SL GREEN REALTY CORP - Quarter Report: 2012 March (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2012

 

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: 1-13199

 

SL GREEN REALTY CORP.

(Exact name of registrant as specified in its charter)

 

 

420 Lexington Avenue, New York, New York 10170

(Address of principal executive offices) (Zip Code)

 

(212) 594-2700

(Registrant’s telephone number, including area code)

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES x  NO o

 

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

 

 

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

 

The number of shares outstanding of the registrant’s common stock, $0.01 par value, was 89,634,376 as of April 30, 2012.

 

 

Table of Contents

 

SL GREEN REALTY CORP.

 

INDEX

 

		PAGE
PART I.	FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
	Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011	3
	Consolidated Statements of Income for the three months ended March 31, 2012 and 2011 (unaudited)	4
	Consolidated Statements of Comprehensive Income for the three months ended March 31, 2012 and 2011 (unaudited)	5
	Consolidated Statement of Equity for the three months ended March 31, 2012 (unaudited)	6
	Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011 (unaudited)	7
	Notes to Consolidated Financial Statements (unaudited)	8
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	38
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	52
ITEM 4.	CONTROLS AND PROCEDURES	52
PART II.	OTHER INFORMATION	53
ITEM 1.	LEGAL PROCEEDINGS	53
ITEM 1A.	RISK FACTORS	53
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	53
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	53
ITEM 4.	MINE SAFETY DISCLOSURES	53
ITEM 5.	OTHER INFORMATION	53
ITEM 6.	EXHIBITS	54
SIGNATURES		55

 

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PART I.                                                    FINANCIAL INFORMATION

ITEM 1.     Financial Statements

SL Green Realty Corp.

Consolidated Balance Sheets

(Amounts in thousands, except per share data)

 

		March 31, 2012			December 31, 2011
		(Unaudited)
Assets
Commercial real estate properties, at cost:
Land and land interests		$	2,816,831		$	2,684,626
Building and improvements		7,191,889			7,147,527
Building leasehold and improvements		1,317,492			1,302,790
Property under capital lease		12,208			12,208
		11,338,420			11,147,151
Less: accumulated depreciation		(1,202,507		)	(1,136,603		)
		10,135,913			10,010,548
Assets held for sale		—			76,562
Cash and cash equivalents		133,665			138,192
Restricted cash		98,563			86,584
Investment in marketable securities		25,689			25,323
Tenant and other receivables, net of allowance of $19,605 and $16,772 in 2012 and 2011, respectively		29,020			32,107
Related party receivables		7,665			4,001
Deferred rents receivable, net of allowance of $30,611 and $29,156 in 2012 and 2011, respectively		300,419			281,974
Debt and preferred equity investments, net of discount of $23,784 and $24,996 and allowance of $41,050 and $50,175 in 2012 and 2011, respectively		999,573			985,942
Investments in unconsolidated joint ventures		1,022,931			893,933
Deferred costs, net		211,728			210,786
Other assets		796,547			737,900
Total assets		$	13,761,713		$	13,483,852
Liabilities
Mortgages and other loans payable		$	4,409,715		$	4,314,741
Revolving credit facility		400,000			350,000
Senior unsecured notes		1,171,331			1,270,656
Accrued interest payable and other liabilities		116,498			126,135
Accounts payable and accrued expenses		137,500			142,428
Deferred revenue/gains		373,573			357,193
Capitalized lease obligation		17,130			17,112
Deferred land leases payable		18,608			18,495
Dividend and distributions payable		29,652			28,398
Security deposits		47,996			46,367
Liabilities related to assets held for sale		—			61,988
Junior subordinate deferrable interest debentures held by trusts that issued trust preferred securities		100,000			100,000
Total liabilities		6,822,003			6,833,513
Commitments and contingencies		—			—
Noncontrolling interest in operating partnership		237,763			195,030
Series H Preferred Units, $25.00 liquidation preference, 80 issued and outstanding at March 31, 2012 and December 31, 2011, respectively		2,000			2,000
Series G Preferred Units, $25.00 liquidation preference, 1,902 issued and outstanding at March 31, 2012		47,550			—
Equity
SL Green stockholders’ equity:
Series C preferred stock, $0.01 par value, $25.00 liquidation preference, 11,700 issued and outstanding at March 31, 2012 and December 31, 2011, respectively		274,022			274,022
Series D preferred stock, $0.01 par value, $25.00 liquidation preference, 4,000 issued and outstanding at March 31, 2012 and December 31, 2011, respectively		96,321			96,321
Common stock, $0.01 par value 160,000 shares authorized and 92,460 and 89,210 issued and outstanding at March 31, 2012 and December 31, 2011, respectively (inclusive of 3,605 and 3,427 shares held in Treasury at March 31, 2012 and December 31, 2011, respectively)		925			892
Additional paid-in-capital		4,469,777			4,236,959
Treasury stock at cost		(319,866		)	(308,708		)
Accumulated other comprehensive loss		(24,376		)	(28,445		)
Retained earnings		1,665,547			1,704,506
Total SL Green stockholders’ equity		6,162,350			5,975,547
Noncontrolling interests in other partnerships		490,047			477,762
Total equity		$	6,652,397		$	6,453,309
Total liabilities and equity		$	13,761,713		$	13,483,852

 

The accompanying notes are an integral part of these financial statements.

 

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SL Green Realty Corp.

