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UNITED STATES FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) For the quarterly period ended June 30, 2012 Commission File Number: 001-32330 NORTHSTAR REALTY FINANCE CORP.
399 Park Avenue, 18th Floor New York, NY 10022 (212) 547-2600 Indicate by the 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 ý 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 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý 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 the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: The Company has one class of common stock, par value $0.01 per share, 134,675,417 shares outstanding as of August 6, 2012.
2 This Quarterly Report on Form 10-Q contains certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act. Forward-looking statements are generally identifiable by use of forward-looking terminology such as "may," "will," "should," "potential," "intend," "expect," "seek," "anticipate," "estimate," "believe," "could," "project," "predict," "continue," "future" or other similar words or expressions. Forward-looking statements are not guarantees of performance and are based on certain assumptions, discuss future expectations, describe plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Such statements include, but are not limited to, those relating to the operating performance of our investments, our financing needs, the effects of our current strategies, loan and securities activities, our ability to manage our collateralized debt obligations, or CDOs, and our ability to raise capital. Our ability to predict results or the actual effect of plans or strategies is inherently uncertain, particularly given the economic environment. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements and you should not unduly rely on these statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from those forward looking statements. These factors include, but are not limited to:
3
The foregoing list of factors is not exhaustive. All forward-looking statements included in this Quarterly Report on Form 10-Q are based upon information available to us on the date hereof and we are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results. Factors that could have a material adverse effect on our operations and future prospects are set forth in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. The factors set forth in the Risk Factors section could cause our actual results to differ significantly from those contained in any forward-looking statement contained in this report. 4
CONSOLIDATED BALANCE SHEETS (Amounts in Thousands, Except Share Data)
See accompanying notes to consolidated financial statements. 5
CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in Thousands, Except Share and Per Share Data) (Unaudited)
See accompanying notes to consolidated financial statements. 6
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Amounts in Thousands) (Unaudited)
See accompanying notes to consolidated financial statements. 7 NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EQUITY (Amounts in Thousands)
See accompanying notes to consolidated financial statements. 8
CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in Thousands) (Unaudited)
See accompanying notes to consolidated financial statements. 9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Per Share Data (Unaudited) 1. Formation and Organization NorthStar Realty Finance Corp., a real estate finance company and Maryland corporation (the "Company"), is an internally-managed real estate investment trust ("REIT"), which was formed in October 2003 in order to continue and expand the commercial real estate ("CRE") debt, CRE securities and net lease businesses conducted by its predecessor. In addition, the Company engages in asset management and other activities related to real estate and real estate finance. Substantially all of the Company's assets, directly or indirectly, are held by, and the Company conducts its operations, directly or indirectly, through NorthStar Realty Finance Limited Partnership, a Delaware limited partnership and the operating partnership of the Company (the "Operating Partnership"). 2. Summary of Significant Accounting Policies Basis of Quarterly Presentation The accompanying consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and note disclosures normally included in the consolidated financial statements prepared under U.S. GAAP have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of the Company's financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These consolidated financial statements should be read in conjunction with the Company's consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission ("SEC"). Principles of Consolidation The consolidated financial statements include the accounts of the Company, and its subsidiaries, which are majority-owned and controlled by the Company or a variable interest entity ("VIE") where the Company is the primary beneficiary. All significant intercompany balances have been eliminated in consolidation. A VIE is defined as an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The determination of whether an entity is a VIE includes both a qualitative and quantitative analysis. The Company bases its qualitative analysis on its review of the design of the entity, its organizational structure including decision-making ability and relevant financial agreements and its quantitative analysis on the forecasted cash flows of the entity. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events. A VIE must be consolidated only by its primary beneficiary, which is defined as the party who, along with its affiliates and agents, has a potentially significant interest in the entity and controls such entity's significant decisions. The Company determines whether it is the primary beneficiary of a VIE 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 2. Summary of Significant Accounting Policies (Continued) by considering qualitative and quantitative factors, including, but not limited to: which activities most significantly impact the VIE's economic performance and which party controls such activities; the amount and characteristics of its investment; the obligation or likelihood for the Company or other interests to provide financial support; consideration of the VIE's purpose and design, including the risks the VIE was designed to create and passthrough to its variable interest holders and the similarity with and significance to the business activities of the Company and the other interests. The Company reassesses its determination of whether it is the primary beneficiary of a VIE each reporting period. Significant judgments related to these determinations include estimates about the current and future fair value and performance of investments held by these VIEs and general market conditions. Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that could affect the amounts reported in the consolidated financial statements. Actual results could differ materially from these estimates and assumptions. Reclassifications Certain prior period amounts have been reclassified in the consolidated financial statements to conform to the current period presentation. Comprehensive Income The Company reports consolidated comprehensive income in separate statements following its consolidated statements of operations. Comprehensive income is defined as the change in equity resulting from net income (loss) and other comprehensive income (loss) ("OCI"). The Company's components of OCI principally include: (i) unrealized gain (loss) of securities available for sale for which the fair value option is not elected; and (ii) the reclassification of unrealized gain (loss) on derivative instruments that are or were deemed to be effective hedges. Fair Value Option The fair value option provides an election that allows companies to irrevocably elect fair value for certain financial assets and liabilities on an instrument-by-instrument basis at initial recognition. Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they occur. Real Estate Debt Investments CRE debt investments are generally intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan origination fees, discounts and unfunded commitments. CRE debt investments that are deemed to be impaired are carried at amortized cost less a loan loss reserve, if deemed appropriate, and represents fair value. 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 2. Summary of Significant Accounting Policies (Continued) Real Estate Securities The Company classifies its CRE securities as available for sale on the acquisition date. Available for sale securities are recorded at fair value. The Company has generally elected to apply the fair value option of accounting for its CRE securities portfolio. For those CRE securities for which the fair value option of accounting was elected, any unrealized gains (losses) from changes in fair value are recorded in unrealized gains (losses) on investments and other in the Company's consolidated statements of operations. The Company may decide to not elect the fair value option for certain CRE securities due to the nature of the particular instrument. For those CRE securities for which the fair value option of accounting was not elected, any unrealized gains (losses) from the change in fair value is reported as a component of accumulated other comprehensive income (loss) in the Company's consolidated statements of equity, to the extent impairment losses are considered temporary. Operating Real Estate Operating real estate is carried at historical cost less accumulated depreciation. The Company follows the purchase method of accounting for acquisitions of operating real estate held for investment, where the purchase price of operating real estate is allocated to tangible assets such as land, building, tenant improvements and other identified intangibles. The Company evaluates whether real estate acquired in connection with a foreclosure, UCC/deed in lieu of foreclosure or a consentual modification of a loan (herein collectively referred to as taking title to a property) ("REO") constitutes a business and whether business combination accounting is relevant. Any excess upon taking title to a property between the carrying value of a loan over the estimated fair value of the property is charged to provision for loan losses. Operating real estate, including REO, which has met the criteria to be classified as held for sale, is separately presented in the consolidated balance sheets. Such operating real estate is reported at the lower of its carrying value or its estimated fair value less the cost to sell. Once a property is determined to be held for sale, depreciation is no longer recorded. In addition, the results of operations are reclassified to income (loss) from discontinued operations in the consolidated statements of operations. Other REO for which the Company intends to market for sale in the near term is recorded at estimated fair value. Revenue Recognition Real Estate Debt Investments Interest income is recognized on an accrual basis and any related discount, premium, origination costs and fees are amortized over the life of the investment using the effective interest method. The amortization is reflected as an adjustment to interest income in the consolidated statements of operations. The accretion of discount or amortization of a premium is discontinued if such loan is reclassified to held for sale. 12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 2. Summary of Significant Accounting Policies (Continued) Loans acquired at a discount with deteriorated credit quality are accreted to expected recovery. The Company continues to estimate the amount of recovery over the life of such loans. A subsequent increase in expected future cash flows is recognized as an adjustment to the accretable yield prospectively over the remaining life of such loan. Real Estate Securities Interest income is recognized using the effective interest method with any purchased premium or discount accreted through earnings based upon expected cash flows through the expected maturity date of the security. Changes to expected cash flows may result in a change to the yield which is then used prospectively to recognize interest income. Operating Real Estate Rental income from operating real estate is derived from leasing of space to various types of corporate tenants and healthcare operators. The leases are for fixed terms of varying length and generally provide for annual rentals and expense reimbursements to be paid in monthly installments. Rental income from leases is recognized on a straight-line basis over the term of the respective leases. Credit Losses and Impairment on Investments Real Estate Debt Investments Loans are considered impaired when based on current information and events, it is probable that the Company will not be able to collect principal and interest amounts due according to the contractual terms. The Company assesses the credit quality of the portfolio and adequacy of loan loss reserves on a quarterly basis, or more frequently as necessary. Significant judgment of the Company is required in this analysis. The Company considers the estimated net recoverable value of the loan as well as other factors, including but not limited to the fair value of any collateral, the amount and the status of any senior debt, the quality and financial condition of the borrower and the competitive situation of the area where the underlying collateral is located. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized may differ materially from the carrying value as of the balance sheet date. If upon completion of the assessment, the fair value of the underlying collateral is less than the net carrying value of the loan, a loan loss reserve is recorded with a corresponding charge to the provision for loan losses. The loan loss reserve for each loan is maintained at a level that is determined to be adequate by management to absorb probable losses. Income recognition is suspended for loans at the earlier of the date at which payments become 90-days past due or when, in the opinion of the Company, a full recovery of income and principal becomes doubtful. When the ultimate collectability of the principal of an impaired loan is in doubt, all payments are applied to principal under the cost recovery method. When the ultimate collectability of the principal of an impaired loan is not in doubt, contractual interest is recorded as interest income when received, under the cash basis method until an accrual is resumed when the loan becomes 13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 2. Summary of Significant Accounting Policies (Continued) contractually current and performance is demonstrated to be resumed. A loan is written off when it is no longer realizable and/or legally discharged. Real Estate Securities CRE securities for which the fair value option is elected are not evaluated for other-than-temporary impairment ("OTTI") as changes in fair