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, 2013

 

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 the definitions of “large accelerated filer”, “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 7, 2013 was 195,261,425.

 

 

 



 

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 their dates.

 

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, 2012 and in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2013, June 30, 2013 and September 30, 2013, 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;

 

·                  the Company’s ability to integrate LNR Property LLC, a Delaware limited liability company (“LNR”), which was acquired on April 19, 2013, into our business and achieve the benefits that the we anticipate from this acquisition;

 

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

 

·      the Company’s ability to complete the spin-off of its single family residential segment to its stockholders, as described below;

 

·                  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; 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 data)

 

 

 

As of
September 30, 2013

 

As of
December 31, 2012

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

536,834

 

$

177,671

 

Restricted cash

 

82,706

 

3,429

 

Loans held-for-investment, net (subject to $95,000 participation liability)

 

3,790,262

 

2,914,434

 

Loans held-for-sale ($279,121 and $0 held at fair value)

 

345,139

 

 

Loans transferred as secured borrowings

 

85,590

 

85,901

 

Investment securities ($529,423 and $884,254 held at fair value)

 

566,793

 

884,254

 

Intangible assets — servicing rights ($158,023 and $0 held at fair value)

 

187,732

 

 

Residential real estate, net

 

548,022

 

99,115

 

Non-performing residential loans

 

197,716

 

68,883

 

Investment in unconsolidated entities

 

138,168

 

32,318

 

Goodwill

 

107,099

 

 

Derivative assets

 

9,513

 

9,227

 

Accrued interest receivable

 

20,952

 

24,120

 

Other assets

 

98,383

 

25,021

 

Variable interest entity (“VIE”) assets, at fair value

 

97,359,666

 

 

Total Assets

 

$

104,074,575

 

$

4,324,373

 

Liabilities and Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

189,172

 

$

30,094

 

Related-party payable

 

26,788

 

1,803

 

Dividends payable

 

90,130

 

73,796

 

Derivative liabilities

 

32,252

 

27,770

 

Secured financing agreements, net

 

1,312,044

 

1,305,812

 

Convertible senior notes, net

 

995,072

 

 

Loan transfer secured borrowings

 

86,682

 

87,893

 

Loan participation liability

 

95,000

 

 

VIE liabilities, at fair value

 

96,934,006

 

 

Total Liabilities

 

99,761,146

 

1,527,168

 

Commitments and contingencies (Note 23)

 

 

 

 

 

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, 195,887,275 issued and 195,261,425 outstanding as of September 30, 2013 and 136,125,356 issued and 135,499,506 outstanding as of December 31, 2012

 

1,959

 

1,361

 

Additional paid-in capital

 

4,295,058

 

2,721,353

 

Treasury stock (625,850 shares)

 

(10,642

)

(10,642

)

Accumulated other comprehensive income

 

69,287

 

79,675

 

Accumulated deficit

 

(85,339

)

(72,401

)

Total Starwood Property Trust, Inc. Stockholders’ Equity

 

4,270,323

 

2,719,346

 

Non-controlling interests in consolidated subsidiaries

 

43,106

 

77,859

 

Total Equity

 

4,313,429

 

2,797,205

 

Total Liabilities and Equity

 

$

104,074,575

 

$

4,324,373

 

 

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,

 

 

 

2013

 

2012

 

2013

 

2012

 

Revenues:

 

 

 

 

 

 

 

 

 

Interest income from loans

 

$

94,045

 

$

56,261

 

$

236,671

 

$

179,078

 

Interest income from investment securities

 

17,804

 

16,585

 

52,621

 

40,404

 

Servicing fees

 

36,509

 

 

75,644

 

 

Other revenues

 

2,098

 

66

 

4,077

 

180

 

Rental income

 

5,080

 

59

 

8,733

 

59

 

Total revenues

 

155,536

 

72,971

 

377,746

 

219,721

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Management fees

 

24,235

 

14,659

 

58,675

 

42,673

 

Interest expense

 

36,743

 

12,030

 

77,678

 

34,345

 

General and administrative

 

48,335

 

3,084

 

97,769

 

8,838

 

Business combination costs

 

342

 

 

17,958

 

 

Acquisition and investment pursuit costs

 

1,177

 

622

 

4,495

 

2,737

 

Residential properties and non-performing loans — other operating costs

 

6,023

 

327

 

10,622

 

327

 

Depreciation and amortization

 

4,988

 

78

 

8,644

 

78

 

Loan loss allowance

 

1,160

 

 

1,915

 

 

Other expense

 

304

 

 

533

 

 

Total costs and expenses

 

123,307

 

30,800

 

278,289

 

88,998

 

Income before other income, income taxes and non-controlling interests

 

32,229

 

42,171

 

99,457

 

130,723

 

Other income:

 

 

 

 

 

 

 

 

 

Income of consolidated VIEs, net

 

47,963

 

 

79,912

 

 

Change in fair value of servicing rights

 

(1,867

)

 

1,031

 

 

Change in fair value of investment securities, net

 

(2,278

)

 

(3,265

)

 

Change in fair value of mortgage loans held-for-sale, net

 

25,857

 

 

26,315

 

(5,760

)

Earnings from unconsolidated entities

 

4,577

 

787

 

10,915

 

2,739

 

Gain on sale of investments, net

 

8,059

 

9,017

 

22,968

 

19,147

 

Loss on derivative financial instruments, net

 

(22,451

)

(7,561

)

(65

)

(9,784

)

Foreign currency gain, net

 

9,580

 

6,725

 

3,495

 

11,222

 

Total other-than-temporary impairment (“OTTI”)

 

(86

)

(737

)

(1,460

)

(5,582

)

Noncredit portion of OTTI recognized in other comprehensive income (loss)

 

34

 

61

 

1,007

 

2,854

 

Net impairment losses recognized in earnings

 

(52

)

(676

)

(453

)

(2,728

)

Other income

 

3,705

 

180

 

3,744

 

530

 

Total other income

 

73,093

 

8,472

 

144,597

 

15,366

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes and non-controlling interests

 

105,322

 

50,643

 

244,054

 

146,089

 

Income tax provision

 

13,721

 

301

 

25,691

 

840

 

Net income

 

91,601

 

50,342

 

218,363

 

145,249

 

Net income attributable to non-controlling interests

 

1,886

 

130

 

4,124

 

388

 

Net income attributable to Starwood Property Trust, Inc.

 

$

89,715

 

$

50,212

 

$

214,239

 

$

144,861

 

Net income per share of common stock:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.52

 

$

0.43

 

$

1.36

 

$

1.34

 

Diluted

 

$

0.52

 

$

0.43

 

$

1.36

 

$

1.34

 

 

 

 

 

 

 

 

 

 

 

Distributions declared per common share

 

$

0.46

 

$

0.44

 

$

1.36

 

$

1.32

 

 

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,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net income

 

$

91,601

 

$

50,342

 

$

218,363

 

$

145,249

 

Other comprehensive income (loss) (net change by component):

 

 

 

 

 

 

 

 

 

Cash flow hedges

 

(197

)

(411

)

1,583

 

(1,623

)

Unrealized gain (loss) on available-for-sale securities

 

(1,768

)

50,307

 

(15,895

)

67,804

 

Foreign currency remeasurement

 

10,967

 

 

3,924

 

 

Other comprehensive income (loss)

 

9,002

 

49,896

 

(10,388

)

66,181

 

Comprehensive income

 

100,603

 

100,238

 

207,975

 

211,430

 

Less: Comprehensive income attributable to non-controlling interests

 

(1,886

)

(130

)

(4,124

)

(388

)

Comprehensive income attributable to Starwood Property Trust, Inc.

 

$

98,717

 

$

100,108

 

$

203,851

 

$

211,042

 

 

See notes to condensed consolidated financial statements.

