Exhibit 99.2
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Consolidated Financial Statements
For the Year Ended January 31, 2013 and the period from July 1, 2011 to January 31, 2012
With Report of Independent Auditors
FC 8 SPRUCE MEZZANINE, LLC AND SUBSIDIARIES
TABLE OF CONTENTS
| Consolidated Financial Statements | Page | |
| Report of Independent Auditors | 1-2 | |
| Consolidated Balance Sheets | 3 | |
| Consolidated Statements of Operations and Comprehensive Income (Loss) | 4 | |
| Consolidated Statements of Members' Equity | 5 | |
| Consolidated Statements of Cash Flows | 6 | |
| Notes to Consolidated Financial Statements | 7-18 | |
______________________________________________________________________________
REPORT OF INDEPENDENT AUDITORS
To the Members of
FC 8 Spruce Mezzanine, LLC:
We have audited the accompanying financial statements of FC 8 Spruce Mezzanine, LLC, which comprise the balance sheet as of January 31, 2013, and the related statement of operations and comprehensive income (loss), change in members’ equity and cash flow for the year then ended, and the related notes to the financial statements.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
249 East Ocean Boulevard, Suite 900 Long Beach, CA 90802 TELEPHONE (562) 432-9482 FACSIMILE (562 432-9483 http://www.novoco.com
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of FC 8 Spruce Mezzanine, LLC as of January 31, 2013, and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.
Other Matter
The accompanying balance sheet of FC 8 Spruce Mezzanine, LLC (formerly known as FC Beekman Mezzanine, LLC) as of January 31, 2012, and the related statement of operations and comprehensive income (loss) and cash flow for the period from July 1, 2011 to January 31, 2012 were not audited, reviewed, or compiled by us and, accordingly, we do not express an opinion or any other form of assurance on them.
/s/ Novogradac & Company LLP
Long Beach, California
April 30, 2013
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Consolidated Balance Sheets
| January 31, | |||||||||||||
| 2013 | 2012 | ||||||||||||
| Assets | (Unaudited) | ||||||||||||
| Real Estate | |||||||||||||
| Building | $ | — | $ | 634,670,958 | |||||||||
| Land | — | 115,376,518 | |||||||||||
| Furniture, fixtures and equipment | — | 15,979,812 | |||||||||||
| Total Real Estate | — | 766,027,288 | |||||||||||
| Less accumulated depreciation | — | (7,426,119 | ) | ||||||||||
| Real Estate, net | — | 758,601,169 | |||||||||||
| Cash and equivalents | — | 12,771,999 | |||||||||||
| Restricted cash | — | 46,174,900 | |||||||||||
| Accounts receivable | — | 167,874 | |||||||||||
| Investment in unconsolidated subsidiaries | 129,047,560 | — | |||||||||||
| Prepaid expenses and other assets | — | 2,852,091 | |||||||||||
| Mortgage procurement costs, net | — | 14,760,578 | |||||||||||
| Lease procurement costs, net | — | 1,869,854 | |||||||||||
| 129,047,560 | 78,597,296 | ||||||||||||
| Total Assets | $ | 129,047,560 | $ | 837,198,465 | |||||||||
| Liabilities and Members' Equity | |||||||||||||
| Mortgage loan payable | $ | — | $ | 539,000,000 | |||||||||
| Construction payables | — | 23,072,730 | |||||||||||
| Accounts payable and accrued expenses | — | 1,735,871 | |||||||||||
| Accounts payable, affiliates | — | 732,600 | |||||||||||
| Security deposits payable | — | 2,349,016 | |||||||||||
| Total Liabilities | — | 566,890,217 | |||||||||||
| Members' Equity | 129,047,560 | 270,308,248 | |||||||||||
| Total Liabilities and Members' Equity | $ | 129,047,560 | $ | 837,198,465 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
3
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income (Loss)
| Period from | |||||||||||||
| Year Ended | July 1, 2011 to | ||||||||||||
| January 31, 2013 | January 31, 2012 | ||||||||||||
| (Unaudited) | |||||||||||||
| Revenues | |||||||||||||
| Rental income | $ | 29,398,037 | $ | 10,402,027 | |||||||||
| Other revenues | 1,190,718 | 559,456 | |||||||||||
| Total Revenues | 30,588,755 | 10,961,483 | |||||||||||
| Operating Expenses | |||||||||||||
| Depreciation and amortization | 16,085,892 | 7,043,059 | |||||||||||
| Operating and maintenance expenses | 5,111,768 | 3,676,312 | |||||||||||
| Utilities expense | 2,270,943 | 841,208 | |||||||||||
