This excerpt taken from the CT 10-K filed Mar 10, 2006.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
We reported net income of $44.1 million for the year ended December 31, 2005, an increase of $22.1 million or over 100.0% from the net income of $22.0 million for the year ended December 31, 2004. These increases were primarily the result of an increase in net interest income from loans and other investments (due to both higher levels of aggregate investments and increases in average LIBOR), the receipt of incentive management fees from Fund II, a gain on the sale of our investment in GRO, income from accelerated amortization from early pay-offs, and the reduction in the cost of debt through the use of CDO financings. These increases were partially offset by increases in general and administrative expenses associated with Fund II employee incentive management payments, one time charges for third party services, accelerated amortization of capitalized costs associated with the fund management business and increases in tax expense.
Interest and related income from loans and other investments amounted to $86.2 million for the year ended December 31, 2005, an increase of $39.6 million or 85.0% from the $46.6 million amount for the year ended December 31, 2004. Average interest-earning assets increased from approximately $552.9 million for the year ended December 31, 2004 to approximately $1.1 billion for the year ended December 31, 2005. The average interest rate earned on such assets decreased from 8.40% for the year ended December 31, 2004 to 8.08% for the year ended December 31, 2005. During the year ended December 31, 2005, we recognized $4.0 million in additional income on the early repayment of loans and the applicable acceleration of net premium amortization. The decrease in rates was due primarily to a change in the mix of our investment portfolio to include more lower risk B Notes in 2005 (which generally carry lower interest rates than mezzanine loans) and a general decrease in credit spreads obtained on newly originated investments, partially offset by a higher average LIBOR rate, which increased by 1.89% from 1.50% for the twelve months ended December 31, 2004 to 3.39% for the twelve months ended December 31, 2005.
We utilize our existing collateralized debt obligations and repurchase obligations to finance our interest-earning assets.
Interest and related expenses on secured debt amounted to $37.2 million for the year ended December 31, 2005, an increase of $23.5 million from the $13.7 million amount for the year ended December 31, 2004. The increase in expense was due to an increase in the amount of average interest-bearing liabilities outstanding from approximately $333.5 million for the year ended December 31, 2004 to approximately $780.9 million for the year ended December 31, 2005 and an increase in the average rate paid on interest-bearing liabilities from 4.10% to 4.70% for the same periods. The increase in the average rate is substantially due to increases in the average LIBOR rate, partially offset by the use of collateralized debt obligations and more favorable terms under our repurchase obligations.
During 2004, we also utilized the convertible junior subordinated debentures to finance our interest-earning assets, recognizing $6.4 million of expenses related to the convertible junior subordinated debentures. No expense was recorded for the twelve months ended December 31, 2005, as the liability was extinguished in 2004 upon the conversion of one half of the principal amount due on the debentures into common stock on July 28, 2004 and the conversion of the remaining amount due on the debentures into common stock on September 29, 2004.
Other revenues increased $7.8 million from $10.6 million for the twelve months ended December 31, 2004 to $18.4 million for the twelve months ended December 31, 2005. The increase was primarily due to the sale of an equity investment which resulted in a $5.0 million gain and the receipt of incentive management fees from Fund II of $8.0 million during the twelve months ended December 31, 2005. These items were partially offset by a decrease in base management fees and investment income from Fund II, due to lower levels of investment in 2005 as the fund winds down, and a decrease in base management fees and investment income from Fund III, as Fund III reached the end of its investment period on June 2, 2005 and the base fees are now charged on invested capital as opposed to committed capital. Furthermore, in connection with the receipt of the incentive management fees, Fund II GP, which is 50% owned by us and is the general partner of Fund II, expensed costs that it had previously capitalized of $2.4 million, of which $1.2 million flowed through to us.
General and administrative expenses increased $6.7 million to $21.9 million for the twelve months ended December 31, 2005 from $15.2 million for the twelve months ended December 31, 2004. The increase in general and administrative expenses was primarily due to the allocation of Fund II incentive management fees for payment to employees (representing 25% of the total received, or $2.0 million), increases in employee compensation expense from the issuance of additional restricted stock and the annual bonus accrual, due diligence costs of $475,000 from an abandoned corporate acquisition, $282,000 of expenses from the abandonment of a proposed fund and additional expenses related to the services provided under our contract with GRO which began in April 2004.
On at least a quarterly basis, management reevaluates the reserve for possible credit losses based upon our current portfolio of loans. Each loan in our portfolio is evaluated using our proprietary loan risk rating system, which considers loan to value, debt yield, cash flow stability, exit plan, 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 likelihood of default. Based upon our detailed review at December 31, 2004, we concluded that a reserve for possible credit losses was no longer warranted and the reserve was recaptured. Based upon the changes in conditions of these loans and the evaluations completed on the remainder of the portfolio, we concluded that a reserve for possible credit losses was not warranted at December 31, 2005.
We have made an election to be taxed as a REIT under Section 856(c) of the Internal Revenue Code of 1986, as amended, commencing with the tax year ending December 31, 2003. As a REIT, we generally are not subject to federal income tax. To maintain qualification as a REIT, we must distribute at least 90% of our REIT taxable income to our shareholders and meet certain other requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates. We may also be subject to certain state and local taxes on our income and property. Under certain circumstances, federal income and excise taxes may be due on our undistributed taxable income.
At December 31, 2005 and 2004, we were in compliance with all REIT requirements and, as such, have not provided for income tax expense on our REIT taxable income for the years ended December 31, 2005 and 2004. We also have taxable REIT subsidiaries which are subject to tax at regular corporate rates. During the year ended December 31, 2005 we recorded $213,000 of income tax expense for income that was attributable to our taxable REIT subsidiaries. During the year ended December 31, 2004, we recorded an income tax benefit resulting from losses generated by our taxable REIT subsidiary of $451,000.