iStar Inc (STAR) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to iStar Financial's first-quarter 2006 earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, today's conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to iStar Financial's Vice President of Investor Relations and Marketing, Mr. Andy Backman. Please go ahead, sir.

Thank you, John, and good morning, everyone. Thank you for joining us today to review iStar Financial's first-quarter 2006 earnings report. With me today are Jay Sugarman, Chairman and Chief Executive Officer; Tim O'Connor, Chief Operating Officer; and Katy Rice, our Chief Financial Officer.

This morning's call is being webcast on our corporate website at www.iStarFinancial.com in the Investor Relations sections. 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 825770.

Before I turn the call over to Jay, I need to remind everyone that statements made 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's Chairman and CEO, Jay Sugarman. Jay?

Thanks, Andy, and welcome and thank you all for joining us today. We began this year with a solid first quarter that included a range of transactions with strong credit statistics, strong equity sponsors, and attractive spreads. Once again, the mix was dominated by senior loans, with significant equity invested subordinate to us and relatively moderate loan to cost levels. With our expanded platform and growing reach in the marketplace, we are finding a greater range of investments to choose from, and continue to find opportunities that meets our risk/return objectives.

I want to talk a little bit more about our increasing reach in a minute. Let's run through the key metrics for the quarter first.

On the earnings front, we saw a nice pickup from last year's first quarter, with AEPS coming in at $0.90 per share and revenues growing strongly on a year-over-year basis. On the origination side, we closed 16 separate transactions, and funded just over $800 million on new and previously committed transactions.

One interesting thing to note, I mentioned the mix this quarter was mostly senior loans. But in several instances, we started discussions on transactions, thinking we were going to be investing in the mezzanine portion of the capital structure and actually ended up investing in the senior portion after concluding the risk/return was better in the safer part of the capital structure. Our recent credit upgrades have enabled us to be more competitive on senior loans. And this dynamic is one we have been looking to take advantage of recently.

With regards to return on equity and spreads, we had a very good quarter, with spreads solidly in our target zone, and return on equity finishing over 21%. As I've said over the past several years, these levels of return on equity with our still underleveraged balance sheet are higher than our long-term targets, and give us some leeway to accelerate growth by nibbling at lower-risk, lower-return-on-equity business when appropriate.

On the credit side, we remain comfortable with the portfolio and the real estate markets overall. Most markets appear reasonably strong. And while we remain less bullish than others that cap rates can fall or even stay where they are when long-term interest rates rise, we are seeing our favorite metric, replacement cost, begin to rise noticeably in many markets. Rising replacement costs should help sustain favorable supply/demand characteristics in the real estate markets for some time to come, and will offset some of the pressure from rising rates.

With that brief summary, let me turn it over to Katy now for a full recap of the quarter. And then I'll come back and talk about our increasing market reach.

Thanks, Jay. Good morning, everyone. Let's start with our results. As Jay mentioned, our adjusted earnings came in at $0.90 per diluted common share. Our AEPS was higher this quarter due to an increase in interest income from previous quarters' loan originations. In addition, other income was up because the majority of the income from our current timber portfolio is earned in the cold months of the first and fourth quarters of the year.

Our net investment income was a record $111.2 million, up over 19% from the first quarter of 2005, which is primarily due to the year-over-year growth in our portfolio. Our net finance margin at the end of the quarter was 359 basis points. And as Jay mentioned, our return on equity for the quarter was just over 21%.

As you may have noticed this quarter, we reported net finance margins, including both our asset yields and debt costs, in our press release. This metric is slightly different than net interest margin, which is what we previously discussed. Net interest margin was an internal management tool that measured our spreads, but also took into account the timing of both investments and repayments during the quarter.

Going forward, we will be reporting net finance margin, which we define as the rate of return on assets less the cost of debt without the effect of the timing of investments and repayments during the quarter. These are very similar metrics, but we believe that the net finance margin will provide you with a more consistent data point with which to measure our spreads. We provide a more detail definition of net finance margin in the MD&A section of our most recent 10-K, as well as in the footnotes in our earnings release.

For comparative purposes, under the prior methodology, our net interest margin was 318 basis points last quarter. And under the new methodology, our net finance margin was 326 basis points last quarter.

Despite a very competitive environment, we generated $663 million in new financing commitments in 16 separate transactions this quarter, $610 million of which were funded. The majority of our originations this quarter were first mortgage or senior debt commitments. However, we closed several fixed-rate mezzanine transactions as well.

