iStar Inc (STAR) 2004 Q3 法說會逐字稿

Welcome to iStar Financial's third quarter 2004 earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded, and with that being said 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, chief operating officer. This call is being simultaneously cast on our Website. We also have a replay number 1-800-475-6701 with a confirmation code of 749773. Before I turn the call over to Jay, 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 report. Now, I would like to turn the call over to iStar Financial's Chairman and CEO, Jay Sugarman. Jay?

This morning we reported earnings that once again reached a new record. It was a nice way to finish the last quarter before reaching investment grade status at all three rating agencies. As many of you know, it has been a long journey with both S&P and Moody's, and we are delighted to have now reached our goal and to be able to realize the full value of the franchise we have built over the last decade. In anticipation of those upgrades and the recognition of many macroeconomic and global factors that we thought were unresolved during the past quarter, we did take a somewhat reserved stance in competing with the wave of capital that has been working its way into the credit and real estate markets. We feel quite confident now that we can begin to ramp up our investment activities. We look forward to gearing up for what we believe will be a very strong 2005. What you are going to hear in our call next quarter will be a lot more detail about the new businesses and new strategies we will be pursuing, and the new professionals we will be hiring to help us reach the goals we have set out for the coming year. We are very pleased with the way those initiatives are developing but it is still premature to discuss them on this call.

In the meantime, let me give you the highlights of our final non-investment grade quarter. On the earnings front, strong originations during the first half of the year enabled us to meet our earnings targets despite consciously slowing investment activity and accepting increased repayments while we waited for resolution in at least a few key areas in the economic picture. Adjusted earnings increased 5% on a year-over-year basis and are closing in on $100 million for the quarter. On the originations front, we closed 12 separate transactions and committed just under $500 million in new and follow-on transactions. Net interest margins still remain strong mostly because we are avoiding the parts of the market where competition is rapidly driving down spreads.

Our return on equity finished again at just below 20%, despite running with leverage that is still well below our investment grade targets. With a portfolio heavily weighted toward high quality first mortgages and long-term tenant credit leases and more clarity from the rating agencies, we will now be able to move that leverage level up to more appropriate levels when needed. Lastly, credit quality, our portfolio remained well positioned and the changes in the credit scores this quarter were mostly a result of repayments of several large highly seasoned assets. Let me turn it over to Katy for more detail on the quarter, and then come back and talk about the future, the new investment grade future. Katy?

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

Let us start with our results. We had another strong quarter with adjusted earnings coming in at $0.87 per diluted common share, which was right in the middle of our previous guidance. Our net investment income rose to a record $102 million, up 17% from the third quarter of 2003. Our return on book assets was 5.9% and our return on equity for the quarter was 19.9%. Our leverage at the end of the third quarter was 1.7x debt-to-book equity plus accumulated depreciation and loan loss reserves. Third quarter interest coverage was 2.7x and our fixed-charge coverage was 2.3x.

In terms of new businesses this quarter, we generated $481 million in new financing commitments in 12 separate transactions. We had significant repayments and prepayments totaling $691 million this quarter. With respect to the underlying collateral, about 41% was retail, 16% was in the entertainment and leisure sector, 11% was mixed use and 10% was hotel. Geographically, 31% of our new commitments this quarter were located in the Southeast region, 23% in the West, and 15% in the Southwest. 50% of our origination volume was floating rate and 50% was fixed rate. Our in-place net interest margin at the end of the quarter was 397 basis points, which was at the top end of our typical range of 350 to 400 basis points.

Despite a very competitive environment year-to-date we have had record new commitments totaling $2.2 billion bringing our cumulative repeat customer transactions up to $6.4 billion. We continue to believe that the repeat customer metric is an important measure of our ability to differentiate our capital by consistently providing responsive and thoughtful advice to our customers.