Consolidated Statements of Income

(Unaudited, and amounts in thousands, except per share data)

 

		Three Months Ended
		March 31,
		2012			2011
Revenues
Rental revenue, net		$	260,814		$	227,020
Escalation and reimbursement		41,663			30,275
Investment and preferred equity income		26,338			64,678
Other income		10,377			7,248
Total revenues		339,192			329,221
Expenses
Operating expenses (including approximately $3,459 (2012) and $3,115 (2011) paid to affiliates)		73,269			60,298
Real estate taxes		51,498			40,067
Ground rent		8,806			7,834
Interest expense, net of interest income		80,137			64,266
Amortization of deferred financing costs		3,580			3,800
Depreciation and amortization		77,083			63,497
Loan loss and other investment reserves, net of recoveries		564			(3,150		)
Transaction related costs		1,151			2,434
Marketing, general and administrative		20,196			20,021
Total expenses		316,284			259,067
Income from continuing operations before equity in net income of unconsolidated joint ventures, noncontrolling interests and discontinued operations		22,908			70,154
Equity in net (loss) income from unconsolidated joint ventures		(1,560		)	8,206
Purchase price fair value adjustment		—			13,788
Equity in net gain on sale of interest in unconsolidated joint venture/real estate		7,260			—
Loss on investment in marketable securities		—			(127		)
Income from continuing operations		28,608			92,021
Net (loss) income from discontinued operations		(78		)	1,873
Gain on sale of discontinued operations		6,627			—
Net income		35,157			93,894
Net income attributable to noncontrolling interests in the operating partnership		(888		)	(1,852		)
Net income attributable to noncontrolling interests in other partnerships		(1,071		)	(3,610		)
Net income attributable to SL Green		33,198			88,432
Preferred stock dividends		(7,942		)	(7,545		)
Net income attributable to SL Green common stockholders		$	25,256		$	80,887
Amounts attributable to SL Green common stockholders:
Income from continuing operations		$	11,916		$	65,574
Purchase price fair value adjustment		—			13,482
Equity in net gain on sale of interest in unconsolidated joint venture/real estate		7,014			—
Net (loss) income from discontinued operations		(76		)	1,831
Gain on sale of discontinued operations		6,402			—
Net income		$	25,256		$	80,887
Basic earnings per share:
Net income from continuing operations before discontinued operations		$	0.14		$	1.01
Equity in net gain on sale of interest in unconsolidated joint venture/real estate		0.08			—
Gain on sale of discontinued operations		0.07			—
Net income from discontinued operations		—			0.01
Net income attributable to SL Green common stockholders		$	0.29		$	1.02
Diluted earnings per share:
Net income from continuing operations before discontinued operations		$	0.14		$	1.00
Equity in net gain on sale of interest in unconsolidated joint venture/real estate		0.08			—
Gain on sale of discontinued operations		0.07			—
Net income from discontinued operations		—			0.01
Net income attributable to SL Green common stockholders		$	0.29		$	1.01
Dividends per share		$	0.25		$	0.10
Basic weighted average common shares outstanding		86,744			79,401
Diluted weighted average common shares and common share equivalents outstanding		90,173			81,643

 

The accompanying notes are an integral part of these financial statements.

 

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SL Green Realty Corp.

Consolidated Statements of Comprehensive Income

(Unaudited, and amounts in thousands)

 

		Three Months Ended March 31,
		2012			2011
Net income		$	35,157		$	93,894
Other comprehensive income:
Net unrealized gain on derivative instruments		314			949
SL Green’s share of joint venture net unrealized gain on derivative instruments		2,801			2,501
Unrealized gain on marketable securities		770			6,285
Other comprehensive income		3,885			9,735
Comprehensive income		39,042			103,629
Comprehensive income attributable to noncontrolling interests		(1,775		)	(5,549		)
Comprehensive income attributable to SL Green common stockholders		$	37,267		$	98,080

 

The accompanying notes are an integral part of these financial statements.

 

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SL Green Realty Corp.

Consolidated Statement of Equity

(Unaudited, and amounts in thousands, except per share data)

 

		SL Green Realty Corp. Stockholders
		Series C			Series D			Common Stock					Additional						Accumulated Other
		Preferred Stock			Preferred Stock			Shares		Par Value			Paid- In-Capital			Treasury Stock			Comprehensive Income (Loss)			Retained Earnings			Noncontrolling Interests			Total
Balance at December 31, 2011		$	274,022		$	96,321		85,783		$	892		$	4,236,959		$	(308,708	)	$	(28,445	)	$	1,704,506		$	477,762		$	6,453,309
Net income after allocation to noncontrolling interests in SLGOP																						33,198			1,071			34,269
Comprehensive income																			4,069									4,069
Preferred dividends																						(7,942		)				(7,942		)
Redemption of units and DRIP proceeds								1,308		13			99,780															99,793
Reallocation of noncontrolling interest in the operating partnership																						(41,935		)				(41,935		)
Deferred compensation plan & stock award, net								64		3			470			(11,158		)										(10,685		)
Amortization of deferred compensation plan													7,061															7,061
Proceeds from issuance of common stock								1,629		16			122,937															122,953
Proceeds from stock options exercised								71		1			2,570															2,571
Consolidation of joint venture																									18,331			18,331
Cash distributions to noncontrolling interests																									(7,117)			(7,117		)
Cash distribution declared ($0.25 per common share, none of which represented a return of capital for federal income tax purposes)																						(22,280		)				(22,280		)
Balance at March 31, 2012		$	274,022		$	96,321		88,855		$	925		$	4,469,777		$	(319,866	)	$	(24,376	)	$	1,665,547		$	490,047		$	6,652,397

 

The accompanying notes are an integral part of these financial statements.

