iStar Inc (STAR) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the iStar Financial first quarter earnings teleconference. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions given at that time. (OPERATOR INSTRUCTIONS). As a reminder, this teleconference is being recorded.

I would now like to turn your teleconference over to the Vice President of Investor Relations and Marketing, Mr. Andy Backman. Please go ahead, sir.

Thank you Phil, and good morning everyone. Thank you for joining us today. With me today are Jay Sugarman, Chairman and Chief Executive Officer; Jay Nydick, President; Katy Rice, our Chief Financial Officer; Tim O'Connor, our Chief Operating Officer; and Collette Tretrola , our Senior Vice President and Controller.

This morning's call is being webcast on our corporate website at www.iStarfinancial.com in the Investor Relations section. There will be a replay of the call beginning at 1:30 PM Eastern Time today. The dial-in for the replay is 1-800-475-6701 with the confirmation code of 777522.

Before I turn the call over to Jay, I need to remind everyone 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 CEO, Jay Sugarman. Jay?

Thanks Andy, and thank you for joining us today. As you saw in our release this morning, iStar began the year with a busy quarter that sets the table for the rest of the year and for the years to come. While earnings were within our previous guidance range, they were not where they have been in the past, however we believe we have put in place the foundation for a bigger, better and stronger company and continue to expect this year to be one of increasing growth off the first quarter's base numbers.

Our decision to slow originations during the last two quarters of 2004 and the still high level of repayments has created a challenge for another quarter or two, but we are now well positioned to rebuild earnings momentum, despite a market that remains overheated.

I want to talk more on the market and our strategy in a minute, but first let's run through the key numbers of this quarter. On the earnings side, AEPS, adjusted earnings per share, was $0.74 per share -- pretty much where we expected, and clearly the low point we forecast during the transition into our Phase III strategic plan.

The biggest issue for us right now is the repayment of assets put on in higher interest rates and higher spread environments. To offset that, we need to continue the ramp up of several of our new initiatives and also position ourselves for what we believe will be a better spread environment in the near future.

On the originations side, we closed 16 separate transactions, committed over $1.2 billion in new and follow-on transactions this quarter, really focusing on situations where we believe we had a clear competitive advantage. The quarter included a lot of repeat customer business, a lot of multi asset transactions, and a continuation of our trend towards lower risk and lower spread transactions, as you will see from our Loan to Value statistics and net interest margins.

With regard to return on equity and spreads, return on equity finished at just over 17%, lower than the recent past, but still strong given our leverage and asset safety. To give you some sense of the relatively low leverage we are running at right now, you need to only look at the recent asset pools of subordinated B notes and mezzanine loans that are being financed in the collateralized debt obligation market at better than 3 and 4 to 1x leverage, while our portfolio of predominantly first mortgages and investment grade credit tenant leases is still being run at less than 2 to 1. That said, it is also a fact that our spreads have been compressed as various investments made in higher rate/higher spread environments have paid off. We have not yet stretched to replace those yields and are still waiting for better market conditions before we are likely to do so.

Credit quality; Real estate fundamentals are improving in several of the higher profile markets in which we operate, so our portfolio feels strong, but fundamentals are improving from a low base, and many lenders seem to be pricing in almost perfect conditions. This quarter, we added one new loan that did not pay off at maturity toward our NPL list, but it is a loan that the borrower has indicated will be refinanced shortly and at our basis represents almost no principal risk. Strangely, we actually think this loan will end up generating a higher return than our original underwriting due to the incremental fees accruing prior to this refinancing.

Let me turn it over to Katy now for a full recap of the quarter.

Thanks, Jay. Good morning, everyone. As usual, I would like to cover three topics this morning. First I will summarize our results for the first quarter and review our earnings guidance. Next, I'll talk about risk management and credit quality. Finally, I will review our capital markets activities and balance sheet position.

Let's start with our results. As Jay mentioned, our adjusted earnings came in at $0.74 per diluted common share, which was in the middle of our previous guidance range. Our net investment income was a record $94.6 million, up 10% from the first quarter of 2004. Our return on book assets was 5.1%, and our return on equity for the quarter was 17.3%. Our inplace net interest margin at the end of the quarter was 324 basis points, which is reflective of the higher proportion of first mortgage products that we have originated over the past 18 months, the roll off of higher yielding assets, and the spread compression that is occurring across all real estate financing products.