 

5



 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements 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

 

Equity 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

 

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

 

 

 

 

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, 2013

 

136,125,356

 

$

1,361

 

$

2,721,353

 

625,850

 

$

(10,642

)

$

(72,401

)

$

79,675

 

$

2,719,346

 

$

77,859

 

$

2,797,205

 

Proceeds from public offering of common stock

 

59,225,000

 

593

 

1,512,926

 

 

 

 

 

 

 

 

 

1,513,519

 

 

 

1,513,519

 

Equity offering costs

 

 

 

 

 

(955

)

 

 

 

 

 

 

 

 

(955

)

 

 

(955

)

Convertible senior notes

 

 

 

 

 

48,502

 

 

 

 

 

 

 

 

 

48,502

 

 

 

48,502

 

Stock-based compensation

 

523,731

 

5

 

12,865

 

 

 

 

 

 

 

 

 

12,870

 

 

 

12,870

 

Manager incentive fee paid in stock

 

13,188

 

 

 

367

 

 

 

 

 

 

 

 

 

367

 

 

 

367

 

Net income

 

 

 

 

 

 

 

 

 

 

 

214,239

 

 

 

214,239

 

4,124

 

218,363

 

Dividends declared, $1.36 per share

 

 

 

 

 

 

 

 

 

 

 

(227,177

)

 

 

(227,177

)

 

 

(227,177

)

Other comprehensive loss, net

 

 

 

 

 

 

 

 

 

 

 

 

 

(10,388

)

(10,388

)

 

 

(10,388

)

VIE non-controlling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,067

)

(1,067

)

Non-controlling interests assumed through LNR acquisition

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8,705

 

8,705

 

Contribution from non-controlling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,399

 

1,399

 

Distribution to non-controlling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(47,914

)

(47,914

)

Balance, September 30, 2013

 

195,887,275

 

$

1,959

 

$

4,295,058

 

625,850

 

$

(10,642

)

$

(85,339

)

$

69,287

 

$

4,270,323

 

$

43,106

 

$

4,313,429

 

 

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,

 

 

 

2013

 

2012

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net income

 

$

218,363

 

$

145,249

 

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

 

 

 

 

 

Amortization of deferred financing costs

 

7,044

 

3,896

 

Amortization of net convertible debt discount and deferred fees

 

5,693

 

 

Accretion of net discount on investment securities

 

(23,484

)

(25,064

)

Accretion of net deferred loan fees and discounts

 

(26,917

)

(35,026

)

Amortization of premium from loan transfer secured borrowings

 

(1,211

)

(669

)

Stock-based compensation

 

12,870

 

12,296

 

Stock-based component of incentive fees

 

367

 

2,522

 

Change in fair value of fair value option investment securities

 

3,265

 

 

Change in fair value of consolidated VIEs

 

(22,428

)

 

Change in fair value of servicing rights

 

(1,031

)

 

Change in fair value of loans held-for-sale

 

(26,315

)

5,760

 

Change in fair value of derivatives

 

(2,196

)

3,328

 

Foreign currency gain, net

 

(3,481

)

(11,516

)

Gain on sale of investments

 

(23,728

)

(19,274

)

Impairment of real estate

 

536

 

 

Other-than-temporary impairment of investment securities

 

453

 

2,728

 

Loan loss allowance

 

1,915

 

 

Depreciation and amortization

 

8,022

 

 

Earnings from unconsolidated entities

 

(7,427

)

 

Distributions of earnings from unconsolidated entities

 

2,315

 

 

Capitalized costs written off

 

1,517

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Related party payable, net

 

25,475

 

4,197

 

Accrued interest receivable, less purchased interest

 

(8,603

)

(5,280

)

Other assets

 

(6,874

)

5,819

 

Accounts payable, accrued expenses and other liabilities

 

36,087

 

10,473

 

Originations of loans held-for-sale, net of principal collections

 

(847,844

)

 

Net proceeds from sale of loans held-for-sale

 

402,475

 

132,012

 

Net cash (used in) provided by operating activities

 

(275,142

)

231,451

 

Cash Flows from Investing Activities:

 

 

 

 

 

Purchase of LNR, net of cash acquired

 

(586,383

)

 

Purchase of investment securities

 

(82,754

)

(575,690

)

Proceeds from sales of investment securities

 

442,877

 

199,510

 

Proceeds from principal collections on investment securities

 

56,793

 

67,452

 

Origination and purchase of loans held-for-investment

 

(1,658,240

)

(943,330

)

Proceeds from principal collections on loans

 

394,616

 

494,307

 

Proceeds from loans sold

 

369,621

 

28,740

 

Acquisition and improvement of single family homes

 

(458,733

)

 

Proceeds from sale of single family homes

 

6,696

 

 

Purchase of other assets

 

(1,631

)

(30,496

)

Purchase of non-performing loans

 

(153,141

)

 

Proceeds from sale of non-performing loans

 

27,198

 

 

Investment in unconsolidated entities

 

(8,558

)

 

Proceeds from sale of interest in unconsolidated entities

 

 

874

 

Distribution of capital from unconsolidated entities

 

3,210

 

892

 

Payments for purchase or termination of derivatives

 

(648

)

 

Proceeds from termination of derivatives

 

9,940

 

 

Return of investment basis in purchased derivative asset

 

1,533

 

2,780

 

Increase in restricted cash

 

(54,860

)

 

Net cash used in investing activities

 

(1,692,464

)

(754,961

)

 

See notes to condensed consolidated financial statements.

 

7



 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Cash Flows (Continued)

(Unaudited, amounts in thousands)

 

 

 

For the Nine
 Months Ended September 30,

 

 

 

2013

 

2012

 

Cash Flows from Financing Activities:

 

 

 

 

 

Borrowings under financing agreements

 

$

2,691,382

 

$

1,370,306

 

Proceeds from issuance of convertible senior notes

 

1,037,926

 

 

Principal repayments on borrowings

 

(2,674,437

)

(1,164,373

)

Payment of deferred financing costs

 

(13,281

)

(8,029

)

Proceeds from loan participation liability

 

95,000

 

35,738

 

Proceeds from common stock offering

 

1,513,519

 

457,321

 

Payment of equity offering costs

 

(955

)

(2,250

)

Payment of dividends

 

(210,843

)

(134,473

)

Contributions from non-controlling interests

 

1,399

 

 

Distributions to non-controlling interests

 

(47,914

)

(558

)

Issuance of debt of consolidated VIEs

 

8,760

 

 

Repayment of debt of consolidated VIEs

 

(93,293

)

 

Distributions of cash from consolidated VIEs

 

18,598

 

 

Net cash provided by financing activities

 

2,325,861

 

553,682

 

Net increase in cash and cash equivalents

 

358,255

 

30,172

 

Cash and cash equivalents, beginning of period

 

177,671

 

114,027

 

Effect of exchange rate changes on cash

 

908

 

 

Cash and cash equivalents, end of period

 

$

536,834

 

$

144,199

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

54,548

 

$

34,640

 

Income taxes paid

 

$

24,794

 

$

990

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

Fair value of assets acquired

 

$

1,041,927

 

$

 

Fair value of liabilities assumed

 

$

562,279

 

$

 

Dividends declared, but not yet paid

 

$

90,130

 

$

51,629

 

Unsettled trade receivable

 

$

14,338

 

$

 

Consolidation of VIEs (VIE asset/liability additions)

 

$

15,033,274

 

$

 

Deconsolidation of VIEs (VIE asset/liability reductions)

 

$

584,804

 

$

 

Repurchase agreements settled net with proceeds from sale of loans held-for-sale

 

$

449,134

 

$

 

Interest only security received in connection with securitization

 

$

1,889

 

$

 

 

See notes to condensed consolidated financial statements.

 

8



 

Starwood Property Trust, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

As of September 30, 2013

(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 upon the completion of its initial public offering (“IPO”). From our inception in 2009 through the end of the first quarter of 2013, we have been focused primarily on originating, acquiring, financing and managing commercial mortgage loans and other commercial real estate debt investments, commercial mortgage-backed securities, and other commercial real estate-related debt investments. We have traditionally referred to the following as our target assets:

 

·                  Commercial real estate mortgage loans;

·                  Commercial real estate mortgage-backed securities (“CMBS”);

·                  Other commercial real estate-related debt investments;

·                  Residential mortgage-backed securities (“RMBS”); and

·                  Residential real estate owned (“REO”) and residential non-performing mortgage loans.

