the ultimate impact on the credit of our portfolio assets for two primary reasons. Number one, the absolute standard in the marketplace for the kinds of floating-rate assets that we originate is for the borrower to be required to implement some form of interest rate management at the loan level.

Translating -- the lenders require that caps or swaps be but in place for the entire amount of the loan including our portion, our subordinate portion of the loan at the outset and for the term of the financing or else the loan does not get made. So there's interest rate protection against the divergence of rates increasing while cash flow does not that's included at the loan level in our underlying assets.

The second thing or factor that makes us comfortable is the cash flow yields that we underwrite in our investment program. In other words, as we've said repeatedly, we finance cash flow. We underwrite the properties that we finance and size our exposure on a cash flow coverage basis. If you look at the NOI or net operating income from the underlying collateral compared to our last dollar of debt, we have very significant cash flow coverage to our debt position.

If you look at it that way in terms of NOI divided by last dollar of debt it effectively gives you a number or a metric that essentially translates into how will these assets perform in a higher interest rate environment. And we feel very comfortable that the underlying cash flow from our collateral is more than adequate to withstand a fairly significant increase in rates certainly to a convergence to the historical norm level which is how we underwrite our assets. We don't assume and haven't assumed in the last couple years when rates have been historically quite low that that situation will continue because that's not a good way to make sure that at the maturity date of your assets an exit is possible.

That's very helpful. Second question, you're obviously able to make some loans given the CDO financing strategy that you probably wouldn't have made but for that ability. Can you talk a little bit about the warehousing risk if any you take making loans that will probably ultimately end up being in a CDO but have to be warehoused on the balance sheet until that execution?

Sure. Let's see where to start. We have negotiated warehousing lines that allow us to position product on our balance sheet and essentially be ready to drop into the CDO financings when underlying collateral in that pool repays. And we've been able to negotiate and but in place very cost-effective warehousing lines with the expectation that they will be used to drop assets into the CDOs. So in warehousing context we don't really have a significant difference, there's some, but we don't have a significant difference between the cost of our financing during a warehouse period and the cost when we ultimately drop it into the CDO.

(multiple speakers) basically financing -- floating-rate assets and we're financing them with floating-rate liabilities. So you don't have the same kind of risk that others might have where you're warehousing fixed-rate collateral and taking risk of both interest rate movements and/or spread movements. Because effectively what we've done is we've locked in the spread on our financing and we are index matched floating to floating.

The last part is what I'm most interested in. You're not taking a ton of risk that you're making loans that are being financed on the warehouse with an expectation that makes sense to finance them at some spreads that are available in the CDO market and then spreads widen before you execute those CDOs and you end up with loans that aren't going to return what you were hoping when you originated. That kind of --.

I think it's actually the opposite, Don, because what we've done is we've locked in the cost or the spread of our financing for an extended period of time. The newest CDO has a five-year reinvestment period which essentially means that we can use it as, if you will, a revolving credit. If spreads increase as a result of whatever -- increasing rates, shifting curve, dynamics in the credit market -- we still have locked in the spread on our financing. We will originate assets under that scenario at wider spreads and we'll make more money.

Thanks a lot, John.

Thank you.

Don Fandetti, Smith Barney.

Good morning. Quick question, can you provide an update on spreads in both the B Note and mezz market over the last 90 days -- just kind of general market commentary?

Yes, Steve Plavin is here, our Chief Operating Officer who runs our investment business on a day-to-day business. He's the closest to it so why don't we have him give his two cents.

Don, I think the trend on spreads is that they continue to tighten. I think the degree of tightening has begun to narrow a little bit as the absolute level of the spreads has gotten quite low. The greatest degree of spread tightening has been on the loans that have the most universal appeal, so that would be loans secured by a midtown Manhattan asset.

We haven't -- we've seen spreads stabilize for assets that are not primary assets in primary markets and assets that are tougher for the German banks and the insurance companies to put pressure on spreads in our market to underwrite. The origination environment actually is fairly robust right now. The challenges are the deals that have the broadest appeal to the widest number of prospective mezzanine lenders.

But just to clarify, the B Notes that you're targeting on an apples-to-apples basis this quarter versus last quarter, spreads really haven't moved much?

We target a broad array of assets in our investment program. I would say the large urban assets; the trend has been that spreads are continuing to tighten. But we also have, as you know, a program to make smaller B Notes and mezzanine loans. And there we have not seen spreads continue to tighten like we have on the large urban assets. Our smaller loan spreads are relatively stable and on the larger urban assets the trend has been that those spreads continue to tighten.

It looks like you guys have done a pretty good job in terms of managing your prepayments; they've been fairly low. Can you talk about your outlook going forward on prepayments?

