- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 1-10150
--------------------------
ISTAR FINANCIAL INC.
(Exact name of registrant as specified in its charter)
MARYLAND 95-6881527
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1114 AVENUE OF THE AMERICAS, 27TH FLOOR 10036
NEW YORK, NY (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 930-9400
--------------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of Exchange on which registered:
COMMON STOCK, $0.001 PAR VALUE NEW YORK STOCK EXCHANGE
9.375% SERIES B CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
9.200% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
8.000% SERIES D CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant; (i) 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 (ii) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
As of May 11, 2001, there were 86,014,817 shares of common stock of iStar
Financial Inc., $0.001 par value per share outstanding ("Common Stock").
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
ISTAR FINANCIAL INC.
INDEX TO FORM 10-Q
PAGE
--------
PART I. Consolidated Financial Information.......................... 3
Item 1. Financial Statements:
Consolidated Balance Sheets at March 31, 2001 and December
31, 2000................................................... 3
Consolidated Statements of Operations--For the three months
ended March 31, 2001 and 2000.............................. 4
Consolidated Statements of Changes in Shareholders'
Equity--For the three months ended March 31, 2001.......... 5
Consolidated Statements of Cash Flows--For the three months
ended March 31, 2001 and 2000.............................. 6
Notes to Consolidated Financial Statements.................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 28
PART II. Other Information........................................... 37
Item 1. Legal Proceedings........................................... 37
Item 2. Changes in Securities and Use of Proceeds................... 37
Item 3. Defaults Upon Senior Securities............................. 37
Item 4. Submission of Matters to a Vote of Security Holders......... 37
Item 5. Other Information........................................... 37
Item 6. Exhibits and Reports on Form 8-K............................ 37
SIGNATURES............................................................ 38
PART I--CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ISTAR FINANCIAL INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
AS OF AS OF
MARCH 31, DECEMBER 31,
2001 2000
---------- ------------
ASSETS
Loans and other lending investments, net.................... $2,236,030 $2,225,183
Real estate subject to operating leases, net................ 1,638,017 1,670,169
Cash and cash equivalents................................... 22,301 22,752
Restricted cash............................................. 13,225 20,441
Marketable securities....................................... 41 41
Accrued interest and operating lease income receivable...... 18,606 20,167
Deferred operating lease income receivable.................. 12,812 10,236
Deferred expenses and other assets.......................... 68,890 62,224
Investment in iStar Operating Inc........................... 3,970 3,562
---------- ----------
Total assets.............................................. $4,013,892 $4,034,775
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, accrued expenses and other liabilities.... $ 64,473 $ 52,038
Dividends payable........................................... 5,225 56,661
Debt obligations............................................ 2,120,834 2,131,967
---------- ----------
Total liabilities......................................... 2,190,532 2,240,666
---------- ----------
Commitments and contingencies............................... -- --
Minority interests in consolidated entities................. 2,649 6,224
Shareholders' equity:
Series A Preferred Stock, $0.001 par value, liquidation
preference $50.00 per share, 4,400 shares issued and
outstanding at March 31, 2001 and December 31, 2000,
respectively.............................................. 4 4
Series B Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 2,000 shares issued and
outstanding at March 31, 2001 and December 31, 2000,
respectively.............................................. 2 2
Series C Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 1,300 shares issued and
outstanding at March 31, 2001 and December 31, 2000,
respectively.............................................. 1 1
Series D Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 4,000 shares issued and
outstanding at March 31, 2001 and December 31, 2000,
respectively.............................................. 4 4
Common Stock, $0.001 par value, 200,000 shares authorized,
85,925 and 85,726 shares issued and outstanding at March
31, 2001 and December 31, 2000, respectively.............. 86 85
Warrants and options........................................ 16,943 16,943
Additional paid in capital.................................. 1,969,603 1,966,396
Retained earnings (deficit)................................. (109,372) (154,789)
Accumulated other comprehensive income (losses) (See
Note 12).................................................. (15,819) (20)
Treasury stock (at cost).................................... (40,741) (40,741)
---------- ----------
Total shareholders' equity................................ 1,820,711 1,787,885
---------- ----------
Total liabilities and shareholders' equity................ $4,013,892 $4,034,775
========== ==========
The accompanying notes are an integral part of the financial statements.
3
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE
THREE MONTHS
ENDED MARCH 31,
-------------------
2001 2000
-------- --------
REVENUE:
Interest income........................................... $ 66,913 $ 60,083
Operating lease income.................................... 49,523 46,272
Other income.............................................. 6,183 4,533
-------- --------
Total revenue........................................... 122,619 110,888
-------- --------
COSTS AND EXPENSES:
Interest expense.......................................... 46,360 37,789
Operating costs-corporate tenant lease assets............. 3,236 3,325
Depreciation and amortization............................. 8,808 9,009
General and administrative................................ 6,102 6,903
Provision for possible credit losses...................... 1,750 1,500
Stock-based compensation expense.......................... 860 548
-------- --------
Total costs and expenses................................ 67,116 59,074
-------- --------
Net income before minority interest, gain on sale of
corporate tenant lease assets, extraordinary loss and
cumulative effect of change in accounting principle....... 55,503 51,814
Minority interest in consolidated entities.................. (95) (41)
Gain on sale of corporate tenant lease assets............... 555 533
-------- --------
Net income before extraordinary loss and cumulative effect
of change in accounting principle......................... 55,963 52,306
Extraordinary loss on early extinguishment of debt.......... (1,037) (317)
Cumulative effect of change in accounting principle (See
Note 12).................................................. (282) --
-------- --------
Net income.................................................. 54,644 51,989
Preferred dividend requirements............................. (9,227) (9,227)
-------- --------
Net income allocable to common shareholders................. $ 45,417 $ 42,762
======== ========
Basic earnings per common share............................. $ 0.53 $ 0.50
======== ========
Diluted earnings per common share........................... $ 0.52 $ 0.50
======== ========
The accompanying notes are an integral part of the financial statements.
4
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
SERIES A SERIES B SERIES C SERIES D COMMON WARRANTS ADDITIONAL
PREFERRED PREFERRED PREFERRED PREFERRED STOCK AND PAID-IN
STOCK STOCK STOCK STOCK AT PAR OPTIONS CAPITAL
--------- --------- --------- --------- -------- --------- ----------
Balance at December 31, 2000.............. $ 4 $ 2 $ 1 $ 4 $ 85 $16,943 $1,966,396
Exercise of options....................... -- -- -- -- 1 -- 1,572
Dividends declared-preferred stock........ -- -- -- -- -- -- 83
Restricted stock units issued to employees
in lieu of cash bonuses................. -- -- -- -- -- -- 1,478
Restricted stock units granted to
employees............................... -- -- -- -- -- -- 24
Issuance of stock under DRIP plan......... -- -- -- -- -- -- 50
Change in accumulated other comprehensive
income.................................. -- -- -- -- -- -- --
Net income for the period................. -- -- -- -- -- -- --
---- ---- ---- ---- ---- ------- ----------
Balance at March 31, 2001................. $ 4 $ 2 $ 1 $ 4 $ 86 $16,943 $1,969,603
==== ==== ==== ==== ==== ======= ==========
ACCUMULATED
RETAINED OTHER
EARNINGS COMPREHENSIVE TREASURY
(DEFICIT) INCOME STOCK TOTAL
--------- -------------- -------- ----------
Balance at December 31, 2000.............. $(154,789) $ (20) $(40,741) $1,787,885
Exercise of options....................... -- -- -- 1,573
Dividends declared-preferred stock........ (9,227) -- -- (9,144)
Restricted stock units issued to employees
in lieu of cash bonuses................. -- -- -- 1,478
Restricted stock units granted to
employees............................... -- -- -- 24
Issuance of stock under DRIP plan......... -- -- -- 50
Change in accumulated other comprehensive
income.................................. -- (15,799) -- (15,799)
Net income for the period................. 54,644 -- -- 54,644
--------- -------- -------- ----------
Balance at March 31, 2001................. $(109,372) $(15,819) $(40,741) $1,820,711
========= ======== ======== ==========
The accompanying notes are an integral part of the financial statements.
5
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE
THREE MONTHS
ENDED MARCH 31,
---------------------
2001 2000
--------- ---------
Cash flows from operating activities:
Net income.................................................. $ 54,644 $ 51,989
Adjustments to reconcile net income to cash flows provided
by operating activities:
Minority interest......................................... 95 41
Non-cash expense for options issued....................... 860 548
Depreciation and amortization............................. 14,309 11,134
Amortization of discounts/premiums, deferred interest and
costs on lending investments............................ (4,872) (7,067)
Equity in (earnings) loss of unconsolidated joint ventures
and subsidiaries........................................ (2,802) (324)
Distributions from operations of unconsolidated joint
ventures................................................ 1,098 952
Straight-line operating lease income adjustments.......... (2,576) (2,282)
Realized losses on sales of securities.................... -- 229
Gain on sale of corporate tenant lease assets............. (555) (533)
Extraordinary loss on early extinguishment of debt........ 1,037 317
Cumulative effect of change in accounting principle....... 282 --
Provision for possible credit losses...................... 1,750 1,500
Changes in assets and liabilities:
(Increase) decrease in restricted cash.................. 7,216 (1,061)
(Increase) decrease in accrued interest and operating
lease income receivable................................ 1,561 (1,413)
Increase in deferred expenses and other assets.......... (1,039) (3,443)
Decrease in accounts payable, accrued expenses and other
liabilities............................................ (2,594) (4,756)
--------- ---------
Cash flows provided by operating activities............... 68,414 45,831
--------- ---------
Cash flows from investing activities:
New investment originations/acquisitions.................. (224,479) (211,925)
Principal fundings on existing loan commitments........... (29,924) (16,542)
Net proceeds from sale of corporate tenant lease assets... 3,755 45,291
Repayments of and principal collections from loans and
other lending investments............................... 247,392 121,803
Investments in and advances to unconsolidated joint
ventures................................................ (319) (668)
Distributions from unconsolidated joint ventures.......... 24,265 --
Capital expenditures on real estate subject to operating
leases.................................................. (2,406) (1,858)
--------- ---------
Cash flows provided by (used in) investing activities..... 18,284 (63,899)
--------- ---------
Cash flows from financing activities:
Net borrowings under revolving credit facilities.......... 41,160 65,177
Borrowings under term loans............................... 17,040 30,000
Repayments under term loans............................... (37,333) (9,726)
Borrowing under repurchase agreements..................... 367 --
Repayments under repurchase agreements.................... (31,325) (119)
Repayments under bond offerings........................... (1,990) --
Common dividends paid..................................... (51,436) (48,441)
Preferred dividends paid.................................. (9,144) (9,144)
Distributions to minority interest in consolidated
entities................................................ (3,670) (41)
Extraordinary loss on early extinguishment of debt........ (1,037) (317)
Payments for deferred financing costs..................... (11,428) (1,913)
Purchase of treasury stock................................ -- (106)
Proceeds from exercise of options......................... 1,647 --
--------- ---------
Cash flows provided by (used in) financing activities..... (87,149) 25,370
--------- ---------
Increase (decrease) in cash and cash equivalents............ (451) 7,302
Cash and cash equivalents at beginning of period............ 22,752 34,408
--------- ---------
Cash and cash equivalents at end of period.................. $ 22,301 $ 41,710
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest, net of amounts
capitalized............................................. $ 42,823 $ 36,850
========= =========
The accompanying notes are an integral part of the financial statements.
6
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION AND BUSINESS
ORGANIZATION--iStar Financial Inc. (the "Company") began its business in
1993 through private investment funds formed to capitalize on inefficiencies in
the real estate finance market. In March 1998, these funds contributed their
approximately $1.1 billion of assets to the Company's predecessor, Starwood
Financial Trust, in exchange for a controlling interest in that company
(collectively, the "Recapitalization Transactions"). Since that time, the
Company has grown by originating new lending and leasing transactions, as well
as through corporate acquisitions. Specifically, in September 1998, the Company
acquired the loan origination and servicing business of a major insurance
company, and in December 1998, the Company acquired the mortgage and mezzanine
loan portfolio of its largest private competitor. Additionally, in
November 1999, the Company acquired TriNet Corporate Realty Trust, Inc.
