UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

OR

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                          to                         

Commission File Number 1-14788

Capital Trust, Inc.

(Exact name of registrant as specified in its charter)

Maryland		94-6181186
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
410 Park Avenue, 14th Floor, New York, NY		10022
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code: (212) 655-0220

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x     No  o 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  o    No   x  

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of outstanding shares of the registrant’s class A common stock, par value $0.01 per share, as of July 31, 2007 was 17,509,459.

CAPITAL TRUST, INC.

INDEX

Part I.		Financial Information
		Item 1:		Financial Statements
				Consolidated Balance Sheets – June 30, 2007 (unaudited) and December 31, 2006 (audited)
				Consolidated Statements of Income – Three and Six Months Ended June 30, 2007 and 2006 (unaudited)
				Consolidated Statements of Changes in Shareholders’ Equity – Six Months Ended June 30, 2007 and 2006 (unaudited)
				Consolidated Statements of Cash Flows - Six Months Ended June 30, 2007 and 2006 (unaudited)
				Notes to Consolidated Financial Statements (unaudited)
		Item 2:		Management’s Discussion and Analysis of Financial Condition and Results of Operations
		Item 3:		Quantitative and Qualitative Disclosures About Market Risk
		Item 4:		Controls and Procedures
Part II.		Other Information
		Item 1:		Legal Proceedings
		Item 1A:		Risk Factors
		Item 2:		Unregistered Sales of Equity Securities and Use of Proceeds
		Item 3:		Defaults Upon Senior Securities
		Item 4:		Submission of Matters to a Vote of Security Holders
		Item 5:		Other Information
		Item 6:		Exhibits
		Signatures

 

Capital Trust, Inc. and Subsidiaries

Consolidated Balance Sheets

June 30, 2007 and December 31, 2006

(in thousands)

		June 30,			December 31,
		2007			2006
		(unaudited)			(audited)
Assets
Cash and cash equivalents		$	24,479		$	26,142
Restricted cash		3,787			1,707
Commercial mortgage backed securities		891,367			810,970
Loans receivable		2,197,529			1,754,536
Total return swaps		—			1,815
Equity investment in unconsolidated subsidiaries		12,109			11,485
Deposits and other receivables		6,565			3,128
Accrued interest receivable		15,550			14,888
Interest rate hedge assets		10,570			2,565
Deferred income taxes		3,609			3,609
Prepaid and other assets		23,151			17,719
Total assets		$	3,188,716		$	2,648,564
Liabilities and Shareholders’ Equity
Liabilities:
Accounts payable and accrued expenses		$	30,364		$	38,061
Repurchase obligations		964,807			704,444
Collateralized debt obligations		1,199,748			1,212,500
Participations sold		334,244			209,425
Senior unsecured credit facility		75,000			—
Junior subordinated debentures		128,875			51,550
Interest rate hedge liabilities		39			1,688
Deferred origination fees and other revenue		3,550			4,624
Total liabilities		2,736,627			2,222,292
Commitments and contingencies
Shareholders’ equity:
Class A common stock, $0.01 par value, 100,000 shares authorized, 17,065 and 16,933 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively (“class A common stock”)		171			169
Restricted class A common stock, $0.01 par value 445 and 481 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively (“restricted class A common stock” and together with class A common stock, “common stock”)		5			5
Additional paid-in capital		421,764			417,641
Accumulated other comprehensive gain		22,154			12,717
Accumulated earnings/(deficit)		7,995			(4,260		)
Total shareholders’ equity		452,089			426,272
Total liabilities and shareholders’ equity		$	3,188,716		$	2,648,564

 

See accompanying notes to unaudited consolidated financial statements.

1

Capital Trust, Inc. and Subsidiaries

Consolidated Statements of Income

Three and Six Months Ended June 30, 2007 and 2006

(in thousands, except share and per share data)

(unaudited)

		Three Months Ended  June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
Income from loans and other investments:
Interest and related income		$	68,797		$	46,219		$	126,247		$	77,851
Less: Interest and related expenses		40,192			26,267			76,293			43,536
Income from loans and other investments, net		28,605			19,952			49,954			34,315
Other revenues:
Management fees		582			627			1,331			1,235
Incentive management fees		—			84			962			212
Servicing fees		45			—			112			—
Other interest income		272			120			582			351
Total other revenues		899			831			2,987			1,798
Other expenses:
General and administrative		7,832			5,701			14,644			10,826
Depreciation and amortization		60			2,063			1,388			2,340
Total other expenses		7,892			7,764			16,032			13,166
Recovery of provision for losses		4,000			—			4,000			—
Income/(loss) from equity investments		(230		)	403			(933		)	722
Income before income taxes		25,382			13,422			39,976			23,669
(Benefit)/provision for income taxes		—			(770		)	(254		)	(1,471		)
Net income		$	25,382		$	14,192		$	40,230		$	25,140
Per share information:
Net earnings per share of common stock:
Basic		$	1.45		$	0.92		$	2.29		$	1.63
Diluted		$	1.43		$	0.91		$	2.27		$	1.62
Weighted average shares of common stock outstanding:
Basic		17,558,493			15,396,496			17,536,245			15,388,326
Diluted		17,728,180			15,536,948			17,715,810			15,525,586
Dividends declared per share of common stock		$	0.80		$	0.70		$	1.60		$	1.30

 

See accompanying notes to unaudited consolidated financial statements.