Our credit statistics remain strong. First quarter interest coverage was 2.3x, and our fixed charge coverage was 2.0x. Our leverage at the end of the first quarter was 1.9x debt-to-book equity plus accumulated depreciation and loan loss reserves -- which is still below our current target of 2.25x and significantly below our risk state capital model, which shows 2.7x as the appropriate leverage level, based on our current asset mix.

Despite a very competitive environment, we generated a record $1.2 billion in new financing commitments in 16 separate transactions this quarter. 76% of our commitments were comprised of first mortgages, first mortgage participations, and corporate tenant leases. Repayments and pre-payments moderated somewhat this quarter and totaled $475 million.

As a quick update to some of the new initiatives that we discussed on last quarter's call, we successfully completed the acquisition of Falcon Financial on March first and are busy integrating Falcon into our AutoStar platform. Our AutoStar team has been working hard to build brand identity within the high-end auto dealer client base, and it is beginning to gain some penetration with both the CTL and lending products. More recently, we also closed on our acquisition of a substantial minority interest in Oak Hill Advisors on April 1st.

Now let's move onto our earnings guidance. As we discussed last quarter, while pre-payments moderated somewhat this quarter, we expect to see higher levels of loan pre-payments in the next couple of quarters, as capital inflows into the commercial real estate sector remain strong. While the timing of pre-payments is difficult to predict, we now anticipate receiving somewhat higher pre-payments than we forecasted in the second and third quarters of 2005.

Our earnings guidance for 2005 remains unchanged with diluted AEPS of $3.25 to $3.50 and diluted earnings per share of $2.25 to $2.60. Because pre-payment activity remains high, we believe that our net asset growth for 2005 will be in the $2.5 to $3 billion range.

For the second quarter, we expect diluted AEPS of $0.80 and GAAP EPS of $0.57. However, we have several loans with significant pre-payment penalties that could prepay in either the second or third quarter, so depending on the timing of these pre-payments, second quarter earnings could be several cents above or below our guidance.

Now let's turn to risk management and credit quality. This quarter, our overall asset quality improved slightly. The asset quality of our loans, as measured by our quarterly risk rating process, improved both with respect to trends versus underwriting and risk of principal loss. In-place debt service coverage at the end of the quarter remains strong at 2.4x based on either actual cash flow or trailing 12-month cash flows through year-end and current interest rates. Our last dollar loan to value for the entire structured finance portfolio was just 66%, so our borrowers continue to have significant equity investments to support our loans.

The average risk rating of our CTL assets at the end of the first quarter also improved slightly. Our CTL portfolio remains well-leased at 95.2% with a weighted average remaining lease term of 11.5 years. Lease expirations in 2005 represent just 0.3% of our annualized total revenue for the first quarter of 2005.

At the end of the quarter, our Non-Performing Loans represented 1.3% of our total assets. This quarter, we added a fairly large first mortgage loan that was not paid off at maturity to our NPL list. The collateral for this loan is a newly completed residential complex here in New York City. We believe that this loan is well covered by our underlying collateral and do not expect a loss on principal or interest on this loan.NPLs this quarter also included two loans that have been on non-accrual for the last several quarters and no repossessed assets. Watch List assets represented just 0.06% of total assets this quarter.

Now let me briefly review our capital markets activities and our balance sheet. During the first quarter, we issued $1.1 billion of senior unsecured notes in a combination of 3-year floating rate and 7-year fixed rate maturities. This was our inaugural unsecured notes issuance as a fully investment-grade finance company, and we were very pleased with both the number and the quality of investors who participated, many of which were new to iStar Financial.

More recently in mid-April, we issued $500 million of senior unsecured notes with both 5 and 10-year maturities. While the bond market was quite choppy at this juncture with wider spreads across all sectors, we were able to successfully complete an over-subscribed offering.

