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| GKK > SEC Filings for GKK > Form 10-Q on 9-Aug-2012 | All Recent SEC Filings |
9-Aug-2012
Quarterly Report
Overview
Gramercy Capital Corp. is a self-managed, integrated commercial real estate investment and asset management company. We were formed in April 2004 and commenced operations upon the completion of our initial public offering in August 2004. In June 2012, following a strategic review process completed by a special committee of the Board of Directors, we announced we will remain independent and will now focus on deploying our capital into income-producing net leased real estate. Our new investment criteria will focus on single tenant net lease investments with durable credits across a variety of industries in markets across the United States. New investments initially will be funded from existing financial resources. Subsequently, subject to market conditions, we expect to seek to raise additional debt and/or equity capital to support further growth. Our legacy commercial real estate finance business, which operates under the name Gramercy Finance, manages approximately $2.0 billion of whole loans, bridge loans, subordinate interests in whole loans, mezzanine loans, preferred equity, commercial mortgage-backed securities, or CMBS, and other real estate related securities which are financed through three non-recourse, collateralized debt obligations, or CDOs. Our legacy property management and investment business, which operates under the name Gramercy Realty, currently manages approximately $2.0 billion of commercial properties leased primarily to regulated financial institutions and affiliated users throughout the United States. We, along with our Board of Directors, are currently conducting an operational review of our existing assets and operations with the goal of reducing the current cost structure, further strengthening the balance sheet and determining which legacy assets and operations complement the new investment strategy. Neither Gramercy Finance nor Gramercy Realty is a separate legal entity, but are divisions through which our commercial real estate finance and property management and investment businesses are conducted.
We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, and generally will not be subject to U.S. federal income taxes to the extent we distribute our taxable income, if any, to our stockholders. We have in the past established, and may in the future establish taxable REIT subsidiaries, or TRSs, to effect various taxable transactions. Those TRSs would incur U.S. federal, state and local taxes on the taxable income from their activities.
We conduct substantially all of our operations through our operating partnership, GKK Capital LP, or our Operating Partnership. We are the sole general partner of our Operating Partnership. Our Operating Partnership conducts our finance business primarily through two private REITs, Gramercy Investment Trust and Gramercy Investment Trust II; our commercial real estate investment business through various wholly-owned entities; and our realty management business through a wholly-owned TRS.
Unless the context requires otherwise, all references to "Gramercy," "our Company," "we," "our" and "us" mean Gramercy Capital Corp., a Maryland corporation, and one or more of its subsidiaries, including our Operating Partnership.
Gramercy Finance
The aggregate carrying values, allocated by product type and weighted average coupons of Gramercy Finance's loans, and other lending investments and CMBS investments as of June 30, 2012 and December 31, 2011, were as follows (dollars in thousands):
Allocation by Floating Rate Average
Carrying Value (1) Investment Type Fixed Rate Average Yield Spread over LIBOR (2)
2012 2011 2012 2011 2012 2011 2012 2011
Whole loans, 339 331
floating rate $ 607,597 $ 689,685 62.3 % 63.8 % - - bps bps
Whole loans,
fixed rate 202,542 202,209 20.8 % 18.7 % 8.33 % 8.35 % - -
Subordinate
interests in
whole loans, 250 575
floating rate 3,710 25,352 0.4 % 2.3 % - - bps bps
Subordinate
interests in
whole loans,
fixed rate 91,209 89,914 9.4 % 8.3 % 10.51 % 10.50 % - -
Mezzanine loans, 894 860
floating rate 45,446 46,002 4.7 % 4.3 % - - bps bps
Mezzanine loans,
fixed rate 23,659 23,847 2.4 % 2.2 % 10.34 % 10.34 % - -
Preferred
equity, floating 288 234
rate 250 3,615 0.0 % 0.3 % - - bps bps
Preferred
equity, fixed
rate - 1,295 0.0 % 0.1 % 0.00 % 0.00 % - -
Subtotal/ 377 370
Weighted average 974,413 1,081,919 100.0 % 100.0 % 9.10 % 9.08 % bps bps
CMBS, floating 106 96
rate 48,313 47,855 5.7 % 6.2 % - - bps bps
CMBS, fixed rate 803,623 727,957 94.3 % 93.8 % 8.53 % 8.22 % - -
Subtotal/ 106 96
Weighted average 851,936 775,812 100.0 % 100.0 % 8.53 % 8.22 % bps bps
358 354
Total $ 1,826,349 $ 1,857,731 100.0 % 100.0 % 8.69 % 8.48 % bps bps
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(1) Loans and other lending investments are presented net of unamortized fees, discounts, reserves for loan losses, impairments and other adjustments.
