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RESOURCE CAPITAL CORP.

(Exact name of registrant as specified in its charter)

 

Maryland		20-2287134
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
712 5 th Avenue, 10 th Floor New York, NY		10019
(Address of principal executive offices)		(Zip Code)

PART I.   FINANCIAL INFORMATION

 

Item 1.   Financial Statements

 

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

 

		September 30, 2006			December 31, 2005
		(Unaudited)
ASSETS
Cash and cash equivalents		$	13,505		$	17,729
Restricted cash			29,054			23,592
Receivables on investment securities sold			753,195			−
Due from broker			−			525
Available-for-sale securities, pledged as collateral, at fair value			395,884			1,362,392
Available-for-sale securities, at fair value			−			28,285
Loans			1,054,602			569,873
Direct financing leases and notes, net of unearned income			91,909			23,317
Investments in unconsolidated trusts			1,548			−
Derivatives, at fair value			−			3,006
Interest receivable			11,369			9,337
Accounts receivable			503			183
Principal paydown receivables			14,668			5,805
Other assets			3,142			1,503
Total assets		$	2,369,379		$	2,045,547
LIABILITIES
Repurchase agreements, including accrued interest of $ 1,012 and $2,104		$	770,167		$	1,068,277
Collateralized debt obligations (“CDOs”) (net of debt issuance costs of $18,730 and $10,093)			1,206,751			687,407
Warehouse agreement			−			62,961
Secured term facility			87,080			−
Unsecured revolving credit facility			−			15,000
Distribution payable			6,594			5,646
Accrued interest expense			11,357			9,514
Unsecured junior subordinated debentures held by  unconsolidated trusts that issued trust preferred securities			51,548			−
Management and incentive fee payable − related party			614			896
Derivatives, at fair value			3,094			−
Security deposits			868			−
Accounts payable and accrued liabilities			1,319			513
Total liabilities			2,139,392			1,850,214
STOCKHOLDERS’ EQUITY
Preferred stock, par value $0.001: 100,000,000 shares authorized; no shares issued and outstanding			-			-
Common stock, par value $0.001: 500,000,000 shares authorized;  17,821,434 and 15,682,334 shares issued and outstanding (including 234,224 and 349,000 restricted shares)			18			16
Additional paid-in capital			247,934			220,161
Deferred equity compensation			(1,364	)		(2,684	)
Accumulated other comprehensive loss			(3,951	)		(19,581	)
Distributions in excess of earnings			(12,650	)		(2,579	)
Total stockholders’ equity			229,987			195,333
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	2,369,379		$	2,045,547

 

See accompanying notes to consolidated financial statements

3

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Index

 

RES OUR CE CAPITAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

(Unaudited)

		Three Months Ended September 30,						Nine Months Ended September 30,			Period from March 8, 2005 (Date Operations Commenced) to September 30,
		2006			2005			2006			2005
REVENUES
Net interest income:
Interest income from securities available-for-sale		$	16,248		$	16,248		$	48,673		$	26,741
Interest income from loans			19,905			4,864			46,625			6,322
Interest income − other			2,995			484			8,179			1,627
Total interest income			39,148			21,596			103,477			34,690
Interest expense			30,855			15,595			78,576			23,736
Net interest income			8,293			6,001			24,901			10,954
OTHER (LOSS) REVENUE
Net realized (losses) gains on investments			(8,314	)		192			(8,853	)		178
Other income			384			−			391			−
Total other (loss) revenue			(7,930	)		192			(8,462	)		178
EXPENSES
Management fees − related party			917			822			3,147			1,839
Equity compensation − related party			798			836			1,620			1,873
Professional services			480			222			1,266			344
Insurance			126			122			372			273
General and administrative			443			415			1,220			795
Total expenses			2,764			2,417			7,625			5,124
NET (LOSS) INCOME		$	(2,401	)	$	3,776		$	8,814		$	6,008
NET (LOSS) INCOME PER SHARE - BASIC		$	(0.14	)	$	0.25		$	0.51		$	0.39
NET (LOSS) INCOME PER SHARE - DILUTED		$	(0.14	)	$	0.24		$	0.51		$	0.39
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING − BASIC			17,585,171			15,333,334			17,261,091			15,333,334
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING − DILUTED			17,585,171			15,458,133			17,388,566			15,458,133
DIVIDENDS DECLARED PER SHARE		$	0.37		$	0.20		$	1.06		$	0.20

See accompanying notes to consolidated financial statements

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Index

R ESO URCE CAPITAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2006

(in thousands, except share data)

(Unaudited)

		Common Stock						Additional Paid-In			Deferred Equity			Accumulated Other Comprehensive			Retained			Distributions in Excess of			Comprehensive			Total Stockholders’
		Shares			Amount			Capital			Compensation			Loss			Earnings			Earnings			Income			Equity
Balance, January 1, 2006			15,682,334		$	16		$	220,161		$	(2,684	)	$	(19,581	)	$	−		$	(2,579	)	$	(19,581	)	$	195,333
Net proceeds from common stock offerings			2,120,800			2			29,663																		29,665
Offering costs									(2,384	)																	(2,384	)
Stock based compensation			18,300						254			(60	)														194
Stock based compensation, fair value adjustment									240			(240	)														−
Amortization of stock based compensation												1,620															1,620
Net income																		8,814						8,814			8,814
Available-for-sale securities, fair value adjustment															21,847									21,847			21,847
Designated derivatives, fair value adjustment															(6,217	)								(6,217	)		(6,217	)
Distributions on common stock																		(8,814	)		(10,071	)					(18,885	)
Comprehensive income																							$	4,863
Balance, September 30, 2006			17,821,434		$	18		$	247,934		$	(1,364	)	$	(3,951	)	$	−		$	(12,650	)				$	229,987

 

See accompanying notes to consolidated financial statements

 

5

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Index

R ESO URCE CAPITAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

		Nine Months Ended September 30, 2006			Period from March 8, 2005 (Date Operations Commenced) to September 30, 2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	8,814		$	6,008
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization			250			−
Amortization of discount on investments and notes			(362	)		(259	)
Amortization of debt issuance costs			1,094			183
Amortization of stock-based compensation			1,620			1,873
Non-cash incentive compensation to the manager			108			−
Net realized gain on derivative instruments			(3,453	)		−
Net realized loss (gain) on investments			11,427			(178	)
Changes in operating assets and liabilities:
Increase in restricted cash			(5,463	)		−
Decrease (increase) in due from broker			525			(6,635	)
Increase in interest receivable, net of purchased interest			(2,102	)		(7,968	)
Increase in accounts receivable			(368	)		−
Decrease (increase) in principal paydown receivables			2,801			(4,701	)
Increase in other assets			(1,873	)		(1,166	)
Increase in accrued interest expense			750			11,587
(Decrease) increase in management and incentive fee payable			(196	)		549
Increase in security deposits			868			−
Increase in accounts payable and accrued liabilities			844			613
Net cash provided by (used in) operating activities			15,284			(94	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available-for-sale			(8,939	)		(1,538,995	)
Principal payments received on securities available-for-sale			117,402			79,230
Proceeds from sale of securities available-for-sale			131,577			5,483
Purchase of loans			(743,113	)		(470,151	)
Principal payments received on loans			154,764			9,630
Proceeds from sale of loans			103,793			58,079
Purchase of direct financing leases and notes			(97,524	)		(25,097	)
Proceeds from and payments received on direct financing leases and notes			29,509			−
Purchase of property and equipment			(6	)		−
Net cash used in investing activities			(312,537	)		(1,881,821	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuances of common stock (net of offering costs of $2,384 and $566)			27,281			214,784
Proceeds from borrowings:
Repurchase agreements			7,060,816			5,494,638
Collateralized debt obligations			527,980			689,500
Warehouse agreements			159,616			572,927
Secured term facility			109,333			−
Unsecured credit facility			21,000			−
Payments on borrowings:
Repurchase agreements			(7,357,834	)		(4,436,030	)
Warehouse agreements			(222,577	)		(537,672	)
Secured term facility			(22,253	)		−
Unsecured revolving credit facility			(36,000	)		−
Proceeds from issuance of unsecured junior subordinated debentures to subsidiary trusts issuing preferred securities			50,000			−
Settlement of derivative instruments			3,335			−
Payment of debt issuance costs			(9,731	)		(10,554	)
Distributions paid on common stock			(17,937	)		(3,136	)
Net cash provided by financing activities			293,029			1,984,457
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS			(4,224	)		102,542
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			17,729			−
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	13,505		$	102,542