 

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SL Green Realty Corp.

Consolidated Statements of Cash Flows

(Unaudited, and amounts in thousands, except per share data)

 

		Three Months Ended
		March 31,
		2012			2011
Operating Activities
Net income		$	35,157		$	93,894
Adjustment to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		80,663			67,979
Equity in net loss (income) from unconsolidated joint ventures		1,560			(8,206		)
Equity in net gain on sale of joint venture interest/ real estate		(7,260		)	—
Gain on sale of discontinued operations		(6,627		)	—
Distributions of cumulative earnings from unconsolidated joint ventures		4,408			2,915
Purchase price fair value adjustment		—			(13,788		)
Gain on sale of debt securities		—			(19,840		)
Loan loss and other investment reserves		564			(3,150		)
Loss on investments in marketable securities		—			127
Deferred rents receivable		(21,123		)	(24,367		)
Other non-cash adjustments		5,554			(1,823		)
Changes in operating assets and liabilities:
Restricted cash — operations		(12,771		)	(3,131		)
Tenant and other receivables		14			1,025
Related party receivables		(3,664		)	2,449
Deferred lease costs		(7,152		)	(7,651		)
Other assets		(24,230		)	(7,014		)
Accounts payable, accrued expenses and other liabilities		4,118			(5,833		)
Deferred revenue and land leases payable		7,620			3,073
Net cash provided by operating activities		56,831			76,659
Investing Activities
Acquisitions of real estate property		(145,558		)	(10,000		)
Additions to land, buildings and improvements		(32,561		)	(21,396		)
Escrowed cash — capital improvements/acquisition deposits		(1,533		)	45,975
Investments in unconsolidated joint ventures		(105,633		)	(31,299		)
Distributions in excess of cumulative earnings from unconsolidated joint ventures		16,652			95,704
Net proceeds from disposition of real estate/joint venture interest		23,088			—
Other investments		(40,016		)	(148,264		)
Debt and preferred equity and other investments, net of repayments/participations		(8,631		)	103,429
Net cash (used in) provided by investing activities		(294,192		)	34,149
Financing Activities
Proceeds from mortgages and other loans payable		108,500			40,000
Repayments of mortgages and other loans payable		(13,526		)	(148,761		)
Proceeds from revolving credit facility and senior unsecured notes		300,000			458,550
Repayments of revolving credit facility and senior unsecured notes		(352,454		)	(693,373		)
Proceeds from stock options exercised and DRIP issuance		102,089			3,802
Net proceeds from sale of common stock		122,953			161,714
Purchases of treasury stock		(11,158		)	—
Distributions to noncontrolling interests in other partnerships		(7,117		)	(2,210		)
Contributions from noncontrolling interests in other partnerships		18,331			—
Distributions to noncontrolling interests in operating partnership		(762		)	(228		)
Dividends paid on common and preferred stock		(28,453		)	(15,682		)
Deferred loan costs and capitalized lease obligation		(5,569		)	(13,441		)
Net cash provided by (used in) financing activities		232,834			(209,629		)
Net decrease in cash and cash equivalents		(4,527		)	(98,821		)
Cash and cash equivalents at beginning of period		138,192			332,830
Cash and cash equivalents at end of period		$	133,665		$	234,009

 

The accompanying notes are an integral part of these financial statements.

 

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SL Green Realty Corp.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2012

 

1.  Organization and Basis of Presentation

 

SL Green Realty Corp., also referred to as the Company or SL Green, a Maryland corporation, and SL Green Operating Partnership, L.P., which is referred to as SLGOP or the Operating Partnership, a Delaware limited partnership, were formed in June 1997 for the purpose of combining the commercial real estate business of S.L. Green Properties, Inc. and its affiliated partnerships and entities.  The Operating Partnership received a contribution of interest in the real estate properties, as well as 95% of the economic interest in the management, leasing and construction companies which are referred to as the Service Corporation, a consolidated variable interest entity.  All of the management, leasing and construction services with respect to the properties wholly-owned by us are conducted through SL Green Management LLC which is 100% owned by our Operating Partnership.  The Company has qualified, and expects to qualify in the current fiscal year, as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code, and operates as a self-administered, self-managed REIT.  A REIT is a legal entity that holds real estate interests and, through payments of dividends to stockholders, is permitted to reduce or avoid the payment of Federal income taxes at the corporate level.  Unless the context requires otherwise, all references to the “Company,” “we,” “our” and “us” means the Company and all entities owned or controlled by the Company, including the Operating Partnership.

 

Substantially all of our assets are held by, and our operations are conducted through, the Operating Partnership.  The Company is the sole managing general partner of the Operating Partnership.  As of March 31, 2012, noncontrolling investors held, in the aggregate, a 3.3% limited partnership interest in the Operating Partnership.  We refer to this as the noncontrolling interests in the Operating Partnership.  See Note 13.

 

Reckson Associates Realty Corp., or Reckson, and Reckson Operating Partnership, L.P., or ROP, are subsidiaries of the Operating Partnership.

