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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NO. 1-10150
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STARWOOD FINANCIAL TRUST
(Exact name of registrant as specified in its charter)
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<S> <C>
MARYLAND 95-6881527
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1114 AVENUE OF THE AMERICAS, 27(TH) FLOOR 10036
NEW YORK, NY 10036 (Zip Code)
(Address of principal executive offices)
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(212) 930-9400
Registrant's telephone number, including area code:
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
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TITLE OF EACH CLASS: NAME OF EXCHANGE ON WHICH REGISTERED:
Class A Shares of beneficial interest, American Stock Exchange
$1.00 par value
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
As of March 12, 1999, the aggregate market value of the Class A Shares of
beneficial interest held by non-affiliates(1) of the registrant was
approximately $2,361 million, based upon the closing price of $45.00 on the
American Stock Exchange composite tape on such date.
As of March 12, 1999, there were 52,455,951 Class A Shares of beneficial
interest of Starwood Financial Trust, $1.00 par value per share, outstanding.
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(1) For purposes of this Annual Report only, includes all outstanding Class A
Shares other than those held directly by the Registrant's trustees and
executive officers.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the registrant's definitive proxy statement for the registrant's
1999 Annual Meeting, to be filed within 120 days after the close of the
registrant's fiscal year, are incorporated by reference into Part III of the
Annual Report on Form 10-K.
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TABLE OF CONTENTS
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PAGE
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PART I
Item 1. Business........................................................................................... 3
Item 2. Properties......................................................................................... 25
Item 3. Legal Proceedings.................................................................................. 25
Item 4. Submission of Matters to a Vote of Security Holders................................................ 25
PART II
Item 5. Market for Registrant's Equity and Related Share Matters........................................... 26
Item 6. Selected Financial Data............................................................................ 27
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 29
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................................ 34
Item 8. Financial Statements and Supplemental Data......................................................... 37
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............... 62
PART III
Item 10. Directors and Executive Officers of the Registrant................................................ 62
Item 11. Executive Compensation............................................................................ 62
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................... 62
Item 13. Certain Relationships and Related Transactions.................................................... 62
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.................................. 62
SIGNATURES................................................................................................. 65
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PART I
ITEM 1. BUSINESS
EXPLANATORY NOTE FOR PURPOSES OF THE "SAFE HARBOR PROVISIONS" OF SECTION 21E OF
THE SECURITIES AND EXCHANGE ACT OF 1934, AS AMENDED
Except for historical information contained herein, this Annual Report on
Form 10-K contains forward-looking statements within the meaning of Section 21E
of the Securities and Exchange Act of 1934, as amended, which involve certain
risks and uncertainties. Forward-looking statements are included with respect
to, among other things, the Company's current business plan, business strategy
and portfolio management. The Company's actual results or outcomes may differ
materially from those anticipated. Important factors that the Company believes
might cause such differences are discussed in the cautionary statements
presented under the caption "Factors That May Affect the Company's Business
Strategy" in Item 1 of this Form 10-K or otherwise accompany the forward-looking
statements contained in this Form 10-K. In assessing forward-looking statements
contained herein, readers are urged to read carefully all cautionary statements
contained in this Form 10-K.
GENERAL
Starwood Financial Trust (the "Company") is a leading specialized finance
company that engages in opportunistic lending to the real estate industry by
implementing an innovative, value added and entrepreneurial approach to
providing investment capital. The Company primarily focuses on providing high
yielding mortgage, mezzanine and lease financing to the real estate industry
through the origination and acquisition of loans to create superior
risk-adjusted returns for its shareholders.
The Company's capital structure consists of Class A Shares, par value $1.00
per share (the "Class A Shares"), Class B Shares, par value $0.01 per share (the
"Class B Shares" and, together with the Class A Shares, the "Shares") and Series
A Preferred Shares, par value $0.01 per share (the "Preferred Shares"). The
Class A Shares are publicly traded on the American Stock Exchange under the
symbol "APT." The Class B Shares are entitled to a 1% economic interest and a
33% voting interest in the Company, and are exchangeable at the option of the
holder into Class A Shares at the rate of 49 Class B Shares for each Class A
Share. Each of the Shares is entitled to one vote per share. The Preferred
Shares have a liquidation value of $50.00 per share, carry a dividend yield of
9.50% per annum, payable quarterly in arrears, and are callable without premium
at the Company's option on or after December 15, 2003. On each of December 15,
2005, 2006 and 2007, the dividend rate on the Preferred Shares will increase by
0.25% per annum.
Effective as of June 18, 1998, the Company (which was originally organized
as a business trust under the laws of California) changed its domicile to
Maryland by merging with a newly-formed subsidiary organized as a real estate
investment trust under Maryland law. As a result of this merger, the Company
effectively consummated a one-for-six reverse split of its capital stock. All
share numbers and per share amounts included in this Annual Report have been
adjusted to reflect the reverse stock split. Prior to March 18, 1998, the
Company was known as Angeles Participating Mortgage Trust.
Although the Company did not qualify as a real estate investment trust (a
"REIT") for Federal income tax purposes for its fiscal years 1993 through 1997,
it did not incur any material tax liabilities as a result of its operations. As
confirmed by a closing agreement with the Internal Revenue Service ("IRS")
obtained in March 1998, the Company is eligible to and intends to make an
election to be taxed as a REIT for its tax year beginning January 1, 1998.
3
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RECENT TRANSACTIONS
RECAPITALIZATION TRANSACTIONS
On March 18, 1998, the Company: (i) paid $25.5 million of cash and issued
9,191,333 Class A Shares at a price of $15.00 per share to Starwood Mezzanine
Investors, L.P. ("Starwood Mezzanine") in exchange for the contribution by
Starwood Mezzanine to the Company of its entire interest in a portfolio of
mortgage, mezzanine and partnership loans secured by residential, hotel, office
and mixed use real estate and other assets; (ii) paid $324.3 million in cash and
issued 41,179,131 Class A Shares at a price of $15.00 per share to Starwood
Opportunity Fund IV, L.P. ("SOF IV") in exchange for the contribution by SOF IV
to the Company of a portfolio of mortgage loans and leases secured by
residential, hotel, office and mixed use real estate and other assets, cash of
$17.9 million and rights under certain letters of intent (collectively, the
"Recapitalization Transactions"); and (iii) borrowed $350.0 million under a
$625.0 million credit facility. Upon consummation of the Recapitalization
Transactions, Starwood Mezzanine had a 13.1% voting interest and a 20.6%
economic interest in the Company and SOF IV had a 52.4% voting interest and a
78.6% economic interest in the Company.
In connection with the Recapitalization Transactions: (i) the Company
changed its name from Angeles Participating Mortgage Trust to Starwood Financial
Trust; (ii) the Company entered into an advisory agreement (the "Advisory
Agreement") with Starwood Financial Advisors, L.L.C. (the "Advisor") pursuant to
which the Advisor manages the affairs of the Company; (iii) the Declaration of
Trust of the Company was amended and restated (as amended and restated, the
"Declaration of Trust"); (iv) all of the limited partnership interests in APMT
Limited Partnership were exchanged for Class A Shares, which left the Company as
the sole partner of the partnership; (v) the partnership was dissolved and all
of its assets were distributed to the Company; (vi) the Company's 1996 Trustees'
Share Incentive Plan and 1996 Share Incentive Plan were combined, amended and
restated into the Starwood Financial Trust 1996 Share Incentive Plan; (vii) the
Company entered into several credit facilities, which in the aggregate provided
the Company up to approximately $625.0 million in new financing, with up to an
additional $175.0 million available, subject to certain conditions, to
consummate the Recapitalization Transactions and provide funds for working
capital, new loan origination and acquisition and general corporate purposes;
and (viii) certain existing agreements were amended and restated. See
"Investment Policy" and "Advisory Agreement."
LAZARD TRANSACTION
On December 15, 1998, the Company consummated: (i) the sale of 4,400,000
Preferred Shares and warrants (the "Warrants") to purchase 6,000,000 Class A
Shares to Lazard Freres Real Estate Fund II, L.P. ("Fund II"), Lazard Freres
Real Estate Offshore Fund II, L.P. (the "Offshore Fund"), and LF Mortgage REIT
(the "Private REIT" and, collectively with Fund II and the Offshore Fund, the
"Investors"); and (ii) the acquisition of certain assets (the "Acquired Assets")
from Lazard Freres Real Estate Fund L.P. ("Fund I"), Fund II, Prometheus
Mid-Atlantic Holding, L.P. ("PMAH"), Pacific Preferred LLC ("Pacific"), Atlantic
Preferred II LLC ("Atlantic"), Indian Preferred LLC ("Indian") and Prometheus
Investment Holding, L.P. ("PIHLP" and, collectively with Fund I, Fund II, PMAH,
Pacific, Atlantic, Indian and PIHLP, the "Sellers"). Such transactions are
referred to collectively as the "Lazard Transaction." The Warrants are
exercisable on or after December 15, 1999 at a price of $35.00 per share and
expire on December 15, 2005.
The Acquired Assets included eight mortgage and mezzanine loans which were
acquired for $238.5 million and are backed by a diverse portfolio of Class A
office, multifamily and retail properties located in San Francisco, San Jose,
Los Angeles, New York, suburban Washington, D.C., Philadelphia and Pittsburgh.
On the date of acquisition, the acquired loans had a weighted average
unleveraged yield to maturity of 13.15% and a weighted average maturity of 7.5
years.
The Company also purchased an 85% senior participation in a portfolio of
commercial mortgage-backed securities for $41.8 million. These securities are
backed by a pool of ten large balance loans secured
4
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by first mortgages on office, multifamily, self-storage, retail, hotel and
senior living properties. The Company's 85% interest in the securities is senior
to a 15% interest retained by the Sellers. As of the date of acquisition, these
securities had a face amount of $54.5 million, were rated "BB" and "B" and
carried a weighted average unleveraged yield of 11.66% and a weighted average
maturity of 13.5 years.
In consideration for the Preferred Shares and Warrants, the Investors paid
the Company an aggregate of $220.0 million. In consideration for the Acquired
Assets, the Company paid the Sellers an aggregate of $280.3 million (including
assumed debt). The Company purchased the Acquired Assets with the proceeds from
the sale of the Preferred Shares and Warrants, $12.4 million of cash on hand and
$47.9 million in existing debt assumed in connection with the transaction.
INVESTMENT POLICY
The Company's purpose and investment policy is to originate and acquire a
diverse portfolio of debt and debt-like interests in real estate or real
estate-related assets, including to: (i) originate and acquire mortgage and
mezzanine loans collateralized, in whole or in part, by commercial and
residential real estate assets; (ii) acquire direct or indirect interests in
short- or long-term real estate-related debt securities and mortgage interests,
which may include warrants, equity participations or similar rights incidental
to a debt investment by the Company; (iii) acquire positions in non-performing
and sub-performing debt for the purpose of either restructuring the debt to
performing status or converting the debt into equity interests in the underlying
assets securing such debt; and (iv) provide credit tenant and net lease
financing and invest in similar credit-backed income streams. The Company is
restricted from making certain types of investments which may limit its
flexibility in implementing its investment policy. See "Policies and Procedures
With Respect to Certain Activities-Investment Policies."
The Company currently originates and acquires loans backed by various types
of income-producing commercial and residential real estate, with an emphasis on
senior and junior commercial mortgage loans, including mezzanine financing,
higher-yielding senior mortgage loans and non-performing or sub-performing
loans. The Company has not in the past, and does not currently intend to invest
a significant portion of its capital in commercial mortgage-backed securities. A
significant portion of the Company's loans are structured so that the Company's
investment is subordinate to third-party first mortgage debt but senior to the
real estate owner/operator's equity position. The Company does not have any
prescribed allocation among investments and the Company could invest all or any
portion of its assets in any of the investments described above. The Company's
primary investment structures include:
- MEZZANINE LOANS. The Company intends to continue to take advantage of its
historical expertise in providing high-yielding loans that are
subordinated to first lien mortgage loans and secured by a second lien
mortgage or a pledge of the ownership interest in the borrower ("Mezzanine
Loans"). Mezzanine Loans may also take the form of a preferred equity
investment in the borrower with substantially similar terms.
- MORTGAGE LOANS. The Company provides high-yielding first mortgage loans to
borrowers in need of flexible, custom-tailored financings. These loans may
be short-, medium- or long-term in duration, and may include loans which
are not provided by conventional, "securitized" lenders such as commercial
and investment banks.
- DISCOUNT MORTGAGES AND MINORITY PARTICIPATIONS. The Company intends to
continue to acquire non-performing and sub-performing debt or minority
participations in such loans at a discount for the purpose of
restructuring the debt to performing status or negotiating a payoff with
the borrower at a price above the Company's basis in the loan.
- OPERATING LEASES. The Company may acquire properties that are subject to
long-term net lease financing arrangements with tenants that the Company
believes to be creditworthy. The Company believes that, in many cases, the
fixed stream of payments from such leases has similar risk/reward
characteristics to other types of mortgage or mezzanine financings
originated by the Company.
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The investment and financing policies of the Company and its policies with
respect to all other activities, including its growth, debt, capitalization,
dividends and operating policies, are determined by the Board of Trustees.
Although the Board of Trustees has no present intention to do so, these policies
may be amended or revised at any time and from time to time at their discretion,
without a vote of the shareholders of the Company. A change in these policies
could adversely affect the Company's financial condition, operating results or
the market price of the Class A Shares.
The results of the Company's future operations will be dependent upon the
availability of, as well as the Advisor's and management's ability to identify,
complete and realize, real estate financing opportunities. It may take
considerable time to find and consummate appropriate financing transactions. In
general, the availability of desirable financing opportunities and the results
of the Company's operations will be affected by the level and volatility of
interest rates, conditions in the financial markets, and general economic
conditions. No assurances can be given that the Company will be successful in
originating or acquiring economically desirable loans or that the loans, once
originated or acquired, will maintain their economic desirability.
In addition to the above investment structures, the Company also develops
and acquires businesses that enhance its core business through the creation of
strategic relationships or proprietary origination pipelines. For example, the
Company, through an unconsolidated/taxable subsidiary, acquired the loan
origination and servicing business of Phoenix Realty Securities, Inc.
("Phoenix") in September 1998 and consummated the Lazard Transaction in December
1998. The Company believes that expanding its core business will enable it to
capitalize on the consolidation trend in the financial services and real estate
industries.
INVESTMENT PORTFOLIO
GENERAL
The Company's loans are secured by a diverse portfolio of commercial
property, including mortgage and partnership loans and leases secured by
residential, hotel, office and mixed use real estate and other assets. The
following chart shows the breakdown of the Company's portfolio as of December
31, 1998:
LOAN TYPE
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<CAPTION>
GROSS PERCENTAGE
CARRYING VALUE OF TOTAL
(IN THOUSANDS) PORTFOLIO
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Senior Mortgages...................................................................... $ 656,631 32.6%
Subordinated Mortgages................................................................ 458,280 22.7
Discount Mortgages.................................................................... 86,259 4.3
Partnership Loans / Unsecured Notes................................................... 346,421 17.2
Construction Loans.................................................................... 97,819 4.9
Real Estate Under Long-Term Operating Leases.......................................... 189,942 9.4
Loan Participations................................................................... 40,877 2.0
Investments in Specialty Finance Joint Ventures....................................... 47,722 2.4
Investments in Unconsolidated Ventures/Servicing...................................... 30,104 1.5
Other Real Estate-Related Investments................................................. 62,398 3.0
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Gross carrying value.............................................................. $ 2,016,453 100.0%
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</TABLE>
None of the Company's assets constitute loans to Starwood Hotels & Resorts
and its affiliates and the Company currently expects that none of its business
will be attributable to Starwood Hotels & Resorts and its affiliates in the
future.
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The following summarizes information relating to concentration and
significant terms within the Company's portfolio of loans and other investments
as of December 31, 1998, based on gross carrying values:
CONCENTRATION BY SIZE--As of and for the year ended December 31, 1998, no
individual tenant or group of affiliated borrowers represented a significant
concentration of assets or revenues (i.e., greater than 10%).
CONCENTRATION BY UNDERLYING ASSET/COLLATERAL TYPE
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GROSS PERCENTAGE
CARRYING VALUE OF TOTAL
(IN THOUSANDS) PORTFOLIO
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Office................................................................................ $ 756,865 37.5%
Hotel/Resorts......................................................................... 563,958 28.0%
Retail................................................................................ 315,048 15.6%
Residential........................................................................... 194,177 9.6%
Other................................................................................. 186,405 9.3%
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Gross carrying value.............................................................. $ 2,016,453 100.0%
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For this purpose, the carrying values for certain loans secured by mixed use
property were allocated by management based on estimated relative values of the
underlying collateral components.
CONCENTRATION BY LOCATION
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GROSS PERCENTAGE
CARRYING VALUE OF TOTAL
(IN THOUSANDS) PORTFOLIO
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California............................................................................ $ 543,809 27.0%
New York.............................................................................. 248,781 12.3%
Washington............................................................................ 222,602 11.0%
Florida............................................................................... 202,208 10.0%
Texas................................................................................. 146,269 7.3%
Illinois.............................................................................. 112,301 5.6%
All other states combined............................................................. 435,535 21.6%
Corporate obligations................................................................. 104,948 5.2%
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Gross carrying value.............................................................. $ 2,016,453 100.0%
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SUMMARY OF RECOURSE PROVISIONS
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GROSS PERCENTAGE
CARRYING VALUE OF TOTAL
(IN THOUSANDS) PORTFOLIO
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Non-recourse--secured by real estate.................................................. $ 1,245,660 61.8%
Recourse (including operating lease assets)........................................... 370,468 18.4%
Non-recourse--secured by partnership interests........................................ 288,082 14.3%
Corporate obligations................................................................. 112,243 5.5%
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Gross carrying value.............................................................. $ 2,016,453 100.0%
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SUMMARY OF PREPAYMENT TERMS
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<CAPTION>
GROSS PERCENTAGE
CARRYING VALUE OF TOTAL
(IN THOUSANDS) PORTFOLIO
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Yield maintenance..................................................................... $ 414,397 20.6%
Lock-out for greater than 70% of original term with
yield maintenance or other payment premium on a
substantial portion of remaining term............................................... 249,639 12.4%
Long-term operating lease--generally not pre-payable.................................. 189,942 9.4%
Lock-out for greater than 70% of original term,
payable thereafter without premium.................................................. 42,163 2.1%
Other prepayment premiums............................................................. 602,080 29.9%
No significant prepayment protection.................................................. 518,232 25.6%
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Gross carrying value.............................................................. $ 2,016,453 100.0%
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As of December 31, 1998, the majority of the Company's outstanding loans are
subject to substantial prepayment protection in the form of lock-outs, yield
maintenance provisions or other prepayment premiums which are expected to
provide protection to the Company. Those loans not subject to prepayment
penalties generally include: (i) variable-rate mortgages based on LIBOR,
acquired at par, which would not result in any gain or loss upon repayment; and
(ii) discount loans or loan participations acquired at discounts to face values,
which would result in gains upon repayment.
The properties underlying the long-term lease may be purchased at fair
market value by the lessee in limited circumstances, including catastrophic loss
or condemnation of the property.
SUMMARY OF INTEREST CHARACTERISTICS
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GROSS PERCENTAGE
CARRYING VALUE OF TOTAL
(IN THOUSANDS) PORTFOLIO
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Fixed-rate investments................................................................ $ 1,435,829 71.2%
Variable-rate investments............................................................. 580,624 28.8%
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Gross carrying value.............................................................. $ 2,016,453 100.0%
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For this purpose, fixed-rate investments include the real estate assets
under long-term operating lease pursuant to which the Company receives a fixed
annual base rental revenue and 7.5% of annual operating revenue for the
underlying leased hotels in excess of a defined base amount. Variable-rate loan
investments are generally based on 30-day LIBOR and reprice monthly.
SUMMARY OF DELINQUENCIES AND POSSIBLE LOSSES--Starwood Mezzanine and SOF IV have
had lending operations since February 15, 1994 and July 3, 1996, respectively,
and during those periods through the date of the Recapitalization Transactions
had not experienced any significant delinquencies or losses on any loan
investment, including the investments contributed to the Company in the
Recapitalization Transactions. Although no such issues were identified with
respect to specific loan investments contributed, the possibility of
delinquencies and losses was considered in evaluating the terms of the
Recapitalization Transactions. Since the consummation of the Recapitalization
Transactions, the Company has not experienced any significant delinquencies or
losses on any loan investment. There can be no assurances that delinquencies or
losses will not be experienced by the Company in the future with respect to the
contributed investments or other investments originated or acquired by the
Company.
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SENIOR MORTGAGES
The Company had approximately $656.6 million of Senior Mortgages outstanding
as of December 31, 1998. Senior Mortgages are first mortgage loans secured by a
priority interest in the underlying property. While the Company anticipates that
its Senior Mortgages will generally be medium- to long-term, the Company may
make Senior Mortgages that are short-term in duration. Generally, Senior
Mortgages require a balloon payment of principal and interest at maturity.
The following table sets forth certain information regarding the Company's
Senior Mortgages as of March 18, 1998 (the date that the Recapitalization
Transactions were consummated) and December 31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 18, 1998 DECEMBER 31, 1998
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<S> <C> <C>
Number of Loans Outstanding........................ 8 12
Number of Borrowers................................ 8 12
Original Balance of Commitment Amount.............. $502,114 $752,299
Outstanding Balance................................ $445,614 $658,336
Carrying Value..................................... $444,250 $656,631
Original Maturity Dates............................ 1999 to 2007 1999 to 2009
Interest Accrual Rates............................. Fixed: 8.97% to 16.00% Fixed: 7.28% to 16.00%
Variable: LIBOR + 1.25% to Variable: LIBOR + 1.25% to
3.25% 3.25%
Interest Payment Rates............................. Fixed: 8.00% to 12.00% Fixed: 7.28% to 12.00%
Variable: LIBOR + 1.25% to Variable: LIBOR + 1.25% to
3.25% 3.25%
Principal Amortization............................. Yes Yes
Participation Features............................. Yes Yes
Underlying Property Type........................... Office, Hotel, Mixed Use and Office, Hotel, Mixed Use,
Apartment Apartment and Retail
Average Loan-to-Value.............................. 60% 65%
</TABLE>
GENERAL. One of the Senior Mortgages permits: (i) accrual of interest on a
portion of the principal of such loan, payable at maturity; and (ii) the
deferral of certain additional interest payments under certain circumstances.
The Senior Mortgages are generally secured by mortgages encumbering real
properties comprised of a resort conference center in Westchester County, New
York, office buildings in Seattle, Washington, a mixed use complex in New York,
New York, office buildings in Houston and Dallas, Texas, an office portfolio in
San Diego, California, a residential complex in San Diego, California, a
commercial office building in San Francisco, California, a mixed used complex in
Boston, Massachusetts, a residential complex in New York, New York, three
regional malls in Chicago, Illinois, San Francisco, California and Fort Myers,
Florida and certain pledges of partnership interests.
