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 September 30, 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 October 31, 2014 was 222,402,882.

 

 

 



Table of Contents

 

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 respective 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, this Quarterly Report on Form 10-Q and our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2014 and June 30, 2014, 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

19

 

Note 6 Investment in Unconsolidated Entities

23

 

Note 7 Goodwill and Intangible Assets

23

 

Note 8 Secured Financing Agreements

24

 

Note 9 Convertible Senior Notes

26

 

Note 10 Loan Securitization/Sale Activities

27

 

Note 11 Derivatives and Hedging Activity

28

 

Note 12 Offsetting Assets and Liabilities

30

 

Note 13 Variable Interest Entities

30

 

Note 14 Related-Party Transactions

31

 

Note 15 Stockholders’ Equity

33

 

Note 16 Earnings per Share

34

 

Note 17 Accumulated Other Comprehensive Income

36

 

Note 18 Fair Value

37

 

Note 19 Income Taxes

42

 

Note 20 Commitments and Contingencies

43

 

Note 21 Segment Data

44

 

Note 22 Subsequent Events

50

Item 2.

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

51

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

70

Item 4.

Controls and Procedures

73

Part II

Other Information

 

Item 1.

Legal Proceedings

74

Item 1A.

Risk Factors

74

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

74

Item 3.

Defaults Upon Senior Securities

74

Item 4.

Mine Safety Disclosures

74

Item 5.

Other Information

74

Item 6.

Exhibits

76

 

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
September 30, 2014

 

As of
December 31, 2013

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

327,322

 

$

317,627

 

Restricted cash

 

45,725

 

69,052

 

Loans held-for-investment, net

 

5,198,927

 

4,363,718

 

Loans held-for-sale, at fair value

 

248,165

 

206,672

 

Loans transferred as secured borrowings

 

142,516

 

180,414

 

Investment securities ($522,835 and $566,789 held at fair value)

 

894,302

 

935,107

 

Intangible assets—servicing rights ($130,420 and $150,149 held at fair value)

 

145,790

 

177,173

 

Residential real estate, net

 

 

749,214

 

Non-performing residential loans

 

 

215,371

 

Investment in unconsolidated entities

 

110,569

 

122,954

 

Goodwill

 

140,437

 

140,437

 

Derivative assets

 

13,354

 

7,769

 

Accrued interest receivable

 

35,065

 

37,630

 

Other assets

 

123,472

 

95,813

 

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

 

109,468,293

 

103,151,624

 

Total Assets

 

$

116,893,937

 

$

110,770,575

 

Liabilities and Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

154,058

 

$

225,374

 

Related-party payable

 

24,866

 

17,793

 

Dividends payable

 

108,056

 

90,171

 

Derivative liabilities

 

5,462

 

24,192

 

Secured financing agreements, net

 

2,708,108

 

2,257,560

 

Convertible senior notes, net

 

1,006,927

 

997,851

 

Secured borrowings on transferred loans

 

142,575

 

181,238

 

VIE liabilities, at fair value

 

108,879,922

 

102,649,263

 

Total Liabilities

 

113,029,974

 

106,443,442

 

Commitments and contingencies (Note 20)

 

 

 

 

 

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, 223,602,551 issued and 222,388,801 outstanding as of September 30, 2014 and 196,139,045 issued and 195,513,195 outstanding as of December 31, 2013

 

2,236

 

1,961

 

Additional paid-in capital

 

3,793,428

 

4,300,479

 

Treasury stock (1,213,750 shares and 625,850 shares)

 

(23,635

)

(10,642

)

Accumulated other comprehensive income

 

69,681

 

75,449

 

Retained earnings (accumulated deficit)

 

7,302

 

(84,719

)

Total Starwood Property Trust, Inc. Stockholders’ Equity

 

3,849,012

 

4,282,528

 

Non-controlling interests in consolidated subsidiaries

 

14,951

 

