Can Capital Trust's Results Be For Real?

Update: CT filed its 10-K this morning. CT had a $19.6 million unrealized loss on derivatives. Even more troubling, "At December 31, 2007, 58 CMBS investments with an aggregate carrying value of $618.4 million were carried at values in excess of their market values. Market value for these CMBS investments was $555.3 million at December 31, 2007." None of that loss flowed through the income statement.

Capital Trust (CT) reported fourth-quarter GAAP earnings of $1.62 per diluted share, blowing away consensus estimates of $1.00/share. On a GAAP basis, Capital Trust significantly outperformed competitors CapitalSource (CSE) and iStar Financial (SFI), both of whom reported quarterly losses.

In all fairness, Capital Trust has a history of solid operating performance and has delivered good risk-adjusted returns. Unsuspecting shareholders, however, may not be hearing the whole story - at least not until CT files its 10-K next Friday.

CMBS exposure has raised concerns for the investment banks, and spreads on the CMBX are hitting record territory day after day. Yet CT reported no "other-than-temporary" impairment on its $877 million of mezzanine (BB+ and BBB- rated) CMBS. Meanwhile, iStar took a $133 million charge for its corporate loan portfolio, but Capital Trust's income statement showed no such impairment charges.

What about derivative losses? CapitalSource took an enormous charge for loss on its derivative contracts, but again, Capital Trust's income statement is silent on the issue. The income statement does, however, include a one-time gain on the sale of an equity method investment, which provided for more than half of CT's quarterly net income.

A careful review of Capital Trust's balance sheet shows that the accumulated comprehensive income swung by $16.5 million, presumably as a result of an increase in unrealized losses. When combined with the one-time gain of $15.1 million on investment sales, Capital Trust could have swung to a fourth-quarter loss of $3 million for the quarter.

CT's accounting appears to be within the boundaries of GAAP, and the Company continues to operate with relatively low leverage compared to its peers. Nonetheless, it's hard to believe that Capital Trust believes it could fully recover the carrying value of its loan and CMBS portfolios in the current credit environment.

Commercial Stars Continue to Shine

Two outstanding companies in the commercial origination sector, iStar Financial (SFI) and Capital Trust (CT), both reported solid Q3 results today. iStar's results were a bit more muddied due to the Fremont acquisition closing in July, but adjusted earnings came in two pennies better than expected. Capital Trust posted GAAP earnings in-line with expectations.

Both companies continue to progress solidly despite the credit turmoil, with iStar even raising its dividend to $0.87/share, despite cutting its adjusted earnings forecast. Although iStar did not suffer too much from valuation adjustments this quarter, I believe we are beginning to see a similar trend of taxable income far outpacing GAAP results, even in the CRE mREITs.

I look for the commercial market to slow at a more gradual pace than the sudden bursting of the residential balloon. Let's hope both Capital Trust and iStar have made the right moves to weather the downturn.