Table of Contents

 

 

 

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 March 31, 2014

 

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 May 6, 2014 was 221,385,672.

 

 

 



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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, 2013, including those set forth under the captions “Risk Factors” and “Business”;

 

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

 

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

 

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

 

·                  our ability to fully 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 we anticipate from this acquisition;

 

·                  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 and residential 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 and securities investing activities;

 

·                  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



Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

Part I

Financial Information

 

Item 1.

Financial Statements

4

 

Condensed Consolidated Balance Sheets

4

 

Condensed Consolidated Statements of Operations

5

 

Condensed Consolidated Statements of Comprehensive Income

6

 

Condensed Consolidated Statements of Equity

7

 

Condensed Consolidated Statements of Cash Flows

8

 

Notes to Condensed Consolidated Financial Statements

10

 

Note 1 Business and Organization

10

 

Note 2 Summary of Significant Accounting Policies

11

 

Note 3 Acquisitions and Divestitures

14

 

Note 4 Loans

15

 

Note 5 Investment Securities

17

 

Note 6 Investment in Unconsolidated Entities

22

 

Note 7 Goodwill and Intangible Assets

23

 

Note 8 Secured Financing Agreements

24

 

Note 9 Convertible Senior Notes

25

 

Note 10 Loan Securitization/Sale Activities

26

 

Note 11 Derivatives and Hedging Activity

27

 

Note 12 Offsetting Assets and Liabilities

29

 

Note 13 Variable Interest Entities

29

 

Note 14 Related-Party Transactions

30

 

Note 15 Stockholders’ Equity

31

 

Note 16 Earnings per Share

32

 

Note 17 Accumulated Other Comprehensive Income

34

 

Note 18 Benefit Plans

34

 

Note 19 Fair Value

34

 

Note 20 Income Taxes

39

 

Note 21 Commitments and Contingencies

40

 

Note 22 Segment Data

41

 

Note 23 Subsequent Events

45

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

46

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

59

Item 4.

Controls and Procedures

60

Part II

Other Information

 

Item 1.

Legal Proceedings

61

Item 1A.

Risk Factors

61

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

61

Item 3.

Defaults Upon Senior Securities

61

Item 4.

Mine Safety Disclosures

61

Item 5.

Other Information

61

Item 6.

Exhibits

63

 

3



Table of Contents

 

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
March 31, 2014

 

As of
December 31, 2013

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

226,471

 

$

317,627

 

Restricted cash

 

43,117

 

69,052

 

Loans held-for-investment, net

 

4,634,923

 

4,363,718

 

Loans held-for-sale, at fair value

 

186,837

 

206,672

 

Loans transferred as secured borrowings

 

143,042

 

180,414

 

Investment securities ($553,933 and $566,789 held at fair value)

 

923,085

 

935,107

 

Intangible assets—servicing rights ($144,898 and $150,149 held at fair value)

 

168,056

 

177,173

 

Residential real estate, net

 

 

749,214

 

Non-performing residential loans

 

 

215,371

 

Investment in unconsolidated entities

 

104,520

 

122,954

 

Goodwill

 

140,437

 

140,437

 

Derivative assets

 

4,617

 

7,769

 

Accrued interest receivable

 

34,515

 

37,630

 

Other assets

 

111,223

 

95,813

 

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

 

118,451,518

 

103,151,624

 

Total Assets

 

$

125,172,361

 

$

110,770,575

 

Liabilities and Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

137,831

 

$

225,374

 

Related-party payable

 

29,458

 

17,793

 

Dividends payable

 

95,424

 

90,171

 

Derivative liabilities

 

18,057

 

24,192

 

Secured financing agreements, net

 

2,601,062

 

2,257,560

 

Convertible senior notes, net

 

1,000,839

 

997,851

 

Secured borrowings on transferred loans

 

143,038

 

181,238

 

VIE liabilities, at fair value

 

117,931,005

 

102,649,263

 

Total Liabilities

 

121,956,714

 

106,443,442

 

Commitments and contingencies (Note 21)

 

 

 

 

 

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, 196,711,522 issued and 196,085,672 outstanding as of March 31, 2014 and 196,139,045 issued and 195,513,195 outstanding as of December 31, 2013

 

1,967

 

1,961

 

Additional paid-in capital

 

3,192,245

 

4,300,479

 

Treasury stock (625,850 shares)

 

(10,642

)

(10,642

)

Accumulated other comprehensive income

 

80,115

 

75,449

 

Accumulated deficit

 

(59,542

)

(84,719

)

Total Starwood Property Trust, Inc. Stockholders’ Equity

 

3,204,143

 

4,282,528

 

Non-controlling interests in consolidated subsidiaries

 

11,504

 

44,605

 

Total Equity

 

3,215,647

 

4,327,133

 

Total Liabilities and Equity

 

$

125,172,361

 

$

110,770,575

 

 

See notes to condensed consolidated financial statements.

