UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Amendment No. 1
| (Mark One) | ||
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, 2010 | ||
or | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to | ||
Commission file number: 001-32330
NorthStar Realty Finance Corp.
(Exact Name of Registrant as Specified in its Charter)
| Maryland (State or other Jurisdiction of Incorporation or Organization) | 11-3707493 (I.R.S. Employer Identification No.) | |
399 Park Avenue, 18th Floor New York, New York (Address of Principal Executive Offices) | 10022 (Zip Code) |
(212) 547-2600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Class | Name of Each Exchange on Which Registered | |
|---|---|---|
| Common Stock, $0.01 par value | New York Stock Exchange | |
| 8.75% Series A Cumulative Redeemable | ||
| Preferred Stock, $0.01 par value | New York Stock Exchange | |
| 8.25% Series B Cumulative Redeemable | ||
| Preferred Stock, $0.01 par value | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act:None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No ý
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 ý 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K/A or any amendment to this Form 10-K/A. ý
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 definition of "large accelerated filer", "accelerate filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer o | Accelerated filer ý | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý
The aggregate market value of the registrant's voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2010, was $205,907,287. As of February 24, 2011, the registrant had issued and outstanding 77,175,882 shares of common stock, par value $0.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the registrant's 2011 Annual Meeting of Stockholders (the "2011 Proxy Statement"), to be filed within 120 days after the end of the registrant's fiscal year ending December 31, 2010, are incorporated by reference into this Annual Report on Form 10-K/A in response to Part III, Items 10, 11, 12, 13 and 14.
This Amendment No. 1 on Form 10-K/A (the "Amended Form 10-K") amends the Annual Report on Form 10-K of NorthStar Realty Finance Corp. (the "Company") for the fiscal year ended December 31, 2010 filed with the U.S. Securities and Exchange Commission on February 25, 2011 (the "2010 Form 10-K"). The sole purpose of this Amended Form 10-K is to add certain information that was omitted from the 2010 Form 10-K in error. The omitted information includes (i) the new subsection entitled "Item 1. Business—Management Update" and (ii) additional language in the Risk Factor entitled "Item 1A. Risk Factors—Risks Related to Our Company—Our ability to operate our business successfully would be harmed if key personnel terminate their employment with us."
For ease of reference, this Amended Form 10-K sets forth the entire 2010 Form 10-K as previously filed, amended only to give effect to the additions discussed above. In addition, pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the Amended Form 10-K included new certifications of our principal executive officer and principal financial officer on Exhibits 31.1, 31.2, 32.1 and 32.2, each as of the date of filing of this Amended Form 10-K.
This Amended Form 10-K does not reflect events occurring after the filing of the 2010 Form 10-K and, other than as discussed above and other than changing certain references to the Form 10-K to this Form 10-K/A, does not modify or update the disclosures in the original 2010 Form 10-K in any way.
| | | Page | ||
|---|---|---|---|---|
PART I | ||||
Item 1. | Business | 4 | ||
Item 1A. | Risk Factors | 17 | ||
Item 1B. | Unresolved Staff Comments | 62 | ||
Item 2. | Properties | 63 | ||
Item 3. | Legal Proceedings | 65 | ||
PART II | ||||
Item 5. | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 66 | ||
Item 6. | Selected Financial Data | 68 | ||
Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 71 | ||
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk | 104 | ||
Item 8. | Financial Statements and Supplementary Data | 109 | ||
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 190 | ||
Item 9A. | Controls and Procedures | 190 | ||
Item 9B. | Other Information | 191 | ||
PART III | ||||
Item 10. | Directors, Executive Officers and Corporate Governance | 192 | ||
Item 11. | Executive Compensation | 192 | ||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 192 | ||
Item 13. | Certain Relationships and Related Transactions and Directors Independence | 192 | ||
Item 14. | Principal Accountant Fees and Services | 192 | ||
PART IV | ||||
Item 15. | Exhibits and Financial Statement Schedules | 193 |
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This Annual Report on Form 10-K/A contains certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments and financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology such as "may," "will," "should," "potential," "intend," "expect," "seek," "anticipate," "estimate," "believe," "could," "project," "predict," "continue" or other similar words or expressions. Forward-looking statements are not guarantees of performance and are based on certain assumptions, discuss future expectations, describe plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual effect of plans or strategies is inherently uncertain, particularly given the economic environment. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from those forward looking statements. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.
Factors that could have a material adverse effect on our operations and future prospects are set forth in "Risk Factors" in this Annual Report on Form 10-K/A beginning on page 15. The factors set forth in the Risk Factors section could cause our actual results to differ significantly from those contained in any forward-looking statement contained in this report.
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Our Company
We are a real estate finance company that has focused primarily on originating, investing in and managing commercial real estate debt, commercial real estate securities and net lease properties. We have invested in those areas of commercial real estate that enabled us to leverage our real estate investment expertise, utilize our broad capital markets knowledge, and capitalize on our ability to employ innovative financing structures. We believe that our three principal business lines are complementary to each other due to their overlapping sources of investment opportunities, common reliance on real estate fundamentals and ability to apply similar asset management skills to maximize value and to protect capital. We conduct our operations so as to qualify as a real estate investment trust, or a REIT, for federal income tax purposes. In this Annual Report, "we" or the "Company" means NorthStar Realty Finance Corp. and its consolidated subsidiaries, unless the context otherwise requires.
The U.S. economy is continuing to experience high unemployment and low economic growth compared to historical periods. These conditions were precipitated by the collapse of the U.S. residential real estate sector in 2007, and continue to have a negative impact on commercial real estate fundamentals. During 2010, liquidity began to return to commercial real estate debt and equity markets despite these poor economic conditions; however, many investors remain cautious in providing capital to legacy commercial real estate finance companies, like us, until the economic outlook becomes more clear. Our priorities are to actively manage portfolio credit to preserve capital, generate and recycle liquidity from existing assets, reduce leverage by purchasing our issued debt at discounts to par, make opportunistic investments and to access new investment capital through channels other than the listed public capital markets, such as the non-traded REIT market.
Since 2008, most of our new investment activities have been funded using proceeds from repayments and sales of investments within our portfolio. During 2010, we began raising equity capital in the non-traded REIT sector. We sponsor and are the advisor of NorthStar Real Estate Income Trust, Inc. ("NSREIT"), a registered and non-listed REIT that is currently raising capital via a continuous offering. We also have filed a registration statement on Form S-11for NorthStar Senior Care Trust, Inc., a non-listed REIT that intends to invest in loans and real estate focused on the healthcare sector. We earn fees for managing these REITs and expect that a portion of our new investment activities will be conducted on behalf of these sponsored companies.
The following describes the major commercial asset classes in which we have invested and which we continue to actively manage to maximize value and to preserve our capital. Beginning in the second half of 2007 and continuing throughout 2010, we significantly reduced new investment activity in our company, which was generally limited to a level supported by recycled capital from repayments and asset sales.
For financial information regarding our reportable segments, see Note 20, Segment Reporting, in our accompanying Consolidated Financial Statements for the year ended December 31, 2010.
Real Estate Debt
Overview
Our real estate debt business has historically focused on originating, structuring and acquiring senior and subordinate debt investments secured primarily by commercial and multifamily properties, including first lien mortgage loans, which are also referred to as senior mortgage loans, junior participations in first lien mortgage loans, which are often referred to as B-Notes, second lien mortgage
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loans, mezzanine loans and preferred equity interests in borrowers who own such properties. We generally hold these instruments for investment, but we sometimes syndicate or sell portions of loans to maximize risk adjusted returns, manage credit exposure and generate liquidity.
We have built a franchise with a reputation for providing capital to high quality real estate investors who want a responsive and flexible balance sheet lender. Given that we are a lender who does not generally seek to sell or syndicate the full amount of the loans we originate, we are able to maintain flexibility in how we structure loans that meet the unique needs of our borrowers. Typical commercial mortgage-backed securities, or CMBS, and other conduit securitization lenders generally could not provide these types of loans because of constraints within their funding structures and because they usually originated loans with the intent to sell them to third parties and relinquish control. Additionally, our centralized investment organization has enabled senior management to review potential new loans early in the origination process which, unlike many large institutional lenders with several levels of approval required to commit to a loan, allowed us to respond quickly and provided a high degree of certainty to our borrowers that we would close a loan on terms substantially similar to those initially proposed. We believe that this level of service has enhanced our reputation in the marketplace. In addition, we believe the early and active role of senior management in our investment process has been key to maximizing recoveries of invested capital from our investments and ability to be responsive to changing market conditions. As of December 31, 2010, our average funded loan size was $18.9 million and we managed 143 separate commercial real estate loans with a carrying value of $1.8 billion.
The collateral underlying our real estate debt investments consists largely of income-producing real estate assets, properties that require some capital investment to increase cash flows, or assets undergoing repositionings or conversions, and may involve vertical construction or unimproved land. We seek to make real estate debt investments that offer the most attractive risk-adjusted returns and evaluate the risk based upon our underwriting criteria, sponsorship and the pricing of comparable investments. We have accessed the asset-backed markets to match-fund our real estate debt investments with non-recourse, term debt liabilities which were structured as collateralized debt obligations ("CDOs"). These CDO transactions are flexible financing structures that have typically permitted us to re-invest proceeds from asset repayments for a five-year period after issuance with no repayment of the term debt, subject to certain criteria; thereafter, the CDO is repaid when the underlying assets pay off. In addition to these CDO financings, we have utilized secured term financings and credit facilities to finance real estate debt investments.
Targeted Investments
Our real estate debt investments typically have many of the following characteristics: (i) terms of two to ten years inclusive of any extension options; (ii) collateral in the form of a first mortgage or a subordinate interest in a first mortgage on real property, a pledge of ownership interests in a real estate owning entity or a preferred equity investment in a real estate owning entity; (iii) investment amounts of $5 million to $100 million; (iv) floating interest rates priced at a spread over LIBOR or fixed interest rates; (v) an interest rate cap or other hedge to protect against interest rate volatility; and (vi) an intercreditor agreement that outlines our rights relative to other investors in the capital structure of the transaction and that typically provides us with a right to cure any defaults to the lender of those tranches senior to us and, under certain circumstances, to purchase senior tranches.
Investment Process for Real Estate Debt
We have employed a standardized investment and underwriting process that focuses on a number of factors in order to ensure each investment is being evaluated appropriately, including: (i) macroeconomic conditions that may influence operating performance; (ii) fundamental analysis of the underlying real estate collateral, including tenant rosters, lease terms, zoning, operating costs and
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the asset's overall competitive position in its market; (iii) real estate market factors that may influence the economic performance of the collateral; (iv) the operating expertise and financial strength of the sponsor or borrower; (v) real estate and leasing market conditions affecting the asset; (vi) the cash flow in place and projected to be in place over the term of the loan; (vii) the appropriateness of estimated costs associated with rehabilitation or new construction; (viii) a valuation of the property, our investment basis relative to its value and the ability to liquidate an investment through a sale or refinancing of the underlying asset; (ix) review of third-party reports including appraisals, engineering and environmental reports; (x) physical inspections of properties and markets; and (xi) the overall legal structure of the investment and the lenders' rights.
We may originate and structure debt investments directly with borrowers or may acquire loans from third parties. In the past we emphasized direct origination of our debt investments because this allows us a greater degree of control in loan structuring and in potential future loan modification or restructuring negotiations, provides us the opportunity to create subordinate interests in the loan, if desired, that meet our risk-return objectives, allows us to maintain a more direct relationship with our borrowers and provides an opportunity for us to earn origination and other fees. We believe that the continued lack of available debt capital for commercial real estate and sub-par economic conditions may present opportunities to obtain attractive terms from both new directly-originated loans and from pre-existing loans acquired from third-party originators, who may be motivated to sell due to liquidity needs or who are exiting the business.
At December 31, 2010 we held the following real estate debt investments (dollars in thousands):
December 31, 2010 | Principal Balances | Carrying Value(1)(2) | Allocation by Investment Type | Average Fixed Rate | Average Spread Over LIBOR(3) | Average Spread Over Prime | Number of Investments | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Whole loans, floating rate—LIBOR | $ | 1,533,352 | $ | 1,042,194 | 56.5 | % | — | % | 2.79 | % | — | % | 71 | ||||||||||
Whole loans—floating rate—prime | 106,279 | 17,417 | 0.9 | % | — | — | 3.32 | % | 3 | ||||||||||||||
Whole loans, fixed rate | 211,565 | 107,419 | 5.8 | % | 5.76 | % | — | — | 27 | ||||||||||||||
Subordinate mortgage interests, floating rate | 220,444 | 143,153 | 7.8 | % | — | 3.06 | % | — | 10 | ||||||||||||||
Subordinate mortgage interests, fixed rate | 74,443 | 46,805 | 2.5 | % | 7.62 | % | — | — | 3 | ||||||||||||||
Mezzanine loans, floating rate | 387,183 | 305,901 | 16.6 | % | — | 2.76 | % | — | 16 | ||||||||||||||
Mezzanine loan, fixed rate | 153,027 | 140,956 | 7.7 | % | 5.65 | % | — | — | 7 | ||||||||||||||
Preferred—Float | 17,444 | 17,444 | 0.9 | % | — | 4.00 | % | — | 1 | ||||||||||||||
Other loans—floating | 11,460 | 11,460 | 0.6 | % | — | 2.50 | % | — | 2 | ||||||||||||||
Other loans—fixed | 12,152 | 12,152 | 0.7 | % | 6.44 | % | — | — | 3 | ||||||||||||||
Total/Weighted average | $ | 2,727,349 | $ | 1,844,901 | 100.0 | % | 6.05 | % | 2.82 | % | 3.32 | % | 143 | ||||||||||
- (1)
- Approximately $1.7 billion of these investments serve as collateral for the Company's CDO financings, $44.0 million is financed under a borrowing facility and the remainder is unleveraged. The Company has future funding commitments, which are subject to certain conditions that borrowers must meet to qualify for such fundings, totaling $48.5 million related to these investments. The Company expects that a minimum of $45.5 million of these future fundings will be funded within the Company's existing CDO financings and require no additional capital from the Company. Assuming that all loans that have future fundings meet the terms to qualify for such
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funding, the Company's equity requirement on future funding requirements would be approximately $3.0 million.
- (2)
- Includes $18.7 million in real estate debt investments, held for sale.
- (3)
- Approximately $525.2 million of the Company's real estate debt investments have a weighted-average LIBOR rate floor of 2.08%
The following charts display our loan portfolio by collateral type and by geographic location:
| Loan Portfolio by Collateral Type | Loans by Geographic Location | |
 |  |
Real Estate Securities
Overview
Our real estate securities business has historically invested in, created and managed portfolios of commercial real estate debt securities, which we have financed by raising third-party capital in transactions structured as CDOs. These securities include CMBS, debt obligations of REITs and term debt transactions backed primarily by commercial real estate securities, or CRE CDOs. Substantially all of our securities investments have explicit credit ratings assigned by at least one of the three leading nationally-recognized statistical rating agencies (Moody's Investors Service, Standard & Poor's Ratings Services, Inc. and Fitch Ratings, generally referred to as rating agencies), and were typically rated investment grade at the time of purchase. In addition to these securities, our CDOs may also invest in bank loans to REITs and real estate operating companies, real estate whole loans, or subordinate debt investments such as B-Notes and mezzanine loans.
We seek to mitigate credit risk through credit analysis, subordination and diversification. The CMBS we invest in are generally junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of one or more subordinate classes of securities or other form of credit support within a securitization transaction. The senior unsecured REIT debt securities we invest in carry similar credit ratings and reflect comparable credit risk. Credit risk refers to each individual borrower's ability to make required interest and principal payments on the scheduled due dates. While the expected yield on our securities investments is sensitive to the performance of the underlying assets, the more subordinated securities, in the case of CMBS, and the issuer's underlying equity, in the case of REIT securities, are designed to bear the first risk of default and loss. In addition to diversification by issuer and security within our CDOs, the underlying real estate portfolios represented by each such security are further diversified by number of properties, property type, geographic location, and tenant composition. We further seek to minimize credit risk by monitoring the real estate securities portfolios of our term debt issuances and the underlying credit quality of their holdings.
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The average rating of our securities investments was B/B2 as of December 31, 2010. In addition, our securities portfolio had an average investment size of approximately $3.4 million as of December 31, 2010.
Our Real Estate Securities Investments
The various types of securities backed by real estate assets that we invest in, including CMBS, fixed income securities issued by REITs and real estate term debt transactions, are described in more detail below.
CMBS. CMBS, or commercial mortgage-backed securities, are securities backed by obligations (including certificates of participation in obligations) that are principally secured by mortgages on real property or interests therein having a multifamily or commercial use and located in the United States. Underlying property types include regional malls, neighborhood shopping centers, office buildings, industrial or warehouse properties, hotels, apartment buildings, self-storage, and healthcare facilities. Loan collateral is held in a trust that issues securities in the form of fixed and floating-rate notes secured by the cash flows from the underlying loans. The securities issued by the trust have varying levels of priority in the allocation of cash flows from the pooled loans and are rated by one or more of the rating agencies. These ratings reflect the risk characteristics of each class of CMBS and range from "AAA" to "C". Any losses realized on defaulted loans are first absorbed by any non-rated classes, with losses then allocated in reverse sequential order to the most junior, lowest-rated bond classes. Typically, all principal received on the loans is allocated first to the most senior outstanding class of bonds and then to the next class in order of seniority.
REIT Fixed Income Securities: Substantially all of our long-term investments in REIT fixed income securities consist of non-amortizing senior unsecured notes issued by equity REITs. REITs own a variety of property types with a large number of companies focused on the office, retail, multifamily, industrial, healthcare and hotel sectors. REIT senior unsecured notes typically incorporate protective financial covenants and have credit ratings issued by one or more rating agencies. We may also invest in junior unsecured debt, preferred equity or common equity of REITs.
Commercial Real Estate CDOs: Commercial real estate term CDOs (also referred to as CRE CDO's) are debt obligations typically collateralized by a combination of CMBS and REIT unsecured debt. CRE CDOs may also include real estate whole loans, B-notes and other asset-backed securities as part of their underlying collateral. These assets are held within a special-purpose vehicle that issues rated liabilities and equity in private securities offerings. We have used the CRE CDO markets to finance a majority of our real estate loans and securities investments.
Underwriting Process for Real Estate Securities
Our underwriting process for real estate securities is focused on evaluating both the real estate risk of the underlying assets and the structural protections available to the particular class of securities in which we are investing. We believe that even when a security such as a CMBS or a REIT bond is backed by a diverse pool of properties, risk cannot be evaluated purely by statistical or quantitative means. Properties backing loans with identical debt service coverage ratios or loan-to-value ratios can have very different risk characteristics depending on their age, location, lease structure and physical condition. Our underwriting process seeks to identify those factors that may lead to an increase or decrease in credit quality over time.
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When evaluating a CMBS pool backed by a large number of loans, we combine real estate analysis on individual loans with stress testing of the portfolio under various sets of default and loss assumptions. First, we identify a sample of loans in the pool which are subject to individual analysis. This sample typically includes the largest 10 to 15 loans in the pool, as well as loans selected for higher risk characteristics such as low debt service coverage ratios, properties located in weaker markets, or properties that exhibit greater cash flow volatility such as hotels. We also may review a random sample of small to medium sized loans in the pool. The loans in the sample are typically analyzed based on available information including underwriter reports, servicer reports and third- party information providers, as well as any additional market or property level information that we are able to obtain including information that may be available from our other business lines. Each loan in the sample is assigned a risk rating, which affects the default assumption for that loan in our stress test. A loan with the highest risk rating is assumed to default and suffer a loss whereas loans with better risk ratings are assigned a lower probability of default. The stress tests we run allow us to determine whether the bond class in which we are investing would suffer a loss under the stressed assumptions.
REIT securities are evaluated based on the quality, type and location of the property portfolio, the capital structure and financial ratios of the company, and management's track record, operating expertise and strategy. We also evaluate the REIT's debt covenants. Our investment decisions are based on the REIT's ability to withstand financial stress, as well as more subjective criteria related to the quality of management and of the property portfolio.
At December 31, 2010, we held the following real estate securities investments:
December 31, 2010 | Carrying Value | Estimated Fair Value | ||||||
|---|---|---|---|---|---|---|---|---|
CMBS | $ | 2,040,582 | $ | 1,392,099 | ||||
Third party CDO notes | 174,537 | 37,213 | ||||||
REIT debt | 222,112 | 236,958 | ||||||
Trust preferred securities | 34,917 | 24,784 | ||||||
Total | $ | 2,472,148 | $ | 1,691,054 | ||||
The following charts display our CMBS assets under management by vintage and our on-balance sheet securities assets under management by asset type based on par values.
| CMBS AUM by Vintage | Securities AUM | |
 |  |
Core Net Lease
Overview
Our core net lease strategy has historically involved investing primarily in office, industrial and retail properties across the United States that are net leased long term to corporate tenants. Net lease properties are typically leased to a single tenant who agrees to pay basic rent, plus all taxes, insurance, capital and operating expenses arising from the use of the leased property. We may also invest in
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properties that are leased to tenants for which we are responsible for some of the operating expenses and capital costs. At the end of the lease term, the tenant typically has a right to renew the lease at market rates or to vacate the property with no further ongoing obligation. Accordingly, we target properties that are located in primary or secondary markets with strong demand fundamentals, and that have a property design and location that make them suitable and attractive for alternative tenants.
We believe that the majority of net lease investors who acquire office, industrial and retail properties are primarily focused on assets leased to investment-grade tenants with lease terms of 15 years or longer. In our experience, there is a more limited universe of investors with the real estate and capital markets expertise necessary to underwrite net lease assets with valuations that are more closely linked to real estate fundamentals than to tenant credit.
During 2009 and 2010, we made no new net lease investments because our increased cost of capital relative to prior years continues to make investing in net lease assets uneconomical. Our primary focus in this area during 2010 was to actively manage our existing asset base by focusing on leasing vacant space and working toward tenant renewals. Weak economic conditions are currently causing difficulties in leasing vacant space and in obtaining attractive lease rates from prospective tenants. Based on current capital markets and economic conditions we do not expect new net lease investing to be a material part of our business in the near future.
Healthcare Net Lease
We own and manage a portfolio of healthcare net lease assets, a majority of which are assisted living facilities with the remainder comprised of skilled nursing facilities, a medical campus and a medical office building. We initially entered the healthcare net lease business in 2006 through a joint venture, and in 2009 acquired our partner's interest and hired a senior management team that was formerly employed by our partner who also managed the assets. Our management team has significant experience investing in a wide variety of healthcare properties, ranging from low-acuity assisted living facilities to higher-acuity skilled nursing facilities. We have historically sought out opportunities to acquire individual assets or portfolios of assets from local or regionally-focused owner/operators with established track records and in markets where barriers to entry exist. The assets typically have been purchased from and leased back to private operators under long-term net leases. We believe that our management team that is focused on this sector provides us a competitive advantage because of its extensive relationships in the industry and its knowledge of and experience in operating, owning and lending to healthcare-related assets.
Underwriting Process and Financing for Net Lease Investments
Our core net lease investments were underwritten utilizing our skills in evaluating real estate market and property fundamentals, real estate residual values and tenant credit. At inception and throughout the life of our ownership we conduct detailed tenant credit analyses to assess, among other things, the potential for credit deterioration and lease default risk. This analysis is also employed to measure the adequacy of landlord protection mechanisms incorporated into the underlying lease. Our underwriting process included sub-market and property-level due diligence in order to understand downside investment risks, including quantifying the costs associated with tenant defaults and releasing scenarios. We also evaluated stress scenarios to understand refinancing risk.
Our healthcare net lease investments were underwritten utilizing a comprehensive analysis of the profitability of a targeted business or facility, its cash flow, occupancy, patient and payer mix, financial trends in revenues and expenses, barriers to competition, the need in the market for the type of healthcare services provided by the business or the facility, the strength of the location and the underlying value of the business or the facility, as well as the financial strength and experience of the management team of the business or the facility.
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Our core and healthcare net lease investments are principally financed with non-recourse first mortgages having terms approximately matching the term of the underlying leases.
Our Net Lease Investments
At December 31, 2010, we held the following net lease investments (dollars in thousands):
Type of Property | Number of Properties | Carrying Value | Percentage of Aggregate Carrying Value | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Healthcare | 100 | $ | 581,655 | 59.7 | % | ||||||
Office | 14 | 248,981 | 25.5 | ||||||||
Retail | 11 | 51,402 | 5.3 | ||||||||
Investment in unconsolidated joint venture-office/flex(1) | 3 | 23,191 | 2.4 | ||||||||
Office/Flex | 1 | 29,531 | 3.0 | ||||||||
Distribution center | 1 | 23,127 | 2.4 | ||||||||
Retail/Office | 1 | 3,366 | 0.3 | ||||||||
Real estate owned | 4 | 13,141 | 1.4 | ||||||||
Total(2) | 135 | $ | 974,394 | 100.0 | % | ||||||
- (1)
- Our investment in the unconsolidated net lease joint venture is $6.2 million.
- (2)
- Includes $13.1 million of operating real estate reclassified to assets of properties held for sale at December 31, 2010.
NRF Capital Markets
NRF Capital Markets, LLC, or NRF Capital Markets, is our wholly-owned subsidiary wholesale broker-dealer located in Denver, CO. NRF Capital Markets was formed in 2009 to distribute equity of our sponsored REITs in the non-traded REIT sector, and is currently raising equity capital for NSREIT. We expect that NRF Capital Markets will in the future assist us in accessing diverse sources of capital for companies that may be sponsored and managed by us, such as for NSREIT and NorthStar Senior Care Trust, Inc.
During 2010, we filed a registration statement on Form S-11for NorthStar Senior Care Trust, Inc., a REIT which will target healthcare property and debt investments. We intend to raise equity for this company in the non-traded REIT market and to use our expertise in the healthcare sector to make investments.
Business Strategy
Our long-term primary objectives are to make real estate-related investments that increase our franchise value, produce attractive risk-adjusted returns and generate predictable cash flow for distribution to our stockholders. The recent global economic recession has required us to focus on preserving capital and managing liquidity. Although the capital markets for commercial real estate performed well during 2010 and banks began to originate new loans for securitization, as a legacy commercial mortgage finance company with assets primarily originated prior to 2008, we cannot currently raise large amounts of corporate equity capital at attractive levels. We are observing continued weak performance levels in our asset base due to poor economic and employment conditions and expect that investors will wait until economic conditions have strengthened before investing more significantly in legacy finance REITs. We believe that we have created a franchise that derives a competitive advantage from the combination of our real estate, credit underwriting and capital markets expertise, which enables us to manage credit risk across our business lines as well as to structure and
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finance our assets efficiently. We hope that our reputation in the marketplace will enable us to be early in raising corporate capital when market conditions improve. We will also seek to conduct certain new investment activities, where possible, in managed vehicles using equity capital raised primarily from sources other than from our balance sheet, such as in the non-traded REIT sector. During 2010, we began raising capital for non-traded REITs sponsored by us, and believe that our fixed income investment strategy and expertise is unique in that market. If we are successful in raising capital for these managed vehicles, we believe that these structures could provide a higher return on our invested equity capital due to the management and incentive fees that may be generated, and would broaden our sources of capital so that we would be less reliant on the public equity markets to grow our business.
We believe that our complementary core businesses provide us with the following synergies that enhance our competitive position:
Sourcing Investments. CMBS, purchased real estate debt and net leased properties are often sourced from the same originators. In addition, we can offer a single source of financing by purchasing or originating a rated senior interest for our real estate securities portfolio and an unrated junior interest for our real estate debt portfolio.
Credit Analysis. Real estate debt interests are usually marketed to investors prior to the issuance of CMBS backed by rated senior interests secured by the same property. By participating in both sectors, we can utilize our underwriting resources more efficiently and enhance our ability to underwrite the securitized debt.
Flexible Asset-Backed and Secured Term Financing. We believe our experience and reputation as an issuer and manager in the asset-backed debt markets, our credit track record and our relationships with major money-center banks should provide us preferential access to match-funded financing for our real estate securities, real estate debt and net lease investments. Match funded debt capital is currently very difficult to obtain. The asset-backed markets for commercial real estate remain closed for most types of real estate loans and banks and life companies are currently working to deleverage their balance sheets and therefore are not making significant new lending commitments. Our current strategy has been to use our existing flexible financing structures to leverage new investments, or to acquire new investments that generate attractive returns without leverage.
Capital Allocation. Through our participation in these three principal businesses and the fixed income markets generally, we benefit from market information that enables us to make more informed decisions with regard to the relative valuation of financial assets and capital allocation.
Our investment and portfolio management processes are centralized and overseen by our senior management team. We have formal guidelines which require senior management approval for all new investments, and Board approval is required for investments exceeding size and concentration limits. Senior management also reviews and approves portfolio management strategies including loan modification and workout situations.
Financing Strategy
We seek to access a wide range of secured and unsecured debt and public and private equity capital sources to fund our investment activities and asset growth. Since our IPO in 2004, we have completed preferred and common equity offerings raising approximately $1.0 billion of aggregate net proceeds. Additionally, during 2007 and 2008 we issued $252.5 million of unsecured exchangeable senior notes. We have also raised $286.3 million of long-term, subordinated debt capital that is equity-like in nature due to its 30-year term and relatively few covenants.
In the past, we have sought to access diverse short and long-term funding sources that enable us to deliver attractive risk-adjusted returns to our shareholders while match-funding our investments to
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minimize interest rate and maturity risk. This means we financed assets with debt having like-kind interest rate benchmarks (fixed or floating) and similar maturities. Our real estate debt and securities businesses typically used warehouse and secured credit facilities with major financial institutions to initially fund investments until a sufficient pool of assets was accumulated to efficiently execute a CRE CDO transaction.
In a CDO financing, rated bonds are issued and backed by pools of securities or loan collateral originated or acquired by us. The bonds are non-recourse and the interest income from the collateral is used to service the interest cost on the rated bonds. After a reinvestment period, which is typically five years, principal from collateral payoffs is used to amortize the notes, so there is no maturity risk. We typically have sold all of the investment-grade rated CDO bonds, and retain the non-investment grade classes as our "equity" interest in the financing. CDO financings provided low cost financing because the most senior bond classes were rated "AAA/Aaa" by the rating agencies at the time of issuance.
Net lease investments are generally match-funded with non-recourse first mortgage debt representing approximately 75% to 80% of the total value of the investment. We seek to match the term of the financing with the remaining lease term.
During 2010, the CMBS new issue market began to recover, with approximately $10 billion of issuance. Many experts expect at least $30-$40 billion of new CMBS issuance for 2011. These levels are well below the over $200 billion issued in each of 2006 and 2007, but are comparable to the $26-$77 billion of annual issuance experienced between 1996 and 2003. There have not yet been any new CRE CDO financings, but the corporate collateralized loan (CLO) market, which has a similar structure to CRE CDOs, is issuing new financings. We believe the real estate securitization markets are in the early stages of recovery, and will again provide attractive match-funded debt capital. We believe that our credit track record and reputation with bank lenders and the securitization markets could enable us to be an early user of this capital if it becomes available for independent finance companies like us.
Hedging Strategy
We use derivatives primarily to manage interest rate risk exposure. These derivatives are typically in the form of interest rate swap agreements and the primary objective is to minimize the interest rate risks associated with our investing and financing activities. The counterparties to these arrangements are major financial institutions with which we may also have other financial relationships.
Creating an effective strategy for dealing with interest rate movements is complex and no strategy can completely insulate us from risks associated with such fluctuations. There can be no assurance that our hedging activities will have the intended impact on our results. A more detailed discussion of our hedging policy is provided in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources."
Portfolio Management
We actively monitor collateral and property-level performance of our asset base through our portfolio management group which is closely supervised by our senior executive team. All major portfolio management strategies and tactics are developed using the extensive experience of our senior executives and a majority of our employees are dedicated to portfolio management activities.
For commercial real estate loans, we typically have a contractual right to regularly receive updated information from our borrowers such as budgets, operating statements, rent rolls, major tenant lease signings, renewals, expirations and modifications. We also monitor for changes in property management, borrower's and sponsor's financial condition, timing and funding of distributions from reserves and capital accounts or future funding draws, real estate market conditions, sales of comparable and competitive properties, occupancy and asking rents at competitive properties and
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financial performance of major tenants. When a borrower cannot comply with its requirements according to the loan terms, we generally have a range of strategies to choose from, including foreclosing on the collateral in order to sell it, extending the final maturity date in return for a paydown and/or a fee, changing the interest rate or making any other modification to the loan terms which we believe maximizes long-term value and preserves capital.
We closely monitor our securities investments by using sophisticated third- party applications that are designed to screen for performance issues in the loan collateral underlying the securities. We also utilize our capital markets expertise to seek opportunities to sell securities investments which we believe the market is valuing too highly relative to the underlying risk.
We closely monitor our net lease assets to ensure, among other things, the tenants are complying with the terms of their respective leases, and seek to enter into renewal discussions with tenants well in advance of lease expirations. We also physically inspect these assets regularly so that we can ensure that the tenants are maintaining the assets as required.
Poor economic conditions have negatively impacted commercial real estate cash flows and valuations. During 2010, debt and equity capital began returning to the real estate markets, especially in supply-constrained urban areas such as New York City, Washington, DC and Boston, MA, and to asset types expected to benefit most immediately from an economic recovery, such as hotels and apartments. Although investors and lenders appear more confident in a few select markets, many of our assets are continuing to experience stress and have not benefited from the early signs of recovery in real estate. We expect a broader improvement in real estate conditions during 2011, but also anticipate that credit management will remain challenging.
As of March 2011, we will be added to Standard and Poor's Select Service list as an approved special servicer. This designation provides us with the ability to provide asset management services to CMBS securitizations rated by S&P relating to troubled or defaulted mortgages underlying the securitization.
Regulation
We are subject, in certain instances, to supervision and regulation by state and federal governmental authorities and may be subject to various laws and judicial and administrative decisions imposing various requirements and restrictions, which, among other things: (1) regulate credit granting activities; (2) establish maximum interest rates, finance charges and other fees we can charge our customers; (3) require disclosures to customers; (4) govern secured transactions; and (5) set collection, foreclosure, repossession and claims-handling procedures and other trade practices. Although most states do not regulate commercial finance, certain states impose limitations on interest rates and other charges and on certain collection practices and creditor remedies and require licensing of lenders and financiers and adequate disclosure of certain contract terms. We are also required to comply with certain provisions of the Equal Credit Opportunity Act that are applicable to commercial real estate loans.
We believe that we are not, and intend to conduct our operations so as not to become regulated as an investment company under the Investment Company Act of 1940, as amended, or the Investment Company Act. We have been, and intend to continue to rely on current interpretations of the staff of the Securities and Exchange Commission, or the SEC, in an effort to continue to qualify for an exemption from registration under the Investment Company Act. For more information on the exemptions that we utilize, see "Item 1A—Risk Factors—Maintenance of our Investment Company Act exemption imposes limits on our operations."
Certain of our subsidiaries may apply to be registered investment advisors under the Investment Advisors Act of 1940, or the Investment Advisors Act, and, as such, may also be supervised by the SEC. The Investment Advisors Act requires registered investment advisors to comply with numerous
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obligations, including record-keeping requirements, operational procedures and disclosure obligations. Such subsidiaries may also be registered with various states and thus, subject to the oversight and regulation of such states' regulatory agencies. The regulatory environment in which investment advisors operate changes frequently and regulations have increased significantly in recent years. We may be adversely affected as a result of new or revised legislation or regulations or by changes in the interpretation or enforcement of existing laws and regulations.
We have elected and expect to continue to make an election to be taxed as a REIT under Section 856 through 860 of the Internal Revenue Code of 1986, as amended, or the Code. As a REIT, we must currently distribute, at a minimum, an amount equal to 90% of our taxable income. In addition, we must distribute 100% of our taxable income to avoid paying corporate federal income taxes. REITs are also subject to a number of organizational and operational requirements in order to elect and maintain REIT status. These requirements include specific share ownership tests and assets and gross income composition tests. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates. Even if we qualify for taxation as a REIT, we may be subject to state and local income taxes and to federal income tax and excise tax on our undistributed income.
On April 20, 2010, NRF Capital Markets became registered with the SEC and a member of the Financial Industry Regulatory Authority, or FINRA. Much of the regulation of broker-dealers has been delegated to self-regulatory organizations, or SROs, principally FINRA, that adopt and amend rules, subject to approval by the SEC, which govern their members and conduct periodic examinations of member firms' operations. The SEC, SROs and state securities commissions may conduct administrative proceedings that can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees. Such administrative proceedings, whether or not resulting in adverse findings, can require substantial expenditures and can have an adverse impact on the reputation of a broker-dealer.
As a registered broker-dealer, NRF Capital Markets is required by federal law to be a member of the Securities Investor Protection Corporation, or SIPC. When the SIPC fund falls below a certain amount, members are required to pay annual assessments to replenish the reserves. In anticipation of inadequate SIPC fund levels during the current economic environment, our broker-dealer subsidiary will be required to pay 0.25% of net operating revenues as a special assessment. As of December 31, 2010, we have incurred an immaterial amount of special assessment charges. The SIPC fund provides protection for securities held in customer accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances.
In addition, as a registered broker-dealer and member of FINRA, NRF Capital Markets is subject to the SEC's Uniform Net Capital Rule 15c3-1, which is designed to measure the general financial integrity and liquidity of a broker-dealer and requires the maintenance of minimum net capital. Net capital is defined as the net worth of a broker-dealer subject to certain adjustments. In computing net capital, various adjustments are made to net worth that exclude assets not readily convertible into cash. Additionally, the regulations require that certain assets, such as a broker-dealer's position in securities, be valued in a conservative manner so as to avoid over-inflation of the broker-dealer's net capital.
The U.S. Government, Federal Reserve, U.S. Treasury, Federal Deposit Insurance Corporation, Securities and Exchange Commission and other governmental and regulatory bodies have taken or are considering taking actions in response to the recent financial crisis. We are unable to predict whether or when such actions may occur or what impact, if any, such actions could have on our business, results of operations and financial condition. In July 2010, the Dodd Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank, was passed by the U.S. Congress and signed into law. Certain aspects of Dodd-Frank provide strengthened regulations for business activities we are engaged in. For example, Dodd-Frank contains laws affecting the securitization of mortgages with requirements for risk retention by originators and/or sponsors of mortgage securitization and laws affecting credit rating agencies. We
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are unable to predict at this time how this legislation, as well as other laws that may be adopted in the future, will impact the environment for financing and investing for CMBS and/or mortgage loans, the securitization industry, interest rate swaps and other derivatives as much of the Dodd-Frank's implementation will likely require numerous implementing regulations and other rulemaking by government regulators. However, at minimum, we believe that Dodd-Frank and the regulations to be promulgated thereunder are likely to increase the economic and compliance costs for participants in the mortgage and securitization industries, including us.
In the judgment of management, existing statutes and regulations have not had a material adverse effect on our business. However, it is not possible to forecast the nature of future legislation, regulations, judicial decisions, orders or interpretations, nor their impact upon our future business, financial condition, results of operations or prospects.
Competition
We have in the past been subject to significant competition in seeking real estate investments. Historically, we have competed with many third parties engaged in real estate investment activities including other REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, private institutional funds, hedge funds, private opportunity funds, investment banking firms, CMBS lenders, governmental bodies and other entities. In addition, there are other REITs with asset investment objectives similar to ours and others may be organized in the future, and in 2009 three commercial finance REITs with strategies similar to ours went public. Some of these competitors, including larger REITs and the recently-public REITs with no legacy asset issues, have substantially greater financial resources than we do and generally may be able to accept more risk. They may also enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies.
Additionally, future competition from new market entrants may limit the number of suitable investment opportunities offered to us. It may also result in higher prices, lower yields and a narrower spread of yields over our borrowing costs, making it more difficult for us to acquire new investments on attractive terms.
Employees
As of December 31, 2010, NorthStar had 91 employees. Management believes that a major strength of NorthStar is the quality and dedication of our people. We strive to maintain a work environment that fosters professionalism, excellence, diversity and cooperation among our employees.
Management Update
On February 25, 2011, Andrew C. Richardson resigned as the Company's Chief Financial Officer, Executive Vice President and Treasurer, effective as of March 27, 2011.
Corporate Governance and Internet Address
We emphasize the importance of professional business conduct and ethics through our corporate governance initiatives. Our Board of Directors consists of a majority of independent directors; the audit, nominating and corporate governance, and compensation committees of our Board of Directors are composed exclusively of independent directors. We have adopted corporate governance guidelines and a code of business conduct and ethics, which delineate our standards for our officers, directors and employees.
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Our internet address iswww.nrfc.com. The information on our website is not incorporated by reference in this Annual Report on Form 10-K/A. We make available, free of charge through a link on our site, our annual reports on Form 10-K/A, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports, if any, as filed with the SEC, as soon as reasonably practicable after such filing. Our site also contains our code of business conduct and ethics, code of ethics for senior financial officers, corporate governance guidelines, and the charters of our audit committee, nominating and corporate governance committee and compensation committee of our Board of Directors. Within the time period required by the rules of the SEC and the New York Stock Exchange, or NYSE, we will post on our website any amendment to our code of business conduct and ethics and our code of ethics for senior financial officers as defined in the code.
Our business is subject to a number of risks that are substantial and inherent in our business. This section describes some of the more important risks that we face, any of which could have a material adverse effect on our business, financial condition, results of operations and future prospects. The risk factors set forth in this section could cause our actual results to differ significantly from those contained in this Annual Report on Form 10-K/A. In connection with the forward-looking statements that appear in this Annual Report on Form 10-K/A, you should carefully review the factors discussed below and the cautionary statements referred to under "Forward-Looking Statements."
Risks Related to Our Businesses
The commercial real estate finance industry has been and may continue to be adversely affected by conditions in the global financial markets and economic conditions in the U.S. generally.
The U.S. economy is continuing to experience high unemployment and low economic growth compared to historical periods. These conditions were precipitated by the collapse of the U.S. residential real estate sector in 2007, and continue to have a negative impact on commercial real estate fundamentals. During 2010, liquidity began to return to commercial real estate debt and equity markets despite these poor economic conditions; however, many investors remain cautious in providing capital to legacy commercial real estate finance companies, like us, until the economic outlook becomes clearer. Although we are hopeful that the financial markets will continue to improve, a worsening of these conditions would likely exacerbate any adverse effects the market environment may have on us, on others in the commercial real estate finance industry and on commercial real estate generally.
Liquidity is essential to our businesses and we rely on outside sources of capital that have been severely impacted by the recent economic recession.
We require significant outside capital to fund our businesses. A primary source of liquidity for us has been the equity and debt capital markets, including issuances of common equity, preferred equity, trust preferred securities and convertible senior notes. When the subprime residential lending and single family housing market collapse quickly spread broadly into the capital markets, our business was adversely affected, including due to the lack of access to capital and prohibitively high costs of obtaining capital. Since 2008, most of our new investment activities have been funded using proceeds from repayments and sales of investments within our portfolio. Although investor interest in real estate improved during 2010, we do not know whether any sources of capital will be available to us in the future on terms that are acceptable to us, if at all. If we cannot obtain sufficient capital on acceptable terms, our business and our ability to operate will be severely impacted. For information about our available sources of funds, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources" and the notes to the consolidated financial statements in this Annual Report on Form 10-K/A.
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We also depend on external sources of capital because the Internal Revenue Code of 1986, as amended, requires that a REIT distribute 90% of its taxable income to its shareholders, including taxable income where we do not receive corresponding cash. We intend to distribute all or substantially all of our REIT taxable income in order to comply with the REIT distribution requirements of the Code.
Our exchangeable senior notes are recourse obligations to us.
As of December 31, 2010, the amount outstanding under our exchangeable senior notes was $128.9 million. These amounts are full recourse obligations of the company. If we are not able to extend, refinance or repurchase the indebtedness, we may not have the ability to repay these amounts when they come due. Our inability to repay any of our exchangeable senior notes could cause the acceleration of the indebtedness, which would have a material adverse effect on our business.
Our exchangeable senior notes contain cross- acceleration provisions.
Our indentures governing our exchangeable senior notes contain cross-acceleration provisions whereby a default under one agreement could result in a default and acceleration of indebtedness under other agreements. If a cross-acceleration were to occur, we may not be able to pay our debts or access capital from external sources in order to refinance our debts. If some or all of our debt obligations default and it causes a default under other indebtedness, our business, financial condition and results of operations could be materially and adversely affected.
Our CDOs have certain coverage tests that are required to be met in order for payments to be made to our subordinate bonds and equity notes. Failing coverage tests could significantly impact our cash flow and overall liquidity position.
Our CDOs generally require that the underlying collateral and cash flow generated by the collateral to be in excess of ratios stipulated in the related indentures. These ratios are called overcollateralization, or OC, and interest coverage, or IC, tests and are used primarily to determine whether and to what extent principal and interest proceeds on the underlying collateral debt securities and other assets may be used to pay principal of, and interest on, the subordinate classes of bonds in the CDOs. Uncured defaults on commercial real estate loans and rating agency downgrades on commercial real estate securities are the primary causes for decreases in the OC and IC ratios. In the event these tests are not met, cash that would normally be distributed to us would be used to amortize the senior notes until the financing is back in compliance with the tests. Additionally, we may elect to buy assets out of our CDOs in order to preserve cash flow, which could have a significant impact on our liquidity. As of December 31, 2010 we were in compliance with all of the OC and IC tests in our CDOs, except for N-Star Real Estate CDO II and the CSE RE 2006-A CDO. Nonetheless, we expect that weak economic conditions, lack of capital for "legacy" commercial real estate and credit ratings downgrades of real estate securities will make complying with OC and IC tests more difficult in the future. Our failure to satisfy the coverage tests could adversely affect our operating results, liquidity and cash flows.
The reinvestment period for certain of our CDOs will expire in 2011.
The reinvestment periods, which allow us to reinvest principal payments on the underlying assets into qualifying replacement collateral, for our N-Star Real Estate CDO VI and N-Star Real Estate CDO VII, will each expire in June 2011. The CDO notes have a stated maturity in June 2041 and June 2051, respectively, although the actual life of the notes are expected to be substantially shorter. The reinvestment periods have already expired for our N-Star Real Estate CDO I and N-Star Real Estate CDO II, in 2003 and 2004, respectively, and for our N-Star Real Estate CDO III, N-Star REL CDO IV and N-Star Real Estate CDO V, in 2010. Since we will be unable to reinvest principal in these
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CDOs, principal repayments will pay down the senior-most notes, which will de-lever the CDO and negatively impact our return on equity. Additionally, our ability to reinvest has been important in maintaining OC and IC ratios. Following the conclusion of the reinvestment period in a CDO, our ability to maintain the OC and IC ratios will be negatively impacted.
We retain the subordinate classes of bonds and equity notes in the CDOs that we have issued, which entails certain risks, including that subordinate classes of bonds and equity notes in the CDOs receive distributions only if the CDO generates enough income to pay all of the other bond classes.
The subordinate classes of bonds and equity notes that we retain in the CDOs that we have issued represent leveraged investments in the underlying assets. Various classes of securities participate in the income stream in CDOs and distributions on subordinate classes of bonds and equity notes are generally made only after payment of interest on, and principal of, the senior bond classes. Although generally there is no interest or principal due on the equity notes, distributions may be made to holders of the subordinate classes of bonds and equity notes on each payment date after all of the other required payments are made on each payment date. There will be little or no income available to the subordinate classes of bonds and equity notes if there are defaults by the obligors under the underlying collateral and those defaults exceed a certain amount. In that event, the value of our investment in the CDO could decrease quickly and substantially. There can be no assurance that after making required payments on the senior bond classes there will be any remaining funds available to pay us. Accordingly, our subordinate classes of bonds and equity notes may not be paid in full and we may be subject to a loss of all of our interest in the event that payments are not made on the underlying assets or losses are incurred with respect to the underlying assets, which could have a material adverse effect on us.
A payment default on bonds underlying one of our CDOs could have a compounding effect on our other CDOs.
Certain of our CDOs have invested in bonds issued by other CDOs that we created and manage. Such investments expose us to increased risk, as potential defaults in any particular CDO would also affect other CDOs that own bonds in the CDO that experiences defaults. Defaults across certain of our CDOs could, therefore, have a material impact on the cash flow of other CDOs that we own that may not have otherwise had such an impact.
We are unable to complete additional CDOs due to the collapse of the credit markets.
We historically accessed the asset-backed markets to match-fund our real estate debt investments with non-recourse, term debt liabilities which were structured as CDOs. When the subprime residential lending and single family housing market collapse quickly spread broadly into the capital markets in 2007, the resulting investor concerns surrounding the real estate markets and the asset-backed markets generally, among other things, left no liquidity available through the issuance of new CDOs. Although the general economic condition began to improve during 2010, there has been no successful CDO financing since the collapse of the credit markets in 2007. Issuing CDOs was a critical part of our overall business plan and we currently believe that CDOs will not be available for the foreseeable future, if ever.
The documentation governing our CDOs is complex.
The operation of each of our CDOs is governed by an indenture, collateral management agreement and other documentation. The documents are complex and collectively describe the conditions upon which we can sell assets and reinvest principal proceeds and set forth covenants and other provisions to which we and the CDOs are subject. As described above, our ability to sell certain assets and reinvest proceeds is instrumental in maintaining the IC and OC ratios. In certain circumstances the performance of the underlying CDO collateral has raised ambiguities in both our and
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other CDO documentation. Although we have as a general matter been able to reach agreement with our CDO trustees as to how the CDO documentation should be interpreted, it is possible that we and our CDO trustees may not be able to reach agreement on important CDO documentation provisions in the future. To the extent we and our CDO trustees are unable to resolve any differences in CDO documentation interpretation, or third parties do not agree with conclusions that are reached by us and/or the CDO trustees, our ability to manage the underlying collateral, and thus maintain the IC and OC ratios and otherwise optimize the performance of the CDOs, may be adversely affected.
Continued disruptions in the financial markets and difficult economic conditions could adversely affect the values of investments we made.
Weakened U.S. macroeconomic conditions combined with the recent turmoil in the capital markets, and constrained equity and debt capital available for investment in commercial real estate, have resulted in fewer buyers seeking to acquire commercial properties compared to historic levels. Additionally, these buyers are requiring greater returns and are ascribing lower valuations for commercial real estate properties. Furthermore, difficult economic conditions have, and may in the future, negatively impact commercial real estate fundamentals, which could have adverse effects on the collateral securing our commercial real estate loans.
Adverse economic conditions could significantly reduce the amount of income we earn on our commercial real estate loans.
Adverse economic conditions have caused us to experience an increase in the number of commercial real estate loans that could result in loan delinquencies, foreclosures and nonperforming assets and a decrease in the value of the property or other collateral which secures our commercial real estate loans, all of which could adversely affect our results of operations. Loan defaults result in a decrease in interest income and may require the establishment of, or an increase in, loan loss reserves. The decrease in interest income resulting from a loan default or defaults may be for a prolonged period of time as we seek to recover, primarily through legal proceedings, the outstanding principal balance, accrued interest and default interest due on a defaulted commercial real estate loan, plus the legal costs incurred in pursuing our legal remedies. Legal proceedings, which may include foreclosure actions and bankruptcy proceedings, are expensive and time consuming. The decrease in interest income, and the costs involved in pursuing our legal remedies will reduce the amount of cash available to meet our expenses and adversely impact our liquidity and operating results.
Loan restructurings may reduce our net interest income.
As a result of the adverse economic conditions and difficult conditions that we experienced in the commercial real estate market, we continue to restructure loans. In order to preserve long-term value, we are often required to lower the interest rate on our loans in connection with a restructuring, which ultimately reduces our net interest income. Although the commercial mortgage-backed securities markets are beginning to recover, we expect loan restructurings where we reduce interest rates to continue, which will have an adverse impact on our net interest margin.
Our borrowers were unable to achieve their business plans due to the difficult economic environment and strain on commercial real estate, which has caused stress in our commercial real estate loan portfolio.
Many of our commercial real estate loans were made to borrowers who had business plans to improve occupancy and cash flows that have not been accomplished due to the economic recession. The economic recession created a number of obstacles to borrowers attempting to achieve their business plans, including lower occupancy rates and lower lease rates across all property types, which continues to be exacerbated by high unemployment and overall financial uncertainty. If borrowers are
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unable to achieve their business plans, the related commercial real estate loans could go into default and severely impact our operating results and cash flows.
Many of our commercial real estate loans are funded with interest reserves and our borrowers may be unable to replenish those interest reserves once they run out.
Given the transitional nature of many of our commercial real estate loans, we required borrowers to pre-fund reserves to cover interest and operating expenses until the property cash flows were projected to increase sufficiently to cover debt service costs. We also generally required the borrower to replenish reserves if they became deficient due to underperformance or if the borrower wanted to exercise extension options under the loan. Despite low interest rates, revenues on the properties underlying commercial real estate loans decreased in the recent economic environment, which made it more difficult for borrowers to meet their payment obligations to us. In fact, many of our borrowers only met their obligations to us because of the reserves we set up at the outset of our loans. We expect that in the future many of the reserves will run out and some of our borrowers will have difficulty servicing our debt and will not have sufficient capital to replenish reserves, which could have a significant impact on our operating results and cash flow.
Our mortgage loans, mezzanine loans, participation interests in mortgage and mezzanine loans, real estate securities and preferred equity investments have been and may continue to be adversely affected by widening credit spreads.
Our investments in commercial real estate loans and real estate securities are subject to changes in credit spreads. When credit spreads widen, which was the case in 2008 and early 2009, the economic value of existing loans decreases. Although credit spreads decreased in 2010, if a lender were to originate a loan today, such loan would likely still carry a greater credit spread than that attributable to many of the loans that we originated. Even though a loan may be performing in accordance with its loan agreement and the underlying collateral has not changed, the economic value of the loan may be negatively impacted by the incremental interest foregone from the widened credit spread. Although credit spreads tightened in 2010 and into early 2011, the economic value of our commercial real estate loan portfolio and our real estate securities portfolio has been significantly impacted by credit spread widening.
Loan repayments are unlikely in the current market environment.
In the past, a source of liquidity for us was the voluntary repayment of loans. Because the CMBS market has just recently begun to recover and traditional commercial real estate lenders severely curtailed their lending between mid-2007 and 2009, resulting in a severe shortage of debt capital for real estate investors and those needing to refinance maturing loans, real estate owners are having difficulty refinancing their assets at maturity. If borrowers are not able to refinance loans at their maturity, the loans could go into default and the liquidity that we would receive from such repayments will not be available. Furthermore, without a functioning commercial real estate finance market, borrowers that are performing on their loans will almost certainly extend such loans if they have that right, which will further delay our ability to access liquidity through repayments.
Higher loan loss reserves are expected if economic conditions do not improve significantly.
If the U.S. economy does not improve significantly, we will likely continue to experience significant loan loss provisions, defaults and asset impairment charges in 2011. Borrowers may also be less able to pay principal and interest on loans if the economy does not continue to strengthen and they continue to experience financial stress. Declines in real property values also increased loan-to-value ratios on our loans and, therefore, weakened our collateral coverage and increased the likelihood of higher loan loss
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provisions. A continuing period of increased defaults and foreclosures would adversely affect our interest income, financial condition, business prospects and our cash flows.
Loan loss reserves are difficult to estimate in a turbulent economic environment.
Our loan loss reserves are evaluated on a quarterly basis. Our determination of loan loss reserves requires us to make certain estimates and judgments, which have been, and may continue to be, difficult to determine in turbulent economic conditions. While the overall economy has seen some signs of growth, our estimates and judgments are based on a number of factors, including projected cash flows from the collateral securing our commercial real estate loans, loan structure, including the availability of reserves and recourse guarantees, likelihood of repayment in full at the maturity of a loan, potential for refinancing and expected market discount rates for varying property types, which remain uncertain. Our estimates and judgments may not be correct and, therefore, our results of operations and financial condition could be severely impacted.
Furthermore, in the current commercial real estate environment, in order to maximize value we may be more likely to extend and work out a loan, rather than pursue foreclosure. However, in situations where there are multiple creditors in large capital structures, it can be particularly difficult to assess the most likely course of action that a lender group or the borrower may take. Consequently, there could be a wide range of potential principal recovery outcomes, the timing of which can be unpredictable, based on the strategy pursued by a lender group and/or by a borrower. These multiple creditor situations tend to be associated with our larger loans. We, as one of a group of lenders, are often a lender on a subordinated basis, and do not independently control the decision making. Risks associated with our largest multiple creditor loans include:
East Rutherford, NJ Retail Construction First Mortgage Loan. We own a 22% interest held in Meadowlands One, LLC that is secured by a retail/entertainment complex located in East Rutherford, NJ ("NJ Property"), and the lender group is in the process of seeking to recapitalize the NJ Property. While the lender group has selected a developer to complete the NJ Property, there is no assurance that a recapitalization will be completed or that a recapitalization will be completed on terms acceptable to us, which could have a material adverse effect on our business and operations.
Las Vegas, NV Casino/Hotel Mezzanine Loan. We own an $89 million mezzanine loan (the "NV Loan") that is secured by the Hard Rock Hotel and Casino in Las Vegas, NV (the "Hard Rock"). We, along with certain of the other lenders, and the borrower and its affiliates under the NV Loan, have entered into a term sheet that provides for a long-term restructuring of the NV Loan. As part of the restructuring, it is expected that Brookfield will take ownership of the Hard Rock and will enter into a seven-year loan with the existing senior lender, subject to achieving certain tests, and we will retain our $89 million mezzanine loan (or its economic equivalent), as well as an equity participation in the Hard Rock. There is no assurance that the restructuring will be completed or, if completed, that it will be successful over time. Accordingly, we may lose all of our investment, which could have a material adverse effect on our business and operations.
The mortgage loans we originate and invest in and the commercial mortgage loans underlying the mortgage-backed securities we invest in are subject to risks of delinquency, foreclosure, loss and bankruptcy of the borrower under the loan. If the borrower defaults, it may result in losses to us.
Mortgage loans are secured by real estate and are subject to risks of delinquency, foreclosure, loss and bankruptcy of the borrower, all of which are and will continue to be prevalent if the overall economic environment does not continue to improve significantly. The ability of a borrower to repay a loan secured by real estate is typically dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net
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operating income of the property is reduced, the borrower's ability to repay the loan may be impaired. Net operating income of a property can be affected by, among other things:
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- macroeconomic conditions;
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- tenant mix;
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- success of tenant businesses;
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- property management decisions;
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- property location and condition;
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- property operating costs, including insurance premiums, real estate taxes and maintenance costs;
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- competition from comparable types of properties;
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- changes in governmental rules, regulations and fiscal policies, including environmental legislation;
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- changes in laws that increase operating expenses or limit rents that may be charged;
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- any need to address environmental contamination at the property;
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- the occurrence of any uninsured casualty at the property;
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- changes in national, regional or local economic conditions and/or specific industry segments;
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- declines in regional or local real estate values;
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- declines in regional or local rental or occupancy rates;
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- increases in interest rates;
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- real estate tax rates and other operating expenses;
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- acts of God;
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- social unrest and civil disturbances;
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- terrorism; and
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- increases in costs associated with renovation and/or construction.
Any one or a combination of these factors may cause a borrower to default on a loan or to declare bankruptcy. If a default or bankruptcy occurs and the underlying asset value is less than the loan amount, we will suffer a loss.
Additionally, we may suffer losses for a number of reasons, including the following, which could have a material adverse effect on our financial performance.
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- If the value of real property or other assets securing our commercial real estate loans deteriorates. The majority of our commercial real estate loans are fully or substantially non-recourse, although a large amount of our commercial real estate loans provide for interest reserve replenishments which are recourse. In the event of a default by a borrower on a non-recourse loan, we will only have recourse to the real estate-related assets (including escrowed funds and reserves) collateralizing the loan. For this purpose, we consider commercial real estate loans made to special purpose entities formed solely for the purpose of holding and financing particular assets to be non-recourse loans. We sometimes also make commercial real estate loans that are secured by equity interests in the borrowing entities or by investing directly in the owner of the property. There can be no assurance that the value of the assets securing our commercial real estate loans will not deteriorate over time due to factors beyond our control, as was the case
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- If a borrower or guarantor defaults on recourse obligations under our commercial real estate loans. We sometimes obtain individual or corporate guarantees, which are not secured, from borrowers or their affiliates. In cases where guarantees are not fully or partially secured, we typically rely on financial covenants from borrowers and guarantors which are designed to require the borrower or guarantor to maintain certain levels of creditworthiness. As a result of recent economic conditions, many borrowers and guarantors faced financial difficulties and were unable to comply with their financial covenants. If the economy does not continue to strengthen, they will continue to experience financial stress. Where we do not have recourse to specific collateral pledged to satisfy such guarantees or recourse loans, we will only have recourse as an unsecured creditor to the general assets of the borrower or guarantor, some or all of which may be pledged to satisfy other lenders. There can be no assurance that a borrower or guarantor will comply with its financial covenants, or that sufficient assets will be available to pay amounts owed to us under our commercial real estate loans and guarantees.
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- If our due diligence does not reveal all of a borrower's liabilities or does not reveal other weaknesses in its business. Before making a commercial real estate loan to a borrower, we assess the strength and skills of an entity's management and other factors that we believe are material to the performance of the investment. This process is particularly important and subjective with respect to newly organized entities because there may be little or no information publicly available about the entities. In making the assessment and otherwise conducting customary due diligence, we rely on the resources available to us and, in some cases, an investigation by third parties. There can be no assurance that our due diligence processes will uncover all relevant facts or that any investment will be successful.
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- In the event of a default or bankruptcy of a borrower, particularly in cases where the borrower has incurred debt that is senior to our commercial real estate loan. If a borrower defaults on our commercial real estate loan and the mortgaged real estate or other borrower assets collateralizing our commercial real estate loan are insufficient to satisfy our commercial real estate loan, we may suffer a loss of principal or interest. In the event of a borrower bankruptcy, we may not have full recourse to the assets of the borrower, or the assets of the borrower may not be sufficient to satisfy our commercial real estate loan. In addition, certain of our commercial real estate loans are subordinate to other debt of the borrower. If a borrower defaults on our commercial real estate loan or on debt senior to our commercial real estate loan, or in the event of a borrower bankruptcy, our commercial real estate loan will be satisfied only after the senior debt. Bankruptcy and borrower litigation can significantly increase the time needed for us to acquire underlying collateral in the event of a default, during which time the collateral may decline in value. In addition, there are significant costs and delays associated with the foreclosure process. Borrower bankruptcies and litigation relating to our assets increased appreciably in the recent economic recession, which required us to spend significant amounts of money and required significant senior management resources in order to protect our interests. If the economic markets do not continue to improve, we will continue to see such costs and delays.
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- If provisions of our commercial real estate loan agreements are unenforceable. Our rights and obligations with respect to our commercial real estate loans are governed by written loan agreements and related documentation. It is possible that a court could determine that one or more provisions of a loan agreement are unenforceable, such as a loan prepayment provision or the provisions governing our security interest in the underlying collateral.
during the during the recent economic recession. Mezzanine loans are subject to the additional risk that other lenders may be directly secured by the real estate assets of the borrowing entity.
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The subordinate mortgage notes, participation interests in mortgage notes, mezzanine loans and preferred equity investments we have originated and invested in may be subject to risks relating to the structure and terms of the transactions, as well as subordination in bankruptcy, and there may not be sufficient funds or assets remaining to satisfy our investments, which may result in losses to us.
We have focused on originating, structuring and acquiring senior and subordinate debt investments secured primarily by commercial properties, including first lien mortgage loans, junior participations in first lien mortgage loans, which are often referred to as B-Notes, second lien mortgage loans, mezzanine loans and preferred equity interests in borrowers who own such properties. These investments may be subordinate to other debt on commercial property and are secured by subordinate rights to the commercial property or by equity interests in the commercial entity. If a borrower defaults or declares bankruptcy, after senior obligations are met, there may not be sufficient funds or assets remaining to satisfy our subordinate interests. Because each transaction is privately negotiated, subordinate investments can vary in their structural characteristics and lender rights. Our rights to control the default or bankruptcy process following a default will vary from transaction to transaction. The subordinate investments that we originate and invest in may not give us the right to demand foreclosure as a subordinate real estate debtholder. Furthermore, the presence of intercreditor agreements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies and control decisions made in bankruptcy proceedings relating to borrowers. Similarly, a majority of the participating lenders may be able to take actions to which we object but to which we will be bound. Certain transactions that we have originated and invested in could be particularly difficult, time consuming and costly to workout because of their complicated structure and the diverging interests of all the various classes of debt in the capital structure of a given asset.
Our control over management for our CSE RE 2006-A CDO loans is governed by contractual agreements with CapitalSource Inc., which may limit our control of certain loans.
In certain circumstances under the CSE RE 2006-A CDO, we are required to seek approval from CapitalSource prior to taking actions with respect to the loans comprising the CSE RE 2006-A CDO, which may hinder our ability to enforce the loan or to foreclose upon the collateral securing the loan or otherwise exercise remedies that we believe are appropriate.
We are subject to risks associated with construction lending, such as declining real estate values, cost over-runs and delays in completion.
Our commercial real estate loan assets include loans made to developers to construct prospective projects. The primary risks to us of construction loans are the potential for cost over-runs, the developer's failing to meet a project delivery schedule and the inability of a borrower to sell or refinance the project at completion and repay our commercial real estate loan due to declining real estate values. These risks could cause us to have to fund more money than we originally anticipated in order to complete the project. We may also suffer losses on our commercial real estate loans if the borrower is unable to sell the project or refinance our commercial real estate loan.
In addition to risks associated with the United States economy generally, we are subject to risks associated with economic conditions in Germany with respect to one of our loans.
We own a €43.3 million participation in a mezzanine loan that is collateralized by a German retail portfolio that is net leased to a single tenant, or the German Loan. Accordingly, economic conditions in Germany could have a direct impact on the German Loan. The German Loan was restructured in 2010; however, there can be no assurance that the restructuring will be successful over time and that the German Loan will not default in the future.
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We have and may continue to invest in CMBS, including subordinate securities, which entail certain risks.
CMBS are generally securities backed by obligations (including certificates of participation in obligations) that are principally secured by mortgages on real property or interests therein having a commercial or multifamily use, such as regional malls, other retail space, office buildings, industrial or warehouse properties, hotels, apartment buildings, nursing homes and senior living centers, and may include, without limitation, CMBS conduit securities, CMBS credit tenant lease securities, CMBS large loan securities and synthetic securities. We invest in a variety of CMBS, including CMBS which are subject to the first risk of loss if any losses are realized on the underlying mortgage loans. CMBS entitle the holders thereof to receive payments that depend primarily on the cash flow from a specified pool of commercial or multifamily mortgage loans. Consequently, CMBS will be affected by payments, defaults, delinquencies and losses on the underlying commercial real estate loans, which began to increase significantly toward the end of 2008 and are expected to continue into 2011. Furthermore, if the rental and leasing markets do not continue to improve, including reduced occupancy rates and reduced market rental rates, it could reduce cash flow from the loan pools underlying our CMBS investments.
Additionally, CMBS are subject to particular risks, including lack of standardized terms and payment of all or substantially all of the principal only at maturity rather than regular amortization of principal. Additional risks may be presented by the type and use of a particular commercial property. Commercial property values and net operating income are subject to volatility, which may result in net operating income becoming insufficient to cover debt service on the related commercial real estate loan. The repayment of loans secured by income-producing properties is typically dependent upon the successful operation of the related real estate project rather than upon the liquidation value of the underlying real estate. Furthermore, the net operating income from and value of any commercial property are subject to various risks. The exercise of remedies and successful realization of liquidation proceeds relating to CMBS may be highly dependent on the performance of the servicer or special servicer. Expenses of enforcing the underlying commercial real estate loans (including litigation expenses) and expenses of protecting the properties securing the commercial real estate loans may be substantial. Consequently, in the event of a default or loss on one or more commercial real estate loans contained in a securitization, we may not recover our investment.