2

Capital Trust, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

For the Six Months Ended June 30, 2007 and 2006

(in thousands)

(unaudited)

								Restricted						Accumulated
					Class A			Class A			Additional			Other
		Comprehensive			Common			Common			Paid-In			Comprehensive			Accumulated
		Income/(Loss)			Stock			Stock			Capital			Income/(Loss)			Deficit			Total
Balance at January 1, 2006					$	149		$	4		$	326,299		$	14,879		$	(2,481	)	$	338,850
Net income		$	25,140		—			—			—			—			25,140			25,140
Unrealized gain on derivative financial instruments		13,206			—			—			—			13,206			—			13,206
Amortization of unrealized gain on securities		(814		)	—			—			—			(814		)	—			(814		)
Sale of shares of class A common stock under stock option agreements		—			—			—			219			—			—			219
Deferred gain on settlement of swap, net of amortization		—			—			—			—			1,100			—			1,100
Restricted class A common stock earned		—			—			—			1,831			—			—			1,831
Dividends declared on class A common stock		—			—			—			—			—			(19,918		)	(19,918		)
Balance at June 30, 2006		$	37,532		$	149		$	4		$	328,349		$	28,371		$	2,741		$	359,614
Balance at January 1, 2007					$	169		$	5		$	417,641		$	12,717		$	(4,260	)	$	426,272
Net income		$	40,230		—			—			—			—			40,230			40,230
Unrealized gain on derivative financial instruments		9,644			—			—			—			9,644			—			9,644
Unrealized gain on available for sale security		110			—			—			—			110			—			110
Amortization of unrealized gain on securities		(837		)	—			—			—			(837		)	—			(837		)
Currency translation adjustments		810			—			—			—			810			—			810
Issuance of stock relating to asset purchase		—			—			—			707			—			—			707
Sale of shares of class A common stock under stock option agreements		—			—			—			952			—			—			952
Deferred gain/(loss) on settlement of swap, net of amortization		—			—			—			—			(290		)	—			(290		)
Restricted class A common stock earned		—			2			—			2,464			—			—			2,466
Dividends declared on class A common stock		—			—			—			—			—			(27,975		)	(27,975		)
Balance at June 30, 2007		$	49,957		$	171		$	5		$	421,764		$	22,154		$	7,995		$	452,089

 

See accompanying notes to unaudited consolidated financial statements.

3

Capital Trust, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Six months ended June 30, 2007 and 2006

(in thousands)

(unaudited)

		Six Months Ended June 30,
		2007			2006
Cash flows from operating activities:
Net income		$	40,230		$	25,140
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,388			2,340
(Income)/loss from equity investments		933			(722		)
Distributions from equity investments		320			633
Restricted class A common stock earned		2,464			1,831
Amortization of premiums and accretion of discounts on loans, CMBS, and debt, net		(1,022		)	(635		)
Amortization of deferred gains on interest rate hedges		(137		)	(86		)
Stock based compensation		—			(45		)
Changes in assets and liabilities, net:
Deposits and other receivables		1,616			5,236
Accrued interest receivable		(662		)	(2,462		)
Deferred income taxes		—			(692		)
Prepaid and other assets		1,930			960
Deferred origination fees and other revenue		(1,074		)	2,104
Accounts payable and accrued expenses		2,676			(2,073		)
Net cash provided by operating activities		48,662			31,529
Cash flows from investing activities:
Purchases of commercial mortgage-backed securities		(110,550		)	(359,280		)
Principal collections on and proceeds from sale of commercial mortgage-backed securities		29,968			11,344
Origination and purchase of loans receivable		(1,005,084		)	(453,559		)
Principal collections on loans receivable		442,442			181,992
Equity investments in unconsolidated subsidiaries		(3,919		)	—
Return of capital from investments in unconsolidated subsidiaries		1,616			2,295
Purchase of total return swaps		—			(4,138		)
Proceeds from total return swaps		1,815			4,000
Purchases of equipment and leasehold improvements		(307		)	—
Payments for business purchased		(2,560		)	—
Payment of capitalized costs		(115		)	—
Decrease/(increase) in restricted cash		(2,080		)	(2,080		)
Net cash used in investing activities		(648,774		)	(619,426		)
Cash flows from financing activities:
Proceeds from repurchase obligations		1,163,636			534,529
Repayment of repurchase obligations		(903,272		)	(570,403		)
Proceeds from credit facilities		100,000			—
Repayment of credit facilities		(25,000		)	—
Issuance of junior subordinated debentures		77,325			51,550
Purchase of common equity in CT Preferred Trust I & CT Preferred Trust II		(2,325		)	(1,550		)
Proceeds from issuance of collateralized debt obligations		—			429,398
Repayments of collateralized debt obligations		(12,598		)	(2,632		)
Proceeds from participations sold		239,742			155,950
Settlement of interest rate hedges		(153		)	1,186
Payment of deferred financing costs		(2,218		)	(3,799		)
Sale of shares of class A common stock under stock option agreements		952			219
Reimbursement of offering expenses		—			123
Stock issuance for business purchased		707			—
Dividends paid on class A common stock		(38,347		)	(21,415		)
Net cash provided by financing activities		598,449			573,156
Net decrease in cash and cash equivalents		(1,663		)	(14,741		)
Cash and cash equivalents at beginning of year		26,142			24,974
Cash and cash equivalents at end of period		$	24,479		$	10,233

