UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2012

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-34436

 


 

Starwood Property Trust, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland

 

27-0247747

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

591 West Putnam Avenue

 

 

Greenwich, Connecticut

 

06830

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:

(203) 422-8100

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer, large accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

The number of shares of the issuer’s common stock, $0.01 par value, outstanding as of November 6, 2012 was 135,290,351.

 

 

 



 

Special Note Regarding Forward Looking Statements

 

This Quarterly Report on Form 10-Q contains certain forward-looking statements, including without limitation, statements concerning our operations, economic performance and financial condition. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are developed by combining currently available information with our beliefs and assumptions and are generally identified by the words “believe,” “expect,” “anticipate” and other similar expressions. Forward-looking statements do not guarantee future performance, which may be materially different from that expressed in, or implied by, any such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date made.

 

These forward-looking statements are based largely on our current beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us or within our control, and which could materially affect actual results, performance or achievements. Factors that may cause actual results to vary from our forward-looking statements include, but are not limited to:

 

·                  factors described in our Annual Report on Form 10-K for the year ended December 31, 2011 and in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2012, June 30, 2012 and September 30, 2012, including those set forth under the captions “Risk Factors” and “Business”;

 

·                  defaults by borrowers in paying debt service on outstanding items;

 

·                  impairment in the value of real estate property securing our loans;

 

·                  availability of mortgage origination and acquisition opportunities acceptable to us;

 

·                  potential mismatches in the timing of asset repayments and the maturity of the associated financing agreements;

 

·                  national and local economic and business conditions;

 

·                  general and local commercial real estate property conditions;

 

·                  changes in federal government policies;

 

·                  changes in federal, state and local governmental laws and regulations;

 

·                  increased competition from entities engaged in mortgage lending;

 

·                  changes in interest rates;

 

·                  changes in the exchange rates between the U.S. dollar and the respective currencies for our non-dollar denominated investments; and

 

·                  the availability of and costs associated with sources of liquidity.

 

In light of these risks and uncertainties, there can be no assurances that the results referred to in the forward-looking statements contained in this Quarterly Report on Form 10-Q will in fact occur. Except to the extent required by applicable law or regulation, we undertake no obligation to, and expressly disclaim any such obligation to, update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, changes to future results over time or otherwise.

 

2



 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Balance Sheets

(Unaudited, amounts in thousands, except share and per share data)

 

 

 

As of
September 30, 2012,

 

As of
December 31, 2011,

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

144,199

 

$

114,027

 

Loans held for investment

 

2,580,789

 

2,268,599

 

Loans held-for-sale at fair value

 

 

128,593

 

Loans transferred as secured borrowings

 

86,021

 

50,316

 

Mortgage-backed securities, available-for-sale, at fair value

 

866,865

 

341,734

 

Other investments

 

75,750

 

44,379

 

Accrued interest receivable

 

18,314

 

15,176

 

Derivative assets

 

11,024

 

12,816

 

Other assets

 

22,385

 

21,807

 

Total Assets

 

$

3,805,347

 

$

2,997,447

 

Liabilities and Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable and accrued expenses

 

$

8,869

 

$

5,051

 

Related-party payable

 

12,545

 

8,348

 

Dividends payable

 

51,629

 

41,431

 

Derivative liabilities

 

25,591

 

19,652

 

Secured financing agreements, net

 

1,309,450

 

1,103,517

 

Loan transfer secured borrowings

 

88,268

 

53,199

 

Other liabilities

 

7,757

 

1,102

 

Total Liabilities

 

1,504,109

 

1,232,300

 

Commitments and contingencies (Note 14)

 

 

 

 

 

Equity:

 

 

 

 

 

Starwood Property Trust, Inc. Stockholders’ Equity:

 

 

 

 

 

Preferred stock, $0.01 per share, 100,000,000 shares authorized, no shares issued and outstanding

 

 

 

Common stock, $0.01 per share, 500,000,000 shares authorized, and 117,516,201 issued and 116,890,351 outstanding as of September 30, 2012 and 93,811,351 issued and 93,185,501 outstanding as of December 31, 2011

 

1,175

 

938

 

Additional paid-in capital

 

2,297,971

 

1,828,319

 

Treasury stock (625,850 shares as of September 30, 2012 and December 31, 2011, respectively)

 

(10,642

)

(10,642

)

Accumulated other comprehensive income (loss)

 

62,183

 

(3,998

)

Accumulated deficit

 

(54,938

)

(55,129

)

Total Starwood Property Trust, Inc. Stockholders’ Equity

 

2,295,749

 

1,759,488

 

Non-controlling interests in consolidated subsidiaries

 

5,489

 

5,659

 

Total Equity

 

2,301,238

 

1,765,147

 

Total Liabilities and Equity

 

$

3,805,347

 

$

2,997,447

 

 

See notes to condensed consolidated financial statements.

 

3



 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Operations

(Unaudited, amounts in thousands, except per share data)

 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net interest margin:

 

 

 

 

 

 

 

 

 

Interest income from mortgage-backed securities

 

$

16,585

 

$

6,195

 

$

40,404

 

$

20,176

 

Interest income from loans

 

56,261

 

51,879

 

179,078

 

125,643

 

Interest expense

 

(12,030

)

(7,321

)

(34,345

)

(21,723

)

Net interest margin

 

60,816

 

50,753

 

185,137

 

124,096

 

Expenses:

 

 

 

 

 

 

 

 

 

Management fees (including $4,097 and $2,922 for the three months ended September 30, 2012 and 2011 and $11,926 and $10,268 for the nine months ended September 30, 2012 and 2011 of non-cash stock-based compensation)

 

14,659

 

10,004

 

42,673

 

29,014

 

Acquisition and investment pursuit costs

 

622

 

1,201

 

2,737

 

1,820

 

General and administrative (including $139 and $69 for the three months ended September 30, 2012 and 2011 and $370 and $164 for the nine months ended September 30, 2012 and 2011 of non-cash stock-based compensation)

 

3,084

 

2,177

 

8,838

 

7,041

 

Total expenses

 

18,365

 

13,382

 

54,248

 

37,875

 

Income before other income (expense) and income taxes

 

42,451

 

37,371

 

130,889

 

86,221

 

Interest income from cash balances

 

66

 

63

 

180

 

326

 

Other income (expense)

 

621

 

975

 

2,923

 

1,422

 

Other-than-temporary impairment (“OTTI”), net of $61 and $435 recognized in other comprehensive income (loss) for the three months ended September 30, 2012 and 2011 and $2,854 and $435 for the nine months ended September 30, 2012 and 2011

 

(676

)

(892

)

(2,728

)

(2,621

)

Net gains on sales of investments

 

9,017

 

4,961

 

19,147

 

20,836

 

Net realized foreign currency gains (losses)

 

(337

)

(61

)

8,515

 

(63

)

Net gains (losses) on currency derivatives

 

(7,510

)

8,617

 

(10,392

)

2,382

 

Net gains (losses) on interest rate derivatives

 

(51

)

(19,171

)

608

 

(25,982

)

Net gains on credit derivatives

 

 

2,259

 

 

3,730

 

Net change in unrealized gains (losses) on loans held-for-sale at fair value

 

 

(10,679

)

(5,760

)

(1,725

)

Unrealized foreign currency remeasurement gains (losses)

 

7,062

 

(9,403

)

2,707

 

(4,245

)

Income before income taxes

 

50,643

 

14,040

 

146,089

 

80,281

 

Income tax provision (benefit)

 

301

 

(463

)

840

 

741

 

Net Income

 

50,342

 

14,503

 

145,249

 

79,540

 

Net income attributable to non-controlling interests

 

(130

)

(25

)

(388

)

(1,191

)

Net income attributable to Starwood Property Trust, Inc.

 

$

50,212

 

$

14,478

 

$

144,861

 

$

78,349

 

Net income per share of common stock:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.43

 

$

0.16

 

$

1.34

 

$

0.95

 

Diluted

 

0.43

 

0.15

 

1.34

 

0.94

 

 

 

 

 

 

 

 

 

 

 

Distributions declared per common share

 

$

0.44

 

$

0.44

 

$

1.32

 

$

1.30

 

 

See notes to condensed consolidated financial statements.

 

4



 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Comprehensive Income

(Unaudited, amounts in thousands)

 

 

 

For the Three Months
Ended September 30,

 

For the Nine Months
Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net Income

 

$

50,342

 

$

14,503

 

$

145,249

 

$

79,540

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Change in fair value of cash flow hedges

 

(411

)

(17

)

(1,623

)

14

 

Unrealized gain (loss) in fair value of available-for-sale securities

 

47,895

 

(15,819

)

64,307

 

(11,137

)

Reclassification adjustment for net realized gains (losses) on sale of securities

 

1,736

 

 

769

 

(10,305

)

Reclassification for OTTI

 

676

 

892

 

2,728

 

2,621

 

Comprehensive income (loss)

 

100,238

 

(441

)

211,430

 

60,733

 

Less: Comprehensive income attributable to non-controlling interests

 

(130

)

(25

)

(388

)

(52

)

Comprehensive income (loss) attributable to Starwood Property Trust, Inc.

 

$

100,108

 

$

(466

)

$

211,042

 

$

60,681

 

 

See notes to condensed consolidated financial statements.

 

5



 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statement of Equity

(Unaudited, amounts in thousands, except share data)

 

 

 

Common Stock

 

Additional

 

 

 

 

 

 

 

Accumulated
Other
Comprehensive

 

Total
Starwood
Property
Trust, Inc.

 

Non-

 

 

 

 

 

 

 

Par

 

Paid-In

 

Treasury Stock

 

Accumulated

 

Income

 

Stockholders’

 

Controlling

 

Total

 

 

 

Shares

 

Value

 

Capital

 

Shares

 

Amount

 

Deficit

 

(Loss)

 

Equity

 

Interests

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2012

 

93,811,351

 

$

938

 

$

1,828,319

 

625,850

 

$

(10,642

)

$

(55,129

)

$

(3,998

)

$

1,759,488

 

$

5,659

 

$

1,765,147

 

Proceeds from public offering of common stock

 

23,000,000

 

230

 

457,091

 

 

 

 

 

 

 

 

 

457,321

 

 

 

457,321

 

Underwriting and offering costs

 

 

 

 

 

(2,250

)

 

 

 

 

 

 

 

 

(2,250

)

 

 

(2,250

)

Stock-based compensation

 

584,427

 

6

 

12,290

 

 

 

 

 

 

 

 

 

12,296

 

 

 

12,296

 

Manager incentive fee paid in stock

 

120,423

 

1

 

2,521

 

 

 

 

 

 

 

 

 

2,522

 

 

 

2,522

 

Treasury stock purchased

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

144,861

 

 

 

144,861

 

388

 

145,249

 

Dividends declared, $1.32 per share

 

 

 

 

 

 

 

 

 

 

 

(144,670

)

 

 

(144,670

)

 

 

(144,670

)

Other comprehensive income, net

 

 

 

 

 

 

 

 

 

 

 

 

 

66,181

 

66,181

 

 

 

66,181

 

Distribution to non-controlling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(558

)

(558

)

Balance, September 30, 2012

 

117,516,201

 

$

1,175

 

$

2,297,971

 

625,850

 

$

(10,642

)

$

(54,938

)

$

62,183

 

$

2,295,749

 

$

5,489

 

$

2,301,238

 

 

See notes to condensed consolidated financial statements

 

6



 

Starwood Property Trust, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited, amounts in thousands)

 

 

 

For the Nine Months ended
September 30,

 

 

 

2012

 

2011

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net income

 

$

145,249

 

$

79,540

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Amortization of deferred financing costs

 

3,896

 

2,390

 

Accretion of net discount on mortgage-backed securities

 

(25,064

)

(12,452

)

Accretion of net deferred loan fees and discounts

 

(35,026

)

(18,461

)

Amortization of premium from collateralized debt obligations

 

(669

)

(665

)

Stock-based compensation

 

12,296

 

10,432

 

Incentive-fee compensation

 

2,522

 

1,206

 

Gain on sale of available-for-sale securities

 

(12,097

)

(10,472

)

Gain on sale of loans

 

(7,177

)

(10,337

)

Gain on foreign currency remeasurement

 

(8,809

)

 

Gain on sale of other investments

 

 

(27

)

Net change in unrealized (gains) losses on loans held-for-sale at fair value

 

5,760

 

1,725

 

Unrealized (gains) losses on interest rate hedges

 

(9,991

)

11,099

 

Unrealized gains on credit hedges

 

 

(161

)

Unrealized (gains) losses on currency hedges

 

13,319

 

(2,674

)

Unrealized foreign currency remeasurement losses (gains)

 

(2,707

)

4,245

 

OTTI

 

2,728

 

2,621

 

Changes in operating assets and liabilities:

 

 

 

 

 

Related-party payable

 

4,197

 

2,704

 

Accrued interest receivable, less purchased interest

 

(5,280

)

(8,034

)

Other assets

 

5,819

 

(6,221

)

Accounts payable and accrued expenses

 

3,818

 

(345

)

Other liabilities

 

6,655

 

732

 

Origination of held-for-sale loans

 

 

(270,066

)

Proceeds from sale of held-for-sale loans

 

132,012

 

294,149

 

Net cash provided by operating activities

 

231,451

 

70,928

 

Cash Flows from Investing Activities:

 

 

 

 

 

Purchase of mortgage-backed securities

 

(575,690

)

(187,133

)

Proceeds from sale of mortgage-backed securities

 

199,510

 

283,778

 

Proceeds from mortgage-backed securities maturities

 

 

11,765

 

Mortgage-backed securities principal repayments

 

67,452

 

94,827

 

Origination and purchase of loans held for investment

 

(942,692

)

(1,018,480

)

Loan maturities

 

460,789

 

264,615

 

Proceeds from sale of loans held for investment

 

28,740

 

5,000

 

Loan investment principal repayments

 

33,518

 

13,092

 

Purchased interest on investments

 

(638

)

(915

)

Purchase of other investments

 

(30,496

)

(37,088

)

Return of investment from other investments

 

892

 

235

 

Proceeds from sale of other investments

 

874

 

2,844

 

Return of investment basis in purchased derivative asset

 

2,780

 

 

Purchase of treasury securities

 

 

(112,619

)

Proceeds from sale of treasury securities

 

 

112,741

 

Cash deposited as collateral under treasury securities loan agreement

 

 

(112,741

)

Return of collateral under treasury securities loan agreement

 

 

112,741

 

Net cash used in investing activities

 

(754,961

)

(567,338

)

Cash Flows from Financing Activities:

 

 

 

 

 

Borrowings under secured financing agreements

 

1,370,306

 

1,016,488

 

Principal repayments on borrowings under secured financing arrangements

 

(1,164,373

)

(991,812

)

Proceeds from secured borrowings

 

35,738

 

 

Payment of deferred financing costs

 

(8,029

)

(2,192

)

Proceeds from common stock offering

 

457,321

 

476,740

 

Payment of underwriting and offering costs

 

(2,250

)

(28,287

)

Treasury stock purchased

 

 

(5,981

)

Payment of dividends

 

(134,473

)

(101,298

)

Distributions to non-controlling interest owners

 

(558

)

(9,267

)

Net cash provided by financing activities

 

553,682

 

354,391

 

Net increase (decrease) in cash and cash equivalents

 

30,172

 

(142,019

)

Cash and cash equivalents, beginning of period

 

114,027

 

226,854

 

Cash and cash equivalents, end of period

 

$

144,199

 

$

84,835

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

34,640

 

$

19,475

 

Income taxes paid

 

$

990

 

$

1,074

 

Supplemental disclosure of non-cash financing activity:

 

 

 

 

 

Dividends declared, but not yet paid

 

$

51,629

 

$

41,556

 

 

See notes to condensed consolidated financial statements.

 

7



 

Starwood Property Trust, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements

 

As of September 30, 2012

(Unaudited)

 

1. Business and Organization

 

Starwood Property Trust, Inc. (“the Trust” together with its subsidiaries, “we” or the “Company”) is a Maryland corporation that commenced operations on August 17, 2009 (“Inception”) upon the completion of its initial public offering (“IPO”).  We are focused on originating, investing in, financing and managing commercial mortgage loans and other commercial real estate debt investments, commercial mortgage-backed securities (“CMBS”), and other commercial real estate-related debt investments.  We collectively refer to commercial mortgage loans, other commercial real estate debt investments, CMBS, and other commercial real estate-related debt investments as our target assets.  We also invest in residential mortgage-backed securities (“RMBS”) and residential REO, and may invest in distressed or non-performing loans, commercial properties subject to net leases and residential mortgage loans.  As market conditions change over time, we may adjust our strategy to take advantage of changes in interest rates and credit spreads as well as economic and credit conditions.

 

We are organized and conduct our operations such that the Trust qualifies as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As such, the Trust will generally not be subject to U.S. federal corporate income tax on that portion of net income that is distributed to stockholders if we distribute at least 90% of our taxable income to our stockholders by prescribed dates and comply with various other requirements.

 

We are organized as a holding company that conducts our business primarily through four wholly-owned subsidiaries. In 2009, we formed joint ventures (the “Joint Ventures”) with Starwood Hospitality Fund II (“Hotel II”) and Starwood Opportunity Fund VIII (“SOF VIII”) in accordance with the co-investment and allocation agreement with SPT Management, LLC, our Manager (the “Manager”). The Joint Ventures are owned 75% (and controlled) by us and are therefore consolidated into our condensed consolidated financial statements. As of June 30, 2011, the last of the investments held by the Joint Ventures had been sold, and the entities were dissolved during the three months ended September 30, 2012.

 

As of September 30, 2012, investments with collateral in the hospitality, office, residential, and retail sectors represented 49.3%, 18.8%, 9.6%, and 8.8% of our investment portfolio, respectively. Such allocations could materially change in the future.

 

2. Summary of Significant Accounting Policies

 

Basis of Accounting and Principles of Consolidation

 

The accompanying unaudited condensed consolidated financial statements include our accounts and those of our consolidated subsidiaries. Intercompany amounts have been eliminated. All adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and changes in cash flow have been made. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.  The most significant and subjective estimate that we make is projecting the cash flows to be received on our investments, which has a significant impact on the amounts of interest income, credit losses (if any), and fair values that we record and/or disclose.  In addition, the fair value of financial instruments that are estimated using a discounted cash flows method are significantly impacted by the rates at which we estimate market participants would discount the cash flows.

 

A non-controlling interest in a consolidated subsidiary is defined as “the portion of the equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent”. Non-controlling interests are presented as a separate component of equity in the condensed consolidated balance sheets. In addition, the presentation of net income attributes earnings to controlling and non-controlling interests.

 

These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the period ended December 31, 2011, as filed with the Securities and Exchange Commission (“SEC”). In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the company’s financial position, results of operations and cash flows have been included.

 

8



 

Deferred Financing Costs

 

Costs incurred in connection with obtaining secured financing arrangements are capitalized and amortized over the initial terms of the respective facilities as a component of interest expense. As of September 30, 2012 and December 31, 2011, we had approximately $9.4 million and $5.0 million, respectively, of capitalized financing costs, net of amortization. For the three and nine months ended September 30, 2012, approximately $1.5 million and $3.9 million, respectively, of amortization was included in interest expense on the statement of operations. For the three and nine months ended September 30, 2011, approximately $1.0 million and $2.4 million, respectively, of amortization was included in interest expense on the statement of operations.

 

Income Taxes

 

The Trust has elected to be taxed as a REIT and intends to comply with the Code with respect thereto.  Accordingly, we will not be subject to federal income tax as long as certain asset, income, dividend distribution and stock ownership tests are met. Many of these requirements are technical and complex and if we fail to meet these requirements we may be subject to federal, state, and local income tax and penalties. In addition, a REIT’s income from prohibited transactions is subject to a 100% penalty tax. We have three taxable REIT subsidiaries (the “TRSs”) where certain investments may be made and activities conducted that (i) may have otherwise been subject to the prohibited transaction tax and (ii) may not be favorably treated for purposes of complying with the various requirements for REIT qualification.  The income, if any, within the TRSs is subject to federal and state income taxes as a domestic C corporation based upon the TRSs’ net income. For the three and nine months ended September 30, 2012, we recorded a provision for income taxes of $0.3 million and $0.8 million related to the activities in our TRSs.  These provisions were determined using a federal income tax rate of 34% and state income tax rate of 7.5%.  For the three and nine months ended September 30, 2011, we recorded an income tax benefit of $0.5 million and a provision for income taxes of $0.7 million related to the activities in our TRSs. These provisions were determined using a federal income tax rate of 34% and state income tax rate of 7.5%.

 

Underwriting Commissions and Offering Costs

 

Underwriting and offering costs related to our equity offering activities, which consist primarily of our equity offerings in April and early October 2012 as well as our at-the-market offering program (refer to disclosure in Note 10), aggregated $2.3 million during the nine months ended September 30, 2012.  We incurred approximately $1.1 million in connection with our equity offering in May 2011. Underwriting and offering costs are reflected as a reduction of additional paid-in capital in the consolidated statement of equity.

 

Recent Accounting Pronouncements

 

In December 2011, the FASB issued amended guidance which will enhance disclosures required by GAAP by requiring improved information about financial instruments and derivative instruments that are either (1) offset or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset. This information will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. We will be required to apply the amendments beginning with our first quarter, 2013 financial statements by providing the disclosures required by those amendments retrospectively for all comparative periods presented. We are in the process of evaluating the impact that this guidance will have on our financial statement disclosures.

 

3. Debt Securities

 

We classified all CMBS and RMBS investments as available-for-sale as of September 30, 2012 and December 31, 2011. The CMBS and RMBS classified as available-for-sale are reported at fair value in the balance sheet with changes in fair value recorded in accumulated other comprehensive (loss) income. The tables below summarize various attributes of our investments in mortgage-backed securities (“MBS”) available-for-sale as of September 30, 2012 and December 31, 2011 (amounts in thousands):

 

 

 

 

 

 

 

 

 

Unrealized Gains or (Losses) Recognized in Accumulated Other
Comprehensive Income (Loss)

 

 

 

September 30,
2012

 

Purchased
Amortized Cost

 

Credit
OTTI

 

Recorded
Amortized Cost

 

Non-Credit
OTTI

 

Unrealized
Gains

 

Unrealized
Losses

 

Net Fair Value
Adjustment

 

Fair Value

 

CMBS

 

$

498,740

 

$

 

$

498,740

 

$

 

$

30,225

 

$

 

$

30,225

 

$

528,965

 

RMBS

 

311,590

 

(8,585

)

303,005

 

(61

)

36,704

 

(1,748

)

34,895

 

337,900

 

Total

 

$

810,330

 

$

(8,585

)

$

801,745

 

$

(61

)

$

66,929

 

$

(1,748

)

$

65,120

 

$

866,865

 

 

9



 

September 30, 2012

 

Weighted
Average
Coupon (1)

 

Weighted
Average
Rating

 

Weighted
Average Life
(“WAL”)
(Years) (3)

 

Weighted
Average Yield (4)

 

CMBS

 

3.8

%

(2)

 

3.5

 

7.0

%

RMBS

 

1.5

%

B-

 

5.3

 

10.5

%

 


(1)         The weighted average coupon of the MBS is calculated as a fraction, with the numerator as the sum of (i) the stated interest rate for each individual security as of quarter-end, multiplied with (ii) the current face amount of each individual security, and the denominator as the sum of the total current face amount of the MBS. For floating rate MBS, the interest rate used is comprised of the stated spread plus the applicable LIBOR rate which is 0.21425%, as of September 30, 2012.