 

On April 19, 2013, we acquired the equity of LNR Property LLC (“LNR”) and certain of its subsidiaries for an initial agreed upon purchase price of approximately $859 million, which was reduced for transaction expenses and distributions occurring after September 30, 2012, resulting in cash consideration of approximately $730 million. Immediately prior to the acquisition, an affiliate acquired the remaining equity comprising LNR’s commercial property division for a purchase price of $194 million. The portion of the LNR business acquired by us includes the following: (i) a servicing business that manages and works out problem assets, (ii) a finance business that is focused on selectively acquiring and managing real estate finance investments, including unrated, investment grade and non-investment grade rated CMBS, including subordinated interests of securitization and resecuritization transactions, and high yielding real estate loans; and (iii) a mortgage loan business which originates conduit loans for the primary purpose of selling these loans into securitization transactions. Refer to Note 3 for further discussion.

 

We are organized and conduct our operations to qualify as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As such, we will generally not be subject to U.S. federal corporate income tax on that portion of our 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.

 

In connection with the LNR acquisition, we established several taxable REIT subsidiaries (“TRSs”). TRSs permit us to participate in certain activities from which REITs are generally precluded, as long as these activities meet specific criteria, are conducted within the parameters of certain limitations established by the Code, and are conducted in entities which elect to be treated as taxable subsidiaries under the Code. To the extent these criteria are met, we will continue to maintain our qualification as a REIT.

 

The newly established TRSs engage in various real estate related operations, including special servicing of commercial real estate, originating and securitizing commercial mortgage loans, and investing in entities which engage in real estate related operations. As of September 30, 2013, $1.1 billion of the LNR assets were owned by TRS entities. Our TRSs are not consolidated for federal income tax purposes, but are instead taxed as corporations. For financial reporting purposes, a provision for current and deferred taxes is established for the portion of earnings recognized by us with respect to our interest in TRSs.

 

We are organized as a holding company and conduct our business primarily through our various wholly owned subsidiaries. We are externally managed and advised by SPT Management, LLC (our “Manager”) pursuant to the terms of a Management Agreement. Our Manager is controlled by Barry Sternlicht, our Chairman and Chief Executive Officer. Our Manager is an affiliate of Starwood Capital Group, a privately-held private equity firm founded and controlled by Mr. Sternlicht.

 

2. Summary of Significant Accounting Policies

 

Balance Sheet Presentation of LNR Variable Interest Entities

 

The acquisition of LNR substantially changed the presentation of our financial statements in accordance with generally accepted accounting principles (“GAAP”). As noted above, LNR operates a finance business that acquires unrated, investment grade and non-investment grade rated CMBS. These securities represent interests in securitization structures (commonly referred to as special purpose entities, or “SPEs”). These SPEs are structured as pass through entities that receive principal and interest on the underlying collateral and distribute those payments to the certificate holders. Under GAAP, SPEs typically qualify as variable interest entities (“VIEs”). These are entities that, by design, either (1) lack sufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties, or (2) have equity investors that do not have the ability to make

 

9



 

significant decisions relating to the entity’s operations through voting rights, or do not have the obligation to absorb the expected losses, or do not have the right to receive the residual returns of the entity.

 

Because LNR often serves as the special servicer of the trusts in which they invest, consolidation of these structures is required pursuant to the accounting guidance outlined in detail below. This results in a consolidated balance sheet which presents the gross assets and liabilities of the SPEs. The assets and other instruments held by these SPEs are restricted and can only be used to fulfill the obligations of the entity. Additionally, the obligations of the SPEs do not have any recourse to the general credit of any other consolidated entities, nor to us as the consolidator of these SPEs.

 

The SPE liabilities initially represent investment securities on our balance sheet (pre-consolidation). Upon consolidation of these VIEs, our associated investment securities and any associated components of equity, such as unrealized holding gains or losses or OTTI are eliminated, as is the interest income and any impairment losses related to those securities. Similarly, the fees we earn in our roles as special servicer of the bonds issued by the consolidated VIEs or as collateral administrator of the consolidated VIEs are also eliminated. Finally, an allocable portion of the identified servicing intangible associated with the eliminated fee streams is eliminated in consolidation.

 

Please refer to the segment presentation in Note 24 for a presentation of the LNR business without consolidation of these VIEs.

 

Basis of Accounting and Principles of Consolidation

 

The accompanying condensed consolidated financial statements include our accounts and those of our consolidated subsidiaries. Our results include those of LNR for the period from April 19, 2013 (LNR acquisition date) through September 30, 2013 (the “LNR Stub Period”). Intercompany amounts have been eliminated. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations, and cash flows have been included.

 

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 fiscal year ended December 31, 2012 (the “Form 10-K”), as filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the operating results for the full year.

 

Refer to our Form 10-K for a description of our recurring accounting policies. We have included disclosure in this Note 2 regarding principles of consolidation and other accounting policies that either (i) became significant as a result of our acquisition of LNR, or (ii) became significant due to an increase in the significance of the underlying business activity.

 

Entities not deemed to be variable interest entities (“VIEs”) are consolidated if we own a majority of the voting securities or interests or hold the general partnership interest, except in those instances in which the minority voting interest owner or limited partner effectively participates through substantive participative rights. Substantive participative rights include the ability to select, terminate and set compensation of the investee’s management, if applicable, and the ability to participate in capital and operating decisions of the investee, including budgets, in the ordinary course of business.

 

We invest in entities with varying structures, many of which do not have voting securities or interests, such as general partnerships, limited partnerships, and limited liability companies. In many of these structures, control of the entity rests with the general partners or managing members, while other members hold passive interests. The general partner or managing member may hold anywhere from a relatively small percentage of the total financial interests to a majority of the financial interests. For entities not deemed to be VIEs, where we serve as the sole general partner or managing member, we are considered to have the controlling financial interest and therefore the entity is consolidated, regardless of our financial interest percentage, unless there are other limited partners or investing members that effectively participate through substantive participative rights. In those circumstances where we, as majority controlling interest owner, cannot cause the entity to take actions that are significant in the ordinary course of business, because such actions could be vetoed by the minority controlling interest owner, we do not consolidate the entity.

 

As noted above, the most common type of VIE is an SPE. SPEs are commonly used in securitization transactions in order to isolate certain assets and distribute the cash flows from those assets to investors. SPEs are an important part of the financial markets, including the mortgage- and asset-backed securities and commercial paper markets, as they provide market liquidity by facilitating investors’ access to specific portfolios of assets and risks. SPEs may be organized as trusts, partnerships or corporations and are typically established for a single, discrete purpose. SPEs are not typically operating entities and usually have a limited life and no employees. The basic SPE structure involves a company selling assets to the SPE; the SPE funds the purchase of those assets by issuing securities to investors. The legal documents that govern the transaction specify how the cash earned on the assets must be

 

10



 

allocated to the SPE’s investors and other parties that have rights to those cash flows. SPEs are generally structured to insulate investors from claims on the SPE’s assets by creditors of other entities, including the creditors of the seller of the assets.

 

When we consolidate entities other than SPEs, the ownership interests of any minority parties are reflected as non-controlling interests. 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 consolidated balance sheets. In addition, the presentation of net income attributes earnings to controlling and non-controlling interests.

 

When we consolidate SPEs, beneficial interests payable to third parties are reflected as liabilities when the interests are legally issued in the form of debt. Investments in entities which are not consolidated are accounted for by the equity method or by the cost method if either our investment is considered to be minor or we lack significant influence over the investee.

 

Variable Interest Entities

 

We evaluate all of our interests in VIEs for consolidation. When our interests are determined to be variable interests, we assess whether we are deemed to be the primary beneficiary of the VIE. The primary beneficiary of a VIE is required to consolidate the VIE. Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, Consolidation, defines the primary beneficiary as the party that has both (i) the power to direct the activities of the VIE that most significantly impact its economic performance, and (ii) the obligation to absorb losses and the right to receive benefits from the VIE which could be potentially significant. We consider our variable interests as well as any variable interests of our related parties in making this determination. Where both of these factors are present, we are deemed to be the primary beneficiary and we consolidate the VIE. Where either one of these factors is not present, we are not the primary beneficiary and do not consolidate the VIE.

 

To assess whether we have the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, we consider all facts and circumstances, including our role in establishing the VIE and our ongoing rights and responsibilities. This assessment includes first, identifying the activities that most significantly impact the VIE’s economic performance; and second, identifying which party, if any, has power over those activities. In general, the parties that make the most significant decisions affecting the VIE or have the right to unilaterally remove those decision makers are deemed to have the power to direct the activities of a VIE.