 

See accompanying notes to unaudited consolidated financial statements

4

Capital Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

1.     Organization

References herein to “we,” “us” or “our” refer to Capital Trust, Inc. and its subsidiaries unless the context specifically requires otherwise.

We are a fully integrated, self-managed finance and investment management company that specializes in credit sensitive structured financial products. To date, our investment programs have focused on loans and securities backed by commercial real estate assets. We invest for our own account directly on our balance sheet and for third parties through a series of investment management vehicles. From the commencement of our finance business in 1997 through June 30, 2007, we have completed over $10.0 billion of investments in the commercial real estate debt arena. We conduct our operations as a real estate investment trust, or REIT, for federal income tax purposes and we are headquartered in New York City.

2.     Summary of Significant Accounting Policies

The accompanying unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The accompanying unaudited consolidated interim financial statements should be read in conjunction with the financial statements and the related management discussion and analysis of financial condition and results of operations filed with our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.  In our opinion, all material adjustments (consisting of normal, recurring accruals) considered necessary for a fair presentation have been included. The results of operations for the three and six months ended June 30, 2007 are not necessarily indicative of results that may be expected for the entire year ending December 31, 2007.  Our accounting and reporting policies conform in all material respects to accounting principles generally accepted in the United States.

Principles of Consolidation

The accompanying unaudited consolidated interim financial statements include, on a consolidated basis, our accounts, the accounts of our wholly-owned subsidiaries and our interests in variable interest entities in which we are the primary beneficiary.  All significant intercompany balances and transactions have been eliminated in consolidation. Our interests in CT Preferred Trust I and CT Preferred Trust II, the issuers of our junior subordinated debentures, are accounted for using the equity method and their assets and liabilities are not consolidated into our financial statements due to our determination that CT Preferred Trust I and CT Preferred Trust II are variable interest entities in which we are not the primary beneficiary under Financial Accounting Standards Board, or FASB, Interpretation No. 46, or FIN 46. We account for our co-investment interest in a private equity fund we co-sponsored and continue to manage, CT Mezzanine Partners III, Inc., or Fund III, under the equity method of accounting. We also account for our investment in Bracor Investimentos Imobiliarios Ltda., or Bracor, under the equity method of accounting. As such, we report a percentage of the earnings of Fund III and Bracor equal to our ownership percentage on a single line item in the consolidated statement of operations as income from equity investments.

Revenue Recognition

Interest income from our loans receivable is recognized over the life of the investment using the effective interest method and is recorded on the accrual basis. Fees, premiums, discounts and direct costs in connection with these investments are deferred until the loan is advanced and are then recognized over the term of the loan as an adjustment to yield. Fees on commitments that expire unused are recognized at expiration. For loans where we have unfunded commitments, we amortize the appropriate items on a straight line basis. Income recognition is generally suspended for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed.

Fees from special servicing and asset management services are recognized as services are rendered. We account for incentive fees we can potentially earn from our investment management business in accordance with Method 1 of Emerging Issues Task Force Topic D-96. Under Method 1, no incentive income is recorded until all contingencies have been eliminated.

5

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Capital Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(unaudited)

2.     Summary of Significant Accounting Policies, continued

Cash and Cash Equivalents

We classify highly liquid investments with original maturities of three months or less from the date of purchase as cash equivalents.  At June 30, 2007 and December 31, 2006, a majority of the cash and cash equivalents consisted of overnight investments in commercial paper.  As of, and for the periods ended, June 30, 2007 and December 31, 2006, we had bank balances in excess of federally insured amounts.  We have not experienced any losses on our demand deposits, commercial paper or money market investments.

Restricted Cash

Restricted cash is comprised of $3.8 million that is on deposit with the trustee for our collateralized debt obligations, or CDOs, and is expected to be used to pay contractual interest and principal and to purchase replacement collateral for our reinvesting CDOs during their respective reinvestment periods.