(2)         Includes a $425.2 million investment in senior securities that were not rated, that are secured by substantially all of the assets of a worldwide operator of hotels, resorts, and timeshare properties, and which had an estimated loan-to-value ratio as of September 30, 2012 in the range of 39%-44%. The remaining $103.8 million CMBS investment position is rated BB+.

(3)         Represents the WAL of each respective group of MBS. The WAL of each individual security is calculated as a fraction, the numerator of which is the sum of the timing (in years) of each expected future principal payment multiplied by the balance of the respective payment, and with the denominator equal to the sum of the expected principal payments. This calculation was made as of September 30, 2012. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the security.

(4)         Most of the CMBS and all of the RMBS were purchased at a discount, some of which will be accreted into income over the expected remaining life of the security.  The majority of the income from these securities is earned from the accretion of these discounts.

 

Within the hospitality sector, as of September 30, 2012 we had an aggregate investment of $425.2 million in senior debt secured by substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties. As of March 31, 2012 the debt investment was comprised of $115.5 million in loans and $387.6 million in securities. On April 16, 2012 the remaining $115.5 million of loans were converted to securities. On August 23, 2012 we sold $165.0 million of these CMBS resulting in a gain of $8.2 million. As of September 30, 2012, the aggregate face value of $426.5 million represented 5.8% of the total face value of this operator’s senior debt outstanding, and the aggregate carrying value of our investment represented 11.2% of our total assets.

 

 

 

 

 

 

 

 

 

Unrealized Gains or (Losses) Recognized in Accumulated Other
Comprehensive Income (Loss)

 

 

 

December 31,
2011

 

Purchased
Amortized Cost

 

Credit
OTTI

 

Recorded
Amortized Cost

 

Non-Credit
OTTI

 

Unrealized
Gains

 

Unrealized
Losses

 

Net Fair Value
Adjustment

 

Fair Value

 

CMBS

 

$

177,353

 

$

 

$

177,353

 

$

 

$

 

$

(567

)

$

(567

)

$

176,786

 

RMBS

 

170,424

 

(6,001

)

164,423

 

(1,310

)

3,367

 

(1,532

)

525

 

164,948

 

Total

 

$

347,777

 

$

(6,001

)

$

341,776

 

$

(1,310

)

$

3,367

 

$

(2,099

)

$

(42

)

$

341,734

 

 

December 31,
2011

 

Weighted
Average
Coupon(1)

 

Weighted
Average
Rating

 

WAL (3)

 

CMBS

 

2.1

%

(2)

 

3.5

 

RMBS

 

1.0

%

B-

 

4.8

 

 


(1)         The weighted average coupon of the MBS is calculated as a fraction, with the numerator as the sum of (i) the stated interest rate for each individual security as of quarter-end, multiplied with (ii) the current face amount of each individual security, and the denominator as the sum of the total current face amount of the MBS. For floating rate MBS, the interest rate used is comprised of the stated spread plus the greater of the applicable LIBOR rate at each respective quarter-end. The one-month LIBOR rate as of December 31, 2011 was 0.2953%.

(2)        Represents senior securities that were not rated, that are secured by substantially all of the assets of a worldwide operator of hotels, resorts, and timeshare properties, and which had an estimated loan-to-value ratio as of December 31, 2011 in the range of 39%-44%.

(3)         Represents the WAL of each respective group of MBS. The WAL of each individual security or loan is calculated as a fraction, the numerator of which is the sum of the timing (in years) of each expected future principal payment multiplied by the balance of the respective payment, and with the denominator equal to the sum of the expected principal payments. This calculation was made as of December 31, 2011. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the security.

 

10



 

During the nine months ended September 30, 2012, purchases and sales executed, as well as the principal payments received, were as follows (amounts in thousands):

 

 

 

RMBS

 

CMBS

 

Purchases

 

$

203,438

 

$

372,252

 

Sales/Maturities

 

26,049

 

173,461

 

Principal payments received

 

52,310

 

15,142

 

 

During the nine months ended September 30, 2012, we sold $165.0 million of CMBS resulting in a gain of $8.2 million. There have been no CMBS maturities during the nine months ended September 30, 2012.

 

During the nine months ended September 30, 2011, purchases and sales executed, as well as the principal payments received, were as follows (amounts in thousands):

 

 

 

RMBS

 

CMBS

 

Purchases

 

$

139,953

 

$

 

Sales/Maturities

 

49,951

 

223,378

 

Principal payments received

 

52,607

 

42,220

 

 

As of September 30, 2012, 80.4%, of the CMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 1.75%.  As of December 31, 2011, all of the CMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 1.75%.

 

Subject to certain limitations on durations, we have allocated an amount to invest in RMBS that cannot exceed 10% of our total assets. We have engaged a third party manager who specializes in RMBS to execute the trading of RMBS, the cost of which was $1.5 million and $0.5 million for the nine months ended September 30, 2012 and September 30, 2011, respectively, which has been recorded as an offset to interest income in the accompanying condensed consolidated statements of operations.  As of September 30, 2012, approximately $298.7 million, or 88.4%, of the RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 0.38%. As of December 31, 2011, approximately $154.7 million, or 93.8%, of the RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 0.43%.  We purchased all of the RMBS at a discount that will be accreted into income over the expected remaining life of the security. The majority of the income from this strategy is earned from the accretion of these discounts.

 

The following table presents the gross unrealized losses and estimated fair value of our securities that were in an unrealized loss position as of September 30, 2012 and for which OTTI charges have not been recognized in earnings, fully or partially (amounts in thousands):

 

 

 

Estimated Fair Value

 

Unrealized Losses

 

As of September 30, 2012

 

Securities with a loss
less
than 12 months

 

Securities with a loss
greater than 12 months

 

Securities with a loss
less than 12 months

 

Securities with a loss
greater than 12 months

 

CMBS

 

$

 

$

 

$

 

$

 

RMBS

 

17,826

 

854

 

(1,714

)

(34

)

Total

 

$

17,826

 

$

854

 

$

(1,714

)

$

(34

)

 

As of September 30, 2012 there were 11 securities with unrealized losses.  After evaluating each security we determined that the impairments on two of these securities, both of which are non-agency and whose impairments totaled $0.7 million, were other-than-temporary. All of this impairment was attributable to credit losses, which we calculated by comparing (i) the revised estimated future cash flows of each security discounted at the yield determined as of the initial acquisition date or, if since revised, as of the last date previously revised to (ii) our amortized cost basis.  For the three months ended September 30, 2012, our aggregate MBS credit losses (as reported in the condensed consolidated statement of operations) were $0.7 million.  We further determined that none of the nine remaining securities was other-than-temporarily impaired.  We considered a number of factors in reaching this conclusion, including that we did not intend to sell any individual security, it was not considered more likely than not that we would be forced to sell any individual security prior to recovering our amortized cost, and there were no material credit events that would have caused us to otherwise conclude that we would not recover our cost.  Significant judgment is required in projecting cash flows for our impaired RMBS, all of which were non-agency and none of which we expect to sell or be forced to sell before recovering our current cost basis. Actual cash flows income and/or realized impairments could be materially different from what is currently projected and/or reported.

 

11



 

The following table presents the gross unrealized losses and estimated fair value of our securities that were in an unrealized loss position as of December 31, 2011 and for which OTTI charges have not been recognized in earnings, fully or partially (amounts in thousands):

 

 

 

Estimated Fair Value

 

Unrealized Losses

 

As of December 31, 2011

 

Securities with a loss less
than 12 months

 

Securities with a loss
greater than 12 months

 

Securities with a loss
less than 12 months

 

Securities with a loss
greater than 12 months

 

CMBS

 

$

176,786

 

$

 

$

(567

)

$

 

RMBS

 

70,103

 

2,684

 

(2,444

)

(399

)

Total

 

$

246,889

 

$

2,684

 

$

(3,011

)

$

(399

)

 

As of December 31, 2011 there were 42 securities with unrealized losses. After evaluating each security we determined that the impairments on 25 of these securities, all of which are non-agency and whose impairments totaled $4.7 million, were other-than-temporary. Credit losses represented $3.4 million of this total, which we calculated by comparing (i) the revised estimated future cash flows of each security discounted at the yield determined as of the initial acquisition date or, if since revised, as of the last date previously revised, to (ii) our amortized cost basis. For the year ended December 31, 2011, our aggregate MBS credit losses (as reported in the statement of operations) were $6.0 million. We further determined that none of the 17 remaining securities were other-than-temporarily impaired. We considered a number of factors in reaching this conclusion, including that we did not intend to sell any individual security, it was not considered more likely than not that we would be forced to sell any individual security prior to recovering our amortized cost, and there were no material credit events that would have caused us to otherwise conclude that we would not recover our cost. Significant judgment is required in projecting cash flows for our non-agency RMBS. As a result, actual income and/or impairments could be materially different from what is currently projected and/or reported.

 

4. Loans

 

Our investments in loans held-for-investment are accounted for at amortized cost and the loans held-for-sale are accounted for at the lower of cost or fair value, unless we elect (upon origination or acquisition) to record such loans at fair value. The following table summarizes our investments in mortgages and loans by subordination class as of September 30, 2012 and December 31, 2011 (amounts in thousands):

 

September 30, 2012

 

Carrying
Value

 

Face Amount

 

Weighted
Average
Coupon (2)

 

Weighted
Average Life
(years) (3)

 

First Mortgages

 

1,362,605

 

1,402,755

 

6.5

 %

3.5

 

Subordinated Mortgages (1)

 

356,762

 

390,376

 

9.7

 %

4.2

 

Mezzanine Loans

 

861,422

 

885,450

 

8.6

 %

3.5

 

Total loans held for investment

 

2,580,789

 

2,678,581

 

 

 

 

 

Loans held in securitization trust

 

86,021

 

86,514

 

4.7

 %

3.5

 

Total loans

 

2,666,810

 

2,765,095

 

 

 

 

 

 

December 31, 2011

 

Carrying
Value

 

Face
Amount

 

Weighted
Average
Coupon (2)

 

Weighted
Average Life
(years) (3)

 

First mortgages

 

$

1,202,611

 

$

1,248,549

 

6.6

%

3.2

 

Subordinated mortgages (1)

 

437,163

 

487,175

 

7.4

%

4.1

 

Mezzanine loans

 

628,825

 

642,831

 

8.4

%

3.0

 

Total loans held for investment

 

2,268,599

 

2,378,555

 

 

 

 

 

First mortgages held-for-sale at fair value

 

128,593

 

122,833

 

5.9

%

8.9

 

Loans transferred as secured borrowings

 

50,316

 

50,632

 

5.0

%

3.7

 

Total Loans

 

$

2,447,508

 

$

2,552,020

 

 

 

 

 

 


(1)         Subordinated mortgages includes (i) subordinated mortgages that we retain after having sold first mortgage positions related to the same collateral, (ii) B-Notes, and (iii) subordinated loan participations.

 

(2)         The weighted average coupon of each respective group of loans is calculated as a fraction, with the numerator as the sum of (i) the stated interest rate for each individual loan as of quarter-end, converted to a 30/360 interest accrual basis, multiplied with (ii) the face amount of each individual loan, and the denominator as the sum of each respective group of loans. For floating rate loans, the interest rate used is comprised of the stated spread plus the greater of the (i) LIBOR floor or (ii) applicable LIBOR rate at each respective quarter-end.

 

12



 

(3)         Represents the WAL of each respective group of loans. The WAL is calculated as a fraction, the numerator of which is the sum of the timing (in years) of each expected future principal payment multiplied by the balance of the respective payment, and with the denominator equal to the sum of the expected principal payments. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the loan.

 

As of September 30, 2012, approximately $1.5 billion, or 56.7% of the loans were variable rate and pay interest at LIBOR plus a weighted-average spread of 5.45%. The following table summarizes our investments in floating rate loans (amounts in thousands):

 

 

 

September 30, 2012

 

December 31, 2011

 

Index

 

Rate

 

Carrying Value

 

Rate

 

Carrying Value

 

1 Month LIBOR

 

0.2143%

 

$

484,371

 

0.2953%

 

$

264,030

 

3 Month LIBOR

 

0.3585%

 

14,843

 

0.5810%

 

143,371

 

1 Month Citibank LIBOR(1)

 

0.2025%

 

101,448

 

0.2700%

 

134,041

 

3 Month Citibank LIBOR(1)

 

0.3475%

 

7,187

 

0.5600%

 

7,102

 

6 Month Citibank LIBOR(1)

 

0.6300%

 

 

0.7800%

 

6,039

 

LIBOR Floor

 

0.5%-2.00%

 

903,610

 

0.5% - 2.0%

 

551,275

 

Total

 

 

 

$

1,511,459

 

 

 

$

1,105,858

 

 


(1)         The Citibank LIBOR rate is equal to the rate per annum at which deposits in United States dollars are offered by the principal office of Citibank, N.A. in London, England to prime banks in the London interbank market.

 

We evaluate each of our loans for impairment at least quarterly.  Our loans are typically collateralized by real estate. As a result, we regularly evaluate the extent and impact of any credit deterioration associated with the performance and/or value of the underlying collateral property, as well as the financial and operating capability of the borrower. Specifically, a property’s operating results and any cash reserves are analyzed and used to assess (i) whether cash flow from operations is sufficient to cover the debt service requirements currently and into the future, (ii) the ability of the borrower to refinance the loan at maturity, and/or (iii) the property’s liquidation value. We also evaluate the financial wherewithal of any loan guarantors as well as the borrower’s competency in managing and operating the properties. In addition, we consider the overall economic environment, real estate sector, and geographic sub-market in which the borrower operates. Such impairment analyses are completed and reviewed by asset management and finance personnel who utilize various data sources, including (i) periodic financial data such as property operating statements, occupancy, tenant profile, rental rates, operating expenses, the borrower’s exit plan, and capitalization and discount rates, (ii) site inspections, and (iii) current credit spreads and discussions with market participants.

 

Our evaluation process as described above produces an internal risk rating between 1 and 5, which is a weighted-average of the numerical ratings in the following categories: (i) sponsor capability and financial condition, (ii) loan and collateral performance relative to underwriting, (iii) quality and stability of collateral cash flows, and (iv) loan structure. We utilize the overall risk ratings as a concise means to monitor any credit migration on a loan as well as on the whole portfolio.  While the overall risk rating is generally not the sole factor we use in determining whether a loan is impaired, a loan with a higher overall risk rating would tend to have more adverse indicators of impairment, and therefore would be more likely to experience a credit loss.  For any loans rated as a “5,” we would record a loan loss allowance in an amount equal to the greater of (i) 1.5% of the aggregate net carrying amount and (ii) the loss amount measured by the excess of the loan’s carrying amount over the estimated collateral value.

 

The rating categories generally include the characteristics described below, but these are utilized as guidelines and therefore not every loan will have all of the characteristics described in each category:

 

Rating

 

 

 

Characteristics

1

 

·

 

Sponsor capability and financial condition—Sponsor is highly rated or investment grade or, if private, the equivalent thereof with significant management experience.

 

 

·

 

Loan collateral and performance relative to underwriting—The collateral has surpassed underwritten expectations.

 

 

·

 

Quality and stability of collateral cash flows—Occupancy is stabilized, the property has had a history of consistently high occupancy, and the property has a diverse and high quality tenant mix.

 

 

·

 

Loan structure—Loan-to-collateral value ratio (“LTV”) does not exceed 65%. The loan has structural features that enhance the credit profile.

2

 

·

 

Sponsor capability and financial condition—Strong sponsorship with experienced management team and a responsibly leveraged portfolio.

 

 

·

 

Loan collateral and performance relative to underwriting—Collateral performance equals or exceeds underwritten expectations and covenants and performance criteria are being met or exceeded.

 

 

·

 

Quality and stability of collateral cash flows—Occupancy is stabilized with a diverse tenant mix.

 

13



 

 

 

·

 

Loan structure—LTV does not exceed 70% and unique property risks are mitigated by structural features.

3

 

·

 

Sponsor capability and financial condition—Sponsor has historically met its credit obligations, routinely pays off loans at maturity, and has a capable management team.

 

 

·

 

Loan collateral and performance relative to underwriting—Property performance is consistent with underwritten expectations.

 

 

·

 

Quality and stability of collateral cash flows—Occupancy is stabilized, near stabilized, or is on track with underwriting.

 

 

·

 

Loan structure—LTV does not exceed 80%.

4

 

·

 

Sponsor capability and financial condition—Sponsor credit history includes missed payments, past due payment, and maturity extensions. Management team is capable but thin.

 

 

·

 

Loan collateral and performance relative to underwriting—Property performance lags behind underwritten expectations. Performance criteria and loan covenants have required occasional waivers. A sale of the property may be necessary in order for the borrower to pay off the loan at maturity.

 

 

·

 

Quality and stability of collateral cash flows—Occupancy is not stabilized and the property has a large amount of rollover.

 

 

·

 

Loan structure—LTV is 80% to 90%.

5

 

·

 

Sponsor capability and financial condition—Credit history includes defaults, deeds-in-lieu, foreclosures, and/or bankruptcies.

 

 

·

 

Loan collateral and performance relative to underwriting—Property performance is significantly worse than underwritten expectations. The loan is not in compliance with loan covenants and performance criteria and may be in default. Sale proceeds would not be sufficient to pay off the loan at maturity.

 

 

·

 

Quality and stability of collateral cash flows—The property has material vacancy and significant rollover of remaining tenants.

 

 

·

 

Loan structure—LTV exceeds 90%.

 

As of September 30, 2012, the risk ratings by class of loan were as follows (amounts in thousands):

 

 

 

Balance Sheet Classification at September 30, 2012

 

Risk

 

Loans Held for Investment

 

Loans Transferred

 

 

 

Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

As Secured
Borrowings

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

2

 

134,006

 

2,438

 

393,908

 

13,135

 

543,487

 

3

 

1,146,779

 

309,389

 

459,880

 

72,886

 

1,988,934

 

4

 

81,820

 

44,935

 

7,634

 

 

134,389

 

5

 

 

 

 

 

 

 

 

$

1,362,605

 

$

356,762

 

$

861,422

 

$

86,021

 

$

2,666,810

 

 

As of December 31, 2011, the risk ratings by class of loan were as follows (amounts in thousands):

 

 

 

Balance Sheet Classification at December 31, 2011

 

 

 

Risk

 

Loans Held for Investment

 

Loans
Held for
Sale

 

Loans Transferred

 

 

 

Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

First
Mortgages

 

As Secured
Borrowings

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

2

 

108,900

 

131,281

 

139,167

 

89,760

 

13,193

 

482,301

 

3

 

1,054,717

 

251,788

 

481,982

 

38,833

 

37,123

 

1,864,443

 

4

 

38,994

 

54,094

 

7,676

 

 

 

100,764

 

5

 

 

 

 

 

 

 

 

 

$

1,202,611

 

$

437,163

 

$

628,825

 

$

128,593

 

$

50,316

 

$

2,447,508

 

 

After completing our analysis of each loan, including the resulting risk ratings as described above, we concluded that no allowance for loan losses was necessary as of September 30, 2012 and December 31, 2011.

 

14



 

For the three months ended September 30, 2012, the activity in our loan portfolio was as follows (amounts in thousands):

 

Balance June 30, 2012

 

$

2,220,826

 

Acquisitions/originations

 

497,253

 

Additional funding

 

1,349

 

Capitalized interest (1)

 

314

 

Basis of loans sold

 

52

 

Basis of loans prepaid/matured

 

(51,068

)

Principal repayments

 

(18,237

)

Discount accretion/premium amortization

 

5,702

 

Foreign currency remeasurement gain

 

12,819

 

Receivable loan payoffs

 

(2,200

)

Balance September 30, 2012

 

$

2,666,810

 

 

For the nine months ended September 30, 2012, the activity in our loan portfolio (including loans held-for-sale) was as follows (amounts in thousands):

 

Balance December 31, 2011

 

$

2,447,508

 

Acquisitions/originations

 

930,598

 

Additional funding

 

12,096

 

Capitalized interest (1)

 

2,864

 

Basis of loans sold

 

(153,575

)

Basis of loans prepaid/matured

 

(460,789

)

Transfer out- Loan converted to a security

 

(115,100

)

Principal repayments

 

(33,518

)

Discount accretion/premium amortization

 

35,026

 

Foreign currency remeasurement gain

 

9,660

 

Net change in unrealized loss on loans held-for-sale at fair value

 

(5,760

)

Receivable loan payoffs

 

(2,200

)

Balance September 30, 2012

 

$

2,666,810

 

 


(1)         Represents accrued interest income on loans whose terms do not require current payment of interest.

 

We acquired or originated $943.4 million (face value of loans, net of $32.3 million in discounts and upfront fees collected at closing) in loans during the nine months ended September 30, 2012, which included: (1) a $125.0 million participation in a senior loan, converted to a CMBS in the second quarter, secured by all the material assets of a worldwide operator of hotels, resorts, and timeshare properties for a discounted purchase price of $115.7 million; (2) an origination of a $63.0 million first mortgage, of which $59.0 million was funded at closing, collateralized by 10 office buildings located in California; (3) an origination of a $40.0 million mezzanine loan secured by a 10-property portfolio of full-service and extended-stay hotels located in eight different states; (4) an origination of a $73.0 million junior mezzanine loan, of which $45.0 million was initially funded, collateralized by six office buildings in Virginia; (5) an origination of a $170.0 million first mortgage loan, of which $135.0 million was initially funded, collateralized by two office buildings in midtown Manhattan; (6)  an origination of a $30.0 million mezzanine loan collateralized by an office building in Pennsylvania; (7) an origination of a $51.5 million first mortgage collateralized by three hotels in North Carolina, New Jersey, and Virginia; (8) a purchase of a 50% undivided participation interest in a EUR-denominated mezzanine loan for $68.4 million, collateralized by three hotels in France and Germany; (9) an acquisition of a $250.0 million participation in a mezzanine loan at a discounted price of $233.75 million, secured by indirect equity interests in subsidiaries that own substantially all the assets of a worldwide operator of hotels, resorts and timeshare properties; (10) an origination of a $46.0 million first mortgage collateralized by a 351 key hotel in Maryland; (11) an origination of a $61.0 million first mortgage, of which $48.5 million was funded at closing, collateralized by two office buildings in California; and (12) approximately $12.1 million in additional funding on existing loan investments.

