-----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, J2HTy+rowfDJFaENq0KMjq3RuzV4wTB8KJ8b5pUtIMZZdHr45Rd8Uj9W/N/KD9Wn sZZkL+t+QZPKh2Zz5cLLbQ== 0000903112-00-000612.txt : 20000331 0000903112-00-000612.hdr.sgml : 20000331 ACCESSION NUMBER: 0000903112-00-000612 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPITAL TRUST INC CENTRAL INDEX KEY: 0001061630 STANDARD INDUSTRIAL CLASSIFICATION: MORTGAGE BANKERS & LOAN CORRESPONDENTS [6162] IRS NUMBER: 946181186 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-14788 FILM NUMBER: 586624 BUSINESS ADDRESS: STREET 1: 605 THIRD AVE CITY: NEW YORK STATE: NY ZIP: 10016 BUSINESS PHONE: 2126550220 MAIL ADDRESS: STREET 1: BATTLE FOWLER LLP STREET 2: 75 E 55TH ST CITY: NEW YORK STATE: NY ZIP: 10022 10-K 1 FORM 10K As filed with the Securities and Exchange Commission on March 30, 2000 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1999 ----------------- [ ] 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.) 605 Third Avenue, 26th Floor, New York, NY 10016 - ------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 655-0220 -------------- Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class on Which Registered ------------------- ------------------- Class A Common Stock, New York Stock Exchange $0.01 par value ("Class A Common Stock")
Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for at least the past 90 days. Yes X No __ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] MARKET VALUE ------------ Based on the closing sales price of $3 13/16 per share, the aggregate market value of the outstanding Class A Common Stock held by non-affiliates of the registrant as of March 20, 2000 was $50,402,000. OUTSTANDING STOCK ----------------- As of March 20, 2000 there were 22,318,828 outstanding shares of Class A Common Stock. The Class A Common Stock is listed on the New York Stock Exchange (trading symbol "CT"). Trading is reported in many newspapers as "CapitalTr". DOCUMENTS INCORPORATED BY REFERENCE ----------------------------------- Part III incorporates information by reference from the Registrant's definitive proxy statement to be filed with the Commission within 120 days after the close of the Registrant's fiscal year.
- ------------------------------------------------------------------------------ CAPITAL TRUST, INC. - ------------------------------------------------------------------------------ PAGE Explanatory Note Regarding Succession Transaction ii Explanatory Note Regarding Forward-Looking Statements Safe Harbor ii - ------------------------------------------------------------------------------ PART I - ------------------------------------------------------------------------------ Item 1. Business 1 Item 2. Properties 13 Item 3. Legal Proceedings 13 Item 4. Submission of Matters to a Vote of Security Holders 14 - ------------------------------------------------------------------------------ PART II - ------------------------------------------------------------------------------ Item 5. Market for the Registrant's Common Equity and Related Security Holder Matters 15 Item 6. Selected Financial Data 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 25 Item 8. Financial Statements and Supplementary Data 27 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 27 - ------------------------------------------------------------------------------ PART III - ------------------------------------------------------------------------------ Item 10. Directors and Executive Officers of the Registrant 28 Item 11. Executive Compensation 28 Item 12. Security Ownership of Certain Beneficial Owners and Management 28 Item 13. Certain Relationships and Related Transactions 28 - ------------------------------------------------------------------------------ PART IV - ------------------------------------------------------------------------------ Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 29 - ------------------------------------------------------------------------------ Signatures 33 Index to Consolidated Financial Statements F-1
-i- EXPLANATORY NOTE REGARDING SUCCESSION TRANSACTION - ------------------------------------------------- Capital Trust, Inc., a Maryland corporation (the "Company"), is the successor to Capital Trust, a California business trust (the "Predecessor"), following consummation of the reorganization whereby the Predecessor ultimately merged with and into the Company. Upon consummation of the Reorganization, the entire class of class A common stock, par value $0.01 per share, of the Company became registered under Section 12(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), in accordance with Rule 12g-3(a) thereunder. The Commission assigned a new file number (File No. 1-14788), replacing the Predecessor's file number (File No. 1-8063), for use in periodic filings required under the Exchange Act and the rules thereunder. EXPLANATORY NOTE REGARDING FORWARD-LOOKING STATEMENTS SAFE HARBOR - ----------------------------------------------------------------- Except for historical information contained herein, this annual report on Form 10-K 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 strategy and portfolio management. The Company's actual results or outcomes may differ materially from those anticipated. Important factors that the Company believes might cause such differences are discussed in the cautionary statements presented under the caption "Factors which may Affect the Company's Business Strategy" in Item 1 of this Form 10-K or otherwise accompany the forward-looking statements contained in this Form 10-K. In assessing forward-looking statements contained herein, readers are urged to read carefully all cautionary statements contained in this Form 10-K. -ii- PART I - ------------------------------------------------------------------------------ Item 1. Business - ------------------------------------------------------------------------------ General - ------- Capital Trust, Inc. (the "Company") is an investment management and real estate finance company designed to take advantage of high-yielding lending and investment opportunities in commercial real estate and related assets. The Company, for its own account and as an investment manager, makes investments in various types of income-producing commercial real estate and its current investment program emphasizes senior and junior commercial mortgage loans, certificated mezzanine investments, direct equity investments and subordinated interests in commercial mortgage-backed securities ("CMBS"). Pursuant to the Company's current business strategy, the Company seeks to manage its portfolio of loans and other assets such that a majority of the Company's investments are subordinate to third-party financing but senior to the owner/operator's equity position and therefore represent "mezzanine" capital. As discussed herein, the Company recently entered into a strategic relationship with Citigroup Investments Inc. ("Citigroup"), pursuant to which, among other things, affiliates of the parties will co-sponsor, commit to invest capital in and manage a series of high-yield commercial real estate mezzanine investment opportunity funds (collectively, "Mezzanine Funds"). This venture represents a new strategic direction for the Company as it transitions itself from primarily a balance sheet lender to an investment management firm engaged in originating, structuring and managing high-yield real estate financial assets for third party investment funds. It is the intent of the Company to invest in these funds, to continue to aggressively manage its existing investment portfolio, and to selectively add investments to its portfolio that do not conflict with its role as exclusive investment manager to the Mezzanine Funds. The Company also provides real estate investment banking, advisory and asset management services through its wholly owned subsidiary, Victor Capital Group, L.P. ("Victor Capital"). The Company otherwise remains positioned opportunistically to invest on balance sheet in a diverse array of real estate and finance-related assets and enterprises, including operating companies, which satisfy its investment criteria. Unless the context otherwise requires, "the Company" means Capital Trust, Inc., a Maryland Corporation, its consolidated subsidiaries and its predecessor, Capital Trust (f/k/a California Real Estate Investment Trust, a California business trust (the "Predecessor")). In executing its business plan, the Company utilizes the extensive real estate industry contacts and relationships of Equity Group Investments, L.L.C. ("EGI"). EGI is a privately held real estate and corporate investment firm controlled by Samuel Zell, who serves as chairman of the board of directors of the Company. Mr. Zell is chairman of the board of trustees of Equity Office Properties Trust and Equity Residential Properties Trust, the largest U.S. real estate investment trusts ("REITs") operating in the office and multifamily residential sectors, respectively. The Company also draws upon the extensive client roster of Victor Capital for potential investment opportunities and expects to realize origination synergies from its strategic relationship with Citigroup and its affiliates, which together constitute the most global financial services company, providing some 100 million consumers, corporations and institutions with a broad array of financial products and services. Strategic Relationship with Citigroup On March 8, 2000, the Company entered into a strategic relationship with Citigroup in connection with commencing its new investment management business. Together, the strategic partners have agreed, among other things, to co-sponsor, commit to invest capital in, and manage a series of Mezzanine Funds. In connection with this relationship, Citigroup and the Company have made capital commitments to the Mezzanine Funds of up to an aggregate of $400.0 million and $112.5 million, respectively, subject to certain terms and conditions. -1- The strategic relationship is governed by a venture agreement, dated as of March 8, 2000 (the "Venture Agreement"), pursuant to which the parties have created CT Mezzanine Partners I LLC ("Fund I"), funded with capital commitments of $150 million and $50 million from Citigroup and the Company, respectively, subject to identification of suitable investments of suitable investments acceptable to Citigroup and the Company. A wholly owned subsidiary of the Company serves as the exclusive investment manager to Fund I, which is currently negotiating suitable investments for the fund. Additionally, Citigroup and the Company have agreed to additional capital commitments of up to $250.0 million and $62.5 million, respectively, to future co-sponsored Mezzanine Funds that close prior to December 31, 2001 subject to third-party capital commitments and other conditions contained the Venture Agreement. Pursuant to the Venture Agreement, an affiliate of the Company has been named the exclusive investment manager to the Mezzanine Funds. Further, each party has agreed to certain exclusivity obligations with respect to the origination of assets suitable for the Mezzanine Funds and the Company granted Citigroup the right of first refusal to co-sponsor future Mezzanine Funds. The Company has also agreed, as soon as practicable, to take the steps necessary for it to be treated as a REIT for tax purposes subject to changes in law, or good faith inability to meet the requisite qualifications. Unless the Company can find a suitable "reverse merger" REIT candidate, the earliest that the Company can qualify for re-election to REIT status will be upon filing its tax return for the year ended December 31, 2002. The Company believes that its new business venture with Citigroup emphasizes its strengths and provides it with the building blocks for a scalable platform for high quality earnings growth. It also shifts the Company's focus from that of a "balance sheet" lender to that of an investment manager. The investment management business, as structured with Citigroup, also allows the Company to tap the private equity markets as a source of fresh capital to fund its business. The venture further provides the potential for significant operating leverage allowing the Company to grow earnings and to increase return on equity without simply incurring additional financial risk. Developments During Fiscal Year 1999 - ------------------------------------ Fiscal year 1999 represented the Company's second full year of operations as a specialty finance and advisory company. During the year, the Company increased its total asset base to $827.8 million at December 31, 1999 from $766.4 million at December 31, 1998. The Company's growth was primarily the result of its originating and funding approximately $302 million of new loan and investment assets and further advances under existing unfunded commitments net of $211 million of repayments, satisfactions and dispositions. The Company funded this increase in assets with credit obtained pursuant to a term redeemable securities contract entered into in connection with the purchase of a portfolio of CMBS assets as described below. The Company believes that its Credit Facilities (as hereinafter defined) and the proceeds from capital raising activities provide the Company with the capital necessary to meet its capital commitments to the Mezzanine Funds, and as permitted, to expand and diversify its portfolio of loans and other investments enabling the Company to compete for and consummate larger transactions meeting the Company's target risk/return profile. In addition to traditional capital sources, the Company has explored, and will continue to explore, diversified capital sources to fund its investment activities including, but not limited to, other joint-ventures, strategic alliances and money management ventures. Since December 31, 1998, the Company has identified, negotiated and committed to fund or acquire five loans and investments. These include three Mortgage Loans (as hereinafter defined) totaling $45.0 million, one corporate loan for $52.5 million, which the Company classified in other loans, and a diversified portfolio of "BB" rated CMBS Subordinated Interests (as hereinafter defined) with an aggregate face amount of $246.0 million which were purchased for $196.9 million. The Company also funded $7.2 million of commitments under four loans and Certificated Mezzanine Investments (as hereinafter defined) originated in prior periods. These increases were offset by the full satisfaction of seven loans totaling $190.5 million and the recording of a write-down on one loan asset for $500,000 and the subsequent sale of it for $9.5 million, at net book value, during the period. The Company also received $10.8 million of partial repayments on loans and Certificated Mezzanine Investments. At December 31, 1999, the Company had outstanding loans, certificated mezzanine investments and investments in CMBS totaling -2- approximately $777 million and additional commitments for fundings on outstanding loans and certificated mezzanine investments of approximately $30.8 million. During 1999, the Company accessed $137.8 million of additional credit through its borrowing under the Term Redeemable Securities Contract in conjunction with its BB CMBS Portfolio acquisition (as hereinafter defined). The Company also extended the maturity of its two Credit Facilities by more than one year on each facility. As of December 31, 1999, the Company's portfolio of financial assets consisted of ten Mortgage Loans, ten Mezzanine Loans, two Certificated Mezzanine Investments, four other loans, including the corporate loan issued in 1999, (collectively the "Loan Portfolio") and 18 classes of CMBS Subordinated Interests (together with the Loan Portfolio, the "Investment Portfolio"). At December 31, 1999, one Senior Mortgage Loan with a principal balance of $21,114,000 was in default due to the loan maturing on December 29, 1999; at December 31, 1999, the loan was earning a fixed interest rate of 20% (the default rate) and was repaid in full with interest on January 7, 2000. During 1999, the Company recorded a write-down of one loan asset by $500,000 and subsequently sold it for $9.5 million, at book value. There were no other delinquencies or losses on such assets as of December 31, 1999 and for the year then ended. The table set forth below details the composition of the Investment Portfolio at December 31, 1999.
Underlying Number Type of Loan/ Property of Loans/ Original Outstanding Unfunded Current Interest Investment Type Investments Commitment Face Amount Commitment Maturity Rate - ----------- ---------- ----------- ---------- ----------- ---------- -------- -------------- Senior Mortgage Office/ 7 $ 195,477,000 $ 176,775,000 $ 14,808,000 1999 to Fixed: 20.00% Loans Retail/ 2001 Variable: LIBOR + Hotel 3.20% to LIBOR + 10.00% Subordinate Office/ 3 102,000,000 93,557,000 8,443,000 2000 to Variable: LIBOR + Mortgage Loans Hotel 2001 5.08% to LIBOR + 7.00% Mezzanine Loans Office/ 10 212,045,000 191,673,000 -- 2000 to Fixed: 10.81% to Retail/ 2008 12.50% Assisted Variable: LIBOR + Living/ 5.25% to LIBOR + Hotel 8.25% Certificated Office 2 54,466,000 45,432,000 7,536,000 2000 Variable: LIBOR + Mezzanine 3.95% to LIBOR + Investments 5.50% CMBS (1) Various 18 282,526,000 282,526,000 -- 2003 to Fixed: 7.00% to 2114 9.16% Variable: LIBOR + 2.75% to LIBOR + 7.00% Other Loans Retail/ 4 55,050,000 54,471,000 -- 2000 to Fixed: 9.50% Commercial/ 2017 Variable: LIBOR + Corporate 5.00% to LIBOR + 6.00% Total 44 $901,564,000 $844,4345,000 $ 30,787,000 == ============ ============ ============
(1) With respect to the CMBS, in 1998, the Company purchased $36,509,000 face amount of interests in three classes of CMBS Subordinated Interests issued by a financial asset securitization investment trust for $36,335,000, which, at December 31, 1999, had an amortized cost of $36,396,000 and a market value of $33,089,000. In March 1999, the Company purchased 15 "BB" rated CMBS subordinated interest securities from 11 separate issues (the "BB CMBS Portfolio") with an aggregate face amount of $246.0 million for $196.9 million. In connection with the transaction, an affiliate of the seller provided three-year term financing for 70% of the purchase price at a floating rate above the London Interbank Offered Rate ("LIBOR") and entered into an interest rate swap with the Company for the full duration of the BB CMBS Portfolio securities thereby providing a hedge for interest rate risk. The financing was provided at a rate that was below the current market for similar financings and, as such, the carrying amount of the assets and the debt were reduced by $10,927,000 to adjust the yield on the debt to current market terms. At -3- December 31, 1999, the portfolio had an amortized carrying value of $187,825,000 and a market value of $175,806,000. Real Estate Lending and Investment Market - ----------------------------------------- The Company believes that the continued strength of commercial real estate property values, coupled with fundamental structural changes in the real estate capital markets (primarily related to the growth in CMBS issuance) and the effect of the general credit spread widening since the global capital markets crisis in September 1998, has created significant market-driven opportunities for companies specializing in commercial real estate lending and investing. Such opportunities are expected to result from the following developments: o Scale and Rollover. The U.S. commercial mortgage market--a market that is comparable in size to the corporate and municipal bond markets--has approximately $1.2 trillion in total mortgage debt outstanding, which debt is primarily held privately. In addition, a significant amount of commercial mortgage loans held by U.S. financial institutions is scheduled to mature in the near future. o Rapid Growth of Securitization. With issuance volume of approximately $66 billion in 1999, the total estimated CMBS market capitalization has grown to $300 billion from approximately $6 billion in 1990. To date, the CMBS market expansion has been fueled in large part by "conduits" that originate whole loans primarily for resale to financial intermediaries, which in turn package the loans as securities for distribution to public and private investors. The Company believes that as the underwriting criteria utilized by securitized lenders becomes accepted as the market standard, borrowers are left constrained by relatively inflexible securitization/rating agency standards, including lower loan-to-value ratios, thereby creating significant demand for mezzanine financing (typically between 65% and 90% of total capitalization). In addition, since many high quality loans may not immediately qualify for securitization, due primarily to rating agency guidelines, or other factors, significant opportunities are created for shorter-maturity bridge and transition mortgage financings. o Consolidation. As the real estate market continues to evolve, the Company expects that consolidation will occur and efficiency will increase. Over time, the Company believes that the market leaders in the real estate finance sector will be fully integrated finance companies capable of originating, underwriting, structuring, managing and retaining real estate risk, whether as a principal or as an investment manager. The Company believes that the commercial real estate capital markets for both debt and equity are in the midst of dramatic structural change. As a result, the need for mezzanine investment capital has grown significantly. The Company seeks to capitalize on this market opportunity. Business Strategy - ----------------- Whether as a principal or as an investment manager, the Company seeks to generate returns from a portfolio of leveraged investments. As it commences its transition to an investment management firm, the Company will further seek to generate additional revenue from investment management fees and promotional returns that will be tied to a portfolio of leveraged investments held by the managed funds. The Company currently pursues investment and lending opportunities designed to capitalize on inefficiencies in the real estate capital, mortgage and finance markets. The Company also earns revenue from its real estate advisory and investment banking services. The Company believes that it is well positioned to capitalize on the market opportunities, which, if carefully underwritten, structured and monitored, represent attractive investments that pose potentially less risk than direct equity ownership of real property. Further, the Company believes that the rapid growth of the CMBS market has given rise to opportunities for the Company to selectively acquire non-investment grade classes of such securities, which the Company believes are priced inefficiently in terms of their risk/reward profile. -4- During 1999, the Company dedicated significant resources to exploring strategic acquisitions and joint ventures in order to bolster its capital position, expand its business platform, grow its portfolio of interest earning assets, and to take advantage of potential consolidation opportunities in the sector. Although the Company believed that during 1999 the lending environment was very favorable and that the Company was able to originate and/or acquire loans and investments meeting its targeted risk/yield profile, the Company made the strategic decision to manage its portfolio of loans and investments at its current level of approximately $800 million. During 1999, in keeping with this plan, the Company originated sufficient new loans and investments to keep its portfolio of interest earning assets static and therefore did not experience the substantial increases in net interest income from loans and investments corresponding to the substantial growth in interest earning assets that had occurred in prior years. The Company believed that by maintaining its investment portfolio at its current level, it was able to preserve sufficient sources of liquidity to facilitate potential strategic acquisitions and/or joint ventures such as the strategic relationship concluded with Citigroup. The Company's investment program emphasizes, but is not limited to, the following general categories of real estate and finance-related assets, all of which are suitable investments for the Mezzanine Funds: o Mortgage Loans. The Company pursues opportunities to originate and fund senior and junior mortgage loans ("Mortgage Loans") to commercial real estate owners and property developers who require interim financing until permanent financing can be obtained. The Company's Mortgage Loans are generally not intended to be permanent in nature, but rather are intended to be relatively short-term in duration, with extension options as deemed appropriate, and typically require a balloon payment of principal at maturity. The Company may also originate and fund permanent Mortgage Loans in which the Company intends to sell the senior tranche, thereby creating a Mezzanine Loan. o Mezzanine Loans. The Company originates high-yielding loans that are subordinate to first lien mortgage loans on commercial real estate and are secured either by a second lien mortgage or a pledge of the ownership interests in the borrowing property owner ("Mezzanine Loans"). Generally, the Company's Mezzanine Loans have a longer anticipated duration than its Mortgage Loans and are not intended to serve as transitional mortgage financing. o Certificated Mezzanine Investments. The Company purchases high-yielding investments that are subordinate to senior secured loans on commercial real estate. Such investments represent interests in debt service from loans or property cash flow and are issued in certificate form. These certificated investments carry substantially similar terms and risks as the Company's Mezzanine Loans. o Subordinated Interests. The Company pursues rated and unrated investments in public and private subordinated interests ("Subordinated Interests") in commercial collateralized mortgage obligations ("CMOs") and other CMBS. o Other Investments. The Company remains positioned to develop an investment portfolio of commercial real estate and finance-related assets meeting the Company's target risk/return profile. Except as limited by its role as exclusive investment manager to the Mezzanine Funds, the Company is not limited in the kinds of commercial real estate and finance-related assets in which it can invest on balance sheet and believes that it is positioned to expand opportunistically its financing business. The Company may pursue investments in, among other assets, construction loans, distressed mortgages, foreign real estate and finance-related assets, operating companies, including loan origination and loan servicing companies, and fee interests in real property (collectively, "Other Investments"). While serving as the investment manager for the Mezzanine Funds, the Company will be limited to making Mortgage Loans, Mezzanine Loans, Certificated Mezzanine Investments, and investments in Subordinated Interests (collectively "Business Assets") on behalf of the Mezzanine Funds, unless such investments are otherwise not accepted for origination or acquisition by the Mezzanine Funds. In this regard, during the respective investment periods of the Mezzanine Funds, the majority of the Company's -5- investment activity in Business Assets will be conducted through and for the Mezzanine Funds, although the Company will continue to invest in Other Investments and other assets which fulfill the Company's risk/reward characteristics and that do not otherwise conflict with its duties as an investment manager. The Company seeks to maximize yield through the use of leverage, consistent with maintaining an acceptable level of risk. Although there may be limits to the leverage that can be applied to certain of the Company's assets, the Company does not intend to exceed a debt-to-equity ratio of 5:1. At December 31, 1999, the Company's debt-to-equity ratio (treating the Convertible Trust Preferred Securities as a component of equity) was 1.66:1. Other than restrictions which result from the Company's intent to avoid regulation under the Investment Company Act of 1940, as amended (the "Investment Company Act"), the Company is not subject to any restrictions on the particular percentage of its portfolio invested in any of the above-referenced asset classes, nor is it limited in the kinds of assets in which it can invest except that prospective Business Assets must first be presented to the Mezzanine Funds for origination or acquisition. The Company has no predetermined limitations or targets for concentration of asset type or geographic location. Instead of adhering to any prescribed limits or targets, the Company makes acquisition decisions through asset and collateral analysis, evaluating investment risks on a case-by-case basis. To the extent that the Company's assets become concentrated in a few states or a particular region, the Company's return on investment will become more dependent on the economy of such states or region. Until appropriate investments are made, cash available for investment may be invested in readily marketable securities or in interest-bearing deposit accounts. Principal Investment Categories - ------------------------------- The discussion below describes the principal categories of assets emphasized in the Company's current business plan and assets that will be eligible as Business Assets. Mortgage Loans. The Company actively pursues opportunities to originate and fund Mortgage Loans to real estate owners and property developers who need interim financing until permanent financing can be obtained. The Company's Mortgage Loans generally are not intended to be "permanent" in nature, but rather are intended to be of a relatively short-term duration, with extension options as deemed appropriate, and generally require a balloon payment at maturity. These types of loans are intended to be higher-yielding loans with higher interest rates and commitment fees. Property owners or developers in the market for these types of loans include, but are not limited to, property owners who are completing a transition of their commercial real property such as an asset repositioning or an asset lease-up, traditional property owners and operators who desire to acquire a property before it has received a commitment for a long-term mortgage from a traditional commercial mortgage lender, or a property owner or investor who has an opportunity to purchase its existing mortgage debt or third party mortgage debt at a discount; in each instance, the Company's loan would be secured by a Mortgage Loan. The Company may also originate traditional, long-term mortgage loans and, in doing so, would compete with traditional commercial mortgage lenders. In pursuing such a strategy, the Company generally intends to sell or refinance the senior portion of the mortgage loan, individually or in a pool, and retain a Mezzanine Loan. In addition, the Company believes that, as a result of the recent increase in commercial real estate securitizations, there are attractive opportunities to originate short-term bridge loans to owners of mortgaged properties that are temporarily prevented as a result of timing and structural reasons from securing long-term mortgage financing through securitization. Mezzanine Loans. The Company seeks to take advantage of opportunities to provide mezzanine financing on commercial property that is subject to first lien mortgage debt. The Company believes that there is a growing need for mezzanine capital (i.e., capital representing the level between 65% and 90% of property value) as a result of current commercial mortgage lending practices setting loan-to-value targets as low as 65%. The Company's mezzanine financing takes the form of subordinated loans, commonly known as second mortgages, or, in the case of loans originated for securitization, partnership loans (also known as pledge loans). For example, on a commercial property subject to a first lien mortgage loan with a principal balance equal to 70% of the value of the property, the Company could lend the owner of the property (typically a partnership) an additional 15% to 20% of the value of the property. The Company believes that as a result of (i) the significant changes in the lending practices of traditional commercial real -6- estate lenders, primarily relating to more conservative loan-to-value ratios, and (ii) the significant increase in securitized lending with strict loan-to-value