MATURITY DATE AND PREPAYMENT TERMS. The Senior Mortgages have maturity
dates that range from December 1999 to December 2009, with certain extension
rights in some cases. Two of the Senior Mortgages are subject to a prepayment
lock-out period during which time such loans may not be prepaid. Otherwise, the
remaining Senior Mortgages are generally prepayable at specified dates and in
specified amounts, subject to certain conditions, including the payment of
prepayment penalties based on specified yield maintenance formulas and/or other
required costs.
PARTICIPATING EQUITY INTEREST. Some of the Senior Mortgages require
payments based on specified percentages of cash flow, property appreciation and
a share of funds maintained in certain reserve accounts.
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LIMITED NON-RECOURSE. The Senior Mortgages are generally non-recourse loans
as to which, in the event of a default under such loans, recourse generally may
be had only against the collateral, except for certain standard carve-outs. One
of the Senior Mortgages is fully recourse against the borrower.
CROSS-DEFAULT PROVISIONS. Two of the Senior Mortgages are cross-defaulted
with certain lines of credit or loans made to the borrower from other lenders.
GUARANTIES. Some of the Senior Mortgages are supported by certain secured,
limited recourse guaranties of payment and performance.
SUBORDINATE FINANCING. Three of the Senior Mortgages are subject to junior
financing in the aggregate original principal amount of $131.9 million which are
part of the Subordinate Mortgages and the Discount Mortgages included in the
Company's portfolio. One of the other Senior Mortgages may be bifurcated, at the
lender's request under certain circumstances, into a senior lien tranche and a
junior lien tranche, both of which are part of the Company's portfolio.
Currently, both such tranches are secured by a senior mortgage lien.
SUBORDINATED MORTGAGES
The Company had approximately $458.3 million of Subordinated Mortgages
outstanding as of December 31, 1998. Subordinated Mortgages provide financing on
commercial property that is subject to first lien mortgage debt. The Company's
mezzanine financing may take the form of: (i) subordinated loans, commonly known
as second mortgages ("Subordinated Mortgages"); (ii) in the case of loans
originated for securitization, partnership loans (also known as pledge loans)
("Partnership Loans/Unsecured Notes"); or (iii) preferred equity investments.
For example, on a commercial property subject to a first lien mortgage loan with
a principal balance equal to 60% of the value of the property, the Company could
lend the owner of the property an additional 15% to 20% of the value of the
property. Typically, as security for a Subordinated Mortgage, the owner would
pledge to the Company the property subject to the first lien (giving the Company
a second lien position that may be subject to an intercreditor agreement). Then
the Company would be in a position to take over the operation of the property in
the event of a default by the owner. The Company expects that Subordinated
Mortgages will generally provide the Company with the right to receive a stated
interest rate on the loan balance. In certain instances, the Company may
negotiate to receive a percentage of net cash flow or gross revenues from the
property, payable to the Company on an on-going basis, and a percentage of any
increase in value of the property, payable upon maturity, refinancing of the
loan, or the sale of the property, or the Company may otherwise seek terms to
allow the Company to charge an interest rate that would provide an attractive
risk-adjusted return. See "Partnership Loans/Unsecured Notes" below for a
summary of the Company's Partnership Loans/Unsecured Notes.
10
<PAGE>
The following table sets forth certain information regarding the Company's
Subordinated Mortgages as of March 18, 1998 (the date that the Recapitalization
Transactions were consummated) and December 31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 18, 1998 DECEMBER 31, 1998
------------------------------------ ------------------------------------
<S> <C> <C>
Number of Loans Outstanding......... 5 13
Number of Borrowers................. 5 12
Original Balance of Commitment $175,375 $501,874
Amount............................
Outstanding Balance................. $155,538 $445,203
Carrying Value...................... $156,341 $458,280
Original Maturity Dates............. 2002 to 2007 1999 to 2007
Interest Accrual Rates.............. Fixed: 10.00% to 15.25% Fixed: 9.53% to 15.25%
Variable: LIBOR + 4.00% to 5.80%
Interest Payment Rates.............. Fixed: 10.00% to 15.25% Fixed: 9.53% to 15.25%
Variable: LIBOR + 4.00% to 5.80%
Principal Amortization.............. Yes Yes
Participation Features.............. Yes Yes
Underlying Property Type............ Office, Hotel & Resort Office, Hotel, Mixed Use & Retail
Average Loan-to-Value............... 71% 74%
</TABLE>
GENERAL. The Subordinated Mortgages bear interest at either fixed or
variable rates requiring monthly interest payments and/or specified amortization
payments. Under some of the Subordinated Mortgages, if for any month the
interest paid is less than a specified amount, the difference shall accrue
interest at a specified fixed rate, or cash flow from subsequent months must be
deposited into interest accounts to cover previous interest payments that are
not paid. The Subordinated Mortgages are secured by mortgages encumbering real
properties comprised of 15 hotels located in seven states, fee and ground
leasehold interests in a mixed use complex of office, retail and hotel space in
Washington, D.C., a hotel in Houston, Texas, office buildings in Houston and
Dallas, Texas, New York, New York and Washington, D.C. an office portfolio in
San Diego, California, mixed use properties in Boston, Massachusetts and New
York, New York, a retail property in Concorde, California, and six hotel
properties, five in California and one in Michigan.
MATURITY DATE AND PREPAYMENT TERMS. The Subordinated Mortgages have
maturity dates that range from May 1999 to November 2007, subject to extension
in certain cases. Some of the Subordinated Mortgages are subject to prepayment
lock-out periods during which time such loans may not be prepaid. At specified
periods during the terms of the Subordinated Mortgages, prepayment is generally
permitted, subject to certain conditions set forth in the applicable loan
documents, including, in some cases, the payment of prepayment penalties based
on specified yield maintenance formulas or required internal rates of return.
LIMITED NON-RECOURSE LOANS. The Subordinated Mortgages are generally
non-recourse loans as to which, in the event of a default under such loans,
recourse generally may be had only against the collateral, except for certain
standard carve-outs.
EXISTING SENIOR FINANCING. Two of the Subordinated Mortgages are subject to
senior financing in the aggregate original principal amount of $217.7 million,
which Senior Mortgages are part of the Company's portfolio. The other 11
Subordinated Mortgages are subject to senior financing in the aggregate original
11
<PAGE>
principal amount of $205.0 million, which is not part of the Company's
portfolio. The rights between senior and junior lenders are generally governed
by specified intercreditor agreements which may provide the junior lender with
certain notice and cure rights, but otherwise limit the rights and remedies of
the junior lender.
CROSS-DEFAULT PROVISIONS. One of the Subordinated Mortgages is
cross-defaulted with certain loans entered into by partners of the borrower for
such Subordinated Mortgages.
GUARANTIES. One of the Subordinated Mortgages is supported by certain
secured, limited recourse unconditional guaranty of payment and performance, and
other limited guaranties of payment and performance.
PARTICIPATING EQUITY INTEREST. One of the Subordinated Mortgages requires
participation payments, payable with monthly interest payments, based on
specified percentages of cash flow and net proceeds generated from the sale or
refinancing of the real property securing such loan.
TAX ASPECTS OF SUBORDINATED MORTGAGES. Subordinated Mortgages secured by
mortgages on real property generally constitute qualifying assets and generally
generate qualifying income for purposes of the REIT provisions of the Code.
Under the Code, any amount received or accrued by a REIT, directly or
indirectly, with respect to any obligation is generally not included as
qualifying interest income if the determination of the amount depends in whole
or in part on the income or profits of any person (whether or not derived from
property secured by the obligation). Although amounts received by the Company
that are determined with reference to the operating income of a borrower
generally do not constitute qualifying income for purposes of the Code, certain
of such amounts received will constitute qualifying income if the borrower
receives substantially all of its gross income from the related property through
the leasing of substantially all of its interests in the property, to the extent
the amounts received from the borrower are attributable to amounts that would be
characterized as qualified rents from real property under the Code. The
provisions of the Code regarding the qualification of the Company as a REIT may
restrict the Company's ability to originate or acquire certain Subordinated
Mortgages. The Board of Trustees will monitor the Company's compliance with the
various REIT qualification tests imposed under the Code with respect to
investing in Subordinated Mortgages. However, no assurance can be given that the
Company will satisfy these tests on a continuing basis.
DISCOUNT MORTGAGES
As of December 31, 1998, the Company had approximately $86.3 million of
loans or minority participations in such loans which were acquired at a discount
to face value (collectively, "Discount Mortgages"). The Company believes that
Discount Mortgages often represent attractive investments on a total return
basis and may present opportunities for the origination of new mortgage loans.
Although the period during which the Company will hold Discount Mortgages will
vary considerably from asset to asset, the Company believes that most such
investments will be held in its portfolio no more than five years.
12
<PAGE>
The following table sets forth certain information regarding the Company's
Discount Mortgages as of March 18, 1998 (the date that the Recapitalization
Transactions were consummated) and December 31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 18, 1998 DECEMBER 31, 1998
------------------------------------ ------------------------------------
<S> <C> <C>
Number of Loans Outstanding......... 2 2
Number of Borrowers................. 2 2
Original Balance of Commitment $125,402 $125,402
Amount............................
Outstanding Balance................. $132,429 $123,683
Carrying Value...................... $80,397 $86,259
Original Maturity Dates............. 1999 and 2007 1999 and 2007
Interest Accrual Rates.............. 5.00% to 7.00% 5.00% to 7.00%
Interest Payment Rates.............. 5.00% to 7.00%(1) 5.00% to 7.00%(1)
Principal Amortization.............. Yes Yes
Participation Features.............. Yes Yes
Underlying Property Type............ Office, Hotel and Apartment Office, Hotel and Apartment
Average Loan-to-Value............... 92% 95%
</TABLE>
- ------------------------------
(1) Interest rates apply to outstanding principal balance and not the Company's
carrying value of such loans.
GENERAL. The two loans in this category consist of: (i) debt with an
original principal balance of $72.4 million, secured by, among other non-real
property collateral, a second lien mortgage encumbering a combination office,
hotel and apartment building in Denver, Colorado and a 50% interest in an
unconsolidated partnership holding debt with an original principal balance of
$79.9 million, secured by a third lien mortgage encumbering the same property;
and (ii) subordinate debt with an original principal balance of $54.3 million
secured by five office buildings in Seattle, Washington. The Discount Mortgages
bear interest at fixed rates. One of the loans has monthly compounding of
interest, with payments due on a monthly basis, requiring either monthly
interest payments or specified principal payments at certain times during the
term thereof when certain specified conditions are satisfied.
MATURITY DATE AND PREPAYMENT TERMS. The Discount Mortgages have maturity
dates ranging from December 1999 to June 2007, with certain rights for
extensions. The Discount Mortgages may be prepaid, but where prepayment occurs
before a certain specified date, prepayment must be accompanied by certain
specified yield maintenance payments.
RECOURSE LOAN. The Discount Mortgages are fully recourse to the borrowers.
REPAYMENT GUARANTY. One of the Discount Mortgages is supported by a
repayment guaranty, which guaranty terminates upon payment in full of the
associated senior debt or upon judicial foreclosure by or a deed in lieu to the
holder of the senior debt.
BUY/SELL AGREEMENT. One of the Discount Mortgages is subject to the terms
of a buy/sell agreement pursuant to which, upon the occurrence of certain
events, the borrower under the loan would be required to either agree to buy
certain interests or to sell certain interests in the underlying collateral.
Specified parties have the rights to elect to exercise the buy/sell right, in
which event the non-triggering party must either agree to buy the other party's
interest or to sell to the other party the triggering party's interest in the
underlying collateral. In the event that the borrower under the loan initiates
this latter two-way buy/sell option, it must prepay the $72.4 million the loan
in full.
SENIOR FINANCING AND INTERCREDITOR AGREEMENT. The underlying collateral is
subject to senior financing in the aggregate original amount of $65.0 million
which is not part of the portfolio and $94.7 million which
13
<PAGE>
is part of the Company's portfolio. The rights between senior and junior lenders
are generally governed by specified intercreditor agreements which provide for
certain cure rights for defaults under such senior financing.
HOTEL MANAGEMENT. In lieu of a management agreement, the general partner of
the borrower under one of the Discount Mortgages acts as a manager of the
underlying collateral, and is entitled to receive property management fees,
construction management fees, leasing commissions, and reimbursement of certain
approved items. All fees are subordinated to the $72.4 million loan in the event
of a default thereunder.
PARTNERSHIP LOANS/UNSECURED NOTES
The Company had approximately $346.4 million of Partnership Loans/Unsecured
Notes outstanding as of December 31, 1998. Partnership Loans/Unsecured Notes
represent financing on commercial property that is subject to first lien
mortgage debt. Typically, as security for its debt to the Company in a
Partnership Loan or Unsecured Note, the owner would pledge to the Company either
the property subject to the first lien (giving the Company a second lien
position that may be subject to an intercreditor agreement) or the limited
partnership and/or general partnership interest in the owner. If the owner's
general partnership interest is pledged, then the Company would be in a position
to take over the operation of the property in the event of a default by the
owner. The Company expects that Partnership Loans/Unsecured Notes will generally
provide the Company with the right to receive a stated interest rate on the loan
balance. In certain instances, the Company may negotiate to receive a percentage
of net cash flow or gross revenues from the property, payable to the Company on
an on-going basis, and a percentage of any increase in value of the property,
payable upon maturity, refinancing of the loan, or the sale of the property, or
the Company may otherwise seek terms to allow the Company to charge an interest
rate that would provide an attractive risk-adjusted return.
The following table sets forth certain information regarding the Company's
Partnership Loans/ Unsecured Notes as of March 18, 1998 (the date that the
Recapitalization Transactions were consummated) and December 31, 1998 (dollars
in thousands):
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 18, 1998 DECEMBER 31, 1998
------------------------------------ ------------------------------------
<S> <C> <C>
Number of Loans Outstanding......... 2 13
Number of Borrowers................. 2 13
Original Balance of Commitment $27,300 $358,585
Amount............................
Outstanding Balance................. $27,300 $342,040
Carrying Value...................... $25,188 $346,421
Effective Maturity Dates............ 2002 and 2004 2000 to 2008
Interest Accrual Rates.............. Fixed: 11.25% to 15.00% Fixed: 8.50% to 17.50%
Variable: LIBOR + 5.37%
Interest Payment Rates.............. Fixed: 11.25% to 15.00% Fixed: 8.00% to 15.00%
Variable: LIBOR + 5.37%
Principal Amortization.............. No Yes
Participation Features.............. Yes Yes
Underlying Property Type............ Office and Hotel Office, Hotel, Residential, and Land
Average Loan-to-Value............... 51% 80%
</TABLE>
GENERAL. The Partnership Loans/Unsecured Notes bear interest at fixed rates
and require monthly interest payments, and are generally secured by pledges of
partnership, membership or stock interests, and certain other non-real property
collateral. The real properties owned by the borrowing entities under the
14
<PAGE>
Partnership Loans/Unsecured Notes consist of office properties in New York, New
York, Detroit, Michigan, Philadelphia and Pittsburgh, Pennsylvania, residential
properties in San Jose, San Francisco, and Los Angeles, California, land in
Florida, 21 hotel properties in Georgia, Maryland, North Carolina, Pennsylvania,
Tennessee, and Virginia and 16 hotel properties in California, Colorado,
Michigan, Ohio, Oregon, Texas and Washington.
MATURITY AND PREPAYMENT TERMS. The Partnership Loans/Unsecured Notes have
effective maturity dates that range from September 2000 to August 2008. Some of
these loans are subject to prepayment lock-out periods during which time such
loans may not be prepaid. At specified periods during the term of the loans,
prepayment is generally permitted, subject to certain conditions, including the
payment of prepayment penalties based on specified yield maintenance formulas.
PARTICIPATING EQUITY INTEREST. Some of the Partnership Loans/Unsecured
Notes require participation payments based on specified percentages of cash flow
and net proceeds from sales or refinancings generated from properties related to
the loans.
RECOURSE LOAN. The Partnership Loans/Unsecured Notes are either recourse or
non-recourse to the personal assets of the borrowing entities, but where a loan
is non-recourse, the borrower is personally liable for certain specified
carve-outs.
GUARANTIES. Some of the Partnership Loans/Unsecured Notes are supported by
secured or unsecured guaranties, subject to specified recourse limitations as to
the guarantor.
EXISTING SENIOR LOANS ON THE REAL PROPERTY. The real properties owned by
the borrowers under the Partnership Loans/Unsecured Loans are subject to
third-party senior financing in the aggregate original amount of $1,424.6
million. The rights between senior and junior lenders are generally governed by
specified intercreditor agreements.
TAX ASPECTS OF PARTNERSHIP LOANS/UNSECURED NOTES. Partnership
Loans/Unsecured Notes which are not secured by mortgages on real property
generally do not constitute qualifying assets or generate qualifying income for
purposes of the 75% asset and gross income tests under the Code.
Under the Code, any amount received or accrued by a REIT, directly or
indirectly, with respect to any obligation is generally not included as
qualifying interest income if the determination of the amount depends in whole
or in part on the income or profits of any person (whether or not derived from
property secured by the obligation). Although amounts received by the Company
that are determined with reference to the operating income of a borrower
generally do not constitute qualifying income for purposes of the Code, certain
of such amounts received will constitute qualifying income if the borrower
receives substantially all of its gross income from the related property through
the leasing of substantially all of its interests in the property, to the extent
the amounts received from the borrower are attributable to amounts that would be
characterized as qualified rents from real property under the Code. The
provisions of the Code regarding the qualification of the Company as a REIT may
restrict the Company's ability to originate or acquire certain Partnership
Loans/Unsecured Notes. The Board of Trustees will monitor the Company's
compliance with the various REIT qualification tests imposed under the Code with
respect to investing in Partnership Loans/Unsecured Notes. However, no assurance
can be given that the Company will satisfy these tests on a continuing basis.
CONSTRUCTION LOANS
The Company had approximately $97.8 million of loans to finance construction
projects ("Construction Loans") outstanding as of December 31, 1998.
15
<PAGE>
The following table sets forth certain information regarding the Company's
Construction Loans as of March 18, 1998 (the date that the Recapitalization
Transactions were consummated) and December 31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 18, 1998 DECEMBER 31, 1998
------------------------------------ ------------------------------------
<S> <C> <C>
Number of Loans Outstanding......... 2 3
Number of Borrowers................. 2 3
Original Balance of Commitment $92,390 $131,390
Amount............................
Outstanding Balance................. $85,471 $ 93,514
Carrying Value...................... $90,247 $ 97,819
Original Maturity Dates............. 1999 and 2004 1999 and 2007
Interest Accrual Rates.............. Fixed: 12.00% to 12.50% Fixed: 10.30% to 12.50%
Interest Payment Rates.............. Fixed: 10.00% to 12.50% Fixed: 10.00% to 12.50%
Principal Amortization.............. No Yes
Participation Features.............. No No
Underlying Property Type............ Senior Living, Resort and Conference Senior Living, Resort and Conference
Center Center
Average Loan-to-Value............... 71% 74%
</TABLE>
GENERAL. Approximately $36.6 million of the committed amount under the
Construction Loan had not yet been funded as of December 31, 1998. The
Construction Loans are disbursed in accordance with approved construction
disbursement schedules and budgets. The Construction Loans bear interest at
fixed rates and require monthly interest payments in specified amounts. Two of
the Construction Loans are secured by mortgages encumbering real properties
comprised of a recently completed condominium project and a recently completed
luxury resort hotel, conference center and beach club, and golf course, both
located in Florida, along with certain other partnership and stock collateral.
The other Construction Loan is secured by a mortgage encumbering real property
comprised of an existing conference center and a to-be-built addition to such
facility. One of the Construction Loans is also supported by letters of credit
which are subject to return upon the occurrence of certain repayment conditions
and thresholds.
MATURITY DATE AND PREPAYMENT TERMS. The Construction Loans have maturity
dates that range from November 1999 to March 2007. Periodically during the term
of the Construction Loans, under certain specified conditions, the Construction
Loans may be prepaid either in full or in part, or just in full, as applicable,
upon the satisfaction of certain specified conditions, including, without
limitation, the payment of a specified prepayment fee.
RESERVES. The Construction Loans require that the borrowers thereunder fund
certain reserves from, among other specified funds, all of the cash flow and net
sales proceeds generated from the real properties securing the Construction
Loans, which reserves are to be used for the payment of interest, certain
construction costs, or other operating or capital expenses.
GUARANTIES. The Construction Loans are supported by repayment and/or
completion guaranties. The repayment guaranties range from full repayment to
repayment of only certain specified losses. One of the guarantors under one of
the Construction Loans has provided a promissory note which will be returned to
such guarantor when certain specified funds have been contributed to the reserve
established for such Construction Loan.
SENIOR ENCUMBRANCES. A portion of the real property securing one of the
Construction Loans is subject to certain third-party senior mortgages, including
portions of the property on which a condominium project has been developed.
16
<PAGE>
REAL ESTATE UNDER LONG-TERM OPERATING LEASE
GENERAL. Pursuant to the terms of the RLH lease (the "RLH Lease"), Red Lion
Hotels, Inc., a Delaware corporation, a wholly-owned subsidiary of Doubletree
Corporation ("Tenant"), master leases 17 parcels of real property (the "RLH
Properties"), each of which is improved with Doubletree or Red Lion hotels (the
"Leased Hotels"). The RLH Lease is absolutely net so that Tenant controls all
aspects of the RLH Properties' operations and management, and is required to pay
all rents and other sums to or on behalf of the Company, as landlord. The Tenant
is required, at its own cost, to replace fixtures, furnishing and equipment
("FF&E") and other fixed assets and operating equipment and inventory as
required, which are the property of the Tenant, and to fund an FF&E reserve
account. The Tenant is required to indemnify the Company and certain others for
all costs and expenses imposed upon or incurred by an indemnified party in
connection with the use, alteration, operation, management, condition (including
environmental condition and compliance), design, construction, maintenance,
repair or restoration of any of the leased premises and the employment of any
persons at the leased premises. Promus Hotel Corp., the parent of Doubletree
Corporation, has executed a full guaranty of the punctual payment and
performance of any and all liabilities and obligations of Tenant arising out of
or related to the RLH Lease.
TERM. The RLH Lease is a long-term lease that extends through 2020,
including three automatic five-year extension terms unless a proper termination
notice is delivered by the Tenant. The final expiration of the RLH Lease,
assuming all extensions, would occur in 2035.
ORGANIZATION. RLH Partnership, L.P., a Delaware limited partnership, is the
fee owner or ground lessee of the RLH Properties. The general partner of RLH
Partnership, L.P. is Red Lion G.P., Inc. and the limited partner is SFT/RLH,
Inc. ("SFT/RLH"), a wholly-owned subsidiary of the Company. SFT/RLH is also the
sole stockholder of Red Lion G.P., Inc. A subsidiary of the Company has a 99%
membership interest in RLH Partnership, L.P. and is the controlling entity of
the interest.
BASE AND PERCENTAGE RENT. The Company collects a specified annual base rent
payable monthly in arrears and 7.5% of annual operating revenues in excess of a
base amount for all of the Leased Hotels. Under certain conditions, Tenant's
rent is subject to certain increases if Tenant completes an expansion at any
Leased Hotel.
