February 26, 2009 - 7:05pm EST by
2009 2010
Price: 1.29 EPS -$2.68 NA
Shares Out. (in M): 105 P/E NA NA
Market Cap (in $M): 136 P/FCF NA NA
Net Debt (in $M): 12,019 EBIT 0 0
TEV ($): 12,155 TEV/EBIT NA NA

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iStar Financial is commercial mortgage REIT run by Jay Sugerman with two primary businesses:  a real estate lending business to developers and other real estate companies and a portfolio of owned real estate which they acquire in sale lease back transactions with major credit tenants (the Corporate Tennant Lease Portfolio).

iStar is currently under distress due to liquidity and credit issues but interesting opportunities exist in the common stock (7% of book), preferred debt (10-15% of liquidity pref), and unsecured bonds (trading at 30c to 80c on the dollar) because the company can create significant liquidity from its largely unencumbered asset/ unsecured liability balance sheet through a bank debt exchange currently being negotiated, because the company's portfolio is almopst all first liens or high credit sale lease back assets, and the ability to offset losses through gains from repurchases of unsecured bonds and repurchases of common stock.

iStar was able to report basically break even results in Q4 2008 despite $250 million of loan loss provisions and $150 million of impairments to other assets due to $323 million of gains from repurchases of unsecured bonds and $19 million of gains from sales of CTL assets.  Interestingly, iStar was able to increase book value per share during Q4 from $14.54 per share to $17.40 per share by repurchasing 26.7 million shares or 20.4% of the float.

iStar has a managed loan portfolio of $12.8 billion which is made up of $8.8 billion of loans originated by iStar and $4.0 billion of loans originated by Fremont.  iStar made an ill timed acquisition of Fremont's construction lending business in 2007.  iStar also has $3.04 billion of corporate tenant lease (CTL) assets and other investments of $447.3 million.

$3.5 billion of the company's loans are Non-performing:  $2.3 billion originated by iStar and $1.2 billion originated by Fremont.  Non-performing loans are made up of both loans not current with interest payments and loans which have maturity defaults.  The NPL portfolio increased $1 billion from Q3 2008.  iStar also has $1.3 billion of loans on its 'watch list', with $641.4 originated by iStar and $758.6 Fremont loans.  The watch list is down from $1.7 billion in Q3.

iStar has $977 million of credit support against its managed loan portfolio and CTL assets consisting of $800 million of specific reserves, $177 of general reserves, and $56 million remaining from the discount purchase of the Fremont portfolio.  91.5% of the company's asset base is made of up first mortgages, participations in first mortgages and CTL assets.  The weighted average LTV of the loan portfolio is 75.8%.

iStar has $1.2 billion of funding commitments remaining in 2009 and $1.3 billion of debt maturities; both daunting numbers.  The company expects $1.8 billion of loan repayments for the rest of 2009 down from an estimate of $3.3 billion on the Q3 call which was October 31st and $5.0 billion in the July Q2 call.  The company also is predicting $1.7 billion of proceeds from NPL resolutions for the rest of 2009 up from $500 million predicted on the Q3 call.  The company expects to end the year with $1 billion of liquidity which could be doubled if the bank debt exchange is closed.  Clearly, the company's credibility is at issue due to the significant increase in their expectations for NPL resolutions despite having achieved little todate ($18.5 million was sold in Q4).

That said, the bank deal would provide them with significant liquidity with which they can insist on better prices in asset sales, continue repurchasing debt at a significant discount and even repurchase additional equity to protect book value per share.

The bank deal will provide iStar with $700 million to $1 billion of additional bank loans.  iStar's unsecured bank lenders would agree to put up a new loan amounting to approximately 40% of their current commitment.  The new facility would receive a first lien and the existing bank lines would receive a second lien on a pool of unencumbered assets that would be valued at least at 120% of the combined first and second lien.  The banks would get their current lines bumped to L+150 from L+70 today and the new facility would receive L+250 and a 25bp fee.  The bank line's covenants would also be loosened, most importantly, the Tangible net worth covenant would be lowered to $1.5 billion from $2.3 billion today.  The new facility would mature in 2012 and the existing facilities would keep their 2011 and 2012 maturities.  The new bank agreements would also allow similar deals to be structured with the company's unsecured bond lenders.  I believe the further repurchase of stock would also be allowed.  The company currently has received commitments of $700 million and expects to close the transaction in mid March subject to customary closing conditions.  The bank deal getting done is a huge swing factor.

If the bank deal is completed, the company should have a $1.7 to $2.0 billion cushion above their projected cash flow needs, significant room to allow for the failure to sell NPLs on time or at expected values or for the failure of the repayments to come in on time or as currently projected.  The company's business is not shut down.  The managed portfolio generated $730 million of principal repayments during the fourth quarter when the capital markets where all but shut down (the company kept $404 million after its requirement to pass on 70% of repayments from the Fremont portfolio to CapitalSource until the $1.3 billion Fremont 'A' Note is repaid).   The company funded $683 million of loan commitments in Q4.

In summary, iStar is a distressed commercial mortgage REIT trading at 7% of book value per share because of bankruptcy concerns.  However, the company entered this credit crisis with primarily unencumbered assets and unsecured liabilities which afford it significant flexibility in managing through its problems.  A currently agreed but not closed bank debt exchange could provide significant liquidity and covenant relief and continued unsecured bond and common stock purchases could allow the company to offset losses to book value and book value per share respectively.

The preferred shares are also attractive trading at 10-15% of their liquidation preference.  They are protected by $1.84 billion of common equity, $977 million of reserves, and $295 of impairments on a managed portfolio of $16.3 billion or almost 20% of the entire portfolio which has many high quality assets and is 91.5% first mortgages.

The unsecured bonds trade between 30c and 89c on the dollar depending on coupon and maturity.  The company repurchased $636 million of its unsecured bonds in the fourth quarter of 2008.



The catalysts for value are the closing of the bank debt exchange in by mid March, the company's ability to convert its significant NPL assets to cash (would require the return of some liquidity for distressed commercial real estate assets bringing vulture buyers and NPL sellers to an actual trade), pick up in demand for residential real estate which would speed the conversion of the company's borrowers' significant completed condo and WIP condo inventory to be sold, continued success by the company in offsetting losses by repurchasing unsecured bonds at attractive discounts or buying common stock at fire sale prices.  A short squeeze is also possible as these developments progress as the Short Interest is currently 21.5% of the float; the ratio may increase if the company continues to repurchase stock (20% of float repurchased in Q4).  Also, further debt restructurings of either the Fremont 'A' note with CapitalSource or providing unsecured bonds with security in exchange for some concession could improve the company's positioning as it navigates this difficult environment.

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