UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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
STARWOOD FINANCIAL TRUST
(Exact name of registrant as specified in its charter)
Maryland 95-6881527
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1114 Avenue of the Americas, 27th floor 10036
New York, New York (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 930-9400
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of Exchange on which
Class A Shares, $1.00 par registered:
value, of Starwood Financial Trust American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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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 [X].
The aggregate market value of the Class A Shares held by non-affiliates on
March 23, 1998 was approximately $10,492,000.
As of March 23, 1998, there were 314,341,744 shares of Starwood Financial
Trust, Class A, $1.00 par value, outstanding.
Total Pages: 54
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TABLE OF CONTENTS
Page
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PART I......................................................................4
ITEM 1. BUSINESS...........................................................4
General................................................................4
Recapitalization Transactions..........................................5
History................................................................6
Investment Policy......................................................6
Advisory Agreement....................................................10
License Agreement.....................................................12
Underwriting Policy and Procedures....................................12
Investment Portfolio..................................................12
Summary of subordination and default characteristics..................17
Summary of delinquencies and possible losses..........................17
Senior Mortgage Loans.................................................17
Subordinate Mortgage Loans............................................19
Opportunistic Mortgage Loans..........................................20
Unsecured Loans.......................................................22
Construction Loans....................................................22
Real Estate under Long-term Operating Lease...........................24
Loan Participations...................................................25
Other.................................................................26
Letters of Intent.....................................................26
The Partnership.......................................................26
Competition...........................................................27
Qualification as a REIT...............................................27
Unfunded Commitments..................................................27
Employees.............................................................27
PART II....................................................................27
ITEM 6. SELECTED FINANCIAL DATA..........................................27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..............................31
General...............................................................31
Liquidity and Capital Resources.......................................32
Fiscal Year 1997 Compared to 1996.....................................33
Fiscal Year 1996 Compared to 1995.....................................34
New Accounting Pronouncements.........................................34
Interest Rate Risks...................................................35
ITEM 8. FINANCIAL STATEMENTS..............................................36
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PART I
This amendment contains certain statements that may be deemed
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements contained herein include, but are not limited to,
statements relating to the objectives, strategies and plans of Starwood
Financial Trust (the "Trust"), and all statements (other than statements of
historical fact) that address actions, events or circumstances that the Trust or
its management expects, believes or intends will occur in the future.
Forward-looking statements are not guarantees of future performance and involve
risks and uncertainties that could cause actual results to differ materially
from historical results or those anticipated at the time the forward-looking
statements are made, including, without limitation, risks and uncertainties
associated with the following: the Trust's continued ability to qualify for
taxation as a REIT; completion of future acquisitions and dispositions; the
availability of capital for acquisitions and originations; competition within
the specialty finance industry and lending industry; general real estate and
national economic conditions; the ability of the Trust and others with which it
does business to address the Year 2000 issue, and the costs associated
therewith; and the other risks and uncertainties set forth in the annual,
quarterly and current reports and proxy statements of the Trust. The Trust
undertakes no obligation to publicly update or revise any forward-looking
statement, whether as a result of new information, future events or otherwise
unless so required by law.
ITEM 1. BUSINESS
In response to comments received from the Securities and Exchange
Commission, the Trust hereby amends Item 1. Business of Part I of the Trust's
Annual Report on Form 10-K for the year ended December 31, 1997 (the "Annual
Report") by deleting the text thereunder and inserting in lieu thereof the
following:
The statements contained in this report that are not historical facts,
including statements containing the words "believes," "anticipates," "expects"
and words of similar import, are forward-looking statements subject to the safe
harbor created by the Private Securities Litigation Reform Act of 1995. A number
of important factors could cause the Trust's actual results for 1998 and beyond
to differ materially from those expressed in any forward-looking statements made
by, or on behalf of, the Trust. These factors include, without limitation, the
factors listed below.
General
Starwood Financial Trust (the "Trust") is a California business trust that
was formed in April 1988. Prior to March 13, 1998, the Trust was known as
Angeles Participating Mortgage Trust. The Trust's capital structure consists of
Class A Shares, par value $1.00 per share ("Class A Shares") and Class B Shares,
par value $.01 per share ("Class B Shares" and together with the Class A Shares,
the "Shares"). The Class A Shares are publicly traded on the American Stock
Exchange under the symbol "APT." As of December 31, 1997, the Trust had
7,550,000 Class A
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shares outstanding and 3,775,000 Class B Shares outstanding, along with
4,568,944 Units convertible into Class A Shares. On March 18, 1998, following
the consummation of the Recapitalization Transaction (defined below), there were
314,341,744 Class A Shares outstanding and 157,170,872 Class B Shares
outstanding that can be converted into 3,207,568 Class A Shares. The Class B
Shares are entitled to a 1% economic interest and a 33% voting interest in the
Trust. Each of the Shares is entitled to one vote per share.
The Trust is an organization of the type commonly known as a "business
trust." The Declaration of Trust provides that no shareholder of the Trust (a
"Shareholder") will be personally liable for any obligation of the Trust solely
as a result of his status as a Shareholder. The Declaration of Trust further
provides that the Trust shall indemnify each Shareholder against any claim or
liability to which the Shareholder may become subject by reason of his being or
having been a Shareholder. In addition, it is the Trust's policy to include a
clause in its contracts which provides that Shareholders assume no personal
liability for obligations entered into on behalf of the Trust. However, with
respect to certain claims such as tort claims, contractual claims where
shareholder liability is not so negated, claims for taxes, certain environmental
claims and certain statutory liability, the Shareholders may under applicable
law be personally liable to the extent that such claims are not satisfied by the
Trust. The common law in California with respect to business trusts is limited
and does not provide clear guidance with respect to the limited liability of the
Shareholders. The Trust has public liability insurance which it considers
adequate. Any risk of personal liability to Shareholders will be limited to
situations in which the Trust's assets plus its insurance coverage would be
insufficient to satisfy the claims against the Trust and its Shareholders. In
addition, the Trust currently intends to change the domicile of the Trust to a
state with clear guidance with respect to Shareholder liability.
Recapitalization Transactions
On March 18, 1998, the Trust (i) paid $25.5 million of cash, as adjusted,
and issued 55,148,000 Class A Shares at a price of $2.50 per share to Starwood
Mezzanine Investors, L.P. ("Mezzanine") in exchange for the contribution by
Mezzanine to the Trust of its entire interest in a portfolio of mortgage and
partnership loans secured by residential, hotel, office and mixed use real
estate and other assets, (ii) paid $324.3 million in cash, as adjusted, and
issued 247,074,800 Class A Shares at a price of $2.50 per share to Starwood
Opportunity Fund IV, L.P. ("SOF IV") in exchange for the contribution by SOF IV
to the Trust of a portfolio of mortgage loans and leases secured by residential,
hotel, office and mixed use real estate and other assets, a portfolio of first
mortgage loans, cash of $17.9 million and rights under certain letters of intent
(collectively, the "Recapitalization Transactions") and (iii) borrowed $350
million under a $625.0 million credit facility currently available to the Trust.
Upon consummation of the Recapitalization Transaction, Mezzanine had a 13.1%
voting interest and a 20.6% economic interest and SOF IV had a 52.4% voting
interest and a 78.6% economic interest in the Trust.
In connection with the Recapitalization Transactions: (i) the Trust changed
its name from Angeles Participating Mortgage Trust to Starwood Financial Trust;
(ii) the Trust entered into an advisory agreement (the "Advisory Agreement")
with Starwood Financial Advisors, L.L.C. (the
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"Advisor") pursuant to which the Advisor manages the investment affairs of the
Trust; (iii) the Declaration of Trust of the Trust was amended and restated (as
amended and restated the "Declaration of Trust"); (iv) all of the limited
partnership interests in APMT Limited Partnership (the "Partnership") were
exchanged for Class A Shares which left the Trust as the sole partner of
Partnership; (v) the Partnership was dissolved and all of its assets were
distributed to the Trust; (vi) the Trust'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 Trust entered into
several credit facilities which in the aggregate provide the Trust 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 "Recapitalization
Transactions," "Investment Policy" and "Advisory Agreement" below. See
"Investment Portfolio" below for a description of the assets contributed to the
Trust by Mezzanine and SOF IV in the Recapitalization Transactions.
As a result of the consummation of the Recapitalization Transactions, there
is an increase in the Trust's exposure to real estate investment 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 Trust or properties which are owned
by the Trust 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 Trust's rights, the effect of competition from properties owned by
others, liability associated with uninsurable losses and unknown environmental
liabilities.
History
The Trust was originally formed by Angeles Corporation ("Angeles") for the
purpose of making various types of mortgage and other loans to entities
affiliated with Angeles. In early 1993, Angeles and its affiliates began
experiencing financial difficulties which resulted in a default on their loans
held by the Trust. In November 1993, the Trust sold all of its loans to an
unaffiliated third party and with the proceeds of such sale and cash on hand
distributed $37.2 million to the Trust's shareholders. Through a series of
transactions during 1994 and 1996, Mezzanine and certain affiliates of the
general partner of Mezzanine acquired control of the Trust.
Investment Policy
Prior to September 1996, the purpose and investment policy of the Trust was
primarily to make mortgage loans to entities affiliated with Angeles. However,
since the liquidation of the Trust's portfolio in 1993 until September 1996, the
Trust did not pursue its stated investment
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policy. Instead, during such period, the Trust's assets were held in a trust as
a reserve against contingent claims. This contingent claims trust was terminated
in August 1996. In September 1996, the shareholders of the Trust voted to change
the purpose and investment policy of the Trust. In March 1998, the shareholders
of the Trust again voted to change the purpose and investment policy of the
Trust.
As approved by the shareholders of the Trust in March 1998, the purpose and
investment policy of the Trust is to acquire a diverse portfolio of debt and
debt-like interests in real estate or real estate related assets, including to
(i) originate mortgage loans and/or acquire mortgage loans or acquire securities
collateralized, in whole or in part, by mortgage loans, as well as make equity
investments in real estate and real estate-related assets, (ii) acquire direct
or indirect interests in short term, medium and 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 Trust,
(iii) make, hold and dispose of purchase money loans with respect to assets sold
by the Trust, and (iv) acquire positions in non-performing and sub-performing
debt for the purpose of either restructuring it as performing debt or, if such
efforts are unsuccessful, of obtaining shortly thereafter primary management
rights over or equity interests in the underlying assets securing such debt (the
"Diversified Portfolio").
The Trust is restricted from making certain types of investments as a
result of the restrictions and conflicts described below (the "Investment
Restrictions"). These restrictions may limit the flexibility of the Trust 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 Trust, the
Trust 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 debt holder within one (1) 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
Trust or that are acquired as a result of the exercise of remedies in respect of
a loan in which the Trust has an interest) or (iii) selling or contributing to
or acquiring any interests in Starwood Hotels & Resorts Trust, including debt
positions or equity interests obtained by the Trust under, pursuant to or by
reason of the holding of debt positions. None of the Trust's assets constitute
loans to Starwood Hotels & Resorts and its affiliates and the Trust currently
expects that none of its business will be attributable to Starwood Hotels &
Resorts and its affiliates in the future.
The Trust's authority with respect to the Diversified Portfolio includes
the power to acquire, hold, own, develop, redevelop, construct, improve,
maintain, operate, manage, sell, lease, rent, transfer, encumber, mortgage,
convey, exchange and otherwise dispose of or deal with the Diversified Portfolio
and the Diversified Portfolio may be held by the Trust directly or indirectly.
The Board of Trustees has the ultimate authority over the management of the
Trust, the conduct of its affairs and the management and disposition of its
property. The Diversified Portfolio may include controlling or non-controlling
investments in or relating to any general category of real estate assets,
including without limitation, hotel, office, mixed-use, retail,
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industrial, mini-storage and residential improvements to land, excluding any
investments prohibited by the Investment Restrictions.
The Trust currently plans to originate and make investments in various
types of income producing commercial real estate and its investment program will
emphasize senior and junior commercial mortgage loans, including mezzanine
financing (i.e., capital representing the level between 65% and 90% of property
values), higher yielding senior mortgage loans, non-performing or sub-performing
loans and performing and non-performing subordinated interests ("Subordinated
Interests") in commercial mortgage-backed securities ("CMBS"). The Trust
anticipates that a majority of the investments to be held in its portfolio for
the long-term will be structured so that the Trust's investment is subordinate
to third party first mortgage debt but senior to the real estate
owner/operator's equity position. However, the Trust does not have any
prescribed allocation among investments and the Trust could invest all or any
portion of its assets in any investment that would be permitted in the
Diversified Portfolio. The Trust anticipates that it will invest in a diverse
array of real estate-related assets and enterprises that satisfy its investment
criteria including but not limited to the following:
o Mortgage Loans. The Trust will provide 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. They may include projects under
construction, redevelopment or expansion, which may ultimately be refinanced
through more traditional sources once capital improvements are completed.
o Mezzanine Loans. The Trust intends to take advantage of current market
opportunities to provide high-yielding loans that are subordinated to first lien
mortgage loans and secured lien mortgage or a pledge of the ownership interest
in the borrowing property owner ("Mezzanine Loans"). Mezzanine Loans may also
take the form of a preferred equity investment in the borrower with
substantially similar terms.
o Opportunistic Loans and Minority Participations. The Trust intends 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 a
performing obligation. These assets may be priced below book value or have a
deemed book value which is less than reproduction cost.
o Triple Net Leases. The Trust may acquire properties that are subject to
long- term triple net lease arrangements with tenants that the Trust believes to
be creditworthy. In many cases, the fixed stream of payment from such positions
may have similar risk/reward characteristics as the mortgage loans to be
originated by the Trust.
o Subordinated Interests. The Trust may acquire rated and unrated, short
term, medium and long-term real estate related debt securities, including
performing and non-performing Subordinated Interests in CMBS issued in public or
private transactions. CMBS typically are divided into two or more classes,
sometimes called "tranches." The senior classes are higher rated securities,
which are rated from low investment grade (BBB) to higher investment grade
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(AA or AAA). The junior, subordinated classes typically include lower rated,
non-investment grade BB and B classes, and an unrated, higher-yielding, credit
support class (which generally is required to absorb the first losses on the
underlying mortgage loans). The Trust currently anticipates that it may invest
in the non-investment grade tranches of CMBS. However, the Trust had no
investments in Subordinated Interests as of March 13, 1998 and currently
anticipates that investments in CMBS will not comprise a significant part of the
Trust's assets.