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS − (Continued)

(in thousands)

(Unaudited)

 

		Nine Months Ended September 30, 2006			Period from March 8, 2005 (Date Operations Commenced) to September 30, 2005
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Distributions on common stock declared but not paid		$	6,594		$	−
Unsettled security sales − receivables on investment securities sold		$	753,195		$	−
Unsettled security sales - principal paydown receivables		$	14,481		$	−
Unsettled security purchases - due to broker		$	−		$	3,000
Issuance of restricted stock		$	−		$	5,393
SUPPLEMENTAL DISCLOSURE:
Interest expense paid in cash		$	107,195		$	17,960

 

 

See accompanying notes to consolidated financial statements

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R ESO URCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(Unaudited)

NOTE 1 - ORGANIZATION AND BASIS OF QUARTERLY PRESENTATION

Resource Capital Corp. and subsidiaries (the ‘‘Company’’) was incorporated in Maryland on January 31, 2005 and commenced its operations on March 8, 2005 upon receipt of the net proceeds from a private placement of shares of its common stock. The Company’s principal business activity is to purchase and manage a diversified portfolio of commercial real estate-related assets and commercial finance assets. The Company’s investment activities are managed by Resource Capital Manager, Inc. (‘‘Manager’’) pursuant to a management agreement (‘‘Management Agreement’’). The Manager is a wholly owned indirect subsidiary of Resource America, Inc. (“RAI”) (Nasdaq: REXI).

The consolidated financial statements and the information and tables contained in the notes to the consolidated financial statements are unaudited. However, in the opinion of management, these interim financial statements include all adjustments necessary to fairly present the results of the interim periods presented. The unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the period ended December 31, 2005. The results of operations for the three and nine months ended September 30, 2006 may not necessarily be indicative of the results of operations for the full year ending December 31, 2006.

Certain reclassifications have been made to the 2005 consolidated financial statements to conform to the 2006 presentation.

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Income Taxes

 

For financial reporting purposes, current and deferred taxes are provided for on the portion of earnings recognized by the Company with respect to its interest in Resource TRS, Inc. (“Resource TRS”), a domestic taxable real estate investment trust (“REIT”) subsidiary, because it is taxed as a regular subchapter C corporation under the provisions of the Internal Revenue Code of 1986, as amended. As of September 30, 2006, Resource TRS did not have any taxable income.

Apidos CDO I and Apidos CDO III, the Company’s foreign taxable REIT subsidiaries, are organized as exempted companies incorporated with limited liability under the laws of the Cayman Islands, and are generally exempt from federal and state income tax at the corporate level because their activities in the United States are limited to trading in stock and securities for their own account. Therefore, despite their status as taxable REIT subsidiaries, they generally will not be subject to corporate tax on their earnings and no provision for income taxes is required; however, because they are “controlled foreign corporations,” the Company will generally be required to include Apidos CDO I’s and Apidos CDO III’s current taxable income in its calculation of REIT taxable income.

Allowance and Provision for Loan Losses

At September 30, 2006, all of the Company’s loans are current with respect to the scheduled payments of principal and interest. In reviewing the portfolio of loans and the observable secondary market prices, the Company did not identify any loans that exhibit characteristics indicating that impairment has occurred. Accordingly, as of September 30, 2006, the Company had not recorded an allowance for loan losses.

 

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RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Stock Based Compensation

The Company has adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share Based Payment,” as of January 1, 2006. Issuances of restricted stock and options are accounted for using the fair value based methodology prescribed by SFAS No. 123(R) whereby the fair value of the award is measured on the grant date and recorded in stockholders’ equity through an increase to additional paid-in capital and an offsetting entry to deferred equity compensation (a contra-equity account). For issuances to the Company’s Manager, the unvested stock and options are adjusted quarterly to reflect changes in fair value as performance under the agreement is completed. For issuance to the Company’s four non-employee directors, the amount is not remeasured under the fair value-based method. The deferred compensation for each of these issuances is amortized over the service period and included in equity compensation expense (see Note 8).

Variable Interest Entities

During July 2005, the Company entered into warehouse and master participation agreements with an affiliate of Citigroup Global Markets Inc. (“Citigroup”) providing that Citigroup will fund the purchase of loans by Apidos CDO III. On May 9, 2006, the Company terminated its Apidos CDO III warehouse agreement with Citigroup upon the closing of the CDO. The warehouse funding liability was replaced with the issuance of long-term debt by Apidos CDO III. The Company owns 100% of the equity issued by Apidos CDO III and is deemed to be the primary beneficiary. As a result, the Company consolidated Apidos CDO III at September 30, 2006.

Accounting for Certain Mortgage-Backed Securities and Related Repurchase Agreements

In certain circumstances, the Company has purchased debt investments from a counterparty and subsequently financed the acquisition of those debt investments through repurchase agreements with the same counterparty. The Company currently records the acquisition of the debt investments as assets and the related repurchase agreements as financing liabilities gross on the consolidated balance sheets. Interest income earned on the debt investments and interest expense incurred on the repurchase obligations are reported gross on the consolidated statements of operations. However, under a certain technical interpretation of SFAS 140, “Accounting for Transfers and Servicing of Financial Assets,” such transactions may not qualify as a purchase. Management of the Company believes, and it is industry practice, that it is accounting for these transactions in an appropriate manner.  However, the result of this technical interpretation would prevent the Company from presenting the debt investments and repurchase agreements and the related interest income and interest expense on a gross basis on the Company’s consolidated financial statements. Instead, the Company would present the net investment in these transactions with the counterparty as a derivative with the corresponding change in fair value of the derivative being recorded through earnings. The value of the derivative would reflect changes in the value of the underlying debt investments and changes in the value of the underlying credit provided by the counterparty. As of September 30, 2006, the Company had no transactions in mortgage-backed securities where debt instruments were financed with the same counterparty.

 

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RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES − (Continued)

Interest Rate Risk

The primary market risk to the Company is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Company’s control. Changes in the general level of interest rates can affect net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in connection with the interest-bearing liabilities, by affecting the spread between the interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates also can affect the value of the Company’s interest-earning assets and the Company’s ability to realize gains from the sale of these assets. A decline in the value of the Company’s interest-earning assets pledged as collateral for borrowings under repurchase agreements could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels.

The Company seeks to manage the extent to which net income changes as a function of changes in interest rates by matching adjustable-rate assets with variable-rate borrowings. During periods of changing interest rates, interest rate mismatches could negatively impact the Company’s consolidated financial condition, consolidated results of operations and consolidated cash flows. In addition, the Company mitigates the potential impact on net income of periodic and lifetime coupon adjustment restrictions in its investment portfolio by entering into interest rate hedging agreements such as interest rate caps and interest rate swaps.

Changes in interest rates may also have an effect on the rate of mortgage principal prepayments and, as a result, prepayments on mortgage-backed securities in the Company’s investment portfolio. The Company seeks to mitigate the effect of changes in the mortgage principal repayment rate by balancing assets purchased at a premium with assets purchased at a discount. At September 30, 2006, the aggregate discount exceeded the aggregate premium on the Company’s mortgage-backed securities by approximately $3.3 million. At December 31, 2005, the aggregate discount exceeded the aggregate premium on the Company’s mortgage-backed securities by approximately $2.8 million.

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN 48”), “Accounting for Uncertainty in Income Taxes - An Interpretation of SFAS 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB 109, “Accounting for Income Taxes.” FIN 48 also 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. The new FASB standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company is currently determining the effect, if any, the adoption of FIN 48 will have on its financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (“FAS 157”) “Fair Value Measurements”.  FAS 157 clarifies the definition of fair value, establishes a framework for measuring fair value in GAAP and expands the disclosure of fair value measurements.  This statement is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years.  The Company is currently determining the effect, if any, the adoption of FAS 157 will have on its financial statements.

