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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 1-10150
--------------------------
ISTAR FINANCIAL INC.
(Exact name of registrant as specified in its charter)
MARYLAND 95-6881527
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1114 AVENUE OF THE AMERICAS, 27TH FLOOR
NEW YORK, NY 10036
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 930-9400
--------------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of Exchange on which registered:
COMMON STOCK, $0.001 PAR VALUE NEW YORK STOCK EXCHANGE
9.375% SERIES B CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
9.200% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
8.000% SERIES D CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant; (i) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (ii) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
As of November 5, 2001, there were 86,760,229 shares of common stock of
iStar Financial Inc., $0.001 par value per share, outstanding ("Common Stock").
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ISTAR FINANCIAL INC.
INDEX TO FORM 10-Q
PAGE
--------
PART I. Consolidated Financial Information.......................... 2
Item 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 2001 and
December 31, 2000.......................................... 2
Consolidated Statements of Operations--For the three- and
nine-month periods ended September 30, 2001 and 2000....... 3
Consolidated Statement of Changes in Shareholders'
Equity--For the nine-month period ended September 30,
2001....................................................... 4
Consolidated Statements of Cash Flows--For the three- and
nine-month periods ended September 30, 2001 and 2000....... 5
Notes to Consolidated Financial Statements.................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 29
PART II. Other Information........................................... 39
Item 1. Legal Proceedings........................................... 39
Item 2. Changes in Securities and Use of Proceeds................... 39
Item 3. Defaults Upon Senior Securities............................. 39
Item 4. Submission of Matters to a Vote of Security Holders......... 39
Item 5. Other Information........................................... 39
Item 6. Exhibits and Reports on Form 8-K............................ 39
SIGNATURES............................................................ 40
PART I--CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ISTAR FINANCIAL INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
ASSETS
Loans and other lending investments, net.................... $2,392,605 $2,225,183
Corporate tenant lease assets, net.......................... 1,659,637 1,670,169
Cash and cash equivalents................................... 15,155 22,752
Restricted cash............................................. 10,853 20,441
Accrued interest and operating lease income receivable...... 20,843 20,167
Deferred operating lease income receivable.................. 17,632 10,236
Deferred expenses and other assets.......................... 77,728 62,224
Investment in iStar Operating............................... 2,100 3,603
---------- ----------
Total assets.............................................. $4,196,553 $4,034,775
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, accrued expenses and other liabilities.... $ 75,478 $ 52,038
Dividends payable........................................... 5,225 56,661
Debt obligations............................................ 2,291,774 2,131,967
---------- ----------
Total liabilities......................................... 2,372,477 2,240,666
---------- ----------
Commitments and contingencies............................... -- --
Minority interest in consolidated entities.................. 2,650 6,224
Shareholders' equity:
Series A Preferred Stock, $0.001 par value, liquidation
preference $50.00 per share, 4,400 shares issued and
outstanding at September 30, 2001 and December 31, 2000,
respectively.............................................. 4 4
Series B Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 2,000 shares issued and
outstanding at September 30, 2001 and December 31, 2000,
respectively.............................................. 2 2
Series C Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 1,300 shares issued and
outstanding at September 30, 2001 and December 31, 2000,
respectively.............................................. 1 1
Series D Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 4,000 shares issued and
outstanding at September 30, 2001 and December 31, 2000,
respectively.............................................. 4 4
Common Stock, $0.001 par value, 200,000 shares authorized,
86,568 and 85,726 shares issued and outstanding at
September 30, 2001 and December 31, 2000, respectively.... 87 85
Warrants and options........................................ 20,953 16,943
Additional paid in capital.................................. 1,981,400 1,966,396
Retained earnings (deficit)................................. (117,230) (154,789)
Accumulated other comprehensive income (losses) (See Note
12)....................................................... (23,054) (20)
Treasury stock (at cost).................................... (40,741) (40,741)
---------- ----------
Total shareholders' equity................................ 1,821,426 1,787,885
---------- ----------
Total liabilities and shareholders' equity................ $4,196,553 $4,034,775
========== ==========
The accompanying notes are an integral part of the financial statements.
2
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
REVENUE:
Interest income................................... $ 62,389 $ 70,148 $193,205 $197,095
Operating lease income............................ 49,912 46,327 148,678 139,822
Other income...................................... 8,529 4,208 22,389 12,568
-------- -------- -------- --------
Total revenue................................... 120,830 120,683 364,272 349,485
-------- -------- -------- --------
COSTS AND EXPENSES:
Interest expense.................................. 41,177 46,470 128,905 127,029
Operating costs--corporate tenant lease assets.... 3,210 3,284 9,720 9,568
Depreciation and amortization..................... 8,669 8,705 26,255 26,575
General and administrative........................ 6,131 5,859 18,731 20,570
Provision for possible credit losses.............. 1,750 1,750 5,250 4,750
Stock-based compensation expense.................. 520 569 2,580 1,703
-------- -------- -------- --------
Total costs and expenses........................ 61,457 66,637 191,441 190,195
-------- -------- -------- --------
Net income before minority interest, gains/(losses)
on sales of corporate tenant lease assets,
extraordinary loss and cumulative effect of change
in accounting principle........................... 59,373 54,046 172,831 159,290
Minority interest in consolidated entities.......... (41) (41) (177) (123)
Gains/(losses) on sales of corporate tenant lease
assets............................................ (1,196) 1,974 403 2,948
-------- -------- -------- --------
Net income before extraordinary loss and cumulative
effect of change in accounting principle.......... 58,136 55,979 173,057 162,115
Extraordinary loss on early extinguishment of
debt.............................................. (583) (388) (1,620) (705)
Cumulative effect of change in accounting principle
(See Note 3)...................................... -- -- (282) --
-------- -------- -------- --------
Net income.......................................... $ 57,553 $ 55,591 $171,155 $161,410
Preferred dividend requirements..................... (9,227) (9,227) (27,681) (27,681)
-------- -------- -------- --------
Net income allocable to common shareholders......... $ 48,326 $ 46,364 $143,474 $133,729
======== ======== ======== ========
Basic earnings per common share..................... $ 0.56 $ 0.54 $ 1.67 $ 1.57
======== ======== ======== ========
Diluted earnings per common share................... $ 0.54 $ 0.54 $ 1.63 $ 1.55
======== ======== ======== ========
The accompanying notes are an integral part of the financial statements.
3
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
(IN THOUSANDS)
(UNAUDITED)
SERIES A SERIES B SERIES C SERIES D COMMON WARRANTS ADDITIONAL RETAINED
PREFERRED PREFERRED PREFERRED PREFERRED STOCK AND PAID-IN EARNINGS
STOCK STOCK STOCK STOCK AT PAR OPTIONS CAPITAL (DEFICIT)
--------- --------- --------- --------- -------- -------- ---------- ---------
Balance at December 31,
2000........................ $ 4 $ 2 $ 1 $ 4 $ 85 $16,943 $1,966,396 $(154,789)
Exercise of options........... -- -- -- -- 2 -- 11,762 --
Dividends declared--preferred
stock....................... -- -- -- -- -- -- 247 (27,681)
Dividends declared--common
stock....................... -- -- -- -- -- -- (105,915)
Restricted stock units issued
to employees in lieu of cash
bonuses..................... -- -- -- -- -- -- 1,478 --
Restricted stock units granted
to employees................ -- -- -- -- -- -- 1,038 --
Options granted to
employees................... -- -- -- -- -- 4,010 --
Issuance of stock--DRIP
plan........................ -- -- -- -- -- -- 479 --
Net income for the period..... -- -- -- -- -- -- -- 171,155
Cumulative effect of change in
accounting principle........ -- -- -- -- -- -- -- --
Change in accumulated other
comprehensive income........ -- -- -- -- -- -- -- --
---- ---- ---- ---- ---- ------- ---------- ---------
Balance at September 30,
2001........................ $ 4 $ 2 $ 1 $ 4 $ 87 $20,953 $1,981,400 $(117,230)
==== ==== ==== ==== ==== ======= ========== =========
ACCUMULATED OTHER
COMPREHENSIVE TREASURY
INCOME (LOSSES) STOCK TOTAL
----------------- -------- ----------
Balance at December 31,
2000........................ $ (20) $(40,741) $1,787,885
Exercise of options........... -- -- 11,764
Dividends declared--preferred
stock....................... -- -- (27,434)
Dividends declared--common
stock....................... -- -- (105,915)
Restricted stock units issued
to employees in lieu of cash
bonuses..................... -- -- 1,478
Restricted stock units granted
to employees................ -- -- 1,038
Options granted to
employees................... -- -- 4,010
Issuance of stock--DRIP
plan........................ -- -- 479
Net income for the period..... -- -- 171,155
Cumulative effect of change in
accounting principle........ (9,445) -- (9,445)
Change in accumulated other
comprehensive income........ (13,589) -- (13,589)
-------- -------- ----------
Balance at September 30,
2001........................ $(23,054) $(40,741) $1,821,426
======== ======== ==========
The accompanying notes are an integral part of the financial statements.