CTL activity remained muted, but we closed several transactions on our AutoStar platform. We also funded approximately $206 million of prior commitments this quarter. Our repayments and prepayments moderated somewhat, totaling $474 million. And we sold two small CTL assets for approximately $8 million, resulting in net asset growth for the quarter of $335 million.

As we mention frequently, our origination volumes and repayment and prepayment activity tend to be somewhat lumpy, and can vary from quarter to quarter. This is the primary reason we decided to move away from providing quarterly guidance last year.

Now let's turn to risk management and credit quality. This quarter, there were no significant changes to our risk ratings in either the loan or the CTL portfolios. Our last dollar loan to value for the entire structured finance portfolio fell to just 63%, so our borrowers continue to have significant equity investment to support our loans.

At the end of the quarter, our nonperforming loans represented 0.35% of our total assets, down from the prior quarter. We removed one loan, and added one CTL to our watchlist this quarter, resulting in watchlist assets representing 0.71% of total assets as of the end of the quarter.

Our CTL portfolio remains well leased at 95.7%, with a weighted average remaining lease term of 10.8 years. Lease expirations in 2006 remain small, and represent just 2.4% of our annualized total revenue for the first quarter of 2006.

Our credit statistics remain strong. First-quarter interest coverage was 2.2 times, and our fixed charge coverage was 1.9 times. Our leverage at the end of the first quarter was 2.1 times debt to book equity, plus accumulated depreciation, depletion, and loan loss reserves. This is still below our current target, which is in the mid 2 times range.

Many investors ask us how a rising interest rate environment will affect us. We match-fund fixed-rate assets with fixed-rate debt, and floating-rate assets with floating-rate debt. We're committed to operating our business such that a 100 basis point move in interest rate has a minimal impact on our earnings. We define minimal as a range of plus or minus 2.5%. We're currently operating well within our policy, with a 100 basis point increase in short-term rates actually increasing our adjusted earnings by about 1.2%, which means that we're very well-positioned in a rising rate environment.

Our earnings guidance for 2006 remains unchanged, with diluted AEPS of $3.35 to $3.50, and diluted earnings per share of $2.35 to $2.50. We continue to believe that our net asset growth for 2006 will be in the $1.5 billion range. We expect to fund our growth in the coming year with a combination of unsecured debt and equity. And the timing of our issuances will be based on our pipeline and our projected funding needs.

Earlier in the quarter, our Board announced an increase to our quarterly dividend, beginning with the first quarter of 2006 to $0.77 per share or $3.08 per share on an annualized basis, which is a 5% increase over last year's dividend. Our first quarter dividend will be paid on April 28.

Lastly, we have made a number of changes to the press release this quarter, including the addition of the net finance margin information, which we hope will provide you with additional detail and color on our business and assist you in your review of the Company. So with that, let me turn it back to Jay.

Thanks, Katy. Okay, let me go back now and briefly touch on our expanding reach. You know, we spent the beginning of last year developing a long-term plan to target areas where we thought our core skills could be successfully applied, and where we thought the best risk-adjusted returns could be generated for our shareholders. We positioned ourselves to expand into those areas by making several key acquisitions, and accumulating industry experience either directly through key hires or indirectly through investments in other platforms with market-leading expertise. We're now seeing the first fruits of those investments, with increased deal flow, better market penetration among the leading equity investors we target as our core customer base.

One recently announced transaction involved a sizable acquisition of timberlands for International Paper. Now it's important to know that prior to this deal, we have spent the better part of two years investigating the timber industry and putting together a senior management team led by a 30-year timber industry veteran and by the former Chief Investment Officer of a significant institutional investor, both with deep experience in the timber industry. During those two years, we examined a number of transactions, searching for deals that we believed have the potential to generate relatively stable, extra long-term cash flows.

And the IP transaction was noteworthy, both for the long-term relationship it will create with International Paper, and for the institutional investors we brought into the deal alongside our equity, who share our belief that the risk-adjusted returns generated by our strategy for this asset class can be very attractive.

Now the cash-on-cash yields in this particular transaction will start off below our target levels. But we believe the cash flows in 2009 and beyond and the overall IRR are very consistent with iStar's long-term investment goals.

One other area I would like to mention is our subsidiary in London, iStar Europe. Leveraging off of our partner, Oak Hill Advisors' London office, we have been able to ramp up that business relatively quickly, with key local hires giving us immediate presence in the market. And while we're going slowly at the moment with relatively small investments, we do see significant opportunity to follow existing customers into that market and to expand our franchise and customer base further, just as we have done in United States.