Now let's move on to our earnings guidance. As we discussed last quarter there continues to be a tremendous amount of inexpensive capital in both the public and private commercial real estate markets and many of our borrowers anticipate prepaying loans with the proceeds from initial public offerings, asset sales and refinancings. As a consequence we expect a higher level of prepayments in the fourth quarter than we originally forecasted. As you know most of our loans have some form of call protection, so many of these prepayments will generate significant prepayment penalties. Increased prepayment penalties will result in higher other income in the fourth quarter, which will be offset by a reduction of the interest income generated from the repaid loans going forward.

Our earnings guidance for the remainder of the year incorporates both the strong origination volumes, totaling almost $2.2 billion, that we experienced so far this year and our current expectation that prepayments in the fourth quarter will be higher than we anticipated at the beginning of the year. As we mentioned last quarter, we are taking advantage of the strong commercial real estate sales environment to selectively sell certain non-core sale/leaseback assets. We expect to complete the sale of approximately $130 million of assets in the fourth quarter, at a significant gain to our basis, and we are currently marketing several additional non-core assets that may close in the fourth quarter as well. These sales represented just a small percentage of our $3.0 plus billion dollar corporate tenant-lease portfolio.

We anticipate that the combination of the fourth quarter prepayment volume and our asset sales will outpace our origination volume and are therefore forecasting minimal to slightly negative net asset growth for the fourth quarter. We expect the favorable timing of the investment volume in the first and second quarters, as well as the higher other income from prepayment penalties to mitigate most of the earnings impact of increased prepayments this year.

So, with that as a backdrop, lets talk about our 2004 earnings guidance. For the full year 2004, before giving effect to the first quarter compensation and preferred stock and bond redemption charges, we expect adjusted earnings of $3.45 to $3.48 per diluted common share, and diluted EPS of $2.78 to $2.83. After giving effect to the first quarter charges we expect diluted adjusted earnings of $2.35 to $2.38, and GAAP EPS of $1.68 to $1.73. The increases in our GAAP earnings guidance is primarily related to the gains we expect from the asset sales in the fourth quarter.

Now lets move on to our 2005 earnings guidance. As Jay mentioned, we are entering a new era in the Company's history and are excited about many of the new opportunities that we are exploring. A number of factors will drive our earnings and the level of net asset growth that we achieve in 2005. We expect markets to remain highly competitive, however, we also expect that both our new investment grade cost of funds and the growth of some of our new business initiatives will result in a higher velocity of originations. So in 2005, we expect adjusted earnings of $3.50 to $3.70 per diluted share and diluted GAAP earnings of $2.58 to $2.82 per share. Our assumptions for our guidance include $3 billion to $3.5 billion of net asset growth, which reflect both a higher velocity of originations and a tapering of prepayments in 2005. We expect to fund our net asset growth next year with a combination of unsecured debt and equity. As we have stated in the past, it is our intention to modestly increase our leverage next year so any equity issuance would most likely be in the later part of the year. While difficult to determine how quickly we can capitalize on the opportunities that we see in 2005 we will continue to provide you with updates as the year progresses and we have a clearer view of our investment pipeline and funding needs.

Now let's turn to risk management and credit quality. This quarter, our overall asset quality remained steady. The asset quality of our loans declined slightly with the weighted average risk rating of 2.68 for risk of principal loss, compared to 2.59 last quarter and 3.17 for performance compared to original underwriting, compared to last quarter's rating of 3.15. In place debt service coverage at the end of the quarter remained strong at 2.14x, based on trailing 12-month cash flows through June 30th, and current interest rates. Our last dollar loan-to-value for the entire structured finance portfolio was just 67.5%, so our borrowers continue to have significant equity investments to support our loans.

Now, let’s move to the CTL portfolio. The average risk rating of our CTL assets at the end of the third quarter improved slightly to 2.47 versus 2.50 in the prior quarter. Tim O'Connor and our risk management team continue to see stabilization and improved leasing activity in many real estate markets across the country, although we are not yet seeing much improvement in lease rates. Our CTL portfolio remains well leased at 95.7% with a weighted average remaining lease term of 10.5 years. The expirations in 2004 represented 1.7% of our annualized total revenue for the third quarter of 2004. We continue to have little exposure to near term real estate market conditions.