(2) Spreads over an index other than 30 day-LIBOR have been adjusted to a LIBOR based equivalent. In some cases, LIBOR is floored, giving rise to higher current effective spreads.
Our loans and other investments serve as collateral for our CDO securities, and the income generated from these investments is used to fund interest obligations of our CDO securities and the remaining income, if any, is retained by us, provided that minimum interest coverage and asset overcollateralization covenants as specified in the CDO indentures are satisfied. We are not obligated to provide any financial support to these CDOs. We provide certain advisory and administrative services to our CDOs, pursuant to collateral management agreements. The collateral management agreements provide for a senior collateral management fee and a subordinate collateral management fee payable quarterly.
If some or all of our CDOs fail the minimum interest coverage and asset overcollateralization covenants, all cash flows from the applicable CDO other than senior collateral management fees would be diverted to repay principal and interest on the most senior outstanding CDO securities, and we may not receive some or all residual payments or the subordinate collateral management fee until the applicable CDO regained compliance with such tests.
The period during which we are permitted to reinvest principal payments on the underlying assets into qualifying replacement collateral for our 2005 CDO and 2006 CDO expired in July 2010 and July 2011, respectively, and will expire for our 2007 CDO in August 2012. In the past, our ability to reinvest has been instrumental in maintaining compliance with the overcollateralization and interest coverage tests for our CDOs. Following the conclusion of each CDO's reinvestment period, our ability to maintain compliance with such tests for that CDO will be negatively impacted.
As of June 30, 2012, Gramercy Finance also held interests in one credit tenant net lease investment, or CTL investment, and six interests in real estate acquired through foreclosures.
Gramercy Realty
Summarized in the table below are key property portfolio statistics for Gramercy
Realty's owned portfolio as of June 30, 2012 and December 31, 2011:
Number of Properties Rentable Square Feet Occupancy
June 30, December 31, June 30, December 31, June 30, December 31,
Properties 2012 2011 2012 2011 2012 2011
Branches 31 41 209,578 261,732 32.1 % 28.9 %
Office Buildings 13 15 362,492 491,084 46.3 % 44.7 %
Total 44 56 572,070 752,816 41.1 % 39.2 %
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In addition to its owned portfolio, Gramercy Realty also manages approximately $2.0 billion of real estate assets that were transferred to affiliates of KBS Real Estate Investment Trust, Inc., or KBS, pursuant to a collateral transfer and settlement agreement, or the Settlement Agreement, executed in September 2011. The portfolio of transferred properties, or the KBS Portfolio, is comprised of 524 bank branches, 278 office buildings and one land parcel, totaling approximately 20.5 million rentable square feet.
In September 2011, we entered into an asset management arrangement upon the terms and conditions set forth in the Settlement Agreement, or the Interim Management Agreement, to provide for our continued management of the KBS Portfolio through December 31, 2013 for a fixed fee of $10.0 million annually, the reimbursement of certain costs and incentive fees equal to 10.0% of the excess of the equity value, if any, of the transferred collateral over $375.0 million plus all new capital invested into the transferred collateral by KBS, its affiliates and/or joint venture partners, or the Threshold Value Participation, and 12.5% of the excess equity value, if any, of the transferred collateral over $468.5 million plus all new capital invested into the transferred collateral by KBS, its affiliates and/or joint venture partners, or the Excess Value Participation. The minimum amount of the Threshold Value Participation equals $3.5 million. The Settlement Agreement obligated the parties to negotiate in good faith to replace the Interim Management Agreement with a more complete and definitive management services agreement on or before March 31, 2012 and provided that if the parties failed to complete a definitive agreement, the Interim Management Agreement would have terminated by its terms on June 30, 2012.
