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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 1-15371
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ISTAR FINANCIAL INC.
(Exact name of registrant as specified in its charter)
MARYLAND 95-6881527
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1114 AVENUE OF THE AMERICAS, 27TH FLOOR 10036
NEW YORK, NY (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (212)930-9400
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Securities registered pursuant to Section 12(b) of the Act:
NAME OF EXCHANGE ON WHICH REGISTERED:
COMMON STOCK, $0.001 PAR VALUE NEW YORK STOCK EXCHANGE
9.375% SERIES B CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
9.200% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
8.000% SERIES D CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant: (i) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (ii) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
As of November 4, 2002, there were 89,993,704 shares of common stock of
iStar Financial Inc., $0.001 par value per share outstanding ("Common Stock").
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ISTAR FINANCIAL INC.
INDEX TO FORM 10-Q
PAGE
--------
PART I. Consolidated Financial Information.......................... 3
Item 1. Financial Statements:....................................... 3
Consolidated Balance Sheets at September 30, 2002 and
December 31, 2001......................................... 3
Consolidated Statements of Operations--For the three- and
nine-month periods ended September 30, 2002 and 2001...... 4
Consolidated Statement of Changes in Shareholders'
Equity--For the nine-month period ended September 30,
2002...................................................... 5
Consolidated Statements of Cash Flows--For the three- and
nine-month periods ended September 30, 2002 and 2001...... 6
Notes to Consolidated Financial Statements.................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 39
Item 4. Controls and Procedures..................................... 53
PART II. Other Information........................................... 54
Item 1. Legal Proceedings........................................... 54
Item 2. Changes in Securities and Use of Proceeds................... 54
Item 3. Defaults Upon Senior Securities............................. 54
Item 4. Submission of Matters to a Vote of Security Holders......... 54
Item 5. Other Information........................................... 54
Item 6. Exhibits and Reports on Form 8-K............................ 54
SIGNATURES............................................................. 55
CERTIFICATIONS......................................................... 56
2
PART I. CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ISTAR FINANCIAL INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2002 2001*
------------- ------------
ASSETS
Loans and other lending investments, net.................... $2,939,769 $2,377,763
Corporate tenant lease assets, net.......................... 2,174,555 1,781,565
Investments in joint ventures and unconsolidated
subsidiaries.............................................. 24,362 58,226
Assets held for sale........................................ 24,800 --
Cash and cash equivalents................................... 20,144 15,670
Restricted cash............................................. 36,949 17,852
Accrued interest and operating lease income receivable...... 18,055 26,688
Deferred operating lease income receivable.................. 33,311 21,195
Deferred expenses and other assets.......................... 95,538 79,601
---------- ----------
Total assets.............................................. $5,367,483 $4,378,560
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, accrued expenses and other liabilities.... $ 94,572 $ 87,538
Dividends payable........................................... 5,225 5,225
Debt obligations............................................ 3,387,560 2,495,369
---------- ----------
Total liabilities......................................... 3,487,357 2,588,132
---------- ----------
Commitments and contingencies............................... -- --
Minority interest in consolidated entities.................. 2,581 2,650
Shareholders' equity:
Series A Preferred Stock, $0.001 par value, liquidation
preference $50.00 per share, 4,400 shares issued and
outstanding at September 30, 2002 and December 31, 2001,
respectively.............................................. 4 4
Series B Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 2,000 shares issued and
outstanding at September 30, 2002 and December 31, 2001,
respectively.............................................. 2 2
Series C Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 1,300 shares issued and
outstanding at September 30, 2002 and December 31, 2001,
respectively.............................................. 1 1
Series D Preferred Stock, $0.001 par value, liquidation
preference $25.00 per share, 4,000 shares issued and
outstanding at September 30, 2002 and December 31, 2001,
respectively.............................................. 4 4
Common Stock, $0.001 par value, 200,000 shares authorized,
89,937 and 87,387 shares issued and outstanding at
September 30, 2002 and December 31, 2001, respectively.... 90 87
Warrants and options........................................ 20,332 20,456
High Performance Units...................................... 1,359 --
Additional paid-in capital.................................. 2,071,104 1,997,931
Retained earnings (deficit)................................. (162,852) (174,874)
Accumulated other comprehensive income (losses) (See Note
12)....................................................... (4,540) (15,092)
Treasury stock (at cost).................................... (47,959) (40,741)
---------- ----------
Total shareholders' equity................................ 1,877,545 1,787,778
---------- ----------
Total liabilities and shareholders' equity................ $5,367,483 $4,378,560
========== ==========
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* RECLASSIFIED TO CONFORM TO 2002 PRESENTATION.
The accompanying notes are an integral part of the financial statements.
3
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2002 2001* 2002 2001*
-------- -------- -------- --------
REVENUE:
Interest income................................... $ 66,786 $ 62,389 $187,057 $193,205
Operating lease income............................ 63,561 45,984 177,483 137,605
Other income...................................... 4,822 9,187 21,263 23,893
-------- -------- -------- --------
Total revenue................................... 135,169 117,560 385,803 354,703
-------- -------- -------- --------
COSTS AND EXPENSES:
Interest expense.................................. 47,471 41,141 135,935 128,796
Operating costs--corporate tenant lease assets.... 3,656 3,206 9,662 9,713
Depreciation and amortization..................... 12,729 8,646 35,013 26,191
General and administrative........................ 8,088 6,131 22,849 18,731
General and administrative--stock-based
compensation.................................... 9,546 520 17,365 2,580
Provision for loan losses......................... 2,000 1,750 5,750 5,250
-------- -------- -------- --------
Total costs and expenses........................ 83,490 61,394 226,574 191,261
-------- -------- -------- --------
Net income before equity in earnings from joint
ventures and unconsolidated subsidiaries, minority
interest and other items.......................... 51,679 56,166 159,229 163,442
Equity in earnings from joint ventures and
unconsolidated subsidiaries....................... 85 1,961 1,301 5,645
Minority interest in consolidated entities.......... (40) (41) (122) (177)
Income from discontinued operations................. 823 1,246 3,333 3,744
Gain (loss) from discontinued operations............ 123 (1,196) 717 403
Extraordinary loss on early extinguishment of
debt.............................................. -- (583) (12,166) (1,620)
Cumulative effect of change in accounting principle
(See Note 3)...................................... -- -- -- (282)
-------- -------- -------- --------
Net income.......................................... $ 52,670 $ 57,553 $152,292 $171,155
Preferred dividend requirements..................... (9,227) (9,227) (27,681) (27,681)
-------- -------- -------- --------
Net income allocable to common shareholders......... $ 43,443 $ 48,326 $124,611 $143,474
======== ======== ======== ========
Basic earnings per common share..................... $ 0.49 $ 0.56 $ 1.41 $ 1.67
======== ======== ======== ========
Diluted earnings per common share................... $ 0.47 $ 0.54 $ 1.36 $ 1.63
======== ======== ======== ========
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* RECLASSIFIED TO CONFORM TO 2002 PRESENTATION.
The accompanying notes are an integral part of the financial statements.
4
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
SERIES A SERIES B SERIES C SERIES D COMMON WARRANTS HIGH ADDITIONAL
PREFERRED PREFERRED PREFERRED PREFERRED STOCK AND PERFORMACE PAID-IN
STOCK STOCK STOCK STOCK AT PAR OPTIONS UNITS CAPITAL
--------- --------- --------- --------- -------- -------- ---------- ----------
Balance at December 31, 2001...... $4 $2 $1 $4 $87 $20,456 $ -- $1,997,931
Exercise of options............... -- -- -- -- 3 (435) -- 12,739
Dividends declared--preferred
stock........................... -- -- -- -- -- -- -- 248
Dividends declared--common
stock........................... -- -- -- -- -- -- -- --
Restricted stock units issued to
employees....................... -- -- -- -- -- -- -- 16,283
Options granted to employees...... -- -- -- -- -- 311 -- --
High performance units sold to
employees....................... -- -- -- -- -- -- 1,359 --
Issuance of stock--DRIP........... -- -- -- -- -- -- -- 43,903
Purchase of treasury shares....... -- -- -- -- -- -- -- --
Net income for the period......... -- -- -- -- -- -- -- --
Change in accumulated other
comprehensive income............ -- -- -- -- -- -- -- --
-- -- -- -- --- ------- ------ ----------
Balance at September 30, 2002..... $4 $2 $1 $4 $90 $20,332 $1,359 $2,071,104
== == == == === ======= ====== ==========
RETAINED ACCUMULATED
EARNINGS OTHER COMPREHENSIVE TREASURY
(DEFICIT) INCOME (LOSSES) STOCK TOTAL
--------- ------------------- -------- ----------
Balance at December 31, 2001...... $(174,874) $(15,092) $(40,741) $1,787,778
Exercise of options............... -- -- -- 12,307
Dividends declared--preferred
stock........................... (27,681) -- -- (27,433)
Dividends declared--common
stock........................... (112,589) -- -- (112,589)
Restricted stock units issued to
employees....................... -- -- -- 16,283
Options granted to employees...... -- -- -- 311
High performance units sold to
employees....................... -- -- -- 1,359
Issuance of stock--DRIP........... -- -- -- 43,903
Purchase of treasury shares....... -- -- (7,218) (7,218)
Net income for the period......... 152,292 -- -- 152,292
Change in accumulated other
comprehensive income............ -- 10,552 -- 10,552
--------- -------- -------- ----------
Balance at September 30, 2002..... $(162,852) $ (4,540) $(47,959) $1,877,545
========= ======== ======== ==========
The accompanying notes are an integral part of the financial statements.
