Mortgage REIT Insider: Loan Losses Hit Hard as CRE Bust Looms
Higher-than-expected loan loss provisions pummeled shares of the commercial mortgage REIT sector this past week. Capital Trust, Inc. (CT) recently posted an unexpected loss of $1.59/share for the second quarter and adjusted income of $0.73/share, well short of the $0.84/share earnings consensus. CT's shocking loss came courtesy of a net $50 million exposure to mezzanine loans secured by Harry Macklowe-owned office buildings in Manhattan, which it no longer believes it will be able to recover. Jefferies & Co. downgraded shares of Capital Trust to hold from a previous buy rating following the company's second-quarter loss, as they believe CT is in the early stages of a larger credit cycle for commercial real estate. Shares of Capital Trust fell 14 percent on Wednesday to a new multi-year low. Not helping matters any was a report from Fitch Ratings that suggested defaults on commercial mortgage-backed securities may more than quadruple from their current levels, as the U.S. economy continues to deteriorate and commercial mortgage deals written at the height of the bubble get hit hard. iStar Financial Inc. (SFI) fared little better. Although iStar had preannounced lower-than-expected second quarter earnings, the company’s revised full-year outlook was much worse than anticipated: iStar now predicts that it will post a full-year loss for 2008, primarily as a result of a massive increase in loan loss provisions. During the second quarter, the company recorded $276.7 million in loan loss provisions, including $60.0 million of general provisions and $216.7 million of asset specific provisions, nearly doubling the total reserve for potential loan losses. iStar also announced plans to slash its dividend by 60 percent from $0.87/share to just $0.30 - $0.40/share for the third quarter, as gains from asset sales were unable to fully offset a reduced earnings outlook. Nonetheless, shares of iStar rose sharply despite the sour outlook, after the company said it is not in danger of breaching its loan covenants in the short term, nor did it expect to have to raise additional debt or equity this year or in 2009. RAIT Financial Trust (RAS), on the other hand, posted another comeback quarter. The company generated adjusted earnings of $0.54/share for the quarter, well ahead of the $0.46/share dividend and a dime above consensus estimates. Despite the rosy earnings, however, RAIT’s net investment income was well below consensus due to a $25 million addition to loan loss provisions; the charge effectively doubled RAIT’s total provision for loan loss exposure. GAAP earnings were $1.83/share for the quarter, but most of these earnings were driven by a net $97 million gain on marks for RAIT’s CDO liabilities. Economic book value, however, climbed sharply during the period. At June 30, RAIT’s economic book value was $13.90/share -- almost double the share price of the company’s common stock. Shares of RAIT rallied on the results, climbing more than 5 percent in early trading on Friday. Agency earnings – almost there Most of the agency mREITs reported second quarter earnings this week, with most of them just missing consensus expectations due to a reduction in leverage during the quarter. Spreads for the legacy agency mREITs remained strong at 185 – 200 basis points for most of the sector, although Capstead Mortgage Corp. (CMO) cautioned that it sees spreads coming down about twenty basis points during the third quarter, as its short duration ARM assets reset downward. On the other end of the spectrum, American Capital Agency (AGNC) reported a net interest margin of 3.15 percent due to its 100 percent investment in fixed-rate assets, though about a third of its portfolio is hedged with interest rate swaps. The biggest winner during the week was likely Hatteras Financial Corp. (HTS), which posted a 2.33 percent net interest margin on its $5.1 billion portfolio of hybrid ARM assets. GAAP earnings were $0.88/share, which misses consensus estimates by $0.02 but significantly exceeded the $0.75/share second quarter dividend. Hatteras shares spiked on the results Wednesday, but were unable to hold on to their gains. Editor’s note: Patrick Harden is a Certified Public Accountant with three years of experience in auditing publicly-traded real estate investment trusts. For the past two years, he has been involved in the mortgage finance industry as a member of the financial reporting group at a publicly-traded mortgage bank. His column covering mortgage REITs runs every Friday. Disclosure: The author was long shares of SFI, RAS when this story was published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.