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CLARION COMMERCIAL HOLDINGS, INC.
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
Commission File Number: 1-14167
CLARION COMMERCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Maryland 13-3988895
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
335 Madison Avenue, 10017
New York, New York
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number including area code): (212) 883-2500
NOT APPLICABLE
(Former name, former address, and former fiscal year if
changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes (X) No ( )
As of August 13, 2001, 4,078,393 shares of Class A Common Stock ($.001 par
value) were outstanding.
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CLARION COMMERCIAL HOLDINGS, INC.
FORM 10-Q
INDEX
PART I FINANCIAL INFORMATION........................................................................3
Item 1: Financial Statements......................................................................3
Consolidated Statements of Financial Condition/Net Assets..........................................3
Consolidated Statements of Operations..............................................................4
Consolidated Statement of Changes in Stockholders' Equity/Net Assets...............................5
Consolidated Statements of Cash Flows..............................................................6
NOTES TO FINANCIAL STATEMENTS......................................................................7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......11
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................15
PART II - OTHER INFORMATION.............................................................................15
Item 1. Legal Proceedings............................................................................15
Item 2. Changes in Securities and Use of Proceeds....................................................15
Item 3. Defaults Upon Senior Securities..............................................................15
Item 4. Submission of Matters to a Vote of Security Holders..........................................15
Item 5. Other Information............................................................................15
Item 6. Exhibits and Reports on Form 8-K.............................................................15
SIGNATURES..............................................................................................16
2
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PART I FINANCIAL INFORMATION
Item 1: Financial Statements
CLARION COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION/NET ASSETS
(Unaudited)
Liquidation Going Concern
Basis Basis
June 30, December 31,
2001 2000
----------------------------------
ASSETS
Cash and cash equivalents $ 88,450 $ 733,253
Securities - trading, at fair value 43,887,481 48,605,957
Other investments 3,632,664 3,918,651
Deposits with brokers as collateral for securities sold short - 28,023,910
Trade receivable 5,765,388 -
Accrued interest receivable and other assets 760,732 644,225
----------------------------------
Total assets 54,134,715 $81,925,996
----------------------------------
LIABILITIES
Repurchase agreements 16,098,000 $14,100,000
Government securities sold short - 28,225,294
Dividends payable - 812,873
Other liabilities 365,014 844,464
Reserve for estimated costs during liquidation period 1,115,186 -
----------------------------------
Total liabilities 17,578,200 43,982,631
----------------------------------
STOCKHOLDERS' EQUITY/NET ASSETS
Preferred Stock, par value $.01 per share, 25,000,000 shares
Authorized; no shares issued -
Class A Common Stock, par value $.001 per share, 74,000,000 shares
Authorized; 4,073,393 and 4,064,367 shares issued and outstanding
on June 30, 2001 and December 31, 2000, respectively 4,064
Additional paid-in capital 88,078,116
Net loss and distributions (50,138,815)
-----------------
Total stockholders' equity 37,943,365
-----------------
Total liabilities and stockholders' equity $81,925,996
=================
Net assets in liquidation $36,556,515
=================
The accompanying notes are an integral part of these consolidated financial statements.
3
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CLARION COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
Going Concern Basis Going Concern Basis
June 30, June 30, June 30, June 30,
2001 2000 2001 2000
------------------------------------------------------------------------
Income:
Interest income from securities - trading $ 1,438,492 $ 2,340,470 $ 2,947,927 $ 5,147,270
Income from other investments 128,521 90,898 255,804 225,301
Interest income from cash and cash
equivalents 4,885 71,945 10,541 79,279
------------------------------------------------------------------------
Total income 1,571,898 2,503,313 3,214,272 5,451,850
------------------------------------------------------------------------
Expenses:
Interest 215,562 1,032,235 574,832 2,359,648
Management fee 125,748 127,617 255,171 256,481
Other expenses 321,954 389,822 618,503 556,283
------------------------------------------------------------------------
Total expenses 663,264 1,549,674 1,448,506 3,172,412
------------------------------------------------------------------------
Other operating gains and losses:
Loss from securities-trading (1,353,764) (759,666) (1,288,251) (395,502)
------------------------------------------------------------------------
Income (loss) - going concern basis (445,130) 193,973 477,515 1,883,936
Estimated costs during liquidation period (1,115,186) - (1,115,186) -
------------------------------------------------------------------------
Net Income (Loss) $(1,560,316) $ 193,973 $(637,671) $ 1,883,936
========================================================================
Net Income (Loss) per share:
Basic $ (0.38) $ 0.05 $ (0.16) $ 0.46
========================================================================
Diluted $ (0.38) $ 0.05 $ (0.16) $ 0.46
========================================================================
Weighted average shares
Basic 4,073,393 4,061,968 4,073,343 4,071,920
========================================================================
Diluted 4,073,393 4,061,968 4,073,343 4,071,920
========================================================================
The accompanying notes are an integral part of these consolidated financial statements.