17
<PAGE>
Certain information relating to the Leased Hotels is summarized as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
-------------------------------------
NUMBER OF AVERAGE AVERAGE
PROPERTY LOCATION ROOMS DAILY RATE OCCUPANCY
- --------------------------------------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
Seattle, Washington...................................... 850 $ 95.01 76.7%
Salt Lake City, Utah..................................... 497 101.05 78.8%
Sacramento, California................................... 376 69.76 80.3%
San Diego, California.................................... 300 105.73 81.1%
Sonoma, California....................................... 245 94.68 64.9%
Medford, Oregon.......................................... 186 65.35 63.8%
Boise, Idaho............................................. 182 56.17 78.7%
Pendleton, Oregon........................................ 168 62.86 59.2%
Kelso, Washington........................................ 162 65.63 53.9%
Vancouver, Washington.................................... 160 77.84 65.2%
Durango, Colorado........................................ 159 97.32 66.8%
Wenatchee, Washington.................................... 149 49.38 74.8%
Coos Bay, Oregon......................................... 143 58.52 65.3%
Eugene, Oregon........................................... 137 63.31 59.3%
Astoria, Oregon.......................................... 124 67.90 46.9%
Missoula, Montana........................................ 76 48.13 74.1%
Bend, Oregon............................................. 75 55.32 61.1%
----------- ----------- -----
TOTAL/WEIGHTED AVERAGE................................. 3,989 $ 81.29 71.5%
----------- ----------- -----
----------- ----------- -----
</TABLE>
LOAN PARTICIPATIONS
The Company had approximately $40.9 million of loan participations ("Loan
Participations") outstanding as of December 31, 1998.
The following table sets forth certain information regarding the Company's
Loan Participations as of March 18, 1998 (the date that the Recapitalization
Transactions were consummated) and December 31, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 18, 1998 DECEMBER 31, 1998
------------------------------------ ------------------------------------
<S> <C> <C>
Number of Loans Outstanding......... 3 4
Number of Borrowers................. 3 4
Original Balance of Commitment $22,656 $43,339
Amount............................
Outstanding Balance................. $22,534 $42,450
Carrying Value...................... $12,828 $40,877
Original Maturity Dates............. 1999 and 2000 1999 and 2005
Interest Accrual Rates.............. Fixed: 7.13% Fixed: 7.13% to 14.00%
Variable: LIBOR + 0.58% to 1.75% Variable: LIBOR + 0.58%
Interest Payment Rates.............. Fixed: 5.45% to 6.40% Fixed: 5.65% to 13.60%
Variable: LIBOR + 0.58% to 1.75% Variable: LIBOR + 0.58%
Principal Amortization.............. Yes Yes
Participation Features.............. No No
Underlying Property Type............ Hotel and Office Hotel and Office
Average Loan-to-Value............... 77% 88%
</TABLE>
18
<PAGE>
GENERAL. The Company's interest in each of the Participation Loans is
limited to a certain specified participation percentage. The Participation Loans
bear interest at either variable rates based on LIBOR plus an additional
specified amount, or at fixed rates subject to certain scheduled increases, and
require monthly interest payments and/or specified amortization payments. The
Participation Loans are secured by mortgages encumbering real properties
comprised of office buildings in New York, New York, Rockville, Maryland,
Washington, D.C., and Lousiville, Kentucky and a leasehold interest in a hotel
in Uniondale, New York, and certain other non-real property collateral.
MATURITY AND PREPAYMENT TERMS. The Participation Loans have maturity dates
that range from May 1999 to May 2005. The Participation Loans may either be
prepaid in full or in part without the payment of a prepayment penalty or are
not prepayable.
GUARANTIES. Some of the Participation Loans are supported by either a
completion guaranty or a repayment guaranty.
CO-LENDING ARRANGEMENT. Each of the Participation Loans is subject to the
interest of other participants in the loans and the relationship among
participating lenders is generally governed by the terms of certain
participation or co-lending agreements.
PARTICIPATING EQUITY INTEREST. One of the Participation Loans requires
participation payments upon the sale or refinancing of the real property
securing such loan.
SPECIALTY FINANCE JOINT VENTURE LOANS
The Company entered into a joint venture with Franchise Mortgage Acceptance
Company in July 1998 to finance the acquisition and development of small
business loans and real estate-related assets. The loans financed by the joint
venture ("Specialty Finance Joint Venture Loans") are secured by various
specialty finance assets, including golf courses, marinas, funeral homes,
restaurants, convenient stores and gas stations. As of December 31, 1998, the
Company had made an aggregate investment of $47.3 million in the joint venture.
The specialty finance market has different characteristics from the
commercial real estate industry. The assets securing loans in this market
generally have stable valuations and the operator/franchisee is a key factor in
the success of the franchise. Typically, the lender will provide financing for a
higher percentage of the value of the real property collateral based upon
appraisals of the enterprise value of the operator's business and related real
estate assets from nationally-recognized appraisers. Such enterprise value
typically exceeds the value of the real estate collateral alone.
The Company had approximately $47.7 million of Specialty Joint Venture Loans
outstanding as of December 31, 1998.
19
<PAGE>
The following table sets forth certain information regarding the Company's
Specialty Joint Venture Loans as of March 18, 1998 (the date that the
Recapitalization Transactions were consummated) and December 31, 1998 (dollars
in thousands):
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 18, 1998 DECEMBER 31, 1998
---------------- -------------------------
<S> <C> <C>
Number of Loans Outstanding....................... -- 10
Number of Borrowers............................... -- 7
Original Balance of Commitment Amount............. $-- $50,400
Outstanding Balance............................... $-- $50,200
Carrying Value.................................... $-- $47,722
Original Maturity Dates........................... N/A 2000 to 2018
Fixed: 8.14% to
Interest Accrual Rates............................ N/A 9.45%
Variable: LIBOR
+ 3.75% to 4.50%
Fixed: 8.14% to
Interest Payment Rates............................ N/A 9.45%
Variable: LIBOR
+ 3.75% to 4.50%
Principal Amortization............................ N/A Yes
Participation Features............................ N/A No
Underlying Property Type.......................... N/A Various
Average Loan-to-Value............................. N/A 75%
</TABLE>
OTHER REAL ESTATE-RELATED INVESTMENTS
The Company also pursues a variety of other commercial real estate
investments that complement its core business and allow it to meet the needs of
its customers. These other types of investments may include subordinated
interests, real estate-related secured or unsecured debt securities, foreign
real estate-related financings, and other types of financings. The Company
intends to pursue such investments on an opportunistic basis.
As of December 31, 1998, the Company's other real estate-related investments
were publicly-traded bonds of two issuers with a market value of approximately
$47.5 million, one of which matures in May 2002 and carries a coupon of 12.75%
per annum and the other of which matures in March 2007 and carries a coupon of
12.50%. Both bonds pay semi-annually.
SERVICING
In September 1998, Starwood Operating, Inc. (collectively with its
subsidiaries "Starwood Operating"), a taxable corporation that is not
consolidated with the Company for financial reporting or tax purposes, acquired
the loan origination and servicing business of Phoenix. The Company owns all of
the preferred stock and a 95% economic interest in the Starwood Operating.
Starwood Operating serviced loans with an outstanding balance of approximately
$3.2 billion as of December 31, 1998.
Starwood Operating is approved as a Master Servicer by Standard & Poor's
Rating Services for commercial loans serviced by Starwood Operating for
third-party clients as of December 31, 1998.
20
<PAGE>
The following table sets forth the number and amount of loans serviced by
Starwood Operating for third-party clients as of December 31, 1998.
<TABLE>
<S> <C>
Loans Serviced:
Number........................ 238
Amount (in thousands)......... $1,200,000
</TABLE>
Starwood Operating generally does not purchase the rights to service loans
for others. Capitalized servicing rights amounted to $2.0 million as of December
31, 1998. In accordance with Statement of Financial Accounting Standards
("SFAS") No. 122, "Accounting for Mortgage Servicing Rights", the Company
amortizes mortgage servicing rights over the estimated weighted average life of
the loan and periodically evaluates its mortgage servicing rights for impairment
based on the fair value of those rights, which is recognizable through a
valuation analysis.
ADVISORY AGREEMENT
Pursuant to the Advisory Agreement, the Advisor manages the affairs of the
Company, subject to the Company's purpose and investment policy, its investment
restrictions and the directives of the Board of Trustees. The services provided
by the Advisor include: (i) identifying financing opportunities for the Company;
(ii) advising the Company with respect to and effecting acquisitions and
dispositions of the Company's loans; (iii) monitoring, managing and servicing
the Company's loan portfolio; and (iv) arranging debt financing for the Company.
The Advisor will not act in a manner that is inconsistent with the express
direction of the Board of Trustees and reports to the Board of Trustees and the
officers of the Company with respect to its activities. The Advisor is not
responsible for the administration of the Company.
The Company pays the Advisor a quarterly base management fee of 0.3125%
(1.25% per annum) of the "Book Equity Value" of the Company determined as of the
last day of each quarter but estimated and paid in advance subject to
recomputation. "Book Equity Value" is generally defined as the excess of the
book value of the assets of the Company over all liabilities of the Company.
In addition, the Company pays the Advisor a quarterly incentive fee of 5.00%
of the Company's "Adjusted Net Income" during each quarter that the Adjusted Net
Income for such quarter (restated and annualized as a rate of return on the
Company's Book Equity Value for such quarter) equals or exceeds the "Benchmark
BB Rate." "Adjusted Net Income" is generally defined as the Company's gross
income less the Company's expenses for the applicable quarter (including the
base fee for such quarter but not the incentive fee for such quarter). In
calculating both Book Equity Value and Adjusted Net Income, real estate-related
depreciation and amortization (other than amortization of financing costs and
other prepaid expenses to the extent such costs and prepaid expenses have
previously been booked as an asset of the Company) are not deducted. In
addition, debt that is exchangeable or convertible into equity securities is not
treated as a liability of the Company if the value of the equity securities into
which such debt obligation is convertible equals or exceeds the outstanding
balance of such debt obligation and the interest expense of such debt is not
included as an expense and, thus, does operate to reduce the Company's gross
income. The Advisor is also reimbursed for certain expenses it incurs on behalf
of the Company.
Because payment of both the base fee and the incentive advisory fees
commenced 90 days after the consummation of the Recapitalization Transactions,
fees were recognized ratably over the period from March 18, 1998 through
December 31, 1998. The operating results of the Company for such period were
greater than they would have been had the advisory fee not been deferred.
The Company may be subject to conflicts of interest with the Advisor because
the incentive fee, which is based on the Company's income, may create an
incentive for the Advisor to recommend investments with greater income
potential, which may be riskier and more speculative, than would be the case if
the fee did not include a performance-related component.
21
<PAGE>
The Advisory Agreement has an initial term of three years subject to
automatic renewal for one-year periods unless the Company has been liquidated or
a Termination Event (as defined in the Advisory Agreement and which generally
includes violations of the Advisory Agreement by the Advisor, a bankruptcy event
of the Advisor or the imposition of a material liability on the Company as a
result of the Advisor's bad faith, willful misconduct, gross negligence or
reckless disregard of duties) has occurred and is continuing. In addition, the
Advisor may terminate the Advisory Agreement on 60 days' written notice to the
Company and the Company may terminate the Advisory Agreement upon 60 days'
written notice if a Termination Event has occurred or if the decision to
terminate is based on an affirmative vote of the holders of two thirds or more
of the voting shares of the Company at the time outstanding.
The Company is dependent on the services of the Advisor and its officers and
employees for the successful execution of its business strategy. The Company is
subject to the risk that the Advisor might terminate the Advisory Agreement to
the extent that no suitable replacement were found to manage the affairs of the
Company. Messrs. Sternlicht, Sugarman, Dishner, Eilian and Kleeman, each a
Trustee of the Company, directly or indirectly, collectively own a substantial
economic and voting interest in the Advisor, which is a recently-formed entity.
Mr. Sternlicht, Chairman of the Board of Trustees of the Company, is also
chairman of the Advisor and Mr. Sugarman, Chief Executive Officer, President and
Trustee of the Company, is also chief executive officer and president of the
Advisor.
POLICIES WITH RESPECT TO CERTAIN ACTIVITIES
The following is a description of certain investment, financing and other
policies of the Company. Subject to the Declaration of Trust, these policies may
be amended or revised from time to time without the approval of the Company's
shareholders.
INVESTMENT POLICIES. The Company believes that it will not be, and intends
to conduct its operations so as not to become, regulated as an investment
company under the Investment Company Act. The Investment Company Act generally
exempts entities that are "primarily engaged in purchasing or otherwise
acquiring mortgages and other liens on and interests in real estate"
(collectively, "Qualifying Interests"). The Company intends to rely on current
interpretations by the staff of the Securities and Exchange Commission ("SEC")
in an effort to qualify for this exemption. To comply with the foregoing
guidance, the Company, among other things, must maintain at least 55% of its
assets in Qualifying Interests and also may be required to maintain an
additional 25% in Qualifying Interests or other real estate-related assets.
Generally, the Senior Mortgages and certain of the Subordinated Mortgages in
which the Company may invest constitute Qualifying Interests.
The Company is restricted from making certain types of investments which may
limit its flexibility in implementing its investment policy. Specifically,
without the amendment, termination or waiver of provisions of certain
non-competition agreements between Starwood Capital Group, L.P. and Starwood
Hotels & Resorts, the Company is prohibited from: (i) making investments in
loans collateralized by hotel assets where it is anticipated that the underlying
equity will be acquired by the debtholder within one year from the acquisition
of such debt; (ii) acquiring equity interests in hotels (other than acquisitions
of warrants, equity participations or similar rights incidental to a debt
investment by the Company or that are acquired as a result of the exercise of
remedies in respect of a loan in which the Company has an interest); or (iii)
selling or contributing to or acquiring any interests in Starwood Hotels &
Resorts, including debt positions or equity interests obtained by the Company
under, pursuant to or by reason of the Company's ownership of debt positions.
Subject to the limitations on ownership of certain types of assets and the
gross income tests imposed by the Code, the Company also may invest in the
securities of other REITs, other entities engaged in real estate activities or
other issuers, including for the purpose of exercising control over such
entities.
FINANCING POLICIES. As a general policy, the Company intends to limit its
total consolidated indebtedness incurred so that at the time any debt is
incurred, the Company's debt-to-equity ratio (on a book value
22
<PAGE>
basis) does not exceed 2.0-2.5 to 1.0. The Company's Declaration of Trust does
not, however, limit the amount or percentage of indebtedness that the Company
may incur. In addition, the Company may from time to time modify its debt policy
in light of current economic conditions, relative costs of debt and equity
capital, market values of its properties, general conditions in the market for
debt and equity securities, fluctuations in the market price of its Class A
Shares, growth and acquisition opportunities and other factors. Accordingly, the
Company may increase or decrease its debt-to-equity ratio beyond the limits
described above. If these policies were changed, the Company could become more
highly leveraged, resulting in an increased risk of default on its obligations
and a related increase in debt service requirements that could adversely affect
the financial condition and results of operations of the Company and the
Company's ability to make distributions to shareholders.
Although the Company will consider factors other than book value in making
decisions regarding the incurrence of debt (such as its interest coverage and
fixed charge coverage ratios), there can be no assurance that the
debt-to-equity, or any other measure of leverage, at the time the debt is
incurred or at any other time will be consistent with any particular level of
distributions to shareholders.
To the extent that the Board of Trustees decides to obtain additional
capital, the Company may raise such capital through additional equity offerings
(including offerings of preferred or convertible securities), debt financings or
retention of cash available for distribution (subject to provisions in the Code
concerning taxability of undistributed REIT income), or a combination of these
methods. The Company presently anticipates that any additional borrowings would
be made directly or through operating subsidiaries. Borrowings may be unsecured
or may be secured by any or all of the assets of the Company or any existing or
new asset-owning subsidiary and may have full or limited recourse to all or any
portion of the assets of the Company or any existing or new asset-owning
subsidiary. Indebtedness incurred by the Company may be in the form of bank
borrowings, purchase money obligations to sellers of properties, publicly- or
privately-placed debt instruments or financing from institutional investors or
other lenders. The proceeds from any borrowings by the Company may be used for
working capital, to refinance existing indebtedness or to finance the
origination or acquisition of additional loans, and for the payment of
distributions.
UNDERWRITING POLICY AND PROCEDURES. The Company manages credit risk through
its underwriting procedures, centralized approval of individual transactions and
active portfolio and account management. As part of its underwriting process,
the Company reviews historical and projected financial information relating to
the properties underlying its loan investments and related borrowers, analyzes
loan-to-value, debt service coverage and other financial ratios, reviews market
feasibility and other demographic and economic information, and assesses the
structural characteristics of the proposed loans. The primary focus of the
Company's management of credit risk is on the financial performance, sufficiency
and credit quality of the collateral underlying the Company's loans and the
ability of the related borrower to meet interest and principal payments on such
loans. Credit risk is also actively managed through portfolio diversification by
industry, geographic region and individual borrower exposure, as well as the
regular monitoring of collateral performance through intensive servicing and
asset management procedures.
INTEREST RATE MANAGEMENT TECHNIQUES. The Company has engaged in and will
continue to engage in a variety of interest rate management techniques for the
purpose of managing the effective maturity or interest rate of its assets and/or
liabilities. These techniques also may be used to attempt to protect against
declines in the market value of the Company's assets resulting from general
trends in debt markets. Any such transaction is subject to risks and may limit
the potential earnings on the Company's investments in real estate-related
assets. Such techniques include interest rate swaps (the exchange of fixed-rate
payments for floating-rate payments) and interest rate caps. The Company uses
interest rate swaps and interest rate caps to hedge mismatches in interest rate
maturities, to reduce the Company's exposure to interest rate fluctuations and
to provide more stable spreads between investment yields and the rates on its
financing sources. Amounts arising from the differential are recognized as an
adjustment to interest income related to the earning assets or liabilities.
23
<PAGE>
POLICIES WITH RESPECT TO OTHER ACTIVITIES. At all times, the Company
intends to make investments in a manner consistent with the requirements of the
Code for the Company to qualify as a REIT unless, because of changing
circumstances or changes in the Code (or in Treasury Regulations), the Company's
Board of Trustees, with the consent of the holders of a majority of the
outstanding voting shares, determines that it is no longer in the best interests
of the Company to qualify as a REIT.
COMPETITION
The Company is engaged in a highly competitive business. In originating and
acquiring assets, the Company competes with numerous public and private
companies, including other finance companies, REITs, mortgage banks, pension
funds, savings and loan associations, insurance companies, institutional
investors, investment banking firms and other lenders and industry participants,
as well as individual investors. In addition, there are several finance
companies and REITs with investment objectives similar to the Company, and
others may be organized in the future. The existing participants and potential
new entrants compete with the Company for the available supply of investments
suitable for origination or acquisition by the Company as well as equity capital
and thereby may adversely affect the market price of the Class A Shares. In
addition, adverse publicity affecting this sector of the capital markets or
significant operating failures of competitors may adversely affect the market
price of the Class A Shares. Certain of the Company's competitors are larger
than the Company, have longer operating histories, may have access to greater
capital and other resources, may have management personnel with more experience
than the officers of the Company, and may have other advantages over the Company
in conducting certain businesses and providing certain services.
REGULATION
The operations of the Company are subject, in certain instances, to
supervision and regulation by state and federal governmental authorities and may
be subject to various laws and judicial and administrative decisions imposing
various requirements and restrictions, which, among other things: (i) regulate
credit granting activities; (ii) establish maximum interest rates, finance
charges and other charges; (iii) require disclosures to customers; (iv) govern
secured transactions; and (v) set collection, foreclosure, repossession and
claims-handling procedures and other trade practices. Although most states do
not regulate commercial finance, certain states impose limitations on interest
rates and other charges and on certain collection practices and creditor
remedies and require licensing of lenders and financiers and adequate disclosure
of certain contract terms. The Company is also required to comply with certain
provisions of the Equal Credit Opportunity Act that are applicable to commercial
loans.
In the judgment of management, existing statutes and regulations have not
had a material adverse effect on the business conducted by the Company. However,
it is not possible to forecast the nature of future legislation, regulations,
judicial decisions, orders or interpretations, nor their impact upon the future
business, financial condition or results of operations or prospects of the
Company.
The Company intends to make an election to be taxed as a REIT under Section
856 through 860 of the Code. As a REIT, the Company generally will not be
subject to federal income tax if it distributes at least 95% of its taxable
income for each year to its shareholders. REITs are also subject to a number of
organizational and operational requirements in order to elect and maintain REIT
status. These requirements include specific share ownership tests and assets and
gross income composition tests. If the Company fails to qualify as a REIT in any
taxable year, the Company will be subject to federal income tax (including any
applicable alternative minimum tax) on its taxable income at regular corporate
tax rates. Even if the Company qualifies for taxation as a REIT, the Company may
be subject to state and local income taxes and to federal income tax and excise
tax on its undistributed income.
24
<PAGE>
Although the Company did not qualify as a REIT for its fiscal years 1993
through 1997, it received a written agreement from the IRS confirming its
agreement that the Company is eligible to make an election under Section
856(c)(1) of the Code to be taxed as a REIT for its taxable year ending December
31, 1998.
FACTORS THAT MAY AFFECT THE COMPANY'S BUSINESS STRATEGY
The implementation of the Company's business strategy and investment
policies are subject to certain risks, including the effect of economic and
other conditions on property values, the general illiquidity of real estate
investments, the risks of default in respect of mortgage or other debt covenants
(and risks attendant thereto, such as delays frequently encountered by lenders
in enforcing remedies or in gaining control over the real estate collateral),
the abilities of the properties collateralizing debt instruments held by the
Company or properties which are owned by the Company to generate revenues
sufficient to meet operating expenses and to pay scheduled debt service, the
risk that prepayment restrictions may be insufficient to deter prepayments, the
existence of junior mortgages that may affect the Company's rights, the effect
of competition from properties owned by others, liability associated with
uninsurable losses and unknown environmental liabilities.
EMPLOYEES
As of December 31, 1998, the Company had no employees.
ITEM 2. PROPERTIES.
The Company's principal executive and administrative offices are located at
1114 Avenue of the Americas New York, NY 10036, 27th floor. Its telephone
number, general facsimile number and e-mail address are (212) 930-9400, (212)
930-9494 and sftny.com, respectively. The lease for the Company's office space
expires in February 2010. The Company believes that this office space is
suitable for its operations for the foreseeable future. The Company also
maintains a regional office in Hartford, Connecticut.
See also Item 1--"Investment Portfolio--Real Estate Under Long-Term
Operating Lease" for real estate assets held by the Company for investment
purposes.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not a party to any material litigation or legal proceedings,
or to the best of its knowledge, any threatened litigation or legal proceedings,
which, in the opinion of management, individually or in the aggregate, would
have a material adverse effect on its results of operations or financial
condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders during the
fourth quarter of 1998.
25
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED SHARE MATTERS.