 

4



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Operations

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

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Revenues:

 

 

 

 

 

Interest income from loans

 

$

104,910

 

$

67,690

 

Interest income from investment securities

 

29,454

 

16,240

 

Servicing fees

 

34,211

 

 

Other revenues

 

3,404

 

79

 

Total revenues

 

171,979

 

84,009

 

Costs and expenses:

 

 

 

 

 

Management fees

 

27,821

 

15,069

 

Interest expense

 

37,831

 

17,426

 

General and administrative

 

46,101

 

4,038

 

Business combination costs

 

 

4,196

 

Acquisition and investment pursuit costs

 

394

 

81

 

Depreciation and amortization

 

4,636

 

 

Loan loss allowance

 

497

 

30

 

Other expense

 

1,689

 

33

 

Total costs and expenses

 

118,969

 

40,873

 

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

 

53,010

 

43,136

 

Other income:

 

 

 

 

 

Income of consolidated VIEs, net

 

56,004

 

 

Change in fair value of servicing rights

 

(5,251

)

 

Change in fair value of investment securities, net

 

8,361

 

405

 

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

 

20,893

 

 

Earnings from unconsolidated entities

 

64

 

741

 

Gain on sale of investments, net

 

1,555

 

13,524

 

(Loss) gain on derivative financial instruments, net

 

(7,866

)

16,228

 

Foreign currency gain (loss), net

 

1,477

 

(7,665

)

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

 

(1,192

)

(527

)

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

 

979

 

485

 

Net impairment losses recognized in earnings

 

(213

)

(42

)

Other income, net

 

18

 

 

Total other income

 

75,042

 

23,191

 

Income from continuing operations before income taxes

 

128,052

 

66,327

 

Income tax provision

 

(5,620

)

(615

)

Income from continuing operations

 

122,432

 

65,712

 

Loss from discontinued operations, net of tax (Note 3)

 

(1,551

)

(2,288

)

Net income

 

120,881

 

63,424

 

Net income attributable to non-controlling interests

 

(280

)

(1,181

)

Net income attributable to Starwood Property Trust, Inc.

 

$

120,601

 

$

62,243

 

 

 

 

 

 

 

Per share data:

 

 

 

 

 

Basic earnings per share data:

 

 

 

 

 

Income from continuing operations attributable to Starwood Property Trust, Inc.

 

$

0.62

 

$

0.47

 

Loss from discontinued operations attributable to Starwood Property Trust, Inc.

 

(0.01

)

(0.01

)

Net income attributable to Starwood Property Trust, Inc.

 

$

0.61

 

$

0.46

 

Diluted earnings per share data:

 

 

 

 

 

Income from continuing operations attributable to Starwood Property Trust, Inc.

 

$

0.61

 

$

0.47

 

Loss from discontinued operations attributable to Starwood Property Trust, Inc.

 

(0.01

)

(0.01

)

Net income attributable to Starwood Property Trust, Inc.

 

$

0.60

 

$

0.46

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.48

 

$

0.44

 

 

See notes to condensed consolidated financial statements.

 

5



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Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Comprehensive Income

(Unaudited, amounts in thousands)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Net income

 

$

120,881

 

$

63,424

 

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

 

 

 

 

 

Cash flow hedges

 

122

 

279

 

Available-for-sale securities

 

3,498

 

(2,349

)

Foreign currency remeasurement

 

1,046

 

(7,061

)

Other comprehensive income (loss)

 

4,666

 

(9,131

)

Comprehensive income

 

125,547

 

54,293

 

Less: Comprehensive income attributable to non-controlling interests

 

(280

)

(1,181

)

Comprehensive income attributable to Starwood Property Trust, Inc.

 

$

125,267

 

$

53,112

 

 

See notes to condensed consolidated financial statements.

 

6



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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, 2014

 

196,139,045

 

$

1,961

 

$

4,300,479

 

625,850

 

$

(10,642

)

$

(84,719

)

$

75,449

 

$

4,282,528

 

$

44,605

 

$

4,327,133

 

Stock-based compensation

 

434,189

 

4

 

7,203

 

 

 

 

 

7,207

 

 

7,207

 

Manager incentive fee paid in stock

 

138,288

 

2

 

3,306

 

 

 

 

 

3,308

 

 

3,308

 

Net income

 

 

 

 

 

 

120,601

 

 

120,601

 

280

 

120,881

 

Dividends declared, $0.48 per share

 

 

 

 

 

 

(95,424

)

 

(95,424

)

 

(95,424

)

Spin-off of Starwood Waypoint Residential Trust

 

 

 

(1,118,743

)

 

 

 

 

(1,118,743

)

(1,594

)

(1,120,337

)

Other comprehensive income, net

 

 

 

 

 

 

 

4,666

 

4,666

 

 

4,666

 

Distribution to non-controlling interests

 

 

 

 

 

 

 

 

 

(31,787

)

(31,787

)

Balance, March 31, 2014

 

196,711,522

 

$

1,967

 

$

3,192,245

 

625,850

 

$

(10,642

)

$

(59,542

)

$

80,115

 

$

3,204,143

 

$

11,504

 

$

3,215,647

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

Convertible senior notes

 

 

 

28,118

 

 

 

 

 

28,118

 

 

28,118

 

Stock-based compensation

 

187,501

 

2

 

4,654

 

 

 

 

 

4,656

 

 

4,656

 

Manager incentive fee paid in stock

 

13,188

 

 

366

 

 

 

 

 

366

 

 

366

 

Net income

 

 

 

 

 

 

62,243

 

 

62,243

 

1,181

 

63,424

 

Dividends declared, $0.44 per share

 

 

 

 

 

 

(60,147

)

 

(60,147

)

 

(60,147

)

Other comprehensive loss, net

 

 

 

 

 

 

 

(9,131

)

(9,131

)

 

(9,131

)

Contributions from non-controlling interests

 

 

 

 

 

 

 

 

 

6

 

6

 

Distribution to non-controlling interests

 

 

 

 

 

 

 

 

 

(44,098

)

(44,098

)

Balance, March 31, 2013

 

136,326,045

 

$

1,363

 

$

2,754,491

 

625,850

 

$

(10,642

)

$

(70,305

)

$

70,544

 

$

2,745,451

 

$

34,948

 

$

2,780,399

 

 

See notes to condensed consolidated financial statements.