4
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ---------------------
2001 2000* 2001 2000*
-------- -------- --------- ---------
Cash flows from operating activities:
Net income.................................................. $ 57,553 $ 55,591 $ 171,155 $ 161,410
Adjustments to reconcile net income to cash flows provided
by operating activities:
Minority interest......................................... 41 41 177 123
Non-cash expense for options issued....................... 520 569 2,580 1,703
Depreciation and amortization............................. 13,616 12,662 41,412 35,642
Amortization of discounts/premiums, deferred interest and
costs on lending investments............................ (11,742) (6,007) (31,043) (17,758)
Equity in earnings of unconsolidated joint ventures and
subsidiaries............................................ (1,957) (1,415) (5,646) (3,826)
Distributions from operating joint ventures............... 983 996 3,899 3,374
Deferred operating lease income receivable................ (2,320) (2,348) (7,303) (6,879)
Realized (gains)/losses on sales of securities............ -- -- -- 229
(Gains)/losses on sale of corporate tenant lease assets... 1,196 (1,974) (403) (2,948)
Extraordinary loss on early extinguishment of debt........ 583 388 1,620 705
Cumulative effect of change in accounting principle....... -- -- 282 --
Provision for possible credit losses...................... 1,750 1,750 5,250 4,750
Changes in assets and liabilities:
(Increase) decrease in accrued interest and operating
lease income receivable................................ (3,582) 398 (430) (1,783)
(Increase) decrease in deferred expenses and other
assets................................................. 2,179 (2,663) (49) (12,631)
Increase (decrease) in accounts payable, accrued
expenses and other liabilities......................... 5,640 552 2,896 (3,784)
-------- -------- --------- ---------
Cash flows provided by operating activities............... 64,460 58,540 184,397 158,327
-------- -------- --------- ---------
Cash flows from investing activities:
New investment originations............................... (154,038) (227,300) (701,509) (670,473)
Principal fundings on existing loan commitments........... (20,739) (12,768) (45,181) (50,577)
Net proceeds from sale of corporate tenant lease assets... 12,452 -- 20,286 146,265
Repayments of and principal collections from loans and
other lending investments............................... 10,206 210,388 567,185 373,620
Investments in and advances to unconsolidated joint
ventures................................................ (169) -- (656) (13,943)
Distributions from unconsolidated joint ventures.......... -- 14,812 24,265 16,782
Capital expenditures for build-to-suit activities......... (4,098) (707) (10,517) (717)
Capital improvement projects on corporate tenant lease
assets.................................................. (2,146) (516) (4,229) (2,859)
Other capital expenditures on corporate tenant lease
assets.................................................. (987) (3,321) (2,559) (4,050)
-------- -------- --------- ---------
Cash flows used in investing activities................... (159,519) (19,412) (152,915) (205,952)
-------- -------- --------- ---------
Cash flows from financing activities:
Net borrowings (repayments) under revolving credit
facilities.............................................. (256,257) 154,587 (73,204) (342,539)
Borrowings under term loans............................... 67,624 -- 277,664 90,000
Repayments under term loans............................... (1,055) (4,759) (117,270) (245,114)
Repayments under unsecured notes.......................... -- -- (100,000) --
Borrowings under repurchase agreements.................... 65 220 432 28,201
Repayments under repurchase agreements.................... -- (3,594) (56,008) (5,986)
Borrowings under secured bond offerings................... -- 5,000 -- 863,254
Repayments under secured bond offerings................... (22,011) (120,445) (123,909) (121,684)
Borrowings under unsecured bond offerings................. 350,000 -- 350,000 --
Common dividends paid..................................... (53,264) (51,429) (157,351) (151,040)
Preferred dividends paid.................................. (9,145) (9,144) (27,433) (27,433)
(Increase) decrease in restricted cash held in connection
with debt obligations................................... 16,946 (178) 9,588 (6,121)
Distributions to minority interest in consolidated
entities................................................ (41) (41) (3,752) (123)
Extraordinary loss on early extinguishment of debt........ -- -- (1,037) (317)
Payments for deferred financing costs..................... (12,624) (491) (29,083) (26,286)
Purchase of treasury stock................................ -- -- -- (106)
Proceeds from exercise of options and issuance of DRIP
shares.................................................. 3,675 6,013 12,284 6,096
-------- -------- --------- ---------
Cash flows provided by (used in) financing activities..... 83,913 (24,261) (39,079) 60,802
-------- -------- --------- ---------
Increase (decrease) in cash and cash equivalents............ (11,146) 14,867 (7,597) 13,177
Cash and cash equivalents at beginning of period............ 26,301 32,718 22,752 34,408
-------- -------- --------- ---------
Cash and cash equivalents at end of period.................. $ 15,155 $ 47,585 $ 15,155 $ 47,585
======== ======== ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest, net of amounts
capitalized............................................. $ 33,824 $ 39,674 $ 111,790 $ 111,287
======== ======== ========= =========
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* RECLASSIFIED TO CONFORM TO 2001 PRESENTATION.
The accompanying notes are an integral part of the financial statements
5
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 seeks to deliver superior risk-adjusted returns on equity for
shareholders by providing innovative and value-added financing solutions to its
customers.
The Company has implemented its investment strategy by: (1) focusing on the
origination of large, highly structured mortgage, corporate and lease financings
where customers require flexible financial solutions, and avoiding commodity
businesses in which there is significant direct competition from other providers
of capital; (2) developing direct relationships with borrowers and corporate
tenants as opposed to sourcing transactions through intermediaries; (3) adding
value beyond simply providing capital by offering borrowers and corporate
tenants specific lending expertise, flexibility, certainty and continuing
relationships beyond the closing of a particular financing transaction; and
(4) taking advantage of market anomalies in the real estate financing markets
when the Company believes credit is mispriced by other providers of capital,
such as the spread between lease yields and the yields on corporate tenants'
underlying credit obligations.
The Company intends to continue to emphasize a mix of portfolio financing
transactions to create built-in diversification and single-asset financings for
properties with strong, long-term competitive market positions.
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, Starwood Financial Trust,
in exchange for a controlling interest in that company (collectively, the
"Recapitalization Transactions"). Since that time, the Company has grown by
originating new lending and leasing transactions, as well as through corporate
acquisitions. Specifically, in September 1998, the Company acquired the loan
origination and servicing business of a major insurance company, and in
December 1998, the Company acquired the mortgage and mezzanine loan portfolio of
its largest private competitor. Additionally, in November 1999, the Company
acquired TriNet Corporate Realty Trust, Inc. ("TriNet" or the "Leasing
Subsidiary"), which was then the largest publicly traded company specializing in
the net leasing of corporate office and industrial facilities (the "TriNet
Acquisition"). The TriNet Acquisition was structured as a stock-for-stock merger
of TriNet with a subsidiary of the Company. Concurrent with the TriNet
Acquisition, the Company also acquired its external advisor (the "Advisor
Transaction") in exchange for shares of common stock of the Company ("Common
Stock") and converted its organizational form to a Maryland corporation (the
"Incorporation Merger"). As part of the conversion to a Maryland corporation,
the Company replaced its dual class common share structure with a single class
of Common Stock. The Company's Common Stock began trading on the New York Stock
Exchange under the symbol "SFI" in November 1999.
The Company was eligible and elected to be taxed as a REIT for the taxable
year beginning January 1, 1998.
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
6
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--BASIS OF PRESENTATION (CONTINUED)
accepted accounting principles ("GAAP"). The Consolidated Financial Statements
include the accounts of the Company, its qualified REIT subsidiaries, and its
majority-owned and controlled partnerships. Certain third-party mortgage
servicing operations are conducted through iStar Operating, Inc. ("iStar
Operating"), a taxable corporation which is not consolidated with the Company
for financial reporting or income tax purposes. The Company owns all of the
non-voting preferred stock and a 95% economic interest in iStar Operating, which
is accounted for under the equity method for financial reporting purposes. The
Company does not own any of the outstanding voting stock of iStar Operating. In
addition, the Company has an investment in TriNet Management Operating
Company, Inc. ("TMOC"), a taxable noncontrolled subsidiary of the Company, which
is also accounted for under the equity method. Further, certain other
investments in partnerships or joint ventures which the Company does not control
are also accounted for under the equity method. All significant intercompany
balances and transactions have been eliminated in consolidation.
In the opinion of management, the accompanying Consolidated Financial
Statements contain all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of the Company's consolidated financial
position at September 30, 2001 and December 31, 2000 and the results of its
operations, changes in shareholders' equity and its cash flows for the three-
and nine-month periods ended September 30, 2001 and 2000, respectively. Such
operating results are not necessarily indicative of the results that may be
expected for any other interim periods or the entire year.
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LOANS AND OTHER LENDING INVESTMENTS, NET--As described in Note 4, "Loans and
Other Lending Investments," includes the following investments: senior
mortgages, subordinate mortgages, corporate/ partnership loans/unsecured notes,
loan participations and other lending or similar investments. In general,
management considers its investments in this category as held-to-maturity and,
accordingly, reflects such items at amortized historical cost.
CORPORATE TENANT LEASE ASSETS AND DEPRECIATION--Corporate tenant lease
assets are generally recorded at cost. Certain improvements and replacements are
capitalized when they extend the useful life, increase capacity or improve the
efficiency of the asset. Repairs and maintenance items are expensed as incurred.
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 $852,000 and $338,000 during the
nine-month periods ended September 30, 2001 and 2000, respectively, and was
7
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
approximately $365,000 and $0 during the three-month periods ended
September 30, 2001 and 2000, 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.
REVENUE RECOGNITION--The Company's revenue recognition policies are as
follows:
LOANS AND OTHER LENDING INVESTMENTS: The Company generally intends to hold
all of its loans and other lending investments to maturity. Accordingly, it
reflects all of these investments at amortized cost less allowance for loan
losses, acquisition premiums or discounts, deferred loan fees and undisbursed
loan funds. On occasion, the Company may acquire loans at either premiums or
discounts based on the credit characteristics of such loans. These premiums or
discounts are recognized as yield adjustments over the lives of the related
loans. If loans that were acquired at a premium or discount are prepaid, the
Company immediately recognizes the unamortized premium or discount as a decrease
or increase in the prepayment gain or loss, respectively. Loan origination or
exit fees, as well as direct loan origination costs, are also deferred and
recognized over the lives of the related loans as a yield adjustment. Interest
income is recognized using the effective interest method applied on a
loan-by-loan basis.
Certain of the Company's loans provide for accrual of interest at specified
rates which differ from current payment terms. Interest is recognized on such
loans at the accrual rate subject to management's determination that accrued
interest and outstanding principal are ultimately collectible, based on the
underlying collateral and operations of the borrower.
Prepayment penalties or yield maintenance payments from borrowers are
recognized as additional income when received. Certain of the Company's loan
investments provide for additional interest based on the borrower's operating
cash flow or appreciation of the underlying collateral. Such amounts are
considered contingent interest and are reflected as income only upon certainty
of collection.
LEASING INVESTMENTS: Operating lease revenue is recognized on the
straight-line method of accounting from the later of the date of the origination
of the lease or the date of acquisition of the facility subject to existing
leases. Accordingly, contractual lease payment increases are recognized evenly
over the term of the lease. The cumulative difference between lease revenue
recognized under this method and contractual lease payment terms is recorded as
a deferred operating lease income receivable on the balance sheet.
PROVISION FOR POSSIBLE CREDIT LOSSES--The Company's accounting policies
require that an allowance for estimated credit losses be maintained at a level
that management, based upon an evaluation of known and inherent risks in the
portfolio, considers adequate to provide for possible credit losses. Specific
valuation allowances are established for impaired loans in the amount by which
the carrying value, before allowance for estimated losses, exceeds the fair
value of collateral less disposition costs on an individual loan basis.
Management considers a loan to be impaired when, based upon current information
and events, it believes that it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan agreement
on a timely basis. Management measures these impaired loans at the fair value of
the loans' underlying collateral less estimated
8
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 either: (1) the loans become
90 days delinquent; or (2) management determines the borrower is incapable of,
or has ceased efforts toward, curing the cause of the impairment. While on
non-accrual status, interest income is recognized only upon actual receipt.
Impairment losses are recognized as direct write-downs of the related loan with
a corresponding charge to the provision for possible credit losses. Charge-offs
occur when loans, or a portion thereof, are considered uncollectible and of such
little value that further pursuit of collection is not warranted. Management
also provides a portfolio reserve based upon its periodic evaluation and
analysis of the portfolio, historical and industry loss experience, economic
conditions and trends, collateral values and quality, and other relevant
factors.
INCOME TAXES--The Company intends to operate in a manner consistent with and
to elect to be treated as a REIT. As a REIT, the Company is subject to federal
income taxation at corporate rates on its REIT taxable income; however, the
Company is allowed a deduction for the amount of dividends paid to its
shareholders, thereby subjecting the distributed net income of the Company to
taxation at the shareholder level only. iStar Operating and TMOC are not
consolidated for federal income tax purposes and are taxed as corporations. For
financial reporting purposes, current and deferred taxes are provided for in the
portion of earnings recognized by the Company with respect to its interest in
iStar Operating and TMOC.