value are recorded in the Company's consolidated statements of operations. Realized losses on such securities are reclassified to realized gain (loss) on investments and other as losses occur. CRE securities for which the fair value option is not elected are evaluated for OTTI quarterly. Operating Real Estate The Company's real estate portfolio is reviewed on a quarterly basis, or more frequently as necessary, to assess whether there are any indicators that the value of its operating real estate may be impaired or that its carrying value may not be recoverable. A property's value is considered impaired if the Company's estimate of the aggregate future undiscounted cash flows to be generated by the property is less than the carrying value of the property. In conducting this review, the Company considers U.S. macroeconomic factors, including real estate sector conditions, together with asset specific and other factors. To the extent an impairment has occurred and is considered to be other than temporary, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property. Allowances for doubtful accounts for tenant receivables are established based on periodic review of aged receivables resulting from estimated losses due to the inability of tenants to make required rent and other payments contractually due. Additionally, the Company establishes, on a current basis, an allowance for future tenant credit losses on billed and unbilled rents receivable based upon an evaluation of the collectability of such amounts. Troubled Debt Restructuring CRE debt investments modified in a troubled debt restructuring ("TDR") are modifications granting a concession to a borrower experiencing financial difficulties where a lender agrees to terms that are more favorable to the borrower than is otherwise available in the current market. Management judgment is necessary to determine whether a loan modification is considered a TDR. Troubled debt that is fully satisfied via taking title to a property, repossession or other transfers of assets is generally included in the definition of TDR. Loans acquired as a pool with deteriorated credit quality that have been modified are not considered a TDR. Other Refer to the section of the Company's Annual Report on Form 10-K for the year ended December 31, 2011 entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies" for a full discussion of the Company's critical accounting policies. 14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 2. Summary of Significant Accounting Policies (Continued) Recently Issued Pronouncements In May 2011, the Financial Accounting Standards Board ("FASB") issued an accounting update to amend existing guidance concerning fair value measurements and disclosures. The update is intended to achieve common fair value measurements and disclosure requirements under U.S. GAAP and International Financial Reporting Standards and is effective in the first interim or annual period beginning after December 15, 2011. The Company adopted this accounting update in the first quarter 2012 and the required disclosures have been incorporated into Note 4 of the consolidated financial statements. The adoption did not have a material impact on the consolidated financial statements. In June 2011, the FASB issued an accounting update concerning the presentation of comprehensive income. The update requires either a single, continuous statement of comprehensive income be included in the statement of operations or an additional statement of comprehensive income immediately following the statement of operations. The update does not change the components of OCI that must be reported but it eliminates the option to present OCI on the statement of equity. In December 2011, the FASB issued an accounting update to defer the requirement to present the reclassification adjustments to OCI by component and are currently redeliberating this requirement. The remaining requirements of the accounting update were effective for the Company in the first quarter 2012 and were applied retrospectively to all periods reported after the effective date. There was no impact on the consolidated financial statements as the Company currently complies with the update. 3. Variable Interest Entities The Company has evaluated its CRE debt and security investments, investments in unconsolidated ventures, liabilities to subsidiary trusts issuing preferred securities ("junior subordinated notes") and its collateralized debt obligations ("CDOs") to determine whether they are a VIE. The Company monitors these investments and, to the extent it has determined that it potentially owns a majority of the current controlling class, analyzes them for potential consolidation. The Company will continue to analyze future investments and liabilities, as well as reconsideration events, including a modified loan deemed to be a troubled debt restructuring, pursuant to the VIE requirements. These analyses require considerable judgment in determining the primary beneficiary of a VIE. This could result in the consolidation of an entity that would otherwise not have been consolidated or the non-consolidation of an entity that would have otherwise have been consolidated. Consolidated VIEs (the Company is the primary beneficiary) The Company has sponsored nine CDOs, which are referred to as the N-Star CDOs. In addition, the Company has acquired the equity interests of two CDOs, the CSE RE 2006-A CDO ("CSE CDO") and the CapLease 2005-1 CDO ("CapLease CDO"). The Company collectively refers to subordinate CDO bonds, preferred shares and equity notes as equity interests in a CDO. In the case of the CSE CDO, the Company was delegated the collateral management and special servicing rights, and for the CapLease CDO, the Company acquired the collateral management rights. The CRE debt investments that serve as collateral for the CDO financing transactions include first mortgage loans, subordinate mortgage interests, mezzanine loans, credit tenant loans and other loans. 15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 3. Variable Interest Entities (Continued) The CRE securities that serve as collateral for the CDO financing transactions include commercial mortgage-backed securities ("CMBS"), unsecured REIT debt and CDO notes backed primarily by CRE securities and CRE debt. By financing these assets with long-term borrowings through the issuance of CDO bonds, the Company seeks to generate attractive risk-adjusted equity returns and to match the term of its assets and liabilities. In connection with these financing transactions, the Company has various forms of significant ongoing involvement, which may include: (i) holding senior or subordinated interests in the CDOs; (ii) asset management; and (iii) entering into derivative contracts to manage interest rate risk. Each CDO transaction is considered a VIE. The Company has determined it is the primary beneficiary, and as a result, consolidates all of its CDO financing transactions, including the CSE CDO and CapLease CDO. The following table displays the classification and carrying value of assets and liabilities of consolidated VIEs as of June 30, 2012 (amounts in thousands):
