**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 30, 2004**

 

**or**

 

**o****  TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from             to             .**

 

**Commission File No.  333-114673**

 

**GRAMERCY CAPITAL CORP.**

(Exact name of registrant as specified in itscharter)

 

| **Maryland**                                                    | ** ** | **06-1722127**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**420 Lexington Avenue, New York, New York  10170**

(Address of principal executiveoffices - zip code)

 

**(212) 297-1000**

(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 theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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   ý   No o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes  o   No ý

 

The number of shares outstanding of theregistrant’s common stock, $0.01 par value was 13,310,000 at September 9, 2004.

 

 

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**GRAMERCY CAPITAL CORP.**

 

**INDEX**

 
|                                                                                                                                                          | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|                                                                                                                                                          | ** ** |       |
| **PART I.         FINANCIAL INFORMATION**                                                                             | ** ** | 3          |
|                                                                                                                                                          | ** ** |       |
|                                                                                                                                                          | ** ** |       |
| **ITEM 1.          FINANCIAL STATEMENTS**                                                                        | ** ** | 3          |
|                                                                                                                                                          | ** ** |       |
| Balance Sheets as of June 30, 2004 (unaudited)  and April 12, 2004                                                                                            | ** ** | 3          |
| ** **                                                                                                                                                    | ** ** |       |
| Notes to Balance Sheets (unaudited)                                                                                                                           |       | 4          |
|                                                                                                                                                          |       |       |
|                                                                                                                                                          |       |       |
| **ITEM 2.          MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | ** ** | 7          |
|                                                                                                                                                          |       |       |
| **ITEM 3.          QUANTITATIVE AND QUALITATIVE DISCLOSURES  ABOUT MARKET RISK**                                 |       | 12         |
|                                                                                                                                                          |       |       |
| **ITEM 4.          CONTROLS AND PROCEDURES**                                                                     |       | 12         |
|                                                                                                                                                          |       |       |
| **PART II.        OTHER  INFORMATION**                                                                                     |       | 14         |
|                                                                                                                                                          |       |       |
| **ITEM  1.          LEGAL PROCEEDINGS**                                                                          |       | 14         |
|                                                                                                                                                          |       |       |
| **ITEM 2.          CHANGES  IN SECURITIES AND USE OF PROCEEDS**                                                  |       | 14         |
| ** **                                                                                                                                                    |       |       |
| **ITEM 3.          DEFAULTS  UPON SENIOR SECURITIES**                                                            |       | 14         |
| ** **                                                                                                                                                    |       |       |
| **ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS**                                        |       | 14         |
| ** **                                                                                                                                                    |       |       |
| **ITEM  5.          OTHER INFORMATION**                                                                          |       | 14         |
|                                                                                                                                                          |       |       |
| **ITEM 6.          EXHIBITS AND REPORTS ON FORM 8-K**                                                            |       | 14         |
|                                                                                                                                                          |       |       |
| **Signatures**                                                                                                                                                |       | 15         |

 

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**PART I.****                ****FINANCIAL INFORMATION**

###### **ITEM 1.**                  FinancialStatements

 

**Gramercy Capital Corp.**

**BalanceSheets**

**(Amounts in thousands, except per share data)**

 
| ** **                                                                                                                                         | ** ** | **June 30,  2004** | ** ** | **April 12,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                                                                                                                         | ** ** | **(Unaudited)**    | ** ** | **(Note 3)**        | ** ** |
| **Assets:**                                                                                                                                        |       |               |       |                |       |
| Cash and cash equivalents                                                                                                                          |       | $                  | 200,000    |                | $          | 200,000 |   |
| Total assets                                                                                                                                       |       | $                  | 200,000    |                | $          | 200,000 |   |
|                                                                                                                                               |       |               |       |                |       |
| **Liabilities and Stockholders’ Equity:**                                                                                                     |       |               |       |                |       |
| Commitments and contingencies                                                                                                                      |       |               |       |                |       |
| **Stockholders’ Equity:**                                                                                                                     |       |               |       |                |       |
| Preferred stock, par value  $0.001, 25,000,000 shares authorized, no shares issued or outstanding                                                  |       |               |       |                |       |
| Common stock, par value $0.001,  100,000,000 shares authorized, 500,000 shares issued and outstanding at June  30 and April 12, 2004, respectively |       | $                  | 500        |                | $          | 500 |   |
| Additional paid in capital                                                                                                                         |       | 199,500            |       | 199,500             |       |
| Total liabilities and  stockholders’ equity                                                                                                   |       | $                  | 200,000    |                | $          | 200,000 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