44,605

 

Total Equity

 

3,863,963

 

4,327,133

 

Total Liabilities and Equity

 

$

116,893,937

 

$

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
September 30,

 

For the Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Revenues:

 

 

 

 

 

 

 

 

 

Interest income from loans

 

$

110,669

 

$

94,045

 

$

321,034

 

$

236,671

 

Interest income from investment securities

 

28,640

 

17,804

 

85,714

 

52,621

 

Servicing fees

 

34,641

 

36,509

 

101,533

 

75,644

 

Other revenues

 

7,418

 

2,034

 

15,816

 

3,908

 

Total revenues

 

181,368

 

150,392

 

524,097

 

368,844

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Management fees

 

24,943

 

20,925

 

77,849

 

52,140

 

Interest expense

 

39,739

 

34,017

 

115,265

 

74,091

 

General and administrative

 

47,640

 

47,474

 

136,835

 

95,847

 

Business combination costs

 

 

342

 

 

17,958

 

Acquisition and investment pursuit costs

 

759

 

1,393

 

1,924

 

2,390

 

Depreciation and amortization

 

3,017

 

3,435

 

12,807

 

5,663

 

Loan loss allowance, net

 

1,575

 

1,160

 

1,933

 

1,915

 

Other expense

 

2,701

 

513

 

10,416

 

742

 

Total costs and expenses

 

120,374

 

109,259

 

357,029

 

250,746

 

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

 

60,994

 

41,133

 

167,068

 

118,098

 

Other income:

 

 

 

 

 

 

 

 

 

Income of consolidated VIEs, net

 

87,778

 

47,963

 

190,810

 

79,912

 

Change in fair value of servicing rights

 

(7,897

)

(1,867

)

(18,671

)

1,031

 

Change in fair value of investment securities, net

 

1,860

 

(2,278

)

15,180

 

(3,265

)

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

 

15,517

 

25,857

 

48,018

 

26,315

 

Earnings from unconsolidated entities

 

3,805

 

2,222

 

13,432

 

6,733

 

Gain on sale of investments, net

 

1,332

 

6,184

 

12,965

 

19,690

 

Gain (loss) on derivative financial instruments, net

 

29,275

 

(22,451

)

11,619

 

(65

)

Foreign currency (loss) gain, net

 

(21,466

)

9,580

 

(16,212

)

3,495

 

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

 

(264

)

(86

)

(2,256

)

(1,460

)

Noncredit portion of OTTI recognized in other comprehensive income

 

264

 

34

 

1,246

 

1,007

 

Net impairment losses recognized in earnings

 

 

(52

)

(1,010

)

(453

)

Other income, net

 

28

 

374

 

738

 

413

 

Total other income

 

110,232

 

65,532

 

256,869

 

133,806

 

Income from continuing operations before income taxes

 

171,226

 

106,665

 

423,937

 

251,904

 

Income tax provision

 

(3,836

)

(13,721

)

(13,733

)

(25,679

)

Income from continuing operations

 

167,390

 

92,944

 

410,204

 

226,225

 

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

 

 

(3,698

)

(1,551

)

(12,044

)

Net income

 

167,390

 

89,246

 

408,653

 

214,181

 

Net income attributable to non-controlling interests

 

(2,346

)

(1,886

)

(5,140

)

(4,124

)

Net income attributable to Starwood Property Trust, Inc.

 

$

165,044

 

$

87,360

 

$

403,513

 

$

210,057

 

 

 

 

 

 

 

 

 

 

 

Earnings per share data attributable to Starwood Property Trust, Inc.:

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.73

 

$

0.53

 

$

1.89

 

$

1.41

 

Loss from discontinued operations

 

 

(0.02

)

(0.01

)

(0.08

)

Net income

 

$

0.73

 

$

0.51

 

$

1.88

 

$

1.33

 

Diluted:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.73

 

$

0.53

 

$

1.88

 

$

1.41

 

Loss from discontinued operations

 

 

(0.02

)

(0.01

)

(0.08

)

Net income

 

$

0.73

 

$

0.51

 

$

1.87

 

$

1.33

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.48

 

$

0.46

 

$

1.44

 

$

1.36

 

 

See notes to condensed consolidated financial statements.