EARNINGS (LOSS) PER COMMON SHARES--In accordance with the Statement of
Financial Accounting Standards No. 128 ("FASB No. 128"), the Company presents
both basic and diluted earnings per share ("EPS"). Basic earnings per share
("Basic EPS") excludes dilution and is computed by dividing net income available
to common shareholders by the weighted average number of shares outstanding for
the period. Diluted earnings per share ("Diluted EPS") reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock, where such exercise or conversion
would result in a lower earnings per share amount.
RECLASSIFICATIONS--Certain prior year amounts have been reclassified in the
Consolidated Financial Statements and the related notes to conform to the 2001
presentation.
USE OF ESTIMATES--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
CHANGE IN ACCOUNTING PRINCIPLE--In June 1998, the FASB issued Statement of
Financial Accounting Standards No. 133 ("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
9
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
foreign currency exposure. The Company adopted this pronouncement, as amended by
Statement of Financial Accounting Standards No. 137 "Accounting for Derivative
Instruments and Hedging Activities-deferral of the Effective Date of FASB
Statement No. 133" and Statement of Financial Accounting Standards No. 138
"Accounting for Certain Derivative Instruments and Certain Hedging Activities-an
Amendment of FASB Statement No. 133," on January 1, 2001. Because the Company
has primarily used derivatives as cash flow hedges of interest rate risk only,
the adoption of SFAS No. 133 did not have a material financial impact on the
financial position and results of operations of the Company. However, should the
Company change its current use of such derivatives (see Note 8), the adoption of
SFAS No. 133 could have a more significant effect on the Company prospectively.
Upon adoption, the Company recognized a charge to net income of
approximately $282,000 and an additional charge of $9.4 million to other
comprehensive income, representing the cumulative effect of the change in
accounting principle.
OTHER NEW ACCOUNTING STANDARDS--In December 1999, the Securities and
Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB
101"), "Revenue Recognition in Financial Statements." In June 2000, the SEC
staff amended SAB 101 to provide registrants with additional time to implement
SAB 101. The Company adopted SAB 101, as required, in the fourth quarter of
fiscal 2000. The adoption of SAB 101 did not have a material financial impact on
the financial position or the results of operations of the Company.
In 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 is not expected to have a
material impact on the Company's Consolidated Financial Statements.
In March 2000, the FASB issued FASB Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation." The Company
was required to adopt FIN 44 effective July 1, 2000 with respect to certain
provisions applicable to new awards, exchanges of awards in a business
combination, modifications to outstanding awards, and changes in grantee status
that occur on or after that date. FIN 44 addresses practice issues related to
the application of Accounting Practice Bulletin Opinion No. 25, "Accounting for
Stock Issued to Employees." The initial adoption of FIN 44 by the Company did
not have a material impact on its consolidated financial position or results of
operations.
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 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
10
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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 Company is currently evaluating this statement to assess its
impact on the financial statements. 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 will
adopt the provisions of this statement on January 1, 2002. The Company does not
believe the adoption of SFAS No. 144 will have a significant impact on the
Company.
11
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--LOANS AND OTHER LENDING INVESTMENTS
The following is a summary description of the Company's loans and other
lending investments (in thousands) (unaudited):
CARRYING VALUE AS OF
# OF ORIGINAL PRINCIPAL ----------------------------
TYPE OF BORROWERS COMMITMENT BALANCES SEPTEMBER 30, DECEMBER 31, EFFECTIVE
INVESTMENT IN CLASS(1) AMOUNT(1) OUTSTANDING(1) 2001 2000 MATURITY DATES
- ------------------------ ----------- ----------- -------------- ------------- ------------ --------------
Senior Mortgages 19 $1,260,193 $1,155,711 $1,139,316 $1,210,992 2001 to 2019
Subordinated Mortgages 14 423,730 371,282 367,990 325,558 2002 to 2011
Corporate 18 614,066 581,417 553,561 398,978 2001 to 2011
Loans/Partnership
Loans/Unsecured Notes
Loan Participations 3 127,497 111,351 111,254 111,251 2003 to 2005
Other Lending 8 N/A 270,045 239,734 192,404 2002 to 2013
Investments
---------- ----------
Gross Carrying Value $2,411,855 $2,239,183
Provision for Possible
Credit Losses (19,250) (14,000)
---------- ----------
Total, Net $2,392,605 $2,225,183
========== ==========
TYPE OF CONTRACTUAL INTEREST CONTRACTUAL INTEREST PRINCIPAL PARTICIPATION
INVESTMENT PAYMENT RATES(2) ACCRUAL RATES(2) AMORTIZATION FEATURES
- ------------------------ ----------------------- ----------------------- ------------ -------------
Senior Mortgages Fixed: 6.13% to 14.25% Fixed: 6.13% to 18.25% Yes (3) No
Variable: LIBOR + 1.50% Variable: LIBOR + 1.50%
to 6.00% to 6.00%
Subordinated Mortgages Fixed: 7.00% to 15.25% Fixed: 7.32% to 17.00% Yes (3) Yes (4)
Variable: LIBOR + 5.50% Variable: LIBOR + 5.50%
to 5.80% to 5.80%
Corporate Fixed: 6.13% to 15.00% Fixed: 6.13% to 17.50% Yes Yes (4)
Loans/Partnership Variable: LIBOR + 2.78% Variable: LIBOR + 2.78%
Loans/Unsecured Notes to 7.50% to 7.50%
Loan Participations Fixed: 10.00% to 13.60% Fixed: 13.60% to 14.00% Yes Yes (4)
Variable: LIBOR + 4.50% Variable: LIBOR + 4.50%
Other Lending Fixed: 6.75% to 12.75% Fixed: 6.75% to 12.75% No Yes (4)
Investments Variable: LIBOR + 7.56% Variable: LIBOR + 7.56%
to 9.36% to 9.36%
Gross Carrying Value
Provision for Possible
Credit Losses
Total, Net
EXPLANATORY NOTES:
- ----------------------------------------
(1) Amounts and details are for loans outstanding as of September 30, 2001.
(2) Substantially all variable-rate loans are based on 30-day LIBOR and reprice
monthly. The 30-day LIBOR rate on September 30, 2001 was 2.63%.
(3) The loans require fixed payments of principal and interest resulting in
partial principal amortization over the term of the loan with the remaining
principal due at maturity. In addition, one of the loans permits additional
annual prepayments of principal of up to $1.3 million without penalty at the
borrower's option.
(4) Under some of these loans, the lender receives additional payments
representing additional interest from participation in available cash flow
from operations of the property and the proceeds, in excess of a base
amount, arising from a sale or refinancing of the property.
12
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--LOANS AND OTHER LENDING INVESTMENTS (CONTINUED)
During the nine-month periods ended September 30, 2001 and 2000,
respectively, the Company and its affiliated ventures originated or acquired an
aggregate of approximately $701.5 million and $670.5 million in loans and other
lending investments, funded $45.2 million and $50.6 million under existing loan
commitments, and received principal repayments of $567.2 million and
$373.6 million.
As of September 30, 2001, the Company had ten loans with unfunded
commitments. The total unfunded commitment amount was approximately
$124.2 million, of which $56.4 million was discretionary (i.e., at the Company's
option) and $67.8 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 6).
The Company has reflected provisions for possible credit losses of
approximately $1.8 million and $1.8 million in its results of operations during
the three months ended September 30, 2001 and 2000, respectively, and
$5.3 million and $4.8 million during the nine months ended September 30, 2001
and 2000, respectively. These provisions represent portfolio reserves based on
management's evaluation of general market conditions, the Company's internal
risk management policies and credit risk ratings system, industry loss
experience, the likelihood of delinquencies or defaults, and the underlying
collateral. No direct impairment reserves on specific loans were considered
necessary. Management may transfer reserves between general and specific
reserves as considered necessary.
NOTE 5--CORPORATE TENANT LEASE ASSETS
The Company's investments in corporate tenant lease assets, at cost, were as
follows (in thousands) (unaudited):
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
Buildings and improvements.................................. $1,330,317 $1,294,572
Land and land improvements.................................. 343,759 344,490
Less: accumulated depreciation.............................. (71,658) (46,975)
---------- ----------
1,602,418 1,592,087
Investments in unconsolidated joint ventures................ 57,219 78,082
---------- ----------
Corporate tenant lease assets, net.......................... $1,659,637 $1,670,169
========== ==========
Under certain leases, the Company receives additional participating lease
payments to the extent gross revenues of the tenant exceed a base amount. The
Company earned no such additional participating lease payments in the three- and
nine-month periods ended September 30, 2001 and 2000, respectively. In addition,
the Company also receives reimbursements from tenants for certain facility
operating expenses.
INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED JOINT VENTURES--At
September 30, 2001, the Company had investments in five joint ventures:
(1) TriNet Sunnyvale Partners L.P. ("Sunnyvale"), whose external partners are
John D. O'Donnell, Trustee, John W. Hopkins, and Donald S. Grant; (2) Corporate
Technology Associates LLC ("CTC I"), whose external member is Corporate
Technology Centre Partners LLC; (3) Sierra Land Ventures ("Sierra"), whose
external joint venture partner is Sierra-LC Land, Ltd.; (4) TriNet Milpitas
Associates, LLC ("Milpitas"), whose external member is The Prudential Insurance
Company of America; and (5) ACRE Simon, L.L.C. ("ACRE"), whose external
13
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--CORPORATE TENANT LEASE ASSETS (CONTINUED)
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 September 30, 2001, all
facilities held by CTC II and TN-CP had been sold. The Company previously had an
equity investment in CTC II, which was sold for approximately $66.0 million in
September 2000. In connection with this sale, the note receivable from the
venture was modified to mature on December 31, 2001. The note receivable and
related accrued interest are included in Loans and Other Lending Investments at
September 30, 2001 and December 31, 2000.
At September 30, 2001, the ventures comprised 23 net leased facilities.
Additionally, 17.7 acres of land are held for sale. The Company's combined
investment in these joint ventures at September 30, 2001 was $57.2 million. The
joint ventures' purchase price for the 23 facilities owned at September 30, 2001
was $345.4 million. The purchase price of the land held for sale was
$6.8 million. In the aggregate, the joint ventures had total assets of
$386.0 million and total liabilities of $281.1 million as of September 30, 2001,
and net income of $4.5 million and $12.5 million for the three and nine months
ended September 30, 2001. The Company accounts for these investments under the
equity method because the Company's joint venture partners have certain
participating rights which limit the Company's control. The Company's 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 debt as of September 30, 2001 are presented below (in thousands)
(unaudited):
PRO RATA
JOINT SHARE OF
OWNERSHIP EQUITY VENTURE THIRD-PARTY
UNCONSOLIDATED JOINT VENTURE % INVESTMENT INCOME DEBT
- ---------------------------- --------- ---------- -------- -----------
Operating:
Sunnyvale.......................................... 44.7% $12,657 $ 667 $ 10,728
CTC I.............................................. 50.0% 11,416 3,241 60,732
Milpitas........................................... 50.0% 24,089 3,007 40,253
ACRE Simon......................................... 20.0% 5,325 133 6,595
Development:
Sierra............................................. 50.0% 3,732 101 724
------- ------ --------
Total.......................................... $57,219 $7,149 $119,032
======= ====== ========
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 9.0% through November 9, 2003.
