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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 1998
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Commission File Number 0-10503
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CONTINENTAL MORTGAGE AND EQUITY TRUST
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(Exact Name of Registrant as Specified in Its Charter)
California 94-2738844
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
10670 North Central Expressway, Suite 300, Dallas, TX 75231
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(Address of Principal Executive Offices) (Zip Code)
(214) 692-4700
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(Registrant's Telephone Number,
Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Shares of Beneficial Interest,
no par value 4,017,150
- ------------------------------ ---------------------------------
(Class) (Outstanding at October 30, 1998)
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements have not been audited by
independent certified public accountants, but in the opinion of the management
of Continental Mortgage and Equity Trust (the "Trust"), all adjustments
(consisting of normal recurring accruals) necessary for a fair presentation of
consolidated results of operations, consolidated financial position and
consolidated cash flows at the dates and for the periods indicated, have been
included.
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
1998 1997
------------ ------------
(dollars in thousands)
Assets
Notes and interest receivable
Performing ....................................... $ 2,642 $ 2,853
Nonperforming, nonaccruing ....................... 2,257 2,257
------------ ------------
4,899 5,110
Less - allowance for estimated losses ............... (1,456) (1,481)
------------ ------------
3,443 3,629
Foreclosed real estate held for sale, net of
accumulated depreciation ($699 in 1998 and $725
in 1997) ......................................... 5,022 5,670
Real estate under contract for sale, net of
accumulated depreciation ($3,024 in 1997) ........ -- 5,940
Real estate held for investment, net of accumulated
depreciation ($23,567 in 1998 and $19,393 in 1997) 288,814 250,084
Investment in marketable equity securities of
affiliates, at market ............................ 13,571 13,042
Cash and cash equivalents ........................... 4,397 3,088
Other assets (including $535 in 1998 and $791 in
1997 from affiliates) ............................ 15,778 17,917
------------ ------------
$ 331,025 $ 299,370
============ ============
The accompanying notes are an integral part of these Consolidated Financial
Statements.
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CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED BALANCE SHEETS - Continued
September 30, December 31,
1998 1997
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(dollars in thousands)
Liabilities and Shareholders' Equity
------------------------------------
Liabilities
Notes and interest payable ................................. $ 234,744 $ 199,712
Other liabilities (including $2,381 in 1997 to
affiliates) ............................................. 8,966 11,615
------------ ------------
243,710 211,327
Commitments and contingencies
Shareholders' equity
Shares of Beneficial Interest, no par value;
authorized shares, unlimited; issued and out-
standing, 4,017,150 shares in 1998 and 4,021,470
shares in 1997 .......................................... 8,045 8,054
Paid-in capital ............................................ 257,042 257,101
Accumulated distributions in excess of accumulated
earnings ................................................ (189,986) (188,849)
Net unrealized gains on marketable equity
securities of affiliates ................................ 12,214 11,737
------------ ------------
87,315 88,043
------------ ------------
$ 331,025 $ 299,370
============ ============
The accompanying notes are an integral part of these Consolidated Financial
Statements.
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CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------- -------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(dollars in thousands, except per share)
Revenue
Rentals .................... $ 16,539 $ 14,425 $ 47,287 $ 40,630
Interest ................... 168 263 539 729
---------- ---------- ---------- ----------
16,707 14,688 47,826 41,359
Expenses
Property operations ........ 9,987 8,445 27,421 23,576
Interest ................... 5,992 4,350 16,149 12,245
Depreciation ............... 2,005 1,586 6,074 4,563
Advisory fee to affiliate .. 632 548 1,838 1,552
Net income fee to affiliate (140) (99) 58 287
General and administrative . 504 817 1,648 2,219
---------- ---------- ---------- ----------
18,984 15,647 53,183 44,442
---------- ---------- ---------- ----------
(Loss) from operations ........ (2,273) (959) (5,357) (3,083)
Equity in income (loss) of
partnerships ............... 38 (17) 108 56
Gain (loss) on sale of real
estate ..................... 454 (245) 5,916 6,565
---------- ---------- ---------- ----------
Net income (loss) ............. $ (1,781) $ (1,221) $ 667 $ 3,538
========== ========== ========== ==========
Earnings per share
Net income (loss) .......... $ (.44) $ (.30) $ .17 $ .88
========== ========== ========== ==========
Weighted average shares of