 

To assess whether we have the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, we consider all of our economic interests, including debt and equity investments, servicing fees, and other arrangements deemed to be variable interests in the VIE. This assessment requires that we apply judgment in determining whether these interests, in the aggregate, are considered potentially significant to the VIE. Factors considered in assessing significance include: the design of the VIE, including its capitalization structure; subordination of interests; payment priority; relative share of interests held across various classes within the VIE’s capital structure; and the reasons why the interests are held by us.

 

Our purchased investment securities include CMBS which are unrated and non-investment grade rated securities issued by CMBS trusts. In certain cases, we may contract to provide special servicing activities for these CMBS trusts, or, as holder of the controlling class, we may have the right to name and remove the special servicer for these trusts. In our role as special servicer, we provide services on defaulted loans within the trusts, such as foreclosure or work-out procedures, as permitted by the underlying contractual agreements. In exchange for these services, we receive a fee. These rights give us the ability to direct activities that could significantly impact the trust’s economic performance. However, in those instances where an unrelated third party has the right to unilaterally remove us as special servicer, we do not have the power to direct activities that most significantly impact the trust’s economic performance. We evaluated all of our positions in such investments for consolidation.

 

For VIEs in which we are determined to be the primary beneficiary, all of the underlying assets, liabilities and equity of the structures are recorded on our books, and the initial investment, along with any associated unrealized holding gains and losses, are eliminated in consolidation. Similarly, the interest income earned from these structures, as well as the fees paid by these trusts to us in our capacity as special servicer, are eliminated in consolidation. Further, an allocable portion of the identified servicing intangible asset associated with the servicing fee streams, and the corresponding allocable amortization or change in fair value of the servicing intangible asset are also eliminated in consolidation.

 

We perform ongoing reassessments of: (1) whether any entities previously evaluated under the majority voting interest framework have become VIEs, based on certain events, and therefore subject to the VIE consolidation framework, and (2) whether changes in the facts and circumstances regarding our involvement with a VIE causes our consolidation conclusion regarding the VIE to change.

 

We have elected the fair value option in measuring the assets and liabilities of any VIEs we consolidate. Fluctuations in the fair values of the VIE assets and liabilities, along with trust interest income and trust interest and administrative expenses, are presented net in income of consolidated VIEs in our condensed consolidated statements of operations.

 

11



 

Segment Reporting

 

Prior to the acquisition of LNR, we focused primarily on originating and acquiring real estate-related debt investments and operated in one reportable segment. As a result of the acquisition of LNR, as well as the increased significance of our single family home business, we now have the following three reportable segments: real estate investment lending, single family residential, and LNR. Refer to Note 24 for further discussion of our reportable segments.

 

Business Combinations

 

Under FASB ASC Topic 805, Business Combinations, the acquirer in a business combination must recognize, with certain exceptions, the fair values of assets acquired, liabilities assumed, and non-controlling interests when the acquisition constitutes a change in control of the acquired entity. As goodwill is calculated as a residual, all goodwill of the acquired business, not just the acquirer’s share, is recognized under this “full goodwill” approach.

 

We applied the provisions of ASC 805 in accounting for our acquisition of LNR. In doing so, we recorded provisional amounts for certain items as of the date of the acquisition, including the fair value of certain assets and liabilities. During the measurement period, a period which shall not exceed one year, we retrospectively adjust the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of such date that, if known, would have affected the measurement of the amounts recognized. See further discussion in Note 3.

 

Goodwill and Intangible Assets

 

Goodwill is not amortized, but rather tested for impairment annually or more frequently if events or changes in circumstances indicate potential impairment. Goodwill at September 30, 2013 represents the excess of the consideration paid in connection with the acquisition of LNR over the fair value of net assets acquired.

 

In testing goodwill for impairment, we follow ASC Topic 350, Intangibles — Goodwill and Other, which permits a qualitative assessment of whether it is more likely than not that the fair value of a reporting unit is less than its carrying value including goodwill. If the qualitative assessment determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying value including goodwill, then no impairment is determined to exist for the reporting unit. However, if the qualitative assessment determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value including goodwill, we compare the fair value of that reporting unit with its carrying value, including goodwill. If the carrying value of a reporting unit exceeds its fair value, goodwill is considered impaired with the impairment loss equal to the amount by which the carrying value of the goodwill exceeds the implied fair value of that goodwill.

 

Our identifiable intangible assets include special servicing rights for both our domestic and European servicing operations. The fair value measurement method has been elected for measurement of our domestic servicing asset. Election of this method is necessary to conform to our election of the fair value option for measuring the assets and liabilities of the VIEs consolidated pursuant to ASC 810. The amortization method has been elected for our European servicing asset. This asset is amortized in proportion to and over the period of estimated net servicing income, and is tested for potential impairment whenever events or changes in circumstances suggest that its carrying value may not be recoverable.

 

For purposes of testing our European servicing intangible for impairment, we first determine whether facts and circumstances exist that would suggest the carrying value of the intangible is not recoverable. If so, we then compare the fair value of the servicing intangible with its carrying value. The estimated fair value of the intangible is determined using discounted cash flow modeling techniques which require management to make estimates regarding future net servicing cash flows, taking into consideration historical and forecasted loan defeasance rates, delinquency rates and anticipated maturity defaults. If the carrying value of the intangible exceeds its fair value, the intangible is considered impaired and an impairment loss is recognized for the amount by which carrying value exceeds fair value.

 

Loans Held-For-Sale

 

Our loans that we intend to sell or liquidate in the short-term are classified as held-for-sale and are carried at the lower of amortized cost or fair value, unless we have elected to apply the fair value option at origination or purchase. Refer to Note 21 for further disclosure regarding loan transfer activity. The conduit business we acquired from LNR originates fixed rate commercial mortgage loans for future sale to multi-seller securitization trusts. We periodically enter into derivative financial instruments to hedge unpredictable changes in fair value of this loan portfolio, including changes resulting from both interest rates and credit quality. Because these derivatives are not designated, changes in their fair value are recorded in earnings. In order to best reflect the results of the hedged loan portfolio in earnings, we have elected the fair value option for these loans. As a result, changes in the fair value of the loans are also recorded in earnings.

 

12



 

Fair Value Option

 

The guidance in ASC 825, Financial Instruments, provides a fair value option election that allows entities to make an irrevocable election of fair value as the initial and subsequent measurement attribute for certain eligible financial assets and liabilities. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The decision to elect the fair value option is determined on an instrument by instrument basis and must be applied to an entire instrument and is irrevocable once elected. Assets and liabilities measured at fair value pursuant to this guidance are required to be reported separately in our consolidated balance sheets from those instruments using another accounting method.

 

We have elected the fair value option for eligible financial assets and liabilities of our consolidated VIEs, loans held-for-sale originated by LNR’s conduit platform, purchased CMBS issued by VIEs we could consolidate in the future and certain investments in marketable equity securities. The fair value elections for VIE and securitization related items were made in order to mitigate accounting mismatches between the carrying value of the instruments and the related assets and liabilities that we consolidate at fair value. The fair value elections for mortgage loans held-for-sale originated by LNR’s conduit platform were made due to the short-term nature of these instruments. The fair value elections for investments in marketable equity securities were made because the shares are listed on an exchange, which allows us to determine the fair value using a quoted price from an active market.

 

Fair Value Measurements

 

We measure our mortgage-backed securities, derivative assets and liabilities, domestic servicing rights intangible asset and any assets or liabilities where we have elected the fair value option at fair value. When actively quoted observable prices are not available, we either use implied pricing from similar assets and liabilities or valuation models based on net present values of estimated future cash flows, adjusted as appropriate for liquidity, credit, market and/or other risk factors.

 

As discussed above, we measure the assets and liabilities of consolidated VIEs at fair value pursuant to our election of the fair value option. The VIEs in which we invest are “static”; that is, no reinvestment is permitted, and there is no active management of the underlying assets. In determining the fair value of the assets and liabilities of the VIE, we maximize the use of observable inputs over unobservable inputs. We also acknowledge that our principal market for selling CMBS assets is the securitization market where the market participant is considered to be a CMBS trust or a collateralized debt obligation (“CDO”). This methodology results in the fair value of the assets of a static CMBS trust being equal to the fair value of its liabilities.

