<Page>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
<Table>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
</Table>
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
OR
<Table>
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
</Table>
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 1-10150
------------------------
ISTAR FINANCIAL INC.
(Exact name of registrant as specified in its charter)
<Table>
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 10036 (Zip Code)
(Address of principal executive
offices)
</Table>
Registrant's telephone number, including area code: (212)930-9400
------------------------
Securities registered pursuant to Section 12(b) of the Act:
<Table>
<Caption>
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
</Table>
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 10, 2002, there were 88,624,542 shares of common stock of iStar
Financial Inc., $0.001 par value per share outstanding ("Common Stock").
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<Page>
ISTAR FINANCIAL INC.
INDEX TO FORM 10-Q
<Table>
<Caption>
PAGE
--------
PART I. Consolidated Financial Information.......................... 3
Item 1. Financial Statements:
Consolidated Balance Sheets at March 31, 2002 and December
31, 2001.................................................. 3
Consolidated Statements of Operations--For the three months
ended March 31, 2002 and 2001............................. 4
Consolidated Statement of Changes in Shareholders'
Equity--For the three months ended March 31, 2002......... 5
Consolidated Statements of Cash Flows--For the three months
ended March 31, 2002 and 2001............................. 6
Notes to Consolidated Financial Statements.................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 34
PART II. Other Information........................................... 43
Item 1. Legal Proceedings........................................... 43
Item 2. Changes in Securities and Use of Proceeds................... 43
Item 3. Defaults Upon Senior Securities............................. 43
Item 4. Submission of Matters to a Vote of Security Holders......... 43
Item 5. Other Information........................................... 43
Item 6. Exhibits and Reports on Form 8-K............................ 43
SIGNATURES............................................................. 44
</Table>
2
<Page>
PART I. CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ISTAR FINANCIAL INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
(UNAUDITED)
<Table>
<Caption>
AS OF AS OF
MARCH 31, DECEMBER 31,
2002 2001
---------- -------------
ASSETS
Loans and other lending investments, net.................... $2,471,709 $2,377,763
Corporate tenant lease assets, net.......................... 1,994,805 1,841,800
Cash and cash equivalents................................... 9,016 15,670
Restricted cash............................................. 29,702 17,852
Accrued interest and operating lease income receivable...... 26,229 26,688
Deferred operating lease income receivable.................. 25,023 21,195
Deferred expenses and other assets.......................... 87,926 77,592
---------- ----------
Total assets.............................................. $4,644,410 $4,378,560
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, accrued expenses and other liabilities.... $ 78,459 $ 87,538
Dividends payable........................................... 5,225 5,225
Debt obligations............................................ 2,687,670 2,495,369
---------- ----------
Total liabilities......................................... 2,771,354 2,588,132
---------- ----------
Commitments and contingencies............................... -- --
Minority interests in consolidated entities................. 2,650 2,650
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, 2002 and December 31, 2001,
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, 2002 and December 31, 2001,
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, 2002 and December 31, 2001,
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, 2002 and December 31, 2001,
respectively.............................................. 4 4
Common Stock, $0.001 par value, 200,000 shares authorized,
88,417 and 87,387 shares issued and outstanding at March
31, 2002 and December 31, 2001, respectively.............. 88 87
Warrants and options........................................ 20,291 20,456
Additional paid-in capital.................................. 2,024,601 1,997,931
Retained earnings (deficit)................................. (126,990) (174,874)
Accumulated other comprehensive income (losses) (See Note
12)....................................................... (6,854) (15,092)
Treasury stock (at cost).................................... (40,741) (40,741)
---------- ----------
Total shareholders' equity................................ 1,870,406 1,787,778
---------- ----------
Total liabilities and shareholders' equity................ $4,644,410 $4,378,560
========== ==========
</Table>
The accompanying notes are an integral part of the financial statements.
3
<Page>
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<Table>
<Caption>
FOR THE
THREE MONTHS ENDED
MARCH 31,
----------------------
2002 2001
-------- --------
REVENUE:
Interest income........................................... $ 55,876 $ 66,913
Operating lease income.................................... 58,185 49,523
Other income.............................................. 7,735 6,183
-------- --------
Total revenue........................................... 121,796 122,619
-------- --------
COSTS AND EXPENSES:
Interest expense.......................................... 41,689 46,360
Operating costs--corporate tenant lease assets............ 3,025 3,236
Depreciation and amortization............................. 10,653 8,808
General and administrative................................ 6,617 6,102
Provision for loan losses................................. 1,750 1,750
Stock-based compensation expense.......................... 911 860
-------- --------
Total costs and expenses................................ 64,645 67,116
-------- --------
Net income before minority interest, gain on sale of
corporate tenant lease assets, extraordinary loss and
cumulative effect of change in accounting principle....... 57,151 55,503
Minority interest in consolidated entities.................. (40) (95)
Gain on sale of corporate tenant lease assets............... -- 555
-------- --------
Net income before extraordinary loss and cumulative effect
of change in accounting principle......................... 57,111 55,963
Extraordinary loss from early extinguishment of debt........ -- (1,037)
Cumulative effect of change in accounting principle (See
Note 3)................................................... -- (282)
-------- --------
Net income.................................................. $ 57,111 $ 54,644
Preferred dividend requirements............................. (9,227) (9,227)
-------- --------
Net income allocable to common shareholders................. $ 47,884 $ 45,417
======== ========
Basic earnings per common share............................. $ 0.55 $ 0.53
======== ========
Diluted earnings per common share........................... $ 0.53 $ 0.52
======== ========
</Table>
The accompanying notes are an integral part of the financial statements.
4
<Page>
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
SERIES A SERIES B SERIES C SERIES D ADDITIONAL
PREFERRED PREFERRED PREFERRED PREFERRED COMMON WARRANTS AND PAID-IN
STOCK STOCK STOCK STOCK STOCK AT PAR OPTIONS CAPITAL
--------- --------- --------- --------- ------------ ------------- ----------
Balance at December 31,
2001..................... $4 $2 $1 $4 $87 $20,456 $1,997,931
Exercise of options........ -- -- -- -- 1 (165) 4,828
Dividends
declared-preferred
stock.................... -- -- -- -- -- -- 83
Restricted stock units
issued to employees...... -- -- -- -- -- -- 1,327
Issuance of stock-DRIP
plan..................... -- -- -- -- -- -- 20,432
Net income for the
period................... -- -- -- -- -- -- --
Change in accumulated other
comprehensive income..... -- -- -- -- -- -- --
-- -- -- -- --- ------- ----------
Balance at March 31,
2002..................... $4 $2 $1 $4 $88 $20,291 $2,024,601
== == == == === ======= ==========
<Caption>
ACCUMULATED
OTHER
RETAINED COMPREHENSIVE
EARNINGS INCOME TREASURY
(DEFICIT) (LOSSES) STOCK TOTAL
---------------- -------------- -------- ----------
Balance at December 31,
2001..................... $(174,874) $(15,092) $(40,741) $1,787,778
Exercise of options........ -- -- -- 4,664
Dividends
declared-preferred
stock.................... (9,227) -- -- (9,144)
Restricted stock units
issued to employees...... -- -- -- 1,327
Issuance of stock-DRIP
plan..................... -- -- -- 20,432
Net income for the
period................... 57,111 -- -- 57,111
Change in accumulated other
comprehensive income..... -- 8,238 -- 8,238
--------- -------- -------- ----------
Balance at March 31,
2002..................... $(126,990) $ (6,854) $(40,741) $1,870,406
========= ======== ======== ==========
</Table>
The accompanying notes are an integral part of the financial statements.
5
<Page>
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
FOR THE
THREE MONTHS ENDED
MARCH 31,
------------------------
2002 2001*
--------- ---------
Cash flows from operating activities:
Net income.................................................. $ 57,111 $ 54,644
Adjustments to reconcile net income to cash flows provided
by operating activities:
Minority interest in consolidated entities................ 40 95
Non-cash expense for stock-based compensation............. 911 860
Depreciation and amortization............................. 16,386 14,309
Amortization of discounts/premiums, deferred interest and
costs on lending investments............................ (5,372) (4,872)
Equity in earnings of unconsolidated joint ventures and
subsidiaries............................................ (798) (2,802)
Distributions from operating joint ventures............... 3,450 1,098
Deferred operating lease income receivable................ (3,828) (2,576)
Gain on sale of corporate tenant lease assets............. -- (555)
Extraordinary loss on early extinguishment of debt........ -- 1,037
Cumulative effect of change in accounting principle....... -- 282
Provision for loan losses................................. 1,750 1,750
Changes in assets and liabilities:
Decrease in accrued interest and operating lease income
receivable............................................. 459 1,367
Increase in deferred expenses and other assets.......... (4,122) (845)
Decrease in accounts payable, accrued expenses and other
liabilities............................................ (4,658) (2,594)
--------- ---------
Cash flows provided by operating activities............... 61,329 61,198
--------- ---------
Cash flows from investing activities:
New investment originations/acquisitions.................. (404,700) (224,479)
Add-on fundings on existing loan commitments.............. (8,084) (29,924)
Net proceeds from sale of corporate tenant lease assets... -- 3,755
Repayments of and principal collections on loans and other
lending investments..................................... 163,980 247,392
Investments in and advances to unconsolidated joint
ventures................................................ (127) (319)
Distributions from unconsolidated joint ventures.......... -- 24,265
Capital expenditures for build-to-suit activities......... (709) (1,760)
Capital improvement projects on corporate tenant lease
assets.................................................. (967) (250)
Other capital expenditures on corporate tenant lease
assets.................................................. (875) (396)
--------- ---------
Cash flows (used in) provided by investing activities..... (251,482) 18,284
--------- ---------
Cash flows from financing activities:
Net borrowings under revolving credit facilities.......... 187,669 41,160
Borrowings under term loans............................... 34,193 17,040
Repayments under term loans............................... (13,767) (37,333)
Borrowing under repurchase agreements..................... -- 367
Repayments under repurchase agreements.................... (1,236) (31,325)
Repayments under secured bond offerings................... (15,535) (1,990)
Common dividends paid..................................... -- (51,436)
Preferred dividends paid.................................. (9,144) (9,144)
(Increase) decrease in restricted cash held in connection
with debt obligations................................... (11,850) 7,216
Distributions to minority interest in consolidated
entities................................................ (40) (3,670)
Extraordinary loss on early extinguishment of debt........ -- (1,037)
Payments for deferred financing costs..................... (5,660) (11,428)
Proceeds from exercise of options and issuance of DRIP
shares.................................................. 18,869 1,647
--------- ---------
Cash flows provided by (used in) financing activities..... 183,499 (79,933)
--------- ---------
Decrease in cash and cash equivalents....................... (6,654) (451)
Cash and cash equivalents at beginning of period............ 15,670 22,752
--------- ---------
Cash and cash equivalents at end of period.................. $ 9,016 $ 22,301
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest, net of
capitalized interest.................................... $ 46,626 $ 42,823
========= =========
</Table>
- ------------------------------
* RECLASSIFIED TO CONFORM TO 2002 PRESENTATION.
