To be filed with the Securities and Exchange Commission on November 12, 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to _____________ Commission File Number 1-14788 ------- Capital Trust, Inc. ------------------- (Exact name of registrant as specified in its charter) <TABLE> <CAPTION> <S> <C> Maryland 94-6181186 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 410 Park Avenue, 14th Floor, New York, NY 10022 - ------------------------------------------ ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 655-0220 -------------- </TABLE> Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes[X] No[ ] APPLICABLE ONLY TO CORPORATE ISSUERS: The number of outstanding shares of the Registrant's Class A Common Stock, par value $0.01 per share ("Class A Common Stock"), as of November 11, 2002 was 16,515,133.
CAPITAL TRUST, INC. INDEX Part I. Financial Information <TABLE> <CAPTION> <S> <C> <C> Item 1: Financial Statements 1 Consolidated Balance Sheets - September 30, 2002 (unaudited) and December 31, 2001 (audited) 1 Consolidated Statements of Income - Three and nine months Ended September 30, 2002 and 2001 (unaudited) 2 Consolidated Statements of Changes in Stockholders' Equity - Nine months Ended September 30, 2002 and 2001 (unaudited) 3 Consolidated Statements of Cash Flows - Nine months Ended September 30, 2002 and 2001 (unaudited) 4 Notes to Consolidated Financial Statements (unaudited) 5 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3: Quantitative and Qualitative Disclosures about Market Risk 19 Item 4: Controls and Procedures 20 Part II. Other Information Item 1: Legal Proceedings 21 Item 2: Changes in Securities 21 Item 3: Defaults Upon Senior Securities 21 Item 4: Submission of Matters to a Vote of Security Holders 21 Item 5: Other Information 21 Item 6: Exhibits and Reports on Form 8-K 21 Signatures 22 Certifications 23 </TABLE>
Capital Trust, Inc. and Subsidiaries Consolidated Balance Sheets September 30, 2002 and December 31, 2001 (in thousands) <TABLE> <CAPTION> September 30, December 31, -------------------- -------------------- 2002 2001 -------------------- -------------------- (Unaudited) (Audited) Assets <S> <C> <C> Cash and cash equivalents $ 8,731 $ 11,651 Available-for-sale securities, at fair value 87,390 152,789 Commercial mortgage-backed securities available-for-sale, at fair value 157,904 210,268 Loans receivable, net of $10,732 and $13,695 reserve for possible credit losses at September 30, 2002 and December 31, 2001, respectively 135,940 248,088 Equity investment in CT Mezzanine Partners I LLC ("Fund I"), CT Mezzanine Partners II LP ("Fund II") and CT MP II LLC ("Fund II GP") (together "Funds") 33,530 38,229 Deposits and other receivables 471 1,192 Accrued interest receivable 4,358 4,614 Deferred income taxes 10,027 9,763 Prepaid and other assets 2,045 2,206 -------------------- -------------------- Total assets $ 440,396 $ 678,800 ==================== ==================== Liabilities: Accounts payable and accrued expenses $ 7,755 $ 9,842 Notes payable -- 977 Credit facilities 35,000 121,211 Term redeemable securities contract -- 137,132 Repurchase obligations 172,757 147,880 Deferred origination fees and other revenue 1,885 1,202 Interest rate hedge liabilities 32,799 9,987 -------------------- -------------------- Total liabilities 250,196 428,231 -------------------- -------------------- Company-obligated, mandatory redeemable, convertible trust preferred securities of CT Convertible Trust I, holding $89,742 of convertible 10.00% junior subordinated debentures at September 30, 2002 and December 31, 2001 and $60,258 of non- convertible 13.00% junior subordinated debentures of Capital Trust, Inc. at December 31, 2001 ("Convertible Trust Preferred Securities") 88,869 147,941 -------------------- -------------------- Stockholders' equity: Class A common stock, $0.01 par value ("Class A Common Stock"), 100,000 shares authorized, 17,912 and 18,332 shares issued and outstanding at September 30, 2002 and December 31, 2001, respectively 179 183 Restricted Class A Common Stock, $0.01 par value, 300 and 396 shares issued and outstanding at September 30, 2002 and December 31, 2001, respectively ("Restricted Class A Common Stock" and together with Class A Common Stock, "Common Stock") 3 4 Additional paid-in capital 134,411 136,805 Unearned compensation (479) (583) Accumulated other comprehensive loss (33,154) (29,909) Retained earnings / (accumulated deficit) 371 (3,872) -------------------- -------------------- Total stockholders' equity 101,331 102,628 -------------------- -------------------- Total liabilities and stockholders' equity $ 440,396 $ 678,800 ==================== ==================== </TABLE> See accompanying notes to unaudited consolidated financial statements. -1-
Capital Trust, Inc. and Subsidiaries Consolidated Statements of Income Three and Nine months Ended September 30, 2002 and 2001 (in thousands, except per share data) (unaudited) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, --------------------------------- ----------------------------------- 2002 2001 2002 2001 -------------- --------------- --------------- ----------------- <S> <C> <C> <C> <C> Income from loans and other investments: Interest and related income $ 11,036 $ 16,985 $ 37,991 $ 51,742 Less: Interest and related expenses 3,757 5,708 14,020 19,725 -------------- --------------- --------------- ----------------- Income from loans and other investments, net 7,279 11,277 23,971 32,017 -------------- --------------- --------------- ----------------- Other revenues: Management and advisory fees from Funds 2,548 3,118 7,624 5,118 Income/(loss) from equity investments in Funds 1,156 554 (618) 2,422 Advisory and investment banking fees 2,057 75 2,207 202 Net gain on sales of investments and reduced maturity of fair value hedge -- -- 1,651 -- Other interest income 46 92 104 369 -------------- --------------- --------------- ----------------- Total other revenues 5,807 3,839 10,968 8,111 -------------- --------------- --------------- ----------------- Other expenses: General and administrative 3,982 3,991 11,390 11,766 Other interest expense -- 22 23 87 Depreciation and amortization 248 239 744 625 Net unrealized loss on derivative securities and corresponding hedged risk on CMBS securities 180 1,367 2,776 1,259 Provision for/(recapture of) allowance for possible credit losses -- -- (2,963) 748 -------------- --------------- --------------- ----------------- Total other expenses 4,410 5,619 11,970 14,485 -------------- --------------- --------------- ----------------- Income before income taxes and distributions and amortization on Convertible Trust Preferred Securities 8,676 9,497 22,969 25,643 Provision for income taxes 4,454 4,479 11,540 11,986 -------------- --------------- --------------- ----------------- Income before distributions and amortization on Convertible Trust Preferred Securities 4,222 5,018 11,429 13,657 Distributions and amortization on Convertible Trust Preferred Securities, net of income tax benefit of $2,301 and $1,890 for the three months ended September 30, 2002 and 2001, respectively, and $6,195 and $5,668 for the nine months ended September 30, 2002 and 2001, respectively 2,669 2,119 7,186 6,359 -------------- --------------- --------------- ----------------- Net income 1,553 2,899 4,243 7,298 Less: Preferred Stock dividend requirement -- (77) -- (606) -------------- --------------- --------------- ----------------- Net income allocable to Common Stock $ 1,553 $ 2,822 $ 4,243 $ 6,692 ============== =============== =============== ================= Per share information: Net earnings per share of Common Stock: Basic $ 0.09 $ 0.15 $ 0.23 $ 0.32 ============== =============== =============== ================= Diluted $ 0.08 $ 0.11 $ 0.23 $ 0.28 ============== =============== =============== ================= Weighted average shares of Common Stock outstanding: Basic 18,271,224 19,398,136 18,522,982 20,651,117 ============== =============== =============== ================= Diluted 18,323,474 34,959,700 18,728,309 37,575,148 ============== =============== =============== ================= </TABLE> See accompanying notes to unaudited consolidated financial statements. -2-