 

5



Table of Contents

 

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,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net income

 

$

167,390

 

$

89,246

 

$

408,653

 

$

214,181

 

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

 

 

 

 

 

 

 

 

 

Cash flow hedges

 

530

 

(197

)

559

 

1,583

 

Available-for-sale securities

 

3,954

 

(1,768

)

(2,166

)

(15,895

)

Foreign currency remeasurement

 

(9,765

)

10,967

 

(4,161

)

3,924

 

Other comprehensive (loss) income

 

(5,281

)

9,002

 

(5,768

)

(10,388

)

Comprehensive income

 

162,109

 

98,248

 

402,885

 

203,793

 

Less: Comprehensive income attributable to non-controlling interests

 

(2,346

)

(1,886

)

(5,140

)

(4,124

)

Comprehensive income attributable to Starwood Property Trust, Inc.

 

$

159,763

 

$

96,362

 

$

397,745

 

$

199,669

 

 

See notes to condensed consolidated financial statements.

 

6



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

Condensed Consolidated Statements of Equity

(Unaudited, amounts in thousands, except share data)

 

 

 

Common stock

 

Additional

 

 

 

 

 

Retained
Earnings

 

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

 

Proceeds from public offering of common stock

 

25,300,000

 

253

 

564,442

 

 

 

 

 

564,695

 

 

564,695

 

Proceeds from ATM Agreement

 

759,000

 

8

 

18,338

 

 

 

 

 

18,346

 

 

18,346

 

Proceeds from DRIP Plan

 

2,430

 

 

58

 

 

 

 

 

58

 

 

58

 

Equity offering costs

 

 

 

(1,623

)

 

 

 

 

(1,623

)

 

(1,623

)

Common stock repurchased

 

 

 

 

587,900

 

(12,993

)

 

 

(12,993

)

 

(12,993

)

Stock-based compensation

 

1,025,144

 

10

 

21,491

 

 

 

 

 

21,501

 

 

21,501

 

Manager incentive fee paid in stock

 

376,932

 

4

 

8,986

 

 

 

 

 

8,990

 

 

8,990

 

Net income

 

 

 

 

 

 

403,513

 

 

403,513

 

5,140

 

408,653

 

Dividends declared, $1.44 per share

 

 

 

 

 

 

(311,492

)

 

(311,492

)

 

(311,492

)

Spin-off of SWAY

 

 

 

(1,118,743

)

 

 

 

 

(1,118,743

)

(1,594

)

(1,120,337

)

Other comprehensive income, net

 

 

 

 

 

 

 

(5,768

)

(5,768

)

 

(5,768

)

VIE non-controlling interests

 

 

 

 

 

 

 

 

 

382

 

382

 

Distribution to non-controlling interests

 

 

 

 

 

 

 

 

 

(33,582

)

(33,582

)

Balance, September 30, 2014

 

223,602,551

 

$

2,236

 

$

3,793,428

 

1,213,750

 

$

(23,635

)

$

7,302

 

$

69,681

 

$

3,849,012

 

$

14,951

 

$

3,863,963

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

210,057

 

 

210,057

 

4,124

 

214,181

 

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 interest assumed through LNR acquisition

 

 

 

 

 

 

 

 

 

8,705

 

8,705

 

Contributions 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

)

$

(89,521

)

$

69,287

 

$

4,266,141

 

$

43,106

 

$

4,309,247

 

 

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 Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net income

 

$

408,653

 

$

214,181

 

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

 

 

 

 

 

Amortization of deferred financing costs

 

8,501

 

7,044

 