 

As of March 31, 2012, we owned the following interests in commercial office properties in the New York Metropolitan area, primarily in midtown Manhattan, a borough of New York City, or Manhattan.  Our investments in the New York Metropolitan area also include investments in Brooklyn, Queens, Long Island, Westchester County, Connecticut and New Jersey, which are collectively known as the Suburban assets:

 

Location		Ownership		Number of Properties		Square Feet		Weighted Average Occupancy(1)
Manhattan		Consolidated properties		26		18,429,945		93.4	%
		Unconsolidated properties		7		5,326,815		95.6	%
Suburban		Consolidated properties		25		3,863,000		80.8	%
		Unconsolidated properties		6		2,941,700		93.8	%
				64		30,561,460		92.2	%

 

(1)

The weighted average occupancy represents the total leased square feet divided by total available rentable square feet.

 

We also owned investments in 14 stand-alone retail properties encompassing approximately 460,692 square feet, eight development properties encompassing approximately 2,614,996 square feet, two residential properties encompassing 385 units (approximately 430,482 square feet) and two land interests as of March 31, 2012.  In addition, we manage three office properties owned by third parties and affiliated companies encompassing approximately 0.9 million rentable square feet.

 

Partnership Agreement

 

In accordance with the partnership agreement of the Operating Partnership, or the Operating Partnership agreement, we allocate all distributions and profits and losses in proportion to the percentage ownership interests of the respective partners.  As the managing general partner of the Operating Partnership, we are required to take such reasonable efforts, as determined by us in our sole discretion, to cause the Operating Partnership to distribute sufficient amounts to enable the payment of sufficient dividends by us to avoid any Federal income or excise tax at the Company level. Under the operating partnership agreement, each limited partner has the right to redeem units of limited partnership interests for cash, or if we so elect, shares of our common stock on a one-for-one basis.

 

Basis of Quarterly Presentation

 

The accompanying unaudited consolidated 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 Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered

 

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SL Green Realty Corp.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2012

 

necessary for the fair presentation of the financial position of the Company at March 31, 2012 and the results of operations for the periods presented have been included.  The 2012 operating results for the period presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.  These financial statements should be read in conjunction with the financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2011.

 

The balance sheet at December 31, 2011 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

 

2.  Significant Accounting Policies

 

Principles of Consolidation

 

The consolidated financial statements include our accounts and those of our subsidiaries, which are wholly-owned or controlled by us. Entities which we do not control through our voting interest and entities which are variable interest entities, but where we are not the primary beneficiary, are accounted for under the equity method or as debt and preferred equity investments.  See Notes 5 and 6.  All significant intercompany balances and transactions have been eliminated.

 

The FASB amended the guidance for determining whether an entity is a variable interest entity, or VIE, and requires the performance of a qualitative rather than a quantitative analysis to determine the primary beneficiary of a VIE. Under this guidance, an entity would be required to consolidate a VIE if it has (i) the power to direct the activities that most significantly impact the entity’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could be significant to the VIE.

 

A noncontrolling interest in a consolidated subsidiary is defined as the portion of the equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent.  Noncontrolling interests are required to be presented as a separate component of equity in the consolidated balance sheet and modifies the presentation of net income by requiring earnings and other comprehensive income to be attributed to controlling and noncontrolling interests.

 

We assess the accounting treatment for each joint venture and debt and preferred equity investment.  This assessment includes a review of each joint venture or partnership limited liability company agreement to determine which party has what rights and whether those rights are protective or participating.  For all VIE’s, we review such agreements in order to determine which party has the power to direct the activities that most significantly impact the entity’s economic performance.  In situations where we or our partner approves, among other things, the annual budget, receives a detailed monthly reporting package from us, meets on a quarterly basis to review the results of the joint venture, reviews and approves the joint venture’s tax return before filing, and approves all leases that cover more than a nominal amount of space relative to the total rentable space at each property, we do not consolidate the joint venture as we consider these to be substantive participation rights that result in shared power of the activities that most significantly impact the performance of our joint venture.  Our joint venture agreements also contain certain protective rights such as the requirement of partner approval to sell, finance or refinance the property and the payment of capital expenditures and operating expenditures outside of the approved budget or operating plan.

 

Investment in Commercial Real Estate Properties

 

On a periodic basis, we assess whether there are any indicators that the value of our real estate properties may be impaired or that its carrying value may not be recoverable.  A property’s value is considered impaired if management’s estimate of the aggregate future cash flows (undiscounted and without interest charges for consolidated properties) to be generated by the property are less than the carrying value of the property.  To the extent impairment has occurred, the loss will be measured as the excess of the carrying amount of the property over the calculated fair value of the property.  In addition, we assess our investments in unconsolidated joint ventures for recoverability, and if it is determined that a loss in value of the investment is other than temporary, we write down the investment to its fair value.  We evaluate our equity investments for impairment based on the joint venture’s projected discounted cash flows. In November 2011, we recorded a $5.8 million impairment charge in connection with the expected sale of one of our equity investments. No impairment charge was recorded during the three months ended March 31, 2012 and 2011. We do not believe that the value of any of our consolidated properties or equity investments was impaired at March 31, 2012 and December 31, 2011.