The Company is not contractually required to provide financial support to any of its consolidated VIEs, however, the Company, in its capacity as collateral manager and/or special servicer, may in its 16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 3. Variable Interest Entities (Continued) sole discretion provide support such as protective and other advances it deems appropriate. The Company did not provide any other financial support for the six months ended June 30, 2012 and 2011. Unconsolidated VIEs (the Company is not the primary beneficiary, but has a variable interest) Based on management's analysis, the Company is not the primary beneficiary of VIEs it has identified since it does not have both the: (i) power to direct the activities that most significantly impact the VIE's economic performance; and (ii) obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. Accordingly, these VIEs are not consolidated into the Company's financial statements as of June 30, 2012. Real Estate Debt Investments The Company identified two real estate debt investments in the second quarter 2012 to one borrower with a total carrying value of $54.9 million as variable interests in a VIE. The Company has determined that it is not the primary beneficiary of this VIE, and as such, the VIE should not be consolidated in the Company's financial statements. For all other real estate debt investments, the Company has determined that these investments are not VIEs and, as such, the Company has continued to account for all real estate debt investments as loans. Real Estate Securities The Company has identified nine CRE securities with a fair value of $60.9 million as variable interests in VIEs. The Company has determined that it is not the primary beneficiary, and as such, these VIEs are not consolidated in the Company's financial statements. In prior years, in connection with three existing CMBS investments, the Company became the controlling class of a securitization the Company did not sponsor. The Company determined each securitization was a VIE. However, the Company determined at that time and continues to believe that it does not currently or potentially hold a significant interest in any of these securitizations and, therefore, is not the primary beneficiary. As such, these VIEs are not consolidated. In March 2011, in connection with existing investments of certain CMBS, the Company became the controlling class of a securitization that the Company did not sponsor. The Company determined it was the primary beneficiary due to having ownership in more than 50% of the controlling class and the right to appoint the special servicer, which gave the Company the power to direct the activities that impact the economic performance of the VIE. However, the Company sold a significant portion of this investment, and as such, it was determined the Company was no longer the primary beneficiary. Then, in September 2011, the Company was appointed special servicer for a loan in this securitization. The Company does not currently or potentially hold a significant interest and, therefore, is not the primary beneficiary. As such, the VIE is not consolidated. In June 2011, the Company acquired the "B-piece" in a new $2.1 billion CMBS securitization. The Company was appointed as special servicer for the securitization. The Company has determined that the securitization is a VIE. However, the Company determined at that time and continues to believe 17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 3. Variable Interest Entities (Continued) that it does not currently or potentially hold a significant interest and, therefore, is not the primary beneficiary. As such, the VIE is not consolidated. In August 2011, the Company invested in a securitization collateralized by originally investment grade rated N-Star CDO bonds. The Company has determined that the securitization is a VIE. However, the Company determined at that time and continues to believe that it does not have the power to direct the activities that most significantly impact the economic performance of the VIE and does not currently or potentially hold a significant interest and, therefore, is not the primary beneficiary. As such, the VIE is not consolidated. In February 2012, in connection with an existing CMBS investment, the Company became the controlling class of a securitization the Company did not sponsor and was appointed as special servicer for a loan in the securitization. The Company determined the securitization was a VIE. However, the Company determined at that time and continues to believe that it does not currently or potentially hold a significant interest and, therefore, is not the primary beneficiary. As such, the VIE is not consolidated. In March 2012, the Company invested in a securitization collateralized by originally investment grade rated N-Star CDO bonds. The Company has determined that the securitization is a VIE. However, the Company determined at that time and continues to believe that it does not have the power to direct the activities that most significantly impact the economic performance of the VIE and does not currently or potentially hold a significant interest and, therefore, is not the primary beneficiary. As such, the VIE is not consolidated. In April 2012, in connection with an existing CMBS investment, the Company became the controlling class of a securitization the Company did not sponsor. The Company determined the securitization was a VIE. However, the Company determined at that time and continues to believe that it does not currently or potentially hold a significant interest in this securitization and, therefore, is not the primary beneficiary. As such, the VIE is not consolidated. NorthStar Realty Finance Trusts The Company owns all of the common stock of NorthStar Realty Finance Trusts I through VIII (collectively, the "Trusts"). The Trusts were formed to issue trust preferred securities. The Company determined that the holders of the trust preferred securities were the primary beneficiaries of the Trusts. As a result, the Company did not consolidate the Trusts and has accounted for the investment in the common stock of the Trusts under the equity method of accounting. 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 3. Variable Interest Entities (Continued) The following table displays the classification, carrying value and maximum exposure of unconsolidated VIEs as of June 30, 2012 (amounts in thousands):
The Company did not provide financial support to any of its unconsolidated VIEs during the six months ended June 30, 2012 and 2011. As of June 30, 2012, there were no explicit arrangements or implicit variable interests that could require the Company to provide financial support to any of its unconsolidated VIEs. 4. Fair Value Fair Value Measurement The Company follows fair value guidance in accordance with U.S. GAAP to account for its financial instruments. The Company categorizes its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. 19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 4. Fair Value (Continued) Financial assets and liabilities recorded at fair value on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Determination of Fair Value The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy. Real Estate Securities CRE securities are generally valued using a third-party pricing service or broker quotations. These quotations are not adjusted and are based on observable inputs that can be validated, and as such, are classified as Level 2 of the fair value hierarchy. Certain CRE securities are valued based on a single broker quote or an internal price which have less observable pricing, and as such, are classified as Level 3 of the fair value hierarchy. Derivative Instruments Derivative instruments are valued using a third-party pricing service. These quotations are not adjusted and are generally based on valuation models with market observable inputs such as interest rates and contractual cash flows, and as such, are classified as Level 2 of the fair value hierarchy. Derivative instruments are also assessed for credit valuation adjustments due to the risk of non-performance by the Company and derivative counterparties. However, since the majority of the Company's derivatives are held in non-recourse CDO financing structures where, by design, the derivative contracts are senior to all the CDO bonds payable, there is no material impact of a credit valuation adjustment. 