iStar Annual Report 2002

Plain-text annual report

t r o p e R l a u n n A l a i c n a n i F r a t S i 2 0 0 2 2 0 0 2 i S t a r F i n a n c i a l A n n u a l R e p o r t 2 0 0 2 n y s e : s f i Directors –– (3) Jay Sugarman Chairman and Chief Executive Officer, iStar Financial Inc. (1) Willis Andersen, Jr. Principal, REIT Consulting Services (3) Jeffrey G. Dishner Senior Managing Director, Starwood Capital Group Andrew L. Farkas Chairman and Chief Executive Officer, Insignia Financial Group, Inc. (4) Madison F. Grose Senior Managing Director, Starwood Capital Group (4) Robert W. Holman, Jr. Chairman and Chief Executive Officer, National Warehouse Investment Company Merrick R. Kleeman Senior Managing Director, Starwood Capital Group (1) (2) Robin Josephs President, Ropasada, LLC H. Cabot Lodge III Executive Vice President – Investments, iStar Financial Inc. (1) (2) Matthew J. Lustig Managing Director, Lazard Frères Real Estate Investors, LLC William M. Matthes Managing Partner, Behrman Capital (2) (4) John G. McDonald Professor of Finance, Stanford University Graduate School of Business Stephen B. Oresman President, Saltash, Ltd. (2) (3) George R. Puskar Former Chairman, Lend Lease Real Estate Investments (3) Barry S. Sternlicht Chairman and Chief Executive Officer, Starwood Hotels and Resorts (1) (2) (3) (4) Audit Committee Compensation Committee Investment Committee Nominating and Governance Committee iStar is lighting up the real estate finance sector As we celebrate ten years in business and five as a public company, our future is brighter than ever. With a $6.6 billion enterprise value, iStar Financial has solidified its position as the leading finance company focused on the commercial real estate industry. Now more than ever, our customers recognize the high level of knowledge, service, flexibility and creativity with which we fulfill their unique financing requirements. Our performance for shareholders is also getting noticed: consistently delivered double-digit returns, even in difficult times, and one of the best credit track records in the finance industry. It is the kind of performance that is getting hard to keep quiet. Wow! ~ intro milestones iStar Financial annual report 2002 Officers –– Jay Sugarman Chairman and Chief Executive Officer Catherine D. Rice Chief Financial Officer Timothy J. O’Connor Executive Vice President and Chief Operating Officer Nina B. Matis Executive Vice President and General Counsel Spencer B. Haber President – iStar Strategic Capital Barbara Rubin President – iStar Asset Services Executive Vice Presidents –– Daniel S. Abrams Steven R. Blomquist Roger M. Cozzi Jeffrey R. Digel R. Michael Dorsch III Barclay G. Jones III H. Cabot Lodge III Michelle M. MacKay Diane Olmstead Andrew C. Richardson Senior Vice Presidents –– Jeffrey N. Brown Chase S. Curtis, Jr. Geoffrey M. Dugan John F. Kubicko Steven B. Sinnett Elizabeth B. Smith Colette J. Tretola Headquarters –– iStar Financial Inc. 1114 Avenue of the Americas New York, NY 10036 tel: (212) 930-9400 fax: (212) 930-9494 Super-Regional Offices –– One Embarcadero Center, 33rd Floor San Francisco, CA 94111 tel: (415) 391-4300 fax: (415) 391-6529 3480 Preston Ridge Road, Suite 575 Alpharetta, GA 30005 tel: (678) 297-0100 fax: (678) 297-0101 100 Great Meadow Road, Suite 603 Wethersfield, CT 06109 tel: (860) 258-2202 fax: (860) 258-2268 Regional Offices –– 175 Federal Street, 8th Floor Boston, MA 02110 tel: (617) 292-3333 fax: (617) 423-3322 304 Inverness Way South, Suite 195 Englewood, CO 80112 tel: (303) 790-4656 fax: (303) 790-4680 6565 North MacArthur Blvd., Suite 410 Irving, TX 75039 tel: (972) 506-3131 fax: (972) 501-0078 Employees –– At March 14, 2003, the Company had 143 employees. Independent Auditors –– PricewaterhouseCoopers LLP New York, NY Registrar and Transfer Agent –– EquiServe Trust Company, N.A. 525 Washington Boulevard Jersey City, NJ 07310 (800) 756-8200 Dividend Reinvestment Plan –– Registered shareholders may reinvest dividends through the Company’s dividend reinvestment plan. For more information, please call the Transfer Agent or the Company’s Headquarters. Annual Meeting of Shareholders –– June 3, 2003, 8:30 a.m. EST Sofitel Hotel 45 West 44th Street, New York, NY 10036 Investor Information Services –– For help with questions about the Company, and to receive additional corporate information, please contact: Investor Relations Department iStar Financial Inc. 1114 Avenue of the Americas New York, NY 10036 tel: (212) 930-9400 fax: (212) 930-9455 e-mail: investors@istarfinancial.com iStar Financial Web site –– http://www.istarfinancial.com 2002 page .1 We’ve grown to be the largest independent finance company in an attractive $100–$150 billion market niche of a $2+ trillion market For a decade, iStar Financial has focused exclusively on providing creative capital solutions to sophisticated private and corporate owners of high-quality real estate. During this period, we have completed over $7 billion of transactions. Our management team is known for its expertise in each of the key disciplines required to serve these high-end customers: investment negotiations, capital markets pricing, risk management, credit analysis and legal structuring. We compensate our people with long-term equity incentives tied directly to shareholder returns, not with short-term, volume-driven “quotas.” These people and our reputation for fairness and integrity are our most valuable assets. Leadership ~ 0.2 milestones iStar Financial annual report p i h s r e d a e l 2002 page .3 Our credit track record is unparalleled iStar Financial’s superior credit track record is the best in the finance industry. Since beginning our business in 1993, our loan losses and loans on non-accrual status have always been minimal. Our credit performance results from a proven and disciplined approach to investing capital and a pro-active risk management strategy. Our goal is to create a low volatility, high-quality income stream for shareholders with enough reserves in place to ensure our dividend is safe and secure under all market conditions. Safety ~ 0.4 milestones iStar Financial annual report Our investment approach focuses on capital preservation and risk mitigation. We underwrite our investments to zero-loss standards, and only invest capital in transactions that we believe will deliver excellent risk-adjusted returns to our shareholders. We bring a “principal” mentality to investing capital, and all of our senior management professionals have a significant portion of their net worths invested in the company’s equity. This disciplined approach has served us particularly well during the weaker economic and commercial real estate environment over the past two years, and has kept our asset quality strong. Our risk management strategy emphasizes frequent, ongoing dialogue with our customers and real-time information dissemination throughout the company that drives real-time risk mitigation strategies. During weekly company-wide meetings, we identify and address potential credit issues before they become problems, and we draw upon the wide range of in-house intellectual capital and real estate expertise, with on-staff loan servicers, asset managers, credit analysts, licensed engineers, architects and lawyers. This intensive, hands-on and multi-disciplined approach to risk management protects our capital even when assets underperform our initial expectations. y t e f a s 2002 page .5 Our broadly diversified asset base produces stable cash flow With over 120 diversified corporate credits operating in more than 38 industries, a majority of which are investment grade or have implied investment grade ratings, and over nine years of remaining term, our sale/leaseback business produces long-term, highly stable cash flow. This business is complemented by our lending product lines, which are backed by more than 500 underlying properties broadly diversified across property type, geography and borrower. With an average loan-to-value of 68% and actual 2002 debt service coverage of 2.2x, our loan businesses provide a safe, stable source of cash flow that complements our leasing business. Stability ~ 0.6 milestones iStar Financial annual report y t i l i b a t s 2002 page .7 We have positive momentum in our credit ratings During 2002, we received our first investment grade senior unsecured credit rating and were placed on “positive outlook” for a move to investment grade by the two other rating agencies. These moves follow upgrades by all three rating agencies in 2001. We are proud of our positive credit momentum, especially in the face of deteriorating economic conditions, and believe our progress is a testament to our asset quality and risk management discipline. Investment grade status from all three rating agencies will provide us with lower borrowing costs and allow us to redeploy resources to support increased business with our customers. Momentum ~ 0.8 milestones iStar Financial annual report m u t n e m o m 2002 page .9 We have generated solid growth We have consistently grown earnings and dividends every year since going public five years ago. Our customer franchise, scale and unique business model continue to provide us with a competitive advantage over commodity capital providers and multiple opportunities to generate asset, earnings and dividend growth in both “up” and “down” markets. The quality of our customer relationships is evident in the $3.1 billion of transactions completed with customers who have worked with us on more than one transaction, and provides us with an ongoing source of future business. Consistency ~ 0.10 milestones iStar Financial annual report y c n e t s i s n o c 2002 page .11 We have produced strong total rates of return for shareholders iStar Financial continues to build on its long-term track record of delivering strong risk- adjusted returns to its shareholders. In addition to growing earnings, we provide shareholders with an attractive current dividend, which is well supported by cash flow. Since going public, our total rate of return (dividends plus stock price appreciation) has averaged 28.7% annually, and we have increased quarterly dividends by 80.0%. Results ~ 0.12 milestones iStar Financial annual report In 2002, we delivered a 23.0% total rate of return to our shareholders, solidly beating other financial services companies and major market indices in a time of economic and geopolitical turbulence. Moreover, we delivered these strong returns while operating at a fraction of the leverage of most other financial services companies, averaging just 1.7x debt/tangible book equity during 2002. Over the past three years, from 2000 to 2002, when almost every sector of the financial markets has delivered subpar returns to shareholders, iStar Financial has generated average annual returns of over 30% per year, and over 125% in total shareholder returns for the period. s t l u s e r 2002 page .13 We see many opportunities ahead In our ten years in business and our five years as a public company, iStar Financial has emerged to become the leading provider of creative capital solutions to the commercial real estate industry. We have consistently delivered a premium service to our customers in exchange for a premium return, and have passed that premium on to our shareholders in the form of substantial dividends and stock price appreciation. This track record is under- scored by a highly disciplined approach to managing risk and preserving capital, enabling us to become one of the best capitalized companies in the sector. Most importantly, throughout our corporate development, we have preserved the core values of fairness and integrity that remain the hallmark of our company. Now we will begin taking advantage of those strengths to build a truly great company. Blossoming ~ 0.14 milestones iStar Financial annual report total enterprise value 2002 $6,600,000,000 2001 2000 $5,100,000,000 $4,200,000,000 1999 $3,700,000,000 i g n m o s s o l b 2002 page .15 ~ 0.16 proof ) s n o i l l i b n i $ ( 6 5 4 3 2 1 0 6 6 . 5 . 5 $ $ 4 . 4 $ 0 . 4 $ 8 . 3 $ 1 . 2 $ 98 99 00 01 02 ) s n o i l l i b n i $ ( 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1 1 . 3 . 3 $ $ 9 . 1 $ 5 . 1 $ 0 . 1 $ 8 . 0 $ 98 99 00 01 02 ~ Total Assets Total Assets ~ Cumulative Repeat Customer Business Cumulative Repeat Customer Business iStar Financial annual report ) s n o i l l i m n i $ ( 600 500 400 300 200 100 0 7 7 . 5 . 2 5 5 2 $ 5 $ 5 . 3 6 4 $ 1 . 1 7 4 $ 4 . 4 6 2 $ (1) 4 . 5 6 1 $ 98 99 00 01 02 3.0 ) $ ( 2.5 2.0 1.5 0.0 0 4 . 2 $ 5 4 . 2 $ 2 2 5 5 . 2 . $ 2 $ 6 8 . 1 $ (1) 2 5 . 1 $ 98 99 00 01 02 ~ Increasing Revenue Increasing Revenue ~ Increasing Dividends Increasing Dividends Increasing Dividends (1) Because second quarter 1998 was our first full quarter as a public company, 1998 represents revenue for the second quarter through the fourth quarter of 1998, annualized. (1) Because second quarter 1998 was our first full quarter as a public company, 1998 represents dividends for the second quarter through the fourth quarter of 1998, annualized. 2002 page .17 ~ 0.18 proof ) s n o i l l i b n i $ ( 8 7 6 5 4 3 2 1 0 3 3 . . 7 7 $ $ 5 . 5 $ 3 . 4 $ 3 . 3 $ 3 . 2 $ 98 99 00 01 02 ~ Cumulative Financing Transactions Cumulative Financing Transactions 20 ) t n e c r e p ( 15 10 5 0 (1) (2) (2) % % 4 4 . 8 . 1 8 1 % 7 . 7 1 % 8 . 5 1 % 7 . 4 1 (1) % 4 . 2 1 98 99 00 01 02 ~ Return on Average Equity Return on Average Equity Because second quarter 1998 was our first full quarter as a public company, 1998 represents return on average equity for the second quarter through the fourth quarter of 1998. Excludes a $15.0 million non-cash charge related to performance-based vesting of restricted shares granted under our long-term incentive plan. iStar Financial annual report l a i c n a n i F r a t S i 0 0 6 6 2 , 2 2 , $ 2 $ l a i c n a n i F 0 0 0 1 l l e s s u R x e d n I s e c i v r e S e g a r e v A l a i r t s u d n I s e n o J w o D 7 4 8 $ 0 5 8 $ x e d n I 0 0 0 5 e r i h s l i W 9 7 7 $ x e d n I 0 0 5 P & S 9 7 7 $ Q A D S A N 8 8 6 $ 1,500 ) $ ( 1,000 500 0 l a i c n a n i F r a t S i 0 0 3 3 2 , 2 1 $ , 1 $ 2,500 ) $ ( 2,000 1,500 1,000 500 0 x e d n I 0 0 0 5 e r i h s l i W 1 0 6 $ x e d n I 0 0 5 P & S 1 2 6 $ Q A D S A N 4 3 3 $ e g a r e v A l a i r t s u d n I s e n o J w o D 2 6 7 $ l a i c n a n i F 0 0 0 1 l l e s s u R x e d n I s e c i v r e S 5 1 9 $ ~ Value as of 12/31/02 of $1,000 invested at 12/31/01 Value as of 12/31/02 of $1,000 invested at 12/31/01 ~ Value as of 12/31/02 of $1,000 invested at 12/31/99 Value as of 12/31/02 of $1,000 invested at 12/31/99 2002 page .19 ~ 0.20 proof Portfolio Finance Customer: Southwest Value Partners Financing Product: Senior, expandable floating-rate mortgage and junior participating, fixed-rate mortgage financing Collateral: 1.1 million square foot downtown office portfolio and 436 room, four-star hotel located in San Diego, CA Investment Size: $132.8 million Southwest Value Partners was one of the first opportunistic investors to target the recovering San Diego central business district. Having assembled a dominant position in the market, SVP began actively negotiating various loan and joint venture structures with three of the leading private investment funds in the country. Recognizing the opportunity to provide a superior financial solution for the partners, iStar Financial made an unsolicited offer to provide a creative three-part financing, allowing the partners to not only capture much of the upside on a tax-deferred basis, but also to lock-up future tenant improvement capital for improving property cash flow. Using iStar Financial’s flexible structure and signing two of the largest leases in San Diego history, Southwest Value Partners has significantly increased portfolio cash flow and enhanced returns for its partners. Case Studies iStar Financial annual report iStar Financial annual report Corporate Tenant Leasing Customer: Northrop Grumman Corporation (NYSE: NOC) / West Group Financing Product: Credit tenant lease Collateral: 574,588 square foot Class A+ office facility located in Tyson’s Corner, MacLean, VA Investment Size: $143.6 million The facility is the corporate headquarters for Northrop Grumman’s IT Division. Northrop Grumman has a multi-billion dollar market capitalization and is a leading U.S. defense contractor, with a highly diversified base of contracts including the largest shipbuilding program in the U.S. When the owner of the facility sought to monetize its investment, iStar Financial developed an innovative purchase structure that helped the seller to bridge competing objectives among the seller’s partners, while also restructuring the Northrop lease to create a more stable and more valuable income stream. The end result for iStar was a long-term investment supported by an investment grade corporate tenant on a newly- constructed office facility. 2002 2002 page .21 page .21 ~ 0.22 proof Corporate Finance Customer: The Mills Corporation (NYSE: MLS) Financing Product: Term preferred equity investment Collateral: Diversified portfolio of 14 super-regional malls located in major metropolitan markets throughout the U.S. Investment Size: $76.5 million Mills, a leading developer of malls in the U.S., was in the process of seeking a sizable corporate financing commitment to accelerate its corporate growth strategy. iStar Financial worked closely with Mills to understand its complicated organization structure and capital needs, then committed to the entire transaction using a customized funding structure that allowed Mills flexible funding timing to meet its requirements while providing significant protection to iStar. By working with iStar Financial, Mills was able to quickly strengthen its capital structure, more efficiently finance its development pipeline and meet its cash flow objectives. Since iStar’s investment, Mills has consistently increased earnings and cash flow and generated significant returns for its shareholders. Case Studies iStar Financial annual report iStar Financial annual report Structured Finance Customer: Washington Center / Quadrangle Development Corporation Financing Product: Senior and junior fixed-rate second mortgage financing Collateral: 352,566 square foot downtown office building and a connected 889 room Grand Hyatt hotel located in Washington, D.C. Investment Size: $48.7 million Quadrangle developed and owned the premier mixed-use property located in the East End sub-market of Washington D.C. With more than 10 banks involved in its original capital structure, the owner sought refinancing alternatives with a capital provider that could provide all its capital needs and meet its unique structuring needs. iStar Financial quickly committed to provide the junior portion of the financing and helped place a senior mortgage with a life company lender that iStar helped to understand the project. As a result of the simplified capital structure, the owner was able to focus on the operations of the project, substantially increasing both cash flow and value over time. 2002 2002 page .23 page .23 Dear Shareholders, ~ 0.24 chairman’s letter iStar Financial annual report I am pleased to report that 2002 was another very strong As we have always said, there is a very large difference year for iStar Financial and its shareholders. Our success this past year between companies focused on the equity side of the commercial real capped a three-year period in which our company has grown into the estate markets and iStar’s focus on the lower-risk financing side of leading player in the high-end commercial real estate finance market- the market – our portfolio is built to perform even when more equity- place, capturing market share, extending customer relationships and oriented companies are seeing falling earnings and difficult market building on our reputation for delivering capital tailored specifically to conditions. Our strong and growing dividend is built on a foundation the individual needs of our customers. of both well-structured loans on high quality property around the During 2002, we also continued to deliver exceptional results country and long-term corporate tenant lease transactions with a for our shareholders, generating a total shareholder rate of return in wide range of mostly credit-rated companies. The safety and stability excess of 20% for the third consecutive year and outperforming major of these complementary portfolios will continue to enable us to stock market averages by over 30% for the third consecutive year. deliver strong current returns on our capital and strong dividend These superior returns are the direct result of a highly refined business returns to our shareholders. strategy, a top-notch team of highly motivated employees and a recog- So what’s next? As we expand the reach of our business, we nized ability to stay ahead of the curve in each of the three markets on have set out some very concrete goals for the future. First, we will seek which we focus – the real estate finance markets, the capital markets to raise our dividend 5% per year while maintaining our dividend pay- and the corporate finance markets. out ratio as a percentage of earnings at no more than 80% on an annual Despite very challenging market conditions for our cus- basis. Second, we will grow our assets and our customer relationships tomers in both the corporate world and in the real estate world, iStar by moving swiftly to capture the best market opportunities as they was able to complete over $1.8 billion in new investments this past become available. Third, we will seek to expand our management team year, a new record for the company and a strong indicator of our abil- to include the highest caliber people we can find in order to continue ity to take advantage of market turmoil and turn it to our advantage. delivering superior service to our customer base. Fourth, we will con- In times like these, our customers depend on our ability to provide tinue to try to find places in the capital markets that are not well served capital to them in a creative, timely and experienced manner, and our and to identify attractive areas to provide capital on a non-competitive growing proportion of repeat customers suggests we are meeting their basis. And fifth, we will work to help the market understand that the needs and earning their trust. strength and safety of our income stream and business model deserve The growing strength of our business is also apparent in the a far higher valuation than our current share price suggests. growing strength of our financial results. We finished 2002 with over $5 billion in assets, over $2 billion in tangible equity capital, and We expect that our success, our shareholders’ success, and among commercial finance companies, one of the lowest leverage perhaps this annual report, will help draw attention to our company ratios and one of the best credit track records, with no non-performing and enable us to continue demonstrating that, at iStar, doing things the assets at year-end. Our total revenue grew to $526 million, another right way has always been the right thing to do. record for our company and our return on equity reached 18.4%, also a record. Our loss ratios remain the best in the industry and we continue I, and all our employees, thank you for your support. to be pleased by our portfolio even as many markets continue to strug- gle. Those strengths were recognized by the rating agencies this past year as all three raised iStar’s credit ratings, with Fitch moving iStar to investment grade by giving us the only upgrade in their entire com- mercial finance and leasing sector. Jay Sugarman Chairman and Chief Executive Officer 2002 page .25 iStar Financial annual report 28 30 39 41 42 43 44 45 46 64 2002 selected ﬁnancial data management’s discussion and analysis of ﬁnancial condition quantitative and qualitative disclosures about market risk report of independent accountants consolidated balance sheets consolidated statements of operations consolidated statements of cash ﬂows consolidated statements of changes in shareholders’ equity notes to consolidated ﬁnancial statements common stock price and dividends Financial Report ~ 0.27 ﬁnancials selected ﬁnancial data The following table sets forth selected ﬁnancial data on a consolidated historical basis for iStar Financial Inc. (“the Company”). However, prior to March 1998, the Company’s structured ﬁnance opera- tions were conducted by two private investment partnerships which contributed substantially all their structured finance assets to the Company in exchange for cash and shares of the Company. Further, on November 4, 1999, the Company acquired TriNet Corporate Realty Trust, Inc. (“TriNet”), which increased the size of the Company’s operations, and also acquired its former external advisor. Operating results for the year ended December 31, 1999 reﬂect only the effects of these transactions subsequent to their consummation. Accordingly, the historical balance sheet information as of December 31, 1998, as well as the results of operations for the Company for all periods prior to and including the year ended December 31, 1999, do not reﬂect the current operations of the Company as a well capitalized, internally-managed ﬁnance company operating in the com- mercial real estate industry. For these reasons, the Company believes that the information should be read in conjunction with the discus- sions set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Certain prior year amounts have been reclassiﬁed to conform to the 2002 presentation. For the Year Ended December 31, Operating Data: Interest income Operating lease income Other income Total revenue Interest expense Operating costs – corporate tenant lease assets Depreciation and amortization General and administrative General and administrative – stock-based compensation Provision for loan losses Advisory fees Costs incurred in acquiring former external advisor(1) Total costs and expenses Income before equity in earnings from joint ventures and unconsolidated subsidiaries, minority interest and other items Equity in earnings from joint ventures and unconsolidated subsidiaries Minority interest in consolidated entities Extraordinary loss on early extinguishment of debt Cumulative effect of change in accounting principle(2) Net income before discontinued operations Income from discontinued operations Gain from discontinued operations Net income Preferred dividend requirements Net income allocable to common shareholders Basic earnings per common share(3) Diluted earnings per common share Dividends declared per common share(4) Supplemental Data: Adjusted earnings allocable to common shareholders(5)(7) EBITDA(6)(7) Ratio of EBITDA to interest expense(8) Ratio of EBITDA to combined ﬁxed charges(9) Ratio of earnings to ﬁxed charges(10) Ratio of earnings to ﬁxed charges and preferred stock dividends(10) Weighted average common shares outstanding – basic(11) Weighted average common shares outstanding – diluted(11) Cash ﬂows from: Operating activities Investing activities Financing activities Balance Sheet Data: Loans and other lending investments, net Corporate tenant lease assets, net Total assets Debt obligations Minority interest in consolidated entities Shareholders’ equity Supplemental Data: Total debt to shareholders’ equity 2002 2001 2000 1999 1998 (In thousands, except per share data and ratios) $ 255,631 242,100 27,993 525,724 185,375 13,755 47,821 30,449 17,998 8,250 – – 303,648 222,076 1,222 (162) (12,166) – 210,970 3,583 717 $ 215,270 (36,908) $ 178,362 1.98 $ 1.93 $ 2.52 $ $ 281,686 $ 471,444 2.54x 2.12x 2.25x 1.88x 89,886 92,649 $ 254,119 185,943 31,057 471,119 169,974 12,782 35,411 24,151 3,574 7,000 – – 252,892 218,227 7,361 (218) (1,620) (282) 223,468 5,299 1,145 $ 229,912 (36,908) $ 193,004 2.24 $ 2.19 $ 2.45 $ $ 255,132 $ 430,973 2.54x 2.08x 2.34x 1.93x 86,349 88,234 $ 268,011 177,581 17,927 463,519 173,741 12,737 34,384 25,706 2,864 6,500 – – 255,932 207,587 4,796 (195) (705) – 211,483 3,155 2,948 $ 217,586 (36,908) $ 180,678 2.11 $ 2.10 $ 2.40 $ $ 230,688 $ 420,508 2.42x 2.00x 2.25x 1.86x 85,441 86,151 $ 209,848 41,665 12,900 264,413 91,159 2,245 10,324 6,269 412 4,750 16,193 94,476 225,828 38,585 235 (41) – – 38,779 107 – 38,886 (23,843) 15,043 0.25 0.25 1.86 $ $ $ $ $ $ 112,914 12,378 2,708 128,000 44,697 _ 4,287 2,583 5,985 2,750 7,837 – 68,139 59,861 96 (54) – – 59,903 _ – 59,903 (944) 58,959 1.40 1.36 1.14 $ $ $ $ $ $ 127,798 $ 234,779 2.58x 2.04x 1.43x 1.13x 57,749 60,393 65,949 $ $ 116,778 2.61x 1.70x 2.33x 2.28x 41,607 43,460 $ 348,793 (1,149,070) 800,541 $ 293,260 (349,525) 49,183 $ 219,868 (193,805) (37,719) $ 119,625 (143,911) 48,584 54,915 $ (1,271,309) 1,226,208 $ 3,050,342 2,291,805 5,611,697 3,461,590 2,581 2,025,300 $2,377,763 1,781,565 4,380,640 2,495,369 2,650 1,787,778 $2,227,083 1,592,087 4,034,775 2,131,967 6,224 1,787,885 $2,003,506 1,654,300 3,813,552 1,901,204 2,565 1,801,343 $ 1,823,761 189,942 2,059,616 1,055,719 – 970,728 1.7x 1.4x 1.2x 1.1x 1.1x iStar Financial annual report Explanatory Notes: (1) (2) (3) (4) (5) This amount represents a non-recurring, non-cash charge of approximately $94.5 million relating to the acquisition of the Company’s formal external advisor in November 1999. Represents one-time effect of adoption of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” as of January 1, 2001. Prior to November 1999, earnings per common share excludes 1.00% of net income allocable to the Company’s former class B shares. The former class B shares were exchanged for Common Stock in connection with the acquisition of TriNet and other related transactions on November 4, 1999. As a result, the Company now has a single class of Common Stock outstanding. The Company generally declares common and preferred dividends in the month subsequent to the end of the quarter. Adjusted earnings represents net income to common shareholders computed in accordance with GAAP, before depreciation, amortization, gain (loss) from discontinued operations, extraordinary items and cumulative effect of change in accounting principle. For the year ended December 31, 2002, adjusted earnings excludes the $15.0 million non-cash charge related to the performance based vesting of restricted shares granted under the Company’s long-term incentive plan. For the year ended December 31, 1999, adjusted earnings excludes the non- recurring, non-cash cost incurred in acquiring the Company’s former external advisor. (See reconciliation in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”). (6) EBITDA is calculated as total revenue plus equity in earnings from joint ventures and unconsolidated subsidiaries minus the sum of general and administrative expenses, general and administrative – stock-based compensation (excluding the non-cash charge related to the performance based vesting of restricted shares granted under the Company’s long-term incentive plan for the year ended December 31, 2002), provision for loan losses, operating costs on corporate tenant lease assets and advisory fees. For the Year Ended December 31, Total Revenue Plus: Equity in earnings from joint ventures and unconsolidated subsidiaries Less: General and administrative Less: General and administrative – stock-based compensation Less: Provision for loan losses Less: Operating costs – corporate tenant lease assets Less: Advisory fees EBITDA 2002 2001 2000 1999 1998 (In thousands) $525,724 $471,119 $463,519 $264,413 $128,000 1,222 (30,449) (3,048) (8,250) (13,755) – 7,361 (24,151) (3,574) (7,000) 4,796 (25,706) (2,864) (6,500) (12,782) (12,737) 235 (6,269) (412) (4,750) (2,245) – – (16,193) 96 (2,583) (5,985) (2,750) – – $471,444 $430,973 $420,508 $234,779 $116,778 (7) Each of adjusted earnings and EBITDA should be examined in conjunction with net income as shown in the Consolidated Statements of Operations. Neither adjusted earnings nor EBITDA should be considered as an alternative to net income (determined in accordance with GAAP) as an indicator of the Company’s performance, or to cash ﬂows from operating activities (determined in accordance with GAAP) as a measure of the Company’s liquidity, nor is either measure indicative of funds available to fund the Company’s cash needs or available for distribution to shareholders. The Company’s management believes that adjusted earnings and EBITDA more closely approximate operating cash