beneficial interest used in
computing earnings per share 4,012,507 4,025,985 4,011,072 4,026,061
========== ========== ========== ==========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
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CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated
Distributions Accumulated
Shares of in Excess of Other
Beneficial Interest Paid-in Accumulated Comprehensive Shareholders'
Shares Amount Capital Earnings Income Equity
--------- ---------- ---------- ---------- ---------- ----------
(dollars in thousands, except per share)
Balance, January 1,
1998 ................ 4,021,470 $ 8,054 $ 257,101 $ (188,849) $ 11,737 $ 88,043
Comprehensive Income
Net income .......... -- -- -- 667 -- 667
Unrealized gains on
marketable equity
securities ....... -- -- -- -- 477 477
---------
1,144
Repurchase of shares of
beneficial interest . (15,000) (30) (210) -- -- (240)
Shares of beneficial
interest sold under
dividend reinvestment
plan ................ 10,902 21 151 -- -- 172
Fractional shares ...... (222) -- -- -- -- --
Distributions ($.45
per share) .......... -- -- -- (1,804) -- (1,804)
--------- ---------- ---------- ---------- ---------- ----------
Balance, September 30,
1998 ................ 4,017,150 $ 8,045 $ 257,042 $ (189,986) $ 12,214 $ 87,315
========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
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CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months
Ended September 30,
-----------------------------
1998 1997
------------ ------------
(dollars in thousands)
Cash Flows from Operating Activities
Rents collected ................................. $ 47,246 $ 40,397
Interest collected .............................. 384 784
Interest paid ................................... (14,773) (11,343)
Payments for property operations ................ (28,070) (21,533)
General and administrative expenses paid ........ (2,107) (2,640)
Advisory and net income fee paid to affiliate ... (2,146) (2,986)
Distributions from partnerships' operating cash
flow ......................................... 80 228
Other ........................................... (1,351) (564)
------------ ------------
Net cash (used in) provided by operating
activities ............................... (737) 2,343
Cash Flows from Investing Activities
Acquisition of real estate ...................... (46,917) (19,579)
Real estate improvements ........................ (4,345) (3,759)
Proceeds from sale of real estate ............... 22,156 14,388
Sale of notes receivable ........................ 304 --
Funding of notes receivable ..................... -- (73)
Collections on notes receivable ................. 375 2,339
Distributions from partnerships' investing
activities ................................... -- 36
Deposits on pending acquisitions and financings . (77) (898)
Deferred financing costs ........................ (2,147) (525)
Deposits on proposed merger ..................... (440) --
------------ ------------
Net cash (used in) investing activities ...... (31,091) (8,071)
Cash Flows from Financing Activities
Distributions to shareholders ................... (1,804) (1,570)
Proceeds from notes payable and margin borrowings 62,844 28,105
Payments on notes payable ....................... (27,835) (23,850)
Repurchase of shares of beneficial interest ..... (240) --
Shares of beneficial interest sold under dividend
reinvestment plan ............................ 172 --
------------ ------------
Net cash provided by financing activities .... 33,137 3,685
------------ ------------
Net increase (decrease) in cash and cash
equivalents ..................................... 1,309 (2,043)
Cash and cash equivalents, beginning of period ..... 3,088 2,961
------------ ------------
Cash and cash equivalents, end of period ........... $ 4,397 $ 918
============ ============
The accompanying notes are an integral part of these Consolidated Financial
Statements.
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CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
For the Nine Months
Ended September 30,
-------------------------
1998 1997
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(dollars in thousands)
Reconciliation of net income to net cash
provided by operating activities
Net income ......................................... $ 667 $ 3,538
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation .................................... 6,074 4,563
Gain on sale of real estate ..................... (5,916) (6,565)
(Increase) decrease in interest receivable ...... (82) 208
Decrease in other assets ........................ 1,918 403
Increase (decrease) in other liabilities ........ (3,402) 24
Increase in interest payable .................... 32 --
Distributions from partnerships' operating cash
flow ......................................... 80 228
Equity in (income) of partnerships .............. (108) (56)
---------- ----------
Net cash (used in) provided by operating
activities ............................... $ (737) $ 2,343
========== ==========
Noncash investing and financing activities
Notes payable from acquisition of real estate ... $ -- $ 8,056
Unrealized gain on marketable equity securities . 477 6,010
Note receivable from sale of real estate ........ 467 --
The accompanying notes are an integral part of these Consolidated Financial
Statements.
