iStar Inc (STAR) 2002 Q3 法說會逐字稿

Thank you operator, good morning everyone. Joining us today are Jay Sugarman, Chairman & Chief Executive Officer, SPENCER B. HABER President and Chief Financial Officer, Tim O'Connor, Executive Vice President and Chief Operating Officer, and Colette Tricola, Vice President and Controller. Before I turn the call over to Jay I want to inform you that this call is being simultaneously cast for rebroadcast on our website and we also have a replay number of 1-888-203-1112 with a confirmation code of 172809. Before we begin I need to inform you that the statements in this earnings call which are not historical facts may be deemed forward looking statements. Factors that could cause actual results to differ materially from iStar Financial's expectations are detailed in our SEC report. Now I would like to turn the call over to iStar Financial's Chairman & Chief Executive Officer, Jay Sugarman. Jay

Thanks Andy, welcome and thank you for joining us today. This morning we announced another quarter of solid performance for iStar with a continued emphasis on growing and increasing both credit quality and earnings. Net investment income increased to just under $80 million; earnings increased to 70 cents per share on a AEPS basis; net asset growth for the year exceeded a billion dollars; core return on equity reached an all-time high of 19%; and perhaps most importantly our credit ratings were upgraded to investment grade by one of the leading credit rating agencies, making us the only company in the commercial financial leasing sector to be upgraded this year with its rating. After a record setting first half of the year we did slow new volume in the third quarter as the deteriorating macro conditions of our economy and the global unrest appear to be creating more compelling opportunities for the fourth quarter and into next year. Our strategy is to continually assess how opportunities are getting priced in all of our markets and make decisions about when pricing will be the most attractive. During the third quarter we felt confident that the pricing in our markets was just beginning to reflect renewed concerns about the economy and we worked very hard to capture opportunities that already reflected those concerns.

On the other hand we did not aggressively pursue opportunities where we felt better pricing would be available in the near future and we are seeing some of those predictions come true as we move into the fourth quarter. We also continue to emphasizing the safety of our principle focusing on first mortgages with experienced borrowers many of whom we have previously worked with. Just to give you some stats compared with last year the percentage of first mortgages and credit tenant leases we have originated this year is up approximately 16 percentage points from 68% in 2001 to 84% in year to date 2002. Now that may slightly slow earnings growth, but it definitely increases the underlying quality of our earnings now and in the future. And with respect to future earnings we are projecting a 7% to 9% growth in 2003 as we see increases in the relative safety of our portfolio and anticipate remaining somewhat cautious on our outlook on the economy. Volume is expected to remain strong. However in the underlying strength and stability of our cash flow should permit us to increase the estimated first quarter dividends by 5% next year to approximately 66 1/4 cents per share.

I want to say that giving the still unsettled market for the many opportunities such market creates for iStar. You will continue to see us focus on demonstrating the very stable, very solid nature of our business platform. You will see us growing that platform in a disciplined manner, and you will continue to see us believe in such a platform combining strong current cash flow with real growth prospects deserves a much higher evaluation than our current share price reflects. I will turn the specifics of our second quarter over to Spencer.

Thanks Jay, good morning everybody. In our second quarter earnings call at the end of July, when we spoke to you many of you will remember that we went into lots of detail about how the business was doing in part because we said there was a very compelling opportunity at that time to buy the stock. In our view the stock had declined in sympathy with the overall market but not really for any company specific reasons. In the weeks and months after that call the stock steadily declined we think to about 10 to 15%. We think we are back to the future here. The stock has lost ground over the last couple of months with the rest of the market again, but based on what we know this has little to do with how our actual business is performing.

As you can see from the numbers Jay went through we feel the business continues to perform solidly across all major disciplines. So we do see another compelling opportunity to buy the stock here. As we do every quarter I want to cover three topics, our quarterly results, risk management credit quality and then talk about the right side of the balance sheet a little bit. In terms of results, as Jay said, adjusted earnings did come in at a strong 77 cents per diluted share this quarter, net investment income hit a record of just under $80 million. It was up over 20% year over year on $335 million of gross origination volume. In placement interest margins were very strong up to 64 basis points from the Sept. 30, 2001 numbers. Probably as importantly the year-to-date net asset growth by Sept. 30 of this year totals a billion dollars, so we've already hit our increased annual target for the year in the first three quarters. The origination pipeline does remain healthy, as Jay said.