The accompanying notes are an integral part of the financial statements.
6
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS AND ORGANIZATION
BUSINESS--iStar Financial Inc. (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, which is taxed as a real estate investment trust ("REIT"), seeks to
deliver superior risk-adjusted returns on equity to shareholders by providing
innovative and value-added financing solutions to its customers.
The Company's primary product lines include:
- STRUCTURED FINANCE. The Company provides senior and subordinated loans
that typically range in size from $20 million to $100 million to borrowers
controlling institutional quality real estate. These loans may be either
fixed or variable rate and are structured to meet the specific financing
needs of the borrowers, including the acquisition or financing of large,
high-quality real estate. The Company offers borrowers a wide range of
structured finance options, including first mortgages, second mortgages,
partnership loans, participating debt and interim facilities.
- PORTFOLIO FINANCE. The Company provides funding to regional and national
borrowers who own multiple properties in a geographically diverse
portfolio. Loans are cross-collateralized to give borrowers the benefit of
all available collateral and underwritten to recognize inherent portfolio
diversification. Property types include multifamily, suburban office,
hotels and other property types where individual property values are less
than $20 million on average. Loan terms are structured to meet the
specific requirements of the borrower and typically range in size from
$25 million to $150 million.
- CORPORATE FINANCE. The Company provides senior and subordinated capital to
corporations engaged in real estate or real estate-related businesses.
Financing may be either secured or unsecured and typically range in size
from $20 million to $150 million.
- LOAN ACQUISITION. The Company acquires whole loans and loan participations
which present attractive risk-reward opportunities. Loans are generally
acquired at a discount to the principal balance outstanding and may be
acquired with financing provided by the seller. Loan acquisitions
typically range in size from $5 million to $100 million and are
collateralized by all major property types.
- CORPORATE TENANT LEASING. The Company provides capital to corporations, as
well as borrowers who control properties leased to single creditworthy
tenants. The Company's net leased assets are generally mission-critical
headquarters or distribution facilities that are subject to long-term
leases with rated corporate credit tenants, and which provide for all
expenses at the property to be paid by the tenant on a triple net lease
basis. Corporate tenant transactions typically range in size from
$20 million to $200 million.
- SERVICING. Through its iStar Asset Services division, the Company provides
rated servicing to third-party institutional loan portfolios, as well as
to the Company's own portfolio.
The Company's investment strategy targets specific sectors of the real
estate credit markets in which it believes it can deliver value-added, flexible
financial solutions to its customers, thereby differentiating its financial
products from those offered by other capital providers.
7
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--BUSINESS AND ORGANIZATION (CONTINUED)
The Company has implemented its investment strategy by:
- Focusing on the origination of large, structured mortgage, corporate and
lease financings where customers require flexible financial solutions.
- Avoiding commodity businesses in which there is significant direct
competition from other providers of capital such as conduit lending and
investment in commercial or residential mortgage-backed securities.
- Developing direct relationships with borrowers and corporate customers as
opposed to sourcing transactions solely through intermediaries.
- Adding value beyond simply providing capital by offering borrowers and
corporate customers specific lending expertise, flexibility, certainty and
continuing relationships beyond the closing of a particular financing
transaction.
- 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 customers' underlying credit obligations.
ORGANIZATION--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 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"), then the
largest publicly-traded company specializing in corporate sale/leaseback
transactions for 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 former
external advisor in exchange for shares of the Company's common stock ("Common
Stock") and converted its organizational form to a Maryland corporation. As part
of the conversion to a Maryland corporation, the Company replaced its former
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 on
November 4, 1999. Prior to this date, the Company's common shares were traded on
the American Stock Exchange.
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 statements. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles ("GAAP") for complete financial statements. The
Consolidated
8
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--BASIS OF PRESENTATION (CONTINUED)
Financial Statements include the accounts of the Company, its qualified REIT
subsidiaries, and its majority-owned and controlled partnerships.
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, 2002 and December 31, 2001 and the results of its
operations, changes in shareholder's equity and its cash flows for the three
months ended March 31, 2002 and 2001, 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 and other lending or similar
investments. In general, management considers its investments in this category
to be either held-to-maturity or available-for-sale. Items classified as held-
to-maturity are reflected at amortized historical cost, while items classified
as available-for-sale are reported at fair values, with unrealized gains and
losses included in other comprehensive income.
CORPORATE TENANT LEASE ASSETS AND DEPRECIATION--Corporate tenant lease
assets are generally recorded at cost less accumulated depreciation. 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. 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.
Corporate tenant lease 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, corporate
tenant lease 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 $70,000 and $201,000 during the
three-month periods ended March 31, 2002 and 2001, respectively.
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 and leasing
transactions.
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
9
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
A limited number 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 LOAN LOSSES--The Company's accounting policies require that an
allowance for estimated loan losses be maintained at a level that management,
based upon an evaluation of known and inherent risks in the portfolio, considers
adequate to provide for loan 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 as:
(1) management believes that the potential risk exists that scheduled debt
service payments will not be met within the coming 12 months; (2) the loans
become 90 days delinquent; (3) management determines the borrower is incapable
of, or has ceased efforts toward, curing the cause of the impairment; or
(4) the net realizable value of the loan's underlying collateral approximates
the Company's carrying value of such loan. 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 loan 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 loan portfolio reserve
based upon its periodic evaluation and analysis of the portfolio,
10
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
historical and industry loss experience, economic conditions and trends,
collateral values and quality, and other relevant factors.
INCOME TAXES--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.
The Company intends to operate in a manner consistent with and to elect to be
treated as a REIT for tax purposes. iStar Operating Inc. ("iStar Operating") and
TriNet Management Operating Company, Inc. ("TMOC"), the Company's taxable
subsidiaries, 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. Accordingly, except for the
Company's taxable subsidiaries, no current or deferred taxes are provided for in
the Consoliated Financial Statements.
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.
RECLASSIFICATIONS--Certain prior year amounts have been reclassified in the
Consolidated Financial Statements and the related notes to conform to the 2002
presentation.
USE OF ESTIMATES--The preparation of financial statements in conformity with
GAAP 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 ("SFAS No. 133"), "Accounting for
Derivative Instruments and Hedging Activities." 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 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
11
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 9), 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 September 2000, the FASB issued Statement
of Financial Accounting Standards No. 140 ("SFAS No. 140"), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
This statement is applicable for transfers of assets and extinguishments of
liabilities occurring after March 31, 2001. The Company adopted the provisions
of this statement as required for all transactions entered into on or after
April 1, 2001. The adoption of SFAS No. 140 did not have a significant impact on
the Company.
In July 2001, the SEC released Staff Accounting Bulletin No. 102 ("SAB
102"), "Selected Loan Loss Allowance and Documentation Issues." SAB 102
summarizes certain of the SEC's views on the development, documentation and
application of a systematic methodology for determining allowances for loan and
lease losses. Adoption of SAB 102 by the Company did not have a significant
impact on the Company.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 ("SFAS No. 141"), "Business Combinations" and Statement of Financial
Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible
Assets." SFAS No. 141 requires the purchase method of accounting to be used for
all business combinations initiated after June 30, 2001. SFAS No. 141 also
addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in business combinations and requires intangible
assets to be recognized apart from goodwill if certain tests are met. The
Company does not believe the adoption of SFAS No. 141 will have a material
impact on the Company's financial position or results of operations. SFAS
No. 142 requires that goodwill not be amortized but instead be measured for
impairment at least annually, or when events indicate that there may be an
impairment. SFAS No. 142 is effective for fiscal years beginning after
December 15, 2001. Early application is permitted for companies with fiscal
years beginning after March 15, 2001. The Company adopted the provisions of this
statement on January 1, 2002, as required, and the adoption did not have a
significant impact on the Company.
In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS No. 144 provides new guidance on the recognition of
impairment losses on long-lived assets to be held and used or to be disposed of,
and also broadens the definition of what constitutes a discontinued operation
and how the results of a discontinued operation are to be measured and
presented. The provisions of SFAS No. 144 are effective for financial statements
issued for fiscal years beginning after December 15, 2001, and must be applied
at the beginning of a fiscal year. The Company adopted the provisions of this
statement on January 1, 2002, as required, and it did not have a significant
impact on the Company.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145 ("SFAS No. 145"), "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145
rescinds both FASB Statements No. 4 ("SFAS No. 4"), "Reporting Gains and Losses
from Extinguishment of Debt," and the amendment to SFAS No. 4,
12
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FASB Statement No. 64 ("SFAS No. 64"), "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements." Through this rescission, SFAS No. 145 eliminates the
requirement (in both SFAS No. 4 and SFAS No. 64) that gains and losses from the
extinguishment of debt be aggregated and, if material, classified as an
extraordinary item, net of the related income tax effect. An entity is not
prohibited from classifying such gains and losses as extraordinary items, so
long as they meet the criteria in paragraph 20 of Accounting Principles Board
Opinion No. 30 ("APB 30"), "Reporting the Results of Operations--Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions"; however, due to the nature of
the Company's operations, such treatment may not be available to the Company.
Any gains or losses on extinguishments of debt that were previously classified
as extraordinary items in prior periods presented that do not meet the criteria
in APB 30 for classification as an extraordinary item will be reclassified to
income from continuing operations. The provisions of SFAS No. 145 are effective
for financial statements issued for fiscal years beginning after May 15, 2002.
The Company will adopt the provisions of this statement on January 1, 2003.