Capital Trust, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity For the Nine months Ended September 30, 2002 and 2001 (in thousands) (unaudited) <TABLE> <CAPTION> Restricted Class A Class B Class A Class B Class A Comprehensive Preferred Preferred Common Common Common Income/(Loss) Stock Stock Stock Stock Stock ----------------- ----------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Balance at January 1, 2001 $ 23 $ 40 $ 190 $ 28 $ 3 Net income $ 7,298 -- -- -- -- -- Transition adjustment for recognition of derivative financial instruments -- -- -- -- -- -- Unrealized loss on derivative financial instruments, net of related income taxes (15,976) -- -- -- -- -- Unrealized loss on available-for-sale securities, net of related income taxes (2,289) -- -- -- -- -- Issuance of warrants to purchase shares of Class A Common Stock -- -- -- -- -- -- Issuance of Class A Common Stock unit awards -- -- -- 1 -- -- Issuance of restricted Class A Common Stock -- -- -- -- -- 2 Restricted Class A Common Stock earned -- -- -- -- -- -- Vesting of restricted Class A Common Stock to unrestricted Class A Common Stock -- -- -- 1 -- (1) Dividends paid on Preferred Stock -- -- -- -- -- -- Repurchase and retirement of shares of Stock previously outstanding -- (23) (40) (9) (28) -- ----------------- ----------------------------------------------------------- Balance at September 30, 2001 $ (10,967) $ -- $ -- $ 183 $ -- $ 4 ================= =========================================================== Balance at January 1, 2002 $ -- $ -- $ 183 $ -- $ 4 Net income $ 4,243 -- -- -- -- -- Unrealized loss on derivative financial instruments, net of related income taxes (3,958) -- -- -- -- -- Unrealized gain on available-for-sale securities, net of related income taxes 713 -- -- -- -- -- Issuance of Class A Common Stock unit awards -- -- -- 1 -- -- Issuance of restricted Class A Common Stock -- -- -- -- -- 1 Vesting of restricted Class A Common Stock to unrestricted Class A Common Stock -- -- -- 2 -- (2) Restricted Class A Common Stock earned -- -- -- -- -- -- Repurchase and retirement of shares of Class A Common Stock previously outstanding -- -- -- (7) -- -- ----------------- ----------------------------------------------------------- Balance at September 30, 2002 $ 998 $ -- $ -- $ 179 $ -- $ 3 ================= =========================================================== </TABLE> <TABLE> <CAPTION> Accumulated Retained Additional Other Earnings / Paid--In Unearned Comprehensive (Accumulated Capital Compensation Income/(Loss) Deficit) Total -------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Balance at January 1, 2001 $ 181,507 $ (468) $ (10,152) $ (12,505) $ 158,666 Net income -- -- -- 7,298 7,298 Transition adjustment for recognition of derivative financial instruments -- -- (574) -- (574) Unrealized loss on derivative financial instruments, net of related income taxes -- -- (15,976) -- (15,976) Unrealized loss on available-for-sale securities, net of related income taxes -- -- (2,289) -- (2,289) Issuance of warrants to purchase shares of Class A Common Stock 3,276 -- -- -- 3,276 Issuance of Class A Common Stock unit awards 624 -- -- -- 625 Issuance of restricted Class A Common Stock 1,023 (1,025) -- -- -- Restricted Class A Common Stock earned -- 677 -- -- 677 Vesting of restricted Class A Common Stock to unrestricted Class A Common Stock -- -- -- -- -- Dividends paid on Preferred Stock -- -- -- (737) (737) Repurchase and retirement of shares of Stock previously outstanding (49,625) -- -- -- (49,725) -------------------------------------------------------------------- Balance at September 30, 2001 $ 136,805 $ (816) $ (28,991) $ (5,944) $ 101,241 ==================================================================== Balance at January 1, 2002 $ 136,805 $ (583) $ (29,909) $ (3,872) $ 102,628 Net income -- -- -- 4,243 4,243 Unrealized loss on derivative financial instruments, net of related income taxes -- -- (3,958) -- (3,958) Unrealized gain on available-for-sale securities, net of related income taxes -- -- 713 -- 713 Issuance of Class A Common Stock unit awards 312 -- -- -- 313 Issuance of restricted Class A Common Stock 399 (400) -- -- -- Vesting of restricted Class A Common Stock to unrestricted Class A Common Stock -- -- -- -- -- Restricted Class A Common Stock earned -- 504 -- -- 504 Repurchase and retirement of shares of Class A Common Stock previously outstanding (3,105) -- -- -- (3,112) -------------------------------------------------------------------- Balance at September 30, 2002 $ 134,411 $ (479) $ (33,154) $ 371 $ 101,331 ==================================================================== </TABLE> See accompanying notes to unaudited consolidated financial statements. -3-
Capital Trust, Inc. and Subsidiaries Consolidated Statements of Cash Flows Nine months ended September 30, 2002 and 2001 (in thousands) (unaudited) <TABLE> <CAPTION> 2002 2001 ---------------- ----------------- <S> <C> <C> Cash flows from operating activities: Net income $ 4,243 $ 7,298 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Deferred income taxes (264) (1,001) Provision for/(recapture of) allowance for possible credit losses (2,963) 748 Depreciation and amortization 744 625 Loss/(income) from equity investments in Funds 618 (2,422) Net gain on sales of CMBS and available-for-sale securities (711) -- Unrealized loss on hedged and derivative securities 2,776 1,259 Restricted Class A Common Stock earned 504 677 Amortization of premiums and accretion of discounts on loans and investments, net (2,084) (2,065) Accretion of discounts on term redeemable securities contract 680 2,884 Accretion of discounts and fees on Convertible Trust Preferred Securities, net 1,186 599 Changes in assets and liabilities, net: Deposits and other receivables 721 (625) Accrued interest receivable 256 1,830 Prepaid and other assets 15 1,894 Deferred origination fees and other revenue 683 (11) Accounts payable and accrued expenses (1,774) 1,716 ---------------- ----------------- Net cash provided by operating activities 4,630 13,406 ---------------- ----------------- Cash flows from investing activities: Purchases of available-for-sale securities (39,999) (257,877) Principal collections and proceeds from sales of available-for-sale securities 109,671 97,322 Principal collections on certificated mezzanine investments -- 22,379 Principal collections and proceeds from sales of CMBS 67,880 -- Origination and purchase of loans receivable -- (13,319) Principal collections and proceeds from sale of loans receivable 114,955 109,191 Equity investments in Funds (5,973) (31,913) Return of capital from Funds 9,414 28,367 Purchases of equipment and leasehold improvements (5) (181) ---------------- ----------------- Net cash provided by / (used in) investing activities 255,943 (46,031) ---------------- ----------------- Cash flows from financing activities: Proceeds from repurchase obligations 166,974 250,226 Repayment of repurchase obligations (142,097) (111,212) Proceeds from credit facilities 81,000 163,089 Repayment of credit facilities (167,211) (221,665) Proceeds from term redeemable securities contract 35,816 -- Repayment of term redeemable securities contract (173,628) -- Repayment of notes payable (977) (913) Repayment of Convertible Trust Preferred Securities (60,258) -- Dividends paid on Preferred Stock -- (737) Repurchase and retirement of shares of Common and Preferred Stock previously outstanding (3,112) (49,725) ---------------- ----------------- Net cash provided by / (used in) in financing activities (263,493) 29,063 ---------------- ----------------- Net decrease in cash and cash equivalents (2,920) (3,562) Cash and cash equivalents at beginning of year 11,651 11,388 ---------------- ----------------- Cash and cash equivalents at end of period $ 8,731 $ 7,826 ================ ================= </TABLE> See accompanying notes to unaudited consolidated financial statements. -4-
Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements September 30, 2002 (unaudited) 1. Presentation of Financial Information The accompanying unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The accompanying unaudited consolidated interim financial statements should be read in conjunction with the financial statements and the related management's discussion and analysis of financial condition and results of operations filed with the Annual Report on Form 10-K of Capital Trust, Inc. and Subsidiaries (collectively, the "Company") for the fiscal year ended December 31, 2001. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for the nine months ended September 30, 2002, are not necessarily indicative of results that may be expected for the entire year ending December 31, 2002. The accompanying unaudited consolidated interim financial statements of the Company include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform in all material respects to accounting principles generally accepted in the United States. Certain prior period amounts have been reclassified to conform to current period classifications. 2. Use of Estimates The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 3. Available-for-Sale Securities At September 30, 2002, the Company's available-for-sale securities consisted of the following (in thousands): <TABLE> <CAPTION> Gross Unrealized Amortized --------------------- Estimated Cost Gains Losses Fair Value ----------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Federal Home Loan Mortgage Corporation Gold, fixed rate interest at 6.50%, due September 1, 2031 $ 7,700 $ 204 $ -- $ 7,904 Federal Home Loan Mortgage Corporation Gold, fixed rate interest at 6.50%, due September 1, 2031 42,946 957 -- 43,903 Federal Home Loan Mortgage Corporation Gold, fixed rate interest at 6.50%, due September 1, 2031 1,780 47 -- 1,827 Federal Home Loan Mortgage Corporation Gold, fixed rate interest at 6.50%, due April 1, 2032 32,517 1,239 -- 33,756 ----------------------------------------------- $ 84,943 $ 2,447 $ -- $ 87,390 =============================================== </TABLE> The Company purchased the security due April 1, 2032 in March 2002 at a discount with seller provided financing through a repurchase agreement. The Company sold three securities due September 1, 2031 in June 2002 with an amortized cost of $75,006,000 for $75,358,000 resulting in a total gain of $352,000. -5-
Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 4. Commercial Mortgage-Backed Securities In May 2002, the Company received full satisfaction of $36,509,000 face amount of interests in three subordinated CMBS issued by a financial asset securitization investment trust. In connection with the early payoff, the Company recognized an additional $370,000 of unamortized discount as additional interest income in the quarter ended June 30, 2002. In June 2002, three sales of CMBS in two issues were completed. The securities, which had a basis of $31,012,000 including amortization of discounts, were sold for $31,371,000 resulting in a net gain of $359,000. 5. Loans Receivable At September 30, 2002 and December 31, 2001, the Company's loans receivable consisted of the following (in thousands): <TABLE> <CAPTION> September 30, December 31, 2002 2001 ------------------- ------------------ <S> <C> <C> (1) Mortgage Loans $ 19,552 $ 69,998 (2) Mezzanine Loans 113,111 142,160 (3) Other loans receivable 14,009 49,625 ------------------- ------------------ 146,672 261,783 Less: reserve for possible credit losses (10,732) (13,695) ------------------- ------------------ Total loans $ 135,940 $ 248,088 =================== ================== </TABLE> One Mortgage Loan receivable with a principal balance of $8,000,000 reached maturity on July 15, 2000 and has not been repaid with respect to principal and interest. In accordance with the Company's policy for revenue recognition, income recognition has been suspended on this loan and for the nine months ended September 30, 2002, $719,000 of potential interest income has not been recorded. At September 30, 2002, the weighted average interest rate in effect, including amortization of fees and premiums, for the Company's performing loans receivable is as follows: (1) Mortgage Loan 10.72% (2) Mezzanine Loans 10.84% (3) Other loans receivable 12.41% Total loans 10.99% At September 30, 2002, $49,450,000 (36%) of the aforementioned performing loans bear interest at floating rates ranging from LIBOR plus 525 basis points to LIBOR plus 875 basis points. The remaining $89,222,000 (64%) of loans bear interest at fixed rates ranging from 11.62% to 12.00%. During the nine months ended September 30, 2002, the Company released $2,963,000 of its previously established reserve for possible credit losses on loans receivable due to a significant decrease in the portfolio of loans receivable. 6. Equity investment in Funds CT Mezzanine Partners LLC ("Fund I") As of September 30, 2002, Fund I has outstanding loans totaling $83.0 million, all of which are performing in accordance with the terms of their agreements except for one loan for $26.0 million which is in default and for which, beginning June 30, 2001, the accrual of interest was suspended. In March 2002, Fund I established a specific reserve of $13 million for this loan. -6-
Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 7. Long-Term Debt Credit Facilities On February 28, 2002, the Company's $355 million credit facility matured and was settled and was replaced with the repurchase obligations discussed below. At September 30, 2002, the Company has borrowed $35,000,000 under a $100 million credit facility at an average borrowing rate (including amortization of fees incurred and capitalized) of 5.01%. The Company has pledged assets of $102,475,000 as collateral for the borrowing against such credit facility. Effective July 16, 2002, pursuant to an amended and restated credit agreement, the Company extended the expiration of such credit facility from July 2002 to July 2003 with an automatic nine-month amortizing extension option, if not otherwise extended. Repurchase Obligations During the nine months ended September 30, 2002, the Company entered into three new repurchase agreements. One of the new repurchase agreements, with a AAA-rated counterparty, was utilized to refinance CMBS securities that were previously financed with a maturing credit facility and original term redeemable securities contract. At September 30, 2002, the Company sold CMBS assets with a book and market value of $122,179,000 and has a liability, representing the obligation, to repurchase these assets for $88,261,000 that is non-recourse to the Company. This repurchase obligation had an original one year term and the liability balance bears interest at specified rates over LIBOR based upon the credit rating of each asset included in the obligation. The second new repurchase agreement, with a securities dealer, was also utilized to refinance CMBS securities that were previously financed with a maturing credit facility and original term redeemable securities contract. During the second quarter of 2002, the Company transferred all of the CMBS previously financed under this repurchase agreement to the repurchase agreement discussed in the previous paragraph. The third repurchase agreement, with a securities dealer, arose in connection with the purchase of an available-for-sale security in March 2002. At September 30, 2002, the Company sold such asset with a book and market value of $33,755,000 and has a liability, representing the obligation, to repurchase this asset for $32,000,000. This repurchase agreement has a current maturity date in December 2002 and is expected to be extended monthly thereafter. The liability balance bears interest at LIBOR. The repurchase agreement that was outstanding at December 31, 2001, with a securities dealer, arose in connection with the purchase of available-for-sale securities in September 2001 has been extended to December 2002. At September 30, 2002, the Company sold such assets with a book and market value of $53,635,000 and has a liability, representing the obligation, to repurchase this asset for $52,496,000. The liability balance bears interest at LIBOR. The interest rate in effect for all the repurchase obligations outstanding at September 30, 2002 was 2.41%. Term Redeemable Securities Contract On February 28, 2002, the Company's then outstanding term redeemable securities contract became due and settled, upon which event the Company entered into a new term redeemable securities contract. The new term redeemable securities contract was utilized to refinance certain of the assets that were previously financed with the maturing credit facility and original term redeemable securities contract. The new term redeemable securities contract, which allows for a maximum financing of $75 million, is recourse to the Company. The new contract has a two-year term with an automatic one-year amortizing extension option, if not otherwise extended. The Company incurred an initial commitment fee of $750,000 upon the signing of the new contract and the Company pays interest at specified rates over LIBOR. The new contract contains customary representations and warranties, covenants and conditions and events of default. -7-
Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) An affiliate of the counterparty to the new term redeemable securities contract is also a party to an interest rate swap agreement with the Company providing a hedge for interest rate risk on the BB CMBS Portfolio. This agreement had a mutual put option for the value of the hedge exercisable in February 2002. This mutual put has been extended for an additional three years to February 2005. The notional values of the swap, $137,812,000 at December 31, 2001, increased under the terms of the original swap agreement to $169,090,000 in February 2002. The Company has no outstanding borrowings at September 30, 2002 on the new contract but utilizes the collateral pledged on the new contract to collateralize the swap liability. 