iStar Inc (STAR) 2003 Q1 法說會逐字稿

Ladies and gentlemen, good day and welcome to the iStar Financial, Inc. First Quarter Earnings Conference Call. Today's conference is being recorded.

At this time, for opening remarks and introductions, I would like to turn the conference over to iStar Financial's Executive Vice President of Capital Markets, Mr. Andrew Richardson. Please go ahead, sir.

Thank you, operator, and good morning everyone. Joining us today are Jay Sugarman, Chairman and Chief Executive Officer; Katy Rice, Chief Financial Officer; Tim O'Connor, Executive Vice President and Chief Operating Officer; and Steven Sinnott, Senior Vice President.

Before I turn the call over to Jay, I want to inform you that the call is being simultaneously cast on our website. We also have a replay number, 1-800-475-6701, with a confirmation code of 680918.

Before we begin, I need to inform you that 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 Financials expectations are detailed in our SEC reports.

Now, I would like to turn the call over to iStar Financial's Chairman and Chief Executive Officer, Jay Sugarman. Jay?

Thanks, Andy. Welcome everybody. Thank you for joining us today. As you saw in our release this morning, we did report record earnings for the first quarter of 2003, that continues the strong performance iStar has delivered each quarter since going public in 1998.

Earnings were up solidly year-over-year, new investment activity was both high-end quality and well diversified, and our costs to capital continue to decline as the credit markets anticipate a potential upgrade in our ratings.

As we reach our fifth anniversary as a public company, there are a lot of positives to focus on for us as a firm, and we're very pleased with both the company's success to date and it's excellent prospects going forward. Our goal is to continue to demonstrate to the market, both the safety and stability of our business model, as well as the increasing strength of our customer relationships and competitive position in the finance world. And I think the first quarter results should help us in that goal, so let me quickly run down some highlights.

Earnings. Earnings reached all time highs with adjusted earnings of $79 million for the quarter, or $0.78 per share. On originations, we closed 16 separate transactions and over $380 million in new transactions this quarter, and continue to build a solid pipeline for the rest of the year. That level of quarterly transaction activity represents a new high for us and has helped to continue to broaden and diversify our portfolio.

Return on equity and spreads. Return on equity finished at over 18% again, despite running at average leverage levels well below our 2-to-1 maximal leverage target, and still significantly below other commercial finance companies running in the 7-to-1 leverage range. Spreads remained quite good, with interest rate floors and strong borrower demand helping keep them at attractive levels.

Credit quality. Our credit quality remained very solid, and we continue to look for ways to better help the investment community track our portfolio strength. Later, Katy's going to walk you through an additional metric we will begin publishing this quarter to help you all understand our company better and to meet our goal of delivering better information to you.

Balance Sheet. We again tapped the unsecured debt markets this quarter, raising our profile in that market and anticipating our future shift toward a mix of more unsecured debt and a little less secured debt as our ratings reach investment grade levels. We believe we continue to have one of the strongest capitalizations in the entire commercial finance universe, with an equity base and leverage ratios consistent with a strong investment grade credit.

So all told, it was a very solid quarter. Sets us up nicely for the rest of the year. I'm going to talk a little bit about our strategy for the rest of the year after Katy fills you in on the details of the first quarter. Katy?

Thanks, Jay. Good morning, everybody. I'd like to cover three topics this morning. First, I'll summarize our results for the first quarter, then I'll talk about risk management and credit quality, and finally, I'll review our capital markets activities and balance sheet position.

Let's start with our results. As Jay mentioned, we had another strong quarter, particularly in light of the continued softness in the economy. Our adjusted earnings came in at $0.78 per diluted common share, right in line with consensus. Our net investment income rose to 87 million, which was a record for us. Our return on assets was 6.2%, and our return on equity for the quarter was 18.8%.

Our leverage remained unchanged at 1.7 times book equity, and first quarter interest coverage was 2.7 times, and our fixed charge coverage was 2.3 times.

In terms of new business, our investment team had another busy quarter. We originated 16 new transactions with total capital commitments of 383 million. We had repayments this quarter of 114 million. Over 50% of the dollar volume of this quarter's commitments were made to repeat customers. This is a statistic that we track closely. More and more, our customers are recognizing that we provide a unique level of service and flexibility, and they're willing to pay a premium for this service. Repeat customers are our best source of new transactions, and are a real validation of our business model.

This quarter, we continued to originate assets with an emphasis on security and credit, with first mortgages, participations in first mortgages, and investment grade sell/lease backs accounting for 72% of our volume. 39% of our new loan volume was fixed rate, and 61% was floating rate.