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RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES − (Continued)

Recent Accounting Pronouncements − (Continued)

In September 2006, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance for how errors should be evaluated to assess materiality from a quantitative perspective. SAB 108 permits companies to initially apply its provisions by either restating prior financial statements or recording the cumulative effect of initially applying the approach as adjustments to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment to retained earnings. SAB 108 is required to be adopted for the fiscal years ending after November 30, 2006 and is not expected to have a material effect on the Company’s financial statements.

NOTE 3 - RESTRICTED CASH

Restricted cash consists of $24.8 million of principal and interest payments collected on investments held in four CDO trusts, a $1.5 million credit facility reserve used to fund future investments that will be acquired by the Company’s two bank loan CDO trusts and a $1.2 million expense reserve used to cover CDOs’ operating expenses. The remaining $1.6 million consists of an interest reserve and security deposits held in connection with the Company’s equipment lease and loan portfolio.

NOTE 4 - SECURITIES AVAILABLE-FOR-SALE

 

    On September 27, 2006, the Company entered into an agreement to sell its remaining agency residential mortgage-backed securities (“RMBS”) for gross proceeds totaling $753.2 million, realizing a loss of $10.9 million. The proceeds from this sale were used to repay related debt of $716.5 million on October 2, 2006. The balance of the proceeds will be subsequently received in October and November 2006. Principal repayment receivables of $14.5 million relating to the agency RMBS portfolio sold have been reflected in principal paydown receivables in the Company’s consolidated balance sheets.

 

The following tables summarize the Company's mortgage-backed securities, other asset-backed securities and private equity investments, including those pledged as collateral and classified as available-for-sale, which are carried at fair value (in thousands):

September 30, 2006 (Unaudited):		Amortized Cost			Unrealize Gains			Unrealized Losses			Estimated Fair Value
ABS-RMBS		$	346,988		$	1,813		$	(1,733	)	$	347,068
Commercial mortgage-backed			27,954			4			(570	)		27,388
Other asset-backed			21,452			113			(137	)		21,428
Total		$	396,394		$	1,930		$	(2,440	)	$	395,884		(1	)
December 31, 2005:
Agency RMBS		$	1,014,575		$	13		$	(12,918	)	$	1,001,670
ABS-RMBS			346,460			370			(9,085	)		337,745
Commercial mortgage-backed			27,970			1			(608	)		27,363
Other asset-backed			22,045			24			(124	)		21,945
Private equity			1,984			−			(30	)		1,954
Total		$	1,413,034		$	408		$	(22,765	)	$	1,390,677		(1	)

 

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(1)	As of September 30, 2006, all securities were pledged as collateral. As of December 31, 2005, all securities, other than $26.3 million in agency RMBS and $2.0 million in private equity investments, were pledged as collateral.

 

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RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 4 - SECURITIES AVAILABLE-FOR-SALE − (Continued)

The following tables summarize the estimated maturities of the Company’s mortgage-backed securities, other asset-backed securities and private equity investments according to their estimated weighted average life classifications (in thousands, except percentages):

Weighted Average Life		Estimated Fair Value			Amortized Cost			Weighted average Coupon
September 30, 2006 (Unaudited):
Less than one year		$	3,971		$	3,967			6.66	%
Greater than one year and less than five years			344,999			345,110			6.88	%
Greater than five years			46,914			47,317			6.19	%
Total		$	395,884		$	396,394			6.79	%
December 31, 2005:
Less than one year		$	−		$	−			−	%
Greater than one year and less than five years			1,355,910			1,377,537			4.91	%
Greater than five years			34,767			35,497			5.60	%
Total		$	1,390,677		$	1,413,034			4.92	%

 

The following tables show the estimated fair value and gross unrealized losses, aggregated by investment category and length of time, of only those individual securities that have been in a continuous unrealized loss position (in thousands):

 

		Less than 12 Months						Total
		Estimated Fair Value			Gross Unrealized Losses			Estimated Fair Value			Gross Unrealized Losses
September 30, 2006 (Unaudited):
ABS-RMBS		$	74,533		$	(798	)	$	153,692		$	(1,733	)
Commercial mortgage-backed			19,093			(568	)		26,968			(570	)
Other asset-backed			2,999			(137	)		2,999			(137	)
Total temporarily impaired securities		$	96,625		$	(1,503	)	$	183,659		$	(2,440	)
December 31, 2005:
Agency RMBS		$	978,570		$	(12,918	)	$	978,570		$	(12,918	)
ABS-RMBS			294,359			(9,085	)		294,359			(9,085	)
Commercial mortgage-backed			26,905			(608	)		26,905			(608	)
Other asset-backed			12,944			(124	)		12,944			(124	)
Private equity			1,954			(30	)		1,954			(30	)
Total temporarily impaired securities		$	1,314,732		$	(22,765	)	$	1,314,732		$	(22,765	)

 

The temporary impairment of the available-for-sale securities results from the estimated fair value of the securities falling below their amortized cost basis and is solely attributed to changes in interest rates. As of September 30, 2006 and December 31, 2005, respectively, none of the securities held by the Company had been downgraded by a credit rating agency since their purchase. The Company intends and has the ability to hold the securities until the estimated fair value of the securities held is recovered, which may be maturity if necessary. As such, the Company does not believe any of the securities held are other-than-temporarily impaired at September 30, 2006 and December 31, 2005, respectively.

 

12

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RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 5 - LOANS

The following is a summary of the Company’s loans (in thousands):

 

Loan Description		Principal			Unamortized (Discount) Premium			Net Amortized Cost
September 30, 2006 (Unaudited):
Bank loans		$	613,979		$	968		$	614,947
Commercial real estate loans:
Whole loans			76,440			(619	)		75,821
A notes			42,500			17			42,517
B notes			162,280			(109	)		162,171
Mezzanine loans			164,750			(5,604	)		159,146
Total		$	1,059,949		$	(5,347	)	$	1,054,602
December 31, 2005:
Bank loans		$	397,869		$	916		$	398,785
Commercial real estate loans:
B notes			121,671			−			121,671
Mezzanine loans			49,417			−			49,417
Total		$	568,957		$	916		$	569,873

At September 30, 2006, the Company’s bank loan portfolio consisted of $614.7 million of floating rate loans, which bear interest between London Interbank Offered Rate (“LIBOR”) plus 1.38% and LIBOR plus 7.50% with maturity dates ranging from March 2007 to August 2022, and a $249,000 fixed rate loan, which bears interest at 6.25% with a maturity date of September 2015.

At December 31, 2005, the Company’s bank loan portfolio consisted of $398.5 million of floating rate loans, which bear interest between LIBOR plus 1.00% and LIBOR plus 7.00% with maturity dates ranging from April 2006 to October 2020, and a $249,000 fixed rate loan, which bears interest at 6.25% with a maturity date of September 2015.

13

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 5 - LOANS − (Continued)

The following is a summary of the loans in the Company’s commercial real estate loan portfolio at the dates indicated (in thousands):

Description		Quantity		Amortized Cost			Interest Rates		Maturity Dates
September 30, 2006 (Unaudited) :
Whole loans, floating rate		4		$	75,821		LIBOR plus 2.50% to LIBOR plus 3.60%		August 2007 to September 2008
A notes, floating rate		2			42,517		LIBOR plus 1.25% to LIBOR plus 1.35%		January 2008 to April 2008
B notes, floating rate		8			120,251		LIBOR plus 1.90% to LIBOR plus 6.25%		January 2007 to April 2008
B notes, fixed rate		2			41,920		7.18% to 8.68%		April 2016 to July 2016
Mezzanine loans, floating rate		6			75,476		LIBOR plus 2.25% to LIBOR plus 4.50%		August 2007 to July 2008
Mezzanine loan, floating rate		1			6,523		10 year Treasury rate plus 6.64%		January 2016
Mezzanine loans, fixed rate		7			77,147		5.78% to 9.50%		October 2009 to September 2016
Total		30		$	439,655
December 31, 2005 :
B notes, floating rate		7		$	121,671		LIBOR plus 2.15% to LIBOR plus 6.25%		January 2007 to April 2008
Mezzanine loans, floating rate		4			44,405		LIBOR plus 2.25% to LIBOR plus 4.50%		August 2007 to July 2008
Mezzanine loan, fixed rate		1			5,012		9.50%		May 2010
Total		12		$	171,088

As of September 30, 2006 and December 31, 2005, the Company had not recorded an allowance for loan losses. At September 30, 2006 and December 31, 2005, all of the Company’s loans were current with respect to the scheduled payments of principal and interest. In reviewing the portfolio of loans and secondary market prices, the Company did not identify any loans with characteristics indicating that impairment had occurred.