Commercial Mortgage Backed Securities

We classify our commercial mortgage backed securities, or CMBS, investments pursuant to FASB Statement of Financial Accounting Standards No. 115, or FAS 115, on the date of acquisition of the investment. On August 4, 2005, we made a decision to change the accounting classification of our CMBS investments from available for sale to held to maturity. Held to maturity investments are stated at cost plus the amortization of any premiums or discounts and any premiums or discounts are amortized through the consolidated statements of income using the level yield method.  Other than in the instance of impairment, these held to maturity investments are shown in our financial statements at their adjusted values pursuant to the methodology described above.

We may also invest in CMBS and certain other securities which may be classified as available for sale.  Available for sale securities are carried at estimated fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive income/(loss) in shareholders’ equity.  Many of these investments are relatively illiquid and management must estimate their values.  In making these estimates, management utilizes market prices provided by dealers who make markets in these securities, but may, under certain circumstances, adjust these valuations based on management’s judgment.  Changes in the valuations do not affect our reported income or cash flows, but impact shareholders’ equity and, accordingly, book value per share.

Income on these securities is recognized based upon a number of assumptions that are subject to uncertainties and contingencies.  Examples include, among other things, the rate and timing of principal payments, including prepayments, repurchases, defaults and liquidations, the pass-through or coupon rate and interest rates.  Additional factors that may affect our reported interest income on our mortgage backed securities include interest payment shortfalls due to delinquencies on the underlying mortgage loans and the timing and magnitude of credit losses on the mortgage loans underlying the securities that are impacted by, among other things, the general condition of the real estate market, including competition for tenants and their related credit quality, and changes in market rental rates.  These uncertainties and contingencies are difficult to predict and are subject to future events that may alter the assumptions.

We account for CMBS under Emerging Issues Task Force 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets”, or EITF 99-20.  Under EITF 99-20, when significant changes in estimated cash flows from the cash flows previously estimated occur due to actual prepayment and/or credit loss experience and the present value of the revised cash flows using the current expected yield is less than the present value of the previously estimated remaining cash flows, adjusted for cash receipts during the intervening period, an other-than-temporary impairment is deemed to have occurred.  Accordingly, the security is written down to fair value with the resulting change being included in income and a new cost basis established with the original discount or premium written off when the new cost basis is established.  In accordance with this guidance, on a quarterly basis, when significant changes in estimated cash flows from the cash flows previously estimated occur due to actual prepayment and/or credit loss experience, we calculate a revised yield based upon the current amortized cost of the investment, including any other-than-temporary impairments recognized to date, and the revised cash flows.  The revised yield is then applied prospectively to recognize interest income.  Management must also assess whether unrealized losses on securities reflect a decline in value that is other-than-temporary, and, accordingly, write down the impaired security to its fair value, through a charge to earnings.

6

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Capital Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(unaudited)

2.     Summary of Significant Accounting Policies, continued

Significant judgment of management is required in this analysis that includes, but is not limited to, making assumptions regarding the collectibility of the principal and interest, net of related expenses, on the underlying loans.

During the fourth quarter of 2004, we concluded that two of our CMBS investments had incurred other than temporary impairment and we incurred a charge of $5.9 million through the income statement.  At June 30, 2007 we believe there has not been any adverse change in cash flows since December 31, 2004, therefore we did not recognize any additional other than temporary impairment on any CMBS investments.  Significant judgment of management is required in this analysis that includes, but is not limited to, making assumptions regarding the collectibility of the principal and interest, net of related expenses, on the underlying loans.

From time to time we purchase CMBS and other investments in which we have a level of control over the issuing entity; we refer to these investments as controlling class investments, or Controlling Class Investments.  The presentation of Controlling Class Investments in our financial statements is governed in part by FIN 46.  FIN 46 could require that certain Controlling Class Investments be presented on a consolidated basis.  Based upon the specific circumstances of certain of our CMBS investments that are Controlling Class Investments and our interpretation of FIN 46, specifically the exemption for qualifying special purpose entities as defined under FASB Statements of Financial Accounting Standard No. 140, or FAS 140, we have concluded that the entities that have issued the Controlling Class Investments should not be presented on a consolidated basis.  We are aware that FAS 140 is currently under review by standard setters and that, as a result of this review, our current interpretation of FIN 46 and FAS 140 may change.

Loans Receivable and Reserve for Possible Credit Losses

We purchase and originate commercial real estate debt and related instruments, or Loans, to be held as long term investments at amortized cost.  Management must periodically evaluate each of these Loans for possible impairment.  Impairment is indicated when it is deemed probable that we will not be able to collect all amounts due according to the contractual terms of the Loan.  If a Loan were determined to be permanently impaired, we would write down the Loan through a charge to the reserve for possible credit losses.  Given the nature of our Loan portfolio and the underlying commercial real estate collateral, significant judgment on the part of management is required in determining the permanent impairment and the resulting charge to the reserve, which includes but is not limited to making assumptions regarding the value of the real estate that secures the loan.  Each Loan in our portfolio is evaluated at least quarterly using our loan risk rating system which considers loan-to-value, debt yield, cash flow stability, exit plan, loan sponsorship, loan structure and other factors deemed necessary by management to assess the likelihood of delinquency or default.  If we believe that there is a potential for delinquency or default, a downside analysis is prepared to estimate the value of the collateral underlying our Loan, and this potential loss is multiplied by the default likelihood to determine the size of the reserve.  Actual losses, if any, could ultimately differ from these estimates.

