iStar Inc (STAR) 2004 Q1 法說會逐字稿

Good day and welcome to the iStar Financial first quarter 2004 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, and Tim O'Connor Executive Vice President and Chief Operating Officer.

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 727645.

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 Financial's expectations are detailed in our SEC reports. Now I'd like to turn the call over to iStar Financial's Chairman and CEO, Jay Sugarman. Jay?

Thanks Andy. Welcome and thank you all for joining us today. As you saw in our press release this morning, iStar had a very strong first quarter, providing custom-tailored capital to a wide range of high-quality real estate owners around the country. Total funded and committed investments reached record levels approaching almost $1 billion for the first time, and returns on equity and earnings, excluding previously disclosed one-time charges, were at all-time highs. We are working very hard in an environment of increased competition to use our superior expertise and strong reputation for integrity and reliability to capture a high percentage of the transactions we pursue. The number of our deals in the first quarter were the direct result of high-quality investors consciously choosing to pay a small premium to work with iStar.

Having spent many years building up relationships with these high-end equity investors, we are continuing to capitalize on repeat customer business to avoid the bulk of the new capital now entering the real estate finance sector.

Let me give you a couple of highlights from the first quarter. On the earnings front, excluding the several one-time charges that Katy will detail for you shortly, earnings reached a new record, with Adjusted Earnings of $98 million or $0.86 per share, up 10% year-over-year. On the originations side, we closed 14 separate transactions and committed over $900 million in new and follow-on transactions this quarter. As an unfortunate footnote, we had several other transactions fall apart literally within days of closing or the quarter could have been even better.

Return on equity and spreads: Return on equity finished at an even 20%, also a new high for iStar despite running at average leverage levels still well below our portfolio targets and significantly below what other investment-grade commercial finance companies operate at.

Spreads also remain quite good, with interest rate floors and iStar's premium service model helping sustain net interest margins at very attractive levels in excess of 400 basis points.

In terms of credit quality,the slight strengthening we saw in certain real estate fundamentals does augur well for our portfolio, and key portfolio credit scores did improve marginally during the quarter. However, in our portfolio we are continuing our conservative posture as we work to sort out the longer term dynamics in the various sectors. Despite our cautious view of fundamentals, the broader market is providing liquidity at increasingly bullish levels, and we are content for the near-term to accept increased repayments as borrowers tap this aggressive capital.

Lastly, on the balance sheet, as Katy is about to detail, one of the most important accomplishments this quarter, and one with very positive longterm implications for our business, was the successful shift to using the unsecured debt markets to fund the majority of our business. We had anticipated holding off on this shift until our ratings in all three agencies reflected the inherent strengths of our business, but in a business that lives to serve its customers faster, better, and with truly proprietary information, we felt we could not wait any longer to make this important shift. I will come back and highlight why this is such an important event for us in just a minute, but let me turn it over to Katy to fill you in on this and other important details from the quarter.

Thanks Jay. Good morning everyone. I would like to cover three topics. First, I will summarize our results for the first quarter, next, I'll talk about risk management and credit quality and finally, I will review our Capital Markets activities and balance sheet position.

Let's start with our results. As Jay mentioned, we had a strong quarter from a fundamental perspective. Our Adjusted Earnings were $0.86 per diluted common share, before the first quarter charges, which was at the top end of our previous guidance. As we have already discussed previously, the Company incurred several charges this quarter related to stock-based compensation and the redemption of our Series B and Series C Preferred Stock and the redemption of a portion of our 8.75% Senior Notes.

In aggregate these charges totaled $127.4 million. After these charges, Adjusted Earnings were a negative $0.25 per diluted common share.

Our net investment income rose this quarter to a record $93.1 million, up 8.4% from the first quarter of 2003. Our return on equity for the quarter, before the charges was a record 20%. Our leverage at the end of the first quarter was 1.7x book equity plus accumulated depreciation and loan loss reserves.

First quarter interest coverage was 2.9x and our fixed charge coverage was 2.4x . Both of these coverage numbers were calculated before the compensation and redemption charges.

In terms of new business this quarter, we generated a record $949 million in new financing commitments in 14 separate transactions. We also had repayments of $145 million.