As part of our risk management process, we monitor the credit profiles and performances of our corporate tenants. At the end of the third quarter, 78% of our CTL customers were public companies or subsidiaries of public companies. This gives us good visibility with respect to the credit underlying our leases. In addition, our CTL portfolio remains well diversified from industry concentration perspective with 37 different SIC codes represented. This quarter we are modifying the disclosure related to our problem loans to more closely conform to industry standards. We hope this change will assist the investment community in making more meaningful comparisons between iStar and other industry participants.

Beginning with the third quarter, we are reporting the book value of our non-performing loans or NPL's. Non-performing loans include all loans on non-accrual status and all repossessed to real estate collateral. In addition any asset now classified as a NPL will not be included in our watch list. Historically most watch list asset issues have been resolved before the assets performance required it to be put on non-accrual status. We believe that separating NPLs from the watch list will give you better transparency regarding the actual credit performance of our watch list assets. This quarter our non-performing loans totaled $27.5 million, which represented just 0.38% of our total assets. NPLs this quarter included two loans on non-accrual and no repossessed assets. Watch list assets represented just 0.88% of total assets this 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 reserves totaled $308 million and represented approximately 7.87% of the gross book value of our loans at the end of the third quarter. With respect to our corporate tenant leases, our cash deposits, letters of credit, allowances for doubtful accounts and accumulated depreciation totaled $334 million and represented 10.12% of the gross book value of our CTL assets.

Now, let me walk you through our recent capital markets and balance sheet activity. As most of you know, early in the month Standard & Poor's and Moody's upgraded our senior unsecured credit rating to BBB- and Baa3 and the ratings on our preferred stock to BB and Ba2 respectively. Having an investment grade rating from all three agencies has been one of our highest priorities. We are pleased that both agencies recognized the strength of our franchise and acknowledged the quality and stability of our asset base, the depth of our management team and the disciplined investment and asset management culture that we have created. This is truly the beginning of a new era for the Company.

As we have discussed in the past, having investment grade ratings will not dramatically change our near-term earnings outlook. While our debt is now trading 50 to 60 basis points tighter than we issued it earlier in the year, it will take a while for the reduction in cost to work its way through the right side of the balance sheet. Access to the high-grade unsecured debt markets will afford us greater speed and certainty in the execution of our debt transactions and the plethora of fixed income products in the high-grade markets will allow us to more effectively match fund our asset base. We believe that the lower cost of funds resulting from our new ratings will have a greater near-term impact on the left side of our balance sheet. In the past, we have frequently had to pass on well-underwritten transactions brought to us by good customers because they did not meet our ROE hurdles. So today we are looking forward to more effectively meeting the needs of our existing customers as well as pursuing both new customers and new business opportunities. As we discussed earlier and due in part to our new cost of funds, we are now forecasting that the velocity of our new originations will increase in 2005, despite the highly competitive environment.

We are now funding the majority of our investments with our unsecured line of credit. As we accumulate balances on the line we expect to term them out or match fund them with longer term unsecured debt. As I mentioned earlier, we are anticipating fairly significant prepayment volume in the fourth quarter, which will lower outstandings on the line as loans repay. Based on our current expectations with respect to net asset growth, we do not anticipate the need to issue longer-term unsecured debt this quarter. However, any bond issuance in the fourth quarter will be dependant on our actual new origination activity and repayment volume. Rising interest rates continue to be at the top of most people's minds. While interest rates have remained low, most economists continue to predict that rates will increase in the coming year. This has prompted many questions about what happens to our business when rates go up. Our objective is to deliver stable earnings and strong risk-adjusted returns to our shareholders and to insulate our earnings as much as possible from changes in short 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. So while we expect that rising interest rates may create some opportunities on the originations front they will have a relatively small impact on the right side of our balance sheet.