Deferred Financing Costs

The deferred financing costs which are included in other assets on our consolidated balance sheets include issuance costs related to our debt and are amortized using the effective interest method or a method that approximates the effective interest method.

Repurchase Obligations

In certain circumstances, we have financed the purchase of investments from a counterparty through a repurchase agreement with that same counterparty.  We currently record these investments in the same manner as other investments financed with repurchase agreements, with the investment recorded as an asset and the related borrowing under any repurchase agreement as a liability on our consolidated balance sheet. Interest income earned on the investments and interest expense incurred on the repurchase obligations are reported separately on the consolidated statements of income.  There is a position under consideration by standard setters, based upon a technical interpretation of FAS 140, that these transactions will not qualify as a purchase by us.  We believe, consistent with industry practice, that we are accounting for these transactions in an appropriate manner; however, if these investments do not qualify as a purchase under FAS 140, we would be required to present the net investment (asset balance less the repurchase obligation balance) on our balance sheet together with an embedded derivative with the corresponding change in fair value of the derivative being recorded in the consolidated statements of income.

7

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Capital Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(unaudited)

2.     Summary of Significant Accounting Policies, continued

The value of the derivative would reflect not only changes in the value of the underlying investment, but also changes in the value of the underlying credit provided by the counterparty.  Income from these arrangements would be presented on a net basis.  Furthermore, hedge instruments related to these assets and liabilities, currently deemed effective, may no longer be effective and may have to be accounted for as non-hedge derivatives.  As of June 30, 2007 we had entered into 23 such transactions, with a book value of the associated assets of $630.6 million financed with repurchase obligations of $451.7 million. Adoption of the aforementioned treatment would result in a reduction in total assets and liabilities on our consolidated balance sheet of $451.7 million and $395.8 million at June 30, 2007 and December 31, 2006, respectively.

Interest Rate Derivative Financial Instruments

In the normal course of business, we use interest rate derivative financial instruments to manage, or hedge, cash flow variability caused by interest rate fluctuations.  Specifically, we currently use interest rate swaps to effectively convert variable rate liabilities, that are financing fixed rate assets, to fixed rate liabilities.  The differential to be paid or received on these agreements is recognized on the accrual basis as an adjustment to the interest expense related to the attendant liability.  The swap agreements are generally accounted for on a held to maturity basis, and, in cases where they are terminated early, any gain or loss is generally amortized over the remaining life of the hedged item.  These swap agreements must be effective in reducing the variability of cash flows of the hedged items in order to qualify for the aforementioned hedge accounting treatment.  Changes in value of effective cash flow hedges are reflected in our financial statements through accumulated other comprehensive income/(loss) and do not affect our net income.  To the extent a derivative does not qualify for hedge accounting, and is deemed a non-hedge derivative, the changes in its value are included in net income.

To determine the fair value of derivative instruments, we use third parties to periodically value our interests.

Income Taxes

Our financial results generally do not reflect provisions for current or deferred income taxes on our REIT taxable income.  Management believes that we operate in a manner that will continue to allow us to be taxed as a REIT and, as a result, do not expect to pay substantial corporate level taxes (other than taxes payable by our taxable REIT subsidiaries which are accounted for in accordance with FASB Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”, or FAS 109).  Many of these requirements, however, are highly technical and complex.  If we were to fail to meet these requirements, we may be subject to federal, state and local income tax on current and past income, and we may also be subject to penalties.

In June 2006, the FASB issued Financial Interpretation No. 48, or FIN 48.  This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FAS 109. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation was effective January 1, 2007 for the company. The adoption of FIN 48 did not have a material impact on our financial results.

Accounting for Stock-Based Compensation

We account for stock based compensation in accordance with FASB Statement of Financial Accounting Standards No. 123(R).  We have elected to utilize the modified prospective method, and there was no material impact from this adoption.  Compensation expense for the time vesting of stock based compensation grants is recognized on the accelerated attribution method under FASB Interpretation No. 28, and compensation expense for performance vesting of stock based compensation grants is recognized on a straight-line basis.

Comprehensive Income

We comply with the provisions of the FASB Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income”, or FAS 130, in reporting comprehensive income and its components in the full set of general-purpose financial statements. Total comprehensive income was $50.0 million and $37.5 million, for the periods ended June 30, 2007 and 2006, respectively.  The primary component of comprehensive income other than net income was the unrealized gain/(loss) on derivative financial instruments and CMBS.  At June 30, 2007,

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Capital Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(unaudited)

2.     Summary of Significant Accounting Policies, continued

accumulated other comprehensive income was $22.2 million, comprised of unrealized gains on CMBS of $9.2 million, unrealized gains on cash flow swaps of $10.5 million, $1.6 million of deferred realized gains on the settlement of cash flow swaps, and $812,000 of currency translation adjustments.