Amortization of convertible debt discount and deferred fees

 

9,376

 

5,693

 

Accretion of net discount on investment securities

 

(17,174

)

(23,484

)

Accretion of net deferred loan fees and discounts

 

(16,756

)

(26,917

)

Amortization of premium from secured borrowings on transferred loans

 

(862

)

(1,211

)

Share-based compensation

 

21,501

 

12,870

 

Share-based component of incentive fees

 

8,990

 

367

 

Change in fair value of fair value option investment securities

 

(15,180

)

3,265

 

Change in fair value of consolidated VIEs

 

(71,105

)

(22,428

)

Change in fair value of servicing rights

 

18,671

 

(1,031

)

Change in fair value of loans held-for-sale

 

(48,018

)

(26,315

)

Change in fair value of derivatives

 

(14,595

)

(2,196

)

Foreign currency loss (gain), net

 

15,767

 

(3,481

)

Gain on non-performing loans and sale of investments

 

(13,907

)

(23,728

)

Other-than-temporary impairment

 

1,010

 

989

 

Loan loss allowance, net

 

1,933

 

1,915

 

Depreciation and amortization

 

13,178

 

8,022

 

Earnings from unconsolidated entities

 

(13,432

)

(3,245

)

Distributions of earnings from unconsolidated entities

 

9,354

 

2,315

 

Capitalized costs written off

 

 

1,517

 

Changes in operating assets and liabilities:

 

 

 

 

 

Related-party payable, net

 

7,073

 

25,475

 

Accrued interest receivable, less purchased interest

 

(29,770

)

(8,603

)

Other assets

 

(6,192

)

(6,874

)

Accounts payable, accrued expenses and other liabilities

 

(46,997

)

36,087

 

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

 

(1,159,058

)

(847,844

)

Proceeds from sale of loans held-for-sale

 

1,165,583

 

851,609

 

Net cash provided by operating activities

 

236,544

 

173,992

 

Cash Flows from Investing Activities:

 

 

 

 

 

Spin-off of Starwood Waypoint Residential Trust

 

(111,960

)

 

Purchase of LNR, net of cash acquired

 

 

(586,383

)

Purchase of investment securities

 

(67,230

)

(82,754

)

Proceeds from sales of investment securities

 

100,166

 

442,877

 

Proceeds from principal collections on investment securities

 

40,999

 

56,793

 

Origination and purchase of loans held-for-investment

 

(2,123,947

)

(1,658,240

)

Proceeds from principal collections on loans

 

966,350

 

394,616

 

Proceeds from loans sold

 

341,472

 

369,621

 

Acquisition and improvement of single family homes

 

(61,901

)

(458,733

)

Proceeds from sale of single family homes

 

1,784

 

6,696

 

Purchase of other assets

 

(18,731

)

(1,631

)

Purchase of non-performing loans

 

 

(153,141

)

Proceeds from sale of non-performing loans

 

1,153

 

27,198

 

Investment in unconsolidated entities

 

(21,973

)

(8,558

)

Distribution of capital from unconsolidated entities

 

38,946

 

3,210

 

Payments for purchase or termination of derivatives

 

(16,081

)

(648

)

Proceeds from termination of derivatives

 

5,611

 

9,940

 

Return of investment basis in purchased derivative asset

 

1,222

 

1,533

 

Decrease (increase) in restricted cash, net

 

8,890

 

(54,860

)

Net cash used in investing activities

 

(915,230

)

(1,692,464

)

 

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 Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

Cash Flows from Financing Activities:

 

 

 

 

 

Borrowings under financing agreements

 

$

2,917,281

 

$

2,691,382

 

Proceeds from issuance of convertible senior notes

 

 

1,037,926

 

Principal repayments on borrowings

 

(2,459,837

)

(3,123,571

)

Payment of deferred financing costs

 

(11,536

)

(13,281

)

Proceeds from secured borrowings

 