ﬂow and are useful measures for investors to consider, in conjunction with net income and other GAAP measures, in evaluating the commercial ﬁnance company that focuses on real estate lending and corporate tenant leasing; therefore, the Company’s net income (determined in accordance with GAAP) reﬂects signiﬁcant non-cash depreciation expense on corporate tenant lease assets. It should be noted that the Company’s manner of calculating adjusted earnings and EBITDA may differ from the calculations of similarly-titled measures by other companies. The 1999 and 1998 EBITDA to interest expense ratios on a pro forma basis would have been 2.83x and 2.84x, respectively. Combined ﬁxed charges are comprised of interest expense, capitalized interest, amortization of loan costs and preferred stock dividend requirements. The 1999 and 1998 EBITDA to combined ﬁxed charges ratios on a pro forma basis would have been 2.23x and 2.44x, respectively. For the purposes of calculating the ratio of earnings to ﬁxed charges, “earnings” consist of income from continuing operations before income taxes and cumulative effect of changes in accounting principles plus “ﬁxed charges” and certain other adjustments. “Fixed charges” consist of interest incurred on all indebtedness related to continuing operations (including amortization of original issue discount) and the implied interest component of the Company’s rent obligations in the years presented. For 1999, these ratios include the effect of a non- recurring, non-cash charge in the amount of approximately $94.5 million relating to the November 1999 acquisition of the former external advisor to the Company. Excluding the effect of this non-recurring, non-cash charge, the ratio of earnings to ﬁxed charges for that period would have been 2.5x and the Company’s ratio of earnings to ﬁxed charges and preferred stock dividends would have been 2.0x. As adjusted for one-for-six reverse stock split effected by the Company on June 19, 1998. (8) (9) (10) (11) ~ 2002 page .29 management’s discussion and analysis of ﬁnancial condition and results of operations General The Company began its business in 1993 through private investment funds formed to take advantage of the lack of well-capitalized lenders capable of servicing the needs of high-end customers in its markets. In March 1998, the private investment funds contributed their approximately $1.1 billion of assets to the Company’s predecessor in exchange for a controlling interest in that public company. In November 1999, the Company acquired its leasing subsidiary, TriNet Corporate Realty Trust, Inc. (“TriNet” or the “Leasing Subsidiary”), which was then the largest publicly-traded company specializing in cor- porate sale/leaseback for ofﬁce and industrial facilities (the “TriNet Acquisition”). Concurrent with the TriNet Acquisition, the Company also acquired its former external advisor in exchange for shares of its Common Stock and converted its organizational form to a Maryland corporation. The Company’s Common Stock began trading on the New York Stock Exchange under the symbol “SFI” in November 1999. Results of Operations Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Interest income – Interest income increased by $1.5 million to $255.6 million for the 12 months ended December 31, 2002 from $254.1 million for the same period in 2001. This increase was primarily due to $72.5 million of interest income on new originations or addi- tional fundings, net of a $50.5 million decrease from the repayment of loans and other lending investments. This increase was partially offset by a decrease in interest income on the Company’s variable-rate lend- ing investments as the result of lower average one-month LIBOR rates of 1.77% in 2002, compared to 3.88% in 2001. Operating lease income – Operating lease income increased by $56.2 million to $242.1 million for the 12 months ended December 31, 2002 from $185.9 million for the same period in 2001. Of this increase, $59.5 million was attributable to new corporate tenant lease invest- ments. This increase was partially offset by corporate tenant lease dis- positions and lower operating lease income on certain corporate tenant lease assets. Other income – Other income generally consists of prepayment penalties and realized gains from the early repayment of loans and other lending investments, ﬁnancial advisory and asset management fees, lease termination fees, mortgage servicing fees, loan participation payments and dividends on certain investments. During the 12 months ended December 31, 2002, other income included prepayment penal- ties and realized gains on loan repayments of $12.6 million, asset man- agement, mortgage servicing and other fees of approximately $9.0 million, lease termination fees of $2.9 million, loan participation payments of $3.3 million, and other miscellaneous income such as divi- dend payments and insurance claims of $994,000. During the 12 months ended December 30, 2001, other income included loan participation payments of $13.1 million, prepay- ment penalties and gains on loan repayments of $13.0 million and ﬁnancial advisory, lease termination, asset management and mortgage servicing fees of $5.3 million. Interest expense – For the 12 months ended December 31, 2002, interest expense increased by $15.4 million to $185.4 million from $170.0 million for the same period in 2001. This increase was primarily due to the higher average borrowings on the Company’s debt obliga- tions, term loans and secured notes, and by approximately $2.7 million due to additional amortization of deferred financing costs on the Company’s debt obligations in 2002 compared to the same period in 2001. This increase was partially offset by lower average one-month LIBOR rates on the Company’s variable-rate debt of 1.77% in 2002, compared to 3.88% in 2001. Operating costs – corporate tenant lease assets – For the 12 months ended December 31, 2002, operating costs increased by $1.0 million from $12.8 million to $13.8 million for the same period in 2001. This increase is primarily related to new corporate tenant lease investments and higher operating costs on certain corporate tenant lease assets, par- tially offset by corporate tenant lease dispositions. Depreciation and amortization – Depreciation and amortization increased by $12.4 million to $47.8 million for the 12 months ended December 31, 2002 from $35.4 million for the same period in 2001. This increase is primarily due to new corporate tenant lease investments. General and administrative – For the 12 months ended December 31, 2002, general and administrative expenses increased by $6.2 million to $30.4 million, compared to $24.2 million for the same period in 2001. This increase is primarily the result of an increase in personnel and related costs. General and administrative – stock-based compensation – General and administrative-stock-based compensation increased by $14.4 million primarily due to a non-cash charge related to the performance-based vesting of 500,000 restricted shares granted under the Company’s long- term incentive plan and tied to overall shareholder performance (see Note 10 to the Company’s Consolidated Financial Statements). Provision for loan losses – The Company’s charge for provision for loan losses increased to $8.3 million for the 12 months ended December 31, 2002 as compared to $7.0 million for the same period in 2001. As more fully discussed in Note 4 to the Company’s Consolidated Financial Statements, the Company has experienced minimal actual losses on its loan investments to date. The Company considers it pru- dent to reﬂect provisions for loan losses on a portfolio basis based upon the Company’s assessment of general market conditions, the Company’s internal risk management policies and credit risk rating system, industry loss experience, the Company’s assessment of the like- lihood of delinquencies or defaults, and the value of the collateral underlying its investments. Accordingly, since its ﬁrst full quarter oper- ating its current business as a public company (the quarter ended June 30, 1998), management has reﬂected quarterly provisions for loan losses in its operating results. Equity in earnings from joint ventures and unconsolidated subsidiaries – During the 12 months ended December 31, 2002, equity in earnings from joint ventures and unconsolidated subsidiaries decreased by approximately $6.2 million to $1.2 million from $7.4 million for the same period in 2001. This decrease is primarily due to the consolidation of one of the Company’s corporate tenant lease joint venture investments (see Note 6 to the Company’s Consolidated Financial Statements). Income from discontinued operations – For the 12-month periods ended December 31, 2002 and 2001, operating income earned by the Company on corporate tenant lease assets sold (prior to their sale) and assets held for sale of approximately $3.6 million and $5.3 million, respectively, is classiﬁed as “Income from discontinued operations,” even though such income was earned by the Company prior to the assets’ disposition or classiﬁcation as “Assets held for sale.” Gain from discontinued operations – During 2002, the Company disposed of one corporate tenant lease asset for total proceeds of $3.7 million and recognized a gain of approximately $595,000. In addi- tion, one of the Company’s customers exercised an option to terminate its lease on 50.00% of the land leased from the Company. In connection with this termination, the Company realized $17.5 million in cash lease termination payments, offset by a $17.4 million impairment change in connection with the termination, resulting in a net gain of approxi- mately $123,000. During 2001, the Company disposed of four corporate tenant lease assets for total proceeds of $26.3 million and recognized net gains of $1.1 million. Extraordinary loss on early extinguishment of debt – During the 12 months ended December 31, 2002, the Company fully repaid the then remaining $446.2 million of bonds outstanding under its STARs iStar Financial annual report Series 2000-1 ﬁnancing. This prepayment resulted in an extraordinary loss of $12.2 million, which represented approximately $8.2 million in unamortized deferred ﬁnancing costs and approximately $4.0 million in prepayment penalties. During the 12 months ended December 31, 2001, the Company repaid a secured term loan, which had an original maturity date of December 2004. In addition, the Company prepaid an unse- cured revolving credit facility, which had an original maturity date of May 2002. In connection with these prepayments, the Company expensed the remaining unamortized deferred ﬁnancing costs and incurred certain prepayment penalties, which resulted in an extraordi- nary loss of approximately $1.6 million. Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 Interest income – Interest income decreased by $13.9 million to $254.1 million for the 12 months ended December 31, 2001 from $268.0 million for the same period in 2000. Approximately $12.7 mil- lion of this decrease is the result of lower average LIBOR rates on the Company’s variable-rate lending investments of 3.88% in 2001, com- pared to 6.41% in 2000. This decrease was partially offset by $55.1 mil- lion of interest income on new originations or additional fundings, net of $51.6 million from the repayment of loans and other lending invest- ments, in addition to a decrease of $1.5 million from income earned on cash and cash equivalents. Operating lease income – Operating lease income increased by $8.3 million to $185.9 million for the 12 months ended December 31, 2001 from $177.6 million for the same period in 2000. Of this increase, $11.8 million was attributable to new corporate tenant lease invest- ments. This increase was partially offset by corporate tenant lease dis- positions and lower operating lease income on certain corporate tenant lease assets. Other income – Other income consists primarily of prepayment penalties and gains from the early repayment of loans and other lend- ing investments, ﬁnancial advisory and asset management fees, lease termination fees, mortgage servicing fees, loan participation payments and dividends on certain investments. During the year ended December 31, 2001, other income included loan participation payments of $13.1 million, prepayment penalties and gains on loan repayments of $13.0 million and ﬁnancial advisory, lease termination, asset man- agement and mortgage servicing fees of $5.3 million. During the year ended December 31, 2000, other income included prepayment penalties and gains on loan repayments of $10.5 million, $2.1 million in connection with a loan defeasance, loan participation payments of $1.9 million, ﬁnancial advisory, asset man- agement and mortgage servicing fees of $2.6 million and lease termina- tion fees of $770,000. Interest expense – For the 12 months ended December 31, 2001, interest expense decreased by $3.7 million to $170.0 million from $173.7 million for the same period in 2000. This decrease was primarily due to the lower average LIBOR rates on the Company’s variable-rate debt of 3.88% in 2001, compared to 6.41% in 2000. This decrease was partially offset by the higher average borrowings on the Company’s credit facilities, term loans and unsecured notes and $7.6 million addi- tional amortization of deferred ﬁnancing costs on the Company’s debt obligations in 2001 compared to 2000. Operating costs – corporate tenant lease assets – For the 12 months ended December 31, 2001, operating costs were substantially unchanged as compared to the same period in 2000. Such operating costs represent unreimbursed operating expenses associated with cor- porate tenant lease assets. Depreciation and amortization – Depreciation and amortization increased by $1.0 million to $35.4 million for the 12 months ended December 31, 2001 from $34.4 million for the same period in 2000. This increase is due to new corporate tenant lease investments and additional facility improvements, partially offset by corporate tenant lease dispositions in 2000. General and administrative – For the 12 months ended December 31, 2001, general and administrative expenses decreased by $1.5 million to $24.2 million, compared to $25.7 million for the same period in 2000. This decrease is primarily the result of a reduction in ofﬁce and related costs and professional fees, partially offset by an increase in personnel and related costs. General and administrative – stock-based compensation expense – General and administrative – stock-based compensation expense increased by approximately $710,000 as a result of charges relating to grants of stock options and restricted shares. Provision for loan losses – The Company’s charge for provision for loan losses increased to $7.0 million for the 12 months ended December 31, 2001 from $6.5 million for the same period in 2000 as a result of the continued expansion of the Company’s lending operations as well as additional seasoning of its existing lending portfolio. As more fully discussed in Note 4 to the Company’s Consolidated Financial Statements, the Company has experienced minimal actual losses on its loan investments to date. The Company considers it prudent to reﬂect provisions for loan losses on a portfolio basis based upon the Company’s assessment of general market conditions, the Company’s internal risk management policies and credit risk rating system, indus- try loss experience, the Company’s assessment of the likelihood of delinquencies or defaults, and the values of the collateral underlying its investments. Accordingly, since its ﬁrst full quarter operating its cur- rent business as a public company (the quarter ended June 30, 1998), management has reﬂected quarterly provisions for loan losses in its operating results. Equity in earnings from joint ventures and unconsolidated subsidiaries – During the 12 months ended December 31, 2001, equity in earnings from joint ventures and unconsolidated subsidiaries increased by approximately $2.6 million to $7.4 million from $4.8 million for the same period in 2001. This increase is primarily due to new leases com- mencing in 2001, in addition to a lease termination payment received at one of the joint ventures (see Note 6 to the Company’s Consolidated Financial Statements). Income from discontinued operations – For the 12-month periods ended December 31, 2001 and 2000, operating income earned by the Company on corporate tenant lease assets sold (prior to their sale) and assets held for sale of approximately $5.3 million and $3.2 million, respectively, is classiﬁed as “Income from discontinued operations,” even though such income was earned by the Company prior to the assets’ disposition or classiﬁcation as “Assets held for sale.” Gain from discontinued operations – During 2001, the Company disposed of four corporate tenant lease assets for total proceeds of $26.3 million and recognized net gains of $1.1 million. During 2000, the Company disposed of 14 corporate tenant lease assets, including six assets held in joint venture partnerships, for total proceeds of $256.7 million, and recognized net gains of $2.9 million. Extraordinary loss on early extinguishment of debt – During the 12 months ended December 31, 2001 and 2000, the Company or its joint ventures prepaid debt obligations of $133.0 million and $24.5 mil- lion, respectively. These transactions resulted in an extraordinary loss on early extinguishment of debt from prepayment penalties and the expense associated with remaining unamortized deferred ﬁnancing costs in the amount of $1.6 million and $705,000 for the 12 months ended December 31, 2001 and 2000, respectively. Adjusted Earnings Adjusted earnings represents net income to common share- holders computed in accordance with GAAP, before depreciation, amor- tization, gain (loss) from discontinued operations, extraordinary items and cumulative effect of change in accounting principle. Adjustments for unconsolidated partnerships and joint ventures reflect the Company’s share of adjusted earnings calculated on the same basis. The Company believes that to facilitate a clear understanding of the historical operating results of the Company, adjusted earnings 2002 page .31 should be examined in conjunction with net income as shown in the Company’s Consolidated Statements of Operations. Adjusted earnings should not be considered as an alternative to net income (determined in accordance with GAAP) as an indicator of the Company’s perform- ance, or to cash ﬂows from operating activities (determined in accor- dance with GAAP) as a measure of the Company’s liquidity, nor is it indicative of funds available to fund the Company’s cash needs or avail- able for distribution to the Company’s shareholders. The Company’s management believes that adjusted earnings more closely approxi- mates operating cash ﬂow and is a useful measure for investors to consider, in conjunction with net income and other GAAP measures, in evaluating the Company’s financial performance. This is primarily because the Company is a commercial ﬁnance company that focuses on real estate lending and corporate tenant leasing; therefore, the Company’s net income (determined in accordance with GAAP) reﬂects signiﬁcant non-cash depreciation expense on corporate tenant lease assets. It should be noted that the Company’s manner of calculating adjusted earnings may differ from the calculation of similarly-titled measures by other companies. For the Year Ended December 31, 2002 2001 2000 1999 1998 Adjusted earnings: Net income allocable to common shareholders Add: Joint venture income Add: Depreciation Add: Joint venture depreciation and amortization Add: Amortization of deferred ﬁnancing costs Less: Gains from discontinued operations Add: Extraordinary loss – early extinguishment of debt Add: Cumulative effect of change in accounting principle(1) Less: Net income allocable to class B shares(2) Add: Cost incurred in acquiring former external advisor Adjusted diluted earnings allocable to common shareholders: Before non-cash incentive compensation charge(3) After non-cash incentive compensation charge Weighted average diluted common shares outstanding Explanatory Notes: (In thousands) (Unaudited) $180,678 937 34,514 3,662 13,140 (2,948) 705 – – – $15,043 1,603 11,016 365 6,121 – – – (826) 94,476 $178,362 991 48,041 4,433 23,460 (717) 12,166 – – – $193,004 965 35,642 4,044 20,720 (1,145) 1,620 282 – – $281,686 $266,736 93,020 $255,132 $255,132 88,606 $230,688 $230,688 86,523 $127,798 $127,798 61,750 $58,959 _ 4,302 _ 3,354 – – – (666) – $65,949 $65,949 43,460 Represents one-time effect of adoption of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” as of January 1, 2001. Prior to November 1999, adjusted earnings per common share excludes 1.00% of net income allocable to the Company’s former class B shares. The former class B shares were exchanged for Common Stock in connection with the acquisition of TriNet and other related transactions on November 4, 1999. As a result, the Company now has a single class of Common Stock outstanding. Excludes a $15.0 million non-cash charge related to performance-based vesting of restricted shares granted under the Company’s long-term incentive plan for the 12 months ended December 31, 2002. (1) (2) (3) ~ Risk Management First Dollar and Last Dollar Exposure – One component of the Company’s risk management assessment is an analysis of the Company’s first and last dollar loan-to-value percentage with respect to the proper- ties or companies the Company ﬁnances. First dollar loan-to-value rep- resents the average beginning point for the Company’s lending exposure in the aggregate capitalization of the underlying properties or companies it ﬁnances. Last dollar loan-to-value represents the average ending point for the Company’s lending exposure in the aggregate cap- italization of the underlying properties or companies it ﬁnances. Non-Accrual Loans – The Company transfers loans to non- accrual status at such time as: (1) management believes that the poten- tial risk exists that scheduled debt service payments will not be met within the coming 12 months; (2) the loans become 90 days delin- quent; (3) management determines the borrower is incapable of, or ceased efforts toward, curing the cause of an impairment; or (4) the net realizable value of the loan’s underlying collateral approximates the Company’s carrying value of such loan. Interest income is recognized only upon actual cash receipt for loans on non-accrual status. As of December 31, 2002, the Company had three assets on non-accrual sta- tus with an aggregate gross book value of $11.1 million, or 0.20% of the gross book value of the Company’s investments. The Company is cur- rently comfortable that it has adequate collateral to support the book values of the assets. One of the three non-accrual loans is a $3.5 million partnership loan on two shopping malls located in the suburbs of Washington, D.C. This investment was part of a larger loan originally made by afﬁliates of Lazard Freres prior to the Company’s acquisition of Lazard’s structured ﬁnance portfolio in 1998. The loan matures in September 2003 and bears interest at 12.00%. The Company received cash payments equal to the interest due on the loan during the 12 months ended December 31, 2002, and the borrower remains current on its obligations to the Company. However, the Company anticipates that this loan will remain on non-accrual status for the foreseeable future. The second non-accrual loan is a partnership loan with a bal- ance of $5.7 million as of December 31, 2002. The loan is presently secured by partnership interests in two partnerships owning facilities in Colorado leased to the U.S. Government. The Company made the loan in anticipation of buying the facilities upon their completion. The loan matures on March 29, 2003 and bears interest at LIBOR + 3.50%, with a LIBOR ﬂoor of 3.00%. In February 2003 the borrower breached certain technical provisions of the loan documents, constituting a tech- nical event of default. The borrower remains current on its regular interest obligations to the Company and the Company is currently dis- cussing a possible extension of the loan with the borrower. However, as a result of the technical default and the uncertainty surrounding the extension and the timing of the completion of the facilities for the Company’s purchase, the loan has been been placed on non-accrual status. iStar Financial annual report The third non-accrual loan is a $1.9 million investment in debt securities of a real estate company which trades on the Mexican Stock Exchange. This investment was made by TriNet prior to its acqui- sition by the Company in 1999. The securities bear interest at 12.00% per annum payable in arrears in December of each year. In January 2003, the Company received cash payments equal to the interest due on the investment through December 31, 2002, and the borrower remains current on its obligations to the Company. However, the Company anticipates that this investment will remain on non-accrual status for the foreseeable future. Watch List Assets – The Company conducts a quarterly compre- hensive credit review, resulting in an individual risk rating being assigned to each asset. This review is designed to enable management to evaluate and proactively manage asset-speciﬁc credit issues and identify credit trends on a portfolio-wide basis as an “early warning system.” As of December 31, 2002, the Company has four loans and two CTL investments that are on its credit watch list. In addition to the $5.7 million partnership loan mentioned above, the Company had three other loans on its credit watch list. The second watch list loan is a $40.8 million ﬁrst mortgage secured by a hotel property in New York, New York. This mortgage matures on April 30, 2005 and bears interest at LIBOR + 4.50%. The borrower remains current on all of its debt service payments to the Company, and the Company is currently comfortable that it has adequate collat- eral to support the book value of the asset. However, due to poor oper- ating performance exacerbated by the decline in the hotel market in the New York metropolitan area, this loan remains on the watch list. The third watch list loan is a $12.9 million junior participation in a first mortgage loan secured by a hotel property in New York, New York. This loan bears interest at a ﬁxed rate of 7.91% and matures in June 2006. The borrower remains current on all of its debt service payments to the Company and has continued to invest additional equity to fund on-going capital improvements at the property. The Company is comfortable that it has adequate collateral to support the book value of the asset. However, due to poor operating performance exacerbated by the decline in the hotel market in the New York metro- politan area, this loan remains on the watch list. The fourth watch list loan is a $35.8 million junior interest in a $104.5 million ﬁrst mortgage loan secured by a retail shopping mall in Chicago, IL. The whole loan bears interest at 8.88% and matures January 1, 2004. The mall’s cash ﬂow has been negatively impacted by the departure of one of four anchor tenants. The borrower is currently negotiating with one of the anchor tenants to occupy the vacant space. In addition, the borrower has a signiﬁcant equity investment in the property (including approximately $15.0 million of additional equity invested in 2001), and remains current on all of its debt service pay- ments to the Company. The Company is currently comfortable that it has adequate collateral to support the book value of the asset. The Company also has two CTL investments on its credit watch list. In January 2002, a customer occupying two ofﬁce facilities owned by the Company ﬁled a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The customer utilizes these facilities as the U.S. headquarters for one of its major business lines. Since its bankruptcy ﬁling, the customer has been consolidating its space needs into the larger of the two facilities, including approxi- mately 150 of its employees from other area locations. The customer has also invested approximately $3.0 million of its own capital in the facilities. In December 2002, the bankruptcy court approved a plan of reorganization. As part of the reorganization, the customer has attempted to afﬁrm the lease on the larger facility and terminate the lease on the smaller facility. Since the two leases are cross-defaulted, the Company believes the the customer’s afﬁrmation of the larger facility lease is also an affirmation of the smaller facility. The customer remains current on the larger facility’s lease payment to the Company, but has withheld its March payment on the smaller facility pending a potential negotiated settlement with the Company regarding termina- tion of the lease on the smaller facility. Therefore, the smaller facility (with a net carrying value of $3.6 million at December 31, 2002) remains on the Company’s watch list. The Company also placed on the watch list its investment in a corporate tenant lease asset held in joint venture due to the ﬁnancial uncertainty surrounding one of the facility’s primary tenants. As of December 31, 2002, the Company’s equity investment in the venture was $12.4 million and the Company’s share of income from this equity investment for the year ended December 31, 2002 was $1.4 million. Other Loans – As of December 31, 2002, the Company also has a $15.3 million second mortgage on a Class A office building in Washington, D.C. which has paid debt service two months in arrears since December 2002. The loan matures in October 2005 and, but for a small working capital deﬁcit resulting in the two-month arrearage, con- tinues to otherwise pay as agreed. Inclusive of the senior debt on the property, the Company’s last-dollar risk exposure on this asset on a per square foot basis is signiﬁcantly less than neighboring buildings have sold for. As a result, the Company currently believes that it has ade- quate collateral to support the book value of the asset. Liquidity and Capital Resources The Company requires capital to fund its investment activi- ties and operating expenses. The Company has signiﬁcant access to capital resources to fund its existing business plan, which includes the expansion of its real estate lending and corporate tenant leasing busi- nesses. The Company’s capital sources include cash ﬂow from opera- tions, borrowings under lines of credit, additional term borrowings, long-term financing secured by the Company’s assets, unsecured ﬁnancing and the issuance of common, convertible and/or preferred equity securities. Further, the Company may acquire other businesses or assets using its capital stock, cash or a combination thereof. The distribution requirements under the REIT provisions of the Code limit the Company’s ability to retain earnings and thereby replenish or increase capital committed to its operations. However, the Company believes that its signiﬁcant capital resources and access to ﬁnancing will provide it with ﬁnancial ﬂexibility and market respon- siveness at levels sufﬁcient to meet current and anticipated capital requirements, including expected new lending and corporate tenant leasing transactions. The Company believes that its existing sources of funds will be adequate for purposes of meeting its short- and long-term liquidity needs. The Company’s ability to meet its long-term (i.e., beyond one year) liquidity requirements is subject to obtaining additional debt and equity ﬁnancing. Any decision by the Company’s lenders and investors to enter into such transactions with the Company will depend upon a number of factors, such as compliance with the terms of its existing credit arrangements, the Company’s ﬁnancial performance, industry or market trends, the general availability of and rates applicable to ﬁnanc- ing transactions, such lenders’ and investors’ resources and policies concerning the terms under which they make such capital commit- ments and the relative attractiveness of alternative investment or lend- ing opportunities. The Company’s longstanding policy is to limit its book debt- to-equity ratio to approximately 2.0x. As the Company’s leverage approaches this level, the Company will consider equity and other alter- natives to reduce leverage. The exact timing and nature of any equity issuance would be subject to market conditions. 