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TABLE OF CONTENTS

Table of Contents

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

FORM 10-Q

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

For the quarterly period ended March 31, 2010

Commission File Number: 001-32330

NORTHSTAR REALTY FINANCE CORP.
(Exact Name of Registrant as Specified in its Charter)

Maryland
(State or Other Jurisdiction of
Incorporation or Organization)
  11-3707493
(IRS Employer
Identification No.)

399 Park Avenue, 18th Floor New York, NY 10022
(Address of Principal Executive Offices, Including Zip Code)

(212) 547-2600
(Registrant's Telephone Number, Including Area Code)

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

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

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

Large accelerated filer o   Accelerated filer ý   Non-accelerated filer o
(Do not check if a
smaller reporting company)
  Smaller reporting company o

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

        Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:

        The Company has one class of common stock, par value $0.01 per share, 75,426,625 shares outstanding as of May 5, 2010.


Table of Contents


NORTHSTAR REALTY FINANCE CORP.

QUARTERLY REPORT

For the Three Months Ended March 31, 2010

TABLE OF CONTENTS

Index
   
  Page
 

Part I.

 

Financial Information

   
 

Item 1.

 

Financial Statements

   
 

 

Condensed Consolidated Balance Sheets as of March 31, 2010 (unaudited) and December 31, 2009

  3
 

 

Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2010 and March 31, 2009

  4
 

 

Condensed Consolidated Statements of Stockholders' Equity as of March 31, 2010 (unaudited) and December 31, 2009

  5
 

 

Unaudited Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2010 and March 31, 2009

  6
 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and March 31, 2009

  7
 

 

Notes to the Condensed Consolidated Financial Statements (unaudited)

  8
 

Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

  43
 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

   
 

Item 4.

 

Controls and Procedures

  67
 

Part II.

 

Other Information

 
68
 

Item 1.

 

Legal Proceedings

   
 

Item 6.

 

Exhibits

  68
 

Signatures

 
72

2


Table of Contents


NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in Thousands, Except Share Data)

 
  March 31,
2010
  December 31,
2009
 
 
  (unaudited)
   
 

ASSETS:

             

Cash and cash equivalents

  $ 116,771   $ 138,928  

Restricted cash (includes $87,895 and $74,453 from consolidated VIEs, respectively)

    135,381     129,180  

Operating real estate—net

    963,228     978,902  

Available for sale securities, at fair value (includes $1,198,123 and $283,184 from consolidated VIEs, respectively)

    1,249,484     336,220  

Real estate debt investments, net (includes $1,282,138 and $1,356,038 from consolidated VIEs, respectively)

    1,864,790     1,936,482  

Real estate debt investments, held-for-sale (includes $40,515 and $- from consolidated VIEs, respectively)

    40,515     611  

Investments in and advances to unconsolidated ventures

    40,178     38,299  

Receivables, net of allowance of $103 in 2010 and $1,349 in 2009 (includes net $17,777 and $7,421 from consolidated VIEs, respectively)

    25,061     17,912  

Unbilled rents receivable

    10,730     10,206  

Derivative instruments, at fair value (includes $57 and $- from consolidated VIEs, respectively)

    57      

Deferred costs and intangible assets, net

    57,446     57,551  

Other assets (includes $3,454 and $2,888 from consolidated VIEs, respectively)

    24,174     25,273  
           

Total assets

  $ 4,527,815   $ 3,669,564  
           

LIABILITIES:

             

Mortgage notes and loans payable

    796,648     795,915  

Exchangeable senior notes

    126,204     125,992  

Bonds payable, at fair value (includes $1,178,610 and $584,615 from consolidated VIEs, respectively)

    1,178,610     584,615  

Secured term loans

    386,952     368,865  

Liability to subsidiary trusts issuing preferred securities, at fair value

    190,846     167,035  

Obligations under capital leases

    3,519     3,527  

Accounts payable and accrued expenses (includes $5,025 and $1,631 from consolidated VIEs, respectively)

    26,847     30,071  

Escrow deposits payable (includes $28,410 and $28,608 from consolidated VIEs, respectively)

    39,261     39,461  

Derivative liability, at fair value (includes $124,563 and $46,187 from consolidated VIEs, respectively)

    147,447     67,044  

Other liabilities (includes $387 and $358 from consolidated VIEs, respectively)

    26,584     28,399  
           

Total liabilities

    2,922,918     2,210,924  

EQUITY:

             

NorthStar Realty Finance Corp. Stockholders' Equity:

             

8.75% Series A preferred stock, $0.01 par value, $25 liquidation preference per share, 2,400,000 shares issued and outstanding at March 31, 2010 and December 31, 2009, respectively

    57,867     57,867  

8.25% Series B preferred stock, $0.01 par value, $25 liquidation preference per share, 7,600,000 shares issued and outstanding at March 31, 2010 and December 31, 2009, respectively

    183,505     183,505  

Common stock, $0.01 par value, 500,000,000 shares authorized, 75,425,755 and 74,882,600 shares issued and outstanding at March 31, 2010 and December 31, 2009, respectively

    754     749  

Additional paid-in capital

    668,441     662,805  

Retained earnings

    550,439     460,915  

Accumulated other comprehensive loss

    (50,595 )   (92,670 )
           
   

Total NorthStar Realty Finance Corp. Stockholders' Equity

    1,410,411     1,273,171  

Non-controlling interest

    194,486     185,469  
           
 

Total equity

    1,604,897     1,458,640  
           

Total liabilities and stockholders' equity

  $ 4,527,815   $ 3,669,564  
           

See accompanying notes to condensed consolidated financial statements

3


Table of Contents


NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 
  Three Months Ended
March 31,
2010
  Three Months Ended
March 31,
2009
 

Revenues and other income:

             

Interest income

  $ 57,575   $ 36,781  

Interest income—related parties

    621     4,507  

Rental and escalation income

    21,780     25,176  

Advisory and management fee income—related parties

    518     1,691  

Other revenue

    1,055     168  
           
     

Total revenues

    81,549     68,323  

Expenses:

             
   

Interest expense

    32,073     33,187  
   

Real estate properties—operating expenses

    1,769     2,127  
   

Asset management fees—related parties

    466     853  
   

Provision for loan losses

    36,316     21,462  

General and administrative:

             
   

Salaries and equity-based compensation(1)

    16,532     11,610  
   

Auditing and professional fees

    2,940     2,261  
   

Other general and administrative

    4,012     3,568  
           
     

Total general and administrative

    23,484     17,439  

Depreciation and amortization

    8,483     14,285  
           
     

Total expenses

    102,591     89,353  

(Loss) from operations

    (21,042 )   (21,030 )

Equity in earnings/(loss) of unconsolidated ventures

    1,349     (4,418 )

Unrealized (loss)/gain on investments and other

    (1,843 )   90,661  

Realized gain on investments and other

    1,433     36,913  
           

(Loss)/income from continuing operations

    (20,103 )   102,126  

Income from discontinued operations

        605  
           

Consolidated net (loss)/income

    (20,103 )   102,731  
 

Net income (loss) attributable to the non-controlling interests

    411     (12,864 )

Preferred stock dividends

    (5,231 )   (5,231 )
           

Net (loss)/income attributable to NorthStar Realty Finance Corp. common stockholders

  $ (24,923 ) $ 84,636  
           

Net (loss)/income per share from continuing operations (basic/diluted)

    (0.33 )   1.31  

Income per share from discontinued operations (basic/diluted)

        0.01  
           

Net (loss)/income attributable to NorthStar Realty Finance Corp. common stockholders (basic/diluted)

  $ (0.33 ) $ 1.32  
           

Weighted average number of shares of common stock:

             
   

Basic

    75,068,654     64,348,264  
   

Diluted

    82,217,223     72,255,413  

(1)
The three months ended March 31, 2010 and 2009 include $5,058 and $5,144, respectively, of equity-based compensation expense. The three months ended March 31, 2010 includes $3,583 of cash compensation expense and $1,014 of equity based compensation expense relating to a separation and consulting agreement with a former executive.

See accompanying notes to condensed consolidated financial statements

4


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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Amounts in Thousands)

(Unaudited)

 
  Preferred
Stock
at Par
  Shares
of
Common
Stock
  Common
Stock
at Par
  Additional
Paid-in
Capital
  Treasury
Stock
  Accumulated
Other
Comprehensive
Income (Loss)
  Retained
Earnings
  Total
NorthStar
Stockholders
Equity
  Non-controlling
Interests
  Total
Stockholders
Equity
 

Balance at December 31, 2008

  $ 100     62,907   $ 634   $ 861,300     (1,384 ) $ (94,343 ) $ 648,860   $ 1,415,167   $ 198,593   $ 1,613,760  

Equity component of exchangeable senior notes

                (4,321 )               (4,321 )       (4,321 )

Equity component of warrants

                117                 117         117  

Dividend reinvestment and stock purchase plan

        80     1     276                 277         277  

Proceeds from equity distribution agreement

        7,327     69     23,995     1,384             25,448         25,448  

Stock awards/LTIP awards

          94     1     300                 301     20,172     20,473  

Restricted share grant

        15         1                 1         1  

Comprehensive loss

                        1,673         1,673     199     1,872  

Conversion of OP/LTIP units

        744     7     12,013                 12,020     (12,020 )    

Stock dividends

        3,716     37     10,610             (9,607 )   1,040     (1,040 )    

Cash dividends on common stock

                            (27,133 )   (27,133 )   (15,957 )   (43,090 )

Cash dividends on preferred stock

                            (20,925 )   (20,925 )       (20,925 )

Redemption of membership interest

                (214 )               (214 )       (214 )

Equity in private fund

                                                    1,815     1,815  

Net income

                            (130,280 )   (130,280 )   (6,293 )   (136,573 )
                                           

Balance at December 31, 2009

  $ 100     74,883   $ 749   $ 904,077   $   $ (92,670 ) $ 460,915   $ 1,273,171   $ 185,469   $ 1,458,640  
                                           

VIE consolidation begining balance adjustment

                        41,332     121,935     163,267     20,329     183,596  

Amortization of deferred compensation

                4                 4         4  

Dividend reinvestment and stock purchase plan

        24         27                 27         27  

Stock awards/LTIP awards

                                    5,054     5,054  

Restricted share grant

                                         

Comprehensive loss

                        743         743     95     838  

Conversion of OP/LTIP units

        519     5     7,412                 7,417     (7,417 )    

Cash dividends on common stock

                            (7,488 )   (7,488 )   (5,993 )   (13,481 )

Cash dividends on preferred stock

                            (5,231 )   (5,231 )   (2,625 )   (7,856 )

Redemption of membership interest

                (1,807 )               (1,807 )   1,800     (7 )

Equity in private fund

                                                    (1,815 )   (1,815 )

Net income

                            (19,692 )   (19,692 )   (411 )   (20,103 )
                                           

Balance at March 31, 2010

  $ 100     75,426   $ 754   $ 909,713   $   $ (50,595 ) $ 550,439   $ 1,410,411   $ 194,486   $ 1,604,897  
                                           

See accompanying notes to condensed consolidated financial statements

5


Table of Contents


NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in Thousands)

(Unaudited)

 
  Three Months Ended
March 31,
2010
  Three Months Ended
March 31,
2009
 

Consolidated net (loss)/income

  $ (20,103 ) $ 102,731  

Unrealized (loss) on available for sale securities

    (44 )   (15,860 )

Change in fair value of derivatives

    (857 )   979  

Reclassification adjustment for gains included in net income

   
1,739
   
1,397
 
           

Comprehensive (loss)/income

    (19,265 )   89,247  
 

Less: Comprehensive income attributable to non-controlling interests

    (71 )   11,393  
           

Comprehensive (loss)/income attributable to NorthStar Realty Finance Corp. 

  $ (19,195 ) $ 77,854  
           

See accompanying notes to condensed consolidated financial statements

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in Thousands)

(Unaudited)

 
  Three Months Ended
March 31, 2010
  Three Months Ended
March 31, 2009
 

Net cash (used in) provided by operating activities

  $ (3,929 ) $ 8,863  

Cash flows from investing activities:

             

Improvement of Operating real estate

    (402 )   (1,299 )

Acquisition of available for sale securities

    (87,355 )   (17,114 )

Proceeds from disposition of securities available for sale

    38,884     16,501  

Available for sale securities repayments

    6,240     216  

Originations/acquisitions of real estate debt investments

    (10,320 )   (121,677 )

Real estate debt investment repayments

    24,536     6,622  

Proceeds from the sale of real estate debt investments

    611     101,513  

Real estate debt investment acquisition costs

        (116 )

Other loans receivable

        (1,070 )

Restricted cash used for investment activities

    (1,989 )   (443 )

Deferred lease costs

    (220 )    

Investment in and advances to unconsolidated ventures

    (502 )    

Distributions from unconsolidated ventures

    2,109     6,952  
           

Net cash (used in) investing activities

    (28,408 )   (9,915 )

Cash flows from financing activities:

             

Purchase of interest rate cap

    (243 )    

Settlement of derivative

    (283 )    

Collateral held by swap counter party

    4,749     3,709  

Mortgage notes and loan borrowings

    58,200      

Mortgage principal repayments

    (52,733 )   (2,207 )

Borrowing under credit facilities

        1,912  

Repayments credit facilities

        (33,568 )

Repurchase obligation borrowings

        528  

Repurchase obligation repayments

        (175 )

Proceeds from bonds

    9,000     60,000  

Bond repayments

    (13,225 )    

Borrowing under secured term loan

    24,631     1,373  

Secured term loan repayment

    (1,345 )   (1,365 )

Bond repurchases

    (218 )   (25,830 )

Payment of deferred financing costs

    (1,348 )    

Restricted cash from financing activities

    352     (1,081 )

Proceeds from dividend reinvestment and stock purchase plan

    89     14  

Dividends (common and preferred) and distributions

    (12,720 )   (11,376 )

Deferred offering costs

    (1,100 )    

Offering costs

    (69 )    

Distributions to non-controlling interest

    (3,557 )   (3,578 )
           

Net cash provided by (used in) financing activities

    10,180     (11,644 )

Net (decrease) increase in cash & cash equivalents

    (22,157 )   (12,696 )

Cash and cash equivalents—beginning of period

    138,928     134,039  
           

Cash and cash equivalents—end of period

  $ 116,771   $ 121,343  
           

See accompanying notes to condensed consolidated financial statements

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Amount in Thousands, Except per Share Data

(Unaudited)

1. Formation and Organization

        NorthStar Realty Finance Corp., a Maryland corporation (the "Company"), is a self-administered and self-managed real estate investment trust ("REIT"), which was formed in October 2003 in order to continue and expand the real estate debt, real estate securities and net lease businesses conducted by NorthStar Capital Investment Corp. ("NCIC"). Substantially all of the Company's assets are held by, and it conducts its operations through, NorthStar Realty Finance Limited Partnership, a Delaware limited partnership and the operating partnership of the Company (the "Operating Partnership"). On October 29, 2004, the Company closed its initial public offering pursuant to which it issued 20,000,000 shares of common stock, with proceeds to the Company of approximately $160.1 million, net of issuance costs of $19.9 million. Simultaneously with the closing of the equity offering on October 29, 2004, three majority-owned subsidiaries of NCIC contributed certain controlling and non-controlling interests in entities through which NCIC conducted its subordinate real estate debt, real estate securities and net lease businesses to the Operating Partnership in exchange for an aggregate of 4,705,915 units of limited partnership interest in the Operating Partnership (the "OP Units") and approximately $36.1 million in cash and an agreement to pay certain related transfer taxes on behalf of NCIC for approximately $1.0 million. From their inception through October 29, 2004, neither the Company nor the Operating Partnership had any operations.

Consolidating Subsidiaries

NRF Healthcare, LLC

        In May 2006, the Company entered into joint venture called NRF Healthcare, LLC with Chain Bridge Capital LLC to invest in senior housing and healthcare-related net leased assets. In connection with the formation of the venture, Chain Bridge contributed substantially all of its assets to NRF Healthcare, LLC for its $15.1 million membership interest in the joint venture.

        In July 2008, NRF Healthcare, LLC sold a $100 million convertible preferred membership interest to Inland American Real Estate Trust, Inc. ("Inland American"). The Company received approximately $87.7 million of net proceeds from the transaction. Prior to conversion, the convertible preferred investment is entitled to a 10.5% dividend per annum. The convertible preferred membership interest may be converted or redeemed, at Inland American's option, upon the sale or recapitalization of NRF Healthcare, LLC. NRF Healthcare, LLC may, at its option, redeem the convertible preferred interests at any time following the first anniversary of the closing, subject to payment of a call premium that declines over time. In addition, at any time after the second anniversary of the closing, Inland American may convert its preferred membership interests into common equity in NRF Healthcare, LLC. Based on the initial investment amount and capital accounts of the members of NRF Healthcare, LLC, the convertible preferred membership interests represent, upon conversion, approximately a 42% common equity ownership interest in NRF Healthcare, LLC. Inland American will have the option of contributing additional preferred membership interest and participating in new NRF Healthcare, LLC investment opportunities in proportion to its percentage ownership interest, assuming it was to convert its interests to common equity.

        In December 2009, the Company completed a membership interest redemption with NRF Healthcare, LLC, NRFC Healthcare Holding Company, LLC, NorthStar Healthcare Investors, Inc.,

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

1. Formation and Organization (Continued)


Chain Bridge, Wakefield Capital Management, Midwest Care Holdings LLC, or Midwest Holdings, and certain individuals, pursuant to which NRF Healthcare, LLC redeemed the 5.4% membership interest of Chain Bridge and its affiliates in NRF Healthcare, LLC for $2.0 million and its membership interest in certain assets. As a result of the redemption, NorthStar holds 100% of the common equity membership interests in NRF Healthcare, LLC.

2. Summary of Significant Accounting Policies

Basis of Quarterly Presentation

        The accompanying condensed consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under accounting principles generally accepted in the United States have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of the Company's financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These financial statements should be read in conjunction with the Company's consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2009, which was filed with the Securities and Exchange Commission. Capitalized terms used herein, and not otherwise defined, are defined in the Company's December 31, 2009 consolidated financial statements included in its annual report on Form 10-K.

Principles of Consolidation

        The consolidated financial statements include the accounts of the Company, and its subsidiaries, which are either majority owned or controlled by the Company or a variable interest entity ("VIE") where the Company is the primary beneficiary. All significant intercompany balances have been eliminated in consolidation.

Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that could affect the amounts reported in the condensed consolidated financial statements. Actual results could differ from these estimates.

Reclassifications

        Certain prior period amounts have been reclassified to conform to the current period presentation.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

2. Summary of Significant Accounting Policies (Continued)

Recent Accounting Pronouncements

        In January 2010, the Financial Accounting Standards Board ("FASB") issued guidance requiring additional disclosures about fair value measurements regarding transfers between fair value categories as well as purchases, sales, issuances and settlements related to fair value measurements of financial instruments with non-observable inputs. This update was effective and was adopted without a material impact on the Company's financial condition or results of operations for interim and annual periods beginning after December 15, 2009 except for disclosures about purchases, sales, issuances and settlements of financial instruments with non-observable inputs, which are effective for years beginning after December 15, 2010. The additional disclosures required by this update will be included in the note on fair value measurements upon adoption. The Company does not expect these additional disclosures to have a material impact on its financial condition or results of operations.

3. Variable Interest Entities

        On January 1, 2010, the Company adopted the FASB guidance for determining whether an entity is a variable interest entity, or VIE, and which requires an analysis of qualitative rather than quantitative factors to determine the primary beneficiary of a VIE. The guidance requires an entity to consolidate a VIE if (i) it has the power to direct the activities that most significantly impact the VIE's economic performance and (ii) the obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. As a result of the implementation of this pronouncement, the Company consolidated four of its previously off-balance sheet CDO financings, which are referred to as N-Star I, II, III and V. The Company has elected the fair value option of accounting for the available for sale securities and bonds payable of these entities for the purpose of enhancing the transparency of its financial condition.

        The following tables present the cumulative effects of the change in accounting principle as of January 1, 2010 (in thousands):

 
  As
Reported,
December 31, 2009
  As Adjusted,
January 1, 2010
  Effect of Change in
Accounting Principle
 

Non-controlling interest

  $ 185,469   $ 205,798   $ 20,329  

Retained earnings

    460,915     582,850     121,935  

Accumulated other comprehensive loss

    (92,670 )   (51,338 )   41,332  

        The Company has evaluated its real estate debt investments, liability to subsidiary trusts issuing preferred securities and its investments in each of its eight CDO transaction issuers to determine whether they are a variable interest entity ("VIE"). A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. For each of these investments, the Company has evaluated: (1) the sufficiency of the fair value of the entity's equity investment at risk to absorb losses; (2) whether as a group the holders of the equity investment at risk have: (a) the power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity's economic performance; (b) the obligation to absorb the expected losses of the legal entity; and (c) the right to receive the expected residual returns of the legal entity; (3) whether the voting rights of these

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

3. Variable Interest Entities (Continued)


investors are proportional to their obligations to absorb the expected losses of the entity, their rights to receive the expected returns of their equity, or both; and (4) whether substantially all of the entity's activities involve or are conducted on behalf of an investor that has disproportionately fewer voting rights. An investment that lacks one or more of the above four characteristics of a voting interest entity is considered to be a VIE.

        As of March 31, 2010, the Company identified interests in 17 entities which were determined to be VIEs. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events.