8. Derivative Financial Instruments The following table summarizes the notional value and fair value of the Company's derivative financial instruments, principally swap contracts at September 30, 2002. The notional value provides an indication of the extent of the Company's involvement in these instruments at that time, but does not represent exposure to credit or interest rate market risks. <TABLE> <CAPTION> Interest Hedge Type Notional Value Rate Maturity Fair Value - ----------- -------------------- ----------------- --------------- ----------- ----------------- <S> <C> <C> <C> <C> <C> Swap Fair Value Hedge $169,090,000 6.045% 2009 $(25,304,000) Swap Cash Flow Hedge 11,250,000 6.580% 2006 (1,548,000) Swap Cash Flow Hedge 37,125,000 5.905% 2008 (5,130,000) Swap Cash Flow Hedge 18,547,000 6.035% 2003 (817,000) Cap Cash Flow Hedge 18,750,000 11.250% 2007 34,000 </TABLE> On September 30, 2002, the derivative financial instruments were reported at their fair value as other assets and interest rate hedge liabilities of $34,000 and $32,799,000, respectively. During the nine months ended September 30, 2002, the Company recognized a loss of $48,000 for the change in time value for qualifying interest rate hedges. The time value is a component of fair value that must be recognized in earnings, and is shown in the consolidated statement of operations as an offset to the unrealized gain on derivative securities. The fair value hedge in the above table was undertaken by the Company to sustain the value of its CMBS holdings. This fair value hedge, when viewed in conjunction with the fair value of the securities, is sustaining the value of those securities as interest rates rise and fall. In conjunction with the sale of the CMBS previously discussed in Note 4, in order to maintain the effectiveness of the hedge, the Company reduced the maturity of the fair value hedge from December 2014 to November 2009 and recognized a realized gain for the payments received totaling $940,000. During the nine months ended September 30, 2002, the Company recognized a loss of $17,914,000 for the decrease in the value of the swap which was substantially offset by a gain of $17,354,000 for the change in the fair value of the securities attributed to the hedged risk resulting in a $560,000 unrealized loss on derivative securities on the consolidated statement of income. The Company utilizes cash flow hedges in order to better control interest costs on variable rate debt transactions. Interest rate swaps that convert variable payments to fixed payments, interest rate caps, floors, collars, and forwards are considered cash flow hedges. During the nine months ended September 30, 2002, the fair value of the cash flow swaps decreased by $3,959,000, which was recorded as an increase in accumulated other comprehensive loss and will be released to earnings over the remaining lives of the swaps. Over time, the unrealized gains and losses held in accumulated other comprehensive income will be reclassified to earnings. This reclassification is consistent with the timing of when the hedged items are also recognized in earnings. Within the next twelve months, the Company estimates that $2.9 million currently held in accumulated other comprehensive loss will be reclassified to earnings with regard to the cash flow hedges. -8-
Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 9. Convertible Trust Preferred Securities At December 31, 2001, the Company's consolidated trust subsidiary, CT Convertible Trust I (the "Trust") had outstanding $150,000,000 aggregate liquidation amount of variable step up convertible trust preferred securities. The liquidation amount of the convertible trust preferred securities was divided into $89,742,000 of convertible amount (the "Convertible Amount") and $60,258,000 of non-convertible amount (the "Non-Convertible Amount"). The Trust held related 8.25% step up convertible junior subordinated debentures ("Convertible Debentures") in the aggregate principal amount of $92,524,000 (redeemable in September 2004) and 13% step up non-convertible junior subordinated debentures ("Non-Convertible Debentures") in the aggregate principal amount of $62,126,000 (redeemable at any time). The dissolution, redemption and, as applicable, conversion terms of the Convertible Amount and the Non-Convertible Amount mirrored the interest, redemption, and, as applicable, conversion terms of the Convertible Debentures and the Non-Convertible Debentures. On September 30, 2002, the Non-Convertible Debentures were redeemed in full, utilizing additional borrowings on the credit facility and repurchase agreements, resulting in a corresponding redemption in full of the related Non-Convertible Amount. In connection with the redemption transaction, the Company expensed the remaining unamortized discount and fees on the redeemed Non-Convertible Amount resulting in $586,000 of additional expense for the quarter ended September 30, 2002. -9-
Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 10. Earnings Per Share The following table sets forth the calculation of Basic and Diluted EPS for the nine months ended September 30, 2002 and 2001: <TABLE> <CAPTION> Nine months Ended September 30, 2002 Nine months Ended September 30, 2001 -------------------------------------------- -------------------------------------------- Net Income Shares Per Share Net Income Shares Per Share Amount Amount ----------------------------- ------------- -------------- ----------------- ----------- <S> <C> <C> <C> <C> <C> <C> Basic EPS: Net earnings per share of Common Stock $ 4,243,000 18,522,982 $ 0.23 $ 6,692,000 20,651,117 $ 0.32 ============= =========== Effect of Dilutive Securities Options outstanding for the purchase of Common Stock -- 76,477 -- 106,671 Warrants outstanding for the purchase of Common Stock -- 128,850 -- 510,907 Future commitments for share unit awards for the issuance of Class A Common Stock -- -- -- 50,000 Convertible Trust Preferred Securities exchangeable for shares of Common Stock -- -- 3,090,000 12,820,513 Convertible Preferred Stock -- -- 606,000 3,435,940 -------------- ------------- -------------- ----------------- Diluted EPS: Net earnings per share of Common Stock and Assumed Conversions $ 4,243,000 18,728,309 $ 0.23 $ 10,388,000 37,575,148 $ 0.28 ============== ============= ============= ============== ================= =========== </TABLE> The following table sets forth the calculation of Basic and Diluted EPS for the three months ended September 30, 2002 and 2001: <TABLE> <CAPTION> Three Months Ended September 30, 2002 Three Months Ended September 30, 2001 -------------------------------------------- -------------------------------------------- Net Income Shares Per Share Net Income Shares Per Share Amount Amount -------------- ------------- ------------- -------------- ----------------- ----------- <S> <C> <C> <C> <C> <C> <C> Basic EPS: Net earnings per share of Common Stock $ 1,553,000 18,271,224 $ 0.09 $ 2,822,000 19,398,136 $ 0.15 ============= =========== Effect of Dilutive Securities Options outstanding for the purchase of Common Stock -- 52,250 -- 172,734 Warrants outstanding for the purchase of Common Stock -- -- -- 1,336,596 Future commitments for share unit awards for the issuance of Class A Common Stock -- -- -- 50,000 Convertible Trust Preferred Securities exchangeable for shares of Common Stock -- -- 1,030,000 12,820,513 Convertible Preferred Stock -- -- 77,000 1,181,721 -------------- ------------- -------------- ----------------- Diluted EPS: Net earnings per share of Common Stock and Assumed Conversions $ 1,553,000 18,323,474 $ 0.08 $ 3,929,000 34,959,700 $ 0.11 ============== ============= ============= ============== ================= =========== </TABLE> -10-
Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 11. Income Taxes The Company and its subsidiaries file a consolidated federal income tax return. The provision for income taxes for the nine months ended September 30, 2002 and 2001 is comprised as follows (in thousands): 2002 2001 --------------- --------------- Current Federal $ 7,294 $ 7,701 State 2,218 2,778 Local 2,341 2,508 Deferred Federal (197) (605) State (56) (208) Local (60) (188) --------------- --------------- Provision for income taxes $ 11,540 $ 11,986 =============== =============== The reconciliation of income tax computed at the U.S. federal statutory tax rate (35%) to the effective income tax rate for the nine months ended September 30, 2002 and 2001 are as follows (in thousands): <TABLE> <CAPTION> 2002 2001 -------------------------------------------------------- $ % $ % -------------------------------------------------------- <S> <C> <C> <C> <C> Federal income tax at statutory rate $ 8,039 35.0% $ 8,975 35.0% State and local taxes, net of federal tax benefit 2,888 12.6% 3,178 12.4% Utilization of net operating loss carryforwards (381) (1.7)% (367) (1.4)% Compensation in excess of deductible limits 655 2.8% 221 0.8% Other 339 1.5% (21) (0.1)% -------------------------------------------------------- $ 11,540 50.2% $ 11,986 46.7% ======================================================== </TABLE> 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 as of September 30, 2002 and December 31, 2001 are as follows (in thousands): <TABLE> <CAPTION> September 30, December 31, 2002 2001 --------------------- -------------------- <S> <C> <C> Net operating loss carryforward $ 4,975 $ 5,394 Reserves on other assets and for possible credit losses 6,979 6,340 Other 3,079 2,434 --------------------- -------------------- Deferred tax assets 15,033 14,168 Valuation allowance (5,006) (4,405) --------------------- -------------------- $ 10,027 $ 9,763 ===================== ==================== </TABLE> The Company recorded a valuation allowance to reserve a portion of its net deferred tax assets in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("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 can not presently be determined. -11-
