Drive Shack Inc.
Q2 2009 Earnings Call Transcript

Published: 7 Aug 2009

[Operator:]

Good afternoon. At this time, I would like to welcome everyone to the Newcastle second quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). I would now like to turn the call over to Nadean Finke. Please begin.

[Nadean Finke:]

Thank you, Christie. Good afternoon, everyone. I’d like to welcome you all to Newcastle’s second quarter earnings conference call. Joining us today are Ken Riis, our CEO and President; and Brian Sigman, our Chief Financial Officer. I’d also like to point out that statements today which are not historical facts maybe forward-looking statements. Our actual results may differ material from the estimates or expectations in any forward-looking statements. These statements represent the company’s beliefs regarding events that, by their nature, are uncertain and outside the company’s control. So you should not place undue reliance on any of these statements. I would encourage you to review the forward-looking statements disclaimer in our quarterly earnings release including the recommendation to review the risk factors contained in our annual and quarterly reports filed with the SEC. Now I’d like to turn the call over to Ken Riis. Ken?

[Kenn Riis:]

Thanks, Nadean. Good afternoon, everyone, and thank you for joining our 2009 second quarter earnings call. We had a good second quarter. We are now in a stable liquidity position with $69 million of cash and $68 million of non-agency recourse debt. As you all know, our goal since January 2008 has been to deleverage our balance sheet and eliminate our reliance on third-parties to refinance maturing short-term debt. Given the difficult operating environment over the past two years, we worked hard to improve our position. This quarter we achieved that goal. We executed on plan and are now in a stable liquidity position as we can now meet our non-agency recourse obligations with our cash on hand. Obviously, our work is not done yet. We will continue to focus on increasing our liquidity and maximizing cash generated from our investment portfolio. As it relates to the second quarter activity, there are few things I want to highlight. First, we purchased $30 million of our CDO liabilities at a cost of $2.4 million, an activity we will continue to pursue in order to retire the debt and lower interest expense. Second, we eliminated a $51 million construction loan funding obligation, freeing up $38 million of unrestricted cash on our balance sheet and $13 million of restricted cash in our CDOs. And finally, we generated $20 million of operating cash flow net of expenses as we continue to receive material cash flows from five of our seven CDOs. Just as a reminder, we have seven different CDO financings totaling $4.4 billion of debt. These financings are non-recourse to Newcastle and are only secured by the assets within the CDO. This debt is attractive with a low-funding spread of LIBOR plus 45 basis points. We also have the ability to actively manage each portfolio and buy and sell securities within certain limits and reinvest principal during its reinvestment period. This flexibility is important as it allows us to manage credit risk and build over-collateralization or OC cushions in our CDOs through reinvestment of principal. We currently have a $127 million of cash to invest in our CDOs. Our goal is to reinvest this cash in assets with stable credit profiles at discount dollar prices with a focus on increasing our OC cushion. Maintaining a positive OC cushion is key to our ability to generate cash from operations. We currently have about $1.1 billion of CMBS and ABS securities held within our CDOs on downgrade watch by the rating agencies. The extent of these downgrades could impact our cash flows. That said we are working hard to manage this risk and offset the potential impact of the downgrades. Finally, as I look ahead, the commercial real estate markets will continue to experience increased loan delinquencies and defaults as borrowers find it difficult to refinance maturing debt. On the positive side, I think most of the default risk is already priced into the CMBS market and I expect credit spreads to tighten in the second half as they have for most of 2009. Now, I’ll hand it over to Brian Sigman, our CFO, to go through the second quarter financial results. Brian?