2002 page .33 The following table outlines the contractual obligations related to the Company’s long-term debt agreements and operating lease obliga- tions. There are no other long-term liabilities of the Company that would constitute a contractual obligation. Long-Term Debt Obligations: Secured revolving credit facilities Unsecured revolving credit facilities Secured term loans iStar Asset Receivables secured notes(2) Unsecured notes Other debt obligations Total Operating Lease Obligations:(3) Total Explanatory Notes: Principal Payments Due By Period (1) Total Less Than 1 Year 2–3 Years 4–5 Years 6–10 Years After 10 Years (In thousands) $1,273,754 – 682,851 876,368 625,000 15,961 3,473,934 17,608 $3,491,542 $ – – – – – 15,961 15,961 2,908 $18,869 $1,273,754 – 142,211 236,694 – – 1,652,659 5,467 $1,658,126 $ – – 245,975 – 50,000 – 295,975 5,353 $301,328 $ – – 180,292 639,674 350,000 – 1,169,966 3,880 $1,173,846 $ – – 114,373 – 225,000 – 339,373 – $339,373 Assumes exercise of extensions on the Company’s long-term debt obligations to the extent such extensions are at the Company’s option. Based on expected proceeds from principal payments received on loan assets collateralizing such notes. The Company also has a $1.0 million letter of credit outstanding as security for its primary corporate ofﬁce lease. (1) (2) (3) ~ The Company has four LIBOR-based secured revolving credit facilities with an aggregate maximum availability of $2.4 billion, of which $1.3 billion was drawn as of December 31, 2002 (see Note 7 to the Company’s Consolidated Financial Statements). Availability under these facilities is based on collateral provided under a borrowing base calculation. At December 31, 2002, the Company also had an unsecured credit facility totaling $300.0 million which bears interest at LIBOR + 2.125% and matures in July 2004, including a one-year extension at the Company’s option. At December 31, 2002, the Company had not drawn any amounts under this facility. Recent Financing Activities – On May 17, 2000, the Company closed the inaugural offering under its proprietary matched funding program, STARs, Series 2000-1. In the initial transaction, a wholly- owned subsidiary of the Company issued $896.5 million of investment- grade bonds secured by the subsidiary’s assets, which had an aggregate outstanding principal balance of approximately $1.2 billion at incep- tion. Principal payments received on the assets were utilized to repay the most senior class of the bonds then outstanding. The maturity of the bonds match funded the maturity of the underlying assets ﬁnanced under the program. Of the assets of the subsidiary secured by this ﬁnancing, 73.96% (by gross carrying value) consisted of ﬁrst mortgages and subsequent lien positions and the remaining 26.04% consisted of junior loans. For accounting purposes, this transaction was treated as a secured financing: the underlying assets and STARs liabilities remained on the Company’s Consolidated Balance Sheets and no gain on sale was recognized. On May 28, 2002, the Company fully repaid these bonds. On January 11, 2001, the Company closed a new $700.0 mil- lion secured revolving credit facility which is led by a major commer- cial bank. The new facility has a three-year primary term and one-year “term-out” extension option, and bears interest at LIBOR + 1.40% to 2.15%, depending upon the collateral contributed to the borrowing base. The new facility accepts a broad range of structured ﬁnance assets and has a ﬁnal maturity of January 2005. Subsequent to December 31, 2002, the Company extended the final maturity on this facility to January 2007. On February 22, 2001, the Company extended the maturity of its $350.0 million unsecured revolving credit facility to May 2002. On July 27, 2001, the Company repaid this facility and replaced it with a new $300.0 million unsecured revolving credit facility. On May 15, 2001, the Company repaid its $100.0 million 7.30% unsecured notes. These notes were senior unsecured obligations of the Leasing Subsidiary and ranked equally with the Leasing Subsidiary’s other senior unsecured and unsubordinated indebtedness. On June 14, 2001, the Company closed $193.0 million of term loan ﬁnancing secured by 15 corporate tenant lease assets. The variable- rate loan bears interest at LIBOR + 1.85% (not to exceed 10.00% in aggregate) and has two one-year extensions at the Company’s option. The Company used these proceeds to repay a $77.8 million secured term loan maturing in June 2001 and to pay down a portion of its revolving credit facilities. In addition, the Company extended the maturity of its $500.0 million secured revolving credit facility to August 2003. On March 29, 2002, the Company again extended the ﬁnal maturity of this facility to August 2005, which includes a one-year “term-out” extension at the Company’s option. On July 6, 2001, the Company ﬁnanced a $75.0 million struc- tured ﬁnance asset with a $50.0 million term loan bearing interest at LIBOR + 2.50%. The loan has a maturity of July 2006, including a one- year extension at the Company’s option. This investment is a $75.0 mil- lion term preferred investment in a publicly-traded real estate customer. The Company’s investment carries an initial current yield of 10.50%, with annual increases of 0.50% in each of the next two years. In addition, the Company’s investment is convertible into the cus- tomer’s common stock at a strike price of $25.00 per share. The invest- ment is callable by the customer between months 13 and 30 of the term at a yield maintenance premium, and after month 30, at a premium suf- ﬁcient to generate a 14.62% internal rate of return on the Company’s investment. The investment is putable by the Company to the customer for cash after ﬁve years. On July 27, 2001, the Company completed a $300.0 million unsecured revolving credit facility with a group of leading ﬁnancial institutions. The new facility has an initial maturity of July 2003, with a one-year extension at the Company’s option and another one-year extension at the lenders’ option. The new facility replaces two prior credit facilities maturing in 2002 and 2003, and bears interest at LIBOR + 2.125%. On August 9, 2001, the Company issued $350.0 million of 8.75% senior notes due in 2008. The notes are unsecured senior obliga- tions of the Company. The Company used the net proceeds to partially repay outstanding borrowings under its secured credit facilities. On March 29, 2002, the Company extended the maturity of its $500.0 million secured facility to August 2005, which includes a one- year “term-out” extension at the Company’s option. On May 28, 2002, the Company repaid the then remaining $446.2 million of bonds outstanding under its STARs, Series 2000-1 ﬁnancing. Simultaneously, a wholly-owned subsidiary of the Company issued STARs, Series 2002-1, consisting of $885.1 million of investment- grade bonds secured by the subsidiary’s structured ﬁnance and corporate iStar Financial annual report tenant lease assets, which had an aggregate outstanding principal bal- ance of approximately $1.1 billion at inception. Principal payments received on the assets will be utilized to repay the most senior class of the bonds then outstanding. The maturity of the bonds match funds the maturity of the underlying assets ﬁnanced under the program. The weighted average interest rate on the bonds, on an all-ﬂoating rate basis, is approximately LIBOR + 0.56% at inception. For accounting pur- poses, this transaction was treated as a secured ﬁnancing: the underlying assets and STARs liabilities remained on the Company’s Consolidated Balance Sheets, and no gain on sale was recognized. On July 2, 2002, the Company purchased the remaining inter- est in the Milpitas joint venture from the former Milpitas external member for $27.9 million. Upon purchase of the interest, the Milpitas joint venture became fully consolidated for accounting purposes and approximately $79.1 million of secured term debt is reﬂected on the Company’s Consolidated Balance Sheets. On September 30, 2002, the Company closed a new $500.0 mil- lion secured revolving credit facility with a leading ﬁnancial institution. The new facility has a three-year term and bears interest at LIBOR + 1.50% to 2.25%, depending upon the collateral contributed to the bor- rowing base. The new facility accepts a broad range of structured ﬁnance and corporate tenant assets and has a ﬁnal maturity date of September 2005. On December 11, 2002, the Company closed a $61.5 million term loan ﬁnancing with a leading ﬁnancial institution. The proceeds were used to fund a portion of an $82.1 million CTL investment. The non-recourse loan is ﬁxed rate and bears interest at 6.412%, has a matu- rity date of December 2012 and amortizes over a 30-year schedule. Hedging Activities – The Company has variable-rate lending assets and variable-rate debt obligations. These assets and liabilities cre- ate a natural hedge against changes in variable interest rates. This means that as interest rates increase, the Company earns more on its variable-rate lending assets and pays more on its variable-rate debt obli- gations and, conversely, as interest rates decrease, the Company earns less on its variable-rate lending assets and pays less on its variable-rate debt obligations. When the amount of the Company’s variable-rate debt obligations exceeds the amount of its variable-rate lending assets, the Company utilizes derivative instruments to limit the impact of changing interest rates on its net income. The Company does not use derivative instruments to hedge assets or for speculative purposes. The deriva- tives instruments the Company uses are typically in the form of inter- est rate swaps and interest rate caps. Interest rate swaps effectively change variable-rate debt obligations to ﬁxed-rate debt obligations. Interest rate caps effectively limit the maximum interest rate on vari- able-rate debt obligations. In addition, when appropriate the Company may occasionally enter into interest rate swaps that convert ﬁxed-rate debt to variable rate in order to mitigate the risk of changes in fair value of the ﬁxed- rate debt obligations. The primary risks from the Company’s use of derivative instruments is the risk that a counterparty to a hedging arrangement could default on its obligation and the risk that the Company may have to pay certain costs, such as transaction fees or breakage costs, if a hedg- ing arrangement is terminated by the Company. As a matter of policy, the Company enters into hedging arrangements with counterparties that are large, creditworthy ﬁnancial institutions typically rated at least “A” by Standard & Poor’s (“S&P”) and “A2” by Moody’s Investors Service (“Moody’s”). The Company’s hedging strategy is approved and moni- tored by the Company’s Audit Committee on behalf of its Board of Directors and may be changed by the Board of Directors without stock- holder approval. The Company has entered into the following cash ﬂow and fair value hedges that are outstanding as of December 31, 2002. The net value associated with these hedges is reﬂected on the Company’s Consolidated Balance Sheets (in thousands). Type of Hedge Pay-Fixed Swap Pay-Fixed Swap Pay-Fixed Swap Pay-Floating Swap Pay-Floating Swap LIBOR Cap LIBOR Cap LIBOR Cap Total Estimated Value Explanatory Note: Notional Amount $125,000 125,000 75,000 100,000 50,000 345,000 75,000 35,000 Strike Price or Swap Rate 7.058% 7.055% 5.580% 3.878% 3.810% 8.000% 7.750% 7.750% Trade Date 6/15/00 6/15/00 11/4/99(1) 11/27/02 11/27/02 5/22/02 11/4/99(1) 11/4/99(1) Maturity Date 6/25/03 6/25/03 12/1/04 8/15/08 8/15/08 5/28/14 12/1/04 12/1/04 Estimated Value at December 31, 2002 $(3,598) (3,596) (5,743) 2,761 1,203 12,088 21 9 $ 3,145 Acquired in connection with the TriNet Acquisition (see Note 1 to the Company’s Consolidated Financial Statements). (1) ~ Between January 1, 2001 and December 31, 2002, the Company also had outstanding the following cash ﬂow hedges that have expired or been settled (in thousands): Type of Hedge LIBOR Cap Pay-Fixed Swap LIBOR Cap LIBOR Cap ~ Notional Amount $300,000 92,000 75,000 38,336 Strike Price or Swap Rate 9.000% 5.714% 7.500% 7.500% Trade Date 3/16/98 8/10/98 7/16/98 4/30/98 Maturity Date 3/16/01 3/1/01 6/19/01 6/1/01 In connection with STARs, Series 2002-1 in May 2002, the Company entered into a LIBOR interest rate cap struck at 8.00% in the notional amount of $345.0 million. The Company utilizes the provi- sions of Statement of Financial Accounting Standards No. 133 (“SFAS No. 133), “Accounting for Derivative Instruments and Hedging Activities,” with respect to such instruments. SFAS No. 133 provides that the up- front fees paid on option-based products such as caps should be expensed into earnings based on the allocation of the premium to the affected periods as if the agreement were a series of “caplets.” These allocated premiums are then reﬂected as a charge to income (as part of interest expense) in the affected period. On May 28, 2002, in connection with the STARs, Series 2002-1 transaction, the Company paid a premium of $13.7 million for an interest rate cap. Using the “caplet” methodology discussed above, amortization 2002 page .35 of the cap premium is dependent upon the actual value of the caplets at inception. In connection with STARs, Series 2000-1 in May 2000, the Company entered into a LIBOR interest rate cap struck at 10.00% in the notional amount of $312.0 million, and simultaneously sold a LIBOR interest rate cap with the same terms. Since these instruments did not change the Company’s net interest rate risk exposure, they did not qual- ify as hedges and changes in their respective values were charged to earnings. As the terms of these arrangements were substantially the same, the effects of a revaluation of these two instruments substan- tially offset one another. On May 28, 2002, these instruments were set- tled and are no longer outstanding. In connection with a portion of the Company’s ﬁxed-rate cor- porate bonds, the Company entered into two pay-ﬂoating interest rate swaps struck at 3.8775% and 3.81% and in the notional amounts of $100.0 million and $50.0 million, respectively. The Company pays one- month LIBOR and receives the stated ﬁxed rate in return. These swaps mitigate the risk of changes in the fair value of $150.0 million of the Company’s fixed-rate corporate bonds attributable to changes in LIBOR. For accounting purposes, the difference between the ﬁxed rate received and the LIBOR rate paid on the notional amount of the swap is recorded as “Interest expense” in the Company’s Consolidated Statements of Operations. In addition, the Company adjusts the value of the swap to its fair value and adjusts the carrying amount of the hedged liability by an offsetting amount on a quarterly basis. Certain of the Company’s CTL joint ventures, have hedging activities which are more fully described in Note 6 to the Company’s Consolidated Financial Statements. Off-Balance Sheet Transactions – The Company is not dependent on the use of any off-balance sheet ﬁnancing arrangements for liquid- ity. As of December 31, 2002, the Company had investments in three corporate tenant lease joint ventures accounted for under the equity method, which had total debt obligations outstanding of approximately $178.7 million. The Company’s pro rata share of the ventures’ third- party debt was approximately $77.4 million (see Note 6 to the Company’s Consolidated Financial Statements). These ventures were formed for the purpose of operating, acquiring and in certain cases, developing corporate tenant lease facilities. The debt obligations of these joint ventures are non-recourse to the ventures and the Company and mature between ﬁscal years 2004 and 2011. As of December 31, 2002, the debt obligations consisted of six term loans bearing ﬁxed rates per annum ranging from 7.61% to 8.43% and one variable-rate term loan with a rate of LIBOR + 1.25% per annum. The Company has certain discretionary and non-discretionary unfunded commitments related to its loans and other lending invest- ments that it may need to, or choose to, fund in the future. Discre- tionary commitments are those under which the Company has sole discretion with respect to future funding. Non-discretionary commit- ments are those under which the Company is generally obligated to fund at the request of the borrower or upon the occurrence of events outside of the Company’s direct control. As of December 31, 2002, the Company had nine loans with unfunded commitments totaling $97.7 million, of which $22.2 million was discretionary and $75.5 mil- lion was non-discretionary. Ratings Triggers – On July 27, 2001, the Company completed a $300.0 million unsecured revolving credit facility with a group of lead- ing ﬁnancial institutions. The new facility has an initial maturity of July 2003 with a one-year extension at the Company’s option and another one-year extension at the lenders’ option. The new facility replaces two prior credit facilities maturing in 2002 and 2003, and bears interest at LIBOR + 2.125% based on the Company’s senior unse- cured credit ratings of BB+ from S&P, Ba1 from Moody’s and BBB- from Fitch Ratings. If the Company achieves a higher rating from either S&P or Moody’s, the facility’s interest rate will improve to LIBOR + 2.00%. If the Company’s credit rating is downgraded by any of the rating agen- cies (regardless of how far), the facility’s interest rate will increase to LIBOR + 2.25%. In the event the Company receives two credit ratings that are not equivalent, the spread over LIBOR shall be determined by the lower of the two such ratings. As of December 31, 2002, no amounts are outstanding on this facility. Accordingly, management does not believe any rating changes would have a material adverse impact on the Company’s results of operations. There are no other ratings triggers in any of the Company’s debt instruments or other operating or ﬁnan- cial agreements. During the 12 months ended December 31, 2002, the Company’s senior unsecured credit rating was upgraded to an invest- ment grade rating of BBB- from BB+ by Fitch Ratings. In addition, Moody’s and S&P raised their ratings outlook for the Company’s senior unsecured credit rating to “positive.” Transactions with Related Parties – The Company has an invest- ment in iStar Operating Inc. (“iStar Operating”), a taxable subsidiary that, through a wholly-owned subsidiary, services the Company’s loans and certain loan portfolios owned by third parties. The Company owns all of the non-voting preferred stock and a 95.00% economic interest in iStar Operating. An afﬁliate of the Company’s largest shareholder is the owner of all the voting common stock and a 5.00% economic interest in iStar Operating. As of December 31, 2002, there have never been any distributions to the common shareholder, nor does the Company expect to make any in the future. At any time, the Company has the right to acquire all of the common stock of iStar Operating at fair mar- ket value, which the Company believes to be nominal. In addition to the direct general and administrative costs of iStar Operating, the Company allocates a portion of its general overhead expenses to iStar Operating based on the number of employees at iStar Operating as a percentage of the Company’s total employees. In addition, the Company has an investment in TMOC, a tax- able noncontrolled subsidiary that has a $2.0 million investment in a real estate company based in Mexico. The Company owns 95.00% of the outstanding voting and non-voting common stock (representing 1.00% voting power and 95.00% of the economic interest) in TMOC. The other two owners of TMOC stock are executives of the Company, who own a combined 5.00% of the outstanding voting and non-voting common stock (representing 99.00% voting power and 5.00% eco- nomic interest) in TMOC. As of December 31, 2002, there have never been any distributions to the common shareholders, nor does the Company expect to make any in the future. At any time, the Company has the right to acquire all of the common stock of TMOC at fair market value, which the Company believes to be nominal. Both iStar Operating and TMOC have elected to be treated as taxable REIT subsidiaries for purposes of maintaining compliance with the REIT provisions of the Code and are accounted for under the equity method for ﬁnancial statement reporting purposes and are pre- sented in “Investments in and advances to joint ventures and unconsol- idated subsidiaries” on the Company’s Consolidated Balance Sheets. If they were consolidated with the Company for ﬁnancial statement purposes, they would not have a material impact on the Company’s operations. As of December 31, 2002, iStar Operating and TMOC have no debt obligations. The Company entered into an employment agreement with its Chief Executive Ofﬁcer as of March 31, 2001. In addition to the salary and bonus provisions of the agreement, the agreement provides for an award of 2.0 million phantom units to the executive, each of which notionally represents one share of the Company’s Common Stock. Portions of these phantom units will vest on a contingent basis if the average closing price of the Company’s Common Stock achieves certain levels (ranging from $25.00 to $37.00 per share) for 60 consecu- tive calendar days. Contingently vested units will become fully vested, meaning that they are no longer subject to forfeiture, if the executive remains employed through March 30, 2004, or earlier upon certain change of control and termination events. When and if contingently vested phantom units become fully vested units, the Company must deliver to the executive either a number of shares of Common Stock iStar Financial annual report equal to the number of fully vested units or an amount of cash equal to the then fair market value of that number of shares of Common Stock. If shares were unavailable under the Company’s then long-term incen- tive plans, this obligation could require the Company to make a sub- stantial cash payment to the executive. DRIP Program – The Company maintains a dividend reinvest- ment and direct stock purchase plan. Under the dividend reinvestment component of the plan, the Company’s shareholders may purchase additional shares of Common Stock without payment of brokerage commissions or service charges by automatically reinvesting all or a portion of their Common Stock cash dividends. Under the direct stock purchase component of the plan, the Company’s shareholders and new investors may purchase shares of Common Stock directly from the Company without payment of brokerage commissions or service charges. All purchases of shares in excess of $10,000 per month pur- suant to the direct purchase component are at the Company’s sole dis- cretion. Shares issued under the plan may reﬂect a discount of up to 3.00% from the prevailing market price of the Company’s Common Stock. The Company is authorized to issue up to 8.0 million shares of Common Stock pursuant to the dividend reinvestment and direct stock purchase plan. During the 12-month periods ended December 31, 2002 and 2001, the Company issued a total of 1.6 million and approximately 195,000 shares of its Common Stock, respectively, through the direct stock purchase component of the plan. Net proceeds during the 12-month periods ended December 31, 2002 and 2001 were approxi- mately $44.4 million and $4.7 million, respectively. Stock Repurchase Program – The Board of Directors approved, and the Company has implemented, a stock repurchase program under which the Company is authorized to repurchase up to 5.0 million shares of its Common Stock from time to time, primarily using pro- ceeds from the disposition of assets or loan repayments and excess cash ﬂow from operations, but also using borrowings under its credit facili- ties if the Company determines that it is advantageous to do so. As of December 31, 2001, the Company had repurchased a total of approxi- mately 2.3 million shares, at an aggregate cost of approximately $40.7 million. The Company did not repurchase any shares under the stock repurchase program in 2002. Critical Accounting Policies The Company’s Consolidated Financial Statements include the accounts of the Company and all majority-owned and controlled subsidiaries. The preparation of ﬁnancial statements in accordance with GAAP requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompa- nying consolidated ﬁnancial statements. In preparing these ﬁnancial statements, management has made its best estimates and judgments of certain amounts included in the ﬁnancial statements, giving due con- sideration to materiality. The Company does not believe that there is a great likelihood that materially different amounts would be reported related to the accounting policies described below. However, applica- tion of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. Management has the obligation to ensure that its policies and methodologies are in accordance with GAAP. During 2002, manage- ment reviewed and evaluated its critical accounting policies and believes them to be appropriate. The Company’s accounting policies are described in Note 3 to the Company’s Consolidated Financial Statements. Management believes the more signiﬁcant of these to be as follows: Revenue Recognition – The most significant sources of the Company’s revenue come from its lending operations and its corporate tenant lease operations. For its lending operations, the Company reﬂects income using the effective yield method, which recognizes peri- odic income over the expected term of the investment on a constant yield basis. For corporate tenant lease assets, the Company recognizes income on the straight-line method, which effectively recognizes con- tractual lease payments to be received by the Company evenly over the term of the lease. Management believes the Company’s revenue recog- nition policies are appropriate to reﬂect the substance of the underly- ing transactions. Provision for Loan Losses – The Company’s accounting policies require that an allowance for estimated credit losses be reﬂected in the ﬁnancial statements based upon an evaluation of known and inherent risks in its private lending assets. While the Company and its private predecessors have experienced minimal actual losses on their lending investments, management considers it prudent to reﬂect provisions for loan losses on a portfolio basis based upon the Company’s assessment of general market conditions, the Company’s internal risk management policies and credit risk rating system, industry loss experience, the Company’s assessment of the likelihood of delinquencies or defaults, and the value of the collateral underlying its investments. Actual losses, if any, could ultimately differ from these estimates. Impairment of Long-Lived Assets – Corporate tenant lease assets represent “long-lived” assets for accounting purposes. The Company periodically reviews long-lived assets to be held and used in its leasing operations for impairment in value whenever any events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. In management’s opinion, based on this analysis, corpo- rate tenant assets to be held and used are not carried at amounts in excess of their estimated recoverable amounts. Risk Management and Financial Instruments – The Company has historically utilized derivative ﬁnancial instruments only as a means to help to manage its interest rate risk exposure on a portion of its variable- rate debt obligations (i.e., as cash ﬂow hedges). The instruments uti- lized are generally either pay-ﬁxed swaps or LIBOR-based interest rate caps which are widely used in the industry and typically with major ﬁnancial institutions. The Company’s accounting policies generally reﬂect these instruments at their fair value with unrealized changes in fair value reﬂected in “Accumulated other comprehensive income” on the Company’s Consolidated Balance Sheets. Realized effects on the Company’s cash ﬂows are generally recognized currently in income. However, when appropriate the Company may occasionally enter into interest rate swaps that convert ﬁxed-rate debt to variable rate in order to mitigate the risk of changes in fair value of its ﬁxed-rate debt obligations. The Company reﬂects these instruments at their fair value and adjusts the carrying amount of the hedged liability by an off- setting amount. Income Taxes – The Company’s ﬁnancial results generally do not reﬂect provisions for current or deferred income taxes. Manage- ment believes that the Company has and intends to continue to operate in a manner that will continue to allow it to be taxed as a REIT and, as a result, does not expect to pay substantial corporate-level taxes. Many of these requirements, however, are highly technical and complex. If the Company were to fail to meet these requirements, the Company would be subject to Federal income tax. Executive Compensation – The Company’s accounting policies generally provide cash compensation to be estimated and recognized over the period of service. With respect to stock-based compensation arrangements, as of July 1, 2002 (with retroactive application to the beginning of the calendar year), the Company has adopted the fair value method allowed under SFAS No. 123, which values options on the date of grant and recognizes an expense equal to the fair value of the option multiplied by the number of options granted over the related service period. Prior to the third quarter 2002, the Company elected to use APB 25 accounting, which measured the compensation charges based on the intrinsic value of such securities when they become ﬁxed and determinable, and recognized such expense over the related service period. These arrangements are often complex and gen- erally structured to align the interests of management with those of the Company’s shareholders. See Note 10 to the Company’s Consolidated 2002 page .37 Financial Statements for a detailed discussion of such arrangements and the related accounting effects. During 2001, the Company entered into new three-year employment agreements with its Chief Executive Officer and its President. In addition, during 2002 the Company entered into a three- year employment agreement with its new Chief Financial Officer. See Note 10 to the Company’s Consolidated Financial Statements for a more detailed description of these employment agreements. The following is a hypothetical illustration of the effects on the Company’s net income and adjusted earnings of the full vesting of phantom units under the employment agreement with the Chief Executive Ofﬁcer. During the 12 months ended December 31, 2002, 1.0 million of the phantom shares awarded to the Chief Executive Ofﬁcer were contingently vested. Absent an earlier change of control or termination of employment, these 1,000,000 shares will not become fully vested until March 31, 2004. Assuming that the market price of the Common Stock on March 31, 2004 is $28.05 (which was the market price of the Common Stock on December 31, 2002), the Company would incur a one-time charge to both net income and earnings at that time equal to $28.0 million (the fair market value of the 1,000,000 shares at $28.05 per share). On April 29, 2002, the 500,000 unvested restricted shares awarded to the President became contingently vested as the total shareholder return exceeded 60.00% and became fully vested on September 30, 2002 as all employment contingencies were met. The Company incurred a non-cash charge of approximately $15.0 million related to these vested shares, recognized ratably over the service period from the date of contingent vesting through September 30, 2002. Accordingly, the non-cash charge recognized for the 12 months ended December 31, 2002 was approximately $15.0 million. New Accounting Standards In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133 (“SFAS No. 133”), “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 133 estab- lishes accounting and reporting standards for derivative financial instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of ﬁnancial position and measure those instruments at fair value. If certain condi- tions are met, a derivative may be speciﬁcally designated as: (1) a hedge of the exposure to changes in the fair value of a recognized asset or lia- bility or an unrecognized ﬁrm commitment; (2) a hedge of the expo- sure to variable cash ﬂows of a forecasted transaction; or (3) in certain circumstances a hedge of a foreign currency exposure. On January 1, 2001, the Company adopted this pronouncement, as amended by Statement of Financial Accounting Standards No. 137 “Accounting for Derivative Instruments and Hedging Activities – Deferral of the Effective Date of FASB Statement No. 133” and Statement of Financial Accounting Standards No. 138 “Accounting for Certain Hedging Activities – an Amendment of FASB No. 133.” Because the Company has primarily used derivatives as cash ﬂow hedges of interest rate risk only, the adoption of SFAS No. 133 did not have a material ﬁnancial impact on the financial position and results of operations of the Company. However, should the Company change its current use of such derivatives, the adoption of SFAS No. 133 could have a more signiﬁcant effect on the Company prospectively. In December 1999, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition in Financial Statements.” In June 2000, the SEC staff amended SAB 101 to provide registrants with additional time to imple- ment SAB 101. The Company adopted SAB 101, as required, in the fourth quarter of ﬁscal 2000. The adoption of SAB 101 did not have a material ﬁnancial impact on the ﬁnancial position or results of opera- tions of the Company. In March 2000, the FASB issued FASB Interpretation No. 44 (“FIN 44”), “Accounting for Certain Transactions Involving Stock Compensation.” The Company was required to adopt FIN 44 effective July 1, 2000 with respect to certain provisions applicable to new awards, exchanges of awards in a business combination, modiﬁcations to outstanding awards, and changes in grantee status that occur on or after that date. FIN 44 addresses practice issues related to the applica- tion of Accounting Practice Bulletin Opinion No. 25, “Accounting for Stock Issued to Employees.” The initial adoption of FIN 44 did not have a signiﬁcant impact on the Company. In September 2000, the FASB issued Statement of Financial Accounting Standards No. 140 (“SFAS No. 140”), “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” This statement is applicable for transfers of assets and extinguishments of liabilities occurring after June 30, 2001. The Company adopted the provisions of this statement as required for all transactions entered into on or after April 1, 2001. The adoption of SFAS No. 140 did not have a signiﬁcant impact on the Company. In July 2001, the SEC released Staff Accounting Bulletin No. 102 (“SAB 102”), “Selected Loan Loss Allowance and Documentation Issues.” SAB 102 summarizes certain of the SEC’s views on the develop- ment, documentation and application of a systematic methodology for determining allowances for loan and lease losses. Adoption of SAB 102 by the Company did not have a signiﬁcant impact on the Company. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141 (“SFAS No. 141”),“Business Combinations” and Statement of Financial Accounting Standards No. 142 (“SFAS No. 142”), “Goodwill and Other Intangible Assets.” SFAS No. 141 requires the purchase method of accounting to be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also addresses the initial recognition and measurement of goodwill and other intangi- ble assets acquired in business combinations and requires intangible assets to be recognized apart from goodwill if certain tests are met. SFAS No. 142 requires that goodwill not be amortized but instead be measured for impairment at least annually, or when events indicate that there may be an impairment. The Company adopted the provi- sions of both statements, as required, on January 1, 2002 and the adop- tion did not have a signiﬁcant impact on the Company. In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 provides new guidance on the recognition of impairment losses on long-lived assets to be held and used or to be disposed of, and also broadens the deﬁnition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. SFAS No. 144 requires that current operations prior to the disposition of corporate tenant lease assets and prior period results of such opera- tions be presented in discontinued operations in the Company’s Consolidated Statements of Operations. The provisions of SFAS No. 144 are effective for ﬁnancial statements issued for ﬁscal years beginning after December 15, 2001, and must be applied at the begin- ning of a ﬁscal year. The Company adopted the provisions of this state- ment on January 1, 2002, as required, and it did not have a signiﬁcant ﬁnancial impact on the Company. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145 (“SFAS No. 145”), “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 rescinds both FASB Statements No. 4 (“SFAS No. 4”), “Reporting Gains and Losses from Extinguishment of Debt,” and the amendment to SFAS No. 4, FASB Statement No. 64 (“SFAS No. 64”), “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.” Through this rescission, SFAS No. 145 eliminates the requirement (in both SFAS No. 4 and SFAS No. 64) that gains and losses from the extinguishment of debt be aggre- gated and, if material, classiﬁed as an extraordinary item, net of the related income tax effect. An entity is not prohibited from classifying such gains and losses as extraordinary items, so long as they meet the criteria in paragraph 20 of Accounting Principles Board Opinion No. 30 (“APB 30”), “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”; how- ever, due to the nature of the Company’s operations, such treatment iStar Financial annual report may not be available to the Company. Any gains or losses on extin- guishments of debt that were previously classiﬁed as extraordinary items in prior periods presented that do not meet the criteria in APB 30 for classiﬁcation as an extraordinary item will be reclassiﬁed to income from continuing operations. The provisions of SFAS No. 145 are effec- tive for ﬁnancial statements issued for ﬁscal years beginning after May 15, 2002. The Company will adopt the provisions of this state- ment, as required, on January 1, 2003, at which time ($12.2) million and ($1.6) million will be reclassiﬁed to continuing operations for 2002 and 2001, respectively. In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 (“SFAS No. 146”), “Accounting for Exit or Disposal Activities,” to address signiﬁcant issues regarding the recog- nition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance that the Emerging Issues Task Force (“EITF”) has set forth in EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The scope of SFAS No. 146 also includes: (1) costs related to terminating a contract that is not a capital lease; and (2) ter- mination benefits received by employees involuntarily terminated under the terms of a one-time beneﬁt arrangement that is not an on- going beneﬁt arrangement or an individual deferred-compensation contract. The provisions of SFAS No. 146 are effective for exit or dis- posal activities that are initiated after December 31, 2002. The Company does not expect SFAS No. 146 to have a material effect on the Company’s Consolidated Financial Statements. In September 2002, the FASB issued Statement of Financial Accounting Standards No. 147 (“SFAS No. 147”), “Acquisitions of Certain Financial Institutions,” an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9. SFAS No. 147 provides guidance on the accounting for the acquisitions of ﬁnancial institu- tions, except those acquisitions between two or more mutual enter- prises. SFAS No. 147 removes acquisitions of financial institu- tions from the scope of both FASB No. 72, “Accounting for Certain Acquisitions of Banking or Thrift Institutions,” and FASB Interpretation No. 9, Applying APB Opinions No. 16 and 17, “When a Savings and Loan Association or a Similar Institution is Acquired in a Business Combination Accounted for by the Purchase Method,” and requires that those transactions be accounted for in accordance with SFAS No. 141 and SFAS No. 142. SFAS No. 147 also amends SFAS No. 144 to include in its scope long-term, customer-relationship intangi- ble assets of ﬁnancial institutions such as depositor-relationship and borrower-relationship intangible assets and credit cardholder intangi- ble assets. The Company adopted the provisions of this statement, as required, on October 1, 2002, and it did not have a signiﬁcant ﬁnancial impact on the Company’s Consolidated Financial Statements. In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” an interpretation of FASB Statement of Financial Accounting Standards No. 5 (“SFAS No. 5”), “Accounting for Contingencies,” Statement of Financial Accounting Standards No. 57, “Related Party Disclosures,” Statement of Financial Accounting Standards No. 107, “Disclosures about Fair Value of Financial Instruments” and rescinds FASB Interpretation No. 34, “Disclosure of Indirect Guarantees of Indebtedness of Others, an Interpretation of SFAS No. 5.” It requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guar- antee regardless if the Company receives separately identiﬁable consid- eration (i.e., a premium). The new disclosure requirements are effective December 31, 2002. The adoption of FIN 45 did not have a material impact on the Company’s Consolidated Financial Statements, nor is it expected to have a material impact in the future. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 (“SFAS No. 148”), “Accounting for Stock- Based Compensation – Transition and Disclosure,” an amendment of FASB Statement No. 123 (“SFAS No. 123”). This statement provides alternative transition methods for a voluntary change to the fair value basis of accounting for stock-based employee compensation. However, this Statement does not permit the use of the original SFAS No. 123 prospective method of transition for changes to the fair value based method made in ﬁscal years beginning after December 15, 2003. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim ﬁnancial statements about the method of accounting for stock-based employee compensation, description of transition method utilized and the effect of the method used on reported results. The transition and annual disclosure provisions of SFAS No. 148 shall be applied for ﬁscal years ending after December 15, 2002. The new interim disclosure pro- visions are effective for the first interim period beginning after December 15, 2002. The Company adopted SFAS No. 148 with retroac- tive application to January 1, 2002 with no material effect on the Company’s Consolidated Financial Statements. In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” an interpreta- tion of ARB 51. FIN 46 provides guidance on identifying entities for which control is achieved through means other than through voting rights (a “variable interest entity” or “VIE”), and how to determine when and which business enterprise should consolidate a VIE. In addition, FIN 46 requires that both the primary beneﬁciary and all other enter- prises with a signiﬁcant variable interest in a VIE make additional dis- closures. The transitional disclosure requirements will take effect almost immediately and are required for all ﬁnancial statements ini- tially issued after January 31, 2003. The adoption of FIN 46 is not expected to have a material impact on the Company. quantitative and qualitative disclosures about market risk Market Risks Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. In pursuing its business plan, the primary market risk to which the Company is exposed is interest rate risk. Consistent with its liability management objectives, the Company has imple- mented an interest rate risk management policy based on match fund- ing, with the objective that variable-rate assets be primarily ﬁnanced by variable-rate liabilities and ﬁxed-rate assets be primarily ﬁnanced by ﬁxed-rate liabilities. The Company’s operating results will depend in part on the difference between the interest and related income earned on its assets and the interest expense incurred in connection with its interest-bearing liabilities. Competition from other providers of real estate ﬁnancing may lead to a decrease in the interest rate earned on the Company’s interest-bearing assets, which the Company may not be able to offset by obtaining lower interest costs on its borrowings. Changes in the gen- eral level of interest rates prevailing in the ﬁnancial markets may affect the spread (the difference in the principal amount outstanding) between the Company’s interest-earning assets and interest-bearing lia- bilities. Any signiﬁcant compression of the spreads between interest- earning assets and interest-bearing liabilities could have a material adverse effect on the Company. In addition, an increase in interest rates could, among other things, reduce the value of the Company’s interest- bearing assets and its ability to realize gains from the sale of such assets, and a decrease in interest rates could reduce the average life of the Company’s interest-earning assets. A substantial portion of the Company’s loan investments are subject to signiﬁcant prepayment protection in the form of lock-outs, yield maintenance provisions or other prepayment premiums which provide substantial yield protection to the Company. Those assets gen- erally not subject to prepayment penalties include: (1) variable-rate loans based on LIBOR, originated or acquired at par, which would not result in any gain or loss upon repayment; and (2) discount loans and loan participations acquired at discounts to face values, which would result in gains upon repayment. Further, while the Company generally seeks to enter into loan investments which provide for substantial 2002 page .39 prepayment protection, in the event of declining interest rates, the Company could receive such prepayments and may not be able to rein- vest such proceeds at favorable returns. Such prepayments could have an adverse effect on the spreads between interest-earning assets and interest-bearing liabilities. While the Company has not experienced any significant credit losses, in the event of a signiﬁcant rising interest rate environ- ment and/or economic downturn, defaults could increase and result in credit losses to the Company which adversely affect its liquidity and operating results. Further, such delinquencies or defaults could have an adverse effect on the spreads between interest-earning assets and interest-bearing liabilities. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political conditions, and other factors beyond the control of the Company. As more fully discussed in Note 9 to the Company’s Consolidated Financial Statements, the Company employs match funding-based hedging strategies to limit the effects of changes in interest rates on its operations, including engaging in interest rate caps, ﬂoors, swaps, futures and other interest rate-related derivative con- tracts. These strategies are specifically designed to reduce the Company’s exposure, on speciﬁc transactions or on a portfolio basis, to changes in cash ﬂows as a result of interest rate movements in the mar- ket. The Company does not enter into derivative contracts for specula- tive purposes nor as a hedge against changes in credit risk of its borrowers or of the Company itself. Each interest rate cap or ﬂoor agreement is a legal contract between the Company and a third party (the “counterparty”). When the Company purchases a cap or ﬂoor contract, the Company makes an up- front payment to the counterparty and the counterparty agrees to make payments to the Company in the future should the reference rate (typi- cally one- or three-month LIBOR) rise above (cap agreements) or fall below (ﬂoor agreements) the “strike” rate speciﬁed in the contract. Each contract has a notional face amount. Should the reference rate rise above the contractual strike rate in a cap, the Company will earn cap income. Should the reference rate fall below the contractual strike rate in a ﬂoor, the Company will earn ﬂoor income. Payments on an annual- ized basis will equal the contractual notional face amount multiplied by the difference between the actual reference rate and the contracted strike rate. The Company utilizes the provisions of SFAS No. 133 with respect to such instruments. SFAS No. 133 provides that the up-front fees paid on option-based products such as caps should be expensed into earnings based on the allocation of the premium to the affected periods as if the agreement were a series of “caplets.” These allocated premiums are then reﬂected as a charge to income and are included in “Interest expense” on the Company’s Consolidated Statements of Operations in the affected period. Interest rate swaps are agreements in which a series of inter- est rate ﬂows are exchanged over a prescribed period. The notional amount on which swaps are based is not exchanged. In general, the Company’s swaps are “pay ﬁxed” swaps involving the exchange of variable- rate interest payments from the counterparty for ﬁxed interest pay- ments from the Company. However, when appropriate the Company may occasionally enter into “pay ﬂoating” swaps involving the exchange of ﬁxed-rate interest payments from the counterparty for variable-rate interest payments from the Company, which mitigates the risk of changes in fair value of the Company’s ﬁxed-rate debt obligations. Interest rate futures are contracts, generally settled in cash, in which the seller agrees to deliver on a speciﬁed future date the cash equivalent of the difference between the speciﬁed price or yield indicated in the contract and the value of the speciﬁed instrument (i.e., U.S. Treasury securities) upon settlement. Under these agreements, the Company would generally receive additional cash ﬂow at settle- ment if interest rates rise and pay cash if interest rates fall. The effects of such receipts or payments would be deferred and amortized over the term of the speciﬁc related ﬁxed-rate borrowings. In the event that, in the opinion of management, it is no longer probable that a forecasted transaction will occur under terms substantially equivalent to those projected, the Company would cease recognizing such transactions as hedges and immediately recognize related gains or losses based on actual settlement or estimated settlement value. While a REIT may freely utilize the types of derivative instru- ments discussed above to hedge interest rate risk on its liabilities, the use of derivatives for other purposes, including hedging asset-related risks such as credit, prepayment or interest rate exposure on the Company’s loan assets, could generate income which is not qualiﬁed income for purposes of maintaining REIT status. As a consequence, the Company may only engage in such instruments to hedge such risks on a limited basis. There can be no assurance that the Company’s proﬁtability will not be adversely affected during any period as a result of changing interest rates. In addition, hedging transactions using derivative instru- ments involve certain additional risks such as counterparty credit risk, legal enforceability of hedging contracts and the risk that unantici- pated and signiﬁcant changes in interest rates will cause a signiﬁcant loss of basis in the contract. With regard to loss of basis in a hedging contract, indices upon which contracts are based may be more or less variable than the indices upon which the hedged assets or liabilities are based, thereby making the hedge less effective. The counterparties to these contractual arrangements are major ﬁnancial institutions with which the Company and its afﬁliates may also have other ﬁnancial rela- tionships. The Company is potentially exposed to credit loss in the event of nonperformance by these counterparties. However, because of their high credit ratings, the Company does not anticipate that any of the counterparties will fail to meet their obligations. There can be no assurance that the Company will be able to adequately protect against the foregoing risks and that the Company will ultimately realize an eco- nomic beneﬁt from any hedging contract it enters into which exceeds the related costs incurred in connection with engaging in such hedges. The following table quantiﬁes the potential changes in net investment income and net fair value of ﬁnancial instruments should interest rates increase or decrease 100 or 200 basis points, assuming no change in the shape of the yield curve (i.e., relative interest rates). Net investment income is calculated as revenue from loans and other lending investments and operating leases (as of December 31, 2002), less related interest expense and operating costs on corporate tenant lease assets, for the year ended December 31, 2002. Net fair value of ﬁnancial instruments is calculated as the sum of the value of derivative instruments and the present value of cash in-ﬂows generated from interest-earning assets, less cash out-ﬂows in respect of interest-bearing liabilities as of December 31, 2002. The cash ﬂows associated with the Company’s assets are calculated based on management’s best estimate of expected payments for each loan based on loan characteristics such as loan-to-value ratio, interest rate, credit history, prepayment penalty, term and collateral type. Most of the Company’s loans are protected from prepayment as a result of prepayment penalties and contractual terms which prohibit prepayments during speciﬁed periods. However, for those loans where prepayments are not currently precluded by con- tract, declines in interest rates may increase prepayment speeds. The base interest rate scenario assumes the one-month LIBOR rate of 1.38% as of December 31, 2002. Actual results could differ signiﬁcantly from those estimated in the table. Change in Interest Rates –100 Basis Points –50 Basis Points Base Interest Rate +100 Basis Points +200 Basis Points Explanatory Note: Estimated Percentage Change In Net Investment Income Net Fair Value of Financial Instruments(1) 1.44% 0.72% 0.00% (1.44)% (2.88)% 5.00% 2.38% 0.00% (3.23)% (1.52)% Amounts exclude fair values of non-ﬁnancial investments, primarily CTL assets and certain forms of corporate ﬁnance investments. (1) ~ iStar Financial annual report report of independent accountants To the Board of Directors and Shareholders of iStar Financial, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in shareholders’ equity and of cash ﬂows present fairly, in all material respects, the ﬁnancial position of iStar Financial, Inc. and its subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash ﬂows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. These ﬁnancial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these ﬁnancial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements, assessing the accounting principles used and signiﬁcant estimates made by management, and evaluating the overall ﬁnancial statement presentation. We believe that our audits provide a reason- able basis for our opinion. PricewaterhouseCoopers LLP New York, NY February 14, 2003, except for Note 17, which is as of March 11, 2003 2002 page .41 consolidated balance sheets As of December 31, Assets Loans and other lending investments, net Corporate tenant lease assets, net Investments in and advances to joint ventures and unconsolidated subsidiaries Assets held for sale Cash and cash equivalents Restricted cash Accrued interest and operating lease income receivable Deferred operating lease income receivable Deferred expenses and other assets Total assets Liabilities and Shareholders’ Equity Liabilities: Accounts payable, accrued expenses and other liabilities Dividends payable Debt obligations Total liabilities Commitments and contingencies Minority interest in consolidated entities Shareholders’ equity: Series A Preferred Stock, $0.001 par value, liquidation preference $50.00 per share, 4,400 shares issued and outstanding at December 31, 2002 and December 31, 2001 Series B Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 2,000 shares issued and outstanding at December 31, 2002 and December 31, 2001 Series C Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 1,300 shares issued and outstanding at December 31, 2002 and December 31, 2001 Series D Preferred Stock, $0.001 par value, liquidation preference $25.00 per share, 4,000 shares issued and outstanding at December 31, 2002 and December 31, 2001 High Performance Units Common Stock, $0.001 par value, 200,000 shares authorized, 98,114 and 87,387 shares issued and outstanding at December 31, 2002 and December 31, 2001, respectively Warrants and options Additional paid-in capital Retained earnings (deﬁcit) Accumulated other comprehensive income (losses) (See Note 12) Treasury stock (at cost) Total shareholders’ equity Total liabilities and shareholders’ equity Reclassiﬁed to conform to 2002 presentation. The accompanying notes are an integral part of the ﬁnancial statements. * ~ 2002 2001* (In thousands, except per share data) $3,050,342 2,291,805 30,611 28,501 15,934 40,211 26,804 36,739 90,750 $5,611,697 $2,377,763 1,781,565 60,794 – 15,670 17,852 31,797 21,195 74,004 $4,380,640 $ 117,001 5,225 3,461,590 3,583,816 – 2,581 $ 89,618 5,225 2,495,369 2,590,212 – 2,650 4 2 1 4 1,359 4 2 1 4 – 98 20,322 2,281,636 (227,769) (2,301) (48,056) 2,025,300 $5,611,697 87 20,456 1,997,931 (174,874) (15,092) (40,741) 1,787,778 $4,380,640 iStar Financial annual report consolidated statements of operations For the Year Ended December 31, Revenue: Interest income Operating lease income Other income Total revenue Costs and expenses: Interest expense Operating costs – corporate tenant lease assets Depreciation and amortization General and administrative General and administrative – stock-based compensation expense Provision for loan losses Total costs and expenses Net income before equity in earnings from joint ventures and unconsolidated subsidiaries, minority interest and other items Equity in earnings from joint ventures and unconsolidated subsidiaries Minority interest in consolidated entities Extraordinary loss on early extinguishment of debt Cumulative effect of change in accounting principle (See Note 3) Net income before discontinued operations Income from discontinued operations Gain from discontinued operations Net income Preferred dividend requirements Net income allocable to common shareholders Basic earnings per common share Diluted earnings per common share Reclassiﬁed to conform to 2002 presentation. The accompanying notes are an integral part of the ﬁnancial statements. * ~ 2002 2001* 2000* (In thousands, except per share data) $255,631 242,100 27,993 525,724 185,375 13,755 47,821 30,449 17,998 8,250 303,648 222,076 1,222 (162) (12,166) – 210,970 3,583 717 $215,270 (36,908) $178,362 1.98 $ 1.93 $ $254,119 185,943 31,057 471,119 169,974 12,782 35,411 24,151 3,574 7,000 252,892 218,227 7,361 (218) (1,620) (282) 223,468 5,299 1,145 $229,912 (36,908) $193,004 2.24 $ 2.19 $ $268,011 177,581 17,927 463,519 173,741 12,737 34,384 25,706 2,864 6,500 255,932 207,587 4,796 (195) (705) – 211,483 3,155 2,948 $217,586 (36,908) $180,678 2.11 $ 2.10 $ 2002 page .43 consolidated statements of cash ﬂows For the Year Ended December 31, Cash ﬂows from operating activities: Net income Adjustments to reconcile net income to cash ﬂows provided by operating activities: Minority interest in consolidated entities Non-cash expense for stock-based compensation Depreciation and amortization Depreciation and amortization from discontinued operations Amortization of discounts/premiums, deferred interest and costs on lending investments Discounts, loan fees and deferred interest received Equity in earnings from joint ventures and unconsolidated subsidiaries Distributions from operations of joint ventures Deferred operating lease income receivable Realized (gains)/losses on sale of securities Gain from discontinued operations Extraordinary loss on early extinguishment of debt Cumulative effect of change in accounting principle Provision for loan losses Change in investments in and advances to joint ventures and unconsolidated subsidiaries Changes in assets and liabilities: Decrease (increase) in accrued interest and operating lease income receivable Decrease (increase) in deferred expenses and other assets Increase (decrease) in accounts payable, accrued expenses and other liabilities Cash ﬂows provided by operating activities Cash ﬂows from investing activities: New investment originations Add-on fundings under existing loan commitments Net proceeds from sale of corporate tenant lease assets Net proceeds from lease termination payments Proceeds from sale of investment securities Repayments of and principal collections on loans and other lending investments Investments in and advances to joint ventures and unconsolidated subsidiaries Distributions from unconsolidated joint ventures Capital improvements for build-to-suit projects Capital improvement projects on corporate tenant lease assets Other capital expenditures on corporate tenant lease assets Cash ﬂows used in investing activities Cash ﬂows from ﬁnancing activities: Borrowings under revolving credit facilities Repayments under revolving credit facilities Borrowings under term loans Repayments under term loans Borrowings under secured bond offerings Repayments under secured bond offerings Borrowings under unsecured bond offerings Repayments under unsecured notes Borrowings under other debt obligations Repayments under other debt obligations (Increase) decrease in restricted cash held in connection with debt obligations Payments on early extinguishment of debt Payments for deferred ﬁnancing costs Distributions to minority interest in consolidated entities Common dividends paid(1) Preferred dividends paid Proceeds from equity offering Purchase of treasury stock Contribution from signiﬁcant shareholder Proceeds from exercise of options and issuance of DRIP shares Proceeds from high performance units issued to employees Cash ﬂows provided by (used in) ﬁnancing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Supplemental disclosure of cash ﬂow information: 2002 2001* 2000* (In thousands) $ 215,270 $ 229,912 $ 217,586 162 18,059 71,287 219 (33,086) 36,714 (1,222) 5,802 (15,265) – (717) 12,166 – 8,250 (6,598) 3,809 1,758 32,185 348,793 (1,812,993) (21,619) 3,702 17,500 – 671,965 (127) – (1,064) (2,277) (4,157) (1,149,070) 2,496,200 (2,122,994) 115,099 (18,279) 885,079 (475,679) – – 1,094 (1,668) (22,359) (3,950) (45,702) (231) (231,257) (36,578) 202,899 (6,981) 506 63,983 1,359 800,541 264 15,670 15,934 $ 218 3,574 55,831 213 (41,067) 28,425 (7,358) 4,802 (10,923) – (1,145) 1,620 282 7,000 (2,568) 5,083 (204) 19,565 293,260 (924,455) (99,626) 26,306 – – 650,970 (1,601) 24,265 (14,266) (6,629) (4,489) (349,525) 195 2,864 47,290 112 (27,059) 17,153 (4,753) 4,511 (9,130) 233 (2,948) 705 – 6,500 (447) (5,401) (25,841) (1,702) 219,868 (850,144) (56,039) 146,265 – 30 571,846 (27,490) 34,759 (5,022) (6,831) (1,179) (193,805) 2,420,638 (2,285,892) 277,664 (120,333) – (125,962) 350,000 (100,000) 279 (56,008) 2,590 (1,037) (30,382) (3,794) (264,527) (36,578) – – – 22,525 – 49,183 (7,082) 22,752 15,670 $ 2,304,099 (2,487,936) 90,000 (300,799) 863,254 (274,919) – – 65,067 (31,564) (10,246) (317) (21,048) (164) (202,397) (36,576) – (302) – 6,129 – (37,719) (11,656) 34,408 22,752 $ Cash paid during the period for interest, net of amount capitalized $ 157,618 $ 1 41,271 $ 141,632 * Reclassiﬁed to conform to 2002 presentation. Explanatory Note: (1) ~ For the year ended December 31, 2001, the $264.5 million of common dividends shown in the table represents ﬁve quarters of dividends, of which $51.4 million relates to the fourth quarter 2000 dividend (paid in January 2001). The accompanying notes are an integral part of the ﬁnancial statements. iStar Financial annual report consolidated statements of changes in shareholders’ equity Series B Series A Series D Preferred Preferred Preferred Preferred Stock Series C Stock Stock Stock High Accumulated Other Com- Perfor- Common Warrants and Stock mance Options at Par Units Additional Paid-In Capital Retained prehensive Income Earnings (Losses) (Deficit) Treasury Stock Total $4 – – – – – – – – – – $4 – – – – – – – – – – – $4 – – – – – – – – – – – $ – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 1,359 – – – – – – – – – – $85 2 – – – – – – – – – – $87 2 8 – – – – – – 1 – – (In thousands) $85 – – – – $17,935 $ 1,953,972 $ (129,992) – 7,089 (36,906) 330 (205,477) – – 3,637 (992) – – – – – – – – 1,125 – 212 31 – – – – – 217,586 – – – $16,943 $ 1,966,396 $ (154,789) – 22,550 (36,908) 330 (213,089) – – 1,219 (835) – – – $ $ (229) $ (40,439) $ 1,801,343 – 6,097 (36,576) – (205,477) – 3,637 – – – – – – – – – – – 1,125 – – (302) – 212 31 (302) 217,586 209 – 209 (20) $ (40,741) $ 1,787,885 21,717 – (36,578) – (213,089) – 1,219 – – – – – – 1,478 – – 4,348 – – 1,250 – 4,708 – – – – 229,912 – – – – – – – – (9,445) – – – – – – 1,478 1,250 4,348 4,708 229,912 (9,445) – – – $20,456 $ 1,997,931 $ (174,874) – 16,170 – 202,891 (36,908) 330 (231,257) – (443) – – – – (5,627) (5,627) $ (15,092) $ (40,741) $ 1,787,778 15,729 202,899 (36,578) (231,257) – – – – – – – – – 309 19,048 – – – – – – – 506 44,426 334 – – – – – – – 215,270 – – – – – – – – – – 19,048 309 1,359 – – (7,315) – 506 44,427 (6,981) 215,270 – $4 – $1,359 – $98 – – $20,322 $2,281,636 $(227,769) – 12,791 12,791 $ (2,301) $(48,056) $2,025,300 – Balance at January 1, 2000 Exercise of options Dividends declared – preferred Dividends declared – common Acquisition of ACRE Partners Restricted stock units issued to employees in lieu of cash bonuses Restricted stock units granted to employees Issuance of stock – DRIP plan Purchase of treasury shares Net income for the period Change in accumulated other comprehensive income Balance at December 31, 2000 Exercise of options Dividends declared – preferred Dividends declared – common Acquisition of ACRE Partners Restricted stock units issued to employees in lieu of cash bonuses Restricted stock units granted to employees Options granted to employees Issuance of stock – DRIP plan Net income for the period Cumulative effect of change in accounting principle Change in accumulated other comprehensive income Balance at December 31, 2001 Exercise of options Proceeds from equity offering Dividends declared – preferred Dividends declared – common Restricted stock units granted to employees Options granted to employees High performance units sold to employees Contributions from signiﬁcant shareholder Issuance of stock – DRIP plan Purchase of treasury shares Net income for the period Change in accumulated other comprehensive income Balance at December 31, 2002 $4 – – – – – – – – – – $4 – – – – – – – – – – – $4 – – – – – – – – – – – – $4 $2 – – – – – – – – – – $2 – – – – – – – – – – – $2 – – – – – – – – – – – – $2 $1 – – – – – – – – – – $1 – – – – – – – – – – – $1 – – – – – – – – – – – – $1 The accompanying notes are an integral part of the ﬁnancial statements. ~ 2002 page .45 notes to consolidated ﬁnancial statements Note 1 – Business and Organization Business – iStar Financial Inc. (the “Company”) is the leading publicly-traded ﬁnance company focused on the commercial real estate industry. The Company provides structured ﬁnancing to private and corporate owners of real estate nationwide, including senior and junior mortgage debt, corporate mezzanine and subordinated capital, and cor- porate net lease ﬁnancing. The Company, which is taxed as a real estate investment trust (“REIT”), seeks to deliver strong dividends and supe- rior risk-adjusted returns on equity to shareholders by providing inno- vative and value-added ﬁnancing solutions to its customers. The Company’s primary product lines include: Structured Finance. The Company provides senior and subordi- nated loans that typically range in size from $20 million to $100 mil- lion to borrowers holding high-quality real estate. These loans may be either ﬁxed or variable rate and are structured to meet the speciﬁc ﬁnancing needs of the borrowers, including the acquisition or ﬁnanc- ing of large, high-quality real estate. The Company offers borrowers a wide range of structured ﬁnance options, including ﬁrst mortgages, sec- ond mortgages, partnership loans, participating debt and interim facili- ties. The Company’s structured ﬁnance transactions have maturities generally ranging from three to ten years. As of December 31, 2002, based on gross carrying values, the Company’s structured finance assets represented 27.02% of its assets. Portfolio Finance. The Company provides funding to regional and national borrowers who own multiple facilities in geographically diverse portfolios. Loans are cross-collateralized to give the Company the beneﬁt of all available collateral and underwritten to recognize inherent portfolio diversiﬁcation. Property types include multifamily, suburban office, hotels and other property types where individual property values are less than $20 million on average. Loan terms are structured to meet the speciﬁc requirements of the borrower and typi- cally range in size from $25 million to $150 million. The Company’s portfolio ﬁnance transactions have maturities generally ranging from three to ten years. As of December 31, 2002, based on gross carrying values, the Company’s portfolio ﬁnance assets represented 7.08% of its assets. Corporate Finance. The Company provides senior and subordi- nated capital to corporations engaged in real estate or real estate-related businesses. Financings may be either secured or unsecured and typi- cally range in size from $20 million to $150 million. The Company’s corporate ﬁnance transactions have maturities generally ranging from ﬁve to ten years. As of December 31, 2002, based on gross carrying values, the Company’s corporate ﬁnance assets represented 12.18% of its assets. Loan Acquisition. The Company acquires whole loans and loan participations which present attractive risk-reward opportunities. Loans are generally acquired at a small discount to the principal bal- ance outstanding. Loan acquisitions typically range in size from $5 mil- lion to $100 million and are collateralized by all major property types. The Company’s loan acquisition transactions have maturities generally ranging from three to ten years. As of December 31, 2002, based on gross carrying values, the Company’s loan acquisition assets repre- sented 8.60% of its assets. Corporate Tenant Leasing. The Company provides capital to corporations and borrowers who control facilities leased to single credit- worthy tenants. The Company’s net leased assets are generally mission- critical headquarters or distribution facilities that are subject to long-term leases with rated corporate credit tenants, and which provide for all expenses at the property to be paid by the corporate tenant on a triple net lease basis. Corporate tenant lease transactions have terms generally ranging from ten to 20 years and typically range in size from $20 million to $150 million. As of December 31, 2002, based on gross carrying values, the Company’s corporate tenant lease assets repre- sented 43.64% of its assets. Servicing. Through its iStar Asset Services division, the Company provides rated loan servicing to third-party institutional loan portfolios, as well as to the Company’s own assets. The servicing busi- ness did not represent a meaningful percentage of the gross carrying value of the Company’s assets as of December 31, 2002. The Company’s investment strategy targets speciﬁc sectors of the real estate credit markets in which it believes it can deliver value- added, ﬂexible ﬁnancial solutions to its customers, thereby differentiat- ing its ﬁnancial products from those offered by other capital providers. The Company has implemented its investment strategy by: • Focusing on the origination of large, structured mortgage, corporate and lease ﬁnancings where customers require ﬂexible ﬁnan- cial solutions. • Avoiding commodity businesses in which there is signiﬁcant direct competition from other providers of capital such as conduit lending and investment in commercial or residential mortgage-backed securities. • Developing direct relationships with borrowers and corpo- rate customers as opposed to sourcing transactions solely through intermediaries. • Adding value beyond simply providing capital by offering borrowers and corporate customers speciﬁc lending expertise, ﬂexibil- ity, certainty and continuing relationships beyond the closing of a par- ticular ﬁnancing transaction. • Taking advantage of market anomalies in the real estate ﬁnancing markets when the Company believes credit is mispriced by other providers of capital, such as the spread between lease yields and the yields on corporate customers’ underlying credit obligations. Organization – The Company began its business in 1993 through private investment funds formed to capitalize on inefﬁciencies in the real estate ﬁnance market. In March 1998, these funds con- tributed their approximately $1.1 billion of assets to the Company’s predecessor in exchange for a controlling interest in that company. Since that time, the Company has grown by originating new lending and leasing transactions, as well as through corporate acquisitions. Speciﬁcally, in September 1998, the Company acquired the loan origination and servicing business of a major insurance company, and in December 1998, the Company acquired the mortgage and mez- zanine loan portfolio of its largest private competitor. Additionally, in November 1999, the Company acquired TriNet Corporate Realty Trust, Inc. (“TriNet” or the “Leasing Subsidiary”), then the largest publicly- traded company specializing in corporate sale/leaseback transactions for ofﬁce and industrial facilities (the “TriNet Acquisition”). The TriNet Acquisition was structured as a stock-for-stock merger of TriNet with a subsidiary of the Company. Concurrent with the TriNet Acquisition, the Company also acquired its former external advisor in exchange for shares of the Company’s common stock (“Common Stock”) and converted its organi- zational form to a Maryland corporation. As part of the conversion to a Maryland corporation, the Company replaced its former dual class common share structure with a single class of Common Stock. The Company’s Common Stock began trading on the New York Stock Exchange on November 4, 1999. Prior to this date, the Company’s com- mon shares were traded on the American Stock Exchange. Note 2 – Basis of Presentation The accompanying audited Consolidated Financial Statements have been prepared in conformity with generally accepted accounting principles in the United States of America (“GAAP”) for complete ﬁnan- cial statements. The Consolidated Financial Statements include the accounts of the Company, its qualiﬁed REIT subsidiaries, and its majority- owned and controlled partnerships. Certain other investments in partnerships or joint ventures which the Company does not control are also accounted for under the equity method (see Note 5 and 6). All signiﬁcant intercompany bal- ances and transactions have been eliminated in consolidation. iStar Financial annual report Note 3 – Summary of Signiﬁcant Accounting Policies Loans and other lending investments, net – As described in Note 4, “Loans and Other Lending Investments” includes the following invest- ments: senior mortgages, subordinate mortgages, corporate/partnership loans, other lending investments-loans and other lending investments- securities. Management considers nearly all of its loan and other lend- ing investments to be held-to-maturity, although a small number of investments may be classiﬁed as available-for-sale. Items classiﬁed as held-to-maturity are reﬂected at amortized historical cost, while items classified as available-for-sale are reported at fair values. Unrealized gains and losses on available-for-sale investments are included in “Accumulated other comprehensive income” on the Company’s Consolidated Balance Sheets, and are not included in the Company’s net income. Corporate tenant lease assets and depreciation – Corporate tenant lease assets are generally recorded at cost less accumulated deprecia- tion. Certain improvements and replacements are capitalized when they extend the useful life, increase capacity or improve the efﬁciency of the asset. Repairs and maintenance items are expensed as incurred. Depreciation is computed using the straight-line method of cost recov- ery over estimated useful lives of 40.0 years for facilities, ﬁve years for furniture and equipment, the shorter of the remaining lease term or expected life for tenant improvements and the remaining life of the facility for facility improvements. Corporate tenant lease assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell. The Company also periodically reviews long-lived assets to be held and used for an impairment in value whenever events or changes in cir- cumstances indicate that the carrying amount of such assets may not be recoverable. In management’s opinion, corporate tenant lease assets to be held and used are not carried at amounts in excess of their esti- mated recoverable amounts. Capitalized interest – The Company capitalizes interest costs incurred during the construction period on qualiﬁed build-to-suit proj- ects for corporate tenants, including investments in joint ventures accounted for under the equity method. Interest capitalized was approximately $70,000 and $1.0 million during the 12-month periods ended December 31, 2002 and 2001, respectively. Cash and cash equivalents – Cash and cash equivalents include cash held in banks or invested in money market funds with original maturity terms of less than 90 days. Restricted cash – Restricted cash represents amounts required to be maintained in escrow under certain of the Company’s debt obliga- tions and leasing transactions. Revenue recognition – The Company’s revenue recognition poli- cies are as follows: Loans and other lending investments: Management considers nearly all of its loans and other lending investments to be held-to- maturity, although a small number of investments may be classiﬁed as available-for-sale. The Company reﬂects held-to-maturity investments at amortized cost less allowance for loan losses, acquisition premiums or discounts, deferred loan fees and undisbursed loan funds. Unreal- ized gains and losses on available-for-sale investments are included in “Accumulated other comprehensive income” on the Company’s Consolidated Balance Sheets and are not included in the Company’s net income. On occasion, the Company may acquire loans at small premi- ums or discounts based on the credit characteristics of such loans. These premiums or discounts are recognized as yield adjustments over the lives of the related loans. If loans that were acquired at a premium or discount are prepaid, the Company immediately recognizes the unamortized premium or discount as a decrease or increase, respec- tively, in the prepayment gain or loss. Loan origination or exit fees, as well as direct loan origination costs, are also deferred and recognized over the lives of the related loans as a yield adjustment. Interest income is recognized using the effective interest method applied on a loan- by-loan basis. A small number of the Company’s loans provide for accrual of interest at speciﬁed rates which differ from current payment terms. Interest is recognized on such loans at the accrual rate subject to man- agement’s determination that accrued interest and outstanding prin- cipal are ultimately collectible, based on the underlying collateral and operations of the borrower. Prepayment penalties or yield maintenance payments from borrowers are recognized as additional income when received. Certain of the Company’s loan investments provide for additional interest based on the borrower’s operating cash ﬂow or appreciation of the underlying collateral. Such amounts are considered contingent interest and are reﬂected as income only upon certainty of collection. Leasing investments: Operating lease revenue is recognized on the straight-line method of accounting from the later of the date of the origination of the lease or the date of acquisition of the facility subject to existing leases. Accordingly, contractual lease payment increases are recognized evenly over the term of the lease. The cumulative difference between lease revenue recognized under this method and contractual lease payment terms is recorded as “Deferred operating lease income receivable” on the Company’s Consolidated Balance Sheets. Provision for loan losses – The Company’s accounting policies require that an allowance for estimated loan losses be maintained at a level that management, based upon an evaluation of known and inher- ent risks in the portfolio, considers adequate to provide for loan losses. In establishing loan loss provisions, management periodically evalu- ates and analyzes the Company’s assets, historical and industry loss experience, economic conditions and trends, collateral values and qual- ity, and other relevant factors. Speciﬁc valuation allowances are estab- lished for impaired loans in the amount by which the carrying value, before allowance for estimated losses, exceeds the fair value of collat- eral less disposition costs on an individual loan basis. Management considers a loan to be impaired when, based upon current information and events, it believes that it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement on a timely basis. Management measures these impaired loans at the fair value of the loans’ underlying collateral less estimated disposition costs. Impaired loans may be left on accrual sta- tus during the period the Company is pursuing repayment of the loan; however, these loans are placed on non-accrual status at such time as: (1) management believes that the potential risk exists that scheduled debt service payments will not be met within the coming 12 months; (2) the loans become 90 days delinquent; (3) management determines the borrower is incapable of, or has ceased efforts toward, curing the cause of the impairment; or (4) the net realizable value of the loan’s underlying collateral approximates the Company’s carrying value of such loan. While on non-accrual status, interest income is recognized only upon actual receipt. Impairment losses are recognized as direct write-downs of the related loan with a corresponding charge to the pro- vision for loan losses. Charge-offs occur when loans, or a portion thereof, are considered uncollectible and of such little value that further pursuit of collection is not warranted. Management also provides a loan portfolio reserve based upon its periodic evaluation and analysis of the portfolio, historical and industry loss experience, economic con- ditions and trends, collateral values and quality, and other relevant factors. The Company’s loans are generally secured by real estate assets or are corporate lending arrangements to entities with signiﬁ- cant rental real estate operations (i.e., an unsecured loan to a company which operates residential apartments or retail, industrial or ofﬁce facilities as rental real estate). While the underlying real estate assets for the corporate lending instruments may not serve as collateral for the Company’s investments in all cases, the Company evaluates the underlying real estate assets when estimating loan loss exposure because the Company’s loans generally have preclusions as to how much senior and/or secured debt the customer may borrow ahead of the Company’s position. 2002 page .47 Income taxes – The Company is subject to federal income taxa- tion at corporate rates on its “REIT taxable income”; however, the Company is allowed a deduction for the amount of dividends paid to its shareholders, thereby subjecting the distributed net income of the Company to taxation at the shareholder level only. In addition, the Company is allowed several other deductions in computing its “REIT taxable income,” including non-cash items such as depreciation expense. These deductions allow the Company to shelter a portion of its operating cash ﬂow from its dividend payout requirement under federal tax laws. The Company intends to operate in a manner consis- tent with and to elect to be treated as a REIT for tax purposes. iStar Operating Inc. (“iStar Operating”) and TriNet Management Operating Company, Inc. (“TMOC”), the Company’s REIT taxable subsidiaries, are not consolidated for federal income tax purposes and are taxed as cor- porations. For ﬁnancial reporting purposes, current and deferred taxes are provided for in the portion of earnings recognized by the Company with respect to its interest in iStar Operating and TMOC. Accordingly, except for the Company’s taxable subsidiaries, no current or deferred taxes are provided for in the Consolidated Financial Statements. See Note 6 for a detailed discussion on the ownership structure and opera- tions of iStar Operating and TMOC. Earnings (loss) per common share – In accordance with the Statement of Financial Accounting Standards No. 128 (“SFAS No. 128”), the Company presents both basic and diluted earnings per share (“EPS”). Basic earnings per share (“Basic EPS”) excludes dilution and is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding for the period. Diluted earnings per share (“Diluted EPS”) reﬂects the potential dilu- tion that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, where such exer- cise or conversion would result in a lower earnings per share amount. Reclassiﬁcations – Certain prior year amounts have been reclas- siﬁed in the Consolidated Financial Statements and the related notes to conform to the 2002 presentation. Use of estimates – The preparation of ﬁnancial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Change in accounting principle – In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133 (“SFAS No. 133”), “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 133 establishes accounting and reporting standards for derivative ﬁnancial instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of ﬁnancial position and measure those instruments at fair value. If cer- tain conditions are met, a derivative may be speciﬁcally designated as: (1) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized ﬁrm commitment; (2) a hedge of the exposure to variable cash ﬂows of a forecasted transaction; or (3) in certain circumstances, a hedge of a foreign currency exposure. On January 1, 2001, the Company adopted this pronouncement, as amended by Statement of Financial Accounting Standards No. 137 “Accounting for Derivative Instruments and Hedging Activities – Deferral of the Effective Date of FASB Statement No. 133” and Statement of Financial Accounting Standards No. 138 “Accounting for Certain Derivative Instruments and Certain Hedging Activities – an Amendment of FASB Statement No. 133.” Because the Company has primarily used deriva- tives as cash ﬂow hedges of interest rate risk only, the adoption of SFAS No. 133 did not have a material financial impact on the financial position and results of operations of the Company. However, should the Company change its current use of such derivatives, the adop- tion of SFAS No. 133 could have a more significant effect on the Company prospectively. Upon adoption, the Company recognized a charge to net income of approximately $282,000 and an additional charge of $9.4 million to “Accumulated other comprehensive income,” represent- ing the cumulative effect of the change in accounting principle. Other new accounting standards – In December 1999, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition in Financial Statements.” In June 2000, the SEC staff amended SAB 101 to provide registrants with additional time to implement SAB 101. The Company adopted SAB 101, as required, in the fourth quarter of ﬁscal 2000. The adoption of SAB 101 did not have a material ﬁnancial impact on the ﬁnancial position or the results of operations of the Company. In March 2000, the FASB issued FASB Interpretation No. 44 (“FIN 44”), “Accounting for Certain Transactions Involving Stock Compensation.” The Company was required to adopt FIN 44 effective July 1, 2000 with respect to certain provisions applicable to new awards, exchanges of awards in a business combination, modiﬁcations to outstanding awards, and changes in grantee status that occur on or after that date. FIN 44 addresses practice issues related to the applica- tion of Accounting Practice Bulletin Opinion No. 25, “Accounting for Stock Issued to Employees.” The initial adoption of FIN 44 by the Company did not have a signiﬁcant impact on the Company. In September 2000, the FASB issued Statement of Financial Accounting Standards No. 140 (“SFAS No. 140”), “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” This statement is applicable for transfers of assets and extinguishments of liabilities occurring after June 30, 2001. The Company adopted the provisions of this statement as required for all transactions entered into on or after April 1, 2001. The adoption of SFAS No. 140 did not have a signiﬁcant impact on the Company. In July 2001, the SEC released Staff Accounting Bulletin No. 102 (“SAB 102”), “Selected Loan Loss Allowance and Documentation Issues.” SAB 102 summarizes certain of the SEC’s views on the develop- ment, documentation and application of a systematic methodology for determining allowances for loan and lease losses. Adoption of SAB 102 by the Company did not have a signiﬁcant impact on the Company. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141 (“SFAS No. 141”), “Business Combinations” and Statement of Financial Accounting Standards No. 142 (“SFAS No. 142”), “Goodwill and Other Intangible Assets.” SFAS No. 141 requires the pur- chase method of accounting to be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also addresses the initial recognition and measurement of goodwill and other intangible assets acquired in business combinations and requires intangible assets to be recognized apart from goodwill if certain tests are met. SFAS No. 142 requires that goodwill not be amortized but instead be measured for impairment at least annually, or when events indicate that there may be an impairment. The Company adopted the provisions of both state- ments on January 1, 2002, as required, and the adoption did not have a signiﬁcant impact on the Company. In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 provides new guidance on the recognition of impairment losses on long-lived assets to be held and used or to be disposed of, and also broadens the deﬁnition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. SFAS No. 144 requires that current operations prior to the disposition of corporate tenant lease assets and prior period results of such opera- tions be presented in discontinued operations in the Company’s Consolidated Statements of Operations. The provisions of SFAS No. 144 are effective for ﬁnancial statements issued for ﬁscal years beginning after December 15, 2001, and must be applied at the begin- ning of a ﬁscal year. The Company adopted the provisions of this state- ment on January 1, 2002, as required, and it did not have a signiﬁcant ﬁnancial impact on the Company. iStar Financial annual report In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” an interpretation of FASB Statement of Financial Accounting Standards No. 5 (“SFAS No. 5”), “Accounting for Contingencies,” Statement of Financial Accounting Standards No. 57, “Related Party Disclosures,” Statement of Financial Accounting Standards No. 107, “Disclosures about Fair Value of Financial Instruments” and rescinds FASB Interpretation No. 34, “Disclosure of Indirect Guarantees of Indebtedness of Others, an Interpretation of SFAS No. 5.” It requires that upon issuance of a guarantee, the guarantor must recognize a liabil- ity for the fair value of the obligation it assumes under that guarantee regardless if the Company receives separately identiﬁable consideration (i.e., a premium). The new disclosure requirements are effective December 31, 2002. The adoption of FIN 45 did not have a material impact on the Company’s Consolidated Financial Statements, nor is it expected to have a material impact in the future. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 (“SFAS No. 148”), “Accounting for Stock- Based Compensation – Transition and Disclosure,” an amendment of FASB Statement No. 123 (“SFAS No. 123”). This statement provides alternative transition methods for a voluntary change to the fair value basis of accounting for stock-based employee compensation. However, this Statement does not permit the use of the original SFAS No. 123 prospective method of transition for changes to the fair value based method made in ﬁscal years beginning after December 15, 2003. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim ﬁnancial statements about the method of accounting for stock-based employee compensation, description of transition method utilized and the effect of the method used on reported results. The transition and annual disclosure provisions of SFAS No. 148 shall be applied for ﬁscal years ending after December 15, 2002. The new interim disclo- sure provisions are effective for the ﬁrst interim period beginning after December 15, 2002. The Company adopted SFAS No. 148 with retro- active application to January 1, 2002 with no material effect on the Company’s Consolidated Financial Statements. SFAS No. 148 disclosure requirements, including the effect on net income and earnings per share if the fair value-based method had been applied to all outstanding and unvested stock awards in each period, are presented below (in thousands except per share amounts): For the Year Ended December 31, Net income allocable to common shareholders, as reported Total stock-based compensation expense 2002 2001 2000 $178,362 $193,004 $180,678 determined under fair value-based method for all awards, net of related tax effects Pro forma net income Earnings per share: Basic – as reported Basic – pro forma Diluted – as reported Diluted – pro forma ~ (565) (275) $177,797 $192,299 $180,403 (705) $ $ 1.98 $ 1.98 1.93 $ 1.92 2.24 $ 2.23 2.19 $ 2.18 2.11 2.11 2.10 2.09 In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” an interpreta- tion of ARB 51. FIN 46 provides guidance on identifying entities for which control is achieved through means other than through voting rights (a “variable interest entity” or “VIE”), and how to determine when and which business enterprise should consolidate a VIE. In addition, In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145 (“SFAS No. 145”), “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 rescinds both FASB Statements No. 4 (“SFAS No. 4”), “Reporting Gains and Losses from Extinguishment of Debt,” and the amendment to SFAS No. 4, FASB Statement No. 64 (“SFAS No. 64”), “Extinguishments of Debt Made to Satisfy Sinking- Fund Requirements.” Through this rescission, SFAS No. 145 eliminates the requirement (in both SFAS No. 4 and SFAS No. 64) that gains and losses from the extinguishment of debt be aggregated and, if material, classiﬁed as an extraordinary item, net of the related income tax effect. An entity is not prohibited from classifying such gains and losses as extraordinary items, so long as they meet the criteria in paragraph 20 of Accounting Principles Board Opinion No. 30 (“APB 30”), “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”; however, due to the nature of the Company’s operations, such treatment may not be available to the Company. Any gains or losses on extinguishments of debt that were previously classi- ﬁed as extraordinary items in prior periods presented that do not meet the criteria in APB 30 for classiﬁcation as an extraordinary item will be reclassiﬁed to income from continuing operations. The provisions of SFAS No. 145 are effective for ﬁnancial statements issued for ﬁscal years beginning after May 15, 2002. The Company will adopt the provi- sions of this statement, as required, on January 1, 2003, at which time ($12.2) million and ($1.6) million will be reclassiﬁed to continuing operations for 2002 and 2001, respectively. In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 (“SFAS No. 146”), “Accounting for Exit or Disposal Activities,” to address signiﬁcant issues regarding the recog- nition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance that the Emerging Issues Task Force (“EITF”) has set forth in EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The scope of SFAS No. 146 also includes: (1) costs related to terminating a contract that is not a capital lease; and (2) ter- mination benefits received by employees involuntarily terminated under the terms of a one-time beneﬁt arrangement that is not an on- going beneﬁt arrangement or an individual deferred-compensation contract. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect SFAS No. 146 to have a material effect on the Company’s Consolidated Financial Statements. In September 2002, the FASB issued Statement of Financial Accounting Standards No. 147 (“SFAS No. 147”), “Acquisitions of Certain Financial Institutions,” an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9. SFAS No. 147 provides guidance on the accounting for the acquisitions of ﬁnancial institu- tions, except those acquisitions between two or more mutual enter- prises. SFAS No. 147 removes acquisitions of ﬁnancial institutions from the scope of both FASB No. 72, “Accounting for Certain Acquisitions of Banking or Thrift Institutions,” and FASB Interpretation No. 9, Applying APB Opinions No. 16 and 17, “When a Savings and Loan Association or a Similar Institution is Acquired in a Business Combination Accounted for by the Purchase Method,” and requires that those transactions be accounted for in accordance with SFAS No. 141 and SFAS No. 142. SFAS No. 147 also amends SFAS No. 144 to include in its scope long-term, customer-relationship intangible assets of ﬁnancial institutions such as depositor-relationship and borrower- relationship intangible assets and credit cardholder intangible assets. The Company adopted the provisions of this statement, as required, on October 1, 2002, and it did not have a signiﬁcant ﬁnancial impact on the Company’s Consolidated Financial Statements. 2002 page .49 FIN 46 requires that both the primary beneﬁciary and all other enter- prises with a signiﬁcant variable interest in a VIE make additional dis- closures. The transitional disclosure requirements will take effect almost immediately and are required for all ﬁnancial statements ini- tially issued after January 31, 2003. The adoption of FIN 46 is not expected to have a material impact on the Company. Note 4 – Loans and Other Lending Investments The following is a summary description of the Company’s loans and other lending investments (in thousands)(1): Number of Borrowers In Class Principal Balances Outstanding Carrying Value as of December 31, December 31, 2002 2001 29 $1,712,967 $1,675,797 $1,158,669 Type of Investment Senior Mortgages Underlying Property Type Ofﬁce/Residential/ Retail/Industrial/ Conference Center/ Mixed Use/Hotel/ Entertainment Subordinate Mortgages(4) Ofﬁce/Residential/ Retail/Mixed Use/Hotel 22 630,683 629,486 585,698 Corporate/ Partnership Loans Ofﬁce/Residential/ Retail/Mixed Use/ Hotel/Entertainment 20 463,507 441,028 395,083 Other Lending Investments – Loans(6) Other Lending Investments – Securities(7) Ofﬁce/Mixed Use 4 29,411 23,167 10,818 10 322,305 310,114 248,495 Ofﬁce/Residential/ Retail/Industrial/ Mixed Use/ Entertainment Gross Carrying Value Provision for Loan Losses Total, Net Explanatory Notes: $3,079,592 (29,250) $3,050,342 $2,398,763 (21,000) $2,377,763 Effective Maturity Dates Contractual Interest Contractual Interest 2003 to 2011 2003 to 2011 2003 to 2019 to 15.00% Variable: LIBOR +1.50% to to 6.50% Fixed: 7.00% to 15.00% Variable: LIBOR + 1.79% to 5.80% Fixed: 7.33% to 15.00% Variable: LIBOR + 3.50% to 6.50% Payment Rates(2) Accrual Rates(2) Fixed: 7.03% Fixed: 7.03% to 15.00% Variable: LIBOR + 1.50% to 6.50% Fixed: 7.32% to 17.00% Variable: LIBOR + 1.79% to 5.80% Fixed: 7.33% to 17.50% Variable: LIBOR + 3.50% to 6.50% 2006 to 2008 Fixed: 10.00% Fixed: 10.00% Variable: LIBOR + 4.75% Fixed: 6.75% to 12.50% Variable: LIBOR + 5.00% Variable: LIBOR + 4.75% Fixed: 6.75% to 12.50% Variable: LIBOR + 5.00% 2003 to 2013 Prin- cipal Amorti- zation Yes(3) Partici- pation Features No Yes(3) No Yes(3) Yes(5) No Yes(5) Yes(3) No Amounts and details are for loans outstanding as of December 31, 2002. Substantially all variable-rate loans are based on 30-day LIBOR and reprice monthly. The 30-day LIBOR on December 31, 2002 was 1.38%. As of December 31, 2002, three loans with a combined carrying value of $72.4 million have a stated accrual rate that exceeds the stated pay rate. The loans require ﬁxed payments of principal and interest resulting in partial principal amortization over the term of the loan with the remaining principal due at maturity. Includes a participation interest in a second mortgage and a subordinate interest in a private REMIC whose sole asset is a single ﬁrst mortgage loan. Under some of these loans, the lender receives additional payments representing additional interest from participation in available cash ﬂow from operations of the property. Includes one unsecured loan with a carrying value of $403 as of December 31, 2001 which was subsequently repaid in October 2002. Generally consists of term preferred stock or debt interests that are speciﬁcally originated or structured to meet customer ﬁnancing requirements and the Company’s investment criteria. These investments do not typically consist of securities purchased in the open market or as part of broadly-distributed offerings. In addition, one of these securities is classiﬁed as available-for-sale and is reﬂected at fair value with a corresponding entry to “Accumulated other comprehensive income” on the Company’s Consolidated Balance Sheets. (1) (2) (3) (4) (5) (6) (7) ~ During the 12-month periods ended December 31, 2002 and 2001, respectively, the Company and its afﬁliated ventures originated or acquired an aggregate of approximately $1,403.8 million and $700.6 million in loans and other lending investments, funded $21.6 million and $99.6 million under existing loan commitments, and received principal repayments of $672.0 million and $651.0 million. As of December 31, 2002, the Company had nine loans with unfunded commitments. The total unfunded commitment amount was approximately $97.7 million, of which $22.2 million was discretionary and $75.5 million was non-discretionary. The Company’s loans and other lending investments are predominantly pledged as collateral under either the iStar Asset Receivables secured notes, the secured revolving credit facilities or secured term loans (see Note 7). The Company has reflected provisions for loan losses of approximately $8.3 million, $7.0 million and $6.5 million during the years ended December 31, 2002, 2001 and 2000, respectively. These pro- visions represent loan portfolio reserves based on management’s evalu- ation of general market conditions, the Company’s internal risk management policies and credit risk ratings system, industry loss iStar Financial annual report experience, the likelihood of delinquencies or defaults, and the credit quality of the underlying collateral. No direct impairment reserves on speciﬁc loans were considered necessary. Note 5 – Corporate Tenant Lease Assets During the 12-month periods ended December 31, 2002 and 2001, respectively, the Company acquired an aggregate of approxi- mately $409.1 million and $223.9 million in corporate tenant lease assets and disposed of corporate tenant lease assets for net proceeds of approximately $3.7 million and $26.3 million. The Company’s investments in corporate tenant lease assets, at cost, were as follows (in thousands): December 31, Facilities and improvements Land and land improvements Direct ﬁnancing lease Less: accumulated depreciation Corporate tenant lease assets, net ~ 2002 2001 $1,959,309 428,365 32,640 (128,509) $2,291,805 $1,504,956 356,830 – (80,221) $1,781,565 The Company’s CTL assets are leased to customers with initial term expiration dates from 2003 to 2023. Future operating lease pay- ments under non-cancelable leases, excluding customer reimburse- ments of expenses, in effect at December 31, 2002, are approximately as follows (in thousands): Year 2003 2004 2005 2006 2007 Thereafter ~ Amount $ 245,462 231,605 218,209 200,433 177,352 1,481,235 Under certain leases, the Company receives additional partici- pating lease payments to the extent gross revenues of the corporate tenant exceed a base amount. The Company earned $0, $0.4 million and $0.6 million of such additional participating lease payments in the years ended December 31, 2002, 2001 and 2000, respectively. In addition, the Company also receives reimbursements from customers for certain facility operating expenses including common area costs, insurance and real estate taxes. Customer expense reimbursements for the 12 months ended December 31, 2002, 2001 and 2000 were approxi- mately $30.3 million, $25.8 million and $25.3 million, respectively, and are included as a reduction of “Operating costs – corporate tenant lease assets” on the Company’s Consolidated Statements of Operations. The Company is subject to expansion option agreements with two existing customers which could require the Company to fund and to construct up to 161,000 square feet of additional adjacent space on which the Company would receive additional operating lease income under the terms of the option agreements. In addition, upon exercise of such expansion option agreements, the corporate tenants would be required to simultaneously extend their existing lease terms for addi- tional periods ranging from six to ten years. On September 30, 2002, one of the Company’s customers exercised an option to terminate its lease on 50.00% of the land leased from the Company. In connection with this termination, the Company realized $17.5 million in cash lease termination payments, offset by a $17.4 million impairment charge in connection with the termination, resulting in net gain of approximately $123,000. In the fourth quarter of 2002, the customer completed a recapitalization transaction that signiﬁcantly enhanced its credit. In connection with this recapitaliza- tion, the Company agreed to amend the customer’s lease, effective October 1, 2002. In the lease amendment, the Company received $12.5 million in cash as prepaid lease payments and the customer agreed to fixed minimum increases on future lease payments. In exchange, the Company agreed to reduce the customer’s lease obliga- tions for a period not to exceed nine quarters. Following the reduction period, the customer is required to make additional lease payments over a 10-year period sufﬁcient to reimburse the Company for a portion of the temporary reduction in lease payments. In addition, on May 30, 2002, the Company sold one tenant lease asset for net proceeds of $3.7 million, and realized a gain of approximately $595,000. As of December 31, 2002, there were two cor- porate tenant lease assets with a combined book value of $28.5 million classified as “Assets held for sale” on the Company’s Consolidated Balance Sheets. The results of operations from corporate tenant lease assets sold or held for sale in the current period are classiﬁed as “Income from discontinued operations” even though such income was actually received by the Company prior to the asset sale. Gains on sale from cor- porate tenant lease assets are also classiﬁed as “Gain from discontinued operations” on the Company’s Consolidated Statements of Operations. Note 6 – Joint Ventures and Unconsolidated Subsidiaries The Company’s ownership percentages, its investments in and advances to unconsolidated joint ventures and subsidiaries, its respective income (loss) and the Company’s pro rata share of its ventures’ third-party, non-recourse debt as of December 31, 2002 are presented below (in thousands): Unconsolidated Joint Ventures and Subsidiaries Unconsolidated Joint Ventures: Ownership % Equity Investment Sunnyvale CTC I ACRE Simon Milpitas Sierra Unconsolidated Subsidiaries: iStar Operating TMOC Total Explanatory Notes: 44.70% 50.00% 20.00% N/A N/A 95.00% 95.00% $12,323 12,407 5,147 N/A N/A 599 135 $30,611 JV Income (Loss) for the Year Ended December 31, 2002 $2,144 1,429 32 1,512 (36) (3,859) – $1,222 Pro Rata Share of Third-Party Non-Recourse Debt(1) Interest Rate $10,728 60,115 6,511 N/A N/A – – $77,354 LIBOR + 1.25% 7.66% – 7.87% 7.61% – 8.43% N/A N/A N/A N/A Third-Party Debt Scheduled Maturity Date November 2004(2) Various through 2011 Various through 2011 N/A N/A N/A N/A The Company reﬂects its pro rata share of third-party, non-recourse debt, rather than the total amount of the joint venture debt, because the third-party, non-recourse debt held by the joint ventures is not guaranteed by the Company nor does the Company have any additional commitments to fund such debt obligations. Maturity date reﬂects a one-year extension at the venture’s option. (1) (2) ~ 2002 page .51 Investments in and advances to unconsolidated joint ventures: At December 31, 2002, the Company had investments in three joint ven- tures: (1) TriNet Sunnyvale Partners L.P. (“Sunnyvale”), whose external partners are John D. O’Donnell, Trustee, John W. Hopkins, and Donald S. Grant, Trustee; (2) Corporate Technology Centre Associates, LLC (“CTC I”), whose external member is Corporate Technology Centre Partners, LLC; and (3) ACRE Simon, LLC (“ACRE”), whose external part- ner is William E. Simon & Sons Realty Investments, LLC. These ven- tures were formed for the purpose of operating, acquiring and, in certain cases, developing corporate tenant lease facilities. At December 31, 2002, the ventures comprised 12 net leased facilities. The Company’s combined investment in these joint ventures at December 31, 2002 was $30.6 million. The joint ventures’ carrying value for the 12 facilities owned at December 31, 2002 was $196.2 mil- lion. In aggregate, the joint ventures had total assets of $236.2 million and total liabilities of $186.4 million as of December 31, 2002, and net income of $7.0 million for the 12 months ended December 31, 2002. The Company accounts for these investments under the equity method because the Company’s joint venture partners have certain participat- ing rights giving them shared control over the ventures. Effective September 29, 2000, iStar Sunnyvale Partners, LP, which is wholly owned by Sunnyvale, entered into an interest rate cap agreement limiting the venture’s exposure to interest rate movements on its $24.0 million LIBOR-based mortgage loan to an interest rate of 9.00% through November 9, 2003. Currently, the limited partners of Sunnyvale have the option to convert their partnership interest into cash; however, the Company may elect to deliver 297,728 shares of Common Stock in lieu of cash. On April 1, 2002, the former Sierra Land Ventures (“Sierra”) joint venture partner assigned its 50.00% ownership interest in Sierra to a wholly owned subsidiary of the Company. There was no cash or shares exchanged in this transaction. As of April 1, 2002, the Company owns 100.00% of the corporate tenant lease asset previously held by Sierra and therefore consolidates this asset for accounting purposes. On July 2, 2002, the Company paid approximately $27.9 mil- lion in cash to the former member of TriNet Milpitas Associates (“Milpitas”) joint venture in exchange for its 50.00% ownership interest. Pursuant to the terms of the joint venture agreement, the former external member had the right to convert its interest into 984,476 shares of Common Stock of the Company at any time during the period February 1, 2002 through January 31, 2003. On May 2, 2002, the former Milpitas external member exercised this right. Upon the external member’s exercise of its conversion right, the Company had the option to acquire the partner’s interest for cash, instead of shares, for a payment equal to the value of 984,476 shares of Common Stock multi- plied by the ten-day average closing stock price as of the transaction date. The Company made such election and, as of July 2, 2002, owns 100.00% of Milpitas, and therefore consolidates these assets for accounting pur- poses. The Company accounted for the acquisition of the external inter- est using the purchase method. Income generated from the Company’s joint venture invest- ments and unconsolidated subsidiaries is included in “Equity in earn- ings from joint ventures and unconsolidated subsidiaries” on the Company’s Consolidated Statements of Operations. Investments in and advances to unconsolidated subsidiaries: The Company has an investment in iStar Operating, a taxable subsidiary that, through a wholly-owned subsidiary, services the Company’s loans and certain loan portfolios owned by third parties. The Company owns all of the non-voting preferred stock and a 95.00% economic interest in iStar Operating. An afﬁliate of the Company’s largest shareholder is the owner of all the voting common stock and a 5.00% economic interest in iStar Operating. As of December 31, 2002, there have never been any distributions to the common shareholder, nor does the Company expect to make any in the future. At any time, the Company has the right to acquire all of the common stock of iStar Operating at fair mar- ket value, which the Company believes to be nominal. In addition to the direct general and administrative costs of iStar Operating, the Company allocates a portion of its general overhead expenses to iStar Operating based on the number of employees at iStar Operating as a percentage of the Company’s total employees. In addition, the Company has an investment in TMOC, a tax- able noncontrolled subsidiary that has a $2.0 million investment in a real estate company based in Mexico. The Company owns 95.00% of the outstanding voting and non-voting common stock (representing 1.00% voting power and 95.00% of the economic interest) in TMOC. The other two owners of TMOC stock are executives of the Company, who own a combined 5.00% of the outstanding voting and non-voting common stock (representing 99.00% voting power and 5.00% eco- nomic interest) in TMOC. As of December 31, 2002, there have never been any distributions to the common shareholders, nor does the Company expect to make any in the future. At any time, the Company has the right to acquire all of the common stock of TMOC at fair market value, which the Company believes to be nominal. Both iStar Operating and TMOC have elected to be treated as taxable REIT subsidiaries for purposes of maintaining compliance with the REIT provisions of the Code and are accounted for under the equity method for ﬁnancial statement reporting purposes and are pre- sented in “Investments in and advances to joint ventures and uncon- solidated subsidiaries” on the Company’s Consolidated Balance Sheets. If they were consolidated with the Company for ﬁnancial statement purposes, they would not have a material impact on the Company’s operations. As of December 31, 2002, iStar Operating and TMOC have no debt obligations. iStar Financial annual report Note 7 – Debt Obligations As of December 31, 2002 and 2001, the Company has debt obligations under various arrangements with ﬁnancial institutions as follows (in thousands): Secured revolving credit facilities: Line of credit Line of credit Line of credit Line of credit Unsecured revolving credit facilities: Line of credit Total revolving credit facilities Secured term loans: Secured by corporate tenant lease assets Secured by corporate tenant lease assets Secured by corporate tenant lease assets Secured by corporate lending investments Secured by corporate lending investments Secured by corporate lending investments Secured by corporate lending investments Total term loans Less: debt (discount) premium Total secured term loans iStar Asset Receivables secured notes: STARs Series 2000-1: Class A Class B Class C Class D Class E Class F STARs Series 2002-1: Class A1 Class A2 Class B Class C Class D Class E Class F Class G Class H Class J Class K Total iStar Asset Receivables secured notes Less: debt discount Total iStar Asset Receivables secured notes Unsecured notes: 6.75% Dealer Remarketable Securities(6)(7)(8) 7.70% Notes(6)(8) 7.95% Notes(6)(8) 8.75% Notes Total unsecured notes Less: debt discount Plus: impact of pay-ﬂoating swap agreements(9) Total unsecured notes Other debt obligations Total debt obligations Maximum Amount Available $ 700,000 700,000 500,000 500,000 Carrying Value as of December 31, 2002 December 31, 2001 Stated Interest Rates(1) $ 412,550 462,920 283,884 114,400 $ 312,300 439,309 148,937 – LIBOR + 1.75% – 2.25% LIBOR + 1.40% – 2.15% LIBOR + 1.50% – 1.75% LIBOR + 1.50% – 2.25% Scheduled Maturity Date March 2005(2) January 2005(2) August 2005(2) September 2005 300,000 $2,700,000 – $1,273,754 193,000 144,114 95,074 79,126 61,537 60,000 50,000 682,851 (236) 682,615 – – – – – – 236,694 381,296 39,955 26,637 21,310 42,619 26,637 21,309 26,637 26,637 26,637 876,368 (4,425) 871,943 LIBOR + 2.125% July 2004(3) LIBOR + 1.85% 7.44% 6.00% – 11.38% 6.55% 6.41% LIBOR + 2.50% LIBOR + 2.50% July 2006(4) March 2009 Various through 2022 November 2005 December 2012 June 2004(3) July 2006(3) LIBOR + 0.30% LIBOR + 0.50% LIBOR + 1.00% LIBOR + 1.45% LIBOR + 2.75% LIBOR + 3.15% LIBOR + 0.26% LIBOR + 0.38% LIBOR + 0.65% LIBOR + 0.75% LIBOR + 0.85% LIBOR + 1.235% LIBOR + 1.335% LIBOR + 1.435% 6.35% 6.35% 6.35% August 2003 October 2003 January 2004 June 2004 January 2005 January 2005 June 2004(5) December 2009(5) April 2011(5) May 2011(5) January 2012(5) January 2012(5) January 2012(5) January 2012(5) January 2012(5) May 2012(5) May 2012(5) – 900,546 193,000 147,520 55,819 – – 60,000 50,000 506,339 274 506,613 81,152 94,055 105,813 52,906 123,447 5,000 – – – – – – – – – – – 462,373 – 462,373 125,000 100,000 50,000 350,000 625,000 (11,603) 3,920 617,317 15,961 $3,461,590 125,000 100,000 50,000 350,000 625,000 (15,698) – 609,302 16,535 $2,495,369 6.75% 7.70% 7.95% 8.75% March 2013 July 2017 May 2006 August 2008 Various Various Explanatory Notes: (1) (2) (3) (4) (5) (6) (7) (8) (9) Substantially all variable-rate debt obligations are based on 30-day LIBOR and reprice monthly. The 30-day LIBOR rate on December 31, 2002 was 1.38%. Maturity date reﬂects a one-year “term-out” extension at the Company’s option. Subsequent to December 31, 2002, the Company extended the ﬁnal maturity date on the $700.0 million facility maturing January 2005 to January 2007. Maturity date reﬂects a one-year extension at the Company’s option. Maturity date reﬂects two one-year extensions at the Company’s option. Principal payments on these bonds are a function of the principal repayments on loan or corporate tenant lease assets which collateralize these obligations. The dates indicated above represent the expected date on which the ﬁnal payment would occur for such class based on the assumptions that the loans which collateralize the obligations are not voluntarily prepaid, the loans are paid on their effective maturity dates and no extensions of the effective maturity dates of any of the loans are granted. The ﬁnal maturity date for the underlying indenture on class A1 is May 28, 2017 and the ﬁnal maturity date for classes A2, B, C, D, E, F, G, H, J and K is May 28, 2020. The notes are callable by the Company at any time for an amount equal to the total of principal outstanding, accrued interest and the applicable make-whole prepayment premium. Subject to mandatory tender on March 1, 2003, to either the dealer or the Company. The initial coupon of 6.75% applies to the ﬁrst ﬁve-year term through the mandatory tender date. If tendered to the dealer, the notes must be remarketed. The rates reset to then-prevailing market rates upon remarketing. Subsequent to December 31, 2002, the Company modiﬁed the terms of these notes (see Note 17). These obligations were assumed as part of the acquisition of TriNet. As part of the accounting for the purchase, these ﬁxed-rate obligations were considered to have stated interest rates which were below the then-prevailing market rates at which the Leasing Subsidiary could issue new debt obligations and, accordingly, the Company ascribed a market discount to each obligation. Such discounts are amortized as an adjustment to interest expense using the effective interest method over the related term of the obligations. As adjusted, the effective annual interest rates on these obligations were 8.81%, 9.51% and 9.04% for the 6.75% Dealer Remarketable Securities, 7.70% Notes and 7.95% Notes, respectively. On November 27, 2002, the Company entered into two pay-ﬂoating interest rate swaps struck at 3.8775% and 3.81% and in the notional amounts of $100.0 million and $50.0 million, respectively. These swaps mitigate the risk of changes in the fair value of $150.0 million of the Company’s 8.75% Notes attributable to changes in LIBOR. For accounting purposes, quarterly the Company adjusts the value of the swap to its fair value and adjusts the carrying amount of the hedged liability by an offsetting amount. 2002 page .53 Availability of amounts under the secured revolving credit facilities are based on percentage borrowing base calculations. In addi- tion, certain of the Company’s debt obligations contain covenants. These covenants are both financial and non-financial in nature. Signiﬁcant ﬁnancial covenants include limitations on the Company’s ability to incur indebtedness beyond speciﬁed levels, restrictions on the Company’s ability to incur liens on assets and limitations on the amount and type of restricted payments, such as repurchases of its own equity securities, that the Company makes. Signiﬁcant non-ﬁnancial covenants include a requirement in its publicly-held debt securities that the Company offer to repurchase those securities at a premium if the Company undergoes a change of control. As of December 31, 2002, the Company believes it is in compliance with both ﬁnancial and non- ﬁnancial covenants on its debt obligations. On May 17, 2000, the Company closed the inaugural offering under its proprietary matched funding program, STARs, Series 2000-1. In the initial transaction, a wholly-owned subsidiary of the Company issued $896.5 million of investment-grade bonds secured by the sub- sidiary’s assets, which had an aggregate outstanding principal balance of approximately $1.2 billion at inception. Principal payments received on the assets were utilized to repay the most senior class of the bonds then outstanding. The maturity of the bonds match funded the matu- rity of the underlying assets ﬁnanced under the program. Of the assets of the subsidiary secured by this ﬁnancing, 73.96% (by gross carrying value) consisted of ﬁrst mortgages and subsequent lien positions and the remaining 26.04% consisted of junior loans. For accounting purposes, this transaction was treated as a secured financing: the underlying assets and STARs liabilities remained on the Company’s Consolidated Balance Sheets and no gain on sale was recognized. On May 28, 2002, the Company fully repaid these bonds. On January 11, 2001, the Company closed a new $700.0 mil- lion secured revolving credit facility which is led by a major commer- cial bank. The new facility has a three-year primary term and one-year “term-out” extension option, and bears interest at LIBOR + 1.40% to 2.15%, depending upon the collateral contributed to the borrowing base. The new facility accepts a broad range of structured ﬁnance assets and has a ﬁnal maturity of January 2005. Subsequent to December 31, 2002, the Company extended the final maturity on this facility to January 2007. On February 22, 2001, the Company extended the maturity of its $350.0 million unsecured revolving credit facility to May 2002. On July 27, 2001, the Company repaid this facility and replaced it with a new $300.0 million unsecured revolving credit facility. On May 15, 2001, the Company repaid its $100.0 million 7.30% unsecured notes. These notes were senior unsecured obligations of the Leasing Subsidiary and ranked equally with the Leasing Subsidiary’s other senior unsecured and unsubordinated indebtedness. On June 14, 2001, the Company closed $193.0 million of term loan ﬁnancing secured by 15 corporate tenant lease assets. The variable- rate loan bears interest at LIBOR + 1.85% (not to exceed 10.00% in aggregate) and has two one-year extensions at the Company’s option. The Company used these proceeds to repay a $77.8 million secured term loan maturing in June 2001 and to pay down a portion of its revolving credit facilities. In addition, the Company extended the matu- rity of its $500.0 million secured revolving credit facility to August 2003. On March 29, 2002, the Company again extended the ﬁnal maturity of this facility to August 2005, which includes a one-year “term-out” exten- sion at the Company’s option. On July 6, 2001, the Company ﬁnanced a $75.0 million struc- tured ﬁnance asset with a $50.0 million term loan bearing interest at LIBOR + 2.50%. The loan has a maturity of July 2006, including a one- year extension at the Company’s option. This investment is a $75.0 mil- lion term preferred investment in a publicly-traded real estate customer. The Company’s investment carries an initial current yield of 10.50%, with annual increases of 0.50% in each of the next two years. In addition, the Company’s investment is convertible into the cus- tomer’s common stock at a strike price of $25.00 per share. The invest- ment is callable by the customer between months 13 and 30 of the term at a yield maintenance premium, and after month 30, at a premium sufficient to generate a 14.62% internal rate of return on the Company’s investment. The investment is putable by the Company to the customer for cash after ﬁve years. On July 27, 2001, the Company completed a $300.0 million unsecured revolving credit facility with a group of leading ﬁnancial institutions. The new facility has an initial maturity of July 2003, with a one-year extension at the Company’s option and another one- year extension at the lenders’ option. The new facility replaces two prior credit facilities maturing in 2002 and 2003, and bears inter- est at LIBOR + 2.125%. On August 9, 2001, the Company issued $350.0 million of 8.75% senior notes due in 2008. The notes are unsecured senior obliga- tions of the Company. The Company used the net proceeds to repay outstanding borrowings under its secured credit facilities. On March 29, 2002, the Company extended the maturity of its $500.0 million secured facility to August 2005, which includes a one- year “term-out” extension at the Company’s option. On May 28, 2002, the Company fully repaid the then remain- ing $446.2 million of bonds outstanding under its STARs, Series 2000-1 ﬁnancing. Simultaneously, a wholly-owned subsidiary of the Company issued STARs, Series 2002-1, consisting of $885.1 million of investment-grade bonds secured by the subsidiary’s structured ﬁnance and corporate tenant lease assets, which had an aggregate out- standing principal balance of approximately $1.1 billion at inception. Principal payments received on the assets will be utilized to repay the most senior class of the bonds then outstanding. The maturity of the bonds match funds the maturity of the underlying assets ﬁnanced under the program. The weighted average interest rate on the bonds, on an all-ﬂoating rate basis, was approximately LIBOR + 0.56% at inception. For accounting purposes, this transaction was treated as a secured financing: the underlying assets and STARs liabilities remained on the Company’s Consolidated Balance Sheets, and no gain on sale was recognized. On July 2, 2002, the Company purchased the remaining inter- est in the Milpitas joint venture from the former Milpitas external member for $27.9 million. Upon purchase of the interest, the Milpitas joint venture became fully consolidated for accounting purposes and approximately $79.1 million of secured term debt is reﬂected on the Company’s Consolidated Balance Sheets. On September 30, 2002, the Company closed a new $500.0 million secured revolving credit facility with a leading ﬁnancial institution. The new facility has a three-year term and bears interest at LIBOR + 1.50% to 2.25%, depending upon the collateral contributed to the borrowing base. The new facility accepts a broad range of struc- tured ﬁnance and corporate tenant assets and has a ﬁnal maturity date of September 2005. On December 11, 2002, the Company closed a $61.5 million term loan ﬁnancing with a leading ﬁnancial institution. The proceeds were used to fund a portion of an $82.1 million CTL investment. The non-recourse loan is ﬁxed rate and bears interest at 6.412%, has a matu- rity date of December 2012 and amortizes over a 30-year schedule. During the years ended December 31, 2002 and 2001, the Company incurred an extraordinary loss of approximately $12.2 mil- lion and $1.6 million, respectively, as a result of the early retirement of certain debt obligations. Subsequent to December 31, 2002, the Company modiﬁed the terms of the 6.75% Dealer Remarketable Securities (see Note 17). iStar Financial annual report As of December 31, 2002, future expected/scheduled maturities of outstanding long-term debt obligations are as follows (in thousands):(1) 2003 2004 2005 2006 2007 Thereafter Total principal maturities Net unamortized debt discounts Impact of pay-ﬂoating swap agreement Total debt obligations Explanatory Note: $ 15,961 296,694 1,355,965 293,000 2,975 1,509,339 3,473,934 (16,264) 3,920 $3,461,590 Assumes exercise of extensions to the extent such extensions are at the Company’s option. (1) ~ Note 8 – Shareholders’ Equity The Company’s charter provides for the issuance of up to 200.0 million shares of Common Stock, par value $0.001 per share, and 30.0 million shares of preferred stock. The Company has 4.4 million shares of 9.50% Series A Cumulative Redeemable Preferred Stock, 2.3 million shares of 9.375% Series B Cumulative Redeemable Preferred Stock, 1.5 million shares of 9.20% Series C Cumulative Redeemable Preferred Stock, and 4.6 million shares of 8.00% Series D Cumulative Redeemable Preferred Stock. The Series A, B, C and D Cumulative Redeemable Preferred Stock are redeemable without pre- mium at the option of the Company at their respective liquidation pref- erences beginning on December 15, 2003, June 15, 2001, August 15, 2001 and October 8, 2002, respectively. On December 15, 1998, the Company issued warrants to acquire 6.1 million shares of Common Stock, as adjusted for dilution, at $34.35 per share. The warrants are exercisable on or after December 15, 1999 at a price of $34.35 per share and expire on December 15, 2005. Concentration of Shareholder Ownership – On October 30, 2001, SOF IV SMT Holdings, L.P. (“SOF IV”) and certain of its afﬁliates sold 18.975 million shares of Common Stock owned by them (including the subsequently-exercised 2.475 million share over-allotment option granted to the underwriters). In addition, on May 15, 2002, SOF IV sold 10.808 million shares of Common Stock owned by them (including the subsequently-exercised 808,200 share over-allotment option granted to the underwriters). Further, on November 14, 2002, SOF IV sold 3.5 mil- lion shares of Common Stock owned by them (including the subse- quently-exercised 1.5 million over-allotment option granted to the underwriters). The Company did not sell any shares in the ﬁrst two offerings. In the November 2002 offering, the Company sold 8.0 mil- lion primary shares and received net proceeds of approximately $202.9 million. As a result of the secondary offerings, SOF IV currently owns approximately 19.84% of the Company’s Common Stock (based on the diluted sharecount as of December 31, 2002). DRIP Program – The Company maintains a dividend reinvest- ment and direct stock purchase plan. Under the dividend reinvestment component of the plan, the Company’s shareholders may purchase additional shares of Common Stock without payment of brokerage commissions or service charges by automatically reinvesting all or a portion of their Common Stock cash dividends. Under the direct stock purchase component of the plan, the Company’s shareholders and new investors may purchase shares of Common Stock directly from the Company without payment of brokerage commissions or service charges. All purchases of shares in excess of $10,000 per month pur- suant to the direct purchase component are at the Company’s sole dis- cretion. Shares issued under the plan may reﬂect a discount of up to 3.00% from the prevailing market price of the Company’s Common Stock. The Company is authorized to issue up to 8.0 million shares of Common Stock pursuant to the dividend reinvestment and direct stock purchase plan. During the 12-month periods ended December 31, 2002 and 2001, the Company issued a total of 1.6 million and approximately 195,000 shares of its Common Stock, respectively, through the direct stock purchase component of the plan. Net proceeds during the 12-month periods ended December 31, 2002 and 2001 were approxi- mately $44.4 million and $4.7 million, respectively. Stock Repurchase Program – The Board of Directors approved, and the Company has implemented, a stock repurchase program under which the Company is authorized to repurchase up to 5.0 million shares of its Common Stock from time to time, primarily using pro- ceeds from the disposition of assets or loan repayments and excess cash ﬂow from operations, but also using borrowings under its credit facili- ties if the Company determines that it is advantageous to do so. As of December 31, 2001, the Company had repurchased a total of approxi- mately 2.3 million shares at an aggregate cost of approximately $40.7 million. The Company did not repurchase any shares under the stock repurchase program in 2002. Note 9 – Risk Management and Use of Financial Instruments Risk management – In the normal course of its on-going busi- ness operations, the Company encounters economic risk. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or different bases, than its interest-earning assets. Credit risk is the risk of default on the Company’s lending investments that results from a property’s, borrower’s or corporate tenant’s inability or unwill- ingness to make contractually required payments. Market risk reﬂects changes in the value of loans due to changes in interest rates or other market factors, including the rate of prepayments of principal and the value of the collateral underlying loans and the valuation of corporate tenant lease facilities held by the Company. Use of derivative ﬁnancial instruments – The Company’s use of derivative ﬁnancial instruments is primarily limited to the utilization of interest rate agreements or other instruments to manage interest rate risk exposure. The principal objective of such arrangements is to minimize the risks and/or costs associated with the Company’s operat- ing and ﬁnancial structure as well as to hedge speciﬁc anticipated transactions. The counterparties to these contractual arrangements are major ﬁnancial institutions with which the Company and its afﬁliates may also have other ﬁnancial relationships. The Company is poten- tially exposed to credit loss in the event of nonperformance by these counterparties. However, because of their high credit ratings, the Company does not anticipate that any of the counterparties will fail to meet their obligations. 2002 page .55 The Company has entered into the following cash ﬂow and fair value hedges that are outstanding as of December 31, 2002. The net value associated with these hedges is reﬂected on the Company’s Consolidated Balance Sheets (in thousands). Type of Hedge Pay-Fixed Swap Pay-Fixed Swap Pay-Fixed Swap Pay-Floating Swap Pay-Floating Swap LIBOR Cap LIBOR Cap LIBOR Cap Total Estimated Value Explanatory Note: Notional Amount $125,000 125,000 75,000 100,000 50,000 345,000 75,000 35,000 Strike Price or Swap Rate 7.058% 7.055% 5.580% 3.878% 3.810% 8.000% 7.750% 7.750% Trade Date Maturity Date Estimated Value at December 31, 2002 6/15/00 6/15/00 11/4/99(1) 11/27/02 11/27/02 5/22/02 11/4/99(1) 11/4/99(1) 6/25/03 6/25/03 12/1/04 8/15/08 8/15/08 5/28/14 12/1/04 12/1/04 $(3,598) (3,596) (5,743) 2,761 1,203 12,088 21 9 $ 3,145 Acquired in connection with the TriNet Acquisition (see Note 1 to the Company’s Consolidated Financial Statements). (1) ~ Between January 1, 2001 and December 31, 2002, the Company also had outstanding the following cash ﬂow hedges that have expired or been settled (in thousands): Type of Hedge LIBOR Cap Pay-Fixed Swap LIBOR Cap LIBOR Cap ~ Notional Amount $300,000 92,000 75,000 38,336 Strike Price or Swap Rate 9.000% 5.714% 7.500% 7.500% Trade Date 3/16/98 8/10/98 7/16/98 4/30/98 Maturity Date 3/16/01 3/1/01 6/19/01 6/1/01 In connection with STARs, Series 2002-1 in May 2002, the Company entered into a LIBOR interest rate cap struck at 8.00% in the notional amount of $345.0 million. The Company utilizes the provi- sions of SFAS No. 133 with respect to such instruments. SFAS No. 133 provides that the up-front fees paid on option-based products such as caps should be expensed into earnings based on the allocation of the premium to the affected periods as if the agreement were a series of “caplets.” These allocated premiums are then reﬂected as a charge to income (as part of interest expense) in the affected period. On May 28, 2002, in connection with the STARs, Series 2002-1 transaction, the Company paid a premium of $13.7 million for an interest rate cap. Using the “caplet” methodology discussed above, amortization of the cap premium is dependent upon the actual value of the caplets at inception. In connection with STARs, Series 2000-1 in May 2000, the Company entered into a LIBOR interest rate cap struck at 10.00% in the notional amount of $312.0 million, and simultaneously sold a LIBOR interest rate cap with the same terms. Since these instruments did not change the Company’s net interest rate risk exposure, they did not qualify as hedges and changes in their respective values were charged to earnings. As the terms of these arrangements were sub- stantially the same, the effects of a revaluation of these two instru- ments substantially offset one another. On May 28, 2002, these instruments were settled and are no longer outstanding. In connection with the Company’s $350.0 million of ﬁxed-rate corporate bonds, the Company entered into two pay-ﬂoating interest rate swaps struck at 3.8775% and 3.81% and in the notional amounts of $100.0 million and $50.0 million, respectively. The Company pays one-month LIBOR and receives the ﬁxed rate in return. These swaps mitigate the risk of changes in the fair value of $150.0 million of the Company’s ﬁxed-rate corporate bonds attributable to changes in LIBOR. For accounting purposes, the difference between the ﬁxed rate received and the LIBOR rate paid on the notional amount of the swap is recorded as “Interest expense” in the Company’s Consolidated Statements of Operations. In addition, quarterly the Company adjusts the value of the swap to its fair value and adjusts the carrying amount of the hedged liability by an offsetting amount. During the year ended December 31, 1999, the Company set- tled an aggregate notional amount of approximately $63.0 million that was outstanding under certain hedging agreements which the Company had entered into in order to hedge the potential effects of interest rate movements on anticipated ﬁxed-rate borrowings. The set- tlement of such agreements resulted in a receipt of approximately $0.6 million which had been deferred pending completion of the planned ﬁxed-rate ﬁnancing transaction. Subsequently, the transaction was modiﬁed and was actually consummated as a variable-rate ﬁnanc- ing transaction. As a result, the previously deferred receipt no longer qualiﬁed for hedge accounting treatment and the $0.6 million was recognized as a gain included in “Other income” in the Company’s Consolidated Statements of Operations for the year ended December 31, 2000 in connection with the closing of STARs, Series 2000-1 in May 2000. During the year ended December 31, 1999, the Company reﬁ- nanced its $125.0 million term loan maturing March 15, 1999 with a $155.4 million term loan maturing March 5, 2009. The new term loan bears interest at 7.44% per annum, payable monthly, and amortizes over an approximately 22-year schedule. The new term loan repre- sented forecasted transactions for which the Company had previ- ously entered into U.S. Treasury-based hedging transactions. The net $3.4 million cost of the settlement of such hedges has been deferred and is being amortized as an increase to the effective ﬁnancing cost of the new term loan over its effective ten-year term. Credit risk concentrations – Concentrations of credit risks arise when a number of borrowers or customers related to the Company’s investments are engaged in similar business activities, or activities in iStar Financial annual report the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions. The Company regularly monitors various segments of its portfolio to assess potential concentrations of credit risks. Management believes the current credit risk portfolio is reasonably well diversiﬁed and does not contain any unusual concentration of credit risks. Substantially all of the Company’s corporate tenant lease assets (including those held by joint ventures) and loans and other lending investments are collateralized by facilities located in the United States, with significant concentrations (i.e., greater than 10.00%) as of December 31, 2002 in California (22.72%) and Texas (10.32%). As of December 31, 2002, the Company’s investments also contain greater than 10.00% concentrations in the following asset types: ofﬁce-CTL (27.42%), ofﬁce-lending (19.67%), industrial (15.00%) and hotel-lending (11.99%). The Company underwrites the credit of prospective borrow- ers and customers and often requires them to provide some form of credit support such as corporate guarantees, letters of credit and/or cash security deposits. Although the Company’s loans and other lend- ing investments and corporate customer lease assets are geographically diverse and the borrowers and customers operate in a variety of indus- tries, to the extent the Company has a signiﬁcant concentration of interest or operating lease revenues from any single borrower or cus- tomer, the inability of that borrower or customer to make its payment could have an adverse effect on the Company. As of December 31, 2002, the Company’s ﬁve largest borrowers or corporate tenants collectively accounted for approximately 15.67% of the Company’s aggregate annu- alized interest and operating lease revenue. Note 10 – Stock-Based Compensation Plans and Employee Beneﬁts The Company’s 1996 Long-Term Incentive Plan (the “Plan”) is designed to provide incentive compensation for ofﬁcers, other key employees and directors of the Company. The Plan provides for awards of stock options and shares of restricted stock and other performance awards. The maximum number of shares of Common Stock available for awards under the Plan is 9.00% of the outstanding shares of Common Stock, calculated on a fully diluted basis, from time to time; provided that the number of shares of Common Stock reserved for grants of options designated as incentive stock options is 5.0 million, subject to certain antidilution provisions in the Plan. All awards under the Plan, other than automatic awards to non-employee directors, are at the discretion of the Board or a committee of the Board. At December 31, 2002, a total of approximately 9.1 million shares of Common Stock were available for awards under the Plan, of which options to purchase approximately 4.3 million shares of Common Stock were outstanding and approximately 330,000 shares of restricted stock were outstanding. In March 1998, the Company issued approximately 2.5 mil- lion (as adjusted) fully vested and immediately exercisable options to purchase shares of Common Stock at $14.72 per share (as adjusted) to its former advisor with a term of ten years. The former advisor granted a portion of these options to its employees and the remainder was allo- cated to an afﬁliate. Upon the Company’s acquisition of its former advi- sor, these individuals became employees of the Company. In general, the grants to these employees provided for scheduled vesting over a predeﬁned service period of three to ﬁve years and, under certain con- ditions, provide for accelerated vesting. These options expire on March 15, 2008. Changes in options outstanding during each of ﬁscal 2000, 2001 and 2002 are as follows: Number of Shares Non-Employee Directors 146,379 80,000 – – 226,379 90,000 (20,000) – 296,379 90,000 (190,650) (4,600) 191,129 Employees 2,778,252 1,852,059 (412,734) (682,005) 3,535,572 1,618,400 (1,262,811) (107,939) 3,783,222 – (488,674) (17,406) 3,277,142 Other 881,163 80,000 – – 961,163 100,000 (25,000) – 1,036,163 – (164,683) – 871,480 Average Strike Price $19.03 $17.34 $15.67 $25.47 $18.97 $20.31 $16.48 $27.27 $18.98 $27.83 $18.63 $24.87 Options outstanding, December 31, 1999 Granted in 2000 Exercised in 2000 Forfeited in 2000 Options outstanding, December 31, 2000 Granted in 2001 Exercised in 2001 Forfeited in 2001 Options outstanding, December 31, 2001 Granted in 2002 Exercised in 2002 Forfeited in 2002 Options outstanding, December 31, 2002 ~ 2002 page .57 The following table summarizes information concerning outstanding and exercisable options as of December 31, 2002: Exercise Price Range $14.72–$15.00(1) $16.69–$16.88 $17.38–$17.56 $19.63–$19.69 $20.00–$21.44 $22.44 $23.32–$23.64 $24.13–$24.94 $25.10–$26.09 $26.30–$26.97 $27.00 $28.54–$29.82 $30.33 $33.70 $55.39 Explanatory Note: Options outstanding Weighted Average Remaining Contractual Life Weighted Average Exercise Price 5.62 7.02 7.22 8.08 7.28 7.75 1.37 5.05 3.74 1.60 8.48 8.94 0.40 0.01 6.42 6.79 $14.72 $16.86 $17.39 $19.69 $20.91 $22.44 $23.53 $24.54 $26.02 $26.80 $27.00 $29.68 $30.33 $33.70 $55.39 $18.77 Options Outstanding 1,000,213 716,207 422,490 1,536,584 138,466 13,333 43,901 183,700 14,800 77,900 25,000 90,188 67,275 4,600 5,094 4,339,751 Options exercisable Weighted Average Exercise Price $14.72 $16.87 $17.40 $19.69 $20.92 $22.44 $23.52 $24.54 $26.06 $26.80 $27.00 $29.68 $30.33 $33.70 $55.39 $19.00 Currently Exercisable 751,618 350,586 256,658 426,763 82,984 6,667 31,316 183,034 14,134 76,567 8,334 90,188 67,275 4,600 5,094 2,355,818 (1) Includes approximately 764,000 options which were granted, on a fully exercisable basis, in March 1998, and which are now held by an afﬁliate of SOF IV. Beneﬁcial interests in these options were subsequently regranted by that afﬁliate to employees of it and its afﬁliates, subject to vesting requirements. In the event that these employees forfeit such options, they revert to an afﬁliate of SOF IV, which may regrant them at its discretion. As of December 31, 2002, approximately 468,000 of these options have become exercisable by the beneﬁcial owners. Of this total, approximately 288,000 have been exercised as of December 31, 2002. ~ In the third quarter 2002 (with retroactive application to the beginning of the calendar year), the Company adopted the fair value method for accounting for options issued to employees or directors, as allowed under Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation.” Accordingly, the Company recognizes a charge equal to the fair value of these options at the date of grant multiplied by the number of options issued. This charge will be amortized over the related remain- ing vesting terms to individual employees as additional compensation. The impact for options issued since January 1, 2002 is approximately $110,000, which is reflected under “General and administrative – stock-based compensation” on the Company’s Consolidated Statements of Operations. Prior to the third quarter 2002, the Company had elected to use the intrinsic method for accounting for options issued to employ- ees or directors, as allowed under SFAS No. 123 and, accordingly, recog- nized no expense in connection with these options to the extent that the options’ exercise prices equaled or exceeded the quoted prices of the Company’s shares of Common Stock on the grant or investment dates. However, in connection with the acquisition of the Company’s former external advisor, the Company recognized a deferred stock- based compensation charge of approximately $5.1 million. This deferred charge represents the difference between the Company’s clos- ing stock price on the date it acquired its former external advisor (which was $20.25), and the strike price of $14.72 per share (as adjusted) for the unvested portion of the options granted to the former external advisor’s employees, who are now employees of the Company. This deferred charge is being amortized over the related remaining vesting terms to the individual employees as an additional expense under “General and administrative – stock-based compensation” on the Company’s Consolidated Statements of Operations. If the Company’s compensation costs had been determined using the fair value method of accounting for stock options issued under the Plan to employees and directors prescribed by SFAS No. 123 prior to 2002, the Company’s net income for the ﬁscal years ended December 31, 2002, 2001 and 2000 would have been reduced on a pro forma basis by approximately $565,000, $705,000 and $275,000 respec- tively. This would not have signiﬁcantly impacted the Company’s earn- ings per share. The fair value of each signiﬁcant option grant is estimated on the date of grant (May 29, 2002 for the 2002 options) using the Black- Scholes model. For the above SFAS No. 123 calculation, the following assumptions were used for the Company’s fair value calculations of stock options: Expected life (in years) Risk-free interest rate Volatility Dividend yield Weighted average grant date fair value ~ 2002 2001 2000 5 4.38% 5 5 5.30% 4.96% 16.23% 20.83% 26.80% 8.45% 12.00% 13.50% $0.46 $0.76 $1.38 Future charges may be taken to the extent of additional option grants, which are at the discretion of the Board of Directors. During the 12 months ended December 31, 2002, the Company granted 194,558 restricted shares to employees. Of these shares, 39,558 will vest proportionately over three years on the anniversary date of the initial grant. The balance of 155,000 restricted shares will vest on March 31, 2004 if: (1) the employee remains employed until that date; and (2) the 60-day average closing price of the Company’s Common Stock equals or exceeds a set ﬂoor price as of such date. Dividends will be paid on the restricted shares as dividends are paid on shares of the Company’s Common Stock. Assuming the shares become fully vested on March 31, 2004 and the market price of the stock is $28.05 (which was the market price of the Common Stock on December 31, 2002), the Company would incur a one-time charge to both net income and earning at that time equal to $4.3 million (the fair market value of the 155,000 shares at $28.05 per share). During the 12 months ended iStar Financial annual report December 31, 2002, the Company also granted 208,980 restricted shares to its Chief Financial Ofﬁcer (see detailed information below). During the year ended December 31, 2001, the Company granted 94,943 restricted shares to employees in lieu of cash bonuses for the year ended December 31, 2000 at the employees’ election. These restricted shares were immediately vested on the date of grant and were not transferable for a period of one year following vesting. During the year ended December 31, 2000, the Company granted 140,402 restricted shares to employees. Of this total, 71,752 restricted shares were granted in lieu of cash bonuses at the employees’ election, were immediately vested on the date of grant, and were not transferable for a period of one year following vesting. An additional 68,650 of such restricted shares vest over periods ranging from one to three years following the date of grant and are transferable upon vesting. For accounting purposes, the Company measures compensa- tion costs for these shares, not including the contingently issuable shares, as of the date of the grant and expenses such amounts against earnings, either at the grant date (if no vesting period exists) or ratably over the respective vesting period. Such amounts appear on the Company’s Consolidated Statements of Operations under “General and administrative – stock-based compensation expense.” During the year ended December 31, 2002, the Company entered into a three-year employment agreement with its new Chief Financial Ofﬁcer. Under the agreement, the Chief Financial Ofﬁcer receives an annual base salary of $225,000. She may also receive a bonus, which is targeted to be $325,000, subject to an annual review for upward or downward adjustment. In addition, the Company granted the Chief Financial Ofﬁcer 108,980 contingently vested restricted stock awards. These awards become vested on December 31, 2005 if the executive’s employment with the Company has not terminated before such date. Dividends will be paid on the restricted shares as dividends are paid on shares of the Company’s Common Stock. For accounting purposes, the Company will take a total charge of approximately $3.0 million related to the restricted stock awards, which will be amortized over the period from November 6, 2002 through December 31, 2005. This charge is reﬂected on the Company’s Consolidated Statements of Operations under “General and administrative – stock-based compensation.” Further, the Company granted the Chief Financial Officer 100,000 restricted shares which vest in whole or in part if the Company’s shareholders realize total rates of shareholder return (divi- dends plus share price appreciation) of between 0.00% and 20.00%, achieved by the Company between January 2, 2003 and January 31, 2004. Vested shares would be subject to forfeiture if the executive’s employment with the Company terminated under certain circum- stances. Assuming the shares became fully vested on January 31, 2004 and the market price of the stock is $28.05 (which was the market price of the Common Stock on December 31, 2002), the Company would incur a one-time charge to both net income and earnings at that time equal to $2.8 million (the fair market value of the 100,000 shares at $28.05 per share). For accounting purposes, the employment arrange- ment described above is treated as a contingent, variable plan until January 31, 2004. During the year ended December 31, 2001, the Company entered into a new three-year employment agreement with its Chief Executive Ofﬁcer. Under the agreement, the Chief Executive Ofﬁcer receives an annual base salary of $1.0 million. He may also receive a bonus, which is targeted to be an amount equal to his base salary, if the Company achieves certain performance targets set by the Compensation Committee. The bonus award may be increased or reduced from the target depending upon the degree to which the per- formance goals are exceeded or are not met, and may not exceed 200.00% of his base salary. The bonus is reduced by the amount of any dividends paid to the Chief Executive Ofﬁcer in respect of phantom shares (described below) which are awarded to him and have contin- gently vested. The Chief Executive Officer received approximately $2.1 million in such dividends in 2002. As such, no additional bonus was paid. As part of this agreement, the Company conﬁrmed a prior grant of 750,000 stock options made to the executive on March 2, 2001 with an exercise price of $19.69, which represented the market price at the date of the original contingent grant. However, because the grant required further approval by the Compensation Committee and the Board of Directors, no measurement date occurred for accounting pur- poses until such approvals were made, at which point the market price of the Company’s Common Stock was $24.90. Accordingly, an aggre- gate charge of approximately $3.9 million is being recognized with respect to these options over the term of this agreement and is reﬂected on the Company’s Consolidated Statements of Operations under “General and administrative – stock-based compensation.” These options will vest in three equal installments of 250,000 shares in each January beginning in January 2002. The Company also granted the executive 2.0 million unvested phantom shares, each of which represents one share of the Company’s Common Stock. These shares will vest in installments of 350,000 shares, 650,000 shares, 600,000 shares and 400,000 shares on a contingent basis if the 60-day average closing price of the Company’s Common Stock achieves thresholds of $25.00, $30.00, $34.00 and $37.00, respec- tively. As of December 31, 2002, the $25.00 and $30.00 thresholds have been attained, and a total of 1.0 million of these shares have contin- gently vested. Assuming that the market price of the Common Stock on March 31, 2004, is $28.05 (which was the market price of the Common Stock on December 31, 2002), the Company would incur a one-time charge to both net income and earnings at that time equal to $28.0 mil- lion (the fair market value of the 1.0 million shares at $28.05 per share). Shares that have contingently vested generally will not become fully vested until the end of the three-year term of the agreement, except upon certain termination or change of control events. Further, if the average stock price drops below certain speciﬁed levels for a 60-day period prior to such date, such phantom shares would not fully vest and would be forfeited. If the Company is not authorized to issue shares to the executive upon full vesting of the phantom shares, then the vesting will be settled through a cash payment based upon the market price of the Common Stock during a recent trading period. The executive will receive dividends on shares that have contingently or fully vested and have not been forfeited under the terms of the agreement, if and when the Company declares and pays dividends on its Common Stock. Because no shares have been issued, dividends received on these phan- tom shares, if any, will be reﬂected as compensation expense by the Company. For accounting purposes, this arrangement will be treated as a contingent, variable plan and no additional compensation expense will be recognized until the shares, in whole or in part, become irrevo- cably vested, whereupon the Company will reﬂect a charge equal to the then fair value of the phantom shares irrevocably vested. In addition, during the year ended December 31, 2001, the Company entered into a three-year employment agreement with its for- mer President. Under the agreement, in lieu of salary and bonus, the Company granted the executive 500,000 restricted shares. These shares became fully-vested on September 30, 2002 as a result of the Company achieving a 60.00% total shareholder rate of return (dividends plus share price appreciation) since January 1, 2001. Upon the restricted shares becoming fully vested, the Company withheld 250,000 of such shares from the executive to cover the tax obligations associated with the vesting of such shares. These shares are reflected as “Treasury stock” on the Company’s Consolidated Statements of Changes in Shareholders’ Equity. For accounting purposes, the employment arrange- ment described above was treated as a contingent, variable plan until the April 29, 2002 contingent vesting date. The Company incurred a total non-cash charge of approximately $15.0 million related to the vesting of the shares, recognized ratably over the period from April 29, 2002 through September 30, 2002. Accordingly, the non-cash charge recognized for the 12 months ended December 31, 2002 was approxi- mately $15.0 million. 