ratios imposed by the rating agencies, there will continue to be an increasing demand for mezzanine capital by property owners. Typically in a Mezzanine Loan, as security for its debt to the Company, the property owner would pledge to the Company either the property subject to the first lien (giving the Company a second lien position typically subject to an inter-creditor agreement) or the limited partnership and/or general partnership interest in the owner. If the owner's general partnership interest is pledged, then the Company would be in a position to take over the operation of the property in the event of a default by the owner. By borrowing against the additional value in their properties, the property owners obtain an additional level of liquidity to apply to property improvements or alternative uses. Mezzanine Loans generally provide the Company with the right to receive a stated interest rate on the loan balance plus various commitment and/or exit fees. In certain instances, the Company may negotiate to receive a percentage of net operating income or gross revenues from the property, payable to the Company on an ongoing basis, and a percentage of any increase in value of the property, payable upon maturity or refinancing of the loan, or the Company will otherwise seek terms to allow the Company to charge an interest rate that would provide an attractive risk-adjusted return. Certificated Mezzanine Investments. Certificated Mezzanine Investments have substantially similar terms and risks as the Company's Mezzanine Loans but are evidenced by certificates representing interests in property debt service or cash flow rather than by a note. Typically in a Certificated Mezzanine Investment, the Company obtains, as security for the mezzanine capital provided, an interest in the debt service provided by the loans that are secured by the underlying property or in the cash flows generated by the property (held through a trust and evidenced by trust certificates) that is subject to the senior lien or liens encumbering the underlying property. This structure provides the Company with a subordinate investment position typically subject to an inter-creditor agreement with the senior creditor. By borrowing through such a mezzanine structure against the additional value in its assets, the property owner obtains, with the proceeds of the Certificated Mezzanine Investment, an additional level of liquidity to apply to property improvements or alternative uses. Certificated Mezzanine Investments generally provide the Company with the right to receive a stated rate of return on its investment basis plus various commitment, extension and/or other fees. Generally the terms and conditions on these investments are the same as those on a Mezzanine Loan. Subordinated Interests. The Company acquires rated and unrated Subordinated Interests in CMBS issued in public or private transactions. CMBS typically are divided into two or more classes, sometimes called "tranches." The senior classes are higher "rated" securities, which are rated from low investment grade ("BBB") to higher investment grade ("AA" or "AAA"). The junior, subordinated classes typically include a lower rated, non-investment grade "BB" and "B" class, and an unrated, high yielding, credit support class (which generally is required to absorb the first losses on the underlying mortgage loans). The Company currently invests in the non-investment grade tranches of Subordinated Interests. The Company may acquire performing and non-performing (i.e., defaulted) Subordinated Interests. CMBS generally are issued either as CMOs or pass-through certificates that are not guaranteed by an entity having the credit status of a governmental agency or instrumentality, although they generally are structured with one or more of the types of credit enhancement arrangements to reduce credit risk. In addition, CMBS may be illiquid. The credit quality of CMBS depends on the credit quality of the underlying mortgage loans forming the collateral for the securities. CMBS are backed generally by a limited number of commercial or multifamily mortgage loans with larger principal balances than those of single family mortgage loans. As a result, a loss on a single mortgage loan underlying a CMBS will have a greater negative effect on the yield of such CMBS, especially the Subordinated Interests in such CMBS. Before acquiring Subordinated Interests, the Company performs certain credit underwriting and stress testing to attempt to evaluate future performance of the mortgage collateral supporting such CMBS, including (i) a review of the underwriting criteria used in making mortgage loans comprising the Mortgage Collateral for the CMBS, (ii) a review of the relative principal amounts of the loans, their loan-to-value ratios as well as the mortgage loans' purpose and documentation, (iii) where available, a review of the historical performance of the loans originated by the particular originator and (iv) some level of re-underwriting the underlying mortgage loans, including, selected site visits. -7- Unlike the owner of mortgage loans, the owner of Subordinated Interests in CMBS ordinarily does not control the servicing of the underlying mortgage loans. In this regard, the Company attempts to negotiate for the right to cure any defaults on senior CMBS classes and for the right to acquire such senior classes in the event of a default or for other similar arrangements. The Company may also seek to acquire 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 ("Special Servicing Rights") with respect to the mortgage loans underlying CMBS in which the Company owns a Subordinated Interest. Such rights to cure defaults and Special Servicing Rights may give the Company, for example, some control over the timing of foreclosures on such mortgage loans and, thus, may enable the Company to reduce losses on such mortgage loans. The Company has in the past served as a special servicer with respect to a Subordinated Interest investment, but is not currently a rated special servicer. The Company may seek to become rated as a special servicer, or acquire a rated special servicer. Until the Company can act as a rated special servicer, it will be difficult to obtain Special Servicing Rights with respect to the mortgage loans underlying Subordinated Interests. Although the Company's strategy is to purchase Subordinated Interests at a price designed to return the Company's investment and generate a profit thereon, there can be no assurance that such goal will be met or, indeed, that the Company's investment in a Subordinated Interest will be returned in full or at all. The Company believes that it will not be, and intends to conduct its operations so as not to become, regulated as an investment company under the Investment Company Act. The Investment Company Act generally exempts entities that are "primarily engaged in purchasing or otherwise acquiring mortgages and other liens on and interests in real estate" ("Qualifying Interests"). The Company intends to rely on current interpretations by the staff of the Commission in an effort to qualify for this exemption. To comply with the foregoing guidance, the Company, among other things, must maintain at least 55% of its assets in Qualifying Interests and also may be required to maintain an additional 25% in Qualifying Interests or other real estate-related assets. Generally, the Mortgage Loans and certain of the Mezzanine Loans and Certificated Mezzanine Investments in which the Company may invest constitute Qualifying Interests. While Subordinated Interests generally do not constitute Qualifying Interests, the Company may seek to structure such investments in a manner where the Company believes such Subordinated Interests may constitute Qualifying Interests. The Company may seek, where appropriate, (i) to obtain foreclosure rights or other similar arrangements (including obtaining Special Servicing Rights before or after acquiring or becoming a rated special servicer) with respect to the underlying mortgage loans, although there can be no assurance that it will be able to do so on acceptable terms or (ii) to acquire Subordinated Interests collateralized by whole pools of mortgage loans. As a result of obtaining such rights or whole pools of mortgage loans as collateral, the Company believes that the related Subordinated Interests will constitute Qualifying Interests for purposes of the Investment Company Act. The Company does not intend, however, to seek an exemptive order, no-action letter or other form of interpretive guidance from the Commission or its staff on this position. Any decision by the Commission or its staff advancing a position with respect to whether such Subordinated Interests constitute Qualifying Interests that differs from the position taken by the Company could have a material adverse effect on the Company. Other Investments The Company may also pursue a variety of complementary commercial real estate and finance-related businesses and investments in furtherance of executing its current business plan. Such activities include, but are not limited to, investments in other classes of mortgage-backed securities, distressed investing in non-performing and sub-performing loans and fee owned commercial real property, whole loan acquisition programs, foreign real estate-related asset investments, note financings, environmentally hazardous lending, operating company investing/lending, construction and rehabilitation lending and other types of financing activity. Any lending with regard to the foregoing may be on a secured or an unsecured basis and will be subject to risks similar to those attendant to investing in Mortgage Loans, Mezzanine Loans, Certificated Mezzanine Investments and Subordinated Interests. The Company seeks to maximize yield by managing credit risk by employing its credit underwriting procedures, although there can be no assurance that the Company will be successful in this regard. The Company is actively investigating potential business acquisition opportunities that it believes will complement the Company's operations including equity and mortgage REITS (in order to facilitate and/or accelerate the Company electing REIT status for tax purposes), and other firms engaged in commercial -8- loan origination, loan servicing, mortgage banking, financing activities, real estate loan and property acquisitions and real estate investment banking and advisory services similar to or related to the services provided by the Company. No assurance can be given that any such transactions will be negotiated or completed or that any business acquired can be efficiently integrated with the Company's ongoing operations. Portfolio Management - -------------------- As a principal or as an investment manager, the following describes certain of the portfolio management practices that the Company may employ from time to time to earn income, facilitate portfolio management (including managing the effect of maturity or interest rate sensitivity) and mitigate risk (such as the risk of changes in interest rates). There can be no assurance that the Company will not amend or deviate from these policies or adopt other policies in the future. Leverage and Borrowing. The success of the Company's current business plan is dependent upon the Company's ability to grow its portfolio of invested assets through the use of leverage. The Company believes that its new investment management business strategy will reduce the Company's dependence on financial leverage since the Mezzanine Funds do not currently intend to employ leverage to the same extent as the Company. When the Company does use leverage, it will do so by leveraging its assets through the use of, among other things, bank credit facilities including the Credit Facilities, secured and unsecured borrowings, repurchase agreements and other borrowings. When there is an expectation that such leverage will benefit the Company, such borrowings may have recourse to the Company in the form of guarantees or other obligations. If changes in market conditions cause the cost of such financing to increase relative to the income that can be derived from investments made with the proceeds thereof, the Company may reduce the amount of leverage it utilizes. Obtaining the leverage required to execute the current business plan requires the Company to maintain interest coverage ratios and other covenants meeting market underwriting standards. In leveraging its portfolio, the Company plans not to exceed a debt-to-equity ratio of 5:1. The Company has also agreed it will not incur any indebtedness if the Company's debt-to-equity ratio would exceed 5:1 without the prior written consent of the holders of a majority of the outstanding Preferred Stock (as hereinafter defined). Leverage creates an opportunity for increased income, but at the same time creates special risks. For example, leveraging magnifies changes in the net worth of the Company. Although the amount owed will be fixed, the Company's assets may change in value during the time the debt is outstanding. Leverage will create interest expense for the Company that can exceed the revenues from the assets retained. To the extent the revenues derived from assets acquired with borrowed funds exceed the interest expense incurred by the Company, the Company's net income will be greater than if borrowed funds had not been used. Conversely, if the revenues from the assets acquired with borrowed funds are not sufficient to cover the cost of borrowing, the Company's net income will be less than if borrowed funds had not been used. In order to grow and enhance its return on equity, the Company currently utilizes three primary sources of leverage: the Credit Facilities, the Term Redeemable Securities Contract and repurchase agreements. Credit Facilities. The Company has two Credit Facilities under which it can borrow funds to finance origination or acquisition of loan and investment assets. At December 31, 1999, the Company had $343.3 million of outstanding borrowings under the Credit Facilities. On December 31, 1999, the unused portion of the Credit Facilities amounted to $305.2 million providing the Company with adequate liquidity for its short-term needs. Term Redeemable Securities Contract. In connection with the Company's purchase of the BB CMBS Portfolio as discussed earlier, an affiliate of the seller provided financing for 70% of the purchase price, or $137.8 million, at a floating rate of LIBOR plus 50 basis points pursuant to a term redeemable securities contract. This rate was below the market rate for similar financings, and, as such, a discount on the term redeemable securities contract was recorded to reduce the carrying amount by $10.9 million, which had the effect of adjusting the yield to current market terms. The debt has a three-year term that expires in February 2002. -9- Repurchase Agreements. At December 31, 1999, the Company had two existing repurchase agreements and may enter into other such agreements under which the Company would sell assets to a third party with the commitment that the Company repurchase such assets from the purchaser at a fixed price on an agreed date. Repurchase agreements may be characterized as loans to the Company from the other party as they are secured by the underlying assets. The repurchase price reflects the purchase price plus an agreed market rate of interest, which is generally paid on a monthly basis. Interest Rate Management Techniques - ----------------------------------- The Company has engaged in and will continue to engage in a variety of interest rate management techniques for the purpose of managing the effective maturity or interest rate of its assets and/or liabilities. These techniques also may be used to attempt to protect against declines in the market value of the Company's assets resulting from general trends in debt markets. Any such transaction is subject to risks and may limit the potential earnings on the Company's loans and investments in real estate-related assets. Such techniques include interest rate swaps (the exchange of fixed-rate payments and floating-rate payments) and interest rate caps. The Company employs the use of correlated hedging strategies to limit the effects of changes in interest rates on its operations, including engaging in interest rate swaps and interest rate caps to minimize its exposure to changes in interest rates. Amounts arising from the differential are recognized as an adjustment to the interest income related to the earning asset or an adjustment to interest expense related to the interest bearing liability. In June 1998, the FASB issued Statement of Financial Accounting Standards No.133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133") which, as amended by SFAS No. 137, is effective for fiscal years beginning after June 15, 2000, although earlier application is permitted. The Company plans to adopt SFAS No. 133 effective January 1, 2001. Based upon the Company's derivative positions, which are considered effective hedges at December 31, 1999, the Company estimates that it would have reported an increase in other comprehensive income of $3.8 million had the statement been adopted at that time. Real Estate Advisory and Investment Banking Services - ---------------------------------------------------- The Company provides real estate advisory and investment banking services through its Victor Capital subsidiary, which commenced operations in 1989. Victor Capital provides such services to an extensive client roster of real estate investors, owners, developers and financial institutions in connection with mortgage financings, securitizations, joint ventures, debt and equity investments, mergers and acquisitions, portfolio evaluations, restructurings and disposition programs. Victor Capital provides an array of real estate investment banking and advisory services to a variety of clients such as financial institutions, including banks and insurance companies, public and private owners of commercial real estate, creditor committees and investment funds. In such engagements, Victor Capital typically negotiates for a retainer and/or a monthly fee plus disbursements; these fees are typically applied against a success-oriented fee, which is based on achieving the client's goals. While dependent upon the size and complexity of the underlying transaction, Victor Capital's fees for capital raising assignments are generally in the range of 0.5% to 3.0% of the total amount of debt and equity raised. For pure real estate advisory assignments, a fee is typically negotiated in advance and can take the form of a flat fee or a monthly retainer. In certain instances, Victor Capital negotiates for the right to receive a portion of its compensation in-kind, such as the receipt of stock in a publicly traded company. Victor Capital also provides its real estate asset management services primarily to institutional investors such as public and private money management firms. Victor Capital's services may include the identification and acquisition of specific mortgage loans and/or properties and the management and disposition of these assets. On January 1, 1998, the Company adopted FASB Statement of Financial Accounting Standards No. 131, "Disclosure about segments of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 requires disclosures about segments of an enterprise and related information regarding the different types of business activities in which an enterprise engages and the different economic environments in which it operates. In 1998, the Company operated as two segments: Lending/Investment and Advisory and had an internal information system that produced performance and asset data for its two segments along service lines. During the first quarter of 1999, the Company reorganized the structure of its internal organization -10- by merging its Lending/Investment and Advisory segments and thereby no longer managing its operations as separate segments. As such, separate segment reporting is not presented for 1999 as there is only one segment and the financial information for that segment is the same as the information in the consolidated financial statements. The disclosures as to the operating results and identifiable assets as required by SFAS No. 131 are presented for the Company's two segments along service lines for 1998 in Note 23 to the accompanying Consolidated Financial Statements. Factors that may Affect the Company's Business Strategy - ------------------------------------------------------- The success of the Company's business strategy depends in part on important factors, many of which are not within the control of the Company. The availability of desirable loan and investment opportunities and the results of the Company's operations will be affected by the amount of available capital, the level and volatility of interest rates and credit spreads, conditions in the financial markets and general economic conditions. There can be no assurances as to the effects of unanticipated changes in any of the foregoing. The Company's business strategy also depends on the ability to grow its portfolio of invested assets through the use of leverage. There can be no assurance that the Company will be able to obtain and maintain targeted levels of leverage or that the cost of debt financing will increase relative to the income generated from the assets acquired with such financing and cause the Company to reduce the amount of leverage it utilizes. The Company risks the loss of some or all of its assets or a financial loss if the Company is required to liquidate assets at a commercially inopportune time. The Company confronts the prospect that competition from other providers of mezzanine capital may lead to a lowering of the interest rates earned on the Company's interest-earning assets that may not be offset by lower borrowing costs. Changes in interest rates are also affected by the rate of inflation prevailing in the economy. A significant reduction in interest rates could increase prepayment rates and thereby reduce the projected average life of the Company's interest-bearing asset portfolio. While the Company may employ various hedging strategies, there can be no assurance that the Company would not be adversely affected during any period of changing interest rates. In addition, many of the Company's assets will be at risk to the deterioration in or total losses of the underlying real property securing the assets, which may not be adequately covered by insurance necessary to restore the Company's economic position with respect to the affected property. Further, the Company has recently commenced its investment management operation and therefore confronts risks associated with any start-up operation as well as risks specifically related to the investment management business, including but not limited to, the risks associated with the Business Assets as outlined herein, the Company's ability to raise capital, successfully manage and invest the capital raised and obtain leverage for such funds. Adverse changes in national and regional economic conditions can have an effect on real estate values increasing the risk of undercollateralization to the extent that the fair market value of properties serving as collateral security for the Company's assets are reduced. Numerous factors, such as adverse changes in local market conditions, competition, increases in operating expenses and uninsured losses, can affect a property owner's ability to maintain or increase revenues to cover operating expenses and the debt service on the property's financing and, consequently, lead to a deterioration in credit quality or a loan default and reduce the value of the Company's asset. In addition, the yield to maturity on the Company's CMBS assets is subject to default and loss experience on the underlying mortgage loans, as well as interest rate changes caused by pre-payments of principal. If there are realized losses on the underlying loans, the Company may not recover the full amount, or possibly, any of its initial investment in the affected CMBS asset. To the extent there are prepayments on the underlying mortgage loans as a result of refinancing at lower rates, the Company's CMBS assets may be retired substantially earlier than their stated maturities leading to reinvestment in lower yielding assets. Competition - ----------- The Company is engaged in a highly competitive business. The Company competes for loan and investment opportunities with numerous public and private real estate investment vehicles, including financial institutions (such as mortgage banks, pension funds, opportunity funds and REITs) and other institutional investors, as well as individuals. Many competitors are significantly larger than the Company, -11- have well established operating histories and may have access to greater capital and other resources. In addition, the real estate, advisory and investment management services industries are highly competitive and there are numerous well-established competitors possessing substantially greater financial, marketing, personnel and other resources than the Company. Victor Capital competes with national, regional and local real estate service firms and the Company's new investment management operations will compete with large Wall Street investment banking firms and major financial institutions which have extensive investment management track records and third party investor networks already in place. Government Regulation - --------------------- The Company's activities, including the financing of its operations, are subject to a variety of federal and state regulations such as those imposed by the Federal Trade Commission and the Equal Credit Opportunity Act. In addition, a majority of states have ceilings on interest rates chargeable to customers in financing transactions. Employees - --------- As of December 31, 1999, the Company employed 22 full-time professionals and seven other full-time employees. None of the Company's employees are covered by a collective bargaining agreement and management considers the relationship with its employees to be good. -12- - ------------------------------------------------------------------------------ Item 2. Properties - ------------------------------------------------------------------------------ The Company's principal executive and administrative offices are located in approximately 18,700 square feet of office space leased at 605 Third Avenue, 26th Floor, New York, New York 10016 and its telephone number is (212) 655-0220. The lease for such space expires in April 2000 with the Company having a month-to-month lease (with a six-month notice period) thereafter. The Company believes that this office space is suitable for its current operations for the foreseeable future. - ------------------------------------------------------------------------------ Item 3. Legal Proceedings - ------------------------------------------------------------------------------ The Company is not a party to any material litigation or legal proceedings, or to the best of its knowledge, any threatened litigation or legal proceedings, which, in the opinion of management, individually or in the aggregate, would have a material adverse effect on its results of operations or financial condition. 13 - ------------------------------------------------------------------------------ Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------------------------ (a). The Company held its 1999 annual meeting of stockholders on December 16, 1999. (b) and (c). Stockholders acted on the following proposals: 1. To elect ten directors (identified in the table below) to serve until the next annual meeting of stockholders or until such directors' successors are elected and shall have been duly qualified ("Proposal 1"); and 2. To ratify the appointment of Ernst & Young LLP as independent auditors of the Company for the fiscal year ending December 31, 1999 ("Proposal 2"). 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 trustees) 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 21,129,205 -- 64,208 -- Jeffrey A. Altman 21,129,205 -- 64,208 -- Thomas E. Dobrowski 21,129,205 -- 64,208 -- Martin L. Edelman 21,129,205 -- 64,208 -- Gary R. Garrabrant 21,129,105 -- 64,308 -- Craig M. Hatkoff 21,128,954 -- 64,459 -- John R. Klopp 21,128,954 -- 64,459 -- Sheli Z. Rosenberg 21,129,105 -- 64,308 -- Steven Roth 21,129,205 -- 64,208 -- Lynne B. Sagalyn 21,124,583 -- 68,830 -- Proposal 2 21,151,198 10,699 31,516 --
-14- PART II - ------------------------------------------------------------------------------ Item 5. Market for the Registrant's Common Equity and Related Security Holder Matters - ------------------------------------------------------------------------------ The Company's class A common stock, par value $0.01 per share ("Class A Common Stock") is listed on the New York Stock Exchange ("NYSE"). The trading symbol for the Class A Common Stock is "CT". The Company had approximately 1,516 stockholders-of-record at March 20, 2000. The table below sets forth, for the calendar quarters indicated, the reported high and low sale prices of the Class A Common Stock, and prior to the Reorganization (as hereinafter defined) in 1998, of the Predecessor's Class A Common Shares (as hereinafter defined) as reported on the NYSE based on published financial sources. High Low 1997 First Quarter...................6 7/8 2 1/2... Second Quarter..................6 1/8 4 1/2... Third Quarter..................11 3/8 5 5/8... Fourth Quarter.................15 1/8 9 13/16. 1998 First Quarter..................11 1/4 9 Second Quarter.................11 7/8 9 1/16.. Third Quarter...................9 9/16 4 7/16.. Fourth Quarter..................7 3/8 4 3/8... 1999 First Quarter...................6 4 Second Quarter..................5 7/8 3 3/4... Third Quarter...................4 15/16 3 5/8... Fourth Quarter..................5 3 7/8... No dividends were paid on the Company's Class A Common Stock, Class B Common Stock (as hereinafter defined) or on the Predecessor's Class A Common Shares in 1997, 1998 or 1999 and the Company does not expect to declare or pay dividends on its Common Stock in the foreseeable future. The Company's current policy with respect to dividends is to reinvest earnings to the extent that such earnings are in excess of the dividend requirements on the Class A Preferred Stock and Class B Preferred Stock (as hereinafter defined). Unless all accrued dividends and other amounts then accrued through the end of the last dividend period and unpaid with respect to preferred stock have been paid in full, the Company may not declare or pay or set apart for payment any dividends on common stock. The Company's charter provides for a semi-annual dividend of $0.1278 per share on the Preferred Stock based on a dividend rate of 9.5%, amounting to an aggregate annual dividend of $1,615,000 based on the 2,277,585 shares of Class A Preferred Stock and the 4,043,248 shares of Class B Preferred Stock currently outstanding. -15- - ------------------------------------------------------------------------------ Item 6. Selected Financial Data - ------------------------------------------------------------------------------ Prior to July 1997, the Company operated as a real estate investment trust ("REIT"), originating, acquiring, operating and holding income-producing real property and mortgage-related investments. Therefore, the Company's historical financial information, as of and for the years ended December 31, 1995, December 31, 1996 and part of the year ended December 31, 1997, does not reflect any operating results from its finance or real estate investment banking services operations. The following selected financial data relating to the Company have been derived from the historical financial statements as of and for the years ended December 31, 1999, 1998, 1997, 1996, and 1995. Other than the data for the years ended December 31, 1999 and 1998, the following data does not reflect the results of the acquisition of Victor Capital (as hereinafter defined) and the Predecessor's issuance of 12,267,658 Preferred Shares (as hereinafter defined) for $33 million, both of which occurred on July 15, 1997, or the Predecessor's public securities offering of 9,000,000 new Class A Common Shares completed in December 1997. For these reasons, the Company believes that except for the information for the years ended December 31, 1999 and 1998, the following information is not indicative of the Company's current business.