We used the proceeds of both offerings to pay down our lines of credit. As a finance company, we expect to be a regular issuer of unsecured debt. We will always seek to maintain a prudent level of liquidity, and the timing of our issuances will be based on our pipeline and our projected funding needs. As we mentioned on our call last quarter, we expect to issue approximately $2 to $2.5 billion of unsecured debt this year, inclusive of the two offerings we recently completed. Based on our current expectations with respect to net asset growth, we anticipate the need to issue unsecured debt sometime in the third quarter.

We expect to fund our net asset growth in the coming 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 this year, so any equity issuance would most likely be in the later part of the year.

From a credit perspective, we continued to make progress in our migration from secured to unsecured debt. As a result of our recent bond deals, our secured debt as a percentage of our total debt was just 29% versus 56% a year ago.

This quarter, we also completed the exchange of approximately $100 million of TriNet 2017 notes for $117 million of iStar Financial 2014 notes. We also completed the modification of the covenants of the $50 million of TriNet notes due in 2006. The result of these transactions is that we were able to merge our TriNet subsidiary into iStar, thereby eliminating the structural subordination of approximately $785 million of assets for the benefit of our iStar bondholders. In addition to eliminating the subordination, we will no longer need to produce separate financial statements for TriNet.

Many investors ask us how a rising interest rate environment will affect us. As we have discussed on prior calls, we take a fairly conservative approach to managing the right side of our balance sheet. It is our objective 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 actually increasing our adjusted earnings by about 0.39%, so we are very well hedged at this point.

From a macro perspective, we believe that rising interest rates should eventually ease some of the pressure on real estate asset spreads by causing much of the excess, unsophisticated capital that entered the market in search of yield as interest rates decreased to leave the sector. So while we cannot predict when this may happen, we believe that increasing interest rates should benefit our business.

Finally, in the first quarter, our Board announced an increase in our quarterly dividend, beginning with the first quarter of 2005 to $0.7325 per share or $2.93 per share on an annualized basis, which is a 5% increase over last year's dividend.

So with that, let me turn it back to Jay.

Thanks, Katy. All right back to the originations side of the business. Last quarter, we laid out a plan for attacking the markets in a variety of ways, including a number of initiatives intended to broaden our capabilities in our traditional crossover strongholds.

And just to recap, we enhanced our presence in the lending and sale/leaseback markets through three targeted investments. And those really intended to do three things -- one, improve our corporate credit underwriting capabilities, which we accomplished through a minority investment in Oak Hill Advisors, one of the largest corporate credit platforms in the country. Two, to increase our ability to meet all the financing needs of high-end automotive retailers, which we did by purchasing Falcon and bolting it onto our AutoStar platform. And three, to increase our repeat customer business by providing capital to one of the largest investors specializing in transactions combining real estate and corporate private equity. As you remember, we were a lead financing source for the Cerberus/Blackacre takeover of LNR.

While it is too early to see the impact on our origination volumes, we do see significant benefits from the information flow we are bringing to bear on our investment process and would expect to be able to show some meaningful results in at least one or two of the initiatives during our next quarter call. So if you will bear with us, I think we will have some good news for you when we next get together.

Okay, let's go ahead and open it up for questions, Operator.

(OPERATOR INSTRUCTIONS). Susan Berliner, Bear Stearns.

A quick question on your other investments line item. Was that increase solely due to Falcon Financial?

Hey Sue. No, it is actually a number of different things. A good portion of the other investment is actually the intangibles that we have to book for our CTL investments, which do not fit into any category obviously. It is also investments that we have made in portion of investment in LNR. And then a portion of it is some of the investments we are making in the not-yet-announced iStar brands that we are working on. So it is a little bit of a combination.

And can you give us any certain details on what was done out of Falcon Financial during the quarter?

Falcon, we acquired March 1st. So it has just been getting ramped up. I think we have a fairly small volume at this point. We have actually spent more time working on getting their origination platform working with our AutoStar platform. They are out calling on clients, and we are seeing volume. But we did not perform a significant volume for the first quarter for them.

Okay. And the loans you acquired, I think it was in the press release: That was just taken over when you acquired the company?

That is right.

Don Fandetti, Smith Barney.