Currently, the limited partners of Sunnyvale have the option to convert
their partnership interest into cash; however, the Company may elect to deliver
297,728 shares of Common Stock in lieu of cash. Additionally, commencing in
February 2002, subject to acceleration under certain circumstances, the venture
interest held by the external member of Milpitas may be converted into 984,476
shares of Common Stock.
Income generated from the above joint venture investments is included in
Operating Lease Income in the Consolidated Statements of Operations.
14
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--DEBT OBLIGATIONS
As of September 30, 2001 and December 31, 2000, the Company has debt
obligations under various arrangements with financial institutions as follows
(in thousands) (unaudited):
CARRYING VALUE AS OF
MAXIMUM ---------------------------- STATED SCHEDULED
AMOUNT SEPTEMBER 30, DECEMBER 31, INTEREST MATURITY
AVAILABLE 2001 2000 RATES DATE
---------- ------------- ------------ --------------------------- ----------------
SECURED REVOLVING CREDIT FACILITIES:
Line of credit..................... $ 700,000 $ 242,300 $ 284,371 LIBOR + 1.75% -- 2.25% March 2005 (1)
Line of credit..................... 700,000 324,947 -- LIBOR + 1.40% -- 2.15% January 2005 (1)
Line of credit..................... 500,000 125,348 307,978 LIBOR + 1.50% -- 1.75% August 2003 (1)
UNSECURED REVOLVING CREDIT
FACILITIES:
Line of credit..................... 300,000 -- -- LIBOR + 2.125% July 2004 (2)
Line of credit..................... N/A -- 173,450 LIBOR + 1.55% May 2002 (2)
Line of credit..................... N/A -- -- LIBOR + 2.25% January 2003 (2)
---------- ---------- ----------
Total revolving credit
facilities....................... $2,200,000 692,595 765,799
==========
SECURED TERM LOANS:
Secured by corporate tenant lease assets....... 148,339 150,678 7.44% March 2009
Secured by corporate lending investments....... 60,000 60,000 LIBOR + 2.50% June 2004 (3)
Secured by corporate lending investments....... 50,000 -- LIBOR + 2.50% July 2006 (4)
Secured by corporate tenant lease assets....... -- 77,860 LIBOR + 1.38% June 2001
Secured by corporate tenant lease assets....... 58,062 60,471 6.00%-11.38% Various through
2011
Secured by corporate tenant lease assets....... 193,000 -- LIBOR + 1.85% July 2006 (5)
---------- ----------
Total term loans............................... 509,401 349,009
Plus: debt premium............................. 327 51
---------- ----------
Total secured term loans....................... 509,728 349,060
iStar Asset Receivables secured notes:
Class A........................................ 83,205 207,114 LIBOR + 0.30% August 2003 (6)
Class B........................................ 94,055 94,055 LIBOR + 0.50% October 2003 (6)
Class C........................................ 105,813 105,813 LIBOR + 1.00% January 2004 (6)
Class D........................................ 52,906 52,906 LIBOR + 1.45% June 2004 (6)
Class E........................................ 123,447 123,447 LIBOR + 2.75% January 2005 (6)
Class F........................................ 5,000 5,000 LIBOR + 3.15% January 2005 (6)
---------- ----------
Total iStar Asset Receivables secured notes.... 464,426 588,335
UNSECURED NOTES:
6.75% Dealer Remarketable Securities (7)(8).... 125,000 125,000 6.75% March 2013
7.30% Notes (7)................................ -- 100,000 7.30% May 2001
7.70% Notes (7)................................ 100,000 100,000 7.70% July 2017
7.95% Notes (7)................................ 50,000 50,000 7.95% May 2006
8.75% Notes.................................... 350,000 -- 8.75% August 2008
---------- ----------
Total unsecured notes.......................... 625,000 375,000
Less: debt discount (9)........................ (16,664) (18,490)
---------- ----------
Total unsecured notes.......................... 608,336 356,510
OTHER DEBT OBLIGATIONS........................... 16,689 72,263 Various Various
---------- ----------
TOTAL DEBT OBLIGATIONS........................... $2,291,774 $2,131,967
========== ==========
15
EXPLANATORY NOTES:_______________
(1) Maturity date reflects a one-year "term-out" extension at the Company's
option.
(2) On July 27, 2001, the Company replaced both unsecured facilities with a new
$300.0 million revolving credit facility bearing interest at
LIBOR + 2.125%. 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.
(3) Maturity date reflects a one-year extension at the Company's option.
(4) On July 6, 2001, the Company financed a $75.0 million structured finance
asset with a $50.0 million term loan bearing interest at LIBOR + 2.50%. The
loan has an initial maturity of July 2005 with a one-year extension at the
Company's option.
(5) Maturity date reflects two one-year extensions at the Company's option.
(6) 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.
(7) 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.
(8) Subject to mandatory tender on March 1, 2003, to either the dealer or the
Leasing Subsidiary. The initial coupon of 6.75% applies to first five-year
term through the mandatory tender date. If tendered to the dealer, the notes
must be remarketed. The rates reset to market rates upon remarketing.
(9) These obligations were assumed as part of the TriNet Acquisition. As part of
the accounting for the purchase, these fixed-rate obligations were
considered to have stated interest rates which were below the
then-prevailing market rates at which the Leasing Subsidiary could issue new
debt obligations and, accordingly, the Company ascribed a market discount to
each obligation. Such discounts 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.
16
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--DEBT OBLIGATIONS (CONTINUED)
Availability of amounts under the secured revolving credit facilities are
based on percentage borrowing base calculations. 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 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 plus 1.40% to 2.15%, depending upon the collateral
contributed to the borrowing base. The new facility accepts a broad range of
structured finance assets and has a final maturity of January 2005. In addition,
on February 22, 2001, the Company extended the maturity of its $350.0 million
unsecured revolving credit facility to May 2002.
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 financing secured by
15 corporate tenant lease assets. The floating-rate loan bears interest at LIBOR
plus 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 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 repay outstanding borrowings under its secured
credit facilities.
During the nine-month period ended September 30, 2001, the Company incurred
an extraordinary loss of approximately $1.6 million as a result of the early
retirement of certain secured debt obligations of its Leasing Subsidiary.
17
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--DEBT OBLIGATIONS (CONTINUED)
As of September 30, 2001, future expected/scheduled maturities of
outstanding long-term debt obligations are as follows (in thousands) (unaudited)
(1):
2001 (remaining three months)............................... $ 16,688
2002........................................................ 14,711
2003........................................................ 302,609
2004........................................................ 218,719
2005........................................................ 699,261
Thereafter.................................................. 1,056,123
----------
Total principal maturities.................................. 2,308,111
Net unamortized debt discounts.............................. (16,337)
----------
Total debt obligations...................................... $2,291,774
==========
EXPLANATORY NOTE:_______________
(1) Assumes exercise of extensions to the extent such extensions are at the
Company's option.
NOTE 7--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 9.5% 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 8.0% 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.
STOCK REPURCHASE PROGRAM: The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets and excess cash
flow from operations, but also using borrowings under its credit facilities if
the Company determines that it is advantageous to do so. As of both
September 30, 2001 and December 31, 2000, the Company had repurchased
approximately 2.3 million shares at an aggregate cost of approximately
$40.7 million.
NOTE 8--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS
RISK MANAGEMENT--In the normal course of its on-going business operations,
the Company encounters economic risk. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or different bases, than its
interest-earning assets. Credit risk is the risk of default on the Company's
loan assets that results from a property's, borrower's or tenant's inability or
unwillingness to make contractually required payments. Market risk reflects
changes in the value of loans due to changes in interest rates or other market
factors, including the rate of prepayments of principal and the value of the
collateral underlying loans and the valuation of corporate tenant lease
facilities held by the Company.
USE OF DERIVATIVE FINANCIAL INSTRUMENTS--The Company's use of derivative
financial instruments is primarily limited to the utilization of interest rate
agreements or other instruments to manage interest
18
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
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.
In connection with the TriNet Acquisition, the Company acquired LIBOR
interest rate caps currently struck at 7.75%, and 7.75% in notional amounts of
$75.0 million and $35.0 million, respectively, which both expire in
December 2004. In connection with the closing of STARs, Series 2000-1 in
May 2000, the Company entered into a LIBOR interest rate cap struck at 10.00% in
the notional amount of $312.0 million, and simultaneously sold a LIBOR interest
rate cap with the same terms. Since these instruments do not reduce the
Company's net interest rate risk exposure, they do not qualify as hedges and
changes in their respective values are charged to earnings. As the significant
terms of these arrangements are substantially the same, the effects of a
revaluation of these two instruments are expected to substantially offset one
another. At September 30, 2001 and December 31, 2000, the net fair value of the
Company's interest rate caps were $0.3 million and $0.4 million, respectively.
The Company has entered into LIBOR interest rate swaps struck at 7.055% and
7.058%, both with notional amounts of $125.0 million that expire in June 2003.
These swaps effectively fix the interest rate on a portion of the Company's
floating-rate term loan obligations. In connection with the TriNet Acquisition,
the Company acquired an interest rate swap which, together with certain existing
interest rate cap agreements, effectively fix the interest rate on
$75.0 million of the Leasing Subsidiary's LIBOR-based borrowings at 5.58% plus
the applicable margin through December 1, 2004. Management expects that it will
have aggregate LIBOR-based borrowings at the Leasing Subsidiary in excess of the
notional amount for the duration of the swap. The actual borrowing cost to the
Company with respect to indebtedness covered by the swap will depend upon the
applicable margin over LIBOR for such indebtedness, which will be determined by
the terms of the relevant debt instruments. At September 30, 2001 and
December 31, 2000, the fair value (liability) of the Company's interest rate
swaps was ($21.4) million and ($7.7) million, respectively.
During the year ended December 31, 1999, the Company settled an aggregate
notional amount of approximately $63.0 million that was outstanding under
certain hedging agreements which the Company had entered into in order to hedge
the potential effects of interest rate movements on anticipated fixed-rate
borrowings. The settlement of such agreements resulted in a receipt of
approximately $0.6 million which had been deferred pending completion of the
planned fixed-rate financing transaction. Subsequently, the transaction was
modified and was actually consummated as a variable-rate financing transaction.
As a result, the previously deferred receipt no longer qualified for hedge
accounting treatment and the $0.6 million was recognized as a gain included in
other income in the consolidated statement of operations for the year ended
December 31, 2000 in connection with the closing of STARs, Series 2000-1 in
May 2000.
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
19
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
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 10.0%) as of September 30, 2001 in California
(25.0%), Texas (14.4%) and New York (11.1%). As of September 30, 2001, the
Company's investments also contain significant concentrations in the following
asset types: office (49.2%) and hotel lending (13.0%).
The Company underwrites the credit of prospective borrowers and customers
and often requires them to provide some form of credit support such as corporate
guarantees, 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 9--INCOME TAXES
The Company qualified for REIT status and elected to be taxed as a REIT for
the tax years commencing on January 1, 1998.