The Class A Shares are traded on the American Stock Exchange under the
symbol "APT". All of the Class B Shares are held by B Holdings, L.L.C., a
company controlled by affiliates of the general partners of Starwood Mezzanine
and SOF IV. There is no established public trading market for the Class B
Shares. All of the Preferred Shares are held by private investment funds and
there is no established public trading market for such shares.
The following table sets forth the high and low closing sales prices of the
Company's Class A Shares for the quarters ended 1998 and 1997.
<TABLE>
<CAPTION>
QUARTER ENDED HIGH(1) LOW(1)
- ------------------------------------------------------------------------------- ------- -------
<S> <C> <C>
December 31, 1998.............................................................. $80 1/4 $45 1/4
September 30, 1998............................................................. $59 1/4 $35 1/2
June 30, 1998.................................................................. $56 $26 1/4
March 31, 1998................................................................. $36 3/4 $27 3/8
December 31, 1997.............................................................. $36 3/4 $22 1/2
September 30, 1997............................................................. $26 5/8 $13 1/2
June 30, 1997.................................................................. $18 3/4 $15 3/8
March 31, 1997................................................................. $23 5/8 $ 9 3/8
</TABLE>
- ------------------------------
(1) As adjusted for a one-for-six reverse stock split effective June 19, 1998.
On March 12, 1999, the closing sale price of the Class A Shares as reported
by the American Stock Exchange was $45.00. The Company had approximately 1,559
holders of Class A Shares as of March 12, 1999.
The Company did not declare any dividends for the period from November 19,
1993 through the date of the Recapitalization Transactions. In order to maintain
its qualifications as a REIT, the Company intends to make regular quarterly
dividends to its shareholders that, on an annual basis, will represent at least
95% of its taxable income (which may not necessarily equal net income as
calculated in accordance with generally accepted accounting principles),
determined without regard to the deduction for dividends paid and excluding any
net capital gains.
Pursuant to the Company's Declaration of Trust, the holders of the Preferred
Shares are entitled to a 9.50% dividend per annum (the "Preferred Dividend").
Unless all accumulated, accrued and unpaid dividends through the end of any
dividend period with respect to the Preferred Shares are paid in full, the
Company may not pay or set aside for payment any dividends on the Class A Shares
or Class B Shares. Any taxable income remaining after the distribution of
Preferred Dividends and the regular quarterly or other dividends will be
distributed annually to the holders of the Class A and Class B Shares on or
prior to the date of the first regular quarterly divided payment date of the
following taxable year. The dividend policy with respect to the Class A Shares
and Class B Shares is subject to revision by the Board of Trustees. All
distributions in excess of the Preferred Dividends or those required for the
Company to maintain its REIT status will be made by the Company at the sole
discretion of the Board of Trustees and will depend on the taxable earnings of
the Company, the financial condition of the Company, and such other factors as
the
26
<PAGE>
Board of Trustees deems relevant. The Board of Trustees has not established any
minimum distribution level. The following table sets forth the dividends paid or
declared by the Company on its Class A Shares.
<TABLE>
<CAPTION>
STOCKHOLDER DIVIDEND/
QUARTERLY PERIOD ENDED RECORD DATE SHARE
- ----------------------------------------------------------- ---------------------- -----------
<S> <C> <C>
June 30, 1998.............................................. June 30, 1998 $ 0.35
September 30, 1998......................................... October 15, 1998 $ 0.38
December 31, 1998.......................................... December 31, 1998 $ 0.41(1)
</TABLE>
- ------------------------------
(1) A portion of this quarterly dividend (approximately $0.29 per share) will be
treated as income to shareholders of record in 1998, and the remainder will
be treated as 1999 income.
The Company also declared dividends aggregating $929,000 on its Preferred
Shares for the period from December 15, 1998 through December 31, 1998, payable
on January 15, 1999. Further, it declared and paid dividends aggregating
$185,000, $201,000, and $217,000, respectively, to the holders of the Class B
Shares in connection with the June 30, September 30, and December 31, 1998
quarterly dividends to the holders of the Class A Shares.
Distributions to shareholders will generally be taxable as ordinary income,
although a portion of such dividends may be designated by the Company as capital
gain may constitute a tax-free return of capital. The Company annually furnishes
to each of its shareholders a statement setting forth the distributions paid
during the preceding year and their characterization as ordinary income, capital
gain or return of capital.
On June 18, 1998, the Company issued 687 Class A Shares upon exercise of
certain options previously issued to former Trustees of the Company. The
exercise price of the options was $15.00 per share. The shares were issued to
accredited investors and did not involve a public offering. The offering was
therefore exempt from registration under the Securities Act of 1933, as amended,
pursuant to Section 4(2) thereof. As required by the Company's Declaration of
Trust, on the same day, 344 Class B Shares were issued to the current holders of
the Class B Shares for a price of $0.01 per share.
On December 15, 1998, the Company consummated the Lazard Transaction,
pursuant to which it sold 4,400,000 Preferred Shares and Warrants to purchase
6,000,000 Class A Shares to the Investors for an aggregate price of $220.0
million. The Warrants have an exercise price of $35.00 per share which expire on
December 15, 2005. The Preferred Shares and Warrants were issued to accredited
investors and did not involve a public offering. The offering was therefore
exempt from registration under the Securities Act of 1933, as amended, pursuant
to Section 4(2) thereof.
ITEM 6. SELECTED FINANCIAL DATA.
Prior to the consummation of the Recapitalization Transactions on March 18,
1998, the Company did not have substantial capital resources or lending
operations. Therefore, the following selected financial data relating to the
Company's historical financial information as of and for the years ended
December 31, 1997, 1996, 1995, and 1994 and for the period from January 1, 1998
through March 18, 1998 does not reflect the current operations of the Company as
a well capitalized, specialized finance company operating in the commercial real
estate industry.
27
<PAGE>
For these reasons, the Company believes that the following information is
not indicative of the Company's current business and should be read in
conjunction with the discussions set forth in "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996 1995 1994
---------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING DATA:
Interest income.................................................... $ 112,914 $ 896 $ 478 $ 145 $ 296
Operating lease income............................................. 12,378 -- -- -- --
Other income....................................................... 2,804 991 10 3 --
---------- --------- --------- --------- ---------
Total revenue...................................................... 128,096 1,887 488 148 296
---------- --------- --------- --------- ---------
Interest expense................................................... 44,697 -- 272 -- 270
Depreciation and amortization...................................... 4,287 -- -- -- --
General and administrative expense................................. 2,583 461 639 283 356
Advisory fee....................................................... 7,837 -- -- -- --
Provision for possible credit losses............................... 2,750 -- -- -- --
Stock option compensation expense.................................. 5,985 -- -- -- --
---------- --------- --------- --------- ---------
Total expenses..................................................... 68,139 461 911 283 626
---------- --------- --------- --------- ---------
Net income (loss) before minority interest......................... 59,957 1,426 (423) (135) (330)
Minority interest (1).............................................. (54) (1,415) (154) -- --
---------- --------- --------- --------- ---------
Net income (loss).................................................. $ 59,903 $ 11 $ (577) $ (135) $ (330)
---------- --------- --------- --------- ---------
Earnings per Class A Share (2)..................................... $ 1.40 $ 0.00 $ (1.34) $ (0.30) $ (0.78)
---------- --------- --------- --------- ---------
---------- --------- --------- --------- ---------
SUPPLEMENTAL DATA:
Dividends declared on Preferred Shares............................. $ 929 $ -- $ -- $ -- $ --
Dividends declared on Class A and B Shares......................... 60,343 -- -- -- --
Dividends declared per Class A Share............................... 1.14 -- -- -- --
Funds from operations (3)(4)....................................... 63,261 1,426 (423) (135) (330)
Cash flows from:
Operating activities............................................. 54,915 1,271 (227) (184) (397)
Investing activities............................................. (1,271,309) (6,013) (522) 175 (1,371)
Financing activities............................................. 1,226,208 4,924 -- -- 101
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------------------
1998 1997 1996 1995 1994
---------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
BALANCE SHEET DATA:
Loans and other investments, net................................... $2,013,703 $ -- $ -- $ -- $ --
Total assets....................................................... 2,059,616 13,441 5,674 2,194 2,372
Debt obligations................................................... 1,055,719 -- -- -- --
Minority interest.................................................. -- 5,175 3,917 -- --
Shareholders' equity............................................... 970,728 6,351 1,578 2,155 2,290
</TABLE>
- ------------------------------
(1) Represents a minority interest in APMT Limited Partnership which was
converted into Class A Shares on March 18, 1998, the date the partnership
was liquidated and terminated.
(2) Earnings per Class A Share is calculated based on the weighted average
shares outstanding during each of the periods after deduction for dividends
on the Preferred Shares and the Class B Shares' 1% interest.
(3) Management generally considers funds from operations ("FFO") to be one
measure of the financial performance which provides a relevant basis for
comparison among REITs and is presented to assist investors in analyzing the
performance of the Company. In 1995, the National Association of Real Estate
Investment Trusts ("NAREIT") established new guidelines clarifying its
definition of FFO and requested that REITs adopt this new definition
beginning in 1996. FFO, as defined by NAREIT, is income (loss) before
minority interest (determined in accordance with generally accepted
accounting principles), excluding gains (losses) from debt restructuring and
sales of property, plus real estate related depreciation and amortization
and after adjustments for unconsolidated partnerships and joint ventures.
FFO does not represent cash generated from operating activities in
accordance with generally accepted accounting principles and is not
necessarily indicative of cash available to fund cash needs. FFO should not
be considered an alternative to net income as an indication of the Company's
financial performance nor an alternative to cash flows from operating,
investing, and financing activities as measures of liquidity.
(4) Because of certain non-cash or non-recurring items included in income for
generally accepted accounting purposes, which are not adjusted for or
eliminated under the NAREIT definition of FFO, FFO may differ from actual
cash available for distribution to shareholders. These items include
amortization of premiums or discounts on loan investments, provisions for
possible credit losses, gains from sales of assets, or deferred interest
arising from differences between loan accrual and payment rates.
Accordingly, FFO is not necessarily indicative of cash available to fund
cash needs or to pay dividends to shareholders.
28
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
Prior to the Recapitalization Transactions (described in Note 4 to the
Company's consolidated financial statements), the Company's primary source of
cash during 1997 was from income earned on its interest in the participation
certificates in a mortgage note secured by an interest in the Warwick Hotel and
certain investments in government or government-sponsored securities, as well as
short-term cash investments. On October 1, 1997, the Warwick Hotel note was
repaid and the $4.5 million of proceeds were invested in government securities
and other short-term real estate investments.
On September 26, 1996, the Company became sole general partner of APMT
Limited Partnership (see Notes 1 and 4 to the Company's consolidated financial
statements) by contributing $400,000 in cash in exchange for a 8.05% interest in
the partnership. Starwood Mezzanine became the 91.95% limited partner by
contributing to the partnership its entire interest in the participation
certificates in the Warwick Hotel mortgage note, valued by the Company at
approximately $4.6 million at the time of contribution. Starwood Mezzanine's
units were converted into Class A Shares on March 18, 1998 on a one-for-one
basis and the partnership was dissolved.
On January 22, 1997, Starwood Mezzanine exercised its rights under a warrant
(see Note 4 to the Company's financial statements) to acquire 833,333 Class A
Shares. In addition, SAHI, Inc. exercised its rights under the warrant (see Note
4) to acquire 416,667 Class B Shares. As a result of the exercise of warrants to
purchase Class A and B Shares in January 1997, the Company's capital increased
by approximately $5.0 million, and the resulting funds were used to purchase
short-term government securities (See Note 4).
As more fully discussed in Note 4 to the Company's consolidated financial
statements, on March 18, 1998, the Company entered into a series of transactions
approved by the Company's shareholders which, among other things, substantially
recapitalized the Company and modified its investment policy. Effective June 18,
1998, the Company (which was organized under California law) changed its
domicile to Maryland by merging with a newly-formed subsidiary organized under
Maryland law and issued new shares of the subsidiary to its shareholders in
exchange for the previous shares of the Company. Concurrently, the Company
consummated a one-for-six reverse stock split.
Prior to the consummation of the Recapitalization Transactions, the
Company's assets primarily consisted of approximately $11.0 million in
short-term, liquid real estate investments, cash and cash equivalents.
The Company consummated the Lazard Transaction on December 15, 1998 by
purchasing $280.3 million in real estate loans and participation interests and
selling $220.0 million of Preferred Shares and warrants to purchase Class A
Shares.
The Recapitalization Transactions, the Lazard Transaction and other related
transactions have materially impacted the operations of the Company and will
continue to impact the Company's future operations. Accordingly, the reported
historical financial information for periods prior to the Recapitalization
Transactions is not believed to be indicative of the Company's future operating
results or financial condition.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
During fiscal year 1998, total revenue increased by approximately $126.2
million over total revenue for fiscal year 1997. This increase is a result of
the interest generated by the loans and other investments contributed in the
Recapitalization Transactions, as well as approximately $1.0 billion of other
loan investments newly-originated or acquired by the Company during 1998, and an
additional $16.5 million funded under existing loan commitments. The increase
was partially offset by principal repayments of approximately $103.9 million
made to the Company during fiscal year 1998. Included in other income for
29
<PAGE>
fiscal year 1998 are fees associated with the repayment of two first mortgage
loans aggregating approximately $1.2 million, a gain of approximately $0.9
million resulting from the repayment of a $2.8 million loan participation which
had been acquired at a discount, and approximately $600,000 in additional
revenue from certain cash flow participation features on two of the Company's
loan investments. In 1997, a gain of approximately $1.0 million was recognized
in other income on the early repayment of a loan acquired at a discount.
The increase in the Company's total costs and expenses during fiscal year
1998 compared to fiscal year 1997 is primarily due to the expense associated
with the issuance to the Advisor of options to acquire approximately 2.5 million
of the Company's Class A Shares (see Note 11 to the Company's consolidated
financial statements) as well as interest expense on the borrowings under the
revolving credit facilities and other borrowings used to fund the Company's loan
origination and acquisition activities. Additionally, general and administrative
costs associated with the implementation of the Company's new business plan and
advisory fee expenses under the Advisory Agreement increased the Company's total
costs and expenses during fiscal 1998.
The Company believes that because of the significant expansion of the scope
of its operations following the Recapitalization Transactions which occurred on
March 18, 1998, prior periods are not necessarily indicative of the Company's
future operating results or financial condition.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
As discussed in Note 4 to the Company's consolidated financial statements,
revenue for fiscal year 1997 included a gain of approximately $985,000 from the
October 1997 prepayment of a mortgage note on the Warwick Hotel contributed to
the partnership by Starwood Mezzanine in September 1996, which had been
reflected at Starwood Mezzanine's basis upon contribution. A portion of this
gain resulted from the use of predecessor basis. Because Starwood Mezzanine
owned 91.95% of the partnership, the majority of this gain was allocated to
Starwood Mezzanine as minority interest in the partnership in the consolidated
financial statements.
Consolidated revenue for fiscal year 1997 also increased as a result of the
investment by the Company of the proceeds received from the exercise of a
warrant and from a longer relative holding period for the Warwick Hotel mortgage
in 1997 through its repayment by the borrower in October, compared to the period
from contribution to the partnership in September 1996 through December 31,
1996.
During 1997, general and administrative expenses decreased 28% compared with
1996 due to a reduction in legal fees and proxy costs combined with the
elimination of payroll, office rental costs, and reduced professional fees.
During 1997, $1.9 million of costs were incurred in connection with the
Recapitalization Transactions and related transactions. These costs were
capitalized as deferred proxy costs and were offset against the incremental
shareholder equity generated by the Recapitalization Transactions in 1998.
Total assets, excluding $1.9 million in deferred transaction costs relating
to the Recapitalization Transactions, increased from year end 1996 to year end
1997 by $5.9 million primarily due to the $4.9 million received from the
exercise of warrants and $1.4 million of undistributed net income (before
minority interest) for fiscal year 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to fund its loan and other investment
origination and acquisition activities and operating expenses. The Company's
capital sources include cash flow from operations, borrowings under lines of
credit, additional term borrowings and reverse repurchase arrangements,
long-term financing secured by the Company's assets, unsecured financing and the
issuance of common, convertible and/or preferred equity securities. See also the
discussion on market risks in Item 7a.
During 1998, the Company completed two significant transactions involving
the issuance of shares and the purchase of new assets and entered into several
credit facilities.
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<PAGE>
Concurrently with the Recapitalization Transactions, the Company entered
into bank credit agreements under which the Company has the ability to borrow up
to $625.0 million, with up to an additional $175.0 million available, subject to
certain conditions, to fund loan originations or acquisitions (including the
cash portion of the Recapitalization Transactions) and for other general
corporate purposes. The credit agreements were comprised of: (i) a $500.0
million revolving credit facility, which bore interest at a fixed margin over
LIBOR and matures on March 13, 2001; and (ii) a $125.0 million term loan secured
by the Company's operating lease properties, which bore interest at a fixed
margin over LIBOR and matured on March 15, 1999.
During the third quarter, the Company expanded its existing revolving credit
facility from $500.0 million to $675.0 million and entered into an additional
$500.0 million two-year secured credit facility bearing interest at fixed
margins over LIBOR. Availability of amounts to borrow under the revolving credit
facilities are subject to having sufficient assets included as security under
the facilities in accordance with percentage borrowing base calculations.
In addition, since the completion of the Recapitalization Transactions, the
Company has entered into approximately $287.9 million in LIBOR-based term loans
secured by certain first mortgage loans it acquired since March 18, 1998.
Approximately $44.3 million of these loans were repaid prior to December 31,
1998. Further, the Company has borrowed amounts under reverse repurchase
agreements and other obligations, secured by its investments in government
securities and other marketable securities of real estate companies.
Approximately $46.1 million of such borrowings were outstanding as of December
31, 1998.
An aggregate of $11.6 million in loan fees were incurred in connection with
these credit facilities and term loan agreements. These fees have been deferred
and are being amortized over the related credit facilities and term loans.
In anticipation of and since the completion of the Recapitalization
Transactions, the Company has entered into LIBOR interest rate caps struck at
9.00% in the notional amounts of $125.0 million and $300.0 million, which expire
in March 1999 and 2001, respectively. The Company also entered into LIBOR
interest rate caps struck at 7.50% in the notional amounts of $40.4 million and
$38.3 million, which expire in January and June 2001, respectively, on amounts
borrowed under additional term loans. Further, the Company has originated or
acquired assets subject to approximately $236.8 million of interest rate swaps
to effectively fix the interest rate on a portion of the Company's floating-rate
obligations.
The Company is currently pursuing certain anticipated long-term fixed-rate
borrowings and has entered into certain derivative instruments based on U.S.
Treasury securities to hedge the potential effects of interest rate movements on
these transactions. As of December 31, 1998, the Company had entered into
derivative instruments with an aggregate notional amount of approximately $232.0
million. Approximately $136.0 million of these instruments were entered into in
May 1998 and represent fixed rates of approximately 5.8%. The remaining $96.0
million of these instruments were entered into in July 1998 and represent fixed
rates of approximately 5.4%. Under these agreements, the Company will generally
receive additional cash flow at settlement if interest rates rise and pay cash
if interest rates fall. The effects of such receipts or payments will be
deferred and amortized over the term of the specific related fixed-rates
borrowings.
Subsequent to December 31, 1998, the Company refinanced its $125.0 million
term loan maturing March 15, 1999 with a $155.4 million term loan maturing March
5, 2009. The new term loan bears interest at 7.44% per annum, payable monthly,
and amortizes over an approximately 22-year schedule. The new term loan
represented one of the forecasted transactions for which the Company had entered
into the U.S. Treasury-based hedging transactions described above. Accordingly,
the cost of the settlement of such hedges will be deferred and reflected as an
increase to the effective financing cost of the new term loan over its effective
ten-year term.
In the event that, in the opinion of management, it is no longer probable
that the remaining forecasted transactions will occur under terms substantially
equivalent to those projected, the Company
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<PAGE>
will cease recognizing such transactions as hedges and immediately recognize
related gains or losses based on actual settlement or estimated settlement
value. No such gains or losses have been recognized by the Company.
The distribution requirements under the REIT provisions of the Code restrict
the Company's ability to retain earnings and thereby replenish capital committed
to its lending operations. However, the Company believes that its significant
capital resources and access to financing will provide it with financial
flexibility and market responsiveness at levels sufficient to meet current and
anticipated capital requirements, including expected new lending transactions.
The Company's ability to meet its long-term (i.e., beyond one year)
liquidity requirements is subject to the renewal of its credit lines and
repurchase facilities and/or obtaining other sources of financing, including
issuing additional debt or equity from time to time. Any decision by the
Company's lenders and investors to enter into such transactions with the Company
will depend upon a number of factors such as compliance with the terms of its
existing credit arrangements, the Company's financial performance, industry or
market trends, the general availability of and rates applicable to financing
investments, such lenders' and investors' resources and policies concerning the
terms under which they make such loan investments, and the relative
attractiveness of alternative investment or lending opportunities.
Based on its monthly interest and other expenses, monthly cash receipts,
existing lending commitments and funding plans, the Company believes that its
existing sources of funds will be adequate for purposes of meeting its short-
and long-term liquidity needs. However, in light of recent volatility in
financial markets, which may affect the Company's ability to obtain additional
capital resources, there can be no assurance that this will in fact be the case.
Material increases in monthly interest expense or material decreases in monthly
cash receipts, generally would negatively impact the Company's liquidity. On the
other hand, material decreases in monthly interest expense would positively
affect the Company's liquidity.
32
<PAGE>
YEAR 2000 ISSUES
Many computer systems were originally designed to recognize calendar years
by the last two digits in the date code field. Beginning in the Year 2000, these
date code fields will need to accept four-digit entries to distinguish 21(st)
century dates. As a result, in less than one year, computerized systems, which
include information and non-information technology systems and applications used
by the Company, will need to be reviewed, evaluated and modified or replaced, if
necessary, to ensure all such financial information and operating systems are
Year 2000 compliant.
STATE OF READINESS
The Company has adopted a plan and formed a team of internal and external
personnel to address Year 2000 issues. The Company has conducted the discovery
and assessment stages on all its in-house systems that could be significantly
affected by the Year 2000. The completed assessment indicated that all of the
Company's in-house systems are Year 2000 capable. The Company has a 95% economic
interest in Starwood Operating, which is in the third-party mortgage servicing
business. Starwood Operating has completed the assessment of its systems and
implemented all required upgrades and modifications. Starwood Operating is in
the process of testing all systems, which process is expected to be completed by
the first half of 1999. Year 2000 issues at Starwood Operating are being
addressed by the previous owner of the business, which has agreed to indemnify
Starwood Operating for any of Starwood Operating's losses relating to Starwood
Operating's systems and is contractually obligated to ensure that all such
systems are Year 2000 compliant by mid-1999.