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CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying Consolidated Financial Statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. Operating results for the nine month period ended September 30, 1998
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1998. Dollar amounts in tables are in thousands. For further
information, refer to the Consolidated Financial Statements and Notes thereto
included in the Trust's Annual Report on Form 10-K for the year ended December
31, 1997 ("1997 Form 10-K").
Certain balances for 1997 have been reclassified to conform to the 1998
presentation.
NOTE 2. MORTGAGE NOTES RECEIVABLE
As more fully discussed in NOTE 4. "NOTES PAYABLE," seven of the Trust's
mortgage notes receivable, with a combined principal balance of $1.4 million at
December 31, 1997, were pledged as additional collateral on a $2.3 million loan,
primarily secured by the AMOCO Office Building in New Orleans, Louisiana. In
March 1998, the loan was refinanced and the collateral notes were released.
In April 1998, the Trust sold five mortgage notes secured by single-family
residences located in Arizona and Hawaii for $319,000 in cash. The Trust
received net cash of $304,000 after the payment of various closing costs. The
Trust recognized no gain or loss on the sale.
NOTE 3. REAL ESTATE
In January 1998, the Trust completed the sale of the 353 unit Edgewood
Apartments in Lansing, Illinois, that was under contract for sale at December
31, 1997. The apartment complex was sold for $12.1 million in cash, with the
Trust receiving net cash of $2.3 million after paying off $9.3 million in
mortgage debt and the payment of various closing costs. The Trust paid a real
estate brokerage commission of $302,000 to Carmel Realty, Inc. ("Carmel
Realty"), an affiliate of Basic Capital Management, Inc. ("BCM"), the Trust's
advisor. The Trust recognized a gain of $5.6 million on the sale.
Also in January 1998, the Trust purchased the McKinney 36 land, 36.4 acres of
undeveloped land in Collin County, Texas, for $2.1 million in cash. The Trust
paid a real estate brokerage commission of $82,000 to Carmel Realty and a
property acquisition fee of $21,000 to BCM.
In March 1998, the Trust purchased the 1010 Common Building, a 494,579
sq. ft. office building in New Orleans, Louisiana, for $14.5 million.
The building was acquired subject to ground leases that expire from
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CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 3. REAL ESTATE (Continued)
November 2029 to April 2069. The Trust paid $6.3 million in cash and obtained
new mortgage financing of $8.2 million. The lender has committed to fund an
additional $3.8 million for tenant improvements. The mortgage bears interest at
9.7% per annum, requires monthly payments of interest only and matures in April
2001. The Trust paid a real estate brokerage commission of $337,500 to Carmel
Realty and a property acquisition fee of $145,000 to BCM. In April 1998, the
Trust purchased four of the ground leases for $200,000 in cash.
Also in March 1998, the Trust purchased the 225 Baronne Building, a 416,834 sq.
ft. office building in New Orleans, Louisiana, for $11.2 million. The Trust paid
$3.8 million in cash and obtained new mortgage financing of $7.4 million. The
lender has committed to fund an additional $1.6 million for tenant improvements.
The mortgage bears interest at 9.7% per annum, requires monthly payments of
interest only and matures in April 2001. The Trust paid a real estate brokerage
commission of $288,000 to Carmel Realty and a property acquisition fee of
$112,000 to BCM.
Further in March 1998, the Trust sold 4050 Getwell, a 112,382 sq. ft. industrial
warehouse in Memphis, Tennessee, for $2.1 million in cash. The Trust received
net cash of $1.2 million after paying off $793,000 in mortgage debt and the
payment of various closing costs. The Trust paid a real estate brokerage
commission of $81,500 to Carmel Realty. The Trust recognized no gain or loss on
the sale.
In April 1998, the Trust purchased the 338 unit Fontenelle Hills Apartments in
Bellevue, Nebraska, for $12.8 million. The Trust paid $2.0 million in cash and
obtained new mortgage financing of $10.8 million. The mortgage bears interest at
7.16% per annum, requires monthly payments of principal and interest of $73,017
and matures in May 2008. The Trust paid a real estate brokerage commission of
$311,000 to Carmel Realty and a property acquisition fee of $128,000 to BCM.
Also in April 1998, the Trust purchased the Whisenant land, 16.802 acres of
undeveloped land in Collin County, Texas, for $600,000 in cash. The Trust paid a
real estate brokerage commission of $24,000 to Carmel Realty and an acquisition
fee of $6,000 to BCM.