| Advertising | 977,521 | 1,067,810 | |||||||||||
| Insurance | 926,238 | 284,820 | |||||||||||
| Management fee | 693,877 | 357,986 | |||||||||||
| Real estate taxes | 379,237 | 186,838 | |||||||||||
| Total Operating Expenses | 26,445,476 | 13,458,033 | |||||||||||
| Net gain on disposition of partial interest in FC Holdings | 123,790,358 | — | |||||||||||
| Interest expense | (12,178,510 | ) | (6,718,664 | ) | |||||||||
| Amortization of mortgage procurement costs | (780,557 | ) | (367,013 | ) | |||||||||
| Loss on debt extinguishment | — | (9,976,828 | ) | ||||||||||
| Equity in loss from unconsolidated subsidiaries | (213,584 | ) | — | ||||||||||
| Net Income (Loss) | 114,760,986 | (19,559,055 | ) | ||||||||||
| Other Comprehensive Income: | |||||||||||||
| Amortization of interest rate contract | 44,629 | 38,144 | |||||||||||
| Ineffective portion of interest rate contract | — | 1,071,077 | |||||||||||
| Total Other Comprehensive Income | 44,629 | 1,109,221 | |||||||||||
| Total Comprehensive Income (Loss) | $ | 114,805,615 | $ | (18,449,834 | ) | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Consolidated Statements of Members’ Equity
| Members' Equity | |||||||||
| Balance at July 1, 2011 (Unaudited) | �� | $ | 156,958,082 | ||||||
| Contributions | 131,800,000 | ||||||||
| Net Loss | (19,559,055 | ) | |||||||
| Other Comprehensive Income | 1,109,221 | ||||||||
| Balance at January 31, 2012 (Unaudited) | $ | 270,308,248 | |||||||
| Contributions | 10,000,000 | ||||||||
| Distributions | (266,066,303 | ) | |||||||
| Net Income | 114,760,986 | ||||||||
| Other Comprehensive Income | 44,629 | ||||||||
| Balance at January 31, 2013 | $ | 129,047,560 | |||||||
The accompanying notes are an integral part of these consolidated financial statements.
5
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Consolidated Statements of Cash Flows
| Period from | ||||||||||||
| Year Ended | July 1, 2011 to | |||||||||||
| January 31, 2013 | January 31, 2012 | |||||||||||
| (Unaudited) | ||||||||||||
| Cash Flows from Operating Activities | ||||||||||||
| Net Income (Loss) | $ | 114,760,986 | $ | (19,559,055 | ) | |||||||
| Adjustments to reconcile net income (loss) to net cash | ||||||||||||
| provided by (used in) operating activities: | ||||||||||||
| Depreciation and amortization | 16,085,892 | 7,043,059 | ||||||||||
| Net gain on disposition of partial interest in FC Holdings | (123,790,358 | ) | — | |||||||||
| Amortization of mortgage procurement costs | 780,557 | 367,013 | ||||||||||
| Equity in loss from unconsolidated subsidiaries | 213,584 | — | ||||||||||
| Cash distributions from unconsolidated subsidiaries | 4,900,000 | — | ||||||||||
| Loss on debt extinguishment | — | 9,976,828 | ||||||||||
| Mark-to-market adjustment of interest rate | ||||||||||||
| contract included in interest expense | — | 1,155,038 | ||||||||||
| Changes in operating assets and liabilities: | ||||||||||||
| Increase in accounts receivable, net | (950,380 | ) | (152,718 | ) | ||||||||
| Decrease (increase) in prepaid expenses and other assets | 1,861,806 | (875,353 | ) | |||||||||
| Decrease in accounts payable and accrued expenses | (720,459 | ) | (2,273,262 | ) | ||||||||
| (Decrease) increase in accounts payable, affiliates | (210,334 | ) | 164,940 | |||||||||
| Increase in security deposits payables | 1,517,683 | 1,377,273 | ||||||||||
| Net cash provided by (used in) operating activities | 14,448,977 | (2,776,237 | ) | |||||||||
| Cash Flows from Investing Activities | ||||||||||||
| Net proceeds from disposition of partial interest in FC Holdings | 248,019,207 | — | ||||||||||
| Capital expenditures | (31,145,470 | ) | (40,819,091 | ) | ||||||||
| Decrease in restricted cash | 17,460,607 | 20,706,913 | ||||||||||
| Payment of lease procurement costs | (2,607,603 | ) | (1,862,514 | ) | ||||||||
| Decrease in cash and equivalents from deconsolidation of FC Holding | (2,881,414 | ) | — | |||||||||
| Net cash provided by (used in) investing activities | 228,845,327 | (21,974,692 | ) | |||||||||
| Cash Flows from Financing Activities | ||||||||||||
| Principal payments on mortgage loan payable | — | (96,000,000 | ) | |||||||||
| Payment of mortgage procurement costs | — | (2,865,255 | ) | |||||||||