("TriNet" or the "Leasing Subsidiary"), which was then the largest publicly
traded company specializing in the net leasing of corporate office and
industrial facilities (the "TriNet Acquisition"). The TriNet Acquisition was
structured as a stock-for-stock merger of TriNet with a subsidiary of the
Company. Concurrent with the TriNet Acquisition, the Company also acquired its
external advisor (the "Advisor Transaction") in exchange for shares of common
stock of the Company ("Common Stock") and converted its organizational form to a
Maryland corporation (the "Incorporation Merger"). As part of the conversion to
a Maryland corporation, the Company replaced its dual class common share
structure with a single class of Common Stock. The Company's Common Stock began
trading on the New York Stock Exchange under the symbol "SFI" in November 1999.
During 1993 through 1997, the Company did not qualify as a real estate
investment trust ("REIT") under the Internal Revenue Code of 1986, as amended
(the "Code"). However, pursuant to a closing agreement with the Internal Revenue
Service (the "IRS") obtained in March 1998, the Company was eligible and elected
to be taxed as a REIT for the taxable year beginning January 1, 1998.
BUSINESS--The Company is the leading publicly traded finance company focused
on the commercial real estate industry. The Company provides structured
financing to private and corporate owners of real estate nationwide, including
senior and junior mortgage debt, corporate mezzanine and subordinated capital,
and corporate net lease financing. The Company seeks to deliver superior
risk-adjusted returns on equity for shareholders by providing innovative and
value-added financing solutions to its customers.
The Company has implemented its investment strategy by: (1) focusing on the
origination of large, highly structured mortgage, corporate and lease financings
where customers require flexible financial solutions, and avoiding commodity
businesses in which there is significant direct competition from other providers
of capital; (2) developing direct relationships with borrowers and corporate
tenants as opposed to sourcing transactions through intermediaries; (3) adding
value beyond simply providing capital by offering borrowers and corporate
tenants specific lending expertise, flexibility, certainty and continuing
relationships beyond the closing of a particular financing transaction; and
(4) taking advantage of market anomalies in the real estate financing markets
when the Company believes credit is mispriced by other providers of capital,
such as the spread between lease yields and the yields on corporate tenants'
underlying credit obligations.
The Company intends to continue to emphasize a mix of portfolio financing
transactions to create built-in diversification and single-asset financings for
properties with strong, long-term competitive market positions.
NOTE 2--BASIS OF PRESENTATION
The accompanying unaudited Consolidated Financial Statements have been
prepared in conformity with the instructions to Form 10-Q and Article 10,
Rule 10-01 of Regulation S-X for interim financial
7
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--BASIS OF PRESENTATION (CONTINUED)
statements. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles ("GAAP"). The
Consolidated Financial Statements include the accounts of the Company, its
qualified REIT subsidiaries, and its majority-owned and controlled partnerships.
Certain third-party mortgage servicing operations are conducted through iStar
Operating, Inc. ("iStar Operating"), a taxable corporation which is not
consolidated with the Company for financial reporting or income tax purposes.
The Company owns all of the non-voting preferred stock and a 95% economic
interest in iStar Operating, which is accounted for under the equity method for
financial reporting purposes. The Company does not own any of the outstanding
voting stock of iStar Operating. In addition, the Company has an investment in
TriNet Management Operating Company, Inc. ("TMOC"), a taxable noncontrolled
subsidiary of the Company, which is also accounted for under the equity method.
Further, certain other investments in partnerships or joint ventures which the
Company does not control are also accounted for under the equity method. All
significant intercompany balances and transactions have been eliminated in
consolidation.
In the opinion of management, the accompanying Consolidated Financial
Statements contain all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of the Company's consolidated financial
position at March 31, 2001 and December 31, 2000 and the results of its
operations, changes in shareholders' equity and its cash flows for the
three-month periods ended March 31, 2001 and 2000, respectively. Such operating
results are not necessarily indicative of the results that may be expected for
any other interim periods or the entire year.
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LOANS AND OTHER LENDING INVESTMENTS, NET--As described in Note 4, "Loans and
Other Lending Investments," includes the following investments: senior
mortgages, subordinate mortgages, corporate/ partnership loans/unsecured notes,
loan participations and other lending or similar investments. In general,
management considers its investments in this category as held-to-maturity and,
accordingly, reflects such items at amortized historical cost.
REAL ESTATE SUBJECT TO OPERATING LEASES AND DEPRECIATION--Real estate
subject to operating leases is generally recorded at cost. Certain improvements
and replacements are capitalized when they extend the useful life, increase
capacity or improve the efficiency of the asset. Repairs and maintenance items
are expensed as incurred. The Company capitalizes interest costs incurred during
the land development or construction period on qualified development projects,
including investments in joint ventures accounted for under the equity method.
Depreciation is computed using the straight line method of cost recovery over
estimated useful lives of 40.0 years for buildings, five years for furniture and
equipment, the shorter of the remaining lease term or expected life for tenant
improvements, and the remaining life of the building for building improvements.
Real estate assets to be disposed of are reported at the lower of their
carrying amount or fair value less costs to sell. The Company also periodically
reviews long-lived assets to be held and used for an impairment in value
whenever events or changes in circumstances indicate that the carrying amount of
such assets may not be recoverable. In management's opinion, real estate assets
to be held and used are not carried at amounts in excess of their estimated
recoverable amounts.
CAPITALIZED INTEREST--The Company capitalizes interest costs incurred during
the land development or construction period on qualified development projects,
including investments in joint ventures accounted for under the equity method.
Interest capitalized was approximately $201,000 and $338,000 during the three-
month periods ended March 31, 2001 and 2000, respectively.
8
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS--Cash and cash equivalents include cash held in
banks or invested in money market funds with original maturity terms of less
than 90 days.
RESTRICTED CASH--Restricted cash represents amounts required to be
maintained in escrow under certain of the Company's debt obligations.
MARKETABLE SECURITIES--From time to time, the Company invests excess working
capital in short-term marketable securities such as those issued by the
Government National Mortgage Association ("GNMA"), Federal National Mortgage
Association ("FNMA"), and Federal Home Loan Mortgage Corporation ("FHLMC").
Although the Company generally intends to hold such investments for investment
purposes, it may, from time to time, sell any of its investments in these
securities as part of its management of liquidity. Accordingly, the Company
considers such investments as "available-for-sale" and reflects such investments
at fair market value with changes in fair market value reflected as a component
of shareholders' equity.
REPURCHASE AGREEMENTS-- The Company may enter into sales of securities or
loans under agreements to repurchase the same security or loan. The amounts
borrowed under repurchase agreements are carried on the balance sheet as part of
debt obligations at the amount advanced plus accrued interest. Interest incurred
on the repurchase agreements is reported as interest expense.
REVENUE RECOGNITION--The Company's revenue recognition policies are as
follows:
LOANS AND OTHER LENDING INVESTMENTS: The Company generally intends to hold
all of its loans and other lending investments to maturity. Accordingly, it
reflects all of these investments at amortized cost less allowance for loan
losses, acquisition premiums or discounts, deferred loan fees and undisbursed
loan funds. On occasion, the Company may acquire loans at either premiums or
discounts based on the credit characteristics of such loans. These premiums or
discounts are recognized as yield adjustments over the lives of the related
loans. If loans that were acquired at a premium or discount are prepaid, the
Company immediately recognizes the unamortized premium or discount as a decrease
or increase in the prepayment gain or loss, respectively. Loan origination or
exit fees, as well as direct loan origination costs, are also deferred and
recognized over the lives of the related loans as a yield adjustment. Interest
income is recognized using the effective interest method applied on a
loan-by-loan basis.
Certain of the Company's loans provide for accrual of interest at specified
rates which differ from current payment terms. Interest is recognized on such
loans at the accrual rate subject to management's determination that accrued
interest and outstanding principal are ultimately collectible, based on the
underlying collateral and operations of the borrower.
Prepayment penalties or yield maintenance payments from borrowers are
recognized as additional income when received. Certain of the Company's loan
investments provide for additional interest based on the borrower's operating
cash flow or appreciation of the underlying collateral. Such amounts are
considered contingent interest and are reflected as income only upon certainty
of collection.
LEASING INVESTMENTS: Operating lease revenue is recognized on the
straight-line method of accounting from the later of the date of the origination
of the lease or the date of acquisition of the facility subject to existing
leases. Accordingly, contractual lease payment increases are recognized evenly
over the term of the lease. The cumulative difference between lease revenue
recognized under this method and contractual lease payment terms is recorded as
a deferred operating lease income receivable on the balance sheet.
PROVISION FOR POSSIBLE CREDIT LOSSES--The Company's accounting policies
require that an allowance for estimated credit losses be maintained at a level
that management, based upon an evaluation of known and
9
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
inherent risks in the portfolio, considers adequate to provide for possible
credit losses. Specific valuation allowances are established for impaired loans
in the amount by which the carrying value, before allowance for estimated
losses, exceeds the fair value of collateral less disposition costs on an
individual loan basis. Management considers a loan to be impaired when, based
upon current information and events, it believes that it is probable that the
Company will be unable to collect all amounts due according to the contractual
terms of the loan agreement on a timely basis. Management measures these
impaired loans at the fair value of the loans' underlying collateral less
estimated disposition costs. Impaired loans may be left on accrual status during
the period the Company is pursuing repayment of the loan; however, these loans
are placed on non-accrual status at such time that the loans either: (1) become
90 days delinquent; or (2) management determines the borrower is incapable of,
or has ceased efforts toward, curing the cause of the impairment. While on
non-accrual status, interest income is recognized only upon actual receipt.
Impairment losses are recognized as direct write-downs of the related loan with
a corresponding charge to the provision for possible credit losses. Charge-offs
occur when loans, or a portion thereof, are considered uncollectible and of such
little value that further pursuit of collection is not warranted. Management
also provides a portfolio reserve based upon its periodic evaluation and
analysis of the portfolio, historical and industry loss experience, economic
conditions and trends, collateral values and quality, and other relevant
factors.
INCOME TAXES--The Company intends to operate in a manner consistent with and
to elect to be treated as a REIT. As a REIT, the Company is subject to federal
income taxation at corporate rates on its REIT taxable income; however, the
Company is allowed a deduction for the amount of dividends paid to its
shareholders, thereby subjecting the distributed net income of the Company to
taxation at the shareholder level only. iStar Operating and TMOC are not
consolidated for federal income tax purposes and are taxed as corporations. For
financial reporting purposes, current and deferred taxes are provided for in the
portion of earnings recognized by the Company with respect to its interest in
iStar Operating and TMOC.
EARNINGS (LOSS) PER COMMON SHARES--In accordance with the Statement of
Financial Accounting Standards No. 128 ("FASB No. 128"), the Company presents
both basic and diluted earnings per share ("EPS"). Basic earnings per share
("Basic EPS") excludes dilution and is computed by dividing net income available
to common shareholders by the weighted average number of shares outstanding for
the period. Diluted earnings per share ("Diluted EPS") reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock, where such exercise or conversion
would result in a lower earnings per share amount.
USE OF ESTIMATES--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
CHANGE IN ACCOUNTING PRINCIPLE--In June 1998, the FASB issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). On June 23, 1999, the FASB voted to
defer the effectiveness of SFAS No. 133 for one year. SFAS No. 133 is now
effective for fiscal years beginning after June 15, 2000, but earlier
application is permitted as of the beginning of any fiscal quarter subsequent to
June 15, 1998. SFAS No. 133 establishes accounting and reporting standards for
derivative financial instruments and hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as:
(1) a hedge of the exposure to changes in the fair value of a recognized asset
or liability or an unrecognized firm commitment;
10
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(2) a hedge of the exposure to variable cash flows of a forecasted transaction;
or (3) in certain circumstances, a hedge of a foreign currency exposure. The
Company adopted this pronouncement, as amended by Statement of Financial
Accounting Standards No. 137 "Accounting for Derivative Instruments and Hedging
Activities--deferral of the Effective Date of FASB Statement No. 133" and
Statement of Financial Accounting Standards No. 138 "Accounting for Certain
Derivative Instruments and Certain Hedging Activities-an Amendment of FASB
Statement No. 133," on January 1, 2001. Because the Company has primarily used
derivatives as cash flow hedges of interest rate risk only, the adoption of SFAS
No. 133 did not have a material financial impact on the financial position and
results of operations of the Company. However, should the Company change its
current use of such derivatives (see Note 8), the adoption of SFAS No. 133 could
have a more significant effect on the Company prospectively.
Upon adoption, the Company recognized a charge to net income of
approximately $282,000 and an additional charge of $9.4 million to other
comprehensive income, representing the cumulative effect of the change in
accounting principle.