[Brian Sigman:]

Thanks, Ken, and good afternoon everyone. So today based on Ken’s broader view, let me drill down on our liquidity and financial results for the quarter. I also think it is important for me to talk about the new FASB rules and then I’ll close with a few key points. Our liquidity; currently, we have 69 million of unrestricted cash and a 127 million of restricted cash for reinvestment in our CDOs. We also have the following recourse debt excluding our trust preferred; 52 million financing non-agency real estate securities loans and properties and 16 million financing manufactured housing loans. You can find the required amortization of the 68 million of debt in our press release and 10-Q. Additionally, we have $44 million of 30-day repo financing collateralized by Freddie Mac or agency securities. Effective June 30, we limited our future funding obligation to a construction loan and currently have no other recourse obligations other than what I just mentioned. Now onto our financial results for this quarter. As we stated in our press release, we had a GAAP loss of $0.90 per share. Let me explain the components of that. Our net interest income less our expenses and net of the accrued preferred dividends resulted in income of $21 million or $0.40 per share. I would like to point out that accretion in income was significantly lower than the first quarter due to increasing our basis at all of our non-impaired securities resulting from the adoption of FAS 115-2, which I will discuss in a moment. Additionally, in the quarter we had other income of $1.04 per share due to the following three items

[Operator:]

(Operator Instructions). Your first question comes from the line of Matthew Howlett with Fox-Pitt Kelton.

[Matthew Howlett:]

The achievement with the liquidity profile, you guys have come a long way. Getting to the press release, you mentioned the CDOs are remaining compliance or the ones that matter, but you said there was 1 billion of the CMBS and about a 100 million of ABS on watch for downgrade. Now I know S&P hasn’t really done anything (inaudible) Moody’s. But can you tell where the OC test would go, if let’s say weighting on the CMBS, which is BBB minus did that fell a notch or two notches? Is there a way to handicap that where it would go and how much you can offset it by purchasing other stuff at a discount?

[Kenn Riis:]

We expect a downgrade, especially the S&P downgrades to come in over the next two quarters or next six months or so. And I think it’s very difficult to try to gauge what those downgrades will be. And really until they materialize or the downgrades come through, we really don’t know what the impact will be. So really not in position today to speculate on that, and I don’ think it’s prudent for us to do so. We know it’s coming. We’re working on it, and over the next two quarters or so we’ll feel the effects of it, but I don’t want to speculate on what the outcome will be.

[Matthew Howlett:]

Fair enough. And then with half the CMBS is in ‘04 or earlier buckets and do you feel better about that given S&P sort of indicated that most of their downgrades are going to be ‘05 and later?

[Kenn Riis:]

Yes, and we’ll mitigate the extent that they get downgraded if they do get downgraded the (inaudible).

[Matthew Howlett:]

Okay, fair enough. And then, you’ve had some substantial prepayment activity over the last two quarters. I think you mentioned some of that was related to (inaudible) wireless deals they had been prepaying. I mean what’s the outlook, what have you seen in July and what’s the outlook here? I mean obviously you’d love to see it come in as long as with the CDO is still in the revolving period, you can put it back to work at deep discounts. Is there any guidance you can give us on that?

[Kenn Riis:]

Well, in the quarter we had a $124 million of pay-downs and so far in the second quarter we have a $108 million of pay-downs on our CDOs. So as a result, we have the $127 million of cash in our CDOs to reinvest and we’ll just take it as it comes. We’re not trying to predict, but we’ll (inaudible), but it’s been fairly consistent actually over the last few quarters, so we feel good about that.

[Matthew Howlett:]

Well, certainly you’ve kept the 100 million significant in the last month, I mean if that kept up that, that would to me that that sounds substantial. And then last question, I mean Brian this is maybe for you, what’s the level of loans or securities that are held that are unlevered in essence, that are outside of CDOs or outside the repo? What is that number? Is it significant? Is it meaningful?

[Brian Sigman:]

It’s not that large. I think you asked this actually last quarter. If you actually flip the Q, it’s pretty similar to last quarter as well and you go to our segment tables and we’ll file the Q on Monday, you can actually see exactly what we have broken out by segment.

[Operator:]

Your next question comes from the line of Joshua Barber with Stifel Nicolaus.

[Joshua Barber:]

Yeah, my questions have been answered, sorry.

[Operator:]

There are no further questions at this time. Gentlemen, do you have any further or closing remarks?

[Nadean Finke:]

Well, thanks everyone again for joining us this afternoon, and we really appreciate it. Thank you very much.

[Operator:]

This concludes today’s conference call. You may now disconnect.