4
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CLARION COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY/NET ASSETS
FOR THE SIX MONTHS ENDED JUNE 30, 2001
(Unaudited)
Stockholders' equity, January 1, 2001 $ 37,943,365
Class A common stock dividend declared and paid (814,679)
Net loss (637,671)
Issuance of Common Stock - Class A 65,500
--------------
Net assets in liquidation, June 30, 2001 $ 36,556,515
==============
The accompanying notes are an integral part of these consolidated financial statements.
5
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CLARION COMMERCIAL HOLDINGS, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED
(Unaudited)
Going Concern Basis
June 30, June 30,
2001 2000
Cash flows from operating activities:
Net income (loss) $ (637,671) $1,883,936
Adjustments to reconcile net income to net cash used by
Operating activities:
Accretion and amortization, net (183,040) (259,419)
Issuance of shares fees and compensation 65,500 77,000
Net increase (decrease) in unrealized loss on securities-trading 1,865,264 (414,890)
Change in unrealized (gain) loss on government securities sold short (1,916,881) 1,224,265
Increase in accrued interest receivable & other assets (116,507) (168,515)
Decrease in other liabilities (479,450) (428,146)
Increase in estimated costs during liquidation period 1,115,186 -
Purchase of securities-trading (18,779,453) (30,458,810)
Sale and principal payments of securities-trading 21,841,692 66,995,987
Increase in trade receivable (5,765,388) -
Decrease (increase) in deposits with broker as collateral for securities sold 28,023,910 (81,817)
short Decrease in government securities sold short (26,308,413) (246,583)
--------------------------------------
Net cash provided (used) by operating activities (1,275,251) 38,123,008
--------------------------------------
Cash flows from investing activities:
Sale of other investments 250,000 -
Principal payments received on mezzanine investment 10,000 43,333
--------------------------------------
Net cash provided by investing activities 260,000 43,333
--------------------------------------
Cash flows from financing activities:
Borrowings (repayments) under reverse repurchase agreements, net 1,998,000 (33,936,000)
Dividends paid (1,627,552) (1,651,560)
Repurchases of common stock - (2,506,276)
--------------------------------------
Net cash provided (used) by financing activities 370,448 (38,093,836)
--------------------------------------
Net increase (decrease) in cash and cash equivalents (644,803) 72,505
Cash and cash equivalents at beginning of period 733,253 1,143,182
--------------------------------------
Cash and cash equivalents at end of period $ 88,450 $1,215,687
======================================
Supplemental information:
Interest paid $807,254 $1,834,196
======================================
The accompanying notes are an integral part of these consolidated financial statements.
6
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NOTES TO FINANCIAL STATEMENTS
NOTE 1 ORGANIZATION AND BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of
Regulation S-X for interim financial statements. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements and should be read in
conjunction with the annual financial statements and notes thereto included in
the Company's annual report on Form 10-K filed with the Securities and Exchange
Commission. The consolidated financial statements include the accounts of
Clarion Commercial Holdings, Inc. ("Clarion") and its consolidated subsidiaries
(together with Clarion, the "Company"). All intercompany transactions and
balances are eliminated in consolidation.
In the opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments, which except for the entries required to
adopt the liquidation basis as discussed below, consist of normal and recurring
accruals, necessary for a fair presentation of the consolidated financial
condition of the Company at June 30, 2001 and December 31, 2000 and the results
of its operations and its cash flows for the three months and six months ended
June 30, 2001 and 2000. Operating results for the period ended June 30, 2001 are
not necessarily indicative of the results that may be expected for any other
interim periods or the year ending December 31, 2001.
Clarion was incorporated in Maryland in February 1998 and commenced its
operations on June 2, 1998. The Company is a specialty finance company organized
to invest in commercial mortgage-backed securities (primarily subordinate
securities) commercial mortgage loans, mezzanine investments, equity investments
and other real estate related investments.