 

Residential Real Estate & Non-Performing Residential Loans

 

Residential Real Estate

 

Acquired residential real estate is evaluated to determine whether it meets the definition of a business or of an asset under GAAP. For asset acquisitions, we capitalize (1) pre-acquisition costs to the extent such costs would have been capitalized had we owned the asset when the cost was incurred, and (2) closing and other direct acquisition costs. We then allocate the total asset acquisitions cost among land, building and furniture and fixtures, based on their relative fair values, generally utilizing the relative allocation that was contained in the property tax assessment of the same or a similar property, adjusted as deemed necessary.

 

If, at acquisition, a property needs to be renovated before it is ready for its intended use, we commence the necessary development activities. During this development period, we capitalize all direct and indirect costs incurred in renovating the property. Once a property is ready for its intended use, expenditures for ordinary maintenance and repairs thereafter are expensed as incurred, and we capitalize expenditures that improve or extend the life of a home and for furniture, fixtures and equipment.

 

We begin depreciating properties to be held and used when they are ready for their intended use. We compute depreciation using the straight-line method over the estimated useful lives of the respective assets. We depreciate buildings over 30 years, and we depreciate furniture and fixtures over five years. Land is not depreciated.

 

Properties are classified as held for sale when they meet the applicable GAAP criteria, including that the property is being listed for sale and that it is ready to be sold in its current condition. Held for sale properties are reported at the lower of their carrying amount or estimated fair value less costs to sell.

 

We evaluate our properties to be held and used for indications of impairment at least quarterly, typically in connection with preparing the quarter-end financial statements. We assess impairment at the lowest level for which cash flows are available, which is on a per-property basis. If an impairment indicator exists, we compare the property’s expected future undiscounted cash flows to the carrying amount of the property. If the sum of the estimated undiscounted cash flows is less than the carrying amount of the property, we record an impairment charge equal to the excess of the property’s carrying amount over the estimated fair value. In estimating fair

 

13



 

value, we primarily consider the local broker price opinion, but also consider any other comparable home sales or other market data, as necessary.

 

Non-Performing Residential Loans

 

We have purchased pools of distressed and non-performing residential mortgage loans, which we generally seek to (1) convert into homes through the foreclosure or other resolution process that can then either be contributed to our rental portfolio or sold or, to a lesser extent, (2) modify and hold or resell at higher prices if circumstances warrant. In situations where property foreclosure is subject to an auction process and a third party submits the winning bid, we recognize the resulting gain as a gain on the sale of loans held for investment.

 

Our distressed and non-performing residential mortgage loans are on nonaccrual status at the time of purchase as it is probable that principal or interest is not fully collectible. Any payments received thereafter are applied as a reduction to the remaining principal balance as long as concern exists as to the ultimate collection of amounts contractually due.

 

We evaluate our non-performing residential mortgage loans for impairment at least quarterly, typically in connection with preparing the quarter-end financial statements. As our loans held for investment were non-performing when acquired, we generally look to the estimated fair value of the underlying property collateral to assess the recoverability of our investments. As described in our real estate accounting policy above, we primarily utilize the local broker price opinion, but also consider any other comparable home sales or other market data as considered necessary, in estimating a property’s fair value. If the carrying amount of a loan exceeds the estimated fair value of the underlying collateral, we will record an impairment loss for the difference between the estimated fair value of the property collateral and the carrying amount of the loan. Through September 30, 2013, no impairments have been recorded on any of our loans.

 

Revenue Recognition

 

Interest Income

 

Interest income on performing loans and financial instruments is accrued based on the outstanding principal amount and contractual terms of the instrument. Discounts or premiums associated with the purchase of non-performing loans and investment securities are amortized or accreted into interest income as a yield adjustment on the effective interest method, based on expected cash flows through the expected maturity date of the investment. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections. For loans and CMBS in which we expect to collect all contractual amounts due, we do not adjust the projected cash flows to reflect anticipated credit losses.

 

Conversely, for the majority of our RMBS, which have been purchased at a discount to par value, we do not expect to collect all amounts contractually due at the time we acquired the securities. Accordingly, we expect that a portion of the purchase discount will not be recognized as interest income, and is instead viewed as a non-accretable yield. The amount considered as non-accretable yield may change over time based on the actual performance of these securities, their underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a credit deteriorated security is more favorable than forecasted, we will generally accrete more credit discount into interest income than initially or previously expected. These adjustments are made prospectively beginning in the period subsequent to the determination that a favorable change in performance is projected. Conversely, if the performance of a credit deteriorated security is less favorable than forecasted, an other-than-temporary impairment may be taken, and the amount of discount accreted into income will generally be less than previously expected.

 

For loans where we have not elected the fair value option, origination fees and direct loan origination costs are also recognized in interest income over the loan term as a yield adjustment using the effective interest method. When we elected the fair value option, origination fees and direct loan costs are recorded directly in income and are not deferred.

 

Upon the sale of loans or securities which are not accounted for pursuant to the fair value option, the excess (or deficiency) of net proceeds over the net carrying value of such loans or securities is recognized as a realized gain (or loss).

 

Servicing Fees

 

We typically seek to be the special servicer on CMBS transactions in which we invest. When we are appointed to serve in this capacity, we earn special servicing fees from the related activities performed, which consist primarily of overseeing the workout of under-performing and non-performing loans underlying the CMBS transactions. These fees are recognized in income in the period in which the services are performed and the revenue recognition criteria have been met.

 

Transfers

 

Transfers of investment securities, mortgage loans, and investments in unconsolidated entities are accounted for as sales pursuant to the accounting guidance governing transfers and servicing of financial assets, providing that we have surrendered control

 

14



 

over the assets and to the extent that we received consideration other than beneficial interests in the assets. The cost of assets sold is based on the specific identification method.

 

We recognize sales of residential real estate when the sale has closed, title has passed, adequate initial and continuing investment by the buyer is received, possession and other attributes of ownership have been transferred to the buyer, and we are not obligated to perform significant additional activities after closing. All these conditions are typically met at or shortly after closing.

 

Rental Income

 

Rental income attributable to residential leases is recorded when due from tenants, which approximates the amount that would result from straight-lining rents over the lease term. The initial term of our residential leases is generally one year, with renewals upon consent of both parties on an annual or monthly basis.

 

Investment in Unconsolidated Entities

 

We own non-controlling equity interests in various privately-held partnerships and limited liability companies. Unless we elect the fair value option under ASC 825, we use the cost method to account for investments in which we own less than 20% and do not have significant influence over the underlying investees. We use the equity method to account for all other non-controlling interests in partnerships and limited liability companies. Cost method investments are initially recorded at cost and income is generally recorded when distributions are received. Equity method investments are initially recorded at cost and subsequently adjusted for our share of income or loss, as well as contributions made or distributions received.

 

Investments in unconsolidated entities are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is measured based on the excess of the carrying amount of an investment over its estimated fair value. Impairment analyses are based on current plans, intended holding periods and available information at the time the analyses are prepared.

 

For investments in publicly traded companies where we have virtually no influence over the activities of these companies and minimal ownership percentages, such investments are classified as available-for-sale and reported at fair value in the balance sheet, with unrealized gains and losses reported as a component of other comprehensive income (loss). For investments in publicly traded securities where we have the ability to exercise significant influence, but not control, over underlying investees, we have elected the fair value option and report the assets at fair value on the balance sheet with unrealized gains and losses reported in earnings. Dividends on our available-for-sale equity securities are recorded in the statement of operations on the record date.

 

Securitization/Sale and Financing Arrangements

 

We periodically sell our financial assets, such as commercial mortgage loans, CMBS and other assets. In connection with these transactions, we may retain or acquire senior or subordinated interests in the related assets. Gains and losses on such transactions are recognized using the guidance in ASC Topic 860, Transfers and Servicing, which is based on a financial components approach that focuses on control. Under this approach, after a transfer of financial assets that meets the criteria for treatment as a sale—legal isolation, ability of transferee to pledge or exchange the transferred assets without constraint, and transferred control—an entity recognizes the financial assets it retains and any liabilities it has incurred, derecognizes the financial assets it has sold, and derecognizes liabilities when extinguished. We determine the gain or loss on sale of the assets by allocating the carrying value of the sold asset between the sold asset and the interests retained based on their relative fair values, as applicable. The gain or loss on sale is the difference between the cash proceeds from the sale and the amount allocated to the sold asset. If the sold asset is being accounted for pursuant to the fair value option, there is no gain or loss.

