UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
(Amendment No. 1)
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): June 27, 2013 (April 8, 2013)
Starwood Property Trust, Inc.
(Exact name of registrant as specified in its charter)
Maryland |
|
001-34436 |
|
27-0247747 |
591 West Putnam Avenue |
|
06830 |
(Address of principal |
|
(Zip Code) |
executive offices) |
|
|
Registrants telephone number,
including area code:
(203) 422-7700
(Former name or former address, if changed since last report.)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:
o Written communications pursuant to Rule 425 under the Securities Act (17 CAR 230.425)
o Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CAR 240.14a-12)
o Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CAR 240.14d-2(b))
o Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CAR 240.13e-4(c))
Explanatory Note
On April 19, 2013, Starwood Property Trust, Inc., a Maryland corporation (the Company), completed the acquisition (the Acquisition) of all of the outstanding equity interests of LNR Property LLC, a Delaware limited liability company (LNR), as further described in a Current Report on Form 8-K filed with the Securities and Exchange Commission on April 25, 2013.
On April 8, 2013, the Company filed a Current Report on Form 8-K (the Initial Filing) to, among other matters, file audited consolidated financial statements of LNR and its predecessor and unaudited pro forma combined financial information of the Company, as further described therein, including the audited consolidated financial statements of LNR as of and for the year ended December 31, 2012, and reference is hereby made to these financial statements. In this Current Report on Form 8-K/A, the Company is filing (i) the unaudited condensed consolidated financial statements of LNR as of March 31, 2013 and for the three months ended March 31, 2013 and 2012 and (ii) the unaudited pro forma combined financial information of the Company as of and for the three months ended March 31, 2013, after giving effect to the Acquisition. Item 9.01 of the Initial Filing is hereby being supplemented to include the information below. The information previously reported in the Initial Filing is incorporated by reference into this Current Report on Form 8-K/A.
Item 9.01 Financial Statements and Exhibits
(a) Financial Statements of Business Acquired.
The unaudited condensed consolidated financial statements of LNR Property LLC and Subsidiaries as of March 31, 2013 and for the three months ended March 31, 2013 and 2012, and the related notes, are filed as Exhibit 99.1 to this Current Report on Form 8-K/A.
(b) Pro Forma Financial Information.
Starwood Property Trust, Inc. unaudited pro forma combined financial information, comprised of a pro forma combined balance sheet as of March 31, 2013 and a pro forma combined statement of income for the three months ended March 31, 2013, and the related notes, are filed as Exhibit 99.2 to this Current Report on Form 8-K/A.
(d) Exhibits
Exhibit |
|
Description |
|
|
|
15 |
|
Letter of Awareness from Deloitte & Touche LLP, as independent auditors for LNR Property LLC. |
|
|
|
99.1 |
|
LNR Property LLC and Subsidiaries condensed consolidated financial statements (unaudited) as of March 31, 2013 and December 31, 2012 and for the three months ended March 31, 2013 and 2012, and Independent Auditors Review Report. |
|
|
|
99.2 |
|
Starwood Property Trust, Inc. pro forma combined financial information (unaudited) as of March 31, 2013 and for the three months ended March 31, 2013. |
|
|
|
SIGNATURE
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 hereunto duly authorized.
|
| |
Dated: June 27, 2013 |
STARWOOD PROPERTY TRUST, INC. | |
|
|
|
|
By: |
/s/ Andrew J. Sossen |
|
Name: |
Andrew J. Sossen |
|
Title: |
Chief Operating Officer and General Counsel |
EXHIBIT INDEX
Exhibit |
|
Description |
|
|
|
15 |
|
Letter of Awareness from Deloitte & Touche LLP, as independent auditors for LNR Property LLC. |
|
|
|
99.1 |
|
LNR Property LLC and Subsidiaries condensed consolidated financial statements (unaudited) as of March 31, 2013 and December 31, 2012 and for the three months ended March 31, 2013 and 2012, and Independent Auditors Review Report. |
|
|
|
99.2 |
|
Starwood Property Trust, Inc. pro forma combined financial information (unaudited) as of March 31, 2013 and for the three months ended March 31, 2013. |
Exhibit 15
June 27, 2013
To the Members of
LNR Property LLC and Subsidiaries
Miami Beach, FL
We have reviewed, in accordance with the standards of the American Institute of Certified Public Accountants, the unaudited interim financial information of LNR Property LLC and Subsidiaries as of March 31, 2013, and for the three-month periods ended March 31, 2013 and 2012, as indicated in our report dated June 27, 2013; because we did not perform an audit, we expressed no opinion on that information.
We are aware that our report referred to above, which is included in the Current Report on Form 8-K/A of Starwood Property Trust, Inc., is incorporated by reference in Registration Statement No. 333-161402 on Form S-8, Registration Statement No. 333-169008 on Form S-3, and in Registration Statement No. 333-186561 on Form S-3.
We also are aware that the aforementioned report, pursuant to Rule 436(c) under the Securities Act of 1933, is not considered a part of the Registration Statement prepared or certified by an accountant or a report prepared or certified by an accountant within the meaning of Sections 7 and 11 of that Act.
/s/ Deloitte & Touche LLP
Miami, Florida
Exhibit 99.1
LNR Property LLC and Subsidiaries
Condensed Consolidated Financial Statements
as of March 31, 2013 and December 31, 2012
and for the three months ended March 31, 2013 and 2012, and Independent Auditors Review Report
(Unaudited)
INDEPENDENT AUDITORS REVIEW REPORT
To the Members of
LNR Property LLC and Subsidiaries
Miami Beach, FL
We have reviewed the accompanying condensed consolidated balance sheet of LNR Property LLC and Subsidiaries (the Company) as of March 31, 2013, and the related condensed consolidated statements of earnings, comprehensive earnings, members equity and cash flows for the three-month periods ended March 31, 2013 and 2012 (the interim financial information).
Managements Responsibility for the Interim Financial Information
The Companys management is responsible for the preparation and fair presentation of the interim financial information in accordance with accounting principles generally accepted in the United States of America; this responsibility includes the design, implementation, and maintenance of internal control sufficient to provide a reasonable basis for the preparation and fair presentation of interim financial information in accordance with the applicable financial reporting framework.
Auditors Responsibility
Our responsibility is to conduct our reviews in accordance with auditing standards generally accepted in the United States of America applicable to reviews of interim financial information. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial information. Accordingly, we do not express such an opinion.
Conclusion
Based on our reviews, we are not aware of any material modifications that should be made to the interim financial information referred to above for it to be in accordance with accounting principles generally accepted in the United States of America.
Report on Condensed Consolidated Balance Sheet as of December 31, 2012
We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of the Company as of December 31, 2012, and the related consolidated statements of earnings, comprehensive earnings, and members equity and cash flows for the year then ended (not presented herein); and we expressed an unmodified audit opinion on those audited consolidated financial statements in our report dated March 21, 2013. In our opinion, the accompanying condensed consolidated balance sheet of the Company as of December 31, 2012, is consistent, in all material respects, with the audited consolidated financial statements from which it has been derived.
/s/ Deloitte & Touche LLP |
|
Certified Public Accountants |
|
Miami, Florida |
|
June 27, 2013 |
|
LNR PROPERTY LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
|
|
March 31, 2013 |
|
December 31, 2012 |
| |
ASSETS |
|
|
|
|
| |
Cash and cash equivalents |
|
$ |
225,105 |
|
213,341 |
|
Restricted cash |
|
1,821 |
|
571 |
| |
Investment securities, at fair value |
|
71,018 |
|
40,694 |
| |
Mortgage loans held for sale, at fair value |
|
221,552 |
|
210,454 |
| |
Mortgage loans held for investment (zero and $7,000 at fair value) |
|
8,237 |
|
15,345 |
| |
Land held for investment |
|
92,280 |
|
91,251 |
| |
Investments in unconsolidated entities |
|
230,033 |
|
215,018 |
| |
Derivative assets |
|
4,367 |
|
4,457 |
| |
Intangible assets - servicing rights ($127,957 and $133,437 at fair value) |
|
136,438 |
|
143,412 |
| |
Goodwill |
|
237,538 |
|
237,538 |
| |
Other assets |
|
35,867 |
|
37,164 |
| |
Variable interest entity assets, at fair value |
|
92,490,515 |
|
91,058,155 |
| |
Total assets |
|
$ |
93,754,771 |
|
92,267,400 |
|
|
|
|
|
|
| |
LIABILITIES AND EQUITY |
|
|
|
|
| |
|
|
|
|
|
| |
Liabilities: |
|
|
|
|
| |
Accounts payable |
|
$ |
10,432 |
|
12,095 |
|
Accrued expenses and other liabilities |
|
71,823 |
|
72,457 |
| |
Derivative liabilities |
|
894 |
|
244 |
| |
Debts payable |
|
275,811 |
|
283,876 |
| |
Repurchase agreements |
|
137,532 |
|
99,928 |
| |
Variable interest entity liabilities, at fair value |
|
92,151,320 |
|
90,735,416 |
| |
Total liabilities |
|
92,647,812 |
|
91,204,016 |
| |
Commitments and contingent liabilities |
|
|
|
|
| |
|
|
|
|
|
| |
LNR Property LLC Members equity: |
|
|
|
|
| |
Members equity |
|
509,255 |
|
508,601 |
| |
Retained earnings |
|
581,280 |
|
538,827 |
| |
Accumulated other comprehensive earnings |
|
7,705 |
|
7,975 |
| |
Members equity |
|
1,098,240 |
|
1,055,403 |
| |
Noncontrolling interests |
|
8,719 |
|
7,981 |
| |
Total equity |
|
1,106,959 |
|
1,063,384 |
| |
Total liabilities and equity |
|
$ |
93,754,771 |
|
92,267,400 |
|
See accompanying notes to condensed consolidated financial statements.
