iStar Inc (STAR) 2005 Q2 法說會逐字稿

Ladies and gentlemen, good day and welcome to iStar Financial's second-quarter 2005 earnings conference call. (OPERATOR INSTRUCTIONS). At this time for opening remarks and introductions, I would like to turn the conference over to iStar Financial's Vice President of Investor Relations and Marketing, Mr. Andy Backman. Please, go ahead, sir.

Thank you, Tim, and good morning, everyone. Thank you for joining us today to review iStar Financial's second quarter 2005 earnings report. With me today are Jay Sugarman, Chairman and Chief Executive Officer; Jay Nydick, President; Katy Rice, our CFO; Tim O'Connor, our Chief Operating Officer, and Colette Tretola, 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 786625.

Before I turn the call over to Jay, I need to remind everyone that statements in this earnings call which are not historical fact 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 would 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. This morning iStar reported a strong second quarter with revenues, assets and first-half transaction volume all reaching record levels. Earnings also rebounded, up over 10% from the first quarter as we continued to use the breadth and depth of our 180 person platform to find solid opportunities to deploy capital. With the real estate capital markets charging ahead in all directions, we remain focused on finding what we believe are the best risk-adjusted returns in the sector and using our competitive advantages to stay well-positioned.

How do we stay ahead of the capital pack? By working closely with our $8 billion of repeat customers, by providing not just one part of the capital structure but delivering complete one-stop financing packages, and by utilizing our decades of structuring experience to develop innovative, flexible, custom tailored solutions for our customers.

Now while we still have some work to do to replace assets that rolled off or were sold during the past several quarters, we are steadily building our reach throughout the commercial real estate finance and sale / leaseback markets, and we continue to build our knowledgebase to take maximum advantage of the market dislocations that will occur at some point in the future.

I want to give one example from this quarter's originations to demonstrate the strength of our platform, but first let me have Katy run through the key numbers of this quarter. Katy?

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

Let's start with our results. Our adjusted earnings came in at $0.83 per diluted common share. Our net investment income was $97.4 million, up slightly from last quarter. Our return on book assets was 5.3%, and our return on equity for the quarter was 19.1%. Our in-place net interest margin at the end of the quarter was 327 basis points which is reflective of the higher proportion of first mortgage product that we have originated over the past 24 months, the rolloff of higher yielding assets and the spread compression that is occurring across all real estate financing products, and is tempered somewhat by our lower cost of funds.

From a credit perspective, second-quarter interest coverage was 2.2x . Our leverage at the end of the second quarter was 2.0x debt-to-book equity plus accumulated depreciation and loan loss reserves, which is still below our near-term target of 2.25x and significantly below our risk-based capital model, which shows 2.7x as our appropriate long-term leverage level, based on our current asset mix.

As Jay mentioned, despite a very competitive environment, our financing activity exceeded $1 billion for the second straight quarter. We financed a record 23 separate transactions, 64% of which were comprised of first mortgages, first mortgage participations and corporate tenant leases. Repayments and prepayments were in line with our expectations this quarter and totaled $654 million.

As a quick update of some of the initiatives that we discussed earlier in the year, we have completed the integration of Falcon Financial which we acquired in March into our AutoStar platform. Our AutoStar team continues to work hard to build brand identity within the high-end auto dealer client base, and we are gaining penetration with both the CTL and lending products. We now expect to exceed our original goal of having $1 billion of assets within a three-year timeframe.

Our new partners at Oak Hill Advisors are assisting us on a daily basis in reviewing the corporate credit fundamentals of potential CTL investments and of the major tenants in projects that we may lend to. Their involvement is making our underwriting process much more efficient, and in many cases they have been able to provide us with significant insight into certain credits.

Now let's turn to risk management and credit quality. This quarter our overall asset quality, particularly on the loan side, improved. The asset quality of our loans as measured by our quarterly risk ratings process improved both with respect to trend versus underwriting and risk of principal loss. In-place debt service coverage at the end of the quarter remains strong at 2.24x based on either actual cash flow or trailing 12-month cash flows through March 31 and current interest rates. Our last dollar loan to value for the entire structured finance portfolio was just 65%.