The Company is in the process of communicating with its significant
depository institutions, lenders, custodians, vendors, tenants under operating
leases and borrowers with which it interfaces to evaluate their Year 2000
compliance. Approximately 60% of these counterparties have provided written
responses to the Company's written questionnaires. The Company is currently
contacting all counterparties that have not yet been responsive to the written
questionnaires. These counterparties are being interviewed telephonically to
assess their Year 2000 compliance. To date, the Company is not aware of any such
counterparty with a Year 2000 issue that would materially impact the Company's
results of operations, liquidity or capital resources. Other than communicating
with its counterparties, the Company has no means of ascertaining whether a
given counterparty will be Year 2000 ready. The inability of counterparties to
complete their Year 2000 resolution process in a timely manner could materially
impact the Company.
YEAR 2000 PROJECT COSTS
The Company estimates that total costs for the Year 2000 compliance review,
evaluation, assessment and remediation efforts should not exceed $20,000,
although there can be no assurance that actual costs will not exceed this
amount. This amount will be funded through cash flows from operations.
RISKS OF YEAR 2000
The Company believes that it has an effective program in place to resolve
the Year 2000 issue in a timely manner. However, disruptions in the economy
generally resulting from Year 2000 issues could materially affect the Company.
The amount of potential liability and lost revenue cannot be reasonably
estimated at this time.
The Company has asked substantially all of its significant vendors and
service providers to provide reasonable assurances as to those parties' Year
2000 state of readiness. To the extent that vendors and service providers do not
provide satisfactory evidence that their products and services are Year 2000
compliant, the Company will seek to obtain the necessary products and services
from alternate sources. There can be no assurance, however, that Year 2000
remediation by vendors and service providers will be available, and any failure
of such third parties' systems could have a material adverse impact on the
Company's operations. In addition, the failure of borrowers to address Year 2000
issues fully could have a
33
<PAGE>
material and adverse effect on their operations and financial condition, which
could impact their ability to service the outstanding obligations to the
Company. This, in turn, could have a material and adverse effect on the
Company's operations and financial position.
CONTINGENCY PLAN
Based on the assessment to date, the Company believes it is prepared for the
most reasonably likely worst-case scenarios regarding Year 2000 compliance.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement No. 131, "Disclosure about Segments of an Enterprise and Related
Information" ("SFAS No. 131") effective for financial statements issued for
periods beginning after December 15, 1997. SFAS No. 131 requires disclosures
about segments of an enterprise and related information regarding the different
types of business activities in which an enterprise engages and the different
economic environments in which it operates. The Company adopted the requirements
of this pronouncement in its financial statements for the year ended December
31, 1998. The adoption of SFAS No. 131 has not had a material impact on the
Company's financial statement disclosures because it is currently considered to
operate in a single segment.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). SFAS No. 133 establishes accounting and reporting standards for
derivative financial instruments and hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as: (i)
a hedge of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment; (ii) a hedge of the exposure to
variable cash flows of a forecasted transaction; or (iii) in certain
circumstances, a hedge of a foreign currency exposure. This statement becomes
effective in fiscal years ending December 31, 2000. The adoption of SFAS 133 is
not expected to have a material impact on the financial position or results of
operations of the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
MARKET RISKS
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. In
pursuing its business plan, the primary market risk to which the Company is
exposed is interest rate risk. Consistent with its expected election to qualify
as a REIT, the Company has implemented an interest rate risk management policy
based on match funding, with the objective that floating-rate assets be
primarily financed by floating-rate liabilities and fixed-rate assets be
primarily financed by fixed-rate liabilities.
The Company's operating results will depend in part on the difference
between the interest and related income earned on its assets and the interest
expense incurred in connection with its interest-bearing liabilities.
Competition from other providers of real estate financing may lead to a decrease
in the interest rate earned on the Company's interest-bearing assets, which the
Company may not be able to offset by obtaining lower interest costs on its
borrowings. Changes in the general level of interest rates prevailing in the
financial markets may affect the spread between the Company's interest-earning
assets and interest-bearing liabilities. Any significant compression of the
spreads between interest-earning assets and interest-bearing liabilities could
have a material adverse effect on the Company. In addition, an increase in
interest rates could, among other things, reduce the value of the Company's
interest-bearing assets and its ability to realize gains from the sale of such
assets, and a decrease in interest rates could reduce the average life of the
Company's interest-earning assets.
34
<PAGE>
A substantial portion of the Company's loan investments are subject to
significant prepayment protection in the form of lock-outs, yield maintenance
provisions or other prepayment premiums which provide substantial yield
protection to the Company. Those assets generally not subject to prepayment
penalties include: (i) variable-rate loans based on LIBOR, originated or
acquired at par, which would not result in any gain or loss upon repayment; and
(ii) discount loans and loan participations acquired at discounts to face
values, which would result in gains upon repayment. Further, while the Company
generally seeks to enter into loan investments which provide for substantial
prepayment protection, in the event of declining interest rates, the Company
could receive such prepayments and may not be able to reinvest such proceeds at
favorable returns. Such prepayments could have an adverse effect on the spreads
between interest-earning assets and interest-bearing liabilities.
While the Company has not experienced any significant credit losses,
delinquencies or defaults, in the event of a significant rising interest rate
environment and/or economic downturn, defaults could increase and result in
credit losses to the Company which adversely affect its liquidity and operating
results. Further, such delinquencies or defaults could have an adverse effect on
the spreads between interest-earning assets and interest-bearing liabilities.
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political
conditions, and other factors beyond the control of the Company. As more fully
discussed in Note 7 to the Company's consolidated financial statements, the
Company employs match funding-based hedging strategies to limit the effects of
changes in interest rates on its operations, including engaging in interest rate
caps, floors, swaps, futures and other interest rate-related derivative
contracts. These strategies are specifically designed to reduce the Company's
exposure, on specific transactions or on a portfolio basis, to changes in cash
flows as a result of interest rate movements in the market. The Company does not
enter into derivative contracts for speculative purposes nor as a hedge against
changes in credit risk of its borrowers or of the Company itself.
Each interest rate cap or floor agreement is a legal contract between the
Company and a third party (the "counterparty"). When the Company purchases a cap
or floor contract, the Company makes an up-front payment to the counterparty and
the counterparty agrees to make payments to the Company in the future should the
reference rate (typically one- or three-month LIBOR) rise above (cap agreements)
or fall below (floor agreements) the "strike" rate specified in the contract.
Each contract has a notional face amount. Should the reference rate rise above
the contractual strike rate in a cap, the Company will earn cap income. Should
the reference rate fall below the contractual strike rate in a floor, the
Company will earn floor income. Payments on an annualized basis will equal the
contractual notional face amount multiplied by the difference between actual
reference rate and the contracted strike rate. The cost of the up-front payment
is amortized over the term of the contract.
Interest rate swaps are agreements in which a series of interest rate flows
are exchanged over a prescribed period. The notional amount on which swaps are
based is not exchanged. In general, the Company's swaps are "pay fixed" swaps
involving the exchange of floating-rate interest payments from the counterparty
for fixed interest payments from the Company.
Interest rate futures are contracts, generally settled in cash, in which the
seller agrees to deliver on a specified future date the cash equivalent of the
difference between the specified price or yield indicated in the contract and
the value of that of the specified instrument (e.g., U.S. Treasury securities)
upon settlement. The Company generally uses such instruments to hedge forecasted
fixed-rate borrowings. Under these agreements, the Company will generally
receive additional cash flow at settlement if interest rates rise and pay cash
if interest rates fall. The effects of such receipts or payments will be
deferred and amortized over the term of the specific related fixed-rate
borrowings. In the event that, in the opinion of management, it is no longer
probable that a forecasted transaction will occur under terms substantially
equivalent to those projected, the Company will cease recognizing such
transactions as hedges and
35
<PAGE>
immediately recognize related gains or losses based on actual settlement or
estimated settlement value. No such gains or losses have been recognized by the
Company.
While a REIT may freely utilize the types of derivative instruments
discussed above to hedge interest rate risk on its liabilities, the use of
derivatives for other purposes, including hedging asset-related risks such as
credit, prepayment or interest rate exposure on the Company's loan assets, could
generate income which is not qualified income for purposes of maintaining REIT
status. As a consequence, the Company may only engage in such instruments to
hedge such risks on a limited basis.
There can be no assurance that the Company's profitability will not be
adversely affected during any period as a result of changing interest rates. In
addition, hedging transactions using derivative instruments involve certain
additional risks such as counterparty credit risk, legal enforceability of
hedging contracts and the risk that unanticipated and significant changes in
interest rates will cause a significant loss of basis in the contract. With
regard to loss of basis in a hedging contract, indices upon which contracts are
based may be more or less variable than the indices upon which the hedged assets
or liabilities are based, thereby making the hedge less effective. The
counterparties to these contractual arrangements are major financial
institutions with which the Company and its affiliates may also have other
financial relationships. The Company is potentially exposed to credit loss in
the event of nonperformance by these counterparties. However, because of their
high credit ratings, the Company does not anticipate that any of the
counterparties will fail to meet their obligations. There can be no assurance
that the Company will be able to adequately protect against the foregoing risks
and that the Company will ultimately realize an economic benefit from any
hedging contract it enters into which exceeds the related costs incurred in
connection with engaging in such hedges.
The following table quantifies the potential changes in net investment
income and net fair value of financial instruments should interest rates
increase or decrease 200 basis points, assuming no change in the shape of the
yield curve (i.e., relative interest rates). Net investment income is calculated
as revenue from loans and related investments, including operating leases (as of
December 31, 1998) less related interest expense, for the three months ended
December 31, 1998, on an annualized basis. Net fair value of financial
instruments is calculated as the sum of the value of off-balance sheet
instruments and the present value of cash in-flows generated from
interest-earning assets, less cash out-flows in respect of interest-bearing
liabilities as of December 31, 1998. The cash flows associated with the
Company's assets are calculated based on management's best estimate of expected
payments for each loan based on loan characteristics such as loan-to-value
ratio, interest rate, credit history, prepayment penalty, term and property
type. Most of the Company's loans are protected from prepayment as a result of
prepayment penalties and contractual terms which prohibit prepayments during
specified periods. However, for those loans where prepayments are not currently
precluded by contract, declines in interest rates may increase prepayment
speeds. The base interest rate scenario assumes interest rates as of December
31, 1998. Actual results could differ significantly from those estimated in the
table.
ESTIMATED PERCENTAGE CHANGE IN
<TABLE>
<CAPTION>
CHANGE IN INTEREST NET FAIR VALUE OF
RATES NET INVESTMENT INCOME FINANCIAL INSTRUMENTS
- ----------------------- ------------------------- -----------------------
<S> <C> <C>
- -200 Basis Points 3.9% 6.5%
- -100 Basis Points 2.0% 3.1%
Base Interest Rate 0.0% 0.0%
+100 Basis Points (2.0)% (3.0)%
+200 Basis Points (3.9)% (5.7)%
</TABLE>
36
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Index to Financial Statements
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Financial Statements:
Report of Independent Accountants........................................................................ 38
Consolidated Balance Sheets at December 31, 1998 and 1997................................................ 39
Consolidated Statements of Operations for each of the three years in the period ended December 31,
1998................................................................................................... 40
Consolidated Statement of Changes in Shareholders' Equity for each of the three years in the period ended
December 31, 1998...................................................................................... 41
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31,
1998................................................................................................... 42
Notes to Consolidated Financial Statements............................................................... 43
</TABLE>
Financial Statement Schedules:
For each of the three years in the period ended December 31, 1998:
Schedule II--Valuation and qualifying accounts and reserves
Schedule III--Real estate and accumulated depreciation
Schedule IV--Mortgage loans on real estate
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
Financial statements of three owned companies or joint ventures accounted
for under the equity method have been omitted because the Company's
proportionate share of the income from continuing operations before income taxes
is less than 20% of the respective consolidated amount and the investments in
and advances to each company are less than 20% of consolidated total assets.
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<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Starwood Financial Trust:
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Starwood Financial Trust, formerly Angeles Participating Mortgage Trust (the
"Company") and its subsidiaries at December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
As more fully discussed in the Notes to the Consolidated Financial Statements,
on March 18, 1998, the Company consummated certain transactions which: (i)
significantly recapitalized the Company; (ii) expanded the capital resources of
the Company; (iii) changed the investment policy of the Company; (iv) provided
for external management under an advisory agreement; and (v) amended and
restated the Company's stock option plan.
PRICEWATERHOUSECOOPERS LLP
NEW YORK, NY
MARCH 15, 1999
38
<PAGE>
STARWOOD FINANCIAL TRUST
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------
<S> <C> <C>
1998 1997*
------------ ------------
ASSETS
Loans and other investments, net...................................................... $ 2,013,703 $ --
Cash and cash equivalents............................................................. 10,110 296
Restricted cash....................................................................... 5,699 --
Marketable securities................................................................. 5,406 11,175
Accrued interest and rent receivable.................................................. 13,122 58
Deferred expenses and other assets.................................................... 11,054 1,912
Investment in Starwood Operating...................................................... 522 --
------------ ------------
Total assets...................................................................... $ 2,059,616 $ 13,441
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable, accrued expenses and other liabilities.............................. $ 10,536 $ 1,915
Dividends payable..................................................................... 22,633 --
Debt obligations...................................................................... 1,055,719 --
------------ ------------
Total liabilities................................................................. 1,088,888 1,915
------------ ------------
Minority interest..................................................................... -- 5,175
------------ ------------
Commitments and contingencies......................................................... -- --
Shareholders' equity:
Series A Preferred Shares, $0.01 par value, liquidation value $50.00 per share,
4,400,000 shares authorized 4,400,000 and 0 shares issued and outstanding at
December 31, 1998 and 1997, respectively............................................ 44 --
Class A Shares, $1.00 par value, 70,000,000 shares authorized, 52,407,718(1) and
7,550,000 shares issued and outstanding at December 31, 1998 and 1997,
respectively........................................................................ 52,408 7,550
Class B Shares, $0.01 par value, 35,000,000 shares authorized, 26,203,859(1) and
3,775,000 shares issued and outstanding at December 31, 1998 and 1997,
respectively........................................................................ 262 38
Warrants and options.................................................................. 19,131 --
Net unrealized gains (losses) on "available-for-sale" investments..................... (23) (162)
Additional paid-in capital............................................................ 901,365 --
Retained earnings (deficit)........................................................... (2,459) (1,075)
------------ ------------
Total shareholders' equity........................................................ 970,728 6,351
------------ ------------
Total liabilities and shareholders' equity........................................ $ 2,059,616 $ 13,441
------------ ------------
------------ ------------
</TABLE>
*RECLASSIFIED TO CONFORM TO 1998 PRESENTATION.
(1) As adjusted for one-for-six reverse stock split effective June 19, 1998
(Note 1)
The accompanying notes are an integral part of the financial statements.
39
<PAGE>
STARWOOD FINANCIAL TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------
<S> <C> <C> <C>
1998 1997* 1996*
---------- ---------- ----------
REVENUE:
Interest income......................................................... $ 112,914 $ 896 $ 478
Operating lease income.................................................. 12,378 -- --
Other income............................................................ 2,804 991 10
---------- ---------- ----------
Total revenue......................................................... 128,096 1,887 488
---------- ---------- ----------
COSTS AND EXPENSES:
Interest expense........................................................ 44,697 -- 272
Operating lease depreciation............................................ 4,287 -- --
General and administrative.............................................. 2,583 461 639
Advisory fees........................................................... 7,837 -- --
Provision for possible credit losses.................................... 2,750 -- --
Stock option compensation expense....................................... 5,985 -- --
---------- ---------- ----------
Total costs and expenses.............................................. 68,139 461 911
---------- ---------- ----------
Net income before minority interest....................................... 59,957 1,426 (423)
Minority interest......................................................... (54) (1,415) (154)
---------- ---------- ----------
Net income................................................................ $ 59,903 $ 11 $ (577)
---------- ---------- ----------
---------- ---------- ----------
Net income (loss) applicable to Class A Shares............................ $ 58,369 $ 11 $ (571)
---------- ---------- ----------
---------- ---------- ----------
Basic earnings (loss) per Class A Share(1)................................ $ 1.40 $ 0.00 $ (1.34)
---------- ---------- ----------
---------- ---------- ----------
Diluted earnings (loss) per Class A Share(1).............................. $ 1.36 $ 0.00 $ (1.34)
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
*RECLASSIFIED TO CONFORM TO 1998 PRESENTATION.
(1) As adjusted for one-for-six reverse stock split effective June 19, 1998
(Note 1)
The accompanying notes are an integral part of the financial statements.
40
<PAGE>
STARWOOD FINANCIAL TRUST
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON SHARES, AT PAR UNREALIZED
SERIES A WARRANTS GAINS ADDITIONAL RETAINED
PREFERRED ------------------------ AND (LOSSES) ON PAID-IN EARNINGS
SHARES CLASS A CLASS B OPTIONS INVESTMENTS CAPITAL (DEFICIT)
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996*......... $ -- $ 2,550 $ 13 $ 101 $ -- $ -- $ (509)
Net loss............................ -- -- -- -- -- -- (577)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1996*....... -- 2,550 13 101 -- -- (1,086)
Exercise of warrants................ -- 5,000 25 (101) -- -- --
Net unrealized losses............... -- -- -- -- (162) -- --
Net income of the period............ -- -- -- -- -- -- 11
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1997*....... -- 7,550 38 -- (162) -- (1,075)
Recapitalization Transactions....... -- 306,796 1,534 -- -- 432,084 --
Issuance of options to Advisor...... -- -- -- 5,985 -- -- --
Effects of reorganization (1)....... -- (261,956) (1,310) -- -- 262,786 --
Exercise of options................. -- 18 -- (43) -- 310 --
Issuance of Preferred Shares and
Warrants.......................... 44 -- -- 13,189 -- 206,170 --
Change in net unrealized gains
(losses) on investments........... -- -- -- -- 139 -- --
Dividends declared-preferred........ -- -- -- -- -- 15 (944)
Dividends declared-common........... -- -- -- -- -- -- (60,343)
Net income for the period........... -- -- -- -- -- -- 59,903
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 1998........ $ 44 $ 52,408 $ 262 $ 19,131 $ (23) $ 901,365 $ (2,459)
----------- ----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- ----------- -----------
<CAPTION>
TOTAL
-----------
<S> <C>
Balance at January 1, 1996*......... $ 2,155
Net loss............................ (577)
-----------
Balance at December 31, 1996*....... 1,578
Exercise of warrants................ 4,924
Net unrealized losses............... (162)
Net income of the period............ 11
-----------
Balance at December 31, 1997*....... 6,351
Recapitalization Transactions....... 740,414
Issuance of options to Advisor...... 5,985
Effects of reorganization (1)....... (480)
Exercise of options................. 285
Issuance of Preferred Shares and
Warrants.......................... 219,403
Change in net unrealized gains
(losses) on investments........... 139
Dividends declared-preferred........ (929)
Dividends declared-common........... (60,343)
Net income for the period........... 59,903
-----------
Balance at December 31, 1998........ $ 970,728
-----------
-----------
</TABLE>
* RECLASSIFIED TO CONFORM TO 1998 PRESENTATION.
(1) As adjusted for one-for-six reverse stock split effective June 19, 1998.
The accompanying notes are an integral part of the financial statements.
41
<PAGE>
STARWOOD FINANCIAL TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
<S> <C> <C> <C>
1998 1997* 1996*
----------- ----------- -----------
Cash flows from operating activities:
Net income (loss)........................................................ $ 59,903 $ 11 $ (577)
Adjustments to reconcile net income (loss) to cash flows provided by
operating activities:
Minority interest...................................................... 54 1,415 154
Non-cash expense for options issued to Advisor......................... 5,985 -- --
Equity in earnings of unconsolidated joint ventures and subsidiaries... (96) -- --
Depreciation and amortization.......................................... 7,662 -- --
Amortization of discount/premium and deferred interest................. (17,750) -- --
Provision for possible credit losses................................... 2,750 -- --
Changes in assets and liabilities:
Increase in restricted cash............................................ (5,699) -- --
(Increase) decrease in accrued interest and rent receivable............ (5,613) 4 (54)
Decrease in deferred expenses and other assets......................... (902) (1,895) 110
Increase in accounts payable, accrued expenses and other liabilities... 8,621 1,736 140
----------- ----------- -----------
Cash flows provided by operating activities.............................. 54,915 1,271 (227)
----------- ----------- -----------
Cash flows from investing activities:
Net cash outflow for the Recapitalization Transactions................... (334,964) -- --
New loan or investment originations/acquisitions......................... (1,023,345) (31,346) (19,811)
Principal fundings on existing loan commitments.......................... (16,500) -- --
Investment in Starwood Operating......................................... (426) -- --
Sale of investment securities............................................ -- 21,546 17,926
Repayments of and principal collections from loans and other
investments............................................................ 103,926 3,787 1,363
----------- ----------- -----------
Cash flows used in investing activities.................................. (1,271,309) (6,013) (522)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of Class B Shares................................. 1,534 -- --
Net borrowings under revolving credit facilities......................... 640,945 -- --
Net borrowings under term loans.......................................... 368,683 -- --
Borrowings under repurchase agreements................................... 46,091 -- --
Dividends paid........................................................... (38,638) -- --
Payment for deferred financing costs..................................... (11,615) -- --
Repayments relating to investment security purchases..................... -- -- (18,886)
Borrowings relating to investment security purchases..................... -- -- 18,886
Costs incurred in reorganization......................................... (480) -- --
Proceeds from exercise of options........................................ 285 -- --
Proceeds from exercise of warrants....................................... 219,403 4,924 --
----------- ----------- -----------
Cash flows provided by financing activities.............................. 1,226,208 4,924 --
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents......................... 9,814 182 (749)
Cash and cash equivalents at beginning of period......................... 296 114 863
----------- ----------- -----------
Cash and cash equivalents at end of period............................... $ 10,110 $ 296 $ 114
----------- ----------- -----------
----------- ----------- -----------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest............................... $ 38,006 $ -- $ 272
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
* RECLASSIFIED TO CONFORM TO 1998 PRESENTATION
The accompanying notes are an integral part of the financial statements.
42
<PAGE>
STARWOOD FINANCIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION AND BUSINESS
ORGANIZATION--Starwood Financial Trust (the "Company") was formed for the
purpose of originating and acquiring various types of mortgage and other real
estate-related financial investments. Through a series of transactions during
1994 and 1996, Starwood Mezzanine Investors, L.P. ("Starwood Mezzanine") and
certain affiliates of the general partner of Starwood Mezzanine (SAHI, Inc. and
SAHI Partners) acquired control of the Company.
On September 26, 1996, the Company became the sole general partner of APMT
Limited Partnership (see Note 4). As discussed in Note 4, on March 18, 1998, all
the outstanding interests in the Partnership not held by the Company were
exchanged for additional $1.00 par value Class A Shares (the "Class A Shares")
of the Company, the Company became the sole partner of the partnership and the
partnership was terminated.
Also as more fully described in Note 4, on March 18, 1998, the Company
entered into a series of transactions approved by the Company's shareholders
with Starwood Mezzanine and Starwood Opportunity Fund IV, L.P. ("SOF IV") (an
affiliate of the general partners of Starwood Mezzanine), which, among other
things, substantially recapitalized the Company and modified its investment
policy (Starwood Mezzanine, SOF IV, SAHI, Inc. and SAHI Partners are
collectively referred to as the "Starwood Investors").
