-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PnioVxSBfr/vQ0QSVSZM6ZbcWbaKKCqKeR+07VTJ8bhINep8icVkOU8H+K6db8or OYRxQ/4p83f+tFMcEZikSw== 0001116679-04-001714.txt : 20040816 0001116679-04-001714.hdr.sgml : 20040816 20040816161227 ACCESSION NUMBER: 0001116679-04-001714 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040816 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPITAL TRUST INC CENTRAL INDEX KEY: 0001061630 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 946181186 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-14788 FILM NUMBER: 04978893 BUSINESS ADDRESS: STREET 1: 410 PARK AVENUE STREET 2: 14TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10022 BUSINESS PHONE: 2126550220 MAIL ADDRESS: STREET 1: PAUL, HASTINGS, JANOFSKY & WALKER LLP STREET 2: 75 E 55TH ST CITY: NEW YORK STATE: NY ZIP: 10022 10-Q 1 cap10q.txt To be filed with the Securities and Exchange Commission on August 16, 2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 ------------- 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 Number 1-14788 -------- Capital Trust, Inc. ------------------- (Exact name of registrant as specified in its charter) Maryland 94-6181186 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 410 Park Avenue, 14th Floor, New York, NY 10022 - ----------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 655-0220 -------------- 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes[ ] No[ X ] APPLICABLE ONLY TO CORPORATE ISSUERS: The number of outstanding shares of the Registrant's class A common stock, par value $0.01 per share, as of August 5, 2004 was 12,544,161. CAPITAL TRUST, INC. INDEX Part I. Financial Information Item 1: Financial Statements 1 Consolidated Balance Sheets - June 30, 2004 (unaudited) and December 31, 2003 (audited) 1 Consolidated Statements of Income - Three and Six Months Ended June 30, 2004 and 2003 (unaudited) 2 Consolidated Statements of Changes in Shareholders' Equity - Three and Six Months Ended June 30, 2004 and 2003 (unaudited) 3 Consolidated Statements of Cash Flows - Six Months Ended June 30, 2004 and 2003 (unaudited) 4 Notes to Consolidated Financial Statements (unaudited) 5 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 3: Quantitative and Qualitative Disclosures about Market Risk 25 Item 4: Disclosure Controls and Procedures 26 Part II. Other Information Item 1: Legal Proceedings 27 Item 2: Changes in Securities 27 Item 3: Defaults Upon Senior Securities 27 Item 4: Submission of Matters to a Vote of Security Holders 27 Item 5: Other Information 28 Item 6: Exhibits and Reports on Form 8-K 28 Signatures 30 Capital Trust, Inc. and Subsidiaries Consolidated Balance Sheets June 30, 2004 and December 31, 2003 (in thousands)
June 30, December 31, 2004 2003 ------------------ ---------------- Unaudited Audited Assets Cash and cash equivalents $ 39,865 $ 8,738 Available-for-sale securities, at fair value -- 20,052 Commercial mortgage-backed securities available-for-sale, at fair value 195,037 158,136 Loans receivable, net of $6,672 reserve for possible credit losses at June 30, 2004 and December 31, 2003 199,825 177,049 Equity investment in CT Mezzanine Partners I LLC ("Fund I"), CT Mezzanine Partners II LP ("Fund II"), CT MP II LLC ("Fund II GP") and CT Mezzanine Partners III, Inc. ("Fund III") (together "Funds") 21,193 21,988 Deposits and other receivables 3 345 Accrued interest receivable 2,734 3,834 Interest rate hedge assets 3,071 168 Deferred income taxes 4,871 3,369 Prepaid and other assets 5,601 6,247 ------------------ ---------------- Total assets $ 472,200 $ 399,926 ================== ================ Liabilities and Shareholders' Equity Liabilities: Accounts payable and accrued expenses $ 10,087 $ 11,041 Credit facilities 50,000 38,868 Term redeemable securities contract -- 11,651 Repurchase obligations 178,944 146,894 Step up convertible junior subordinated debentures 92,487 92,248 Deferred origination fees and other revenue 2,097 3,207 ------------------ ---------------- Total liabilities 333,615 303,909 ------------------ ---------------- Shareholders' equity: Class A common stock, $0.01 par value, 100,000 shares authorized, 8,236 and 6,502 shares issued and outstanding at June 30, 2004 and December 31, 2003, respectively ("class A common stock") 82 65 Restricted class A common stock, $0.01 par value, 64 and 34 shares issued and outstanding at June 30, 2004 and December 31, 2003, respectively ("restricted class A common stock" and together with class A common stock, "common stock") 1 -- Additional paid-in capital 181,783 141,402 Unearned compensation (1,189) (247) Accumulated other comprehensive loss (30,669) (33,880) Accumulated deficit (11,423) (11,323) ------------------ ---------------- Total shareholders' equity 138,585 96,017 ------------------ ---------------- Total liabilities and shareholders' equity $ 472,200 $ 399,926 ================== ================
See accompanying notes to unaudited consolidated financial statements. -1- Capital Trust, Inc. and Subsidiaries Consolidated Balance Sheets Three and Six Months June 30, 2004 and 2003 (in thousands, except per share data) (unaudited)
Three Months Ended Six Months Ended June 30, June 30, ------------------------------- ------------------------------- 2004 2003 2004 2003 -------------- -------------- -------------- -------------- Income from loans and other investments: Interest and related income $ 9,172 $ 8,737 $ 18,190 $ 17,766 Less: Interest and related expenses on secured debt 2,454 2,458 5,090 4,753 Less: Interest and related expenses on step up convertible junior subordinated debentures 2,432 2,432 4,865 4,865 -------------- -------------- -------------- -------------- Income from loans and other investments, net 4,286 3,847 8,235 8,148 -------------- -------------- -------------- -------------- Other revenues: Management and advisory fees from Funds 2,031 1,432 4,115 2,808 Income/(loss) from equity investments in Funds 431 533 825 1,318 Gain on sales of investments 300 -- 300 -- Other interest income 8 19 16 38 -------------- -------------- -------------- -------------- Total other revenues 2,770 1,984 5,256 4,164 -------------- -------------- -------------- -------------- Other expenses: General and administrative 3,154 2,989 6,092 6,693 Other interest expense -- -- -- -- Depreciation and amortization 274 256 548 488 Provision for/(recapture of) allowance for possible credit losses -- -- -- -- -------------- -------------- -------------- -------------- Total other expenses 3,428 3,245 6,640 7,181 -------------- -------------- -------------- -------------- Income before income taxes 3,628 2,586 6,851 5,131 Provision for income taxes 88 -- 229 -- -------------- -------------- -------------- -------------- Net income $ 3,540 $ 2,586 $ 6,622 $ 5,131 ============== ============== ============== ============== Per share information: Net earnings per share of common stock: Basic $ 0.48 $ 0.46 $ 0.95 $ 0.93 ============== ============== ============== ============== Diluted $ 0.47 $ 0.46 $ 0.93 $ 0.92 ============== ============== ============== ============== Weighted average shares of common stock outstanding: Basic 7,414,509 5,579,341 6,998,960 5,525,307 ============== ============== ============== ============== Diluted 7,541,416 5,628,502 7,122,274 5,557,277 ============== ============== ============== ============== Dividends declared per share of common stock $ 0.45 $ 0.45 $ 0.90 $ 0.90 ============== ============== ============== ==============
See accompanying notes to unaudited consolidated financial statements. -2- Capital Trust, Inc. and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity For the Six Months Ended June 30, 2004 and 2003 (in thousands) (unaudited)
Restricted Class A Class A Additional Comprehensive Common Common Paid-In Unearned Income/(Loss) Stock Stock Capital Compensation -------------- ------------------------------------------- Balance at January 1, 2003 $ 54 $ 1 $ 126,919 $ (320) Net income $ 5,131 -- -- -- -- Unrealized loss on derivative financial instruments (3,987) -- -- -- -- Unrealized loss on available-for-sale securities (5,043) -- -- -- -- Sale of shares of class A common stock under stock option agreement -- -- -- 4 -- Cancellation of restricted class A common stock -- -- -- (192) 192 Vesting of restricted class A common stock to unrestricted class A common stock -- 1 (1) -- -- Restricted class A common stock earned -- -- -- -- 84 Repurchase of warrants to purchase shares of class A common stock -- -- -- (2,132) -- Repurchase and retirement of shares of class A common stock previously outstanding -- (1) -- (946) -- Dividends declared on class A common stock -- -- -- -- -- Shares redeemed in one for three reverse stock split -- -- -- (8) -- Shares of class A common stock issued in private offering -- 11 -- 17,127 -- ----------- ---- --------- --------- -------- Balance at June 30, 2003 $ (3,899) $ 65 $ -- $ 140,772 $ (44) =========== ==== ========= ========= ======== Balance at January 1, 2004 $ 65 $ -- $ 141,402 $ (247) Net income $ 6,622 -- -- -- -- Unrealized gain on derivative financial instruments 2,903 -- -- -- -- Unrealized gain on available-for-sale securities 308 -- -- -- -- Issuance of restricted class A common stock -- -- 1 1,199 (1,200) Sale of shares of class A common stock under stock option agreement -- 1 -- 707 -- Vesting of restricted class A common stock to unrestricted class A common stock -- -- -- -- -- Conversion of class A common stock units to class A common stock -- -- -- 410 -- Restricted class A common stock earned -- -- -- -- 360 Revaluation of restricted class A common stock -- -- -- 102 (102) Shares of class A common stock issued in direct public offering -- 16 -- 37,963 -- Dividends declared on class A common stock -- -- -- -- -- --------- ---- --------- --------- -------- Balance at June 30, 2004 $ 9,833 $ 82 $ 1 $ 181,783 $ (1,189) ========= ==== ========= ========= ======== Accumulated Other Comprehensive Accumulated Income/(Loss) Deficit Total -------------------------------------- Balance at January 1, 2003 $ (28,988) $(13,610) $ 84,056 Net income -- 5,131 5,131 Unrealized loss on derivative financial instruments (3,987) -- (3,987) Unrealized loss on available-for-sale securities (5,043) -- (5,043) Sale of shares of class A common stock under stock option agreement -- -- 4 Cancellation of restricted class A common stock -- -- -- Vesting of restricted class A common stock to unrestricted class A common stock -- -- -- Restricted class A common stock earned -- -- 84 Repurchase of warrants to purchase shares of class A common stock -- -- (2,132) Repurchase and retirement of shares of class A common stock previously outstanding -- -- (947) Dividends declared on class A common stock -- (5,367) (5,367) Shares redeemed in one for three reverse stock split -- -- (8) Shares of class A common stock issued in private offering -- -- 17,138 ----------- -------- --------- Balance at June 30, 2003 $ (38,018) $(13,846) $ 88,929 =========== ======== ========= Balance at January 1, 2004 $ (33,880) $(11,323) $ 96,017 Net income -- 6,622 6,622 Unrealized gain on derivative financial instruments 2,903 -- 2,903 Unrealized gain on available-for-sale securities 308 -- 308 Issuance of restricted class A common stock -- -- -- Sale of shares of class A common stock under stock option agreement -- -- 708 Vesting of restricted class A common stock to unrestricted class A common stock -- -- -- Conversion of class A common stock units to class A common stock -- -- 410 Restricted class A common stock earned -- -- 360 Revaluation of restricted class A common stock -- -- -- Shares of class A common stock issued in direct public offering -- -- 37,979 Dividends declared on class A common stock -- (6,722) (6,722) ----------- -------- --------- Balance at June 30, 2004 $ (30,669) $(11,423) $ 138,585 =========== ======== =========
See accompanying notes to unaudited consolidated financial statements -3- Capital Trust, Inc. and Subsidiaries Consolidated Statements of Cash Flows Six months ended June 30, 2004 and 2003 (in thousands) (unaudited)
2004 2003 ----------------- ----------------- Cash flows from operating activities: Net income $ 6,622 $ 5,131 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Deferred income taxes (1,502) (335) Depreciation and amortization 548 488 Income from equity investments in Funds (825) (1,318) Restricted class A common stock earned 360 84 Gain on sale of investments (300) -- Amortization of premiums and accretion of discounts on loans and investments, net (794) (421) Accretion of discounts and fees on convertible trust preferred securities or convertible step up junior subordinated debentures, net 239 239 Changes in assets and liabilities, net: Deposits and other receivables 342 (408) Accrued interest receivable 1,100 4,273 Prepaid and other assets 662 (1,087) Deferred origination fees and other revenue (1,110) (301) Accounts payable and accrued expenses (1,338) (3,829) ----------------- ----------------- Net cash provided by operating activities 4,004 2,516 ----------------- ----------------- Cash flows from investing activities: Purchases of commercial mortgage-backed securities (35,037) -- Principal collections and proceeds from sales on available-for-sale securities 19,561 31,177 Origination and purchase of loans receivable (47,093) (36,525) Principal collections and proceeds from sale of loans receivable 24,346 30,384 Equity investments in Funds (3,500) (6,216) Return of capital from Funds 4,621 6,651 Purchase of remaining interest in Fund I -- (19,946) Purchases of equipment and leasehold improvements (65) (16) ----------------- ----------------- Net cash provided by (used in) investing activities (37,167) 5,509 ----------------- ----------------- Cash flows from financing activities: Proceeds from repurchase obligations 60,721 28,061 Repayment of repurchase obligations (28,671) (37,217) Proceeds from credit facilities 89,500 59,015 Repayment of credit facilities (78,368) (94,100) Proceeds from term redeemable securities contract -- 20,000 Repayment of term redeemable securities contract (11,651) -- Dividends paid on class A common stock (5,928) (2,442) Sale of shares of class A common stock under stock option agreement 708 4 Proceeds from sale of shares of class A common stock 37,979 17,138 Repurchase and retirement of shares of class A common stock previously outstanding -- (955) Repurchase of warrants to purchase shares of class A common stock -- (2,132) ----------------- ----------------- Net cash provided by (used in) financing activities 64,290 (12,628) ----------------- ----------------- Net increase (decrease) in cash and cash equivalents 31,127 (4,603) Cash and cash equivalents at beginning of year 8,738 10,186 ----------------- ----------------- Cash and cash equivalents at end of period $ 39,865 $ 5,583 ================= =================
See accompanying notes to unaudited consolidated financial statements. -4- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 1. Presentation of Financial Information References herein to "we," "us" or "our" refer to Capital Trust, Inc. and its subsidiaries unless the context specifically requires otherwise. We are a fully integrated, self-managed finance and investment management company that specializes in credit sensitive structured financial products. We invest in loans, debt securities and related instruments for our own account and on behalf of funds that we manage. To date, our investment programs have focused on loans and securities backed by income-producing commercial real estate assets with the objective of achieving attractive risk adjusted returns with low volatility. We conduct our operations to qualify as a real estate investment trust for federal income tax purposes. The accompanying unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The accompanying unaudited consolidated interim financial statements should be read in conjunction with the financial statements and the related management's discussion and analysis of financial condition and results of operations filed with our Annual Report on Form 10-K for the fiscal year ended December 31, 2003. In our opinion, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for the three and six months ended June 30, 2004, are not necessarily indicative of results that may be expected for the entire year ending December 31, 2004. The accompanying unaudited consolidated interim financial statements include our accounts and our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Our accounting and reporting policies conform in all material respects to accounting principles generally accepted in the United States. Certain prior period amounts have been reclassified to conform to current period classifications. 2. Application of New Accounting Standard In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, "Consolidation of Variable Interest Entities," an interpretation of Accounting Research Bulletin 51. Interpretation No. 46 provides guidance on identifying entities for which control is achieved through means other than through voting rights, and how to determine when and which business enterprise should consolidate a variable interest entity. In addition, Interpretation No. 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a variable interest entity make additional disclosures. The transitional disclosure requirements took effect almost immediately and are required for all financial statements initially issued after January 31, 2003. In December 2003, the Financial Accounting Standards Board issued a revision of Interpretation No. 46, Interpretation No. 46R, to clarify the provisions of Interpretation No. 46. The application of Interpretation No. 46R is effective for public companies, other than small business issuers, after March 15, 2004. We have evaluated all of our investments and other interests in entities that may be deemed variable interest entities under the provisions of Interpretation No. 46 and have concluded that no additional entities need to be consolidated. In evaluating Interpretation No. 46R, we concluded that we could no longer consolidate CT Convertible Trust I, the entity which had purchased our step up convertible junior subordinated debentures and issued company-obligated, mandatory redeemable, convertible trust common and preferred securities. Capital Trust, Inc. had issued the convertible junior subordinated debentures and had purchased the convertible trust common securities. The consolidation of CT Convertible Trust I resulted in the elimination of both the convertible junior subordinated debentures and the convertible trust common securities with the convertible trust preferred securities being reported on our balance sheet after liabilities but before equity and the related expense being reported on the income statement below income taxes and net of income tax benefits. After the deconsolidation, we report the convertible junior subordinated debentures as liabilities and the convertible trust common securities as other assets. The expense from the payment of interest on the debentures is reported as interest and related expenses on convertible junior subordinated debentures and the income received from our investment in the common securities is reported as a component of interest and related income. We have elected to restate prior periods for the application of -5- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) Interpretation 46R. The restatement was effected by a cumulative type change in accounting principle on January 1, 2002. There was no change to previously reported net income as a result of such restatement. 3. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 4. Available-for-Sale Securities On June 14, 2004, we sold our entire portfolio of our available-for-sale securities for a gain of $300,000 over their amortized cost. 5. Commercial Mortgage-Backed Securities During the six months ended June 30, 2004, we purchased three investments in two issues of commercial mortgage-backed securities. The securities had a face value of $36,367,000 and were purchased at a discount for $35,037,000. At June 30, 2004, we held twenty-one investments in fourteen separate issues of commercial mortgage-backed securities with an aggregate face value of $251,880,000. Commercial mortgage-backed securities with a face value of $41,367,000 earn interest at a variable rate, which averages the London Interbank Offered Rate, or LIBOR, plus 3.04% (4.28% at June 30, 2004). The remaining commercial mortgage-backed securities, $210,512,000 face value, earn interest at fixed rates averaging 7.70% of the face value. We purchased the commercial mortgage-backed securities at discounts. As of June 30, 2004, the remaining discount to be amortized into income over the remaining lives of the securities was $23,103,000. At June 30, 2004, with discount amortization, the commercial mortgage-backed securities earn interest at a blended rate of 8.73% of the face value less the unamortized discount. As of June 30, 2004, the securities were carried at fair value of $195,037,000, reflecting a $33,739,000 unrealized loss to their amortized cost. -6- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 6. Loans Receivable At June 30, 2004 and December 31, 2003, the our loans receivable consisted of the following (in thousands): June 30, December 31, 2004 2003 --------------- --------------- First mortgage loans $ 11,540 $ 12,672 Property mezzanine loans 115,713 106,449 B Notes 79,244 64,600 --------------- --------------- 206,497 183,721 Less: reserve for possible credit losses (6,672) (6,672) --------------- --------------- Total loans $ 199,825 $ 177,049 =============== =============== One first mortgage loan with an original principal balance of $8,000,000 reached maturity on July 15, 2001 and has not been repaid with respect to principal and interest. In December 2002, the loan was written down to $4,000,000 through a charge to the allowance for possible credit losses. Since the December 2002 write-down, we received proceeds of $962,000 reducing the carrying value of the loan to $3,038,000. In accordance with our policy for revenue recognition, income recognition has been suspended on this loan, and for the three and six months ended June 30, 2004, $224,000 and $449,000, respectively, of potential interest income has not been recorded. All remaining loans are performing in accordance with the terms of the loan agreements. During the six months ended June 30, 2004, we purchased or originated one property mezzanine loan for $23,500,000 and two B Notes for $23,593,000, received partial repayments on ten mortgage and property mezzanine loans totaling $7,493,000 and one property mezzanine loan and one B Note totaling $16,853,000 were satisfied and repaid. We have no outstanding loan commitments at June 30, 2004. At June 30, 2004, the weighted average interest rate in effect, including amortization of fees and premiums, for our performing loans receivable were as follows: First mortgage loan 10.55% Property mezzanine loans 9.18% B Notes 6.79% Total Loans 8.31% At June 30, 2004, $154,640,000 (76%) of the aforementioned performing loans bear interest at floating rates ranging from LIBOR plus 235 basis points to LIBOR plus 900 basis points. The remaining $48,819,000 (24%) of loans bear interest at a fixed rate of 11.67%. 7. Long-Term Debt Credit Facility At June 30, 2004, we have borrowed $50,000,000 under a $150.0 million credit facility at an average borrowing rate (including amortization of fees incurred and capitalized) of 4.32%. We pledged $114,456,000 of assets as collateral for the borrowing against such credit facility. At June 30, 2004, the available credit remaining under the credit facility was $100.0 million of which $32.5 million may be borrowed without the need to pledge additional assets as collateral. Repurchase Obligations At June 30, 2004, we were obligated to four counterparties under repurchase agreements. The repurchase obligation with the first counterparty, an affiliate of a securities dealer, was utilized to finance commercial mortgage-backed securities. At June 30, 2004, we have sold commercial mortgage-backed securities with a book and market value of $184,500,000 and have a liability to repurchase these assets for $116,818,000 that -7- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) is non-recourse to us. This repurchase obligation had an original one-year term that expired in February 2003 and was extended twice to February 2005. The liability balance bears interest at specified rates over LIBOR based upon each asset included in the obligation. The repurchase obligation with the second counterparty, a securities dealer, was entered into on May 28, 2003 pursuant to the terms of a master repurchase agreement that, as increased in August 2003, allows us to incur $100.0 million of repurchase obligations to finance specific assets. Through June 30, 2004, the master repurchase agreement has been utilized in connection with the purchase of five loans. At June 30, 2004, we have sold loans with a book and market value of $53,085,000 and have a liability to repurchase these assets for $40,000,000. The master repurchase agreement was extended during the quarter ended June 30, 2004 and now terminates on June 1, 2006, with an automatic nine-month amortizing extension option, if not otherwise extended, and bears interest at specified rates over LIBOR based upon each asset included in the obligation. The repurchase obligations with the third counterparty, a securities dealer, were entered into during 2003 in connection with the purchase of commercial mortgage-backed securities. At June 30, 2004, we have sold commercial mortgage-backed securities with a book and market value of $5,000,000 and have a liability to repurchase these assets for $4,250,000. The repurchase agreements are matched to the term of the commercial mortgage-backed securities, which have an extended maturity in August 2007, and bear interest at specified rates over LIBOR based upon each asset included in the obligation. The repurchase obligation with the fourth counterparty, a securities dealer, was entered into in connection with the purchase of two loans. At June 30, 2004, we have sold loans with a book and market value of $21,326,000 and have a liability to repurchase these assets for $17,876,000. This repurchase agreement comes due monthly and has a current maturity date in August 2004. The average borrowing rate in effect for all the repurchase obligations outstanding at June 30, 2004 was LIBOR plus 1.09% (2.21% at June 30, 2004). Assuming no additional utilization under the repurchase obligations and including the amortization of fees paid and capitalized over the term of the repurchase obligations, the all-in effective borrowing cost was 2.30% at June 30, 2004. Term Redeemable Securities Contract At December 31, 2003, we had borrowed $11,651,000 under a $75 million term redeemable securities contract. This term redeemable securities contract expired on February 28, 2004 and was repaid by refinancing the previously financed assets under our credit facility. 8. Derivative Financial Instruments The following table summarizes the notional value and fair value of our derivative financial instruments at June 30, 2004. The notional value provides an indication of the extent of our involvement in these instruments at that time, but does not represent exposure to credit, interest rate or foreign exchange market risks.