| Contributions from members | 10,000,000 | 131,800,000 | ||||||||||
| Distributions to members | (266,066,303 | ) | — | |||||||||
| Net cash (used in) provided by financing activities | (256,066,303 | ) | 32,934,745 | |||||||||
| Net (decrease) increase in cash and equivalents | (12,771,999 | ) | 8,183,816 | |||||||||
| Cash and equivalents at beginning of period | 12,771,999 | 4,588,183 | ||||||||||
| Cash and equivalents at end of period | $ | — | $ | 12,771,999 | ||||||||
| Supplemental Disclosure of Cash and Non-cash Activities: | ||||||||||||
| Cash paid for interest, net of capitalized interest | $ | 13,268,273 | $ | 5,544,018 | ||||||||
| Capital expenditures included in construction payables | $ | 7,559,755 | $ | 7,648,716 | ||||||||
| Capital expenditures included in accounts payable, affiliates | $ | 512,036 | $ | 570,359 | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
6
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| A. | Organization and Summary of Significant Accounting Policies |
Organization
FC 8 Spruce Mezzanine, LLC (“FC Mezzanine”), a Delaware limited liability company, was formed for the purpose of acquiring a 100% membership interest in FC 8 Spruce Holdings, LLC (“FC Holdings”), which wholly owns FC 8 Spruce Street Residential, LLC (“FC Residential”). FC Residential, a New York limited liability company, was formed for the purpose of owning and operating the Rental and Retail Units (the “Units”) of the Spruce Street Condominium located on 8 Spruce Street in Manhattan, New York.
The previous owner of the Units, prior to formation of FC Residential, was FC Beekman Associates, LLC (“FC Beekman”), a New York limited liability company. FC Beekman was formed for the purpose of owning, developing and operating the Units and was wholly-owned by FC Beekman Mezzanine, LLC (“Beekman Mezzanine”), a Delaware limited liability company. On December 17, 2012 (the “Transfer Date”), FC Beekman transferred its deed in the Units to FC Residential (the “Transaction”). Concurrent with the Transaction, FC Mezzanine contributed its 100% membership interest in FC Residential to FC Holdings and was its sole member. Prior to the Transfer Date, Beekman Mezzanine and its wholly owned subsidiary are referred to as the “Company”. Concurrent with the Transaction, FC Mezzanine and its subsidiaries are referred to as the “Company”. Profits and losses are allocated and contributions and distributions are made in accordance with each of the respective Company’s operating agreements.
The Spruce Street Condominium (or “Project”) is a 76-story mixed-use building containing approximately 1,110,800 gross square feet and approximately 675,500 rentable square feet (“RSF”). It is comprised of the following condominium units: (i) 899 apartments, 4 of which are penthouse apartments (the “Rental Units”), and approximately 1,300 RSF of ground level retail space (the “Retail Units”); (ii) an ambulatory care facility located on the 5th floor, together with below-grade parking of approximately 175 spaces (the “Hospital Units”); and (iii) a pre-kindergarten through eighth grade New York City public school located on floors one through four (the “School Units”). The Hospital Units and the School Units are owned by NYU Downtown Hospital and New York City Department of Education (the “School”), respectively. The Hospital Units were constructed as part of the consideration for the purchase of the land. The costs incurred in constructing the Hospital Units are included as part of the land basis in the accompanying Consolidated Balance Sheet at January 31, 2012. The School reimbursed the Company up to an agreed upon amount for costs incurred in constructing the School Units.
On December 20, 2012 (the “Deconsolidation Date”), FC Mezzanine sold a 49.00% interest in FC Holdings to 8 Spruce Street GA Investor LLC (the “GA Investor”), a Delaware limited liability company for cash consideration of $250,390,000 and recognized a net gain on disposition of partial interest in FC Holdings of $123,790,358, under accounting guidance related to real estate sales, in the accompanying Consolidated Statements of Operations. The proceeds from the sale, net of closing costs totaled $248,019,207.