In May 1998, the Trust sold the Pinemont Professional Building, a 19,685 sq. ft.
office building in Houston, Texas, for $570,000. The Trust received net cash of
$57,000 and provided $467,000 of seller financing in the form of a wraparound
mortgage note. The note bears interest at 10.4% per annum, requires monthly
payments of principal and interest of $6,281 and matures in July 2008. The Trust
recognized a loss of $154,000 on the sale.
In July 1998, the Trust purchased the Solco Allen land, 55.725 acres of
undeveloped land in Collin County, Texas, for $1.3 million in cash. The
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CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 3. REAL ESTATE (Continued)
Trust paid a real estate brokerage commission of $53,000 to Carmel Realty and an
acquisition fee of $13,000 to BCM.
Also in July 1998, the Trust purchased the Sandison land, 100.171 acres of
undeveloped land in Collin County, Texas, for $4.7 million in cash. The Trust
paid a real estate brokerage commission of $95,000 to Carmel Realty and an
acquisition fee of $47,000 to BCM.
In August 1998, the Trust purchased the 1013 Common land, 18,000 sq. ft. of
developed land in New Orleans, Louisiana, for $582,000 in cash. The Trust paid a
real estate brokerage commission of $23,000 to Carmel Realty and an acquisition
fee of $6,000 to BCM.
In September 1998, the Trust sold the 113,638 sq. ft. Rio Pinar Shopping Center
in Orlando, Florida, for $8.8 million in cash. The Trust received $3.1 million
in cash after paying off $5.1 million in mortgage debt and the payment of
various closing costs. The Trust paid a real estate brokerage commission of
$246,000 to Carmel Realty. The Trust recognized a gain of $478,000 on the sale.
During 1998, the Trust expended $636,000 to rebuild an industrial warehouse in
Atlanta, Georgia that had been destroyed by fire in 1996. Construction was
completed in the third quarter of 1998.
NOTE 4. NOTES PAYABLE
In January 1998, the Trust refinanced the mortgage debt secured by the Promenade
Shopping Center in Highlands Ranch, Colorado in the amount of $7.7 million. The
Trust received net cash of $2.1 million after paying off $5.4 million in
existing mortgage debt, the funding of required escrows and the payment of
various closing costs. The new mortgage bears interest at 7.42% per annum,
requires monthly payments of principal and interest of $56,502 and matures in
January 2008. The Trust paid a mortgage brokerage and equity refinancing fee of
$77,000 to BCM.
In March 1998, the Trust refinanced the mortgage debt in the amount of $15.0
million secured by the AMOCO Office Building in New Orleans, Louisiana, and by
seven mortgage notes receivable. The Trust received net cash of $10.9 million
after paying off $3.8 million in existing mortgage debt and the payment of
various closing costs associated with the financing. The lender has committed to
fund an additional $1.0 million in tenant improvements. The new mortgage bears
interest at 8.7% per annum, requires monthly payments of interest only and
matures in April 2001. The Trust paid a mortgage brokerage and equity
refinancing fee of $150,000 to BCM.
The mortgage debt secured by the AMOCO, 1010 Common and 225 Baronne Office
Buildings in New Orleans, Louisiana are cross-collateralized and cross
defaulted. Both the Trust and BCM have guaranteed repayment of
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CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 4. NOTES PAYABLE (Continued)
the debt. Also, the Trust has committed to borrow an additional $163.0 million
during the period ending March 2000 from the lender. In exchange for this
commitment, the lender may record a second lien mortgage on the office buildings
of up to $2.0 million. $1.0 million of this lien will be released upon the
lender funding an additional $63.0 million in new loans to the Trust or BCM
affiliated entities, with the remaining $1.0 million released pro rata as the
remaining $100.0 million in new loans is funded. At September 30, 1998, $156.2
million of the borrowing commitment remained to be satisfied.
Also in March 1998, the Trust refinanced the mortgage debt secured by the
McCallum Crossing Apartments in Dallas, Texas in the amount of $8.4 million. The
Trust received net cash of $1.8 million after paying off $6.3 million in
existing mortgage debt and the payment of various closing costs. The new
mortgage bears interest at 7.19% per annum, requires monthly payments of
principal and interest of $56,961 and matures in April 2008. The Trust paid a
mortgage brokerage and equity refinancing fee of $84,000 to BCM.