 

We allocate the purchase price of real estate to land and building and, if determined to be material, intangibles, such as the value of above-, below- and at-market leases and origination costs associated with the in-place leases.  We depreciate the amount allocated to building and other intangible assets over their estimated useful lives, which generally range from three to 40 years and from one to 14 years, respectively.  The values of the above- and below-market leases are amortized and recorded as either an increase (in the case of below-market leases) or a decrease (in the case of above-market leases) to rental income over the remaining term of the associated

 

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SL Green Realty Corp.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2012

 

lease, which generally range from one to 14 years.  The value associated with in-place leases is amortized over the expected term of the associated lease, which generally ranges from one to 14 years.  If a tenant vacates its space prior to the contractual termination of the lease and no rental payments are being made on the lease, any unamortized balance of the related intangible will be written off.  The tenant improvements and origination costs are amortized as an expense over the remaining life of the lease (or charged against earnings if the lease is terminated prior to its contractual expiration date).  We assess fair value of the leases based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information.  Estimates of future cash flows are based on a number of factors including the historical operating results, known trends, and market/economic conditions that may affect the property. To the extent acquired leases contain fixed rate renewal options that are below market and determined to be material, we amortized such below market lease value into rental income over the renewal period.

 

We recognized an increase of approximately $2.1 million and $7.2 million in rental revenue for the three months ended March 31, 2012 and 2011, respectively, for the amortization of aggregate below-market leases in excess of above-market leases and amortization of lease origination costs, resulting from the allocation of the purchase price of the applicable properties.  We recognized a reduction in interest expense for the amortization of the above-market rate mortgages assumed of approximately $1.0 million and $1.3 million for the three months ended March 31, 2012 and 2011, respectively.

 

The following summarizes our identified intangible assets (acquired above-market leases and in-place leases) and intangible liabilities (acquired below-market leases) (in thousands):

 

		March 31, 2012			December 31, 2011
Identified intangible assets (included in other assets):
Gross amount		$	721,336		$	673,495
Accumulated amortization		(214,042		)	(193,442		)
Net		$	507,294		$	480,053
Identified intangible liabilities (included in deferred revenue):
Gross amount		$	649,863		$	622,029
Accumulated amortization		(309,854		)	(290,893		)
Net		$	340,009		$	331,136

 

Fair Value Measurements

 

Fair value is a market-based measurement, not an entity-specific measurement, and should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, FASB guidance establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within levels one and two of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within level three of the hierarchy).

 

We determined the fair value of our current investments in marketable securities using level one, level two and level three inputs. Additionally, we determined the valuation allowance for loan losses based on level three inputs. See “Note 5—Debt and Preferred Equity Investments.”

 

The estimated fair values of tangible and intangible assets and liabilities recorded in connection with business combinations are based on level three inputs. We estimate fair values based on cash flow projections utilizing appropriate discount and/or capitalization rates and available market information.

 

We determine impairment in real estate investments and debt and preferred equity investments, including intangibles, utilizing cash flow projections that apply estimated revenue and expense growth rates, discount rates and capitalization rates, which are classified as Level 3 inputs.

 

We use the following methods and assumptions in estimating fair value disclosures for financial instruments.

 

·                  Cash and cash equivalents:  The carrying amount of unrestricted cash and cash equivalents reported in our Consolidated Balance Sheets approximates fair value due to the short maturity of these instruments.

·                  Debt and Preferred Equity Investments:  The fair value of debt and preferred equity investments is estimated by discounting the future cash flows using current interest rates at which similar loans with the same maturities would be

 

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SL Green Realty Corp.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2012

 

made to borrowers with similar credit ratings. See “Reserve for Possible Credit Losses” below regarding valuation allowances for loan losses.

·                  Mortgage and other loans payable and other debt:  The fair value of borrowings is estimated by discounting the future cash flows using current interest rates at which similar borrowings could be made by us.

 

The methodologies used for valuing financial instruments have been categorized into three broad levels as follows:

 

Level 1 — Quoted prices in active markets for identical instruments.

Level 2 — Valuations based principally on other observable market parameters, including

·         Quoted prices in active markets for similar instruments,

·         Quoted prices in less active or inactive markets for identical or similar instruments,

·                            Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates), and

·         Market corroborated inputs (derived principally from or corroborated by observable market data).

Level 3 — Valuations based significantly on unobservable inputs.

·                            Valuations based on third-party indications (broker quotes or counterparty quotes) which were, in turn, based significantly on unobservable inputs or were otherwise not supportable as Level 2 valuations.

·                            Valuations based on internal models with significant unobservable inputs.

 

These levels form a hierarchy. We follow this hierarchy for our financial instruments measured at fair value on a recurring and nonrecurring basis. The classifications are based on the lowest level of input that is significant to the fair value measurement.

 

Investment in Marketable Securities

 

We invest in marketable securities. At the time of purchase, we are required to designate a security as held-to-maturity, available-for-sale, or trading depending on ability and intent. We do not have any securities designated as held-to-maturity or trading at this time. Securities available-for-sale are reported at fair value pursuant to ASC 820-10, with the net unrealized gains or losses reported as a component of accumulated other comprehensive loss.  Unrealized losses that are determined to be other-than-temporary are recognized in earnings up to their credit component. Included in accumulated other comprehensive loss at March 31, 2012 is approximately $7.6 million in net unrealized gains related to marketable securities.

 

The cost of bonds and marketable securities sold is determined using the specific identification method.

 

At March 31, 2012 and December 31, 2011, we held the following marketable securities (in thousands):

 

		March 31,			December 31,
		2012			2011
Level 1 — Equity marketable securities		$	8,613		$	8,065
Level 2 — Commercial mortgage-backed securities		13,205			13,369
Level 3 — Rake bonds		3,871			3,889
Total marketable securities available-for-sale		$	25,689		$	25,323

 

The cost basis of the Level 3 securities was $3.8 million at March 31, 2012 and $3.9 million at December 31, 2011. There were no sales of Level 3 securities during the three months ended March 31, 2012. The Level 3 securities mature at various times through 2030.