13
<Page>
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)(1):
<Table>
<Caption>
CARRYING VALUE
AS OF
# OF PRINCIPAL ------------------------- EFFECTIVE
BORROWERS BALANCES MARCH 31, DECEMBER 31, MATURITY
TYPE OF INVESTMENT UNDERLYING PROPERTY TYPE IN CLASS OUTSTANDING 2002 2001 DATES
------------------ ------------------------ --------- ------------ ---------- ------------ ------------
Senior
Mortgages(3)........ Office/Residential/Retail/ 21 $1,176,643 $1,160,974 $1,158,669 2002 to 2019
Conference Center/
Entertainment/Hotel/
Mixed Use
Subordinate
Mortgages(5)........ Office/Mixed Use/ 22 585,778 581,964 585,698 2002 to 2011
Residential/Hotel
Corporate/Partnership
Loans............... Office/Retail/Hotel/ 18 486,572 459,826 395,083 2003 to 2011
Entertainment/
Residential/Mixed Use
Other Lending
Investments......... Retail/Industrial/Office/ 12 310,831 291,695 259,313 2003 to 2013
Residential/
Entertainment/Mixed Use
---------- ----------
Gross Carrying
Value...............
$2,494,459 $2,398,763
Provision for Loan
Losses..............
(22,750) (21,000)
---------- ----------
Total, Net............
$2,471,709 $2,377,763
========== ==========
<Caption>
CONTRACTUAL INTEREST CONTRACTUAL INTEREST PRINCIPAL PARTICIPATION
TYPE OF INVESTMENT PAYMENT RATES(2) ACCRUAL RATES(2) AMORTIZATION FEATURES
------------------ ----------------------- ----------------------- ------------ -------------
Senior
Mortgages(3)........ Fixed: 7.32% to 10.82% Fixed: 7.32% to 16.00% Yes (4) No
Variable: LIBOR + 1.50% Variable: LIBOR + 1.50%
to 6.50% to 6.50%
Subordinate
Mortgages(5)........ Fixed: 7.00% to 15.25% Fixed: 7.32% to 17.00% Yes (4) Yes (6)
Variable: LIBOR + 2.12% Variable: LIBOR + 2.78%
to 5.80% to 5.80%
Corporate/Partnership
Loans............... Fixed: 7.33% to 15.00% Fixed: 7.33% to 17.50% Yes (4) Yes (6)
Variable: LIBOR + 3.00% Variable: LIBOR + 3.00%
to 6.00% to 6.00%
Other Lending
Investments......... Fixed: 6.75% to 12.50% Fixed: 6.75% to 12.50% No Yes (6)
Variable: LIBOR + 6.50% Variable: LIBOR + 6.50%
Gross Carrying
Value...............
Provision for Loan
Losses..............
Total, Net............
</Table>
EXPLANATORY NOTES:
- ------------------------------
(1) Amounts and details are for loans outstanding as of March 31, 2002.
(2) Substantially all variable-rate loans are based on 30-day LIBOR and reprice
monthly. The 30-day LIBOR rate on March 31, 2002 was 1.88%.
(3) Includes a senior interest in a private REMIC whose sole asset is a single
first mortgage loan.
(4) 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.
(5) Includes a participation interest in a second mortgage and a subordinate
interest in a private REMIC whose sole asset is a single first mortgage
loan.
(6) 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.
14
<Page>
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, 2002 and 2001, respectively,
the Company originated or acquired an aggregate of approximately $321.9 million
and $224.5 million in loans and other lending investments, funded $8.1 million
and $29.9 million under existing loan commitments, and received principal
repayments of $164.0 million and $247.4 million.
As of March 31, 2002, the Company had nine loans with unfunded commitments.
The total unfunded commitment amount was approximately $160.2 million, of which
$41.4 million was discretionary (i.e., at the Company's option) and
$118.8 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 7).
The Company has reflected provisions for loan losses of approximately
$1.8 million for the three-month periods ended March 31, 2002 and 2001,
respectively. These provisions represent loan 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.
NOTE 5--CORPORATE TENANT LEASE ASSETS
The Company's investments in corporate tenant lease assets, at cost, were as
follows (in thousands):
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2002 2001
---------- ------------
Buildings and improvements.......................... $1,649,212 $1,504,956
Land and land improvements.......................... 377,390 356,830
Less: accumulated depreciation...................... (90,497) (80,221)
---------- ----------
1,936,105 1,781,565
Investments in unconsolidated joint ventures........ 58,700 60,235
---------- ----------
Corporate tenant lease assets, net................ $1,994,805 $1,841,800
========== ==========
</Table>
Under certain leases, the Company receives additional participating lease
payments to the extent gross revenues of the corporate tenant exceed a base
amount. The Company earned no such additional participating lease payments in
the three-month periods ended March 31, 2002 and 2001, respectively. In
addition, the Company also receives reimbursements from customers for certain
facility operating expenses including common area costs, insurance and real
estate taxes. For the three months ended March 31, 2002 and 2001, customer
expense reimbursements were approximately $7.0 million and $6.2 million,
respectively, and are included as a reduction of "Operating costs--corporate
tenant lease assets" on the Company's Consolidated Statements of Operations.
The Company is subject to expansion option agreements with three existing
customers which could require the Company to fund and to construct up to 166,000
square feet of additional adjacent space
15
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--CORPORATE TENANT LEASE ASSETS (CONTINUED)
on which the Company would receive additional operating lease income under the
terms of the option agreements.
INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED JOINT VENTURES: At March 31,
2002, 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, 2002, 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, 2002 was $58.7 million. The
joint ventures' carrying value for the 23 facilities owned at March 31, 2002 was
$332.5 million. The joint ventures' carrying value of the land held for sale was
$7.7 million. In the aggregate, the joint ventures had total assets of
$380.4 million and total liabilities of $276.5 million as of March 31, 2002, and
net income of $3.4 million for the three months ended March 31, 2002. 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 ownership percentages, its investments in
and advances to unconsolidated joint ventures, its respective income and the
Company's pro rata share of its ventures' third-party non-recourse debt as of
March 31, 2002 are presented below (in thousands):
<Table>
<Caption>
PRO RATA
SHARE OF THIRD-PARTY DEBT
JOINT THIRD-PARTY ---------------------------------------
UNCONSOLIDATED OWNERSHIP EQUITY VENTURE NON-RECOURSE SCHEDULED
JOINT VENTURE % INVESTMENT INCOME (LOSS) DEBT INTEREST RATE MATURITY DATE
- -------------- --------- ---------- ------------- ------------ ---------------- --------------------
Operating:
Sunnyvale.......... 44.70% $12,854 $ 545 $ 10,728 LIBOR + 1.25% November 2004(1)
CTC I.............. 50.00% 11,307 328 60,475 7.66% - 7.87% Various through 2011
Milpitas........... 50.00% 24,072 1,011 39,984 6.55% November 2005
ACRE Simon......... 20.00% 5,239 (60) 6,560 7.61% - 8.43% Various through 2011
Development:
Sierra............. 50.00% 5,228 (36) -- N/A N/A
------- ------ --------
Total.............. $58,700 $1,788 $117,747
======= ====== ========
</Table>
EXPLANATORY NOTE:
- ------------------------
(1) Maturity date reflects a one-year extension at the venture's option.
Effective September 29, 2000, iStar Sunnyvale Partners, LP (the entity which
is controlled by Sunnyvale) entered into an interest rate cap agreement limiting
the venture's exposure to interest rate movements on its $24.0 million
LIBOR-based mortgage loan to an interest rate of 9.00% 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.
16
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--CORPORATE TENANT LEASE ASSETS (CONTINUED)
Subsequent to quarter end, the Company's Milpitas joint venture partner
exercised its right to convert its interest in the joint venture into 984,476
shares of Common Stock of the Company. The Company has the option, in its sole
discretion, to acquire the partner's interest for cash instead of shares, for a
payment equal to the value of 984,476 shares of Common Stock based on the
ten-day average closing stock price as of the date of the transaction, which is
anticipated to close on July 1, 2002.
Income generated from the above joint venture investments is included in
"Operating Lease Income" in the Consolidated Statements of Operations.
NOTE 6--UNCONSOLIDATED SUBSIDIARIES
The Company has an investment in iStar Operating, a taxable subsidiary that,
through a wholly-owned subsidiary, services the Company's loans and certain loan
portfolios owned by third parties. The Company owns all of the non-voting
preferred stock and a 95.00% economic interest in iStar Operating. An affiliate
of the Company's largest shareholder is the owner of all the voting common stock
and a 5.00% economic interest in iStar Operating. As of March 31, 2002, there
have never been any distributions to the common shareholder, nor does the
Company expect to make any in the future. At any time, the Company has the right
to acquire all of the common stock of iStar Operating at fair market value,
which the Company believes to be nominal. In addition to the direct general and
administrative costs of iStar Operating, the Company allocates a portion of its
general overhead expenses to iStar Operating based on the number of employees at
iStar Operating as a percentage of the Company's total employees.
In addition, the Company has an investment in TMOC, a taxable noncontrolled
subsidiary that has a $2.0 million investment in a real estate company based in
Mexico. The Company owns 95.00% of the outstanding voting and non-voting common
stock (representing 1.00% voting power and 95.00% of the economic interest) in
TMOC. The other two owners of TMOC stock are executives of the Company, who own
a combined 5.00% of the outstanding voting and non-voting common stock
(representing 99.00% voting power and 5.00% economic interest) in TMOC. As of
March 31, 2002, there have never been any distributions to the common
shareholders, nor does the Company expect to make any in the future. At any
time, the Company has the right to acquire all of the common stock of TMOC at
fair market value, which the Company believes to be nominal.
Both iStar Operating and TMOC were formed as taxable corporations for
purposes of maintaining compliance with REIT provisions of the Code and are
accounted for under the equity method for financial statement reporting
purposes. If they were consolidated with the Company for financial statement
purposes, they would have no material impact on the Company's operations. As of
March 31, 2002, these corporations have no debt obligations.
