Blackstone Mortgage Trust Inc (BXMT) 2005 Q2 法說會逐字稿

Hello and welcome to the Capital Trust second-quarter 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 re-payment of the Company's and its funds loan and investment portfolio, the continued maturity and satisfaction of the Company's portfolio assets, as well as other risks contained in the Company's latest Form 10-K and 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.

Thank you. Good morning everyone. Thank you for joining us once again and for your continued interest in Capital Trust.

Last night, we reported our results for the quarter ended June 30 and filed our 10-Q. The bottom line is $0.58 per share, up 23% versus the comparable period last year and down only slightly from the first quarter of '05 when we recognized significant incentive management fees from one of our funds. Year-to-date, GAAP net income totaled just shy of $18 million compared to 6.6 million in the prior year, and income per share increased 27% on a much larger equity base.

Q2 was another busy period for the Capital Trust team. On the origination front, we closed 21 new investments, aggregating $369 million -- 210 million for the balance sheet and 159 million for Fund III. Through June 30, our total 2005 originations stood at $720 million, well ahead of last year's record pace. For the balance sheet, our primary focus during the second quarter continued to be on smaller balance B Notes that can be financed efficiently in our CDOs.

On a weighted average basis, the cash spread on our Q2 origination was 332 basis points, and the last dollar loaned to value was 71%. With low-cost CDO financing in place, these assets produce attractive risk-adjusted returns on equity. Partially offsetting this strong origination volume however was a significant number of payoffs in Q2, including two of the largest loans in the GMAC collateral pool that we purchased last summer in connection with our first CDO. In this environment, prepays are an unfortunate fact of life. But we do expect that the pace of payoffs in Q3 will be lower than in the second quarter, and our pipeline of new originations remain strong.

On the liabilities side, we work very hard to prepare for our third CDO offering in the last 12 months. Announced just after the quarter ended and closed last week, CT CDO 3 expands Capital Trust's footprint in the securitized market and further establishes us as a premier issuer and collateral manager. Our first fixed-rate deal, CDO 3, provides financing for most of our existing fixed-rate CMBS portfolio plus approximately 180 million face amount of new bonds that we purchased at the closing. A static pool, non-reinvesting CDO rated by both Fitch and S&P, this transaction achieves non mark-to-market term and index-matched nonrecourse financing for these assets at a very attractive cost of funds.

In addition, the advance rate we were able to achieve allowed us to fully finance our purchase of the new CMBS and extract an additional 27 million of liquidity from our existing portfolio. As this capital is redeployed into additional earning assets in coming quarters, we anticipate significant future accretion.

During the quarter, we also spent a significant amount of time and money pursuing a corporate acquisition opportunity that we ultimately abandoned. The third-party due diligence costs that we incurred, roughly $0.5 million, were expensed as G&A in Q2, reducing our net income by approximately $0.03 per share. At the end of the day, we couldn't reach an agreement with the seller on price and terms, so we walked away.

We'll continue to look for opportunities to expand our platform. But as we did with this one, we will be disciplined about the risk we undertake and the prices we are willing to pay.

As we have said many times in the past, Capital Trust's fundamental business has three critical components -- first, finding good investment opportunities that generate solid risk-adjusted returns; second, efficiently financing those assets to produce attractive returns on equity; and third, controlling our risk through careful underwriting, aggressive asset management and prudent asset liability matching.

In an environment of tight credit spreads, excess capital and rising interest rates, we have adapted our strategy to meet these market conditions. Instead of simply reaching for additional yield by taking more real estate risk, we focused on lower risk, lower-spread assets, which can be efficiently financed using CDO technology. Again through CDOs, we have locked in the spreads on our debt at historically tight levels and significantly lengthened the duration of our liabilities.

If and when excess capital rotates out of the sector and credit spreads widen, we will enjoy higher returns on equity. And we are positively correlated to LIBOR, which means we make more money as short-term interest rates increase. On the credit side, we are very comfortable that our portfolios can withstand the impact of higher rates.