 

14

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 6 -DIRECT FINANCING LEASES AND NOTES

The Company’s direct financing leases have initial lease terms of 73 months and 54 months, as of September 30, 2006 and December 31, 2005, respectively. The interest rates on notes receivable range from 6% to 13% and from 8% to 9%, as of September 30, 2006 and December 31, 2005, respectively. Investments in direct financing leases and notes, net of unearned income, were as follows (in thousands):

		September 30, 2006			December 31, 2005
		(Unaudited)
Direct financing leases, net of unearned income		$	33,197		$	18,141
Notes receivable			58,712			5,176
Total		$	91,909		$	23,317

 

The components of the net investment in direct financing leases are as follows (in thousands):

		September 30, 2006			December 31, 2005
		(Unaudited)
Total future minimum lease payments		$	39,583		$	21,370
Unearned income			(6,386	)		(3,229	)
Total		$	33,197		$	18,141

The future minimum lease payments expected to be received on non-cancelable direct financing leases and notes were as follows (in thousands):

Years Ending September 30, (Unaudited)		Direct Financing Leases			Notes			Total
2007		$	11,695		$	10,299		$	21,994
2008			10,794			10,599			21,393
2009			6,719			9,782			16,501
2010			5,714			8,035			13,749
2011			2,898			6,073			8,971
Thereafter			1,763			13,924			15,687
		$	39,583		$	58,712		$	98,295

NOTE 7 - BORROWINGS

The Company finances the acquisition of its investments, including securities available-for-sale, loans and equipment leases and notes, primarily through the use of secured and unsecured borrowings in the form of CDOs, repurchase agreements, a secured term facility, warehouse facilities, trust preferred securities issuances and other secured and unsecured borrowings.

 

15

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 7 - BORROWINGS − (Continued)

Certain information with respect to the Company’s borrowings at September 30, 2006 and December 31, 2005 is summarized in the following table (dollars in thousands):

		Outstanding Borrowings			Weighted Average Borrowing Rate		Weighted Average Remaining Maturity		Value of Collateral
September 30, 2006 (Unaudited):
Repurchase Agreements		$	770,167		5.45%		3 days		$	818,084
RREF CDO 2006-1 Senior Notes (1)			259,850		6.15%		39.9 years			339,825
Ischus CDO II Senior Notes (2)			371,014		5.62%		33.9 years			395,884
Apidos CDO I Senior Notes (3)			317,226		5.94%		10.8 years			338,184
Apidos CDO III Senior Notes (4)			258,661		5.76%		13.7 years			275,701
Secured Term Facility			87,080		6.34%		3.5 years			91,909
Unsecured Revolving Credit Facility			−		N/A		2.3 years			−
Unsecured Junior Subordinated Debentures (5)			51,548		9.39%		29.9 years			−
Total		$	2,115,546		5.81%				$	2,259,587
December 31, 2005:
Repurchase Agreements		$	1,068,277		4.48%		17 days		$	1,146,711
Ischus CDO II Senior Notes (2)			370,569		4.80%		34.6 years			387,053
Apidos CDO I Senior Notes (3)			316,838		4.42%		11.6 years			335,831
Apidos CDO III - Warehouse Facility (4)			62,961		4.29%		90 days			62,954
Unsecured Revolving Credit Facility			15,000		6.37%		3.0 years			45,107
Total		$	1,833,645		4.54%				$	1,977,656

 

---

(1)	Amount represents principal outstanding of $265.5 million less unamortized issuance costs of $5.6 million as of September 30, 2006. This CDO transaction closed in August 2006.

(2)	Amount represents principal outstanding of $376.0 million less unamortized issuance costs of $5.0 million and $5.4 million as of September 30, 2006 and December 31, 2005, respectively.

(3)	Amount represents principal outstanding of $321.5 million less unamortized issuance costs of $4.3 million and $4.7 million as of September 30, 2006 and December 31, 2005, respectively.

(4)	Amount represents principal outstanding of $262.5 million less unamortized issuance costs of $3.8 million as of September 30, 2006. This CDO transaction closed in May 2006.

(5)	Amount represents junior subordinated debentures issued to Resource Capital Trust I and RCC Trust II in connection with each respective trust’s issuance of trust preferred securities in May 2006 and September 2006, respectively.

16

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 7 - BORROWINGS − (Continued)

The Company had repurchase agreements with the following counterparties at the dates indicated (dollars in thousands):

		Amount at Risk (1)			Weighted Average Maturity in Days		Weighted Average Interest Rate
September 30, 2006 (Unaudited):
Credit Suisse Securities (USA) LLC (2)		$	25,400		2		5.38%
UBS Securities LLC (2)		$	4,962		2		5.31%
Bear, Stearns International Limited		$	5,898		16		6.83%
Column Financial Inc, a subsidiary of Credit Suisse Securities (USA) LLC.		$	12,262		18		6.50%
December 31, 2005:
Credit Suisse Securities (USA) LLC		$	31,158		17		4.34%
Bear, Stearns International Limited		$	36,044		17		5.51%
Deutsche Bank AG, Cayman Islands Branch		$	16,691		18		5.68%

 

---

(1)	Equal to the estimated fair value of securities or loans sold, plus accrued interest income, minus the sum of repurchase agreement liabilities plus accrued interest expense.

(2)	Facility was repaid in full as part of the sale of the Company’s agency RMBS portfolio on October 2, 2006.

Repurchase and Credit Facilities

 

In August 2006, the Company’s subsidiary, RCC Real Estate SPE 2, LLC, entered into a master repurchase agreement with Column Financial, Inc., a wholly-owned subsidiary of Credit Suisse Securities (USA) LLC, (“CS”) to finance the purchase of commercial real estate loans. The maximum amount of the Company’s borrowing under the repurchase agreement is $300.0 million. Each repurchase transaction specifies its own terms, such as identification of the assets subject to the transaction, sales price, repurchase price, rate and term. The Company has guaranteed RCC Real Estate SPE 2, LLC’s obligations under the repurchase agreement to a maximum of $300.0 million. At September 30, 2006, the Company had borrowed $43.0 million, all of which was guaranteed, with a weighted average interest rate of LIBOR plus 1.17%, which was 6.50% at September 30, 2006.

 

In March 2006, the Company entered into a secured term credit facility with Bayerische Hypo - und Vereinsbank AG to finance the purchase of equipment leases and notes. The maximum amount of the Company’s borrowing under this facility is $100.0 million.

Borrowings under this facility bear interest at one of two rates, determined by asset class:

·

Pool A - one-month LIBOR plus 1.10%; or

·

Pool B - one-month LIBOR plus 0.80%.

The facility expires March 2010. The Company paid $300,000 and $20,000 in commitment fees and unused fees as of September 30, 2006. Commitment fees are being amortized into interest expense using the effective yield method over the life of the facility and are recorded in the consolidated statements of operations. Unused fees are expensed immediately into interest expense and are recorded in the consolidated statements of operations. As of September 30, 2006, the Company had borrowed $87.1 million at a weighted average interest rate of 6.34%.

 

17

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 7 - BORROWINGS − (Continued)

Repurchase and Credit Facilities (continued)

In December 2005, the Company’s subsidiary, RCC Real Estate SPE, LLC, entered into a master repurchase agreement with Deutsche Bank AG, Cayman Islands Branch to finance the purchase of commercial real estate loans. The maximum amount of the Company’s borrowing under the repurchase agreement is $300.0 million. Each repurchase transaction specifies its own terms, such as identification of the assets subject to the transaction, sales price, repurchase price, rate and term. The Company had guaranteed RCC Real Estate SPE’s obligations under the repurchase agreement to a maximum of $30.0 million, which may be reduced based upon the amount of equity the Company has in the commercial real estate loans held on this facility. At September 30, 2006, no borrowings were outstanding under this facility. At December 31, 2005, the Company had borrowed $38.6 million with a weighted average interest rate of LIBOR plus 1.32%, which was 5.68% at December 31, 2005. The Company had no risk under this guaranty at September 30, 2006 and the Company’s maximum risk under this guaranty was $30.0 million at December 31, 2005.