We hate prepayments. At least when the assets are good we hate them. And they're not really able to be particularly well-managed is the truth. On a quarter-to-quarter comparison basis sometimes you'll see more repayments, faster repayments in the timing within a quarter as we experienced in the first quarter of this year as we got some relatively large prepays relatively early in the quarter. We work very hard to originate what I think is a very good flow of new assets on the balance sheet and yet a lot of that was back end loaded. So it's not as predictable or as manageable as you are giving us credit for to be honest, Don.

We do work with the borrowers to try to keep assets on the books. We've had a couple of instances, both balance sheet and in our funds, where it was pretty clear that the borrower had the capacity to refinance at a lower spread simply because both the asset had improved and the market spread had moved and we are in contact with those borrowers as constantly as we can be. We've been able to save a few of those assets, although the way we saved them was by being willing and able with our financing to cut our spread somewhat.

Is there anything you can help us think about in terms of your earlier conversation about locking in your spread or your debt cost on your CDO? Let's say the market continues to tighten and spreads just roll down for a period of time, essentially your spread in your CDO just compresses. Any commentary there?

I think as Steve said -- and he can jump back in -- we've seen I think a diminution (ph) of the relentless spread tightening at least in the last -- as you asked it -- the last 90 days or so. I don't think that we're seeing, at least in the places that we're focusing, the same kind of pressure that we had seen through the course of 2004. But the answer is I guess, yes.

If spreads continue to tighten dramatically that could squeeze our returns in using the CDOs because we have effectively locked in the cost. Let's be clear, the costs of the financings that we've put in place create very adequate, very nice ROEs in today's spread environment and we can tolerate some degree of spread tightening. If you see how far they have already come, as Steve said before, they're pretty tight now to any kind of historical kinds of levels, very tight. And I don't know how much further they can come in.

And my last question is a financial question on your 10-Q. It looks like you have 83 million of floating-rate loans maturing in '05. Are they clustered in any particular quarter or back end weighted?

I think they're reasonably spread throughout the year, Brian. Honestly I don't think there's any big clustering.

No, there's no concentration and I don't think we expect to see any large repayments in the next quarter.

But keep in mind one thing, that floating-rate assets don't carry a lot of call protection. So what we put in that schedule in our Q -- in our K's is contractual maturities and, back to your previous question, you can get prepays that occur on a nonscheduled kind of a basis.

Don, we also -- also those contractual maturities are generally to their initial maturity and most of these loans also have extensive options with them so they could even be longer than that that they stay outstanding.

Great. And my last question, John, any thoughts in terms of CTL real estate assets or are you guys just going to remain a lender?

We've thought about and explored all manner of beast over the years in terms of looking for businesses that we think are complementary, that use our skills that we think primarily are in the categories of credit underwriting and financial structuring and CTLs could theoretically fit that bill in terms of an adjacent area that has similar kinds of requirements for success. But there's nothing on the boards at this point that we're pursuing in that sector.

One of the things that we have always liked about our business is essentially diversity spreading of risk that you get in the multi tenant situation. We've always tried to avoid binary risk assets and obviously depending on how you do it in a CTL sector, you're taking on individual single credit risks there and the results can be interesting.

Thank you.

Thank you.

Dan Welden, Jefferies.

I was wondering if you could outline -- if you'd better define the characteristic of what you think Fund IV might look like?

No.

All right.

I'm sorry, we're working on it. I think that it will have similar characteristics to our previous activities. I think our point is to create investment strategies that essentially are designed to produce high levels of current income with downside protection and relatively low volatility and do so by investing in the real estate structured finance area. But the truth is we're still thinking and tweaking and working on it and so I guess I'll go back to the first one word answer which is, no. Not at this point. I think you'll see something from us in the coming months.

Okay. Another sort of long-term question. In terms of the direction of the credit quality you're going to target, you said that you've gone up a little bit in the spectrum to avoid some of the competition down in the spectrum. As you look further out in broadening your reach do think your next CDO would be focusing even further up towards triple B's?

Could be. Our exercise over the last year or so has been to expand our reach up and down but particularly up the way we think of it -- up the credit stack towards assets that carry somewhat lower risk and yet can be financed with the new technology to produce good solid risk-adjusted returns. Certainly as I think you can see, we're getting more involved in B Notes than that takes you closer and closer to BBB rated securities. And I think we own a fairly large portfolio of CMBS on our balance sheet today. I think that we would certainly look at other strategies to extend and continue investing in that area.

Great, thanks.

Jerry Kahn (ph), William Harris.

With regard to Fund III, the investment period is about to end. How much more do you have that you could invest and what's a likelihood that you'll get that done or that you'll be on the pace of the first quarter or how's that going?

We're actually pretty busy and doing pretty well in Fund III. It has not been easy, as we have said in prior calls.

But you did get 166 million in Q1, that was pretty good.

That's pretty good. And we feel good about that number. We also feel good about the underlying assets behind just the production volume. We think that we're on track -- let me give you a little context. Fund II had its 24 month -- two year investment period from the spring of '01 to the spring of '03. We made 40 separate investments aggregating just about $1.2 billion.