Jay, can you talk a little bit more about how you achieved these stronger relative gross loan origination volumes in the quarter? Did you do different product types? Or were you more aggressive with your bid?

Well, I think as I mentioned, we really focused a lot on repeat customer business that we have been working on for quite a while. It just happened to close in this quarter. I think repeat customers were over three-quarters of the volumes. So a lot of it was in-house, less competitive proprietary opportunities. That is going to continue to be a hallmark of how we compete in this market. We did a lot of multi asset transactions, where there is traunching that allowed us to get a very sizeable sponsor equity investment junior to us -- easier to make that call, frankly, in this kind of market than to pick any one perhaps overheated market call. So you saw a lot of multi asset transactions.

We just continued to believe this is a tough market to want to finance at numbers north of replacement costs. And so most of the deals we did, we were looking for discounts to replacement costs.

We did cut spread a little bit. As you can see in our numbers, we are not out there reaching for yield. We are primarily looking for safe transactions, high-quality sponsor transactions, discounts to replacement cost transactions. So we have not turned the pedal on in terms of when we think there is an opportunity on a macro basis; we are still seeing a lot of very targeted micro opportunities.

Okay, and lastly on your pre-payments. It seems like it continues to be difficult to sort of peg that number going forward. Is there any change in terms of why your borrowers are pre-paying? Is it more sales or more refinancing versus the last few quarters?

Well, it kind of ties back into your first question in terms of the market. We track kind of where we value assets in terms of the loan to values we report to you. And then we track where they actually trade in the marketplace in terms of sales and refinancing.

As of last quarter, if you go back over the last 24 months, our values have understated actual values in the marketplace by 27%. So a number of our customers are paying a reasonably stiff pre-payment penalty because the sales prices are so attractive. Obviously in a stale condition, we do not have a chance to refinance that borrower. So it is kind of the worst of all worlds for us.

In many of those cases, the assets have continued to do what we expected. We would certainly be in line to do a proprietary noncompetitive financing, but they are not coming back to the market for refinancing, they are coming back because they are selling. And all we can do then is shake their hand and take the pre-payment penalty and hope we can do business with them in the future. But many of these investors are very smart. They are sellers right now, not net buyers. So some of the repeat customer business we will get down the road is dependent on the market pulling back. And some of that smart equity getting back into the marketplace as a buyer, as opposed to what we are seeing right now, is a lot of the smart equity, is actually a seller.

And lastly, I am not sure if you have talked about this in the past, but with cap rates certainly moving down on real estate, have you tried to peg where your cap rate on your high-quality real estate portfolio might be in today's market?

We don't go through that exercise. I will tell you that unsolicited, we get offers that again to us are indicative of a very, very heated market. Well, well north of our purchase price and basis but even more importantly well north of replacement costs, which we think is a long-term indicator as one of the key metrics we track. There is a lot of embedded value in the portfolio. But I think from our standpoint, we are trying to craft a portfolio to gives our shareholders both the long-term visibility and strength of earnings but also a platform from which we can grow. So we will selectively sell assets into that market. We are not a wholesale seller, but we are selling some assets that we think the market is a better bid than we are.

Michael Hodes, Goldman Sachs.

My question is really on AutoStar. I was hoping you could give us somewhat more specific detail in terms of an update, maybe give us a sense of volumes that you are starting to see, and how we should think about that evolving over the course of the next couple quarters.

In general, Mike, I am begging your forgiveness, but I want to go one more quarter. We are actually going to break out for you some metrics for that business that will give you a much better sense of how we think about it both in terms of not only volumes but in terms of how we think about the underlying safety of that business and some metrics that we are particularly crafting because of the automotive retailing sector being slightly different than our traditional sale leaseback and lending markets.

But I ask you to wait one more quarter, so we can give you that with the benefit of -- Falcon has got 10 years of information. We are now mining that information; we are not quite ready to give you those metrics. Because we are not quite sure how to best present them. But if you give us one more quarter, we will give you a full debriefing on AutoStar/Falcon -- how it all works together, how we think of the metrics in that business, how they compare to the other lending and sale leaseback businesses we are in. And I just think it would be a lot more fruitful conversation than throwing out some bits and pieces, now that I am not sure we have set the context for understanding.