OTHER NEW ACCOUNTING STANDARDS--In December 1999, the Securities and
Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB
101"), "Revenue Recognition in Financial Statements." In June 2000, the SEC
staff amended SAB 101 to provide registrants with additional time to implement
SAB 101. The Company adopted SAB 101, as required, in the fourth quarter of
fiscal 2000. The adoption of SAB 101 did not have a material financial impact on
the financial position or the results of operations of the Company.
In March 2000, the FASB issued FASB Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation." The Company
was required to adopt FIN 44 effective July 1, 2000 with respect to certain
provisions applicable to new awards, exchanges of awards in a business
combination, modifications to outstanding awards, and changes in grantee status
that occur on or after that date. FIN 44 addresses practice issues related to
the application of Accounting Practice Bulletin Opinion No. 25, "Accounting for
Stock Issued to Employees." The initial adoption of FIN 44 by the Company did
not have a material impact on its consolidated financial position or results of
operations.
11
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--LOANS AND OTHER LENDING INVESTMENTS
The following is a summary description of the Company's loans and other
lending investments (in thousands) (unaudited):
CARRYING VALUE AS OF
# OF ORIGINAL PRINCIPAL ---------------------------
BORROWERS COMMITMENT BALANCES MARCH 31, DECEMBER 31,
TYPE OF INVESTMENT UNDERLYING PROPERTY TYPE IN CLASS(1) AMOUNT(1) OUTSTANDING(1) 2001 2000
- ------------------------- ------------------------- ----------- ------------ -------------- ----------- -------------
Senior Mortgages Office/Hotel/Mixed Use/ 21 $1,371,412 $1,221,411 $1,199,398 $1,210,992
Apartment/Retail/Resort/
Industrial
Subordinated Mortgages Office/Hotel/Mixed Use 13 372,136 318,816 321,968 325,558
Corporate Loans/ Office/Hotel/Residential/ 16 445,346 444,177 422,890 398,978
Partnership Loans/ Apartment/Entertainment
Unsecured Notes
Loan Participations Office/Retail 3 127,497 111,376 111,241 111,251
Other Lending Investments Resort/Office/Mixed Use/ N/A N/A N/A 196,283 192,404
Residential
---------- ----------
Gross Carrying Value $2,251,780 $2,239,183
Provision for Possible
Credit Losses (15,750) (14,000)
---------- ----------
Total, Net $2,236,030 $2,225,183
========== ==========
EFFECTIVE PRINCIPAL PARTICI-
MATURITY CONTRACTUAL INTEREST CONTRACTUAL INTEREST AMORTI- PATION
TYPE OF INVESTMENT DATES PAYMENT RATES(2) ACCRUAL RATES(3) ZATION FEATURES
- ------------------------- ------------- ----------------------- ----------------------- --------- --------
Senior Mortgages 2001 to 2019 Fixed: 6.13% to 18.00% Fixed: 6.13% to 20.00% Yes (3) Yes (4)
Variable: LIBOR + 1.50% Variable: LIBOR + 1.50%
to 9.36% to 9.36%
Subordinated Mortgages 2002 to 2007 Fixed: 7.00% to 15.25% Fixed: 10.07% to 17.00% Yes (3) Yes (4)
Variable: LIBOR + 5.80% Variable: LIBOR + 5.80%
Corporate Loans/ 2001 to 2011 Fixed: 6.13% to 15.00% Fixed: 6.13% to 17.50% Yes Yes (4)
Partnership Loans/ Variable: LIBOR + 2.78% Variable: LIBOR + 2.78%
Unsecured Notes to 7.50% to 7.50%
Loan Participations 2003 to 2005 Fixed: 10.00% to 13.60% Fixed: 13.60% to 14.00% No Yes (4)
Variable: LIBOR + 4.50% Variable: LIBOR + 4.50%
Other Lending Investments 2002 and 2013 Fixed: 6.75% to 12.75% Fixed: 6.75% to 12.75% No Yes
Gross Carrying Value
Provision for Possible
Credit Losses
Total, Net
EXPLANATORY NOTES:
- ----------------------------------
(1) Amounts and details are for loans outstanding as of March 31, 2001.
(2) Substantially all variable-rate loans are based on 30-day LIBOR and reprice
monthly. The 30-day LIBOR rate on March 30, 2001 was 5.08%
(3) The loans require fixed payments of principal and interest resulting in
partial principal amortization over the term of the loan with the remaining
principal due at maturity. In addition, one of the loans permits additional
annual prepayments of principal of up to $1.3 million without penalty at the
borrower's option.
(4) Under some of these loans, the lender receives additional payments
representing additional interest from participation in available cash flow
from operations of the property and the proceeds, in excess of a base
amount, arising from a sale or refinancing of the property.
12
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--LOANS AND OTHER LENDING INVESTMENTS (CONTINUED)
During the three-month periods ended March 31, 2001 and 2000, respectively,
the Company and its affiliated ventures originated or acquired an aggregate of
approximately $224.5 million and $211.9 million in loans and other lending
investments, funded $29.9 million and $16.5 million under existing loan
commitments, and received principal repayments of $247.4 million and
$117.6 million.
As of March 31, 2001, the Company had seven loans with unfunded commitments.
The total unfunded commitment amount was approximately $99.5 million, of which
$10.2 million was discretionary (i.e., at the Company's option) and
$89.3 million was non-discretionary.
The Company's loans and other lending investments are predominantly pledged
as collateral under either the iStar Asset Receivables secured notes, the
secured revolving facilities or secured term loans (see Note 6).
The Company has reflected provisions for possible credit losses of
approximately $1.8 million and $1.5 million in its results of operations during
the three months ended March 31, 2001 and 2000, respectively. These provisions
represent portfolio reserves based on management's evaluation of general market
conditions, the Company's internal risk management policies and credit risk
ratings system, industry loss experience, the likelihood of delinquencies or
defaults, and the underlying collateral. No direct impairment reserves on
specific loans were considered necessary. Management may transfer reserves
between general and specific reserves as considered necessary.
NOTE 5--REAL ESTATE SUBJECT TO OPERATING LEASES
The Company's investments in real estate subject to operating leases, at
cost, were as follows (in thousands) (unaudited):
MARCH 31, DECEMBER 31,
2001 2000
---------- ------------
Buildings and improvements.......................... $1,294,057 $1,294,572
Land and land improvements.......................... 344,080 344,490
Less: accumulated depreciation...................... (55,382) (46,975)
---------- ----------
1,582,755 1,592,087
Investments in unconsolidated joint ventures........ 55,262 78,082
---------- ----------
Real estate subject to operating leases,
net......................................... $1,638,017 $1,670,169
========== ==========
Under certain leases, the Company receives additional participating lease
payments to the extent gross revenues of the tenant exceed a base amount. The
Company earned no such additional participating lease payments in the
three-month periods ended March 31, 2001 and 2000, respectively. In addition,
the Company also receives reimbursements from tenants for certain facility
operating expenses.
INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED JOINT VENTURES--At March 31,
2001, the Company had investments in five joint ventures: (1) TriNet Sunnyvale
Partners L.P. ("Sunnyvale"), whose external partners are John D. O'Donnell,
Trustee, John W. Hopkins, and Donald S. Grant; (2) Corporate Technology
Associates LLC ("CTC I"), whose external member is Corporate Technology Centre
Partners LLC; (3) Sierra Land Ventures ("Sierra"), whose external joint venture
partner is Sierra-LC Land, Ltd.; (4) TriNet Milpitas Associates, LLC
("Milpitas"), whose external member is The Prudential Insurance Company of
America; and (5) ACRE Simon, L.L.C. ("ACRE"), whose external partner is William
E. Simon & Sons Realty Investments, L.L.C. These ventures were formed for the
purpose of operating, acquiring and in certain cases, developing corporate
tenant lease facilities. At March 31, 2001, all facilities held by CTC II and
TN-CP had been sold. The Company previously had an equity investment
13
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--REAL ESTATE SUBJECT TO OPERATING LEASES (CONTINUED)
in CTC II, which was sold for approximately $66.0 million in September 2000. In
connection with this sale, the note receivable from the venture was modified to
mature on December 31, 2001. The note receivable and related accrued interest
are included in Loans and Other Lending Investments at March 31, 2001 and
December 31, 2000.
At March 31, 2001, the ventures comprised 23 net leased facilities.
Additionally, 17.7 acres of land are held for sale. The Company's combined
investment in these joint ventures at March 31, 2001 was $55.3 million. The
joint ventures' purchase price for the 23 facilities owned at March 31, 2001 was
$342.2 million. The purchase price of the land held for sale was $6.8 million.
In the aggregate, the joint ventures had total assets of $375.1 million and
total liabilities of $229.8 million as of March 31, 2001, and net income of
$3.6 million for the three months ended March 31, 2001. The Company accounts for
these investments under the equity method because the Company's joint venture
partners have certain participating rights which limit the Company's control.
The Company's investments in and advances to unconsolidated joint ventures, its
percentage ownership interests, its respective income and the Company's pro rata
share of its ventures' third-party debt as of March 31, 2001 are presented below
(in thousands) (unaudited):
PRO RATA
JOINT SHARE OF
UNCONSOLIDATED OWNERSHIP EQUITY VENTURE THIRD-PARTY
JOINT VENTURE % INVESTMENT INCOME DEBT
- ----------------------------------------------------- --------- ---------- -------- -----------
Operating:
Sunnyvale.......................................... 44.7% $12,778 $ 231 $ 10,728
CTC I.............................................. 50.0% 9,198 1,023 60,942
Milpitas........................................... 50.0% 24,593 1,025 40,514
ACRE Simon......................................... 20.0% 4,987 40 6,562
Development:
Sierra............................................. 50.0% 3,706 75 724
------- ------ --------
Total.......................................... $55,262 $2,394 $119,470
======= ====== ========
Effective September 29, 2000, iStar Sunnyvale Partners, LP (the entity which
is controlled by Sunnyvale) entered into an interest rate cap agreement with
Bear Stearns Financial Products, limiting the venture's exposure to interest
rate movements on its $24.0 million LIBOR-based mortgage loan to an interest
rate cap of 9.0% through November 9, 2003.
Currently, the limited partners of Sunnyvale have the option to convert
their partnership interest into cash; however, the Company may elect to deliver
297,728 shares of Common Stock in lieu of cash. Additionally, commencing in
February 2002, subject to acceleration under certain circumstances, the venture
interest held by the external member of Milpitas may be converted into 984,476
shares of Common Stock.
Income generated from the above joint venture investments is included in
Operating Lease Income in the Consolidated Statements of Operations.
14
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--DEBT OBLIGATIONS
As of March 31, 2001 and December 31, 2000, the Company has debt obligations
under various arrangements with financial institutions as follows (in thousands)
(unaudited):
CARRYING VALUE AS OF
MAXIMUM --------------------------- STATED SCHEDULED
AMOUNT MARCH 31, DECEMBER 31, INTEREST MATURITY
AVAILABLE 2001 2000 RATES DATE
---------- ------------ ------------ -------------------------- ----------------------
SECURED REVOLVING CREDIT
FACILITIES:
Line of credit............... $ 700,000 $ 122,101 $ 284,371 LIBOR + 1.75% - 2.25% March 2005 (1)
Line of credit (2)........... 700,000 384,165 -- LIBOR + 1.40% - 2.15% January 2005
Line of credit............... 500,000 231,993 307,978 LIBOR + 1.50% - 1.75% August 2002 (1)
UNSECURED REVOLVING CREDIT
FACILITIES:
Line of credit............... 350,000 68,700 173,450 LIBOR + 1.55% May 2002 (3)
Line of credit............... 100,000 -- -- LIBOR + 2.25% January 2002 (4)
---------- ---------- ----------
Total revolving credit $2,350,000 806,959 765,799
facilities.................
==========
SECURED TERM LOANS:
Secured by real estate under operating 149,871 150,678 7.44% March 2009
leases.................................
Secured by corporate lending 60,000 60,000 LIBOR + 2.50% June 2004 (4)
investments............................
Secured by real estate under operating 77,860 77,860 LIBOR + 1.38% June 2001
leases (5).............................
Secured by real estate under operating 40,982 60,471 Fixed: 6.00%-11.38% (6)
leases.................................