        The Company is required to consolidate a VIE if the Company is deemed to be the VIEs primary beneficiary. The primary beneficiary is the party that (i) has the power to direct the activities that most significantly impact the VIE's economic performance and (ii) has the obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE.

        The Company determines whether it is the primary beneficiary of a VIE by first performing a qualitative analysis to determine if it holds the power to direct the activities that most significantly impact the VIEs economic performance. This analysis includes: (i) assessing the Company's variable interests (both implicit and explicit) and any other involvements in the VIE, as well as the involvements of other variable interest holders; (ii) consideration of the VIEs purpose and design, including the risks the VIE was designed to create and pass through to its variable interest holders; (iii) identifying the activities that most significantly affect the VIE's economic performance; (iv) determining whether the Company's significant involvement in the design of an entity provided the Company with the opportunity to establish arrangements that result in the Company having the power to direct the VIEs most significant activities; and (v) determining whether the Company's level of economic interest in a VIE is indicative of the amount of power the Company holds in situations where the Company's stated power to direct the VIEs most significant activities is disproportionately less than its economic interest in the entity. The Company performs a quantitative analysis to determine if it has the obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. For purposes of allocating a VIE's expected losses and expected residual returns to its variable interest holders, the Company calculates its share of the VIE's expected losses and expected residual returns using the specific cash flows that would be allocated to it, based on contractual arrangements and/or the Company's position in the capital structure of the VIE, under various probability-weighted scenarios.

        Based on management's analysis, the Company is not the primary beneficiary of nine of the identified VIEs since it (i) does not have the power to direct the activities that most significantly impact the VIE's economic performance and (ii) does not have the obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. Accordingly, these VIEs are not consolidated into the Company's financial statements as of March 31, 2010. The Company reassesses its determination of whether it is the primary beneficiary of a VIE each reporting period.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

3. Variable Interest Entities (Continued)

Consolidated VIEs (the Company is the primary beneficiary)

        The Company has created and manages portfolios of commercial real estate securities and real estate debt investments, which were financed in CDO financings. The collateral securities include commercial mortgage- backed securities ("CMBS"), fixed income securities issued by REITs and CDO financings backed primarily by real estate securities. The collateral debt investments include whole loans, subordinate mortgage interests, mezzanine loans and other loans. By financing these securities with long-term debt through the issuance of CDO financings, the Company expects to generate attractive risk-adjusted equity returns and to match the term of its assets and liabilities. In connection with the Company's CDO financings, the Company has various forms of significant ongoing involvement, which may include: (i) holding senior or subordinated interests in the CDOs; (ii) asset management; and (iii) entering into derivative contracts.

        N-Star I, II, III, IV, V, VI, VII and VIII are consolidated CDO financings.

        The following table displays the classification and carrying amounts of assets and liabilities of consolidated VIEs as of March 31, 2010 (in thousands):

 
  Variable Interest Entity  
 
  N-Star I   N-Star II   N-Star III   N-Star IV   N-Star V   N-Star VI   N-Star VII   N-Star VIII   Total  

Assets of consolidated VIEs:

                                                       

Restricted cash

  $ 1,682   $ 398   $ 2,313   $ 26,414   $ 4,088   $ 11,974   $ 6,021   $ 35,005   $ 87,895  

Available for sale securities, at fair value

    214,281     217,496     205,402     32,187     237,106     12,202     246,546     32,903     1,198,123  

Real estate debt investments, net

            24,480     301,281         298,490     12,572     645,315     1,282,138  

Real estate debt investments, held-for-sale

                        12,527         27,988     40,515  

Receivables, net of allowance

    2,261     2,393     2,402     1,397     3,790     838     2,680     2,016     17,777  

Derivative instruments, at fair value

                            57         57  

Other assets

    8         11     10         2,617     187     621     3,454  
                                       

Total assets of consolidated VIEs(1):

    218,232     220,287     234,608     361,289     244,984     338,648     268,063     743,848     2,629,959  

Liabilities of consolidated VIEs:

                                                       

Bonds payable, at fair value

    185,002     178,174     146,663     132,543     79,521     142,997     85,895     227,815     1,178,610  

Accounts payable and accrued expenses

    1,418     126     1,148     128     525     422     386     872     5,025  

Derivative liability, at fair value

    15,905     15,529     17,760         24,329     6,631     32,583     11,826     124,563  

Escrow deposits payable

                8,776         7,583         12,051     28,410  

Other liabilities

                            387         387  
                                       

Total liabilities of consolidated VIEs(2):

    202,325     193,829     165,571     141,447     104,375     157,633     119,251     252,564     1,336,995  
                                       

Net assets

  $ 15,907   $ 26,458   $ 69,037   $ 219,842   $ 140,609   $ 181,015   $ 148,812   $ 491,284   $ 1,292,964  
                                       

(1)
Assets of each of the consolidated VIEs may only be used to settle obligations of the respective VIE.

(2)
Creditors of each of the consolidated VIEs have no recourse to the general credit of the Company.

        The Company did not provide financial support to any of its consolidated VIEs during the three months ended March 31, 2010 and 2009. At March 31, 2010 there are no explicit arrangements or implicit variable interests that could require the Company to provide financial support to any of its consolidated VIEs.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

3. Variable Interest Entities (Continued)

Unconsolidated VIEs (the Company is not the primary beneficiary, but has a variable interest)

    Real Estate Debt Investments

        The Company has identified one real estate debt investment with a principal amount of $21.8 million as a variable interest in a VIE and has determined that the Company is not the primary beneficiary of this VIE and as such the VIE should not be consolidated in the Company's consolidated financial statements. For all other real estate debt investments, the Company has determined that these investments are not VIEs and, as such, the Company has continued to account for all real estate debt investments as loans.

    NorthStar Realty Finance Trusts

        The Company owns all of the common stock of NorthStar Realty Finance Trusts I through VIII (collectively, the "Trusts"). The Trusts were formed to issue preferred securities. The Company determined that the holders of the trust preferred securities were the primary beneficiaries of the Trusts. As a result, the Company did not consolidate the Trusts and has accounted for the investment in the common stock of the Trusts under the equity method of accounting.

        The following table displays the classification, carrying amounts and maximum exposure of unconsolidated VIEs as of March 31, 2010 (in thousands):

 
  Variable Interest Entity    
   
 
 
  Trusts Issuing Preferred
Securities, at Fair Value
  Real Estate Debt
Investments
  Total   Maximum Exposure
to Loss(1)
 

Real estate debt investments

      $ 21,799   $ 21,799   $ 21,799  
                   

Total assets

        21,799     21,799     21,799  

Liability to subsidiary trusts issuing preferred securities, at fair value

    190,846         190,846     N/A  
                   

Total liabilities

    190,846         190,846     N/A  
                   

Net assets

  ($ 190,846 ) $ 21,799   ($ 169,047 ) $ 21,799  
                   

(1)
The Company's maximum exposure to loss at March 31, 2010 would not exceed the carrying amount of its investment.

        The Company did not provide financial support to any of its unconsolidated VIEs during the three months ended March 31, 2010 and 2009. At March 31, 2010 there are no explicit arrangements or implicit variable interests that could require the Company to provide financial support to any of its unconsolidated VIEs.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

4. Fair Value of Financial Instruments

Fair Value Measurements

    Fair Value Hierarchy

        The Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

        Financial assets and liabilities recorded on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:

Level 1.   Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market (examples include active exchange-traded equity securities, listed derivatives, most U.S. government and agency securities, and certain other sovereign government obligations).

Level 2.

 

Financial assets and liabilities whose values are based on the following:

 

 

a)

 

Quoted prices for similar assets or liabilities in active markets (for example, restricted stock);

 

 

b)

 

Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which trade infrequently);

 

 

c)

 

Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); and

 

 

d)

 

Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (for example, certain mortgage loans).

Level 3.

 

Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management's own assumptions about the assumptions a market participant would use in pricing the asset or liability (examples include private equity investments, beneficial interest in securitizations and long-dated or complex derivatives, including certain foreign exchange options and long-dated options on gas and power).

Determination of Fair Value

        The Company uses valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. The Company's market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

4. Fair Value of Financial Instruments (Continued)


liabilities. The Company's income approach uses valuation techniques to convert future projected cash flows to a single discounted present value amount. When applying either approach, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. The Company reviews the fair values determined by the third-party pricing models and dealer quotes and compares the results to internally generated pricing models on each asset or liability to validate reasonableness.

        The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.

    Available for sale securities

        When available, the fair value of debt securities available for sale is based on quoted prices in active markets. If quoted prices are not available, fair values are obtained from nationally-recognized pricing services, broker quotes, or other model-based valuation techniques. The fair value of Level 2 securities is based on a market approach with prices obtained from nationally-recognized pricing services. Observable inputs used to value these securities can include: reported trades, benchmark yields, issuer spreads and broker/dealer quotes. The fair value of Level 3 securities is typically based on a single broker quote or the Company's discounted cash flow analysis.

    Derivative instruments

        Derivatives are measured using market approach with prices obtained from nationally-recognized pricing service and are generally measured using pricing models with market observable inputs such as interest rates and equity index levels. These measurements are classified as Level 2 within the fair value hierarchy.

    Corporate lending investment

        The Company's corporate lending investment is measured using in income approach with prices obtained from a nationally-recognized banking institution that acted as underwriter for the investment and is generally measured using pricing models with market observable inputs such as interest rates and equity index levels, with adjustments for unobservable inputs. These measurements are classified as Level 3 within the fair value hierarchy.

    N-Star CDO bonds payable

        N-Star CDO bonds payable are measured using an income approach with prices obtained from a nationally-recognized banking institution that acted as underwriter for the investment and are generally measured using pricing models with market observable inputs such as interest rates and equity index levels, with adjustments for unobservable inputs. These measurements are classified as Level 3 within the fair value hierarchy.

    Liability to subsidiary trusts issuing preferred securities

        Liability to subsidiary trusts issuing preferred securities is measured using market approach with prices obtained from an experienced pricing service and is generally measured using pricing models

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

4. Fair Value of Financial Instruments (Continued)

with market observable inputs such as implied credit spreads on the Company's preferred stock and exchangeable senior notes as adjusted for unobservable inputs which reflect the differences between these other instruments and the trust preferred securities. These measurements are classified as Level 3 within the fair value hierarchy.

        Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth the Company's financial assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2010 by level within the fair value hierarchy:

 
  Assets and Liabilities at Fair Value  
 
  Level 1   Level 2   Level 3   Total  

Assets:

                         

Available for sale securities:

                         
 

CMBS

  $   $ 737,452   $ 184,520   $ 921,972  
 

N-Star CDO notes

            1,342     1,342  
 

Third party CDO notes

            28,414     28,414  
 

REIT debt

        258,557     7,344     265,901  
 

Trust preferred securities

            8,486     8,486  
 

Real estate interest

        16,767     6,602     23,369  

Derivative asset

        57         57  

Corporate lending investment

            9,553     9,553  
                   
 

Total assets

  $   $ 1,012,833   $ 246,261   $ 1,259,094  
                   

Liabilities:

                         

N-Star CDO bonds payable

            1,178,610   $ 1,178,610  

Liability to subsidiary trusts issuing preferred securities

            190,846     190,846  

Derivative liability

        147,447         147,447  
                   
 

Total liabilities

  $   $ 147,447   $ 1,369,456   $ 1,516,903  
                   

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

4. Fair Value of Financial Instruments (Continued)

        The following table presents additional information about the Company's available for sale securities, corporate lending investment, bonds payable and liabilities to subsidiary trusts issuing preferred securities which are measured at fair value on a recurring basis at March 31, 2010 for which the Company has utilized Level 3 inputs to determine fair value:

Fair Value Measurements Using Significant Unobservable Inputs (Level 3):

 
  Available
for Sale
Securities
  Corporate
Lending
Investment
  N-Star
CDO Bonds
Payable
  Liability to
Subsidiary
Trusts Issuing
Preferred
Securities
 

Beginning balance:

  $ 309,505   $ 8,943   $ 1,141,096   $ 167,035  
 

Total net transfers into/out of Level 3

    (60,577 )                  
 

Purchases, sales, issuance and settlements, net

    (33,699 )   (2,061 )   (4,325 )      
 

Less: total losses and premium/discount amortization (realized or unrealized):

                         
   

Included in earnings

    4,925     2,671     46,219     23,811  
   

Included in other comprehensive loss

                       
 

Plus: total gains and premium/discount amortization (realized or unrealized):

                         
   

Included in earnings

    26,364           4,380        
   

Included in other comprehensive loss

    40              
                   

Ending balance

  $ 236,708   $ 9,553   $ 1,178,610   $ 190,846  
                   

The amount of total gains or (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets or liabilities still held at the reporting date

  $ 21,479   $ (2,671 ) $ 41,839   $ 23,811  
                   

Fair Value Option

        The Company has elected to apply the fair value option of accounting to the following financial assets and liabilities existing at the time of adoption or at the time the Company recognizes the eligible item:

    Available for sale securities that serve as collateral for the Company's CDO financings;

    CDO bonds payable;

    Liabilities to subsidiary trusts issuing preferred securities; and

    its equity investment in its corporate lending business.

        The Company has elected the fair value option for the above financial instruments for the purpose of enhancing the transparency of its financial condition.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

4. Fair Value of Financial Instruments (Continued)

        Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they occur. The fair value option may be elected on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. The following table sets forth the Company's financial instruments for which the fair value option was elected:

Financial Instruments, at Fair Value
  March 31,
2010
  December 31,
2009(1)
 

Assets:

             

Available for sale securities:

             
 

CMBS

  $ 921,972   $ 249,583  
 

N-Star CDO notes

        4,268  
 

Third party CDO notes

    28,414     9,515  
 

REIT debt

    265,901     30,580  
 

Trust preferred securities

    8,486     8,739  
 

Real estate interest

    23,369      

Corporate lending investment

    9,553     8,943  
           
 

Total assets

  $ 1,257,695   $ 311,628  
           

Liabilities:

             

N-Star CDO bonds payable

    1,178,610     584,615  

Liability to subsidiary trusts issuing preferred securities

    190,846     167,035  
           
 

Total liabilities

  $ 1,369,456   $ 751,650  
           

(1)
December 31, 2009 does not include the assets and liabilities of N-Star I, II, III and V, for which the Company has elected the fair value option, as these CDO financings were unconsolidated CDO financings prior to January 1, 2010.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

4. Fair Value of Financial Instruments (Continued)

        The following table presents the difference between fair values and the aggregate contractual amounts of available for sale securities and liabilities, for which the fair value option has been elected:

 
  Fair Value at
March 31,
2010
  Amount
Due Upon
Maturity
  Difference  

Assets:

                   

Available for sale securities:

                   
 

CMBS

  $ 921,972   $ 2,119,422   $ (1,197,450 )
 

Third party CDO notes

    28,414     143,484     (115,070 )
 

REIT debt

    265,901     271,121     (5,220 )
 

Trust preferred securities

    8,486     15,000     (6,514 )
 

Real estate interest

    23,369     40,659     (17,290 )
               
   

Total assets

  $ 1,248,142   $ 2,589,686   $ (1,341,544 )
               

Liabilities:

                   

N-Star CDO bonds payable

    1,178,610     2,973,514     (1,794,904 )

Liability to subsidiary trusts issuing preferred securities

    190,846     280,133     (89,287 )
               
 

Total Liabilities

  $ 1,369,456   $ 3,253,647   $ (1,884,191 )
               

        At March 31, 2010 and December 31, 2009, the basis in the Company's corporate lending investment was $68.0 million and $70.0 million, respectively. The Company has elected the fair value option for this investment which is accounted for under the equity method of accounting. The fair market value of the Company's investment at March 31, 2010 and December 31, 2009 was $9.6 million and $8.9 million, respectively.

        For the three months ended March 31, 2010 and 2009, the Company recognized a net gain of $33.3 million and a net gain of $89.1 million, respectively, as the result of the change in fair value of financial assets and liabilities for which the fair value option was elected, which is recorded as unrealized gain (loss) on investments and other in the Company's consolidated statement of operations. The net gain for the three months ended March 31, 2009 does not include net gains or losses on the assets and liabilities of N-Star I, II, III and V, as these CDO financings were unconsolidated CDO financings prior to January 1, 2010.

        The impact of changes in instrument-specific credit spreads on N-Star bonds payable and liability to subsidiary trusts issuing preferred securities for which the fair value option was elected was a net gain of $65.6 million and a net gain of $136.7 million for the three months ended March 31, 2010 and 2009, respectively. The Company attributes changes in the fair value of floating rate liabilities to changes in instrument-specific credit spreads. For fixed rate liabilities, the firm allocates changes in fair value between interest rate-related changes and credit spread-related changes based on changes in interest rates. The net gain for the three months ended March 31, 2009 does not include net gains or losses on the assets and liabilities of N-Star I, II, III and V, as these CDO financings were unconsolidated CDO financings prior to January 1, 2010.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

5. Operating Real Estate

Discontinued Operations

        In December 2009, NRF Healthcare, LLC completed the sale of 18 assisted living facilities containing approximately 1,300 beds located in North Carolina to a private investor group for approximately $95.9 million.

        The following table summarizes income from discontinued operations for the three months ended March 31, 2009:

 
  For the Three Months
Ended
March 31, 2009
 

Revenue:

       
 

Rental and escalation income

  $ 2,072  
 

Interest and other

    3  
       
 

Total revenue

    2,075  
       

Expenses:

       
 

General and administrative expenses

    17  
 

Interest expense

    925  
 

Depreciation and amortization

    528  
       
 

Total expenses

    1,471  
       

Income from discontinued operations

  $ 605  
       

6. Available for Sale Securities

        The following is a summary of the Company's available for sale securities at March 31, 2010:

March 31, 2010
  Carrying
Value
  Losses in
Accumulated
OCI
  Cumulative
Unrealized
(Loss)/Gain on
Investments
  Fair
Value(1)
 

CMBS

  $ 1,576,681   $   $ (654,709 ) $ 921,972  

N-Star CDO notes

    15,108     (13,765 )       1,343  

Third party CDO notes

    109,919         (81,505 )   28,414  

REIT debt

    266,869         (969 )   265,900  

Real estate interest

    33,489         (10,120 )   23,369  

Trust preferred securities

    15,000         (6,514 )   8,486  
                   
 

Total

  $ 2,017,066   $ (13,765 ) $ (753,817 ) $ 1,249,484  
                   

(1)
Approximately $1.2 billion of these investments serve as collateral for the Company's consolidated CDO transactions and the balance is financed under other borrowing facilities.

        At March 31, 2010, the maturities of the available for sale securities ranged from two months to 48 years.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

6. Available for Sale Securities (Continued)

        During the three months ended March 31, 2010, proceeds from the sale and redemption of available for sale securities was $38.9 million. The net realized gain on the sale and redemption of available for sale securities was $2.9 million. During the three months ended March 31, 2009, proceeds from the sale and redemption of available for sale securities was $16.5 million. The net realized gain on the sale of available for sale securities was $2.5 million. Proceeds and realized gains from the sale and redemption of available for sale securities for the three months ended March 31, 2009 does not include the sale and redemption of available for sale securities of N-Star I, II, III and V, as these CDO financings were unconsolidated CDO financings prior to January 1, 2010.

        The following is a summary of the Company's available for sale securities at December 31, 2009:

December 31, 2009(1)
  Carrying
Value
  Losses in
Accumulated
OCI
  Cumulative
Unrealized
(Loss)/Gain on
Investments
  Fair
Value(2)
 

CMBS

  $ 443,568   $   $ (193,985 ) $ 249,583  

N-Star CDO notes

    34,115     (13,517 )   (14,723 )   5,875  

Third party CDO notes

    21,750         (12,235 )   9,515  

REIT debt

    26,760         3,820     30,580  

N-Star CDO equity

    72,926     (40,998 )       31,928  

Trust preferred securities

    12,264         (3,525 )   8,739  
                   
 

Total

  $ 611,383   $ (54,515 ) $ (220,648 ) $ 336,220  
                   

(1)
December 31, 2009 does not include the third party available for sale securities of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.

(2)
Approximately $212.4 million of these investments serve as collateral for the Company's only consolidated securities CDO transaction at December 31, 2009 and the balance is financed under other borrowing facilities.

        At December 31, 2009, the maturities of the available for sale securities ranged from one to 42 years.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

7. Real Estate Debt Investments

        At March 31, 2010 and December 31, 2009, the Company held the following real estate debt investments:

March 31, 2010
  Carrying
Value(1)
  Allocation by
Investment Type
  Average
Fixed Rate
  Average Spread
Over LIBOR
  Number of
Investments
 

Whole loans, floating rate(2)

  $ 1,045,760     54.9 %   %   2.85 %   51  

Whole loans, fixed rate

    22,359     1.2     6.66         6  

Subordinate mortgage interests, floating rate

    181,853     9.5         2.71     11  

Subordinate mortgage interests, fixed rate

    24,343     1.3     7.25         2  

Mezzanine loans, floating rate(3)

    522,822     27.4         3.32     19  

Mezzanine loan, fixed rate

    81,457     4.3     8.90         5  

Other loans—floating

    13,588     0.7         2.42     3  

Other loans—fixed

    13,123     0.7     6.43         3  
                       
 

Total/Weighted average

  $ 1,905,305     100.0 %   8.05 %   2.97 %   100  
                       

(1)
Approximately $1.3 billion of these investments serve as collateral for the Company's CDO financings and the balance is financed under other borrowing facilities or unleveraged. The Company has future funding commitments, which are subject to certain conditions that borrowers must meet to qualify for such fundings, totaling $69.4 million related to these investments. The Company expects that a minimum of $46.0 million of these future fundings will be funded within the Company's existing CDO financings and require no additional capital from the Company. Based upon currently approved advance rates on the Company's credit facility and CDOs and assuming that all loans that have future fundings meet the terms to qualify for such funding, the Company's equity requirement on the remaining $23.4 million of future funding requirements would be approximately $6.5 million.