For 2003 our guidance assumes approximately $950 million of net asset growth for the whole year. So we have already done more than that frankly in the first nine months of 2002, but again as Jay said, we want to be somewhat conservative going into 2003. As we forecast our last earnings call our loan repayment activity did pick up in the third quarter to $234 million. As you know it is net asset growth that actually matters and we did continue to generate net asset growth during the quarter and I would also say that we do expect lower repayment activity in the fourth quarter. Leverage grew slightly during the quarter from 1.7 to 1.8 times booked at the equity right in the middle of our targeted range. Again this quarter our credit stats remained strong. Interest coverage was 2 1/2 times the fixed charge coverage was 2.1 times.

Let me go through the detail around the new business activity that we generated during the quarter. During the quarter our largest piece of our new business was first mortgages, which accounted for 77% of new commitments. One of the things you will hear first, and did hear from Jay, and you will hear from us again in the coming quarters is that we are going to continue to alter our investment mix and yield expectations that strongly favor first mortgages and investment grade sale lease backs. In the billion one of net asset growths that we put on in the last twelve months 83% of that has been either first mortgages and investment grade sale lease back. So our first priority continues to be capital preservation. In terms of our commitment to the third quarter as I said 77% was first mortgages and another 21% from the sale-leasebacks business. In terms of collateral type it was pretty well mixed between office at 45%, industrial at 27% and residential at 25%. Fixed and floating, the majority of the origination activity in the third quarter was the floating rate at 77%, it was a floating rate and geographically again like property types it was pretty well diversified between the Northeast, the Mid-Atlantic and the West were between 20 and mid-30 percentages

Now let me go over risk management for a couple of moments. This quarter overall as a quality remained roughly the same as last quarter. If you look at our weighted average risk ratings on the loan side they came in at 2.81, slightly above the 2.74's rating from last quarter and above average on our scale. Recall we use a 1-5 scale where 1 represents the lowest risk and 3 is an average risk. Our sales leaseback ratings also increased slightly from 2.80 from 2.76 last quarter. On the loan side in place debt service coverage at the end of the quarter remained at a strong 2.1 times. That reflects 2002 actuals and budgets and current interest rates. Our borrowers do continue to have significant equity investments supporting our loans. You can see that again this quarter our last dollar loan-to-value across the entire lending business was a solid 68 percent at quarter end. In terms of the CTL, the sale lease back business, it also continues to perform solidly. We ended the quarter at 97 percent lease with a weighted average term of over nine years and if you look at expirations through the end of 2003 in that business they represent just 3.4 percent of our total revenue. We ended the quarter with about 86 percent of our CTL customers as public companies or subsidiaries of public companies. So there's lots of visibility there in terms of results. And they do represent a broad rediversified group of primarily investment grade credits in over 25 SIC codes. In terms of the watch list, our credit watch list at quarter end, we added one loan and one CTL asset for the list. We now have two loans and three CTL assets across the business on that list for a combined book value of $137 million, up slightly from $134 million last quarter. And as with the prior quarter end we have just two small assets on non-accrual with the combined book value of $5.5 million. As we do every quarter I'd like to stress that despite our credit track record we do take measures to protect the balance sheet and earnings in the event of an asset credit problem by establishing both corporate level reserves and assets specific credit protection. You will see these reserves disclosed in our earnings releases again this quarter. At September 30, 2002 on balance sheet loan loss reserves and assets specific cash reserves on loans accounted for a combined 567 basis points of loans receivable. And on the CTL side cash deposits, letters of credit and the accumulated depreciation we take relative to our cost basis in those assets represented 936 basis points on CTL assets. So we feel like despite our credit track record we do have multiple layers of protection and that even if the credit issue arises it shouldn't be material to our balance sheet, our income statement or our earnings guidance.