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**Gramercy CapitalCorp.**

**Notes To Balance Sheets**

**(Unaudited)**

**June 30, 2004**

 

 

**1.****             Organization**

 

Gramercy Capital Corp., orGramercy, was organized in Maryland on April 1, 2004.  Under the Articles of Incorporation, Gramercyis authorized to issue up to 100,000,000 shares of common stock and 25,000,000shares of preferred stock.  Gramercy hashad no operations since its formation.

 

**2.****             Formation of Gramercy/Initial Public Offering**

 

In connection with thecompletion of our initial public offering on August 2, 2004, Gramercycontributed the proceeds of the offering in exchange for units of limitedpartnership interest in GKK Capital LP, a Delaware limited partnership (the“Operating Partnership”).  Gramercy, asthe sole general partner of the Operating Partnership, has responsibility anddiscretion in the management and control of the Operating Partnership, and thelimited partners of the Operating Partnership, in such capacity, will have noauthority to transact business for, or participate in the management activitiesof, the Operating Partnership. Accordingly, Gramercy will account for the Operating Partnership usingthe consolidation method.

 

Cash contributed to theOperating Partnership by Gramercy will be used primarily to acquire real estateloans and securities.  Gramercy will besubject to the risks involved with commercial real estate finance.  These include, among others, the risksnormally associated with changes in the general economic climate,creditworthiness of borrowers, competition for borrowers, changes in tax laws,interest rate levels, and the availability of financing.  Gramercy intends to qualify as a real estateinvestment trust (“REIT”) under the Internal Revenue Code commencing with itstaxable year ending December 31, 2004. In order to maintain its tax status as a REIT, Gramercy plans todistribute at least 90% of its taxable income.

 

**The sole stockholder of Gramercyis SLG Founders LLC, or Founders, which is principally owned by SL GreenOperating Partnership, L.P. SL Green Operating Partnership, L.P., is a majorityowned subsidiary of SL Green Realty Corp., which is the beneficial owner of ourManager, GKK Manager LLC.  The Founder’sinitial capital contribution to Gramercy was $200,000.**

 

**3.****             Basis of Quarterly Presentation**

#### ** **

The accompanying unaudited balance sheet hasbeen prepared in accordance with accounting principles generally accepted inthe United States for interim financial information and with the instructionsto Form 10-Q and Article 10 of Regulation S-X. Accordingly, it does not include all of the information and notesrequired by accounting principles generally accepted in the United States forcomplete financial statements.  Inmanagement’s opinion, all adjustments (consisting of normal recurring accruals)considered necessary for fair presentation have been included.  Gramercy did not incur any operating costs orclose on any investments between April 12, 2004 and June 30, 2004.  As a result, no statement of operations orstatement of cash flows has been presented for that period.

 

The balance sheet at April 12, 2004 has beenderived from the audited financial statement at that date, but does not includeall the information and footnotes required by accounting principles generallyaccepted in the United States for complete financial statements.

 

**4.****             Significant Accounting Policies**

 

**UnderwritingCommissions and Costs**

** **

**Underwriting commissions and costs incurred inconnection with Gramercy’s stock offerings are reflected as a reduction ofadditional paid-in-capital.**

** **

**4**

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** **

**Organization Costs**

 

Costs incurred to organizeGramercy will be expensed as incurred.

 

**5.**             Operating Partnership Agreement

** **

Afterthe closing of the initial public offering, Gramercy owns all of the Class Alimited partner interests in the Operating Partnership.  The Class B limited partner interests will beowned 70% by SL Green Operating Partnership, L.P. and 30% by GKK Manager LLC(the “Manager”).

 

**6.****             Management Agreement and Related PartyTransactions**

 

In connection withGramercy’s initial public offering, Gramercy entered into a managementagreement with GKK Manager LLC, which provides for an initial term throughDecember 2007 with automatic one-year extension options and subject to certaintermination rights.  Gramercy will paythe Manager an annual management fee equal to 1.75% of its gross stockholdersequity (as defined).