NOTE 10--STOCK OPTION PLANS AND EMPLOYEE BENEFITS
The Company's 1996 Long-Term Incentive Plan (the "Plan") is designed to
provide incentive compensation for officers, other key employees and directors
of the Company. The Plan provides for awards of stock options and shares of
restricted stock and other performance awards. The maximum number of shares of
Common Stock available for awards under the Plan is 9.0% 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 September 30, 2001, a total of approximately
7.9 million shares of Common Stock were available for awards under the Plan, of
which options to purchase approximately 5.8 million shares of Common Stock were
outstanding and approximately 651,000 shares of restricted stock were
outstanding.
Concurrently with the Recapitalization Transactions, the Company issued
approximately 2.5 million (as adjusted) fully vested and immediately exercisable
options to purchase class A shares at $14.72 per share (as adjusted) to the
external advisor with a term of ten years. The external advisor granted a
portion of these options to its employees and the remainder were allocated to an
affiliate. Upon consummation of the Advisor Transaction, these individuals
became employees of the Company. In general, the grants to these employees
provided for scheduled vesting over a predefined service period of three to five
years and, under certain conditions, provide for accelerated vesting. These
options expire on March 15, 2008.
20
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK OPTION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
In connection with the TriNet Acquisition, outstanding options to purchase
TriNet stock under TriNet's stock option plans were converted into options to
purchase shares of Common Stock on substantially the same terms, except that
both the exercise price and number of shares issuable upon exercise of the
TriNet options were adjusted to give effect to the merger exchange ratio of 1.15
shares of Common Stock for each share of TriNet common stock. In addition,
options held by the former directors of TriNet and certain executive officers
became fully vested as a result of the transaction.
Changes in options outstanding during the nine months ended September 30,
2001 are as follows:
NUMBER OF SHARES
------------------------------------ AVERAGE
NON-EMPLOYEE STRIKE
EMPLOYEES DIRECTORS OTHER PRICE
--------- ------------ --------- --------
OPTIONS OUTSTANDING, DECEMBER 31, 2000 (UNAUDITED)........ 3,535,572 226,379 961,163 $18.97
Granted in 2001......................................... 1,618,400 90,000 100,000 $20.07
Exercised in 2001....................................... (615,733) (20,000) (25,000) $17.55
Forfeited in 2001....................................... (103,688) -- -- $27.59
--------- ------- ---------
OPTIONS OUTSTANDING, SEPTEMBER 30, 2001 (UNAUDITED)....... 4,434,551 296,379 1,036,163
========= ======= =========
The following table summarizes information concerning outstanding and
exercisable options as of September 30, 2001 (unaudited):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------- ---------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
OPTIONS CONTRACTUAL EXERCISE CURRENTLY EXERCISE
EXERCISE PRICE RANGE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------------- ----------- ----------- -------- ----------- --------
$14.72 - $15.00 1,648,537(1) 6.46 $14.73 1,100,173 $14.72
$16.69 - $16.88 1,062,490 8.27 $16.86 327,900 $16.88
$17.38 - $17.56 537,500 8.47 $17.39 170,835 $17.38
$19.50 - $19.75 1,694,650 9.33 $19.69 2,083 $19.54
$20.33 - $21.44 255,750 6.18 $20.99 146,635 $21.04
$22.44 20,000 9.01 $22.44 -- $ --
$23.32 - $23.64 68,309 2.63 $23.57 48,824 $23.54
$24.13 - $24.94 217,500 6.35 $24.53 216,500 $24.53
$25.10 - $26.09 21,700 4.89 $26.04 20,700 $26.09
$26.30 - $26.97 91,700 2.83 $26.73 89,700 $26.72
$27.00 25,000 9.73 $27.00 -- $ --
$28.26 - $28.54 41,238 2.13 $28.37 41,238 $28.37
$30.33 67,275 1.65 $30.33 57,217 $30.33
$33.15 - $33.70 10,350 1.22 $33.39 8,913 $33.43
$55.39 5,094 7.67 $55.39 3,396 $55.39
--------- ------ ------ --------- ------
5,767,093 7.62 $18.24 2,234,114 $18.18
========= ====== ====== ========= ======
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 September 30, 2001, less than 2,000 of
these options are currently exercisable by the beneficial owners.
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
21
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK OPTION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
equals or exceeds the quoted price of the Company's common shares at the date of
grant or measurement date. In connection with the Advisor Transaction, as part
of the computation of the one-time charge to earnings, the Company calculated a
deferred compensation charge of approximately $5.1 million. This deferred charge
represents the difference of the closing sales price of the shares of Common
Stock on the date of the Advisor Transaction of $20.25 over the strike price of
the options of $14.72 per share (as adjusted) for the unvested portion of the
options granted to former employees of the Advisor who are now employees of the
Company. This deferred charge will be amortized over the related remaining
vesting terms to the individual employees as additional compensation expense.
In connection with the original grant of options in March 1998 to its
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 27.5% volatility rate and an estimated annual
dividend rate of 8.5%. The resulting charge to earnings was calculated as the
number of options allocated to the Advisor multiplied by the estimated value at
consummation. A charge of approximately $6.0 million was reflected in the
Company's first quarter 1998 financial results for this original grant.
Future charges may be taken to the extent of additional option grants, which
are at the discretion of the Board of Directors.
During the nine-month period ended September 30, 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. In addition, the Company entered into a three-year
employment agreement 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
these shares is a function of the total rate of return (dividends and price
appreciation) on the Company's Common Stock, although none of the shares vest
(regardless of the total return to shareholders) if the executive voluntarily
terminates his employment without good reason prior to September 30, 2002. 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. None of these
restricted shares were vested at September 30, 2001.
During the nine months ended September 30, 2001, the Company also entered
into a new three-year employment agreement with its chief executive officer. As
part of this agreement, the Company confirmed a prior grant of 750,000 stock
options made to the executive on March 2, 2001. The options will vest in equal
installments of 250,000 shares in each January beginning with January 2002. The
Company also granted the executive 2,000,000 unvested phantom shares, each of
which represents one share of the Company's Common Stock. These shares will vest
in installments on a contingent basis if the average closing price of the
Company's Common Stock achieves certain levels ($25.00 to $37.00 per share) over
specified periods of time. 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.
22
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK OPTION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
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.
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.
Effective November 4, 1999, the Company implemented a savings and retirement
plan (the "401(k) Plan"), which is a voluntary, defined contribution plan. All
employees are eligible to participate in the 401 (k) Plan following completion
of six months of continuous service with the Company. Each participant may
contribute on a pretax basis between 2% and 15% of such participant's
compensation. At the discretion of the Board of Directors, the Company may make
matching contributions on the participant's behalf of up to 50% of the first 10%
of the participant's annual contribution. The Company made contributions of
approximately $61,000 and $48,000 to the 401(k) Plan for the three-month periods
ended September 30, 2001 and 2000, respectively and approximately $246,000 and
$223,000 to the 401(k) Plan for the nine-month periods ended September 30, 2001
and 2000, respectively.
NOTE 11--EARNINGS PER SHARE
Prior to November 4, 1999, Basic EPS was computed based on the income
allocable to class A shares (net income reduced by accrued dividends on
preferred shares and by 1% allocated to class B shares), divided by the weighted
average number of class A shares outstanding during the period. Diluted EPS was
based on the net earnings allocable to class A shares plus dividends on class B
shares which were convertible into class A shares, divided by the weighted
average number of class A shares and dilutive potential class A shares that were
outstanding during the period. Dilutive potential class A shares included the
class B shares, which were convertible into class A shares at a rate of 49
class B shares for one class A share, and potentially dilutive options to
purchase class A shares issued to the Advisor and the Company's directors and
warrants to acquire class A shares.
23
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--EARNINGS PER SHARE (CONTINUED)
As described in Note 1, in the Incorporation Merger, the class B shares were
converted into shares of Common Stock on a 49-for-one basis (the same ratio at
which class B shares were previously convertible into class A shares), and the
class A shares were converted into shares of Common Stock on a one-for-one
basis. As a result, the Company no longer has multiple classes of common shares.
Basic and diluted earnings per share are based upon the following weighted
average shares outstanding during the three- and nine-month periods ended
September 30, 2001 and 2000, respectively (in thousands):
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
(UNAUDITED)
Weighted average common shares outstanding for basic
earnings per common share............................. 86,470 85,662 86,130 85,345
Add: effect of assumed shares issued under treasury
stock method for stock options and restricted
shares................................................ 2,004 982 1,713 676
Add: effect of contingent shares........................ 350 -- 156 --
------- ------- ------- -------
Weighted average common shares outstanding for diluted
earnings per common share............................. 88,824 86,644 87,999 86,021
======= ======= ======= =======
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 $148.1 million and
$161.6 million for the nine-month periods ended September 30, 2001 and 2000,
respectively, and $49.0 million and $55.6 million for the three-month periods
ended September 2001 and 2000, respectively. The primary component of
comprehensive income other than net income was the adoption and continued
application of SFAS No. 133.
For the three and nine months ended September 30, 2001, the change in fair
market value of the Company's interest rate swaps was $(8.5) million and $(13.6)
million and was recorded as a reduction
24
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--COMPREHENSIVE INCOME (CONTINUED)
to other comprehensive income. The reconciliation to other comprehensive income
is as follows (in thousands) (unaudited):
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net income............................................ $57,553 $55,591 $171,155 $161,410
Other comprehensive income (loss):
Unrealized gains (losses) on securities for the
period............................................ -- (34) -- 195
Cumulative effect of change in accounting principle
(SFAS No. 133) on other comprehensive income...... -- -- (9,445) --
Unrealized derivative gains (losses) on cash flow
hedges............................................ (8,515) -- (13,589) --
------- ------- -------- --------
Comprehensive income.................................. $49,038 $55,557 $148,121 $161,605
======= ======= ======== ========
NOTE 13--DIVIDENDS
In order to maintain its election to qualify as a REIT, the Company must
distribute, at a minimum, an amount equal to 90% of its taxable income and must
distribute 100% of its taxable income to avoid paying corporate federal income
taxes. The distribution rate was modified to 95% from 90% by the REIT
Modernization Act beginning in fiscal 2001. The Company anticipates it will
distribute all of its taxable income to its shareholders. Because taxable income
differs from cash flow from operations due to non-cash revenues or expenses, in
certain circumstances, the Company may be required to borrow to make sufficient
dividend payments to meet this anticipated dividend threshold.
For the year ended December 31, 2000, total dividends declared by the
Company aggregated $205.5 million, or $2.40 per common share. The dividend
attributable to the fourth quarter 2000 was $51.4 million, or $0.60 per share of
Common Stock, and was paid on January 12, 2001. Total dividends attributable to
the nine months ended September 30, 2001 were $159.4 million, or $1.8375 per
share of Common Stock consisting of quarterly dividends of $0.6125 per share
which were declared on April 1, 2001, July 1, 2001 and October 1, 2001. The
Company also declared dividends aggregating $15.7 million, $3.5 million,
$2.2 million and $6.0 million, respectively, on its Series A, B, C and D
preferred stock, respectively, for the nine-month period ended September 30,
2001 and $5.2 million, $1.2 million, $0.7 million and $2.0 million,
respectively, on its Series A, B, C and D preferred stock, respectively, for the
three-month period ended September 30, 2001. There are no divided arrearages on
any of the preferred shares currently outstanding.