In December 2005, the Company entered into a $15.0 million unsecured revolving credit facility with Commerce Bank, N.A. This facility was increased to $25.0 million in April 2006. Outstanding borrowings bear interest at one of two rates elected at the Company’s option; (i) the lender’s prime rate plus a margin ranging from 0.50% to 1.50% based upon the Company’s leverage ratio; or (ii) LIBOR plus a margin ranging from 1.50% to 2.50% based upon the Company’s leverage ratio. The facility expires in December 2008. The Company paid $250,000 and $11,000 in commitment fees and unused line fees as of September 30, 2006. Commitment fees are being amortized into interest expense using the effective yield method over the life of the facility and are recorded in the consolidated statements of operations. Unused line fees are expensed immediately into interest expense and are recorded in the consolidated statements of operations. As of September 30, 2006, no borrowings were outstanding under this facility. At December 31, 2005, the balance outstanding was $15.0 million at an interest rate of 6.37%.

In August 2005, the Company’s subsidiary, RCC Real Estate, Inc. (“RCC Real Estate”), entered into a master repurchase agreement with Bear, Stearns International Limited (“Bear Stearns”) to finance the purchase of commercial real estate loans. The maximum amount of the Company’s borrowing under the repurchase agreement is $150.0 million. Each repurchase transaction specifies its own terms, such as identification of the assets subject to the transaction, sales price, repurchase price, rate and term. The Company has guaranteed RCC Real Estate’s obligations under the repurchase agreement to a maximum of $150.0 million. At September 30, 2006, the Company had borrowed $10.9 million, all of which was guaranteed, with a weighted average interest rate of LIBOR plus 1.50%, which was 6.83% at September 30, 2006. At December 31, 2005, the Company had borrowed $80.8 million with a weighted average interest rate of LIBOR plus 1.14%, which was 5.51% at December 31, 2005.

RCC Real Estate has received a waiver from Bear Stearns with respect to compliance with a financial covenant in the master repurchase agreement between it and Bear Stearns.  The waiver was required due to the Company's net loss during the three months ended September 30, 2006, which was caused by the loss realized by the Company on the sale of the remainder of its portfolio of agency RMBS (see Note 4).  Under the covenant, the Company is required to have no less than $1.00 of net income in any period of four consecutive calendar months.  The waiver is effective through January 31, 2007.

At September 30, 2006, the Company has complied, to the best of its knowledge, with all of its other financial covenants under its debt agreements.

 

18

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 7 - BORROWINGS − (Continued)

Repurchase and Credit Facilities (continued)

In March 2005, the Company entered into a master repurchase agreement with CS to finance the purchase of agency RMBS portfolio. Each repurchase transaction specifies its own terms, such as identification of the assets subject to the transaction, sales price, repurchase price, rate and term. At September 30, 2006, the Company had borrowed $577.2 million with a weighted average interest rate of 5.38%. On October 2, 2006, all outstanding borrowings under this facility were repaid in full in connection with the sale of the Company’s agency RMBS portfolio. At December 31, 2005, the Company had borrowed $948.9 million with a weighted average interest rate of 4.34%.

In March 2005, the Company entered into a master repurchase agreement with UBS Securities LLC to finance the purchase of agency RMBS portfolio. Each repurchase transaction specifies its own terms, such as identification of the assets subject to the transaction, sales price, repurchase price, rate and term. At September 30, 2006, the Company had borrowed $139.1 million with a weighted average interest rate of 5.31%. On October 2, 2006, all outstanding borrowings under this facility were repaid in full in connection with the sale of the Company’s remaining agency RMBS portfolio. At December 31, 2005, the Company had no borrowings under this agreement.

Collateralized Debt Obligations

 

In August 2006, the Company closed Resource Real Estate Funding CDO 2006-1 (“RREF 2006-1”), a $345.0 million CDO transaction that provides financing for commercial real estate loans. The investments held by RREF 2006-1 collateralize the debt it issued and, as a result, the investments are not available to the Company, its creditors or stockholders. RREF 2006-1 issued a total of $308.7 million of senior notes at par to investors of which RCC Real Estate purchased 100% of the class J senior notes (rated BB:Moody’s) and class K senior notes (rated B:Moody’s) for $43.1 million. In addition, Resource Real Estate Funding 2006-1 CDO Investor, LLC, a subsidiary of RCC Real Estate Inc., purchased a $36.3 million equity interest representing 100% of the outstanding preference shares. The senior notes purchased by RCC Real Estate are subordinated in right of payment to all other senior notes issued by RREF 2006-1 but are senior in right of payment to the preference shares. The equity interest is subordinated in right of payment to all other securities issued by RREF 2006-1.

 

The senior notes issued to investors by RREF 2006-1 consist of the following classes: (i) $129.4 million of class A-1 notes bearing interest at 1-month LIBOR plus 0.32%; (ii) $17.4 million of class A-2 notes bearing interest at 1-month LIBOR plus 0.35%; (iii) $5.0 million of class A-2 notes bearing interest at a fixed rate of 5.842%; (iv) $6.9 million of class B notes bearing interest at 1-month LIBOR plus 0.40%; (v) $20.7 million of class C notes bearing interest at 1-month LIBOR plus 0.62%; (vi) $15.5 million of class D notes bearing interest at 1-month LIBOR plus 0.80%; (vii) $20.7 million of class E notes bearing interest at 1-month LIBOR plus 1.30%; (viii) $19.8 million of class F notes bearing interest at 1-month LIBOR plus 1.60%; (ix) $17.3 million of class G notes bearing interest at 1-month LIBOR plus 1.90%; (x) $12.9 million of class H notes bearing interest at 1-month LIBOR plus 3.75%, (xi) $14.7 million of Class J notes bearing interest at a fixed rate of 6.00% and (xii) $28.4 million of Class K notes bearing interest at a fixed rate of 6.00%. As a result of the Company’s ownership of the Class J and K senior notes, these notes eliminate in consolidation. All of the notes issued mature in August 2046, although the Company has the right to call the notes anytime after August 2016 until maturity. The weighted average interest rate on all notes issued to investors was 6.15% at September 30, 2006.

19

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 7 - BORROWINGS − (Continued)

Collateralized Debt Obligations − (Continued)

In May 2006, the Company closed Apidos CDO III, a $285.5 million CDO transaction that provides financing for bank loans. The investments held by Apidos CDO III collateralize the debt it issued and, as a result, the investments are not available to the Company, its creditors or stockholders. Apidos CDO III issued a total of $262.5 million of senior notes at par to investors and RCC Commercial purchased a $23.0 million equity interest representing 100% of the outstanding preference shares. The equity interest is subordinated in right of payment to all other securities issued by Apidos CDO III.

The senior notes issued to investors by Apidos CDO III consist of the following classes: (i) $212.0 million of class A-1 notes bearing interest at 3-month LIBOR plus 0.26%; (ii) $19.0 million of class A-2 notes bearing interest at 3-month LIBOR plus 0.45%; (iii) $15.0 million of class B notes bearing interest at 3-month LIBOR plus 0.75%; (iv) $10.5 million of class C notes bearing interest at 3-month LIBOR plus 1.75%; and (v) $6.0 million of class D notes bearing interest at 3-month LIBOR plus 4.25%. All of the notes issued mature on June 12, 2020, although the Company has the right to call the notes anytime after June 12, 2011 until maturity. The weighted average interest rate on all notes was 5.76% at September 30, 2006.

In August 2005, the Company closed Apidos CDO I, a $350.0 million CDO transaction that provides financing for bank loans. The investments held by Apidos CDO I collateralize the debt it issued and, as a result, the investments are not available to the Company, its creditors or stockholders. Apidos CDO I issued a total of $321.5 million of senior notes at par to investors and RCC Commercial purchased a $28.5 million equity interest representing 100% of the outstanding preference shares. The equity interest is subordinated in right of payment to all other securities issued by Apidos CDO I.