LNR PROPERTY LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands)
(Unaudited)
|
|
For the three months ended March 31, |
| |||
|
|
2013 |
|
2012 |
| |
Revenues |
|
|
|
|
| |
Servicing fees |
|
$ |
43,158 |
|
50,532 |
|
Management fees |
|
4,269 |
|
4,279 |
| |
Other fees |
|
264 |
|
67 |
| |
Rental income |
|
54 |
|
191 |
| |
Total revenues |
|
47,745 |
|
55,069 |
| |
|
|
|
|
|
| |
Costs and expenses |
|
|
|
|
| |
General and administrative |
|
41,124 |
|
38,147 |
| |
Cost of rental operations |
|
274 |
|
127 |
| |
Depreciation and amortization |
|
1,157 |
|
1,284 |
| |
Interest |
|
4,889 |
|
5,328 |
| |
Total costs and expenses |
|
47,444 |
|
44,886 |
| |
|
|
|
|
|
| |
Other income |
|
|
|
|
| |
Income of consolidated VIEs, net |
|
32,060 |
|
8,217 |
| |
Equity in earnings of unconsolidated entities |
|
348 |
|
10,415 |
| |
Change in fair value of servicing rights |
|
(6,285 |
) |
(4,792 |
) | |
Change in fair value of investment securities |
|
(7,544 |
) |
(2,753 |
) | |
Change in fair value of mortgage loans held for sale |
|
16,722 |
|
7,695 |
| |
Loss on derivative financial instruments |
|
(379 |
) |
(641 |
) | |
Interest income |
|
7,114 |
|
5,564 |
| |
Gain on sales of real estate |
|
169 |
|
132 |
| |
Foreign currency gain (loss), net |
|
392 |
|
(26 |
) | |
Other income, net |
|
1,415 |
|
1,248 |
| |
Total other income |
|
44,012 |
|
25,059 |
| |
|
|
|
|
|
| |
Income before income taxes |
|
44,313 |
|
35,242 |
| |
Income tax expense |
|
1,122 |
|
1,805 |
| |
Net income |
|
43,191 |
|
33,437 |
| |
Net income (loss) attributable to noncontrolling interests |
|
738 |
|
(2,741 |
) | |
Net income attributable to members |
|
$ |
42,453 |
|
36,178 |
|
See accompanying notes to condensed consolidated financial statements.
LNR PROPERTY LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(In thousands)
(Unaudited)
|
|
For the three months ended March 31, |
| |||
|
|
2013 |
|
2012 |
| |
Net income |
|
$ |
43,191 |
|
33,437 |
|
|
|
|
|
|
| |
Other comprehensive earnings, net of tax: |
|
|
|
|
| |
Unrealized gain on available-for-sale securities with no other than temporary impairments during the period |
|
418 |
|
1,881 |
| |
Unrealized (loss) gain on foreign currency translation |
|
(688 |
) |
1,638 |
| |
Other comprehensive (loss) earnings |
|
(270 |
) |
3,519 |
| |
|
|
|
|
|
| |
Comprehensive earnings |
|
$ |
42,921 |
|
36,956 |
|
See accompanying notes to condensed consolidated financial statements.
LNR PROPERTY LLC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF MEMBERS EQUITY
(In thousands)
(Unaudited)
|
|
Contributed |
|
Retained |
|
Share Based |
|
Accumulated |
|
Total Members |
|
Non |
|
Total Equity |
| |
Balance at December 31, 2012 |
|
$ |
500,500 |
|
538,827 |
|
8,101 |
|
7,975 |
|
1,055,403 |
|
7,981 |
|
1,063,384 |
|
Net income |
|
|
|
42,453 |
|
|
|
|
|
42,453 |
|
738 |
|
43,191 |
| |
Change in accumulated other comprehensive earnings, net |
|
|
|
|
|
|
|
(270 |
) |
(270 |
) |
|
|
(270 |
) | |
Amortization of share-based compensation awards |
|
|
|
|
|
654 |
|
|
|
654 |
|
|
|
654 |
| |
Balance at March 31, 2013 |
|
$ |
500,500 |
|
581,280 |
|
8,755 |
|
7,705 |
|
1,098,240 |
|
8,719 |
|
1,106,959 |
|
|
|
Contributed |
|
Retained |
|
Share Based |
|
Accumulated |
|
Total Members |
|
Non |
|
Total Equity |
| |
Balance at December 31, 2011 |
|
$ |
500,500 |
|
208,848 |
|
5,550 |
|
6,070 |
|
720,968 |
|
16,274 |
|
737,242 |
|
Net income |
|
|
|
36,178 |
|
|
|
|
|
36,178 |
|
(2,741 |
) |
33,437 |
| |
Permitted tax distributions |
|
|
|
(3,088 |
) |
|
|
|
|
(3,088 |
) |
|
|
(3,088 |
) | |
Share-based compensation award distributions |
|
|
|
|
|
(567 |
) |
|
|
(567 |
) |
|
|
(567 |
) | |
Change in accumulated other comprehensive earnings, net |
|
|
|
|
|
|
|
3,519 |
|
3,519 |
|
|
|
3,519 |
| |
Amortization of share-based compensation awards |
|
|
|
|
|
1,155 |
|
|
|
1,155 |
|
|
|
1,155 |
| |
Balance at March 31, 2012 |
|
$ |
500,500 |
|
241,938 |
|
6,138 |
|
9,589 |
|
758,165 |
|
13,533 |
|
771,698 |
|
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
|
|
For the three months ended March 31, |
| |||
|
|
2013 |
|
2012 |
| |
Cash flows from operating activities: |
|
|
|
|
| |
Net income |
|
$ |
43,191 |
|
33,437 |
|
Adjustments to reconcile net income to net cash used in operating activities: |
|
|
|
|
| |
Depreciation |
|
294 |
|
321 |
| |
Accretion of discount on investment securities and mortgage loans |
|
(112 |
) |
(163 |
) | |
Amortization of share-based compensation awards |
|
654 |
|
1,155 |
| |
Amortization of intangibles and deferred items |
|
1,470 |
|
1,925 |
| |
Change in fair value of servicing rights |
|
6,285 |
|
4,792 |
| |
Change in fair value of assets and liabilities of consolidated VIEs |
|
(2,375 |
) |
13,570 |
| |
Change in fair value of investment securities |
|
7,544 |
|
2,753 |
| |
Equity in earnings of unconsolidated entities |
|
(348 |
) |
(10,415 |
) | |
Distributions of earnings from unconsolidated entities |
|
106 |
|
6,929 |
| |
Interest received on investment securities in excess of income recognized |
|
|
|
10 |
| |
Gains on foreign currency translation |
|
(363 |
) |
(55 |
) | |
Gains on sales of real estate |
|
(169 |
) |
(132 |
) | |
Change in fair value of derivative financial instruments |
|
(1,355 |
) |
409 |
| |
Change in fair value of mortgage loans held for sale |
|
(16,722 |
) |
(7,695 |
) | |
Origination of mortgage loans held for sale, net of principal collections |
|
(271,139 |
) |
(122,166 |
) | |
Net proceeds from sale of mortgage loans held for sale |
|
92,155 |
|
42,846 |
| |
Changes in assets and liabilities: |
|
|
|
|
| |
Decrease (increase) in other assets |
|
278 |
|
(342 |
) | |
Decrease in accounts payable and accrued liabilities |
|
(2,184 |
) |
(21,529 |
) | |
Net cash used in operating activities |
|
(142,790 |
) |
(54,350 |
) | |
|
|
|
|
|
| |
Cash flows from investing activities: |
|
|
|
|
| |
Purchases of furniture, fixtures and equipment |
|
(345 |
) |
(542 |
) | |
Land held for investment: |
|
|
|
|
| |
Additions |
|
(1,426 |
) |
(2,077 |
) | |
Sales proceeds |
|
626 |
|
400 |
| |
Investments in unconsolidated entities |
|
(15,409 |
) |
(2,098 |
) | |
Distributions of capital from unconsolidated entities |
|
1,986 |
|
7,230 |
| |
Proceeds from principal collections on mortgage loans held for investment |
|
7,133 |
|
17 |
| |
Purchases of available-for-sale investment securities |
|
(28,449 |
) |
(8,071 |
) | |
Proceeds from sales of and principal collections on available-for-sale investment securities |
|
5,299 |
|
3,644 |
| |
Payments for purchases and terminations of derivative financial instruments |
|
(1,891 |
) |
(2,261 |
) | |
Proceeds from terminations of derivative financial instruments |
|
3,672 |
|
3,412 |
| |
(Increase) decrease in restricted cash |
|
(1,253 |
) |
2,762 |
| |
Net cash (used in) provided by investing activities |
|
(30,057 |
) |
2,416 |
| |
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
(In thousands)
(Unaudited)
|
|
For the three months ended March 31, |
| |||
|
|
2013 |
|
2012 |
| |
Cash flows from financing activities: |
|
|
|
|
| |
Permitted tax distributions |
|
|
|
(3,088 |
) | |
Distributions for share-based compensation awards |
|
|
|
(567 |
) | |
Proceeds from loans sold under agreement to repurchase |
|
234,132 |
|
60,864 |
| |
Payments on credit facilities |
|
(20,097 |
) |
(8,270 |
) | |
Repayment of debt of consolidated VIEs |
|
(34,314 |
) |
(65,751 |
) | |
Issuance of debt of consolidated VIEs |
|
2,992 |
|
3,925 |
| |
Proceeds from consolidated VIEs |
|
2,258 |
|
1,754 |
| |
Net cash provided by (used in) financing activities |
|
184,971 |
|
(11,133 |
) | |
Effect of exchange rate changes on cash |
|
(360 |
) |
335 |
| |
Net change in cash and cash equivalents |
|
11,764 |
|
(62,732 |
) | |
Cash and cash equivalents at beginning of period |
|
213,341 |
|
172,165 |
| |
Cash and cash equivalents at end of period |
|
$ |
225,105 |
|
109,433 |
|
|
|
|
|
|
| |
Supplemental disclosure of cash flow information: |
|
|
|
|
| |
Cash paid for interest |
|
$ |
3,917 |
|
4,215 |
|
Cash paid for income taxes |
|
4,336 |
|
783 |
| |
Cash received from income tax refunds |
|
69 |
|
5 |
| |
|
|
|
|
|
| |
Supplemental disclosure of non-cash investing and financing activities: |
|
|
|
|
| |
Repurchase agreement settled net with proceeds from sale of loans held for sale |
|
184,556 |
|
72,037 |
| |
Consolidation of VIEs |
|
|
|
|
| |
Variable interest entity assets |
|
11,162,556 |
|
10,806,107 |
| |
Variable interest entity liabilities |
|
11,162,556 |
|
10,806,107 |
| |
Deconsolidation of VIEs |
|
|
|
|
| |
Variable interest entity assets |
|
6,476,081 |
|
2,816,525 |
| |
Variable interest entity liabilities |
|
6,476,081 |
|
2,816,525 |
|
See accompanying notes to condensed consolidated financial statements.