17
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--DEBT OBLIGATIONS
As of March 31, 2002 and December 31, 2001, the Company has debt obligations
under various arrangements with financial institutions as follows (in
thousands):
<Table>
<Caption>
CARRYING VALUE AS OF
MAXIMUM ------------------------- STATED SCHEDULED
AMOUNT MARCH 31, DECEMBER 31, INTEREST MATURITY
AVAILABLE 2002 2001 RATES DATE
---------- ---------- ------------ ----------------------------- --------------------
SECURED REVOLVING CREDIT
FACILITIES:
Line of credit.................. $ 700,000 $ 406,550 $ 312,300 LIBOR + 1.75% - 2.25% March 2005(1)
Line of credit.................. 700,000 469,072 439,309 LIBOR + 1.40% - 2.15% January 2005(1)
Line of credit.................. 500,000 212,593 148,937 LIBOR + 1.50% - 1.75% August 2005(2)
UNSECURED REVOLVING CREDIT
FACILITIES:
Line of credit.................. 300,000 -- -- LIBOR + 2.125% July 2004
---------- ---------- ----------
Total revolving credit
facilities.................... $2,200,000 1,088,215 900,546
==========
SECURED TERM LOANS:
Secured by corporate tenant
lease assets.................. 193,000 193,000 LIBOR + 1.85% July 2006(3)
Secured by corporate tenant
lease assets.................. 146,655 147,520 7.44% March 2009
Secured by corporate lending
investments................... 60,000 60,000 LIBOR + 2.50% June 2004(4)
Secured by corporate tenant
lease assets.................. 77,110 55,819 6.00% - 11.38% Various through 2021
Secured by corporate lending
investments................... 50,000 50,000 LIBOR + 2.50% July 2006(4)
---------- ----------
Total term loans................ 526,765 506,339
Plus: debt premium.............. 263 274
---------- ----------
Total secured term loans........ 527,028 506,613
ISTAR ASSET RECEIVABLES SECURED
NOTES:
Class A......................... 65,617 81,152 LIBOR + 0.30% August 2003(5)
Class B......................... 94,055 94,055 LIBOR + 0.50% October 2003(5)
Class C......................... 105,813 105,813 LIBOR + 1.00% January 2004 (5)
Class D......................... 52,906 52,906 LIBOR + 1.45% June 2004(5)
Class E......................... 123,447 123,447 LIBOR + 2.75% January 2005(5)
Class F......................... 5,000 5,000 LIBOR + 3.15% January 2005(5)
---------- ----------
Total iStar Asset Receivables
secured notes................. 446,838 462,373
UNSECURED NOTES:
6.75% Dealer Remarketable
Securities(6)(7).............. 125,000 125,000 6.75% March 2013
7.70% Notes(6).................. 100,000 100,000 7.70% July 2017
7.95% Notes(6).................. 50,000 50,000 7.95% May 2006
8.75% Notes..................... 350,000 350,000 8.75% August 2008
---------- ----------
Total unsecured notes........... 625,000 625,000
Less: debt discount(8).......... (14,710) (15,698)
---------- ----------
Total unsecured notes........... 610,290 609,302
OTHER DEBT OBLIGATIONS............ 15,299 16,535 Various Various
---------- ----------
TOTAL DEBT OBLIGATIONS............ $2,687,670 $2,495,369
========== ==========
</Table>
18
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--DEBT OBLIGATIONS (CONTINUED)
EXPLANATORY NOTES:
- ------------------------------
(1) Maturity date reflects a one-year "term-out" extension at the Company's
option.
(2) On March 29, 2002, the Company extended the maturity on the revolving credit
facility to August 2005, which includes a one-year "term-out" extension at
the Company's option.
(3) Maturity date reflects two one-year extensions at the Company's option.
(4) Maturity date reflects a one-year extension at the Company's option.
(5) 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.
(6) 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.
(7) Subject to mandatory tender on March 1, 2003, to either the dealer or the
Company. The initial coupon of 6.75% applies to the first five-year term
through the mandatory tender date. If tendered to the dealer, the notes must
be remarketed. The rates reset to then-prevailing market rates upon
remarketing.
(8) These obligations were assumed as part of the acquisition of TriNet. 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 are 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.
Availability of amounts under the secured revolving credit facilities are
based on percentage borrowing base calculations. In addition, certain of the
Company's debt obligations contain financial covenants.
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.
For accounting purposes, this transaction was treated as a secured financing.
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 + 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.
On February 22, 2001, the Company extended the maturity of its
$350.0 million unsecured revolving credit facility to May 2002.
On May 15, 2001, the Company repaid its $100.0 million 7.30% unsecured
notes. These notes were senior unsecured obligations of the Leasing Subsidiary
and ranked equally with the Leasing Subsidiary's other senior unsecured and
unsubordinated indebtedness.
On June 14, 2001, the Company closed $193.0 million of term loan financing
secured by 15 corporate tenant lease assets. The variable-rate loan bears
interest at LIBOR + 1.85% (not to exceed 10.00%) and has two one-year extensions
at the Company's option. The Company used these proceeds to repay a
$77.8 million secured term loan maturing in June 2001 and to pay down a portion
of its revolving credit facilities. In addition, the Company extended the final
maturity of its $500.0 million secured revolving credit facility to August 12,
2003.
On July 6, 2001, the Leasing Subsidiary financed a $75.0 million structured
finance asset with a $50.0 million term loan bearing interest at
LIBOR + 2.50%. The loan has a maturity of July 2006, including a one-year
extension at the Leasing Subsidiary's option.
On July 27, 2001, the Company completed a $300.0 million unsecured revolving
credit facility with a group of leading financial institutions. The new facility
has an initial maturity of July 2003, with a one-year extension at the Company's
option and another one-year
19
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--DEBT OBLIGATIONS (CONTINUED)
extension at the lenders' option. The new facility replaces two prior credit
facilities maturing in 2002 and 2003, and bears interest at LIBOR + 2.125%.
On August 9, 2001, the Company issued $350.0 million of 8.75% senior notes
due in 2008. The notes are unsecured senior obligations of the Company. The
Company used the net proceeds to repay outstanding borrowings under its secured
credit facilities.
On March 29, 2002, the Company extended the maturity of its $500.0 million
secured facility to August 2005, which includes a one-year "term-out" extension
at the Company's option.
As of March 31, 2002, future expected/scheduled maturities of outstanding
long-term debt obligations are as follows (in thousands)(1):
<Table>
2002 (remaining nine months)................................ $ 15,299
2003........................................................ 159,672
2004........................................................ 218,719
2005........................................................ 1,220,107
2006........................................................ 293,000
Thereafter.................................................. 795,320
----------
Total principal maturities.................................. 2,702,117
Net unamortized debt discounts.............................. (14,447)
----------
Total debt obligations...................................... $2,687,670
==========
</Table>
EXPLANATORY NOTE:
- ------------------------
(1) Assumes exercise of extensions to the extent such extensions are at the
Company's option.
NOTE 8--SHAREHOLDERS' EQUITY
The Company's charter 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. The Company has 4.4 million shares of 9.50% Series A Cumulative
Redeemable Preferred Stock, 2.3 million shares of 9.375% Series B Cumulative
Redeemable Preferred Stock, 1.5 million shares of 9.20% Series C Cumulative
Redeemable Preferred Stock, and 4.6 million shares of 8.00% Series D Cumulative
Redeemable Preferred Stock. 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.
On December 15, 1998, the Company issued warrants to acquire 6.1 million
shares of Common Stock, as adjusted for dilution, at $34.35 per share. The
warrants are exercisable on or after December 15, 1999 at a price of $34.35 per
share and expire on December 15, 2005.
CONCENTRATION OF SHAREHOLDER OWNERSHIP--On October 30, 2001, SOFIV SMT
Holdings, L.P. ("SOF IV") and certain other affiliates (collectively, the
"Starwood Investors") sold 18.975 million shares of Common Stock (including the
subsequently exercised 2.475 million share over-allotment option granted to the
underwriters) owned by them. The Company did not sell any shares in this
offering. As a result of the secondary offering, SOF IV currently owns
approximately 38.34% of the Company's Common Stock (based on the diluted
sharecount as of March 31, 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 or loan
repayments 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, 2002 and December 31, 2001, the Company had repurchased
approximately 2.3 million shares at an aggregate cost of approximately
$40.7 million.
20
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--SHAREHOLDERS' EQUITY (CONTINUED)
DRIP PROGRAM--The Company maintains a dividend reinvestment and direct stock
purchase plan. Under the dividend reinvestment component of the plan, the
Company's shareholders may purchase additional shares of Common Stock without
payment of brokerage commissions or service charges by automatically reinvesting
all or a portion of their Common Stock cash dividends. Under the direct stock
purchase component of the plan, the Company's shareholders and new investors may
purchase shares of Common Stock directly from the Company without payment of
brokerage commissions or service charges. All purchases of shares in excess of
$10,000 per month pursuant to the direct purchase component are at the Company's
sole discretion. Shares issued under the plan may reflect a discount of up to
3.00% from the prevailing market price of the Company's Common Stock. The
Company is authorized to issue up to 8.0 million shares of Common Stock pursuant
to the dividend reinvestment and direct stock purchase plan. During the
three-month periods ended March 31, 2002 and 2001, the Company issued a total of
768,369 shares and zero shares of its Common Stock through the direct stock
purchase component of the plan for net proceeds of approximately $20.4 million
and $0, respectively.
NOTE 9--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
lending investments that results from a property's, borrower's or corporate
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 the following cash flow hedges that are
outstanding as of March 31, 2002. The net value (liability) associated with
these hedges is reflected on the Company's balance sheet (in thousands).
<Table>
<Caption>
ESTIMATED
STRIKE VALUE AT
NOTIONAL PRICE OR TRADE MATURITY MARCH 31,
TYPE OF HEDGE AMOUNT SWAP RATE DATE DATE 2002
- ------------- -------- --------- --------- -------- ---------
Pay-Fixed Swap............................................ $125,000 7.058% 6/15/00 6/25/03 $ (5,958)
Pay-Fixed Swap............................................ 125,000 7.055% 6/15/00 6/25/03 (5,954)
Pay-Fixed Swap............................................ 75,000 5.580% 11/4/99(1) 12/1/04 (2,743)
LIBOR Cap................................................. 75,000 7.750% 11/4/99(1) 12/1/04 183
LIBOR Cap................................................. 35,000 7.750% 11/4/99(1) 12/1/04 78
--------
Total Estimated Asset (Liability) Value......................................... $(14,394)
========
</Table>
EXPLANATORY NOTE:
- ------------------------
(1) Acquired in connection with the TriNet Acquisition.
21
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
Between January 1, 2001 and March 31, 2002, the Company had outstanding the
following cash flow hedges that have expired or been settled (in thousands):
<Table>
<Caption>
STRIKE
NOTIONAL PRICE OR TRADE MATURITY
TYPE OF HEDGE AMOUNT SWAP RATE DATE DATE
- ------------- -------- --------- -------- --------
LIBOR Cap................................................... $300,000 9.000% 3/16/98 3/16/01
Pay-Fixed Swap.............................................. 92,000 5.714% 8/10/98 3/1/01
LIBOR Cap................................................... 75,000 7.500% 7/16/98 6/19/01
LIBOR Cap................................................... 38,336 7.500% 4/30/98 6/1/01
</Table>
In connection with the 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 change 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 terms of these arrangements are
substantially the same, the effects of a revaluation of these two instruments
substantially offset one another.