(2)
Includes $8.5 million in real estate debt investments, held for sale.

(3)
Includes $32.0 million in real estate debt investments, held for sale.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

7. Real Estate Debt Investments (Continued)

December 31, 2009(1)
  Carrying
Value(2)
  Allocation by
Investment Type
  Average
Fixed Rate
  Average Spread
Over LIBOR
  Number of
Investments
 

Whole loans, floating rate

  $ 1,014,028     52.3 %   %   2.70 %   52  

Whole loans, fixed rate

    62,373     3.2     6.89         7  

Subordinate mortgage interests, floating rate

    193,275     10.0         2.69     11  

Subordinate mortgage interests, fixed rate

    24,722     1.3     7.25         2  

Mezzanine loans, floating rate

    538,173     27.8         3.35     20  

Mezzanine loan, fixed rate(3)

    90,558     4.7     8.89         7  

Other loans—floating

    8,610     0.4         2.24     2  

Other loans—fixed

    5,354     0.3     5.53         1  
                       
 

Total/Weighted average

  $ 1,937,093     100.0 %   7.90 %   2.90 %   102  
                       

(1)
December 31, 2009 does not include the real estate debt investments of N-Star III, as the CDO financing was an unconsolidated financing prior to January 1, 2010.

(2)
Approximately $1.3 billion of these investments served as collateral for the Company's three commercial real estate debt CDO financings and the balance was financed under other borrowing facilities. The Company had future funding commitments, which were subject to certain conditions that borrowers must have met to qualify for such fundings, totaling $80.0 million related to these investments.

(3)
Includes $0.6 million in real estate debt investments, held for sale.

        Contractual maturities of real estate debt investments at March 31, 2010 are as follows:

Years Ending December 31:
  Initial
Maturity(1)
  Maturity
Including
Extensions
 

2010 (remainder)

  $ 826,834   $ 305,984  

2011

    304,659     373,920  

2012

    482,076     539,108  

2013

        239,379  

2014

    184,633     223,836  

Thereafter

    222,871     338,846  
           
 

Total

    2,021,073     2,021,073  
           

(1)
The year ending December 31, 2010, contains a whole loan with an initial maturity of October 1, 2008 and a principal balance of $21.4 million, a junior participation in a first mortgage with an initial maturity of March 1, 2009 and a principal balance of $28.5 million, a whole loan with an initial maturity of April 1, 2009 and a principal balance of $13.9 million, a junior participation in a first mortgage with an initial maturity of September 9, 2009 and a principal balance of $10.0 million and a whole loan with an initial maturity of December 31, 2009 and a principal balance of $10.5 million that remain outstanding as of March 31, 2010.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

7. Real Estate Debt Investments (Continued)

        Actual maturities may differ from contractual maturities because certain borrowers have the right to prepay with or without prepayment penalties. The contractual amounts differ from the carrying amounts due to unamortized origination fees and costs and unamortized premiums and discounts being reported as part of the carrying amount of the investment. Maturity Including Extensions assumes that all loans with extension options will qualify for extension at initial maturity according to the conditions stipulated in the related loan agreements.

Non-Performing Loans and Provision for Loan Losses

    Non-Performing Loans

        As of March 31, 2010, the Company had five non-performing loans totaling $84.3 million which consisted of a first mortgage having a principal balance of $21.4 million and an initial maturity date of October 1, 2008, a junior participation in a first mortgage having a principal balance of $28.5 million and an initial maturity date of March 1, 2009, a first mortgage having a principal balance of $13.9 million and an initial maturity date of April 1, 2009, a junior participation in a first mortgage having a principal balance of $10.0 million and an initial maturity date of September 9, 2009 and a first mortgage having a principal balance of $10.5 million and an initial maturity date of December 31, 2009, representing approximately 4.2% of the Company's total commercial real estate debt investments. The Company's maximum additional exposure to loss related to these loans of $45.2 million is equal to the outstanding principal balance of the loans, less reserves.

    Provision for Loan Losses

        For the three months ended March 31, 2010, the Company recorded a $36.3 million credit loss provision relating to eight loans and included a $0.8 million credit for a loan held for sale with a fair market value in excess of its carrying amount. For the three months ended March 31, 2009, the Company recorded a $21.5 million credit loss provision relating to 10 loans. As of March 31, 2010, loan loss reserves totaled $108.7 million.

8. Investment in and Advances to Unconsolidated Ventures

        The Company has non-controlling, unconsolidated ownership interests in entities that are accounted for using the equity method. Capital contributions, distributions, and profits and losses of the real estate entities are allocated in accordance with the terms of the applicable partnership and limited liability company agreements. Such allocations may differ from the stated percentage interests, if any, in such entities as a result of preferred returns and allocation formulas as described in such agreements.

CS/Federal Venture

        In February 2006, the Company, through a joint venture with an institutional investor, acquired a portfolio of three adjacent class A office/flex buildings located in Colorado Springs, Colorado for $54.3 million. The joint venture financed the transaction with two non-recourse, first mortgage loans totaling $38.0 million and the balance in cash. The loans mature on February 11, 2016 and bear fixed interest rates of 5.51% and 5.46%. The Company contributed $8.4 million for a 50% interest in the

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

8. Investment in and Advances to Unconsolidated Ventures (Continued)


joint venture and incurred $0.3 million in costs related to its acquisition, which are capitalized to the investment account. These costs will be amortized over the useful lives of the assets held by the joint venture. The Company accounts for its investment under the equity method of accounting. At March 31, 2010 and December 31, 2009, the Company had an investment in CS/Federal of approximately $6.8 million and $6.9 million, respectively. The Company recognized equity in earnings $0.1 million for each of the three months ended March 31, 2010 and 2009.

G-NRF, LTD

        On May 7, 2008, the Company completed a recapitalization of Monroe Capital, its middle-market corporate lending platform. Upon completion of the recapitalization transaction, the new investor became the controlling manager of the assets and the Company deconsolidated the joint venture. The Company currently uses the equity method of accounting to account for the recapitalized joint venture and has elected the fair value option for its equity investment. As of March 31, 2010 and December 31, 2009, the fair market value of the Company's investment in the corporate lending venture was $9.6 million and $8.9 million, respectively. For the three months ended March 31, 2010 and 2009, the Company recognized an unrealized gain of $2.7 million and an unrealized loss of $25.2 million, respectively, related to the fair value adjustment on its equity investment. The Company conducted its quarterly comprehensive credit review of this investment and as a result, concluded that due to the uncertainty of the underlying cash flows, the Company will utilize the cost recovery method of accounting for income recognition on this investment.

NorthStar Real Estate Securities Opportunity Fund

        In July 2007, the Company closed on $109.0 million of equity capital for its Securities Fund, an investment vehicle in which the Company conducts most of its real estate securities investment business.

        The Company is the manager and general partner of the Securities Fund. The Company receives base management fees ranging from 1.0% to 2.0% per annum on third-party capital and is entitled to annual incentive management fees ranging from 20% to 25% of the increase in the Securities Fund's net asset value in excess of an 8.0% per annum return. Base and incentive fees vary depending on the investor capital lockup periods and we do not expect to earn any incentive management fees from the Securities Fund in the future.

        At March 31, 2010 and December 31, 2009, the carrying value of the Company's investment in the Securities Fund was $6.3 million and $7.2 million, respectively, each representing a 31.2% interest in the Securities Fund.

        For the three months ended March 31, 2010 and 2009, the Company recognized equity in losses of $0.9 million and $2.3 million, respectively. The Company also earned $0.1 million in management fees from the Securities Fund for the three months ended March 31, 2009.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

8. Investment in and Advances to Unconsolidated Ventures (Continued)

LandCap Investment

        On October 5, 2007, the Company entered into a joint venture with Whitehall Street Global Real Estate Limited Partnership 2007 ("Whitehall"), to form LandCap Partners, which is referred to as LandCap. LandCap was established to opportunistically invest in single family residential land through land loans, lot option agreements and select land purchases. The joint venture is managed by a third party management group which has extensive experience in the single family housing sector. The Company and Whitehall agreed to provide no additional new investment capital in the LandCap joint venture. At March 31, 2010 and December 31, 2009 the Company's investment in LandCap is carried at $10.1 million. For the three months ended March 31, 2010 and 2009, the Company recognized equity in loss of $0.5 million and $2.4 million, respectively. At March 31, 2010 and December 31, 2009, LandCap had investments totaling $39.1 million. In addition, the Company has advanced approximately $4.9 million under a loan agreement to LandCap, which bears interest at a fixed rate of 12% and is included in other assets in the consolidated balance sheets.

Midwest Care Holdco TRS I LLC

        In June 2009, the Company restructured its net lease relationship with one of its healthcare operators to take advantage of new REIT legislation which now allows a taxable REIT subsidiary affiliate to become the lessee of healthcare- related properties. The restructuring resulted in one of the Company's unconsolidated affiliate Midwest Care Holdco TRS I LLC ("Midwest") becoming the lessee of the properties and Midwest simultaneously entering into a management contract with a third party operator. The management agreement is terminable by Midwest upon 60 days notice. This new structure allows the Company to participate in operating improvements of the underlying properties not previously available under the prior structure. The Company owns a 49% interest in Midwest and does not control the major decisions and as a result, the Company does not consolidate the operations of Midwest. The Company's investment in Midwest is accounted for using the equity method. At March 31, 2010 and December 31, 2009, the Company had an investment in Midwest of approximately $1.4 million and $1.0 million, respectively. The Company recognized equity in earnings related to Midwest of $2.4 million for the three months ended March 31, 2010.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

9. Borrowings

        The following is a table of the Company's outstanding borrowings as of March 31, 2010 and December 31, 2009:

 
  Initial
Stated
Maturity
  Interest
Rate
  Contractual
Balance at
March 31,
2010
  Contractual
Balance at
December 31,
2009(1)
 

Term Loans

                       
 

WA Secured Term Loan(2)

    10/28/2012   LIBOR + 3.50%     246,940     246,884  
 

Euro—note

    10/28/2012   3 month Euribor + 3.50%     79,759     85,218  
 

LB Term Loan

    2/9/2011   LIBOR + 1.50%     22,199     22,199  
 

Term Asset Backed Securities Loan Facility

    10/29/2014   2.64%     14,682     14,682  
 

Term Asset Backed Securities Loan Facility

    3/29/2015   3.63%     23,480      
                     

Total Credit Facilities & Term Loans

              387,060     368,983  

Mortgage notes payable (non-recourse)

                       
 

Salt Lake City

    9/1/2012   5.16%     15,367     15,471  
 

EDS

    10/8/2015   5.37%     46,782     46,977  
 

Executive Center(3)

    1/1/2016   5.85%     51,480     51,480  
 

Green Pond

    4/11/2016   5.68%     17,058     17,119  
 

Indianapolis

    2/1/2017   6.06%     28,050     28,142  
 

Northstar Healthcare GE

    8/30/2010   6.93%         44,163  
 

Northstar Healthcare GE

    5/1/2015   3 month LIBOR + 5.95%     58,200      
 

Northstar Healthcare—Park National

    1/11/2014   5.94%     32,837     32,944  
 

Northstar Healthcare—GE—WLK

    1/11/2017   6.99%     159,138     159,138  
 

Northstar Healthcare—GE—Tusc & Harmony

    1/11/2017   7.09%     7,843     7,843  
 

Northstar Healthcare—Harmony FNMA

    2/1/2017   6.39%     74,783     75,001  
 

Northstar Healthcare—Grove City

    2/1/2038   5.45%     1,828     1,835  
 

Northstar Healthcare—Lancaster

    6/1/2037   6.40%     2,563     2,571  
 

Northstar Healthcare—Marysville

    6/1/2037   6.40%     1,645     1,651  
 

Northstar Healthcare—Washington

    10/1/2038   6.65%     1,947     1,952  
 

Northstar Healthcare—Miller Merril

    6/30/2012   7.07%     117,875     118,320  
 

Northstar Healthcare—ARL Mob Wachovia

    5/11/2017   5.89%     3,379     3,389  
 

Northstar Healthcare—St Francis

    9/10/2010   LIBOR + 2.00%         11,400  
 

Aurora

    7/11/2016   6.22%     32,877     32,982  
 

DSG

    10/11/2016   6.17%     33,673     33,795  
 

Keene

    2/1/2016   5.85%     6,666     6,693  
 

Fort Wayne

    1/1/2015   6.41%     3,378     3,399  
 

Portland

    6/17/2014   7.34%     4,605     4,652  
 

Milpitas

    3/6/2017   5.95%     21,988     22,107  
 

Fort Mill

    4/6/2017   5.63%     27,700     27,700  
 

Reading

    1/1/2015   5.58%     13,841     13,905  
 

Reading

    1/1/2015   6.00%     5,000     5,000  
 

Alliance

    12/6/2017   6.48%     23,469     23,543  

Mezzanine loan payable (non-recourse)

                       
 

Fort Mill

    4/6/2017   6.21%     2,676     2,743  

Exchangeable Senior Notes(4)

    6/15/2027   7.25%     68,165     68,165  

Exchangeable Senior Notes ("NNN Notes")(4)

    6/15/2013   11.50%     60,750     60,750  

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

9. Borrowings (Continued)

 
  Initial
Stated
Maturity
  Interest
Rate
  Contractual
Balance at
March 31,
2010
  Contractual
Balance at
December 31,
2009(1)
 

Bonds payable(5)

                       
 

N-Star I

    8/1/2038   3 month LIBOR + 1.83%
(average spread)
    254,932      
 

N-Star II

    6/1/2039   LIBOR + 1.31% (average spread)     262,727      
 

N-Star III

    6/1/2040   LIBOR + 0.57% (average spread)     352,988      
 

N-Star IV

    7/1/2040   LIBOR + 0.60% (average spread)     282,500     282,500  
 

N-Star V

    9/5/2045   LIBOR + 0.55% (average spread)     443,465      
 

N-Star VI

    6/1/2041   3 month LIBOR + 0.53%
(average spread)
    282,057     279,057  
 

N-Star VII

    6/22/2051   LIBOR + 0.35% (average spread)     499,200     499,200  
 

N-Star VIII

    2/1/2041   LIBOR + 0.48% (average spread)     595,645     590,645  

Liability to subsidiary trusts issuing preferred securities(5)(6)

                       
 

Trust I

    3/30/2035   8.15%     41,240     41,240  
 

Trust II

    6/30/2035   7.74%     25,780     25,780  
 

Trust III

    1/30/2036   7.81%     41,238     41,238  
 

Trust IV

    6/30/2036   7.95%     50,100     50,100  
 

Trust V

    9/30/2036   3 month LIBOR
2.70%
    30,100     30,100  
 

Trust VI

    12/30/2036   3 month LIBOR
2.90%
    25,100     25,100  
 

Trust VII

    4/30/2037   3 month LIBOR
2.50%
    31,475     31,475  
 

Trust VIII

    7/30/2037   3 month LIBOR
2.70%
    35,100     35,100  
                     

            $ 4,566,270   $ 3,225,348  
                     

(1)
December 31, 2009 does not include the bonds payable of N-Star I, II, III and V as these CDO financings were unconsolidated financings prior to January 1, 2010.

(2)
The Company had an additional $17.0 million of availability under the delay draw term facility of the WA Secured Term Loan.

(3)
The Company has a limited recourse obligation with respect to this loan. The amount of such obligation will vary based upon the tenancy of the property. The Company believes such obligation will not exceed $2.5 million.

(4)
The contractual amounts may differ from the carrying value on the consolidated balance sheets due to the equity component of the debt.

(5)
Contractual amounts due may differ from the carrying value on the consolidated balance sheets due to the election of the fair value option. See Note 4.

(6)
The liability to subsidiary trusts for Trusts I, II, III and IV have a fixed interest rate for the first ten years after which the interest rate will float and reset quarterly at rates ranging from LIBOR plus 2.70% to 3.25%. The Company entered into interest rate swap agreements on Trusts V, VI, VII and VIII which fix the interest rates for 10 years at 8.16%, 8.02%, 7.60% and 8.29%, respectively.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

9. Borrowings (Continued)

        Scheduled principal payment requirements on the Company's borrowings based on initial maturity dates are as follows as of March 31, 2010:

 
  Total   Mortgage and
Mezzanine Loans
  Secured Term
Loan
  Liability to
Subsidiary
Trusts Issuing
Preferred
Securities
  Exchangeable
Senior Notes(1)
  Bonds Payable  

2010

  $ 5,848   $ 5,848   $   $   $   $  

2011

    33,314     11,115     22,199              

2012

    534,367     139,503     326,699         68,165      

2013

    71,778     11,028             60,750      

2014

    60,442     45,760     14,682              

Thereafter

    3,860,521     583,394     23,480     280,133         2,973,514  
                           

Total

  $ 4,566,270   $ 796,648   $ 387,060   $ 280,133   $ 128,915   $ 2,973,514  
                           

(1)
$68.2 million of the Company's 7.25% exchangeable senior notes have a final maturity date of June 15, 2027. The above table reflects the holders repurchase rights which may require the Company to repurchase the notes on June 15, 2012.

    At March 31, 2010, the Company was in compliance with all covenants under its borrowings.

    Exchangeable Senior Notes

        As of March 31, 2010 and December 31, 2009, the total carrying amount of the equity components of the exchangeable senior notes was $4.9 million. The principal amount of the exchangeable senior notes liabilities was $128.9 million as of March 31, 2010 and December 31, 2009. The unamortized discount of the liability components was $2.7 million and $2.9 million at March 31, 2010 and December 31, 2009, respectively. The net carrying amount of the liability components was $126.2 million and $126.0 million at March 31, 2010 and December 31, 2009, respectively. Interest expense for the three months ended March 31, 2010 and 2009 related to the exchangeable senior notes was $3.4 million and $5.2 million, respectively, of which $3.0 million and $4.5 million was related to contractual interest, respectively, and $0.4 million and $0.7 million was attributable to amortization of the debt discount and deferred financing costs, respectively.

    Mortgage note refinancing

        On March 31, 2010, the Company closed on a $65.0 million loan with General Electric Capital Corporation. The proceeds will be primarily used to refinance $52.0 million of loans maturing in 2010 on nine of the Company's healthcare-related net leased assets. The excess proceeds from the financing will be used for working capital and general corporate purposes. The loan has a five-year term with a one-year interest only period and principal and interest payments thereafter. The interest rate is 90-day LIBOR + 5.95% with a 1% LIBOR floor.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

10. Related Party Transactions

Advisory Fees

        The Company has agreements with each of its N-Star CDO financings to perform certain advisory services. The Company earned total fees on these agreements of approximately $0.4 million for the three months ended March 31, 2010. The Company earned total fees on these agreements of approximately $1.6 million for the three months ended March 31, 2009. As of January 1, 2010, the advisory fee income related to N-Star I, N-Star II, N-Star III and N-Star V is eliminated as a result of the consolidation of the respective CDO financings.

        The Company has an agreement with NorthStar Income Opportunity REIT I, Inc., a commercial finance REIT, to perform certain advisory services. The Company earned total fees on these agreements of approximately $0.1 million for the three months ended March 31, 2010.

        The Company has an agreement with the Securities Fund to receive base management fees ranging from 1.0% to 2.0% per year on third-party capital. For the three months ended March 31, 2009, the Company earned $0.1 million in management fees.

Asset Management Fees

        The Company entered into a management agreement in April 2006 with Wakefield Capital Management Inc. to perform certain management services. The Company incurred $0.5 million and $0.9 million in management fees for the three months ended March 31, 2010 and 2009, respectively, which are recorded in asset management fees-related parties in the condensed consolidated statement of operations. Pursuant to the December 2009 membership interest redemption and sale agreement, the Company amended the management agreement with Wakefield Capital Management Inc. The amended management fee will be equal to one-twelfth of one percent of the daily weighted average amount of NRFC Healthcare Holding Company, LLC's equity for each previous month.

11. Equity Based Compensation

Omnibus Stock Incentive Plan

        On September 14, 2004, the Board of Directors of the Company adopted the NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (the "Stock Incentive Plan"). The Stock Incentive Plan provides for the issuance of stock-based incentive awards, including incentive stock options, non-qualified stock options, and stock appreciation rights, shares of common stock of the Company, including restricted shares, and other equity-based awards, including OP Units which are structured as profits interests ("LTIP Units") or any combination of the foregoing. The eligible participants in the Stock Incentive Plan include directors, officers and employees of the Company and, prior to October 29, 2005, employees pursuant to the shared facilities and services agreement. An aggregate of 8,933,038 shares of common stock of the Company are currently reserved and authorized for issuance under the Stock Incentive Plan, subject to equitable adjustment upon the occurrence of certain corporate events. As of March 31, 2010, the Company has issued an aggregate of 8,283,340 LTIP Units, net of forfeitures of 60,368 LTIP Units. An aggregate of 1,677,175 LTIP Units were converted to commons stock and 482,989 shares of common stock were issued pursuant to the Stock Incentive Plan.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

11. Equity Based Compensation (Continued)


Of the 8,283,340 LTIP Units, so long as the recipient continues to be an eligible recipient, 4,976,957 will vest to the individual recipient at a rate of one-twelfth of the total amount granted as of the end of each quarter, beginning with the first quarter after the date of grant ended either January 29, April 29, July 29, or October 29 for the three-year vesting period, 2,154,029 will vest over 16 consecutive quarters with the first quarter being January 29, 2008, 701,058 will cliff vest on December 31, 2010, and 170,801 are subject to no vesting requirements. The Company accelerated the vesting of 280,495 LTIP Units as part of the termination agreements provided to employees. In addition, the LTIP Unit holders are entitled to dividends on the entire grant beginning on the date of the grant.

