iStar Inc (STAR) 2007 Q2 法說會逐字稿

Good day. Welcome to iStar Financial's second-quarter 2007 earnings conference call.

Now, at this point and during the presentation today, all of your phone lines are muted or in a listen-only mode. (OPERATOR INSTRUCTIONS). As a reminder, today's conference is being recorded. At this time, let's get right to the second-quarter agenda 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. Andrew Backman. Please go ahead, sir.

Thank you all for joining us this morning to review iStar Financial's second-quarter 2007 earnings report. Joining me for the call today are Jay Sugarman, iStar's Chairman and Chief Executive Officer, Jay Nydick, our President, Tim O'Connor, our Chief Operating Officer, and Katy Rice, our Chief Financial Officer.

This morning's call is being webcast on our Web site 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 a confirmation code of 880751.

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 Financial's expectations are detailed in our SEC reports.

Now, I'd like to turn the call over to iStar Financial's Chairman and CEO, Jay Sugarman. Jay?

Thanks, Andy. Thank you all for joining us today. The second quarter was a strong one for our company with solid earnings growth and an increasingly attractive set of investment opportunities to choose from. We also closed the discounted portfolio acquisition from Fremont and began integrating their personnel across all parts of our firm. As Katy will explain, that transaction should help grow earnings nicely for the remainder of 2007. I will come back in a minute and walk you through why we are quite comfortable that the deal will meet the IRR targets we initially underwrote to, even in light of current market conditions.

But first, let us go through the summary of key metrics for the quarter. On the earnings front, we saw strong earnings growth with EPS coming in at $1.02 per share and our guidance for the second half looking strong as well. On the originations side, we closed 36 separate transactions, funded just under $1.3 billion on new and previously committed transactions. While prepays went up as expected, that has turned out not to be such a bad thing. With credit markets finally pulling back and in some areas correcting fairly dramatically, we are beginning to deploy capital at some of the best risk-adjusted returns we've seen in a long time. As a result, the high repayment level in the second quarter was actually a net positive, as it helps create additional liquidity that can now be invested in this increasingly attractive window.

With regard to return on equity and spreads, we had another good quarter with solid spreads and return on equity finishing just over 20%, despite not yet moving to our capital model targets. That underleverage will also hold us in very good stead as we head into today's current window of opportunity.

Lastly, on credit, we had a handful of our highest-coupon assets move to the watchlist or NPL list, as equity sponsors failed to execute on their business plans. As these assets represented the very outer reaches of our portfolio on the risk/return spectrum, we still feel very comfortable with the core credit quality of the portfolio before adding the newly acquired Fremont assets. Now, let me wait to go over that new portfolio so Katy can recap the second-quarter results, and then I will come back and give you our take on what's going on over there.

Katy?

Thanks, Jay. Good morning. As Jay mentioned, we had another solid quarter as we continued to grow our business and began the process of integrating Fremont.

Before I begin, let me just mention that the results we discuss today do not include the impact of Fremont, since we did not complete the acquisition until after the second quarter closed. We will report consolidated iStar and Fremont results beginning in the third quarter.

Okay, for the second quarter, our adjusted earnings came in at $130 million or $1.02 per diluted common share. Our net investment income came in at $132 million, which was up approximately 25% from the second quarter of last year. The increase in our net investment income year-over-year was primarily due to the growth in our loan portfolio.

We continue to see good deal flow across the business. New commitments for the second quarter were $1.8 billion in 36 separate transactions. Approximately 80% of our second-quarter originations were first mortgage, participation in first mortgages, and senior debt commitments.

New commitments for the second quarter were consistent with our overall portfolio in terms of diversification, both with respect to geography and collateral type. Given the very negative sentiment in the market today, I think it bears repeating that we continue to have no exposure to subprime residential mortgages.

Our total fundings for the quarter were $1.3 billion, which included $381 million from prior commitment. As I reported on the last earnings conference call, we expected to report a significantly higher number of pre and repayments in the second quarter. This was primarily due to the timing of several borrower sales and refinancings in the second quarter and is not indicative of a change in the trend of pre and repayment activity.

Repayments and prepayments for the second quarter totaled $1.05 billion, in line with our expectations and resulting in net asset growth of $235 million for the quarter, excluding the disposition of four small, nonstrategic corporate tenant leased facilities.