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 corporate tenant lease assets (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 10.00%) as of March 31, 2002 in California
(23.28%), Texas (13.83%) and New York (10.06%). As of March 31, 2002, the
Company's investments also contain greater than 10.00% concentrations in the
following asset types: office (46.63%), hotel lending (11.76%) and industrial
(10.02%).
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, letters of credit and/or cash security deposits. 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.
NOTE 10--STOCK-BASED COMPENSATION 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 shares of
restricted stock and other performance awards. The maximum number of shares of
Common Stock available for awards under the Plan is 9.00% 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, 2002, a total of approximately
8.0 million shares of Common Stock were available for awards under the Plan, of
which
22
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
options to purchase approximately 4.8 million shares of Common Stock were
outstanding and approximately 677,000 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 shares of Common Stock at $14.72 per share (as adjusted) to
its former advisor with a term of ten years. The former advisor granted a
portion of these options to its employees and the remainder was allocated to an
affiliate. Upon the acquisition of its former advisor, 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.
Changes in options outstanding during the three months ended March 31, 2002
are as follows:
<Table>
<Caption>
NUMBER OF SHARES
------------------------------------ AVERAGE
NON-EMPLOYEE STRIKE
EMPLOYEES DIRECTORS OTHER PRICE
--------- ------------ --------- --------
OPTIONS OUTSTANDING, DECEMBER 31, 2001...................... 3,783,222 296,379 1,036,163 $18.98
Granted in 2002........................................... -- -- -- $ --
Exercised in 2002......................................... (200,991) -- (60,700) $17.68
Forfeited in 2002......................................... (7,541) -- -- $19.40
--------- ------- ---------
OPTIONS OUTSTANDING, MARCH 31, 2002......................... 3,574,690 296,379 975,463
========= ======= =========
</Table>
23
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
The following table summarizes information concerning outstanding and
exercisable options as of March 31, 2002:
<Table>
<Caption>
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) 1,132,469 6.31 $14.73 773,021 $14.73
$16.69 - $16.88 847,817 7.78 $16.86 481,831 $16.86
$17.38 - $17.56 436,667 7.97 $17.39 237,501 $17.38
$19.50 - $19.69 1,652,860 8.87 $19.69 533,575 $19.69
$20.33 - $21.44 220,050 5.24 $21.00 112,418 $21.07
$22.44 18,220 8.51 $22.44 4,887 $22.44
$23.32 - $23.64 58,592 2.12 $23.56 40,716 $23.52
$24.13 - $24.94 217,500 5.85 $24.53 216,834 $24.53
$25.10 - $26.09 21,700 4.39 $26.04 20,700 $26.09
$26.30 - $26.97 91,700 2.33 $26.73 89,700 $26.72
$27.00 25,000 9.24 $27.00 -- $ --
$28.26 - $28.54 41,238 1.63 $28.37 41,238 $28.37
$30.33 67,275 1.16 $30.33 57,217 $30.33
$33.15 - $33.70 10,350 0.72 $33.39 10,350 $33.39
$55.39 5,094 7.17 $55.39 3,396 $55.39
--------- ---- ------ --------- ------
4,846,532 7.29 $18.65 2,623,384 $18.78
========= ==== ====== ========= ======
</Table>
EXPLANATORY NOTE:
- --------------------
(1) Includes approximately 764,000 options which were granted, on a fully
exercisable basis, in connection with the Recapitalization Transactions, and
which are now held by a privately-owned affiliate of Starwood Capital Group.
Beneficial interests in these options were subsequently regranted by that
affiliate to employees of Starwood Capital Group and its affiliates, subject
to vesting requirements. In the event that these employees forfeit such
options, they revert to the affiliate of Starwood Capital Group, which may
regrant them at its discretion. As of March 31, 2002, approximately 520,000
of these options are currently exercisable by the beneficial owners.
25
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
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 acquisition of the Company's
former external advisor as part of the computation of the one-time charge to
earnings, the Company 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 acquisition of the
Company's former external advisor 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 former external 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 its former
external 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 27.50% volatility rate and an estimated annual
dividend rate of 8.50%. The resulting charge to earnings was calculated as the
number of options allocated to the former external 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 months ended March 31, 2002, the Company granted 39,700
restricted shares to employees that vest proportionately over three years on the
anniversary date of the initial grant.
During the year ended December 31, 2001, the Company granted 94,859
restricted shares to employees in lieu of cash bonuses for the year ended
December 31, 2000 at the employees' election. These restricted shares 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
restricted shares to employees. Of this total, 74,996 restricted shares 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 restricted shares vest over
periods ranging from one to three years following the date of grant and are
transferable upon vesting. For accounting purposes, the Company measures
compensation costs for these shares as of the date of the grant and is charging
such amount to earnings at the grant date if no vesting period existed or
ratably over the respective vesting period.
During the year ended December 31, 2001, the Company entered into a new
three-year employment agreement with its chief executive officer. Under the
agreement, the Chief Executive Officer receives an annual base salary of
$1.0 million. He may also receive a bonus, which is targeted
26
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
to be an amount equal to his base salary, if the Company achieves certain
performance targets set by the Compensation Committee in consultation with the
Chief Executive Officer. The bonus award may be increased or reduced from the
target depending upon the degree to which the performance goals are exceeded or
are not met. The bonus amount may not exceed 200.00% of his base salary. The
bonus is reduced by the amount of any dividends paid to the Chief Executive
Officer in respect of phantom shares (described below) which are awarded to him
and have contingently vested. As part of this agreement, the Company confirmed a
prior grant of 750,000 stock options made to the executive on March 2, 2001 with
an exercise price of $19.69, which represented the market price at the date of
the original contingent grant. However, because the grant required further
approval by the Compensation Committee and the Board of Directors, no
measurement date occurred for accounting purposes until such approvals were
made, at which point the market price of the Company's Common Stock was $24.90.
Accordingly, an aggregate charge of approximately $3.9 million will be
recognized with respect to these options over the terms of this agreement. The
options will vest in three equal installments of 250,000 shares in each January
beginning in January 2002.
The Company also granted the executive 2.0 million unvested phantom shares,
each of which represents one share of the Company's Common Stock. These shares
will vest in installments of 350,000 shares, 650,000 shares, 600,000 shares and
400,000 shares on a contingent basis if the 60-day average closing price of the
Company's Common Stock achieves thresholds of $25.00, $30.00, $34.00 and $37.00,
respectively. As of March 31, 2002, the $25.00 threshold has been attained and
350,000 of these shares have contingently vested. Shares that have contingently
vested generally will not become fully vested until the end of the three-year
term of the agreement, except upon certain termination or change of control
events. Further, if the stock price drops below certain specified levels for the
60-day average before such date, they would also not fully vest and be
forfeited. The executive will receive dividends on shares that have contingently
or fully vested and have not been forfeited under the terms of the agreement, if
and when the Company declares and pays dividends on its Common Stock. Because no
shares have been issued, dividends received on these phantom shares, if any,
will be reflected as compensation expense by the Company. For accounting
purposes, this arrangement will be treated as a contingent, variable plan and no
compensation will be recognized until the shares, in whole or in part, become
irrevocably vested, whereupon the Company will reflect a charge equal to the
then fair value of the phantom shares irrevocably vested.
In addition, the Company entered into a three-year employment agreement,
subject to a one-year extension option, with an executive in connection with his
appointment as President of the Company. Under the agreement, in lieu of salary
and bonus, the Company granted the executive 500,000 unvested restricted shares.
The vesting of the shares is a function of the total return realized by the
Company's common shareholders, as measured by cumulative dividends paid on the
Company's Common Stock from and after January 1, 2001 and the market price of
the Company's Common Stock. If the total shareholder return as of a measurement
date contemplated by the agreement is between 0.00% and 29.99%, then between
zero and 150,000 restricted shares are subject to contingent vesting using
straight-line interpolation. If the total return is between 30.00% and 60.00%,
then the balance of the shares are subject to contingent vesting using
straight-line interpolation. Contingently vested shares will become fully vested
shares (no longer subject to forfeiture) if the executive remains employed
through the term of the agreement, or earlier if there is a change of control
event, certain termination events or an event of death or disability. In
addition, the entire 500,000 share grant will automatically become fully vested
on September 30, 2002 if the target shareholder total return of 60.00% is
achieved for 60
27
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
consecutive calendar days on or prior to September 30, 2002. None of the shares
will vest (regardless of the total rate of return to shareholders) if the
executive voluntarily terminates his employment without good reason before
September 30, 2002.
If the executive voluntarily resigns without good reason after
September 30, 2002, then some or all of his restricted shares will become fully
vested on such date, depending upon the level of total shareholder returns that
have been achieved at that date. Until shares under the agreement are otherwise
vested or forfeited, the executive will receive dividends on the share grant
during the term of the agreement if and when the Company declares and pays
dividends on its Common Stock. For financial statement purposes, such dividends
were accounted for in a manner consistent with the Company's normal Common Stock
dividends as a reduction to retained earnings. None of these restricted shares
had vested at March 31, 2002. For accounting purposes, this arrangement has been
treated as a contingent, variable plan.
On April 29, 2002, the 500,000 unvested restricted shares awarded to the
President became contingently vested as the total shareholder return (as
defined) exceeded 60.00%. Under the terms of the agreement, once contingently
vested, such shares will become fully vested shares (i.e., no longer subject to
forfeiture) unless the executive voluntarily resigns without good reason prior
to September 30, 2002. The Company will incur a non-cash charge of approximately
$15.0 million related to these contingently vested shares, recognized ratably
over the service period from the date of contingent vesting through
September 30, 2002. Accordingly, such non-cash charge will be approximately
$6.1 million and approximately $8.9 million for the second and third quarters of
2002, respectively.
SOFI IV Management, L.L.C. and Starwood Capital Group I, L.P., each a
beneficial owner of Common Stock, and the Company's Chief Executive Officer have
agreed to reimburse the Company for the value of restricted shares awarded to
the President in excess of 350,000 shares, net of tax benefits realized by the
Company or its shareholders on account of compensation expense deductions. The
reimbursement obligation arises once the restricted shares have become fully
vested, which is anticipated to be September 30, 2002. In the case of SOFI IV
Management, L.L.C and Starwood Capital Group, L.L.C., the reimbursement payment
must be made through the delivery of cash or shares of Common Stock within five
days following the full vesting date. If these entities do not have sufficient
cash or shares of Common Stock on hand to make the payment, they may defer the
payment until the later of: (1) six months after the restricted shares become
fully vested; or (2) the last day of the calendar year in which the restricted
shares become fully vested. In the case of the Chief Executive Officer, the
reimbursement will be made through the forfeiture of contingently vested phantom
shares awarded to him under his employment agreement with the Company. The
reimbursement payments will be reflected as additional paid-in capital on the
Company's Consolidated Balance Sheet at the time the payment is received, and
not as an offset to the non-cash charge referenced above.