Last let me talk about the balance sheet. Our outlook remains I think very positive in terms of the right side of the balance sheet. As Jay said, we did get upgraded to an investment grade this quarter by Fitch, which is a significant milestone for the company. We are also up to positive outlook to go to investment grade by both Moody's and S&P this quarter. We really do think these upgrades are quite significant given the unprecedented bear market for financials and credit quality that we're in. We think they speak quite strongly about our asset quality and our performance and our stated objective continues to be to get to Moody's and S&P to move that positive outlook to an investment grade credit rating within the next nine to fifteen months.

Also during the quarter we completed a new $500 million totally committed credit facility with a leading financial institution. That brings our total revolver capacity to a substantial $2.7 billion. At September 30, 2002 we had just $1.3 billion outstanding under our five facilities. So we continue to have lots of dry powder to capitalize on origination opportunities. We continue to have very little debt maturing between now and early 2005. And our ratio of unencumbered assets on secured debt finished the quarter at a healthy 2.1 times. As far as matched funding on interest rates, as we've always said we don't want the business to depend on things we can't control like the shape of the yield, curve or absolute rates. Right now 100 basis point move in short term interest rates impacts annual AEPS by about $0.04 a share a year. That's within our policy tolerance range of plus or minus two and one-half percent. On the earnings front we issued final guidance for 2002 of $3.02 per diluted share. Prior to the non-cash incentive comp charge and as Jay said we're looking for seven and nine percent growth going into 2003.

Our conservative growth estimates for 2003 are the result of more conservative assumptions about our investment mix. As we see economic geopolitical and real estate market conditions continue to flash risk signals we've been conservative as well on releasing assumptions for the small amount of rollover we have in the CTL business between now and the end of 2003, as well as our capital raising assumptions. I think in general we're less focused on taking advantage of an economic recovery, which we think will be somewhat protracted and shallow then we are in maintaining total safety in our earnings and dividends streams. And you can see that in our origination stats on given the percentage of first mortgage and investment great CTLs. In addition, lower base rates for both treasuries and wide more mean that even when matched funded absent rates returns are somewhat lower.

We did say in the earnings release that we currently expect an increase the first quarter of 2003 dividend to $66.25 per share, which is a 5.2 percent increase from this year's quarterly dividend. Because earnings growth does continue to exceed dividends growth, excuse me dividend growth, we can increase our dividend substantially while still reducing our payout ratio based on our expected basic AEPS estimates for next year. The payout ratio should range from approximately 78 to 80 percent. As you know our dividend is supported not just by reported earnings but also by free cash flow. Free cash flow is $2.33 for the first nine months of the year, which is identical to the $2.33 per share of reported basic AEPS that produces a dividend payout ratio and free cash flow of around 81 percent. We've always said that we are poor AEPS because it is the simplest and best proxy for free cash flow. You can see that again in these numbers. They're typically $0.01 to $0.02 difference per quarter for the first nine months of this year they're actually the same.

Just finishing on the dividend and talking about how we look at the dividend. The dividend really does have three layers of credit support if you think about it. On the credit support junior to us in our underlying assets, that's number one, number two is our reserves and then number three is the positive difference between earnings and the dividend as represented by our payout ratio. We continue to believe that the dividend discount model lies a very simple and fairly compelling metric of the stock's value. If you look at just our current dividend of $0.63 per share and assuming five percent growth, which our dividend guidance suggest, then you just have to ask what's the appropriate discount rate for that dividend stream? We've said we think treasuries plus 500 is an appropriate discount rate given the multiple layers of protection I just mentioned. But I will say that with the stock at this level on the dividend going to where its going even at treasuries plus 600 for a discount rate, the stock is worth $50.00 a share using that dividend discount model. So you will continue to hear us talk about the safety of that dividend stream. Even with seven and nine percent earnings growth next year the total rate of return for our potential for our stock without any expansion of the currently depressed multiple is very attractive relative to the risk of that earning stream. There are also other meaningful value catalyst, which we've spoken about, and we'll keep focusing on such as improving that low multiple as asset quality stays strong, as well as the momentum we have with the credit rating. And with that let me turn it back to Jay.