The senior notes issued to investors by Apidos CDO I consist of the following classes: (i) $265.0 million of class A-1 notes bearing interest at 3-month LIBOR plus 0.26%; (ii) $15.0 million of class A-2 notes bearing interest at 3-month LIBOR plus 0.42%; (iii) $20.5 million of class B notes bearing interest at 3-month LIBOR plus 0.75%; (iv) $13.0 million of class C notes bearing interest at 3-month LIBOR plus 1.85%; and (v) $8.0 million of class D notes bearing interest at a fixed rate of 9.251%. All of the notes issued mature on July 27, 2017, although the Company has the right to call the notes anytime after July 27, 2010 until maturity. The weighted average interest rate on all notes was 5.94% at September 30, 2006.

In July 2005, the Company closed Ischus CDO II, a $403.0 million CDO transaction that provides financing for mortgage-backed and other asset-backed securities. The investments held by Ischus CDO II collateralize the debt it issued and, as a result, those investments are not available to the Company, its creditors or stockholders. Ischus CDO II issued a total of $376.0 million of senior notes at par to investors and RCC Real Estate purchased a $27.0 million equity interest representing 100% of the outstanding preference shares. In August 2006, upon approval by the Company’s Board of Directors, the preference shares of Ischus CDO II were transferred to the Company’s wholly-owned subsidiary, RCC Commercial, Inc. (“RCC Commercial”). As of September 30, 2006, RCC Commercial owned a $27.0 million equity interest representing 100% of the outstanding preference shares. The equity interest is subordinate in right of payment to all other securities issued by Ischus CDO II.

The senior notes issued to investors by Ischus CDO II consist of the following classes: (i) $214.0 million of class A-1A notes bearing interest at 1-month LIBOR plus 0.27%; (ii) $50.0 million of class A-1B delayed draw notes bearing interest on the drawn amount at 1-month LIBOR plus 0.27%; (iii) $28.0 million of class A-2 notes bearing interest at 1-month LIBOR plus 0.45%; (iv) $55.0 million of class B notes bearing interest at 1-month LIBOR plus 0.58%; (v) $11.0 million of class C notes bearing interest at 1-month LIBOR plus 1.30%; and (vi) $18.0 million of class D notes bearing interest at 1-month LIBOR plus 2.85%. All of the notes issued mature on August 6, 2040, although the Company has the right to call the notes at par any time after August 6, 2009 until maturity. The weighted average interest rate on all notes was 5.62% at September 30, 2006.

20

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 7 - BORROWINGS − (Continued)

 

Trust Preferred Securities

In May 2006 and September 2006, the Company formed Resource Capital Trust I (“RCTI”) and RCC Trust II (“RCTII”), respectively, for the sole purpose of issuing and selling trust preferred securities. In accordance with FASB Interpretation No. 46R (“FIN 46R”), RCTI and RCTII are not consolidated into the Company’s consolidated financial statements because the Company is not deemed to be the primary beneficiaries of these entities. The Company owns 100% of the common shares in RCTI and RCTII. Each respective trust issued $25.0 million of preferred shares to unaffiliated investors.

In connection with the issuance and sale of the trust preferred securities, the Company issued junior subordinated debentures to RCTI and RCTII of $25.8 million each, representing the Company’s maximum exposure to loss. The debt issuance costs associated with the junior subordinated debentures for RCTI and RCTII at September 30, 2006 were $829,000 and $828,000, respectively. These costs are being amortized into interest expense using the effective yield method over a ten year period and are recorded in the consolidated statements of operations.

The rights of holders of common shares of RCTI and RCTII are subordinate to the rights of the holders of preferred shares only in the event of a default; otherwise, the common shareholders’ economic and voting rights are pari passu with the preferred shareholders. The preferred and common securities of RCTI and RCTII are subject to mandatory redemption upon the maturity or call of the junior subordinated debentures. Unless earlier dissolved, RCTI will dissolve on May 25, 2041 and RCTII will dissolve on September 29, 2041. The junior subordinated debentures are the sole asset of RCTI and RCTII and mature on June 30, 2036 and October 30, 2036, respectively, and may be called at par by the Company any time after June 30, 2011 and October 30, 2011, respectively. Interest is payable for RCTI and RCTII quarterly at a floating rate equal to three-month LIBOR plus 3.95% per annum. The rates for RCTI and RCTII, at September 30, 2006, were 9.45% and 9.32%, respectively. The Company records its investments in RCTI and RCTII’s common shares of $774,000 each as investments in unconsolidated trusts and records dividend income upon declaration by RCTI and RCTII.

NOTE 8 - CAPITAL STOCK AND EARNINGS PER SHARE

The Company had authorized 500,000,000 shares of common stock, par value $0.001 per share, of which 17,821,434 and 15,682,334 shares (including 234,224 and 349,000 restricted shares) were outstanding as of September 30, 2006 and December 31, 2005, respectively.

On March 8, 2005, the Company granted 345,000 shares of restricted common stock and options to purchase 651,666 common shares at an exercise price of $15.00 per share, to the Manager. One third of the shares of restricted stock and options vested on March 8, 2006. The Company also granted 4,000 shares of restricted common stock to the Company’s four non-employee directors as part of their annual compensation. These shares vested in full on March 8, 2006. On March 8, 2006, the Company granted 4,224 shares of restricted stock to the Company’s four non-employee directors as part of their annual compensation. These shares vest in full on March 8, 2007.

 

21

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 8 - CAPITAL STOCK AND EARNINGS PER SHARE − (Continued)

The following table summarizes restricted common stock transactions:

		Manager			Non-Employee Directors			Total
Unvested shares as of December 31, 2005			345,000			4,000			349,000
Issued			−			4,224			4,224
Vested			(115,000	)		(4,000	)		(119,000	)
Forfeited			−			−			−
Unvested shares as of September 30, 2006 (Unaudited)			230,000			4,224			234,224

Pursuant to SFAS No. 123(R), the Company is required to value any unvested shares of restricted common stock granted to the Manager at the current market price. The estimated fair value of the shares of restricted stock granted, including shares issued to the four non-employee directors, was $5.3 million and $5.2 million at September 30, 2006 and December 31, 2005, respectively.

The following table summarizes common stock option transactions:

		Number of Options			Weighted Average Exercise Price
Outstanding as of December 31, 2005			651,666		$	15.00
Granted			−		$	−
Exercised			−		$	−
Forfeited			−		$	−
Outstanding as of September 30, 2006 (Unaudited)			651,666		$	15.00

None of the common stock options outstanding were exercised at September 30, 2006 and December 31, 2005, respectively. As of September 30, 2006, 722 common stock options were exercisable, and no common stock options were exercisable as of December 31, 2005. The common stock options are valued using the Black-Scholes model using the following assumptions:

	September 30, 2006		December 31, 2005
	(Unaudited)
Expected life	9 years		10 years
Discount rate	4.694%		4.603%
Volatility	21.27%		20.11%
Dividend yield	10.40%		12.00%

 

22

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 8 - CAPITAL STOCK AND EARNINGS PER SHARE − (Continued)

The estimated fair value of the total common stock options was $386,200 and $158,300 at September 30, 2006 and December 31, 2005, respectively. The estimated fair value of each option grant at September 30, 2006 and December 31, 2005, respectively, was $0.655 and $0.243. For the three months ended September 30, 2006 and 2005, nine months ended September 30, 2006 and the period from March 8, 2005 (date operations commenced) through September 30, 2005 (hereafter referred to as period ended September 30, 2005), the components of equity compensation expense are as follows (in thousands):

 

		Three Months Ended September 30,						Nine Months Ended September 30,			Period Ended September 30,
		2006			2005			2006			2005
		(Unaudited)						(Unaudited)			(Unaudited)
Options granted to Manager		$	86		$	24		$	208		$	55
Restricted shares granted to Manager			697			797			1,367			1,784
Restricted shares granted to non-employee directors			15			15			45			34
Total equity compensation expense		$	798		$	836		$	1,620		$	1,873

During the three and nine months ended September 30, 2006, the Manager received 6,252 and 14,076 shares, respectively, as incentive compensation, valued at $79,000 and $194,000, respectively, pursuant to the management agreement. No incentive fee compensation shares were issued as of December 31, 2005.

