XFRA:VSP Starwood Property Trust, Inc. Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended March 31, 2012

 

 

 

OR

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-34436

 


 

Starwood Property Trust, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland

 

27-0247747

(State or Other Jurisdiction of
Incorporation or Organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

591 West Putnam Avenue

 

 

Greenwich, Connecticut

 

06830

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:

(203) 422-8100

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer, large accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

The number of shares of the issuer’s common stock, $0.01 par value, outstanding as of May 7, 2012 was 116, 379, 042.

 

 

 



 

Special Note Regarding Forward Looking Statements

 

This Quarterly Report on Form 10-Q contains certain forward-looking statements, including without limitation, statements concerning our operations, economic performance and financial condition. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are developed by combining currently available information with our beliefs and assumptions and are generally identified by the words “believe,” “expect,” “anticipate” and other similar expressions. Forward-looking statements do not guarantee future performance, which may be materially different from that expressed in, or implied by, any such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates.

 

These forward-looking statements are based largely on our current beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us or within our control, and which could materially affect actual results, performance or achievements. Factors that may cause actual results to vary from our forward-looking statements include, but are not limited to:

 

·                  factors described in our Annual Report on Form 10-K for the year ended December 31, 2011 and in this Form 10-Q for the quarter ended March 31, 2012, including those set forth under the captions “Risk Factors” and “Business”;

 

·                  defaults by borrowers in paying debt service on outstanding items;

 

·                  impairment in the value of real estate property securing our loans;

 

·                  availability of mortgage origination and acquisition opportunities acceptable to us;

 

·                  potential mismatches in the timing of asset repayments and the maturity of the associated financing agreements;

 

·                  national and local economic and business conditions;

 

·                  general and local commercial real estate property conditions;

 

·                  changes in federal government policies;

 

·                  changes in federal, state and local governmental laws and regulations;

 

·                  increased competition from entities engaged in mortgage lending;

 

·                  changes in interest rates;

 

·                  the availability of and costs associated with sources of liquidity;

 

·                  factors associated with the ownership of residential real estate assets acquired by us directly or indirectly in settlement of loans, or residential REO, and held for lease and potentially for sale, including: macroeconomic shifts in demand for, and competition in the supply of, residential rental properties; the inability to lease or re-lease properties to tenants on attractive terms or at all; the failure of tenants to pay rent when due or otherwise perform their lease obligations; unanticipated repairs, capital expenditures or other costs; uninsured damages; increases in property taxes and insurance costs; our ability to dispose of the residential REO in a timely manner in response to changes in market conditions; and potential tax liabilities owed, and limitations imposed, upon disposition of the residential REO; and

 

·                  factors relating to our investment in distressed or non-performing residential mortgage loans acquired with the expectation of their conversion into residential REO or other commercial resolution, including our ability to convert such investments into residential REO or to effect another commercial resolution in a timely manner or at all, the costs relating thereto, and the additional real estate investment trust, or REIT, qualification issues associated with the investment in distressed or non-performing residential mortgage loans.

 

In light of these risks and uncertainties, there can be no assurances that the results referred to in the forward-looking statements contained in this Quarterly Report on Form 10-Q will in fact occur. Except to the extent required by applicable law or regulation, we undertake no obligation to, and expressly disclaim any such obligation to, update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, changes to future results over time or otherwise.

 

2



 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Balance Sheets

(Unaudited, amounts in thousands, except share and per share data)

 

 

 

As of
March 31, 2012

 

As of
December 31, 2011

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

132,565

 

$

114,027

 

Loans held for investment

 

2,333,507

 

2,268,599

 

Loans held-for-sale at fair value

 

 

128,593

 

Loans held in securitization trust

 

50,290

 

50,316

 

Mortgage-backed securities, available-for-sale, at fair value

 

644,138

 

341,734

 

Other investments

 

44,144

 

44,379

 

Accrued interest receivable

 

15,851

 

15,176

 

Derivative assets

 

9,455

 

12,816

 

Other assets

 

11,564

 

21,807

 

Total Assets

 

$

3,241,514

 

$

 2,997,447

 

Liabilities and Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable and accrued expenses

 

$

5,053

 

$

5,051

 

Related-party payable

 

13,350

 

8,348

 

Dividends payable

 

41,439

 

41,431

 

Derivative liabilities

 

16,307

 

19,652

 

Secured financing agreements, net

 

1,308,860

 

1,103,517

 

Collateralized debt obligation in securitization trust

 

52,978

 

53,199

 

Other liabilities

 

11,096

 

1,102

 

Total Liabilities

 

1,449,083

 

1,232,300

 

Commitments and contingencies (Note 14)

 

 

 

 

 

Equity:

 

 

 

 

 

Starwood Property Trust, Inc. Stockholders’ Equity:

 

 

 

 

 

Preferred stock, $0.01 per share, 100,000,000 shares authorized, no shares issued and outstanding

 

 

 

Common stock, $0.01 per share, 500,000,000 shares authorized, and 94,004,892 issued and 93,379,042 outstanding as of March 31, 2012 and 93,811,351 issued and 93,185,501 outstanding as of December 31, 2011

 

940

 

938

 

Additional paid-in capital

 

1,832,082

 

1,828,319

 

Treasury stock (625,850 shares as of March 31, 2012 and 625,850 shares as of December 31, 2011, respectively)

 

(10,642

)

(10,642

)

Accumulated other comprehensive income (loss)

 

10,863

 

(3,998

)

Accumulated deficit

 

(46,409

)

(55,129

)

Total Starwood Property Trust, Inc. Stockholders’ Equity

 

 1,786,834

 

1,759,488

 

Non-controlling interests in consolidated subsidiaries

 

5,597

 

5,659

 

Total Equity

 

1,792,431

 

1,765,147

 

Total Liabilities and Equity

 

$

3,241,514

 

$

2,997,447

 

 

See notes to condensed consolidated financial statements.

 

3



 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Operations

(Unaudited, amounts in thousands, except per share data)

 

 

 

For the Three-Months

Ended March 31

 

 

 

2012

 

2011

 

Net interest margin:

 

 

 

 

 

Interest income from mortgage-backed securities

 

$

8,675

 

$

6,860

 

Interest income from loans

 

69,077

 

32,717

 

Interest expense

 

(11,852

)

(8,144

)

Net interest margin

 

65,900

 

31,433

 

Expenses:

 

 

 

 

 

Management fees (including $3,649 and $3,844 for the three-months ended March 31, 2012 and 2011 of non-cash stock-based compensation)

 

15,167

 

9,346

 

Acquisition and investment pursuit costs

 

861

 

88

 

General and administrative (including $116 and $40 for the three-months ended March 31, 2012 and 2011 of non-cash stock-based compensation)

 

3,023

 

2,104

 

Total expenses

 

19,051

 

11,538

 

Income before other income (expense) and income taxes

 

46,849

 

19,895

 

Interest income from cash balances

 

49

 

144

 

Other income (expense)

 

754

 

(472

)

Other-than-temporary impairment (“OTTI”), net of $1,439 and $0 recognized in other comprehensive income (loss) for the three months ended March 31, 2012 and 2011, respectively

 

(656

)

(434

)

Net gains on sales of investments

 

7,333

 

8,104

 

Net realized foreign currency gains (losses)

 

8,834

 

(30

)

Net losses on currency hedges

 

(6,257

)

(3,916

)

Net gains on interest rate hedges

 

566

 

1,450

 

Net losses on credit hedges

 

 

(187

)

Net change in unrealized (losses) gains on loans held-for-sale at fair value

 

(5,760

)

3,187

 

Unrealized foreign currency remeasurement (losses) gains

 

(1,025

)

3,984

 

Income before income taxes

 

50,687

 

31,725

 

Income tax provision

 

(399

)

 

Net Income

 

50,288

 

31,725

 

Net income attributable to non-controlling interests

 

(129

)

(278

)

Net income attributable to Starwood Property Trust, Inc.

 

$

50,159

 

$

31,447

 

Net income per share of common stock:

 

 

 

 

 

Basic

 

$

0.53

 

$

0.44

 

Diluted

 

$

0.53

 

$

0.43

 

 

 

 

 

 

 

Distributions declared per common share

 

$

0.44

 

$

0.42

 

 

See notes to condensed consolidated financial statements.

 

4



 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Comprehensive Income

(Unaudited, amounts in thousands)

 

 

 

 

For the Three-Months

Ended March 31

 

 

 

2012

 

2011

 

Net Income

 

$

50,288

 

$

31,725

 

Other comprehensive income:

 

 

 

 

 

Change in fair value of cash flow hedges

 

(252

)

595

 

Unrealized gain (loss) in fair value of available-for-sale securities

 

14,457

 

(454

)

Reclassification adjustment for net realized gains on sale of securities

 

 

(5,995

)

Reclassification for OTTI

 

656

 

434

 

Comprehensive income

 

65,149

 

26,305

 

Less: Comprehensive income attributable to non-controlling interests

 

(129

)

(25

)

Comprehensive income attributable to Starwood Property Trust, Inc.

 

$

65,020

 

$

26,280

 

 

See notes to condensed consolidated financial statements.

 

5



 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Equity

(Unaudited, amounts in thousands, except share data)

 

 

 

Common Stock

 

Additional

 

 

 

 

 

 

 

Accumulated
Other
Comprehensive

 

Total
Starwood
Property
Trust, Inc.

 

Non-

 

 

 

 

 

 

 

Par

 

Paid-In

 

Treasury Stock

 

Accumulated

 

Income

 

Stockholders’

 

Controlling

 

Total

 

 

 

Shares

 

Value

 

Capital

 

Shares

 

Amount

 

Deficit

 

(Loss)

 

Equity

 

Interests

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2011

 

71,021,342

 

$

706

 

$

1,337,953

 

 

$

 

$

(19,302

)

$

8,203

 

$

1,327,560

 

$

9,669

 

$

1,337,229

 

Stock-based compensation

 

11,082

 

 

 

3,884

 

 

 

 

 

 

 

 

 

3,884

 

 

 

3,884

 

Net income

 

 

 

 

 

 

 

 

 

 

 

31,447

 

 

 

31,447

 

278

 

31,725

 

Dividends declared, $0.42 per share

 

 

 

 

 

 

 

 

 

 

 

(30,539

)

 

 

(30,539

)

 

 

(30,539

)

Other comprehensive loss, net

 

 

 

 

 

 

 

 

 

 

 

 

 

(5,117

)

(5,117

)

(303

)

(5,420

)

Distribution to non-controlling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(851

)

(851

)

Balance, March 31, 2011

 

71,032,424

 

$

706

 

$

1,341,837

 

 

$

 

$

(18,394

)

$

3,086

 

$

1,327,235

 

$

8,793

 

$

1,336,028

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2012

 

93,811,351

 

$

938

 

$

1,828,319

 

625,850

 

$

(10,642

)

$

(55,129

)

$

(3,998

)

$

1,759,488

 

$

5,659

 

$

1,765,147

 

Stock-based compensation

 

193,541

 

2

 

3,763

 

 

 

 

 

 

 

 

 

3,765

 

 

 

3,765

 

Net income

 

 

 

 

 

 

 

 

 

 

 

50,159

 

 

 

50,159

 

129

 

50,288

 

Dividends declared, $0.44 per share

 

 

 

 

 

 

 

 

 

 

 

(41,439

)

 

 

(41,439

)

 

 

(41,439

)

Other comprehensive income, net

 

 

 

 

 

 

 

 

 

 

 

 

 

14,861

 

14,861

 

 

 

14,861

 

Distribution to non-controlling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(191

)

(191

)

Balance, March 31, 2012

 

94,004,892

 

$

940

 

$

1,832,082

 

625,850

 

$

(10,642

)

$

(46,409

)

$

10,863

 

$

1,786,834

 

$

5,597

 

$

1,792,431

 

 

See notes to condensed consolidated financial statements

 

6



 

Starwood Property Trust, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited, amounts in thousands)

 

 

 

For the Three-Months ended
March 31

 

 

 

2012

 

2011

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net Income

 

$

50,288

 

$

31,725

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

Amortization of deferred financing costs

 

1,132

 

394

 

Accretion of net discount on mortgage-backed securities

 

(5,616

)

(3,241

)

Accretion of net deferred loan fees and discounts

 

(21,622

)

(4,697

)

Amortization of premium from collateralized debt obligations

 

(221

)

(216

)

Stock-based compensation

 

3,765

 

3,884

 

Gain on sale of available-for-sale securities

 

(46

)

(6,163

)

Gain on sale of loans

 

(7,287

)

(1,914

)

Gain on sale of other investments

 

 

(27

)