Thanks Spencer. Let me just wrap our prepared comments with a quick summary of our current outlook. Overall we've seen an environment where we should be able to find attractive financing investments while still carefully protecting our capital. You will see us when windows open in our markets. We will move quickly as we did in the pro September 11 environment. And when conditions don't appear quite so attractive we will go about investing at our lower risk, lower volatility investment areas. Right now conditions appear attractive but as Spencer mentioned we will not hesitate to trade away a little bit of return for an extra measure of safety. Let's go ahead operator and open it up and thank you all for joining us.

Thank you, the question and answer session will be conducted electronically. If you would like to ask a question, press star followed by the number one on your telephone. We will proceed in the order that you signal us and we'll take as many questions as time permits. Once again that's star one if you would like to ask a question and we'll pause for just one moment. And our first question comes from Don Deseno with Bank of America.

Hi guys. Obviously the first mortgage and the CTL product have lower returns due to the favorable risk profile. I guess my question is to what extent relative to some of your other financing products do you add value in those products? I guess asked another way to what extent is the lower return due to the better risk profile and to what extent is it that you're running in to more competition and more people out there looking to make those loans?

Hey Don it's Jay. I guess the answer to your question is we're still looking to charge a premium spread for premium service. Whether it be our first mortgage product or CTL product or our corporate financial product or our other loan products. So we definitely think we're earning a premium to market and still looking for opportunities where the competition perhaps is unable or incapable of serving the customer's specific needs. So I don't think it's a spread issue, I think it's absolutely, you know, the safety of the first mortgage is wow very attractive to us and, you know, where we think we want to play right now. You just earn lower overall nominal return.

And I think just to second that Don, it's Spencer, if you looked at our credit spreads, you know which we put in the supplemental information in the press release every quarter, you know, you'll see again I mean pretty consistent spreads, you know, somewhere in the, you know, 400 to 500 range over live or and the 500 to 600 range over on the fixed rate side, as well as on sale/leaseback side. So I think if you look at where we are in terms of the portfolio and, you know, north of two times debt service coverage on the whole, 68 percent last dollar risk on the whole and you look at the credit composition on the CTL side I think, you know, our loan book today which is yielding something like 960 for a four-year tenor, and the CTL book which is yielding north of that for a nine-year tenor, we still feel like we've been able to maintain those spreads. It's just simply there is a substantial difference in absolute yield between junior lending and senior lending. And that's really where some of our shift in the mix over the last twelve months and I think frankly perspectively in the next twelve months wise, you know, if we get to a firm conclusion that we think this economy is turning and I think we have enough sort of tenicals out in the market to have caught it somewhat early on the way down we will alter the investment mix back to a more bullish investment mix. But I think what you're seeing pretty much, you know, is a continued, you know, somewhat bearish investment mix here.

Obviously these two things are going to be related, but if you had to classify your outlook or your posture going forward is it an economic call that your just not comfortable with the environment lending, you know, at the mezzanine level or at least keeping the growth there or is it a pricing call that you don't just think that the pricing reflects? And like I said obviously the two are related but can you categorize it?

Yeah, I think, you know, there is competition in the mezzanine world that we think in some instances is miss pricing that risk or is taking a more aggressive posture than we are. I will tell you we're still finding opportunities in that market but we're finding more with borrowers who are looking for speed certainty, you know, fair dealing and on the first mortgage side, you know, the market is definitely split into secure tieable situation and non-secure tieable situations. And we think we've got a leg up on most players in that market on things that just don't fit into a nice neat little box. We think the risk reward there is very attractive and frankly relative to some of the mezzanine opportunities we're seeing the risk worge looks better.

Great thank you very much.

We will now hear from Jack Malinko with Lehman Brothers.

Hi guys good morning. Just two questions, first looking past 2003 do you have any color on some of the lease rolls in terms of percentage of the income there in 2004 and 2005. And then also I wanted to just get some clarity on a number that you mentioned very early in the presentation. I think you said like 68 percent of new originations moving to 84 percent of new rate of originations is in the form of first mortgage and leases, thanks.

Yeah, let me answer the second one first. Last year if you tally up all the different product mix 68 percent of it that we originated last year fell into either first mortgages or corporate account leasing. Through the first nine months of 2002 84 percent of our investments by dollar amount are in first mortgages and corporate account leasing as a fairly significant share.