 

Revenue Recognition

 

Interest income on debt and preferred equity investments is recognized over the life of the investment using the effective interest method and recognized on the accrual basis.  Fees received in connection with loan commitments are deferred until the loan is funded and are then recognized over the term of the loan as an adjustment to yield.  Anticipated exit fees, whose collection is expected, are also recognized over the term of the loan as an adjustment to yield.  Fees on commitments that expire unused are recognized at expiration.

 

Income recognition is generally suspended for debt and preferred equity investments 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. Interest is recorded as income on impaired loans only to the extent cash is received. Several of the debt and preferred equity investments provide for accrual of interest at specified rates, which differ from current payment terms. Interest is recognized on such loans at the accrual

 

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SL Green Realty Corp.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2012

 

rate subject to management’s determination that accrued interest and outstanding principal are ultimately collectible, based on the underlying collateral and operations of the borrower. If management cannot make this determination, interest income above the current pay rate is recognized only upon actual receipt.

 

If we purchase a debt or preferred equity investment at a discount, intend to hold it until maturity and expect to recover the full value of the investment, we accrete the discount into income as an adjustment to yield over the term of the investment. If we purchase a debt or preferred equity investment at a discount with the intention of foreclosing on the collateral, we do not accrete the discount.

 

Reserve for Possible Credit Losses

 

The expense for possible credit losses in connection with debt and preferred equity investments is the charge to earnings to increase the allowance for possible credit losses to the level that we estimate to be adequate, based on Level 3 data, considering delinquencies, loss experience and collateral quality.  Other factors considered relate to geographic trends and product diversification, the size of the portfolio and current economic conditions.  Based upon these factors, we establish the provision for possible credit losses on each individual investment.  When it is probable that we will be unable to collect all amounts contractually due, the investment is considered impaired.

 

Where impairment is indicated on an investment that is held to maturity, a valuation allowance is measured based upon the excess of the recorded investment amount over the net fair value of the collateral.  Any deficiency between the carrying amount of an asset and the calculated value of the collateral is charged to expense.  The write-off of the reserve balance is called a charge off.  We recorded loan loss reserves of $3.0 million and none on investments being held to maturity and on our held for sale investment during the three months ended March 31, 2012 and 2011, respectively.  We recorded approximately $2.4 million and $3.2 million in recoveries during the three months ended March 31, 2012 and 2011, respectively, in connection with the sales of investments. This is included in Loan loss and other investment reserves, net of recoveries in the accompanying Consolidated Statements of Income.

 

Debt and preferred equity investments held for sale are carried at the lower of cost or fair market value using available market information obtained through consultation with dealers or other originators of such investments as well as discounted cash flow models based on Level 3 data pursuant to ASC 820-10. As circumstances change, management may conclude not to sell an investment designated as held for sale.  In such situations, the investment will be reclassified at its net carrying value to debt and preferred equity investments held to maturity.  For these reclassified investments, the difference between the current carrying value and the expected cash to be collected at maturity will be accreted into income over the remaining term of the investment.

 

Income Taxes

 

We are taxed as a REIT under Section 856(c) of the Code.  As a REIT, we generally are not subject to Federal income tax.  To maintain our qualification as a REIT, we must distribute at least 90% of our REIT taxable income to our stockholders 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, local and franchise taxes.  Under certain circumstances, Federal income and excise taxes may be due on our undistributed taxable income.

 

Pursuant to amendments to the Code that became effective January 1, 2001, we have elected, and may in the future, elect to treat certain of our existing or newly created corporate subsidiaries as taxable REIT subsidiaries, or a TRS.  In general, a TRS of ours may perform non-customary services for our tenants, hold assets that we cannot hold directly and generally may engage in any real estate or non-real estate related business.  Our TRSs’ generate income, resulting in Federal income tax liability for these entities.  Our TRSs’ did not record any Federal, state and local tax provision during either of the three months ended March 31, 2012 and 2011, respectively, and made estimated tax payments of none and $0.1 million during the three months ended March 31, 2012 and 2011, respectively.

 

Stock-Based Employee Compensation Plans

 

We have a stock-based employee compensation plan, described more fully in Note 12.

 

The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable.  In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility.  Because our plan has characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our employee stock options.

 

Compensation cost for stock options, if any, is recognized ratably over the vesting period of the award.  Our policy is to grant options

 

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SL Green Realty Corp.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2012

 

with an exercise price equal to the quoted closing market price of our stock on the grant date.  Awards of stock or restricted stock are expensed as compensation over the benefit period based on the fair value of the stock on the grant date.

 

For share-based awards with a performance or market measure, we recognize compensation cost over the requisite service period, using the accelerated attribution expense method. The requisite service period begins on the date the Compensation Committee authorizes the award and adopts any relevant performance measures. For programs with performance or market measures, the total estimated compensation cost is based on the fair value of the award at the applicable reporting date estimated using a binomial model. For share-based awards for which there is no pre-established performance measure, we recognize compensation cost over the service vesting period, which represents the requisite service period, on a straight-line basis. In accordance with the provisions of our share-based incentive compensation plans, we accept the return of shares of Company common stock, at the current quoted market price, from certain key employee to satisfy minimum statutory tax-withholding requirements related to shares that vested during the period.