See "Investment Portfolio" for a description of the assets held by the
Trust as of March 18, 1998. The investment and financing policies of the Trust
and its policies with respect to all other activities, including its growth,
debt, capitalization, dividends and operating policies, will be 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 the discretion of the Board of Trustees, without a vote of the
Shareholders. A change in these policies could adversely affect the Trust's
financial condition or results of operations or the market price of the Class A
Shares.
The results of the Trust'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 investment opportunities. It may take
considerable time for the Advisor and the Trust to find and consummate
appropriate investments. In general, the availability of desirable investment
opportunities and the results of the Trust's operations will be affected by the
level and volatility of interest rates, by conditions in the financial markets,
and general economic conditions. No assurances can be given that the Trust will
be successful in finding and then acquiring economically desirable assets or
that the assets, once acquired, will maintain their economic desirability.
Messrs. Sternlicht, Sugarman, Dishner, Eilian, Kleeman and Silvey
(collectively the "Starwood Trustees and Officers"), each a Trustee and/or
executive officer of the Trust, directly or indirectly, each have substantial
indirect economic interests in and are officers of certain entities that have
substantial investments in real estate-related assets. In the event the Trust
were to invest in debt or equity interests in properties similar to or in close
proximity to properties owned by these entities, it is possible that the
properties owned by such entities may compete with the properties in which the
Trust has such interests in the future. In this regard, affiliates of the
Advisor have agreed that during the Exclusivity Period, they will not form,
manage, or advise a blind pool investment fund, the primary purpose of which is
to invest in debt (a) that is secured by real estate in the United States, (b)
that has current coupon rates in excess of comparable maturity Treasury spreads
plus 400 basis coupon points, and (c) that has maturities longer than four
years, and which debt otherwise has predominantly debt investment
characteristics. The Exclusivity Period is defined as the period commencing
March 18, 1998 and ending at the earlier of (i) February 27, 2000 or (ii) the
date which is six months after the date on which aggregate proceeds of not less
than $400,000,000 have been raised through one or more public offerings of
stock. In addition, the Trust, on the one hand, and these entities, on the other
hand, may possibly compete with each other in the future with respect to the
acquisition of debt and/or equity interests.
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Although the Trust 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. The
Trust is eligible to and intends to make an election to be taxed as a REIT for
its taxable year beginning January 1, 1998.
Advisory Agreement
In connection with the Recapitalization Transactions, the Trust and the
Advisor entered into an Advisory Agreement pursuant to which the Advisor manages
the investment affairs of the Trust, subject to the Trust'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:
identifying investment opportunities for the Trust; advising the Trust with
respect to and effecting acquisitions and dispositions of the Trust's
investments; monitoring, managing and servicing the Trust's loan portfolio; and
arranging debt financing for the Trust. 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/or the officers of the Trust with respect
to its activities. The Advisor is not responsible for the administration of the
Trust.
Commencing on the 90th day after the consummation of the Recapitalization
Transactions, the Trust will pay the Advisor a quarterly base management fee of
0.3125% (1.25% per annum) of the "Book Equity Value" of the Trust 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, commencing on the 90th day after the consummation of the
Recapitalization Transactions, the Trust will pay the Advisor a quarterly
incentive fee ("Incentive Fee") of five percent (5%) of the Trust's "Adjusted
Net Income" during each quarter that the Adjusted Net Income for such quarter
restated and annualized as an annualized rate of return on the Trust'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) shall not be deducted. In addition, debt that
is exchangeable or convertible into equity securities shall not be 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 will also be reimbursed for certain expenses it incurs on behalf of the
Trust.
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As a result of the delayed commencement of the advisory fee, fees to be
incurred in 1998 will be recognized ratably over the period from March 18, 1998
through December 1998. As a result of this fee deferral, the operating results
of the Trust's calendar 1998 will be greater than they would have been if the
advisory fee had not been deferred and therefore may not be reflective of future
operating results of the Trust.
The Trust may be subject to conflicts of interest with the Advisor because
the Incentive Fee, which is based on the Trust's income, may create an incentive
for the Advisor to recommend investments with greater income potential, which
generally are riskier and more speculative, than would be the case if the fee
did not include a "performance component."
The Advisory Agreement has an initial term of three years subject to
automatic renewal for one year periods unless the Trust 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 Trust 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' notice to the Trust and
the Trust 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 Trust at the time outstanding.
The Trust's investment affairs are managed by the Advisor, subject to the
supervision of the Board of Trustees. Thus, the Trust is dependent on the
services of the Advisor and its officers and employees for the success of the
Trust. The Trust's success depends in part on the continuing ability of the
Advisor to hire and retain knowledgeable personnel. Finally, the Trust is
subject to the risk that the Advisor will terminate the Advisory Agreement and
that no suitable replacement can be found to manage the investment affairs of
the Trust. The Starwood Trustees and Officers directly or indirectly own a
substantial economic and voting interest in the Advisor. The Advisor is a
recently formed entity with no significant assets and no prior history of
operations or experience managing the investment affairs of any other company.
Mr. Sternlicht, Chairman of the Board of Trustees of the Trust, is also Chairman
of the Advisor and Mr. Sugarman, Chief Executive Officer, President and Trustee
of the Trust is also Chief Executive Officer and President of the Advisor. All
investments larger than $10.0 million must be approved by the Board of Trustees,
however, daily operations relating to the investment affairs between the Trust
and the Advisor and its affiliates are not be required to be approved by a
majority of the independent Trustees. Instead, the majority of the independent
Trustees will establish general guidelines for the Trust's investments and
borrowings. The independent Trustees will review transactions engaged in by the
Trust to monitor the activities of the Advisor on a regular basis. Moreover, the
independent Trustees will review the Trust's investment policies annually. In
conducting this review, the independent Trustees will rely primarily on
information provided to them by the Advisor.
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License Agreement
The Trust licenses the Starwood trademark from Starwood Capital Group,
L.L.C. pursuant to a Trademark License Agreement. The Trust pays Starwood
Capital Group, L.L.C. a royalty of $1.00 per year for use of the Starwood
trademark. Starwood Capital Group, L.L.C. may terminate the Trademark License
Agreement on 30 days' written notice; provided, that, Starwood Capital Group
L.L.C. may not terminate the Trademark License Agreement if (i) the Advisory
Agreement is in effect; (ii) the Trust is not in default under the Advisory
Agreement; and (iii) Mezzanine and SOF IV own in the aggregate more than 50% of
the Class A Shares. Notwithstanding the foregoing, Starwood Capital Group,
L.L.C. can terminate the Trademark License Agreement if the Trust engages in
activities other than the acquisition, origination, ownership or servicing of
debt investments or investments that are primarily debt-like in nature. In the
event the Trademark License Agreement is terminated, the Trust would have to
cease using the Starwood name and would have to change its name so that it no
longer included "Starwood."
Underwriting Policy and Procedures
The Trust acquired substantially all of its assets in March 1998 in the
Recapitalization Transactions. The Trust had no full underwriting policies and
procedures prior to the consummation of the Recapitalization Transactions. The
Trust will manage credit risk through its underwriting procedures, centralized
approval of individual transactions and active portfolio and account management.
As part of its underwriting process, the Trust reviews historical and projected
financial information relating to the properties underlying its loan
investments, 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 Trust's management of credit risk is on the financial
performance, sufficiency and credit quality of the collateral underlying the
Trust's loans and the ability of the related borrower to meet interest and
principal payments on such loans through cash flows from the collateral.
Additionally, the Trust reviews the credit history and character of each
borrower with respect to such borrower's past borrowings. Credit risk is also
actively managed through portfolio diversification by industry, geographic
region and individual borrower exposure, as well as regular monitoring of
collateral performance through intensive servicing and asset management
procedures.
Investment Portfolio
As of December 31, 1997 and from such date until the consummation of the
Recapitalization Transactions, the Trust's assets were primarily short term
liquid real estate investments, cash and cash equivalents, some of which were
held indirectly through the Partnership which was liquidated in connection with
the Recapitalization Transactions with all of its assets distributed to the
Trust. On March 18, 1998, the Trust acquired the portfolio of mortgage and
partnership loans and leases secured by residential, hotel, office and mixed use
real estate and other assets, a portfolio of first mortgage loans and rights
under certain letters of intent.
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The following is a summary description of the Assets contributed to the Trust in
the Recapitalization Transactions as of March 18, 1998 (in thousands):
<TABLE>
<CAPTION>
Current Original
Number of Balance of Original
Underlying Borrowers Commitment Balances Ascribed Maturities
Investment Class Property Type In Class(a) Amount Outstanding Value Dates
- ---------------- ------------- ----------- ----------- -------------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Senior Mortgages Office/Hotel/ 8 $ 502,114 $445,614 $ 449,796 1999-2004
Mixed Use/
Apartment
Subordinated Mortgages Office/Hotel 5 175,375 155,538 184,320 2002 to 2005
Resort/Planned
Communities
Opportunistic Mortgages Office/Hotel/ 2 166,644 132,427 81,057 1999 and 2007
Apartment
Unsecured Notes Office/Hotel 2 27,300 27,300 30,850 2002 and 2004
Construction Loans Assisted 2 92,390 85,471 91,985 1999 and 2004
Living/Resorts
Real Estate Under Hotels 1 N/A(3) N/A(3) 195,470 N/A(3)
Long-Term Master Lease
Loan Participations Various 3 22,656 22,534 13,660 1999 and 2000
Other Real Estate
Related Investments Public bonds 2 43,150 43,150 2002 and 2007
-------- ----------
Total 25 $1,094,670
======== ==========
===========================[SPLIT TABLE========================================
Interest Interest
Underlying Accrual Payment Principal Participation
Investment Class Property Type Rates(4) Rates(4) Amortization Features
- ---------------- ------------- ---------------- ----------------- --------- -------------
<S> <C> <C> <C> <C> <C>
Senior Mortgages Office/Hotel/ Fixed: 8.97 to 1 Fixed: 8.0-10.82% Yes (1) Yes (2)
Mixed Use/ Variable: LIBOR+ Variable: LIBOR+
Apartment 1.25 to 3.25% 1.25 to 3.25%
Subordinated Mortgages Office/Hotel Fixed 10.0 to Fixed 10.0 to Yes (1) Yes (2)
Resort/Planned 15.25% 15.25%
Communities
Opportunistic Mortgages Office/Hotel/ 6.0 to 7.0% 6.0 to 7.0% Yes (1) Yes (2)
Apartment
Unsecured Notes Office/Hotel 11.25% to 15.0% 11.25% to 15.0% No Yes (2)
Construction Loans Assisted 12.0 to 12.5% 10.0 to 12.5% No No
Living/Resorts
Real Estate Under Hotels N/A(3) N/A(3) N/A(3) N/A(3)
Long-Term Master Lease
Loan Participations Various Fixed: 7.13% Fixed: 5.45 to Yes(1) Yes
Variable: LIBOR+ 6.40%
.58 to 1.75% Variable: LIBOR+
.58 to 1.75%
Other Real Estate No
Related Investments Public bonds 12.5 to 12.75% 12.5 to 12.75% No
</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 for 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 lease of 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, 2010, and can be extended
for up to five, five-year terms at 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 of the twelve months ended September 30, 1996.
(4) All variable rate loans are based on 30-day LIBOR and reprice monthly.
12
<PAGE>
The following summarizes information relating to concentration and significant
terms within the portfolio of assets contributed in the Recapitalization
Transactions based on ascribed values:
Concentration by size:
Ascribed Value %
------------------------ ------------
(In thousands)
RLH (operating lease) $ 195,470 17.9%
Borrower A (senior and subordinate) 127,450 11.6%
Borrower B (senior and subordinate) 116,137 10.6%
----------------------- --------------
All other loans/investments 655,613 59.9%
----------------------- --------------
$ 1,094,670 100.0%
The RLH operating lease is discussed in detail under "Real Estate Under
Long-Term Operating Lease" as the sole asset group in that class.
The loans to Borrower A represent five first mortgage notes and a second
mortgage residual note which are cross-collateralized by over 1.1 million square
feet of office properties located in Seattle, WA and are personally guaranteed
by the borrower. The loans mature on December 31, 1999. In addition to the five
primary assets, additional collateral includes second or third mortgages on
three office buildings also located in Seattle. The subordinated loan was
acquired at a substantial discount to its face amount. Of the total principal
amount, $97 million was allocated to the first mortgage positions, while $54
million was allocated to a residual note. The $97 million first mortgage
amortizes on a 25-year schedule and bears interest at the rate of LIBOR plus 125
basis points. The second mortgage bears interest at the rate of 7%. The loans
are prepayable at any time without penalty.
The non-recourse loans to Borrower B mature on April 30, 2002 and are
secured by office properties containing 1.1 million square feet located in San
Diego, CA. The loans consist of a $74.3 million variable rate senior mortgage
and a $34.8 million subordinate mortgage bearing interest at 12.0%. The loans
are prepayable subject to certain yield maintenance provisions on the
subordinate mortgage.
Concentration by underlying asset/collateral type:
Ascribed Value %
---------------------------------- ----------------------
(In thousands)
Office $ 516,099 47.1%
Hotel/Resorts 379,842 34.7%
Residential 118,029 10.8%
---------------------------------- ----------------------
Other 80,700 7.4%
---------------------------------- ----------------------
$ 1,094,670 100.0%
================================== ======================
13
<PAGE>
For this purpose, the ascribed 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:
Ascribed Value %
----------------------- ------------------
(In Thousands)
California $ 237,316 21.7%
Washington 203,273 18.6%
New York 123,352 11.3%
Texas 108,679 9.9%
Florida 91,985 8.4%
Massachusetts 60,485 5.5%
Maryland 60,440 5.5%
Colorado 59,767 5.5%
All other states combined 85,021 7.8%
----------------------- ------------------
Corporate obligations 64,352 5.9%
----------------------- ------------------
$ 1,094,670 100.0%
======================= ==================
Summary of recourse provisions:
<TABLE>
<CAPTION>
Ascribed Value %
------------------------- -----------
(In thousands)
<S> <C> <C>
Non-recourse - secured by real estate $ 676,940 61.8%
Recourse (including operating lease assets) 339,348 31.0%
Corporate obligations 64,352 5.9%
------------------------- -----------
Non-recourse - secured by partnership interests 14,030 1.3%
------------------------- -----------
$ 1,094,670 100.0%
</TABLE>
14
<PAGE>
Summary of prepayment terms:
<TABLE>
<CAPTION>
Ascribed Value %
------------------------ -----------------
(In thousands)
<S> <C> <C>
Long-term operating lease - generally not prepayable $ 195,470 17.9%
Lock-out for greater than 70% of original term with 8%
yield maintenance or other prepayment premiums on
a substantial portion of remaining term 249,670 22.