Interest Hedge Type Notional Value Rate Maturity Fair Value - ------------- ------------------------ -------------------- ------------------ -------------- ------------------ Swap Cash Flow Hedge $85,000,000 4.2425% 2015 $ 2,382,000 Swap Cash Flow Hedge 24,000,000 4.2325% 2015 689,000
On June 30, 2004, the derivative financial instruments were reported at their fair value as interest rate hedge assets of $3,071,000. -8- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 9. Shareholders Equity On May 11, 2004, we closed on the initial tranche of a direct public offering to designated controlled affiliates of W. R. Berkley Corporation, which we refer to as Berkley. We issued 1,310,000 shares of our class A common stock and stock purchase warrants to purchase 365,000 shares of our class A common stock for a total purchase price of $30.7 million. On June 21, 2004, we closed on the second tranche of the direct public offering and issued an additional 325,000 shares of our class A common stock for a total purchase price of $7.6 million. The warrants have an exercise price of $23.40 per share and expire on December 31, 2004. Pursuant to a director designation right granted to Berkley in the transaction, we appointed Joshua A. Polan to our board of directors. 10. Earnings Per Share The following table sets forth the calculation of Basic and Diluted EPS for the six months ended June 30, 2004 and 2004:
Six Months Ended June 30, 2004 Six Months Ended June 30, 2003 --------------------------------------------- --------------------------------------------- Per Share Per Share Net Income Shares Amount Net Income Shares Amount --------------- -------------- ------------ --------------- ------------- ------------- Basic EPS: Net earnings per share of common stock $ 6,622,000 6,998,960 $ 0.95 $ 5,131,000 5,525,307 $ 0.93 =========== ============ Effect of Dilutive Securities Options outstanding for the purchase of common stock -- 118,642 -- 31,970 Warrants outstanding for the purchase of common stock -- 4,672 -- -- --------------- -------------- --------------- --------------- Diluted EPS: Net earnings per share of common stock and assumed conversions $ 6,622,000 7,122,274 $ 0.93 $ 5,131,000 5,557,277 $ 0.92 =============== ============= ============ ================ ================ ============
The following table sets forth the calculation of Basic and Diluted EPS for the three months ended June 30, 2004 and 2003:
Three Months Ended June 30, 2004 Three Months Ended June 30, 2003 --------------------------------------------- --------------------------------------------- Per Share Per Share Net Income Shares Amount Net Income Shares Amount --------------- -------------- ------------ --------------- ------------- ------------- Basic EPS: Net earnings per share of common stock $ 3,540,000 7,414,509 $ 0.48 $ 2,586,000 5,579,341 $ 0.46 =========== ============ Effect of Dilutive Securities Options outstanding for the purchase of common stock -- 117,564 -- 49,161 Warrants outstanding for the purchase of common stock -- 9,343 -- -- --------------- -------------- --------------- --------------- Diluted EPS: Net earnings per share of common stock and assumed conversions $ 3,540,000 7,541,416 $ 0.47 $ 2,586,000 5,628,502 $ 0.46 =============== ============= ============ ================ ================ ============
-9- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 11. Income Taxes We intend to make an election to be taxed as a Real Estate Investment Trust, or REIT, under Section 856(c) of the Internal Revenue Code of 1986, as amended, when we file our tax return for the tax year ending December 31, 2003 in the fourth quarter of 2004. As a REIT, we generally are not subject to federal income tax. To maintain qualification as a REIT, we must distribute at least 90% of our REIT taxable income to our shareholders and meet certain other requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates. We may also be subject to certain state and local taxes on our income and property. Under certain circumstances, federal income and excise taxes may be due on our undistributed taxable income. At June 30, 2004, we were in compliance with all REIT requirements. During the three and six months ended June 30, 2004, we recorded $88,000 and $229,000, respectively, of income tax expense for income that was attributable to taxable REIT subsidiaries. Our effective tax rate for the six months ended June 30, 2004 attributable to our taxable REIT subsidiaries was 34.0%. The difference between the U.S. federal statutory tax rate of 35% and the effective tax rate was additional deductions generated from vesting of restricted stock offset by state and local taxes, net of federal tax benefit. 12. Commitments and Contingencies John R. Klopp serves as our chief executive officer and president pursuant to an employment agreement entered into on July 15, 1997, which terminated effective July 15, 2004, the effective date of his new employment agreement that was entered into as of February 24, 2004. The new employment agreement provides for Mr. Klopp's employment as chief executive officer and president through December 31, 2008 (subject to earlier termination under certain circumstances). Under the new employment agreement, Mr. Klopp will receive a base salary and is eligible to receive annual performance compensation awards of cash and restricted shares of common stock. In addition, as of the effective date of the new agreement, July 15, 2004, Mr. Klopp was granted an initial award of 218,818 restricted shares, 50% of which will be subject to time vesting in eight equal quarterly increments commencing on March 31, 2007 and 50% of which will be issued as a performance compensation award and will vest on December 31, 2008 if the total shareholder return, measured from January 1, 2004 through December 31, 2008, is at least 13% per annum. As of the effective date, Mr. Klopp was also awarded performance compensation awards tied to the amount of cash we receive, if any, as incentive management fees from CT Mezzanine Partners III, Inc. The agreement provides for severance payments under certain circumstances and contains provisions relating to non-competition during the term of employment, protection of our confidential information and intellectual property, and non-solicitation of our employees, which provisions extend for 24 months following termination in certain circumstances. 13. Dividends In order to maintain our election to qualify as a REIT, we must currently distribute, at a minimum, an amount equal to 90% of its REIT taxable income and must distribute 100% of its REIT taxable income to avoid paying corporate federal income taxes. We expect to distribute all of our REIT taxable income to our shareholders. Because REIT taxable income differs from cash flow from operations due to non-cash revenues or expenses, in certain circumstances, we may be required to borrow to make sufficient dividend payments to meet this anticipated dividend threshold. On June 22, 2004, we declared a dividend of approximately $3,735,000, or $0.45 per share of common stock applicable to the three-month period ended June 30, 2004, payable on July 15, 2004 to shareholders of record on June 30, 2004. -10- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 14. Employee Benefit Plans 1997 Long-Term Incentive Stock Plan During the three and six months ended June 30, 2004, we did not issue any options to acquire shares of class A common stock. During the six months ended June 30, 2004, we issued 52,515 shares of restricted stock. The shares of restricted stock issued in 2004 are split into two grants. One-half of the shares issued in 2004 vest one-third on each of the following dates: February 1, 2005, February 1, 2006 and February 1, 2007. The remaining one-half are performance based and vest on February 1, 2008 if the total return to shareholders exceeds 13% during the period from January 1, 2004 to December 31, 2007. The following table summarizes the option activity under the incentive stock plan for the six months ended June 30, 2004:
Weighted Average Options Exercise Price Exercise Price per Outstanding per Share Share --------------------- ------------------------------ ---------------------- Outstanding at January 1, 2004 517,468 $12.375 - $30.00 $ 19.09 Granted in 2004 -- -- -- Exercised in 2004 (49,689) $12.375 - $18.00 14.24 Canceled in 2004 (1,946) $15.00 - $15.90 15.39 --------------------- ---------------------- Outstanding at June 30, 2004 465,833 $12.375 - $30.00 $ 19.62 ===================== ======================
At June 30, 2004, 435,385 of the options are exercisable. At June 30, 2004, the outstanding options have various remaining contractual exercise periods ranging from 1.50 to 7.60 years with a weighted average life of 4.98 years. 2004 Long-Term Incentive Plan At the 2004 annual meeting of our shareholders held on June 17, 2004, our 2004 long-term incentive plan, which we refer to as the 2004 Plan, was approved by shareholders. The 2004 Plan permits the grant of nonqualified stock option, incentive stock option, share appreciation right, restricted share, unrestricted share, performance unit, performance share and deferred share unit awards. A maximum of 1,000,000 shares of class A common stock may be issued under the 2004 Plan and, as of June 30, 2004, no shares have been issued under the plan. We have committed to issue to the chief executive officer, pursuant to his employment agreement, 218,818 shares of restricted stock on July 15, 2004 under the 2004 Plan. No participant may receive options or share appreciation rights that relate to more than 500,000 shares per calendar year. Incentive stock options shall be exercisable no more than ten years after their date of grant and five years after the grant in the case of a 10% shareholder. Payment of an option exercise price may be made with cash, with previously owned class A common stock, through a cashless exercise program, surrender of restricted shares, restricted share units, share appreciation rights or deferred share units or by a combination of these methods of payment. Restricted stock may be granted under the 2004 plan with performance goals and periods of restriction as the board of directors may designate. The performance goals may be based on the attainment of certain objective and/or subjective measures. The long-term incentive stock plan also authorizes the grant of share units at any time and from time to time on such terms as shall be determined by the board of directors or administering compensation committee. Share units shall be payable in shares of class A common stock upon the occurrence of certain trigger events. The terms and conditions of the trigger events may vary by share unit award, by the participant, or both. -11- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 15. Supplemental Disclosures for Consolidated Statements of Cash Flows Interest paid on our outstanding debt and convertible junior subordinated debentures during the six months ended June 30, 2004 and 2003 was $9,643,000 and $9,384,000, respectively. We paid income taxes during the six months ended June 30, 2004 and 2003 of $1,910,000 and $1,693,000, respectively. 16. Segment Reporting We have established two reportable segments beginning January 1, 2003. We have an internal information system that produces performance and asset data for our two segments along service lines. The Balance Sheet Investment segment includes all of our activities related to direct loan and investment activities (including direct investments in Funds) and the financing thereof. The Investment Management segment includes all of our activities related to investment management services provided us and third-party funds under management and includes our taxable REIT subsidiary, CT Investment Management Co., LLC and its subsidiaries. The following table details each segment's contribution to our overall profitability and the identified assets attributable to each such segment for the six months ended and as of June 30, 2004, respectively (in thousands):
Balance Sheet Investment Inter-Segment Investment Management Activities Total ----------------- ---------------- ----------------- ----------------- Income from loans and other investments: Interest and related income $ 18,190 $ -- $ -- $ 18,190 Less: Interest and related expenses on credit facilities, term redeemable securities contract and repurchase obligations 5,090 -- -- 5,090 Less: Interest and related expenses on convertible junior subordinated debentures 4,865 -- -- 4,865 ----------------- ---------------- ----------------- ----------------- Income from loans and other investments, net 8,235 -- -- 8,235 ----------------- ---------------- ----------------- ----------------- Other revenues: Management and advisory fees -- 5,519 (1,404) 4,115 Income/(loss) from equity investments in Funds 1,011 (186) -- 825 Gain on sales of investments 300 -- -- 300 Other interest income 10 200 (194) 16 ----------------- ---------------- ----------------- ----------------- Total other revenues 1,321 5,533 (1,598) 5,256 ----------------- ---------------- ----------------- ----------------- Other expenses: General and administrative 2,763 4,733 (1,404) 6,092 Other interest expense 194 -- (194) -- Depreciation and amortization 422 126 -- 548 ----------------- ---------------- ----------------- ----------------- Total other expenses 3,379 4,859 (1,598) 6,640 ----------------- ---------------- ----------------- ----------------- Income before income taxes 6,177 674 -- 6,851 Provision for income taxes -- 229 -- 229 ----------------- ---------------- ----------------- ----------------- Net income $ 6,177 $ 445 $ -- $ 6,622 ================= ================ ================= ================= Total Assets $ 464,244 $ 19,294 $ (11,338) $ 472,200 ================= ================ ================= =================
-12- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) The following table details each segment's contribution to our overall profitability and the identified assets attributable to each such segment for the six months ended and as of June 30, 2003, respectively (in thousands):
Balance Sheet Investment Inter-Segment Investment Management Activities Total ----------------- ---------------- ----------------- ----------------- Income from loans and other investments: Interest and related income $ 17,766 $ -- $ -- $ 17,766 Less: Interest and related expenses on credit facilities, term redeemable securities contract and repurchase obligations 4,753 -- -- 4,753 Less: Interest and related expenses on convertible junior subordinated debentures 4,865 -- -- 4,865 ----------------- ---------------- ----------------- ----------------- Income from loans and other investments, net 8,148 -- -- 8,148 ----------------- ---------------- ----------------- ----------------- Other revenues: Management and advisory fees -- 5,023 (2,215) 2,808 Income/(loss) from equity investments in Funds 1,409 (91) -- 1,318 Other interest income 20 18 -- 38 ----------------- ---------------- ----------------- ----------------- Total other revenues 1,429 4,950 (2,215) 4,164 ----------------- ---------------- ----------------- ----------------- Other expenses: General and administrative 3,496 5,412 (2,215) 6,693 Depreciation and amortization 422 66 -- 488 ----------------- ---------------- ----------------- ----------------- Total other expenses 3,918 5,478 (2,215) 7,181 ----------------- ---------------- ----------------- ----------------- Income before income taxes 5,659 (528) -- 5,131 Provision for income taxes -- -- -- -- ----------------- ---------------- ----------------- ----------------- Net income $ 5,659 $ (528) $ -- $ 5,131 ================= ================ ================= ================= Total Assets $ 390,420 $ 16,892 $ (14,426) $ 392,886 ================= ================ ================= =================
-13- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) The following table details each segment's contribution to our overall profitability for the three months ended June 30, 2004, (in thousands):
Balance Sheet Investment Inter-Segment Investment Management Activities Total ----------------- ---------------- ----------------- ----------------- Income from loans and other investments: Interest and related income $ 9,172 $ -- $ -- $ 9,172 Less: Interest and related expenses on credit facilities, term redeemable securities contract and repurchase obligations 2,454 -- -- 2,454 Less: Interest and related expenses on convertible junior subordinated debentures 2,432 -- -- 2,432 ----------------- ---------------- ----------------- ----------------- Income from loans and other investments, net 4,286 -- -- 4,286 ----------------- ---------------- ----------------- ----------------- Other revenues: Management and advisory fees -- 2,740 (709) 2,031 Income/(loss) from equity investments in Funds 524 (93) -- 431 Gain on sales of investments 300 -- -- 300 Other interest income 6 91 (89) 8 ----------------- ---------------- ----------------- ----------------- Total other revenues 830 2,738 (798) 2,770 ----------------- ---------------- ----------------- ----------------- Other expenses: General and administrative 1,569 2,294 (709) 3,154 Other interest expense 89 -- (89) -- Depreciation and amortization 211 63 -- 274 ----------------- ---------------- ----------------- ----------------- Total other expenses 1,869 2,357 (798) 3,428 ----------------- ---------------- ----------------- ----------------- Income before income taxes 3,247 381 -- 3,628 Provision for income taxes -- 88 -- 88 ----------------- ---------------- ----------------- ----------------- Net income $ 3,247 $ 293 $ -- $ 3,540 ================= ================ ================= =================
All revenues were generated from external sources within the United States. The Balance Sheet Investment segment paid the Investment Management segment fees of $709,000 and $1,404,000, respectively, for management of the segment and $89,000 and $194,000, respectively, for inter-segment interest for the three and six months ended June 30, 2004, which is reflected as offsetting adjustments to other revenues and other expenses in the Inter-Segment Activities column in the tables above. -14- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) The following table details each segment's contribution to our overall profitability attributable to each such segment for the three months ended June 30, 2003 (in thousands):
Balance Sheet Investment Inter-Segment Investment Management Activities Total ----------------- ---------------- ----------------- ----------------- Income from loans and other investments: Interest and related income $ 8,737 $ -- $ -- $ 8,737 Less: Interest and related expenses on credit facilities, term redeemable securities contract and repurchase obligations 2,458 -- -- 2,458 Less: Interest and related expenses on convertible junior subordinated debentures 2,432 -- -- 2,432 ----------------- ---------------- ----------------- ----------------- Income from loans and other investments, net 3,847 -- -- 3,847 ----------------- ---------------- ----------------- ----------------- Other revenues: Management and advisory fees -- 2,487 (1,055) 1,432 Income/(loss) from equity investments in Funds 678 (145) -- 533 Other interest income 9 10 -- 19 ----------------- ---------------- ----------------- ----------------- Total other revenues 687 2,352 (1,055) 1,984 ----------------- ---------------- ----------------- ----------------- Other expenses: General and administrative 1,555 2,489 (1,055) 2,989 Depreciation and amortization 223 33 -- 256 ----------------- ---------------- ----------------- ----------------- Total other expenses 2,140 2,522 (1,055) 3,245 ----------------- ---------------- ----------------- ----------------- Income before income taxes 2,756 (170) -- 2,586 Provision for income taxes -- -- -- -- ----------------- ---------------- ----------------- ----------------- Net income $ 2,756 $ (170) $ -- $ 2,586 ================= ================ ================= =================
All revenues were generated from external sources within the United States. The Investment Management segment earned fees of $2,215,000 and $1,055,000 for management of the Lending and Investment segment for the six and three months ended June 30, 2003, respectively, which is reflected as offsetting adjustments to other revenues and other expenses in the Inter-Segment Activities column in the tables above. 17. Subsequent Events In June and July of 2004, CT Investment Management Co. was approved as a Special Servicer by Fitch Ratings, Standard & Poor's and Moody's Investors Service. These approvals allow CT Investment Management Co. to act as a named Special Servicer for CMBS and B Note investments. On July 20, 2004, we closed a $320.8 million issue of collateralized debt obligations, commonly known as CDOs, that have been privately offered to institutional investors. In connection with the issuance of the CDOs, we closed on the following related transactions: o we purchased a $251.2 million portfolio of floating rate B Notes and mezzanine loans from GMAC Commercial Mortgage Corporation; o we contributed those assets, along with $72.9 million of B Notes, mezzanine loans and subordinate CMBS from our own portfolio, to Capital Trust RE CDO 2004-1 Ltd, our wholly-owned subsidiary that we call the Issuer; o the Issuer issued $320.8 million of floating rate CDOs secured by the Issuer's assets; -15- Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) o the Issuer sold all of the $252.8 million of CDOs that are rated investment grade to third-party investors; and o we acquired and retained all of the $68.1 million of unrated and below investment grade rated CDOs in addition to ownership of all of the Issuer's $3.2 million of equity. Taken together, we refer to these related transactions as the CDO-1 transaction. We will consolidate the Issuer into our financial statements, with the entity's investments shown as loans receivable and the investment grade notes held by third-parties shown as direct liabilities on our balance sheet. As a result of the CDO-1 transaction, our balance sheet assets increased by $251.2 million and we recorded $252.8 million of CDOs as liabilities at the time of the closing. The GMAC Commercial Mortgage assets contributed to the Issuer are comprised of 40 floating rate B Notes and one mezzanine loan with an aggregate balance of $251.2 million. The assets contributed by us consist of seven B Notes, mezzanine loans and subordinate CMBS with an aggregate balance of $72.9 million. Together, the Issuer's initial portfolio represents a combination of large-and small-balance commercial real estate mezzanine investments, ranging in size from $575,489 to $31.9 million with an average balance of $6.8 million and a weighted average remaining contractual life of 19.9 months. All the assets but one are floating rate, with a weighted average rate of LIBOR plus 4.59%. The Issuer issued 10 classes of CDOs that are rated AAA to NR with a total face amount of $320.8 million of which nine classes mature in July 2039 and one class matures in July 2019. The governing documents provide for a four year reinvestment period, commencing on July 20, 2004, during which principal proceeds from the repayment, amortization and sale of assets may be reinvested in qualifying replacement B Notes, mezzanine loans and subordinate CMBS based upon criteria agreed upon with the rating agencies. The CDOs are callable at par at our option as the holder of the entire equity in the Issuer commencing two years after July 20, 2004. The weighted average rate on the investment grade CDOs is LIBOR plus 0.62%. On July 28, 2004, we closed on a public offering of our class A common stock pursuant to which we sold 1,888,289 shares and certain selling shareholders sold 2,136,711 shares obtained upon the concurrent conversion of $44,871,000 of our outstanding convertible junior subordinated debentures. All of the 4,025,000 shares were sold to the public at a price of $23.75 per share. After payment of underwriting discounts and commissions and expenses, we expect net proceeds from the offering to be approximately $42.0 million. -16- ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q. Historical results set forth are not necessarily indicative of our future financial position and results of operations. Introduction We are a fully integrated, self-managed finance and investment management company that specializes in credit-sensitive structured financial products. To date, our investment programs have focused on loans and securities backed by income-producing commercial real estate assets. Since we commenced our finance business in 1997 and through June 30, 2004, we have completed $3.6 billion of real estate-related investments in 123 separate transactions both directly and on behalf of our managed funds. We conduct our operations to qualify as a real estate investment trust, or REIT, for federal income tax purposes and will elect to REIT status when we file our tax return for the 2003 tax year in the fourth quarter of 2004. Currently, we make balance sheet investments for our own account and manage a series of private equity funds on behalf of institutional and individual investors. Our investment management business commenced in March 2000. Pursuant to a venture agreement, we have co-sponsored three funds with Citigroup Alternative Investments LLC: CT Mezzanine Partners I LLC, CT Mezzanine Partners II LP and CT Mezzanine Partners III, Inc., which we refer to as Fund I, Fund II and Fund III, respectively. Recent Developments On May 11, 2004, we closed on the initial tranche of a direct public offering of class A common shares to designated controlled affiliates of W. R. Berkley Corporation, which we refer to as Berkley. We issued 1,310,000 shares of our class A common stock and stock purchase warrants to purchase 365,000 shares of our class A common stock for a total purchase price of $30.7 million. On June 21, 2004, we closed on the second tranche of the direct public offering and issued an additional 325,000 shares of our class A common stock for a total purchase price of $7.6 million. The warrants have an exercise price of $23.40 per share and expire on December 31, 2004. Pursuant to a director designation right granted to Berkley in the transaction, we appointed Joshua A. Polan to our board of directors. In June and July of 2004, CT Investment Management Co. was approved as a Special Servicer by Fitch Ratings, Standard & Poor's and Moody's Investors Service. These approvals allow CT Investment Management Co. to act as a named Special Servicer for CMBS and B Note investments. As Special Servicer, CT Investment Management Co. will increase the control it has in managing certain portions of our portfolio while potentially generating additional fee income. Approval from the agencies was based upon, among other things, our experience in managing and working out problem assets, our established asset management policies and procedures and our technology systems. We believe our ability to be a Special Servicer improves the asset management of our existing portfolio, and facilitates our planned increase in our CMBS and B Note investment activity. On July 20, 2004, we closed a $320.8 million issue of collateralized debt obligations, commonly known as CDOs, which were privately offered to institutional investors. In connection with the issuance of the CDOs, we closed on the following related transactions: o we purchased a $251.2 million portfolio of floating rate B Notes and mezzanine loans from GMAC Commercial Mortgage Corporation; o we contributed those assets, along with $72.9 million of B Notes, mezzanine loans and subordinate CMBS from our own portfolio, to Capital Trust RE CDO 2004-1 Ltd, our wholly-owned subsidiary that we call the Issuer; o the Issuer issued $320.8 million of floating rate CDOs secured by the Issuer's assets; o the Issuer sold all of the $252.8 million of CDOs that are rated investment grade to third-party investors; and o we acquired and retained all of the $68.1 million of unrated and below investment grade rated CDOs in addition to ownership of all of the Issuer's $3.2 million of equity. Taken together, we refer to these related transactions as the CDO-1 transaction. -17- We will consolidate the Issuer into our financial statements, with the entity's investments shown as loans receivable and the investment grade notes held by third-parties shown as direct liabilities on our balance sheet. As a result of the CDO-1 transaction, our balance sheet assets increased by $251.2 million and we recorded $252.8 million of CDOs as liabilities at the time of the closing. The GMAC Commercial Mortgage assets contributed to the Issuer are comprised of 40 floating rate B Notes and one mezzanine loan with an aggregate balance of $251.2 million. The assets contributed by us consist of seven B Notes, mezzanine loans and subordinate CMBS with an aggregate balance of $72.9 million. Together, the Issuer's initial portfolio represents a combination of large-and small-balance commercial real estate mezzanine investments, ranging in size from $575,489 to $31.9 million with an average balance of $6.8 million and a weighted average remaining contractual life of 19.9 months. Excluding CMBS, senior mortgage debt secured by the underlying properties totals $1.7 billion and the initial portfolio has a weighted average last dollar loan-to-value ratio of 68.2% based on third-party appraisals. All the assets but one are floating rate, with a weighted average rate of LIBOR plus 4.59%. The Issuer issued 10 classes of CDOs that are rated AAA to NR with a total face amount of $320.8 million of which nine classes mature in July 2039 and one class matures in July 2019. The governing documents provide for a four year reinvestment period, commencing on July 20, 2004, during which principal proceeds from the repayment, amortization and sale of assets may be reinvested in qualifying replacement B Notes, mezzanine loans and subordinate CMBS based upon criteria agreed upon with the rating agencies. In certain circumstances, including the failure of interest coverage and over-collateralization tests, reinvestment may be suspended and principal proceeds will be used to amortize the CDOs sequentially in order of seniority until the Issuer or its collateral is brought back into compliance with the applicable test(s). Subsequent to the end of the reinvestment period, principal proceeds will be directed to repay the senior-most class of CDOs outstanding at that time. The CDOs are callable at par at our option as the holder of the entire equity in the Issuer commencing two years after July 20, 2004. The weighted average rate on the investment grade CDOs is LIBOR plus 0.62%. The CDO-1 transaction provides us with a number of significant benefits including: o increasing our balance sheet interest earning assets by $251.2 million, a 61% increase compared to March 31, 2004; o creating long-term, non-recourse financing at an all-in borrowing cost that is significantly lower than our existing sources of debt capital; o obtaining long term, floating rate financing that matches both the interest rate index and duration of our assets; o extending the useful life of the financing through a four year reinvestment period during which principal proceeds from the initial CDO assets can be reinvested in qualifying replacement assets; and o establishing us as a CDO issuer and collateral manager, which we believe will facilitate our issuance of additional CDOs in the future. On July 28, 2004, we closed on a public offering of our class A common stock pursuant to which we sold 1,828,289 shares and certain selling shareholders sold 2,136,711 shares obtained upon the concurrent conversion of $44,871,000 of our outstanding convertible junior subordinated debentures. All of the 4,025,000 shares were sold to the public at a price of $23.75 per share. After payment of underwriting discounts and commissions and expenses, we expect net proceeds from the offering to be approximately $42.0 million. We agreed in principal to obtain certain outsourced services from Global Realty Outsourcing, Inc., referred to as GRO, a company in which we have an equity investment and on whose board of directors our president and chief executive officer serves. Pursuant to the proposed agreement, GRO will provide