 

Income Taxes

 

The Company has elected to be qualified and taxed as a REIT under the Code. The Company is subject to federal income taxation at corporate rates on its REIT taxable income, however, the Company is allowed a deduction for the amount of dividends paid to its shareholders, thereby subjecting the distributed net income of the Company to taxation at the shareholder level only. In addition, the Company is allowed several other deductions in computing its REIT taxable income, including non-cash items such as depreciation expense and certain specific reserve amounts that the Company deems to be uncollectable. The Company intends to operate in a manner consistent with and to elect to be treated as a REIT for tax purposes.

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company evaluates the realizability of its deferred tax assets and recognizes a valuation allowance if, based on the available evidence, both positive and negative, it is more likely than not that some portion or all of its deferred tax assets will not be realized. When evaluating the realizability of its deferred tax assets, the Company considers, among other matters, estimates of expected future taxable income, nature of current and cumulative losses, existing and projected book/tax differences, tax planning strategies available, and the general and industry specific

 

15



 

economic outlook. This realizability analysis is inherently subjective, as it requires the Company to forecast its business and general economic environment in future periods.

 

We recognize tax positions in the financial statements only when it is more likely than not that the position will be sustained upon examination of the relevant taxing authority, based on the technical merits of the tax position. A tax position is measured at the largest amount of benefit that will more likely than not be realized upon settlement. A liability is established for the differences between positions taken in a tax return and amounts recognized in the financial statements and no portion of the benefit is recognized in our condensed consolidated statements of operations. We report interest and penalties related to income tax matters as a component of income tax expense.

 

Foreign Currency Transactions

 

Our assets and liabilities denominated in foreign currencies are translated into U.S. dollars using foreign currency exchange rates at the end of the reporting period. Income and expenses are translated at the average exchange rates for each reporting period. The effects of translating the assets, liabilities and income of our foreign investments held by entities with a U.S. dollar functional currency are included in foreign currency gain (loss) in the condensed consolidated statements of operations or other comprehensive income for securities available for sale for which the fair value option has not been elected. The effects of translating the assets, liabilities and income of our foreign investments held by entities with functional currencies other than the U.S. dollar are included in other comprehensive income. Realized foreign currency gains and losses and changes in the value of foreign currency denominated monetary assets and liabilities are included in the determination of net income and are reported as foreign currency gain (loss) in our condensed consolidated statements of operations.

 

Earnings Per Share

 

We calculate basic earnings per share by dividing net income attributable to the Company for the period by the weighted-average of shares of common stock outstanding for that period after consideration of the earnings allocated to our restricted stock units, which are participating securities as defined in GAAP. Diluted earnings per share reflects the potential dilution that that could occur from shares issuable in connection with the incentive fee paid to our Manager under the management agreement and conversion of the convertible senior notes into shares of common stock, except when doing so would be anti-dilutive.

 

Underwriting Commissions and Offering Costs

 

Underwriting and offering costs related to our equity offering activities, which consist primarily of our equity offerings in September 2013, April 2013 and October 2012 as well as our at-the-market offering program, were $0.3 million and $1.0 million for the three and nine months ended September 30, 2013, respectively, and are reflected as a reduction of additional paid-in capital in the condensed consolidated statements of equity. Underwriting and offering costs were $2.3 million and $2.3 million for the three and nine months ended September 30, 2012, respectively.

 

Use of Estimates

 

The preparation of financial statements in conformity with 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 the projection of cash flows we expect to receive 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 expected cash flows.

 

Reclassification

 

As a result of the LNR acquisition as well as the increased significance of our single family home segment as discussed above (also refer to Note 24), certain items in our December 31, 2012 consolidated balance sheet and condensed consolidated statements of operations for the three and nine months ended September 30, 2012 as well as in our condensed consolidated statements of cash flows for the nine months ended September 30, 2012, have been reclassified to conform to the current presentation. The tables below describe the reclassifications to these respective financial statements:

 

16



 

December 31, 2012 Consolidated Balance Sheet (amounts in thousands)

 

Financial Statement Caption

 

Amount As
Previously
Reported

 

Reclassification
Adjustment

 

Amount as
Adjusted

 

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

 

862,587

 

(862,587

)(a)

 

Investment securities

 

 

862,587

 (a)

 

 

 

 

 

 

21,667

 (b)

884,254

 

Other investments

 

221,983

 

(21,667

)(b)

 

 

 

 

 

 

(167,998

)(c)

 

 

 

 

 

 

(32,318

)(d)

 

Residential real estate, net

 

 

99,115

 (c)

99,115

 

Non-performing residential loans

 

 

68,883

 (c)

68,883

 

Investment in unconsolidated entities

 

 

32,318

 (d)

32,318

 

Accounts payable, accrued expenses and other liabilities

 

 

21,204

 (e)

 

 

 

 

 

 

8,890

 (e)

30,094

 

Accounts payable and accrued expenses

 

8,890

 

(8,890

)(e)

 

Other liabilities

 

21,204

 

(21,204

)(e)

 

 


(a)         Mortgage-backed securities, available-for-sale, at fair value are now included in “Investment securities,” which is a new caption in the September 30, 2013 balance sheet.

(b)         There were $21.7 million of marketable equity securities reported within “Other investments” as of December 31, 2012, which are now classified as “Investment securities,” a new caption in the September 30, 2013 balance sheet.

(c)          Our investments in residential real estate and non-performing residential loans have increased significantly during 2013, and are now separately reported in the September 30, 2013 balance sheet. Such amounts were classified within “Other investments” as of December 31, 2012.

(d)         Represents investments in unconsolidated entities that were classified within “Other investments” as of December 31, 2012. Such investments are now reported within “Investment in unconsolidated entities,” which is a new caption in the September 30, 2013 balance sheet.

(e)          We have combined accounts payable, accrued expenses and other liabilities into one caption in the September 30, 2013 balance sheet. Other liabilities were presented separately in the December 31, 2012 balance sheet.

 

Given the nature and significance of LNR’s operations, we removed the “Net interest margin,” subtotal from our condensed consolidated statement of operations, with interest income now included in a new “total revenues” subtotal, and interest expense now included within the new “Total costs and expenses” subtotal. The tables below describe the reclassification adjustments made to specific financial statement captions.

 

Condensed Consolidated Statements of Operations for the Nine Months Ended September 30, 2012
 (amounts in thousands)

 

Financial Statement Caption

 

Amount As
Previously
Reported

 

Reclassification
Adjustment

 

Amount as
Adjusted

 

Other revenues

 

 

180

 (a)

180

 

Interest income from cash balances

 

180

 

(180

)(a)

 

Earnings from unconsolidated entities

 

 

2,739

 (b)

2,739

 

Rental income

 

 

59

 (b)

59

 

Residential segment, other operating costs

 

 

327

 (b)

327

 

Depreciation and amortization

 

 

78

 (b)

78

 

Other income

 

2,923

 

(2,393

)(b)

530

 

Net gains (losses) on currency hedges

 

(10,392

)

10,392

 (c)

 

Net gains (losses) on interest rate hedges

 

608

 

(608

)(c)

 

Loss on derivative financial instruments

 

 

(9,784

)(c)

(9,784

)

Net realized foreign currency gains (losses)

 

8,515

 

(8,515

)(d)

 

Unrealized foreign currency remeasurement gains

 

2,707

 

(2,707

)(d)

 

Foreign currency gain, net

 

 

11,222

 (d)

11,222

 

 

Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2012
 (amounts in thousands)

 

Financial Statement Caption

 

Amount As
Previously
Reported

 

Reclassification
Adjustment

 

Amount as
Adjusted

 

Other revenues

 

 

66

 (a)

66

 

Interest income from cash balances

 

66

 

(66

)(a)

 

Earnings from unconsolidated entities

 

 

787

 (b)

787

 

Rental income

 

 

59

 (b)

59

 

Residential segment, other operating costs

 

 

327

 (b)

327

 

Depreciation and amortization

 

 

78

 (b)

78

 

Other income

 

621

 

(441

)(b)

180

 

Net gains (losses) on currency hedges

 

(7,510

)

7,510

 (c)

 

Net gains (losses) on interest rate hedges

 

(51

)

51

 (c)

 

Loss on derivative financial instruments

 

 

(7,561

)(c)

(7,561

)

Net realized foreign currency gains (losses)

 

(337

)

337

 (d)

 

Unrealized foreign currency remeasurement gains (losses)

 

7,062

 

(7,062

)(d)

 

Foreign currency gain, net

 

 

6,725

 (d)

6,725

 

 

17



 


(a)         Interest income from cash balances has been reclassified into “Other revenues,” a new caption in the income statement for the three and nine months ended September 30, 2013.