The mortgage-backed securities in which we may invest are subject to the risks of the mortgage securities market as a whole and risks of the securitization process.
The value of mortgage-backed securities may change due to shifts in the market's perception of issuers and regulatory or tax changes adversely affecting the mortgage securities market as a whole. Mortgage-backed securities are also subject to several risks created through the securitization process. Subordinate mortgage-backed securities are paid interest only to the extent that there are funds available to make payments. To the extent the collateral pool includes delinquent loans, there is a risk that the interest payment on subordinate mortgage-backed securities will not be fully paid. Subordinate mortgage-backed securities are also subject to greater credit risk than those mortgage-backed securities that are more highly rated.
Interest shortfalls on the CMBS that we own could have an adverse impact on the cash flow in our securities CDOs.
Our CMBS securities are subject to the risk of interest payment shortfalls on the CMBS that we own. These interest shortfalls may arise from underlying loan defaults, appraisal reductions, special-servicer workout fees, and realized losses on liquidation of foreclosed properties. We attempt to mitigate these losses by purchasing bonds with sufficient credit enhancement to avoid such shortfalls. However, there can be no assurance that such interest shortfalls will not continue to increase in the future.
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We may not control the special servicing of the mortgage loans included in the CMBS in which we invest and, in such cases, the special servicer may take actions that could adversely affect our interests.
With respect to each series of CMBS in which we invest, overall control over the special servicing of the related underlying mortgage loans may be held by a directing certificateholder, which is appointed by the holders of the most subordinate class of CMBS in such series. We ordinarily do not have the right to appoint the directing certificateholder. In connection with the servicing of the specially serviced mortgage loans, the related special servicer may, at the direction of the directing certificateholder, take actions that could adversely affect our interests.
The CMBS market was severely impacted by the recent economic recession, which had a negative impact on the CMBS that we own.
Because the CMBS markets were virtually closed and other participants in the commercial real estate lending drastically curtailed lending activity during the economic recession, real estate owners had difficulty refinancing their assets. Property values also decreased over the past couple of years because of scarcity of financing, which, if it was available, had terms generally at much lower leverage and higher cost than available in prior years. Although the consumer asset-backed debt and equity markets began to recover during 2009 and continued to improve during 2010, macroeconomic indicators remain weak and uncertainty regarding future economic conditions may continue to impact commercial real estate values. These conditions, together with wide-spread downgrades of CMBS by the rating agencies, significantly higher risk premiums required by investors and uncertainty surrounding commercial real estate generally, have had, and may continue to have, a negative impact on CMBS and have significantly decreased the value of most of the CMBS that we own from the time we purchased the CMBS, other than, for the most part, CMBS purchased in 2009 and 2010.
Credit ratings assigned to our investments are subject to ongoing evaluations and we cannot assure you that the ratings currently assigned to our investments will not be downgraded.
Some of our investments are rated by Moody's Investors Service, Fitch Ratings and/or Standard & Poor's Rating Services, Inc. The rating agencies have changed their ratings methodologies for all securitized asset classes, including commercial real estate, in light of questionable ratings previously assigned to residential mortgage portfolios. Their reviews have resulted in, and may continue to result in, large amounts of ratings downgrade actions for CMBS, negatively impacting market values of CMBS and in many cases negatively impacting our CDOs. If rating agencies assign a lower-than-expected rating or reduce, or indicate that they may reduce, their ratings of our investments in the future, the value of these investments could significantly decline, which may impact our CDOs and may have an adverse affect on our financial condition.
Market conditions in 2008 and early 2009 have caused and may continue to cause uncertainty in valuing our real estate securities.
The market volatility and the lack of liquidity in 2008 and 2009 made the valuation process pertaining to certain of our assets extremely difficult, particularly our CMBS assets for which there was limited market activity. Historically, our estimate of the value of these investments was primarily based on active issuances and the secondary trading market of such securities as compiled and reported by independent pricing agencies. Although the current market environment has improved with some new issuances and increased secondary trading of CMBS, there continues to be uncertainty in the market and trading is limited. Therefore, our estimate of fair value, which is based on the notion of orderly market transactions, requires significant judgment and consideration of other indicators of value such as current interest rates, relevant market indices, broker quotes, expected cash flows and other relevant market and security-specific data as appropriate. The amount that we could obtain if we were forced to liquidate our securities portfolio into the current market could be materially different than management's best estimate of fair value.
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Our investments in REIT securities are subject to risks relating to the particular REIT issuer of the securities and to the general risks of investing in senior unsecured real estate securities, which may result in losses to us.
In addition to general economic and market risks, our investments in REIT securities involve special risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer. REITs generally are required to substantially invest in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments.
Our investments in REIT securities and other senior unsecured debt are also subject to the risks described above with respect to commercial real estate loans and mortgage-backed securities and similar risks, including risks of delinquency and foreclosure, the dependence upon the successful operation of, and net income from, real property, risks generally related to interests in real property, and risks that may be presented by the type and use of a particular commercial property.
REIT securities are generally unsecured and may also be subordinate to other obligations of the issuer. We may also invest in securities that are rated below investment-grade. As a result, investments in REIT securities are also subject to risks of:
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- limited liquidity in the secondary trading market;
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- substantial market price volatility resulting from changes in prevailing interest rates and real estate values;
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- subordination to the prior claims of banks and other senior lenders to the REIT;
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- the operation of mandatory sinking fund or redemption provisions during periods of declining interest rates that could cause the issuer to reinvest redemption proceeds in lower yielding assets;
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- the possibility that earnings of the REIT may be insufficient to meet its debt service and distribution obligations;
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- the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates, declining real estate values and economic downturns;
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- rating agency credit rating downgrades negatively impacting value of securities; and
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- covenants not being sufficient to protect investors from the adverse credit impact of merger and acquisition transactions and increased leverage of the REIT.
These risks may adversely affect the value of outstanding REIT securities we hold and the ability of the issuers thereof to repay principal and interest or make distributions.
Investments in net lease properties may generate losses.
The value of our investments and the income from our investments in net lease properties may be significantly adversely affected by a number of factors, including:
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- national, state and local economic conditions;
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- real estate conditions, such as an oversupply of or a reduction in demand for real estate space in an area;
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- the perceptions of tenants and prospective tenants of the quality, convenience, attractiveness and safety of our properties;
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- competition from comparable properties;
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- the occupancy rate of, and the rental rates charged at, our properties;
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- the ability to collect on a timely basis all rent from tenants;
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- the effects of any bankruptcies or insolvencies of tenants;
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- the expense of re-leasing space;
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- changes in interest rates and in the availability, cost and terms of mortgage funding;
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- the impact of present or future environmental legislation and compliance with environmental laws;
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- cost of compliance with the Americans with Disabilities Act of 1990, or ADA;
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- adverse changes in governmental rules and fiscal policies;
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- civil unrest;
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- acts of nature, including earthquakes, hurricanes and other natural disasters (which may result in uninsured losses);
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- acts of terrorism or war;
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- adverse changes in zoning laws; and
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- other factors which are beyond our control.
We may obtain only limited warranties when we purchase a property, which will increase the risk that we may lose some or all of our invested capital in the property or rental income from the property which, in turn, could materially adversely affect our business, financial condition and results from operations and our ability to pay distributions to our stockholders.
The seller of a property often sells such property in its "as is" condition on a "where is" basis and "with all faults," without any warranties of merchantability or fitness for a particular use or purpose. In addition, purchase and sale agreements may contain only limited warranties, representations and indemnifications that will only survive for a limited period after the closing. The purchase of properties with limited warranties increases the risk that we may lose some or all of our invested capital in the property, as well as the loss of rental income from that property if an issue should arise that decreases the value of that property and is not covered by the limited warranties or any such issue arises after the survival period of the relevant indemnification provision. If any of these results occur, it may have a material adverse effect on our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
Our investments in net lease properties and a substantial portion of our healthcare business is dependent upon tenants successfully operating their businesses and their failure to do so could have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to our stockholders.
We depend on our tenants to manage the day-to-day operations of our net lease properties and our senior housing facilities in a manner which generates revenues sufficient to allow them to meet their obligations to us, including their obligations to pay rent, maintain certain insurance coverage, pay real estate taxes and maintain the facilities under their operational control in a manner so as not to jeopardize their operating licenses or regulatory status. The ability of our tenants to fulfill their obligations to us may depend, in part, upon the overall profitability of their operations, including any other facilities, properties or businesses they may acquire or operate. The cash flow generated by the operation of our facilities may not be sufficient for a tenant to meet its obligations to us. Our financial position could be weakened and our ability to fulfill our obligations under our indebtedness could be limited if our tenants are unable to meet their obligations to us or we fail to renew or extend our contractual relationship with any of our tenants. Any of these results could have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to our stockholders.
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The bankruptcy, insolvency or financial deterioration of any of our tenants could significantly delay our ability to collect unpaid rents or require us to find new tenants.
Our financial position and our ability to make distributions to our stockholders may be adversely affected by financial difficulties experienced by any of our major operators, including bankruptcy, insolvency or a general downturn in the business, or in the event any of our major tenants do not renew or extend their relationship with us as their lease terms expire.
We are exposed to the risk that our tenants may not be able to meet their obligations, which may result in their bankruptcy or insolvency. Although our leases and loans provide us the right to terminate an investment, evict a tenant, demand immediate repayment and other remedies, the bankruptcy laws afford certain rights to a party that has filed for bankruptcy or reorganization. A tenant in bankruptcy may be able to restrict our ability to collect unpaid rents or interest during the bankruptcy proceeding. Furthermore, dealing with a tenant's bankruptcy or other default may divert management's attention and cause us to incur substantial legal and other costs.
The Bankruptcy Code provides that a debtor has the option to assume or reject an unexpired lease within a certain period of time of filing for bankruptcy, but generally requires such assumption or rejection to be made in its entirety. Most of our healthcare properties are and will be net-leased to a tenant operating multiple facilities pursuant to a single master lease. If one or more of our healthcare property tenants files for bankruptcy relief, it is possible that in bankruptcy the debtor may be required to assume or reject the master lease in its entirety, rather than making the decision on a property-by-property basis, thereby preventing the debtor from assuming the better performing properties and terminating the master lease with respect to the poorer performing properties. Thus, a debtor cannot choose to keep the beneficial provisions of a contract while rejecting the burdensome ones; the contract must be assumed or rejected as a whole. However, where under applicable law a contract (even though it is contained in a single document) is determined to be divisible or severable into different agreements, or similarly, where a collection of documents is determined to constitute separate agreements instead of a single, integrated contract, then in those circumstances a debtor/trustee may be allowed to assume some of the divisible or separate agreements while rejecting the others. If the debtor chooses to assume the agreement or if a non-debtor tenant is unable to comply with the terms of an agreement, we may be forced to modify the agreements in ways that are unfavorable to us.
Because real estate investments are relatively illiquid, our ability to promptly sell properties in our portfolio is limited.
The real estate market is affected by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond our control. We cannot predict whether we will be able to sell any property for the price or on the terms set by us or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property, Additionally, our healthcare properties are special purpose properties that could not be readily converted to general residential, retail or office use. Transfers of operations of healthcare properties are subject to regulatory approvals not required for transfers of other types of commercial operations and other types of real estate. To the extent we are unable to sell any properties for its book value or at all, we may be required to take a non-cash impairment charge or loss on the sale, either of which would reduce our net income.
We may be required to expend funds to correct defects or to make improvements before a property can be sold. We cannot assure you that we will have funds available to correct those defects or to make those improvements. We may agree to transfer restrictions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These transfer restrictions would impede
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our ability to sell a property even if we deem it necessary or appropriate. These facts and any others that would impede our ability to respond to adverse changes in the performance of our properties may have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to our stockholders.
We may not be able to relet or renew leases at the properties held by us on terms favorable to us.
Our net leased assets have been negatively impacted by the economic recession and will continue to be pressured if our economic conditions and rental markets do not continue to show improvement. Upon expiration or earlier termination of leases for space located at our properties, the space may not be relet or, if relet, the terms of the renewal or reletting (including the cost of required renovations or concessions to tenants) may be less favorable than current lease terms. Poor economic conditions would likely reduce tenants' ability to make rent payments in accordance with the contractual terms of their leases and lead to early termination of leases. Furthermore, corporate space needs may contract resulting in lower lease renewal rates and longer releasing periods when leases are not renewed. Any of these situations may result in extended periods where there is a significant decline in revenues or no revenues generated by a property. Additionally, to the extent that market rental rates are reduced, property-level cash flows would likely be negatively affected as existing leases renew at lower rates. If we are unable to relet or renew leases for all or substantially all of the space at these properties, if the rental rates upon such renewal or reletting are significantly lower than expected, or if our reserves for these purposes prove inadequate, we will experience a reduction in net income and may be required to reduce or eliminate distributions to our stockholders.
We may become responsible for capital improvements. To the extent such capital improvements are not undertaken, the ability of our tenants to manage our facilities effectively and on favorable terms may be affected, which in turn could materially adversely affect our business, financial conditions and results of operations and our ability to make distributions to our stockholders.
Although under our typical triple net lease structure our tenants are generally responsible for capital improvement expenditures, it is possible that a tenant may not be able to fulfill its obligations to keep the facility in good operating condition. To the extent capital improvements are not undertaken or are deferred, occupancy rates and the amount of rental and reimbursement income generated by the facility may decline, which would impact the overall value of the affected senior housing facility. Any of these results could have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Lease defaults or terminations or landlord-tenant disputes may adversely reduce our income from our net lease property portfolio.
Lease defaults or terminations by one or more tenants may reduce our revenues unless a default is cured or a suitable replacement tenant is found promptly. The creditworthiness of our tenants in our net leased assets, could be significantly impacted, which could result in their inability to meet the terms of their leases. In addition, disputes may arise between the landlord and tenant that result in the tenant withholding rent payments, possibly for an extended period. These disputes may lead to litigation or other legal procedures to secure payment of the rent withheld or to evict the tenant. Any of these situations may result in extended periods during which there is a significant decline in revenues or no revenues generated by a property. If this were to occur, it could adversely affect our results of operations.
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Environmental compliance costs and liabilities associated with our properties or our real estate related investments may materially impair the value of our investments.
Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property, such as us and our tenants, may be liable in certain circumstances for the costs of investigation, removal or remediation of, or related releases of, certain hazardous or toxic substances, including materials containing asbestos, at, under or disposed of in connection with such property, as well as certain other potential costs relating to hazardous or toxic substances, including government fines and damages for injuries to persons and adjacent property. In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and the costs it incurs in connection with the contamination. Such laws often impose liability without regard to whether the owner knew of, or was responsible for, the presence or disposal of such substances and liability may be imposed on the owner in connection with the activities of a tenant at the property. The presence of contamination or the failure to remediate contamination may adversely affect our or our tenants' ability to sell or lease real estate or to borrow using the real estate as collateral. We, or our tenants, as owner or operator of a site, may be liable under common law to third parties for damages and injuries resulting from environmental contamination emanating from the site. The cost of any required investigation, remediation, removal, fines or personal or property damages and the our or our tenants' liability therefore could exceed the value of the property. In addition, the presence of such substances, or the failure to properly dispose of or remediate such substances, may adversely affect our or our tenants' ability to attract additional residents, ability to sell or rent such property or to borrow using such property as collateral which, in turn, could reduce our revenues.
The scope of the indemnifications our tenants have agreed to provide us may be limited. For instance, some of our agreements with our tenants do not require them to indemnify us for environmental liabilities arising before the tenant took possession of the premises. Further, we cannot assure you that any such tenant would be able to fulfill its indemnification obligations. If we were to be liable for any such environmental liabilities and were unable to seek recovery against our tenant, our business, financial condition and results of operations could be materially and adversely affected.
Furthermore, we may invest in real estate, or mortgage loans secured by real estate, with environmental problems that materially impair the value of the real estate. There are substantial risks associated with such an investment. We have only limited experience in investing in real estate with environmental liabilities.
Uninsured losses or losses in excess of our, or our tenants', insurance coverage could adversely affect our financial condition and our cash flows.
Although we believe our net leased assets, including our healthcare properties, and properties collateralizing our commercial real estate loan and securities investments are adequately covered by insurance, there are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war that may be uninsurable or not economically insurable. Inflation, changes in building codes and ordinances, environmental considerations and other factors, including terrorism or acts of war, also might make the insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under such circumstances, the insurance proceeds received might not be adequate to restore our economic position with respect to the affected real property. Any uninsured loss could result in both loss of cash flow from, and the asset value of, the affected property.
As a result of the events of September 11, 2001, insurance companies are limiting and charging significant premiums to cover acts of terrorism in insurance policies. As a result, although we, our tenants and our borrowers may carry terrorism insurance, we may suffer losses from acts of terrorism
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that are not covered by insurance. In addition, the commercial real estate loans which are secured by certain of our properties contain customary covenants, including covenants that require us to maintain property insurance in an amount equal to the replacement cost of the properties, which may increase the cost of obtaining the required insurance.
We are named as a defendant in a lawsuit and the adverse resolution of this matter could have a material adverse effect on our financial condition and results of operations.
One of our net lease investments was comprised of three office buildings totaling 257,000 square feet located in Chatsworth, CA and was 100% leased to Washington Mutual Bank, FA ("WaMu"). The tenant vacated the buildings as of March 23, 2009, and the leases (the "WaMu Leases") were disaffirmed by the Federal Deposit Insurance Corporation, or the FDIC. In the third quarter of 2009 the lender, GECCMC 2005-CI Plummer Office Limited Partnership (the "Lender"), foreclosed on the property. On August 10, 2009, the Lender filed a complaint against NRFC NNN Holdings, Inc. ("NNN") and NRFC Sub Investor IV, LLC ("NRFC Sub IV"), which are our subsidiaries, in the Superior Court of the State of California, County of Los Angeles. In the complaint, the Lender alleged, among other things, that the WaMu Loan is a recourse obligation of NNN due to the FDIC's disaffirmance of the WaMu Leases. The judge presiding over the lawsuit has entered a judgment against NNN in the amount of approximately $45 million. In January 2011, NNN posted an appeal bond, which is currently collateralized by $26 million of cash, and intends to vigorously pursue an appeal of the decision. An adverse result on appeal would have a material adverse effect on our liquidity and financial condition.
Many of our investments are illiquid, and we may not be able to vary our portfolio in response to further changes in economic and other conditions, which may result in losses to us.
Our investments are relatively illiquid and, therefore, our ability to sell properties, securities or commercial real estate loans in response to changes in economic and other conditions, as we experienced during the economic recession, will be limited, except at distressed prices. The Internal Revenue Code also places limits on our ability to sell properties held for fewer than four years. These considerations could make it difficult for us to dispose of any of our assets even if a disposition were in the best interests of our stockholders. As a result, our ability to vary our portfolio in response to further changes in economic and other conditions may be relatively limited, which may result in losses to us.
We may make investments in assets with lower credit quality, which will increase our risk of losses.
Most of our securities investments have explicit ratings assigned by at least one of the three leading nationally-recognized statistical rating agencies. However, we may invest in unrated securities, enter into net leases with unrated tenants or participate in unrated or distressed mortgage loans. Because the ability of obligors of net leases and mortgages, including mortgages underlying mortgage-backed securities, to make rent or principal and interest payments may be impaired during an economic downtown, as we recently experienced, prices of lower credit quality investments and securities may decline. The existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these investments and securities. We have not established and do not currently plan to establish any investment criteria to limit our exposure to these risks for future investments.
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We have no established investment criteria limiting the geographic concentration of our investments in real estate debt, real estate securities or net lease properties. If our investments are concentrated in an area that experiences adverse economic conditions, our investments may lose value and we may experience losses.
Certain commercial real estate loans and securities in which we invest may be secured by a single property or properties in one geographic location. Additionally, net lease properties that we may acquire may also be located in a geographic cluster. These current and future investments carry the risks associated with significant geographical concentration. We have not established and do not plan to establish any investment criteria to limit our exposure to these risks for future investments. As a result, properties underlying our investments may be overly concentrated in certain geographic areas, and we may experience losses as a result. A worsening of economic conditions in the geographic area in which our investments may be concentrated could have an adverse effect on our business, including reducing the demand for new financings, limiting the ability of customers to pay financed amounts and impairing the value of our collateral.
Our portfolio is highly leveraged, which may adversely affect our return on our investments and may reduce cash available for distribution on our securities.
We leverage our portfolio through borrowings, generally through the use of bank credit facilities, commercial real estate loans, securitizations, including the issuance of CDOs, and other borrowings, many of which are not currently available to us. The type and percentage of leverage varies depending on our ability to obtain credit facilities and the lender's estimate of the stability of the portfolio's cash flow. However, we do not restrict the amount of indebtedness that we may incur. Our return on our investments and cash available for distribution to our stockholders has been reduced because of the recent economic recession, which caused the cost of financing to increase relative to the income that can be derived from our assets. Moreover, we may have to incur more recourse indebtedness in order to obtain financing for our business.
Our joint venture partners could take actions that decrease the value of an investment to us and lower our overall return.
We may enter into joint ventures with third parties to make investments. We may also make investments in partnerships or other co-ownership arrangements or participations. Such investments may involve risks not otherwise present with other methods of investment, including, for example, the following risks:
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- that our co-venturer or partner in an investment could become insolvent or bankrupt;
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- that such co-venturer or partner may at any time have economic or business interests or goals that are or that become inconsistent with our business interests or goals; or
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- that such co-venturer or partner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives.
Any of the above might subject us to liabilities and thus reduce our returns on our investment with that co-venturer or partner.
We are subject to risks associated with owning residential land investments in our LandCap joint venture.
In late 2007, we entered into a joint venture with Whitehall Street Global Real Estate Limited Partnership 2007 to form LandCap Partners, which we refer to as LandCap. The venture is currently managed by a third party. LandCap's investment strategy was to opportunistically invest in single family residential land through land loans, lot option agreements and select land purchases. These investments were expected to generate very little current cash flow and to be held for several years prior to liquidation. We do not expect to provide any new investment capital to LandCap in the future. The
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venture will continue to manage existing investments and we do not expect the venture to return capital to us for several years.
Interest rate fluctuations may reduce the spread we earn on our interest-earning investments and may reduce our net income.
Although we seek to match-fund our assets and mitigate the risk associated with future interest rate volatility, we are primarily subject to interest rate risk because we do not hedge our retained equity interest in our floating rate CDOs. If a CDO has floating rate assets, our earnings will generally increase with increases in floating interest rates to the extent such increases do not cause distress for borrowers and our underlying assets are able to provide sufficient cash to pay such higher rates. Conversely, our earnings will generally decrease with declines in floating interest rates. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.
Our interest rate risk sensitive assets, liabilities and related derivative positions are generally held for non-trading purposes. As of December 31, 2010, a hypothetical 100 basis point increase in interest rates applied to our variable rate assets would increase our annual interest income by approximately $27.5 million, offset by an increase in our interest expense of approximately $23.7 million on our variable rate liabilities. Similarly, a hypothetical 100 basis point decrease in interest rates would decrease our annual interest income by the same net amount.
Our hedging transactions may limit our gains and could result in losses.
To limit the effects of changes in interest rates on our operations, we may employ hedging strategies, including engaging in interest rate swaps, caps, floors and other interest rate exchange contracts as well as engaging in short sales of securities or of future contracts. The use of these types of derivatives to hedge our assets and liabilities carries certain risks, including the risks that:
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- losses on a hedge position will reduce the cash available for distribution to stockholders;
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- losses may exceed the amount invested in such instruments;
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- a hedge may not perform its intended use of offsetting losses on an investment;
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- the counterparties with which we trade may cease making markets and quoting prices in such instruments, which may render us unable to enter into an offsetting transaction with respect to an open position; and
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- the counterparties with which we trade may experience business failures, which would most likely result in a default. Default by such counterparty may result in the loss of unrealized profits, which were expected to offset losses on our assets. Such defaults may also result in a loss of income on swaps or caps, which income was expected to be available to cover our debt service payments.
Our results of operations may be adversely affected during any period as a result of the use of derivatives. If we anticipate that the income from any such hedging transaction will not be qualifying income for REIT income test purposes, we may conduct some or all of our hedging activities through a corporate subsidiary that would be subject to corporate income taxation.
We may change our investment strategy without stockholder consent and make riskier investments.
We may change our investment strategy at any time without the consent of our stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described in this Annual Report on Form 10-K/A. A change in our investment strategy may increase our exposure to interest rate and real estate market fluctuations.
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We have been, and may in the future be, subject to significant competition, and we may not be able to compete successfully for investments.
We have been, and may in the future be, subject to significant competition for attractive investment opportunities from other real estate investors, some of which have greater financial resources than us, including publicly traded REITs, private REITs, investment banking firms, private institutional funds, hedge funds and private opportunity funds. We may not be able to compete successfully for investments.
Actions of the U.S. Government, including the U.S. Congress, Federal Reserve, U.S. Treasury and other governmental and regulatory bodies for the purpose of stabilizing or reforming the financial markets, or market response to those actions, may adversely affect our business.
In July 2010, the U.S. Congress enacted Dodd—Frank in part to impose significant investment restrictions and capital requirements on banking entities and other organizations that are significant to U.S. financial markets. For instance, Dodd—Frank will impose significant restrictions on the proprietary trading activities of certain banking entities and subject other systemically significant organizations regulated by the U.S. Federal Reserve to increased capital requirements and quantitative limits for engaging in such activities. Dodd—Frank also seeks to reform the asset—backed securitization market (including the CMBS market) by requiring the retention of a portion of the credit risk inherent in the pool of securitized assets and by imposing additional registration and disclosure requirements. Dodd—Frank also imposes significant regulatory restrictions on the origination of residential mortgage loans. While the full impact of Dodd—Frank cannot be assessed until implementing regulations are released, Dodd—Frank's extensive requirements may have a significant effect on the financial markets, and may affect the availability or terms of financing from our lenders and the availability or terms of CMBS, both of which may have an adverse effect on our business.
In addition, U.S. Government, Federal Reserve, U.S. Treasury and other governmental and regulatory bodies have taken or are considering taking other actions to address the causes of the recent economic recession. We cannot predict whether or when such actions may occur or what affect, if any, such actions could have on our business, results of operations and financial condition.
The senior living industry is highly competitive and we expect it to become more competitive.
In May 2006, we entered the healthcare-related net lease business by forming a joint venture with Chain Bridge Capital LLC to invest in senior housing and healthcare-related net leased assets, which we refer to as NRF Healthcare, LLC. In 2008, we brought another equity partner, Inland American Real Estate Trust, Inc., or Inland American, into NRF Healthcare, LLC by selling a $100 million preferred membership interest to Inland American, convertible into an approximate 42% interest in NRF Healthcare, LLC. In December 2009, we bought Chain Bridge Capital's interest in NRF Healthcare, LLC and retained certain principals of Chain Bridge who have extensive experience owning and investing in skilled nursing facilities, or SNFs, and assisted living facilities, or ALFs.
In November 2010, we filed a registration statement on Form S-11 for NorthStar Senior Care Trust, Inc., or our Senior Care REIT, a corporation that will not be listed on a major exchange and was formed to originate, acquire and manage a diversified portfolio of debt and equity investments in the healthcare property sector. We expect that if the registration statement filed by our Senior Care REIT is declared effective by the SEC, it would also be managed by us through a subsidiary and we would earn a management fee for our services.
The senior living industry is highly competitive, and we expect that it may become more competitive in the future. The tenants of the facilities we own or lend to compete with numerous other companies that provide long-term care alternatives such as home healthcare agencies, life care at home, facility-based service programs, retirement communities, convalescent centers and other independent
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living, assisted living and skilled nursing providers, including not-for-profit entities. In general, regulatory and other barriers to competitive entry in the independent living and assisted living segments of the senior living industry are not substantial, although there are generally barriers to the development of skilled nursing facilities. Consequently, our tenants may encounter increased competition that could limit their ability to attract new residents, raise resident fees or expand their businesses, which could adversely adverse effect our revenues and earnings.
Inland American exercised their convertible preferred membership interest, which will require us to redeem their interest or sell assets of NRF Healthcare, LLC.
In July 2010, we were notified by Inland American that it desires to have NRF Healthcare, LLC engage in a sale process for a portfolio of 34 senior housing properties or otherwise redeem $50 million of Inland American's convertible preferred membership interest by January 9, 2011. NRF Healthcare, LLC has not redeemed $50 million of the Inland American interest and has engaged a broker to sell the 34 property senior housing portfolio. If such portfolio is not sold by October 9, 2011, then Inland American may undertake a sale process for that portfolio. Inland American may also undertake a sale process for all of the assets of NRF Healthcare, LLC beginning August 8, 2011, unless at least $25 million of Inland American's preferred membership interest has been redeemed by June 10, 2011, in which case all future net cash flow to the common members of NRF Healthcare, LLC will be used to redeem the preferred membership interest. On July 8, 2012, if the preferred membership interest has not been redeemed in full, Inland American may sell the assets of NRF Healthcare, LLC. We are currently exploring alternatives for partial and/or full redemption of the preferred membership interest; however, there is no assurance that we will be able to redeem the preferred membership interest and, accordingly, may lose control of the assets in NRF Healthcare, LLC.
Our failure or the failure of our tenants to comply with licensing and certification requirements, the requirements of governmental reimbursement programs such as Medicare or Medicaid, fraud and abuse regulations or new legislative developments may materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
We or our tenants, as the case may be, are subject to numerous federal, state and local laws and regulations that are subject to frequent and substantial changes (sometimes applied retroactively) resulting from legislation, adoption of rules and regulations, and administrative and judicial interpretations of existing laws. The ultimate timing or effect of any changes in these laws and regulations cannot be predicted. With respect to senior housing facilities held and operated through net-lease transaction structures, we have no direct control over our tenants' ability to meet the numerous federal, state and local regulatory requirements. Failure to comply with these laws, requirements and regulations may materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders. In particular:
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- Licensing and Certification. We, our tenants and our senior housing facilities are subject to regulatory and licensing requirements of federal, state and local authorities and are periodically surveyed by them to confirm compliance. Failure to obtain licensure or loss or suspension of licensure or certification may prevent a facility from operating or result in a suspension of reimbursement payments until all licensure or certification issues have been resolved and the necessary licenses or certification are obtained or reinstated. Our senior housing facilities may require governmental approval in the form of a certificate of need that generally varies by state and is subject to change, prior to the addition of new beds, the addition of service or certain capital expenditures. Facilities may also be affected by changes in accreditation standards or procedures of accrediting agencies that are recognized by governments in the certification process. State licensing laws require tenants of healthcare facilities to comply with extensive
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- Medicare and Medicaid. Generally, a portion of the revenue from the operation of our senior housing facilities and other healthcare properties (and a significant portion of the revenue in the case of a SNF) is derived from governmentally-funded reimbursement programs, primarily Medicare and Medicaid, and failure to maintain enrollment and participation in these programs would result in a loss of funding from such programs. Moreover, federal and state governments have adopted and continue to consider various reform proposals to control healthcare costs. In recent years, there have been fundamental changes in the Medicare program that have resulted in reduced levels of payment for a substantial portion of healthcare services. In many instances, revenues from Medicaid programs are already insufficient to cover the actual costs incurred in providing care to patients. In addition, reimbursement from private payors has in many cases effectively been reduced to levels approaching those of government payors. Governmental concern regarding healthcare costs and their budgetary impact and the specter of fraud and abuse in claims reimbursement may result in significant reductions in payments to our tenants, and future reimbursement rates for either governmental or private payors may not be sufficient to cover cost increases in providing services to patients. Exclusion, debarment, suspension or other ineligibility to participate in federal healthcare programs or any changes in reimbursement policies that reduce reimbursement to levels that are insufficient to cover the cost of providing patient care could cause our or our tenants revenue and the value of the affected senior housing facilities and other healthcare properties to decline.
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- Fraud and Abuse Laws and Regulations. There are complex federal and state laws governing a wide array of referrals, financial relationships and arrangements and prohibiting fraud by healthcare providers, including criminal provisions that prohibit financial inducements for referrals, filing false claims or making false statements to receive payment or certification under Medicare and Medicaid, or failing to refund overpayments or improper payments. Governments are devoting increasing attention and resources to anti-fraud initiatives against healthcare providers. The Office of the Inspector General of the U.S. Department of Health and Human Services has announced a number of new and ongoing initiatives to study instances of potential Medicare and Medicaid overbilling and/or fraud. Violations of these laws subject persons and entities to termination from participation in Medicare, Medicaid and other federally funded healthcare programs. In addition, the federal False Claims Act allows a private individual with knowledge of fraud to bring a claim on behalf of the federal government and earn a percentage of the federal government's recovery. Because of these incentives, these so-called "whistleblower" suits have become more frequent. The violation of any of these laws or regulations by us or by any of our tenants may result in the imposition of significant monetary damages, fines and other penalties.
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- Other Laws. Other laws that impact how we and our tenants conduct business include: federal and state laws designed to protect the confidentiality and security of patient health information; state and local licensure laws; laws protecting consumers against deceptive practices; laws generally affecting the management of our senior housing facilities and other healthcare properties and equipment and how our tenants generally conduct their operations, such as fire, health and safety, and environmental laws; federal and state laws affecting ALFs mandating quality of services and care, and quality of food service; resident rights (including abuse and
standards governing operations. State agencies administering those laws regularly inspect such facilities and investigate complaints. Failure to meet all regulatory requirements could result in the loss of the ability to provide or bill and receive payment for healthcare services. In such event, revenues from those facilities could be reduced or eliminated for an extended period of time or permanently. Transfers of operations of healthcare facilities are subject to regulatory approvals not required for transfers of other types of commercial operations and real estate.
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- Legislative and Regulatory Developments. Legislative proposals are often introduced or proposed in Congress and in some state legislatures that would effect changes in the healthcare system.
neglect laws); and health standards set by the federal Occupational Safety and Health Administration.
The healthcare industry is heavily regulated. New laws or regulations such as the healthcare reform law and related regulations, changes to existing laws or regulations, loss of licensure or failure to obtain licensure could result in the inability of our tenants to make rent payments to us.
The healthcare industry is heavily regulated by federal, state and local governmental bodies. Healthcare facility operators generally are subject to laws and regulations covering, among other things, licensure, certification for participation in government programs, and relationships with physicians and other referral sources. Changes in these laws and regulations could negatively affect the ability of our tenants to make lease payments to us and our ability to make distributions to our stockholders.
Many of our targeted properties and their operators may require a license or certificate of need, or CON, to operate. Failure to obtain a license or CON, or loss of a required license or CON would prevent a facility from operating in the manner intended by the operator. These events could materially adversely affect our tenants' ability to make rent payments to us. State and local laws also may regulate expansion, including the addition of new beds or services or acquisition of medical equipment, and the construction of healthcare-related facilities, by requiring a CON or other similar approval. State CON laws are not uniform throughout the United States and are subject to change. We cannot predict the impact of state CON laws on our development of facilities or the operations of our tenants.
In addition, state CON laws often materially impact the ability of competitors to enter into the marketplace of our facilities. The repeal of CON laws could allow competitors to freely operate in restricted markets. This could negatively affect our tenants' abilities to make rent payments to us.
In limited circumstances, loss of state licensure or certification or closure of a facility could ultimately result in loss of authority to operate the facility and require new CON authorization to re-institute operations. As a result, a portion of the value of the facility may be reduced, which would adversely impact our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Recently enacted comprehensive healthcare reform legislation could materially and adversely affect our business, financial condition and results of operations and our ability to pay distributions to stockholders.
On March 23, 2010, the President signed into law the Patient Protection and Affordable Care Act of 2010, or the Patient Protection and Affordable Care Act, and on March 30, 2010, the President signed into law the Health Care and Education Reconciliation Act of 2010, or the Reconciliation Act, which in part modified the Patient Protection and Affordable Care Act. Together, the two laws serve as the primary vehicle for comprehensive healthcare reform in the U.S. and will become effective through a phased approach, which began in 2010 and will conclude in 2018. The laws are intended to reduce the number of individuals in the U.S. without health insurance and significantly change the means by which healthcare is organized, delivered and reimbursed. The Patient Protection and Affordable Care Act includes program integrity provisions that both create new authorities and expand existing authorities for federal and state governments to address fraud, waste and abuse in federal health programs. In addition, the Patient Protection and Affordable Care Act expands reporting requirements and responsibilities related to facility ownership and management, patient safety and care quality. In the ordinary course of their businesses, our tenants may be regularly subjected to inquiries, investigations and audits by Federal and State agencies that oversee these laws and regulations. If they do not comply with the additional reporting requirements and responsibilities, our tenants' ability to participate in federal health programs may be adversely affected. Moreover, our tenants could be
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required to provide health insurance to a number of additional employees, which in turn could impact such tenants' ability to meet their obligations to us, including their obligations to pay rent, maintain certain insurance coverage, pay real estate taxes and maintain the facilities under their operational control in a manner so as not to jeopardize their operating licenses or regulatory status, and there may be other aspects of the comprehensive healthcare reform legislation for which regulations have not yet been adopted, which, depending on how they are implemented, could materially and adversely affect our tenants, and therefore our business, financial condition, results of operations and ability to pay distributions to you.
A significant portion of our leases expire in the same year.
A significant portion of the leases that we have entered into expire in 2017, which coincides with the debt maturities on the properties subject to these leases. As a result, we could be subject to a sudden and material change in value of our healthcare portfolio and available cash flow from our healthcare assets in the event that these leases are not renewed or in the event that we are not able to extend or refinance the loans on the properties that are subject to these leases.
State law may limit the availability of certain types of healthcare facilities for our acquisition or development and may limit our ability to replace obsolete properties.
Certificate-of-Need laws may impose investment barriers for us. Some states regulate the supply of some types of retirement facilities, such as SNFs or ALFs, through Certificate-of-Need laws. A Certificate-of-Need typically is a written statement issued by a state regulatory agency evidencing a community's need for a new, converted, expanded or otherwise significantly modified retirement facility or service which is regulated pursuant to the state's statutes. These restrictions may create barriers to entry or expansion and may limit the availability of properties for our acquisition or development. In addition, we may invest in properties which cannot be replaced if they become obsolete unless such replacement is approved or exempt under a Certificate-of-Need law.
Our investments in healthcare assets are not only subject to many of the same risks as our other net lease properties, but are subject to additional risks specific to the senior living industry.
The value of our investments and the income from our investments in healthcare related net lease properties are subject to many of the same risks associated with our other net lease properties. However, characteristics of the senior living industry subject our healthcare assets to additional risks described in this subsection entitled "—Risks Relating to Investments in Healthcare Assets".
Our tenants are faced with increased litigation and rising insurance costs that may affect their ability to make their lease or mortgage payments.
In some states, advocacy groups have been created to monitor the quality of care at healthcare facilities, and these groups have brought litigation against tenants. Also, in several instances, private litigation by patients has succeeded in winning very large damage awards for alleged abuses. The effect of this litigation and potential litigation has been to materially increase the costs incurred by our tenants for monitoring and reporting quality of care compliance. In addition, the cost of liability and medical malpractice insurance has increased and may continue to increase so long as the present litigation environment affecting the operations of healthcare facilities continues. Continued cost increases could cause our tenants to be unable to make their lease or mortgage payments, potentially decreasing our revenue and increasing our collection and litigation costs. Moreover, to the extent we are required to take back the affected facilities, our revenue from those facilities could be reduced or eliminated for an extended period of time.
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Events could occur that could adversely affect the ability of seniors to afford the monthly resident fees or entrance fees (including downturns in the economy, housing market, consumer confidence or the equity markets) and, in turn, materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Costs to seniors associated with independent and assisted living services are generally not reimbursable under government reimbursement programs such as Medicaid and Medicare. Only seniors with income or assets meeting or exceeding the comparable median in the regions where our facilities are located typically will be able to afford to pay our monthly resident fees. Economic downturns, softness in the housing market, lower levels of consumer confidence, reductions or declining growth of government entitlement programs, such as social security benefits, stock market volatility and changes in demographics could adversely affect the ability of seniors to afford the monthly resident fees or entrance fees for our senior housing facilities. If our tenants are unable to retain and attract seniors with sufficient income, assets or other resources required to pay the fees associated with independent and assisted living services and other services provided by our tenants at our senior housing facilities, our occupancy rates could decline, which could, in turn, materially adversely affect our business, results of operations and financial condition and our ability to make distributions to our stockholders.
The inability of seniors to sell real estate may delay their moving into our residences which could materially adversely affect our occupancy rates and our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Recent housing price declines and reductions in residential mortgage availability have negatively affected the U.S. housing market, with certain geographic areas experiencing more acute deterioration than others. Downturns in the U.S. housing market, such as the one we have recently experienced, could adversely affect the ability (or perceived ability) of seniors to afford entrance fees and resident fees at our senior housing facilities, as potential residents frequently use the proceeds from the sale of their homes to cover the costs of these fees. Specifically, if seniors have a difficult time selling their homes, these difficulties could impact their ability to relocate into our facilities or finance their stays at our facilities. This could cause the amount of our revenues generated by private payment sources to decline. If the recent volatility in the U.S. housing market continues for a protracted period, it could materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Government budget deficits could lead to a reduction in Medicaid and Medicare reimbursement.
The recent slowdown in the U.S. economy has negatively affected state budgets, which may put pressure on states to decrease reimbursement rates with the goal of decreasing state expenditures under state Medicaid programs. The need to control Medicaid expenditures may be exacerbated by the potential for increased enrollment in state Medicaid programs due to unemployment, declines in family incomes and eligibility expansions required by the recently enacted healthcare reform law. These potential reductions could be compounded by the potential for federal cost-cutting efforts that could lead to reductions in reimbursement rates under both the federal Medicare program and state Medicaid programs. Potential reductions in reimbursements under these programs could negatively impact the ability of our tenants and their ability to meet their obligations to us.
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Possible changes in the acuity profile of our residents as well as payor mix and payment methodologies may materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
The sources and amounts of our revenues from our healthcare property portfolio are determined by a number of factors, including licensed bed capacity, occupancy, the acuity profile of residents and the rate of reimbursement. Changes in the acuity profile of the residents as well as payor mix among private pay, Medicare and Medicaid may materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
The geographic concentration of our senior housing facilities could leave us vulnerable to an economic downturn, regulatory or reimbursement changes or acts of nature in those areas, which could have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to our stockholders.
For the year ended December 31, 2010, we derived 10% or more of our annualized contractual rental revenue from senior housing facilities in our portfolio located in Indiana (14.3%). As a result of such concentration, the conditions of local economies and real estate markets, changes in governmental rules and regulations, particularly with respect to state Medicaid programs, acts of nature and other factors that may result in a decrease in demand for services at our senior housing facilities in this state could have a material adverse effect on our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
Certain operators will account for a significant percentage of our contractual rental revenue, and the failure of any of these operators to meet their obligations to us could materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
For the year ended December 31, 2010, we derived 10% or more of our annualized contractual rental revenue from senior housing facilities in our portfolio operated by Miller Health Systems, Inc. (11.6%), and Midwest Care Holdco TRS I LLC (38.9%). If these operators fail to meet their obligations to us, our business, financial condition, results of operations and our ability to make distributions to our stockholders could be materially and adversely impacted. No other operator generated more than 10% of our annualized rental revenue under existing leases for the year ended December 31, 2010. The failure or inability of this operator to meet its obligations to us could materially reduce our rental revenue and net income, which could in turn reduce the amount of distributions we pay and cause our stock price to decline.
Because of the unique and specific improvements required for healthcare properties, we may be required to incur substantial renovation costs to make certain of our properties suitable for other tenants, which could materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
Healthcare properties are typically highly customized and may not be easily adapted to non-healthcare-related uses. The improvements generally required to conform a property to healthcare use, such as upgrading electrical, gas and plumbing infrastructure, are costly and often times tenant-specific. A new or replacement tenant may require different features in a property, depending on that tenant's particular operations. If a current tenant is unable to pay rent and vacates a property, we may incur substantial expenditures to modify a property for a new tenant, or for multiple tenants with varying infrastructure requirements, before we are able to release the space. Consequently, our healthcare properties may not be suitable for lease to traditional office or other tenants without significant expenditures or renovations, which costs may materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
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We are subject to risks associated with debt financing, which could materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Our healthcare portfolio has total debt of approximately $471.7 million. Financing for future investments and our maturing commitments for our healthcare portfolio may be provided by borrowings under credit facilities, private or public offerings of debt, the assumption of secured indebtedness, mortgage financing on a portion of our owned healthcare portfolio or through joint ventures. We are subject to risks normally associated with debt financing, including the risks that our cash flow will be insufficient to make timely payments of interest, that we will be unable to refinance existing indebtedness or support collateral obligations and that the terms of refinancing will not be as favorable as the terms of existing indebtedness. If we are unable to refinance or extend principal payments due at maturity or pay them with proceeds from other capital transactions, our cash flow may not be sufficient in all years to pay distributions to our stockholders and to repay all maturing debt. Furthermore, if prevailing interest rates, changes in our debt ratings or other factors at the time of refinancing result in higher interest rates upon refinancing, the interest expense relating to that refinanced indebtedness would increase, which could reduce our profitability and the amount of dividends we are able to pay. Moreover, additional debt financing increases the amount of our leverage, which could negatively affect our ability to obtain additional financing in the future or make us more vulnerable to a downturn in our results of operations or the economy generally.
If our tenants fail to cultivate new or maintain existing relationships with residents in the markets in which they operate, our occupancy percentage, payor mix and resident rates may deteriorate which could have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to our stockholders.
The ability of our tenants to improve the overall occupancy percentage, payor mix and resident rates at our senior housing facilities, depends on our tenants' reputation in the communities they serve and our tenants' ability to successfully market our facilities to potential residents. A large part of our tenants' marketing and sales effort is directed towards cultivating and maintaining relationships with key community organizations that work with seniors, physicians and other healthcare providers in the communities where our facilities are located, whose referral practices significantly affect the choices seniors make with respect to their long-term care needs. If our tenants are unable to successfully cultivate and maintain strong relationships with these community organizations, physicians and other healthcare providers, occupancy rates at our facilities could decline, which could materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
We may not be able to compete effectively in those markets where overbuilding exists and our inability to compete in those markets may have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Overbuilding in the senior housing segment in the late 1990s reduced occupancy and revenue rates at senior living facilities. This, combined with unsustainable levels of indebtedness, forced several operators into bankruptcy. The occurrence of another period of overbuilding could adversely affect our future occupancy and resident fee rates, which in turn could materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Our tenants may be subject to significant legal actions that could subject them to increased operating costs and substantial uninsured liabilities, which may affect their ability to meet their obligations to us.
Our tenants may be subject to claims that their services have resulted in resident injury or other adverse effects. The insurance coverage maintained by our tenants, whether through commercial insurance or self-insurance, may not cover all claims made against them or continue to be available at a
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reasonable cost, if at all. In some states, insurance coverage for the risk of punitive damages arising from professional liability and general liability claims and litigation may not, in certain cases, be available to our tenants due to state law prohibitions or limitations of availability. As a result, our tenants operating in these states may be liable for punitive damage awards that are either not covered or are in excess of their insurance policy limits. From time to time, there may also be increases in government investigations of long-term care providers, particularly in the area of Medicare/Medicaid false claims and resident care, as well as increases in enforcement actions resulting from these investigations. Insurance is not available to cover such losses. Any adverse determination in a legal proceeding or government investigation, whether currently asserted or arising in the future, could lead to potential termination from government programs, large penalties and fines and otherwise have a material adverse effect on a healthcare operator's financial condition. If a healthcare operator is unable to obtain or maintain insurance coverage, if judgments are obtained in excess of the insurance coverage, if a healthcare operator is required to pay uninsured punitive damages, or if a healthcare operator is subject to an uninsurable government enforcement action, the healthcare operator could be exposed to substantial additional liabilities, which could result in its bankruptcy or insolvency or have a material adverse effect on the healthcare operator's business and its ability to meet its obligations to us.
Moreover, advocacy groups that monitor the quality of care at healthcare facilities have sued healthcare facility operators and called upon state and federal legislators to enhance their oversight of trends in healthcare facility ownership and quality of care. In response, the recently enacted healthcare reform law imposes additional reporting requirements and responsibilities for healthcare facility operators. Patients have also sued healthcare facility operators and have, in certain cases, succeeded in winning very large damage awards for alleged abuses. This litigation and potential litigation in the future has materially increased the costs incurred by our tenants for monitoring and reporting quality of care compliance. In addition, the cost of medical malpractice and liability insurance has increased and may continue to increase so long as the present litigation environment affecting the operations of healthcare facilities continues. Compliance with the requirements in the healthcare reform law could increase costs as well. Increased costs could limit our tenants' ability to meet their obligations to us, potentially decreasing our revenue and increasing our collection and litigation costs. To the extent we are required to remove or replace a tenant, our revenue from the affected property could be reduced or eliminated for an extended period of time.
Delays in our tenants' collection of their accounts receivable could adversely affect their cash flows and financial condition and their ability to meet their obligations to us.
Prompt billing and collection are important factors in the liquidity of our tenants. Billing and collection of accounts receivable are subject to the complex regulations that govern Medicare and Medicaid reimbursement and rules imposed by non-government payors. The inability of our tenants to bill and collect on a timely basis pursuant to these regulations and rules could subject them to payment delays that could negatively impact their cash flows and ultimately their financial condition and their ability to meet their obligations to us.
Our healthcare properties may be subject to impairment charges, which could materially adversely affect our business, financial condition and results of operations.
We will periodically evaluate our healthcare properties for impairment indicators. The judgment regarding the existence of impairment indicators is based on factors such as market conditions, healthcare operator performance and legal structure. If we determine that a significant impairment has occurred, we would be required to make an adjustment to the net carrying value of the healthcare property, which could have a material adverse affect on our results of operations and funds from operations in the period in which the write-off occurs.
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Compliance with the Americans with Disabilities Act, Fair Housing Act, and fire, safety and other regulations may require us to make unanticipated expenditures which could materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Our facilities and properties are required to comply with the American with Disabilities Act of 1990, or ADA. The ADA generally requires that buildings be made accessible to people with disabilities. We must also comply with the Fair Housing Act, which prohibits us and our tenants from discriminating against individuals on certain bases in any of our practices if it would cause such individuals to face barriers in gaining residency in any of our facilities. In addition, our facilities and properties are required to operate in compliance with applicable fire and safety regulations, building codes and other land use regulations and food licensing or certification requirements as they may be adopted by governmental agencies and bodies from time to time. We may be required to make substantial expenditures to comply with those requirements.
We are facing increasing competition for the acquisition of senior housing facilities and other healthcare properties which may impede our ability to make future acquisitions or may increase the cost of these acquisitions which, in turn, could materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
We compete with many other businesses engaged in real estate investment activities for the acquisition of senior housing facilities and other healthcare properties, including local, regional and national operators and acquirers and developers of healthcare real estate. The competition for senior housing facilities and other healthcare properties may significantly increase the price we might pay for a facility or property we seek to acquire and our competitors may succeed in acquiring those facilities or properties themselves. In addition, operators with whom we attempt to do business may find our competitors to be more attractive because they may have greater resources, may be willing to pay more for the properties or may have a more compatible operating philosophy. In particular, larger healthcare REIT may enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. In addition, the number of entities and the amount of funds competing for suitable investment properties may increase. This competition may result in increased demand for these assets and therefore increased prices paid for them. If we pay higher prices for healthcare properties, our business, financial condition and results of operations and our ability to make distributions to our stockholders may be materially adversely affected.
Risks Related to the Investment Management Business
The organization and management of NSREIT and Senior Care REIT, and any future funds that we raise, may create conflicts of interest.
In addition to managing the assets of our CDOs, we sponsored and, through a majority owned subsidiary, are the advisor of NorthStar Real Estate Income Trust, Inc., which we refer to as NSREIT, a non-listed REIT that is currently raising capital via a continuous offering. Additionally, we sponsored and filed a registration statement on Form S-11 for NorthStar Senior Care Trust, Inc., or our Senior Care REIT, a non-listed REIT that was formed to originate, acquire and manage a diversified portfolio of debt and equity investments in the healthcare sector. We expect that if our Senior Care REIT is declared effective by the SEC, it would also be managed by us through a subsidiary advisor.
NSREIT and Senior Care REIT, along with any new funds we may manage, which together are referred to as our "Funds," will hold assets that we determine should be acquired by the Funds. Doing so may create conflicts of interest, including between investors in these Funds and our shareholders, since our investment strategy may be very similar to that of our Funds, and therefore many investment opportunities that are suitable for us may also be suitable for the Funds.
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We will earn a management fee for our services to our Funds. Our executives and other real estate and debt finance professionals may face conflicts of interest in allocating their time among NorthStar and our Funds. Although as a company we will seek to make these decisions in a manner that we believe is fair and consistent with the operative legal documents governing these investment vehicles, the transfer or allocation of these assets may give rise to investor dissatisfaction or litigation or regulatory enforcement actions. Appropriately dealing with conflicts of interest is complex and difficult and our reputation could be damaged if we fail, or appear to fail, to deal appropriately with one or more potential or actual conflicts of interest. Regulatory scrutiny of, or litigation in connection with, conflicts of interest would have a material adverse effect on our reputation which would materially adversely affect our business and our ability to attract investors for future vehicles.
Our ability to raise capital and attract investors in our Sponsored REITs is critical to their success and our ability to grow depends on our ability to attract a motivated sales force in our licensed broker dealer.
NSREIT and Senior Care REIT, together referred to as our Sponsored REITs, depend upon our ability to attract purchasers of equity interests, which is highly dependent upon the efforts of the motivated sales force of our subsidiary, NRF Capital Markets, LLC, or NRF Capital Markets. NRF Capital Markets is a FINRA member and a wholesale broker-dealer that is registered in the various jurisdictions in which our Funds will do business. Our ability to grow our Sponsored REITs will be dependent on our ability to retain and motivate our sales force and other key personnel and to strategically recruit, retain and motivate new talent. However, we may not be successful in our efforts to recruit, retain and motivate the required personnel as the market for qualified professionals is extremely competitive. If we do not retain a motivated and effective sales force, or our sales professionals join competitors or form competing companies, it could result in the loss of significant investment opportunities and possibly existing investors, which would have a material impact on our Sponsored REITs.
There is no assurance we will be able to enter into additional third-party selling agreement, and declines in asset value and reductions in distributions in our Sponsored REITs could cause the loss of such third-party selling agreements and limit our ability to sign future third-party selling agreements.
NRF Capital Markets has entered into, and we anticipate will enter into, third-party selling agreements in order to raise capital for our Sponsored REITs. There is no assurance that we will be able to enter into additional third-party selling agreements on reasonable terms, or at all, which would hinder or even cease our ability to raise capital for our Sponsored REITs. Additionally, significant declines in asset value and reductions in distributions in our Sponsored REITs could cause us to lose third-party selling agreements and limit our ability to sign future third-party selling agreements.
Misconduct by third-party selling broker-dealers or our sales force, could have a material adverse effect on our business.
We will rely on selling broker-dealers and our broker-dealer sales force to properly offer our securities programs to customers in compliance with our selling agreements and with applicable regulatory requirements. While these persons are responsible for their activities as registered broker-dealers, their actions may nonetheless result in complaints or legal or regulatory action against us.
Our organization and management of the Sponsored REITs could distract our management and have a negative effect on our business.
The organization and management of our Sponsored REITs could divert our management team's attention from our existing business to form and manage the operations and personnel of the Sponsored REITs and implement the business initiatives. Our management team could be required to spend significant time and financial resources on the Sponsored REITs, which could distract and
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prevent them from furthering our core business activities, regardless of the outcome of the Sponsored REITs. Consequently, this could have a negative effect on our business.
Because there are numerous companies seeking to raise capital through non-listed REITs, it may be more difficult for us to do so, particularly as a relatively new sponsor.
The number of entrants in the non-listed REIT space has grown significantly over the last couple of years. We have invested significant capital into the organization and management of our Sponsored REITs, and may in the future invest additional capital in other non-listed REIT products. Based on publicly available information, as of December 2010, there were approximately 60 non-listed REITs in the marketplace and 24 others have filed registration statements. As a result, we will be subject to significant competition from these and other companies seeking to raise capital in the non-listed REIT space. There can be no assurance that we will be able to compete successfully against current and future competitors and raise capital through our Sponsored REITs or recoup our invested capital.
The creation and management of Funds and other investment vehicles could require us to register with the SEC as an investment adviser under the Investment Advisers Act and subject us to costs and constraints that we are not currently subject to.
A consequence of creating and managing Funds and other investment vehicles, including CDO vehicles and Sponsored REITs, is that we may be required to register with the SEC as an investment adviser under the Investment Advisers Act. Registered investment advisers must establish policies and procedures for their operations and make regulatory filings. The Investment Advisers Act and the rules and regulations under this Act generally grant the SEC broad administrative powers, including, in some cases, the power to limit or restrict doing business for failure to comply with such laws and regulations. These laws and regulations have increased, and could further increase, our expenses and require us to devote substantial time and effort to legal and regulatory compliance issues. In addition, the regulatory environment in which investment advisors operate changes frequently and regulations have increased significantly in recent years. We may be adversely affected as a result of new or revised legislation or regulations or by changes in the interpretation or enforcement of existing laws and regulations.
Termination of management arrangements with one or more of our Funds could harm our business.
We provide management services to our existing Funds, and may in the future provide management services to any future funds, through our position as the sole or managing general partner of partnership funds, through our position as the operating manager of other fund entities, through our advisory agreements with our Sponsored REITs, or combinations thereof. Our arrangements are generally expected to be long-term, and frequently have no specified termination dates. However, our management arrangements with, or our position as general partner, operating manager or advisor of, a fund typically may be terminated by action taken by the investors or board of directors of the applicable vehicle. Upon any such termination, our management fees, after payment of any termination payments required, would cease, thereby reducing our expected revenues.
Difficult market conditions and the collapse of the CMBS market adversely affected our Securities Fund, which may impact our ability to raise capital for future Funds.
We managed an off-balance sheet fund, or our Securities Fund, which was formed in July 2007 and is expected to dissolve in early 2011. The deterioration of the capital markets, credit spread widening and corresponding lower mark-to-market adjustments to the assets in our Securities Fund contributed to its value decline and adversely affected the performance of our Securities Fund. Due to the foregoing, raising capital for future Funds could be more difficult.
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There are risks in using prime brokers and custodians.
Our Funds may depend on the services of prime brokers and custodians to carry out certain transactions. In the event of the insolvency of a prime broker and/or custodian, our Funds might not be able to recover equivalent assets in full as they will rank among the prime broker and custodian's unsecured creditors in relation to assets which the prime broker or custodian borrows, lends or otherwise uses. In addition, the Funds' cash held with a prime broker or custodian will not be segregated from the prime broker's or custodian's own cash, and the Funds will therefore rank as unsecured creditors in relation thereto.
Our failure to maintain registration as a broker-dealer member in the various jurisdictions in which we will do business and increased supervision and regulation of broker-dealers under Dodd-Frank could have a material adverse effect on our business, financial condition, liquidity and results of operations.
NRF Capital Markets is a FINRA member broker-dealer that is registered in the various jurisdictions in which our Funds will do business. Our continued membership and registration is contingent upon compliance with regulatory guidelines. There is no guarantee that FINRA, the SEC or the states or territories in which we are registered will not take action against NRF Capital Markets to remove its membership and/or registrations. Accordingly, such events would delay or potentially hinder sales of our Sponsored REITs' securities.
In addition, the recently enacted Dodd-Frank calls for imposition of expanded standards of care by financial market participants in dealing with clients and consumers, including by providing the SEC with authority to adopt rules establishing fiduciary duties for broker-dealers and directing the SEC to examine and improve sales practices and disclosure by broker-dealers and investment advisers. The increased supervision and regulation of broker-dealers are expected to increase our expenses and require NRF Capital Markets to devote more time and effort to compliance issues.
Government intervention may limit our ability to continue to implement certain strategies or manage certain risks.
The pervasive and fundamental disruptions that the global financial markets underwent beginning in 2007 led to extensive and unprecedented governmental intervention, including the Emergency Economic Stabilization Act of 2008, in October 2008, which gave the U.S. Treasury Secretary the authority to use up to $700 billion to, among other things, inject capital into financial institutions and establish a program to purchase from financial institutions residential or commercial real estate loans and other securities, TALF, in November 2008, which allowed the Federal Reserve Bank of New York to provide non-recourse loans to borrowers to fund their purchase of eligible assets, which initially included asset-backed securities but was later expanded to include CMBS and non-Agency residential mortgage-based securities, or RMBS, and, most recently, the Dodd-Frank Wall Street Reform and Consumer Protection Act, in July 2010, which outlined broad policies for the US financial services industry.
Such intervention has also in certain cases been implemented on an "emergency" basis, suddenly and substantially eliminating market participants' ability to continue to implement certain strategies or manage the risk of their outstanding positions. It is impossible to predict what, if any, additional interim or permanent governmental restrictions may be imposed on the markets and the effect of such restrictions on us and our results of operations. There is a high likelihood of significantly increased regulation of the financial markets that could have an impact on our operating results and financial condition.
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Our ability to operate our business successfully would be harmed if key personnel terminate their employment with us.
Our future success depends, to a significant extent, upon the continued services of our key personnel, including David Hamamoto, Andrew Richardson, Albert Tylis and Daniel Gilbert, our executive officers, and Mr. Hamamoto in particular. For instance, the extent and nature of the experience of our executive officers and nature of the relationships they have developed with real estate developers and financial institutions are critical to the success of our business. Our executive officers have significant real estate investment experience. We cannot assure you of their continued employment with us. On February 25, 2011, Mr. Richardson, our Chief Financial Officer, Executive Vice President and Treasurer, resigned effective as of March 27, 2011. The loss of services of certain of our executive officers could harm our business and our prospects.
Our Board of Directors has and will likely in the future adopt certain incentive plans to create incentives that will allow us to retain and attract the services of key employees. These incentive plans may be tied to the performance of our common stock and as a result of the decline in our stock price, we may be unable to motivate and retain our management and these other employees. Our inability to motivate and retain these individuals could also harm our business and our prospects. Additionally, competition for experienced real estate professionals could require us to pay higher wages and provide additional benefits to attract qualified employees, which could result in higher compensation expenses to us.
David Hamamoto, a founder of the Company, has been our Chairman since October 2007 and one of our directors, our President and our Chief Executive Officer since October 2004. Mr. Hamamoto's employment agreement since we became a public company provides that he will devote not less than a majority of his business time, attention and energies to the performance of the duties assigned to him as our Chief Executive Officer and President. Mr. Hamamoto has informed us that he is in discussions with Morgans Hotel Group Co. (a public global hotel management and ownership company focused on the boutique sector), where he has devoted a significant amount of his business time, attention and energies and has served as their Chairman since their initial public offering in February 2006, to become their Executive Chairman. Mr. Hamamoto is also a member of the Investment Committee of Morgans Hotel Group Co. Mr. Hamamoto has informed us that any final decision by him to assume a role as Executive Chairman of Morgans Hotel Group Co. will be made after consultation with the Company's Board of Directors. Regardless of the outcome of those discussions, Mr. Hamamoto will continue with his duties as our Chairman, Chief Executive Officer and President and will continue to devote a majority of his business time, attention and energies to the performance of those duties for us.
Our ability to issue equity awards to employees as compensation could be impacted, which will require greater cash compensation in relation to previous levels of cash compensations.
We have historically paid a substantial portion of our overall compensation in the form of equity awards. Currently, we do not necessarily have availability under our incentive plans to issue equity awards to our employees. We will likely seek shareholder approval for additional equity awards, but in the meantime we will likely compensate our employees in a greater proportion of cash compared to equity awards. Because adjusted funds from operations, or AFFO, excludes equity based compensation expense, payment of higher levels of cash relative to equity awards will have a negative impact on our AFFO and reduce our liquidity position. Additionally, the lack of availability of equity awards could impact our ability to retain employees as equity awards historically have been a significant component of our long-term incentives.
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If our risk management systems are ineffective, we may be exposed to material unanticipated losses.
We continue to refine our risk management techniques, strategies and assessment methods. However, our risk management techniques and strategies may not fully mitigate the risk exposure of our operations in all economic or market environments, or against all types of risk, including risks that we might fail to identify or anticipate. Any failures in our risk management techniques and strategies to accurately quantify such risk exposure could limit our ability to manage risks in our operations or to seek adequate risk-adjusted returns. See "Management Discussion and Analysis of Financial Condition and Results of Operations—Risk Management".
The use of estimates and valuations may be different from actual results, which could have a material effect on our consolidated financial statements.
We make various estimates that affect reported amounts and disclosures. Broadly, those estimates are used in measuring the fair value of certain financial instruments, accounting for goodwill, establishing provisions for potential losses that may arise from loans that we make and potential litigation liability. Although the credit and equity markets are continuing to improve, market volatility experienced between mid-2007 and 2009 has made it extremely difficult to value certain of our real estate securities and CDO debt. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values of these securities in future periods. In addition, at the time of any sales and settlements of these securities, the price we ultimately realize will depend on the demand and liquidity in the market at that time and may be materially lower than our estimate of their current fair value. Estimates are based on available information and judgment. Therefore, actual values and results could differ from our estimates and that difference could have a material effect on our consolidated financial statements.
We believe AFFO is an appropriate measure of our operating performance; however, in certain instances AFFO may not be reflective of actual economic results.
We utilize AFFO as a measure of our operating performance and believe that it is useful to investors because it facilitates an understanding of our operating performance after adjustment for certain non-cash expenses, such as real estate depreciation, equity based compensation and unrealized gains/losses from mark-to-market adjustments. Additionally, we believe that AFFO serves as a good measure of our operating performance because it facilitates evaluation of our company without the effects of selected items required in accordance with accounting principles generally accepted in the United States, or GAAP, that may not necessarily be indicative of current operating performance and that may not accurately compare our operating performance between periods. Nonetheless, in certain instances AFFO may not necessarily be reflective of our actual economic results. For example, if a CMBS position that we purchased at par in a given year is marked down at the end of such year and then sold the subsequent year at a price above the marked down price, but less than par, we would still have a gain for purposes of AFFO between the difference of the year-end mark and the amount that we sold the CMBS for, even though we would have suffered an economic loss on the CMBS position. Our book value would, however, accurately reflect the economic loss because the decrease in value of the CMBS investment in its year of purchase would have been recorded as an unrealized loss in our income statement. Conversely, if we repurchase, for example, one of our issued CDO bonds for 50% of par in a given year and if such CDO bond were marked below 50% of par at the end of the previous year, for AFFO purposes we would recognize a realized loss on retirement of debt from the repurchase even though there is a positive economic impact to the retirement of the debt. Consistent with the prior example, while our book value would properly reflect the economic benefit from the debt repurchase because the decrease in value of the debt would have been recorded as an unrealized gain in the prior year, the impact to AFFO would not be reflective of actual economic results.
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Accounting for assets acquired subject to CDO financing may not be reflective of actual economic results.