 

95,000

 

Proceeds from common stock issuances

 

583,099

 

1,513,519

 

Payment of equity offering costs

 

(1,623

)

(955

)

Payment of dividends

 

(293,607

)

(210,843

)

Contributions from non-controlling interests

 

 

1,399

 

Distributions to non-controlling interests

 

(33,582

)

(47,914

)

Issuance of debt of consolidated VIEs

 

88,412

 

8,760

 

Repayment of debt of consolidated VIEs

 

(129,724

)

(93,293

)

Distributions of cash from consolidated VIEs

 

32,601

 

18,598

 

Net cash provided by financing activities

 

691,484

 

1,876,727

 

Net increase in cash and cash equivalents

 

12,798

 

358,255

 

Cash and cash equivalents, beginning of period

 

317,627

 

177,671

 

Effect of exchange rate changes on cash

 

(3,103

)

908

 

Cash and cash equivalents, end of period

 

$

327,322

 

$

536,834

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

110,208

 

$

54,548

 

Income taxes paid

 

19,040

 

24,794

 

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

 

108,056

 

90,130

 

Consolidation of VIEs (VIE asset/liability additions)

 

27,094,681

 

15,033,274

 

Deconsolidation of VIEs (VIE asset/liability reductions)

 

8,502,882

 

584,804

 

Unsettled common stock repurchased

 

12,993

 

 

Fair value of assets acquired

 

 

1,152,360

 

Fair value of liabilities assumed

 

 

562,279

 

Unsettled trades and loans receivable

 

 

14,338

 

Interest only security received in connection with securitization

 

 

1,889

 

 

See notes to condensed consolidated financial statements.

 

9



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

As of September 30, 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.

 

Our target assets may also include residential mortgage-backed securities (“RMBS”), certain residential mortgage loans, distressed or non-performing commercial loans, commercial properties subject to net leases and equity interests in commercial real estate. 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 two reportable business segments as of September 30, 2014:

 

·                  Real estate investment lending (the “Lending Segment”)—includes all business activities of the Company, excluding the LNR business, 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.

 

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) an investment 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 former single family residential (“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, which has been presented within discontinued operations in the condensed consolidated statements of operations included herein.

 

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.

 

10



Table of Contents

 

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 an investment 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 data in Note 21 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 and nine months ended September 30, 2014 are not necessarily indicative of the operating results for the full year.

 

11



Table of Contents

 

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 (i) are required to be disclosed quarterly, (ii) 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.

 

12



Table of Contents

 

Discontinued Operations

 

On January 31, 2014, we completed the spin-off of our former 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 nine months ended September 30, 2014 and the three and nine months ended September 30, 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 (“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 and Measurement Period Adjustments

 

As a result of the spin-off, the results from our SFR segment have been reclassified as discontinued operations in our condensed consolidated statements of operations for the nine months ended September 30, 2014 and the three and nine months ended September 30, 2013.  In addition, certain prior period amounts have been reclassified to conform to the current period presentation, which had no effect on our previously reported net income.  In that regard, we reclassified $449.1 million of proceeds from sales of loans held-for-sale by LNR to cash flows from operating activities in the condensed consolidated statement of cash flows for the nine months ended September 30, 2013 in order to conform to the current period presentation, which is also consistent with the presentation in our Form 10-K.  These proceeds were previously reported as a non-cash financing activity and reflected net against principal repayments on borrowings for the related repurchase agreements that were settled net with those proceeds.

 

13



Table of Contents

 

The prior period financial statements included herein reflect the retrospective measurement period adjustment related to the LNR acquisition as described in Note 3 to the consolidated financial statements included in our Form 10-K.  Such adjustment reduced earnings from unconsolidated entities and net income by $2.4 million and $4.2 million in the three and nine months ended September 30, 2013, respectively.

 

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.  Early adoption is permitted for disposals not already reported in previously issued financial statements.  We do not expect the application of this ASU to materially impact the Company.