7
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| A. | Organization and Summary of Significant Accounting Policies |
Significant Subsidiary
The Company is an 18% owned equity method investment of Forest City Enterprises, Inc. (“FCE”), a publicly traded company. FCE’s portion of the gain on disposition of partial interest in FC Holdings partially offset by allocated losses from its investment in the Company collectively exceeded 20% of FCE’s pre-tax loss from continuing operations. As a result, the Company was deemed to be a significant subsidiary of FCE for FCE’s fiscal year ended January 31, 2013. Therefore, audited consolidated financial statements for the Company are required to be filed with the Securities and Exchange Commission in accordance with Rule 3-09 of Regulation S-X as of and for the year ended January 31, 2013. The consolidated financial statements as of January 31, 2012 and for the period from July 1, 2011 to January 31, 2012 are unaudited.
Prior to July 1, 2011, FCE and an affiliate held an effective ownership interest in Beekman Mezzanine of 69.60% while the National Electrical Benefit Fund (“NEBF”) held an ownership interest of 30.40%. Beekman Mezzanine was deemed to be a variable interest entity (“VIE”) and FCE was deemed to be the primary beneficiary, which resulted in FCE accounting for its interest in Beekman Mezzanine under full consolidation. On July 1, 2011, Beekman Mezzanine was recapitalized which resulted in NEBF assigning its 30.40% interest to its affiliate, INDURE. INDURE contributed $107,120,584, comprised of cash of $72,120,584 and conversion of a mezzanine loan of $35,000,000 into its equity, and its ownership in Beekman Mezzanine increased from 30.40% to 49.00%. FCE contributed $57,879,416 and its interest together with its affiliate’s interest in Beekman Mezzanine decreased from 69.60% to 51.00%. The $130,000,000 raised was used to pay down the Bonds (see Note B) and establish an escrow account with the Lender to fund remaining construction costs. Beekman Mezzanine was no longer considered a VIE and under the voting model FCE was required to account for its membership interest in accordance with the equity method of accounting.
Basis of Presentation
The accompanying consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In accordance with accounting guidance for consolidation, prior to the Deconsolidation Date, the accompanying financial statements present the consolidated results of the Company. On the Deconsolidation Date in accordance with the voting model, FC Mezzanine commenced accounting for its investments in FC Holdings in accordance with the equity method of accounting (the “Deconsolidation”).
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
8
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| A. | Organization and Summary of Significant Accounting Policies |
Rental Income
The Company's primary source of income is from leasing residential apartments, which are leased for terms of 12 months to 24 months. Certain leases provide for rent abatement periods of one to two months. Revenue is recognized on a straight-line basis over the related lease terms. Due to the Deconsolidation, the straight-line receivable does not consolidate into the Company’s Balance Sheet at January 31, 2013. As of January 31, 2012, the straight-line receivable balance was $1,271,766 and is included in prepaid expenses and other assets in the accompanying Consolidated Balance Sheets.
Cash and Equivalents
The Company considers all cash balances on deposit with financial institutions and highly liquid investments with a maturity of three months or less at the date of acquisition to be cash equivalents.
Concentration of Credit Risk
The Company maintains cash deposits with major financial institutions which from time to time may exceed federally insured limits. The Company periodically assesses the financial condition of the institutions and believes that the risk of any loss is minimal.
Investment in Unconsolidated Subsidiaries
The Company accounts for its investments in unconsolidated subsidiaries using the equity method of accounting whereby the cost of an investment is adjusted for the Company’s share of income or loss from the date of acquisition, increased for equity contributions made and reduced by distributions received. The income or loss for unconsolidated subsidiaries is allocated in accordance with the provisions of the applicable operating agreements, which may differ from the ownership interest held by each investor.
Impairment of Unconsolidated Subsidiaries
The Company reviews its unconsolidated subsidiaries for other-than-temporary impairments whenever events or changes indicate that its carrying value in the investment may be in excess of fair value. A loss in value of an equity method investment which is other-than-temporary is recognized as an impairment of equity method investment. Determining fair value of a real estate investment and whether or not a loss is other-than-temporary involves significant judgments and estimates.
Income Taxes
The Company is a limited liability company. No provision or benefit for federal, state and local income taxes has been reflected in the consolidated financial statements of the Company since such income taxes, if any, are the responsibility of the individual members.