Gain on foreign currency remeasurement

 

(9,146

)

 

Net change in unrealized losses (gains) on loans held-for-sale at fair value

 

5,760

 

(3,187

)

Unrealized gains on interest rate hedges

 

(9,779

)

(1,688

)

Unrealized losses on credit hedges

 

 

187

 

Unrealized losses on currency hedges

 

8,573

 

3,916

 

Unrealized foreign currency remeasurement losses (gains)

 

1,025

 

(3,984

)

OTTI

 

656

 

434

 

Changes in operating assets and liabilities:

 

 

 

 

 

Related-party payable

 

5,002

 

2,159

 

Accrued interest receivable, less purchased interest

 

(1,870

)

(2,180

)

Other assets

 

11,388

 

(2,846

)

Accounts payable and accrued expenses

 

2

 

(79

)

Other liabilities

 

9,995

 

(4,577

)

Origination of held-for-sale loans

 

 

(110,431

)

Proceeds from sale of held-for-sale loans

 

132,128

 

56,312

 

Net cash provided by (used in) operating activities

 

174,127

 

(46,219

)

Cash Flows from Investing Activities:

 

 

 

 

 

Purchase of mortgage-backed securities

 

(301,772

)

(92,493

)

Proceeds from sale of mortgage-backed securities

 

46

 

92,669

 

Proceeds from mortgage-backed securities maturities

 

 

6,160

 

Mortgage-backed securities principal repayments

 

20,099

 

34,033

 

Origination and purchase of loans held for investment

 

(218,872

)

(292,685

)

Loan maturities

 

147,707

 

 

Proceeds from sale of loans held for investment

 

28,786

 

 

Loan investment repayments

 

6,211

 

5,753

 

Purchased interest on investments

 

(437

)

(287

)

Investments in other investments

 

(99

)

(8,726

)

Return of investment from other investments

 

303

 

 

Proceeds from sale of other investments

 

 

2,843

 

Return of investment basis in purchased derivative asset

 

968

 

 

Proceeds from sale of treasury securities

 

 

112,741

 

Cash deposited as collateral under treasury securities loan agreement

 

 

(112,741

)

Net cash used in investing activities

 

(317,060

)

(252,733

)

Cash Flows from Financing Activities:

 

 

 

 

 

Borrowings under secured financing agreements

 

383,037

 

322,927

 

Principal repayments on borrowings under secured financing arrangements

 

(177,694

)

(98,028

)

Payment of deferred financing costs

 

(2,250

)

(177

)

Payment of dividends

 

(41,431

)

(29,081

)

Distributions to non-controlling interest owners

 

(191

)

(851

)

Net cash provided by financing activities

 

161,471

 

194,790

 

Net increase (decrease) in cash and cash equivalents

 

18,538

 

(104,162

)

Cash and cash equivalents, beginning of period

 

114,027

 

226,854

 

Cash and cash equivalents, end of period

 

$

132,565

 

$

122,692

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

13,143

 

$

7,613

 

Income taxes paid

 

$

 

$

174

 

Supplemental disclosure of non-cash investing and financing activity:

 

 

 

 

 

Dividends declared, but not yet paid

 

$

41,439

 

$

30,539

 

 

See notes to condensed consolidated financial statements.

 

7



 

Starwood Property Trust, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements

 

As March 31, 2012

(Unaudited)

 

1. Business and Organization

 

Starwood Property Trust, Inc. (“the Trust” together with its subsidiaries, “we” or the “Company”) is a Maryland corporation that commenced operations on August 17, 2009 (“Inception”) upon the completion of its initial public offering (“IPO”). We are focused primarily on originating, investing in, financing and managing commercial mortgage loans and other commercial real estate debt investments. We also invest in residential mortgage-backed securities (“RMBS”), certain commercial mortgage-backed securities (“CMBS”), and other real estate related investments. We are externally managed and advised by SPT Management, LLC (the “Manager”).

 

We are organized and conduct our operations to qualify as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As such, the Trust will generally not be subject to U.S. federal corporate income tax on that portion of net income that is distributed to stockholders if we distribute at least 90% of our taxable income to our stockholders by prescribed dates and comply with various other requirements.

 

We are organized as a holding company that conducts our business primarily through three wholly-owned subsidiaries. In 2009, we formed joint ventures (the “Joint Ventures”) with Starwood Hospitality Fund II (“Hotel II”) and Starwood Opportunity Fund VIII (“SOF VIII”) in accordance with the co-investment and allocation agreement with our Manager. The Joint Ventures are owned 75% (and controlled) by us and are therefore consolidated into our condensed consolidated financial statements. As of March 31, 2012, the investments held by the Joint Ventures had been sold and there were no remaining substantive investments in these entities.

 

As of March 31, 2012, investments with collateral in the hospitality, retail, and office property sectors represented 47.9%, 16.5%, and 20.2% of our investment portfolio, respectively. Such allocations could materially change in the future.

 

2. Summary of Significant Accounting Policies

 

Basis of Accounting and Principles of Consolidation

 

The accompanying condensed consolidated financial statements include our accounts and those of our consolidated subsidiaries. Intercompany amounts have been eliminated. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.  The most significant and subjective estimate that we make is estimating the cash flows that we expect to receive on our investments, which has a significant impact on the amounts of interest income, credit losses (if any), and estimated fair values that we report and/or disclose.  In addition, our estimated fair value of certain financial instruments is significantly impacted by the rates we select to discount the respective cash flows.

 

A non-controlling interest in a consolidated subsidiary is defined as “the portion of the equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent”. Non-controlling interests are presented as a separate component of equity in the condensed consolidated balance sheets. In addition, the presentation of net income attributes earnings to controlling and non-controlling interests.

 

These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the period ended December 31, 2011, as filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the operating results for the full year.

 

Segment Reporting

 

We are focused on originating and acquiring real estate-related debt investments and currently operate in one reportable segment.

 

8



 

Cash and Cash Equivalents

 

Cash and cash equivalents include cash in banks and short-term investments. Short-term investments are comprised of highly liquid instruments with original maturities of three months or less. We maintain our cash and cash equivalents in multiple financial institutions and at times these balances exceed federally insurable limits.

 

Debt Securities

 

GAAP requires that at the time of purchase, we designate debt securities as held-to-maturity, available-for-sale, or trading depending on our investment strategy and ability to hold such securities to maturity. Held-to-maturity securities are stated at cost plus any premiums or discounts, which are amortized or accreted through the condensed consolidated statements of operations using the effective interest method.  Securities we (i) do not hold for the purpose of selling in the near-term, or (ii) may dispose of prior to maturity, are classified as available-for-sale and are carried at fair value in the accompanying financial statements.  Unrealized gains or losses on available-for-sale securities are reported as a component of accumulated other comprehensive income (loss) in stockholders’ equity. As of March 31, 2012, our CMBS and RMBS were classified as available-for-sale.  The classification of each investment involves management’s judgment, which is subject to change.

 

When the estimated fair value of a security is less than its amortized cost, we consider whether there is other-than-temporary impairment (“OTTI”) in the value of the security. An impairment is deemed an OTTI if (i) we intend to sell the security, (ii) it is more likely than not that we will be required to sell the security before recovering our cost basis, or (iii) we do not expect to recover the entire amortized cost basis of the security even if we do not intend to sell the security or believe it is more likely than not that we will be required to sell the security before recovering our cost basis. If the impairment is deemed to be an OTTI, the resulting accounting treatment depends on the factors causing the OTTI. If the OTTI has resulted from (i) our intention to sell the security, or (ii) our judgment that it is more likely than not that we will be required to sell the security before recovering our cost basis, an impairment loss is recognized in current earnings equal to the entire difference between our amortized cost basis and fair value. Whereas, if the OTTI has resulted from our conclusion that (i) we will not recover our cost basis even if we do not intend to sell the security or (ii) it is not more likely than not that we will be required to sell the security before recovering our cost basis, only the credit loss portion of the impairment is recorded in current earnings, and the portion of the loss related to other factors, such as changes in interest rates, continues to be recognized in accumulated other comprehensive income (loss). Following the recognition of an OTTI through earnings, a new cost basis is established for the security. Determining whether there is an OTTI may require us to exercise significant judgment and make significant assumptions, including, but not limited to, estimated cash flows, estimated prepayments, and loss assumptions. As a result, actual OTTI losses could differ from reported amounts. Such judgments and assumptions are based upon a number of factors, including (i) credit of the issuer or the underlying borrowers, (ii) credit rating of the security, (iii) key terms of the security, (iv) performance of the underlying loans, including debt service coverage and loan-to-value ratios, (v) the value of the collateral for the underlying loans, (vi) the effect of local, industry, and broader economic factors, and (vii) the historical and anticipated trends in defaults and loss severities for similar securities.

 

Loans Held for Investment

 

Loans that are held for investment are carried at cost, net of unamortized acquisition premiums or discounts, loan fees, and origination and acquisition costs as applicable, unless the loans are deemed impaired.

 

We evaluate each loan classified as held for investment for impairment at least quarterly.  Impairment occurs when it is deemed probable that we will not be able to collect all amounts due according to the contractual terms of the loan. If a loan is considered to be impaired, we record an allowance to reduce the carrying value of the loan to the present value of expected future cash flows discounted at the loan’s contractual effective rate or the fair value of the collateral if repayment is expected solely from the collateral.

 

Our loans are typically collateralized by real estate. As a result, we regularly evaluate the extent and impact of any credit deterioration associated with the performance and/or value of the underlying collateral property, as well as the financial and operating capability of the borrower. Specifically, a property’s operating results and any cash reserves are analyzed and used to assess (i) whether cash from operations are sufficient to cover the debt service requirements currently and into the future, (ii) the ability of the borrower to refinance the loan, and/or (iii) the property’s liquidation value. We also evaluate the financial wherewithal of any loan guarantors as well as the borrower’s competency in managing and operating the properties. In addition, we consider the overall economic environment, real estate sector, and geographic sub-market in which the borrower operates. Such impairment analyses are completed and reviewed by asset management and finance personnel, who utilize various data sources, including (i) periodic financial data such as property occupancy, tenant profile, rental rates, operating expenses, the borrower’s exit plan, and capitalization and discount rates, (ii) site inspections, and (iii) current credit spreads and discussions with market participants.

 

In addition, for all of the loans that are deemed to not be individually impaired from the evaluation process described above, we consider whether there are any specific characteristics of such loans indicating that it is probable that a loss has been incurred in a group of loans with those same characteristics.

 

9



 

Upon completion of the process above, we concluded that no allowance for loan losses was necessary as of March 31, 2012 and December 31, 2011. Significant judgment is required when evaluating loans for impairment; therefore, actual results over time could be materially different.

 

Loans Held-for-sale

 

Loans that we intend to sell or liquidate in the short-term are classified as held-for-sale and are carried at the lower of amortized cost or fair value, unless we have elected to record any such loans at fair value at the time they were acquired under Financial Accounting Standards Board (“FASB”) Topic 825, Financial Instruments.  Upfront costs and fees related to loans for which the fair value option is elected are recognized in earnings as incurred and not deferred.  Refer to Note 7 of the condensed consolidated financial statements for further disclosure regarding loans sold.

 

U.S. Treasury Securities Sold Short

 

In February 2011, in order to hedge the impact of interest rate increases on the fair value of our RMBS portfolio, we took short positions on U.S. Treasury securities with durations similar to those expected within our RMBS portfolio. To execute our hedging strategy, we sold to a third party $112.7 million in U.S. Treasury securities that were simultaneously borrowed from our prime broker. The entire cash sale proceeds from the third party were then immediately deposited with our prime broker as collateral for the U.S. Treasury securities borrowing. On March 31, 2011, we purchased from a third party the same series of U.S. Treasury securities that had been borrowed. The securities were then immediately delivered to the prime broker in repayment of the securities borrowing, thereby settling the short position. We realized a gain from this strategy of approximately $122 thousand, which is comprised of the $194 thousand favorable movement in the prices of U.S. Treasury securities (from our short position), offset by $72 thousand of interest that accrued on the securities during the term of the borrowing and transaction costs.

 

Revenue Recognition

 

Interest income is accrued based on the outstanding principal amount and the contractual terms of our loans and securities. Discounts or premiums associated with the purchase of loans and investment securities are amortized into interest income as a yield adjustment on the effective interest method, based on expected cash flows through the expected maturity date of the security. For loans that we have not elected to record at fair value under FASB Topic 825, origination fees and direct loan origination costs are also recognized in interest income over the loan term as a yield adjustment using the effective interest method. When we elect to record a loan at fair value, origination fees and direct loan costs are recorded directly in income and are not deferred.