Earnings per Share of Common Stock

Earnings per share of common stock are presented based on the requirements of the FASB Statement of Accounting Standards No. 128, or FAS 128.  Basic EPS is computed based on the income applicable to common stock and stock units divided by weighted average number of shares of common stock and stock units outstanding during the period.  Diluted EPS is based on the net earnings applicable to common stock and stock units, divided by weighted average number of shares of common stock and stock units and potentially dilutive common stock options.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results may ultimately differ from those estimates.

Reclassifications

Certain reclassifications have been made in the presentation of the prior periods consolidated financial statements to conform to the June 30, 2007 presentation.

Segment Reporting

We operate in two reportable segments. We have an internal information system that produces performance and asset data for the two segments along service lines.

The “Balance Sheet Investment” segment includes all of our activities related to direct loan and investment activities (including our co-investments in investment management vehicles and our investment in Bracor) and the financing thereof.

The “Investment Management” segment includes the activities related to investment management services provided by CT Investment Management Co., LLC, or CTIMCO, and its subsidiaries.  CTIMCO is a taxable REIT subsidiary and is our special servicer and the investment manager of Capital Trust, Inc., and all of our investment management vehicles.

Related Party Transactions

On November 9, 2006, we commenced our CT High Grade MezzanineSM investment management initiative and entered into three separate account agreements with affiliates of W. R. Berkley Corporation, or WRBC, for an aggregate of $250 million.  On July 25, 2007, we amended the agreements to increase the aggregate commitment of the WRBC affiliates to $350 million.  Pursuant to these agreements, we invest, on a discretionary basis, capital on behalf of WRBC in low risk commercial real estate mortgages, mezzanine loans and participations therein.  WRBC beneficially owns approximately 14.2% of our outstanding class A common stock as of July 29, 2007 and a member of our board of directors is an employee of WRBC. The separate accounts are entirely funded with committed capital from WRBC and are managed by a subsidiary of our wholly-owned investment management subsidiary, CT Investment Management Co. LLC, or CTIMCO.  Each separate account has a one-year investment period with extension provisions. CTIMCO will earn a management fee equal to 0.25% per annum on invested assets.

On April 27, 2007, we purchased a $20 million subordinated interest in a mortgage from a dealer.  Proceeds from the original mortgage financing provide for the construction and leasing of an office building in Washington, D.C.  The mortgage borrower is a joint venture between two parties, one of which is 80% controlled by W.R. Berkley Corporation, or WRBC.  WRBC beneficially owns approximately 14.2% of our outstanding class A common stock as of July 29, 2007 and a member of our board of directors is an employee of WRBC.

We believe that the terms of the foregoing transactions are no less favorable than could be obtained by us from unrelated parties on an arm’s length basis.

Business Combination

On June 15, 2007, the company purchased a healthcare loan origination platform with 18 employees, located in Birmingham, Alabama. The company paid a $2.6 million initial purchase price ($1.9 million in cash and $707,000 in stock) and has a contingent obligation to pay an additional $1.8 million ($1.1 million in cash and $700,000 in stock) on March 15, 2009 if the acquired business meets certain performance criteria. The company has recorded $2.1 million of goodwill associated with the initial purchase price.

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Capital Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(unaudited)

3.     Commercial Mortgage Backed Securities

Activity relating to our CMBS investments for the six months ended June 30, 2007 was as follows ($ values in thousands):

												Weighted Average
								Number of		Number of								Maturity
Asset Type		Face Value			Book Value			Securities		Issue		Rating (1)		Coupon(2)		Yield(2)		(Years) (3)
December 31, 2006
Floating Rate		$	86,012		$	84,807		11		9		BBB-		7.42	%	7.51	%	2.0
Fixed Rate		764,607			726,163			66		48		BB+		6.68	%	7.13	%	8.5
Total/Average		850,619			810,970			77		57		BB+		6.75	%	7.17	%	7.8
Originations - Six Months
Floating Rate		109,621			109,617			7		4		BB-		9.66	%	9.66	%	3.8
Fixed Rate		1,000			933			1		1		BB+		6.13	%	6.57	%	3.3
Total/Average		110,621			110,550			8		5		BB-		9.63	%	9.63	%	3.8
Repayments & Other (4) - Six Months
Floating Rate		19,605			19,627			4		—		N/A		N/A		N/A		N/A
Fixed Rate		10,369			10,526			1		1		N/A		N/A		N/A		N/A
Total/Average		29,974			30,153			5		1		N/A		N/A		N/A		N/A
June 30, 2007
Floating Rate		176,028			174,797			14		13		BB		8.87	%	8.92	%	2.9
Fixed Rate		755,238			716,570			66		48		BB+		6.67	%	7.13	%	8.1
Total/Average		$	931,266		$	891,367		80		61		BB+		7.09	%	7.48	%	7.0

 

(1) Weighted average ratings are based on the lowest rating published by Fitch Ratings, Standard & Poor’s or Moody’s Investors Service for each security and exclude $37.4 million of unrated equity investments in collateralized debt obligations.

