ISTAR FINANCIAL INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
OR
o	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

iSTAR FINANCIAL INC.
(Exact name of registrant as specified in its charter)

Maryland (State or other jurisdiction of incorporation or organization)		95-6881527 (I.R.S. Employer Identification Number)
1114 Avenue of the Americas, 27^th Floor New York, NY (Address of principal executive offices)		10036 (Zip code)

Registrant's telephone number, including area code: (212) 930-9400

Securities registered pursuant to Section 12(b) of the Act:

Title of each class:		Name of Exchange on which registered:
Common Stock, $0.001 par value		New York Stock Exchange
8.000% Series D Cumulative Redeemable		New York Stock Exchange
Preferred Stock, $0.001 par value
7.875% Series E Cumulative Redeemable		New York Stock Exchange
Preferred Stock, $0.001 par value
7.800% Series F Cumulative Redeemable		New York Stock Exchange
Preferred Stock, $0.001 par value
7.650% Series G Cumulative Redeemable		New York Stock Exchange
Preferred Stock, $0.001 par value
7.500% Series I 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 ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12-b-2). Yes ý No o

As of May 3, 2005, there were 112,492,439 shares of common stock of iStar Financial Inc. $0.001/par value per share outstanding ("Common Stock").

iStar Financial Inc.
Index to Form 10-Q

		Page
Part I.	Consolidated Financial Information	2
Item 1.	Financial Statements:
	Consolidated Balance Sheets at March 31, 2005 and December 31, 2004	2
	Consolidated Statements of Operations—For each of the three months ended March 31, 2005 and 2004	3
	Consolidated Statements of Changes in Shareholders' Equity—For the three months ended March 31, 2005	4
	Consolidated Statements of Cash Flows—For each of the three months ended March 31, 2005 and 2004	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and the Results of Operations	45
Item 4.	Controls and Procedures	60
Part II.	Other Information	61
Item 1.	Legal Proceedings	61
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	61
Item 3.	Defaults Upon Senior Securities	61
Item 4.	Submission of Matters to a Vote of Security Holders	61
Item 5.	Other Information	61
Item 6.	Exhibits	61
SIGNATURES		63

Part I. Consolidated Financial Information

Item 1. Financial Statements

iStar Financial Inc.

Consolidated Balance Sheets

(In thousands, except per share data)

(unaudited)

		As of March 31, 2005			As of December 31, 2004*
ASSETS
Loans and other lending investments, net		$	4,311,033		$	3,946,189
Corporate tenant lease assets, net			2,974,638			2,877,042
Other investments			192,267			75,092
Investments in joint ventures			5,504			5,663
Cash and cash equivalents			270,503			88,422
Restricted cash			45,702			39,568
Accrued interest and operating lease income receivable			32,058			25,633
Deferred operating lease income receivable			66,177			62,092
Deferred expenses and other assets			91,959			100,536
Goodwill			7,746			—

	Total assets	$	7,997,587		$	7,220,237

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, accrued expenses and other liabilities		$	144,127		$	140,075
Debt obligations			5,316,627			4,605,674

	Total liabilities		5,460,754			4,745,749

Commitments and contingencies			—			—
Minority interest in consolidated entities			20,117			19,246
Shareholders' equity:
Series D Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 4,000 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively			4			4
Series E Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 5,600 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively			6			6
Series F Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 4,000 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively			4			4
Series G Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 3,200 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively			3			3
Series I Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 5,000 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively			5			5
High Performance Units			8,774			7,828
Common Stock, $0.001 par value, 200,000 shares authorized, 111,494 and 111,432 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively			111			111
Warrants and options			6,458			6,458
Additional paid-in capital			2,842,083			2,840,062
Retained earnings (deficit)			(289,358	)		(349,097	)
Accumulated other comprehensive income (losses) (See Note 14)			(3,318	)		(2,086	)
Treasury stock (at cost)			(48,056	)		(48,056	)

	Total shareholders' equity		2,516,716			2,455,242

	Total liabilities and shareholders' equity	$	7,997,587		$	7,220,237

*: Reclassified to conform to 2005 presentation.

The accompanying notes are an integral part of the financial statements.

iStar Financial Inc.
Consolidated Statements of Operations
(In thousands, except per share data)
(unaudited)

			For the Three Months Ended March 31,
			2005			2004
Revenue:
	Interest income		$	92,360		$	83,057
	Operating lease income			77,125			66,026
	Other income			12,013			11,941

		Total revenue		181,498			161,024

Costs and expenses:
	Interest expense			68,951			52,486
	Operating costs—corporate tenant lease assets			5,735			4,713
	Depreciation and amortization			17,875			14,859
	General and administrative			15,361			13,359
	General and administrative—stock-based compensation expense			642			107,541
	Provision for loan losses			2,250			3,000
	Loss on early extinguishment of debt			—			12,172

		Total costs and expenses		110,814			208,130

Income (loss) before equity in earnings from joint ventures, minority interest and other items				70,684			(47,106	)
Equity in earnings (loss) from joint ventures				(160	)		6,248
Minority interest in consolidated entities				(205	)		(133	)