LNR PROPERTY LLC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Summary of Organization, Business and Significant Accounting Policies
Description of Business
LNR Property LLC (collectively with its subsidiaries referred to as we or us or our) was originally organized as a corporation under the laws of Delaware as LNR Property Corporation (LNRPC) and was subsequently converted to a limited liability company after completion of a comprehensive balance sheet recapitalization (the Recapitalization) on July 29, 2010. We are a real estate investment, finance, management and development company that operates the following businesses: (i) a servicing business that manages and works out problem assets, (ii) a finance business that is focused on selectively acquiring and managing real estate finance investments, including unrated, investment grade and non-investment grade rated commercial mortgage backed securities (CMBS), subordinated interests of securitization and resecuritization transactions, and high yielding real estate loans, either directly or through ventures in which we hold an interest; (iii) a mortgage loan business which originates conduit loans for the primary purpose of selling these loans into securitization transactions; (iv) a small balance commercial loan business which acquires, manages and services portfolios of small balance commercial mortgage loans; and (v) a real estate business which is involved in acquiring, developing, repositioning, managing and selling commercial, multi-family residential and residential land, either directly or through ventures in which we hold an interest.
The notes to these condensed consolidated financial statements describe material changes to our business and accounting policies, as well as significant transactions since December 31, 2012, the date of our last audited consolidated financial statements.
Basis of Presentation and Consolidation
The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United Stated of America (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Certain financial information that is normally included in annual financial statements, including certain financial statement footnotes, is not required for interim reporting purposes, and has been condensed or omitted herein. These condensed consolidated financial statements should be read in conjunction with our December 31, 2012 audited consolidated financial statements and notes thereto. The interim financial information at March 31, 2013 and for the three months ended March 31, 2013 and 2012 is unaudited. However, in our opinion, the interim financial information includes all normal and recurring adjustments necessary for a fair presentation of our results for the period presented. The operating results for interim periods are not necessarily indicative of the results that can be expected for a full year.
The accompanying condensed consolidated financial statements include our accounts, those of our wholly owned subsidiaries and certain other entities we are required to consolidate in accordance with ASC 810. For securitization structures and other variable interest entities (VIE), this guidance requires the primary beneficiary of a VIE to consolidate the assets and liabilities of the VIE. The primary beneficiary is the party that has both (1) the power to direct the activities of an entity that most significantly impact the VIEs economic performance; and (2) through its interest in the VIE, the obligation to absorb losses or the right to receive benefits from the VIE that could be potentially significant to the VIE.
We perform ongoing reassessments of (1) whether any entities previously evaluated under the voting interest framework have become VIEs, based on certain events, and therefore subject to the VIE consolidation framework, and (2) whether changes in the facts and circumstances regarding our involvement with a VIE causes our consolidation conclusion regarding the VIE to change. When this assessment indicates that we no longer meet the criteria to be deemed the primary beneficiary of the VIE, the entity is deconsolidated.
Entities not deemed to be VIEs are consolidated if we own a majority of the voting securities or interests or hold the general partnership interest, except in those instances in which the minority voting interest owner effectively participates through substantive participative rights. Substantive participative rights include the ability to select, terminate and set compensation of the investees management, if applicable, and the ability to participate in capital and operating decisions of the investee, including budgets, in the ordinary course of business.
All intercompany transactions and balances among consolidated entities have been eliminated in consolidation.
Variable Interest Entities
VIEs are entities that, by design, either (1) lack sufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties, or (2) have equity investors that do not have the ability to make significant decisions relating to the entitys operations through voting rights, or do not have the obligation to absorb the expected losses, or do not have the right to receive the residual returns of the entity.
The most common type of VIE is a special purpose entity (SPE). SPEs are commonly used in securitization transactions in order to isolate certain assets and distribute the cash flows from those assets to investors. SPEs are an important part of the financial markets, including the mortgage- and asset-backed securities and commercial paper markets, as they provide market liquidity by facilitating investors access to specific portfolios of assets and risks. SPEs may be organized as trusts, partnerships or corporations and are typically established for a single, discrete purpose. SPEs are not typically operating entities and usually have a limited life and no employees. The basic SPE structure involves a company selling assets to the SPE; the SPE funds the purchase of those assets by issuing securities to investors. The legal documents that govern the transaction specify how the cash earned on the assets must be allocated to the SPEs investors and other parties that have rights to those cash flows. SPEs are generally structured to insulate investors from claims on the SPEs assets by creditors of other entities, including the creditors of the seller of the assets.
Our purchased investment securities include CMBS which are primarily comprised of the unrated and non-investment grade rated securities issued by CMBS trusts. These CMBS trusts are VIEs. In certain cases, we may contract to provide special servicing activities for these CMBS trusts, or, as holder of the controlling class, we may have the right to name and remove the special servicer for these trusts. In our role as special servicer, we provide services on defaulted loans within the trusts, such as foreclosure or work-out procedures, as permitted by the underlying contractual agreements. We evaluated all of our positions in such investments for consolidation.
We also hold retained interests in certain collateralized debt obligations (CDOs), whereby CMBS assets from our balance sheet were transferred to an SPE, which then issued to investors various forms of interests in those assets. These CDOs are VIEs. We generally serve as collateral administrator of these CDOs. In this role, we perform certain administrative tasks as defined in the indenture in exchange for a fee. This role also provides us with certain rights, including a right to purchase impaired assets from the trust if an event of default has not occurred. Given the nature of the entity, its activities are relatively
static until an event of default occurs. At that time, the trustee has the right to liquidate or sell assets in the CDO. We evaluated all of our positions in such investments for consolidation.
For further discussion of our interests in VIEs, see Note 2.
Fair Value Option
The guidance in ASC Topic 825, Financial Instruments, provides a fair value option election that allows entities to make an irrevocable election of fair value as the initial and subsequent measurement attribute for certain eligible financial assets and liabilities. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The decision to elect the fair value option is determined on an instrument by instrument basis and must be applied to an entire instrument and is irrevocable once elected. Assets and liabilities measured at fair value pursuant to this guidance are required to be reported separately in our consolidated balance sheets from those instruments using another accounting method. We have elected the fair value option for eligible financial assets and liabilities of our consolidated VIEs, mortgage loans held for sale, short-term mortgage loans held for investment, purchased investment securities issued by VIEs we expect to consolidate in the future, and the securitized financial assets and liabilities of Madison Square Company LLC (Madison). The fair value elections for VIE and securitization related items were made in order to mitigate accounting mismatches between the carrying value of the instruments and the related assets and liabilities that we consolidate at fair value. The fair value elections for mortgage loans held for sale and short-term mortgage loans held for investment were made due to the short-term nature of these instruments.
Fair Value
We measure our available-for-sale CMBS, derivative assets and liabilities, domestic servicing rights intangible and any assets or liabilities where we have elected the fair value option at fair value. When actively quoted observable prices are not available, we either use implied pricing from similar assets and liabilities or valuation models based on net present value of estimated future cash flows, adjusted as appropriate for liquidity, credit, market and/or other risk factors.
As discussed above, we measure the assets and liabilities of consolidated VIEs at fair value pursuant to our election of the fair value option. The VIEs in which we invest are static; that is, no reinvestment is permitted, and there is no active management of the underlying assets. In determining the fair value of the assets and liabilities of the VIE, we maximize the use of observable inputs over unobservable inputs. We also acknowledge that our principal market for selling CMBS assets is the securitization market where the market participant is considered to be a CMBS trust or a CDO. This methodology results in the fair value of the assets of a static CMBS trust being equal to the fair value of its liabilities.
For further discussion and disclosure of fair value measurements, see Note 5.
Investment Securities
Investment securities consist principally of CMBS and the retained interests of resecuritization transactions. We have elected the fair value option for certain investment securities issued from VIEs we expect to consolidate in the future. As discussed in Note 2, the majority of our CMBS holdings have been eliminated in consolidation due to the application of ASC 810.
Mortgage Loans
We classify mortgage loans as held for sale when we have the intent to sell or securitize them. We elect the fair value option for all mortgage loans held for sale, resulting in the loans being carried at fair value, with changes in fair value reflected in earnings.
Loans for which we have the intent and ability to hold for the foreseeable future or until maturity are accounted for in accordance with our existing accounting policies, as described in our December 31, 2012 consolidated financial statements. The fair value option is elected for all short-term mortgage loans held for investment.