5
ISTAR FINANCIAL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE FOR THE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -------------------------
2002 2001* 2002 2001*
--------- --------- ----------- -----------
Cash flows from operating activities:
Net income.................................................. $ 52,670 $ 57,553 $ 152,292 $ 171,155
Adjustments to reconcile net income to cash flows provided
by operating activities:
Minority interest in consolidated entities................ 40 41 122 177
Non-cash expense for stock-based compensation............. 9,568 520 17,409 2,580
Depreciation and amortization............................. 18,180 11,960 52,224 36,529
Depreciation and amortization from discontinued
operations.............................................. -- 1,656 40 4,883
Amortization of discounts/premiums, deferred interest and
costs on lending investments............................ (9,612) (11,742) (22,232) (31,043)
Equity in earnings from joint ventures and unconsolidated
subsidiaries............................................ (85) (1,961) (1,301) (5,645)
Distributions from operations of joint ventures........... 985 983 5,533 3,899
Deferred operating lease income receivable................ (3,525) (2,320) (11,710) (7,303)
(Gain) loss from discontinued operations.................. (123) 1,196 (717) (403)
Extraordinary loss on early extinguishment of debt........ -- 583 12,166 1,620
Cumulative effect of change in accounting principle....... -- -- -- 282
Provision for loan losses................................. 2,000 1,750 5,750 5,250
Changes in assets and liabilities:
Decrease (increase) in accrued interest and operating
lease income receivable................................ 11,236 (3,582) 8,633 (430)
Decrease (increase) in deferred expenses and other
assets................................................. 798 2,179 (315) (50)
(Decrease) increase in accounts payable, accrued
expenses and other liabilities......................... (5,668) 5,644 4,943 2,896
--------- --------- ----------- -----------
Cash flows provided by operating activities............... 76,464 64,460 222,837 184,397
--------- --------- ----------- -----------
Cash flows from investing activities:
New investment originations............................... (283,250) (154,038) (1,374,546) (701,509)
Add-on fundings under existing loan commitments........... (2,483) (20,739) (17,987) (45,181)
Net proceeds from sale of corporate tenant lease assets... -- 12,452 3,702 20,286
Net proceeds from discontinued operations................. 12,500 -- 17,500 --
Repayments of and principal collections on loans and other
lending investments..................................... 223,047 10,206 499,464 567,185
Investments in and advances to unconsolidated joint
ventures................................................ -- (169) (127) (656)
Distributions from unconsolidated joint ventures.......... -- -- -- 24,265
Capital improvements for build-to-suit projects........... (86) (4,098) (1,039) (10,517)
Capital improvement projects on corporate tenant lease
assets.................................................. (714) (2,146) (1,802) (4,229)
Other capital expenditures on corporate tenant lease
assets.................................................. (1,604) (987) (3,799) (2,559)
--------- --------- ----------- -----------
Cash flows used in investing activities................... (52,590) (159,519) (878,634) (152,915)
--------- --------- ----------- -----------
Cash flows from financing activities:
Borrowings under revolving credit facilities.............. 242,043 400,272 2,001,250 1,920,766
Repayments under revolving credit facilities.............. (201,429) (656,529) (1,643,369) (1,993,970)
Borrowings under term loans............................... -- 67,624 53,562 277,664
Repayments under term loans............................... (1,621) (1,055) (16,588) (117,270)
Borrowings under secured bond offerings................... -- -- 885,079 --
Repayments under secured bond offerings................... (5,531) (22,011) (469,784) (123,909)
Borrowings under unsecured bond offerings................. -- 350,000 -- 350,000
Repayments under unsecured notes.......................... -- -- -- (100,000)
Borrowings under other debt obligations................... 1,000 65 1,048 432
Repayments under other debt obligations................... -- -- (1,301) (56,008)
Common dividends paid..................................... (56,525) (53,264) (112,589) (157,351)
Preferred dividends paid.................................. (9,145) (9,145) (27,433) (27,433)
(Increase) decrease in restricted cash held in connection
with debt obligations................................... (5,705) 16,946 (19,097) 9,588
Distributions to minority interest in consolidated
entities................................................ (40) (41) (190) (3,752)
Payments on early extinguishment of debt.................. -- -- (3,950) (1,037)
Payments for deferred financing costs..................... (4,138) (12,624) (40,541) (29,083)
Purchase of treasury stock................................ (7,218) -- (7,218) --
Proceeds from exercise of options and issuance of DRIP
shares.................................................. 24,882 3,675 60,033 12,284
High performance units issued to employees................ 1,359 -- 1,359 --
--------- --------- ----------- -----------
Cash flows (used in) provided by financing activities..... (22,068) 83,913 660,271 (39,079)
--------- --------- ----------- -----------
Increase (decrease) in cash and cash equivalents............ 1,806 (11,146) 4,474 (7,597)
Cash and cash equivalents, at beginning of period........... 18,338 26,301 15,670 22,752
--------- --------- ----------- -----------
Cash and cash equivalents, at end of period................. $ 20,144 $ 15,155 $ 20,144 $ 15,155
========= ========= =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest, net of
capitalized interest.................................... $ 53,388 $ 33,824 $ 129,420 $ 111,790
========= ========= =========== ===========
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* RECLASSIFIED TO CONFORM TO 2002 PRESENTATION.
The accompanying notes are an integral part of the financial statements.
6
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS AND ORGANIZATION
BUSINESS--iStar Financial Inc. (the "Company") is the leading
publicly-traded finance company focused on the commercial real estate industry.
The Company provides structured financing to private and corporate owners of
real estate nationwide, including senior and junior mortgage debt, corporate
mezzanine and subordinated capital, and corporate net lease financing. The
Company, which is taxed as a real estate investment trust ("REIT"), seeks to
deliver superior risk-adjusted returns on equity to shareholders by providing
innovative and value-added financing solutions to its customers.
The Company's primary product lines include:
- STRUCTURED FINANCE. The Company provides senior and subordinated loans
that typically range in size from $20 million to $100 million to borrowers
holding high-quality real estate. These loans may be either fixed or
variable rate and are structured to meet the specific financing needs of
the borrowers, including the acquisition or financing of large,
high-quality real estate. The Company offers borrowers a wide range of
structured finance options, including first mortgages, second mortgages,
partnership loans, participating debt and interim facilities. The
Company's structured finance transactions have maturities generally
ranging from three to ten years. As of September 30, 2002, based on gross
carrying values, the Company's structured finance assets represented
25.08% of its assets.
- PORTFOLIO FINANCE. The Company provides funding to regional and national
borrowers who own multiple facilities in geographically diverse
portfolios. Loans are cross-collateralized to give the Company the benefit
of all available collateral and underwritten to recognize inherent
portfolio diversification. Property types include multifamily, suburban
office, hotels and other property types where individual property values
are less than $20 million on average. Loan terms are structured to meet
the specific requirements of the borrower and typically range in size from
$25 million to $150 million. The Company's portfolio finance transactions
have maturities generally ranging from three to ten years. As of
September 30, 2002, based on gross carrying values, the Company's
portfolio finance assets represented 6.33% of its assets.
- CORPORATE FINANCE. The Company provides senior and subordinated capital to
corporations engaged in real estate or real estate-related businesses.
Financings may be either secured or unsecured and typically range in size
from $20 million to $150 million. The Company's corporate finance
transactions have maturities generally ranging from five to ten years. As
of September 30, 2002, based on gross carrying values, the Company's
corporate finance assets represented 12.80% of its assets.
- LOAN ACQUISITION. The Company acquires whole loans and loan participations
which present attractive risk-reward opportunities. Loans are generally
acquired at a small discount to the principal balance outstanding. Loan
acquisitions typically range in size from $5 million to $100 million and
are collateralized by all major property types. The Company's loan
acquisition transactions have maturities generally ranging from three to
ten years. As of September 30, 2002, based on gross carrying values, the
Company's loan acquisition assets represented 9.62% of its assets.
- CORPORATE TENANT LEASING. The Company provides capital to corporations and
borrowers who control facilities leased to single creditworthy tenants.
The Company's net leased assets are generally mission-critical
headquarters or distribution facilities that are subject to long-term
leases with rated corporate credit tenants, and which provide for all
expenses at the property to
7
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--BUSINESS AND ORGANIZATION (CONTINUED)
be paid by the corporate tenant on a triple net lease basis. Corporate
tenant lease transactions have terms generally ranging from ten to
20 years and typically range in size from $20 million to $150 million. As
of September 30, 2002, based on gross carrying values, the Company's
corporate tenant lease assets represented 41.57% of its assets.
- SERVICING. Through its iStar Asset Services division, the Company provides
rated loan servicing to third-party institutional loan portfolios, as well
as to the Company's own assets. The servicing business did not represent a
meaningful percentage of the gross carrying value of the Company's assets
as of September 30, 2002.
The Company's investment strategy targets specific sectors of the real
estate credit markets in which it believes it can deliver value-added, flexible
financial solutions to its customers, thereby differentiating its financial
products from those offered by other capital providers.
The Company has implemented its investment strategy by:
- Focusing on the origination of large, structured mortgage, corporate and
lease financings where customers require flexible financial solutions.
- Avoiding commodity businesses in which there is significant direct
competition from other providers of capital such as conduit lending and
investment in commercial or residential mortgage-backed securities.
- Developing direct relationships with borrowers and corporate customers as
opposed to sourcing transactions solely through intermediaries.
- Adding value beyond simply providing capital by offering borrowers and
corporate customers specific lending expertise, flexibility, certainty and
continuing relationships beyond the closing of a particular financing
transaction.
- Taking advantage of market anomalies in the real estate financing markets
when the Company believes credit is mispriced by other providers of
capital, such as the spread between lease yields and the yields on
corporate customers' underlying credit obligations.
ORGANIZATION--The Company began its business in 1993 through private
investment funds formed to capitalize on inefficiencies in the real estate
finance market. In March 1998, these funds contributed their approximately
$1.1 billion of assets to the Company's predecessor in exchange for a
controlling interest in that company. Since that time, the Company has grown by
originating new lending and leasing transactions, as well as through corporate
acquisitions.
Specifically, in September 1998, the Company acquired the loan origination
and servicing business of a major insurance company, and in December 1998, the
Company acquired the mortgage and mezzanine loan portfolio of its largest
private competitor. Additionally, in November 1999, the Company acquired TriNet
Corporate Realty Trust, Inc. ("TriNet" or the "Leasing Subsidiary"), then the
largest publicly-traded company specializing in corporate sale/leaseback
transactions for office and industrial facilities (the "TriNet Acquisition").