20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 4. Fair Value (Continued) CDO Bonds Payable CDO bonds payable are valued using quotations from nationally recognized financial institutions that generally acted as underwriter for the transactions. These quotations are not adjusted and are generally based on valuation models using market observable inputs for interest rates and other unobservable inputs for assumptions related to the timing and amount of expected future cash flows, the discount rate, estimated prepayments and projected losses. CDO bonds payable are classified as Level 3 of the fair value hierarchy. Junior Subordinated Notes Junior subordinated notes are valued using quotations from nationally recognized financial institutions. These quotations are not adjusted and are generally based on a valuation model using market observable inputs for interest rates and other unobservable inputs for assumptions related to the implied credit spread of the Company's other borrowings and the timing and amount of expected future cash flows. Junior subordinated notes are classified as Level 3 of the fair value hierarchy. Fair Value Measurement Financial assets and liabilities recorded at fair value on a recurring basis are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following tables set forth the Company's financial assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2012 and December 31, 2011 by level within the fair value hierarchy (amounts in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 4. Fair Value (Continued)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 4. Fair Value (Continued) The following table presents additional information about the Company's financial assets and liabilities which are measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011, for which the Company has utilized Level 3 inputs to determine fair value (amounts in thousands):
The Company relied on the third-party pricing exception with respect to the requirement to provide quantitative disclosures about significant Level 3 inputs being used. The Company believes such pricing service or broker quotes may be based on market transactions with comparable coupons and 23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 4. Fair Value (Continued) credit (such as credit support and delinquency rates). Significant increases (decreases) in any one of the inputs in isolation may result in a significantly different fair value for the financial assets and liabilities utilizing such Level 3 inputs. The Company's non-recurring financial measurements include the measurement of provision for loan losses on CRE debt and provision for loss on equity investments in unconsolidated ventures, which are classified as Level 3 of the fair value hierarchy. The provision for loan losses are generally based on a discounted cash flow model of a loan's underlying collateral. The key unobservable inputs used to determine the provision for loan losses for the three and six months ended June 30, 2012 included discount rates ranging from 7.0% to 15.5% and capitalization rates ranging from 5.0% to 23.0%. Refer to Note 7 for a further discussion of impairment on our CRE debt and Note 8 for a discussion of impairment on investments in unconsolidated ventures, if any. Fair Value Option The Company has generally elected to apply the fair value option of accounting to the following financial assets and liabilities existing at the time of adoption or at the time the Company recognizes the eligible item for the purpose of consistent accounting application: CRE securities; CDO bonds payable; and junior subordinated notes. The Company may decide not to elect the fair value option for certain of its financial assets or liabilities due to the nature of the instrument. The following table sets forth the fair value of the Company's financial instruments for which the fair value option was elected as of June 30, 2012 and December 31, 2011 (amounts in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 4. Fair Value (Continued)
The following table presents the difference between the fair value and the aggregate principal amount of liabilities, for which the fair value option has been elected as of June 30, 2012 (amounts in thousands):
The Company attributes the change in the fair value of floating-rate liabilities to changes in instrument-specific credit spreads. For fixed-rate liabilities, the Company attributes the change in fair value to interest rate-related and instrument-specific credit spread changes. Changes in Fair Value Recorded in the Statements of Operations For the three and six months ended June 30, 2012 and 2011, the Company recognized the following unrealized gains (losses) on investments and other related to the change in fair value of financial assets and liabilities in the consolidated statements of operations:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 4. Fair Value (Continued) The remaining amount of unrealized gains (losses) on investments and other on the Company's consolidated statements of operations relates to net cash payments for interest rate swaps. The unrealized losses for CDO bonds payable attributable to paydowns at par were $80.5 million and $121.9 million for the three and six months ended June 30, 2012, respectively. The remaining amount relates to the changes in fair value. Fair Value of Financial Instruments In addition to the above disclosures regarding financial assets or liabilities which are recorded at fair value, U.S. GAAP requires disclosure of fair value about all financial instruments. Estimated fair value of financial instruments was determined by the Company, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on estimated fair value. 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 4. Fair Value (Continued) The fair value of certain financial assets and liabilities and other financial instruments are shown below as of June 30, 2012 and December 31, 2011 (amounts in thousands):