Intangible Assets
Our domestic servicing asset is measured at fair value. This includes any newly purchased domestic servicing rights during the period. Election of this method is necessary to conform to our election of the fair value approach for measuring the assets and liabilities of the VIEs consolidated pursuant to ASC Topic 810. However, our European servicing intangible utilizes the amortization method for subsequent measurement. This asset is amortized in proportion to and over the period of estimated net servicing income, and is tested for potential impairment whenever events or changes in circumstances suggest that its carrying value may not be fully recoverable.
Derivative Instruments
We periodically enter into derivative financial instruments to hedge unpredictable changes in fair values related to our investment securities and mortgage loans. These derivatives hedge value changes resulting from both interest rates and credit quality. We also hold warrants which are convertible into common units of one of our unconsolidated investees. These warrants qualify as derivatives, as they contain a net settlement provision. None of our derivatives are designated in qualifying hedging relationships, and thus, changes in the fair value of these derivatives are reflected in the condensed consolidated statements of earnings. All derivative instruments are reported in our condensed consolidated balance sheets at fair value.
Revenue and Income Recognition
We typically seek to be the special servicer on CMBS transactions in which we invest. When we are appointed to serve in this capacity, we earn special servicing fees from the related activities performed, which consist primarily of overseeing the workout of under-performing and non-performing loans underlying the CMBS transactions. In addition, we receive management, asset acquisition, development and master servicing fees from third parties and unconsolidated affiliates. These fees are recognized in income in the period in which the services are performed and the revenue recognition criteria have been met.
Interest income on CMBS for which the fair value option has not been elected is recognized in accordance with the accounting guidance governing beneficial interests in securitized financial assets, whereby we estimate all cash flows attributable to an investment security on the date the security is acquired. The amount by which estimated cash flows exceed the initial investment is recognized as
interest income over the life of the security using the effective interest method. Changes in expected cash flows result in prospective adjustments to interest income. Interest income on mortgage loans for which the fair value option is not elected is comprised of interest received plus the accretion of discount, if any, between the carrying value and unpaid principal balance using a methodology that results in a level yield. Interest income on CMBS and mortgage loans for which the fair value option is elected is recognized based on the contractual rate of interest.
Transfers of investment securities, mortgage loans, and investments in unconsolidated entities are accounted for as sales pursuant to the accounting guidance governing transfers and servicing of financial assets, providing that the relevant criteria have been met. Transfers of assets may not meet sale requirements if the assets have not been legally isolated or if our continuing involvement is deemed to give us effective control over the assets. If the transfer is not deemed a sale, it is instead accounted for as a secured borrowing.
2. Consolidation of Variable Interest and Other Entities
As discussed in Note 1, we evaluate all of our investments and other interests in entities for consolidation.
Madison Square Company LLC
Madison is an entity formed for the purpose of investing in unrated and non-investment grade rated CMBS. We own an approximate 65% interest in Madison and since we are deemed the primary beneficiary, consolidate Madison into our financial statements.
Investment Securities
The VIEs we consolidate are structured as pass through entities that receive principal and interest on the underlying collateral and distribute those payments to the certificate holders. The assets and other instruments held by these securitization entities are restricted and can only be used to fulfill the obligations of the entity. Additionally, the obligations of the securitization entities do not have any recourse to the general credit of any other consolidated entities, nor to us as the primary beneficiary. As we invest primarily in non-investment grade and unrated bonds, the SPE liabilities initially represent investment securities on our balance sheet (pre-consolidation). Upon consolidation of these VIEs, our associated investment securities are eliminated as is the interest income related to those securities. Similarly, the fees we earn in our roles as special servicer of the bonds issued by the consolidated VIEs or as collateral administrator of the consolidated VIEs are also eliminated. Finally, an allocable portion of the identified servicing intangible associated with the eliminated fee streams is eliminated in consolidation.
VIEs in which we are the Primary Beneficiary
The inclusion of the assets and liabilities of VIEs in which we are deemed the primary beneficiary has no economic effect on us. Our exposure to the obligations of VIEs is generally limited to our investment in these entities. We are not obligated to provide, nor have we provided, any financial support for any of these consolidated structures.
VIEs in which we are not the Primary Beneficiary
In certain instances, we hold a variable interest in a VIE in the form of CMBS, but either (i) we are not appointed, or do not serve as, special servicer or (ii) an unrelated third party has the rights to unilaterally remove us as special servicer. In these instances, we do not have the power to direct activities that most significantly impact the trusts economic performance. In other cases, the variable interest we hold does not obligate us to absorb losses or provide us with the right to receive benefits from the VIE which could
potentially be significant. For these structures, we are not deemed to be the primary beneficiary of the VIE, and we do not consolidate these VIEs.
Two of our CDO structures are currently in default, which pursuant to the underlying indentures, changes the rights of the variable interest holders. Upon default of a CDO, the trustee or senior note holders are allowed to exercise certain rights, including liquidation of the collateral, which at that time, is the activity which would most significantly impact the CDOs economic performance. Further, when the CDO is in default, the collateral administrator no longer has the option to purchase securities from the CDO. In cases where the CDO is in default and we do not have the ability to exercise rights which would most significantly impact the CDOs economic performance, we do not consolidate the VIE. As of March 31, 2013, neither of these CDO structures was consolidated.
As noted above, we are not obligated to provide, nor have we provided, any financial support for any of our securitization SPEs, whether or not we are deemed to be the primary beneficiary. As such, the risk associated with our involvement in these VIEs is limited to the carrying value of our investment in the entity. As of March 31, 2013 and December 31, 2012, our maximum risk of loss related to VIEs in which we were not the primary beneficiary was $71.0 million and $40.7 million, respectively, on a fair value basis and $68.1 million and $38.2 million, respectively, on an amortized cost basis.
The securitization SPEs which we do not consolidate have debt obligations to beneficial interest holders with unpaid principal balances of $158.2 billion and $143.1 billion at March 31, 2013 and December 31, 2012, respectively. The corresponding assets are comprised primarily of mortgage loans with unpaid principal balances corresponding to the amounts of the outstanding debt obligations.
3. Mortgage Loans
The following table is a summary of our mortgage loans (in thousands):
|
|
March 31, 2013 |
|
December 31, 2012 |
| |
Mortgage loans held for sale, at fair value |
|
$ |
221,552 |
|
210,454 |
|
Mortgage loans held for investment, at fair value |
|
|
|
7,000 |
| |
Mortgage loans held for investment |
|
8,237 |
|
8,345 |
| |
|
|
$ |
229,789 |
|
225,799 |
|
We originate commercial mortgages with the intent to sell these mortgage loans to SPEs for the purposes of securitization. These SPEs then issue CMBS that are collateralized in part by these assets, as well as other assets transferred to the SPE. In certain instances, we retain a subordinated interest in the SPE and serve as special servicer for the SPE.
Mortgage loans originated for securitization are classified as held for sale and are accounted for in accordance with the fair value option. During the three months ended March 31, 2013, we sold $245.9 million par value of these loans for their fair value of $262.4 million and recognized an increase in fair value of mortgage loans held for sale of $16.7 million. The sale proceeds were used in part to repay $184.6 million of the outstanding balance of the repurchase agreement associated with these loans.
Also during the three months ended March 31, 2013, we sold $14.5 million of mortgage loans held for sale into a joint venture in which we hold a 50% ownership interest.
The unpaid principal balance of mortgage loans held for sale as of March 31, 2013 and December 31, 2012 was $221.7 million and $211.3 million, respectively, and none of these loans were 90 days or more past due or on nonaccrual status. As of March 31, 2013 and December 31, 2012, we had unfunded lending commitments of zero and $16.1 million, respectively.
During the three months ended March 31, 2013, our short-term mortgage loans held for investment, for which the fair value option is elected, were repaid.
4. Investments in Unconsolidated Entities
During the year ended December 31, 2012, we obtained a 50% equity interest in a venture established to originate small balance real estate loans to commercial customers. We agreed to originate loans on behalf of the venture until the venture was ready to commence operations on January 25, 2013. At that date, we sold all such loans to the venture for $14.5 million. We account for our interest in the venture pursuant to the equity method of accounting.
During the three months ended March 31, 2013, we vested in a portion of the warrants described in the Derivative Instruments section of Note 1. The fair value of the vested portion was reflected as a derivative asset, with the corresponding income recognized in other income, net in our condensed consolidated statement of earnings for this period.
5. Fair Value Disclosures
Our estimates of fair value are based on the best information available to management as to conditions that existed as of the valuation date. Assets and liabilities recorded at fair value in the condensed consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels are directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities and are as follows:
Level 1 Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2 Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instruments anticipated life.
Level 3 Inputs reflect managements best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
Fair Value on a Recurring Basis
The following is a summary of the valuation techniques employed with respect to assets and liabilities measured and reported at fair value:
Investment securities at fair value: We utilize several inputs and factors in determining the fair value of investment securities classified as available-for-sale or for which the fair value option was elected. These factors include projected future cash flows, ratings, subordination levels, vintage, remaining lives, credit issues, recent trades of similar securities and the spreads used in the prior valuation. We obtain current market spread information where available and use this information in evaluating and validating the market price of all investments. Depending upon the significance of the fair value inputs used in determining these fair values, these securities are classified in either Level 2 or Level 3 of the fair value hierarchy.
In the unlikely event that we are able to obtain quoted prices from an active market for identical assets, these securities would fall within Level 1 of the fair value hierarchy. Unless sufficient trading activity levels exist with respect to the security for which the quote is being provided, these quotes will not be deemed Level 1 inputs and will simply be used as a benchmark, if at all, in assessing the appropriateness
of our valuations. If there is significant market volatility and diversity in quotes, then the related securities are classified within Level 3 of the fair value hierarchy.