The average risk rating of our CTL assets at the end of the second quarter remained constant. Our CTL portfolio remains well leased at 95.1% with a weighted average remaining lease term of 11.5 years. Lease expirations in 2005 represent just 0.1% of our annualized total revenue for the second quarter of 2005.

At the end of the quarter, our Non-Performing loans consisted of two loans, representing just 1.2% of our total assets. There were no additional assets added to our NPL list this quarter. We did not take any impairments or losses this quarter. With respect to our two NPLs, we expect one of these loans to remain on the NPL list until its maturity in 2008. The second NPL is secured by a newly completed residential complex here in New York City. You will recall that we added this loan to our NPL list last quarter. While the borrower expected to refinance the loan in the second quarter, recent sales have made a refinancing uneconomic, and we now expect that this loan will remain on our NPL list until the remaining units are sold. However, given the strength of the New York City residential market, we continue to believe that this loan is well-covered by our underlying collateral and do not expect a loss on principal or interest. And finally, atch ist assets represented just 0.1% of total assets this quarter.

Now let me briefly review our capital markets activities, our balance sheet and our earnings guidance.

In April we issued $500 million of senior unsecured notes in a combination of five and ten-year fixed maturities. While the market was quite choppy earlier in the year, with wider spreads across all sectors, we were able to complete an oversubscribed offering. We used the proceeds of the offering 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 last quarter, we continue to expect to issue $2 to $2.5 billion of unsecured debt this year, inclusive of the $1.6 billion that we have already issued to date. We expect to fund our net asset growth for the remainder of the year with unsecured debt. As we have stated in the past, it is our intention to modestly increase our leverage this year, moving towards our near-term target of 2.25 times book debt-to-book equity plus accumulated depreciation and loan loss reserves.

From a credit perspective, we continue to make progress in our migration from secured to unsecured debt. During the third quarter, two secured credit facilities totaling $850 million will reach their initial maturity dates and we do not currently intend to renew these facilities. While we have had, and continue to have, great relationships with these lenders, we find the lower cost of funds and ease-of-use of our unsecured lines more economical for the Company. As you can see from the second-quarter balance sheet in our press release, our secured debt is now just 25% of our total debt.

This quarter, Fitch revised our ratings outlook from stable to positive and affirmed our BBB- investment-grade rating on our senior unsecured debt. We are particularly pleased that Fitch acknowledged our progress in unencumbering our assets as we shifted to an unsecured funding strategy and in our discipline in maintaining our conservative approach to growing our asset base.

In order to complete the final piece of our transition to becoming an unsecured investment grade borrower, we are currently evaluating the repayment of our iStar Asset Receivables series 2002-1 and 2003-1, which are known in the market as our STARs transactions. These secured facilities were originally set up when we were a below investment grade borrower to match fund our loan and CTL assets, and they provided a cost-effective source of liquidity at the time we closed them.

As of June 30th, there were approximately $716 million of STARs bonds outstanding secured by approximately $1.3 billion of assets. Today we estimate that the prepayment of these bonds would reduce our secured debt to just 12% of our total debt and would reduce our interest cost over time. However, this potential repayment would also require us to incur one-time cash costs, including pre-payment and other fees of approximately $8 million and non-cash charges of approximately $38 million to write off deferred financing fees and expenses. Based on today's Treasury rates, these one-time costs would reduce our full-year 2005 diluted adjusted earnings by approximately $0.07 per share and our diluted GAAP earnings by approximately $0.40 per share.

While there will be one-time costs associated with the STARs repayment, we believe that as an investment grade borrower with strong liquidity and multiple sources of funds, we can match fund these assets on a more cost-effective and flexible basis in the unsecured markets going forward, which is one of the primary reasons we sought to become an unsecured borrower.

Now let's finish up with our earnings guidance.