 

We sold $156.0 million of loans during the nine months ended September 30, 2012, which included: (1) six loans with a carrying value of $122.7 million to an independent third party resulting in proceeds, net of financing repayments, of $40.6 million and (2) 50% of our Euro denominated loan to a strategic partner resulting in proceeds of $28.8 million. The transaction was neutral from an earnings perspective net of the associated currency hedge gain. Additionally, 15 loans matured or were prepaid during the nine months ended September 30, 2012, which resulted in proceeds of $460.3 million (net of realized foreign currency remeasurement gain of $9.1 million) and accelerated accretion of purchase discounts of $15.2 million.

 

5. Other Investments

 

From May 24, 2012 through September 30, 2012, we acquired 272 residential real estate owned (“REO”) properties at an aggregate cost of $30.5 million.  At acquisition, substantially all of the properties were either vacant or had occupants that were not subject to a lease and/or were not paying rent to the previous owner.  Upon acquisition, we began actively preparing the properties to be either rented or sold, as applicable.  From the date of acquisition through September 30, 2012, we incurred approximately $0.5 million in costs of getting these properties ready for their intended use, and such costs were added to our investment basis.  During the three and nine months ended September 30, 2012, we had revenues of $0.1 million and $0.1 million and losses from operations of $0.3 million and $0.8 million, respectively.  The losses from operations were due primarily to the costs incurred in connection with various REO start-up activities, including the negotiation of management agreements with third parties and the structuring of acquisitions.  Through September 30, 2012, we had engaged three third party entities to perform REO acquisition, development and management services.  In addition, through September 30, 2012, we had sold 21 properties for aggregate net proceeds of $1.3 million and an aggregate net loss of $2 thousand, and had rented 28 properties.  The net losses of $0.3 million and $0.8 million for the three and nine months ended September 30, 2012 are included in other income (expense) in the consolidated statement of operations.

 

15



 

As of September 30, 2012 and December 31, 2011, we had an aggregate cost basis of $12.9 million and $13.8 million invested in the publicly traded equity securities of certain REITs that were classified as available-for-sale and carried at fair value with changes in fair value recorded to other comprehensive income (loss).  As of September 30, 2012 and December 31, 2011, the aggregate fair value of such securities was $13.0 million and $12.3 million, respectively, resulting in a net unrealized gain of $0.1 million and a net unrealized loss of $2.5 million, respectively.  For the three and nine months ended September 30, 2012 we recognized dividend income related to these investments of $0.2 million and $0.6 million, respectively, that is included as a component of other income in the condensed consolidated statement of operations.  During the three months ended September 30, 2012, we sold securities with an aggregate cost basis of $0.9 million.  The transaction was neutral from an earnings perspective.  During the nine months ended September 30, 2011, we purchased securities with an aggregate cost basis of $9.3 million.

 

In June 2011, we acquired a non-controlling 49% interest in a privately-held limited liability company for $25.5 million, which is accounted for under the equity method.  In December 2011 we sold 20% of this investment for an amount that approximated our carrying amount.  The limited liability company owns a mezzanine loan participation, and our share of earnings for the three and nine months ended September 30, 2012 was $0.6 million and $1.7 million, respectively, which is included in other income on the condensed consolidated statements of operations.

 

Prior to 2011, we had committed $9.7 million to acquire at least a 5% interest in a privately-held limited liability company formed to acquire assets of a commercial real estate debt management and servicing business primarily for the opportunity to participate in debt opportunities arising from the venture’s special servicing business (the “Participation Right”). As of September 30, 2012, we had funded $8.0 million of our commitment. We recognized $0.2 million and $1.0 million for the three and nine months ended September 30, 2012, respectively, related to this investment, which is included in other income on the condensed consolidated statements of operations.

 

6. Secured Financing Agreements

 

On March 31, 2010, Starwood Property Mortgage Sub-1, L.L.C. (“SPM Sub-1”), our indirect wholly-owned subsidiary, entered into a Master Repurchase and Securities Contract (the “Wells Repurchase Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”). The Wells Repurchase Agreement is secured by approximately $104.4 million of the diversified loan portfolio purchased from Teachers Insurance and Annuity Association of America on February 26, 2010 (“the TIAA Portfolio”). Advances under the Wells Repurchase Agreement accrue interest at a per annum pricing rate equal to the sum of one-month LIBOR plus the pricing margin of 3.0%. If an event of default (as such term is defined in the Wells Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable and interest accrues at the default rate, which is equal to the pricing rate plus 4.0%. The maturity date of the Wells Repurchase Agreement is May 31, 2013. The Wells Repurchase Agreement allowed for advances through May 31, 2010. As of September 30, 2012, $69.0 million was outstanding under the Wells Repurchase Agreement and the carrying value of the pledged collateral was $104.4 million. The Company guarantees certain of the obligations of SPM Sub-1 under the Wells Repurchase Agreement up to maximum liability of 25% of the then currently outstanding repurchase price of all purchased assets.

 

On August 6, 2010, Starwood Property Mortgage Sub-2, L.L.C. (“SPM Sub-2”), our indirect wholly-owned subsidiary, entered into a second Master Repurchase and Securities Contract with Wells Fargo, which second repurchase facility was amended and restated by SPM Sub-2 and Starwood Property Mortgage Sub-2-A, L.L.C. (“SPM Sub-2-A”), our indirect wholly-owned subsidiary, on February 28, 2011, pursuant to an Amended and Restated Master Repurchase and Securities Contract (the “Second Wells Repurchase Agreement”). The Second Wells Repurchase Agreement was amended on May 24, 2011 and November 3, 2011 (“Amendment No. 2”), and is being used by SPM Sub-2 and SPM Sub-2-A to finance the acquisition or origination of commercial

 

16



 

mortgage loans (and participations therein) and mezzanine loans. In connection with Amendment No. 2, available borrowings under the facility increased by $200 million to $550 million. Advances under the Second Wells Repurchase Agreement accrue interest at a per annum pricing rate equal to the sum of one-month LIBOR plus a margin of between 1.75% and 6.0% depending on the type of asset being financed. If an event of default (as such term is defined in the Second Wells Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest accrues at the default rate, which is equal to the pricing rate plus 4.0%. The initial maturity date of the Second Wells Repurchase Agreement is August 5, 2013, subject to two one-year extension options, each of which may be exercised by us upon the satisfaction of certain conditions and the payment of an extension fee. The Company guarantees certain of the obligations of SPM Sub-2 and SPM Sub-2-A under the Second Wells Repurchase Agreement up to a maximum liability of either 25% or 100% of the then-currently outstanding repurchase price of purchased assets, depending upon the type of asset being financed. As of September 30, 2012, $335.0 million was outstanding under the Second Wells Repurchase Agreement and the carrying value of the pledged collateral was $712.7 million.

 

On December 2, 2010, Starwood Property Mortgage Sub-3, L.L.C. (“SPM Sub-3”), our indirect wholly-owned subsidiary, entered into a Master Repurchase Agreement with Goldman Sachs Mortgage Company, which repurchase facility was amended and restated by SPM Sub-3 and Starwood Property Mortgage Sub-3-A, L.L.C. (“SPM Sub-3-A”), our indirect wholly-owned subsidiary, on February 28, 2011, pursuant to an Amended and Restated Master Repurchase Agreement (the “Goldman Repurchase Agreement”). The Goldman Repurchase Agreement will be used to finance the acquisition or origination by SPM Sub-3 and SPM Sub-3-A of commercial mortgage loans that are eligible for CMBS securitization. The Goldman Repurchase Agreement provides for asset purchases of up to $150 million. The Company guarantees certain of the obligations of SPM Sub-3 and SPM Sub-3-A under the Goldman Repurchase Agreement up to a maximum liability of 25% of the then-currently outstanding repurchase price of all purchased loans. Advances under the Goldman Repurchase Agreement accrue interest at a per annum pricing rate equal to the sum of one-month LIBOR plus a margin of between 1.95% and 2.25% depending on the loan-to-value ratio of the purchased mortgage loan. If an event of default (as such term is defined in the Goldman Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest accrues at the default rate, which is equal to the pricing rate plus 2.0%. The maturity date of the Goldman Repurchase Agreement is December 3, 2012. As of September 30, 2012, there were no borrowings under the Goldman Repurchase Agreement.

 

On March 18, 2011, Starwood Property Mortgage, L.L.C. (“SPM”), our indirect wholly-owned subsidiary, entered into a third Master Repurchase and Securities Contract with Wells Fargo (“the Third Wells Repurchase Agreement”). The Third Wells Repurchase Agreement is being used by SPM to finance the acquisition and ownership of RMBS and provides for asset purchases up to $175 million. Advances under the Third Wells Repurchase Agreement generally accrue interest at a per annum pricing rate equal to one-month LIBOR plus a margin of 2.10%. If an event of default (as such term is defined in the Third Wells Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest accrues at the default rate, which is equal to the pricing rate plus 4.0%. The facility was scheduled to terminate on March 16, 2012. We extended the facility for an additional year and the new facility termination date is March 16, 2013. The Company has guaranteed certain of the obligations of SPM under the Third Wells Repurchase Agreement. As of September 30, 2012, $145.0 million was outstanding and the carrying value of the pledged collateral was $254.5 million.

 

On December 30, 2011, Starwood Property Mortgage Sub-5, L.L.C. (“SPM Sub-5”) and Starwood Property Mortgage Sub-5-A, L.L.C. (“SPM Sub-5-A”), our indirect wholly-owned subsidiaries, entered into a fourth Master Repurchase and Securities Contract with Wells Fargo (the “Fourth Wells Repurchase Agreement”). The Fourth Wells Repurchase Agreement provides for advances up to $189.9 million and is secured by a loan portfolio of 21 separate commercial mortgage loans. As of September 30, 2012, advances under the Fourth Wells Repurchase Agreement accrued interest at one-month LIBOR plus a pricing margin of 2.75%. The availability of additional advances, as well as the pricing margin on all outstanding borrowings at any given time, is determined by the current operating cash flows and fair values of the underlying collateral, both in relation to the existing collateral loan receivable balances outstanding, and all as approved by Wells Fargo. The overall term of the Fourth Wells Repurchase Agreement is three years, with two one-year conditional extensions. As of September 30, 2012, SPM Sub-5-A had borrowed $189.9 million under this facility and the carrying value of the pledged collateral was $252.0 million. At closing, we paid a 0.50% commitment fee based upon the total committed proceeds. If the overall facility is extended beginning in December 2014, we would pay a 0.25% extension fee for each year. The Company guarantees 60% of the currently outstanding repurchase price for all purchased assets; however, the Company guarantees 100% of the outstanding balance of any individual repurchase transaction involving a collateral property with operating cash flows that at any time is less than 15% of the related collateral loan receivable balance.

 

On March 6, 2012, Starwood Property Mortgage Sub-7, LLC (“SPM Sub-7”), our indirect wholly-owned subsidiary, entered into a Master Repurchase Agreement with Goldman Sachs International (the “Second Goldman Repurchase Agreement”).  At closing, we borrowed $155.4 million under the Second Goldman Repurchase Agreement to finance the acquisition of $222.8 million in senior debt securities that are expected to mature on November 15, 2015.  The senior debt securities were issued by certain special purpose entities that were formed to hold substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties.  Advances under the Second Goldman Repurchase Agreement accrue interest at a per annum rate of one-month LIBOR plus a spread

 

17



 

of 2.90%.  The maturity date of the Second Goldman Repurchase Agreement is August 15, 2015.  The carrying value of the collateral senior debt securities was $215.9 million and the amount outstanding under the facility was $151.1 million at September 30, 2012.

 

On March 26, 2012, Starwood Property Mortgage Sub-6, LLC (“SPM Sub-6”) and Starwood Property Mortgage Sub-6-A (“SPM Sub-6-A”), our indirect wholly-owned subsidiaries, entered into a Master Repurchase Agreement with Citibank, N.A. (the “Citi Repurchase Agreement).  The Citi Repurchase Agreement provides for asset purchases of up to $125.0 million to finance commercial mortgage loans and senior interests in commercial mortgage loans originated or acquired by us and including loans and interests intended to be included in commercial mortgage loan securitizations as well as those not intended to be securitized.  Advances under the Citi Repurchase Agreement accrue interest at a per annum interest rate equal to the sum of (i) 30-day LIBOR plus (ii) a margin of between 1.75% and 3.75% depending on (A) asset type, (B) the amount advanced and (C) the debt yield and loan-to-value ratios of the purchased mortgage loan, provided that the aggregate weighted average interest rate shall not at any time be less than the sum of one-month LIBOR plus 2.25%.  The facility has an initial maturity date of March 29, 2014, subject to three one-year extension options, which may be exercised by us upon the satisfaction of certain conditions. We have guaranteed the obligations of our subsidiaries under the facility up to a maximum liability of 25% of the then-currently outstanding repurchase price of assets financed.  As of September 30, 2012, SPM Sub-6-A had borrowed $40.1 million under this facility and the carrying value of the pledged collateral was $56.7 million.

 

Under the Wells Repurchase Agreement, the Second Wells Repurchase Agreement, the Goldman Repurchase Agreement, the Third Wells Repurchase Agreement, the Fourth Wells Repurchase Agreement, the Second Goldman Repurchase Agreement, and the Citi Repurchase Agreement, the counterparty retains the sole discretion over both whether to purchase the loan or security from us and, subject to certain conditions, the market value of such loan or security for purposes of determining whether we are required to pay margin to the counterparty.

 

On December 3, 2010, SPT Real Estate Sub II, LLC (“SPT II”), our wholly-owned subsidiary, entered into a term loan credit agreement (the “BAML Credit Agreement”) with Bank of America, N.A. (“Bank of America”) as administrative agent and as lender, and us and certain of our subsidiaries as guarantors. The BAML Credit Agreement, amended and restated on March 9, 2012 (“Amended BAML Credit Agreement”), provides for loans of up to $143.2 million as of September 30, 2012. The initial draw under the BAML Credit Agreement in December 2010 was used, in part, to finance the acquisition of a $205.0 million participation (the “Participation”) in a senior secured loan due November 15, 2015 from Bank of America. The Participation was converted into a security in June 2011 and is due from certain special purpose entities that were formed to hold substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties.  In connection with the March 9, 2012 amendment, we borrowed an additional $81.0 million to partially finance the $125.0 million acquisition of additional participation interest in the senior secured loan.

 

Advances under the Amended BAML Credit Agreement accrue interest at a per annum rate based on LIBOR or a base rate, at the election of SPT II. The margin can vary between 2.35% and 2.50% over LIBOR, and between 1.35% and 1.50% over base rate, based on the performance of the underlying hospitality collateral. The initial maturity date of the Amended BAML Credit Agreement is November 30, 2014, subject to a 12 month extension option, exercisable by SPT II upon satisfaction of certain conditions set forth in the Amended BAML Credit Agreement. Bank of America retains the sole discretion, subject to certain conditions, over the market value of collateral assets for purposes of determining whether we are required to pay margin to Bank of America. As of September 30, 2012, $143.2 million was outstanding under the BAML Credit Agreement. The carrying value of the CMBS pledged as collateral under the Credit agreement was $209.2 million as of September 30, 2012. If an event of default (as such term is defined in the Amended BAML Credit Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest would accrue at an additional 2% per annum over the applicable rate.

 

On July 3, 2012, Starwood Property Mortgage Sub-9, L.L.C. (“SPM Sub-9”) and Starwood Property Mortgage Sub-9-A, L.L.C. (“SPM Sub-9-A”), our indirect wholly-owned subsidiaries, entered into a Purchase and Repurchase Agreement and Securities Contract (“OneWest Repurchase Agreement”) with OneWest Bank, FSB (“OneWest”).  At closing, SPM Sub-9 transferred loan investments to OneWest in exchange for a $78.3 million advance.  Borrowings under the OneWest Repurchase Agreement accrue interest at a pricing rate of one-month LIBOR plus a margin of 3.0%.  If an event of default (as such term is defined in the OneWest Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest accrues at the default rate, which is equal to the pricing rate plus 5.0%.  The initial maturity date of the facility is July 3, 2015 with two one-year extension options, subject to certain conditions.  As of September 30, 2012, $77.4 million was outstanding under the OneWest Bank Repurchase Agreement and the carrying value of the pledged collateral was $112.6 million.

 

On August 3, 2012, Starwood Property Mortgage Sub-10, LLC (“SPM Sub-10”) and Starwood Property Mortgage Sub-10A (“SPM Sub 10-A”), our indirect wholly-owned subsidiaries, jointly entered into a $250.0 million Senior Secured Revolving Credit Facility (“Borrowing Base”) arranged by Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPFS”).  Lender participants in the facility include Bank of America, Citibank, Barclays Bank PLC, Deutsche Bank Trust Company Americas, Goldman Sachs Bank

 

18



 

USA, and Stifel Bank & Trust.  The facility matures 364 days from closing, may be extended from time to time, provided the aggregate tenor shall not exceed four years.  Outstanding borrowings under the facility will be priced at LIBOR + 325 bps, with an unused fee of 30 to 35 bps per annum depending upon the usage of the facility.  The facility will be used primarily to finance our purchase or origination of commercial mortgage loans for the time period between transaction closing and the time in which a financing of the loan can be closed with one of our existing secured warehouse facilities or the loan is sold/syndicated in whole or in part.  The term of financing provided under the facility for any individual loan is limited in most instances to the lesser of six months or the maturity of the facility.  The facility will be secured by each loan for which financing has been provided as well as a no less than $500.0 million in market value of additional preapproved unencumbered senior, subordinate, and mezzanine loan assets.  The facility is full recourse to us.  As of September 30, 2012, there were no borrowings under the Borrowing Base and the carrying value of the pledged collateral was $505.3 million.

 

On August 17, 2012, Starwood Property Trust, Inc. (“SPT”), entered into a Master Repurchase Agreement with Goldman Sachs Lending Partners, LLC (the “Third Goldman Repurchase Agreement”). At closing, we borrowed $158.8 million under the Third Goldman Repurchase Agreement to finance the acquisition of $250.0 million participation interest in a mezzanine note that is expected to mature on November 15, 2015. The mezzanine note was issued by certain special purpose entities that were formed to hold substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties. Advances under the Third Goldman Repurchase Agreement accrue interest at a per annum rate of one-month LIBOR plus a spread of 3.70%. The maturity date of the Third Goldman Repurchase Agreement is September 15, 2015. The carrying value of the mezzanine note was $234.6 million and the amount outstanding under the facility was $158.8 million at September 30, 2012.

 

The following table sets forth our five-year principal repayments schedule for the secured financings, assuming no defaults or expected extensions and excluding the loan transfer secured borrowings (amounts in thousands).   Our credit facilities generally require principal to be paid down prior to the facilities’ respective maturities if and when we receive principal payments on, or sell, the investment collateral that we have pledged.  The amount for the remainder of 2012 generally represents the principal repayments that are scheduled or otherwise expected to be received on our loan and MBS investments:

 

2012 (remaining)

 

$

32,178

 

2013

 

749,257

 

2014

 

340,844

 

2015

 

187,171

 

2016 and thereafter

 

 

Total

 

$

1,309,450

 

 

7. Loan Transfer Activities

 

During 2010, we participated in a commercial mortgage securitization which generated non-recourse match funded financing with an effective cost of funds of approximately 3.5%. We separated five mortgage loans with an aggregate face value of $178.0 million into senior and junior loans. We contributed the five senior loans, or A Notes (the “Contributed Loans”), with a face value of approximately $84.0 million to the securitization trust and received approximately $92.0 million in proceeds, while retaining $94.0 million of junior interests. The Contributed Loans are secured by office, retail and industrial properties. Each of the five Contributed Loans was either originated or acquired by us as part of a first mortgage loan. In connection with the securitization, two of the first mortgage loans were each split by us into an A Note and a B Note and three of the first mortgage loans had each been previously split into A Notes, B Notes and C Notes. The secured financing liability relates to two of the Contributed Loans, which mature in 2014 and 2015 that did not qualify for sale treatment under GAAP.  As of September 30, 2012 and December 31, 2011, the balance of the loans pledged to the securitization trust was $50.3 million and $50.3 million, respectively, and the related liability of the securitization trust was $52.5 million and $53.2 million, respectively.

 

During the first quarter of 2011, we contributed three loans to a securitization trust for approximately $56.0 million in gross proceeds. Control of the loans was surrendered in the loan transfer and it was therefore treated as a sale under GAAP, resulting in a gain of $1.9 million. We effectively realized a net gain of $1.8 million on this transaction after considering the realized losses on the interest rate hedges of $0.1 million that was terminated in connection with the sale.

 

During the first quarter of 2012, we sold six loans with a carrying value of $122.7 million to an independent third party resulting in proceeds, net of financing repayments, of $40.6 million.  Control of the loans was surrendered in the loan transfer and it was therefore treated as a sale under GAAP, resulting in a realized gain of $9.4 million.  The net economic gain of this transaction, including a realized loss of $8.4 million on the termination of the corresponding interest rate hedge, was $1.0 million.  Additionally, we sold 50% of our Euro denominated loan to a strategic partner resulting in proceeds of $28.8 million and a realized loss of $2.1 million; however, this transaction was earnings neutral after considering the realized gains on the related currency hedges of $2.1 million that were terminated in connection with the sale.  We have no continuing involvement in the loans.

 

19



 

During the third quarter of 2012, we sold the $36.1 million A-Note of a $51.5 million first mortgage loan that we had closed in July 2012, and retained the $15.4 million B-Note.  The loan is collateralized by a portfolio of three hotels.  The cash proceeds received from the sale approximated our carrying value in the A-Note.  We retained the $15.4 million B-Note.  The A-Note and B-Note bear interest at one-month LIBOR plus 3.5% and 11.83%, respectively.  The buyer has an option to require us to repurchase the A-Note unless and until a default condition is cured with respect to one of the collateral properties, at which time the put option would terminate.  In exchange for providing this put option, we receive 0.5% of the interest otherwise due to the buyer under the A-Note unless and until the put option terminates.  The buyer has not exercised its option to date.  While we fully expect the franchise agreement default condition will be cured as it was caused by a short-term construction project at the property that has since been completed, our participation in the interest accruing under the A-Note represents an element of continuing involvement that requires us to account for the sale as a secured borrowing.  The carrying amount of the A-Note and secured borrowing were $35.7 million at September 30, 2012, and are classified in loans transferred as secured borrowings and loan transfer secured borrowings, respectively.

 

8. Derivatives and Hedging Activity

 

Risk Management Objective of Using Derivatives

 

We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, foreign exchange, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments. Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates, credit spreads, and foreign exchange rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of the known or expected cash receipts and known or expected cash payments principally related to our investments, anticipated level of loan sales, and borrowings.

 

Cash Flow Hedges of Forecasted Interest Payments

 

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

 

In connection with our repurchase agreements, we have entered into ten interest rate swaps that have been designated as cash flow hedges of the interest rate risk associated with forecasted interest payments. As of September 30, 2012, the aggregate notional of our interest rate swaps designated as cash flow hedges of interest rate risk totaled $322.6 million.  Under these agreements, we will pay fixed monthly coupons at fixed rates ranging from 0.557% to 2.228% of the notional amount to the counterparty and receive floating rate LIBOR. Our interest rate swaps designated as cash flow hedges of interest rate risk have maturities ranging from November 2012 to October 2018.