Mortgage loans held for sale: We measure the fair value of mortgage loans held for sale using a discounted cash flow analysis unless observable market data (i.e. securitized pricing) is available. A discounted cash flow analysis requires management to make estimates regarding future interest rates and credit spreads. The most significant of these inputs relates to credit spreads and is unobservable. Thus, we have determined that the fair values of mortgage loans valued using a discounted cash flow analysis should be classified in Level 3 of the fair value hierarchy, while mortgage loans valued using securitized pricing should be classified in Level 2 of the fair value hierarchy. Mortgage loans classified in Level 3 are transferred to Level 2 if securitized pricing becomes available with the transfer recognized as of that date.
Mortgage loans held for investment, at fair value: We measure the fair value of mortgage loans held for investment in a manner similar to our mortgage loans held for sale.
Liabilities of consolidated VIEs: We utilize several inputs and factors in determining the fair value of VIE liabilities, including future cash flows, market transaction information, ratings, subordination levels, and current market spread and pricing information where available. Quoted market prices are used when this debt trades as an asset. Depending upon the significance of the fair value inputs used in determining these fair values these liabilities are classified in either Level 2 or Level 3 of the fair value hierarchy. VIE liabilities may shift between Level 2 and Level 3 of the fair value hierarchy if the significant fair value inputs used to price the VIE liabilities become observable or cease to be observable.
Assets of consolidated VIEs: The VIEs in which we invest are static; that is, no reinvestment is permitted, and there is no active management of the underlying assets. In determining the fair value of the assets of the VIE, we maximize the use of observable inputs over unobservable inputs. We also acknowledge that our principal market for selling CMBS assets is the securitization market where the market participant is considered to be a CMBS trust or a CDO. This methodology results in the fair value of the assets of a static CMBS trust being equal to the fair value of its liabilities. Depending upon the significance of the fair value inputs used in determining their fair values, these assets are classified in either Level 2 or Level 3 of the fair value hierarchy. These assets may shift between Level 2 and Level 3 of the fair value hierarchy if the significant fair value inputs used to price the assets become observable or cease to be observable.
Intangible asset Domestic servicing rights: The fair value of this intangible is determined using discounted cash flow modeling techniques which require management to make estimates regarding future net servicing cash flows, including forecasted loan defeasance, delinquency and anticipated maturity defaults which are calculated assuming a debt yield at which default occurs. Since the most significant of these inputs are unobservable, we have determined that the fair values of these intangibles in their entirety should be classified in Level 3 of the fair value hierarchy.
Derivative assets and liabilities: For all interest rate swaps, fair value is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each interest rate swap. This analysis reflects the contractual terms of the swap, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterpartys nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds and guarantees.
Although we have determined that the majority of the inputs used to value these interest rate swaps are classified in Level 2 of the fair value hierarchy, the credit valuation adjustments associated with these interest rate swaps utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the
likelihood of default by us and our counterparties. However, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of these derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of these derivatives. As a result, we have determined that these derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
For all credit index instruments, fair value is determined based on changes in the relevant indices from the date of initiation of the instrument to the reporting date, as these changes determine the amount of any future cash settlement between us and the counterparty. These indices are considered Level 2 inputs as they are directly observable. We have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our credit index instruments and have determined that any credit valuation adjustment would not be significant to the overall valuation as the counterparty to these contracts is a highly rated global financial institution. As a result, we have determined that credit index instruments are classified in Level 2 of the fair value hierarchy.
For warrants, fair value is determined using an option-pricing model. Because the warrants represent interests in a nonpublic company, the key inputs to the model are unobservable. These inputs include the estimated enterprise value, estimated volatility based on metrics for comparable companies, and the expected term of the warrants. Since the most significant inputs are unobservable, we have determined that the fair value of the warrants in their entirety should be classified in Level 3 of the fair value hierarchy.
Embedded derivatives: For our embedded derivatives, fair value is computed based upon estimated cash flows of the related preferred interests resulting from any unhedged change in LIBOR, discounted at an appropriate discount rate. This determination is based in part on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. Although the forward curves utilized in the valuation of our embedded derivatives represent Level 2 inputs, the discounted cash flows which are most significant to the overall valuation of these derivatives represent Level 3 inputs. Accordingly, we have determined that the embedded derivatives in their entirety are classified in Level 3 of the fair value hierarchy.
Debts payable at fair value: The allocated portion of the Madison CDO debt is determined using the fair values of the associated investment securities as a benchmark. Depending upon the significance of the fair value inputs used in determining the underlying benchmark fair values, this debt is classified in either Level 2 or Level 3 of the fair value hierarchy.
The following table presents additional information about our assets and liabilities measured at fair value on a recurring basis for which we utilized Level 3 inputs to determine fair value (in thousands):
|
|
Investment |
|
Domestic |
|
VIE Assets |
|
VIE |
|
Mortgage |
|
Mortgage |
|
Derivative |
|
Total |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Balance at December 31, 2012 |
|
$ |
27,052 |
|
133,437 |
|
2,303,973 |
|
(1,981,234 |
) |
200,393 |
|
7,000 |
|
|
|
690,621 |
|
Total realized and unrealized (losses) gains: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Included in earnings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Change in fair value |
|
(8,056 |
) |
(6,285 |
) |
(93,214 |
) |
54,912 |
|
16,825 |
|
|
|
|
|
(35,818 |
) | |
Included in other comprehensive earnings |
|
418 |
|
|
|
|
|
|
|
|
|
|
|
|
|
418 |
| |
Net accretion |
|
92 |
|
|
|
|
|
|
|
|
|
|
|
|
|
92 |
| |
Purchases / Originations / Vesting |
|
16,753 |
|
805 |
|
|
|
|
|
266,990 |
|
|
|
1,280 |
|
285,828 |
| |
Sales |
|
(1,718 |
) |
|
|
|
|
|
|
(262,394 |
) |
|
|
|
|
(264,112 |
) | |
Issuances |
|
|
|
|
|
|
|
(2,992 |
) |
|
|
(7,000 |
) |
|
|
(9,992 |
) | |
Cash repayments / receipts |
|
|
|
|
|
|
|
34,314 |
|
(262 |
) |
|
|
|
|
34,052 |
| |
Transfers into level 3 |
|
13,072 |
|
|
|
141,761 |
|
(141,761 |
) |
|
|
|
|
|
|
13,072 |
| |
Transfers out of level 3 |
|
(126 |
) |
|
|
(85,053 |
) |
85,053 |
|
|
|
|
|
|
|
(126 |
) | |
Consolidations of VIEs |
|
(674 |
) |
|
|
11,103 |
|
(11,103 |
) |
|
|
|
|
|
|
(674 |
) | |
Deconsolidations of VIEs |
|
15,384 |
|
|
|
(9,491 |
) |
9,491 |
|
|
|
|
|
|
|
15,384 |
| |
Balance at March 31, 2013 |
|
$ |
62,197 |
|
127,957 |
|
2,269,079 |
|
(1,953,320 |
) |
221,552 |
|
|
|
1,280 |
|
728,745 |
|
Amount of total (losses) gains for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at March 31, 2013 |
|
$ |
(6,705 |
) |
(6,285 |
) |
(93,214 |
) |
54,912 |
|
(99 |
) |
|
|
|
|
(45,106 |
) |
|
|
Investment |
|
Embedded |
|
Domestic |
|
VIE Assets |
|
VIE |
|
Debts |
|
Mortgage |
|
Total |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Balance at December 31, 2011 |
|
$ |
36,127 |
|
10 |
|
146,555 |
|
2,537,067 |
|
(2,312,534 |
) |
(3,914 |
) |
107,435 |
|
510,746 |
|
Total realized and unrealized gains (losses): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Included in earnings: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Loss on derivative financial instruments |
|
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
(10 |
) | |
Change in fair value |
|
(3,045 |
) |
|
|
(4,792 |
) |
(324,266 |
) |
307,981 |
|
298 |
|
7,695 |
|
(16,129 |
) | |
Included in other comprehensive earnings |
|
1,881 |
|
|
|
|
|
|
|
|
|
|
|
|
|
1,881 |
| |
Net accretion |
|
163 |
|
|
|
|
|
|
|
|
|
|
|
|
|
163 |
| |
Purchases / Originations |
|
11,334 |
|
|
|
|
|
|
|
|
|
|
|
122,450 |
|
133,784 |
| |
Sales |
|
(3,644 |
) |
|
|
|
|
|
|
|
|
|
|
(114,883 |
) |
(118,527 |
) | |
Issuances |
|
|
|
|
|
|
|
|
|
(2,970 |
) |
|
|
|
|
(2,970 |
) | |
Cash repayments / receipts |
|
(9 |
) |
|
|
|
|
|
|
67,280 |
|
|
|
(283 |
) |
66,988 |
| |
Transfers into level 3 |
|
|
|
|
|
|
|
130,301 |
|
(130,301 |
) |
|
|
|
|
|
| |
Transfers out of level 3 |
|
|
|
|
|
|
|
(276,055 |
) |
276,055 |
|
|
|
|
|
|
| |
Consolidations of VIEs |
|
|
|
|
|
|
|
135,738 |
|
(135,738 |
) |
|
|
|
|
|
| |
Deconsolidations of VIEs |
|
|
|
|
|
|
|
(99 |
) |
99 |
|
|
|
|
|
|
| |
Balance at March 31, 2012 |
|
$ |
42,807 |
|
|
|
141,763 |
|
2,202,686 |
|
(1,930,128 |
) |
(3,616 |
) |
122,414 |
|
575,926 |
|
Amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at March 31, 2012 |
|
(3,514 |
) |
|
|
(4,792 |
) |
(324,266 |
) |
307,981 |
|
298 |
|
30 |
|
(24,263 |
) |
The following table presents quantitative information regarding significant unobservable inputs used to value our Level 3 assets and liabilities measured at fair value on a recurring basis.