Years Ended December 31, ------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------------------ ----------- ------------------------ (in thousands, except for per share data) STATEMENT OF OPERATIONS DATA: REVENUES: Interest and investment income ............................. $ 89,839 $63,954 $ 6,445 $ 1,136 $ 1,396 Advisory and investment banking fees ....................... 17,772 10,311 1,698 -- -- Rental income .............................................. -- -- 307 2,019 2,093 Gain (loss) on sale of investments ......................... 35 -- (432) 1,069 66 Other ...................................................... -- -- -- -- 46 -------- -------- -------- ------- ------- Total revenues .......................................... 107,646 74,265 8,018 4,224 3,601 -------- -------- -------- ------- ------- OPERATING EXPENSES: Interest ................................................... 39,791 27,665 2,379 547 815 General and administrative ................................. 17,345 17,045 9,463 1,503 933 Rental property expenses ................................... -- -- 124 781 688 Provision for possible credit losses ....................... 4,103 3,555 462 1,743 3,281 Depreciation and amortization .............................. 345 249 92 64 662 -------- -------- -------- ------- ------- Total operating expenses ................................ 61,584 48,514 12,520 4,638 6,379 -------- ------- ------- Income (loss) before income tax expense and distributions and amortization on Convertible Trust Preferred Securities ............................... 46,062 25,751 (4,502) (414) (2,778) Income tax expense ......................................... 22,020 9,367 -- -- -- -------- -------- -------- ------- ------- Income (loss) before distributions and amortization on Convertible Trust Preferred ............. 24,042 16,384 (4,557) (414) (2,778) Securities Distributions and amortization on Convertible Trust Preferred Securities, net of income tax benefit.... 6,966 2,941 -- -- -- -------- -------- -------- ------- ------- NET INCOME (LOSS) .......................................... 17,076 13,443 (4,557) (414) (2,778) Less: Preferred Stock dividend and dividend requirement ..................................... 2,375 3,135 1,471 -- -- -------- -------- -------- ------- ------- Net income (loss) allocable to Common Stock ................ $ 14,701 $10,308 $ (6,028) $ (414) $(2,778) ======== ======== ======== ======= ======= PER SHARE INFORMATION: Net income (loss) per share of Common Stock: Basic.................................................. $ 0.69 $ 0.57 $ (0.63) $ (0.05) $ (0.30) ======== ======== ======== ======== ======== Diluted................................................ $ 0.55 $ 0.44 $ (0.63) $ (0.05) $ (0.30) ======== ======== ======== ======== ======== Weighted average shares of Common Stock outstanding: Basic.................................................. 21,334 18,209 9,527 9,157 9,157 ======== ======== ======== ======== ======== Diluted................................................ 43,725 30,625 9,527 9,157 9,157 ======== ======== ======== ======== ======== As of December 31, ------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------------------ ----------- ------------------------ BALANCE SHEET DATA: Total assets..................................... $827,808 $766,438 $317,366 $ 30,036 $ 33,532 Total liabilities................................ 522,925 472,207 174,077 5,565 8,625 Convertible Trust Preferred Securities........... 146,343 145,544 -- -- -- Stockholders' equity............................. 158,540 148,687 143,289 24,471 24,907
-16- - ------------------------------------------------------------------------------ Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - ------------------------------------------------------------------------------ Overview - -------- Prior to July 1997, the Company operated as a REIT, originating, acquiring, operating and holding income-producing real property and mortgage-related investments. Since July 1997, the Company has pursued a new strategic direction operating as a finance company designed primarily to take advantage of high-yielding mezzanine investments and other real estate asset and finance opportunities in commercial real estate. At that time, the Company elected to no longer qualify for treatment as a REIT for federal income tax purposes. Consequently, the results for the year ended December 31, 1997 reflect partial year real estate finance and advisory operations. The results for the years ended December 31, 1999 and 1998 reflect full year real estate finance and advisory operations. The Company is successor to the Predecessor, following consummation of the reorganization on January 28, 1999, whereby the Predecessor ultimately merged with and into the Company, which thereafter continued as the surviving Maryland corporation (the "Reorganization"). Unless the context otherwise requires, hereinafter references to the business, assets, liabilities, capital structure, operations and affairs of "the Company" include those of "the Predecessor" prior to the Reorganization. Ownership and Capital Changes - ----------------------------- On January 3, 1997, CalREIT Investors Limited Partnership ("CRIL"), an affiliate of EGI and Samuel Zell, purchased from the Predecessor's former parent 6,959,593 common shares of beneficial interest, $1.00 par value ("Common Shares") in the Predecessor (representing approximately 76% of the then-outstanding Common Shares) for an aggregate purchase price of $20,222,011. In July 1997, the Predecessor consummated the sale of 12,267,658 class A 9.5% cumulative convertible preferred shares of beneficial interest, $1.00 par value ("Class A Preferred Shares"), in the Predecessor, to Veqtor Finance Company, L.L.C. ("Veqtor"), a then affiliate of Samuel Zell and the then principals of Victor Capital, for an aggregate purchase price of $33,000,000 (the "Investment"). Concurrently with the foregoing transaction, Veqtor purchased the 6,959,593 Common Shares (which were reclassified at that time as class A common shares of beneficial interest, $1.00 par value ("Class A Common Shares")) held by CRIL for an aggregate purchase price of approximately $21.3 million. Concurrently with the foregoing transactions, the Predecessor consummated the acquisition of the real estate services businesses of Victor Capital and appointed a new management team from among the ranks of Victor Capital's professional team and elsewhere. The Predecessor thereafter immediately commenced full implementation of its operations as a finance and advisory company under the direction of its newly elected board of trustees and new management team. In December 1997, the Predecessor completed a public securities offering of 9,000,000 new Class A Common Shares in the Company at $11.00 per share raising approximately $91.4 million in net proceeds ("the Offering"). In July 1998, the Company completed a private placement of $150 million of Convertible Trust Preferred Securities that are convertible into Class A Common Stock (as hereinafter defined) at a conversion price of $11.70 per share. The Company raised approximately $145.2 million in net proceeds from the private placement transaction. In the Reorganization, the Predecessor merged with and into Captrust Limited Partnership, a Maryland limited partnership ("CTLP"), with CTLP continuing as the surviving entity, and CTLP merged with and into the Company, with the Company continuing as the surviving Maryland corporation. Each outstanding Class A Common Share was converted into one share of class A common stock, par value $0.01 per share ("Class A Common Stock"), and each outstanding Class A Preferred Share was converted into one share of class A 9.5% cumulative convertible preferred stock, par value $0.01 per share ("Class A Preferred Stock"), of the Company. As a result, all of the Predecessor's previously issued Class A Common Shares have been reclassified as shares of Class A Common Stock and all of the Predecessor's previously issued Class A Preferred Shares have been reclassified as shares of Class A Preferred Stock. -17- As of December 31, 1998, there were 12,267,658 shares of Class A Preferred Stock issued and outstanding, no shares of Class B Preferred Stock (as defined below) were issued and outstanding, 18,158,816 shares of Class A Common Stock were issued and outstanding and no shares of Class B Common Stock issued and outstanding. The 12,267,658 shares of Class A Preferred Stock outstanding at December 31, 1998 were originally issued and purchased by Veqtor on July 15, 1997 for an aggregate purchase price of approximately $33 million (see Note 1). Until August 10, 1999 (the "Conversion Date"), Veqtor owned 6,959,593 of the outstanding shares of Class A Common Stock and all 12,267,658 of the outstanding shares of Class A Preferred Stock. Veqtor was then controlled by the chairman of the board, the vice chairman and chief executive officer and the vice chairman and chairman of the executive committee of the board of directors of the Company in their capacities as the persons controlling the common members of Veqtor. Prior to the Conversion Date, the common members owned approximately 48% of the equity ownership of Veqtor and three commercial banks, as preferred members of Veqtor, owned the remaining 52% of the equity ownership of Veqtor. On the Conversion Date, in accordance with a commitment made by Veqtor and its common members, Veqtor redeemed the outstanding preferred units in Veqtor held by its preferred members in exchange for their pro rata share of the Company's stock owned by Veqtor. Due to the regulatory status of the redeemed preferred members as bank holding companies or affiliates thereof, prior to effecting the transfer of stock upon the redemption, Veqtor was obligated to convert 2,293,784 shares of Class A Common Stock into an equal number of shares of Class B Common Stock and 4,043,248 shares of Class A Preferred Stock into an equal number of shares of Class B Preferred Stock. Pursuant to provisions of the Company's charter relating to compliance with the Bank Holding Company Act of 1956, as amended ("BHCA"), bank holding companies or their affiliates can own no more than 4.9% of the voting stock of the Company. Therefore, in connection with the redemption, the redeemed preferred members received 1,292,103 shares of Class A Common Stock, 2,293,784 shares of non-voting Class B Common Stock, 2,277,585 shares of Class A Preferred Stock and 4,043,248 shares of non-voting Class B Preferred Stock. After the Conversion Date, until the Separation Transaction (as defined below), the common members of Veqtor owned 100% of the equity ownership of Veqtor. On September 30, 1999, in accordance with a commitment made by Veqtor and its common members, all 5,946,825 shares of Class A Preferred Stock held by Veqtor were, upon exercise of existing conversion rights, converted into an equal number of shares of Class A Common Stock. As a result of the foregoing redemption and subsequent conversion transactions, as of September 30, 1999, Veqtor owned 9,320,531 (or approximately 42.4%) of the outstanding shares of Class A Common Stock and the Company's annual dividend on Preferred Stock has been reduced from $3,135,000 to $1,615,000. In December 1999, a series of coordinated transactions (the "Separation Transaction") were effected in which beneficial ownership of an aggregate of 6,128,243 shares of the 9,320,531 shares of Class A Common Stock previously owned by Veqtor prior to the Separation Transaction were transferred to partnerships controlled by the vice chairman and chief executive officer of the Company (the "Klopp LP"), the vice chairman and chairman of the executive committee of the board of directors of the Company (the "Hatkoff LP") and certain of the former partners of CTILP (the "Other Partnerships"). Each of partnerships acquired direct beneficial ownership of such number of shares of Class A Common Stock equal to the number of shares in which the persons currently controlling such partnerships held an indirect pecuniary interest prior to the Separation Transaction. Veqtor retained direct beneficial ownership of 3,192,888 shares of Class A Common Stock, which represents the number of shares in which the persons then controlling Veqtor held an indirect pecuniary interest prior to the Separation Transaction. Upon consummation of the Separation Transaction by means of the foregoing transactions, Hatkoff LP, Klopp LP, Veqtor and the Other Partnerships acquired (or, in the case of Veqtor, retained) direct beneficial ownership of 2,330,132, 2,330,132, 3,192,288 and 1,467,979 shares of Class A Common Stock, respectively. On January 1, 2000, ownership and control of Veqtor was transferred to a trust for the benefit of the family of the Company's chairman of the board. -18- Overview of Financial Condition - ------------------------------- During the first quarter of 1999, the Company, through its then newly formed wholly-owned subsidiary, CT-BB Funding Corp., acquired a portfolio (the "BB CMBS Portfolio") of "BB" rated commercial mortgage-backed securities ("CMBS") from an affiliate of the Company's credit provider under the First Credit Facility (as hereinafter defined). The portfolio, which is comprised of 11 separate issues with an aggregate face amount of $246.0 million, was purchased for $196.9 million. In connection with the transaction, an affiliate of the seller provided three-year term financing for 70% of the purchase price at a floating rate above the London Interbank Offered Rate ("LIBOR") and entered into an interest rate swap with the Company for the full duration of the BB CMBS Portfolio thereby providing a hedge for interest rate risk. The financing was provided at a rate, which was below the current market for similar financings, and, as such, the carrying amounts of the assets and the debt were reduced by $10.9 million that had the effect of adjusting the yield on the debt to current market terms. After giving effect to the discounted purchase price, the fair value adjustment and the adjustment of the carrying amount of the assets to bring the debt to current market terms, the weighted average interest rate in effect for the BB CMBS Portfolio at December 31, 1999 is 12.19%. In 1999, the Company originated three Mortgage Loans totaling $45.0 million, one other loan for $52.5 million and funded $7.2 million of commitments under existing loans amd Certificated Mezzanine Investments. The Company received full satisfaction of seven loans totaling $190.5 million and recorded a write-down of one loan asset by $500,000 and subsequently sold it for $9.5 million, at net book value, during the period. The Company also received $10.8 million of partial repayments on loans and Certificated Mezzanine Investments. At December 31, 1999, the Company had outstanding loans, certificated mezzanine investments and investments in CMBS totaling approximately $777 million and additional commitments for fundings on outstanding loans and certificated mezzanine investments of approximately $30.8 million. The Company believes that the loans and investments originated in 1999 will provide investment yields within the Company's target range of 500 to 700 basis points above LIBOR. The Company maximizes its return on equity by utilizing its existing cash on hand and then employing leverage on its investments. The Company may make loans and investments with yields that fall outside of the investment range set forth above, but that correspond with the level of risk perceived by the Company to be inherent in such investments. The Company's assets are subject to various risks that can affect results, including 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. Any significant compression of the spreads of the interest rates earned on interest-earning assets over the interest rates paid on interest-bearing liabilities could have a material adverse effect on the Company's operating results as could 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. Adverse changes in national and regional economic conditions can have an effect on real estate values increasing the risk of undercollateralization to the extent that the fair market value of properties serving as collateral security for the Company's assets are reduced. Numerous factors, such as adverse changes in local market conditions, competition, increases in operating expenses and uninsured losses, can affect a property owner's ability to maintain or increase revenues to cover operating expenses and the debt service on the property's financing and, consequently, lead to a deterioration in credit quality or a loan default and reduce the value of the Company's asset. In addition, the yield to maturity on the Company's CMBS assets is subject to default and loss experience on the underlying mortgage loans, as well as interest rate changes caused by pre-payments of principal. If there are realized losses on the underlying loans, the Company may not recover the full amount, or possibly, any of its initial investment in the affected CMBS asset. To the extent there are prepayments on the underlying mortgage loans as a result of refinancing at lower rates, the Company's CMBS assets may be retired substantially earlier than their stated maturities leading to reinvestment in lower yielding assets. There can be no assurance that the Company's assets will not experience any of the foregoing risks or that, as a result of any such experience, the Company will not suffer a reduced return on investment or an investment loss. During the year ended December 31, 1999, the Company sold all of its other available-for-sale securities -19- that had an amortized cost of $2,764,000 for a $35,000 gain. In connection with the sale, the Company satisfied the repurchase obligation outstanding relating to these assets for $2,526,000. In connection with the sale of a loan described above, a repurchase obligation outstanding at December 31, 1998 for $7.5 million was satisfied. Two other repurchase obligations outstanding at December 31, 1998 totaling $27.0 million were satisfied by the transfer of the liabilities associated with the two related assets to the Credit Facilities (as hereinafter defined). A fourth repurchase obligation outstanding at December 31, 1998 for $10.5 million was settled for cash. At December 31, 1999, the Company was party to two repurchase obligations relating to assets sold by the Company with an aggregate carrying amount of $45.4 million, which approximates the assets' market value, and has liabilities to repurchase these assets for $28.7 million. The average interest rate in effect for the two remaining repurchase obligations at December 31, 1999 is 7.76%. The Company is party to two credit agreements with commercial lenders (the "First Credit Facility" and the "Second Credit Facility", (together the "Credit Facilities")) that after amendments provide for $655 million of credit. The First Credit Facility provides for a $355 million line of credit with an original three year term. Concurrent with the BB CMBS Portfolio transaction, the $355 million First Credit Facility's maturity was extended to February 28, 2002 with an automatic one-year amortizing extension option, if not otherwise extended. The Second Credit Facility provides for a $300 million line of credit with an original 18-month term. During the year ended December 31, 1999, the Company extended the maturity date of its Second Credit Facility from December 1999 to June 2000 with an automatic nine-month amortizing extension option, if not otherwise extended. The Credit Facilities provide for advances to fund lender-approved loans and investments made by the Company ("Funded Portfolio Assets"). The obligations of the Company under the Credit Facilities are secured by pledges of the Funded Portfolio Assets acquired with advances under the Credit Facilities. Borrowings under the Credit Facilities bear interest at specified rates over LIBOR, which rates may fluctuate, based upon the credit quality of the Funded Portfolio Assets. Future repayments and redrawdowns of amounts previously subject to the drawdown fee will not require the Company to pay any additional fees. The Credit Facilities provide for margin calls on asset-specific borrowings in the event of asset quality and/or market value deterioration as determined under the Credit Facilities. The Credit Facilities contain customary representations and warranties, covenants and conditions and events of default. The Credit Facilities also contain a covenant obligating the Company to avoid undergoing an ownership change that results in Craig M. Hatkoff, John R. Klopp or Samuel Zell no longer retaining their senior offices and directorships with the Company and practical control of the Company's business and operations. At December 31, 1999, the Company had $343.3 million of outstanding borrowings under the Credit Facilities as compared to $371.8 million at December 31, 1998. The decrease of $28.5 million in the amount outstanding under the Credit Facilities from the amount outstanding at December 31, 1998 was due to the significant loan repayments received, offset by borrowings utilized to fund the non-financed portion of the BB CMBS Portfolio acquisition, cash utilized in loan originations and cash utilized to satisfy the repurchase obligation that matured. As of December 31, 1999, certain of the Company's loans and other investments have been hedged with interest rate swaps so that the assets and the corresponding liabilities were matched at floating rates over LIBOR and certain of the Company's liabilities have been hedged so that the liabilities and the corresponding CMBS were matched at fixed rates. During the year ended December 31, 1999, the Company terminated two swaps and partially terminated a third swap in connection with the payoff of a loan and the sale of a loan resulting in a payment of $323,000 which was recorded as a reduction in interest income for the year. At December 31, 1999, the Company was party to interest rate swap agreements for notional amounts totaling approximately $220 million with financial institution counterparties whereby the Company swapped fixed-rate instruments, with average interest rates of approximately 5.93%, for floating rate instruments with interest rates at LIBOR. The agreements mature at varying times from September 2001 to July 2014. The Company is exposed to credit loss in the event of non-performance by the counterparties (banks whose securities are rated investment grade) to the interest rate swap and cap agreements, although it does -20- not anticipate such non-performance. The counterparties would bear the interest rate risk of such transactions as market interest rates increase. If an interest rate swap or interest rate cap is sold or terminated and cash is received or paid, the gain or loss is deferred and recognized when the hedged asset is sold or matures. During 1999, the Company dedicated significant resources to exploring strategic acquisitions and joint ventures in order to bolster its capital position, expand its business platform, grow its portfolio of interest earning assets, and to take advantage of potential consolidation opportunities in the sector. Although the Company believed that during 1999 the lending environment was very favorable and that the Company was able to originate and/or acquire loans and investments meeting its targeted risk/yield profile, the Company made the strategic decision to manage its portfolio of loans and investments at its current level of approximately $800 million. During 1999, and in keeping with this plan, the Company originated sufficient new loans and investments to keep its portfolio of interest earning assets static and therefore did not experience the substantial increases in net interest income from loans and investments corresponding to the substantial growth in interest earning assets that had occurred in prior years. The Company believed that by maintaining its investment portfolio at its current level, it was able to preserve sufficient sources of liquidity to facilitate potential strategic acquisitions and/or joint ventures such as the strategic relationship concluded with Citigroup. Results of Operations for the Years Ended December 31, 1999 and 1998 - -------------------------------------------------------------------- The Company reported net income allocable to shares of Common Stock of $14,701,000 for the year ended December 31, 1999, an increase of $4,393,000 from the net income allocable to shares of Common Stock of $10,308,000 for the year ended December 31, 1998. This change was primarily the result of an increase in advisory and investment banking fees and an increase in income from loans and other investments, net, partially offset by an increase in the distributions on the Convertible Trust Preferred Securities and an increase in the provision for income taxes. Income from loans and other investments, net, amounted to $49,136,000 for the year ended December 31, 1999, an increase of $14,072,000 over the $35,064,000 amount for the year ended December 31, 1998. This increase was due primarily to increase in average earning assets of $223.4 million while interest bearing liabilities only increased by $133.5 million. The approximately $90 million difference was financed with proceeds from the Convertible Trust Preferred Securities. The increase in interest and related income was primarily due to the increase in the amount of average interest earning assets from approximately $526.3 million for the year ended December 31, 1998 to approximately $749.7 million for the year ended December 31, 1999. The average interest rate in effect for both years was 11.8%. The increase in interest and related expenses was due to an increase in the amount of average interest bearing liabilities from approximately $338.3 million at an average rate of 8.1% for the year ended December 31, 1998 to approximately $471.8 million at an average rate of 8.4% for the year ended December 31, 1999. The increase in rate was due primarily to the Company utilizing its Credit Facilities for a higher percentage of its borrowing needs at rates generally higher than it had previously enjoyed through repurchase agreements. The Company also utilized the net proceeds from the $150.0 million of Convertible Trust Preferred Securities that were issued on July 28, 1998 to finance its interest earning assets. During the year ended December 31, 1999, the Company recognized $6,966,000 of net expenses related to these securities. During the year ended December 31, 1998, the Company recognized $2,941,000 of net expenses related to these securities. Distributions to the holders totaled $12,375,000 for the year ended December 31, 1999, and $5,225,000 for the year ended December 31, 1998. Amortization of discount and origination costs totaled $799,000 during the year ended December 31, 1999 and $337,000 for the year ended December 31, 1998. These expenses were partially offset by a tax benefit of $6,208,000 during the year ended December 31, 1999 and $2,621,000 for the year ended December 31, 1998. -21- During the year ended December 31, 1999, other revenues increased $7,107,000 to $19,056,000 over the same period in 1998. The changes for the year ended December 31, 1999 was primarily due to an increase in advisory and investment banking fees generated by Victor Capital and its related subsidiaries. Other expenses increased from $21,262,000 for the year ended December 31, 1998 to $22,130,000 for year ended December 31, 1999. The largest components of other expenses are employee salaries and related costs and the provision for possible credit losses. In March 1999, to reduce general and administrative expenses to a level in line with budgeted business activity, the Company reduced its workforce by approximately 30% and recorded a restructuring charge of $650,000. This charge along with increases in compensation for the remaining employees offset by a decrease in professional fees accounted for the increase in general and administrative expenses for the year ended December 31, 1999 as compared to 1998. The Company had 29 full time employees at December 31, 1999. The increase in the provision for possible credit losses from $3,555,000 for the year ended December 31, 1998 to $4,103,000 for the year ended December 31, 1999 was due to the increase in average earning assets as previously described. Management believes that the reserve for possible credit losses is adequate. For the years ended December 31, 1999 and 1998, the Company accrued income tax expense of $22,020,000 and $9,367,000, respectively, for federal, state and local income taxes. The increase in the effective tax rate (from 36.4% to 47.8%) was primarily due to a decrease in the net operating loss carryforwards utilized to offset taxable income. For the year ended December 31, 1998, net operating loss carryforwards reduced the effective tax rate by 10.7% due to significant losses generated in 1997 that were not limited for utilization in 1998. For the year ended December 31, 1999, the reduction was only 1.1% as all of the losses generated in 1997 were utilized in 1998. The preferred stock dividend and dividend requirement arose in 1997 as a result of the Company's issuance of $33 million of Class A Preferred Stock on July 15, 1997. Dividends accrued on these shares at a rate of 9.5% per annum on a per share price of $2.69 for the 12,267,658 shares outstanding or $3,135,000 per annum through the second quarter of 1999. As discussed above, 5,946,825 shares of Preferred Stock were converted to an equal number of shares of Common Stock during the third quarter of 1999 thereby reducing to 6,320,833 the number of outstanding shares of Preferred Stock to 6,320,833 