---------- ----------
Total term loans......................... 328,713 349,009
Debt premiums............................ 214 51
---------- ----------
Total secured term loans................. 328,927 349,060
iStar Asset Receivables secured notes:
Class A.................................. 205,124 207,114 LIBOR + 0.30% August 2003 (7)
Class B.................................. 94,055 94,055 LIBOR + 0.50% October 2003 (7)
Class C.................................. 105,813 105,813 LIBOR + 1.00% January 2004 (7)
Class D.................................. 52,906 52,906 LIBOR + 1.45% June 2004 (7)
Class E.................................. 123,447 123,447 LIBOR + 2.75% January 2005 (7)
Class F.................................. 5,000 5,000 LIBOR + 3.15% January 2005 (7)
---------- ----------
Total iStar Asset Receivables secured 586,345 588,335
notes..................................
UNSECURED NOTES (8):
6.75% Dealer Remarketable Securities 125,000 125,000 6.75% March 2013
(9)....................................
7.30% Notes.............................. 100,000 100,000 7.30% May 2001
7.70% Notes.............................. 100,000 100,000 7.70% July 2017
7.95% Notes.............................. 50,000 50,000 7.95% May 2006
---------- ----------
Total unsecured notes.................... 375,000 375,000
Less: debt discount (10)................. (17,702) (18,490)
---------- ----------
Total unsecured notes.................... 357,298 356,510
OTHER DEBT OBLIGATIONS....................... 41,305 72,263 Various Various
---------- ----------
TOTAL DEBT OBLIGATIONS....................... $2,120,834 $2,131,967
========== ==========
15
- ------------------------------
EXPLANATORY NOTES:
(1) Includes a one-year "term-out" extension at the Company's option.
(2) On January 11, 2001, the Company closed a new $700.0 million secured
revolving credit facility. The new facility has a three-year primary term
and a one-year "term-out" extension option, and bears interest at LIBOR plus
1.40% to 2.15%, depending upon the collateral contributed to the borrowing
base.
(3) In February 2001, the Company extended the maturity of this credit facility
to May 2002.
(4) Includes a one-year extension at the Company's option.
(5) The Company provides a guarantee for 25% of the principal balance
outstanding.
(6) These mortgage loans mature at various dates through 2011.
(7) Principal payments on these bonds are a function of the principal repayments
on loan assets which collateralize these obligations. The dates indicated
above represent the expected date on which the final payment would occur for
such class based on the assumptions that the loans which collateralize the
obligations are not voluntarily prepaid, the loans are paid on their
effective maturity dates and no extensions of the effective maturity dates
of any of the loans are granted. The final maturity date for the underlying
indenture on classes A, B, C, D, E and F is September 25, 2022.
(8) The notes are callable by the Company at any time for an amount equal to the
total of principal outstanding, accrued interest and the applicable
make-whole prepayment premium.
(9) Subject to mandatory tender on March 1, 2003, to either the dealer or the
Leasing Subsidiary. The initial coupon of 6.75% applies to first five-year
term through the mandatory tender date. If tendered to the dealer, the notes
must be remarketed. The rates reset upon remarketing.
(10) These obligations were assumed as part of the TriNet Acquisition. As part
of the accounting for the purchase, these fixed rate obligations were
considered to have stated interest rates which were below the then
prevailing market rates at which the Leasing Subsidiary could issue new debt
obligations and, accordingly, the Company ascribed a market discount to each
obligation. Such discounts will be amortized as an adjustment to interest
expense using the effective interest method over the related term of the
obligations. As adjusted, the effective annual interest rates on these
obligations were 8.81%, 8.75%, 9.51% and 9.04%, for the 6.75% Dealer
Remarketable Securities, 7.30% Notes, 7.70% Notes and 7.95% Notes,
respectively.
16
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--DEBT OBLIGATIONS (CONTINUED)
Availability of amounts under the secured revolving credit facilities are
based on percentage borrowing base calculations.
Certain of the Leasing Subsidiary's debt obligations contain financial
covenants pertaining to the subsidiary. Such obligations also establish
restrictions on certain intercompany transactions between the Leasing Subsidiary
and other Company affiliates. Further, such obligations also provide for a limit
on distributions from the Leasing Subsidiary at 85% of cash flow from operations
on a rolling four-quarter basis.
On January 31, 2000, the Company closed a new unsecured revolving credit
facility. The facility is led by a major commercial bank, which committed
$50.0 million of the facility amount. On July 7, 2000, the Company increased the
facility amount to $100.0 million through syndication. The new facility has a
two-year primary term and a one-year extension, at the Company's option, and
bears interest at LIBOR plus 2.25%.
On February 4, 2000, the Company extended the term of its existing
$500.0 million secured credit facility. The Company extended the original
August 2000 maturity date to August 2002, through a one-year extension to the
facility's draw period and an additional one-year "term out" period during which
outstanding principal amortizes 25% per quarter. In connection with the
extension, the Company and the facility lender also expanded the range of assets
that the lender would accept as collateral under the facility. In exchange for
the extension and expansion, the Company agreed to increase the facility's
interest rate from LIBOR plus 1.25% to 1.50%, to a revised rate of LIBOR plus
1.50% to 1.75%, depending upon certain conditions.
On May 17, 2000, the Company closed the inaugural offering under its
proprietary matched funding program, iStar Asset Receivables ("STARS"),
Series 2000-1. In the initial transaction, a wholly-owned subsidiary of the
Company issued $896.5 million of investment grade bonds secured by the
subsidiary's assets, which had an aggregate outstanding principal balance of
approximately $1.2 billion at inception. Principal payments received on the
assets will be utilized to repay the most senior class of the bonds then
outstanding. The maturity of the bonds match funds the maturity of the
underlying assets financed under the program. The Company initially purchased
the class F bonds at a par value of $38.2 million, which the Company financed
with a $27.8 million repurchase agreement maturing in May 2001, which had a
balance of $24.5 million at March 31, 2001 and is included in other debt
obligations in the preceding table (this repurchase agreement was repaid
subsequent to the quarter ended March 31, 2001). On July 17, 2000, the Company
sold, at par, $5.0 million of the class F bonds to an institutional investor.
For accounting purposes, these transactions were treated as secured financings.
On June 20, 2000, the Company closed a $60.0 million term loan secured by a
corporate lending investment it originated in the first quarter of 2000. The new
loan replaced a $30.0 million interim facility, and effectively match funds the
expected weighted average maturity of the underlying corporate loan asset. The
loan has a three-year primary term and a one-year extension, at the Company's
option, and bears interest at LIBOR plus 2.50%.
On December 28, 2000, the Company expanded its existing $675.0 million
secured warehouse facility to $700.0 million. The Company extended the original
March 2001 maturity date to March 2005, including a one-year "term-out"
extension option to the facility's maturity during which the interest rate
spread will increase 0.25%, no additional draws under the facility will be
permitted, and the outstanding principal must amortize 25% per quarter. In
connection with the extension, the Company and the facility lender also
increased the range of collateral eligible for inclusion in the facility. Also
in connection with the extension,
17
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--DEBT OBLIGATIONS (CONTINUED)
the Company agreed to increase the facility's interest rate from LIBOR plus
1.50% to a revised rate of LIBOR plus 1.75% to 2.25%, depending upon certain
conditions.
On January 11, 2001, the Company closed a new $700.0 million secured
revolving credit facility which is led by a major commercial bank. The new
facility has a three-year primary term and one-year "term-out" extension option,
and bears interest at LIBOR plus 1.40% to 2.15%, depending upon the collateral
contributed to the borrowing base. The new facility accepts a broad range of
structured finance assets and has a final maturity of January 2005. In addition,
on February 22, 2001, the Company extended the maturity of its $350.0 million
unsecured revolving credit facility to May 2002.
During the three-month period ended March 31, 2001, the Company incurred an
extraordinary loss of approximately $1.0 million as a result of the early
retirement of certain secured debt obligations of its Leasing Subsidiary.
Future expected/scheduled maturities of outstanding long-term debt
obligations are as follows (in thousands) (unaudited):
2001 (remaining nine months)................................ $ 213,662
2002(1)..................................................... 246,894
2003........................................................ 367,878
2004(1)..................................................... 218,719
2005(1)..................................................... 638,395
Thereafter.................................................. 452,774
----------
Total principal maturities.................................. 2,138,322
Net unamortized debt (discounts)............................ (17,488)
----------
Total debt obligations...................................... $2,120,834
==========
EXPLANATORY NOTE:
- ------------------------------
(1) Assumes exercise of one-year extension option on both secured and unsecured
revolving facilities.
NOTE 7--SHAREHOLDERS' EQUITY
As described in Note 1, the Company consummated a series of transactions on
November 4, 1999 in which its class A and class B shares were exchanged into a
single class of Common Stock. The Company's charter now provides for the
issuance of up to 200.0 million shares of Common Stock, par value $0.001 per
share, and 30.0 million shares of preferred stock. As part of these
transactions, the Company adopted articles supplementary creating four series of
preferred stock designated as 9.5% Series A Cumulative Redeemable Preferred
Stock, consisting of 4.4 million shares, 9.375% Series B Cumulative Redeemable
Preferred Stock, consisting of 2.3 million shares, 9.20% Series C Cumulative
Redeemable Preferred Stock, consisting of approximately 1.5 million shares, and
8.0% Series D Cumulative Redeemable Preferred Stock, consisting of 4.6 million
shares. The Series B, C and D Cumulative Redeemable Preferred Stock were issued
in the TriNet Acquisition in exchange for similar issuances of TriNet stock then
outstanding. The Series A, B, C and D Cumulative Redeemable Preferred Stock are
redeemable without premium at the option of the Company at their respective
liquidation preferences beginning on December 15, 2003, June 15, 2001,
August 15, 2001 and October 8, 2002, respectively.
18
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--SHAREHOLDERS' EQUITY (CONTINUED)
STOCK REPURCHASE PROGRAM: The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets and excess cash
flow from operations, but also using borrowings under its credit facilities if
the Company determines that it is advantageous to do so. As of both March 31,
2001 and December 31, 2000, the Company had repurchased approximately
2.3 million shares at an aggregate cost of approximately $40.7 million.
NOTE 8--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS
RISK MANAGEMENT--In the normal course of its on-going business operations,
the Company encounters economic risk. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or different bases, than its
interest-earning assets. Credit risk is the risk of default on the Company's
loan assets that results from a property's, borrower's or tenant's inability or
unwillingness to make contractually required payments. Market risk reflects
changes in the value of loans due to changes in interest rates or other market
factors, including the rate of prepayments of principal and the value of the
collateral underlying loans and the valuation of corporate tenant lease
facilities held by the Company.
USE OF DERIVATIVE FINANCIAL INSTRUMENTS--The Company's use of derivative
financial instruments is primarily limited to the utilization of interest rate
agreements or other instruments to manage interest rate risk exposure. The
principal objective of such arrangements is to minimize the risks and/or costs
associated with the Company's operating and financial structure as well as to
hedge specific anticipated transactions. The counterparties to these contractual
arrangements are major financial institutions with which the Company and its
affiliates may also have other financial relationships. The Company is
potentially exposed to credit loss in the event of nonperformance by these
counterparties. However, because of their high credit ratings, the Company does
not anticipate that any of the counterparties will fail to meet their
obligations.
The Company has entered into a LIBOR interest rate cap struck at 7.50% in
the notional amount of $38.3 million, which expires in June 2001. In addition,
in connection with the TriNet Acquisition, the Company acquired LIBOR interest
rate caps currently struck at 7.75%, 7.75% and 7.50% in notional amounts of
$75.0 million, $35.0 million and $75.0 million, respectively, which expire in
December 2004, December 2004 and August 2001, respectively. In connection with
the closing of STARS, Series 2000-1 in May 2000, the Company entered into a
LIBOR interest rate cap struck at 10.00% in the notional amount of
$312.0 million, and simultaneously sold a LIBOR interest rate cap with the same
terms. Since these instruments do not reduce the Company's net interest rate
risk exposure, they do not qualify as hedges and changes in their respective
values are charged to earnings. As the significant terms of these arrangements
are substantially the same, the effects of a revaluation of these two
instruments are expected to substantially offset one another. In January 2001
and March 2001, two interest rate caps with notional amounts of $40.4 million
and $300.0 million, respectively, matured. At March 31, 2001 and December 31,
2000, the net fair value of the Company's interest rate caps were $0.1 million
and $0.4 million, respectively.
The Company has entered into LIBOR interest rate swaps struck at 7.055%, and
7.058%, both with notional amounts of $125.0 million that expire in June 2003.