 

On May 28, 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which establishes key principles by which an entity determines the amount and timing of revenue recognized from customer contracts.  The ASU is effective for the first interim or annual period beginning after December 15, 2016. Early application is not permitted.  We do not expect the application of this ASU to materially impact the Company.

 

On June 12, 2014 the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, which requires entities to account for repurchase-to-maturity transactions as secured borrowings rather than as sales and expands disclosure requirements related to certain transfers of financial assets. The ASU is effective for the first interim or annual period beginning after December 15, 2014. Early application is not permitted.  We do not expect the application of this ASU to materially impact the Company.

 

On August 5, 2014, the FASB issued ASU 2014-13, Consolidation (Topic 810) - Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (“CFE”), which establishes a measurement alternative allowing qualifying entities to measure both the CFE’s financial assets and financial liabilities based on the fair value of the financial assets or financial liabilities, whichever is more observable.  The measurement alternative is available upon initial consolidation of the CFE or adoption of this ASU and can be applied on a CFE-by-CFE basis.  The ASU is effective for annual periods, and interim periods therein, beginning after December 15, 2015.  Early application is permitted.  We have elected to apply this measurement alternative to all of our existing consolidated CFEs.  Application of this ASU has no impact on the Company as it is consistent with our existing accounting practices.

 

3.  Acquisitions and Divestitures

 

SFR Spin-off

 

As described in Note 1, on January 31, 2014, we completed the spin-off of our former 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 discontinued operations for the SFR segment prior to the spin-off (in thousands):

 

 

 

For the Three Months Ended
September 30,

 

For the Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Total revenues

 

$

 

$

5,155

 

$

3,876

 

$

8,913

 

Total costs and expenses

 

 

14,048

(1)

6,369

 

27,543

(1)

Loss before other income and income taxes

 

 

(8,893

)

(2,493

)

(18,630

)

Total other income

 

 

5,195

 

942

 

6,598

 

Loss before income taxes

 

 

(3,698

)

(1,551

)

(12,032

)

Income tax benefit (provision)

 

 

 

 

(12

)

Net loss

 

$

 

$

(3,698

)

$

(1,551

)

$

(12,044

)

 


(1)                                 Costs and expenses for the three and nine months ended September 30, 2013 include allocated interest expense of $2.3 million and $3.6 million, respectively. Refer to Note 21 for discussion of our cost allocation method.

 

14



Table of Contents

 

The following table presents the summarized consolidated balance sheet of the SFR segment as of January 31, 2014, the date of the 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

 

 

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 to the consolidated financial statements included in our Form 10-K for further discussion of the LNR acquisition including the final purchase price allocation and retrospective measurement period adjustments.

 

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 September 30, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

Carrying
Value

 

Face
Amount

 

Weighted
Average
Coupon

 

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

 

September 30, 2014

 

 

 

 

 

 

 

 

 

First mortgages

 

$

3,384,985

 

$

3,445,226

 

5.6

%

3.7

 

Subordinated mortgages(1)

 

386,865

 

418,221

 

8.5

%

4.0

 

Mezzanine loans

 

1,432,994

 

1,429,777

 

10.6

%

3.1

 

Total loans held-for-investment

 

5,204,844

 

5,293,224

 

 

 

 

 

Loans held-for-sale, fair value option elected

 

248,165

 

248,620

 

4.7

%

9.8

 

Loans transferred as secured borrowings

 

142,516

 

142,681

 

5.3

%

2.5

 

Total gross loans

 

5,595,525

 

5,684,525

 

 

 

 

 

Loan loss allowance (loans held-for-investment)

 

(5,917

)

 

 

 

 

 

Total net loans

 

$

5,589,608

 

$

5,684,525

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

First mortgages

 

$

2,714,512

 

$

2,766,217

 

5.5

%

4.3

 

Subordinated mortgages(1)

 

407,462

 

442,475

 

9.7

%

4.2

 

Mezzanine loans

 

1,245,728

 

1,246,841

 

11.7

%

3.5

 

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

 

 

 

 

 

 

15



Table of Contents

 


(1)                                 Subordinated mortgages include B-notes and junior participations in first mortgages where we do not own the senior A-note or senior participation.  If we own both the A-note and B-note, we categorize the loan as a first mortgage loan.