We also take a conservative approach with respect to our asset and liability management. 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 6.5 years and the weighted average maturity of our liabilities is 5.2 years. 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. We believe that we have plenty of liquidity to fund our business in the year ahead, particularly with our new ratings and enhanced access to the credit markets. From an equity perspective, we review our dividend at the beginning of each year and target a 5% annual dividend growth rate and a 78% to 82% payout ratio. A 100 basis point increase in interest rates would only increase our current dividend payout ratio from 80% to 81% . We are committed to providing shareholders with a strong dividend that has a solid earnings cushion. And with that let me turn it back to Jay.

Thanks Katy. We have been looking forward to running this Company, full out for many years and we clearly did make a lot of progress toward our goals over the years, but it finally feels like we have reached the point where we are on a level playing field with the rest of the finance world. As Katy mentioned, many of our borrowers give us first look at transactions that we have had to pass on, because of our higher cost of funds and our below target leverage levels. I think I can say with the investment grades safely in hand, we are very confident that our high service, high quality model can now reach into all corners of the real estate finance world and deliver the best product at a competitive price. Now in order to do that, we will begin adding to our already deep management team, at both the senior lever and in several new geographic and asset categories. And I apologize for not going into more detail this quarter, but we will be giving you that detail when it is appropriate. Let me go ahead and open it up for questions now operator.

(OPERATOR INSTRUCTIONS) Michael Hodes, Goldman Sachs.

Good morning, first off congratulations on the upgrade.

Thank you.

I really have two questions, I understand the reluctance to go into depth at this point on some of the new initiatives, in terms of the asset growth that you are expecting next year maybe you could give us a sense whether we should expect much coming from the corporate tenant lease side, that is an area that you had previously highlighted that it has been some what overheated, I know you are opportunistic could it be showing some assets there this quarter? And then secondly in terms of the ratings upgrade, the fixed income market to a certain degree, had anticipated this and I know your funding costs have improved over the course of last year relative to your various benchmarks, could you try and make it clearer and maybe give us a sense from your perspective, mechanically what we should expect over the next year or two in terms of improvement in how that is going to manifest in terms of cost of funds?

Yes Michael, let me take the first part of it and then touch on the second, in case Katy has anything to add. We do believe in the CTL markets that -- while very competitive, there are pockets of opportunity that we are going to now exploit using both our new cost of funds, and as I mentioned potentially some new hires that will help us cover those markets a little bit better. There are still a few places out there in the CTL world, where we think the combination of corporate credit, capital market and real estate skills preclude some of this easy money that is coming into play and that is where we are going to focus most of our efforts. I think that in the market you can get 10 or 15 bids for something we were just not even spending any time on. We are looking for opportunities where the customer has a very specific need. It tends to be larger in size or more specialized in nature and we are seeing good traction there in the number of transactions that we have pursued in the third quarter and end of the fourth quarter. So, I think you will see us spend more time there. Our hit ratio will be better there and I think the CTL volumes will pick up next year.

I think mechanically in terms of the cost of funds advantage – it is really two things. It is not just the cost of funds, remember, we have run this Company at significantly below what we believe is a conservative investment-grade leverage level. This quarter we ended at 1.7x. We really wanted to hear from the agencies, a concurrence with our internal leverage models that break down appropriate leverage for each product type you are in, and look at the size and scale of the Company as a whole and they have given us comfort that, yes, there is an appropriate leverage level that protects not only our creditors but also all the way down through the capital structure, our preferred shareholders, and the dividend we pay our common shareholders. In this last cycle with the agencies – we are spending a lot of time with them. They are very forthcoming on their views on that. I think we are in general agreement about the appropriate models for the Company at least at this size, this stage, and this diversification level. I think that gives us the comfort to now run the Company closer to what we always thought was an appropriate target leverage level. So, while the new lower cost of funds is definitely an advantage, as Katy said, it will take time for that to spool through the rest of the balance sheet. Our new transactions, we can really run them on an appropriate leverage, lower cost of fund basis and that does open up a much larger segment of the market. First and foremost, I think you will see it hit with some repeat customer business where a borrower simply comes to us and says, `Look, I have doubled the value of my asset, your loan is mis-priced, what are you going to do about it?' Historically, we have said we cannot do anything, but we werere running the business in a way that we think was appropriate for the cost of funds and the size we were at. That has changed, and I do think this is a new era and in that there will be very few conversations with borrowers where we can not serve their needs. Especially when the property has doubled in value, and represents a very solid and safe investment, and where we would probably not have a financial product that would work for them .