With respect to the underlying collateral, about 29% was in the entertainment and leisure category, 17% was residential, 15% was mixed-use, and 13% was office. We are continuing to originate assets with an emphasis on security with first mortgages accounting for 55% and corporate tenant leases accounting for 32% of this quarter's volume. 58% of our volume was floating rate and 42% was fixed rate.

Our in-place net interest margins at the end of the quarter were 410 basis points, a few basis points higher than our typical range of 350 to 400 basis points.

Geographically, 41% of our new commitments this quarter were located in the West, where we continue to believe there are some good value propositions. 25% were in the Northeast and 11% in the Southeast.

I would like to spend a few minutes reviewing the first quarter charges that we discussed on our last earnings call and in subsequent press releases. I know that we have reviewed this several times, but I want to be sure that everyone understands the impact of the charges.

I will start with the compensation charges. Based on achieving a total rate of return of 175.8% from January 2001 to March 2004, our CEO Jay Sugarman's 2 million incentive share award vested. On March 30th we recorded a one-time charge of $86 million in the line item "General and Administrative Stock Based Compensation". The charge is equal to our stock price on March 30th multiplied by 2 million shares.

Most of you are familiar with our CEO's compensation arrangement under our long-term incentive plan. It is described in detailin our last two annual proxy statements and in each of our quarterly financial statements since 2001, but let me quickly summarize some of the key points.

Three years ago, the Board structured our CEO's employment agreement with four tranches of incentive shares that vested once certain stock price hurdles were met.

The agreement was structured such that he would receive no incentive shares if the Company generated less than a 20% average annual total rate of return to its shareholders during the period beginning January 2001 and ending March 2004. In order to earn the maximum number of shares or 2 million, the Company had to generate an average annual total rate of return of more than 35% during the same period.

Earlier this quarter, our CEO entered into a new three-year employment agreement which has three components. First, an annual salary and cash bonus, which is based upon meeting various performance targets set by the Compensation Committee of the Board of Directors.

Second, 236,000 shares of common stock grants which are fully vested but is restricted from sale for five years. The third component is his participation in the 2006 CEO and Director's HPU program which was approved by shareholders last year.

The HPU program, which is described in detail in our proxy statement, is a performance-based compensation plan that requires participants to purchase units in the plan three years prior to any potential vesting. It only has material value to the participants if the Company provides excess returns to its shareholders.

In addition to the CEO shares, as we discussed last quarter, two other incentive share awards vested in the first quarter of 2004. Based on achieving a total rate of return of 56.1 % from November 2002 to January 2004, the 100,000 incentive share award that I received when I joined the Company vested at the end of January.

In addition, the 155,000 share award that was issued to the principals of the former ACRE Partners vested this quarter. This represents the final contingent consideration related to our acquisition of their company in 2000.

So the aggregate first quarter 2004 compensation charge was approximately 2.5 million shares multiplied by the current stock price on each award's vesting date, or $106.9 million.

In January, we announced that we were redeeming the 2 million outstanding shares of our 9.375% Series B Preferred Stock and the 1.3 million shares of our 9.2% Series C Preferred Stock. We assumed these securities as part of our acquisition of TriNet, the net lease company we acquired in 1999. GAAP required that the Series B and Series C Preferred Stock be marked to their fair market values at the time of the acquisition, which resulted in iStar Financial recording a $9.0 million discount to the $82.5 million face value. Upon completing the redemption of the Series B and C Preferred Stock on February 23rd, we recognized the $9.0 million discount as additional preferred dividends, thereby reducing adjusted and GAAP earnings by $9.0 million.

In late March, we completed the redemption of $110 million of our 8.75% Senior Notes due 2008 at a dollar price of 108.75%. $240 million of the Senior Notes remain outstanding. The cost to redeem these high coupon bonds resulted in a reduction of adjusted and GAAP earnings of $9.6 million and $11.5 million, respectively.

So in aggregate, the first quarter charges for compensation and the redemption of the Preferred Stock and bonds total $127.4 million. We have provided a schedule detailing the effect of the charges on page 14 of the press release.

Now let's move on to earnings guidance. First, let's talk about our 2004 earnings guidance before giving effect to the compensation and Preferred Stock and bond redemption charges.