Lock-out for greater than 70% of original term, 2%
prepayable thereafter without premium 24,489 2.
Yield maintenance 142,565 13.0%
Other prepayment premiums 129,920 11.9%
------------------------ -----------------
No significant prepayment protection 352,556 32.2%
------------------------ -----------------
$ 1,094,670 100.0%
======================== =================
</TABLE>
As of December 31, 1997, the Trust's primary investments are primarily
government or government sponsored instruments such as the Government National
Mortgage Association (GNMA), Federal National Mortgage Association (FNMA) and
Federal Home Loan Mortgage (FHLMC). Certain of these investments were acquired
at premiums or discounts based on current market rates and expected prepayment
rates. To the extent that prepayments exceed those expected, actual yields will
decrease for premium investments and increase for discount investments. To the
extent that prepayments are less than those expected, actual yields will
increase for premium investments and decrease for discount investments.
With respect to the assets contributed to Trust in the Recapitalization
Transactions, the majority of these loans are subject to substantial prepayment
protection in the form of lock-outs, yield maintenance provisions or other
prepayment premiums which provide protection to the Trust. Those assets not
subject to prepayment penalties include: (i) variable rate mortgages based on
LIBOR, contributed at par, which would not result in any gain or loss upon
repayment; and (ii) opportunistic loans/loan participations acquired at
discounts to face values, which would result in gains upon repayment.
The loans without substantial prepayment protection primarily represent
variable rate senior mortgages or opportunistic loans/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.
15
<PAGE>
Summary of interest characteristics:
Ascribed Value %
------------------- ----------------
(In thousands)
Fixed rate investments $ 750,511 68.6%
Variable rate investments 344,159 31.4%
------------------- ----------------
$ 1,094,670 100.0%
=================== ================
For this purpose, fixed rate investments are considered to include the real
estate assets under long-term operating lease under which the Trust 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 reset monthly.
Summary of subordination and default characteristics:
The Company holds both the senior and the subordinated mortgages with
respect to the non-recourse loans to Borrower A and Borrower B. The Company has
all rights as a mortgage holder and under the uniform commercial code with
respect to the properties underlying these mortgages in the event of a default.
The Company's rights with respect to the property underlying these investments
are not subordinated to any other lender of borrowed money.
Summary of delinquencies and possible losses
As of December 31, 1997, the Trust's primary investments are primarily
government or government sponsored instruments and, as a result, have no recent
delinquency or loss experience. 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 have not
experienced any significant delinquencies or losses on any loan investment,
including those contributed to the Trust. Although no such issues were
identified with respect to specific loan investments contributed, the
possibility of delinquencies and losses were considered in evaluating the terms
of the Recapitalization Transactions. There can be no assurances that
delinquencies or losses will not be experienced by the Trust in the future with
respect to the contributed investments or other investments originated or
acquired by the Trust.
Senior Mortgage Loans
Description of Senior Mortgage Loans and the Collateral. There are eight
(8) loans (the "Senior Mortgage Loans") in this category with an aggregate
original principal balance of $502,114,000 and approximately $445,614,000
outstanding as of March 18, 1998. The Senior
16
<PAGE>
Mortgage Loans bear interest at either a fixed rate per annum or a variable rate
based on LIBOR plus an additional specified amount, requiring either monthly
interest payments or specified amortization payments. One of the Senior Mortgage
Loans 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 Mortgage Loans are generally
secured by mortgages encumbering real properties comprised of a resort
conference center in New York, office buildings in Seattle, Washington, a mixed
use complex in New York, office buildings in Houston, Texas 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 and certain pledges of partnership interests.
Maturity Date and Prepayment Terms. The Senior Mortgage Loans have maturity
dates that range from December, 1999 to December, 2007, with certain extension
rights in some cases. Two (2) of the Senior Mortgage Loans are subject to a
prepayment lock-out period during which time such loans may not be prepaid.
Otherwise, the remaining Senior Mortgage Loans are generally prepayable at
certain specified dates and in certain 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 Mortgage Loans require
payments of participating equity based on specified percentages of cash flow,
property appreciation and a share of funds maintained in certain reserve
accounts.
Limited Non-Recourse. The Senior Mortgage Loans are generally nonrecourse
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 Mortgage Loans is fully recoursed against the
borrower.
Cross-Default Provisions. Two (2) of the Senior Mortgage Loans are cross-
defaulted with certain lines of credit or loans made to the borrower under such
lines of credit or loans from different lenders.
Prohibition on Sale, Encumbrance and Transfer. The Senior Mortgage Loans
generally prohibit the transfer, sale or encumbrance of the real properties or
interests in the borrowers related to such Senior Mortgage Loans, with certain
specified exceptions.
Guaranties. Some of the Senior Mortgage Loans are supported by certain
secured, limited recourse guaranties of payment and performance.
Environmental Indemnity. Certain of the Senior Mortgage Loans are supported
by environmental indemnities.
17
<PAGE>
Subordinate Financing. Three (3) of the Senior Mortgage Loans are subject
to junior financing in the aggregate original principal amount of $131,935,000
which are part of the Subordinate Mortgage Loans and the Opportunistic Mortgage
Loans that are a part of this portfolio and are referred to below. One (1) of
the other Senior Mortgage Loans 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 this portfolio. Currently, both such tranches are
secured by a senior mortgage lien.
Forward Additional Loan Commitment. One (1) of the Senior Mortgage Loans
includes an additional commitment for an additional loan of up to $25,000,000 as
construction financing, subject to the satisfaction of certain specified
conditions.
Subordinate Mortgage Loans
Description of Subordinate Mortgage Loans and the Collateral. There are
five (5) loans (the "Subordinate Mortgage Loans") in this category with an
aggregate principal balance of $175,375,000 and approximately $155,538,000
outstanding as of March 18, 1998. The Subordinate Mortgage Loans bear interest
at either fixed or variable rates per annum requiring either monthly interest
payments or specified amortization payments. Under some of the Subordinate
Mortgage Loans, if for any month the interest paid is less than a specified
amount, the difference shall accrue interest at a specified fixed rate per
annum, or cash flow from subsequent months must be deposited into specified
interest accounts to cover previous interest payments that are not paid. The
Subordinate Mortgage Loans are secured by mortgages encumbering real properties
comprised of fifteen (15) hotels located in seven (7) states, fee and ground
leasehold interests in a mixed use complex of office, retail and hotel space in
Washington, D.C., office buildings in Houston, Texas and Dallas, Texas, and an
office portfolio in San Diego, California.
Maturity Date and Prepayment Terms. The Subordinate Mortgage Loans have
maturity dates that range from May, 2002, to December, 2007, subject to
extension in certain cases. Some of the Subordinate Mortgage 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 Subordinate Mortgage Loans,
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 Subordinate Mortgage Loans are generally
nonrecourse 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.
Prohibition on Sale, Encumbrances and Transfer. The Subordinate Mortgage
Loans generally prohibit the transfer, sale or encumbrance or release of the
real properties or interests in the borrowers related to such Subordinate
Mortgage Loans, with certain specified exceptions.
18
<PAGE>
Environmental Indemnity. Certain of the Subordinate Mortgage Loans are
supported by environmental indemnities.
Existing Senior Financing. Two (2) of the Subordinate Mortgage Loans are
subject to senior financing in the aggregate original principal amount of
$217,700,060 which are part of the Senior Mortgage Loans that are a part of this
portfolio and are referred to herein. The other two (2) Subordinate Mortgage
Loans are subject to senior financing in the aggregate original principal amount
of $205,000,000 which are not a part of this 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.
Management of Hotels. Management of the hotel real properties securing the
Subordinated Mortgage Loans are generally governed by management agreements.
Cross-Default Provisions. One (1) of the Subordinate Mortgage Loans is
cross- defaulted with certain loans entered into by certain partners of the
borrower for such Subordinate Mortgage Loan.
Purchased Promissory Note. One (1) of the promissory notes evidencing a
Subordinate Mortgage Loan was purchased from a third party lending institution.
The original lender has been indemnified for claims relating to acts of the
purchasing lender in connection with the note sale agreement, the debt evidenced
by the subject promissory note, the use or ownership of the real property
securing such note, and any contingency fee contracts with attorneys or
collection agencies.
Guaranties. One (1) of the Subordinate Mortgage Loans is supported by
certain secured, limited recourse unconditional guaranties of payment and
performance, and other limited guaranties of payment and performance.
Participating Equity Interest. One (1) of the Subordinate Mortgage Loans
requires payments of participating equity, 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.
Opportunistic Mortgage Loans
Description of Opportunistic Mortgage Loans. The two (2) loans (the
"Opportunistic Loans") in this category consists of (i) debt (the "Middle
Tranche") with an original principal balance of $72,400,000, secured by, among
other non-real property collateral, a second lien mortgage encumbering a
combination hotel and apartment building in Denver, Colorado and a 50% interest
in an unconsolidated partnership holding debt (the "Junior Tranche") with an
original principal balance of $79,868,613, secured by a third lien mortgage
encumbering the same combined hotel and apartment building and (ii) subordinate
debt with an original principal
19
<PAGE>
balance of $54.3 million secured by five buildings in Seattle, Washington. The
Opportunistic Loans bear interest at fixed or variable rates per annum. 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 Opportunistic Loans have maturity
dates ranging from December, 1999 to June, 2007, with certain rights for
extensions. The Opportunistic Loans 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 Opportunistic Loans are fully recourse to the borrower
thereunder.
Prohibition on Sale, Encumbrance and Transfer. The Opportunistic Loans
generally prohibit the transfer, sale or encumbrance of the real property or
interests in the borrower related to such Opportunistic Loan, with certain
specified exceptions.
Repayment Guaranty. One of the Opportunistic Loans is supported by a
repayment guaranty, which guaranty terminates upon payment in full of the 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 Opportunistic Loans is subject to the terms
of a buy/sell agreement pursuant to which, upon the occurrence of certain
events, the borrower under the Opportunistic Loan would be required to either
agree to buy certain interests or to sell to certain interests in the underlying
collateral. Certain 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 borrower under the
Opportunistic Loans initiates this latter two-way buy/sell option, it must
prepay the Middle Tranche in full.
Senior Financing and Intercreditor Agreement. The underlying collateral is
subject to senior financing in the aggregate original amount of $65,000,000
which is not part of the portfolio and $94,700,000 of which is part of the
portfolio. The rights between senior and junior lenders are generally governed
by specified intercreditor agreements which provides 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 Opportunistic Loans 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 Middle Tranche in the event of
a default thereunder.
20
<PAGE>
Unsecured Loans
Description of Unsecured Loans and the Collateral. There are two (2) loans
(the "Unsecured Loans") in this category with an aggregate original and current
principal balance of $27,300,000. The Unsecured Loans bear interest at fixed
rates per annum, requiring monthly interest payments. The Unsecured Loans 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 Unsecured Loans consist of mixed office and retail
in New York, New York and twenty-one (21) hotel sites in Georgia, Maryland,
North Carolina, Pennsylvania, Tennessee, and Virginia.
Maturity and Prepayment Terms. The Unsecured Loans have maturity dates that
range from April, 2002 to January, 2004. Some of the Unsecured 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 Unsecured 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 Unsecured Loans require payments
of participating equity based on specified percentages of cash flow and net
proceeds from sale or refinancings generated from properties related to the
Unsecured Loans.
Prohibition on Sale, Encumbrance and Transfer. The Unsecured Loans generally
prohibit the transfer, sale or encumbrance of the real properties or interests
in the borrowers related to such Unsecured Loan, with certain specified
exceptions.
Recourse Loan. The Unsecured Loans 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 carveouts.
Guarantees. Some of the Unsecured Loans are supported by secured or
unsecured guarantees, subject to specified recourse limitations as to the
guarantor.
Environmental Indemnity. Some of the Unsecured Loans are supported by
environmental indemnities.
Existing Senior Loans on the Real Property. The real properties owned by
the borrowers under the Unsecured Loans are subject to senior financing in the
aggregate original amount of $107,800,000 which is not being contributed to the
Trust. The rights between senior and junior lenders are generally governed by
specified intercreditor agreements.
Construction Loans
Description of Construction Loans and the Collateral. There are two (2)
loans (the "Constructions Loans") in this category with an aggregate available
original principal balance of
21
<PAGE>
$92,390,000, of which approximately $6,459,000 had not yet been funded as of
March 18, 1998. The Construction Loans are to be disbursed in accordance with
certain approved construction disbursement schedules and budgets. The
Construction Loans bear interest at fixed rates per annum, requiring monthly
interest payments in specified amounts. The Construction Loans are secured by
mortgages encumbering real properties comprised of a to-be-built condominium
project and a to-be-built luxury resort hotel, conference center and beach club,
and golf course both located in Florida, along with certain other partnership
and stock collateral. One (1) 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 July, 2004. 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.
Guarantees. The Construction Loans are supported by repayment and/or
completion guarantees. 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.
Environmental Indemnity. The Construction Loans are supported by
environmental indemnities. A maintenance building on one of the real properties
securing one of the Construction Loans on which a golf course will be developed
is subject to environmental contamination, and such portion of real property is
the subject of a monitoring and remediation plan.
Prohibition on Sale, Encumbrance and Transfer. The Construction Loans
generally prohibit the transfer, sale or encumbrance of the real properties or
interests in the borrowers related to such Construction Loans, with certain
specified exceptions.
Senior Encumbrances. A portion of the real property securing one of the
Construction Loans is subject to certain senior mortgages thereon, including
portions of the property on which a condominium project will be developed.