Income (loss) from continuing operations				70,319			(40,991	)
Income from discontinued operations				—			5,739
Gain from discontinued operations				—			136

Net income (loss)				70,319			(35,116	)
Preferred dividend requirements				(10,580	)		(19,600	)

Net income (loss) allocable to common shareholders and HPU holders(1)			$	59,739		$	(54,716	)

Basic earnings per common share(2)			$	0.52		$	(0.50	)

Diluted earnings per common share(3)			$	0.52		$	(0.50	)

Explanatory Notes:

(1): HPU holders are Company employees who purchased high performance common stock units under the Company's High Performance Unit Program.
(2): For the three months ended March 31, 2005 and 2004, excludes $1,483 and $(905) of net income (loss) allocable to HPU holders, respectively.
(3): For the three months ended March 31, 2005 and 2004, excludes $1,468 and $(905) of net income (loss) allocable to HPU holders, respectively.
The accompanying notes are an integral part of the financial statements.

iStar Financial Inc.
Consolidated Statements of Changes in Shareholders' Equity
(In thousands)
(unaudited)

	Series D Preferred Stock		Series E Preferred Stock		Series F Preferred Stock		Series G Preferred Stock		Series I Preferred Stock		HPU's		Common Stock at Par		Warrants & Options		Additional Paid-In Capital		Retained Earnings (Deficit)			Accumulated Other Comprehensive Income (Losses)			Treasury Stock			Total
Balance at December 31, 2004	$	4	$	6	$	4	$	3	$	5	$	7,828	$	111	$	6,458	$	2,840,062	$	(349,097	)	$	(2,086	)	$	(48,056	)	$	2,455,242
Exercise of options and warrants		—		—		—		—		—		—		—		—		605		—			—			—			605
Dividends declared-preferred		—		—		—		—		—		—		—		—		—		(10,580	)		—			—			(10,580	)
Restricted stock units granted to employees		—		—		—		—		—		—		—		—		935		—			—			—			935
High performance units sold to employees		—		—		—		—		—		946		—		—		—		—			—			—			946
Issuance of stock-DRIP/Stock purchase plan		—		—		—		—		—		—		—		—		481		—			—			—			481
Net income for the period		—		—		—		—		—		—		—		—		—		70,319			—			—			70,319
Change in accumulated other comprehensive income (losses)		—		—		—		—		—		—		—		—		—		—			(1,232	)		—			(1,232	)

Balance at March 31, 2005	$	4	$	6	$	4	$	3	$	5	$	8,774	$	111	$	6,458	$	2,842,083	$	(289,358	)	$	(3,318	)	$	(48,056	)	$	2,516,716

The accompanying notes are an integral part of the financial statements.

iStar Financial Inc.
Consolidated Statements of Cash Flows
(In thousands)
(unaudited)

			For the Three Months Ended March 31,
			2005			2004
Cash flows from operating activities:
Net income (loss)			$	70,319		$	(35,116	)
Adjustments to reconcile net income (loss) to cash flows provided by operating activities:
	Minority interest in consolidated entities			205			133
	Non-cash expense for stock-based compensation			713			51,438
	Depreciation and amortization			18,283			14,859
	Depreciation and amortization from discontinued operations			—			1,191
	Amortization of deferred financing costs			7,526			7,765
	Amortization of discounts/premiums, deferred interest and costs on lending investments			(18,719	)		(15,865	)
	Discounts, loan fees and deferred interest received			39,392			10,640
	Equity in earnings (loss) from joint ventures			160			(6,248	)
	Distributions from operations of joint ventures			—			74
	Loss on early extinguishment of debt			—			12,172
	Deferred operating lease income receivable			(3,987	)		(5,465	)
	Gain from discontinued operations			—			(136	)
	Provision for loan losses			2,250			3,000
Changes in assets and liabilities:
		Changes in accrued interest and operating lease income receivable		(4,543	)		228
		Changes in deferred expenses and other assets		9,912			8,012
		Changes in accounts payable, accrued expenses and other liabilities		(18,859	)		42,747

		Cash flows from operating activities		102,652			89,429

Cash flows from investing activities:
	New investment originations			(841,647	)		(710,835	)
	Cash paid for acquisition of Falcon Financial			(113,696	)		—
	Add-on fundings under existing loan commitments			(93,204	)		(16,647	)
	Net proceeds from sale of corporate tenant lease assets			—			2,822
	Repayments of and principal collections on loans and other lending investments			422,128			144,880
	Capital improvement projects on corporate tenant lease assets			(3,854	)		(1,373	)
	Other capital expenditures on corporate tenant lease assets			(2,139	)		(2,554	)

		Cash flows from investing activities		(632,412	)		(583,707	)