 

The Manager and SL Green Operating Partnership L.P.,will hold Class B limited partner interests for a nominal percentage of theOperating Partnership.  To provide anincentive for the Manager to enhance the value of the common stock, the Managerand SL Green Operating Partnership, L.P. will be entitled to an incentivereturn payable through the Class B limited partner interests equal to 25% ofthe amount by which funds from operations (as defined in the agreement) pluscertain accounting gains exceed the product of the weighted averageStockholders Equity of Gramercy multiplied by 9.5% (divided by 4 to adjust forquarterly calculations).  SL GreenOperating Partnership L.P. and the Manager will own 70 units and 30 units ofthe Class B limited partner interests, respectively.  The incentive return payable on the Class Blimited partner interests will be treated as an expense to Gramercy as earned,and will be recorded when the payment of such amounts become probable andreasonably estimable in accordance with the partnership agreement.

 

Gramercy will be obligated toreimburse the Manager for its costs incurred under an asset servicing agreementand an outsource agreement between the Manager and SL Green OperatingPartnership L.P.  The asset servicingagreement will provide for an annual fee of 0.15% of the book value ofGramercy’s investments, excluding certain defined investments.  The outsourcing agreement will provide a feeof $1.25 million per year, increasing 3% annually over the prior year.

 

Upon successful completion ofits planned initial public offering, Gramercy will be obligated to reimburseapproximately $1.8 million to SL Green Operating Partnership L.P. for costsincurred in connection with the formation, organization and initial publicoffering of Gramercy and $800,000 to reimburse consulting fees paid by SL Greento Messrs. Hall and Foley.

 

**7.****             Subsequent Events**

 

On July 27, 2004, Gramercy wasdeclared effective by the Securities and Exchange Commission and completed itsinitial public offering. Gramercy sold 12,500,000 shares of common stock andraised net proceeds of approximately $177.7 million.

 

During August, 2004, Gramercy originatedinvestments totaling  $124.8 million. Theinvestments include subordinate participation interests in first mortgage loanssecured by office properties in multiple geographic markets.  The investments have initial maturities of 3years.   The weighted average spread overLIBOR for these investments is 7.27%.

 

On August 31, 2004, Gramercyclosed on the three credit facilities discussed in Item 2, Management’sDiscussion

 

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and Analysis – Liquidity andCapital Resources with terms that are substantially the same as thosedisclosed.

 

Each of these facilitiesrequires that Gramercy satisfy certain financial covenants. The terms of eachof these facilities include certain restrictions and covenants which limit,among other things, the payment of dividends, and which require compliance withfinancial ratios relating to the minimum amount of liquidity, minimum amount oftangible net worth, the minimum amount of debt service coverage and fixedcharge coverage, and the maximum amount of  indebtedness.

 

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###### **ITEM2.**                  MANAGEMENT’S DISCUSSION &ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

**Overview**

 

We are a newly-formedspecialty finance company focused on originating and acquiring, for our ownaccount, subordinate interests in whole loans, mezzanine loans, preferredequity interests in entities that own real estate and whole loans.  Our investments will relate to commercial andmulti-family real estate.  We willconduct substantially all of our operations through our operating partnership,GKK Capital LP.  We will be externallymanaged and advised by GKK Manager LLC, a subsidiary of SL Green.  We intend to elect to be taxed as a REITunder the Internal Revenue Code and generally will not be subject to federalincome taxes to the extent we distribute our income to our stockholders.  However, we may establish taxable REITsubsidiaries to effect various taxable transactions.  Those taxable REIT subsidiaries will incurfederal, state and local taxes on the taxable income from their activities.

 

**Critical Accounting Policies**

 

Our financial statements areprepared in accordance with accounting principles general accepted in theUnited States, known as GAAP. These accounting principles require us to makesome complex and subjective decisions and assessments.  Our most critical accounting polices involvedecisions and assessments which could significantly affect our reported assetsand liabilities, as well as our reported revenues and expenses.  We believe that all of the decisions andassessments upon which our financial statements are based were reasonable atthe time made based upon information available to us at that time.  Our Manager has identified our most criticalaccounting policies to be the following:

 

**Loans and Investments**

 

Loans held for investment areintended to be held to maturity and, accordingly, are carried at cost, net ofunamortized loan origination costs and fees, unless such loan or investment isdeemed to be impaired.  We invest inpreferred equity interests that allow us to participate in a percentage of theunderlying property’s cash flows from operations and proceeds from a sale orrefinancing.  At the inception of eachsuch investment, we must determine whether such investment should be accountedfor as a loan, joint venture or as real estate.