U.S. GAAP requires that we record acquired assets and liabilities, including assets and liabilities of CDOs, at their fair market values as of the acquisition date. In July 2010, we were delegated the collateral management and special servicing rights, and acquired the original below-investment grade notes, of a $1.1 billion commercial real estate loan CDO for $7 million. The assets acquired and liabilities assumed were recorded at their then fair market values. Even though we acquired the most junior certificated notes in the CDO that as of the acquisition date were, and continue to be, non-cash flowing, U.S. GAAP requires that we consolidate the assets and liabilities underlying the notes, and treat each asset and outstanding note as separate and distinct from each other. All of the loans acquired and CDO note liabilities assumed were recorded at discounts to their outstanding principal balances. Going forward, the acquisition discounts on the loans are accreted as non-cash interest income to the estimated recovery values of the loans. We elected to fair value the CDO note liabilities assumed, therefore cash interest expense from the liabilities is recorded as interest expense, and inter-period changes in market value of the liabilities are recorded as unrealized gains (losses). This results in the recognition in our income statement of cash and non-cash interest income from the loans, and interest expense and unrealized gain/loss mark-to-market adjustments of the liabilities. This accounting may result in our recognition of net income from the CDO well in excess of the actual net interest margin generated, and our AFFO may be different than GAAP net income because AFFO excludes unrealized gains and losses from mark-to-market adjustments. Furthermore, while we may have significant GAAP net income and corresponding AFFO as well as operating cash flows, we may not be receiving any cash distributions from our acquired notes. Instead, such cash would be used to amortize the issued liabilities. Also, the portion of interest income recognized from amortization of the acquisition discounts on the loans may never be realized because the face amount of the CDO note liabilities issued may ultimately be greater than amounts recovered from the assets.
For 2010, we recognized $67.2 million of interest income ($26.9 million cash and $40.3 million non-cash accretion), $4.0 million of cash interest expense and $113.1 million of unrealized losses relating to the acquired CDO. AFFO and net loss from the CDO were $76.2 million and $33.2 million, respectively, for 2010.
AFFO includes realized gains on items such as extinguishment of debt and sales of real estate securities, which we may not be able to replicate in the future.
Historically, in addition to interest income that we earn on our assets, for purposes of AFFO we have also realized gains on extinguishing our debt and CDO bonds, and from the sales of real estate securities. In 2010, extinguishment of debt gains and gains on the sale of real estate securities were $134.6 million, representing AFFO per share of $1.62. Replicating these gains may not be possible, which could significantly impact our AFFO in the future. If we are unable to generate substantial gains in order to increase our AFFO, our stock price could be negatively impacted, which could have a material adverse effect on us.
GAAP requirements and our mark-to-market adjustments of our liabilities do not necessarily provide a precise economic reflection of our shareholders' equity.
We have elected to mark-to-market our liabilities in our real estate CDOs, but we do not mark-to-market the corresponding loans, which we hold at par net of any related credit loss reserves. Even if these loans are performing, because of a number of factors, including credit spread widening and concerns over commercial real estate generally, a third-party may not be willing to pay par for such loans. Therefore, our carrying value for these loans is likely above their current economic value. Additionally, while we have liabilities that are marked below the principal amount that we owe on such liabilities, which correspondingly increases our shareholders' equity, absent repurchasing such liabilities at a discount we will be required to repay the full par amount of such liabilities at maturity or upon a liquidation of the underlying collateral or our company. As a result of the foregoing, our shareholders'
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equity is and will likely continue to not necessarily be reflective of current economic or liquidation value.
Our dividend policy is subject to change.
On a quarterly basis, our Board of Directors determines an appropriate common stock dividend based upon numerous factors, including REIT qualification requirements, the amount of cash flows provided by operating activities, availability of existing cash balances, borrowing capacity under existing credit agreements, access to cash in the capital markets and other financing sources, our view of our ability to realize gains in the future through appreciation in the value of our assets, general economic conditions and economic conditions that more specifically impact our business or prospects. Although we have significantly reduced our dividends in 2009 and 2010 relative to prior years, future dividend levels are subject to further adjustment based upon any one or more of the risk factors set forth in this Form 10-K/A, as well as other factors that our Board of Directors may, from time to time, deem relevant to consider when determining an appropriate common stock dividend.
We are highly dependent on information systems, and systems failures could significantly disrupt our business.
As a financial services firm, our business is highly dependent on communications and information systems. Any failure or interruption of our systems could cause delays or other problems in our activities, which could have a material adverse effect on our financial performance.
Maintenance of our Investment Company Act exemption imposes limits on our operations.
We conduct our operations so that we are not required to register as an investment company under the Investment Company Act. Section 3(a)(1)(C) of the Investment Company Act defines as an investment company any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer's total assets (exclusive of government securities and cash items) on an unconsolidated basis. Excluded from the term "investment securities," among other things, are securities issued by majority owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. Because we are a holding company that conducts its businesses through subsidiaries, the securities issued by our subsidiaries that rely on the exception from the definition of "investment company" in Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we may own directly, may not have a combined value in excess of 40% of the value of our total assets on an unconsolidated basis. This requirement limits the types of businesses in which we may engage through these subsidiaries.
We believe that neither our operating partnership nor the subsidiary REIT through which we hold the substantial majority of our investments are investment companies because each of them satisfy the 40% test of Section 3(a)(1)(C). We must monitor their holdings to ensure that the value of their investment securities does not exceed 40% of their respective total assets (exclusive of government securities and cash items) on an unconsolidated basis. Certain of our other subsidiaries do not satisfy the 40% test, but instead rely on exceptions and exemptions from registration as an investment company under the Investment Company Act that either limits the types of assets these subsidiaries may purchase or the manner in which these subsidiaries may acquire and sell assets. For instance, certain of our CDOs rely on the exemption from registration as an investment company under the Investment Company Act provided by Rule 3a-7 thereunder, which is available for certain structured financing vehicles. This exemption limits the ability of these CDOs to sell their assets and reinvest the proceeds from asset sales. Our subsidiary that invests in net lease properties relies on the exception from the definition of "investment company" provided by Sections 3(c)(6) and 3(c)(5)(C) of the Investment Company Act, and certain of our other CDOs similarly rely on the 3(c)(5)(C) exception
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from the definition of "investment company." These provisions exempt companies that primarily invest in real estate, mortgages and certain other qualifying real estate assets. When a CDO relies on the exception from the definition of "investment company" provided by 3(c)(5)(C) of the Investment Company Act, the CDO is limited in the types of real estate related assets that it could invest in. Our subsidiaries that engage in operating businesses and satisfy the 40% test are also not subject to the Investment Company Act.
If the combined value of the investment securities issued by our subsidiaries that rely on the exception provided by Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we may own directly exceeds 40% of our total assets on an unconsolidated basis, we may be deemed to be an investment company. If we fail to maintain an exemption, exception or other exclusion from registration as an investment company, we could, among other things, be required either (a) to substantially change the manner in which we conduct our operations to avoid being required to register as an investment company or (b) to register as an investment company, either of which could have an adverse effect on us and the market price of our common stock. If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to diversification and industry concentration and other matters.
Maryland takeover statutes may prevent a change of our control. This could depress our stock price.
Under Maryland law, "business combinations" between a Maryland corporation and an interested stockholder or an affiliate of an interested stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. An interested stockholder is defined as any person who beneficially owns 10% or more of the voting power of the corporation's shares or an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding voting stock of the corporation. A person is not an interested stockholder under the statute if the Board of Directors approved in advance the transaction by which he otherwise would have become an interested stockholder. However, in approving a transaction, the Board of Directors may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by the board.
After the five-year prohibition, any business combination between the Maryland corporation and an interested stockholder generally must be recommended by the Board of Directors of the corporation and approved by the affirmative vote of at least 80% of the votes entitled to be cast by holders of outstanding shares of voting stock of the corporation; and two-thirds of the votes entitled to be cast by holders of voting stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder.
These super-majority vote requirements do not apply if the corporation's common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form previously paid by the interested stockholder for its shares.
The business combination statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer, including potential acquisitions that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders. The statute permits various exemptions from its provisions, including business combinations that are exempted by the Board of Directors prior to the time that the interested stockholder becomes an
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interested stockholder. Pursuant to the statute, our Board of Directors has exempted any business combinations between us and any person, provided that any such business combination is first approved by our Board of Directors (including a majority of our directors who are not affiliates or associates of such person). Consequently, the five-year prohibition and the super-majority vote requirements do not apply to business combinations between us and any of them. As a result, such parties may be able to enter into business combinations with us that may not be in the best interest of our stockholders, without compliance with the supermajority vote requirements and the other provisions in the statute.
Our authorized but unissued common and preferred stock and other provisions of our charter and bylaws may prevent a change in our control.
Our charter authorizes us to issue additional authorized but unissued shares of our common stock or preferred stock and authorizes our board, without stockholder approval, to amend our charter to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we have the authority to issue. In addition, our Board of Directors may classify or reclassify any unissued shares of common stock or preferred stock and may set the preferences, rights and other terms of the classified or reclassified shares. Our board could establish a series of common stock or preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for the common stock or otherwise be in the best interest of our stockholders.
Our charter and bylaws also contain other provisions that may delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Maryland law also allows a corporation with a class of equity securities registered under the Securities Exchange Act of 1934, as amended, or the Securities Exchange Act, and at least three independent directors to elect to be subject, by provision in its charter or bylaws or a resolution of its Board of Directors and notwithstanding any contrary provision in the charter or bylaws, to a classified board, unless its charter prohibits such an election. Our charter contains a provision prohibiting such an election to classify our board under this provision of Maryland law. This makes us more vulnerable to a change in control. If our stockholders voted to amend this charter provision and to classify our Board of Directors, the staggered terms of our directors could reduce the possibility of a tender offer or an attempt at a change in control even though a tender offer or change in control might be in the best interests of our stockholders.
Risks Related to Our REIT Tax Status
Our failure to qualify as a REIT would subject us to federal income tax and reduce cash available for distribution to our stockholders.
We intend to continue to operate in a manner so as to qualify as a REIT for federal income tax purposes. However, qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only a limited number of judicial and administrative interpretations exist. Even an inadvertent or technical mistake could jeopardize our REIT status. Our continued qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis.
Moreover, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT. If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of, and trading prices for, our stock.
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We hold a substantial majority of our assets in a majority owned subsidiary, which we refer to as our private REIT. Our private REIT is organized to qualify as a REIT for federal income tax purposes. Additionally, we have sponsored and manage, through our private REIT, additional subsidiaries that intend to qualify as REITs. Our private REIT and its REIT subsidiaries must also meet all of the REIT qualification tests under the Internal Revenue Code and are subject to all of the same risks as us. If our private REIT or one of its REIT subsidiaries did not qualify as a REIT, it is likely that we would also not qualify as a REIT. If, for any reason, we failed to qualify as a REIT and we were not entitled to relief under certain Internal Revenue Code provisions, we would be unable to elect REIT status for the four taxable years following the year during which we ceased to so qualify.
Complying with REIT requirements may force us to borrow funds to make distributions to stockholders or otherwise depend on external sources of capital to fund such distributions.
To qualify as a REIT, we are required to distribute annually at least 90% of our taxable income, subject to certain adjustments, to our stockholders. To the extent that we satisfy the distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we may elect to retain and pay income tax on our net long-term capital gain. In that case, a shareholder would be taxed on its proportionate share of our undistributed long-term gain and would receive a credit or refund for its proportionate share of the tax we paid. A shareholder, including a tax-exempt or foreign shareholder, would have to file a federal income tax return to claim that credit or refund. Furthermore, we will be subject to a 4% nondeductible excise tax if the actual amount that we distribute to our stockholders in a calendar year is less than a minimum amount specified under federal tax laws. We anticipate that distributions generally will be taxable as ordinary income, although a portion of such distributions may be designated by us as long-term capital gain to the extent attributable to capital gain income recognized by us, or may constitute a return of capital to the extent that such distribution exceeds our earnings and profits as determined for tax purposes.
From time to time, we may generate taxable income greater than our net income for financial reporting purposes due to, among other things, amortization of capitalized purchase premiums, mark-to-market adjustments and reserves. In addition, our taxable income may be greater than our cash flow available for distribution to stockholders as a result of, among other things, repurchases of our outstanding debt at a discount and investments in assets that generate taxable income in advance of the corresponding cash flow from the assets (for example, if a borrower defers the payment of interest in cash pursuant to a contractual right or otherwise).
We believe that our operating partnership properly elected to defer, under section 108(i) of the Internal Revenue Code, the recognition of cancellation of indebtedness, or COD, income generated from repurchasing its debt at a discount. If the Internal Revenue Service, or IRS, successfully challenges our operating partnership's ability to make that election, we may be treated as having failed to pay sufficient dividends to satisfy the 90% distribution requirement and/or avoid the corporate income tax and the 4% nondeductible excise tax. We may be required to correct any failure to meet the 90% distribution requirement by paying deficiency dividends to our stockholders and an interest charge to the IRS in a later year.
If we do not have other funds available in the situations described in the preceding paragraphs, we could be required to borrow funds on unfavorable terms, sell investments at disadvantageous prices or find another alternative source of funds to make distributions sufficient to enable us to distribute enough of our taxable income to satisfy the REIT distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year. These alternatives could increase our costs or reduce our equity.
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Because of the distribution requirement, it is unlikely that we will be able to fund all future capital needs, including capital needs in connection with investments, from cash retained from operations. As a result, to fund future capital needs, we likely will have to rely on third-party sources of capital, including both debt and equity financing, which may or may not be available on favorable terms or at all. Our access to third-party sources of capital will depend upon a number of factors, including the market's perception of our growth potential and our current and potential future earnings and cash distributions and the market price of our stock.
We may distribute our common stock in a taxable dividend, in which case stockholders may sell shares of our common stock to pay tax on such dividends, placing downward pressure on the market price of our common stock.
We may distribute taxable dividends that are payable in cash and common stock. Under IRS Revenue Procedure 2010-12 up to 90% of any such taxable dividend paid with respect to our 2011 taxable year could be payable in shares of our common stock. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of our current and accumulated earnings and profits, as determined for federal income tax purposes. As a result, stockholders may be required to pay income tax with respect to such dividends in excess of the cash dividends received. If a U.S. stockholder sells the common stock that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our common stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. federal income tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in common stock. If we utilize Revenue Procedure 2010-12 and a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common stock.
We could fail to qualify as a REIT if the IRS successfully challenges our treatment of our mezzanine loans and repurchase agreements.
We intend to continue to operate in a manner so as to qualify as a REIT for federal income tax purposes. However, qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only a limited number of judicial and administrative interpretations exist. If the IRS disagrees with the application of these provisions to our assets or transactions, including assets we have owned and past transactions, our REIT qualification could be jeopardized. For example, IRS Revenue Procedure 2003-65 provides a safe harbor pursuant to which a mezzanine loan, if it meets each of the requirements contained in the revenue procedure, will be treated by the IRS as a real estate asset for purposes of the REIT asset tests, and interest derived from it will be treated as qualifying mortgage interest for purposes of the REIT 75% income test. Although the Revenue Procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. Moreover, our mezzanine loans typically do not meet all of the requirements for reliance on this safe harbor. We have invested, and will continue to invest, in mezzanine loans in a manner that we believe will enable us to continue to satisfy the REIT gross income and asset tests. In addition, we have entered into sale and repurchase agreements under which we nominally sold certain of our mortgage assets to a counterparty and simultaneously entered into an agreement to repurchase the sold assets. We believe that we will be treated for federal income tax purposes as the owner of the mortgage assets that are the subject of any such agreement notwithstanding that we transferred record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we did not own the mortgage assets during the term of the sale and repurchase agreement, in which case our ability to qualify as a REIT could be adversely affected. Even if the IRS were to disagree with one or more of our interpretations and we were treated as having failed to satisfy one of the REIT qualification requirements, we could maintain our REIT qualification
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if our failure was excused under certain statutory savings provisions. However, there can be no guarantee that we would be entitled to benefit from those statutory savings provisions if we failed to satisfy one of the REIT qualification requirements, and even if we were entitled to benefit from those statutory savings provisions, we could be required to pay a penalty tax.
Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.
Even if we remain qualified for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from certain activities conducted as a result of a foreclosure, the federal alternative minimum tax and state or local income, property and transfer taxes, such as mortgage recording taxes. Any of these taxes would decrease cash available for distribution to our stockholders. In addition, in order to meet the REIT qualification requirements, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or inventory, we may hold some of our assets through taxable subsidiary corporations.
Complying with REIT requirements may cause us to forego otherwise attractive opportunities or liquidate otherwise attractive investments.
To qualify as a REIT for federal income tax purposes we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. As discussed above, we may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. Additionally, we may be unable to pursue investments that would be otherwise attractive to us in order to satisfy the source of income requirements for qualifying as a REIT.
We must also ensure that at the end of each calendar quarter at least 75% of the value of our assets consists of cash, cash items, government securities and qualified real estate assets. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets can consist of the securities of any one issuer (other than government securities and qualified real estate assets), and no more than 25% of the value of our total securities can be represented by securities of one or more taxable REIT subsidiaries. If we fail to comply with these requirements at the end of any calendar quarter, we must correct such failure within 30 days after the end of the calendar quarter to avoid losing our REIT status and suffering adverse tax consequences, unless certain relief provisions apply. As a result, compliance with the REIT requirements may hinder our ability to operate solely on the basis of profit maximization and may require us to liquidate or forego otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
Modifications of the terms of our mortgage loans, mezzanine loans and B-Notes and loans supporting our mortgage-backed securities in conjunction with reductions in the value of the real property securing such loans could cause us to fail to qualify as a REIT.
Our investments in mortgage loans, mezzanine loans and B-Notes and mortgage-backed securities have been and may continue to be materially affected by the weakened condition of the real estate market and the economy in general. As a result, many of the terms of our mortgage loans, mezzanine loans and B-Notes and the loans supporting our mortgage-backed securities have been modified and may in the future be modified to avoid foreclosure actions and for other reasons. Under the Internal Revenue Code, if the terms of a loan are modified in a manner constituting a "significant modification," such modification triggers a deemed exchange of the original loan for the modified loan.
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In general, under applicable Treasury Regulations, if a loan is secured by real property and other property and the highest principal amount of the loan outstanding during a taxable year exceeds the fair market value of the real property securing the loan determined as of (i) the date we agreed to acquire the loan or (ii) in the event of a significant modification, the date we modified the loan, then a portion of the interest income from such loan will not be qualifying income for purposes of the 75% gross income test, but will be qualifying income for purposes of the 95% gross income test. Although the law is not entirely clear, a portion of the loan will likely be a non-qualifying asset for purposes of the 75% asset test. The non-qualifying portion of such a loan would be subject to, among other requirements, the requirement that a REIT not hold securities possessing more than 10% of the total value of the outstanding securities of any one issuer, or the 10% Value Test.
The IRS recently issued Revenue Procedure 2011-16, which provides a safe harbor pursuant to which we will not be required to redetermine the fair market value of the real property securing a loan for purposes of the gross income and asset tests discussed above in connection with a loan modification that is (1) occasioned by a borrower default or (2) made at a time when we reasonably believe that the modification to the loan will substantially reduce a significant risk of default on the original loan. No assurance can be provided all of our loan modifications have or will qualify for the safe harbor in Revenue Procedure 2011-16. To the extent we significantly modify loans in a manner that does not qualify for that safe harbor, we will be required to redetermine the value of the real property securing the loan at the time it was significantly modified. In determining the value of the real property securing such a loan, we generally will not obtain third- party appraisals, but rather will rely on internal valuations. No assurance can be provided that the IRS will not successfully challenge our internal valuations. If the terms of our mortgage loans, mezzanine loans and B-Notes and loans supporting our mortgage backed securities are significantly modified in a manner that does not qualify for the safe harbor in Revenue Procedure 2011-16 and the fair market value of the real property securing such loans has decreased significantly, we could fail the 75% gross income test, the 75% asset test and/or the 10% Value Test. Unless we qualified for relief under certain Internal Revenue Code cure provisions, such failures could cause us to fail to qualify as a REIT.
Our ability to invest in distressed debt may be limited by our intention to maintain our qualification as a REIT.
We have and may in the future acquire distressed debt, including distressed mortgage loans, mezzanine loans, B-Notes and mortgage-backed securities. In general, under the applicable Treasury Regulations, if a loan is secured by real property and other property and the highest principal amount of the loan outstanding during a taxable year exceeds the fair market value of the real property securing the loan as of (i) the date we agreed to acquire the loan or (ii) in the event of a significant modification, the date we modified the loan, then a portion of the interest income from such a loan will not be qualifying income for purposes of the 75% gross income test, but will be qualifying income for purposes of the 95% gross income test. Although the law is not entirely clear, a portion of the loan will also likely be a non-qualifying asset for purposes of the 75% asset test. The non-qualifying portion of such a loan would be subject to, among other requirements, the 10% Value Test. The IRS recently issued Revenue Procedure 2011-16, which provides a safe harbor under which the IRS has stated that it will not challenge a REIT's treatment of a loan as being, in part, a qualifying real estate asset in an amount equal to the lesser of (1) the fair market value of the real property securing the loan determined as of the date the REIT committed to acquire the loan or (2) the fair market value of the loan on the date of the relevant quarterly REIT asset testing date. This safe harbor will help us comply with the REIT asset tests immediately following the acquisition of distressed debt. It will be less helpful if the value of the distressed debt increases over time. Under the safe harbor, when the current value of a distressed debt exceeds the fair market value of the real property that secures the debt, determined as of the date we committed to acquire the debt, the excess will be treated as a non-qualifying asset. Accordingly, an increasing portion of a distressed debt will be treated as a
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non-qualifying asset as the value of the distressed debt increases. Additionally, Revenue Procedure 2011-16 states that the IRS will treat distressed debt acquired by a REIT as producing in part non-qualifying income for the 75% gross income test. Specifically, Revenue Procedure 2011-16 indicates that interest income on distressed debt will be treated as qualifying income based on the ratio of (1) fair market value of the real property securing the debt determined as of the date we committed to acquire the debt and (2) the face amount of the debt (and not the purchase price or current value of the debt). The face amount of a distressed debt will typically exceed the fair market value of the real property securing the debt on the date we commit to acquire the debt. Because distressed debt that we acquire may produce a significant amount of non-qualifying income for purposes of the 75% gross income test and a significant portion of a distressed debt may be treated as a non-qualifying asset for the REIT asset tests once the debt increases in value, we may be limited in our ability to invest in distressed debt and maintain our qualification as a REIT.
Our investments in distressed debt may produce "phantom income" that will increase the amount of taxable income we have to distribute to satisfy the REIT distribution requirement and avoid corporate income and excise taxes, which may cause us to sell assets, borrow funds, or make taxable distributions of debt or equity securities to satisfy that requirement and avoid those taxes.
Our acquisition of distressed debt may cause us to recognize "phantom income" (or non-cash income) for federal income tax purposes. For example, if we acquire non-publicly traded distressed debt and then significantly modify that debt, we would recognize gain on the resulting deemed exchange equal to the difference between the adjusted issue price of the modified distressed debt and our adjusted tax basis in the unmodified distressed debt. Because we typically acquire distressed debt at a significant discount, our adjusted tax basis in the unmodified distressed debt typically is significantly lower than the adjusted issue price of the modified distressed debt. Accordingly, if we significantly modify non-publicly traded distressed debt, we may recognize a substantial amount of taxable income without receiving any cash. That "phantom income" will increase the amount of taxable income we are required to distribute to satisfy the REIT distribution requirement and avoid corporate income and excise taxes. To satisfy that requirement and avoid those taxes, we may have to sell assets or borrow funds at inopportune times or make taxable distributions of our debt or equity securities.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Internal Revenue Code may limit our ability to hedge our operations effectively. Our aggregate gross income from non-qualifying hedges, fees, and certain other non-qualifying sources cannot exceed 5% of our annual gross income. Additionally, our gross income from qualifying hedges entered into prior to July 31, 2008 constitutes non-qualifying income for purposes of the 75% gross income test. Consequently, our gross income from qualifying hedges entered into prior to July 31, 2008, along with other sources of non-qualifying income for purposes of the 75% gross income test, cannot exceed 25% of our annual gross income. As a result, we might have to limit our use of advantageous hedging techniques or implement those hedges through a taxable REIT subsidiary. Any hedging income earned by a taxable REIT subsidiary would be subject to federal, state and local income tax at regular corporate rates. This could increase the cost of our hedging activities or expose us to greater risks associated interest rate or other changes than we would otherwise incur.
We may fail to qualify as a REIT as a result of our fee income from managing certain structured finance and investment vehicles and our income from active businesses.
We currently manage certain structured finance and investment vehicles that are treated as taxable REIT subsidiaries or REITs. Fee income and active business income that we generate directly (rather than through a taxable REIT subsidiary) constitute non-qualifying income for purposes of the 95% and 75% gross income tests. It is not possible to predict with complete accuracy the amount of gross
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income that we will generate in any taxable year due to, among other things, fluctuations in interest rates. Accordingly, our qualifying income for purposes of our gross income tests may be lower than we anticipate, and, conversely, our fee income and active business income may be higher than we anticipate. If our fee income and active business income, combined with other sources of non-qualifying income, such as income from non-qualifying hedges, were to exceed 5% of our gross income, we would fail to satisfy the 95% gross income test. Unless we qualified for certain Internal Revenue Code cure provisions, a failure of the 95% gross income test would cause us to fail to qualify as a REIT.
Liquidation of assets may jeopardize our REIT status.
To continue to qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our mortgage, preferred equity or other investments to satisfy our obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our status as a REIT.
Adverse legislative or regulatory tax changes could reduce the market price of our common stock.
At any time, the federal income tax laws governing REITs or the administrative interpretations of those laws may be amended. Any of those new laws or interpretations may take effect retroactively and could adversely affect us or you as a stockholder. For example, legislation enacted in 2003, 2006 and 2010 generally reduced the federal income tax rate on most dividends paid by corporations to investors taxed at individual rates to a maximum of 15% through the end of 2012. REIT dividends, with limited exceptions, do not benefit from the rate reduction, because a REITs income is generally not subject to corporate level tax. As such, this legislation could cause shares in non-REIT corporations to be a more attractive investment to investors taxed at individual rates than shares in REITs and could have an adverse effect on the value of our stock.
The prohibited transactions tax may limit our ability to engage in transactions, including dispositions of assets and certain methods of securitizing loans, that would be treated as sales for federal income tax purposes.
A REIT's net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including loans, held primarily for sale to customers in the ordinary course of business. If we securitize loans in a manner that is, for federal income tax purposes, treated as a sale of the loans we may be subject to the prohibited transaction tax. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans and may limit the structures we utilize for our securitization transactions even though such sales or structures might otherwise be beneficial to us. Additionally, we may be subject to the prohibited transaction tax upon a disposition of real property. Although a safe-harbor to the characterization of the sale of real property by a REIT as a prohibited transaction is available, we cannot assure you that we can comply with the safe harbor or that we will avoid owning property that may be characterized as held primarily for sale to customers in the ordinary course of business. Consequently, we may choose not to engage in certain sales of real property or may conduct such sales through a taxable REIT subsidiary.
We may recognize substantial amounts of REIT taxable income, which we would be required to distribute to our stockholders, in a year in which we are not profitable under GAAP principles or other economic measures.
We may recognize substantial amounts of REIT taxable income in years in which we are not profitable under GAAP or other economic measures as a result of the differences between GAAP and tax accounting methods. For example, we may recognize substantial amounts of COD income for federal income tax purposes (but not for GAAP purposes) due to discount repurchases of our debt, which could cause our REIT taxable income to exceed our GAAP income. Additionally, we may deduct
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our capital losses only to the extent of our capital gains, and not against our ordinary income, in computing our REIT taxable income for a given taxable year. Finally, certain of our assets and liabilities are marked-to-market for GAAP purposes but not for tax purposes, which could result in losses for GAAP purposes that are not recognized in computing our REIT taxable income. Consequently, we could recognize substantial amounts of REIT taxable income, and would be required to distribute such income to our stockholders, in a year in which we are not profitable under GAAP principles or other economic measures.
We may lose our REIT status if the IRS successfully challenges our characterization of our income from our foreign taxable REIT subsidiaries.
We have elected to treat several Cayman Islands companies, including issuers in term debt transactions, as taxable REIT subsidiaries. We intend to treat certain income inclusions received with respect to our equity investments in those foreign taxable REIT subsidiaries as qualifying income for purposes of the 95% gross income test but not the 75% gross income test. Because there is no clear precedent with respect to the qualification of such income for purposes of the REIT gross income tests, no assurance can be given that the IRS will not assert a contrary position. In the event that such income was determined not to qualify for the 95% gross income test, we could be subject to a penalty tax with respect to such income to the extent it exceeds 5% of our gross income or we could fail to qualify as a REIT.
If our foreign taxable REIT subsidiaries are subject to U.S. federal income tax at the entity level, it would greatly reduce the amounts those entities would have available to distribute to us and that they would have available to pay their creditors.
There is a specific exemption from federal income tax for non-U.S. corporations that restrict their activities in the United States to trading stock and securities (or any activity closely related thereto) for their own account whether such trading (or such other activity) is conducted by the corporation or its employees through a resident broker, commission agent, custodian or other agent. We intend that our foreign taxable REIT subsidiaries will rely on that exemption or otherwise operate in a manner so that they will not be subject to U.S. federal income tax on their net income at the entity level. If the IRS were to succeed in challenging that tax treatment, it would greatly reduce the amount that those foreign taxable REIT subsidiaries would have available to pay to their creditors and to distribute to us.
The stock ownership restrictions of the Internal Revenue Code for REITs and the 9.8% stock ownership limit in our charter may inhibit market activity in our stock and restrict our business combination opportunities.
To qualify as a REIT, five or fewer individuals, as defined in the Internal Revenue Code, may not own, actually or constructively, more than 50% in value of our issued and outstanding stock at any time during the last half of a taxable year. Attribution rules in the Internal Revenue Code determine if any individual or entity actually or constructively owns our stock under this requirement. Additionally, at least 100 persons must beneficially own our stock during at least 335 days of a taxable year. To help insure that we meet these tests, our charter restricts the acquisition and ownership of shares of our stock.
Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our Board of Directors, no person, including entities, may own more than 9.8% of the value of our outstanding shares of stock or more than 9.8% in value or number (whichever is more restrictive) of our outstanding shares of common stock. The board may not grant an exemption from these restrictions to any proposed transferee whose ownership in excess of 9.8% of the value of our outstanding shares would result in the termination of our status as a REIT. Despite these restrictions, it is possible that there will be five or fewer individuals who own more than 50% in value of our outstanding shares, which could cause us to
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fail to qualify as a REIT. These restrictions on transferability and ownership will not apply, however, if our Board of Directors determines that it is no longer in our best interest to continue to qualify as a REIT.
These ownership limits could delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of the stockholders.
Our dividends that are attributable to excess inclusion income will likely increase the tax liability of our tax-exempt stockholders, foreign stockholders, and stockholders with net operating losses.
In general, dividend income that a tax-exempt entity receives from us should not constitute unrelated business taxable income as defined in Section 512 of the Internal Revenue Code. If we realize excess inclusion income and allocate it to our stockholders, however, then this income would be fully taxable as unrelated business taxable income to a tax-exempt entity under Section 512 of the Internal Revenue Code. A foreign stockholder would generally be subject to U.S. federal income tax withholding on this income without reduction pursuant to any otherwise applicable income tax treaty. U.S. stockholders would not be able to offset such income with their net operating losses.
Although the law is not entirely clear, the IRS has taken the position that we are subject to tax at the highest corporate rate on the portion of our excess inclusion income equal to the percentage of our stock held in record name by "disqualified organizations" (generally tax-exempt investors, such as certain state pension plans and charitable remainder trusts, that are not subject to the tax on unrelated business taxable income). To the extent that our stock owned by "disqualified organizations" is held in street name by a broker/dealer or other nominee, the broker/dealer or nominee would be liable for a tax at the highest corporate rate on the portion of our excess inclusion income allocable to the stock held on behalf of the "disqualified organizations." A regulated investment company or other pass-through entity owning our stock may also be subject to tax at the highest corporate tax rate on any excess inclusion income allocated to their record name owners that are "disqualified organizations."
Excess inclusion income could result if a REIT held a residual interest in a real estate mortgage investment conduit, or REMIC. In addition, excess inclusion income also may be generated if a REIT issues debt obligations with two or more maturities and the terms of the payments of these obligations bear a relationship to the payments that the REIT received on mortgage loans or mortgage-backed securities securing those debt obligations. Although we do not hold any REMIC residual interests, we anticipate that certain of the term debt transactions conducted by our private REIT will produce excess inclusion income that will be allocated to our stockholders. Accordingly, we expect that a portion of our dividends will constitute excess inclusion income, which will likely increase the tax liability of tax-exempt stockholders, foreign stockholders, stockholders with net operating losses, regulated investment companies and other pass-through entities whose record name owners are disqualified organizations, and brokers/dealers and other nominees who hold stock on behalf of disqualified organizations.
Item 1B. Unresolved Staff Comments
Not applicable.
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Our investments in net lease properties, which comprise our net lease business segment, are described under "Business—Net Lease." The following table sets forth certain information with respect to each of our net lease properties and real estate owned (or "REO") properties as of December 31, 2010:
Property Information:
Location City, State | Square Feet | Rent per square ft.($)(1) | Number of Buildings | Ownership Interest | Type | Leasehold Expiration Date | Lease/ Sublease Expiration Date | Encumbrances (In Thousands $) | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Bloomingdale, IL | 50,000 | $ | 10.50 | 1 | Leasehold | Retail | Jan-27 | Jan-22 | $ | 5,599 | ||||||||||||
Concord Holdings, NH | 50,000 | 11.25 | 1 | Fee | Retail | N/A | May-16 | 5,836 | ||||||||||||||
| 20,087 | 12.75 | 1 | Fee | Retail | N/A | Jan-16 | 2,344 | |||||||||||||||
Fort Wayne, IN | 50,000 | 18.50 | 1 | Leasehold | Retail | Jan-25 | Aug-24 | 3,313 | ||||||||||||||
Keene, NH | 45,471 | 15.20 | 1 | Fee | Retail | N/A | Oct-20 | 6,588 | ||||||||||||||
Melville, NY | 46,533 | 8.75 | 1 | Leasehold | Retail | Jan-22 | Jan-22 | 4,344 | ||||||||||||||
Millbury, MA | 54,175 | 8.49 | 1 | Leasehold | Retail | Jan-24 | Jan-24 | 4,617 | ||||||||||||||
New York, NY | 7,500 | 92.57 | 1 | Leasehold | Retail | Dec-12 | Dec-12 | — | ||||||||||||||
North Attleboro, MA | 50,025 | 8.62 | 1 | Leasehold | Retail | Jan-24 | Jan-24 | 4,599 | ||||||||||||||
Portland, ME | 52,900 | 15.66 | 1 | Leasehold | Retail | Aug-30 | Aug-23 | 4,466 | ||||||||||||||
Wichita, KS | 48,782 | 11.61 | 1 | Fee | Retail | N/A | Mar-23 | 5,985 | ||||||||||||||
Total Retail | 475,473 | $ | 13.35 | 11 | $ | 47,691 | ||||||||||||||||
Auburn Hills, MI | 50,000 | $ | 11.91 | 1 | Fee | Office | N/A | Sep-15 | $ | 5,306 | ||||||||||||
| 55,692 | 13.81 | 1 | Fee | Office | N/A | Sep-15 | 5,910 | |||||||||||||||
Aurora, CO | 183,529 | 17.74 | 1 | Fee | Office | N/A | Jun-15 | 32,583 | ||||||||||||||
Camp Hill, PA | 214,150 | 12.62 | 1 | Fee | Office | N/A | Sep-15 | 24,332 | ||||||||||||||
Columbus, OH | 199,112 | 11.70 | 1 | Fee | Office | N/A | Nov-17 | 23,239 | ||||||||||||||
Fort Mill, SC | 165,000 | 12.78 | 1 | Fee | Office | N/A | Oct-20 | 30,182 | ||||||||||||||
Milpitas, CA | 180,481 | 14.89 | 2 | Fee | Office | N/A | Feb-17 | 21,638 | ||||||||||||||
Indianapolis, IN | 333,600 | 7.29 | 1 | Fee | Office/Flex | N/A | Dec-25 | 27,790 | ||||||||||||||
New York, NY | 17,665 | 55.52 | 1 | Leasehold | Retail/Office | July-15 | June 2011 - Jul 16 | — | ||||||||||||||
Rancho Cordova, CA | 68,000 | 22.89 | 1 | Fee | Office | N/A | Sep-15 | 10,670 | ||||||||||||||
Rockaway, NJ | 15,038 | 7.61 | 1 | Fee | Office | N/A | May-15 | 2,098 | ||||||||||||||
| 106,000 | 15.51 | Fee | Office | N/A | Jul-17 | 14,786 | ||||||||||||||||
Salt Lake City, UT | 117,553 | 19.70 | 1 | Fee | Office | N/A | Apr-12 | 15,059 | ||||||||||||||
Cincinnati, OH | 139,264 | 2.05 | 1 | Fee | Office | N/A | Mar-10 | 15,686 | ||||||||||||||
| 173,145 | — | 1 | Fee | Office | N/A | Dec-09 | 19,208 | |||||||||||||||
| 174,554 | 13.19 | 1 | Fee | Office | N/A | Dec-15 | 16,586 | |||||||||||||||
Total Office | 2,192,783 | $ | 11.89 | 16 | $ | 265,073 | ||||||||||||||||
Black Mountain, NC | 36,235 | $ | 19.47 | 1 | Fee | Healthcare | N/A | Jul-21 | $ | 5,296 | ||||||||||||
Blountstown, FL | 33,722 | 18.03 | 1 | Fee | Healthcare | N/A | Jul-21 | 3,871 | ||||||||||||||
Bremerton, WA | 68,601 | 16.87 | 1 | Fee | Healthcare | N/A | Oct-21 | 7,275 | ||||||||||||||
Caroltton, GA | 49,000 | 10.51 | 1 | Fee | Healthcare | N/A | Jan-17 | 2,951 | ||||||||||||||
Castletown, IN | 46,026 | 19.21 | 1 | Fee | Healthcare | N/A | Jun-16 | 6,669 | ||||||||||||||
Charleston, IL | 39,393 | 10.20 | 1 | Fee | Healthcare | N/A | Jan-17 | 5,846 | ||||||||||||||
Chesterfield, IN | 19,062 | 25.93 | 1 | Fee | Healthcare | N/A | Jun-17 | 3,989 | ||||||||||||||
Cincinnati, OH | 69,806 | 28.40 | 1 | Fee | Healthcare | N/A | Jan-17 | 11,397 | ||||||||||||||
Clemmons, NC | 30,929 | 21.12 | 1 | Fee | Healthcare | N/A | Apr-22 | 2,156 | ||||||||||||||
Clinton, OK | 31,377 | 0.20 | 1 | Fee | Healthcare | N/A | Jan-17 | 1,334 | ||||||||||||||
Columbia City, IN | 22,395 | 42.97 | 1 | Fee | Healthcare | N/A | Jun-17 | 7,909 | ||||||||||||||
Daly City, CA | 26,262 | 23.13 | 1 | Fee | Healthcare | N/A | Aug-21 | 4,797 | ||||||||||||||
| 78,482 | 18.15 | 1 | Leasehold | Healthcare | Aug-21 | Aug-21 | 11,244 | |||||||||||||||
Denmark, WI | 8,320 | 18.18 | 1 | Fee | Healthcare | N/A | Jan-17 | 1,201 | ||||||||||||||
Dunkirk, IN | 19,140 | 13.05 | 1 | Fee | Healthcare | N/A | Jun-17 | 2,087 | ||||||||||||||
East Arlington, TX | 26,552 | 7.23 | 1 | Fee | Healthcare | N/A | Dec-13 | 3,349 | ||||||||||||||
Effingham, IL | 7,808 | 16.03 | 1 | Fee | Healthcare | N/A | Jan-17 | 547 | ||||||||||||||
| 39,393 | 18.46 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,601 | |||||||||||||||
Elk City, OK | 51,989 | 7.70 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,341 | ||||||||||||||
Fairfield, IL | 39,393 | 15.25 | 1 | Fee | Healthcare | N/A | Jan-17 | 6,402 | ||||||||||||||
Fort Wayne, IN | 31,500 | 18.50 | 1 | Fee | Healthcare | N/A | Jun-17 | 4,792 | ||||||||||||||
Franklin, WI | 27,556 | 19.83 | 1 | Fee | Healthcare | N/A | Jan-17 | 6,272 | ||||||||||||||
Fullerton, CA | 5,500 | 25.28 | 1 | Fee | Healthcare | N/A | Jan-17 | 779 | ||||||||||||||
Fullerton, CA | 26,200 | 27.22 | 1 | Fee | Healthcare | N/A | Jan-17 | 7,575 | ||||||||||||||
Garden Grove, CA | 26,500 | 46.64 | 1 | Fee | Healthcare | N/A | Jan-17 | 11,168 | ||||||||||||||
Green Bay, WI | 23,768 | 16.83 | 1 | Fee | Healthcare | N/A | Jan-17 | 3,127 | ||||||||||||||
Grove City | 20,672 | 15.66 | 1 | Fee | Healthcare | N/A | Jan-17 | 3,040 | ||||||||||||||
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Location City, State | Square Feet | Rent per square ft.($)(1) | Number of Buildings | Ownership Interest | Type | Leasehold Expiration Date | Lease/ Sublease Expiration Date | Encumbrances (In Thousands $) | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Harrisburg, IL | 36,393 | 13.67 | 1 | Fee | Healthcare | N/A | Jan-17 | 3,674 | ||||||||||||||
Hartford City, IN | 22,400 | 3.72 | 1 | Fee | Healthcare | N/A | Jun-17 | 2,052 | ||||||||||||||
Hillsboro, OR | 286,652 | 12.75 | 3 | Fee | Healthcare | N/A | Dec-13 | 32,536 | ||||||||||||||
Hobart, IN | 43,854 | 15.42 | 1 | Fee | Healthcare | N/A | Jun-17 | 5,832 | ||||||||||||||
Huntington, IN | 31,169 | 18.86 | 1 | Fee | Healthcare | N/A | Jun-17 | 4,452 | ||||||||||||||
Indianapolis, IN | 36,416 | 7.14 | 1 | Fee | Healthcare | N/A | Jun-17 | 2,203 | ||||||||||||||
Kenosha, WI | 22,958 | 19.04 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,070 | ||||||||||||||
Kingfisher, OK | 26,698 | 12.55 | 1 | Fee | Healthcare | N/A | Jan-17 | 3,964 | ||||||||||||||
La Vista, NE | 26,683 | 12.52 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,267 | ||||||||||||||
LaGrange, IN | 9,872 | 4.22 | 1 | Fee | Healthcare | N/A | Jun-17 | 509 | ||||||||||||||
| 46,539 | 12.30 | 1 | Fee | Healthcare | N/A | Jun-17 | 5,007 | |||||||||||||||
Lancaster, OH | 21,666 | 22.18 | 1 | Fee | Healthcare | N/A | Jan-17 | 6,279 | ||||||||||||||
Madison, WI | 25,411 | 18.85 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,212 | ||||||||||||||
Manitowoc, WI | 30,679 | 16.57 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,943 | ||||||||||||||
Marysville, OH | 16,992 | 40.56 | 1 | Fee | Healthcare | N/A | Jan-17 | 5,392 | ||||||||||||||
Mattoon, IL | 39,393 | 12.69 | 1 | Fee | Healthcare | N/A | Jan-17 | 5,662 | ||||||||||||||
| 39,393 | 16.73 | 1 | Fee | Healthcare | N/A | Jan-17 | 6,922 | |||||||||||||||
McFarland, WI | 25,700 | 17.14 | 1 | Fee | Healthcare | N/A | Jan-17 | 3,777 | ||||||||||||||
Mansfield, OH | 3,780 | 10.06 | 1 | Fee | Healthcare | N/A | Dec-17 | — | ||||||||||||||
| 4,000 | 23.09 | 1 | Fee | Healthcare | N/A | Dec-17 | — | |||||||||||||||
| 13,209 | 9.59 | 1 | Fee | Healthcare | N/A | Dec-17 | — | |||||||||||||||
Memphis, TN | 73,381 | 24.45 | 1 | Fee | Healthcare | N/A | Jan-17 | 14,598 | ||||||||||||||
Menomonmee, WI | 30,176 | 21.00 | 1 | Fee | Healthcare | N/A | Jan-17 | 5,986 | ||||||||||||||
Middletown, IN | 18,500 | 23.90 | 1 | Fee | Healthcare | N/A | Jun-17 | 3,351 | ||||||||||||||
Mooresville, IN | 24,945 | 19.81 | 1 | Fee | Healthcare | N/A | Jun-17 | 1,497 | ||||||||||||||
Morris, IL | 94,719 | 16.95 | 2 | Fee | Healthcare | N/A | Mar-16 | 2,161 | ||||||||||||||
Mt. Sterling, KY | 67,706 | 20.10 | 1 | Fee | Healthcare | N/A | Jan-22 | 11,204 | ||||||||||||||
Oklahoma City, OK | 45,187 | 4.52 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,416 | ||||||||||||||
Olney, IL | 25,185 | 10.88 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,227 | ||||||||||||||
| 39,393 | 11.04 | 1 | Fee | Healthcare | N/A | Jan-17 | 2,449 | |||||||||||||||
Paris, IL | 39,393 | 17.00 | 1 | Fee | Healthcare | N/A | Jan-17 | 6,819 | ||||||||||||||
Peru, IN | 36,861 | 14.11 | 1 | Fee | Healthcare | N/A | Jun-17 | 6,320 | ||||||||||||||
Peshtigo, WI | 19,380 | 9.63 | 1 | Fee | Healthcare | N/A | Dec-17 | — | ||||||||||||||
Plymouth, IN | 39,092 | 10.25 | 1 | Fee | Healthcare | N/A | Jun-17 | 5,166 | ||||||||||||||
Portage, IN | 38,205 | 14.98 | 1 | Fee | Healthcare | N/A | Jun-17 | 6,921 | ||||||||||||||
Racine, WI | 26,583 | 18.97 | 2 | Fee | Healthcare | N/A | Jan-17 | 9,903 | ||||||||||||||
Rantoul, IL | 39,393 | 11.77 | 1 | Fee | Healthcare | N/A | Jan-17 | 5,621 | ||||||||||||||
Robinson, IL | 29,161 | 13.01 | 1 | Fee | Healthcare | N/A | Jan-17 | 3,990 | ||||||||||||||
Rockford, IL | 54,000 | 8.36 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,940 | ||||||||||||||
Rockport, IN | 26,000 | 9.40 | 1 | Fee | Healthcare | N/A | Jun-17 | 1,687 | ||||||||||||||
Rushville, IN | 13,118 | 7.81 | 1 | Fee | Healthcare | N/A | Jun-17 | 542 | ||||||||||||||
| 35,304 | 17.09 | 1 | Fee | Healthcare | N/A | Jun-17 | 4,021 | |||||||||||||||
Santa Ana, CA | 24,500 | 38.89 | 1 | Fee | Healthcare | N/A | Jan-17 | 7,874 | ||||||||||||||
Sheboygan, WI | 39,784 | 24.30 | 2 | Fee | Healthcare | N/A | Jan-17 | 9,164 | ||||||||||||||
Stephenville, TX | 28,875 | 19.01 | 1 | Fee | Healthcare | N/A | Jan-17 | 6,150 | ||||||||||||||
Sterling, IL | 149,008 | 5.50 | 2 | Fee | Healthcare | N/A | Mar-16 | 2,346 | ||||||||||||||
Stevens Point, WI | 26,443 | 21.77 | 2 | Fee | Healthcare | N/A | Jan-17 | 8,363 | ||||||||||||||
Stoughton, WI | 24,686 | 8.85 | 1 | Fee | Healthcare | N/A | Jan-17 | 1,662 | ||||||||||||||
Sullivan, IN | 18,415 | 4.24 | 1 | Fee | Healthcare | N/A | Jan-17 | 872 | ||||||||||||||
| 44,077 | 14.75 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,826 | |||||||||||||||
Sycamore, IL | 54,000 | 12.02 | 1 | Fee | Healthcare | N/A | Jan-17 | 8,487 | ||||||||||||||
Syracuse, IN | 57,980 | 9.42 | 1 | Fee | Healthcare | N/A | Jan-17 | 3,439 | ||||||||||||||
Tipton, IN | 62,139 | 18.47 | 1 | Fee | Healthcare | N/A | Jun-17 | 7,942 | ||||||||||||||
Tuscola, IL | 36,393 | 13.44 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,168 | ||||||||||||||
Two Rivers, WI | 14,369 | 21.71 | 1 | Fee | Healthcare | N/A | Jan-17 | 2,668 | ||||||||||||||
Vandalia, IL | 39,393 | 15.02 | 1 | Fee | Healthcare | N/A | Jan-17 | 7,328 | ||||||||||||||
Wabash, IN | 35,374 | 5.29 | 1 | Fee | Healthcare | N/A | Jun-17 | 1,281 | ||||||||||||||
Wasbash, IN | 70,746 | 7.65 | 1 | Fee | Healthcare | N/A | Jun-17 | 3,633 | ||||||||||||||
Wakarusa, IN | 48,000 | 6.95 | 1 | Fee | Healthcare | N/A | Jun-17 | 6,355 | ||||||||||||||
| 89,828 | 24.93 | 1 | Fee | Healthcare | N/A | Jun-17 | 9,871 | |||||||||||||||
Warsaw, IN | 25,514 | 11.21 | 1 | Fee | Healthcare | N/A | Jun-17 | 3,581 | ||||||||||||||
Washington Crt Hse, OH | 19,660 | 25.10 | 1 | Fee | Healthcare | N/A | Jan-17 | 5,223 | ||||||||||||||
Wausau, WI | 24,047 | 18.52 | 1 | Fee | Healthcare | N/A | Jan-17 | 7,443 | ||||||||||||||
Weatherford, OK | 53,000 | 1.46 | 1 | Fee | Healthcare | N/A | Jan-17 | 4,484 | ||||||||||||||
Wichita, KS | 81,810 | 11.61 | 1 | Fee | Healthcare | N/A | Dec-19 | 7,848 | ||||||||||||||
Wisconsin Rapids, WI | 20,869 | 11.91 | 1 | Fee | Healthcare | N/A | Jan-17 | 1,112 | ||||||||||||||
Total Healthcare | 3,620,030 | $ | 15.19 | 100 | $ | 471,706 | ||||||||||||||||
Reading, PA | 609,000 | $ | 0.34 | 1 | Fee | Distribution Ctr | N/A | Jan-17 | $ | 18,644 | ||||||||||||
Total Other | 609,000 | $ | 0.34 | 1 | $ | 18,644 | ||||||||||||||||
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Location City, State | Square Feet | Rent per square ft.($)(1) | Number of Buildings | Ownership Interest | Type | Leasehold Expiration Date | Lease/ Sublease Expiration Date | Encumbrances (In Thousands $) | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Atlanta, GA | 382,054 | N/A | 1 | REO | REO/Multifamily | N/A | Various | — | |||||||||||||
Philadelphia, PA | 142,988 | N/A | 1 | REO | REO/Office | N/A | N/A | — | |||||||||||||
Chandler, AZ | N/A | N/A | — | REO | REO/Land | N/A | N/A | — | |||||||||||||
Florence, AZ | N/A | N/A | — | REO | REO/Land | N/A | N/A | — | |||||||||||||
Total REO | 525,042 | N/A | 2 | — | |||||||||||||||||
Total | $ | 7,422,328 | $ | 11.80 | 130 | $ | 803,114 | ||||||||||||||
- (1)
- Rent per square foot is calculated as aggregate rental receipts divided by aggregate square footage.
As of, and for the year ended December 31, 2010, we had no single property with a book value or gross revenues, respectively, equal to or greater than 10% of our total assets. For the year ended December 31, 2010, we had no single property that accounted for gross revenues equal to or greater than 10% of our total revenues.
Chatsworth Property
One of our net lease investments was comprised of three office buildings totaling 257,000 square feet located in Chatsworth, CA and was 100% leased to Washington Mutual Bank, FA, or WaMu. NNN, which is a subsidiary of ours, is a defendant in a lawsuit, or the Lawsuit, filed on August 10, 2009 by the Lender, in the Superior Court of the State of California, County of Los Angeles, relating to a loan the properties previously owned by one of our subsidiaries, NRFC Sub IV, that were 100% leased, or the Lease, to WaMu. The Lawsuit alleges, among other things, that the loan provided by Lender to NRFC Sub IV became a recourse obligation of NNN due to an alleged termination of the Lease. The judge presiding over the Lawsuit granted the Lender's motion for summary judgment and, accordingly, entered a judgment against NNN in the amount of approximately $45 million, or the Judgment. NNN intends to vigorously pursue an appeal of the decision.
Pursuant to the guidance Accounting for Contingencies, an estimated loss from a loss contingency shall be accrued by a charge to income if two conditions are met. First, information available prior to the issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that on one or more future events will occur confirming the facts of the loss. Second, the amount of the loss can be reasonably estimated. We believe it is not probable that the Lawsuit will result in an unfavorable outcome and, therefore, we have not established an accrual relating to the Lawsuit.
In connection with filing for an appeal, pursuant to California law, NNN is required to post a bond in an amount equal to one and a half times the amount of the Judgment, or the Bond. Accordingly, we have entered into a standard General Agreement of Indemnity with an issuer of surety bonds, or the Surety Agreement, which could require us to post collateral equal to the amount of the Bond. As part of the Surety Agreement, in connection with the issuance of the Bond, we have posted cash collateral equal to 38% of the amount of the Bond, or approximately $26 million.
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Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is listed on the New York Stock Exchange under the symbol "NRF".
The following table sets forth the high, low and last sales prices for our common stock, as reported on the New York Stock Exchange, and dividends per share with respect to the periods indicated.
Period | High | Low | Close | Dividends | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2009 | |||||||||||||
First Quarter | $ | 4.90 | $ | 1.25 | $ | 2.32 | $ | 0.10 | |||||
Second Quarter | $ | 4.10 | $ | 2.22 | $ | 2.83 | $ | 0.10 | |||||
Third Quarter | $ | 4.08 | $ | 2.51 | $ | 3.51 | $ | 0.10 | |||||
Fourth Quarter | $ | 3.74 | $ | 3.11 | $ | 3.43 | $ | 0.10 | |||||
2010 | |||||||||||||
First Quarter | $ | 5.22 | $ | 3.43 | $ | 4.21 | $ | 0.10 | |||||
Second Quarter | $ | 5.06 | $ | 2.65 | $ | 2.67 | $ | 0.10 | |||||
Third Quarter | $ | 3.89 | $ | 2.63 | $ | 3.74 | $ | 0.10 | |||||
Fourth Quarter | $ | 4.88 | $ | 3.64 | $ | 4.75 | $ | 0.10 | |||||
On January 20, 2009, we declared dividend at $0.25 per share of common stock, payable with respect to the quarter ended December 31, 2008, to stockholders of record as of January 28, 2009. The dividend was paid on February 27, 2009 in a combination of 40% cash and 60% common stock to stockholders of record as of the close of business on January 28, 2009.
On April 21, 2009, we declared a cash dividend of $0.10 per share of common stock. The dividend was paid on May 15, 2009 to the stockholders of record as of the close of business on May 5, 2009.
On July 21, 2009, we declared a cash dividend of $0.10 per share of common stock. The dividend was paid on August 14, 2009 to the stockholders of record as of the close of business on August 4, 2009.
On October 20, 2009, we declared a cash dividend of $0.10 per share of common stock. The dividend was paid on November 16, 2009 to the stockholders of record as of the close of business on November 6, 2009.
On January 19, 2010, we declared a dividend of $0.10 per share of common stock. The dividend was paid on February 12, 2010 to the stockholders of record as of the close of business on February 5, 2010.
On April 20, 2010, we declared a dividend of $0.10 per share of common stock. The dividend was paid on May 14, 2010, to the stockholders of record as of the close of business on May 4, 2010.
On July 20, 2010, we declared a dividend of $0.10 per share of common stock. The dividend was paid on August 16, 2010, to the stockholders of record as of the close of business on August 6, 2010.
On October 19, 2010, we declared a dividend of $0.10 per share of common stock. The dividend was paid on November 15, 2010, to the stockholders of record as of the close of business on November 5, 2010.
On January 19, 2011, we declared a dividend of $0.10 per share of common stock. The dividend was paid on February 14, 2011 to the stockholders of record as of the close of business on February 4, 2011.
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On October 8, 2008 our Board of Directors authorized a share repurchase program of up to 10,000,000 shares of our outstanding common stock, or approximately 16% of our outstanding common stock as of December 31, 2010. Stock repurchases under this program may be made from time to time through the open market or in privately negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market conditions, and other corporate liquidity requirements and priorities. For the three months ended December 31, 2010 we did not purchase any shares pursuant to the share repurchase program.
On February 23, 2011, the closing sales price for our common stock, as reported on the NYSE, was $5.13. As of February 23, 2011, there were 172 record holders of our common stock. This figure does not reflect the beneficial ownership of shares held in nominee name.
Performance Graph
Set forth below is a graph comparing the cumulative total stockholder return on shares of our common stock with the cumulative total return of the NAREIT All REIT Index and the Russell 2000 Index. The period shown commences on January 1, 2006 and ends on December 31, 2010, the end of our most recently completed fiscal year. The graph assumes an investment of $100 on January 1, 2006 and the reinvestment of any dividends. The stock price performance shown on this graph is not necessarily indicative of future price performance. The information in the graph and the table below was obtained from SNL Financial without independent verification.
| | Period Ending | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Index | 12/31/05 | 12/31/06 | 12/31/07 | 12/31/08 | 12/31/09 | 12/31/10 | |||||||||||||
NorthStar Realty Finance Corp. | 100.00 | 179.48 | 109.88 | 57.51 | 56.78 | 86.64 | |||||||||||||
Russell 2000 | 100.00 | 118.37 | 116.51 | 77.15 | 98.11 | 124.46 | |||||||||||||
NAREIT All REIT Index | 100.00 | 134.35 | 110.39 | 69.18 | 88.17 | 112.48 | |||||||||||||
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Equity Compensation Plan Information
The following table summarizes information, as of December 31, 2010, relating to our equity compensation plans pursuant to which grants of securities may be made from time to time.
Plan Category | Number of Securities to Be Issued Upon Exercise of Outstanding Options, Warrants and Rights(1) | Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights | Number of Securities Available for Future Issuance | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
Approved by Security Holders: | ||||||||||||
2004 Omnibus Stock Incentive Plan | 4,172,446 | n/a | 70,952 | |||||||||
2004 Long-Term Incentive Bonus Plan | 116,830 | n/a | — | |||||||||
Total | 4,289,276 | 70,952 | ||||||||||
- (1)
- Represents units of partnership interest which are structured as profits interest, or LTIP Units, in our operating partnership. Conditioned on minimum allocation to the capital accounts of the LTIP Unit for federal income tax purposes, each LTIP Unit may be converted, at the election of the holder, into one common unit of limited partnership interest in our operating partnership, or OP Units. Each of the OP Units underlying these LTIP Units are redeemable at the election of the OP Unit holder, at the option of the Company in its capacity as general partner of our operating partnership, for: (i) cash equal to the then fair market value of one share of our common stock; or (ii) one share of our common stock.
Item 6. Selected Financial Data
The information below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes, each included elsewhere in this Form 10-K/A.
The selected historical consolidated information presented for the years ended December 31, 2010, 2009, 2008, 2007 and 2006 and relates to our operations and has been derived from our audited consolidated statement of operations included in this Annual Report on Form 10-K/A or our prior Annual Reports on Form 10-K/A.
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Our consolidated financial statements include our majority owned subsidiaries which we control. Where we have a non-controlling interest, such entity is reflected on an unconsolidated basis.
| | Year Ended December 31, | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2010 | 2009 | 2008 | 2007 | 2006 | |||||||||||||
| | (In thousands, except share and per share amounts) | |||||||||||||||||
Statements of Operations Data:(1) | ||||||||||||||||||
Revenues: | ||||||||||||||||||
Interest income | $ | 318,792 | $ | 142,213 | $ | 212,432 | $ | 292,131 | $ | 135,091 | ||||||||
Interest income—related parties | 1,108 | 17,692 | 14,995 | 13,516 | 11,671 | |||||||||||||
Rental and escalation income | 124,828 | 98,143 | 107,559 | 91,301 | 35,683 | |||||||||||||
Advisory and management fee income—related parties | 3,201 | 7,295 | 12,496 | 7,658 | 5,906 | |||||||||||||
Commission income | 2,476 | — | — | |||||||||||||||
Other revenue | 3,268 | 736 | 16,494 | 6,242 | 5,874 | |||||||||||||
Total revenues | 453,673 | 266,079 | 363,976 | 410,848 | 194,225 | |||||||||||||
Expenses: | ||||||||||||||||||
Interest expense | 131,335 | 121,289 | 190,538 | 241,287 | 103,639 | |||||||||||||
Real estate properties—operating expenses | 37,691 | 14,653 | 8,160 | 8,719 | 8,561 | |||||||||||||
Asset management fees—related party | 466 | 3,356 | 4,721 | 4,368 | 594 | |||||||||||||
Fund raising fees and other joint venture costs | — | — | 2,879 | 6,295 | — | |||||||||||||
Commission expense | 1,867 | — | — | |||||||||||||||
Impairment on operating real estate | 5,249 | — | 5,580 | — | — | |||||||||||||
Provision for loan losses | 168,446 | 83,745 | 11,200 | — | — | |||||||||||||
General and administrative Salaries and equity based compensation(2) | 54,828 | 47,213 | 53,269 | 36,148 | 22,547 | |||||||||||||
Auditing and professional fees | 13,803 | 9,636 | 7,075 | 6,787 | 4,765 | |||||||||||||
Other general and administrative | 20,778 | 13,685 | 14,486 | 13,610 | 7,739 | |||||||||||||
Total general and administrative | 89,409 | 70,534 | 74,830 | 56,545 | 35,051 | |||||||||||||
Depreciation and amortization | 34,097 | 41,726 | 41,043 | 31,916 | 13,042 | |||||||||||||
Total expenses | 468,560 | 335,303 | 338,951 | 349,130 | 160,887 | |||||||||||||
Income/(loss) from operations | (14,887 | ) | (69,224 | ) | 25,025 | 61,718 | 33,338 | |||||||||||
Equity in (loss)/earnings of unconsolidated ventures | 2,253 | (1,809 | ) | (11,918 | ) | (11,684 | ) | 432 | ||||||||||
Unrealized gain/(loss) on investments and other | (538,572 | ) | (209,976 | ) | 649,113 | (4,330 | ) | 4,934 | ||||||||||
Realized gain on investments and other | 145,722 | 128,461 | 37,699 | 3,559 | 1,845 | |||||||||||||
Gain from acquisitions | 15,363 | — | — | — | — | |||||||||||||
Income/(loss) from continuing operations | (390,121 | ) | (152,548 | ) | 699,919 | 49,263 | 40,549 | |||||||||||
Income from discontinued operations | (1,967 | ) | 2,176 | 2,410 | 1,047 | 798 | ||||||||||||
Gain on sale of discontinued operations | 2,528 | 13,799 | — | — | 445 | |||||||||||||
Gain on sale of joint venture interest | — | — | — | — | 279 | |||||||||||||
Consolidated net income (loss) | (389,560 | ) | (136,573 | ) | 702,329 | 50,310 | 42,071 | |||||||||||
Net income (loss) attributable to the non-controlling interests | 15,019 | 6,293 | (72,172 | ) | (3,276 | ) | (4,006 | ) | ||||||||||
Preferred stock dividends | (20,925 | ) | (20,925 | ) | (20,925 | ) | (16,533 | ) | (860 | ) | ||||||||
Net income available to common stockholders | $ | (395,466 | ) | $ | (151,205 | ) | $ | 609,232 | $ | 30,501 | $ | 37,205 | ||||||
Net income (loss) per share from continuing operations | (5.17 | ) | (2.40 | ) | 9.61 | 0.48 | 0.91 | |||||||||||
Income per share from discontinued operations (basic/diluted) | (0.03 | ) | 0.04 | 0.04 | 0.02 | 0.01 | ||||||||||||
Gain per share on sale of discontinued operations and joint venture interest (basic/diluted) | 0.03 | 0.20 | — | — | 0.02 | |||||||||||||
Net income (loss) per share available to common stockholders | $ | (5.17 | ) | $ | (2.16 | ) | $ | 9.65 | $ | 0.50 | $ | 0.94 | ||||||
Common stock dividends declared per share | $ | 0.40 | $ | 0.55 | $ | 1.44 | $ | 1.43 | $ | 1.21 | ||||||||
Preferred stock dividends declared | 20,925 | 20,925 | 20,925 | 16,533 | 860 | |||||||||||||
Weighted average number of shares of common stock outstanding: | ||||||||||||||||||
Basic | 76,552,702 | 69,869,717 | 63,135,608 | 61,510,951 | 39,635,919 | |||||||||||||
Diluted | 82,842,990 | 77,193,083 | 70,136,783 | 65,086,953 | 44,964,455 | |||||||||||||
- (1)
- The years ended December 31, 2009, 2008, 2007 and 2006 do not include the revenues and expenses of N-Star I, II, III and V as these CDO financings were unconsolidated CDO financings prior to January 1, 2010.
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- (2)
- The years ended December 31, 2010, 2009, 2008, 2007 and 2006 include $16,991, $20,474, $ 24,680, $16,007 and $9,080 in equity based compensation, respectively. Cash incentive compensation expense incurred but payable in future periods totaled $4,616, $4,635, $2,169, $0 and $0, respectively, for the years ended December 31, 2010, 2009, 2008, 2007 and 2006. The year ended December 31, 2010 includes $3,583 of cash compensation expense and $1,014 of equity based compensation expense relating to a separation and consulting agreement with a former executive.
| | December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||
| | (In thousands) | ||||||||||||||||
Balance Sheet Data | |||||||||||||||||
Operating real estate—net | $ | 938,062 | $ | 978,902 | $ | 1,127,000 | $ | 1,134,136 | $ | 468,608 | |||||||
Available for sale securities, at fair value | 1,691,054 | 336,220 | 221,143 | 549,522 | 788,467 | ||||||||||||
Real estate debt investments, net | 1,826,239 | 1,936,482 | 1,976,864 | 2,007,022 | 1,571,510 | ||||||||||||
Real estate debt investments, held-for-sale | 18,662 | 611 | 70,606 | — | — | ||||||||||||
Corporate loan investments | — | — | — | 457,139 | — | ||||||||||||
Investments in and advances to unconsolidated/uncombined ventures | 94,412 | 38,299 | 101,507 | 33,143 | 11,845 | ||||||||||||
Total assets | 5,151,991 | 3,669,564 | 3,943,726 | 4,792,782 | 3,185,620 | ||||||||||||
Mortgage notes and loans payable | 803,114 | 795,915 | 910,620 | 912,365 | 390,665 | ||||||||||||
Exchangeable senior notes | 126,889 | 125,992 | 233,273 | 172,500 | — | ||||||||||||
Bonds payable | 2,258,805 | 584,615 | 468,638 | 1,654,185 | 1,682,229 | ||||||||||||
Contingently redeemable non-controlling interest | 94,822 | 94,822 | — | — | — | ||||||||||||
Credit facilities | — | — | 44,881 | 501,432 | 16,000 | ||||||||||||
Secured term loans | 36,881 | 368,865 | 403,907 | 416,934 | — | ||||||||||||
Liability to subsidiary trusts issuing preferred securities | 191,250 | 167,035 | 69,617 | 286,258 | 213,558 | ||||||||||||
Repurchase obligations | — | — | 176 | 1,864 | 80,261 | ||||||||||||
Total liabilities | 3,779,478 | 2,210,924 | 2,329,966 | 4,152,248 | 2,502,990 | ||||||||||||
Non-controlling interests | 55,173 | 90,647 | 198,593 | 22,495 | 22,859 | ||||||||||||
Stockholders' equity | 1,277,691 | 1,363,818 | 1,415,167 | 618,039 | 659,771 | ||||||||||||
Total liabilities and stockholders' equity | $ | 5,151,991 | $ | 3,669,564 | $ | 3,943,726 | $ | 4,792,782 | $ | 3,185,620 | |||||||
| | Year Ended December 31, | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||
| | (In thousands) | ||||||||||||||||
Other Data: | |||||||||||||||||
Cash Flow from: | |||||||||||||||||
Operating activities from continuing operations | $ | 35,558 | $ | 54,518 | $ | 87,612 | $ | 102,238 | $ | 53,998 | |||||||
Investing activities | 119,025 | 123,319 | (110,708 | ) | (2,373,929 | ) | (1,852,961 | ) | |||||||||
Financing activities | (168,072 | ) | (172,948 | ) | 3,306 | 2,380,767 | 1,815,828 | ||||||||||
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 of this report.