The TriNet Acquisition was structured as a stock-for-stock merger of TriNet with
a subsidiary of the Company.
Concurrent with the TriNet Acquisition, the Company also acquired its former
external advisor in exchange for shares of the Company's common stock ("Common
Stock") and converted its organizational form to a Maryland corporation. As part
of the conversion to a Maryland corporation,
8
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--BUSINESS AND ORGANIZATION (CONTINUED)
the Company replaced its former dual class common share structure with a single
class of Common Stock. The Company's Common Stock began trading on the New York
Stock Exchange on November 4, 1999. Prior to this date, the Company's common
shares were traded on the American Stock Exchange.
NOTE 2--BASIS OF PRESENTATION
The accompanying unaudited Consolidated Financial Statements have been
prepared in conformity with the instructions to Form 10-Q and Article 10,
Rule 10-01 of Regulation S-X for interim financial statements. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles ("GAAP") for complete financial statements. The
Consolidated Financial Statements include the accounts of the Company, its
qualified REIT subsidiaries, and its majority-owned and controlled partnerships.
In the opinion of management, the accompanying Consolidated Financial
Statements contain all adjustments, consisting of normal recurring adjustments,
necessary for a fair statement of the Company's consolidated financial position
at September 30, 2002 and December 31, 2001 and the results of its operations,
changes in shareholders' equity and its cash flows for the three- and nine-month
periods ended September 30, 2002 and 2001, respectively. Such operating results
are not necessarily indicative of the results that may be expected for any other
interim periods or the entire year.
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LOANS AND OTHER LENDING INVESTMENTS, NET--As described in Note 4, "Loans and
Other Lending Investments" includes the following investments: senior mortgages,
subordinate mortgages, corporate/ partnership loans, other lending
investments-loans and other lending investments-securities. Management considers
nearly all of its loan and other lending investments to be held-to-maturity,
although a small number of investments may be classified as available-for-sale.
Items classified as held-to-maturity are reflected at amortized historical cost,
while items classified as available-for-sale are reported at fair values.
Unrealized gains and losses on available-for-sale investments are included in
"Accumulated other comprehensive income" on the Company's Consolidated Balance
Sheets, and are not included in the Company's net income.
CORPORATE TENANT LEASE ASSETS AND DEPRECIATION--Corporate tenant lease
assets are generally recorded at cost less accumulated depreciation. Certain
improvements and replacements are capitalized when they extend the useful life,
increase capacity or improve the efficiency of the asset. Repairs and
maintenance items are expensed as incurred. Depreciation is computed using the
straight-line method of cost recovery over estimated useful lives of 40.0 years
for facilities, five years for furniture and equipment, the shorter of the
remaining lease term or expected life for tenant improvements and the remaining
life of the facility for facility improvements.
Corporate tenant lease assets to be disposed of are reported at the lower of
their carrying amount or fair value less costs to sell. The Company also
periodically reviews long-lived assets to be held and used for an impairment in
value whenever events or changes in circumstances indicate that the carrying
amount of such assets may not be recoverable. In management's opinion, corporate
tenant lease assets to be held and used are not carried at amounts in excess of
their estimated recoverable amounts.
9
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CAPITALIZED INTEREST--The Company capitalizes interest costs incurred during
the construction period on qualified build-to-suit projects for corporate
tenants, including investments in joint ventures accounted for under the equity
method. Interest capitalized was approximately $0 and $365,000 during the
three-month periods ended September 30, 2002 and 2001, respectively, and was
approximately $70,000 and $852,000 during the nine-month periods ended
September 30, 2002 and 2001, respectively.
CASH AND CASH EQUIVALENTS--Cash and cash equivalents include cash held in
banks or invested in money market funds with original maturity terms of less
than 90 days.
RESTRICTED CASH--Restricted cash represents amounts required to be
maintained in escrow under certain of the Company's debt obligations and leasing
transactions.
REVENUE RECOGNITION--The Company's revenue recognition policies are as
follows:
LOANS AND OTHER LENDING INVESTMENTS: Management considers nearly all of its
loans and other lending investments to be held-to-maturity, although a small
number of investments may be classified as available-for-sale. The Company
reflects held-to-maturity investments at amortized cost less allowance for loan
losses, acquisition premiums or discounts, deferred loan fees and undisbursed
loan funds. Unrealized gains and losses on available-for-sale investments are
included in "Accumulated other comprehensive income" on the Company's
Consolidated Balance Sheets and are not included in the Company's net income. On
occasion, the Company may acquire loans at small premiums or discounts based on
the credit characteristics of such loans. These premiums or discounts are
recognized as yield adjustments over the lives of the related loans. If loans
that were acquired at a premium or discount are prepaid, the Company immediately
recognizes the unamortized premium or discount as a decrease or increase in the
prepayment gain or loss, respectively. Loan origination or exit fees, as well as
direct loan origination costs, are also deferred and recognized over the lives
of the related loans as a yield adjustment. Interest income is recognized using
the effective interest method applied on a loan-by-loan basis.
A small number of the Company's loans provide for accrual of interest at
specified rates which differ from current payment terms. Interest is recognized
on such loans at the accrual rate subject to management's determination that
accrued interest and outstanding principal are ultimately collectible, based on
the underlying collateral and operations of the borrower.
Prepayment penalties or yield maintenance payments from borrowers are
recognized as additional income when received. Certain of the Company's loan
investments provide for additional interest based on the borrower's operating
cash flow or appreciation of the underlying collateral. Such amounts are
considered contingent interest and are reflected as income only upon certainty
of collection.
LEASING INVESTMENTS: Operating lease revenue is recognized on the
straight-line method of accounting from the later of the date of the origination
of the lease or the date of acquisition of the facility subject to existing
leases. Accordingly, contractual lease payment increases are recognized evenly
over the term of the lease. The cumulative difference between lease revenue
recognized under this method and contractual lease payment terms is recorded as
"Deferred operating lease income receivable" on the Company's Consolidated
Balance Sheets.
PROVISION FOR LOAN LOSSES--The Company's accounting policies require that an
allowance for estimated loan losses be maintained at a level that management,
based upon an evaluation of known and inherent risks in the portfolio, considers
adequate to provide for loan losses. In establishing loan
10
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
loss provisions, management periodically evaluates and analyzes the Company's
assets, historical and industry loss experience, economic conditions and trends,
collateral values and quality, and other relevant factors. Specific valuation
allowances are established for impaired loans in the amount by which the
carrying value, before allowance for estimated losses, exceeds the fair value of
collateral less disposition costs on an individual loan basis. Management
considers a loan to be impaired when, based upon current information and events,
it believes that it is probable that the Company will be unable to collect all
amounts due according to the contractual terms of the loan agreement on a timely
basis. Management measures these impaired loans at the fair value of the loans'
underlying collateral less estimated disposition costs. Impaired loans may be
left on accrual status during the period the Company is pursuing repayment of
the loan; however, these loans are placed on non-accrual status at such time as:
(1) management believes that the potential risk exists that scheduled debt
service payments will not be met within the coming 12 months; (2) the loans
become 90 days delinquent; (3) management determines the borrower is incapable
of, or has ceased efforts toward, curing the cause of the impairment; or
(4) the net realizable value of the loan's underlying collateral approximates
the Company's carrying value of such loan. While on non-accrual status, interest
income is recognized only upon actual receipt. Impairment losses are recognized
as direct write-downs of the related loan with a corresponding charge to the
provision for loan losses. Charge-offs occur when loans, or a portion thereof,
are considered uncollectible and of such little value that further pursuit of
collection is not warranted. Management also provides a loan portfolio reserve
based upon its periodic evaluation and analysis of the portfolio, historical and
industry loss experience, economic conditions and trends, collateral values and
quality, and other relevant factors.
The Company's loans are generally secured by real estate assets or are
corporate lending arrangements to entities with significant rental real estate
operations (e.g., an unsecured loan to a company which operates residential
apartments or retail, industrial or office facilities as rental real estate).
While the underlying real estate assets for the corporate lending instruments
may not serve as collateral for the Company's investments in all cases, the
Company evaluates the underlying real estate assets when estimating loan loss
exposure because the Company's loans generally have preclusions as to how much
senior and/or secured debt the customer may borrow ahead of the Company's
position.
INCOME TAXES--The Company is subject to federal income taxation at corporate
rates on its "REIT taxable income"; however, the Company is allowed a deduction
for the amount of dividends paid to its shareholders, thereby subjecting the
distributed net income of the Company to taxation at the shareholder level only.
In addition, the Company is allowed several other deductions in computing its
"REIT taxable income," including non-cash items such as depreciation expense.
These deductions allow the Company to shelter a portion of its operating cash
flow from its dividend payout requirement under federal tax laws. The Company
intends to operate in a manner consistent with and to elect to be treated as a
REIT for tax purposes. iStar Operating Inc. ("iStar Operating") and TriNet
Management Operating Company, Inc. ("TMOC"), the Company's taxable subsidiaries,
are not consolidated for federal income tax purposes and are taxed as
corporations. For financial reporting purposes, current and deferred taxes are
provided for in the portion of earnings recognized by the Company with respect
to its interest in iStar Operating and TMOC. Accordingly, except for the
Company's taxable subsidiaries, no current or deferred taxes are provided for in
the Consolidated Financial Statements. See Note 6 for a detailed discussion on
the ownership structure and operations of iStar Operating and TMOC.
11
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS (LOSS) PER COMMON SHARE--In accordance with the Statement of
Financial Accounting Standards No. 128 ("SFAS No. 128"), the Company presents
both basic and diluted earnings per share ("EPS"). Basic earnings per share
("Basic EPS") excludes dilution and is computed by dividing net income available
to common shareholders by the weighted average number of shares outstanding for
the period. Diluted earnings per share ("Diluted EPS") reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock, where such exercise or conversion
would result in a lower earnings per share amount.