 

7



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Cash Flows

(Unaudited, amounts in thousands)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net income

 

$

120,881

 

$

63,424

 

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

 

 

 

 

 

Amortization of deferred financing costs

 

2,895

 

3,193

 

Amortization of convertible debt discount and deferred fees

 

2,988

 

841

 

Accretion of net discount on investment securities

 

(7,398

)

(9,180

)

Accretion of net deferred loan fees and discounts

 

(1,806

)

(7,856

)

Amortization of premium from secured borrowings on transferred loans

 

(787

)

(374

)

Share-based compensation

 

7,207

 

4,656

 

Share-based component of incentive fees

 

3,308

 

366

 

Change in fair value of fair value option investment securities

 

(8,361

)

 

Change in fair value of consolidated VIEs

 

(21,877

)

 

Change in fair value of servicing rights

 

5,251

 

 

Change in fair value of loans held-for-sale

 

(20,893

)

 

Change in fair value of derivatives

 

7,110

 

(16,318

)

Foreign currency (gain) loss, net

 

(1,492

)

7,390

 

Gain on non-performing loans and sale of investments

 

(2,498

)

(15,004

)

Other-than-temporary impairment of investment securities

 

213

 

42

 

Loan loss allowance

 

497

 

30

 

Depreciation and amortization

 

5,786

 

713

 

Earnings from unconsolidated entities

 

(64

)

 

Distributions of earnings from unconsolidated entities

 

956

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Related-party payable, net

 

11,665

 

9,307

 

Accrued interest receivable, less purchased interest

 

3,063

 

1,802

 

Other assets

 

(20,474

)

5,839

 

Accounts payable, accrued expenses and other liabilities

 

(22,574

)

35,984

 

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

 

(261,733

)

 

Proceeds from sale of loans held-for-sale

 

302,461

 

 

Net cash provided by operating activities

 

104,324

 

84,855

 

Cash Flows from Investing Activities:

 

 

 

 

 

Spin-off of Starwood Waypoint Residential Trust

 

(111,960

)

 

Purchase of investment securities

 

(9,890

)

(37,175

)

Proceeds from sales of investment securities

 

27,883

 

19,480

 

Proceeds from principal collections on investment securities

 

8,227

 

21,726

 

Origination and purchase of loans held-for-investment

 

(728,594

)

(129,817

)

Proceeds from principal collections on loans

 

316,428

 

93,651

 

Proceeds from loans sold

 

146,400

 

44,631

 

Acquisition and improvement of single family homes

 

(61,901

)

(114,925

)

Proceeds from sale of single family homes

 

1,784

 

3,360

 

Purchase of non-performing loans

 

 

(104,142

)

Proceeds from sale of non-performing loans

 

1,153

 

 

Distribution of capital from unconsolidated entities

 

17,834

 

150

 

Payments for purchase or termination of derivatives

 

(11,274

)

 

Proceeds from termination of derivatives

 

799

 

 

Return of investment basis in purchased derivative asset

 

407

 

518

 

Deposit on purchase of LNR

 

 

(40,665

)

Decrease (increase) in restricted cash, net

 

234

 

(38,040

)

Net cash used in investing activities

 

(402,470

)

(281,248

)

 

See notes to condensed consolidated financial statements.

 

8



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Cash Flows (Continued)

(Unaudited, amounts in thousands)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Cash Flows from Financing Activities:

 

 

 

 

 

Borrowings under financing agreements

 

$

997,767

 

$

347,521

 

Proceeds from issuance of convertible senior notes

 

 

587,700

 

Principal repayments on borrowings

 

(656,573

)

(625,513

)

Payment of deferred financing costs

 

(7,418

)

(24

)

Payment of dividends

 

(90,171

)

(73,796

)

Contributions from non-controlling interests

 

 

6

 

Distributions to non-controlling interests

 

(31,788

)

(44,098

)

Issuance of debt of consolidated VIEs

 

45,761

 

 

Repayment of debt of consolidated VIEs

 

(53,385

)

 

Distributions of cash from consolidated VIEs

 

2,740

 

 

Net cash provided by financing activities

 

206,933

 

191,796

 

Net decrease in cash and cash equivalents

 

(91,213

)

(4,597

)

Cash and cash equivalents, beginning of period

 

317,627

 

177,671

 

Effect of exchange rate changes on cash

 

57

 

 

Cash and cash equivalents, end of period

 

$

226,471

 

$

173,074

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

44,638

 

$

10,536

 

Income taxes paid

 

2,725

 

327

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

Net assets distributed in spin-off of Starwood Waypoint Residential Trust

 

$

1,008,377

 

$

 

Dividends declared, but not yet paid

 

95,424

 

60,147

 

Unsettled trade receivable

 

 

206,608

 

Consolidation of VIEs (VIE asset/liability additions)

 

20,236,513

 

 

Deconsolidation of VIEs (VIE asset/liability reductions)

 

1,289,569

 

 

Conversion of non-performing residential loans to residential real estate

 

3,590

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

As of March 31, 2014

(Unaudited)

 

1. Business and Organization

 

Starwood Property Trust, Inc. (“STWD” together with its subsidiaries, “we” or the “Company”) is a Maryland corporation that commenced operations in August 2009, upon the completion of our initial public offering (“IPO”). We are focused primarily on originating, acquiring, 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 in both the U.S. and Europe. We refer to the following as our target assets:

 

· commercial real estate mortgage loans, including preferred equity interests;

 

· CMBS; and

 

· other commercial real estate-related debt investments.