Level 3 Financial Instruments |
|
Valuation Technique |
|
Significant Unobservable Inputs |
|
Range as of March 31, 2013 |
Investment Securities |
|
Discounted cash flow |
|
Yield |
|
0% to 638.8% |
|
|
|
|
Duration |
|
0 to 7.7 years |
Domestic Servicing Rights Intangible |
|
Discounted cash flow |
|
Debt yield |
|
9% |
|
|
|
|
Discount rate |
|
15% |
VIE Assets |
|
Discounted cash flow |
|
Yield |
|
0% to 704.4% |
|
|
|
|
Duration |
|
0 to 24.5 years |
VIE Liabilities |
|
Discounted cash flow |
|
Yield |
|
0% to 704.4% |
|
|
|
|
Duration |
|
0 to 24.5 years |
Mortgage Loans Held for Sale |
|
Discounted cash flow |
|
Yield |
|
4.3% to 4.9% |
|
|
|
|
Duration |
|
5.0 to 10.0 years |
Derivative Asset |
|
Option-pricing model |
|
Volatility |
|
19% to 68% |
|
|
|
|
Duration |
|
1.5 years |
6. Commitments and Contingent Liabilities
We are subject to various claims, legal actions and complaints arising in the ordinary course of business. In our opinion, the disposition of these matters will not have a material adverse effect on our financial condition, results of operations or cash flows. We are also subject to the usual obligations associated with entering into contracts for the purchase, development and sale of real estate, as well as the management of entities and special servicing of CMBS and mortgage loans in the routine conduct of our business.
We provide commitments to fund capital contributions to certain unconsolidated entities and consolidated joint ventures, as required by the respective partnership agreements or pursuant to approved business plans. These commitments amounted to $126.9 million and $142.4 million at March 31, 2013 and December 31, 2012, respectively, and are not reflected in our condensed consolidated financial statements.
During the year ended December 31, 2011, we entered into an arrangement with a government agency to redevelop a former military air station in Massachusetts into a mixed-use commercial development project. The agreement provides for our phased acquisition and development of property in exchange for cash, the assumption of the government agencys promissory note, and certain revenue sharing rights. The revenue sharing rights are payable based on the gross consideration received by us upon the transfer of all or any portion of the project to a vertical developer. We have recorded a liability of $7.4 million in our condensed consolidated balance sheets at each of March 31, 2013 and December 31, 2012, based on the anticipated profit participation payments to be made under this arrangement.
In connection with the Recapitalization, we recognized an intangible unfavorable lease liability of $11.8 million related to an operating lease for our corporate headquarters in Miami Beach, Florida. This liability is included in accrued expenses and other liabilities and is being amortized over the remaining 8 years of the underlying lease term. Amortization of this liability is reflected in general and administrative expense in our condensed consolidated statements of earnings. The liability was $9.0 million and $9.2 million as of March 31, 2013 and December 31, 2012, respectively. We sublease a portion of this office space and collect sublease income and we lease other premises and office equipment under non-cancelable operating leases with terms expiring through March 2021, exclusive of renewal option periods. At the Recapitalization date, we recognized an intangible favorable lease asset of $1.0 million related to these operating leases. This asset is included in other assets in our condensed consolidated balance sheets. Rental expense and the offsetting rental income related to the subleases are included in general and administrative expense in our condensed consolidated statements of earnings, and were as follows:
|
|
Three months ended March 31, |
| |||
|
|
2013 |
|
2012 |
| |
|
|
|
|
|
| |
Rental Income |
|
$ |
662 |
|
545 |
|
Rental Expense |
|
1,886 |
|
1,770 |
| |
The future minimum rents and sublease income related to all of our existing leases and subleases for each of the next five fiscal years and in the aggregate thereafter are expected to be as follows (in thousands):
|
|
2013 |
|
2014 |
|
2015 |
|
2016 |
|
2017 |
|
Thereafter |
| |
Minimum Rents |
|
$ |
4,569 |
|
6,103 |
|
5,919 |
|
5,249 |
|
4,703 |
|
17,060 |
|
Sublease Income |
|
1,033 |
|
1,223 |
|
1,143 |
|
827 |
|
112 |
|
9 |
| |
7. Subsequent Events
Subsequent events have been considered through June 27, 2013, the date the condensed consolidated financial statements were available to be issued.
In April 2013, Starwood Property Trust and Starwood Capital Group acquired 100% of the outstanding units of LNR Property LLC for a total purchase price of approximately $1.05 billion in cash. In conjunction with the acquisition, our senior debt facility was repaid.
In April 2013, before the condensed consolidated financial statements were available to be issued, we sold certain of our mortgage loans held for sale for their fair value of approximately $231.2 million. The sale proceeds were used in part to repay approximately $161.3 million of the outstanding balance of the repurchase agreement associated with the sold mortgage loans.
Exhibit 99.2
Unaudited Pro Forma Combined Financial Statements
as of March 31, 2013 and for the three months ended March 31, 2013
The following unaudited pro forma combined balance sheet as of March 31, 2013 and the unaudited pro forma combined statement of income for the three months ended March 31, 2013 are based on the historical financial statements of Starwood Property Trust, Inc. (STWD or the Company) and LNR Property LLC (LNR) after giving effect to STWDs acquisition of approximately $859 million of LNRs business. The remainder of the business was acquired by an investment fund controlled by an affiliate of STWDs external manager. The transaction was completed using the acquisition method of accounting and adjustments described in the accompanying notes to the unaudited pro forma combined financial statements have been made as if such acquisition had occurred as of March 31, 2013 for purposes of the unaudited pro forma combined balance sheet and as of January 1, 2013 for purposes of the unaudited pro forma combined income statement for the three months ended March 31, 2013.
The transaction is being accounted for as a business combination using the acquisition method of accounting in accordance with Accounting Standards Codification No. 805 (ASC 805), Business Combinations. Under the acquisition method of accounting, the total estimated cash purchase price of $859 million, together with the estimated fair value of the liabilities assumed in the transaction, is allocated to the tangible and intangible assets acquired, based on their estimated fair values. In preparing the accompanying unaudited pro forma combined financial statements, management has generally allocated its aggregate purchase consideration based upon (i) the amounts reported in the LNR historical financial statements for any assets that are reported at fair value in accordance with LNRs historical accounting policies, or (ii) managements preliminary estimates of fair value. The allocation of the estimated purchase price is preliminary pending finalization of managements estimates and/or adjusting for any differences between LNRs estimate of the fair value of certain assets and that of STWD. Final purchase accounting adjustments may differ materially from the pro forma adjustments presented herein.
The unaudited pro forma combined financial statements are based upon available information, preliminary estimates and certain assumptions that we believe are reasonable in the circumstances, as set forth in the notes to the unaudited pro forma financial statements. The unaudited pro forma combined financial statements do not take into account any synergies or cost savings that may be realized as a result of the acquisition.
The unaudited pro forma combined financial statements are presented for informational purposes only and are not necessarily indicative of the future financial position or results of operations of the combined company or the combined financial position or the results of operations that would have been realized had the acquisition transaction been consummated during the period or as of the dates for which the unaudited pro forma combined financial statements are presented.
Certain conforming reclassification adjustments have been made to the STWD and LNR historical financial statement presentations. The pro forma financial information should be read in conjunction with, and is qualified by reference to STWDs historical consolidated financial statements and notes thereto, and those of LNR, which are included herein.
Starwood Property Trust, Inc.