On October 12, 2000, the Company's Board of Directors unanimously voted to
recommend that a plan of liquidation and dissolution be submitted to its
stockholders. After reviewing the Company's strategic alternatives, the Board
concluded that the liquidation of the Company was the best available alternative
for maximizing stockholder value and, accordingly, was in the best interest of
the Company and its stockholders. On March 6, 2001, the Company's Board of
Directors approved a specific plan of liquidation and dissolution and determined
to submit the plan to the Company's stockholders for their consideration. On May
31, 2001, the Company's stockholders approved the liquidation agreement pursuant
to which the Company's existing management agreement with Clarion Capital, LLC
would be amended to provide that Clarion Capital, LLC, the existing manager of
the Company's assets, will manage the liquidation of the Company.
The Company adopted the liquidation basis of accounting as of June 30, 2001.
Accordingly, the Company's assets are stated at their estimated net realizable
values and liabilities include estimated costs and expenses to be incurred
through the anticipated date of liquidation. Prior to June 30, 2001, the
Company's books were maintained on the going concern basis of accounting.
Because most of the Company's investments were carried at their estimated fair
values, adoption of the liquidation basis of accounting did not have a material
effect on the Company's net assets. However, due to changes in market
conditions, the timing of sales, and other factors, the amounts ultimately
realized upon liquidation of the Company's investments may differ, perhaps
materially, from the carrying amounts as of June 30, 2001.
NOTE 2 SIGNIFICANT ACCOUNTING POLICIES
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated statement of financial condition and revenues and expenses for
the periods covered. Actual results could differ from those estimates and
assumptions.
A summary of the Company's significant accounting policies follows:
SECURITIES - TRADING
7
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At the date of acquisition, the Company elected to designate its government
securities and commercial mortgage-backed securities ("CMBS") as trading assets.
Such securities are carried at their estimated fair value, with the net
unrealized gains or losses included in earnings. For a description of the
methodology used in determining fair value of the Company's CMBS investments,
refer to Note 3. Interest income is recognized as it becomes receivable, and
includes amortization of premiums and accretion of discounts, computed using the
effective yield method, after considering estimated prepayments and credit
losses. Actual credit loss and prepayment experience is reviewed periodically
and effective yields adjusted if necessary.
RISK MANAGEMENT
During the first quarter of 2001 the Company implemented a hedging strategy
based on the use of Treasury yield locks. A Treasury yield lock is a contract to
sell short a specific Treasury and buy it back on a specified date sometime in
the future. The Company utilized these contracts as a means of mitigating
("hedging") the potential financial statement impact of changes in the fair
value of its portfolio of CMBS due to changes in interest rates. These
instruments are recorded at fair value, with unrealized gains or losses recorded
in earnings as part of the gain (loss) on securities-trading.
OTHER INVESTMENTS
The Company's 10% interest in Clarion Capital, LLC (the "Manager") along with an
option to purchase the remaining 90% membership interest was sold to the Manager
for $250,000 pursuant to the plan of liquidation and dissolution. This sale was
completed during June 2001 and resulted in no gain or loss to the Company.
The preferred interest in a limited partnership is accounted for at cost, which
is deemed to approximate its net realizable value, if the preferred interest
were sold outright.
COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income" defines comprehensive income as
the change in equity of a business enterprise during a period from transactions
and other events and circumstances, excluding those resulting from investments
by and distributions to owners. The Company had no items of other comprehensive
income during any of the periods presented, so its comprehensive income was the
same as its net income.
NEW ACCOUNTING PRONOUNCEMENT
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It requires
that the Company recognize all derivatives as either assets or liabilities in
the statement of financial condition and measure those instruments at fair
value. If certain conditions are met, a derivative may be specifically
designated as a hedge of the exposure to changes in the fair value of a
recognized asset or liability or a hedge exposure to variable cash flows of a
forecasted transaction. The accounting for changes in the fair value of a
derivative (e.g. through earnings or outside earnings, through comprehensive
income) depends on the intended use of the derivative and the resulting
designation.
On January 1, 2001, the Company adopted SFAS 133, as amended. Based on the
Company's hedging strategies, adoption of SFAS 133 had no impact on the
Company's financial statements.
NET INCOME PER SHARE
Net income per share is computed in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 128, Earnings Per Share, and is calculated on
the basis of the weighted average number of common shares outstanding during the
period plus the additional dilutive effect of common stock equivalents. The
dilutive effect of outstanding stock options is calculated using the treasury
stock method.
8
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For the three months and six months ending June 30, 2001 and 2000, diluted net
income per share was the same as basic net income per share, because all
outstanding stock options were not dilutive.