The Series A preferred stock has a liquidation preference of $50.00 per
share and carries an initial dividend yield of 9.50% per annum. The dividend
rate on the preferred shares will increase to 9.75% on December 15, 2005, to
10.00% on December 15, 2006 and to 10.25% on December 15, 2007 and thereafter.
Dividends on the Series A preferred shares are payable quarterly in arrears and
are cumulative.
Holders of shares of the Series B preferred stock are entitled to receive,
when and as declared by the Board of Directors, out of funds legally available
for the payment of dividends, cumulative preferential cash dividends at the rate
of 9.375% per annum of the $25.00 liquidation preference, equivalent to a fixed
annual rate of $2.34 per share. Dividends are cumulative from the date of
original
25
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13--DIVIDENDS (CONTINUED)
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.
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% or more of revenues
(see Note 8 for other information regarding concentrations of credit risk).
The Company evaluates performance based on the following financial measures
for each segment. Selected results of operations for the three- and nine-month
periods ended September 30, 2001 and
26
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--SEGMENT REPORTING (CONTINUED)
2000 and selected asset information as of September 30, 2001 and December 31,
2000 regarding the Company's operating segments are as follows (in thousands):
CORPORATE
REAL ESTATE TENANT CORPORATE/ COMPANY
LENDING LEASING (1) OTHER (2) TOTAL
----------- ----------- ---------- ----------
(UNAUDITED)
TOTAL REVENUES(3):
Three months ended:
September 30, 2001............................ $ 71,342 $ 50,025 $ (537) $ 120,830
September 30, 2000............................ 72,363 48,360 (40) 120,683
Nine months ended:
September 30, 2001............................ $ 216,265 $ 149,006 $ (999) $ 364,272
September 30, 2000............................ 206,588 142,690 207 349,485
TOTAL OPERATING AND INTEREST EXPENSE(4):
Three months ended:
September 30, 2001............................ $ 29,799 $ 25,007 $ 6,651 $ 61,457
September 30, 2000............................ 32,118 28,089 6,430 66,637
Nine months ended:
September 30, 2001............................ $ 91,470 $ 78,661 $ 21,310 $ 191,441
September 30, 2000............................ 82,959 84,963 22,273 190,195
NET OPERATING INCOME BEFORE MINORITY INTEREST
AND GAIN ON SALE OF NET LEASE ASSETS(5):
Three months ended:
September 30, 2001............................ $ 41,543 $ 25,018 $ (7,188) $ 59,373
September 30, 2000............................ 40,245 20,271 (6,470) 54,046
Nine months ended:
September 30, 2001............................ $ 124,795 $ 70,345 $(22,309) $ 172,831
September 30, 2000............................ 123,629 57,727 (22,066) 159,290
TOTAL LONG-LIVED ASSETS(6):
September 30, 2001............................ $2,392,605 $1,659,637 N/A $4,052,242
December 31, 2000............................. 2,225,183 1,670,169 N/A 3,895,352
TOTAL ASSETS:
September 30, 2001............................ $2,392,605 $1,659,637 $144,311 $4,196,553
December 31, 2000............................. 2,225,183 1,670,169 139,423 4,034,775
EXPLANATORY NOTES:_______________
(1) Includes the Company's pre-existing Corporate Tenant Leasing investments
since March 18, 1998 and the Corporate Tenant Leasing business acquired in
the TriNet Acquisition since November 4, 1999.
(2) Corporate and Other represents all corporate level items, including general
and administrative expenses and any intercompany eliminations necessary to
reconcile to the consolidated Company totals. This caption also includes the
Company's servicing business, which is not considered a material separate
segment.
(3) Total revenues represents all revenues earned during the period from the
assets in each segment. Revenue from the Real Estate Lending business
primarily represents interest income and revenue from the Corporate Tenant
Leasing business primarily represents operating lease income.
27
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14--SEGMENT REPORTING (CONTINUED)
(4) Total operating and interest expense represents provision for possible
credit losses for the Real Estate Lending business and operating costs on
corporate tenant lease assets for the Corporate Tenant Leasing business, as
well as interest expense specifically related to each segment. General and
administrative expense, advisory fees (prior to November 4, 1999) and
stock-based compensation expense is included in Corporate and Other for all
periods. Depreciation and amortization of $8.7 million and $8.7 million for
the three-month periods ended September 30, 2001 and 2000, respectively, and
$26.3 million and $26.6 million for the nine-month periods ended
September 30, 2001 and 2000, respectively, are included in the amounts
presented above.
(5) Net operating income before minority interests represents net operating
income before minority interest, gain on sale of corporate tenant lease
assets and extraordinary loss as defined in note (3) above, less total
operating and interest expense, as defined in note (4) above.
(6) Total long-lived assets is comprised of Loans and Other Lending Investments,
net and Corporate Tenant Lease Assets net, for each respective segment.
NOTE 15--SUBSEQUENT EVENTS
On October 30, 2001, Starwood Mezzanine Investors, L.P. and Starwood
Opportunity Fund IV, L.P and one of their affiliates sold 16.5 million shares of
Common Stock owned by them at a price of $23.30 per share. The Company did not
sell any shares in this offering. The selling stockholders also granted the
underwriters an option to purchase up to an additional 2.475 million of their
shares of Common Stock solely to cover over-allotments. On November 7, 2001, the
underwriters exercised this option. As a result of the secondary offering,
Starwood Opportunity Fund IV, L.P. owns approximately 39.1% of the Company's
Common Stock (based on the diluted sharecount as of September 30, 2001).
Starwood Mezzanine Investors, L.P. owns no shares of Common Stock following the
offering.
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes thereto appearing elsewhere in this report and
also with the Company's Annual Report for 2000 filed on Form 10-K. Unless
otherwise defined in this report, or unless the context otherwise requires, the
capitalized words or phrases referred to in this section have the meaning
ascribed to them in such financial statements and the notes thereto.
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
Company's private investment funds contributed their approximately $1.1 billion
of assets to the Company's predecessor, Starwood Financial Trust, in exchange
for a controlling interest in that public company. In November 1999, the Company
acquired its leasing subsidiary, TriNet Corporate Realty Trust, Inc., which was
then the largest publicly-traded company specializing in the net leasing of
corporate office and industrial facilities. Concurrent with the TriNet
Acquisition, the Company also acquired its external advisor in exchange for
shares of its Common Stock and converted its organizational form to a Maryland
corporation. As part of the conversion to a Maryland corporation, the Company
replaced its dual-class Common Stock structure with a single class of Common
Stock. This single class of 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 SEPTEMBER 30, 2001 COMPARED TO THE THREE-MONTH PERIOD
ENDED SEPTEMBER 30, 2000
INTEREST INCOME--Interest income decreased to approximately $62.4 million
for the three months ended September 30, 2001 from approximately $70.1 million
for the same period in 2000. This decrease in interest income is primarily a
result of the decrease in average LIBOR rates on the Company's variable-rate
lending investments, which was partially offset by an increase in the average
balance of loans and other lending investments.
OPERATING LEASE INCOME--Operating lease income increased to $49.9 million
for the three months ended September 30, 2001 from $46.3 million for the same
period in 2000. Of this increase, approximately $826,000 was attributable to new
corporate tenant lease investments and $1.7 million to additional operating
lease income from existing corporate tenant lease investments owned in both
quarters. In addition, joint venture income contributed $1.2 million to the
increase.
OTHER INCOME--Other income for the three-month period ended September 30,
2001 is primarily comprised of sales proceeds from participation interests.
Other income for the three-month period ended September 30, 2000 included a
prepayment penalty from the refinancing of a senior mortgage and a corporate
loan, in addition to a gain resulting from the repayment of a senior loan held
at a discount upon the conversion of such loan to a corporate tenant lease
holding pursuant to a purchase option granted to the Company in connection with
its original investment in the asset.
29
INTEREST EXPENSE--The Company's interest expense decreased by $5.3 million
for the three months ended September 30, 2001 over the same period in the prior
year. The decrease was primarily due to lower average LIBOR rates on the
Company's outstanding floating-rate debt obligations.
OPERATING COSTS-CORPORATE TENANT LEASE ASSETS--Operating costs did not
significantly change for the three months ended September 30, 2001 compared to
the comparable period in 2000.
DEPRECIATION AND AMORTIZATION--Depreciation and amortization decreased by
approximately $36,000 to $8.7 million for the three months ended September 30,
2001 over the same period in the prior year. This decrease is primarily the
result of corporate tenant lease dispositions in 2000 and 2001, partially offset
by additional depreciation on investments.
GENERAL AND ADMINISTRATIVE--The Company's general and administrative
expenses during the three months ended September 30, 2001 increased by
approximately $272,000 to $6.1 million compared to the same period in 2000.
PROVISION FOR POSSIBLE CREDIT LOSSES--As more fully discussed in Note 4 to
the Company's Consolidated Financial Statements, the Company has not realized
any actual losses on any of its loan investments to date. However, the Company
has considered it prudent to establish a policy of providing reserves for
potential losses in the current portfolio which may occur in the future.
Accordingly, since its first full quarter operating its current business as a
public company (the quarter ended June 30, 1998), management has reflected
quarterly provisions for possible credit losses in its operating results. The
Company will continue to recognize quarterly provisions until a stabilized
reserve level is attained.
STOCK-BASED COMPENSATION EXPENSE--Stock-based compensation expense did not
significantly change for the three months ended September 30, 2000 as compared
to the 2000 period.
GAIN ON SALE OF CORPORATE TENANT LEASE ASSETS--On August 30, 2001, the
Company disposed of one corporate tenant lease asset for total proceeds of
$13.0 million, and recognized a loss of approximately $1.2 million. This asset
was formerly owned by TriNet prior to its acquisition by the Company, and was
vacant when acquired by the Company in the TriNet Acquisition.
During the third quarter of 2000, one of the Company's joint venture sold
its facility for total proceeds of $41.9 million, and the Company recognized a
gain of approximately $1.7 million. In addition, another of the Company's joint
ventures sold all five of its facilities for total proceeds of $66.0 million,
and the Company recognized a gain of approximately $222,000.
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT--During the three months
ended September 30, 2001, the Company prepaid an unsecured revolving credit
facility which had an original maturity date of May 2002. In connection with
this prepayment, the Company expensed the remaining unamortized deferred
financing costs, which resulted in an extraordinary loss on early extinguishment
of debt of approximately $583,000 during the quarter.
During the third quarter of 2000, certain of the proceeds from an asset
disposition in one of the Company's joint ventures were used to repay
$16.4 million of a third-party debt at the joint venture. In connection with
this paydown, the joint venture incurred certain prepayment penalties, which
resulted in an extraordinary loss on early extinguishment of debt to the Company
of $388,000.
NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2001 COMPARED TO THE NINE-MONTH PERIOD
ENDED SEPTEMBER 30, 2000
INTEREST INCOME--Interest income decreased to approximately $193.2 million
for the nine months ended September 30, 2001 from approximately $197.1 million
for the same period in 2000. This decrease in interest income is primarily a
result of the decrease in average LIBOR rates on the Company's variable-rate
lending investments, which was partially offset by the increase in the average
balance of loans and other lending investments.
30
OPERATING LEASE INCOME--Operating lease income increased to $148.7 million
for the nine months ended September 30, 2001 from $139.8 million for the same
period in 2000. Of this increase, $8.2 million was attributable to new corporate
tenant lease investments and $4.4 million to additional operating lease income
from existing corporate tenant lease investments owned in both quarters. In
addition, joint venture income contributed $3.1 million to the increase. These
increases in operating lease income from assets owned were partially offset by a
$6.9 million decrease in operating lease income resulting from asset
dispositions made in 2000 and 2001.
OTHER INCOME--Other income for the nine-month period ended September 30,
2001 is primarily comprised of gains and prepayment penalties from the early
repayment of senior mortgages, subordinate mortgages and corporate/partnership
loans, participation payments and management fees. Other income for the
nine-month period ended September 30, 2000 included prepayment fees resulting
from the full or partial repayments of three loans, a fee resulting from the
purchase of a sub-performing loan and subsequent restructuring of such loan to
fully-performing status, and a realized gain resulting from the repayment of a
senior loan held at a discount upon the conversion of such loan to a corporate
tenant lease holding pursuant to a purchase option granted to the Company in
connection with its original investment in the asset.
INTEREST EXPENSE--The Company's interest expense increased by $1.9 million
for the nine months ended September 30, 2001 over the same period in the prior
year. The increase was primarily due to higher average borrowings by the
Company's credit facilities, other term loans and unsecured notes, in addition
to the amortization of deferred financing costs on the Company's credit
facilities. This increase was partially offset by the lower average LIBOR rates
on the Company's floating-rate debt obligations.
OPERATING COSTS-CORPORATE TENANT LEASE ASSETS--For the nine months ended
September 30, 2001, operating costs increased by approximately $152,000 to
$9.7 million, from $9.6 million for the same period in 2000.
DEPRECIATION AND AMORTIZATION--Depreciation and amortization decreased by
approximately $320,000 to $26.3 million for the nine months ended September 30,
2001 over the same period in the prior year. This decrease is primarily the
result of corporate tenant lease dispositions in 2000 and 2001, partially offset
by additional depreciation on investments.
GENERAL AND ADMINISTRATIVE--The Company's general and administrative
expenses during the nine months ended September 30, 2001 decreased by
approximately $1.8 million to $18.7 million compared to the same period in 2000.
PROVISION FOR POSSIBLE CREDIT LOSSES--As more fully discussed in Note 4 to
the Company's Consolidated Financial Statements, the Company has not realized
any actual losses on any of its loan investments to date. However, the Company
has considered it prudent to establish a policy of providing reserves for
potential losses in the current portfolio which may occur in the future.
Accordingly, since its first full quarter operating its current business as a
public company (the quarter ended June 30, 1998), management has reflected
quarterly provisions for possible credit losses in its operating results. The
Company will continue to recognize quarterly provisions until a stabilized
reserve level is attained.
STOCK-BASED COMPENSATION EXPENSE--Stock-based compensation expense increased
by approximately $877,000 as a result of charges relating to grants of stock
options, including amortization of the deferred charge related to options
granted to employees of the Company's former external advisor subsequent to such
personnel becoming direct employees of the Company as of November 4, 1999.
GAIN ON SALE OF CORPORATE TENANT LEASE ASSETS--During the nine months ended
September 30, 2001, the Company disposed of three corporate tenant lease assets
for total proceeds of $21.4 million, and recognized gains of approximately
$403,000.
31
During the first nine months of 2000, the Company disposed of seven assets
for total proceeds of $256.2 million, and recognized gains of approximately
$2.9 million.
EXTRAORDINARY LOSS ON EARLY EXTINGUISHMENT OF DEBT--During the nine months
ended September 30, 2001, the Company repaid a secured term loan which had an
original maturity date of December 2004. In connection with this early
repayment, the Company incurred certain prepayment penalties, which resulted in
an extraordinary loss on early extinguishment of debt of approximately
$1.0 million during the first quarter of 2001. In addition, in the third
quarter, the Company prepaid an unsecured revolving credit facility which had an
original maturity date of May 2002. In connection with this prepayment, the
Company expensed the remaining unamortized deferred financing costs, which
resulted in an extraordinary loss on early extinguishment of debt of
approximately $583,000.
During the first quarter of 2000, certain of the proceeds from an asset
disposition were used to partially repay $8.1 million of a secured term loan. In
connection with this partial paydown, the Company incurred certain prepayment
penalties, which resulted in an extraordinary loss on early extinguishment of
debt of $317,000. In addition, during the third quarter of 2000, certain of the
proceeds from an asset disposition in one of the Company's joint ventures were
used to repay $16.4 million of a third-party debt at the joint venture. In
connection with this paydown, the joint venture incurred certain prepayment
penalties, which resulted in an extraordinary loss on early extinguishment of
debt to the Company of $388,000.
INTEREST RATE RISK MANAGEMENT
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. In
pursuing its business plan, the primary market risk to which the Company is
exposed is interest rate risk. Consistent with its liability management
objectives, the Company has implemented an interest rate risk management policy
based on match funding, with the objective that floating-rate assets be
primarily financed by floating-rate liabilities and fixed-rate assets be
primarily financed by fixed-rate liabilities.
The Company's operating results will depend in part on the difference
between the interest and related income earned on its assets and the interest
expense incurred in connection with its interest-bearing liabilities.
Competition from other providers of real estate financing may lead to a decrease
in the interest rate earned on the Company's interest-bearing assets, which the
Company may not be able to offset by obtaining lower interest costs on its
borrowings. Changes in the general level of interest rates prevailing in the
financial markets may affect the spread between the Company's interest-earning
assets and interest-bearing liabilities. Any significant compression of the
spreads between interest-earning assets and interest-bearing liabilities could
have a material adverse effect on the Company. In addition, an increase in
interest rates could, among other things, reduce the value of the Company's
interest-bearing assets and its ability to realize gains from the sale of such
assets, and a decrease in interest rates could reduce the average life of the
Company's interest-earning assets.
A substantial portion of the Company's loan investments are subject to
significant prepayment protection in the form of lock-outs, yield maintenance
provisions or other prepayment premiums which provide substantial yield
protection to the Company. Those assets generally not subject to prepayment
penalties include: (1) variable-rate loans based on LIBOR, originated or
acquired at par, which would not result in any gain or loss upon repayment; and
(2) discount loans and loan participations acquired at discounts to face values,
which would result in gains upon repayment. Further, while the Company generally
seeks to enter into loan investments which provide for substantial prepayment
protection, in the event of declining interest rates, the Company could receive
such prepayments and may not be able to reinvest such proceeds at favorable
returns. Such prepayments could have an adverse effect on the spreads between
interest-earning assets and interest-bearing liabilities.
32
While the Company has not experienced any significant credit losses, in the
event of a significant rising interest rate environment and/or economic
downturn, defaults could increase and result in credit losses to the Company
which adversely affect its liquidity and operating results. Further, such
delinquencies or defaults could have an adverse effect on the spreads between
interest-earning assets and interest-bearing liabilities.
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political
conditions, and other factors beyond the control of the Company. As more fully
discussed in Note 8 to the Company's Consolidated Financial Statements, the
Company employs match funding-based hedging strategies to limit the effects of
changes in interest rates on its operations, including engaging in interest rate
caps, floors, swaps, futures and other interest rate-related derivative
contracts. These strategies are specifically designed to reduce the Company's
exposure, on specific transactions or on a portfolio basis, to changes in cash
flows as a result of interest rate movements in the market. The Company does not
enter into derivative contracts for speculative purposes nor as a hedge against
changes in credit risk of its borrowers or of the Company itself.
Each interest rate cap or floor agreement is a legal contract between the
Company and a third party (the "counterparty"). When the Company purchases a cap
or floor contract, the Company makes an up-front payment to the counterparty and
the counterparty agrees to make payments to the Company in the future should the
reference rate (typically one- or three-month LIBOR) rise above (cap agreements)
or fall below (floor agreements) the "strike" rate specified in the contract.
Each contract has a notional face amount. Should the reference rate rise above
the contractual strike rate in a cap, the Company will earn cap income. Should
the reference rate fall below the contractual strike rate in a floor, the
Company will earn floor income. Payments on an annualized basis will equal the
contractual notional face amount multiplied by the difference between the actual
reference rate and the contracted strike rate. The cost of the up-front payment
is amortized over the term of the contract.
Interest rate swaps are agreements in which a series of interest rate flows
are exchanged over a prescribed period. The notional amount on which swaps are
based is not exchanged. In general, the Company's swaps are "pay fixed" swaps
involving the exchange of floating-rate interest payments from the counterparty
for fixed interest payments from the Company.
Interest rate futures are contracts, generally settled in cash, in which the
seller agrees to deliver on a specified future date the cash equivalent of the
difference between the specified price or yield indicated in the contract and
the value of that of the specified instrument (e.g., U.S. Treasury securities)
upon settlement. The Company generally uses such instruments to hedge forecasted
fixed-rate borrowings. Under these agreements, the Company will generally
receive additional cash flow at settlement if interest rates rise and pay cash
if interest rates fall. The effects of such receipts or payments will be
deferred and amortized over the term of the specific related fixed-rate
borrowings. In the event that, in the opinion of management, it is no longer
probable that a forecasted transaction will occur under terms substantially
equivalent to those projected, the Company will cease recognizing such
transactions as hedges and immediately recognize related gains or losses based
on actual settlement or estimated settlement value.
While a REIT may freely utilize the types of derivative instruments
discussed above to hedge interest rate risk on its liabilities, the use of
derivatives for other purposes, including hedging asset-related risks such as
credit, prepayment or interest rate exposure on the Company's loan assets, could
generate income which is not qualified income for purposes of maintaining REIT
status. As a consequence, the Company may only engage in such instruments to
hedge such risks on a limited basis.
There can be no assurance that the Company's profitability will not be
adversely affected during any period as a result of changing interest rates. In
addition, hedging transactions using derivative instruments involve certain
additional risks such as counterparty credit risk, legal enforceability of
33
hedging contracts and the risk that unanticipated and significant changes in
interest rates will cause a significant loss of basis in the contract. With
regard to loss of basis in a hedging contract, indices upon which contracts are
based may be more or less variable than the indices upon which the hedged assets
or liabilities are based, thereby making the hedge less effective. The
counterparties to these contractual arrangements are major financial
institutions with which the Company and its affiliates may also have other
financial relationships. The Company is potentially exposed to credit loss in
the event of nonperformance by these counterparties. However, because of their
high credit ratings, the Company does not anticipate that any of the
counterparties will fail to meet their obligations. There can be no assurance
that the Company will be able to adequately protect against the foregoing risks
and that the Company will ultimately realize an economic benefit from any
hedging contract it enters into which exceeds the related costs incurred in
connection with engaging in such hedges.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to fund its investment activities and operating
expenses. The Company has significant access to capital resources to fund its
existing business plan, which includes the expansion of its real estate lending
and corporate tenant leasing businesses. The Company's capital sources include
cash flow from operations, borrowings under lines of credit, additional term
borrowings, long-term financing secured by the Company's assets, unsecured
financing and the issuance of common, convertible and /or preferred equity
securities. Further, the Company may acquire other businesses or assets using
its capital stock, cash or a combination thereof.