 

(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 using amounts and timing of future principal payments, as projected at origination.

 

As of September 30, 2014, approximately $4.2 billion, or 74.5%, of all of our loans were variable rate and paid interest principally at LIBOR plus a weighted-average spread of 6.18%. The following table summarizes our investments in floating rate loans (amounts in thousands):

 

 

 

September 30, 2014

 

December 31, 2013

 

Index

 

Base Rate

 

Carrying
Value

 

Base Rate

 

Carrying
Value

 

1 Month LIBOR USD

 

0.1565%

 

$

129,608

 

0.1677%

 

$

150,076

 

3 Month LIBOR GBP

 

0.5653%

 

385,448

 

0.5253%

 

392,950

 

3 Month LIBOR EUR

 

0.0571%

 

28,658

 

 

 

LIBOR floor

 

0.15% - 3.00% (1)

 

3,618,041

 

0.19% - 3.00% (1)

 

2,688,308

 

Total

 

 

 

$

4,161,755

 

 

 

$

3,231,334

 

 


(1)                                 The weighted-average LIBOR floor was 0.36% and 0.49% as of September 30, 2014 and December 31, 2013, respectively.

 

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

 

Our evaluation process as described above produces an internal risk rating between 1 and 5, which is a weighted-average of the numerical ratings in the following categories: (i) sponsor capability and financial condition, (ii) loan and collateral performance relative to underwriting, (iii) quality and stability of collateral cash flows, and (iv) loan structure. We utilize the overall risk ratings as a concise means to monitor any credit migration on a loan as well as on the whole portfolio. While the overall risk rating is generally not the sole factor we use in determining whether a loan is impaired, a loan with a higher overall risk rating would tend to have more adverse indicators of impairment, and therefore would be more likely to experience a credit loss.

 

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

 

Rating

 

Characteristics

1

 

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

 

 

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

 

 

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

 

 

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

 

 

 

2

 

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

 

 

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

 

16



Table of Contents

 

Rating

 

Characteristics

 

 

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

 

 

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

 

 

 

3

 

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

 

 

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

 

 

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

 

 

·                  Loan structure—LTV does not exceed 80%.

 

 

 

4

 

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

 

 

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

 

 

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

 

 

·                  Loan structure—LTV is 80% to 90%.

 

 

 

5

 

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

 

 

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

 

 

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

 

 

·                  Loan structure—LTV exceeds 90%.

 

As of September 30, 2014, the risk ratings for loans subject to our rating system, which 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

 

% of
Total
Loans

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

%

2

 

102,161

 

113,510

 

214,834

 

 

 

12,936

 

443,441

 

7.9

%

3

 

3,138,864

 

241,107

 

1,102,588

 

 

 

129,580

 

4,612,139

 

82.5

%

4

 

93,446

 

32,248

 

115,572

 

 

 

 

241,266

 

4.3

%

5

 

45,965

 

 

 

 

 

 

45,965

 

0.8

%

N/A

 

446

 

 

 

4,103

 

248,165

 

 

252,714

 

4.5

%

 

 

$

3,380,882

 

$

386,865

 

$

1,432,994

 

$

4,103

 

$

248,165

 

$

142,516

 

$

5,595,525

 

100.0

%

 

17



Table of Contents

 

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

 

% of
Total
Loans

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

%

2

 

94,981

 

103,369

 

153,119

 

 

 

13,022

 

364,491

 

7.7

%

3

 