In April 1998, the Trust obtained mortgage financing secured by its unencumbered
McKinney 36 land in Collin County, Texas in the amount of $2.1 million. The
Trust received net cash of $2.0 million after the payment of various closing
costs. The new mortgage bears interest at 9.25% per annum, requires monthly
payments of interest only and matures in April 2000. The Trust paid a mortgage
brokerage and equity refinancing fee of $21,000 to BCM.
In May 1998, the Trust refinanced the mortgage debt secured by the Willow Wick
Apartments in North Augusta, South Carolina in the amount of $2.1 million. The
Trust received net cash of $1.1 million after paying off $854,000 in existing
mortgage debt and the payment of various closing costs. The new mortgage bears
interest at 7.205% per annum, requires monthly payments of principal and
interest of $13,990 and matures in June 2008. The Trust paid a mortgage
brokerage and equity refinancing fee of $21,000 to BCM.
In July 1998, concurrent with the purchases of the Solco Allen and Whisenant
land, as discussed in NOTE 3. "REAL ESTATE," the Trust obtained mortgage
financing in the amount of $5.2 million secured by the Solco Allen, Sandison and
the Whisenant land, all in Collin County, Texas. The mortgage bears interest at
9.25% per annum, requires monthly payments of interest only and matures in April
2000.
NOTE 5. COMMITMENTS AND CONTINGENCIES
The Trust is involved in various lawsuits arising in the ordinary course of
business. Management of the Trust is of the opinion that the outcome of these
lawsuits would have no material impact on the Trust's financial condition,
results of operations or liquidity.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Introduction
Continental Mortgage and Equity Trust (the "Trust") was formed to invest in real
estate through acquisitions, leases and partnerships and in mortgage loans on
real estate, including first, wraparound and junior mortgage loans. The Trust
was organized on August 27, 1980 and commenced operations on December 3, 1980.
Liquidity and Capital Resources
Cash and cash equivalents aggregated $4.4 million at September 30, 1998,
compared with $3.1 million at December 31, 1997. The principal reasons for the
increase in cash are discussed in the paragraphs below.
The Trust's principal sources of cash have been and will continue to be property
operations, proceeds from property sales, principal payments on mortgage notes
receivable and borrowings. The Trust expects the net cash provided by its
operations and from external sources, such as property sales, financings and
refinancings, will be sufficient to meet the Trust's various cash needs,
including, but not limited to, debt service obligations, shareholder
distributions and property maintenance and improvements.
The Trust's cash flow from property operations (rents collected less payments
for expenses applicable to rental income) increased from $18.9 million in the
first nine months of 1997 to $19.4 million in the first nine months of 1998. Of
this net increase, $1.1 million is the result of the Trust having acquired five
apartment complexes and six commercial properties during 1997 and 1998 and an
additional $1.7 million due to increased rental and occupancy rates primarily at
the Trust's commercial properties. These increases were partially offset by a
decrease of $2.1 million due to the sale of four commercial properties in 1997
and one apartment complex and three commercial properties in 1998. The Trust's
management believes that the Trust's cash flow from property operations will
continue to increase as the Trust continues to benefit from the properties
acquired in the last three months of 1997 and first nine months of 1998.
In January 1998, the Trust sold the 353 unit Edgewood Apartments in Lansing,
Illinois, for $12.1 million in cash. The Trust received net cash of $2.3 million
after paying off the then existing mortgage debt and the payment of various
closing costs.
Also in January 1998, the Trust refinanced the mortgage debt secured by the
Promenade Shopping Center in Highlands Ranch, Colorado in the amount of $7.7
million. The Trust received net cash of $2.1 million after paying off the then
existing mortgage debt.
Further in January 1998, the Trust purchased the McKinney 36 land, 36.4 acres of
undeveloped land in Collin County, Texas, for $2.1 million in
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
cash. In April 1998, the Trust obtained mortgage financing secured by such land
in the amount of $2.1 million. The Trust received net cash from the financing of
$2.0 million.
In March 1998, the Trust purchased the 494,579 sq. ft. 1010 Common
Office Building in New Orleans, Louisiana, for $14.5 million consisting
of $6.3 million in cash and mortgage financing of $8.2 million.
Also in March 1998, the Trust purchased the 416,834 sq. ft. 225 Baronne
Office Building in New Orleans, Louisiana, for $11.2 million consisting
of $3.8 million in cash and mortgage financing of $7.4 million.