DIVIDENDS
On April 16, 2001, the Company made a distribution of $0.20 per share to
stockholders of record at the close of business on March 31, 2001. The character
of the distribution to the stockholders for income tax purposes has not been
determined at this time.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment Trust ("REIT")
and has complied with the provisions of the Internal Revenue Code of 1986, as
amended (the "Code"), with respect thereto. Accordingly, the Company is not
subject to federal income tax to the extent of its distributions to stockholders
as long as certain asset, income and stock ownership tests are met. The Company
intends to conduct its activities during the liquidation period in a manner that
will enable it to maintain its REIT status.
The Company has elected mark-to market valuation treatment for its investment
portfolio under Internal Revenue Code Section 475. Under this election the
Company must treat all unrealized trading gains and losses as realized for
income tax purposes as well as treating all trading transactions as operating
gains and losses.
NOTE 3 SECURITIES - TRADING
The Company's securities - trading consist of CMBS with an estimated fair value
of $43,887,481 and an amortized cost of $57,323,064 at June 30, 2001, resulting
in an unrealized loss of $13,435,583 at that date. At December 31, 2000, the
Company's securities - trading consisted of CMBS with an estimated fair value of
$48,605,957 and an amortized cost of $60,176,274, resulting in an unrealized
loss of $11,570,317 at that date.
The aggregate estimated fair values by underlying credit rating of the Company's
CMBS at June 30, 2001 and December 31, 2000 are as follows:
June 30, 2001 December 31, 2000
------------------ ---------------------
Security Rating Estimated Fair Value % of Total Estimated Fair Value % of Total
- -----------------------------------------------------------------------------------------------------------------------
AAA $ 12,999,047 29.6% $ - 0.0%
BBB - 0.0% 16,078,336 33.1%
BB 20,120,516 45.8% 20,461,704 42.1%
B 6,610,374 15.1% 7,156,176 14.7%
B- 1,366,313 3.1% 1,859,459 3.8%
NR 2,791,231 6.4% 3,050,282 6.3%
-----------------------------------------------------------------------------------------------
$ 43,887,481 100.0% $ 48,605,957 100.0%
===============================================================================================
As of June 30, 2001, the mortgage loans underlying the CMBS interests held by
the Company were secured by properties of the types and in the states identified
below:
Property Type Percentage (1) State Percentage (1)
- ----------------------------------------- --------------------------------------
Retail 39.0% MN 18.2%
Multifamily 20.2 TX 11.3
Office 16.4 CA 9.8
Hotel 12.0 NY 8.3
Other 12.4 All others (2) 52.4
(1) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(2) No other state comprises more than 5% of the total.
9
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As of June 30, 2001, the weighted average unpaid principal balance of loans
underlying the CMBS investments of the Company that are more than 60 days
delinquent is 0.06% of the unpaid principal balance of the total collateral as
of that date.
The fair value of the Company's portfolio of CMBS is generally estimated by
management based on market prices provided by third party market participants.
The market for the Company's CMBS periodically suffers from a lack of liquidity,
accordingly, the fair values reported reflect estimates and may not necessarily
be indicative of the amounts the Company could realize in a current market
exchange.
On February 16, 2001, the Company closed all of its contracts to sell U.S.
Treasury securities (short sales) and entered into a Treasury yield lock to
hedge the interest rate risk of its CMBS portfolio. A Treasury yield lock is a
contract to sell short a specific U.S. Treasury and buy it back on a specified
date sometime in the future. These instruments are recorded at fair value, with
unrealized gains or losses recorded in earnings as part of the gain (loss) on
securities-trading. The contract has a notional amount of $31,593,000, is
referenced to the US Treasury, 5.50%, 05/15/09 and was scheduled to terminate on
August 20, 2001. The fair value of this contract at June 30, 2001 was an asset
of $128,238, which is included in other assets on the balance sheet. The net
gain on the Company's hedging activities for the three and six months ended June
30, 2001 was $849,964 and $331,205, respectively, which is included in gains
from securities-trading in the consolidated statement of operations. In
addition, the Company earned $200,080 on short sale proceeds held by brokers and
incurred interest of $197,385 on the short sales contracts prior to their
termination during the first quarter of 2001.
On July 31, 2001, the Company closed the Treasury yield lock and realized a loss
of approximately $655,000. This loss resulted from a decrease in the yield on
the related US Treasury during July of approximately 0.42% and corresponded to
an increase in the Company's CMBS investments. On July 31, 2001 the Company
opened contracts to sell U.S. Treasury securities (short sales) as a means of
hedging its interest rate risk.