(b)         Earnings from unconsolidated entities and various other items are now separate captions in the income statement for the three and nine months ended September 30, 2013. We previously classified such items for the three and nine months ended September 30, 2012, within “Other income.”

(c)          The amounts in “Net gains (losses) on currency hedges” and “Net gains (losses) on interest rate hedges” have been reclassified into “Loss on derivative financial instruments,” a new caption in the income statement for the three and nine months ended September 30, 2013.

(d)         The amounts in “Net realized foreign currency gains (losses) and “Unrealized foreign currency remeasurement gains (losses)” have been reclassified into “Foreign currency gain, net,” which is a new caption in the income statement for the three and nine months ended September 30, 2013.

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012

(amounts in thousands)

 

Financial Statement Caption

 

Amount As
Previously
Reported

 

Reclassification
Adjustment

 

Amount as
Adjusted

 

Gain on sale of available-for-sale securities

 

(12,097

)

12,097

 (a)

 

Gain on sale of loans

 

(7,177

)

7,177

 (a)

 

Gain on sale of investments

 

 

(19,274

)(a)

(19,274

)

 

 

 

 

 

 

 

 

Unrealized gains (losses) on interest rate hedges

 

(9,991

)

9,991

 (b)

 

Unrealized losses on currency hedges

 

13,319

 

(13,319

)(b)

 

Change in fair value of derivatives

 

 

3,328

 (b)

3,328

 

 

 

 

 

 

 

 

 

Gain on foreign currency remeasurement

 

(8,809

)

8,809

 (c)

 

Unrealized foreign currency remeasurement losses (gains)

 

(2,707

)

2,707

 (c)

 

Foreign currency gain, net

 

 

(11,516

)(c)

(11,516

)

 

 

 

 

 

 

 

 

Purchased interest on investments

 

(638

)

638

 (d)

 

Origination and purchase of loans held-for-investment

 

(942,692

)

(638

)(d)

(943,330

)

 

 

 

 

 

 

 

 

Loan maturities

 

460,789

 

(460,789

)(e)

 

Loan investment principal repayments

 

33,518

 

(33,518

)(e)

 

Proceeds from principal collections on loans

 

 

494,307

 (e)

494,307

 

 


(a)         We have combined “Gain on sale of available-for-sale securities” and “Gain on sale of loans” into “Gain on sale of investments,” a new caption in our cash flow statement for the nine months ended September 30, 2013.

(b)         We have combined “Unrealized gains (losses) on interest rate hedges” and “Unrealized (gains) losses on currency hedges” into “Change in fair value of derivatives,” which is a new caption in our cash flow statement for the nine months ended September 30, 2013.

(c)          We have combined “Gain on foreign currency remeasurement” and “Unrealized foreign currency remeasurement losses (gains)” into “Foreign currency gain, net,” which is a new caption in our cash flow statement for the nine months ended September 30, 2013.

(d)         We have combined “Purchased interest on investments” into “Origination and purchase of loans held-for-investment.”

(e)          We have combined “Loan maturities” and “Loan investment principal repayments” into “Proceeds from principal collections on loans,” which is a new caption in our cash flow statement for the nine months ended September 30, 2013.

 

18



 

Recent Accounting Developments

 

As noted above, the consolidation of securitization VIEs has a significant impact on our balance sheet and statement of operations presentation on a GAAP basis.  Also as noted above, we measure the assets and liabilities of consolidated VIEs at fair value pursuant to our election of the fair value option.  In doing so, we maximize the use of observable inputs over unobservable inputs, which results in the fair value of the assets of a static CMBS trust, or collateralized financing entity (“CFE”), being equal to the fair value of its liabilities.

 

On July 19, 2013, the Financial Accounting Standards Board (“FASB”) issued an exposure draft (“ED”) related to Emerging Issues Task Force (“EITF”) Issue No. 12-G, Accounting for the Difference Between the Fair Value of Assets and Liabilities of a Consolidated Collateralized Financing Entity.  The ED attempts to address diversity in practice related to the measurement of a CFE’s assets and liabilities at fair value.  In doing so, the ED indicates that the fair value measurement of a CFE’s financial liabilities should be consistent with the fair value measurement of its financial assets.  This is consistent with our current treatment, as described above and in the “Fair Value” section herein.

 

However, the ED also concludes that reporting entities must use the fair value of the financial assets (and carrying value of any non-financial assets temporarily held by the CFE) to measure the financial liabilities.  This is inconsistent with the methodology we apply, which uses the fair value of the financial liabilities to measure the financial assets.

 

Comment letters on the ED were due by October 17, 2013.  We have submitted a comment letter to the FASB expressing our concerns with respect to this issue.  We have also engaged in discussions with the FASB regarding our comment letter and the significant limitations that the ED would impose on our ability to prepare GAAP financial statements.

 

3.  Acquisition of LNR Property LLC

 

As described in Note 1, on April 19, 2013, we acquired certain net assets of LNR for an initial agreed upon purchase price of $859 million, which was reduced for transaction expenses and distributions occurring after September 30, 2012, resulting in cash consideration of approximately $730 million. The transaction was accounted for as a business combination under the acquisition method of accounting as discussed in Note 2.

 

The following table summarizes the initial and adjusted provisional estimates of identified assets acquired and liabilities assumed at the acquisition date, before consolidation of securitization VIEs, which had no impact on the purchase price (in thousands):

 

 

 

Initial
Provisional
Amounts

 

Measurement
Period
Adjustments

 

Adjusted
Provisional
Amounts

 

Assets acquired:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

143,771

 

$

 

$

143,771

 

Restricted cash

 

24,413

 

 

24,413

 

Loans held-for-investment

 

8,015

 

 

8,015

 

Loans held-for-sale

 

256,502

 

 

256,502

 

Investment securities

 

314,471

 

 

314,471

 

Intangible assets — servicing rights

 

276,989

 

 

276,989

 

Investment in unconsolidated entities

 

97,588

 

(1,170

)

96,418

 

Derivative assets

 

3,103

 

 

3,103

 

Interest receivable

 

1,315

 

 

1,315

 

Other assets

 

60,853

 

(152

)

60,701

 

Total assets acquired

 

1,187,020

 

(1,322

)

1,185,698

 

 

 

 

 

 

 

 

 

Liabilities assumed:

 

 

 

 

 

 

 

Accounts payable, accrued expenses and other liabilities

 

118,621

 

4,927

 

123,548

 

Secured financing agreements

 

438,377

 

 

438,377

 

Derivative liabilities

 

354

 

 

354

 

Total liabilities assumed

 

557,352

 

4,927

 

562,279

 

Net assets acquired

 

$

629,668

 

$

(6,249

)

$

623,419

 

 

19



 

Goodwill represents the excess of the purchase price over the fair value of the underlying net tangible and identifiable intangible assets acquired and liabilities assumed. This determination of goodwill is as follows (amounts in thousands):

 

 

 

Initial
Provisional
Amounts

 

Measurement
Period
Adjustments

 

Adjusted
Provisional
Amounts

 

Purchase price

 

$

 730,518

 

 

$

 730,518

 

Provisional estimates of the fair value of net assets acquired

 

629,668

 

(6,249

)

623,419

 

Goodwill

 

$

100,850

 

6,249

 

$

107,099

 

 

On the acquisition date, we repaid LNR’s senior credit facility for its outstanding balance and accrued interest of $268.9 million.