We continue to expect diluted Adjusted Earnings for 2004 of $3.40 to $3.48 per diluted common share and diluted EPS of $2.43 to $2.53. For the second quarter, we expect diluted AEPS of $0.85 to $0.87 and GAAP EPS of $0.62 to $0.65.

Our full year 2004 earnings will be reduced by the compensation and Preferred Stock and bond redemption charges that we just reviewed.

For the full year after taking into account the charges, we expect diluted AEPS of $2.30 to $2.38 and GAAP EPS of $1.32 to $1.42.

Our guidance assumes net asset growth in 2004 of approximately $1.4 to $1.6 billion. It incorporates our expectations that more of our loans may prepay in advance of their actual maturity dates during the year. If these borrowers repay early, we would expect net asset growth at the lower end of our range. However, our guidance also incorporates the fact that we committed $950 million to new investments in the first quarter so a significant portion of our annual net asset growth is generating earnings, for the better part of the year.

We expect the favorable timing of the investment volume in the first quarter to mitigate most of the impact of increased repayments.

The recent increase in interest rates have prompted many questions about what happens to our business if rates continue to rise, as most economists are predicting. Our objective is to deliver stable earnings and excess returns to our shareholders and to insulate our earnings as much as possible from changes in short-term and long-term interest rates. We match fund fixed-rate assets with fixed-rate debt and floating-rate assets with floating-rate debt. We are committed to operating our business such that a 100 basis point move in interest rates has a minimal impact on our earnings. We define minimal as a range of plus or minus 2.5%.

We are currently operating well within our policy with a 100 basis point increase in rates decreasing adjusted earnings by only about 1.4%, or just about a penny a share per quarter.

In addition, we fund ourselves so that the maturity of our liabilities closely matches the maturities of our assets. Currently, the weighted average maturity of our assets is 6.8 years, and the weighted average maturity of our liabilities is 5.6 years. From an equity perspective, a 100 basis point increase in interest rates would only increase our annual dividend payout ratio from 79% to 80.7%. So, while rising rates may create some opportunities on the origination front, they will have a relatively small impact on the right side of our balance sheet.

Earlier in the first quarter, we announced a 5.3% quarterly dividend increase, from $0.6625 to $0.6675 . Or $2.79 on an annualized basis. We review our dividend annually and target a 5% annual dividend growth rate and a 78% to 82% pay out ratio.

We are committed to providing shareholders with a strong dividend that has a solid earnings cushion.

Now let's turn to risk management and credit quality. This quarter, our overall asset quality improved slightly. With respect to our loans the weighted average risk rating was 2.62 for risk of principal loss, compared with 2.67 last quarter, and 3.16 for performance compared to original underwriting compared to last quarter's ratings of 3.15.

In place debt service coverage at the end of the quarter remained a very strong 2.2x based on trailing twelve-month cash flows through December 31, 2003 and current interest rates. Our last dollar loan to value for the entire portfolio was 67% . So our borrowers continue to have significant equity investments to support our loans and cushion us from realizing the continued effects of softer commercial real estate markets.

Now let's move to the CTL portfolio. The average risk rating of our CTL assets at the end of the first quarter improved slightly to 2.52 vs. 2.62 in the prior quarter. Tim O'Connor and our risk management team are starting to see stabilization in many real estate markets across the country with tenants beginning to reassess their space needs as the economy begins to improve.

Our CTL portfolio remains well leased at 94.1% with a weighted average remaining lease term of 11 years. Lease expirations in 2004 represent just 1.7% of our annualized total revenue for the first quarter of 2004, so we continue to have little exposure to near-term 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 year, 78% of our CTL customers were public companies or subsidiaries of public companies and over half were investment grade or implied investment grade. This gives us good visibility with respect to the credits underlying our leases. In addition, our CTL portfolio remains well diversified from an industry concentration perspective with over 39 SIC codes represented.

In addition to reviewing our risk ratings each quarter, we also determine whether assets should be added to our “watchlist” or put on non-accrual. At the end of the first quarter, “watch list” assets represented 1.59% of total assets, a slight increase from 1.55% in the prior quarter. Nonaccrual assets represented just 0.55% of total assets as compared to 0.61% at the end of December.