Organization and Overview
We are a real estate investment trust, or REIT, that was formed in October 2003 to continue and expand the real estate debt, real estate securities and net lease businesses of our predecessor. We conduct substantially all of our operations and make our investments through our operating partnership, of which we are the sole general partner. Through our operating partnership, including its subsidiaries, we primarily:
- •
- originate, structure and acquire senior and subordinate debt investments secured primarily by commercial and multifamily properties;
- •
- invest in, create and manage portfolios of fixed income securities backed primarily by commercial real estate assets, including CMBS and REIT unsecured debt; and
- •
- acquire office, industrial, retail and healthcare related properties that are primarily net leased to corporate tenants.
We believe that these businesses are complementary to each other due to their overlapping sources of investment opportunities, common reliance on real estate fundamentals and ability to utilize secured debt to finance assets and enhance returns. We seek to match-fund our real estate securities and real estate debt investments primarily by issuing term debt, obtaining secured term financing and accessing private equity.
Sources of Operating Revenues
We primarily derive revenues from interest income on the real estate debt investments that we originate with borrowers or acquire from third parties and our real estate securities in which we invest. We generate rental income from our net lease investments.
We primarily derive income on a recurring basis through the difference between the interest and rental income we are able to generate from our investments, and the cost at which we are able to obtain financing for our investments. In order to protect this difference, or "spread", we seek to match-fund our investments using secured sources of long term financing such as CDO financings, mortgage financings and long-term unsecured subordinate debt. Match-funding means that we try to obtain debt with maturities equal to our asset maturities, and borrow funds at interest rate benchmarks similar to our assets. Match-funding results in minimal impact to spread when interest rates are rising and falling and minimizes refinancing risk since our asset maturities match those of our debt. We may also acquire investments which generate attractive returns with no long-term financing. Realized gains have more recently been a significant source of income and have been primarily derived by selling securities at premiums to our carrying values and by repurchasing our issued debt at discounts to contractual face amounts. Both of these activities are opportunistic in nature and are very dependent on market conditions; therefore it is difficult to predict whether realized gains may be a significant part of income in the future.
Real Estate Debt
We primarily earn interest income from real estate debt investments. At December 31, 2010, our real estate debt portfolio had a carrying value of $1.8 billion consisting of senior and subordinate debt investments. We made six new investments and 52 loans were acquired as part of the CSE RE 2006-A
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CDO transaction in 2010, one new investment in 2009, three investments in 2008, 41 investments in 2007 and 74 investments in 2006.
Approximately 56.6% of our loan assets generate interest income based upon a floating index, primarily one-month LIBOR or the prime rate, plus a credit spread. Our revenues will be impacted by changes in floating interest rates; however, we seek to minimize the impact of changes in floating interest rates by financing floating rate assets with floating rate debt having interest rates benchmarked to the same index as our assets. Decreases in floating interest rates may result in lower income for our stockholders because the unfinanced portion of the asset is not hedged, notwithstanding the match-funding of floating rate assets with floating rate liabilities.
Real Estate Securities
We earn interest income from real estate fixed income securities and, prior to their consolidation, management fees from our off-balance sheet CDO financings. Similar to our real estate debt business, we seek to minimize the impact of floating interest rates by funding floating rate assets with floating rate debt and by hedging fixed rate assets funded with floating rate debt.
Core Net Lease Properties
We earn rental and escalation income from our core net leased properties, which includes primarily suburban office, industrial and retail properties. During 2007 and 2006, we acquired $125.9 million and $164.9 million, respectively, of core net lease properties. We made no core net lease acquisitions during 2008, 2009 or 2010.
Healthcare Net Lease
We earn rental and escalation income from our healthcare net leased properties, which we characterize as mid-acuity, and that are operated by and/or leased to regional, middle-market tenants or operators. We define mid-acuity as those properties that provide needed services to residents that cannot be easily or as affordably provided in a home or other health care setting. These types of properties include including independent living facilities, assisted living facilities, skilled nursing facilities, memory care facilities and continuing care retirement facilities as well as in medical office buildings and research facilities. During 2008, 2007 and 2006, we acquired $4.2 million, $591.0 million and $78.8 million, respectively, of healthcare net lease properties. We made no healthcare net lease acquisitions during 2009 or 2010.
Commission Income
Commission income represents income earned by us for selling equity, through our broker-dealer subsidiary, for the NorthStar Income Opportunity REIT I, Inc., a commercial finance REIT sponsored by us.
Profitability and Performance Metrics
We calculate several metrics to evaluate the profitability and performance of our business.
- •
- Adjusted funds from operations: ("AFFO") (see "Non-GAAP Financial Measures—Funds from Operations and Adjusted Funds from Operations" for a description of this metric).
- •
- Return on Equity ("ROE"), before and after general and administrative expenses. We calculate return on equity using AFFO, inclusive and exclusive of general and administrative expenses, divided by average common book equity during the period as a measure of the profitability generated by our assets and company on common stockholders' equity invested.
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- •
- Credit losses are a measure of the performance of our investments and can be used to compare the credit performance of our assets to our competitors and other finance companies.
- •
- Assets Under Management ("AUM") growth is a key driver of our ability to grow our earnings, but in the current economic environment is of lesser importance than other metrics such as AFFO and ROE due to lack of available new investment capital in the commercial real estate sector.
Credit risk management is our ability to manage our assets in a manner that preserves principal and income and minimizes credit losses that would decrease income.
Corporate expense management influences the profitability of our business. We must balance making appropriate investments in our infrastructure and employees with the recognition that our accounting, finance, legal and risk management infrastructure does not directly generate quantifiable revenues for us. We frequently refer to general and administrative expenses, excluding stock-based compensation expense, divided by total revenues as a measure of our efficiency in managing expenses.
Availability and cost of capital will impact our profitability and earnings since we must raise new capital to fund a majority of our AUM growth.
Outlook and Recent Trends
U.S. macroeconomic and real estate sector conditions have remained poor since 2007, when the subprime residential lending and single family housing market collapse quickly spread broadly into the capital markets. The resulting virtual shutdown of the credit and equity markets pushed the U.S. economy into recession, and the unemployment rate increased from a low of 4.4% in 2007 to 9.4% at December 31, 2010. Traditional commercial real estate lenders such as banks and life insurance companies severely curtailed their lending between mid-2007 and 2009, resulting in a severe shortage of debt capital for real estate investors and those needing to refinance maturing loans. The corporate bond, consumer asset-backed debt and equity markets began to recover during 2009 and continued to improve during 2010, although macroeconomic indicators remain weak. The commercial mortgage-backed markets are beginning to recover and issued approximately $10 billion of securities in 2010.
Despite poor economic conditions, the Morgan Stanley REIT Index returned approximately 28.6% for 2009 and approximately 28.5% for 2010. In addition, three REITs with a real estate debt focus raised approximately $1.5 billion of capital in 2009, but no new commercial mortgage REITs went public during 2010. Notwithstanding the ability of the public REIT market to raise capital, this market is very small relative to the size of the estimated $1.5 trillion commercial real estate finance market. More recently, U.S. economic conditions appear to be improving (based on 2.6% annualized GDP growth as of September 30, 2010, the most recent available data), however, the unemployment rate remains high indicating a low rate of business expansion, which drives commercial real estate cash flows. Commercial real estate tends to lag economic recoveries and with the exception of certain high-density, supply-constrained markets such as New York City, Washington DC and Boston, MA, we expect commercial real estate fundamentals to continue to be difficult into 2011.
Commercial Real Estate Macroeconomic Conditions
Virtually all commercial real estate property types have been adversely impacted by the recent economic recession, including core property types such as hotel, retail, office, industrial and multi-family properties. Land, condominium and other commercial property types have also been severely impacted. As a result, cash flows and values associated with properties serving as collateral for our loans are generally weaker than expected when we originated the loans. Our credit loss provisioning levels for 2009 and 2010 were higher than in the past due to the impact of these conditions. Despite weak economic conditions, during 2010, investor interest began returning to commercial real estate
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especially in urban areas having high concentrations of institutional quality real estate, and in certain asset types such as apartments and hotels that are expected to benefit quickly from recovering economic conditions. During 2011, the degree to which commercial real estate values erode or improve within the local markets in which our real estate collateral is located will impact the level of credit losses in our asset base.
Many of our real estate loans bear interest rates based on a spread to one-month LIBOR, a floating rate index based on rates that banks charge each other to borrow. One-month LIBOR as of December 31, 2010, is 0.26%, well below its 2.93% average over the past five years. Lower LIBOR means lower debt service costs for our borrowers which have partially offset decreasing cash flows caused by the economic recession, and extended the life of interest reserves for those loans that require interest reserves to service debt while the collateral properties are being repositioned by our borrowers. Lower interest rates also theoretically support real estate valuations because a lower discount rate is applied to underlying future real estate cash flow assumptions in valuing a property, although the availability and cost of debt capital appears to have a much more significant impact on property values. Although investor interest in real estate has improved during 2010, much of the new capital has been directed to the highest quality, stabilized urban real estate assets and properties expected to benefit quickly from improving economic conditions. Many of our collateral properties had business plans to improve occupancy and cash flows that have not been accomplished due to the recent economic recession. Weak cash flow performance and conservative underwriting standards by current market lenders continues to cause extreme difficulties in obtaining repayments at maturity.
For existing loans, when credit spreads widen, which was the case in 2008 and early 2009, the economic value of existing loans decreases. Although credit spreads decreased in 2010, if a lender were to originate a similar loan today, such loan would likely still carry a greater credit spread than the existing loan. Even though a loan may be performing in accordance with its loan agreement and the underlying collateral has not changed, the economic value of the loan may be negatively impacted by the incremental interest foregone from the widened credit spread. Accordingly, when a lender wishes to sell or finance the loan, the reduced value of the loan will impact the total proceeds that the lender will receive.
Our real estate securities investments are also negatively impacted by weaker real estate market and economic conditions. Within the underlying loan pools, slowdown in economic conditions is reducing tenants' ability to make rent payments in accordance with the terms of their leases. Additionally, to the extent that market rental rates are reduced, property-level cash flows are negatively affected as existing leases renew at lower rates. Finally, declining occupancy rates also impact cash flow and reduce borrowers' ability to service their outstanding loans.
Real estate securities values are also influenced by credit ratings assigned to the securities by accredited rating agencies. In 2009, the rating agencies changed their ratings methodologies for all securitized asset classes, including commercial real estate, in light of questionable ratings previously assigned to residential mortgage portfolios. Combined with a poor economic outlook, their reviews have resulted in, large amounts of ratings downgrade actions for CMBS in 2009 and in 2010, negatively impacting market values of CMBS and in many cases negatively impacting the CDO financing structures used by us and others to leverage these investments.
Our net leased assets are also adversely impacted by a weaker economy as well. Corporate space needs are contracting resulting in lower lease renewal rates and longer releasing periods when leases are not renewed. Poor economic conditions may negatively impact the creditworthiness of our tenants, which could result in their inability to meet the terms of their leases.
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Our Strategy
We responded to these difficult conditions by decreasing investment activity and aggressively raising corporate capital when we observed deteriorating market conditions. We expect credit to continue to be challenging through 2011 and we continue to focus our company resources on portfolio management activities to preserve our invested capital and liquidity. We anticipate that most of our investment activity and uses of available unrestricted cash liquidity for the foreseeable future will be focused on discounted repurchases of our previously issued debt securities and for growth in our asset management portfolio, as well as opportunistic investments.
The relative lack of supply and high demand for capital is allowing investors with cash to make investments with very attractive returns compared to historical levels. For this reason, we are working to raise equity capital through alternative channels, especially in the nonlisted REIT market. During 2010, we raised approximately $37.7 million in the non-traded REIT sector for NSREIT and its predecessor, and filed a registration statement for NorthStar Senior Care Trust, Inc. We are the advisor to these companies and earn management fees which vary based on the amount of assets under management and investment performance. We expect to use our broad commercial real estate investment and management platform to operate these companies and to earn management fees in return for our services, and the non-traded REIT efforts reflect our strategy of accessing alternative sources of equity capital, leveraging our existing platform to generate fee revenues and to become less reliant on the public markets to grow our business.
Our Financing Structures
On June 30, 2010, we fully repaid and extinguished, at a discount to the outstanding principal amount, the First Amended and Restated Credit Agreement (the "Credit Agreement") and the Second Amendment to Note Purchase Agreement (the "Note Purchase Agreement," and together with the Credit Agreement, the "WA Secured Term Loan") with Wachovia Bank, National Association ("Wachovia"), having an outstanding principal balance of approximately $304.0 million and secured by assets having an aggregate unpaid principal balance of approximately $448.6 at the time of the payoff. We paid approximately $208.0 million of cash and granted the lender a 40% participation interest in the principal proceeds of a €43.3 million participation in a mezzanine loan that is collateralized by a German retail portfolio.
As of December 31, 2010, approximately $4.1 billion of our collateralized debt obligations permit reinvestment of capital proceeds which means when the underlying assets repay or are sold we are able to reinvest the proceeds in new assets without having to repay the liabilities. Approximately $265.1 million of our funded loan commitments have their initial maturity date during 2011; however, many of the loans contain extension options of at least one year. We also expect that a majority of the $186.2 million of loans having final maturities during 2011 will have their maturities extended beyond 2011 with the expectation that future periods will have more attractive economic conditions and cheaper debt capital. It is therefore difficult to estimate how much capital, if any, will be generated in our CDO financings from loan repayments during 2011.
Our CDO structures do not have corporate financial covenants but require that the underlying loans and securities meet interest coverage and collateral value coverage (as defined by the indentures) in order for us to receive regular cash flow distributions. If the tests are not met, cash flow is diverted from us to repay the liabilities until the tests are back into compliance. In some cases, our ability to reinvest can be adversely impacted if these tests are not in compliance. Ratings downgrades and defaults of CMBS and other securities can reduce the deemed value of the security in measuring collateral coverage, depending on the level of the downgrade. Also, defaults in our loans can reduce the collateral coverage of the defaulted loan in our CDO structures. As economic conditions remain weak and capital for "legacy" commercial real estate assets remains scarce, we expect credit quality in
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our assets to remain weak. While we have devoted a majority of our resources to managing our existing asset base, a continued poor economic environment and additional credit ratings downgrades will make maintaining compliance with the CDO structures more difficult, jeopardizing regular cash flow distributions to our company.
We believe that liquidity is returning to the commercial real estate finance markets and corporate debt capital is currently available to the stronger equity REITs. Approximately $10 billion in multi-borrower CMBS transactions were completed in 2010 and many industry experts are predicting at least $30-$40 billion of CMBS issuance in 2011. Wall Street banks have also begun to more actively provide credit to real estate lenders to originate or purchase new real estate loans. We expect that credit availability will continue to improve during 2011, increasing opportunities for us to access attractive debt capital.
Risk Management
We use many methods to actively manage our asset base to preserve our income and capital. For loans and net lease assets, frequent dialogue with borrowers/tenants and inspections of our collateral and owned properties have proven to be an effective process for identifying issues early and prior to missed debt service and lease payments. Many of our loans also require borrowers to replenish cash reserves for items such as taxes, insurance and future debt service costs. Late replenishments of cash reserves also may be an early indicator there could be a problem with the borrower or collateral property. We also may negotiate modifications to loan terms if we believe such modification improves our ability to maximize principal recovery. Modifications may include changes to contractual interest rates, maturity dates and other borrower obligations. When we make a concession such as reducing an interest rate or extending a maturity date, we seek to get additional collateral and/or fees in return for the modification although as challenging real estate conditions continue, obtaining additional collateral from struggling borrowers has become more difficult. In some cases we may issue default notices and begin foreclosure proceedings when the borrower is not complying with the loan terms and we believe taking control of the collateral is the best course of action to protect our capital. For net leases, we may seek to obtain up-front or accelerated payment in return for an early cancelation of the lease if we believe the tenant's creditworthiness has significantly deteriorated and that taking control of the property and re-leasing it maximizes value.
In certain circumstances, we may pursue loan sales and payoffs at discounts to our book value. We may agree to discounted sales or payoffs where we believe there is an economic benefit from monetizing the asset in advance of its contractual maturity date. For example, we may accept a discounted payoff where we believe the cash proceeds can be reinvested at a much higher rate of return (including the capital loss from the payoff), where we believe there is significant risk of collateral value or cash flow erosion through maturity, or where we believe refinancing risk at maturity is very high. When evaluating sales and payoffs at discounts to book value, we also consider the impact such transactions have on our financing structures, corporate debt covenants and earnings.
Securities investments generally have a more liquid market than loans and net lease assets, but we typically have very little control over restructuring decisions when there are problems with the underlying collateral. We manage risk in the securities portfolio by selling the asset when we can obtain a price that is attractive relative to its risk. In certain situations, we may sell an asset because there is an opportunity to reinvest the capital into a new asset with a more attractive risk/return profile.
We conduct a quarterly comprehensive credit review which is designed to enable management to evaluate and proactively manage asset-specific credit issues and identify credit trends on a portfolio-wide basis as an "early warning system." Nevertheless, we cannot be certain that our review will identify all issues within our portfolio due to, among other things, adverse economic conditions or events adversely affecting specific assets; therefore, potential future losses may also stem from assets
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that are not identified by our credit reviews. During the quarterly reviews, assets are put on non-performing status and identified for possible impairment based upon several factors, including missed or late contractual payments, significant declines in collateral performance, and other data which may indicate a potential issue in our ability to recover our capital from the investment.
On July 8, 2010, we acquired, as part of the CSE RE 2006-A CDO acquisition, commercial real estate loans having an aggregate $1.1 billion outstanding principal balance. The loans were recorded as of July 8, 2010, at their estimated $396.0 million fair market value. As of December 31, 2010, the CSE RE 2006-A loans had an aggregate $966.6 million outstanding principal balance and an aggregate $291.0 million carrying value. The $616.9 million acquisition discount as of December 31, 2010, acts as a built-in reserve for credit issues and recoveries less than contractual amounts related to these acquired loans. Although fair market values and any related discounts to outstanding principal balances were determined on a loan-by-loan basis and therefore cannot be allocated to other loans, we believe the overall discount provides protection to our basis for ongoing credit issues associated with this portfolio.
At December 31, 2010, our loan portfolio, inclusive of the CSE RE 2006-A CDO, had the following credit statistics (in thousands):
Non-Performing Loans(1)(2) | Number of Loans(3) | Outstanding Principal Balance | Reserves | CSE CDO Acquisition Discount | Aggregate Net Balance | Collateral Types and Locations (% by loan balance) | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
First mortgages | 10 | $ | 220,961 | $ | 10,323 | $ | 178,245 | $ | 32,393 | 60% land located in FL, CA, PA, CO, 27% | |||||||
| multifamily located in FL, CA, TX, 6% | |||||||||||||||||
| hospitality located in IL, 6% retail located in | |||||||||||||||||
| WI and 1% nursing located in KY. | |||||||||||||||||
Junior participations in first mortgages | 3 | 51,988 | 28,460 | 0 | 23,528 | 55% land located in FL and 45% office | |||||||||||
| located in GA, IN. | |||||||||||||||||
Total | 13 | $ | 272,949 | $ | 38,783 | $ | 178,245 | $ | 55,922 | ||||||||
Performing loans with loan loss reserves | |||||||||||||||||
First mortgages | 2 | $ | 55,820 | $ | 10,660 | $ | 0 | $ | 45,160 | 100% office located in TX and CA. | |||||||
Junior participations in first mortgages | 3 | 76,536 | 55,085 | 0 | 21,450 | 43% land located in NV, 41% retail located | |||||||||||
| in GA, and 16% office in NY. | |||||||||||||||||
Mezzanine | 6 | 177,867 | 92,671 | 0 | 85,196 | 56% hotel located throughout the USA, 21% | |||||||||||
| retail located in AZ and IA, 14% multi-family | |||||||||||||||||
| located in CA, 4% office located in CA, 3% | |||||||||||||||||
| corporate loan located in NC and 2% land | |||||||||||||||||
| located in CA. | |||||||||||||||||
Total | 11 | $ | 310,222 | $ | 158,417 | $ | 0 | $ | 151,805 | ||||||||
Total NPLs and total performing loans with loan loss reserves | 24 | $ | 583,171 | $ | 197,200 | $ | 178,245 | $ | 207,727 | ||||||||
- (1)
- A loan is classified as non-performing at such time as the loan becomes 90 days delinquent in interest or principal payments or the loan has a maturity default.
- (2)
- Outstanding principal balances includes $15.6 million of minority interest held by third parties.
- (3)
- Where NorthStar holds more than one loan on the same collateral or group of collateral properties, the loans are considered a single investment for purpose of reporting non-perforning loans and reserves.
At December 31, 2010, our loan portfolio principal and interest aging is as follows (inclusive of our non-performing loans) (in thousands):
1 - 90 Days | 90+ Days | |||
|---|---|---|---|---|
| $41,975 | $ | 223,390 | ||
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For the three months ended December 31, 2010, we recorded a $32.8 million credit loss provision relating to three loans. For the year ended December 31, 2010, we recorded $168.4 million of credit loss provisions relating to 16 loans, which included; (i) $6.5 million for four first mortgage loans sold during the period, net of $1.3 million in credit loss reversal for two of the loans sold for which we received net sale proceeds in excess of their carrying amounts, having an aggregate principal amount of approximately $90.3 million and sold for approximately $61.9 million, (ii) $13.9 million in provisions for two mezzanine loans having an aggregate principal amount of approximately $71.2 million and sold for approximately $57.6 million, (iii) $0.2 million in provisions for a junior participation in a first mortgage loan having a principal amount of approximately $21.4 million and sold for approximately $21.2 million and (iv) $3.0 million in provisions for a junior participation in a first mortgage loan having a principal amount of approximately $18.0 million that was foreclosed and recorded as REO held for sale at December 31, 2010.
As of December 31, 2010, loan loss reserves totaled $197.2 million and related to 13 loans having an aggregate $347.9 million gross book value (exclusive of the related reserve) and includes reserves of $25.7 million related to loans having an aggregate gross book value of $43.6 million (exclusive of the related reserve) that were added to the reserve balance as a result of the acquisition of N-Star CDO IX.
Activity in the allowance for credit losses on real estate debt investments for year ended December 31, 2010, is as follows (in thousands):
Credit Loss Reserve | | |||
|---|---|---|---|---|
Balance at December 31, 2009 | $ | 77,400 | ||
Provision for credit losses | 168,446 | |||
N-Star CDO IX loan reserves | 25,679 | |||
Write-offs and sold loans | (51,205 | ) | ||
Foreclosure on loan | (23,120 | ) | ||
Balance at December 31, 2010 | $ | 197,200 | ||
At December 31, 2010, we had four loans, exclusive of the CSE RE 2006-A loans, totaling $64.5 million of aggregate outstanding principal amount on non-performing status due to maturity defaults, and $38.7 million of our credit loss reserves were allocated to these loans. First mortgages represent approximately 19.4% of the gross book value of these loans (exclusive of reserves), and 44.1% of the loans are backed by land collateral. There can be no assurance that there will be acceptable outcomes under our non-performing loans and accordingly, we may, in the future, determine that more reserves are required for these loans.
Overall, the prolonged poor economic conditions and the scarcity of commercial real estate debt capital resulted in increasing stress levels for commercial real estate credit. A shrinking economy generally results in decreasing real estate cash flows as corporations and consumers reduce their real estate needs, travel and spending. While the overall economy has recently seen some signs of growth, generally lower property cash flows than when the existing financing was completed are causing real estate owners to have difficulty refinancing their assets at maturity. Many owners are also having trouble achieving their business plans to the extent they acquired a property to reposition it or otherwise invest capital to increase the property's cash flows. Property values have also generally decreased over the past few years because of scarcity of financing, which when it is available the terms generally are at much lower leverage and higher cost than available in prior years, uncertainty regarding future economic conditions and higher returning investment opportunities available in other asset classes. Decreasing values make it difficult for real estate investors to sell their properties and to recoup their capital. As a result of the weak commercial real estate market, many lenders, including us,
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are concluding that extending loans at original maturity, rather than foreclosure and sale, may be the most attractive path for maximizing value.
Many of our loans were made to borrowers who had a business plan to improve the collateral property and who therefore needed a flexible balance sheet lender. In many cases we required the borrowers to pre-fund reserves to cover interest and operating expenses until the property cash flows increased sufficiently to cover debt service costs. We also required the investor to refill these reserves if they became deficient due to underperformance and if the borrower wanted to exercise extension options under the loan. Despite low interest rates, we expect that in the future some of our borrowers may have difficulty servicing our debt because they cannot achieve their business plan in this economic environment. If any of our borrowers are unable to replenish reserves and otherwise are unable to ultimately achieve their business plans, the related loans may become non-performing. In addition, even if a borrower's business plan is achieved, current real estate valuations and the financing environment may result in a borrower being unable to recoup its invested capital and a default under the loan causing a partial or full loss of our loan principal.
Each of our loan investments, while primarily backed by commercial real estate collateral, is unique and requires customized asset management strategies for dealing with potential credit situations. The complexity of each situation depends on many factors, including the number of collateral properties, the type of property, macro and local market conditions impacting the demand, cash flow and value of the of the collateral, and the financial condition of our borrowers and their willingness to support our collateral properties. Additionally, in many cases there are multiple lenders involved with specific collateral properties and these lenders may have different objectives which influence their preferred strategy for dealing with a credit situation.
Our impairment analyses often requires that we make assumptions regarding collateral values and the timing regarding when we will receive debt service payments, including principal recovery. In a difficult environment for commercial real estate, our impairment analyses may lead us to the determination that extending and working out a loan, rather than pursuing foreclosure, is the best course of action to maximize total and long-term value. However, in situations where there are multiple creditors in large capital structures, it can be particularly difficult to assess the most likely course of action that a lender group or the borrower may take. Consequently, there could be a wide range of potential principal recovery outcomes, the timing of which can be unpredictable, based on the strategy pursued by a lender group and/or by a borrower. Our impairment analysis in each of these situations is based on our assessment of the facts and circumstances currently known to us and because these situations often involve complicated collateral and complex creditor and borrower dynamics, our assessment of recovery value may change more dramatically and quickly and without the visibility that may be available in other situations. These multiple creditor situations tend to be associated with larger loans, and NorthStar has been and continues to be involved in situations such as these, although NorthStar, as one of a group of lenders and often a lender on a subordinated basis, does not independently control the decision making. The discussion below summarizes the largest credit situations that currently meet some of the foregoing characteristics.
East Rutherford, NJ Retail Construction First Mortgage Loan.
We own a 22% interest held in Meadowlands One, LLC that is secured by a retail/entertainment complex located in East Rutherford, NJ ("NJ Property"), and the lender group is in the process of seeking to recapitalize the NJ Property. While the lender group has selected a developer to complete the NJ Property, there is no assurance that a recapitalization will be completed or that a recapitalization will be completed on terms acceptable to us, which could have a material adverse effect on our business and operations.
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Las Vegas, NV Casino/Hotel Mezzanine Loan.
We own an $89 million mezzanine loan (the "NV Loan") that is secured by the Hard Rock Hotel and Casino in Las Vegas, NV (the "Hard Rock"). We, along with certain of the other lenders, and the borrower and its affiliates under the NV Loan, have entered into a term sheet that provides for a long-term restructuring of the NV Loan. As part of the restructuring, it is expected that Brookfield will take ownership of the Hard Rock and will enter into a seven-year loan with the existing senior lender, subject to achieving certain tests, and we will retain our $89 million mezzanine loan (or its economic equivalent), as well as an equity participation in the Hard Rock. There is no assurance that the restructuring will be completed or, if completed, that it will be successful over time. Accordingly, we may lose all of our investment, which could have a material adverse effect on our business and operations.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations is based on our financial statements which have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. These accounting principles requires the use of estimates and assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Actual results could differ significantly from those estimates. The estimates are based on information that is currently available to management, as well as on various other assumptions that management believes are reasonable under the circumstances. We have identified our critical accounting policies that affect the more significant judgments and estimates used by us in the preparation of our consolidated financial statements to be the following:
Principles of Consolidation
The consolidated financial statements include our accounts and our majority-owned subsidiaries and variable interest entities ("VIE") where we are deemed the primary beneficiary. All significant inter-company balances have been eliminated in consolidation.
Valuation of Financial Instruments
Proper valuation of financial instruments is a critical component of our financial statement preparation. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date (i.e., the exit price).
We have categorized our financial instruments, based on the priority of the inputs to the valuation technique, into a three level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
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Financial assets and liabilities recorded on the Consolidated Balance Sheets are categorized based on the inputs to the valuation techniques as follows:
| Level 1. | Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market (examples include active exchange-traded equity securities, listed derivatives, most U.S. Government and agency securities, and certain other sovereign government obligations). | |||
Level 2. | Financial assets and liabilities whose values are based on the following: | |||
a) | Quoted prices for similar assets or liabilities in active markets (for example, restricted stock); | |||
b) | Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently); | |||
c) | Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); and | |||
d) | Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (for example, certain mortgage loans). | |||
Level 3. | Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management's own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include private equity investments, commercial mortgage backed securities, and long-dated or complex derivatives including certain foreign exchange options and long dated options on gas and power). | |||
The fair values of our financial instruments are based on observable market prices when available. Such prices are based on the last sales price on the date of determination, or, if no sales occurred on such day, at the "bid" price at the close of business on such day and if sold short at the "asked" price at the close of business on such day. Interest rate swap contracts are valued based on market rates or prices obtained from recognized financial data service providers. These prices are provided by a recognized financial data service provider.
We have valued our financial instruments, in the absence of observable market prices, using the valuation methodologies described below applied on a consistent basis. For some financial instruments little market activity may exist; management's determination of fair value is then based on the best information available in the circumstances, and may incorporate management's own assumptions and involve a significant degree of management's judgment.
Investments for which market prices are not observable are generally investments in equity or income notes of CDO financings, equity interests in collateralized loan obligations and trust preferred securities. Fair values of these investments are determined by reference to market rates or prices provided by the underwriters of the structured securities or cash flow models utilizing an internal rate of return provided by the underwriters of the CDO or CLO transaction. An analysis is applied to the estimated future cash flows using various factors depending on the investments, including various reinvestment parameters.
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Liabilities for which market prices are not generally observable include our liability to subsidiary trusts issuing preferred securities. The fair value of these debt instruments are based upon an analysis of other instruments issued by us that are currently actively traded including our preferred stock and exchangeable senior notes. An analysis is performed on the implied credit spreads that could be observed for these instruments. We believe that the credit spreads for our preferred stock and exchangeable senior notes are valid proxies for those of the liability to subsidiary trusts issuing preferred securities because they share many of the same structural and credit features. However, in deriving appropriate credit spreads for the liability to subsidiary trusts issuing preferred securities on the basis of observed credit spreads for preferred stock and exchangeable senior notes, several adjustments are made to reflect the differences between these instruments and the liability to subsidiary trusts issuing preferred securities.
Operating Real Estate
We allocate the purchase price of operating properties to land, building, tenant improvements, deferred lease cost for the origination costs of the in-place leases and to intangibles for the value of the above or below market leases. We amortize the value allocated to the in-place leases over the remaining lease term. The value allocated to the above or below market leases are amortized over the remaining lease term as an adjustment to rental income.
A property to be disposed of is reported at the lower of its carrying value or its estimated fair value less the cost to sell. Once an asset is determined to be held for sale, depreciation and straight-line rental income are no longer recorded. In addition, the asset is reclassified to assets held for sale on the consolidated balance sheet and the results of operations are reclassified to income (loss) from discontinued operations in our consolidated statements of operations.
Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is recorded at the lower of its cost, which is the unpaid balance of the loan plus foreclosure costs, or fair market value at the date of foreclosure.
Fair Value Option
The fair value option of accounting for financial assets and financial liabilities provides a fair value option election that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they occur. The fair value option permits election on an instrument by instrument basis at initial recognition. We have elected to fair value our third party available for sale securities, our exchangeable senior notes, our N-Star bonds payable and our liabilities to subsidiary trust issuing preferred securities.
Available for Sale Securities
We determine the appropriate classification of our investments in securities at the time of purchase and reevaluate such determination at each balance sheet date. Securities for which we do not have the intent or the ability to hold to maturity are classified as available for sale securities. We have designated our investments in the equity notes and our non investment grade notes of unconsolidated CDO financings as available for sale securities as they meet the definition of a debt instrument due to their redemption provisions. These securities are carried at estimated fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) in the consolidated statements of stockholders' equity. Our available for sale securities that serve as collateral for our CDO financings, which we have elected the fair value option, are carried at fair value with the net unrealized gains or losses reported as a component of earnings in the statement of operations. For additional information regarding unrealized gains and losses due to changes in the fair value of our
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available for sale securities at December 31, 2010 and 2009, see Note 5 of the notes to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K/A.
Revenue Recognition
Interest Income from our real estate debt investments is recognized on an accrual basis over the life of the investment using the effective interest method, fees, discounts, premiums, anticipated exit fees and direct cost are recognized over the term of the loan as an adjustment to the yield. Fees on commitments that expire unused are recognized at expiration.
Interest income from available for sale securities is recognized on an accrual basis over the life of the investment on a yield-to-maturity basis.
Interest income on our investments in the equity notes of our unconsolidated CDO financings is recognized on an estimated effective yield to maturity basis. Accordingly, on a quarterly basis, we calculate a revised yield on the current amortized cost of the investment and a current estimate of cash flows based upon actual and estimated prepayment and credit loss experience. The revised yield is then applied prospectively to recognize interest income.
Rental Income from our net lease portfolio is recognized on a straight-line basis over the non-cancelable term of the respective leases.
Credit Losses, Impairment and Allowance for Doubtful Accounts
We assess whether unrealized losses on the change in fair value on our available for sale securities reflect a decline in value which is other than temporary. If it is determined the decline in value is other than temporary, the impaired securities are written down through earnings to their fair values. Significant judgment of management is required in this analysis, which includes, but is not limited to, making assumptions regarding the collectability of the principal and interest, net of related expenses, on the underlying loans.
Allowances for real estate debt investment losses are established based upon a periodic review of the loan investments. Income recognition is suspended for the investments at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the suspended investment becomes contractually current and performance is demonstrated to be resumed. In performing this review, management considers the estimated net recoverable value of the investment as well as other factors, including the fair market value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the economic situation of the region where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized from the investments may differ materially from the carrying value at the balance sheet date.
On a periodic basis, we assess whether there are any indicators that the value of our real estate properties may be impaired or that its carrying value may not be recoverable. A property's value is considered impaired if management's estimate of the aggregate future cash flows to be generated by the property are less than the carrying value of the property. To the extent an impairment has occurred and is considered to be other than temporary, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property.
Allowances for doubtful accounts for tenant receivables are established based on periodic review of aged receivables resulting from estimated losses due to the inability of tenants to make required rent and other payments contractually due. Additionally, we established, on a current basis, an allowance for future tenant credit losses on billed and unbilled rents receivable based upon an evaluation of the collectability of such amounts.
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Management is required to make subjective assessments as to whether there are impairments in the values of its investment in unconsolidated ventures accounted for using the equity method. As no public market exists for these investments, management estimates the recoverability of these investments based on projections and cash flow analysis. These assessments have a direct impact on our net income because recording an impairment loss results in an immediate negative adjustment to net income.
Stock Based Compensation
We have adopted the fair value method of accounting for equity based compensation awards. For all fixed equity based awards to employees and directors, which have no vesting conditions other than time of service, the fair value of the equity award at the grant date will be amortized to compensation expense over the award's vesting period. For performance based compensation plans we recognize compensation expense at such time as the performance hurdle is anticipated to be achieved over the performance period based upon the fair value at the date of grant. For target-based compensation plans we recognize compensation expense over the vesting period based upon the fair value of the plan.
Derivatives and Hedging Activities
We account for our derivatives and hedging activities as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. Additionally, the fair value adjustments of each period will affect our consolidated financial statements differently depending on whether the derivative instrument qualifies as a hedge for accounting purposes and, if so, the nature of the hedging activity.
For those derivative instruments that are designated and qualify as hedging instruments, we must designate the hedging instrument, based upon the exposure being hedged, as either a cash flow hedge or a fair value hedge.
We enter into derivatives that are intended to qualify as hedges under accounting principles generally accepted in the United States, unless specifically stated otherwise. Toward this end, the terms of hedges are matched closely to the terms of hedged items.
With respect to derivative instruments that have not been designated as hedges, or are hedges on debt that is remeasured at fair value, any net payments under, or fluctuations in the fair value of, such derivatives are recognized currently in income. Our basis swaps have been designated as non-hedge derivatives.
In January 2008, we elected the fair value option for our bonds payable and its liability to subsidiary trusts issuing preferred securities. Accordingly, the changes in fair value of these financial instruments are recorded in earnings. As a result of this election, the interest rate swap agreements associated with these debt instruments no longer qualify for hedge accounting since the underlying debt is remeasured with changes in the fair value recorded in earnings. The unrealized gains or losses accumulated in other comprehensive income, related to these interest rate swaps, will be reclassified into earnings over the shorter of either the life of the swap or the associated debt with current mark-to-market unrealized gains or losses recorded in earnings.
Our derivative financial instruments contain credit risk to the extent that our bank counterparties may be unable to meet the terms of the agreements. We minimize such risk by limiting our counterparties to major financial institutions with single A or better credit ratings. In addition, the potential risk of loss with any one party resulting from this type of credit risk is monitored.
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Recent Accounting Pronouncements
In December 2010, the Financial Accounting Standards Board, or FASB, issued an accounting update specifying that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. Our adoption of this update will not have a material effect on our financial condition, results of operations, or cash flows.
Comparison of the Year Ended December 31, 2010 to the Year Ended December 31, 2009
Revenues
Interest Income
Interest income for the year ended December 31, 2010 totaled $318.8 million, representing an increase of $176.6 million, or 124%, compared to $142.2 million for the year ended December 31, 2009. For the year ended December 31, 2010, the increase in interest income was primarily attributable to: (i) the addition of $107.4 million in interest income as the result of the January 1, 2010 consolidation of the N-Star I, N-Star II, N-Star III and N-Star V CDO financings' available for sale securities and real estate debt investments; (ii) the addition of $67.2 million in interest income, of which $26.7 million was related to contractual interest, $23.6 million related to accretion of the discount on loans fully repaid and $16.9 million related to accretion of the discount on loans outstanding, as the result of the July 8, 2010 consolidation of CSE RE 2006-A CDO financing's real estate debt investments and available for sale securities and (iii) the addition of $21.2 million in interest income as the result of the July 7, 2010 consolidation of the N-Star IX CDO financing's available for sale securities and real estate debt investments partially offset by: (i) a lower average one-month LIBOR of approximately 8 basis points and lower comparable asset balances resulting in a decrease of approximately $19.2 million in interest income.
Interest Income—Related Parties
Interest income from related parties for the year ended December 31, 2010 totaled $1.1 million, representing a decrease of $16.6 million, or 94%, compared to $17.7 million for the year ended December 31, 2009. As of January 1, 2010, the consolidation of the N-Star I, N-Star II, N-Star III and N-Star V CDO financings, the original non-investment grade notes are no longer accounted for as available for sale securities, resulting in a decrease in interest income—related parties of $16.6 million.
Rental and Escalation Income
Rental and escalation income for the year ended December 31, 2010 totaled $124.8 million, representing an increase of $26.7 million, or 27%, compared to $98.1 million for the year ended December 31, 2009. The increase was primarily attributable to an increase of approximately $31.7 million related to the consolidation of Midwest as a result of our acquisition of the 51% membership interest in Midwest formerly owned by Chain Bridge and an increase in rental income of approximately $0.6 million related to a new lease on one of our properties, partially offset by a decrease of $5.2 million related to lower rents and the remaining vacancy at the Cincinnati, OH property and a decrease of $0.4 million related to the Chatsworth, CA property lease disaffirmation and foreclosure of the properties by the first mortgage lender in 2009.
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Advisory and Management Fee Income—Related Parties
Advisory fees from related parties for the year ended December 31, 2010 totaled $3.2 million, representing a decrease of approximately $4.1 million, or 56%, compared to $7.3 million for the year ended December 31, 2009. As of January 1, 2010, the related party advisory and management fee income earned on the N-Star I, N-Star II, N-Star III and N-Star V CDO financings is eliminated and included in interest income as a result of the consolidation of the respective CDO financings. The decrease in advisory and management fee income—related parties is attributable to the elimination of the advisory and management fee income earned on the previously non-consolidated CDO financings.
Commission Income
Commission income represents income earned by us for selling equity, through our broker-dealer subsidiary, principally, for the NorthStar Income Opportunity REIT I, Inc. For the year ended December 31, 2010, we recorded $2.5 million in commission income related to these capital raising efforts. We had no such commission income for the year ended December 31, 2009.
Other Revenue
Other revenue for the year ended December 31, 2010 totaled $3.3 million, representing an increase of $2.6 million, or 371%, compared to $0.7 million for the year ended December 31, 2009. Other revenue for the year ended December 31, 2010 consisted primarily $1.4 million in exit fees, $0.9 million in early redemption fees on available for sale securities and $1.0 million in other fees. Other revenue for year ended December 31, 2009 consisted primarily of $0.3 million in assumption and late fees, $0.2 million in unused credit line fees and $0.2 million in other fees.
Expenses
Interest Expense
Interest expense for the year ended December 31, 2010 totaled $131.3 million, representing an increase of $10.0 million, or 8%, compared to $121.3 million for the year ended December 31, 2009. The increase in interest was primarily the result of: (i) the addition of $19.1 million in interest expense as the result of the January 1, 2010 consolidation of the N-Star I, N-Star II, N-Star III and N-Star V CDO bonds payable; (ii) the addition of $4.8 million in interest expense as the result of the July 8, 2010 acquisition and consolidation of CSE RE 2006-A CDO bonds payable; (iii) the addition of $2.7 million in interest expense as the result of the July 7, 2010 consolidation of the N-Star IX CDO bonds payable; and (iv) $1.4 million in additional interest related to the Term Asset-Backed Securities Loan Facility, or TALF, program debt. The increase in interest expense was partially offset by; (i) $9.7 million lower interest on our issued CDO notes and trust preferred debt due to lower average LIBOR rates and interest savings during 2010 relating to debt repurchases and repayments made in 2009; (ii) $4.2 million in lower interest as a result of the June 30, 2010 repayment of the WA Secured Term Loan and Euro-note; (iii) $3.8 million lower interest on our 11.50% and 7.25% exchangeable senior notes due to 2009 and 2010 repurchases; and (iv) $0.2 million lower interest related to the termination of our unsecured revolving credit facility in 2009.
Real Estate Properties—Operating Expenses
Real estate property operating expenses for the year ended December 31, 2010 totaled $37.7 million, representing an increase of $23.0 million, or 156%, compared to $14.7 million for year ended December 31, 2009. The increase was primarily attributable $25.6 million related to the consolidation of Midwest as a result of our acquisition of the 51% membership interest in Midwest, formerly owned by Chain Bridge, partially offset by $1.4 million related to a reduced real estate tax assessment, lower expenses of approximately $0.9 million due to reduced occupancy and a decrease of
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$0.3 million related to the first mortgage lender foreclosing on the Chatsworth, CA properties in during the third quarter of 2009.
Asset Management Fees—Related Party
Advisory fees for related parties for the year ended December 31, 2010 totaled $0.5 million, representing a decrease of $2.9 million, or 85%, compared to $3.4 million for the year ended December 31, 2009. The decrease was primarily related to lower asset management fees associated with our healthcare portfolio due to the internalization of our healthcare management team.
Commission Expense
Commission expense represents the portion of commission income which is paid to broker dealers with whom we have distribution agreements. For the year ended December 31, 2010, we recorded $1.9 million in commission expense related to capital raising efforts. We had no such commission expense for the year ended December 31, 2009.
Impairment on Operating Real Estate
Impairment on Operating Real Estate for the year ended December 31, 2010 totaled $5.2 million. We had no impairment on operating real estate for the year ended December 31, 2009. The impairment relates to three office properties totaling 486,963 square feet located in Cincinnati, OH, which is 36% leased as of December 31, 2010. At December 31, 2010, the buildings had a combined $53.7 million net book value and are financed with a non-recourse $51.5 million first mortgage loan.
Provision for Loan Losses
Provision for loan losses for the year ended December 31, 2010 totaled $168.4 million for 16 loans and includes $23.5 million aggregate provision for eight loans sold or held for sale, and one of which was foreclosed during the year, net of $1.3 million of credits for two loans sold with a fair market value in excess of their carrying amounts. The provision for loan losses for 2010 includes $35.7 million for first mortgage loans, $53.0 million for subordinated mortgage interests, $79.8 million for mezzanine loans and $1.8 million in credits for first mortgage loans. The provision for loan losses for 2009 includes $38.0 million for first mortgage loans, $16.0 million for subordinated mortgage interests and $29.7 million for mezzanine loans.
General and Administrative
General and administrative expenses for the year ended December 31, 2010 totaled $89.4 million, representing an increase of $18.9 million, or 27%, compared to $70.5 million for the year ended December 31, 2009. The primary components of our general and administrative expenses were the following:
Salaries and equity-based compensation for the year ended December 31, 2010 totaled $54.8 million, representing an increase of approximately $7.6 million, or 16%, compared to $47.2 million, for the year ended December 31, 2009. The increase was attributable to an $11.1 million increase related to salaries and accrued cash incentive compensation costs partially offset by a $3.5 million decrease related to equity-based compensation. The $11.1 million increase in salaries and accrued compensation was attributable to a one-time expense of $3.5 million relating to the separation and consulting agreement with our former COO and higher staffing levels in 2010 primarily relating to our broker-dealer subsidiary and internalizing management of our healthcare management team. The $3.5 million decrease in equity-based compensation expense was attributable to a $6.6 million decrease in expense from equity-based awards issued under our 2004 Omnibus Stock Incentive Plan becoming fully vested. The decrease was partially offset by an additional $1.0 million of equity-based
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compensation expense related to the accelerated vesting of equity-based awards in connection with the separation agreement with our former COO and a $2.1 million increase in equity-based compensation expense related to the long-term incentive component of our incentive compensation plan.
Auditing and professional fees for the year ended December 31, 2010 totaled $13.8 million, representing an increase of $4.2 million, or 44%, compared to $9.6 million for the year ended December 31, 2009. The increase was primarily attributable to approximately a $1.4 million increase in legal fees for general corporate work, and portfolio management, $1.9 million increase in legal fees related to our non-listed and private REITs, a $1.3 million increase in fees relating to capital raising, asset sales and membership redemption in our healthcare portfolio and a $0.2 million increase in legal fees related to the Chatsworth property foreclosure, partially offset by a decrease of $0.6 million related to 2009 lease restructuring expenses in our healthcare portfolio.
Other general and administrative expenses for the year ended December 31, 2010 totaled $19.7 million, representing an increase of approximately $6.3 million, or 47%, compared to $13.4 million for the year ended December 31, 2009. The increase was primarily attributable to a $2.0 million fee related to the Chatsworth surety bond, $1.8 million of increased overhead costs relating to opening our Denver, Colorado office for our broker-dealer subsidiary and a Bethesda, Maryland office for our healthcare management team during 2010, legal fees and other costs related to investment initiatives ultimately not consummated of approximately $1.5 million, increased taxes of approximately $0.8 million principally related to our Midwest taxable REIT subsidiary, increased costs relating to REO properties of $0.6 million, and $0.4 million of costs associated with the acquisition of the CSE Re 2006-A CDO.
Depreciation and Amortization
Depreciation and amortization expense for the year ended December 31, 2010 totaled $34.1 million, representing a decrease of $7.6 million, or 18%, compared to $41.7 million for the year ended December 31, 2009. The decrease was primarily related to a decrease of $7.7 million attributable to the 2009 write-off of certain costs associated with the lease restructuring and termination of one of our operators in our healthcare portfolio, a decrease of $1.0 million related to deferred lease costs and tenant improvements in our net lease portfolio being fully amortized and a decrease of $0.2 million related to charges associated with the 2009 foreclosure by the first mortgage lender of the Chatsworth, CA property. The decrease was partially offset by an increase of $0.6 million related to 2010 new operating real estate improvements and $0.6 million related to the authorization of intangible asset.
Equity in Earnings (Loss) of Unconsolidated Ventures
Equity in earnings (loss) for the year ended December 31, 2010 was net earnings of $2.3 million, representing an increase of $4.1 million, compared to a loss of $1.8 million for the year ended December 31, 2009. For 2010, we recognized equity in earnings of $8.3 million from the sale of corporate lending investment, $2.5 million from our previously unconsolidated affiliated lessee formed in 2009 resulting from the termination of a lease to a third party in our healthcare real estate portfolio, and $0.5 million in connection with a net lease joint venture. The equity in earnings was partially offset by equity in losses of $3.9 million from the Securities Fund (which includes both realized and unrealized gains from asset sales and mark-to-market adjustments), $2.9 million on our equity investment in the NJ Property and $2.5 million from the LandCap joint venture. For 2009, we recognized equity in losses of $6.5 million from the Securities Fund (which includes both realized and unrealized gains from asset sales and mark-to-market adjustments) and $3.7 million from the LandCap joint venture. The losses were partially offset by equity in earnings of $8.0 million from our unconsolidated affiliated lessee formed in 2009 resulting from the termination of a lease to a third party in our healthcare real estate portfolio, and $0.4 million in connection with a net lease joint venture.
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Unrealized Gain (Loss) on Investments and Other
Unrealized gain/(loss) on investments and other decreased by approximately $326.6 million for the year ended December 31, 2010 to a loss of $538.6 million, compared to a loss of $210.0 million for the year ended December 31, 2009. The unrealized loss on investments and other for 2010 consisted primarily of unrealized mark-to-market losses of $668.0 million on various issued CDO bonds payable resulting from decreasing market credit spreads increasing the values of these liabilities, and $140.7 million of unrealized losses on interest rate swap derivatives. The $140.7 million of swap losses is comprised of approximately $100.0 million of net cash payments under the swaps, and $40.7 million of mark-to-market adjustments. The 2010 losses also include $24.2 million of mark-to-market adjustments relating to the liability to subsidiary trusts issuing preferred securities. The unrealized losses in 2010 were partially offset by $294.3 million of unrealized gains related to positive mark-to-market adjustments on available for sales securities assets, also caused primarily by decreasing credit spreads. The unrealized loss on investments for the year ended December 31, 2009 consisted primarily of unrealized losses related to mark-to-market adjustments of $97.4 million on liability to subsidiary trusts issuing preferred securities and $51.1 million on various N-Star bonds payable resulting from decreasing market credit spreads increasing the values of these liabilities, unrealized losses related to mark-to-market adjustments of $31.1 million on our corporate lending joint venture (which is an equity investment that is marked to market), unrealized losses of $22.1 million on interest rate swap derivatives no longer qualifying, or not designated as, hedging instruments and unrealized losses of $8.3 million on various available for sale securities. The $22.1 million of swap losses is comprised of approximately $21.1 million of net cash payments under the swaps, and $1.0 million of mark-to-market adjustments.
Realized Gain on Investments and Other
The realized gain of $145.7 million for the year ended December 31, 2010 consisted primarily of a realized gain of approximately $95.9 million on the repayment and extinguishment of our WA Secured Term Loan, net realized gains of approximately $76.2 million on the sale of certain available for sale securities, a gain of $7.5 million on the sale of our interest in our middle market corporate lending venture, a gain of approximately $2.5 million on the sale of certain real estate debt investments, a net foreign currency translation gain of $1.2 million related to our Euro-denominated investment and a net gain of $0.4 million on the repurchase of certain notes payable. The realized gains were partially offset by a realized loss of approximately $35.3 million related to the 40% participation interest in the principal proceeds of the German Loan granted to the lender upon repayment and extinguishment of our WA Secured Term Loan, a realized loss of approximately $0.4 million on the redemption of available for sale securities, a realized loss of approximately $1.6 million related to other-than-temporary impairments on certain available for sale securities and a $0.3 million realized loss on the termination of an interest rate swap. The realized gain of $128.5 million for the year ended December 31, 2009 consisted primarily of net realized gains of $51.3 million on the repurchase of $92.6 million face amount of our 7.25% exchangeable senior notes, $8.2 million on the repurchase of $19.3 million face amount of our 11.5% exchangeable senior notes, net realized gains of $73.3 million on the sale of certain real estate debt securities available for sale, a $0.4 million gain on the repurchase of various N-Star bonds and $0.2 million in various write-offs on the sale of real estate debt investments, offset partially by realized losses of $3.8 million related to the discounted payoff of a first mortgage, losses of $0.7 million on the abandonment of CDO notes and a foreign currency translation loss of $0.7 million related to our Euro-denominated investment.
Gain on Acquisitions
On July 8, 2010, the Company consolidated the assets acquired and liabilities assumed of the CSE RE 2006-A CDO and recorded a gain of approximately $15.4 million for the year ended December 31,
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2010, resulting from the excess of the fair market value of the net assets acquired over the purchase price. We had no such gain for the year ended December 31, 2009.
(Loss)/Income from Discontinued Operations
Loss/income from discontinued operations represents the operations of properties sold or held for sale during the period. As of December 31, 2010, we recorded as held for sale, two REO parcels of land located in Arizona, and an REO multifamily property located in Georgia, both of which were acquired in connection with the acquisition of CSE RE 2006-A and an REO office building containing 142,988 square feet located in Philadelphia, PA. In May 2010, we completed the sale of a leasehold interest containing approximately 10,800 square feet of retail space located in New York City. In December 2009, NRF Healthcare, LLC completed the sale of 18 assisted living facilities containing approximately 1,300 beds located in North Carolina. Accordingly, a loss of $2.0 million and income of $2.2 million, respectively, related to the operations of these properties was reclassified to income from discontinued operations for the year ended December 31, 2010 and 2009.
Gain on Sale from Discontinued Operations
In May 2010, we completed the sale of a leasehold interest containing approximately 10,800 square feet of retail space located in New York City to a private investor group for approximately $3.3 million, representing a gain of approximately $2.5 million. In December 2009, we sold a portfolio of 18 assisted living facilities located in North Carolina and recognized a gain on sale of $13.8 million for the year ended December 31, 2009.
Comparison of the Year Ended December 31, 2009 to the Year Ended December 31, 2008
Revenues
Interest Income
Interest income for the year ended December 31, 2009 totaled $142.2 million, representing a decrease of $70.2 million, or 33%, compared to $212.4 million for the year ended December 31, 2008. In 2009, the combination of a lower average one-month LIBOR of approximately 247 basis points and lower comparable asset balances resulted in a decrease of approximately $65.4 million in interest income. In addition, the recapitalization and deconsolidation of our corporate lending venture in 2008 further decreased interest income by $11.3 million. The decrease was partially offset by a net increase to interest income of approximately $6.5 million resulting primarily from the acquisition during 2009 of higher yielding commercial real estate securities and real estate debt investment fundings with a net book value of $481.2 million subsequent to December 31, 2008 offset by approximately $465.3 million of investment dispositions and repayments during 2009.
Interest Income—Related Parties
Interest income from related parties for the year ended December 31, 2009 totaled $17.7 million, representing an increase of $2.7 million, or 18%, compared to $15.0 million for the year ended December 31, 2008. The increase is attributable to securities purchases within our non-consolidated CDO financings in which we own the non-investment grade note classes. We are earning higher yields on securities purchased during 2009 due to wider credit spreads. All of our real estate securities CDO financings completed since 2006, in which we retain the equity notes, have been accounted for as on-balance sheet financings.
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Rental and Escalation Income
Rental and escalation income for the year ended December 31, 2009 totaled $98.1 million, representing a decrease of $9.5 million, or 19%, compared to $107.6 million for the year ended December 31, 2008. The decrease was primarily attributable to decreases of $8.4 million related to the Reading, PA property lease termination in 2008 and the Chatsworth, CA property lease disaffirmation and foreclosure of the properties by the first mortgage lender in 2009, a decrease of $7.4 million was attributable to the change of our net lease relationship with one of our healthcare operators, which resulted in one of our unconsolidated affiliates becoming the lessee of the properties and our unconsolidated affiliate simultaneously entered into a management agreement with a third party operator and $0.9 million related to lower rents on the lease renewal for the Cincinnati, OH property for the year ended December 31, 2009 as compared to the year ended December 31, 2008, partially offset by an increase in rental income of $5.9 million related to the restructuring and termination of two of our leases with an operator in our healthcare portfolio and a $1.4 million increase in rental income in our net lease healthcare portfolio for leases, which are based on CPI indices.
Advisory and Management Fee Income—Related Parties
Advisory fees from related parties for the year ended December 31, 2009 totaled $7.3 million, representing a decrease of approximately $5.2 million, or 42%, compared to $12.5 million for the year ended December 31, 2008. The decrease was primarily attributable to the sale of 67% of the advisory fee income stream from one of our CDO financings to the Securities Fund which resulted in the recognition of an additional $4.8 million in advisory fee income during the second quarter 2008. In addition, the reinvestment periods have expired in two of our CDO financings resulting in lower advisory fees due to collateral payoffs.
Other Revenue
Other revenue for the year ended December 31, 2009 totaled $0.7 million, representing a decrease of $15.8 million, or 96%, compared to $16.5 million for the year ended December 31, 2008. Other revenue for year ended December 31, 2009 consisted primarily of $0.3 million in assumption and late fees, $0.2 million in unused credit line fees and $0.2 million in other fees. Other revenue for the year ended December 31, 2008 consisted primarily of: (i) a $9.0 million lease termination fee; (ii) $5.6 million in profit participation proceeds from modifications of real estate debt investments; (iii) $0.6 million of exit fees; and (iv) $1.3 million of unused credit line fees, prepayment penalties, draw fees and other miscellaneous revenue.
Expenses
Interest Expense
Interest expense for the year ended December 31, 2009 totaled $121.3 million, representing a decrease of $69.2 million, or 36%, compared to $190.5 million for the year ended December 31, 2008. The decrease in interest was primarily the result of: (i) $40.1 million lower interest on our issued CDO notes and trust preferred debt due to lower average LIBOR rates, debt repurchases and repayments; (ii) $8.2 million lower interest on our 7.25% exchangeable senior notes due to repurchases; (iii) $5.9 million lower interest as a result of the recapitalization, termination and de-consolidation of our corporate lending venture in 2008; (iv) $7.9 million lower interest relating to lower average balances and lower LIBOR rates on our WA Secured Term Loan; (v) $3.9 million in lower interest rates on our Euro-note; (vi) $3.1 million lower interest as a result of the foreclosure by the first mortgage lender of our Chatsworth, CA properties; (vii) $2.2 million lower interest related to the termination of our unsecured revolving credit line in May 2008; and (viii) $1.1 million lower interest related to lower average balances on repurchase obligations. The decrease in interest expense was
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partially offset by $3.2 million in additional expense from our $80.0 million 11.50% exchangeable senior notes issued in May 2008.
Real Estate Properties—Operating Expenses
Real estate property operating expenses for year ended December 31, 2009 totaled $14.7 million, representing an increase of $6.5 million, or 77%, compared to $8.2 million for year ended December 31, 2008. The increase was primarily attributable to $7.0 million of operating expenses now consolidated in our financial statements resulting from terminating two of our net leases with an operator in our healthcare portfolio. The properties will continue to be managed by third parties and we will now consolidate the revenues and expenses relating to these operations. The increase was also attributable to expenses of $0.5 million that are no longer reimbursed related to the Reading, PA facility that is now vacant, partially offset by $1.0 million in lower expenses as a result of the first mortgage lender foreclosing on the Chatsworth, CA properties.
Asset Management Fees—Related Party
Advisory fees for related parties for the year ended December 31, 2009 totaled $3.4 million, representing a decrease of $1.3 million, or 28%, compared to $4.7 million for the year ended December 31, 2008. The decrease was primarily attributable to the termination of the corporate lending joint venture agreement. We incurred $3.4 million in asset management fees associated with our healthcare portfolio and no management fees to the corporate lending joint venture for the year ended December 31, 2009, respectively. We incurred $3.4 million of asset management fees associated with our healthcare portfolio and $1.3 million of management fees to our former corporate lending venture for the year ended December 31, 2008, respectively.
Fundraising Fees and Other Joint Venture Costs
We did not incur any fundraising fees and other joint venture costs for the year ended December 31, 2009. In 2008 these costs included a $2.9 million write-off of goodwill relating to our NRF Capital acquisition in 2005.
Impairment on Operating Real Estate
We had no impairment on operating real estate for the year ended December 31, 2009 compared to a $5.6 million impairment for the year ended December 31, 2008. The impairment on operating real estate was taken on our net investment comprised of three office buildings totaling 257,000 square feet located in Chatsworth, CA and 100% leased as of December 31, 2008. The buildings had a combined $57.0 million net book value and were financed with a non-recourse $43.0 million first mortgage loan and a $9.3 million mezzanine loan. On February 5, 2009, we became aware the tenant intended to vacate the properties by March 23, 2009. As a result, we determined that we would return the property back to the first mortgage lender and accordingly, we took an impairment charge of $5.6 million as of December 31, 2008.
Provision for Loan Losses
Provision for loan losses for the year ended December 31, 2009 totaled $83.7 million for 15 loans. The provision for loan losses for 2009 included $38.0 million for first mortgage whole loans, $16.0 million for subordinated mortgage interests and $29.7 million for mezzanine loans. Provision for loan losses for 2008 totaled $11.2 million. During 2008, we recorded $15.7 million for 10 separate loans and reversed $4.5 million of reserves relating to four separate loans due to resolution of the impairment which resulted in the original reserve.
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General and Administrative
General and administrative expenses for the year ended December 31, 2009 totaled $70.5 million, representing a decrease of $4.3 million, or 6%, compared to $74.8 million for the year ended December 31, 2008. The primary components of our general and administrative expenses were the following:
Salaries and equity-based compensation for the year ended December 31, 2009 totaled $47.2 million, representing a decrease of approximately $6.1 million, or 11%, compared to $53.3 million, for the year ended December 31, 2008. The decrease was attributable to a $1.9 million decrease related to salaries and accrued cash incentive compensation costs and a $4.2 million decrease related to equity-based compensation. The $1.9 million decrease in salaries and accrued compensation was attributable to lower staffing levels in 2009. Included in salaries and accrued cash incentive compensation cost for 2009 and 2008 are $4.6 million and $2.2 million, respectively, of deferred cash incentive compensation payable in future periods upon continuing employment. The $4.2 million decrease in equity-based compensation expense was attributable to the one-time grants of $0.7 million in 2008 in connection with employee compensation arrangements and $1.2 million in connection with employee separation agreements. In addition, approximately $2.2 million of the decrease was attributable to a decrease of vesting of equity-based awards issued under our 2004 Omnibus Stock Incentive Plan and our 2006 Outperformance Plan relating to awards fully vesting and a $0.1 million decrease in our annual director's grants.
Auditing and professional fees for the year ended December 31, 2009 totaled $9.6 million, representing an increase of $2.5 million, or 35%, compared to $7.1 million for the year ended December 31, 2008. The increase was primarily attributable to approximately $1.2 relating to lease restructuring expense in our healthcare portfolio, and a $1.3 million increase in legal fees for general corporate work, and portfolio management.
Other general and administrative expenses for the year ended December 31, 2009 totaled $13.6 million, representing a decrease of approximately $1.4 million, or 12%, compared to $14.5 million for the year ended December 31, 2008. The decrease was primarily attributable to decreased overhead costs resulting from lower staffing levels during the year ended December 31, 2009.
Depreciation and Amortization
Depreciation and amortization expense for the year ended December 31, 2009 totaled $41.7 million, representing an increase of $0.7 million, or 2%, compared to $41.0 million for the year ended December 31, 2008. This increase was primarily attributable to an increase of $6.3 million related to the write off of certain costs associated with the lease restructuring and termination of two of our leases with an operator in our healthcare portfolio and our restructured net lease relationship with one of our healthcare operators partially offset by lower depreciation and amortization of $5.7 million relating to the lease termination for the Reading, PA property and the foreclosure by the first mortgage lender of the Chatsworth, CA property.
Equity in (Loss) of Unconsolidated Ventures
Equity in (loss) for the year ended December 31, 2009 was a net $1.8 million loss, representing a decrease of $10.1 million, compared to a loss of $11.9 million for the year ended December 31, 2008. For the year ended December 31, 2009, we recognized equity in losses of $6.5 million from the Securities Fund (which includes both realized and unrealized gains from asset sales and mark-to-market adjustments) and $3.7 million from the LandCap joint venture. The losses were partially offset by equity in earnings of $8.0 million from our unconsolidated affiliated lessee formed in 2009, resulting from the termination of a lease to a third party in our healthcare real estate portfolio and $0.4 million in connection with a net lease joint venture. For the year ended December 31, 2008, we recognized
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equity in losses of $12.4 million from the Securities Fund and equity in loss of $3.4 million on the LandCap joint venture. The losses in 2008 were partially offset by income from our investment in a corporate lending venture prior to terminating the joint venture in May 2008, from which we recognized $3.4 million of equity in earnings and $0.5 million in connection with our net lease joint venture.
Unrealized Gain (Loss) on Investments and Other
Unrealized gain (loss) on investments and other decreased by approximately $859.1 million for the year ended December 31, 2009 to a loss of $210.0 million, compared to a gain of $649.1 million for the year ended December 31, 2008. The unrealized loss on investments for the year ended December 31, 2009 consisted primarily of unrealized mark-to-market losses of $97.4 million on liability to subsidiary trusts issuing preferred securities and $51.1 million on various issued CDO bonds payable resulting from decreasing market credit spreads increasing the values of these liabilities, unrealized mark-to-market losses of $31.1 million on our corporate lending joint venture (which is an equity investment that is marked to market), unrealized losses of $22.1 million on interest rate swap derivatives no longer qualifying, or not designated as, hedging instruments and unrealized losses of $8.3 million on various available for sale securities. The $22.1 million of swap losses is comprised of approximately $21.1 million of net cash payments under the swaps, and $1.0 million of mark-to-market adjustments. The unrealized gain on investment for the year ended December 31, 2008 consisted primarily of unrealized mark-to-market gains of $958.2 million on various N-Star CDO bonds payable and $95.2 million on liability to subsidiary trusts issuing preferred securities, offset partially by unrealized mark-to-market losses of $338.0 million on various available for sale securities, $30.0 million on our corporate lending joint venture and $36.3 million on interest rate swaps as a result of these swaps no longer qualifying for hedge accounting.