and the dividend requirement to $1,615,000 per annum. Results of Operations for the Years Ended December 31, 1998 and 1997 The Company reported total revenues of $74.3 million for the year ended December 31, 1998, an increase of $66.3 million over total revenues of $8.0 million reported for the year ended December 31, 1997. The Company reported net income allocable to Common Stock of $10,308,000 for the year ended December 31, 1998, an increase of $16,336,000 from the net loss allocable to Common Stock of $6,028,000 for the year ended December 31, 1997. These changes were primarily the result of the full implementation of the Company's operations as a real estate finance and advisory company that generated revenues from loans and other investments and significant advisory and investment banking fees. Interest and related income from loans and other investments amounted to $62,316,000 for the year ended December 31, 1998, an increase of $57,324,000 over the $4,992,000 for the year ended December 31, 1997. This increase was primarily due to an eleven-fold increase in the average interest earning assets from approximately $46.8 million for the year ended December 31, 1997 to approximately $526.3 million for the year ended December 31, 1998. The increase was also enhanced by an increase in the average rate earned on the investments from 10.66% to 11.84% Interest and related expenses had a similar percentage change increasing from $2,223,000 at December 31, 1997 to $27,252,000 at December 31, 1998. This increase of $25,029,000 is due to an increase in the average interest bearing liabilities from approximately $27.5 million for the year ended December 31, 1997 to approximately $338.3 million for the year ended December 31, 1998. The average rate paid on average interest-bearing liabilities remained constant from year to year at 8.1%. During the year ended December 31, 1998, other revenues totaled $11,949,000, an increase of $8,923,000 over the same period in 1997. The increase for the year ended December 31, 1998 was primarily due to an additional $8,613,000 of advisory and investment banking fees generated by Victor -22- Capital and its related subsidiaries over the amount of such fees generated in the prior year and an additional $185,000 of other interest income being earned in 1998. The Company also experienced a $307,000 decrease in rental income as the Company sold its remaining rental properties during the first quarter of 1997 for which the Company recorded a loss of $432,000. Other expenses increased from $10,297,000 for the year ended December 31, 1997 to $21,262,000 for the year ended December 31, 1998. The increase was primarily due to the additional general and administrative expenses necessary for the commencement and continuation of full-scale operations as a finance company, the largest components of such expenses are employee salaries and related costs, and the provision for possible credit losses. As of December 31, 1998, the Company had 44 full-time employees as compared to 29 at December 31, 1997 (who were employed for only five and a half months following the acquisition of Victor Capital on July 15, 1997). The provision for possible credit losses was $3,555,000 for the year ended December 31, 1998, as the Company provided reserves on its loan and investment portfolio pursuant to its reserve policy. The significant increase from the $462,000 provision for possible credit loss for the year ended December 31, 1997 was due to the increase in average earning assets outstanding as previously described. In 1997, the Company did not incur any income tax expense or benefit associated with the loss it incurred due to the uncertainty of realization of net operating loss carryforwards. In the year ended December 31, 1998, the Company accrued $9,367,000 of income tax expense for federal, state and local income taxes. For federal purposes, the Company utilized net operating loss carryforwards of approximately $4.9 million to reduce its current tax expense and released approximately $1.0 million of reserves on deferred tax assets in calculating the accrual for the year ended December 31, 1998. This had the effect of reducing the effective tax rate from the expected rate of 47% to 36%. As discussed above, the Company issued $150,000,000 of Convertible Trust Preferred Securities on July 28, 1998. The Company recognized $2,941,000 of net expenses related to these securities during the year ended December 31, 1998. This amount consisted of distributions to the holders totaling $5,225,000 and amortization of discount and origination costs totaling $337,000 that were partially offset by tax benefits of $2,621,000. The preferred stock dividend and dividend requirement arose in 1997 as a result of the Company's issuance of $33 million of Preferred Stock on July 15, 1997. Dividends accrued on such stock at a rate of 9.5% per annum on a per share price of $2.69 for the 12,267,658 shares outstanding. Liquidity and Capital Resources - ------------------------------- At December 31, 1999, the Company had $38,782,000 in cash. Liquidity in 2000 will be provided primarily by cash on hand, cash generated from operations, principal and interest payments received on investments, loans and securities, and additional borrowings under the Credit Facilities. The Company believes these sources of capital will adequately meet future cash requirements. The Company expects that during 2000 it will use a significant amount of its available capital resources to satisfy its capital contributions required in connection with the previously discussed venture with Citigroup. In connection with the existing portfolio investment and loan business, the Company intends to employ leverage up to a maximum 5:1 debt-to-equity ratio to enhance its return on equity. The Company experienced a net decrease in cash of approximately $7.8 million for the year ended December 31, 1999, compared to a net decrease in cash of $2.6 million for the year ended December 31, 1998. For the year ended December 31, 1999, cash provided by operating activities was $24.2 million, an increase of approximately $9.4 million from cash provided by operations of $14.8 million during the same period in 1998. Cash used in investing activities during this same period decreased by approximately $371.3 million to approximately $76.6 million, down from $447.9 million, primarily as a result of the decreased loan origination and investment activity. Cash provided by financing activities decreased approximately $386.0 million to approximately $44.5 million, down from $430.5 million, primarily from a reduced need to borrow on the Credit Facilities as a result of the Company's stabilized loan and investment portfolio. -23- At December 31, 1999, the Company had two outstanding notes payable totaling $3,474,000, outstanding borrowings on the Credit Facilities of $343,263,000 and outstanding repurchase obligations of $28,703,000. At December 31, 1999, the Company had $305,166,000 of borrowing capacity available under the Credit Facilities. Impact of Inflation - ------------------- The Company's operating results depend in part on the difference between the interest income earned on its interest-earning assets and the interest expense incurred in connection with its interest-bearing liabilities. 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 the Company's income by affecting the spread between the Company's interest-earning assets and interest-bearing liabilities, as well as, among other things, the value of the Company's interest-earning assets and its ability to realize gains from the sale of assets and the average life of the Company's interest-earning assets. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors beyond the control of the Company. The Company employs the use of correlated hedging strategies to limit the effects of changes in interest rates on its operations, including engaging in interest rate swaps and interest rate caps to minimize its exposure to changes in interest rates. There can be no assurance that the Company will be able to adequately protect against the foregoing risks or that the Company will ultimately realize an economic benefit from any hedging contract into which it enters. Year 2000 Information - --------------------- The Company completed its Year 2000 readiness project and did not experience any adverse effects of the Year 2000 Issue. The Company incurred costs totaling $225,000 in connection with the Year 2000 readiness project ($30,000 expensed and $195,000 capitalized for new systems and equipment) and does not expect any additional project costs in the future. -24- - ------------------------------------------------------------------------------ Item 7A. Quantitative and Qualitative Disclosures about Market Risk - ------------------------------------------------------------------------------ The principal objective of the Company's 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, the Company uses 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 the Company does not use derivative financial instruments for trading purposes. The Company uses interest rate swaps to reduce the Company's exposure to interest rate fluctuations on certain fixed rate loans and investments and to provide more stable spreads between rates received on loans and investments and the rates paid on their financing sources. The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates at December 31, 1999. 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. -25-
Expected Maturity Dates ------------------------------------------------------------------------------------------------ 2000 2001 2002 2003 2004 Thereafter Total Fair Value ---- ---- ---- ---- ---- ---------- ----- ---------- (dollars in thousands) Assets: CMBS Fixed Rate - - $196,874 - - - $196,874 $175,806 Average interest rate - - 12.19% - - - 12.19% Variable Rate - - - $ 36,509 - - $ 36,509 $ 33,089 Average interest rate - - - 12.34% - - 12.34% Certificated Mezzanine Investments Variable Rate $ 45,432 - - - - - $ 45,432 $ 45,432 Average interest rate 10.54% - - - - - 10.54% Loans receivable Fixed Rate $ 21,115 $ 28,000 $ 3,000 - - $ 97,861 $149,976 $147,286 Average interest rate 20.00% 12.59% 12.50% - - 11.40% 12.86% Variable Rate $155,218 $133,223 $ 52,500 - - $ 26,500 $367,441 $354,621 Average interest rate 11.87% 11.37% 12.47% - - 11.88% 11.78% Liabilities: Credit facilities Variable Rate - $157,823 - $185,440 - - $343,263 $343,263 Average interest rate - 9.58% - 8.85% - - 9.18% Term redeemable securities contract Variable Rate - - $137,812 - - - $137,812 $129,642 Average interest rate - - 9.96% - - - 9.96% Repurchase obligations Variable Rate $ 28,703 - - - - - $ 28,703 $ 28,703 Average interest rate 7.76% - - - - - 7.76% Convertible Trust Preferred Securities Fixed Rate - - - - - $150,000 $150,000 $146,343 Average interest rate - - - - - 9.02% 9.02% Interest rate swaps - $ 28,000 $137,812 $ 19,109 - $53,250 $238,171 $ 17,170 Average fixed pay rate - 5.79% 6.05% 6.04% - 6.01% 6.01% Average variable receive rate - 6.48% 6.46% 6.46% - 6.47% 6.47%
-26- - ------------------------------------------------------------------------------ Item 8. Financial Statements and Supplementary Data - ------------------------------------------------------------------------------ The financial statements required by this item and the reports of the independent accountants thereon required by Item 14(a)(2) appear on pages F-2 to F-37. See accompanying Index to the Consolidated Financial Statements on page F-1. The supplementary financial data required by Item 302 of Regulation S-K appears in Note 24 to the consolidated financial statements. - ------------------------------------------------------------------------------ Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure - ------------------------------------------------------------------------------ None -27- PART III - ------------------------------------------------------------------------------ Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------------------------ The information regarding the Company's trustees is incorporated herein by reference to the Company's definitive proxy statement to be filed not later than April 29, 2000, with the Securities and Exchange Commission pursuant to Regulation 14A under the Exchange Act. - ------------------------------------------------------------------------------ Item 11. Executive Compensation - ------------------------------------------------------------------------------ The information required by Item 402 of Regulation S-K is incorporated herein by reference to the Company's definitive proxy statement to be filed not later than April 29, 2000, with the Securities and Exchange Commission pursuant to Regulation 14A under the Exchange Act. - ------------------------------------------------------------------------------ Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------------ The information required by Item 403 of Regulation S-K is incorporated herein by reference to the Company's definitive proxy statement to be filed not later than April 29, 2000, with the Securities and Exchange Commission pursuant to Regulation 14A under the Exchange Act. - ------------------------------------------------------------------------------ Item 13. Certain Relationships and Related Transactions - ------------------------------------------------------------------------------ The information required by Item 404 of Regulation S-K is incorporated herein by reference to the Company's definitive proxy statement to be filed not later than April 29, 2000, with the Securities and Exchange Commission pursuant to Regulation 14A under the Exchange Act. -28- PART IV - ------------------------------------------------------------------------------ Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ (a) (1) Financial Statements See the accompanying Index to Financial Statement Schedule on page F-1. (a) (2) Consolidated Financial Statement Schedules None. All schedules have been omitted because they are not applicable or because the required information is shown in the consolidated financial statements or notes thereto. (a) (3) Exhibits EXHIBIT INDEX Exhibit Number Description - ---------- ----------- 2.1 Agreement and Plan of Merger, by and among Capital Trust, Capital Trust, Inc. and the Captrust Limited Partnership, dated as of November 12, 1999 (filed as Exhibit 2.1 to Capital Trust, Inc.'s Current Report on Form 8-K (File No. 1-14788) filed on January 29, 1999 and incorporated herein by reference). 3.1 Charter of the Capital Trust, Inc. (comprised of Articles of Amendment and Restatement of Charter and amendments thereof by Articles Supplementary with respect to Class A 9.5% Cumulative Convertible Preferred Stock and Articles Supplementary with respect to Class B 9.5% Cumulative Convertible Non-Voting Preferred Stock) (filed as Exhibit 3.1 to Capital Trust, Inc.'s Current Report on Form 8-K (File No. 1-14788) filed on January 29, 1999 and incorporated herein by reference). 3.2 Amended and Restated By-Laws of Capital Trust, Inc. (filed as Exhibit 3.2 to Capital Trust, Inc.'s Current Report on Form 8-K (File No. 1-14788) filed on January 29, 1999 and incorporated herein by reference). 4.1 Articles Supplementary with respect to Class A 9.5% Cumulative Convertible Preferred Stock of Capital Trust, Inc. and Articles Supplementary with respect to Class B 9.5% Cumulative Convertible Non-Voting Preferred Stock of Capital Trust, Inc. (included in Exhibit 3.1). 4.4 Certificate of Trust of CT Convertible Trust I (filed as Exhibit 4.1 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on August 6, 1998 and incorporated herein by reference). 4.5 Preferred Securities Purchase Agreement dated as of July 27, 1998 among Capital Trust, CT Convertible Trust I, Vornado Realty L.P., EOP Limited Partnership, Mellon Bank N.A., as trustee for General Motors Hourly-Rate Employes Pension Trust, and Mellon Bank N.A., as trustee for General Motors Salaried Employes Pension Trust (filed as Exhibit 4.2 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on August 6, 1998 and incorporated herein by reference). -29- Exhibit Number Description - --------- ------------ 4.6 Declaration of Trust of CT Convertible Trust I ("CT Trust I") dated as of July 28, 1998 by the Trustees (as defined therein), Capital Trust, as sponsor, and the holders, from time to time, of undivided beneficial interests in CT Trust I to be issued pursuant to such Declaration (filed as Exhibit 4.3 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on August 6, 1998 and incorporated herein by reference). 4.7.a. Indenture dated as of July 28, 1998 between Capital Trust and Wilmington Trust Company, as trustee (filed as Exhibit 4.4 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on August 6, 1998 and incorporated herein by reference). 4.7.b. Supplemental Indenture, dated as of January 28, 1999, with respect to Indenture dated as of July 28, 1998, between Capital Trust, Inc. and Wilmington Trust Company, as trustee (filed as Exhibit 4.2 to Capital Trust, Inc.'s Current Report on Form 8-K (File No. 1-14788) filed on January 29, 1999 and incorporated herein by reference). 4.8 Preferred Securities Guarantee Agreement dated as of July 28, 1998 by Capital Trust and Wilmington Trust Company, as trustee (filed as Exhibit 4.5 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on August 6, 1998 and incorporated herein by reference). 4.9 Common Securities Guarantee Agreement dated as of July 28, 1998 by Capital Trust (filed as Exhibit 4.6 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on August 6, 1998 and incorporated herein by reference). 10.1 Preferred Share Purchase Agreement, dated as of June 16, 1997, by and between Capital Trust and Veqtor Finance Company, LLC (filed as Exhibit 10.1 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on July 30, 1997 and incorporated herein by reference). 10.2 Non-Negotiable Notes of Capital Trust payable to John R. Klopp, Craig M. Hatkoff and Valentine Wildove & Company, Inc. (filed as Exhibit 10.2 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on July 30, 1997 and incorporated herein by reference). +10.3 Capital Trust, Inc. Amended and Restated 1997 Long-Term Incentive Stock Plan (filed as Exhibit 10.1 to Capital Trust, Inc.'s Current Report on Form 8-K (File No. 1-14788) filed on January 29, 1999 and incorporated herein by reference). +10.4 Capital Trust, Inc. Amended and Restated 1997 Non-Employee Director Stock Plan (filed as Exhibit 10.2 to Capital Trust, Inc.'s Current Report on Form 8-K (File No. 1-14788) filed on January 29, 1999 and incorporated herein by reference). +10.5 Capital Trust, Inc. 1998 Employee Stock Purchase Plan (filed as Exhibit 10.3 to Capital Trust, Inc.'s Current Report on Form 8-K (File No. 1-14788) filed on January 29, 1999 and incorporated herein by reference). +10.6 Capital Trust, Inc. 1998 Non-Employee Stock Purchase Plan (filed as Exhibit 10.4 to Capital Trust, Inc.'s Current Report on Form 8-K (File No. 1-14788) filed on January 29, 1999 and incorporated herein by reference). +10.7 Capital Trust, Inc. Stock Purchase Loan Plan (filed as Exhibit 10.5 to Capital Trust, Inc.'s Current Report on Form 8-K (File No. 1-14788) filed on January 29, 1999 and incorporated herein by reference). +10.8 Employment Agreement, dated as of July 15, 1997, by and between Capital Trust and John R. Klopp (filed as Exhibit 10.5 to Capital Trust's Registration Statement on Form S-1 (File No. 333-37271) filed on October 6, 1997 and incorporated herein by reference). +10.9 Employment Agreement, dated as of July 15, 1997, by and between Capital Trust and Craig M. Hatkoff (filed as Exhibit 10.6 to Capital Trust's Registration Statement on Form S-1 (File No. 333-37271) filed on October 6, 1997 and incorporated herein by reference). -30- Exhibit Number Description +10.10 Consulting Agreement, dated as of July 15, 1997, by and between Capital Trust and Gary R. Garrabrant (filed as Exhibit 10.7 to Capital Trust's Registration Statement on Form S-1 (File No. 333-37271) filed on October 6, 1997 and incorporated herein by reference). 10.11 Sublease, dated as of July 29, 1997, between New York Job Development Authority and Victor Capital Group, L.P. (filed as Exhibit 10.8 to Capital Trust's Registration Statement on Form S-1 (File No. 333-37271) filed on October 6, 1997 and incorporated herein by reference). 10.12.a Amended and Restated Credit Agreement, dated as of January 1, 1998, between Capital Trust and German American Capital Corporation ("GACC") (filed as Exhibit 10.1 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on March 18, 1998 and incorporated herein by reference), as amended by First Amendment to Amended and Restated Credit Agreement, dated as of June 22, 1998, between Capital Trust and GACC (filed as Exhibit 10.3 to Capital Trust's Quarterly Report on Form 10-Q (File No. 1-8063) filed on August 14, 1998 and incorporated herein by reference), as amended by Second Amendment to Amended and Restated Credit Agreement, dated as of July 23, 1998, between Capital Trust and GACC (filed as Exhibit 10.10 to Capital Trust, Inc.'s Amendment No. 2 to Registration Statement on Form S-4 (File No. 333-52619) filed on October 23, 1998 and incorporated herein by reference). 10.12.b Third Amendment to Amended and Restated Credit Agreement, dated as of July 23, 1998, between Capital Trust, Inc. and GACC (filed as Exhibit 10.12b to Capital Trust, Inc.'s Annual Report on Form 10-K (File No. 1-14788) filed on March 31, 1999 and incorporated herein by reference). +10.13 Employment Agreement, dated as of August 15, 1998, by and between Capital Trust and Stephen D. Plavin (filed as Exhibit 10.15 to Capital Trust, Inc.'s Amendment No. 2 to Registration Statement on Form S-4 (File No. 333-37271) filed on October 23, 1998 and incorporated herein by reference). 10.14 Master Loan and Security Agreement, dated as of June 8, 1998, between Capital Trust and Morgan Stanley Mortgage Capital Inc. (filed as Exhibit 10.1 to Capital Trust's Quarterly Report on Form 10-Q (File No. 1-8063) filed on August 14, 1998 and incorporated herein by reference). 10.15 CMBS Loan Agreement, dated as of June 30, 1998, between Capital Trust and Morgan Stanley & Co. International Limited (filed as Exhibit 10.2 to Capital Trust's Quarterly Report on Form 10-Q (File No. 1-8063) filed on August 14, 1998 and incorporated herein by reference). 10.16 Co-Investment Agreement, dated as of July 28, 1998, among Capital Trust, Vornado Realty L.P., EOP Operating Limited Partnership, and General Motors Investment Management Corporation, as agent for and for the benefit of the Pension Plans (as defined therein) (filed as Exhibit 10.1 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on August 6, 1998 and incorporated herein by reference). 10.17 Registration Rights Agreement, dated as of July 28, 1998, among Capital Trust, Vornado Realty L.P., EOP Limited Partnership, Mellon Bank N.A., as trustee for General Motors Hourly-Rate Employes Pension Trust, and Mellon Bank N.A., as trustee for General Motors Salaried Employes Pension Trust (filed as Exhibit 10.2 to Capital Trust's Current Report on Form 8-K (File No. 1-8063) filed on August 6, 1998 and incorporated herein by reference). *21.1 Subsidiaries of Capital Trust, Inc. *23.1 Consent of Ernst & Young LLP *27.1 Financial Data Schedule. - --------------- + Represents a management contract or compensatory plan or arrangement. * Filed herewith. -31- (a) (4) Report on Form 8-K During the fiscal quarter ended December 31, 1999, the Registrant filed the following Current Report on Form 8-K: None -32- SIGNATURES Pursuant to the requirements of Section 13 or Section 15(d) 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. March 27, 2000 /s/ John R. Klopp - ------------------ ----------------- Date John R. Klopp Vice Chairman and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. March 27, 2000 /s/ Samuel Zell Date Samuel Zell Chairman of the Board of Directors March 27, 2000 /s/ John R. Klopp - ------------------ ----------------- Date John R. Klopp Vice Chairman and Chief Executive Officer and Director March 27, 2000 /s/ Edward L. Shugrue III - ------------------ ------------------------- Date Edward L. Shugrue III Managing Director and Chief Financial Officer March 27, 2000 /s/ Brian H. Oswald - ------------------ ------------------- Date Brian H. Oswald Chief Accounting Officer March 27, 2000 /s/ Jeffrey A. Altman - ------------------ --------------------- Date Jeffrey A. Altman, Director March 27, 2000 /s/ Thomas E. Dobrowski - ------------------ ----------------------- Date Thomas E. Dobrowski, Director March 27, 2000 /s/ Martin L. Edelman - ------------------ --------------------- Date Martin L. Edelman, Director March 27, 2000 /s/ Gary R. Garrabrant - ------------------ ---------------------- Date Gary R. Garrabrant, Director March 27, 2000 /s/ Craig M. Hatkoff - ------------------ -------------------- Date Craig M. Hatkoff Vice Chairman and Director March 27, 2000 /s/ Sheli Z. Rosenberg - ------------------ ---------------------- Date Sheli Z. Rosenberg, Director March 27, 2000 /s/ Steven Roth Date Steven Roth, Director March 27, 2000 /s/ Lynne B. Sagalyn - ------------------ -------------------- Date Lynne B. Sagalyn, Director March 27, 2000 /s/ Michael Watson Date Michael Watson, Director March 27, 2000 /s/ Marc P. Weill - ------------------ ----------------- Date Marc P. Weill, Director -33- Index to Consolidated Financial Statements Report of Independent Auditors.............................................F-2 Audited Financial Statements Consolidated Balance Sheets as of December 31, 1999 and 1998...............F-3 Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997...........................................F-4 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1999, 1998 and 1997...........................F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997...........................................F-6 Notes to Consolidated Financial Statements.................................F-7 F-1 Report of Independent Auditors The Board of Directors Capital Trust, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheets of Capital Trust, Inc. and Subsidiaries (the "Company") as of December 31, 1999 and 1998 and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 1999 and 1998, and the consolidated results of its operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP New York, New York February 14, 2000, except for Note 25, as to which the date is March 8, 2000 F-2
Capital Trust, Inc. and Subsidiaries Consolidated Balance Sheets December 31, 1999 and 1998 (in thousands) 1999 1998 -------------- -------------- Assets Cash and cash equivalents $ 38,782 $ 46,623 Other available-for-sale securities, at fair value - 3,355 Commercial mortgage-backed securities available-for-sale, at fair value 214,058 31,650 Certificated mezzanine investments available-for-sale, at fair value 45,432 45,480 Loans receivable, net of $7,605 and $4,017 reserve for possible credit losses at December 31, 1999 and December 31, 1998, respectively 509,811 620,858 Excess of purchase price over net tangible assets acquired, net 286 308 Deposits and other receivables 533 401 Accrued interest receivable 9,528 8,041 Deferred income taxes 5,368 3,029 Prepaid and other assets 4,010 6,693 -------------- -------------- Total assets 827,808 $ 766,438 ============== ============== Liabilities and Stockholders' Equity Liabilities: Accounts payable and accrued expenses $ 14,432 $ 12,356 Notes payable 3,474 4,247 Credit facilities 343,263 371,754 Term redeemable securities contract 129,642 - Repurchase obligations 28,703 79,402 Deferred origination fees and other revenue 3,411 4,448 -------------- -------------- Total liabilities 522,925 472,207 -------------- -------------- Company-obligated, mandatory redeemable, convertible preferred securities of CT Convertible Trust I, holding solely 8.25% junior subordinated debentures of Capital Trust, Inc. ("Convertible Trust Preferred Securities") 146,343 145,544 -------------- -------------- Stockholders' equity: Class A 9.5% cumulative convertible preferred stock, $0.01 par value, $0.26 cumulative annual dividend, 100,000 shares authorized, 2,278 and 12,268 shares issued and outstanding at December 31, 1999 and December 31, 1998, respectively (liquidation preference of $6,127) ("Class A Preferred Stock") 23 123 Class B 9.5% cumulative convertible non-voting preferred stock, $0.01 par value, $0.26 cumulative annual dividend, 100,000 shares authorized, 4,043 shares issued and outstanding at December 31, 1999 (liquidation preference of $10,876) ("Class B Preferred Stock" and together with Class A Preferred Stock, "Preferred Stock") 40 - Class A common stock, $0.01 par value, 100,000 shares authorized, 21,862 and 18,159 shares issued and outstanding at December 31, 1999 and December 31, 1998, respectively 219 182 Class B common stock, $0.01 par value, 100,000 shares authorized, 2,294 shares issued and outstanding at December 31, 1999 ("Class B Common Stock") 23 - Restricted Class A Common Stock, $0.01 par value, 127 and 55 shares issued and outstanding at December 31, 1999 and December 31, 1998, respectively ("Restricted Class A Common Stock" and together with Class A Common Stock and Class B Common Stock, "Common Stock") 1 1 Additional paid-in capital 189,456 188,816 Unearned compensation (407) (418) Accumulated other comprehensive loss (10,164) (4,665) Accumulated deficit (20,651) (35,352) -------------- -------------- Total stockholders' equity 158,540 148,687 -------------- -------------- Total liabilities and stockholders' equity $ 827,808 $ 766,438 ============== ============== See accompanying notes to consolidated financial statements.