We think we're on track to come close to that same total gross production number for Fund III over its investment period which is June of '03 through June of '05. We feel very good about that. Spreads are certainly compressed and as a result we believe that the total returns will be down a bit from comparing Fund II to Fund III, but still on a risk-adjusted basis and on a comparative basis to other investment alternatives we think the yields will be good and the credit quality has been very strong.

So if you hit that target that's 1.2 billion, right?

Yes.

And I have another question for you. Looking at your FFO -- and I spotted a couple stories this morning that were out early -- $0.60, help me adjust that for the effect of the incentive. The way I look at it is you earned a little over 6 million but you had to pay out 1.2 plus you had taxes. How much of that 6.2 million actually ended up in FFO? And on the other hand you reduced your investment in the fund. So I'm not sure what the right number is.

When you say FFO we really report and the numbers are really geared towards GAAP net income, so they're a little bit different here. We received $6.2 million in cash money in the form of the incentive management fees. A portion of that had been previously allocated to employees.

That's 1.2 million, right?

1.5 -- 25% or there abouts. We took some non-cash expenses or charges which essentially wrote off I guess you'd say previously capitalized costs and we paid some taxes or provided for taxes in our financial statements for GAAP purposes. And when you boil all of that down, the net impact on a GAAP earnings basis was -- I think as we said in the press release, a little bit over $1 million or about $0.07 a share for the quarter. Back that out of 60 and you get back down to the $0.53 to $0.54 kind of range without the incentive management fee in it for the first quarter on a GAAP basis.

And it is $0.07 GAAP?

GAAP.

Thank you.

Don Destino, JMP Securities.

Actually you sort of head on it, John. Last quarter you talked a little bit about having some additional interest in fixed-rate CMBS product. Any update there?

Nothing I guess substantive in the first quarter. We were really focused on getting the CDO done, adding those assets and that's been our primary focus. Clearly one of our objectives, as we've stated, is to lengthen out our duration. Because, as you see, all the questions of a few moments ago regarding prepays and runoff, one of the issues in our current book of business is that the assets are relatively short and relatively uncall protected. So one of our objectives is to explore ways do lengthen out the duration of our asset-base and, again, sort of same thing, explore areas -- investment areas that are very comparable and very complementary to what we do.

Longer term CMBS is one of the things on our agenda. In the first quarter -- I think to your specific question -- no real changes in our portfolios, no real initiatives in that direction, but we are ready. One of the exercises last year was getting our special servicer ratings in place, increasing our asset management infrastructure and systems and all of that is basically now in place. So I think as we move forward through the year we will focus in that sector.

Allow me two more, one maybe long and one hopefully very quick one. Could you maybe handicap the possibility over say the next 18 months that you would be in the investment period more than one managed fund? In other words, you would be pursuing a couple of strategies at the same time rather than focusing on investing in one fund at a time?

Yes, I think that's possible. It's clearly something that we are working on and the non-answer as to what Fund IV is going to look like is part of us trying to design a program which we think is reflective of the market opportunities that are out there, sensitive to the desires of our private equity fund investors and make sense relative to our balance sheet investment activities which are also part of the mix for Capital Trust. But I think the short answer is yes. I'm not sure I'd put a percentage or handicap on, but that clearly is something that we are looking at and would hope to be able to achieve. The investment management business gives us operating leverage that we think is an important component part of our overall business plan.

Got it. And then finally -- and I apologize if this sounds like minutiae, but the delta between your all-in costs and the actual coupon on your first CDO relative to your second CDO, the first CDO looks like the expenses above and beyond the coupon were a lot lighter. Am I misinterpreting that or is there some reason why the second one would be less expensive to do than the first one? And is there any further improvement available there?

I think that the add-on was relatively comparable. Let's go through the math. CDO one, the raw cost was roughly LIBOR plus 60 -- 63 and I think the calculated all in one is about LIBOR plus 100, 104. In this case the raw cash cost is under 50 basis points LIBOR plus 49 and I think when we spread all of these over all the up front distribution costs and legal costs and everything else I think we said in the press release we think the all in effective cost about LIBOR plus 70. Actual costs were -- legal costs were down a little bit, having done it once we were able to do it a little bit more effectively, efficiently and actually underwriting costs were a little bit lower.

Got it.

Also, it's interesting, the second CDO -- just something to think about -- there's a longer reinvestment period in the second CDO, a five-year reinvestment period as opposed to four in last summer's transaction which allows us essentially to have a longer period of reusage on the financing which is not unimportant. So it's a longer ammo period.

Got it. Perfect, thank you.

That was the last question at this time. (OPERATOR INSTRUCTIONS). It does not appear that there are any more questions queuing up.

Thank you all. We'll see you next quarter.

That concludes today's conference call. We do appreciate your participation. Have a wonderful day. You may now disconnect.