In connection with the July 2006 hiring of a commercial mortgage direct loan origination team by Resource Real Estate, Inc. (see Related Party Transactions - Note 9), the Company agreed to issue up to 100,000 shares of common stock and options to purchase an additional 100,000 shares of common stock, if certain loan origination performance thresholds are achieved.  The performance thresholds are two-tiered.  Upon the achievement of $400.0 million of direct loan originations of commercial real estate loans, 60,000 restricted shares of common stock and options to purchase an additional 60,000 shares of common stock are issuable.  Upon the achievement of another $300.0 million of direct loan originations of commercial real estate loans, a second tranche of 40,000 restricted shares of common stock and options to purchase another 40,000   shares of common stock are issuable.     The restricted shares and options to purchase shares of common stock vest over a two-year period after issuance. The Company accounts for equity instruments issued to non-employees for goods or services in accordance with the provisions of SFAS No. 123(R) and Emerging Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services ("EITF 96-18"). Accordingly, when the non-employees complete their performance or when a performance commitment is reached, the Company is required to measure the fair value of the equity instruments.  No expense was recognized for the three months ended September 30, 2006, as neither a performance commitment nor completion of performance was achieved.

23

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RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 8 - CAPITAL STOCK AND EARNINGS PER SHARE − (Continued)

The following table presents a reconciliation of basic and diluted earnings per share for the periods presented as follows (in thousands, except share and per share amounts):

 

		Three Months Ended September 30,						Nine Months Ended September 30,			Period Ended September 30,
		2006			2005			2006			2005
		(Unaudited)						(Unaudited)			(Unaudited)
Basic :
Net (loss) income		$	(2,401	)	$	3,776		$	8,814		$	6,008
Weighted average number of shares outstanding			17,585,171			15,333,334			17,261,091			15,333,334
Basic net (loss) income per share		$	(0.14	)	$	0.25		$	0.51		$	0.39
Diluted :
Net (loss) income		$	(2,401	)	$	3,776		$	8,814		$	6,008
Weighted average number of shares outstanding			17,585,171			15,333,334			17,261,091			15,333,334
Additional shares due to assumed conversion of dilutive instruments			−			124,799			127,475			124,799
Adjusted weighed-average number of common shares outstanding (1)			17,585,171			15,458,133			17,388,566			15,458,133
Diluted net (loss) income per share		$	(0.14	)	$	0.24		$	0.51		$	0.39

 

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(1)	For the three months ended September 30, 2006, the weighted average number of shares used in calculating the diluted net loss per share is the same as the basic weighted average number of shares as a result of a net loss available to common shareholders for the period.

Potentially dilutive shares relating to stock options to purchase 651,666 shares of common stock and warrants to purchase 1,568,244 shares of common stock for the three and nine months ended September 30, 2006 and 349,000 restricted shares and options to purchase 651,666 shares of common stock for the three months ended September 2005 and the period ended September 30, 2005 are not included in the calculation of diluted net income per share because the effect is anti-dilutive.

NOTE 9 - RELATED-PARTY TRANSACTIONS

Management Agreement

The base management fee for the three and nine months ended September 30, 2006 was $916,000 and $2.7 million, respectively. The incentive management fee for the nine months ended September 30, 2006 was $432,000. No incentive management fee was earned by the Manager for the three months ended September 30, 2006. The base management fee for the three months ended September 30, 2005 and period from March 8, 2005 to September 30, 2005 was $822,000 and $1.8 million, respectively. No incentive management fee was earned by the Manager for the three months and the period ended September 30, 2005.

At September 30, 2006, the Company was indebted to the Manager for base management fees of $614,000 and for reimbursement of expenses of $263,000. At December 31, 2005, the Company was indebted to the Manager for base and incentive management fees of $552,000 and $344,000, respectively, and for reimbursement of expenses of $143,000. These amounts are included in management and incentive fee payable and accounts payable and accrued liabilities, respectively.

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RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 9 - RELATED-PARTY TRANSACTIONS − (Continued)

Relationship with Resource Real Estate

Resource Real Estate, Inc., a subsidiary of RAI, originates, finances and manages the Company’s commercial real estate loan portfolio, including whole loans, A notes, B notes and mezzanine loans. The Company reimburses Resource Real Estate for loan origination costs associated with all loans originated. At September 30, 2006 and December 31, 2005, the Company was indebted to Resource Real Estate for loan origination costs in connection with the Company’s commercial real estate loan portfolio of $332,000 and $22,000, respectively.

Relationship with LEAF Financial Corporation (“LEAF”)

LEAF, a subsidiary of RAI, originates and manages equipment leases and notes on the Company’s behalf. The Company purchases these leases and notes from LEAF at a price equal to their book value plus a reimbursable origination cost not to exceed 1% to compensate LEAF for its origination costs. In addition, the Company pays LEAF an annual servicing fee, equal to 1% of the book value of managed assets, for servicing the Company’s equipment leases and notes. At September 30, 2006 and December 31, 2005, the Company was indebted to LEAF for servicing fees in connection with the Company’s equipment finance portfolio of $143,000 and $41,000, respectively. The LEAF servicing fees for the three and nine months ended September 30, 2006 were $210,000 and $430,000, respectively. No LEAF servicing fees were incurred for the three months and period ended September 30, 2005.

During the three months ended September 30, 2006, the Company sold two notes back to LEAF at a price equal to their book value. The total proceeds received on outstanding notes receivable were $16.3 million.

Relationship with RAI

At September 30, 2006, RAI, had a 10.7% ownership interest in the Company, consisting of 1,900,000 shares it had purchased, 14,076 shares it received as incentive compensation pursuant to the management agreement and 307 vested shares associated with the issuance of restricted stock. In addition, certain officers of the Manager and its affiliates had a 2.3% ownership interest in the Company, consisting of 334,667 shares they had purchased and 83,995 vested shares associated with the issuance of restricted stock as of September 30, 2006. All purchased shares were acquired in offerings by the Company at the same price at which shares were purchased by the other investors in those offerings.

Relationship with Law Firm

Until 1996, the Company’s Chairman, Edward Cohen, was of counsel to Ledgewood, P.C., a law firm. The Company paid Ledgewood $25,000 and $314,000 for the three and nine months ended September 30, 2006, respectively, and $203,000 and $613,000 for the three months and period ended September 30, 2005. Mr. Cohen receives certain debt service payments from Ledgewood related to the termination of his affiliation with Ledgewood and its redemption of his interest.

25

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RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 10 - DISTRIBUTIONS

On September 19, 2006, the Company declared a quarterly distribution of $0.37 per share of common stock, $6.6 million in the aggregate, which was paid on October 13, 2006 to stockholders of record as of September 29, 2006.

On June 20, 2006, the Company declared a quarterly distribution of $0.36 per share of common stock, $6.4 million in the aggregate, which was paid on July 21, 2006 to stockholders of record as of June 29, 2006.

On March 16, 2006, the Company declared a quarterly distribution of $0.33 per share of common stock, $5.9 million in the aggregate, which was paid on April 10, 2006 to stockholders of record as of March 27, 2006.

 

On January 13, 2006, the Company paid a special dividend to stockholders of record on January 4, 2006, including holders of restricted stock, consisting of warrants to purchase the Company’s common stock. Each warrant entitles the holder to purchase one share of common stock at an exercise price of $15.00 per share. Stockholders received one warrant for each ten shares of common stock and restricted stock held. If an existing stockholder owned shares in other than a ten-share increment, the stockholder received an additional warrant. The warrants will expire on January 13, 2009 and will not be exercisable until January 13, 2007. An aggregate of 1,568,244 shares are issuable upon exercise of the warrants.

NOTE 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107, “Disclosure About Fair Value of Financial Instruments,”   requires disclosure of the fair value of financial instruments for which it is practicable to estimate value. The estimated fair value of available-for-sale securities, derivatives and direct financing leases and notes is equal to their respective carrying value presented in the consolidated balance sheets. The estimated fair value of loans held for investment was $1.1 billion and $571.7 million as of September 30, 2006 and December 31, 2005, respectively. The estimated fair value of all other assets and liabilities approximate carrying value as of September 30, 2006 and December 31, 2005 due to the short-term nature of these items.

NOTE 12 - DERIVATIVE INSTRUMENTS

At September 30, 2006, the Company had 11 interest rate swap contracts and four forward interest rate swap contracts. The Company will pay an average fixed rate of 5.34% and receive a variable rate equal to one-month and three-month LIBOR on the interest rate swap contracts. The aggregate notional amount of these contracts was $212.3 million. The Company will pay an average fixed rate of 5.31% and receive a variable rate equal to one-month LIBOR on the forward interest rate swap contracts, which will commence in February 2007. The aggregate notional amount of these contracts was $61.0 million. In addition, the Company had one interest rate cap agreement outstanding whereby it reduced its exposure to variability in future cash outflows attributable to changes in LIBOR. The aggregate notional amount of this contract was $15.0 million at September 30, 2006.