Okay and then just separately on the whole topic of pre-payments. Maybe you could give us a sense of when you think about where you might see pre-payments, loans or financings where the penalties are fairly substantial versus ones that are kind of out of that period. Maybe just remind us what kind of dynamics are at work there. You mentioned that second or third quarter, you could see some loans with significant pre-payment penalties coming through. I know that was the case in the fourth quarter -- just help us gauge that.

Sure. I think that it is difficult from your side also to figure out even though the volume of pre-payments may go up, some of them may have more what we consider kind of run of the mill pre-payment penalties based on the way the loan was structured or the time that it has been out versus when it is being repaid.

Some loans again because of the way they were structured may have very significant pre-payment penalties. That is the case this year. We have a couple of loans that are sort of bridging the second and third quarter. It is very difficult for us to gauge. And frankly, it is often difficult for our borrowers to gauge. As I am sure you can appreciate when somebody says, “Hey, I am working either to sell my asset or to refinance it and we are targeting sort of mid to end of June.” Oftentimes, things slip in a real estate closing.

It is difficult for us to gauge. And we have forecast the $0.80, as we mentioned, for the second quarter. But that could be plus or minus probably up to $0.05, depending on the timing of those pre-payments. We would expect, if it is at the lower end, obviously that the third quarter would be the beneficiary of those pre-payment penalties.

Just to give you some numbers -- about $0.5 billion of our assets actually have effective maturities this year. So we know for a fact that $0.5 billion are opened and required to be prepaid.

Of the remaining balance, probably 50% have meaningful call protection. And as Katy said, the other 50% have such de minimus protection that we would assume that the borrower will make its decision not based on any pre-payment issues.

Kristina Clark, Wachovia.

I know you guys do not want to get into the specific numbers. But I was wondering if you might be able to review with us your overall approach on the auto dealership finance front? You know, how you identify attractive opportunities? And how big you see that this is becoming over time as a piece of the overall iStar Company?

Sure. I will go back to what we said last time when we announced kind of where we were headed here. We think the key entry point into that business for us was the relationship we have built with Staubach. Both the resale retail services side and their auto group have decade-long relationships with many of the top dealers in the country.

Again, we are focusing on the high-end dealers. We are not chasing the $100 million or $50 million less sales dealerships. We are really looking at the high-end. Staubach has probably one of the best calls into the majority of those folks. Presidio, which also is a meaningful player at the high-end of the market, particularly in the public side of the auto dealership world with the consolidators, also bringing us deal flows.

So we think our deal flow in many respects is proprietary. It is based on calls that are difficult for others to make. We do think that capital automotive is still a strong competitor in the sector. But outside of them, we think it is a relatively narrow list. And we think Staubach adds this true competitive advantage. And Presidio gives us true competitive advantage in the public market.

So I think we have targeted the customer well. I think we have figured out what entry points we needed to get to that customer. Obviously, iStar has the reputation and history and balance sheet to provide them any type of capital they need. That is sort of our piece of the puzzle inunderstanding how you satisfy end customers with a complete suite of products. And putting those three things together, we have said we expected business to be at least a $1 billion of assets in 3 years and would frankly be disappointed if it took 3 years to get to a $1 billion.

So I will leave those clues with you. We are going to come back next quarter with more defined metrics and a more defined sense of where volumes are at. But I think we have tried to lay out for you why we chose the market, how we have attacked the market, where we expect the business to get to over a medium-range timeframe. And based on what we see today, we should have no problem meeting all three of those criteria.

And quickly I want to reemphasize, I think this is something I get questions a lot on. The AutoStar business, while it is a new client base for us, which is one of the benefits of working with Staubach and Presidio, it is loans and leases just like our existing business. So while the auto dealers have slightly different metrics, as do many of our clients in terms of how you lend or how do you structure a CTL, it is the same business that we are in. And we have all of the asset management and underwriting skills to attack that business.

Matthew Park, A.G. Edwards.

I am just wanting to see whether you have seen any early signs of where investors are putting their capital, as you call them, may be leaving the market, or where they are heading.