Geographically, we continue to divert the [fire] asset base with 39% of our new commitments located in the Northeast, 20% in the Mid-Atlantic region, and 14% in the South and Southeast.

Our in place net interest margin at the end of the quarter was 423 basis points. This is an exceptionally high number as we generally think that net interest margins in the 350 to 400 basis point range are really good. Currently, over 50% of our floating rate loans have LIBOR floors, which are typically in the 2-3% range. With LIBOR remaining quite low, at about 1.3%, these LIBOR floors are providing an additional boost to our net interest margin.

With respect to our 2003 earnings guidance, we continue to expect adjusted earnings per diluted common share of $3.22 to $3.28 for the year. With respect to the second quarter, we expect to generate adjusted earnings per diluted common share of $0.79 to $0.80 cents. Our guidance assumes net asset growth of 800 million to 1 billion this year, consistent with our prior expectations.

As we've already announced, we increased our dividends 5.2% in the first quarter from 63 to 66.25 cents per share. Our pay-out ratio for the first quarter was 83%.

Beginning with this quarter's earnings release, SEC Reg. G requires companies to disclose non-GAAP financial measures to also show the related GAAP measure, and a reconciliation between the two amounts. So, we'll begin communicating GAAP EPS guidance with this quarter's earnings release.

As you know, the principal difference between GAAP earnings and adjusted earnings is non-cash depreciation and amortization. Because we're required to depreciate our own Corporate Tenant Lease assets, changes in the mix of our origination volume between loans and leases, which otherwise does not have a significant impact on adjusted earnings, could result in more GAAP earnings volatility. For these reasons, we're issuing quarterly and annual GAAP EPS guidance with a wider range than our adjusted earnings guidance.

For 2003, we expect GAAP earnings per diluted common share of $2.34 to $2.44. And, for the second quarter, we expect GAAP EPS of $0.57 to $0.59. We've provided a reconciliation of GAAP EPS and adjusted earnings on page 14 of the press release.

Now, let's turn to risk management and credit quality. As you know, our risk ratings are the result of our quarterly credit review, which is a two-day, bottom-up review of each asset. As Jay mentioned, during the first quarter of 2003, we further refined our risk rating system for loans in order to better reflect two statistics that were implicit in our prior rating system. The first is our assessment of the risk of principal loss, and the second is how the collateral is performing compared to our original underwriting.

During this quarter's risk rating session, we assigned these two risk ratings to our loans, using the one to five scale. Let me walk you through our new rating scale. For risk of principal loss, a "one" indicates no expected principal loss in any foreseeable scenario. A "two" indicates no expected principal loss in all but extreme scenarios. A "three" indicates no expected principal loss in all reasonably foreseeable scenarios. A "four" indicates a possible risk of principal loss in at least one reasonably foreseeable scenario. And a "five" indicates a possible risk of principal loss in more than one reasonably foreseeable scenario.

Our risk rating for performance compared to original underwriting also range from one to five, with a "one" indicating performance well above our underwriting, a "two" indicating performance above our underwriting, a "three" indicating performance in line with our underwriting, a "four" indicating performance below our underwriting, and a "five" indicating performance well below our underwriting.

We've included both of these loan risk ratings in our first quarter earnings release and we believe that breaking out both statistics will enable you to better understand how the risk to recovery of our principal is relatively insensitive to fluctuations in underlying real estate market conditions and changes in collateral performance.

This quarter, our overall asset quality remains strong. With respect to our loans, the weighted average rating for risk of principal loss was 2.54 and, for performance compared to original underwriting, the average was 2.95. The average of these two ratings was 2.75. This compares, although not directly, to last quarter's rating of 2.75.

For our structured finance portfolio, the in-place debt service coverage at the end of the quarter remained a very strong 2.1 times. This is based on 2002 actual cash flows and interest rates. Our last dollar loan to value was 69.2%, so our borrowers continue to have significant equity investments to support our loans and cushion us from realizing the effects of softer commercial real estate markets.

Now, let's move to the CTL Portfolio. Our CTL risk ratings continue to reflect our assessment of the quality and longevity of the cash flow yield from the assets. The average risk rating of our CTL assets at the end of the first quarter remained unchanged at 2.76. Our CTL Portfolio remains well leased at 95.8%, with an average remaining lease term of 9.4 years. Lease expirations in 2003 represent just 2.2% of our annualized total revenue for the first quarter of 2003, so we continue to have little exposure to near term underlying real estate conditions.