As we discussed last quarter, we have experienced and expect to continue to experience high levels of loan prepayments in the next couple of quarters, as capital inflows into the commercial real estate sector remains strong. Many of our borrowers are selling or refinancing their assets at very aggressive levels. In addition, while we are only marketing a small number of CTL assets at the moment, we have been selectively selling assets out of our CTL portfolio, which have totaled over $380 million since 2004. The exact timing of when we will receive prepayments for our borrowers and sales proceeds from our CTL sales is often difficult for us to predict. For example, if one of our customers is in the process of selling his portfolio, the closing may wind up being delayed for a week or two as all of the parties involved reach agreement on the transaction terms. If the closing were originally scheduled towards the latter part of the quarter, it could easily slip into the next quarter. This is quite normal for real estate transactions; however, it makes our job of forecasting the timing of prepayments of sale proceeds very difficult. For this reason we are providing guidance for the remainder of 2005 rather than breaking it out on a quarterly basis.

Now with respect to our investment volume, despite the competitive environment, we are still finding compelling opportunities to invest our capital, as you can see from the $2.4 billion that we have committed in the first half of this year. Currently, we expect to originate approximately $4 billion of investments this year and anticipate receiving somewhat higher prepayments than we originally forecasted in the $2 to $2.5 billion range.

So with that as a backdrop, we are narrowing the range of our 2005 diluted AEPS guidance to $3.30 to $3.40, which is in the original guidance range of $3.25 to $3.50, and we are narrowing our range of diluted earnings per share to $2.25 to $2.45. For the second half of the year, we expect diluted AEPS of $1.73 to $1.83 and GAAP EPS of $1.15 to $1.35. To the extent we were to move forward with the prepayment of the STARs transactions this year, our diluted AEPS and diluted GAAP earnings would be reduced by approximately $0.07 and $0.40 respectively, based on current Treasury rates.

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

Thanks, Katy. We do not usually like to talk about specific investments, but I thought we should quickly walk through a transaction that highlights the strengths of iStar's platform and shows how we are still winning our share of the high-quality transactions out there.

Last quarter one of our repeat customers approached us with an off-market opportunity to provide a large financing on a portfolio of over 25 million square feet of industrial space in most of the top industrial markets on the West Coast. The high quality of the real estate was matched by an over $1 billion equity investment by a leading institutional equity sponsor.With a desire to work with a single provider, the need for a closing on the date certain and a number of structural complexities created by one-off mortgages encumbering the portfolio, the borrower came to iStar directly and negotiated a package of custom tailored provisions that provided flexibility to the borrower and appropriate protections to iStar. We committed to close the deal on the necessary date, with no syndication or securitization risk or issues, and significantly reduced the borrower's closing costs and simplified the closing process by being their sole source provider. We think these types of transactions are the best examples of the unique combination of size, speed, structuring capability and certainty that we can offer top tier customers to meet their financing needs.

With that, let's go ahead and open it up for questions. Operator?

Don Destino, JMP Securities.

Jay and Katy, a couple of questions about the funding strategy. We keep seeing what heretofore seem like extraordinary CDO executions from some of your competitors with collateral that I think most would agree is not the same quality. It is certainly not from a loan to value perspective. So that kind of begs two questions in my mind.

One, is there something inconsistent about iStar at 2 to 1 leverage being at BBB- credit versus some of these 4 or 5 to 1 CDOs in which 85% of the debt is AAA. I realize that there is a difference between secured and unsecured debt, but even discounting that, there seems to be something inconsistent given the asset quality differences.

And then the second question is Jay, is it ever tempting when you see these CDO executions to say, the heck with this unsecured strategy? I mean if they are going to give money away at these types of terms, you know that is something that we should be taking advantage of.

Yes, that is a good question. It gives some good insight into what is happening with the asset-backed market right now. Obviously the rating agencies have become much more aggressive with respect to the asset-backed market, and we do evaluate our own capital model from time to time based on what we see out in the market. We are in the process of doing that now.

But there absolutely is a disconnect at this point, and the gap is becoming wider with respect to where corporate transactions, corporate ratings, leverage levels versus the CDO or asset-backed market. So you're absolutely right, there is.

I would say, however, with respect to funding iStar, we made a decision awhile back that I think we are still very comfortable with, which was to become an unsecured borrower. And, in fact, as we talked about this morning, we are considering repaying our last significant chunk of secured debt in the STARs transactions.