RECLASSIFICATIONS--Certain prior year amounts have been reclassified in the
Consolidated Financial Statements and the related notes to conform to the 2002
presentation.
USE OF ESTIMATES--The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the dates of the financial statements and the reported
amounts of revenues and expenses during the reporting periods. Actual results
could differ from those estimates.
CHANGE IN ACCOUNTING PRINCIPLE--In June 1998, the FASB issued Statement of
Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 establishes
accounting and reporting standards for derivative financial instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a derivative may
be specifically designated as: (1) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized firm
commitment; (2) a hedge of the exposure to variable cash flows of a forecasted
transaction; or (3) in certain circumstances, a hedge of a foreign currency
exposure. On January 1, 2001, the Company adopted this pronouncement, as amended
by Statement of Financial Accounting Standards No. 137 "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133" and Statement of Financial Accounting Standards No. 138
"Accounting for Certain Derivative Instruments and Certain Hedging
Activities--an Amendment of FASB Statement No. 133." Because the Company has
primarily used derivatives as cash flow hedges of interest rate risk only, the
adoption of SFAS No. 133 did not have a material financial impact on the
financial position and results of operations of the Company. However, should the
Company change its current use of such derivatives, the adoption of SFAS
No. 133 could have a more significant effect on the Company prospectively.
Upon adoption, the Company recognized a charge to net income of
approximately $282,000 and an additional charge of $9.4 million to other
comprehensive income, representing the cumulative effect of the change in
accounting principle.
OTHER NEW ACCOUNTING STANDARDS--In September 2000, the FASB issued Statement
of Financial Accounting Standards No. 140 ("SFAS No. 140"), "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
This statement is applicable for transfers of assets and extinguishments of
liabilities occurring after June 30, 2001. The Company adopted the provisions of
this statement as required for all transactions entered into on or after
April 1, 2001. The adoption of SFAS No. 140 did not have a significant impact on
the Company.
In July 2001, the SEC released Staff Accounting Bulletin No. 102 ("SAB
102"), "Selected Loan Loss Allowance and Documentation Issues." SAB 102
summarizes certain of the SEC's views on the
12
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
development, documentation and application of a systematic methodology for
determining allowances for loan and lease losses. Adoption of SAB 102 by the
Company did not have a significant impact on the Company.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 141 ("SFAS No. 141"), "Business Combinations" and Statement of Financial
Accounting Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible
Assets." SFAS No. 141 requires the purchase method of accounting to be used for
all business combinations initiated after June 30, 2001. SFAS No. 141 also
addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in business combinations and requires intangible
assets to be recognized apart from goodwill if certain tests are met. SFAS
No. 142 requires that goodwill not be amortized but instead be measured for
impairment at least annually, or when events indicate that there may be an
impairment. The Company adopted the provisions of both statements on January 1,
2002, as required, and the adoption did not have a significant impact on the
Company.
In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS No. 144 provides new guidance on the recognition of
impairment losses on long-lived assets to be held and used or to be disposed of,
and also broadens the definition of what constitutes a discontinued operation
and how the results of a discontinued operation are to be measured and
presented. SFAS No. 144 requires that current operations prior to the
disposition of corporate tenant lease assets and prior period results of such
operations be presented in discontinued operations in the Company's Consolidated
Statements of Operations. The provisions of SFAS No. 144 are effective for
financial statements issued for fiscal years beginning after December 15, 2001,
and must be applied at the beginning of a fiscal year. The Company adopted the
provisions of this statement on January 1, 2002, as required, and it did not
have a significant financial impact on the Company.
In April 2002, the FASB issued Statement of Financial Accounting Standards
No. 145 ("SFAS No. 145"), "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145
rescinds both FASB Statements No. 4 ("SFAS No. 4"), "Reporting Gains and Losses
from Extinguishment of Debt," and the amendment to SFAS No. 4, FASB Statement
No. 64 ("SFAS No. 64"), "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." Through this rescission, SFAS No. 145 eliminates the requirement
(in both SFAS No. 4 and SFAS No. 64) that gains and losses from the
extinguishment of debt be aggregated and, if material, classified as an
extraordinary item, net of the related income tax effect. An entity is not
prohibited from classifying such gains and losses as extraordinary items, so
long as they meet the criteria in paragraph 20 of Accounting Principles Board
Opinion No. 30 ("APB 30"), "Reporting the Results of Operations--Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions"; however, due to the nature of
the Company's operations, such treatment may not be available to the Company.
Any gains or losses on extinguishments of debt that were previously classified
as extraordinary items in prior periods presented that do not meet the criteria
in APB 30 for classification as an extraordinary item will be reclassified to
income from continuing operations. The provisions of SFAS No. 145 are effective
for financial statements issued for fiscal years beginning after May 15, 2002.
The Company will adopt the provisions of this statement, as required, on
January 1, 2003.
13
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 ("SFAS No. 146"), "Accounting for Exit or Disposal Activities," to
address significant issues regarding the recognition, measurement, and reporting
of costs that are associated with exit and disposal activities, including
restructuring activities that are currently accounted for pursuant to the
guidance that the Emerging Issues Task Force ("EITF") has set forth in EITF
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The scope of SFAS No. 146 also includes: (1) costs related to
terminating a contract that is not a capital lease; and (2) termination benefits
that employees who are involuntarily terminated receive under the terms of a
one-time benefit arrangement that is not an ongoing benefit arrangement or an
individual deferred-compensation contract. The provisions of SFAS No. 146 are
effective for exit or disposal activities that are initiated after December 31,
2002. The Company does not expect SFAS No. 146 to have a material effect on the
Company's Consolidated Financial Statements.
In September 2002, the FASB issued Statement of Financial Accounting
Standards No. 147 ("SFAS No. 147"), "Acquisitions of Certain Financial
Institutions," an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9. SFAS No. 147 provides guidance on the accounting for the
acquisitions of financial institutions, except those acquisitions between two or
more mutual enterprises. SFAS No. 147 removes acquisitions of financial
institutions from the scope of both FASB No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," and FASB Interpretation No. 9,
Applying APB Opinions No. 16 and 17, "When a Savings and Loan Association or a
Similar Institution Is Acquired in a Business Combination Accounted for by the
Purchase Method," and requires that those transactions be accounted for in
accordance with SFAS No. 141 and SFAS No. 142. SFAS No. 147 also amends SFAS
No. 144, to include in its scope long-term, customer-relationship intangible
assets of financial institutions such as depositor-relationship and
borrower-relationship intangible assets and credit cardholder intangible assets.
The Company will adopt the provisions of this statement, as required, on
October 1, 2002. The Company does not expect SFAS No. 147 to have a material
effect on the Company's Consolidated Financial Statements.
14
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4--LOANS AND OTHER LENDING INVESTMENTS
The following is a summary description of the Company's loans and other
lending investments (in thousands)(1):
CARRYING VALUE
AS OF
# OF PRINCIPAL ------------------------------ EFFECTIVE
UNDERLYING PROPERTY BORROWERS BALANCES SEPTEMBER 30, DECEMBER 31, MATURITY
TYPE OF INVESTMENT TYPE IN CLASS OUTSTANDING 2002 2001 DATES
------------------ ----------------------- --------- -------------- -------------- ------------- ------------
Senior Mortgages(3).... Office/Residential/Retail/ 29 $1,846,489 $1,808,376 $1,158,669 2002 to 2019
Conference Center/
Mixed Use/Hotel/
Entertainment
Subordinate
Mortgages(5)......... Office/Residential/Mixed 18 505,115 504,081 585,698 2002 to 2011
Use/Hotel
Corporate/Partnership
Loans................ Office/Residential/Retail/ 16 364,198 342,347 395,083 2002 to 2011
Mixed Use/Hotel/
Entertainment
Other Lending
Investments--Loans(7).. Office/Industrial/Mixed 5 28,134 21,505 10,818 2004 to 2008
Use
Other Lending
Investments--
Securities(8)........ Office/Residential/Retail/ 9 302,522 290,210 248,495 2003 to 2013
Industrial/Mixed Use/
Entertainment
---------- ----------
Gross Carrying Value...
$2,966,519 $2,398,763
Provision for Loan
Losses............... (26,750) (21,000)
---------- ----------
Total, Net.............
$2,939,769 $2,377,763
========== ==========
CONTRACTUAL INTEREST CONTRACTUAL INTEREST PRINCIPAL PARTICIPATION
TYPE OF INVESTMENT PAYMENT RATES(2) ACCRUAL RATES(2) AMORTIZATION FEATURES
------------------ ----------------------- ----------------------- ------------ -------------
Senior Mortgages(3).... Fixed: 7.03% to 15.00% Fixed: 7.03% to 15.00% Yes (4) No
Variable: LIBOR + 1.50% Variable: LIBOR + 1.50%
to 6.50% to 6.50%
Subordinate
Mortgages(5)......... Fixed: 7.00% to 15.00% Fixed: 7.32% to 17.00% Yes (4) No
Variable: LIBOR + 2.78% Variable: LIBOR + 2.78%
to 6.00% to 6.00%
Corporate/Partnership
Loans................ Fixed: 7.33% to 15.00% Fixed: 7.33% to 17.50% Yes (4) Yes (6)
Variable: LIBOR + 3.50% Variable: LIBOR + 3.50%
to 6.00% to 6.00%
Other Lending
Investments--Loans(7).. Fixed: 10.00% Fixed: 10.00% No Yes (6)
Variable: LIBOR + 4.75% Variable: LIBOR + 4.75%
Other Lending
Investments--
Securities(8)........ Fixed: 6.75% to 12.50% Fixed: 6.75% to 12.50% Yes (4) No
Gross Carrying Value...
Provision for Loan
Losses...............
Total, Net.............
EXPLANATORY NOTES:
- ----------------------------------
(1) Amounts and details are for loans outstanding as of September 30, 2002.
(2) Substantially all variable-rate loans are based on 30-day LIBOR and reprice
monthly. The 30-day LIBOR on September 30, 2002 was 1.81%.
(3) Includes a senior interest in a private REMIC whose sole asset is a single
first mortgage loan.