Yeah okay thanks.

In terms of Jacks first question just to answer it reverse order I think what you'll see if the risk management group in Tim's group I think it's done a pretty good job of spreading that lease roll out frankly quite far. I think as a percentage of current revenues as opposed to future revenues. I think we're being somewhat conservative in terms of the denominator. The 2004 number is plus or minus 4 percent, the 2005 number's plus or minus 3 percent. So I think, you know, we've done a good job, you know, even out over the next couple of years it's not just like roll in '03. I think '04 and '05 are also pretty well under control. That assumes no revenue growth. Those numbers are lower to the extent of the revenue gross.

Okay in the weighted average lease term they're still around eight or nine years?

9.1.

9.1, okay thanks.

Thanks.

Michael Hoditz with Goldman Sachs has our next question.

Yeah, hi good morning guys. I apologize if you've already addressed this in your initial remarks I had trouble getting on the call. But the two related questions, first on your asset growth expectations, your net asset growth expectations, I was wondering if you could delineate what your anticipating for refundings just given the interest rate environment we're in and then secondly if you could just give us an update on your thinking about the corporate leverage rate? Thanks.

Sure, hey Mike it's Spencer. In terms of your first question on net asset growth we assume and I apologize I think a couple a people got on the call late. We assume in our 2003 guidance $950 million of net asset growth. So far this year we've done about a billion. The $950 next year of net assumes roughly a billion and one-half of gross and about $550 of repayments. In terms of corporate leverage we ended the quarter at 1.8 times booked debt-to-equity. We've said, you know, we're comfortable in the range of one and one-half to two times. We're kind of right in the middle of that range right now. And I think you'll see us, you know, run it, you know, consistently within that range throughout that period. I think our estimated average leverage next year is right in the middle of that range.

Great, thanks.

Thanks.

We'll now hear from Brian Roman with Weiss, Peck and Grier.

Yeah, good morning. Just following on your comment about difficulty getting on the call. Can't overstate that enough if you guys spoke for 20 minutes probably got caught the last three of them and you might check with your service provider on that one because the music was great but the discussion was limited. And so by the way is there a replay number.

Yeah, let me give it to you again and I profusely apologize on behalf of our operator. I don't know if it's happened before but we're going to make sure it doesn't happen again. The replay number is 888-203-1112.

Okay great.

Just let me give you the access code, 172809 and I'll also just tell you that there's any bi-side guys or cell side for that matter but any bi-side account that wants more caller you feel free to call us directly.

Sure I appreciate that. The last piece that I did catch I just want to follow up on when you were talking about dividend safety and you mentioned three layers surrounding that. Could you just elaborate on that?

Yeah, I'm happy to do that. Really the way we think about is, you know, what is the protection ultimately that the dividend has if you trace it up the chain through our PL&R balance sheet. Clearly, the first layer of protection is that across most of our business we're not taking first dollar risk. In the lending business our last dollar of risk right now is 68 percent as the percentage of value.

You present your aggregate loan-to-value?

Correct, there's 32 percent equity of somebody else's money at risk there. Second, in terms of reserves we do consistently take credit reserves every quarter and we do that despite our loss track record, which we haven't had one in the loan side, but in terms of reserves on the loan side there are general loss reserves on the balance sheet and then there are also cash reserves that we require to be pre-funded when we make loans that sit in accounts for which we are secured. And when you aggregate those on the loan side it's about 570 basis points on principal and then on the sale leaseback side we have substantial letters of credit that back up our lease exposure, as well as cash deposits and other forms of protection there. The final thing is obviously we don't pay out our cash flow. If you look at just to give the numbers because I'm sorry that some of you guys got on late, reported basic adjusted EPS for the first nine months of the year was $2.33 a share. Obviously, the basic numbers are what count when you look at dividends. Because we don't pay dividends on diluted shares, we pay them basic shares and our free cashflow number for the first nine months of this year was basically right on top of that number. It was $2.33 a share. So if you look at dividend payout ratio and the cashflow coverage right now we're running in the low '80s we think that that will tick down to the high '70s by next year even with the increased dividend.