One of the things that I think you don't see in the CDO market--people often talk about the interest costs, but they don't talk about the overall cost of the transactions, which when you get fees whether it's investment bank rating agencies or lawyers are fairly high. In addition, they are extremely laborious often taking two to three months of pretty significant effort to set up.

So we do not think for us that, in the near-term, that will make sense. But you are absolutely right to point out the fairly significant difference in leverage levels.

Let me just add. We think Oak Hill is one of the best asset-backed structuring groups out there on the corporate side. They have got a number of CLOs out there. One of their interests in us being partners with them is to bring some of our real estate expertise to them. We think the CDO model is an exceptionally attractive way to finance what I would call nonproprietary, off-the-street securities. That is a business that Oak Hill has been in for 17 years. We would certainly be willing to lend our expertise to them to help them ramp up a business that could be a leader in that sector as well. But I think you will say on the more proprietary opportunities we are going to stay unsecured. It is not something we want to show around the street. It is certainly not the best way to serve our customers, but there is obviously a place for ABS in the market, and we have got a partner who is top tier at that. So we will keep our eyes on that market and see if we can come up with a better mousetrap.

That is very helpful. Thanks a lot.

Susan Berliner, Bear Stearns.

I was wondering if you guys could provide a little bit more details on AutoStar. Remind us where it is flowing through on the balance sheet and the income statement, and just give us any specifics regarding that business that you can.

And secondly, Katy, I guess I was interested in your comments about leverage the near-term target versus the longer-term target. I think you said 2.7. If you can elaborate a little bit more on that and just discuss what you discuss with the ratings agencies, that would be really helpful.

Sure. Let me take the first part of your question regarding AutoStar. We have gotten a number of questions and I would like to just walk you through where -- excuse me, where Oak Hill is on the balance sheet and AutoStar. AutoStar, you would see, is really part of the loan and lease portfolio. So you do not see that broken out separately.

But with respect to metrics, we did provide some metrics within the earnings release on some of the loan to value and CTL metrics. We have about $540 million of assets at this point. And our lease portfolio at this point is 100% leased with an average lease term a little bit longer than our lease term in our core portfolio, but AutoStar CTLs are about 12.4 years. And about 75% of the tenants in the AutoStar CTL portfolio are from the publicly traded consolidators or top 10 dealers nationwide, so it's a pretty strong credit profile.

On the loan side in the AutoStar portfolio, the weighted average LCD is about 67%. So it is about what? I think we are about 65% in the bigger portfolio. So it is about similar. And the weighted average maturity is approximately nine and a half years. That is quite a bit longer than our portfolio, the core portfolio, mostly because of the majority of the AutoStar loans at this point are fixed-rate loans which have longer-terms.

With respect to your questions about leverage, our near-term targets as we have been discussing really for the last couple of quarters that we did discuss with the rating agencies are 2.25x. As we have shared with our investors and in our presentations, we do have a risk-based capital model. It is a fairly simple model. It shows right now our five asset classes ranging from first mortgages being our safest assets, moving all the way down through unsecured and corporate loans. Obviously each of those asset types have a different prudent leverage level and as we answer Don's question talking a little bit about how those leverage levels have moved quite a bit recently in the asset-backed market, we have not yet adjusted our model, but we are looking at where that might shake out. There probably would not be significant changes to them.

But if you look at our capital model right now based on our current asset mix, it would show leverage levels, prudent leverage levels, of about 2.7x. And interestingly, Fitch publishes the capital model for us. Their inputs are slightly different than ours, but I think they come out at 2.7 or 2.8x. And their measure is actually based on a single-A capital model.

So that is what ultimately our long-term target is, and we hope as we grow the asset base, increasing diversification and the strength and franchise of the Company, we will be able to target with all of the rating agencies what we think is still a very prudent leverage level for the Company.

So you are going to review with Moody's and S&P before you change any sort of your leverage targets near-term?

Yes, absolutely. We have had the discussion briefly with them, but we did agree that we would wait until we were roughly $10 billion of assets to revisit that discussion.