On March 30, 2012, we entered into an Asset Management Services Agreement, or the Management Agreement, with KBS Acquisition Sub, LLC, or KBSAS, a wholly-owned subsidiary of KBS, pursuant to which we will provide asset management services to KBSAS with respect to the KBS Portfolio. The Management Agreement provides for our continued management of the KBS Portfolio, through December 31, 2015 for (i) a base management fee of $12.0 million per year, payable monthly, plus the reimbursement of all property related expenses paid by us on behalf of KBSAS, subject to deferral of $167 thousand per month at KBSAS's option until the accrued amount equals $2.5 million or June 30, 2013, whichever is earlier, and (ii) an incentive fee, or the Threshold Value Profits Participation, in an amount equal to the greater of: (a) $3.5 million or (b) 10% of the amount, if any, by which the portfolio equity value exceeds $375.0 million (as adjusted for future cash contributions into, and distributions out of, KBSAS by KBS). In any event, the Threshold Value Profits Participation is capped at a maximum of $12.0 million. The Threshold Value Profits Participation is payable 60 days after the earlier to occur of June 30, 2014 (or March 31, 2015 upon satisfaction of certain extension conditions, including the payment by KBSAS to us of a $750 thousand extension fee) and the date on which KBSAS, directly or indirectly, sells, conveys or otherwise transfers at least 90% of the KBS Portfolio (by value).
The Management Agreement may be terminated by us, (i) without any KBSAS default under the Management Agreement, on or after December 31, 2012, upon 90 days' prior written notice or (ii) at any time by five business days' prior written notice in the event of a KBSAS default under the Management Agreement. The Management Agreement may be terminated by KBSAS, (i) without Cause (as defined in the Management Agreement), with an effective termination date of March 31 or September 30 of any year but at no time prior to April 1, 2013, upon 90 days' prior written notice or (ii) at any time after April 1, 2013 for Cause. In the event of a termination of the Management Agreement by KBSAS after April 1, 2013 but prior to December 31, 2015, we will be entitled to receive a declining balance termination fee, ranging from $5.0 million to $2.0 million, calculated as specified in the Management Agreement.
Liquidity
Liquidity is a measurement of the ability to meet cash requirements, including
ongoing commitments to repay borrowings, fund and maintain loans and other
investments, pay dividends and other general business needs. In addition to cash
on hand, our primary sources of funds for short-term (within the next 12 months)
liquidity requirements, including working capital, distributions, if any, debt
service and additional investments, consists of (i) cash flow from operations;
(ii) proceeds and management fees from our existing CDOs; (iii) proceeds from
principal and interest payments and rents on our investments; (iv) proceeds from
potential loan and asset sales; (v) proceeds from the Management Agreement for
the KBS Portfolio; and, to a lesser extent: (vi) new financings and (vii)
proceeds from additional common or preferred equity offerings. We believe these
sources of financing will be sufficient to meet our short-term liquidity
requirements. In June 2012, following a strategic review process completed by a
special committee of the Board of Directors, we announced we will remain
independent and will now focus on deploying our capital into income-producing
net leased real estate. Our new investment criteria will focus on single tenant
net lease investments with durable credits across a variety of industries in
markets across the United States. New investments initially will be funded from
existing financial resources. Subsequently, subject to market conditions, we
expect to seek to raise additional debt and/or equity capital to support further
growth. In the event we are not able to successfully secure financing, we will
rely primarily on cash on hand, cash flows from operations, principal, interest
and lease payments on our investments, management fees and proceeds from asset
and loan sales to satisfy our liquidity requirements. If we (i) are unable to
renew, replace or expand our sources of financing, (ii) are unable to execute
asset and loan sales in a timely manner or to receive anticipated proceeds from
them or (iii) fully utilize available cash, it may have an adverse effect on our
business, results of operations, and ability to make distributions to our
stockholders.