 

Upon the sale of loans or securities, the excess (or deficiency) of net proceeds over the amortized cost of such loans or securities is recognized as a realized gain (or loss).

 

Investments in Unconsolidated Entities

 

We own non-controlling equity interests in various privately-held partnerships and limited liability companies. We use the cost method to account for investments when we (i) own five percent or less of and (ii) do not have significant influence over, the underlying investees.  We use the equity method to account for all other non-controlling interests in partnerships and limited liability companies.  Cost method investments are initially recorded at cost and income is generally recorded when distributions are received.  Equity method investments are initially recorded at cost and subsequently adjusted for our share of income or loss, as well as contributions made or distributions received.

 

We also own publicly-traded equity securities of certain companies in the real estate industry.  We have no influence over the activities of these companies due to our minimal percentage ownership.  These investments are classified as available-for-sale and reported at fair value in the balance sheet, with unrealized gains and losses reported as a component of other comprehensive income (loss).  Dividends on our available-for-sale equity securities are recorded in the statement of operations on the record date.

 

Investments in unconsolidated entities are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  When the fair value of an equity investment in an unconsolidated entity is less than its cost basis, we consider whether there is an OTTI.  OTTI analyses are based on current plans, intended holding periods and other available information at the time the analyses are prepared.

 

Securitization/Sale and Financing Arrangements

 

We periodically sell our financial assets, such as commercial mortgage loans, CMBS and other assets. In connection with these transactions, we may retain or acquire senior or subordinated interests in the related assets. Gains and losses on such transactions are recognized using the guidance in FASB Topic 860, Transfers and Servicing, which is based on a financial components approach that focuses on control. Under this approach, after a transfer of financial assets that meets the criteria for treatment as a sale—legal isolation, ability of transferee to pledge or exchange the transferred assets without constraint, and transferred control—an entity recognizes the financial assets it retains and any liabilities it has incurred, derecognizes the financial assets it has sold, and

 

10



 

derecognizes liabilities when extinguished. We determine the gain or loss on sale of mortgage loans by allocating the carrying value of the underlying mortgage between securities or loans sold and the interests retained based on their fair values, as applicable. The gain or loss on sale is the difference between the cash proceeds from the sale and the amount allocated to the securities or loans sold.

 

Acquisition and Investment Pursuit Costs

 

Net costs incurred in connection with acquiring investments, as well as in pursuing unsuccessful investment acquisitions and loan originations, are charged to current earnings and not deferred.

 

Foreign Currency Transactions

 

Our assets and liabilities denominated in foreign currencies are translated into U.S. dollars using foreign currency exchange rates at the end of the reporting period. Income and expenses are translated at the weighted-average exchange rates for each reporting period. As of March 31, 2012 and December 31, 2011, the U.S. dollar was the functional currency of all investments denominated in foreign currencies. The effects of translating the assets, liabilities and income of our foreign investments are included in unrealized foreign currency remeasurement (loss) gain in the statements of operations.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash investments, CMBS, RMBS, loan investments, and interest receivable. We may place cash investments in excess of insured amounts with high quality financial institutions. We perform an ongoing analysis of credit risk concentrations in our investment portfolio by evaluating exposure to various counterparties, markets, underlying property types, contract terms, tenant mix, and other credit metrics.

 

Derivative Instruments and Hedging Activities

 

GAAP provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, we must provide qualitative disclosures that explain our objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

 

We record all derivatives in the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and have satisfied the criteria necessary to apply hedge accounting under GAAP. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. We regularly enter into derivative contracts that are intended to economically hedge certain of our risks, even though the transactions may not qualify for, or we may not elect to pursue, hedge accounting. In such cases, changes in the fair value of the derivatives are recorded in earnings.

 

Deferred Financing Costs

 

Costs incurred in connection with obtaining secured financing arrangements are capitalized and amortized over the respective loan terms of the respective facilities as a component of interest expense. As of March 31, 2012 and December 31, 2011, we had approximately $6.1 million and $5.0 million, respectively, of capitalized financing costs, net of amortization. For the three months ended March 31, 2012 and March 31, 2011, approximately $1.1 million and $0.4 million, respectively, of amortization was included in interest expense on the statement of operations.

 

Earnings per share

 

We calculate basic earnings per share by dividing net income (loss) attributable to the Company for the period by the weighted-average of shares of common stock outstanding for that period after consideration of the earnings allocated to our restricted stock and restricted stock units, which are participating securities as defined in GAAP. Diluted earnings per share takes into effect any dilutive instruments, such as restricted stock and restricted stock units, except when doing so would be anti-dilutive.

 

Share-based payments

 

We recognize the cost of share-based compensation and payment transactions using the same expense category as would be charged for payments in cash. The fair value of the restricted stock or restricted stock units granted is recorded to expense on a straight-line basis over the vesting period for the award, with an offsetting increase in stockholders’ equity. For grants to employees

 

11



 

and directors, the fair value is determined based upon the stock price on the grant date. For non-employee grants, the fair value is based on the stock price when the shares vest, which requires the amount to be adjusted in each reporting period based on the fair value of the award at the end of the reporting period until the award has vested.

 

Income Taxes

 

We have elected to be taxed as a REIT and intend to comply with the Code with respect thereto. Accordingly, we will not be subject to federal income tax as long as certain asset, income, dividend distribution and stock ownership tests are met. Many of these requirements are technical and complex and if we fail to meet these requirements we may be subject to federal, state, and local income tax and penalties. A REIT’s net income from prohibited transactions is subject to a 100% penalty tax. We have two taxable REIT subsidiaries (the “TRSs”) where certain investments may be made and activities conducted that (i) may have otherwise been subject to the prohibited transaction tax and (ii) may not be favorably treated for purposes of complying with the various requirements for REIT qualification.  The income, if any, within the TRSs is subject to federal and state income taxes as a domestic C corporation based upon the TRSs’ net income. For the three months ended March 31, 2012, we recorded a provision for income taxes of $0.4 million related to the activities in our TRSs.  These provisions were determined using a Federal income tax rate of 34% and state income tax rate of 7.5%.  For the three months ended March 31, 2011, we recorded no provision for income taxes related to the activities in our TRSs.

 

Underwriting Commissions and Offering Costs

 

Underwriting and offering costs incurred totaled approximately $1.1 million in connection with our equity offering in May 2011, approximately $18.9 million in connection with the equity offering in December 2010, and approximately $57.6 million in connection with our initial public offering in 2009. Underwriting and offering costs are reflected as a reduction in additional paid-in capital in the statement of equity.

 

Recent Accounting Pronouncements

 

In December 2011, the FASB issued amended guidance which will enhance disclosures required by GAAP by requiring improved information about financial instruments and derivative instruments that are either (1) offset or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset. This information will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. We are in the process of evaluating the impact that this guidance will have on our financial statement disclosures.

 

Reclassifications

 

After the first quarter of 2011, we began separately reporting the amount of acquisition and investment pursuit costs in the statement of operations. In prior periods, such amounts were included in general administrative expenses but have been reclassified to conform to the new presentation.  Additionally, after the first quarter of 2011 we began combining unrealized and realized gains and losses on interest rate and currency hedges, as well as for loans held for sale at fair value, which had been presented separately in prior periods.

 

3. Debt Securities

 

We classified all CMBS and RMBS investments as available-for-sale as of March 31, 2012 and December 31, 2011. The CMBS and RMBS classified as available-for-sale are reported at fair value in the balance sheet with changes in fair value recorded in accumulated other comprehensive (loss) income. The tables below summarize various attributes of our investments in mortgage-backed securities (“MBS”) available-for-sale as of March 31, 2012 and December 31, 2011 (amounts in thousands):

 

 

 

 

 

 

 

 

 

Unrealized Gains or (Losses) Recognized in Accumulated Other
Comprehensive Income (Loss)

 

 

 

March 31, 2012

 

Purchased
Amortized Cost

 

Credit
OTTI

 

Recorded
Amortized Cost

 

Non-Credit
OTTI

 

Unrealized
Gains

 

Unrealized
Losses

 

Net Fair Value
Adjustment

 

Fair Value

 

CMBS

 

$478,971

 

$—

 

$478,971

 

$—

 

$7,981

 

$—

 

$7,981

 

$486,952

 

RMBS

 

156,722

 

(6,657

)

150,065

 

(1,439

)

8,663

 

(103

)

7,121

 

157,186

 

Total

 

$635,693

 

$(6,657

)

$629,036

 

$(1,439

)

$16,644

 

$(103

)

$15,102

 

$644,138

 

 

12



 

March 31, 2012

 

Weighted
Average
Coupon(1)

 

Weighted
Average
Rating

 

Weighted
Average Life 
(“WAL”)
(Years)(3)

 

Weighted
Average Yield (4)

 

CMBS

 

3.8

%

(2)

 

3.8

 

7.15

%

RMBS

 

1.0

%

B-

 

5.0

 

10.85

%

 


(1)          Calculated using the one-month LIBOR rate as of March 31, 2012 of 0.24125%.

(2)          Includes a $388 million investment  in senior securities that were not rated, that are secured by substantially all of the assets of a worldwide operator of hotels, resorts, and timeshare properties, and which had an estimated loan-to-value ratio as of March 31, 2012 in the range of 39%-44%. The remaining $99.3 CMBS investment position is rated BB+.

(3)          Represents the WAL of each respective group of MBS. The WAL of each individual security is calculated as a fraction, the numerator of which is the sum of the timing (in years) of each expected future principal payment multiplied by the balance of the respective payment, and with the denominator equal to the sum of the expected principal payments. This calculation was made as of March 31, 2012. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the security.

(4)          Most of the CMBS and all of the RMBS were purchased at a discount that will be accreted into income over the expected remaining life of the security.  The majority of the income from these securities is earned from the accretion of these discounts.

 

Within the hospitality sector, as of March 31, 2012 we have in aggregate investment of $503.1 million in senior debt secured by substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties. The debt investment is comprised of $115.5 million in loans and $387.6 million in securities. As of March 31, 2012, the aggregate face value of $539.7 million represents 7.2% of the total face value of the senior debt outstanding, and the aggregate carrying value of our investment represents 15.5% of our total assets. See disclosure in Note 15 to the condensed consolidated financial statements regarding an additional interest in the senior debt that we purchased subsequent to March 31, 2012.

 

 

 

 

 

 

 

 

 

Unrealized Gains or (Losses) Recognized in Accumulated Other
Comprehensive Income (Loss)

 

 

 

December 31,
2011

 

Purchased
Amortized Cost

 

Credit
OTTI

 

Recorded
Amortized Cost

 

Non-Credit
OTTI

 

Unrealized
Gains

 

Unrealized
Losses

 

Net Fair Value
Adjustment

 

Fair Value

 

CMBS

 

$

177,353

 

$

 

$

177,353

 

$

 

$

 

$

(567

)

$

(567

)

$

176,786

 

RMBS

 

170,424

 

(6,001

)

164,423

 

(1,310

)

3,367

 

(1,532

)

525

 

164,948

 

Total

 

$

347,777

 

$

(6,001

)

$

341,776

 

$

(1,310

)

$

3,367

 

$

(2,099

)

$

(42

)

$

341,734

 

 

December 31,
2011

 

Weighted
Average
Coupon(1)

 

Weighted
Average
Rating

 

WAL (3)

 

CMBS

 

2.1

%

NR(2)

 

3.5

 

RMBS

 

1.0

%

B-

 

4.8

 

 


(1)          Generally calculated using the one-month LIBOR rate as of December 31, 2011 of 0.2953% for floating rate securities.

(2)         Represents senior securities that were not rated, that are secured by substantially all of the assets of a worldwide operator of hotels, resorts, and timeshare properties, and which had an estimated loan-to-value ratio as of December 31, 2011 in the range of 39%-44%.

(3)          Represents the WAL of each respective group of MBS. The WAL of each individual security or loan is calculated as a fraction, the numerator of which is the sum of the timing (in years) of each expected future principal payment multiplied by the balance of the respective payment, and with the denominator equal to the sum of the expected principal payments. This calculation was made as of December 31, 2011. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the security.

 

During the three-months ended March 31, 2012, purchases and sales executed, as well as the principal payments received, were as follows (amounts in thousands):

 

 

 

RMBS

 

CMBS

 

Purchases

 

$

 

$

301,772

 

Sales/Maturities

 

 

 

Principal payments received

 

16,539

 

3,560

 

 

 

During the three-months ended March 31, 2012, we have not sold any CMBS positions. There have been no maturities during the three-months ended March 31, 2012.