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 2.00% and 15.00% of such participant's
compensation. At the discretion of the Board of Directors, the Company may make
matching contributions on the participant's behalf of up to 50.00% of the first
10.00% of the participant's annual contribution. The Company made gross
contributions of approximately $171,000 and $113,000 to the 401(k) Plan for the
three months ended March 31, 2002 and 2001, respectively.
28
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--EARNINGS PER SHARE
The following table presents a reconciliation of the numerators and
denominators of the basic and diluted EPS calculations (in thousands, except per
share data):
<Table>
<Caption>
FOR THE
THREE MONTHS ENDED
MARCH 31,
-------------------------
2002 2001
-------- --------
Numerator:
Net income before extraordinary loss and cumulative
effect of change in accounting principle......... $57,111 $ 55,963
Preferred dividend requirements.................... (9,227) (9,227)
Net income allocable to common shareholders before
extraordinary loss and cumulative effect of
change in accounting principle................... 47,884 46,736
Extraordinary loss on early extinguishment of
debt............................................. -- (1,037)
Cumulative effect of change in accounting
principle........................................ -- (282)
------- --------
Net income allocable to common shareholders........ $47,884 $ 45,417
======= ========
Denominator:
Weighted average common shares outstanding for
basic earnings per common share.................. 87,724 85,833
Add: effect of assumed shares issued under treasury
stock method for stock options and restricted
shares........................................... 1,617 1,316
Add: effect of contingent shares................... 350 --
Add: effects of assumed warrants exercised under
treasury stock method for stock options.......... -- --
------- --------
Weighted average common shares outstanding for
diluted earnings per common share................ 89,691 87,149
======= ========
Basic earnings per common share:
Net income allocable to common shareholders before
extraordinary loss and cumulative effect of
change in accounting principle................... $ 0.55 $ 0.54
Extraordinary loss on early extinguishment of
debt............................................. (0.00) (0.01)
Cumulative effect of change in accounting
principle........................................ (0.00) (0.00)
------- --------
Net income allocable to common shareholders........ $ 0.55 $ 0.53
======= ========
Diluted earnings per common share:
Net income allocable to common shareholders before
extraordinary loss and cumulative effect of
change in accounting principle................... $ 0.53 $ 0.53
Extraordinary loss on early extinguishment of
debt............................................. (0.00) (0.01)
Cumulative effect of change in accounting
principle........................................ (0.00) (0.00)
------- --------
Net income allocable to common shareholders........ $ 0.53 $ 0.52
======= ========
</Table>
29
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130 ("SFAS No. 130"), "Reporting Comprehensive Income" 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 $65.3 million and
$39.0 million for the three months ended March 31, 2002 and 2001, respectively.
The primary components of comprehensive income other than net income are the
adoption and continued application of SFAS No. 133 to the Company's cash flow
hedges and the Company's mark-to-market on its available-for-sale securities.
For the three months ended March 31, 2002, the change in fair market value
of the Company's interest rate swaps was $4.6 million and was recorded as an
increase to other comprehensive income. The reconciliation to other
comprehensive income is as follows (in thousands):
<Table>
<Caption>
FOR THE
THREE MONTHS ENDED
MARCH 31,
-------------------------
2002 2001
-------- --------
Net income............................................ $57,111 $54,644
Other comprehensive income (loss):
Unrealized gains (losses) on available-for-sale
securities for the period......................... 3,665 --
Cumulative effect of change in accounting principle
(SFAS No. 133) on other comprehensive income...... -- (9,445)
Unrealized gains (losses) on cash flow hedges....... 4,573 (6,190)
------- -------
Comprehensive income.................................. $65,349 $39,009
======= =======
</Table>
As of March 31, 2002 and December 31, 2001, accumulated other comprehensive
income reflected in the Company's equity on the balance sheet is comprised of
the following (in thousands):
<Table>
<Caption>
AS OF AS OF
MARCH 31, DECEMBER 31,
2002 2001
---------- -------------
Unrealized gains (losses) on available-for-sale
securities.......................................... $ 9,354 $ 5,689
Unrealized gains (losses) on cash flow hedges......... (16,208) (20,781)
-------- --------
Accumulated other comprehensive income (loss)......... $ (6,854) $(15,092)
======== ========
</Table>
NOTE 13--DIVIDENDS
In order to maintain its election to qualify as a REIT, the Company must
currently distribute, at a minimum, an amount equal to 90.00% of its taxable
income and must distribute 100.00% of its taxable income to avoid paying
corporate federal income taxes. The Company anticipates it will distribute all
of its taxable income to its shareholders. Because taxable income differs from
cash flow from operations
30
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13--DIVIDENDS (CONTINUED)
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 April 1, 2002, the Company declared a dividend of approximately
$56.1 million, or $0.63 per common share applicable to the three-month period
ended March 31, 2002 and payable to shareholders of record on April 15, 2002.
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 months ended March 31, 2002. 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.
31
<Page>
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 that 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 10.00% or more of revenues
(see Note 9 for other information regarding concentrations of credit risk).
The Company evaluates performance based on the following financial measures
for each segment:
<Table>
<Caption>
CORPORATE
REAL ESTATE TENANT CORPORATE/ COMPANY
LENDING LEASING OTHER(1) TOTAL
----------- ---------- ---------- ----------
(UNAUDITED)
TOTAL REVENUES(2):
Three months ended:
March 31, 2002................................ $ 63,868 $ 59,296 $ (1,368) $ 121,796
March 31, 2001................................ 72,333 49,633 653 122,619
TOTAL OPERATING AND INTEREST EXPENSES(3):
Three months ended:
March 31, 2002................................ $ 21,576 $ 22,942 $ 20,127 $ 64,645
March 31, 2001................................ 32,722 20,579 13,815 67,116
NET OPERATING INCOME BEFORE MINORITY
INTERESTS(4):
Three months ended:
March 31, 2002................................ $ 42,292 $ 36,354 $(21,495) $ 57,151
March 31, 2001................................ 39,611 29,054 (13,162) 55,503
TOTAL LONG-LIVED ASSETS(5):
March 31, 2002................................ $2,471,709 $1,994,805 N/A $4,466,514
December 31, 2001............................. 2,377,763 1,841,800 N/A 4,219,563
TOTAL ASSETS:
March 31, 2002................................ $2,471,709 $1,994,805 $177,896 $4,644,410
December 31, 2001............................. 2,377,763 1,841,800 158,997 4,378,560
</Table>
EXPLANATORY NOTES:
- --------------------
(1) 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.
(2) 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.
(3) Total operating and interest expense represents provision for loan 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 specifically related to each segment. Interest expense
32
<Page>
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--SEGMENT REPORTING (CONTINUED)
on unsecured notes, general and administrative expense and stock-based
compensation expense is included in Corporate and Other for all periods.
Depreciation and amortization of $10,653, and $8,808 for the three-month
periods ended March 31, 2002 and 2001, respectively, are included in the
amounts presented above.
(4) Net operating income before minority interests represents net operating
income before minority interest, gain on sale of corporate tenant lease
assets and extraordinary loss, less total operating and interest expense, as
defined in note (3) above.
(5) Total long-lived assets is comprised of Loans and Other Lending Investments,
net and Corporate Tenant Lease Assets, net, for each respective segment.
33
<Page>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company began its business in 1993 through private investment funds
formed to take advantage of the lack of well-capitalized lenders capable of
servicing the needs of high-end customers in its markets. In March 1998, the
private investment funds contributed their approximately $1.1 billion of assets
to the Company's predecessor in exchange for a controlling interest in that
public company. In November 1999, the Company acquired its leasing subsidiary,
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"). Concurrent with the TriNet Acquisition, the Company also acquired
its former external advisor in exchange for shares of its Common Stock and
converted its organizational form to a Maryland corporation. The Company's
Common Stock began trading on the New York Stock Exchange under the symbol "SFI"
in November 1999.
None of the Company's investment assets were directly impacted by the
terrorist attacks against the United States on September 11, 2001. While the
Company believes that the diversification of its portfolio, its strict
underwriting standards and its use of credit enhancement techniques represent an
appropriate emphasis on risk management, the Company cannot predict the effect
that any future terrorist attack might have on the U.S. economy and the
Company's business.
RESULTS OF OPERATIONS
THREE-MONTH PERIOD ENDED MARCH 31, 2002 COMPARED TO THE THREE-MONTH PERIOD ENDED
MARCH 31, 2001
INTEREST INCOME--Interest income decreased $11.0 million to $55.9 million
for the three months ended March 31, 2002 from $66.9 million for the same period
in 2001. Approximately $8.4 million of this decrease is the result of lower
average one-month LIBOR rates of 1.85% in 2002 compared to 5.51% in 2001 on the
Company's variable-rate lending investments. This decrease was partially offset
by $16.3 million of interest income on new originations or additional fundings,
net of an $18.0 million decrease from the repayment of loans and other lending
investments, in addition to a decrease of $614,000 from income earned on cash
and cash equivalents.
OPERATING LEASE INCOME--Operating lease income increased $8.7 million to
$58.2 million for the three months ended March 31, 2002 from $49.5 million for
the same period in 2001. Of this increase, $9.4 million was attributable to new
corporate tenant lease investments. This increase was partially offset by a
$606,000 decrease in joint venture income and a $343,000 decrease in operating
lease income resulting from asset dispositions completed in 2001.
OTHER INCOME--Other income consists primarily of prepayment penalties and
gains from the early repayment of loans and other lending investments, financial
advisory and asset management fees, lease termination fees, mortgage servicing
fees, loan participation payments and dividends on certain investments. During
the three months ended March 31, 2002, other income included prepayment
penalties and gains on loan repayments of $7.6 million, financial advisory,
asset management, mortgage servicing and other fees of $1.4 million and loan
participation payments of $115,000.
During the three months ended March 31, 2001, other income included loan
participation payments of $2.1 million, financial advisory fees of $868,000 and
prepayment penalties of $725,000.