        The Company has recognized compensation expense of $4.7 million and $5.0 million for the three months ended March 31, 2010 and 2009, respectively. As of March 31 2010, there were approximately 2,677,845 unvested LTIP Units and no LTIP Units were forfeited during the period. The related compensation expense to be recognized over the remaining vesting period of the Omnibus Incentive Plan LTIP grants is $16.4 million, provided there are no forfeitures.

        The status of all of the LTIP grants as of March 31, 2010 and December 31, 2009 is as follows:

 
  March 31, 2010   December 31, 2009  
 
  LTIP
Grants
  Weighted
Average
Grant Price
  LTIP
Grants
  Weighted
Average
Grant Price
 

Balance at beginning of year(1)

    7,323   $ 9.85     8,067   $ 9.86  

Granted

                 

Converted to common stock

    (519 )   9.93     (744 )   9.83  

Forfeited

                 
                   

Ending balance(2)

    6,804   $ 9.84     7,323   $ 9.85  
                   

(1)
Reflects balance at January 1, 2010 and January 1, 2009 for the periods ended March 31, 2010 and December 31, 2009, respectively.

(2)
Reflects balance at March 31, 2010 and December 31, 2009, respectively.

Incentive Compensation Plan

        On July 21, 2009, the Compensation Committee of the Board of Directors (the "Committee") of the Company approved the material terms of a new Incentive Compensation Plan for the Company's executive officers and other employees (the "Plan"). Under the Plan, a potential incentive compensation pool is expected to be established each calendar year. The size of the incentive pool will be calculated as the sum of (a) 1.75% of the Company's "adjusted equity capital" and (b) 25% of the Company's adjusted funds from operations, as adjusted ("AFFO"), above a 9% return hurdle on adjusted equity capital. Payout from the incentive pool is subject to achievement of additional performance goals summarized below.

        The incentive pool is expected to be divided into the following three separate incentive compensation components: (1) an annual cash bonus, tied to annual performance of the Company and

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

11. Equity Based Compensation (Continued)


paid after year end at or around completion of the year end audit; (2) a deferred cash bonus, determined based on the same year's performance, but paid 50% following the close of each of the first and second years after such incentive pool is determined, subject to the participant's continued employment through each payment date; and (3) a long-term incentive, paid at the end of a three-year period based on the Company's achievement of cumulative performance goals for the three-year period, subject to the participant's continued employment through the payment date. Performance goals for each component will be set by the Committee initially upon the adoption of the Plan and at the beginning of each subsequent calendar year for each new cycle. The goals will generally be divided into ranges of performance, each of which will correspond to a pay-out level equal to a percentage of a participant's pool allocation for such component.

        The annual bonus component for 2010 will be calculated based on AFFO and liquidity targets (weighted 50% and 25%, respectively) with the remaining 25% of the 2010 annual bonus determined in the Committee's discretion. Additionally, the Committee has also allocated $2.0 million under the Plan for 2010 discretionary cash bonuses. The deferred bonus component will be calculated based on the same performance measures as the annual bonus, but paid as described above. For the long-term incentive component, each participant will initially be granted a number of restricted stock units determined by dividing the value of the participant's pool allocation for this component by the 20-day average closing price of the Company's common stock at the end of the first year of the grant cycle (such amount, the "Initial Long-Term Allocation"). Upon the conclusion of the three-year performance period, the participant will receive a payout equal to the value of one share of common stock at the time of such payout, with respect to a share of common stock during the three-year performance period, for each unit actually earned based on the Company's achievement of cumulative AFFO and/or a stock price goal during the performance period (the "Long-Term Payout"). The Long-Term Payout will be made in the form of shares of common stock to the extent available under the Company's equity compensation plans or, if all or a portion of such shares are not available, in cash; provided, that the amount of cash paid to any participant with respect to the 2010 long-term incentive component shall not exceed such participant's Initial Long-Term Allocation.

        The Company recorded $0.3 million in equity-based compensation expense related to the long term incentive component of the Plan for the three months ended March 31, 2010.

12. Stockholders' Equity

Dividend Reinvestment and Stock Purchase Plan

        In April 2007, the Company implemented a Dividend Reinvestment and Stock Purchase Plan (the "Plan"), pursuant to which it registered with the SEC and reserved for issuance 15,000,000 shares of its common stock. Under the terms of the Plan, stockholders who participate in the Plan may purchase shares of the Company's common stock directly from it, in cash investments up to $10,000. At the Company's sole discretion, it may accept optional cash investments in excess of $10,000 per month, which may qualify for a discount from the market price of 0% to 5%. Plan participants may also automatically reinvest all or a portion of their dividends for additional shares of the Company's stock.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

12. Stockholders' Equity (Continued)


The Company expects to use the proceeds from any dividend reinvestments or stock purchases for general corporate purposes.

        During the three months ended March 31, 2010, the Company issued a total of 23,975 common shares pursuant to the Plan for a gross sales price of approximately $0.1 million. During the three months ended March 31, 2009, the Company issued a total of 4,968 common shares pursuant to the Plan.

Equity Distribution Agreements

        In May 2009, the Company entered into an equity distribution agreement with JMP Securities LLC ("JMP"). In accordance with the terms of the agreement, the Company may offer and sell up to 10,000,000 shares of its common stock from time to time through JMP. JMP will receive a commission from the Company of up to 2.5% of the gross sales price of all shares sold through it under the equity distribution agreement. For the three months ended March 31, 2010, the Company did not sell any common shares pursuant to its equity distribution agreement with JMP.

        In May 2008, the Company entered into an equity distribution agreement with Wachovia Capital Markets, LLC ("Wachovia"). In accordance with the terms of the agreement, the Company may offer and sell up to 10,000,000 shares of its common stock from time to time through Wachovia. Wachovia will receive a commission from the Company of up to 2.5% of the gross sales price of all shares sold through it under the equity distribution agreement. For the three months ended March 31, 2010 and 2009, the Company did not sell any common shares pursuant to its equity distribution agreement with Wachovia.

Dividends

        On January 19, 2010, the Company declared a dividend of $0.10 per share of common stock. The dividends were paid on February 12, 2010 to the stockholders of record as of February 5, 2010.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

12. Stockholders' Equity (Continued)

Earnings Per Share

        Earnings per share for the three months ended March 31, 2010 and 2009 is computed as follows (in thousands):

 
  Three Months
Ended
March 31, 2010
  Three Months
Ended
March 31, 2009
 

Numerator (Income)

             

Basic Earnings

             

Net (loss)/income attributable to NorthStar Realty Finance Corp. common stockholders

  $ (24,923 ) $ 84,636  

Effect of dilutive securities:

             
 

(Loss)/income allocated to non-controlling interest

    (2,373 )   10,400  
           

Dilutive net income available to stockholders

  $ (27,296 ) $ 95,036  
           

Basic Earnings:

             

Shares available to common stockholders

    75,069     64,348  

Effect of dilutive securities:

             

OP/LTIP units

    7,148     7,907  
           

Dilutive Shares

    82,217     72,255  
           

        The earnings per share calculation takes into account the conversion of LTIP units into common shares. The LTIPS convert on a one-for-one basis into commons shares and share equally in the Company's earnings. Depending on the timing of LTIP conversions and the amount of LTIPS converted, relative to the timing of the Company's earnings allocated to the LTIP non-controlling interest, and the weighting of the common shares, the LTIP conversions may result in an anti-dilutive effect on earnings per share.

13. Non-controlling Interest

Operating Partnership

        Non-controlling interest represents the aggregate limited partnership interests or OP Units in the Operating Partnership held by limited partners (the "Unit Holders"). Income allocated to the non-controlling interest is based on the Unit Holders ownership percentage of the Operating Partnership. The ownership percentage is determined by dividing the numbers of OP Units held by the Unit Holders by the total number of dilutive shares. The issuance of additional shares of beneficial interest (the "Common Shares" or "Share") or OP Units changes the percentage ownership of both the Unit Holders and the Company. Since a unit is generally redeemable for cash or Shares at the option of the Company, it is deemed to be equivalent to a Share. Therefore, such transactions are treated as capital transactions and result in an allocation between shareholders' equity and non-controlling interest in the accompanying consolidated balance sheet to account for the change in the ownership of the underlying equity in the Operating Partnership. As of March 31, 2010 and December 31, 2009,

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

13. Non-controlling Interest (Continued)


non-controlling interest related to the aggregate limited partnership units of 6,804,130 and 7,323,310, represented an 8.27% and 8.91% interest in the Operating Partnership, respectively. Income allocated to the operating partnership non-controlling interest for the three months ended March 31, 2010 and 2009 was a loss of $2.4 million and income of $10.4 million, respectively.

Joint Ventures

        In May 2006, the Company formed NRF Healthcare, LLC with Chain Bridge. On July 9, 2008, NRF Healthcare, LLC sold a $100 million convertible preferred membership interest to Inland American Real Estate Trust, Inc. In December 2009, the Company completed a membership interest redemption with NRF Healthcare, LLC, NRFC Healthcare Holding Company, LLC, NorthStar Healthcare Investors, Inc., Chain Bridge, Wakefield Capital Management, Midwest Care Holdings LLC, or Midwest Holdings, and certain individuals, pursuant to which NRF Healthcare, LLC redeemed the 5.4% membership interest of Chain Bridge and its affiliates in NRF Healthcare, LLC for $2.0 million and its membership interest in certain assets. As a result of the redemption, NorthStar holds 100% of the equity interests in NRF Healthcare, LLC, other than the convertible preferred membership interests held by Inland. Accordingly, NRF Healthcare, LLC's financial statements are consolidated into the Company's consolidated financial statements and Inland American's capital is treated as a non-controlling interest. Income allocated to the non-controlling interests for the three months ended March 31, 2010 and 2009 was $2.6 million and $2.5 million, respectively.

        In one of the Company's CDO financings, the Company sold 16.7% of the equity notes to a third party. The equity notes held by the third party are reflected as non-controlling interest in the Company's condensed consolidated financial statements.

14. Risk Management and Derivative Activities

Derivatives

        The Company uses derivatives primarily to manage interest rate risk exposure. These derivatives are typically in the form of interest rate swap agreements and the primary objective is to minimize interest rate risks associated with the Company's investment and financing activities. The counterparties of these arrangements are major financial institutions with which the Company may also have other financial relationships. The Company is exposed to credit risk in the event of non-performance by these counterparties and it monitors their financial condition; however, the Company currently does not anticipate that any of the counterparties will fail to meet their obligations because of their high credit ratings and financial support from the U.S. Government. The objective in using interest rate derivatives is to add stability to interest expense and to manage exposure to interest rate movements.

        The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three months ended March 31, 2010 and 2009, such derivatives were used to hedge the variable cash flows associated with certain variable-rate debt. The ineffective portion of the change in fair value of the

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

14. Risk Management and Derivative Activities (Continued)


derivatives is recognized directly in earnings. During the three months ended March 31, 2010 and 2009, the Company recorded immaterial amounts of hedge ineffectiveness in earnings.

        Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company's variable-rate debt. During the remainder of 2010, the Company estimates that an additional $6.3 million will be reclassified as an increase to interest expense.

        The following tables summarize the Company's derivative financial instruments that were designated as cash flow hedges of interest rate risk as of March 31, 2010 and December 31, 2009:

 
  Number of
Investments
  Notional
Amount
  Fair Value
Net Asset/
(Liability)
  Range of
Fixed LIBOR
  Range of Maturity

Interest rate swaps

                         

As of March 31, 2010

    8   $ 75,884   $ (8,206 ) 4.18% - 5.08%   December 2010 - August 2018

As of December 31, 2009

    10   $ 90,749   $ (7,691 ) 4.18% - 5.08%   March 2010 - August 2018

        In January 2008, the Company elected the fair value option for its bonds payable and its liability to subsidiary trusts issuing preferred securities. As a result, the changes in fair value of these financial instruments are now recorded in earnings and the interest rate swap agreements associated with these debt instruments no longer qualify for hedge accounting given that the underlying debt is remeasured with changes in the fair value recorded in earnings. The unrealized gains or losses accumulated in other comprehensive income, related to these interest rate swaps, will be reclassified into earning over the shorter of either the life of the swap or the associated debt with current mark-to-market unrealized gains or losses recorded in earnings.

        Derivatives not designated as hedges are not speculative and are used to manage the Company's exposure to interest rate movements and other identified risks but do not meet strict hedge accounting requirements. For the three months ended March 31, 2010 and 2009, the Company recorded, in earnings, a mark-to-market unrealized loss of $33.7 million and an unrealized loss of $2.9 million, respectively, for the non-qualifying interest rate swaps. For the three months ended March 31, 2010 and 2009, the Company recorded a $1.4 million and a $1.4 million reclassification from accumulated other comprehensive income for the non-qualifying interest rate swaps, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

14. Risk Management and Derivative Activities (Continued)

        The following tables summarize the Company's derivative financial instruments that were not designated as hedges in qualifying hedging relationships as of March 31, 2010 and December 31, 2009:

 
  Number of
Investments
  Notional
Amount
  Fair Value
Net Asset/
(Liability)
  Range of
Fixed LIBOR
  Range of Maturity  

Interest rate swaps

                             

As of March 31, 2010

    36   $ 2,001,491   $ (139,184 ) 0.36% - 7.00%     May 2010 - June 2018  

As of December 31, 2009(1)

    22   $ 897,335   $ (59,353 ) 0.34% - 5.63%     May 2010 - June 2018  

(1)
December 31, 2009 does not include the interest rate swaps of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.

        The following table presents the fair value of the Company's derivative financial instruments as well as their classification on its balance sheet as of March 31, 2010 and December 31, 2009:

Tabular Disclosure of Fair Values of Derivative Instruments

 
  Asset Derivatives   Liability Derivatives  
 
  As of
March 31, 2010
  As of
December 31,
2009(1)
  As of
March 31, 2010
  As of
December 31,
2009(1)
 
 
  Balance
Sheet
Location
  Fair
Value
  Balance
Sheet
Location
  Fair
Value
  Balance
Sheet
Location
  Fair
Value
  Balance
Sheet
Location
  Fair
Value
 

Derivatives designated as hedging instruments

                                         

Interest rate products

  Derivative
instrument,
at fair value
  $   Derivative
instrument,
at fair value
  $   Derivative
liability,
at fair value
  $ (8,206 ) Derivative
liability,
at fair value
  $ (7,691 )
                                   

Total derivatives designated as hedging instruments

      $       $       $ (8,206 )     $ (7,691 )
                                   

Derivatives not designated as hedging instruments

                                         

Interest rate products

  Derivative
instrument,
at fair value
  $ 57   Derivative
instrument,
at fair value
  $   Derivative
liability,
at fair value
  $ (139,241 ) Derivative
liability,
at fair value
  $ (59,353 )
                                   

Total derivatives not designated as hedging instruments

      $ 57       $       $ (139,241 )     $ (59,353 )
                                   

(1)
December 31, 2009 does not include the derivative instruments of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

14. Risk Management and Derivative Activities (Continued)

        The following tables present the effect of the Company's derivative financial instruments on its statement of operations for the three months ended March 31, 2010 and 2009:

Derivatives in Cash Flow Hedging Relationships

 
  Location of Gain/(loss)
recognized in income
  Three
Months
Ended
March 31,
2010
  Three
Months
Ended
March 31,
2009(1)
 

Interest rate products

                 

Amount of gain or (loss) in OCI on derivative (effective portion)

  n/a   $ (857 ) $ 2  

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

  Interest Expense   $ (335 ) $ (1,397 )

(1)
The three months ended March 31, 2009 does not include gains or loses and amounts reclassified from accumulated OCI into income on the derivative instruments of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.

Derivatives Not Designated as Hedging Instruments

 
  Location of Gain/(loss)
recognized in income
  Three
Months
Ended
March 31,
2010
  Three
Months
Ended
March 31,
2009(1)
 

Interest rate products

                 

Amount of gain or (loss) recognized in income

  Unrealized gain (loss) on investment and other   $ (33,749 ) $ 2,940  

Amount of gain or (loss) reclassified from accumulated OCI into income

  Unrealized gain (loss) on investment and other   $ (1,404 ) $  

(1)
The three months ended March 31, 2009 does not include gains or loses and amounts reclassified from accumulated OCI into income on the derivative instruments of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.

        At March 31, 2010, the Company's counterparties hold approximately $23.1 million of cash margin as collateral against its swap contracts.

Credit Risk Concentrations

        Concentrations of credit risk arise when a number of borrowers, tenants or issuers related to the Company's investments are engaged in similar business activities or located in the same geographic location to be similarly affected by changes in economic conditions. The Company monitors its portfolio to identify potential concentrations of credit risks. The Company has no one borrower or one

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

14. Risk Management and Derivative Activities (Continued)


tenant that generates 10% or more of its total revenue. However, approximately 34.7% of the Company's rental and escalation revenue for the three months ended March 31, 2010 is generated from three tenants in the Company's healthcare net lease portfolio. The Company believes the remainder of its net lease portfolio is reasonably well diversified and does not contain any unusual concentration of credit risks.

15. Segment Reporting

        The Company's real estate debt segment is focused on originating, structuring and acquiring senior and subordinate debt investments secured primarily by commercial real estate properties. The Company generates revenues from this segment by earning interest income from its debt investments and its operating expenses consist primarily of interest costs from financing the assets. This segment generates income from operations by earning a positive spread between the yield on its assets and the interest cost of its debt. The Company evaluates performance and allocates resources to this segment based upon its contribution to income from continuing operations.

        The Company's operating real estate segment is focused on acquiring commercial real estate facilities located throughout the U.S. that are primarily leased under long-term triple-net leases to corporate tenants. Triple-net leases generally require the lessee to pay all costs of operating the facility, including taxes and insurance and maintenance of the facility. The Company's net-leased facilities are currently located in New York, Ohio, California, Utah, Pennsylvania, New Jersey, Indiana, Illinois, New Hampshire, Massachusetts, Kansas, Maine, South Carolina, Michigan, Colorado, North Carolina, Florida, Washington, Oregon, Wisconsin, Georgia, Oklahoma, Nebraska, Tennessee, Texas and Kentucky. Revenues from these assets are generated from rental income received from lessees of the facilities, and operating expenses, which include interest costs related to financing the assets, operating expenses, real estate taxes, insurance, ground rent and repairs and maintenance. The segment generates income from operations by leasing these facilities at a higher rate than the costs of owning and financing the assets.

        The Company's real estate securities segment is focused on investing in a wide range of commercial real estate debt securities, including CMBS, REIT unsecured debt, credit tenant loans and unsecured subordinate securities of commercial real estate companies. The Company generates revenues from this segment by earning interest income and advisory fees from owning and managing these investments. Its operating expenses consist primarily of interest costs from financing its securities. The segment generates income from operations by earning advisory fees and a positive spread between the yield on its assets and the interest cost of its debt.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

15. Segment Reporting (Continued)

        The following table summarizes segment reporting for the three months ended March 31, 2010 and 2009:

 
  Real Estate
Debt
  Operating
Real Estate
  Real Estate
Securities(1)
  Healthcare
Real Estate
Joint
Venture
  Corporate
Investments
and
Other(2)
  Consolidated
Total
 

Total revenues for the three months ended

                                     
 

March 31, 2010

  $ 21,654   $ 9,725   $ 38,020   $ 12,082   $ 68   $ 81,549  
 

March 31, 2009

    28,225     11,158     15,331     14,041     (432 )   68,323  

Consolidated net (loss)/income for the three months ended

                                     
 

March 31, 2010

    (31,946 )   (2,442 )   57,209     (81 )   (42,843 )   (20,103 )
 

March 31, 2009

    89,504     (7,621 )   23,421     (1,210 )   (1,968 )   102,126  

Consolidated net (loss)/income after non-controlling interests and before preferred dividend for the three months ended

                                     
 

March 31, 2010

    (29,168 )   (2,230 )   52,907     (2,715 )   (38,486 )   (19,692 )
 

March 31, 2009

    79,709     (6,787 )   20,858     (3,069 )   (844 )   89,867  

Total assets as of

                                     
 

March 31, 2010

  $ 2,113,427   $ 411,580   $ 1,251,211   $ 625,362   $ 96,235     4,527,815  

(1)
Total revenues for the three months ended March 31, 2010 and 2009 excludes $0.4 million in net realized and unrealized losses and $127.6 million in net realized and unrealized gains, respectively.

(2)
Corporate Investments and Other includes corporate level investments, corporate level interest income, interest expense and unallocated general & administrative expenses.