 

26

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Index

RESOURCE CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006 − (Continued)

(Unaudited)

NOTE 12 - DERIVATIVE INSTRUMENTS − (Continued)

At December 31, 2005, the Company had six interest rate swap contracts outstanding whereby the Company will pay an average fixed rate of 3.89% and receive a variable rate equal to one-month and three-month LIBOR. The aggregate notional amount of these contracts was $972.2 million at December 31, 2005. In addition, the Company had one interest rate cap agreement outstanding whereby it reduced its exposure to variability in future cash outflows attributable to changes in LIBOR. The aggregate notional amount of this contract was $15.0 million at December 31, 2005.

The estimated fair value of the Company’s interest rate swaps, forward swaps and interest rate cap was $(3.3) million and $3.0 million as of September 30, 2006 and December 31, 2005, respectively. The Company had aggregate unrealized losses of $3.4 million and aggregate unrealized gains of $2.8 million on the interest rate swap agreements and interest rate cap agreement, as of September 30, 2006 and December 31, 2005, respectively, which is recorded in accumulated other comprehensive loss. In connection with the January 2006 sale of a portion of the Company’s agency RMBS portfolio, the Company realized a swap termination gain of $881,000, which is reflected in interest expense in the Company’s consolidated statements of operations. In connection with the sale of the Company’s remaining agency RMBS portfolio on September 27, 2006, the Company realized a swap termination gain of $2.6 million. This swap agreement had an original termination date of October 2007. The realized gain is reflected in net realized gains on investments in the Company’s consolidated statements of operations.

NOTE 13 - SUBSEQUENT EVENT

On October 2, 2006, in connection with the sale of the Company’s agency RMBS portfolio, all borrowings were repaid under the CS and UBS Securities LLC agency RMBS repurchase facilities totaling $716.5 million. In addition, the net proceeds were used to repay outstanding borrowings under the Column Financial Inc. commercial real estate loan repurchase facility in October 2006.

On October 31, 2006, the Company entered into a secured term credit facility with Morgan Stanley Bank to finance the purchase of equipment leases and notes.  The maximum amount of the Company’s borrowing under this facility is $100.0 million for the first 12 months and $250.0 million thereafter.  The facility expires October 2009. 

 

Borrowings under this facility bear interest at one of two rates, determined by the outstanding balance of the facility:

 

·

Less than $100.0 million - one-month LIBOR plus 0.60%; and

·

Greater than $100.0 million - one-month LIBOR plus 0.75%

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Index

 

ITEM 2 .

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Unaudited)

 

This report contains certain forward-looking statements. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expects,” “intend,” “may,” “plan,” “potential,” “project,” “should,” “will” and “would” or the negative of these terms or other comparable terminology. Such statements are subject to the risks and uncertainties more particularly described in Item 1A, under the caption “Risk Factors,” in our Annual Report on Form 10-K for period ended December 31, 2005. These risks and uncertainties could cause actual results to differ materially. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly release the results of any revisions to forward-looking statements which we may make to reflect events or circumstances after the date of this Form 10-Q or to reflect the occurrence of unanticipated events, except as may be required under applicable law.

Overview

 

We are a specialty finance company that has elected and intends to continue to qualify as a real estate investment trust, or REIT, under Subchapter M of the Internal Revenue Code of 1986, as amended. Our objective is to provide our stockholders with total returns over time, including quarterly distributions and capital appreciation, while seeking to manage the risks associated with our investment strategy. We invest in a combination of real estate-related assets and, to a lesser extent, higher-yielding commercial finance assets. We finance a substantial portion of our portfolio investments through borrowing strategies seeking to match the maturities and repricing dates of our financings with the maturities and repricing dates of those investments, and to mitigate interest rate risk through derivative instruments. Future distributions and capital appreciation are not guaranteed, however, and we have only limited operating history and REIT experience upon which you can base an assessment of our ability to achieve our objectives.

We generate our income primarily from the spread between the revenues we receive from our assets and the cost to finance the purchase of those assets and hedge interest rate risks. We generate revenues from the interest we earn on our first priority tranches of commercial mortgage loans, or A notes, subordinated tranches of commercial mortgage loans, or B notes, mezzanine debt, whole loans, commercial mortgage-backed securities, or CMBS, residential mortgage-backed securities, or RMBS, other asset-backed securities, or ABS, bank loans and payments on equipment leases and notes. We use a substantial amount of leverage to enhance our returns and we finance each of our different asset classes with different degrees of leverage. The cost of borrowings to finance our investments comprises a significant part of our expenses. Our net income will depend on our ability to control these expenses relative to our revenue. In our ABS-RMBS, CMBS, other ABS, bank loans and equipment leases and notes, we use warehouse facilities as a short-term financing source and collateralized debt obligations, or CDOs, and, to a lesser extent, other term financing as a long-term financing source. In our commercial real estate loan portfolio, we use repurchase agreements as a short-term financing source, and CDOs and, to a lesser extent, other term financing as a long-term financing source. We expect that our other term financing will consist of long-term match-funded financing provided through long-term bank financing and asset-backed financing programs.

 

Before October 2, 2006, we had a significant portfolio of agency RMBS. In order to redeploy the capital we had invested in this asset class into higher-yielding asset classes, we entered into an agreement to sell this portfolio on September 27, 2006. The sale settled on October 2, 2006, and we have no remaining agency RMBS. We had financed the acquisition of our agency RMBS with short-term repurchase arrangements. We also had sought to mitigate the risk created by any mismatch between the maturities and repricing dates of our agency RMBS and the maturities and repricing dates of the repurchase agreements we used to finance them through derivative instruments, principally floating-to-fixed interest rate swap agreements and interest rate cap agreements. We terminated these derivatives upon completion of the sale of our agency RMBS.

 

28

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Index

On March 8, 2005, we received net proceeds of $214.8 million from a private placement of 15,333,334 shares of common stock. On February 10, 2006, we received net proceeds of $27.3 million from our initial public offering of 4,000,000 shares of common stock (including 1,879,200 shares sold by certain selling stockholders of ours). As of September 30, 2006, we had invested 20.3% of our portfolio in commercial real estate-related assets, 33.2% in agency RMBS, 15.0% in ABS - RMBS and 31.5% in commercial finance assets. As a result of the October 2, 2006 settlement of our agency RMBS portfolio, our portfolio composition subsequent to the third quarter has shifted so that, as of that date and giving effect to the sale, we had invested 30.3% of our portfolio in commercial real estate-related assets, 22.5% in ABS-RMBS and 47.2% in commercial finance assets.

We expect that diversifying our portfolio by shifting the mix towards higher-yielding assets will increase our earnings, subject to maintaining the credit quality of our portfolio. If we are unable to maintain the credit quality of our portfolio, however, our earnings will decrease. Because the amount of leverage we intend to use will vary by asset class, our asset allocation may not reflect the relative amounts of equity capital we have invested in the respective classes. To illustrate after giving effect to the agency RMBS portfolio settlement on October 2, 2006, our equity was invested 68.0% in commercial real estate-related assets, 21.7% in commercial finance assets and 10.3% in ABS-RMBS. The results of operations discussed below are for the three and nine months ended September 30, 2006, three months ended September 30, 2005 and the period from March 8, 2005 (date operations commenced) to September 30, 2005 (which we refer to as the period ended September 30, 2005).

Results of Operations

 

Our net loss for the three months ended September 30, 2006 including a net loss of $8.3 million from the sale of our agency RMBS portfolio was $2.4 million, or $0.14 per weighted average common share (basic and diluted) as compared to net income of $3.8 million, or $0.24 per weighted average common share-diluted for the three months ended September 30, 2005.

Our net income for the nine months ended September 30, 2006, including a net loss of $8.8 million from the sale of our agency RMBS portfolio, was $8.8 million, or $0.51 per weighted average common share (basic and diluted) as compared to $6.0 million, or $0.39 per weighted average common share (basic and diluted) for the period ended September 30, 2005.