 

Specific valuation allowancesare established for impaired loans based on the fair value of collateral on anindividual loan basis.  The fair value ofthe collateral is determined by an evaluation of operating cash flow from theproperty during the projected holding period, and estimated sales valuecomputed by applying an expected capitalization rate to the stabilized netoperating income of the specific property, less selling costs, discounted atmarket discount rates.

 

If upon completion of thevaluation, the fair value of the underlying collateral securing the impairedloan is less than the net carrying value of the loan, an allowance is createdwith a corresponding charge to the provision for loan losses.  The allowance for each loan is maintained ata level we believe is adequate to absorb probable losses.

#### ** **

#### ***Classifications of Mortgage-Backed Securities***

 

In accordance with applicableGAAP, our investments in mortgage-backed securities are classified asavailable-for-sale securities.  As aresult, changes in fair value are recorded as a balance sheet adjustment toaccumulated other comprehensive income (loss), which is a component ofstockholders equity, rather than through our statement of operations.  If available-for-sale securities wereclassified as trading securities, there could be substantially greatervolatility in earnings from period-to-period.

#### ** **

#### ***Valuations of Mortgage-Backed Securities***

 

All mortgage-backedsecurities are carried on the balance sheet at fair value.  Our mortgage-backed securities have fairvalues determined by our Manager.  OurManager will determine the fair value of mortgage-backed securities based onthe types of securities in which we have invested.  For liquid, investment-grade securities, weare likely to consult with dealers of such securities to periodically obtainupdated market pricing for the same or similar

 

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** **

instruments.  For non-investment grade securities, we willactively monitor the performance of the underlying properties and loans andupdate our pricing model to reflect changes in projected cash flows.  The value of the securities will be derivedby applying discount rates to such cash flows based on current marketyields.  The yields employed may beobtained from our own experience in the market, advice from dealers and/orinformation obtain in consultation with other investors in similarinstruments.  Because fair valueestimates may vary to some degree, our Manager must make certain judgments andassumptions about the appropriate price to use to calculate the fair values forfinancial reporting purposes.  Differentjudgments and assumptions could result in different presentations of value.

 

When the fair value of anavailable-for-sale security is less than the amortized cost, our Managerconsiders whether there is an other-than-temporary impairment in the value ofthe security (for example, whether the security will be sold prior to therecovery of fair value).  If, in our Manager’sjudgment, an other-than-temporary impairment exists, the cost basis of thesecurity is written down to the then-current fair value, and this loss isrealized and charged against earnings. The determination of other-than temporary impairment is a subjectiveprocess, and different judgments and assumptions could affect the timing ofloss realization.

 

#### ***Revenue Recognition***

 

Interest income on debtinvestments is recognized over the life of the investment using the effectiveinterest method and recognized on the accrual basis.  Fees received in connection with loancommitments are deferred until the loan is funded and are then recognized overthe term of the loan as an adjustment to yield. Anticipated exit fees, whose collection is expected, are also recognizedover the term of the loan as an adjustment to yield.  Fees on commitments that expire unused arerecognized at expiration.

 

Income recognition is generallysuspended for debt investments at the earlier of the date at which paymentsbecome 90 days past due or when, in our opinion a full recover of income andprincipal becomes doubtful.  Incomerecognition is resumed when the loan becomes contractually current andperformance is demonstrated to be resumed.

 

#### ***Reserve for Possible Credit Losses***

 

The expense for possible creditlosses in connection with debt investments is the charge to earnings toincrease the allowance for possible credit losses to the level that managementestimates to be adequate considering delinquencies, loss experience andcollateral quality.  Other factorsconsidered relate to geographic trends and project diversification, the size ofthe portfolio and current economic conditions. Based upon these factors, we establish the provision for possible creditlosses by category of asset.  When it isprobable that we will be unable to collect all amounts contractually due, theaccount is considered impaired.