(4) The loans require fixed payments of principal and interest resulting in
partial principal amortization over the term of the loan with the remaining
principal due at maturity.
(5) Includes a participation interest in a second mortgage and a subordinate
interest in a private REMIC whose sole asset is a single first mortgage
loan.
(6) Under some of these loans, the lender receives additional payments
representing additional interest from participation in available cash flow
from operations of the property.
(7) Includes one unsecured loan with a carrying value of approximately $313 as
of September 30, 2002 and approximately $403 as of December 31, 2001.
(8) Generally consists of term preferred stock or debt interests that are
specifically originated or structured to meet customer financing
requirements and the Company's investment criteria. These investments do not
typically consist of securities purchased in the open market or as part of
broadly-distributed offerings.
15
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4--LOANS AND OTHER LENDING INVESTMENTS (CONTINUED)
During the nine-month periods ended September 30, 2002 and 2001,
respectively, the Company originated or acquired an aggregate of approximately
$1,097.8 million and $663.1 million in loans and other lending investments,
funded $18.0 million and $45.2 million under existing loan commitments, and
received principal repayments of $499.5 million and $567.2 million.
As of September 30, 2002, the Company had nine loans with unfunded
commitments. The total unfunded commitment amount was approximately
$63.8 million, of which $32.9 million was discretionary and $30.8 million was
non-discretionary.
The Company's loans and other lending investments are predominantly pledged
as collateral under either the iStar Asset Receivables secured notes, the
secured revolving facilities or secured term loans (see Note 7).
The Company has reflected provisions for loan losses of approximately
$2.0 million and $1.8 million in its results of operations during the
three-month periods ended September 30, 2002 and 2001, respectively, and
$5.8 million and $5.3 million during the nine-month periods ended September 30,
2002 and 2001, respectively. These provisions represent loan portfolio reserves
based on management's evaluation of general market conditions, the Company's
internal risk management policies and credit risk ratings system, industry loss
experience, the likelihood of delinquencies or defaults, and the credit quality
of the underlying collateral. No direct impairment reserves on specific loans
were considered necessary.
NOTE 5--CORPORATE TENANT LEASE ASSETS
During the nine-month periods ended September 30, 2002 and 2001,
respectively, the Company acquired an aggregate of approximately $276.8 million
and $38.4 million in corporate tenant lease assets and disposed of approximately
$3.7 million and $20.3 million in in corporate tenant lease assets.
The Company's investments in corporate tenant lease assets, at cost, were as
follows (in thousands):
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Facilities and improvements......................... $1,870,267 $1,504,956
Land and land improvements.......................... 420,672 356,830
Less: accumulated depreciation...................... (116,384) (80,221)
---------- ----------
Corporate tenant lease assets, net................ $2,174,555 $1,781,565
========== ==========
Under certain leases, the Company receives additional participating lease
payments to the extent gross revenues of the corporate tenant exceed a base
amount. The Company earned no such additional participating lease payments in
the three- or nine-month periods ended September 30, 2002 and 2001. In addition,
the Company also receives reimbursements from customers for certain facility
operating expenses including common area costs, insurance and real estate taxes.
Customer expense reimbursements for the three months ended September 30, 2002
and 2001 were approximately $7.5 million and $5.8 million, respectively, and
$22.2 million and $18.4 million for the nine months ended September 30, 2002 and
2001, respectively, and are included as a reduction of "Operating
costs--corporate tenant lease assets" on the Company's Consolidated Statements
of Operations.
The Company is subject to expansion option agreements with two existing
customers which could require the Company to fund and to construct up to 161,000
square feet of additional adjacent space
16
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--CORPORATE TENANT LEASE ASSETS (CONTINUED)
on which the Company would receive additional operating lease income under the
terms of the option agreements. In addition, upon exercise of such expansion
option agreements, the corporate tenants would be required to simultaneously
extend their existing lease terms for additional periods ranging from six to ten
years.
On September 30, 2002, one of the Company's customers exercised an option to
terminate its lease on 50% of the land leased from the Company. In connection
with this termination, the Company realized $17.5 million in cash lease
termination payments, offset by a $17.4 million impairment charge in connection
with the termination, resulting in a net gain of approximately $123,000. As of
September 30, 2002, the terminated parcel is classified as held for sale on the
Company's Consolidated Balance Sheets. On May 30, 2002, the Company sold one
corporate tenant lease asset for net proceeds of $3.7 million, and a realized
gain of approximately $595,000. The results of operations from corporate tenant
lease assets sold or held for sale in the current period are classified as
discontinued operations even though such income was actually received by the
Company prior to the asset sale. Gains on sale from corporate tenant lease
assets are also classified as discontinued operations.
NOTE 6--JOINT VENTURES AND UNCONSOLIDATED SUBSIDIARIES
The Company's ownership percentages, its investments in and advances to
unconsolidated joint ventures and subsidiaries, its respective income and the
Company's pro rata share of its ventures' third-party, non-recourse debt as of
September 30, 2002 are presented below (in thousands):
JV INCOME PRO RATA
(LOSS) FOR SHARE OF THIRD-PARTY DEBT
THREE MONTHS THIRD-PARTY -----------------------------------
UNCONSOLIDATED JOINT VENTURES OWNERSHIP EQUITY ENDED NON-RECOURSE INTEREST SCHEDULED
AND SUBSIDIARIES % INVESTMENT SEPTEMBER 30, 2002 DEBT(1) RATE MATURITY DATE
- ----------------------------- --------- ---------- ------------------ ------------ ------------- --------------------
UNCONSOLIDATED JOINT
VENTURES:
Sunnyvale................. 44.70% $11,957 $ 542 $10,728 LIBOR + 1.25% November 2004(2)
CTC I..................... 50.00% 12,080 394 60,246 7.66% - 7.87% Various through 2011
ACRE Simon................ 20.00% 5,208 34 6,529 7.61% - 8.43% Various through 2011
UNCONSOLIDATED SUBSIDIARIES:
iStar Operating........... 95.00% (5,018) (885) -- N/A N/A
TMOC...................... 95.00% 135 -- -- N/A N/A
------- ------- -------
Total................... $24,362 $ 85 $77,503
======= ======= =======
EXPLANATORY NOTES:
- ------------------------------
(1) The Company reflects its pro rata share of third-party, non-recourse debt,
rather than the total amount of the joint venture debt, because the
third-party, non-recourse debt held by the joint ventures is not guaranteed
by the Company nor does the Company have any additional commitment to fund
the debt.
(2) Maturity date reflects a one-year extension at the venture's option.
17
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--JOINT VENTURES AND UNCONSOLIDATED SUBSIDIARIES (CONTINUED)
INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED JOINT VENTURES: At
September 30, 2002, the Company had investments in three joint ventures:
(1) TriNet Sunnyvale Partners L.P. ("Sunnyvale"), whose external partners are
John D. O'Donnell, Trustee, John W. Hopkins, and Donald S. Grant, Trustee;
(2) Corporate Technology Centre Associates, LLC ("CTC I"), whose external member
is Corporate Technology Centre Partners, LLC; and (3) ACRE Simon, LLC ("ACRE"),
whose external partner is William E. Simon & Sons Realty Investments, LLC. These
ventures were formed for the purpose of operating, acquiring and, in certain
cases, developing corporate tenant lease facilities.
At September 30, 2002, the ventures comprised 12 net leased facilities. The
Company's combined investment in these joint ventures at September 30, 2002 was
$29.2 million. The joint ventures' carrying value for the 12 facilities owned at
September 30, 2002 was $197.6 million. In aggregate, the joint ventures had
total assets of $234.8 million and total liabilities of $185.8 million as of
September 30, 2002, and net income of $1.8 million and $5.3 million for the
three and nine months ended September 30, 2002. The Company accounts for these
investments under the equity method because the Company's joint venture partners
have certain participating rights giving them shared control over the ventures.
Effective September 29, 2000, iStar Sunnyvale Partners, LP entered into an
interest rate cap agreement limiting the venture's exposure to interest rate
movements on its $24.0 million LIBOR-based mortgage loan to an interest rate of
9.00% through November 9, 2003. Currently, the limited partners of Sunnyvale
have the option to convert their partnership interest into cash; however, the
Company may elect to deliver 297,728 shares of Common Stock in lieu of cash.
On April 1, 2002, the former Sierra Land Ventures ("Sierra") joint venture
partner assigned its 50.00% ownership interest in Sierra to a wholly owned
subsidiary of the Company. There was no cash or shares exchanged in this
transaction. As of April 1, 2002, the Company owns 100.00% of the corporate
tenant lease asset previously held by Sierra and therefore consolidates this
asset for accounting purposes.
On July 2, 2002, the Company paid approximately $30.5 million in cash to the
former member of TriNet Milpitas Associates ("Milpitas") joint venture in
exchange for its 50.00% ownership interest. Pursuant to the terms of the joint
venture agreement, the former external member had the right to convert its
interest into 984,476 shares of Common Stock of the Company at any time during
the period February 1, 2002 through January 31, 2003. On May 2, 2002, the former
Milpitas external member exercised this right. Upon the external member's
exercise of its conversion right, the Company had the option to acquire the
partner's interest for cash, instead of shares, for a payment equal to the value
of 984,476 shares of Common Stock multiplied by the ten-day average closing
stock price as of the transaction date. The Company made such election and, as
of July 2, 2002, owns 100.00% of Milpitas, and therefore consolidates these
assets for accounting purposes. The Company accounted for the acquisition of the
external interest using the purchase method.
Income generated from the Company's joint venture investments and
unconsolidated subsidiaries is included in "Equity in earnings from joint
ventures and unconsolidated subsidiaries" on the Company's Consolidated
Statements of Operations.