Unaudited Pro Forma
Combined Balance Sheet
March 31, 2013
(Amounts in thousands, except share and per share data)
|
|
Historical 3/31/13 |
|
Historical |
|
LNR Pro Forma |
|
STWD Pro |
|
STWD |
| |||||
Assets |
|
|
|
|
|
|
|
|
|
|
| |||||
Cash & cash equivalents |
|
$ |
173,074 |
|
$ |
225,105 |
|
$ |
(225,105 |
)(A) |
$ |
(53,028 |
)(A) |
$ |
120,046 |
|
Restricted cash |
|
41,469 |
|
1,821 |
|
23,100 |
(B) |
|
|
66,390 |
| |||||
Loans held for investment |
|
2,530,489 |
|
8,237 |
|
|
|
|
|
2,538,726 |
| |||||
Loans held for sale |
|
378,690 |
|
|
|
|
|
|
|
378,690 |
| |||||
Loans held for sale at fair value |
|
|
|
221,552 |
|
|
|
|
|
221,552 |
| |||||
Loans transferred as secured borrowings |
|
85,763 |
|
|
|
|
|
|
|
85,763 |
| |||||
Mortgage-backed securities, available-for-sale |
|
635,533 |
|
|
|
|
|
|
|
635,533 |
| |||||
Investment securities, at fair value |
|
|
|
71,018 |
|
|
|
|
|
71,018 |
| |||||
Securities, held to maturity |
|
|
37,190 |
|
|
|
|
|
|
|
|
37,190 |
| |||
Land held for investment |
|
|
|
92,280 |
|
(92,280 |
)(C) |
|
|
|
| |||||
Investment in unconsolidated entities |
|
|
|
230,033 |
|
(133,271 |
)(D) |
|
|
96,762 |
| |||||
Other investments |
|
430,044 |
|
|
|
|
|
|
|
430,044 |
| |||||
Receivable for securities sold |
|
206,608 |
|
|
|
|
|
|
|
206,608 |
| |||||
Derivative assets |
|
14,933 |
|
4,367 |
|
|
|
|
|
19,300 |
| |||||
Intangible assets - servicing rights |
|
|
|
136,438 |
|
26,519 |
(E) |
|
|
162,957 |
| |||||
Other intangible assets acquired |
|
|
|
|
|
12,800 |
(F) |
|
|
12,800 |
| |||||
Goodwill |
|
|
|
237,538 |
|
(88,893 |
)(G) |
|
|
148,645 |
| |||||
Accrued interest |
|
20,500 |
|
|
|
|
|
|
|
20,500 |
| |||||
Other assets |
|
56,675 |
|
35,867 |
|
(3,108 |
)(H) |
7,122 |
(J) |
96,556 |
| |||||
Variable interest entity assets, at fair value |
|
|
|
92,490,515 |
|
|
|
|
|
92,490,515 |
| |||||
Total Assets |
|
$ |
4,610,968 |
|
$ |
93,754,771 |
|
$ |
(480,238 |
) |
$ |
(45,906 |
) |
$ |
97,839,595 |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Liabilities |
|
|
|
|
|
|
|
|
|
|
| |||||
Accounts payable, accrued expenses, and other liabilities |
|
$ |
66,078 |
|
$ |
82,255 |
|
$ |
(18,016 |
)(I) |
$ |
(5,400 |
)(N) |
$ |
124,917 |
|
Related party payable |
|
11,110 |
|
|
|
|
|
|
|
11,110 |
| |||||
Dividends payable |
|
60,147 |
|
|
|
|
|
|
|
60,147 |
| |||||
Derivative liabilities |
|
17,468 |
|
894 |
|
|
|
|
|
18,362 |
| |||||
Secured financing agreements |
|
1,027,820 |
|
137,532 |
|
|
|
300,000 |
(J) |
1,465,352 |
| |||||
Convertible senior notes |
|
560,423 |
|
|
|
|
|
|
|
560,423 |
| |||||
Loan transfer secured borrowings |
|
87,523 |
|
|
|
|
|
|
|
87,523 |
| |||||
Debts Payable |
|
|
|
275,811 |
|
(222,783 |
)(A) |
(53,028 |
)(A) |
|
| |||||
Variable interest entity liabilities, at fair value |
|
|
|
92,151,320 |
|
|
|
|
|
92,151,320 |
| |||||
Total Liabilities |
|
1,830,569 |
|
92,647,812 |
|
(240,799 |
) |
241,572 |
|
94,479,154 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Equity |
|
|
|
|
|
|
|
|
|
|
| |||||
Preferred stock, $0.01 per share, 100,000,000 shares authorized, no shares issued and outstanding |
|
|
|
|
|
|
|
|
|
|
| |||||
Common stock, $0.01 per share, 500,000,000 shares authorized, and 136,326,045 issued and 135,700,195 outstanding as of March 31, 2013 |
|
1,363 |
|
|
|
|
|
216 |
(K) |
1,579 |
| |||||
Additional paid in capital |
|
2,754,491 |
|
|
|
|
|
582,730 |
(K) |
3,337,221 |
| |||||
Treasury stock (625,850 shares as of March 31, 2013) |
|
(10,642 |
) |
|
|
|
|
|
|
(10,642 |
) | |||||
Accumulated other comprehensive income |
|
70,544 |
|
7,705 |
|
(7,705 |
)(L) |
|
|
70,544 |
| |||||
Members equity |
|
|
|
509,255 |
|
(509,255 |
)(L) |
|
|
|
| |||||
(Accumulated deficit) retained earnings |
|
(70,305 |
) |
581,280 |
|
(581,280 |
)(L) |
(11,623 |
)(M) |
(81,928 |
) | |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Total STWD Stockholders Equity |
|
2,745,451 |
|
|
|
|
|
571,323 |
|
3,316,774 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Total Members Equity |
|
|
|
1,098,240 |
|
(1,098,240 |
) |
|
|
|
| |||||
Non-controlling interests in consolidated subsidiaries |
|
34,948 |
|
8,719 |
|
|
|
|
|
43,667 |
| |||||
Total Equity |
|
2,780,399 |
|
1,106,959 |
|
(1,098,240 |
) |
571,323 |
|
3,360,441 |
| |||||
Total Liabilities & Equity |
|
$ |
4,610,968 |
|
$ |
93,754,771 |
|
$ |
(1,339,039 |
) |
$ |
812,895 |
|
$ |
97,839,595 |
|
Starwood Property Trust, Inc.
Unaudited Pro Forma
Combined Income Statement
Three months Ended March 31, 2013
(Amounts in thousands, except share and per share data)
|
|
Historical |
|
Historical |
|
LNR |
|
STWD |
|
STWD |
| |||||
Revenues: |
|
|
|
|
|
|
|
|
|
|
| |||||
Interest income from mortgage-backed securities |
|
$ |
15,428 |
|
$ |
5,309 |
|
$ |
|
|
$ |
|
|
$ |
20,737 |
|
Interest income from loans |
|
67,765 |
|
1,805 |
|
|
|
|
|
69,570 |
| |||||
Servicing fees |
|
|
|
43,158 |
|
|
|
|
|
43,158 |
| |||||
Management fees |
|
|
|
4,269 |
|
(3,783 |
)(A) |
|
|
486 |
| |||||
Rental income & other fees |
|
|
|
318 |
|
(54 |
)(A) |
|
|
264 |
| |||||
Total revenues |
|
83,193 |
|
54,859 |
|
(3,837 |
) |
|
|
134,215 |
| |||||
Costs and Expenses: |
|
|
|
|
|
|
|
|
|
|
| |||||
General and administrative |
|
4,286 |
|
41,124 |
|
(3,019 |
)(A) |
|
|
42,391 |
| |||||
Management fees |
|
14,275 |
|
|
|
|
|
6,963 |
(E) |
21,238 |
| |||||
Interest |
|
16,987 |
|
4,889 |
|
(3,971 |
)(B) |
2,879 |
(F) |
20,784 |
| |||||
Business combination costs |
|
4,391 |
|
|
|
|
|
|
|
4,391 |
| |||||
Investment pursuit costs |
|
81 |
|
|
|
|
|
|
|
81 |
| |||||
Cost of rental operations |
|
|
|
274 |
|
(274 |
)(A) |
|
|
|
| |||||
Depreciation and amortization |
|
|
|
1,157 |
|
447 |
(C) |
|
|
1,604 |
| |||||
Loan loss allowance |
|
30 |
|
|
|
|
|
|
|
30 |
| |||||
Total costs and expenses |
|
40,050 |
|
47,444 |
|
(6,817 |
) |
9,842 |
|
90,519 |
| |||||
Income before other income (expense) and income taxes |
|
43,143 |
|
7,415 |
|
2,980 |
|
(9,842 |
) |
43,696 |
| |||||
Income of consolidated VIEs, net |
|
|
|
32,060 |
|
|
|
|
|
32,060 |
| |||||
Equity in earnings and impairments of unconsolidated entities |
|
|
|
348 |
|
1,445 |
(A) |
|
|
1,793 |
| |||||
Net gains on sales of investments |
|
13,859 |
|
169 |
|
(169 |
)(A) |
|
|
13,859 |
| |||||
Net gains (losses) on derivative instruments |
|
16,228 |
|
(379 |
) |
|
|
|
|
15,849 |
| |||||
Change in fair value of mortgages held for sale |
|
|
|
16,722 |
|
|
|
|
|
16,722 |
| |||||
Other-than-temporary impairments on mortgage-backed securities |
|
(42 |
) |
|
|
|
|
|
|
(42 |
) | |||||
Change in fair value of investment securities, at fair value |
|
405 |
|
(7,544 |
) |
|
|
|
|
(7,139 |
) | |||||
Change in fair value of servicing rights |
|
|
|
(6,285 |
) |
|
|
|
|
(6,285 |
) | |||||
Foreign currency (losses) gains |
|
(7,666 |
) |
392 |
|
|
|
|
|
(7,274 |
) | |||||
Other (expense) income, net |
|
(1,726 |
) |
1,415 |
|
(135 |
)(A) |
|
|
(446 |
) | |||||
Income from continuing operations before income taxes |
|
64,201 |
|
44,313 |
|
4,121 |
|
(9,842 |
) |
102,793 |
| |||||
Income tax (provision) benefit |
|
(777 |
) |
(1,122 |
) |
(10,637 |
)(D) (F) |
|
|
(12,536 |
) | |||||
Net income from continuing operations before non-controlling interests |
|
63,424 |
|
43,191 |
|
(6,516 |
) |
(9,842 |
) |
90,257 |
| |||||
Net (income) loss attributable to non-controlling interests |
|
(1,181 |
) |
(738 |
) |
|
|
|
|
(1,919 |
) | |||||
Income from continuing operations |
|
$ |
62,243 |
|
$ |
42,453 |
|
$ |
(6,516 |
) |
$ |
(9,842 |
) |
$ |
88,338 |
|
Diluted Earnings Per Share - As Previously Reported |
|
$ |
0.46 |
|
|
|
|
|
|
|
|
| ||||
Diluted Earnings Per Share - Pro Forma |
|
|
|
|
|
|
|
|
|
$ |
0.56 |
(G) |
Notes to Unaudited Pro Forma
Combined Financial Statements
1. Description of Transaction
On April 19, 2013, Starwood Property Trust, Inc. (STWD or the Company) acquired, from the owners of LNR Property LLC (LNR), the following LNR business segments for a total cash purchase price of approximately $859 million. The remainder of the LNR businesses, totaling approximately $190 million, were acquired by an investment fund controlled by an affiliate of STWDs external manager, and are not reflected herein:
· U.S. Special Servicer A U.S. special servicer of commercial loans with over $128.9 billion in loans under management and real estate owned as of March 31, 2013;
· U.S. Investment Securities Portfolio a portfolio of whole loans, CMBS and collateralized debt obligation (CDO) investments;
· Archetype Mortgage Capital (AMC) a commercial real estate conduit loan origination platform;
· Archetype Financial Institution Services an acquirer, manager, and servicer of portfolios of small balance commercial loans;
· LNR Europe consists of Hatfield Philips, a wholly-owned subsidiary that is an independent primary and special servicer in Europe, and a non-controlling interest in LNR European Investment Fund, a European CRE debt fund; and
· Auction.com (ADC) 50 percent of LNRs interest in a real estate exchange selling residential and commercial real estate via auction.