 

Where impairment is indicated,a valuation write-down or write-off is measured based upon the excess of therecorded investment amount over the net fair value of the collateral, asreduced by selling costs.  Any deficiencybetween the carrying amount of an asset and the net sales price of repossessedcollateral is charged to the allowance for credit losses.

 

***Incentive Distribution (Class B Limited Partner Interest)***

 

**ThroughClass B limited partner interests, SL Green can avail itself of theflow-through of capital gains realized by us. The Class B limited partner interest will be entitled to receivequarterly profit distributions based on our financial performance.  We will record any distributions on Class Blimited partner interest as an incentive distribution expense in the periodwhen earned and when payment of such amounts has become probable and reasonablyestimable in accordance with the partnership agreement.  As these interests are speculative in natureand subject to future performance, no value was ascribed to the originalissuance of these interests and no consideration was paid in exchange for theseinterests.  These cash distributions willreduce the amount of cash available for distribution to our common unitholdersin our operating partnership and to common stockholders.**

 

#### ***Derivative Instruments***

 

In the normal course ofbusiness, we use a variety of derivative instruments to manage, or hedge,interest rate risk.  We require thathedging derivative instruments be effective in reducing the interest rate riskexposure that they are

 

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designated to hedge.  This effectiveness is essential forqualifying for hedge accounting.  Somederivative instruments are associated with an anticipated transaction.  In those cases, hedge effectiveness criteriaalso require that it be probable that the underlying transaction occurs.  Instruments that meet these hedging criteriaare formally designated as hedges at the inception of the derivative contract.

 

To determine the fair values ofderivative instruments, we use a variety of methods and assumptions that arebased on market conditions and risks existing at each balance sheet date.  For the majority of financial instrumentsincluding most derivatives, long-term investments and long-term debt, standardmarket conventions and techniques such as discounted cash flow analysis,option-pricing models, replacement cost, and termination cost are used todetermine fair value.  All methods ofassessing fair value result in a general approximation of value, and such valuemay never actually be realized.

 

We currently intend to usederivative instruments to minimize our exposure to risk, rather than as a meansof generating income.

 

# ***Recent Accounting Pronouncement***

 

In January 2003, the FinancialAccounting Standards Board (or FASB) issued FASB Interpretation No. 46“Consolidation of Variable Interest Entities” (or FIN 46), which requires avariable interest entity (or VIE), to be consolidated by its primarybeneficiary.  The primary beneficiary isthe party that absorbs a majority of the VIE’s anticipated losses and/or a majorityof the expected returns.

 

In December 2003, the FASBrevised FIN 46 (or FIN 46-R), delaying the effective date for certain entitiescreated before February 1, 2003 and making other amendments to clarify theapplication of the guidance.  Our Managerwill evaluate our investments for potential variable interests by evaluatingthe sufficiency of the entities equity investment at risk to absorb losses.

 

# ***Income Taxes***

 

We intend to elect to be taxedas a REIT, under Sections 856 through 860 of the Internal Revenue Codebeginning with our taxable year ending December 31, 2004.  To qualify as a REIT, we must meet certainorganizational and operational requirements, including a requirement todistribute at least 90% of our ordinary taxable income to stockholders.  As a REIT, we generally will not be subjectto federal income tax on taxable income that we distribute to ourstockholders.  If we fail to qualify as aREIT in any taxable year, we will then be subject to federal income taxes onour taxable income at regular corporate rates and we will not be permitted toqualify for treatment as a REIT for federal income tax purposes for four yearsfollowing the year during which qualification is lost unless the InternalRevenue Service grants us relief under certain statutory provisions.  Such an event could materially adverselyaffect our net income and net cash available for distributions tostockholders.  However, be believe thatwe will be organized and operate in such a manner as to qualify for treatmentas a REIT and we intend to operate in the foreseeable future in such a mannerso that we will qualify as a REIT for federal income tax purposes.

 

## ***Liquidity and Capital Resources***

 

Liquidity is a measurement ofthe ability to meet cash requirements, including ongoing commitments to repayborrowings, fund and maintain loans and investments, pay dividends and othergeneral business needs.  Our primarysources of funds for liquidity consist of funds raised in our initial publicoffering and borrowings under credit facilities.  Additional sources of liquidity will be netcash provided by operating activities, repayment of

 

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principal (and contingentinterest, if any) by our borrowers in connection with origination or acquiredloans and investments, the issuance by us or special purpose vehicles owned byus of fixed income securities collateralized by certain of our investments andthe issuance by us of preferred equity or common equity in secondary offerings.