seventeen dedicated employees to assist us in monitoring assets and evaluating potential investments, fifteen of whom will be located in Chennai, India. GRO began performing these services for us in April 2004 in advance of concluding negotiation of the definative agreement. Balance Sheet Overview At March 31, 2004, we had four investments in Federal Home Loan Mortgage Corporation Gold securities with a face value of $15,989,000. These securities were sold during the second quarter resulting in a gain of $300,000 to their amortized cost. -18- We held twenty-one investments in fourteen separate issues of commercial mortgage-backed securities with an aggregate face value of $251,880,000 at June 30, 2004. Commercial mortgage-backed securities with a face value of $41,367,000 earn interest at a variable rate that averages the LIBOR plus 3.04% (4.28% at June 30, 2004). The remaining commercial mortgage-backed securities, $210,512,000 face value, earn interest at fixed rates averaging 7.70% of the face value. We purchased the commercial mortgage-backed securities at discounts. As of June 30, 2004, the remaining discount to be amortized into income over the remaining lives of the securities was $23,103,000. At June 30, 2004, with discount amortization, the commercial mortgage-backed securities earn interest at a blended rate of 8.73% of the face value less the unamortized discount. As of June 30, 2004, the securities were carried at fair value of $195,037,000, reflecting a $33,739,000 unrealized loss to their amortized cost. During the six months ended June 30, 2004, we purchased or originated one property mezzanine loan for $23,500,000 and two B Notes for $23,593,000, received partial repayments on ten mortgage and property mezzanine loans totaling $7,493,000 and full satisfaction of one property mezzanine loan and one B Note totaling $16,853,000. At June 30, 2004, we had outstanding loans receivable totaling approximately $206.5 million. At June 30, 2004, we had fifteen performing loans receivable with a current carrying value of $203,459,000. One of the loans for $48,819,000 bears interest at a fixed rate of interest of 11.98%. The fourteen remaining loans, totaling $154,640,000, bear interest at a variable rate of interest averaging LIBOR plus 5.77% (7.15% at June 30, 2004 including LIBOR floors). One mortgage loan receivable with an original principal balance of $8,000,000 reached maturity on July 15, 2001 and has not been repaid with respect to principal and interest. In December 2002, the loan was written down to $4,000,000 through a charge to the allowance for possible credit losses. Since the write-down, we have received proceeds of $962,000 reducing the carrying value of the loan to $3,038,000. In accordance with our policy for revenue recognition, income recognition has been suspended on this loan and for the six months ended June 30, 2004, $449,000 of potential interest income has not been recorded. All other loans are performing in accordance with their terms. At June 30, 2004, we had investments in funds of $21,193,000, including $6,073,000 of unamortized costs that were capitalized in connection with entering into our venture agreement with Citigroup Alternative Investments LLC and the commencement of the related fund management business. These costs are being amortized over the lives of the funds and the venture agreement and are reflected as a reduction in income/(loss) from equity investments in funds. We utilize borrowings under a committed credit facility, along with repurchase obligations, to finance our balance sheet assets and we recently utilized CDOs as a source of financing for the first time in connection with the CDO-1 transaction. At June 30, 2004, we had $50,000,000 of outstanding borrowings under our $150.0 million credit facility, of which $32.5 million of the remaining $100 million of available credit may be borrowed without the need to pledge additional collateral assets, which we believe provides us with adequate liquidity for our short-term needs over the next 12-month period. The credit facility provides for advances to fund lender-approved loans and investments made by us. Borrowings under the credit facility are secured by pledges of assets owned by us. Borrowings under the credit facility bear interest at specified spreads over LIBOR, which spreads vary based upon the perceived risk of the pledged assets. The credit facility provides for margin calls on asset-specific borrowings in the event of asset quality and/or market value deterioration as determined under the credit facility. The credit facility contains customary representations and warranties, covenants and conditions and events of default. Based upon borrowings in place at June 30, 2004, the effective rate on the credit facility was LIBOR plus 1.51% (2.62% at June 30, 2004). As of June 30, 2004, we had capitalized costs of $901,000 that are being amortized over the remaining life of the facility (12.5 months at June 30, 2004). After amortizing these costs to interest expense, the all-in effective borrowing cost on the facility as of June 30, 2004 was 4.32% based upon the amount currently outstanding on the credit facility. At December 31, 2003, we had borrowed $11,651,000 under a $75 million term redeemable securities contract. This term redeemable securities contract expired on February 28, 2004 and was repaid by refinancing the previously financed assets under the credit facility. In connection with the sale of Federal Home Loan Mortgage Corporation Gold available-for-sale securities we repurchased the assets that were financed under a repurchase obligation and terminated the contract. -19- In the first quarter of 2004, we entered another repurchase obligation with an existing provider in connection with the purchase of a loan. This repurchase agreement comes due monthly and has a current maturity date in August 2004. A repurchase obligation that was entered into on May 28, 2003 was extended during the quarter ended June 30, 2004 and now terminates on June 1, 2006, with an automatic nine-month amortizing extension option, if not otherwise extended. At June 30, 2004, we had total outstanding repurchase obligations of $178,944,000. Based upon advances in place at June 30, 2004, the blended rate on the repurchase obligations is LIBOR plus 1.09% (2.21% at June 30, 2004). We had capitalized costs of $306,000 as of June 30, 2004, which are being amortized over the remaining lives of the repurchase obligations. After amortizing these costs to interest expense based upon the amount currently outstanding on the repurchase obligations, the all-in effective borrowing cost on the repurchase obligations as of June 30, 2004 was 2.30%. We expect to enter into new repurchase obligations at their maturity or settle the repurchase obligations with the proceeds from the repayment of the underlying financed asset. We were party to two cash flow interest rate swaps with a total notional value of $109 million as of June 30, 2004. These cash flow interest rate swaps effectively convert floating rate debt to fixed rate debt, which is utilized to finance assets that earn interest at fixed rates. We receive a rate equal to LIBOR (1.11% at June 30, 2004) and pay an average rate of 4.24%. The market value of the swaps at June 30, 2004 was an asset of $3,071,000, which is recorded as interest rate hedge assets and as an offset to accumulated other comprehensive loss on our balance sheet. In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, "Consolidation of Variable Interest Entities," an interpretation of Accounting Research Bulletin 51. Interpretation No. 46 provides guidance on identifying entities for which control is achieved through means other than through voting rights, and how to determine when and which business enterprise should consolidate a variable interest entity. In addition, Interpretation No. 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a variable interest entity make additional disclosures. The transitional disclosure requirements took effect almost immediately and are required for all financial statements initially issued after January 31, 2003. In December 2003, the Financial Accounting Standards Board issued a revision of Interpretation No. 46, Interpretation No. 46R, to clarify the provisions of Interpretation No. 46. The application of Interpretation No. 46R is effective for public companies, other than small business issuers, after March 15, 2004. We have evaluated all of our investments and other interests in entities that may be deemed variable interest entities under the provisions of Interpretation No. 46 and have concluded that no additional entities need to be consolidated. In evaluating Interpretation No. 46R, we concluded that we could no longer consolidate CT Convertible Trust I, the entity which had purchased our step up convertible junior subordinated debentures and issued company-obligated, mandatory redeemable, convertible trust common and preferred securities. We had issued the convertible junior subordinated debentures and had purchased the convertible trust common securities. The consolidation of CT Convertible Trust I resulted in the elimination of both the convertible junior subordinated debentures and the convertible trust common securities with the convertible trust preferred securities being reported on our balance sheet after liabilities but before equity and the related expense being reported on the income statement below income taxes and net of income tax benefits. After the deconsolidation, we report the convertible junior subordinated debentures as liabilities and the convertible trust common securities as other assets. The expense from the payment of interest on the debentures is reported as interest and related expenses on convertible junior subordinated debentures and the income received from our investment in the common securities is reported as a component of interest and related income. We have elected to restate prior periods for the application of Interpretation 46R. The restatement was effected by a cumulative type change in accounting principle on January 1, 2002. There was no change to previously reported net income as a result of such restatement. As of June 30, 2004, we had $92,524,000 aggregate principal amount of our convertible junior subordinated debentures outstanding. The holders converted $44,871,000 of the convertible junior subordinated debentures in connection with the closing of our public offering of class A common stock on July 28, 2004. The convertible junior subordinated debentures are convertible into shares of class A common stock, in increments of $1,000 in liquidation amount, at a conversion price of $21.00 per share and are redeemable by us, in whole or in part, on or after September 30, 2004. Distributions on the outstanding convertible junior subordinated debentures are payable quarterly in arrears on each calendar quarter-end. The convertible junior subordinated debentures bear interest at 10% through September 30, -20- 2004. The interest rate increases by 0.75% on October 1, 2004 and on each October 1 thereafter. If the quarterly dividend paid on a share of our class A common stock multiplied by four and divided by $21.00 is in excess of the interest rate in effect at that time, then the holders are entitled to be paid additional interest at that rate. In 2000, we announced an open market share repurchase program under which we may purchase, from time to time, up to 666,667 shares of our class A common stock. Since that time the authorization has been increased by the board of directors to purchase cumulatively up to 2,366,923 shares of class A common stock. In June 30, 2004 we had 666,339 shares remaining authorized for repurchase under the program. At June 30, 2004, we had 8,300,343 shares of our class A common stock outstanding. Investment Management Overview We operated principally as a balance sheet investor until the start of our investment management business in March 2000 when we entered into a venture with affiliates of Citigroup Alternative Investments to co-sponsor and invest capital in a series of commercial real estate mezzanine investment funds managed by us. Pursuant to the venture agreement, we have co-sponsored with Citigroup Alternative Investments Fund I, Fund II and Fund III. We have capitalized costs of $6,073,000, net, from the formation of the venture and the Funds that are being amortized over the remaining anticipated lives of the Funds and the related venture agreement. Fund I commenced its investment operations in May 2000 with equity capital supplied solely by Citigroup Alternative Investments (75%) and us (25%). From May 11, 2000 to April 8, 2001, the investment period for the fund, Fund I completed $330 million of total investments in 12 transactions. On January 31, 2003, we purchased from an affiliate of Citigroup Alternative Investments its interest in Fund I and began consolidating the operations of Fund I in our consolidated financial statements. Fund II had its initial closing on equity commitments on April 9, 2001 and its final closing on August 7, 2001, ultimately raising $845.2 million of total equity commitments, including $49.7 million (5.9%) from us and $198.9 million (23.5%) from Citigroup Alternative Investments. Third-party private equity investors, including public and corporate pension plans, endowment funds, financial institutions and high net worth individuals, made the balance of the equity commitments. During its two-year investment period, which expired on April 9, 2003, Fund II invested $1.2 billion in 40 separate transactions. Fund II utilizes leverage to increase its return on equity, with a target debt-to-equity ratio of 2:1. Total capital calls during the investment period were $329.0 million. CT Investment Management Co. LLC, our wholly-owned taxable REIT subsidiary, acts as the investment manager to Fund II and receives 100% of the base management fees paid by the fund. As of April 9, 2003, the end of the Fund II investment period, CT Investment Management Co. began earning annual base management fees of 1.287% of invested capital. Based upon Fund II's invested capital at June 30, 2004, the date upon which the calculation for the next quarter is based, CT Investment Management Co. will earn base management fees of $400,000 for the quarter ending September 30, 2004. We and Citigroup Alternative Investments, through our collective ownership of the general partner, are also entitled to receive incentive management fees from Fund II if the return on invested equity is in excess of 10% after all invested capital has been returned. The Fund II incentive management fees are split equally between Citigroup Alternative Investments and us. We will pay 25% of our share of the Fund II incentive management fees as long-term incentive compensation to our employees. No such incentive fees have been earned at June 30, 2004 and as such, no amount has been accrued as income for such potential fees in our financial statements. The amount of incentive fees to be received in the future will depend upon a number of factors, including the level of interest rates and the fund's ability to generate returns in excess of 10%, which is in turn impacted by the duration and ultimate performance of the fund's assets. Potential incentive fees received as Fund II winds down could result in significant additional income from operations in certain periods during which such payments can be recorded as income. If Fund II's assets were sold and liabilities were settled on July 1, 2004 at the recorded book value, net of the allowance for possible credit losses, and the fund's equity and income were distributed, we would record approximately $7.6 million of gross incentive fees. We do not anticipate making any additional equity contributions to Fund II or its general partner. Our net investment in Fund II and its general partner at June 30, 2004 was $8.8 million. As of June 30, 2004, Fund II had 18 outstanding loans and investments totaling $324.1 million, all of which were performing in accordance with the terms of their agreements. -21- On June 2, 2003, Fund III effected its initial closing on equity commitments and on August 8, 2003, its final closing, raising a total of $425.0 million in equity commitments. Our equity commitment was $20.0 million (4.7%) and Citigroup Alternative Investments' equity commitment was $80.0 million (18.8%), with the balance made by third-party private equity investors. From the initial closing through June 30, 2004, we have made equity investments in Fund III of $6,300,000. As of June 30, 2004, Fund III had thirteen outstanding loans and investments totaling $386.1 million, all of which were performing in accordance with the terms of their agreements. CT Investment Management Co. receives 100% of the base management fees from Fund III calculated at a rate equal to 1.42% per annum of committed capital during Fund III's two-year investment period, which expires June 2, 2005, and 1.42% of invested capital thereafter. Based upon Fund III's $425.0 million of total equity commitments, CT Investment Management Co. will earn annual base management fees of $6.0 million during the investment period. We and Citigroup Alternative Investments are also entitled to receive incentive management fees from Fund III if the return on invested equity is in excess of 10% after all invested capital has been returned. We will receive 62.5% and Citigroup Alternative Investments will receive 37.5% of the total incentive management fees. We expect to distribute a portion of our share of the Fund III incentive management fees as long-term incentive compensation to our employees. Three and Six Months Ended June 30, 2004 Compared to Three and Six Months Ended June 30, 2003 We reported net income of $3,540,000 for the three months ended June 30, 2004, an increase of $954,000 from the net income of $2,586,000 for the three months ended June 30, 2003. We reported net income of $6,622,000 for the six months ended June 30, 2004, an increase of $1,491,000 from the net income of $5,131,000 for the six months ended June 30, 2003. These increases were primarily the result of an increase in management and advisory fees from Funds. Since the investment period for Fund III did not commence until June 2003, we earned only one month of base management fees during both the three and six months ended June 30, 2003, while in 2004 we collected base management fees on Fund III for the each month in the respective three and six month periods. Also, increases in net income from loans and investments resulted from of our use of the proceeds from the sale of common stock in May and June of 2004 to reduce debt. Interest and related income from loans and other investments amounted to $18,190,000 for the six months ended June 30, 2004, an increase of $424,000 from the $17,766,000 amount for the six months ended June 30, 2003. Average interest-earning assets increased from approximately $350.1 million for the six months ended June 30, 2003 to approximately $398.4 million for the six months ended June 30, 2004. The average interest rate earned on such assets decreased from 10.2% for the six months ended June 30, 2003 to 9.2% for the six months ended June 30, 2004. During the six months ended June 30, 2003, we recognized $367,000 in additional income on the early repayment of loans. Without this additional interest income, the earning rate for the 2003 period would have been 9.9%. LIBOR rates averaged 1.1% for the six months ended June 30, 2004 and 1.3% for the six months ended June 30, 2003, a decrease of 0.2%. The remaining decrease in rates was due to the repayment of two fixed rates loans (which earned interest at rates in excess of the portfolio average) and a change in the mix of our investment portfolio to include lower risk B Notes in 2004 (which generally carry lower interest rates than mezzanine loans and can be financed at lower rates). Interest and related income from loans and other investments amounted to $9,172,000 for the three months ended June 30, 2004, a increase of $435,000 from the $8,737,000 amount for the three months ended June 30, 2003. Average interest-earning assets increased from approximately $348.6 million for the three months ended June 30, 2003 to approximately $411.5 million for the three months ended June 30, 2004. The average interest rate earned on such assets decreased from 10.1% for the three months ended June 30, 2003 to 8.9% for the three months ended June 30, 2004. LIBOR rates averaged 1.2% for the three months ended June 30, 2004 and 1.3% for the three months ended June 30, 2003, a decrease of 0.1%. The remaining decrease in rates was again due to the repayment of two fixed rate loans and a change in the mix of our investment portfolio to include lower risk B Notes in 2004. We utilize our existing credit facility and repurchase obligations to finance our interest-earning assets. Interest and related expenses on secured debt amounted to $5,090,000 for the six months ended June 30, 2004, an increase of $337,000 from the $4,753,000 amount for the six months ended June 30, 2003. The increase in expense was due to an increase in the amount of average interest-bearing liabilities outstanding from approximately $208.9 million for the six months ended June 30, 2003 to approximately $219.3 million for the six months ended June 30, 2004, and an increase in the average rate on interest-bearing liabilities from 4.6% to 4.7% for the same periods. The increase in the average rate is substantially due to an increase in the rate paid on repurchase -22- agreements, which increased from 2.2% for the six months ended June 30, 2003 to 2.5% for the six months ended June 30, 2004. This rate increase resulted from a significant decrease in Federal Home Loan Mortgage Corporation securities, which were sold in June 2004, and which had been financed at LIBOR flat. Interest and related expenses on secured debt amounted to $2,454,000 for the three months ended June 30, 2004, a decrease of $4,000 from the $2,458,000 amount for the three months ended June 30, 2003. The decrease in expense was due to an increase in the amount of average interest-bearing liabilities outstanding from approximately $204.8 million for the three months ended June 30, 2003 to approximately $219.9 million for the three months ended June 30, 2004, offset by a decrease in the average rate on interest-bearing liabilities from 4.8% to 4.5% for the same periods. The decrease in the average rate paid on borrowings is due to lower spreads being applied to financed assets due to the increased liquidity and lower risk of B Notes. We also utilize the convertible junior subordinated debentures to finance our interest-earning assets. During the three and six months ended June 30, 2004 and 2003, we recognized $2,432,000 and $4,865,000, respectively, of expenses related to the convertible junior subordinated debentures, as the amount and terms of the debt were the same in both periods. Other revenues increased $786,000 from $1,984,000 for the three months ended June 30, 2003 to $2,770,000 for the three months ended June 30, 2004 and $1,092,000 from $4,164,000 for the three months ended June 30, 2003 to $5,256,000 for the three months ended June 30, 2004. The increase is primarily due to the management fees received from Fund III in 2004, as Fund III did not commence its investment period until June 2003, and the recognition of a $300,000 gain on the sale of available-for-sale securities. This was partially offset by a decrease in the earnings from Fund II, due to lower levels of investment in 2004 as the fund winds down. General and administrative expenses increased $165,000 to $3,154,000 for the three months ended June 30, 2004 from $2,989,000 for the three months ended June 30, 2003. The increase in general and administrative expenses was primarily due to costs incurred in being approved as a Special Servicer and additional expenses related to the proposed outsourced services agreement with GRO. General and administrative expenses decreased $601,000 to $6,092,000 for the six months ended June 30, 2004 from $6,693,000 for the six months ended June 30, 2003. The decrease in general and administrative expenses was primarily due to reduced employee compensation offset by costs incurred in being approved as a Special Servicer and additional expenses related to the proposed GRO agreement. We intend to make an election to be taxed as a REIT under Section 856(c) of the Internal Revenue Code of 1986, as amended, commencing with the tax year ending December 31, 2003. As a REIT, we generally are not subject to federal income tax. To maintain qualification as a REIT, we must distribute at least 90% of our REIT taxable income to our shareholders and meet certain other requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates. We may also be subject to certain state and local taxes on our income and property. Under certain circumstances, federal income and excise taxes may be due on our undistributed taxable income. At June 30, 2004, we were in compliance with all REIT requirements and as such, have only provided for income tax expense on taxable income attributed to our taxable REIT subsidiaries during the three months ended June 30, 2004. Liquidity and Capital Resources At June 30, 2004, we had $39,865,000 in cash. Our primary sources of liquidity for 2004 are expected to be cash on hand, cash generated from operations, principal and interest payments received on loans and investments, additional borrowings under our credit facility, CDOs and repurchase obligations and proceeds from the sale of securities. We believe these sources of capital are adequate to meet future cash requirements for the remainder of 2004. We expect that during 2004, we will use a significant amount of our available capital resources to satisfy capital contributions required pursuant to our equity commitments to Fund III and to originate or purchase new loans and investments for our balance sheet. We intend to continue to employ leverage on our balance sheet assets to enhance our return on equity. We experienced a net increase in cash of $31,127,000 during the six months ended June 30, 2004, compared to a net decrease of $4,603,000 during the six months ended June 30, 2003. Cash provided by operating activities during the six months ended June 30, 2004 was $4,004,000, compared to $2,516,000 during the same period of 2003. For the six months ended June 30, 2004, cash used in investing activities was $37,167,000, compared to cash provided of -23- $5,509,000 during the same period in 2003. The change was primarily due our new loan and investment activity totaling $82.1 million for the six months ended June 30, 2004. We financed the new investment activity with additional borrowings under our credit facility, term redeemable securities contract and repurchase obligations. This along with the cash received from our direct public offering to Berkley accounted for substantially all of the change in the net cash activity from financing activities. During the investment periods for Fund I and Fund II, we generally did not originate or acquire loans or commercial mortgage-backed securities directly for our own balance sheet portfolio. When the Fund II investment period ended, we began originating loans and investments for our own account as permitted by the provisions of Fund III. We expect to use our available working capital to make contributions to Fund III or any other funds sponsored by us as and when required by the equity commitments made by us to such funds. At June 30, 2004, we had outstanding borrowings under our credit facility of $50,000,000, and outstanding repurchase obligations totaling $178,944,000. The terms of these agreements are described above under the caption "Balance Sheet Overview". At June 30, 2004, we had pledged assets that enable us to borrow an additional $33.0 million and had $243.2 million of credit available for the financing of new and existing unpledged assets pursuant to these sources of financing. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements. Impact of Inflation Our operating results depend in part on the difference between the interest income earned on our interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities. Changes in the general level of interest rates prevailing in the economy in response to changes in the rate of inflation or otherwise can affect our income by affecting the spread between our interest-earning assets and interest-bearing liabilities, as well as, among other things, the value of our interest-earning assets and our ability to realize gains from the sale of assets and the average life of our 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 our control. We employ the use of correlated hedging strategies to limit the effects of changes in interest rates on our operations, including engaging in interest rate swaps and interest rate caps to minimize our exposure to changes in interest rates. There can be no assurance that we will be able to adequately protect against the foregoing risks or that we will ultimately realize an economic benefit from any hedging contract into which we enter. Note on Forward-Looking Statements Except for historical information contained herein, this quarterly report on Form 10-Q contains forward-looking statements within the meaning of the Section 21E of the Securities and Exchange Act of 1934, as amended, which involve certain risks and uncertainties. Forward-looking statements are included with respect to, among other things, the Company's current business plan, business and investment strategy and portfolio management. These forward-looking statements are identified by their use of such terms and phrases as "intends," "intend," "intended," "goal," "estimate," "estimates," "expects," "expect," "expected," "project," "projected," "projections," "plans," "anticipates," "anticipated," "should," "designed to," "foreseeable future," "believe," "believes" and "scheduled" and similar expressions. The Company's actual results or outcomes may differ materially from those anticipated. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Important factors that we believe might cause actual results to differ from any results expressed or implied by these forward-looking statements are discussed in the cautionary statements contained in Exhibit 99.1 to this Form 10-Q, which are incorporated herein by reference. In assessing forward-looking statements contained herein, readers are urged to read carefully all cautionary statements contained in this Form 10-Q. -24- ITEM 3. Quantitative and Qualitative Disclosures about Market Risk The principal objective of our asset/liability management activities is to maximize net interest income, while minimizing levels of interest rate risk. Net interest income and interest expense are subject to the risk of interest rate fluctuations. To mitigate the impact of fluctuations in interest rates, we use interest rate swaps to effectively convert fixed rate assets to variable rate assets for proper matching with variable rate liabilities and variable rate liabilities to fixed rate liabilities for proper matching with fixed rate assets. Each derivative used as a hedge is matched with an asset or liability with which it has a high correlation. The swap agreements are generally held-to-maturity and we do not use derivative financial instruments for trading purposes. We use interest rate swaps to effectively convert variable rate debt to fixed rate debt for the financed portion of fixed rate assets. The differential to be paid or received on these agreements is recognized as an adjustment to the interest expense related to debt and is recognized on the accrual basis. The following table provides information about our financial instruments that are sensitive to changes in interest rates at June 30, 2004. For financial assets and debt obligations, the table presents cash flows to the expected maturity and weighted average interest rates based upon the current carrying values. For interest rate swaps, the table presents notional amounts and weighted average fixed pay and variable receive interest rates by contractual maturity dates. Notional amounts are used to calculate the contractual cash flows to be exchanged under the contract. Weighted average variable rates are based on rates in effect as of the reporting date.