2. Funding Sources
STWD funded the acquisition of LNR with cash. In addition to the purchase price of $859 million described above, STWD incurred transaction and financing costs aggregating $24 million. The sources for the purchase price and transaction costs were as follows (amounts in thousands, except shares and share price):
Issuance of 21,602,594 shares of common stock, at an offering price of $26.985 (price of the common stock offering which priced on April 9, 2013) |
|
$ |
582,946 |
|
Borrowings under term loan closed on April 19, 2013 |
|
300,000 |
| |
Total Sources |
|
$ |
882,946 |
|
3. Fair value of assets acquired, liabilities assumed, and calculation of goodwill
In accordance with the guidelines for preparing pro forma financial statements, the total purchase price has been allocated in the accompanying unaudited pro forma combined financial statements based upon (i) the amounts reported in the LNR historical financial statements for any assets that are reported at fair value in accordance with LNRs historical accounting policies, or (ii) managements preliminary estimates of fair value. The allocation to LNRs tangible and intangible assets and liabilities under this methodology as if the transaction occurred as of March 31, 2013, is as follows (amounts in thousands):
Assets Acquired |
|
|
| |
Cash |
|
$ |
|
|
Restricted cash |
|
24,921 |
| |
Mortgage loans held for investment |
|
8,237 |
| |
Mortgage loans held for sale |
|
221,552 |
| |
Investment securities |
|
71,018 |
| |
Investment in unconsolidated entities |
|
96,762 |
| |
Servicing rights |
|
162,957 |
| |
Net equity in variable interest entity assets (a) |
|
339,195 |
| |
Other intangible assets |
|
12,800 |
| |
Other assets, restricted cash, derivative assets, and accrued interest |
|
37,126 |
| |
Liabilities Assumed |
|
|
| |
Accounts payable,accrued expenses, and other liabilities |
|
(65,134 |
) | |
Secured financing arrangements |
|
(137,532 |
) | |
Debts payable |
|
(53,028 |
) | |
Non-controlling interests |
|
(8,719 |
) | |
Net assets acquired |
|
$ |
710,155 |
|
(a) Represents the excess fair value of variable interest entity assets of $92,490,515 over variable interest entity liabilities of $92,151,320.
Goodwill represents the excess of the purchase price over the fair value of the underlying net tangible and identifiable intangible assets acquired and liabilities assumed. This determination of goodwill is preliminary, and is subject to change when the evaluation is complete. A preliminary determination of the goodwill is as follows (amounts in thousands):
Total purchase price |
|
$ |
858,800 |
|
Preliminary estimate of the fair value of the net assets acquired |
|
(710,155 |
) | |
Goodwill |
|
$ |
148,645 |
|
4. Pro Forma Adjustments
The accompanying unaudited pro forma combined financial statements have been prepared as if the acquisition had occurred as of March 31, 2013 for balance sheet purposes and as of January 1, 2013 for income statement purposes and reflect the following pro forma adjustments (amounts in thousands, except share and per share amounts):
Pro Forma Unaudited Combined Balance Sheet as of March 31, 2013:
(A) Reflects (i) the required repayment of an LNR credit facility in connection with the transaction, which had an outstanding balance of $268,125 as of March 31, 2013, (ii) in LNR column an adjustment to eliminate $10,008 of cash related to the portion of LNR that STWD did not acquire, and (iii) in LNR column an adjustment to eliminate $7,686 of debts payable which STWD did not assume.
(B) Adjustment to add the estimated funds that were required to be transferred to a trust in connection with the transaction, with such funds being reserved for future distributions to certain LNR employees to the extent that they voluntarily continue their employment for a period of nine months subsequent to the transaction closing.
(C) Adjustment to eliminate LNRs investments in land and land development, which STWD did not acquire.
(D) Net adjustment to eliminate LNRs investments in unconsolidated entities which STWD did not acquire, and to reflect the fair value of LNRs investments in unconsolidated entities that STWD acquired. The aggregate estimated fair value of the investments acquired is $96.8 million, which is principally comprised of 50% of LNRs non-controlling equity investment in Auction.com and its non-controlling interest in a European debt venture.
(E) Represents an adjustment to reflect the estimated fair value of the portion of special servicing rights that STWD acquired that were not reported at fair value in LNRs March 31, 2013 balance sheet.
(F) Adjustment reflects the estimated fair value of the other intangible assets acquired, including internally developed technology, customer relationships, and other contracts and arrangements.
(G) Represents goodwill related to the transaction. See Note 3 to these unaudited pro forma combined financial statements.
(H) Represents an adjustment to reflect the estimated fair value of other assets that STWD acquired.
(I) Adjustments to eliminate the accounts payable and accrued liabilities, and other liabilities, respectively, related to the commercial property division of LNR that STWD did not assume.
(J) In connection with closing the acquisition, STWD entered into a $300 million term loan facility that has a seven year term and an expected interest rate of 3.5% and an overall borrowing cost of 3.84% per annum. In addition, the fees to obtain the facility were $7,122, which are reflected as an adjustment to other assets.
(K) Represents the assumed issuance of 21,602,594 shares of STWD common stock, at an offering price of $26.985 (the price of the common stock offering which priced on April 9, 2013), as described in Note 2 to the unaudited pro forma combined financial statements.
(L) Adjustment represents the elimination of LNRs historical equity in combination.
(M) Represents the estimated total third party costs not already accrued and incurred through March 31 2013, such as merger and acquisition fees to STWDs advisor on the transaction, as well as legal, accounting, and other third party due diligence costs. All such costs are required to be expensed immediately in the income statement under ASC 805. As required by the pro forma financial statement guidelines, such amounts have not been reflected in the unaudited pro forma combined income statement for the three months ended March 31, 2013 as they do not have a recurring impact on net income, but are reflected as an adjustment to Accumulated deficit in the March 31, 2013 unaudited pro forma combined balance sheet.
(N) Represents the payment of business combination costs that were accrued as of March 31, 2013 in the STWD balance sheet.
Pro Forma Unaudited Combined Income Statement for the Three months Ended March 31, 2013:
(A) Adjustment represents the elimination of revenues, expenses, and gains related to the commercial property division of LNR, which STWD did not acquire.
(B) Adjustment represents the elimination of interest expense related to borrowings under an LNR credit facility that is required to be repaid in connection with the transaction. See discussion of the debt repayment in Note (A) to the pro forma combined balance sheet.
(C) Represents an adjustment to increase depreciation and amortization based upon the preliminary estimates of fair value of certain tangible and intangible assets, as disclosed in Note 3 to the unaudited combined pro forma financial statements.
(D) STWD has previously elected to be taxed as a real estate investment trust (REIT) for U.S. federal income tax purposes. Accordingly, STWD is not subject to federal income tax as long as certain asset, income, dividend distribution and stock ownership tests are met. A REITs net income from prohibited transactions is subject to a 100% penalty tax. STWD intends to conduct certain of the business activities that will be acquired from LNR in one or more taxable REIT subsidiaries (TRSs), primarily the loan servicing and loan conduit operations, as well as its investment in ADC. Certain investments may be made and activities conducted in a TRS that (i) may otherwise be subject to the prohibited transactions tax and (ii) may not be favorably treated for purposes of complying with the various requirements for REIT qualification. The income, if any, within a TRS is subject to federal and state income taxes applicable to domestic C corporations. This adjustment represents the estimated additional income tax expense that would have been incurred had STWD conducted such activities in TRS entities during the three months ended March 31, 2013, based upon statutory rates. This adjustment has been made for pro forma financial statement purposes only, and does not represent income tax obligations that will be assumed or paid by STWD in connection with the transaction, or income taxes that will be incurred in the future.
(E) Represents an adjustment to add the incremental base management and incentive fees that would be incurred as a result of the assumed equity offering as described in Note 2 to the unaudited combined pro forma financial statements and Note (K) to the unaudited combined pro forma balance sheet, as well as LNRs operating results for the three months ended March 31, 2013.
The base management fee is calculated as follows:
Assumed proceeds from equity raise |
|
$ |
582,946 |
|
Annual base management fee rate |
|
1.50 |
% | |
Annual base management fee (on annual basis) |
|
$ |
8,744 |
|
Annual base management fee (for one quarter) |
|
$ |
2,186 |
|
The incremental incentive fee adjustment of $4,841 represents the additional incentive fee that would have been incurred if the assumed equity issuance described in footnote (K) of the notes to the unaudited pro forma combined balance sheet had occurred on January 1, 2013, and the Core earnings of LNR, calculated using the amounts in LNRs income statement for the three months ended March 31, 2013 in accordance with the STWD definition, were both incorporated into STWDs historical Core earnings computation in the fourth quarter of 2013. Refer to note 9 of STWDs 2013 consolidated financial statements for a description of the incentive fee terms.
(F) As disclosed in Note (J) to the unaudited combined pro forma balance sheet, STWD entered into a $300 million term loan facility that has a seven year term and an expected interest rate of 3.5% and an overall borrowing cost of 3.84% per annum in connection with closing the LNR acquisition.
(G) Represents the pro forma combined earnings per share, including the impact of the common equity issuance that is assumed in Note 2 to the combined pro forma financial statements, calculated as follows (amounts in thousands except for share and per share amounts):
|
|
As Reported |
|
Pro Forma |
| ||
Income from continuing operations attributable to Starwood Property Trust, Inc. |
|
$ |
62,243 |
|
$ |
88,338 |
|
Income allocated to participating securities |
|
(454 |
) |
(454 |
) | ||
Numerator for basic and diluted earnings per share |
|
$ |
61,789 |
|
$ |
87,884 |
|
Weighted average shares used in diluted earnings per share |
|
135,479,543 |
|
157,082,137 |
| ||
Diluted income per share |
|
$ |
0.46 |
|
$ |
0.56 |
|