Disclosure about fair value of financial instruments is based on pertinent information available to management as of the reporting date. Although management is not aware of any factors that would significantly affect fair value, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein. Real Estate Debt Investments, Net For CRE debt investments, fair value of the fixed- and floating-rate investments was approximated by comparing the current yield to the estimated yield for newly originated loans with similar credit risk or the market yield at which a third party might expect to purchase such investment. Prices were calculated assuming fully-extended maturities regardless of structural or economic tests required to achieve such extended maturities. For any CRE debt investments that are deemed impaired, carrying 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 4. Fair Value (Continued) value approximates fair value. These fair value measurements of CRE debt are generally based on unobservable inputs and are, therefore, classified as Level 3 of the fair value hierarchy. Mortgage Notes Payable For fixed-rate mortgage notes payable, the Company uses rates currently available with similar terms and remaining maturities to estimate fair value. These measurements are determined using comparable U.S. Treasury rates as of the end of the reporting period. These fair value measurements are based on observable inputs and are classified as Level 2 of the fair value hierarchy. Credit Facilities The Company has amounts outstanding under two term credit facilities entered into in the fourth quarter 2011, both of which bear floating rate of interest. As of the reporting date, the Company believes the carrying value approximates fair value. This fair value measurement is based on observable inputs and is classified as Level 2 of the fair value hierarchy. Secured Term Loan Secured term loan includes the Company's Term Asset-Backed Securities Loan Facility ("TALF") borrowing. The estimated fair value is based on interest rates available for issuance of debt with similar terms and remaining maturities. This fair value measurement is based on observable inputs and is classified as Level 2 of the fair value hierarchy. Exchangeable Senior Notes For the exchangeable senior notes, the Company uses available market information, which includes quoted market prices or recent transactions, if available, to estimate their fair value and are, therefore, based on observable inputs and are classified as Level 2 of the fair value hierarchy. The following table summarizes the exchangeable senior notes as of June 30, 2012 (amounts in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 5. Operating Real Estate Operating Real Estate and REO Held for Investment In January 2012, the Company acquired a 71-unit independent living facility located in Lancaster, Ohio for $6.5 million. Contemporaneously, the Company entered into a borrowing agreement for $4.5 million. In April 2012, in connection with a debt investment, the Company took title to a student housing property located in Los Angeles, California. The Company's loan had a $25.2 million carrying value at such time, which approximates fair value. The Company estimated the fair value of the assets and liabilities for all real estate acquired (including taking title to a property) at the date of acquisition. The final allocation of the purchase price is subject to refinement upon receipt of all information requested related to the properties. The following summarizes our preliminary allocation of purchase price of the assets and liabilities assumed upon acquisition related to 2011 and 2012 acquisitions that continue to be subject to refinement upon receipt of all information (amounts in thousands):
Other REO For the six months ended June 30, 2012, in connection with a debt investment, the Company acquired other REO by taking title to a retail property located in Park City, Utah and a hotel located in Arlington, Texas. The original loan balance of the retail property was $10.7 million and the initial REO value recorded was $4.0 million and the original loan balance of the hotel property and the initial REO value recorded was $6.1 million. Both initial REO values approximated fair value. 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 5. Operating Real Estate (Continued) Operating Real Estate Sales The Company completed the following sales of operating real estate for the six months ended June 30, 2012 (amounts in thousands):
In addition, for the three months ended June 30, 2012, the Company sold 14 timeshare units for total sales proceeds of $7.3 million, including seller financing of $0.1 million, resulting in a realized gain of $6.2 million. For the six months ended June 30, 2012, the Company sold 22 timeshare units for total sales proceeds of $10.7 million, including seller financing of $0.2 million, resulting in a realized gain of $11.2 million ($2.1 million related to prior gains no longer deferred). Discontinued Operations In January 2012, in connection with a partial interest in a debt investment, the Company took title to a healthcare property located in Lexington, Kentucky. The loan had a zero carrying value at such time. Contemporaneous with taking title, the Company purchased the remaining interest in the loan from a third party for $0.8 million implying a total value of $1.0 million and as a result, the Company recorded $0.3 million in other income (loss) in the consolidated statements of operations. For the six months ended June 30, 2012, assets held for sale relate to this healthcare property. The remaining asset held for sale is land which is not deemed to be a discontinued operation. 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 5. Operating Real Estate (Continued) The following table summarizes income (loss) from discontinued operations and related gain (loss) on sale from discontinued operations for the three and six months ended June 30, 2012 and 2011 (amounts in thousands):
Midwest Holdings On March 31, 2011, the Company sold its 100% common membership interest in Midwest Care Holdco TRS I LLC ("Midwest Holdings") and assigned all of its rights, title, obligations and other interests in Midwest Holdings to the purchaser and contemporaneously entered into a new lease agreement with an affiliate of the purchaser. As of March 31, 2011, the operations of Midwest Holdings were deconsolidated. The Company recognized a realized loss of $0.5 million in connection with the sale and deconsolidation of its common membership interest. 31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 6. Real Estate Securities, Available for Sale As of June 30, 2012, the Company held the following CRE securities (amounts in thousands):
The CMBS portfolio as of June 30, 2012 is comprised of 559 investments that are predominantly conduit CMBS, meaning each asset is a pool backed by a large number of commercial real estate loans. As a result, the portfolio is typically well-diversified by collateral type and geography. As of June 30, 2012, contractual maturities of the CRE securities portfolio ranged from one month to 44 years, with a weighted average expected maturity of 3.1 years. 32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 6. Real Estate Securities, Available for Sale (Continued) As of December 31, 2011, the Company held the following CRE securities (amounts in thousands):
For the three months ended June 30, 2012, proceeds from the sale of CRE securities were $99.7 million, resulting in a net realized gain of $9.9 million. For the three months ended June 30, 2011, proceeds from the sale of CRE securities were $39.6 million, resulting in a net realized gain of $3.4 million. For the six months ended June 30, 2012, proceeds from the sale of CRE securities were $200.3 million, resulting in a net realized gain of $15.8 million. For the six months ended June 30, 2011, proceeds from the sale of CRE securities were $126.4 million, resulting in a net realized gain of $24.1 million. The Company's CRE securities portfolio includes 22 securities for which the fair value option was not elected. As of June 30, 2012, the aggregate carrying value of these securities was $125.5 million, representing a $0.8 million net unrealized loss included in other comprehensive income (loss). The Company held nine securities with an unrealized loss of $1.9 million as of June 30, 2012 and such securities were in an unrealized loss position for a period of less than 12 months. Based on management's quarterly evaluation, no OTTI was identified related to these securities. The Company 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 6. Real Estate Securities, Available for Sale (Continued) does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities prior to recovery of its amortized cost basis, which may be at maturity. 7. Real Estate Debt Investments As of June 30, 2012, the Company held the following CRE debt investments (amounts in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 7. Real Estate Debt Investments (Continued) As of December 31, 2011, the Company held the following CRE debt investments (amounts in thousands):