 

During the first quarter 2011, the purchases, sales, and principal pay-downs were as follows:

 

 

 

RMBS

 

CMBS

 

Purchases

 

$

45,315

 

$

0

 

Sales

 

35,336

 

29,150

 

Principal pay-downs

 

19,412

 

14,621

 

 

13



 

As of March 31, 2012, 79.6%, of the CMBS are variable rate and pay interest at LIBOR plus a weighted average spread of 1.75%.  As of December 31, 2011, 100.0% of the CMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 1.75%.

 

Subject to certain limitations on durations, we have allocated an amount to invest in RMBS that cannot exceed 10% of our total assets. We have engaged a third party manager who specializes in RMBS to execute the trading of RMBS, the cost of which was $0.3 million and $0.2 million for the three-months ended March 31, 2012 and March 31, 2011, respectively, which has been recorded as an offset to interest income in the accompanying condensed consolidated statements of operations.  As of March 31, 2012, approximately $146.9 million, or 93.4%, of the RMBS are variable rate and pay interest at LIBOR plus a weighted average spread of 0.43%. As of December 31, 2011, approximately $154.7 million, or 93.8%, of the RMBS were variable rate and pay interest at LIBOR plus a weighted average spread of 0.43%.  We purchased all of the RMBS at a discount that will be accreted into income over the expected remaining life of the security. The majority of the income from this strategy is earned from the accretion of these discounts.

 

The following table presents the gross unrealized losses and estimated fair value of our securities that are in an unrealized loss position as of March 31, 2012 and for which OTTIs (full or partial) have not been recognized in earnings (amounts in thousands):

 

 

 

Estimated Fair Value

 

Unrealized Losses

 

As of March 31, 2012

 

Securities with a loss less
than 12 months

 

Securities with a loss
greater than 12 months

 

Securities with a loss
less than 12 months

 

Securities with a loss
greater than 12 months

 

CMBS

 

$

 

$

 

$

 

$

 

RMBS

 

14,839

 

1,355

 

(1,193

)

(349

)

Total

 

$

14,839

 

$

1,355

 

$

(1,193

)

$

(349

)

 

As of March 31, 2012 there were 15 securities with unrealized losses.  After evaluating each security we determined that the impairments on 13 of these securities, all of which are non-agency and whose impairments totaled $2.1 million, were other-than-temporary. Credit losses represented $0.7 million of this total, which we calculated by comparing (i) the estimated future cash flows of each security discounted at the yield determined as of the initial acquisition date or, if since revised, as of the last date previously revised to (ii) our amortized cost basis.  For the three months ended March 31, 2012, our aggregate MBS credit losses (as reported in the condensed consolidated statement of operations) were $0.7 million.  We further determined that neither of the two remaining securities were other-than-temporarily impaired.  We considered a number of factors in reaching this conclusion, including that we did not intend to sell any individual security, it was not considered more likely than not that we would be forced to sell any individual security prior to recovering our amortized cost, and there were no material credit events that would have caused us to otherwise conclude that we would not recover our cost.  Significant judgment is required is used in projecting cash flows for our non-agency RMBS. As a result, actual income and/or impairments could be materially different from what is currently projected and/or reported.

 

The following table presents the gross unrealized losses and estimated fair value of our securities that are in an unrealized loss position as of December 31, 2011 and for which OTTIs (full or partial) have not been recognized in earnings (amounts in thousands):

 

 

 

Estimated Fair Value

 

Unrealized Losses

 

As of December 31, 2011

 

Securities with a loss less
than 12 months

 

Securities with a loss
greater than 12 months

 

Securities with a loss
less than 12 months

 

Securities with a loss
greater than 12 months

 

CMBS

 

$

176,786

 

$

 

$

(567

)

$

 

RMBS

 

70,103

 

2,684

 

(2,444

)

(399

)

Total

 

$

246,889

 

$

2,684

 

$

(3,011

)

$

(399

)

 

4. Loans

 

Our investments in loans held-for-investment are accounted for at amortized cost and the loans held-for-sale are accounted for at the lower of cost or fair value, unless we elect (upon origination or acquisition) to record such loans at fair value. The following table summarizes our investments in mortgages and loans by subordination class as of March 31, 2012 and December 31, 2011 (amounts in thousands):

 

March 31, 2012

 

Carrying
Value

 

Face Amount

 

Weighted
Average
Coupon

 

Weighted
Average Life
(years) (2)

 

First mortgages

 

$

1,375,766

 

$

1,428,505

 

6.2

%

3.3

 

Subordinated mortgages (1)

 

313,688

 

348,072

 

9.4

%

4.5

 

Mezzanine loans

 

644,053

 

655,199

 

8.6

%

3.0

 

Total loans held for investment

 

2,333,507

 

2,431,776

 

 

 

 

 

Loans held in securitization trust

 

50,290

 

50,604

 

5.0

%

3.0

 

Total Loans

 

$

2,383,797

 

$

2,482,380

 

 

 

 

 

 

14



 

December 31, 2011

 

Carrying
Value

 

Face
Amount

 

Weighted
Average
Coupon

 

Weighted
Average Life
(years) (2)

 

First mortgages

 

$

1,202,611

 

$

1,248,549

 

6.6

%

3.2

 

Subordinated mortgages (1)

 

437,163

 

487,175

 

7.4

%

4.1

 

Mezzanine loans

 

628,825

 

642,831

 

8.4

%

3.0

 

Total loans held for investment

 

2,268,599

 

2,378,555

 

 

 

 

 

First mortgages held-for-sale at fair value

 

128,593

 

122,833

 

5.9

%

8.9

 

Loans held in securitization trust

 

50,316

 

50,632

 

5.0

%

3.7

 

Total Loans

 

$

2,447,508

 

$

2,552,020

 

 

 

 

 

 


(1)          Subordinated mortgages includes (i) subordinated mortgages that we retain after having sold first mortgage positions related to the same collateral, (ii) B-Notes, and (iii) subordinated loan participations.

(2)          Represents the WAL of each respective group of loans. The WAL of each individual loan is calculated as a fraction, the numerator of which is the sum of the timing (in years) of each expected future principal payment multiplied by the balance of the respective payment, and with the denominator equal to the sum of the expected principal payments. This calculation was made as of March 31, 2012 and December 31, 2011. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the loan.

 

As of March 31, 2012, approximately $1.2 billion, or 50.1%, of the loans are variable rate and pay interest at LIBOR plus a weighted-average spread of 4.62%. The following table summarizes our investments in floating rate loans (amounts in thousands):

 

 

 

March 31, 2012

 

December 31, 2011

 

Index

 

Rate

 

Carrying Value

 

Rate

 

Carrying Value

 

1 Month LIBOR

 

0.2413%

 

$

382,145

 

0.2953%

 

$

264,030

 

3 Month LIBOR

 

0.4682%

 

14,641

 

0.5810%

 

143,371

 

1 Month Citibank LIBOR(1)

 

0.2250%

 

134,589

 

0.2700%

 

134,041

 

3 Month Citibank LIBOR(1)

 

0.4550%

 

7,132

 

0.5600%

 

7,102

 

6 Month Citibank LIBOR(1)

 

0.7200%

 

6,081

 

0.7800%

 

6,039

 

LIBOR Floor

 

0.5% - 2.0%

 

648,578

 

0.5% - 2.0%

 

551,275

 

Total

 

 

 

$

1,193,166

 

 

 

$

1,105,858

 

 


(1)          The Citibank LIBOR rate is equal to the rate per annum at which deposits in United States dollars are offered by the principal office of Citibank, N.A. in London, England to prime banks in the London interbank market.

 

As described in Note 2, we evaluate each of our loans for impairment at least quarterly.  Our loans are typically collateralized by real estate. As a result, we regularly evaluate the extent and impact of any credit deterioration associated with the performance and/or value of the underlying collateral property, as well as the financial and operating capability of the borrower. Specifically, a property’s operating results and any cash reserves are analyzed and used to assess (i) whether cash flow from operations is sufficient to cover the debt service requirements currently and into the future, (ii) the ability of the borrower to refinance the loan at maturity, and/or (iii) the property’s liquidation value. We also evaluate the financial wherewithal of any loan guarantors as well as the borrower’s competency in managing and operating the properties. In addition, we consider the overall economic environment, real estate sector, and geographic sub-market in which the borrower operates. Such impairment analyses are completed and reviewed by asset management and finance personnel who utilize various data sources, including (i) periodic financial data such as property operating statements, occupancy, tenant profile, rental rates, operating expenses, the borrower’s exit plan, and capitalization and discount rates, (ii) site inspections, and (iii) current credit spreads and discussions with market participants.

 

Our evaluation process as described above produces an internal risk rating of between 1 and 5, which is a weighted-average of the numerical ratings in the following categories: (i) sponsor capability and financial condition, (ii) loan and collateral performance relative to underwriting, (iii) quality and stability of collateral cash flows, and (iv) loan structure. We utilize the overall risk ratings as a concise means to monitor any credit migration on a loan as well as on the whole portfolio.  While the overall risk rating is not the sole factor we use in determining whether a loan is impaired, a loan with a higher overall risk rating would tend to have more adverse indicators of impairment, and therefore would be more likely to experience a credit loss.

 

The rating categories generally include the characteristics described below, but these are utilized as guidelines and therefore not every loan will have all of the characteristics described in each category:

 

15



 

Rating

 

 

Characteristics

1

 

·

Sponsor capability and financial condition—Sponsor is highly rated or investment grade or, if private, the equivalent thereof with significant management experience.

 

 

·

Loan collateral and performance relative to underwriting—The collateral has surpassed underwritten expectations.

 

 

·

Quality and stability of collateral cash flows—Occupancy is stabilized, the property has had a history of consistently high occupancy, and the property has a diverse and high quality tenant mix.

 

 

·

Loan structure—Loan-to-collateral value ratio (“LTV”) does not exceed 65%. The loan has structural features that enhance the credit profile.

2

 

·

Sponsor capability and financial condition—Strong sponsorship with experienced management team and a responsibly leveraged portfolio.

 

 

·

Loan collateral and performance relative to underwriting—Collateral performance equals or exceeds underwritten expectations and covenants and performance criteria are being met or exceeded.

 

 

·

Quality and stability of collateral cash flows—Occupancy is stabilized with a diverse tenant mix.

 

 

·

Loan structure—LTV does not exceed 70% and unique property risks are mitigated by structural features.

3

 

·

Sponsor capability and financial condition—Sponsor has historically met its credit obligations, routinely pays off loans at maturity, and has a capable management team.

 

 

·

Loan collateral and performance relative to underwriting—Property performance is consistent with underwritten expectations.

 

 

·

Quality and stability of collateral cash flows—Occupancy is stabilized, near stabilized, or is on track with underwriting.

 

 

·

Loan structure—LTV does not exceed 80%.

4

 

·

Sponsor capability and financial condition—Sponsor credit history includes missed payments, past due payment, and maturity extensions. Management team is capable but thin.

 

 

·

Loan collateral and performance relative to underwriting—Property performance lags behind underwritten expectations. Performance criteria and loan covenants have required occasional waivers. A sale of the property

 may be necessary in order for the borrower to pay off the loan at maturity.

 

 

·

Quality and stability of collateral cash flows—Occupancy is not stabilized and the property has a large amount of rollover.

 

 

·

Loan structure—LTV is 80% to 90%.

5

 

·

Sponsor capability and financial condition—Credit history includes defaults, deeds-in-lieu, foreclosures, and/or bankruptcies.

 

 

·

Loan collateral and performance relative to underwriting—Property performance is significantly worse than underwritten expectations. The loan is not in compliance with loan covenants and performance criteria and may be in default. Sale proceeds would not be sufficient to pay off the loan at maturity.

 

 

·

Quality and stability of collateral cash flows—The property has material vacancy and significant rollover of remaining tenants.

 

 

·

Loan structure—LTV exceeds 90%.

 

As of March 31, 2012, the risk ratings by class of loan were as follows (amounts in thousands):

 

 

 

Balance Sheet Classification at March 31, 2012

 

Risk

 

Loans Held for Investment

 

Loans held in

 

 

 

Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

Securitization
Trust

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

2

 

224,136

 

2,445

 

128,175

 

13,172

 

367,928

 

3

 

1,112,302

 

256,661

 

515,878

 

37,118

 

1,921,959

 

4

 

39,328

 

54,582

 

 

 

93,910

 

5

 

 

 

 

 

 

 

 

$

1,375,766

 

$

313,688

 

$

644,053

 

$

50,290

 

$

2,383,797

 

 

16



 

As of December 31, 2011, the risk ratings by class of loan were as follows (amounts in thousands):

 

 

 

Balance Sheet Classification at December 31, 2011

 

 

 

Risk

 

Loans Held for Investment

 

Loans
Held for
Sale

 

Loans held in

 

 

 

Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

First
Mortgages

 

Securitization
Trust

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

2

 

108,900

 

131,281

 

139,167

 

89,760

 

13,193

 

482,301

 

3

 

1,054,717

 

251,788

 

481,982

 

38,833

 

37,123

 

1,864,443

 

4

 

38,994

 

54,094

 

7,676

 

 

 

100,764

 

5

 

 

 

 

 

 

 

 

 

$

1,202,611

 

$

437,163

 

$

628,825

 

$

128,593

 

$

50,316

 

$

2,447,508

 

 

After completing our analysis of each loan, including the resulting risk ratings as described above, we concluded that no allowance for loan losses was necessary as of March 31, 2012 or December 31, 2011.