2,452,763

 

272,375

 

1,012,674

 

 

 

167,392

 

3,905,204

 

82.1

%

4

 

153,987

 

31,718

 

79,935

 

 

 

 

265,640

 

5.6

%

5

 

 

 

 

 

 

 

 

%

N/A

 

 

 

 

12,781

 

206,672

 

 

219,453

 

4.6

%

 

 

$

2,701,731

 

$

407,462

 

$

1,245,728

 

$

12,781

 

$

206,672

 

$

180,414

 

$

4,754,788

 

100.0

%

 

After completing our impairment evaluation process, we concluded that no impairment charges were required on any individual loans held-for-investment as of September 30, 2014 or December 31, 2013. As of September 30, 2014, approximately $4.1 million of our loans held-for-investment were in default, all of which are within the LNR Segment and were acquired as non-performing loans prior to the April 19, 2013 acquisition.

 

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.” The following table presents the activity in our allowance for loan losses (amounts in thousands):

 

 

 

For the Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

Allowance for loan losses at January 1

 

$

3,984

 

$

2,061

 

Provision for loan losses

 

1,933

 

1,915

 

Charge-offs

 

 

 

Recoveries

 

 

 

Allowance for loan losses at September 30

 

$

5,917

 

$

3,976

 

Recorded investment in loans related to the allowance for loan loss

 

$

287,231

 

$

265,068

 

 

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

 

 

 

For the Nine Months Ended
September 30,

 

 

 

2014

 

2013

 

Balance at January 1

 

$

4,750,804

 

3,000,335

 

Acquisitions/originations/additional funding

 

3,283,546

 

2,770,895

 

Capitalized interest(1)

 

31,994

 

12,481

 

Basis of loans sold(2)

 

(1,505,764

)

(1,221,396

)

Loan maturities/principal repayments

 

(1,009,222

)

(394,908

)

Discount accretion/premium amortization

 

16,756

 

26,917

 

Changes in fair value

 

48,018

 

26,315

 

Unrealized foreign currency remeasurement gain (loss)

 

(21,088

)

3,784

 

Capitalized costs written off

 

 

(1,517

)

Change in loan loss allowance, net

 

(1,933

)

(1,915

)

Transfer to other assets

 

(3,503

)

 

Balance at September 30

 

$

5,589,608

 

$

4,220,991

 

 


(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.

 

18



Table of Contents

 

5. Investment Securities

 

Investment securities were comprised of the following as of September 30, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

Carrying Value as of

 

 

 

September 30, 2014

 

December 31, 2013

 

RMBS, available-for-sale

 

$

216,319

 

$

296,236

 

Single-borrower CMBS, available-for-sale

 

106,086

 

114,346

 

CMBS, fair value option (1)

 

697,733

 

550,282

 

Held-to-maturity (“HTM”) securities

 

371,467

 

368,318

 

Equity security, fair value option

 

15,471

 

15,247

 

Subtotal - Investment securities

 

1,407,076

 

1,344,429

 

VIE eliminations (1)

 

(512,774

)

(409,322

)

Total investment securities

 

$

894,302

 

$

935,107

 

 


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

 

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

 

Three Months ended

 

Available-for-sale

 

CMBS, fair

 

HTM

 

Equity

 

 

 

September 30, 2014

 

RMBS

 

CMBS

 

value option

 

Securities

 

Security

 

Total

 

Purchases

 

$

 

$

 

$

13,777

 

$

 

$

 

$

13,777

 

Sales

 

5,588

 

 

 

 

 

5,588

 

Principal collections

 

21,870

 

 

1

 

14

 

 

21,885

 

 

September 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

$

 

$

1,889

 

$

21,982

 

$

 

$

 

$

23,871

 

Sales

 

 

206,972

 

 

 

 

206,972

 

Principal collections

 

14,124

 

2,546

 

 

 

 

16,670

 

 

Nine Months ended