18
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--JOINT VENTURES AND UNCONSOLIDATED SUBSIDIARIES (CONTINUED)
INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED SUBSIDIARIES: The Company has
an investment in iStar Operating, a taxable subsidiary that, through a
wholly-owned subsidiary, services the Company's loans and certain loan
portfolios owned by third parties. The Company owns all of the non-voting
preferred stock and a 95.00% economic interest in iStar Operating. An affiliate
of the Company's largest shareholder is the owner of all the voting common stock
and a 5.00% economic interest in iStar Operating. As of September 30, 2002,
there have never been any distributions to the common shareholder, nor does the
Company expect to make any in the future. At any time, the Company has the right
to acquire all of the common stock of iStar Operating at fair market value,
which the Company believes to be nominal. In addition to the direct general and
administrative costs of iStar Operating, the Company allocates a portion of its
general overhead expenses to iStar Operating based on the number of employees at
iStar Operating as a percentage of the Company's total employees.
In addition, the Company has an investment in TMOC, a taxable noncontrolled
subsidiary that has a $2.0 million investment in a real estate company based in
Mexico. The Company owns 95.00% of the outstanding voting and non-voting common
stock (representing 1.00% voting power and 95.00% of the economic interest) in
TMOC. The other two owners of TMOC stock are executives of the Company, who own
a combined 5.00% of the outstanding voting and non-voting common stock
(representing 99.00% voting power and 5.00% economic interest) in TMOC. As of
September 30, 2002, there have never been any distributions to the common
shareholders, nor does the Company expect to make any in the future. At any
time, the Company has the right to acquire all of the common stock of TMOC at
fair market value, which the Company believes to be nominal.
Both iStar Operating and TMOC were formed as taxable corporations for
purposes of maintaining compliance with the REIT provisions of the Code and are
accounted for under the equity method for financial statement reporting purposes
and are presented in "Investments in joint ventures and unconsolidated
subsidiaries" on the Company's Consolidated Balance Sheets. If they were
consolidated with the Company for financial statement purposes, they would not
have a material impact on the Company's operations. As of September 30, 2002,
iStar Operating and TMOC have no debt obligations.
19
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--DEBT OBLIGATIONS
As of September 30, 2002 and December 31, 2001, the Company has debt
obligations under various arrangements with financial institutions as follows
(in thousands):
CARRYING VALUE AS OF
MAXIMUM ---------------------------- STATED SCHEDULED
AMOUNT SEPTEMBER 30, DECEMBER 31, INTEREST MATURITY
AVAILABLE 2002 2001 RATES(1) DATE
---------- ------------- ------------ ----------------------------- --------------------
SECURED REVOLVING CREDIT
FACILITIES:
Line of credit............... $ 700,000 $ 447,551 $ 312,300 LIBOR + 1.75% - 2.25% March 2005(2)
Line of credit............... 700,000 579,566 439,309 LIBOR + 1.40% - 2.15% January 2005(2)
Line of credit............... 500,000 231,311 148,937 LIBOR + 1.50% - 1.75% August 2005(2)
Line of credit............... 500,000 -- -- LIBOR + 1.50% - 2.25% September 2005(3)
UNSECURED REVOLVING CREDIT
FACILITIES:
Line of credit............... 300,000 -- -- LIBOR + 2.125% July 2004(4)
---------- ---------- ----------
Total revolving credit
facilities................. $2,700,000 1,258,428 900,546
==========
SECURED TERM LOANS:
Secured by corporate tenant
lease assets............... 193,000 193,000 LIBOR + 1.85% July 2006(5)
Secured by corporate tenant
lease assets............... 144,997 147,520 7.44% March 2009
Secured by corporate lending
investments................ 60,000 60,000 LIBOR + 2.50% June 2004(4)
Secured by corporate tenant
lease assets............... 175,008 55,819 6.00% - 11.38% Various through 2022
Secured by corporate lending
investments................ 50,000 50,000 LIBOR + 2.50% July 2006(4)
---------- ----------
Total term loans............. 623,005 506,339
Less: debt (discount)
premium.................... (262) 274
---------- ----------
Total secured term loans..... 622,743 506,613
ISTAR ASSET RECEIVABLES SECURED
NOTES:
STARs Series 2000-1:
Class A.................... -- 81,152 LIBOR + 0.30% August 2003
Class B.................... -- 94,055 LIBOR + 0.50% October 2003
Class C.................... -- 105,813 LIBOR + 1.00% January 2004
Class D.................... -- 52,906 LIBOR + 1.45% June 2004
Class E.................... -- 123,447 LIBOR + 2.75% January 2005
Class F.................... -- 5,000 LIBOR + 3.15% January 2005
STARs Series 2002-1:
Class A1................... 242,589 -- LIBOR + 0.26% June 2004(6)
Class A2................... 381,296 -- LIBOR + 0.38% December 2009(6)
Class B.................... 39,955 -- LIBOR + 0.65% April 2011(6)
Class C.................... 26,637 -- LIBOR + 0.75% May 2011(6)
Class D.................... 21,310 -- LIBOR + 0.85% January 2012(6)
Class E.................... 42,619 -- LIBOR + 1.235% January 2012(6)
Class F.................... 26,637 -- LIBOR + 1.335% January 2012(6)
Class G.................... 21,309 -- LIBOR + 1.435% January 2012(6)
Class H.................... 26,637 -- 6.35% January 2012(6)
Class J.................... 26,637 -- 6.35% May 2012(6)
Class K.................... 26,637 -- 6.35% May 2012(6)
---------- ----------
Total iStar Asset Receivables
secured notes.............. 882,263 462,373
Less: debt discount.......... (4,493) --
---------- ----------
Total iStar Asset Receivables
secured notes.............. 877,770 462,373
UNSECURED NOTES:
6.75% Dealer Remarketable
Securities(7)(8)(9)........ 125,000 125,000 6.75% March 2013
7.70% Notes(7)(9)............ 100,000 100,000 7.70% July 2017
7.95% Notes(7)(9)............ 50,000 50,000 7.95% May 2006
8.75% Notes.................. 350,000 350,000 8.75% August 2008
---------- ----------
Total unsecured notes........ 625,000 625,000
Less: debt discount.......... (12,663) (15,698)
---------- ----------
Total unsecured notes........ 612,337 609,302
OTHER DEBT OBLIGATIONS......... 16,282 16,535 Various Various
---------- ----------
TOTAL DEBT OBLIGATIONS......... $3,387,560 $2,495,369
========== ==========
20
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--DEBT OBLIGATIONS (CONTINUED)
EXPLANATORY NOTES:
- ------------------------------
(1) Substantially all variable-rate debt obligations are based on 30-day LIBOR
and reprice monthly. The 30-day LIBOR on September 30, 2002 was 1.81%.
(2) Maturity date reflects a one-year "term-out" extension at the Company's
option.
(3) On September 30, 2002, the Company closed a $500.0 million secured revolving
credit facility with a leading financial institution. The facility has a
final maturity date of September 2005 and bears interest at LIBOR + 1.50% to
2.25%.
(4) Maturity date reflects a one-year extension at the Company's option.
(5) Maturity date reflects two one-year extensions at the Company's option.
(6) Principal payments on these bonds are a function of the principal repayments
on loan or corporate tenant lease assets which collateralize these
obligations. The dates indicated above represent the expected date on which
the final payment would occur for such class based on the assumptions that
the loans which collateralize the obligations are not voluntarily prepaid,
the loans are paid on their effective maturity dates and no extensions of
the effective maturity dates of any of the loans are granted. The final
maturity date for the underlying indenture on class A1 is May 28, 2017 and
the final maturity date for classes A2, B, C, D, E, F, G, H, J and K is
May 28, 2020.
(7) The notes are callable by the Company at any time for an amount equal to the
total of principal outstanding, accrued interest and the applicable
make-whole prepayment premium.
(8) Subject to mandatory tender on March 1, 2003, to either the dealer or the
Company. The initial coupon of 6.75% applies to the first five-year term
through the mandatory tender date. If tendered to the dealer, the notes must
be remarketed. The rates reset to then-prevailing market rates upon
remarketing.
(9) These obligations were assumed as part of the acquisition of TriNet. As part
of the accounting for the purchase, these fixed-rate obligations were
considered to have stated interest rates which were below the
then-prevailing market rates at which the Leasing Subsidiary could issue new
debt obligations and, accordingly, the Company ascribed a market discount to
each obligation. Such discounts are amortized as an adjustment to interest
expense using the effective interest method over the related term of the
obligations. As adjusted, the effective annual interest rates on these
obligations were 8.81%, 9.51% and 9.04% for the 6.75% Dealer Remarketable
Securities, 7.70% Notes and 7.95% Notes, respectively.
Availability of amounts under the secured revolving credit facilities are
based on percentage borrowing base calculations. In addition, certain of the
Company's debt obligations contain covenants. These covenants are both financial
and non-financial in nature. Significant financial covenants include limitations
on the Company's ability to incur indebtedness beyond specified levels,
restrictions on the Company's ability to incur liens on assets and limitations
on the amount and type of restricted payments, such as repurchases of its own
equity securities, that the Company makes. Significant non-financial covenants
include a requirement in its publicly-held debt securities that the Company
offer to repurchase those securities at a premium if the Company undergoes a
change of control. As of September 30, 2002, the Company believes it is in
compliance with both financial and non-financial covenants on its debt
obligations.
On May 17, 2000, the Company closed the inaugural offering under its
proprietary matched funding program, STARs, Series 2000-1. In the initial
transaction, a wholly-owned subsidiary of the Company issued $896.5 million of
investment-grade bonds secured by the subsidiary's assets, which had an
aggregate outstanding principal balance of approximately $1.2 billion at
inception. Principal payments received on the assets were utilized to repay the
most senior class of the bonds then outstanding. The maturity of the bonds match
funded the maturity of the underlying assets financed under the program. Of the
assets of the subsidiary secured by this financing, 73.96% (by gross carrying
value) consisted of first mortgages and subsequent lien positions and the
remaining 26.04% consisted of junior loans. For accounting purposes, this
transaction was treated as a secured financing: the underlying assets and STARs
liabilities remained on the Company's Consolidated Balance Sheets and no gain on
sale was recognized. On May 28, 2002, the Company fully repaid these bonds.