 

Awards can also be made in the form of a separate series of units of limited partnership interest in our Operating Partnership called long-term incentive plan (LTIP) units. LTIP units, which can be granted either as free-standing awards or in tandem with other awards under our stock incentive plan, are valued by reference to the value of our common stock at the time of grant, and are subject to such conditions and restrictions as our compensation committee may determine, including continued employment or service, computation of financial metrics and/or achievement of pre-established performance goals and objectives.

 

Earnings per Share

 

We present both basic and diluted earnings per share, or EPS.  Basic EPS excludes dilution and is computed by dividing net income attributable to common stockholders by the weighted average number of common shares outstanding during the period. Basic EPS includes participating securities, consisting of unvested restricted stock that receive nonforfeitable dividends similar to shares of common stock. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, where such exercise or conversion would result in a lower EPS amount.  This also includes units of limited partnership interest. The dilutive effect of the outstanding nonvested shares of common stock (“nonvested shares”) and restricted stock units (“RSUs”) that have not yet been granted but are contingently issuable under the share-based compensation programs is reflected in the weighted average diluted shares calculation by application of the treasury stock method at the beginning of the quarterly period in which all necessary conditions have been satisfied. The dilutive effect of stock options are reflected in the weighted average diluted outstanding shares calculation by application of the treasury stock method. There is no dilutive effect for the exchangeable senior debentures as the conversion premium will be paid in cash.

 

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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

Concentrations of Credit Risk

 

Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash investments, debt and preferred equity investments and accounts receivable.  We place our cash investments in excess of insured amounts with high quality financial institutions.  The collateral securing our debt and preferred equity investments is primarily located in the New York Metropolitan area. See Note 5. We perform ongoing credit evaluations of our tenants and require certain tenants to provide security deposits or letters of credit.  Though these security deposits and letters of credit are insufficient to meet the total value of a tenant’s lease obligation, they are a measure of good faith and a source of funds to offset the economic costs associated with lost rent and the costs associated with re-tenanting the space.  Although the properties in our real estate portfolio are primarily located in Manhattan, we also have properties located in Brooklyn, Queens, Long Island, Westchester County, Connecticut and New Jersey.  The tenants located in our buildings operate in various industries.  Other than one tenant who accounts for approximately 7.5% of our share of annualized cash rent, no other tenant in our portfolio accounted for more than 6.9% of our annualized cash rent, including our share of joint venture annualized cash rent at March 31, 2012. Approximately 10%, 5%, 7% and 6% of our annualized cash rent, including our share of joint venture annualized cash rent, was attributable to 1515 Broadway, 420 Lexington Avenue, 1185 Avenue of the Americas and One Madison Avenue, respectively, for the quarter ended March 31, 2012.  In addition, two debt and preferred equity investments accounted for more than 10% of the income earned on debt and preferred equity investments during the three months ended March 31, 2012.

 

Reclassification

 

Certain prior year balances have been reclassified to conform to our current year presentation primarily in order to eliminate discontinued operations from income from continuing operations.

 

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SL Green Realty Corp.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2012

 

Accounting Standards Updates

 

In May 2011, the FASB issued updated guidance on fair value measurement which amends U.S. GAAP to conform to IFRS measurement and disclosure requirements.  The amendments change the wording used to describe the requirements in U.S. GAAP for measuring fair value, changes certain fair value measurement principles and enhances disclosure requirements.  The guidance was effective as of the first quarter of 2012 and its adoption did not have a material effect on our consolidated financial statements.

 

In June 2011, the FASB issued guidance to increase the prominence of other comprehensive income in the financial statements. The standard gives businesses two options for presenting other comprehensive income (OCI), which until now has typically been included within the statement of equity. An OCI statement can be included with the statement of income, and together the two will make a statement of total comprehensive income. Alternatively, businesses can have an OCI statement separate from the statement of income, but the two statements will have to appear consecutively within a financial report. These requirements related to the presentation of OCI are effective for interim and annual reporting periods beginning after December 15, 2011. We adopted this guidance and presented a separate Statement of Comprehensive Income in our consolidated financial statements. In December 2011, the FASB temporarily delayed those requirements that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. During the deferral period, the FASB plans to re-evaluate the requirement, with a final decision expected in 2012.

 

In December 2011, the FASB issued guidance that concluded when a parent ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt, the reporting entity must apply the accounting guidance for sales of real estate to determine whether it should derecognize the in substance real estate. The reporting entity is precluded from derecognizing the real estate until legal ownership has been transferred to the lender to satisfy the debt. The guidance is effective for calendar year-end public and nonpublic companies in 2013 and is to be applied on a prospective basis. Early adoption of the guidance is permitted. Adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

 

3.  Property Acquisitions

 

In October 2011, SL Green formed a joint venture with Stonehenge Partners and in January 2012 acquired five retail and two multifamily properties in Manhattan for $193.1 million, inclusive of the issuance of $47.6 million aggregate liquidation preference of 4.5% Series G preferred operating partnership units. The residential component, which encompasses 385 units and 488,000 square feet, was financed with an aggregate 12-year $100.0 million fixed rate mortgage which bears interest at 4.125%. One of the retail properties was financed with a 5-year $8.5 million mortgage. We are currently in the process of analyzing the fair value of the in-place leases; and consequently, no value has yet been assigned to the leases. Therefore, the purchase price allocation is preliminary and subject to change. We consolidate this joint venture as it is a VIE and we have been designated as the primary beneficiary.