Substantially all of our loan and other investments and CMBS are pledged as collateral for our CDO bonds and the income generated from these investments is used to fund interest obligations of our CDO bonds and the remaining income, if any, is retained by us. Our CDO bonds contain minimum interest coverage and asset overcollateralization covenants that must be met in order for us to receive cash flow on the interests retained by us in the CDOs and to receive the subordinate collateral management fee earned. If we fail these covenants in some or all of the CDOs, all cash flows from the applicable CDO, other than senior collateral management fees, would be diverted to repay principal and interest on the most senior outstanding CDO bonds and we may not receive some or all residual payments or the subordinate collateral management fee until that CDO regained compliance with such tests. As of July 2012, the most recent distribution date, our 2006 CDO was in compliance with interest coverage and asset overcollateralization covenants, however the compliance margins were narrow and very small declines in collateral performance and credit metrics from one or more assets could cause the CDO to fall out of compliance. Our 2005 CDO failed its overcollateralization test at the July 2012 distribution date and previously failed its overcollateralization tests at the October 2011, April 2011 and January 2011 distribution dates. Our 2007 CDO failed its overcollateralization test beginning with the November 2009 distribution date and it is unlikely that the 2007 CDO's overcollateralization test will be satisfied in the foreseeable future. We cannot be certain that the CDO tests will continue to be satisfied and that we will continue to receive cash flows relating to our CDOs in the future, and believe that we will likely fail the overcollaterization test for the 2005 CDO and the 2006 CDO at the October 2012 distribution date. If the cash flow from our 2005 CDO and our 2006 CDO is redirected, our business, financial condition, and results of operations would be materially and adversely affected.
The chart below is a summary of our CDO compliance tests as of the most recent distribution dates (July 25, 2012 for our 2005 CDO and our 2006 CDO and May 19, 2012 for our 2007 CDO):
Cash Flow Triggers CDO 2005-1 CDO 2006-1 CDO 2007-1
Overcollateralization (1)
Current 109.02 % 105.25 % 83.13 %
Limit 117.85 % 105.15 % 102.05 %
Compliance margin -8.83 % 0.10 % -18.92 %
Pass/Fail Fail Pass Fail
Interest Coverage (2)
Current 332.82 % 627.79 % N/A
Limit 132.85 % 105.15 % N/A
Compliance margin 199.97 % 522.64 % N/A
Pass/Fail Pass Pass N/A
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(1) The overcollateralization ratio divides the total principal balance of all collateral in the CDO by the total bonds outstanding for the classes senior to those retained by us. To the extent an asset is considered a defaulted security, the asset's principal balance is multiplied by the asset's recovery rate which is determined by the rating agencies. For a defaulted security with a CUSIP that is actively traded, the lower of market value or the product of the security's principal balance multiplied by the asset's recovery rate, as determined by the rating agencies, is used for the overcollateralization ratio.
(2) The interest coverage ratio divides interest income by interest expense for the classes senior to those retained by us.
In the event of a breach of our CDO covenants that we could not cure in the near
term, we would be required to fund our non-CDO expenses, with (i) cash on hand,
(ii) cash distributions from any CDO not in default, if any, (iii) proceeds from
the Management Agreement for the KBS Portfolio, or (iv) income from our real
property and unencumbered loan assets, (v) sale of assets, or (vi) accessing the
equity or debt capital markets, if available.
The following discussion related to our Condensed Consolidated Financial Statements should be read in conjunction with our Condensed Consolidated Financial Statements appearing in Item 1 of this Quarterly Report on Form 10-Q.
Critical Accounting Policies
Our discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, known as GAAP. These accounting principles require us to make some complex and subjective decisions and assessments. Our most critical accounting policies involve decisions and assessments, which could significantly affect our reported assets, liabilities and contingencies, as well as our reported revenues and expenses. We believe that all of the decisions and assessments upon which our financial statements are based were reasonable at the time and made based upon information available to us at that time. We evaluate these decisions and assessments on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.
Refer to our 2011 Annual Report on Form 10-K for a discussion of our critical accounting policies, which include variable interest entities, or VIEs, real estate and CTL investments, leasehold interests, investments in joint ventures, assets held-for-sale, commercial mortgage-backed securities, tenant and other receivables, intangible assets, deferred costs, revenue recognition, reserve for loan losses, rent expense, stock-based compensation plans, derivative instruments and income taxes. There have been no changes to these policies in 2012.