** **

**On August 31,2004, we closed on three credit facilities with Wachovia Capital Markets, LLCor one or more of its affiliates.  Thefirst credit facility is a $250 million repurchase agreement.  This facility, which may be increased to $350million, has a term of three years with one 12-month extension option.  The facility provides for a pricing rate of a spread of 1.25% to3.75% over 30-day LIBOR and an advance rate that varies from 50% to 95% based upon the collateral provided under aborrowing base calculation.  Thisfacility provides for a mark-to-market provision by the counterparty.  The lender will have a consent right withrespect to the inclusion of investments in this facility, will determineperiodically the market value of the investments, and will have the right torequire additional collateral if the estimated market value of the includedinvestments declines.  We can utilize the$25 million revolving credit facility described below to fund requirements foradditional collateral pursuant to the warehouse financing or to fund theacquisition of assets, which could otherwise be funded under the $50 millioncredit facility described below.**

** **

**The second credit facility is a $50 million repurchasefacility with a term of two years and also has one 12-month extension option. This facility bears interest at a**spreadover LIBOR of 225 basis points. The advance rate on this facility varieswith thecollateral being acquired.  This facilitydoes not provide for a customary mark-to-market provision by thecounterparty.  Amounts drawn under thisfacility must be repaid within 210 days.

 

The third credit facility is a$25 million revolving credit facility with a term of two years.  Amounts drawn under this facility forliquidity purposes bear interest at a rate equal to a spread over LIBOR of 525basis points.  Amounts drawn under thisfacility for acquisition purposes bear interest at a spread over LIBOR of 225basis points.  Amounts drawn under thisfacility for liquidity purposes must be repaid within 90-days.  Amounts drawn under this facility generallywill be secured by assets established under a borrowing base calculation.

 

Financial covenants for thesefacilities will include covenants that (a) our maximum total liabilities ratiowill not exceed 85%, (b) require us to maintain minimum liquidity of at least$10 million in cash and cash equivalents for the first two years and $15million thereafter, (c) our fixed charge coverage ratio shall at no time beless than 1.50 to 1.00, (d) our minimum interest coverage ratio shall at notime be less than 1.75 to 1.00, (e) require us to maintain minimum tangible networth of not less than the greater of (i) $129.75 million, an (ii) 75% of theproceeds of our equity issuances and (f) restrict the maximum amount of ourtotal indebtedness.  The covenants alsorestrict us from making distributions in excess of a maximum of 103% of ourfunds from operations (as defined by the National Association of Real EstateInvestment Trusts) through July 2005 and 100% thereafter, except that we may inany case pay distributions necessary to maintain REIT status.

 

The revolving credit facilitiesand the warehouse financing require that we pay down borrowings under thesefacilities as principal payments on our loans and investment are received.

 

We believe these sources offinancing, together with the net proceeds of this offering, will be sufficientto meet our short-term liquidity needs. Our ability to meet our long-term liquidity and capital resourcerequirements will be subject to obtaining additional debt financing and equitycapital.  If we are unable to renew,replace or expand our sources of financing on substantially similar terms, itmay have an adverse effect on our business and results of operations.  In addition, an event of default is triggeredunder both facilities if the management agreement with GKK Manager LLC isterminated.  Depending on marketconditions, we expect that once the net proceeds of this offering are fullyinvested, our debt financing will be in the range of 70% to 80% of our totalassets.  Any indebtedness we incur willlikely be subject to continuing covenants and we will likely be required tomake continuing representations and warranties about our company in connectionwith such debt.  Our debt financing termsmay require us to keep uninvested cash on hand, or to maintain a certainportion of our assets free of liens, each of which could serve to limit ourborrowing ability.  Moreover, our debtmay be secured by our assets.  If wedefault in the payment of interest or principal on any such debt, breach anyrepresentation or warranty in connection with any borrowing or violate anycovenant in any loan document, our lender may accelerate the maturity of suchdebt requiring us to immediately repay all outstanding principal.  If we are unable to make such payment, ourlender could foreclose on our assets that are pledged as collateral to suchlender.  The lender could also sue us orforce us into bankruptcy.  Any such eventwould have a material adverse effect on our liquidity and the value of ourcommon stock.  In addition, postingadditional collateral to support our credit facilities will reduce ourliquidity and limit our ability to leverage our assets.