And then, I think previously maybe Katy had talked about some opportunities in California in more traditional businesses -- and was wondering whether you could give us an update?

Okay. Let's talk about the macro conditions of the marketplace, which I think I have used the word overheated a number of times. We still believe there is a lot of liquidity in the marketplace, particularly in the real estate side. In the last couple weeks, you have at least seen a little bit of a pullback. We have seen CNBS spreads widen a little bit. But I do not think that is the beginning of any trend yet.

Where the market has begun to crack a little bit -- again, this is one of the benefits of the broad vision we now have across all capital markets -- is in the corporate market, the high yield markets and the second lien markets have widened pretty materially and have seen a direct impact not only from the automotive sector really pulling down a number of the large cap names. But you have just seen a hesitancy for people to step up and do transactions that I would say 6 months ago were getting done, even 3 months ago were getting done.

So we have seen a little bit of rationality creeping back into at least one part of the capital markets. Unfortunately it is not our primary part, so we are still waiting for that to happen. But again, we look at some fairly simple metrics that we have looked at for 20 years. And all indications point to this is a very hot market right now. There is a lot of liquidity sloshing around. Those conditions almost never become permanent. In fact, I cannot think of a case where they have. So it is really a question of the cycle playing its way through. We do think real estate fundamentals are picking up slowly from a low base. So there are no imminent issues that are going to cause this problem.

But we are cognizant, as are others, that these are market conditions that rarely continue for long, long periods of time. And we are biding our time. And as you heard from Katy, the loan to value on our loan portfolio is the lowest it has been -- I know, since we have started tracking that metric. So we have definitely bowed down risk across the portfolio waiting for an opportunity to use our skills, use our breadth of vision, use our new contacts and relationships to step in where historically we have made great money. I will just tell you those conditions do not exist yet.

And on the second piece --

Yes, I think Matthew, maybe with respect to California, obviously that is an active market for us, one that we know very well. And we have spent a good bit of time particularly say maybe 18 months ago, maybe 24 now, in the Bay Area market where obviously values have been quite depressed after the tech bust. I think we are starting to see that market normalize a little bit depending on where you are. And we have also been very active down in Southern California, so nothing unusual. I think those markets are very different and have continued to sort of recover as the underlying economies in those areas have recovered.

Thank you. But was there any other region that sort of stands out for you at this point?

Not geographically. We do aim to be quite diverse geographically. We think that is an important factor in building safety into the portfolio. But we do tend to be lending and buying properties in the larger markets, the larger metropolitan areas with strong or improving fundamentals. But there are not areas that we target necessarily for specific investment.

Yes, again, I would say Matthew, a lot of multi asset transactions this quarter, no specific regional focus, no specific city focus. We are looking for opportunities. Primarily again, we are very good sponsors of doing very smart things. And we are finding places in the capital structure we think were very safe and going to wait till spreads widen out here or interest rates move a little bit in our favor.

Don Destino, JMP Securities.

A couple questions. First, Jay or maybe Katy, when you look -- obviously, you have got a view that credit spreads cannot stay as tight as they are right now. But is there any opportunity to extend maturities on unsecured floating rates, debt facilities, to kind of take advantage of widening credit spreads on at least the floating rate part of your asset, based on when those spreads do widen out? In other words, obviously you are going to fund your portfolio currently, your floating rate portfolio currently, with unsecured floating rate debt. But can you extend those maturities so as those payout and you go to redeploy, if spreads have widened kind of lock in today's very tight floating rate spreads? Does that make sense?

Katy Rice - iStar Financial - CFO Yes, I think that's a good question. And it is actually one that Andy and I spent a good bit of time on. Obviously, we want to stay very matched with respect to floating rate assets and floating rate debt. And as a newly investment-grade company, we are now much more able to access and we did that since February-the floating rate market. We did a 3-year floating rate transaction. Prior to becoming investment-grade, we tended to do that synthetically, where we would issue fixed rate, for example 5-year debt, and then swap it back to floating in order to remain matched with respect to our assets and liabilities.