22
<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 seventeen (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 Landlord (as
defined). 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 shall be the property of Tenant and to fund an FF&E
reserve account. The Tenant is required to indemnify the Landlord 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 employment
of any person(s) at the leased premises. Doubletree Corporation has executed a
full guarantee 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 2010,
including five (5) automatic 5-year extension terms unless a proper termination
notice is delivered by the Tenant. The final expiration of the RLH Lease,
assuming all extensions would be in 2035.
Organization. RLH Partnership, L.P., a Delaware limited partnership (the
"Landlord") is the fee owner or ground lessee of the RLH Properties. The general
partner of the Landlord is Red Lion G.P., Inc. and the limited partner is RLH
Net Lease Investment, LLC ("RLH Net"), each of which is wholly owned by a
subsidiary of the Trust. RLH Net is also the sole stockholder of Red Lion G.P.,
Inc. A subsidiary of the Trust has a 99% membership interest in RLH Net and is
the controlling entity of the interest.
Base and Percentage Rent. Landlord collects a specified annual base rent
payable quarterly 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.
Operation and Maintenance. Tenant is obligated to keep and maintain the
Leased Hotels in at least as good condition as existed on the commencement date.
Tenant is responsible for the payment of all costs and expenses incurred in the
use, operation or maintenance of the leased premises, including rents and other
amounts owed under any ground lease management fees real estate taxes,
insurance, supplies and materials, the cost of all maintenance, janitorial,
security and service agreements, electricity, water and any other utilities
supplied to the leased premises.
Limited Nonrecourse to Landlord. Any claim based on the Landlord's
liability under the RLH Lease shall be enforced against the leased premises and
not against any other tangible or intangible assets, properties or funds of the
Landlord; provided, however, if, as a result of a
23
<PAGE>
judicial foreclosure of any mortgage, the Landlord's interest in any Leased
Hotel is transferred to a mortgagee or other entity, and at such foreclosure
Tenant has a legal proceeding against the Landlord, Tenant shall have the right
to enforce any judgment from any assets or other properties of the Landlord.
The underlying real estate is comprised of the following hotel properties:
<TABLE>
<CAPTION>
For the year ended December 31, 1997
-------------------------------------------------------------
Number of Average Daily Average
Rooms Rate Occupancy
--------- ------------- ---------
<S> <C> <C> <C>
Seattle, Washington 850 $93.59 71.3%
Salt Lake City, Utah 497 101.96 78.5%
Sacramento, California 376 67.05 77.1%
San Diego, California 300 96.36 75.4%
Sonoma, California 245 88.54 68.1%
Medford, Oregon 186 63.80 64.8%
Boise, Idaho 182 58.16 74.4%
Pendleton, Oregon 168 65.09 52.7%
Kelso, Washington 162 65.25 60.5%
Vancouver, Washington 160 81.86 67.2%
Durango, Colorado 159 98.44 59.7%
Wenatchee, Washington 149 48.42 75.0%
Coos Bay, Oregon 143 61.51 62.7%
Eugene, Oregon 137 63.45 64.3%
Astoria, Oregon 124 68.02 45.2%
Missoula, Montana 76 50.15 67.5%
Bend, Oregon 75 59.34 63.8%
---------------
3,989
===============
</TABLE>
Loan Participations
Description of Participation Loans and the Collateral. There are three (3)
loans (the "Participation Loans") in this category which are Participations in
loans that have an aggregate original principal balance of $22,656,000. The
interest in each of the Participation Loans is limited to a certain specified
participation percentage. The Participation Loans bear interest at either a
variable rate per annum based on LIBOR plus an additional specified amount, or
at fixed rates per annum subject to certain scheduled increases, and requiring
either no monthly
24
<PAGE>
payments, monthly interest payments or specified amortization payments. The
Participation Loans are secured by mortgages encumbering real properties
comprised of an office building in New York, New York, an office building in
Rockville, Maryland, 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, 2000. 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 (1) of the Participation Loans requires
payment of participating equity upon the sale or refinancing of the real
property securing such loan.
Other
This category generally includes publicly traded bonds with a market value
of approximately $47.5 million of two issuers, one of which matures in May 2002
with a coupon of 12.75% per annum that pays semi-annually and the other which
matures in March 2007 with a coupon of 12.5% per annum that pays semi-annually.
Letters of Intent
In addition to the assets described above, SOF IV also contributed to the
Trust its rights under certain letters of intent. The letters of intent are
non-binding obligations to originate or acquire mortgages on office, residential
and hotel properties. There can be no assurance that definitive agreements with
respect to the transactions contemplated by the letters of intent will be
executed on the terms set forth in the letters of intent or at all, and if
executed that such transactions will be consummated.
The Partnership
Prior to its termination on March 18, 1998, the Partnership was a limited
partnership organized under the Delaware Revised Uniform Limited Partnership
Act. The Trust was the sole general partner and Mezzanine was the sole limited
partner of the Partnership with 8.05% and 91.95% interests in the Partnership,
respectively. On March 18, 1998, Mezzanine exchanged all of its Units in the
Partnership for 4,568,944 Class A Shares. Upon completing this exchange, the
Trust was the sole partner in the Partnership and Partnership was terminated and
its assets and liabilities were distributed to the Trust.
25
<PAGE>
Competition
The Trust is engaged in a highly competitive business. In originating and
acquiring assets, the Trust 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 Trust, and others may be organized in the
future. The existing participants and potential new entrants compete with the
Trust for the available supply of investments suitable for acquisition or
origination by the Trust 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 Trust's anticipated competitors are larger than the Trust, 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 Trust, and may have other advantages over the Trust in conducting certain
businesses and providing certain services.
Qualification as a REIT
The Trust did not meet the qualification requirements of a REIT under
Sections 856-860 of the Internal Revenue Code of 1986, as amended (the "Code")
for the years 1993 through 1997, the Trust is eligible to and intends to elect
REIT status in 1998. As a REIT, the Trust will generally not be subject to
federal income tax on that portion of its real estate investment trust taxable
income which is distributed to its shareholders.
Unfunded Commitments
The Trust had no unfunded commitments as of December 31, 1997.
Employees
As of December 31, 1997 the Trust had no employees.
PART II
ITEM 6. SELECTED FINANCIAL DATA
In response to comments received from the Securities and Exchange
Commission, the Trust hereby amends Item 6. Selected Financial Data of Part II
of the Annual Report by deleting all of the information under such Item and
inserting in lieu thereof the following:
26
<PAGE>
The following tables set forth the selected financial information for the
Trust on a historical and pro forma basis. As more fully described in Note 8 to
the Consolidated Financial Statements, pro forma information includes the
effects of the following: (i) the Recapitalization Transactions; (ii) the
exchange of each outstanding Unit held by holders other than the Trust for one
Class A Share; (iii) liquidation and termination of the Partnership; and (iv)
borrowings necessary to consummate the aforementioned transactions
(collectively, the "Transactions"). The pro forma operating data for the year
ended December 31, 1997 is presented as if the Transactions had been completed
on January 1, 1997 and the pro forma balance sheet due data is presented as if
the Transactions had been completed on December 31, 1997.
27
<PAGE>
The selected financial information on the following page should be read in
conjunction with the discussions set forth in "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and the financial
statements included elsewhere in this filing. The pro forma information is not
necessarily indicative of what the actual financial position and results of
operations of the Trust would have been as of and for the periods indicated, nor
does it purport to represent the future position or results of operations for
future periods.
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------------------------------------------
Pro Forma Historical
---------------------------------------------------------------------------------------
1997 1997 1996 1995 1994 1993
---- ---- ---- ---- ---- ----
(in thousands except per share data)
<S> <C> <C> <C> <C> <C> <C>
Operating Data (1)
Interest income $ 61,956 $ 896 $ 478 $ 145 $ 296 $ 2,185
Prepayment and participation income 25,137 985 - - - -
Gain from sale of mortgages - - - - - 2,545(2)
Rental income 15,311 - - - - -
Other income 887 6 10 3 - -
------- ----- --- --- --- -----
Total revenue 103,291 1,887 488 148 296 4,730
------- ----- --- --- --- -----
Interest expense 23,151 - 272 - 270 -
Depreciation and amortization 6,875 - - - - -
General and administrative expense 1,510 461 639 283 356 982
Management/advisory fee 8,143 - - - - -
Other expenses 2,117 - - - - -
------- ----- --- --- --- -----
Total expenses 41,796 461 911 283 626 982
------- ----- --- --- --- -----
Net income (loss) before minority
interest in Partnership 61,495 1,426 (423) (135) (330) 3,748
Minority interest in Partnership (3) - (1,415) (154) - - -
------- ------- ------- ------ ------ ------
Net income (loss) $61,495 $ 11 $ (577) $(135) $(330) $3,478
======= ======= ======= ======= ======= ======
Earnings per Class A Share (4) $ 0.20 $ 0.00 $(0.22) $(0.05) $(0.13) $ 1.45
======= ======= ======= ======= ======= ======
Supplemental Data:
Funds from operations (5) (6) 70,087 1,426 (423) (135) (330) 1,203
Cash flows from:
Operating activities 3,166 (227) (184) (397) 2,531
Investing activities (6,013) (522) 175 (1,371) 39,400
Financial activities 3,029 - - 101 (39,503)
Dividends - - - - 38,639
Dividends per share $ - $ - $ - $ - $ 15.00(7)
28
<PAGE>
As of December 31,
---------------------------------------------------------------------------------------
Pro Forma Historical
---------------------------------------------------------------------------------------
1997 1997 1996 1995 1994 1993
---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Real estate investments $ 1,073,877$ 11,175$ 5,481 $ 1,196 $ 1,371$ -
Total assets 1,096,676 13,441 5,674 2,194 2,372 2,680
Debt obligations 350,000 - - - - -
Minority interest in consolidation entities - 5,175 3,917 - - -
Shareholders' equity 742,206 6,351 1,578 2,155 2,290 2,519
</TABLE>
Explanatory Notes:
(1) As a result of the sale of a substantial portion of the Trust's assets
and related distribution of the proceeds in 1993, the Trust's ongoing
investment operations were substantially reduced.
(2) During 1993, the Trust sold its entire remaining portfolio then
consisting of four mortgage loans resulting in proceeds in excess of
carrying values and obligations of approximately $2.5 million.
(3) Represents the minority interest in the Partnership which were
converted into Class A Shares on March 18, 1998, upon which date the
Partnership was liquidated and terminated.
(4) Earnings per Class A Share is calculated based on the weighted average
shares outstanding during each of the periods after deduction for the
Class B Shares 1% interest.
(5) Management generally considers funds from operations ("FFO") to be one
measure of the financial performance of a REIT which provides a
relevant basis for comparisons among REITs and it is presented to
assist investors in analyzing the performance of the Trust. 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
is defined as income before minority interest (computed in accordance
with generally accepted accounting principles), excluding gains
(losses) from debt restructuring and sales of property, provisions for
losses and real estate related depreciation and amortization
(excluding amortization of financing costs). 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 Trust's financial
performance or as an alternative to cash flows from operating,
investing, and financing as measures of liquidity.
(6) Pro forma FFO may differ from actual cash available for distribution
to shareholders 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.
These include such items as amortization of premiums or discounts on
loan investments, 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. (7) Includes a
$14.50 per Class A Share distribution paid in November 1993 from the
proceeds as a result of the sale of substantially all of the Trust's
remaining real estate loan investments.
29
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In response to comments received from the Securities and Exchange
Commission, the Trust hereby amends Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations of Part II of the Annual Report
by deleting the text thereunder and inserting in lieu thereof the following:
General
The Trust's primary source of cash during 1997 and 1996 was from income
earned on its interest in the participation certificates in the Warwick Hotel
mortgage note and certain investments in government or government sponsored
securities as well as short term cash investments. The Trust's primary source of
cash in 1995 was from income earned on its investments in government or
government sponsored securities and short term cash investments.
During 1995 and the first three quarters of 1996, the Trust's only
investment activities were purchases of government obligations. Consequently,
its operations during 1995 and the first three quarters 1996 consisted solely of
interest income from these obligations and the payment of administrative
expenses.
On March 15, 1994, the Trust announced that it had entered into an
agreement with SAHI and SAHI, Inc. for the sale of warrants for the right to
purchase five million Class A Shares at a price of $1 per share and 2,500,000
Class B Shares for a price of $0.01 per share. SAHI and SAHI, Inc. purchased the
warrants for $101,000, which amount was applied against the purchase price of
the first Class A and Class B Shares purchased pursuant to the warrant.
On September 26, 1996, the Trust became sole general partner of the
Partnership by contributing $400,000 in cash, in exchange for a 8.05% interest
in the Partnership evidenced by 400,000 Units. 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
Trust at approximately $4.6 million at the time of contribution. Mezzanine's
Units were converted into Class A Shares on March 18, 1998 on a one-for-one
basis and the Partnership was terminated.
On January 22, 1997, Mezzanine exercised its rights under a warrant to
acquire 5,000,000 Class A Shares. In addition, SAHI, Inc. exercised its rights
under the warrant to acquire 2,500,000 Class B Shares. As a result of the
exercise of the warrants, the Trust's capital increased by $5,025,000, and funds
from this capitalization were used to purchase short-term government securities.
On October 1, 1997 the Warwick Hotel note was repaid and the $4.5 million
of proceeds were invested in government securities that matured in December
1997.
30
<PAGE>
As more fully discussed in Note 7 to the Trust's consolidated financial
statements, for fiscal years 1993 to 1997 the Trust did not qualify as a REIT,
however, the Trust intends to elect to qualify as a REIT under the Code for its
1998 taxable year and, as such, anticipates distributing annually at least 95%
of its taxable income, subject to certain adjustments. Cash for such
distributions is expected to be generated from the Trust's operations, although
the Trust may borrow funds to make distributions. The Trust's operations for any
period may be affected by a number of factors including the investment assets
held, the operations of the collateral underlying secured loans or the business
of the borrowers with respect to unsecured loans or the interest rate
environment.
The Trust consummated the Recapitalization Transactions in March 1998. The
Recapitalization Transactions were approved by the Trust's shareholders at a
meeting held on March 13, 1998. Prior to the consummation of the
Recapitalization Transactions, the Trust's assets primarily consisted of
approximately $11.0 million in short-term, liquid real estate investments, cash
and cash-equivalents. The Recapitalization Transactions were primarily
undertaken for a number of reasons including the following business purposes:
(i) the consummation of the Recapitalization Transactions increased the real
estate loan and related assets held by the Trust from approximately $10 million
to over $1 billion and were accretive to the net tangible book value per Class A
Share; (ii) the belief that the implementation of the Recapitalization
Transactions would provide the Shareholders with a potential for growth of their
investment and overall return; and (iii) the ability of the Trust to implement
its investment policy and purpose as a result of the consummation of the
Recapitalization Transactions.