 

We may also invest in residential mortgage-backed securities (“RMBS”), certain residential mortgage loans, distressed or non-performing commercial loans, commercial properties subject to net leases and commercial real estate owned. 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 have three reportable business segments which include:

 

·                  Real estate investment lending (the “Lending Segment”)—includes all business activities of the Company, excluding the single family residential and LNR businesses, which generally represents investments in real estate related loans and securities that are held-for-investment.

 

·                  LNR—includes all business activities of the acquired LNR Property LLC (“LNR”) business excluding the consolidation of securitization VIEs.

 

·                  Single family residential (“SFR”)—includes the business activities associated with our investments in single-family residential properties and non-performing single-family residential mortgage loans.  This segment was spun off on January 31, 2014 as discussed below and in Note 3 herein.

 

On April 19, 2013, we acquired the equity of 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 of the Company 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) servicing businesses in both the U.S. and Europe that manage and work 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.

 

On January 31, 2014, we completed the spin-off of our SFR segment to our stockholders. The newly-formed real estate investment trust, Starwood Waypoint Residential Trust (“SWAY”), is listed on the New York Stock Exchange (“NYSE”) and trades under the ticker symbol “SWAY.” Our stockholders received one common share of SWAY for every five shares of our common stock held at the close of business on January 24, 2014. As part of the spin-off, we contributed $100 million to the unlevered balance sheet of SWAY to fund its growth and operations. As of January 31, 2014, SWAY held net assets of $1.1 billion. The net assets of SWAY consisted of approximately 7,200 units of single-family homes and residential non-performing mortgage loans as of January 31, 2014. In connection with the spin-off, 40.1 million shares of SWAY were issued. Refer to Note 3 herein for additional information regarding SFR segment financial information.

 

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

 

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Table of Contents

 

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 additional 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.

 

These 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 March 31, 2014, $799.8 million 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 accounting principles generally accepted in the United States of America (“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 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 it invests, consolidation of these structures is required pursuant to GAAP as 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 are eliminated, as is the interest income 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 22 herein 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 and VIEs. Intercompany amounts have been eliminated in consolidation. 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, 2013 (the “Form 10-K”), as filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three months ended March 31, 2014 are not necessarily indicative of the operating results for the full year.

 

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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 are required either (i) to be disclosed quarterly, (ii) that we view as critical, or (iii) became significant since December 31, 2013 due to a corporate action or increase in the significance of the underlying business activity.

 

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. ASC 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 consolidated statements of operations.

 

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Table of Contents

 

Discontinued Operations

 

On January 31, 2014, we completed the spin-off of our SFR segment to our stockholders as discussed in Note 1.  In accordance with Accounting Standards Codification (“ASC”) Topic 205, Presentation of Financial Statements, the results of the SFR segment are presented within discontinued operations in our condensed consolidated statements of operations for the three months ended March 31, 2014 and 2013.

 

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.

 

Loans Receivable and Provision for Loan Losses

 

In our Lending Segment we purchase and originate commercial real estate debt and related instruments generally to be held as long-term investments at amortized cost. We are required to periodically evaluate each of these loans for possible impairment. Impairment is indicated when it is deemed probable that we will not be able to collect all amounts due according to the contractual terms of the loan. If a loan is determined to be impaired, we write down the loan through a charge to the provision for loan losses. Actual losses, if any, could ultimately differ from these estimates.

 

We perform a quarterly review of our portfolio of loans. In connection with this review, we assess the performance of each loan and assign a risk rating based on several factors including risk of loss, loan-to-value ratio, or LTV, collateral performance, structure, exit plan, and sponsorship. Loans are rated “1” through “5”, from less risk to greater risk in connection with this review.

 

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 loans, investment securities and intangible assets, 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 assets and liabilities that are estimated using a discounted cash flows method is significantly impacted by the rates at which we estimate market participants would discount the expected cash flows.

 

Reclassifications

 

As a result of the LNR acquisition, certain items in our condensed consolidated statements of operations and cash flows for the three months ended March 31, 2013 have been reclassified or combined to conform to the current period’s presentation. We removed the “Net interest margin” subtotal from our condensed consolidated statements of operations, with interest income now included in a new “Revenues” subtotal, and interest expense now included within the new “Costs and expenses” subtotal. Additionally, the results from our SFR segment have been reclassified as discontinued operations as a result of the spin-off.  The reclassifications and combinations related to our condensed consolidated statement of cash flows for the three months ended March 31, 2013 had no effect on previously reported totals or subtotals.

 

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Recent Accounting Developments

 

On April 10, 2014 the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which requires only those disposals which represent a strategic shift that has or will have a major impact on an entity’s operations or financial results be presented as discontinued operations.  The ASU is effective for annual periods beginning on or after December 15, 2014, and interim periods within those annual periods, and requires prospective application.  We do not expect the application of this ASU to materially impact the Company.