So, we think the incremental volume next year and it is tough to really give you a timing on that, but we know based on historical precedence, that we are going to see a lot of opportunities that we would have passed on but we are not going to have to pass on anymore. As to when the volume kicks in early in 2005, it may take a little bit of while for just the natural flow of volume to get back to us. But, I think you will see us come out of a relatively restrained period, where we wanted to see whether things were shaping out in the macroeconomic world and get our ducks in order, particularly on the rating agencies side. I think we have a very good business plan going forward and now we are going to attack the market with both the lower cost of funds, the slightly more appropriate leverage levels on each new transaction, and picking our way through our market that is still overly liquid in our minds across a wide range of credit products. We have been spending the last 6 months figuring out where they are not overly liquid, and you will see us make some fairly strong announcements about initiatives in those areas.

Thanks a lot, Jay.

Don Destino, JMP Securities.

Hi guys. I see, you have been running the business at pretty close to 20% ROE for the last several quarters and I know that is kind of above where you have been historically. What do you think that kind of target range ROE is given now that you may have the opportunity to push leverage a little bit given the lower cost of funds. I understand that there are just as big opportunities on the growth side as there are on the profitability side, but do you view the current run rate ROE as a good long term ROE, particularly given your commentary that spreads have really tightened and the market is so liquid?

That is a good question. I mean we have been, I would not say surprised but this has been a business that has run at a 20% ROE with almost no volatility, I think in the investment world, that is an anomaly. We have always thought this business could create better risk-adjusted returns, certainly more than any hedge fund we have ever seen. The challenge for us going forward is that this is a customer centric business; we need to go where the customers need us and frankly, our target ROEs have always been 15% to 20%. They have been running at the high end of that range for a long time, and we continue to believe there are good risk-adjusted returns available in our marketplace. I think we have probably been pretty stingy with our capital, both because of our viewpoint that the ratings were so important, and because we wanted to go slow and steady, we wanted to build diversification and we wanted to build the internal processes in the team. Frankly, we feel like we have done all that the right way.

I think we can be a little more generous at least internally in approving transactions that we all know are good risk-adjusted return but may not meet the high end of that ROE target. I think 20% ROE in a world where the 10 year treasurary is trading below 4% is just a heroic ROE to do with almost no volatility. So, I would not mind giving up a point or a two on that to really serve our customer in a more complete, one-stop shop way. I would say we were somewhat surprised that ROE has stayed this high for this long, but it does reflect the fact that we are generating very good risk-adjusted returns on the front-end of the machine. I think now, the right side of the balance sheet will carry a little bit more of the water and could our ROEs be in the high teens at 18%, or 19% instead of 20%, sure that would take a lot of new transactions at a slightly lower ROE, we would actually do that. But I do not think we are ready to predict that yet but I would not be surprised if a year or two from now, the 20% ROE comes down just a touch.

But just expanding on that a little bit and getting kind of your view of how you want to run the Company? Is there a thought that, hey if I could accelerate the growth a little bit at the expense of some ROE that is worthwhile but my stock is going to be valued on an FFO multiple or a dividend yield basis and the fast tracking grow about in a quality way, that is worthwhile if that may cost me a little ROE? Is that fair?

Yes. One good example of that is, we look for things that are mispriced and if we can buy treasury bonds at 50 basis points wider than a treasury bond should trade at, we want to do that trade. That is adding real risk-adjusted value to our shareholders. We have historically not been able to do that because it requires higher leverage levels for very high quality assets and a lower cost of funds to actually implement that kind of strategy. If that was a 15% ROE against treasury bond credit, we would be ecstatic. That is creating unbelievable risk-adjusted returns. They may not be 20% percent but on a risk-adjusted basis, we can all argue that we have added 1000 basis points of credit yield against zero risk. So, that is the kind of opportunity that I think now is available to us. We have seen it in the past, we know it exists in our markets. We know our borrowers bring us opportunities like that and we have just not been able to execute, we had to turn that business away.