As we do each quarter, we continue to build loan loss reserves to ensure that we are well protected when credit issues arise. Our general loan loss reserves and asset specific cash reserve totaled $265 million and represented approximately 6.58% of gross book value of our loans at the end of the first quarter.

With respect to our corporate tenant leases, our cash deposits, letters of credit, allowances for doubtful accounts and accumulated depreciation totaled $295 million and represented 9.39% of gross book value of our corporate tenant lease assets.

Finally, let me walk you through our recent capital market activities and our balance sheet. Late last year, we began working with J.P. Morgan and Bank of America to arrange a new unsecured credit facility to replace our existing $300 million unsecured credit facility.

On April 19th, we closed on a new $850 million unsecured credit facility. We intend to use this new facility as our primary source of working capital and for funding new investments, prior to match funding them with a mixture of longer-term debt and equity. Nineteen banks and financial institutions participated in the facility, 14 of which were new to our unsecured credit. The facility has a three-year term with a one-year extension at our option.

At our current ratings the facility will bear interest at LIBOR plus 100 basis points with a 25 basis point annual facility fee.

The new credit facility is an important part of transitioning our balance sheet towards unsecured debt and will enable us to fund new investments more efficiently and protect proprietary information about our investments.

Last month, we reduced the capacity available under one of our secured credit facilities from $700 million to $250 million. We expect to continue to reduce the capacity of our secured credit facility, while still maintaining a prudent level of availability in the event there are disruptions in the unsecured corporate credit markets.

As most of you know, it is our objective to transition from being a primarily secured borrower to becoming a primarily unsecured borrower when it is cost-effective for us to do so. As Jay mentioned, based on the recent strength in the capital markets, particularly the bond markets, we were able to make significant progress towards this goal over the past several months.

During the first quarter, we issued $850 million of fixed rate debt and $175 million of floating rate senior unsecured notes with maturity dates ranging from 2007 to 2014. The fixed rate notes were issued at spreads ranging from 170 to 195 over the applicable treasury rate, resulting in yields of 4.90%to 5.75 %. The floating rate notes were issued at an interest rate of LIBOR + 1.25%.

We are pleased with the number of new fixed income investors that participated in the offerings and with the market's overall recognition of our credit momentum. Over 65% of our new investors were high-grade buyers. We used the $850 million aggregate proceeds of these offerings to repay borrowings under our secured credit facilities and to fund new investment activity. Our unencumbered assets now total over $3.5 billion.

From a liability management perspective, we have almost no debt maturing this year and very little debt maturing in the next three years. Our asset maturities are well in excess of our liability maturities over the same period.

In February, we redeemed all of the outstanding 9.375% Series B and 9.2% Series C Preferred Stock, with a combined liquidation preference of $82.5 million. As we have already discussed there was a $9 million charge associated with the redemption. In early March, we issued $125 million of Series I Preferred Stock at a dividend rate of 7.5%..

Lastly, we believe that we have plenty of liquidity to fund our business through 2004, particularly with our new credit facility in place. And with that, let me turn it back it over to Jay.

Thanks Katy, for that detail. I really just wanted to go back for a minute and expand a little bit on this shift to the unsecured markets, despite being very expensive in the short-term, why I believe it will be a watershed event in iStar's history. Remember what makes our business special. We have built every part of our Company to deliver unequaled levels of expertise, flexibility, and on-going service to high-end customers in our market. By using unsecured debt versus secured debt we enhance our capability in each of those areas.

In terms of expertise, we no longer have to share all of the proprietary information we are set up to collect, analyze and invest upon to fund our most innovative transactions. That proprietary information is the lifeblood of our business, and we have essentially been giving it away to get others to fund our business. That will happen no longer. In terms of flexibility, the speed and simplicity of unsecured debt allows us to be far more flexible in structuring transactions and enables us to match fund far more quickly. Our information advantages should give us a speed and certainty advantage and using unsecured debt will allow us to fully exploit those advantages.

Lastly, in terms of ongoing service, we no longer have to keep a third-party lender intimately familiar with each and every iStar investment in the event a customer comes back with a tweak or wrinkle down the road. Now when customers come back to us during the life of a loan or sale/leaseback with new opportunities or ideas, we can have a single one-on-one dialogue that will result in a much higher probability of a satisfied customer and better risk/award for iStar.