Fees associated with the higher prepayments were the primary contributor to the increase in other income we saw in the quarter. Other income for the quarter was approximately $39 million versus $28 million last quarter.

With respect to our credit statistics for the quarter, interest coverage was unchanged from last quarter at 2x. Fixed-charge coverage improved slightly, quarter-over-quarter, at 1.9x. Our leverage, defined as debt to equity plus accumulated depreciation, depletion and loan-loss reserves, remains below our targeted range at 2.5x at the end of the second quarter, unchanged from the first quarter.

Our return on equity came in at just under 21%, well above our mid teens target. Our net finance margin was essentially in line with last quarter at 322 basis points, and our margins continue to hold up well despite the continued liquidity in the market.

Let me take a moment now to discuss credit quality for iStar, and then towards the end of my remarks, I will give you update on the Fremont portfolio based upon what we've seen since we closed the acquisition earlier this month. This quarter, we saw a slight increase in our watchlist assets and an uptick in our NPLs. As Jay mentioned, most of these loans were higher risk adjusted transactions that were underwritten with higher return expectations and that in most cases have not achieved their original business plans. However, despite this increase in NPLs, we do not believe that there are any major or systemic changes in the overall quality or trends in our portfolio.

This quarter, we kept one asset on the watchlist from last quarter, added four net assets, and moved four assets from our watchlist to NPL status. Five assets on our watchlist at the end of the second quarter totaled approximately $179 million, or 1.45% of total assets, up slightly but essentially in line with recent percentage levels for the portfolio.

For our NPLs, we did see a more significant increase quarter-over-quarter. Specifically, in addition to the four assets we moved from our watchlist to NPL status, we added one loan and removed one loan from the list. The seven assets we had on NPL status at the end of the second quarter totaled $213 million, or 1.73% of total assets. Last quarter, the total was $78 million or 0.64% of total assets.

As I mentioned earlier, we do not believe that there are any systemic credit issues or changes in the credit trend of the overall portfolio. Rather, the issues we've identified on both our watchlist and NPL list are asset-specific and represent a very small percentage of our total assets.

Risk management is a critical part of our business strategy. As many of you know, we conduct an extensive review of our entire loan and CTL portfolio each quarter. That review also includes our analysis of current market conditions. Based upon the second-quarter review, we did see a slight decrease to our overall credit metrics for the structured finance and CTL assets. Specifically, the weighted average principal risk for our structured finance assets increased slightly, coming in at 2.78 for the second quarter versus 2.64 for the prior quarter. The weighted average risk rating on our CTL portfolio came in at 2.5 versus 2.45 from the prior quarter.

Approximately 93% of our structured finance assets have a risk rating of 3.5 or better. Our ratings are based on a scale of 1 to 5, with 1 having the lowest risk and 5 having the highest risk. Of the 7% of our assets that are rated a 4 or higher, two-thirds of these assets are on our watchlist and NPL status.

As you can see, our overall percentage of highest-risk assets is low, and each one is carefully monitored. We continue to believe we are adequately reserved for the issues we've identified in the portfolio with $62 million in on-balance-sheet reserves.

Before I turn to our guidance expectations and a brief review of the Fremont portfolio, let me take a moment to comment on our capital markets initiative. During the second quarter, we increased our short-term sources of capital. Specifically, we entered into a new, five-year, $1.2 billion multi-currency unsecured revolving credit facility. The facility was completed with over 22 leading financial institutions and serves as additional capacity to our existing $2.2 billion unsecured line, providing us with a total of $3.4 billion in unsecured short-term capital. This additional liquidity is important to us, not only with respect to the increased velocity of our business due to the Fremont acquisition, but it should also enable us to capitalize on some of the opportunities we may see as a result of the dislocations in the capital markets today.

In addition, as we've previously reported during the second quarter, we arranged interim financing that was used to fund the Fremont transaction at closing. We expect to repay this 364-day interim facility through the issuance of debt and equity. The timing of any debt or equity issuance will be predicated on market conditions.

As we've also mentioned before, we expect a European bond issuance, either in euro or sterling, given our state ramp-up in Europe.

Before turning to guidance, let me briefly comment on the Fremont portfolio, based on what we have seen since we closed the transaction on July 2. First, despite the negative sentiment in the housing market, we have not seen any significant changes in the portfolio from what we originally underwrote. The weighted average spread in the portfolio remains about 3.3% and is expected to decline somewhat over the next 24 months.