And lastly, for those of you who care about these things, we have changed our corporate tagline to better reflect what really separates iStar's approach from others in the finance industry. And I won't spoil the surprise, but please look for our new tagline in our annual report and ad campaign and let us know what you think.

Okay, now, let's open up for questions.

(OPERATOR INSTRUCTIONS) Don Destino, JMP Securities.

Congrats on a strong quarter. Jay, a couple of questions about Timberstar. You said in the press release that you elected to syndicate part of your investment, due to strong interest from other equity sponsors. Is there a tit-for-tat there? Is that just you building relationships, or can you syndicate at better terms? Or what drove that decision to give up some of the equity?

Well, I guess we spent quite a bit of time and quite a bit of money building some expertise in that area. The IP transaction was a very large transaction. We're looking for partners always who we think we can do lots more business with. In this case, we got significant interest from some pretty strong and sophisticated platforms that we would look to do more business with in the future. So yes, there was a component of it that should generate some deal flow and some relationship opportunities down the road.

But also relative to our own commitments, this was a relatively large transaction with a relatively high concentration in one part of country. And our business plan in that sector is really premised on building a nicely rounded, diversified portfolio. The size of this transaction would have materially skewed it to one timber basket. That's not consistent with our long-term goal there. So there are a lot of good reasons strategically- and relationship-wise for bringing in that smart capital was a good idea.

Got you. And then next question is probably for Katy -- could you quantify or just provide a little more color over the seasonal aspect of the earnings recognition from the timber investment?

And I guess there's a couple of things going on -- in the fourth and first quarter, you're going to have more income from timber but you're also have a lower yield right now than what you're expecting. So could you put that into context with what looked like really strong margins? How much of that is seasonal, and how much of that is being restrained by lower cash on cash returns on timber in the early years?

I think a couple of things -- just to differentiate in everybody's mind, the timber that we own currently -- we have about a $155 million investment in land in Maine, timberland in Maine, which is obviously very seasonal with respect to whether. Timber cutting in Maine is actually optimized when it's cold and the machinery can get into the timber and have traction. It is not particularly strong when it's raining or muddy.

So this particular timber tract is fairly seasonal, with most of the cutting and income coming in in the fourth quarter of the year and the first quarter of the year. So what you are seeing partially in the $0.90 is that skewed amount of timber in the other income.

But I also say -- obviously, last year we had a lot of net asset growth in the fourth quarter and some of those loans were, as we mentioned, somewhat shorter-term transactions that had fairly significant yields. So you're seeing the impact this quarter from that as well.

Going forward, IP -- the transaction that we are in the process of doing -- we're not closing that transaction until the third quarter of this year. So that transaction we expect to be much less seasonal, because the weather -- it's a Texas/Arkansas/Louisiana portfolio, where the weather is obviously not much of a factor.

Got you. That's very helpful. Last question -- looks like the repayment rates came down a little bit in the first quarter, although now that I'm looking at my model, I think it came down in the first quarter last year. Is that seasonal, or is there any reason to think that maybe we will have some relief from the rapid repayment rates we saw last couple of years?

Yes, I think it is always hard for us to predict prepayments. Obviously, some of that number is just simply maturities or repayments that we expect to receive in and around that quarter. But I would say that prepayments remain pretty lumpy. I would say generally, we have seen a pushout and somewhat of a slowdown in terms of the rapid volume that we experienced in the last couple of years. But I'm not sure there's a complete trend there yet.

Mark DeVries, Lehman Brothers.

Yes, were you surprised at all by how quickly you received another upgrade after you got the initial upgrade to investment-grade?

No, we worked pretty closely with the rating agencies throughout the year. And I think they spent quite a bit of time on the story over the last couple of years. And as we brought our unsecured debt levels, primarily through the repayment of the STARs transactions, which were our asset-backed deals -- we had an expectation that that would bring the secured debt level at the overall company down to ranges that they were extremely comfortable with. So that was sort of the next catalyst, if you will, for those upgrades -- in addition to, obviously, ratings are based on a variety of factors -- our track record, our franchise. So I think that was partly the catalyst -- and then our continued strength in the other areas gave them plenty of confidence to move forward with the second upgrade.

Is there a potential for further upgrades in the near term?

We hope so, but probably not in the near term. We certainly hope there are potential upgrades in a longer term. But I think we're comfortable with where we are. We're continuing to work with all three agencies to help them understand our expanding businesses and our leverage model.

Is it too early yet to have a feel for what the latest upgrade is doing for lowering your funding costs?