The unrealized gain (loss) on the short US Treasury contracts for the three
months and six months ending June 30, 2000 was $526,398 and ($1,224,265),
respectively, which is included in gain (loss) from securities-trading in the
consolidated statement of operations. The realized gain (loss) on these
contracts for the three months and six months ended June 30, 2000 was ($550,332)
and $375,500, respectively, which is included in gain (loss) from
securities-trading in the consolidated statement of operations.
The Company earned $390,637 and $715,790 on short sale proceeds held by brokers
and incurred interest of $358,230 and $713,838 on the short sales contracts for
the three months and six months ending June 30, 2000, respectively.
NOTE 4 TRANSACTIONS WITH AFFILIATES
Clarion has a management agreement with the Manager, as amended by the
liquidation agreement, under which the Manager manages the Company's day-to-day
operations during the liquidation process, subject to the direction and
oversight of Clarion's Board of Directors. The Company pays the Manager a
monthly fee plus various incentives based on the Manager's performance.
The management fee as amended by the liquidation agreement is payable commencing
June 1, 2001 and until such time as the manager has sold the last CMBS asset of
the Company or the management agreement terminates. The manager will receive a
monthly fee as follows: $44,000 for June 2001 through November 2001; $25,000 for
December 2001 and January 2002; and $7,500 for each subsequent month. Upon the
complete liquidation of all of the CMBS assets of the Company, for the eighteen
calendar months from June 1, 2001 through November 30, 2002, but prior to the
dissolution of the Company, the monthly fee payable to the manager will be
reduced to $7,500. At any point following the reduction of the monthly fee to
$7,500, the Company can terminate this agreement. Upon the sale or liquidation
of the mezzanine investment or termination of the management agreement prior to
the sale or liquidation of the mezzanine investment, the manager will receive a
one-time fee of $80,000. Upon completion of the sale or liquidation of the CMBS
assets, the manager will receive additional compensation according to the
following schedule:
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If sale of last CMBS asset Manager will receive
occurs in month additional compensation of:
------------------------------- ------------------------------
August 2001 $472,000
September 2001 428,000
October 2001 384,000
November 2001 340,000
December 2001 290,000
January 2002 265,000
February 2002 or later 250,000
In accordance with the terms of the management agreement and the management
agreement as amended by the liquidation plan, the Company paid $125,748 and
$255,171 in management fees for the three months and six months ended June 30,
2001. In addition, the Company has accrued $640,000 in management fees into the
reserve for estimated costs during liquidation. The Company incurred $127,617
and $256,481 in management fees for the three months and six months ended June
30, 2000, respectively. The Company has not accrued for, or paid, the Manager
any incentive compensation since inception.
NOTE 5 REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements with Bear Stearns to finance
a portion of its investments. As of June 30, 2001 and December 31, 2000, the
Company had entered into repurchase agreements in the amount of $16,098,000 and
$14,100,000, respectively. The maturity of the agreements as of June 30, 2001
was 31 days and the weighted average interest rate was 4.39%, based on one-month
LIBOR plus a weighted average spread of 0.52%. The maturity of the agreements as
of December 31, 2000 was 29 days and the weighted average interest rate was
7.40%, based on one-month LIBOR plus a weighted average spread of 0.84%. The
repurchase agreements are collateralized by certain of the Company's portfolio
of CMBS investments, with an aggregate carrying value of approximately $24.3
million at June 30, 2001, including one asset which was sold on June 28, 2001
and settled on July 3, 2001. The proceeds of the sale are included in trade
receivable on the balance sheet and were used to reduce the related repurchase
agreement.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company was organized in February 1998 to invest in commercial
mortgage-backed securities (primarily subordinate securities), commercial
mortgage loans, mezzanine investments, equity investments, and other real estate
related investments. The Company is currently in the process of liquidation.
The following discussion of the Company's financial condition, results of
operations, and capital resources and liquidity should be read in conjunction
with the Company's financial statements and related notes.
MARKET CONDITIONS:
Spreads on investment grade CMBS decreased by approximately 20 basis points,
while spreads on CMBS rated BB remained unchanged and spreads for CMBS rated B
increased by 125 basis points. The price of a fixed income security (such as a
CMBS) or a commercial loan is often determined by adding an interest rate spread
to a benchmark interest rate, such as the U.S. Treasury rate. As the spread on a
security increases (decreases), the value of the security decreases (increases).