Expected Maturity Dates ------------------------------------------------------------------------------------- 2004 2005 2006 2007 2008 Thereafter Total Fair Value ---- ---- ---- ---- ---- ---------- ----- ---------- Assets: (dollars in thousands) Commercial Mortgage-backed Securities Fixed Rate -- -- $ 7,811 $ 135 $ 1,420 $ 201,146 $ 210,512 $155,060 Average interest rate -- -- 9.60% 9.56% 9.51% 11.92% 11.78% Variable Rate $ 5,000 -- -- -- $ 34,783 $ 1,268 $ 41,051 $ 39,977 Average interest rate 4.19% -- -- -- 3.95% 23.60% 4.26% Loans receivable Fixed Rate -- -- -- -- -- $ 48,819 $ 48,819 $ 57,280 Average interest rate -- -- -- -- -- 11.98% 11.98% Variable Rate $ 13,431 $ 23,977 $ 20,978 $ 15,716 $ 58,076 $ 25,510 $157,688 $149,655 Average interest rate 7.64% 7.37% 6.29% 8.83% 6.88% 6.10% 7.01% Liabilities: Credit Facility Variable Rate -- $ 50,000 -- -- -- -- $ 50,000 $50,000 Average interest rate -- 4.32% -- -- -- -- 4.32% Repurchase obligations Variable Rate $ 17,876 $ 121,068 $ 40,000 -- -- -- $178,944 $178,944 Average interest rate 1.74% 2.09% 3.18% -- -- -- 2.29% Convertible junior subordinated debentures Fixed Rate $ 92,524 -- -- -- -- -- $92,524 $97,866 Average interest rate 10.00% -- -- -- -- -- 10.00% Interest rate swaps Notional amounts -- -- -- -- -- $ 109,000 $109,000 $ 3,071 Average fixed pay rate -- -- -- -- -- 4.24% 4.24% Average variable receive rate -- -- -- -- -- 1.11% 1.11%
25 ITEM 4. Disclosure Controls and Procedures Evaluation of Disclosure Controls and Procedures An evaluation of the effectiveness of the design and operation of our "disclosure controls and procedures" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) was carried out as of the end of the period covered by this quarterly report. This evaluation was made under the supervision and with the participation of our management, including its Chief Executive Officer and Chief Financial Officer. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (a) are effective to ensure that information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act is timely recorded, processed, summarized and reported and (b) include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act is accumulated and communicated to our management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Changes in Internal Controls There have been no significant changes in our "internal control over financial reporting" (as defined in rule 13a-15(f) under the Securities Exchange Act) that occurred during the period covered by this quarterly report that has materially affected or is reasonably likely to materially affect our internal control over financial reporting. 26 PART II. OTHER INFORMATION ITEM 1: Legal Proceedings None ITEM 2: Changes in Securities None ITEM 3: Defaults Upon Senior Securities None ITEM 4: Submission of Matters to a Vote of Security Holders At the 2004 annual meeting of our shareholders held on June 17, 2004, shareholders considered and voted upon: 1. A proposal to elect nine directors (identified in the table below) to serve until the next annual meeting of shareholders and until such directors' successors are duly elected and qualify ("Proposal 1"); and 2. A proposal to approve our 2004 long-term incentive plan ("Proposal 2"); and 3. A proposal to approve, for purposes of the New York Stock Exchange listing standards, the issuance of 325,000 shares of our class A common stock and 365,000 shares of our class A common stock issuable upon the exercise of stock purchase warrants in a direct public offering made pursuant to a securities purchase agreement with W. R. Berkley Corporation ("Proposal 3"); and 4. A proposal to ratify the appointment of Ernst & Young LLP as our independent auditors for the fiscal year ending December 31, 2004 ("Proposal 4"). The following table sets forth the number of votes in favor, the number of votes opposed, the number of abstentions (or votes withheld in the case of the election of directors) and broker non-votes with respect to each of the foregoing proposals.
Proposal Votes in Favor Votes Opposed Abstentions Broker Non-Votes (Withheld) Proposal 1 Samuel Zell 5,891,192 -- 42,336 -- Jeffrey A. Altman 5,842,795 -- 90,733 -- Thomas E. Dobrowski 5,825,705 -- 107,823 -- Martin L. Edelman 5,908,282 -- 25,246 -- Craig M. Hatkoff 5,908,282 -- 25,246 -- John R. Klopp 5,908,079 -- 25,449 -- Henry N. Nassau 5,825,738 -- 107,790 -- Joshua A. Polan 5,842,795 -- 90,733 -- Lynne B. Sagalyn 5,825,738 -- 107,790 -- Proposal 2 3,655,052 1,184,364 10,517 1,083,595 Proposal 3 4,834,708 6,293 8,932 1,083,595 Proposal 4 5,834,660 94,989 3,879 --
27 ITEM 5: Other Information None ITEM 6: Exhibits and Reports on Form 8-K (a) Exhibits o 3.2 First Amendment to Amended and Restated Bylaws of Capital Trust, Inc. 10.1 Securities Purchase Agreement, dated as of May 11, 2004, by and among Capital Trust, Inc., W. R. Berkley Corporation and certain shareholders of Capital Trust, Inc. (filed as Exhibit 10.1 to the Company's Current Report on Form 8-K, filed on May 11, 2004 and incorporated herein by reference). 10.2 Registration Rights Agreement dated as of May 11, 2004, by and among Capital Trust, Inc. and W. R. Berkley Corporation (filed as Exhibit 10.2 to the Company's Current Report on Form 8-K, filed on May 11, 2004 and incorporated herein by reference). o 10.3 Second Amendment to Master Repurchase Agreement, dated as of June 1, 2004, by and between Goldman Sachs Mortgage Company, Commerzbank AG, New York Branch and Capital Trust, Inc. + 10.4 Capital Trust, Inc. 2004 Long-Term Incentive Plan. 11.1 Statements regarding Computation of Earnings per Share (Data required by Statement of Financial Accounting Standard No. 128, Earnings per Share, is provided in Note 10 to the consolidated financial statements contained in this report). o 31.1 Certification of John R. Klopp, Chief Executive Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. o 31.2 Certification of Brian H. Oswald, Chief Financial Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. o 32.1 Certification of John R. Klopp, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. o 32.2 Certification of Brian H. Oswald, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. o 99.1 Risk Factors. o Filed herewith. + Represents a management contract or compensatory plan or arrangement. 28 (b) Reports on Form 8-K During the fiscal quarter ended June 30, 2004, we filed the following Current Reports on Form 8-K: (1) Current Report on Form 8-K (with respect to Item 5 and Item 7 only), dated May 11, 2004, as filed with the SEC on May 11, 2004, reporting under Item 5 "Other Events" and Item 7 "Financial Statements, Pro Forma Financial Information and Exhibits" our issuance and sale to W. R. Berkley Corporation of 1,310,000 shares of our class A common stock and stock purchase warrants to purchase 365,000 shares of our class A common stock and the agreement to sell an additional 325,000 shares of our class A common stock on June 18, 2004, subject to shareholder approval at our 2004 annual meeting of shareholders. (2) Current Report on Form 8-K, dated June 14, 2004, as filed with the SEC on June 14, 2004, reporting under Item 5 "Other Events" and Item 7 "Financial Statements, Pro Forma Financial Information and Exhibits" our issuance of a press release announcing the proposed offering of approximately $276 aggregate principal amount of non-recourse collateralized debt obligations. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CAPITAL TRUST, INC. August 16, 2004 /s/ John R. Klopp - --------------- ----------------- Date John R. Klopp Chief Executive Officer /s/ Brian H. Oswald Brian H. Oswald Chief Financial Officer 29 EX-3 2 ex3-2.txt EX. 3.2 - 1ST AMDT TO AMD & REST. BYLAWS Exhibit 3.2 FIRST AMENDMENT TO AMENDED AND RESTATED BYLAWS OF CAPITAL TRUST, INC. ------------------- FIRST AMENDMENT to Amended and Restated Bylaws (the "Bylaws") of Capital Trust, Inc. (the "Corporation"), adopted and approved by the Board of Directors of the Corporation as of May 6, 2004. Article II, Section 10 of the Bylaws is hereby amended by deleting the last sentence of the final paragraph in its entirety and inserting the following in lieu thereof: Notwithstanding any other provision of the charter of the Corporation or these Bylaws, Title 3, Subtitle 7 of the Corporations and Associations Article of the Annotated Code of Maryland (or any successor statute) shall not apply to any acquisition of shares of class A common stock, $0.01 par value, of the Corporation by W. R. Berkley Corporation, a Delaware corporation, or any of its controlled affiliates (collectively, "Berkley"). This section may be repealed, in whole or in part, at any time, whether before or after an acquisition of control shares and, upon such repeal, may, to the extent provided by any successor bylaw, apply to any prior or subsequent control share acquisition; provided, however, that this section may not be repealed, in whole or in part, with respect to any prior or subsequent control share acquisition of (i) Veqtor, or any affiliates thereof, without its prior written consent, (ii) any Permitted Transferee of Veqtor, without its prior written consent, or (iii) Berkley, without its prior written consent. IN WITNESS WHEREOF, the undersigned has executed this First Amendment as of the date above first written. Capital Trust, Inc. /s/ Brian H. Oswald ------------------- Secretary EX-10 3 ex10-3.txt EX. 10.3 - 2D AMDT TO MASTER REPURCHASE AG Exhibit 10.3 SECOND AMENDMENT TO MASTER REPURCHASE AGREEMENT SECOND AMENDMENT TO MASTER REPURCHASE AGREEMENT, dated as of June 1, 2004 (this "Amendment"), to the Master Repurchase Agreement (the "Original Agreement"), dated as of May 28, 2003, as amended by the First Amendment to Master Repurchase Agreement, dated as of August 28, 2003 (the "First Amendment" and together with the Original Agreement, the "Repurchase Agreement"), by and between Goldman Sachs Mortgage Company, as a buyer and as Administrative Agent ("GSMC"), Commerzbank AG, New York Branch, as a buyer ("Commerzbank") and Capital Trust, Inc., as seller ("Seller"). Capitalized terms used but not defined herein shall have the meanings set forth in the Repurchase Agreement. RECITAL ------- WHEREAS, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties have agreed to extend the Facility Termination Date under the Repurchase Agreement and to amend the Transaction Documents as set forth herein. NOW, THEREFORE, IT IS AGREED AS FOLLOWS: 1. Facility Termination Date. (a) The definition of "Facility Termination Date" in Section 2(c) of Annex I to the Repurchase Agreement is hereby deleted in its entirety and replaced with the following: "`Facility Termination Date' shall mean June 1, 2006 unless extended pursuant to Section 3(r) of Annex 1." (b) The reference to June 1, 2004 in Section 3(r) of Annex I to the Repurchase Agreement is hereby amended to read June 1, 2006. 2. Other Amendments. (a) Definition of Eligible Loans. The definition of "Eligible Loans" in Section 2(c) of Annex I to the Repurchase Agreement is hereby deleted in its entirety and replaced with the following: " `Eligible Loans' shall mean any of the following types of loans listed in (i) through (v) below, (v) acceptable to Buyer in the exercise of its sole and absolute discretion, (w) secured directly or indirectly by an Eligible Property, (x) having a remaining term (after giving effect to the exercise of any extension options) not to exceed seven (7) years, (y) as to which the applicable representations and warranties set forth in Exhibit V are true and correct as of the applicable Purchase Date and (z) has a maximum LTV of 85%: (i) performing Mezzanine Loans which are secured by pledges of the equity ownership interests in entities that directly or indirectly own Eligible Properties (the "Mezzanine Loans"). (ii) senior participation interests (or a senior promissory note that is, in effect, similar in nature to a senior participation interest) in performing Mortgage Loans secured by first liens on Eligible Properties that also may secure a junior promissory note (or junior interest) in such loan (the "Senior First Mortgage B Notes"). (iii) junior participation interests (or a junior promissory note that is, in effect, similar in nature to a junior participation interest) in performing Mortgage Loans secured by first liens on Eligible Properties that also secure a senior promissory note (or senior interest) in such loan (the "Junior First Mortgage B Notes"). (iv) any other performing loan, participation interest, preferred equity investment or other junior mezzanine or subordinate investment which has a maximum LTV of 85% and which does not otherwise conform to the criteria set forth in clauses (i) through (iii) above that Buyer elects in its sole discretion to purchase (the "Other Mezzanine Investments")." (b) First Mortgage B Notes: The following definition is hereby added to Secton 2(c) of Annex I to the Repurchase Agreement (in the appropriate alphabetical order): " `First Mortgage B Note' shall mean any Senior First Mortgage B Note or Junior First Mortgage B Note." (c) Purchase Percentage: The definition of the term "Purchase Percentage" in Section 2(c) of Annex I to the Repurchase Agreement is hereby amended to read as follows: " `Purchase Percentage' shall mean, with respect to any Purchased Loan, the applicable "Purchase Percentage" specified in Schedule 1 and approved by Buyer for a Loan Type (or as otherwise specified in the applicable Confirmation)." (d) Extended Repurchase Period: The terms "Extended Repurchase Period" and "Extended Repurchase Period Monthly Payment Amount" are hereby deleted from Section 2(c) of Annex I to the Repurchase Agreement and Section 3(s) of Annex I to the Repurchase Agreement is hereby deleted in its entirety. (e) Schedule 1: Schedule 1 attached to Annex I to the Repurchase Agreement is hereby replaced in its entirety with Schedule A-1 attached hereto. 3. Continuing Effect. Except as expressly amended by this Amendment, the Repurchase Agreement and the other Transaction Documents remain in full force and effect in accordance with their respective terms, and are hereby in all respects ratified and confirmed. 4. References to Repurchase Agreement. All references to the Repurchase Agreement in any Transaction Document or in any other document executed or delivered in connection therewith shall, from and after the execution and delivery of this Amendment, be deemed a reference to the Repurchase Agreement as amended hereby, unless the context expressly requires otherwise. 2 5. Governing Law. This Amendment shall be governed by and construed and interpreted in accordance with the laws of the State of New York. 6. Counterparts. This Amendment may be executed in any number of counterparts, each of which when so executed and delivered shall be an original, but all of which shall constitute one and the same instrument. 3 IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed and delivered in their names as of the date first above written. GOLDMAN SACHS MORTGAGE COMPANY, as a Buyer By: Goldman Sachs Real Estate Funding Corp. By: /s/ Jonathan Sobel ----------------------------------- Name: Jonathan Sobel Title: Director GOLDMAN SACHS MORTGAGE COMPANY, as Administrative Agent By: Goldman Sachs Real Estate Funding Corp. By: /s/ Jonathan Sobel ----------------------------------- Name: Jonathan Sobel Title: Director COMMERZBANK AG, NEW YORK BRANCH, as a Buyer By: /s/ Anthony J. Tuffy ----------------------------- Name: Anthony J. Tuffy Title: Senior Vice President By: /s/ Michael Zanolli ----------------------------- Name: Michael Zanolli Title: Senior Vice President 4 CAPITAL TRUST, INC., as Seller By: /s/ Brian H. Oswald ----------------------------- Name: Brian H. Oswald Title: Chief Financial Officer 5 SCHEDULE 1 Purchase Percentages and Applicable Spreads ------------------------------------------- - ------------------------------------------------ -------------- ------------- Applicable Spread Purchase (basis LTV Percentage* points)* - ------------------------------------------------ -------------- ------------- LTV less than or equal to 60% Less than or 100 equal to 65% - ------------------------------------------------ -------------- ------------- Greater than 125 65% but less than or equal to 85% - ------------------------------------------------ -------------- ------------- LTV greater than 60% and less than or Less than or 135 equal to 70% equal to 60% - ------------------------------------------------ -------------- ------------- Greater than 160 60% but less than or equal to 80% - ------------------------------------------------ -------------- ------------- Less than or 175 LTV greater than 70% and less than or equal to equal to 85% 50% - ------------------------------------------------ -------------- ------------- Greater than 200 50% but less than or equal to 70% - ------------------------------------------------ -------------- ------------- - --------- * Or as otherwise determined by Buyer in its sole discretion on a case-by-case basis and set forth in a Confirmation. 6 EX-10 4 ex10-4.txt EX. 10.4 - 2004 LONG-TERM INCENTIVE PLAN Exhibit 10.4 CAPITAL TRUST, INC. 2004 LONG-TERM INCENTIVE PLAN 1. Establishment, Purpose, and Types of Awards Capital Trust, Inc., a Maryland corporation (the "Company") hereby establishes an incentive compensation plan to be known as the "Capital Trust, Inc. 2004 Long-Term Incentive Plan" (hereinafter referred to as the "Plan"), for the purpose of attracting, retaining and motivating select employees, officers, directors, advisors, and consultants for the Company and its Affiliates and to provide incentives and awards for superior performance. The Plan permits the granting of the following types of awards ("Awards"), according to the Sections of the Plan listed here: Section 6 Options Section 7 Share Appreciation Rights Section 8 Restricted and Unrestricted Share Awards Section 9 Deferred Share Units Section 10 Performance Awards The Plan is not intended to affect and shall not affect any stock options, equity-based compensation, or other benefits that the Company or its Affiliates may have provided, or may separately provide in the future pursuant to any agreement, plan, or program that is independent of this Plan. 2. Defined Terms Terms in the Plan that begin with an initial capital letter have the defined meaning set forth in Appendix A, unless defined elsewhere in this Plan or the context of their use clearly indicates a different meaning. 3. Shares Subject to the Plan Subject to the provisions of Section 13 of the Plan, the maximum number of Shares that the Company may issue is 1,000,000 Shares for all Awards. For all Awards, these Shares may be authorized but unissued Shares, or Shares that the Company has reacquired or otherwise holds in treasury. Shares that are subject to an Award that for any reason expires, is forfeited, is cancelled, or becomes unexercisable, and Shares that are for any other reason not paid or delivered under the Plan shall again, except to the extent prohibited by Applicable Law, be available for subsequent Awards under the Plan. In addition, the Committee may make future Awards with respect to Shares that the Company retains from otherwise delivering pursuant to an Award either (i) as payment of the exercise price of an Award, or (ii) in order to satisfy the withholding or employment taxes due upon the grant, exercise, vesting, or distribution of an Award. 1 Notwithstanding the foregoing, but subject to adjustments pursuant to Section 13 below, the number of Shares that are available for ISO Awards shall be determined, to the extent required under applicable tax laws, by reducing the number of Shares designated in the preceding paragraph by the number of Shares granted pursuant to ISO Awards (whether or not Shares are issued pursuant to such Awards); provided that any Shares that are either purchased under the Plan and forfeited back to the Plan, or surrendered in payment of the Exercise Price for an Award shall be available for issuance pursuant to ISO Awards. 4. Administration (a) General. The Committee shall administer the Plan in accordance with its terms, provided that the Board may act in lieu of the Committee on any matter. The Committee shall hold meetings at such times and places as it may determine and make such rules and regulations for the conduct of its business as it deems advisable. In the absence of a duly appointed Committee or if the Board otherwise chooses to act in lieu of a Committee, the Board shall function as the Committee for all purposes of the Plan. (b) Committee Composition. The Board shall appoint the members of the Committee. If and to the extent permitted by Applicable Law, the Committee may authorize one or more Reporting Persons (or other officers) to make Awards to Eligible Persons who are not Reporting Persons (or other officers whom the Committee has specifically authorized to make Awards). The Board may at any time appoint additional members to the Committee, remove and replace members of the Committee with or without Cause, and fill vacancies on the Committee however caused. (c) Powers of the Committee. Subject to the provisions of the Plan, the Committee shall have the authority, in its sole discretion: (i) to determine Eligible Persons to whom Awards shall be granted from time to time and the number of Shares, units, or SARs to be covered by each Award; (ii) to determine, from time to time, the Fair Market Value of Shares; (iii) to determine, and to set forth in Award Agreements, the terms and conditions of all Awards, including any applicable exercise or purchase price, the installments and conditions under which an Award shall become vested (which may be based on performance), terminated, expired, cancelled, renewed, or replaced, and the circumstances for vesting acceleration or waiver of forfeiture restrictions, and other restrictions and limitations; (iv) to approve the forms of Award Agreements and all other documents, notices and certificates in connection therewith which need not be identical either as to type of Award or among Participants; (v) to construe and interpret the terms of the Plan and any Award Agreement, to determine the meaning of their terms, and to prescribe, amend, and rescind rules and procedures relating to the Plan and its administration; and 2 (vi) in order to fulfill the purposes of the Plan and without amending the Plan, modify, cancel, or waive the Company's rights with respect to any Awards, to adjust or to modify Award Agreements for changes in Applicable Law, and to recognize differences in foreign law, tax policies, or customs; and (vii) to make all other interpretations and to take all other actions that the Committee may consider necessary or advisable to administer the Plan or to effectuate its purposes. Subject to Applicable Law and the restrictions set forth in the Plan, the Committee may delegate administrative functions to individuals who are Reporting Persons, officers, or Employees of the Company or its Affiliates. (d) Deference to Committee Determinations. The Committee shall have the discretion to interpret or construe ambiguous, unclear, or implied (but omitted) terms in any fashion it deems to be appropriate in its sole discretion, and to make any findings of fact needed in the administration of the Plan or Award Agreements. The Committee's prior exercise of its discretionary authority shall not obligate it to exercise its authority in a like fashion thereafter. The Committee's interpretation and construction of any provision of the Plan, or of any Award or Award Agreement, shall be final, binding, and conclusive. The validity of any such interpretation, construction, decision or finding of fact shall not be given de novo review if challenged in court, by arbitration, or in any other forum, and shall be upheld unless clearly arbitrary or capricious. (e) No Liability; Indemnification. Neither the Board nor any Committee member, nor any Person acting at the direction of the Board or the Committee, shall be liable for any act, omission, interpretation, construction or determination made in good faith with respect to the Plan, any Award or any Award Agreement. The Company and its Affiliates shall pay or reimburse any member of the Committee, as well as any Director, Employee, or Consultant who takes action in connection with the Plan, for all expenses incurred with respect to the Plan, and to the full extent allowable under Applicable Law shall indemnify each and every one of them for any claims, liabilities, and costs (including reasonable attorney's fees) arising out of their good faith performance of duties under the Plan. The Company and its Affiliates may obtain liability insurance for this purpose. 5. Eligibility (a) General Rule. The Committee may grant ISOs only to Employees (including officers who are Employees) of the Company or an Affiliate that is a "parent corporation" or "subsidiary corporation" within the meaning of Section 424 of the Code, and may grant all other Awards to any Eligible Person. A Participant who has been granted an Award may be granted an additional Award or Awards if the Committee shall so determine, if such Person is otherwise an Eligible Person and if otherwise in accordance with the terms of the Plan. (b) Grant of Awards. Subject to the express provisions of the Plan, the Committee shall determine from the class of Eligible Persons those individuals to whom Awards under the Plan may be granted, the number of Shares subject to each Award, the price (if any) to be paid 3 for the Shares or the Award and, in the case of Performance Awards, in addition to the matters addressed in Section 10 below, the specific objectives, goals and performance criteria that further define the Performance Award. Each Award shall be evidenced by an Award Agreement signed by the Company and, if required by the Committee, by the Participant. The Award Agreement shall set forth the material terms and conditions of the Award established by the Committee. (c) Limits on Awards. No Participant may receive Options and SARs that relate to more than 500,000 Shares per calendar year. The Committee will adjust these limitations pursuant to Section 13 below. (d) Replacement Awards. The Committee may, in its sole discretion and upon such terms as it deems appropriate, require as a condition of the grant of an Award to a Participant that the Participant surrender for cancellation some or all of the Awards or other awards that have previously been granted to the Participant under this Plan or otherwise. An Award that is conditioned upon such surrender may or may not be the same type of Award, may cover the same (or a lesser or greater) number of Shares as such surrendered Award, may have other terms that are determined without regard to the terms or conditions of such surrendered Award, and may contain any other terms that the Committee deems appropriate. In the case of Options, these other terms may not involve an Exercise Price that is lower than the Exercise Price of the surrendered Option unless either the new grant will not create any material financial expense for the Company or the Company's shareholders approve the grant itself or the program under which it is made pursuant to the Plan. 6. Option Awards (a) Types; Documentation. The Committee may in its discretion grant ISOs to any Employee and Non-ISOs to any Eligible Person, and shall evidence any such grants in an Award Agreement that is delivered to the Participant. Each Option shall be designated in the Award Agreement as an ISO or a Non-ISO. At the sole discretion of the Committee, any Option may be exercisable, in whole or in part, immediately upon the grant thereof, or only after the occurrence of a specified event, or only in installments, which installments may vary. Options granted under the Plan may contain such terms and provisions not inconsistent with the Plan that the Committee shall deem advisable in its sole and absolute discretion. (b) ISO $100,000 Limitation. To the extent that the aggregate Fair Market Value of Shares with respect to which Options designated as ISOs first become exercisable by a Participant in any calendar year (under this Plan and any other plan of the Company or any Affiliate) exceeds $100,000, such excess Options shall be treated as Non-ISOs. For purposes of determining whether the $100,000 limit is exceeded, the Fair Market Value of the Shares subject to an ISO shall be determined as of the Grant Date. In reducing the number of Options treated as ISOs to meet the $100,000 limit, the most recently granted Options shall be reduced first. In the event that Section 422 of the Code is amended to alter the limitation set forth therein, the limitation of this Section 6(b) shall be automatically adjusted accordingly. (c) Term of Options. Each Award Agreement shall specify a term at the end of which the Option automatically expires, subject to earlier termination provisions contained in Section 6(h) hereof; provided, that, the term of any Option may not exceed ten years from the Grant 4 Date. In the case of an ISO granted to an Employee who is a Ten Percent Holder on the Grant Date, the term of the ISO shall not exceed five years from the Grant Date. (d) Exercise Price. The exercise price of an Option shall be determined by the Committee in its discretion and shall be set forth in the Award Agreement, subject to the following special rules: (i) ISOs. If an ISO is granted to an Employee who on the Grant Date is a Ten Percent Holder, the per Share exercise price shall not be less than 110% of the Fair Market Value per Share on such Grant Date. If an ISO is granted to any other Employee, the per Share exercise price shall not be less than 100% of the Fair Market Value per Share on the Grant Date. (ii) Non-ISOs. The per Share exercise price for the Shares to be issued pursuant to the exercise of a Non-ISO shall not be less than 50% of the Fair Market Value per Share on the Grant Date. (iii) Named Executive Officers. The per Share exercise price shall not be less than 100% of the Fair Market Value per Share on the Grant Date of an Option if (A) on such Grant Date, the Participant is subject to the limitations set forth in Section 162(m) of the Code, and (B) the grant is intended to qualify as performance-based compensation under Section 162(m) of the Code. (iv) Repricing. The Committee may at any time unilaterally reduce the exercise price for any Option, but only if (I) the reduction will not cause material financial expense for the Company or the Company's shareholders approve the reduction or the program under which it is made, and (II) the Committee promptly provides a written notice to any Participant affected by the reduction. (e) Exercise of Option. The times, circumstances and conditions under which an Option shall be exercisable shall be determined by the Committee in its sole discretion and set forth in the Award Agreement. The Committee shall have the discretion to determine whether and to what extent the vesting of Options shall be tolled during any unpaid leave of absence; provided, however, that in the absence of such determination, vesting of Options shall be tolled during any such leave approved by the Company. (f) Minimum Exercise Requirements. An Option may not be exercised for a fraction of a Share. The Committee may require in an Award Agreement that an Option be exercised as to a minimum number of Shares, provided that such requirement shall not prevent a Participant from purchasing the full number of Shares as to which the Option is then exercisable. (g) Methods of Exercise. Prior to its expiration pursuant to the