The Recapitalization Transactions and other related transactions will
materially impact the future operations of the Trust. Accordingly the reported
financial information is not believed to be indicative of the Trust's future
operating results or financial condition.
Liquidity and Capital Resources
The Trust requires capital to fund its real estate-related investments and
operating expenses. The Trust's capital sources upon consummation of the
Recapitalization Transactions include cash flow from operations, borrowings
under lines of credit arranged concurrently with the transactions, additional
bank borrowings, mortgage loans on the Trust's real estate and future equity
offerings.
Concurrently with the Recapitalization Transactions, the Trust entered into
bank credit agreements under which the Trust may currently 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 previously described) and provide
working capital to fund new loan originations and for the other general
corporate purposes. The credit agreements are comprised of (i) a $500.0 million
revolving credit facility which bears interest only payable monthly at LIBOR
plus 1.5% and with outstanding principal due at maturity on March 13, 2001 and
(ii) a $125.0 million Term Loan secured by the properties under long term
operating lease which bears interest only payable monthly at LIBOR
31
<PAGE>
plus 1.5% and which matures on March 15, 1999. Availability of amounts to borrow
under the revolving credit facility is subject to having sufficient assets
includable as security under the line under a percentage borrowing base
calculation. An aggregate of $8.0 million in loan fees relating to these
arrangements were paid at closing of the Recapitalization Transactions. These
fees will be amortized over the related loan terms.
In anticipation of consummating these bank financing transactions described
above, effective on March 16, 1998, the Trust entered into LIBOR interest rate
caps at 9% in the notional amounts of $125.0 million and $300.0 million expiring
on March 16, 1999 and 2001, respectively for an aggregate cost of $158,750.
Upon completion of the Recapitalization Transactions and consummation of
the bank credit facilities, the Trust believes that the Trust's significant
capital resources and access to financing will provide the Trust with increased
financial flexibility and market responsiveness at levels sufficient to meet
current and anticipated capital requirements including expected loan origination
or acquisition of additional investments.
Fiscal Year 1997 Compared to 1996
As discussed in Note 4 to the Consolidated Financial Statements, revenue
for fiscal 1997 includes 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. Since 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 1997 also increased as a result of the
investment by the Trust of the proceeds received from the exercise of the Class
A Warrants and from a longer relative holding period for the Warwick 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 described below. These
costs were capitalized as deferred proxy costs and will be offset against the
incremental shareholder equity generated by the Recapitalization Transactions.
Total assets, excluding $1.9 million in deferred transaction costs relating
to the Recapitalization Transactions, increased from the year end 1996 to the
year end 1997 by $5.9 million primarily due to the $4.9 million received from
the exercise of the warrants and $1.4 million of undistributed net income
(before minority interest for fiscal 1997).
32
<PAGE>
Fiscal Year 1996 Compared to 1995
Total revenues for 1996 increased 230% as a result of leveraged
acquisitions of Federal Home Loan Mortgage Corporation pass-through certificates
("Government Securities"), the formation of the Partnership, and the interest
generated by the investments of the Partnership.
During the year ended December 31, 1996, the Trust received approximately
$9,750 as a result of a $75,000 claim filed in connection with the bankruptcy of
a former borrower relating to additional interest owed to the Trust on one of
its loans during 1993. The $9,750 of income received during 1996 represents a
second payment towards this claim.
The Trust's general and administrative expense increased 126% during 1996
due primarily to an increase in legal and professional fees. The Trust incurred
these fees due to the preparation of a proxy statement and related material for
the Trust's 1996 shareholder meeting, as well as the formation of the
Partnership.
Total assets increased to $5.6 million in 1996 from $2.2 million in 1995
primarily as a result of the contribution to the Partnership of the Warwick
Hotel mortgage participation certificates.
New Accounting Pronouncements
In February 1997, the Financial Accounting Standards Boards ("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 fully diluted earnings per share with diluted earnings per share ("Diluted
EPS"). Basic EPS is computed based on the income applicable to Class A Shares
(which is net loss reduced by the dividends on preferred 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
convertible preferred 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 convertible preferred
shares and dilutive share options. The Trust adopted this accounting standard
effective December 31, 1997, as required.
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130") effective for fiscal years beginning after December 15,
1997, although earlier application is permitted. SFAS No. 130 establishes
standards for 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 Trust was
not previously required to present comprehensive income or the components
therewith under generally accepted accounting
33
<PAGE>
principles. The Trust intends to adopt the requirements of this pronouncement in
its financial statements for the year ending December 31, 1998.
In June 1997, the 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 Trust intends to adopt the requirements of this pronouncement in its
financial statements for the year ended December 31, 1998. The adoption of SFAS
No. 131 is not expected to have a material impact on the Trust's financial
statement disclosures.
Interest Rate Risks
The Trust's operating results will depend in part on the difference between
the interest income earned on its interest-earning assets and the interest
expense incurred in connection with its interest-bearing liabilities.
Competition from other providers of mezzanine capital may lead to a lowering of
the interest rate earned on the Trust's interest bearing assets which the Trust
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 economy can
affect the spread between the Trust's interest-earning assets and interest-
bearing liabilities. Any significant compression of the spreads between
interest-earning assets and interest-bearing liabilities could have material
adverse effect on the Trust. In addition, an increase in interest rates could,
among other things, reduce the value of the Trust's interest-bearing assets and
its ability to realize gains from the sale of such assets, and a decrease in the
interest rates could reduce the average life of the Trust's interest earning
assets.
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political
considerations, and other factors beyond the control of the Trust. The Trust may
employ various hedging strategies to limit the effects of changes in interest
rates on its operations, including engaging in interest rate swaps, caps, floors
and other interest rate exchange contracts. There can be no assurance that the
profitability of the Trust will not be adversely affected during any period as a
result of changing interest rates. In addition, hedging transactions involve
certain additional risks such as counter-party credit risk, legal enforceability
of hedging contracts and the risk that unanticipated and significant changes in
interest 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 priced may
be more or less variable than the indices upon which the hedged loans are
priced, thereby making the hedge less effective. There can be no assurance that
the Trust will be able to adequately protect against the foregoing risks and
that the Trust will ultimately realize an economic benefit from any hedging
contract it enters into.
34
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
In response to comments received from the Securities and Exchange
Commission, the Trust hereby amends Item 8. Financial Statements of Part II of
the Annual Report by deleting the information thereunder and inserting in lieu
thereof the following:
STARWOOD FINANCIAL TRUST
Index to Financial Statements
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants 37
Balance Sheets at December 31, 1997 and 1996 38
Statements of Operations for each of the three years in the period ended
December 31, 1997 39
Consolidated Statements of Changes in Shareholders' Equity
for each of the three years in the period ended December 31, 1997 40
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1997 41
Notes to Consolidated Financial Statements 42
All schedules are omitted because they are currently not applicable
or the required information is shown in the financial statements or notes
thereto.
</TABLE>
35
<PAGE>
Report of Independent Accountants
To the 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
"Trust") and its subsidiaries at December 31, 1997 and 1996, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Trust'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 Note 8, on March 18, 1998 the Trust consummated
certain transactions which (i) significantly recapitalized the Trust, (ii)
expanded the capital resources of the Trust, (iii) changed the investment policy
of the Trust, (iv) provided for external management under an Advisory Agreement
and (v) amended and restated of the Trust's stock option plan.
Price Waterhouse LLP
New York, NY
March 20, 1998
36
<PAGE>
Starwood Financial Trust
Consolidated Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
1997 1996
------------------------ ----------------------
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 296 $ 114
Investments 11,175 1,774
Mortgage note receivable - 3,707
Deferred transaction costs 1,895 -
Accrued interest 58 56
Other assets 17 23
------ ------
Total assets $ 13,441 $ 5,674
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable $ - $ 37
Accrued expenses 1,915 142
------ ------
Total liabilities 1,915 179
------ ------
Minority Interest 5,175 3,917
------ ------
Commitments and contingencies - -
Shareholders' equity:
Class A Shares (7,550,000 and 2,550,000 shares issued and
outstanding, $1.00 par value, unlimited shares authorized
respectively) 7,550 2,550
Class B Shares (3,775,000 and 1,275,000 shares issued and
outstanding, $.01 par value, unlimited shares authorized) 38 13
Net unrealized loss on "available-for-sale" investments (162) -
Additional paid in capital 42,228 42,329
Accumulated undistributed net realized gain from sale of mortgages 2,545 2,545
Accumulated distributions in excess of cumulative net income other
than gain from sale of mortgages (45,848) (45,859)
------- --------
Total Shareholders' equity 6,351 1,578
------- --------
Total liabilities and Shareholders' equity $ 13,441 $ 5,674
======= ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
37
<PAGE>
Starwood Financial Trust
Consolidated Statements of Operations
(in thousands except per share data)
<TABLE>
<CAPTION>
Years ended December 31,
--------------------------------------------------------------
1997 1996 1995
--------------- -------------- ---------------------
<S> <C> <C> <C>
Revenue:
Interest income from mortgage notes $ 486 $ 166 $ -
Gain from early loan repayment 985 - -
Interest income from investments 410 312 145
--------------- -------------- ---------------------
Other income 1,887 488 148
Total revenue
Costs and expenses:
Interest expense - 272 -
------------- ------------ -----------------------
General and administrative 461 639 283
------------- ------------ -----------------------
Total costs and expenses 461 911 283
------------- ------------ -----------------------
Minority Interest (1,415) (154) -
------------- ------------ -----------------------
Net income (loss) $ 11 $ (577) $ (135)
============= ============ =======================
Net income (loss) per Class A Share $ 0.00 $ (0.22) $ (0.05)
============= ============ =======================
Weighted average number of Class A
Shares outstanding (in thousands) 7,244 2,550 2,550
============= ============ =======================
The accompanying notes are an integral part of the financial statements.
38
</TABLE>
<PAGE>
Starwood Financial Trust
Statements of Changes in Shareholders' Equity
(In thousands)
<TABLE>
<CAPTION>
Accumulated
Net Distributions
Unrealized In Excess of
Class A Class B Losses on Paid-in Cumulative
Shares Shares Investments Capital Net Income Total
------ ------ ----------- ------- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995 2,550 13 42,329 (42,602) 2,290
Net loss - - - (135) (135)
Balance at December 31, 1995 2,550 13 42,329 (42,737) 2,155
Net loss - - -- (577) (577)
Balance at December 31, 1996 2,550 13 42,329 (43,314) 1,578
Exercise of warrants 5,000 25 (101) - 4,924
Net unrealized losses - - (162) - (162)
Net income - - - 11 11
----- ---- ------ ------- --------- -----
Balance of December 31, 1997 7,550 38 $(162) $42,228 $(43,303) $6351
===== ==== ====== ======= ========= =====
</TABLE>
The accompanying notes are an integral part of the financial statements.
39
<PAGE>
Starwood Financial Trust
Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
----------------------------------------------------
Years ended December 31,
----------------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 11 $ (577) $ (135)
Adjustments to reconcile net (loss) increase to cash flows
from operating activities:
Minority Interest 1,415 154 -
Changes in Assets and Liabilities:
Decrease (increase) in other receivables 4 (54) 6
Decrease (increase) in other assets - 110 (12)
Increase (decrease) in accounts payable and
accrued expenses 1,736 140 (43)
------- ----------- ---------
Cash flows provided by (used in) operating activities 3,166 (227) (184)
------- ----------- ---------
Cash flows from investing activities:
Investments in securities (31,346) (19,811) (165)
Principal collections of investment securities 80 1,307 340
Sale of investment securities 21,546 17,926 -
Principal collections from mortgage notes 3,707 56 -
Cash flows provided by (used in) investing activities (6,013) (522) 175
------- ----------- ---------
Cash flows from financing activities:
Repayments related to investment security purchases - (18,886) -
Borrowings related to investment security purchases - 18,886 -
Increase in deferred transaction costs (1,895) - -
Exercise of warrants 4,924 - -
------- ----------- ---------
Cash flows provided by financing activities 3,029 - -
------- ----------- ---------
Increase (decrease) in cash and cash equivalents 182 (749) (9)
Cash and cash equivalents at beginning of period 114 863 872
------- ----------- ---------
Cash and cash equivalents at end of period $ 296 $ 114 $ 863
======= =========== =========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ - $ 272 $ -
======= =========== =========
Supplemental disclosure of non cash financing activity:
Contribution of Note Receivable $ - $ 3,763 $ -
======= =========== =========
The accompanying notes are an integral part of the financial statements.
</TABLE>
40
<PAGE>
Starwood Financial Trust
Notes to Consolidated Financial Statements
Note 1 - Organization and Business
Starwood Financial Trust (the "Trust"), formerly Angeles Participating
Mortgage Trust, was formed for the purpose of making and acquiring various types
of mortgage and other loans. During 1993 through 1997, the Trust 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"), the Trust will be eligible to and
intends to elect to be taxed as a REIT for the taxable year beginning January 1,
1998.
The Trust was originally formed by Angeles Corporation ("Angeles") for the
purpose of making various types of mortgage and other loans to entities
affiliated with Angeles. In early 1993, Angeles and its affiliates began
experiencing financial difficulties which resulted in a default on their loans
held by the Trust. In November 1993, the Trust sold all of its loans to an
unaffiliated third party and with the proceeds of such sale and cash on hand
distributed $37.2 million to the Trust's shareholders. Through a series of
transactions during 1994 and 1996, Starwood Mezzanine Investors, L.P.
("Mezzanine")and certain affiliates of the general partner of Mezzanine acquired
control of the Trust.
Prior to September 1996, the purpose and investment policy of the Trust was
primarily to make mortgage loans to entities affiliated with Angeles. However,
since the liquidation of the Trust's portfolio in 1993 until September 1996, the
Trust did not pursue its stated investment policy. Instead, during such period,
the Trust's assets were held in a trust as a reserve against contingent claims.