Effective June 18, 1998, the Company (which had previously been organized
under California law) changed its domicile to Maryland by merging with a
newly-formed subsidiary organized under Maryland law and issued new shares of
the subsidiary to its shareholders in exchange for the previous shares of the
Company. Concurrently, the Company consummated a one-for-six reverse stock
split.
During 1993 through 1997, the Company failed to qualify as a real estate
investment trust ("REIT") under the Internal Revenue Code of 1986, as amended
(the "Code"). However, pursuant to a closing agreement with the Internal Revenue
Service (the "IRS") obtained in March 1998, the Company is eligible to and
intends to elect to be taxed as a REIT for the taxable year beginning January 1,
1998.
BUSINESS--The Company is a leading specialized finance company that engages
in opportunistic lending to the real estate industry by implementing an
innovative, value added and entrepreneurial approach to providing investment
capital. The Company primarily focuses on providing high-yielding mezzanine
capital to the real estate industry through the origination, restructuring and
purchase of mortgage loans to create superior risk-adjusted returns.
The Company's purpose and investment policy is to originate and acquire a
diverse portfolio of debt and debt-like interests in real estate or real estate
related assets, including to: (i) originate and acquire mortgage and mezzanine
loans collateralized, in whole or in part, by commercial and residential real
estate assets; (ii) acquire direct or indirect interests in short- or long-term
real estate-related debt securities and mortgage interests, which may include
warrants, equity participations or similar rights incidental to a debt
investment by the Company; (iii) acquire positions in non-performing and
sub-performing debt for the purpose of either restructuring the debt to
performing status or converting the debt into equity interests in the underlying
assets securing such debt; and (iv) provide credit tenant and net lease
financing and invest in similar credit-backed income streams. The Company is
restricted from making certain types of investments which may limit its
flexibility in implementing its investment policy. See "Policies and Procedures
With Respect to Certain Activities--Investment Policies."
- ------------------------
(1) All share information contained herein is presented as adjusted for effects
of one-for-six reverse stock split effective June 19, 1998
43
<PAGE>
STARWOOD FINANCIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company currently plans to originate and acquire loans backed by various
types of income-producing commercial real estate, with an emphasis on senior and
junior commercial mortgage loans, including mezzanine financing, higher-yielding
senior mortgage loans and non-performing or sub-performing loans. The Company
has not in the past, and does not currently intend to invest a significant
portion of the Company's capital in commercial mortgage-backed securities. A
significant portion of loans are structured so that the Company's investment is
subordinate to third-party first mortgage debt but senior to the real estate
owner/operator's equity position. However, the Company does not have any
prescribed allocation among investments and the Company could invest all or any
portion of its assets in any of the investments described above.
NOTE 2--BASIS OF PRESENTATION
The accompanying audited consolidated financial statements have been
prepared in conformity with generally accepted accounting principles ("GAAP").
The consolidated financial statements include the accounts of the Company and
its qualified REIT subsidiaries. Certain third-party mortgage servicing
operations are conducted through Starwood Operating, Inc. ("Starwood
Operating"), a taxable corporation, which is not consolidated with the Company
for financial reporting or income tax purposes. The Company owns all of the
preferred stock and a 95% economic interest in Starwood Operating, which is
accounted for under the equity method for financial reporting purposes. Further,
certain other investments in partnerships or joint ventures which the Company
does not control are also accounted for under the equity method.
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
LOANS AND OTHER INVESTMENTS, NET--As described in Note 5, loans and other
investments, net includes the following investments: senior mortgages, junior
mortgages, discount mortgages, partnership loans, construction loans,
investments in real estate under operating leases, loan participations and
investments in certain real estate-related marketable securities. In general,
management considers its loan and marketable real estate-related securities
investments as held-to-maturity and, accordingly, reflects such items at
amortized historical cost.
CASH AND CASH EQUIVALENTS--Cash and cash equivalents include cash held in
banks or invested in money market funds with original maturity terms of less
than 90 days.
NON-CASH ACTIVITY--During the year ended December 31, 1998, the Company had
significant non-cash activity including: (i) conversion of units in APMT Limited
Partnership (shown as "minority interest" in the consolidated financial
statements) to Class A Shares (see Note 4); (ii) issuance of options to the
Advisor to acquire Class A Shares of the Company (see Note 11); and (iii)
issuance of new Class A Shares in exchange for a portion of the acquisition of
loans and related investments as part of the Recapitalization Transactions (see
Note 4).
The cash portion of the Recapitalization Transactions is summarized as
follows (in thousands):
<TABLE>
<S> <C>
Acquisition of loans and other investments... $(1,061,006)
Acquired accrued interest and rent
receivable................................. (7,451)
Par value of Class A Shares issued........... 302,223
Additional paid in capital on Class A Shares
issued..................................... 431,270
-----------
Net cash outflow for the Recapitalization
Transactions............................... $ (334,964)
-----------
-----------
</TABLE>
MARKETABLE SECURITIES--The Company has certain investments in marketable
securities such as those issued by the Government National Mortgage Association
(GNMA), Federal National Mortgage Association (FNMA), and Federal Home Loan
Mortgage Corporation (FHLMC). Although the Company generally intends to hold
such investments for long-term investment purposes, it may, from time to time,
44
<PAGE>
STARWOOD FINANCIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
sell any of its investments in these securities as part of its management of
liquidity. Accordingly, the Company considers such investments as
"available-for-sale" and reflects such investments at fair market value with
changes in fair market value reflected as a component of shareholders equity.
REPURCHASE AGREEMENTS--The Company may enter into sales of securities or
loans under agreements to repurchase the same security or loan. The amounts
borrowed under repurchase agreements are carried on the balance sheet as part of
debt obligations at the amount advanced plus accrued interest. Interest incurred
on the repurchase agreements is reported as interest expense.
REVENUE RECOGNITION--Interest income, including amortization of loan fees
and premiums or discounts, is recognized using the effective interest method.
Income under equity participation features is recognized when earned and
payable. Income from prepayment penalties is recognized when received.
PROVISION FOR POSSIBLE CREDIT LOSSES--The Company's accounting policies
require that an allowance for estimated credit losses be maintained at a level
that management, based upon an evaluation of known and inherent risks in the
portfolio, considers adequate to provide for possible credit losses. Further,
specific valuation allowances are established for impaired loans in the amount
by which the carrying value, before allowance for estimated losses, exceeds the
fair value of collateral less disposition costs on an individual loan basis.
Management considers a loan to be impaired when, based upon current information
and events, it believes that it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan agreement
on a timely basis. Management measures these impaired loans at the fair value of
the loans' underlying collateral less estimated disposition costs. Impaired
loans may be left on accrual status during the period the Company is pursuing
repayment of the loan. These loans are placed on non-accrual status at such time
that the loans either: (i) become 90 days delinquent; or (ii) management
determines the borrower is incapable of, or has ceased efforts toward, curing
the cause of the impairment. Impairment losses are recognized as direct
write-downs of the related loan with a corresponding charge to the provision for
possible credit losses. Charge-offs occur when loans, or a portion thereof, are
considered uncollectible and of such little value that further pursuit of
collection is not warranted. Management's periodic evaluation of the allowance
for possible credit losses is based upon an analysis of the portfolio,
historical and industry loss experience, economic conditions and trends,
collateral values and quality and other relevant factors.
INCOME TAXES--The Company did not qualify as a REIT from 1993 through 1997;
however, it did not incur any material tax liabilities as a result of its
operations. See Note 10 to the consolidated financial statements for more
information.
As confirmed in a closing agreement with the IRS obtained in March 1998, the
Company is eligible and intends to elect to be taxed as a REIT for its tax year
beginning January 1, 1998. As a REIT, the Company will be subject to income
taxation at corporate rates on its REIT taxable income; however, the Company is
allowed a deduction for the amount of dividends paid to its shareholders,
thereby subjecting the distributed net income of the Company to taxation at the
shareholder level only. Starwood Operating is not consolidated for federal
income tax purposes and is taxed as a corporation. For financial reporting
purposes, current and deferred taxes are provided for in the portion of earnings
recognized by the Company with respect to its interest in Starwood Operating.
NET INCOME APPLICABLE TO CLASS A SHARES--Net income applicable to Class A
Shares represents net income less current accumulated dividends on the
outstanding preferred shares less 1% of the remaining net income, representing
amounts applicable to the Class B Shares.
EARNINGS (LOSS) PER CLASS A SHARE--In February 1997, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 128, "Earnings per Share" ("SFAS No. 128") effective for periods
ending after December 15, 1997. SFAS No. 128 simplifies the standard for
computing earnings per share and makes them comparable with international
earnings per share standards. The statement replaces primary earnings per share
with basic earnings per share ("Basic EPS") and
45
<PAGE>
STARWOOD FINANCIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
fully-diluted earnings per share with diluted earnings per share ("Diluted
EPS"). The Company adopted this accounting standard effective December 31, 1997,
as required. Prior periods have been restated for comparative purposes in
accordance with SFAS No. 128.
USE OF ESTIMATES--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
NOTE 4--TRANSACTIONS WITH AFFILIATES AND RECAPITALIZATION
TRANSACTIONS WITH AFFILIATES--In November 1993, the Company was notified
that SAHI, Inc. (one of the Starwood Investors) had acquired all of the
Company's 212,500 outstanding Class B Shares. Subsequent to the acquisition of
the Class B Shares, SAHI Partners (another of the Starwood Investors) purchased
the Class B Shares from SAHI, Inc. and accumulated 40,683 Class A Shares, or
9.60% of the total then outstanding.
On March 15, 1994, the Company announced that it had entered into an
agreement with SAHI and SAHI, Inc. for the sale of a warrant for the right to
purchase 833,333 Class A Shares at a price of $6.00 per share (the "Class A
Warrant") and 416,667 shares of Class B Shares at a price of $0.06 per share
(the "Class B Warrant"). SAHI and SAHI, Inc. purchased the warrants for
$101,000, which amount was applied against the purchase price for the initial
Class A and Class B Shares purchased pursuant to the warrants. On March 28,
1996, the Class A Warrant was assigned to Starwood Mezzanine.
On September 26, 1996, the Company became sole general partner of APMT
Limited Partnership by contributing $400,000 in cash in exchange for an 8.05%
interest in such partnership. Starwood Mezzanine became the 91.95% limited
partner by contributing to the partnership its entire interest in the
participation certificates in the Warwick Hotel mortgage note, valued by the
Company at approximately $4.6 million as of September 30, 1996. Starwood
Mezzanine's interest in the partnership was evidenced by units, which were
convertible into cash, Class A Shares or a combination of both pursuant to an
exchange rights agreement. As described below, the units were converted to Class
A Shares in the first quarter of 1998.
On January 22, 1997, Starwood Mezzanine exercised its rights under the Class
A Warrant to acquire 833,333 Class A Shares. After its exercise of the Class A
Warrant, Starwood Mezzanine beneficially owned 833,333 Class A Shares and
761,491 units. In addition, SAHI, Inc. exercised its rights under the Class B
Warrant to acquire 416,667 Class B Shares. After its exercise of the Class B
Warrant, SAHI Inc. beneficially owned 1,009,911 Class B Shares and 40,683 Class
A Shares. Upon exercise of the Class A and Class B Warrants, SAHI, SAHI, Inc.
and Starwood Mezzanine jointly owned 69.46% of the outstanding Class A Shares
and, with the voting interest of the Class B Shares, controlled 79.64% of the
voting interest of the Company. The Company increased its capital by
approximately $5.0 million, and the resulting funds were used to purchase
qualified short-term government securities.
During the quarter ended March 31, 1998, the Company consummated certain
transactions and entered into agreements which significantly recapitalized and
expanded the capital resources of the Company as well as modified future
operations, including those described herein below in "Recapitalization
Transactions."
RECAPITALIZATION TRANSACTIONS--As more fully discussed in Note 5, pursuant
to a series of transactions beginning in March 1994 and including the exercise
of certain warrants in January 1997, Starwood Mezzanine and certain entities
affiliated with the general partners of Starwood Mezzanine acquired joint
ownership of 69.46% and 100% of the outstanding Class A Shares and Class B
Shares of the Company, respectively, through which they controlled approximately
79.64% of the voting interest in the Company as of December 31, 1997. Prior to
the consummation of these transactions (collectively, the "Recapitalization
46
<PAGE>
STARWOOD FINANCIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Transactions"), Starwood Mezzanine also owned 761,491 units which represented
the remaining 91.95% of the Partnership not held by the Company, which were
convertible into either cash, an additional 761,491 Class A Shares of the
Company, or a combination of the two, as determined by the Company.
On March 18, 1998, each outstanding unit held by Starwood Mezzanine was
exchanged for one Class A Share of the Company and, concurrently, the
partnership was liquidated through a distribution of its net assets to the
Company, its then sole partner.
Simultaneously, Starwood Mezzanine contributed various real estate loan
investments to the Company in exchange for 9,191,333 Class A Shares and $25.5
million in cash, as adjusted. SOF IV contributed real estate loans and
investments, $17.9 million in cash and certain letters of intent in exchange for
41,179,133 Class A Shares of the Company and a cash payment of $324.3 million.
Concurrently, the holders of the Class B Shares who were affiliates of the
general partners of Starwood Mezzanine and SOF IV acquired 25,565,979 additional
Class B Shares sufficient to maintain existing voting preferences pursuant to
the Company's Amended and Restated Declaration of Trust. Immediately after these
transactions, the Starwood Investors owned approximately 99.27% of the
outstanding Class A Shares of the Company and 100% of the Class B Shares. Assets
acquired from Starwood Mezzanine have been reflected using step acquisition
accounting at predecessor basis adjusted to fair value to the extent of
post-transaction third-party ownership. Assets acquired from SOF IV have been
reflected at their fair market value.
The following summary pro forma information includes the effects of the
following transactions consummated in March 1998: (i) the Recapitalization
Transactions; (ii) the exchange of each outstanding unit in the partnership held
by holders other than the Company for one Class A Share; (iii) the liquidation
and termination of the partnership; and (iv) the borrowings necessary to
consummate the aforementioned transactions. The pro forma operating data for the
years ended December 31, 1998 and 1997 are presented as if the transactions had
been completed on January 1, 1998 and 1997, respectively.
47
<PAGE>
STARWOOD FINANCIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PRO FORMA
CONDENSED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
---------------------
<S> <C> <C>
1998 1997
---------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C>
REVENUE:
Interest income.......................................................................... $ 132,284 $ 61,956
Operating lease income................................................................... 15,604 15,311
Other income............................................................................. 3,080 26,024
---------- ---------
Total revenue.......................................................................... 150,968 103,291
---------- ---------
COSTS AND EXPENSES:
Interest expense......................................................................... 50,558 23,151
Operating lease depreciation............................................................. 5,466 6,875
General and administrative............................................................... 3,029 3,627
Advisory fees............................................................................ 13,638 8,143
Provision for possible credit losses..................................................... 2,750 --
---------- ---------
Total costs and expenses............................................................... 75,441 41,796
---------- ---------
Pro forma net income..................................................................... $ 75,527 $ 61,495
---------- ---------
---------- ---------
Pro forma basic net income per Class A Share............................................. $ 1.43 $ 1.16
---------- ---------
---------- ---------
Weighted average number of Class A Shares outstanding.................................... 52,408 52,390
---------- ---------
---------- ---------
</TABLE>
The pro forma operating data for the year ended December 31, 1998 excludes a
charge of approximately $6.0 million or $0.11 per Class A Share, as adjusted,
relating to the value of options to acquire Class A Shares issued to Starwood
Financial Advisors, L.L.C. (the "Advisor") concurrently with the consummation of
the Recapitalization Transactions, as such charge is considered largely
non-recurring in nature. However, future charges may be taken to the extent of
additional option grants, which are at the discretion of the Board of Trustees.
While other real estate-related investments are assumed to have taken place
as of the beginning of each period, mortgage note receivable originations or
acquisitions are not reflected in these pro forma numbers until the actual
origination or acquisition date by Mezzanine or SOF IV. Consequently, since many
of the mortgage originations or acquisitions did not occur until some time in
1997, a full year of revenue from these assets is not included in the 1997 pro
forma results. Pro forma other income for the year ended December 31, 1997
includes approximately $14.0 million related to the early repayment of an
improvement note held by Starwood Mezzanine and approximately $8.0 million in
participation income received by SOF IV from a borrower resulting from the sale
of a portion of the underlying collateral. Interest expense has been reflected
in the pro forma operating data for the year ended December 31, 1997 only to the
extent that the pro forma weighted average for the real estate loans and related
investments actually outstanding during the period exceeded the aggregate
capital contributed in the Recapitalization Transactions. The pro forma
financial information is not necessarily indicative of what the consolidated
results of operations of the Company would have been as of and for the periods
indicated, nor does it purport to represent the results of operations for future
periods.
ADVISORY AGREEMENT--In connection with the Recapitalization Transactions,
the Company and the Advisor entered into an Advisory Agreement (the "Advisory
Agreement") pursuant to which the Advisor
48
<PAGE>
STARWOOD FINANCIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
manages the affairs of the Company, subject to the Company's purpose and
investment policy, the investment restrictions and the directives of the Board
of Trustees. The services provided by the Advisor include the following: (i)
identifying investment opportunities for the Company; (ii) advising the Company
with respect to and effecting acquisitions and dispositions of the Company's
investments; (iii) monitoring, managing and servicing the Company's loan
portfolio; and (iv) arranging debt financing for the Company. The Advisor will
not act in a manner that is inconsistent with the express direction of the Board
of Trustees and reports to the Board of Trustees and the officers of the Company
with respect to its activities.
The Company pays the Advisor a quarterly base management fee of 0.3125%
(1.25% per annum) of the "Book Equity Value" of the Company determined as of the
last day of each quarter but estimated and paid in advance subject to
recomputation. "Book Equity Value" is generally defined as the excess of the
book value of the assets of the Company over all liabilities of the Company.
In addition, the Company pays the Advisor a quarterly incentive fee of 5.00%
of the Company's "Adjusted Net Income" during each quarter that the Adjusted Net
Income for such quarter (restated and annualized as a rate of return on the
Company's Book Equity Value for such quarter) equals or exceeds the "Benchmark
BB Rate." "Adjusted Net Income" is generally defined as the Company's gross
income less the Company's expenses for the applicable quarter (including the
base fee for such quarter but not the incentive fee for such quarter). In
calculating both Book Equity Value and Adjusted Net Income, real estate-related
depreciation and amortization (other than amortization of financing costs and
other prepaid expenses to the extent such costs and prepaid expenses have
previously been booked as an asset of the Company) are not deducted. In
addition, debt that is exchangeable or convertible into equity securities is not
treated as a liability of the Company if the value of the equity securities into
which such debt obligation is convertible equals or exceeds the outstanding
balance of such debt obligation and the interest expense of such debt is not
included as an expense and, thus, does operate to reduce the Company's gross
income. The Advisor is also reimbursed for certain expenses it incurs on behalf
of the Company.
Because payment of both the base fee and the incentive fee commenced 90 days
after the consummation of the Recapitalization Transactions, fees were
recognized ratably over the period from March 18, 1998 through December 31,
1998. The operating results of the Company for such period were greater than
they would have been had the advisory fee not been deferred.
The Company may be subject to conflicts of interest with the Advisor because
the incentive fee, which is based on the Company's income, may create an
incentive for the Advisor to recommend investments with greater income
potential, which may be riskier and more speculative, than would be the case if
the fee did not include a performance-related component.
The Advisory Agreement has an initial term of three years subject to
automatic renewal for one-year periods unless the Company has been liquidated or
a Termination Event (as defined in the Advisory Agreement and which generally
includes violations of the Advisory Agreement by the Advisor, a bankruptcy event
of the Advisor or the imposition of a material liability on the Company as a
result of the Advisor's bad faith, willful misconduct, gross negligence or
reckless disregard of duties) has occurred and is continuing. In addition, the
Advisor may terminate the Advisory Agreement on 60 days' written notice to the
Company and the Company may terminate the Advisory Agreement upon 60 days'
written notice if a Termination Event has occurred or if the decision to
terminate is based on affirmative vote of the holders of two thirds or more of
the voting shares of the Company at the time outstanding.
Thus, the Company is dependent on the services of the Advisor and its
officers and employees for the successful execution of its business strategy.
The Company is subject to the risk that the Advisor might terminate the Advisory
Agreement to the extent that no suitable replacement were found to manage the
affairs of the Company.
49
<PAGE>
NOTE 5--LOANS AND OTHER INVESTMENTS
The following is a summary description of the Company's loans and other
investments (in thousands):
<TABLE>
<CAPTION>
CARRYING VALUE
# OF ORIGINAL PRINCIPAL AS OF DECEMBER 31 EFFECTIVE
UNDERLYING BORROWERS COMMITMENT BALANCES ---------------------- MATURITY
TYPE OF INVESTMENT PROPERTY TYPE IN CLASS AMOUNT OUTSTANDING 1998 1997 DATES
- --------------------------- ------------------ ----------- ------------ ----------- ----------- --------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Senior Mortgages Office/Hotel/ 12 $ 752,299 $ 658,336 $ 656,631 $ -- 1999 to 2009
Mixed Use/
Apartment/Retail
Subordinated Mortgages Office/Hotel/ 12 501,874 445,203 458,280 -- 1999 to 2007
Mixed Use/ Retail
Discount Mortgages Office/Hotel/ 2 125,402 123,683 86,259 -- 1999 and 2007
Apartment
Partnership Loans/ Office/Hotel/ 13 358,585 342,040 346,421 -- 2000 to 2028
Unsecured Notes Residential/Land
Construction Loans Senior Living/ 3 131,390 93,514 97,819 -- 1999 to 2007
Resorts/
Conference Center
Real Estate Under Operating Hotels 1 N/A (3) N/A (3) 189,942 -- N/A (3)
Leases
Loan Participations Hotel/Office 4 43,339 42,450 40,877 -- 1999 to 2005
Specialty Finance Joint Various 7 50,400 50,200 47,722 -- 2000 to 2018
Venture Loans (4)
Investments in Various 7 N/A N/A 30,104 -- N/A
Unconsolidated Ventures
Other Real Estate-Related Real Estate- N/A N/A N/A 62,398 -- 2002 and 2007
Investments Related Securities
----------- ---------
Gross Carrying Value $ 2,016,453 $ --
Provision for Possible
Credit Losses (2,750) --
----------- ---------
Total, Net $ 2,013,703 $ --
----------- ---------
----------- ---------
<CAPTION>
CONTRACTUAL CONTRACTUAL
INTEREST INTEREST
ACCRUAL PAYMENT PRINCIPAL PARTICIPATION
TYPE OF INVESTMENT RATES (5) RATES (5) AMORTIZATION FEATURES
- --------------------------- ------------------------ ------------------------ ------------ ------------
<S> <C> <C> <C> <C>
Senior Mortgages Fixed: 7.28% to 16.00% Fixed: 7.28% to 12.00% Yes (1) Yes (2)
Variable: LIBOR + 1.25% Variable: LIBOR + 1.25%
to 3.25% to 3.25%
Subordinated Mortgages 9.53% to 15.25% 9.53% to 15.25% Yes (1) Yes (2)
Variable: LIBOR + 4.00% Variable: LIBOR + 4.50%
to 5.80% to 5.80%
Discount Mortgages Fixed: 5.00% to 7.00% Fixed: 5.00% to 7.00% Yes (1) Yes (2)
Partnership Loans/ 8.50% to 17.50% 8.00% to 15.00% Yes Yes (2)
Unsecured Notes Variable: LIBOR + 5.37% Variable: LIBOR + 5.37%
Construction Loans Fixed: 10.30% to 12.50% Fixed: 10.00% to 12.50% Yes No
Real Estate Under Operating N/A (3) N/A (3) N/A (3) N/A (3)
Leases
Loan Participations Fixed: 7.13% to 14.00% Fixed: 5.65% to 13.60% Yes No
Variable: LIBOR + 0.58% Variable: LIBOR + 0.58%
Specialty Finance Joint Fixed: 8.14% to 9.45% Fixed: 8.14% to 9.45% Yes No
Venture Loans (4) Variable: LIBOR + 3.75% Variable: LIBOR + 3.75%
to 4.50% to 4.50%
Investments in Various Various No No
Unconsolidated Ventures
Other Real Estate-Related Fixed: 12.50% to 12.75% Fixed: 12.50% to 12.75% No No
Investments
Gross Carrying Value
Provision for Possible
Credit Losses
Total, Net
</TABLE>
EXPLANATORY NOTES
1. The loans require fixed payments of principal and interest resulting in
partial principal amortization over the term of the loan with the remaining
principal due at maturity. In addition, one of the loans permits additional
annual prepayments of principal of up to $1.3 million without penalty at the
borrower's option.