2002 page .59 The executive received dividends on the share grant from the date of the agreement as and when the Company declared and paid dividends on its Common Stock. For ﬁnancial statement purposes, such dividends were accounted for in a manner consistent with the Company’s normal Common Stock dividends as a reduction to retained earnings. Certain affiliates of SOF IV and the Company’s Chief Executive Ofﬁcer have agreed to reimburse the Company for the value of restricted shares awarded to the President in excess of 350,000 shares, net of tax beneﬁts realized by the Company or its shareholders on account of compensation expense deductions. The reimbursement obligation arose once the restricted share award became fully vested on September 30, 2002. In the case of the SOF IV afﬁliates, the reimburse- ment payment must be made through the delivery of approximately $2.4 million in cash or 131,250 shares of Common Stock. As of December 31, 2002, the SOF IV afﬁliates have paid approximately $506,000 in cash, which is reﬂected as “Additional paid-in capital” on the Company’s Consolidated Balance Sheets. In the case of the Chief Executive Ofﬁcer, the reimbursement payment was made through the delivery of 12,343 vested shares of Common Stock as of December 31, 2002. These reimbursement payments are reﬂected as “Additional paid- in capital” on the Company’s Consolidated Balance Sheets, and not as an offset to the non-cash charge referenced above. On July 28, 2000, the Company granted to its employees prof- its interests in a wholly-owned subsidiary of the Company called iStar Venture Direct Holdings, LLC. At December 31, 2002, iStar Venture Direct Holdings, LLC had a net investment of approximately $606,000 in the preferred stock of a real estate-related software company. The proﬁts interests have three-year vesting schedules, and are subject to forfeiture in the event of termination of employment for cause or a vol- untary resignation. The Company currently estimates that the proﬁts interests have minimal or no value. High Performance Unit Program In May 2002, the Company’s shareholders approved the iStar Financial High Performance Unit Program. The program, as more fully described in the Company’s annual proxy statement dated April 8, 2002, is a performance-based employee compensation plan that only has material value to the participants if the Company provides superior returns to its shareholders. The program entitles the employee partici- pants to receive cash distributions in the nature of common stock divi- dends if the total rate of return on the Company’s Common Stock (share price appreciation plus dividends) exceeds certain performance levels. Initially, there were three plans within the program: the 2002 plan, the 2003 plan, and the 2004 plan. Each plan has 5,000 shares of High Performance Common Stock associated with it. Each share of High Performance Common Stock carries 0.25 votes per share. For these three plans, the Company’s performance is meas- ured over a one-, two-, or three-year valuation period, beginning on January 1, 2002 and ending on December 31, 2002, December 31, 2003 and December 31, 2004, respectively. The end of the valuation period (i.e., the “valuation date”) will be accelerated if there is a change in con- trol of the Company. The High Performance Common Stock has a nom- inal value unless the total rate of shareholder return for the relevant valuation period exceeds the greater of: (1) 10.00%, 20.00%, or 30.00% for the 2002 plan, the 2003 plan and the 2004 plan, respectively; and (2) a weighted industry index total rate of return consisting of equal weightings of the Russell 1000 Financial Index and the Morgan Stanley REIT Index for the relevant period. If the total rate of return on the Company’s Common Stock exceeds the threshold performance levels for a particular plan, then dis- tributions will be paid on the shares of High Performance Common Stock related to that plan in the same amounts and at the same times as distributions are paid on a number of shares of the Company’s Common Stock equal to the following: 7.50% of the Company’s excess total rate of return (over the higher of the two threshold performance levels) multiplied by the weighted average market value of the Company’s common equity capitalization during the measurement period, all as divided by the average closing price of a share of the Company’s Common Stock for the 20 trading days immediately preced- ing the applicable valuation date. If the total rate of return on the Company’s Common Stock does not exceed the threshold performance levels for a particular plan, then the shares of High Performance Common Stock related to that plan will have only nominal value. In this event, each of the 5,000 shares will be entitled to dividends equal to 0.01 times the divi- dend paid on a share of Common Stock, if and when dividends are declared on the common stock. Regardless of how much the Company’s total rate of return exceeds the threshold performance levels, the dilutive impact to the Company’s shareholders resulting from distributions on High Performance Common Stock in each plan is limited to 1.00% of the number of shares of the Company’s Common Stock outstanding, on a fully diluted basis, on the valuation date for each plan. The employee participants have purchased their interests in High Performance Common Stock through a limited liability company at purchase prices approved by the Company’s Board of Directors. The Company’s Board has established the prices of the High Performance Common Stock based upon, among other things, an independent valua- tion from a major securities ﬁrm. The aggregate initial purchase prices were set on June 25, 2002 and were approximately $2.8 million, $1.8 million and $1.3 million for the 2002, 2003 and 2004 plans, respec- tively. No employee is permitted to exchange his or her interest in the LLC for shares of High Performance Common Stock prior to the appli- cable valuation date. The total shareholder return for the valuation period under the 2002 plan was 21.94%, which exceeded both the ﬁxed performance threshold of 10.00% and the industry index return of (5.83%). As a result of this superior performance, the participants in the 2002 plan are entitled to receive cash distributions equivalent to the amount of cash dividends payable on 819,254 shares of the Company’s Common Stock, as and when such dividends are paid. Such dividend payments begin with the ﬁrst quarter 2003 dividend and will reduce net income allocable to common shareholders when paid. The Company will pay dividends on the 2002 plan shares in the same amount per share and on the same distribution dates that shares of the Company’s Common Stock are paid. The Company has the right, but not the obligation, to repurchase at cost 50.00% of the interests earned by an employee in the 2002 plan if the employee breaches certain non-competition, non- solicitation and conﬁdentiality covenants through January 1, 2005. A new 2005 plan has been established with a three-year valua- tion period ending December 31, 2005. Awards under the 2005 plan were approved on January 14, 2003. The 2005 plan has 5,000 shares of High Performance Common Stock with an aggregate initial purchase price of $573,000. The provisions of the 2005 plan are substantially the same as the prior plans. The additional equity from the issuance of the High Performance Common Stock is recorded as a separate class of stock and included within shareholders’ equity. Future distributions, if any, will be deducted from net income available for common shareholders. 401(k) Plan Effective November 4, 1999, the Company implemented a sav- ings and retirement plan (the “401(k) Plan”), which is a voluntary, deﬁned contribution plan. All employees are eligible to participate in the 401(k) Plan following completion of three months of continuous service with the Company. Each participant may contribute on a pretax basis between 2.00% and 15.00% of such participant’s compensation. At the discretion of the Board of Directors, the Company may make matching contributions on the participant’s behalf of up to 50.00% of the first 10.00% of the participant’s annual compensation. The Company made gross contributions of approximately $356,000, $319,000 and $320,000 to the 401(k) Plan for the years ended December 31, 2002, 2001 and 2000, respectively. iStar Financial annual report Note 11 – Earnings Per Share The following table presents a reconciliation of the numera- tors and denominators of the basic and diluted EPS calculations for the years ended December 31, 2002, 2001 and 2000, respectively (in thou- sands, except per share data): In addition, there were approximately 167,000, 261,000 and 632,000 stock options, 6.1 million, 6.1 million and 6.1 million warrants and 371,000, 373,000 and 373,000 joint venture shares that were anti- dilutive for the 12-month periods ended December 31, 2002, 2001 and 2000, respectively. 2002 2001 2000 Note 12 – Comprehensive Income In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130 (“SFAS No. 130”), “Reporting Comprehensive Income” effective for fiscal years beginning after December 15, 1997. The statement changes the reporting of certain items currently reported as changes in the shareholders’ equity section of the balance sheet and establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose ﬁnancial statements. SFAS No. 130 requires that all components of comprehensive income shall be reported in the ﬁnan- cial statements in the period in which they are recognized. Further- more, a total amount for comprehensive income shall be displayed in the ﬁnancial statements. The Company has adopted this standard effec- tive January 1, 1998. Total comprehensive income was $228.1 million, $214.8 million and $217.8 million for the years ended December 31, 2002, 2001 and 2000, respectively. The primary components of com- prehensive income other than net income consist of amounts attrib- utable to the adoption and continued application of SFAS No. 133 to the Company’s cash ﬂow hedges and changes in the fair value of the Company’s available-for-sale investments. For the years ended December 31, 2002 and 2001, the change in fair market value of the Company’s cash ﬂow hedges and fair value hedges was an increase of $5.2 million and a decrease of $11.3 million, respectively, and was recorded as an adjustment to other comprehen- sive income. The reconciliation to other comprehensive income is as follows (in thousands): For the Year Ended December 31, Net income Other comprehensive income: Unrealized gains on available-for- sale investments Cumulative effect of change in accounting principle (SFAS No. 133) on other comprehensive income Unrealized gains (losses) on cash ﬂow and 2002 2001 2000 $215,270 $229,912 $217,586 7,601 5,709 209 – (9,445) – fair value hedges Comprehensive income 5,190 $228,061 (11,336) $214,840 – $217,795 Unrealized gains on available-for-sale investments are recorded as adjustments to shareholders’ equity (through “Accumulated other com- prehensive income” on the Company’s Consolidated Balance Sheets), and are not included in adjusted earnings or net income unless realized. As of December 31, 2002 and 2001, accumulated other com- prehensive income reﬂected in the Company’s shareholders’ equity is comprised of the following (in thousands): As of December 31, Unrealized gains on available-for-sale investments Unrealized losses on cash ﬂow and fair value hedges Accumulated other comprehensive income (loss) 2002 2001 $ 13,290 (15,591) $ (2,301) $ 5,689 (20,781) $(15,092) ~ accounting principle – Net income allocable to common shareholders $178,362 $193,004 $180,678 Denominator: Weighted average common shares (282) – For the Year Ended December 31, Numerator: Net income before income from discontinued operations, gain from discontinued operations, extraordinary loss and cumulative effect of change in accounting principle Preferred dividend requirements Net income allocable to common shareholders before income from discontinued operations, gain from discontinued operations, extraordinary loss and cumulative effect of change in accounting principle Income from discontinued operations Gain from discontinued operations Extraordinary loss on early extinguishment of debt Cumulative effect of change in outstanding for basic earnings per common share Add: effect of assumed shares issued under treasury stock method for stock options and restricted shares Add: effect of contingent shares Weighted average common shares outstanding for diluted earnings per common share Basic earnings per common share: Net income allocable to common shareholders before income from discontinued operations, gain from discontinued operations, extraordinary loss and cumulative effect of change in accounting principle Income from discontinued operations Gain from discontinued operations Extraordinary loss on early extinguishment of debt Cumulative effect of change in accounting principle Net income allocable to common shareholders $ Diluted earnings per common share: Net income allocable to common shareholders $223,136 $225,370 $212,188 (36,908) (36,908) (36,908) 186,228 3,583 717 188,462 5,299 1,145 175,280 3,155 2,948 (12,166) (1,620) (705) 89,886 86,349 85,441 1,645 1,118 1,680 205 710 – 92,649 88,234 86,151 $ 2.07 $ 0.04 0.01 2.18 $ 0.06 0.02 2.05 0.04 0.03 ~ (0.14) (0.02) (0.01) – 1.98 $ (0.00) 2.24 $ – 2.11 before income from discontinued operations, gain from discontinued operations, extraordinary loss and cumulative effect of change in accounting principle Income from discontinued operations Gain from discontinued operations Extraordinary loss on early extinguishment of debt Cumulative effect of change in accounting principle Net income allocable to $ 2.01 $ 0.04 0.01 2.14 $ 0.06 0.01 2.04 0.04 0.03 (0.13) (0.02) (0.01) – (0.00) – common shareholders $ 1.93 $ 2.19 $ 2.10 ~ 2002 page .61 Note 13 – Dividends In order to maintain its election to qualify as a REIT, the Company must currently distribute, at a minimum, an amount equal to 90.00% of its taxable income and must distribute 100.00% of its tax- able income to avoid paying corporate federal income taxes. The Company anticipates it will distribute all of its taxable income to its shareholders. Because taxable income differs from cash ﬂow from oper- ations due to non-cash revenues or expenses (such as depreciation), in certain circumstances, the Company may generate operating cash ﬂow in excess of its dividends or, alternatively, may be required to borrow to make sufﬁcient dividend payments. For the year ended December 31, 2002, total dividends declared by the Company aggregated $231.3 million, or $2.52 per com- mon share, consisting of quarterly dividends of $0.63 per share which were declared on April 1, 2002, July 1, 2002, October 1, 2002 and December 2, 2002. The Company also declared dividends aggregating $20.9 million, $4.7 million, $3.0 million and $8.0 million, respectively, on its Series A, B, C and D preferred stock, respectively, for the year ended December 31, 2002. There are no divided arrearages on any of the preferred shares currently outstanding. The Series A preferred stock has a liquidation preference of $50.00 per share and carries an initial dividend yield of 9.50% per annum. The dividend rate on the preferred shares will increase to 9.75% on December 15, 2005, to 10.00% on December 15, 2006 and to 10.25% on December 15, 2007 and thereafter. Dividends on the Series A pre- ferred shares are payable quarterly in arrears and are cumulative. Holders of shares of the Series B preferred stock are entitled to receive, when and as declared by the Board of Directors, out of funds legally available for the payment of dividends, cumulative preferential cash dividends at the rate of 9.375% per annum of the $25.00 liquida- tion preference, equivalent to a ﬁxed annual rate of $2.34 per share. Dividends are cumulative from the date of original issue and are payable quarterly in arrears on or before the 15th day of each March, June, September and December or, if not a business day, the next suc- ceeding business day. Any dividend payable on the Series B preferred stock for any partial dividend period will be computed on the basis of a 360-day year consisting of twelve 30-day months. Dividends will be payable to holders of record as of the close of business on the ﬁrst day of the calendar month in which the applicable dividend payment date falls or on another date designated by the Board of Directors of the Company for the payment of dividends that is not more than 30 nor less than ten days prior to the dividend payment date. Holders of shares of the Series C preferred stock are entitled to receive, when and as declared by the Board of Directors, out of funds legally available for the payment of dividends, cumulative preferential cash dividends at the rate of 9.20% per annum of the $25.00 liquida- tion preference, equivalent to a ﬁxed annual rate of $2.30 per share. The remaining terms relating to dividends of the Series C pre- ferred stock are substantially identical to the terms of the Series B preferred stock described above. Holders of shares of the Series D preferred stock are entitled to receive, when and as declared by the Board of Directors, out of funds legally available for the payment of dividends, cumulative preferential cash dividends at the rate of 8.00% per annum of the $25.00 liquida- tion preference, equivalent to a ﬁxed annual rate of $2.00 per share. The remaining terms relating to dividends of the Series D preferred stock are substantially identical to the terms of the Series B pre- ferred stock described above. The 2002 High Performance Common Stock plan reached its valuation date on December 31, 2002 and shares of High Performance Common Stock, equivalent to 819,254 shares of Common Stock became vested. The Company will pay dividends on these units in the same amount per share and on the same distribution dates as shares of the Company’s Common Stock. Such dividends payments begin with the ﬁrst quarter 2003 dividend and will reduce net income allocable to common shareholders when paid. The exact amount of future quarterly dividends to common shareholders will be determined by the Board of Directors based on the Company’s actual and expected operations for the ﬁscal year and the Company’s overall liquidity position. Note 14 – Fair Values of Financial Instruments SFAS No. 107, “Disclosures About Fair Value of Financial Instruments” (“SFAS No. 107”), requires the disclosure of the estimated fair values of ﬁnancial instruments. The fair value of a ﬁnancial instru- ment is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Quoted market prices, if available, are utilized as esti- mates of the fair values of ﬁnancial instruments. Because no quoted market prices exist for a signiﬁcant part of the Company’s ﬁnancial instruments, the fair values of such instruments have been derived based on management’s assumptions, the amount and timing of future cash ﬂows and estimated discount rates. The estimation methods for individual classiﬁcations of ﬁnancial instruments are described more fully below. Different assumptions could signiﬁcantly affect these esti- mates. Accordingly, the net realizable values could be materially differ- ent from the estimates presented below. The provisions of SFAS No. 107 do not require the disclosure of the fair value of non-ﬁnancial instruments, including intangible assets or the Company’s corporate tenant lease assets. In addition, the estimates are only indicative of the value of individual ﬁnancial instruments and should not be considered an indi- cation of the fair value of the Company as an operating business. Short-term ﬁnancial instruments – The carrying values of short- term ﬁnancial instruments including cash and cash equivalents and short-term investments approximate the fair values of these instru- ments. These ﬁnancial instruments generally expose the Company to limited credit risk and have no stated maturities, or have an average maturity of less than 90 days and carry interest rates which approxi- mate market. Loans and other lending investments – For the Company’s interests in loans and other lending investments, the fair values were estimated by discounting the future contractual cash ﬂows (excluding participa- tion interests in the sale or reﬁnancing proceeds of the underlying col- lateral) using estimated current market rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities. Marketable securities – Securities held for investment, securities available for sale, loans held for sale, trading account instruments, long- term debt and trust preferred securities traded actively in the second- ary market have been valued using quoted market prices. Other ﬁnancial instruments – The carrying value of other ﬁnan- cial instruments including, restricted cash, accrued interest receivable, accounts payable, accrued expenses and other liabilities approximate the fair values of the instruments. Debt obligations – A substantial portion of the Company’s exist- ing debt obligations bear interest at ﬁxed margins over LIBOR. Such margins may be higher or lower than those at which the Company could currently replace the related ﬁnancing arrangements. Other obli- gations of the Company bear interest at ﬁxed rates, which may differ from prevailing market interest rates. As a result, the fair values of the Company’s debt obligations were estimated by discounting current debt balances from December 31, 2002 and 2001 to maturity using esti- mated current market rates at which the Company could enter into sim- ilar ﬁnancing arrangements. Interest rate protection agreements – The fair value of interest rate protection agreements such as interest rate caps, ﬂoors, collars and swaps used for hedging purposes (see Note 9) is the estimated amount the Company would receive or pay to terminate these agreements at the reporting date, taking into account current interest rates and cur- rent creditworthiness of the respective counterparties. iStar Financial annual report The book and fair values of ﬁnancial instruments as of December 31, 2002 and 2001 were (in thousands): Financial assets: Loans and other lending investments Marketable securities Provision for loan losses Financial liabilities: Debt obligations Interest rate protection agreements ~ Note 15 – Segment Reporting 2002 2001 Book Value Fair Value Book Value Fair Value $3,079,592 35 (29,250) $3,301,452 35 (29,250) $2,398,763 285 (21,000) $2,508,119 285 (21,000) 3,461,590 3,145 $3,500,927 3,145 2,495,369 (18,925) 2,506,046 (18,925) Statement of Financial Accounting Standard No. 131 (“SFAS No. 131”) establishes standards for the way that public business enterprises report information about operating segments in annual ﬁnancial statements and requires that those enterprises report selected ﬁnancial information about operating segments in interim ﬁnancial reports issued to shareholders. The Company has two reportable segments: Real Estate Lending and Corporate Tenant Leasing. The Company does not have substantial foreign operations. The accounting policies of the segments are the same as those described in Note 3. The Company has no single customer that accounts for more than 4.03% of revenues (see Note 9 for other information regarding concentrations of credit risk). The Company evaluates performance based on the following ﬁnancial measures for each segment: Real Estate Lending Corporate Tenant Leasing Corporate and Other(1) Company Total (In thousands) 2002 Total revenues(2) Equity in earnings from joint ventures and unconsolidated subsidiaries Total operating and interest expense(3) Net operating income before minority interests(4) Total long-lived assets(5) Total assets 2001 Total revenues(2) Equity in earnings from joint ventures and unconsolidated subsidiaries Total operating and interest expense(3) Net operating income before minority interests(4) Total long-lived assets(5) Total assets 2000 Total revenues(2) Equity in earnings from joint ventures and unconsolidated subsidiaries Total operating and interest expense(3) Net operating income before minority interests(4) Total long-lived assets(5) Total assets Explanatory Notes: $ 279,158 – 94,274 184,884 3,050,342 3,126,219 $ 246,890 5,081 105,607 146,364 2,291,805 2,442,087 $ 282,802 – 109,568 173,234 2,377,763 2,448,493 $ 280,474 – 115,906 164,568 2,227,083 2,285,506 $ 188,688 9,617 77,481 120,824 1,781,565 1,889,879 $ 179,412 5,058 79,662 104,808 1,592,087 1,706,949 $ (324) $ 525,724 1,222 303,648 223,298 5,342,147 5,611,697 (3,859) 103,767 (107,950) N/A 43,391 $ $ (371) (2,256) 65,843 (68,470) N/A 42,268 3,633 (262) 60,364 (56,993) N/A 42,320 $ 471,119 7,361 252,892 225,588 4,159,328 4,380,640 $ 463,519 4,796 255,932 212,383 3,819,170 4,034,775 Corporate and Other represents all corporate level items, including general and administrative expenses and any intercompany eliminations necessary to reconcile to the consolidated Company totals. This caption also includes the Company’s servicing business, which is not considered a material separate segment. Total revenues represents all revenues earned during the period from the assets in each segment. Revenue from the Real Estate Lending business primarily represents interest income and revenue from the Corporate Tenant Leasing business primarily represents operating lease income. Total operating and interest expense represents provision for loan losses for the Real Estate Lending business and operating costs on corporate tenant lease assets for the Corporate Tenant Leasing business, as well as interest expense speciﬁcally related to each segment. Interest expense on unsecured notes, general and administrative expense and general and administrative – stock-based compensation is included in Corporate and Other for all periods. Depreciation and amortization of $47,821, $35,411 and $34,384 in 2002, 2001 and 2000, respectively, are included in the amounts presented above. Net operating income represents net operating income before minority interest, income from discontinued operations, gain (loss) from discontinued operations, extraordinary loss on early extinguishment of debt and cumulative effect of change in accounting principle. Net operating income excludes income from discontinued operations of $3,583, $5,299 and $3,155 for the years ended December 31, 2002, 2001 and 2000, respectively. Total long-lived assets is comprised of Loans and Other Lending Investments, net and Corporate Tenant Lease Assets, net, for each respective segment. (1) (2) (3) (4) (5) ~ 2002 page .63 Note 16 – Quarterly Financial Information (Unaudited) The following table sets forth the selected quarterly ﬁnancial data for the Company (in thousands, except per share amounts). 2002 Revenue Net income Net income allocable to common shares Net income per common share – basic Weighted average common shares outstanding – basic 2001 Revenue Net income Net income allocable to common shares Net income per common share – basic Weighted average common shares outstanding – basic ~ Note 17 – Subsequent Events Quarter Ended December 31, September 30, June 30, March 31, $140,321 62,976 53,749 0.57 93,671 $ $116,757 58,755 49,528 0.57 86,969 $ $135,035 52,670 43,443 0.49 89,431 $ $117,430 57,553 48,326 0.56 86,470 $ $130,790 42,513 33,286 0.38 88,656 $ $118,497 58,960 49,733 0.58 86,081 $ $119,578 57,111 47,884 0.55 87,724 $ $118,435 54,644 45,417 0.53 85,833 $ Subsequent to December 31, 2002, the Company modiﬁed the terms of the 6.75% Dealer Remarketable Securities, increased the principal amount and sold additional notes in an amount totaling $150.0 million. The notes were modiﬁed to become obligations of the Company (as opposed to the Leasing Subsidiary), the covenants were modiﬁed to reﬂect the covenants contained in the Company’s other unsecured notes, and the maturity date was modiﬁed to be March 2008. The new interest rate on the modiﬁed notes is set at 7.00%. common stock price and dividends (unaudited) The high and low sales prices per share of Common Stock are The following table sets forth the dividends paid or declared set forth below for the periods indicated. by the Company on its Common Stock: Quarter Ended 2001 March 31, 2001 June 30, 2001 September 30, 2001 December 31, 2001 2002 March 31, 2002 June 30, 2002 September 30, 2002 December 31, 2002 ~ High Low $25.25 $28.20 $28.46 $26.05 $28.90 $31.45 $29.55 $28.40 $19.19 $22.85 $22.49 $23.01 $24.59 $28.50 $25.30 $25.90 Quarter Ended 2001(1) March 31, 2001 June 30, 2001 September 30, 2001 December 31, 2001 2002(2) March 31, 2002 June 30, 2002 September 30, 2002 December 31, 2002 ~ Explanatory Notes: Shareholder Record Date Dividend/Share April 16, 2001 July 16, 2001 October 15, 2001 December 17, 2001 April 15, 2002 July 15, 2002 October 15, 2002 December 16, 2002 $0.6125 $0.6125 $0.6125 $0.6125 $0.6300 $0.6300 $0.6300 $0.6300 On March 14, 2003, the closing sale price of the Common Stock as reported by the NYSE was $28.50. The Company had approxi- mately 2,619 holders of record of Common Stock as of March 14, 2003. (1) (2) For tax reporting purposes, the 2001 dividends were classiﬁed as 90.55% ($2.2206) ordinary income and 9.45% ($0.2318) return of capital for those shareholders who held shares of the Company for the entire year. For tax reporting purposes, the 2002 dividends were classiﬁed as 87.61% ($2.2078) ordinary income, 1.80% ($0.0454) 20.00% capital gain and 10.59% ($0.2668) return of capital for those shareholders who held shares of the Company for the entire year. i m o c . n o s d d a . w w w i n o s d d A y b n g s e D i iStar Financial annual report Directors –– (3) Jay Sugarman Chairman and Chief Executive Officer, iStar Financial Inc. (1) Willis Andersen, Jr. Principal, REIT Consulting Services (3) Jeffrey G. Dishner Senior Managing Director, Starwood Capital Group Andrew L. Farkas Chairman and Chief Executive Officer, Insignia Financial Group, Inc. (4) Madison F. Grose Senior Managing Director, Starwood Capital Group (4) Robert W. Holman, Jr. Chairman and Chief Executive Officer, National Warehouse Investment Company Merrick R. Kleeman Senior Managing Director, Starwood Capital Group (1) (2) Robin Josephs President, Ropasada, LLC H. Cabot Lodge III Executive Vice President – Investments, iStar Financial Inc. (1) (2) Matthew J. Lustig Managing Director, Lazard Frères Real Estate Investors, LLC William M. Matthes Managing Partner, Behrman Capital (2) (4) John G. McDonald Professor of Finance, Stanford University Graduate School of Business Stephen B. Oresman President, Saltash, Ltd. (2) (3) George R. Puskar Former Chairman, Lend Lease Real Estate Investments (3) Barry S. Sternlicht Chairman and Chief Executive Officer, Starwood Hotels and Resorts (1) (2) (3) (4) Audit Committee Compensation Committee Investment Committee Nominating and Governance Committee iStar is lighting up the real estate finance sector As we celebrate ten years in business and five as a public company, our future is brighter than ever. With a $6.6 billion enterprise value, iStar Financial has solidified its position as the leading finance company focused on the commercial real estate industry. Now more than ever, our customers recognize the high level of knowledge, service, flexibility and creativity with which we fulfill their unique financing requirements. Our performance for shareholders is also getting noticed: consistently delivered double-digit returns, even in difficult times, and one of the best credit track records in the finance industry. It is the kind of performance that is getting hard to keep quiet. Wow! ~ intro milestones iStar Financial annual report 2002 Officers –– Jay Sugarman Chairman and Chief Executive Officer Catherine D. Rice Chief Financial Officer Timothy J. O’Connor Executive Vice President and Chief Operating Officer Nina B. Matis Executive Vice President and General Counsel Spencer B. Haber President – iStar Strategic Capital Barbara Rubin President – iStar Asset Services Executive Vice Presidents –– Daniel S. Abrams Steven R. Blomquist Roger M. Cozzi Jeffrey R. Digel R. Michael Dorsch III Barclay G. Jones III H. Cabot Lodge III Michelle M. MacKay Diane Olmstead Andrew C. Richardson Senior Vice Presidents –– Jeffrey N. Brown Chase S. Curtis, Jr. Geoffrey M. Dugan John F. Kubicko Steven B. Sinnett Elizabeth B. Smith Colette J. Tretola Headquarters –– iStar Financial Inc. 1114 Avenue of the Americas New York, NY 10036 tel: (212) 930-9400 fax: (212) 930-9494 Super-Regional Offices –– One Embarcadero Center, 33rd Floor San Francisco, CA 94111 tel: (415) 391-4300 fax: (415) 391-6529 3480 Preston Ridge Road, Suite 575 Alpharetta, GA 30005 tel: (678) 297-0100 fax: (678) 297-0101 100 Great Meadow Road, Suite 603 Wethersfield, CT 06109 tel: (860) 258-2202 fax: (860) 258-2268 Regional Offices –– 175 Federal Street, 8th Floor Boston, MA 02110 tel: (617) 292-3333 fax: (617) 423-3322 304 Inverness Way South, Suite 195 Englewood, CO 80112 tel: (303) 790-4656 fax: (303) 790-4680 6565 North MacArthur Blvd., Suite 410 Irving, TX 75039 tel: (972) 506-3131 fax: (972) 501-0078 Employees –– At March 14, 2003, the Company had 143 employees. Independent Auditors –– PricewaterhouseCoopers LLP New York, NY Registrar and Transfer Agent –– EquiServe Trust Company, N.A. 525 Washington Boulevard Jersey City, NJ 07310 (800) 756-8200 Dividend Reinvestment Plan –– Registered shareholders may reinvest dividends through the Company’s dividend reinvestment plan. For more information, please call the Transfer Agent or the Company’s Headquarters. Annual Meeting of Shareholders –– June 3, 2003, 8:30 a.m. EST Sofitel Hotel 45 West 44th Street, New York, NY 10036 Investor Information Services –– For help with questions about the Company, and to receive additional corporate information, please contact: Investor Relations Department iStar Financial Inc. 1114 Avenue of the Americas New York, NY 10036 tel: (212) 930-9400 fax: (212) 930-9455 e-mail: investors@istarfinancial.com iStar Financial Web site –– http://www.istarfinancial.com t r o p e R l a u n n A l a i c n a n i F r a t S i 2 0 0 2 2 0 0 2 i S t a r F i n a n c i a l A n n u a l R e p o r t 2 0 0 2 n y s e : s f i

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