The ten-year U.S Treasury rate increased approximately 0.50% for the three
months ended June 30, 2001. This compares to an increase 0.01% in the three
months ended June 30, 2000. In the same way that a change in spread for CMBS
causes its value to change, changing interest rates also causes its value to
change. In order to offset the potential change in CMBS value due to changing
interest rates, the Company "sells short" U.S. Treasury securities or
11
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enters into Treasury yield lock contracts. In the three months ended June 30,
2001 and 2000, the Company's hedging activities effectively offset the change in
value of the Company's CMBS positions due to the change in interest rates.
RESULTS OF OPERATIONS
General:
Net loss for the three months and six months ending June 30, 2001 amounted to
$1,560,316 or $0.38 per share, basic and diluted, and $637,671 or $0.16 per
share, basic and diluted, respectively. The net loss for the three months ending
June 30, 2001 was attributable primarily to income from investments of $1.6
million. This was offset by net realized and unrealized losses from
securities-trading of $1.4 million, interest expense of $0.2 million, other
expenses of $0.4 million and the accrual of estimated costs to be incurred
during the liquidation period of $1.1 million. The net income for the six months
ending June 30, 2001 was attributable primarily to income from investments of
$3.2 million and was offset by interest expense of $0.6 million, other expenses
of $0.9 million, estimated liquidation costs of $1.1 million and a $1.3 million
loss (realized and unrealized) from securities-trading.
Net income for the three months and six months ending June 30, 2000 amounted to
$193,973 or $0.05 per share, basic and diluted, and $1,883,936 or $0.46 per
share, basic and diluted, respectively. The net income for the three months
ending June 30, 2000 was attributable primarily to income from investments of
$2.5 million. This was offset by interest expense of $1.0 million, net loss
(realized and unrealized) from securities-trading of $0.8 million and other
expenses of $0.5 million. The net income for the six months ending June 30, 2000
was attributable primarily to income from investments of $5.5 million and was
offset by interest expense of $2.4 million, other expenses of $0.8 million, and
a $0.4 million loss (realized and unrealized) from securities-trading.
Investment Income:
For the three months and six months ending June 30, 2001 and for the three
months and six months ending June 30, 2000, the Company earned income from
investments, as follows:
<Table>
<Caption>
Three Months Six Months Three Months Six Months
Ending Ending Ending Ending
Investment June 30, 2001 June 30, 2001 June 30, 2000 June 30, 2000
- -------------------------------------------------------------------------------------------------------------------------------
CMBS $ 1,438,492 $ 2,747,847 $ 1,949,833 $ 4,431,480
Deposits with brokers as collateral
for securities sold short - 200,080 390,637 715,790
Mezzanine investment 128,521 255,804 90,898 225,301
Cash and cash equivalents 4,885 10,541 71,945 79,279
------------------------------------------------------------------------------------
TOTAL $ 1,571,898 $ 3,214,272 $ 2,503,313 $ 5,451,850
====================================================================================
</Table>
Interest Expense:
For the three months and six months ending June 30, 2001, the Company incurred
interest expense of $215,562 and $377,446, respectively from repurchase
agreements and $0 and $197,386 from government securities sold short,
respectively.
As of June 30, 2001 and December 31, 2000, the Company had entered into
repurchase agreements in the amount of $16,098,000 and $14,100,000,
respectively. The weighted average interest rates were 4.39% and 7.40%,
respectively, and are based on a variable rate, one-month LIBOR plus a weighted
average spread of 0.52% and 0.84%, respectively. All of the Company's repurchase
agreements are with Bear Stearns.
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During the first quarter of 2001, the Company closed all short positions in U.S.
Treasury securities. The Company utilized a Treasury yield lock contract to
hedge certain assets in its CMBS portfolio. The Treasury yield lock open at June
30, 2001 has a notional amount of $31,953,000, is referenced to the U.S.
Treasury 5.50%, 05/15/09, and matures on August 20, 2001. The fair value of this
contract at June 30, 2001 was $128,238 which is included in "accrued interest
receivable and other assets" on the balance sheet.
On July 31, 2001, the Company closed the Treasury yield lock and realized a loss
of approximately $655,000. This loss resulted from a decrease in the yield on
the related US Treasury during July of approximately 0.42% and corresponded to
an increase in the Company's CMBS investments. On July 31, 2001 the Company
opened contracts to sell U.S. Treasury securities (short sales) as a means of
hedging its interest rate risk.
As of December 31, 2000, the Company had the following open short positions in
U.S. Treasury securities: $2,263,000 (face) of U.S. Treasury 5.25%, 02/15/2029
and $25,516,000 (face) of U.S. Treasury 5.50%, 05/15/2009.