terms of the applicable Award Agreement, and subject to the times, circumstances, and conditions for exercisability contained in the applicable Award Agreement, each Option may be exercised, in whole or in part (provided that the Company shall not be required to issue fractional shares), by delivery of written notice of exercise to the secretary of the Company accompanied by the payment of the full exercise price of the Shares being purchased. Unless otherwise provided in 5 the applicable Award Agreement, the acceptable methods of payment on the Grant Date of any Option shall include the following: (i) cash or check payable to the Company (in U.S. dollars); (ii) other Shares that (A) are owned by the Participant who is purchasing Shares pursuant to an Option, (B) have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Shares as to which the Option is being exercised, (C) were not acquired by such Participant pursuant to the exercise of an Option, unless such Shares have been owned by such Participant for at least six months or such other longer period as the Committee may determine, (D) are all, at the time of such surrender, free and clear of any and all claims, pledges, liens and encumbrances, or any restrictions which would in any manner restrict the transfer of such shares to or by the Company (other than such restrictions as may have existed prior to an issuance of such Shares by the Company to such Participant), and (E) are duly endorsed for transfer to the Company; (iii) a cashless exercise program that the Committee may approve, from time to time in its discretion, pursuant to which a Participant may concurrently provide irrevocable instructions (A) to such Participant's broker or dealer to effect the immediate sale of the purchased Shares and remit to the Company, out of the sale proceeds available on the settlement date, sufficient funds to cover the exercise price of the Option plus all applicable taxes required to be withheld by the Company by reason of such exercise and (B) to the Company to deliver the certificates for the purchased Shares directly to such broker or dealer in order to complete the sale; (iv) the Participant's surrender of Restricted Shares, Restricted Share Units, Share Appreciation Rights, or Deferred Share Units; provided that to the extent payment is made by means of the surrender of any Award which is unvested or subject to restrictions, the Shares issued pursuant to such surrender shall be subject to the same vesting terms and other restrictions that applied to the surrendered Award; or (v) any combination of the foregoing methods of payment. The Committee shall have the discretion to exclude from an Award Agreement any methods of payment set forth above. The Company shall not be required to deliver Shares pursuant to the exercise of an Option until payment of the full exercise price therefore is received by the Company. (h) Termination of Continuous Service. The Committee may establish and set forth in the applicable Award Agreement the terms and conditions on which an Option shall remain exercisable, if at all, following termination of a Participant's Continuous Service. The Committee may waive or modify these provisions at any time. To the extent that a Participant is not entitled to exercise an Option at the date of his or her termination of Continuous Service, or if the Participant (or other Person entitled to exercise the Option) does not exercise the Option to the extent so entitled within the time specified in the Award Agreement or below (as applicable), the Option shall terminate and the Shares underlying the unexercised portion of the Option shall 6 revert to the Plan and become available for future Awards. In no event may any Option be exercised after the expiration of the Option term as set forth in the Award Agreement. The following provisions shall apply to the extent an Award Agreement does not specify the terms and conditions upon which an Option shall terminate when there is a termination of a Participant's Continuous Service: (i) Termination other than Upon Disability or Death or for Cause. In the event of termination of a Participant's Continuous Service (other than as a result of Participant's death, disability, retirement or termination for Cause), the Participant shall have the right to exercise an Option at any time within 90 days following such termination to the extent the Participant was entitled to exercise such Option at the date of such termination. (ii) Disability. In the event of termination of a Participant's Continuous Service as a result of his or her "disability" within the meaning of Section 22(e)(3) of the Code, the Participant shall have the right to exercise an Option at any time within one year following such termination to the extent the Participant was entitled to exercise such Option at the date of such termination. (iii) Retirement. In the event of termination of a Participant's Continuous Service as a result of Participant's retirement, the Participant shall have the right to exercise the Option at any time within six months following such termination to the extent the Participant was entitled to exercise such Option at the date of such termination. (iv) Death. In the event of the death of a Participant during the period of Continuous Service since the Grant Date of an Option, or within 90 days following termination of the Participant's Continuous Service, the Option may be exercised, at any time within one year following the date of the Participant's death, by the Participant's estate or by a Person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent the right to exercise the Option had vested at the date of death or, if earlier, the date the Participant's Continuous Service terminated. (v) Cause. If the Committee determines that a Participant's Continuous Service terminated due to Cause, the Participant shall immediately forfeit the right to exercise any Option, and it shall be considered immediately null and void. (i) Reverse Vesting. The Plan Administrator in its discretion may allow a Participant to exercise unvested Options, in which case the Shares then issued shall be Restricted Share Units having analogous vesting restrictions to the unvested Options. (j) Buyout Provisions. The Committee may at any time offer to buy out an Option, in exchange for a payment in cash or Shares, based on such terms and conditions as the Committee shall establish and communicate to the Participant at the time that such offer is made. In addition, if the Fair Market Value for Shares subject to an Option is more than 33% below their exercise price for more than 30 consecutive business days, the Committee may unilaterally terminate and cancel the Option either (i) by paying the Participant, in cash or Shares, an amount not less than the Black-Scholes value of the vested portion of the Option, or (ii) by irrevocably 7 committing to grant a new Option, on a designated date more than six months after such termination and cancellation of such Option (but only if the Participant's Continuous Service has not terminated prior to such designated date), on substantially the same terms as the cancelled Option, provided that the per Share exercise price for the new Option shall equal the per Share Fair Market Value of a Share on the date the new grant occurs. 7. Share Appreciate Rights (SARs) (a) Grants. The Committee may in its discretion grant Share Appreciation Rights to any Eligible Person, in any of the following forms: (i) SARs related to Options. The Committee may grant SARs either concurrently with the grant of an Option or with respect to an outstanding Option, in which case the SAR shall extend to all or a portion of the Shares covered by the related Option. An SAR shall entitle the Participant who holds the related Option, upon exercise of the SAR and surrender of the related Option, or portion thereof, to the extent the SAR and related Option each were previously unexercised, to receive payment of an amount determined pursuant to Section 7(e) below. Any SAR granted in connection with an ISO will contain such terms as may be required to comply with the provisions of Section 422 of the Code and the regulations promulgated thereunder. (ii) SARs Independent of Options. The Committee may grant SARs which are independent of any Option subject to such conditions as the Committee may in its discretion determine, which conditions will be set forth in the applicable Award Agreement. (iii) Limited SARs. The Committee may grant SARs exercisable only upon or in respect of a Change in Control or any other specified event, and such limited SARs may relate to or operate in tandem or combination with or substitution for Options or other SARs, or on a stand-alone basis, and may be payable in cash or Shares based on the spread between the exercise price of the SAR, and (A) a price based upon or equal to the Fair Market Value of the Shares during a specified period, at a specified time within a specified period before, after or including the date of such event, or (B) a price related to consideration payable to Company's shareholders generally in connection with the event. (b) Exercise Price. The per Share exercise price of an SAR shall be determined in the sole discretion of the Committee, shall be set forth in the applicable Award Agreement, and shall be no less than 50% of the Fair Market Value of one Share. The exercise price of an SAR related to an Option shall be the same as the exercise price of the related Option. The exercise price of an SAR shall be subject to the special rules on pricing contained in paragraphs (iii) and (iv) of Section 6(d) hereof. (c) Exercise of SARs. Unless the Award Agreement otherwise provides, an SAR related to an Option will be exercisable at such time or times, and to the extent, that the related Option will be exercisable. An SAR may not have a term exceeding ten years from its Grant Date. An SAR granted independently of any other Award will be exercisable pursuant to the terms of the Award Agreement. Whether an SAR is related to an Option or is granted 8 independently, the SAR may only be exercised when the Fair Market Value of the Shares underlying the SAR exceeds the exercise price of the SAR. (d) Effect on Available Shares. To the extent that an SAR is exercised, only the actual number of delivered Shares (if any) will be charged against the maximum number of Shares that may be delivered pursuant to Awards under this Plan. The number of Shares subject to the SAR and the related Option of the Participant will, however, be reduced by the number of underlying Shares as to which the exercise relates, unless the Award Agreement otherwise provides. (e) Payment. Upon exercise of an SAR related to an Option and the attendant surrender of an exercisable portion of any related Award, the Participant will be entitled to receive payment of an amount determined by multiplying - (i) the excess of the Fair Market Value of a Share on the date of exercise of the SAR over the exercise price per Share of the SAR, by (ii) the number of Shares with respect to which the SAR has been exercised. Notwithstanding the foregoing, an SAR granted independently of an Option may limit the amount payable to the Participant to a percentage, specified in the Award Agreement but not exceeding one-hundred percent (100%), of the amount determined pursuant to the preceding sentence. (f) Form and Terms of Payment. Subject to Applicable Law, the Committee may, in its sole discretion, settle the amount determined under Section 7(e) above solely in cash, solely in Shares (valued at their Fair Market Value on the date of exercise of the SAR), or partly in cash and partly in Shares. In any event, cash shall be paid in lieu of fractional Shares. Absent a contrary determination by the Committee, all SARs shall be settled in cash as soon as practicable after exercise. Notwithstanding the foregoing, the Committee may, in an Award Agreement, determine the maximum amount of cash or Shares or combination thereof that may be delivered upon exercise of an SAR. (g) Termination of Employment or Consulting Relationship. The Committee shall establish and set forth in the applicable Award Agreement the terms and conditions on which an SAR shall remain exercisable, if at all, following termination of a Participant's Continuous Service. The provisions of Section 6(h) above shall apply to the extent an Award Agreement does not specify the terms and conditions upon which an SAR shall terminate when there is a termination of a Participant's Continuous Service. (h) Repricing and Buy-out. The Committee has the same discretion to reprice and to buy-out SARs as it has to take such actions with respect to Options. 8. Restricted and Unrestricted Share Awards (a) Grants. The Committee may in its discretion grant restricted shares ("Restricted Shares") to any Eligible Person and shall evidence such grant in an Award Agreement that is delivered to the Participant which sets forth the number of Restricted Shares, the purchase price 9 for such Restricted Shares (if any) and the terms upon which the Restricted Shares may become vested. In addition, the Company may in its discretion grant the right to receive Shares after certain vesting requirements are met ("Restricted Share Units") to any Eligible Person and shall evidence such grant in an Award Agreement that is delivered to the Participant which sets forth the number of Shares (or formula, that may be based on future performance or conditions, for determining the number of Shares) that the Participant shall be entitled to receive upon vesting and the terms upon which the Shares subject to Restricted Share Units may become vested. Unless otherwise provided in the Award Agreement, the holder of Restricted Shares shall receive any cash and stock dividends declared and paid on the Restricted Shares. Unless otherwise provided in the Award Agreement, the holder of Restricted Share Units shall receive (i) in the case of any cash dividends declared and paid on the Shares, a cash amount equal to that amount that would otherwise be payable as cash dividends so declared and paid if the Shares subject to the then outstanding Restricted Share Units were outstanding and (ii) in the case of any stock dividends declared and paid on the Shares, a grant of additional Restricted Share Units (which shall be subject to the same outstanding vesting terms) for the number of Shares equal to any stock dividends so declared and paid that would otherwise be payable if the Shares subject to the then outstanding Restricted Share Units were outstanding. The Committee may condition any Award of Restricted Shares or Restricted Share Units to a Participant on receiving from the Participant such further assurances and documents as the Committee may require to enforce the restrictions. In addition, the Committee may grant Awards hereunder in the form of unrestricted Shares ("Unrestricted Shares"), which shall vest in full upon the date of grant or such other date as the Committee may determine or which the Committee may issue pursuant to any program under which one or more Eligible Persons (selected by the Committee in its discretion) elect to receive Unrestricted Shares in lieu of cash bonuses that would otherwise be paid. (b) Vesting. The Committee shall set forth in an Award Agreement granting Restricted Shares or Restricted Share Units, the terms and conditions under which the Participant's interest in the Restricted Shares or the Shares subject to Restricted Share Units will become vested. Except as set forth in the applicable Award Agreement or as the Committee otherwise determines, upon termination of a Participant's Continuous Service for any other reason, the Participant shall forfeit his or her unvested Restricted Shares and Restricted Share Units; provided that if a Participant purchases the Restricted Shares and forfeits them for any reason, the Company shall return the purchase price to the Participant only if and to the extent set forth in an Award Agreement. (c) Issuance of Restricted Shares Prior to Vesting. The Company shall issue stock certificates that evidence Restricted Shares pending the lapse of applicable restrictions, and that bear a legend making appropriate reference to such restrictions. Except as set forth in the applicable Award Agreement or the Committee otherwise determines, the Company or a third party that the Company designates shall hold such Restricted Shares and any dividends not currently paid to the Participant pursuant to the applicable Award Agreement. (d) Issuance of Shares upon Vesting. As soon as practicable after vesting of a Participant's Restricted Shares (or Shares underlying Restricted Share Units) and the Participant's satisfaction of applicable tax withholding requirements, the Company shall release to the Participant, free from the vesting restrictions, one Share for each vested Restricted Share (or issue one Share free of the vesting restriction for each vested Restricted Share Unit), unless 10 an Award Agreement provides otherwise. No fractional shares shall be distributed, and cash shall be paid in lieu thereof. (e) Dividends payable on Vesting. If an Award Agreement does not provide for an earlier payment of dividends, whenever Shares are issued to a Participant or duly-authorized transferee under Section 8(d) above pursuant to the vesting of Restricted Shares or the Shares underlying Restricted Share Units, such Participant or duly-authorized transferee shall also be entitled to receive, with respect to each Share issued, an amount equal to any cash dividends (plus simple interest at a rate of five percent per annum, or such other reasonable rate as the Committee may determine) and a number of Shares equal to any stock dividends, which were declared and paid to the holders of Shares between the Grant Date and the date such Share is issued to the extent not currently paid to the Participant pursuant to the applicable Award Agreement. (f) Section 83(b) Elections. If a Participant who has received Restricted Share Units provides the Committee with written notice of his or her intention to make an election under Section 83(b) of the Code with respect to the Shares subject to such Restricted Share Units (the "Section 83(b) Election"), the Committee may in its discretion convert the Participant's Restricted Share Units into Restricted Shares, on a one-for-one basis, in full satisfaction of the Participant's Restricted Share Unit Award. (g) Deferral Elections. At any time within the calendar year in which a Participant who is a member of a "select group of management or highly compensated employees" (within the meaning of ERISA) receives an Award of either Restricted Shares or Restricted Share Units, the Committee may permit the Participant to irrevocably elect, on a form provided by and acceptable to the Committee, to defer the receipt of all or a percentage of the Shares that would otherwise be transferred to the Participant upon the vesting of such Award. If the Participant makes this election, the Shares subject to the election, and any associated unpaid dividends and interest thereon, shall be credited as Deferred Share Units (as defined below) to an Account (as defined below) established pursuant to Section 9 hereof on the date such Shares would otherwise have been released or issued to the Participant pursuant to Section 8(d) above. Notwithstanding the foregoing, Shares with respect to which a Participant makes a Section 83(b) Election shall not be eligible for deferral pursuant to Section 9 below. 9. Deferred Share Units (a) Elections to Defer. The Committee may permit any Eligible Person who is a Director, Consultant or member of a "select group of management or highly compensated employees" (within the meaning of the ERISA) to irrevocably elect, on a form provided by and acceptable to the Committee (the "Election Form"), to forego the receipt of cash or other compensation (including Restricted Shares for which a Section 83(b) Election has not been made, Shares subject to Restricted Share Units and the dividends or the cash amount equal to the amount of dividends that would otherwise be paid in respect of Restricted Shares or Shares subject to Restricted Share Units), and in lieu thereof to have the Company credit to an internal Plan account (the "Account") a number of deferred share units ("Deferred Share Units") having a Fair Market Value equal to the Shares and other compensation deferred. These credits will be made at the end of each calendar month during which compensation is deferred. Each Election 11 Form shall take effect five business days after its delivery to the Company, unless during such five business day period the Company sends the Participant a written notice explaining why the Election Form is invalid. Notwithstanding the foregoing sentence, Election Forms shall be ineffective with respect to any compensation that a Participant earns before the date on which the Company receives the Election Form. (b) Vesting. Each Participant shall be 100% vested at all times in any Shares subject to Deferred Share Units. (c) Crediting of Dividends. Unless otherwise provided in the Award Agreement, whenever cash dividends are declared and paid on the Shares, the Account shall be credited with additional Deferred Share Units calculated by dividing (i) the amount obtained by multiplying the number of Shares subject to the then outstanding Deferred Share Units by the per share dividend amount by (ii) the Fair Market Value of the Shares on the date of payment of the dividends. Whenever stock dividends are declared and paid on the Shares, the Account shall be credited with additional Deferred Shares Units for the number of Shares equal to any stock dividends declared and paid on the Shares that would otherwise be payable if the Shares subject to the then outstanding Deferred Share Units were outstanding. (d) Issuances of Shares. The Company shall provide a Participant with one Share for each Deferred Share Unit in five substantially equal annual installments that are issued before the last day of each of the five calendar years that end after the date on which the Participant's Continuous Service terminates, unless - (i) the Participant has properly elected a different form of distribution, on a form approved by the Committee that permits the Participant to select any combination of a lump sum and annual installments that are completed within ten years following termination of the Participant's Continuous Service, and (ii) the Company has received the Participant's distribution election form either more than 90 days before a Change in Control, or more than one year before the date on which the Participant's Continuous Service terminates for any reason other than death, or before the Participant's death. Fractional shares shall not be issued, and instead shall be paid out in cash. (e) Hardship Withdrawals. In the event a Participant suffers an unforeseeable hardship within the contemplation of this Section 9(e) , the Participant may apply to the Company for an immediate distribution of all or a portion of the Participant's Deferred Share Units. The hardship must result from a sudden and unexpected illness or accident of the Participant or a dependent of the Participant, casualty loss of property, or other similar conditions beyond the control of the Participant. Examples of purposes which are not considered hardships include post-secondary school expenses or the desire to purchase a residence. In no event will a distribution be made to the extent the hardship could be relieved through reimbursement or compensation by insurance or otherwise, or by liquidation of the Participant's nonessential assets to the extent such liquidation would not itself cause a severe financial hardship. The amount of any distribution hereunder shall be limited to the amount necessary to relieve the Participant's 12 financial hardship. The Committee shall determine whether a Participant has a qualifying hardship and the amount which qualifies for distribution, if any. The Committee may require evidence of the purpose and amount of the need, and may establish such application or other procedures as it deems appropriate. (f) Unsecured Rights to Deferred Compensation. A Participant's right to Deferred Share Units shall at all times constitute an unsecured promise of the Company to pay benefits as they come due. The right of the Participant or the Participant's duly-authorized transferee to receive benefits hereunder shall be solely an unsecured claim against the general assets of the Company. Neither the Participant nor the Participant's duly-authorized transferee shall have any claim against or rights in any specific assets, shares, or other funds of the Company. 10. Performance Awards (a) Performance Units. The Committee may in its discretion grant Performance Units to any Eligible Person and shall evidence such grant in an Award Agreement that is delivered to the Participant which sets forth the terms and conditions of the Award. A Performance Unit is an Award which is based on the achievement of specific goals with respect to the Company or any Affiliate or individual performance of the Participant, or a combination thereof, over a specified period of time. Subject to subsection (d) hereof , the maximum Performance Unit compensation that may be paid to any one Participant with respect to any one Performance Period (hereinafter defined) shall be 250,000 Shares, $5,000,000 in cash, or both. (b) Performance Compensation Awards. The Committee may, at the time of grant of a Performance Unit, designate such Award as a "Performance Compensation Award" in order that such Award constitutes "qualified performance-based compensation" under Code Section 162(m), in which event the Committee shall have the power to grant such Performance Compensation Award upon terms and conditions that qualify it as "qualified performance-based compensation" within the meaning of Code Section 162(m). With respect to each such Performance Compensation Award, the Committee shall establish, in writing within the time required under Code Section 162(m), a "Performance Period," "Performance Measure(s)", and "Performance Formula(e)" (each such term being hereinafter defined). Once established for a Performance Period, the Performance Measure(s) and Performance Formula(e) shall not be amended or otherwise modified to the extent such amendment or modification would cause the compensation payable pursuant to the Award to fail to constitute qualified performance-based compensation under Code Section 162(m). A Participant shall be eligible to receive payment in respect of a Performance Compensation Award only to the extent that the Performance Measure(s) for such Award are achieved and the Performance Formula(e) as applied against such Performance Measure(s) determines that all or some portion of such Participant's Award has been earned for the Performance Period. As soon as practicable after the close of each Performance Period, the Committee shall review and certify in writing whether, and to what extent, the Performance Measure(s) for the Performance Period have been achieved and, if so, determine and certify in writing the amount of the Performance Compensation Award to be paid to the Participant and, in so doing, may use negative discretion to decrease, but not increase, the amount of the Award otherwise payable to the Participant based upon such performance. Subject to subsection (d) 13 hereof, the maximum Performance Compensation Award for any one Participant for any one Performance Period shall be 250,000 Shares, $5,000,000 in cash, or both. (c) Definitions. (i) "Performance Formula" means, for a Performance Period, one or more objective formulas or standards established by the Committee for purposes of determining whether or the extent to which an Award has been earned based on the level of performance attained or to be attained with respect to one or more Performance Measure(s). Performance Formulae may vary from Performance Period to Performance Period and from Participant to Participant and may be established on a stand-alone basis, in tandem or in the alternative. (ii) "Performance Measure" means one or more of the following selected by the Committee to measure Company, Affiliate, and/or business unit performance for a Performance Period, whether in absolute or relative terms, including, without limitation: terms relative to a peer group or index; basic, diluted, or adjusted earnings per share; sales or revenue; earnings before interest, taxes, and other adjustments (in total or on a per share basis); basic or adjusted net income; basic or adjusted funds from operations or cash flow; returns on equity, assets, capital, revenue or similar measure; level and growth of dividends; the price or increase in price of Shares; total shareholder return; distributions received on the account of so called carried interests or incentive management fees from CT Mezzanine Partners II LP, CT Mezzanine Partners III, Inc., and any other private equity fund managed by the Company; total assets; growth in assets or new originations of assets; equity market capitalization; assets under management; third-party equity capital under management or raised; and mergers, acquisitions, sales of assets of Affiliates or business units. Each such measure shall be to the extent applicable, determined in accordance with generally accepted accounting principles as consistently applied by the Company (or such other standard applied by the Committee) and, if so determined by the Committee, and in the case of a Performance Compensation Award, to the extent permitted under Code Section 162(m), adjusted to omit the effects of extraordinary items, gain or loss on the disposal of a business segment, unusual or infrequently occurring events and transactions and cumulative effects of changes in accounting principles. Performance Measures may vary from Performance Period to Performance Period and from Participant to Participant, and may be established on a stand-alone basis, in tandem or in the alternative. (iii) "Performance Period" means one or more periods of time (of not less than one fiscal year of the Company), as the Committee may designate, over which the attainment of one or more Performance Measure(s) will be measured for the purpose of determining a Participant's rights in respect of an Award. (d) With respect to the maximum limits set forth in Section 10(a) and 10(b) above, the Committee shall have the discretion to provide in any Award Agreement that any amounts earned in excess of these amounts during a Performance Period will either be credited as Deferred Share Units, or as deferred cash compensation under a separate plan of the Company or an Affiliate (provided in the latter case that such deferred compensation either bears a 14 reasonable rate of interest or has a value based on one or more predetermined actual investments). Any amounts for which payment to the Participant is deferred pursuant to the preceding sentence shall be paid to the Participant in a future year or years but not earlier than, and only to the extent that, the Participant is either not receiving compensation in excess of these limits for a Performance Period, or is not subject to the restrictions set forth under Section 162(b) of the Code 11. Taxes (a) General. As a condition to the issuance or distribution of Shares pursuant to the Plan, the Participant (or in the case of the Participant's death, the Person who succeeds to the Participant's rights) shall make such arrangements as the Company may require for the satisfaction of any applicable federal, state, local or foreign withholding tax obligations that may arise in connection with the Award and the issuance of Shares. The Company shall not be required to issue any Shares until such obligations are satisfied. If the Committee allows the withholding or surrender of Shares to satisfy a Participant's tax withholding obligations, the Committee shall not allow Shares to be withheld in an amount that exceeds the minimum statutory withholding rates for federal and state tax purposes, including payroll taxes. (b) Default Rule for Employees. In the absence of any other arrangement, an Employee shall be deemed to have directed the Company to withhold or collect from his or her cash compensation an amount sufficient to satisfy such tax obligations from the next payroll payment otherwise payable after the date of the exercise of an Award. (c) Special Rules. In the case of a Participant other than an Employee (or in the case of an Employee where the next payroll payment is not sufficient to satisfy such tax obligations, with respect to any remaining tax obligations), in the absence of any other arrangement and to the extent permitted under the Applicable Law, the Participant shall be deemed to have elected to have the Company withhold from the Shares or cash to be issued pursuant to an Award that number of Shares (or equivalent cash amount) having a Fair Market Value determined as of the applicable Tax Date (as defined below) equal to the amount required to be withheld. For purposes of this Section 11, the Fair Market Value of the Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined under the Applicable Law (the "Tax Date"). (d) Surrender of Shares. If permitted by the Committee, in its discretion, a Participant may satisfy the minimum applicable tax withholding and employment tax obligations associated with an Award by surrendering Shares to the Company (including Shares that would otherwise be issued pursuant to the Award) that have a Fair Market Value determined as of the applicable Tax Date equal to the amount required to be withheld. In the case of Shares previously acquired from the Company that are surrendered under this Section 11, such Shares must have been owned by the Participant for more than six months on the date of surrender (or such longer period of time the Company may in its discretion require). 