These swaps effectively fix the interest rate on a portion of the Company's
floating-rate term loan obligations. In connection with the TriNet Acquisition,
the Company acquired an interest rate swap which, together with certain existing
interest rate cap agreements, effectively fix the interest rate on
$75.0 million of the Leasing Subsidiary's LIBOR-based borrowings at 5.58% plus
the applicable margin through December 1, 2004. Management expects that it
19
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
will have aggregate LIBOR-based borrowings at the Leasing Subsidiary in excess
of the notional amount for the duration of the swap. The actual borrowing cost
to the Company with respect to indebtedness covered by the swap will depend upon
the applicable margin over LIBOR for such indebtedness, which will be determined
by the terms of the relevant debt instruments. In January 2001 and June 2000,
interest rate swaps with notional amounts of approximately $92.0 million and
$112.0 million, respectively, matured. At March 31, 2001 and December 31, 2000,
the fair value (liability) of the Company's interest rate swaps was ($13.9)
million and ($7.7) million, respectively.
During the year ended December 31, 1999, the Company settled an aggregate
notional amount of approximately $63.0 million that was outstanding under
certain hedging agreements which the Company had entered into in order to hedge
the potential effects of interest rate movements on anticipated fixed-rate
borrowings. The settlement of such agreements resulted in a receipt of
approximately $0.6 million which had been deferred pending completion of the
planned fixed-rate financing transaction. Subsequently, the transaction was
modified and was actually consummated as a variable-rate financing transaction.
As a result, the previously deferred receipt no longer qualified for hedge
accounting treatment and the $0.6 million was recognized as a gain included in
other income in the consolidated statement of operations for the year ended
December 31, 2000 in connection with the closing of STARS, Series 2000-1 in May
2000.
During the year ended December 31, 1999, the Company refinanced its
$125.0 million term loan maturing March 15, 1999 with a $155.4 million term loan
maturing March 5, 2009. The new term loan bears interest at 7.44% per annum,
payable monthly, and amortizes over an approximately 22-year schedule. The new
term loan represented forecasted transactions for which the Company had
previously entered into U.S. Treasury-based hedging transactions. The net
$3.4 million cost of the settlement of such hedges has been deferred and is
being amortized as an increase to the effective financing cost of the new term
loan over its effective ten-year term.
CREDIT RISK CONCENTRATIONS--Concentrations of credit risks arise when a
number of borrowers or customers related to the Company's investments are
engaged in similar business activities, or activities in the same geographic
region, or have similar economic features that would cause their ability to meet
contractual obligations, including those to the Company, to be similarly
affected by changes in economic conditions. The Company regularly monitors
various segments of its portfolio to assess potential concentrations of credit
risks. Management believes the current credit risk portfolio is reasonably well
diversified and does not contain any unusual concentration of credit risks.
Substantially all of the Company's real estate subject to operating leases
(including those held by joint ventures) and loans and other lending
investments, are collateralized by facilities located in the United States, with
significant concentrations (i.e., greater than 10%) as of March 31, 2001 in
California (23.6%), Texas (16.0%) and New York (11.0)%. As of March 31, 2001,
the Company's investments also contain significant concentrations in the
following asset/collateral types: office (48.3%) and hotel/resorts (21.0%).
The Company underwrites the credit of prospective borrowers and customers
and often requires them to provide some form of credit support such as corporate
guarantees or letters of credit. Although the Company's loans and other lending
investments and corporate customer lease assets are geographically diverse and
the borrowers and customers operate in a variety of industries, to the extent
the Company has a significant concentration of interest or operating lease
revenues from any single borrower or customer, the inability of that borrower or
customer to make its payment could have an adverse effect on the Company. As of
March 31, 2001, the Company's five largest borrowers or customers collectively
accounted for approximately 21.5% of the Company's aggregate annualized interest
and operating lease revenue.
20
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--INCOME TAXES
Although originally formed to qualify as a REIT under the Code for the
purpose of making and acquiring various types of mortgage and other loans,
during 1993 through 1997, the Company failed to qualify as a REIT. As confirmed
by a closing agreement with the IRS obtained in March 1998, the Company was
eligible, elected to be taxed as a REIT and qualified for REIT status for the
tax years commencing on January 1, 1998. The Company did not incur any material
tax liabilities as a result of its operations during such years.
NOTE 10--STOCK OPTION PLANS AND EMPLOYEE BENEFITS
The Company's 1996 Long-Term Incentive Plan (the "Plan") is designed to
provide incentive compensation for officers, other key employees and directors
of the Company. The Plan provides for awards of stock options and restricted
stock and other performance awards. The maximum number of shares of Common Stock
available for awards under the Plan is 9% of the outstanding shares of Common
Stock, calculated on a fully diluted basis, from time to time; provided that the
number of shares of Common Stock reserved for grants of options designated as
incentive stock options is 5.0 million, subject to certain antidilution
provisions in the Plan. All awards under the Plan, other than automatic awards
to non-employee directors, are at the discretion of the Board or a committee of
the Board. At March 31, 2001, a total of approximately 7.8 million shares of
Common Stock were available for awards under the Plan, of which options to
purchase approximately 5.6 million shares of Common Stock were outstanding and
approximately 239,000 shares of restricted stock were outstanding.
Concurrently with the Recapitalization Transactions, the Company issued
approximately 2.5 million (as adjusted) fully vested and immediately exercisable
options to purchase class A shares at $14.72 per share (as adjusted) to the
external advisor with a term of ten years. The external advisor granted a
portion of these options to its employees and the remainder were allocated to an
affiliate. Upon consummation of the Advisor Transaction, these individuals
became employees of the Company. In general, the grants to these employees
provided for scheduled vesting over a predefined service period of three to five
years and, under certain conditions, provide for accelerated vesting. These
options expire on March 15, 2008.
In connection with the TriNet Acquisition, outstanding options to purchase
TriNet stock under TriNet's stock option plans were converted into options to
purchase shares of Common Stock on substantially the same terms, except that
both the exercise price and number of shares issuable upon exercise of the
TriNet options were adjusted to give effect to the merger exchange ratio of 1.15
shares of Common Stock for each share of TriNet common stock. In addition,
options held by the former directors of TriNet and certain executive officers
became fully vested as a result of the transaction.
Also, as a result of the TriNet Acquisition, TriNet terminated its dividend
equivalent rights program. The program called for immediate vesting and cash
redemption of all dividend equivalent rights upon a change of control of 50% or
more of the voting common stock. Concurrent with the TriNet Acquisition, all
dividend equivalent rights were vested and amounts due to former TriNet
employees of approximately $8.3 million were paid by the Company. Such payments
were included as part of the purchase price paid by the Company to acquire
TriNet for financial reporting purposes.
21
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK OPTION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
Changes in options outstanding during the three months ended March 31, 2001
are as follows:
NUMBER OF SHARES
------------------------------------ AVERAGE
NON-EMPLOYEE STRIKE
EMPLOYEES DIRECTORS OTHER PRICE
--------- ------------ --------- --------
OPTIONS OUTSTANDING, DECEMBER 31, 2000
(UNAUDITED)...................................... 3,535,572 226,379 961,163 $18.97
Granted in 2001.................................. 839,400 -- 100,000 $19.69
Exercised in 2001................................ (101,259) -- -- $15.20
Forfeited in 2001................................ (1,627) -- -- $26.63
--------- ------- ---------
OPTIONS OUTSTANDING, MARCH 31, 2001 (UNAUDITED).... 4,272,086 226,379 1,061,163
========= ======= =========
The following table summarizes information concerning outstanding and
exercisable options as of March 31, 2001 (unaudited):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
OPTIONS CONTRACTUAL EXERCISE CURRENTLY EXERCISE
EXERCISE PRICE RANGE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------------- ----------- ----------- -------- ----------- --------
$14.72 - $15.00 1,913,812(1) 6.96 $14.73 1,006,727 $14.72
$16.69 - $16.88 1,189,604 8.78 $16.86 451,548 $16.86
$17.38 - $17.56 550,000 8.96 $17.39 166,669 $ --
$19.50 - $19.75 945,650 9.76 $19.69 -- $ --
$20.63 - $21.44 258,050 6.62 $21.01 100,050 $21.13
$22.44 - $22.45 54,500 3.57 $22.44 34,500 $22.45
$23.32 - $23.64 130,180 3.38 $23.46 100,689 $23.41
$24.13 - $24.57 173,650 4.56 $24.31 173,650 $24.31
$25.22 - $26.09 34,500 3.15 $25.74 34,500 $25.74
$26.30 - $26.85 108,100 3.17 $26.74 108,100 $26.74
$28.26 - $28.54 67,113 2.96 $28.37 62,540 $28.37
$30.33 119,025 2.97 $30.33 98,906 $30.33
$33.15 - $33.70 10,350 1.72 $33.39 8,913 $33.43
$55.39 5,094 8.17 $55.39 1,698 $55.39
--------- ----- ------ --------- ------
5,559,628 7.57 $18.03 2,348,490 $18.63
========= ===== ====== ========= ======
EXPLANATORY NOTE:
- ------------------------------
(1) Includes approximately 764,000 options which were granted, on a fully
exercisable basis, in connection with the Recapitalization Transactions to
Starwood Capital Group, and were subsequently regranted by that entity to
its employees subject to vesting requirements. As a result of those vesting
requirements, less than 2,000 of these options are currently exercisable by
the beneficial owners. In the event that these employees forfeit such
options, they revert to Starwood Capital Group, who may regrant them at its
discretion.
The Company has elected to use the intrinsic method for accounting for
options issued to employees or directors, as allowed under Statement of
Financial Accounting Standards No. 123 "Accounting for Stock Based Compensation"
("SFAS No. 123") and, accordingly, recognizes no compensation charge in
connection with these options to the extent that the options exercise price
equals or exceeds the quoted price of the Company's common shares at the date of
grant or measurement date. In connection with the Advisor Transaction, as part
of the computation of the one-time charge to earnings, the Company
22
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK OPTION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
calculated a deferred compensation charge of approximately $5.1 million. This
deferred charge represents the difference of the closing sales price of the
shares of Common Stock on the date of the Advisor Transaction of $20.25 over the
strike price of the options of $14.72 per share (as adjusted) for the unvested
portion of the options granted to former employees of the Advisor who are now
employees of the Company. This deferred charge will be amortized over the
related remaining vesting terms to the individual employees as additional
compensation expense.
In connection with the original grant of options in March 1998 to the
Advisor, the Company utilized the option value method as required by SFAS
No. 123. An independent financial advisory firm estimated the value of these
options at date of grant to be approximately $2.40 per share using a
Black-Scholes valuation model. In the absence of comparable historical market
information for the Company, the advisory firm utilized assumptions consistent
with activity of a comparable peer group of companies, including an estimated
option life of five years, a 27.5% volatility rate and an estimated annual
dividend rate of 8.5%. The resulting charge to earnings was calculated as the
number of options allocated to the Advisor multiplied by the estimated value at
consummation. A charge of approximately $6.0 million was reflected in the
Company's first quarter 1998 financial results for this original grant.
Future charges may be taken to the extent of additional option grants, which
are at the discretion of the Board of Directors.
During the three-month period ended March 31, 2001, the Company granted
94,859 restricted stock units ("RSU's") to employees in lieu of cash bonuses for
the year ended December 31, 2000 at the employees' election. These RSU's were
immediately vested on the date of grant and are not transferable for a period of
one year following vesting. During the year ended December 31, 2000, the Company
granted 143,646 RSU's to employees. Of this total, 74,996 RSU's were granted in
lieu of cash bonuses at the employees' election, were immediately vested on the
date of grant, and were not transferable for a period of one year following
vesting. An additional 68,650 of such RSU's vest over periods ranging from one
to three years following the date of grant and are transferable upon vesting.
Effective November 4, 1999, the Company implemented a savings and retirement
plan (the "401 (k) Plan"), which is a voluntary, defined contribution plan. All
employees are eligible to participate in the 401 (k) Plan following completion
of six months of continuous service with the Company. Each participant may
contribute on a pretax basis between 2% and 15% of such participant's
compensation. At the discretion of the Board of Directors, the Company may make
matching contributions on the participant's behalf up to 50% of the first 10% of
the participant's annual contribution. The Company made contributions of
approximately $113,000 and $100,000 to the 401(k) Plan for the three-month
periods ended March 31, 2001 and 2000, respectively.