As expected and as we discussed when we announced the acquisition, watchlist assets and NPL assets have increased from the time we announced the transaction in May. While we expect to incur losses within this portfolio, we continue to believe that we are adequately reserved. In fact, in a couple of instances, we have already experienced recoveries on troubled loans in excess of our original expectations. While it is still early, we believe that the range of investment returns on the portfolio will be equal to or in excess of our target.

At the end of the second quarter, based upon our review of the Fremont portfolio and our risk assessment criteria, there were 22 assets on the watchlist totaling $1.07 billion in total commitments versus 21 assets which totaled $1.03 billion in total commitments when we announced the transaction in May. In addition, we now have 16 of the Fremont assets on NPL status totaling $495 million or 5.1% of total commitments. This compares to 13 assets when we announced the transaction in May that totaled approximately $400 million or 3.6% of total commitments. The credit trends in the Fremont portfolio are consistent with our expectations and our original underwriting.

As Jay will discuss in a couple of minutes, we are pleased with the progress we have made with the integration to date and we're confident that this transaction will generate very solid returns.

Let me wrap up with a discussion of our earnings guidance. As we said when we announced Fremont, we expect the acquisition to be accretive this year. The based on our current review of our expanded business, we now expect 2000 diluted AEPS of $4 to $4.20, and diluted GAAP earnings per share of $2.90 to $3.10. We now expect net asset growth of approximately $6 billion for 2007, including the Company's retained interest in the Fremont portfolio which has an approximate book value of $2 billion. Excluding the Fremont interest, we expect net asset growth of approximately $4 billion for the year, up from our previous guidance of $3 billion.

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

Let me talk for a minute about the Fremont portfolio and the integration process. When we originally underwrote that transaction, we had two cases, basically an upside case and a downside case. The downside case built in some of the very weak dynamics we saw developing in many of the underlying collateral positions. Given our view that markets were overly bullish for the most part, a theme you've heard us talk about regularly on these calls, we use the downside case to price the deal. As a result, we priced the transaction to generate our target IRRs assuming a downside case, and our initial guidance assumed that downside case. As Katy mentioned, during the transaction call, we fully expect to have to work through a number of stressed asset situations.

With the purchase price and reserve levels we have for those assets, our IRR expectations have not changed, so on the asset side, the earnings side, IRR side, we still like the deal.

On the integration side, we are moving forward with a comprehensive plan that recognizes the fundamental differences in our two platforms and looks to take the best from both organizations to move to the next level. Team members are working across all the disciplines to bring the market and transaction knowledge of both organizations to bear on our asset management and investment decisions. If we do our job right, the Company will be even better positioned to take advantage of the dislocations taking place right now in the capital markets. Now, that is not going to happen overnight, but so far, so good.

With that, let me open it up for questions. Operator?

Ladies and gentlemen, as you just heard, at this point, we invite any questions or comments that you may have. Today's question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS). Don Fandetti, Citigroup.

Jay, a quick question on your NPLs -- it sounds like you have seven assets. Can you talk a little bit about what specifically makes those up? It was a pretty sizable increase from the prior quarter.

Sure. I am not going to go into any specifics because of obviously our sensitive situation, but I want to give you a general sense of what kind of assets and why I think they are pretty much anomalies in the portfolio. Let us start with there are seven loans backed by six assets, so really there are six situations to talk about. Three of them, frankly, are irrelevant. We're going to get our money back; the real estate is going to cover it. They are just messy. So I really focus on the four loans backed by three assets, and again as I said, these are pretty far out on the risk/reward spectrum.

One deal was in effect an R&D investment in a new platform we were considering. It was an opportunity that, while it is an immense business, there is a reason you get paid a lot of money to go into it as a lender. A lot of things out of left-field sort of went wrong with the transaction. It still has a very high-quality sponsor sitting behind it doing everything they can to figure it out. But that is definitely one that went sideways on us. I would categorize that as kind of a one-off in a new business, and it is what it is.

A second deal which had, again, a very high-quality institutional named sponsor, very high-quality real estate, a series of one-off mistakes that, as the markets weaken, they just could not overcome, and these are the kind of mistakes that should not happen with high-quality sponsors, and you do not expect them to happen. So again, I can kind of chalk that one up to one-off, nonsystemic risk. At the same time, though, they probably would have gotten out of that mistake if the markets were just raging ahead. Their local submarket did not allow them to get over those mistakes. We still like the real estate, still think, long-term, we are probably going to be fine there. But that is going to take time to work its way through. In a much hotter market, the sponsor here be able to sneak through that one as well.