Capital Trust, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) (unaudited) 12. Employee Benefit Plans 1997 Long-Term Incentive Stock Plan During the nine months ended September 30, 2002, the Company issued an aggregate of 242,000 options to acquire shares of Class A Common Stock with an exercise price of $5.30 per share (the fair market value based on reported trading price on the date of the grant). The Company also issued 75,472 restricted shares of Class A Common Stock which vest one third on each of the following dates: February 1, 2003, February 1, 2004 and February 1, 2005. The Company also canceled 52,083 shares of performance based restricted stock which were granted in 1999. The following table summarizes the option activity under the incentive stock plan for the quarter ended September 30, 2002: <TABLE> <CAPTION> Weighted Average Options Exercise Price Exercise Price Outstanding per Share per Share ------------------- ------------------------ ------------------ <S> <C> <C> <C> Outstanding at January 1, 2002 1,731,667 $4.125 - $10.00 $ 6.42 Granted in 2002 242,000 $5.30 5.30 Exercised in 2002 -- -- -- Canceled in 2002 (51,501) $4.125 - $6.00 4.99 ------------------- ------------------ Outstanding at September 30, 2002 1,922,166 $4.125 - $10.00 $ 6.32 =================== ================== </TABLE> At September 30, 2002, 1,307,264 of the options are exercisable. At September 30, 2002, the outstanding options have various remaining contractual exercise periods ranging from 4.79 to 9.35 years with a weighted average life of 6.73 years. 13. Supplemental Disclosures for Consolidated Statements of Cash Flows Interest paid on the Company's outstanding debt and Convertible Preferred Trust Securities during the nine months ended September 30, 2002 and 2001 was $25,516,000 and $25,867,000, respectively. Income taxes paid by the Company during the nine months ended September 30, 2002 and 2001 was $8,275,000 and $9,664,000, respectively. 14. Subsequent Event On October 3, 2002, the Company purchased and retired 1,696,800 shares of Class A Common Stock at a price of $4.49 per share (including commissions). -12-
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q. Historical results set forth are not necessarily indicative of the future financial position and results of operations of the Company. Balance Sheet Portfolio Developments and Contributions to Funds On February 28, 2002, the Company's $355 million credit facility matured and the term redeemable securities contract became due and settled, upon which events the Company entered into a new term redeemable securities contract and two new repurchase obligations. The new term redeemable securities contract was utilized to refinance certain of the assets that were previously financed with the maturing credit facility and original term redeemable securities contract. The new contract, which allows for a maximum financing of $75 million, is recourse to the Company and has a two-year term with an automatic one-year amortizing extension option, if not otherwise extended. The Company incurred an initial commitment fee of $750,000 upon the signing of the new contract and the Company pays interest at specified rates over LIBOR. The new contract contains customary representations and warranties, covenants and conditions and events of default. An affiliate of the counterparty to the new term redeemable securities contract is also a party to an interest rate swap agreement with the Company for the full duration of a CMBS portfolio purchased from an affiliate of the counterparty, thereby providing a hedge for interest rate risk. This agreement had a mutual put option for the value of the hedge exercisable in February 2002. This mutual put has been extended for an additional three years to February 2005. The notional value of the swap, $137,812,000 at December 31, 2001, increased under the terms of the original swap agreement to $169,090,000 in February 2002. In conjunction with a sale of CMBS in June 2002, in order to maintain the effectiveness of the hedge, the Company reduced the maturity of the fair value hedge from December 2014 to November 2009 and received payments totalling $940,000. One of the new repurchase obligations, with a AAA-rated counterparty, was utilized to refinance CMBS securities that were previously financed with a maturing credit facility and the original term redeemable securities contract. At September 30, 2002, the Company sold CMBS assets with a book and market value of $122,179,000 and has a liability, representing the obligation, to repurchase these assets for $88,261,000 that is non-recourse to the Company. This repurchase obligation has a one year term and the liability balance bears interest at specified rates over LIBOR based upon the credit rating of each asset included in the obligation. The second new repurchase agreement, with a securities dealer, was also utilized to refinance CMBS securities that were previously financed with a maturing credit facility and the original term redeemable securities contract. During the second quarter of 2002, the Company transferred all of the CMBS previously financed under this repurchase agreement to the repurchase agreement discussed in the previous paragraph. In the quarter ended March 31, 2002, to remain in compliance with the Investment Company Act of 1940, as amended, the Company purchased $40.0 million of Federal Home Loan Mortgage Corporation Gold fixed rate whole pool mortgage-backed securities. To finance this purchase, the Company entered into a repurchase obligation that currently matures in December 2002 and is expected to be extended monthly thereafter. In total, the Company sold four Federal Home Loan Mortgage Corporation Gold fixed rate securities with a market value of $87.4 million at September 30, 2002 and the Company has a liability, representing the obligation, to repurchase these assets for $84.5 million. The average interest rate in effect for the repurchase obligations outstanding at September 30, 2002 was 2.41%. The Company expects to enter into new repurchase obligations at their maturity. The Company analyzes its investments and will adjust their levels when and if required for Investment Company Act compliance purposes. In conjunction with this analysis and due to favorable market conditions, in June 2002, the Company sold three Federal Home Loan Mortgage Corporation Gold fixed rate whole pool mortgage-backed securities due September 1, 2031 with an amortized cost of $75,006,000 and completed three sales of CMBS in two issues with a basis of $31,012,000. The Company recognized a net realized gain of $711,000 in conjunction with these sales. The Company also received full payment of three other CMBS issues that it held with a face value of $36.5 million. -13-
Since December 31, 2001, consistent with its transition from the balance sheet lending to the investment management business, the Company has not originated or purchased any new loans and has no future commitments under any existing loans. The Company received full satisfaction of two loans totaling $75.5 million and partial repayments on five loans totaling $39.4 million in 2002. At September 30, 2002, the Company had outstanding loans totaling approximately $146.7 million. The Company's investment in Fund I at September 30, 2002 is $14.4 million. Since December 31, 2001, the Company has not made any equity contributions to Fund I and has received $8.3 million as a return of equity. The Company has capitalized costs of $4,752,000 that are being amortized over the anticipated lives of the Funds. As of September 30, 2002, Fund I has outstanding loans and investments totaling $83.0 million, all of which are performing in accordance with the terms of their agreements except for one loan for $26.0 million which is in default and for which, beginning September 30, 2001, the accrual of interest was suspended. In March 2002, Fund I established a specific reserve of $13 million for this loan. Since December 31, 2001, the Company has made equity contributions to Fund II of $5.2 million and equity contributions to Fund II's general partner of $823,000. The Company's remaining equity commitment to Fund II and its general partner is $39.7 million. The Company has capitalized costs of $3.8 million relating to the formation of Fund II that are being amortized over the anticipated lives of the Funds. The Company's investment in Fund II and its general partner at September 30, 2002 is $19.1 million. As of September 30, 2002, Fund II has outstanding loans and investments totaling $674.0 million, all of which are performing in accordance with the terms of their agreements. Results of Operations for the Three and Nine months Ended September 30, 2002 and 2001 - -------------------------------------------------------------------------------- The Company reported net income allocable to shares of Common Stock of $4,243,000 for the nine months ended September 30, 2002, a decrease of $2,449,000 from the net income allocable to shares of Common Stock of $6,692,000 for the nine months ended September 30, 2001. This decrease was primarily the result of decreased net interest income from loans and other investments as the Company continues its transition to the investment management business offset by increased advisory and investment management fees, a recapture of the allowance for possible credit losses and the elimination of the Preferred Stock dividend. The Company reported net income allocable to shares of Common Stock of $1,553,000 for the three months ended September 30, 2002, a decrease of $1,269,000, from the net income allocable to shares of Common Stock of $2,822,000 