Realized Gain on Investments and Other
The realized gain of $128.5 million for the year ended December 31, 2009 consisted primarily of net realized gains of $51.3 million on the repurchase of $92.6 million face amount of our 7.25% exchangeable senior notes, $8.2 million on the repurchase of $19.3 million face amount of our 11.5% exchangeable senior notes, net realized gains of $73.3 million on the sale of certain real estate debt securities available for sale, a $0.4 million gain on the repurchase of various N-Star bonds and $0.2 million in various write-offs on the sale of real estate debt investments, offset partially by realized losses of $3.8 million related to the discounted payoff of a first mortgage, losses of $0.7 million on the abandonment of CDO notes and a foreign currency translation loss of $0.7 million related to our Euro-denominated investment. The realized gain on investments and other of $37.7 million for the year ended December 31, 2008, was attributable to the recapitalization of our corporate loan venture in which we recognized a $46.0 million realized gain upon the extinguishment of a portion of the debt, a simultaneous $27.1 million cost basis reduction of our investment in the recapitalized venture and a realized loss of $18.9 million related to the sale of certain corporate loans within the portfolio. In addition, in 2008, we recognized a $38.2 million gain on the repurchase of various N-Star bonds, exchangeable senior notes and liability to subsidiary trusts issuing preferred securities, a foreign currency translation loss of $0.3 million related to our Euro-denominated investment and a $0.2 million loss on the sale of certain securities.
Income from Discontinued Operations
Income from discontinued operations represents the operations of properties sold or held for sale during the period. In May 2010, we completed the sale of a leasehold interest containing approximately 10,800 square feet of retail space located in New York City. In December 2009, NRF Healthcare, LLC completed the sale of 18 assisted living facilities containing approximately 1,300 beds located in North
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Carolina. Accordingly, net income of $2.2 million and $2.4 million related to the operations of these properties was reclassified to income from discontinued operations for the years ended December 31, 2009 and 2008, respectively.
Gain on Sale from Discontinued Operations
In December 2009, we sold a portfolio of 18 assisted living facilities located in North Carolina and we recognized a gain on sale of $13.8 million for the year ended December 31, 2009. We had no such gain on sale for the year ended December 31, 2008.
Liquidity and Capital Resources
We require significant capital to fund our investment activities and operating expenses. Our capital sources may include cash flow from operations, net proceeds from asset repayments and sales, borrowings under revolving credit facilities, financings secured by our assets such as first mortgage and CDO financings, long-term senior and subordinate corporate capital such as senior notes, senior notes exchangeable into common stock, trust preferred securities and perpetual preferred and common stock. As we discussed in "Outlook and Recent Trends", availability of such capital from all of these sources is extremely scarce (if available at all) for legacy commercial mortgage REITs, and this capital may be difficult to obtain during 2011; however, we will seek to obtain any such capital opportunities if it becomes available.
Our total available liquidity at December 31, 2010 was approximately $240.6 million, including $125.4 million of unrestricted cash and cash equivalents and $115.2 million of uninvested and available funds in our CDO financings, which is available only for reinvestment within the CDO structures. On June 30, 2010, we fully repaid and extinguished, at a discount to the outstanding principal amount, our WA Secured Term Loan having an outstanding principal balance of approximately $304.0 million and secured by assets having an aggregate unpaid principal balance of approximately $448.6 at the time of the payoff. We paid approximately $208.0 million of cash and granted the lender a 40% participation interest in the principal proceeds of the German Loan owned by us that is collateralized by a German retail portfolio.
As set forth in our periodic reports filed with the SEC, one of our net lease investments was comprised of three office buildings totaling 257,000 square feet located in Chatsworth, CA and was 100% leased to WaMu. NNN, which is a subsidiary of ours, is a defendant in the Lawsuit, filed by the Lender, in the Superior Court of the State of California, County of Los Angeles, relating to a loan the properties previously owned by one of our subsidiaries, NRFC Sub IV, that were 100% leased to WaMu. The Lawsuit alleges, among other things, that the loan provided by Lender to NRFC Sub IV became a recourse obligation of NNN due to an alleged termination of the Lease. The judge presiding over the Lawsuit granted the Lender's motion for summary judgment and, accordingly, entered a judgment against NNN in the amount of approximately $45 million. NNN intends to vigorously pursue an appeal of the decision. In connection with such appeal, pursuant to California law NNN is required to post a bond in an amount equal to one and a half times the amount of the Judgment (the "Bond"). Accordingly, we have entered into a standard General Agreement of Indemnity with an issuer of surety bonds (the "Surety Agreement"), which could require us to post collateral equal to the amount of the Bond. As part of the Surety Agreement, in connection with the expected issuance of the Bond, we have agreed to post cash collateral equal to 38% of the amount of the Bond and posted approximately $26 million cash collateral in January 2011.
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On July 10, 2010, we were notified by Inland American that it desires to have NRF Healthcare, LLC engage in a sale process for a portfolio of 34 senior housing properties or otherwise redeem $50 million of Inland American's convertible preferred membership interest in NRF Healthcare, LLC by January 9, 2011. If NRF Healthcare, LLC has not redeemed $50 million of the Inland American investment or sold the 34 property senior housing portfolio by October 9, 2011, then Inland American may undertake a sale process for the portfolio. Inland American may also undertake a sale process for all of the assets of NRF Healthcare, LLC beginning August 8, 2011, unless at least $25 million of Inland American's preferred interest has been redeemed by June 10, 2011, in which case all future net cash flow to the common members of NRF Healthcare, LLC will be used to redeem the preferred membership interest. On July 8, 2012, if the preferred membership interest has not been redeemed in full, Inland American may sell the assets of NRF Healthcare, LLC. We are currently exploring alternatives for partial and/or full redemption of the preferred membership interest.
As a REIT, we are required to distribute at least 90% of our annual REIT taxable income to our stockholders, including taxable income where we do not receive corresponding cash, and we intend to distribute all or substantially all of our REIT taxable income in order to comply with the REIT distribution requirements of the Internal Revenue Code and to avoid federal income tax and the non-deductible excise tax. In the past, we have maintained high unrestricted cash balances relative to the historical difference between our distributions and cash provided by operating activities. On a quarterly basis, our Board of Directors determines an appropriate common stock dividend based upon numerous factors, including AFFO, REIT qualification requirements, the amount of cash flows provided by operating activities, availability of existing cash balances, borrowing capacity under existing credit agreements, access to cash in the capital markets and other financing sources, our view of our ability to realize gains in the future through appreciation in the value of our assets, general economic conditions and economic conditions that more specifically impact our business or prospects. Although we significantly reduced the cash portion of quarterly dividends paid in 2009 and 2010 relative to prior periods, future dividend levels are subject to further adjustment based upon our evaluation of the factors described above, as well as other factors that our Board of Directors may, from time to time, deem relevant to consider when determining an appropriate common stock dividend.
We currently believe that our existing sources of funds should be adequate for purposes of meeting our short-term liquidity needs; however, our CDO financing structures require that the underlying collateral and cash flow generated by the collateral to be in excess of ratios stipulated in the related indentures. These ratios are called overcollateralization, or OC, and interest coverage, or IC, tests. The reinvestment periods, which allow us to reinvest principal payments on the underlying assets into qualifying replacement collateral and is instrumental in maintaining OC and IC ratios, for our N-Star CDO I, II, III, IV and V have expired, and, for our N-Star CDO VI, N-Star CDO VII, N-Star CDO VIII and N-Star CDO IX will expire in June 2011, June 2011, February 2012 and June 2012, respectively. Since we are or will be unable to reinvest principal in these CDOs, principal repayments will pay down the senior-most notes, which will de-lever the CDO. Following the conclusion of the reinvestment period in these CDOs, our ability to maintain the OC and IC ratios will be negatively impacted. In the event these tests are not met, cash that would normally be distributed to us would be used to amortize the senior notes until the financing is back in compliance with the tests. In the event cash flow is diverted to repay the notes, this could decrease cash available to pay our dividend and to comply with REIT requirements. Additionally, we may be required to buy assets out of our CDO financings in order to preserve cash flow. As of December 31, 2010, N-Star CDO II was not in compliance with its OC and IC tests and CSE RE 2006-A was in compliance with its IC test but not its OC test. We expect that weak economic conditions, lack of capital for "legacy" commercial real estate and credit ratings downgrades of real estate securities will make complying with OC and IC tests more difficult in the future.
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The following is a summary of our CDO cash distribution and coverage tests as of December 31, 2010:
| | | Cash Distributions(1) | Quarterly Interest Coverage Cushion(2) | Overcollateralization Cushion | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Primary Collateral Type | Quarter Ended December 31, 2010 | December 31, 2010 | December 31, 2010 | At Offering | ||||||||||
N-Star I | CMBS | $ | 250 | $ | 573 | $ | 19,522 | $ | 8,687 | ||||||
N-Star II | CMBS | 0 | (220 | ) | (3,370 | ) | 10,944 | ||||||||
N-Star III | CMBS | 1,894 | 1,880 | 22,378 | 13,610 | ||||||||||
N-Star IV | Loans | 2,283 | 1,765 | 69,908 | 19,808 | ||||||||||
N-Star V | CMBS | 1,608 | 2,888 | 13,678 | 12,940 | ||||||||||
N-Star VI | Loans | 1,608 | 854 | 39,177 | 17,412 | ||||||||||
N-Star VII | CMBS | 2,091 | 887 | 9,433 | 13,966 | ||||||||||
N-Star VIII | Loans | 3,535 | 3,779 | 83,258 | 42,193 | ||||||||||
N-Star IX | CMBS | 2,171 | 2,684 | 27,248 | 24,516 | ||||||||||
CSE RE 2006-A | Loans | 0 | 3,675 | (3,506 | ) | (151,595) | (3) | ||||||||
Table shows cash distributions to the retained income notes. Interest coverage and overcollateralization coverage to the most constrained class.
- (1)
- Cash distributions are exclusive of senior management fees which are not subject to the coverage tests.
- (2)
- Quarterly interest cushion and overcollateralization cushions from remittance report issued on date nearest to December 31, 2010.
- (3)
- CSE RE 2006-A based on trustee report as of June 24, 2010, which was closest to the date of acquisition.
We will seek to meet our long term liquidity requirements, including the repayment of debt and our investment funding needs, through existing cash resources, opportunistic issuances of debt or equity capital, including exchangeable notes, our existing CDOs and the liquidation or refinancing of assets at maturity; nonetheless, our ability to meet a long-term (beyond one year) liquidity requirement may be subject to obtaining additional debt and equity financing. Any decision by our lenders and investors to provide us with financing will depend upon a number of factors, such as our compliance with the terms of its existing credit arrangements, our financial performance, industry or market trends, the general availability of and rates applicable to financing transactions, such lenders' and investors' resources and policies concerning the terms under which they make capital commitments and the relative attractiveness of alternative investment or lending opportunities.
Modification of Mortgage Loan
We own a partially vacant net lease property located in Cincinnati, Ohio. In November 2010, the mortgage lender declared a payment default and, in December 2010, began foreclosure proceedings on the property. We are currently in discussions with the lender seeking to modify the mortgage terms; however, there can be no assurance that there will be a favorable resolution and the lender may ultimately foreclose on the property.
Mortgage note refinancing
On March 31, 2010, we closed on a $65.0 million loan with General Electric Capital Corporation. The proceeds were primarily used to refinance $52.0 million of loans maturing in 2010 on nine of our
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healthcare-related net leased assets. The excess proceeds from the financing will be used for working capital and general corporate purposes. The loan has a five-year term with a one-year interest only period and principal and interest payments thereafter. The interest rate is 90-day LIBOR + 5.95% with a 1% LIBOR floor.
Debt Repurchases
During the year ended December 31, 2010, we repurchased approximately $87.5 million face amount of our N-Star CDO and CSE RE 2006-A bonds payable for a total of $14.0 million. We recorded a total net realized gain of $0.4 million in connection with the repurchase the bonds for the year ended December 31, 2010. The repurchase of the bonds for the year ended December 31, 2010 also represented an aggregate $73.1 million discount to the par value of the debt.
During the year ended December 31, 2009, we repurchased approximately $92.6 million face amount of our 7.25% exchangeable senior notes for a total of $40.0 million, $19.3 million face amount of our 11.50% exchangeable senior notes for a total of $10.2 million and $27.4 million face amount of our N-Star CDO bonds payable for a total of $5.4 million. We recorded a total net realized gain of $59.9 million in connection with the repurchase of our notes and bonds for the year ended December 31, 2009. The repurchase of the notes and bonds for the year ended December 31, 2009 also represented an aggregate $83.7 million discount to the par value of the debt.
Secured Term Loan
On October 28, 2009, in connection with the WA Secured Term Loan, we entered into a warrant agreement, or the Warrant Agreement, with the lender under which we issued 1,000,000 warrants, or the Warrants, to the lender to purchase one million shares of our common stock. 500,000 Warrants are exercisable through October 28, 2019, at a price of $7.50 per share, 250,000 Warrants are exercisable through October 28, 2020, at a price of $8.60 per share and 250,000 Warrants are exercisable after October 28, 2011 and through October 28, 2021, at a price of $10.75 per share. The exercise price of the Warrants may be paid in cash or by cashless exercise. The exercise price and the number of shares of common stock issuable upon exercise of the Warrants are subject to adjustment for dividends paid in common stock, subdivisions or combinations.
On June 30, 2010, in connection with the repayment and extinguishment of the WA Secured Term Loan, we issued, to the lender, warrants, or the Repayment Warrants, to purchase 2,000,000 shares of our common stock. The Repayment Warrants are exercisable immediately through June 30, 2020, at a price of $7.60 per share. The exercise price of the Repayment Warrants may be paid in cash or by cashless exercise. The exercise price and the number of shares of common stock issuable upon exercise of the Repayment Warrants are subject to adjustment for dividends paid in common stock, subdivisions or combinations.
JP Facility
In August 2009, we terminated the Master Repurchase Agreement ("JP Facility") with JP Morgan and repaid the remaining principal balance of $12.2 million.
Equity Distribution Agreement
In May, 2009, we entered into an equity distribution agreement with JMP Securities, LLC, or JMP. In accordance with the terms of the agreement, we may offer and sell up to 10,000,000 shares of our common stock from time to time through JMP. JMP will receive a commission from us of up to 2.5% of the gross sales price of all shares sold through it under the equity distribution agreement. We may offer and sell shares of our common stock pursuant to our equity distribution agreement if we believe
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the economics are attractive, and may use the proceeds for investments, debt repayment or general corporate purposes.
During the year ended December 31, 2010, we did not issue any shares pursuant to our equity distribution agreement with JMP. During the year ended December 31, 2009, we issued 7,326,942 common shares and received approximately $25.7 million of net cash proceeds pursuant to our equity distribution agreement with JMP.
Dividend Reinvestment and Stock Purchase Plan
Effective as of April 27, 2007, we implemented a Dividend Reinvestment and Stock Purchase Plan, or the Plan, pursuant to which we registered and reserved for issuance 15,000,000 shares of our common stock. Under the terms of the Plan, stockholders who participate in the Plan may purchase shares of our common stock directly from us, in cash investments up to $10,000. At our sole discretion, we may accept optional cash investments in excess of $10,000 per month, which may qualify for a discount from the market price of 0% to 5%. Plan participants may also automatically reinvest all or a portion of their dividends for additional shares of our stock. We expect to use the proceeds from any dividend reinvestments or stock purchases for general corporate purposes.
During the year ended December 31, 2010, we issued a total of 92,362 common shares pursuant to the Plan for a gross sales price of approximately $0.4 million. During the year ended December 31, 2009, we issued a total of 80,395 common shares pursuant to the Plan for a gross sales price of approximately $0.3 million.
Cash Flows
Year Ended December 31, 2010 Compared to December 31, 2009
The net cash provided by operating activities was $35.6 million for the year ended December 31, 2010 compared to the net cash flow provided by operating activities of $54.5 million for the year ended December 31, 2009. The decrease was primarily due to increased overhead from our newly formed broker-dealer subsidiary, the internalization of our healthcare management, the maturity of our $500 million interest rate swap in the second half of 2009 under which we paid one-month LIBOR and received a 3.03% fixed rate and lower spreads on our lending assets which decreased interest income generated from our asset base. The decrease was partially offset by interest income from our CSE RE 2006-A acquisition and the acquisition of the N-Star CDO IX equity notes in 2010.
The net cash flow provided by investing activities was $119.0 million for the year ended December 31, 2010 compared to the net cash provided by investing activities of $123.3 million for the year ended December 31, 2009. The primary source of cash flow provided by investing activities in 2010 was proceeds from the sale of real estate debt investments, real estate debt repayments and the disposition of available for sale securities. The primary sources of cash flow provided by investing activities in 2009 were proceeds from the sale and repayments of real estate securities and real estate debt investments and proceeds from the sale of a portfolio of net leased healthcare properties.
The net cash flow used by financing activities was $168.1 million for the year ended December 31, 2010 compared to cash used by financing activities of $172.9 million of cash used by financing activities for the year ended December 31, 2009. The primary use of cash flow by financing activities was the WA Secured Term Loan repayment and the pay down of bonds. Net cash flow used in financing activity in 2009 was primarily related to secured term loan repayments, bond repurchases and repayments, mortgage principal and credit facilities repayments.
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Year Ended December 31, 2009 Compared to December 31, 2008
The net cash flow provided by operating activities was $54.5 million for the year ended December 31, 2009 compared to the net cash flow provided by operating activities of $87.6 million for the year ended December 31, 2008. The decrease was primarily due to the lower LIBOR rates which decreased interest income generated from our asset base. Approximately $9.8 million of the decrease related to loan asset restructurings, partially offset by $481.2 million from higher yielding CMBS securities purchases and real estate debt investment fundings.
The net cash flow provided by investing activities was $123.3 million for the year ended December 31, 2009 compared to the net cash used by investing activities of $110.7 million for the year ended December 31, 2008. The primary sources of cash flow provided by investing activities in 2009 were proceeds from the sale and repayments of real estate securities and real estate debt investments and proceeds from the sale of a portfolio of net leased healthcare properties. The primary uses of cash flow used by investing activities in 2008 were the origination or acquisition of real estate debt investments, and the acquisition of real estate securities.
The net cash flow used by financing activities was $173.0 million for the year ended December 31, 2009 compared to $3.3 million of cash provided by financing activities for the year ended December 31, 2008. The primary use of cash flow by financing activities was secured term loan repayments, bond repurchases and repayments, mortgage principal and credit facilities repayments. Net cash flow in provided by financing activity in 2008 was primarily related to the paydown of our bonds, credit facilities, and secured term loan as a result of principal paydowns of our assets.
Capital Expenditures
During 2011, we expect to incur $0.8 million in capital expenditures with respect to our healthcare net lease portfolio and $0.2 million with respect to our core net lease portfolio.
Contractual Obligations and Commitments
As of December 31, 2010, we had the following contractual commitments and commercial obligations (dollars in thousands):
| | Payments Due by Period | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Contractual Obligations | Total | 1 year or less | 1 - 3 years | 4 - 5 years | After 5 Years | |||||||||||
Mortgage notes | $ | 800,632 | $ | 8,912 | $ | 152,457 | $ | 239,278 | $ | 399,985 | ||||||
Mezzanine loan payable | 2,482 | 320 | 698 | 801 | 663 | |||||||||||
Exchangeable senior notes(1) | 60,749 | — | 60,750 | (1) | — | — | ||||||||||
Bonds payable | 4,448,546 | — | — | — | 4,448,546 | |||||||||||
Secured term loan | — | — | — | — | — | |||||||||||
Liability to subsidiary trusts issuing preferred securities | 280,133 | — | — | — | 280,133 | |||||||||||
Capital leases(2) | 11,219 | 182 | 364 | 364 | 10,309 | |||||||||||
Operating leases | 66,032 | 5,796 | 11,331 | 11,221 | 37,684 | |||||||||||
Outstanding unfunded commitments(3) | 48,463 | 41,723 | 6,740 | — | — | |||||||||||
Estimated interest payments(4) | 512,940 | 114,015 | 207,323 | 134,627 | 56,975 | |||||||||||
Total contractual obligations | $ | 6,231,196 | $ | 170,948 | $ | 439,663 | $ | 386,291 | $ | 5,234,295 | ||||||
- (1)
- $68.2 million of our 7.25% exchangeable senior notes have a final maturity date of June 15, 2027. The above table assumes the holders exercise their repurchase rights which would require us to repurchase the notes on June 15, 2012.
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- (2)
- Includes interest on the capital leases.
- (3)
- Our future funding commitments, which are subject to certain conditions that borrowers must meet to qualify for such fundings, totaled $48.5 million, of which a minimum of $45.5 million will be funded within our existing CDO financings. Fundings are categorized by estimated funding period. Assuming that all loans that have future fundings meet the terms to qualify for such funding, our equity requirement on the remaining future funding requirements would be approximately $3.0 million over the next two years.
- (4)
- Estimated interest payments are based on the weighted-average life of the debt. One-month LIBOR plus the respective spread as of December 31, 2010 was used to estimate payments for our floating rate debt.
Our debt obligations contain covenants that are both financial and non-financial in nature. Significant financial covenants include a requirement that we maintain a minimum tangible net worth, and a minimum level of liquidity. As of December 31, 2010, we were in compliance with all financial and non-financial covenants in our debt agreements.
Off Balance Sheet Arrangements
None
Recent Developments
On January 19, 2011, we declared a cash dividend of $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on February 14, 2011 to the stockholders of record as of the close of business on February 4, 2011.
On January 19, 2011, we declared a dividend of $0.10 per share of common stock. The dividends were paid on February 14, 2011 to the stockholders of record as of February 4, 2011.
Inflation
Our leases for tenants of operating real estate are either:
- •
- net leases where the tenants are responsible for all or a significant portion of the real estate taxes, insurance and operating expenses and the leases provide for increases in rent either based on changes in the Consumer Price Index, or CPI, or pre-negotiated increases; or
- •
- operating leases which provide for separate escalations of real estate taxes and operating expenses over a base amount, and/or increases in the base rent based on changes in the CPI.
We believe that most inflationary increases in expenses will be offset by the expense reimbursements and contractual rent increases described above to the extent of occupancy.
We believe that the risk associated with an increase in market interest rates on the floating rate debt used to finance our investments in our CDO financings and our direct investments in real estate debt, will be largely offset by our strategy of matching the terms of our assets with the terms of our liabilities and through our use of hedging instruments.
See "Quantitative and Qualitative Disclosures About Market Risk" in Item 7A of this Annual Report on Form 10-K/A for additional information on our exposure to market risk.
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Non-GAAP Financial Measures
Funds from Operations and Adjusted Funds from Operations
Management believes that funds from operations, or FFO, and adjusted funds from operations, or AFFO, each of which are non-GAAP measures, are additional appropriate measures of the operating performance of a REIT and NorthStar in particular. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT, as net income or loss (computed in accordance with GAAP), excluding gains or losses from sales of depreciable properties, the cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, and after adjustments for unconsolidated/uncombined partnerships and joint ventures. AFFO, as defined by NAREIT, is a computation made by analysts and investors to measure a real estate company's cash flow generated by operations.
We calculate AFFO by subtracting from (or adding) FFO:
- •
- normalized recurring expenditures that are capitalized by us and then amortized, but which are necessary to maintain our properties and revenue stream, e.g., leasing commissions and tenant improvement allowances;
- •
- an adjustment to reverse the effects of the straight-lining of rents and fair value lease revenue;
- •
- the amortization or accrual of various deferred costs including intangible assets and equity based compensation;
- •
- an adjustment to reverse the effects of unrealized gains/(losses); and
- •
- An adjustment to reverse the effects of acquisition gains or losses.
Our calculation of AFFO differs from the methodology used for calculating AFFO by certain other REITs and, accordingly, our AFFO may not be comparable to AFFO reported by other REITs. Our management utilizes FFO and AFFO as measures of our operating performance, and believes they are also useful to investors, because they facilitate an understanding of our operating performance after adjustment for certain non-cash expenses, such as real estate depreciation, which assumes that the value of real estate assets diminishes predictably over time and, in the case of AFFO, equity based compensation. Additionally, FFO and AFFO serve as measures of our operating performance because they facilitate evaluation of our company without the effects of selected items required in accordance with GAAP that may not necessarily be indicative of current operating performance and that may not accurately compare our operating performance between periods. Furthermore, although FFO, AFFO and other supplemental performance measures are defined in various ways throughout the REIT industry, we also believe that FFO and AFFO may provide us and our investors with an additional useful measure to compare our financial performance to certain other REITs.
Neither FFO nor AFFO is equivalent to net income or cash generated from operating activities determined in accordance with U.S. GAAP. Furthermore, FFO and AFFO do not represent amounts available for management's discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Neither FFO nor AFFO should be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.
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Set forth below is a reconciliation of FFO and AFFO to net income from continuing operations before non-controlling interest for the years ended December 31, 2010, 2009 and 2008 (in thousands):
| | Year Ended December 31, 2010 | Year Ended December 31, 2009 | Year Ended December 31, 2008 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Funds from Operations: | ||||||||||
(Loss) income from continuing operations | $ | (390,121 | ) | $ | (152,548 | ) | $ | 699,919 | ||
Non-controlling interest in joint ventures | (10,845 | ) | (9,555 | ) | (4,614 | ) | ||||
Consolidated net Income/(loss) before non-controlling interest in operating partnership | (400,966 | ) | (162,103 | ) | 695,305 | |||||
Adjustments: | ||||||||||
Preferred stock dividends | (20,925 | ) | (20,925 | ) | (20,925 | ) | ||||
Depreciation and amortization | 34,097 | 41,726 | 41,043 | |||||||
Funds from discontinued operations | (1,899 | ) | 4,340 | (1 | ) | |||||
Real estate depreciation and amortization—unconsolidated ventures | 948 | 1,088 | 945 | |||||||
Funds from Operations | $ | (388,745 | ) | $ | (135,874 | ) | $ | 716,367 | ||
Adjusted Funds from Operations: | ||||||||||
Funds from Operations | $ | (388,745 | ) | $ | (135,874 | ) | $ | 716,367 | ||
Straight-line rental income, net | (1,427 | ) | (2,276 | ) | (2,322 | ) | ||||
Straight-line rental income, discontinued operations | — | — | — | |||||||
Straight-line rental income and fair value lease revenue, unconsolidated ventures | (81 | ) | (143 | ) | (155 | ) | ||||
Amortization of equity-based compensation | 16,991 | 20,474 | 24,680 | |||||||
Amortization of above/below market leases | (905 | ) | (801 | ) | (1,740 | ) | ||||
Unrealized (gains)/losses from mark-to-market adjustments | 437,691 | 188,887 | (664,119 | ) | ||||||
Unrealized (gains)/losses from mark-to-market adjustments, unconsolidated ventures | 3,357 | 12,276 | 17,026 | |||||||
Gain from acquisitions | (15,363 | ) | — | — | ||||||
Adjusted Funds from Operations | $ | 51,518 | $ | 82,543 | $ | 89,737 | ||||
Return on Average Common Book Equity
We calculate return on average common book equity ("ROE") on a consolidated basis and for each of our major business lines. We believe that ROE provides a good indication of our performance and our business lines because we believe it provides the best approximation of cash returns on common equity invested. Management also uses ROE, among other factors, to evaluate profitability and efficiency of equity capital employed, and as a guide in determining where to allocate capital within its business. ROEs may fluctuate from quarter to quarter based upon a variety of factors, including the timing and amount of investment fundings, repayments and asset sales, capital raised and leverage used, and the yield on investments funded.
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Return on Average Common Book Equity
(including and excluding G&A and one-time items)
(dollars in thousands)
| | | Year Ended December 31, 2010 | Year Ended December 31, 2009 | Year Ended December 31, 2008 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Adjusted Funds from Operations (AFFO) | [A | ] | $ | 51,518 | $ | 82,545 | $ | 94,337 | ||||||
Plus: Fundraising Fees, Debt Issuance Costs and Other | — | — | 2,879 | |||||||||||
Plus: General & Administrative Expenses | 89,409 | 70,542 | 74,830 | |||||||||||
Less: Equity-Based Compensation included in G&A | 16,991 | 20,474 | 24,672 | |||||||||||
Less: Bad debt expense included in G&A | 1,451 | 1,554 | — | |||||||||||
AFFO, excluding G&A | [B | ] | 122,485 | 131,059 | 147,374 | |||||||||
Average Common Book Equity & Operating Partnership Non-Controlling Interest(1) | [C | ] | $ | 1,160,990 | $ | 1,194,310 | $ | 887,515 | ||||||
Return on Average Common Book Equity (including G&A) | [A]/[C | ] | 4.4 | % | 6.9 | % | 10.6 | % | ||||||
Return on Average Common Book Equity (excluding G&A) | [B]/[C | ] | 10.6 | % | 11.0 | % | 16.6 | % | ||||||
- (1)
- Average Common Book Equity & Operating Partnership Non-controlling Interest computed using beginning and ending of period balances. ROE will be impacted by the timing of new investment closings and repayments during the quarter.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Although we seek to match-fund our assets and mitigate the risk associated with future interest rate volatility, we are primarily subject to interest rate risk prior to match-funding our investments and because we maintain a net floating rate asset or liability position. To the extent we have net floating rate assets, our earnings will increase with increases in floating interest rates, and decrease with declines in floating interest rates. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.
Our interest rate risk sensitive assets, liabilities and related derivative positions are held for non-trading purposes. As of December 31, 2010, a hypothetical 100 basis point increase in interest rates applied to our variable rate assets would increase our annual interest income by approximately $27.5 million offset by an increase in our interest expense of approximately $23.7 million on our variable rate liabilities. Similarly, a hypothetical 100 basis point decrease in interest rates would decrease our annual interest income by the same net amount ($9.4 million).
Real Estate Debt
We invest in real estate debt which is secured by commercial and multifamily properties, including first lien mortgage loans, junior participations in first lien mortgage loans, second lien mortgage loans, mezzanine loans, and preferred equity interests in borrowers who own such properties. We hold these instruments for investment rather than trading purposes. These investments bear interest at either a floating or fixed rate. The interest rates on our floating rate investments typically float at a fixed spread over an index such as LIBOR. These instruments typically reprice every 30 days based upon LIBOR in effect at that time. Given the frequent and periodic repricing of our floating rate investments, changes in benchmark interest rates are unlikely to materially affect the value of our floating rate portfolio.
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Changes in short-term rates will, however, affect earnings from our investments. Increases in LIBOR will increase the interest income received by us on our investments and therefore increase our earnings. Decreases in LIBOR have the opposite effect.
We also invest in fixed rate investments. The value of these investments may be affected by changes in long-term interest rates. To the extent that long-term interest rates increase, the value of long-term fixed rate assets is diminished. Any fixed rate real estate debt investments which we hold would be similarly impacted. We do not seek to hedge this type of risk unless the asset is leveraged as we believe the costs of such a hedging transaction over the term of such an investment would outweigh the benefits. If fixed rate real estate debt is funded with floating rate liabilities, we typically convert the floating rate to fixed through the use of interest rate swaps, caps or other hedges. Because the interest rates on our fixed rate investments are fixed through maturity of the investment, changes in interest rates do not affect the income we earn from our fixed rate investments.
The value of our fixed and floating rate real estate debt investments changes with market credit spreads. This means that when market-demanded risk premiums, or credit spreads, increase, the value of our fixed and floating rate assets decrease, and vice versa. Market credit spreads are currently much wider than existed at the time we originated a majority of our real estate debt investments. These wider market credit spreads imply that our real estate debt investments may be worth less than the amounts at which we carry these investments on our balance sheet, but because we have typically financed these investments with debt priced in a similar credit environment and intend to hold them to maturity we do not believe that intra- and inter-period changes in value caused by changing credit spreads material impacts the economics associated with our real estate debt investments.
In our real estate debt business we are also exposed to credit risk, which is the risk that the borrower under our loan agreements cannot repay its obligations to us in a timely manner. Our loans are collateral dependent, meaning the principal source of repayment is from a sale or refinancing of the collateral securing our loan. Default risk increases in weak economic conditions because collateral cash flows may be below expectations when the loan was originated. Defaults also increase when, at loan maturity, the cost of debt and equity capital is higher than when the loan was originated. In the event that a borrower cannot repay our loan, we may exercise our remedies under the loan documents, which may include a foreclosure against the collateral. We describe many of the options available to us in this situation in "Item 1 Business" of our Annual Report on Form 10-K/A. To the extent the value of our collateral exceeds the amount of our loan (including all debt senior to us) and the expenses we incur in collecting on our loan, we would collect 100% of our loan amount. To the extent that the amount of our loan plus all debt senior to our position exceeds the realizable value of our collateral, then we would incur a loss. We also incur credit risk in our periodically scheduled interest payments which may be interrupted as a result of the operating performance of the underlying collateral.
We seek to manage credit risk through a thorough analysis of a transaction before we make such an investment. Our analysis is based upon a broad range of real estate, financial, economic and borrower-related factors which we believe are critical to evaluating the credit risk inherent in a transaction.
We expect our investments to be denominated in U.S. dollars or, if they are denominated in another currency, to be converted back to U.S. dollars through the use of currency swaps. It may not be possible to eliminate all of the currency risk as the payment characteristics of the currency swap may not exactly match the payment characteristics of the investments.
Real Estate Securities
In our real estate securities business, we seek to mitigate credit risk through credit analysis, subordination and diversification. The CMBS we invest in are junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of one or more subordinate
105
classes of securities or other form of credit support within a securitization transaction. The senior unsecured REIT debt securities we invest in reflect comparable credit risk. Credit risk refers to each individual borrower's ability to make required interest and principal payments on the scheduled due dates. While the expected yield on these securities is sensitive to the performance of the underlying assets, the more subordinated securities and certain other features of a securitization, in the case of mortgage backed securities, and the issuer's underlying equity and subordinated debt, in the case of REIT securities, are designed to bear the first risk of default and loss. The real estate securities portfolios of our investment grade CDO financings are diversified by asset type, industry, location and issuer. We further seek to minimize credit risk by monitoring the real estate securities portfolios of our investment grade CDO financings and the underlying credit quality of their holdings.
The real estate securities underlying our investment grade CDO financings are also subject to credit spread risk. The majority of these securities are fixed rate securities, which are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. In other words, their value is dependent on the yield demanded on such securities by the market, based on their credit relative to U.S. Treasuries. An excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher or "wider" spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value these securities. Under these conditions, the value of our real estate securities portfolio would tend to decrease. Conversely, if the spread used to value these securities were to decrease or "tighten," the value of our real estate securities would tend to increase. Such changes in the market value of our real estate securities portfolio may affect our net equity or cash flow either directly through their impact on unrealized gains or losses on available for sale securities by diminishing our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital.
Returns on our real estate securities are sensitive to interest rate volatility. If interest rates increase, the funding cost on liabilities that finance the securities portfolio will increase if these liabilities are at a floating rate or have maturities shorter than the assets.
Our general financing strategy has focused on the use of "match-funded" structures. This means that we seek to align the maturities of our debt obligations with the maturities of our investments in order to minimize the risk of being forced to refinance our liabilities prior to the maturities of our assets, as well as to reduce the impact of fluctuating interest rates on earnings. In addition, we match interest rates on our assets with like-kind debt, so that fixed rate assets are financed with fixed rate debt and floating rate assets are financed with floating rate debt, directly or through the use of interest rate swaps, caps or other financial instruments or through a combination of these strategies. Our investment grade CDO financings utilize interest rate swaps to minimize the mismatch between their fixed rate assets and floating rate liabilities.
Our financing strategy is dependent on our ability to place the match-funded debt we use to finance our real estate securities at spreads that provide a positive funding spread. Match funded debt is currently very difficult to obtain, and market-demanded yields on all real estate assets have increased. Our current strategy is to use our existing CDO structures to fund new investment activity when repayment or sale proceeds are available within the financing, or to acquire securities which generate attractive returns without leverage.
Interest rate changes may also impact our net book value as our investments in debt securities are marked-to-market each quarter with changes in fair value reflected in unrealized gains/losses or other comprehensive income (a separate component of owners' equity). Generally, as interest rates increase, the value of fixed rate securities within the CDO transaction, such as CMBS, decreases and as interest rates decrease, the value of these securities will increase. Conversely, we mark our CDO liabilities to
106
market which causes a partial offset to the income and balance sheet impact of marking the securities assets to market.
Core Net Lease and Healthcare Net Lease Properties
Our ability to manage the interest rate risk and credit risk associated with the assets we acquire is integral to the success of our net lease properties investment strategy. Although we may, in special situations, finance our purchase of net lease assets with floating rate debt, our general policy is to mitigate our exposure to rising interest rates by financing our net lease property purchases with fixed rate mortgages. We seek to match the term of fixed rate mortgages to our expected holding period for the underlying asset. Factors we consider to assess the expected holding period include, among others, the primary term of the lease as well as any extension options that may exist.
The value of our net lease real estate properties may be influenced by long-term fixed interest rates. To derive value, an investor typically forecasts expected future cash flows to be generated by the property then discounts the cash flows at a discount rate based upon a long-term fixed interest rate (such as the 10-year U.S. Treasury Note yield) plus a risk premium based on the property type and creditworthiness of the tenants. Lower risk free rates generally result in lower discount rates and therefore higher valuations and vice versa although the scarcity of financing for net lease properties and investor concerns over commercial real estate generally have recently decreased commercial real estate valuations, including valuations for net lease properties. We intend to hold our net lease properties for long periods, but the market value of the asset may fluctuate with changes in interest rates, among other things.
We are subject to the credit risk of the corporate lessee of our net lease properties. We undertake a rigorous credit evaluation of each tenant prior to acquiring net lease asset properties. This analysis includes an extensive due diligence investigation of the tenant's business as well as an assessment of the strategic importance of the underlying real estate to the tenant's core business operations. Where appropriate, we may seek to augment the tenant's commitment to the facility by structuring various credit enhancement mechanisms into the underlying leases. These mechanisms could include security deposit requirements or affiliate guarantees from entities we deem to be creditworthy.
In June 2009, we restructured our net lease relationship with one of our healthcare operators to take advantage of new REIT legislation which now allows a taxable REIT subsidiary affiliate to become the lessee of healthcare-related properties. The restructuring resulted in one of our unconsolidated affiliate Midwest Care Holdco TRS I LLC ("Midwest") becoming the lessee of the properties and Midwest simultaneously entering into a management contract with a third party operator. The management agreement is terminable by Midwest upon 60 days notice. This new structure allows us to participate in operating improvements of the underlying properties not previously available under the prior structure. Under these arrangements we are less vulnerable to credit risk with respect to the manager of the facility, but our taxable REIT subsidiary has more exposure to fluctuations in net income at the properties (both reductions and increases) which would not be the case in a lease to an unaffiliated lessee operating the property.
Derivatives and Hedging Activities
We use derivatives primarily to manage interest rate risk exposure. These derivatives are typically in the form of interest rate swap agreements and the primary objective is to minimize interest rate risks associated with the our investment and financing activities. The counterparties of these arrangements are major financial institutions with which we may also have other financial relationships. We are exposed to credit risk in the event of non-performance by these counterparties and we monitor their financial condition; however, we currently do not anticipate that any of the counterparties will fail to meet their obligations because of their high credit ratings and financial support from the U.S.
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Government. At December 31, 2010, our counterparties hold approximately $33.5 million of cash margin as collateral against our swap contracts.
In January 2008, we elected the fair value option for our bonds payable and our liability to subsidiary trusts issuing preferred securities. As a result, the changes in fair value of these financial instruments are now recorded in earnings and the interest rate swap agreements associated with these debt instruments no longer qualify for hedge accounting given that the underlying debt is remeasured with changes in the fair value recorded in earnings. The unrealized gains or losses accumulated in other comprehensive income, related to these interest rate swaps, will be reclassified into earning over the shorter of either the life of the swap or the associated debt with current mark-to-market unrealized gains or losses recorded in earnings. For the years ended December 31, 2010, 2009 and 2008, we recorded, in earnings, a mark-to-market unrealized loss of $134.0 million, an unrealized gain of $4.6 million and an unrealized loss of $15.9 million, respectively, for the non-qualifying interest rate swaps. For the years ended December 31, 2010 , 2009 and 2008, we recorded a $6.6 million, a $5.6 million and a $5.5 million reclassification from accumulated other comprehensive income for the non-qualifying interest rate swaps, respectively.
The following tables summarize our derivative financial instruments that were designated as cash flow hedges of interest rate risk as of December 31, 2009 (in thousands):
| | Number of Investments | Notional Amount | Fair Value Net Asset/ (Liability) | Range of Fixed LIBOR | Range of Maturity | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Interest rate swaps | |||||||||||||
As of December 31, 2009 | 10 | $ | 90,749 | $ | (7,691 | ) | 4.18% - 5.08% | March 2010 - August 2018 | |||||
The following tables summarize our derivative financial instruments that were not designated as hedges in qualifying hedging relationships as of December 31, 2010 and December 31, 2009 (in thousands):
| | Number of Investments | Notional Amount | Fair Value Net Asset/ (Liability) | Range of Fixed LIBOR | Range of Maturity | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Interest rate swaps | |||||||||||||
As of December 31, 2010 | 64 | $ | 2,812,409 | $ | (220,630 | ) | 0.37% - 7.00% | February 2011 - October 2019 | |||||
As of December 31, 2009(1) | 22 | $ | 897,335 | $ | (59,353 | ) | 0.34% - 5.63% | May 2010 - June 2018 | |||||
- (1)
- December 31, 2009 does not include the interest rate swaps of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.
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Item 8. Financial Statements and Supplementary Data
The consolidated financial statements of NorthStar Realty Finance Corp. and the notes related to the foregoing financial statements, together with the independent registered public accounting firm's reports thereon are included in this Item 8.
INDEX TO FINANCIAL STATEMENTS
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
| | Page | |
|---|---|---|
Reports of Independent Registered Public Accounting Firm | 110 | |
Consolidated Balance Sheets as of December 31, 2010 and 2009 | 112 | |
Consolidated Statements of Operations for the years ended December 31, 2010, 2009 and 2008 | 113 | |
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2010, 2009 and 2008 | 114 | |
Consolidated Statements of Comprehensive Income for the years ended December 31, 2010, 2009 and 2008 | 115 | |
Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008 | 116 | |
Notes to Consolidated Financial Statements | 118 | |
Schedule II—Valuation and Qualifying Accounts and Reserves | 181 | |
Schedule III—Real Estate and Accumulated Depreciation as of December 31, 2010 | 182 | |
Schedule IV—Loans and other Lending Investments as of December 31, 2010 | 189 |
109
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
NorthStar Realty Finance Corp.
We have audited NorthStar Realty Finance Corp. and subsidiaries' (the "Company") internal control over financial reporting as of December 31, 2010, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, NorthStar Realty Finance Corp. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established inInternal Control—Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of NorthStar Realty Finance Corp. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders' equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2010, and our report dated February 25, 2011 expressed an unqualified opinion thereon.
/s/ GRANT THORNTON LLP
New York, New York
February 25, 2011
110
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
NorthStar Realty Finance Corp.
We have audited NorthStar Realty Finance Corp. and subsidiaries' (the "Company") internal control over financial reporting as of December 31, 2010, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, NorthStar Realty Finance Corp. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established inInternal Control—Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of NorthStar Realty Finance Corp. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders' equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2010, and our report dated February 25, 2011 expressed an unqualified opinion thereon.
/s/ GRANT THORNTON LLP
New York, New York
February 25, 2011
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands, Except Share Data)
| | December 31, 2010 | December 31, 2009 | |||||||
|---|---|---|---|---|---|---|---|---|---|
ASSETS: | |||||||||
Cash and cash equivalents | $ | 125,439 | $ | 138,928 | |||||
Restricted cash (includes $263,314 and $74,453 from consolidated VIEs, respectively) | 309,384 | 129,180 | |||||||
Operating real estate, net | 938,062 | 978,902 | |||||||
Available for sale securities, at fair value (includes $1,668,217 and $283,184 from consolidated VIEs, respectively) | 1,691,054 | 336,220 | |||||||
Real estate debt investments, net (includes $1,659,882 and $1,356,038 from consolidated VIEs, respectively) | 1,826,239 | 1,936,482 | |||||||
Real estate debt investments, held-for-sale (includes $18,661 and $—from consolidated VIEs, respectively) | 18,662 | 611 | |||||||
Investments in and advances to unconsolidated ventures (includes $66,959 and $—from consolidated VIEs, respectively) | 94,412 | 38,299 | |||||||
Receivables, net of allowance of $2,642 in 2010 and $1,349 in 2009 (includes net $26,337 and $7,421 from consolidated VIEs, respectively) | 32,329 | 17,912 | |||||||
Unbilled rents receivable | 10,404 | 10,206 | |||||||
Derivative instruments, at fair value (includes $42 and $—from consolidated VIEs, respectively) | 59 | — | |||||||
Deferred costs and intangible assets, net | 52,973 | 57,551 | |||||||
Assets of properties held for sale (includes $13,141 and $—from consolidated VIEs, respectively) | 13,141 | — | |||||||
Other assets (includes $14,277 and $2,888 from consolidated VIEs, respectively) | 39,833 | 25,273 | |||||||
Total assets | $ | 5,151,991 | $ | 3,669,564 | |||||
LIABILITIES: | |||||||||
Mortgage notes and loans payable | 803,114 | 795,915 | |||||||
Exchangeable senior notes | 126,889 | 125,992 | |||||||
Bonds payable, at fair value (includes $2,258,807 and $584,615 from consolidated VIEs, respectively) | 2,258,805 | 584,615 | |||||||
Secured term loans | 36,881 | 368,865 | |||||||
Liability to subsidiary trusts issuing preferred securities, at fair value | 191,250 | 167,035 | |||||||
Accounts payable and accrued expenses (includes $15,668 and $1,631 from consolidated VIEs, respectively) | 49,819 | 30,071 | |||||||
Escrow deposits payable (includes $60,163 and $28,608 from consolidated VIEs, respectively) | 60,711 | 39,461 | |||||||
Derivative liability, at fair value (includes $190,993 and $46,187 from consolidated VIEs, respectively) | 220,689 | 67,044 | |||||||
Liabilities of properties held for sale (includes $131 and $—from consolidated VIEs, respectively) | 131 | — | |||||||
Other liabilities (includes $8,654 and $358 from consolidated VIEs, respectively) | 31,189 | 31,926 | |||||||
Total liabilities | 3,779,478 | 2,210,924 | |||||||
Contingently redeemable non-controlling interest | 94,822 | 94,822 | |||||||
EQUITY: | |||||||||
NorthStar Realty Finance Corp. Stockholders' Equity: | |||||||||
8.75% Series A preferred stock, $0.01 par value, $25 liquidation preference per share, 2,400,000 shares issued and outstanding at December 31, 2010 and December 31, 2009, respectively | 57,867 | 57,867 | |||||||
8.25% Series B preferred stock, $0.01 par value, $25 liquidation preference per share, 7,600,000 shares issued and outstanding at December 31, 2010 and December 31, 2009, respectively | 183,505 | 183,505 | |||||||
Common stock, $0.01 par value, 500,000,000 shares authorized, 78,104,753 and 74,882,600 shares issued and outstanding at December 31, 2010 and December 31, 2009, respectively | 781 | 749 | |||||||
Additional paid-in capital | 723,102 | 662,805 | |||||||
Retained earnings | 293,382 | 460,915 | |||||||
Accumulated other comprehensive loss | (36,119 | ) | (92,670 | ) | |||||
Total NorthStar Realty Finance Corp. Stockholders' Equity | 1,222,518 | 1,273,171 | |||||||
Non-controlling interests | 55,173 | 90,647 | |||||||
Total equity | 1,277,691 | 1,363,818 | |||||||
Total liabilities and stockholders' equity | $ | 5,151,991 | $ | 3,669,564 | |||||
See accompanying notes to consolidated financial statements.
112
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amount in Thousands, Except Share and per Share Data)
| | Year Ended December 31, 2010 | Year Ended December 31, 2009 | Year Ended December 31, 2008 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Revenues and other income: | |||||||||||||
Interest income | $ | 318,792 | $ | 142,213 | $ | 212,432 | |||||||
Interest income—related parties | 1,108 | 17,692 | 14,995 | ||||||||||
Rental and escalation income | 124,828 | 98,143 | 107,559 | ||||||||||
Advisory and management fee income—related parties | 3,201 | 7,295 | 12,496 | ||||||||||
Commission income | 2,476 | — | — | ||||||||||
Other revenue | 3,268 | 736 | 16,494 | ||||||||||
Total revenues | 453,673 | 266,079 | 363,976 | ||||||||||
Expenses: | |||||||||||||
Interest expense | 131,335 | 121,289 | 190,538 | ||||||||||
Real estate properties—operating expenses | 37,691 | 14,653 | 8,160 | ||||||||||
Asset management fees—related parties | 466 | 3,356 | 4,721 | ||||||||||
Fundraising fees and other joint venture costs | 2,879 | ||||||||||||
Commission expense | 1,867 | — | — | ||||||||||
Impairment on operating real estate | 5,249 | — | 5,580 | ||||||||||
Provision for loan losses | 168,446 | 83,745 | 11,200 | ||||||||||
General and administrative: | |||||||||||||
Salaries and equity-based compensation(1) | 54,828 | 47,213 | 53,269 | ||||||||||
Auditing and professional fees | 13,803 | 9,636 | 7,075 | ||||||||||
Other general and administrative | 20,778 | 13,685 | 14,486 | ||||||||||
Total general and administrative | 89,409 | 70,534 | 74,830 | ||||||||||
Depreciation and amortization | 34,097 | 41,726 | 41,043 | ||||||||||
Total expenses | 468,560 | 335,303 | 338,951 | ||||||||||
(Loss)/income from operations | (14,887 | ) | (69,224 | ) | 25,025 | ||||||||
Equity in earnings/(loss) of unconsolidated ventures | 2,253 | (1,809 | ) | (11,918 | ) | ||||||||
Unrealized (loss)/gain on investments and other | (538,572 | ) | (209,976 | ) | 649,113 | ||||||||
Realized gain on investments and other | 145,722 | 128,461 | 37,699 | ||||||||||
Gain from acquisitions | 15,363 | — | — | ||||||||||
(Loss)/income from continuing operations | (390,121 | ) | (152,548 | ) | 699,919 | ||||||||
(Loss)/income from discontinued operations | (1,967 | ) | 2,173 | 2,410 | |||||||||
Gain on sale from discontinued operations | 2,528 | 13,799 | — | ||||||||||
Consolidated net (loss)/income | (389,560 | ) | (136,576 | ) | 702,329 | ||||||||
Less: net (loss)/income attributable to the non-controlling interests | 15,019 | 6,293 | (72,172 | ) | |||||||||
Preferred stock dividends | (20,925 | ) | (20,925 | ) | (20,925 | ) | |||||||
Net (loss)/income attributable to NorthStar Realty Finance Corp. common stockholders | $ | (395,466 | ) | $ | (151,208 | ) | $ | 609,232 | |||||
Net (loss)/income per share from continuing operations (basic/diluted) | (5.17 | ) | (2.40 | ) | 9.61 | ||||||||
(Loss)/income per share from discontinued operations (basic/diluted) | (0.03 | ) | 0.04 | 0.04 | |||||||||
Gain per share on sale of discontinued operations (basic/diluted) | 0.03 | 0.20 | — | ||||||||||
Net (loss)/income per common share attributable to NorthStar Realty Finance Corp. common stockholders (basic/diluted) | $ | (5.17 | ) | $ | (2.16 | ) | $ | 9.65 | |||||
Weighted average number of shares of common stock: | |||||||||||||
Basic | 76,552,702 | 69,869,717 | 63,135,608 | ||||||||||
Diluted | 82,842,990 | 77,193,083 | 70,136,783 | ||||||||||
- (1)
- The years ended December 31, 2010, 2009 and 2008 include $16,991, $20,474 and $24,680 respectively, of equity-based compensation expense. The year ended December 31,2010 includes $3,583 of cash compensation expense and $1,014 of equity based compensation expense relating to a separation and consulting agreement with a former executive. Cash incentive compensation expense incurred but payable in future periods totaled $4,616, $4,635 and $2,169, respectively, for the years ended December 31, 2010, 2009 and 2008.
See accompanying notes to consolidated financial statements.
113
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Amounts in Thousands)
| | Preferred Stock at Par | Shares of Common Stock | Common Stock at Par | Additional Paid-in Capital | Treasury Stock | Accumulated Other Comprehensive Income (Loss) | Retained Earnings | Total NorthStar Stockholders Equity | Non-controlling Interests | Total Stockholders Equity | |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance at December 31, 2008 | $ | 100 | 62,907 | $ | 634 | $ | 861,300 | (1,384 | ) | $ | (94,343 | ) | $ | 648,860 | $ | 1,415,167 | $ | 103,938 | $ | 1,613,760 | |||||||||||
Equity component of exchangeable senior notes | — | — | — | (4,321 | ) | — | — | — | (4,321 | ) | — | (4,321 | ) | ||||||||||||||||||
Equity component of warrants | — | — | — | 117 | — | — | — | 117 | — | 117 | |||||||||||||||||||||
Dividend reinvestment and stock purchase plan | — | 80 | 1 | 276 | — | — | — | 277 | — | 277 | |||||||||||||||||||||
Proceeds from equity distribution agreement | — | 7,327 | 69 | 23,995 | 1,384 | — | — | 25,448 | — | 25,448 | |||||||||||||||||||||
Stock awards/LTIP awards | 94 | 1 | 300 | — | — | — | 301 | 20,172 | 20,473 | ||||||||||||||||||||||
Restricted share grant | — | 15 | — | 1 | — | — | — | 1 | — | 1 | |||||||||||||||||||||
Comprehensive loss | — | — | — | — | — | 1,673 | — | 1,673 | 199 | 1,872 | |||||||||||||||||||||
Conversion of OP/LTIP units | — | 744 | 7 | 12,013 | — | — | — | 12,020 | (12,020 | ) | — | ||||||||||||||||||||
Stock dividends | — | 3,716 | 37 | 10,610 | — | — | (9,607 | ) | 1,040 | (1,040 | ) | — | |||||||||||||||||||
Cash dividends on common stock | — | — | — | — | — | — | (27,133 | ) | (27,133 | ) | (15,957 | ) | (43,090 | ) | |||||||||||||||||
Cash dividends on preferred stock | — | — | — | — | — | — | (20,925 | ) | (20,925 | ) | — | (20,925 | ) | ||||||||||||||||||
Redemption of membership interest | — | — | — | (214 | ) | — | — | — | (214 | ) | — | (214 | ) | ||||||||||||||||||
Equity in private fund | 1,815 | 1,815 | |||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | (130,280 | ) | (130,280 | ) | (6,293 | ) | (136,573 | ) | |||||||||||||||||
Balance at December 31, 2009 | $ | 100 | 74,883 | $ | 749 | $ | 904,077 | $ | — | $ | (92,670 | ) | $ | 460,915 | $ | 1,273,171 | $ | 90,647 | $ | 1,363,818 | |||||||||||
VIE consolidation begining balance adjustments | — | — | — | — | — | 41,332 | 110,790 | 152,122 | 30,535 | 182,657 | |||||||||||||||||||||
Acquisition of N-Star IX | — | — | — | — | — | — | 147,626 | 147,626 | — | 147,626 | |||||||||||||||||||||
Amortization of deferred compensation | — | — | — | 17 | — | — | — | 17 | 16,673 | 16,690 | |||||||||||||||||||||
Non-controlling interest contribution to joint venture | — | — | — | — | — | — | — | — | 11,336 | 11,336 | |||||||||||||||||||||
Dividend reinvestment and stock purchase plan | — | 92 | 1 | 282 | — | — | — | 283 | — | 283 | |||||||||||||||||||||
Stock awards/LTIP awards | — | 99 | 1 | 299 | — | — | — | 300 | — | 300 | |||||||||||||||||||||
Equity component of warrants | — | — | — | 61 | — | — | — | 61 | — | 61 | |||||||||||||||||||||
Comprehensive loss | — | — | — | — | — | 15,219 | — | 15,219 | 1,290 | 16,509 | |||||||||||||||||||||
Conversion of OP/LTIP units | — | 3,031 | 30 | 61,445 | — | — | — | 61,475 | (61,475 | ) | — | ||||||||||||||||||||
Cash dividends on common stock | — | — | — | — | — | — | (30,483 | ) | (30,483 | ) | (8,299 | ) | (38,782 | ) | |||||||||||||||||
Cash dividends on preferred stock | — | — | — | — | — | — | (20,925 | ) | (20,925 | ) | (10,500 | ) | (31,425 | ) | |||||||||||||||||
Redemption of membership interest | — | — | — | (1,807 | ) | — | — | — | (1,807 | ) | 1,800 | (7 | ) | ||||||||||||||||||
Equity in private fund | (1,815 | ) | (1,815 | ) | |||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | (374,541 | ) | (374,541 | ) | (15,019 | ) | (389,560 | ) | |||||||||||||||||
Balance at December 31, 2010 | $ | 100 | 78,105 | $ | 781 | $ | 964,374 | $ | — | $ | (36,119 | ) | $ | 293,382 | $ | 1,222,518 | $ | 55,173 | $ | 1,277,691 | |||||||||||
See accompanying notes to consolidated financial statements.
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in Thousands)
| | Year Ended December 31, 2010 | Year Ended December 31, 2009 | Year Ended December 31, 2008 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Consolidated net (loss)/income | $ | (389,560 | ) | $ | (136,573 | ) | $ | 702,329 | |||
Unrealized gain/(loss) on available for sale securities | 13,353 | (9,949 | ) | (20,694 | ) | ||||||
Change in fair value of derivatives | (3,448 | ) | 6,232 | (12,777 | ) | ||||||
Reclassification adjustment for gains included in net income | 6,605 | 5,589 | 26,557 | ||||||||
Comprehensive (loss)/income | (373,050 | ) | (134,701 | ) | 695,415 | ||||||
Less: Comprehensive (loss)/income attributable to non-controlling interests | (13,729 | ) | (6,094 | ) | (71,275 | ) | |||||
Comprehensive (loss)/income attributable to NorthStar Realty Finance Corp. | $ | (359,321 | ) | $ | (128,607 | ) | $ | 624,140 | |||
See accompanying notes to consolidated financial statements.
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Thousands)
| | Year Ended December 31, 2010 | Year Ended December 31, 2009 | Year Ended December 31, 2008 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Cash flows from operating activities: | |||||||||||
Consolidated net income (loss) | $ | (389,560 | ) | $ | (136,573 | ) | 702,329 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
Operating real estate Impairment | 6,429 | — | 5,580 | ||||||||
Equity in loss/(earnings) of unconsolidated ventures | (2,253 | ) | 9,450 | 11,918 | |||||||
Depreciation and amortization | 34,149 | 43,891 | 43,232 | ||||||||
Amortization of origination fees/costs | (40,844 | ) | (8,730 | ) | (9,919 | ) | |||||
Amortization of deferred financing costs | 6,096 | 5,498 | 7,137 | ||||||||
Equity based compensation | 16,991 | 20,474 | 24,680 | ||||||||
Unrealized loss (gain) on investments and other | 438,585 | 188,887 | (664,119 | ) | |||||||
Realized gain on sale of investments and other | (148,459 | ) | (142,290 | ) | (39,804 | ) | |||||
Gain from acquisition | (15,363 | ) | — | — | |||||||
Amortization of bond discount/premiums on securities | (42,085 | ) | (13,170 | ) | (3,218 | ) | |||||
Distributions from equity investments | 9,097 | 419 | 2,657 | ||||||||
Amortization of capitalized above/below market leases | (905 | ) | (801 | ) | (1,758 | ) | |||||
Unbilled rents receivable | (1,479 | ) | (2,225 | ) | (2,296 | ) | |||||
Interest accretion | (1,316 | ) | (3,632 | ) | (8,737 | ) | |||||
Provision for loan losses | 168,446 | 83,745 | 11,200 | ||||||||
Allowance for uncollectable accounts | 1,451 | 1,554 | — | ||||||||
Changes in assets and liabilities: | |||||||||||
Restricted cash | (22,949 | ) | 6,321 | 21,686 | |||||||
Receivables | 851 | 3,942 | 5,320 | ||||||||
Deferred costs and intangible assets | — | — | 260 | ||||||||
Other assets | 2,102 | 2,391 | 4,202 | ||||||||
Accounts payable and accrued expenses | (909 | ) | 2,546 | (6,868 | ) | ||||||
Cash received from purchase of equity investment | 2,307 | — | — | ||||||||
Escrow deposit payable | 21,250 | (6,892 | ) | (19,092 | ) | ||||||
Deferred management fee income | — | — | 3,848 | ||||||||
Real estate debt investment origination fees | 2,639 | 939 | 3,181 | ||||||||
Other liabilities | (8,713 | ) | (1,226 | ) | (3,807 | ) | |||||
Net cash provided by operating activities | $ | 35,558 | $ | 54,518 | $ | 87,612 | |||||
Cash flows from investing activities: | |||||||||||
Acquisition of operating real estate, net | — | — | (4,261 | ) | |||||||
Improvement of operating real estate | (1,498 | ) | (3,597 | ) | (20,289 | ) | |||||
Acquisition of available for sale securities | (301,259 | ) | (257,801 | ) | (59,186 | ) | |||||
Proceeds from disposition of available for sale securities | 302,379 | 210,399 | 6,115 | ||||||||
Available for sale securities repayments | 68,137 | 2,706 | 3,043 | ||||||||
Originations/acquisitions of real estate debt investments | (125,848 | ) | (223,382 | ) | (329,266 | ) | |||||
Real estate debt investment repayments | 313,199 | 111,452 | 290,449 | ||||||||
Proceeds from the sale of real estate debt investments | 143,665 | 140,753 | 30,400 | ||||||||
Net proceeds from disposition of operating real estate | 3,078 | 91,546 | — | ||||||||
Real estate debt investment acquisition costs | — | (97 | ) | (275 | ) | ||||||
Intangible asset related to acquisition | — | — | 2,875 | ||||||||
Corporate debt investment acquisitions | — | — | (16,362 | ) | |||||||
Corporate debt investment repayments | — | — | 24,985 | ||||||||
Proceeds from disposition of corporate debt investment | — | — | 102,575 | ||||||||
Other loans receivable | (221 | ) | (1,170 | ) | (9,826 | ) | |||||
Other loans receivable repayment | — | 3,084 | 14,000 | ||||||||
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Amounts in Thousands)
| | Year Ended December 31, 2010 | Year Ended December 31, 2009 | Year Ended December 31, 2008 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Restricted cash used in investment activities | (284,300 | ) | 29,064 | (109,513 | ) | ||||||
Purchase of equity interest | (2,195 | ) | — | — | |||||||
Deferred costs and intangible assets | (7,495 | ) | (157 | ) | — | ||||||
Other receivables | (1,082 | ) | (2,240 | ) | — | ||||||
Acquisition deposits | — | (300 | ) | (741 | ) | ||||||
Investment in and advances to unconsolidated ventures | (7,332 | ) | (847 | ) | (44,143 | ) | |||||
Distributions from unconsolidated ventures | 19,797 | 23,906 | 8,712 | ||||||||
Net cash provided by (used in) investing activities | 119,025 | 123,319 | (110,708 | ) | |||||||
Cash flows from financing activities: | |||||||||||
Collateral held by broker | — | — | 12,746 | ||||||||
Securities sold, not yet purchased | — | — | (12,778 | ) | |||||||
Purchase of interest rate cap | (300 | ) | — | — | |||||||
Settlement of derivative | (283 | ) | — | — | |||||||
Collateral held by swap counter party | 9,189 | 2,384 | (20,837 | ) | |||||||
Mortgage notes and loan borrowings | 78,200 | — | 3,677 | ||||||||
Mortgage notes principal repayments | (66,267 | ) | (62,638 | ) | (5,422 | ) | |||||
Borrowing under credit facilities | — | 1,912 | 39,816 | ||||||||
Credit facilities repayments | — | (46,794 | ) | (118,403 | ) | ||||||
Repurchase obligation borrowings | — | 528 | 2,200 | ||||||||
Repurchase obligation repayments | — | (703 | ) | (3,887 | ) | ||||||
Proceeds from bonds | 174,318 | 91,000 | 137,011 | ||||||||
Bond repayments | (271,316 | ) | (20,693 | ) | (95,300 | ) | |||||
Bond repurchases | (17,653 | ) | (55,567 | ) | (49,859 | ) | |||||
Borrowing under secured term loan | 24,739 | 39,570 | 70,864 | ||||||||
Secured term loan repayment | (248,744 | ) | (76,750 | ) | (80,190 | ) | |||||
Payment of deferred financing costs | (2,297 | ) | (4,239 | ) | (5,188 | ) | |||||
Capital contributions by non-controlling interest | 4,686 | 1,815 | 94,822 | ||||||||
Restricted cash from financing activities | 212,975 | (3,861 | ) | 86,832 | |||||||
Proceeds from exchangeable senior notes | — | — | 80,000 | ||||||||
Proceeds from common stock offerings | — | 26,253 | 2,268 | ||||||||
Proceeds from dividend reinvestment and stock purchase plan | 346 | 63 | — | ||||||||
Purchase of treasury stock | — | — | (1,384 | ) | |||||||
Dividends (common and preferred) and distributions | (51,408 | ) | (48,058 | ) | (122,059 | ) | |||||
Deferred offering costs | (449 | ) | (408 | ) | — | ||||||
Offering costs | (70 | ) | (804 | ) | (252 | ) | |||||
Distributions to non-controlling interest | (13,738 | ) | (15,958 | ) | (11,371 | ) | |||||
Net cash (used in)/provided financing activities | (168,072 | ) | (172,948 | ) | 3,306 | ||||||
Net (decrease) increase in cash & cash equivalents | (13,489 | ) | 4,889 | (19,790 | ) | ||||||
Cash and cash equivalents—beginning of period | 138,928 | 134,039 | 153,829 | ||||||||
Cash and cash equivalents—end of period | $ | 125,439 | $ | 138,928 | $ | 134,039 | |||||
Supplemental disclosure of cash flow information: | |||||||||||
Cash paid for interest | $ | 232,324 | $ | 104,270 | $ | 216,115 | |||||
See accompanying notes to consolidated financial statements.
117
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Thousands, Except per Share Data)
1. Formation and Organization
NorthStar Realty Finance Corp., a Maryland corporation (the "Company"), is a self-administered and self-managed real estate investment trust ("REIT"), which was formed in October 2003 in order to continue and expand the real estate debt, real estate securities and net lease businesses conducted by its predecessor. Substantially all of the Company's assets are held by, and it conducts its operations through, NorthStar Realty Finance Limited Partnership, a Delaware limited partnership and the operating partnership of the Company (the "Operating Partnership").
Consolidating Subsidiaries
NRF Healthcare, LLC
In May 2006, the Company entered into a joint venture called NRF Healthcare, LLC with Chain Bridge Capital LLC to invest in senior housing and healthcare-related net leased assets. In connection with the formation of the venture, Chain Bridge contributed substantially all of its assets to NRF Healthcare, LLC for its $15.1 million membership interest in the joint venture.
In December 2009, the Company completed a membership interest redemption with NRF Healthcare, LLC, NRFC Healthcare Holding Company, LLC, NorthStar Healthcare Investors, Inc., Chain Bridge, Wakefield Capital Management, Midwest Care Holdings LLC, or Midwest Holdings, and certain individuals, pursuant to which NRF Healthcare, LLC redeemed the 5.4% membership interest of Chain Bridge and its affiliates in NRF Healthcare, LLC for $2.0 million and its membership interest in certain assets. As a result of the redemption, NorthStar holds 100% of the common equity membership interests in NRF Healthcare, LLC.