Really the third deal, frankly, we rolled the dice and lost. It was a 20% first mortgage. I think the coupon alone tells you where the risk profile of that deal was. I think, inside of our portfolio, that is an anomalous type transaction but in each of these cases, we were being paid a lot of money to go into places that we do not replicate very often. So I guess if there is any good news in that number, it is that those assets are not sitting in the core kind of iStar portfolio; they are sitting in the outer bounds of either one-off opportunities or new R&D opportunities that we kind of dipped our toes in, at least in one case have gotten stung pretty good, clearly not going to build a platform around that but it was a business that had $1 billion potential and it was probably worth a try.

So we don't look at anything in that NPL list and go "Oh my gosh, there's a whole chain of events happening that is going to take down big pieces of the book." I look at a 20% first mortgage, a 30% second mortgage, double-digit teen returns on every one of those deals on an unlevered basis and go "You know, we took the risk" -- and not the kind of deal probably five years ago we would have done, but as we have gotten much bigger and as our reach has grown, probably the kind of deal every once in a while you're going to see us do. When markets turn, that two, three, four, outer-edge deals are probably the ones most at risk.

Then just quickly -- thank you for that detail -- in terms of the commercial real estate business in general, obviously a lot of fears of sort of contagion. What are your thoughts today on your core business in commercial real estate?

Let us talk about it in two ways. One, I think the overall credit markets have clearly seized up, but real estate is probably going to be the tail of that. We have not seen the correction nearly as fast in real estate as we have seen in corporate and certainly in some of the corporate crossover deals. So I think the real estate story is yet to be told. We are starting to see signs that some of the hot money in this sector is no longer there. We are certainly seeing that in the stock market; we are certainly seeing it -- starting to see it in the credit market. But it is a slow-moving beast. I do not think you are going to see, at least in the credit markets, the kind of real estate opportunities you have seen in other historical downdrafts, really until later this quarter or even into the fourth quarter. So we are watching the dynamic pretty closely but remember, most real estate transactions take 8, 10, 12 weeks to close, so I think a lot of the stress in the system is just now being communicated to the borrowing community.

So that's what we have our eyes open for; that is where our liquidity is going to be a big advantage. You are going to see, in this market, size and liquidity suddenly become very valuable. Being one of the largest players in this sector with some of the best liquidity is going to be a big advantage. We fully expect to be able to take advantage of that in a lot of places.

James Shanahan, Wachovia.

The news from the homebuilders continues to be very negative, including news of write-downs of land investments. They are also allowing land purchase options to expire due to lack of demand, that sort of thing. Can you update us on what your expose is to land and pre-development loans, and perhaps where those LTVs are now versus to the LTVs at origination?

I can try to do that. Obviously, with Fremont -- I assume you want the combined number?

I was really more interested in the legacy portfolio, because you have provided so many quality disclosures about the Fremont transaction.

I think, in terms of the overall book, we look at sort of in-place today probably 10% of the book being in different buckets that you mentioned. Some of these are midstream; some of them are early-life; some of them are completed-construction transactions and they are really in a sellout phase.

Aggregating that, I think the most speculative stuff is less than 5% of the book, kind of the middle of the pack stuff that is probably high single digits. Then the stuff that we think is working its way toward the end of the chain is probably around 10 or 12% as well.

You know, my honest perception, despite the overlay clearly that is a negative perception, is that the underlying risk-adjusted returns in most of those deals are still actually really good. Because you are allowed, in that business, to actually force the structure upon the borrower, typically, and because we did not go into a lot of transactions where the structure was forced on us. So I guess I would caution you that, yes, the market overlay is certainly very weak right now, but when you look at the opportunities out there and as we have continued to look at them, where we can get structure and collateral and guarantees and things we can actually underwrite to even in a downside case, a lot of those deals actually I do not perceive the kind of risk that the overall market conditions would suggest when you just see the highlights.

So I guess our feeling is this market needed to correct. It is correcting very hard, which is not a bad thing. I think some of the reaction in the marketplace is correct and overdue, but I also see as a long-term matter the structural protections we see in that business and the pricing in that business continuing to be interesting and not something we're going to shy away from, particularly as other, less-involved players get their fingers burned and walk away. I think it actually creates more opportunity, not less.