 

During the three months ended September 30, 2013, we retrospectively adjusted our initial provisional estimates of the identified assets acquired and liabilities assumed for new information obtained regarding facts and circumstances that existed as of the acquisition date. Such balance sheet adjustments had no retrospective effect on previously reported results of operations.

 

Since the acquisition date and before consolidation of securitization VIEs, LNR has recognized revenues of $152.6 million and net earnings of $79.8 million which are reflected in our condensed consolidated statements of operations.  We incurred acquisition-related costs such as advisory, legal, and due diligence services of approximately $0.3 million and $18.0 million during the three and nine months ended September 30, 2013, respectively, which are included in business combination costs within our condensed consolidated statements of operations.

 

The pro forma revenue and net income of the combined entity for the three and nine months ended September 30, 2013 and 2012, assuming the business combination was consummated on January 1, 2012, are as follows (amounts in thousands):

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Revenues

 

$

155,536

 

$

150,058

 

$

459,856

 

$

416,109

 

Net income

 

97,288

 

112,757

 

299,338

 

263,908

 

 

Pro forma revenues and expenses were adjusted to exclude interest expense on LNR’s senior credit facility, which was repaid at the acquisition date, and certain other non-recurring acquisition related costs.  We included an estimated income tax provision and management fee expense for periods prior to the acquisition date and estimated interest expense for the term loan facility discussed in Note 10.  The amounts of these adjustments are as follows (in thousands):

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net interest expense addition (deduction)

 

$

 

$

(1,416

)

$

752

 

$

(4,385

)

Non-recurring acquisition costs addition (deduction)

 

(7,291

)

7,699

 

(125,936

)

23,097

 

Income tax provision addition

 

1,604

 

15,722

 

15,577

 

28,647

 

Management fee expense addition

 

 

23,164

 

18,657

 

32,907

 

 

4. Restricted Cash

 

In connection with the LNR acquisition, we assumed a $23.1 million escrow account funded by the sellers of LNR on behalf of certain employees. The cash from this account is payable to the employees upon the occurrence of certain events, including involuntary termination without cause or the employees rendering of service through the nine month anniversary of the acquisition date.  Also in connection with the LNR acquisition, we were required to cash collateralize certain obligations of LNR, including letters of credit and performance obligations.  The Company funded $3.3 million for these obligations and our affiliate funded the remaining $6.2 million.  The full amount is in the name of a subsidiary of the Company and is therefore reflected as the Company’s restricted cash.  An offsetting payable to our affiliate of $6.2 million is recorded in related party payable in our condensed consolidated balance sheets. A summary of our restricted cash as of September 30, 2013 and December 31, 2012, is as follows (amounts in thousands):

 

 

 

September 30, 2013

 

December 31, 2012

 

Funds held in escrow for employees

 

$

19,587

 

$

 

Cash collateral for derivative financial instruments

 

14,608

 

 

Cash collateral for performance obligations

 

9,482

 

 

Funds held in escrow on behalf of borrowers and other

 

39,029

 

3,429

 

 

 

$

82,706

 

$

3,429

 

 

20



 

5. 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 have elected the fair value option. The following table summarizes our investments in mortgages and loans by subordination class as of September 30, 2013 and December 31, 2012 (amounts in thousands):

 

September 30, 2013

 

Carrying
Value

 

Face
Amount

 

Weighted
Average
Coupon

 

WAL
(years)(2)

 

First mortgages

 

$

1,928,052

 

$

1,975,959

 

6.1

%

4.3

 

Subordinated mortgages(1)

 

523,393

 

560,147

 

7.9

%

3.5

 

Mezzanine loans

 

1,342,793

 

1,354,863

 

10.8

%

3.5

 

Total loans held-for-investment

 

3,794,238

 

3,890,969

 

 

 

 

 

First mortgages held-for-sale, lower of cost or fair value

 

66,018

 

67,000

 

3.5

%

4.9

 

First mortgages held-for-sale, fair value option elected

 

279,121

 

273,110

 

5.3

%

9.3

 

Loans transferred as secured borrowings

 

85,590

 

85,740

 

4.7

%

2.4

 

Total gross loans

 

4,224,967

 

4,316,819

 

 

 

 

 

Loan loss allowance

 

(3,976

)

 

 

 

 

 

Total net loans

 

$

4,220,991

 

$

4,316,819

 

 

 

 

 

 

December 31, 2012

 

Carrying
Value

 

Face
Amount

 

Weighted
Average
Coupon

 

WAL
(years)(2)

 

First mortgages

 

$

1,461,666

 

$

1,502,382

 

6.2

%

3.8

 

Subordinated mortgages(1)

 

397,159

 

430,444

 

9.8

%

4.0

 

Mezzanine loans

 

1,057,670

 

1,079,897

 

10.3

%

3.6

 

Total loans held-for-investment

 

2,916,495

 

3,012,723

 

 

 

 

 

Loans transferred as secured borrowings

 

85,901

 

86,337

 

4.7

%

3.2

 

Total gross loans

 

3,002,396

 

3,099,060

 

 

 

 

 

Loan loss allowance

 

(2,061

)

 

 

 

 

 

Total net loans

 

$

3,000,335

 

$

3,099,060

 

 

 

 

 

 


(1)                                 Subordinated mortgages include (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)                                 Represents the WAL of each respective group of loans. The WAL of each individual 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 a denominator equal to the sum of the expected principal payments using the contractually extended maturity dates of the assets. This calculation was made as of September 30, 2013 and December 31, 2012. 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, 2013, approximately $2.7 billion, or 64.1%, of the loans are variable rate and pay interest at LIBOR or EURIBOR plus a weighted-average spread of 6.17%. The following table summarizes our investments in floating rate loans (amounts in thousands):

 

 

 

September 30, 2013

 

December 31, 2012

 

Index

 

Rate

 

Carrying Value

 

Rate

 

Carrying Value

 

1 Month LIBOR

 

0.1789%

 

$

453,690

 

0.2087%

 

$

674,327

 

1 Month Citibank LIBOR(1)

 

N/A

 

 

0.1900%

 

93,195

 

3 Month Citibank LIBOR(1)

 

N/A

 

 

0.3000%

 

7,217

 

3 Month EURIBOR

 

0.225%

 

54,091

 

N/A

 

 

LIBOR Floor

 

0.19% - 3.0%(2)

 

2,201,216

 

0.5% - 2.0%

 

1,143,443

 

Total

 

 

 

$

2,708,997

 

 

 

$

1,918,182

 

 


(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.

(2)                                 The weighted-average LIBOR Floor is 0.52% as of September 30, 2013.

 

As of September 30, 2013, the risk ratings for loans subject to our rating system, which is described in our Form 10-K, and excludes loans on cost recovery method and loans for which the fair value option has been elected, by class of loan were as follows (amounts in thousands):

 

21



 

 

 

Balance Sheet Classification

 

 

 

Risk

 

Loans Held-For-Investment

 

 

 

Loans
Transferred

 

 

 

Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

Loans Held-
For-Sale

 

As Secured
Borrowings

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

2

 

25,473

 

2,422

 

343,818

 

 

13,046

 

384,759

 

3

 

1,740,951

 

489,430

 

919,293

 

66,018

 

72,544

 

3,288,236

 

4

 

153,845

 

31,541

 

79,682

 

 

 

265,068

 

5

 

 

 

 

 

 

 

Not Rated

 

7,783

 

 

 

279,121

 

 

286,904

 

 

 

$

1,928,052

 

$

523,393

 

$

1,342,793

 

$

345,139

 

$

85,590

 

$

4,224,967

 

 

As of December 31, 2012, the risk ratings by class of loan, excluding loans where we have elected the fair value option, were as follows (amounts in thousands):

 

 

 

Balance Sheet Classification

 

 

 

Risk

 

Loans Held-For-Investment

 

 

 

Loans
Transferred

 

 

 

Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

Loans Held-
For-Sale

 

As Secured
Borrowings

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

2

 

39,734

 

2,434

 

370,671

 

 

13,113

 

425,952

 

3

 

1,350,455

 

363,275

 

679,371

 

 

72,788

 

2,465,889

 

4

 

59,970

 

31,450

 

7,628

 

 

 

99,048

 

5

 

11,507