Okay, so can I just follow up with something I think it came in the first questioned answered. I think you were talking about competition. I caught most of what you were saying, you were talking about competition for product that it's coming in the mezzanine worlds, securitizable product versus non-securitizable and what you're going for. Could you just elaborate on that a little bit?

Yeah sure, let me give you a little breakdown of what's going in the marketplace. There has been quite a bit of money moving into what we would describe as the d-note market, which is a prepackaged junior financing market that's developed around the large investment bank securitization models. Where they will take down an entire envelope and then traunch up the financing into a keener piece which they can go ahead and securitize pretty effectively and cost effectively. And a junior piece, which they want to go out sell but it's done. It's not something you negotiate it's something that the investment bank has put together and is offering to the market.

Is it in the mezzanine area?

Yeah, junior financing. I've been mezzanine because you'll hear it described as d-note or hear it described as senior mezz, junior mezz. Effectively it is a prepackaged financing that is junior to a senior financing that's to be securitized.

Right.

It is a very large market right now. It's probably one of the most active markets.

This is the CMBS market, correct?

Yeah.

Okay.

It has induced a lot of competition because the risk return of that business still looks on a relative basis to be very attractive. You're talking about returns that are 400, 500, and 600 over for, you know, collateral positions that appear quite safe.

Without naming names is this consistent with the recent IPL in this area?

No.

Okay.

Actually not. They focus on a different part of the curve and we can talk about off-line.

We will.

But fundamentally I think the mezzanine market is, you know, actively bid. There's a number of players who've moved into market. What those folks are not capable of doing is something that iStar's been doing for the last ten years, which is bringing a full suite of capabilities, underwriting, structuring, closing, expanding or contracting as market conditions move. We bring a fundamentally different business proposition to the mezzanine market which particularly in longer terms situations I think we've become a market leader by demonstrating an ability to understand the capital structure and actually provide the right piece of paper with the right structuring, as opposed for putting it together a prepackaged relatively standardized model. Not to say that business isn't still good risk award, we think it is. It's not say it will not continue to be a small part our business it will. But we've seen a lot of money come in just as we see any more on commodities standardized commercial financial markets drain away some of the excess spread there. So we are looking for the parts of that market that we can actually earn. They earn fairly significant premium for the credit risk we take.

Okay, thank you very much.

Thanks

And as a reminder if you would like to ask a question press star one at this time and moving on we'll hear from Jim Wolfe with RBC Capital Market.

Good morning, Spencer I was wondering with respect to the new $500 million facility is there anything about that facility that differentiates itself from the balance of the other facilities you have that's worth knowing? And also if you could talk a little bit about how you might use that facility going forward?

Sure Jim. There's nothing that's particularly notable about it other than it's another $500 million. It's totally committed it's a three-year deal. I think the terms in terms of the advance rates and pricing and what have you are pretty consistent with our other credit facilities. You know I think the way we think about it I mean there are two things that are significant about it. One is we always like more capacity and two is without naming names because I prefer not to for competitive reasons it does set up a very substantial relationship with a very, very well regarded financial institution that is in and around complementary businesses to us and that we are hopeful will result in more co-origination opportunities with that institution. But from the mechanics of the facility it works pretty much just like the other ones.

Okay, great. Also with respect to the in-place in that interest margin can you tell us where that stood at September 30, 2002 and maybe what your expectation would be on that as we go forward?

Yeah, I think, you know, we've pretty consistently said that a number above 400 is a good number basis points and, you know, a number between 350 and 400 is probably a good run rate number. You know above 400 is exceptional and 350 to 400 is probably sort of normal for us. At the end of the third quarter the in-place number was 404 basis points that compares to 340 in the year ago September 30, 2001.

Okay great thank you.

Thanks Jim.

And as a final reminder if you would like to ask a question press star one at this time and we'll pause for just one moment. And we do have a question from Scott O'Shea with Deutsche Bank.

Good morning guys. A couple of questions, first off could you talk about just how your rent levels in the CTL portfolio currently compare to market rents for equivalent assets? That's one. Also, I'd like to just get an update on debt service coverage trends in the loan portfolio. And the last question would be were there any loans that came up for schedule maturity that, you know, were rolled over or renewed or were they just paid off this quarter?