Thank you for that. A follow-up, if I may? A question about the other income line item which has always sort of been a source of volatility, although it seems like it has been consistently rising over time. But $38 million in other income was a bit of a surprise to us and up significantly, both on a sequential-quarter basis but really for any quarter in '06, maybe double those levels. So I am curious what was unique about this quarter and what part of that you would expect to replicate, say, in Q3 or Q4.

Yes, the increase in other income, which was about $39 million this quarter versus $28 million last quarter, was really the result of the high prepayment volume we had in the second quarter. That was really a result of just the timing of a couple of transactions that borrowers were either selling assets or refinancing. So our re and prepayment activity was very high this quarter; it was about $1.05 billion, which generated that additional other income. You will usually see that when we have big re or prepayment activity, particularly prepayment activity, that other income -- you can look back actually a couple of years on a quarterly basis and it's somewhat of a run-rate. I think the run-rate has obviously been going up as just the general portfolio has been growing, but then occasionally you will see outlier quarters and that is simply where you have either a couple of large transactions or sort of a preponderance of prepayments.

There are still a couple of big prepayment potential things in the book, but I would not look to replicate that kind of number on a quarterly basis. So I think you are right. The sheer number of repayments last quarter and the actual ones that repaid had built into them some pretty attractive returns on them. But that is not something we program in or you should program in, going forward.

So would be it fair to assume that maybe something closer to Q1's other income total might be more appropriate on a recurring basis?

Yes. I mean, it will remain lumpy but I mean, you can look back, again, over the quarters and sort of -- it has been going up because just of portfolio growth and we are having more prepayment and repayment activity, just because the portfolio is bigger, but certainly, as Jay mentioned, I would not use the 39 as your run-rate.

Susan Berliner, Bear Stearns.

Good morning. Jay, I was wondering if you could just tell us, for the watchlist assets, what category would they fall on? Would that be in other investment?

No.

No, Sue, those are loan assets, by and large. In fact, they are all loan assets, and they are five assets and it is a pretty diverse collateral package, if you will. There is hotel, retail, apartment/residential, and a couple of AutoStar loans.

Okay, that is exactly what I was looking for. Thank you. And by second question is, I guess, looking forward on the provisions, would the -- I guess it was stable to last quarter. Going forward, I guess you are assuming these loans have pretty good collateral or you would have risen it more, or is that not a correct assumption?

Yes. The provision is really a result of our quarterly risk rating meetings, and we spend a lot of time each quarter walking through each asset, particularly the watchlist and NPLs, to determine what we think appropriate reserves should be and whether we need to increase the reserve level to cover those.

So at this quarter, we felt comfortable increasing the reserve about $5 million. But as we go forward, as we learn more and as certain events unfold with respect to these assets, we would make that judgment each quarter.

We did anticipate -- and again, this will still be based on a quarterly risk rating -- but with the addition of the Fremont portfolio -- that we underwrote that to increase reserves somewhat over time. So you may see increases from that portfolio as well.

Great. Thanks very much.

Douglas Harter, Credit Suisse.

I was wondering if you could talk about any success in getting the Fremont staff to underwrite to iStar standards in the first month.

Actually, we have given them much more time than just one month. We have said "Look, it is clear to us that some of the dynamics that we look at in our business are different, so we are not putting any pressure on them whatsoever to do transactions. We are actually asking them to team up with people inside of iStar and just watch transactions go through the pipeline here and how they get sort of pushed and pulled and thought through. So at this point, we are much more in training mode than we are in transaction mode, but I think what we're likely to do and have communicated is we want all of the Fremont folks to go out and hit a single, take a low-risk, relatively easy-to-underwrite transaction, bring it through the system so they can see some of the differences and some of the places where maybe they need to do things a little differently, and how they can communicate best with their customers that new process.

So I think, at this point, everything, as I said, looks good. I think we've got a lot of very experienced personnel who, frankly, just came out of a different system. We are just trying to inculcate them in how we think about risk/reward, not just in one very narrow part of the business but across multiple parts of the capital structure and multiple parts of the investment spectrum. That is a little bit of a change.

So one of the things I think you heard us say in the transaction call was the earnings profile that we are laying out did not predicate itself on a lot of great things happening quickly. We are giving ourselves quite a bit of time to do that integration. We still think the earnings curve and the dividend curve look pretty attractive as a result of the transaction.