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

16. Supplemental Disclosure of Non-Cash Investing and Financing Activities

        A summary of non-cash investing and financing activities for the three months ended March 31, 2010 and 2009 is presented below:

 
  2010   2009  

Consolidation of assets of N-Star I, II, III and V CDO financings

  $ (812,166 ) $  

Consolidation of liabilities of N-Star I, II, III and V CDO financings

    628,595      

Consolidation of non-controlling interest in N-Star I CDO financing

    3,216      

Distribution of operating real estate to non-controlling interest

    9,525      

Assumption of mortgage notes and loans payable to non-controlling interest

    (4,734 )    

Deconsolidation of non-controlling interest in NorthStar Income Opportunity REIT I, Inc

    (1,815 )    

Stock dividend

        10,646  

17. Fair Value of Financial Instruments

        The following disclosures of estimated fair value were determined by the Company, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

        As of March 31, 2010 and December 31, 2009, cash equivalents, accounts receivable, accounts payable, repurchase agreements with major banks and securities firms and the master repurchase agreement balances reasonably approximate their fair values due to the short-term maturities of these items. The available for sale securities and securities sold, not yet purchased are carried on the balance sheet at their estimated fair value.

        For the real estate debt investments the fair value of the fixed and floating rate investments was approximated comparing yields at which the investments are held to estimated yields at which loans originated with similar credit risks or market yields at which a third party might require to purchase the investment by discounting future cash flows at such market yields. Prices were calculated assuming fully extended maturities regardless of if structural or economic tests required to achieve such extended maturities. At March 31, 2010 the fair market value was $1.6 billion with a gross principal amount of $2.0 billion. At December 31, 2009, the fair market value was $1.7 billion with a gross principal amount of $2.0 billion.

        For the exchangeable senior notes, the Company uses available market information, which includes quoted market prices or recent transactions, if available to estimate their fair value. At March 31, 2010, the fair market value of the 7.25% exchangeable senior notes was $57.5 million, with a carrying amount of $67.1 million and the fair market value of the 11.50% exchangeable senior notes was $52.8 million with a carrying amount of $59.1 million. At December 31, 2009, the fair market value of the 7.25% exchangeable senior notes was $34.8 million with a carrying amount of $67.0 million and the fair

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NORTHSTAR REALTY FINANCE CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount in Thousands, Except per Share Data

(Unaudited)

17. Fair Value of Financial Instruments (Continued)


market value of the 11.50% exchangeable senior notes was $28.1 million with a carrying amount of $59.0 million.

        For fixed rate mortgage loans payable, the Company uses rates currently available to them with similar terms and remaining maturities to estimate their fair value. At March 31, 2010, the fair market value was $805.8 million with a carrying amount of $796.6 million. At December 31, 2009, the fair market value was $800.1 million with a carrying amount of $795.9 million.

        Disclosure about fair value of financial instruments is based on pertinent information available to management as of March 31, 2010 and December 31, 2009. Although management is not aware of any factors that would significantly affect the fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein.

18. Commitments and Contingencies

Chatsworth Property

        One of the Company's net lease investments was comprised of three office buildings totaling 257,000 square feet located in Chatsworth, CA and was 100% leased to Washington Mutual Bank, FA ("WaMu"). The tenant vacated the buildings as of March 23, 2009, and the leases (the "WaMu Leases") were disaffirmed by the FDIC. The assets were financed with a non-recourse $42.9 million first mortgage loan (the "WaMu Loan") and a $9.2 million mezzanine loan which was collateral for one of the Company's securities term financings. In the fourth quarter of 2008, the Company took an impairment charge relating to these properties and in the third quarter of 2009 the lender, GECCMC 2005-CI Plummer Office Limited Partnership (the "Lender"), foreclosed on the property.

        On August 10, 2009, the Lender filed a complaint against NRFC NNN Holdings, Inc. ("NNN") and NRFC Sub Investor IV, LLC, which are subsidiaries of ours, in the Superior Court of the State of California, County of Los Angeles. In the complaint, the Lender alleges, among other things, that the WaMu Loan is a recourse obligation of NNN due to the FDIC's disaffirmance of the WaMu Leases. The Company believes this case is without merit and is defending this suit vigorously.

19. Subsequent Events

Dividends

        On April 20, 2010, the Company declared a dividend of $0.10 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends will be paid on May 14, 2010 to the stockholders of record as of the close of business on May 4, 2010.

Midwest Care Holdco TRS I LLC

        In April 2010, pursuant to the membership redemption agreement entered into in December 2009, the Company acquired the 51% membership interest in Midwest owned by Chain Bridge for $1.0 million in cash. As a result of the acquisition, the Company now holds 100% of the common membership interest in Midwest and controls all major decisions. Accordingly the operations of Midwest, which were previously accounted for under the equity method, will be consolidated.

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Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations

        The following discussion should be read in conjunction with our financial statements and notes thereto included in this report.

Forward-Looking Statements

        This report contains information that may constitute "forward-looking statements." Such forward-looking statements relate to, among other things, the operating performance of our investments and financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology such as "may," "will," "should," "potential," "intend," "expect," "seek," "anticipate," "estimate," "believe," "could," "project," "predict," "continue" or other similar words or expressions. Forward-looking statements are not guarantees of performance and are based on certain assumptions, discuss future expectations, describe plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual effect of plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from those forward looking statements. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.

        Factors that could have a material adverse effect on our operations and future prospects are set forth in "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2009, and those described from time to time in our future reports filed with the Securities and Exchange Commission. The factors set forth in the Risk Factors section could cause our actual results to differ significantly from those contained in any forward- looking statement contained in this report.

Introduction

        We primarily derive revenues from interest income on the real estate debt investments that we originate with borrowers or acquire from third parties and our real estate securities in which we invest. We generate rental income from our net lease investments. Other income comprises a much smaller and more variable source of revenues and is generated principally from fees associated with early loan repayments.

        We primarily derive income on a recurring basis through the difference between the interest and rental income we are able to generate from our investments, and the cost at which we are able to obtain financing for our investments. In order to protect this difference, or "spread", we seek to match-fund our investments using secured sources of long term financing such as CDO financings, mortgage financings and long-term unsecured subordinate debt. Match-funding means that we try to obtain debt with maturities equal to our asset maturities, and borrow funds at interest rate benchmarks similar to our assets. Match-funding results in minimal impact to spread when interest rates are rising and falling and minimizes refinancing risk since our asset maturities match those of our debt. We may also acquire investments which generate attractive returns with no long-term financing. Realized gains have more recently been a significant source of income and have been primarily derived by selling securities at premiums to our carrying values and by repurchasing our issued debt at discounts to contractual face amounts. Both of these activities are opportunistic in nature and are very dependent on market conditions; therefore it is difficult to predict whether realized gains may be a significant part of income in the future.

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Profitability and Performance Metrics

        We calculate several metrics to evaluate the profitability and performance of our business.

    Adjusted funds from operations: ("AFFO") (see "Non-GAAP Financial Measures—Funds from Operations and Adjusted Funds from Operations" for a description of this metric).

    Return on Equity ("ROE"), before and after general and administrative expenses. We calculate return on equity using AFFO, inclusive and exclusive of general and administrative expenses, divided by average common book equity during the period as a measure of the profitability generated by our assets and company on common stockholders' equity invested.

    Credit losses are a measure of the performance of our investments and can be used to compare the credit performance of our assets to our competitors and other finance companies.

    Assets Under Management ("AUM") growth is a key driver of our ability to grow our earnings, but is of lesser importance than other metrics such as AFFO and ROE due to lack of available new investment capital in the commercial real estate sector.

        Credit risk management is our ability to manage our assets in a manner that preserves principal and income and minimizes credit losses that would decrease income.

        Corporate expense management influences the profitability of our business. We must balance making appropriate investments in our infrastructure and employees with the recognition that our accounting, finance, legal and risk management infrastructure does not directly generate quantifiable revenues for us. We frequently refer to general and administrative expenses, excluding stock-based compensation expense, divided by total revenues as a measure of our efficiency in managing expenses.

        Availability and cost of capital will impact our profitability and earnings since we must raise new capital to fund a majority of our AUM growth.

Outlook and Recent Trends

        U.S. macroeconomic, financial and real estate sector conditions have remained poor since 2007, when the subprime residential lending and single family housing market collapse quickly spread broadly into the capital markets. The resulting virtual shutdown of the credit and equity markets pushed the U.S. economy into recession, with the unemployment rate increasing from a low of 4.4% in 2007 to 9.7% at March 31, 2010. Several major financial institutions failed or had to be rescued in 2008, 140 banks failed in 2009 and 57 banks have failed through April 23, 2010. The U.S. Government responded in early 2009 to deteriorating conditions by creating several programs such as the Troubled Asset Relief Program and the Public-Private Investment Program (TARP and TALF, respectively), designed to create demand for financial instruments and to re-equitize weaker banks. Congress also passed in early 2009 a $787 billion economic stimulus package, and the U.S. Federal Reserve lowered the Fed Funds target rate from over 5% in 2007 to 0-0.25% in 2009 (where it remains as of March 31, 2010) and introduced massive amounts of cash liquidity into the banking system.

        The corporate bond, consumer asset-backed debt and equity markets began to recover during 2009 and continued to improve during the first quarter of 2010, although macroeconomic statistics remained weak and the commercial mortgage-backed markets remained virtually closed. Other traditional commercial real estate lenders such as banks and life companies severely curtailed their lending between mid-2007 and 2009, resulting in a severe shortage of debt capital for real estate investors and those needing to refinance maturing loans. Several large commercial banks have begun to rebuild their commercial mortgage lending operations, but new loan volume remains low, and new loans are being offered at leverage levels much lower than were available prior to the recession. The lack of available credit for commercial real estate has generally depressed values and resulted in increasing loan defaults and restructurings throughout the industry. Furthermore, poor economic conditions have generally

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resulted in declining cash flow from commercial real estate, further depressing values and increasing the difficulty in finding new capital.

        During 2009 the TALF program began providing 85% three and five-year non-recourse financing for the highest rated commercial mortgage-backed securities (CMBS) in order to decrease credit spreads and with the expectation that the subsidized financing would eventually enable the CMBS markets to begin functioning. The program for legacy CMBS securities ended March 31, 2010, and the program for new issue CMBS securities, which was used for only one transaction, were modestly successful in reducing yields on the highest rated securities. In April 2010, the first multi-borrower CMBS securitization since mid-2008 was completed ($310 million), but the underlying first mortgage collateral represented very low leverage levels relative to loans underwritten before the financial crisis. The new issue market will have to grow dramatically and investors will have to become more risk tolerant in order to meet the needs of a majority of borrowers who have pre-existing loans on their properties.

        Despite these conditions, REITs have collectively raised nearly $30 billion of debt and equity capital, and the Morgan Stanley REIT Index returned approximately 28.6% for 2009 and approximately 20% year-to-date through April 26, 2010. In addition, three newly-formed REITs with a real estate debt focus raised approximately $1.5 billion of capital in 2009. Notwithstanding the ability of the public REIT market to raise capital, this market is very small relative to the size of the estimated $1.5 trillion commercial real estate finance market. More recently, U.S. economic conditions appear to be improving (based on GDP growth), however, the unemployment rate remains high indicating a low rate of business expansion, which drives commercial real estate cash flows. Commercial real estate tends to lag economic recoveries and we expect commercial real estate fundamentals to continue to deteriorate through 2010.

    Commercial Real Estate Macroeconomic Conditions

        Virtually all commercial real estate property types have been adversely impacted by this prolonged economic recession and liquidity crisis, including hotel, retail, office, industrial and multi-family properties. Land, condominium and other commercial property types have also been severely impacted. As a result, cash flows and values associated with properties serving as collateral for our loans are generally weaker than expected when we originated the loans. Business and retailer failures increased during 2009 and into 2010 and are expected to negatively impact occupancy rates in the future. Our credit loss provisioning levels for 2009 and the first quarter of 2010 were higher than in the past due to the impact of these conditions. The degree to which commercial real estate values are impacted by weaker economic conditions and the level of credit losses in our asset base will be determined primarily by the length that such conditions persist, the scarcity and cost of new debt capital, the absolute level of one-month LIBOR and the severity of the economic contraction, among other things.

        Most of our real estate loans bear interest rates based on a spread to one-month LIBOR, a floating rate index based on rates that banks charge each other to borrow. One-month LIBOR as of March 31, 2010 is 0.24%, well below its 3.35% average over the past five years. Lower LIBOR means lower debt service costs for our borrowers which have partially offset decreasing cash flows caused by the economic recession, and extended the life of interest reserves for those loans that require interest reserves to service debt while the collateral properties are being repositioned by our borrowers. Lower interest rates also theoretically support real estate valuations because a lower discount rate is applied to underlying future real estate cash flow assumptions in valuing a property, although the availability and cost of debt capital appears to have a much more significant impact on property values. Currently, a lack of readily available financing, economic uncertainty and higher returning alternative investment opportunities have increased investor return expectations resulting in much higher risk premiums and, despite the lower interest rate, lower valuations for commercial real estate properties. The conditions are adversely impacting the performance of our real estate loans and securities and the related

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collateral properties. The deep economic recession combined with a crippled banking sector has resulted in weakening cash flows from collateral properties and extreme difficulties in obtaining repayments at maturity.

        For existing loans, when credit spreads widen, which was the case in 2008 and early 2009, the economic value of existing loans decreases. If a lender were to originate a similar loan today, such loan would carry a greater credit spread than the existing loan. Even though a loan may be performing in accordance with its loan agreement and the underlying collateral has not changed, the economic value of the loan may be negatively impacted by the incremental interest foregone from the widened credit spread. Accordingly, when a lender wishes to sell or finance the loan, the reduced value of the loan will impact the total proceeds that the lender will receive.

        Our real estate securities investments are also negatively impacted by weaker real estate market and economic conditions. Within the underlying loan pools, slowdown in economic conditions is reducing tenants' ability to make rent payments in accordance with the terms of their leases. Additionally, to the extent that market rental rates are reduced, property-level cash flows are negatively affected as existing leases renew at lower rates. Finally, declining occupancy rates also impact cash flow and reduce borrowers' ability to service their outstanding loans.

        Real estate securities values are also influenced by credit ratings assigned to the securities by accredited rating agencies. In 2009, the rating agencies changed their ratings methodologies for all securitized asset classes, including commercial real estate, in light of questionable ratings previously assigned to residential mortgage portfolios. Combined with a poor economic outlook, their reviews have resulted in, large amounts of ratings downgrade actions for CMBS in 2009 and to date in 2010, negatively impacting market values of CMBS and in some cases negatively impacting the CDO financing structures used by us and others to leverage these investments.

        Our net leased assets are also adversely impacted by a weaker economy as well. Corporate space needs are contracting resulting in lower lease renewal rates and longer releasing periods when leases are not renewed. Poor economic conditions may negatively impact the creditworthiness of our tenants, which could result in their inability to meet the terms of their leases.

    Our Strategy

        We responded to these difficult conditions by decreasing investment activity and aggressively raising corporate capital when we observed deteriorating market conditions. We expect credit to continue to be challenging through 2010 and we continue to focus our company resources on portfolio management activities to preserve our invested capital and liquidity. We anticipate that most of our investment activity and uses of available unrestricted cash liquidity for the foreseeable future will be focused on discounted repurchases of our previously issued debt securities which generally have been available in the market at very attractive prices, for amortization of bank debt and for growth in our asset management portfolio.

        The relative lack of supply and high demand for capital is allowing investors with cash to make investments with very attractive returns compared to historical levels. For this reason, we are working to raise equity capital through alternative channels, especially in the nonlisted REIT market. We have filed a registration statement on Form S-11 for NorthStar Real Estate Income Trust, Inc., a commercial finance REIT that will be managed by us and will not be listed on a major exchange, and we built NRF Capital Markets, our wholesale broker dealer, to distribute the equity for this new REIT and other non-listed REITs sponsored by us. We are also raising equity under an SEC Regulation D exemption for NorthStar Income Opportunity REIT I, Inc., a commercial finance REIT also managed by us. We expect to use our broad commercial real estate investment and management platform to operate these companies and to earn management fees in return for our services.

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        REITs focused on healthcare properties are currently being attractively valued, compared to historical levels, by the public equity markets, and at a much lower cost of capital than us. In December 2009, we filed a registration statement on Form S-11 for NRF Healthcare Investors, Inc. (NRH), a newly formed REIT containing a majority of our net leased healthcare real estate business having a net book value of approximately $604.6 million at March 31, 2010. We expect that if NRH goes public it would also be managed by us and we would earn a management fee for our services.

        Both the private REITs and the NRH filing reflect our strategy of accessing alternative sources of equity capital, leveraging our existing platform to generate fee revenues and to become less reliant on the public markets to grow our business.

    Our Financing Structures

        As of March 31, 2010, approximately $3.5 billion of our collateralized debt obligations permit reinvestment of capital proceeds which means when the underlying assets repay we are able to reinvest the proceeds in new assets without having to repay the liabilities. We also have assets with a net book value of approximately $450.6 million financed on a bank term loan with an outstanding balance of $326.7 million at March 31, 2010. On October 28, 2009, we completed a three-year extension of this bank term loan and we repaid approximately $52.5 million of the outstanding balance by using uninvested cash contained within our CDO financings. The bank debt requires six semi-annual amortization payments of $15 million, representing aggregate paydowns totaling $90 million over its term. Approximately $826.9 million of our funded loan commitments have their initial maturity date during the remainder of 2010; however, most of the loans contain extension options of at least one year (many subject to performance criteria). We also expect that a majority of the $306.0 million of loans having final maturities during the remainder of 2010 will have their maturities extended beyond 2010 with the expectation that future periods will have more attractive economic conditions and cheaper debt capital. It is therefore difficult to estimate how much capital, if any, will be generated in our CDO financings from loan repayments during the remainder of 2010 to create availability to further amortize the bank loan.

        Our CDO structures do not have corporate financial covenants but require that the underlying loans and securities meet interest coverage and collateral value coverage (as defined by the indentures) in order for us to receive regular cash flow distributions. If the tests are not met cash flow is diverted from us to repay the liabilities until the tests are back into compliance. In some cases, our ability to reinvest can be adversely impacted if these tests are not in compliance. Ratings downgrades and defaults of CMBS and other securities can reduce the deemed value of the security in measuring collateral coverage, depending on the level of the downgrade. Also, defaults in our loans can reduce the collateral coverage of the defaulted loan in our CDO structures. As economic conditions remain weak and capital for commercial real estate remains scarce, we expect credit quality in our assets and across the commercial real estate sector to continue to weaken. While we have devoted a majority of our resources to managing our existing asset base, a continued poor environment and additional credit ratings downgrades will make maintaining compliance with the CDO structures more difficult, jeopardizing regular cash flow distributions to our company.

        We believe that liquidity will eventually return more broadly to the commercial real estate finance markets and corporate debt capital is currently available to the stronger equity REITs. Three single-borrower CMBS transactions were completed in the fourth quarter of 2009 and, more importantly, a $310 million multi-borrower CMBS transaction, the first since mid-2008, was completed in April 2010. Other sources of capital could include term loans from financial institutions and life insurance companies, more restrictive commercial real estate finance structures, which may not permit reinvestment from asset repayments, and financing provided by motivated sellers of assets. We also believe that the CMBS markets will eventually heal and once again become an important source of secured, non-recourse debt capital for commercial real estate.

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Risk Management

        We use many methods to actively manage our asset base to preserve our income and capital. Generally, for loans and net lease assets, frequent dialogue with borrowers/tenants and inspections of our collateral and owned properties have proven to be an effective process for identifying issues early and prior to missed debt service and lease payments. Many of our loans also require borrowers to replenish cash reserves for items such as taxes, insurance and future debt service costs. Late replenishments of cash reserves also may be an early indicator there could be a problem with the borrower or collateral property. We also may negotiate modifications to loan terms if we believe such modification improves our ability to maximize principal recovery. Modifications may include changes to contractual interest rates, maturity dates and other borrower obligations. Generally, when we make a concession such as reducing an interest rate or extending a maturity date, we seek to get additional collateral and/or fees in return for the modification although as challenging real estate conditions continue, obtaining additional collateral from struggling borrowers has become more difficult. In some cases we may issue default notices and begin foreclosure proceedings when the borrower is not complying with the loan terms and we believe taking control of the collateral is the best course of action to protect our capital. For net leases, we may seek to obtain up-front or accelerated payment in return for an early cancelation of the lease if we believe the tenant's creditworthiness has significantly deteriorated and that taking control of the property and re-leasing it maximizes value.

        In certain circumstances, we may pursue loan sales and payoffs at discounts to our book value. Generally, we may agree to discounted sales or payoffs where we believe there is an economic benefit from monetizing the asset in advance of its contractual maturity date. For example, we may accept a discounted payoff where we believe the cash proceeds can be reinvested at a much higher rate of return (including the capital loss from the payoff), where we believe there is significant risk of collateral value or cash flow erosion through maturity, or where we believe refinancing risk at maturity is very high. When evaluating sales and payoffs at discounts to book value, we also consider the impact such transactions have on our financing structures, corporate debt covenants and earnings.

        Securities investments generally have a more liquid market than loans and net lease assets, but we typically have very little control over restructuring decisions when there are problems with the underlying collateral. Generally, we manage risk in the securities portfolio by selling the asset when we can obtain a price that is attractive relative to its risk. In certain situations, we may sell an asset because there is an opportunity to reinvest the capital into a new asset with a more attractive risk/return profile.