F-3
Capital Trust, Inc. and Subsidiaries Consolidated Statements of Operations For the Years Ended December 31, 1999, 1998 and 1997 (in thousands, except per share data) 1999 1998 1997 ---------------- ---------------- ----------------- Income from loans and other investments: Interest and related income $ 88,590 $ 62,316 $ 4,992 Less: Interest and related expenses 39,454 27,252 2,223 ---------------- ---------------- ---------------- Income from loans and other investments, net 49,136 35,064 2,769 ---------------- ---------------- ---------------- Other revenues: Advisory and investment banking fees 17,772 10,311 1,698 Rental income - - 307 Other interest income 1,249 1,638 1,453 Gain (loss) on sale of rental properties and investments 35 - (432) ---------------- ---------------- --------------- Total other revenues 19,056 11,949 3,026 ---------------- ---------------- ---------------- Other expenses: General and administrative 17,345 17,045 9,463 Other interest expense 337 413 156 Rental property expenses - - 124 Depreciation and amortization 345 249 92 Provision for possible credit losses 4,103 3,555 462 ---------------- ---------------- ---------------- Total other expenses 22,130 21,262 10,297 ---------------- ---------------- ---------------- Income (loss) before income taxes and distributions and amortization on Convertible Trust Preferred Securities 46,062 25,751 (4,502) Provision for income taxes 22,020 9,367 55 ---------------- ---------------- ---------------- Income (loss) before distributions and amortization on Convertible Trust Preferred Securities 24,042 16,384 (4,557) Distributions and amortization on Convertible Trust Preferred Securities, net of income tax benefit of $6,208 and $2,621 for the years ended December 31, 1999 and 1998, respectively 6,966 2,941 - ---------------- ---------------- --------------- Net income (loss) 17,076 13,443 (4,557) Less: Preferred Stock dividend 2,375 3,135 1,341 Preferred Stock dividend requirement - - 130 ---------------- ---------------- --------------- Net income (loss) allocable to Common Stock $ 14,701 $ 10,308 $ (6,028) ================ ================ =============== Per share information: Net earnings (loss) per share of Common Stock Basic $ 0.69 $ 0.57 $ (0.63) ================ ================ =============== Diluted $ 0.55 $ 0.44 $ (0.63) ================ ================ =============== Weighted average shares of Common Stock outstanding Basic 21,334,412 18,208,812 9,527,013 ================ ================ =============== Diluted 43,724,731 30,625,459 9,527,013 ================ ================ =============== See accompanying notes to consolidated financial statements.
F-4
Capital Trust, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity For the Years Ended December 31, 1999, 1998 and 1997 (in thousands) Restricted Class A Class B Class A Class B Class A Comprehensive Preferred Preferred Common Common Common Income/(loss) Stock Stock Stock Stock Stock ----------------- ----------------------------------------------------------- Balance at January 1, 1997 $ - $ - $ - $ 92 $ - $ - Net loss (4,557) - - - - - Change in unrealized gain on available-for-sale securities, net of related income taxes 409 - - - - - Issuance of Class A Common Stock - - - 90 - - Issuance of Class A Preferred Stock - 123 - - - - Dividends paid on Preferred Stock - - - - - - ----------------- ----------------------------------------------------------- Balance at December 31, 1997 $ (4,148) $ 123 $ - $ 182 $ - $ - Net income 13,443 - - - - - ================= Change in unrealized loss on available-for-sale securities, net of related income taxes (5,052) - - - - - Issuance of Class A Common Stock under stock option plan - - - - - - Issuance of restricted Class A Common Stock - - - - - 1 Cancellation of previously issued restricted Class A Common Stock - - - - - - Restricted Class A Common Stock earned - - - - - - Dividends paid on Preferred Stock - - - - - - ----------------- ----------------------------------------------------------- Balance at December 31, 1998 $ 8,391 $ 123 $ - $ 182 $ - $ 1 ================= Net income 17,076 - - - - - Change in unrealized loss on available-for-sale securities, net of related income taxes (5,499) - - - - - Conversion of Class A Common and Preferred Stock to Class B - (40) 40 (23) 23 - Conversion of Class A Preferred Stock to Class A Common Stock - (60) - 60 - - Issuance of Class A Common Stock unit awards - - - - - - Cancellation of previously issued restricted Class A Common Stock - - - - - (1) Issuance of restricted Class A Common Stock - - - - - 1 Restricted Class A Common Stock earned - - - - - - Dividends paid on Preferred Stock - - - - - - ----------------- ----------------------------------------------------------- Balance at December 31, 1999 $ 11,577 $ 23 $ 40 $ 219 $ 23 $ 1 ================= =========================================================== See accompanying notes to consolidated financial statements.
Capital Trust, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity For the Years Ended December 31, 1999, 1998 and 1997 (in thousands) Accumulated Additional Other Paid-In Unearned Comprehensive Accumulated Capital Compensation Income/(Loss) Deficit Total --------------------------------------------------------------------- Balance at January 1, 1997 $ 64,163 $ - $ (22) $ (39,762) $ 24,471 Net loss - - - (4,557) (4,557) Change in unrealized gain on available-for-sale securities, net of related income taxes - - 409 - 409 Issuance of Class A Common Stock 91,347 - - - 91,437 Issuance of Class A Preferred Stock 32,747 - - - 32,870 Dividends paid on Preferred Stock - - - (1,341) (1,341) --------------------------------------------------------------------- Balance at December 31, 1997 $ 188,257 $ - $ 387 $ (45,660) $ 143,289 Net income - - - 13,443 13,443 Change in unrealized loss on available-for-sale securities, net of related income taxes - - (5,052) - (5,052) Issuance of Class A Common Stock under stock option plan 10 - - - 10 Issuance of restricted Class A Common Stock 724 (725) - - - Cancellation of previously issued restricted Class A Common Stock (175) 156 - - (19) Restricted Class A Common Stock earned - 151 - - 151 Dividends paid on Preferred Stock - - - (3,135) (3,135) --------------------------------------------------------------------- Balance at December 31, 1998 $ 188,816 $ (418) $ (4,665) $ (35,352) $ 148,687 Net income - - - 17,076 17,076 Change in unrealized loss on available-for-sale securities, net of related income taxes - - (5,499) - (5,499) Conversion of Class A Common and Preferred Stock to Class B - - - - - Conversion of Class A Preferred Stock to Class A Common Stock - - - - - Issuance of Class A Common Stock unit awards 312 - - - 312 Cancellation of previously issued restricted Class A Common Stock (271) 180 - - (92) Issuance of restricted Class A Common Stock 599 (600) - - - Restricted Class A Common Stock earned - 431 - - 431 Dividends paid on Preferred Stock - - - (2,375) (2,375) --------------------------------------------------------------------- Balance at December 31, 1999 $ 189,456 $ (407) $ (10,164) $ (20,651) $ 158,540 ===================================================================== See accompanying notes to consolidated financial statements.
F-5
Capital Trust, Inc. and Subsidiaries Consolidated Statements of Cash Flows For the Years Ended December 31, 1999, 1998 and 1997 (in thousands) 1999 1998 1997 ---------------- ---------------- ----------------- Cash flows from operating activities: Net income (loss) $ 17,076 $ 13,443 $ (4,557) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Deferred income taxes (2,339) (3,029) - Provision for credit losses 4,103 3,555 462 Depreciation and amortization 345 249 92 Restricted Class A Common Stock earned 431 151 - Amortization of premiums and accretion of discounts on loans and investments, net (1,032) 1,250 - Accretion of discount on term redeemable securities contract 2,757 - - Accretion of discounts and fees on Convertible Trust Preferred Securities, net 799 337 - (Gain) loss on sale of rental properties and investments (35) - 432 Expenses reversed on cancellation of restricted stock previously issued (92) (19) - Changes in assets and liabilities net of effects from subsidiaries purchased: Deposits and other receivables (132) (117) 2,707 Accrued interest receivable (1,487) (7,223) (818) Prepaid and other assets 2,417 (3,545) (2,988) Deferred origination fees and other revenue (1,037) 3,079 1,369 Accounts payable and accrued expenses 2,388 6,638 5,857 Other liabilities - - (64) ---------------- ---------------- ----------------- Net cash provided by operating activities 24,162 14,769 2,492 ---------------- ---------------- ----------------- Cash flows from investing activities: Purchases of commercial mortgage-backed securities (185,947) (36,334) (49,524) Principal collections on and proceeds from sale of commercial mortgage-backed securities - 49,490 34 Advances on and purchases of certificated mezzanine investments (985) (23,947) (21,998) Principal collections on certificated mezzanine investments 1,033 465 - Origination and purchase of loans receivable (103,732) (515,449) (189,711) Principal collections on and proceeds from sales of loans receivable 209,792 70,405 9,935 Purchases of equipment and leasehold improvements (57) (496) (479) Proceeds from sale of rental properties - - 8,153 Principal collections and proceeds from sales of available-for-sale securities 3,344 7,957 4,947 Acquisition of Victor Capital Group, L.P., net of cash acquired - - (4,066) -------------- -------------- --------------- Net cash used in investing activities (76,552) (447,909) (242,709) ---------------- -------------- --------------- Cash flows from financing activities: Proceeds from repurchase obligations 3,929 41,837 109,458 Repayment of repurchase obligations (54,626) (44,608) (27,285) Proceeds from credit facilities 214,246 618,686 81,864 Repayment of credit facilities (242,737) (326,796) (2,000) Proceeds from notes payable - 10,000 4,001 Repayment of notes payable (773) (10,706) (4,217) Net proceeds from issuance of Convertible Trust Preferred - 145,207 - Securities Net proceeds from issuance of term redeemable securities 126,885 - - contract Dividends paid on Class A Preferred Stock (2,375) (3,135) (1,341) Net proceeds from issuance of Class A Common Stock under stock option plan - 10 - Net proceeds from issuance of Class A Common Stock - - 91,437 Net proceeds from issuance of Class A Preferred Stock - - 32,870 -------------- ---------------- ---------------- Net cash provided by financing activities 44,549 430,495 284,787 -------------- ---------------- ---------------- Net increase (decrease) in cash and cash equivalents (7,841) (2,645) 44,570 Cash and cash equivalents at beginning of year 46,623 49,268 4,698 -------------- ---------------- ---------------- Cash and cash equivalents at end of year $ 38,782 $ 46,623 $ 49,268 ============== ================ ================
See accompanying notes to consolidated financial statements. F-6 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 1999, 1998 and 1997 1. Organization Capital Trust, Inc. (the "Company") is a finance company designed to take advantage of high-yielding lending and investment opportunities in commercial real estate and related assets. The Company makes investments in various types of income producing commercial real estate, including senior and junior commercial mortgage loans, preferred equity investments, direct equity investments and subordinate interests in commercial mortgage-backed securities ("CMBS"). The Company also provides real estate investment banking, advisory and asset management services through its wholly owned subsidiary, Victor Capital Group, L.P. ("Victor Capital"). The Company is the successor to Capital Trust (f/k/a California Real Estate Investment Trust), a business trust organized under the laws of the State of California pursuant to a declaration of trust dated September 15, 1966 (the "Predecessor"), following the consummation of the Reorganization (as defined and described below). On December 31, 1996, 76% of the Predecessor's then-outstanding common shares of beneficial interest, $1.00 par value ("Common Shares") were held by the Predecessor 's former parent ("Former Parent"). On January 3, 1997, the Former Parent sold its entire 76% ownership interest in the Predecessor (consisting of 6,959,593 Common Shares) to CalREIT Investors Limited Partnership ("CRIL"), an affiliate of Equity Group Investments, L.L.C. ("EGI") and Samuel Zell, the Company's current chairman of the board of directors, for an aggregate price of approximately $20.2 million. Prior to the purchase, which was approved by the Predecessor's then-incumbent board of trustees, EGI and Victor Capital, a then privately held company owned by two of the current directors of the Company, presented to the Predecessor's then-incumbent board of trustees a proposed new business plan in which the Predecessor would cease to be a real estate investment trust ("REIT") and instead become a finance company as discussed above. EGI and Victor Capital also proposed that they provide the Predecessor with a new management team to implement the business plan and invest, through an affiliate, a minimum of $30 million in a new class of preferred equity to be issued by the Predecessor. In connection with the foregoing, the Predecessor subsequently agreed that, concurrently with the consummation of the proposed preferred equity investment, it would acquire for $5.0 million Victor Capital's real estate investment banking, advisory and asset management businesses, including the services of its experienced management team (see Note 2). On July 15, 1997, the proposed preferred equity investment was consummated and 12,267,658 class A 9.5% cumulative convertible preferred shares of beneficial interest, $1.00 par value ("Class A Preferred Shares"), in the Predecessor were sold to Veqtor Finance Company, L.L.C. ("Veqtor"), a then affiliate of Samuel Zell and the then principals of Victor Capital, for an aggregate purchase price of $33.0 million. Concurrently with the foregoing transaction, Veqtor purchased from CRIL the 6,959,593 Common Shares held by it for an aggregate purchase price of approximately $21.3 million (which shares were reclassified on that date as class A common shares of beneficial interest, $1.00 par value ("Class A Common Shares"), in the Predecessor pursuant to the terms of an amended and restated declaration of trust, dated July 15, 1997, adopted on that date (the "Amended and Restated Declaration of Trust")). See Note 14. At the Predecessor's 1998 annual meeting of shareholders (held on January 28, 1999), the Predecessor's shareholders approved the reorganization of the Predecessor into a Maryland corporation (the "Reorganization"). In the Reorganization, which was consummated on January 28, 1999, the Predecessor merged with and into Captrust Limited Partnership, a Maryland limited partnership ("CTLP"), with CTLP continuing as the surviving entity, and CTLP merged with and into the Company, with the Company continuing as the surviving Maryland corporation. Each outstanding Class A Common Share was converted into one share of class A common stock, par value $0.01 per share ("Class A Common Stock"), and each outstanding Class A Preferred Share was converted into one share of class A 9.5% cumulative convertible preferred stock, par value $0.01 per share ("Class A Preferred Stock"), of the Company. The Company assumed all outstanding obligations to issue shares of Class A Common Stock under the Incentive Stock Plan and Director Stock Plan (as defined and described in Note 18). Unless the context otherwise requires, hereinafter references to the business, assets, liabilities, capital structure, operations and affairs of "the Company" shall include those of "the Predecessor" prior to the Reorganization. F-7 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. Acquisition of Victor Capital On July 15, 1997, the Company consummated the acquisition of the real estate investment banking, advisory and asset management businesses of Victor Capital and certain affiliated entities including the following wholly-owned subsidiaries: VCG Montreal Management, Inc., Victor Asset Management Partners, L.L.C., VP Metropolis Services, L.L.C., and 970 Management, LLC. Victor Capital provides services to real estate investors, owners, developers and financial institutions in connection with mortgage financings, securitizations, joint ventures, debt and equity investments, mergers and acquisitions, portfolio evaluations, restructurings and disposition programs. Victor Capital's wholly owned subsidiaries provide asset management and advisory services relating to various mortgage pools and real estate properties. In addition, VCG Montreal Management, Inc. holds a nominal interest in a Canadian real estate venture. The purchase price in the Victor Capital acquisition was $5.0 million, which was paid by the Company with the issuance of non-interest bearing acquisition notes, payable in ten semi-annual equal installments of $500,000. The acquisition notes have been discounted to approximately $3.9 million based on an imputed interest rate of 9.5%. The acquisition has been accounted for under the purchase method of accounting. The excess of the purchase price of the acquisition in excess of net tangible assets acquired approximated $342,000. During the period from July 15, 1997 to December 31, 1997, significant advisory income collected as a result of the Company's acquisition of Victor Capital was applied as a reduction of current accounts receivable and thereby not reflected as revenue. Had the acquisition occurred on January 1, 1997, pro forma revenues, net loss (after giving effect to the Class A Preferred Stock dividend and dividend requirement) and net loss per common share (basic and diluted) for the year ended December 31, 1997 would have been: $11,271,000, $5,347,000 and $0.56, respectively. 3. Summary of Significant Accounting Policies Principles of Consolidation During the year ended December 31, 1997, the Company owned commercial rental property in Sacramento, California through a 59% limited partnership interest in Totem Square L.P., a Washington limited partnership ("Totem"), and an indirect 1% general partnership interest in Totem through its wholly-owned subsidiary Cal-REIT Totem Square, Inc. An unrelated party held the remaining 40% interest. This property was sold during the year ended December 31, 1997 and the Totem Square L.P. and Totem Square, Inc. subsidiaries were liquidated and dissolved. The consolidated financial statements of the Company include the accounts of the Company, VIC, Inc., which holds Victor Capital and its wholly-owned subsidiaries (included in the consolidated statement of operations since their acquisition on July 15, 1997), Natrest Funding I, Inc. (a single purpose entity holding one Mortgage Loan), CT-BB Funding Corp. (an entity which purchased fifteen CMBS securities as described in Note 6), CT Convertible Trust I (as described in Note 13) and the results from the disposition of its rental property held by Totem, which was sold on March 4, 1997 prior to commencement of the Company's new business plan (see Note 1). All significant intercompany balances and transactions have been eliminated in consolidation. F-8 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. Summary of Significant Accounting Policies, continued Revenue Recognition Interest income for the Company's mortgage and other loans and investments is recognized over the life of the investment using the effective interest method and recognized on the accrual basis. Fees received in connection with loan commitments, net of direct expenses, are deferred until the loan is advanced and are then recognized over the term of the loan as an adjustment to yield. Fees on commitments that expire unused are recognized at expiration. Income recognition is generally suspended for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Fees from professional advisory services are generally recognized at the point at which all Company services have been performed and no significant contingencies exist with respect to entitlement to payment. Fees from asset management services are recognized as services are rendered. Reserve for Possible Credit Losses The provision for possible credit losses is the charge to income to increase the reserve for possible credit losses to the level that management estimates to be adequate considering delinquencies, loss experience and collateral quality. Other factors considered relate to geographic trends and product diversification, the size of the portfolio and current economic conditions. Based upon these factors, the Company establishes the provision for possible credit losses by category of asset. When it is probable that the Company will be unable to collect all amounts contractually due, the account is considered impaired. Where impairment is indicated, a valuation write-down or write-off is measured based upon the excess of the recorded investment amount over the net fair value of the collateral, as reduced by selling costs. Any deficiency between the carrying amount of an asset and the net sales price of repossessed collateral is charged to the reserve for credit losses. Cash and Cash Equivalents The Company classifies highly liquid investments with original maturities of three months or less from the date of purchase as cash equivalents. At December 31, 1999 and 1998, cash equivalents of approximately $37.1 million and $46.4 million, respectively, consisted of an investment in a money market fund that invests in U.S. Treasury bills. Bank balances in excess of federally insured amounts totaled approximately $1.5 million and $26,000 as of December 31, 1999 and 1998, respectively. The Company has not experienced any losses on its demand deposits or money market investments. Other Available-for-Sale Securities Other available-for-sale securities are reported on the consolidated balance sheet at fair value with any corresponding temporary change in value reported as an unrealized gain or loss (if assessed to be temporary), as a component of comprehensive income in stockholders' equity, net of related income taxes (see Note 5). F-9 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. Summary of Significant Accounting Policies, continued Commercial Mortgage-Backed Securities At December 31, 1997, the Company had the intent and ability to hold its subordinated investment in a commercial mortgage-backed security ("CMBS") until maturity. Consequently, this investment was classified as held to maturity and was carried at amortized cost. During 1998, due to prepayments made on underlying securities that reduced the interest rate/risk profile and maturity of a CMBS, the Company concluded that it no longer anticipated holding the asset to maturity. Due to the decision to sell this held-to-maturity security, the Company has transferred all of its investments in CMBS from held-to-maturity securities to available-for-sale and they are recorded as such at December 31, 1999 and 1998. Income from CMBS is recognized based on the effective interest method using the anticipated yield over the expected life of the investments. Changes in yield resulting from prepayments are recognized over the remaining life of the investment. The Company recognizes impairment on its CMBS whenever it determines that the impact of expected future credit losses, as currently projected, exceeds the impact of the expected future credit losses as originally projected. Impairment losses are determined by comparing the current fair value of a CMBS to its existing carrying amount, the difference being recognized as a loss in the current period in the consolidated statements of operations of the period in which the loss is identified. Reduced estimates of credit losses are recognized as an adjustment to yield over the remaining life of the portfolio. Certificated Mezzanine Investments Certificated Mezzanine Investments available-for-sale are reported on the consolidated balance sheets at fair value with any corresponding temporary change in value resulting in an unrealized gain (loss) being reported as a component of comprehensive income in the stockholders' equity section of the balance sheet, net of related income taxes. See Note 7. Derivative Financial Instruments The Company uses interest rate swaps to effectively convert fixed rate assets to variable rate assets for proper matching with variable rate liabilities ("Asset-based Swap") and to convert variable rate liabilities to fixed rate liabilities for proper matching with fixed rate assets ("Liability-based Swap"). The differential to be paid or received on these agreements is recognized as an adjustment to the interest income related to the earning asset or an adjustment to interest expense related to the interest bearing liability and is recognized on the accrual basis. These swaps are highly effective in reducing the Company's risk of changes in LIBOR as they effectively convert the financed portion of an asset to a variable rate for which the financing cost is also at a variable rate. As the Asset-based Swaps relate to assets that are accounted for on an amortized cost basis, these swaps are accounted for as off-balance sheet assets. The Liability-based Swaps relate to assets that are accounted for on a mark-to-market basis and the value of the swaps are included as an adjustment to the carrying value. The Company also uses interest rate caps to reduce its exposure to interest rate changes on investments. The Company will receive payments on an interest rate cap should the variable rate for which the cap was purchased exceed a specified threshold level and will be recorded as an adjustment to the interest income related to the related earning asset. 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 the Company does not use derivative financial instruments for trading purposes. F-10 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. Summary of Significant Accounting Policies, continued Equipment and Leasehold Improvements, Net Equipment and leasehold improvements, net, are stated at original cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method based on the estimated lives of the depreciable assets. Amortization is computed over the remaining terms of the related leases. Expenditures for maintenance and repairs are charged directly to expense at the time incurred. Expenditures determined to represent additions and betterments are capitalized. Cost of assets sold or retired and the related amounts of accumulated depreciation are eliminated from the accounts in the year of sale or retirement. Any resulting profit or loss is reflected in the consolidated statement of operations. Sales of Real Estate The Company complies with the provisions of Statement of Financial Accounting Standards No. 66, "Accounting for Sales of Real Estate." Accordingly, the recognition of gains is deferred until such transactions have complied with the criteria for full profit recognition under the Statement. The Company has deferred gains of $239,000 at December 31, 1999 and 1998. Deferred Debt Issuance Costs The Company capitalizes costs incurred related to the issuance of long-term debt. These costs are deferred and amortized on a straight-line basis over the life of the related debt, which approximates the level-yield method, and is recognized as a component of interest expense. Income Taxes Prior to commencement of full implementation of operations as a finance company on July 15, 1997, the Company had a REIT status, as permitted by the Internal Revenue Code, and, as such, was not taxed on that portion of its taxable income which was distributed to shareholders, provided that at least 95% of its real estate trust taxable income was distributed and that the Company met certain other REIT requirements. At July 15, 1997, the Company elected to not meet the requirements to continue to be taxed as a REIT and was therefore not considered a REIT retroactive to January 1, 1997. The Company records its income taxes in accordance with Financial Accounting Standards Board Statement No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). Under SFAS No. 109, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying statutory tax rates for future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years and for carryforwards that are useable in future years. A valuation allowance is recognized if it is more likely than not that some portion of the deferred asset will not be recognized. When evaluating whether a valuation allowance is appropriate, SFAS No. 109 requires a company to consider such factors as previous operating results, future earning potential, tax planning strategies and future reversals of existing temporary differences. The valuation allowance is increased or decreased in future years based on changes in these criteria. F-11 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. Summary of Significant Accounting Policies, continued Amortization of the Excess of Purchase Price Over Net Tangible Assets Acquired The Company recognized the excess of purchase price over net tangible assets acquired in a business combination accounted for as a purchase transaction and is amortizing it on a straight-line basis over a period of 15 years. The carrying value of the excess of purchase price over net tangible assets acquired is analyzed quarterly by the Company based upon the expected revenue and profitability levels of the acquired enterprise to determine whether the value and future benefit may indicate a decline in value. If the Company determines that there has been a decline in the value of the acquired enterprise, the Company will write down the value of the excess of purchase price over net tangible assets acquired to the revised fair value. As of December 31, 1999, the Company has $56,000 of accumulated amortization recorded against the original excess of purchase price over net tangible assets acquired of $342,000. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles 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. Comprehensive Income Effective January 1, 1998, the Company adopted the Financial Accounting Standards Board's ("FASB") Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). The statement changes the reporting of certain items currently reported in the stockholders' equity section of the balance sheet and establishes standards for reporting of comprehensive income and its components in a full set of general-purpose financial statements. Total comprehensive income (loss) was $11,577,000, $8,391,000 and $(4,148,000) for the years ended December 31, 1999, 1998 and 1997, respectively. The primary component of comprehensive income other than net income was the unrealized gain (loss) on available-for-sale securities, net of related income taxes. Earnings per Share of Common Stock Earnings per share of Common Stock is presented based on the requirements of Statement of Accounting Standards No. 128 ("SFAS No. 128"). Basic EPS is computed based on the income applicable to Common Stock (which is net income or loss reduced by the dividends on the Preferred Stock) divided by the weighted-average number of shares of Common Stock outstanding during the period. Diluted EPS is based on the net earnings applicable to Common Stock plus, if dilutive, dividends on the Preferred Stock and interest paid on Convertible Trust Preferred Securities, net of tax benefit, divided by the weighted average number of shares of Common Stock and potentially dilutive shares of Common Stock that were outstanding during the period. At December 31, 1999, potentially dilutive shares of Common Stock include the convertible Preferred Stock and Convertible Trust Preferred Securities. At December 31, 1998, potentially dilutive shares of Common Stock include the convertible Preferred Stock and dilutive Common Stock options. At December 31, 1997, the shares of Preferred Stock and Common Stock options were not considered Common Stock equivalents for purposes of calculating Diluted EPS as they were antidilutive and accordingly, there was no difference between Basic EPS and Diluted EPS or weighted average shares of Common Stock outstanding. Reclassifications Certain reclassifications have been made in the presentation of the 1998 and 1997 consolidated financial statements to conform to the 1999 presentation. F-12 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 3. Summary of Significant Accounting Policies, continued Segment Reporting In 1998, the Company adopted FASB Statement of Financial Accounting Standards No. 131, "Disclosure about segments of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 requires disclosures about segments of an enterprise and related information regarding the different types of business activities in which an enterprise engages and the different economic environments in which it operates. In 1998, the Company operated as two segments: Lending/Investment and Advisory for which the disclosures required by SFAS No. 131 for the year ended December 31, 1998 are presented in Note 23. During the first quarter of 1999, the Company reorganized the structure of its internal organization by merging its Lending/Investment and Advisory segments and thereby no longer managing its operations as separate segments. As such, separate segment reporting is not presented for 1999 as there is only one segment and the financial information for that segment is the same as the information in the consolidated financial statements. The accounting policies of the reportable segments in 1998 are the same as those described within this summary of significant accounting policies. New Accounting Pronouncements In June 1998, the FASB issued Statement of Financial Accounting Standards No.133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). Subsequently, SFAS No. 137, "Deferral of the Effective Date of FASB No. 133" deferred the adoption of SFAS No. 133 to years beginning after June 15, 2000. SFAS No. 133 will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value, if any, will be immediately recognized in earnings. The Company plans to adopt SFAS No. 133 effective January 1, 2001. Based upon the Company's derivative positions, which are considered effective hedges at December 31, 1999, the Company estimates that it would have reported an increase in other comprehensive income of $3.8 million had the statement been adopted at that time. 4. Rental Properties At January 1, 1997, the Company's rental property portfolio included a retail and mixed-use property carried at $8,585,000. This property was sold during 1997. At January 1, 1997 the Company had an allowance for valuation losses on rental properties of $6,898,000. During the year ended December 31, 1997, a provision for valuation losses of $1,743,000 was recorded and $8,641,000 was charged against the allowance for valuation losses decreasing the allowance for valuation losses on rental properties to zero at December 31, 1997. The Company did not hold any rental properties during the years ended December 31, 1999 and 1998. F-13 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 5. Other Available-for-Sale Securities During the year ended December 31, 1999, the Company sold its entire portfolio of other available-for sale securities at a gain of $35,000 over their amortized cost. At December 31, 1998, the Company's other available-for-sale securities consisted of the following (in thousands):
Gross Unrealized Estimated --------------------- Cost Gains Losses Fair Value ----------------------------------------------- Federal National Mortgage Association, adjustable rate interest at 7.474%, due April 1, 2024 $ 1,159 $ 17 $ - $ 1,176 Federal Home Loan Mortgage Association, adjustable rate interest at 7.626%, due June 1, 2024 425 5 - 430 Federal National Mortgage Association, adjustable rate interest at 7.512%, due May 1, 2025 106 - - 106 Federal National Mortgage Association, adjustable rate interest at 7.725%, due May 1, 2026 463 3 - 466 Federal National Mortgage Association, adjustable rate interest at 7.604%, due June 1, 2026 1,139 13 - 1,152 Norwest Corp. Voting Common Stock, 630 shares 17 8 - 25 ----------------------------------------------- $ 3,309 $ 46 $ - $ 3,355 ===============================================
The maturity dates of debt securities were not necessarily indicative of expected maturities as principal is often prepaid on such instruments. 85,600 shares of SL Green Realty Corp. Common Stock were received as partial payment for advisory services rendered by Victor Capital to SL Green Realty Corp. This stock was restricted from sale by the Company for a period of one year from the date of issuance or until August 20, 1998. The stock was sold in December 1998 for $1,798,000 with no resulting realized gain or loss. The cost of securities sold is determined using the specific identification method. 6. Commercial Mortgage-Backed Securities ("CMBS") The Company pursues rated and unrated investments in public and private subordinated interests ("Subordinated Interests") in CMBS. In 1997, the Company completed an investment for the entire junior subordinated class of CMBS that provided for both interest payments and principal repayments. The CMBS investment consisted of a security with a face value of $49,592,000 that was purchased at a discount for $49,174,000 plus accrued interest. At the time of acquisition, the investment was subordinated to approximately $351.3 million of senior securities. At December 31, 1997, the CMBS investment (including interest receivable) was $49,471,000 and had a yield of 8.96%. During 1998, due to prepayments made on underlying securities that reduced the interest rate/risk profile and maturity of this CMBS, the Company concluded that it no longer anticipated holding this security to maturity. The security was sold during 1998 at a gain of approximately $100,000. Because of this decision to sell a held-to-maturity security, the Company transferred all of its investments in commercial mortgage-backed securities from held-to-maturity securities to available-for-sale and continues to classify the CMBS as such. F-14 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 6. Commercial Mortgage-Backed Securities ("CMBS"), continued In connection with the CMBS investment above, the Company was named "special servicer" for the entire $413 million loan portfolio in which capacity the Company earned fee income for management of the collection process when any of the loans became non-performing. During the year ended December 31, 1998, fees totaling $43,000 were earned relating to the special servicing arrangement. No fees were earned during the year ended December 31, 1997. During the year ended December 31, 1998, the Company purchased $36,509,000 face amount of interests in three subordinated CMBS issued by a financial asset securitization investment trust for $36,335,000, which, at December 31, 1999, had an amortized cost of $36,396,000 and a market value of $33,089,000. These securities bear interest at floating rates, for which the weighted average interest rate in effect, after fair value adjustment at December 31, 1999, is 12.34%, and mature in January 2003. In connection with the aforementioned investments, at December 31, 1999, the Company has deferred acquisition costs of $51,000 that are being amortized as a reduction of interest income on a basis to realize a level yield over the life of the investment. On March 3, 1999, the Company, through its then newly formed wholly-owned subsidiary, CT-BB Funding Corp., acquired a portfolio of fixed-rate "BB" rated CMBS (the "BB CMBS Portfolio") from an affiliate of the Company's credit provider under the First Credit Facility (as hereinafter defined). The portfolio, which is comprised of 11 separate issues with an aggregate face amount of $246.0 million, was purchased for $196.9 million. In connection with the transaction, an affiliate of the seller provided three-year term financing for 70% of the purchase price at a floating rate above the London Interbank Offered Rate ("LIBOR") and entered into an interest rate swap with the Company for the full duration of the BB CMBS Portfolio securities thereby providing a hedge for interest rate risk. The financing was provided at a rate that was below the current market for similar financings and, as such, the carrying amount of the assets and the debt were reduced by $10.9 million to adjust the yield on the debt to current market terms. The BB CMBS Portfolio securities bear interest at fixed rates that have an average face rate of 7.74% on the face amount and mature at various dates from March 2005 to December 2014. After giving effect to the discounted purchase price, the fair value adjustment and the adjustment of the carrying amount of the assets to bring the debt to current market terms, the weighted average interest rate in effect for the BB CMBS Portfolio at December 31, 1999 was 12.19%. 7. Certificated Mezzanine Investments The Company purchases high-yielding mezzanine investments that are subordinate to senior secured loans on commercial real estate. Such investments represent interests in debt service from loans or property cash flow and are issued in certificate form. These certificated investments carry substantially similar terms and risks as the Company's Mezzanine Loans. The certificated mezzanine investments are floating rate securities that are carried at market value of $45,432,000 and $45,480,000 on December 31, 1999 and 1998, respectively. As the market value and amortized cost were the same on December 31, 1999 and 1998, no unrealized gains or losses have been recorded. One of the certificated mezzanine investments was subject to early redemption penalties through October 1999. The certificated mezzanine investments have remaining terms of five to eleven months with the security with the five-month maturity having 24 months of additional extensions available. The weighted average interest rate in effect for the two certificated mezzanine investments is 10.51% at December 31, 1999. In connection with the aforementioned investments, at December 31, 1999, the Company has deferred origination fees, net of direct costs of $19,000 that are being amortized into interest income on a basis to realize a level yield over the life of the investment. F-15 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 8. Loans Receivable The Company currently pursues lending opportunities designed to capitalize on inefficiencies in the real estate capital, mortgage and finance markets. The Company has classified its loans receivable into the following general categories: o Mortgage Loans. The Company originates and funds senior and junior mortgage loans ("Mortgage Loans") to commercial real estate owners and property developers who require interim financing until permanent financing can be obtained. The Company's Mortgage Loans are generally not intended to be permanent in nature, but rather are intended to be of a relatively short-term duration, with extension options as deemed appropriate, and typically require a balloon payment of principal at maturity. The Company may also originate and fund permanent Mortgage Loans in which the Company intends to sell the senior tranche, thereby creating a Mezzanine Loan (as defined below). o Mezzanine Loans. The Company originates high-yielding loans that are subordinate to first lien mortgage loans on commercial real estate and are secured either by a second lien mortgage or a pledge of the ownership interests in the borrowing property owner ("Mezzanine Loans"). Generally, the Company's Mezzanine Loans have a longer anticipated duration than its Mortgage Loans and are not intended to serve as transitional mortgage financing. o Other Loans Receivable. This classification includes loans originated during the Company's prior operations as a REIT and other loans and investments not meeting the above criteria. At December 31, 1999 and 1998, the Company's loans receivable consisted of the following (in thousands):
1999 1998 ------------------- ------------------- Mortgage Loans $ 270,332 $ 305,578 Mezzanine Loans 192,613 317,278 Other loans receivable 54,471 2,019 ------------------- ------------------- 517,416 624,875 Less: reserve for possible credit losses (7,605) (4,017) ------------------- ------------------- Total loans $ 509,811 $ 620,858 =================== ===================
At December 31, 1999, one mortgage loan with a principal balance of $21,114,000 was in default as the loan matured on December 29, 1999. At December 31, 1999, the loan was earning a fixed interest rate of 20% (the default rate) and was repaid in full with interest on January 7, 2000. At December 31, 1999, the weighted average interest rate in effect, after giving effect to interest rate swaps and including amortization of fees and premiums, for the Company's performing loans receivable was as follows: Mortgage Loans 11.40% Mezzanine Loans 12.07% Other loans receivable 12.43% Total Loans 11.77% At December 31, 1999, $367,441,000 (74%) of the aforementioned performing loans bear interest at floating rates ranging from LIBOR plus 320 basis points to LIBOR plus 1000 basis points. The remaining $128,861,000 (26%) of loans were financed at fixed rates ranging from 9.50% to 12.50%. F-16 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 8. Loans Receivable, continued The range of maturity dates and weighted average maturity at December 31, 1999 of the Company's performing loans receivable was as follows:
Weighted Average Range of Maturity Dates Maturity ----------------------------------------- ------------- Mortgage Loans May 2000 to July 2001 12 Months Mezzanine Loans December 2000 to September 2008 67 Months Other loans receivable May 2000 to August 2017 35 Months Total Loans May 2000 to August 2017 36 Months
In addition, one of the loans for $41,558,000 has borrower extension rights for an additional year and another loan for $28,000,000 has borrower extension rights for an additional two years. At December 31, 1999, there are no loans to a single borrower or to related groups of borrowers that exceeded ten percent of total assets. Approximately 45% and 11% of all loans are secured by properties in New York and Texas, respectively. Approximately 53% of all loans are secured by office buildings and approximately 16% are secured by office/hotel properties. These credit concentrations are adequately collateralized as of December 31, 1999. During the year ended December 31, 1999, the Company completed four new loan transactions totaling $97,500,000 and provided $6,233,000 of additional fundings on four loans originated in prior periods. The Company funded all of the foregoing loans receivable originated during the year ended December 31, 1999 and has remaining outstanding commitments at December 31, 1999 totaling $23,251,000. In connection with the aforementioned loans, at December 31, 1999 and 1998 the Company has deferred origination fees, net of direct costs of $3,330,000 and $4,460,000, respectively, that are being amortized into income over the life of the loan. At December 31, 1999 and 1998, the Company has also recorded $3,479,000 and $1,243,000, respectively, of exit fees, which will be collected at the loan pay-off. These fees are recorded as interest income on a basis to realize a level yield over the life of the loans. As of December 31, 1999, loans totaling $469,655,000 are pledged as collateral for borrowings on the Credit Facilities (as defined below). As of December 31, 1997, the Company was in the process of monetizing its assets and accordingly, recorded such assets at the lower of cost or current market value, less estimated selling costs. The Company has established a reserve for possible credit losses on loans receivable as follows (in thousands):
1999 1998 1997 -------------- -------------- -------------- Beginning balance $ 4,017 $ 462 $ - Provision for possible credit losses 4,103 3,555 462 Amounts charged against reserve for possible credit losses (515) - - -------------- -------------- -------------- Ending balance $ 7,605 $ 4,017 $ 462 ============== ============== ==============
F-17 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 9. Risk Factors The Company's assets are subject to various risks that can affect results, including 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. Any significant compression of the spreads of the interest rates earned on interest-earning assets over the interest rates paid on interest-bearing liabilities could have a material adverse effect on the Company's operating results as could 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. Adverse changes in national and regional economic conditions can have an effect on real estate values increasing the risk of undercollateralization to the extent that the fair market value of properties serving as collateral security for the Company's assets are reduced. Numerous factors, such as adverse changes in local market conditions, competition, increases in operating expenses and uninsured losses, can affect a property owner's ability to maintain or increase revenues to cover operating expenses and the debt service on the property's financing and, consequently, lead to a deterioration in credit quality or a loan default and reduce the value of the Company's assets. In addition, the yield to maturity on the Company's CMBS assets are subject to the default and loss experience on the underlying mortgage loans, as well as by the rate and timing of payments of principal. If there are realized losses on the underlying loans, the Company may not recover the full amount, or possibly, any of its initial investment in the affected CMBS asset. To the extent there are prepayments on the underlying mortgage loans as a result of refinancing at lower rates, the Company's CMBS assets may be retired substantially earlier than their stated maturities leading to reinvestment in lower yielding assets. There can be no assurance that the Company's assets will not experience any of the foregoing risks or that, as a result of any such experience, the Company will not suffer a reduced return on investment or an investment loss. 10. Equipment and Leasehold Improvements At December 31, 1999 and 1998, equipment and leasehold improvements, net, are summarized as follows (in thousands):
Period of Depreciation or Amortization 1999 1998 ------------------------- -------------- ---------------- Office equipment 3 to 7 years $ 759 $ 715 Leasehold improvements Term of leases 245 232 -------------- ---------------- 1,004 947 Less: accumulated depreciation (642) (320) -------------- ---------------- $ 362 $ 627 ============== ================
Depreciation and amortization expense on equipment and leasehold improvements, which are computed on a straight-line basis totaled $322,000, $227,000 and $64,000 for the years ended December 31, 1999, 1998 and 1997, respectively. Equipment and leasehold improvements are included at their depreciated cost in prepaid and other assets in the consolidated balance sheets. 11. Notes Payable At December 31, 1999 and 1998, the Company has notes payable aggregating $3,474,000 and $4,247,000, respectively. In connection with the acquisition of Victor Capital and affiliated entities, the Company issued $5.0 million of non-interest bearing unsecured notes ("Acquisition Notes") to the sellers, who are the current vice chairman and chief executive officer and the vice chairman and chairman of the executive committee of the board of directors of the Company, payable in ten semi-annual payments of $500,000. The Acquisition Notes were originally discounted to $3,908,000 based on an imputed interest rate of 9.5%. F-18 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. Notes Payable, continued At December 31, 1999, the Acquisition Notes have six remaining semi-annual payments maturing July 1, 2002. The net present value of the remaining payments on the Acquisition Notes at December 31, 1999 and 1998 amounted to $2,680,000 and $3,419,000, respectively. The Company is also indebted under a note payable due to a life insurance company. This note is secured by the property that was sold in 1998. The note bears interest at 9.50% per annum with principal and interest payable monthly until August 7, 2017 when the entire unpaid principal balance and any unpaid interest is due. The life insurance company has the right to call the entire note due and payable upon ninety days prior written notice. At December 31, 1999 and 1998, the balance of the note payable amounted to $794,000 and $828,000, respectively. 12. Long-Term Debt Credit Facilities Effective September 30, 1997, the Company entered into a credit agreement with a commercial lender that provided for a three-year $150 million line of credit (the "First Credit Facility"). Effective January 1, 1998, pursuant to an amended and restated credit agreement, the Company increased its First Credit Facility to $250 million and subsequently further amended the credit agreement to increase the facility to $300 million effective June 22, 1998 and $355 million effective July 23, 1998. The Company incurred an initial commitment fee upon the signing of the credit agreement and the credit agreement calls for additional commitment fees when the total borrowing under the Credit Facility exceeds $75 million, $150 million, $250 million and $300 million. Effective February 26, 1999, pursuant to an amended and restated credit agreement, the Company extended the expiration of such credit facility from December 2001 to February 2002 with an automatic one-year amortizing extension option, if not otherwise extended. On June 8, 1998, the Company entered into an additional credit agreement with with another commercial lender that provides for a $300 million line of credit with an orginial expiration date in December 1999 (the "Second Credit Facility" together with the First Credit Facility, the "Credit Facilities"). The Company incurred an initial commitment fee upon the signing of the Second Credit Facility and will pay an additional commitment fee when borrowings exceed $250 million. Effective March 30, 1999, pursuant to an amended and restated credit agreement, the Company extended the expiration of such credit facility from December 1999 to June 2000 with an automatic nine-month amortizing extension option, if not otherwise extended. The Credit Facilities provide for advances to fund lender-approved loans and investments made by the Company ("Funded Portfolio Assets"). The obligations of the Company under the Credit Facilities are secured by pledges of the Funded Portfolio Assets acquired with advances under the Credit Facilities. Borrowings under the Credit Facilities bear interest at specified rates over LIBOR, which rates may fluctuate, based upon the credit quality of the Funded Portfolio Assets. Future repayments and redrawdowns of amounts previously subject to the drawdown fee will not require the Company to pay any additional fees. The Credit Facilities provide for margin calls on asset-specific borrowings in the event of asset quality and/or market value deterioration as determined under the Credit Facilities. The Credit Facilities contain customary representations and warranties, covenants and conditions and events of default. The Credit Facilities also contain a covenant obligating the Company to avoid undergoing an ownership change that results in Craig M. Hatkoff, John R. Klopp or Samuel Zell no longer retaining their senior offices and directorships with the Company and practical control of the Company's business and operations. At December 31, 1999, the Company has borrowed $185,440,000 against the First Credit Facility at an average borrowing rate (including amortization of fees incurred and capitalized) of 8.85%. The Company has pledged assets of $273,247,000 as collateral for the borrowing against the First Credit Facility. F-19 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 12. Long-Term Debt, continued Credit Facilities, continued At December 31, 1999, the Company has borrowed $157,823,000 against the Second Credit Facility at an average borrowing rate (including amortization of fees incurred and capitalized) of 9.58%. The Company has pledged assets of $229,497,000 as collateral for the borrowing against the Second Credit Facility. On December 31, 1999, the unused amounts available under the Credit Facilities were $305,166,000. Repurchase Obligations The Company has entered into two repurchase obligations ("Repurchase Obligations") discussed below to finance the acquisition of assets at December 31, 1999. The first repurchase agreement, with a securities dealer, arose in connection with the purchase of a Certificated Mezzanine Investment. At December 31, 1999, the Company has sold such asset totaling $21,839,000, which approximates market value, and has a liability to repurchase this asset for $10,919,000. The liability balance bears interest at a specified rate over LIBOR and matures in March 2000. The other repurchase agreement, with another securities dealer, also arose in connection with the purchase of a Certificated Mezzanine Investment. At December 31, 1999, the Company has sold such asset with a book value of $23,594,000, which approximates market value, and has a liability to repurchase this asset for $17,784,000. The liability balance bears interest at a specified rate over LIBOR and matures in May 2000. The average interest rate in effect for both variable rate Repurchase Obligations at December 31, 1999 is 7.76%. At December 31, 1998, the Company had entered into seven repurchase agreements which either matured and were satisfied or were extended during 1999. Four of the repurchase agreements, with a securities dealer, arose in connection with the purchase of a Certificated Mezzanine Investment, a Mortgage Loan and two Mezzanine Loans. At December 31, 1998, the Company had sold such assets totaling $71,469,000, which approximates market value, and had a liability to repurchase these assets for $53,704,000. The liability balance bore interest at specified rates over LIBOR and the agreements generally have a one-year term with extensions available by mutual consent. One of the repurchase agreements, with another securities dealer, arose in connection with the purchase of a Certificated Mezzanine Investment. At December 31, 1998, the Company had sold such asset with a book value of $23,641,000, which approximates market value, and had a liability to repurchase this asset for $14,918,000. The liability balance bore interest at a specified rate over LIBOR. The Company also had entered into a repurchase agreement with a securities broker in conjunction with the purchase of one of the classes of subordinated CMBS issued by a financial asset securitization investment trust. At December 31, 1998, the Company had sold such securities with a cost of $10,000,000 (market value $8,543,750) and had a liability to repurchase these assets for $7,642,000. The liability balance bore interest at a specified rate over LIBOR. The Company also had entered into a repurchase agreement with a securities broker in conjunction with the financing of all of its FNMA and FHLMC securities. At December 31, 1998, the Company had sold such securities with a book value totaling $3,292,000 (market value $3,330,000) and had a liability to repurchase these assets for $3,137,000. The liability balance bore interest at a specified rate over LIBOR. F-20 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 12. Long-Term Debt, continued Term Redeemable Securities Contract The average interest rate in effect for all variable rate Repurchase Obligations at December 31, 1998 was 6.74%. Term Redeemable Securities Contract In connection with the purchase of the BB CMBS Portfolio described in Note 6, an affiliate of the seller provided financing for 70% of the purchase price, or $137.8 million, at a floating rate of LIBOR plus 50 basis points pursuant to a term redeemable securities contract. This rate was below the market rate for similar financings, and, as such, a discount on the term redeemable securities contract was recorded to reduce the carrying amount by $10.9 million, which had the effect of adjusting the yield to current market terms. The debt has a three-year term that expires in February 2002. An affiliate of the seller also entered into an interest rate swap with the Company for the full duration of the BB CMBS Portfolio thereby providing a hedge for interest rate risk. The notional values of the swaps were tied to the amount of debt for the term of the debt and then to the assets for the remaining terms of the assets. The swaps had a positive value at December 31, 1999 of $13,332,000. By entering into interest rate swaps, the Company has effectively converted the term redeemable securities contract to a fixed interest rate of 6.55%. After adjusting the carrying amount and yield to current market terms, the term redeemable securities contract bears interest at a fixed interest rate of 9.73%. 