For the six months ended June 30, 2012, the Company originated five loans and acquired two loans with an aggregate principal amount of $171.3 million (including an interest owned through a joint venture) with a weighted average expected return on invested equity of approximately 17%. There is no assurance the Company will realize this expected return on equity over the term of these investments. The Company's actual return on equity could vary significantly from its expectations. For the three months ended June 30, 2012 and 2011, the Company sold one loan for a realized gain of $0.3 million and four loans for a realized gain of $51.6 million, respectively. For the six months ended June 30, 2012 and 2011, the Company sold two loans for a realized gain of $0.7 million and five loans for a realized gain of $53.1 million, respectively. 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 7. Real Estate Debt Investments (Continued) Maturities of CRE debt investments based on principal amount as of June 30, 2012 are as follows (amounts in thousands):
The aggregate carrying value of the delinquent loan due to a maturity default was $2.2 million as of June 30, 2012. The weighted average maturity including extensions of the CRE debt investments is 4.0 years. Actual maturities may differ from contractual maturities because certain borrowers have the right to prepay with or without prepayment penalties and the Company may also extend contractual maturities in connection with loan modifications. The contractual amounts differ from the carrying values due to unamortized origination fees and costs, unamortized premiums and discounts and loan loss reserves being reported as part of the carrying value of the investment. As of June 30, 2012, the Company had $452.9 million of unamortized discounts ($386.2 million related to the CSE CDO) and $4.6 million of unamortized origination fees and costs. Maturity Including Extensions in the table above assumes that all debt with extension options will qualify for extension at initial maturity according to the conditions stipulated in the related debt agreements. In July 2010, in connection with the acquisition of the equity interests in the CSE CDO, the Company consolidated certain CRE debt investments with deteriorated credit quality. As of June 30, 2012, such debt had an aggregate principal amount of $351.6 million and an aggregate carrying value of $51.7 million, of which $105.6 million of the remaining discount will be accreted. The change in the accreted amount for the six months ended June 30, 2012 was primarily due to payoffs and changes to estimated recoverable amounts. 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 7. Real Estate Debt Investments (Continued) The following table summarizes the status of the Company's loan portfolio (amounts in thousands):
The Company's maximum additional exposure to loss related to the non-performing loans as of June 30, 2012 and December 31, 2011 is $3.7 million and $2.2 million, respectively. Provision for Loan Losses For the three and six months ended June 30, 2012, the Company recorded $6.5 million and $13.4 million of provision for loan losses related to two and five loans, respectively. For the three and six months ended June 30, 2011, the Company recorded $14.2 million and $38.7 million of provision for loan losses related to four and nine loans, respectively. Activity in loan loss reserves on CRE debt investments for the three and six months ended June 30, 2012 and 2011 is as follows (amounts in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 7. Real Estate Debt Investments (Continued) Credit Quality Monitoring The Company's CRE debt investments are typically secured by direct senior priority liens on real estate properties or by interests in entities that directly own real estate properties, which serve as the primary source of cash for the payment of principal and interest. The Company differentiates the relative credit quality of its debt investments principally based upon whether the borrower is currently paying contractual debt service and/or whether the Company believes it will be able to do so in the future, as well as the Company's expectations as to the ultimate recovery of principal at maturity and updates this information quarterly. Those debt investments for which the Company expects to receive full payment of contractual principal and interest payments are categorized as "loans with no loan loss reserve." The Company groups weaker credit quality debt investments that are not considered a NPL, for which it believes there is an impairment such that future collection of all or some portion of principal and interest is in doubt, in a category called "other loans with a loan loss reserve/non-accrual status." The Company categorizes a debt investment as an NPL if it is in maturity default and/or is past due at least 90 days on its contractual debt service payments. The Company's definition of an NPL may differ from that of other companies that track NPLs. 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 7. Real Estate Debt Investments (Continued) The following table is a summary of the carrying value of the CRE debt investments, by credit quality indicator, as of each applicable balance sheet date (amounts in thousands):
Impaired Loans The Company considers impaired loans to generally include non-performing loans ("NPLs"), loans with a loan loss reserve, loans on non-accrual status (excluding loans acquired with deteriorated credit 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 7. Real Estate Debt Investments (Continued) quality) and TDRs. As of June 30, 2012 and December 31, 2011, impaired loans are comprised of the following (amounts in thousands):
The following table summarizes the Company's average carrying value of impaired loans by type and the income recorded on such loans subsequent to their being deemed impaired for the three months ended June 30, 2012 and 2011 (amounts in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 7. Real Estate Debt Investments (Continued) The following table summarizes the Company's average carrying value of impaired loans by type and the income recorded on such loans subsequent to their being deemed impaired for the six months ended June 30, 2012 and 2011 (amounts in thousands):