9
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| A. | Organization and Summary of Significant Accounting Policies |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to report information regarding its exposure to various tax positions taken by the Company. The Company has determined whether any tax positions have met the recognition threshold and has measured the Company's exposure to those tax positions. Management believes that the Company has adequately addressed all relevant tax positions and that there are no unrecorded tax liabilities. Federal and state tax authorities generally have the right to examine and audit the previous three years of tax returns filed. Any interest or penalties assessed to the Company are recorded in operating expenses. No interest or penalties from federal or state tax authorities were recorded in the accompanying financial statements.
Subsequent Events Review
The Company has evaluated events and transactions that occurred between January 31, 2013 and the date of the Report of Independent Auditors, which is the date the consolidated financial statements were available to be issued. There were no significant subsequent events.
| B. | Deconsolidation (unaudited) |
Deconsolidation of FC Holdings
The following table represents the consolidated balance sheet of FC Holdings immediately prior to the Deconsolidation Date:
| December 19, 2012 | ||||||||
| Net real estate | $ | 752,280,928 | ||||||
| Cash and equivalents | 2,881,414 | |||||||
| Restricted cash | 28,714,293 | |||||||
| Accounts receivable, net | 1,118,254 | |||||||
| Prepaid expenses and other assets | 990,285 | |||||||
| Mortgage procurement costs, net | 13,932,809 | |||||||
| Lease procurement costs, net | 2,073,956 | |||||||
| Total Assets | $ | 801,991,939 | ||||||
| Mortgage loan payable | $ | 539,000,000 | ||||||
| Construction payables | 15,512,975 | |||||||
| Accounts payable and accrued expenses | 1,015,412 | |||||||
| Accounts payable, affiliates | 522,266 | |||||||
| Security deposits | 3,866,699 | |||||||
| Total Liabilities | 559,917,352 | |||||||
| Members' Equity | 242,074,587 | |||||||
| Total Liabilities and Members' Equity | $ | 801,991,939 | ||||||
10
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| B. | Deconsolidation (unaudited) |
The detail of certain balance sheet accounts of FC Holdings, except for cash and equivalents, at January 31, 2012 are described below.
Real Estate
The Company's capitalization policy follows the accounting guidance on capitalization of interest cost and accounting for costs and initial rental operations of real estate properties. Determination of when a development project is substantially complete and capitalization must cease involves a degree of judgment. The Company ceases capitalization on the portion substantially completed and occupied or held available for occupancy and capitalizes only those costs associated with the portion under construction. Upon receipt of certificates of occupancy from the City of New York, the Units are deemed substantially complete. The initial apartments became available in March 2011. As of August 2012, the Project was deemed 100% complete.
Real estate is recorded at cost. Depreciation of property is calculated using the straight-line method over the estimated useful lives of the assets which range from 5 to 50 years. The cost of maintenance and repairs is charged to expense as incurred and major improvements are capitalized.
The Company reviews its long-lived assets to determine if its carrying costs will be recovered from future undiscounted cash flows whenever events or changes indicate that the recoverability of long-lived assets may not be supported by current assumptions. In cases where the Company does not expect to recover its carrying costs, an impairment loss is recorded in accordance with accounting guidance on the impairment of long-lived assets. Significant estimates are made in the determination of future undiscounted cash flows. The Company did not record any impairments for the periods presented.
Restricted Cash
Restricted cash consists of cash held in escrow as required by the Lender and tenant security deposits as required by tenant leases. Escrow funds are released upon certain conditions being met. Due to the Deconsolidation, restricted cash does not consolidate into the Company’s Balance Sheet at January 31, 2013. At January 31, 2012, restricted cash is comprised of the following:
| January 31, 2012 | ||||
| To fund construction costs | $ | 42,932,550 | ||
| Tenant security deposits | 2,356,968 | |||
| Other | 885,382 | |||
| Total Restricted Cash | $ | 46,174,900 | ||
11
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| B. | Deconsolidation (unaudited) |
Allowance for Doubtful Accounts
Tenant receivables are periodically evaluated for collectability based on the tenants' past history, their current status and financial condition. As of January 31, 2013 and 2012, no reserve was required.
Deferred Costs
Mortgage procurement costs are deferred when incurred and amortized over the term of the related financing. Credit enhancement procurement costs are deferred and amortized over the term of the enhancement. Lease procurement costs are deferred when incurred and amortized on a straight-line basis over the term of the related lease. Lease procurement costs related to leases of one year or less are expensed as incurred. Due to the Deconsolidation, deferred costs do not consolidate into the Company’s Consolidated Balance Sheet at January 31, 2013. At January 31, 2012, accumulated amortization of mortgage and credit enhancement procurement costs was $1,441,470 and accumulated amortization of lease procurement costs was $852,301.