No. We have issued bonds with our new rating in February. And I would say that we probably -- let's see, gained maybe 20 to 45 basis points, depending upon the maturities. But obviously, the impact in the overall Company is small, as we continue to add debt at the higher rating and older, more yieldy debt burns off, you'll begin to see that.

The only issue that you're seeing now with our debt costs moving up is actually just an increase in LIBOR. But because we're match-funded, our assets -- our LIBOR-based --loans, our assets are also increasing in yield.

Don Fandetti, Citigroup.

Katy, a quick question -- at the end of '05, I think you had very high returning short-term loans that you alluded to. Can you give us an idea of when those mature and what the par amount was? I assume that's a big contributor to sort of the upside this quarter.

Don, it's actually not a huge contributor. But it does -- a couple of them will mature throughout the year in '06. And I don't actually have a breakdown of the numbers. But it was probably two or three loans at the end of Q4.

Okay. So it sounds like then you are implying that more of the upside was due to this other income from timber, if I'm understanding that correctly? And it seemed like that line item was about 14 million, which is not too far off from your normalized 12-ish to 13 number.

Yes, some of the increase was just the increase in the portfolio. So we have more assets that are earning income. Some of it was what you're referencing, was a few of the assets at the end of the fourth quarter and the large volume in the fourth quarter, some of which will burn off this year, but that was a small percentage of it -- and then as you're referencing, timber -- the seasonality of the timber transaction that we've done to date.

And then, Jay, in terms of your timber deal, obviously, that was a great transaction for you to act as a syndicator. I don't recall if you have done a lot of that. Do you think that is a good model for your business going forward, to maybe where you have more fee income, given your balance sheet?

There's no question we have access to proprietary deal flow that others would be interested in. I guess it's a choice, really, for management of where we spend our time.

I will tell you it's not a lot of fun syndicating. It takes a lot of management time and attention and negotiations that, once you have committed to a deal, feel like not necessarily the highest and best use of management time. In cases like this, where we think we can build longer-term relationships that will lead to other opportunities, that investment of the time and resources is justified in where it fits our strategic needs.

But we're going to have to think a lot more about allocating management time and resources to generate fees in transactions where we think, as a principal, we're generating better-than-market risk-adjusted returns, having gone to the point of saying, can we build a business model where we can charge enough fees to make that an attractive business line? Well, we can certainly tell you that there's plenty of interest in the kind of higher-than-market risk-adjusted returns we generate from our deal flow. So it's certainly an opportunity. It's one that as we expand our reach, we'll start thinking about. But nothing on our plans right now.

Okay. And then just lastly, has your outlook or appetite for mezzanine debt changed or gotten more positive?

No groundswell one way or the other right now. I would say that the reduced cost of funds on the senior side have allowed us to be more competitive on senior debt, which I think has skewed the book of business more towards seniors recently. Mezzanine should continue to be an attractive area in a few choice locations and markets, and with choice sponsors. But there is no endemic mezzanine opportunity just sitting out there that we're targeting and tacking towards.

So I can't tell you there is a big wave of opportunities out there -- continue to see a couple of transactions every quarter that are really good, and continue to hit those.

(OPERATOR INSTRUCTIONS) Paul Hamilos, AG Edwards.

Can you provide some additional clarity on how you think about leverage? I think in the past, you have mentioned something about a 2.5 times target for book debt to tangible equity. And I'm curious how you think about tangible equity? Is it this book equity plus accumulated depreciation and loan loss reserves, or is it the more traditional book equity less goodwill?

Yes, it's the former. In terms of the tangible book equity, we do think of it as adding back accumulated depreciation and loan loss reserve. And that is the way our leverage model, which -- currently, we have sort of five buckets per leverage. Our assets fallen to those five buckets, and depending on the weighted average amount in each of those areas, kind of indicates where our target leveraged should be. So in other words, senior debt in first mortgages can be more prudently leveraged at higher levels than mezzanine transactions.

So the leverage model takes that into account, and is a dynamic model. But we do think of tangible equity, particularly with our CTL assets as -- CTL assets are not really depreciating over long periods of time. In fact, in general, most real estate markets, they are appreciating. So we feel that adding back depreciation makes sense there.

And is 2.5 times the right target, or is it a moving number?

Well, it moves slightly based on the actual assets -- assets in the portfolio. So we leverage, for example, our first mortgages four times. So if we skew that way, it would move up slightly -- it's a weighted average number. Obviously, each -- quarter to quarter it doesn't move a lot, given the net asset growth on a quarterly basis versus the overall size of the portfolio.