 

3.  Acquisitions and Divestitures

 

SFR Spin-off

 

As described in Note 1, on January 31, 2014, we completed the spin-off of our SFR segment to our stockholders.  The results of operations for the SFR segment are presented within discontinued operations in our condensed consolidated statements of operations for all periods presented. We have no continuing involvement with the SFR segment following the spin-off.  Subsequent to the spin-off, SWAY entered into a management agreement with an affiliate of our Manager. The following table presents the summarized consolidated results of operations for the SFR segment prior to the spin-off, excluding segment allocations (in thousands):

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Total revenues

 

$

3,876

 

$

1,164

 

Total costs and expenses

 

6,369

 

3,625

 

Loss before other income and income taxes

 

(2,493

)

(2,461

)

Total other income

 

942

 

335

 

Loss before income taxes

 

(1,551

)

(2,126

)

Income tax provision

 

 

(162

)

Net loss

 

$

(1,551

)

$

(2,288

)

 

The following table presents the summarized consolidated balance sheet of the SFR segment as of January 31, 2014, the date of spin-off (in thousands):

 

 

 

January 31, 2014

 

Assets:

 

 

 

Cash and cash equivalents

 

$

111,960

 

Restricted cash

 

189

 

Residential real estate, net

 

812,017

 

Non-performing residential loans

 

211,019

 

Other assets

 

9,498

 

Total Assets

 

$

1,144,683

 

 

 

 

 

Liabilities and Equity

 

 

 

Liabilities:

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

24,346

 

Equity:

 

 

 

Additional paid-in capital

 

1,130,405

 

Accumulated deficit

 

(11,662

)

Total Stockholders’ Equity

 

1,118,743

 

Non-controlling interests in consolidated subsidiaries

 

1,594

 

Total Equity

 

1,120,337

 

Total Liabilities and Equity

 

$

1,144,683

 

 

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Table of Contents

 

LNR Acquisition

 

As described in Note 1, on April 19, 2013, we acquired the equity 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.  We applied the provisions of ASC 805 in accounting for our acquisition of LNR. Refer to Note 3 of our Form 10-K for further discussion of the LNR acquisition including the final purchase price allocation.

 

4. Loans

 

Our loans held-for-investment are accounted for at amortized cost and our 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 tables summarize our investments in mortgages and loans by subordination class as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

March 31, 2014

 

Carrying
Value

 

Face
Amount

 

Weighted
Average
Coupon

 

Weighted
Average Life
(“WAL”)
(years)(2)

 

First mortgages

 

$

2,810,468

 

$

2,866,252

 

5.8

%

4.2

 

Subordinated mortgages(1)

 

501,222

 

536,714

 

8.3

%

4.0

 

Mezzanine loans

 

1,327,714

 

1,336,832

 

11.2

%

3.3

 

Total loans held-for-investment

 

4,639,404

 

4,739,798

 

 

 

 

 

Loans held-for-sale, fair value option elected

 

186,837

 

181,450

 

5.1

%

9.5

 

Loans transferred as secured borrowings

 

143,042

 

143,069

 

5.5

%

3.0

 

Total gross loans

 

4,969,283

 

5,064,317

 

 

 

 

 

Loan loss allowance (loans held-for-investment)

 

(4,481

)

 

 

 

 

 

Total net loans

 

$

4,964,802

 

$

5,064,317

 

 

 

 

 

 

December 31, 2013

 

Carrying
Value

 

Face
Amount

 

Weighted
Average
Coupon

 

Weighted
Average Life
(“WAL”)
(years)(2)

 

First mortgages

 

$

2,616,441

 

$

2,666,875

 

5.6

%

4.3

 

Subordinated mortgages(1)

 

505,533

 

541,817

 

8.7

%

4.2

 

Mezzanine loans

 

1,245,728

 

1,246,841

 

12.2

%

3.7

 

Total loans held-for-investment

 

4,367,702

 

4,455,533

 

 

 

 

 

Loans held-for-sale, fair value option elected

 

206,672

 

209,099

 

5.3

%

9.6

 

Loans transferred as secured borrowings

 

180,414

 

180,483

 

5.4

%

2.9

 

Total gross loans

 

4,754,788

 

4,845,115

 

 

 

 

 

Loan loss allowance (loans held-for-investment)

 

(3,984

)

 

 

 

 

 

Total net loans

 

$

4,750,804

 

$

4,845,115

 

 

 

 

 

 


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

 

(2)                                 Represents the WAL of each respective group of loans as of the respective balance sheet date. 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. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the loan.

 

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Table of Contents

 

As of March 31, 2014, approximately $3.6 billion, or 71.8%, of the loans were variable rate and paid interest principally at LIBOR plus a weighted-average spread of 5.18%. The following table summarizes our investments in floating rate loans (amounts in thousands):

 

 

 

March 31, 2014

 

December 31, 2013

 

Index

 

Base Rate

 

Carrying
Value

 

Base Rate

 

Carrying
Value

 

1 Month LIBOR

 

0.1520%

 

$

630,005

 

0.1677%

 

$

590,444

 

LIBOR Floor

 

0.19% - 3.00%(1)

 

2,937,015

 

0.19% - 3.00%(1)

 

2,641,162

 

U.S. Prime Rate

 

3.25%

 

2,197

 

3.25%

 

2,226

 

Total

 

 

 

$

3,569,217

 

 

 

$

3,233,832

 

 


(1)                                 The weighted-average LIBOR Floor was 0.41% and 0.49% as of March 31, 2014 and December 31, 2013, respectively.