The only downside to all of this is that making the transition without having investment-grade ratings at all three agencies has cost us probably 50 to 100 basis points of additional annual interest cost on the $1 billion dollars of capital we raised this quarter and probably more on the capital we raised last quarter. Despite this, we remain convinced it was the right long-term move for the Company and we will do our best to continue to demonstrate why our conservative balance sheet and discipline business model deserve to be rated in line with other top tier investment-grade commercial finance companies. That's all I have. Let's open it up for questions.

(OPERATOR INSTRUCTIONS)

Don Destino with JMP Securities

I have two questions for Katy and one for Jay. Katy I dropped off for just a minute while you were talking about asset-liability matching. Did you by chance mention or could you mention what percentage of the portfolio is subject to “in–the- money” interest rate floors at the end of the quarter?

I did not. Interest rate floors with respect to our LIBOR loans - I think they average right now about 1.94%.

Got it. And what percentage of the portfolio is subject to this?

About 60% of our floating rate loans have LIBOR floors.

Got it and another question. When you were describing the pricing of the unsecured -- the new unsecured line you set at your current ratings. Does that imply that the pricing improves with a ratings upgrade?

Yes, very typical. In corporate covenants there is a grid, a pricing grid, based on our ratings. So, currently, it's at LIBOR + 100 basis points with a 25 basis point facility fee. If we were to be upgraded by one of either Moody's or S&P to the BBB- level, that would be reduced to LIBOR + 87.5 basis points with a 17.5 basis point facility fee.

Got it. Thank you and then Jay, you held the line on what I consider very low leverage despite the charges in the quarter. So you can certainly move up in leverage and can certainly improve the cost of debt with your debt ratings upgrade. Have you ever done the math or given any thought to what the ROE potential of this business is, once all the pieces are in place?

Yes, obviously, we run that model all the time and think about each of our business lines separately. Each business line is targeted towards a 15% to 20% ROE. Obviously, depending on the mix of businesses, overall corporate leverage will bounce around, up and down. So we can certainly run the balance sheet given all the metrics we've seen in the market at significantly higher leverage. We have told our investors our ROE targets are 15% - 20%. In good times with high net interest margins, it might actually be slightly above that. But we don't drive leverage just to look at ROEs. We're really driving each individual business line to optimally finance itself. We think those leverage levels are significantly higher than where we're running today but, again, just thinking about it as we grow, as we get bigger, we get more diversified. You're likely to see us try to reach closer to the optimum level for each line that will probably move our ROEs up slightly.

Got it. Just one last question. Sounded like your language changed a little bit this quarter, relative to the last couple of quarters. Your appetite for some of your higher margin businesses despite the fact that fundamentals may be improving, I'm assuming that's just purely competitively driven. Just too much money coming into the market?

That's a good assumption. It's both that and that's a real factor in some of our thinking. Also we just found better opportunities elsewhere where customers said, "Look, I only want to work with one person. I want you to do all my debt, I don't want to tranche it up, I don't want to see it sliced up, I just want to have one person I can talk to."

That is one of iStar's unique capabilities in the marketplace and we were really able to exploit that a lot this quarter.

Right, thank you very much.

Ann Maysek representing Deutsche Bank

Good morning. Just one question. The press release made mention of the Company's potential intention to reduce some of the CTL portfolio, based on strong pricing in the market. Can you give a little more color on that in terms of what might you consider non-strategic and how much of a reduction might you contemplate in that particular portfolio?

Yes, obviously, we see the liquidity that's come into the market as a plus in many ways and are trying to take advantage of it in the sales market where we think we have assets that, either because of the term of the leases or the concentration in our portfolio in a particular SIC code, probably makes an appropriate time to tiptoe into that market. It is never a component of our business to actively trade assets. But where we do see slight opportunities to improve the profile of the portfolio, we will take advantage of them. I would argue in any year but particularly in this year it's going to be a relatively de minimus number, compared to the balance sheet. This year maybe that number will be as high as $150 million. But, again, relative to the $7.5 billion of assets it's still just a very, very small component of our strategy.

Great. Thanks very much.

Michael Hodes with Goldman Sachs.