for the three months ended September 30, 2001. This decrease was primarily the result of decreased net interest income from loans and other investments offset by increased advisory and investment management fees. The Company expects additional reductions in interest and related income due to decreases in leveraged interest earning assets that may not be offset by increased income from investment management operations. Interest and related income from loans and other investments amounted to $37,991,000 for the nine months ended September 30, 2002, a decrease of $13,751,000 from the $51,742,000 amount for the nine months ended September 30, 2001. Average interest earning assets decreased from approximately $549.6 million for the nine months ended September 30, 2001 to approximately $452.2 million for the nine months ended September 30, 2002. The Company's average interest rate earned decreased from 12.58% for the nine months ended September 30, 2001 to 10.05% for the nine months ended September 30, 2002. During the nine months ended September 30, 2002, the Company recognized an additional $1.5 million on the early repayment of loans and investments, while during the nine months ended September 30, 2001, the Company recognized an additional $4.8 million on the early repayment of loans. Without this additional interest income, the earning rate for 2002 would have been 9.7% versus 11.4% for 2001, a decrease of 1.7%. LIBOR rates averaged 1.8% for the nine months ended September 30, 2002 and 4.4% for the nine months ended September 30, 2001, a decrease of 2.6%. Since substantial portions of the Company's assets earn interest at fixed-rates, the decrease in the average earning rate did not correspond to the full decrease in the average LIBOR rate. Interest and related income from loans and other investments amounted to $11,036,000 for the three months ended September 30, 2002, a decrease of $5,949,000 from the $16,985,000 amount for the three months ended September 30, 2001. Average interest earning assets decreased from approximately $502.2 million for the three months ended September 30, 2001 to approximately $404.1 million for the three months ended September 30, 2002. The Company's average interest rate earned decreased from 13.42% for the three months ended September 30, 2001 to 10.83% for the three months ended September 30, 2002. During the three months ended September 30, 2002, the Company recognized an additional $1.1 million on the early repayment of loans, while during the three months ended September 30, 2001, the Company recognized an additional $3.2 million on the early repayment of loans. Without this additional interest income, the earning rate for 2002 would have been 9.7% versus 10.9% for 2001, a -14-
decrease of 1.2%. LIBOR rates averaged 1.8% for the three months ended September 30, 2002 and 3.5% for the three months ended September 30, 2001, a decrease of 1.7%. Since substantial portions of the Company's assets earn interest at fixed-rates, the decrease in the average earning rate did not correspond to the full decrease in the average LIBOR rate. Interest and related expenses amounted to $14,020,000 for the nine months ended September 30, 2002, a decrease of $5,705,000 from the $19,725,000 amount for the nine months ended September 30, 2001. The decrease in expense was due to a decrease in the average rate paid on interest bearing liabilities from 9.0% for the nine months ended September 30, 2001 to 6.7% for the nine months ended September 30, 2002 and a decrease in the amount of average interest bearing liabilities outstanding from approximately $294.0 million for the nine months ended September 30, 2001 to approximately $279.5 million for the nine months ended September 30, 2002. The decrease in the average rate is substantially due to the increased use of repurchase agreements as debt in 2002 at lower spreads to LIBOR than the credit facilities utilized in 2001 and the decrease in the average LIBOR rate. Due to the decrease in total debt, the percentage of debt that has been swapped to fixed rates in 2002 increased partially offsetting the previously discussed decreases. Interest and related expenses amounted to $3,757,000 for the three months ended September 30, 2002, a decrease of $1,951,000 from the $5,708,000 amount for the three months ended September 30, 2001. The decrease in expense was due to a decrease in the average rate paid on interest bearing liabilities from 9.0% for the three months ended September 30, 2001 to 8.8% for the three months ended September 30, 2002, and a decrease in the amount of average interest bearing liabilities outstanding from approximately $251.0 million for the three months ended September 30, 2001 to approximately $169.9 million for the three months ended September 30, 2002. Again, the decrease in the average rate is due to the increased use of repurchase agreements for a higher percentage of interest bearing liabilities and the decrease in the average LIBOR rate offset substantially by increased net payments on swap contracts. In addition, the Company also utilized proceeds from the $150.0 million of Convertible Trust Preferred Securities, which were issued on July 28, 1998 to finance its interest earning assets. On April 1, 2002, in accordance with the terms of the securities, the blended rate on such securities increased from 10.16% to 11.21%. On October 1, 2002, after repayment of the Non-Convertible Amount (as discussed below), the rate on such securities is 10.00%. During the nine months ended September 30, 2002 and 2001, the Company recognized $7,186,000 and $6,359,000, respectively, of net expenses related to the Convertible Trust Preferred Securities. This amount consisted of distributions to the holders totaling $12,195,000 and $11,428,000, respectively, and amortization of discount and origination costs totaling $1,186,000 and $599,000, respectively, during the nine months ended September 30, 2002 and 2001. This was partially offset by a tax benefit of $6,195,000 and $5,668,000 during the nine months ended September 30, 2002 and 2001, respectively. The increase in the amortization of discount and origination costs resulted from the recognition of the unamortized discount and fees on the Non-Convertible Amount expensed upon repayment of the Non-Convertible Amount on September 30, 2002. During the three months ended September 30, 2002 and 2001, the Company recognized $2,669,000 and $2,119,000, respectively, of net expenses related to the Convertible Trust Preferred Securities. This amount consisted of distributions to the holders totaling $4,184,000 and $3,809,000, respectively, and amortization of discount and origination costs totaling $786,000 and $200,000, respectively, during the three months ended September 30, 2002 and 2001. This was partially offset by a tax benefit of $2,301,000 and $1,890,000 during the three months ended September 30, 2002 and 2001, respectively. The increase in the amortization of discount and origination costs again resulted from the recognition of the unamortized discount and fees on the Non-Convertible Amount expensed upon repayment of the Non-Convertible Amount on September 30, 2002. During the nine months ended September 30, 2002, other revenues increased $2,857,000 to $10,968,000 from $8,111,000 in the same period of 2001. During the nine months ended September 30, 2002, the Company sold investments and reduced the maturity of its fair value hedge, which resulted in a gain of $1,651,000, and earned a $2.0 million fee from the Company's final advisory assignment. The Company also received the increased revenue from Fund II (management and advisory income in addition to the return on investment in the fund), which began operations in the second quarter of 2001. Fund I increased its allowance for possible credit losses by establishing a specific reserve for the non-performing loan it is carrying. The loss from equity investments in Funds is due to this additional expense. -15-