Ann Maysek, Deutsche Bank Securities.

Good morning. Katy, just a quick question on your credit facilities -- you mentioned $3.4 billion total. How much of that is undrawn, currently?

Yes, we have $3.4 billion of unsecured and about $500 million of a secured facility for a total of $3.9 billion. It's about a third drawn right now, so we have good liquidity.

David Fick, Stifel Nicolaus.

You may have already covered this in your opening remarks, but then you talk a little bit about the Orlando City Place transaction? It was referenced in the local news, the bankruptcy and foreclosure there -- as well as update us on the Comerica JV that you announced?

Sure. At least on the Orlando one, that is one of the ones I am really not worried about, David. The real estate collateral, the basis for the key, their quality of that asset, the incremental land that is attached to it -- the equity guys are not going to be happy. Some of the subordinated lenders are not going to be happy. But in our minds, that is, plus or minus, a very small number to what we have it on our books at. So that is not one of the ones that I am kind of spending a lot of time on.

Obviously, it is distressing that we had to go through a bankruptcy to clear out some of the subordinated debtor issues and some of the other claimants to make a sales process smooth. We would rather have just been able to let the borrower do that themselves, but there are a lot of people who are going to lose money here who were not going to let that process go through smoothly. So re-pack was the best way to get them to where we wanted them to be it.

Right.

On Comerica, as we said, I think Comerica is a great asset. We had interest from local people who wanted to be our partners. We kind of told them an indicative value that would be required and somebody said "Yes, I would like to be involved and I have local money that would like to be involved." They bought 10% of the ownership of the assets at our basis and are now involved in the asset. We thought having a local presence there long-term was probably the right thing to do.

So they bought at your basis? I thought there was a bit of a premium implied in the way the transaction was described.

It is so small as to not be relevant.

Okay. Then lastly, your financing for Fremont, the temporary facility -- do you have any sort of hedge there just in case there is a real credit crunch at some point?

A hedge in terms of interest rates?

Yes.

Yes, it is a LIBOR-based facility. It is LIBOR plus 50, with no fees for a year. Almost 100% of the Fremont portfolio is also LIBOR-based, so --.

It is implicitly hedged. That's right. Okay, thank you.

Tim Wengerd, Deutsche Bank.

I'm on for Stephen Laws. I had a quick question about your leverage going forward. You know, with adding the Fremont portfolio, how do you see your leverage targets changing and how would it change, given the credit markets?

Yes, at the end of the quarter, we were, as Jay mentioned, under-levered at about 2.5x. Right now, we are targeting something in the mid-3s, which is still below our capital model. We did indicate, when we acquired Fremont, that we would finance the transaction on a leverage-neutral basis. We do expect to raise both debt and equity to repay the interim facility. Obviously, with the negative sentiment and dislocations in both the debt and credit markets right now, that capital raise will really be dependent in terms of timing, on seeing a little more stability in the market before we decide to dive in.

Just one thing to make sure -- I know all you guys know this, but Fremont was 100% first mortgages. Obviously, first mortgages in our capital model and in S&P's capital model are at the higher end of the leverage range than CTLs and some of the junior and subordinated and other investments. So a lot of that increase is simply a function of the portfolio skewing much more directly towards first mortgages and away from the lower-leverage CTLs and sub investments. I think part of that increase that Katy is mentioning is really just a function of portfolio mix and the rest of it will be a function of -- we still have never really gotten to our target leverage model. In this kind of environment, if the opportunities actually present themselves the way we think they might, we will consciously move closer to our target leverage level.

Okay, great. Thank you.

Michael Dimler, UBS.

I wonder if you could provide a little bit more color on the non-U.S. issuance plans. In terms of a target, what kind of a percentage are you looking at going forward in non-U.S.?

Right now, our European operation has a book of just over $1 billion. It is about two-thirds euro/one-third sterling. As we move forward, obviously our credit facilities are multi-currency, so we are currently financing those assets just on the credit facilities and match-funding the currency with the credit facility. But as we go forward, we would like to term that out and be in the European bond market raising euro and sterling liabilities to match-funded that business.

How much is currently outstanding under that facility?

Well, it is not a separate facility, so this is just our credit facilities. But the book of business in Europe is just over $1 billion.