Great, and just one follow-up on the AutoStar business. Are you guys financing any franchise?

Yes, the evaluation that we look at when we look at loans in the auto dealer world is a combination of both corporate and real estate value. So there is some level in terms of the overall valuation of franchise that we give credit to.

Okay, great. Thank you very much.

Dave McGowan, Citigroup.

A couple of follow-ups. First of all on the STARs prepayment, to the extent you anticipate going through with that this year, am I right in assuming that would be additive to the 2 to 2.5 billion of full-year issuance?

Yes, David. We have just started the analysis, and I think we were not ready to give a number that might increase that number. Probably because it will depend on the pipeline and the prepays. But I think it is fair to say that it will not be less than that number.

Okay. Sure. (multiple speakers)

We do not think it will be materially more.

And then secondly, some more rating agency questions or one more rating agency question. In addition to the leverage discussions, what effect do you think the reduction in unencumbered assets will have in getting them a little bit more comfortable? Have you had those discussions yet?

You know, we have not. We have done a number of things over the last year in addition to funding all of our new net asset growth with unsecured debt which has naturally shifted our balance sheet. We have also removed the TriNet subsidiary. We have eliminated that subsidiary, which had a structural subordination for our bondholders. We continue to prepay certain mortgages that we have.

So we have made continued progress in that migration. Obviously, if we were to repay the STARs bonds, that would be a fairly significant unencumbering of that $1-3 billion of assets. So we would hope that would continue to impress upon them the strength of the unencumbered pool, the size of the unencumbered pool for bondholders. We would hope that certainly Fitch acknowledged that in the recent move from stable to positive outlook. So we have not had any updates in the normal course of our discussions with Moody's or S&P.

Well, good luck with those discussions. Thanks a lot, Katy.

Kristina Clark, Wachovia Securities.

I actually had two questions. I was wondering if you could talk a little bit more about your experience so far with AutoStar this year? Have you encountered anything either good or bad that you had not anticipated with respect to growing the portfolio?

And then secondly, is it possible that removing part of the funding diversification, getting rid of secured debt in its entirety could give the rating agencies some pause with being too concentrated on unsecured debt?

Let me tackle the first one on AutoStar. We are trying to be very deliberate about how we build that business starting with both informational and relationship advantages that we can turn into a very long and prosperous business.

There is one great company out there, Capital Automotive, that has been doing it a long time. We think we and they are going to try to serve customers in a comprehensive way. But there is competition coming in trying to play alongside of us, and that is a little bit of a surprise. We think the dealer community is best served by working with folks who have been in this business a long time. We have partnered with folks who had been in the business for over a decade. We know Capital Automotive has been providing capital for almost a decade.

So we would hope that quality will win out in that business, but I will tell you capital is trying to find opportunities in this marketplace, and we may have done ourselves a little bit of a disservice in announcing AutoStar before it was fully ramped up. But we did want to give the market some sense of where we think pockets of opportunity are and where iStar is focused.

It is still a very small part of our balance sheet. It is still a very small part of our originations. But we do think it has the potential to grow beyond a $1 billion business within the three-year timeframe we set out. So no real surprises yet. We do think there is a little more capital in that sector than there might be over the longer period of time, but it is not really preventing us from executing our business plan.

With respect to the secured/unsecured question, I think the rating agencies are well aware of our ability and the liquidity positive nature of any securitization that we would ever contemplate. Obviously as a below investment grade borrower, we were heavily reliant on those markets. We know them well. We have a great following in those markets.

Right now I think we are really focused on creating the flexibility and lowering our cost of funds as we go forward. You know the STARs transactions would help us achieve that. And I do hear you on the reliance on unsecured debt, but I do think given our history that both the agencies and bondholders and investors are aware of our ability, particularly given some of the new technology in the CDO market that we would have to ultimately do some securitizations if we chose to.

Matthew Park, A.G. Edwards.

Just a couple of questions on the new deals that you are putting on. I was wondering about whether you could give us any color on the average deal size? Just doing a kind of a very simple math, it seems that your average deal size -- the new deal size seems to have come down a little bit. I was just wondering what is causing that.