The distribution requirements under the REIT provisions of the Code limit
the Company's ability to retain earnings and thereby replenish capital committed
to its operations. However, the Company believes that its significant capital
resources and access to financing will provide it with financial flexibility and
market responsiveness at levels sufficient to meet current and anticipated
capital requirements, including expected new lending and leasing transactions.
The Company believes that its existing sources of funds will be adequate for
purposes of meeting its short- and long-term liquidity needs. As the Company has
publicly announced, it has taken a conservative view of the level of its asset
originations during the next 12 months, given the uncertainty surrounding the
U.S. economy. The Company's ability to meet its long-term (i.e., beyond one
year) liquidity requirements is subject to the renewal of its credit lines
and/or obtaining other sources of financing, including issuing additional debt
or equity from time to time. Any decision by the Company's lenders and investors
to enter into such transactions with the Company will depend upon a number of
factors, such as compliance with the terms of its existing credit arrangements,
the Company's financial performance, industry or market trends, the general
availability of and rates applicable to financing transactions, such lenders'
and investors' resources and policies concerning the terms under which they make
such capital commitments and the relative attractiveness of alternative
investment or lending opportunities.
The Company has entered into LIBOR-based secured revolving credit facilities
of $700.0 million, $700.0 million and $500.0 million, respectively, which expire
in fiscal 2005, 2005 and 2003, respectively. The maturities of these secured
revolving facilities include a one-year "term-out" extension at the Company's
option. As of September 30, 2001, the Company had drawn approximately
$242.3 million, $324.9 million and $125.3 million under these facilities,
respectively. Availability under these facilities is based on collateral
provided under a borrowing base calculation. At September 30, 2001, 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 September 30, 2001, the Company had not
drawn any amounts under this facility.
In connection with the TriNet Acquisition, the Company acquired LIBOR
interest rate caps currently struck at 7.75% and 7.75% in notional amounts of
$75.0 million and $35.0 million,
34
respectively, which both expire in December 2004. In connection with the closing
of STARs, Series 2000-1 in May 2000, the Company entered into a LIBOR interest
rate cap struck at 10.00% in the notional amount of $312.0 million, and
simultaneously sold a LIBOR interest rate cap with the same terms. Since these
instruments do not reduce the Company's net interest rate risk exposure, they do
not qualify as hedges and changes in their respective values are charged to
earnings. As the significant terms of these arrangements are substantially the
same, the effects of a revaluation of these two instruments are expected to
substantially offset one another. At September 30, 2001 and December 31, 2000,
the net fair value of the Company's interest rate caps were $0.3 million and
$0.4 million, respectively.
The Company has entered into LIBOR interest rate swaps struck at 7.055% and
7.058%, both with notional amounts of $125.0 million and expiring in June 2003.
These swaps effectively fix the interest rate on a portion of the Company's
floating-rate term loan obligations. In connection with the TriNet Acquisition,
the Company acquired an interest rate swap which, together with certain existing
interest rate cap agreements, effectively fix the interest rate on
$75.0 million of the Leasing Subsidiary's LIBOR-based borrowings at 5.58% plus
the applicable margin through December 1, 2004. Management expects that it will
have aggregate LIBOR-based borrowings at the Leasing Subsidiary in excess of the
notional amount for the duration of the swap. The actual borrowing cost to the
Company with respect to indebtedness covered by the swap will depend upon the
applicable margin over LIBOR for such indebtedness, which will be determined by
the terms of the relevant debt instruments. At September 30, 2001 and
December 31, 2000, the fair value (liability) of the Company's remaining
interest rate swaps was $(21.4) million and $(7.7) million, respectively.
On January 11, 2001, the Company closed a new $700.0 million secured
revolving credit facility which is led by a major commercial bank. The new
facility has a three-year primary term and one-year "term-out" extension option,
and bears interest at LIBOR plus 1.40% to 2.15%, depending upon the collateral
contributed to the borrowing base. The new facility accepts a broad range of
structured finance assets and has a final maturity of January 2005.
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 financing secured by
15 corporate tenant lease assets. The floating-rate loan bears interest at LIBOR
plus 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.
35
On July 27, 2001, the Company completed a $300.0 million 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 repay outstanding borrowings under its secured
credit facilities.
STOCK REPURCHASE PROGRAM: The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets and excess cash
flow from operations, but also using borrowings under its credit facilities if
the Company determines that it is advantageous to do so. As of both
September 30, 2001 and December 31, 2000, the Company had repurchased
approximately 2.3 million shares at an aggregate cost of approximately
$40.7 million.
ADJUSTED EARNINGS
Adjusted earnings represents net income computed in accordance with GAAP,
before gains (losses) on sales of corporate tenant lease assets, extraordinary
items and cumulative effect, plus depreciation and amortization, less preferred
stock dividends, and after adjustments for unconsolidated partnerships and joint
ventures. Adjustments for unconsolidated partnerships and joint ventures are
calculated to reflect adjusted earnings on the same basis.
The Company believes that to facilitate a clear understanding of the
historical operating results of the Company, adjusted earnings should be
examined in conjunction with net income as shown in the Consolidated Statements
of Operations. Adjusted earnings should not be considered as an alternative to
net income (determined in accordance with GAAP) as an indicator of the Company's
performance, or to cash flows from operating activities (determined in
accordance with GAAP) as a measure of the Company's liquidity, nor is it
indicative of funds available to fund the Company's cash needs.
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
Adjusted earnings:
Net income.......................................... $57,553 $55,591 $171,155 $161,410
Add: Depreciation................................... 8,669 8,705 26,255 26,575
Add: Allocated share of joint venture
depreciation...................................... 960 1,148 2,828 2,590
Add: Amortization of deferred financing costs....... 4,959 4,042 15,391 9,330
Less: Preferred dividends........................... (9,227) (9,227) (27,681) (27,681)
Add: Cumulative effect of change in accounting
principle (1)..................................... -- -- 282 --
Less: (Gains)/losses on sales of corporate tenant
lease assets...................................... 1,196 (1,974) (403) (2,948)
Add: Extraordinary loss on early extinguishment of
debt.............................................. 583 388 1,620 705
------- ------- -------- --------
Adjusted earnings allocable to common shareholders:
Basic............................................... $64,693 $58,673 $189,447 $169,981
======= ======= ======== ========
Diluted............................................. $64,928 $58,909 $190,156 $170,685
======= ======= ======== ========
Adjusted earnings per common share:
Basic............................................... $ 0.75 $ 0.68 $ 2.20 $ 1.99
======= ======= ======== ========
Diluted............................................. $ 0.73 $ 0.68 $ 2.15 $ 1.98
======= ======= ======== ========
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.
36
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," January 1, 2001.
Because the Company has primarily used derivatives as cash flow hedges of
interest rate risk only, the adoption of SFAS No. 133 did not have a material
financial impact on the financial position and results of operations of the
Company. However, should the Company change its current use of such derivatives
(see Note 8), the adoption of SFAS No. 133 could have a more significant effect
on the Company prospectively.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." In June 2000, the SEC staff amended SAB 101 to provide registrants
with additional time to implement SAB 101. The Company adopted SAB 101, as
required, in the fourth quarter of fiscal 2000. The adoption of SAB 101 did not
have a material financial impact on the financial position or results of
operations of the Company.
In 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 is not expected to have a
material impact on the Company's Consolidated Financial Statements.
In March 2000, the FASB issued FASB Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation." The Company
was required to adopt FIN 44 effective July 1, 2000 with respect to certain
provisions applicable to new awards, exchanges of awards in a business
combination, modifications to outstanding awards, and changes in grantee status
that occur on or after that date. FIN 44 addresses practice issues related to
the application of Accounting Practice Bulletin Opinion No. 25, "Accounting for
Stock Issued to Employees." The initial adoption of FIN 44 by the Company did
not have a material impact on its consolidated financial position or results of
operations.
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 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
37
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 is currently evaluating the
effect, if any, the adoption of SFAS No. 142 will have on the Company's
financial position or results of operations.
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 Company is currently evaluating this statement to assess its
impact on the financial statements. 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 will
adopt the provisions of this statement on January 1, 2002. The Company does not
believe the adoption of SFAS No. 144 will have a significant impact on the
Company.
OTHER MATTERS
1940 ACT EXEMPTION
The Company at all times intends to conduct its business so as to not become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, then the
Company's ability to use leverage would be substantially reduced. The Investment
Company Act exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate" (i.e., "Qualifying Interests"). Under the current interpretation of
the staff of the SEC, in order to qualify for this exemption, the Company must
maintain at least 55% of its assets directly in Qualifying Interests. As of
September 30, 2001, the Company calculates that it is in and has maintained
compliance with this requirement.
FORWARD-LOOKING STATEMENTS
When used in this Form 10-Q, in future SEC filings or in press releases or
other written or oral communications, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. The Company
cautions that such forward-looking statements speak only as of the date made and
that various factors including regional and national economic conditions,
changes in levels of market interest rates, credit and other risks of lending
and investment activities, and competitive and regulatory factors could affect
the Company's financial performance and could cause actual results for future
periods to differ materially from those anticipated or projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect events or circumstances after
the date of such statements except as required by law.
38
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
1.1 Underwriting Agreement dated August 9, 2001 relating to the
Company's 8 3/4% Senior Notes Due 2008.(1)
4.6 Form of Supplemental Indenture dated as of August 16,
2001.(1)
4.7 Form of Global Note evidencing 8 3/4% Senior Notes 2008.(1)
EXPLANATORY NOTE:
- ------------------------
(1) Incorporated by reference to the Company's Current Report on Form 8-K filed
on August 15, 2001.
B. REPORTS ON FORM 8-K
On each of August 1, 2001 and August 15, 2001, a Current Report on Form 8-K
was filed in order to file exhibits in connection with the offering of the
Company's 8 3/4% Senior Notes Due in 2008.
39
SIGNATURES
Pursuant to the requirements of Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
iSTAR FINANCIAL INC.
REGISTRANT
Date: November 14, 2001 /s/ JAY SUGARMAN
-----------------------------------------------
Jay Sugarman
CHAIRMAN OF THE BOARD OF DIRECTORS AND
CHIEF EXECUTIVE OFFICER
Date: November 14, 2001 /s/ SPENCER B. HABER
-----------------------------------------------
Spencer B. Haber
PRESIDENT, CHIEF FINANCIAL OFFICER, DIRECTOR AND
SECRETARY
40