During the three months ended September 30, 2002, other revenues increased $1,968,000 to $5,807,000 from $3,839,000 in the same period of 2001. This increase was due to the $2.0 million fee earned from the Company's final advisory assignment. As previously disclosed, the Company will not generally invest in Mezzanine Loans for its own balance sheet as Fund II (to which it has a remaining $39.7 million equity commitment) is the principal vehicle through which the Company invests in loans and investments in accordance with the Company's current investment program. If the amount of the Company's maturing loans and investments increase significantly before the excess capital generated thereby is invested in Fund II or other funds, or is otherwise accretively deployed, the Company may experience shortfalls in revenues and lower earnings until offsetting revenues are derived from funds under management and other sources. The investment period for Fund II expires in April 2003, at which time the management fee earned from the fund will be reduced as the base upon which the fee is calculated changes from capital commitments to invested capital. General and administrative expenses were modestly lower amounting to $11,390,000 for the nine months ended September 30, 2002 versus $11,766,000 for the nine months ended September 30, 2001 and $3,982,000 for the three months ended September 30, 2002 versus $3,991,000 for the three months ended September 30, 2001. The Company employed an average of 27 employees during both the nine months ended September 30, 2002 and the nine months ended September 30, 2001. The Company had 26 full-time employees and one part-time employee at September 30, 2002. During the nine months ended September 30, 2002, the Company recaptured $2,963,000 of its previously established allowance for possible credit losses. The Company deemed this recapture necessary due to the substantial reduction in the loan portfolio and a general reduction in the risk of the loans remaining defaulting based upon current conditions. After the recapture, the Company believes that the reserve is adequate based on the existing loans in the balance sheet portfolio. For the nine months ended September 30, 2002 and 2001, the Company accrued income tax expense of $11,540,000 and $11,986,000, respectively, for federal, state and local income taxes. The increase (from 46.7% to 50.2%) in the effective tax rate was primarily due to higher levels of compensation in excess of deductible limits in the current year and increased amortization of capitalized costs from Fund II, which are not deductible for tax. Until the repurchase of the preferred stock by the Company, dividends accrued on these shares at a rate of 9.5% per annum on a per share price of $2.69. In 2001, the remaining shares of Preferred Stock were repurchased thereby eliminating the dividend requirement for 2002. Liquidity and Capital Resources At September 30, 2002, the Company had $8,731,000 in cash. The primary sources of liquidity for the Company for the remainder of 2002 will be cash on hand, cash generated from operations, principal and interest payments received on loans and investments (including loan repayments and the return of capital from Fund I), and additional borrowings under the Company's credit facility and its term redeemable securities contract. The Company believes that these sources of capital will adequately meet future cash requirements. The Company expects that during 2002, it will use a significant amount of its available capital resources to satisfy its capital contributions required in connection with its remaining $39.7 million equity commitment to Fund II and its general partner and to repurchase the Company's outstanding Common Stock under its open market share repurchase program. The Company intends to continue to employ leverage on its existing balance sheet assets to enhance its return on equity. The Company experienced a net decrease in cash of $2,920,000 for the nine months ended September 30, 2002 compared to a decrease of $3,562,000 for the nine months ended September 30, 2001. Cash provided by operating activities during the nine months ended September 30, 2002 was $4,630,000, compared to $13,406,000 provided during the same period of 2001. For the nine months ended September 30, 2002, cash provided by investing activities was $255,943,000, compared to $46,031,000 used during the same period in 2001. This change was primarily due to an increase in the level of repayments received on loans receivable and repayments and sales of CMBS and available-for-sale securities and a decrease in the level of purchases of available-for-sale securities. The Company utilized the cash received on loan repayments and repayments and sales of CMBS and available-for-sale securities to reduce borrowings under its credit facilities, accounting for the majority of the $263,493,000 of net cash used in financing activities for the nine months ended September 30, 2002. -16-
In 2001, the Company announced an open market share repurchase program under which the Company may purchase, from time to time, up to four million shares of the Company's Class A Common Stock. On May 1, 2002, the Company purchased and retired 536,370 shares of Class A Common Stock at an average price of $4.86 per share (including commissions). As of the date of this purchase, the Company had repurchased 3,100,770 shares of Class A Common Stock pursuant to the program. In May 2002, the Company announced an increase in the program restoring the number of shares of Class A Common Stock subject to repurchase under the program to four million shares (an addition of 3,100,770 shares). On August 19, 2002, the Company purchased and retired 104,900 shares of Class A Common Stock at a price of $4.81 per share (including commissions). On October 3, 2002, the Company purchased and retired an additional 1,696,800 shares of Class A Common Stock at a price of $4.49 per share (including commissions). After this repurchase, the Company has 2,198,300 shares authorized for repurchase under the plan. At September 30, 2002, the Company was party to a credit facility with a commercial lender that provides for $100 million of credit. The line of credit matured in July 2002 and was extended for an additional year and has an automatic nine-month amortizing extension option, if not otherwise extended. At September 30, 2002, the Company has borrowed $35,000,000 under the credit facility at an average borrowing rate (including amortization of fees incurred and capitalized) of 5.01%. The decrease in the amount outstanding under the credit facilities from the amount outstanding at December 31, 2001 was due to the use of cash received on loan repayments and sales and repayments of CMBS and available-for-sale securities to pay down the credit facility. The $100 million credit facility provides the Company with adequate liquidity for its short-term needs. The existing credit facility provides for advances to fund lender-approved loans and investments made by the Company. The obligations of the Company under the credit facility are required to be secured by pledges of the assets originated or acquired by the Company with advances under the credit facility. Borrowings under the credit facility bear interest at specified rates over LIBOR, which rates may fluctuate, based upon the credit quality of the pledged 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 facility provides for margin calls on asset-specific borrowings in the event of asset quality and/or market value deterioration as determined under the credit facility. The credit facility contains customary representations and warranties, covenants and conditions and events of default. At September 30, 2002, the Company has no outstanding borrowings on its $75 million term redeemable securities contract and has outstanding repurchase obligations of $172,757,000. In connection with the maturity of the credit facility and the term redeemable securities contract that matured and became due in February 2002, the Company entered into a new term redeemable securities contract with the same counterparty, which allows for a maximum financing of $75 million. The new term redeemable securities contract has a two-year term with an automatic one-year amortizing extension option, if not otherwise extended. In February 2002, the Company also entered into two new repurchase obligations with new counterparties to refinance the remaining assets financed under the original term redeemable securities contract. The Company has utilized the collateral pledged on the new contract to collateralize its swap liability. The Company's convertible trust preferred securities were modified in May 2000 in a transaction pursuant to which the outstanding securities were canceled and new variable step up convertible trust preferred securities with an aggregate liquidation amount of $150 million ("Convertible Trust Preferred Securities") were issued to the holders of the canceled securities in exchange therefore, and the original underlying convertible debentures were canceled and new 8.25% step up convertible junior subordinated debentures in the aggregate principal amount of $92,524,000 (the "Convertible Debentures") and new 13% step up non-convertible junior subordinated debentures in the aggregate principal amount of $62,126,000 (the "Non-Convertible Debentures" and together with the Convertible Debentures, the "Debentures") were issued to the CT Convertible Trust I (the "Trust"), as the holder of the canceled bonds, in exchange therefore. The liquidation amount of the Convertible Trust Preferred Securities is divided into $89,742,000 of convertible amount (the "Convertible Amount") and $60,258,000 of non-convertible amount (the "Non-Convertible Amount"), the distribution, redemption and, as applicable, conversion terms of which, mirror the interest, redemption and, as applicable, the conversion terms of the Convertible Debentures and the Non-Convertible Debentures, respectively, held by the Trust. The Non-Convertible Debentures were redeemed in full on September 30, 2002 resulting in a corresponding redemption in full of the Non-Convertible Amount. In connection with the redemption transaction, the Company expensed the remaining unamortized discount and fees on the Non-Convertible Amount resulting in $586,000 of additional expense for the quarter ended September 30, 2002. -17-