INTEREST EXPENSE--For the three months ended March 31, 2002, interest
expense decreased by $4.7 million to $41.7 million from $46.4 million for the
same period in 2001. This decrease was primarily due to the lower average
one-month LIBOR rates of 1.85% in 2002 compared to 5.51% in 2001 on the
Company's variable-rate debt obligations. This decrease was partially offset by
the higher average borrowings on the Company's debt obligations, term loans and
unsecured notes, and by approximately $200,000 of additional amortization of
deferred financing costs on the Company's debt obligations in 2002 compared to
the same period in 2001.
34
<Page>
OPERATING COSTS--CORPORATE TENANT LEASE ASSETS--For the three months ended
March 31, 2002, operating costs were comparable to the same period in 2001.
Operating costs represent unreimbursed operating expenses associated with
corporate tenant lease assets.
DEPRECIATION AND AMORTIZATION--Depreciation and amortization increased by
approximately $1.9 million to $10.7 million for the three months ended
March 31, 2002 from $8.8 million for the same period in 2001. This increase is
due to new corporate tenant lease investments, partially offset by corporate
tenant lease dispositions completed in 2001.
GENERAL AND ADMINISTRATIVE--For the three months ended March 31, 2002,
general and administrative expenses increased by $515,000 to $6.6 million,
compared to $6.1 million for the same period in 2001. This increase is primarily
the result of an increase in personnel and related costs.
PROVISION FOR LOAN LOSSES--The Company's charge for provision for loan
losses remained at $1.8 million for the three months ended March 31, 2002 as
compared to the same period in 2001. 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 loan portfolio reserves
for losses which may be realized in the future. Accordingly, since its first
full quarter operating its current business as a public company (the quarter
ended June 30, 1998), management has reflected quarterly provisions for loan
losses in its operating results. The Company plans to continue to recognize
quarterly provisions until a stabilized reserve level is attained.
STOCK-BASED COMPENSATION EXPENSE--Stock-based compensation expense increased
by approximately $51,000 as a result of charges relating to grants of stock
options and restricted shares.
GAIN ON SALE OF CORPORATE TENANT LEASE ASSETS--During the three months ended
March 31, 2002, the Company did not dispose of any corporate tenant lease
assets.
During the first quarter of 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.
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT--During the three months
ended March 31, 2002, the Company did not incur any losses on the early
extinguishment of debt.
In March 2001, the Company repaid a mortgage loan which had an original
maturity date of December 2004. This prepayment resulted in an extraordinary
loss of $1.0 million during the first quarter of 2001.
ADJUSTED EARNINGS
Adjusted earnings represents net income computed in accordance with GAAP,
before gain on sale of corporate tenant lease assets, extraordinary items and
cumulative effect of change in accounting principle, plus depreciation and
amortization, less preferred stock dividends, and after adjustments for
unconsolidated partnerships and joint ventures. Adjustments for unconsolidated
partnerships and joint ventures reflect the Company's share of adjusted earnings
calculated 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,
35
<Page>
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.
<Table>
<Caption>
FOR THE
THREE MONTHS ENDED
MARCH 31,
-----------------------
2002 2001
-------- --------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
(UNAUDITED)
Adjusted earnings:
Net income................................................ $57,111 $54,644
Add: Depreciation......................................... 10,653 8,808
Add: Joint venture depreciation and amortization.......... 1,217 951
Add: Amortization of deferred financing costs............. 5,735 5,542
Less: Preferred dividends................................. (9,227) (9,227)
Less: Gain on sale of corporate tenant lease assets....... -- (555)
Add: Extraordinary loss early extinguishment of debt...... -- 1,037
Add: Cumulative effect of change in accounting
principle(1)............................................ -- 282
------- -------
Adjusted earnings allocable to common shareholders:
Basic..................................................... $65,489 $61,482
======= =======
Diluted................................................... $65,738 $61,722
======= =======
Adjusted earnings per common share:
Basic..................................................... $ 0.75 $ 0.72
======= =======
Diluted................................................... $ 0.73 $ 0.71
======= =======
</Table>
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.
RISK MANAGEMENT
NON-ACCRUAL LOANS--The Company transfers loans to non-accrual status at such
time as: (1) management believes that the potential risk exists that scheduled
debt service payments will not be met within the coming 12 months; (2) the loans
become 90 days delinquent; (3) management determines the borrower is incapable
of, or ceased efforts toward, curing the cause of an impairment; or (4) the net
realizable value of the loan's underlying collateral approximates the Company's
carrying value of such loan. Interest income is recognized only upon actual cash
receipt for loans on non-accrual status. As of March 31, 2002, the Company had
two assets on non-accrual status with an aggregate gross book value of
$5.9 million, or 0.13% of the gross book value of the Company's investments.
Each borrower remains current on all of its debt service payments to the
Company, and the Company currently believes that the fair value of the
collateral supports the book values of the assets.
One of the two non-accrual loans is a $4.0 million partnership loan on two
shopping malls located in the suburbs of Washington, D.C. This investment was
part of a larger loan originally made by affiliates of Lazard Freres prior to
the Company's acquisition of Lazard's structured finance portfolio in 1998. The
loan matures in September 2003 and bears interest at 12.00%. The Company
received cash payments equal to the interest due on the loan during the three
months ended March 31, 2002, and the borrower remains current on its obligations
to the Company. However, the Company anticipates that this loan will remain on
non-accrual status for the foreseeable future.
Additionally, the Company, through its investment in TriNet Management
Operating Company, has a $2.0 million investment in debt securities that are
convertible into shares of a real estate company
36
<Page>
which trades on the Mexican Stock Exchange. This investment was made by TriNet
prior to its acquisition by the Company in 1999. The securities bear interest at
12.00% per annum payable in arrears on December 4th of each year. The Company
received cash payments equal to the interest due on the investment through
December 31, 2001, and the Company expects to be paid its interest for the year
ended 2002 in December 2002. However, the Company anticipates that this
investment will remain on non-accrual status for the forseeable future.
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 or increase
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
corporate tenant leasing transactions.
The Company believes that its existing sources of funds will be adequate for
purposes of meeting its short- and long-term liquidity needs. The Company's
ability to meet its long-term (i.e., beyond one year) liquidity requirements is
subject to obtaining additional debt and equity financing. 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.
The Company has three LIBOR-based secured revolving credit facilities of
$700.0 million, $700.0 million and $500.0 million, respectively, which all have
final maturities in fiscal year 2005. The final maturity of each of the three
facilities includes a one-year "term-out" extension at the Company's option. As
of March 31, 2002, the Company had drawn approximately $406.6 million,
$469.1 million and $212.6 million under these facilities, respectively.
Availability under these facilities is based on collateral provided under a
borrowing base calculation. At March 31, 2002, the Company also had an unsecured
credit facility totaling $300.0 million which bears interest at LIBOR + 2.125%
and matures in July 2004, including a one-year extension at the Company's
option. At March 31, 2002, the Company had not drawn any amounts under this
facility.
RECENT FINANCING ACTIVITIES--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. For accounting purposes, this
transaction was treated as a secured financing.
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 + 1.40% to 2.15%, depending upon the
37
<Page>
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.
On February 22, 2001, the Company extended the maturity of its
$350.0 million unsecured revolving credit facility to May 2002.
On May 15, 2001, the Leasing Subsidiary repaid its $100.0 million 7.30%
unsecured notes.
On June 14, 2001, the Company closed $193.0 million of term loan financing
secured by 15 corporate tenant lease assets. The variable-rate loan bears
interest at LIBOR + 1.85% (not to exceed 10.00%) and has two one-year extensions
at the Company's option. The Company used these proceeds to repay a
$77.8 million secured term loan maturing in June 2001 and to pay down a portion
of its revolving credit facilities. In addition, the Company extended the final
maturity of its $500.0 million secured revolving credit facility to August 12,
2003.
On July 6, 2001, the Leasing Subsidiary financed a $75.0 million structured
finance asset with a $50.0 million term loan bearing interest at
LIBOR + 2.50%. The loan has a maturity of July 2006, including a one-year
extension at the Leasing Subsidiary's option.
On July 27, 2001, the Company completed a $300.0 million unsecured revolving
credit facility with a group of leading financial institutions. The new facility
has an initial maturity of July 2003, with a one-year extension at the Company's
option and another one-year extension at the lenders' option. The new facility
replaces two prior credit facilities maturing in 2002 and 2003, and bears
interest at LIBOR + 2.125%.
On August 9, 2001, the Company issued $350.0 million of 8.75% senior notes
due in 2008. The notes are unsecured senior obligations of the Company. The
Company used the net proceeds to partially repay outstanding borrowings under
its secured credit facilities.
On March 29, 2002, the Company extended the maturity of its $500.0 million
secured facility to August 2005, which includes a one-year "term-out" extension
at the Company's option.
HEDGING ACTIVITIES--The Company has entered into the following cash flow
hedges that are outstanding as of March 31, 2002. The net value (liability)
associated with these hedges is reflected on the Company's balance sheet (in
thousands).
<Table>
<Caption>
ESTIMATED
STRIKE VALUE AT
NOTIONAL PRICE OR TRADE MATURITY MARCH 31,
TYPE OF HEDGE AMOUNT SWAP RATE DATE DATE 2002
- ------------- -------- --------- --------- -------- ----------
Pay-Fixed Swap............ $125,000 7.058% 6/15/00 6/25/03 $ (5,958)
Pay-Fixed Swap............ 125,000 7.055% 6/15/00 6/25/03 (5,954)
Pay-Fixed Swap............ 75,000 5.580% 11/4/99(1) 12/1/04 (2,743)
LIBOR Cap................. 75,000 7.750% 11/4/99(1) 12/1/04 183
LIBOR Cap................. 35,000 7.750% 11/4/99(1) 12/1/04 78
--------
Total Estimated Asset (Liability) Value................................... $(14,394)
========
</Table>
EXPLANATORY NOTE:
- ------------------------
(1) Acquired in connection with the TriNet Acquisition. (See Note 1 to the
Company's Consolidated Financial Statements).
Between January 1, 2001 and March 31, 2002, the Company had outstanding the
following cash flow hedges that have expired or been settled (in thousands):
<Table>
<Caption>
STRIKE
NOTIONAL PRICE OR TRADE MATURITY
TYPE OF HEDGE AMOUNT SWAP RATE DATE DATE
- ------------- -------- --------- -------- --------
LIBOR Cap........................... $300,000 9.000% 3/16/98 3/16/01
Pay-Fixed Swap...................... 92,000 5.714% 8/10/98 3/1/01
LIBOR Cap........................... 75,000 7.500% 7/16/98 6/19/01
LIBOR Cap........................... 38,336 7.500% 4/30/98 6/1/01
</Table>
38
<Page>
In connection with 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 change 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 terms of these arrangements are
substantially the same, the effects of a revaluation of these two instruments
substantially offset one another.