Good morning. Most of my questions have already been addressed. But, Jay, I was hoping you could maybe update us on your thinking about loan commitment size. Obviously, there was good volume in this first quarter. I don't know how evenly spread it was but it seems like the average commitment was approaching $70 million. I just was hoping you could talk to us about that. And, then, I think I read about your involvement in financing some bowling alleys and I was wondering if you could comment on that as well?

Yes, I guess two dynamics we've been seeing really started to play out in our favor. One is, customers saying to us, "Look I need speed, I need certainty. I need to know that once we close, I'm still talking to the same entity every day."

While tranching and slicing and dicing has been good for lots inthe capital markets there's still, I think, a desire by high-end customers to know who their lender is at all times and who their landlord is at all times. So we've seen a lot of dynamics in the market moving towards multiple owners, multiple slices of the capital structure. Many of our customers this quarter, given that they see with their equity money a chance to get in on the rebound in the markets looking to move nimbly and quickly, we are perfectly set up to provide them all parts of their capital structuring. So, yes, the average investment size this quarter was large.

Underlying a lot of those assets was fairly good diversification. You mentioned the AMF transaction. That's 186 separate properties that represents the core earning power of a recently purchased $700 million company. So there's a tremendous amount of capital invested, in effect junior to our core portfolio, we think places like that where very high-quality LBO sponsors are looking for one-stop shopping. They're looking for somebody who understands corporate credit, who understands real estate, who can be creative in structuring the transaction to meet their very specific business needs.

It's pretty unique and it's not the cookie cutter capital you see being raised out there perhaps in the more retail-oriented markets. Its sophisticated equity looking for sophisticated capital providers like iStar to help them execute their business plans. And I think that transaction while very large, again, on a per asset basis was very small, under $2 million per asset. So we got great diversification, great equity sponsorship there. I think the pricing is very attractive relative to what we see others doing in the market and you will continue to see us as this whole shift to unsecured as our cost to capital becomes less disadvantageous, able to access some of the markets where we know that high-end customer exists. Have not been able to sit in front of them and serve them, previous, based on the way we funded ourselves and our cost of capital.

Those markets are now opening up to us and, again, I think it's a fairly important event in our history to now be sitting in front of them with all the expertise, all the service, all the reputational advantages we've had and now not be at such an extreme disadvantage on cost of funds or the way we funded our sales.

So I think you'll see us really pushing to some markets where we know these high-end customers need us. We've just not been able to serve them. You'll see us push into those markets and start serving new customers who have the same profile as the customers we've always served.

Got you. Just, secondly, regarding the dialogue with the rating agencies. I recognize that this is an ongoing dialogue. But I'm curious in the past, my sense is that the major reviews have occurred in the fall, although last fall Moody's implied that they would be revisiting it I think in the second quarter. Maybe you can just give us a sense of how that works and whether there is anything scheduled in terms of reviews or updates from them?

Yes, and Mike, you're right. It's Katy. Moody's did indicate that they would like to review us sometime mid-year. We would expect that would probably come after second quarter results where we will sit down and walk through the progress that we've made, particularly on the unsecured/secured question, which was one of the tangible things that both Moody's and S&P indicated last fall that they would like to see progress on. We do think we've made very good progress on that front and look forward to updating Moody's and, hopefully, we will also update S&P at the same time.

Gotcha. Thanks a lot.

Susan Berliner with Bear Stearns

Good morning. I have a few questions. One, I was curious if you can give a little more detail on any markets in the West Coast. It seems like you've been focusing a lot more there and then I'll come back with a couple more questions.

Yes. I think anybody who's followed iStar knows of the things we're most proud of is being able to spot opportunities well before the marketplace. We always cite a statistic that showed we didn't make a single loan in Silicon Valley or San Francisco in December 1998 to October 2001, since really the tech/telecom bust and the events of 9/11 we have been targeting Northern California as one of the most interesting markets given that values have fallen very severely, fundamentals were extremely weak, high-quality entrepreneurial equity capital was beginning to stir in that market. We wanted to be their primary capital source and you've seen us do a significant amount of activity in those markets. Following that smart equity around, really to their local marketplace, and watching where they are seeing opportunities and then, again, providing them this very flexible, very custom-tailored capital so they can take advantage of some of the hiccups out there at a real estate basis that we have not seen in many, many years.