NOTE 11--EARNINGS PER SHARE
Prior to November 4, 1999, Basic EPS was computed based on the income
allocable to class A shares (net income reduced by accrued dividends on
preferred shares and by 1% allocated to class B shares), divided by the weighted
average number of class A shares outstanding during the period. Diluted EPS was
based on the net earnings allocable to class A shares plus dividends on class B
shares which were convertible into class A shares, divided by the weighted
average number of class A shares and dilutive potential class A shares that were
outstanding during the period. Dilutive potential class A shares included the
class B shares, which were convertible into class A shares at a rate of 49
class B shares for one class A share, and potentially dilutive options to
purchase class A shares issued to the Advisor and the Company's directors and
warrants to acquire class A shares.
23
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--EARNINGS PER SHARE (CONTINUED)
As described in Note 1, in the Incorporation Merger, the class B shares were
converted into shares of Common Stock on a 49-for-one basis (the same ratio at
which class B shares were previously convertible into class A shares), and the
class A shares were converted into shares of Common Stock on a one-for-one
basis. As a result, the Company no longer has multiple classes of common shares.
Basic and diluted earnings per share are based upon the following weighted
average shares outstanding during the three-month periods ended March 31, 2001
and 2000, respectively (in thousands):
FOR THE
THREE MONTHS
ENDED MARCH 31,
-------------------
2001 2000
-------- --------
(UNAUDITED)
Weighted average common shares outstanding for basic
earnings per common share................................. 85,833 85,087
Add effect of assumed shares issued under treasury stock
method for stock options and restricted stock units....... 1,316 362
------ ------
Weighted average common shares outstanding for diluted
earnings per common share................................. 87,149 85,449
====== ======
NOTE 12--COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS No. 130") effective for fiscal
years beginning after December 15, 1997. The statement changes the reporting of
certain items currently reported as changes in the shareholders' equity section
of the balance sheet and establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. SFAS No. 130 requires that all components of comprehensive
income shall be reported in the financial statements in the period in which they
are recognized. Furthermore, a total amount for comprehensive income shall be
displayed in the financial statements. The Company has adopted this standard
effective January 1, 1998. Total comprehensive income was $29.8 million and
$51.7 million for the three-month periods ended March 31, 2001 and 2000,
respectively. The primary component of comprehensive income other than net
income was the adoption of SFAS No. 133.
For the three months ended March 31, 2001, the change in fair market value
of the Company's interest rate swaps was $6.2 million and was recorded in other
comprehensive income. The reconciliation to other comprehensive income is as
follows (in thousands) (unaudited):
Net income.................................................. $ 45,417
Other comprehensive income (loss):
Unrealized gains (losses) on securities for the period.... --
Cumulative effect of change in accounting principle (SFAS
No. 133) on other comprehensive income.................. (9,445)
Unrealized derivative losses on cash flow hedges.......... (6,190)
--------
Other comprehensive income.................................. $ 29,782
========
NOTE 13--DIVIDENDS
In order to maintain its election to qualify as a REIT, the Company must
distribute, at a minimum, an amount equal to 90% of its taxable income and must
distribute 100% of its taxable income to avoid paying
24
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13--DIVIDENDS (CONTINUED)
corporate federal income taxes. The distribution rate was modified to 95% from
90% by the REIT Modernization Act beginning in fiscal 2001. The Company
anticipates it will distribute all of its taxable income to its shareholders.
Because taxable income differs from cash flow from operations due to non-cash
revenues or expenses, in certain circumstances, the Company may be required to
borrow to make sufficient dividend payments to meet this anticipated dividend
threshold.
On November 4, 1999, the class A shares were converted into shares of Common
Stock on a one-for-one basis. In November 1999, the Company declared and paid a
dividend of a total of one million shares of Common Stock pro rata to all
holders of record of Common Stock as of the close of business on November 3,
1999. For the year ended December 31, 2000, total dividends declared by the
Company aggregated $205.5 million, or $2.40 per common share. On April 2, 2001,
the Company declared a dividend of approximately $52.6 million, or $0.6125 per
common share applicable to the three-month period ended March 31, 2001 and
payable to shareholders of record on April 16, 2001. The Company also declared
dividends aggregating $5.2 million, $1.2 million, $0.7 million and
$2.0 million, respectively, on its Series A, B, C and D preferred stock,
respectively, for the three-month period ended March 31, 2001. There are no
divided arrearages on any of the preferred shares currently outstanding.
The Series A preferred stock has a liquidation preference of $50.00 per
share and carries an initial dividend yield of 9.50% per annum. The dividend
rate on the preferred shares will increase to 9.75% on December 15, 2005, to
10.00% on December 15, 2006 and to 10.25% on December 15, 2007 and thereafter.
Dividends on the Series A preferred shares are payable quarterly in arrears and
are cumulative.
Holders of shares of the Series B preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 9.375% per annum of the $25.00 liquidation preference, equivalent to a fixed
annual rate of $2.34 per share. Dividends are cumulative from the date of
original issue and are payable quarterly in arrears on or before the 15th day of
each March, June, September and December or, if not a business day, the next
succeeding business day. Any dividend payable on the Series B preferred stock
for any partial dividend period will be computed on the basis of a 360-day year
consisting of twelve 30-day months. Dividends will be payable to holders of
record as of the close of business on the first day of the calendar month in
which the applicable dividend payment date falls or on another date designated
by the Board of Directors of the Company for the payment of dividends that is
not more than 30 nor less than ten days prior to the dividend payment date.
Holders of shares of the Series C preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 9.20% per annum of the $25.00 liquidation preference, equivalent to a fixed
annual rate of $2.30 per share. The remaining terms relating to dividends of the
Series C preferred stock are substantially identical to the terms of the
Series B preferred stock described above.
Holders of shares of the Series D preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 8.00% per annum of the $25.00 liquidation preference, equivalent to a fixed
annual rate of $2.00 per share. The remaining terms relating to dividends of the
Series D preferred stock are substantially identical to the terms of the
Series B preferred stock described above.
The exact amount of future quarterly dividends to common shareholders will
be determined by the Board of Directors based on the Company's actual and
expected operations for the fiscal year and the Company's overall liquidity
position.
25
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--SEGMENT REPORTING
Statement of Financial Accounting Standard No. 131 ("SFAS No. 131")
establishes standards for the way the public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected financial information about operating
segments in interim financial reports issued to shareholders.
The Company has two reportable segments: Real Estate Lending and Corporate
Tenant Leasing. The Company does not have substantial foreign operations. The
accounting policies of the segments are the same as those described in Note 3.
The Company has no single customer that accounts for 10% or more of revenues
(see Note 8 for other information regarding concentrations of credit risk).
The Company evaluates performance based on the following financial measures
for each segment. Selected results of operations for the three months ended
March 31, 2001 and 2000 and selected asset information as of March 31, 2001 and
December 31, 2000 regarding the Company's operating segments are as follows (in
thousands):
CORPORATE
REAL ESTATE TENANT CORPORATE/ COMPANY
LENDING LEASING(1) OTHER(2) TOTAL
----------- ---------- ---------- ----------
(UNAUDITED)
Total revenues(3):
Three months ended:
March 31, 2001................................ $ 72,333 $ 49,633 $ 653 $ 122,619
March 31, 2000................................ 60,083 46,272 4,533 110,888
Total operating and interest expense(4):
Three months ended:
March 31, 2001................................ $ 32,722 $ 27,432 $ 6,962 $ 67,116
March 31, 2000................................ 22,517 29,080 7,477 59,074
Net operating income before minority
interests(5):
Three months ended:
March 31, 2001................................ $ 39,611 $ 22,201 $ (6,309) $ 55,503
March 31, 2000................................ 37,566 17,192 (2,944) 51,814
Total long-lived assets(6):
March 31, 2001................................ $2,236,030 $1,638,017 N/A $3,874,047
December 31, 2000............................. 2,225,183 1,670,169 N/A 3,895,352
Total assets:
March 31, 2001................................ $2,236,030 $1,638,017 $139,845 $4,013,892
December 31, 2000............................. 2,225,183 1,670,169 139,423 4,034,775
EXPLANATORY NOTES:
- ------------------------------
(1) Includes the Company's pre-existing Corporate Tenant Leasing investments
since March 18, 1998 and the Corporate Tenant Leasing business acquired in
the TriNet Acquisition since November 4, 1999.
(2) Corporate and Other represents all corporate level items, including general
and administrative expenses and any intercompany eliminations necessary to
reconcile to the consolidated Company totals. This caption also includes the
Company's servicing business, which is not considered a material separate
segment.
(3) Total revenues represents all revenues earned during the period from the
assets in each segment. Revenue from the Real Estate Lending business
primarily represents interest income and revenue from the Corporate Tenant
Leasing business primarily represents operating lease income.
(4) Total operating and interest expense represents provision for possible
credit losses for the Real Estate Lending business and operating costs on
corporate tenant lease assets for the Corporate Tenant Leasing business, as
well as interest expense
26
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--SEGMENT REPORTING (CONTINUED)
specifically related to each segment. General and administrative expense,
advisory fees (prior to November 4, 1999) and stock option compensation
expense is included in Corporate and Other for all periods. Depreciation and
amortization of $8,808 and $9,009 for the three-month periods ended
March 31, 2001 and 2000, respectively, are included in the amounts presented
above.
(5) Net operating income before minority interests represents net operating
income before minority interest, gain on sale of corporate tenant lease
assets and extraordinary loss as defined in note (3) above, less total
operating and interest expense, as defined in note (4) above.
(6) Total long-lived assets is comprised of Loans and Other Lending Investments,
net and Real Estate Subject to Operating Leases, net, for each respective
segment.
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
As discussed in Note 1 to the Company's Consolidated Financial Statements,
on March 18, 1998, the Company completed the Recapitalization Transactions
which, among other things, substantially recapitalized the Company and modified
its investment policy.
Immediately prior to the consummation of the Recapitalization Transactions,
the Company's assets primarily consisted of approximately $11.0 million in
short-term, liquid real estate investments, cash and cash equivalents.
On December 15, 1998, the Company sold $220.0 million of preferred shares
and warrants to purchase class A shares to a group of investors affiliated with
Lazard Freres. Concurrent with the sale of the preferred shares and warrants,
the Company purchased $280.3 million in real estate loans and participation
interests from a group of investors also affiliated with Lazard Freres. These
transactions are referred to collectively as the "Lazard Transaction."
As discussed in Note 1 to the Company's Consolidated Financial Statements,
on November 3, 1999, the Company's shareholders approved a series of
transactions including: (1) the acquisition of TriNet; (2) the acquisition of
the Company's external advisor; and (3) the reorganization of the Company from a
trust to a corporation and the exchange of the class A and class B shares for
Common Stock. Pursuant to the TriNet acquisition, TriNet merged with and into a
subsidiary of the Company, with TriNet surviving as a wholly-owned subsidiary of
the Company. In the acquisition, each share of common stock of TriNet was
converted into 1.15 shares of Common Stock. Each share of TriNet Series A,
Series B and Series C Cumulative Redeemable Preferred Stock was converted into a
share of Series B, Series C or Series D (respectively) Cumulative Redeemable
Preferred Stock of the Company. The Company's preferred stock issued to the
former TriNet preferred shareholders has substantially the same terms as the
TriNet preferred stock, except that the new Series B, C and D preferred shares
have additional voting rights not associated with the TriNet preferred stock.
The Company's Series A Preferred Stock remained outstanding with the same rights
and preferences as existed prior to the TriNet acquisition. As a consequence of
the acquisition of its external advisor, the Company is now internally-managed
and no longer pays external advisory fees.
The transactions described above and other related transactions have
materially impacted the historical operations of the Company. Accordingly, the
reported historical financial information for periods prior to these
transactions is not believed to be fully indicative of the Company's future
operating results or financial condition.
RESULTS OF OPERATIONS
THREE-MONTH PERIOD ENDED MARCH 31, 2001 COMPARED TO THE THREE-MONTH PERIOD ENDED
MARCH 31, 2000
INTEREST INCOME--Interest income increased to approximately $66.9 million
for the three months ended March 31, 2001 from approximately $60.1 million for
the same period in 2000. This increase in interest income is a result of a
higher average balance of loans and other lending investments due to $733.7
million of newly-originated loan investments subsequent to March 31, 2000 and an
additional $99.5 million funded under existing loan commitments. The increase
was partially offset by a reduction in interest earned as a result of principal
repayments of approximately $649.0 million made to the Company on its loan
investments during the same period.
OPERATING LEASE INCOME--Operating lease income increased to approximately
$49.5 million for the three months ended March 31, 2001 from approximately
$46.3 million for the same period in 2000. Of this increase, $3.0 million was
attributable to new corporate tenant lease investments made after March 31, 2000
and $1.1 million to additional operating lease income from existing corporate
tenant lease investments owned in both quarters. In addition, joint venture
income contributed $1.9 million to the increase. These increases in operating
lease income from assets owned were partially offset by a
28
$2.8 million decrease in operating lease income resulting from asset
dispositions made after March 31, 2000.