 

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the nine months ended September 30, 2012 we recorded no hedge ineffectiveness in earnings.  During the three and nine months ended September 30, 2011 we record $0 and $45 thousand, respectively, as hedge ineffectiveness in earnings, which is included in interest expense on the condensed consolidated statements of operations.

 

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the associated variable-rate debt. Over the next twelve months, we estimate that an additional $1.7 million will be reclassified as an increase to interest expense.  We are hedging our exposure to the variability in future cash flows for forecasted transactions over a maximum period of 105 months.

 

Non-designated Hedges

 

Derivatives not designated as hedges are derivatives that do not meet the criteria for hedge accounting under GAAP or for which we have not elected to designate as hedges.  We do not use these derivatives for speculative purposes but instead they are used to manage our exposure to foreign exchange rates, interest rate changes, and certain credit spreads.  Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in net (losses) gains on interest rate, currency or credit hedges in the condensed consolidated statements of operations.

 

20



 

During 2010, we entered into a series of forward contracts whereby we agree to sell an amount of GBP for agreed upon amounts of USD at various dates through October 2013.  These forward contracts were executed to economically fix the USD amounts of GBP-denominated cash flows expected to be received by us related to our GBP-denominated loan investment.  During 2011, we entered into a series of forward contracts whereby we agreed to sell an amount of EUR for an agreed upon amount of USD at various dates through June of 2014.  These forward contracts were executed to economically fix the USD amount of EUR-denominated cash flows expected to be received by us related to a mezzanine loan investment in Germany.  During the three months ended March 31, 2012, we terminated a portion of our contracts to sell EUR.  The purpose of the terminations was to reduce the amount of EUR we were to sell at future dates as a result of the refinancing of our EUR-denominated loan investment.  During the three months ended September 30, 2012, we entered into a series of forward contracts whereby we agreed to sell an amount of EUR for an agreed upon amount of USD at various dates through January of 2014.  These forward contracts were executed to economically fix the USD amount of EUR-denominated cash flows expected to be received by us related to a second EUR denominated mezzanine loan.  During the three months ended March 31, 2012, we entered into positions to buy GBP for an agreed upon amount of USD at various dates through October 2013 to fix the future value of our losses on pre-existing GBP forward positions.  We also entered into a new series of forward contracts whereby we agreed to sell GBP for an agreed upon amount of USD at various dates through March 2016.

 

As of September 30, 2012, we had 13 foreign exchange forward derivatives to sell GBP with a total notional amount of GBP 180.9 million, 6 foreign exchange forward derivatives to buy GBP with a total notional amount of GBP 96.5 million and 14 foreign exchange forward derivatives to sell EUR with a total notional of EUR 94 million.

 

During 2010 and 2011, we entered into five interest rate swaps that were not designated as hedges.  Under these agreements, we pay fixed coupons at fixed rates ranging from 0.716% to 2.505% of the notional amount to the counterparty and receive floating rate LIBOR.  These interest rate swaps are used to limit the price exposure of certain assets due to changes in benchmark USD-LIBOR swap rates from which the pricing of these assets is derived.  As of September 30, 2012, the aggregate notional amount of these interest rate swaps totaled $165.0 million. Changes in the fair value of these interest rate swaps are recorded directly in earnings.

 

In connection with our acquisition of a loan portfolio during the fourth quarter of 2011, we entered into nine interest rate swaps whereby we receive fixed coupons ranging from 2.86% to 6.28% of the notional amount and pay floating rate LIBOR.  We acquired these swaps at a cost of $7.5 million.  The premium paid reflects the fact that these swaps had above market rates which we receive.   These swaps effectively convert certain floating rate loans we acquired to fixed rate loans.  As of September 30, 2012, the aggregate notional amount of these swaps totaled $76.7 million. Changes in the fair value of these interest rate swaps are recorded directly in earnings.

 

During the nine months ended September 30, 2011 we entered into a series of derivatives that are intended to hedge against increases in market credit spreads of CMBS.  Such movements would have a negative impact on the proceeds we expect to receive from contributing loans into commercial mortgage loan securitizations.  The aggregate notional amount of the derivative was $25.0 million and it matured in December 2011.  Under the terms of the contract, a market credit spread index was defined at the contract’s inception by reference to a portfolio of specific independent CMBS.  To the extent the referenced credit spread index increases, our counterparty pays us.  To the extent the referenced credit spread index decreases, we pay our counterparty.  We pay/receive approximately every 30 days based upon the movement in the referenced index during such period.  The net gain from inception of the hedge through September 30, 2011 was $2.4 million. There were no credit hedges in place during the nine months ended September 30, 2012.

 

The table below presents the fair value of our derivative financial instruments as well as their classification on the balance sheet as of September 30, 2012 and December 31, 2011 (amounts in thousands).

 

Tabular Disclosure of Fair Values of Derivative Instruments (amounts in thousands)

 

 

 

Derivatives in an Asset Position

 

Derivatives in a Liability Position

 

 

 

As of September 30, 2012

 

As of December 31, 2011

 

As of September 30, 2012

 

As of December 31, 2011

 

 

 

Balance
Sheet
Location

 

Fair
Value

 

Balance
Sheet
Location

 

Fair
Value

 

Balance
Sheet
Location

 

Fair
Value

 

Balance
Sheet
Location

 

Fair
Value

 

Derivatives designated as hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Derivative Assets

 

$

 

N/A

 

$

 

Derivative Liabilities

 

$

3,043

 

Derivative Liabilities

 

$

1,420

 

Total derivatives designated as hedging instruments

 

 

 

$

 

 

 

$

 

 

 

$

3,043

 

 

 

$

1,420

 

Derivatives not designated as hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Derivative Assets

 

$

5,488

 

Derivative Assets

 

$

7,555

 

Derivative Liabilities

 

$

2,064

 

Derivative Liabilities

 

$

11,342

 

Foreign exchange contracts

 

Derivative Assets

 

5,536

 

Derivative Assets

 

5,261

 

Derivative Liabilities

 

20,484

 

Derivative Liabilities

 

6,890

 

Total derivatives not designated as hedging instruments

 

 

 

$

11,024

 

 

 

$

12,816

 

 

 

$

22,548

 

 

 

$

18,232

 

 

21



 

Cash flow hedges impact for the three months ended September 30, 2012 (amounts in thousands):

 

Derivative type for
cash flow hedge 

 

Amount of loss
recognized in
OCI
on derivative
(effective portion)

 

Location of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Amount of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Location of loss
recognized in
income on
derivative
(ineffective portion)

 

Amount of loss
recognized in
income on
derivative
(ineffective portion)

 

Interest Rate Swaps

 

$

1,072

 

Interest Expense

 

$

661

 

Interest Expense

 

$

 

 

Cash flow hedges impact for the three months ended September 30, 2011 (amounts in thousands):

 

Derivative type for
cash flow hedge

 

Amount of loss
recognized in
OCI
on derivative
(effective portion)

 

Location of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Amount of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Location of gain
recognized in
income on
derivative
(ineffective portion)

 

Amount of gain
recognized in
income on
derivative
(ineffective portion)

 

Interest Rate Swaps

 

$

544

 

Interest Expense

 

$

527

 

Interest Expense

 

$

 

 

Cash flow hedges impact for the nine months ended September 30, 2012 (amounts in thousands):

 

Derivative type for
cash flow hedge 

 

Amount of loss
recognized in
OCI
on derivative
(effective portion)

 

Location of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Amount of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Location of loss
recognized in
income on
derivative
(ineffective portion)

 

Amount of loss
recognized in
income on
derivative
(ineffective portion)

 

Interest Rate Swaps

 

$

3,534

 

Interest Expense

 

$

1,912

 

Interest Expense

 

$

 

 

22



 

Cash flow hedges impact for the nine months ended September 30, 2011 (amounts in thousands):

 

Derivative type for
cash flow hedge

 

Amount of loss
recognized in
OCI
on derivative
(effective portion)

 

Location of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Amount of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Location of gain
recognized in
income on
derivative
(ineffective portion)

 

Amount of gain
recognized in
income on
derivative
(ineffective portion)

 

Interest Rate Swaps

 

$

1,759

 

Interest Expense

 

$

1,730

 

Interest Expense

 

$

45

 

 

Non-designated derivatives impact for the three months ended September 30, 2012 and September 30, 2011 (amounts in thousands):

 

Derivatives Not Designated

 

Location of Gain/(Loss)
Recognized in Income on

 

Amount of Gain/(Loss)
Recognized in Income on
Derivative

 

as Hedging Instruments 

 

Derivative

 

2012

 

2011

 

Interest Rate Swaps — Realized losses

 

Gains (losses) on interest rate hedges

 

$

26

 

$

(12,302

)

Interest Rate Swaps — Net change in unrealized gains (losses)

 

Gains (losses) on interest rate hedges

 

$

(77

)

$

(6,869

)

Foreign Exchange — Realized losses

 

Gains (losses) on currency hedges

 

$

663

 

$

(86

)

Foreign Exchange — Net change in unrealized gains (losses)

 

Gains (losses) on currency hedges

 

$

(8,173

)

$

8,703

 

Credit Spread Derivative— Realized losses

 

Gains (losses) on credit spread hedges

 

$

 

$

4,539

 

Credit Spread Derivative— Net change in unrealized gains

 

Gains (losses) on credit spread hedges

 

$

 

$

(2,280

)

 

Non-Designated derivatives impact for the nine months ended September 30, 2012 and September 30, 2011 (amounts in thousands):

 

Derivatives Not Designated

 

Location of Gain/(Loss)
Recognized in Income on

 

Amount of Gain/(Loss)
Recognized in Income on
Derivative

 

as Hedging Instruments 

 

Derivative

 

2012

 

2011

 

Interest Rate Swaps — Realized losses

 

Gains (losses) on interest rate hedges

 

$

(9,383

)

$

(14,883

)

Interest Rate Swaps — Net change in unrealized gains (losses)

 

Gains (losses) on interest rate hedges

 

$

9,991

 

$

(11,099

)

Foreign Exchange — Realized gains (losses)

 

Gains (losses) on currency hedges

 

$

2,928

 

$

(292

)

Foreign Exchange — Net change in unrealized losses

 

Gains (losses) on currency hedges

 

$

(13,320

)

$

2,674

 

Credit Spread Derivative— Realized losses

 

Gains (losses) on credit spread hedges

 

$

 

$

3,569

 

Credit Spread Derivative— Net change in unrealized gains

 

Gains (losses) on credit spread hedges

 

$

 

$

161

 

 

Credit-risk-related Contingent Features

 

We have entered into agreements with certain of our derivative counterparties that contain provisions where if we were to default on any of our indebtedness, including defaults where repayment of the indebtedness has not been accelerated by the lender, we may also be declared in default on our derivative obligations. We also have certain agreements that contain provisions where if our ratio of principal amount of indebtedness to total assets at any time exceeds 75%, then we could be declared in default of our derivative obligations.

 

As of September 30, 2012 the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $22.3 million. As of September 30, 2012, we have posted collateral of $3.6 million related to these agreements. If we had breached any of these provisions at September 30, 2012, we could have been required to settle our obligations under the agreements at their termination liability value of $22.3 million.

 

9. Related-Party Transactions

 

Management Agreement

 

We entered into a Management Agreement with our Manager upon closing of our IPO, which provides for an initial term of three years with automatic one-year extensions thereafter unless terminated as described below. Under the Management Agreement, our Manager, subject to the oversight of our board of directors, is required to manage our day-to-day activities, for which our Manager receives a base management fee and is eligible for an incentive fee and stock awards. Our Manager is also entitled to charge us for certain expenses incurred on our behalf, as described below.

 

23



 

Base Management Fee    The base management fee is 1.5% of our stockholders’ equity per annum and is calculated and payable quarterly in arrears in cash. For purposes of calculating the management fee, our stockholders’ equity is defined as: (a) the sum of (1) the net proceeds from all issuances of our equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus (2) our retained earnings at the end of the most recently completed calendar quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less (b) any amount that we pay to repurchase our common stock since inception. It also excludes (1) any unrealized gains and losses and other non-cash items that have impacted stockholders’ equity as reported in our financial statements prepared in accordance with GAAP, and (2) one-time events pursuant to changes in GAAP, and certain non-cash adjustments not otherwise described above, in each case after discussions between our Manager and our independent directors and approval by a majority of our independent directors. As a result, our stockholders’ equity, for purposes of calculating the management fee, could be greater or less than the amount of stockholders’ equity shown in our condensed consolidated financial statements.

 

For the three and nine months ended September 30, 2012 approximately $8.5 million and $23.3 million was incurred for base management fees, respectively, of which $8.5 million was payable at September 30, 2012.  For the three and nine months ended September 30, 2011, approximately $6.7 million and $17.6 million was incurred for base management fees, respectively. The management fee payable as of December 31, 2011 was $6.7 million.

 

Incentive Fee    Our Manager is entitled to be paid the incentive fee described below with respect to each calendar quarter (or part thereof that the Management Agreement is in effect) if (1) our Core Earnings (as defined below) for the previous 12-month period (or part thereof that the Management Agreement is in effect) exceeds an 8% threshold, and (2) our Core Earnings for the 12 most recently completed calendar quarters (or part thereof that the Management Agreement is in effect) is greater than zero.

 

The incentive fee will be an amount, not less than zero, equal to the difference between (1) the product of (x) 20% and (y) the difference between (i) our Core Earnings (as defined below) for the previous 12-month period (or part thereof that the Management Agreement is in effect), and (ii) the product of (A) the weighted average of the issue price per share of our common stock of all of our public offerings multiplied by the weighted average number of all shares of common stock outstanding (including any restricted stock units, any restricted shares of common stock and other shares of common stock underlying awards granted under our equity incentive plans) in such previous 12-month period (or part thereof that the Management Agreement is in effect), and (B) 8%, and (2) the sum of any incentive fee paid to our Manager with respect to the first three calendar quarters of such previous 12-month period (or part thereof that the Management Agreement is in effect). One half of each quarterly installment of the incentive fee is payable in shares of our common stock so long as the ownership of such additional number of shares by our Manager would not violate the 9.8% stock ownership limit set forth in our articles of incorporation, after giving effect to any waiver from such limit that our board of directors may grant in the future. The remainder of the incentive fee is payable in cash. The number of shares to be issued to our Manager is equal to the dollar amount of the portion of the quarterly installment of the incentive fee payable in shares divided by the average of the closing prices of our common stock on the New York Stock Exchange for the five trading days prior to the date on which such quarterly installment is paid.

 

Core Earnings is a non-GAAP financial measure. We calculate Core Earnings as GAAP net income (loss) excluding non-cash equity compensation expense, the incentive fee, depreciation and amortization of real estate (to the extent that we own properties), and any unrealized gains, losses or other non-cash items recorded in net income for the period, regardless of whether such items are included in other comprehensive income or loss, or in net income. The amount is adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash adjustments, in each case after discussions between our Manager and our independent directors and as approved by a majority of our independent directors.

 

For the three and nine months ended September 30, 2012, we incurred approximately $2.1 million and $7.5 million in incentive fee.  During the quarter ended September 30, 2012, we paid the manager $2.3 million of the incentive fee earned, 50% in cash and the remaining 50% in stock through the issuance of 50,203 shares of common stock at a price of $22.61 per share.  As of September 30, 2012, the incentive fee payable was $2.4 million, which is included in related party payable in the condensed consolidated balance sheet. For the three and nine months ended September 30, 2011, we incurred approximately $0.4 million and $1.2 million in incentive fee, 50% in cash and the remaining 50% in stock through the issuance of 9,021 shares of common stock at a price of $22.08 per share.

 

Expense Reimbursement    We are required to reimburse our Manager for operating expenses incurred by our Manager on our behalf.  In addition, pursuant to the terms of the Management Agreement, we are required to reimburse our Manager for the cost of legal, tax, consulting, auditing and other similar services rendered for us by our Manager’s personnel provided that such costs are no greater than those that would be payable if the services were provided by an independent third party. The expense reimbursement is not subject to any dollar limitations but is subject to review by our independent directors. For the three and nine months ended September 30, 2012, approximately $1.7 million and $4.6 million were incurred, respectively, for executive compensation and other reimbursable expenses of which approximately $1.7 million was payable as of September 30, 2012.  For the three and nine months ended September 30, 2011, approximately $1.0 million and $2.8 million were incurred, respectively, for executive compensation and other reimbursable expenses of which approximately $1.1 million was payable as of September 30, 2011.

 

24



 

Termination Fee    After the initial three-year term, we can terminate the Management Agreement without cause, as defined in the Management Agreement, with an affirmative two-thirds vote by our independent directors and 180 days written notice to our Manager. Upon termination without cause, our Manager is due a termination fee equal to three times the sum of the average annual base management fee and incentive fee earned by our Manager over the preceding eight calendar quarters. No termination fee is payable if our Manager is terminated for cause, as defined in the Management Agreement, which can be done at any time with 30 days written notice from our board of directors.

 

Loan Investments

 

In April 2011 we purchased a $35 million pari passu participation interest (the “Mammoth Participation Interest”) in a $75 million subordinate loan (the “Mammoth Loan”) from an independent third party and a syndicate of financial institutions and other entities acting as subordinate lenders to Mammoth Mountain Ski Area, LLC (“Mammoth”). Mammoth is a single-purpose, bankruptcy remote entity that is owned and controlled by Starwood Global Opportunity Fund VII-A, L.P., Starwood Global Opportunity Fund VII-B, L.P., Starwood U.S. Opportunity Fund VII-D, L.P. and Starwood U.S. Opportunity Fund VII-D-2, L.P. (collectively, the “Sponsors”). Each of the Sponsors is indirectly wholly-owned by Starwood Capital Group Global I, L.L.C., and an affiliate of our Chief Executive Officer. The Mammoth Loan was approved by our independent directors in accordance with our related party transaction policy.  The Mammoth Loan has a term of up to six years and an interest rate of 14.0% through April 2014 and 13.25% thereafter. We acquired the Mammoth Participation Interest in the Mammoth Loan from an independent third party and own such Mammoth Participation Interest subject to a participation agreement between us and the independent third party (the “Mammoth Participation Agreement”). The Mammoth Participation Agreement provides for the payment to us, on a pro rata basis with an independent third party, of customary payments in respect of the Mammoth Participation Interest and affords us customary voting, approval and consent rights so long as no event of default is continuing under the Mammoth Loan.

 

On July 20, 2012, we purchased a 50% undivided participation interest (the “Le Meridien Participation Interest”) in a EUR-denominated mezzanine loan for $68.4 million (“Le Méridien Loan”) from an independent third party.  The borrower is Starman Luxembourg Holdings S.À R.L. (“Holdings”), an entity that indirectly owns and operates a portfolio of hotels in France and Germany.  Holdings is owned 50% by an independent third party and 50% by several private investment funds previously sponsored by Starwood Capital Group Global I, L.L.C., an affiliate of our Manager.  The Le Méridien Loan has an initial term of two years with an option to extend for an additional year, subject to certain conditions, an interest rate of 12.5%, an upfront fee of 2.0% and a prepayment fee of 1.0%.  We acquired the Le Meridien Participation Interest from an independent third party and own the Le Meridien Participation Interest subject to a participation agreement between us and the independent third party (the “Le Meridien Participation Agreement”). The Le Meridien Participation Agreement provides for the payment to us, on a pro rata basis with an independent third party, of customary payments in respect of our Le Meridien Participation Interest and affords us customary voting, approval and consent rights.

 

Refer to Note 15 to the condensed consolidated financial statements for disclosure of a related party loan investment that closed subsequent to September 30, 2012.

 

10. Stockholders’ Equity

 

The Company’s authorized capital stock consists of 100,000,000 shares of preferred stock, $0.01 par value per share, and 500,000,000 shares of common stock, $0.01 par value per share.

 

In May 2011, we completed a follow-on offering of 22,000,000 shares of our common stock at a price of $21.67 per share.

 

In April 2012, we completed another follow-on offering of 23,000,000 shares of our common stock at a price of $19.88 per share.

 

In June 2012 we entered into an ATM Equity Offering Sales Agreement with Merrill Lynch, Pierce, Fenner & Smith Incorporated, (the “Agent”), relating to our shares of common stock.  In accordance with the terms of the agreement, we may offer and sell shares of our common stock having an aggregate gross sales price of up to $250 million from time to time through the agent, as our sales Agent. Sales of the shares, if any, will be made by means of ordinary brokers’ transactions or otherwise at market prices prevailing at the time of sale, at prices related to prevailing market prices or at negotiated prices.  Through November 7, 2012, we had not directed our Agent to sell any shares.

 

At the time of our IPO in 2009, the underwriters for the IPO agreed to defer and condition the receipt of a portion of their underwriting fees on our future achievement of certain minimum investment returns. Similarly, at the time of the IPO our Manager agreed to pay to the underwriters a separate portion of the underwriting fees on our behalf, with our reimbursement of our Manager of those amounts conditioned upon our achievement of the same investment returns. In the absence of the achievement of such investment returns, we would not pay the underwriters the deferred portion of the underwriting fees nor would our Manager be reimbursed for the portion of the underwriting fees that it paid on our behalf. Specifically, pursuant to the IPO underwriting agreement among the underwriters, our Manager and us, we were required to pay to the underwriters $18.1 million of underwriting fees if during

 

25



 

any full four calendar quarter period during the 24 full calendar quarters after the consummation of the IPO our Core Earnings for any such four-quarter period exceeded the product of (x) the weighted-average of the issue price per share of all public offerings of our common stock, multiplied by the weighted-average number of shares outstanding (including any restricted stock units, any restricted shares of common stock and any other shares of common stock underlying awards granted under our equity incentive plans) in such four-quarter period and (y) 8%. Additionally, because at the time of our IPO our Manager paid $9.1 million of underwriting fees on our behalf, pursuant to our Management Agreement with our Manager, we agreed to reimburse our Manager for such payments to the extent the same 8% performance threshold was exceeded. For the four calendar quarter periods ended March 31, 2011 we exceeded the threshold and therefore paid $27.2 million related to these contingent arrangements during the second quarter of 2011. Prior to 2011, we had recorded a deferred liability and an offsetting reduction to additional paid-in-capital for the full $27.2 million based upon actual and forecasted operating results at the time.

 

In August 2011, our board of directors authorized us to repurchase up to $100 million of our outstanding common shares over a one-year period.  Purchases made pursuant to the program are to be made in either the open market or in privately negotiated transactions from time to time as permitted by federal securities laws and other legal requirements. The timing, manner, price and amount of any repurchases are determined by us and are subject to economic and market conditions, stock price, applicable legal requirements and other factors. The program may be suspended or discontinued at any time.  Through December 31, 2011, we purchased 625,850 common shares on the open market at an aggregate cost of approximately $10.6 million, resulting in a weighted average share cost of $17.00. No additional shares were purchased during the nine months ended September 30, 2012.