The market remains extremely competitive. But I believe that Capital Trust is well-positioned to succeed. Of course, none of this works without a coordinated team effort. And I believe CT has the best team on the field. Steve Plavin, our COO; Geoff Jervis, our CFO are here with me this morning. And I will now turn it over to Geoff to run through the numbers in greater detail.

Thank you, John. Good morning everyone. The second quarter and the weeks immediately following quarter end were indeed very busy for Capital Trust.

Starting with the balance sheet, total assets grew from $878 million at year-end 2004 to over $1 billion as of June 30th, representing net asset growth of $155 million or 18%. Looking inside the numbers, the primary driver of total asset growth was an increase in interest-earning assets, including CMBS, loans receivable and our new total returns swap.

Interest-earning assets increased $171 million for the same period from $804 million at year-end 2004 to $975 million at June 30th, an increase of 21%.

As John mentioned, the major drivers of changes in interest-earning assets are originations and repayments. During the first 6 months of the year, originations totaled $416 million and total re-payments were $212 million.

At quarter end, our CMBS portfolio consisted of 20 investments and 15 different securitizations for a total book balance of $258 million. During the first half of the year, we originated two new floating rate CMBS investments, and one existing fixed-rate security was repaid in full. The loan portfolio at quarter end consisted of 1 $8 million first mortgage loan, 69 B Notes totaling $573 million, and 8 mezzanine loans totaling $137 million. Other than the $8 million first mortgage investment, the loan in Mexico we have discussed in the past and we carry at $3 million, the portfolio is 100% performing.

As you will note, there is a new line item on our balance sheet -- total return swap. While the collateral is not unique, equity interest in a real estate operating company, the structure is. The $4 million amount shown on the balance sheet represents our synthetic interest in a $20 million loan. Where we would have traditionally purchased the whole $20 million loan and financed it with our credit facilities or CDOs showing the $20 million asset -- and in this case, $16 million of liabilities equating to an equity investment of $4 million dollars -- in this structure, we purchased the $4 million synthetic interest effectively net of financing, showing only our net investment as an asset. This investment is treated as a non-hedged derivative under GAAP. And as such, changes in its value will be run through the income statement. We believe that there will be a greater volume of similar structures in the market going forward.

With respect to our co-investment or private equity funds, $21 million on the balance sheet is comprised of our remaining $2 million co-invest in Fund II, our $14 million co-investment in Fund III, and approximately $5 million of capitalized costs associated with the investment management business. At June 30th, Fund II and Fund III had 83 million and $774 million of assets remaining respectively. And both portfolios remained 100% performing.

On the liability side, CDOs continued to play a significant role in our business model. At quarter end, 79% of our interest-bearing liabilities were in the form of CDOs. As John mentioned, we executed our third CDO earlier this month. And while it is not reflected in the quarter's numbers, I will talk about the transaction in a minute.

In addition to CDOs, we continued to realize improvements in the terms and pricings of our standard credit facilities and repurchase agreements. Subsequent to quarter end, we executed two new credit facilities with a lender. And while the terms are not at the level of our CDOs, we continue to narrow the gap with spreads ranging from 200 basis to 40 basis points over LIBOR, and advanced rates ranging from 70% to 92% depending upon the collateral characteristics. As we go forward, these facilities will remain an integral part of our capital structure.

To finish the balance sheet, there was no new equity capital raised during the period, and book value per share was $20.81 at June 30th compared to $20.79 at year-end 2004. As a result of the new investment activity, our debt-to-equity ratio increased to 2.2 to 1 at quarter end as compared to 1.7 to 1 at year-end 2004. With respect to liquidity, our position remains strong with $17 million of restricted and unrestricted cash, $72 million of immediately available borrowings and over $400 million of additional capacity under our credit arrangements.

Turning to the income statement, we reported net income of $8.9 million for the quarter or $0.58 per share on a diluted basis. This compares to $3.5 million or $0.47 per share for the same period 1 year ago. The $5.4 million increase to net income, 150%, is primarily due to the growth in net interest income, driven by increased interest-earning assets, a significant reduction in our cost of debt, and partially offset by lower spreads on new assets.