So I think from a quality of earnings stream and safety of earnings stream, we think that represents one of the most interesting markets. Obviously, other markets are overheated in our minds and you'll see us try to stay away from that capital and focus where it really does take real estate expertise and capital market expertise and corporate credit expertise. A lot of folks out there are just showing up with a bunch of money. We're probably not going to be able to compete with them. We will let them win their share of the deals. We will go where they clearly do not have the sophistication to play and we will use our strength and work with those borrowers who understand that strength, to really take advantage of the handful of markets that right now we think are mispriced in our favor.

Great and the other two questions I had, the first being if you could go over some of your past exposures and reference I guess to total revenues or total assets? And the other question I have was if you guys have any goal for your unencumbered number at year end?

Yes. In terms of top exposures, right now, the top 10 loans total about 15% of the total loan assets. And the top corporate tenant leases, top 10 corporate tenant leases total about 16.7% or almost 17% of those assets. In terms of the unencumbered target, we have pretty much finished up Phase I of the unencumbering of the balance sheet which was really to pay off our secured lines of credit.

Most of that has been done now and now, obviously, we're putting the new unsecured line in place and will be utilizing that to fund new investments. So, really, from here what you will see is the unencumbered pool growing with our asset growth.

Okay, great. Thank you.

Mike Marron with Bear Stearns

Just one quick follow-up from Bear Stearns. The other income line item was up by $5.5 million over the last year. Could you provide a little color on that?

Sure. As you guys probably know, other income is really primarily dependent on prepayment fees on loans. It typically ranges from about 3% to about 8% of revenues. The last couple of quarters, given that rates have been down, we have experienced increased prepayment activity. We do expect to experience that throughout the rest of 2004. The comparison this quarter is a little difficult because Q1 '03 happens to be the lowest other income we've had since the beginning of 2000. So it's probably an unusual comparison this quarter. But if you look back to Q3 and Q4 of 2003, you'll see right around the same run rate. And we would expect it to be in this range going forward for the next couple of quarters.

Dan Rosenbaum representing Merrill Lynch

Katy, I'm wondering if you could help me think through the appropriate reserve levels to target going forward? It looks like we are seeing better credit performance and you're doing more senior mortgages yet you increased your reserve level a bit. This also suggests pretty good earnings power. So I'm wondering what is the right level of reserves to target and whether the rating agencies want to see a particular level from you?

No, we formulated our reserve policy based on a lot of data that's been collected, really over the last 15 or 20 years on mortgage losses from the insurance world and the CMBS world. We target 150 basis points per loan that we make. And that's a combination of, as you know, assets specific reserves which is somewhat unique to real estate. And then our general reserves which we add to each quarter.

Right now, we are right around that 150 basis point target. We did add $3 million to the reserve this quarter. That's based primarily -- and it's up a little bit -- that's based primarily on just the asset growth that we had this quarter, not necessarily an indication that we are concerned about assets. So you'll see it grow with the asset growth.

And just to follow up on the rating agencies. They have not given us any thoughts on targeted reserve levels so we don't have a lot of feedback from them. But, frankly, some of the information that we used to put that together comes from the rating agencies.

Okay. Thank you.

Susan Berliner with Bear Stearns

Just one other question in regards to your loans that you had on the watch list in non-accrual. Is there any update since the 10-K was filed?

No. We just walked through the watch list in terms of being about 1.59% of total assets. And non-accrual is coming in at the end of the first quarter at about 55 basis points.

But the same loans, same customers?

Yes. On the non-accruals it's actually the same list. It's three loan assets. Two are office, one is hotel. And on the watch list there are five assets, four loans and one corporate tenant lease.

Okay, great. Thank you.

There are no other questions in queue at this time.

Thank you, Operator. Thank all of you for attending our first quarter call. We look forward to, as I said, this new era at iStar where we really can start taking advantage of all the progress we've made in the last 12 months and we will certainly be sharing that with the agencies. We will also be sharing it with our customers in the form of faster, better, and we hope easily demonstrated different level of service. We will come back and give you an update 90 days from now. Thanks again.

Ladies and gentlemen, that does conclude our conference for today.