 

Our board of directors declared the following dividends in 2011 and 2012:

 

Ex-Dividend Date

 

Record Date

 

Announce Date

 

Pay Date

 

Amount

 

Frequency

 

9/26/2012

 

9/28/2012

 

8/3/2012

 

10/15/2012

 

$

0.44

 

Quarterly

 

6/27/2012

 

6/29/2012

 

5/8/2012

 

7/13/2012

 

$

0.44

 

Quarterly

 

3/28/2012

 

3/30/2012

 

2/29/2012

 

4/13/2012

 

$

0.44

 

Quarterly

 

12/28/2011

 

12/31/2011

 

11/4/2011

 

1/13/2012

 

$

0.44

 

Quarterly

 

9/28/2011

 

9/30/2011

 

8/2/2011

 

10/14/2011

 

$

0.44

 

Quarterly

 

6/28/2011

 

6/30/2011

 

5/10/2011

 

7/15/2011

 

$

0.44

 

Quarterly

 

3/29/2011

 

3/31/2011

 

3/1/2011

 

4/15/2011

 

$

0.42

 

Quarterly

 

 

Equity Incentive Plans

 

We have reserved an aggregate of 3,112,500 shares of common stock for issuance under the Starwood Property Trust, Inc. Equity Plan and Starwood Property Trust, Inc. Manager Equity Plan and an additional 100,000 shares of common stock for issuance under the Starwood Property Trust, Inc. Non-Executive Director Stock Plan. These plans provide for the issuance of restricted stock or restricted stock units. The holders of awards of restricted stock or restricted stock units will be entitled to receive dividends or “distribution equivalents,” which will be payable at such time dividends are paid on our outstanding shares of common stock.

 

We granted each of our four independent directors 2,200 shares of restricted stock concurrently with our IPO, with a total fair value of approximately $175 thousand. The grants vested ratably in three annual installments on each of the first, second, and third anniversaries of the grant date, respectively, subject to the director’s continued service. Effective August 19, 2010, we granted each of our four independent directors an additional 1,000 shares of restricted stock, with a total fair value of approximately $75 thousand. The grants vested in one annual installment on the first anniversary of the grant.  Effective August 19, 2011, we granted each of our four independent directors an additional 2,877 shares of restricted stock, with a total fair value of approximately $200 thousand. The grants vested in one annual installment on the first anniversary of the grant.  On August 16, 2012, we granted each of our four independent directors 2,201 restricted common shares with an aggregate fair value of approximately $200 thousand. The grants will vest on August 16, 2013.  For the three and nine months ended September 30, 2012, approximately $87 thousand and $216 thousand were included in general and administrative expense, respectively, related to the grants.  For the three and nine months ended September 30, 2011, approximately $48 thousand and $114 thousand were included in general and administrative expense, respectively, related to the grants.

 

In August 2009, we granted 1,037,500 restricted stock units with a fair value of approximately $20.8 million at the grant date to our Manager under the Manager Equity Plan. The grants vest ratably in quarterly installments over three years beginning on October 1, 2009, with 86,458 shares vesting each quarter, respectively. In connection with the supplemental equity offering in December 2010, we granted 1,075,000 restricted stock units with a fair value of approximately $21.8 million at the grant date to our Manager under the Manager Equity Plan. The grants vest ratably in quarterly installments over three years beginning on March 31, 2011, with 89,583 shares vesting each quarter. In May 2012, we granted 30,000 restricted common shares with a fair value of $602 thousand to the Manager under the Manager Equity Plan.  As of the grant date, 25,000 of these shares vested and the remaining shares vest in quarterly installments at a rate of 2,500 shares per quarter beginning on September 30, 2012.  For the three and nine months

 

26



 

ended September 30, 2012, approximately 178,542 and 555,625 shares have vested, respectively, and approximately $4.1 million and $11.9 million has been included in management fees related to these grants, respectively.  For the three and nine months ended September 30, 2011, approximately 176,041 and 528,123 shares have vested, respectively, and approximately $2.9 million and $10.3 million has been included in management fees related to these grants, respectively.  Refer to Note 15 for disclosure of an additional grant of restricted stock units to our Manager subsequent to September 30, 2012.

 

In May 2011, we issued 9,021 shares of common stock to the Manager at a price of $22.08 per share. In August 2011, we issued 54,234 shares of common stock to the Manager at a price of $18.58 per share.  In May 2012, we issued 70,220 shares of common stock to the Manager at a price of $19.76 and in August 2009 we issued shares of common stock to the Manager at a price of $22.61. These shares were issued to the Manager as satisfaction of 50% of the incentive compensation due to the Manager as required under the Management Agreement, refer to Note 9 in the consolidated financial statements.

 

In February 2011, we granted 11,082 restricted stock units with a fair value of $250 thousand to an employee under the Starwood Property Trust, Inc. Equity Plan.  The award vests ratably in quarterly installments over three years beginning on March 31, 2011.  In March 2012, we granted 17,500 restricted common shares with a fair value of $368 thousand to employees under the Starwood Property Trust, Inc. Equity Plan.  Of the total award, 12,500 restricted shares vest in quarterly installments over three years beginning on March 31, 2012 and 5,000 shares vest in annual installments over three years beginning on December 31, 2012.  For the three and nine months ended September 30, 2012, 1,965 and 5,896 shares, respectively, have vested, and approximately $52 thousand and $154 thousand, respectively, was included in general and administrative expense related to these grants.  For the three and nine months ended September 30, 2011, 924 and 2,771 shares have vested, respectively, and approximately $21 thousand and $50 thousand, respectively, was included in general and administrative expense related to these grants.

 

Schedule of Non-Vested Share and Share Equivalents

 

 

 

Restricted Stock
Grants to
Independent
Directors

 

Restricted Stock
and Restricted
Stock
Unit
Grants to
Employees

 

Restricted Stock
and Restricted
Stock
Unit
Grants to
Manager

 

Total

 

Balance as of December 31, 2011

 

15,175

 

7,385

 

976,044

 

998,604

 

Granted

 

8,804

 

17,500

 

30,000

 

56,304

 

Vested

 

(14,441

)

(5,896

)

(555,624

)

(575,961

)

Forfeited

 

 

 

 

 

Balance as of September 30, 2012

 

9,538

 

18,989

 

450,420

 

478,947

 

 

Vesting Schedule

 

 

 

Restricted Stock
Grants to
Independent
Directors

 

Restricted Stock
Unit
Grants to
Employees

 

Restricted Stock
Unit
Grants to
Manager

 

Total

 

2012 (remainder of)

 

 

3,631

 

92,087

 

95,718

 

2013

 

9,538

 

9,527

 

358,333

 

377,398

 

2014

 

 

5,831

 

 

5,831

 

Total

 

9,538

 

18,989

 

450,420

 

478,947

 

 

11. Accumulated Other Comprehensive Income

 

Accumulated other comprehensive income is comprised of the following, net of non-controlling interests in consolidated subsidiaries (amounts in thousands):

 

 

 

September 30,
2012

 

September 30,
2011

 

Cumulative unrealized gain on available-for-sale securities

 

$

65,226

 

$

(7,854

)

Effective portion of cumulative loss on cash flow hedges

 

(3,043

)

(1,611

)

Total

 

$

62,183

 

$

(9,465

)

 

12. Net Income per Share

 

The following table provides a reconciliation of both net income and the number of common shares used in the computation of basic and diluted income per share. We use the two-class method in calculating both basic and diluted earnings per share as our

 

27



 

unvested restricted stock units (refer to Note 10) are participating securities as defined in GAAP (amounts in thousands, except share and per share amounts):

 

 

 

Three Months
Ended

 

Nine Months
Ended

 

 

 

September 30,
2012

 

September 30,
2012

 

Net income attributable to Starwood Property Trust, Inc.

 

$

50,212

 

$

144,861

 

Net (loss) allocated to participating securities

 

(275

)

(980

)

Numerator for basic and diluted net income per share

 

$

49,937

 

$

143,881

 

Basic weighted average shares outstanding

 

116,673,477

 

107,077,837

 

Weighted average number of diluted shares outstanding(1) 

 

117,381,559

 

107,958,047

 

Basic income per share

 

$

0.43

 

$

1.34

 

Diluted income per share

 

$

0.43

 

$

1.34

 

 


(1)         The weighted average number of diluted shares outstanding includes the impact as of September 30, 2012 of (i) unvested restricted stock units totaling 478,947, and (ii) 47,736 shares that would be hypothetically issuable as part of the incentive fee payable to the Manager if we assume that September 30, 2012 was the end of the measurement period, respectively.

 

 

 

Three Months
Ended

 

Nine Months
Ended

 

 

 

September 30,
2011

 

September 30,
2011

 

Net income attributable to Starwood Property Trust, Inc.

 

$

14,478

 

$

78,349

 

Net (loss) allocated to participating securities

 

(507

)

(1,796

)

Numerator for basic and diluted net income per share

 

$

13,971

 

$

76,553

 

Basic weighted average shares outstanding

 

93,249,249

 

82,234,976

 

Weighted average number of diluted shares outstanding(2) 

 

94,596,978

 

83,755,295

 

Basic income per share

 

$

0.16

 

$

0.95

 

Diluted income per share

 

$

0.15

 

$

0.94

 

 


(2)         The weighted average number of diluted shares outstanding includes the impact of (i) unvested restricted stock units totaling 1,175,572 as of, and (ii) 48,742 shares that would be hypothetically issuable as part of the incentive fee payable to the Manager if we assume that September 30, 2011 was the end of the measurement period, respectively.

 

13. Fair Value of Financial Instruments

 

GAAP establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial instruments at fair values. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:

 

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

Level 2 - Prices are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.

 

Level 3 - Prices are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment) unobservable inputs may be used. Unobservable inputs reflect our own assumptions about the factors that market participants would use in pricing an asset or liability, and would be based on the best information available.

 

GAAP requires disclosure of fair value information about financial instruments, whether or not recognized in the financial statements, for which it is practical to estimate the value. In cases where quoted market prices are not available, fair values are based upon the application of discount rates to estimated future cash flows using market yields, or other valuation methodologies.  Any changes to the valuation methodology will be reviewed by our management to ensure the changes are appropriate. The methods used may produce a fair value calculation that is not indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair

 

28



 

value at the reporting date. We use inputs that are current as of the measurement date, which may fall within periods of market dislocation, during which price transparency may be reduced.

 

Our Level III financial instruments are privately-held transactions and/or not actively traded in a marketplace.  For each such instrument, we strive to reasonably estimate the expected cash flows and the current rate of return an investor would demand for the same, or more often, similar type financial instruments.  We also obtain third-party information, such as broker quotes on MBS from market participants, when they are available and considered relevant.  At least quarterly, we review our process for estimating the fair value of our Level III instruments and make adjustments as necessary.

 

We determine the fair value of our financial instruments as follows:

 

Available-for-sale debt securities

 

Available-for-sale debt securities are valued utilizing observable and unobservable market inputs. The observable market inputs may include recent transactions, broker quotes and vendor prices (“market data”). However, to the extent there is material price dispersion amongst the market data, the fair value determination for these securities significantly utilizes unobservable inputs in discounted cash flow models including prepayments, default and severity estimates based on the recent performance of the collateral, the underlying collateral characteristics, industry trends, as well as expectations of macro-economic events (e.g. housing price curves, interest rate curves, etc.). At each measurement date, we consider both the observable and unobservable valuation inputs in the determination of fair value, as applicable, and securities are classified as Level III when unobservable inputs have the most significant impact.

 

Available-for-sale equity securities

 

The available-for-sale equity securities are publicly registered in the United States and listed on the New York Stock Exchange.

 

Derivatives

 

The valuation of derivative contracts are determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves, spot and market forward points. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The fair value of the foreign currency forward contracts is based on interest differentials between the currencies being traded, spot and market forward points.

 

We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

 

Although we have determined that the majority of the inputs used to value our derivatives fall within Level II of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level III inputs, such as estimates of current credit spreads to evaluate the likelihood of default by ourselves and our counterparties. As of September 30, 2012 and December 31, 2011, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, we have determined that our derivative valuations in their entirety are classified in Level II of the fair value hierarchy.

 

Loans

 

We estimate the fair values of our loans by using market prices, when available, or discounting their expected cash flows at a rate we estimate would be demanded by the market participants that would be most likely to buy our loans. The expected cash flows used are the same as those used to calculate our level yield income in the financial statements.

 

29



 

The following table presents our financial instruments carried at fair value on a recurring basis in the condensed consolidated balance sheet as of September 30, 2012 (amounts in thousands):

 

 

 

Fair Value at Reporting Date Using Inputs:

 

 

 

September 30, 2012

 

 

 

Total

 

Level I

 

Level II

 

Level III

 

Available-for-sale debt securities:

 

 

 

 

 

 

 

 

 

RMBS

 

$

337,900

 

 

 

 

 

$

337,900

 

CMBS

 

528,965

 

 

 

$

528,965

 

 

 

Total available-for-sale debt securities

 

866,865

 

 

528,965

 

337,900

 

Available-for-sale equity securities:

 

 

 

 

 

 

 

 

 

Real estate industry

 

13,035

 

$

13,035

 

 

 

 

 

Total available-for-sale equity securities

 

13,035

 

13,035

 

 

 

 

 

Total available-for-sale securities

 

879,900

 

13,035

 

528,965

 

337,900

 

Derivative Assets:

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

5,536

 

 

 

5,536

 

 

 

Interest rate contracts

 

5,488

 

 

 

5,488

 

 

 

Derivatives Liabilities:

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

(5,106

)

 

 

(5,106

)

 

 

Foreign exchange contracts

 

(20,485

)

 

 

(20,485

)

 

 

Total derivatives

 

(14,567

)

 

(14,567

)

 

Total

 

$

865,333

 

$

13,035

 

$

514,398

 

$

337,900

 

 

30



 

The changes in investments classified as Level III are as follows for the three months ended September 30, 2012 (amounts in thousands):

 

Fair Value Measurements Using Significant Unobservable Inputs

(Level III)

 

 

 

Loans held-for-sale, at
fair value

 

RMBS available-
for-sale, at fair value

 

Total

 

Beginning balance, June 30, 2012

 

$

 

$

233,456

 

$

233,456

 

Purchases

 

 

95,814

 

95,814

 

Originations

 

 

 

 

Sales

 

 

(9,425

)

(9,425

)

Maturities

 

 

 

 

Principal amortization

 

 

(18,542

)

(18,542

)

Net decrease in assets

 

 

67,847

 

67,847

 

Gain (loss) amounts from Level III investments:

 

 

 

 

 

 

 

Unrealized (loss) gain on assets

 

 

30,575

 

30,575

 

Realized gain on assets

 

 

730

 

730

 

Accretion of discount

 

 

5,924

 

5,924

 

OTTI

 

 

(637

)

(637

)

Other

 

 

5

 

5

 

Net gain on assets

 

 

36,597

 

36,597

 

Ending balance, as of September 30, 2012

 

$

 

$

337,900

 

$

337,900

 

 

The changes in investments classified as Level III are as follows for the nine months ended September 30, 2012 (amounts in thousands):

 

Fair Value Measurements Using Significant Unobservable Inputs

(Level III)

 

 

 

Loans held-for-sale, at
fair value

 

RMBS available-
for-sale, at fair value

 

Total

 

Beginning balance, January 1, 2012

 

$

128,593

 

$

341,734

 

$

470,327

 

Purchases

 

 

203,433

 

203,433

 

Originations

 

 

 

 

Transfer out

 

 

(176,786)

 

(176,786)

 

Sales

 

(132,128

)

(26,049

)

(158,177

)

Maturities

 

 

 

 

Principal amortization

 

(122

)

(52,310

)

(52,432

)

Net increase (decrease) in assets

 

(132,250

)

(51,712

)

(183,962

)

Gain (loss) amounts from Level III investments:

 

 

 

 

 

 

 

Unrealized (loss) gain on assets

 

(5,760

)

34,371

 

28,611

 

Realized gain on assets

 

9,417

 

3,643

 

13,060

 

Accretion of discount

 

 

12,548

 

12,548

 

OTTI

 

 

(2,689

)

(2,689

)

Other

 

 

5

 

5

 

Net gain on assets

 

3,657

 

47,878

 

51,535

 

Ending balance, as of September 30, 2012

 

$

 

$

337,900

 

$

337,900

 

 

Due to an increase in the observable, relevant market activity for the CMBS investment position that we owned as of January 1, 2012, we transferred a $176,786 MBS investment from Level III to Level II during the three months ended March 31, 2012.

 

31



 

The following table presents our financial instruments carried at fair value on a recurring basis in the consolidated balance sheet as of December 31, 2011 (amounts in thousands):

 

 

 

Fair Value at Reporting Date Using Inputs:

 

 

 

December 31, 2011

 

 

 

Total

 

Level I

 

Level II

 

Level III

 

Loans held-for-sale at fair value

 

$

128,593

 

 

 

 

 

$

128,593

 

Available-for-sale debt securities:

 

 

 

 

 

 

 

 

 

RMBS

 

164,948

 

 

 

 

 

164,948

 

CMBS

 

176,786

 

 

 

 

 

176,786

 

Total available-for-sale debt securities

 

341,734

 

 

 

341,734

 

Available-for-sale equity securities:

 

 

 

 

 

 

 

 

 

Real estate industry

 

11,269

 

$

11,269

 

 

 

Total available-for-sale equity securities:

 

11,269

 

11,269

 

 

 

Total investments

 

481,596

 

11,269

 

 

470,327

 

Derivative Assets:

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

5,261

 

 

 

$

5,261

 

 

 

Interest rate contracts

 

7,555

 

 

 

7,555

 

 

 

Derivatives Liabilities:

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

(12,762

)

 

 

(12,762

)

 

 

Foreign exchange contracts

 

(6,890

)

 

 

(6,890

)

 

 

Total Derivatives:

 

(6,836

)

 

(6,836

)

 

Total:

 

$

474,760

 

$

11,269

 

$

(6,836

)

$

470,327

 

 

The changes in investments classified as Level III and carried at fair value are as follows for the year ended December 31, 2011 (amounts in thousands):

 

 

 

Loans held-for-sale, at
fair value

 

MBS available-
for-sale, at fair value

 

Total

 

Beginning balance, January 1, 2011

 

$

144,163

 

$

 

$

144,163

 

Purchases

 

 

115,795

 

115,795

 

Originations

 

270,066

 

 

270,066

 

Transfer in

 

(7,000

)

282,763

 

275,763

 

Sales

 

(294,126

)

(3,600

)

(297,726

)

Maturities

 

 

(15,408

)

(15,408

)

Principal amortization

 

(252

)

(36,562

)

(36,814

)

Net increase on assets

 

(31,312

)

342,988

 

311,676

 

Gain (loss) on loans held-for-sale, at fair value:

 

 

 

 

 

 

 

Unrealized gain on assets

 

5,760

 

(7,961

)

(2,201

)

Realized gain on assets

 

10,314

 

249

 

10,563

 

Accretion of discount

 

 

10,730

 

10,730

 

OTTI

 

 

(4,272

)

(4,272

)

Other

 

(332

)

 

(332

)

Net gain on assets

 

15,742

 

(1,254

)

14,488

 

Ending balance, as of December 31, 2011

 

$

128,593

 

$

341,734

 

$

470,327

 

 

The following table presents the fair value of our Level III financial instruments, not carried at fair value on the condensed consolidated balance sheet (amounts in thousands):

 

 

 

Carrying
Value as of
September 30,
2012

 

Fair
Value as of
September 30,
2012

 

Carrying
Value as of
December 31,
2011

 

Fair
Value as of
December 31,
2011

 

Financial Instruments not carried at Fair Value:

 

 

 

 

 

 

 

 

 

Loans held for investment

 

$

2,580,789

 

$

2,647,656

 

$

2,268,599

 

$

2,308,300

 

Loans transferred as secured obligations

 

$

86,021

 

$

87,321

 

$

50,316

 

$

50,958

 

Other Investments

 

$

32,317

 

$

32,317

 

$

33,110

 

$

33,110

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

Secured financing agreements

 

$

1,309,450

 

$

1,310,668

 

$

1,103,517

 

$

1,104,612

 

Loans transfer secured borrowings

 

$

88,268

 

$

88,411

 

$

53,199

 

$

53,199

 

 

32



 

The following is quantitative information about significant unobservable inputs in our Level III Measurements (dollar amounts in thousands):

 

Quantitative Information about Level III Fair Value Measurements

 

 

 

Fair Value
at September 30,
2012

 

Valuation Technique

 

Unobservable Input

 

Range

 

RMBS

 

$

337,900

 

Discounted cash flow

 

Constant prepayment rate

 

(0.4%) - 10.2%

 

 

 

 

 

 

 

Constant default rate

 

2.2% - 17.2%

 

 

 

 

 

 

 

Loss severity

 

34% - 102% (b)

 

 

 

 

 

 

 

Delinquency Rate

 

5% - 60%

 

 

 

 

 

 

 

Servicer Advances

 

14% - 100%

 

 

 

 

 

 

 

Annual Coupon Deterioration

 

0% - 0.31%

 

Loans held for investment

 

$

2,647,656

 

Discounted cash flow

 

Projected cash flows (a) Discount rates

 

3.8% -15.6%

 

Loans transferred as secured borrowings

 

$

87,321

 

Discounted cash flow

 

Projected cash flows (a) Discount rates

 

3.8% - 4.6%

 

Other investments

 

$

32,317

 

Discounted cash flow

 

Projected cash flows (a) Discount rates

 

9.5%

 

Secured financing agreements

 

$

1,310,668

 

Discounted cash flow

 

Projected cash flows (a) Discount rates

 

2.4% - 5.4%

 

Loan transfer secured borrowings

 

$

88,411

 

Discounted cash flow

 

Projected cash flows (a) Discount rates

 

3.5% - 3.8%

 

 


(a)         As of September 30, 2012, management expects to collect all amounts contractually due.

(b)         90% of the portfolio falls within a range of 40-85%.

 

14. Commitments and Contingencies

 

As described in Note 5, as of September 30, 2012, we had unfunded commitments totaling $1.7 million related to an investment.

 

As of September 30, 2012, we had future funding commitments on 17 loans totaling $128.2 million.  The funding commitments relate primarily to development, leasing commissions and tenant improvements to the extent new leases on the underlying collateral are signed.

 

Management is not aware of any other contractual obligations, legal proceedings, or any other contingent obligations incurred in the normal course of business that would have a material adverse effect on our financial statements.

 

15. Subsequent Events

 

On October 3, 2012, we sold the $94.5 million A-Note component of a $135.0 million first mortgage loan on two Class B office buildings located in the SoHo district of Midtown Manhattan.  We retained the $40.5 million B-Note.  We originated the first mortgage loan during the second quarter of 2012.

 

On October 10, 2012, we completed an underwritten public offering of 18,400,000 shares of our common stock at a price of $22.74 for total gross proceeds of approximately $418.4 million.  In addition, on October 10, 2012 we granted 875,000 restricted stock units with a fair value of approximately $19.9 million at the grant date to our Manager under the Manager Equity Plan.  This award will vest ratably in quarterly installments over a three-year period beginning on December 31, 2012, subject to the Manager’s continued service as our manager.