(2) Calculations based on LIBOR of 5.32% as of June 30, 2007 and LIBOR of 5.32% as of December 31, 2006.

(3) Represents the maturity of the investment assuming all extension options are executed.

(4) Includes full repayments, sale, partial repayments, mark-to-market adjustments, and the impact of premium and discount amortization and losses, if any.  The figures shown in “Number of Securities” and “Number of Issues” represent the full repayments/sales, if any.

We acquire rated and unrated subordinated investments in CMBS.  As detailed in Note 2, on August 4, 2005, pursuant to the provisions of FAS 115, we made a decision to change the accounting classification of our then portfolio of CMBS investments from available for sale to held to maturity.

While we typically account for our CMBS investments on a held to maturity basis, under certain circumstances we will account for CMBS on an available for sale basis.  At June 30, 2007, we had one CMBS investment that we designated and account for on an available for sale basis with a face value of $10.0 million. The security earns interest at a fixed rate of 7.87%.  As of June 30, 2007, the security was carried at its fair market value of $10.5 million. The investment matures in February 2010.

Quarterly, we reevaluate our CMBS portfolio to determine if there has been an other-than-temporary impairment based upon our assessment of future cash flow receipts.  For the six months ended June 30, 2007, we believe that

10

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Capital Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(unaudited)

3.     Commercial Mortgage Backed Securities, continued

there has not been any adverse change in cash flows for our CMBS portfolio and, therefore, did not recognize any other-than-temporary impairments.  Significant judgment of management is required in this analysis that includes, but is not limited to, making assumptions regarding the collectibility of principal and interest, net of related expenses, on the underlying loans.

Certain of our CMBS investments are carried at values in excess of their market values.  This difference can be caused by, among other things, changes in interest rates, changes in credit spreads, realized/unrealized losses and general market conditions.  At June 30, 2007, 59 CMBS investments with an aggregate carrying value of $591.3 million were carried at values in excess of their market values.  Market value for these CMBS investments was $571.2 million at June 30, 2007.

11

Capital Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(unaudited)

4. Loans Receivable

Activity relating to our loans receivable for the six months ended June 30, 2007 was as follows ($ values in thousands):

										Weighted Average
								Number of						Maturity
Asset Type		Face Value(1)			Book Value(1)			Investments(1)		Coupon(2)		Yield (2)		(Years)(3)
December 31, 2006
Floating rate(4)
Mortgage loans		$	234,419		$	234,419		14		7.85	%	8.47	%	4.0
Subordinate mortgage interests		669,532			668,365			28		8.29	%	8.37	%	3.9
Mezzanine loans		622,055			621,877			23		9.57	%	9.76	%	4.3
Total/Average		1,526,006			1,524,661			65		8.75	%	8.96	%	4.1
Fixed rate
Mortgage loans		—			—			—		—		—		—
Subordinate mortgage interests		42,309			41,486			4		7.78	%	7.85	%	16.0
Mezzanine loans		187,161			185,751			11		9.07	%	9.25	%	4.9
Total/Average		229,470			227,237			15		8.80	%	8.96	%	7.2
Total/Average - December 31, 2006		1,755,476			1,751,898			80		8.75	%	8.96	%	4.5
Originations(5) - Six Months
Floating rate
Mortgage loans		367,259			367,259			9		7.69	%	8.01	%	3.9
Subordinate mortgage interests		221,342			221,192			9		8.23	%	8.27	%	4.8
Mezzanine loans		416,632			416,632			9		8.69	%	8.68	%	3.4
Total/Average		1,005,233			1,005,083			27		8.22	%	8.35	%	4.0
Fixed rate
Mortgage loans		—			—			—		—		—		—
Subordinate mortgage interests		—			—			—		—		—		—
Mezzanine loans		—			—			—		—		—		—
Total/Average		—			—			—		—		—		—
Total/Average		1,005,233			1,005,083			27		8.22	%	8.35	%	4.0
Repayments & Other(6)- Six Months
Floating rate
Mortgage loans		13,817			13,817			1		N/A		N/A		N/A
Subordinate mortgage interests		298,830			297,918			8		N/A		N/A		N/A
Mezzanine loans		231,968			231,950			9		N/A		N/A		N/A
Total/Average		544,615			543,685			18		N/A		N/A		N/A
Fixed rate
Mortgage loans		—			—			—
Subordinate mortgage interests		40			(26		)	—		N/A		N/A		N/A
Mezzanine loans		15,119			15,793			2		N/A		N/A		N/A
Total/Average		15,159			15,767			2		N/A		N/A		N/A
Total/Average		559,774			559,452			20		N/A		N/A		N/A
June 30, 2007
Floating rate
Mortgage loans		587,861			587,861			22		7.75	%	8.07	%	4.1
Subordinate mortgage interests		592,044			591,639			29		8.02	%	8.01	%	3.9
Mezzanine loans		806,719			806,559			23		9.18	%	9.24	%	3.7
Total/Average		1,986,624			1,986,059			74		8.41	%	8.53	%	3.9
Fixed rate
Mortgage loans		—			—			—		—		—		—
Subordinate mortgage interests		42,269			41,512			4		7.72	%	7.80	%	17.7
Mezzanine loans		172,042			169,958			9		8.99	%	9.13	%	4.5
Total/Average		214,311			211,470			13		8.74	%	8.87	%	7.1
Total/Average - June 30, 2007		$	2,200,935		$	2,197,529		87		8.44	%	8.56	%	4.2

 

(1)             December 31, 2006 values do not include one non performing loan that was successfully resolved in the second quarter of 2007.