Average interest-earning assets for the quarter were $943 million compared to $412 million a year ago. The cost of debt for interest-bearing liabilities has also improved dramatically, decreasing from 6.3% in the second quarter of 2004 to 4.4% for this quarter. Even more powerful, when viewed in light of the changes in LIBOR, LIBOR averaged 1.2% for the second quarter of 2004 and averaged 3.1% for this quarter.

As mentioned above, these benefits were partially offset by a reduction in the spreads on new assets. For the 3-month period ended June 30, 2005, the average interest rate earned on our assets was 7.9% as compared to 8.9% for the same period a year ago. This change can be explained in large part by the Company's effort to originate a higher proportion of lower-risk B Notes and the fact that there has been significant spread compression in our markets.

In light of the current interest rate and economic news, we reiterate our commitment to maintaining an appropriate asset/liability mix that manages the impact of changes in interest rates. As have been our policy, we are positively correlated to changes in interest rates. And as of June 30th, our book is comprised of $174 million of net floating rate exposure. As such, a 100 basis point increase in interest rates would equate to an increase of $1.7 million to net interest income, roughly $0.11 per share on an annual basis.

Other revenues for the quarter totaled $3 million, a modest increase from $2.8 million last year. The primary drivers of other revenues are base management fees earned from Fund II and Fund III, as well as incentive compensation earned from Fund II. As to base management fees, on June 2nd, Fund III ended its contractual investment period and per its terms, no longer earned fees on committed capital, $425 million. But it switched over to earning fees on invested capital, the same metric for Fund II. At quarter end, total invested capital in Fund II and Fund III was $29 million and $288 million respectively.

During the period, we continued to earn incentive compensation from Fund II, recognizing $1.2 million of income in the second quarter. With only a handful of assets remaining, 8 to be precise, future incentive compensation payments will be driven by repayments of the Funds' remaining assets. In other words, while our expectations for incentive management fees remains the same, this component of income will be lumpy, and timing will be hard to predict.

On the expense side, G&A for the quarter was $5.3 million, an increase of $2.1 million from the period a year ago. Main drivers of the increase were $475,000 of expense related to an abandoned acquisition, $300,000 in employee incentive compensation payments from the Fund II promote, and increased employee compensation. In June, we declared our quarterly dividend of $0.55 per share and paid the dividend on July 15th to shareholders of record on June 30th.

That wraps it up for the financials. And at this point, I would like to spend a moment describing our new CDO, CDO 3 as we call it. As John mentioned, this CDO is different from the first two in that -- one, it is comprised of 100% CMBS; two, the assets and liabilities are 100% fixed rate; and three, given the long-term nature of these assets, this CDO is static without a reinvestment feature. The best way to understand this transaction is in sequence. Before we closed CDO 3, we had a subset of our CMBS portfolio, $159 million face amount CMBS. It was carried at $146 million, financed with $85 million under one of our repurchase agreements.

The Company's net investment was approximately $60 million. In addition, we had an $85 million notional value swap in place to match the fixed rate cash flows with the floating rate liabilities debt service. In conjunction with the issuance of CDO 3, we purchased $182 million face amount CMBS portfolio for $157 million. CDO 3 allowed us to finance the combined $341 million face amount portfolio with the combined market value of $303 million with $270 million of term and index-matched, non mark-to-market, nonrecourse fixed-rate liabilities -- reducing Capital Trust investment from $60 million pre-CDO to $33 million post-CDO. And as John mentioned, netting the Company $27 million of cash proceeds.

From an income statement standpoint, the net interest income from the CDO is roughly equal to the net interest income from CT's investment prior to the CDO. The difference being the amount of equity invested by CT, $33 million today as opposed to $60 million pre-CDO. The $27 million of cash extracted from the CDO will be used to invest in net assets, and that new investment activity is expected to generate significant accretion over time.

In addition to the details above, we have settled the $85 million swap we had outstanding at quarter end, as it was no longer necessary with index-matched financing in place. And we will be changing our accounting treatment on the bonds, switching them from available for sale to held to maturity to more accurately reflect our investment pieces on these bonds.

That wraps it up for my end. And at this point, I will turn it back to John.

And I guess I will open it up for questions please.

(OPERATOR INSTRUCTIONS). Don Destino, JMP Securities.