 

On October 16, 2012, through a newly-formed venture with Starwood Distressed Opportunity Fund IX (“Fund IX”), an affiliate of our Manager, we co-originated a $475 million first mortgage and mezzanine financing for the acquisition and redevelopment of a 10-story retail building located at 701 Seventh Avenue in the Times Square area of Manhattan. Of the total loan amount, $375 million was funded at closing, $281.2 million of which was funded by us and $93.8 million that was funded by Fund IX. In addition, $100 million will be funded upon reaching certain milestones during the transformation of the property.  On October 22, 2012, the venture sold a 25 percent participation in both the first mortgage and mezzanine loan to Vornado Realty Trust (“Vornado”).  Upon settling this sale, the Company, Starwood Distressed Opportunity Fund IX, and Vornado had funded $210.9 million, $70.3 million and $93.8 million, respectively, and each party will fund their pro rata share of any future fundings. Following the sale to Vornado, the Starwood entities retained the controlling position in both the first mortgage and mezzanine loans.

 

On October 26, 2012, we originated a $126 million first mortgage secured by a 25 story Class A office tower located at 100 Montgomery Street, San Francisco, CA. The loan has an initial funding of $115. 5 million with a future funding obligation of $10.5 million for tenant improvements and leasing commissions.   The loan bears interest at one-month LIBOR plus 3.95%, subject to a 0.25% LIBOR floor.  The loan has a three-year term with two one-year extensions, subject to certain conditions.

 

33



 

On November 5, 2012, we purchased the senior participation in a whole loan secured by an office building located in Washington DC for $45.6 million.  The loan has a three-year term with two one-year extensions.

 

On November 6, 2012 our board of directors declared a dividend of $0.44 per share for the fourth quarter of 2012, which is payable on January 15, 2013 to common stockholders of record on December 31, 2012.

 

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the information included elsewhere in this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. This description contains forward-looking statements that involve risks and uncertainties. Actual results could differ significantly from the results discussed in the forward-looking statements due to the factors set forth in “Risk Factors” and elsewhere in the Quarterly Reports on Form 10-Q for the quarters ended March 31, 2012, June 30, 2012, and September, 30 2012, and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

 

Overview

 

Starwood Property Trust, Inc. (together with its subsidiaries, “we” or the “Company”) is a Maryland corporation that commenced operations on August 17, 2009 upon completion of our initial public offering. We are focused on originating, investing in, financing and managing commercial mortgage loans and other commercial real estate debt investments, commercial mortgage-backed securities (“CMBS”), and other commercial real estate-related debt investments.  We collectively refer to commercial mortgage loans, other commercial real estate debt investments, CMBS, and other commercial real estate-related debt investments as our target assets.  We also invest in residential mortgage-backed securities (“RMBS”) and residential REO, and may invest in distressed or non-performing loans, commercial properties subject to net leases and residential mortgage loans.  As market conditions change over time, we may adjust our strategy to take advantage of changes in interest rates and credit spreads as well as economic and credit conditions.

 

Our objective is to provide attractive risk-adjusted global returns to our investors over the long term, primarily through dividends and secondarily through capital appreciation. We employ leverage, to the extent available, to fund the acquisition of our target assets and to increase potential returns to our stockholders. In order to achieve these objectives, we are focusing on asset selection and the relative value of various sectors within the debt market to construct a diversified investment portfolio designed to produce attractive returns across a variety of market conditions and economic cycles. We are organized as a holding company that conducts its business primarily through its various subsidiaries.

 

We have elected to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes, commencing with our initial taxable year ended December 31, 2009. We also operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940, as amended.

 

34



 

Recent Developments

 

The significant developments during 2012 include the following:

 

Three months ended March 31, 2012

 

·                  Sold 50% of our Euro-denominated loan to a strategic partner, which resulted in proceeds of $28.8 million and a realized loss of $2.1 million. However, the transactions were earnings neutral after considering the realized gains on currency hedges of $2.1 million that were terminated in connection with the sale.

·                  Acquired $95.4 million of GBP-denominated B-Notes secured by four resorts in the United Kingdom. The newly issued B-Notes are part of an overall corporate refinancing in which we had a $143.9 million pre-existing GBP-denominated investment. The pre-existing investment was originally purchased at a discount and, due to the early prepayment, we recognized additional income of approximately $12.2 million during the first quarter of 2012, which is considered to be a non-recurring event.

·                  Acquired $222.8 million of CMBS at a discounted price of $206.4 million, where the obligors are certain special purpose entities that were formed to hold substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties.  The acquisition was financed using a new $155.4 million facility provided by the seller.

·                  Originated a $40.0 million mezzanine loan secured by a 10-property portfolio of full-service and extended-stay hotels located in eight different states.

·                  Our subsidiary extended the maturity date of its $100 million master repurchase and securities contract with an affiliate of Wells Fargo Securities, LLC used to finance the acquisition and ownership of RMBS, from March 16, 2012 to March 15, 2013. Advances under the facility accrue interest at a per annum interest rate equal to the sum of (i) 30-day LIBOR plus (ii) a margin of 2.10%. We have guaranteed the obligations of our subsidiary under the facility. The facility and related guarantee contain various affirmative and negative covenants applicable to us that are similar in nature to covenants contained in our other financing agreements.

·                  Acquired a $125.0 million participation in a senior loan secured by all the material assets of a worldwide operator of hotels, resorts and timeshare properties for a discounted purchase price of approximately $115.7 million. The acquisition was financed with an $81.0 million increase in a financing facility previously provided by the seller.

·                  We, through certain of our subsidiaries, entered into a new $125.0 million financing facility with an affiliate of Citigroup Global Markets Inc., to finance commercial mortgage loans and senior interests in commercial mortgage loans originated or acquired by us and including loans and interests intended to be included in commercial mortgage loan securitizations as well as those not intended to be securitized. Advances under the facility accrue interest at a per annum interest rate equal to the sum of (i) 30-day LIBOR plus (ii) a margin of between 1.75% and 3.75% depending on (A) asset type, (B) the amount advanced and (C) the debt yield and loan-to-value ratios of the purchased mortgage loan. The facility has an initial maturity date of March 29, 2014, subject to three one-year extension options, which may be exercised by us upon the satisfaction of certain conditions. We have guaranteed the obligations of our subsidiaries under the facility up to a maximum liability of 25% of the then-currently outstanding repurchase price of assets financed there under. The facility and related guarantee contain various affirmative and negative covenants applicable to us that are similar in nature to covenants contained in our other financing agreements.

·                  On February 29, 2012, our board of directors declared a dividend of $0.44 per share for the first quarter of 2012, which was payable on April 13, 2012 to shareholders of record on March 30, 2012.

·                  Funded a $59.0 million mortgage loan secured by an office campus located in Northern California. The terms of the loan provide for up to $4.0 million of future advances upon the satisfaction of specified conditions.

·                  Sold the remainder of our held-for-sale first mortgage loans targeted for securitization. As of December 31, 2011, our net equity investment in these six loans was $36.5 million and the loans had a carrying value of $128.6 million. We realized an aggregate profit of approximately $1.0 million on the held-for-sale loans and associated interest rate hedges.

 

Three months ended June 30, 2012

 

·                  Acquired $75.6 million of CMBS at a discounted price of $70.7 million, where the obligors are certain special purpose entities that were formed to hold substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties.  The acquisition was partially financed using a $49.3 million increase in a financing facility previously provided by the seller.

·                  Sold 20,000,000 shares of common stock at a net price of $19.88 per share, resulting in gross proceeds of $397.7 million. On April 30, 2012, the underwriters exercised their option to purchase 3,000,000 additional shares of common stock at $19.88 per share, resulting in additional gross proceeds of $59.6 million.

·                  Originated a $73.0 million junior mezzanine loan, of which $45.0 million was initially funded, collateralized by a portfolio of six office buildings located in Rosslyn, Virginia.  The loan provides for up to $28.0 million in future funding for projected capital improvements and leasing costs.  Our junior mezzanine loan was co-originated with a $125.0 million first mortgage loan and a $40.0 million senior mezzanine loan, which were separately funded by third party lenders at closing.

 

35



 

·                  Originated a $170.0 million first mortgage loan on two Class B office buildings located in the SoHo district of Midtown Manhattan. Collectively known as One SoHo Square, the two properties located at 161 Avenue of the Americas and 233 Spring Street comprise over 600,000 square feet of office and retail space, which is currently 96% occupied. The first mortgage loan had an initial funding of $135.0 million, with $35.0 million available for future advances to pay for tenant improvements, leasing commissions and redevelopment costs.

·                  Originated an $11.6 million first mortgage loan collateralized by a collection of office, retail and parking properties in downtown San Diego, California.

·                  On May 8, 2012, our board of directors declared a dividend of $0.44 per share for the second quarter of 2012, which was payable on July 13, 2012 to common stockholders of record as of June 30, 2012.

·                  On May 24 and June 28, 2012 we acquired 226 and 26 residential real estate owned (“REO”) properties from a major bank at a cost of $24.5 million and $2.8 million, respectively.  Most of the properties were vacant at acquisition, and we are actively preparing the properties to be either rented or sold, as applicable.  From the date of acquisition through June 30, 2012, we incurred approximately $0.3 million in costs of getting the properties ready for their intended use, and such costs were added to our investment basis.

·                  Originated a $30.0 million mezzanine loan collateralized by an office building in Philadelphia, Pennsylvania.

·                  During the second quarter 2012 we acquired $173.0 million of RMBS (face value) at a $65.2 million discount.

 

Three months ended September 30, 2012:

 

·                  On July 3, 2012, we entered into a Purchase and Repurchase Agreement and Securities Contract (“Onewest Repurchase Agreement”) with Onewest Bank, FSB (“Onewest”).  At closing, we transferred loan investments to Onewest in exchange for a $78.3 million advance.  Borrowings under the Onewest Repurchase Agreement accrue interest at a pricing rate of one-month LIBOR plus a margin of 3.0%.  The initial maturity date of the facility is July 3, 2015 with two one-year extension options, subject to certain conditions.

·                  On July 6, 2012, we originated a $51.5 million first mortgage collateralized by three hotels located in North Carolina, New Jersey, and Virginia.  The initial term for the loan is two years, with three one-year extension options.

·                  On July 20, 2012, we purchased a 50% undivided participation interest (the “Le Meridien Participation Interest”) in a EUR-denominated mezzanine loan for $68.4 million (“Le Méridien Loan”) from an independent third party.  The borrower is Starman Luxembourg Holdings S.À R.L. (“Holdings”), an entity that indirectly owns and operates a portfolio of hotels in France and Germany.  Holdings is owned 50% by an independent third party and 50% by several private investment funds that were previously sponsored by Starwood Capital Group Global I, L.L.C., an affiliate of our Manager.  The Le Méridien Loan has an initial term of two years with an option to extend for an additional year, subject to certain conditions, an interest rate of 12.5%, an upfront fee of 2.0% and a prepayment fee of 1.0%.  We acquired the Le Meridien Participation Interest from an independent third party and own the Le Meridien Participation Interest subject to a participation agreement between us and the independent third party (the “Le Meridien Participation Agreement”). The Le Meridien Participation Agreement provides for the payment to us, on a pro rata basis with an independent third party, of customary payments in respect of the Le Meridien Participation Interest and affords us customary voting, approval and consent rights.

·                  On August 3, 2012, Starwood Property Mortgage Sub-10, LLC (“SPM Sub-10”) and Starwood Property Mortgage Sub-10A (“SPM Sub 10-A”), our indirect wholly-owned subsidiaries, jointly entered into a $250.0 million Senior Secured Revolving Credit Facility arranged by Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPFS”).  Lender participants in the facility include Bank of America, Citibank, Barclays Bank PLC, Deutsche Bank Trust Company Americas, Goldman Sachs Bank USA, and Stifel Bank & Trust.  The facility matures 364 days from closing, and may be extended from time to time, provided the aggregate tenure shall not exceed four years.  Outstanding borrowings under the facility will be priced at LIBOR + 325 bps, with an unused fee of 30 to 35 bps per annum depending upon the usage of the facility.  The facility will be used primarily to finance our purchase or origination of commercial mortgage loans for the time period between transaction closing and the time in which a financing of the loan can be closed with one of our existing secured warehouse facilities or the loan is sold/syndicated in whole or in part.  The term of financing provided under the facility for any individual loan is limited in most instances to the lesser of six months or the maturity of the facility.  The facility will be secured by each loan for which financing has been provided as well at least $500,000,000 in market value of additional preapproved unencumbered senior, subordinate, and mezzanine loan assets.  The facility is full recourse to us.

·                  On August 2, 2012, our board of directors declared a dividend of $0.44 per share for the third quarter of 2012, which was payable on October 15, 2012 to common stockholders of record on September 28, 2012.

·                  On August 17, 2012, we originated a $46.0 million first mortgage collateralized by a 315-room Hilton hotel in Rockville, Maryland.  The term of the loan is three years, with two one-year extension options.

 

36



 

·                  On August 21, 2012, we acquired a $250.0 million participation in a mezzanine loan that is secured primarily by indirect equity interests in subsidiaries that own substantially all of the assets of a worldwide operator of hotels, resorts, and timeshare properties.  We acquired this investment at a discounted price of $233.75 million, with $158.75 million being financed by the seller.  The maturity date of the mezzanine loan is November 12, 2012, with three one-year extensions remaining, subject to a 0.5% fee for the second and third remaining extensions.  Coincident with this purchase, we sold $165 million in face value of the securitized first mortgage loan component of the same financing transaction, which resulted in a gain of $8.2 million.  This sale was undertaken to manage our overall credit exposure to the borrower.

·                  On September 18, 2012, we originated a $61.0 million first mortgage collateralized by two Class B+/A- office buildings located in Glendale, California. The term of the loan is three years, with two one-year extension options.

 

Subsequent to September 30, 2012

 

·                  On October 3, 2012, we sold the $94.5 million A-Note component of a $135.0 million first mortgage loan on two Class B office buildings located in the SoHo district of Midtown Manhattan.  We retained the $40.5 million B-Note.  We originated the first mortgage loan during the second quarter of 2012.

·                  On October 10, 2012, we completed an underwritten public offering of 18,400,000 shares of our common stock at a price of $22.74 for total estimated gross proceeds of approximately $418.4 million.  In addition, on October 10, 2012 we granted 875,000 restricted stock units with a fair value of approximately $19.9 million at the grant date to our Manager under the Manager Equity Plan.  This award will vest ratably in quarterly installments over a three-year period beginning on December 31, 2012, subject to the Manager’s continued service as our manager.

·                  On October 16, 2012, through a newly-formed venture with Starwood Distressed Opportunity Fund IX (“Fund IX”), an affiliate of our Manager, we co-originated a $475 million first mortgage and mezzanine financing for the acquisition and redevelopment of a 10-story retail building located at 701 Seventh Avenue in the Times Square area of Manhattan. Of the total loan amount, $375 million was funded at closing, $281.2 million of which was funded by us and $93.8 million that was funded by Fund IX.  In addition, $100 million will be funded upon reaching certain milestones during the transformation of the property.  On October 22, 2012, the venture sold a 25 percent participation in both the first mortgage and mezzanine loan to Vornado Realty Trust (“Vornado”).  Upon settling this sale, the Company, Starwood Distressed Opportunity Fund IX, and Vornado had funded $210.9 million, $70.3 million and $93.8 million, respectively, and each party will fund their pro rata share of any future fundings. Following the sale to Vornado, the Starwood entities retained the controlling position in both the first mortgage and mezzanine loans.

·                  On October 26, 2012, we originated a $126 million first mortgage secured by a 25 story Class A office tower located at 100 Montgomery Street, San Francisco, CA. The loan has an initial funding of $115.5 million with a future funding obligation of $10.5 million for tenant improvements and leasing commissions.  The loan bears interest at one-month LIBOR plus 3.95%, subject to a 0.25% LIBOR floor.  The loan has a three-year term with two one-year extensions, subject to certain conditions.

·                  On November 5, 2012, we purchased the senior participation in a whole loan secured by an office building located in Washington DC for $45.6 million.  The loan has a three-year term with two one-year extensions.

·                  On November 6, 2012 our board of directors declared a dividend of $0.44 per share for the fourth quarter of 2012, which is payable on January 15, 2013 to common stockholders of record on December 31, 2012.

 

Our investment portfolio was comprised of the following at September 30, 2012 (dollar amounts in thousands):

 

 

 

Property
Type

 

Carrying
Value

 

Face
Amount

 

%
Owned

 

Financing (1)

 

Net
Investment

 

Vintage

 

Loan Originations

 

Assorted

 

$

1,555,141

 

$

1,562,406

 

100

%

$

384,503

 

$

1,170,638

 

2009-2012

 

Loan Acquisitions

 

Assorted

 

1,111,669

 

1,202,688

 

100

%

571,902

 

539,767

 

1989-2012

 

CMBS

 

Assorted

 

528,965

 

523,619

 

100

%

294,284

 

234,681

 

2010-2012

 

RMBS

 

Residential

 

337,900

 

510,917

 

100

%

145,089

 

192,811

 

2003-2007

 

Other Investments

 

Assorted

 

 

75,750

 

75,750

 

94

%

 

 

75,750

 

N/A

 

 

 

 

 

$

3,609,425

 

$

3,875,380

 

 

 

$

1,395,778

 

$

2,213,647

 

 

 

 


(1)   Excludes financing of $1.9 million related to the prepayment of a loan in September 2012.  Amounts were remitted in October 2012.  The $2.2 million loan receivable is recorded in Other Assets and the corresponding financing is recorded in secured financing agreements on the condensed consolidated balance sheet.

 

Our total investment portfolio, excluding other investments, has the following characteristics based on carrying values:

 

Collateral Property Type

 

As of
September 30,

2012

 

As of
December 31,
2011

 

Hospitality

 

49.3

%

39.9

%

Office

 

18.8

 

20.1

 

Retail

 

8.8

 

21.0

 

Residential

 

9.6

 

5.9

 

Industrial

 

3.0

 

3.8

 

Mixed Use

 

3.5

 

5.6

 

Multi-family

 

1.9

 

3.3

 

Other

 

5.1

 

0.4

 

 

 

100.0

%

100.0

%

 

37



 

Geographic Location

 

As of
September 30,

2012

 

As of
December 31,
2011

 

West

 

25.9

%

23.5

%

Northeast

 

19.8

 

12.5

 

Southeast

 

17.3

 

19.0

 

Mid-Atlantic

 

14.0

 

19.7

 

Midwest

 

10.3

 

12.9

 

International

 

8.5

 

7.6

 

Southwest

 

4.2

 

4.8

 

 

 

100.0

%

100.0

%

 

Critical Accounting Policies and Use of Estimates

 

Refer to the section of our Annual Report on Form 10-K for the year ended December 31, 2011 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” for full discussion of our critical accounting policies.  Our critical accounting policies have not materially changed during 2012.

 

Recent Accounting Pronouncements

 

In December 2011, the FASB issued amended guidance which will enhance disclosures required by GAAP by requiring improved information about financial instruments and derivative instruments that are either (1) offset or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset. This information will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. We will be required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods, by providing the disclosures required by those amendments retrospectively for all comparative periods presented. We are in the process of evaluating the impact that this guidance will have on our financial statement disclosures.

 

38



 

Results of Operations

 

Net income attributable to Starwood Property Trust, Inc. for the three and nine months ended September 30, 2012 was approximately $50.2 million and $144.9 million, respectively, or $0.43 and $1.34 per weighted average share of basic common stock and $0.43 and $1.34 per weighted average share of diluted common stock, respectively, up from $14.5 million and $78.3 million, respectively, or $0.16 and $0.95 per weighted average share of basic common stock and $0.15 and $0.94 per weighted average share of diluted common stock, respectively for the same periods in 2011. For the three and nine months ended September 30, 2012, net interest margin increased by approximately $10.1 million and $61.0 million from the prior comparable periods, resulting from increases in interest income of $14.8 million and $73.7 million, respectively, and increases in interest expense of $4.7 million and $12.6 million, respectively. The increase in net interest margin is primarily due to increased investment activity and the prepayment of our GBP-denominated loan during the three months ended March 31, 2012, which resulted in $13.1 million of accelerated discount accretion.  The increase in interest expense is a result of increased borrowing under the nine financing facilities we have drawn upon as of September 30, 2012.  From September 30, 2011 to September 30, 2012 other investments increased $32.2 million, MBS securities increased by $514.8 million and investments in loans increased $679.2 million.  As of September 30, 2012, the weighted average cost of the secured financings was 3.7%, including the impact of interest rate hedges.

 

For the three and nine months ended September 30, 2012, non-investment expenses increased by $5.0 million and $16.4 million, respectively, from the same periods in 2011. The year over year period increases were due to increases (decreases) in the base management fee of $4.7 million and $13.7 million, respectively, stock compensation expense of $1.2 million and $1.8 million, respectively, investment pursuit costs of ($0.6) million and $0.9 million, respectively, general and administrative expenses of $0.9 million and $1.8 million, respectively, and the accrued incentive fee of $2.1 million and $2.4 million, respectively. The increase in the base management fee was due primarily to our supplemental equity raises in May 2011 with net proceeds of $475.4 million and April 2012 with net proceeds of $454.8 million. The increase in the incentive fee was primarily attributable to the prepayment of our GBP denominated loan, resulting in $13.1 million of accelerated accretion of the purchase discount.  In May 2012, the Manager was granted an additional 30,000 restricted stock units, resulting in higher stock compensation expense in the subsequent periods. Lastly, the increase in general and administrative expense is primarily attributed to increased professional fees, such as legal, audit and consulting, in connection with growing the investment portfolio.

 

For the three and nine months ended September 30, 2012, we had realized gains (losses) from the sale of investments of $9.0 million and $19.1 million, respectively, of which $0 and $7.1 million, respectively, related to the sale of loans and $9.0 million and $12.0 million, respectively related to the sale of MBS securities.  The gain on sale of loans primarily related to the sale of our loans held-for-sale and partial sale of our EUR-denominated loan and the sale of CMBS with a face value of $190 million and a realized gain of $8.0 million.  Refer to Note 7 of the condensed consolidated financial statements for more information on loan sales and securitization activity.  For the three and nine months ended September 30, 2011, we had realized gains from the sale of investments of $5.0 million and $20.8 million, of which $0.0 million and $10.5 million related to the sale of MBS securities and other investments and, $5.0 million and $10.3 million related to the sale of loans.  For the three and nine months ended September 30, 2012, we had net losses on currency hedges of ($7.5) million and ($10.4) million, respectively, compared to gains of $8.6 million and $2.4 million, respectively, from the prior comparable periods.  For the three and nine months ended September 30, 2012, we had unrealized foreign currency remeasurement gains of $7.1 million and $2.7 million, respectively, compared to unrealized foreign currency remeasurement losses of ($9.4) million and ($4.2) million, respectively, from the prior comparable periods.  The fluctuation in the currency hedge and foreign currency remeasurement gains and losses year over year was primarily due to the movement in the EUR and GBP to USD exchange rates, as well as derivative contracts that matured or were effectively settled. Additionally, the pre-payment of our GBP denominated loan resulted in effective currency hedge losses of $10.0 million and realized foreign currency remeasurement gains of $8.8 million.  The partial sale of our EUR denominated loan resulted in realized gains on foreign currency hedges of $2.1 million.  For the three and nine months ended September 30, 2012, we had realized gains (losses) on interest rate hedges of ($51) thousand and $0.6 million, compared realized gains on interest rate hedges of $12.3 million and $9.4 million, respectively, from the comparable prior periods.  We had no credit hedges for the three and nine months ended September 30, 2012, compared to net gains on credit hedges of $2.3 million and $3.7 million, respectively, from the prior comparable periods. 