 

As of March 31, 2014, the risk ratings for loans subject to our rating system, which is described in our Form 10-K and excludes loans on the cost recovery method and loans for which the fair value option has been elected, by class of loan were as follows (amounts in thousands):

 

 

 

Balance Sheet Classification

 

 

 

 

 

Loans Held-For-Investment

 

 

 

Loans

 

 

 

Risk
Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

Cost
Recovery
Loans

 

Loans Held-
For-Sale

 

Transferred
As Secured
Borrowings

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

2

 

100,691

 

104,092

 

226,689

 

 

 

12,994

 

444,466

 

3

 

2,552,430

 

360,398

 

986,067

 

 

 

130,048

 

4,028,943

 

4

 

147,063

 

36,732

 

114,958

 

 

 

 

298,753

 

5

 

 

 

 

 

 

 

 

N/A

 

2,219

 

 

 

8,065

 

186,837

 

 

197,121

 

 

 

$

2,802,403

 

$

501,222

 

$

1,327,714

 

$

8,065

 

$

186,837

 

$

143,042

 

$

4,969,283

 

 

As of December 31, 2013, the risk ratings for loans subject to our rating system by class of loan were as follows (amounts in thousands):

 

 

 

Balance Sheet Classification

 

 

 

 

 

Loans Held-For-Investment

 

 

 

Loans

 

 

 

Risk
Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

Cost
Recovery
Loans

 

Loans Held-
For-Sale

 

Transferred
As Secured
Borrowings

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

2

 

94,981

 

103,369

 

153,119

 

 

 

13,022

 

364,491

 

3

 

2,354,692

 

370,446

 

1,012,674

 

 

 

167,392

 

3,905,204

 

4

 

153,987

 

31,718

 

79,935

 

 

 

 

265,640

 

5

 

 

 

 

 

 

 

 

N/A

 

 

 

 

12,781

 

206,672

 

 

219,453

 

 

 

$

2,603,660

 

$

505,533

 

$

1,245,728

 

$

12,781

 

$

206,672

 

$

180,414

 

$

4,754,788

 

 

After completing our impairment evaluation process as described in our Form 10-K, we concluded that no impairment charges were required on any individual loans held-for-investment as of March 31, 2014 or December 31, 2013. As of March 31, 2014, approximately $57.8 million of our loans held-for-investment were in default, approximately $8.0 million of which are within the LNR Segment and were acquired as non-performing loans prior to the April 19, 2013 acquisition.  The remaining $49.8 million of the defaulted loan balance is comprised of a single mezzanine loan within the Lending Segment.  The senior loan was in technical default as of March 31, 2014 due to a covenant breach, which caused our mezzanine loan to be in default.  The loan is in the process of being refinanced, with a substantial equity investment by the borrower.  No lender concessions are expected to be granted in connection with the refinancing. Additionally, none of our held-for-sale loans where we have elected the fair value option was 90 days or more past due or on nonaccrual status.

 

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In accordance with our policies, we record an allowance for loan losses equal to (i) 1.5% of the aggregate carrying amount of loans rated as a “4,” plus (ii) 5% of the aggregate carrying amount of loans rated as a “5.” These groups accounted for 6.0% and 5.6% of our loan portfolio as of March 31, 2014 and December 31, 2013, respectively.  The following table presents the activity in our allowance for loan losses (amounts in thousands):

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Allowance for loan losses at January 1

 

$

3,984

 

$

2,061

 

Provision for loan losses

 

497

 

30

 

Charge-offs

 

 

 

Recoveries

 

 

 

Allowance for loan losses at March 31

 

$

4,481

 

$

2,091

 

Recorded investment in loans related to the allowance for loan loss

 

$

298,753

 

$

112,573

 

 

The activity in our loan portfolio was as follows (amounts in thousands):

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Balance at January 1

 

$

4,750,804

 

$

3,000,335

 

Acquisitions/originations/additional funding

 

981,762

 

129,817

 

Capitalized interest(1)

 

8,656

 

1,611

 

Basis of loans sold(2)

 

(448,317

)

(44,631

)

Loan maturities/principal repayments

 

(353,934

)

(93,651

)

Discount accretion/premium amortization

 

1,806

 

7,632

 

Changes in fair value

 

20,893

 

 

Unrealized foreign currency remeasurement gain (loss)

 

3,629

 

(6,141

)

Loan loss allowance

 

(497

)

(30

)

Balance at March 31

 

$

4,964,802

 

$

2,994,942

 

 


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

(2)         See Note 10 for additional disclosure on these transactions.

 

5. Investment Securities

 

Investment securities were comprised of the following as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

Carrying Value as of

 

 

 

March 31, 2014

 

December 31, 2013

 

RMBS, available-for-sale

 

$

291,217

 

$

296,236

 

Single-borrower CMBS, available-for-sale

 

113,477

 

114,346

 

CMBS, fair value option (1)

 

564,818

 

550,282

 

Held-to-maturity (“HTM”) securities

 

369,152

 

368,318

 

Equity security, fair value option

 

15,115

 

15,247

 

Subtotal - Investment securities

 

1,353,779

 

1,344,429

 

VIE eliminations (1)

 

(430,694

)

(409,322

)

Total investment securities

 

$

923,085

 

$

935,107

 

 


(1)         Certain fair value option CMBS are eliminated in consolidation against VIE liabilities pursuant to ASC 810.