2. Under some of these loans, the lender receives additional payments
representing additional interest from participation in available cash flow
from operations of the property and the proceeds, in excess of a base
amount, arising from a sale or refinancing of the property.
3. The lease is a triple-net operating lease covering 17 hotels under which the
lessee pays all costs associated with the operation of the hotels, including
real estate taxes, insurance, utilities, services and capital expenditures.
The initial term of the lease expires on December 31, 2020, and can be
extended for up to three five-year terms at the lessee's option. Rent
payments under the lease consist of base rent and additional rent based on
the amount by which the aggregate operating revenue for any given year
exceeds the aggregate operating revenue for the 12 months ended September
30, 1996. The carrying amount is presented net of accumulated depreciation
of approximately $4.3 million as of December 31, 1998.
4. Information for this investment classification, except for the Company's
carrying value, represents terms of loans in an unconsolidated joint
venture. See narrative discussion of venture in this note.
5. All variable-rate loans are based on 30-day LIBOR and reprice monthly.
50
<PAGE>
NOTE 5--LOANS AND OTHER INVESTMENTS
During the period from March 18, 1998 (the date of the consummation of the
Recapitalization Transactions) to December 31, 1998, the Company and its
affiliated ventures originated or acquired an aggregate of approximately $1.0
billion in loans and related investments, funded $16.5 million in additional
commitments on existing loans and received principal repayments of $103.9
million.
In addition, on July 24, 1998, the Company entered into a strategic
origination venture with a publicly-traded finance company to originate loans
secured by specialty real estate. Under its terms, the venture is expected to be
ultimately capitalized 70.00% with third-party debt and 30.00% with capital
contributions from the Company and its venture partner. The Company will
contribute preferred equity in exchange for a 12.00% preferred return and 50.00%
of the residual profits in excess of the aggregate of its preferred return and a
12.00% return to the subordinate joint venture partner. Pending the closing of
third-party senior debt financing, the Company plans to advance senior equity to
the venture at a preferred return at a fixed margin over LIBOR. Since July 24,
1998, the venture has funded approximately $50.4 million of loans. Of the total
loan amounts, the Company funded an aggregate of $47.3 million, representing its
interim funding of the venture's senior debt and its share of the venture's
preferred equity.
The Company has reflected provisions for possible credit losses of $2.8
million in its results of operations during the year ended December 31, 1998. No
provisions were reflected in years ended December 31, 1997 or 1996 as the
Company had no significant lending operations prior to the Recapitalization
Transactions. There was no other activity in the Company's reserve balances
during the three-year period ended December 31, 1998. These provisions represent
portfolio reserves based on management's evaluation of general market
conditions, the Company's and industry loss experience, likelihood of
delinquencies or defaults and the underlying collateral. No direct impairment
reserves on specific loans were considered necessary. Management may transfer
reserves between general and specific reserves as considered necessary.
CREDIT RISK CONCENTRATIONS--Concentrations of credit risks arise when a
number of borrowers or tenants related to the Company's investments are engaged
in similar business activities, or activities in the same geographic region, or
have similar economic features that would cause their ability to meet
contractual obligations, including those to the Company, to be similarly
affected by changes in economic conditions. The Company regularly monitors
various segments of its portfolio to assess potential concentrations of credit
risks. Management believes the current credit risk portfolio is reasonably well
diversified and does not contain any unusual concentration of credit risks.
Substantially all of the Company's loan and other investments are
collateralized by properties located in the United States, with significant
concentrations (i.e., greater than 10%) as of December 31, 1998 in California
(27.0%), New York (12.3%), Washington (11.0%), and Florida (10.0%). As of
December 31, 1998, the Company's investments also contain significant
concentrations in the following asset/collateral types: office (37.5%),
hotel/resorts (28.0%), and retail (15.6%).
51
<PAGE>
NOTE 6--DEBT OBLIGATIONS
As of December 31, 1998, the Company has debt obligations under various
arrangements with financial institutions as follows (in thousands):
<TABLE>
<CAPTION>
MAXIMUM PRINCIPAL
AMOUNT BALANCE AS OF INTEREST MATURITY
AVAILABLE DECEMBER 31, 1998 RATE DATE
---------- ----------------- --------------------------- --------------
<S> <C> <C> <C> <C>
REVOLVING CREDIT FACILITIES:
Line of credit..................... $ 675,000 $ 554,907 LIBOR + 1.50% March 2001
Line of credit..................... 500,000 86,038 LIBOR + 1.00%-1.25% August 2000
-----------------
Total revolving credit
facilities..................... $ 640,945
-----------------
TERM LOANS:
Secured by real estate under
operating leases................. $ 125,000 LIBOR + 1.50% March 1999
Secured by senior mortgage
investment....................... 89,991 LIBOR + 1.00% August 2000
Secured by senior and subordinate
mortgage investments............. 112,927 LIBOR + 1.00% August 2000
Secured by senior mortgage
investment....................... 40,765 LIBOR + 1.00% May 1999
-----------------
Total term loans................. $ 368,683
OTHER DEBT OBLIGATIONS:.............. 46,091 Various Various
-----------------
TOTAL DEBT OBLIGATIONS............... $ 1,055,719
-----------------
-----------------
</TABLE>
Subsequent to December 31, 1998, the Company refinanced its $125.0 million
term loan maturing March 15, 1999 with a $155.4 million term loan maturing March
5, 2009. The new term loan bears interest at 7.44% per annum, payable monthly,
and amortizes over an approximately 22-year schedule. The new term loan
represented one of the forecasted transactions for which the Company had entered
into the U.S. Treasury-based hedging transactions (see Note 9). Accordingly, the
cost of the settlement of such hedges will be deferred and reflected as an
increase to the effective financing cost of the new term loan over its effective
ten-year term.
Availability of amounts under the revolving credit facilities are based on a
percentage borrowing base calculation. An aggregate of $11.6 million in loan
fees were incurred under the Company's debt obligations. These fees are
amortized over the related loan terms and included in interest expense. The
Company had no outstanding long-term debt obligations as of December 31, 1997.
NOTE 7--PREFERRED SHARES
On December 15, 1998, for an aggregate purchase price of $220.0 million, the
Company issued 4.4 million Preferred Shares and warrants to acquire 6.0 million
Class A Shares at $35.00 per share. The proceeds were allocated between the two
securities issued based on estimated relative fair values.
The Preferred Shares have a liquidation value of $50.00 per share, carry an
initial dividend yield of 9.50% per annum and are callable without premium at
the Company's option on or after December 15, 2003. The dividend rate on the
Preferred Shares will increase to 9.75% on December 15, 2005, to 10.00% on
December 15, 2006 and to 10.25% on December 15, 2007 and thereafter. No other
classes of preferred shares of beneficial interest are outstanding as of
December 31, 1998.
52
<PAGE>
Dividends on the Preferred Shares are payable quarterly in arrears and are
cumulative. The Preferred shares have preference over the Company's Class A and
Class B Shares with respect to the payment of dividends and the distribution of
assets in the event of a liquidation or dissolution of the Company.
NOTE 8--CLASS A SHARES AND CLASS B SHARES
The Company is authorized to issue 105.0 million shares representing 70.0
million Class A Shares and 35.0 million Class B Shares, with a par value of
$1.00 and $0.01 per share, respectively. Class B Shares are required to be
issued by the Company in an amount equal to one-half of the number of Class A
Shares outstanding. Class A and Class B Shares are each entitled to one vote per
share with respect to the election of trustees and other matters. Pursuant to
the Company's declaration of trust, the Class B Shares are convertible at the
option of the Class B Shareholders into Class A Shares on the basis of 49 Class
B Shares for one Class A Share. However, the current holder of Class B Shares
has agreed with the Company that it will not convert the Class B Shares into
Class A Shares without the approval of a majority of trustees that are not
affiliated with such holder. All distributions of cash are made 99% to the
holders of Class A Shares and 1% to the holders of Class B Shares.
On December 15, 1998, for an aggregate purchase price of $220.0 million, the
Company issued 4.4 million Preferred Shares and warrants to acquire 6.0 million
Class A Shares at $35.00 per share. The proceeds were allocated between the two
securities issued based on estimated relative fair values.
NOTE 9--RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS
RISK MANAGEMENT--In the normal course of its on-going business operations,
the Company encounters economic risk. There are three main components of
economic risk: interest rate risk, credit risk and market risk. The Company is
subject to interest rate risk to the degree that its interest-bearing
liabilities mature or reprice at different speeds, or different bases, than its
interest-earning assets. Credit risk is the risk of default on the Company's
loan portfolio that results from a property's or borrower's inability or
unwillingness to make contractually required payments. Market risk reflects
changes in the value of loans held for sale, securities available for sale and
purchased mortgage servicing rights due to changes in interest rates or other
market factors, including the rate of prepayments of principal and the value of
the collateral underlying loans and the valuation of real estate held by the
Company.
USE OF DERIVATIVE FINANCIAL INSTRUMENTS--The Company's use of derivative
financial instruments is primarily limited to the utilization of interest rate
agreements or other instruments to manage interest rate exposure. The principal
objective of such arrangements is to minimize the risks and/or costs associated
with the Company's operating and financial structure as well as to hedge
specific anticipated transactions. The counterparties to these contractual
arrangements are major financial institutions with which the Company and its
affiliates may also have other financial relationships. The Company is
potentially exposed to credit loss in the event of nonperformance by these
counterparties. However, because of their high credit ratings, the Company does
not anticipate that any of the counterparties will fail to meet their
obligations. Prior to the Recapitalization Transactions, the Company did not
significantly utilize derivative financial instruments.
In anticipation of and since the completion of the Recapitalization
Transactions, the Company has entered into LIBOR interest rate caps struck at
9.00% in the notional amounts of $125.0 million and $300.0 million expiring in
March 1999 and 2001, respectively. The Company also entered into LIBOR interest
rate caps struck at 7.50% in the notional amounts of $40.4 million and $38.3
million expiring in January and June 2001, respectively, on amounts borrowed
under additional term loans. Further, the Company has also entered into
approximately $206.8 million of interest rate swaps to effectively fix the
interest rate on a portion of the Company's floating-rate obligations.
The Company is currently pursuing certain anticipated long-term fixed-rate
borrowings and has entered into certain derivative instruments based on U.S.
Treasury securities to hedge the potential effects
53
<PAGE>
of interest rate movements on these transactions. As of December 31, 1998, the
Company had entered into an aggregate notional amount of approximately $232.0
million under such agreements. Approximately $136.0 million of these instruments
were entered into in May 1998 and represent fixed rates of approximately 5.8%.
The remaining portion, or approximately $96.0 million, of these instruments were
entered into in July 1998 and represent fixed rates of approximately 5.4%. Under
these agreements, the Company will generally receive additional cash flow at
settlement if interest rates rise and pay cash if interest rates fall. The
effects of such receipts or payments will be deferred and amortized over the
term of the specific related fixed-rate borrowings.
Subsequent to December 31, 1998, the Company refinanced its $125.0 million
term loan maturing March 15, 1999 with a $155.4 million term loan maturing March
5, 2009. The new term loan bears interest at 7.44% per annum, payable monthly,
and amortizes over an approximately 22-year schedule. The new term loan
represented one of the forecasted transactions for which the Company had entered
into the U.S. Treasury-based hedging transactions described above. Accordingly,
the cost of the settlement of such hedges will be deferred and reflected as an
increase to the effective financing cost of the new term loan over its effective
ten-year term.
In the event that, in the opinion of management, it is no longer probable
that the remaining forecasted transactions will occur under terms substantially
equivalent to those projected, the Company will cease recognizing such
transactions as hedges and immediately recognize related gains or losses based
on actual settlement or estimated settlement value. No such gains or losses have
been recognized by the Company.
NOTE 10--INCOME TAXES
Although originally formed to qualify as a REIT under the Code for the
purpose of making and acquiring various types of mortgage and other loans,
during 1993 through 1997, the Company failed to qualify as a REIT. As confirmed
by a closing agreement with the Internal Revenue Service (the "IRS") obtained in
March 1998, the Company will be eligible to and intends to elect to be taxed as
a REIT for the tax year commencing on January 1, 1998. The Company did not incur
any material tax liabilities as a result of its operations during such years.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and income tax purposes, as well as operating loss and tax credit carry
forwards. A valuation allowance is recorded if, based on the weight of available
evidence, it is more likely than not that some portion or all of the deferred
income tax asset will not be realized. Given the limited nature of the Company's
operations and assets and liabilities from 1993 through 1997, the only deferred
tax assets are net operating loss carry forwards ("NOL's") which arose during
such periods. Since the Company intends to elect to be treated as a REIT for its
tax year beginning January 1, 1998, it is anticipated that such NOL's will
expire unutilized. Accordingly, no net value, after consideration of a 100%
valuation allowance, has been reflected in these financial statements as of
December 31, 1998 and 1997.
NOTE 11 - 1996 SHARE INCENTIVE PLAN
The Company amended and restated its stock option plan to provide a means of
incentive compensation for officers, key employees, trustees, consultants and
advisors. Stock options, restricted stock awards and other performance awards
may be granted under the Starwood Financial Trust 1996 Share Incentive Plan (the
"Plan"). Under the amended Plan, up to a maximum of 9.00% of the outstanding
Class A Shares on a fully-diluted basis, as adjusted for subsequent issuances of
Class A Shares, are reserved for issuance under the Plan. All grants of shares
under the Plan, other than automatic grants to non-employee trustees, will be at
the sole discretion of the Board of Trustees or a specifically designated
subcommittee of such trustees. Approximately 2,493,843 options to purchase Class
A Shares at $15.00 per share that are
54
<PAGE>
immediately exercisable were granted to the Advisor under the Plan upon
consummation of the Recapitalization Transactions, and additional grants may be
made to the Advisor or employees of the Company in the future.
An independent financial advisory firm estimated the value of these options
at date of grant to be approximately $2.40 per share using a Black-Scholes
valuation model. In the absence of comparable historical market information for
the Company, the advisory firm utilized assumptions consistent with activity of
a comparable peer group of companies, including an estimated option life of five
years, a 27.50% volatility rate and an estimated annual dividend rate of 8.50%.
Options issued to employees will be accounted for using the intrinsic method
and, accordingly, no earnings charge will be reflected for options issued to
direct employees since the exercise price approximates the concurrent exchange
transaction price at date of grant. Options issued to the Advisor will be
accounted for under the option value method and, accordingly, resulted in a
charge to earnings upon consummation of the Recapitalization Transactions equal
to the number of options allocated to the Advisor multiplied by the estimated
value at consummation. The charge of approximately $6.0 million has been
reflected in the Company's first quarter 1998 financial results. Future charges
may be taken to the extent of additional option grants, which are at the
discretion of the Board of Trustees.
NOTE 12--EARNINGS PER SHARE
Basic EPS is computed based on the income applicable to Class A Shares
(which is net income reduced by accrued dividends on the preferred shares and by
1% allocated to Class B Shares) divided by the weighted average number of Class
A Shares outstanding during the period. Diluted EPS is based on the net earnings
applicable to Class A Shares plus dividends on Class B Shares which are
convertible into Class A Shares, divided by the weighted average number of Class
A Shares and dilutive potential Class A Shares that were outstanding during the
period. Dilutive potential Class A Shares include the Class B Shares, which are
convertible into Class A Shares at a rate of 49 Class B Shares for one Class A
Share, and potentially dilutive options to purchase Class A Shares issued to the
Advisor and the trustees of the Company and warrants to acquire Class A Shares.
Basic and diluted earnings per Class A Share are based upon the following
weighted average shares outstanding during the years ended December 31, 1998,
1997 and 1996, respectively.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- --------- -----
<S> <C> <C> <C>
(IN THOUSANDS)
Weighted average Class A Shares outstanding for basic earnings per Class A Share.... 41,607 1,258 425
Add effect of assumed shares issued under treasury stock method for stock options... 1,311 542 --
Add effects of conversion of Class B Shares (1 for 49 ratio)........................ 445 762 --
Add effects of assumed warrants exercised under treasury stock method for stock
options........................................................................... 97 -- --
--------- --------- ---
Weighted average Class A Shares outstanding for diluted earnings per Class A
Share............................................................................. 43,460 2,562 425
--------- --------- ---
--------- --------- ---
</TABLE>
As previously indicated, effective June 19, 1998, the Company consummated a
one-for-six reverse stock split for its Class A and Class B Shares. Historical
earnings per share have been retroactively restated to reflect the reverse split
for comparative purposes.
55
<PAGE>
NOTE 13--COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130") effective for fiscal years beginning after December 15,
1997. The statement changes the reporting of certain items currently reported as
changes in the shareholders equity section of the balance sheet and establishes
standards for the reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. SFAS No. 130
requires that all components of comprehensive income shall be reported in the
financial statements in the period in which they are recognized. Furthermore, a
total amount for comprehensive income shall be displayed in the financial
statement where the components of other comprehensive income are reported. The
Company was not previously required to present comprehensive income or its
components under generally accepted accounting principles. The Company has
adopted this standard effective January 1, 1998. Total comprehensive income was
$59.9 million, $(151,000) and $(577,000) for the years ended December 31, 1998,
1997 and 1996 respectively. The primary component of comprehensive income other
than net income was the change in value of certain investments in marketable
securities classified as available-for-sale.
NOTE 14--DIVIDENDS
In order to maintain its election to qualify as a real estate investment
trust, the Company must distribute, at a minimum, an amount equal to 95% of its
taxable income and must distribute 100% of its taxable income to avoid paying
corporate federal income taxes. Accordingly, the Company anticipates it will
distribute all of its taxable income to its shareholders. Because taxable income
differs from cash flow from operations due to non-cash revenues or expenses, in
certain circumstances, the Company may be required to borrow to make sufficient
dividend payments to meet this anticipated dividend threshold.
Total dividends declared by the Company aggregated $59.7 million or $1.14
per Class A Share for the year ended December 31, 1998. On December 17, 1998,
the Company declared a dividend of approximately $21.5 million or $0.41 per
Class A Share applicable to the fourth quarter and payable to shareholders of
record on December 31, 1998. No dividends were declared or paid during 1997 or
1996. The exact amount of future quarterly dividends to Class A shareholders
will be determined by the Board of Trustees based on the Company's actual and
expected operations for the fiscal year and the Company's overall liquidity
position.
NOTE 15--FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments" ("SFAS
107"), requires the disclosure of the estimated fair values of financial
instruments. The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. Quoted market prices, if available,
are utilized as estimates of the fair values of financial instruments. Because
no quoted market prices exist for a significant part of the Company's financial
instruments, the fair values of such instruments have been derived based on
management's assumptions, the amount and timing of future cash flows and
estimated discount rates. The estimation methods for individual classifications
of financial instruments are described more fully below. Different assumptions
could significantly affect these estimates. Accordingly, the net realizable
values could be materially different from the estimates presented below. The
provisions of SFAS 107 do not require the disclosure of the fair value of
non-financial instruments, including intangible assets or its real estate assets
under long-term operating lease.
In addition, the estimates are only indicative of the value of individual
financial instruments and should not be considered an indication of the fair
value of the Company.
SHORT-TERM FINANCIAL INSTRUMENTS--The carrying values of short-term
financial instruments including cash and cash equivalents and short-term
investments approximate the fair values of these instruments. These financial
instruments generally expose the Company to limited credit risk and have no
stated
56
<PAGE>
maturities, or have an average maturity of less than 90 days and carry interest
rates which approximate market.
LOANS AND OTHER INVESTMENTS--For that portion of the Company's interests in
loans and other investments which represent financial instruments, which
excludes interests in real estate under long-term operating leases and preferred
limited partnership interests not considered financial instruments for this
purpose, the fair values were estimated by discounting the future contractual
cash flows (excluding participation interests in the sale or refinancing
proceeds of the underlying collateral) using estimated current market rates at
which similar loans would be made to borrowers with similar credit ratings for
the same remaining maturities.
FINANCIAL INSTRUMENTS TRADED IN THE SECONDARY MARKET--Securities held for
investment, securities available for sale, loans held for sale, trading account
instruments, long-term debt and trust preferred securities traded actively in
the secondary market have been valued using quoted market prices.
OTHER FINANCIAL INSTRUMENTS--The carrying value of other financial
instruments including, restricted cash, accrued interest receivable, accounts
payable, accrued expenses and other liabilities approximate the fair values of
the instruments.
DEBT OBLIGATIONS--The Company's existing debt obligations bear interest at
fixed margins over LIBOR or spreads over Treasuries. Such margins or spreads may
be higher or lower than those at which the Company could currently replace the
related financing arrangements. As a result, the fair values of the Company's
debt obligations were estimated by discounting current debt balances from
December 31, 1998 to maturity using estimated current market rates at which the
Company could enter into similar financing arrangements.
INTEREST RATE PROTECTION AGREEMENTS--The fair value of interest rate
protection agreements such as interest rate caps, floors, collars and swaps used
for hedging purposes (see Note 9) is the estimated amount the Company would
receive or pay to terminate these agreements at the reporting date, taking into
account current interest rates and current creditworthiness of the respective
counterparties.