So from your perspective, though, there's still a fair amount of room to increase the leverage, though?

Yes, at the end of this quarter, we were at about 2.1 times. And we're moving towards that mid 2 times target.

I just have one more follow-up. On the net finance margin, I noticed there was a pretty significant increase quarter to quarter. And I'm wondering if you can help us reconcile the driver of that increase, because there wasn't a concomitant increase in the debt cost as well. Is it that there were some interest rate lags that reset on the asset side, or can you help us understand that?

Yes. Actually, the net finance margin -- and this is a new metric, versus the NIMs, the old net interest margin, which is the old metric which we talked about earlier -- on a net finance margin basis, last quarter we were at 3.26. This quarter we were at 3.59.

And as you can see in the press release, yields on our overall portfolio were up. Some of that has to do with an increase in LIBOR. And some of it is due to an increase in the yield on some of the loans that we mentioned that we did in the fourth quarter of last year.

As you can see also, although we don't have the comparative numbers yet in the press release, on a weighted average cost of debt basis, our weighted average cost of debt in the first quarter was about 6 52. That's up from the fourth quarter, somewhat counter intuitively, because our costs have gone down, but LIBOR is rising. So that's where you see the -- both increased the match funding, both on the debt and the equity side.

So, we have got a 33 basis point increase quarter over quarter -- I guess I was just surprised to see that because of the transition in your portfolio towards more of a senior lending model this quarter. I'm just surprised that they would add that much to the spread.

Let me give you kind of a larger, overarching comment on that. We have always faced the trade-off between yield and volume. As I said, as our reach has increased, we have the choice among many different parts of the risk and return spectrum. We have not as of yet really started to work down that curve in terms of margin -- taking lower-margin, lower-ROE business. As I mentioned in my introductory remarks, 21% ROE at 2.1 leverage is well above what we target for this business over a long period of time.

So we think we have an opportunity to step down the margin curve and the ROE curve a little bit here, increase volume a little bit here. That is really a transition that the Company has thought about and talked extensively about. You did not see that in the first quarter, but we are cognizant that we are making a trade-off by keeping the yields and targeted yields this high, and not taking advantage of some of the deal flow we have at lower return, lower spread, lower ROE levels.

So I think we're cautioning you that these are unusually large margins and unusually high ROEs at this leverage level -- we think we have got a large portion of our customer business that until we have the cost of funds that we have now, we really couldn't play in. We would expect to begin playing in that. Most of it is senior debt. Most of it is attractive business that we've just never had the ability to go after. And I think you'll see us start going after that a little more aggressively throughout the year.

James Shanahan, Wachovia Securities.

The question I have is related to the CTL business and related to these yield questions that people have been focusing on. Can you explain why there was such a big increase in CTL income, while there wasn't really much of an increase in the balance, and there wasn't an increase much in the percentage leased? Can you tell me about the drivers there?

Sure. We have got a couple of opportunities in the portfolio to work with clients who we have multiple property relationships with to move around some of their cost of funds and some of the financings they have done with us. In one case, that increased the CTL side, cost us a little money on our loan side. But as with a customer who needed some flexibility -- and again, that's one of the specialties of iStar, is an ability to work with our customers across a broad range of capital structures, a broad range of property types. In this case, they got some benefit for their P&L by changing the nature of some of their costs on to the CTL side and away from the debt side.

So net-net to us, we feel pretty good that we did a transaction that was smart for us. But you're going to see some of those anomalies show up every once in a while in our book. This was a case where CTLs benefit, and the loan income did not.

So you're seeing the CTL income increase. You don't necessarily see a corresponding decrease in the loans, just because of the loan volumes that we're doing in the other part of the business. Obviously, were not doing a lot of CTL volume. But in this particular transaction that Jay is referencing, we worked with that customer to expand their CTL portfolio to some degree at the cost of some of the loans.

With that being our final question, I'll turn the call back over to Mr. Andy Backman for closing remarks.

Great, thank you very much. Thanks everyone for joining us this morning. If you should have any additional questions on today's earnings release, please feel free to contact me directly, or the new member of our Investor Relations team, Jason Fooks. John, would you please give the replay instructions? And once again, thank everyone for joining us.

Certainly. And ladies and gentlemen, this conference is available for replay. It starts today at 1:30 PM Eastern, will last until May 9th at midnight. You may access the replay at any time by dialing 1-800-475-6701 and entering the access code 825770. (OPERATOR INSTRUCTIONS).

That does conclude your conference for today. Thank you for your participation, and you may now disconnect.