Earnings Roundup - Thursday Edition

Chimera Investment Corp (CIM) reported core earnings for the period commencing November 21 and ending December 31, 2007 of $1.3 million or $0.03 per average share. The Company reported a GAAP loss for the period commencing November 21 and ending December 31, 2007 of $2.9 million or $0.08 per average share. The difference between the Company’s Core Earnings and GAAP results is related to the Company’s unrealized losses on interest rate swaps at December 31, 2007 - meaning the Company is not designating its hedges under FAS 133.

Capstead Mortgage (CMO) reported net income of $15,860,000 for the quarter ended December 31, 2007 compared to net income of $2,350,000 for the fourth quarter of 2006. After considering preferred share dividends, the Company earned $0.31 per diluted common share for the fourth quarter of 2007 compared to a loss of $0.14 per diluted common share for the fourth quarter of 2006. Not surprisingly, Capstead's results benefitted from several accretive equity raises and aggressive Fed rate cuts.

BRT Realty Trust (BRT) announced its results of operations for the first quarter of its fiscal year. For the three months ended December 31, 2007, BRT reported total revenues of $7,508,000 and net income of $3,230,000, or $.28 per share on a diluted basis. For the three months ended December 31, 2006, total revenues, net income and net income per share on a diluted basis were $12,745,000, $8,289,000 and $.95 per share, respectively. BRT's results suffered as a result of a decrease in interest and fee income on outstanding loans. The decrease in interest on loans was due to (i) a decline in the average balance of loans outstanding, (ii) the increase in non-earning loans, and (iii) a decline in the rate earned on the portfolio. During the quarter ended December 31, 2007 two loans, aggregating $18,700,000, became non-earning.

What's Buried in BRT's 10-K?

I found a few interesting snippets from BRT's recently filed 10-K that make me wonder just how safe a business BRT is in:

When we invest in junior mortgage loans, junior participations in existing loans or mezzanine loans, the collateral securing our loan is subordinate to the liens of senior mortgages or senior participations. At September 30, 2007, approximately 6% of our real estate mortgages, or $14 million in principal amount, were represented by junior mortgages, junior participations or mezzanine loans. In certain cases, we may find it advisable to make additional payments in order to maintain the current status of prior liens or to discharge them entirely or to make working capital advances to support current operations. It is possible that the amount which may be recovered by us in cases in which we hold a junior position may be less, or significantly less, than our total investment, less allowances for possible loan losses.

We make loans to multiple borrowing entities that are controlled by the same individual. At September 30, 2007, we had six loans outstanding with an aggregate principal amount of $64.0 million to six borrowing entities controlled by one individual. In fiscal 2007 loans to borrowing entities controlled by this individual accounted for approximately 51% of the loans originated by us and 34.1% of loans originated by us and the CIT joint venture. The individual controlling these borrowing entities became incapacitated in May 2007, is not able to manage his business or to make business decisions and is not expected to be actively engaged in business in the future and, therefore, neither he nor any entity controlled by him is expected to obtain any additional loans from us. A guardian appointed by the Court to oversee the affairs of this individual and the management group of our borrowers are seeking to complete an orderly sale of the assets securing our loans.

For tax purposes, we report on a calendar year basis. For financial reporting purposes our fiscal year is September 30th. We distributed substantially all of our taxable income for calendar 2006 by October 2007. We estimate taxable income for calendar 2007 will be approximately $39.7 million, of which approximately $20.6 million is expected to represent capital gain income.

Let's do some quick math. Only $19.1 million of expected taxable income is sustainable ordinary income from business activities. That level of taxable income only supports a quarterly dividend of $0.39/share. Therefore BRT will have to continue selling assets to maintain its dividend, which represents an unsustainable long-term strategy.

With lowered originations, shaky second liens, and a concentration of credit risk in loans whose collateral is being liquidated regardless of market conditions, BRT's future doesn't seem very bright.

More Bad News at BRT

Two weeks ago, I wondered if trouble was brewing at BRT Realty Trust (BRT). In an after-hourse press release on Monday, BRT confirmed that the news was indeed pretty bad.

In its September 10, 2007 release, the company estimated that it would have $55,858,000 of non-earning loans at September 30, 2007. The company now expects that $63,627,000 of its first-lien mortgages will be categorized as non-earning at September 30, 2007. That means that 25.5% of its gross loan portfolio is in some way not performing.

BRT admitted that "[i]n connection with its year end audit, the company...expects to take an [additional] allowance for loan losses of $8,300,000..." The amount is shockingly high as compared to the prior year, when there was no provision for loan losses. Another marked change to the balance sheet is the presence of REO. BRT expects to have REO of $9.3 million at September 30, with another seven foreclosures totalling $63.6 million in process.

While the loan loss provisions will not impact taxable income, the foreclosures will translate into realized losses during BRT's fiscal 2008. Those losses will limit taxable income going forward, so while BRT may pay a $0.62/share dividend for the fourth quarter of 2007, its dividend will come into question for fiscal 2008 and beyond.

Trouble Brewing at BRT?

BRT Realty Trust (BRT), a short-term commercial-focused lender, is the only mREIT the author knows that has a fiscal year-end not on December 31. BRT's fiscal year-end is September 30 - thus the company's 10-K is not due until December 14. However, an early September disclosure combined with the downward adjustments normally resulting from a year-end audit make me wonder if trouble is brewing at BRT.

BRT Realty Trust focuses on making subprime and hard money bridge loans to commercial projects - retail spaces and condo conversions, for example. These bridge loans carry a high interest rate and typically payoff quickly, as they are only a temporary source of financing. In the past, this quick turnover has offset the credit quality of the loans, as they matured quickly enough to prevent losses.

In early September, however, BRT reported that 21.6% of its loan portfolio will be classified as non-earning assets, which will reduce interest and other revenue by $1.8 million. What BRT didn't disclose is the amount of additional loan loss reserves it will need to take against these assets. As of June 30, the loan loss reserve against non-earning assets was approximately 7% of those non-earning assets. I believe BRT will need to bump this provision up to 10% of non-earning assets. Based on the press release figure of $55.858 million, BRT will need to record a current period provision of $3.917 million. An additional $3.917 million in ALLL plus the loss of $1.881 million in Q4 revenue plus additional $0.248 million in expected reduction in equity income yields a hit to income of about $6.0 million.

That $6.0 million would have been enough to push BRT into the red before accounting for the sale of its highly-appreciated stake in Entertainment Properties Trust (EPR). We'll see if BRT sells additional amounts in EPR for the fourth quarter to preserve positive net income. The remaining EPR stake could still be monetized for a gain of about $25 million.

Overall, BRT is trading at about 76% of book value, but lacking additional gains from appreciation in EPR and the likelihood of a loss from core operations, I expect to see book value fall to near market levels in the short-term.