Other Expenses:
In accordance with the terms of the management agreement and the management
agreement as amended by the liquidation plan, the Company paid $125,748 and
$255,171 in management fees for the three months and six months ended June 30,
2001, respectively. In addition, the Company has accrued $640,000 in management
fees into the reserve for estimated costs during liquidation. The Company
incurred $127,617 and $256,481 in management fees for the three months and six
months ended June 30, 2000, respectively. The Company has not accrued for, or
paid, the Manager any incentive compensation since inception.
Other Operating Gains & Losses
For the three months and six months ending June 30, 2001, the Company recorded
realized and unrealized losses of $1,353,764 and $1,288,251, respectively, on
its securities portfolio. For the three months and six months ending June 30,
2000, the Company recognized losses of $759,666 and $395,502 respectively, on
its securities portfolio.
In the three months ending June 30, 2001 the Company sold one of its CMBS
investments for total proceeds of $5,765,388. This transaction resulted in a
realized loss of $11,722.
CHANGES IN FINANCIAL CONDITION
General: Total assets as of June 30, 2001, amounted to $54.1 million and were
comprised primarily of $43.9 million of CMBS, a mezzanine investment of $3.6
million and a trade receivable of $5.8 million. Total liabilities of the Company
as of June 30, 2001 amounted to $17.6 million and were comprised primarily of
repurchase agreements in the amount of $16.1 million and a reserve for estimated
costs during liquidation period of $1.1 million.
CAPITAL RESOURCES AND LIQUIDITY:
Liquidity is a measurement of the Company's ability to meet its potential cash
requirements during the liquidation period including ongoing commitments to
repay borrowings and other general business purposes. The Company's primary
sources of funds for liquidity consist of repurchase agreements and maturities
and principal payments on securities and loans, and proceeds from sales thereof.
The Company believes that its cash on hand, earnings from its assets and
proceeds from sales will be adequate to support the Company and pay its
obligations during the liquidation period.
The Company's operating activities used cash of $1.3 million during the six
months ending June 30, 2001. This was due primarily to the Company's trading and
hedging activities. This compares with the Company's operating activities during
the six months ending June 30, 2000, which generated cash flows of $38.1
million. This was due primarily to an excess of interest income on investments
over financing costs of approximately $2.3 million and net proceeds from
purchasing and selling commercial mortgage backed securities of $36.5 million,
which was used primarily to reduce outstanding debt.
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The Company's investing activities provided cash of $0.3 million during the six
months ending June 30, 2001, due primarily to the sale of the Company's
investment in the Manager.
The Company's financing activities generated cash of $0.4 million during the six
months ending June 30, 2001, due primarily to proceeds from borrowings on
repurchase agreements of $2.0 million and offset by distributions to
shareholders of $1.6 million. The Company's financing activities used cash of
$38.1 million during the six months ending June 30, 2000, due primarily to
payments made on repurchase agreements of $33.9 million, purchases of treasury
stock of $2.5 million and distributions to shareholders of $1.7 million.
On October 12, 2000, the Company's Board of Directors unanimously voted to
recommend that a plan of liquidation and dissolution be submitted to its
stockholders. After reviewing the Company's strategic alternatives, the Board
concluded that the liquidation of the Company was the best available alternative
for maximizing stockholder value and, accordingly, was in the best interest of
the Company and its stockholders. On March 6, 2001, the Company's Board of
Directors approved a specific plan of liquidation and dissolution and determined
to submit the plan to the Company's stockholders for their consideration. On May
31, 2001, the Company's stockholders approved the liquidation agreement pursuant
to which the Company's existing management agreement with Clarion Capital, LLC
would be amended to provide that Clarion Capital, LLC, the existing manager of
the Company's assets, will manage the liquidation of the Company.
The Company has begun the process of liquidating its assets, pursuant to the
plan of liquidation. Three CMBS assets were sold in June and July for proceeds
totaling approximately $22.5 million. The proceeds were used to pay off the
repurchase agreements, with the excess available for liquidating distributions
to the stockholders. The timing and amount of any distributions depends upon a
variety of factors, some of which are not under the Company's control. Although
the Company considers its assumptions and estimates of the values and timing of
the liquidation to be reasonable, there can be no assurance that the values
ultimately realized, the timing of such sales and the costs actually incurred
during liquidation will not be materially different from the Company's estimate.