This contingent claims trust was terminated in August 1996. In September 1996,
the shareholders of the Trust voted to change the purpose and investment policy
of the Trust. As described in Note 8, in March 1998, the shareholders of the
Trust again voted to change the purpose and investment policy of the Trust
On September 26, 1996, the Trust became the sole general partner of the
APMT Limited Partnership (the "Partnership") (see Notes 4 and 5). As discussed
in Note 8, subsequent to year end, all the outstanding interests in the
Partnership not held by the Trust were exchanged for additional Class A Shares
of the Trust, the Trust became the sole partner of the Partnership and the
Partnership was terminated.
Also as more fully described in Note 8, pursuant to the concurrent approval
through a shareholder vote, on March 18, 1998, the Trust entered into a series
of transactions which, among other things, substantially recapitalized the Trust
and modified its investment policy.
Note 2 - Summary of Significant Accounting Policies
Basis of accounting - The accompanying consolidated financial statements of
the Trust include the accounts of the Trust and the Partnership. These financial
statements were prepared
41
<PAGE>
in accordance with GAAP and, therefore, revenue is recorded as earned and costs
and expenses are recorded as incurred. The consolidated statements reflect
eliminated intercompany balances. Certain prior years amounts have been
reclassified to conform to current year classifications.
Cash and cash equivalents - Cash and cash equivalents include cash held in
bank or invested in money market funds with original maturity terms of less than
90 days.
Income taxes - The Trust 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 7 to these consolidated financial statements for more
information.
As confirmed in a Closing Agreement with the IRS obtained in March, 1998,
the Trust is eligible and intends to elect to be taxed as a REIT for its taxable
year beginning January 1, 1998. As a qualified REIT, the Trust will be subject
to income taxation at corporate rates on its REIT taxable income, however, the
Trust is allowed a deduction for the amount of dividends paid to its
shareholders, thereby subjecting the distributed net income of the Trust to
taxation at the shareholder level only. For income tax purposes, the Trust
reports revenue and expenses on the accrual method.
Net income (loss) per Class A Share - The net income per Class A Share was
based upon 7,244,000 weighted average shares outstanding for the year ended
December 31, 1997 and 2,550,000 weighted average shares outstanding during each
of the two years ending December 31, 1996 and 1995, after deduction of the 1%
Class B Shares' interest (see Note 5).
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 3 - Investments
The Trust held two investments in government securities in 1995 that had an
8.5% coupon and matured on January 1, 1996. In 1996, the Trust sold and
subsequently purchased $20 million in government securities which resulted in
interest income, before financing costs, of approximately $251,000 and a $91,000
trading loss which is included with interest expense. As of December 31, 1997,
the Trust held four investments in Government National Mortgage Association
securities ("GNMA") and 10 investments in Federal Home Loan Mortgage Corporation
("FHLMC") pass-through certificates aggregating $1.4 million and $9.6 million,
respectively. The GNMAs each have a coupon rate of 7.5%; three of the GNMAs
mature in 2027 and the other GNMA matures in 2026. The FHLMCs have coupon rates
ranging from 5.5% to 6.5% with maturity dates ranging from August 1998 to May
2003. In accordance with Statement of Financial Accounting Standards No. 115
("FASB 115") the Trust has classified all GNMA and FHLMC investments as
"available for sale" because they are freely tradeable. As of
42
<PAGE>
December 31, 1997, the Trust recorded a current unrealized loss of $162,000 from
its GNMAs and FHLMCs which is reflected in the shareholders' equity section of
the balance sheet in accordance with FASB 115. In addition, the Partnership
invested approximately $0.1 million in various other publicly traded REITs
during the third quarter of 1997.
Note 4 - Mortgage Note Receivable
On September 26, 1996, the Trust became the sole general partner of the
Partnership by contributing $400,000 in cash, in exchange for 400,000 Operating
Partnership Units ("Units")(a 8.05% interest) in the Partnership. Mezzanine
contributed to the Partnership its entire interest in certain mortgage
participation certificates valued by the Trust at approximately $4.6 million as
of September 30, 1996, in exchange for 4,568,944 Units (a 91.95% interest) in
the Partnership. These Units were convertible into Class A Shares of the Trust
on a one-for-one basis, cash or a combination of both, at the option of the
Trust.
The Trust and the Partnership are considered to be entities under common
control and the consolidated operations of the Trust and the Partnership have
been accounted in accordance with generally accepted accounting principles
governing such entities. Consequently, the mortgage note contributed by Starwood
Mezzanine into the Partnership was reflected in the financial statements at its
predecessor basis of $3.76 million.
The mortgage participation certificates comprise the first mortgage note on
the Warwick Hotel, a 20-story hotel and apartment complex located in
Philadelphia, PA. The mortgage had a face value of $4.9 million and required
monthly payments of approximately $71,000, representing principal and interest
at a rate of 9% per annum. The note was originally issued with a face amount of
$8.5 million on December 1, 1979 with the final payment due November 30, 2004.
Starwood Mezzanine acquired this note at a discount from face value in February
1995 and had been accounting for it under the effective interest method.
On October 1, 1997, the mortgage participation certificates had a basis of
$3.5 million. They were repaid on this date for $4.5 million, which was
reinvested in government securities that matured in December 1997.
Note 5 - Shareholders' Equity
The shares of the Trust are of two classes: Class A Shares (par value $1.00
per share) and Class B Shares (par value $.01 per share). There is no limit on
the number of either Class A or Class B Shares which the Trust is authorized to
issue. Class B Shares have been issued by the Trust 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. 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. All distributions of cash will be distributed 99% to the Class A
Shareholders and 1% to the Class B Shareholders.
43
<PAGE>
In November 1993, the Trust was notified that SAHI, Inc. had acquired all
of the Trust's 1,275,000 outstanding Class B Shares. Subsequent to the
acquisition of the Class B Shares, SAHI Partners, ("SAHI") purchased the Class B
Shares from SAHI, Inc. and accumulated 244,100 Class A Shares or 9.57% of the
total outstanding Class A Shares of the Trust as of December 1996.
On March 15, 1994, the Trust announced that it had entered into an
agreement with SAHI and SAHI, Inc., for the sale of a warrant for the right to
purchase five million shares of the Trust's Class A Shares at a price of $1.00
per share (the " Class A Warrant") and 2,500,000 shares of Class B Shares at a
price of $.01 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 first Class A and Class B Shares purchased pursuant to the warrants. On
March 28, 1996, the Class A Warrants were assigned to Starwood Mezzanine.
On September 26, 1996, the Trust became sole general partner of the newly
formed Partnership by contributing $400,000 in cash, in exchange for a 8.05%
interest in the Partnership and 400,000 Units. Concurrently, Starwood Mezzanine
received a 91.95% limited partnership interest in exchange for contributing to
the Partnership its entire interest in the participation certificates in the
Warwick Hotel mortgage note valued by the Trust at approximately $4.6 million as
of September 30, 1996. Starwood Mezzanine's interest in the Partnership is
evidenced by 4,568,944 Units, which were convertible into cash, Class A Shares
or a combination of both pursuant an exchange rights agreement. In addition,
Starwood Mezzanine has the right to require the Trust to register for public
sale, any or all of the Class A Shares in the Partnership issued to it upon the
exercise of the Class A Warrant or upon exchange of the Units issued to Starwood
Mezzanine. As described in Note 8, 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 5,000,000 Class A Shares. After its exercise of the
Class A Warrant, Starwood Mezzanine beneficially owned 5,000,000 shares of Class
A Shares and 4,568,944 Units. In addition, SAHI, Inc. exercised its rights under
the Class B Warrant to acquire 2,500,000 Class B Shares. After its exercise of
the Class B Warrant, SAHI Inc. beneficially owned 6,059,471 Shares of Class B
Shares and 244,100 shares of Class A Shares. Each share of Class A Shares and
Class B Shares is entitled to one vote per share. Upon exercise of the entire
Class A and Class B Warrants, SAHI, SAHI, Inc., and Starwood Mezzanine jointly
own 70% of the outstanding Class A Shares and, with the voting interest of the
Class B Shares, control 80% of the voting interest of the Trust. The Trust
increased its capital by $5,025,000, and funds from this capitalization were
utilized to purchase qualified short-term government securities.
As more fully discussed in Note 8, subsequent to year end a
recapitalization transaction was completed which significantly increased the
Trust's equity.
44
<PAGE>
Note 6 - Incentive Plan
On September 26, 1996, the shareholders approved an incentive plan for
Trustees and an incentive plan for employees. The Trustee plan provides for the
issuance of up to 50,000 stock options and the employee plan provides for the
grant of up to 377,500 shares in the form of stock options, share appreciation
rights, restricted shares, and deferred shares. On September 26, 1996, 2,000
options were granted under the plan with an exercise price of $1.38 per share.
On October 24, 1997, additional options to purchase 6,000 Class A Shares at an
exercise price of $2.50 per share were granted. The options are fully vested.
Note 7 - 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 Trust failed to qualify as a REIT. As confirmed by
a Closing Agreement with the Internal Revenue Service (the "IRS") obtained in
March, 1998, the Trust will be eligible to and intends to elect to be taxed as a
REIT for the tax year commencing on January 1, 1998. Because the Trust had net
losses for income tax purposes in 1993 through 1997, the Trust does not owe any
Federal income tax for 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 Trusts'
operations and assets and liabilities from 1993 through 1997, the only
significant deferred tax assets are net operating loss carry forwards ("NOL's")
which arose during such periods. Since the Trust 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, 1997 and 1996.
Note 8 - Subsequent Events
Subsequent to year end, the Trust consummated certain transactions and
entered into agreements which significantly recapitalize and expand the capital
resources of the Trust as well as modify future operations including the
following:
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 (collectively, Starwood Mezzanine,
Starwood Opportunity Fund IV, L.P. and other affiliates are referred to as
45
<PAGE>
"Starwood") acquired joint ownership of 70% and 100% of the outstanding Class A
Shares and Class B Shares of the Trust, respectively, through which they
controlled approximately 80% of the voting interest in the Trust as of December
31, 1997. Prior to the consummation of the Recapitalization Transactions
(defined below), Starwood Mezzanine also owned 4,568,944 Units which represents
the remaining 91.95% of the Partnership not held by the Trust, which were
convertible into either cash, and additional 4,568,944 Class A Shares of the
Trust, or a combination of the two, as determined by the Trust.
On March 18, 1998, each outstanding Unit held by Starwood Mezzanine was
exchanged for one Class A Share of the Trust and, concurrently, the Partnership
was liquidated through a distribution of its net assets to the Trust, then its
sole Partner.
Simultaneously, Starwood Mezzanine and Starwood Opportunity Fund IV, L.P.
("SOF IV") (an affiliate of the general partners of Starwood Mezzanine)
consummated the transactions contemplated by the contribution agreement
("Contribution Agreement") among Mezzanine, SOF IV and the Trust to
substantially recapitalize and increase the size of the Trust's assets and
operations. Pursuant to the Contribution Agreement, Starwood Mezzanine
contributed various real estate loan investments to the Trust in exchange for
55,148,000 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 247,074,800 Class A Shares of the Trust and a
cash payment of $324.3 million. Concurrently, the holders of the Class B Shares
who are affiliates of the general partners of Starwood Mezzanine and SOF IV
acquired 153,395,872 additional Class B Shares sufficient to maintain existing
voting preferences pursuant to the Trust's Amended and Restated Declaration of
Trust (the "Declaration of Trust"). Immediately after these transactions,
Starwood and its affiliates owned approximately 99.3% of the outstanding Class A
Shares of the Trust and 100% of the Class B Shares. (Collectively, the
transactions described in this note are the "Recapitalization Transactions".)
Assets acquired from Starwood Mezzanine will be 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 will be
reflected at their fair market value.
New Credit Facilities
On March 18, 1998 the Trust entered into bank credit agreements under which
the Trust may currently borrow up to $625.0 million, with up to an additional
$175.0 million available, subject to certain conditions, to fund loan
originations (including the cash portion of the Recapitalization Transactions
described above) and provide working capital to fund new loan originations and
for other general corporate purposes. The credit agreement are comprised of a i)
a $500.0 million revolving credit facility which bears interest only payable
monthly at LIBOR plus 1.5% and with outstanding principal due at maturity on
March 13, 2001 and (ii) a $125.0 million Term Loan secured by the properties
under long term operating lease which bears interest only payable monthly at
LIBOR plus 1.5% and which matures on March 15, 1999. Availability of amounts to
borrow under the revolving credit facility is subject to having sufficient
assets includable as security under the line under a percentage Borrowing Base
calculation. An aggregate of $8.0
46
<PAGE>
million in loan fees relating to these arrangements were paid at closing of the
Recapitalization Transactions. These fees will be amortized over the related
loan terms.
In anticipation of consummating these Financing transactions, effective on
March 16, 1998, the Trust entered into LIBOR interest rate caps at 9% in the
notional amounts of $125.0 million and $300.0 million expiring on March 16, 1999
and 2001, respectively, for an aggregate cost of $158,750.
Modification to Trust's Investment Policy
As approved by the shareholders of the Trust in March 1998, the purpose and
investment policy of the Trust is to acquire a diverse portfolio of debt and
debt-like interests in real estate or real estate related assets, including to
(i) originate mortgage loans and/or acquire mortgage loans or acquire securities
collateralized, in whole or in part, by mortgage loans, as well as make equity
investments in real estate and real estate-related assets, (ii) acquire direct
or indirect interests in short term, medium and 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 Trust,
(iii) make, hold and dispose of purchase money loans with respect to assets sold
by the Trust, and (iv) acquire positions in non-performing and sub-performing
debt for the purpose of either restructuring it as performing debt or, if such
efforts are unsuccessful, of obtaining shortly thereafter primary management
rights over or equity interests in the underlying assets securing such debt (the
"Diversified Portfolio").
The Trust is restricted from making certain types of investments as a
result of the restrictions and conflicts described below (the "Investment
Restrictions"). These restrictions may limit the flexibility of the Trust 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 Trust, the
Trust 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 debt holder within one (1) 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
Trust or that are acquired as a result of the exercise of remedies in respect of
a loan in which the Trust has an interest) or (iii) selling or contributing to
or acquiring any interests in Starwood Hotels & Resorts Trust, including debt
positions or equity interests obtained by the Trust under, pursuant to or by
reason of the holding of debt positions.