21
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--DEBT OBLIGATIONS (CONTINUED)
On January 11, 2001, the Company closed a new $700.0 million secured
revolving credit facility which is led by a major commercial bank. The new
facility has a three-year primary term and one-year "term-out" extension option,
and bears interest at LIBOR + 1.40% to 2.15%, depending upon the collateral
contributed to the borrowing base. The new facility accepts a broad range of
structured finance assets and has a final maturity of January 2005.
On February 22, 2001, the Company extended the maturity of its
$350.0 million unsecured revolving credit facility to May 2002. On July 27,
2001, the Company repaid this facility and replaced it with a new
$300.0 million unsecured revolving credit facility.
On May 15, 2001, the Company repaid its $100.0 million 7.30% unsecured
notes. These notes were senior unsecured obligations of the Leasing Subsidiary
and ranked equally with the Leasing Subsidiary's other senior unsecured and
unsubordinated indebtedness.
On June 14, 2001, the Company closed $193.0 million of term loan financing
secured by 15 corporate tenant lease assets. The variable-rate loan bears
interest at LIBOR + 1.85% (not to exceed 10.00% in aggregate) and has two
one-year extensions at the Company's option. The Company used these proceeds to
repay a $77.8 million secured term loan maturing in June 2001 and to pay down a
portion of its revolving credit facilities. In addition, the Company extended
the maturity of its $500.0 million secured revolving credit facility to August
2003. On March 29, 2002, the Company again extended the final maturity of this
facility to August 2005, which includes a one-year "term-out" extension at the
Company's option.
On July 6, 2001, the Company financed a $75.0 million structured finance
asset with a $50.0 million term loan bearing interest at LIBOR + 2.50%. The loan
has a maturity of July 2006, including a one-year extension at the Company's
option. This investment is a $75.0 million term preferred investment in a
publicly-traded real estate customer. The Company's investment carries an
initial current yield of 10.50%, with annual increases of 0.50% in each of the
next two years. In addition, the Company's investment is convertible into the
customer's common stock at a strike price of $25.00 per share. The investment is
callable by the customer between months 13 and 30 of the term at a yield
maintenance premium, and after month 30, at a premium sufficient to generate a
14.62% internal rate of return on the Company's investment. The investment is
putable by the Company to the customer for cash after five years.
On July 27, 2001, the Company completed a $300.0 million unsecured revolving
credit facility with a group of leading financial institutions. The new facility
has an initial maturity of July 2003, with a one-year extension at the Company's
option and another one-year extension at the lenders' option. The new facility
replaces two prior credit facilities maturing in 2002 and 2003, and bears
interest at LIBOR + 2.125%.
On August 9, 2001, the Company issued $350.0 million of 8.75% senior notes
due in 2008. The notes are unsecured senior obligations of the Company. The
Company used the net proceeds to repay outstanding borrowings under its secured
credit facilities.
On March 29, 2002, the Company extended the maturity of its $500.0 million
secured facility to August 2005, which includes a one-year "term-out" extension
at the Company's option.
On May 28, 2002, the Company fully repaid the then remaining $446.2 million
of bonds outstanding under its STARs, Series 2000-1 financing. Simultaneously, a
wholly-owned subsidiary of the Company issued STARs, Series 2002-1, consisting
of $885.1 million of investment-grade bonds secured
22
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--DEBT OBLIGATIONS (CONTINUED)
by the subsidiary's structured finance and corporate tenant lease assets, which
had an aggregate outstanding principal balance of approximately $1.1 billion at
inception. Principal payments received on the assets will be utilized to repay
the most senior class of the bonds then outstanding. The maturity of the bonds
match funds the maturity of the underlying assets financed under the program.
The weighted average interest rate on the bonds, on an all-floating rate basis,
was approximately LIBOR + 0.56% at inception. For accounting purposes, this
transaction was treated as a secured financing: the underlying assets and STARs
liabilities remained on the Company's Consolidated Balance Sheets, and no gain
on sale was recognized.
On July 2, 2002, the Company purchased the remaining interest in the
Milpitas joint venture from the former Milpitas external member. Upon purchase
of the interest, the Milpitas joint venture became fully consolidated for
accounting purposes and approximately $79.2 million of secured term debt was
transferred to the Company's Consolidated Balance Sheets.
On September 30, 2002, the Company closed a new $500.0 million secured
revolving credit facility with a leading financial institution. The new facility
has a three-year term and bears interest at LIBOR + 1.50% to 2.25%, depending
upon the collateral contributed to the borrowing base. The new facility accepts
a broad range of structured finance and corporate tenant assets and has a final
maturity date of September 2005.
As of September 30, 2002, future expected/scheduled maturities of
outstanding long-term debt obligations are as follows (in thousands)(1):
2002 (remaining three months)............................... $ 16,282
2003........................................................ --
2004........................................................ 302,589
2005........................................................ 1,341,158
2006........................................................ 293,000
Thereafter.................................................. 1,451,949
----------
Total principal maturities.................................. 3,404,978
Net unamortized debt discounts.............................. (17,418)
----------
Total debt obligations...................................... $3,387,560
==========
EXPLANATORY NOTE:
- ------------------------
(1) Assumes exercise of extensions to the extent such extensions are at the
Company's option.
NOTE 8--SHAREHOLDERS' EQUITY
The Company's charter provides for the issuance of up to 200.0 million
shares of Common Stock, par value $0.001 per share, and 30.0 million shares of
preferred stock. The Company has 4.4 million shares of 9.50% Series A Cumulative
Redeemable Preferred Stock, 2.3 million shares of 9.375% Series B Cumulative
Redeemable Preferred Stock, 1.5 million shares of 9.20% Series C Cumulative
Redeemable Preferred Stock, and 4.6 million shares of 8.00% Series D Cumulative
Redeemable Preferred Stock. The Series A, B, C and D Cumulative Redeemable
Preferred Stock are redeemable without premium at the option of the Company at
their respective liquidation preferences beginning on December 15, 2003,
June 15, 2001, August 15, 2001 and October 8, 2002, respectively.
On December 15, 1998, the Company issued warrants to acquire 6.1 million
shares of Common Stock, as adjusted for dilution, at $34.35 per share. The
warrants are exercisable on or after December 15, 1999 at a price of $34.35 per
share and expire on December 15, 2005.
23
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--SHAREHOLDERS' EQUITY (CONTINUED)
CONCENTRATION OF SHAREHOLDER OWNERSHIP--On October 30, 2001, SOF IV SMT
Holdings, L.P. ("SOF IV") and certain of its affiliates sold 18.975 million
shares of Common Stock (including the subsequently exercised 2.475 million share
over-allotment option granted to the underwriters) owned by them. In addition,
on May 15, 2002, SOF IV sold 10.808 million shares of Common Stock (including
the subsequently exercised 808,200 share over-allotment option granted to the
underwriters) owned by them. The Company did not sell any shares in these
offerings. As a result of the secondary offerings, SOF IV currently owns
approximately 25.47% of the Company's Common Stock (based on the diluted
sharecount as of September 30, 2002).
STOCK REPURCHASE PROGRAM--The Board of Directors approved, and the Company
has implemented, a stock repurchase program under which the Company is
authorized to repurchase up to 5.0 million shares of its Common Stock from time
to time, primarily using proceeds from the disposition of assets or loan
repayments and excess cash flow from operations, but also using borrowings under
its credit facilities if the Company determines that it is advantageous to do
so. The only repurchase the Company has made under this program since
November 2000, has been 250,000 shares during the three months ended
September 30, 2002. As of September 30, 2002 and December 31, 2001, the Company
had repurchased approximately 2.6 million shares and 2.3 million shares,
respectively, at an aggregate cost of approximately $48.0 million and
$40.7 million, respectively.
DRIP PROGRAM--The Company maintains a dividend reinvestment and direct stock
purchase plan. Under the dividend reinvestment component of the plan, the
Company's shareholders may purchase additional shares of Common Stock without
payment of brokerage commissions or service charges by automatically reinvesting
all or a portion of their Common Stock cash dividends. Under the direct stock
purchase component of the plan, the Company's shareholders and new investors may
purchase shares of Common Stock directly from the Company without payment of
brokerage commissions or service charges. All purchases of shares in excess of
$10,000 per month pursuant to the direct purchase component are at the Company's
sole discretion. Shares issued under the plan may reflect a discount of up to
3.00% from the prevailing market price of the Company's Common Stock. The
Company is authorized to issue up to 8.0 million shares of Common Stock pursuant
to the dividend reinvestment and direct stock purchase plan. During the
three-month periods ended September 30, 2002 and 2001, the Company issued a
total of 369,609 and 11,239 shares of its Common Stock, respectively, and during
the nine-month periods ended September 30, 2002 and 2001, the Company issued a
total of 1,597,429 and 24,008 shares of its Common Stock, respectively, through
the direct stock purchase component of the plan. Net proceeds during the
three-month periods ended September 30, 2002 and 2001 were approximately
$10.4 million and $297,088, respectively, and $43.9 million and $624,149 during
the nine-month periods ended September 30, 2002 and 2001, respectively.
NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS
RISK MANAGEMENT--In the normal course of its on-going business operations,
the Company encounters economic risk. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or different bases, than its
interest-earning assets. Credit risk is the risk of default on the Company's
lending investments that results from a property's, borrower's or corporate
tenant's inability or unwillingness to make contractually required payments.
Market risk reflects changes in the value of loans due to changes in interest
rates or other market
24
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
factors, including the rate of prepayments of principal and the value of the
collateral underlying loans and the valuation of corporate tenant lease
facilities held by the Company.
USE OF DERIVATIVE FINANCIAL INSTRUMENTS--The Company's use of derivative
financial instruments is primarily limited to the utilization of interest rate
agreements or other instruments to manage interest rate risk exposure. The
principal objective of such arrangements is to minimize the risks and/or costs
associated with the Company's operating and financial structure as well as to
hedge specific anticipated transactions. The counterparties to these contractual
arrangements are major financial institutions with which the Company and its
affiliates may also have other financial relationships. The Company is
potentially exposed to credit loss in the event of nonperformance by these
counterparties. However, because of their high credit ratings, the Company does
not anticipate that any of the counterparties will fail to meet their
obligations.