Distributions on the remaining Convertible Trust Preferred Securities are payable quarterly in arrears on each calendar quarter-end and correspond to the payments of interest made on the Debentures, the sole assets of the Trust. Distributions are payable only to the extent interest payments are made in respect to the Debentures. The remaining Convertible Trust Preferred Securities currently bear a coupon rate of 10.00% per annum, which rate will step up in accordance with the coupon rate step up terms applicable to the Convertible Amount. The Convertible Amount was originally issued with a coupon rate of 8.25% per annum and thereafter is subject to an increase on April 1, 2002 to the greater of (i) 10.00% per annum, increasing by 0.75% on October 1, 2004 and on each October 1 thereafter or (ii) a percentage per annum equal to the quarterly dividend paid on a share of Class A Common Stock multiplied by four and divided by $7.00. The rate in effect following April 1, 2002 through September 30, 2002 was 10.00%. The Convertible Amount is convertible into shares of Class A Common Stock, in increments of $1,000 in liquidation amount, at a conversion price of $7.00 per share. The Convertible Amount is redeemable by the Company, in whole or in part, on or after September 30, 2004. Impact of September 11, 2001 The events of September 11 have created uncertainty regarding the ability of real estate owners of high profile assets to obtain insurance coverage protecting against terrorist attacks at commercially reasonable rates. The issue is exacerbated by the fact that most insurance policies (and the terrorism insurance that has traditionally been a part of such policies) expire on December 31 of each year and most secured loans typically require comprehensive terrorism insurance. The absence of suitable insurance coverage will likely affect the general real estate lending market, lending volume and the market's overall liquidity. In turn, real estate valuations may be impacted, particularly for asset types seen as vulnerable to attack, including: central business district office buildings, certain regional malls and assets located near sites perceived as high-risk being the most sensitive. The lack of resolution regarding affordable long-term terrorism insurance coverage for all property types combined with the general slow-down of the U.S. economy may negatively impact existing loans and investments and may reduce the number of suitable investment opportunities available to Fund II and the pace at which its investments are made. A reduction in asset originations could adversely affect the Company's ability to grow earnings. Note on Forward-Looking Statements Except for historical information contained herein, this quarterly report on Form 10-Q contains forward-looking statements within the meaning of the Section 21E of the Securities and Exchange Act of 1934, as amended, which involve certain risks and uncertainties. Forward-looking statements are included with respect to, among other things, the Company's current business plan, business and investment strategy and portfolio management. These forward-looking statements are identified by their use of such terms and phrases as "intends," "intend," "intended," "goal," "estimate," "estimates," "expects," "expect," "expected," "project," "projected," "projections," "plans," "anticipates," "anticipated," "should," "designed to," "foreseeable future," "believe," "believes" and "scheduled" and similar expressions. The Company's actual results or outcomes may differ materially from those anticipated. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Important factors that the Company believes might cause actual results to differ from any results expressed or implied by these forward-looking statements are discussed in the cautionary statements contained in Exhibit 99.3 to this Form 10-Q (filed as Exhibit 99.1 to the Company's Annual Report on Form 10-K, filed on April 1, 2002), which are incorporated herein by reference. In assessing forward-looking statements contained herein, readers are urged to read carefully all cautionary statements contained in this Form 10-Q -18-
ITEM 3. 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 effectively convert variable rate debt to fixed rate debt for the financed portion of fixed rate assets. The differential to be paid or received on these agreements is recognized as an adjustment to the interest expense related to debt and is recognized on the accrual basis. The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates at September 30, 2002. 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. <TABLE> <CAPTION> Expected Maturity Dates ------------------------------------------------------------------------------------- 2002 2003 2004 2005 2006 Thereafter Total Fair Value ---- ---- ---- ---- ---- ---------- ----- ---------- (dollars in thousands) Assets: <S> <C> <C> <C> <C> <C> <C> <C> <C> Available-for sale securities Fixed Rate $ 5,662 $ 23,911 $ 23,485 $ 13,862 $ 7,709 $ 9,602 $ 84,231 $ 87,390 Average interest rate 6.12% 6.12% 6.12% 6.12% 6.12% 6.12% 6.12% CMBS Fixed Rate -- -- -- -- $ 7,811 $201,159 $208,970 $157,904 Average interest rate -- -- -- -- 11.20% 11.89% 11.86% Loans receivable Fixed Rate -- -- -- -- -- $ 88,838 $ 88,838 $ 97,885 Average interest rate -- -- -- -- -- 11.68% 11.68% Variable Rate $ 16,218 $ 10,176 $ 8,667 $ 15,167 $ 667 $ 6,555 $ 57,450 $ 50,774 Average interest rate 11.15% 12.08% 0.57% 7.93% 7.35% 7.35% 8.39% Liabilities: Credit Facilities Variable Rate -- $ 35,000 -- -- -- -- $ 35,000 $ 35,000 Average interest rate -- 5.01% -- -- -- -- 5.01% Repurchase obligations Variable Rate $ 84,496 $ 88,261 -- -- -- -- $172,757 $172,757 Average interest rate 1.85% 2.95% -- -- -- -- 2.40% Convertible Trust Preferred Securities Fixed Rate -- -- -- $ 89,742 -- -- $ 89,742 $ 88,869 Average interest rate -- -- -- 10.00% -- -- 10.00% Interest rate swaps Notional amounts -- $ 18,547 -- $169,090 -- $ 48,375 $204,734 $ (32,799) Average fixed pay rate -- 6.04% -- 6.05% -- 6.06% 6.05% Average variable receive rate -- 1.82% -- 1.82% -- 1.82% 1.82% </TABLE> -19-
ITEM 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures An evaluation of the effectiveness of the design and operation of the Company's "disclosure controls and procedures" (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) was carried out within 90 days prior to the filing of this quarterly report. This evaluation was made under the supervision and with the participation of the Company's management, including its Chief Executive Officer and Chief Financial Officer. Based upon this evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures (a) are effective to ensure that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is timely recorded, processed, summarized and reported and (b) include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Changes in Internal Controls There have been no significant changes in the Company's internal controls or, to the knowledge of the management of the Company, in other factors that could significantly affect these controls subsequent to the date of the Company's evaluation. -20-
PART II. OTHER INFORMATION ITEM 1: Legal Proceedings None ITEM 2: Changes in Securities None ITEM 3: Defaults Upon Senior Securities None ITEM 4: Submission of Matters to a Vote of Security Holders None ITEM 5: Other Information None <TABLE> <CAPTION> ITEM 6: Exhibits and Reports on Form 8-K (a) Exhibits Statements regarding computation of earnings (loss) per share <S> <C> 11.1 Statements regarding Computation of Earnings per Share (Data required by Statement of Financial Accounting Standard No. 128, Earnings per Share, is provided in Note 10 to the consolidated financial statements contained in this report). 99.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.3 Risk Factors (filed as Exhibit 99.1 to the Company's Annual Report on Form 10-K, filed on April 1, 2002 and incorporated herein by reference). (b) Reports on Form 8-K During the fiscal quarter ended September 30, 2002, the Company filed the following Current Reports on Form 8-K: </TABLE> None -21-
SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CAPITAL TRUST, INC. November 12, 2002 /s/ John R. Klopp - ----------------- ----------------- Date John R. Klopp Chief Executive Officer /s/ Edward L. Shugrue III ------------------------- Edward L. Shugrue III Chief Financial Officer -22-
CERTIFICATION PURSUANT TO 17 CFR 240.13a-14 PROMULGATED UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, John R. Klopp, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Capital Trust, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 /s/ John R. Klopp -------------------------- John R. Klopp Chief Executive Officer -23-
CERTIFICATION PURSUANT TO 17 CFR 240.13a-14 PROMULGATED UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Edward L. Shugrue III, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Capital Trust, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 /s/ Edward L. Shugrue III -------------------------- Edward L. Shugrue III Chief Financial Officer -24-