13. Convertible Trust Preferred Securities On July 28, 1998, the Company privately placed 150,000 8.25% Step Up Convertible Trust Preferred Securities (liquidation amount $1,000 per security) with an aggregate liquidation amount of $150 million (the "Convertible Trust Preferred Securities"). The Convertible Trust Preferred Securities were issued by the Company's consolidated statutory trust subsidiary, CT Convertible Trust I (the "Trust"). The Convertible Trust Preferred Securities represent an undivided beneficial interest in the assets of the Trust that consist solely of the Company's Convertible Debentures (as hereafter defined). This private placement transaction was completed concurrently with the related issuance and sale to the Trust of the Company's 8.25% Step Up Convertible Junior Subordinated Debentures in the aggregate principal amount of $154,650,000 (the "Convertible Debentures"). Distributions on the Convertible Trust Preferred Securities are payable quarterly in arrears on each calendar quarter-end and correspond to the payments of interest made on the Convertible Debentures, the sole assets of the Trust. Distributions are payable only to the extent payments are made in respect to the Convertible Debentures. The Company received $145,207,000 in net proceeds, after original issue discount of 3% from the liquidation amount of the Convertible Trust Preferred Securities and transaction expenses, pursuant to the above transactions. The proceeds were used to pay down the Company's Credit Facilities. The Convertible Trust Preferred Securities are convertible into shares of Class A Common Stock, at the direction of the holders of the Convertible Trust Preferred Securities made to the conversion agent to exchange such Convertible Trust Preferred Securities for a portion of the Convertible Debentures held by the Trust on the basis of one security for each $1,000 principal amount of Convertible Debentures, and immediately convert such amount of Convertible Debentures into Class A Common Stock at an initial rate of 85.47 shares of Class A Common Stock per $1,000 principal amount of the Convertible Debentures (which is equivalent to a conversion price of $11.70 per share of Class A Common Stock). The Convertible Debentures have a 20-year maturity and are non-callable for five years. Upon repayment of the Convertible Debentures at maturity or upon redemption, the proceeds of such repayment or payment shall be simultaneously paid and applied to redeem, among other things, the Convertible Trust Preferred Securities. If the securities have not been redeemed by September 30, 2004, the distribution rate will step up by 0.75% per annum for each annual period thereafter. The 3% ($4,500,000) discount and transaction fees on the issuance will be amortized over the expected life of the Convertible Trust Preferred Securities. F-21 13. Convertible Trust Preferred Securities, continued For financial reporting purposes, the Trust is treated as a subsidiary of the Company and, accordingly, the accounts of the Trust are included in the consolidated financial statements of the Company. Intercompany transactions between the Trust and the Company, including the Junior Subordinated Debentures, are eliminated in the consolidated financial statements of the Company. The Convertible Trust Preferred Securities are presented as a separate caption between liabilities and stockholders' equity in the consolidated balance sheet of the Company as "Company-obligated, mandatorily redeemable, convertible preferred securities of CT Convertible Trust I, holding solely 8.25% junior subordinated debentures of Capital Trust, Inc. ("Convertible Trust Preferred Securities")". Distributions on the Convertible Trust Preferred Securities are recorded, net of the tax benefit, in a separate caption immediately following the provision for income taxes in the consolidated statement of operations of the Company. 14. Stockholders' Equity Authorized Capital Upon consummation of the Reorganization (see Note 1), each outstanding Class A Common Share of the Predecessor was converted into one share of Class A Common Stock of the Company, and each outstanding Class A Preferred Share of the Predecessor was converted into one share of Class A Preferred Stock of the Company. As a result, all of the Predecessor's previously issued Class A Common Shares have been reclassified as shares of Class A Common Stock and all of the Predecessor's previously issued Class A Preferred Shares have been reclassified as shares of Class A Preferred Stock. The Company has the authority to issue up to 300,000,000 shares of stock, consisting of (i) 100,000,000 shares of Class A Common Stock, (ii) 100,000,000 shares of Class B Common Stock, and (iii) 100,000,000 shares of Preferred Stock. The board of directors is generally authorized to issue additional shares of authorized stock without stockholders' approval. Common Stock Except as described herein or as required by law, all shares of Class A Common Stock and shares of Class B Common Stock are identical and entitled to the same dividend, distribution, liquidation and other rights. The Class A Common Stock are voting shares entitled to vote on all matters presented to a vote of stockholders, except as provided by law or subject to the voting rights of any outstanding Preferred Stock. The shares of Class B Common Stock do not have voting rights and are not counted in determining the presence of a quorum for the transaction of business at any meeting of the stockholders of the Company. Holders of record of shares of Class A Common Stock and shares of Class B Common Stock on the record date fixed by the Company's board of directors are entitled to receive such dividends as may be declared by the board of directors subject to the rights of the holders of any outstanding Preferred Stock. Each share of Class A Common Stock is convertible at the option of the holder thereof into one share of Class B Common Stock and, subject to certain conditions, each share of Class B Common Stock is convertible at the option of the holder thereof into one share of Class A Common Stock. The Company is restricted from declaring or paying any dividends on its Class A Common Stock or Class B Common Stock unless all accrued and unpaid dividends with respect to any outstanding Preferred Stock have been paid in full. F-22 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. Stockholders' Equity, continued Preferred Stock In connection with the Reorganization, the Company created two classes of Preferred Stock, Class A Preferred Stock and the Class B Preferred Stock. As described above, upon consummation of the Reorganization, the Predecessor's outstanding Class A Preferred Shares were converted into shares of the Company's Class A Preferred Stock. Except as described herein or as required by law, both classes of Preferred Stock are identical and entitled to the same dividend, distribution, liquidation and other rights. The holders of the Class A Preferred Stock are entitled to vote together with the holders of the Class A Common Stock as a single class on all matters submitted to a vote of stockholders. Each share of Class A Preferred Stock entitles the holder thereof to a number of votes per share equal to the number of shares of Class A Common Stock into which such shares of Class A Preferred Stock is then convertible. Except as described herein, the holders of Class B Preferred Stock do not have voting rights and are not counted in determining the presence of a quorum for the transaction of business at a stockholders' meeting. The affirmative vote of the holders of a majority of the outstanding Preferred Stock, voting together as a separate single class, except in certain circumstances, have the right to approve any merger, consolidation or transfer of all or substantially all of the assets of the Company. Holders of the Preferred Stock are entitled to receive, when and as declared by the board of directors, cash dividends per share at the rate of 9.5% per annum on a per share price of $2.69. Such dividends shall accrue (whether or not declared) and, to the extent not paid for any dividend period, will be cumulative. Dividends on the authorized Preferred Stock are payable, when and as declared, semi-annually, in arrears, on December 26 and June 25 of each year. Each share of Class A Preferred Stock is convertible at the option of the holder thereof into an equal number of shares of Class B Preferred Stock, or into a number of shares Class A Common Stock equal to the ratio of (x) $2.69 plus an amount equal to all dividends per share accrued and unpaid thereon as of the date of such conversion to (y) the conversion price in effect as of the date of such conversion. Each share of Class B Preferred Stock is convertible at the option of the holder thereof, subject to certain conditions, into an equal number of shares of Class A Preferred Stock or into a number of shares of Class B Common Stock equal to the ratio of (x) $2.69 plus an amount equal to all dividends per share accrued and unpaid thereon as of the date of such conversion to (y) the conversion price in effect as of the date of such conversion. The conversion price in effect as of December 31, 1999 is $2.69 and therefore the outstanding shares of Preferred Stock are convertible into an equal number of shares of Common Stock. Common and Preferred Stock Outstanding As of December 31, 1998, there were 12,267,658 shares of Class A Preferred Stock issued and outstanding, no shares of Class B Preferred Stock were issued and outstanding, 18,158,816 shares of Class A Common Stock were issued and outstanding and no shares of Class B Common Stock were issued and outstanding. The 12,267,658 shares of Class A Preferred Stock outstanding at December 31, 1998 were originally issued and purchased by Veqtor on July 15, 1997 for an aggregate purchase price of approximately $33 million (see Note 1). Until August 10, 1999 (the "Conversion Date"), Veqtor owned 6,959,593 of the outstanding shares of Class A Common Stock and all 12,267,658 of the outstanding shares of Class A Preferred Stock. Veqtor was then controlled by the chairman of the board, the vice chairman and chief executive officer and the vice chairman and chairman of the executive committee of the board of directors of the Company in their capacities as the persons controlling the common members of Veqtor. Prior to the Conversion Date, the common members owned approximately 48% of the equity ownership of Veqtor and three commercial banks, as preferred members of Veqtor, owned the remaining 52% of the equity ownership of Veqtor. F-23 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. Stockholders' Equity, continued On the Conversion Date, in accordance with a commitment made by Veqtor and its common members, Veqtor redeemed the outstanding preferred units in Veqtor held by its preferred members in exchange for their pro rata portion of the Company's stock owned by Veqtor. Due to the regulatory status of the redeemed preferred members as bank holding companies or affiliates thereof, prior to effecting the transfer of stock upon the redemption, Veqtor was obligated to convert 2,293,784 shares of Class A Common Stock into an equal number of shares of Class B Common Stock and 4,043,248 shares of Class A Preferred Stock into an equal number of shares of Class B Preferred Stock. Pursuant to provisions of the Company's charter relating to compliance with the Bank Holding Company Act of 1956, as amended ("BHCA"), bank holding companies or their affiliates can own no more than 4.9% of the voting stock of the Company. Therefore, in connection with the redemption, the redeemed preferred members received 1,292,103 shares of Class A Common Stock, 2,293,784 shares of non-voting Class B Common Stock, 2,277,585 shares of Class A Preferred Stock and 4,043,248 shares of non-voting Class B Preferred Stock. After the Conversion Date until the Separation Transaction (as defined below), the common members of Veqtor owned 100% of the equity ownership of Veqtor. On September 30, 1999, in accordance with a commitment made by Veqtor and its common members, all 5,946,825 shares of Class A Preferred Stock were, upon exercise of existing conversion rights, converted into an equal number of shares of Class A Common Stock. As a result of the foregoing redemption and subsequent conversion transactions, as of September 30, 1999, Veqtor owned 9,320,531 (or approximately 42.4%) of the outstanding shares of Class A Common Stock and the Company's annual dividend on Preferred Stock has been reduced from $3,135,000 to $1,615,000. In December 1999, a series of coordinated transactions (the "Separation Transaction") were effected in which beneficial ownership of an aggregate of 6,128,243 shares of the 9,320,531 shares of Class A Common Stock previously owned by Veqtor prior to the Separation Transaction were transferred partnerships controlled by the vice chairman and chief executive officer of the Company (the "Klopp LP"), the vice chairman and chairman of the executive committee of the board of directors of the Company (the "Hatkoff LP") and certain of the former partners of CTILP (the "Other Partnerships"). Each of the partnerships acquired direct beneficial ownership of such number of shares of Class A Common Stock equal to the number of shares in which the persons currently controlling such partnerships held an indirect pecuniary interest prior to the Separation Transaction. Veqtor retained direct beneficial ownership of 3,192,288 shares of Class A Common Stock, which represents the number of shares in which the persons then controlling Veqtor held an indirect pecuniary interest prior to the Separation Transaction. Upon consummation of the Separation Transaction by means of the foregoing transactions, Hatkoff LP, Klopp LP, Veqtor and the Other Partnerships acquired (or, in the case of Veqtor, retained) direct beneficial ownership of 2,330,132, 2,330,132, 3,192,288 and 1,467,979 shares of Class A Common Stock, respectively. On January 1, 2000, ownership and control of Veqtor was transferred to a trust for the benefit of the family of the Company's chairman of the board. F-24 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. Stockholders' Equity, continued Earnings per Share The following table sets forth the calculation of Basic and Diluted EPS:
Year Ended December 31, 1999 Year Ended December 31, 1998 ----------------------------------------------- ---------------------------------------------- Per Share Per Share Net Income Shares Amount Net Income Shares Amount ----------------- ----------------------------- ---------------- ----------------- ----------- Basic EPS: Net earnings per share of Common Stock $ 14,701,000 21,334,412 $ 0.69 $ 10,308,000 18,208,812 $ 0.57 ============ =========== Effect of Dilutive Securities Options outstanding for the purchase of Common Stock -- -- -- 148,989 Future commitments for stock unit awards for the issuance of Common Stock -- 300,000 -- -- Convertible Trust Preferred Securities exchangeable for shares of Common Stock 6,966,000 12,820,513 -- -- Convertible Preferred Stock 2,375,000 9,269,806 3,135,000 12,267,658 ----------------- ----------------- ---------------- ----------------- Diluted EPS: Net earnings per share of Common Stock and Assumed Conversions $ 24,042,000 43,724,731 $ 0.55 $ 13,443,000 30,625,459 $ 0.44 ================= ============================= ================ ================= ===========
For the year ended December 31, 1997, the shares of Preferred Stock and Common Stock options were not considered Common Stock equivalents for purposes of calculating Diluted EPS as they were antidilutive and accordingly, there was no difference between Basic EPS and Diluted EPS or weighted average shares of Common Stock outstanding. F-25 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 15. General and Administrative Expenses General and administrative expenses for the years ended December 31, 1999, 1998 and 1997 consist of (in thousands):
1999 1998 1997 ------------------ ------------------- ------------------- Salaries and benefits $ 12,914 $ 11,311 $ 5,035 Professional services 2,352 3,138 2,311 Other 2,079 2,596 2,117 ------------------ ------------------- ------------------- Total $ 17,345 $ 17,045 $ 9,463 ================== =================== ===================
16. Income Taxes The Company and its subsidiaries file a consolidated federal income tax return. The provision for income taxes for the years ended December 31, 1999 and 1998 is comprised as follows (in thousands):
1999 1998 1997 --------------- --------------- --------------- Current Federal $ 14,538 $ 7,226 $ - State 5,176 2,740 - Local 4,673 2,480 55 Deferred Federal (1,430) (2,282) - State (492) (419) - Local (445) (378) - --------------- --------------- ------------ Provision for income taxes $ 22,020 $ 9,367 $ 55 =============== =============== ===========
The Company has federal net operating loss carryforwards ("NOLs") as of December 31, 1999 of approximately $11.6 million. Such NOLs expire through 2012. The Company also has a federal capital loss carryover of approximately $1.6 million that can be used to offset future capital gains. Due to CRIL's purchase of 6,959,593 Common Shares from the Predecessor's Former Parent in January 1997 and another prior ownership change, a substantial portion of the NOLs are limited for federal income tax purposes to approximately $1.4 million annually. Any unused portion of such annual limitation can be carried forward to future periods. The reconciliation of income tax computed at the U.S. federal statutory tax rate (35% for the years ended December 31, 1999 and 1998 and 34% for the year ended December 31, 1997) to the effective income tax rate for the years ended December 31, 1999, 1998 and 1997 are as follows (in thousands):
1999 1998 1997 ----------------------- ------------------------ ------------------------ $ % $ % $ % ----------- ----------- ----------- ------------ ----------- ------------ Federal income tax at statutory rate $ 16,122 35.0% $ 9,013 35.0% $ (1,531) (34.0)% State and local taxes, net of federal tax benefit 5,793 12.6% 2,874 11.2% 36 0.1% Tax benefit of net operating loss not currently recognized - - % - -% 1,536 34.0% Utilization of net operating loss (495) (1.1)% (2,755) (10.7)% - - % carryforwards Compensation in excess of deductible limits 566 1.2% 221 0.9% - - % Other 34 0.1% 14 0.0% 14 0.0% ----------- ----------- ----------- ------------ ------------------------ $ 22,020 47.8% $ 9,367 36.4% $ 55 0.1% =========== =========== =========== ============ ========================
F-26 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 16. Income Taxes, continued Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax reporting purposes. The components of the net deferred tax assets are as follows (in thousands):
December 31, --------------------------------- 1999 1998 --------------- --------------- Net operating loss carryforward $ 3,889 $ 4,559 Reserves on other assets and for possible credit losses 6,312 4,621 Other 795 119 --------------- --------------- Deferred tax assets 10,966 9,299 Valuation allowance (5,628) (6,270) -------------- --------------- $ 5,368 $ 3,029 =============== ===============
The Company recorded a valuation allowance to reserve a portion of its net deferred assets in accordance with SFAS No. 109. Under SFAS No. 109, this valuation allowance will be adjusted in future years, as appropriate. However, the timing and extent of such future adjustments cannot presently be determined. 17. Interest Rate Risk Management The Company uses interest rate swaps and interest rate caps to reduce the Company's exposure to interest rate fluctuations on certain loans and investments and to provide more stable spreads between investment yields and the rates on their financing sources. In connection with the purchase of the BB CMBS Portfolio described in Note 6 and the related term redeemable securities contract, an affiliate of the seller entered into interest rate swaps with the Company for the full duration of the BB CMBS Portfolio securities thereby providing a hedge for interest rate risk. The notional values of the swaps were tied to the amount of debt for the term of the debt and then to the assets for the remaining terms of the assets. In 1999, the Company terminated two swaps and partially terminated a third swap that was outstanding at December 31, 1998, in connection with the payoff of a loan and the sale of a loan resulting in a payment of $323,000. At December 31, 1999, the Company has entered into interest rate swap agreements for notional amounts totaling approximately $219,869,000 with two investment grade financial institution counterparties whereby the Company swapped fixed rate instruments, which averaged approximately 5.93% at December 31, 1999 and 6.03% for the year then ended, for floating rate instruments equal LIBOR which averaged approximately 6.47% at December 31, 1999 and 5.25% for the year then ended. Amounts arising from the differential are recognized as an adjustment to interest income related to the earning asset or an adjustment to interest expense related to the term redeemable securities contract. If an interest rate swap or interest rate cap is sold or terminated and cash is received or paid, the gain or loss is deferred and recognized when the hedged asset is sold or matures. The agreements mature at varying times from September 2001 to December 2014 with a remaining average term of 126 months. The Company purchased an interest rate cap with a notional amount of $18.75 million at a cost of approximately $71,000. The interest rate cap provides for payments to the Company if LIBOR exceeds 11.25% during the period from November 2003 to November 2007. The Company is exposed to credit loss in the event of non-performance by the counterparties (which are banks whose securities are rated investment grade) to the interest rate swap and cap agreements, although it does not anticipate such non-performance. The counterparties would bear the interest rate risk of such transactions as market interest rates increase. F-27 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 18. Employee Benefit Plans Employee 401(k) and Profit Sharing Plan In 1999, the Company instituted a 401(k) and profit sharing plan that allows eligible employees to contribute up to 15% of their salary into the plan on a pre-tax basis, subject to annual limits. The Company has committed to make contributions to the plan equal to 3% of all eligible employees' compensation subject to annual limits and may make additional contributions based upon earnings. The Company's contribution expense for the year ended December 31, 1999, was $191,000. 1997 Long-Term Incentive Stock Plan In May 1997, the board of trustees of the Predecessor adopted the original 1997 long-term incentive share plan, which was approved by the Predecessor's shareholders, and thereafter amended to reflect the Predecessor's name change, in July 1997. In May 1998, the Predecessor's board of trustees originally adopted, subject to shareholder approval, the original form of an amended and restated 1997 long-term incentive share plan, which was subsequently approved at the Predecessor's 1998 annual meeting of shareholders on January 28, 1999 (the "1998 Annual Meeting"). Upon consummation of the Reorganization, the Company succeeded to and assumed the amended and restated plan which has been amended to reflect the succession of the Company (the plan is hereinafter referred to as the "Incentive Stock Plan"). The Incentive Stock Plan permits the grant of nonqualified stock option ("NQSO"), incentive stock option ("ISO"), restricted stock, stock appreciation right ("SAR"), performance unit, performance stock and stock unit awards. A maximum of 2,828,798 shares of Class A Common Stock may be issued during the fiscal year 2000 pursuant to awards under the Incentive Stock Plan and the Director Stock Plan (as defined below) in addition to the shares subject to awards outstanding under the two plans at December 31, 1999. The maximum number of shares that may be subject to awards to any employee during the term of the plan may not exceed 500,000 shares and the maximum amount payable in cash to any employee with respect to any performance period pursuant to any performance unit or performance stock award is $1.0 million. The ISOs 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% stockholder and vest over a period of three years with one-third vesting at each anniversary date. Payment of an option may be made with cash, with previously owned Class A Common Stock, by foregoing compensation in accordance with performance compensation committee or compensation committee rules or by a combination of these. Restricted stock may be granted under the Incentive Stock 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. In 1999 and 1998 the Company issued 104,167 shares and 72,500 shares, respectively, of restricted stock, of which 32,500 shares and 17,500 shares, respectively, were canceled upon the resignation of employees prior to vesting. The shares of restricted stock issued in 1999 vest one-third on each of the following dates: February 2, 2000, February 2, 2001 and February 2, 2002. The shares of restricted stock issued in 1998 vest one-third on each of the following dates: January 30, 2001, January 30, 2002 and January 30, 2003. The Company also granted 52,083 shares of performance based restricted stock for which none of the performance goals have been met and the shares have not been issued. The Incentive Stock Plan also authorizes the grant of stock 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. Stock units shall be payable in Class A Common Stock upon the occurrence of certain trigger events. The terms and conditions of the trigger events may vary by stock unit award, by the participant, or both. F-28 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 18. Employee Benefit Plans, continued 1997 Long-Term Incentive Stock Plan, continued The following table summarizes the activity under the Incentive Stock Plan for the years ended December 31, 1999, 1998 and 1997:
Weighted Average Options Exercise Price Exercise Price Outstanding per Share per Share --------------- -------------------------- ------------------- Outstanding at January 1, 1997 - $ - $ - Granted in 1997 607,000 $6.00 6.00 --------------- ------------------- Outstanding at December 31, 1997 607,000 $6.00 6.00 Granted in 1998 907,250 $9.00 - $11.38 9.93 Exercised in 1998 (1,666) $6.00 6.00 Canceled in 1998 (243,500) $6.00 - $10.00 7.81 --------------- ------------------- Outstanding at December 31, 1998 1,269,084 $6.00 - $11.38 8.46 Granted in 1999 352,000 $6.00 6.00 Canceled in 1999 (387,167) $6.00 - $11.38 8.06 --------------- ------------------- Outstanding at December 31, 1999 1,233,917 $6.00 - $10.00 $ 7.89 =============== ===================
At December 31, 1999 and 1998, 487,761 and 272,834, respectively, of the options were exercisable. None of the options were exercisable at December 31, 1997. At December 31, 1999, the outstanding options have various remaining contractual lives ranging from 7-1/2 to 9-1/12 years with a weighted average life of 8.25 years. 1997 Non-Employee Director Stock Plan In May 1997, the board of trustees of the Predecessor adopted the original 1997 non-employee trustee share plan, which was approved by the Predecessor's shareholders, and thereafter amended to reflect the Predecessor's name change, in July 1997. In May 1998, the Predecessor's board of trustees originally adopted, subject to shareholder approval, the original form of an amended and restated 1997 non-employee trustee share plan which was subsequently approved at the Predecessor's 1998 Annual Meeting. Upon consummation of the Reorganization, the Company succeeded to and assumed the amended and restated plan, which has been amended to reflect the succession of the Company (the plan is hereinafter referred to as the "Director Stock Plan"). The Director Stock Plan permits the grant of NQSO, restricted stock, SAR, performance unit, stock and stock unit awards. A maximum of 2,828,798 shares of Class A Common Stock may be issued during the fiscal year 2000 pursuant to awards under the Director Stock Plan and the Incentive Stock Plan, in addition to the shares subject to awards outstanding under the two plans at December 31, 1999. The board of directors shall determine the purchase price per share of Class A Common Stock covered by a NQSO granted under the Director Stock Plan. Payment of a NQSO may be made with cash, with previously owned shares of Class A Common Stock, by foregoing compensation in accordance with board rules or by a combination of these payment methods. SARs may be granted under the plan in lieu of NQSOs, in addition to NQSOs, independent of NQSOs or as a combination of the foregoing. A holder of a SAR is entitled upon exercise to receive shares of Class A Common Stock, or cash or a combination of both, as the board of directors may determine, equal in value on the date of exercise to the amount by which the fair market value of one share of Class A Common Stock on the date of exercise exceeds the exercise price fixed by the board on the date of grant (which price shall not be less than 100% of the market price of a share of Class A Common Stock on the date of grant) multiplied by the number of shares in respect to which the SARs are exercised. F-29 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 18. Employee Benefit Plans, continued 1997 Non-Employee Director Stock Plan, continued Restricted stock may be granted under the Director Stock 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 Director Stock Plan also authorizes the grant of stock units at any time and from time to time on such terms as shall be determined by the board of directors. Stock 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 stock unit award, by the participant, or both. The following table summarizes the activity under the Director Stock Plan for the years ended December 31, 1999, 1998 and 1997:
Weighted Average Options Exercise Price Exercise Price Outstanding per Share per Share --------------- -------------------------- ------------------- Outstanding at January 1, 1997 - $ - $ - Granted in 1997 50,000 $6.00 6.00 --------------- ------------------- Outstanding at December 31, 1997 50,000 $6.00 6.00 Granted in 1998 205,000 $10.00 10.00 --------------- ------------------- Outstanding at December 31, 1998 255,000 $6.00-$10.00 9.22 Granted in 1999 - $ - - --------------- ------------------- Outstanding at December 31, 1999 255,000 $6.00-$10.00 $ 9.22 =============== ===================
At December 31, 1999 and 1998, 101,688 and 16,666, respectively, of the options were exercisable. None of the options were exercisable at December 31, 1997. At December 31, 1999, the outstanding options have a remaining contractual life of 7-1/2 years to 8-1/12 years with a weighted average life of 7.98 years. Accounting for Stock-Based Compensation SFAS No. 123, "Accounting for Stock-Based Compensation" was issued by the FASB in October 1996. SFAS No. 123 encourages the adoption of a new fair-value based accounting method for employee stock-based compensation plans. SFAS No. 123 also permits companies to continue accounting for stock-based compensation plans as prescribed by APB Opinion No. 25. However, companies electing to continue accounting for stock-based compensation plans under APB Opinion No. 25, must make pro forma disclosures as if the company adopted the cost recognition requirements under SFAS No. 123. The Company has continued to account for stock-based compensation under APB Opinion No. 25. Accordingly, no compensation cost has been recognized for the Incentive Stock Plan or the Director Stock Plan in the accompanying consolidated statements of operations as the exercise price of the stock options granted thereunder equaled the market price of the underlying stock on the date of the grant. Pro forma information regarding net income and net earnings per common share has been estimated at the date of the grant using the Black-Scholes option-pricing model based on the following assumptions:
1999 1998 1997 ------------------ ------------------- ------------------- Risk-free interest rate 5.2% 5.2% 5.7% Volatility 40.0% 40.0% 40.0% Dividend yield 0.0% 0.0% 0.0% Expected life (years) 5.0 5.0 5.0
F-30 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 18. Employee Benefit Plans, continued Accounting for Stock-Based Compensation, continued The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the Company's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The weighted average fair value of each stock option granted during the years ended December 31, 1999, 1998 and 1997 were $2.41, $4.44 and $2.63, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information for the years ended December 31, 1999, 1998 and 1997 is as follows (in thousands, except for net earnings (loss) per share of common stock):
1999 1998 1997 ----------------------- ------------------------ ------------------------ As As As reported Pro forma reported Pro forma reported Pro forma ----------- ----------- ----------- ------------ ----------- ------------ Net income (loss) $ 17,076 $ 16,274 $ 13,443 $ 12,214 $ (4,557) $ (4,953) Net earnings (loss) per share of common stock: Basic $ 0.69 $ 0.62 $ 0.57 $ 0.50 $ (0.63) $ (0.67) Diluted $ 0.55 $ 0.53 $ 0.44 $ 0.40 $ (0.63) $ (0.67)
The pro forma information presented above is not representative of the effect stock options will have on pro forma net income or earnings per share for future years. 19. Fair Values of Financial Instruments SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized in the statement of financial condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based upon estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and the estimated future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts do not represent the underlying value of the Company. F-31 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 19. Fair Values of Financial Instruments, continued The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and cash equivalents: The carrying amount of cash on hand and money market funds is considered to be a reasonable estimate of fair value. Other available-for-sale securities: The fair value was determined based upon the market value of the securities. Commercial mortgage-backed securities: The fair value was obtained by obtaining quotes from a market maker in the security. Certificated mezzanine investments: The fair value was obtained by obtaining quotes from a market maker in the security. Loans receivable, net: The fair values were estimated by using current institutional purchaser yield requirements for loans with similar credit characteristics. Interest rate cap agreement: The fair value was estimated based upon the amount at which similar financial instruments would be valued. Credit Facilities: The Credit Facilities are at floating rates of interest for which the spread over LIBOR is at rates that are similar to those in the market currently. Therefore, the carrying value is a reasonable estimate of fair value. Repurchase obligations: The repurchase obligations, which are generally short term in nature, bear interest at a floating rate and the book value is a reasonable estimate of fair value. Term redeemable securities contract: The fair value was estimated based upon the amount at which similar privately placed financial instruments would be valued. Convertible Trust Preferred Securities: The fair value was estimated based upon the amount at which similar privately placed financial instruments would be valued. Interest rate swap agreements: The fair values were estimated based upon the amount at which similar financial instruments would be valued. The carrying amounts of all assets and liabilities approximate the fair value except as follows (in thousands):
December 31, 1999 December 31, 1998 ------------------------------- ------------------------------ Carrying Fair Carrying Fair Amount Value Amount Value ------------- ------------- ------------- ------------- Financial Assets: Loans receivable, net 509,811 494,302 620,858 614,477 CMBS 214,058 200,726 31,650 31,650 Interest Rate Swap Agreements - 13,332 - - Interest rate cap agreement 48 46 60 6 Unrecognized Financial Instruments: Interest Rate Swap Agreements - 3,839 - (4,521)
F-32 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 20. Supplemental Schedule of Non-Cash and Financing Activities The following is a summary of the significant non-cash investing and financing activities during the year ended December 31, 1997 (in thousands): Stock received as partial compensation for advisory services $ 1,798 In connection with the sale of properties and notes receivable, the Company entered into various non-cash transactions as follows during the year ended December 31, 1997 (in thousands): Sales price less selling costs $ 8,396 Amount due from buyer (1,090) ---------------- Net cash received $ 7,306 ================ Interest paid on the Company's outstanding debt for 1999, 1998 and 1997 was $49,103,000, $25,184,000 and $1,877,000, respectively. Income taxes paid by the Company in 1999 and 1998 were $17,165,000 and $7,866,000, respectively. No income taxes were paid in 1997. 21. Transactions with Related Parties The Company entered into a consulting agreement, dated as of July 15, 1997, with a director of the Company. The consulting agreement had an initial term of one year that was extended to December 31, 1998 and terminated at that date. Pursuant to the agreement, the director provided consulting services for the Company including strategic planning, identifying and negotiating mergers, acquisitions, joint ventures and strategic alliances, and advising as to capital structure matters. During the years ended December 31, 1998 and 1997, the Company incurred expenses of $165,000 and $300,000, respectively, in connection with this agreement. The Company entered into a consulting agreement, dated as of January 1, 1998, with another director of the Company. The consulting agreement had an initial term of one year and has been extended to December 31, 2000. Pursuant to the agreement, the director provides consulting services for the Company including new business identification, strategic planning and identifying and negotiating mergers, acquisitions, joint ventures and strategic alliances. During each of the years ended December 31, 1999 and 1998, the Company incurred expenses of $96,000 in connection with this agreement. The Company pays EGI, an affiliate under common control of the chairman of the board of directors, for certain corporate services provided to the Company. These services include consulting on legal matters, tax matters, risk management, investor relations and investment banking. During the years ended December 31, 1999, 1998 and 1997, the Company incurred $86,000, $216,000 and $134,000, respectively, of expenses in connection with these services. During the year ended December 31, 1998, the Company, through two of its acquired subsidiaries, earned asset management fees pursuant to agreements with entities in which two of the executive officers and directors of the Company have an equity interest and serve as officers, members or as a general partner thereof. During the years ended December 31, 1999, 1998 and 1997, the Company earned $391,000, $1,682,000 and $327,000, respectively, from such agreements, which have been included in the consolidated statements of operations. F-33 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 22. Commitments and Contingencies Leases The Company leases premises and equipment under operating leases with various expiration dates. Minimum annual rental payments at December 31, 1999 are as follows (in thousands): Years ending December 31: - ------------------------ 2000 $ 205 2001 25 2002 25 --------------- $ 255 =============== Rent expense for office space and equipment amounted to $470,000, $530,000 and $310,000 for the years ended December 31, 1999, 1998 and 1997, respectively. Litigation In the normal course of business, the Company is subject to various legal proceedings and claims, the resolution of which, in management's opinion, will not have a material adverse effect on the consolidated financial position or the results of operations of the Company. Employment Agreements The Company has employment agreements with three of its executive officers. The employment agreements with two of the executive officers provide for five-year terms of employment commencing as of July 15, 1997. Such agreements contain extension options that extend such agreements automatically unless terminated by notice, as defined, by either party. The employment agreements provide for base annual salaries of $500,000, which has been increased to $600,000, and will be increased each calendar year to reflect increases in the cost of living and will otherwise be subject to increase at the discretion of the board of directors. Such executive officers are also entitled to annual incentive cash bonuses to be determined by the board of directors based on individual performance and the profitability of the Company and are participants in the Incentive Stock Plan and other employee benefit plans of the Company. The employment agreement with one executive officer provides for a term of employment commencing as of August 15, 1998 and expiring on January 2, 2002, which shall be automatically extended until December 31, 2002 unless, prior to April 7, 2001, either party shall have delivered to the other a non-renewal notice. The employment agreement provides for a base annual salary of $350,000, which will be increased each calendar year to reflect increases in the cost of living and may otherwise be further increased at the discretion of the board of directors. The employment agreement also provides for annual incentive cash bonuses for calendar years 1999 through 2001 to be determined by the board of directors based on individual performance and the profitability of the Company, provided that the minimum of each of said three annual incentive bonuses shall be no less than $750,000. In addition to the base salary and incentive bonus, the executive received during calendar year 1999, a special cash payment of $1,200,000 of which $850,000 was expensed in 1998. The executive is entitled to participate in employee benefit plans of the Company at levels determined by the board of directors and commensurate with his position and receives Company provided life and disability insurance. In accordance with the agreement, the executive was granted, pursuant to the Incentive Stock Plan, options to purchase 100,000 shares of Class A Common Stock with an exercise price of $9.00 immediately vested and exercisable as of the date of the agreement. The Company also agreed to grant, pursuant to the Incentive Stock Plan, fully vested shares of Class A Common Stock, 50,000 shares on January 1, 1999 and 100,000 shares on each of the three successive anniversaries thereof. F-34 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 23. Segment Reporting In 1998, the Company adopted a new accounting pronouncement requiring disclosure about the Company's segments based on a management approach. In 1998, the Company operated as two segments: Lending/Investment and Advisory and had an internal information system that produced performance and asset data for its two segments along service lines. During the first quarter of 1999, the Company reorganized the structure of its internal organization by merging its Lending/Investment and Advisory segments and thereby no longer managing its operations as separate segments. The Company has only one reportable segment that includes operations, lending/investment and advisory activities. As such, separate segment reporting is not presented for 1999 as there is only one segment and the financial information for that segment is the same as the information in the consolidated financial statements. The restatement of the 1998 segment information for the change in the reportable segments is not presented as again it is the same as the information in the consolidated financial statements. In 1998, the Lending and Investment segment included all of the Company's activities related to the loan and investment portfolio and the financing thereof. In 1998, the Advisory segment included all of the Company's activities related to fee services provided to real estate investors, owners, developers and financial institutions in connection with mortgage financings, securitizations, joint ventures, debt and equity investments, mergers and acquisitions, portfolio evaluations, restructurings and disposition programs. The segment also provided asset management and advisory services relating to various mortgage pools and real estate properties. F-35 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 24. Summary of Quarterly Results of Operations (Unaudited) The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 1999, 1998 and 1997 (in thousands except per share data):
March 31 June 30 September 30 December 31 --------------- --------------- --------------- --------------- 1999 Revenues $ 25,865 $ 22,930 $ 24,338 $ 34,513 Net income $ 3,792 $ 3,025 $ 3,050 $ 7,209 Preferred Stock dividends $ 784 $ 784 $ 403 $ 404 Net income per share of Common Stock: Basic $ 0.16 $ 0.12 $ 0.11 $ 0.28 Diluted $ 0.12 $ 0.10 $ 0.10 $ 0.20 1998 Revenues $ 11,207 $ 20,166 $ 21,872 $ 21,020 Net income $ 2,673 $ 5,024 $ 3,144 $ 2,602 Preferred Stock dividends $ 784 $ 784 $ 783 $ 784 Net income per share of Common Stock: Basic $ 0.10 $ 0.24 $ 0.13 $ 0.10 Diluted $ 0.09 $ 0.16 $ 0.10 $ 0.09 1997 Revenues $ 613 $ 371 $ 2,729 $ 4,737 Net loss $ (508) $ (352) $ (1,593) $ (2,104) Preferred Stock dividends and dividend requirement $ - $ - $ 679 $ 792 Net loss per share of Common Stock - Basic and Diluted $ (0.06) $ (0.04) $ (0.25) $ (0.27)
25. Subsequent Event On March 8, 2000, the Company entered into a strategic relationship with Citigroup Investments Inc., ("Citigroup"), in connection with commencing its new investment management business. Together, the strategic partners have agreed, among other things, to co-sponsor, commit to invest capital in, and manage a series of high-yield commercial real estate mezzanine investment opportunity funds (collectively, the "Mezzanine Funds"). In connection with this relationship, Citigroup and the Company have made capital commitments to the Mezzanine Funds of up to an aggregate of $400.0 million and $112.5 million, respectively, subject to certain terms and conditions. F-36 Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 25. Subsequent Event, continued The strategic relationship is governed by a venture agreement, dated as of March 8, 2000 (the "Venture Agreement"), pursuant to which the parties have created CT Mezzanine Partners I LLC ("Fund I"), which is funded with capital commitments of $150 million and $50 million from Citigroup and the Company, respectively, subject to the identification of suitable investments acceptable to Citigroup and the Company. A wholly owned subsidiary of the Company serves as the exclusive investment manager to Fund I that is currently negotiating suitable investments for the fund. Additionally, Citigroup and the Company have agreed to additional capital commitments of up to $250.0 million and $62.5 million, respectively, to sponsor future Mezzanine Funds that close prior to December 31, 2001 subject to the amount of third-party capital commitments and other conditions contained in the Venture Agreement. In consideration of, among other things, Citigroup's $400 million capital commitment to the venture, the Company issued Citigroup warrants to purchase 4.25 million shares of Class A Common Stock at $5.00 per share with a five-year term and has agreed, subject to stockholder approval, to issue additional warrants to purchase up to an additional 5.25 million shares on the same terms and conditions expressly contingent upon the amount of capital contributions to future funds; alternatively, if the required stockholder approval of the issuance of the shares underlying such warrants is not obtained, the Company will provide contingent cash rights designed to provide equivalent value. Pursuant to the Venture Agreement, an affiliate of the Company has been named the exclusive investment manager to the Mezzanine Funds. Further, each party has agreed to certain exclusivity obligations with respect to the origination of assets suitable for the Mezzanine Funds and the Company granted Citigroup the right of first refusal to co-sponsor future Mezzanine Funds. The Company has also agreed, as soon as practicable, to take the steps necessary for it to be treated as a REIT for tax purposes subject to changes in law, or good faith inability to meet the requisite qualifications. Unless the Company can find a suitable "reverse merger" REIT candidate, the earliest that the Company can qualify for re-election to REIT status will be upon filing its tax return for the year ended December 31, 2002. Pursuant to the Venture Agreement, the Company increased the number of its directorships by two and appointed Marc Weill and Michael Watson, chief executive officer and senior vice president of Citigroup Investments Inc., respectively, as directors immediately. In order to comply with the terms of the Venture Agreement and in order to facilitate its conversion to REIT status as soon as practicable, the Company and the holders of the Convertible Trust Preferred Securities have agreed in principle to terminate their co-investment agreement with the Company and to amend the terms of such securities by: (i) raising the current coupon rate payable from 8.25% per annum to an initial blended rate of 10.16% per annum; (ii) increasing the coupon on approximately 60% of the securities to step-up commencing April 1, 2002 to the greater of 10% (subject to an automatic step-up by 75 basis points on October 1, 2004 and on each October 1 thereafter) or the dividend yield on the underlying Class A Common Stock calculated pursuant to a formula prescribed therein; (iii) increasing the coupon on approximately 40% of the securities by 75 basis points on October 1, 2004 and on each October 1 thereafter; (iv) changing the redemption provisions such that approximately 40% in liquidation amount of the securities is redeemable, in whole or in part, at any time and such that the remaining balance in liquidation amount of the securities is redeemable, in whole or in part, on or after September 30, 2004; and (v) eliminating the conversion provisions with respect to approximately 40% of the securities and reducing the conversion price at which the balance of the securities can be converted into shares of Class A Common Stock from $11.70 to $7.00 per share. As a result, the total number of shares of Class A Common Stock issuable on conversion of all of the amended securities will not exceed 12,820,512, the number issuable on conversion of the original Convertible Trust Preferred Securities. F-37 EX-21.1 2 LIST OF SUBSIDIARIES Exhibit 21.1
JURISDICTION OF D/B/A ENTITY INCORPORATION JURISDICTION Victor Capital Group, L.P. Delaware Vic, Inc. Delaware Vic NY VCG Montreal Management, Inc. New York Victor Asset Management, Inc. New York 970 Management LLC New York VP Metropolis Services, L.L.C. New Jersey Natrest Funding I, Inc. Delaware IPJ Funding Corp. Delaware CT Convertible Trust I Delaware CT-BB Funding Corp. Delaware BB Real Estate Investment Corp. Delaware CT-F1, LLC Delaware CT-F2-GP, LLC Delaware CT-F2-LP, LLC Delaware CT Investment Management Co., LLC Delaware CT Mezzanine Partners I LLC Delaware CT MP II LLC Delaware
EX-23.1 3 CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report on Form 10-K of Capital Trust, Inc. of our report dated February 14, 2000, except for Note 25 which is as of March 8, 2000 (hereinafter referred to as our Report), included in the 1999 Annual Report to Shareholders of Capital Trust, Inc. Our audits included the financial statement schedules of Capital Trust, Inc. listed in Item 14(a). These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedules referred to above, when considered in relation to the basis financial statements taken as a whole, present fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in Registration Statements (Form S-8 No. 333- 39743 and No. 333-72725) and in the related Prospecti of our Report with respect to the consolidated financial statements and schedules of Capital Trust, Inc. included and incorporated by reference in this Annual Report on Form 10-K for the year ended December 31, 1999. /s/ Ernst & Young LLP Ernst & Young LLP New York, New York March 30, 2000 EX-27.1 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF CAPITAL TRUST, INC. FOR THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 0001061630 Capital Trust, Inc. 1,000 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 38,782 259,490 517,416 7,605 0 0 1,004 642 827,808 14,432 505,082 146,434 0 243 158,297 827,808 0 107,646 0 70,655 0 4,103 0 32,888 15,812 17,076 0 0 0 17,076 0.69 0.55
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