And then generally speaking, what is the anticipated return on asset on the incremental assets that you are currently originating given the compressed returns that you are seeing elsewhere?

I do not know if you are referring the new business to the AutoStar business.

No, I am just looking at the aggregate. Just going through the simple stuff.

Okay. I think on a quarterly basis it is actually pretty hard to draw a lot of conclusions in our portfolio. A couple of transactions within the quarter can sway those numbers a little bit. So there is a lumpiness effect to looking at it on a quarterly basis.

I would say, however, our typical AutoStar loan and lease are smaller than the remainder of the loan lease portfolio. That is just the nature of that business. So you might be seeing a little bit of that.

Okay. So if I were to follow up there, the number of transactions you closed has increased, and is that primarily due to the AutoStar?

Yes, I think -- yes, a little bit. There is just an increased volume overall, but yes, AutoStar has added to that incremental volume, and I would say the risk-adjusted spreads that we are seeing while we have talked over time about spread compression, which I think everybody is experiencing, we are continuing -- we showed an ROA this quarter of 5.1%, which is pretty much in line with where we have been in the last couple of quarters.

This is a business we run off returns on equity. We started in 1992 with a 15% ROE target. We have been pretty consistent over the last decade that is a good solid risk-adjusted return. I think you can see from the credit side we are creating almost four times treasury returns with very little volatility, very little credit risk. We think that is a good solid number to keep focusing on.

Obviously ROEs have actually been higher than that in our book for a long time. But when we make the new investment using the risk-based capital model that Katy has laid out, we are looking for that appropriate leverage to generate a 15 ROE on the overall portfolio. And despite the fact that spreads are compressing, despite the fact that we think we are materially underleveraged relative to some of the other competitive numbers we see, that 15 ROE is still a driving number in our business. And on a portfolio basis, we are still able to achieve it.

So we are seeing spread compression. We are also seeing our cost of funds go down. We are hoping that the market understands that we have run this business significantly underleveraged for a long, long time. We would like to get to a more appropriate stabilized leverage level over the immediate term here, and I think we will still be able to generate the ROEs we have historically delivered.

Thanks for the color. I guess one thing I would like to get to is that if the prepayment slows down or becomes more normal, what do you think that we should be looking for in terms of a return on asset?

Again, I am less focused on return on assets, but as Katy said, 5 to 5.5 has been an historical range that makes some sense. I will tell you it is an ROE business. So if we shift to first mortgages or we shift to a different product type, you are going to see a change in ROA but really focus on the ROE. That is where our investment decisions are made. And I think you will see ROA is probably staying in that 5, 5.5 range.

James Shanahan, Wachovia.

A couple of brief questions. Earlier Katy commented that iStar now expects the AutoStar business to exceed original expectation of $1 billion portfolio in three years. Did you mean specifically that you anticipated to achieve that $1 billion portfolio size earlier than expected, or that the portfolio would be larger than originally anticipated?

And a follow-up question. Can you please update us on what is happening with the TimberStar business, and is it still your expectation that will remain a very small piece of the story?

Sure. On AutoStar let's be very clear. We think about transactions we do everyday whether they have the capability to be a loan and lease business with over $1 billion of potential, which means we dedicate specific dedicated resources to that entity. We look for real competitive advantages. We look for repeatability of customers. We look for a high-end segment that for one reason or another is underserved. At that point we will start dedicating efforts to build a loan and lease portfolio that has the potential to be $1 billion business.

To us that kind of size takes it out of the realm of being a deal and turns it into a market segment that we should be penetrating. It is the same business. It is just a question of how repeatable the transactions are and how definable our barriers to entry and competitive advantages are.

In AutoStar we think we have developed a platform that has all the things we look for in a business that has the ability to grow, be a market leader, have real barrier to entry competitive advantages, and we are focused on delivering to the customer a solution that we think is better than is provided by the general marketplace.

I think we can say with some assurance we feel comfortable that business should beat $1 billion inside of three years. So if you give us three years, we will go beyond the billion. If you are looking for the day on which we hit a billion, it is probably inside of three years.