I would like to say there is going to be a component of that business going forward. It is not going to be the core business but we talked about going from the $2.5 billion of volume we are going to do this year to the four plus next year. Some of that incremental volume is going to be things we have passed on historically. We are just going to town now, and it might not be a 20% ROE but I will tell you on a risk-adjusted, credit-adjusted basis, we are going to like it and you are going to like it. I think it obviously helps grow earnings but more importantly allows us to again expand that customer base, serve them where they need to be served, so when they do have a very high ROE low-risk proposition, they are going to call us first. They are going to have made the connection with us. They are going to now review things in a better way for them, and it leads, I think, 2 or 3 years on how to a more robust business. It has killed us that we have not been able to take advantage of that over the last 5 years. You will see us now start to take advantage of it.

Don Fandetti, Wachovia.

A quick question, Jay. How important is the AutoStar joint venture to your '05 net asset growth assumption?

I do not really want to go into too much detail. Based on the early return it is going to be a very solid generator for some of the CTL transaction volume. For those of you who have not seen the announcement we formed a venture with Staubauch companies and Presidio capital partners. It is really bringing our one-stop shopping approach to a very large segment of the market place where auto dealers are looking for financings, sale/leaseback and improvement in capital. Combined with Staubauch’s deep penetration in that market and our ability to custom tailor solutions for what is generally a fairly wealthy segment of real estate owners, we think it is a perfect fit for our business strategies. We think it is obviously a very large business. Volumes could be in the $100 million a quarter or more, but we are not again predicting we are not putting quotas on how much we need to do,we are asking customers what they need us to do and looking at that pipeline today we would say it could be a material part of the business on the CTL side going forward.

One another question, just want to get a handle on what gives you the comfort that prepayments will slow, if I look around in the real estate markets transactions such as buying the Ruben's team portfolio, high and down where you suspect you may have been prepaid. Wouldn't that scenario continue to increase as rates move up?

Well, two things will slow these things. One is, we are frankly -- in a lot of situations in our prepayments. We have weighed prepayment penalties on assets where a borrower did extremely well. We made well above our target ROEs so in order to preserve the relationship we did not preclude them from doing a transaction that made sense for them and frankly was a very positive one for us. And there is not a lot of those situations left in the portfolio as we look out into 2005. There is still going to be prepayments, a lot of things that we expected to prepay, have prepaid already. A lot of the longer-term fixed rate deals where we do not expect prepayments, and we are not expecting it to happen in 2005 either, sure, if values continue on trajectory, we may have to revise that, but we feel like values have reached the level where if interest rates begin to move back up a little bit, we would see a stabilization as opposed to this, and really the rush into the market we have seen in the last 6 months where capital is coming almost indiscriminately on some transactions that we frankly were very surprised got repaid as Katy mentioned there will be lots of other income to offset the bruises here, but some of those did catch us by surprise. We looked through our portfolio a little more carefully in light of that and do not see the same sort of scenario playing out in 2005.

Matthew Park, AG Edwards.

I am taking a bit more general perspective. Is there anything that changed during the quarter perhaps competitive environment or certain regional opportunities that has changed from the beginning of the third quarter to perhaps now?

I think the macro environment is still the same. I think real estate fundamentals are improving pretty much across the board now. The hotels moved earliest. We have actually seen a number of apartment markets finally stabilized. I would not say they are getting better, but they are stabilizing. We are seeing at least the core office markets are beginning to at least see leasing activity. Again, rental rates are not anything to right home about, but the market feels like it has got an underlying tone that means it is going to be stable in almost all the asset sectors and that is all really iStar looks for. We do not really benefit from upside. In fact, as you heard, prepayments actually occur more quickly when the markets start turning up quickly. So, stability is a good thing for us that is generally our viewpoint on almost every market we play in.