The Company has entered into the following cash flow hedges that are
outstanding as of September 30, 2002. The net value (liability) associated with
these hedges is reflected on the Company's Consolidated Balance Sheets (in
thousands).
STRIKE ESTIMATED
NOTIONAL PRICE OR TRADE MATURITY VALUE AT
TYPE OF HEDGE AMOUNT SWAP RATE DATE DATE SEPTEMBER 30, 2002
- ------------- -------- --------- --------- -------- ------------------
Pay-Fixed Swap....... $125,000 7.058% 6/15/00 6/25/03 $(5,166)
Pay-Fixed Swap....... 125,000 7.055% 6/15/00 6/25/03 (5,163)
Pay-Fixed Swap....... 75,000 5.580% 11/4/99(1) 12/1/04 (5,890)
LIBOR Cap............ 345,000 8.000% 5/22/02 5/28/14 13,622
LIBOR Cap............ 75,000 7.750% 11/4/99(1) 12/1/04 35
LIBOR Cap............ 35,000 7.750% 11/4/99(1) 12/1/04 15
-------
Total Estimated Asset (Liability) Value........................... $(2,547)
=======
EXPLANATORY NOTE:
- ------------------------
(1) Acquired in connection with the TriNet Acquisition.
Between January 1, 2001 and September 30, 2002, the Company had outstanding
the following cash flow hedges that have expired or been settled (in thousands):
STRIKE
NOTIONAL PRICE OR TRADE MATURITY
TYPE OF HEDGE AMOUNT SWAP RATE DATE DATE
- ------------- -------- --------- -------- --------
LIBOR Cap.............................. $300,000 9.000% 3/16/98 3/16/01
Pay-Fixed Swap......................... 92,000 5.714% 8/10/98 3/1/01
LIBOR Cap.............................. 75,000 7.500% 7/16/98 6/19/01
LIBOR Cap.............................. 38,336 7.500% 4/30/98 6/1/01
In connection with STARs, Series 2002-1 in May 2002, the Company entered
into a LIBOR interest rate cap struck at 8.00% in the notional amount of
$345.0 million. The Company utilizes the provisions of SFAS No. 133 with respect
to such instruments. SFAS No. 133 provides that the up-front fees paid on
option-based products such as caps should be expensed into earnings based on the
allocation of the premium to the affected periods as if the agreement were a
series of "caplets." These allocated premiums are then reflected as a charge to
income (as part of interest expense) in the affected period.
25
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS (CONTINUED)
On May 28, 2002, in connection with the STARs, Series 2002-1 transaction,
the Company paid a premium of $13.7 million for an interest rate cap. Using the
"caplet" methodology discussed above, amortization of the cap premium is
dependent upon the actual value of the cap over time.
In connection with STARs, Series 2000-1 in May 2000, the Company entered
into a LIBOR interest rate cap struck at 10.00% in the notional amount of
$312.0 million, and simultaneously sold a LIBOR interest rate cap with the same
terms. Since these instruments did not change the Company's net interest rate
risk exposure, they did not qualify as hedges and changes in their respective
values were charged to earnings. As the terms of these arrangements were
substantially the same, the effects of a revaluation of these two instruments
substantially offset one another. On May 28, 2002, these instruments were
settled and are no longer outstanding.
During the year ended December 31, 1999, the Company refinanced its
$125.0 million term loan maturing March 15, 1999 with a $155.4 million term loan
maturing March 5, 2009. The new term loan bears interest at 7.44% per annum,
payable monthly, and amortizes over an approximately 22-year schedule. The new
term loan represented forecasted transactions for which the Company had
previously entered into U.S. Treasury-based hedging transactions. The net
$3.4 million cost of the settlement of such hedges has been deferred and is
being amortized as an increase to the effective financing cost of the new term
loan over its effective ten-year term.
CREDIT RISK CONCENTRATIONS--Concentrations of credit risks arise when a
number of borrowers or customers related to the Company's investments are
engaged in similar business activities, or activities in the same geographic
region, or have similar economic features that would cause their ability to meet
contractual obligations, including those to the Company, to be similarly
affected by changes in economic conditions. The Company regularly monitors
various segments of its portfolio to assess potential concentrations of credit
risks. Management believes the current credit risk portfolio is reasonably well
diversified and does not contain any unusual concentration of credit risks.
Substantially all of the Company's corporate tenant lease assets (including
those held by joint ventures) and loans and other lending investments are
collateralized by facilities located in the United States, with significant
concentrations (i.e., greater than 10.00%) as of September 30, 2002 in
California (23.19%), New York (11.33%) and Texas (11.06%). As of September 30,
2002, the Company's investments also contain greater than 10.00% concentrations
in the following asset types: office (46.56%), industrial (14.30%) and hotel
lending (11.58%).
The Company underwrites the credit of prospective borrowers and customers
and often requires them to provide some form of credit support such as corporate
guarantees, letters of credit and/or cash security deposits. Although the
Company's loans and other lending investments and corporate customer lease
assets are geographically diverse and the borrowers and customers operate in a
variety of industries, to the extent the Company has a significant concentration
of interest or operating lease revenues from any single borrower or customer,
the inability of that borrower or customer to make its payment could have an
adverse effect on the Company.
NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS
The Company's 1996 Long-Term Incentive Plan (the "Plan") is designed to
provide incentive compensation for officers, other key employees and directors
of the Company. The Plan provides for awards of stock options and shares of
restricted stock and other performance awards. The maximum number of shares of
Common Stock available for awards under the Plan is 9.00% of the outstanding
shares of Common Stock, calculated on a fully diluted basis, from time to time;
provided that the
26
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
number of shares of Common Stock reserved for grants of options designated as
incentive stock options is 5.0 million, subject to certain antidilution
provisions in the Plan. All awards under the Plan, other than automatic awards
to non-employee directors, are at the discretion of the Board or a committee of
the Board. At September 30, 2002, a total of approximately 8.2 million shares of
Common Stock were available for awards under the Plan, of which options to
purchase approximately 4.5 million shares of Common Stock were outstanding and
approximately 63,400 shares of restricted stock were outstanding.
In March 1998, the Company issued approximately 2.5 million (as adjusted)
fully vested and immediately exercisable options to purchase shares of Common
Stock at $14.72 per share (as adjusted) to its former advisor with a term of ten
years. The former advisor granted a portion of these options to its employees
and the remainder was allocated to an affiliate. Upon the acquisition of its
former advisor, these individuals became employees of the Company. In general,
the grants to these employees provided for scheduled vesting over a predefined
service period of three to five years and, under certain conditions, provide for
accelerated vesting. These options expire on March 15, 2008.
Changes in options outstanding during the nine months ended September 30,
2002 are as follows:
NUMBER OF SHARES
------------------------------------- AVERAGE
NON-EMPLOYEE STRIKE
EMPLOYEES DIRECTORS OTHER PRICE
--------- ------------- --------- --------
OPTIONS OUTSTANDING, DECEMBER 31, 2001.......... 3,783,222 296,379 1,036,163 $18.98
Granted in 2002............................. -- 90,000 -- $29.82
Exercised in 2002........................... (407,048) (104,400) (163,727) $18.33
Forfeited in 2002........................... (10,401) (4,600) -- $22.12
--------- -------- ---------
OPTIONS OUTSTANDING, SEPTEMBER 30, 2002......... 3,365,773 277,379 872,436
========= ======== =========
27
ISTAR FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--STOCK-BASED COMPENSATION PLANS AND EMPLOYEE BENEFITS (CONTINUED)
The following table summarizes information concerning outstanding and
exercisable options as of September 30, 2002:
OPTIONS
OPTIONS OUTSTANDING EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
OPTIONS CONTRACTUAL EXERCISE CURRENTLY EXERCISE
EXERCISE PRICE RANGE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------------- ----------- ----------- -------- ----------- --------
$14.72 - $15.00(1) 1,003,775 5.87 $14.72 755,180 $14.72
$16.69 - $16.88 733,240 7.27 $16.86 367,453 $16.87
$17.38 - $17.56 434,000 7.47 $17.39 251,501 $17.39
$19.50 - $19.69 1,593,144 8.33 $19.69 476,924 $19.69
$20.33 - $21.44 219,716 4.84 $21.00 164,417 $21.03
$22.44 13,333 8.01 $22.44 -- $ --
$23.32 - $23.64 44,073 1.62 $23.53 31,402 $23.52
$24.13 - $24.94 183,700 5.19 $24.54 183,034 $24.54
$25.10 - $26.09 14,800 3.99 $26.02 14,134 $26.06
$26.30 - $26.97 77,900 1.85 $26.80 76,567 $26.80
$27.00 25,000 8.73 $27.00 8,334 $27.00
$28.54 - $29.82 90,188 9.21 $29.68 90,188 $29.68
$30.33 67,275 0.91 $30.33 67,275 $30.33
$33.15 - $33.70 10,350 0.22 $33.39 10,350 $33.39
$55.39 5,094 6.67 $55.39 5,094 $55.39
--------- ---- ------ --------- ------
4,515,588 6.93 $18.83 2,501,853 $19.09
========= ==== ====== ========= ======
EXPLANATORY NOTE:
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(1) Includes approximately 764,000 options which were granted, on a fully
exercisable basis, in March 1998, and which are now held by an affiliate of
SOF IV. Beneficial interests in these options were subsequently regranted by
that affiliate to employees of it and its affiliates, subject to vesting
requirements. In the event that these employees forfeit such options, they
revert to an affiliate of SOF IV, which may regrant them at its discretion.
As of September 30, 2002, approximately 416,000 of these options have become
exercisable by the beneficial owners. Of this total, approximately 286,000
have been exercised as of September 30, 2002.
In the third quarter 2002, the Company adopted the fair value method for
accounting for options issued to employees or directors, as allowed under
Statement of Financial Accounting Standards No. 123 (