Why don't I take the debt service coverage and the loan maturity question and then I'll have Tim and Jay talk about the CTL lease rates.

Debt service coverage trends. In the press release every quarter it's been 2.1 times pro frankly for the last two or three quarters. That is a better than run rate number for us. It obviously part of that is a function lower interest rates. I would tell you that if you go all the way back, you know over the last nine years and kind of look at numbers for us, you know, a stabilized number is closer to 1.5 to 1.7 times is probably, you know, a good running range for us in what I would call a normalized business environment and a normal yield curve with low rates we're over 2 times right now. But I think that that's a higher number than I would expect or ask people to look for going forward.

With respect to loans rolling over the answer's no. Didn't do it, in fact, I would tell you all of the loans that we paid in the third quarter we were sorry to see go. So I wish we had rolled them over but those were all maturities or early prepays. Tim do you want to talk about?

Sure. Scott we talked a little bit earlier about the expiration profile and obviously we are most focused on those leases that are rolling in the near term. So even if you go out through '05 we talked earlier not a whole lot in the next two years about 3 percent then another 4 percent another 3 percent in the out years. If you drill down and look at the detail behind those rolls, today we're probably within 5 percent or so overall of where market is 5 percent on the negative side that is. So that there is a slight roll down in the near term, but actually getting where market has gone recently you might expect more but the benefit we have by the nature of our portfolio we do have longer term leases. So we have legacy leases in the portfolio that did not go through and get inflated as the market over the last several years jumped up. So we do have again limited roll to the extent the roll is there, you know, we feel pretty comfortable that we can, you know, if the market actually moves in our direction, which it may or may not, we feel pretty comfortable we'll be able to hit numbers that are comparable to what we have in place today.

I'd add two things to that. One, we don't really as you know run the business in kind of a loss to lease fashion. We look at credit in term primarily as Tim suggested and we look at basis in the collateral or the residual relative to the credit in term and the spread in treasuries that we're getting. And that's the way we price credit risk. Now obviously it's not irrelevant what is going on at overall market but what we've done is try to identify mission critical facilities like headquarters buildings and mission critical distribution facilities and have that conversation at the corporate level and not get mired into a real estate conversation with our customers. Some times it works sometimes it doesn't. I would also say we've already built in into our guidance for next year I think some pretty conservative assumptions about this point. So I think we feel, you know, pretty good about where we are.

Okay great. Just a follow up on the DSC number, how much variation around that that 2.1 number is there? You know focusing more say on the one to one and one-half range. Is there much in there at all or?

yeah, I mean I don't have a standard deviation for you. I can tell you that there are very few loans with what we would call thin coverage and in occasionally we will do a loan that has lower coverage because if there's something about the transaction whether it's pre-funded cash reserves or a tenant that they're about to design or what have you they get us comfortable doing that but, you know, out of the box coverage numbers shouldn't be that different than that sort of, you know, one and one-half to one-sixth, one-seven range I talked about. There are a couple of loans that are, you know, covering below that but yeah I think we feel pretty comfortable about where we are. The best way to get a handle on kind of what you're, you know, grasping for or looking for is the credit watch list. You know we put loans on credit watch we think for some reason we need to really focus on them in terms of being really proactive around risk management. There is one hotel asset on that list we've talked about extensively over the last year that has somewhat thin debt service coverage. There is one regional mall that is on that list that has somewhat thin debt service coverage. But in both cases where the borrowers have continued to step up on the asset because they have very large cash equity investments junior us But I think we feel very comfortable with the way the loan portfolio is performing right now.

Okay great that all thanks.

And I hear from Sonja Peritenian with Solomon, Smith, Barney.

Hi, I apologize if you talked about this early in the call but I was wondering if you could just give us sort of an update on like what your hearing and feeling in the northern California area as well as in the northeast?