The Trust's authority with respect to the Diversified Portfolio includes
the power to acquire, hold, own, develop, redevelop, construct, improve,
maintain, operate, manage, sell, lease, rent, transfer, encumber, mortgage,
convey, exchange and otherwise dispose of or deal with the Diversified Portfolio
and the Diversified Portfolio may be held by the Trust directly or indirectly.
The Diversified Portfolio may include controlling or non-controlling investments
in or relating to any general category of real estate assets, including without
limitation, hotel, office,
47
<PAGE>
mixed-use, retail, industrial, mini-storage and residential improvements to
land, excluding any investments prohibited by the Investment Restrictions.
The Trust currently plans to originate and make investments in various
types of income producing commercial real estate and its investment program will
emphasize senior and junior commercial mortgage loans, including mezzanine
financing (i.e., capital representing the level between 65% and 90% of property
values), higher yielding senior mortgage loans, non-performing or sub-performing
loans and performing and non-performing subordinated interests ("Subordinated
Interests") in commercial mortgage-backed securities ("CMBS"). The Trust
anticipates that a majority of the investments to be held in its portfolio for
the long-term will be structured so that the Trust's investment is subordinate
to third party first mortgage debt but senior to the real estate
owner/operator's equity position.
The investment and financing policies of the Trust and its policies with
respect to all other activities, including its growth, debt, capitalization,
dividends and operating policies, will be 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 the discretion of
the Board of Trustees, without a vote of the Shareholders.
Advisory Agreement
In connection with the Recapitalization Transactions, the Trust and
Starwood Financial Advisors, L.L.C. (the "Advisor") entered into an Advisory
Agreement pursuant to which the Advisor manages the investment affairs of the
Trust, subject to the Trust'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: identifying investment opportunities for
the Trust; advising the Trust with respect to and effecting acquisitions and
dispositions of the Trust's investments; monitoring, managing and servicing the
Trust's loan portfolio; and arranging debt financing for the Trust. 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/or the officers of
the Trust with respect to its activities.
Commencing on the 90th day after the consummation of the Recapitalization
Transactions, the Trust will pay to the Advisor a quarterly base management fee
of 0.3125% (1.25% per annum) of the "Book Equity Value" of the Trust (as defined
in the Advisory Agreement) determined as of the last day of each quarter, but
estimated and paid in advance subject to recomputation. Fees to be paid in 1998
will be recognized ratably during the period from March 18, 1998 through
December 31, 1998. As a result of the delayed commencement of the advisory fee,
the operating results of the Trust for fiscal 1998 will be higher than they
would have been if the advisory fee had not been deferred and therefore may not
be reflective of future operating results of the Trust.
In addition, commencing on the 90th day after the consummation of the
Recapitalization Transactions, the Trust will pay the Advisor a quarterly
incentive fee of five percent (5%) of the
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<PAGE>
Trust's "Adjusted Net Income" (as defined in the Advisory Agreement) during each
quarter that the Adjusted Net Income for such quarter restated and annualized as
an annualized rate of return on the Trust's Book Equity Value for such quarter
equals or exceeds the "Benchmark BB Rate" (as defined in the Advisory
Agreement). The Advisor will be also be reimbursed for certain expenses it
incurs on behalf of the Trust.
The Advisory Agreement has an initial term of three years subject to
automatic renewal for one year periods unless the Trust 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 Trust 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' notice to the Trust and
the Trust 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 Trust at the time outstanding.
1996 Share Incentive Plan
The Trust 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 9.0% 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
sub-committee of such Trustees. Approximately 14,963,057 options to purchase
Class A Shares at $2.50 per share that are immediately exercisable were granted
to the Advisor under the Plan upon consummation of the Recapitalization
Transactions and future grants may be made to the Advisor or employees of the
Trust in the future.
An independent financial advisory firm estimated the value of these options
at the date of grant to be approximately $0.40 per share using a Black-Scholes
valuation model. In the absence of comparable historical market information for
the Trust, the advisory firm utilized assumptions consistent with activity of a
comparable peer group of companies including an estimated option life of five
years, a 27.5% volatility rate and an estimated dividend rate of 8.5%. 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, result in a charge
to earnings upon consummation of the Recapitalization Transaction equal to the
number of options allocated to the Advisor multiplied by the estimated value at
consummation. The charge of approximately $6.0 million will be reflected in the
Trust's first
49
<PAGE>
quarter 1998 financial results, however, such charge has been excluded from the
pro forma financial information presented in this note, as it represents a
non-recurring charge. Future charges may be taken to the extent of additional
option grants, which are at the discretion of the Board of Trustees.
An independent financial advisory firm estimated the value of these options
at date of grant to be approximately $1.07 per share using a Black-Scholes
valuation model. In the absence of comparable historical market information for
the Trust, the advisory firm utilized assumptions consistent with activity of a
comparable peer group of companies including an estimated option life of five
years, a 35% volatility rate and an estimated dividend rate sufficient to
maintain the Trust's status as a REIT (i.e. 95% of taxable income). 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, result 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 $16.0 million will be reflected in the
Trust's first quarter 1998 financial results, however, such charge has been
excluded from the pro forma financial information presented in this note, as it
represents a non-recurring charge. Future charges may be taken to the extent of
additional option grants, which are at the discretion of the Board of Trustees.
The following summary pro forma information includes the effects of the
following transactions consummated in March, 1998: (i) Recapitalization
Transaction, (ii) exchange of each outstanding Unit held by holders other than
the Trust for one Class A Share, and (iii) liquidation and termination of the
Partnership (iv) the borrowings necessary to consummate the aforementioned
transactions. The pro forma balance sheet data is presented as if the
transactions had been completed on December 31, 1997 and the pro forma operating
data for the year ended December 31,1997 is presented as if the transactions had
been completed on January 1, 1997.
50
<PAGE>
Pro Forma
Condensed Balance Sheet
(In thousands, except for net income per Class A Share)
As of
December 31, 1997
-----------------
Assets:
Real estate investments $ 1,073,877
Cash and cash equivalents 9,198
Other assets 13,601
---------
$ 1,096,676
=========
Debt obligations $ 350,000
Other liabilities 2,119
Accounts accrued expenses and payable 2,351
Shareholders equity 742,206
---------
$ 1,096,676
=========
51
<PAGE>
Pro Forma
Condensed Statement of Operations
(In thousands, except for net income per Class a Share)
For the Year Ended
--------------------------
December 31, 1997
Revenue:
Interest income $61,956
Prepayment and Participation Income 25,137
Rental income 15,311
Other 887
-------------
103,291
Expenses:
Interest expense 23,151
Depreciation 6,875
General and administrative 1,510
Advisory fee 8,143
Other 2,117
-------------
41,796
Pro forma net income $61,495
=============
Pro forma net income per Class A Share $0.20
=============
Weighted average number of Class A Shares 314,342
=============
Outstanding
The pro forma financial information is not necessarily indicative of what the
actual financial position and results of operations of the Trust would have been
as of and for the periods indicated, nor does it purport to represent the future
financial position or results of operations for future periods
52
<PAGE>
Note 9 - Quarterly Financial Information (Unaudited)
The following table sets forth the selected quarterly financial data for
the Trust (in thousands except for per share amounts).
<TABLE>
<CAPTION>
------------------------------------------------------------------------
Quarter Ended
1997 12/31/97 9/30/97 6/30/97 3/31/97
- ---- -------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenue $ 1,181 $ 246 $ 220 $ 240
Net income/(loss) $ (14) $ 2 $ 5 $ 18
Net income/(loss) per Class A Share $ 0 $ 0 $ 0 $ 0
Weighted average Class A Shares outstanding 7,550 7,550 7,550 6,328
1996 12/31/96 9/30/96 6/30/96 3/31/96
- ---- -------- ------- ------- -------
Revenue $ 424 $ 35 $ 21 $ 8
Net loss $ (75) $ (246) $ (59) $ (197)
Net loss per Class A Share $ (0.02) $ (0.10) $ (0.02) $ (0.08)
Weighted average Class A Shares outstanding 2,550 2,550 2,550 3
</TABLE>
53
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Trust has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
STARWOOD FINANCIAL TRUST
Registrant
Date February 23, 1999 /s/ Jay Sugarman
Jay Sugarman
Chief Executive Officer and President
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON. D.C. 20549
February 4, 1999
DIVISION OF
CORPORATE FINANCE
Mail Stop 4-9
Jay Sugarman, CEO and President
Starwood Financial Trust
1114 Avenue of the Americas, 27th Floor
New York, New York 10036
Re: Starwood Financial Trust
Amendment No. 1 to Form 10-K for the fiscal year ended December 31, 1997
Amendment No. 1 to Form 10-Q for the period ended September 30, 1998
Amendment No. 1 to Form 8-K dated 3/18/98
Filed January 19, 1999
File No. 1-10150
Dear Mr. Sugarman:
We have the following comments on your filings. Unless directed
otherwise, please revise your document in response to these comments.
Form 10-K for the fiscal year ended December 31, 1997
- -----------------------------------------------------
General
1. It is not appropriate to amend your form 10-K by disclosing where you
delete and add language. In your next amendment, please include the
complete text of all items where you amended the disclosure in both
this, and the next amendment. See Rule 12b-15.
Item 1. Description of Business, page 1
- ---------------------------------------
Investment Policy
- -----------------
2. We note your revision in response to comment 3. Why have you deleted
the meaning of mezzanine financing in your amendment? In your next
amendment, please revise to include the original definition, explaining
that it is capital representing 65%-90% of property value.
3. Disclose that you have no full underwriting policies or procedures.
<PAGE>
Starwood Financial Trust
page 2
Advisory Agreement
- ------------------
4. In the changed sentence, the second to last in 1(b), do you mean the
Trust could invest all or any portion of its assets in any investment
that "could" be included in the Diversified Portfolio?
5. Your response to comment 7 is noted, however, the disclosure in written
in an overly complex, legalistic manner. Is this copied right out of
the Advisory Agreement? Please revise to clearly describe Book Equity
Value and Adjusted Net Income.
Investment Portfolio
- --------------------
6. Disclose the identity of Borrowers A and B. See Item 101(c)(vii).
7. Response to comment 8 is noted, however, we cannot locate where you
have provided disclosure of:
a) the nature of the obligors on the mortgages and their ability
to pay, and
b) the relative subordination of subordinated interests,
including the rights of the company upon delinquency,
default or foreclosure.
Please revise. With respect to your summary subordination disclosure,
do you hold any subordinated interest with respect to borrowers other
than Borrowers A and B? With respect to your last sentence in this
section, are your subordinated mortgages only subordinate to your
senior ones? Does the subordinated nature of the mortgages permit
Borrowers A and B to obtain senior mortgages at any time?
8. Where do you provide relevant delinquency, loss and prepayment data? We
note your response to comment 9 is identical to that for comment 8.
Comment 9 was directed at eliciting additional disclosure.
Competition
- -----------
9. Rather than focus this discussion on what may happen, discuss the
current competitive conditions in your industry. To the extent you have
been affected by the significant competition in the market for loans of
the type you seek, so state.
Financial Statements and Notes, page 20
- ---------------------------------------
10. We have read and considered your response to comment 15. In the last
paragraph on page 14 of the 10-K/A explain how an increase in net
income results in an increase in assets.
11. We have reviewed your response to comment 16. Revise the 3/31/97 per
share amount in Note 9 of the Financial Statements contained in the
Form 10-K on page 32.
<PAGE>
Starwood Financial Trust
page 3
12. In your response to comment 17, you state that ". . . Starwood
Mezzanine owned a 91.95% limited partnership interest in the
Partnership . . . ." Revise the footnote and any other similar
disclosures to clarify whether Starwood Mezzanine obtained its 91.95%
interest in exchange for the contribution of the mortgage
participation certificates. In addition, if it obtained the 91.95%
limited partnership interest through another transaction, describe
that transaction. Further, state whether the Trust became the sole
general partner of the Partnership before or after Starwood
Mezzanine's contribution. We may have additional comment.
13. We are not clear why the mortgage participation certificates which
were transferred from Starwood Mezzanine were not recorded at fair
value. According to paragraph 2 of Note 4 to the financial statements
included in the form 10-K, "[t]he Trust and the Partnership are
considered to be entities under common control." Since the transfer
was between Starwood Mezzanine and the Partnership, it seems to us
that you need to demonstrate that Starwood Mezzanine was also under
common control in order to account for this transaction as a transfer
among entities under common control. Show us the ownership charts of
the Trust, the Partnership and of Starwood Mezzanine immediately prior
to the transfer of the mortgage participation certificates to the
Partnership. The ownership chart for each entity should list the
owner, their relative percentage of ownership and the type of interest
(i.e. limited partner or general partner). Explain to us how these
charts support your contention that this transaction was a transfer
among entities under common control. We may have additional comment.
14. We have read and considered your response to comment 18. According to
page 16 of the Form 10-K/A, on March 18, 1998, each outstanding Unit
of the Partnership held by Starwood Mezzanine was exchanged for one
Class A share of the Trust. Explain to us why this was not accounted
for at fair value as the acquisition of minority interest in the
Partnership. We may have further comment.
15. In addition, we are not clear why the recapitalization transactions
resulted in a step up in basis. Please explain. Please tell us what
literature you relied upon, either directly or by analogy, in making
your determination of the appropriate accounting treatment. We may
have additional comments.
16. According to page 16 of the Form 10-K/A Starwood Mezzanine contributed
real estate loan investments to the Trust in exchange for 55,148,000
Class A shares and $25.5 million in cash. Disclose the fair value of
these real estate loan investments and indicate how the fair value was
determined. Provide us with an ownership chart of Starwood Mezzanine
and of the Trust as of March 18, 1998, immediately before this
transfer. The ownership chart for each entity should list the owner,
their relative percentage of ownership and the type of interest (i.e.
limited partner or general partner). Explain to us why this transfer
was not accounted for as a transfer among entities under common
control. What percentage of Starwood Mezzanine's assets did the
contributed loan investments represent? We may have further comment.
17. Refer to your response to comment 19. Page 16 of the Form 10-K/A
states that SOF IV was an affiliate of the general partners of
Starwood Mezzanine. Please demonstrate how they were
<PAGE>
Starwood Financial Trust
page 4
affiliated by providing us with an ownership chart of SOF IV, Starwood
Mezzanine and of the Trust as of March 18, 1998. The ownership chart
should identify the owners, their relative percentage interest and the
type of interest (i.e. limited partner or general partner interests).