 

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To maintain our status as aREIT under the Internal Revenue Code, we must distribute annually at least 90%of our taxable income.  Thesedistribution requirements limit our ability to retain earnings and therebyreplenish or increase capital for operations. However, we believe that our significant capital resources and access tofinancing will provide us with financial flexibility at levels sufficient tomeet current and anticipated capital requirements, including funding newlending and investment opportunities.

 

##### ***Quantitativeand Qualitative Disclosures about Market Risk***

 

Market risk includes risks thatarise from changes in interest rates, commodity prices, equity prices and othermarket changes that affect market sensitive instruments.  In pursuing our business plan, we expect thatthe primary market risks to which we will be exposed are real estate andinterest rate risks.

 

#### ***RealEstate Risk***

 

Commercial and multi-familyproperty values and net operating income derived from such properties aresubject to volatility and may be affected adversely by a number of factors,including, but not limited to, national, regional and local economic conditionswhich may be adversely affected by industry slowdowns and other factors), localreal estate conditions (such as an oversupply of retail, industrial, office orother commercial space), changes or continued weakness in specific industrysegments, construction quality, age and design, demographic factors,retroactive changes to building or similar codes, and increases in operatingexpenses (such as energy costs).  In theevent net operating income decreases, a borrower may have difficulty repayingour loans, which could result in losses to us. In addition, decreases in property values reduce the value of thecollateral and the potential proceeds available to a borrower to repay ourloans, which could also cause us to suffer losses.  Even when a property’s net operating incomeis sufficient to cover the property’s debt service, at the time a loan is made,there can be no assurance that this will continue in the future.

###### ** **

###### ***InterestRate Risk***

 

Interest rate risk is highlysensitive to many factors, including governmental monetary and tax policies,domestic and international economic and political considerations and otherfactors beyond our control.

 

Our operating results will dependin large part on differences between the income from our assets and ourborrowing costs.  Most of our assets andborrowings are expected to be variable-rate instruments.  The objective of this strategy is to minimizethe impact of interest rate changes on our net interest income.  Many of our loans may be subject to variousinterest rate floors.  As a result, theimpact of a change in interest rates may be different on our interest incomethan it is on our interest expense.  Inaddition, as the size of our portfolio increases and the percentage ofborrowings as a percent of assets increases, a change in interest rates mayhave a negative impact on our net income. We do not expect to enter into hedging transactions with respect to allof our fixed-rate assets that are financed with floating rate debt.  Accordingly, there will be an interest ratemismatch with respect to such assets, which may adversely affect our operatingresults.

 

In the event of a significantrising interest rate environment and/or economic downturn, delinquencies anddefaults could increase and result in credit losses to us, which couldadversely affect our liquidity and operating results.  Further, such delinquencies or defaults couldhave an adverse effect on the spreads between interest-earning assets andinterest-bearing liabilities.

 

 

**Forward-Looking Information**

 

This report includes certain statements that may be deemed to be“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, or the Act, and Section 21E of theSecurities Exchange

 

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Act of 1934, as amended, or the Exchange Act.  Such forward-looking statements relate to,without limitation, our future capital expenditures, dividends and acquisitions(including the amount and nature thereof) and other trends of the real estateindustry, business strategies, and the expansion and growth of ouroperations.  These statements are basedon certain assumptions and analyses made by us in light of our experience andour perception of historical trends, current conditions, expected futuredevelopments and other factors we believe are appropriate.  We intend such forward-looking statements tobe covered by the safe harbor provisions for forward-looking statementscontained in Section 27A of the Act and Section 21E of the Exchange Act.  Such statements are subject to a number ofassumptions, risks and uncertainties which may cause our actual results, performanceor achievements to be materially different from future results, performance orachievements expressed or implied by these forward-looking statements.  Forward-looking statements are generallyidentifiable by the use of the words “may,” “will,” “should,” “expect,”“anticipate,” “estimate,” “believe,” “intend,” “project,” “continue,” or thenegative of these words, or other similar words or terms.  Readers are cautioned not to place unduereliance on these forward-looking statements. Among the factors about which we have made assumptions are:

 

·        the success or failure of ourefforts to implement our current business strategy;

·        economic conditions generally andin the commercial finance and real estate markets specifically;

·        the performance and financialcondition of borrowers and corporate customers;

·        the actions of our competitors andour ability to respond to those actions;

·        the cost of our capital, whichdepends in part on our asset quality, the nature of our relationships with ourlenders and other capital providers, our business prospects and outlook andgeneral market conditions;

·        changes in governmentalregulations, tax rates and similar matters; and

·        legislative and regulatory changes(including changes to laws governing the taxation of REITs)

 

and other factors, many of which are beyond our control.  We undertake no obligation to publicly updateor revise any forward-looking statements, whether as a result of future events,new information or otherwise.

 

The risks included here are not exhaustive.  Other sections of this report may includeadditional factors that could adversely affect Gramercy’s business andfinancial performance.  Moreover,Gramercy operates in a very competitive and rapidly changing environment.  New risk factors emerge from time to time andit is not possible for management to predict all such risk factors, nor can itassess the impact of all such risk factors on Gramercy’s business or the extentto which any factor, or combination of factors, may cause actual results todiffer materially from those contained in any forward-looking statements.  Given these risks and uncertainties,investors should not place undue reliance on forward-looking statements as aprediction of actual results.

** **

**ITEM3.**  Quantitativeand Qualitative Disclosure About Market Risk

 

See Item 2, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations - Market Rate Risk” for additionalinformation regarding our exposure to interest rate fluctuations.

 

**ITEM 4.**  Controls and Procedures

** **

**a.**             Evaluation of Disclosure Controls andProcedures

** **

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure based closely on the definition of “disclosure controls andprocedures” in Rule 13a-15(e).  Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management necessarily was required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.  Also, we may haveinvestments in certain unconsolidated entities. As we do not control these entities, our disclosure controls andprocedures with respect to such entities are necessarily substantially morelimited than those we maintain with respect to our consolidated subsidiaries.

 

As of the end of the period covered by this report, we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and our Chief Financial Officer, of the

 

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effectiveness of the design and operation of our disclosure controlsand procedures.  Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective as of the end of theperiod covered by this report.

 

**b.**             Changes in Internal Controls overFinancial Reporting

** **

**There were no changes inGramercy’s internal controls over financial reporting identified in connectionwith the evaluation of such internal controls that occurred during Gramercy’slast fiscal quarter that have materially affected, or are reasonably likely tomaterially**affect, Gramercy’s internal controls overfinancial reporting.

 

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##### **PART II**                 OTHERINFORMATION

 

##### **ITEM1.**                  LEGAL PROCEEDINGS

 

None

 

##### **ITEM 2.**                  CHANGES IN SECURITIES AND USE OF PROCEEDS

 

None

 

##### **ITEM 3.**                  DEFAULTSUPON SENIOR SECURITIES

 

None

 

##### **ITEM 4.**                  SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None

 

##### **ITEM 5.**                  OTHERINFORMATION

 

None

 

##### **ITEM 6.**                 EXHIBITSAND REPORTS ON FORM 8-K

 

(a)           Exhibits:

 

31.1         Certification by the Chief Executive Officerpursuant to Section 302 of the Sarbanes-Oxley Act of 2002 filed herewith.

 

31.2         Certification by the Chief Financial Officerpursuant to Section 302 of the Sarbanes-Oxley Act of 2002 filed herewith.

 

32.1         Certification pursuant to 18 U.S.C. section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 202 filedherewith.

 

32.2         Certification pursuant to 18 U.S.C. section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002filed herewith.

 

 

(b)           Reports on Form 8-K:

None

 

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** **

**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   |               |   | GRAMERCY CAPITAL CORP. |
|--------|--------------------|--------|------------------------|
|   |               |   |                   |   |
|   |               |   |                   |   |
|   |               |   | By:                    | /s/ Robert R. Foley |   |
|   |               |   |                   | Robert R. Foley |
|   |               |   |                   | Chief Financial Officer |
|   |               |   |                   |   |
|   |               |   |                   |   |
| Date:  | September 10, 2004 |   |                   |   |
|   |               |   |                   |   |

 

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