Results of Operations
Comparison of the three months ended June 30, 2012 to the three months ended June 30, 2011
Revenues
2012 2011 Change
Interest income $ 36,225 $ 39,748 $ (3,523 )
Less: Interest expense 20,184 20,323 (139 )
Net interest income 16,041 19,425 (3,384 )
Management fees 9,616 - 9,616
Rental revenue 1,360 1,349 11
Operating expense reimbursements 353 326 27
Other income 1,498 18,901 (17,403 )
Total revenue $ 28,868 $ 40,001 $ (11,133 )
Equity in net income from joint venture $ 29 $ 31 $ (2 )
Gain on extinquishment of debt $ - $ 10,870 $ (10,870 )
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Interest income is generated on our whole loans, subordinate interests in whole loans, mezzanine loans, preferred equity interests and CMBS. For the three months ended June 30, 2012 and 2011, $26,228 and $26,129, respectively, were earned on fixed rate investments, while the remaining $9,997 and $13,619, respectively, were earned on floating rate investments. The decrease of $3,523 over the prior period is primarily due to a $6,476 decrease in interest income resulting from maturing loan investments and principal amortization, a $1,468 decrease due to the suspensions and reversals of interest income accruals and a $1,576 decrease due to the payoff or sale of CMBS investments. These decreases were partially offset by an increase of $6,251 in interest income from new CMBS and lending investments, and a $219 increase due to interest rate modifications on loans or changes in rates since June 2011.
Interest expense was $20,184 for the three months ended June 30, 2012 compared to $20,323 for the three months ended June 20, 2011. The decrease of $139 is primarily attributable to changes in LIBOR.
Management fees for the three months ended June 30, 2012 are $9,616. Management fees are comprised of property management, asset management and administration fees paid pursuant to the Management Agreement.
Rental revenue for the three months ended June 30, 2012 and 2011 of $1,360 and $1,349, respectively. The increase in rental revenue of $11 is primarily due to renewals and new leases on non-bank tenants.
Operating expense reimbursement was $353 for the three months ended June 30, 2012 and $326 for the three months ended June 30, 2011, an increase of $27. The increase is mainly due to increased direct billable operating expenses of $32.
Other income of $1,498 for the three months ended June 30, 2012 is primarily comprised of $1,230 of operating revenues from properties which we foreclosed or acquired a controlling interest. Other income of $18,901 for the three months ended June 30, 2011 is primarily composed of gains on the sale of CMBS investments totaling $17,389, revenues from properties we foreclosed on or acquired a controlling interest in since July 2010 of $1,053 and $83 of interest on restricted cash balances and other cash balances held by us.
The equity in net income of joint venture of $29 for the three months ended June 30, 2012 represents our proportionate share of the income generated by our joint venture interests including $67 of real estate-related depreciation and amortization, which when added back, results in a contribution to Funds from Operations, or FFO, of $96. The equity in net income of joint venture of $31 for the three months ended June 30, 2011 represents our proportionate share of income generated by our joint venture interests including $67 of real estate-related depreciation and amortization. There is also $737 net loss of joint venture classified as discontinued operations, including $1,029 of real estate-related depreciation and amortization. When depreciation and amortization are added back, it results in a contribution to FFO of $390 for the three months ended June 30, 2011. Our use of FFO as an important non-GAAP financial measure is discussed in more detail below.
During the three months ended June 30, 2012, there were no repurchases of notes issued by our three CDOs. During the three months ended June 30, 2011, we repurchased, at a discount $37,859 notes issued by our three CDOs, generating net gains on early extinguishment of debt of $10,870.
Expenses
2012 2011 Change
Property operating expenses $ 9,405 $ 4,858 $ 4,547
Net impairment recognized in earnings 16,006 6,037 9,969
Depreciation and amortization 312 292 20
Management, general and
administrative 11,928 7,181 4,747
Provision for loan loss 5,989 18,783 (12,794)
Provision for taxes 2,107 3 2,104
Total expenses $ 45,747 $ 37,154 $ 8,593
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Property operating expenses for the three months ended June 30, 2012 is primarily comprised of expenses incurred on our portfolio of properties owned by our Gramercy Realty division and the management of the KBS Portfolio. These expenses increased $4,547 from the $4,858 recorded in the three months ended June 30, 2011. The increase is primarily due to $4,640 of property management fees and reimbursable costs related to our asset management of properties . . .
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