 

For the three months ended March 31, 2012, the activity in our loan portfolio (including loans held-for-sale) was as follows (amounts in thousands):

 

Balance December 31, 2011

 

$

2,447,508

 

Acquisitions/originations

 

213,688

 

Additional funding

 

5,184

 

Capitalized interest (1)

 

1,672

 

Basis of loans sold

 

(153,627

)

Basis of loans prepaid

 

(138,561

)

Principal repayments

 

(6,211

)

Discount accretion/premium amortization

 

21,622

 

Unrealized foreign currency remeasurement loss

 

(1,718

)

Net change in unrealized loss on loans held-for-sale at fair value

 

(5,760

)

Balance March 31, 2012

 

$

2,383,797

 

 


(1)          Represents accrued interest income on loans whose terms do not require current payment of interest.

 

We acquired or originated $224.0 million (face value) in loans during the three months ended March 31, 2012, which included: (1) a $125.0 million participation in a senior loan secured by all the material assets of a major hotel company for a discounted purchase price of $115.7 million; (2) an origination of a $63.0 million first mortgage, of which $59.0 million was funded at closing, collateralized by 10 office buildings located in California; and (3) an origination of a $40.0 million mezzanine loan secured by a 10-property portfolio of full-service and extended-stay hotels located in eight different states. We sold $153.6 million of loans during the three months ended March 31, 2012, which included: (1) six loans with a carrying value of $122.7 million to an independent third party resulting in proceeds, net of financing repayments, of $40.6 million and (2) 50% of our Euro denominated loan to a strategic partner resulting in proceeds of $28.8 million. The transaction was neutral from an earnings perspective net of the associated currency hedge gain. Our GBP-denominated loan prepaid during the three months ended March 31, 2012, resulting in proceeds of $147.7 million and an additional $13.1 million of accelerated accretion of the purchase discount. The loan had a carrying value of $134.6 million at the date of prepayment.

 

5. Other Investments

 

In January 2010, we committed $6.3 million to acquire a 5.6% interest in a privately-held limited liability company formed to acquire assets of a commercial real estate debt management and servicing business primarily for the opportunity to participate in debt opportunities arising from the venture’s special servicing business (the “Participation Right”). In May 2010, we made an additional $3.4 million commitment to the venture to maintain at least a 5% ownership and its corresponding Participation Right. Because we do not have control or significant influence over the venture, the investment is accounted for under the cost method. As of March 31, 2012, we had funded $8.0 million of our commitment. There was no income for the three months ended March 31, 2012 or 2011 related to this investment.

 

Through March 31, 2012, we had purchased a net total of $13.8 million ($9.3 million of which was purchased during the year ended December 31, 2011) of publicly traded equity securities that are classified as available-for-sale and carried at fair value

 

17



 

with changes in fair value recorded to other comprehensive income (loss). For the three months ended March 31, 2012 and March 31, 2011, we had an unrealized loss of $2.6 million and unrealized gain of $0.4 million, respectively, related to these investments, and recognized dividend income of $0.2 million and $0.1 million, respectively, included as a component of other income in the condensed consolidated statements of operations.  All of the equity securities have been in an unrealized loss position for less than 12 months and are not other-than-temporarily impaired.

 

In June 2011, we acquired a non-controlling 49% interest in a privately-held limited liability company for $25.5 million, which is accounted for under the equity method.  The entity owns a mezzanine loan participation, and our share of earnings for the three months ended March 31, 2012 was $0.6 million, which is included in other income on the condensed consolidated statements of operations.

 

6. Secured Financing Agreements

 

On March 31, 2010, Starwood Property Mortgage Sub-1, L.L.C. (“SPM Sub-1”), our indirect wholly-owned subsidiary, entered into a Master Repurchase and Securities Contract (the “Wells Repurchase Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”). The Wells Repurchase Agreement is secured by approximately $161.2 million of the diversified loan portfolio purchased from Teachers Insurance and Annuity Association of America on February 26, 2010 (“the TIAA Portfolio”). Advances under the Wells Repurchase Agreement accrue interest at a per annum pricing rate equal to the sum of one-month LIBOR plus the pricing margin of 3.0%. If an event of default (as such term is defined in the Wells Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable and interest accrues at the default rate, which is equal to the pricing rate plus 4.0%. The maturity date of the Wells Repurchase Agreement is May 31, 2013. The Wells Repurchase Agreement allowed for advances through May 31, 2010. As of March 31, 2012, $108.4 million was outstanding under the Wells Repurchase Agreement and the carrying value of the pledged collateral was $161.2 million. The Company guarantees certain of the obligations of SPM Sub-1 under the Wells Repurchase Agreement up to maximum liability of 25% of the then currently outstanding repurchase price of all purchased assets.

 

On August 6, 2010, Starwood Property Mortgage Sub-2, L.L.C. (“SPM Sub-2”), our indirect wholly-owned subsidiary, entered into a second Master Repurchase and Securities Contract with Wells Fargo, which second repurchase facility was amended and restated by SPM Sub-2 and Starwood Property Mortgage Sub-2-A, L.L.C. (“SPM Sub-2-A”), our indirect wholly-owned subsidiaries, on February 28, 2011, pursuant to an Amended and Restated Master Repurchase and Securities Contract (the “Second Wells Repurchase Agreement”). The Second Wells Repurchase Agreement was amended on May 24, 2011 and November 3, 2011 (“Amendment No. 2”), and is being used by SPM Sub-2 and SPM Sub-2-A to finance the acquisition or origination of commercial mortgage loans (and participations therein) and mezzanine loans. In connection with Amendment No. 2, available borrowings under the facility increased by $200 million, to $550 million. Advances under the Second Wells Repurchase Agreement accrue interest at a per annum pricing rate equal to the sum of one-month LIBOR plus a margin of between 1.75% and 6.0% depending on the type of asset being financed. If an event of default (as such term is defined in the Second Wells Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest accrues at the default rate, which is equal to the pricing rate plus 4.0%. The initial maturity date of the Second Wells Repurchase Agreement is August 5, 2013, subject to two one-year extension options, each of which may be exercised by us upon the satisfaction of certain conditions and the payment of an extension fee. The Company guarantees certain of the obligations of SPM Sub-2 and SPM Sub-2-A under the Wells Repurchase Agreement up to a maximum liability of either 25% or 100% of the then-currently outstanding repurchase price of purchased assets, depending upon the type of asset being financed. As of March 31, 2012, $438.8 million was outstanding under the Second Wells Repurchase Agreement and the carrying value of the pledged collateral was $768.4 million.

 

On December 2, 2010, Starwood Property Mortgage Sub-3, L.L.C. (“SPM Sub-3”), our indirect wholly-owned subsidiary, entered into a Master Repurchase Agreement with Goldman Sachs Mortgage Company, which repurchase facility was amended and restated by SPM Sub-3 and Starwood Property Mortgage Sub-3-A, L.L.C. (“SPM Sub-3-A”), our indirect wholly-owned subsidiary, on February 28, 2011, pursuant to an Amended and Restated Master Repurchase Agreement (the “Goldman Repurchase Agreement”). The Goldman Repurchase Agreement will be used to finance the acquisition or origination by SPM Sub-3 and SPM Sub-3-A of commercial mortgage loans that are eligible for CMBS securitization. The Goldman Repurchase Agreement provides for asset purchases of up to $150 million. The Company guarantees certain of the obligations of SPM Sub-3 and SPM Sub-3-A under the Goldman Repurchase Agreement up to a maximum liability of 25% of the then-currently outstanding repurchase price of all purchased loans. Advances under the Goldman Repurchase Agreement accrue interest at a per annum pricing rate equal to the sum of one-month LIBOR plus a margin of between 1.95% and 2.25% depending on the loan-to-value ratio of the purchased mortgage loan. If an event of default (as such term is defined in the Goldman Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest accrues at the default rate, which is equal to the pricing rate plus 2.0%. The maturity date of the Goldman Repurchase Agreement is December 3, 2012. As of March 31, 2012, there were no borrowings under the Goldman Repurchase Agreement.

 

18



 

On March 18, 2011, Starwood Property Mortgage, L.L.C. (“SPM”), our indirect wholly-owned subsidiary, entered into a third Master Repurchase and Securities Contract with Wells Fargo (“the Third Wells Repurchase Agreement”). The Third Wells Repurchase Agreement is being used by SPM to finance the acquisition and ownership of RMBS and provides for asset purchases up to $100.0 million. Advances under the Third Wells Repurchase Agreement generally accrue interest at a per annum pricing rate equal to one-month LIBOR plus a margin of 2.10%. If an event of default (as such term is defined in the Third Wells Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest accrues at the default rate, which is equal to the pricing rate plus 4.0%. The facility was scheduled to terminate on March 16, 2012. We extended the facility for an additional year and the new facility termination date is March 16, 2013. The Company has guaranteed certain of the obligations of SPM under the Third Wells Repurchase Agreement. As of March 31, 2012, $80.4 million was outstanding and the carrying value of the RMBS collateral was $134.4 million.

 

On June 30, 2011, Starwood Property Mortgage Sub-4, L.L.C. (“SPM Sub-4”) and Starwood Property Mortgage Sub-4-A, L.L.C. (“SPM Sub-4-A”), our indirect wholly-owned subsidiaries, entered into a Mortgage Loan Purchase Agreement (the “Deutsche Repurchase Agreement”) with Deutsche Bank AG, Cayman Islands Branch. The Deutsche Repurchase Agreement provides for asset purchases of up to $150 million. The Company has guaranteed certain of the obligations of SPM Sub-4 and SPM Sub-4-A under the Deutsche Repurchase Agreement up to a maximum liability of the sum of (a) the greater of (i) 25% of the then currently outstanding repurchase price of all purchased loans, and (ii) $20,000,000, plus (b) all obligations associated with hedging. Advances under the Deutsche Repurchase Agreement accrue interest at a pricing rate equal to the sum of one-month LIBOR plus a margin of between 1.85% and 2.5% depending on the property type and loan-to-value ratio of the purchased mortgage asset. If an event of default (as such term is defined in the Deutsche Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest accrues at the default rate, which is equal to the pricing rate plus 4.0%. The maturity date of the Deutsche Repurchase Agreement is June 30, 2012 with two one-year extension options, subject to the satisfaction of certain conditions. As of March 31, 2012, there were no borrowings under the Deutsche Repurchase Agreement.

 

On June 28, 2011, SPT Rosslyn Holdings, L.L.C. (“SPT Rosslyn”), our indirect wholly-owned subsidiary, entered into a Master Repurchase Agreement (the “Second Deutsche Repurchase Agreement”) with Deutsche Bank AG, New York Branch (“Deutsche NY”). In connection with the Second Deutsche Repurchase Agreement, SPT Rosslyn transferred assets to Deutsche NY, with such transfer providing access to repurchase borrowings of up to $117.4 million. Interest on these borrowings accrues at a pricing rate equal to one-month LIBOR plus a margin of between 3.5% and 5.0%, depending on the loan-to-value. If an event of default (as such term is defined in the Second Deutsche Repurchase Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest accrues at the default rate, which is equal to the pricing rate plus 5.0%. As of March 31, 2012, SPT Rosslyn had borrowed $97.3 million under this facility and the carrying value of the pledged collateral was $167.4 million. The borrowing matures in May 2012. The Company has guaranteed certain of the obligations of SPT Rosslyn under the Second Deutsche Repurchase Agreement.