15 12. Non-Transferability of Awards (a) General. Except as set forth in this Section 12, or as otherwise approved by the Committee for a select group of management or highly compensated Employees, Awards may not be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner other than by will or by the laws of descent or distribution. The designation of a beneficiary by a Participant will not constitute a transfer. An Award may be exercised, during the lifetime of the Participant issued an Award, only by such Participant, the duly-authorized legal representative of a disabled Participant, or a transferee permitted by this Section 12. (b) Limited Transferability Rights. Notwithstanding anything else in this Section 12, the Committee may in its discretion provide in an Award Agreement that the Award may be transferred by instrument to an inter vivos or testamentary trust (or other entity) in which the Award is to be passed to beneficiaries upon the death of the trustor (settlor), or by gift to charitable institutions, the Participant's "Immediate Family" (as defined below), on such terms and conditions as the Committee deems appropriate. "Immediate Family" means any child, stepchild, grandchild, parent, stepparent, grandparent, spouse, former spouse, domestic partner, sibling, niece, nephew, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law, and shall include adoptive relationships. 13. Adjustments Upon Changes in Capitalization, Merger or Certain Other Transactions (a) Changes in Capitalization. The Committee shall equitably adjust the number of Shares covered by each outstanding Award, and the number of Shares that have been authorized for issuance under the Plan but as to which no Awards have yet been granted or that have been returned to the Plan upon cancellation, forfeiture, or expiration of an Award, as well as the price per Share covered by each such outstanding Award, to reflect any increase or decrease in the number of issued Shares resulting from a stock-split, reverse stock-split, stock dividend, combination, recapitalization or reclassification of the Shares, or any other increase or decrease in the number of issued Shares effected without receipt of consideration by the Company. In the event of any such transaction or event, the Committee may provide in substitution for any or all outstanding Options under the Plan such alternative consideration (including securities of any surviving entity) as it may in good faith determine to be equitable under the circumstances and may require in connection therewith the surrender of all Options so replaced. In any case, such substitution of securities shall not require the consent of any Person who is granted options pursuant to the Plan. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be required to be made with respect to, the number or price of Shares subject to any Award. (b) Dissolution or Liquidation. In the event of the dissolution or liquidation of the Company other than as part of a Change of Control, each Award will terminate immediately prior to the consummation of such action, subject to the discretion of the Committee to exercise any discretion authorized in the case of a Change in Control. 16 (c) Change in Control. In the event of a Change in Control (or beforehand through an Award Agreement or modification of an Award Agreement), the Committee may in its sole and absolute discretion and authority, without obtaining the approval or consent of the Company's shareholders or any Participant (subject to the specific commitments made in any Award Agreement) with respect to his or her outstanding Awards, take one or more of the following actions: (i) arrange for or otherwise provide that each outstanding Award shall be assumed or a substantially similar award shall be substituted by a successor corporation or a parent or subsidiary of such successor corporation (the "Successor Corporation"); (ii) accelerate the vesting of Awards for any period that the Committee may authorize at the end of which the Committee may provide for termination of any unexercised Options or SARs, so that Awards shall vest (and, to the extent applicable, become exercisable) as to the Shares that otherwise would have been unvested and provide that repurchase rights of the Company, if any, with respect to Shares issued upon exercise of an Award shall lapse as to the Shares subject to such repurchase right; or (iii) arrange or otherwise provide for the payment of cash or other consideration to Participants in exchange for the satisfaction and cancellation of outstanding Awards. Notwithstanding the above, in the event a Participant holding an Award assumed or substituted by the Successor Corporation in a Change in Control is Involuntarily Terminated by the Successor Corporation in connection with, or within 12 months following consummation of, the Change in Control, then any assumed or substituted Award held by the terminated Participant at the time of termination shall accelerate and become fully vested (and exercisable in full in the case of Options and SARs), and any repurchase right applicable to any Shares shall lapse in full. The acceleration of vesting and lapse of repurchase rights provided for in the previous sentence shall occur immediately prior to the effective date of the Participant's termination. (d) Certain Distributions. In the event of any distribution to the Company's shareholders of securities of any other entity or other assets (other than dividends payable in cash or stock of the Company) without receipt of consideration by the Company, the Committee may, in its discretion, appropriately adjust the price per Share covered by each outstanding Award to reflect the effect of such distribution. 14. Time of Granting Awards. The date of grant ("Grant Date") of an Award shall be the date on which the Committee makes the determination granting such Award or such other date as is determined by the Committee, provided that in the case of an ISO, the Grant Date shall be the later of the date on which the Committee makes the determination granting such ISO or the date of commencement of the Participant's employment relationship with the Company. 17 15. Modification of Awards and Substitution of Options. (a) Modification, Extension, and Renewal of Awards. Within the limitations of the Plan and any Award Agreement, the Committee may modify an Award (i) to accelerate the rate at which an Option or SAR may be exercised (including without limitation permitting an Option or SAR to be exercised in full without regard to the installment or vesting provisions of the applicable Award Agreement or whether the Option or SAR is at the time exercisable, to the extent it has not previously been exercised), (ii) to accelerate the vesting of any Award, (iii) to extend or renew outstanding Awards, or (iv) to accept the cancellation of outstanding Awards to the extent not previously exercised either for the granting of new Awards or for other consideration in substitution or replacement thereof. (b) Substitution of Options. Notwithstanding any inconsistent provisions or limits under the Plan, in the event the Company or an Affiliate acquires (whether by purchase, merger or otherwise) all or substantially all of outstanding capital stock or assets of another corporation or in the event of any reorganization or other transaction qualifying under Section 424 of the Code, the Committee may, in accordance with the provisions of that Section, substitute Options for options under the plan of the acquired company provided (i) the excess of the aggregate fair market value of the shares subject to an option immediately after the substitution over the aggregate option price of such shares is not more than the similar excess immediately before such substitution and (ii) the new Option does not give Persons additional benefits, including any extension of the exercise period. 16. Term of Plan. The Plan shall continue in effect for a term of ten (10) years from its effective date as determined under Section 20 below, unless the Plan is sooner terminated under Section 17 below. 17. Amendment and Termination of the Plan. (a) Authority to Amend or Terminate. Subject to Applicable Laws, the Board may from time to time amend, alter, suspend, discontinue, or terminate the Plan. (b) Effect of Amendment or Termination. No amendment, suspension, or termination of the Plan shall materially and adversely affect Awards already granted unless either it relates to an adjustment pursuant to Section 13 above, or it is otherwise mutually agreed between the Participant and the Committee, which agreement must be in writing and signed by the Participant and the Company. Notwithstanding the foregoing, the Committee may amend the Plan to eliminate provisions which are no longer necessary as a result of changes in tax or securities laws or regulations, or in the interpretation thereof. 18. Conditions Upon Issuance of Shares. Notwithstanding any other provision of the Plan or any agreement entered into by the Company pursuant to the Plan, the Company shall not be obligated, and shall have no liability for failure, to issue or deliver any Shares under the Plan unless such issuance or delivery would 18 comply with Applicable Law, with such compliance determined by the Company in consultation with its legal counsel. 19. Reservation of Shares. The Company, during the term of this Plan, will at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. 20. Effective Date. This Plan shall become effective on the date of its approval by the Board; provided that this Plan shall be submitted to the Company's shareholders for approval, and if not approved by the shareholders within one year from the date of approval by the Board, this Plan and any Awards shall be null, void, and of no force and effect. Awards granted under this Plan before approval of this Plan by the shareholders shall be granted subject to such approval and no Shares shall be distributed before such approval. 21. Controlling Law. All disputes relating to or arising from the Plan shall be governed by the internal substantive laws (and not the laws of conflicts of laws) of the State of New York, to the extent not preempted by United States federal law. If any provision of this Plan is held by a court of competent jurisdiction to be invalid and unenforceable, the remaining provisions shall continue to be fully effective. 22. Laws And Regulations. (a) U.S. Securities Laws. This Plan, the grant of Awards, and the exercise of Options and SARs under this Plan, and the obligation of the Company to sell or deliver any of its securities (including, without limitation, Options, Restricted Shares, Restricted Share Units, Unrestricted Shares, Deferred Share Units, and Shares) under this Plan shall be subject to all Applicable Law. In the event that the Shares are not registered under the Securities Act of 1933, as amended (the "Act"), or any applicable state securities laws prior to the delivery of such Shares, the Company may require, as a condition to the issuance thereof, that the Persons to whom Shares are to be issued represent and warrant in writing to the Company that such Shares are being acquired by him or her for investment for his or her own account and not with a view to, for resale in connection with, or with an intent of participating directly or indirectly in, any distribution of such Shares within the meaning of the Act, and a legend to that effect may be placed on the certificates representing the Shares. (b) Other Jurisdictions. To facilitate the making of any grant of an Award under this Plan, the Committee may provide for such special terms for Awards to Participants who are foreign nationals or who are employed by the Company or any Affiliate outside of the United States of America as the Committee may consider necessary or appropriate to accommodate differences in local law, tax policy or custom. The Company may adopt rules and procedures relating to the operation and administration of this Plan to accommodate the specific requirements of local laws and procedures of particular countries. Without limiting the 19 foregoing, the Company is specifically authorized to adopt rules and procedures regarding the conversion of local currency, taxes, withholding procedures and handling of stock certificates which vary with the customs and requirements of particular countries. The Company may adopt sub-plans applicable to particular locations and countries. 23. No Shareholder Rights. Neither a Participant nor any transferee of a Participant shall have any rights as a shareholder of the Company with respect to any Shares underlying any Award until the date of issuance of a share certificate to a Participant or a transferee of a Participant for such Shares in accordance with the Company's governing instruments and Applicable Law. Prior to the issuance of Shares pursuant to an Award, a Participant shall not have the right to vote or to receive dividends or any other rights as a shareholder with respect to the Shares underlying the Award, notwithstanding its exercise in the case of Options and SARs. No adjustment will be made for a dividend or other right that is determined based on a record date prior to the date the stock certificate is issued, except as otherwise specifically provided for in this Plan. 24. No Employment Rights. The Plan shall not confer upon any Participant any right to continue an employment, service or consulting relationship with the Company, nor shall it affect in any way a Participant's right or the Company's right to terminate the Participant's employment, service, or consulting relationship at any time, with or without Cause. 20 CAPITAL TRUST, INC. 2004 LONG-TERM INCENTIVE PLAN __________ Appendix A: Definitions __________ As used in the Plan, the following definitions shall apply: "Affiliate" means, with respect to any Person (as defined below), any other Person that directly or indirectly controls or is controlled by or under common control with such Person. For the purposes of this definition, "control," when used with respect to any Person, means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of such Person or the power to elect directors, whether through the ownership of voting securities, by contract or otherwise; and the terms "affiliated," "controlling" and "controlled" have meanings correlative to the foregoing. "Applicable Law" means the legal requirements relating to the administration of options and share-based plans under applicable U.S. federal and state laws, the Code, any applicable stock exchange or automated quotation system rules or regulations, and the applicable laws of any other country or jurisdiction where Awards are granted, as such laws, rules, regulations and requirements shall be in place from time to time. "Award" means any award made pursuant to the Plan, including awards made in the form of an Option, an SAR, a Restricted Share, an Unrestricted Share, a Restricted Share Unit, a Deferred Share Unit and a Performance Award, or any combination thereof, whether alternative or cumulative, authorized by and granted under this Plan. "Award Agreement" means any written document setting forth the terms of an Award that has been authorized by the Committee. The Committee shall determine the form or forms of documents to be used, and may change them from time to time for any reason. "Board" means the Board of Directors of the Company. "Cause" for termination of a Participant's Continuous Service will exist if the Participant is terminated from employment or other service with the Company or an Affiliate for any of the following reasons: (i) the Participant's conviction of a felony committed in connection with his or her employment or service with the Company, (ii) the Participant's willful and failure to substantially perform his or her duties and responsibilities to the Company or deliberate violation of a material Company policy; (iii) the Participant's commission of any material act or acts of fraud, embezzlement, dishonesty, or other willful misconduct; (v) the Participant's material unauthorized use or disclosure of any proprietary information or trade secrets of the Company or any other party to whom the Participant owes an obligation of nondisclosure as a result of his or 21 her relationship with the Company; or (v) Participant's willful and material breach of any of his or her obligations under any written agreement or covenant with the Company. The Committee shall in its discretion determine whether or not a Participant is being terminated for Cause. The Committee's determination shall, unless arbitrary and capricious, be final and binding on the Participant, the Company, and all other affected Persons. The foregoing definition does not in any way limit the Company's ability to terminate a Participant's employment or consulting relationship at any time, and the term "Company" will be interpreted herein to include any Affiliate or successor thereto, if appropriate. "Change in Control" means any of the following: (a) Approval by the shareholders of the Company of the dissolution or liquidation of the Company; (b) Approval by the shareholders of the Company of an agreement to merge or consolidate, or otherwise reorganize, with or into one or more entities that are not Affiliates, as a result of which less than 50% of the outstanding voting securities of the surviving or resulting entity immediately after such transaction are, or will be, owned, directly or indirectly, by shareholders of the Company immediately before such transaction (assuming for purposes of such determination that there is no change in the record ownership of the Company's securities from the record date for such approval until such transaction and that such record owners hold no securities of the other parties to such reorganization), but including in such determination any securities of the other parties to such transaction held by Affiliates of the Company); (c) Approval by the shareholders of the Company of the sale of substantially all of the Company's business and/or assets to a Person or entity that is not an Affiliate of the Company; (d) Any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act but excluding any Person described in and satisfying the conditions of Rule 13d-1(b)(1) thereunder), other than a Person that is a shareholder of the Company on the Effective Date or a trustee or a fiduciary holding securities under an employee benefit plan of the Company or any of its subsidiaries or an entity owned directly or indirectly by the shareholders of the Company in substantially the same proportion as their ownership of the stock of the Company, becomes the beneficial owner (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing more than 33% of the combined voting power of the Company's then outstanding securities entitled to then vote generally in the election of directors of the Company other than as a result of the acquisition of securities directly from the Company; or (e) During any period not longer than two consecutive years, individuals who at the beginning of such period constituted the Board cease to constitute at least a majority thereof, unless the election, or the nomination for election by the Company's shareholders, of each new Board member was approved by a vote of at least three-fourths of the Board members then still 22 in office who were Board members at the beginning of such period (including for these purposes, new members whose election or nomination was so approved). "Code" means the U.S. Internal Revenue Code of 1986, as amended. "Committee" means one or more committees or subcommittees of the Board appointed by the Board to administer the Plan in accordance with Section 4 above. With respect to any decision involving an Award intended to satisfy the requirements of Section 162(m) of the Code, the Committee shall consist solely of two or more Directors of the Company who are "outside directors" within the meaning of Section 162(m) of the Code. "Company" means Capital Trust, Inc., a Maryland corporation. "Consultant" means any natural person, including an advisor, who is engaged by the Company or any Affiliate to render services and is compensated for such services. "Continuous Service" means the absence of any interruption or termination of service as an Employee, Director, or Consultant. Continuous Service shall not be considered interrupted in the case of: (i) sick leave; (ii) military leave; (iii) any other leave of absence approved by the Committee, provided that such leave is for a period of not more than 90 days, unless reemployment upon the expiration of such leave is guaranteed by contract or statute, or unless provided otherwise pursuant to Company policy adopted from time to time; (iv) changes in status from Director to advisory director or emeritus status; or (iv) in the case of transfers between locations of the Company or between the Company, its Affiliates or their respective successors. Changes in status between service as an Employee, Director, and a Consultant will not constitute an interruption of Continuous Service. "Deferred Share Units" mean Awards pursuant to Section 9 of the Plan. "Director" means a member of the Board, or a member of the board of directors of an Affiliate. "Eligible Person" means any Consultant, Director or Employee and includes non-Employees to whom an offer of employment has been extended. "Employee" means any natural person whom the Company or any Affiliate classifies as an employee (including an officer) for employment tax purposes. The payment by the Company of a director's fee to a Director shall not be sufficient to constitute "employment" of such Director by the Company. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Fair Market Value" means, as of any date (the "Determination Date") means: (i) the closing price of a Share on the New York Stock Exchange or the American Stock Exchange (collectively, the "Exchange"), on the Determination Date, or, if shares were not traded on the Determination Date, then on the nearest preceding trading day during which a sale occurred; or (ii) if such stock is not traded on the Exchange but is quoted on NASDAQ or a successor quotation system, (A) the last sales price (if the stock is then listed as a National Market Issue 23 under The Nasdaq National Market System) or (B) the mean between the closing representative bid and asked prices (in all other cases) for the stock on the Determination Date as reported by NASDAQ or such successor quotation system; or (iii) if such stock is not traded on the Exchange or quoted on NASDAQ but is otherwise traded in the over-the-counter, the mean between the representative bid and asked prices on the Determination Date; or (iv) if subsections (i)-(iii) do not apply, the fair market value established in good faith by the Board. "Grant Date" has the meaning set forth in Section 14 of the Plan. "Incentive Share Option or ISO" hereinafter means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code, as designated in the applicable Award Agreement. "Involuntary Termination" means termination of a Participant's Continuous Service under the following circumstances occurring on or after a Change in Control: (i) termination without Cause by the Company or an Affiliate or successor thereto, as appropriate; or (ii) voluntary termination by the Participant within 60 days following (A) a material reduction in the Participant's job responsibilities, provided that neither a mere change in title alone nor reassignment to a substantially similar position shall constitute a material reduction in job responsibilities; (B) an involuntary relocation of the Participant's work site to a facility or location more than 50 miles from the Participant's principal work site at the time of the Change in Control; or (C) a material reduction in Participant's total compensation other than as part of an reduction by the same percentage amount in the compensation of all other similarly-situated Employees, Directors or Consultants. "Non-ISO" means an Option not intended to qualify as an ISO, as designated in the applicable Award Agreement. "Option" means any stock option granted pursuant to Section 6 of the Plan. "Participant" means any holder of one or more Awards, or the Shares issuable or issued upon exercise of such Awards, under the Plan. "Performance Awards" mean Performance Units and Performance Compensation Awards granted pursuant to Section 10. "Performance Compensation Awards" mean Awards granted pursuant to Section 10(b) of the Plan. "Performance Unit" means Awards granted pursuant to Section 10(a) of the Plan which may be paid in cash, in Shares, or such combination of cash and Shares as the Committee in its sole discretion shall determine. "Person" means any natural person, association, trust, business trust, cooperative, corporation, general partnership, joint venture, joint-stock company, limited partnership, limited liability company, real estate investment trust, regulatory body, governmental agency or instrumentality, unincorporated organization or organizational entity. 24 "Plan" means this Capital Trust, Inc. 2004 Long-term Incentive Plan. "Reporting Person" means an officer, Director, or greater than ten percent shareholder of the Company within the meaning of Rule 16a-2 under the Exchange Act, who is required to file reports pursuant to Rule 16a-3 under the Exchange Act. "Restricted Shares" mean Shares subject to restrictions imposed pursuant to Section 8 of the Plan. "Restricted Share Units" mean Awards designated as such pursuant to Section 8 of the Plan. "Rule 16b-3" means Rule 16b-3 promulgated under the Exchange Act, as amended from time to time, or any successor provision. "SAR" or "Share Appreciation Right" means Awards granted pursuant to Section 7 of the Plan. "Share" means a share of class A common stock, par value $0.01 per share, of the Company, as adjusted or substituted in accordance with Section 13 of the Plan. "Ten Percent Holder" means a Person who owns stock representing more than ten percent (10%) of the combined voting power of all classes of stock of the Company or any Affiliate. "Unrestricted Shares" mean Awards designated as such pursuant to Section 8 of the Plan. 25 CAPITAL TRUST, INC. 2004 LONG-TERM INCENTIVE PLAN As approved by the Board of Directors on May 6, 2004 and by the shareholders on June 17, 2004 EX-31 5 ex31-1.txt EX. 31.1: CEO SECTION 302 CERTIFICATION Exhibit 31.1 CERTIFICATION PURSUANT TO 17 CFR 240.13a-14 PROMULGATED UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, John R. Klopp, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Capital Trust, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 16, 2004 /s/ John R. Klopp ----------------- John R. Klopp Chief Executive Officer EX-31 6 ex31-2.txt EX. 31.2: CFO SECTION 302 CERTIFICATION Exhibit 31.2 CERTIFICATION PURSUANT TO 17 CFR 240.13a-14 PROMULGATED UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Brian H. Oswald, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Capital Trust, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 16, 2004 /s/ Brian H. Oswald ------------------- Brian H. Oswald Chief Financial Officer EX-32 7 ex32-1.txt EX. 32.1: CEO SECTION 906 CERTIFICATION Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Capital Trust, Inc. (the "Company") on Form 10-Q for the period ending June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, John R. Klopp, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ John R. Klopp ----------------- John R. Klopp Chief Executive Officer August 16, 2004 EX-32 8 ex32-2.txt EX. 32.1: CFO SECTION 906 CERTIFICATION Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Capital Trust, Inc. (the "Company") on Form 10-Q for the period ending June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Brian H. Oswald, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Brian H. Oswald - ------------------- Brian H. Oswald Chief Financial Officer August 16, 2004 EX-99 9 ex99-1.txt EX. 99.1 - FORWARD LOOKING INFO & RISK FACTORS EXHIBIT 99.1 FORWARD-LOOKING INFORMATION AND RISK FACTORS Our Annual Report on Form l0-K for the year ended December 31, 2003, our 2003 Annual Report to Shareholders, any of our Quarterly Reports on Form 10-Q or Current Reports on Form 8-K of the Company, or any other oral or written statements made in press releases or otherwise by or on behalf of Capital Trust, may contain forward-looking statements within the meaning of the Section 21E of the Securities and Exchange Act of 1934, as amended, which involve certain risks and uncertainties. Forward-looking statements predict or describe our future operations, our business plans, our business and investment strategies and portfolio management and the performance of our investments and funds under management. These forward-looking statements are identified by their use of such terms and phrases as "intends," "intend," "intended," "goal," "estimate," "estimates," "expects," "expect," "expected," "project," "projected," "projections," "plans," "seeks," "anticipates," "anticipated," "should," "could," "may," "will," "designed to," "foreseeable future," "believe," "believes" and "scheduled" and similar expressions. Our actual results or outcomes may differ materially from those anticipated. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Our actual results may differ significantly from any results expressed or implied by these forward-looking statements. Some, but not all, of the factors that might cause such a difference include, but are not limited to: o the general political, economic and competitive conditions, in the United States; o the level and volatility of prevailing interest rates and credit spreads, adverse changes in general economic conditions and real estate markets, the deterioration of credit quality of borrowers and the risks associated with the ownership and operation of real estate; o a significant compression of the spreads of the interest rates earned on interest-earning assets over the interest rates paid on interest-bearing liabilities that adversely affects operating results; o adverse developments in the availability of desirable loan and investment opportunities and the ability to obtain and maintain targeted levels of leverage and borrowing costs; o adverse changes in local market conditions, competition, increases in operating expenses and uninsured losses affecting a property owner's ability to cover operating expenses and the debt service on financing provided by us; o authoritative generally accepted accounting principles or policy changes from such standard-setting bodies as the Financial Accounting Standards Board and the Securities and Exchange Commission; and o the risk factors set forth below. Risks Related to Our Investment Program Our existing loans and investments expose us to a high degree of risk associated with investing in commercial real estate-related assets. Real estate historically has experienced significant fluctuations and cycles in performance that may result in reductions in the value of our real estate-related investments. The performance and value of our loans and investments once originated or acquired by us depends on many factors beyond our control. The ultimate performance and value of our investments is subject to the varying degrees of risk generally incident to the ownership and operation of the commercial properties which collateralize or support our investments. The ultimate performance and value of our loans and investments depends upon the commercial property owner's ability to operate the property so that it produces cash flows needed to pay the interest and principal due to us on our loans and investments. Revenues and cash flows may be adversely affected by: o changes in national economic conditions; o changes in local real estate market conditions due to changes in national or local economic conditions or changes in local property market characteristics; o competition from other properties offering the same or similar services; o changes in interest rates and in the availability of mortgage financing; o the ongoing need for capital improvements, particularly in older structures; o changes in real estate tax rates and other operating expenses; o adverse changes in governmental rules and fiscal policies, civil unrest, acts of God, including earthquakes, hurricanes and other natural disasters, acts of war or terrorism, which may decrease the availability of or increase the cost of insurance or result in uninsured losses; o adverse changes in zoning laws; o the impact of present or future environmental legislation and compliance with environmental laws; and o other factors that are beyond our control and the control of the commercial property owners. In the event that any of the properties underlying our loans or investments experiences any of the foregoing events or occurrences, the value of, and return on, such investments, our profitability and the market price of our class A common stock would be negatively impacted. We may change our investment strategy without shareholder consent which may result in riskier investments than our current investments. As part of our strategy, we may seek to expand our investment activities beyond real estate-related investments. We may change our investment activities at any time without the consent of our shareholders, which could result in our making investments that are different from, and possibly riskier than, our current real estate investments. New investments we may make outside of our area of expertise may not perform as well as our current portfolio of real estate investments. We are exposed to the risks involved with making subordinated investments. Our investments involve the risks attendant to investments consisting of subordinated loan positions. In many cases, management of our investments and our remedies with respect thereto, including the ability to foreclose on or direct decisions with respect to the collateral securing such investments, is subject to the rights of senior lenders and the rights set forth in inter-creditor or servicing agreements. We may not be able to obtain the level of leverage necessary to optimize our return on investment. Our return on investment depends, in part, upon our ability to grow our balance sheet portfolio of invested assets and those of our funds through the use of leverage at interest rates that are lower than the interest rates earned on our investments. We generally obtain leverage through bank credit facilities, repurchase agreements and other borrowings. Our ability to obtain the necessary leverage on attractive terms ultimately depends upon the quality of the portfolio assets that are being pledged and our ability to maintain interest coverage ratios meeting prevailing market underwriting standards which vary according to lenders' assessments of our and our funds' creditworthiness and the terms of the borrowings. Our failure to obtain and/or maintain leverage at desired levels, or to obtain leverage on attractive terms, could have a material adverse effect on our performance or that of our funds. Moreover, we are dependent upon a few lenders to provide the primary credit facilities for our origination or acquisition of loans and investments. Our ability to obtain financing through collateralized debt obligations is subject to conditions in the debt capital markets, which may be adverse from time to time, that affect the level of investor demand for such securities, which are impacted by factors beyond our control. -2- We are subject to the risks of holding leveraged investments. Leverage creates an opportunity for increased return on equity, but at the same time creates other risks. For example, leveraging magnifies changes in the net worth of our funds. We and our funds will leverage assets only when there is an expectation that leverage will enhance returns, although we cannot assure you that the use of leverage will prove to be beneficial. Increases in credit spreads in the market generally may adversely affect the market value of our investments. Because borrowings under our credit facilities are secured by our investments, the borrowings available to us may decline if the market value of our investments decline. Moreover, we cannot assure you that we and our funds will be able to meet debt service obligations and, to the extent such obligations are not met, there is a risk of loss of some or all of our and their assets through foreclosure or a financial loss if we or they are required to liquidate assets at a commercially inopportune time to satisfy our debt obligations. Our success depends on the availability of attractive investments and our ability to identify, structure, consummate, manage and realize returns on attractive investments. Our operating results are dependent upon the availability of, as well as our ability to identify, structure, consummate, manage and realize returns on, credit-sensitive investment opportunities. In general, the availability of desirable credit sensitive investment opportunities and, consequently, our balance sheet returns and our funds' investment returns, will be affected by the level and volatility of interest rates, by conditions in the financial markets, by general economic conditions, by the market and demand for credit-sensitive investment opportunities, and by the supply of capital for such investment opportunities. We cannot assure you that we will be successful in identifying and consummating investments which satisfy our rate of return objectives or that such investments, once consummated, will perform as anticipated. In addition, notwithstanding the fact that we earn base management fees based upon committed capital during the investment period, if we are not successful in investing all available equity capital for our funds, the potential revenues we earn, including base management fees that are charged on the amount of invested assets after the investment period and incentive management fees, will be reduced. We may expend significant time and resources in identifying and pursuing targeted investments, some of which may not be consummated. The real estate investment business is highly competitive. Our success depends on our ability to compete with other providers of capital for real estate investments. Our business is highly competitive. We compete for attractive investments with traditional lending sources, such as insurance companies and banks, as well as other REITs, specialty finance companies and private equity funds with similar investment objectives, which may make it more difficult for us to consummate our target investments. Many of our competitors have greater financial resources than us, which provides them with greater operating flexibility. Our loans and investments may be subject to fluctuations in interest rates which may not be adequately protected, or protected at all, by our hedging strategies. Our current balance sheet investment program emphasizes loans with "floating" interest rates to protect against fluctuations in interest rates. We do, however, from time to time make fixed rate loans and purchase fixed rate securities, which are subject to the risk of fluctuations in interest rates. Depending on market conditions, fixed rate assets may become a greater portion of our new loan originations. In such cases, we may employ various hedging strategies to limit the effects of changes in interest rates, including engaging in interest rate swaps, caps, floors and other interest rate derivative products. No strategy can completely insulate us or our funds from the risks associated with interest rate changes and there is a risk that they may provide no protection at all. Hedging transactions involve certain additional risks such as counterparty risk, the legal enforceability of hedging contracts, the early repayment of hedged transactions and the risk that unanticipated and significant changes in interest rates may cause a significant loss of basis in the contract and a change in current period expense. We cannot assure you that we will be able to enter into hedging transactions or that such hedging transactions will adequately protect us or our funds against the foregoing risks. In addition, cash flow hedges which are not perfectly correlated with a variable rate financing will impact our reported income as gains, and losses on the ineffective portion of such hedges will be recorded. -3- Our loans and investments may be illiquid which will constrain our ability to vary our portfolio of investments. Our real estate investments are relatively illiquid. Such illiquidity may limit our ability to vary our portfolio or our funds' portfolios of investments in response to changes in economic and other conditions. Illiquidity may result from the absence of an established market for investments as well as the legal or contractual restrictions on their resale. In addition, illiquidity may result from the decline in value of a property securing one of our or our funds' investments. We cannot assure you that the fair market value of any of the real property serving as security will not decrease in the future, leaving our or our funds' investments under-collateralized or not collateralized at all, which could impair the liquidity and value, as well as our return on such investments. We may not have control over certain of our loans and investments. Our ability to manage our portfolio of loans and investments may be limited by the form in which they are made. In certain situations, we or our funds may: o acquire investments subject to rights of senior classes and servicers under inter-creditor or servicing agreements; o acquire only a participation in an underlying investment; o co-invest with third parties through partnerships, joint ventures or other entities, thereby acquiring non-controlling interests; or o rely on independent third party management or strategic partners with respect to the management of an asset. Therefore, we may not be able to exercise control over the loan or investment. Such financial assets may involve risks not present in investments where senior creditors, servicers or third party controlling investors are not involved. Our rights to control the process following a borrower default may be subject to the rights of senior creditors or servicers whose interests may not be aligned with ours. A third party partner or co-venturer may have financial difficulties resulting in a negative impact on such asset, may have economic or business interests or goals which are inconsistent with ours and those of our funds, or may be in a position to take action contrary to our or our funds' investment objectives. In addition, we and our funds may, in certain circumstances, be liable for the actions of our third party partners or co-venturers. We may not achieve our targeted rate of return on our investments. We originate or acquire investments based on our estimates or projections of overall rates of return on such investments, which in turn are based on, among other considerations, assumptions regarding the performance of assets, the amount and terms of available financing to obtain desired leverage and the manner and timing of dispositions, including possible asset recovery and remediation strategies, all of which are subject to significant uncertainty. In addition, events or conditions that we have not anticipated may occur and may have a significant effect on the actual rate of return received on an investment. We are currently experiencing a low interest rate environment which negatively impacts our ability to originate or acquire investments that produce rates of returns similar to existing investments that were added to our portfolio during a higher interest rate environment. As we acquire or originate investments for our balance sheet portfolio, whether as new additions or as replacements for maturing investments, there can be no assurance that we will be able to originate or acquire investments that produce rates of return comparable to rates on our existing investments. The commercial mortgage and mezzanine loans we originate or acquire and the commercial mortgage loans underlying the CMBS in which we invest are subject to delinquency, foreclosure and loss, which could result in losses to us. Our commercial mortgage and mezzanine loans are secured by commercial property and are subject to risks of delinquency and foreclosure, and risks of loss that are greater than similar risks associated with loans made on the -4- security of single-family residential property. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of the property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower's ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by, among other things: tenant mix, success of tenant businesses, property management decisions, property location and condition, competition from comparable types of properties, changes in laws that increase operating expenses or limit rents that may be charged; any need to address environmental contamination at the property; changes in national, regional or local economic conditions and/or specific industry segments; declines in regional or local real estate values and declines in regional or local rental or occupancy rates; increases in interest rates, real estate tax rates and other operating expenses; and changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest and civil disturbances. Our investments in subordinated CMBS are subject to losses. In general, losses on an asset securing a mortgage loan included in a securitization will be borne first by the equity holder of the property, then by a cash reserve fund or letter of credit, if any, and then by the most junior security holder. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit and any classes of securities junior to those in which we invest, we may not be able to recover all of our investment in the securities we purchase. In addition, if the underlying mortgage portfolio has been overvalued by the originator, or if the values subsequently decline and, as a result, less collateral is available to satisfy interest and principal payments due on the related mortgage-backed securities, the securities in which we invest may incur significant losses. The prices of lower credit quality securities are generally less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns and underlying borrower developments. A projection of an economic downturn, for example, could cause a decline in the price of lower credit quality securities because the ability of borrowers of the mortgages underlying the mortgage-backed securities to make principal and interest payments may be impaired. In such event, existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these securities. We may experience significant reductions in net income if the impairments on our CMBS investments are deemed to be "other-than-temporary". The current fair value of certain of our CMBS investments is less than their recorded amortized cost. Since our CMBS investments are accounted for as available-for-sale securities, we have reduced our shareholders equity by an amount equal to the difference between the amortized cost and the fair value by taking a charge to other comprehensive income. As of June 30, 2004, these unrealized losses totaled $35.9 million. Under generally accepted accounting principles, if there are significant changes in the future to the expected cash flows from a particular investment due to prepayment or credit loss experience, the investment will have incurred an other-than-temporary impairment. If that occurs, we will be required to write down the investment to its fair value and take a charge to income equal to the unrealized loss, recognizing an offsetting increase to other comprehensive income with equity remaining unchanged. If we recognize other-than-temporary impairments on our CMBS investments that have experienced significant reductions in fair value, the resulting write-downs could result in significant reductions of our net income for the period in which the other-than-temporary impairment is recognized. We may invest in troubled assets that are subject to a higher degree of financial risk. We may make investments in non-performing or other troubled assets that involve a higher degree of financial risk. We cannot assure you that our investment objectives will be realized or that there will be any return on our investment. Furthermore, investments in properties subject to work-out conditions or under bankruptcy protection laws may, in certain circumstances, be subject to additional potential liabilities that could exceed the value of our original investment, including equitable subordination and/or disallowance of claims or lender liability. We may not be able to acquire eligible investments for a collateralized debt obligation issuance, or may not be able to issue collateralized debt obligation securities on attractive terms, which may require us to utilize more costly financing for our investments. -5- We intend to capitalize on opportunities to finance certain of our investments on a non-recourse, long-term basis, such as through the issuance of collateralized debt obligations. During the period that we are acquiring these investments, we intend to finance our purchases through our credit and repurchase obligation facilities. We use these facilities to finance our acquisition of investments until we have accumulated a sufficient quantity of investments, at which time we may refinance these lines through a securitization, such as a collateralized debt obligation issuance, or other types of long-term financing. As a result, we are subject to the risk that we will not be able to acquire a sufficient amount of eligible investments to maximize the efficiency of a collateralized debt obligation issuance. In addition, conditions in the capital markets may make the issuance of collateralized debt obligations less attractive to us when we do have a sufficient pool of collateral. If we are unable to issue a collateralized debt obligation to finance these investments, we may be required to utilize other forms of potentially less attractive financing. We may not be able to find suitable replacement investments in collateralized debt obligations with reinvestment periods. Some collateralized debt obligations have periods where principal proceeds received from assets securing the collateralized debt obligation can be reinvested for a defined period of time, commonly referred to as a reinvestment period. Our ability to find suitable investments during the reinvestment period that meet the criteria set forth in the collateralized debt obligation documentation and by rating agencies may determine the success of our collateralized debt obligation investments. Our potential inability to find suitable investments may cause, among other things, interest deficiencies, hyper-amortization of the senior collateralized debt obligation liabilities and may cause us to reduce the life of our collateralized debt obligations and accelerate the amortization of certain fees and expenses. The use of collateralized debt obligation financings with over-collateralization and interest coverage requirements may have a negative impact on our cash flow. The terms of collateralized debt obligations will generally provide that the principal amount of investments must exceed the principal balance of the related bonds by a certain amount and that interest income exceeds interest expense by a certain amount. We anticipate that the collateralized debt obligation terms will provide that, if certain delinquencies and/or losses or other factors cause a decline in collateral or cash flow levels, the cash flow otherwise payable on our investment may be redirected to repay classes of CDOs senior to ours until the issuer or the collateral is in compliance with the terms of the governing documents. Other tests (based on delinquency levels or other criteria) may restrict our ability to receive net income from assets pledged to secure collateralized debt obligations. We cannot assure you that the performance tests will be satisfied. Nor can we assure you, in advance of completing negotiations with the rating agencies or other key transaction parties as to the actual terms of the delinquency tests, over-collateralization and interest coverage terms, cash flow release mechanisms or other significant factors upon which net income to us will be calculated. Failure to obtain favorable terms with regard to these matters may adversely affect the availability of net income to us. If our investments fail to perform as anticipated, our over-collateralization, interest coverage or other credit enhancement expense associated with our collateralized debt obligation financings will increase. We may be required to repurchase loans that we have sold or to indemnify holders of our collateralized debt obligations. If any of the loans we originate or acquire and sell or securitize through collateralized debt obligations do not comply with representations and warranties that we make about certain characteristics of the loans, the borrowers and the underlying properties, we may be required to repurchase those loans or replace them with substitute loans. In addition, in the case of loans that we have sold instead of retained, we may be required to indemnify persons for losses or expenses incurred as a result of a breach of a representation or warranty. Repurchased loans typically require a significant allocation of working capital to carry on our books, and our ability to borrow against such assets is limited. Any significant repurchases or indemnification payments could adversely affect our financial condition and operating results. -6- The impact of the events of September 11, 2001 and the resulting effect on terrorism insurance expose us to certain risks. The terrorist attacks on September 11, 2001 disrupted the U.S. financial markets, including the real estate capital markets, and negatively impacted the U.S. economy in general. Any future terrorist attacks, the anticipation of any such attacks, and the consequences of any military or other response by the U.S. and its allies may have a further adverse impact on the U.S. financial markets and the economy generally. We cannot predict the severity of the effect that such future events would have on the U.S. financial markets, the economy or our business. In addition, the events of September 11 created significant uncertainty regarding the ability of real estate owners of high profile assets to obtain insurance coverage protecting against terrorist attacks at commercially reasonable rates, if at all. With the enactment of the Terrorism Risk Insurance Act of 2002, insurers must make terrorism insurance available under their property and casualty insurance policies through the end of 2004, which may be extended by the Secretary of the Treasury through the end of 2005, but this legislation does not regulate the pricing of such insurance. The absence of affordable insurance coverage may adversely affect the general real estate lending market, lending volume and the market's overall liquidity and may reduce the number of suitable investment opportunities available to us and the pace at which we are able to make investments. If the properties that we invest in are unable to obtain affordable insurance coverage, the value of those investments could decline and in the event of an uninsured loss, we could lose all or a portion of our investment. The economic impact of any future terrorist attacks could also adversely affect the credit quality of some of our loans and investments. Some of our loans and investments will be more susceptible to the adverse effects than others, such as hotel loans, which may experience a significant reduction in occupancy rates following any future attacks. We may suffer losses as a result of the adverse impact of any future attacks and these losses may adversely impact our results of operation. Risks Related to Our Investment Management Business Because we commenced our investment management business in 2000, we are subject to risks and uncertainties associated with developing and operating a new business, and we may not achieve from this new business the investment returns that we expect. Our investment management business commenced in 2000 and, therefore, has a limited track record of proven results upon which to predict our future performance. We will encounter risks and difficulties as we proceed to develop and operate our investment management business. In order to achieve our goals as an investment manager, we must: o manage our funds successfully by investing a majority of our funds' capital in suitable investments that meet the funds' specified investment criteria; o actively manage the assets in our portfolios in order to realize targeted performance; o incentivize our management and professional staff to the task of developing and operating the investment management business; and o structure, sponsor and capitalize future funds and other investment products under our management that provide investors with attractive investment opportunities. If we do not successfully develop and operate our investment management business to achieve the investment returns that we or the market anticipates, the market price of our class A common stock could decline. We may pursue fund management opportunities related to other classes of investments where we do not have prior investment experience. We may expand our fund management business to the management of private equity funds involving other investment classes where we do not have prior investment experience. We may find it difficult to attract third party investors without a performance track record involving such investments. Even if we attract third party investment, -7- there can be no assurance that we will be successful in deploying the capital to achieve targeted returns on the investments. We face substantial competition from established participants in the private equity market as we offer mezzanine and other funds to third party investors. We face significant competition from large financial and other institutions that have proven track records in marketing and managing private equity investment funds and otherwise have a competitive advantage over us because they have access to pre-existing third party investor networks into which they can channel competing investment opportunities. If our competitors offer investment products that are competitive with the mezzanine and other fund investments offered by us, we will find it more difficult to attract investors and to capitalize our mezzanine and other funds. Our funds are subject to the risk of defaults by third party investors on their capital commitments. The capital commitments made by third party investors to our funds represent unsecured promises by those investors to contribute cash to the funds from time to time as investments are made by the funds. Accordingly, we are subject to general credit risks that the investors may default on their capital commitments. If defaults occur, we may not be able to close loans and investments we have identified and negotiated, which could materially and adversely affect the funds' investment program or make us liable for breach of contract, in either case to the detriment of our franchise in the private equity market. Risks Related to Our Company We are dependent upon our senior management team to develop and operate our business. Our ability to develop and operate our business depends to a substantial extent on the experience, relationships and expertise of our senior management and key employees. We cannot assure you that these individuals will remain in our employ. The employment agreement with our chief executive officer, John R. Klopp, expires on December 31, 2008, unless further extended. The loss of the services of our senior management and key employees could have a material adverse effect on our operations. There may be conflicts between the interests of our investment funds and us. We are subject to a number of potential conflicts between our interests and the interests of our managed investment funds. Although we have agreed to offer Fund III the first opportunity to invest in investment opportunities which have characteristics and projected leveraged returns which meet Fund III's investment and return objectives, we are subject to potential conflicts of interest in the allocation of investment opportunities between our balance sheet and our managed funds. In addition, we may make investments that are senior or junior to, participations in, or have rights and interests different from or adverse to, the investments made by our managed funds. Our interests in such investments may conflict with the interests of our managed funds in related investments at