Except as discussed herein, management is not aware of any other trends, events,
commitments or uncertainties that may have a significant effect on liquidity.
STOCKHOLDERS' EQUITY/NET ASSETS IN LIQUIDATION
Net assets in liquidation as of June 30, 2001 was $36.6 million. In the six
months ending June 30, 2001, stockholders' equity/net assets in liquidation
decreased by $1.4 million. This decrease was due to the net loss from operations
of $0.6 million and by the payment of $0.8 million in distributions.
SUBSEQUENT EVENT: SALE OF SECURITIES
On July 30, 2001, the Company sold two of its CMBS assets to an unaffiliated
broker-dealer for total proceeds of $16.7 million. The sale was an arms
length transaction following the solicitation of bids from several dealers in
such securities.
FORWARD-LOOKING STATEMENTS:
Certain statements contained herein are not, and certain statements contained in
future filings by the Company with the SEC, in the Company's press releases or
in the Company's other public or shareholder communications may not be, based on
historical facts and are "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Forward-looking statements
which are based on various assumptions (some of which are beyond the Company's
control), may be identified by reference to a future period or periods, or by
the use of forward-looking terminology, such as "may," "will," "believe,"
"expect," "anticipate," "continue," or similar terms or variations on those
terms, or the negative of those terms. Actual results could differ materially
from those set forth in forward-looking statements due to a variety of factors,
including, but not limited to, those related to the economic environment,
particularly in the market areas in which the Company operates, competitive
products and pricing, fiscal and monetary policies of the U.S. Government,
changes in prevailing interest rates, acquisitions and the integration of
acquired businesses, credit risk management, asset/liability management, the
financial and securities markets and the availability of and costs associated
with sources of liquidity. The Company does not undertake, and specifically
disclaims any obligation, to publicly release the result of any revisions, which
may be made to any
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forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the exposure to loss resulting from changes in interest rates,
lending environments, changes in spreads on CMBS, real estate cash flows and
values, foreign currency exchange rates, commodity prices and equity prices. The
primary market risks to which the investments of the Company are exposed are
lending environments, interest rate risk, real estate cash flows and CMBS spread
risk, which are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and political
considerations and other factors beyond the control of the Company. Changes in
the general level of interest rates can also affect the net interest income of
the Company.
The Company is further exposed to interest rate risk through its short term
financing through repurchase agreements at rates that are based on 30-day LIBOR.
The repurchase agreements into which the Company has entered are for terms of
less than, or equal to 30 days. Changes in interest rates may increase the
Company's cost of financing its investments.
Furthermore, if the Company were unable to replace its short term financing, it
may be forced to sell its assets in order to pay down its repurchase agreements
at a time when the market for the sale of such assets is unfavorable. If this
were to occur, the Company could realize substantial losses.
The investments of the Company are also exposed to spread risk. The price of a
fixed income security is generally determined by adding an interest rate spread
to a benchmark interest rate, such as the U.S. Treasury rate. As the spread on a
security widens (or increases), the price (or value) of the security falls. As
spreads on CMBS widen, the fair value of the Company's portfolio falls. Spread
widening in the market for CMBS can occur as a result of market concerns over
the stability of the commercial real estate market, excess supply of CMBS, or
general credit or liquidity concerns in CMBS markets or other markets.
The Company enters into contracts to sell securities that it does not own at the
time of the sale, at a specified price at a specified time (short sales). The
Company also utilizes Treasury yield locks. A Treasury yield lock is a contract
to sell short a specific Treasury and buy it back on a specified date sometime
in the future. The Company utilizes these contracts as a means of mitigating
("hedging") the potential financial statement impact of changes in the fair
value of its portfolio of CMBS due to changes in interest rates. As the value of
the Company's CMBS declines (increases) with increases (decreases) in interest
rates, the value of the contracts increases (decreases). There can be no
guarantee, however, that the change in value of the contract will completely
offset the change in value of the fixed-rate interest-earning asset. Risks in
these contracts arise from the possible inability of counterparties to meet the
terms of their contracts and from movements in securities values and interest
rates. Furthermore, if the market value of the securities involved in the short
sale increases, the Company may be required to meet a "margin call".
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
At June 30, 2001 there were no legal proceedings to which the Company was a
party or of which any of its property was subject.
Item 2. Changes in Securities and Use of Proceeds
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CLARION COMMERCIAL HOLDINGS, INC,
Dated: August 13, 2001 By: /s/ Fredrick D. Arenstein
-------------------------------------------
Name: Fredrick D. Arenstein
Title: Treasurer
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