Three questions -- first, what's the rationale or what's going on in the market that makes the swaps, the total return swaps, a more likely investment target going forward?

This is Steve Plavin, Don. What we are seeing in the market now is origination by some of the Wall Street firms of some real estate-related, non-traditional investments. And part of what were doing is trying to accommodate the accounting treatment of the street firms. They're making investments they want to leave on their books for reporting purposes but shift the economic and risk impact to investors like us.

So by accommodating the accounting treatment of the street firms, we're able to essentially get the same investment that we otherwise get if we actually booked the loan in its entirety. Yet, the financing is built in, and the return structure is equivalent to or more favorable to us than buying the equivalent whole loan.

Do you think you're getting paid at least a little bit for accommodating them? Or do you think you're basically getting the same economics you would have gotten had you consolidated?

No, I think we get paid a premium for the structure.

And then second question is on the latest CDO. I'm going to restate what you said, Geoff, just to make sure that I understand it. Effectively, we can think of this as kind of a free, no fees to banker, no dilution, $27 million equity race? With the revenue or the net income dollars being effectively equivalent to the day before the transaction closed but freeing up 27 million of unrestricted cash -- is that a fair way to think about it?

With apologies to the bankers, yes.

And then the third one -- third question is -- you have now closed your investment period on Fund III. Would it be reasonable to expect that a fourth fund is forthcoming?

I think that would be a reasonable expectation. We are working on it as we have said before. I want to be sure that what we create is calibrated to the market opportunity. And as a private placement, basically can't say much more.

Daniel Welden, Jefferies.

I was wondering if we could talk a little bit about -- I guess the margin pressure has come from a portfolio shift towards higher quality, which is offset by higher leverage. Could you talk a little bit about the spread trends within each asset class? And whether or not you expect stabilization or further compression just due to competitive pressures within these classes?

Both Steven and I will do it. In general, there has just generally continued to be spread compression with an enormous flow of capital into our sector, essentially capital simply seeking current yield. So I mean it is absolutely accurate to say that the spread compression has been across the board. But it is also accurate to say that it has not been evenly distributed. Steve?

Yes, I also think that we will continue to see some spread compression just given the amounts of capital that are entering the mezzanine B Notes space. But the pace of spread compression has definitely slowed. So we are seeing less absolute basis point reductions in the spread. And we are also seeing that the competition, the real spread tightening, is in a narrow subset of the assets that we pursue -- really concentrated among major urban assets -- CBD office buildings in the major markets, major regional malls. And as you stray from the major markets, there are still investment opportunities that haven't been so impacted by compressed spreads.

The spread compression is across the board from the lowest gross assets that we look at to the highest risk assets that we look at. But again, most of the competitive pressure, most of the spread compression has been in the major urban assets, primary assets and primary markets that are most easily financed by the largest numbers of competitors in the marketplace.

And just as a follow-up -- from your respective right now, do you still see the B Notes as a better opportunity for the back half of the year than mezz?

Well, if you differentiate B Notes and mezz by B Notes being sort of more senior, lower risk investmentd and mezz being the high risk investments, I think we are still -- we are seeing pretty good activity in both markets. We are still actively engaged in trying to originate both. Both the mezzanine loans and the CDOs and the B Notes fit into our CDOs. So I haven't seen a real pattern in terms of the opportunities that we have to invest shifting more towards B Notes or mezz or higher risk or lower risk. We are still seeing good activity across the whole spectrum.

And then just one last question on the CDOs. I guess each of your CDOs is targeted at a different niche in the market, the first two allowing for reinvestment. Where do you think directly you would want to go from here? Would it be too broaden your investment base further in the next CDO execution?

Yes, I think that's right. Currently, CDO 1 and CDO 2 work in tandem in sort of the CDO 1 addresses the BB, B space, and CDO 2 addresses the BBB, BB space. I think you could see us going in either direction, either down to sort of a B unrated CDO and/or up to an investment grade CDO.

Don Fandetti, Citigroup.

John, I am not sure if you'd comment on this. But on the acquisition that you looked at, did you consider putting that into a fund? Or would have that have been a non-balance sheet?

On balance sheet.