There have been particular pockets that we see not being swept up in this capital flow and I think that is where you will hear us make additional announcements about strong teams we are putting together to begin taking this one-stop shop anything you need, customer centric business model into those markets. We are frankly across the funds in a leverage model that allows us to be competitive. I do not think we have to go in and say we can deliver the best type quality solution for you, but by the way you are going to pay a 100 basis point premium. I think we can be a lot more competitive. I think we can penetrate those markets much more quickly. There will be a ramp-up time and I am going to promise that in the fourth quarter, these things are going to be in high gear, but they will likely be in place by the end of the year and we will be able to talk about them in the context for 2005.

Sam Miran, Gem Value Fund.

Congratulations on the investment grade ratings. A lot of us have believed you guys deserved that a long time ago. So, it is also nice to see the credit rating agencies finally come around. My question is more general in the long-term, we talked about this a little bit on this call, but I was just wondering from a longer term perspective, if we were to look at iStar say doubling its balance sheet over time. What does the impact of the credit ratings due for you versus not having it, and how much faster does it allow you to do that? And then what are the implications on leverage and the type of returns you would expect over that time frame?

Well, I think we have always built our business model around being an investment grade Company, and frankly what you have seen over the last 5 years is us competing with one hand tied behind our back. It is not really changing our plans, it is actually allowing us to implement the plan we set out 5 years ago, which was to find the highest and best customers who value the private bank approach we bring to them, who value the one person, one decision, one phone call approach as opposed to the securitization and syndication markets, which in a rapidly moving real estate market and I think, proved to many borrowers to be a real problem in terms of operating their business the way they would like to. So, this is kind of unleashing the full potential of the franchise, you mentioned doubling our asset base that is certainly something that we believe is now possible, and probably would be improbable had we not been able to make this move. So many pockets of the market have opened up to us now, obviously, even in the last 6 to 12 months, Katy’s side of the firm is so much more efficient, can be so much more streamlined in match funding, in giving very concrete views on what our cost of capital and the debt side is going to be. It just -- it makes this for us more than better. And I think, as we entered the third quarter and you heard on our last conference call, there are some macroeconomic variables that -- we just want to see how they sift out before we start to use some of the benefits of both the upgrade and the ease of executions that are now at our disposal. So, as you think about us going forward, the machine is better, it is faster, it is has a lower cost, and it is more appropriately leveraged. I do not want to tell you what our ROE targets are, they are still 15% to 20%. After we think this business generates day in, day out, year in, year out, but is one of the earlier questions we have touched on, we really want to arbitrage the credit markets. Every time we do a deal we added value for our shareholders, and not just become a commodity market player. The markets right now are pricing risks very tightly, they are pricing liquidity very tightly. We could go out and get a bunch of deals, we could grow earnings very quickly, we could move our leverage to appropriate levels very fast, and we would have a very nice earnings story to tell you, but I would tell you that the underlying franchise here is not focused on just delivering earnings, it is on delivering value. Every deal we do, we want to be able to look you in the eye and say, you could have taken a dollar, put it in the market, and hear we earned you (x) plus something. And that is why I think this franchise is so valuable; I am hoping with these upgrades, we are now in a position to really cut lose. As some of the new people go to some new markets, really touch parts of the market we have not gone after, and over the next several years really build the franchise for high-end customers. Wherever they go, we want to go, wherever they are that is where we want to be, and that is going to take a little more time for which we could have done it 3, 4, 5 years ago, but we have I think shown over that period what we are capable of even with one hand tied behind our back, even with a cost disadvantage, even with a leverage disadvantage. We have seen these ROEs stay very high, we have seen them stay very stable. You see our credit track record I think that shows we are very disciplined, no one is going to change that -- I mean that is the DNA of the firm what I do think you will see is if we can make a 15 % ROE against the treasury credit, we are going to go make it. We are not going to be quite so concerned about if we need to maintain ROEs really, really high. I think now we are just going to prove to the marketplace that a better business model, a better mousetrap can go into lots of new markets and take market share. And that is where we are going.