Sure Sonja there is Jay. I guess the northeast feels like it's a little bit stronger on a relative basis than many other parts of the country. I think it's a function of the type of assets we invest and typically have very long lease terms underlying them or very strong market positions. So there's a much broader part of the market that seems protected from near term real estate conditions. Those parts of the market that are exposed have seen some weakening but I think, you know, the investment environment and clearly the financing environment in the northeast is still quite strong. I think conversely when you turn to San Francisco, San Jose, those markets are still trying to find the bottom. And what we see out there, you know, a lot less protective long-term leases fairer to entry markets. So you've got, you know, assets that are out there relatively unprotected from what's going on in the overall economy and in particular the sub-economy that exists out there. That situation has not righted itself and probably won't for quite a while. I think the keys to look for out there are, you know, high quality assets with low basis will do fine and will survive and will get to the next, you know, up-cycle. Those assets that were built, you know, for uneconomic reasons or at the very top of the market are going to struggle very, you know, for quite a while. So I feel much more optimistic about the northeast at this point than I do about predicting a turnover on the west coast and it's primarily northern California. Southern California appears quite strong still. We're watching the port situation quite carefully because that impacts a fairly broad sector down there but in the northwest and in San Francisco, San Jose I think, you know, it's going to be a while.

And how do you feel about your credits in the northern California area? I know you had originally given, you know, lease rates that were probably well below market and how do you think they compare now?

Yeah look on the loan on the loan side we had almost no exposure I think we talked before for three years we didn't make a single loan in those markets because we just couldn't make sense of the risk award. So on the loan I tell you we got, you know, nothing to worry about.

And on the lease side, you know, we don't have any more roll in California this year and I think next year it's about 1.5 percent. Right now the in-place lease rates are now 1.5 percent just to give you a number is about $17.40 per square foot per year. So I think we feel pretty comfortable there that, you know, it's hard to generalize obviously which we're trying to do here but, you know, top of this cycle lease rates are a multiple of that number.

We will, as Spencer said, will extend our down time leasing assumptions but given their relatively low little roll we have it does not have a material impact.

Are you concerned with any of the companies in that area declaring bankruptcy?

We put companies on watch lists where we think that is a potential problem. We think it's again relative to the overall size of the portfolio, you know, at this point still immaterial but yeah we watch those companies. We, you know, are going through another earning cycle. Our credit group is going through every one of those companies to see where they are and how they're performing. And, you know, we do that pretty rigorously to make sure we're out in front of those situations and where we are usually there's a way to protect our position.

And I'd say, you know, Sonja that continues to be the principle reason why we would add a CTL asset to the watch list. Similar to my comment on debt service coverage on the loan side, on the CTL side the principle reason why an asset would get added is the customer credit. And so I think you can see that kind of reflected in our watch list numbers.

Okay great guys.

And we do have one more question left in the queue from John Bloomberg with Olympic Growth Funds.

Gentlemen, with interest rates below your dividend rate how come your not buying in substantial amounts of your stock?

Honestly from our perspective I'm not sure we would look at it quite as simply as interest rates relative to our dividend, but ultimately I can tell you that the reasons that we're not out buying stock right now are much more strategic than financial. And that is a couple things, one from our perspective there are very attractive places to put our capital in our core businesses serving our customers and while I wouldn't dispute that stock is a very attractive place to put our capital right now I don't think shrinking our float and our market cap and moving capital from serving customers with the kind of returns we've been able to generate. It crosses the threshold where that's a compelling thing to do. I also think that for purposes of our credit rating it's important to demonstrate to the rating agencies at least for the near term that, you know, we're going to be very sensitive about the size of our equity capital base. I won't disagree with you that, you know, there are not a whole lot of risk for wards in the market that we think are as attractive as any security in our capital structure. Whether it's out corporate bonds or our preferred or our common but hopefully, you know, it will articulate I think there are other reasons why at least in the near term, you know, it's less likely to happen. There is clearly a point at which we will do that and we've done it in the past. When the stock got hit a couple of years ago we stepped up and bought, you know, two and one-half million shares. So, at some point we will I just don't think for all things considered it's the right thing for us to do right now.

Mr. Bloomberg are there any further questions?

No.

Okay, that concludes today's conference, thank you for your participation.

Thank you all again we apologize for the telecommunication dishes we will follow up and find out exactly what happened but unfortunately we weren't alerted to that. So thank you again for your participation. You can go on our website and hear it and we've also got the replay number and if you have any follow up questions give us a call. Thanks again.