And also to clarify, Geoff, in the quarter, the 799,000, was that a pre-payment penalty or was that just income?

That was a loan that we had booked at a discount that paid off at par. It was an acceleration of the discount.

So it is sort of a one time in the quarter?

Yes.

And also in terms of your leverage, how long do you think -- clearly, one could look to your leverage and determine that you're under-leveraged, given where your leverage is on your CDOs? Where do you think your overall corporate leverage goes over the next 12 months? Do you think you would go to 3 times or above within 12 months?

I think that is the target. I don't know exactly when we would get there. But given the risk profile of our assets, we believe that higher leveraged levels are easily supportable and sustainable. And obviously, what we have been doing this year is levering out that portfolio and terming out the portfolio to both increase the leverage against those assets and also better the match that we have. So I would say the answer is yes. But I wouldn't put a real carter around the specific timing.

And Don, I think one way to look at it is to look at the liquidity that was mentioned on the call and in the Q, which is about $70 million of available borrowings and then another $17 million of cash and restricted cash. And think of those two components with a holdback for sort of defensive liquidity as the equity investment in new loans going forward. And if you can apply 3 to 1 or 4 to 1 on the new investments, you can back solve into where you can see debt to equity going.

I guess I'm just trying to figure out how quickly you can get there, given your outlook for pre-payments. Clearly, you have the capacity to leverage up, but --

It is a really good question. And it is not one that is particularly answerable. As we have discussed in the past, on floating rate assets, there's not a lot of call protection. And there's not a whole lot of predictability as to when those pre-pays come. We do think we had -- in the Q2, we had a couple of very large ones that ran through. Don't see that happening again in Q3, but it is pretty hard to predict.

A lot of the pre-pays that we have experienced recently have come out of the GMAC portfolio that we purchased last summer and which became part of the collateral pool for our first CDO. Those were assets that GMAC had originated, held on their balance sheet for various periods of time, and we bought them mid-stream, anticipating that they would have a relatively short life. But honestly, I think we've been a little bit surprised at the pace of re-payment that we have experienced in that GMAC pool.

We are pretty much through that, not entirely. But a very large proportion of those assets have actually now already paid off. And we have replaced them with new assets, which are fresher originations, more direct originations from us. And hopefully, we will get some more duration out of them.

James Shanahan, Wachovia Securities.

Two questions please -- number one, Geoff mentioned the receipt of the $2.4 million incentivize fees would be lumpy. Do you believe that CT should recognize those fees sometime in the second half of the year? Or is it possible that the receipt of those fees could be sometime in '06, at least some portion of it?

Some of the assets inside the fund have lockouts that will take them to -- probably through next year. One of the investments is a CMBS investment, which will probably go to '06. So I would say that probably -- roughly speaking -- haven't done the math -- roughly half of it will be in '05, and half of it will be in '06.

That is very helpful. And the second question related to the abandoned acquisition -- can you discuss the type of opportunities that you perceive to be an attractive use of capital? And what sort of businesses are a good fit from an acquisition standpoint?

Well, what fits for us would be businesses that share what I think our core skills, which are basically credit underwriting and financial structuring. So we are always looking at adjacent activities and products that we can apply those same two primary sets of skills to and achieve the kinds of returns that we anticipate.

So I don't really want to go too specifically into what we did not do because I think it is more important what we are doing and what we are looking to achieve going forward. And that is growth, both organically -- using our own network and our own resources -- but also considering acquisitions if we can find a situation that we think fits with our skill set and our comfort level that fits in terms of our risk appetite and not insignificantly that we think we can buy at a price that makes sense in today's environment. That last piece is not so easy.

And can you tell if the target company was the subject of multiple bidders? Or more than one -- was there more than one suitor?

You know what? I hate to do this to you, but I'm just not going to go there.

I understand. I believe that was stretching a bit to try to --

I'm just not going to go there. So sorry.

(OPERATOR INSTRUCTIONS). There are no more questions at this time. That concludes the Capital Trust second-quarter 2005 conference call. A recorded replay of the call will be available from noon today through midnight on August 25th. The replay call number is 888-269-5330 or 402-220-7326 for international callers. Thank you.

Thank you all.