In April 2010, pursuant to the membership redemption agreement entered into in December 2009, the Company acquired the 51% membership interest in Midwest Holdings owned by Chain Bridge for $1.0 million in cash. As a result of the acquisition, the Company now holds 100% of the common membership interest in Midwest Holdings and controls all major decisions. Accordingly, the operations of Midwest Holdings, which were previously accounted for under the equity method, are consolidated.
2. Summary of Significant Accounting Policies
Basis of Accounting
The accompanying consolidated financial statements of the Company are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company, and its subsidiaries, which are either majority owned or controlled by the Company or a variable interest entity ("VIE") where the Company is the primary beneficiary. All significant intercompany balances have been eliminated in consolidation.
Variable Interest Entities
The Company identifies entities for which control is achieved through means other than through voting rights (a "variable interest entity" or "VIE"), and determines when and which business
118
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
2. Summary of Significant Accounting Policies (Continued)
enterprise, if any, should consolidate the VIE. In addition, the Company discloses information pertaining to such entities wherein the Company is the primary beneficiary or other entities wherein the Company has a significant variable interest.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that could affect the amounts reported in the consolidated financial statements. Actual results could differ from these estimates.
Operating Real Estate
Operating real estate properties are carried at historical cost less accumulated depreciation. Costs directly related to the acquisition are expensed as incurred. Ordinary repairs and maintenance which are not reimbursed by the tenants are expensed as incurred. Major replacements and betterments which improve or extend the life of the asset are capitalized and depreciated over their useful life.
Properties are depreciated using the straight-line method over the estimated useful lives of the assets.
The estimated useful lives are as follows:
Category | Term | |
|---|---|---|
Building (fee interest) | 40 years | |
Building improvements | Lesser of the remaining life of building or useful life | |
Building (leasehold interest) | Lesser of 40 years or the remaining term of the lease | |
Property under capital lease | Lesser of 40 years or the remaining term of the lease | |
Tenant improvements | Lesser of the useful life or the remaining term of the lease | |
Furniture and fixtures | Four to ten years |
A property to be disposed of is reported at the lower of its carrying value or its estimated fair value less the cost to sell. Once an asset is determined to be held for sale, depreciation and straight-line rental income are no longer recorded. In addition, the asset is reclassified to assets held for sale on the consolidated balance sheet and the results of operations are reclassified to income (loss) from discontinued operations in the consolidated statements of operations.
The Company allocates the purchase price of operating properties to land, building, tenant improvements, deferred lease cost for the origination costs of the in-place leases and to intangibles for the value of the above or below market leases. The Company amortizes the value allocated to the in-place leases over the remaining lease term. The value allocated to the above or below market leases are amortized over the remaining lease term as an adjustment to rental income.
Real estate that the Company acquires as a result of foreclosure or by deed-in-lieu of foreclosure is recorded at the lower of its cost, which is the unpaid balance of the loan, or fair market value at the date of foreclosure.
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
2. Summary of Significant Accounting Policies (Continued)
Investments in and Advances to Unconsolidated Ventures
The Company has various investments in unconsolidated ventures. In circumstances where the Company has a non-controlling interest but are deemed to be able to exert influence over the affairs of the enterprise the Company utilizes the equity method of accounting. Under the equity method of accounting, the initial investment is increased each period for additional capital contributions and a proportionate share of the entity's earnings and decreased for cash distributions and a proportionate share of the entity's losses.
Management periodically reviews its investments for impairment based on projected cash flows from the venture over the holding period. When any impairment is identified, the investments are written down to recoverable amounts.
Fair Value Measurements
Fair value is used to measure many of the Company's financial instruments. The fair value of these financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., the exit price).
Fair Value Option
The Company had the one-time option to elect fair value on January 1, 2008 for its existing financial assets and liabilities. For all new financial instruments, the Company has the one-time option to elect fair value for these financial assets or liabilities on the election date. The changes in the fair value of these instruments are recorded in unrealized gain (loss) on investments and other in the consolidated statements of operations.
Available for Sale Securities
The Company determines the appropriate classification of its investments in securities at the time of purchase and reevaluates such determination at each balance sheet date. Securities for which the Company does not have the intent or the ability to hold to maturity are classified as available for sale securities. The Company's available for sale securities that serve as collateral for its CDO financings, which the Company has elected the fair value option, are carried at fair value with the net unrealized gains or losses reported as a component of earnings in the statement of operations. Prior to consolidation of the CDO financings as the result of the Company being deemed the primary beneficiary, the Company designated its investments in the equity notes and its non investment grade notes of unconsolidated CDO financings as available for sale securities as they met the definition of a debt instrument due to their redemption provisions. These securities are carried at estimated fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) in the consolidated statements of stockholders' equity.
Real Estate Debt Investments
Real estate debt investments are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan origination fees, discounts, and unfunded commitments unless such loan or investment is deemed to be impaired. Discounts and premiums on purchased assets are amortized
120
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
2. Summary of Significant Accounting Policies (Continued)
over the life of the investment using the effective interest method. The origination cost and fees are deferred and amortized using the effective interest method over the life of the related loan investment. The amortization is reflected as an adjustment to interest income.
Real Estate Debt Investments Held for Sale
Real estate debt investments held for sale are carried at the lower of cost or market value using available market information including sales prices and information obtained through consultation with dealers or other originators of such investments. The Company classifies, as held for sale, real estate debt investments that are actively being marketed for sale.
Cash and Cash Equivalents
The Company considers all highly liquid investments that have remaining maturity dates of three months or less when purchased to be cash equivalents. Cash, including amounts restricted, exceeded the Federal Deposit Insurance Corporation deposit insurance limit of $250,000 per institution at December 31, 2010 and 2009. The Company mitigates its risk by placing cash and cash equivalents with major financial institutions.
Restricted Cash
Restricted cash consists of deposits with the trustee related to the consolidating CDO financings which is primarily proceeds of loan repayments which will be used to reinvest in collateral or repayment of the bonds in the CDOs and escrows for taxes, insurance, capital expenditures, tenant security deposits, payments required under certain lease agreements and escrow deposits collected in connection with whole loan originations. The Company mitigates its risk by placing restricted cash with major financial institutions.
Deferred Costs, Net
Deferred lease costs consist of fees incurred to initiate and renew operating leases and purchase price-allocations to lease cost. Lease costs are being amortized using the straight-line method over the terms of the respective leases.
Deferred financing costs represent commitment fees, legal and other third-party costs associated with obtaining financing. These costs are amortized over the term of the financing. Unamortized deferred financing costs are expensed when the associated debt is refinanced or repaid before maturity. Costs incurred in seeking financing transactions, which do not close, are expensed in the period the financing transaction was terminated.
Detachable Stock Warrants
The Company allocates proceeds received from issuing debt with detachable stock purchase warrants between the debt and the warrants, based on their relative fair values at the time of issuance. The portion of the proceeds that is allocated to the warrants was recorded as additional paid-in-capital. The resulting discount on the debt will be recorded as interest expense over the life of the associated debt, using the effective interest method, in the consolidated statement of operations.
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
2. Summary of Significant Accounting Policies (Continued)
Comprehensive Income
Comprehensive income (loss), is comprised of consolidated net income, as presented in the consolidated statements of operations, adjusted for changes in unrealized gains or losses on available for sale securities and changes in the fair value of derivative financial instruments accounted for as cash flow hedges recorded in other comprehensive income.
Underwriting Commissions and Costs
Underwriting commissions and direct costs incurred in connection with the Company's public offering are reflected as a reduction of additional paid-in-capital.
Revenue Recognition
Rental income from leases is recognized on a straight-line basis over the noncancelable term of the respective leases. The excess of rents recognized over amounts contractually due pursuant to the underlying leases are included in unbilled rent receivable in the accompanying consolidated balance sheets.
Tenant reimbursement income is recognized in the period in which the related expense is incurred. Rental revenue, which is based upon a percentage of the sales recorded by the Company's tenants is recognized in the period such sales were earned by the respective tenants.
Interest income from the Company's loan investments is recognized on an accrual basis over the life of the investment using the effective interest method. Additional interest to be collected at the origination of the loan or the payoff of the loan is recognized over the term of the loan as an adjustment to yield.
Interest income from available for sale securities is recognized on the accrual basis over the life of the investment on a yield-to-maturity basis.
Advisory fee income from both third parties and affiliates is recognized on the accrual basis as services are rendered and the fee income is contractually earned in accordance with the respective agreements. Fees from affiliated ventures accounted for under the equity method, are eliminated against the related equity in earnings in such affiliated ventures to the extent of the Company's ownership.
Credit Losses, Impairment and Allowance for Doubtful Accounts
The Company assesses whether unrealized losses on the change in fair value on their available for sale securities, for which the fair value option was not elected, reflect a decline in value which is other than temporary. If it is determined the decline in value is other than temporary the impaired securities are written down through earnings to their fair values. Significant judgment of management is required in this analysis, which includes, but is not limited to, making assumptions regarding the collectability of the principal and interest, net of related expenses, on the underlying collateral.
For all classes of real estate debt investments, allowances are established based upon a periodic review of the investments. Income recognition is suspended for loans at the earlier of the date at which
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
2. Summary of Significant Accounting Policies (Continued)
payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the suspended loan becomes contractually current and performance is demonstrated to be resumed. In performing this review, management considers the estimated net recoverable value of the loan as well as other factors, including the fair market value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the economic situation of the region where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized from the loan investments may differ materially from the carrying value at the balance sheet date.
On a periodic basis, the Company assesses whether there are any indicators that the value of our operating real estate properties may be impaired or that its carrying value may not be recoverable. A property's value is considered impaired if management's estimate of the aggregate future undiscounted cash flows to be generated by the property is less than the carrying value of the property. To the extent an impairment has occurred and is considered to be other than temporary, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property.
Allowance for doubtful accounts for tenant receivables are established based on periodic review of aged receivables resulting from estimated losses due to the inability of its tenants to make required rent and other payments contractually due. Additionally, the Company establishes, on a current basis, an allowance for future tenant credit losses on billed and unbilled rents receivable based upon an evaluation of the collectability of such amounts.
Rent Expense
Rent expense is recorded on a straight-line basis over the term of the respective leases. The excess of rent expense incurred on a straight-line basis over rent expense, as it becomes payable according to the terms of the lease, is recorded as rent payable and is included in other liabilities in the consolidated balance sheets.
Income Taxes
The Company has elected to be treated as a REIT under Internal Revenue Code Sections 856 through 859 and intends to remain so qualified. As a REIT, the Company is not subject to Federal income tax. To maintain its qualification as a REIT, the Company must distribute at least 90% of its REIT taxable income to its stockholders and meet certain other requirements. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to Federal income tax on its taxable income at regular corporate rates. The Company may also be subject to certain state, local and franchise taxes. Under certain circumstances, Federal income and excise taxes may be due on its undistributed taxable income.
Pursuant to amendments to the Code that became effective January 1, 2001, the Company has elected or may elect to treat certain of its existing or newly created corporate subsidiaries as taxable REIT subsidiaries (each a "TRS"). In general, a TRS of the Company may perform non-customary services for tenants of the Company, hold assets that the Company cannot hold directly and may engage in any real estate or non-real estate related business. A TRS is subject to regular corporate
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
2. Summary of Significant Accounting Policies (Continued)
income tax. The Company has established several TRSs in jurisdictions for which no taxes are assessed on corporate earnings. However, the Company must include earnings from these TRSs currently.
The Company will recognize interest and penalties, if any, related to uncertain tax positions as income tax expense, which is included in general and administrative expense.
Derivatives and Hedging Activities
In the normal course of business, the Company uses a variety of derivative instruments to manage, or hedge interest rate risk. The Company recognizes derivatives as either assets or liabilities in the consolidated balance sheets and measures those instruments at fair value. The fair value adjustments of each period will affect the consolidated financial statements of the Company differently depending on whether the derivative instrument qualifies as a hedge for accounting purposes and, if so, the nature of the hedging activity.
The Company enters into cash flow hedges and must designate them at the time of entering into the derivative. The derivatives entered into by the Company are intended to qualify as hedges under accounting principles generally accepted in the United States, unless specifically stated otherwise. Toward this end, the terms of hedges are matched closely to the terms of hedged items. The Company assesses the effectiveness of the cash flow hedges both at inception and on an on-going basis and determines whether the hedge is highly effective in offsetting changes in cash flows of the hedged item. The Company records the effective portion of changes in the estimated fair value in accumulated other comprehensive income (loss) and subsequently reclassifies the related amount of accumulated other comprehensive income (loss) to earnings when the hedging relationship is terminated. If it is determined that a derivative has ceased to be a highly effective hedge, the Company will discontinue hedge accounting for such transaction.
With respect to derivative instruments that have not been designated as hedges, or are hedges on debt that is remeasured at fair value, any net payments under, or fluctuations in the fair value of, such derivatives are recognized currently in income. The Company's basis swaps have been designated as non-hedge derivatives.
The Company's derivative financial instruments contain credit risk to the extent that its bank counterparties may be unable to meet the terms of the agreements. The Company minimizes such risk by limiting its counterparties to major financial institutions with good credit ratings. In addition, the potential risk of loss with any one party resulting from this type of credit risk is monitored.
Stock Based Compensation
The Company has adopted the fair value method of accounting for its equity based compensation awards. The fair value method of accounting requires an estimate of the fair value of the equity award at the time of grant rather than the intrinsic value method. All fixed equity based awards to employees and directors, which have no vesting conditions other than time of service, will be amortized to compensation expense over the award's vesting period based on the fair value of the award at the date of grant.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
2. Summary of Significant Accounting Policies (Continued)
Foreign Currency Translation
The Company's functional currency of its euro-dominated investment is the US dollar. Non-monetary assets and liabilities are translated at historical rates and monetary assets and liabilities are translated at the exchange rates in effect at the end of the reporting period. Statement of operation accounts are translated at the average rates for the reporting period. Any gains and losses from the translation of foreign currency to US dollars are included in the statement of operations. Since the Company's foreign currency Euro-dominated investment is approximately 82% financed with Euro-dominated debt, any net foreign currency translation gains or losses on the portion of the investment not financed with Euro-denominated debt are included in realized gains (losses) in the Company's consolidated statement of operations.
Earnings Per Share
The Company's basic earnings per share ("EPS") is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding. For purposes of calculating earnings per share, the Company considered all unvested restricted stock which participates in the dividends of the Company to be outstanding. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted to common stock, where such exercise or conversion would result in a lower EPS amount. This also includes units of limited partnership interest in the Operating Partnership. The dilutive effects of units of limited partnership interest and their equivalents are computed using the "treasury stock" method.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current period presentation.
On January 1, 2009, the Company adopted the accounting pronouncement regarding convertible debt instruments that, by their stated terms, may be settled in cash (or other assets) upon conversion, including partial cash settlement of the conversion option. The pronouncement requires bifurcation of the instrument into a debt component that is initially recorded at fair value and an equity component. The difference between the fair value of the debt component and the initial proceeds from issuance of the instrument is recorded as a component of equity. The liability component of the debt instrument is accreted to par using the effective interest method; accretion is reported as a component of interest expense. The equity component is not subsequently re-valued as long as it continues to qualify for equity treatment. Additionally, the pronouncement precludes the use of the fair value option of accounting. The financial statements for 2008 have been restated for the effects of the retroactive application of the pronouncement.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
2. Summary of Significant Accounting Policies (Continued)
The following tables present the cumulative effects of the change in accounting principle for the year ended December 31, 2008:
| | Year Ended December 31. 2008 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| | As Originally Reported | As Adjusted | Effect of Change in Accounting Principle | |||||||
Interest expense(1) | $ | 191,472 | $ | 194,295 | $ | 2,823 | ||||
Unrealized gain (loss) on investments and other | 752,332 | 649,113 | (103,219 | ) | ||||||
Realized gain on investments and other | 36,036 | 37,699 | 1,663 | |||||||
Fundraising fees, debt issuance costs and other | 7,823 | 2,875 | (4,948 | ) | ||||||
Non-controlling interests | (82,098 | ) | (72,172 | ) | 9,926 | |||||
Net income attributable to NorthStar Realty Finance Corp. common stockholders | 698,741 | 609,232 | (89,509 | ) | ||||||
Earnings per share | $ | 11.07 | $ | 9.65 | $ | (1.51 | ) | |||
- (1)
- As adjusted amount excludes additional reclassifications as a result of discontinued operations (see Note 4 for additional information).
On January 1, 2009, the Company adopted the provisions of the accounting pronouncement regarding non-controlling interests in consolidated financial statements. The pronouncement clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The pronouncement also changes the way the consolidated income statement is presented by requiring consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. The adoption of this pronouncement does not affect prior periods reported net income or retained earnings; however, the presentation and disclosure requirements have been applied retrospectively for all periods presented.
Recently Issued Pronouncements
In January 2010, the FASB issued an accounting update requiring additional disclosures about fair value measurements regarding transfers between fair value categories as well as purchases, sales, issuances and settlements related to fair value measurements of financial instruments with non-observable inputs. This update was effective and was adopted by the Company for interim and annual periods beginning after December 15, 2009 except for disclosures about purchases, sales, issuances and settlements of financial instruments with non-observable inputs, which are effective for years beginning after December 15, 2010. The additional disclosures required by this update will be included in the note on fair value measurements upon adoption.
In July 2010, the FASB issued an accounting update requiring more robust and disaggregated disclosure about the credit quality of an entity's loans and its allowance for loan losses. The new
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
2. Summary of Significant Accounting Policies (Continued)
guidance significantly expands the existing disclosure requirements and is focused on providing transparency regarding an entity's exposure to credit losses. This update is effective for interim and annual reporting periods ending on or after December 15, 2010. The additional disclosures required by this update are included in the note on real estate debt investments.
In December 2010, the FASB issued an accounting update specifying that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The Company's adoption of this update will not have a material effect on its financial condition, results of operations, or cash flows.
3. Variable Interest Entities
On January 1, 2010, the Company adopted the FASB guidance for determining whether an entity is a variable interest entity, or VIE, and which requires an analysis of qualitative rather than quantitative factors to determine the primary beneficiary of a VIE. The guidance requires an entity to consolidate a VIE if (i) it has the power to direct the activities that most significantly impact the VIE's economic performance and (ii) the obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. As a result of the implementation of this pronouncement, the Company consolidated four of its previously off-balance sheet CDO financings, which are referred to as N-Star I, II, III and V. The Company has elected the fair value option of accounting for the available for sale securities and bonds payable of these entities for the purpose of consistent accounting application.
The following tables present the cumulative effects of the change in accounting principle as of January 1, 2010 (in thousands):
| | As Reported, December 31, 2009 | As Adjusted, January 1, 2010 | Effect of Change in Accounting Principle | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Non-controlling interest | $ | 90,647 | $ | 110,976 | $ | 20,329 | ||||
Retained earnings | 460,915 | 582,850 | 121,935 | |||||||
Accumulated other comprehensive loss | (92,670 | ) | (51,338 | ) | 41,332 | |||||
The Company has evaluated its real estate debt investments, liability to subsidiary trusts issuing preferred securities, and its investments in each of its nine CDO transaction issuers to determine whether they are a variable interest entity ("VIE"). A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. For each of these investments, the Company has evaluated: (1) the sufficiency of the fair value of the entity's equity investment at risk to absorb losses; (2) whether as a group the holders of the equity investment at risk have: (a) the power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity's
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
3. Variable Interest Entities (Continued)
economic performance; (b) the obligation to absorb the expected losses of the legal entity; and (c) the right to receive the expected residual returns of the legal entity; (3) whether the voting rights of these investors are proportional to their obligations to absorb the expected losses of the entity, their rights to receive the expected returns of their equity, or both; and (4) whether substantially all of the entity's activities involve or are conducted on behalf of an investor that has disproportionately fewer voting rights. An investment that lacks one or more of the above four characteristics of a voting interest entity is considered to be a VIE.
As of December 31, 2010, the Company identified interests in 19 entities which were determined to be VIEs. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events.
The Company is required to consolidate a VIE if the Company is deemed to be the VIEs primary beneficiary. The primary beneficiary is the party that (i) has the power to direct the activities that most significantly impact the VIE's economic performance and (ii) has the obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE.
The Company determines whether it is the primary beneficiary of a VIE by first performing a qualitative analysis to determine if it holds the power to direct the activities that most significantly impact the VIEs economic performance. This analysis includes: (i) assessing the Company's variable interests (both implicit and explicit) and any other involvements in the VIE, as well as the involvements of other variable interest holders; (ii) consideration of the VIEs purpose and design, including the risks the VIE was designed to create and pass through to its variable interest holders; (iii) identifying the activities that most significantly affect the VIE's economic performance; (iv) determining whether the Company's significant involvement in the design of an entity provided the Company with the opportunity to establish arrangements that result in the Company having the power to direct the VIEs most significant activities; and (v) determining whether the Company's level of economic interest in a VIE is indicative of the amount of power the Company holds in situations where the Company's stated power to direct the VIEs most significant activities is disproportionately less than its economic interest in the entity. The Company performs a quantitative analysis to determine if it has the obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. For purposes of allocating a VIE's expected losses and expected residual returns to its variable interest holders, the Company calculates its share of the VIE's expected losses and expected residual returns using the specific cash flows that would be allocated to it, based on contractual arrangements and/or the Company's position in the capital structure of the VIE, under various scenarios.
Based on management's analysis, the Company is not the primary beneficiary of nine of the identified VIEs since it (i) does not have the power to direct the activities that most significantly impact the VIE's economic performance and (ii) does not have the obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. Accordingly, these VIEs are not consolidated into the Company's financial statements as of December 31, 2010. The Company reassesses its determination of whether it is the primary beneficiary of a VIE each reporting period.
On July 8, 2010, an affiliate of CapitalSource Inc. ("CapitalSource") (i) delegated to an affiliate of the Company collateral management and special servicing rights, and the associated fees, relating to
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
3. Variable Interest Entities (Continued)
CapitalSource's approximately $1.1 billion collateralized debt obligation consisting primarily of first mortgage loans on commercial real estate (the "CSE RE 2006-A" CDO) and (ii) sold to the Company the CSE RE 2006-A Class J notes (approximately $50 million current balance) and the Class K notes (approximately $60 million current balance). The total consideration paid in the transaction by the Company was $7 million. The Company has evaluated its investment in CSE RE 2006-A and has determined that CSE RE 2006-A is a VIE and that the Company is the primary beneficiary of the VIE. As a result, the Company consolidated CSE RE 2006-A as of July 8, 2010 and recorded a gain of approximately $15.4 million resulting from the excess of the fair market value of the net assets acquired over the purchase price. The CSE RE 2006-A loans will be accreted to projected recovery values over the respective term of each of the loans. The Company has elected the fair value option of accounting for the bonds payable of CSE RE 2006-A for the purpose of consistent accounting application.
On July 7, 2010, the Company purchased the N-Star CDO IX income notes and management fees from the NorthStar Real Estate Securities Opportunity Fund ("Securities Fund") for approximately $3.3 million. The Company has evaluated its investment in the N-Star CDO IX income notes and has determined that N-Star CDO IX is a VIE and that the Company is the primary beneficiary of the VIE. As a result, the Company consolidated the assets and liabilities of N-Star CDO IX at their respective carrying values as of the acquisition date. The Company has elected the fair value option of accounting for the available for sale securities and bonds payable of N-Star CDO IX for the purpose of consistent accounting application.
Consolidated VIEs (the Company is the primary beneficiary)
The Company has originated, acquired and manages portfolios of commercial real estate securities and real estate debt investments, which were financed in CDO financings. The collateral securities include commercial mortgage-backed securities ("CMBS"), fixed income securities issued by REITs and CDO financings backed primarily by real estate securities. The collateral debt investments include whole loans, subordinate mortgage interests, mezzanine loans and other loans. By financing these securities with long-term debt through the issuance of CDO financings, the Company expects to generate attractive risk-adjusted equity returns and to match the term of its assets and liabilities. In connection with the Company's CDO financings, the Company has various forms of significant ongoing involvement, which may include: (i) holding senior or subordinated interests in the CDOs; (ii) asset management; and (iii) entering into derivative contracts.
N-Star I, II, III, IV, V, VI, VII, VIII, IX and CSE RE 2006-A are consolidated CDO financings.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
3. Variable Interest Entities (Continued)
The following table displays the classification and carrying amounts of assets and liabilities of consolidated VIEs as of December 31, 2010 (in thousands):
| | Variable Interest Entity | |||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | N-Star I | N-Star II | N-Star III | N-Star IV | N-Star V | N-Star VI | N-Star VII | N-Star VIII | N-Star IX | CapitalSource | Total | |||||||||||||||||||||||
Assets of consolidated VIEs: | ||||||||||||||||||||||||||||||||||
Restricted cash | $ | 27,730 | $ | 677 | $ | 13,006 | $ | 23,375 | $ | 1,719 | $ | 44,794 | $ | 1,480 | $ | 32,746 | $ | 18,750 | $ | 99,037 | $ | 263,314 | ||||||||||||
Available for sale securities, at fair value | 202,671 | 192,528 | 238,251 | 32,754 | 280,668 | 14,949 | 308,378 | 25,880 | 307,860 | 64,278 | 1,668,217 | |||||||||||||||||||||||
Real estate debt investments, net | — | — | 31,507 | 326,293 | — | 291,684 | 19,953 | 649,565 | 45,535 | 295,345 | 1,659,882 | |||||||||||||||||||||||
Investments in and advances to unconsolidated ventures | — | — | — | — | — | — | — | 66,959 | — | — | 66,959 | |||||||||||||||||||||||
Real estate debt investments, held-for-sale | — | — | — | — | — | — | — | — | 5,396 | 13,265 | 18,661 | |||||||||||||||||||||||
Receivables, net of allowance | 1,781 | 1,559 | 1,978 | 1,481 | 3,357 | 1,086 | 3,215 | 2,026 | 4,253 | 5,601 | 26,337 | |||||||||||||||||||||||
Derivative instruments, at fair value | — | — | — | — | — | — | 35 | — | — | 7 | 42 | |||||||||||||||||||||||
Assets of properties held for sale | — | — | — | — | — | — | — | 8,040 | — | 5,101 | 13,141 | |||||||||||||||||||||||
Other assets | 47 | 43 | 15 | 305 | — | 2,607 | 54 | 6 | 298 | 10,902 | 14,277 | |||||||||||||||||||||||
Total assets of consolidated VIEs(1): | 232,229 | 194,807 | 284,757 | 384,208 | 285,744 | 355,120 | 333,115 | 785,222 | 382,092 | 493,536 | 3,730,830 | |||||||||||||||||||||||
Liabilities of consolidated VIEs: | ||||||||||||||||||||||||||||||||||
Bonds payable, at fair value | 193,242 | 139,922 | 156,107 | 164,315 | 170,358 | 180,813 | 233,892 | 322,431 | 207,136 | 490,591 | 2,258,807 | |||||||||||||||||||||||
Accounts payable and accrued expenses | 1,324 | 104 | 1,126 | 122 | 522 | 381 | 329 | 1,124 | 2,082 | 8,554 | 15,668 | |||||||||||||||||||||||
Escrow deposits payable | — | — | — | 19,662 | — | 12,853 | — | 10,010 | 1,352 | 16,286 | 60,163 | |||||||||||||||||||||||
Derivative liability, at fair value | 14,120 | 14,726 | 18,666 | — | 31,169 | 8,538 | 39,452 | 18,258 | 34,767 | 11,297 | 190,993 | |||||||||||||||||||||||
Liabilities of properties held for sale | — | — | — | — | — | — | — | 32 | — | 99 | 131 | |||||||||||||||||||||||
Other liabilities | — | — | 70 | — | — | — | 314 | — | 8,270 | — | 8,654 | |||||||||||||||||||||||
Total liabilities of consolidated VIEs(2): | 208,686 | 154,752 | 175,969 | 184,099 | 202,049 | 202,585 | 273,987 | 351,855 | 253,607 | 526,827 | 2,534,416 | |||||||||||||||||||||||
Net assets | $ | 23,543 | $ | 40,055 | $ | 108,788 | $ | 200,109 | $ | 83,695 | $ | 152,535 | $ | 59,128 | $ | 433,367 | $ | 128,485 | $ | (33,291 | ) | $ | 1,196,414 | |||||||||||
- (1)
- Assets of each of the consolidated VIEs may only be used to settle obligations of the respective VIE.
- (2)
- Creditors of each of the consolidated VIEs have no recourse to the general credit of the Company.
The Company did not provide financial support to any of its consolidated VIEs during the years ended December 31, 2010 and 2009. At December 31, 2010, there are no explicit arrangements or implicit variable interests that could require the Company to provide financial support to any of its consolidated VIEs.
Unconsolidated VIEs (the Company is not the primary beneficiary, but has a variable interest)
Real Estate Debt Investments
The Company has identified one real estate debt investment with a principal amount of $20.6 million as a variable interest in a VIE and has determined that the Company is not the primary beneficiary of this VIE and as such the VIE should not be consolidated in the Company's consolidated financial statements. For all other real estate debt investments, the Company has determined that these
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
3. Variable Interest Entities (Continued)
investments are not VIEs and, as such, the Company has continued to account for all real estate debt investments as loans.
NorthStar Realty Finance Trusts
The Company owns all of the common stock of NorthStar Realty Finance Trusts I through VIII (collectively, the "Trusts"). The Trusts were formed to issue preferred securities. The Company determined that the holders of the trust preferred securities were the primary beneficiaries of the Trusts. As a result, the Company did not consolidate the Trusts and has accounted for the investment in the common stock of the Trusts under the equity method of accounting. The following table displays the classification, carrying amounts and maximum exposure of unconsolidated VIEs as of December 31, 2010 (in thousands):
| | Variable Interest Entity | | | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Trusts Issuing Preferred Securities, at Fair Value | Real Estate Debt Investments | Total | Maximum Exposure to Loss(1) | |||||||||
Real estate debt investments | — | $ | 20,556 | $ | 20,556 | $ | 20,556 | ||||||
Total assets | — | 20,556 | 20,556 | 20,556 | |||||||||
Liability to subsidiary trusts issuing preferred securities, at fair value | 191,250 | — | 191,250 | N/A | |||||||||
Total liabilities | 191,250 | — | 191,250 | N/A | |||||||||
Net assets | $ | (191,250 | ) | $ | 20,556 | $ | (170,694 | ) | $ | 20,556 | |||
- (1)
- The Company's maximum exposure to loss at December 31, 2010, would not exceed the carrying amount of its investment.
The Company did not provide financial support to any of its unconsolidated VIEs during the years ended December 31, 2010 and 2009. At December 31, 2010, there are no explicit arrangements or implicit variable interests that could require the Company to provide financial support to any of its unconsolidated VIEs.
4. Fair Value of Financial Instruments
Fair Value Measurements
Fair Value Hierarchy
The Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
4. Fair Value of Financial Instruments (Continued)
Financial assets and liabilities recorded on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
| Level 1. | Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market (examples include active exchange-traded equity securities, listed derivatives, most U.S. government and agency securities, and certain other sovereign government obligations). | |||
| Level 2. | Financial assets and liabilities whose values are based on the following: | |||
a) | Quoted prices for similar assets or liabilities in active markets (for example, restricted stock); | |||
b) | Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently); | |||
c) | Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); and | |||
d) | Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (for example, certain mortgage loans). | |||
Level 3. | Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management's own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include private equity investments, beneficial interest in securitizations and long-dated or complex derivatives, including certain foreign exchange options and long-dated options on gas and power). | |||
Determination of Fair Value
The Company uses valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. The Company's market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The Company's income approach uses valuation techniques to convert future projected cash flows to a single discounted present value amount. When applying either approach, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. The Company reviews the fair values determined by the third-party pricing models and dealer quotes and compares the results to internally generated pricing models on each asset or liability to validate reasonableness.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
4. Fair Value of Financial Instruments (Continued)
The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.
Available for sale securities
When available, the fair value of available for sale securities is based on quoted prices in active markets. If quoted prices are not available, fair values are obtained from nationally-recognized pricing services, broker quotes, or other model-based valuation techniques. The fair value of Level 2 securities is based on a market approach with prices obtained from nationally-recognized pricing services. Observable inputs used to value these securities can include: reported trades, benchmark yields, issuer spreads and broker/dealer quotes. The fair value of Level 3 securities is typically based on a single broker quote or the Company's discounted cash flow analysis.
Derivative instruments
Derivatives are measured using market approach with prices obtained from nationally-recognized pricing service and are generally measured using pricing models with market observable inputs such as interest rates and equity index levels. These measurements are classified as Level 2 within the fair value hierarchy.
Corporate lending investment
The Company's corporate lending investment is measured using in income approach with prices obtained from a nationally-recognized banking institution that acted as underwriter for the investment and is generally measured using pricing models with market observable inputs such as interest rates and equity index levels, with adjustments for unobservable inputs. These measurements are classified as Level 3 within the fair value hierarchy.
CDO bonds payable
CDO bonds payable are measured with prices obtained from a nationally-recognized banking institution that acted as underwriter for the investment and are generally measured using pricing models with market observable inputs such as interest rates and equity index levels, with adjustments for unobservable inputs. These measurements are classified as Level 3 within the fair value hierarchy.
Liability to subsidiary trusts issuing preferred securities
Liability to subsidiary trusts issuing preferred securities is measured using market approach with prices obtained from an experienced pricing service and is generally measured using pricing models with market observable inputs such as implied credit spreads on the Company's preferred stock and exchangeable senior notes as adjusted for unobservable inputs which reflect the differences between these other instruments and the trust preferred securities. These measurements are classified as Level 3 within the fair value hierarchy.
Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth the Company's financial
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
4. Fair Value of Financial Instruments (Continued)
assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2010, by level within the fair value hierarchy:
| | Assets and Liabilities at Fair Value | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Level 1 | Level 2 | Level 3 | Total | ||||||||||
Assets: | ||||||||||||||
Available for sale securities: | ||||||||||||||
CMBS | $ | — | $ | 1,016,372 | $ | 375,727 | $ | 1,392,099 | ||||||
Third party CDO notes | — | — | 37,213 | 37,213 | ||||||||||
REIT debt | — | 182,106 | 54,852 | 236,958 | ||||||||||
Trust preferred securities | — | — | 24,784 | 24,784 | ||||||||||
Derivative asset | — | 59 | — | 59 | ||||||||||
Total assets | $ | — | $ | 1,198,537 | $ | 492,576 | $ | 1,691,113 | ||||||
Liabilities: | ||||||||||||||
N-Star CDO bonds payable | — | — | 2,258,805 | $ | 2,258,805 | |||||||||
Liability to subsidiary trusts issuing preferred securities | — | — | 191,250 | 191,250 | ||||||||||
Derivative liability | — | 220,689 | — | 220,689 | ||||||||||
Total liabilities | $ | — | $ | 220,689 | $ | 2,450,055 | $ | 2,670,744 | ||||||
The following table presents additional information about the Company's available for sale securities, corporate lending investment, bonds payable and liabilities to subsidiary trusts issuing preferred securities which are measured at fair value on a recurring basis at December 31, 2010, for which the Company has utilized Level 3 inputs to determine fair value:
| | Available for Sale Securities | Corporate Lending Investment | N-Star CDO Bonds Payable | Liability to Subsidiary Trusts Issuing Preferred Securities | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Beginning balance: | $ | 309,505 | $ | 8,943 | $ | 1,141,096 | $ | 167,035 | |||||||
Total net transfers into/out of Level 3 | 91,281 | ||||||||||||||
Purchases, sales, issuance and settlements, net | 64,197 | (17,430 | ) | 450,144 | — | ||||||||||
Total losses (realized or unrealized): | |||||||||||||||
Included in earnings | 132,851 | — | 667,974 | 24,215 | |||||||||||
Included in other comprehensive loss | — | — | — | — | |||||||||||
Total gains (realized or unrealized): | |||||||||||||||
Included in earnings | 160,444 | 8,488 | 409 | — | |||||||||||
Included in other comprehensive loss | — | — | — | — | |||||||||||
Ending balance | $ | 492,576 | $ | — | $ | 2,258,805 | $ | 191,250 | |||||||
The amount of total gains or (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets or liabilities still held at the reporting date | $ | 27,593 | $ | 8,488 | $ | (667,564 | ) | $ | (24,215 | ) | |||||
134
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
4. Fair Value of Financial Instruments (Continued)
Fair Value Option
The Company has elected to apply the fair value option of accounting to the following financial assets and liabilities existing at the time of adoption or at the time the Company recognizes the eligible item:
- •
- Available for sale securities;
- •
- CDO bonds payable;
- •
- Liabilities to subsidiary trusts issuing preferred securities; and
- •
- its equity investment in its corporate lending business.
The Company has elected the fair value option for the above financial instruments for the purpose of consistent accounting application.
Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they occur. The fair value option may be elected on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. The following table sets forth the Company's financial instruments for which the fair value option was elected:
Financial Instruments, at Fair Value | December 31, 2010 | December 31, 2009(1) | ||||||
|---|---|---|---|---|---|---|---|---|
Assets: | ||||||||
Available for sale securities: | ||||||||
CMBS | $ | 1,392,099 | $ | 249,583 | ||||
N-Star CDO notes | — | 4,268 | ||||||
Third party CDO notes | 37,213 | 9,515 | ||||||
REIT debt | 236,958 | 30,580 | ||||||
Trust preferred securities | 24,784 | 8,739 | ||||||
Corporate lending investment (2) | — | 8,943 | ||||||
Total assets | $ | 1,691,054 | $ | 311,628 | ||||
Liabilities: | ||||||||
N-Star CDO bonds payable | 2,258,805 | 584,615 | ||||||
Liability to subsidiary trusts issuing preferred securities | 191,250 | 167,035 | ||||||
Total liabilities | $ | 2,450,055 | $ | 751,650 | ||||
- (1)
- December 31, 2009 does not include the assets and liabilities of N-Star I, II, III and V, for which the Company has elected the fair value option, as these CDO financings were unconsolidated CDO financings prior to January 1, 2010.
- (2)
- During 2010, the Company's corporate lending joint venture sold assets having a fair market value in excess of their carrying value and the Company sold its interest in the
135
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
4. Fair Value of Financial Instruments (Continued)
joint venture to the joint venture partner. As a result, the Company reduced its equity investment to zero at December 31, 2010.
The following table presents the difference between fair values and the aggregate contractual amounts of available for sale securities and liabilities, for which the fair value option has been elected:
| | Fair Value at December 31, 2010 | Amount Due Upon Maturity | Difference | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
Assets: | ||||||||||||
Available for sale securities: | ||||||||||||
CMBS | $ | 1,392,099 | $ | 2,844,090 | $ | (1,451,991 | ) | |||||
Third party CDO notes | 37,213 | 206,620 | (169,407 | ) | ||||||||
REIT debt | 249,350 | 244,366 | 4,984 | |||||||||
Trust preferred securities | 12,392 | 20,000 | (7,608 | ) | ||||||||
Total assets | $ | 1,691,054 | $ | 3,315,076 | $ | (1,624,022 | ) | |||||
Liabilities: | ||||||||||||
N-Star CDO bonds payable | 2,258,805 | 4,448,545 | (2,189,740 | ) | ||||||||
Liability to subsidiary trusts issuing preferred securities | 191,250 | 280,133 | (88,883 | ) | ||||||||
Total Liabilities | $ | 2,450,055 | $ | 4,728,678 | $ | (2,278,623 | ) | |||||
At December 31, 2010 and December 31, 2009, the basis in the Company's corporate lending investment was zero and $70.0 million, respectively. The Company has elected the fair value option for this investment which is accounted for under the equity method of accounting. The fair market value of the Company's investment at December 31, 2010 and December 31, 2009 was zero and $8.9 million, respectively.
For the year ended December 31, 2010 and 2009, the Company recognized a net loss of $397.9 million and a net loss of $156.8 million, respectively, as the result of the change in fair value of financial assets and liabilities for which the fair value option was elected, which is recorded as unrealized gain (loss) on investments and other in the Company's consolidated statement of operations. The net loss for the year ended December 31, 2009 does not include losses or gains on the assets and liabilities of N-Star I, II, III and V, as these CDO financings were unconsolidated CDO financings prior to January 1, 2010.
The impact of changes in instrument-specific credit spreads on N-Star bonds payable and liability to subsidiary trusts issuing preferred securities for which the fair value option was elected was a net loss of $692.2 million and $148.5 million, respectively, for the year ended December 31, 2010 and 2009. The Company attributes changes in the fair value of floating rate liabilities to changes in instrument-specific credit spreads. For fixed rate liabilities, the Company allocates changes in fair value between interest rate-related changes and credit spread-related changes based on changes in interest rates. The net loss for the year ended December 31, 2009 does not include losses or gains on the assets and liabilities of N-Star I, II, III and V, as these CDO financings were unconsolidated CDO financings prior to January 1, 2010.
136
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
5. Operating Real Estate
At December 31, 2010 and 2009, operating real estate, net consists of the following:
| | December 31, 2010 | December 31, 2009 | |||||
|---|---|---|---|---|---|---|---|
Land | $ | 146,780 | $ | 148,473 | |||
Buildings and improvements | 838,539 | 851,302 | |||||
Leasehold interests | 18,288 | 19,271 | |||||
Tenant improvements | 33,351 | 33,680 | |||||
Furniture and fixtures | 7,698 | 7,161 | |||||
Capital leases | 1,836 | 3,028 | |||||
| 1,046,492 | 1,062,915 | ||||||
Less: Accumulated depreciation | 108,430 | 84,013 | |||||
Operating real estate, net | $ | 938,062 | $ | 978,902 | |||
Depreciation expense amounted to approximately $24.4 million and $24.2 million for the year ended December 31, 2010 and 2009, respectively. In addition to the amounts included in the above table, approximately $66.1 million and $66.5 million of real estate acquisition costs as of December 31, 2010 and 2009, respectively, are classified as deferred lease costs. See Note 9 for additional information.
Dispositions—2010
In May 2010, the Company completed the sale of a leasehold interest containing approximately 10,800 square feet of retail space located in New York City to a private investor group for approximately $3.3 million, representing a gain of approximately $2.5 million.
Dispositions—2009
NRF Healthcare, LLC
In December 2009, NRF Healthcare, LLC completed the sale of 18 assisted living facilities containing approximately 1,300 beds located in North Carolina to a private investor group for approximately $95.9 million, representing a gain on sale of approximately $13.8 million.
Discontinued Operations
In connection with the acquisition of the CSE RE 2006-A equity notes and the consolidation of CSE RE 2006-A, the CDO financing had, as of December 31, 2010, three foreclosed assets consisting of two parcels of land located in Arizona with a combined fair market value at the time of acquisition of approximately $1.6 million and a multifamily property located in Georgia having a fair market value at the time of acquisition of approximately $3.9 million. During the third quarter of 2010, we recorded as held for sale, the two REO parcels of land located in Arizona and the multifamily property located in Georgia. During the fourth quarter of 2010, we recorded as held for sale, an REO office building containing 142,988 square feet located in Philadelphia, PA.
137
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
5. Operating Real Estate (Continued)
The following table summarizes income from discontinued operations and related gain on sale of discontinued operations for the years ended December 31, 2010, 2009 and 2008:
| | For the Year Ended December 31, 2010 | For the Year Ended December 31, 2009 | For the Year Ended December 31, 2008 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Revenue: | |||||||||||
Rental and escalation income | $ | 1,068 | $ | 8,710 | $ | 8,514 | |||||
Interest and other | 88 | 3 | 14 | ||||||||
Total revenue | 1,156 | 8,713 | 8,528 | ||||||||
Expenses: | |||||||||||
Property operating expenses | 865 | 120 | 141 | ||||||||
Asset management fees—related parties | 52 | 25 | 25 | ||||||||
Auditing and professional fees | 94 | 4 | — | ||||||||
General and administrative expenses | 819 | 35 | 5 | ||||||||
Interest expense | 60 | 4,187 | 3,757 | ||||||||
Depreciation and amortization | 53 | 2,166 | 2,190 | ||||||||
Impairment on operating real estate | 1,180 | — | — | ||||||||
Total expenses | 3,123 | 6,537 | 6,118 | ||||||||
Income from discontinued operations | (1,967 | ) | 2,176 | 2,410 | |||||||
Gain on disposition of discontinued operations | 2,528 | 13,799 | — | ||||||||
Total income from discontinued operations | $ | 561 | $ | 15,975 | $ | 2,410 | |||||
The following table sets forth the major classes of assets and liabilities of properties classified as held for sale at December 31, 2010:
| | December 31, 2010 | |||
|---|---|---|---|---|
ASSETS: | ||||
Operating real estate—net | $ | 13,141 | ||
Assets of properties held for sale | $ | 13,141 | ||
LIABILITIES: | ||||
Accounts payable and accrued expenses | 60 | |||
Other liabilities | 71 | |||
Liabilities of properties held for sale | $ | 131 | ||
138
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
6. Available for Sale Securities
The following is a summary of the Company's available for sale securities at December 31, 2010:
December 31, 2010 | Carrying Value | Cumulative Unrealized (Loss)/Gain on Investments | Fair Value(1) | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
CMBS | $ | 2,040,582 | $ | (648,483 | ) | $ | 1,392,099 | ||||
Third party CDO notes | 174,537 | (137,324 | ) | 37,213 | |||||||
REIT debt | 222,112 | 14,846 | 236,958 | ||||||||
Trust preferred securities | 34,917 | (10,133 | ) | 24,784 | |||||||
Total | $ | 2,472,148 | $ | (781,094 | ) | $ | 1,691,054 | ||||
- (1)
- Approximately $1.7 billion of these investments serve as collateral for the Company's consolidated CDO transactions and the balance is either financed under other borrowing facilities or unleveraged.
At December 31, 2010, the maturities of the available for sale securities ranged from three months to 46 years.
During the years ended December 31, 2010, proceeds from the sale and redemption of available for sale securities was $370.5 million. The net realized gain on the sale and redemption of available for sale securities was $75.8 million. During the year ended December 31, 2009, proceeds from the sale and redemption of available for sale securities was $213.1 million. The net realized gain on the sale of available for sale securities was $72.8 million. Proceeds and realized gains from the sale and redemption of available for sale securities for the year ended December 31, 2009 does not include the sale and redemption of available for sale securities of N-Star I, II, III and V, as these CDO financings were unconsolidated CDO financings prior to January 1, 2010.
The following is a summary of the Company's available for sale securities at December 31, 2009:
December 31, 2009(1) | Carrying Value | Losses in Accumulated OCI | Cumulative Unrealized (Loss)/Gain on Investments | Fair Value(2) | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
CMBS | $ | 443,568 | $ | — | $ | (193,985 | ) | $ | 249,583 | |||||
N-Star CDO notes | 34,115 | (13,517 | ) | (14,723 | ) | 5,875 | ||||||||
Third party CDO notes | 21,750 | — | (12,235 | ) | 9,515 | |||||||||
REIT debt | 26,760 | — | 3,820 | 30,580 | ||||||||||
N-Star CDO equity | 72,926 | (40,998 | ) | — | 31,928 | |||||||||
Trust preferred securities | 12,264 | — | (3,525 | ) | 8,739 | |||||||||
Total | $ | 611,383 | $ | (54,515 | ) | $ | (220,648 | ) | $ | 336,220 | ||||
- (1)
- December 31, 2009 does not include the third party available for sale securities of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.
139
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
6. Available for Sale Securities (Continued)
- (2)
- Approximately $212.4 million of these investments serve as collateral for the Company's only consolidated securities CDO transaction at December 31, 2009 and the balance is financed under other borrowing facilities.
7. Real Estate Debt Investments
At December 31, 2010, the Company held the following real estate debt investments:
December 31, 2010 | Principal Balances | Carrying Value(1)(2) | Allocation by Investment Type | Average Fixed Rate | Average Spread Over LIBOR(3) | Average Spread Over Prime | Number of Investments | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Whole loans, floating rate—LIBOR | $ | 1,533,352 | $ | 1,042,194 | 56.5 | % | — | % | 2.79 | % | — | % | 71 | ||||||||||
Whole loans—floating rate—prime | 106,279 | 17,417 | 0.9 | % | 3.32 | % | 3 | ||||||||||||||||
Whole loans, fixed rate | 211,565 | 107,419 | 5.8 | % | 5.76 | % | — | — | 27 | ||||||||||||||
Subordinate mortgage interests, floating rate | 220,444 | 143,153 | 7.8 | % | — | 3.06 | % | — | 10 | ||||||||||||||
Subordinate mortgage interests, fixed rate | 74,443 | 46,805 | 2.5 | % | 7.62 | % | — | — | 3 | ||||||||||||||
Mezzanine loans, floating rate | 387,183 | 305,901 | 16.6 | % | — | 2.76 | % | — | 16 | ||||||||||||||
Mezzanine loan, fixed rate | 153,027 | 140,956 | 7.7 | % | 5.65 | % | — | — | 7 | ||||||||||||||
Preferred—Float | 17,444 | 17,444 | 0.9 | % | — | 4.00 | % | — | 1 | ||||||||||||||
Other loans—floating | 11,460 | 11,460 | 0.6 | % | — | 2.50 | % | — | 2 | ||||||||||||||
Other loans—fixed | 12,152 | 12,152 | 0.7 | % | 6.44 | % | — | — | 3 | ||||||||||||||
Total/Weighted average | $ | 2,727,349 | $ | 1,844,901 | 100.0 | % | 6.05 | % | 2.82 | % | 3.32 | % | 143 | ||||||||||
- (1)
- Approximately $1.7 billion of these investments serve as collateral for the Company's CDO financings, $44.0 million is financed under a borrowing facility and the remainder is unleveraged. The Company has future funding commitments, which are subject to certain conditions that borrowers must meet to qualify for such fundings, totaling $48.5 million related to these investments. The Company expects that a minimum of $45.5 million of these future fundings will be funded within the Company's existing CDO financings and require no additional capital from the Company. Assuming that all loans that have future fundings meet the terms to qualify for such funding, the Company's equity requirement on future funding requirements would be approximately $3.0 million.
- (2)
- Includes $18.7 million in real estate debt investments, held for sale.
- (3)
- Approximately $525.2 million of the Company's real estate debt investments have a weighted-average LIBOR rate floor of 2.08%
On July 8, 2010, the Company consolidated the assets acquired and liabilities assumed of CSE RE 2006-A and recorded a gain of approximately $15.4 million resulting from the excess of the fair market value of the net assets acquired over the consideration paid. The following table displays the
140
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
7. Real Estate Debt Investments (Continued)
outstanding principal balance and the fair market value of the assets acquired and the liabilities assumed at acquisition (in thousands):
| | At Closing | |||||||
|---|---|---|---|---|---|---|---|---|
| | Principal Balance | Fair Market Value | ||||||
Loan assets—performing | $ | 810,690 | $ | 380,003 | ||||
Loan assets—non-performing | 243,113 | 15,970 | ||||||
REO | 18,259 | 4,201 | ||||||
Restricted cash | 77,084 | 77,084 | ||||||
Derivative assets | — | 38 | ||||||
Receivables | 2,815 | 2,815 | ||||||
Total assets | $ | 1,151,961 | $ | 480,111 | ||||
CDO notes outstanding | $ | 1,012,490 | $ | 440,096 | ||||
Derivative liabilities | — | 11,829 | ||||||
Accounts payable and accrued expenses | 12,528 | 12,528 | ||||||
Total liabilities | $ | 1,025,018 | $ | 464,453 | ||||
Non-controlling interest | 2,083 | 295 | ||||||
Net assets | $ | 124,860 | $ | 15,363 | ||||
Management rights | NA | $ | 7,000 | |||||
At December 31, 2009, the Company held the following real estate debt investments:
December 31, 2009(1) | Principal Balances | Carrying Value(2) | Allocation by Investment Type | Average Fixed Rate | Average Spread Over LIBOR | Number of Investments | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Whole loans, floating rate | $ | 1,049,784 | $ | 1,014,028 | 52.3 | % | — | % | 2.70 | % | 52 | |||||||||
Whole loans, fixed rate | 62,086 | 62,373 | 3.2 | 6.89 | — | 7 | ||||||||||||||
Subordinate mortgage interests, floating rate | 209,621 | 193,275 | 10.0 | — | 2.69 | 11 | ||||||||||||||
Subordinate mortgage interests, fixed rate | 29,000 | 24,722 | 1.3 | 7.25 | — | 2 | ||||||||||||||
Mezzanine loans, floating rate | 563,405 | 538,173 | 27.8 | — | 3.35 | 20 | ||||||||||||||
Mezzanine loan, fixed rate(3) | 94,535 | 90,558 | 4.7 | 8.89 | — | 7 | ||||||||||||||
Other loans—floating | 8,610 | 8,610 | 0.4 | — | 2.24 | 2 | ||||||||||||||
Other loans—fixed | 5,354 | 5,354 | 0.3 | 5.53 | — | 1 | ||||||||||||||
Total/Weighted average | $ | 2,022,396 | $ | 1,937,093 | 100.0 | % | 7.90 | % | 2.90 | % | 102 | |||||||||
- (1)
- December 31, 2009 does not include the real estate debt investments of N-Star III, as the CDO financing was an unconsolidated financing prior to January 1, 2010.
- (2)
- Approximately $1.3 billion of these investments served as collateral for the Company's three commercial real estate debt CDO financings and the balance was financed under other borrowing facilities. The
141
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
7. Real Estate Debt Investments (Continued)
Company had future funding commitments, which were subject to certain conditions that borrowers must have met to qualify for such fundings, totaling $80.0 million related to these investments.
- (3)
- Includes $0.6 million in real estate debt investments, held for sale.
Contractual maturities of real estate debt investments at December 31, 2010 are as follows:
Years Ending December 31: | Initial Maturity(1) | Maturity Including Extensions | ||||||
|---|---|---|---|---|---|---|---|---|
2011 | $ | 265,131 | $ | 186,170 | ||||
2012 | 999,991 | 536,468 | ||||||
2013 | 735,055 | 506,401 | ||||||
2014 | 56,130 | 293,096 | ||||||
2015 | 175,742 | 469,159 | ||||||
Thereafter | 495,300 | 736,055 | ||||||
Total | $ | 2,727,349 | $ | 2,727,349 | ||||
- (1)
- The year ending December 31, 2011, contains eight whole loans with initial maturities prior to December 31, 2010, having an aggregate principal balance of $213.1 million and three junior participations in first mortgages with initial maturities prior to December 31, 2010, having an aggregate principal balance of $52.0 million that remain outstanding as of December 31, 2010. The aggregate carrying value of these maturity-defaulted loans is $52.7 million as of December 31, 2010.
Actual maturities may differ from contractual maturities because certain borrowers have the right to prepay with or without prepayment penalties. The contractual amounts differ from the carrying amounts due to unamortized origination fees and costs and unamortized premiums and discounts being reported as part of the carrying amount of the investment. At December 31, 2010, the Company had $683.2 million of unamortized discounts and deferred fees. Maturity Including Extensions assumes that all loans with extension options will qualify for extension at initial maturity according to the conditions stipulated in the related loan agreements.
142
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
7. Real Estate Debt Investments (Continued)
As of December 31, 2010, the status of the Company's performing and non-performing loans was as follows:
| | As of December 31, 2010 | As of December 31, 2009 | ||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Loan Count | Performing Loans | Loan Count | Non- Performing Loans | Total(3) | Loan Count | Performing Loans | Loan Count | Non- Performing Loans | Total | ||||||||||||||||||||||
Originated and Acquired Debt Investments | ||||||||||||||||||||||||||||||||
Whole loans | 52 | $ | 892,950 | 1 | $ | 12,500 | $ | 905,450 | 53 | $ | 1,050,903 | 6 | $ | 60,797 | $ | 1,111,700 | ||||||||||||||||
Subordinate mortgage interests | 10 | 182,685 | 3 | 51,988 | 234,673 | 11 | 195,536 | 2 | 38,462 | 233,998 | ||||||||||||||||||||||
Mezzanine loans | 23 | 539,527 | — | — | 539,527 | 27 | 654,831 | — | — | 654,831 | ||||||||||||||||||||||
Preferred | 1 | 17,444 | — | — | 17,444 | — | — | — | — | — | ||||||||||||||||||||||
Other loans | 5 | 23,612 | — | — | 23,612 | 3 | 13,964 | — | — | 13,964 | ||||||||||||||||||||||
Total Originated and Acquired Debt Investments | 91 | 1,656,218 | 4 | 64,488 | 1,720,706 | 94 | 1,915,234 | 8 | 99,259 | 2,014,493 | ||||||||||||||||||||||
Provision for Loan Losses | 14 | (158,417 | ) | 2 | (38,783 | ) | (197,200 | ) | 7 | (39,500 | ) | 6 | (37,900 | ) | (77,400 | ) | ||||||||||||||||
Total Originated and Acquired Debt Investments, net | 1,497,801 | 25,705 | 1,523,506 | 1,875,734 | 61,359 | 1,937,093 | ||||||||||||||||||||||||||
CSE RE 2006-A | ||||||||||||||||||||||||||||||||
Whole loans(1) | 38 | 252,347 | 9 | 30,216 | 282,563 | — | — | — | — | — | ||||||||||||||||||||||
Subordinate mortgage interests(2) | 1 | 38,832 | — | — | 38,832 | — | — | — | — | — | ||||||||||||||||||||||
CSE RE 2006-A | 39 | 291,179 | 9 | 30,216 | 321,395 | — | — | — | — | — | ||||||||||||||||||||||
Provision for Loan Losses | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||
CSE RE 2006-A | 291,179 | 30,216 | 321,395 | — | — | — | ||||||||||||||||||||||||||
Total Debt Investments | 130 | 1,947,397 | 13 | 94,704 | 2,042,101 | 94 | 1,915,234 | 8 | 99,259 | 2,014,493 | ||||||||||||||||||||||
Total Provision for Loan Losses | 14 | (158,417 | ) | 2 | (38,783 | ) | (197,200 | ) | 7 | (39,500 | ) | 6 | (37,900 | ) | (77,400 | ) | ||||||||||||||||
Total Debt Investments, net | $ | 1,788,980 | $ | 55,921 | $ | 1,844,901 | $ | 1,875,734 | $ | 61,359 | $ | 1,937,093 | ||||||||||||||||||||
- (1)
- CSE RE 2006-A whole loans have an aggregate outstanding principal amount of approximately $919.1 million at December 31, 2010.
- (2)
- CSE RE 2006-A subordinate mortgage interests have an aggregate outstanding principal amount of approximately $8.3 million at December 31, 2010.
- (3)
- Includes $18.7 million of real estate debt investments classified as held for sale.
The Company's maximum additional exposure to loss related to the non-performing loans is approximately $55.9 million.
Provision for Loan Losses
For the year ended December 31, 2010, the Company recorded a $168.4 million credit loss provision relating to 16 loans, eight of which were sold, or held for sale and one of which was foreclosed during the period, and included $1.8 million in credit loss reversal for two loans sold with a fair market value in excess of their carrying amounts. For the year ended December 31, 2009, the
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
7. Real Estate Debt Investments (Continued)
Company recorded an $83.7 million credit loss provision relating 15 loans. As of December 31, 2010, loan loss reserves totaled $197.2 million.
Activity in the allowance for credit losses on real estate debt investments for year ended December 31, 2010 and 2009, is as follows:
Credit Loss Reserve | | |||
|---|---|---|---|---|
Balance at December 31, 2008 | $ | 11,200 | ||
Provision for credit losses | 83,745 | |||
Write-offs and sold loans | (13,945 | ) | ||
Foreclosure on loan | (3,600 | ) | ||
Balance at December 31, 2009 | 77,400 | |||
Provision for credit losses | 168,446 | |||
N-Star CDO IX loan reserves | 25,679 | |||
Write-offs and sold loans | (51,205 | ) | ||
Foreclosure on loan | (23,120 | ) | ||
Balance at December 31, 2010 | $ | 197,200 | ||
At December 31, 2010, the loan loss reserve is comprised of the following:
Class of Loan | # of Loans | Principal Amount | Carrying Amount | Credit Loss Provision | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Whole loans | 3 | $ | 68,320 | $ | 47,165 | $ | (20,984 | ) | ||||||
Subordinate mortgage interests | 5 | 119,247 | 26,593 | (83,545 | ) | |||||||||
Mezzanine loans | 8 | 177,595 | 84,708 | (92,671 | ) | |||||||||
Total | 16 | $ | 365,162 | $ | 158,466 | $ | (197,200 | ) | ||||||
The Company's commercial real estate loans are typically secured by liens on real estate properties or by interests in entities that directly own real estate properties, which serve as the primary source of cash for the payment of principal and interest. The Company differentiates the relative credit quality of its loans based upon whether the collateral is currently paying contractual debt service, and whether the Company believes it will be able to do so in the future. Those loans for which the Company expects to receive full payment of contractual principal and interest payments are categorized as "performing." The Company groups weaker credit quality loans that are currently performing, but for which it believes there is an impairment such that future collection of all principal and interest is in doubt, in a category called "performing, with credit reserves." The Company's weakest credit quality loans are generally non-performing loans. NPLs typically have a maturity default and/or are past due at least 90 days on their contractual debt service payments.
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
7. Real Estate Debt Investments (Continued)
The following table is a summary of real estate debt investments by credit quality indicator as of each applicable balance sheet date:
Credit Quality Indicator | Carrying Amount December 31, 2010 | Carrying Amount December 31, 2009 | ||||||
|---|---|---|---|---|---|---|---|---|
Non-performing loans | $ | 55,922 | $ | 61,359 | ||||
Performing loans with a reserve | 156,286 | 101,228 | ||||||
Performing loans | 1,632,693 | 1,774,505 | ||||||
Total | $ | 1,844,901 | $ | 1,937,092 | ||||
At December 31, 2010, the Company had real estate debt investments with an aggregate carrying amount of $76.1 million on nonaccrual status.
At December 31, 2010, the Company's loan portfolio principal and interest aging is as follows (inclusive of its non-performing loans) (in thousands):
| 1 - 90 Days | 90+ Days | |||
|---|---|---|---|---|
| $41,975 | $ | 223,390 | ||
Discounted Payoffs
On June 30, 2009, the Company received $23.6 million of cash proceeds relating to the repayment of a $27.4 million first mortgage loan backed by a data center property bearing interest at LIBOR + 4.5% and having a February 2012 final maturity date. The Company agreed to the discounted payoff of its loan on this niche asset for the economic and credit risk benefits. Accordingly, during the second quarter 2009, the Company recorded a $3.8 million credit loss relating to this discounted payoff.
On December 16, 2009, the Company received $23.1 million of cash proceeds relating to the repayment of $28.4 million on two first mortgage loans backed by land, bearing a weighted average interest rate of LIBOR + 5.3% and having a March 2010 final maturity date. The Company agreed to the discounted payoff of its loans on these assets in order to avoid a prolonged foreclosure with the borrower. Accordingly, during the fourth quarter 2009, the Company recorded a $5.3 million credit loss relating to this discounted payoff.
8. Investments in and Advances to Unconsolidated Ventures
The Company has non-controlling, unconsolidated ownership interests in entities that are accounted for using the equity method. Capital contributions, distributions, and profits and losses of the real estate entities are allocated in accordance with the terms of the applicable partnership and limited liability company agreements. Such allocations may differ from the stated percentage interests, if any, in such entities as a result of preferred returns and allocation formulas as described in such agreements.
145
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
8. Investments in and Advances to Unconsolidated Ventures (Continued)
CS/Federal Venture
In February 2006, the Company, through a joint venture with an institutional investor, acquired a portfolio of three adjacent class A office/flex buildings located in Colorado Springs, Colorado for $54.3 million. The joint venture financed the transaction with two non-recourse, first mortgage loans totaling $38.0 million and the balance in cash. The loans mature on February 11, 2016 and bear fixed interest rates of 5.51% and 5.46%. The Company contributed $8.4 million for a 50% interest in the joint venture and incurred $0.3 million in costs related to its acquisition, which are capitalized to the investment account. These costs will be amortized over the useful lives of the assets held by the joint venture. The Company accounts for its investment under the equity method of accounting. At December 31, 2010 and 2009, the Company had an investment in CS/Federal of approximately $6.2 million and $6.9 million, respectively. The Company recognized equity in earnings of $0.5 million, $0.4 million and $0.5 million for the years ended December 31, 2010, 2009 and 2008, respectively.
G-NRF, LTD
On May 7, 2008, the Company completed a recapitalization of Monroe Capital, its middle-market corporate lending platform. Upon completion of the recapitalization transaction, the new investor became the controlling manager of the assets and the Company deconsolidated the joint venture. The Company currently uses the equity method of accounting to account for the recapitalized joint venture and has elected the fair value option for its equity investment. In the second quarter 2010, the corporate lending joint venture sold assets and as a result the Company received a $15.0 million distribution. Since the Company accounts for this investment under the cost recovery method, approximately $6.7 million of the distribution was applied to the investment reducing the Company's basis in the investment to zero. The remaining cash distribution of $8.3 million was recognized as income and recorded in equity in earnings. During the third quarter 2010, the Company sold its interest in the venture, with a zero carrying value, to its joint venture partner for a total consideration of $7.5 million, resulting in a $7.5 million realized gain.
NorthStar Real Estate Securities Opportunity Fund
In July 2007, the Company closed on $109.0 million of equity capital for its Securities Fund, an investment vehicle in which the Company previously conducted a portion of its real estate securities investment business.
The Company is the manager and general partner of the Securities Fund. The Company receives base management fees ranging from 1.0% to 2.0% per annum on third-party capital and is entitled to annual incentive management fees ranging from 20% to 25% of the increase in the Securities Fund's net asset value in excess of an 8.0% per annum return. Base and incentive fees vary depending on the investor capital lockup periods and we do not expect to earn any incentive management fees from the Securities Fund in the future.
During the second quarter 2010, a subsidiary of the Company, as general partner of the Securities Fund, notified the Securities Fund's administrator and limited partners of its determination to liquidate and dissolve the Securities Fund. Accordingly, during the second quarter 2010, the Securities Fund began to liquidate its assets in an orderly manner. On July 7, 2010, the Securities Fund completed the
146
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
8. Investments in and Advances to Unconsolidated Ventures (Continued)
sale of its remaining investments, which included the sale of the N-Star CDO IX income notes and management fees to a wholly-owned subsidiary of the Company for $3.3 million. The Company consolidated the assets and liabilities of the CDO at their respective fair market values as of the acquisition date. A subsidiary of the Company, as general partner of the Securities Fund, is currently in the process of determining the Securities Fund's final net asset value and expects to complete the process of dissolving the Securities Fund during the first half 2011. As of December 31, 2010, the Company has received approximately $2.7 million in distributions related to the final liquidation of the Securities Fund.
At December 31, 2010 and 2009, the carrying value of the Company's investment in the Securities Fund was $0.7 million and $7.2 million, respectively, each representing a 31.2% interest in the Securities Fund.
For the years ended December 31, 2010, 2009 and 2008, the Company recognized equity in losses of $3.9 million, equity in losses of $6.5 million and equity in losses of $12.4 million, respectively.
LandCap Investment
On October 5, 2007, the Company entered into a joint venture with Whitehall Street Global Real Estate Limited Partnership 2007 ("Whitehall"), to form LandCap Partners, which is referred to as LandCap. LandCap was established to opportunistically invest in single family residential land through land loans, lot option agreements and select land purchases. The joint venture is managed by a third party management group which has extensive experience in the single family housing sector. The Company and Whitehall agreed to provide no additional new investment capital in the LandCap joint venture. At December 31, 2010 and December 31, 2009 the Company's investment in LandCap is carried at $8.8 million and $10.1 million, respectively. At December 31, 2010 and 2009, LandCap had investments totaling $34.9 million and $37.9 million, respectively. In addition, the Company has advanced approximately $4.9 million under a loan agreement to LandCap, which bears interest at a fixed rate of 12% and is included in other assets in the consolidated balance sheets. For the years ended December 31, 2010, 2009 and 2008, the Company recognized equity in losses of $2.5 million, equity in losses of $3.7 million and equity in losses of $3.3 million, respectively.