OTHER INCOME--Included in other income for three-month period ended
March 31, 2001 are participation payments of approximately $2.1 million,
advisory fees of approximately $868,000, and a prepayment penalty of
approximately $725,000 on a payoff of a senior mortgage.
INTEREST EXPENSE--The Company's interest expense increased by $8.6 million
for the three months ended March 31, 2001 over the same period in the prior
year. The increase was in part due to higher average aggregate borrowings by the
Company on its credit facilities, other term loans and secured notes, the
proceeds of which were used to fund additional investments.
OPERATING COSTS-CORPORATE TENANT LEASE ASSETS--For the three months ended
March 31, 2001, property operating costs associated with corporate tenant lease
assets decreased by approximately $89,000 to approximately $3.2 million, net of
recoveries from corporate tenants. Such operating costs represent unreimbursed
operating expenses associated with corporate tenant lease assets.
DEPRECIATION AND AMORTIZATION--Depreciation and amortization decreased by
approximately $201,000 to $8.8 million for the three months ended March 31, 2001
over the same period in the prior year. This decrease is primarily the result of
corporate tenant lease dispositions in 2000, partially offset by additional
investments.
GENERAL AND ADMINISTRATIVE--The Company's general and administrative
expenses during the three months ended March 31, 2001 decreased by approximately
$801,000 to $6.1 million compared to the same period in 2000. These decreases
were generally the result of the increased efficiency of the Company's
operations after the acquisition of TriNet for a full year.
PROVISION FOR POSSIBLE CREDIT LOSSES--The Company's charge for provision for
possible credit losses increased to $1.8 million from $1.5 million as a result
of expanded lending operations as well as additional seasoning of the Company's
existing lending portfolio. As more fully discussed in Note 4 to the Company's
Consolidated Financial Statements, the Company has not realized any actual
losses on any of its loan investments to date. However, the Company has
considered it prudent to establish a policy of providing reserves for potential
losses in the current portfolio which may occur in the future. Accordingly,
since its first full quarter as a public company (the quarter ended June 30,
1998), management has reflected quarterly provisions for possible credit losses
in its operating results. The Company will continue to recognize quarterly
provisions until a stabilized reserve level is attained.
STOCK-BASED COMPENSATION EXPENSE--Stock compensation expense increased by
approximately $312,000 as a result of charges relating to grants of stock
options to non-employees, in addition to grants of stock options to the
Company's employees, including amortization of the deferred charge related to
options granted to employees of the Company's former external advisor subsequent
to such personnel becoming direct employees of the Company as of November 4,
1999.
GAIN ON SALE OF CORPORATE TENANT LEASE ASSETS--On March 29, 2001, the
Company disposed of one corporate tenant lease asset for total proceeds of
$3.9 million, and recognized a gain of approximately $555,000.
During the first quarter of 2000, the Company disposed of two assets for
total proceeds of $46.0 million, and recognized gains of approximately $533,000.
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT--In March 2001, the
Company repaid the 1994 mortgage loan which had an original maturity date of
December 2004. In connection with this early repayment, the Company incurred
certain prepayment penalties, which resulted in an extraordinary loss of
$1.0 million during the first quarter of 2001.
Prior to the prepayment, and during the first quarter of 2000, certain of
the proceeds from an asset disposition were used to partially repay
$8.1 million of the 1994 Mortgage Loan. In connection with this partial paydown,
the Company incurred certain prepayment penalties, which resulted in additional
extraordinary loss of $317,000.
29
INTEREST RATE RISK MANAGEMENT
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. In
pursuing its business plan, the primary market risk to which the Company is
exposed is interest rate risk. Consistent with its liability management
objectives, the Company has implemented an interest rate risk management policy
based on match funding, with the objective that floating-rate assets be
primarily financed by floating-rate liabilities and fixed-rate assets be
primarily financed by fixed-rate liabilities.
The Company's operating results will depend in part on the difference
between the interest and related income earned on its assets and the interest
expense incurred in connection with its interest-bearing liabilities.
Competition from other providers of real estate financing may lead to a decrease
in the interest rate earned on the Company's interest-bearing assets, which the
Company may not be able to offset by obtaining lower interest costs on its
borrowings. Changes in the general level of interest rates prevailing in the
financial markets may affect the spread between the Company's interest-earning
assets and interest-bearing liabilities. Any significant compression of the
spreads between interest-earning assets and interest-bearing liabilities could
have a material adverse effect on the Company. In addition, an increase in
interest rates could, among other things, reduce the value of the Company's
interest-bearing assets and its ability to realize gains from the sale of such
assets, and a decrease in interest rates could reduce the average life of the
Company's interest-earning assets.
A substantial portion of the Company's loan investments are subject to
significant prepayment protection in the form of lock-outs, yield maintenance
provisions or other prepayment premiums which provide substantial yield
protection to the Company. Those assets generally not subject to prepayment
penalties include: (1) variable-rate loans based on LIBOR, originated or
acquired at par, which would not result in any gain or loss upon repayment; and
(2) discount loans and loan participations acquired at discounts to face values,
which would result in gains upon repayment. Further, while the Company generally
seeks to enter into loan investments which provide for substantial prepayment
protection, in the event of declining interest rates, the Company could receive
such prepayments and may not be able to reinvest such proceeds at favorable
returns. Such prepayments could have an adverse effect on the spreads between
interest-earning assets and interest-bearing liabilities.
While the Company has not experienced any significant credit losses, in the
event of a significant rising interest rate environment and/or economic
downturn, defaults could increase and result in credit losses to the Company
which adversely affect its liquidity and operating results. Further, such
delinquencies or defaults could have an adverse effect on the spreads between
interest-earning assets and interest-bearing liabilities.
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political
conditions, and other factors beyond the control of the Company. As more fully
discussed in Note 8 to the Company's Consolidated Financial Statements, the
Company employs match funding-based hedging strategies to limit the effects of
changes in interest rates on its operations, including engaging in interest rate
caps, floors, swaps, futures and other interest rate-related derivative
contracts. These strategies are specifically designed to reduce the Company's
exposure, on specific transactions or on a portfolio basis, to changes in cash
flows as a result of interest rate movements in the market. The Company does not
enter into derivative contracts for speculative purposes nor as a hedge against
changes in credit risk of its borrowers or of the Company itself.
Each interest rate cap or floor agreement is a legal contract between the
Company and a third party (the "counterparty"). When the Company purchases a cap
or floor contract, the Company makes an up-front payment to the counterparty and
the counterparty agrees to make payments to the Company in the future should the
reference rate (typically one- or three-month LIBOR) rise above (cap agreements)
or fall below (floor agreements) the "strike" rate specified in the contract.
Each contract has a notional face amount. Should the reference rate rise above
the contractual strike rate in a cap, the Company will earn cap income. Should
the reference rate fall below the contractual strike rate in a floor, the
Company
30
will earn floor income. Payments on an annualized basis will equal the
contractual notional face amount multiplied by the difference between the actual
reference rate and the contracted strike rate. The cost of the up-front payment
is amortized over the term of the contract.
Interest rate swaps are agreements in which a series of interest rate flows
are exchanged over a prescribed period. The notional amount on which swaps are
based is not exchanged. In general, the Company's swaps are "pay fixed" swaps
involving the exchange of floating-rate interest payments from the counterparty
for fixed interest payments from the Company.
Interest rate futures are contracts, generally settled in cash, in which the
seller agrees to deliver on a specified future date the cash equivalent of the
difference between the specified price or yield indicated in the contract and
the value of that of the specified instrument (e.g., U.S. Treasury securities)
upon settlement. The Company generally uses such instruments to hedge forecasted
fixed-rate borrowings. Under these agreements, the Company will generally
receive additional cash flow at settlement if interest rates rise and pay cash
if interest rates fall. The effects of such receipts or payments will be
deferred and amortized over the term of the specific related fixed-rate
borrowings. In the event that, in the opinion of management, it is no longer
probable that a forecasted transaction will occur under terms substantially
equivalent to those projected, the Company will cease recognizing such
transactions as hedges and immediately recognize related gains or losses based
on actual settlement or estimated settlement value.
While a REIT may freely utilize the types of derivative instruments
discussed above to hedge interest rate risk on its liabilities, the use of
derivatives for other purposes, including hedging asset-related risks such as
credit, prepayment or interest rate exposure on the Company's loan assets, could
generate income which is not qualified income for purposes of maintaining REIT
status. As a consequence, the Company may only engage in such instruments to
hedge such risks on a limited basis.
There can be no assurance that the Company's profitability will not be
adversely affected during any period as a result of changing interest rates. In
addition, hedging transactions using derivative instruments involve certain
additional risks such as counterparty credit risk, legal enforceability of
hedging contracts and the risk that unanticipated and significant changes in
interest rates will cause a significant loss of basis in the contract. With
regard to loss of basis in a hedging contract, indices upon which contracts are
based may be more or less variable than the indices upon which the hedged assets
or liabilities are based, thereby making the hedge less effective. The
counterparties to these contractual arrangements are major financial
institutions with which the Company and its affiliates may also have other
financial relationships. The Company is potentially exposed to credit loss in
the event of nonperformance by these counterparties. However, because of their
high credit ratings, the Company does not anticipate that any of the
counterparties will fail to meet their obligations. There can be no assurance
that the Company will be able to adequately protect against the foregoing risks
and that the Company will ultimately realize an economic benefit from any
hedging contract it enters into which exceeds the related costs incurred in
connection with engaging in such hedges.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to fund its investment activities and operating
expenses. The Company has significant access to capital resources to fund its
existing business plan, which includes the expansion of its real estate lending
and corporate tenant leasing businesses. The Company's capital sources include
cash flow from operations, borrowings under lines of credit, additional term
borrowings, long-term financing secured by the Company's assets, unsecured
financing and the issuance of common, convertible and /or preferred equity
securities. Further, the Company may acquire other businesses or assets using
its capital stock, cash or a combination thereof.
The distribution requirements under the REIT provisions of the Code limit
the Company's ability to retain earnings and thereby replenish capital committed
to its operations. However, the Company believes that its significant capital
resources and access to financing will provide it with financial flexibility and
market responsiveness at levels sufficient to meet current and anticipated
capital requirements, including expected new lending and leasing transactions.
31
The Company's ability to meet its long-term (i.e., beyond one year)
liquidity requirements is subject to the renewal of its credit lines and /or
obtaining other sources of financing, including issuing additional debt or
equity from time to time. Any decision by the Company's lenders and investors to
enter into such transactions with the Company will depend upon a number of
factors, such as compliance with the terms of its existing credit arrangements,
the Company's 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
such capital commitments and the relative attractiveness of alternative
investment or lending opportunities.
Based on its monthly interest and other expenses, monthly cash receipts,
existing investment commitments and funding plans, the Company believes that its
existing sources of funds will be adequate for purposes of meeting its short-
and long-term liquidity needs. Material increases in monthly interest expense or
material decreases in monthly cash receipts would negatively impact the
Company's liquidity. On the other hand, material decreases in monthly interest
expense would positively affect the Company's liquidity.
As more fully discussed in Note 6 to the Company's Consolidated Financial
Statements, at March 31, 2001, the Company had existing fixed-rate borrowings of
approximately $149.9 million secured by real estate under operating leases which
mature in 2009, an aggregate of approximately $137.9 million in LIBOR-based,
variable-rate loans secured by subordinate mortgage investments and real estate
under operating leases which mature between fiscal 2001 and 2003, fixed-rate
corporate debt obligations aggregating approximately $357.3 million which mature
between 2001 and 2017, and other variable- and fixed-rate secured debt
obligations aggregating approximately $82.3 million which mature at various
dates through 2010.