 

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Purchases, sales and principal collections for all investment securities were as follows (amounts in thousands):

 

 

 

Available-for-sale

 

CMBS, fair

 

HTM

 

Equity

 

 

 

 

 

RMBS

 

CMBS

 

value option

 

Securities

 

Security

 

Total

 

Three Months ended March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

$

 

$

 

$

9,890

 

$

 

$

 

$

9,890

 

Sales

 

9,309

 

 

18,574

 

 

 

27,883

 

Principal collections

 

7,819

 

408

 

 

 

 

8,227

 

Three Months ended March 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

 

 

 

37,190

 

 

37,190

 

Sales

 

12,711

 

206,608

(1)

 

 

6,769

 

226,088

 

Principal collections

 

16,868

 

4,858

 

 

 

 

21,726

 

 


(1)         Settlement occurred subsequent to March 31, 2013.  We account for all investment securities transactions on a trade date basis.

 

RMBS and Single-borrower CMBS, Available-for-Sale

 

With the exception of one CMBS classified as HTM, the Company classified all of its RMBS and CMBS investments where the fair value option has not been elected as available-for-sale as of March 31, 2014 and December 31, 2013. These RMBS and CMBS are reported at fair value in the balance sheet with changes in fair value recorded in accumulated other comprehensive income (“AOCI”).

 

The tables below summarize various attributes of our investments in available-for-sale RMBS and single-borrower CMBS where the fair value option has not been elected as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

 

 

 

 

 

 

Unrealized Gains or (Losses)
Recognized in AOCI

 

 

 

 

 

Purchase
Amortized
Cost

 

Credit
OTTI

 

Recorded
Amortized
Cost

 

Non-Credit
OTTI

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Net
Fair Value
Adjustment

 

Fair Value

 

March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RMBS

 

$

243,354

 

$

(10,342

)

$

233,012

 

$

(979

)

$

59,419

 

$

(235

)

$

58,205

 

$

291,217

 

Single-borrower CMBS

 

100,980

 

 

100,980

 

 

12,497

 

 

12,497

 

113,477

 

Total

 

$

344,334

 

$

(10,342

)

$

333,992

 

$

(979

)

$

71,916

 

$

(235

)

$

70,702

 

$

404,694

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RMBS

 

$

253,912

 

$

(11,134

)

$

242,778

 

$

(55

)

$

55,154

 

$

(1,641

)

$

53,458

 

$

296,236

 

Single-borrower CMBS

 

100,687

 

 

100,687

 

 

13,659

 

 

13,659

 

114,346

 

Total

 

$

354,599

 

$

(11,134

)

$

343,465

 

$

(55

)

$

68,813

 

$

(1,641

)

$

67,117

 

$

410,582

 

 

 

 

Weighted Average
Coupon(1)

 

Weighted Average
Rating
(Standard & Poor’s)

 

WAL (Years)(3)

 

March 31, 2014

 

 

 

 

 

 

 

RMBS

 

1.0

%

B-

 

7.8

 

Single-borrower CMBS

 

11.5

%

BB+

(2)

4.0

 

December 31, 2013

 

 

 

 

 

 

 

RMBS

 

1.0

%

B-

 

6.8

 

Single-borrower CMBS

 

11.5

%

BB+

(2)

5.9

 

 


(1)                                 Calculated using the March 31, 2014 and December 31, 2013 one-month LIBOR rate of 0.152% and 0.168%, respectively, for floating rate securities.

 

(2)                                 As of March 31, 2014 and December 31, 2013, approximately 99.1% and 98.8%, respectively, of the CMBS securities were rated BB+.

 

(3)                                 Represents the WAL of each respective group of securities calculated as of the respective balance sheet date. The WAL of each individual security or loan is calculated as a fraction, the numerator of which is the sum of the timing

 

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(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. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the security.

 

As of March 31, 2014, $1.0 million, or 0.9%, of the single-borrower CMBS were variable rate. As of December 31, 2013, $1.3 million, or 1.2%, of the single-borrower CMBS were variable rate. As of March 31, 2014, approximately $252.1 million, or 86.6%, of the RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 0.38%. As of December 31, 2013, approximately $256.1 million, or 86.5%, of the RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 0.37%. 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 contains a reconciliation of aggregate principal balance to amortized cost for our RMBS and single-borrower CMBS as of March 31, 2014 and December 31, 2013, excluding CMBS where we have elected the fair value option (amounts in thousands):

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

RMBS

 

CMBS

 

RMBS

 

CMBS

 

Principal balance

 

$

388,066

 

$

100,980

 

$

414,020

 

$

100,687

 

Accretable yield

 

(99,622

)

 

(101,046

)

 

Non-accretable difference

 

(55,432

)

 

(70,196

)

 

Total discount

 

(155,054

)

 

(171,242

)

 

Amortized cost

 

$

233,012

 

$

100,980

 

$

242,778

 

$

100,687

 

 

The principal balance of credit deteriorated RMBS was $300.7 million and $320.4 million as of March 31, 2014 and December 31, 2013, respectively. Accretable yield related to these securities totaled $79.3 million and $78.3 million as of March 31, 2014 and December 31, 2013, respectively.