Fair Value of Financial Instruments
Management estimates the fair value of its debt instruments by discounting future cash payments at interest rates that the Company believes approximates the current market. The estimated fair value is based upon market prices of public debt, available industry financing data, current treasury rates, recent financing transactions and other factors. The fair value of the Company's debt at January 31, 2012 is further described in the Mortgage Loan Payable section of this Note B. The carrying amount of the Company's accounts payable and accrued expenses at January 31, 2012 approximate fair value based upon the short-term nature of the instruments.
Real Estate Tax Abatement
The Project has been granted a phased abatement of real estate taxes for a twenty year period after construction in accordance with Section 421-a of the New York State Real Property Tax Law. To receive this abatement, the Company has agreed that all Rental Units in the Project will be subject to the New York City Rent Stabilization Law during the abatement period. The Law restricts the percentage increases in rent charged on new and renewed leases. It also restricts the lease term to be no longer than two years.
Derivative Instruments and Hedging Activities
The Company maintains an overall interest rate risk-management strategy that incorporates the use of derivative instruments to minimize unplanned fluctuations in cash flows and earnings that may be caused by interest rate volatility. The principal risk to the Company through its interest rate hedging strategy is the potential inability of the financial institutions from which the interest rate protection was purchased to cover all of its obligations. To mitigate this exposure, the Company purchases its interest rate protection from either the institution that holds the debt or from institutions with a minimum A- credit rating. The Company does not enter into derivative financial instrument contracts for trading or speculative purposes.
12
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| B. | Deconsolidation (unaudited) |
As required by accounting guidance for derivative instruments and hedging activities, all derivatives are recognized on the Consolidated Balance Sheets at their fair value. On the date that the Company enters into a derivative contract, it designates the derivative as either a hedge of a forecasted transaction or the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (“a cash flow hedge”). Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge, to the extent that the hedge is highly effective, are recorded in other comprehensive income (loss) until earnings are affected by the variability of cash flows of the hedged transaction. Any hedge ineffectiveness (which represents the amount by which the changes in fair value of the derivative exceed the variability in the cash flows of the forecasted transaction) is recorded in current-period earnings as interest expense in the accompanying Consolidated Statements of Operations.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management strategy for undertaking hedging transactions. The Company formally assesses (both at the hedge’s inception and on an ongoing basis) whether the derivatives used in hedging transactions were highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods.
The Company discontinues hedge accounting prospectively when; (1) it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item; (2) the derivative expires or is sold, terminated, or exercised; (3) it is no longer probable that the forecasted transaction will occur; or (4) management determines that designating the derivative as a hedging instrument is no longer appropriate. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company records the derivative at its fair value on the Consolidated Balance Sheets, recognizing changes in the fair value in current-period earnings as interest expense in the accompanying Consolidated Statements of Operations.
FC Beekman purchased a London Interbank Offered Rate (“LIBOR”) based interest rate cap on March 26, 2008 for $3,698,000 to reduce its exposure to variability in expected future cash outflows attributable to increases in interest rates on its variable rate debt. The cap has a notional value of $476,100,000, an effective date of April 1, 2011 and a maturity date of April 1, 2013. At the time of purchase, the cap qualified and was designated as a cash flow hedge. During 2011, due to the pay down of the Bonds (see the Mortgage Loan Payable section of this Note B), the cap no longer qualified to receive hedge accounting and the Company reclassified other comprehensive income (“OCI”) in the amount of $1,071,077 as an increase to interest expense representing a missed forecasted future transaction. After the reclassification, the remaining balance of OCI related to the interest rate cap during the time it was designated as a cash flow hedge which was during the development phase of the property. In accordance with accounting guidance on derivatives and hedging activities, the Company is amortizing the remaining OCI on a straight-line basis over a period of 50 years, which is included in depreciation expense.
13
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| B. | Deconsolidation (unaudited) |
On the Deconsolidation Date, the Company wrote off 49.00% of the accumulated OCI balance to members’ equity. As of January 31, 2013 and 2012, the balance of accumulated OCI was $1,251,515 and $2,504,810, respectively. The Company expects that within the next twelve months it will reclassify amounts recorded in accumulated other comprehensive loss as an increase in depreciation expense of approximately $25,000.