The book and fair values of financial instruments as of December 31, 1998
and 1997 were (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------------------------- --------------------
BOOK FAIR BOOK FAIR
VALUE VALUE VALUE VALUE
------------ ------------ --------- ---------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Loans and other investments(1).................................. $ 1,826,511 $ 1,924,037 $ -- $ --
Marketable securities........................................... 5,406 5,406 11,175 11,175
Allowance for credit losses..................................... (2,750) (2,750) -- --
FINANCIAL LIABILITIES:
Debt obligations................................................ 1,055,719 1,039,771 -- --
Interest rate protection agreements............................. 577 (17,719) -- --
</TABLE>
- ------------------------
(1) Amounts exclude values relating to non-financial instruments, primarily
assets under long-term operating leases and preferred limited partnership
interests.
57
<PAGE>
NOTE 16--QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table sets forth the selected quarterly financial data for the
Company (in thousands, except for per share amounts).
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1998 1998 1998 1998
------------ ------------- --------- -----------
<S> <C> <C> <C> <C>
1998
Revenue...................................................... $ 48,349 $ 42,077 $ 33,704 $ 3,966
Net income (loss)............................................ 22,954 20,935 19,889 (3,875)
Net income (loss) applicable to Class A Shares............... 21,790 20,726 19,690 (3,836)
Net income (loss) per Class A Share.......................... $ 0.42 $ 0.40 $ 0.38 $ (0.44)
Weighted average Class A Shares outstanding(1)............... 52,408 52,390 52,390 8,644
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
1997 1997 1997 1997
------------ ------------- --------- -----------
<S> <C> <C> <C> <C>
1997
Revenue...................................................... $ 1,181 $ 247 $ 220 $ 240
Net income (loss)............................................ (14) 2 5 18
Net income (loss) applicable to Class A Shares............... (14) 2 5 18
Net income (loss) per Class A Share.......................... $ 0.01 $ 0.00 $ 0.00 $ 0.01
Weighted average Class A Shares outstanding(1)............... 1,258 1,258 1,258 1,258
</TABLE>
- ------------------------
(1) As adjusted for one-for-six reverse stock split effective June 19, 1998
(Note 1).
58
<PAGE>
STARWOOD FINANCIAL TRUST
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
------------------------
<S> <C> <C> <C> <C> <C>
BALANCE AT CHARGED TO CHARGES TO BALANCE AT
BEGINNING COSTS AND OTHER END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
- ---------------------------------------------------- ----------- ----------- ----------- ----------- -----------
FOR THE YEAR ENDED DECEMBER 31, 1998
None.............................................. $ -- $ -- $ -- $ -- $ --
FOR THE YEAR ENDED DECEMBER 31, 1998
None.............................................. $ -- $ -- $ -- $ -- $ --
FOR THE YEAR ENDED DECEMBER 31, 1998
Provision for possible credit losses (A).......... $ -- $ 2,750 $ -- $ -- $ 2,750
</TABLE>
EXPLANATORY NOTES:
(A) See Note 5 to the Company's 1998 Consolidated Financial Statements.
59
<PAGE>
STARWOOD FINANCIAL TRUST
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION
AS OF DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
INITIAL COST AND
GROSS CARRYING VALUE
TO THE COMPANY (C)
--------------------
<S> <C> <C> <C> <C> <C> <C> <C>
ACCUMULATED DATE DATE
DESCRIPTION/LOCATION # OF ROOMS ENCUMBRANCES LAND BUILDING DEPRECIATION CONSTRUCTED ACQUIRED (D)
- -------------------------- ----------- ------------- --------- --------- ------------- --------------- -------------
REAL ESTATE UNDER LONG-
TERM OPERATING LEASE (A)
Seattle, Washington....... 850 (B) $ 5,101 $ 32,080 $ 715 1969 3/18/98
Salt Lake City, Utah...... 497 (B) 5,620 32,695 744 1988 3/18/98
Sacramento, California.... 376 (B) 1,281 9,809 293 1976 3/18/98
San Diego, California..... 300 (B) 4,394 27,030 661 1990 3/18/98
Sonoma, California........ 245 (B) 3,308 20,623 501 1987 3/18/98
Medford, Oregon........... 186 (B) 609 4,668 141 1968 3/18/98
Boise, Idaho.............. 182 (B) 968 6,405 176 1979 3/18/98
Pendleton, Oregon......... 168 (B) 556 4,245 138 1977 3/18/98
Kelso, Washington......... 162 (B) 502 3,779 123 1977 3/18/98
Vancouver, Washington..... 160 (B) 507 3,981 133 1973 3/18/98
Durango, Colorado......... 159 (B) 1,242 7,865 195 1986 3/18/98
Wenatchee, Washington..... 149 (B) 513 3,825 120 1974 3/18/98
Coos Bay, Oregon.......... 143 (B) 404 3,049 92 1972 3/18/98
Eugene, Oregon............ 137 (B) 361 2,721 88 1965 3/18/98
Astoria, Oregon........... 124 (B) 269 2,043 59 1967 3/18/98
Missoula, Montana......... 76 (B) 210 1,607 54 1972 3/18/98
Bend, Oregon.............. 75 (B) 233 1,726 54 1971 3/18/98
----- ------------- --------- --------- ------
Totals.................... 3,989 $ 125,000 $ 26,078 $ 168,151 $ 4,287
----- ------------- --------- --------- ------
----- ------------- --------- --------- ------
<CAPTION>
<S> <C>
DEPRECIABLE
DESCRIPTION/LOCATION LIFE
- -------------------------- -----------------
REAL ESTATE UNDER LONG-
TERM OPERATING LEASE (A)
Seattle, Washington....... (E)
Salt Lake City, Utah...... (E)
Sacramento, California.... (E)
San Diego, California..... (E)
Sonoma, California........ (E)
Medford, Oregon........... (E)
Boise, Idaho.............. (E)
Pendleton, Oregon......... (E)
Kelso, Washington......... (E)
Vancouver, Washington..... (E)
Durango, Colorado......... (E)
Wenatchee, Washington..... (E)
Coos Bay, Oregon.......... (E)
Eugene, Oregon............ (E)
Astoria, Oregon........... (E)
Missoula, Montana......... (E)
Bend, Oregon.............. (E)
Totals....................
</TABLE>
EXPLANATORY NOTES:
- ------------------------------
(A) These properties are subject to a single master lease arrangement with
Promus Hotel Corporation.
(B) The properties are secured by a single cross-collateralized mortgage loan
with a principal balance of $125.0 million at December 31, 1998. The loan
balance is not ascribed to specific properties.
(C) There is no material differences between the gross carrying amounts for
generally accepted accounting purposes and for federal income tax reporting
purposes as of December 31, 1998.
(D) All properties were acquired in connection with March 18, 1998
Recapitalization Transactions--see Note 4 to the Company's Consolidated
Financial Statements. There are no substantial additions to fixed assets
subsequent to the Recapitalization Transactions.
(E) Depreciation is calculated as follows: Building & Land Improvements:
straight-line over 39 years. Office Equipment, FF&E and Other: straight-line
over seven years.
60
<PAGE>
STARWOOD FINANCIAL TRUST
SCHEDULE IV--MORTGAGE LOANS ON REAL ESTATE
AS OF DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
INTEREST
ACCRUAL
TYPE OF LOAN/BORROWER DESCRIPTION/LOCATION RATES
- --------------------------------------------------------------------------------- --------------------------- ------------------
<S> <C> <C>
SENIOR MORTGAGES
Borrower A (1).................................................................. Office, San Diego, CA LIBOR + 1.50%
Borrower B (1)................................................................. Office, Dallas, TX LIBOR + 1.75%
Borrower C (1)................................................................. Office, Seattle, WA LIBOR + 1.25%
Borrower D..................................................................... Office/Apt., San Diego and LIBOR + 3.25%
San Francisco, CA
Borrower E..................................................................... Retail, Chicago, IL 8.88%
Borrower F (1)................................................................. Retail, Concorde, CA 7.75%
Borrower G (1)................................................................. Mixed, Boston, MA 8.97%
Borrower H (1)................................................................. Hotels, Various states LIBOR + 2.00%
All other senior mortgages individually < 3%...................................
SUBORDINATE MORTGAGES
Borrower A..................................................................... Office, San Diego, CA 12.00%
Borrower B..................................................................... Office, Dallas, TX 15.00%
Borrower F (1)................................................................. Retail, Concorde, CA 9.53%
Borrower F (1)................................................................. Retail, Concorde, CA 10.13%
Borrower G (1)................................................................. Mixed, Boston, MA 8.97%
Borrower H (1)................................................................. Hotels, Various states 12.50%
Borrower I..................................................................... Office, New York, NY LIBOR + 4.50%
Borrower J (1)................................................................. Hotels, Various states LIBOR + 5.80%
All other subordinate mortgages individually < 3%..............................
DISCOUNT MORTGAGES
Borrower C (1)................................................................. Office, Seattle, WA 5.00%-7.00%
All other discount mortgages individually < 3%.................................
PARTNERSHIP LOANS / UNSECURED NOTES
Borrower J (1)................................................................. Hotels, Various states LIBOR + 5.37%
Borrower K..................................................................... Office, Los Angeles, CA 13.75%
All other partnership loans/unsecured notes individually < 3%..................
CONSTRUCTION LOANS
Borrower L..................................................................... Resort, Amelia Island, FL 12.50%
All other construction mortgages individually < 3%.............................
LOAN PARTICIPATIONS
All loan participations are individually < 3%..................................
SPECIALTY FINANCE JOINT VENTURE LOANS
Total investment in origination venture is < 3%................................
INVESTMENTS IN UNCONSOLIDATED VENTURES
Total investment in unconsolidated ventures is < 3%............................
OTHER REAL ESTATE-RELATED INVESTMENTS
All other real estate-related investments are individually < 3%................
Totals...........................................................................
<CAPTION>
INTEREST FINAL PERIODIC
PAYMENT MATURITY PAYMENT
TYPE OF LOAN/BORROWER RATES DATE TERMS(3)
- --------------------------------------------------------------------------------- ------------------ ----------- -----------
<S> <C> <C> <C>
SENIOR MORTGAGES
Borrower A (1).................................................................. LIBOR + 1.50% 4/30/02 P&I
Borrower B (1)................................................................. LIBOR + 1.75% 8/24/04 IO
Borrower C (1)................................................................. LIBOR + 1.25% 12/14/99 P&I
Borrower D..................................................................... LIBOR + 3.25% 12/31/02 P&I
Borrower E..................................................................... 8.88% 1/1/04 P&I
Borrower F (1)................................................................. 7.75% 9/1/09 P&I
Borrower G (1)................................................................. 8.97% 11/10/07 P&I
Borrower H (1)................................................................. LIBOR + 2.00% 5/3/99 IO
All other senior mortgages individually < 3%...................................
SUBORDINATE MORTGAGES
Borrower A..................................................................... Cash Flow 4/30/02 CF
Borrower B..................................................................... LIBOR + 3.43% 8/24/04 IO
Borrower F (1)................................................................. 9.53% 9/1/00 P&I
Borrower F (1)................................................................. 10.13% 10/1/00 P&I
Borrower G (1)................................................................. 8.97% 11/10/07 IO
Borrower H (1)................................................................. 12.50% 5/3/99 IO
Borrower I..................................................................... LIBOR + 4.50% 8/1/03 IO
Borrower J (1)................................................................. LIBOR + 5.80% 9/15/03 IO
All other subordinate mortgages individually < 3%..............................
DISCOUNT MORTGAGES
Borrower C (1)................................................................. 5.00%-7.00% 12/14/99 CF
All other discount mortgages individually < 3%.................................
PARTNERSHIP LOANS / UNSECURED NOTES
Borrower J (1)................................................................. LIBOR + 5.37% 9/15/03 IO
Borrower K..................................................................... 9.00% 11/11/27 IO
All other partnership loans/unsecured notes individually < 3%..................
CONSTRUCTION LOANS
Borrower L..................................................................... 10.00%-12.50% 7/31/04 IO
All other construction mortgages individually < 3%.............................
LOAN PARTICIPATIONS
All loan participations are individually < 3%..................................
SPECIALTY FINANCE JOINT VENTURE LOANS
Total investment in origination venture is < 3%................................
INVESTMENTS IN UNCONSOLIDATED VENTURES
Total investment in unconsolidated ventures is < 3%............................
OTHER REAL ESTATE-RELATED INVESTMENTS
All other real estate-related investments are individually < 3%................
Totals...........................................................................
<CAPTION>
FACE CARRYING
PRIOR AMOUNT OF AMOUNT OF
TYPE OF LOAN/BORROWER LIENS (2) LOANS LOANS
- --------------------------------------------------------------------------------- --------- ----------- -----------
SENIOR MORTGAGES
Borrower A (1).................................................................. $ -- $ 79,201 $ 79,201
Borrower B (1)................................................................. -- 82,800 82,800
Borrower C (1)................................................................. -- 91,132 91,132
Borrower D..................................................................... -- 65,120 64,030
Borrower E..................................................................... -- 111,120 110,566
Borrower F (1)................................................................. -- 10,505 10,912
Borrower G (1)................................................................. -- 36,513 36,513
Borrower H (1)................................................................. -- 34,283 33,908
All other senior mortgages individually < 3%................................... -- 147,662 147,570
SUBORDINATE MORTGAGES
Borrower A..................................................................... -- 38,312 44,507
Borrower B..................................................................... -- 27,822 28,454
Borrower F (1)................................................................. -- 74,668 77,112
Borrower F (1)................................................................. -- 34,330 35,464
Borrower G (1)................................................................. -- 18,000 23,215
Borrower H (1)................................................................. 70,600 11,428 11,253
Borrower I..................................................................... 500,000 100,000 99,563
Borrower J (1)................................................................. 110,000 30,000 29,710
All other subordinate mortgages individually < 3%.............................. -- 110,643 109,003
DISCOUNT MORTGAGES
Borrower C (1)................................................................. -- 50,783 37,400
All other discount mortgages individually < 3%................................. -- 72,900 48,859
PARTNERSHIP LOANS / UNSECURED NOTES
Borrower J (1)................................................................. 134,000 70,500 69,898
Borrower K..................................................................... 176,500 62,861 62,471
All other partnership loans/unsecured notes individually < 3%.................. -- 208,679 214,052
CONSTRUCTION LOANS
Borrower L..................................................................... -- 51,168 55,486
All other construction mortgages individually < 3%............................. -- 42,346 42,333
LOAN PARTICIPATIONS
All loan participations are individually < 3%.................................. -- 42,450 40,877
SPECIALTY FINANCE JOINT VENTURE LOANS
Total investment in origination venture is < 3%................................ -- 50,200 47,722
INVESTMENTS IN UNCONSOLIDATED VENTURES
Total investment in unconsolidated ventures is < 3%............................ N/A N/A 30,104
OTHER REAL ESTATE-RELATED INVESTMENTS
All other real estate-related investments are individually < 3%................ N/A N/A 17,532
--------- ----------- -----------
Totals........................................................................... $ 991,100 $ 1,755,426 $ 1,781,645
--------- ----------- -----------
--------- ----------- -----------
</TABLE>
EXPLANATORY NOTES:
(1) Loan is part of a part of common borrowing provided by Starwood Financial
Trust (see corresponding letter reference).
(2) Excludes senior loans held by the Company to the same borrower.
(3) P&I = principal and interest; IO = interest only; CF = cash flow.
61
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Portions of the Company's definitive proxy statement for the 1999 annual
meeting of shareholders to be filed within 120 days after the close of the
Company's fiscal year are incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Portions of the Company's definitive proxy statement for the 1999 annual
meeting of shareholders to be filed within 120 days after the close of the
Company's fiscal year are incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Portions of the Company's definitive proxy statement for the 1999 annual
meeting of shareholders to be filed within 120 days after the close of the
Company's fiscal year are incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Portions of the Company's definitive proxy statement for the 1999 annual
meeting of the shareholders to be filed within 120 days after the close of the
Company's fiscal year are incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) and (d). Financial statements and schedules--see Index to Financial
Statements and Schedules included in Item 8.
(b) Reports on Form 8-K.
The Company's current Report on Form 8-K dated December 15, 1998 was
filed on December 23, 1998.
(c) Exhibits--see index on following page.
62
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------
<C> <S> <C>
3.1 Amended and Restated Declaration of Trust dated March 1998.*
3.2 Articles of Amendment to the Company's Amended and Restated Declaration of Trust. ***
3.3 Articles Supplementary relating to the Series A Preferred Shares of Beneficial Interest. ***
3.4 Bylaws of the Company. *
4.1 Amended and Restated Registration Rights Agreement dated March 18, 1998 among Starwood
Financial Trust and Starwood Mezzanine Investors, L.P., SAHI Partners and SOFI-IV SMT
Holdings, L.L.C. **
4.2 Investor Rights Agreement, dated as of December 15, 1998 among Starwood Financial Trust, a
Maryland real estate investment trust, Starwood Mezzanine Investors, L.P., a Delaware limited
partnership, SOFI-IV SMT Holdings, L.L.C., a Delaware limited liability company, B Holdings,
L.L.C., a Delaware limited liability company, and Lazard Freres Real Estate Fund II, L.P., a
Delaware limited partnership, Lazard Freres Real Estate Offshore Fund II L.P., a Delaware
limited Partnership, and LF Mortgage REIT, a Maryland real estate investment trust.***
4.4 Form of warrant certificates. ***
4.5 Form of certificate for Series A Preferred Shares of beneficial interest. ***
4.6 Form of share certificate for Class A Shares of the Company. **
10.1 Starwood Financial Trust 1996 Share Incentive Plan. **
10.2 Contribution Agreement dated as of February 11, 1998, between Starwood Financial Trust,
Starwood Mezzanine Investors, L.P. and Starwood Opportunity Fund IV, L.P. **
10.3 Second Amended and Restated Shareholder's Agreement dated March 18, 1998 among B Holdings,
L.L.C., SAHI Partners, Starwood Mezzanine Investors, L.P., SOFI-IV SMT Holdings, L.L.C., and
Starwood Financial Trust. **
10.4 Investment Advisory Agreement dated as of March 18, 1998 between Starwood Financial Trust and
Starwood Financial Advisors, L.L.C. **
10.5 Securities Purchase Agreement, dated as of December 15, 1998, by and between Starwood
Financial Trust, Lazard Freres Real Estate Fund II, L.P., a Delaware limited partnership,
Lazard Freres Real Estate Offshore Fund II, L.P., a Delaware limited partnership, and LF
Mortgage REIT, a Maryland real estate investment trust. ***
</TABLE>
63
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------
<C> <S> <C>
10.6 Asset Purchase and Sale Agreement, dated as of December 15, 1998 by and between Lazard Freres
Real Estate Fund, L.P., a Delaware limited partnership, Lazard Freres Real Estate Fund II,
L.P., a Delaware limited partnership, Prometheus Mid-Atlantic Holding, L.P., a Delaware
limited partnership, Pacific Preferred LLC, a New York limited liability company, Atlantic
Preferred II LLC, a New York limited liability company, Indian Preferred LLC, a New York
limited liability company and Prometheus Investment Holding, L.P., a Delaware limited
partnership and Starwood Financial Trust. ***
21.1 Subsidiaries of the Company.
</TABLE>
- ------------------------
* Incorporated by reference from the Company's Registration Statement on Form
S-4 filed on May 12, 1998.
** Incorporated by reference from the Company's Annual Report on Form 10-K for
the year ended December 31, 1997 filed on April 2, 1998.
*** Incorporated by reference from the Company's Form 8-K filed on December 23,
1998.
64
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C>
STARWOOD FINANCIAL TRUST
------------------------------------------------
REGISTRANT
Date March 31, 1999 /s/ JAY SUGARMAN
------------------------------------------------
Jay Sugarman
CHIEF EXECUTIVE OFFICER AND PRESIDENT
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following person on behalf of
the registrant and in the capacities and on the dates indicated.
<TABLE>
<S> <C>
Date March 31, 1999 /s/ BARRY S. STERNLICHT
------------------------------------------------
Barry S. Sternlicht
CHAIRMAN OF THE BOARD OF TRUSTEES
Date March 31, 1999 /s/ JAY SUGARMAN
------------------------------------------------
Jay Sugarman
CHIEF EXECUTIVE OFFICER, PRESIDENT AND TRUSTEE
Date March 31, 1999 /s/ SPENCER B. HABER
------------------------------------------------
Spencer B. Haber
CHIEF FINANCIAL OFFICER AND SECRETARY
(PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
Date March 31, 1999 /s/ JEFFREY G. DISHNER
------------------------------------------------
Jeffrey G. Dishner
TRUSTEE
Date March 31, 1999 /s/ JONATHAN EILIAN
------------------------------------------------
Jonathan Eilian
TRUSTEE
Date March 31, 1999 /s/ MERRICK R. KLEEMAN
------------------------------------------------
Merrick R. Kleeman
TRUSTEE
Date March 31, 1999 /s/ ROBIN JOSEPHS
------------------------------------------------
Robin Josephs
TRUSTEE
Date March 31, 1999 /s/ WILLIAM MATTHES
------------------------------------------------
William Matthes
TRUSTEE
Date March 31, 1999 /s/ KNEELAND C. YOUNGBLOOD
------------------------------------------------
Kneeland C. Youngblood
TRUSTEE
</TABLE>
65
<PAGE>
Exhibit 21.1
LIST OF SUBSIDIARIES
<TABLE>
<CAPTION>
STATE OR
ORGANIZATION/
SUBSIDIARY INCORPORATION OTHER NAMES USED
- ----------------------------------------------------------- -------------------- -------------------------------
<S> <C> <C>
BM Center, LLC Delaware None
FMAC Star Fund, L.L.P. Connecticut None
Red Lion G.P., Inc. Delaware None
RLH Partnership, L.P. Delaware None
SFT I. Inc. Delaware Starwood Financial I (CA)
SFT II. Inc. Delaware Starwood Financial II (CA)
SFT Bonds A, Inc. Delaware None
SFT-Ford City, Inc. Delaware None
SFT-Port Charlotte, Inc. Delaware None
SFT-Sun Valley, Inc. Delaware None
SFT/RLH, Inc. Delaware None
SFT Venturer, LLC Delaware None
SFT Whole Loans A, Inc. Delaware None
Starwood Cayman Bonds, Inc. Delaware None
Starwood Cayman Bonds GP, Inc. Delaware None
Starwood D.C., Inc. Delaware None
Starwood/Denver Place, L.L.C. Delaware None
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 10,110
<SECURITIES> 5,406
<RECEIVABLES> 13,122
<ALLOWANCES> 2,750
<INVENTORY> 0
<CURRENT-ASSETS> 25,888
<PP&E> 194,229
<DEPRECIATION> 4,287
<TOTAL-ASSETS> 2,059,616
<CURRENT-LIABILITIES> 10,536
<BONDS> 0
0
44
<COMMON> 52,670
<OTHER-SE> 918,014
<TOTAL-LIABILITY-AND-EQUITY> 2,059,616
<SALES> 0
<TOTAL-REVENUES> 128,096
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 20,746
<LOSS-PROVISION> 2,750
<INTEREST-EXPENSE> 44,697
<INCOME-PRETAX> 59,903
<INCOME-TAX> 0
<INCOME-CONTINUING> 59,903
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 59,903
<EPS-PRIMARY> 1.40
<EPS-DILUTED> 1.36
</TABLE>
