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

 

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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

 

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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