 

In November 2011, we acquired all of the interests in 51 East 42nd Street, a 142,000 square-foot office building for approximately $80.0 million, inclusive of the issuance of $2.0 million aggregate liquidation preference of 6.0% Series H preferred operating partnership units.

 

The following summarizes our preliminary allocation of the purchase price of the assets acquired and liabilities assumed upon the assumption of control over 51 East 42nd Street (in thousands):

 

Land		$	44,095
Building		33,470
Above market lease value		5,616
Acquired in-place leases		4,333
Assets acquired		87,514
Below market lease value		7,514
Liabilities assumed		7,514
Purchase price allocation		$	80,000
Net consideration funded at closing		$	79,632

 

In November 2011, we, along with The Moinian Group, formed a joint venture to recapitalize 180 Maiden Lane, a fully-leased, 1.1

 

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SL Green Realty Corp.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2012

 

million-square-foot Class A office tower. The consideration for our 49.9 percent stake in the joint venture included $41.0 million in cash and operating partnership units valued at $31.7 million. In connection with the issuance of these operating partnership units, we recorded an $8.3 million fair value adjustment due to changes in our stock price. Simultaneous with the closing of the recapitalization, the joint venture refinanced the existing $344.2 million indebtedness with a five-year $280-million mortgage. We consolidate this joint venture due to the control we exert over leasing activities at the property. We consolidate this joint venture as it is a VIE and we have been designated as the primary beneficiary.

 

The following summarizes our preliminary allocation of the purchase price of the assets acquired and liabilities assumed upon the assumption of control over 180 Maiden Lane (in thousands):

 

Land		$	191,523
Building		233,230
Above market lease value		7,944
Acquired in-place leases		29,948
Assets acquired		462,645
Below market lease value		20,320
Liabilities assumed		20,320
Purchase price allocation		$	442,325
Net consideration funded at closing		$	41,835

 

In May 2011, we acquired a substantial ownership interest in the 205,000-square-foot office condominium at 110 East 42nd Street, along with control of the asset. We had previously provided a $16.0 million senior mezzanine loan as part of our sale of the condominium unit in 2007. The May 2011 transaction included a consensual modification of that loan. In conjunction with the transaction, we successfully restructured the in-place mortgage financing, which had previously been in default.

 

The following summarizes our allocation of the purchase price of the assets acquired and liabilities assumed upon the assumption of control over 110 East 42nd Street (in thousands):

 

Land		$	34,000
Building		46,411
Above market lease value		823
Acquired in-place leases		5,396
Assets acquired		86,630
Below market lease value		2,326
Liabilities assumed		2,326
Purchase price allocation		$	84,304
Net consideration funded at closing		$	2,744
Debt assumed		$	65,000

 

In April 2011, we acquired SITQ Immobilier, a subsidiary of Caisse de depot et placement du Quebec, or SITQ’s, interest in 1515 Broadway, thereby consolidating full ownership of the 1,750,000 square-foot building. The transaction valued the consolidated interests at $1.23 billion. We acquired the interest subject to the $458.8 million mortgage encumbering the property. We recognized a purchase price fair value adjustment of $475.1 million upon the closing of this transaction. This property, which we initially acquired in May 2002, was previously accounted for as an investment in unconsolidated joint ventures.

 

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SL Green Realty Corp.

Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2012

 

The following summarizes our allocation of the purchase price of the assets acquired and liabilities assumed upon the purchase of partnership interest in 1515 Broadway (in thousands):

 

Land		$	462,700
Building		707,938
Above market lease value		18,298
Acquired in-place leases		98,661
Other assets, net of other liabilities		27,127
Assets acquired		1,314,724
Fair value adjustment to mortgage note payable		(3,693		)
Below market lease value		84,417
Liabilities assumed		80,724
Purchase price allocation		$	1,234,000
Net consideration funded at closing		$	259,228

 

In January 2011, we purchased City Investment Fund, or CIF’s, 49.9% interest in 521 Fifth Avenue, thereby assuming full ownership of the 460,000 square-foot building. The transaction valued the consolidated interest at approximately $245.7 million excluding $4.5 million of cash and other assets acquired. We acquired the interest subject to the $140.0 million mortgage encumbering the property. We recognized a purchase price fair value adjustment of $13.8 million upon the closing of this transaction. In April 2011, we refinanced the property with a new $150.0 million 2-year mortgage which carries a floating rate of interest of 200 basis points over the 30-day LIBOR. In connection with that refinancing, we acquired the fee interest in the property for $15.0 million.

 

The following summarizes our allocation of the purchase price of the assets acquired and liabilities assumed upon the purchase of 521 Fifth Avenue (in thousands):

 

Land		$	110,100
Building		146,686
Above market lease value		3,318
Acquired in-place leases		23,016
Assets acquired		283,120
Below market lease value		25,977
Liabilities assumed		25,977
Purchase price allocation		$	257,143
Net consideration funded at closing		$	70,000

 

4.  Property Dispositions and Assets Held for Sale

 

In February 2012, we sold the leased fee interest at 292 Madison Avenue for $85.0 million. We recognized a gain of $6.6 million on the sale.

 

In May 2011, we sold the property located at 28 West 44th Street for $161.0 million. The property is approximately 359,000 square feet. We recognized a gain of $46.1 million on the sale.

 

Discontinued operations included the results of operations of real estate assets sold prior to March 31, 2012. This included 28 West 44th Street, which was sold in May 2011 and 292 Madison Avenue which was sold in February 2012.

 

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