We will continue to do some of that synthetically, but because the floating rate market really does not go out much beyond 3, perhaps 5 years in the primary market. But it is something that is actually quite exciting to us. Because I think it is a slightly different investor base on the floating rate debt side, so it is something that is enabling us to broaden out our capital sources.

And then let me just beat the pre-payment issue thoroughly into the ground. Jay, in the past, you've spoken about how sometimes you invest in customer relationships to try to promote repeat customers by -- I don't know if we are giving it the right word -- but by not collecting the full pre-payment penalty that you were contractually entitled to. Is that still a strategy that you use and how often do you use it? And have you ever tried to figure out what the return on that investment is?

We definitely are still doing it. Don, I think it is part of being in a customer business where you -- healthy if you are going to be here for a long, long time. Frankly and candidly, I would say the return on investments had not been so great, particularly when a customer is selling an asset and then looking you in the eye and saying, I think this market is overheated too. You are going to wait a long time until you get that to come back to you.

But I would say over the 12 years we have been in business, we have built a reputation as one of the fairest players in the market. We will always listen thoughtfully to proposals. We rarely put a stick in the sand and say, no further. But I will tell you that we are not just giving away money for free. We expect these customers to come back to us and do more business with us. So we use it judiciously.

I will just tell you that a lot of our best customers are net sellers right now. They are not actively buying or financing. And the deals they do, they need what I would typically call "dumb money" to finance them. They need as much proceeds in the lowest spread they can get just to make the deal work. And frankly, we will just tell them, not this time. Happy for you, get that away from us.

What we hope is when the market turns and some of that entrepreneurial capital gets back in that game and needs quiet, fast, absolutely credible capital to stand by them to do those transactions, that we are their first call. And I still believe that will happen. So we have made the investment, and we will tell you we haven't seen a lot of return on a lot of those investments. But these are high-quality sponsors. I fundamentally believe they know we did them a favor, and they will come back to us when the opportunity is right.

Michael Dimler, UBS.

I wouldn't mind if you comment a little bit on your credit rating outlook. Specifically, your recent bond issue has covenants, which fall away if your company is upgraded to mid BBB level. Is that something that you are contemplating, actively seeking? If you could offer any comment on that?

Sure. For those of you who have not been following us for a particularly long time, we were upgraded by Moody's and S&P last October. So we are fairly recent to the investment-grade world. We obviously continued to work with all three rating agencies -- keeping them up to speed on our business, keeping them up to speed on what we are doing and sort of where we see the progress in the portfolio. Some of the rating agencies have set forth very broad levels of criteria to get upgraded. But obviously, there are a lot of factors that go into that. And we would not have an expectation that we would be seeking an upgrade so quickly after we were upgraded frankly.

So I am not giving you a very specific answer because I am not sure we have one with the agencies yet. They are continuing to learn about our business, follow it, watch it. And we are hoping probably sometime in the next 18 to 24 months to revisit that discussion with them.

Susan Berliner, Bear Stearns.

Just one quick question on your collateral breakout in the back. It looked like the other category increased a lot. I am assuming auto is in there. Is there anything else in there?

Yes, Sue, that is the same answer that I gave. Was it you or maybe another caller? A portion of that is truly sort of other things that just do not fit into categories. The auto actually breaks into either loans or leases, depending on whether it is CTL or loans. So the other is truly other. Some of it is some of the things that we are working on that we are not announcing yet under some other iStar-branded financing platforms that do not really fit yet into a category. They are not big enough to have a category.

And are you guys still targeting for the second half of the year another new initiative or two?

That will be the game plan. Again, they need to meet those three criteria we have been laying out -- $1 billion in three years, customer lands a significant new exogenous reason for demanding or needing financing, and no natural competitor who provides across the board services like we can. These businesses are meant to be big category killing businesses. There are not that many opportunities out there. We do have three of four things we are incubating. They may turn out to be only one or two great one-off deals. Whether they are businesses or whether they are just smart transactions, we have found the hole in the market and that is really the reason they are pocketed in other right now.

We cannot say with enough clarity that we have the entry nor the deal flow pipeline that allows us to come out and say, this is an iStar-branded platform. We are going to commit people and resources to it. We are going to bring our leasing and our sale leaseback capabilities to it. And we are going to build a brand name that you are going to see splashed across the industry.