Great. Well, you and your team have done a better job than anyone we have seen in terms of putting a long-term strategy together and then executing on it. So, we are look forward to the new era.

Mark DeVries, Lehman Brothers

Could you share with us any of the other relevant assumptions behind the '05 guidance and more particularly does it assume that some of the over heated markets begin to cool off?

Okay, if you were to look at the model but it sounds like your question is more about just return on the market. We are not anticipating the market to come back to us. We are anticipating that it does not go completely haywire. If you are following the popular press right now there is money flowing into real estate from international, domestic, and retail customer just by every source you can see.. We think a lot of people including ourselves are taking advantage of that on a selective basis. It is probably odd for some of you to hear us talk about a lot of prepayment and then hear us telling you we are going to sell assets, discretionary assets that are performing well, we are going to turn on and flip them into the market. We just think there are places where our capital is better used and if we can take some money off the table, where an investor has a different risk profile and different return profile than we do, they then probably have a higher and better use for that asset than we do. We willl redeploy assets where we think there is a more specialized need for our services when risk adjusted returns are better for us. So that dynamic will probably not go away any time soon. There is a lot of inertia behind it, and Frankly we think it is 10-years over due. We have always thought the risk-adjusted returns in our sector were too good. They are better than anything else we see in the market place. What will we be focusing on, I think, it is again where are those corporate credit capital markets and real estate expertise really receive an excess return. And so I think you will see us stay out of some of the core markets, you will see that money continue to move towards -- what they perceive to be the easiest the low paying improve. We will probably not be buying any CBO office buildings at 6 caps or more than 5 caps or financing those things. That is not our business, that is something that I think a lot of this new capital, I believe, there is good risk return for them probably not for us. On the other hand, I think we will tap into the market place wherethey do require all the expertise we can bring. There is not just one simple factor there are multiple factors. We continue to get those calls, we continue to be one of the preferred providers and we are teaming up with other players in the market who think like us in a similar way to make sure that we get our fair share of those deals. We are not apposed to splitting a deal with somebody if they have done good work in the past or we have had a relationship in the past. We will make sure we both get to play.

So there are ways to play in a market that gets competitive, we have had to deal with this before in 1998, which was almost equally as competitive. We think unfortunately the ending of this cycle might be similar or some of these new players figure out it is a lot harder than it looks from the outside and their money will go elsewhere, and that trigger may be higher interest rates or may be a macroeconomic variable that none of us can predict. But I think, if you are asking me, do I think our $4 billion volume origination assumes there is going to be an event and people are going to back off the credit market, it does not.

Okay. Are there any quarters in the near-term where we can expect to see any kind of dilution caused by investments if you have to make any new initiative?

Yes, Mark, I think the way you should look at this, is obviously the prepayment volume in Q3 and Q4 coupled with the asset sales, which are coming right at the end of the year, obviously we had the benefit of earning income off all those assets in '04. We will not have the benefit of earning income on those assets in early '05. So there is as Jay mentioned a little bit of a catch up here that needs to occur.

We remain relative to the value they will bring to us. The new overhead is relatively modest. I do not see that as the biggest factor, I see the timing of the ramp up of those investments and we think just based on what we are seeing today will happen last up, sothe new cost will be met with new revenues.

(OPERATOR INSTRUCTIONS). Mr. Sugarman, Ms. Rice, and our host panel we have no further questions. I will turn the call back to you.

Well, thank you everybody. Again it is an exciting period for us. We are working full blast here to get ready for 2005. We think in the fourth quarter we are going to really be ramping up some interesting businesses. We are going to be looking forward to talking to you about it in our next call, and hope you all will be with us in February. Thanks, operator.

And thank you ladies and gentlemen. That does conclude our financial results for this quarter. Thank you very much for your participation as well as for using AT&T's Executive TeleConference Service. You may now disconnect.