Midwest Care Holdco TRS I LLC
In June 2009, the Company restructured its net lease relationship with one of its healthcare operators to take advantage of new REIT legislation which now allows a taxable REIT subsidiary affiliate to become the lessee of healthcare- related properties. The restructuring resulted in one of the Company's unconsolidated affiliate Midwest becoming the lessee of the properties and Midwest simultaneously entering into a management contract with a third party operator. The management agreement is terminable by Midwest upon 60 days notice. This new structure allows the Company to participate in operating improvements of the underlying properties not previously available under the prior structure. The Company owned a 49% interest in Midwest and did not control the major decisions and as a result, the Company did not consolidate the operations of Midwest. In April 2010, pursuant to the membership redemption agreement entered into in December 2009, the Company acquired the remaining 51% membership interest in Midwest Holdings owned by Chain Bridge for $1.0 million in cash. As a result of the acquisition, the Company holds 100% of the common
147
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
8. Investments in and Advances to Unconsolidated Ventures (Continued)
membership interest in Midwest and controls all major decisions. Accordingly the operations of Midwest, which were previously accounted for under the equity method, are consolidated. The Company has estimated the fair value of assets acquired at the date of acquisition. The Company recognized equity in earnings of $2.0 million for the year ended December 31, 2010.
At December 31, 2009, the Company had an investment in Midwest of approximately $1.0 million and recognized equity in earnings of $7.5 million for the year ended December 31, 2009.
NorthStar Income Opportunity REIT I, Inc. / NorthStar Real Estate Income Trust, Inc.
On October 18, 2010, NorthStar Income Opportunity REIT I, Inc. ("NIOR"), an unconsolidated entity in which the Company has an equity investment, completed a merger with NorthStar Real Estate Income Trust, Inc., ("NSREIT") a consolidated subsidiary of the Company and each a commercial finance REIT sponsored by the Company. NSREIT became the surviving entity of the merger. As of October 18, 2010, the Company deconsolidated, and has an equity investment in, NSREIT and accounts for its investment in NSREIT under the equity method of accounting.
At December 31, 2010, the Company had an investment in NSREIT, the surviving entity, of approximately $1.8 million. At December 31, 2009, the Company had an investment in NIOR of approximately $1.6 million. The Company recognized equity in loss on this investment of $0.2 million for the year ended December 31, 2010.
Meadowlands One, LLC
The Company owned a $92.5 million pari passu participation in a $498.6 million first mortgage held in Meadowlands One, LLC that is secured by a retail/entertainment complex located in East Rutherford, NJ (the "NJ Property"). During the third quarter 2010, the lender group took effective ownership of the NJ Property. The Company accounts for its 22% equity interest in the investment under the equity method of accounting, and at December 31, 2010, the carrying value of the Company's investment was approximately $72.6 million. For the year ended December 31, 2010, the Company recognized equity in losses of $2.9 million from its investment.
Reconciliation between the operating data for all unconsolidated/uncombined ventures and equity in earnings is as follows:
| | For the Year Ended December 31, 2010 | For the Year Ended December 31, 2009 | For the Year Ended December 31, 2008 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Net income | $ | 431 | $ | (13,535 | ) | $ | (51,469 | ) | ||
Other partners' share of income | (692 | ) | 4,084 | 37,198 | ||||||
Fee income basis difference | — | 1,263 | ||||||||
Joint venture equity write-off | — | 811 | ||||||||
Elimination entries | 2,514 | 7,642 | 279 | |||||||
Earnings from unconsolidated/uncombined ventures | $ | 2,253 | $ | (1,809 | ) | $ | (11,918 | ) | ||
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
8. Investments in and Advances to Unconsolidated Ventures (Continued)
Reconciliation between the Company's investment in unconsolidated entities as of December 31, 2010 and December 31, 2009 is as follows:
| | December 31, 2010 | December 31, 2009 | |||||
|---|---|---|---|---|---|---|---|
Company's equity in unconsolidated entities | $ | 93,361 | $ | 36,874 | |||
Elimination entries | 746 | 1,109 | |||||
Purchase price basis difference | 305 | 316 | |||||
Investment in and advances to unconsolidated ventures | $ | 94,412 | $ | 38,299 | |||
The condensed combined balance sheets for the unconsolidated joint ventures at December 31, 2010 and 2009 are as follows:
| | 2010 | 2009 | |||||||
|---|---|---|---|---|---|---|---|---|---|
| | (unaudited) | (unaudited) | |||||||
Assets | |||||||||
Cash | $ | 42,572 | $ | 25,655 | |||||
Restricted cash | 551 | 4,006 | |||||||
Operating real estate, net | 579,957 | 86,206 | |||||||
Available for sale securities, at fair value | 31,264 | 312,242 | |||||||
Deferred costs, net | 3,234 | 3,708 | |||||||
Other assets | 835 | 8,166 | |||||||
Total assets | $ | 658,413 | $ | 439,983 | |||||
Liabilities and members' equity | |||||||||
Mortgage notes and loans payable | $ | 45,576 | $ | 46,138 | |||||
Other liabilities | 41,072 | 221,844 | |||||||
Members' equity | 571,765 | 172,001 | |||||||
Total liabilities and members' equity | $ | 658,413 | $ | 439,983 | |||||
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
8. Investments in and Advances to Unconsolidated Ventures (Continued)
The condensed combined statements of operations for the unconsolidated joint ventures for the years ended December 31, 2010, 2009 and 2008 are as follows;
| | 2010 | 2009 | 2008 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | (unaudited) | (unaudited) | (unaudited) | |||||||||
Revenues and other income: | ||||||||||||
Interest income | $ | 17,010 | $ | 19,724 | $ | 18,292 | ||||||
Rental and escalation income | 18,021 | 44,110 | 4,720 | |||||||||
Other revenue | 249 | 1,956 | 267 | |||||||||
Total revenue | 35,280 | 65,790 | 23,279 | |||||||||
Expenses: | ||||||||||||
Interest expense | 10,555 | 4,017 | 4,542 | |||||||||
General and administrative | 9,560 | 16,941 | 7,752 | |||||||||
Depreciation and amortization | 1,913 | 2,406 | 1,936 | |||||||||
Other expenses | 21,436 | 27,793 | 2,465 | |||||||||
Total Expenses | 43,464 | 55,247 | 16,695 | |||||||||
Income from operations | (8,184 | ) | 14,543 | 6,584 | ||||||||
Unrealized gain/(loss) on investments | 72,498 | (25,277 | ) | (60,661 | ) | |||||||
Realized loss on investments | (63,883 | ) | (2,605 | ) | — | |||||||
Net income | $ | 431 | $ | (13,339 | ) | $ | (54,077 | ) | ||||
9. Deferred Costs and Intangible Assets, Net
Deferred costs and intangible assets as of December 31, 2010 and 2009 consisted of the following:
| | December 31, 2010 | December 31, 2009 | |||||
|---|---|---|---|---|---|---|---|
Deferred lease costs | $ | 68,062 | $ | 67,897 | |||
Deferred loan costs | 15,078 | 18,612 | |||||
Intangible assets | 7,839 | 839 | |||||
Reimbursable deal costs | 862 | 2,650 | |||||
| 91,841 | 89,998 | ||||||
Less accumulated amortization | (38,868 | ) | (32,447 | ) | |||
Deferred costs and intangible assets, net | $ | 52,973 | $ | 57,551 | |||
Deferred lease cost includes the allocation of a portion of the purchase price to lease origination costs associated with the in-place leases. For acquisitions for the year ended December 31, 2009, an additional $0.3 million was allocated from the purchase price to deferred lease cost.
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
10. Borrowings
The following table summarizes the Company's outstanding borrowings as of December 31, 2010 and 2009:
| | Initial Stated Maturity | Interest Rate | Contractual Balance at December 31, 2010 | Contractual Balance at December 31, 2009(1) | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Term Loans (recourse) | |||||||||||||
WA Secured Term Loan(2) | 10/28/2012 | LIBOR + 3.50% | — | 246,884 | |||||||||
Euro—note | 10/28/2012 | 3 month Euribor + 3.50% | — | 85,218 | |||||||||
LB Term Loan(3) | 2/9/2011 | LIBOR + 1.50% | 22,199 | 22,199 | |||||||||
Term Loans (non-recourse) | |||||||||||||
Term Asset Backed Securities Loan Facility | 10/29/2014 | 2.64% | 14,682 | 14,682 | |||||||||
Total Credit Facilities & Term Loans | 36,881 | 368,983 | |||||||||||
Exchangeable Senior Notes (recourse)(4)(5) | 6/15/2027 | 7.25% | 68,165 | 68,165 | |||||||||
Exchangeable Senior Notes ("NNN Notes") (recourse)(4) | 6/15/2013 | 11.50% | 60,750 | 60,750 | |||||||||
Liability to subsidiary trusts issuing preferred securities (subordinate recourse)(6)(7) | |||||||||||||
Trust I | 3/30/2035 | 8.15% | 41,240 | 41,240 | |||||||||
Trust II | 6/30/2035 | 7.74% | 25,780 | 25,780 | |||||||||
Trust III | 1/30/2036 | 7.81% | 41,238 | 41,238 | |||||||||
Trust IV | 6/30/2036 | 7.95% | 50,100 | 50,100 | |||||||||
Trust V | 9/30/2036 | 3 month LIBOR 2.70% | 30,100 | 30,100 | |||||||||
Trust VI | 12/30/2036 | 3 month LIBOR 2.90% | 25,100 | 25,100 | |||||||||
Trust VII | 4/30/2037 | 3 month LIBOR 2.50% | 31,475 | 31,475 | |||||||||
Trust VIII | 7/30/2037 | 3 month LIBOR 2.70% | 35,100 | 35,100 | |||||||||
Mortgage notes payable (non-recourse) | |||||||||||||
Salt Lake City | 9/1/2012 | 5.16% | 15,059 | 15,471 | |||||||||
EDS | 10/8/2015 | 5.37% | 46,218 | 46,977 | |||||||||
Executive Center(8) | 1/1/2016 | 5.85% | 51,480 | 51,480 | |||||||||
Green Pond | 4/11/2016 | 5.68% | 16,884 | 17,119 | |||||||||
Indianapolis | 2/1/2017 | 6.06% | 27,789 | 28,142 | |||||||||
Northstar Healthcare GE | — | 6.93% | — | 44,163 | |||||||||
Northstar Healthcare GE | 5/1/2015 | 3 month LIBOR + 5.95% | 58,200 | — | |||||||||
Northstar Healthcare—Park National | 1/11/2014 | 5.94% | 32,537 | 32,944 | |||||||||
Northstar Healthcare—GE—WLK | 1/11/2017 | 6.99% | 159,135 | 159,138 | |||||||||
Northstar Healthcare—GE—Tusc & Harmony | 1/11/2017 | 7.09% | 7,842 | 7,843 | |||||||||
Northstar Healthcare—Harmony FNMA | 2/1/2017 | 6.39% | 73,901 | 75,001 | |||||||||
Northstar Healthcare—Grove City | 8/1/2015 | 9.25% | 3,040 | 1,835 | |||||||||
Northstar Healthcare—Lancaster | 8/1/2015 | 9.25% | 6,280 | 2,571 | |||||||||
Northstar Healthcare—Marysville | 8/1/2015 | 9.25% | 5,393 | 1,651 | |||||||||
Northstar Healthcare—Washington | 8/1/2015 | 9.25% | 5,223 | 1,952 | |||||||||
Northstar Healthcare—Miller Merril | 6/30/2012 | 7.07% | 116,806 | 118,320 | |||||||||
Northstar Healthcare—ARL Mob Wachovia | 5/11/2017 | 5.89% | 3,349 | 3,389 | |||||||||
Northstar Healthcare—St Francis | 9/10/2010 | LIBOR + 2.00% | — | 11,400 | |||||||||
Aurora | 7/11/2016 | 6.22% | 32,583 | 32,982 | |||||||||
DSG | 10/11/2016 | 6.17% | 33,325 | 33,795 | |||||||||
Keene | 2/1/2016 | 5.85% | 6,588 | 6,693 | |||||||||
Fort Wayne | 1/1/2015 | 6.41% | 3,313 | 3,399 | |||||||||
Portland | 6/17/2014 | 7.34% | 4,466 | 4,652 | |||||||||
Milpitas | 3/6/2017 | 5.95% | 21,639 | 22,107 | |||||||||
Fort Mill | 4/6/2017 | 5.63% | 27,700 | 27,700 | |||||||||
Reading | 1/1/2015 | 5.58% | 13,643 | 13,905 | |||||||||
Reading | 1/1/2015 | 6.00% | 5,000 | 5,000 | |||||||||
Alliance | 12/6/2017 | 6.48% | 23,239 | 23,543 | |||||||||
Mezzanine loan payable (non-recourse) | |||||||||||||
Fort Mill | 4/6/2017 | 6.21% | 2,482 | 2,743 | |||||||||
151
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
10. Borrowings (Continued)
| | Initial Stated Maturity | Interest Rate | Contractual Balance at December 31, 2010 | Contractual Balance at December 31, 2009(1) | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Bonds payable (non-recourse)(6) | |||||||||||||
N-Star I | 8/1/2038 | 3 month LIBOR + 1.93% (average spread) | 225,701 | — | |||||||||
N-Star II | 6/1/2039 | LIBOR + 1.30% (average spread) | 197,212 | — | |||||||||
N-Star III | 6/1/2040 | LIBOR + 0.59% (average spread) | 313,907 | — | |||||||||
N-Star IV | 7/1/2040 | LIBOR + 0.59% (average spread) | 258,769 | 282,500 | |||||||||
N-Star V | 9/5/2045 | LIBOR + 0.53% (average spread) | 434,633 | — | |||||||||
N-Star VI | 6/1/2041 | 3 month LIBOR + 0.52% (average spread) | 271,698 | 279,057 | |||||||||
N-Star VII | 6/22/2051 | LIBOR + 0.35% (average spread) | 499,200 | 499,200 | |||||||||
N-Star VIII | 2/1/2041 | LIBOR + 0.45% (average spread) | 586,460 | 590,645 | |||||||||
N-Star IX | 8/7/2052 | LIBOR + 0.40% (average spread) | 744,960 | — | |||||||||
CapSource | 1/20/2037 | 3 month LIBOR + 0.42% (average spread) | 916,005 | — | |||||||||
| $ | 5,697,588 | $ | 3,225,348 | ||||||||||
- (1)
- December 31, 2009 does not include the bonds payable of N-Star I, II, III and V as these CDO financings were unconsolidated financings prior to January 1, 2010.
- (2)
- On June 30, 2010, the Company fully repaid and extinguished, at a discount to its outstanding principal amount, its secured recourse WA Secured Term Loan.
- (3)
- The Company has a limited recourse obligation with respect to this loan of 50% of the outstanding loan balance.
- (4)
- The contractual amounts may differ from the carrying value on the consolidated balance sheets due to the equity component of the debt.
- (5)
- The holders have repurchase rights which may require the Company to repurchase the notes on June 15, 2012.
- (6)
- Contractual amounts due may differ from the carrying value on the consolidated balance sheets due to the election of the fair value option. See Note 4.
- (7)
- The liability to subsidiary trusts for Trusts I, II, III and IV have a fixed interest rate for the first ten years after which the interest rate will float and reset quarterly at rates ranging from LIBOR plus 2.70% to 3.25%. The Company entered into interest rate swap agreements on Trusts V, VI, VII and VIII which fix the interest rates for 10 years at 8.16%, 8.02%, 7.60% and 8.29%, respectively.
- (8)
- The Company has a limited recourse obligation with respect to this loan. The amount of such obligation will vary based upon the tenancy of the property. The Company believes such obligation will not exceed $2.5 million.
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
10. Borrowings (Continued)
Scheduled principal payment requirements on the Company's borrowings based on initial maturity dates are as follows as of December 31, 2010:
| | Total | Mortgage and Mezzanine Loans | Secured Term Loan | Liability to Subsidiary Trusts Issuing Preferred Securities | Exchangeable Senior Notes(1) | Bonds Payable | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2011 | $ | 31,431 | $ | 9,232 | $ | 22,199 | $ | — | $ | — | $ | — | |||||||
2012 | 210,053 | 141,888 | — | — | 68,165 | — | |||||||||||||
2013 | 72,017 | 11,267 | — | — | 60,750 | — | |||||||||||||
2014 | 60,930 | 46,248 | 14,682 | — | — | — | |||||||||||||
2015 | 193,831 | 193,831 | — | — | — | — | |||||||||||||
Thereafter | 5,129,326 | 400,648 | — | 280,133 | — | 4,448,545 | |||||||||||||
Total | $ | 5,697,588 | $ | 803,114 | $ | 36,881 | $ | 280,133 | $ | 128,915 | $ | 4,448,545 | |||||||
- (1)
- $68.2 million of the Company's 7.25% exchangeable senior notes have a final maturity date of June 15, 2027. The above table reflects the holders repurchase rights which may require the Company to repurchase the notes on June 15, 2012.
At December 31, 2010, the Company was in compliance with all covenants under its borrowings.
Secured Term Loan
On October 28, 2009, the Company entered into the First Amended and Restated Credit Agreement (the "Credit Agreement") and the Second Amendment to Note Purchase Agreement (the "Note Purchase Agreement," and together with the Credit Agreement, the "WA Secured Term Loan") with Wachovia Bank, National Association ("Wachovia"). The maturity date of the WA Secured Term Loan was extended for three years to October 28, 2012 and the WA Secured Term Loan bears interest at LIBOR plus 3.50%. The WA Secured Term Loan eliminates all margin call provisions and does not restrict the payment of dividends, subject in both cases to the semi-annual amortization payments described below. The WA Secured Term Loan also provides for up to $300 million of revolving borrowing capacity as the amount outstanding under the WA Secured Term Loan is reduced below $300 million, on a dollar-for-dollar basis. The Secured Term Loan eliminates the corporate fixed charge and recourse debt covenants and maintains the liquidity and tangible net worth covenants in the WA Secured Term Loan. The Company repaid approximately $52.5 million of the outstanding balance in connection with the WA Secured Term Loan.
On October 28, 2009, in connection with the WA Secured Term Loan, the Company entered into a warrant agreement (the "Warrant Agreement") with Wachovia under which we issued one million warrants (the "Warrants") to Wachovia to purchase one million shares of the Company's common stock, par value $0.01 per share ("Common Stock"), at a weighted average exercise price of $8.59 per share. 500,000 Warrants are exercisable immediately at a price of $7.50 per share, 250,000 Warrants are exercisable after October 28, 2010 at a price of $8.60 per share and 250,000 Warrants are exercisable after October 28, 2011 at a price of $10.75 per share. The exercise price of the Warrants may be paid in cash or by cashless exercise. The exercise price and the number of shares of Common Stock issuable
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
10. Borrowings (Continued)
upon exercise of the Warrants are subject to adjustment for dividends paid in common stock, subdivisions or combinations. The Company determined that the allocable fair value of the warrants, as of October 28, 2009, was $0.1 million. The fair value of the warrants was recorded in equity and the associated discount on the debt will be amortized into interest expense using the effective interest method over the life of the associated debt.
On June 30, 2010, the Company fully repaid and extinguished, at a discount to its outstanding principal amount WA Secured Term Loan, which was fully recourse to the Company, having an outstanding principal balance of approximately $304.0 million and secured by assets having an aggregate unpaid principal balance of approximately $448.6 million at the time of the payoff. The Company paid approximately $208.0 million of cash and granted the lender a 40% participation interest in the principal proceeds of a €72.5 million participation in a mezzanine loan owned by the Company that is collateralized by a German retail portfolio (the "German Loan").
In connection with the repayment and extinguishment of the WA Secured Term Loan, the Company issued, to the lender, warrants (the "Repayment Warrants") to purchase two million shares of its common stock. The Repayment Warrants are exercisable immediately through June 30, 2020, at a price of $7.60 per share. The exercise price of the Repayment Warrants may be paid in cash or by cashless exercise and the exercise price and the number of shares of common stock issuable upon exercise of the Repayment Warrants are subject to anti-dilution adjustments.
The Company recognized approximately $60.6 million of net realized gains in connection with the repayment and extinguishment of the WA Secured Term Loan and the granting of the 40% participation interest in the principal proceeds of the German Loan.
Exchangeable Senior Notes
In June 2007, the Company issued $172.5 million of 7.25% exchangeable senior notes (the "Notes") which are due in 2027. The Notes were offered in accordance with Rule 144A under the Securities Act of 1933, as amended. The Notes pay interest semi-annually on June 15 and December 15, at a rate of 7.25% per annum, and mature on June 15, 2027. The Notes have an initial exchange rate representing an exchange price of $16.89 per share of the Company's common stock. The initial exchange rate is subject to adjustment under certain circumstances. The Notes are senior unsecured obligations of the Company's operating partnership and may be exchangeable upon the occurrence of specified events, and at any time on or after March 15, 2027, and prior to the close of business on the second business day immediately preceding the maturity date, into cash or a combination of cash and shares of the Company's common stock, if any, at the Company's option. The Notes are redeemable, at the Company's option, on and after June 15, 2014. The Company may be required to repurchase the Notes on June 15, 2012, 2014, 2017 and 2022, and upon the occurrence of certain designated events. The net proceeds from the offering were approximately $167.5 million, after deducting fees and expenses. The proceeds of the offering were used to repay certain of the Company's existing indebtedness, to make additional investments and for general corporate purposes.
In May 2008, NRFC NNN Holdings, LLC ("Triple Net Holdings"), a wholly-owned subsidiary of the Company issued $80.0 million of 11.50% exchangeable senior notes (the "NNN Notes") due in 2013. The NNN Notes were offered in accordance with Rule 144A under the Securities Act of 1933, as
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
10. Borrowings (Continued)
amended. The NNN Notes pay interest semi-annually on June 15 and December 15, at a rate of 11.50% per annum, and mature on June 15, 2013. The NNN Notes have an initial exchange rate representing an exchange price of $12.00 per share of the Company's common stock, subject to adjustment under certain circumstances. The NNN Notes are senior unsecured obligations of Triple Net Holdings and may be exchangeable upon the occurrence of specified events, and at any time on or after March 15, 2013, and prior to the close of business on the second business day immediately preceding the maturity date, into cash, shares of the Company's common stock or a combination of cash and shares of the Company's common stock, if any, at the Company's option. The NNN Notes are redeemable, at the Company's option, on and after June 15, 2011. The Company may be required to repurchase the NNN Notes upon the occurrence of certain events. The net proceeds from the offering were approximately $71.4 million, after deducting a $4.6 million security deposit representing one semi-annual interest payment, and fees and expenses.
As of December 31, 2010 and December 31, 2009, the total carrying amount of the equity components of the exchangeable senior notes was $4.9 million. The principal amount of the exchangeable senior notes liabilities was $128.9 million as of December 31, 2010 and December 31, 2009. The unamortized discount of the liability components was $2.0 million and $2.9 million at December 31, 2010 and December 31, 2009, respectively. The net carrying amount of the liability components was $126.9 million and $126.0 million at December 31, 2010 and December 31, 2009, respectively. Interest expense for the years ended December 31, 2010, 2009 and 2008 related to the exchangeable senior notes was $13.8 million, $16.8 million and $20.7 million, respectively, of which $11.9 million, $14.5 million and $17.9 million was related to contractual interest, respectively, and $1.9 million, $2.3 million and $2.8 million was attributable to amortization of the debt discount and deferred financing costs, respectively.
Modification of Mortgage Loan
The Company owns a partially vacant net lease property located in Cincinnati, Ohio. In November 2010, the mortgage lender declared a payment default and, in December 2010, began foreclosure proceedings on the property. The Company is currently in discussions with the lender seeking to modify the mortgage terms; however, there can be no assurance that there will be a favorable resolution and the lender may ultimately foreclose on the property.
Mortgage note refinancing
On March 31, 2010, the Company closed on a $65.0 million loan with General Electric Capital Corporation. The proceeds were primarily used to refinance $52.0 million of loans maturing in 2010 on nine of the Company's healthcare-related net leased assets. The excess proceeds from the financing will be used for working capital and general corporate purposes. The loan has a five-year term with a one-year interest only period and principal and interest payments thereafter. The interest rate is 90-day LIBOR + 5.95% with a 1% LIBOR floor.
On July 30, 2010, the Company closed on a $20.0 million loan with VCC Healthcare Fund, LLC. The proceeds will be used to refinance $8.0 million of loans maturing between June 2037 and October 2038 on four of the Company's healthcare- related net leased assets. The excess proceeds from
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
10. Borrowings (Continued)
the financing will be used for working capital and general corporate purposes. The loan has a five-year term and an interest rate of 9.25%.
Debt Repurchases
During the year ended December 31, 2009, the Company repurchased approximately $92.6 million face amount of its 7.25% exchangeable senior notes for a total of $40.0 million, $19.3 million face amount of its 11.50% exchangeable senior notes for a total of $10.2 million and $27.4 million face amount of its N-Star CDO bonds payable for a total of $5.4 million. The Company recorded a total net realized gain of $59.9 million in connection with the repurchase of its notes and bonds for the year ended December 31, 2009. The repurchase of the notes and bonds for the year ended December 31, 2009 also represented an aggregate $83.7 million discount to the par value of the debt.
During the year ended December 31, 2008, the Company repurchased $111.4 million of its notes, which consisted of $93.6 million of its N-Star CDO bonds payable, $11.7 million of its 7.25% exchangeable senior notes and $6.1 million of its liability to subsidiary trusts issuing preferred securities for a total of $49.8 million. The Company recorded a realized gain of $36.5 million in connection with the repurchase of its notes. These repurchases also represented a $61.6 million discount to the par value of the debt.
JP Facility
On October 8, 2008, the Company and a subsidiary entered into Amendment No. 1 (the "Amendment") to the Master Repurchase Agreement (as amended, the "JP Facility") with JPMorgan. The JP Facility had approximately $50.4 million outstanding on the amendment date and such amounts bear interest at spreads of 1.25% to 1.80% over one-month LIBOR. Advance rates for the assets currently financed under the JP Facility range from 55% to 80% of the value of the collateral for which the advance is made. Interest rates and advance rates on future borrowings under the JP Facility will be determined by JPMorgan. Pursuant to the Amendment, the maximum amount outstanding under the JP Facility shall not exceed $150 million and we have agreed to guaranty the outstanding amount under the JP Facility. In August 2009, the Company terminated the JP Facility and repaid the remaining principal balance of $12.2 million.
LB Term Loan
In June 2008, a wholly owned subsidiary of the Company entered into a $24.2 million term loan agreement with an investment bank (the "LB Term Loan"). The collateral for the LB Term Loan is a $44.0 million mezzanine loan position and the Company has guaranteed 50% of the outstanding term debt. The LB Term Loan matures in February 2012, has a one-year extension option and bears interest at a spread of 1.50% over one-month LIBOR. The LB Term Loan contains certain covenants including, among others, financial covenants of a minimum tangible net worth and a minimum debt-to-equity ratio.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
11. Commitments and Contingencies
Obligations Under Capital Leases and Operating Lease Agreements
The Company is the lessee of two locations under capital leases, seven ground leases under operating real estate, of which five are paid directly by the tenants, and five corporate offices that are located in New York, NY, Los Angeles, CA, Dallas, TX, Englewood, CO, and Bethesda, MD. The following is a schedule of minimum future rental payments under these contractual lease obligations as of December 31, 2010:
Years Ending December 31: | | |||
|---|---|---|---|---|
2011 | $ | 5,600 | ||
2012 | 5,392 | |||
2013 | 5,506 | |||
2014 | 5,460 | |||
2015 | 5,331 | |||
Thereafter | 36.533 | |||
Total minimum lease payments | 63,822 | |||
Less: Amounts representing interest | 9,220 | |||
Future minimum lease payments | $ | 54,602 | ||
Under one of the capital leases, the Company also pays rent equal to 15% of the minimum rental income received from the sub-tenant. The Company's Los Angeles office is sub-leased through December 31, 2011 and generated approximately $0.1 million in sub-lease rental income for each of the years ended December 31, 2010 and 2009. The Company recognized $2.9 million, $2.6 million and $3.1 million in rental expense for its five corporate offices for the years ended December 31, 2010, 2009 and 2008, respectively.
Chatsworth Property
One of the Company's net lease investments was comprised of three office buildings totaling 257,000 square feet located in Chatsworth, CA and was 100% leased to Washington Mutual Bank, FA, or WaMu. NRFC NNN Holdings, Inc. , or NNN, which is a subsidiary of the Company's, is a defendant in a lawsuit, or the Lawsuit, filed by GECCMC 2005-CI Plummer Office Limited Partnership, or the Lender, in the Superior Court of the State of California, County of Los Angeles, relating to a loan the properties previously owned by one of the Company's subsidiaries, NRFC Sub IV, that were 100% leased, or the Lease, to WaMu. The Lawsuit alleges, among other things, that the loan provided by Lender to NRFC Sub IV became a recourse obligation of NNN due to an alleged termination of the Lease. The judge presiding over the Lawsuit granted the Lender's motion for summary judgment and, accordingly, entered a judgment against NNN in the amount of approximately $45 million, or the Judgment. NNN intends to vigorously pursue an appeal of the decision.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
11. Commitments and Contingencies (Continued)
Pursuant to the guidance Accounting for Contingencies, an estimated loss from a loss contingency shall be accrued by a charge to income if two conditions are met. First, information available prior to the issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. It is implicit in this condition that it must be probable that on one or more future events will occur confirming the facts of the loss. Second, the amount of the loss can be reasonably estimated. The Company believes it is not probable that the Lawsuit will result in an unfavorable outcome and, therefore, the Company has not established an accrual relating to the Lawsuit.
In connection with filing for an appeal, pursuant to California law NNN is required to post a bond in an amount equal to one and a half times the amount of the Judgment, or the Bond. Accordingly, the Company has entered into a standard General Agreement of Indemnity with an issuer of surety bonds, or the Surety Agreement, which could require the Company to post collateral equal to the amount of the Bond. As part of the Surety Agreement, in connection with the issuance of the Bond, the Company expects to post cash collateral equal to thirty-eight percent of the amount of the Bond, or approximately $26 million.
12. Rental Income Under Operating Leases
Rental income from real estate is derived from the leasing and sub-leasing of space to commercial tenants. The leases are for fixed terms of varying length and provide for annual rentals and expense reimbursements to be paid in monthly installments.
The following is a schedule of future minimum rental income under non-cancelable leases at December 31, 2010:
Years Ending December 31: | | |||
|---|---|---|---|---|
2011 | $ | 78,081 | ||
2012 | 76,162 | |||
2013 | 75,505 | |||
2014 | 71,961 | |||
2015 | 68,640 | |||
Thereafter | 145,016 | |||
| $ | 515,365 | |||
Included in rental income is percentage rent of $694, $650 and $585 for the years ended December 31, 2010, 2009 and 2008, respectively.
13. Related Party Transactions
Advisory Fees
The Company has agreements with each of its N-Star CDO financings and its CSE RE 2006-A CDO financing to perform certain advisory services. The Company earned total fees on these agreements of approximately $3.1 million, $7.1 million and $12.0 million for the years ended December 31, 2010, 2009 and 2008, respectively. As of January 1, 2010, the advisory fee income related
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
13. Related Party Transactions (Continued)
to N-Star I, N-Star II, N-Star III and N-Star V is eliminated as a result of the consolidation of the respective CDO financings.
The Company has an agreement with NSREIT, a commercial finance REIT, to perform certain advisory services. As of December 31, 2010, the Company has earned an immaterial amount of fees on this agreement.
The Company has an agreement with the Securities Fund to receive base management fees ranging from 1.0% to 2.0% per year on third-party capital. For the years ended December 31, 2010, 2009 and 2008, the Company earned $0.1 million, $0.2 million and $0.5 million in management fees.
Asset Management Fees
The Company entered into a management agreement in April 2006 with Wakefield Capital Management Inc. to perform certain management services. The Company incurred $0.5 million, $3.4 million and $3.4 million in management fees for the years ended December 31, 2010, 2009 and 2008, respectively, which are recorded in asset management fees-related parties in the condensed consolidated statement of operations. In April 2010, in connection with the Company's acquisition of the 51% membership interest in Midwest Holdings, the Company amended the management agreement with Wakefield Capital Management, Inc. The amended management fee will be equal to one dollar per year.
The Company entered into a management agreement in March 2007 with the management company of our corporate lending venture to perform certain management services. On May 7, 2008, the Company terminated its management agreement with the management company of our corporate lending venture. The Company incurred zero in management fees for the years ended December 31, 2010 and 2009, and $1.3 million in management fees for the years ended December 31, 2008, respectively, which are recorded in asset management fees-related parties in the consolidated statement of operations.
Legacy Fund
The Company has two real estate debt investments with a subsidiary of Legacy Partners Realty Fund I, LLC (the "Legacy Fund"), as borrower, totaling $33.4 million in principal amount. In January 2010, the Company extended the $19.2 million loan through January 2012, with three additional one-year extension options. In June 2010 the Company modified the $14.1 million loan. The interest rate was increased to LIBOR plus 450 and extended the maturity date to April, 2013, with two one-year extension options. One of the Company's directors, Preston Butcher, is the chairman of the Board of Directors and chief executive officer and owns a significant interest in Legacy Partners Commercial, LLC, which indirectly owns an equity interest in, and owns the manager of, the Legacy Fund. The loans are included in real estate debt investments in the consolidated balance sheets.
Hard Rock Hotel Loan
In March 2007, the Company acquired a $100.0 million junior participation (subsequently converted into a second loss mezzanine loan in November 2007) in the financing provided by Credit Suisse, or CS, in connection with the acquisition of the Hard Rock Hotel and Casino, or Hard Rock, in
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
13. Related Party Transactions (Continued)
Las Vegas, NV, by a joint venture between DLJ Merchant Banking and Morgans Hotel Group, or Morgans, which is a minority partner in the joint venture. In August 2008, the Company purchased a $30.0 million junior participation from CS, in connection with the acquisition of 11.05 acres of land immediately adjacent to the Hard Rock by the same joint venture. Both loans were subsequently modified in December 2009, which included the extension of each loan's maturity date. David Hamamoto, the Company's chairman and chief executive officer, is the chairman of the board of Morgans.
14. Fair Value of Financial Instruments
The following disclosures of estimated fair value were determined by the Company, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
As of December 31, 2010 and 2009, cash equivalents, accounts receivable and accounts payable, reasonably approximate their fair values due to the short-term maturities of these items. The available for sale securities are carried on the balance sheet at their estimated fair value.
For the real estate debt investments the fair value of the fixed and floating rate investments was approximated comparing yields at which the investments are held to estimated yields at which loans originated with similar credit risks or market yields at which a third party might require to purchase the investment by discounting future cash flows at such market yields. Prices were calculated assuming fully extended maturities regardless of if structural or economic tests required to achieve such extended maturities. At December 31, 2010, the fair market value was $1.6 billion with a gross principal amount of $2.7 billion. Of the $2.7 billion gross principal amount, approximately $997.1 million of gross principal amount in CSE RE 2006-A was recorded at a fair market value of approximately $321.4 million at December 31, 2010. At December 31, 2009, the fair market value was $1.7 billion with a gross principal amount of $2.0 billion.
For the exchangeable senior notes, the Company uses available market information, which includes quoted market prices or recent transactions, if available to estimate their fair value. At December 31, 2010, the fair market value of the 7.25% exchangeable senior notes was $64.4 million, with a carrying amount of $67.4 million and the fair market value of the 11.50% exchangeable senior notes was $56.8 million with a carrying amount of $59.4 million. At December 31, 2009, the fair market value of the 7.25% exchangeable senior notes was $34.8 million with a carrying amount of $67.0 million and the fair market value of the 11.50% exchangeable senior notes was $28.1 million with a carrying amount of $59.0 million.
For fixed rate mortgage loans payable, the Company uses rates currently available to them with similar terms and remaining maturities to estimate their fair value. At December 31, 2010, the fair market value was 818.9 million with a carrying amount of $803.1 million. At December 31, 2009, the fair market value was $800.1 million with a carrying amount of $795.9 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
14. Fair Value of Financial Instruments (Continued)
Disclosure about fair value of financial instruments is based on pertinent information available to management as of December 31, 2010 and December 31, 2009. Although management is not aware of any factors that would significantly affect the fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein.
15. Equity Based Compensation
Omnibus Stock Incentive Plan
On September 14, 2004, the Board of Directors of the Company adopted the NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (the "Stock Incentive Plan"). The Stock Incentive Plan provides for the issuance of stock- based incentive awards, including incentive stock options, non-qualified stock options, and stock appreciation rights, shares of common stock of the Company, including restricted shares, and other equity-based awards, including OP Units which are structured as profits interests ("LTIP Units") or any combination of the foregoing. The eligible participants in the Stock Incentive Plan include directors, officers and employees of the Company and, prior to October 29, 2005, employees pursuant to the shared facilities and services agreement. An aggregate of 8,933,038 shares of common stock of the Company are currently reserved and authorized for issuance under the Stock Incentive Plan, subject to equitable adjustment upon the occurrence of certain corporate events. As of December 31, 2010, the Company has issued an aggregate of 8,280,417 LTIP Units, net of forfeitures of 63,291 LTIP Units. An aggregate of 4,107,971 LTIP Units were converted to commons stock and 581,669 shares of common stock were issued pursuant to the Stock Incentive Plan. Of the 8,280,417 LTIP Units, so long as the recipient continues to be an eligible recipient, 4,974,034 will vest to the individual recipient at a rate of one-twelfth of the total amount granted as of the end of each quarter, beginning with the first quarter after the date of grant ended either January 29, April 29, July 29, or October 29 for the three-year vesting period, 2,154,029 will vest over 16 consecutive quarters with the first quarter being January 29, 2008, 701,058 cliff vested on December 31, 2010, and 170,801 are subject to no vesting requirements. The Company accelerated the vesting of 280,495 LTIP Units as part of the termination agreements provided to employees. In addition, the LTIP Unit holders are entitled to dividends on the entire grant beginning on the date of the grant.
The Company has recognized compensation expense of $13.3 million, $19.7 million and $21.3 million for the years ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010, there were approximately 899,004 unvested LTIP Units and no LTIP Units were forfeited during the period. The related compensation expense to be recognized over the remaining vesting period of the Omnibus Incentive Plan LTIP grants is $5.7 million, provided there are no forfeitures.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
15. Equity Based Compensation (Continued)
The status of all of the LTIP grants as of December 31, 2010 and 2009 is as follows:
| | December 31, 2010 | December 31, 2009 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | LTIP Grants | Weighted Average Grant Price | LTIP Grants | Weighted Average Grant Price | |||||||||
Balance at beginning of year(1) | 7,323 | $ | 9.85 | 8,067 | $ | 9.86 | |||||||
Granted | — | — | — | — | |||||||||
Converted to common stock | (3,031 | ) | 12.59 | (744 | ) | 9.83 | |||||||
Forfeited | (3 | ) | 8.55 | — | — | ||||||||
Ending balance(2) | 4,289 | $ | 7.92 | 7,323 | $ | 9.85 | |||||||
- (1)
- Reflects balance at January 1, 2010 and January 1, 2009 for the periods ended December 31, 2010 and December 31, 2009, respectively.
- (2)
- Reflects balance at December 31, 2010 and December 31, 2009, respectively.
Incentive Compensation Plan
On July 21, 2009, the Compensation Committee of the Board of Directors (the "Committee") of the Company approved the material terms of a new Incentive Compensation Plan for the Company's executive officers and other employees (the "Plan"). Under the Plan, a potential incentive compensation pool is expected to be established each calendar year. The size of the incentive pool will be calculated as the sum of (a) 1.75% of the Company's "adjusted equity capital" and (b) 25% of the Company's adjusted funds from operations, as adjusted ("AFFO"), above a 9% return hurdle on adjusted equity capital. Payout from the incentive pool is subject to achievement of additional performance goals summarized below.
The incentive pool is expected to be divided into the following three separate incentive compensation components: (1) an annual cash bonus, tied to annual performance of the Company and paid after year end at or around completion of the year end audit; (2) a deferred cash bonus, determined based on the same year's performance, but paid 50% following the close of each of the first and second years after such incentive pool is determined, subject to the participant's continued employment through each payment date; and (3) a long-term incentive, paid at the end of a three-year period based on the Company's achievement of cumulative performance goals for the three-year period, subject to the participant's continued employment through the payment date. The Committee expects to evaluate the Plan on an annual basis and consider alternatives to the foregoing as the Committee deems appropriate and in the best interests of shareholders. Performance goals for each component will be set by the Committee initially upon the adoption of the Plan and at the beginning of each subsequent calendar year for each new cycle. The goals will generally be divided into ranges of performance, each of which will correspond to a pay-out level equal to a percentage of a participant's pool allocation for such component.
The annual bonus component for 2010 was calculated based on AFFO and liquidity targets (weighted 50% and 25%, respectively) with the remaining 25% of the 2010 annual bonus determined in
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
15. Equity Based Compensation (Continued)
the Committee's discretion. Additionally, the Committee had also allocated $2.0 million under the Plan for 2010 discretionary cash bonuses, of which $1.5 million will be paid. The deferred bonus component was calculated based on the same performance measures as the annual bonus, but paid as described above. For the long-term incentive component for 2010, each participant was granted a number of restricted stock units determined by dividing the value of the participant's pool allocation for this component by the 20-day average closing price of the Company's common stock as of December 31, 2010 (such amount, the "Initial Long-Term Allocation"). Upon the conclusion of the three-year performance period, the participant will receive a payout equal to the value of one share of common stock at the time of such payout, with respect to a share of common stock during the three-year performance period, for each unit actually earned based on the Company's achievement of cumulative AFFO and/or a stock price goal during the performance period (the "Long-Term Payout"). The Long-Term Payout will be made in the form of shares of common stock to the extent available under the Company's equity compensation plans or, if all or a portion of such shares are not available, in cash; provided, that the amount of cash paid to any participant with respect to the 2010 long-term incentive component shall not exceed such participant's Initial Long-Term Allocation.
The Company recorded $2.1 million in equity-based compensation expense related to the long term incentive component of the Plan for the year ended December 31, 2010.
2006 Outperformance Plan
In January 2006, the Compensation Committee of the Board of Directors approved the NorthStar Realty Finance Corp. 2006 Outperformance Plan (the "2006 Outperformance Plan"), a long-term compensation program to further align the interests of the Company's stockholders and management. The Company did not meet the performance hurdles under the 2006 Outperformance Plan as of the conclusion of the 2006 Outperformance Plan on December 31, 2008. The Company recorded compensation expense for the 2006 Outperformance Plan of $0.2 million, $1.1 million and $1.1 million for the year ended December 31, 2010, 2009 and 2008, respectively.
16. Stockholders' Equity
Dividend Reinvestment and Stock Purchase Plan
In April 2007, the Company implemented a Dividend Reinvestment and Stock Purchase Plan (the "Plan"), pursuant to which it registered with the SEC and reserved for issuance 15,000,000 shares of its common stock. Under the terms of the Plan, stockholders who participate in the Plan may purchase shares of the Company's common stock directly from it, in cash investments up to $10,000. At the Company's sole discretion, it may accept optional cash investments in excess of $10,000 per month, which may qualify for a discount from the market price of 0% to 5%. Plan participants may also automatically reinvest all or a portion of their dividends for additional shares of the Company's stock. The Company expects to use the proceeds from any dividend reinvestments or stock purchases for general corporate purposes.
During the year ended December 31, 2010, the Company issued a total of 92,362 common shares pursuant to the Plan for a gross sales price of approximately $0.4 million. During the year ended
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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
16. Stockholders' Equity (Continued)
December 31, 2009, the Company issued a total of 80,395 common shares pursuant to the Plan for a gross sales price of approximately $0.3 million.
Equity Distribution Agreements
In May 2009, the Company entered into an equity distribution agreement with JMP Securities LLC ("JMP"). In accordance with the terms of the agreement, the Company may offer and sell up to 10,000,000 shares of its common stock from time to time through JMP. JMP will receive a commission from the Company of up to 2.5% of the gross sales price of all shares sold through it under the equity distribution agreement. For the year ended December 31, 2010, the Company did not sell any common shares pursuant to its equity distribution agreement with JMP. For the year ended December 31, 2009, the Company issued 7,326,942 common shares and received approximately $25.7 million of net cash proceeds pursuant to its equity distribution agreement with JMP.
Common Stock
In May 2010, the Company issued 98,860 shares of common stock with a fair value at the date of grant of $0.3 million to its Board of Directors as part of their annual grants.
In May 2009, the Company issued 94,045 shares of common stock with a fair value at the date of grant of $0.3 million to its Board of Directors as part of their annual grants.
In May 2008, the Company issued 37,812 shares of common stock with a fair value at the date of grant of $0.4 million to its Board of Directors as part of their annual grants.
In December 2009, the Company issued 14,925 shares of restricted common stock with a fair value at the date of grant of $0.1 million to a newly appointed member of its Board of Directors.
For the year ended December 31, 2009, the Company issued a total of 235,183 shares of common stock related to employee compensation arrangements and employee separation agreements.
Stock Repurchase Program
On October 8, 2008, the Company's Board of Directors authorized a stock repurchase program of up to 10,000,000 shares of our outstanding common stock, or approximately 16% of its outstanding common stock. Stock repurchases under this program will be made from time to time through the open market or in privately negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market conditions, and other corporate liquidity requirements and priorities. For the year ended December 31, 2008, the Company repurchased a total of approximately 475,051 common shares for approximately $1.4 million. For the years ended December 31, 2010 and 2009, the Company did not repurchase any common shares pursuant to its stock repurchase program.
Dividends
On January 22, 2008, the Company declared a cash dividend of $0.36 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
16. Stockholders' Equity (Continued)
dividends were paid on February 15, 2008 to stockholders of record as of the close of business on February 5, 2008.
On April 22, 2008, the Company declared a cash dividend of $0.36 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on May 15, 2008 to the stockholders of record as of the close of business on May 5, 2008.
On July 22, 2008, the Company declared a cash dividend of $0.36 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on August 15, 2008 to the stockholders of record as of the close of business on August 5, 2008.
On October 8, 2008, the Company declared a cash dividend of $0.36 per share of common stock. On October 21, 2008, the Company declared a cash dividend of $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on November 14, 2008 to the stockholders of record as of the close of business on November 4, 2008.
On January 20, 2009, the Company declared a dividend of $0.25 per share of common stock. The dividends were paid on February 27, 2009 to the stockholders of record as of January 28, 2009. The common stock dividends were paid in a combination of 40% cash and 60% common stock which totaled approximately 3,715,869 shares of common stock.
On January 20, 2009, the Company declared a cash dividend of $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on February 16, 2009 to the stockholders of record as of the close of business on February 6, 2009.
On April 21, 2009, the Company declared a cash dividend of $0.10 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on May 15, 2009 to the stockholders of record as of the close of business on May 5, 2009.
On July 21, 2009, the Company declared a dividend of $0.10 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on August 14, 2009 to the stockholders of record as of the close of business on August 5, 2009.
On October 20, 2009, the Company declared a dividend of $0.10 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on November 16, 2009 to the stockholders of record as of the close of business on November 6, 2009.
On January 19, 2010, the Company declared a dividend of $0.10 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on February 12, 2010, to the stockholders of record as of February 5, 2010.
On April 20, 2010, the Company declared a dividend of $0.10 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
16. Stockholders' Equity (Continued)
dividends were paid on May 14, 2010, to the stockholders of record as of the close of business on May 4, 2010.
On July 20, 2010, the Company declared a dividend of $0.10 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on August 16, 2010, to the stockholders of record as of the close of business on August 6, 2010.
On October 19, 2010, the Company declared a dividend of $0.10 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends will be paid on November 15, 2010, to the stockholders of record as of the close of business on November 5, 2010.
Earnings Per Share
Earnings per share for the years ended December 31, 2010, 2009 and 2008 is computed as follows (in thousands):
| | Year Ended December 31, 2010 | Year Ended December 31, 2009 | Year Ended December 31, 2008 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Numerator (Income) | |||||||||||
Basic Earnings | |||||||||||
Net (loss)/income attributable to NorthStar Realty Finance Corp. common stockholders | $ | (395,466 | ) | $ | (151,205 | ) | $ | 609,232 | |||
Effect of dilutive securities: | |||||||||||
Income/(loss) allocated to non-controlling interest | (25,864 | ) | (15,848 | ) | 67,558 | ||||||
Dilutive net income/(loss) available to stockholders | $ | (421,330 | ) | $ | (167,053 | ) | $ | 676,790 | |||
Basic Earnings: | |||||||||||
Shares available to common stockholders | 76,553 | 69,870 | 63,136 | ||||||||
Effect of dilutive securities: | |||||||||||
OP/LTIP units | 6,290 | 7,323 | 7,001 | ||||||||
Dilutive Shares | 82,843 | 77,193 | 70,137 | ||||||||
Net income/(loss) per share attributable to NorthStar Realty Finance Corp. common stockholders—Basic/Diluted | $ | (5.09 | ) | $ | (2.16 | ) | $ | 9.65 | |||
The earnings per share calculation takes into account the conversion of LTIP units into common shares. The LTIPS convert on a one-for-one basis into commons shares and share equally in the Company's earnings. Depending on the timing of LTIP conversions and the amount of LTIPS converted, relative to the timing of the Company's earnings allocated to the LTIP non-controlling interest, and the weighting of the common shares, the LTIP conversions may result in an anti-dilutive effect on earnings per share.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
17. Non-controlling Interest
Operating Partnership
Non-controlling interest represents the aggregate limited partnership interests or OP Units in the Operating Partnership held by limited partners (the "Unit Holders"). Income allocated to the non-controlling interest is based on the Unit Holders ownership percentage of the Operating Partnership. The ownership percentage is determined by dividing the numbers of OP Units held by the Unit Holders by the total number of dilutive shares. The issuance of additional shares of beneficial interest (the "Common Shares" or "Share") or OP Units changes the percentage ownership of both the Unit Holders and the Company. Since a unit is generally redeemable for cash or Shares at the option of the Company, it is deemed to be equivalent to a Share. Therefore, such transactions are treated as capital transactions and result in an allocation between shareholders' equity and non-controlling interest in the accompanying consolidated balance sheet to account for the change in the ownership of the underlying equity in the Operating Partnership. As of December 31, 2010 and December 31, 2009, non-controlling interest related to the aggregate limited partnership units of 4,292,199 and 7,323,310, represented a 5.21% and 8.91% interest in the Operating Partnership, respectively. Income/(loss) allocated to the operating partnership non-controlling interest for the years ended December 31, 2010 and 2009 was a loss of $25.9 million and a loss of $15.8 million, respectively.
Contingently Redeemable Non-controlling Interest
In July 2008, NRF Healthcare, LLC sold a $100 million convertible preferred membership interest to Inland American Real Estate Trust, Inc. ("Inland American"). NRF Healthcare, LLC received approximately $87.7 million of net proceeds from the transaction. Prior to conversion, the convertible preferred investment is entitled to a 10.5% dividend per annum. The convertible preferred membership interest may be converted or redeemed, at Inland American's option, upon the sale or recapitalization of NRF Healthcare, LLC. NRF Healthcare, LLC may, at its option, redeem the convertible preferred interests at any time. In addition, Inland American may convert its preferred membership interests into common equity in NRF Healthcare, LLC. Based on the initial investment amount and capital accounts of the members of NRF Healthcare, LLC, the convertible preferred membership interests represent, upon conversion, approximately a 42% common equity ownership interest in NRF Healthcare, LLC. Inland American will have the option of contributing additional preferred membership interest and participating in new NRF Healthcare, LLC investment opportunities in proportion to its percentage ownership interest, assuming it was to convert its interests to common equity.
In July, 2010, the Company was notified by Inland American that Inland American desires to have NRF Healthcare, LLC engage in a sale process for a portfolio of 34 senior housing properties or otherwise redeem $50 million of Inland American's convertible preferred membership interest in NRF Healthcare, LLC by January 9, 2011. If NRF Healthcare, LLC has not redeemed $50 million of the Inland American investment or sold the 34 property senior housing portfolio by October 9, 2011, then Inland American may undertake a sale process for the portfolio. Inland American may also undertake a sale process for all of the assets of NRF Healthcare, LLC beginning August 8, 2011, unless at least $25 million of Inland American's preferred interest has been redeemed by June 10, 2011, in which case all future net cash flow to the common members of NRF Healthcare, LLC will be used to redeem the preferred membership interest. On July 8, 2012, if the preferred membership interest has not been
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
17. Non-controlling Interest (Continued)
redeemed in full, Inland American may sell the assets of NRF Healthcare, LLC. The Company is currently exploring alternatives for partial and/or full redemption of the preferred membership interest.
For the years ending December 31, 2010 and 2009, the Company reclassified Inland American's non-controlling interest from equity to temporary equity on the consolidated balance sheets in accordance with its interpretation ofAccounting Series Release No. 268, Presentation in Financial Statements of "Redeemable Preferred Stocks", Section No. 211, "Redeemable Preferred Stocks"
Income allocated to the non-controlling interests for the years ended December 31, 2010 and 2009 was income of $10.8 million and $9.6 million, respectively.
Joint Ventures
A third party holds 16.7% of the equity notes of N-Star CDO I. The equity notes held by the third party are reflected as non-controlling interest in the Company's condensed consolidated financial statements.
In March 2007, the Company formed a joint venture with Monroe. On May 7, 2008, the Company completed a recapitalization of Monroe Capital, its middle- market corporate lending venture. Upon completion of the recapitalization transaction, the Company deconsolidated the venture. Monroe Capital's equity is no longer a component of non-controlling interest. Loss allocated to non-controlling interest prior to the recapitalization of Monroe Capital for the year ended December 31, 2008 was $0.3 million.
18. Risk Management and Derivative Activities
Derivatives
Derivatives
The Company uses derivatives primarily to manage interest rate risk exposure. These derivatives are typically in the form of interest rate swap agreements and the primary objective is to minimize interest rate risks associated with the Company's investment and financing activities. The counterparties of these arrangements are major financial institutions with which the Company may also have other financial relationships. The Company is exposed to credit risk in the event of non-performance by these counterparties and it monitors their financial condition; however, the Company currently does not anticipate that any of the counterparties will fail to meet their obligations because of their high credit ratings and financial support from the U.S. Government. The objective in using interest rate derivatives is to add stability to interest expense and to manage exposure to interest rate movements.
The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the year ended December 31, 2009, such derivatives were used to hedge the variable cash flows associated with certain variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the year ended December 31, 2009, the Company recorded immaterial amounts of hedge ineffectiveness in earnings.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
18. Risk Management and Derivative Activities (Continued)
The following tables summarize the Company's derivative financial instruments that were designated as cash flow hedges of interest rate risk as December 31, 2009:
| | Number of Instruments | Notional Amount | Fair Value Net Asset/ (Liability) | Range of Fixed LIBOR | Range of Maturity | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Interest rate swaps | |||||||||||||
As of December 31, 2009 | 10 | $ | 90,749 | $ | (7,691 | ) | 4.18% - 5.08% | March 2010 - August 2018 | |||||
Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company's variable-rate debt.
In January 2008, the Company elected the fair value option for its bonds payable and its liability to subsidiary trusts issuing preferred securities. As a result, the changes in fair value of these financial instruments are now recorded in earnings and the interest rate swap agreements associated with these debt instruments no longer qualify for hedge accounting given that the underlying debt is remeasured with changes in the fair value recorded in earnings. The unrealized gains or losses accumulated in other comprehensive income, related to these interest rate swaps, will be reclassified into earning over the shorter of either the life of the swap or the associated debt with current mark-to-market unrealized gains or losses recorded in earnings.
Derivatives not designated as hedges are not speculative and are used to manage the Company's exposure to interest rate movements and other identified risks but do not meet strict hedge accounting requirements. For the years ended December 31, 2010, 2009 and 2008 the Company recorded, in earnings, a mark-to-market unrealized loss of $134.0 million, an unrealized gain of $4.6 million and an unrealized loss of $15.9 million, respectively, for the non-qualifying interest rate swaps. For the years ended December 31, 2010, 2009 and 2008, the Company recorded a $6.6 million, a $5.6 million and a $5.5 million reclassification from accumulated other comprehensive income for the non-qualifying interest rate swaps, respectively.
The following tables summarize the Company's derivative financial instruments that were not designated as hedges in qualifying hedging relationships as of December 31, 2010 and 2009:
| | Number of Investments | Notional Amount | Fair Value Net Asset/ (Liability) | Range of Fixed LIBOR | Range of Maturity | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Interest rate swaps | |||||||||||||
As of December 31, 2010 | 64 | $ | 2,812,409 | $ | (220,630 | ) | 0.37% - 7.00% | February 2011 - October 2019 | |||||
As of December 31, 2009(1) | 22 | $ | 897,335 | $ | (59,353 | ) | 0.34% - 5.63% | May 2010 - June 2018 | |||||
- (1)
- December 31, 2009 does not include the interest rate swaps of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
18. Risk Management and Derivative Activities (Continued)
The following table presents the fair value of the Company's derivative financial instruments as well as their classification on its balance sheet as of December 31, 2010 and 2009:
Tabular Disclosure of Fair Values of Derivative Instruments
| | Asset Derivatives | Liability Derivatives | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | As of December 31, 2010 | As of December 31, 2009(1) | As of December 31, 2010 | As of December 31, 2009(1) | |||||||||||||||||
| | Balance Sheet Location | Fair Value | Balance Sheet Location | Fair Value | Balance Sheet Location | Fair Value | Balance Sheet Location | Fair Value | |||||||||||||
Derivatives designated as hedging instruments | |||||||||||||||||||||
Interest rate products | Derivative instrument, at fair value | $ | — | Derivative instrument, at fair value | $ | — | Derivative liability, at fair value | $ | — | Derivative liability, at fair value | $ | (7,691 | ) | ||||||||
Total derivatives designated as hedging instruments | $ | — | $ | — | $ | — | $ | (7,691 | ) | ||||||||||||
Derivatives not designated as hedging instruments | |||||||||||||||||||||
Interest rate products | Derivative instrument, at fair value | $ | 59 | Derivative instrument, at fair value | $ | — | Derivative liability, at fair value | $ | (220,689 | ) | Derivative liability, at fair value | $ | (59,353 | ) | |||||||
Total derivatives not designated as hedging instruments | $ | 59 | $ | — | $ | (220,689 | ) | $ | (59,353 | ) | |||||||||||
- (1)
- December 31, 2009 does not include the derivative instruments of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
18. Risk Management and Derivative Activities (Continued)
The following tables present the effect of the Company's derivative financial instruments on its statement of operations for the years ended December 31, 2010, 2009 and 2008:
Derivatives in Cash Flow Hedging Relationships
| | Location of Gain/(loss) recognized in income | Year Ended December 31, 2010 | Year Ended December 31, 2009(1) | Year Ended December 31, 2008(1) | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
Interest rate products | ||||||||||||
Amount of gain or (loss) in OCI on derivative (effective portion) | n/a | $ | (3,448 | ) | $ | 2,115 | $ | (14,758 | ) | |||
Amount of gain or (loss) reclassified from accumulated OCI into income (effective portion) | Interest Expense | $ | 30 | $ | 28 | $ | 28 | |||||
- (1)
- The years ended December 31, 2009 and 2008 do not include gains or losses and amounts reclassified from accumulated OCI into income on the derivative instruments of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.
Derivatives Not Designated as Hedging Instruments
| | Location of Gain/(loss) recognized in income | Year Ended December 31, 2010 | Year Ended December 31, 2009(1) | Year Ended December 31, 2008(1) | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
Interest rate products | ||||||||||||
Amount of gain or (loss) recognized in income | Unrealized gain (loss) on investment and other | $ | (134,070 | ) | $ | (16,463 | ) | $ | (30,851 | ) | ||
Amount of gain or (loss) reclassified from accumulated OCI into income | Unrealized gain (loss) on investment and other | $ | (6,635 | ) | $ | (5,618 | ) | $ | (5,460 | ) | ||
- (1)
- The years ended December 31, 2009 and 2008 do not include gains or losses and amounts reclassified from accumulated OCI into income on the derivative instruments of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.
At December 31, 2010, the Company's counterparties hold approximately $26.7 million of cash margin as collateral against its swap contracts.
Credit Risk Concentrations
Concentrations of credit risk arise when a number of borrowers, tenants, operators or issuers related to the Company's investments are engaged in similar business activities or located in the same
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
18. Risk Management and Derivative Activities (Continued)
geographic location to be similarly affected by changes in economic conditions. The Company monitors its portfolio to identify potential concentrations of credit risks. The Company has no one borrower, tenant or operator that generates 10% or more of its total revenue. However, approximately 34% of the Company's rental and escalation revenue for the year ended December 31, 2010, is generated from one tenant and one operator in the Company's healthcare net lease portfolio. The Company believes the remainder of its net lease portfolio is reasonably well diversified and does not contain any unusual concentration of credit risks.
19. Quarterly Financial Information (Unaudited)
The tables below reflect the Company's selected quarterly information for the Company for the years ended December 31, 2010, 2009 and 2008:
| | Three Months Ended | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | December 31, 2010 | September 30, 2010 | June 30, 2010 | March 31, 2010 | ||||||||||
| | (unaudited) | |||||||||||||
Total revenue | $ | 149,351 | $ | 126,780 | $ | 95,929 | $ | 81,613 | ||||||
(Loss) from continuing operations | (267,070 | ) | $ | (146,683 | ) | 43,664 | (20,033 | ) | ||||||
(Loss) from discontinued operations | (111 | ) | (116 | ) | (1,619 | ) | (120 | ) | ||||||
Consolidated net (loss)/income | (267,181 | ) | (146,849 | ) | 44,573 | (20,103 | ) | |||||||
Net income attributable to NorthStar Realty Finance Corp. common stockholders | (258,410 | ) | (144,118 | ) | 31,985 | (24,923 | ) | |||||||
Net income (loss) per share attributable to NorthStar Realty Finance Corp. common stockholders—basic/diluted | $ | (3.33 | ) | $ | (1.87 | ) | $ | 0.42 | $ | (0.33 | ) | |||
Weighted-average shares outstanding | ||||||||||||||
basic | 77,564,571 | 77,139,868 | 76,407,339 | 75,068,654 | ||||||||||
diluted | 82,383,931 | 82,364,109 | 82,279,682 | 82,217,223 | ||||||||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
19. Quarterly Financial Information (Unaudited) (Continued)
| | Three Months Ended | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | December 31, 2009 | September 30, 2009 | June 30, 2009 | March 31, 2009 | ||||||||||
| | (unaudited) | |||||||||||||
Total revenue | $ | 67,235 | $ | 62,228 | $ | 66,399 | $ | 70,217 | ||||||
Income (loss) from continuing operations | (189,989 | ) | $ | (67,629 | ) | 2,404 | 102,667 | |||||||
Income (loss) from discontinued operations | (190 | ) | 657 | 659 | 669 | |||||||||
Consolidated net income (loss) | (176,000 | ) | (65,773 | ) | 2,469 | 102,731 | ||||||||
Net income (loss) attributable to NorthStar Realty Finance Corp. common stockholders | (165,122 | ) | (66,466 | ) | (4,253 | ) | 84,635 | |||||||
Net income (loss) per share attributable to NorthStar Realty Finance Corp. common stockholders—basic/diluted | $ | (2.01 | ) | $ | (0.86 | ) | $ | (0.06 | ) | $ | 1.17 | |||
Weighted-average shares outstanding | ||||||||||||||
basic | 74,311,394 | 69,896,439 | 67,353,541 | 64,348,264 | ||||||||||
diluted | 82,134,760 | 77,356,187 | 75,049,690 | 72,255,413 | ||||||||||
| | Three Months Ended | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | December 31, 2008 | September 30, 2008 | June 30, 2008 | March 31, 2008 | ||||||||||
| | (unaudited) | |||||||||||||
Total revenue | $ | 83,980 | $ | 91,383 | $ | 90,939 | $ | 97,674 | ||||||
Income (loss) from continuing operations | 251,202 | 250,951 | (23,836 | ) | 221,602 | |||||||||
Income (loss) from discontinued operations | 661 | 630 | 569 | 550 | ||||||||||
Consolidated net income (loss) | 251,863 | 251,581 | (23,267 | ) | 222,152 | |||||||||
Net income attributable to NorthStar Realty Finance Corp. common stockholders | 218,992 | 218,310 | (25,059 | ) | 193,805 | |||||||||
Net income (loss) per share attributable to NorthStar Realty Finance Corp. common stockholders—basic/diluted | $ | 3.11 | $ | 3.11 | $ | (0.36 | ) | $ | 2.78 | |||||
Weighted-average shares outstanding | ||||||||||||||
basic | 63,160,947 | 62,825,383 | 62,708,688 | 62,243,736 | ||||||||||
diluted | 70,422,832 | 70,229,958 | 70,192,538 | 69,589,079 | ||||||||||
20. Segment Reporting
The Company's real estate debt segment is focused on originating, structuring and acquiring senior and subordinate debt investments secured primarily by commercial real estate properties. The Company generates revenues from this segment by earning interest income from its debt investments and its operating expenses consist primarily of interest costs from financing the assets. This segment generates income from operations by earning a positive spread between the yield on its assets and the interest cost of its debt. The Company evaluates performance and allocates resources to this segment based upon its contribution to income from continuing operations.
The Company's operating real estate segment is focused on acquiring commercial real estate facilities located throughout the U.S. that are primarily leased under long-term triple-net leases to
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
20. Segment Reporting (Continued)
corporate tenants. Triple-net leases generally require the lessee to pay all costs of operating the facility, including taxes and insurance and maintenance of the facility. The Company's net-leased facilities are currently located in New York, Ohio, California, Utah, Pennsylvania, New Jersey, Indiana, Illinois, New Hampshire, Massachusetts, Kansas, Maine, South Carolina, Michigan, Colorado, North Carolina, Florida, Washington, Oregon, Wisconsin, Georgia, Oklahoma, Nebraska, Tennessee, Texas and Kentucky. Revenues from these assets are generated from rental income received from lessees of the facilities, and operating expenses, which include interest costs related to financing the assets, operating expenses, real estate taxes, insurance, ground rent and repairs and maintenance. The segment generates income from operations by leasing these facilities at a higher rate than the costs of owning and financing the assets.