	Cash flows from financing activities:
	Borrowings under secured revolving credit facilities			510,000			1,031,335
	Repayments under secured revolving credit facilities			(560,552	)		(1,197,070	)
	Borrowings under unsecured revolving credit facilities			1,154,000			—
	Repayments under unsecured revolving credit facilities			(1,381,000	)		(130,000	)
	Borrowings under term loans			3,814			198,771
	Repayments under term loans			(2,890	)		(255,082	)
	Borrowings under unsecured bond offerings			1,090,477			1,007,575
	Repayments under unsecured notes			—			(110,000	)
	Repayments under secured bond offerings			(86,835	)		(70,514	)
	Repayments under other debt obligations			—			(10,148	)
	Contribution from minority interest partner			1,038			—
	Changes in restricted cash held in connection with debt obligations			(6,134	)		(9,708	)
	Prepayment penalty on early extinguishment of debt			—			(9,625	)
	Payments for deferred financing costs			(1,132	)		(1,246	)
	Distributions to minority interest in consolidated entities			(373	)		(208	)
	Net proceeds from preferred offering/exchange			—			203,048
	Redemption of preferred stock			—			(165,000	)
	Preferred dividends paid			(10,580	)		(9,778	)
	HPUs issued			946			2,252
	Contribution from significant shareholder			—			1,935
	Proceeds from exercise of options and issuance of DRIP/Stock purchase shares			1,062			25,283

		Cash flows from financing activities		711,841			501,820

Increase in cash and cash equivalents				182,081			7,542
Cash and cash equivalents at beginning of period				88,422			80,090

Cash and cash equivalents at end of period			$	270,503		$	87,632

Supplemental disclosure of cash flow information:
	Cash paid during the period for interest, net of amount capitalized		$	64,935		$	45,965

The accompanying notes are an integral part of the financial statements.

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 custom-tailored financing to high-end private and corporate owners of real estate, including senior and junior mortgage debt, senior and mezzanine corporate capital, and corporate net lease financing. The Company, which is taxed as a real estate investment trust ("REIT"), seeks to deliver strong dividends and superior risk-adjusted returns on equity to shareholders by providing the highest quality financing 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. 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, 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 March 31, 2005, based on gross carrying values, the Company's structured finance assets represented 28.6% 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 March 31, 2005, based on gross carrying values, the Company's portfolio finance assets represented 11.5% 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 March 31, 2005, based on gross carrying values, the Company's corporate finance assets represented 9.2% 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 March 31, 2005, based on gross carrying values, the Company's loan acquisition assets represented 5.2% of its assets.
•: Corporate Tenant Leasing. The Company provides capital to corporations and borrowers who control facilities leased to single creditworthy customers. The Company's net leased assets are generally mission-critical headquarters or distribution facilities that are subject to long-term leases with public companies, many of which are rated corporate credits and which provide for all expenses at the facility to be paid by the corporate customer on a triple net lease basis. Corporate tenant lease ("CTL") transactions have terms generally ranging from ten to 20 years and typically

range in size from $20 million to $150 million. As of March 31, 2005, based on gross carrying values, the Company's CTL assets (including investments in joint ventures) represented 40.9% of its assets.

The Company's investment strategy targets specific sectors of the real estate credit markets in which it believes it can deliver the highest quality, 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 and "one-call" responsiveness post-closing.
•: 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 in addition to sourcing transactions through intermediaries.
•: Adding value beyond simply providing capital by offering borrowers and corporate customers expertise in multiple markets, flexibility, certainty and long-term relationships.
•: Taking advantage of market anomalies in the real estate and corporate financing markets when the Company believes credit is mispriced by other providers of capital.

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"), 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.

In March 2005, in connection with the amendment of certain covenants in the 7.95% TriNet Notes due 2006, the Company merged TriNet into the Company. As of March 31, 2005, TriNet no longer exists.

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 10-01 of Regulation S-X for interim financial statements. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles in the United States of America ("GAAP") for complete financial statements. The Consolidated Financial Statements include the accounts of the Company, its qualified REIT subsidiaries, its majority-owned and controlled partnerships and other entities that are consolidated under the provisions of FASB Interpretation No. 46 ("FIN 46")(see Note 6).

Certain other investments in partnerships or joint ventures which the Company does not control are accounted for under the equity method (see Note 6). All significant intercompany balances and transactions have been eliminated in consolidation.

In the opinion of management, the accompanying Consolidated Financial Statements contain all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the Company's consolidated financial position at March 31, 2005 and December 31, 2004 and the results of its operations, changes in shareholders' equity and its cash flows for the three months ended March 31, 2005 and 2004, respectively. Such operating results may not be indicative of the expected results for any other interim periods or the entire year.

Note 3—Summary of Significant Accounting Policies

Loans and other lending investments—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 loans 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. Items classified as available-for-sale are reported at fair values with unrealized gains and losses included in "Accumulated other comprehensive income (losses)" on the Company's Consolidated Balance Sheets and are not included in the Company's net income.

Corporate tenant lease assets and depreciation—CTL 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 the shorter of estimated useful lives or 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.

CTL assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell and are included in "Assets held for sale" on the Company's Consolidated Balance Sheets. The Company also periodically reviews long-lived assets to be held and used for an impairment in value w