At January 31, 2012, FC Beekman’s interest rate caps are included in prepaid expenses and other assets in the accompanying Consolidated Balance Sheets. At January 31, 2012, the current notional and fair value of interest rate caps not designated as hedging instruments is as follows:
| Current Notional | Fair Value | |||||
| Interest rate cap not designated as a hedging instrument | $ | 476,100,000 | $ | 8 | ||
The following table presents the impact of losses related to the interest rate cap designated as a cash flow hedge included in the accompanying Consolidated Statements of Operations and within members’ equity on the Consolidated Balance Sheets:
| On Accompanying Consolidated Statements of Operations | On Accompanying Consolidated Balance Sheets | |||||||||||||||
| Depreciation and amortization | Interest Expense | Equity in loss from unconsolidated subsidiaries | Prepaid expenses and other assets | Accumulated other comprehensive income (loss) | ||||||||||||
| Balance at July 1, 2011 | $ | — | $ | — | $ | — | $ | 83,969 | $ | (3,614,031 | ) | |||||
| Mark to market - ineffective portion | — | 83,961 | — | (83,961 | ) | — | ||||||||||
| Dedesignation event | — | 1,071,077 | — | — | 1,071,077 | |||||||||||
| Depreciation expense | 38,144 | — | — | — | 38,144 | |||||||||||
| Balance at January 31, 2012 | 38,144 | 1,155,038 | — | 8 | (2,504,810 | ) | ||||||||||
| Depreciation expense | 38,144 | — | — | — | 38,144 | |||||||||||
| Deconsolidation event | — | — | — | (8 | ) | 1,208,666 | ||||||||||
| FC Mezzanine's share of depreciation expense | — | — | 6,485 | — | 6,485 | |||||||||||
| Balance at January 31, 2013 | $ | 38,144 | — | $ | 6,485 | $ | — | $ | (1,251,515 | ) | ||||||
14
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| B. | Deconsolidation (unaudited) |
Mortgage Loan Payable
The Company obtained financing for the Project from the New York City Housing Development Corporation (“HDC”). Due to the Deconsolidation, the mortgage loan payable does not consolidate into the Company’s Balance Sheet at January 31, 2013.
The following table shows the detail of the bonds issued and outstanding (the “Bonds”) at January 31, 2012:
| Pre-July 1, 2011 | At January 31,2012 | ||||||||||||
Amount Outstanding | July 1, 2011 Payment | Amount Outstanding | Interest Rate | ||||||||||
| 2008 Series A, tax-exempt | $ | 203,900,000 | $ | — | $ | 203,900,000 | 0.11% | ||||||
| 2009 Series A-1, taxable | 158,700,000 | (35,350,000 | ) | 123,350,000 | 0.20% | ||||||||
| 2009 Series A-2, taxable | 79,350,000 | (17,650,000 | ) | 61,700,000 | 0.20% | ||||||||
| 2010 Series A-1, taxable | 98,050,000 | (21,850,000 | ) | 76,200,000 | 0.18% | ||||||||
| 2010 Series A-2, taxable | 95,000,000 | (21,150,000 | ) | 73,850,000 | 0.20% | ||||||||
| $ | 635,000,000 | $ | (96,000,000 | ) | $ | 539,000,000 | |||||||
On May 28, 2008, HDC issued $203,900,000 principal amount of 2008 Series A Revenue Bonds. On March 4, 2009, HDC issued $158,700,000 principal amount of 2009 Series A-1 Revenue Bonds and $79,350,000 principal amount of 2009 Series A-2 Revenue Bonds. On May 12, 2010, HDC issued $98,050,000 principal amount of 2010 Series A-1 Revenue Bonds and $95,000,000 principal amount of 2010 Series A-2 Revenue Bonds. On July 1, 2011, the Company retired $96,000,000 of the Bonds, as depicted in the table above. The Bonds are scheduled to mature on March 1, 2048.
Each series of bonds was issued as a variable rate obligation. The interest is calculated weekly based upon the remarketing agent’s (the “Agent”) determination of the rate required to allow the Bonds to be sold at par plus accrued interest, up to a maximum interest rate of 12% per annum. The rates on the Bonds have historically traded at a rate which closely approximates the Securities Industry and Financial Markets Association Index (“SIFMA”). The Company may elect to convert the interest rate on the Bonds, as defined in the agreement. In general, the Bonds are subject to redemption and payment prior to maturity, in whole or in part, at the option of HDC, which can only be exercised at the Company's request. The Agent earns an annual remarketing fee of 0.07% of the Bonds par value.