Okay. A separate matter -- if you could kind of talk generally about, in terms of the steepening we see in commercial finance, the credit curve, which participants in the market are getting squeezed right now? Which are the most vulnerable? What are you seeing in terms of the risk appetite at the smaller end of the scale, in terms of risk -- entrepreneurs?

Well, I guess I would take you at the other end of the curve and say, the market still follows supply and demand. You see an enormous amount of supply stuck in the system. You have seen some of the structured product investors unable to access capital. That is where the fastest dislocation has taken place. You have seen it most dramatically on the corporate side of the world.

As I said, the real estate structured product investors are slowly being squeezed but a number of them continue to have access to capital. I just think size and abundant liquidity are not something that is going to be sustainable in that business model if market conditions stay the way they are.

That works its way through the snake down to the grassroots of our business. You know lots of parts of the market are getting squeezed, and you are seeing repricing on transactions, slowly but surely. But we have seen a number of relatively high-profile deals clear the market, and clear the market at pricing that I would say is not indicative of a market collapse. This is specifically to real estate.

So clearly land, clearly anything in the homebuilder sector is going to reprice the hardest right now. Again, I am not saying that we're going to redline that; that may be an opportunity. But we have not seen it really move into the mainstream asset types in the kind of way that we think creates unusual risk-adjusted returns. So, that is what we're going to be watching for if the supply of real estate capital continues to be available. I am not sure we are going to see that repricing, and right now, for the moment, I cannot sit here and tell you that we see giant cracks in the real estate market. We still see little cracks, and we are seeing cap rates move a little bit, and we are seeing a couple of asset deals that have to be repriced. But you have not seen what I think you are seeing in the LBO and corporate markets were you are seeing a very significant real-time repricing across the board. That is what we are watching for. Fortunately, we are in a platform that has the ability to see across multiple markets and pick and choose which are the best risk-adjusted returns.

We do not really play in the small transaction world. Obviously, our average investment size is $30 million to $40 million, so I am not sure we can help you with -- who is the little entrepreneur getting hurt? I do not know. It is not our customer. Our customer is the high-end player and most of them I think still have access to capital and are looking at this as an opportunity, not as a time to go and sit on their hands.

Great color. Thank you.

James Fotheringham, Goldman Sachs.

Just two quick questions, perhaps for Katy -- would it be reasonable for us to assume that, with your raising earnings guidance, that expectations for dividend growth should follow in step? Also, any update on your discussions with Moody's regarding the potential increase to your leverage ceiling? Could you put those ongoing discussions in the context of the current environment as well as the Fremont acquisition?

Sure. With respect to the dividend, obviously it is our intent to distribute, as most REITs do, all of our taxable income. We have raised our earnings guidance and we do think it is a little early in the year to -- because there are a lot of things that go into that throughout the year in terms of asset sales -- our timber business changes our taxable net income -- to really forecast whether we will be under-distributed at our current dividend level. But you know, it is fair to say that would be -- there is potential for that, and it would probably come in the form of a special dividend.

With respect to our discussions with Moody's, they actually issued a report in I want to say April, which was sort of their updated format. They have updated their format I think for both finance companies and real estate companies. They took investors through not only a review of our business but a discussion that indicated that they do not really do capital models for any companies, but they did comment on leverage and indicated that they thought our leverage was in-line with our growth and size and diversification.

Jordan Hymowitz, Philadelphia Financial.

I am trying to understand your reserves a little bit. Your watchlist as a percent of assets, you know, has gone from like 16 basis points to 1.45, and your NPLs have gone from $32 to $173 year-over-year. At the same time, your reserve coverage has gone from 1.7 times to 0.3 times. I mean, you have got to be looking at the reserve coverage ratio somewhat on this, especially with Fremont coming on. Where do you think that reserve ratio is going to trend and that coverage ratio is going to trend?

Yes, I think -- and this is something that we walk a lot of investors through. You've got to remember that commercial real estate generally has extremely high recovery rates versus other types of financial assets, like credit cards or airplane leasing, financings. So we look at not just the overall number but we look specifically at each asset. As Jay mentioned, for example, on the Orlando asset, which is on our NPL list, we fully expect to recover 100% of our book amount of the loan. So we really look asset by asset to determine that, not simply at the overall list. Some assets go NPL and just get messy, but we're not worried about actually having a loss.