        We conduct a quarterly comprehensive credit review which is designed to enable management to evaluate and proactively manage asset-specific credit issues and identify credit trends on a portfolio-wide basis as an "early warning system." Nevertheless, we cannot be certain that our review will identify all issues within our portfolio due to, among other things, adverse economic conditions or events adversely affecting specific assets; therefore, potential future losses may also stem from assets that are not identified by our credit reviews. During the quarterly reviews, assets are put on non-performing status and identified for possible impairment based upon several factors, including missed or late contractual payments, significant declines in collateral performance, and other data which may indicate a potential issue in our ability to recover our capital from the investment.

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        At March 31, 2010, our loan portfolio had the following credit statistics (in thousands):

Non-Performing Loans(1)
  Number
of Loans
  Aggregate
Balance
  Reserves   Aggregate
Net Balance
  Collateral Types and Locations (% by loan balance)
 

First mortgages

    3   $ 45,798   $ 16,065   $ 29,732   77% land located in New York, NY and 23% hotel located in
Omaha, NE.
 

Junior participations in first mortgages

    2     38,462     23,000     15,462   74% land located in Orlando, FL and 26% retail located in
Kingston & West Seneca, NY.
                     

Total

    5   $ 84,260   $ 39,065   $ 45,194    
   

Performing loans with loan loss reserves

                           
 

First mortgages(2)

    4   $ 105,114   $ 26,480   $ 78,634   90% office located in Philadelphia, PA, Austin, TX, San Jose &
Livermore, CA, 7% land located in Livermore, CA and 3%
retail located in Pleasant Hill, IA.
 

Junior participations in first mortgages

    1     33,727     7,000     26,727   100% land located in Las Vegas, NV.
 

Mezzanine

    4     108,504     36,171     72,333   46% hotel located throughout the USA, 32% retail located in
Phoenix, AZ and 22% multi-family located in Ventura, CA.
                     

Total

    9   $ 247,345   $ 69,651   $ 177,694    
                     
 

Total NPLs and performing loans with loan loss reserves

    14   $ 331,605   $ 108,716   $ 222,888    
                       

(1)
A loan is classified as non-performing at such time as the loan becomes 90 days delinquent in interest or principal payments or the loan has a maturity default.

(2)
Includes a first mortgage and mezzanine loan held by NorthStar, having a combined $33 million outstanding balance and having the same collateral base, considered a single first mortgage for purposes of this table.

        At March 31, 2010, our loan portfolio principal and interest aging is as follows (inclusive of our non-performing loans) (in thousands):

1 - 30 Days   31 - 60 Days   61 - 90 Days   90+ Days
$77   $65   $10,562   $73,826

        For the three months ended March 31, 2010, we recorded $37.1 million of credit loss provisions relating to eight loans and recorded a $0.8 million credit for a loan held for sale with a fair market value in excess of its carrying amount. During March 2010 NorthStar foreclosed on a $15.0 million defaulted first mortgage loan backed by hotel collateral located in Phoenix, AZ and NorthStar simultaneously sold the hotel for approximately $9.6 million. In prior periods NorthStar had recorded $5.0 million of credit loss reserves for this asset and it was a NPL at December 31, 2009. As of March 31, 2010, loan loss reserves totaled $108.7 million and related to 12 loans having an aggregate $311.1 million book value (exclusive of the related reserve).

        Activity in the allowance for credit losses on real estate debt investments for the three months ended March 31, 2010, is as follows:

Credit Loss Reserve
   
 

Balance at December 31, 2009

  $ 77,400  

Provision for credit losses

    36,316  

Write-offs

    (5,000 )
       

Balance at March 31, 2010

  $ 108,716  
       

        At March 31, 2010, we had five loans totaling $84.3 million on non-performing status due to maturity defaults, and $39.1 million of our credit loss reserves were allocated to these loans. First mortgages represent approximately 54.4% of the book value of these loans (exclusive of reserves), and 75.7% of the loans are backed by land collateral. There can be no assurance that there will be

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acceptable outcomes under our non-performing loans and accordingly, we may determine that more reserves are required for these loans.

        In April 2010, NorthStar sold a $13.9 million first mortgage loan backed by land collateral located in New York, NY for approximately $8.5 million. The mortgage was a NPL and in prior periods NorthStar had recorded $6.3 million of loan loss reserves for this asset. In April 2010 NorthStar also sold a $39.1 million mezzanine loan backed by a portfolio of hotel properties for approximately $32.1 million. NorthStar had recorded $7.0 million of loan loss reserves for this asset. During April 2010 NorthStar also foreclosed on an $18.0 million first mortgage loan backed by office collateral located in Philadelphia, PA. NorthStar had in prior periods recorded $8.8 million of loan loss reserves for this asset.

        Overall, the prolonged poor economic conditions and the continuing lack of commercial real estate debt capital is resulting in increasing stress levels for commercial real estate credit. A shrinking economy generally results in decreasing real estate cash flows as corporations and consumers reduce their real estate needs, travel and spending. While the overall economy has seen some signs of growth, because market volume remains very low, and banks and life companies have drastically curtailed new lending activity, real estate owners are having difficulty refinancing their assets at maturity. Many owners are also having trouble achieving their business plans to the extent they acquired a property to reposition it or otherwise invest capital to increase the property's cash flows. Property values have also generally decreased over the past few years because of scarcity of financing, which when it is available the terms generally are at much lower leverage and higher cost than available in prior years, uncertainty regarding future economic conditions and higher returning investment opportunities available in other asset classes. Decreasing values make it difficult for real estate investors to sell their properties and to recoup their capital. As a result of the weak commercial real estate market, many lenders, including us, are concluding that extending loans at original maturity, rather than foreclosure and sale, may be the most attractive path for maximizing value.

        For the three months ended March 31, 2010, we modified the contractual interest rates of loans as part of restructuring or extension negotiations and, in some cases, we discontinued the recognition of income for interest accrual rates in excess of the stated cash pay rates. In the aggregate, these changes, as well as loans which were non-performing during the quarter, resulted in an approximate $2.9 million reduction to interest income ($12.2 million on an annualized basis).

        Many of our loans were made to borrowers who had a business plan to improve the collateral property and who therefore needed a flexible balance sheet lender. In many cases we required the borrowers to pre-fund reserves to cover interest and operating expenses until the property cash flows increased sufficiently to cover debt service costs. We also generally required the investor to refill these reserves if they became deficient due to underperformance and if the borrower wanted to exercise extension options under the loan. Despite low interest rates, we expect that in the future some of our borrowers may have difficulty servicing our debt because they cannot achieve their business plan in this economic environment. If any of our borrowers are unable to replenish reserves and otherwise ultimately achieve their business plans, the related loans may become non-performing. In addition, even if a borrower's business plan is achieved, current real estate valuations and the financing environment may result in a borrower being unable to recoup its invested capital and a default under the loan causing a partial or full loss of our loan principal.

        Each of our loan investments, while primarily backed by commercial real estate collateral, is unique and requires customized asset management strategies for dealing with potential credit situations. The complexity of each situation depends on many factors, including the number of collateral properties, the type of property, macro and local market conditions impacting the demand, cash flow and value of the of the collateral, and the financial condition of our borrowers and their willingness to support our collateral properties. Additionally, in many cases there are multiple lenders involved with

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specific collateral properties and these lenders may have different objectives which influence their preferred strategy for dealing with a credit situation.

        Our impairment analyses often requires that we make assumptions regarding collateral values and the timing regarding when we will receive debt service payments, including principal recovery. In a difficult environment for commercial real estate, our impairment analyses may lead us to the determination that extending and working out a loan, rather than pursuing foreclosure, is the best course of action to maximize total and long-term value. However, in situations where there are multiple creditors in large capital structures, it can be particularly difficult to assess the most likely course of action that a lender group or the borrower may take. Consequently, there could be a wide range of potential principal recovery outcomes, the timing of which can be unpredictable, based on the strategy pursued by a lender group and/or by a borrower. Our impairment analysis in each of these situations is based on our assessment of the facts and circumstances currently known to us and because these situations often involve complicated collateral and complex creditor and borrower dynamics, our assessment of recovery value may change more dramatically and quickly and without the visibility that may be available in other situations. These multiple creditor situations tend to be associated with larger loans, and NorthStar has been and continues to be involved in situations such as these, although Northstar, as one of a group of lenders and often a lender on a subordinated basis, does not independently control the decision making. The discussion below summarizes the largest credit situations that currently meet some of the foregoing characteristics.

    East Rutherford, NJ Retail Construction First Mortgage Loan

        We own a $92.5 million pari passu participation in a $498.6 million first mortgage that is secured by a retail/entertainment complex located in East Rutherford, NJ (the "NJ Loan"). The NJ Loan was most recently modified as of March 31, 2010 and the maturity date of the NJ Loan was extended to August 2010 to provide the borrower additional time to seek new capital for the project. There can be no assurance that the borrower will be successful in attracting the capital necessary for the project and that the NJ Loan will not default in the future. If the NJ Loan were to default, we may lose a substantial amount of our investment, which could have a material adverse effect on our business and operations.

    German Retail Portfolio Mezzanine Loan Participation

        We own a €72.5 million participation in a mezzanine loan that is collateralized by a German retail portfolio that is net leased to a single tenant (the "Tenant") that has filed for bankruptcy in Germany (the "German Loan"). There are ongoing negotiations relating to a restructuring of the German Loan, as well as ongoing discussions relating to a potential sale of the Tenant by the German bankruptcy administrator. There can be no assurance that the restructuring will be successful and that the German Loan will not default in the future. There can also be no assurance that the bankruptcy administrator will be successful in selling the Tenant. An unsuccessful sale of the Tenant would result in the Tenant's liquidation and termination of the leases on the retail portfolio that serve as collateral for the German Loan. If the German Loan were to default or the Tenant were liquidated, we may lose all of our investment, which could have a material adverse effect on our business and operations.

    Las Vegas, NV Casino/Hotel Mezzanine Loan

        We own an $89.0 million mezzanine loan that is secured by the Hard Rock Hotel and Casino in Las Vegas, NV (the "NV Loan"). The NV Loan was most recently restructured in December 2009. The final maturity date of the NV Loan was extended to February 2014 to provide additional time for market conditions to improve and for performance at the property to stabilize. As part of the extension, interest reserves were also established to support the NV Loan. There can be no assurance that market conditions will improve in the future or that the performance at the property will improve

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such that its cash flow can support the NV Loan. If the NV Loan were to default or the interest reserves are depleted and the borrower is not willing to provide additional capital for the property, we may lose all of our investment, which could have a material adverse effect on our business and operations.

Critical Accounting Policies

        Refer to the section of our Annual Report on Form 10-K for the year ended December 31, 2009 entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting policies" for a full discussion of our critical accounting policies.

Recent Accounting Pronouncements

        In January 2010, the Financial Accounting Standards Board ("FASB) issued guidance requiring additional disclosures about fair value measurements regarding transfers between fair value categories as well as purchases, sales, issuances and settlements related to fair value measurements of financial instruments with non-observable inputs. This update was effective and was adopted without a material impact on our financial condition or results of operations for interim and annual periods beginning after December 15, 2009 except for disclosures about purchases, sales, issuances and settlements of financial instruments with non-observable inputs, which are effective for years beginning after December 15, 2010. The additional disclosures required by this update will be included in the note on fair value measurements upon adoption. We do not expect these additional disclosures to have a material impact on our financial condition or results of operations.


RESULTS OF OPERATIONS

Comparison of the Three Months Ended March 31, 2010 to the Three Months Ended March 31, 2009

Revenues

    Interest Income

        Interest income for the three months ended March 31, 2010 totaled $57.6 million, representing an increase of $20.8 million, or 57%, compared to $36.8 million for the three months ended March 31, 2009. For the three months ended March 31, 2010, the increase in interest income was primarily attributable to: (i) the addition of $24.0 million in interest income as the result of the January 1, 2010 consolidation of the N-Star I, N-Star II, N-Star III and N-Star V CDO financing's available for sale securities and real estate debt investments; and (ii) the acquisition of higher yielding commercial real estate securities subsequent to March 31, 2009 resulting in $4.5 million of higher interest, partially offset by: (i) the modification of the contractual interest rates on loans as part of restructuring or extension negotiations resulting in a decrease of approximately $5.4 million in interest income; (ii) the discontinuation of the recognition of income for interest accrual rates in excess of the stated cash pay rates related to loans which were non-performing during the quarter resulting in a decrease of approximately $2.0 million in interest income; and (iii) a lower average one-month LIBOR of approximately 22 basis points and lower comparable asset balances resulting in a decrease of approximately $0.3 million in interest income.

    Interest Income—Related Parties

        Interest income from related parties for the three months ended March 31, 2010 totaled $0.6 million, representing a decrease of $3.9 million, or 87%, compared to $4.5 million for the three months ended March 31, 2009. As of January 1, 2010, the consolidation of the N-Star I, N-Star II, N-Star III and N-Star V CDOs financing the non-investment grade notes are no longer accounted for

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as available for sale securities, resulting in a decrease in interest income—related parties of $3.9 million.

    Rental and Escalation Income

        Rental and escalation income for the three months ended March 31, 2010 totaled $21.8 million, representing a decrease of $3.4 million, or 13%, compared to $25.2 million for the three months ended March 31, 2009. The decrease was primarily attributable to decreases of $1.9 million related to the change of our net lease relationship with one of our healthcare operators, which resulted in one of our unconsolidated affiliates becoming the lessee of the properties and our unconsolidated affiliate simultaneously entered into a management agreement with a third party operator, $1.0 million related to lower rents and remaining vacancy on the lease renewal for the Cincinnati, OH property and $0.6 million related to the Chatsworth, CA property lease disaffirmation and foreclosure of the properties by the first mortgage lender in 2009, partially offset by an increase in rental income of $0.1 million related to a new lease on one of our properties.

    Advisory and Management Fee Income—Related Parties

        Advisory fees from related parties for the three months ended March 31, 2010 totaled $0.5 million, representing a decrease of approximately $1.2 million, or 71%, compared to $1.7 million for the three months ended March 31, 2009. As of January 1, 2010, the related party advisory and management fee income earned on the N-Star I, N-Star II, N-Star III and N-Star V CDO financings is eliminated as a result of the consolidation of the respective CDO financings. The decrease in advisory and management fee income—related parties is attributable to the elimination of the advisory and management fee income earned on the previously non-consolidated CDO financings.

    Other Revenue

        Other revenue for the three months ended March 31, 2010 totaled $1.1 million, representing an increase of $0.9 million, or 450%, compared to $0.2 million for the three months ended March 31, 2009. Other revenue for three months ended March 31, 2010 consisted primarily of $0.9 million in early redemption fees on debt securities available for sale and $0.2 million in other fees. Other revenue for the three months ended March 31, 2009 consisted primarily of $0.1 million in exit fees and $0.1 million in unused credit line fees.

Expenses

    Interest Expense

        Interest expense for the three months ended March 31, 2010 totaled $32.1 million, representing a decrease of $1.1 million, or 3%, compared to $33.2 million for the three months ended March 31, 2009. The decrease in interest was primarily the result of: (i) $3.3 million lower interest on our issued CDO notes and trust preferred debt due to lower average LIBOR rates, 2009 debt repurchases and repayments; (ii) $1.8 million lower interest on our 11.50% and 7.25% exchangeable senior notes due to 2009 repurchases; (iii) $0.8 million lower interest as a result of the foreclosure by the first mortgage lender of our Chatsworth, CA properties; (iv) $0.4 million in lower interest rates on our Euro-note; and (v) $0.1 million lower interest related to the termination of our unsecured revolving credit line. The decrease in interest expense was partially offset by; (i) the addition of $4.6 million in interest expense as the result of the January 1, 2010 consolidation of the N-Star I, N-Star II, N-Star III and N-Star V CDO financing bonds payable; (ii) 0.3 million in additional interest related to asset acquisitions under the Term Asset-Backed Securities Loan Facility, or TALF program; and (iii) $0.4 million higher interest relating to an increased spread on our amended WA Secured Term Loan.

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    Real Estate Properties—Operating Expenses

        Real estate property operating expenses for three months ended March 31, 2010 totaled $1.8 million, representing a decrease of $0.3 million, or 14%, compared to $2.1 million for three months ended March 31, 2009. The decrease was primarily attributable to $0.3 million in lower expenses as a result of the first mortgage lender foreclosing on the Chatsworth, CA properties in during the third quarter of 2009.

    Asset Management Fees—Related Party

        Advisory fees for related parties for the three months ended March 31, 2010 totaled $0.5 million, representing a decrease of $0.4 million, or 44%, compared to $0.9 million for the three months ended March 31, 2009. The decrease was primarily related to the reduced asset management fee rate pursuant to the amended management agreement with Wakefield Capital Management Inc. We incurred $0.4 million and $0.9 million of management fees to Wakefield Capital Management for the three months ended March 31, 2010 and 2009, respectively.

    Provision for Loan Losses

        Provision for loan losses for the three months ended March 31, 2010 totaled $36.3 million for eight loans and included a $0.8 million credit for a loan held for sale with a fair market value in excess of its carrying amount. The provision for loan losses for the three months ended March 31, 2010 included $6.1 million for first mortgage whole loans, $14.0 million for subordinated mortgage interests, $17.0 million for mezzanine loans and a $0.8 million credit for a first mortgage whole loan. Provision for loan losses for the three months ended March 31, 2009 totaled $21.5 million for ten loans and included $12.0 million for mezzanine loans, $6.5 million for whole loans and $3.0 million for subordinated mortgage interests.

    General and Administrative

        General and administrative expenses for the three months ended March 31, 2010 totaled $23.5 million, representing an increase of $6.1 million, or 35%, compared to $17.4 million for the three months ended March 31, 2009. The primary components of our general and administrative expenses were the following:

        Salaries and equity-based compensation for the three months ended March 31, 2010 totaled $16.5 million, representing an increase of approximately $4.9 million, or 42%, compared to $11.6 million, for the three months ended March 31, 2009. The increase was attributable to a $5.0 million increase related to salaries and accrued cash incentive compensation costs and a $0.1 million decrease related to equity-based compensation. The $5.0 million increase in salaries and accrued compensation was attributable to a one-time expense of $3.5 million relating to the separation and consulting agreement with our former COO and higher staffing levels in 2010 primarily relating to our broker-dealer subsidiary and internalizing management of our healthcare net lease assets. The $0.1 million decrease in equity-based compensation expense was attributable to a $1.3 million decrease in expense from equity-based awards issued under our 2004 Omnibus Stock Incentive Plan becoming fully vested. The decease was partially offset by an additional $1.0 million of equity-based compensation expense related to the accelerated vesting of equity-based awards in connection with the separation agreement with our former COO and a $0.2 million of equity-based compensation expense related to the long-term incentive component of our incentive compensation plan.

        Auditing and professional fees for the three months ended March 31, 2010 totaled $3.0 million, representing an increase of $0.7 million, or 26%, compared to $2.3 million for the three months ended March 31, 2009. The increase was primarily attributable to approximately a $0.2 million increase in legal fees related to our non-listed and private REITs, a $0.2 million increase in legal fees related to

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the Chatsworth property foreclosure, a $0.1 million increase in fees relating to capital raising and asset sales in our healthcare portfolio and a $0.1 million increase in legal fees for general corporate work, and portfolio management.

        Other general and administrative expenses for the three months ended March 31, 2010 totaled $4.1 million, representing an increase of approximately $0.5 million, or 14%, compared to $3.6 million for the three months ended March 31, 2009. The increase was primarily attributable to increased overhead costs resulting from higher staffing levels during the three months ended March 31, 2010.

    Depreciation and Amortization

        Depreciation and amortization expense for the three months ended March 31, 2010 totaled $8.5 million, representing a decrease of $5.8 million, or 41%, compared to $14.3 million for the three months ended March 31, 2009. The decrease was primarily attributable to a decrease of $5.4 million related to charges associated with the 2009 foreclosure by the first mortgage lender of the Chatsworth, CA property, a decrease of $0.3 million related to the membership redemption agreement with Chain Bridge pursuant to which we contributed certain assets and a decrease of $0.1 million related to several assets in our net lease portfolio being fully depreciated.

    Equity in (Loss) Earnings of Unconsolidated Ventures

        Equity in earnings (loss) for the three months ended March 31, 2010 was net earnings of $1.3 million, representing an increase of $5.7 million, compared to a loss of $4.4 million for the three months ended March 31, 2009. For the three months ended March 31, 2010, we recognized equity in earnings of $2.4 million from our unconsolidated affiliated lessee formed in 2009, resulting from the termination of a lease to a third party in our healthcare real estate portfolio and $0.1 million in connection with a net lease joint venture. The equity in earnings were partially offset by equity in losses of $0.9 million from the Securities Fund (which includes both realized and unrealized gains from asset sales and mark-to-market adjustments) and $0.5 million from the LandCap joint venture. For the three months ended March 31, 2009, we recognized equity in losses of $2.3 million from the LandCap joint venture and equity in losses of $2.3 million from the Securities Fund (which includes both realized and unrealized gains from asset sales and mark-to-market adjustments). The losses were partially offset by equity in earnings of $0.2 million in connection with a net lease joint venture.