15
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| B. | Deconsolidation (unaudited) |
The Bonds are enhanced by an irrevocable letter of credit (the “L/C”) issued by RBS Citizens, N.A. (the “Lender”) in the amount of $545,077,011 (the “Maximum Amount”) which represents both the principal amount and a specified amount of interest on the Bonds. The L/C was originally set to expire on June 30, 2016. Concurrent with the Transaction, the maturity date of the L/C changed to June 30, 2015 and FC Residential, an affiliate of FCE, was required to fund $10,000,000 into the Lender’s escrow account until a certain debt service coverage ratio is achieved as defined in the Lender agreement. The Company pays a monthly L/C fee of 2.20% per annum on the Maximum Amount and pays a monthly fronting fee of 0.15% per annum on the Maximum Amount. In addition, the L/C requires the Company to maintain a certain debt coverage ratio upon achievement of 95% occupancy. The Company is not in default of any covenant as of the issuance of these consolidated financial statements.
Based on borrowing rates currently available to the Company for long term debt with similar terms and maturities, the estimated fair value of the Bonds at January 31, 2012 was $524,973,350.
Transactions with Affiliates
The Company had the following transactions with affiliates of FCE:
| • | During 2012, a development fee of $6,156,641 was paid to an affiliate of a member of the Company. The fee was capitalized and presented in Note C as part of net real estate. |
| • | Cumulative site management fees paid in connection with overseeing the development and construction of the Project totaled $30,016,023 as of January 31, 2012 and are capitalized to building in the accompanying Consolidated Balance Sheets. |
| • | Fees related to commissioning services during the design and construction stages totaled $225,000 as of January 31, 2012 and are capitalized to building in the accompanying Consolidated Balance Sheets. |
| • | Execution of Completion Guaranty for the benefit of the Lender, that will be released upon meeting conditions as defined in the Guaranty agreement. |
| C. | Equity Method Investment |
Effective December 20, 2012, FC Mezzanine accounts for its interest in FC Holdings under the equity method of accounting. At January 31, 2013, FC Mezzanine has a $129,047,560 investment basis representing its 51% interest in FC Holdings.
16
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| C. | Equity Method Investment |
Below is a reconciliation between the Company’s carrying value and its members’ equity in FC Holdings’ balance sheet at January 31, 2013:
| Investment in FC Holdings | $ | 129,047,560 | ||||||
Basis difference(1) | (142,513,072 | ) | ||||||
| FC Mezzanine Equity in FC Holdings | $ | (13,465,512 | ) | |||||
(1) | The basis difference is primarily caused by the gain recognized on the sale of partial interest in FC Holdings and certain costs capitalized at the FC Mezzanine level. | |||||||
Summarized balance sheet information for FC Holdings as of January 31, 2013 is as follows:
| January 31, 2013 | ||||||||
| Net real estate | $ | 749,641,462 | ||||||
| Cash and equivalents | 4,722,603 | |||||||
| Restricted cash | 28,677,359 | |||||||
| Accounts receivable, net | 1,691,171 | |||||||
| Prepaid expenses and other assets | 2,384,994 | |||||||
| Mortgage procurement costs, net | 13,824,621 | |||||||
| Lease procurement costs, net | 1,946,019 | |||||||
| Total Assets | $ | 802,888,229 | ||||||
| Mortgage loan payable | $ | 539,000,000 | ||||||
| Construction payables | 16,012,410 | |||||||
| Accounts payable and accrued expenses | 983,647 | |||||||
| Accounts payable, affiliates | 512,203 | |||||||
| Security deposits | 3,829,233 | |||||||
| Total Liabilities | 560,337,493 | |||||||
| GA Investor equity | 256,016,248 | |||||||
| FC Mezzanine equity | (13,465,512 | ) | ||||||
| Total Members' Equity | 242,550,736 | |||||||
| Total Liabilities and Members' Equity | $ | 802,888,229 | ||||||
17
FC 8 Spruce Mezzanine, LLC and Subsidiaries
Notes to Consolidated Financial Statements
| C. | Equity Method Investment |
Summarized operating information, which represents 100% of the operations of FC Holdings from the Deconsolidation Date through January 31, 2013, is as follows:
| For the period | ||||
| December 20, 2012 | ||||
| to January 31, 2013 | ||||
| Revenues | $ | 4,879,106 | ||
| Depreciation and amortization | (2,362,844 | ) | ||
| Operating expenses | (1,102,666 | ) | ||
| Interest expense | (1,832,388 | ) | ||
| Net loss | $ | (418,792 | ) | |
| FC Mezzanine's portion of net loss | $ | (213,584 | ) | |
18