As part of our risk management process, we monitor the credit profiles and performance of our corporate tenants. At the end of the quarter, over 89% of our CTL customers were public companies or subsidiaries of public companies, and 54% were investment grade or applied investment grade. This gives us good visibility with respect to the credit underlying our leases.

In addition to reviewing our risk ratings each quarter, we also determine whether assets should be added to our watch list or put on non-accrual. At the end of the quarter, we added one loan with a book value of approximately 7 million to the watch list. This loan is collateralized by an office building located in the Mid-West, which is experiencing near term tenant rollover in a fairly soft market, so we thought it would be prudent to put it on the watch list. The watch list now includes five loans and two CTL assets, with a total book value of 115 million.

We continue to have three loans totaling 11 million in aggregate on non-accrual. All of the assets on our watch list and are non-accrual, are currently paying as agreed, but we will continue to monitor these assets very closely.

As we do each quarter, we continue to build loss reserves. While we've not experienced a credit loss, we want to be sure that we are well protected in the event that a credit issue does arise. Our general loss reserve and asset specific cash reserve total 196 million, or 597 basis points at the end of the first quarter. With respect to our CTLs, our cash deposits, letters of credit, and accumulated depreciation totaled 237 million, or 935 basis points of book assets as of March 31st. Based on the size and diversity of our asset base and the reserve levels that we've built, we're comfortable that, to the extent we were to suffer a credit loss, it would not have a material impact on our balance sheet or earnings guidance.

Finally, let me walk you through our recent capital markets activities on our balance sheet. In March, we issued 150 million of unsecured 7% senior notes, due in 2008 at par. We used the proceeds to repay unsecured debt that was maturing in March. We generated significant demand for the offering during the road show, including interest from several high rate buyers, so we wound up tightening the pricing on the deal almost 25 basis points. The bonds subsequently traded up and, in early April, our underwriter received calls from several bond holders interesting in purchasing additional notes at a premium. We issued an additional 35 million as an add-on to the earlier offering at a price of 102.75 to yield 6.34%. This represented a spread of 383 basis points over the five-year treasury. We were pleased with the number of new fixed income investors that participating in the offering and, with the market's overall recognition of our positive credit momentum. We remain highly focused on achieving investment grade ratings from Moody's and S&P this year, and believe that we are on track to do so.

We also announced the recent extension of one of our $700 million credit facilities. We extended the final maturity from 2005 to 2007. Currently, we have five credit facilities with a total committed capacity of $2.7 billion, and just $1.5 billion drawn at the end of the quarter. We have no meaningful debt maturities until 2005, so we continue to have plenty of liquidity to fund our growth in 2003.

With that, let me turn it back to Jay.

Thanks, Katy. Okay, the rest of 2003. What we're seeing is a financing market with more demand from borrowers and corporations, but also more capital sources trying to take advantage of the attractive spread we've been collecting. Now, by adding more investment personnel over the last two years, we have been able to continue to pick our spots and avoid most of the new capital coming in, while still meeting our origination goal without compromising on either safety or spread.

What it tells me is that we're getting better and better and winning over customers with our expertise and long-term commitments to meet their needs, rather than competing on price. And that does constitute a very real competitive advantage in today's market. By focusing all of our efforts on our high-end customer base, we've built a relatively unique business in the real estate finance world, and I think you'll see us working to strengthen those customer relationships even further going forward.

With that, let me wrap up, say thank you, and open it up for questions.

Thank you. Ladies and gentlemen, if you'd like to ask a question, please press the "1" on your touch-tone phone. You'll hear a tone indicating you've been placed in queue. You may remove yourself from the queue at any time by pressing the pound key. If you're using a speakerphone, please pick up your handset before dialing.

Our first question comes from Michael Hodes with Goldman Sachs. Please go ahead.

Yes, hi. Good morning, and congrats on a solid quarter. Just a quick question on the provision level. Clearly, the credit trends remain strong. I was hoping maybe you could update us on how you're thinking about that line item as we go forward. It did move down from where it was in the fourth quarter.

Yes, it did move down slightly. We are continuing to build reserves. We're probably building them more related to our net asset growth at this point rather than building them from small base. We think the base is just relatively good at this point, and we will build them more according to the net asset growth.

Okay. Thank you.

Thank you. Our next question comes from Jack Micenko with Lehman Brothers. Please go ahead.

Good morning. In the commentary in the press release, Jay, you had stated that you are, I think in essence, taking a look at some of the specialties lending product lines going forward. Is that an indication that you think the commercial credit market is improving, and would it be rational to assume that maybe there'd be more growth in that in the next couple quarters? I know on the second quarter call last year in July was I think the first time we got a clear indication that you were focused more on the first. And I'm just trying to get a sense of whether this is a strategy shift, or if I'm reading too much into that. Thanks.