    Unrealized Gain (Loss) on Investments and Other

        Unrealized gain (loss) on investments and other decreased by approximately $92.5 million for the three months ended March 31, 2010 to a loss of $1.8 million, compared to a gain of $90.7 million for the three months ended March 31, 2009. The unrealized gain on investments and other for the three months ended March 31, 2010 consisted primarily of $96.4 million mark-to-market adjustment gains on various available for sale securities and mark-to-market adjustment gains of $2.6 million on our corporate lending joint venture (which is an equity investment that is marked to market), partially offset by unrealized mark-to-market adjustment losses of $41.8 million on various issued CDO bonds payable, $35.2 million unrealized losses on interest rate swap derivatives no longer qualifying, or not designated as, hedging instruments and mark-to-market adjustment losses of $23.8 million on liability to subsidiary trusts issuing preferred. The unrealized gain on investment for the three months ended March 31, 2009 consisted primarily of unrealized gains related to mark-to-market adjustments of $135.6 million on various N-Star CDO bonds payable, unrealized gains of $1.5 million on interest rate swap derivatives no longer qualifying, or not designated as, hedging instruments and unrealized gains of $1.9 million on liability to subsidiary trusts issuing preferred securities. The increase was partially offset by unrealized losses related to mark-to-market adjustments of $23.2 million on various available for sale securities and unrealized losses of $25.2 million on our corporate lending joint venture (which is an equity investment that is marked to market).

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    Realized Gain on Investments and Other

        The realized gain of $1.4 million for the three months ended March 31, 2010 consisted primarily of net realized gains of $3.3 million on the sale of certain real estate debt securities available for sale offset partially by a net foreign currency translation loss of $1.2 million related to our Euro-denominated investment, net losses of $0.4 million on the redemption of certain available for sale securities and a loss of $0.3 million on the termination of an interest rate swap in connection with the GE refinancing. The realized gain on investments and other of $36.9 million for the three months ended March 31, 2009, was attributable to net realized gains of $34.4 million on the repurchase of $61.0 million of our 7.25% exchangeable senior notes and net realized gains of $2.5 million on the sale of certain debt securities available for sale, offset partially a foreign currency translation gain of $0.1 million related to our Euro-denominated investment.

    Income from Discontinued Operations

        Income from discontinued operations represents the operations of properties sold or held for sale during the period. In December 2009, our healthcare venture sold a portfolio of 18 assisted living facilities located in North Carolina. Accordingly, income of $0.6 million related to the operations of these properties was reclassified to income from discontinued operations for the three months ended March 31, 2009.

Liquidity and Capital Resources

        We require significant capital to fund our investment activities and operating expenses. Our capital sources may include cash flow from operations, net proceeds from asset repayments and sales, borrowings under revolving credit facilities, financings secured by our assets such as first mortgage and CDO financings, long-term senior and subordinate corporate capital such as senior notes, trust preferred securities and perpetual preferred and common stock. As we discussed in "Outlook and Recent Trends", availability of such capital from all of these sources is extremely scarce (if available at all) for most financial institutions that do not have access to U.S. Government funding sources such as the Fed Discount window, including commercial mortgage REITs, and we expect this capital to be difficult to obtain during 2010.

        Our total available liquidity at March 31, 2010 was approximately $214.2 million, including $116.8 million of unrestricted cash and cash equivalents and $97.4 million of uninvested and available funds in our CDO financings, which is available only for reinvestment within the CDO structures. Under the WA Secured Term Loan, we are required to make semi-annual amortization payments of $15.0 million, and $90.0 million of total aggregate amortization payments over the term of the loan. We expect to fund these amortization payments from existing cash liquidity, proceeds from future loan repayments and/or asset sales.

        As a REIT, we are required to distribute at least 90% of our annual REIT taxable income to our stockholders, including taxable income where we do not receive corresponding cash, and we intend to distribute all or substantially all of our REIT taxable income in order to comply with the REIT distribution requirements of the Internal Revenue Code and to avoid federal income tax and the non-deductible excise tax. In the past, we have maintained high unrestricted cash balances relative to the historical difference between our distributions and cash provided by operating activities. On a quarterly basis, our Board of Directors determines an appropriate common stock dividend based upon numerous factors, including AFFO, REIT qualification requirements, the amount of cash flows provided by operating activities, availability of existing cash balances, borrowing capacity under existing credit agreements, access to cash in the capital markets and other financing sources, our view of our ability to realize gains in the future through appreciation in the value of our assets, general economic conditions and economic conditions that more specifically impact our business or prospects. Although

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we significantly reduced the cash portion of quarterly dividends paid in 2009 and 2010 to date relative to prior periods, future dividend levels are subject to further adjustment based upon our evaluation of the factors described above, as well as other factors that our Board of Directors may, from time to time, deem relevant to consider when determining an appropriate common stock dividend.

        We currently believe that our existing sources of funds should be adequate for purposes of meeting our short-term liquidity needs; however, our CDO financing structures generally require that the underlying collateral and cash flow generated by the collateral to be in excess of ratios stipulated in the related indentures. These ratios are called overcollateralization, or OC, and interest coverage, or IC, tests. The reinvestment periods, which allow us to reinvest principal payments on the underlying assets into qualifying replacement collateral and is instrumental in maintaining OC and IC ratios, for our N-Star CDO I, II and III have expired, and, for our N-Star CDO IV, N-Star CDO V, N-Star CDO VI, N-Star CDO VII, N-Star CDO VIII and N-Star CDO IX will expire in July 2010, September 2010, June 2011, June 2011, February 2012 and June 2012, respectively. Since we are or will be unable to reinvest principal in these CDOs, principal repayments will pay down the senior-most notes, which will de-lever the CDO. Following the conclusion of the reinvestment period in these CDOs, our ability to maintain the OC and IC ratios will be negatively impacted. In the event these tests are not met, cash that would normally be distributed to us would be used to amortize the senior notes until the financing is back in compliance with the tests. In the event cash flow is diverted to repay the notes, this could decrease cash available to pay our dividend and to comply with REIT requirements. Additionally, we may be required to buy assets out of our CDO financings in order to preserve cash flow. As of March 31, 2010, we were in compliance with all of the OC and IC tests in our CDO financings. We expect that very weak economic conditions, lack of capital for commercial real estate, decreasing real estate values and credit ratings downgrades of real estate securities will make complying with OC and IC tests more difficult in 2010 and in the future.

        The following is a summary of our CDO cash distribution and coverage tests as of March 31, 2010:

 
   
  Cash Distributions(1)   Quarterly
Interest Coverage
Cushion(2)
  Overcollateralization
Cushion
 
 
  Primary
Collateral
Type
  Quarter Ended
March 31,
2010
  March 31,
2010
  March 31,
2010
  At
Offering
 

N-Star I(3)

  CMBS   $ 429   $ 350   $ 8,812   $ 8,687  

N-Star II

  CMBS     177     137     4,671     10,944  

N-Star III

  CMBS     1,688     1,904     52,579     13,610  

N-Star IV

  Loans     2,228     2,131     47,973     19,808  

N-Star V

  CMBS     1,269     1,432     54,589     12,940  

N-Star VI

  Loans     1,125     3,510     34,951     17,412  

N-Star VII

  CMBS     2,501     2,192     80,206     13,966  

N-Star VIII

  Loans     3,912     5,055     71,032     42,193  

N-Star IX(4)

  CMBS     1,468     1,501     55,481     24,516  

Table shows cash distributions to the retained income notes. Interest coverage and overcollateralization coverage to the most constrained class.

(1)
Cash distributions are exclusive of senior management fees which are not subject to the coverage tests.

(2)
Quarterly interest cushion and overcollateralization cushion from remittance report issued on date nearest to March 31, 2010.

(3)
N-Star I equity cash flow represents NorthStar's 83% ownership percentage. First quarter 2010 cash distribution excludes a $0.9 million fee received related to a tender offer.

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(4)
NorthStar indirectly owns approximately 31% of N-Star IX income notes through its interest in the Securities Fund.

        We will seek to meet our long term liquidity requirements, including the repayment of debt and our investment funding needs, through existing cash resources, our existing CDOs and the liquidation or refinancing of assets at maturity; nonetheless, our ability to meet a long-term (beyond one year) liquidity requirement may be subject to obtaining additional debt and equity financing. Any decision by our lenders and investors to provide us with financing will depend upon a number of factors, such as our compliance with the terms of its existing credit arrangements, our financial performance, industry or market trends, the general availability of and rates applicable to financing transactions, such lenders' and investors' resources and policies concerning the terms under which they make capital commitments and the relative attractiveness of alternative investment or lending opportunities.

    Equity Distribution Agreement

        In May, 2009, we entered into an equity distribution agreement with JMP Securities, LLC, or JMP. In accordance with the terms of the agreement, we may offer and sell up to 10,000,000 shares of our common stock from time to time through JMP. JMP will receive a commission from us of up to 2.5% of the gross sales price of all shares sold through it under the equity distribution agreement. We may offer and sell shares of our common stock pursuant to our equity distribution agreement if we believe the economics are attractive, and may use the proceeds for investments, debt repayment or general corporate purposes.

        During the three months ended March 31, 2010, we did not issue any shares pursuant to our equity distribution agreement with JMP.

    Dividend Reinvestment and Stock Purchase Plan

        Effective as of April 27, 2007, we implemented a Dividend Reinvestment and Stock Purchase Plan, or the Plan, pursuant to which we registered and reserved for issuance 15,000,000 shares of our common stock. Under the terms of the Plan, stockholders who participate in the Plan may purchase shares of our common stock directly from us, in cash investments up to $10,000. At our sole discretion, we may accept optional cash investments in excess of $10,000 per month, which may qualify for a discount from the market price of 0% to 5%. Plan participants may also automatically reinvest all or a portion of their dividends for additional shares of our stock. We expect to use the proceeds from any dividend reinvestments or stock purchases for general corporate purposes.

        During the three months end March 31, 2010, we issued a total of 23,975 common shares pursuant to the Plan for a gross sales price of approximately $0.1 million.

    Mortgage note refinancing

        On March 31, 2010, we closed on a $65.0 million loan with General Electric Capital Corporation. The proceeds will be primarily used to refinance $52.0 million of loans maturing in 2010 on nine of our healthcare-related net leased assets. The excess proceeds from the financing will be used for working capital and general corporate purposes. The loan has a five-year term with a one-year interest only period and principal and interest payments thereafter. The interest rate is 90-day LIBOR + 5.95% with a 1% LIBOR floor.

Cash Flows

        The net cash used by operating activities was $3.9 million for the three months ended March 31, 2010 compared to the net cash flow provided by operating activities of $8.9 million for the three

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months ended March 31, 2009. The decrease was primarily due to the lower LIBOR rates and lower spreads on our lending assets which decreased interest income generated from our asset base.

        The net cash flow used in investing activities was $28.4 million for the three months ended March 31, 2010 compared to the net cash used in investing activities of $9.9 million for the three months ended March 31, 2009. The primary uses of cash flow used in investing activities in 2010 were the acquisition of available for sale securities and originations of real estate debt investments. The primary uses of cash flow used by investing activities in 2009 were the origination or acquisition of real estate debt investments, and the acquisition of real estate securities.

        The net cash flow provided by financing activities was $10.2 million for the three months ended March 31, 2010 compared to cash used by financing activities of $11.6 million of cash used by financing activities for the three months ended March 31, 2009. The primary source of cash flow by financing activities was mortgage notes and loan borrowings. Net cash flow used in financing activity in 2009 was primarily related to the repurchase of our bonds and repayments on our credit facilities.

Contractual Obligations and Commitments

        As of March 31, 2010, we had the following contractual commitments and commercial obligations (dollars in thousands):

 
  Payments Due by Period  
Contractual Obligations
  Total   1 year   2-3 years   4-5 years   After 5 Years  

Mortgage notes

  $ 793,972   $ 5,654   $ 149,962   $ 56,040   $ 582,316  

Mezzanine loan payable

    2,676     194     656     748     1,078  

Exchangeable senior notes(1)

    128,915         68,165     60,750      

Bonds payable

    2,973,514                 2,973,514  

Secured term loan

    387,060         348,898     14,682     23,480  

Liability to subsidiary trusts issuing preferred securities

    280,133                 280,133  

Capital leases(2)

    16,008     365     982     1,004     13,657  

Operating leases

    69,398     4,229     10,983     10,968     43,218  

Outstanding unfunded commitments(3)

    69,381     60,776     8,558     47      

Estimated interest payments

    613,826     85,708     237,465     163,117     127,535  
                       

Total contractual obligations

  $ 5,334,883   $ 156,927   $ 825,668   $ 307,356   $ 4,044,931  
                       

(1)
$68.2 million of our 7.25% exchangeable senior notes have a final maturity date of June 15, 2027. The above table reflects the holders repurchase rights which may require us to repurchase the notes on June 15, 2012.

(2)
Includes interest on the capital leases.

(3)
Our future funding commitments, which are subject to certain conditions that borrowers must meet to qualify for such fundings, totaled $69.4 million, of which a minimum of $46.0 million will be funded within our existing CDO financings. Fundings are categorized by estimated funding period. We expect that our secured credit facility lender generally will advance a majority of future fundings that are not otherwise funded within our CDO financings. Based upon currently approved advance rates on our credit facility and CDOs and assuming that all loans that have future fundings meet the terms to qualify for such funding, our equity requirement on the remaining $23.4 million of future funding requirements would be approximately $6.5 million over the next two years.

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        Our debt obligations contain covenants that are both financial and non-financial in nature. Significant financial covenants include a requirement that we maintain a minimum tangible net worth, a minimum level of liquidity and a minimum fixed charge coverage ratio. As of March 31, 2010, we were in compliance with all financial and non-financial covenants in our debt agreements.

Recent Developments

Dividends

        On April 20, 2010, we declared a dividend of $0.10 per share of common stock, $0.54688 per share of Series A preferred stock and $0.51563 per share of Series B preferred stock. The dividends will be paid on May 14, 2010 to the stockholders of record as of the close of business on May 5, 2010.

Midwest Care Holdco TRS I LLC

        In April 2010, pursuant to the membership redemption agreement entered into in December 2009, we acquired the 51% membership interest in Midwest owned by Chain Bridge for $1.0 million in cash. As a result of the acquisition, we now hold 100% of the common membership interest in Midwest and control all major decisions. Accordingly the operations of Midwest, which were previously accounted for under the equity method, will be consolidated.

Inflation

        Our leases for tenants of operating real estate are generally either:

    net leases where the tenants are responsible for all or a significant portion of the real estate taxes, insurance and operating expenses and the leases provide for increases in rent either based on changes in the Consumer Price Index, or CPI, or pre-negotiated increases; or

    operating leases which provide for separate escalations of real estate taxes and operating expenses over a base amount, and/or increases in the base rent based on changes in the CPI.

        We believe that most inflationary increases in expenses will be offset by the expense reimbursements and contractual rent increases described above to the extent of occupancy.

        We believe that the risk associated with an increase in market interest rates on the floating rate debt used to finance our investments in our CDO financings and our direct investments in real estate debt, will be largely offset by our strategy of matching the terms of our assets with the terms of our liabilities and through our use of hedging instruments.

        See "Quantitative and Qualitative Disclosures About Market Risk" in Item 7A of our Annual Report on Form 10-K for additional information on our exposure to market risk.

Non-GAAP Financial Measures

    Funds from Operations and Adjusted Funds from Operations

        Management believes that funds from operations, or FFO, and adjusted funds from operations, or AFFO, each of which are non-GAAP measures, are additional appropriate measures of the operating performance of a REIT and NorthStar in particular. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT, as net income or loss (computed in accordance with GAAP), excluding gains or losses from sales of depreciable properties, the cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, and after adjustments for unconsolidated/uncombined partnerships and joint ventures. AFFO, as defined by NAREIT, is a computation made by analysts and investors to measure a real estate company's cash flow generated by operations.

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        We calculate AFFO by subtracting from (or adding) to FFO:

    normalized recurring expenditures that are capitalized by us and then amortized, but which are necessary to maintain our properties and revenue stream, e.g., leasing commissions and tenant improvement allowances;

    an adjustment to reverse the effects of the straight-lining of rents and fair value lease revenue;

    the amortization or accrual of various deferred costs including intangible assets and equity based compensation; and

    an adjustment to reverse the effects of unrealized gains/(losses).

        Our calculation of AFFO differs from the methodology used for calculating AFFO by certain other REITs and, accordingly, our AFFO may not be comparable to AFFO reported by other REITs. Our management utilizes FFO and AFFO as measures of our operating performance, and believes they are also useful to investors, because they facilitate an understanding of our operating performance after adjustment for certain non-cash expenses, such as real estate depreciation, which assumes that the value of real estate assets diminishes predictably over time and, in the case of AFFO, equity based compensation. Additionally, FFO and AFFO serve as measures of our operating performance because they facilitate evaluation of our company without the effects of selected items required in accordance with GAAP that may not necessarily be indicative of current operating performance and that may not accurately compare our operating performance between periods. Furthermore, although FFO, AFFO and other supplemental performance measures are defined in various ways throughout the REIT industry, we also believe that FFO and AFFO may provide us and our investors with an additional useful measure to compare our financial performance to certain other REITs.

        Neither FFO nor AFFO is equivalent to net income or cash generated from operating activities determined in accordance with U.S. GAAP. Furthermore, FFO and AFFO do not represent amounts available for management's discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Neither FFO nor AFFO should be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.

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        Set forth below is a reconciliation of FFO and AFFO to net income from continuing operations before non-controlling interest for the three months ended March 31, 2010 and 2009 (in thousands):

 
  Three Months
Ended
March 31, 2010
  Three Months Ended March 31, 2009  

Funds from Operations:

             

(Loss)/income from continuing operations

  $ (20,103 ) $ 102,126  

Non-controlling interest in joint ventures

    (1,962 )   (2,464 )
           

Consolidated net (loss)/income before non-controlling interest in operating partnership

    (22,065 )   99,662  

Adjustments:

             

Preferred stock dividends

    (5,231 )   (5,231 )

Depreciation and amortization

    8,483     14,285  

Funds from discontinued operations

        1,134  

Real estate depreciation and amortization—unconsolidated ventures

    237     247  
           

Funds from Operations

  $ (18,576 ) $ 110,097  
           

Adjusted Funds from Operations:

             

Funds from Operations

  $ (18,576 ) $ 110,097  

Straight-line rental income, net

    (546 )   (472 )

Straight-line rental income, discontinued operations

         

Straight-line rental income and fair value lease revenue, unconsolidated ventures

    (26 )   (32 )

Amortization of equity-based compensation

    5,058     5,144  

Amortization of above/below market leases

    (264 )   (325 )

Unrealized (gains)/losses from mark-to-market adjustments

    (20,158 )   (94,563 )

Unrealized (gains)/losses from mark-to-market adjustments, unconsolidated ventures

    625     2,765  
           

Adjusted Funds from Operations

  $ (33,887 ) $ 22,614  
           

Return on Average Common Book Equity

        We calculate return on average common book equity ("ROE") on a consolidated basis and for each of our major business lines. We believe that ROE provides a good indication of our performance and our business lines because we believe it provides the best approximation of cash returns on common equity invested. Management also uses ROE, among other factors, to evaluate profitability and efficiency of equity capital employed, and as a guide in determining where to allocate capital within its business. ROEs may fluctuate from quarter to quarter based upon a variety of factors, including the timing and amount of investment fundings, repayments and asset sales, capital raised and leverage used, and the yield on investments funded.

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Return on Average Common Book Equity
(including and excluding G&A and one-time items)
(dollars in thousands)

 
   
  Three Months Ended
March 31,
2010
  Annualized
March 31,
2010
   
  Year Ended
December 31,
2009
 

Adjusted Funds from Operations (AFFO)

      $ (33,887 ) $ (135,548 ) [A]   $ 82,545  

Plus: General & Administrative Expenses

        23,484               70,542  

Less: Equity-Based Compensation included in G&A

        5,058               20,474  

Less: Bad debt expense included in G&A

        323               1,554  
                         

AFFO, excluding G&A

        (15,784 )   (63,136 ) [B]     131,059  

Average Common Book Equity & Operating Partnership Non-Controlling Interest(1)

  [C]   $ 1,191,879             $ 1,194,310  
 

Return on Average Common Book Equity (including G&A)

  [A]/[C]     Neg               6.9 %
 

Return on Average Common Book Equity (excluding G&A)

  [B]/[C]     Neg               11.0 %

(1)
Average Common Book Equity & Operating Partnership Non-controlling Interest computed using beginning and ending of period balances. ROE will be impacted by the timing of new investment closings and repayments during the quarter.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

        Although we seek to match-fund our assets and mitigate the risk associated with future interest rate volatility, we are primarily subject to interest rate risk prior to match-funding our investments and because we generally maintain a net floating rate asset or liability position. To the extent we have net floating rate assets, our earnings will generally increase with increases in floating interest rates, and decrease with declines in floating interest rates. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.

        Our interest rate risk sensitive assets, liabilities and related derivative positions are generally held for non-trading purposes. As of March 31, 2010, a hypothetical 100 basis point increase in interest rates applied to our variable rate assets would increase our annual interest income by approximately $23.6 million offset by an increase in our interest expense of approximately $13.8 million on our variable rate liabilities. Similarly, a hypothetical 100 basis point decrease in interest rates would decrease our annual interest income by the same net amount.

Real Estate Debt

        We invest in real estate debt which is generally secured by commercial and multifamily properties, including first lien mortgage loans, junior participations in first lien mortgage loans, second lien mortgage loans, mezzanine loans, and preferred equity interests in borrowers who own such properties. We generally hold these instruments for investment rather than trading purposes. These investments bear interest at either a floating or fixed rate. The interest rates on our floating rate investments typically float at a fixed spread over an index such as LIBOR. These instruments typically reprice every 30 days based upon LIBOR in effect at that time. Given the frequent and periodic repricing of our floating rate investments, changes in benchmark interest rates are unlikely to materially affect the value of our floating rate portfolio. Changes in short-term rates will, however, affect earnings from our

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investments. Increases in LIBOR will increase the interest income received by us on our investments and therefore increase our earnings. Decreases in LIBOR have the opposite effect.