Explain to us why the March 18, 1998 transactions with SOF IV were not
accounted for at carryover basis as a transfer among entities under
common control. What percentage of SOF IV's assets did the March 18,
1998 contribution represent? We may have further comment.
18. According to page 16 of the Form 10-K/A the holders of the Class B
shares which are affiliates of the general partners of Starwood
Mezzanine and SOF IV acquired 153,395,872 additional Class B shares.
Disclose what consideration these Class B holders gave the Trust for
these additional shares. If no consideration was given or less than
fair value of the shares was given, why have you not reflected this as
a capital distribution?
19. Based upon your response to comment 32, selected financial data should
be included in the Form 10-K for Doubletree, Borrower A and Borrower B
since they are significant between the ten and twenty percent level. In
addition expand the disclosure regarding Borrower B to clarify whether
the loans have cross default or cross collateralization provisions.
10-Q for the period ended September 30, 1998
- --------------------------------------------
Interest Rate Risk Management, page 17
- --------------------------------------
20. Where do you provide further discussion on the relative interest rate
sensitivity of your assets and liabilities and the spread between asset
and liability yields?
21. We cannot locate any discussion concerning the impact of prepayments,
delinquencies and defaults on your spread as requested previously in
comment 23. Please revise or advise.
22. Quantify the costs of the transactions described and disclose that the
potential costs of these transactions may exceed their benefits.
23. Describe the associated risks of your hedging activities. Discuss such
risks as basis risks, legal enforceability risks and regulatory risks.
Describe in sufficient detail the potential adverse effects of each of
these risks.
Liquidity and Capital Resources, page 18
- ----------------------------------------
24. As previously requested, disclose the dates the Treasury rate-lock
agreements were entered into and the rates which were fixed.
Year 2000 Issues, page 19
- -------------------------
State of Readiness, page 20
- ---------------------------
<PAGE>
Starwood Financial Trust
page 5
25. You disclose that the previous owner of Starwood Operating has agreed
to indemnify Starwood Operating for all costs of addressing losses
related to year 2000 issues. Do you mean for all losses resulting from
year 2000 issues, or only those attributable to Starwood Operating's
systems?
26. You state you're in the process of communicating with significant
depository institutions, lenders, custodians, vendors, etc. What
percentage of those contacted have responded? Have your communications
been written or oral? Have their responses been written or oral?
Risks of Year 2000, page 20
- ---------------------------
27. We note you've asked substantially all significant vendors and service
providers to provide reasonable assurances as to their state of year
2000 readiness. Have any responded? If yes, disclose the amount that
have responded. Were responses written or oral?
Procedural Matters
- ------------------
Amendments should be filed within two weeks of the date of this letter.
The filings should be accompanied by a letter responding to each comment, noting
the location in the revised material of the change and providing any
supplemental information requested by the staff. Any material deletions should
also be noted in the response letter. If you believe any comment to be
inappropriate, please tell us why in your letter.
General disclosure questions may be directed to Kim Mazur at (202)
942-1941. Any questions regarding accounting comments may be directed to J.J.
Matthews at (202) 942-2881, or Linda van Doorn, Assistant Chief Accountant, at
(202) 942-1960. In addition, please do not hesitate to contact the undersigned
or Paula Dubberly, Esq., Assistant Director, at (202) 942-1960, both of whom
supervised the review of your filing.
Sincerely,
David M. Lynn
Special Counsel
cc: Courtney A. Dinsmore, Esq.
Mayer, Brown & Platt
1675 Broadway
New York, New York 10019-5820
<PAGE>
Exhibit I
Starwood Financial Trust
Summary of Accounting Considerations in
Connection with Various Transactions with Affiliates
The purpose of this supplement is to convey and clarify certain information
provided to the Staff in support of the accounting treatment for certain
transactions consummated by the Company with certain affiliated entities
including Starwood Mezzanine Investors, L.P. ("Starwood Mezzanine") and Starwood
Opportunity Fund IV, L.P. ("SOF IV").
This complex structure was necessitated by the various business arrangements
between Starwood Capital and its control group ("Starwood") affiliates with the
investment partnerships (collectively: Starwood Opportunity Fund II, L.P.,
Starwood Mezzanine and SOF IV) and various legal liability, ERISA and tax
structuring requirements.
Management acknowledges the complexity of the ownership structure and the
difficulty in conveying these concepts in writing. Management believes that the
accounting treatment utilized by the Company in connection with these
transactions was both appropriate and conservative under the circumstances.
Accordingly, should the Staff have further questions in this regard, management
would like to request a conference with the Staff, either in person or
telephonically, to discuss these issues.
The four primary transactions under discussion are the following:
1. Contribution of mortgage participation certificates by Starwood Mezzanine
(Date: September 26, 1996)
2. Recapitalization Transaction - conversion of Partnership Units by Starwood
Mezzanine for Class A Shares of the Company (Date March 18, 1998).
3. Recapitalization Transaction - Contribution of financial assets by Starwood
Mezzanine for cash and Class A Shares of the Company (Date March 18, 1998)
4. Recapitalization Transaction - Contribution of financial assets by SOF IV
for cash and Class A Shares of the Company (Date March 18, 1998).
To faciliate this discussion, the following information has been provided in
summary form; (i) listing of key control dates considered; (ii) Company and
affiliate entity ownership/voting control computations at various key dates; and
(iii) other key control factors.
I. Key Control Dates:
o November, 1993 - The Company announced that SAHI, Inc. (a Starwood
affiliate) had acquired all of the Company's then outstanding Class B
Shares. These shares were purchased from SAHI, Inc. by SAHI Partners which
also acquired 244,100 Class A Shares or 9.57% of the total then outstanding
shares.
o March 15, 1994 - The Company entered into an agreement whereby for
consideration of $101,000 it sold warrants to acquire 5.0 million Class A
Shares and 2.5 million Class B Shares to SAHI, Inc and SAHI Partners,
respectively.
o March 15, 1996 - SAHI, Inc. and SAHI Partners assigned their interest in
the Class A warrants to Starwood Mezzanine for cash equal to their cost
basis.
o September 26, 1996 - The APMT Limited Partnership (the "Partnership") was
formed with the Company as the sole General Partner holding an 8.05%
interest in exchange for a contribution of $400,000 in cash. As part of the
formation, Starwood Mezzanine received a 91.95% limited partnership
interest in the Partnership in exchange for a contribution of mortgage
participation certificates with a then estimated fair value of
approximately $4.6 million and a predecessor basis of approximately $3.8.
o January 22, 1997 - Starwood Mezzanine exercised its rights under the
warrants to acquire 5.0 million Class A Shares of the Company at $1 per
share and SAHI, Inc. exercised its rights under the warrants to acquire 2.5
million Class B Shares of the Company at $0.01 per share.
o March 18, 1998 - Recapitalization Transactions consumated - including: (i)
contribution of financial assets by Starwood Mezzanine and SOF IV in
exchange for cash and Class A Shares; (ii) conversion of partnership units
into Class A Shares; and (iii) acquisition of additional Class B Shares by
an entity controlled by Starwood.
II. Ownership/voting control analysis:
o Exhibit I.A - Ownership structure immediately before Partnership Formation
(September 26, 1996) o Exhibit I.B - Ownership structure immediately before
the Recapitalization Transactions (March 18, 1998) o Exhibit I.C -Ownership
structure immediately after the Recapitalization Transactions (March 18,
1998) o Exhibit I.D - Analysis of common ownership between Starwood
Mezzanine and SOF IV
III. Other Key Control Factors:
o The voting control afforded Starwood by the Class A/Class B structure.
Under this structure, as Class A Shares are issued, the existing holders of
Class B shares are afforded the right to purchase, at $0.01 par value, one
Class B Share for every two Class A Shares issued. Each Class B Share has
one vote in situations requiring a vote under the Company's Declaration of
Trust - thereby, providing a 33.33% voting control block to the owners of
the Class B Shares.
o The control rights afforded Starwood as the sole general partners of
Starwood Opportunity Fund II, Starwood Mezzanine and SOF IV under the terms
of the respective partnership agreements.
Transaction 1 - Accounting for Formation of Partnership
On September 26, 1996, Starwood Mezzanine held an option to acquire 5,000,000
Class A Shares of the Company for $1 per share. These warrants were currently
exercisable. Further, certain affiliates of the General Partner of Starwood
Mezzanine held approximately 9.57% of the then outstanding Class A Shares and
100% of the Class B Shares (which represented 33.33% of the then outstanding
voting shares). Finally, executives of the General Partner of Starwood Mezzanine
were the sole officers of the Company and held a controlling interest through 5
of 8 positions on the Company's Board of Trustees. On September 26, 1996,
assuming exercise of the warrants, Starwood Mezzanine and its affiliates owned
69.46 % of the Class A Shares and 100% of the Class B Shares representing fully
diluted voting control of 79.64%.
The Partnership did not exist prior to September 26, 1996. In connection with
its formation, the Company contributed $400,000 in exchange for an 8.05%
interest and became the sole General Partner of the Partnership. Starwood
Mezzanine contributed its interests in certain mortgage participation
certificates to the Partnership in exchange for a 91.95% limited partnership
interest in the Partnership. The limited partnership interest were covertible
into shares of the Company at the option of Starwood Mezzanine. Starwood
Mezzanine's limited partners had no rights under the partnership agreement to
approve the transaction. Subsequent to the formation of the Partnership,
assuming exercise of the warrants and conversion of the partnership interests,
Starwood Mezzanine and its affiliates owned 80.97 % of the Class A Shares and
100% of the Class B Shares representing fully diluted voting control of 87.3%.
As illustrated above, Starwood Mezzanine and its affiliates had both economic
and voting control of both the Company and Starwood Mezzanine at the time of the
formation of the Partnership and immediately thereafter. Accordingly, as a
consequence, the contribution transaction was reflected at Starwood Mezzanine's
basis of approximately $3.8 million as a transfer of assets under common
control. Further, it should be noted that any gain/loss as a result of the basis
difference would be largely allocated to Starwood Mezzanine as a result of its
91.95% interest in the Partnership. Since the Company was the sole G.P., the
Partnership was consolidated by the Company in its accounting records.
Transaction 2 - Recapitalization transaction - Conversion of Partnership Units
As can be seen in Exhibit I.B, immediately before the conversion of the
Partnership interest, Starwood Mezzanine owned directly (without assuming
conversion of the Partnership Units) approximately 66.23% of the then
outstanding Class A Shares and Starwood affilates owned an additional 3.23% of
the Class A Shares and 100% of the Class B Shares representing a interests of
79.64% of the outstanding voting shares. Further, Starwood Mezzanine's limited
partners had no rights under the partnership agreement to approve the conversion
of the Partnership interests into Class A Shares. The transaction was fully
taxable to Starwood Mezzanine (i.e. full step-up for federal tax purposes),
resulting in a substantial tax gain.
Accounting guidance looked to for this transaction included EITF 95-7
Implementation Issues related to the Treatment of Minority Interests in Certain
Real Estate Investment Trusts. Given, the ownership structure, Starwood
Mezzanine was considered to be in an equivalent position to that of a sponsor in
an operating partnership REIT formation. The EITF indicates "...that subsequent
acquisitions of the sponsor's minority interest in the operating partnership in
exchange for REIT shares should also be recorded at the book value of the
minority interest acquired."
Transaction 3 - Recapitalization transaction - Contribution by Starwood
Mezzanine
As can be seen in Exhibit I.C., immediately before the contribution of assets by
Starwood Mezzanine to the Company (the "SM Contribution"), Starwood Mezzanine
owned directly (assuming conversion of the Partnership Units) approximately
78.96% of the then outstanding Class A Shares and Starwood owned an additional
2.01% of the Class A Shares and 100% of the Class B Shares, representing an
87.3% voting control by Starwood (including Starwood Mezzanine). Further,
Starwood Mezzanine's limited partners had no rights under the partnership
agreement to approve the SM Contribution. The SM Contribution was fully taxable
to Starwood Mezzanine (i.e. full step-up for federal tax purposes), resulting in
a substantial tax gain.
As a consequence of these factors, Starwood Mezzanine and its affiliates were
considered to have both economic and effective control of both the Company and
Starwood Mezzanine at the time of the transaction and immediately thereafter.
Accordingly, the SM Contribution was reflected as a step-acquisition using fair
values derived by an independent investment bank, resulting in an increase from
Starwood Mezzanine's basis of approximately $0.7 million. This basis adjustment
was attributed to the underlying loans contributed and will amortize over the
expected terms of the loans as a reduction of recognized income.
Transaction 4 - Recapitalization transaction - Contribution by SOF IV
As can be seen Exhibit I.C., immediately before the contribution of assets by
SOF IV to the Company ( the "SOF IV Contribution"), Starwood Mezzanine owned
directly (assuming conversion of the Partnership Units) approximately 78.96% of
the then outstanding Class A shares and Starwood an additional 2.01% of the
Class A Shares and 100% of the Class B Shares, representing an 87.3% voting
control by Starwood. However, SOF IV's limited partners had the right under the
partnership agreement to approve the SOF IV Contribution. Further, there was a
significant disparity of ownership between the economic owners of Starwood
Mezzanine and SOF IV as demonstrated in Exhibit I.D which indicates only a
19.26% of common ownership of Starwood Mezzanine investors in SOF IV. The SOF IV
Contribution was fully taxable to SOF IV (i.e. full step-up for federal tax
purposes), resulting in a substantial tax gain.
As a consequence of these factors, while Starwood Mezzanine and its affiliates
were considered to have both economic and effective control of both the Company
and Starwood Mezzanine at the time of the Recapitalization Transaction and
immediately thereafter, the significant disparity of ownership and approval
rights of SOF IV's limited partners indicated that the control for the SOFI IV
transaction did not fully rest with Starwood. Accordingly, the SOFI IV
Contribution was reflected as a purchase resulting in an increase from SOF IV's
basis of approximately $87.0 million. This basis adjustment was attributed to
the underlying real estate loans and related investments contributed using fair
values derived by an independent investment bank for all assets, except the
variable rate senior mortgages for which face value was considered to
approximate par. The basis step up generally represents premiums which will
amortize over the expected terms of the loans as a reduction of recognized
income.