Certain of the Company's corporate tenant lease joint ventures have hedging
activities which are more fully described in Note 5 to the Company's
Consolidated Financial Statements.
OFF-BALANCE SHEET TRANSACTIONS--The Company is not dependent on the use of
any off-balance sheet financing arrangements for liquidity. The Company has
investments in five corporate tenant lease joint ventures that are accounted for
under the equity method which have total debt obligations outstanding of
approximately $257.7 million (see Note 5). The Company's pro rata share of the
ventures' third-party debt is approximately $117.7 million. These ventures were
formed for the purpose of operating, acquiring and in certain cases, developing
corporate tenant lease facilities. The debt obligations of these joint ventures
are non-recourse to the ventures and the Company and mature between fiscal years
2004 and 2011. They consist of six term loans bearing fixed rates per annum
ranging from 6.55% to 8.43% and one variable-rate term loan with a rate of
LIBOR + 1.25% per annum.
RATINGS TRIGGERS--On July 27, 2001, the Company completed a $300.0 million
unsecured revolving credit facility with a group of leading financial
institutions. The new facility has an initial maturity of July 2003 with a
one-year extension at the Company's option and another one-year extension at the
lenders' option. The new facility replaces two prior credit facilities maturing
in 2002 and 2003, and bears interest at LIBOR + 2.125% based on the Company's
senior unsecured credit ratings of BB+ and Ba1 from Standard & Poor's and
Moody's Investor Service, respectively. If the Company achieves a higher rating,
the facility's interest rate will improve to LIBOR + 2.00%. If the Company's
credit rating is downgraded (regardless of how far), the facility's interest
rate will increase to LIBOR + 2.25%. In the event the Company receives two
credit ratings that are not equivalent, the spread over LIBOR shall be
determined by the lower of the two such ratings. As of March 31, 2002, no
amounts have yet been drawn on this facility. Accordingly, management does not
believe any rating changes would have a material adverse impact on the Company's
results of operations. There are no other ratings triggers in any of the
Company's debt instruments or other operating or financial agreements.
DRIP PROGRAM--The Company maintains a dividend reinvestment and direct stock
purchase plan. Under the dividend reinvestment component of the plan, the
Company's shareholders may purchase additional shares of Common Stock without
payment of brokerage commissions or service charges by automatically reinvesting
all or a portion of their Common Stock cash dividends. Under the direct stock
purchase component of the plan, the Company's shareholders and new investors may
purchase shares of Common Stock directly from the Company without payment of
brokerage commissions or service charges. All purchases of shares in excess of
$10,000 per month pursuant to the direct purchase component are at the Company's
sole discretion. Shares issued under the plan may reflect a discount of up to
3.00% from the prevailing market price of the Company's Common Stock. The
Company is authorized to issue up to 8.0 million shares of Common Stock pursuant
to the dividend reinvestment and direct stock purchase plan. During the
three-month periods ended March 31, 2002 and 2001, the Company issued a total of
768,369 shares and zero shares of its Common Stock through the direct stock
purchase component of the plan for net proceeds of approximately $20.4 million
and $0, respectively.
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
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shares of its Common Stock from time to time, primarily using proceeds from the
disposition of assets or loan repayments 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, 2002 and December 31,
2001, the Company had repurchased approximately 2.3 million shares at an
aggregate cost of approximately $40.7 million.
CRITICAL ACCOUNTING POLICIES
The Company's Consolidated Financial Statements include the accounts of the
Company and all majority-owned and controlled subsidiaries. The preparation of
financial statements in accordance with GAAP requires management to make
estimates and assumptions in certain circumstances that affect amounts reported
in the accompanying consolidated financial statements. In preparing these
financial statements, management has made its best estimates and judgments of
certain amounts included in the financial statements, giving due consideration
to materiality. The Company does not believe that there is a great likelihood
that materially different amounts would be reported related to the accounting
policies described below. However, application of these accounting policies
involves the exercise of judgment and use of assumptions as to future
uncertainties and, as a result, actual results could differ from these
estimates.
Management has the obligation to ensure that its policies and methodologies
are in accordance with GAAP. During the three months ended March 31, 2002,
management reviewed and evaluated its critical accounting policies and believes
them to be appropriate. The Company's accounting policies are described in
Note 3 to the Company's Consolidated Financial Statements.
EXECUTIVE COMPENSATION--The Company's accounting policies generally provide
cash compensation to be estimated and recognized over the period of service.
With respect to stock-based compensation arrangements, the Company has elected
to use APB 25 accounting, which measures the compensation charges based on the
intrinsic value of such securities when they become fixed and determinable, and
recognizes such expense over the related service period. These arrangements are
often complex and generally structured to align the interests of management with
those of the Company's shareholders. See Note 10 to the Company's Consolidated
Financial Statements for a detailed discussion of such arrangements and the
related accounting effects.
During 2001, the Company entered into new three-year employment agreements
with its Chief Executive Officer and its President. See Note 10 to the Company's
Consolidated Financial Statements for a more detailed description of both
employment agreements.
The following is a hypothetical illustration of the effects on the Company's
net income and adjusted earnings per share of the full vesting of phantom units
under the employment agreement with the Chief Executive Officer. During the
three months ended June 30, 2001, 350,000 of the phantom shares awarded to the
Chief Executive Officer became contingently vested. Absent an earlier change of
control or termination of employment, these 350,000 shares will not become fully
vested until March 31, 2004. Assuming that the market price of the Common Stock
on March 31, 2004 is $28.90 (which was the market price of the Common Stock on
March 31, 2002), the Company would incur a one-time, non-cash charge to both net
income and adjusted earnings at that time equal to $10.1 million (the fair
market value of the 350,000 shares at $28.90 per share). Assuming that there are
90.0 million diluted weighted average shares outstanding on March 31, 2004, the
effect of the one-time, non-cash charge on diluted adjusted earnings per share
would be $0.1124 per share.
On April 29, 2002, the 500,000 unvested restricted shares awarded to the
President became contingently vested as the total shareholder return (as
defined) exceeded 60.00%. Under the terms of the agreement, once contingently
vested, such shares will become fully vested shares (i.e., no longer subject to
forfeiture) unless the executive voluntarily resigns without good reason prior
to September 30, 2002. The Company will incur a non-cash charge of approximately
$15.0 million related
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to these contingently vested shares, recognized ratably over the service period
from the date of contingent vesting through September 30, 2002. Accordingly,
such non-cash charge will be approximately $6.1 million and $8.9 million for the
second and third quarters of 2002, respectively.
NEW ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging
Activities." 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," 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 9), the adoption of SFAS No. 133 could have a more significant effect
on the Company prospectively.
In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140 ("SFAS No. 140"), "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities." This statement is
applicable for transfers of assets and extinguishments of liabilities occurring
after March 31, 2001. The Company adopted the provisions of this statement as
required for all transactions entered into on or after April 1, 2001. The
adoption of SFAS No. 140 did not have a significant impact on the Company.
In July 2001, the SEC released Staff Accounting Bulletin No. 102 ("SAB
102"), "Selected Loan Loss Allowance and Documentation Issues." SAB 102
summarizes certain of the SEC's views on the development, documentation and
application of a systematic methodology for determining allowances for loan and
lease losses. Adoption of SAB 102 by the Company did not have a significant
impact on the Company.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 ("SFAS No. 141"), "Business Combinations" and Statement of Financial
Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible
Assets." SFAS No. 141 requires the purchase method of accounting to be used for
all business combinations initiated after June 30, 2001. SFAS No. 141 also
addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in business combinations and requires intangible
assets to be recognized apart from goodwill if certain tests are met. The
Company does not believe the adoption of SFAS No. 141 will have a significant
effect on the Company's financial position or results of operations. SFAS
No. 142 requires that goodwill not be amortized but instead be measured for
impairment at least annually, or when events indicate that there may be an
impairment. SFAS No. 142 is effective for fiscal years beginning after
December 15, 2001. Early application is permitted for companies with fiscal
years beginning after March 15, 2001. The Company adopted the provisions of this
statement, as required, on January 1, 2002 and the adoption did not have a
significant impact on the Company.
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In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS No. 144 provides new guidance on the recognition of
impairment losses on long-lived assets to be held and used or to be disposed of,
and also broadens the definition of what constitutes a discontinued operation
and how the results of a discontinued operation are to be measured and
presented. The provisions of SFAS No. 144 are effective for financial statements
issued for fiscal years beginning after December 15, 2001, and must be applied
at the beginning of a fiscal year. The Company adopted the provisions of this
statement on January 1, 2002, as required, and it did not have a significant
impact on the Company.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145 ("SFAS No. 145"), "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145
rescinds both FASB Statements No. 4 ("SFAS No. 4"), "Reporting Gains and Losses
from Extinguishment of Debt," and the amendment to SFAS No. 4, FASB Statement
No. 64 ("SFAS No. 64"), "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." Through this rescission, SFAS No. 145 eliminates the requirement
(in both SFAS No. 4 and SFAS No. 64) that gains and losses from the
extinguishment of debt be aggregated and, if material, classified as an
extraordinary item, net of the related income tax effect. An entity is not
prohibited from classifying such gains and losses as extraordinary items, so
long as they meet the criteria in paragraph 20 of Accounting Principles Board
Opinion No. 30 ("APB 30"), "Reporting the Results of Operations--Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions"; however, due to the nature of
the Company's operations, such treatment may not be available to the Company.
Any gains or losses on extinguishments of debt that were previously classified
as extraordinary items in prior periods presented that do not meet the criteria
in APB 30 for classification as an extraordinary item will be reclassified to
income from continuing operations. The provisions of SFAS No. 145 are effective
for financial statements issued for fiscal years beginning after May 15, 2002.
The Company will adopt the provisions of this statement on January 1, 2003.
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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
None.
B. REPORTS ON FORM 8-K
None.
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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.
<Table>
iSTAR FINANCIAL INC.
REGISTRANT
Date: May 15, 2002 /s/ JAY SUGARMAN
--------------------------------------------------
Jay Sugarman
CHAIRMAN OF THE BOARD OF DIRECTORS AND
CHIEF EXECUTIVE OFFICER
Date: May 15, 2002 /s/ SPENCER B. HABER
--------------------------------------------------
Spencer B. Haber
PRESIDENT, CHIEF FINANCIAL OFFICER, DIRECTOR AND
SECRETARY
</Table>
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