 

The following table discloses the changes to accretable yield and non-accretable difference for our RMBS and single-borrower CMBS during the three months ended March 31, 2014 and 2013, excluding CMBS where we have elected the fair value option (amounts in thousands):

 

 

 

Accretable Yield

 

Non-Accretable
Difference

 

 

 

RMBS

 

CMBS

 

RMBS

 

CMBS

 

Balance as of January 1, 2014

 

$

101,046

 

$

 

$

70,196

 

$

 

Accretion of discount

 

(6,564

)

 

 

 

Principal write-downs

 

 

 

(366

)

 

Purchases

 

 

 

 

 

Sales

 

(1,962

)

 

(7,509

)

 

OTTI

 

213

 

 

 

 

Transfer to/from non-accretable difference

 

6,889

 

 

(6,889

)

 

Balance as of March 31, 2014

 

$

99,622

 

$

 

$

55,432

 

$

 

 

 

 

 

 

 

 

 

 

 

Balance as of January 1, 2013

 

$

108,486

 

$

21,511

 

$

97,605

 

$

 

Accretion of discount

 

(6,151

)

(3,029

)

 

 

Principal write-downs

 

 

 

(496

)

 

Purchases

 

 

 

 

 

Sales

 

(2,418

)

(9,873

)

(2,038

)

 

OTTI

 

42

 

 

 

 

Transfer to/from non-accretable difference

 

(1,002

)

 

1,002

 

 

Balance as of March 31, 2013

 

$

98,957

 

$

8,609

 

$

96,073

 

$

 

 

Subject to certain limitations on durations, we have allocated an amount to invest in RMBS that cannot exceed 10% of our total assets excluding LNR VIEs. We have engaged a third party manager who specializes in RMBS to execute the trading of RMBS, the cost of which was $0.6 million for each of the three months ended March 31, 2014 and 2013, which has been recorded as management fees in the accompanying condensed consolidated statements of operations.

 

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The following table presents the gross unrealized losses and estimated fair value of the available-for-sale securities (i) where we have not elected the fair value option, (ii) that were in an unrealized loss position as of March 31, 2014 and December 31, 2013, and (iii) for which OTTIs (full or partial) have not been recognized in earnings (amounts in thousands):

 

 

 

Estimated Fair Value

 

Unrealized Losses

 

 

 

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

 

As of March 31, 2014

 

 

 

 

 

 

 

 

 

RMBS

 

$

20,799

 

$

799

 

$

(1,040

)

$

(174

)

Single-borrower CMBS

 

 

 

 

 

Total

 

$

20,799

 

$

799

 

$

(1,040

)

$

(174

)

As of December 31, 2013

 

 

 

 

 

 

 

 

 

RMBS

 

$

26,344

 

$

1,809

 

$

(1,444

)

$

(252

)

Single-borrower CMBS

 

 

 

 

 

Total

 

$

26,344

 

$

1,809

 

$

(1,444

)

$

(252

)

 

As of March 31, 2014, there were six securities with unrealized losses reflected in the table above. After evaluating each security and recording adjustments, as necessary, for other-than-temporary impairments, the remaining unrealized losses reflected above were not considered to represent other-than-temporary impairments. 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. Credit losses, which represent most of the other-than-temporary impairments we record, are calculated by comparing (i) the 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. Significant judgment is used 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.

 

CMBS, Fair Value Option

 

As discussed in the “Fair Value Option” section of Note 2 herein, we elect the fair value option for LNR’s CMBS in an effort to eliminate accounting mismatches resulting from the current or potential consolidation of securitization VIEs. As of March 31, 2014, the fair value and unpaid principal balance of CMBS where we have elected the fair value option, before consolidation of securitization VIEs, were $564.8 million and $3.9 billion, respectively. These balances represent our economic interests in these assets. However, as a result of our consolidation of securitization VIEs, the vast majority of this fair value ($430.7 million at March 31, 2014) is eliminated against VIE liabilities before arriving at our GAAP balance for fair value option CMBS. During the three months ended March 31, 2014, we purchased $44.7 million of CMBS for which we elected the fair value option. Due to our consolidation of securitization VIEs, $34.8 million of this amount is reflected as repayment of debt of consolidated VIEs in our condensed consolidated statement of cash flows.

 

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As of March 31, 2014 and December 31, 2013, none of our CMBS where we have elected the fair value option were variable rate. The table below summarizes various attributes of our investment in fair value option CMBS as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

Weighted
Average
Coupon

 

Weighted
Average
Rating
(Standard &
Poor’s)

 

WAL
(Years)(1)

 

March 31, 2014

 

 

 

 

 

 

 

CMBS, fair value option

 

5.4

%

C

(2)

5.6

 

December 31, 2013

 

 

 

 

 

 

 

CMBS, fair value option

 

5.4

%

D

(2)

4.4

 

 


(1)                                 The WAL of each security is calculated based on the period of time over which we expect to receive principal cash flows. Expected principal cash flows are based on contractual payments net of expected losses.

 

(2)                                 As of March 31, 2014 and December 31, 2013, includes $53.8 million and $55.5 million, respectively, in fair value option CMBS that are not rated but assigned a rating weight one level lower than NR for purposes of this calculation. As of March 31, 2014 and December 31, 2013, the remaining $80.3 million and $85.4 million, respectively, in fair value option CMBS had a weighted average rating of CC and C, respectively.

 

HTM Securities

 

The table below summarizes various attributes of our investments in HTM securities as of March 31, 2014 and December 31, 2013 (amounts in thousands):