So again, we do a thorough analysis every quarter of, based on our risk ratings, of where our reserves -- we think they should be. I do think they will pick up as we bring the Fremont portfolio on board. We underwrote it to do that, and that is the part of the overall IRR and target returns that we underwrote. I do think you'll see it go up, but again, we look each quarter and base that number on what we see in terms of actual, potential loss.

So I mean, once Fremont comes in, what will the reserves to NPAs look like at this point? Because you have -- because of purchase accounting, you will be able to allocate some of that to reserves to begin with because you purchased it at discount.

Yes, once we bring the portfolio on our books, we are also bringing over their loan-loss reserves, which is approximately -- we are still working on the purchase accounting with Fremont, but it will be approximately $200 million of additional loan-loss reserves.

How much of their NPA is at this point?

Based on the our review, their NPLs are about 16 assets, $495 million. It is about 5.1% of the total commitment.

Jordan, one of the things we are watching in that portfolio is what is the expected loss scenario when these things go bad? I would say we are getting a decent sense on that on condo conversion, which is really where we thought most of the reserves needed to be applied, less so on some of the condominium construction stuff they had, although I would tell you, in general, that stuff -- even when it has gotten into problems, as Katy sort of mentioned in her remarks -- as rental properties, they have been trading north or very close to the basis. So even in some of the cases where we thought we would have losses, you have seen sale condo/conversion deals actually trade out on a rental basis at decent numbers. That is not going to be true for every asset. Clearly, when I said we took a downside case, you know, we do not think rental assets are going to trade at forecast forever. But certainly in this kind of market where real estate equity is still a reasonably strong bid, some of those assets look like they are going to trade out at numbers that are better than what we expected.

So I think you will see that reserve balance move in the context of where we see markets and recoveries. I think it is fair to say we will be ahead of the portfolio in terms of reserving. If we thought there were material downdrafts in the marketplace and valuation, yes, those reserves are going to be going up. But I think the earnings profile of the Company, certainly with Fremont on board, is sufficient to say we should be well-reserved. If we're not well-reserved and we make a mistake, you guys should blame us because we have told you before we will be reserved ahead of issues.

Well, let me ask the question in a different way, because you guys have always been more reserved than any other company in this space by a long shot, and your reserves for years were always like at 1.5x NPLs. The environment -- it was perfect at that point so there were no NPLs, so that was a skewed ratio.

Yes.

But what do you think is a right ratio? Even Fremont, then, is a 40% coverage ratio versus today. Is a 30% to 40% coverage ratio where you are comfortable running with? At that point, it almost seems way below everybody else.

Yes, I think, just to give you some context around the numbers, their reserves were in the 3% to 3.25% range of assets. On a combined pro forma basis, we will be with them about 1.8% of total assets. So bringing their reserves over will definitely bump that number up quite a bit.

Okay, thank you.

James Shanahan, Wachovia.

My question about reserves was asked and answered, but I had another one. Expenses have been rising. I am curious how we should anticipate your base level of G&A to run here once you layer on the Fremont folks and any other associated real estate expenses that they may have.

Yes, this quarter, we actually had some unusual expenses in the G&A line related to our Moor Park venture over in Europe, and related to the integration of Fremont. So they were running higher than sort of a run-rate, if you will, for iStar. But going forward, our earnings guidance obviously incorporates the increase in G&A related to Fremont.

Okay, so we should just solve for that based upon the -- what you have told us with regards to asset yields on the acquired portfolio and funding costs, and provisions and just sort of back into what that number might be?

Yes, I mean, we are still refining it. Again, we closed the transaction a little less than a month ago.

Sure. Okay, thanks.

With that, Mr. Sugarman and our host panel, I will turn the call back to you. There are no further questions.

Thank everybody for joining us this morning. If, in fact, you should have additional questions on today's call or release, please feel free to give me a call directly here in New York. Brent, would you mind giving the conference call replay instructions once begin? Thank you.

Indeed, I would be happy to. Thank you very much. Ladies and gentlemen, Mr. Sugarman is making today's call in trouble for digitized replayed. It is for two weeks starting at 1:30 PM Eastern daylight Time July 30 all the through 11:59 PM August 15. To access AT&T's executive replay service, please dial 800-475-6701 and at the voice prompt, enter today's conference ID, 880751.

That does conclude our earnings conference for this second quarter. Thank you very much for your participation as well as for using AT&T's Executive Teleconference service. You may now disconnect.