 

39



 

The reported and diluted per share amounts of our interest margin and expenses for the three months ended September 30, 2012 and 2011 were as follows (amounts in thousands except per share data):

 

 

 

For the three month period ended September 30,

 

 

 

2012

 

2011

 

 

 

Reported
Amount

 

Per Diluted
Share

 

Reported
Amount

 

Per Diluted
Share

 

Net interest margin:

 

 

 

 

 

 

 

 

 

Cash coupon received from loans

 

$

50,559

 

$

0.43

 

$

45,088

 

$

0.48

 

Constant yield adjustments on loans(1)

 

5,702

 

0.05

 

6,791

 

0.07

 

Cash coupon received from mortgage-backed securities (“MBS”)

 

6,017

 

0.05

 

1,084

 

0.01

 

Constant yield adjustments on mortgage-backed securities(2)

 

10,568

 

0.09

 

5,111

 

0.05

 

Cash interest expense

 

(9,929

)

(0.08

)

(5,917

)

(0.06

)

Amortization of debt issuance costs

 

(2,101

)

(0.02

)

(1,404

)

(0.01

)

Net interest margin

 

60,816

 

0.52

 

50,753

 

0.54

 

Expenses:

 

 

 

 

 

 

 

 

 

Base management fee

 

8,461

 

0.07

 

6,650

 

0.07

 

Management incentive fee

 

2,101

 

0.02

 

432

 

0.01

 

Stock compensation - Manager

 

4,097

 

0.03

 

2,922

 

0.03

 

Total management fees

 

14,659

 

0.12

 

10,004

 

0.11

 

Transaction and dead deal costs

 

622

 

0.01

 

1,201

 

0.01

 

General and administrative

 

3,084

 

0.03

 

2,177

 

0.02

 

Total expenses

 

18,365

 

0.16

 

13,382

 

0.14

 

Income before other income (expenses) and income taxes

 

$

42,451

 

$

0.36

 

$

37,371

 

$

0.40

 

 


(1)         Represents the aggregate adjustments necessary to recognize income from loans on a constant yield basis, which is comprised primarily of discount accretion, but also includes the amortization of loan fees and costs.

(2)         Represents the aggregate adjustments necessary to recognize income from MBS on a constant yield basis, which is comprised primarily of discount accretion.

 

The reported and diluted per share amounts of our interest margin and expenses for the nine months ended September 30, 2012 and 2011 were as follows (amounts in thousands except per share data):

 

 

 

For the nine month period ended September 30,

 

 

 

2012

 

2011

 

 

 

Reported
Amount

 

Per Diluted
Share

 

Reported
Amount

 

Per Diluted
Share

 

Net interest margin:

 

 

 

 

 

 

 

 

 

Cash coupon received from loans

 

$

144,052

 

$

1.33

 

$

107,182

 

$

1.28

 

Constant yield adjustments on loans(1)

 

35,026

 

0.32

 

18,461

 

0.22

 

Cash coupon received from mortgage-backed securities (“MBS”)

 

15,340

 

0.14

 

7,724

 

0.09

 

Constant yield adjustments on mortgage-backed securities(2)

 

25,064

 

0.24

 

12,452

 

0.15

 

Cash interest expense

 

(28,900

)

(0.27

)

(17,991

)

(0.22

)

Amortization of debt issuance costs

 

(5,445

)

(0.05

)

(3,732

)

(0.04

)

Net interest margin

 

185,137

 

1.71

 

124,096

 

1.48

 

Expenses:

 

 

 

 

 

 

 

 

 

Base management fee

 

23,260

 

0.22

 

17,568

 

0.21

 

Management incentive fee

 

7,487

 

0.07

 

1,178

 

0.01

 

Stock compensation - Manager

 

11,926

 

0.11

 

10,268

 

0.13

 

Total management fees

 

42,673

 

0.40

 

29,014

 

0.35

 

Transaction and dead deal costs

 

2,737

 

0.02

 

1,820

 

0.02

 

General and administrative

 

8,838

 

0.08

 

7,041

 

0.08

 

Total expenses

 

54,248

 

0.50

 

37,875

 

0.45

 

Income before other income (expenses) and income taxes

 

$

130,889

 

$

1.21

 

$

86,221

 

$

1.03

 

 

40



 


(1)

Represents the aggregate adjustments necessary to recognize income from loans on a constant yield basis, which is comprised primarily of discount accretion, but also includes the amortization of loan fees and costs.

(2)

Represents the aggregate adjustments necessary to recognize income from MBS on a constant yield basis, which is comprised primarily of discount accretion.

 

The overall increase in net interest margin per diluted share for the three and nine months ended September 30, 2012 over the comparable periods in the prior year was due to the deployment of more capital throughout the second half of 2011 and year-to-date 2012, and the early repayment of our GBP-denominated loan, which resulted in net additional net interest margin income of $13.1 million.  Management fees for the three and nine months ended September 30, 2012 increased from the same periods in the prior year due to the increase in core earnings per share, which resulted primarily from the early repayment of our GBP-denominated loan as mentioned above.

 

Cash Flows

 

Cash and cash equivalents increased by $30.2 million from December 31, 2011.  The increase resulted from cash provided from operating activities of $226.0 million and cash provided from financing activities of $553.7 million, offset by cash used in investing activities of $749.5 million.

 

The primary drivers of the cash generated from operations were cash income from loans and MBS of $159.4 million and proceeds from the sale of our loans held-for-sale.  For the nine months ended September 30, 2012, cash income from loans was $144.1 million and cash income from MBS was $15.3 million, increases from the prior comparable period of $36.9 million and $7.6 million, respectively.  The increase in cash income was primarily due to our growing investment portfolio and continued deployment of capital from the same period last year.  In March 2012, we sold our remaining held-for-sale loans into a securitization for gross cash proceeds of $132.0 million and had two partial sales of our EUR denominated loan, which resulted in a net realized gain of $7.2 million.

 

Net cash used in investing activities primarily related to the origination and purchase of loans and the purchase of MBS, net of loan and security principal repayments.  For the nine months ended September 30, 2012, we purchased or originated $942.7 million of loans, purchased $575.7 million of MBS and had $460.8 million of loans payoff.  For the nine months ended September 30, 2011, we purchased or originated $1,018.5 million of loans, purchased $187.1 million of MBS, had $264.6 million of loans payoff and sold $261.6 million of MBS resulting in a realized gain of $10.3 million.

 

Net cash used in financing activities primarily related to the borrowings and repayments under our secured financing arrangements, payment of dividends and proceeds from common stock equity offerings.  For the nine months ended September 30, 2012, we borrowed $1,370.3 million and repaid $1,164.4 million under our secured financing arrangements, paid $134.5 million in dividends to our shareholders and generated $456.7 million in net proceeds from our April 2012 common stock offering.  For the nine months ended September 30, 2011, we borrowed $1.0 billion and repaid $991.8 million under our secured financing arrangements, paid $101.3 million dividends to our shareholders, generated $475.6 million in net proceeds from our May 2011 common stock offering and paid $27.2 million in deferred offering costs from our IPO.

 

Liquidity and Capital Resources

 

Liquidity is a measure of our ability to meet our cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make new investments where appropriate, pay any dividends to our stockholders, and other general business needs. We closely monitor our liquidity position and believe that we have sufficient current liquidity and access to additional liquidity to meet our financial obligations for at least the next 12 months. Our primary sources of liquidity are as follows:

 

Cash Generated from Operating the Business, Including Repayments

 

Cash from operations is generally comprised of interest income from our investments, net of any associated financing expense, principal repayments from our investments and proceeds from the sale of investments, net of any associated financing repayments, and changes in working capital balances.

 

41



 

Cash and Cash Equivalents

 

As of September 30, 2012, we had cash and cash equivalents of $144.2 million.

 

Potential Liquidation of Certain RMBS and CMBS Positions

 

We regularly make certain investments in CMBS and RMBS. Our CMBS includes a $425.2 million investment in senior securities that are not rated, that are secured by substantially all of the assets of a worldwide operator of hotels, resorts, and timeshare properties, and which had an estimated loan-to-value ratio as of September 30, 2012 in the range of 39% - 44%. The remaining $103.8 million CMBS investment position is rated BB+. We have restricted our RMBS investments to an amount that at all times is no greater than 10% of our total assets. The portfolio generally has a duration of approximately five years and we have engaged a third party manager who specializes in RMBS to assist us in managing this portfolio. As of September 30, 2012, our investments in RMBS and CMBS are classified as available-for-sale and had a fair value of $337.9 million and $528.9 million, respectively.

 

Borrowings under Various Financing Arrangements

 

We utilize a variety of financing arrangements to finance certain assets. We generally utilize four types of financing arrangements:

 

1)                  Repurchase Agreements:  Repurchase agreements effectively allow us to borrow against loans and securities that we own. Under these agreements, we sell our loans and securities to a counterparty and agree to repurchase the same loans and securities from the counterparty at a price equal to the original sales price plus an interest factor. The counterparty retains the sole discretion over both whether to purchase the loan and security from us and, subject to certain conditions, the market value of such loan or security for purposes of determining whether we are required to pay margin to the counterparty. Generally, if the lender determines (subject to certain conditions) that the market value of the collateral in a repurchase transaction has decreased by more than a defined minimum amount, we would be required to repay any amounts borrowed in excess of the product of (i) the revised market value multiplied by (ii) the applicable advance rate. During the term of a repurchase agreement, we receive the principal and interest on the related loans and securities and pay interest to the counterparty. As of September 30, 2012, we had several repurchase agreements, as described in the table provided below.

 

2)                  Bank Credit Facilities:  We use bank credit facilities (including term loans and revolving facilities) to finance our assets. These financings may be collateralized or non-collateralized and may involve one or more lenders. Credit facilities typically have maturities ranging from two to five years and may accrue interest at either fixed or floating rates. As of September 30, 2012, we have two bank credit facilities as described in the table provided below.

 

3)                  Loan Sales/Syndications/Securitizations:  We seek non-recourse long-term financing from loan sales, syndications and/or securitizations of our investments in mortgage loans. The sales, syndications, and securitizations generally involve a senior portion of our loan, but may involve the entire loan. Loan sales and syndications generally involve the sale of a senior note component or participation interest to a third party lender. Securitization generally involves transferring notes to a special purpose vehicle (or the issuing entity), which then issues one or more classes of non-recourse notes pursuant to the terms of an indenture. The notes are secured by the pool of assets. In exchange for the transfer of assets to the issuing entity, we receive cash proceeds from the sale of non-recourse notes. Sales, syndications and securitizations of our portfolio investments might magnify our exposure to losses on those portfolio investments because the retained subordinate interest in any particular overall loan would be subordinate to the loan components sold and we would, therefore, absorb all losses sustained with respect to the overall loan before the owners of the senior notes experience any losses with respect to the loan in question.

 

42



 

Summary of Financing Facilities as of September 30, 2012 (dollar amounts in thousands):

 

 

 

Wells
Fargo I

 

Wells
Fargo II

 

Goldman
Sachs

 

Bank of
America

 

Wells
Fargo III

 

Wells
Fargo IV

 

Goldman
Sachs II

 

Citibank

 

Borrowing
Base

 

Goldman III

 

Onewest
Bank

 

Facility Type

 

Repurchase

 

Repurchase

 

Repurchase

 

Bank Credit Facility

 

Repurchase

 

Repurchase

 

Repurchase

 

Repurchase

 

Bank Credit Faciltiy

 

Repurchase

 

Repurchase

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revolver

 

No

 

Yes

 

Yes

 

No

 

Yes

 

No

 

No

 

Yes

 

Yes

 

No

 

No

 

Eligible Assets

 

Identified Loans

 

Identified Loans

 

Identified Loans

 

Single Borrower Secured Note

 

Identified RMBS

 

Identified Loans

 

Single Borrower Secured Note

 

Identified Loans

 

Identified Loans

 

Single Borrower Secured Note

 

Identified Loans

 

Initial Maturity

 

May-13

 

Aug-13

 

Dec-12

 

Nov-14

 

Mar-13

 

Dec-14

 

Aug-15

 

Mar-14

 

Aug-13

 

Sep-15

 

Jul-15

 

Extended Maturity (a) 

 

N/A

 

Aug-15

 

N/A

 

Nov-15

 

N/A

 

Dec-16

 

N/A

 

Mar-17

 

Aug-16

 

N/A

 

Jul-17

 

Pricing

 

LIBOR + 3%

 

LIBOR + 1.75% to 6%

 

LIBOR +1.95% to 2.25%

 

LIBOR + 2.35% to 2.5%

 

LIBOR + 2.10%

 

LIBOR + 2.75%

 

LIBOR + 2.90%

 

LIBOR + 1.75% to 3.75%

 

LIBOR +3.25%(j)

 

LIBOR +3.70%

 

LIBOR +3.00%

 

Minimum Loss to Trigger a Margin Call

 

(b)

 

(b)

 

(e)

 

$0

 

$250

 

(h)

 

$2,000

 

(i)

 

N/A

 

$4,000

 

(k)

 

Maximum Advance Rate on Collateral

 

(c)

 

75%

 

80%

 

(c)

 

(d)

 

(d)

 

(c)

 

75%

 

100% (l)

 

67.9%

 

75%

 

Pledged Asset Carrying Value

 

$104,433

 

$712,660

 

$0

 

$209,242

 

$254,478

 

$252,009

 

$215,930

 

$56,690

 

$505,260

 

$234,577

 

$112,552

 

Maximum Facility Size

 

$69,004

 

$550,000

 

$150,000

 

$143,176

 

$175,000

 

$189,853

 

$151,108

 

$125,000

 

$250,000

 

$158,750

 

$77,351

 

Outstanding Balance

 

$69,004

 

$335,025

 

$0

 

$143,176

 

$145,089

 

$189,853

 

$151,108

 

$40,094

 

$0

 

$158,750

 

$77,351

 

Approved but Undrawn Capacity (f) 

 

$0

 

$126,219

 

$0

 

$0

 

$0

 

$0

 

$0

 

$0

 

$0

 

$0

 

$0

 

Unallocated Financing Amount (g) 

 

$0

 

$88,756

 

$150,000

 

$0

 

$29,911

 

$0

 

$0

 

$84,906

 

$250,000

 

$0

 

$0

 

 


(a)                                 Subject to certain conditions as defined in facility agreement.

(b)                                 35 bps of aggregate outstanding principal amount.

(c)                                  Effectively not applicable as of September 30, 2012 as there was no longer any borrowing capacity available.

(d)                                 There is no defined maximum advance rate under this facility. The advance rates are determined separately for each repurchase transaction.

(e)                                  Margin deficit exists if the aggregate repurchase price exceeds the aggregate sum for all assets of the product of (i) the advance rate for each asset multiplied by (ii) its fair value.

(f)                                   Approved but undrawn capacity represents the total draw amount that has been approved by the lender related to the assets that have been pledged as collateral, less the actual amount that has been drawn.

(g)                                  Unallocated financing amount represents the maximum facility size less the total draw capacity that has been approved by the lender.

(h)                                 Lesser of $1.0 million or 35 bps of aggregate outstanding principal amount.

(i)                                     Margin may be called if the market value of all purchased assets is less than 99.5% of the sum of each asset’s initial purchase price divided by its approved advance rate.

(j)                                    Subject to borrower’s option to choose alternative benchmark based rates pursuant to the terms of the credit agreement.

(k)                                 3% of the aggregate repurchase price

(l)                                     Although 100% is the maximum advance rate, due to valuation mechanisms within the credit agreement most borrowings will be at a lower advance rate.

 

43



 

Summary of Total Financing Facility Ending Balances as of September 30, 2012 (amounts in thousands):

 

Aggregate Pledged Asset Carrying Value 

 

$

2,657,831

 

Aggregate Maximum Facility Size

 

$

2,039,242

 

Less: Aggregate Outstanding Balance

 

$

(1,309,450

)

Aggregate Undrawn Capacity

 

$

729,792

 

Aggregate Approved but Undrawn Capacity

 

$

126,219

 

 

Variance between Average and Quarter-End Credit Facility Borrowings Outstanding

 

The following table compares the average amount of repurchase transactions outstanding during the quarter and the amount of repurchase transactions outstanding as of the end of each quarter, together with an explanation of significant variances:

 

Quarter Ended

 

Quarter-End
Balance
(in 000’s)

 

Weighted-Average
Balance During Quarter
(in 000’s)

 

Variance
(in 000’s)

 

Explanations
for Significant
Variances

 

March 31, 2012

 

$

1,308,860

 

$

1,270,300

 

$

38,560

 

(a)

 

June 30, 2012

 

$

1,065,388

 

$

1,074,612

 

$

(9,224

)

(b)

 

September 30, 2012

 

$

1,309,450

 

$

1,280,953

 

$

28,497

 

(c)

 

 


(a)         Variance is primarily due to the following transactions:  (i) paydown of $92.1 million under the Goldman Repurchase Agreement on March 29, 2012 using proceeds from the sale of 6 conduit loans; (ii) $81.0 million draw under the BAML Credit Agreement in mid-March 2012 in conjunction with the closing of a $125.0 million participation in a senior loan; (iii)  A draw of $112.0 million was made under the Second Deustche Repurchase Agreement was made on December 27, 2011 to provide liquidity for the acquisition of a separate portfolio of loans for $333.0 million, which closed on December 30, 2011. $70.0 million was repaid under the Second Deutsche Repurchase Agreement in March 2012 after the loans were approved for financing under the Fourth Wells Repurchase Agreement in Q1 2012; (iv) $88.0 million additional draw on the Fourth Wells Repurchase Agreement to leverage a $333.0 million portfolio of loans that closed on December 30, 2011 where the majority of loans were approved for financing in Q1 2012; and (v) $155.4 million draw under the Second Goldman Repurchase Agreement in the beginning of February in conjunction with the acquisition of $222.8 million of CMBS.

(b)         Variance is primarily due to the following transactions:  (i) paydown of $38.5 million under the Wells Repurchase Agreement in early June 2012 using proceeds from the prepayment of 4 loans in the TIAA portfolio; (ii) various draws and repayments during the quarter under the Second Wells Repurchase Agreement in anticipation of multiple loan closings; (iii) additional draw of $55.1 million under the Third Wells Repurchase Agreement to lever the RMBS acquired during the quarter; (iv) paydown of $92.0 million in under the Second Deustche Repurchase Agreement using proceeds from the equity offering in April 2012, subsequent draw of $45.0 million in early May 2012 in anticipation of the REO pool acquisition, and repayment of $50.3 million in conjunction with the payoff of the loan pledged under the facility in early May 2012; and (v) paydown of $24.5 million under the Fourth Wells Repurchase Agreement in conjunction with the prepayment of 3 loans during May and June of 2012.

(c)          Variance is primarily due to the following transactions: (i) paydown of $98.7 million under the Bank of America Merrill Lynch Hilton line in late August 2012 using the proceeds from the sale of three securities; (ii) various draws and repayments during the quarter, including a draw of $132.3 million, under the Second Wells Repurchase Agreement in anticipation of multiple loan closings; (iii) additional draw of $30 million under the Third Wells Repurchase Agreement to lever the RMBS acquired during the quarter; (iv) a draw of $32.2 million under the Citi Repurchase Agreement in late September 2012; and (v) an initial draw of $158.8 million on a newly created financing line.

 

44



 

Quarter Ended

 

Quarter-End
Balance
(in 000’s)

 

Weighted-Average
Balance During Quarter
(in 000’s)

 

Variance
(in 000’s)

 

Explanations
for Significant
Variances

 

March 31, 2011

 

$

804,558

 

$

679,616

 

$

124,942

 

(d)

 

June 30, 2011

 

$

697,668

 

$

733,743

 

$

(36,075

)

(e)

 

September 30, 2011

 

$

604,308

 

$

711,823

 

$

(107,515

)

(f)

 

 


(d)         Variance is primarily due to the following transactions:  (i) approximately $207.6 million drawn under the Second Wells Repurchase Agreement in March 2011 related to five loans that were pledged, (ii) pay-down of $12.3 million in late March 2011 using proceeds from sales of TALF securities; and (iii) $78.4 million initially drawn under the Third Wells Repurchase Agreement in mid-March 2011, of which $40.0 million was repaid at the end of March 2011 using excess proceeds from third party asset sales.

(e)          Variance is primarily due to the following transactions: (i) repayment of $158.9 million in debt concurrent with CMBS sales under the TALF financing in late June 2011; (ii) repayment of $70 million on the facility upon maturity of 10 loans under the Wells Repurchase Agreement in early April 2011; and (iii) draws of $83.9 million on the Goldman line related to six conduit loans in mid-late June of 2011.

(f)           Variance is primarily due to the following transactions: (i) repayment of $62.1 million in debt concurrent with the maturity of a loan under the Wells Repurchase Agreement in early September 2011 and (ii) a pay-down of $68.2 million in debt concurrent with two loans sold into securitization under the Second Wells Repurchase Agreement in late August 2011.

 

45



 

Scheduled Principal Repayments on Investment

 

The following scheduled and/or projected principal repayments on our investments were based upon the amounts outstanding and contractual terms of the financing facilities in effect as of September 30, 2012 (amounts in thousands):

 

 

 

Scheduled Principal
Repayments on Loans

 

Scheduled/Projected
Principal Repayments on
RMBS and CMBS

 

Projected Required
Repayments
of Financing

 

Total Scheduled
Principal Repayments,
net of financing

 

Fourth Quarter 2012

 

$

45,711

 

$

23,199

 

$

(32,178

)

$

36,732

 

First Quarter 2013 (1) 

 

99,004

 

23,286

 

(212,667

)

(90,377

)

Second Quarter 2013

 

82,380

 

20,932

 

(56,132

)

47,180

 

Third Quarter 2013 (2)

 

7,861

 

19,175

 

(289,525

)

(262,489

)

Total

 

$

234,956

 

$

86,592

 

$

(590,502

)

$

(268,954

)

 


(1)

We expect to extend or otherwise refinance the Third Wells Repurchase Agreement, which is scheduled to mature in March 2013. This represents $145.1 million of the projected required repayments of financing in first quarter 2013.

(2)

We expect to extend the Second Wells Repurchase Agreement, which is scheduled to mature in August 2013. We have two one-year extension options, subject to certain conditions. This represents $282.5 million of the projected required repayments of financing in third quarter 2013.

 

Other Potential Sources of Financing

 

In the future, we may also use other sources of financing to fund the acquisition of our target assets, including other secured as well as unsecured forms of borrowing. We may also seek to raise further equity capital or issue debt securities in order to fund our future investments.