 

On December 30, 2011, Starwood Property Mortgage Sub-5, L.L.C. (“SPM Sub-5”) and Starwood Property Mortgage Sub-5-A, L.L.C. (“SPM Sub-5-A”) and , our indirect wholly-owned subsidiaries, entered into a fourth Master Repurchase and Securities Contract with Wells Fargo (the “Fourth Wells Repurchase Agreement”). The Fourth Wells Repurchase Agreement provides for advances up to $236.0 million and is secured by a loan portfolio of 26 separate commercial mortgage loans that we acquired on December 30, 2011 for $307.3 million. As of March 31, 2012, the $231.5 million in advances under the Fourth Wells Repurchase Agreement accrued interest at one-month LIBOR plus a pricing margin of 2.75%. The availability of additional advances, as well as the pricing margin on all outstanding borrowings at any given time, is determined by the current operating cash flows and fair values of the underlying collateral, both in relation to the existing collateral loan receivable balances outstanding, and all as approved by Wells Fargo. The overall term of the Fourth Wells Repurchase Agreement is three years, with two one-year conditional extensions. As of March 31, 2012, SPM Sub-6 had borrowed $231.5 million under this facility and the carrying value of the pledged collateral was $307.3 million. However, $50.7 million of the borrowings outstanding at March 31, 2012 are due in June 2012, subject to a conditional six-month extension for a 0.25% fee. At closing, we paid a 0.50% commitment fee based upon the total committed proceeds. If the overall facility is extended beginning in December 2014, we would pay a 0.25% extension fee for each year. The Company guarantees 60% of the currently outstanding repurchase price for all purchased assets; however, the Company guarantees 100% of the outstanding balance of any individual repurchase transaction involving a collateral property with operating cash flows that at any time is less than 15% of the related collateral loan receivable balance.

 

On March 6, 2012, Starwood Property Mortgage Sub-7, LLC (“SPM Sub-7”), our indirect wholly-owned subsidiary, entered into a Master Repurchase Agreement with Goldman Sachs International (the “Second Goldman Repurchase Agreement”).  At closing, we borrowed $155.4 million under the Second Goldman Repurchase Agreement to finance the acquisition of $222.8 million in senior debt securities that are expected to mature on November 15, 2015.  The senior debt securities were issued by certain special purpose entities that were formed to hold substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties.  Advances under the Second Goldman Repurchase Agreement accrue interest at a per annum rate of one-month LIBOR plus a spread of 2.90%.  The maturity date of the Second Goldman Repurchase Agreement is August 15, 2015.  The carrying value of

 

19



 

the collateral senior debt securities was $206.6 million and the amount outstanding under the facility was $154.3 million at March 31, 2012.

 

On March 26, 2012, Starwood Property Mortgage Sub-6, LLC (“SPM Sub-6”) and Starwood Property Mortgage Sub-6-A (“SPM Sub-6-A”), our indirect wholly-owned subsidiaries, entered into a Master Repurchase Agreement with Citibank, N.A. (the “Citi Repurchase Agreement).  The Citi Repurchase Agreement provides for asset purchases of up to $125.0 million to finance  commercial mortgage loans and senior interests in commercial mortgage loans originated or acquired by us and including loans and interests intended to be included in commercial mortgage loan securitizations as well as those not intended to be securitized.  Advances under the Citi Repurchase Agreement accrue interest at a per annum interest rate equal to the sum of (i) 30-day LIBOR plus (ii) a margin of  between 1.75% and 3.75% depending on (A) asset type, (B) the amount advanced and (C) the debt yield and loan-to-value ratios of the purchased mortgage loan, provided that the aggregate weighted average interest rate shall not at any time be less than the sum of one-month LIBOR plus 2.25%.  The facility has an initial maturity date of March 29, 2014, subject to three one-year extension options, which may be exercised by us upon the satisfaction of certain conditions. We have guaranteed the obligations of our subsidiaries under the facility up to a maximum liability of 25% of the then-currently outstanding repurchase price of assets financed.  There were no borrowings under the Citi Repurchase Agreement as of March 31, 2012.

 

Under the Wells Repurchase Agreement, the Second Wells Repurchase Agreement, the Goldman Repurchase Agreement, the Third Wells Repurchase Agreement, the Deutsche Repurchase Agreement, the Second Deutsche Repurchase Agreement, the Fourth Wells Repurchase Agreement, the Second Goldman Repurchase Agreement, and the Citi Repurchase Agreement, the counterparty retains the sole discretion over both whether to purchase the loan or security from us and, subject to certain conditions, the market value of such loan or security for purposes of determining whether we are required to pay margin to the counterparty.

 

On December 3, 2010, SPT Real Estate Sub II, LLC (“SPT II”), our wholly-owned subsidiary, entered into a term loan credit agreement (the “BAML Credit Agreement”) with Bank of America, N.A. (“Bank of America”) as administrative agent and as lender, and us and certain of our subsidiaries as guarantors. The BAML Credit Agreement, amended and restated on March 9, 2012 (“Amended BAML Credit Agreement”), provides for loans of up to $198.1 million as of March 31, 2012. The initial draw under the BAML Credit Agreement in December 2010 was used, in part, to finance the acquisition of a $205.0 million participation (the “Participation”) in a senior secured loan due November 15, 2015 from Bank of America. The Participation was converted into a security in June 2011 and is due from certain special purpose entities that were formed to hold substantially all of the assets of a worldwide operator of hotels, resorts and timeshare properties.  In connection with the March 9, 2012 amendment, we borrowed an additional $81.0 million to partially finance the $125.0 million acquisition of additional participation interest in the senior secured loan.

 

Advances under the Amended BAML Credit Agreement accrue interest at a per annum rate based on LIBOR or a base rate, at the election of SPT II. The margin can vary between 2.35% and 2.50% over LIBOR, and between 1.35% and 1.50% over base rate, based on the performance of the underlying hospitality collateral. The initial maturity date of the Amended BAML Credit Agreement is November 30, 2014, subject to a 12 month extension option, exercisable by SPT II upon satisfaction of certain conditions set forth in the Amended BAML Credit Agreement. Bank of America retains the sole discretion, subject to certain conditions, over the market value of collateral assets for purposes of determining whether we are required to pay margin to Bank of America. As of March 31, 2012, $198.1 million was outstanding under the BAML Credit Agreement. The carrying value of the CMBS pledged as collateral under the Credit agreement was $296.5 million as of March 31, 2012. If an event of default (as such term is defined in the Amended BAML Credit Agreement) occurs and is continuing, amounts borrowed may become due and payable immediately and interest would accrue at an additional 2% per annum over the applicable rate.  See Note 15 for the disclosure of a development related to the Amended BAML Credit Agreement that occurred subsequent to March 31, 2012.

 

The following table sets forth our five-year principal repayments schedule for the secured financings assuming no defaults or expected extensions, which excludes the collateralized debt obligation in securitization trust (amounts in thousands).   Our credit facilities generally require principal to be paid down prior to the facilities’ respective maturities if and when we receive principal payments on, or sell, the investment collateral that we have pledged.  The amount for the remainder of 2012 generally represents the principal repayments that will be required on our credit facilities as a result of our receipt of principal repayments that are scheduled or otherwise expected to be received on our loan and MBS investments:

 

2012 (remaining)

 

$

180,659

 

2013

 

640,448

 

2014

 

184,693

 

2015

 

303,060

 

2016 and thereafter

 

 

Total

 

$

1,308,860

 

 

20



 

7. Loan Securitization/Sale Activities

 

During 2010, we participated in a commercial mortgage securitization which generated non-recourse match funded financing with an effective cost of funds of approximately 3.5%. We separated five mortgage loans with an aggregate face value of $178.0 million into senior and junior loans. We contributed the five senior loans, or A Notes (the “Contributed Loans”), with a face value of approximately $84.0 million to the securitization trust and received approximately $92.0 million in proceeds, while retaining $94.0 million of junior interests. The Contributed Loans are secured by office, retail and industrial properties and have remaining maturities between four and seven years.  Each of the five Contributed Loans was either originated or acquired by us as part of a first mortgage loan. In connection with the securitization, two of the first mortgage loans were each split by us into an A Note and a B Note and three of the first mortgage loans had each been previously split into A Notes, B Notes and C Notes.  The secured financing liability relates to two of the Contributed Loans that we securitized but did not qualify for sale treatment under GAAP. As of March 31, 2012 and December 31, 2011, the balance of the loans pledged to the securitization trust was $50.3 million and $50.3 million, respectively, and the related liability of the securitization trust was $53.0 million and $53.2 million, respectively.

 

During the first quarter of 2011, we contributed three loans to a securitization trust for approximately $56.0 million in gross proceeds. Control of the loans was surrendered in the loan transfer and it was therefore treated as a sale under GAAP, resulting in a gain of $1.9 million. We effectively realized a net gain of $1.8 million on this transaction after considering the realized losses on the interest rate hedges of $0.1 million that was terminated in connection with the sale.

 

During the first quarter of 2012, we sold six loans with a carrying value of $122.7 million to an independent third party resulting in proceeds, net of financing repayments, of $40.6 million.  Control of the loans was surrendered in the loan transfer and it was therefore treated as a sale under GAAP, resulting in a realized gain of $9.4 million.  The net economic gain of this transaction, including a realized loss of $8.4 million on the termination of the corresponding interest rate hedge, was $1.0 million.  Additionally, we sold 50% of our Euro denominated loan to a strategic partner resulting in proceeds of $28.8 million and a realized loss of $2.1 million;  however, this transaction was earnings neutral after considering the realized gains on the related currency hedges of $2.1 million that were terminated in connection with the sale.

 

8. Derivatives and Hedging Activity

 

Risk Management Objective of Using Derivatives

 

We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, foreign exchange, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments. Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates, credit spreads, and foreign exchange rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of the known or expected cash receipts and known or expected cash payments principally related to our investments, anticipated level of loan sales, and borrowings.

 

Cash Flow Hedges of Forecasted Interest Payments

 

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

 

In connection with our repurchase agreements, we have entered into nine interest rate swaps that have been designated as cash flow hedges of the interest rate risk associated with forecasted interest payments. As of March 31, 2012, the aggregate notional of our interest rate swaps designated as cash flow hedges of interest rate risk totaled $342.3 million.  Under these agreements, we will pay fixed monthly coupons at fixed rates ranging from 0.557% to 2.228% of the notional amount to the counterparty and receive floating rate LIBOR. Our interest rate swaps designated as cash flow hedges of interest rate risk have maturities ranging from November 2012 to October 2018.

 

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three months ended March 31, 2012 and March 31, 2011, we recorded $0 and $45 thousand, respectively as hedge ineffectiveness in earnings, which is included in interest expense on the condensed consolidated statements of operations.

 

21



 

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the associated variable-rate debt. Over the next twelve months, we estimate that an additional $2.1 million will be reclassified as an increase to interest expense.  We are hedging our exposure to the variability in future cash flows for forecasted transactions over a maximum period of 79 months.

 

Non-designated Hedges

 

Derivatives not designated as hedges are derivatives that do not meet the criteria for hedge accounting under GAAP or for which we have not elected to designate as hedges.  We do not use these derivatives for speculative purposes but are instead used to manage our exposure to foreign exchange rates, interest rate changes, and certain credit spreads.  Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in net (losses) gains on interest rate, currency or credit hedges in the condensed consolidated statements of operations.

 

During 2010, we entered into a series of forward contracts whereby we agree to sell an amount of GBP for agreed upon amounts of USD at various dates through October of 2013.  These forward contracts were executed to economically fix the USD amounts of GBP-denominated cash flows expected to be received by us related to our GBP-denominated loan investment.  During 2011, we entered into a series of forward contracts whereby we agree to sell an amount of EUR for an agreed upon amount of USD at various dates through June of 2014.  These forward contracts were executed to economically fix the USD amount of EUR-denominated cash flows expected to be received by us related to our mezzanine loan in Germany.  During the three months ended March 31, 2012, we terminated a portion of our contracts to sell EUR.  The purpose of the terminations was to reduce the amount of EUR we were to sell at future dates as a result of the refinancing of our EUR-denominated loan investment.  During the three months ended March 31, 2012, we entered into positions to buy GBP for an agreed upon amount of USD at various dates through 2013 to fix the future value of our losses on pre-existing GBP forward positions.  We also entered into a new series of forward contracts whereby we agree to sell GBP for an agreed upon amount of USD at various dates through March 2016.

 

As of March 31, 2012, we had 18 foreign exchange forward derivatives to sell GBP with a total notional amount of GBP 186.1 million, 10 foreign exchange forward derivatives to buy GBP with a total notional amount of GBP 98.2 million and 10 foreign exchange forward derivatives to sell EUR with a total notional of EUR 28.8 million that were not designated as hedges in qualifying hedging relationships.

 

During 2010 and 2011, we entered into several interest rate swaps that were not designated as hedges.  Under these remaining agreements, we pay fixed coupons at fixed rates ranging from 0.716% to 2.435% of the notional amount to the counterparty and receive floating rate LIBOR.  These interest rate swaps are used to limit the price exposure of certain assets due to changes in benchmark USD-LIBOR swap rates from which the pricing of these assets is derived.  During the three months ended March 31, 2012, we terminated our swap that had a fixed rate of 3.10%. As of March 31, 2012, the aggregate notional amount of these five remaining interest rate swaps totaled $165.0 million. Changes in the fair value of these interest rate swaps are recorded directly in earnings.