The Company's real estate securities segment is focused on investing in a wide range of commercial real estate debt securities, including CMBS, REIT unsecured debt, credit tenant loans and unsecured subordinate securities of commercial real estate companies. The Company generates revenues from this segment by earning interest income and advisory fees from owning and managing these investments. Its operating expenses consist primarily of interest costs from financing its securities. The segment generates income from operations by earning advisory fees and a positive spread between the yield on its assets and the interest cost of its debt.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
20. Segment Reporting (Continued)
The following table summarizes segment reporting for the years ended December 31, 2010, 2009 and 2008 (in thousands):
| | Real Estate Debt | Operating Real Estate | Real Estate Securities | Corporate Loans | Healthcare | Broker- Dealer | Unallocated(1) | Consolidated Total | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
December 31,2010: | ||||||||||||||||||||||||||
Interest income | $ | 143,659 | $ | 20 | $ | 176,183 | $ | — | $ | 247 | $ | — | $ | (209 | ) | $ | 319,900 | |||||||||
Rental and escalation income | 155 | 36,570 | — | — | 88,104 | — | (1 | ) | 124,828 | |||||||||||||||||
Commission income | — | — | — | — | — | 2,476 | — | 2,476 | ||||||||||||||||||
Other revenue | 2,334 | 11 | 3,464 | — | 189 | 46 | 425 | 6,469 | ||||||||||||||||||
| 146,148 | 36,601 | 179,647 | — | 88,540 | 2,522 | 215 | 453,673 | |||||||||||||||||||
Interest expense | (28,985 | ) | (21,554 | ) | (24,400 | ) | — | (34,039 | ) | — | (22,354 | ) | (131,332 | ) | ||||||||||||
Operating expenses | (36 | ) | (4,730 | ) | — | — | (32,907 | ) | — | (18 | ) | (37,691 | ) | |||||||||||||
Commission expense | — | — | — | — | — | (1,867 | ) | — | (1,867 | ) | ||||||||||||||||
Realized gain (loss) | 79,357 | 2,493 | 74,847 | 7,508 | (494 | ) | — | (98 | ) | 163,613 | ||||||||||||||||
Unrealized gain (loss) | (269,468 | ) | — | (230,874 | ) | — | (40 | ) | — | (38,189 | ) | (538,571 | ) | |||||||||||||
Equity earning in unconsolidated venture | (5,390 | ) | 526 | (3,911 | ) | 8,509 | 1,987 | — | 532 | 2,253 | ||||||||||||||||
Impairment on operating real estate / loan loss reserves | (167,963 | ) | (5,249 | ) | (233 | ) | — | — | — | (249 | ) | (173,694 | ) | |||||||||||||
Depreciation & amortization | (548 | ) | (15,687 | ) | — | — | (16,666 | ) | (26 | ) | (1,170 | ) | (34,097 | ) | ||||||||||||
G&A and other | (13,147 | ) | (1,904 | ) | (4,199 | ) | (4,346 | ) | (6,698 | ) | (5,975 | ) | (53,611 | ) | (89,880 | ) | ||||||||||
| (406,180 | ) | (46,105 | ) | (188,770 | ) | 11,671 | (88,857 | ) | (7,868 | ) | (115,157 | ) | (841,266 | ) | ||||||||||||
Income from discontinued operations | (2,063 | ) | 96 | — | — | — | — | — | (1,967 | ) | ||||||||||||||||
Consolidated net (loss)/income | (262,095 | ) | (9,408 | ) | (9,123 | ) | 11,671 | (317 | ) | (5,346 | ) | (114,942 | ) | (389,560 | ) | |||||||||||
Net income (loss) attributable to the non-controlling interest | 17,401 | 624 | 606 | (775 | ) | (10,824 | ) | 355 | 7,631 | 15,018 | ||||||||||||||||
Preferred stock dividends | (14,078 | ) | (506 | ) | (490 | ) | 627 | (17 | ) | (287 | ) | (6,174 | ) | (20,925 | ) | |||||||||||
Net income (loss) attributable to NorthStar Realty Finance Corp. common stockholders | $ | (258,772 | ) | $ | (9,289 | ) | $ | (9,007 | ) | $ | 11,523 | $ | (11,158 | ) | $ | (5,278 | ) | $ | (113,485 | ) | $ | (395,466 | ) | |||
Total Assets as of December 31, 2010 | $ | 2,216,425 | $ | 418,386 | $ | 1,741,395 | $ | 89 | $ | 634,932 | $ | 1,591 | $ | 139,173 | $ | 5,151,991 | ||||||||||
175
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
20. Segment Reporting (Continued)
| | Real Estate Debt | Operating Real Estate | Real Estate Securities | Corporate Loans | Healthcare | Broker- Dealer | Unallocated(1) | Consolidated Total | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
December 31,2009: | ||||||||||||||||||||||||||
Interest income | $ | 100,697 | $ | 20 | $ | 59,687 | $ | — | $ | 276 | $ | — | $ | (775 | ) | $ | 159,905 | |||||||||
Rental and escalation income | 140 | 41,612 | — | — | 56,390 | — | 1 | 98,143 | ||||||||||||||||||
Commission income | — | — | — | — | — | — | — | — | ||||||||||||||||||
Other revenue | 550 | 3 | 7,470 | — | — | — | 8 | 8,031 | ||||||||||||||||||
| 101,387 | 41,635 | 67,157 | — | 56,666 | — | (766 | ) | 266,079 | ||||||||||||||||||
Interest expense | (42,331 | ) | (21,829 | ) | (23,462 | ) | — | (12,539 | ) | — | (21,128 | ) | (121,289 | ) | ||||||||||||
Operating expenses | — | (7,325 | ) | — | — | (7,315 | ) | — | (13 | ) | (14,653 | ) | ||||||||||||||
Commission expense | — | — | — | — | — | — | — | — | ||||||||||||||||||
Realized gain (loss) | (3,156 | ) | — | 73,568 | — | 12,328 | — | 59,520 | 142,260 | |||||||||||||||||
Unrealized gain (loss) | (84,617 | ) | — | 25,684 | (31,451 | ) | (21,089 | ) | — | (98,503 | ) | (209,976 | ) | |||||||||||||
Equity earning in unconsolidated venture | (3,696 | ) | 419 | (6,547 | ) | — | 7,483 | — | 532 | (1,809 | ) | |||||||||||||||
Impairment on operating real estate / loan loss reserves | (84,415 | ) | — | — | — | — | — | 670 | (83,745 | ) | ||||||||||||||||
Depreciation & amortization | (16 | ) | (16,858 | ) | — | — | (24,263 | ) | (1 | ) | (588 | ) | (41,726 | ) | ||||||||||||
G&A and other | (10,445 | ) | (1,462 | ) | (2,807 | ) | 29,817 | (6,360 | ) | (1,268 | ) | (81,366 | ) | (73,891 | ) | |||||||||||
| (228,676 | ) | (47,055 | ) | 66,436 | (1,634 | ) | (51,755 | ) | (1,269 | ) | (140,876 | ) | (404,829 | ) | ||||||||||||
Income from discontinued operations | — | 467 | — | — | 1,709 | — | — | 2,176 | ||||||||||||||||||
Consolidated net (loss)/income | (127,289 | ) | (4,953 | ) | 133,593 | (1,634 | ) | 6,620 | (1,269 | ) | (141,642 | ) | (136,573 | ) | ||||||||||||
Net income (loss) attributable to the non-controlling interest | 14,771 | 575 | (15,504 | ) | 190 | (10,323 | ) | 147 | 16,437 | 6,293 | ||||||||||||||||
Preferred stock dividends | (19,503 | ) | (759 | ) | 20,469 | (250 | ) | 1,014 | (194 | ) | (21,702 | ) | (20,925 | ) | ||||||||||||
Net income (loss) attributable to NorthStar Realty Finance Corp. common stockholders | $ | (132,021 | ) | $ | (5,137 | ) | $ | 138,558 | $ | (1,694 | ) | $ | (2,689 | ) | $ | (1,316 | ) | $ | (146,907 | ) | $ | (151,205 | ) | |||
Total Assets as of December 31, 2009 | $ | 2,139,259 | $ | 444,558 | $ | 329,915 | $ | 12,565 | $ | 633,635 | $ | 956 | $ | 108,676 | $ | 3,669,564 | ||||||||||
176
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
20. Segment Reporting (Continued)
| | Real Estate Debt | Operating Real Estate | Real Estate Securities | Corporate Loans | Healthcare | Broker- Dealer | Unallocated(1) | Consolidated Total | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
December 31,2008: | ||||||||||||||||||||||||||
Interest income | $ | 161,325 | $ | 15 | $ | 53,279 | $ | 11,917 | $ | 374 | $ | — | $ | 528 | $ | 227,438 | ||||||||||
Rental and escalation income | (3 | ) | 50,819 | — | — | 56,709 | — | 21 | 107,546 | |||||||||||||||||
Commission income | — | — | — | — | — | — | — | — | ||||||||||||||||||
Other revenue | 7,233 | 9,013 | 12,550 | 96 | 3 | — | 97 | 28,992 | ||||||||||||||||||
| 168,555 | 59,847 | 65,829 | 12,013 | 57,086 | — | 646 | 363,976 | |||||||||||||||||||
Interest expense | (89,502 | ) | (28,358 | ) | (33,508 | ) | (5,997 | ) | (21,276 | ) | — | (11,897 | ) | (190,538 | ) | |||||||||||
Operating expenses | — | (7,834 | ) | — | — | (325 | ) | — | (1 | ) | (8,160 | ) | ||||||||||||||
Commission expense | — | — | — | — | — | — | — | — | ||||||||||||||||||
Realized gain (loss) | 24,533 | — | 4,422 | — | 1,382 | — | 7,362 | 37,699 | ||||||||||||||||||
Unrealized gain (loss) | 619,760 | — | (14,422 | ) | (29,993 | ) | (118,225 | ) | — | 191,993 | 649,113 | |||||||||||||||
Equity earning in unconsolidated venture | (3,348 | ) | 502 | (12,448 | ) | 3,098 | — | — | 278 | (11,918 | ) | |||||||||||||||
Impairment on operating real estate / loan loss reserves | (7,200 | ) | (5,580 | ) | — | — | — | — | (4,000 | ) | (16,780 | ) | ||||||||||||||
Depreciation & amortization | (20 | ) | (22,488 | ) | — | — | (17,302 | ) | — | (1,233 | ) | (41,043 | ) | |||||||||||||
G&A and other | (9,678 | ) | (2,111 | ) | (2,235 | ) | 25,948 | 96,527 | — | (190,881 | ) | (82,430 | ) | |||||||||||||
| 534,545 | (65,869 | ) | (58,191 | ) | (6,944 | ) | (59,219 | ) | — | (8,379 | ) | 335,943 | ||||||||||||||
Income from discontinued operations | — | 241 | — | — | 2,169 | — | — | 2,410 | ||||||||||||||||||
Consolidated net (loss)/income | 703,100 | (5,781 | ) | 7,638 | 5,069 | 36 | — | (7,733 | ) | 702,329 | ||||||||||||||||
Net income (loss) attributable to the non-controlling interest | (67,632 | ) | 556 | (735 | ) | (488 | ) | (4,617 | ) | — | 744 | (72,172 | ) | |||||||||||||
Preferred stock dividends | (20,948 | ) | 172 | (227 | ) | (151 | ) | (1 | ) | — | 230 | (20,925 | ) | |||||||||||||
Net income (loss) attributable to NorthStar Realty Finance Corp. common stockholders | $ | 614,520 | $ | (5,053 | ) | $ | 6,676 | $ | 4,430 | $ | (4,582 | ) | $ | — | $ | (6,759 | ) | $ | 609,232 | |||||||
Total Assets as of December 31, 2008 | $ | 2,266,115 | $ | 515,577 | $ | 259,326 | $ | 49,544 | $ | 732,513 | $ | — | $ | 120,649 | $ | 3,943,724 | ||||||||||
- (1)
- Corporate Investments and Other includes corporate level investments, corporate level interest income, interest expense and unallocated general & administrative expenses.
177
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
21. Supplemental Disclosure of Non-Cash Investing and Financing Activities
A summary of non-cash investing and financing activities for the years ended December 31, 2010, 2009 and 2008 is presented below:
| | 2010 | 2009 | 2008 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Assets of CSE RE 2006-A CDO | (480,312 | ) | — | — | ||||||
Liabilities of CSE RE 2006-A CDO | 464,656 | — | — | |||||||
Assets of N-Star CDO financings | (1,143,649 | ) | — | — | ||||||
Liabilities of N-Star CDO financings | 798,706 | — | — | |||||||
Non-controlling interest in N-Star CDO financing | 3,511 | — | — | |||||||
Distribution of operating real estate to non-controlling interest | 9,525 | — | — | |||||||
Assumption of mortgage notes and loans payable to non-controlling interest | (4,734 | ) | — | — | ||||||
Deconsolidation of non-controlling interest in NorthStar Income Opportunity REIT I, Inc. | (1,815 | ) | — | — | ||||||
40% participation interest in the principal proceeds of the German Loan granted to the lender in connection with the repayment and extinguishment of the WA Secured Term Loan | 35,287 | — | — | |||||||
Elimination of available for sale securities | 1,342 | — | — | |||||||
Elimination of bonds payable | 32,286 | — | — | |||||||
Deed in lieu of foreclosure of operating real estate | (76,389 | ) | — | — | ||||||
Contribution of book value of assets to unconsolidated joint venture | — | 112,097 | ||||||||
Write-off of operating real estate, tenant improvement, deferred financing cost and below market lease due to foreclosure | — | 51,732 | — | |||||||
Reduction of mortgage notes payable due to foreclosure | — | (52,067 | ) | — | ||||||
Write-off of deferred cost and straight-line rents in connection with disposition of operating real estate | — | 3,009 | — | |||||||
Reduction of restricted cash due to foreclosure | — | 68 | — | |||||||
Real estate debt investment pay-down due from servicer | — | (50 | ) | — | ||||||
Write-off of deferred financing cost in connection with fair value election accounting | — | — | 29,918 | |||||||
Initial mark-to-market adjustment in connection with fair value election accounting | — | — | (317,111 | ) | ||||||
Allocation of purchase price of operating real estate to deferred cost | — | (272 | ) | |||||||
Non-controlling interest buy-out | — | — | (1,566 | ) | ||||||
Reclassification of prior-year construction in progress | — | — | (4,409 | ) | ||||||
Write-off of deferred lease cost, tenant improvements and below market lease adjustments due to lease termination | — | — | (3,456 | ) | ||||||
Application of tenant security deposits to receivable | — | — | 1,990 | |||||||
Allocation of proceeds from exchangeable senior notes to equity | — | — | (3,100 | ) | ||||||
Allocation of payment of deferred financing fees to cost of capital | — | — | 191 | |||||||
Equity component of warrant issue | — | 117 | — | |||||||
Stock Dividend | — | 10,646 | — | |||||||
178
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
22. Income Taxes
The Company and its subsidiary, NRFC Sub-REIT Corp, have each elected to be taxed as a REIT and to comply with the related provisions of the Internal Revenue Code of 1986, as amended, the ("Code"). Accordingly, the Company generally will not be subject to U.S. federal income tax to the extent of its distributions to shareholders and as long as certain asset, income and share ownership tests are met. If the Company were to fail to meet these requirements, it would be subject to U.S. federal income tax, which could have a material adverse impact on its results of operations and amounts available for distributions to its shareholders. The Company believes that all of the criteria to maintain the Company's and NRFC Sub-REIT Corp's REIT qualification have been met for the applicable periods, but there can be no assurance that these criteria will continue to be met in subsequent periods.
The Company maintains various taxable REIT subsidiaries, ("TRSs"), which may be subject to U.S. federal, state and local income taxes and foreign taxes. Current and deferred taxes are provided on the portion of earnings (losses) recognized by the Company with respect to its interest in domestic TRSs. Deferred income tax assets and liabilities are computed based on temporary differences between the Company's GAAP consolidated financial statements and the federal and state income tax basis of assets and liabilities as of the consolidated balance sheet date. The Company evaluates the realizability of its deferred tax assets (e.g., net operating loss and capital loss carryforwards) and recognizes a valuation allowance if, based on the available evidence, it is more likely than not that some portion or all of its deferred tax assets will not be realized. When evaluating the realizability of its deferred tax assets, the Company considers estimates of expected future taxable income, existing and projected book/tax differences, tax planning strategies available, and the general and industry specific economic outlook. This realizability analysis is inherently subjective, as it requires the Company to forecast its business and general economic environment in future periods. Changes in estimate of deferred tax asset realizability, if any, are included in income tax expense on the consolidated statements of operations.
From time to time, the Company's TRSs generate taxable income from intercompany transactions. The TRS entities generate taxable revenue from fees for services provided to our various lines of business. Certain entities may be consolidated in the Company's financial statements. In consolidation, these fees are eliminated when the entity is included in the consolidated group. Nonetheless, all income taxes are accrued by the TRSs in the year in which the taxable revenue is received. These income taxes are not eliminated when the related revenue is eliminated in consolidation.
Certain TRS entities are domiciled in the non-US jurisdictions and, accordingly, taxable income generated by these entities may not be subject to local income taxation, but generally will be included in the Company's taxable income on a current basis, whether or not distributed. Upon distribution of any previously included income, no incremental U.S. federal, state, or local income taxes would be payable by the Company.
The TRS entities may be subject to tax laws that are complex and potentially subject to different interpretations by the taxpayer and the relevant governmental taxing authorities. In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of these inherently complex tax laws. Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. The Company reviews the tax balances of its TRS entities quarterly and as new information becomes available, the balances are adjusted as appropriate.
179
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Amounts in Thousands, Except per Share Data)
23. Pro Forma Financial Information
As discussed in Note 1, the Company acquired the 51% membership interest in Midwest Holdings previously owned by Chain Bridge for $1.0 million in cash. As a result of the acquisition, the Company now holds 100% of the common membership interest in Midwest Holdings and controls all major decisions. Accordingly, the operations of Midwest Holdings, which were previously accounted for under the equity method, are consolidated.
The pro forma financial information set forth below is based upon the Company's historical condensed consolidated statements of operations for the years ended December 31, 2010 and 2009, adjusted to give effect of this transaction as of January 1, 2009.
| | Year Ended December 31, 2010 | Year Ended December 31, 2009 | |||||
|---|---|---|---|---|---|---|---|
Pro Forma revenues | $ | 494,743 | $ | 285,410 | |||
Pro Forma net income | $ | (393,335 | ) | $ | (150,428 | ) | |
Pro Forma net income per common share—basis/diluted | $ | (5.14 | ) | $ | (2.15 | ) | |
The pro forma financial information is presented for informational purposes only and may not be indicative of what actual results of operations would have been had the transactions occurred January 1, 2009, nor does it purport to represent the results of future operations.
23. Subsequent Events (Unaudited)
On January 19, 2011, the Company declared a cash dividend of $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends were paid on February 14, 2011 to the stockholders of record as of the close of business on February 4, 2011.
On January 19, 2011, the Company declared a dividend of $0.10 per share of common stock. The dividends were paid on February 14, 2011 to the stockholders of record as of February 14, 2011.
On January 7, 2011, as part of the Surety Agreement, in connection with the issuance of the Bond, the Company posted cash collateral equal to thirty-eight percent of the amount of the Bond, or approximately $26.1 million.
180
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(In thousands)
| | Balance at Beginning of Period | Charged to Costs and Expenses | Other Charges | Deductions | Balance at End of Period | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Description | |||||||||||||||||
For the Year Ended December 31, 2008 | |||||||||||||||||
Reserve for loan losses | $ | — | $ | 14,900 | $ | — | $ | (3,700 | ) | $ | 11,200 | ||||||
Allowance for doubtful accounts | 320 | 473 | — | (347 | ) | 447 | |||||||||||
| $ | 320 | $ | 15,373 | $ | — | $ | (4,047 | ) | $ | 11,647 | |||||||
For the Year Ended December 31, 2009 | |||||||||||||||||
Reserve for loan losses | $ | 11,200 | $ | 84,416 | $ | — | $ | (18,216 | ) | $ | 77,400 | ||||||
Allowance for doubtful accounts | 447 | 1,554 | — | (1,473 | ) | 528 | |||||||||||
| $ | 11,647 | $ | 85,970 | $ | — | $ | (19,689 | ) | $ | 77,928 | |||||||
For the Year Ended December 31, 2010 | |||||||||||||||||
Reserve for loan losses | $ | 77,400 | $ | 168,446 | $ | — | $ | (48,646 | ) | $ | 197,200 | ||||||
Allowance for doubtful accounts | 528 | 1,130 | — | (64 | ) | 1,594 | |||||||||||
| $ | 77,928 | $ | 169,576 | $ | — | $ | (48,710 | ) | $ | 198,794 | |||||||
181
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION
As of December 31, 2010
(Amounts in Thousands, Except per Share Data)
| Column A | Column B | Column C Initial Cost | Column D Cost Capitalized Subsequent To Acquisition | Column E Gross Amount at Which Carried at Close of Period | Column F | Column H | Column I | ||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Location | Encumbrances | Land | Buildings & Improvements | Land | Buildings & Improvements | Land | Buildings & Improvements | Total | Accumulated Depreciation | Total | Date Acquired | Life on Which Depreciation is Computed | |||||||||||||||||||||||||
36 West 34 Street, NY, NY | — | — | 4,333 | — | 375 | — | 4,708 | 4,708 | 1,342 | 3,366 | Mar-99 | Various | |||||||||||||||||||||||||
701 Seventh Avenue, NY, NY | — | — | 3,245 | — | — | — | 3,245 | 3,245 | 2,769 | 476 | Mar-99 | Various | |||||||||||||||||||||||||
Salt Lake Cit, UT | 15,059 | 672 | 19,739 | — | 322 | 672 | 20,061 | 20,733 | 3,884 | 16,849 | Aug-05 | 40 years | |||||||||||||||||||||||||
Auburn Hills, MI | 11,216 | 2,980 | 8,607 | — | — | 2,980 | 8,607 | 11,587 | 2,081 | 9,506 | Sep-05 | 40 years | |||||||||||||||||||||||||
Rancho Cordova, CA | 10,670 | 3,060 | 9,360 | — | — | 3,060 | 9,360 | 12,420 | 1,778 | 10,642 | Sep-05 | 40 years | |||||||||||||||||||||||||
Camp Hill, PA | 24,332 | 5,900 | 19,510 | — | — | 5,900 | 19,510 | 25,410 | 4,281 | 21,129 | Sep-05 | 40 years | |||||||||||||||||||||||||
Springdale, OH | 19,208 | 3,030 | 20,469 | — | 130 | 3,030 | 20,599 | 23,629 | 3,166 | 20,463 | Dec-05 | 40 years | |||||||||||||||||||||||||
Springdale, OH | 16,586 | 2,470 | 17,821 | — | (1,681 | ) | 2,470 | 16,140 | 18,610 | 3,025 | 15,585 | Dec-05 | 40 years | ||||||||||||||||||||||||
Springdale, OH | 15,686 | 1,500 | 17,690 | — | (1,588 | ) | 1,500 | 16,102 | 17,602 | 3,236 | 14,366 | Dec-05 | 40 years | ||||||||||||||||||||||||
Rockaway, NJ | 16,884 | 6,118 | 15,664 | — | 295 | 6,118 | 15,959 | 22,077 | 2,311 | 19,766 | Mar-06 | 40 years | |||||||||||||||||||||||||
Indianapolis, IN | 27,790 | 1,670 | 32,306 | — | — | 1,670 | 32,306 | 33,976 | 4,445 | 29,531 | Mar-06 | 40 years | |||||||||||||||||||||||||
Blountstown, FL | 3,871 | 378 | 5,069 | — | — | 378 | 5,069 | 5,447 | 565 | 4,882 | Jul-06 | 40 years | |||||||||||||||||||||||||
East Arlington, TX | 3,349 | 3,619 | 901 | — | 5 | 3,619 | 906 | 4,525 | 79 | 4,446 | May-07 | 40 years | |||||||||||||||||||||||||
Wichita, KS | 7,848 | 2,282 | 10,478 | — | 10 | 2,282 | 10,488 | 12,770 | 794 | 11,976 | Dec-07 | 40 years | |||||||||||||||||||||||||
Clemmons, NC | 2,156 | 337 | 4,541 | — | 33 | 337 | 4,574 | 4,911 | 360 | 4,551 | Apr-07 | 40 years | |||||||||||||||||||||||||
Grove City | 3,040 | 613 | 6,882 | — | 206 | 613 | 7,088 | 7,701 | 647 | 7,054 | Jun-07 | 40 years | |||||||||||||||||||||||||
Franklin, WI | 6,272 | 872 | 3,903 | — | — | 872 | 3,903 | 4,775 | 386 | 4,389 | Jan-07 | 40 years | |||||||||||||||||||||||||
Denmark, WI | 1,201 | 241 | 1,668 | — | — | 241 | 1,668 | 1,909 | 165 | 1,744 | Jan-07 | 40 years | |||||||||||||||||||||||||
Green Bay, WI | 3,127 | 638 | 3,508 | — | — | 638 | 3,508 | 4,146 | 347 | 3,799 | Jan-07 | 40 years | |||||||||||||||||||||||||
Kenosha, WI | 4,070 | 697 | 4,679 | — | — | 697 | 4,679 | 5,376 | 463 | 4,913 | Jan-07 | 40 years | |||||||||||||||||||||||||
Madison, WI | 4,212 | 764 | 4,485 | — | — | 764 | 4,485 | 5,249 | 443 | 4,806 | Jan-07 | 40 years | |||||||||||||||||||||||||
Manitowoc, WI | 4,943 | 811 | 5,008 | — | — | 811 | 5,008 | 5,819 | 495 | 5,324 | Jan-07 | 40 years | |||||||||||||||||||||||||
182
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued)
As of December 31, 2010
(Amounts in Thousands, Except per Share Data)
| Column A | Column B | Column C Initial Cost | Column D Cost Capitalized Subsequent To Acquisition | Column E Gross Amount at Which Carried at Close of Period | Column F | Column H | Column I | ||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Location | Encumbrances | Land | Buildings & Improvements | Land | Buildings & Improvements | Land | Buildings & Improvements | Total | Accumulated Depreciation | Total | Date Acquired | Life on Which Depreciation is Computed | |||||||||||||||||||||||||
McFarland, WI | 3,777 | 703 | 4,793 | — | — | 703 | 4,793 | 5,496 | 474 | 5,022 | Jan-07 | 40 years | |||||||||||||||||||||||||
Racine, WI | 9,903 | 1,609 | 10,359 | — | — | 1,609 | 10,359 | 11,968 | 1,025 | 10,943 | Jan-07 | 40 years | |||||||||||||||||||||||||
Menomonmee, WI | 5,986 | 1,011 | 4,837 | — | — | 1,011 | 4,837 | 5,848 | 479 | 5,369 | Jan-07 | 40 years | |||||||||||||||||||||||||
Sheboygan, WI | 9,164 | 1,542 | 10,141 | — | — | 1,542 | 10,141 | 11,683 | 1,004 | 10,679 | Jan-07 | 40 years | |||||||||||||||||||||||||
Stevens Point, WI | 8,363 | 1,837 | 12,458 | — | — | 1,837 | 12,458 | 14,295 | 1,233 | 13,062 | Jan-07 | 40 years | |||||||||||||||||||||||||
Stoughton, WI | 1,662 | 349 | 2,205 | — | — | 349 | 2,205 | 2,554 | 218 | 2,336 | Jan-07 | 40 years | |||||||||||||||||||||||||
Wausau, WI | 7,443 | 498 | 9,214 | — | — | 498 | 9,214 | 9,712 | 912 | 8,800 | Jan-07 | 40 years | |||||||||||||||||||||||||
Two Rivers, WI | 2,668 | 1,421 | 3,281 | — | — | 1,421 | 3,281 | 4,702 | 325 | 4,377 | Jan-07 | 40 years | |||||||||||||||||||||||||
Wisconsin Rapids, WI | 1,112 | 416 | 2,868 | — | — | 416 | 2,868 | 3,284 | 284 | 3,000 | Jan-07 | 40 years | |||||||||||||||||||||||||
Lancaster, OH | 6,279 | 294 | 6,094 | — | 329 | 294 | 6,423 | 6,717 | 605 | 6,112 | Jun-07 | 40 years | |||||||||||||||||||||||||
Marysville, OH | 5,392 | 2,218 | 5,015 | — | 334 | 2,218 | 5,349 | 7,567 | 497 | 7,070 | Jun-07 | 40 years | |||||||||||||||||||||||||
Indianapolis, IN | 2,203 | 210 | 2,511 | — | — | 210 | 2,511 | 2,721 | 222 | 2,499 | Jun-07 | 40 years | |||||||||||||||||||||||||
Castletown, IN | 6,669 | 677 | 8,077 | — | — | 677 | 8,077 | 8,754 | 715 | 8,039 | Jun-07 | 40 years | |||||||||||||||||||||||||
Chesterfield, IN | 3,989 | 815 | 4,204 | — | — | 815 | 4,204 | 5,019 | 372 | 4,647 | Jun-07 | 40 years | |||||||||||||||||||||||||
Columbia City, IN | 7,909 | 1,034 | 6,390 | — | — | 1,034 | 6,390 | 7,424 | 566 | 6,858 | Jun-07 | 40 years | |||||||||||||||||||||||||
Dunkirk, IN | 2,087 | 310 | 2,299 | — | — | 310 | 2,299 | 2,609 | 203 | 2,406 | Jun-07 | 40 years | |||||||||||||||||||||||||
Fort Wayne, IN | 4,792 | 1,478 | 4,409 | — | — | 1,478 | 4,409 | 5,887 | 390 | 5,497 | Jun-07 | 40 years | |||||||||||||||||||||||||
Hartford City, IN | 2,052 | 199 | 1,782 | — | — | 199 | 1,782 | 1,981 | 158 | 1,823 | Jun-07 | 40 years | |||||||||||||||||||||||||
Hobart, IN | 5,832 | 1,835 | 5,019 | — | — | 1,835 | 5,019 | 6,854 | 444 | 6,410 | Jun-07 | 40 years | |||||||||||||||||||||||||
Huntington, IN | 4,452 | 526 | 5,037 | — | — | 526 | 5,037 | 5,563 | 446 | 5,117 | Jun-07 | 40 years | |||||||||||||||||||||||||
LaGrange, IN | 509 | 47 | 584 | — | — | 47 | 584 | 631 | 52 | 579 | Jun-07 | 40 years | |||||||||||||||||||||||||
LaGrange, IN | 5,007 | 446 | 5,494 | — | — | 446 | 5,494 | 5,940 | 486 | 5,454 | Jun-07 | 40 years | |||||||||||||||||||||||||
183
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued)
As of December 31, 2010
(Amounts in Thousands, Except per Share Data)
| Column A | Column B | Column C Initial Cost | Column D Cost Capitalized Subsequent To Acquisition | Column E Gross Amount at Which Carried at Close of Period | Column F | Column H | Column I | ||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Location | Encumbrances | Land | Buildings & Improvements | Land | Buildings & Improvements | Land | Buildings & Improvements | Total | Accumulated Depreciation | Total | Date Acquired | Life on Which Depreciation is Computed | |||||||||||||||||||||||||
Middletown, IN | 3,351 | 132 | 4,750 | — | — | 132 | 4,750 | 4,882 | 420 | 4,462 | Jun-07 | 40 years | |||||||||||||||||||||||||
Mooresville, IN | 1,497 | 631 | 4,187 | — | — | 631 | 4,187 | 4,818 | 371 | 4,447 | Jun-07 | 40 years | |||||||||||||||||||||||||
Peru, IN | 6,320 | 502 | 7,135 | — | — | 502 | 7,135 | 7,637 | 632 | 7,005 | Jun-07 | 40 years | |||||||||||||||||||||||||
Plymouth, IN | 5,166 | 128 | 5,538 | — | — | 128 | 5,538 | 5,666 | 490 | 5,176 | Jun-07 | 40 years | |||||||||||||||||||||||||
Portage, IN | 6,921 | 1,438 | 7,988 | — | — | 1,438 | 7,988 | 9,426 | 707 | 8,719 | Jun-07 | 40 years | |||||||||||||||||||||||||
Rockport, IN | 1,687 | 253 | 2,092 | — | — | 253 | 2,092 | 2,345 | 185 | 2,160 | Jun-07 | 40 years | |||||||||||||||||||||||||
Rushville, IN | 542 | 62 | 1,177 | — | — | 62 | 1,177 | 1,239 | 104 | 1,135 | Jun-07 | 40 years | |||||||||||||||||||||||||
Rushville, IN | 4,021 | 310 | 5,858 | — | — | 310 | 5,858 | 6,168 | 519 | 5,649 | Jun-07 | 40 years | |||||||||||||||||||||||||
Sullivan, IN | 872 | 102 | 441 | — | — | 102 | 441 | 543 | 39 | 504 | Jun-07 | 40 years | |||||||||||||||||||||||||
Sullivan, IN | 4,826 | 1,794 | 4,469 | — | — | 1,794 | 4,469 | 6,263 | 395 | 5,868 | Jun-07 | 40 years | |||||||||||||||||||||||||
Syracuse, IN | 3,439 | 125 | 4,564 | — | — | 125 | 4,564 | 4,689 | 404 | 4,285 | Jun-07 | 40 years | |||||||||||||||||||||||||
Tipton, IN | 7,942 | 1,102 | 10,836 | — | (27 | ) | 1,102 | 10,809 | 11,911 | 778 | 11,133 | Jun-07 | 40 years | ||||||||||||||||||||||||
Wasbash, IN | 3,633 | 1,451 | 4,154 | — | — | 1,451 | 4,154 | 5,605 | 77 | 5,528 | Jun-07 | 40 years | |||||||||||||||||||||||||
Wabash, IN | 1,281 | 1,060 | 870 | — | — | 1,060 | 870 | 1,930 | 368 | 1,562 | Jun-07 | 40 years | |||||||||||||||||||||||||
Wakarusa, IN | 6,355 | 153 | 7,111 | — | — | 153 | 7,111 | 7,264 | 629 | 6,635 | Jun-07 | 40 years | |||||||||||||||||||||||||
Wakarusa, IN | 9,871 | 289 | 13,420 | — | — | 289 | 13,420 | 13,709 | 1,188 | 12,521 | Jun-07 | 40 years | |||||||||||||||||||||||||
Warsaw, IN | 3,581 | 319 | 3,722 | — | — | 319 | 3,722 | 4,041 | 329 | 3,712 | Jun-07 | 40 years | |||||||||||||||||||||||||
Sullivan II | — | 494 | — | — | — | 494 | — | 494 | — | 494 | Jun-07 | 40 years | |||||||||||||||||||||||||
Huntington II | — | 120 | — | — | — | 120 | — | 120 | — | 120 | Jun-07 | 40 years | |||||||||||||||||||||||||
Middletown II | — | 52 | — | — | — | 52 | — | 52 | — | 52 | Jun-07 | 40 years | |||||||||||||||||||||||||
Rockport II | — | 366 | — | — | — | 366 | — | 366 | — | 366 | Jun-07 | 40 years | |||||||||||||||||||||||||
Warsaw II | — | 77 | — | — | — | 77 | — | 77 | — | 77 | Jun-07 | 40 years | |||||||||||||||||||||||||
184
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued)
As of December 31, 2010
(Amounts in Thousands, Except per Share Data)
| Column A | Column B | Column C Initial Cost | Column D Cost Capitalized Subsequent To Acquisition | Column E Gross Amount at Which Carried at Close of Period | Column F | Column H | Column I | ||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Location | Encumbrances | Land | Buildings & Improvements | Land | Buildings & Improvements | Land | Buildings & Improvements | Total | Accumulated Depreciation | Total | Date Acquired | Life on Which Depreciation is Computed | |||||||||||||||||||||||||
Daly City, CA | 4,797 | 3,297 | 1,872 | — | — | 3,297 | 1,872 | 5,169 | 146 | 5,023 | Aug-07 | 40 years | |||||||||||||||||||||||||
Daly City, CA | 11,244 | — | — | — | 12,321 | — | 12,321 | 12,321 | 2,873 | 9,448 | Aug-07 | 40 years | |||||||||||||||||||||||||
Washington Crt Hse, OH | 5,223 | 341 | 5,169 | 13 | 232 | 354 | 5,401 | 5,755 | 498 | 5,257 | Jun-07 | 40 years | |||||||||||||||||||||||||
Harrisburg, IL | 3,674 | 191 | 5,059 | — | 5 | 191 | 5,064 | 5,255 | 501 | 4,754 | Jun-07 | 40 years | |||||||||||||||||||||||||
Clinton, OK | 1,334 | 225 | 3,513 | — | 438 | 225 | 3,951 | 4,176 | 456 | 3,720 | Jan-07 | 40 years | |||||||||||||||||||||||||
Olney, IL | 4,227 | 109 | 5,419 | — | 56 | 109 | 5,475 | 5,584 | 545 | 5,039 | Jan-07 | 40 years | |||||||||||||||||||||||||
Vandalia, IL | 7,328 | 82 | 7,969 | — | 4 | 82 | 7,973 | 8,055 | 789 | 7,266 | Jan-07 | 40 years | |||||||||||||||||||||||||
Paris, IL | 6,819 | 187 | 6,797 | — | 21 | 187 | 6,818 | 7,005 | 675 | 6,330 | Jan-07 | 40 years | |||||||||||||||||||||||||
Rantoul, IL | 5,621 | 151 | 5,377 | — | 10 | 151 | 5,387 | 5,538 | 532 | 5,006 | Jan-07 | 40 years | |||||||||||||||||||||||||
Robinson, IL | 3,990 | 219 | 4,746 | — | 90 | 219 | 4,836 | 5,055 | 486 | 4,569 | Jan-07 | 40 years | |||||||||||||||||||||||||
Cincinatti, OH | 11,397 | 2,052 | 15,776 | — | 697 | 2,052 | 16,473 | 18,525 | 1,736 | 16,789 | Jan-07 | 40 years | |||||||||||||||||||||||||
Memphis, TN | 14,598 | 4,770 | 14,305 | — | 566 | 4,770 | 14,871 | 19,641 | 1,508 | 18,133 | Jan-07 | 40 years | |||||||||||||||||||||||||
Charleston, IL | 5,846 | 485 | 6,211 | — | 6 | 485 | 6,217 | 6,702 | 615 | 6,087 | Jan-07 | 40 years | |||||||||||||||||||||||||
Caroltton, GA | 2,951 | 816 | 4,220 | — | 127 | 816 | 4,347 | 5,163 | 441 | 4,722 | Jan-07 | 40 years | |||||||||||||||||||||||||
Kingfisher, OK | 3,964 | 128 | 5,497 | — | 289 | 128 | 5,786 | 5,914 | 615 | 5,299 | Jan-07 | 40 years | |||||||||||||||||||||||||
Elk City, OK | 4,341 | 143 | 6,721 | — | 397 | 143 | 7,118 | 7,261 | 771 | 6,490 | Jan-07 | 40 years | |||||||||||||||||||||||||
Olney, IL | 2,449 | 57 | 2,897 | — | 20 | 57 | 2,917 | 2,974 | 288 | 2,686 | Jan-07 | 40 years | |||||||||||||||||||||||||
Effingham, IL | 4,601 | 340 | 4,994 | — | 45 | 340 | 5,039 | 5,379 | 501 | 4,878 | Jan-07 | 40 years | |||||||||||||||||||||||||
Fairfield, IL | 6,402 | 153 | 7,898 | — | 26 | 153 | 7,924 | 8,077 | 786 | 7,291 | Jan-07 | 40 years | |||||||||||||||||||||||||
Fullerton, CA | 7,575 | 4,065 | 8,564 | — | 130 | 4,065 | 8,694 | 12,759 | 884 | 11,875 | Jan-07 | 40 years | |||||||||||||||||||||||||
La Vista, NE | 4,267 | 562 | 4,966 | — | 47 | 562 | 5,013 | 5,575 | 499 | 5,076 | Jan-07 | 40 years | |||||||||||||||||||||||||
Mattoon, IL | 6,922 | 227 | 7,534 | — | 20 | 227 | 7,554 | 7,781 | 748 | 7,033 | Jan-07 | 40 years | |||||||||||||||||||||||||
185
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued)
As of December 31, 2010
(Amounts in Thousands, Except per Share Data)
| Column A | Column B | Column C Initial Cost | Column D Cost Capitalized Subsequent To Acquisition | Column E Gross Amount at Which Carried at Close of Period | Column F | Column H | Column I | |||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Location | Encumbrances | Land | Buildings & Improvements | Land | Buildings & Improvements | Land | Buildings & Improvements | Total | Accumulated Depreciation | Total | Date Acquired | Life on Which Depreciation is Computed | ||||||||||||||||||||||||||
Mattoon, IL | 5,662 | 210 | 6,871 | — | 13 | 210 | 6,884 | 7,094 | 682 | 6,412 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Stephenville, TX | 6,150 | 507 | 6,459 | 13 | 86 | 520 | 6,545 | 7,065 | 648 | 6,417 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Fullerton, CA | 779 | 1,357 | 872 | — | 21 | 1,357 | 893 | 2,250 | 88 | 2,162 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Rockford, IL | 4,940 | 1,101 | 4,814 | — | 37 | 1,101 | 4,851 | 5,952 | 481 | 5,471 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Effingham, IL | 547 | 211 | 1,145 | — | 9 | 211 | 1,154 | 1,365 | 113 | 1,252 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Santa Ana, CA | 7,874 | 2,281 | 7,046 | — | 143 | 2,281 | 7,189 | 9,470 | 737 | 8,733 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Sycamore, IL | 8,487 | 816 | 9,897 | — | 56 | 816 | 9,953 | 10,769 | 989 | 9,780 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Oklahoma City, OK | 4,416 | 757 | 5,184 | 3 | 346 | 760 | 5,530 | 6,290 | 600 | 5,690 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Garden Grove, CA | 11,168 | 6,975 | 5,927 | — | 165 | 6,975 | 6,092 | 13,067 | 630 | 12,437 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Weatherford, OK | 4,484 | 229 | 5,600 | — | 369 | 229 | 5,969 | 6,198 | 646 | 5,552 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Mt. Sterling, KY | 11,204 | 599 | 12,561 | — | 25 | 599 | 12,586 | 13,185 | 1,116 | 12,069 | Feb-07 | 40 years | ||||||||||||||||||||||||||
Tuscola, IL | 4,168 | 237 | 4,616 | — | 123 | 237 | 4,739 | 4,976 | 504 | 4,472 | Jan-07 | 40 years | ||||||||||||||||||||||||||
Windsor, NC | — | 397 | — | — | — | 397 | — | 397 | — | 397 | Feb-07 | 40 years | ||||||||||||||||||||||||||
Bremerton, WA | 7,275 | 964 | 8,171 | — | 185 | 964 | 8,356 | 9,320 | 866 | 8,454 | Dec-06 | 40 years | ||||||||||||||||||||||||||
Sterling, IL | 2,346 | 129 | 6,229 | — | 550 | 129 | 6,779 | 6,908 | 808 | 6,100 | May-06 | 40 years | ||||||||||||||||||||||||||
Black Mountain, NC | 5,296 | 468 | 5,786 | — | — | 468 | 5,786 | 6,254 | 645 | 5,609 | Jul-06 | 40 years | ||||||||||||||||||||||||||
Hillsboro, OR | 32,536 | 3,954 | 39,233 | — | — | 3,954 | 39,233 | 43,187 | 3,965 | 39,222 | Dec-06 | 40 years | ||||||||||||||||||||||||||
Morris, IL | 2,161 | 568 | 9,103 | — | 822 | 568 | 9,925 | 10,493 | 1,077 | 9,416 | May-06 | 40 years | ||||||||||||||||||||||||||
Chenita Group Home | — | 73 | 249 | — | — | 73 | 249 | 322 | 18 | 304 | Jan-08 | 40 years | ||||||||||||||||||||||||||
Whispering Oaks | — | 244 | 1,359 | — | — | 244 | 1,359 | 1,603 | 101 | 1,502 | Jan-08 | 40 years | ||||||||||||||||||||||||||
Twin Oaks Living | — | 58 | 1,027 | — | — | 58 | 1,027 | 1,085 | 77 | 1,008 | Jan-08 | 40 years | ||||||||||||||||||||||||||
Twin Oaks Care | — | 42 | 747 | — | — | 42 | 747 | 789 | 56 | 733 | Jan-08 | 40 years | ||||||||||||||||||||||||||
Salem Annex | — | 11 | 90 | — | — | 11 | 90 | 101 | 2 | 99 | Jan-08 | 40 years | ||||||||||||||||||||||||||
186
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued)
As of December 31, 2010
(Amounts in Thousands, Except per Share Data)
| Column A | Column B | Column C Initial Cost | Column D Cost Capitalized Subsequent To Acquisition | Column E Gross Amount at Which Carried at Close of Period | Column F | Column H | Column I | |||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Location | Encumbrances | Land | Buildings & Improvements | Land | Buildings & Improvements | Land | Buildings & Improvements | Total | Accumulated Depreciation | Total | Date Acquired | Life on Which Depreciation is Computed | ||||||||||||||||||||||||||
Aurora, CO | 32,583 | 2,650 | 35,786 | 24 | — | 2,674 | 35,786 | 38,460 | 4,309 | 34,151 | Jul-06 | 40 years | ||||||||||||||||||||||||||
North Attleboro, MA | 4,599 | — | 5,445 | — | — | — | 5,445 | 5,445 | 706 | 4,739 | Sep-06 | 40 years | ||||||||||||||||||||||||||
Bloomingdale, IL | 5,599 | — | 5,810 | — | — | — | 5,810 | 5,810 | 756 | 5,054 | Sep-06 | 40 years | ||||||||||||||||||||||||||
Concord Holdings, NH | 8,180 | 2,145 | 9,216 | — | — | 2,145 | 9,216 | 11,361 | 1,220 | 10,141 | Sep-06 | 40 years | ||||||||||||||||||||||||||
Melville, NY | 4,344 | — | 3,187 | — | — | — | 3,187 | 3,187 | 465 | 2,722 | Sep-06 | 40 years | ||||||||||||||||||||||||||
Millbury, MA | 4,617 | — | 5,994 | — | — | — | 5,994 | 5,994 | 696 | 5,298 | Sep-06 | 40 years | ||||||||||||||||||||||||||
Wichita, KS | 5,985 | 1,325 | 5,584 | — | — | 1,325 | 5,584 | 6,909 | 698 | 6,211 | Sep-06 | 40 years | ||||||||||||||||||||||||||
Keene, NH | 6,588 | 3,033 | 5,919 | — | — | 3,033 | 5,919 | 8,952 | 761 | 8,191 | Sep-06 | 40 years | ||||||||||||||||||||||||||
Fort Wayne, IN | 3,313 | — | 3,642 | — | — | — | 3,642 | 3,642 | 510 | 3,132 | Sep-06 | 40 years | ||||||||||||||||||||||||||
Portland, ME | 4,466 | — | 6,687 | — | — | — | 6,687 | 6,687 | 1,249 | 5,438 | Sep-06 | 40 years | ||||||||||||||||||||||||||
Milpitas, CA | 21,638 | 16,800 | 8,847 | — | — | 16,800 | 8,847 | 25,647 | 1,382 | 24,265 | Feb-07 | 40 years | ||||||||||||||||||||||||||
Columbus, OH | 23,239 | 4,375 | 29,184 | — | — | 4,375 | 29,184 | 33,559 | 2,750 | 30,809 | Nov-07 | 40 years | ||||||||||||||||||||||||||
Fort Mill, SC | 30,182 | 3,300 | 31,554 | — | — | 3,300 | 31,554 | 34,854 | 3,404 | 31,450 | Mar-07 | 40 years | ||||||||||||||||||||||||||
Reading, PA | 18,643 | 3,225 | 21,792 | — | 44 | 3,225 | 21,836 | 25,061 | 1,934 | 23,127 | Jun-07 | 40 years | ||||||||||||||||||||||||||
Philadelphia, PA | — | 2,359 | 5,681 | — | — | 2,359 | 5,681 | 8,000 | — | 8,040 | Dec-10 | N/A | ||||||||||||||||||||||||||
Atlanta, GA | — | 841 | 3,363 | — | — | 551 | 3,363 | 4,204 | — | 4,204 | Dec-10 | N/A | ||||||||||||||||||||||||||
Chandler, AZ | — | 551 | — | — | — | 551 | — | 551 | — | 551 | Dec-10 | N/A | ||||||||||||||||||||||||||
Florence, AZ | — | 345 | — | — | — | 345 | — | 345 | — | 345 | Dec-10 | N/A | ||||||||||||||||||||||||||
| $ | 803,114 | $ | 151,517 | $ | 902,173 | $ | 53 | $ | 17,284 | $ | 151,877 | $ | 908,715 | $ | 1,059,592 | $ | 108,389 | $ | 951,203 | |||||||||||||||||||
187
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
SCHEDULE III—REAL ESTATE AND ACCUMULATED DEPRECIATION
(Amounts in Thousands, Except per Share Data)
The changes in real estate for the year ended December 31, 2010, December 31, 2009 and December 31, 2008 are as follows:
| | 2010 | 2009 | 2008 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Balance at beginning of period | $ | 1,062,915 | $ | 1,194,469 | $ | 1,172,580 | ||||
Property acquisitions | 13,480 | — | 3,989 | |||||||
Improvements | 1,618 | 3,597 | 24,698 | |||||||
Impairments | (5,248 | ) | (55,286 | ) | (5,580 | ) | ||||
Retirements/disposals | (12,834 | ) | (79,865 | ) | (1,218 | ) | ||||
Balance at end of period | $ | 1,059,931 | $ | 1,062,915 | $ | 1,194,469 | ||||
The changes in accumulated depreciation, exclusive of amounts relating to equipment, auto and furniture and fixtures, for the period ended December 31, 2010, December 31, 2009 and December 31, 2008 are as follows:
| | 2010 | 2009 | 2008 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Balance at beginning of period | $ | 84,013 | $ | 67,469 | $ | 38,444 | ||||
Depreciation for the period | 31,173 | 28,285 | 30,243 | |||||||
Assets held for sale | — | — | — | |||||||
Retirements/disposals | (6,797 | ) | (11,741 | ) | (1,218 | ) | ||||
Balance at end of period | $ | 108,389 | $ | 84,013 | $ | 67,469 | ||||
188
NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES
SCHEDULE IV—LOANS AND OTHER LENDING INVESTMENTS
December 31, 2010 (in thousands)
Description | Interest Rate | Final Maturity Date | Periodic Payment Terms(1) | Prior Liens | Principal Amount of Loans | Carrying Amount of Loans | Number of Loans | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Junior Participation—Float < | Office | LIBOR + 1.50 - 3.35 | 7/9/2010 - 4/10/2014 | I/O | $ | 196,225 | $ | 75,187 | $ | 67,607 | 5 | ||||||||||||
3% of total | Hotel | 4.50 | 2/22/2013 | I/O | 307,800 | 42,371 | 42,332 | 1 | |||||||||||||||
carrying amount | Land | 0.00 - 2.00 | 1/1/2010 - 2/9/2014 | I/O | 134,078 | 61,597 | 2 | 2 | |||||||||||||||
| Retail | 4.28 - 8.42 | 9/9/2011 - 12/31/2011 | I/O | 110,496 | 32,990 | 32,778 | 2 | ||||||||||||||||
| Multifamily | 4.35 | 4/9/2013 | I/O | — | 8,300 | 435 | 1 | ||||||||||||||||
Junior Participation—Fixed < | Office | 6.13 - 8.44 | 10/1/2015 - 5/11/2016 | I/O | 182,442 | 28,893 | 25,047 | 2 | |||||||||||||||
3% of total carrying | Retail | 7.85 | 5/11/2015 | I/O | — | 45,550 | 21,758 | 1 | |||||||||||||||
amount | |||||||||||||||||||||||
Mezzanine—Fixed >3% of | Retail | 0.50 | 7/20/2014 | I/O | 3,338,342 | 57,462 | 57,151 | 1 | |||||||||||||||
total carrying amount* | Office | 10.85 | 6/15/2016 | I/O | 410,000 | 63,572 | 63,556 | 1 | |||||||||||||||
Mezzanine—Fixed < 3% of | Multifamily | 7.16 | 1/1/2016 | I/O | 51,954 | 13,752 | 13,752 | 1 | |||||||||||||||
total carrying amount | Senior Corporate | 8.00 | 5/11/2015 | I/O | — | 6,063 | 5,396 | 1 | |||||||||||||||
| Retail | 0.00 | 4/1/2011 | I/O | 3,959 | 2,735 | (0 | ) | 1 | |||||||||||||||
| Land | 0.00 | 4/1/2011 | I/O | 65,660 | 3,047 | 400 | 1 | ||||||||||||||||
| Office | 0.00 | 4/1/2011 | I/O | 57,178 | 6,396 | 700 | 1 | ||||||||||||||||
Mezzanine—Float > | Multifamily | 3.50 | 4/1/2012 | I/O | 66,898 | 60,175 | 60,046 | 1 | |||||||||||||||
3% of total | |||||||||||||||||||||||
carrying amount* | |||||||||||||||||||||||
Mezzanine—Float < 3% of | Multifamily | LIBOR + 2.00 - 4.00 | 8/10/2011 - 1/1/2016 | I/O | 182,543 | 73,452 | 69,413 | 6 | |||||||||||||||
| Office | 2.70 - 6.36 | 1/15/2011 - 7/10/2016 | I/O | 401,679 | 56,678 | 56,741 | 3 | ||||||||||||||||
| Hotel | 0.70 - 4.50 | 12/31/2011 - 2/9/2012 | I/O | 2,928,798 | 149,590 | 93,817 | 4 | ||||||||||||||||
| Retail | 0.00 | 5/1/2017 | I/O | 212,000 | 34,773 | 13,448 | 1 | ||||||||||||||||
| Condo | 7.40 | 7/1/2011 | I/O | — | 12,516 | 12,435 | 1 | ||||||||||||||||
Other—Fixed < 3% of total | Other | 5.53 | 6/25/2018 | I/O | — | 4,476 | 4,476 | 1 | |||||||||||||||
carrying amount | Industrial | 8.91 | 5/1/2015 | I/O | — | 1,102 | 1,102 | 1 | |||||||||||||||
| Office | 6.65 | 12/5/2019 | I/O | — | 6,574 | 6,574 | 1 | ||||||||||||||||
Other—Floating < 3% of | Retail | LIBOR + 2.50 | 12/16/2011 - 12/14/1212 | I/O | — | 11,460 | 11,460 | 2 | |||||||||||||||
total carrying amount | |||||||||||||||||||||||
Whole Loan—Fixed < 3% of | Industrial | 5.07 - 5.78 | 6/1/2015 - 8/1/2015 | I/O | — | 12,299 | 12,317 | 3 | |||||||||||||||
total carrying amount | Healthcare | 0.00 - 9.53 | 6/30/2011 - 9/1/2031 | I/O | — | 137,426 | 87,196 | 17 | |||||||||||||||
| Land | 0 | 5/12/2010 | I/O | — | 56,108 | 2,174 | 1 | ||||||||||||||||
| Retail | 6.36 - 7.03 | 11/25/2017 - 6/15/2018 | I/O | — | 5,732 | 5,732 | 6 | ||||||||||||||||
Whole Loan—Float Prime | Various | 1.25 | 11/19/2011 | I/O | — | 8,568 | 1,520 | 1 | |||||||||||||||
| Timeshare | 1.75 - 3.50 | 9/19/2012 - 4/12/2014 | I/O | — | 97,711 | 15,897 | 2 | ||||||||||||||||
Whole Loan—Float | Hotel | LIBOR + 0.00 - 6.00 | 12/12/2011 - 11/15/2015 | I/O | — | 319,564 | 166,040 | 13 | |||||||||||||||
(LIBOR+) | Industrial | 1.65 - 4.00 | 6/30/2011 - 4/1/2016 | I/O | — | 53,255 | 53,043 | 4 | |||||||||||||||
< 3% of total | Land | 1/1/2010 - 1/1/2015 | I/O | — | 202,923 | 63,569 | 8 | ||||||||||||||||
carrying amount | Mixed-Use | 1/5/2012 - 12/31/2015 | I/O | — | 37,824 | 15,179 | 3 | ||||||||||||||||
| Multifamily | 7/24/2011 - 6/9/2017 | I/O | — | 353,774 | 322,259 | 14 | |||||||||||||||||
| Healthcare | 2.50 - 7.00 | 1/31/2011 - 1/30/2012 | I/O | — | 28,481 | 19,462 | 4 | ||||||||||||||||
| Office | 1.65 - 8.60 | 1/31/2011 - 7/10/2016 | I/O | — | 339,855 | 318,022 | 18 | ||||||||||||||||
| Condo | 1/31/2011 - 1/8/2013 | I/O | — | 79,928 | 57,127 | 2 | |||||||||||||||||
| Timeshare | 3 | 7/23/2014 | I/O | — | 76,470 | 15,685 | 1 | ||||||||||||||||
| Self-Storage | 3.4 | 11/30/2014 | I/O | — | 18,057 | 6,002 | 1 | ||||||||||||||||
| Retail | 0.00 - 5.50 | 7/1/2011 - 8/18/2011 | I/O | — | 23,219 | 5,805 | 2 | ||||||||||||||||
Preferred—Float | Multifamily | 4 | 6/1/2017 | I/O | — | 17,444 | 17,444 | 1 | |||||||||||||||
Total | $ | 8,650,053 | $ | 2,727,349 | $ | 1,844,901 | 143 | ||||||||||||||||
- *
- Represents loans greater than 3% of the total carrying amount which may require individual disclosure
- (1)
- Interest only, or I/O; Principal and Interest, or P&I.
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| | 2010 | 2009 | 2008 | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Balance at beginning of period | $ | 1,937,093 | $ | 2,047,470 | $ | 2,007,022 | |||||
Additions during the year: | |||||||||||
New loans and additional advances on existing loans | 1,941,972 | 487,306 | 335,618 | ||||||||
Acquisition cost and (fees) | (2,674 | ) | 4,255 | 122 | |||||||
Premiums/(Discounts) | (730,417 | ) | (3,219 | ) | |||||||
Amortization of acquisition costs, fees, premiums and discounts | 138,786 | 2,352 | 9,928 | ||||||||
Deductions: | |||||||||||
Collection of principal | 1,439,859 | 604,290 | 302,001 | ||||||||
Balance at end of period(1) | $ | 1,844,901 | $ | 1,937,093 | $ | 2,047,470 | |||||
- (1)
- Includes $18.7 million and $0.6 million in real estate debt investments, held for sale at December 31, 2010 and 2009, respectively.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
Attached as exhibits to this Form 10-K/A are certifications of the Company's Chief Executive Officer and Chief Financial Officer, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). This "Controls and Procedures" section includes information concerning the controls and procedures evaluation referred to in the certifications. Part II, Item 8 of this Form 10-K/A sets forth the report of Grant Thornton LLP, our independent registered public accounting firm, regarding its audit of the Company's internal control over financial reporting set forth below in this section. This section should be read in conjunction with the certifications and the Grant Thornton LLP report for a more complete understanding of the topics presented.
Disclosure Controls and Procedures
The management of the Company established and maintains disclosure controls and procedures that are designed to ensure that material information relating to the Company and its subsidiaries required to be disclosed in the reports that are filed or submitted under the 1934 Act are recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
As of the end of the period covered by this report, the Company's management conducted an evaluation, under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures are effective. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Company's periodic reports.
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Internal Control over Financial Reporting
(a) Management's annual report on internal control over financial reporting.
Management is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Exchange Act Rule 13a-15(f), internal control over financial reporting is a process designed by, or under the supervision of, the principal executive and principal financial officer and effected by the Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Company carried out an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2010 based on the "Internal Control—Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon this evaluation, management has concluded that the Company's internal control over financial reporting was effective as of December 31, 2010.
(b) Attestation report of the registered public accounting firm.
Our independent registered public accounting firm, Grant Thornton LLP, independently assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2010. Grant Thornton has issued an attestation report, which is included in Part II, Item 8. of this Form 10-K/A.
(c) Changes in internal control over financial reporting.
There have been no changes in the Company's internal control over financial reporting during the most recent quarter ended December 31, 2010 that have materially affected, or are reasonably likely to affect, internal controls over financial reporting.
Inherent Limitations on Effectiveness of Controls
The Company's management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.
Not applicable.
191
Item 10. Directors and Executive Officers and Corporate Governance*
Certain information relating to our code of business conduct and ethics and code of ethics for senior financial officers (as defined in the code) is included in Part I, Item 1 of this Annual Report on Form 10-K/A.
Item 11. Executive Compensation*
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters*
Item 13. Certain Relationships and Related Transactions and Directors Independence*
Item 14. Principal Accountant Fees and Services*
- *
- The information that is required by Items 10, 11, 12, 13 and 14 is incorporated herein by reference from the definitive proxy statement relating to the 2011 Annual Meeting of Stockholders of the Company, which is to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, no later than 120 days after the end of the Company's fiscal year ending December 31, 2010.
192
Item 15. Exhibits and Financial Statement Schedules
- (a)
- and (c) Financial Statement and Schedules—see Index to Financial Statements and Schedules included in Item 8.
- (b)
- Exhibits
Exhibit Number | Description of Exhibit | ||
|---|---|---|---|
| 3.1 | Articles of Amendment and Restatement of NorthStar Realty Finance Corp., as filed with the State Department of Assessments and Taxation of Maryland on October 20, 2004 (incorporated by reference to Exhibit 3.1 to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675)) | ||
3.2 | Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.2 to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675)) | ||
3.3 | Amendment No. 1 to the Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.3 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on April 27, 2005) | ||
3.4 | Articles Supplementary Classifying NorthStar Realty Finance Corp.'s 8.75% Series A Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to Exhibit 3.2 to NorthStar Realty Finance Corp.'s Registration Statement on Form 8-A, dated September 14, 2006) | ||
3.5 | Articles Supplementary Classifying NorthStar Realty Finance Corp.'s 8.25% Series B Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to Exhibit 3.2 to NorthStar Realty Finance Corp.'s Registration Statement on Form 8-A, dated February 7, 2007) | ||
3.6 | Articles Supplementary Classifying and Designating Additional Shares of NorthStar Realty Finance Corp.'s 8.25% Series B Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to Exhibit 3.6 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007) | ||
10.1 | Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of October 19, 2004, by and among NorthStar Realty Finance Corp., as sole general partner and initial limited partner and the other limited partners a party thereto from time to time (incorporated by reference to Exhibit 10.1 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004) | ||
10.2 | NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.9 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004) | ||
10.3 | LTIP Unit Vesting Agreement under the NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership and NRF Employee, LLC (incorporated by reference to Exhibit 10.10 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004) | ||
10.4 | Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.7(a) to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675)) | ||
193
Exhibit Number | Description of Exhibit | ||
|---|---|---|---|
| 10.5 | NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan (incorporated by reference to Exhibit 10.13 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004) | ||
10.6 | Form of Notification under NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan (incorporated by reference to Exhibit 10.14 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004) | ||
10.7 | Form of Indemnification Agreement for directors and officers of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 10.15 to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675)) | ||
10.8 | Amendment No. 1 to Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of March 14, 2006, by and among NorthStar Realty Finance Corp., as sole general partner and initial limited partner and the other limited partners a party thereto from time to time (incorporated by reference to Exhibit 10.34 to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for the year ended December 31, 2005) | ||
10.9 | Second Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of September 14, 2006 (incorporated by reference to Exhibit 3.2 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed September 14, 2006) | ||
10.10 | Third Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of February 7, 2007 (incorporated by reference to Exhibit 3.2 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed February 9, 2007) | ||
10.11 | Amendment No. 1 to NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 99.2 to the NorthStar Realty Finance Corp. Post-Effective Amendment No. 2 to Form S-8 filed on April 13, 2007) | ||
10.12 | Amendment No. 2 to NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 99.3 to the NorthStar Realty Finance Corp. Post-Effective Amendment No. 3 to Form S-8 filed on June 6, 2007) | ||
10.13 | Fourth Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of May 24, 2007 (incorporated by reference to Exhibit 3.3 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed May 29, 2007) | ||
10.14 | Registration Rights Agreement relating to the 7.25% Exchangeable Senior Notes due 2027 of NorthStar Realty Finance Limited Partnership, dated June 18, 2007 (incorporated by reference to Exhibit 4.2 to the NorthStar Realty Finance Corp. Registration Statement on Form S-3 (File No. 333-146679)) | ||
10.15 | Indenture dated as of June 18, 2007, between NorthStar Realty Finance Limited Partnership, as Issuer, NorthStar Realty Finance Corp., as Guarantor, and Wilmington Trust Company, as Trustee (incorporated by reference to Exhibit 4.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on June 22, 2007) | ||
10.16 | Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and David T. Hamamoto (incorporated by reference to Exhibit 99.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed October 5, 2007) | ||
194
Exhibit Number | Description of Exhibit | ||
|---|---|---|---|
| 10.17 | Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Andrew C. Richardson (incorporated by reference to Exhibit 99.2 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed October 5, 2007) | ||
10.18 | Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Daniel R. Gilbert (incorporated by reference to Exhibit 99.3 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed October 5, 2007) | ||
10.19 | Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Albert Tylis (incorporated by reference to Exhibit 99.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed July 27, 2009) | ||
10.20 | Registration Rights Agreement relating to the 11.50% Exchangeable Senior Notes due 2013 of NRFC NNN Holdings, LLC, dated May 28, 2008 (incorporated by reference to Exhibit 4.2 to the NorthStar Realty Finance Corp. Registration Statement on Form S-3 (File No. 333-152545)) | ||
10.21 | Indenture dated as of May 28, 2008, among NRFC NNN Holdings, LLC, as Issuer, NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership, and NRFC Sub-REIT Corp., as Guarantors, and Wilmington Trust Company, as Trustee (incorporated by reference to Exhibit 4.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on May 28, 2008) | ||
10.22 | Fifth Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of May 29, 2008 (incorporated by reference to Exhibit 10.37 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2008) | ||
10.23 | NorthStar Realty Finance Corp. Executive Incentive Bonus Plan (incorporated by reference to Exhibit 10.31 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009) | ||
10.24 | Form of Award Agreement (incorporated by reference to Exhibit 99.2 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on September 11, 2009) | ||
10.25 | Common Stock Purchase Warrant, Certificate No. W-1, dated October 28, 2009, issued to Wachovia Bank, National Association (incorporated by reference to Exhibit 10.36 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009) | ||
10.26 | Common Stock Purchase Warrant, Certificate No. W-2, dated October 28, 2009, issued to Wachovia Bank, National Association (incorporated by reference to Exhibit 10.37 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009) | ||
10.27 | Common Stock Purchase Warrant, Certificate No. W-3, dated October 28, 2009, issued to Wachovia Bank, National Association (incorporated by reference to Exhibit 10.38 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009) | ||
10.28 | Separation and Consulting Agreement, dated January 25, 2010, between NorthStar Realty Finance Corp. and Richard J. McCready (incorporated by reference to Exhibit 99.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on January 25, 2010) | ||
195
Exhibit Number | Description of Exhibit | ||
|---|---|---|---|
| 10.29 | Letter Agreement, dated June 30, 2010, by Wells Fargo Bank, National Association and Wells Fargo Bank, N.A., London Branch (as successor-by-merger to Wachovia Bank, N.A. (London Branch)), as acknowledged and agreed by NorthStar Realty Finance Corp. and certain of its Affiliates and Subsidiaries (incorporated by reference to Exhibit 10.29 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010) | ||
10.30 | Common Stock Purchase Warrant, Certificate No. W-4, dated June 30, 2010, issued to Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.30 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2010) | ||
12.1 | Ratio of Earnings to Combined Fixed Charges and Preference Dividends (incorporated by reference to Exhibit 12.1 to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for the year ended December 31, 2010). | ||
21.1 | Significant Subsidiaries of the Registrant (incorporated by reference to Exhibit 21.1 to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for the year ended December 31, 2010). | ||
23.1 | Consent of Grant Thornton LLP (incorporated by reference to Exhibit 23.1 to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for the year ended December 31, 2010). | ||
24.1 | Power of Attorney (incorporated by reference to Exhibit 24.1 to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for the year ended December 31, 2010). | ||
31.1 | * | Certification by the Chief Executive Officer pursuant to 17 CFR 240.13a-14(a)/15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | * | Certification by the Chief Financial Officer pursuant to 17 CFR 240.13a-14(a)/15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | * | Certification by the Chief Executive Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | * | Certification by the Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
196
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on February 28, 2011.
| NORTHSTAR REALTY FINANCE CORP. | ||||||
By: | /s/ DAVID T. HAMAMOTO | |||||
| Name: | David T. Hamamoto | |||||
| Title: | Chairman and Chief Executive Officer | |||||
197