In addition, the Company has entered into LIBOR-based secured revolving
credit facilities of $700.0 million, $700.0 million and $500.0 million,
respectively, which expire in fiscal 2005, 2005 and 2002, respectively. The
maturities of these secured revolving facilities include a one-year "term-out"
extension at the Company's option. As of March 31, 2001, the Company had drawn
approximately $122.1 million, $384.2 million and $232.0 million under these
facilities, respectively. Availability under these facilities is based on
collateral provided under a borrowing base calculation. The Company also has two
unsecured credit facilities totaling $450.0 million. The $100.0 million facility
had no outstanding balance as of March 31, 2001, matures in January 2002, which
includes a one-year extension option and bears interest at LIBOR plus 2.25%. In
addition, the Leasing Subsidiary's $350.0 million unsecured credit facility had
a balance of $68.7 million as of March 31, 2001, matures on May 31, 2002 and
bears interest at LIBOR plus 1.55%. In February 2001, the Company extended the
maturity of this credit facility to May 2002. Under the terms of the this
facility, the Leasing Subsidiary is generally permitted to make cash
distributions to the Company in an amount equal to 85% of cash flow from
operations in any rolling four-quarter period. On February 22, 2001, the Company
extended the term of this facility to May 2002.
The Company has entered into a LIBOR interest rate cap struck at 7.50% in
the notional amount of $38.3 million, which expires in June 2001. In addition,
in connection with the TriNet Acquisition, the Company acquired LIBOR interest
rate caps currently struck at 7.75%, 7.75% and 7.50% in notional amounts of
$75.0 million, $35.0 million and $75.0 million, respectively, which expire in
December 2004, December 2004 and August 2001, respectively. In connection with
the closing of STARS, Series 2000-1 in May 2000, the Company entered into a
LIBOR interest rate cap struck at 10.00% in the notional amount of
$312.0 million, and simultaneously sold a LIBOR interest rate cap with the same
terms. Since these instruments do not reduce the Company's net interest rate
risk exposure, they do not qualify as hedges and changes in their respective
values are charged to earnings. As the significant terms of these arrangements
are substantially the same, the effects of a revaluation of these two
instruments are expected to substantially offset one another. In January 2001
and March 2001, two interest rate caps with notional amounts of $40.4 million
and $300.0 million, respectively, matured. At March 31, 2001 and December 31,
2000, the net fair value of the Company's interest rate caps were $0.1 million
and $0.4 million, respectively.
32
The Company has entered into LIBOR interest rate swaps struck at 7.055%, and
7.058%, both with notional amounts of $125.0 million that expire in June 2003.
These swaps effectively fix the interest rate on a portion of the Company's
floating-rate term loan obligations. In connection with the TriNet Acquisition,
the Company acquired an interest rate swap which, together with certain existing
interest rate cap agreements, effectively fix the interest rate on
$75.0 million of the Leasing Subsidiary's LIBOR-based borrowings at 5.58% plus
the applicable margin through December 1, 2004. Management expects that it will
have aggregate LIBOR-based borrowings at the Leasing Subsidiary in excess of the
notional amount for the duration of the swap. The actual borrowing cost to the
Company with respect to indebtedness covered by the swap will depend upon the
applicable margin over LIBOR for such indebtedness, which will be determined by
the terms of the relevant debt instruments. In January 2001 and June 2000,
interest rate swaps with notional amounts of approximately $92.0 million and
$112.0 million, respectively, matured. At March 31, 2001 and December 31, 2000,
the fair value (liability) of the Company's remaining interest rate swaps was
($13.9) million and ($7.7) million, respectively.
On January 31, 2000, the Company closed a new unsecured revolving credit
facility. The facility is led by a major commercial bank, which committed
$50.0 million of the facility amount. On July 7, 2000, the Company increased the
facility amount to $100.0 million through syndication. The new facility has a
two-year primary term and a one-year extension, at the Company's option, and
bears interest at LIBOR plus 2.25%.
On February 4, 2000, the Company extended the term of its existing
$500.0 million secured credit facility. The Company extended the original
August 2000 maturity date to August 2002, through a one-year extension to the
facility's draw period and an additional one-year "term out" period during which
outstanding principal amortizes 25% per quarter. In connection with the
extension, the Company and the facility lender also expanded the range of assets
that the lender would accept as collateral under the facility. In exchange for
the extension and expansion, the Company agreed to increase the facility's
interest rate from LIBOR plus 1.25% to 1.50%, to a revised rate of LIBOR plus
1.50% to 1.75%, depending upon certain conditions.
On May 17, 2000, the Company closed the inaugural offering under its
proprietary matched funding program, STARS, Series 2000-1. In the initial
transaction, a wholly-owned subsidiary of the Company issued $896.5 million of
investment grade bonds secured by the subsidiary's assets, which had an
aggregate outstanding principal balance of approximately $1.2 billion at
inception. Principal payments received on the assets will be utilized to repay
the most senior class of the bonds then outstanding. The maturity of the bonds
match funds the maturity of the underlying assets financed under the program.
The Company initially purchased the class F bonds at a par value of
$38.2 million, which the Company financed with a $27.8 million repurchase
agreement maturing in May 2001, which had a balance of $24.5 million at
March 31, 2001 and is included in other debt obligations in the preceding table
(this repurchase agreement was repaid subsequent to the quarter ended March 31,
2001). On July 17, 2000, the Company sold, at par, $5.0 million of the class F
bonds to an institutional investor. For accounting purposes, these transactions
were treated as secured financings.
On June 20, 2000, the Company closed a $60.0 million term loan secured by a
corporate lending investment it originated in the first quarter of 2000. The new
loan replaced a $30.0 million interim facility, and effectively match funds the
expected weighted average maturity of the underlying corporate loan asset. The
loan has a three-year primary term and a one-year extension, at the Company's
option, and bears interest at LIBOR plus 2.50%.
On December 28, 2000, the Company expanded its existing $675.0 million
secured warehouse facility to $700.0 million. The Company extended the original
March 2001 maturity date to March 2005, including a one-year "term-out"
extension option to the facility's maturity during which the interest rate
spread will increase 0.25%, no additional draws under the facility will be
permitted, and the outstanding principal must amortize 25% per quarter. In
connection with the extension, the Company and the facility lender also
increased the range of collateral eligible for inclusion in the facility. Also
in connection with the extension,
33
the Company agreed to increase the facility's interest rate from LIBOR plus
1.50% to a revised rate of LIBOR plus 1.75% to 2.25%, depending upon certain
conditions.
On January 11, 2001, the Company closed a new $700.0 million secured
revolving credit facility which is led by a major commercial bank. The new
facility has a three-year primary term and one-year "term-out" extension option,
and bears interest at LIBOR plus 1.40% to 2.15%, depending upon the collateral
contributed to the borrowing base. The new facility accepts a broad range of
structured finance assets and has a final maturity of January 2005. In addition,
on February 22, 2001, the Company also extended the maturity of its
$350.0 million unsecured revolving credit facility to May 2002.
STOCK REPURCHASE PROGRAM: The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets and excess cash
flow from operations, but also using borrowings under its credit facilities if
the Company determines that it is advantageous to do so. As of both March 31,
2001 and December 31, 2000, the Company had repurchased approximately
2.3 million shares at an aggregate cost of approximately $40.7 million.
ADJUSTED EARNINGS
Adjusted earnings represents net income computed in accordance with GAAP,
before gains (losses) on sales of corporate tenant lease assets, extraordinary
items and cumulative effect, plus depreciation and amortization, less preferred
stock dividends, and after adjustments for unconsolidated partnerships and joint
ventures. Adjustments for unconsolidated partnerships and joint ventures are
calculated to reflect adjusted earnings on the same basis.
The Company believes that to facilitate a clear understanding of the
historical operating results of the Company, adjusted earnings should be
examined in conjunction with net income as shown in the Consolidated Statements
of Operations. Adjusted earnings should not be considered as an alternative to
net income (determined in accordance with GAAP) as an indicator of the Company's
performance, or to cash flows from operating activities (determined in
accordance with GAAP) as a measure of the Company's liquidity, nor is it
indicative of funds available to fund the Company's cash needs.
FOR THE
THREE MONTHS
ENDED MARCH 31,
----------------------
2001 2000
-------- --------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
(UNAUDITED)
Adjusted earnings:
Net income................................................ $54,644 $51,989
Add: Depreciation......................................... 8,808 9,009
Add: Allocated share of joint venture depreciation........ 951 610
Add: Amortization of deferred financing costs............. 5,542 2,234
Less: Preferred dividends................................. (9,227) (9,227)
Add: Cumulative effect of change in accounting
principle (1)........................................... 282 --
Less: Gain on sale of corporate tenant lease assets....... (555) (533)
Add: Extraordinary loss-early extinguishment of debt...... 1,037 317
------- -------
Adjusted earnings allocable to common shareholders:
Basic..................................................... $61,482 $54,399
======= =======
Diluted................................................... $61,722 $54,399
======= =======
Adjusted earnings per common share:
Basic..................................................... $ 0.72 $ 0.64
======= =======
Diluted................................................... $ 0.71 $ 0.64
======= =======
EXPLANATORY NOTE:
- ------------------------------
(1) Represents one-time effect of adoption of Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" as of January 1, 2001.
34
NEW ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). On June 23, 1999, the FASB voted to defer the effectiveness of SFAS
No. 133 for one year. SFAS No. 133 is now effective for fiscal years beginning
after June 15, 2000, but earlier application is permitted as of the beginning of
any fiscal quarter subsequent to June 15, 1998. SFAS No. 133 establishes
accounting and reporting standards for derivative financial instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a derivative may
be specifically designated as: (1) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized firm
commitment; (2) a hedge of the exposure to variable cash flows of a forecasted
transaction; or (3) in certain circumstances a hedge of a foreign currency
exposure. The Company adopted this pronouncement, as amended by Statement of
Financial Accounting Standards No. 137 "Accounting for Derivative Instruments
and Hedging Activities--deferral of the Effective Date of FASB Statement
No. 133" and Statement of Financial Accounting Standards No. 138 "Accounting for
Certain Hedging Activities-an Amendment of FASB No. 133," January 1, 2001.
Because the Company has primarily used derivatives as cash flow hedges of
interest rate risk only, the adoption of SFAS No. 133 did not have a material
financial impact on the financial position and results of operations of the
Company. However, should the Company change its current use of such derivatives
(see Note 8), the adoption of SFAS No. 133 could have a more significant effect
on the Company prospectively.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." In June 2000, the SEC staff amended SAB 101 to provide registrants
with additional time to implement SAB 101. The Company adopted SAB 101, as
required, in the fourth quarter of fiscal 2000. The adoption of SAB 101 did not
have a material financial impact on the financial position or results of
operations of the Company.
In March 2000, the FASB issued FASB Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation." The Company
was required to adopt FIN 44 effective July 1, 2000 with respect to certain
provisions applicable to new awards, exchanges of awards in a business
combination, modifications to outstanding awards, and changes in grantee status
that occur on or after that date. FIN 44 addresses practice issues related to
the application of Accounting Practice Bulletin Opinion No. 25, "Accounting for
Stock Issued to Employees." The initial adoption of FIN 44 by the Company did
not have a material impact on its consolidated financial position or results of
operations.
OTHER MATTERS
1940 ACT EXEMPTION
The Company at all times intends to conduct its business so as to not become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, then the
Company's ability to use leverage would be substantially reduced. The Investment
Company Act exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate" (i.e., "Qualifying Interests"). Under the current interpretation of
the staff of the SEC, in order to qualify for this exemption, the Company must
maintain at least 55% of its assets directly in Qualifying Interests. As of
March 31, 2001, the Company calculates that it is in and has maintained
compliance with this requirement.
FORWARD LOOKING STATEMENTS
When used in this Form 10-Q, in future SEC filings or in press releases or
other written or oral communications, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward looking
35
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. The Company cautions that such forward looking statements speak only as
of the date made and that various factors including regional and national
economic conditions, changes in levels of market interest rates, credit and
other risks of lending and investment activities, and competitive and regulatory
factors could affect the Company's financial performance and could cause actual
results for future periods to differ materially from those anticipated or
projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect events or circumstances after
the date of such statements except as required by law.
36
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM-8-K
a. Exhibits
3.1 Master Repurchase Agreement between iStar DB Seller, LLC, Seller and
Deutsche Bank AG, New York Branch, Buyer dated January 11, 2001.
b. Reports on Form 8-K
None.
37
SIGNATURES
Pursuant to the requirements of Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
iSTAR FINANCIAL INC.
REGISTRANT
Date: May 15, 2001 /s/ JAY SUGARMAN
------------------------------------------------
Jay Sugarman
CHAIRMAN OF THE BOARD OF DIRECTORS,
CHIEF EXECUTIVE OFFICER AND PRESIDENT
Date: May 15, 2001 /s/ SPENCER B. HABER
------------------------------------------------
Spencer B. Haber
EXECUTIVE VICE PRESIDENT--FINANCE,
CHIEF FINANCIAL OFFICER, DIRECTOR AND SECRETARY
38