When we have those things in place, again like AutoStar as I mentioned next quarter, we will start crafting for you a separate series of metrics so you can track that individual business. Because in our minds, it has reached a point where it can be viewed as an individual business line. And it may have its own metrics, separate and apart from our core product lines. So we are continuing to extend from the core into things we have already done transactions in. Many times we have lent into the industry before. But now, we are trying to actually take a position that we can be the dominant provider of capital. And as I said, that's not something that happens overnight. We do believe by the end of the year, we will have at least one more announcement for you.

Mark DeVries, Lehman.

What happened to the duration of the new investments this quarter compared to what is currently on your balance sheet? And is there any focus on trying to lengthen that duration to lower sensitivity to pre-payments in the future?

That is a good question. We struggle with the fact that the tenure sits in the low fours. And extending duration on floating rate is almost perversely the wrong thing to do because you can rarely get call protection. So it is a one-sided option to the borrower. So the floating rate stuff we continue to see in the 3 to 5-year range at most. So you are really not going to be able to do anything on that.

On the fixed rate side, if we see an attractive spread, and we think we can lock it in and then Katy can finance it -- that's about the only way we can play long duration assets when fundamentally we are set up to take advantage of what we think are higher rates. So we do not want to take on fixed rate assets without being able to put on fixed rate liability. We have done some of that. And obviously, the sale leaseback market provides great long-term visibility. That is a business primarily in which you will see us adding duration because we can match from that pretty attractively.

In the fixed rate loan market, I will just tell you -- there is a) not a lot of people going out despite our recommendations that they are seeing historically low interest rates, and they should extend. And b) the spreads we are seeing in those plus the low interest rate environment have made them just not a huge part of the business.

So I think the loan side has shortened up materially because of the move to floating rates. We expect that to shift back as rates rise. But we have not seen a bunch of borrowers knocking down our doors locking in rates yet, which is a surprise frankly to us. We think it is the right thing for them to do. But you will see us on the sale/leaseback side getting 15 to 20-year investments in place, match funding those with the things Katy has mentioned. And that dynamic between the loans and lease side, we are still pretty comfortable. We are in the 5 to 6-year range. And that feels good right now. It is about where we want to be.

Okay. And Katy, the choppiness of the bond market that you mentioned, did that cause your latest unsecured issuance to go at it at wider spreads than the previous one?

Yes, absolutely. I think the first issue that we did in the beginning of the year in February, was probably all-time tight. Subsequent to that, the bond market was really reacting to a lot of corporate specific, not iStar-specific. But the GM, the number of different earnings releases, IBM, etc. -- and I think have used that -- investors have used a little bit of that disruption to widen out spreads for really every issuer. So we did absolutely experience spread widening in both the 5 and the 10-year deal that we did.

Are you seeing that choppiness start to calm and spreads tighten in the secondary market? Or are they still pretty wide?

In general?

Yes.

I think the bond market remains pretty choppy, you know depending on sort of the day that you call the desk. It has really been quite choppy.

Jordan Hymotiz, Philadelphia Financial.

Follow-up on Mike Hodes' question. You said your auto targets about $1 billion at least in 3 years. What's the current balance?

Are you talking about just in terms of AutoStar?

Yes.

Well, look, Falcon was a $280 million deal. We set up AutoStar almost 12 months ago now. We would expect very soon-to-be in the $0.5 billion range there. But again, Jordan, I know you guys want the information, and we want to give it to you in a complete contextual way. So we are going to give you enough of that information next quarter; you will have all the goods. But I really want to set the table for you guys in terms of thinking about what AutoStar is and how we look at it. So just hang with us one more quarter, and you will get everything you want.

Okay, super. But just a current balance of the two then combined is about 650?

A little less than that.

Closer to $0.5 billion right now.

And I would like to turn the conference back to Mr. Backman at this time.

Great, thank you everybody for joining us today. If you do have any other questions, please feel free to give myself or Heather a call – or anybody on the team. Phil, would you please give the replay instructions for today?

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