 

In connection with our acquisition on a loan portfolio during the fourth quarter of 2011, we entered into nine interest rate swaps whereby we receive fixed coupons ranging from 2.86% to 6.28% of the notional amount and pay floating rate LIBOR.  We acquired these swaps at a cost of $7.5 million.  The premium paid reflects the fact that these swaps had above market rates which we receive.   These swaps effectively convert certain floating rate loans we acquired to fixed rates.  As of March 31, 2012, the aggregate notional amount of these swaps totaled $107.9 million. Changes in the fair value of these interest rate swaps are recorded directly in earnings.

 

During the first quarter of 2011 we entered into a derivative that is intended to hedge against increases in market credit spreads of CMBS.  Such movements would have a negative impact on the proceeds we expect to receive from contributing loans into commercial mortgage loan securitizations.  The notional amount of the derivative is $50.0 million and it matures in August 2011.  Under the terms of the contract, a market credit spread index was defined at the contract’s inception by reference to a portfolio of specific independent CMBS.  To the extent the referenced credit spread index increases, our counterparty pays us.  To the extent the referenced credit spread index decreases, we pay our counterparty.  We pay/receive approximately every 30 days based upon the movement in the referenced index during such period.  The net loss from inception of the hedge through March 31, 2011 was $187 thousand and we were due $67 thousand as of March 31, 2011.   There were no credit hedges in place during the three months ended March 31, 2012.

 

The table below presents the fair value of our derivative financial instruments as well as their classification on the balance sheet as of March 31, 2012 and December 31, 2011 (amounts in thousands).

 

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Tabular Disclosure of Fair Values of Derivative Instruments (amounts in thousands)

 

 

 

Derivatives in an Asset Position

 

Derivatives in a Liability Position

 

 

 

As of March 31, 2012

 

As of December 31, 2011

 

As of March 31, 2012

 

As of December 31, 2011

 

 

 

Balance
Sheet
Location

 

Fair
Value

 

Balance
Sheet
Location

 

Fair
Value

 

Balance
Sheet
Location

 

Fair
Value

 

Balance
Sheet
Location

 

Fair
Value

 

Derivatives designated as hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Derivative Assets

 

$

22

 

N/A

 

$

 

Derivative Liabilities

 

$

1,694

 

Derivative Liabilities

 

$

1,420

 

Total derivatives designated as hedging instruments

 

 

 

$

22

 

 

 

$

 

 

 

$

1,694

 

 

 

$

1,420

 

Derivatives not designated as hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Derivative Assets

 

$

6,912

 

Derivative Assets

 

$

7,555

 

Derivative Liabilities

 

$

1,890

 

Derivative Liabilities

 

$

11,342

 

Foreign exchange contracts

 

Derivative Assets

 

2,521

 

Derivative Assets

 

5,261

 

Derivative Liabilities

 

12,723

 

Derivative Liabilities

 

6,890

 

Total derivatives not designated as hedging instruments

 

 

 

$

9,433

 

 

 

$

12,816

 

 

 

$

14,613

 

 

 

$

18,232

 

 

Cash flow hedges impact for the three months ended March 31, 2012 (amounts in thousands):

 

Derivative type for
cash flow hedge 

 

Amount of loss
recognized in
OCI
on derivative
(effective portion)

 

Location of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Amount of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Location of loss
recognized in
income on
derivative
(ineffective portion)

 

Amount of loss
recognized in
income on
derivative
(ineffective portion)

 

Interest Rate Swaps

 

$

839

 

Interest Expense

 

$

587

 

Interest Expense

 

$

 

 

Cash flow hedges impact for the three months ended March 31, 2011 (amounts in thousands):

 

Derivative type for
cash flow hedge

 

Amount of loss
recognized in
OCI
on derivative
(effective portion)

 

Location of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Amount of loss
reclassified from
accumulated OCI
into income
(effective portion)

 

Location of gain
recognized in
income on
derivative
(ineffective portion)

 

Amount of gain
recognized in
income on
derivative
(ineffective portion)

 

Interest Rate Swaps

 

$

32

 

Interest Expense

 

$

584

 

Interest Expense

 

$

45

 

 

Non-Designated derivatives impact for the three months ended March 31, 2012 and March 31, 2011 (amounts in thousands):

 

Derivatives Not Designated

 

Location of Gain/(Loss)
Recognized in Income on

 

Amount of Gain/(Loss)
Recognized in Income on
Derivative

 

as Hedging Instruments 

 

Derivative

 

2012

 

2011

 

Interest Rate Swaps — Realized losses

 

Gains (losses) on interest rate hedges

 

$

(9,213

)

$

(238

)

Interest Rate Swaps — Net change in unrealized gains

 

Gains (losses) on interest rate hedges

 

$

9,779

 

$

1,688

 

Foreign Exchange — Realized gains

 

Gains (losses) on currency hedges

 

$

2,316

 

$

 

Foreign Exchange — Net change in unrealized losses

 

Gains (losses) on currency hedges

 

$

(8,573

)

$

(3,916

)

Credit Spread Derivative— Realized gains

 

Gains (losses) on credit spread hedges

 

$

 

$

 

Credit Spread Derivative— Net change in unrealized losses

 

Gains (losses) on credit spread hedges

 

$

 

$

(187

)

 

Credit-risk-related Contingent Features

 

We have entered into agreements with certain of our derivative counterparties that contain provisions where if we were to default on any of our indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, we may also be declared in default on our derivative obligations. We also have certain agreements that contain provisions where if our ratio of principal amount of indebtedness to total assets at any time exceeds 75%, then we could be declared in default of our derivative obligations.

 

As of March 31, 2012 the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $15.6 million. As of March 31, 2012, we had posted collateral of $3.3 million related to these agreements. If we had breached any of these provisions at March 31, 2012, we could have been required to settle our obligations under the agreements at their termination liability value of $15.6 million.

 

9. Related-Party Transactions

 

Management Agreement

 

We entered into a Management Agreement with our Manager upon closing of our IPO, which provides for an initial term of three years with automatic one-year extensions thereafter unless terminated as described below. Under the Management Agreement, our Manager, subject to the oversight of our board of directors, is required to manage our day-to-day activities, for which our Manager

 

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receives a base management fee and is eligible for an incentive fee and stock awards. Our Manager is also entitled to charge us for certain expenses incurred on our behalf, as described below.

 

Base Management Fee.    The base management fee is 1.5% of our stockholders’ equity per annum and calculated and payable quarterly in arrears in cash. For purposes of calculating the management fee, our stockholders’ equity means: (a) the sum of (1) the net proceeds from all issuances of our equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus (2) our retained earnings at the end of the most recently completed calendar quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less (b) any amount that we pay to repurchase our common stock since inception. It also excludes (1) any unrealized gains and losses and other non-cash items that have impacted stockholders’ equity as reported in our financial statements prepared in accordance with GAAP, and (2) one-time events pursuant to changes in GAAP, and certain non-cash items not otherwise described above, in each case after discussions between our Manager and our independent directors and approval by a majority of our independent directors. As a result, our stockholders’ equity, for purposes of calculating the management fee, could be greater or less than the amount of stockholders’ equity shown in our condensed consolidated financial statements.

 

For the three month periods ended March 31, 2012 and March 31, 2011 approximately $6.7 million and $5.0 million was incurred for base management fees, respectively. Management fee payable as of both March 31, 2012 and December 31, 2011 was $6.7 million.

 

Incentive Fee.    From August 17, 2009 (the effective date of the Management Agreement), our Manager is entitled to be paid the incentive fee described below with respect to each calendar quarter (or part thereof that the Management Agreement is in effect) if (1) our Core Earnings (as defined below) for the previous 12-month period (or part thereof that the Management Agreement is in effect) exceeds an 8% threshold, and (2) our Core Earnings for the 12 most recently completed calendar quarters (or part thereof that the Management Agreement is in effect) is greater than zero.

 

The incentive fee will be an amount, not less than zero, equal to the difference between (1) the product of (x) 20% and (y) the difference between (i) our Core Earnings (as defined below) for the previous 12-month period (or part thereof that the Management Agreement is in effect), and (ii) the product of (A) the weighted average of the issue price per share of our common stock of all of our public offerings multiplied by the weighted average number of all shares of common stock outstanding (including any restricted stock units, any restricted shares of common stock and other shares of common stock underlying awards granted under our equity incentive plans) in such previous 12-month period (or part thereof that the Management Agreement is in effect), and (B) 8%, and (2) the sum of any incentive fee paid to our Manager with respect to the first three calendar quarters of such previous 12-month period (or part thereof that the Management Agreement is in effect). One half of each quarterly installment of the incentive fee is payable in shares of our common stock so long as the ownership of such additional number of shares by our Manager would not violate the 9.8% stock ownership limit set forth in our articles of incorporation, after giving effect to any waiver from such limit that our board of directors may grant in the future. The remainder of the incentive fee is payable in cash. The number of shares to be issued to our Manager is equal to the dollar amount of the portion of the quarterly installment of the incentive fee payable in shares divided by the average of the closing prices of our common stock on the New York Stock Exchange for the five trading days prior to the date on which such quarterly installment is paid.

 

Core Earnings is a non-GAAP financial measure. We calculate Core Earnings as GAAP net income (loss) excluding non-cash equity compensation expense, the incentive fee, depreciation and amortization of real estate (to the extent that we own properties), any unrealized gains, losses or other non-cash items recorded in net income for the period, regardless of whether such items are included in other comprehensive income or loss, or in net income. The amount is adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges as determined by our Manager and approved by a majority of our independent directors.

 

We incurred approximately $4.8 million and $0.4 million during the three months ended March 31, 2012 and 2011, respectively, in incentive fee.  As of March 31, 2012, the incentive fee accrued was approximately $4.8 million.

 

Expense Reimbursement.    We are required to reimburse our Manager for operating expenses incurred by our Manager on our behalf.  In addition, pursuant to the terms of the Management Agreement, we are required to reimburse our Manager for the cost of legal, tax, consulting, auditing and other similar services rendered for us by our Manager’s personnel provided that such costs are no greater than those that would be payable if the services were provided by an independent third party. The expense reimbursement is not subject to any dollar limitations but is subject to review by our independent directors. For the three months ended March 31, 2012 and March 31, 2011, approximately $1.6 million and $0.8 million were incurred, respectively, for executive compensation and other reimbursable expenses of which approximately $1.9 million and $0.5 million were payable as of March 31, 2012 and March 31, 2011, respectively.

 

Termination Fee.    After the initial three-year term, we can terminate the Management Agreement without cause, as defined in the Management Agreement, with an affirmative two-thirds vote by our independent directors and 180 days written notice to our

 

24



 

Manager. Upon termination without cause, our Manager is due a termination fee equal to three times the sum of the average annual base management fee and incentive fee earned by our Manager over the preceding eight calendar quarters. No termination fee is payable if our Manager is terminated for cause, as defined in the Management Agreement, which can be done at any time with 30 days written notice from our board of directors.

 

Loan Participation

 

In 2011 we purchased a $35,000,000 pari passu participation interest (the “Participation Interest”) in a $75,000,000 subordinate loan (the “Mammoth Loan”) from an independent third party and a syndicate of financial institutions and other entities acting as subordinate lenders to Mammoth Mountain Ski Area, LLC (“Mammoth”). Mammoth is a single-purpose, bankruptcy remote entity that is owned and controlled by Starwood Global Opportunity Fund VII-A, L.P., Starwood Global Opportunity Fund VII-B, L.P., Starwood U.S. Opportunity Fund VII-D, L.P. and Starwood U.S. Opportunity Fund VII-D-2, L.P. (collectively, the “Sponsors”). Each of the Sponsors is indirectly wholly-owned by Starwood Capital Group Global I, L.L.C., and an affiliate of our Chief Executive Officer. The Mammoth Loan was approved by our non-executive directors in accordance with our related party transaction policy.  The Mammoth Loan has a term of up to six years and an interest rate of 13.25%. We acquired our Participation Interest in the Mammoth Loan from an independent third party and own such Participation Interest subject to a participation agreement between us and the independent third party (the “Participation Agreement”). The Participation Agreement provides for the payment to us, on a pro rata basis with an independent third party, of customary payments in respect of our Participation Interest and affords us customary voting, approval and consent rights so long as no event of default is continuing under the Mammoth Loan.