 

Leverage Policies

 

To the extent available we employ leverage, to both fund the acquisition of new investments and meet our return objectives, each within the context of our overall risk management strategy. Leverage can be either direct by utilizing private third party financing, or indirect through originating, acquiring, or retaining subordinated mortgages, B-notes, subordinated loan participations or mezzanine loans. Although the type of leverage we deploy is dependent on the underlying asset that is being financed, we intend when possible to utilize leverage whose maturity is equal to or greater than the maturity of the underlying asset. In addition, we intend to mitigate the impact of potential future interest rate increases on our borrowings through utilization of hedging instruments, primarily interest rate swap agreements.

 

The amount of leverage we deploy for particular investments in our target assets depends upon our Manager’s assessment of a variety of factors, which may include the anticipated liquidity and price volatility of the assets in our investment portfolio, the potential for losses and extension risk in our portfolio, the gap between the duration of our assets and liabilities, including hedges, the availability and cost of financing the assets, our opinion of the creditworthiness of our financing counterparties, the health of the U.S. economy and commercial and residential mortgage markets, our outlook for the level, slope, and volatility of interest rates, the credit quality of our assets, the collateral underlying our assets, and our outlook for asset spreads relative to the LIBOR curve. Under our current repurchase agreements and bank credit facility, our total leverage may not exceed 75%, as adjusted to remove the impact of the consolidation of variable interest entities and the treatment of bona-fide sales of financial instruments as financings, pursuant to GAAP.

 

Contractual Obligations and Commitments

 

Contractual obligations as of September 30, 2012 are as follows (amounts in thousands):

 

 

 

Total

 

Less than
1 year

 

1 to 3 years

 

3 to 5 years

 

More than
5 years

 

Secured financings, including interest payable

 

$

1,370,132

 

$

625,431

 

$

744,701

 

$

 

$

 

Loan transfer secured borrowings

 

98,831

 

4,626

 

58,133

 

36,072

 

 

Loan funding obligations

 

128,246

 

27,696

 

84,624

 

15,926

 

 

Venture investment funding obligation (1)

 

1,672

 

1,672

 

 

 

 

Total

 

$

1,598,881

 

$

659,425

 

$

887,458

 

$

51,998

 

$

 

 

46



 


(1)         Unfunded commitments relate to Investments in Island III-C (Centerline).

 

The table above does not include amounts due under our Management Agreement or derivative agreements as those contracts do not have fixed or determinable payments. Refer to Notes 8 and 9 to the condensed consolidated financial statements for obligations related to these agreements.

 

Off-Balance Sheet Arrangements

 

As of September 30, 2012, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured investment vehicles, or special purpose or variable interest entities, established to facilitate off-balance sheet arrangements or other contractually narrow or limited purposes. Further, as of September 30, 2012, we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide additional funding to any such entities.

 

Dividends

 

We intend to continue to make regular quarterly distributions to holders of our common stock. U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. We intend to continue to pay regular quarterly dividends to our stockholders in an amount at least equal to our estimated taxable income, if and to the extent authorized by our board of directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our debt. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.

 

The Company’s board of directors declared the following dividends in 2011 and 2012:

 

Ex-Dividend Date

 

Record Date

 

Announce Date

 

Pay Date

 

Amount

 

Frequency

 

9/26/2012

 

9/28/2012

 

8/3/2012

 

10/15/2012

 

$

0.44

 

Quarterly

 

6/27/2012

 

6/29/2012

 

5/08/2012

 

7/13/2012

 

$

0.44

 

Quarterly

 

3/28/2012

 

3/30/2012

 

2/29/2012

 

4/13/2012

 

$

0.44

 

Quarterly

 

12/28/2011

 

12/31/2011

 

11/4/2011

 

1/13/2012

 

$

0.44

 

Quarterly

 

9/28/2011

 

9/30/2011

 

8/2/2011

 

10/14/2011

 

$

0.44

 

Quarterly

 

6/28/2011

 

6/30/2011

 

5/10/2011

 

7/15/2011

 

$

0.44

 

Quarterly

 

3/29/2011

 

3/31/2011

 

3/1/2011

 

4/15/2011

 

$

0.42

 

Quarterly

 

 

On November 6, 2012, our board of directors declared a dividend of $0.44 per share of common stock for the quarter ending December 31, 2012. The dividend is payable on January 15, 2013 to common stockholders of record on December 31, 2012.

 

Non-GAAP Financial Measures

 

Core Earnings is a non-GAAP financial measure. We calculate Core Earnings as GAAP net income (loss) excluding non-cash equity compensation expense, the incentive fee, depreciation and amortization of real estate (to the extent that we own properties), any unrealized gains, losses or other non-cash items recorded in net income for the period, regardless of whether such items are included in other comprehensive income or loss, or in net income. The amount is adjusted to exclude one-time events pursuant to changes in GAAP and certain other certain other non-cash adjustments, in each case after discussions between our Manager and our independent directors and as approved by a majority of our independent directors.

 

We believe that Core Earnings provides an additional measure of our core operating performance by eliminating the impact of certain non-cash expenses and facilitating a comparison of our financial results to those of other comparable REITs with fewer or no non-cash charges and comparison of our own operating results from period to period. Our management uses Core Earnings in this way, and also uses Core Earnings to compute the incentive fee due under our Management Agreement. We believe that our investors also use Core Earnings or a comparable supplemental performance measure to evaluate and compare our performance to our peers, and as such we believe that the disclosure of Core Earnings is useful to (and expected by) our investors.

 

However, we caution that Core Earnings does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income (determined in accordance with GAAP), or an indication of our cash flow from operating activities (determined in accordance with GAAP), a measure of our liquidity, or an indication of funds

 

47



 

available to fund our cash needs, including our ability to make cash distributions. In addition, our methodology for calculating Core Earnings may differ from the methodologies employed by other REITs to calculate the same or similar supplemental performance measures, and accordingly, our reported Core Earnings may not be comparable to the Core Earnings reported by other REITs.

 

Our Core Earnings for the three and nine months ended September 30, 2012 were approximately $58.7 million and $163.7 million, or $0.50 and $1.52 per diluted weighted average share, respectively. The table below provides a reconciliation of net income to Core Earnings for this period:

 

September 30, 2012 Reconciliation of Net Income to Core Earnings (amounts in thousands except per share data):

 

 

 

Three Months
Ended September 30,
2012

 

Nine Months
Ended September 30,
2012

 

 

 

Reported
Amount

 

Per
Diluted
Share

 

Reported
Amount

 

Per
Diluted
Share

 

Net income attributable to Starwood Property Trust, Inc.

 

$

50,212

 

$

0.43

 

$

144,861

 

$

1.34

 

Unrealized loss on loans held-for-sale at fair value

 

 

 

5,760

 

0.05

 

Unrealized gain on interest rate hedges

 

77

 

(0.00

)

(9,991

)

(0.09

)

Other-than-temporary impairment

 

676

 

0.01

 

2,728

 

0.03

 

Unrealized foreign currency loss

 

(7,066

)

(0.06

)

(2,707

)

(0.03

)

Unrealized (gain) loss on currency hedges

 

8,173

 

0.07

 

13,320

 

0.12

 

Management incentive fee

 

2,101

 

0.01

 

7,487

 

0.08

 

Non-cash stock-based compensation

 

4,236

 

0.04

 

12,296

 

0.11

 

Realized other-than-temporary impairment for sold securities

 

 

(0.00

)

(105

)

(0.00

)

Depreciation

 

78

 

0.00

 

78

 

0.00

 

Loss from effective hedge termination

 

325

 

(0.00

)

(9,913

)

(0.09

)

Core Earnings

 

$

58,812

 

$

0.50

 

$

163,814

 

$

1.52

 

 

Effective beginning in the first quarter 2012, we slightly modified the definition of Core Earnings to allow for management to make adjustments, subject in each case to the approval of a majority of the independent directors, to Core Earnings that should be made in non-standard situations if and when they arise in order for us to calculate such earnings in a manner consistent with the objective of the measure.  During the first quarter 2012, we had such a situation.  In February 2012, our GBP-denominated loan prepaid.  At the time the loan was originally closed, we had hedged our exposure to fluctuations in the GBP/USD exchange rate through a series of foreign exchange forward contracts.  Under these derivative contracts, we sold GBP to our counterparty in exchange for USD (at a fixed exchange rate) on scheduled dates and at specified notional amounts that corresponded to the dates on which we expected to receive GBP-denominated interest and principal payments on our loan investment.  As a result of the loan being prepaid in February 2012, the foreign exchange forward contracts were no longer necessary hedges.  At that time, the hedge contracts were in a loss position to us of approximately $10 million.  In the process of negotiating the termination of the contracts, management was able to lock-in the amount of the loss by entering into new derivative contracts with a separate counterparty that had the same maturity dates and notional amounts, but wherein we would sell USD in exchange for GBP (offsetting positions).  We executed this structure as opposed to liquidating the original contracts as it was more cost effective.  However, because the original contracts remain in place, the loss has not been “realized” as that term is defined in GAAP.  As a result, while we have effectively locked-in the loss, it would not have been deducted in Core Earnings as previously defined.  Therefore, we have modified the definition of Core Earnings to allow for adjustments in non-standard situations such as this, provided that we obtain the approval for any such adjustments from a majority of our independent directors.  Adjustments subsequent to the first quarter 2012 are being made such that the appropriate amount of Core Earnings is reported as the offsetting contracts mature.

 

Our Core Earnings for the three and nine months ended September 30, 2011 were approximately $39.3 million and $106.8 million, or $0.42 and $1.28 per diluted weighted average share, respectively. The table below provides a reconciliation of net income to Core Earnings for this period:

 

48



 

September 30, 2011 Reconciliation of Net Income to Core Earnings (amounts in thousands except per share data):

 

 

 

Three Months
Ended September 30,
2011

 

Nine Months
Ended September 30,
2011

 

 

 

Reported
Amount

 

Per
Diluted
Share

 

Reported
Amount

 

Per
Diluted
Share

 

Net income attributable to Starwood Property Trust, Inc.

 

$

14,478

 

$

0.15

 

$

78,349

 

0.94

 

Unrealized loss on loans held for sale at fair value

 

10,679

 

0.11

 

1,725

 

0.02

 

Unrealized loss on interest rate hedges

 

6,869

 

0.08

 

11,099

 

0.13

 

Unrealized loss (gain) on credit spread hedges

 

2,280

 

0.02

 

(161

)

0.00

 

Other-than-temporary impairment

 

892

 

0.01

 

2,621

 

0.03

 

Unrealized foreign currency loss

 

9,403

 

0.10

 

4,245

 

0.05

 

Unrealized gain on currency hedge

 

(8,703

)

(0.09

)

(2,674

)

(0.03

)

Management Incentive Fee

 

432

 

0.01

 

1,178

 

0.01

 

Non-cash stock-based compensation

 

2,991

 

0.03

 

10,432

 

0.13

 

Core Earnings

 

$

39,321

 

$

0.42

 

$

106,814

 

$

1.28

 

 

Item 3.   Quantitative and Qualitative Disclosures About Market Risk.

 

We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity for our stockholders to realize attractive risk-adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.

 

Our analysis of risks is based on our Manager’s experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of decisions by the Manager may produce results that differ significantly from the estimates and assumptions used in our models and the projected results.

 

Credit Risk

 

We are subject to varying degrees of credit risk in connection with our investments. We have exposure to credit risk on the loan assets and underlying mortgage loans in our non-Agency RMBS and CMBS portfolios as well as other assets. Our Manager seeks to manage credit risk by performing deep credit fundamental analysis of potential investments. Credit risk is also addressed through our Manager’s on-going surveillance, and investments are monitored for variance from expected prepayments, defaults, severities, losses and cash flow on a monthly basis.

 

Our investment guidelines do not limit the amount of our equity that may be invested in any type of our target assets; however, not more than 25% of our equity may be invested in any individual asset without the consent of a majority of our independent directors. Our investment decisions depend on prevailing market conditions and may change over time in response to opportunities available in different interest rate, economic and credit environments. As a result, we cannot predict the percentage of our equity that will be invested in any of our target assets at any given time.

 

At September 30, 2012, the S&P ratings of our RMBS portfolio were as follows (amounts in thousands):

 

S&P Rating

 

Carrying Value

 

Percentage

 

AA

 

$

3,791

 

1.1

%

A

 

1,039

 

0.3

%

BBB+

 

145

 

0.1

%

BBB

 

23,075

 

6.8

%

BBB-

 

5,742

 

1.7

%

BB+

 

6,653

 

2.0

%

BB

 

1,511

 

0.4

%

BB-

 

4,717

 

1.4

%

B+

 

38,227

 

11.4

%

B

 

3,533

 

1.0

%

B-

 

25,834

 

7.6

%

CCC

 

178,537

 

52.9

%

CC+

 

14,692

 

4.3

%

CC

 

994

 

0.3

%

D

 

28,691

 

8.5

%

NR

 

719

 

0.2

%

Total RMBS

 

$

337,900

 

100.0

%

 

49



 

As of September 30, 2012, $425.2 million of CMBS were not rated, which represented debt secured by substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties and which had an estimated loan-to-value ratio in the range of 39%-44% as of September 30, 2012. The remaining $103.8 CMBS investment position is rated BB+.

 

At December 31, 2011, the S&P ratings of our RMBS portfolio were as follows (amounts in thousands):

 

S&P Rating

 

Carrying Value

 

Percentage

 

AA+

 

$

86

 

0.1

%

AA

 

1,223

 

0.7

%

AA-

 

5,396

 

3.3

%

A

 

4,835

 

2.9

%

A-

 

3,376

 

2.0

%

BBB+

 

5,558

 

3.4

%

BBB

 

121

 

0.1

%

BB+

 

4,513

 

2.7

%

BB

 

3,987

 

2.4

%

BB-

 

4,400

 

2.7

%

B+

 

5,293

 

3.2

%

B

 

5,405

 

3.3

%

B-

 

9,110

 

5.5

%

CCC

 

99,446

 

60.3

%

CC

 

6,344

 

3.8

%

D

 

3,583

 

2.2

%

NR

 

2,272

 

1.4

%

Total MBS

 

$

164,948

 

100.0

%

 

Interest Rate Risk

 

Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We are subject to interest rate risk in connection with our investments and the related financing obligations. In general, we finance the acquisition and/or origination of our target assets through financings in the form of warehouse facilities, bank credit facilities (including term loans and revolving facilities), securitizations and repurchase agreements. We mitigate interest rate risk through the use of hedging instruments, primarily interest rate swap agreements. Interest rate swap agreements are utilized to hedge against future interest rate increases on our borrowings and potential adverse changes in the value of certain assets that result from interest rate changes.

 

Interest Rate Effect on Net Interest Margin

 

Our operating results depend in large part on differences between the income earned on our investments and our cost of borrowing and hedging activities. The cost of our borrowings is generally based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally may increase (1) while the yields earned on our leveraged fixed-rate mortgage assets remain static and (2) at a faster pace than the yields earned on our leveraged floating rate mortgage assets, which could result in a decline in our net interest margin. The severity of any such decline would depend on our asset/liability composition at the time as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of our target assets. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations. Hedging techniques are partly based on assumed levels of prepayments of our investments. If prepayments are slower or faster than assumed, the life of the investment would be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions.

 

Interest Rate Mismatch Risk

 

We have funded a portion of our origination and acquisition of mortgage loans and MBS with borrowings that are based on LIBOR, while the interest rates on these assets may be indexed to LIBOR or another index rate, such as the one-year Constant Maturity Treasury (“CMT”) index, the Monthly Treasury Average (“MTA”) index or the 11th District Cost of Funds Index (“COFI”). Accordingly, any increase in LIBOR relative to one-year CMT rates, MTA or COFI may result in an increase in our borrowing costs that may not be matched by a corresponding increase in the interest earnings on these assets. Any such interest rate index mismatch could adversely affect our profitability, which may negatively impact distributions to our stockholders. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above.

 

50



 

Prepayment Risk

 

Prepayment risk is the risk that principal will be repaid at a different rate than anticipated, causing the return on certain investments to be less than expected. As we receive prepayments of principal on our assets, any premiums paid on such assets are amortized against interest income. In general, an increase in prepayment rates accelerates the amortization of purchase premiums, thereby reducing the return earned on the assets. Conversely, discounts on such assets are accreted into interest income. In general, an increase in prepayment rates accelerates the accretion of purchase discounts, thereby increasing the return earned on the assets.

 

Extension Risk

 

Our Manager computes the projected weighted-average life of our assets based on assumptions regarding the rate at which the borrowers will prepay the mortgages or extend. If prepayment rates decrease in a rising interest rate environment or extension options are exercised, the life of the fixed-rate assets could extend beyond the term of the secured debt agreements. This could have a negative impact on our results of operations. In some situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.

 

Fair Value Risk

 

The estimated fair value of our investments fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the estimated fair value of the fixed-rate investments would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of the fixed-rate investments would be expected to increase. As market volatility increases or liquidity decreases, the fair value of our assets may be adversely impacted. If we are unable to readily obtain independent pricing to validate our estimated fair value of the securities in our portfolio, the fair value gains or losses recorded and/or disclosed may be adversely affected.

 

Foreign Currency Risk

 

We intend to hedge our currency exposures in a prudent manner. However, our currency hedging strategies may not eliminate all of our currency risk due to, among other things, uncertainties in the timing and/or amount of payments received on the related investments, and/or unequal, inaccurate, or unavailability of hedges to perfectly offset changes in future exchange rates. Additionally, we may be required under certain circumstances to collateralize our currency hedges for the benefit of the hedge counterparty, which could adversely affect our liquidity.

 

During 2010, we entered into a series of forward contracts whereby we agreed to sell an amount of GBP for an agreed-upon amount of USD at various dates through October 2013. These forward contracts were executed to fix the USD amount of GBP denominated cash flows we expect to receive from our GBP-denominated loan.  During the first quarter of 2012, the GBP-denominated loan was prepaid.  As a result of the loan being prepaid in February 2012, the foreign exchange forward contracts were no longer necessary hedges. At that time, the hedge contracts were in a loss position to us of approximately $10.0 million. In the process of negotiating the termination of the contracts, management was able to lock-in the amount of the loss by entering into new derivative contracts with a separate counterparty that had the same maturity dates and notional amounts, but wherein we would sell USD in exchange for GBP (offsetting positions). We executed this structure as opposed to liquidating the original contracts as it was more cost effective.  As of September 30, 2012, we had a $103.8 million GBP-denominated CMBS investment (using the September 30, 2012 spot rate of 1.6167). During the first three months of 2012, we entered into a series of forward contracts whereby we agreed to sell an amount of GBP for an agreed-upon amount of USD at various dates through March 2016. These forward contracts were executed to fix the USD amount of GBP-denominated cash flows we expect to receive from our GBP-denominated CMBS investment.  As of September 30, 2012, the GBP hedging strategies above resulted in 13 foreign exchange forward sales contracts with a total notional value of $180.9 million and 6 such foreign exchange forward purchase contracts with a total notional value of USD $59.7 million (using the September 30, 2012 spot rate of 1.6167) .

 

As of September 30, 2012, we had a $29.1 million EUR-denominated loan investment (using the September 30, 2012 spot rate of 1.2860). During 2011, we entered into a series of forward contracts whereby we agree to sell an amount of EUR for an agreed upon amount of USD at various dates through June 2014. These forward contracts were executed to economically fix the USD amount of EUR-denominated cash flows expected to be received by us related to our mezzanine loan in Germany. As of September 30, 2012, we had 8 such foreign exchange forward contracts with a total notional value of USD $21.5 million (using the September 30, 2012 spot rate of 1.2860).

 

As of September 30, 2012, we had a $72.2 million EUR-denominated loan investment (using the September 30, 2012 spot rate of 1.2860). During 2012, we entered into a series of forward contracts whereby we agree to sell an amount of EUR for an agreed upon

 

51



 

amount of USD at various dates through January 2014. These forward contracts were executed to economically fix the USD amount of EUR-denominated cash flows expected to be received by us related to our loan in Luxembourg. As of September 30, 2012, we had 6 such foreign exchange forward contracts with a total notional value of USD $51.6 million (using the September 30, 2012 spot rate of 1.2860).

 

Real Estate

 

Commercial and residential mortgage assets are subject to volatility and may be adversely affected by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loans, which could also cause us to suffer losses.

 

Inflation Risk

 

Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance significantly more than inflation does. Changes in interest rates may correlate with inflation rates and/or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our distributions are determined by our board of directors consistent with our obligation to distribute to our stockholders at least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification; in each case, our activities and balance sheet are measured with reference to historical cost and/or fair value without considering inflation.

 

Risk Management

 

To the extent consistent with maintaining our REIT qualification, we seek to manage risk exposure to protect our portfolio of financial assets against the effects of major interest rate changes. We generally seek to manage this risk by:

 

·                  attempting to structure our financing agreements to have a range of different maturities, terms, amortizations and interest rate adjustment periods;

 

·                  using hedging instruments, primarily interest rate swap agreements but also financial futures, options, interest rate cap agreements, floors and forward sales to adjust the interest rate sensitivity of our investment portfolio and our borrowings; and

 

·                  using loan sales, syndications, and securitization financing to better match the maturity of our financing with the duration of our assets.

 

Item 4.    Controls and Procedures.

 

Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including the Chief Executive Officer, as appropriate, to allow timely decisions regarding required disclosures.

 

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

 

Changes to Internal Control Over Financial Reporting.  No change in internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) occurred during the three month period ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

52



 

PART II—OTHER INFORMATION

 

Item 1.    Legal Proceedings.

 

Currently, no material legal proceedings are pending, threatened, or to our knowledge, contemplated against us.

 

Item 1A.    Risk Factors.

 

There have been no material changes to the risk factors previously disclosed in our Form 10-Q for the quarterly period ended June 30, 2012, which was filed with the SEC on August 8, 2012.

 

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds.

 

On August 15, 2012, we granted 50,203 shares of common stock to the Manager at a price of $22.61 per share as satisfaction of 50% of the incentive compensation due to the Manager as required by the Management Agreement.  The issuance of these shares was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(a)(2) thereof.

 

Item 3.    Defaults Upon Senior Securities.

 

None.

 

Item 4.    Mine Safety Disclosures

 

Not applicable.

 

Item 5.           Other Information

 

None.

 

53



 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

STARWOOD PROPERTY TRUST, INC.

 

 

Date:  November 7, 2012

By:

/s/ Barry S. Sternlicht

 

 

Barry S. Sternlicht

 

 

Chief Executive Officer Principal Executive Officer

 

 

 

Date:  November 7, 2012

By:

/s/ Perry Stewart Ward

 

 

Perry Stewart Ward

 

 

Chief Financial Officer, Treasurer and Principal Financial Officer

 

54



 

Item 6.    Exhibits.

 

(a)          Index to Exhibits

 

INDEX TO EXHIBITS

 

Exhibit No.

 

Description

 

 

 

31.1

 

Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002

 

 

 

31.2

 

Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002

 

 

 

32.1

 

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

32.2

 

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

55