(2)             Calculations based on LIBOR of 5.32% as of June 30, 2007 and LIBOR of 5.32% as of December 31, 2006.

(3)             Represents the maturity of the investment assuming all extension options are executed.

(4)             During the period one subordinate mortgage interest with a book value of $6,866 switched from a fixed rate to a floating rate.

(5)             Includes additional fundings on prior period originations.  The figures shown in “Number of Investments” represent the actual number of originations during the period.

(6)             Includes full repayments, sales, partial repayments and the impact of premium and discount amortization and losses, if any.  The figures shown in “Investments” represent the full repayments/sales, if any.

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Capital Trust, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(unaudited)

4. Loans Receivable, continued

During the second quarter of 2007, we successfully resolved our only non performing loan. The loan was a first mortgage with an original principal balance of $8.0 million that reached maturity on July 15, 2000.  In December 2002, the loan was written down to $4.0 million. From 2002 to March 31, 2007 we had received $1.4 million in cash collections, which further reduced the carrying value of the loan to $2.6 million. During the second quarter of 2007, we received net proceeds of $10.9 million which resulted in reducing the carrying value of the loan to zero and recording $4.0 million of a recovery of provision for losses and $4.3 million of interest income.

In some instances, we have a further obligation to fund additional amounts under our loan arrangements, or Unfunded Loan Commitments.  At June 30, 2007, we had 15 such Unfunded Loan Commitments for a total future funding obligation of $277.5 million.

In connection with the aforementioned loans, at June 30, 2007, we have deferred origination fees, net of direct costs of $3.5 million which are being amortized into income over the life of the loans.

At June 30, 2007, we had $5.1 million included in deposits and other receivables which represented loans that were satisfied and repaid prior to June 30, the proceeds of which had not been remitted to us by our servicers at quarter end.

Quarterly, management reevaluates the reserve for possible credit losses based upon our current portfolio of loans. Each loan in our portfolio is evaluated using our loan risk rating system which considers loan to value, debt yield, cash flow stability, exit plan, loan sponsorship, loan structure and any other factors necessary to assess the likelihood of delinquency or default.  If we believe that there is a potential for delinquency or default, a downside analysis is prepared to estimate the value of the collateral underlying our loan, and this potential loss is multiplied by the default likelihood. At June 30, 2007, a detailed review of the entire portfolio was completed, and we concluded that a reserve for possible credit losses was not warranted.

5.              Total Return Swaps

Total return swaps are derivative contracts in which one party agrees to make payments that replicate the total return of a defined underlying asset, typically in return for another party agreeing to bear the risk of performance of the defined underlying asset.  Under our current total return swaps, we bear the risk of performance of the underlying asset and receive payments from our counterparty as compensation.  In effect, these total return swaps allow us to receive the leveraged economic benefits of asset ownership without our acquiring, or our counterparty selling, the actual underlying asset.  Our total return swaps reference commercial real estate loans and contain a put provision whereby our counterparty has the right to require us to buy the entire reference loan at its par value under certain reference loan performance scenarios.  The put obligation imbedded in these arrangements constitutes a recourse obligation for us to perform under the terms of the contract.

Activity relating to our total return swaps for the six months ended June 30, 2007 was as follows ($ values in thousands):

													Weighted Average
		Fair Market Value (Book Value)			Cash Collateral			Reference/Loan Participation			Number of Investments		Yield(1)		Maturity (Years) (2)
December 31, 2006		$	1,815		$	1,815		$	40,000		2		20.55	%	1.4
Originations- Six Months		—			—			—			—		—		—
Repayments- Six Months		1,815			1,815			20,000			1		N/A		N/A
June 30, 2007(3)		$	—		$	—		$	20,000		1		N/A		N/A

 

(1) Calculations based on LIBOR of 5.32% as of June 30, 2007 and LIBOR of 5.32% as of December 31, 2006.

(2) Maturity (years) based on initial maturity date of the commitments.

(3) The total return swaps currently have no outstanding balance and a $3.0 million unfunded commitment exists.

The total return swaps are treated as non-hedge derivatives for accounting purposes and, as such, changes in their market value are recorded through the consolidated statements of income.  At June 30, 2007, our total return swaps were valued at par and no such consolidated statement of income impact was recorded.

13