        We also invest in fixed rate investments. The value of these investments may be affected by changes in long-term interest rates. To the extent that long-term interest rates increase, the value of long-term fixed rate assets is diminished. Any fixed rate real estate debt investments which we hold would be similarly impacted. We do not generally seek to hedge this type of risk unless the asset is leveraged as we believe the costs of such a hedging transaction over the term of such an investment would generally outweigh the benefits. If fixed rate real estate debt is funded with floating rate liabilities, we typically convert the floating rate to fixed through the use of interest rate swaps, caps or other hedges. Because the interest rates on our fixed rate investments are generally fixed through maturity of the investment, changes in interest rates do not affect the income we earn from our fixed rate investments.

        The value of our fixed and floating rate real estate debt investments changes with market credit spreads. This means that when market-demanded risk premiums, or credit spreads, increase, the value of our fixed and floating rate assets decrease, and vice versa. Market credit spreads are currently much wider than existed at the time we originated a majority of our real estate debt investments. These wider market credit spreads imply that our real estate debt investments may be worth less than the amounts at which we carry these investments on our balance sheet, but because we have typically financed these investments with debt priced in a similar credit environment and intend to hold them to maturity we do not believe that intra- and inter-period changes in value caused by changing credit spreads material impacts the economics associated with our real estate debt investments.

        In our real estate debt business we are also exposed to credit risk, which is the risk that the borrower under our loan agreements cannot repay its obligations to us in a timely manner. Our loans are generally collateral dependent, meaning the principal source of repayment is from a sale or refinancing of the collateral securing our loan. Default risk increases in weak economic conditions because collateral cash flows may be below expectations when the loan was originated. Defaults also increase when, at loan maturity, the cost of debt and equity capital is higher than when the loan was originated. In the event that a borrower cannot repay our loan, we may exercise our remedies under the loan documents, which may include a foreclosure against the collateral. We describe many of the options available to us in this situation in "Item 1 Business" of our Annual Report on Form 10-K. To the extent the value of our collateral exceeds the amount of our loan (including all debt senior to us) and the expenses we incur in collecting on our loan, we would collect 100% of our loan amount. To the extent that the amount of our loan plus all debt senior to our position exceeds the realizable value of our collateral, then we would incur a loss. We also incur credit risk in our periodically scheduled interest payments which may be interrupted as a result of the operating performance of the underlying collateral.

        We seek to manage credit risk through a thorough analysis of a transaction before we make such an investment. Our analysis is based upon a broad range of real estate, financial, economic and borrower-related factors which we believe are critical to evaluating the credit risk inherent in a transaction.

Real Estate Securities

        In our real estate securities business, we seek to mitigate credit risk through credit analysis, subordination and diversification. The CMBS we invest in are generally junior in right of payment of interest and principal to one or more senior classes, but benefit from the support of one or more subordinate classes of securities or other form of credit support within a securitization transaction. The senior unsecured REIT debt securities we invest in reflect comparable credit risk. Credit risk refers to each individual borrower's ability to make required interest and principal payments on the scheduled

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due dates. While the expected yield on these securities is sensitive to the performance of the underlying assets, the more subordinated securities and certain other features of a securitization, in the case of mortgage backed securities, and the issuer's underlying equity and subordinated debt, in the case of REIT securities, are designed to bear the first risk of default and loss. The real estate securities portfolios of our investment grade CDO financings are diversified by asset type, industry, location and issuer. We further seek to minimize credit risk by monitoring the real estate securities portfolios of our investment grade CDO financings and the underlying credit quality of their holdings.

        The real estate securities underlying our investment grade CDO financings are also subject to credit spread risk. The majority of these securities are fixed rate securities, which are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. In other words, their value is dependent on the yield demanded on such securities by the market, based on their credit relative to U.S. Treasuries. An excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher or "wider" spread over the benchmark rate (usually the applicable U.S. Treasury security yield) to value these securities. Under these conditions, the value of our real estate securities portfolio would tend to decrease. Conversely, if the spread used to value these securities were to decrease or "tighten," the value of our real estate securities would tend to increase. Such changes in the market value of our real estate securities portfolio may affect our net equity or cash flow either directly through their impact on unrealized gains or losses on available-for-sale securities by diminishing our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital.

        Returns on our real estate securities are sensitive to interest rate volatility. If interest rates increase, the funding cost on liabilities that finance the securities portfolio will increase if these liabilities are at a floating rate or have maturities shorter than the assets.

        Our general financing strategy has focused on the use of "match-funded" structures. This means that we seek to align the maturities of our debt obligations with the maturities of our investments in order to minimize the risk of being forced to refinance our liabilities prior to the maturities of our assets, as well as to reduce the impact of fluctuating interest rates on earnings. In addition, we generally match interest rates on our assets with like-kind debt, so that fixed rate assets are financed with fixed rate debt and floating rate assets are financed with floating rate debt, directly or through the use of interest rate swaps, caps or other financial instruments or through a combination of these strategies. Our investment grade CDO financings utilize interest rate swaps to minimize the mismatch between their fixed rate assets and floating rate liabilities.

        Our financing strategy is dependent on our ability to place the match-funded debt we use to finance our real estate securities at spreads that provide a positive funding spread. Match funded debt is currently very difficult to obtain, and market-demanded yields on all real estate assets have increased. Our current strategy is to use our existing CDO structures to fund new investment activity when repayment or sale proceeds are available within the financing, or to acquire securities which generate attractive returns without leverage.

        Interest rate changes may also impact our net book value as our investments in debt securities are marked-to-market each quarter with changes in fair value reflected in unrealized gains/losses or other comprehensive income (a separate component of owners' equity). Generally, as interest rates increase, the value of fixed rate securities within the CDO transaction, such as CMBS, decreases and as interest rates decrease, the value of these securities will increase. Conversely, we mark our CDO liabilities to market which causes a partial offset to the income and balance sheet impact of marking the securities assets to market.

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Net Lease Properties

        Our ability to manage the interest rate risk and credit risk associated with the assets we acquire is integral to the success of our net lease properties investment strategy. Although we may, in special situations, finance our purchase of net lease assets with floating rate debt, our general policy is to mitigate our exposure to rising interest rates by financing our net lease property purchases with fixed rate mortgages. We seek to match the term of fixed rate mortgages to our expected holding period for the underlying asset. Factors we consider to assess the expected holding period include, among others, the primary term of the lease as well as any extension options that may exist.

        The value of our net lease real estate properties may be influenced by long-term fixed interest rates. To derive value, an investor typically forecasts expected future cash flows to be generated by the property then discounts the cash flows at a discount rate based upon a long-term fixed interest rate (such as the 10-year U.S. Treasury Note yield) plus a risk premium based on the property type and creditworthiness of the tenants. Lower risk free rates generally result in lower discount rates and therefore higher valuations and vice versa although the scarcity of financing for net lease properties and investor concerns over commercial real estate generally have recently decreased commercial real estate valuations, including valuations for net lease properties. We generally intend to hold our net lease properties for long periods, but the market value of the asset may fluctuate with changes in interest rates, among other things.

        We are subject to the credit risk of the corporate lessee of our net lease properties. We undertake a rigorous credit evaluation of each tenant prior to acquiring net lease asset properties. This analysis includes an extensive due diligence investigation of the tenant's business as well as an assessment of the strategic importance of the underlying real estate to the tenant's core business operations. Where appropriate, we may seek to augment the tenant's commitment to the facility by structuring various credit enhancement mechanisms into the underlying leases. These mechanisms could include security deposit requirements or affiliate guarantees from entities we deem to be creditworthy.

        In June 2009, we restructured our net lease relationship with one of our healthcare operators to take advantage of new REIT legislation which now allows a taxable REIT subsidiary affiliate to become the lessee of healthcare-related properties. The restructuring resulted in one of our unconsolidated affiliate Midwest Care Holdco TRS I LLC ("Midwest") becoming the lessee of the properties and Midwest simultaneously entering into a management contract with a third party operator. The management agreement is terminable by Midwest upon 60 days notice. This new structure allows us to participate in operating improvements of the underlying properties not previously available under the prior structure. Under these arrangements we are less vulnerable to credit risk with respect to the manager of the facility, but our taxable REIT subsidiary has more exposure to fluctuations in net income at the properties (both reductions and increases) which would not be the case in a lease to an unaffiliated lessee operating the property.

Derivatives and Hedging Activities

        We use derivatives primarily to manage interest rate risk exposure. These derivatives are typically in the form of interest rate swap agreements and the primary objective is to minimize interest rate risks associated with the our investment and financing activities. The counterparties of these arrangements are major financial institutions with which we may also have other financial relationships. We are exposed to credit risk in the event of non-performance by these counterparties and we monitor their financial condition; however, we currently do not anticipate that any of the counterparties will fail to meet their obligations because of their high credit ratings and financial support from the U.S. Government. At March 31, 2010, our counterparties hold approximately $23.1 million of cash margin as collateral against our swap contracts.

        In January 2008, we elected the fair value option for our bonds payable and our liability to subsidiary trusts issuing preferred securities. As a result, the changes in fair value of these financial

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instruments are now recorded in earnings and the interest rate swap agreements associated with these debt instruments no longer qualify for hedge accounting given that the underlying debt is remeasured with changes in the fair value recorded in earnings. The unrealized gains or losses accumulated in other comprehensive income, related to these interest rate swaps, will be reclassified into earning over the shorter of either the life of the swap or the associated debt with current mark-to-market unrealized gains or losses recorded in earnings. For the three months ended March 31, 2010 and 2009, we recorded, in earnings, a mark-to-market unrealized loss of $13.2 million and an unrealized loss of $2.9 million, respectively, for the non-qualifying interest rate swaps. For the three months ended March 31, 2010 and 2009, we recorded a $1.7 million and a $1.4 million reclassification from accumulated other comprehensive income for the non-qualifying interest rate swaps, respectively.

        The following tables summarize our derivative financial instruments that were designated as cash flow hedges of interest rate risk as of March 31, 2010 and December 31, 2009 (in thousands):

 
  Number of
Investments
  Notional
Amount
  Fair Value
Net Asset/
(Liability)
  Range of
Fixed LIBOR
  Range of Maturity

Interest rate swaps

                         

As of March 31, 2010

    8   $ 75,884   $ (8,206 ) 4.18% - 5.08%   December 2010 - August 2018

As of December 31, 2009

    10   $ 90,749   $ (7,691 ) 4.18% - 5.08%   March 2010 - August 2018

        The following tables summarize our derivative financial instruments that were not designated as hedges in qualifying hedging relationships as of March 31, 2010 and December 31, 2009 (in thousands):

 
  Number of
Investments
  Notional
Amount
  Fair Value
Net Asset/
(Liability)
  Range of
Fixed LIBOR
  Range of Maturity  

Interest rate swaps

                             

As of March 31, 2010

    36   $ 2,001,491   $ (139,184 ) 0.36% - 7.00%     May 2010 - June 2018  

As of December 31, 2009(1)

    22   $ 897,335   $ (59,353 ) 0.34% - 5.63%     May 2010 - June 2018  

(1)
December 31, 2009 does not include the interest rate swaps of N-Star I, II, III and V, as these CDO financings were unconsolidated financings prior to January 1, 2010.

Item 4.    Controls and Procedures

        As of the end of the period covered by this report, our management conducted an evaluation (as required under Rules 13a-15(b) and 15d-15(b) under the Securities Exchange Act), under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures to disclose material information otherwise required to be set forth in our periodic reports.

Internal Control over Financial Reporting

        Changes in internal control over financial reporting.    There have not been any changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 6.    Exhibits

        (a)   Exhibits

Exhibit Number   Description of Exhibit
  3.1   Articles of Amendment and Restatement of NorthStar Realty Finance Corp., as filed with the State Department of Assessments and Taxation of Maryland on October 20, 2004 (incorporated by reference to Exhibit 3.1 to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675))

 

3.2

 

Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.2 to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675))

 

3.3

 

Amendment No. 1 to the Bylaws of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 3.3 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on April 27, 2005)

 

3.4

 

Articles Supplementary Classifying NorthStar Realty Finance Corp.'s 8.75% Series A Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to Exhibit 3.2 to NorthStar Realty Finance Corp.'s Registration Statement on Form 8-A, dated September 14, 2006)

 

3.5

 

Articles Supplementary Classifying NorthStar Realty Finance Corp.'s 8.25% Series B Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to Exhibit 3.2 to NorthStar Realty Finance Corp.'s Registration Statement on Form 8-A, dated February 7, 2007)

 

3.6

 

Articles Supplementary Classifying and Designating Additional Shares of NorthStar Realty Finance Corp.'s 8.25% Series B Preferred Stock, liquidation preference $25.00 per share (incorporated by reference to Exhibit 3.6 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007)

 

10.1

 

Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of October 19, 2004, by and among NorthStar Realty Finance Corp., as sole general partner and initial limited partner and the other limited partners a party thereto from time to time (incorporated by reference to Exhibit 10.1 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)

 

10.2

 

NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.9 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)

 

10.3

 

LTIP Unit Vesting Agreement under the NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership and NRF Employee, LLC (incorporated by reference to Exhibit 10.10 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)

 

10.4

 

Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.7(a) to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675))

 

10.5

 

NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan (incorporated by reference to Exhibit 10.13 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)

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Exhibit Number   Description of Exhibit
  10.6   Form of Notification under NorthStar Realty Finance Corp. 2004 Long-Term Incentive Bonus Plan (incorporated by reference to Exhibit 10.14 to the NorthStar Realty Finance Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)

 

10.7

 

Form of Indemnification Agreement for directors and officers of NorthStar Realty Finance Corp. (incorporated by reference to Exhibit 10.15 to the NorthStar Realty Finance Corp. Registration Statement on Form S-11 (File No. 333-114675))

 

10.8

 

Amendment No. 1 to Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of March 14, 2006, by and among NorthStar Realty Finance Corp., as sole general partner and initial limited partner and the other limited partners a party thereto from time to time (incorporated by reference to Exhibit 10.34 to NorthStar Realty Finance Corp.'s Annual Report on Form 10-K for the year ended December 31, 2005)

 

10.9

 

Second Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of September 14, 2006 (incorporated by reference to Exhibit 3.2 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed September 14, 2006)

 

10.10

 

Third Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of February 7, 2007 (incorporated by reference to Exhibit 3.2 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed February 9, 2007)

 

10.11

 

Amendment No. 1 to NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 99.2 to the NorthStar Realty Finance Corp. Post-Effective Amendment No. 2 to Form S-8 filed on April 13, 2007)

 

10.12

 

Amendment No. 2 to NorthStar Realty Finance Corp. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 99.3 to the NorthStar Realty Finance Corp. Post-Effective Amendment No. 3 to Form S-8 filed on June 6, 2007)

 

10.13

 

Note Purchase Agreement, dated as of March 29, 2007, between NRF—Reindeer Ltd., as seller, and Wachovia Bank, N.A., as purchaser (incorporated by reference to Exhibit 10.13 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)

 

10.14

 

Fourth Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of May 24, 2007 (incorporated by reference to Exhibit 3.3 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed May 29, 2007)

 

10.15

 

Registration Rights Agreement relating to the 7.25% Exchangeable Senior Notes due 2027 of NorthStar Realty Finance Limited Partnership, dated June 18, 2007 (incorporated by reference to Exhibit 4.2 to the NorthStar Realty Finance Corp. Registration Statement on Form S-3 (File No. 333-146679))

 

10.16

 

Indenture dated as of June 18, 2007, between NorthStar Realty Finance Limited Partnership, as Issuer, NorthStar Realty Finance Corp., as Guarantor, and Wilmington Trust Company, as Trustee (incorporated by reference to Exhibit 4.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on June 22, 2007)

 

10.17

 

Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and David T. Hamamoto (incorporated by reference to Exhibit 99.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed October 5, 2007)

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Exhibit Number   Description of Exhibit
  10.18   Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Andrew C. Richardson (incorporated by reference to Exhibit 99.2 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed October 5, 2007)

 

10.19

 

Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Daniel R. Gilbert (incorporated by reference to Exhibit 99.3 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed October 5, 2007)

 

10.20

 

Executive Employment and Non-Competition Agreement, dated as of October 4, 2007, between the Company and Albert Tylis (incorporated by reference to Exhibit 99.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed July 27, 2009)

 

10.21

 

Credit Agreement, dated as of November 6, 2007, by and among NRFC WA Holdings, LLC, NRFC WA Holdings II, LLC, NRFC WA Holdings VII, LLC, NRFC WA Holdings X, LLC, NRFC WA Holdings XII, LLC, as borrowers, NorthStar Realty Finance Corp. and NorthStar Realty Finance L.P., as guarantors, and Wachovia Bank, National Association, as administrative agent (incorporated by reference to Exhibit 10.53 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007)

 

10.22

 

Limited Guaranty Agreement, dated as of November 6, 2007, by and among NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership and Wachovia Bank, National Association, as administrative agent (incorporated by reference to Exhibit 10.54 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2007)

 

10.23

 

First Amendment to Note Purchase Agreement, dated as of November 6, 2007, by and among NRF-Reindeer Ltd., as seller, NorthStar Realty Finance Corp., as guarantor, and Wachovia Bank, N.A., as purchaser, and consented and agreed to by NRFC Luxembourg Holdings I S.Á R.L., as pledgor (incorporated by reference to Exhibit 10.24 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)

 

10.24

 

Registration Rights Agreement relating to the 11.50% Exchangeable Senior Notes due 2013 of NRFC NNN Holdings, LLC, dated May 28, 2008 (incorporated by reference to Exhibit 4.2 to the NorthStar Realty Finance Corp. Registration Statement on Form S-3 (File No. 333-152545))

 

10.25

 

Indenture dated as of May 28, 2008, among NRFC NNN Holdings, LLC, as Issuer, NorthStar Realty Finance Corp., NorthStar Realty Finance Limited Partnership, and NRFC Sub-REIT Corp., as Guarantors, and Wilmington Trust Company, as Trustee (incorporated by reference to Exhibit 4.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on May 28, 2008)

 

10.26

 

Fifth Amendment to the Agreement of Limited Partnership of NorthStar Realty Finance Limited Partnership, dated as of May 29, 2008 (incorporated by reference to Exhibit 10.37 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended June 30, 2008)

 

10.27

 

NorthStar Realty Finance Corp. Executive Incentive Bonus Plan (incorporated by reference to Exhibit 10.31 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)

 

10.28

 

Form of Award Agreement (incorporated by reference to Exhibit 99.2 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on September 11, 2009)

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Exhibit Number   Description of Exhibit
  10.29   First Amended and Restated Credit Agreement, dated as of October 28, 2009, by and among NRFC WA Holdings, LLC, NRFC WA Holdings II, LLC, NRFC WA Holdings VII, LLC, NRFC WA Holdings X, LLC and NRFC WA Holdings XII, LLC, as borrowers, NorthStar Realty Finance Corp., and NorthStar Realty Finance L.P., as guarantors, the lenders party thereto, and Wachovia Bank, National Association, as administrative agent (incorporated by reference to Exhibit 10.33 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)

 

10.30

 

First Amended and Restated Guaranty Agreement, dated as of October 28, 2009, by NorthStar Realty Finance Corp., NorthStar Realty Finance L.P., and Wachovia Bank, National Association, as administrative agent (incorporated by reference to Exhibit 10.34 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)

 

10.31

 

Second Amendment to Note Purchase Agreement and Repurchase Documents, dated as of October 28, 2009, by and among NRF-Reindeer Ltd., as seller, NorthStar Realty Finance Corp., as guarantor and Wachovia Bank, N.A., as purchaser, and consented and agreed to by NRFC Luxembourg Holdings I S.Á R.L. and NRFC Sub-REIT Corp., as pledgor (incorporated by reference to Exhibit 10.35 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)

 

10.32

 

Common Stock Purchase Warrant, Certificate No. W-1, dated October 28, 2009, issued to Wachovia Bank, National Association (incorporated by reference to Exhibit 10.36 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)

 

10.33

 

Common Stock Purchase Warrant, Certificate No. W-2, dated October 28, 2009, issued to Wachovia Bank, National Association (incorporated by reference to Exhibit 10.37 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)

 

10.34

 

Common Stock Purchase Warrant, Certificate No. W-3, dated October 28, 2009, issued to Wachovia Bank, National Association (incorporated by reference to Exhibit 10.38 to NorthStar Realty Finance Corp.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)

 

10.35

 

Separation and Consulting Agreement, dated January 25, 2010, between NorthStar Realty Finance Corp. and Richard J. McCready (incorporated by reference to Exhibit 99.1 to the NorthStar Realty Finance Corp. Current Report on Form 8-K filed on January 25, 2010)

 

31.1

 

Certification by the Chief Executive Officer pursuant to 17 CFR 240.13a-14(a)/15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2

 

Certification by the Chief Financial Officer pursuant to 17 CFR 240.13a-14(a)/15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1

 

Certification by the Chief Executive Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2

 

Certification by the Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

    NORTHSTAR REALTY FINANCE CORP.

Date: May 6, 2010

 

By:

 

/s/ DAVID T. HAMAMOTO

David T. Hamamoto
Chief Executive Officer

 

 

By:

 

/s/ ANDREW C. RICHARDSON

Andrew C. Richardson
Chief Financial Officer

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