the time of origination or in the event of a default or restructuring of the investment. In the event a default occurs with respect to such an investment, the directors of Fund III appointed by us have agreed to recuse themselves from any vote of the board of Fund III concerning such investment and our co-sponsor's controlled advisor to Fund III will assume and perform our asset management responsibility with respect to such investment. Finally, our officers and employees may have conflicts in allocating their time and services among us and our managed funds. Our balance sheet portfolio continues to have concentrations in mark-to-market mortgage-backed securities which subjects us to greater variations in equity and income as we record balance sheet gains and losses on such assets. Our venture agreement with affiliates of Citigroup Alternative Investments, LLC placed restrictions on our ability to originate new mezzanine loan investments for our balance sheet during the investment period for Fund II which resulted in our balance sheet portfolio becoming more concentrated in longer term fixed rate mortgage-backed securities that had been originated prior to 2000. We have adopted accounting policies under which such securities are recorded as available-for-sale and changes in the market value will impact either or both shareholders' -8- equity or net income depending on the characterization of the change in market value. If a reduction in market value is deemed to be other than temporary, generally due to a change in the credit risk, the reduction in value will be recorded as a reduction of net income. If any of the available-for-sale securities are sold, the resulting gain or loss will be recorded through the income statement. All other changes in market value will impact shareholders equity only. While the restrictions on our balance sheet investment activities diminished when the investment period for Fund II ended and we have begun making new investments for our own account, there can be no assurance that the concentration in mark-to-market mortgage-backed securities will be reduced in the near term through new originations. In an environment of relatively low interest rates, there is also a higher risk that our existing non-mark-to-market loans will pay off early. To the extent our balance sheet remains concentrated in mark-to-market assets, we will remain subject to potential swings in equity and income as we record gains and losses on such assets on our balance sheet. If interest rates fluctuate and significantly affect the market value of such mark-to-market assets, the corresponding reductions or increases in our equity and income may be significant. We must manage our portfolio in a manner that allows us to rely on an exclusion from registration under the Investment Company Act of 1940 in order to avoid the consequences of regulation under that Act. We rely on an exclusion from registration as an investment company afforded by Section 3(c)(5)(C) of the Investment Company Act of 1940. Under this exclusion, we are required to maintain, on the basis of positions taken by the SEC staff in interpretive and no-action letters, a minimum of 55% of the value of the total assets of our portfolio in "mortgages and other liens on and interests in real estate." We refer to this category of investments herein as "Qualifying Interests." In addition, we must maintain an additional minimum of 25% of the value of our total assets in Qualifying Interests or other real estate-related assets. Because registration as an investment company would significantly affect our ability to engage in certain transactions or to organize ourselves in the manner we are currently organized, we intend to maintain our qualification for this exclusion from registration. In the past, when required due to the mix of assets in our balance sheet portfolio, we have purchased pools of whole loan residential mortgage-backed securities that we treat as Qualifying Interests based on SEC staff positions. Investments in such pools of whole loan residential mortgage-backed securities may not represent an optimum use of our investable capital when compared to the available investments we target pursuant to our investment strategy. We continue to analyze our investments and may acquire other pools of whole loan mortgage-backed securities when and if required for compliance purposes. In addition, certain of our investments in subordinated CMBS have terms which we believe allows them to be categorized as Qualifying Interests, including rights to cure any defaults on senior CMBS classes, rights to acquire such senior classes in the event of a default or special servicing rights to service defaulted mortgage loans, including rights to control the oversight and management of the resolution of such mortgage loans by workout or modification of loan provisions, foreclosure, deed in lieu of foreclosure or otherwise, and to control decisions with respect to the preservation of the collateral generally, including property management and maintenance decisions. We have not obtained an exemptive order or a no-action letter or other form of interpretive guidance from the SEC or its staff supporting our position, and, therefore, any decision by the SEC or its staff which advances a position to the contrary would require us to no longer treat these investments in subordinated CMBS as Qualifying Interests. If our portfolio does not comply with the requirements of the exclusion we rely upon, we could be forced to alter our portfolio by selling or otherwise disposing of a substantial portion of the assets that are not Qualifying Interests or by acquiring a significant position in assets that are Qualifying Interests. Altering our portfolio in this manner may have a material adverse effect on our investments if we are forced to dispose of or acquire assets in an unfavorable market. We may expand our franchise through business acquisitions and the recruitment of financial professionals, which may present additional costs and other challenges and may not prove successful. Our business plan contemplates expansion of our franchise into complementary investment strategies involving other credit-sensitive structured financial products. We may undertake such expansion through business acquisitions or the recruitment of financial professionals with experience in other products. We may also expend a substantial amount of time and capital pursuing opportunities to expand into complementary investment strategies that we do not consummate. The expansion of our operations could place a significant strain on our management, -9- financial and other resources. Our ability to manage future expansion will depend upon our ability to monitor operations, maintain effective quality controls and significantly expand our internal management and technical and accounting systems, all of which could result in higher operating expenses and could adversely affect our current business, financial condition and results of operations. We cannot assure you that we will be able to identify and integrate businesses or professional teams we acquire to pursue complementary investment strategies and expand our business. Moreover, any decision to pursue expansion into businesses with complementary investment strategies will be in the discretion of our management and may be consummated without prior notice or shareholder approval. In such instances, shareholders will be relying on our management to assess the relative benefits and risks associated with any such expansion. Risks Relating to Our Class A Common Stock Because a limited number of shareholders, including members of our management team, own a substantial number of our shares, decisions made by them may be detrimental to your interests. By virtue of their direct and indirect share ownership, John R. Klopp, a director and our president and chief executive officer, Craig M. Hatkoff, a director and former officer, and other shareholders indirectly owned by trusts for the benefit of our chairman of the board, Samuel Zell, have the power to significantly influence our affairs and are able to influence the outcome of matters required to be submitted to shareholders for approval, including the election of our directors, amendments to our charter, mergers, sales of assets and other acquisitions or sales. The influence exerted by these shareholders over our affairs might not be consistent with the interests of some or all of our other shareholders. We cannot assure you that these shareholders will not exercise their influence over us in a manner detrimental to your interests. As of June 30, 2004, these shareholders collectively own and control 2,480,805 shares of our class A common stock representing approximately 28.9% of our outstanding class A common stock. This concentration of ownership may have the effect of delaying or preventing a change in control of our company, including transactions in which you might otherwise receive a premium for your class A common stock, and might negatively affect the market price of our class A common stock. Berkley owns 1,635,000 shares of our class A common stock and may purchase an additional 365,000 shares upon the exercise of warrants, which assuming the exercise of the warrants, represents 23.1% of our outstanding class A common stock. The conversion of the outstanding convertible trust preferred securities held by Vornado Realty, L.P., General Motors Trust Bank, National Association, as trustee for the GMAM Investment Funds Trust and JPMorgan Chase Bank, as trustee for the GMAM Group Pension Trust II, could result in other significant concentrated holdings of our class A common stock. Vornado Realty, L.P. may acquire 1,424,474 shares of our class A common stock, General Motors Trust Bank, National Association, as trustee for the GMAM Investment Funds Trust may acquire 49,856 shares of our class A common stock and JPMorgan Chase Bank, as trustee for the GMAM Group Pension Trust II may acquire 662,381 shares of our class A common stock. An officer of Berkley and a person associated with the General Motor's pension trusts serve on our board of directors and, therefore, have the power to significantly influence our affairs. Through their significant ownership of our class A common stock, assuming for this purpose the trust preferred securities were converted, these security holders may have the ability to influence the outcome of matters submitted for shareholder approval. Some provisions of our charter and bylaws, and Maryland law may deter takeover attempts, which may limit the opportunity of our shareholders to sell their shares at a favorable price. Some of the provisions of our charter and bylaws and Maryland law discussed below could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our shareholders by providing them with the opportunity to sell their shares at a premium to the then current market price. Issuance of Preferred Stock Without Shareholder Approval. Our charter authorizes our board of directors to authorize the issuance of up to 100,000,000 shares of preferred stock and up to 100,000,000 shares of class A common stock. Our charter also authorizes our board of directors, without shareholder approval, to classify or reclassify any unissued shares of our class A common stock and preferred stock into other classes or series of stock and to amend our charter to increase or decrease the aggregate number of shares of stock of any class or series that may be issued. Our board of directors, therefore, can exercise its power to reclassify our stock to increase the -10- number of shares of preferred stock we may issue without shareholder approval. Preferred stock may be issued in one or more series, the terms of which may be determined without further action by shareholders. These terms may include preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption. The issuance of any preferred stock, however, could materially adversely affect the rights of holders of our class A common stock and, therefore, could reduce its value. In addition, specific rights granted to future holders of our preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The power of our board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change in control, thereby preserving the current shareholders' control. Advance Notice Bylaw. Our bylaws contain advance notice procedures for the introduction of business and the nomination of directors. These provisions could discourage proxy contests and make it more difficult for you and other shareholders to elect shareholder-nominated directors and to propose and approve shareholder proposals opposed by management. Maryland Takeover Statutes. We are subject to the Maryland Business Combination Act which could delay or prevent an unsolicited takeover of us. The statute substantially restricts the ability of third parties who acquire, or seek to acquire, control of us to complete mergers and other business combinations without the approval of our board of directors even if such transaction would be beneficial to shareholders. "Business combinations" between such a third party acquiror or its affiliate and us are prohibited for five years after the most recent date on which the acquiror or its affiliate becomes an "interested shareholder." An "interested shareholder" would be any person who beneficially owns 10 percent or more of our shareholder voting power or an affiliate or associate of ours who, at any time within the two-year period prior to the date interested shareholder status is determined, was the beneficial owner of 10 percent or more of our shareholder voting power. If our board of directors approved in advance the transaction that would otherwise give rise to the acquiror or its affiliate attaining such status, such as the issuance of shares of our class A common stock to Berkley, the acquiror or its affiliate would not become an interested shareholder and, as a result, it could enter into a business combination with us. Our board of directors could choose not to negotiate with an acquirer if the board determined in its business judgment that considering such an acquisition was not in our strategic interests. Even after the lapse of the five-year prohibition period, any business combination with an interested shareholder must be recommended by our board of directors and approved by the affirmative vote of at least: o 80% of the votes entitled to be cast by shareholders; and o two-thirds of the votes entitled to be cast by shareholders other than the interested shareholder and affiliates and associates thereof. The super-majority vote requirements do not apply if the transaction complies with a minimum price requirement prescribed by the statute. The statute permits various exemptions from its provisions, including business combinations that are exempted by the board of directors prior to the time that an interested shareholder becomes an interested shareholder. Our board of directors has exempted any business combination involving family partnerships controlled separately by John R. Klopp and Craig M. Hatkoff, and a limited liability company indirectly controlled by a trust for the benefit of Samuel Zell and his family. As a result, these persons and Berkley may enter into business combinations with us without compliance with the super-majority vote requirements and the other provisions of the statute. We are subject to the Maryland Control Share Acquisition Act. With certain exceptions, the Maryland General Corporation Law provides that "control shares" of a Maryland corporation acquired in a control share acquisition have no voting rights except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter, excluding shares owned by the acquiring person or by our officers or directors who are our employees, and may be redeemed by us. "Control shares" are voting shares which, if aggregated with all other shares owned or voted by the acquirer, would entitle the acquirer to exercise voting power in electing directors within one of the specified ranges of voting power. A person who has made or proposes to make a control share acquisition, upon satisfaction of certain conditions, including an undertaking to pay expenses, may compel our board -11- to call a special meeting of shareholders to be held within 50 days of demand to consider the voting rights of the "control shares" in question. If no request for a meeting is made, we may present the question at any shareholders' meeting. If voting rights are not approved at the shareholders' meeting or if the acquiring person does not deliver the statement required by Maryland law, then, subject to certain conditions and limitations, we may redeem any or all of the control shares, except those for which voting rights have previously been approved for fair value. If voting rights for control shares are approved at a shareholders' meeting and the acquirer may then vote a majority of the shares entitled to vote, then all other shareholders may exercise appraisal rights. The fair value of the shares for purposes of these appraisal rights may not be less than the highest price per share paid by the acquirer in the control share acquisition. The control share acquisition statute does not apply to shares acquired in a merger, consolidation or share exchange if we are a party to the transaction, nor does it apply to acquisitions approved or exempted by our charter or bylaws. We have exempted certain holders identified in our bylaws from this statute which exemptions extend to Berkley, family partnerships controlled separately by John R. Klopp and Craig M. Hatkoff, and a limited liability company indirectly controlled by a trust for the benefit of Samuel Zell and his family. We are also subject to the Maryland Unsolicited Takeovers Act which permits our board of directors, among other things, to elect on our behalf to stagger the terms of directors, to increase the shareholder vote required to remove a director and to provide that shareholder-requested meetings may be called only upon the request of shareholders entitled to cast at least a majority of the votes entitled to be cast at the meeting. Such an election would significantly restrict the ability of third parties to wage a proxy fight for control of our board of directors as a means of advancing a takeover offer. If an acquirer was discouraged from offering to acquire us, or prevented from successfully completing a hostile acquisition, you could lose the opportunity to sell your shares at a favorable price. Shares eligible for sale in the near future may cause the market price for our class A common stock to decline. Sales of a substantial number of shares of our class A common stock in the public market, or the perception that these sales could occur, may depress the market price for our class A common stock. These sales could also impair our ability to raise additional capital through the sale of our equity securities in the future. The number and timing of shares of class A common stock available for sale in the public market is limited by restrictions under federal securities laws and under agreements that we and each of our executive officers and directors and certain shareholders have entered into with the underwriters for our public offering of class A common stock completed in July 2004. Those agreements restrict these persons from selling, pledging or otherwise disposing of their shares, subject to specified exceptions, for a period of 90 days after July 22, 2004 without the prior written consent of the lead underwriter. The lead underwriter may, however, in its sole discretion, release all or any portion of the class A common stock from the restrictions of the lockup agreements. Subject to any restrictions pursuant to other agreements or under applicable law, 3,993,307 shares will be eligible for sale in the public market at various times commencing 90 days from July 22, 2004. In addition, 550,835 shares of common stock may be issued pursuant to the exercise of stock options that are outstanding as of June 30, 2004. The market value of our class A common stock may be adversely affected by many factors. As with any public company, a number of factors may adversely influence the price of our class A common stock, many of which are beyond our control. These factors include: o the level of institutional interest in us; o the perception of REITs generally and REITs with portfolios similar to ours, in particular, by market professionals; o the attractiveness of securities of REITs in comparison to other companies; and o the market's perception of our growth potential and potential future cash dividends. An increase in market interest rates may lead prospective purchasers of our class A common stock to expect a higher dividend yield, which would adversely affect the market price of our class A common stock. -12- One of the factors that will influence the price of our class A common stock will be the dividend yield on our stock (distributions as a percentage of the price of our stock) relative to market interest rates. An increase in market interest rates may lead prospective purchasers of our class A common stock to expect a higher dividend yield, which would adversely affect the market price of our class A common stock. Your ability to sell a substantial number of shares of our class A common stock may be restricted by the low trading volume historically experienced by our class A common stock. Although our class A common stock is listed on the New York Stock Exchange, the daily trading volume of our shares of class A common stock has historically been lower than the trading volume for certain other companies. As a result, the ability of a holder to sell a substantial number of shares of our class A common stock in a timely manner without causing a substantial decline in the market of the shares, especially by means of a large block trade, may be restricted by the limited trading volume of the shares of our class A common stock. Risks Related to our REIT Status Our charter does not permit any individual to own more than over 2.5% of our class A common stock, and attempts to acquire our class A common stock in excess of the 2.5% limit would be void without the prior approval of our board of directors. For the purpose of preserving our qualification as a REIT for federal income tax purposes, our charter prohibits direct or constructive ownership by any individual of more than 2.5% of the lesser of the total number or value of the outstanding shares of our class A common stock as a means of preventing ownership of more than 50% of our class A common stock by five or fewer individuals. The charter's constructive ownership rules are complex and may cause the outstanding class A common stock owned by a group of related individuals or entities to be deemed to be constructively owned by one individual. As a result, the acquisition of less than 2.5% of our outstanding class A common stock by an individual or entity could cause an individual to own constructively in excess of 2.5% of our outstanding class A common stock, and thus be subject to the charter's ownership limit. There can be no assurance that our board of directors, as permitted in the charter, will increase this ownership limit in the future. Any attempt to own or transfer shares of our class A common stock in excess of the ownership limit without the consent of our board of directors will be void, and will result in the shares being transferred by operation of law to a charitable trust, and the person who acquired such excess shares will not be entitled to any distributions thereon or to vote such excess shares. Our charter contains a provision that exempts certain of our officers, directors and their related persons from this ownership limit and we increased the limit for William R. Berkley to 6.0% and for one other major shareholder of Berkley identified to us to 4.0%. The 2.5% ownership limit may have the effect of precluding a change in control of us by a third party without the consent of our board of directors, even if such change in control would be in the interest of our shareholders or would result in a premium to the price of our class A common stock (and even if such change in control would not reasonably jeopardize our REIT status). The ownership limit exemptions and the reset limits granted to date would limit our board of directors' ability to reset limits in the future and at the same time maintain compliance with the REIT qualification requirement prohibiting ownership of more than 50% of our class A common stock by five or fewer individuals. There are no assurances that we will be able to pay dividends in the future. We intend to pay quarterly dividends and to make distributions to our shareholders in amounts such that all or substantially all of our taxable income in each year, subject to certain adjustments, is distributed. This, along with other factors, should enable us to qualify for the tax benefits accorded to a REIT under the Internal Revenue Code. All distributions will be made at the discretion of our board of directors and will depend on our earnings, our financial condition, maintenance of our REIT status and such other factors as our board of directors may deem relevant from time to time. There are no assurances that we will be able to pay dividends in the future. In addition, some of our distributions may include a return of capital, which would reduce the amount of capital available to operate our business. -13- Recent tax legislation may have negative consequences for REITs. Recent tax legislation allows certain corporations to pay dividends that qualify for a reduced tax rate in the hands of certain shareholders. This legislation generally does not apply to REITs. Although the legislation does not adversely affect the tax treatment of REITs, it may cause investments in non-REIT corporations to become relatively more desirable. As a result, the capital markets may be less favorable to REITs, such as ourselves, when they seek to raise equity capital, and the prices at which REIT equity securities trade, including our class A common stock, may decline or underperform non-REIT corporations. We will be dependent on external sources of capital to finance our growth. As with other REITs, but unlike corporations generally, our ability to finance our growth must largely be funded by external sources of capital because we generally will have to distribute to our shareholders 90% of our taxable income in order to qualify as a REIT, including taxable income where we do not receive corresponding cash. Our access to external capital will depend upon a number of factors, including general market conditions, the market's perception of our growth potential, our current and potential future earnings, cash distributions and the market price of our class A common stock. If we do not maintain our qualification as a REIT, we will be subject to tax as a regular corporation and face a substantial tax liability. Our taxable REIT subsidiaries will be subject to income tax. We expect to operate so as to qualify as a REIT under the Internal Revenue Code. However, qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only a limited number of judicial or administrative interpretations exist. Even a technical or inadvertent mistake could jeopardize our REIT status. Furthermore, new tax legislation, administrative guidance or court decisions, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT. If we fail to qualify as a REIT in any tax year, then: o we would be taxed as a regular domestic corporation, which under current laws, among other things, means being unable to deduct distributions to shareholders in computing taxable income and being subject to federal income tax on our taxable income at regular corporate rates; o any resulting tax liability could be substantial, could have a material adverse effect on our book value and could reduce the amount of cash available for distribution to shareholders; and o unless we were entitled to relief under applicable statutory provisions, we would be required to pay taxes, and thus, our cash available for distribution to shareholders would be reduced for each of the years during which we did not qualify as a REIT. Income from our fund management business is expected to be realized by one of our taxable REIT subsidiaries, and, accordingly, will be subject to income tax. Complying with REIT requirements may cause us to forego otherwise attractive opportunities. In order to qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, our sources of income, the nature of our investments in commercial real estate and related assets, the amounts we distribute to our shareholders and the ownership of our stock. We may also be required to make distributions to shareholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with REIT requirements may hinder our ability to operate solely on the basis of maximizing profits. Complying with REIT requirements may force us to liquidate or restructure otherwise attractive investments. In order to qualify as a REIT, we must also ensure that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets. The remainder of our investments in securities cannot include more than 10% of the outstanding voting securities of any -14- one issuer or 10% of the total value of the outstanding securities of any one issuer. In addition, no more than 5% of the value of our assets can consist of the securities of any one issuer. If we fail to comply with these requirements, we must dispose of a portion of our assets within 30 days after the end of the calendar quarter in order to avoid losing our REIT status and suffering adverse tax consequences. Complying with REIT requirements may force us to borrow to make distributions to shareholders. From time to time, our taxable income may be greater than our cash flow available for distribution to shareholders. If we do not have other funds available in these situations, we may be unable to distribute substantially all of our taxable income as required by the REIT provisions of the Internal Revenue Code. Thus, we could be required to borrow funds, sell a portion of our assets at disadvantageous prices or find another alternative. These options could increase our costs or reduce our equity. The "taxable mortgage pool" rules may limit the manner in which we effect future securitizations. Certain of our future securitizations could be considered to result in the creation of taxable mortgage pools for federal income tax purposes. Since we conduct our operations to qualify as a REIT, so long as we own 100% of the equity interests in a taxable mortgage pool, we would not be adversely affected by the characterization of the securitization as a taxable mortgage pool (assuming that we do not have any shareholders who might cause a corporate income tax to be imposed upon us by reason of our owning a taxable mortgage pool). We would be precluded, however, from selling to outside investors equity interests in such securitizations or from selling any debt securities issued in connection with such securitizations that might be considered to be equity interests for tax purposes. These limitations will preclude us from using certain techniques to maximize our returns from securitization transactions. If the securitization vehicles in which we participate were considered a taxable mortgage pool, shareholders who are tax-exempt and shareholders who are not United States persons may be required to pay tax on their share of any excess inclusion income. -15- -----END PRIVACY-ENHANCED MESSAGE-----