As of June 30, 2012, the Company had one first mortgage loan with a principal amount of $12.5 million past due greater than 90 days. As of December 31, 2011, the Company had one subordinated mortgage interest with a principal amount of $10.0 million past due less than 30 days and one first mortgage loan with a principal amount of $12.5 million and one subordinated mortgage interest with a principal amount of $28.5 million past due greater than 90 days. These amounts exclude non-accrual loans discussed in the charts above. Troubled Debt Restructurings The following table summarizes CRE debt investments that were modified during the six months ended June 30, 2012 and 2011 and considered a TDR (amounts in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 7. Real Estate Debt Investments (Continued) The Company did not have any CRE debt investments modified that were considered TDRs during the three months ended June 30, 2012. For the three months ended June 30, 2011, the Company had one loan modification considered a TDR with a carrying value of $41.6 million that reduced the interest rate from 2.35% to 0.50%. For the three and six months ended June 30, 2011, the Company had one CRE debt investment where the Company took title to the property and was considered to be a TDR. The carrying value of such loan at the time of taking title was $13.4 million. All loans modified in a TDR generally provided interest rate concessions and/or deferral of principal repayments. Any loan modification is intended to maximize the collection of the principal and interest related to such loan. 8. Investment in and Advances to Unconsolidated Ventures The Company has non-controlling, unconsolidated ownership interests in entities that are generally accounted for using the equity method. Capital contributions, distributions and profits and losses of such entities are allocated in accordance with the terms of the applicable partnership and limited liability company agreements. Such allocations may differ from the stated percentage interests, if any, in such entities as a result of preferred returns and allocation formulas as described in such agreements. The Company may account for such investments using the cost method if the Company does not maintain significant influence over the unconsolidated entity. Meadowlands The Company owns a $109.7 million interest in Meadowlands Two, LLC, which holds 100% of Meadowlands One, LLC, which is secured by a retail/entertainment complex located in East Rutherford, New Jersey (the "NJ Property"). During the third quarter 2010, the lender group took effective ownership of the NJ Property. The Company accounts for its 22% equity interest in the investment under the equity method of accounting. As of June 30, 2012 and December 31, 2011, the carrying value of the Company's investment in the NJ Property was $64.6 million and $65.5 million, respectively. For the three months ended June 30, 2012 and 2011, the Company recognized equity in losses of $0.5 million and $1.5 million, respectively. For the six months ended June 30, 2012 and 2011, the Company recognized equity in losses of $0.9 million and $8.2 million including a provision for loss on equity investment of $4.5 million in the first quarter 2011. LandCap Partners On October 5, 2007, the Company entered into a joint venture with Whitehall Street Global Real Estate Limited Partnership 2007 ("Whitehall") to form LandCap Partners and LandCap LoanCo. (collectively referred to as "LandCap"). LandCap was established to opportunistically invest in single-family residential land through land loans, lot option agreements and select land purchases. The joint venture is managed by a third-party management group which has extensive experience in the single family housing sector. The Company and Whitehall agreed to provide no additional new investment capital in the LandCap joint venture. As of June 30, 2012 and December 31, 2011, the Company's 49% 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 8. Investment in and Advances to Unconsolidated Ventures (Continued) interest in LandCap was $14.0 million and $14.4 million, respectively. As of June 30, 2012 and December 31, 2011, LandCap had investments totaling $33.1 million and $34.0 million, respectively. For the three months ended June 30, 2012 and 2011, the Company recognized equity in losses of $0.6 million and $0.3 million, respectively. For the six months ended June 30, 2012 and 2011, the Company recognized equity in losses of $0.7 million and $0.7 million, respectively. CS Federal Drive, LLC In February 2006, the Company, through a joint venture with an institutional investor, CS Federal Drive, LLC ("CS/Federal"), acquired a portfolio of three adjacent class A office/flex buildings located in Colorado Springs, Colorado for $54.3 million. The joint venture financed the transaction with two non-recourse, mortgage notes totaling $38.0 million and the remainder in cash. The borrowings mature on February 11, 2016 and bear fixed interest rates of 5.51% and 5.46%, respectively. The Company contributed $8.4 million for a 50% interest in the joint venture and incurred $0.3 million in costs related to its acquisition, which are capitalized to the investment. These costs are amortized over the useful lives of the assets held by the joint venture. As of June 30, 2012 and December 31, 2011, the Company had an investment in CS/Federal of $5.5 million and $5.7 million, respectively. For the three months ended June 30, 2012 and 2011, the Company recognized equity in earnings of $0.2 million and $0.2 million, respectively. For the six months ended June 30, 2012 and 2011, the Company recognized equity in earnings of $0.4 million and $0.3 million, respectively. NorthStar Real Estate Income Trust, Inc. As of June 30, 2012, the Company owns 1.8% of the common stock in NorthStar Real Estate Income Trust, Inc. ("NorthStar Income"), a CRE debt-oriented REIT sponsored by the Company, with a commitment to purchase up to $10 million of shares of NorthStar Income's common stock during the period through July 19, 2013, in the event that its distributions to stockholders exceed its modified funds from operations (as defined in accordance with the current practice guidelines issued by the Investment Program Association). In connection with this commitment, the Company purchased 212,822 shares for $1.9 million for the six months ended June 30, 2012 resulting in 466,024 aggregate shares acquired for $4.2 million since inception. As of June 30, 2012 and December 31, 2011, the Company had an investment in NorthStar Income of $5.8 million and $4.0 million, respectively. For the three months ended June 30, 2012 and 2011, the Company recognized $0.1 million and an immaterial amount in equity in earnings, respectively. For the six months ended June 30, 2012 and 2011, the Company recognized $0.2 million and an immaterial amount in equity in earnings, respectively. NorthStar Real Estate Securities Opportunity Fund A subsidiary of the Company, as general partner of NorthStar Real Estate Securities Opportunity Fund ("Securities Fund"), liquidated the Securities Fund in 2011. The Company owned a 34.3% interest in Securities Fund. For the three and six months ended June 30, 2011, the Company recognized an immaterial amount of equity in losses. 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amounts in Thousands, Except Per Share Data (Unaudited) 8. Investment in and Advances to Unconsolidated Ventures (Continued) Other In May 2012, the Company acquired a 9.8% interest in a joint venture that owns a pari passu participation in a first mortgage loan secured by a portfolio of luxury residences located in resort destinations. The Company owns an additional interest in the same loan through the CSE CDO with a carrying value of $16.1 million as of June 30, 2012. As of June 30, 2012, the Company had an investment of $5.8 million in this joint venture. For the three months ended June 30, 2012, the Company recognized $0.3 million of in equity in earnings related to this investment. 9. Borrowings The Company's outstanding borrowings as of June 30, 2012 and December 31, 2011 are as follows (amounts in thousands):
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