But I think what is most important is we like the business. We think there are barriers to entry. We think we have competitive advantages. There is competition in that market. There is one premier player, and there are a lot of other people just looking. We think we have the potential to be another strong player in that market.

Some of the other things we are looking at are really at this point not businesses. They are transactions that have crossed our table that have very similar dynamics to our loan business or our sale leaseback business. And in one way or another we think there is a potential to build a better mousetrap.

But until we come to you and say we think this is a repeatable business with a high-end customer base that needs iStar's expertise, at this point many of the other things we are looking at are simply good deals. Good risk-adjusted deals we have provided a better solution than the market could. Because of our size, because of our certainty, because of our expertise, because of our increased corporate credit knowledge, we do think we can do some things that the rest of the market cannot. We are trying to find places where the market will pay for that, and we hope there are more of those to come, but I will tell you we are really prosecuting our basic business and out of that comes opportunity that looks like $1 billion platform opportunities. None of them have ramped up to a point where it is even worth talking about, but we have seen some dynamics in the marketplace that have intrigued us. And when we come to you, we will come to you with a business plan that has all the pieces of the puzzle laid out. It does not mean it is going to be a success, but it does mean we have convinced ourselves there is something real here. There is something big here. There is something that we think we can be better at, and when that happens, we get very focused on it. We put dedicated resources on it. We think about how the business should be financed. We think about how the business should be staffed. We think about how our customers want to learn about us, know about us, work with us. That is a whole different level than just doing transactions.

And so AutoStar was the first one where we saw opportunity to go beyond just doing a couple of transactions. Timber and some of the other places I will tell you are nowhere near that level yet. But if they get to that level, we will certainly come to you with a fully laid out business plan that suggests there is real opportunity for iStar shareholders to benefit.

Aside from the Timber investment that was disclosed on the 10-Q, have there been any incremental Timber-related investments?

Not in the second quarter. We are keeping our eyes on that in many markets, but again these are ordinary course of business transactions with people we are very comfortable, know their businesses cold. So we are tip-toeing in a lot of directions, but our core businesses really are still our focus.

Don Destino, JMP Securities.

One little follow-up minutiae type question. Katy. We have seen and continue to get commentary from auditors that they do not particularly like general reserves, and we have seen a couple of companies actually just completely reverse their general reserves. Where are you guys on that? Are your auditors still okay with you having non-specific reserves? Is there any risk that you might have to stop provisioning for general reserves?

That is a good question, especially because this quarter we did not take a reserve. We have a policy and it has been established several years ago that we follow. It is obviously monitored by our audit committee and our auditors review each quarter the policy and how we are executing it. Our policy is to have 150 basis points of reserve for our loan assets.

The interesting thing and something that many people in the finance world do not know in real estate transactions it is market to get asset specific reserves. Meaning interest reserves, tax and tenant improvement type reserves depending on sort of the specifics of the loan. So we have in many cases and in almost all cases on our loans, some level of what we call asset specific reserves. We then add to that, if those levels are below 150 basis points, we add general reserves to top that up to 150 basis points.

So our general reserve does have a basis. It does have a theory behind it. We have looked at a lot of the historical mortgage data over the last 20 years in developing our policy. So we will continue this quarter. Mostly because of certain prepayments that had large asset specific reserves, we are actually slightly over reserved, so we did not need to add to our reserves. But our auditors are very comfortable with our policy.

Jennifer Pinnick, Merrill Lynch.

You stated that 64% of your new volume this quarter was first mortgage participation and CTL. This is versus 76% in Q1. I was wondering are other parts of the capital structure starting to provide better risk returns, maybe better yields? Maybe if you could give us a sense of what the remaining 36% represents?

Yes, I guess I would not go so far as to say we are targeting parts of the capital structure right now as better risk adjusted return. In fact, I would say we still think the senior paper is better risk adjusted return than the junior paper.