 

10. Stockholders’ Equity

 

The Company’s authorized capital stock consists of 100,000,000 shares of preferred stock, $0.01 par value per share, and 500,000,000 shares of common stock, $0.01 par value per share.

 

On August 17, 2009, we sold 47,575,000 shares of our common stock (including 1,000,000 shares sold to an entity controlled by Starwood Capital Group pursuant to a simultaneous private placement) in our IPO at an offering price of $20 per share.

 

In December 2010, we completed a follow-on offering of 23,000,000 shares of our common stock at a price of $19.73 per share.

 

In May 2011, we completed another follow-on offering of 22,000,000 shares of our common stock at a price of $21.67 per share.

 

At the time of our IPO in 2009, the underwriters for the IPO agreed to defer and condition the receipt of a portion of their underwriting fees on our future achievement of certain minimum investment returns. Similarly, at the time of the IPO our Manager agreed to pay to the underwriters a separate portion of the underwriting fees on our behalf, with our reimbursement of our Manager of those amounts conditioned upon our achievement of the same investment returns. In the absence of the achievement of such investment returns, we would not pay the underwriters the deferred portion of the underwriting fees nor would our Manager be reimbursed for the portion of the underwriting fees that it paid on our behalf. Specifically, pursuant to the IPO underwriting agreement among the underwriters, our Manager and us, we were required to pay to the underwriters $18.1 million of underwriting fees if during any full four calendar quarter period during the 24 full calendar quarters after the consummation of the IPO our Core Earnings for any such four-quarter period exceeded the product of (x) the weighted-average of the issue price per share of all public offerings of our common stock, multiplied by the weighted-average number of shares outstanding (including any restricted stock units, any restricted shares of common stock and any other shares of common stock underlying awards granted under our equity incentive plans) in such four-quarter period and (y) 8%. Additionally, because at the time of our IPO our Manager paid $9.1 million of underwriting fees on our behalf, pursuant to our Management Agreement with our Manager, we agreed to reimburse our Manager for such payments to the extent the same 8% performance threshold was exceeded. For the four calendar quarter periods ended March 31, 2011 we exceeded the threshold and therefore paid $27.2 million related to these contingent arrangements during the second quarter of 2011. Prior to 2011, we had recorded a deferred liability and an offsetting reduction to additional paid-in-capital for the full $27.2 million based upon actual and forecasted operating results at the time.

 

In August 2011, our board of directors authorized us to repurchase up to $100 million of our outstanding common shares over a one-year period.  Purchases made pursuant to the program are to be made in either the open market or in privately negotiated transactions from time to time as permitted by federal securities laws and other legal requirements. The timing, manner, price and amount of any repurchases are determined by us and are subject to economic and market conditions, stock price, applicable legal requirements and other factors. The program may be suspended or discontinued at any time.  Through December 31, 2011, we purchased 625,850 common shares on the open market at an aggregate cost of approximately $10.6 million, resulting in a weighted average share cost of $17.00. No additional shares were purchased during the three months ended March 31, 2012.

 

25



 

Our board of directors declared the following dividends in 2011 and 2012:

 

Ex-Dividend Date

 

Record Date

 

Announce Date

 

Pay Date

 

Amount

 

Frequency

 

3/28/2012

 

3/30/2012

 

2/29/2012

 

4/13/2012

 

$

0.44

 

Quarterly

 

12/28/2011

 

12/31/2011

 

11/4/2011

 

1/13/2012

 

$

0.44

 

Quarterly

 

9/28/2011

 

9/30/2011

 

8/2/2011

 

10/14/2011

 

$

0.44

 

Quarterly

 

6/28/2011

 

6/30/2011

 

5/10/2011

 

7/15/2011

 

$

0.44

 

Quarterly

 

3/29/2011

 

3/31/2011

 

3/1/2011

 

4/15/2011

 

$

0.42

 

Quarterly

 

 

Equity Incentive Plans

 

We have reserved an aggregate of 3,112,500 shares of common stock for issuance under the Starwood Property Trust, Inc. Equity Plan and Starwood Property Trust, Inc. Manager Equity Plan and an additional 100,000 shares of common stock for issuance under the Starwood Property Trust, Inc. Non-Executive Director Stock Plan. These plans provide for the issuance of restricted stock or restricted stock units. The holders of awards of restricted stock or restricted stock units will be entitled to receive dividends or “distribution equivalents,” which will be payable at such time dividends are paid on our outstanding shares of common stock.

 

We granted each of our four independent directors 2,200 shares of restricted stock concurrently with our IPO, with a total fair value of approximately $175 thousand. The grants vest ratably in three annual installments on each of the first, second, and third anniversaries of the grant date, respectively, subject to the director’s continued service. Effective August 19, 2010, we granted each of our four independent directors an additional 1,000 shares of restricted stock, with a total fair value of approximately $75 thousand. The grants vested in one annual installment on the first anniversary of the grant.  Effective August 19, 2011, we granted each of our four independent directors an additional 2,877 shares of restricted stock, with a total fair value of approximately $200 thousand. The grant will vest in one annual installment on the first anniversary of the grant, subject to the director’s continued service.   For the three months ended March 31, 2012 and March 31, 2011, approximately $64 thousand and $32 thousand were included in general and administrative expense, respectively, related to the grants.

 

In August 2009, we granted 1,037,500 restricted stock units with a fair value of approximately $20.8 million at the grant date to our Manager under the Manager Equity Plan. The grants vest ratably in quarterly installments over three years beginning on October 1, 2009, with 86,458 shares vesting each quarter, respectively. In connection with the supplemental equity offering in December 2010, we granted 1,075,000 restricted stock units with a fair value of approximately $21.8 million at the grant date to our Manager under the Manager Equity Plan. The grants vest ratably in quarterly installments over three years beginning on March 31, 2011, with 89,583 shares vesting each quarter. For the three months ended March 31, 2012 and March 31, 2011, approximately 176,041 and 176,041 shares have vested, respectively, and approximately $3.6 million and $3.8 million has been included in management fees related to these grants, respectively.

 

We granted 5,000 restricted stock units with a fair value of $100 thousand to an employee under the Starwood Property Trust, Inc. Equity Plan in August 2009. The award was scheduled to vest ratably in quarterly installments over three years beginning on October 1, 2009. Upon the departure of this employee in July 2010, we issued 1,250 shares of our common stock relating to the vested portion of the award, while the remaining 3,750 unvested units were forfeited.  In February 2011, we granted 11,082 restricted stock units with a fair value of $250 thousand to an employee under the Starwood Property Trust, Inc. Equity Plan.  The award vests ratably in quarterly installments over three years beginning on March 31, 2011.  In March 2012, we granted 17,500 restricted stock units with a fair value of $368 thousand to employees under the Starwood Property Trust, Inc. Equity Plan.  Of the total award, 12,500 restricted shares vest in quarterly installments over three years beginning on March 31, 2012 and 5,000 shares vest in annual installments over three years beginning on December 31, 2012.  As of March 31, 2012 and March 31, 2011, 1,965 and 923 shares have vested, respectively, and for the quarters ended March 31, 2012 and March 31, 2011, approximately $51 thousand and $9 thousand was included in general and administrative expense related to the grants, respectively.

 

Schedule of Non-Vested Share and Share Equivalents

 

 

 

Restricted Stock
Grants to
Independent
Directors

 

Restricted Stock
Unit
Grants to
Employees

 

Restricted Stock
Unit
Grants to
Manager

 

Total

 

Balance as of December 31, 2011

 

15,175

 

7,385

 

976,044

 

998,604

 

Granted

 

 

17,500

 

 

17,500

 

Vested

 

(733

)

(1,965

)

(176,041

)

(178,739

)

Forfeited

 

 

 

 

 

Balance as of March 31, 2012

 

14,442

 

22,920

 

800,003

 

837,365

 

 

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Vesting Schedule

 

 

 

Restricted Stock
Grants to
Independent
Directors

 

Restricted Stock
Unit
Grants to
Employees

 

Restricted Stock
Unit
Grants to
Manager

 

Total

 

2012 (remainder of)

 

13,708

 

7,562

 

441,667

 

462,937

 

2013

 

734

 

9,527

 

358,336

 

368,597

 

2014

 

 

5,831

 

 

5,831

 

Total

 

14,442

 

22,920

 

800,003

 

837,365

 

 

11. Accumulated Other Comprehensive Income

 

Accumulated other comprehensive income is comprised of the following, net of non-controlling interests in consolidated subsidiaries (amounts in thousands):

 

 

 

March 31, 2012

 

March 31, 2011

 

Cumulative unrealized gain on available-for-sale securities

 

12,536

 

4,116

 

Effective portion of cumulative loss on cash flow hedges

 

(1,673

)

(1,030

)

Total

 

10,863

 

3,086

 

 

12. Net Income per Share

 

The following table provides a reconciliation of both net income and the number of common shares used in the computation of basic and diluted income per share. We use the two-class method in calculating both basic and diluted earnings per share as our unvested restricted stock units (refer to Note 10) are participating securities as defined in GAAP (amounts in thousands, except share and per share amounts):

 

 

 

 

Three Month Period Ended

 

 

 

March 31, 2012

 

March 31, 2011

 

Net income attributable to Starwood Property Trust, Inc.

 

$

50,159

 

$

31,447

 

Net (loss) allocated to participating securities

 

(434

)

(706

)

Numerator for basic and diluted net income per share

 

$

49.725

 

$

30,741

 

Basic weighted average shares outstanding

 

93,166,866

 

71,013,358

 

Weighted average number of diluted shares outstanding(1) 

 

94,227,928

 

72,743,362

 

Basic income per share

 

$

0.53

 

$

0.44

 

Diluted income per share

 

$

0.53

 

$

0.43

 

 


(1)         The weighted average number of diluted shares outstanding includes the impact of (i) unvested restricted stock units totaling 800,003 and 1,524,194 as of March 31, 2012 and March 31, 2011, respectively, and (ii) 65,998 and 37,256 shares that would be hypothetically issuable as part of the incentive fee payable to the Manager if we assume that March 31, 2012 and March 31, 2011 was the end of the measurement period, respectively.

 

13. Fair Value of Financial Instruments

 

GAAP establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial instruments at fair values. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:

 

Level I - Quoted prices in active markets for identical assets or liabilities.

 

Level II - Prices are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.

 

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Level III - Prices are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment) unobservable inputs may be used. Unobservable inputs reflect our own assumptions about the factors that market participants would use in pricing an asset or liability, and would be based on the best information available.

 

We determine the fair value of our financial instruments as follows:

 

Available-for-sale debt securities

 

Available-for-sale debt securities are valued utilizing observable and unobservable market inputs. The observable market inputs may include recent transactions, broker quotes and vendor prices (“market data”). However, to the extent there is material price dispersion amongst the market data, the fair value determination for these securities significantly utilizes unobservable inputs in discounted cash flow models including prepayments, default and severity estimates based on the recent performance of the collateral, the underlying collateral characteristics, industry trends, as well as expectations of macro-economic events (e.g. housing price curves, interest rate curves, etc.). At each measurement date, we consider both the observable and unobservable valuation inputs in the determination of fair value, as appropriate, and securities are classified as level III when unobservable inputs have the most significant impact.

 

Available-for-sale equity securities

 

The available-for-sale equity securities are publicly registered and traded in the United States and their prices are listed on the New York Stock Exchange.

 

Derivatives

 

The valuation of derivative contracts are determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves, spot and market forward points. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The fair value of the foreign currency forward contracts is based on interest differentials between the currencies being traded, spot and market forward points.

 

We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

 

Although we have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. As of March 31, 2012 and December 31, 2011, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, we have determined that our derivative valuations in their entirety are classified in Level II of the fair value hierarchy.

 

Loans

 

We estimate the fair values of our loans by using market prices, when available, or discounting their expected cash flows at a rate we estimate would be demanded by the market participants that are most likely to buy our loans. The expected cash flows used are the same as those used to calculate our level yield income in the financial statements.

 

Any changes to the valuation methodology will be reviewed by our management to ensure the changes are appropriate. The methods used may produce a fair value calculation that is not indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. We use inputs that are current as of the measurement date, which may fall within periods of market dislocation, during which price transparency may be reduced.

 

The following table presents our financial instruments carried at fair value on a recurring basis in the condensed consolidated balance sheet as of March 31, 2012 (amounts in thousands):

 

28



 

 

 

Fair Value at Reporting Date Using Inputs:

 

 

 

March 31, 2012

 

 

 

Total

 

Level I

 

Level II

 

Level III

 

Available-for-sale debt securities:

 

 

 

 

 

 

 

 

 

RMBS

 

$

157,186