Well, it's obviously something we think about all the time. We have been very conservative when we thought the markets were overshooting in terms of expectations. I would tell you we finally are reaching a period where I think expectations are very close to reality. I mean, a more fair playing field for us to play in and so we'll probably do business in all of our product lines on a relatively normalized ratio where, in the past, I think we gravitated towards safer transactions because we saw a lot of people taking underwriting assumptions that we just couldn't get comfortable with.

I do think that the market probably is reaching a bottom. There are lots of bad news out there, but people are underwriting that bad news into their assumptions, not just us, but across the entire capital markets. That's typically a good time for us to look at all parts of the capital structure and figure out where the best risk reward is.

As you saw in the first quarter, we continue to have a predilection to go for safety over yield, but there will be a time where some of the other parts of the capital structure are going to be equally compelling. So, we will continue to keep our eyes open. I'm not predicting a dramatic shift anytime soon, but it is a correct statement to say we're looking at all parts of the capital structure now as potentially being interesting.

And potentially that a bottom has been reached. If I annualize the net asset growth in the quarter, I get to a little bit ahead of the guidance for the year. Any comment there on timing issues within the first quarter?

Yeah, I mean, this is our age-old problem, Jack, is that between timing and mix, net investment growth can be a very meaningful statistic, but only in conjunction with those other two things. First quarter, typically most of the business does get done late in the quarter. January's a tough quarter to close anything, so you get most of your business done in February and March. That sets you up nicely for the second and third quarters and then the end of the summer's typically a lull as well, so the fourth quarter typically has a little bit of the lag effect as well and close a lot at the end of the year. That being, now, it does iron itself out given the size of our origination platform and the number of deals we're doing. So, you shouldn't see any pronounced effects on that, but we always caution people, our business is not, you know, widgets that come out every day. But, we see over time, as the portfolio's gotten bigger, the number of originations get bigger, that trend smoothing out.

Great. Thanks. Great quarter.

Thank you.

Thank you. And just a reminder, if there are any further questions, please press "1" now. We'll move on to the line of Mike Marron with Bear Stearns. Please go ahead.

Thanks. Good afternoon. If you could remind me, on the normal repayments that you experience each quarter, are they typically loan maturities or negotiated early repayments?

Well, there are obviously maturing loans that pay off, and we have a good handle on those numbers. What we generally have to take a guestimate at is borrowers to come back to us and say, look, good things have happened. I want to sell an asset. I want to do something different with my assets. Typically, we do have call protection. For the right borrower in the right situation, we will obviously be thoughtful about responding to them and not just say, you owe us x-points of premium and that's the end of the story. Many of our borrowers do use us for the flexibility we can provide as a non-balance sheet lender, where we can have a conversation with them, with all the facts on the table, and make a thoughtful decision, something that the securitized world still is unable to do. It still represents a pretty significant competitive advantage for us.

So, I would say some portion of every quarter's retainments are people coming to us, generally with good news. What we've seen in the last 10 years is most of the conversations are taking place when somebody has had a very positive event and would like to recalibrate their capital structure. And we've built in enough call protection that they at least want to give them a shot at talking with them about other opportunities and ways to work together in return for maybe giving them a little break on a prepayment penalty. And again, we will do that. Our business is about capturing a premium for less risk than others. And if somebody's got good news, we can certainly work with them and try to identify ways to stay in business together.

Okay, great. One other question. For the loans that are on your watch list, is there any particular property type or geographic concentration to that group?

We have seven loans on the watch list, and they are hotels, office and retail. So, not a huge concentration of anything. They have about a $115 million gross book value. As I mentioned, we added one loan, it's an office building, to the watch list.

Okay. Thanks.

Thank you. And we have no further questions at this time. Please go ahead with your closing remarks.

Well again, thanks to everybody for joining us today. We're pretty excited about the rest of the year. Obviously, the news on the geopolitical front is better than the last time we spoke with you. We've got all of our tentacles out in the U.S., trying to figure out when this economy's going to turn and when various pockets in the real estate market are going to turn. I would tell you it's still a little bit of a rough road out there but, in terms of the financing markets, the number of opportunities and the quality of the opportunities remains high. So, we're not counting on a turn anytime soon, but it doesn't seem to be particularly impacting our business, so we're still looking for a very good and strong year at iStar. And we'll look forward to talking to you in another quarter.