The large transaction I talked about at the end of the prepared remarks fell kind of in the cracks. It was not a senior mortgage because there was a lot of one-off senior mortgages in place, but it went up to only 57% LTV in the portfolio. So it was a senior-like piece of paper, but we qualify that as a corporate loan because it was sitting behind a lot of corporate mortgages. It was not directly secured by the real estate. It was more secured by the parent entity, as I said it has a $1 billion plus investment from an institutional investor.

That one transaction, which actually turned out to be the largest transaction in the quarter, we felt was one of the best risk-adjusted returns, but it was not a senior loan. So I would not read too much into the shift in the numbers.

Again, we are looking for best risk-adjusted returns up and down the capital stack. To date I still believe the senior stuff is better. But obviously we have the capability to play up and down the capital stack, and the more flexibility needed, probably the better the solution we provide. So I would not read too much into that number.

Mark DeVries, Lehman Brothers.

What is your outlook for net interest margins for the remainder of the year? If you were to see prepayments remain pretty strong and also the competitive environment staying intense, would you expect to do some additional erosion in the non-interest margin?

You know, we look back at our history, we have a running chart, and they have been a little bit lower for short periods of time but never on an extended basis. And personally I do not think they are going to go much lower. You know we think there are plenty of opportunities out there. As evidenced by the volume we have done, the third quarter is always a little tricky because of the summer and August, but we expect to get transactions done over the next half of the year that are consistent with at least current net interest margins.

Okay. It also seems like prepayments keep consistently getting higher than you were initially looking for. Is there a point when you think there might be an effective burnout, regardless of whether the environment changes as that pace slows?

Well, it's a function of two things I think. One is the shift to a shorter term perspective by our borrowers. As Katy mentioned, in AutoStar we are doing deals at nine and half years. I was saying the broader commercial real estate finance market there has been a definite shorting up on terms, a definite shorting up on call protection. So just the natural velocity of the business has increased, and we talked about that in the past phone calls. I do not see a diminution of velocity unless market conditions change materially. As we add new assets, we are adding new assets with two to three to four-year average lives, they are going to come back. That half of the business has a very high velocity. But it is matched by our CTL business which has a 10, 15, 20-year time horizon. So we think we have got one very stable long-term business and one much more high velocity business, and I really do not see that changing a lot. What we have been surprised by is the willingness of borrowers to pay very significant prepayment penalties, which I would actually argue in many cases have been uneconomic, but the sales prices they are achieving are so above their expectations that they are willing to pay it. So I think if you ask them six months ago were they going to repay, they would say no. But if somebody makes them an offer that is so compelling, they have generally come to us and said we are willing to pay the prepayment penalty.

We are not unhappy. The IRRs on the deals you are seeing repaying are really quite high, much better than our pro forma. So there is good news from repayments. The IRRs are great. But ultimately it makes us work even harder to continue to replenish the loan side of our business, and I would not be surprised by seeing repayments stay at a fairly high level. It is the prepays versus the repays this year that have really been above forecast.

Fred Taylor, Lord Abbett.

Yes, I think at this point most of my questions are answered. I just asked on the AutoStar, the 540 of assets. Are the returns on that better, worse, similar to your existing sort of averages? Is it in line with the returns that Capital Automotive REIT gets? Can you sort of just give us a feel for that, and I think everyone would love to see that when it is bigger, broken out separately on the balance sheet and P&L?

Yes, I would say there is the Legacy business, and then there is what is going on in the marketplace right now. I would say the marketplace right now is really competitive. The ROEs are still high but I think the risk-adjusted returns in our core business are actually a touch higher. So we are focused on that business because it has got an ability to generate long, stable, good mid-teens ROEs. But we are not seeing any transactions where you are getting the high teens, almost 20% ROEs that we still see in some of our core business lines. So steady business, but we are not being surprised on the upside by the returns. In fact, we think the competition is probably a little out over its skis in some of the transactions we have seen.

There are no further questions at this time.

Okay. Let me turn it back to Andy for the final wrap-up.

Thanks, Jay, and thanks, everybody, for joining us this morning. If you should have additional questions regarding today's earnings release, please feel to give me a call directly. Tim, could you please give the conference call replay instructions once again? Thank you.

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