In March 1998, the Trust refinanced the mortgage debt in the amount of $15.0
million secured by the AMOCO Office Building in New Orleans, Louisiana, and by
seven mortgage notes receivable. The Trust received net cash of $10.9 million
after paying off the then existing mortgage debt.
The mortgage debt secured by the above three New Orleans Office Buildings is
cross-collateralized and cross defaulted. Both the Trust and Basic Capital
Management, Inc. ("BCM"), the Trust's advisor, have guaranteed repayment of the
debt. The Trust committed to borrow an additional $163.0 million from the lender
during the period ending March 2000, of which $156.2 million of the borrowing
commitment at September 30, 1998, remained to be satisfied. In exchange for this
commitment, the lender may record a second lien mortgage on the New Orleans
office buildings of up to $2.0 million. $1.0 million of this lien will be
released upon the lender funding an additional $63.0 million in new loans to the
Trust or BCM affiliated entities, with the remaining $1.0 million released pro
rata as the remaining $100.0 million in new loans is funded.
Also in March 1998, the Trust sold the 112,382 sq. ft. 4050 Getwell Industrial
Warehouse in Memphis, Tennessee, for $2.1 million in cash. The Trust received
net cash of $1.2 million after paying off the then existing mortgage debt and
the payment of various closing costs.
Further in March 1998, the Trust refinanced the mortgage debt secured by the
McCallum Crossing Apartments in Dallas, Texas, in the amount of $8.4 million.
The Trust received net cash of $1.8 million after paying off the then existing
mortgage debt.
In April 1998, the Trust purchased the 338 unit Fontenelle Hills Apartments in
Bellevue, Nebraska, for $12.8 million, consisting of $2.0 million in cash and
mortgage financing of $10.8 million.
Also in April 1998, the Trust purchased the Whisenant land, 16.802 acres of
undeveloped land in Collin County, Texas, for $600,000 in cash.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
In May 1998, the Trust refinanced the mortgage debt secured by the Willow Wick
Apartments in North Augusta, South Carolina in the amount of $2.1 million. The
Trust received net cash of $1.1 million after paying off the then existing
mortgage debt.
In July 1998, the Trust purchased the Solco Allen land, 55.725 acres of
undeveloped land in Collin County, Texas, for $1.3 million in cash.
Also in July 1998, the Trust purchased the Sandison land, 100.171 acres of
undeveloped land in Collin County, Texas, for $4.7 million in cash.
Subsequent to these purchases, the Trust obtained mortgage financing in the
amount of $5.2 million secured by the Solco Allen, Sandison and Whisenant land,
all in Collin County, Texas. The Trust received net cash of $4.9 million after
the payment of closing costs.
In August 1998, the Trust purchased the 1013 Common land, 18,000 sq. ft.
of developed land in New Orleans, Louisiana, for $582,000 in cash.
In September 1998, the Trust sold the 113,638 sq. ft. Rio Pinar Shopping Center
in Orlando, Florida, for $8.8 million in cash. The Trust received $3.1 million
in cash after paying off the existing mortgage debt and the payment of various
closing costs.
In December 1989, the Trust's Board of Trustees authorized the Trust to
repurchase a total of 1,465,000 of its shares of beneficial interest. The Trust
completed the authorized repurchases during the first quarter of 1998. The Trust
repurchased such shares at a total cost to the Trust of $7.8 million. In April
1998, the Trust's Board of Trustees authorized the Trust to repurchase an
additional 200,000 of its shares of beneficial interest. No shares have been
repurchased under this authorization.
In the first nine months of 1998, the Trust paid quarterly distributions of $.45
per share or a total of $1.8 million and sold 10,902 shares of beneficial
interest through its dividend reinvestment plan for a total of $172,000.
Management reviews the carrying values of the Trust's properties and mortgage
notes receivable at least annually and whenever events or a change in
circumstances indicate that impairment may exist. Impairment is considered to
exist if, in the case of a property, the future cash flow from the property
(undiscounted and without interest) is less than the carrying amount of the
property. For notes receivable, impairment is considered to exist if it is
probable that all amounts due under the terms of the note will not be
collected. In those instances where impairment is found to exist, a provision
for loss is recorded by a charge against earnings. The mortgage note receivable
review includes an evaluation of the collateral property securing such note.
The property review generally includes selective property inspections,
discussions with the manager of the
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
property and visits to selected properties in the surrounding area and a review
of the following: (i) the property's current rents compared to market rents;
(ii) the property's expenses; (iii) the property's maintenance requirements;
and, (iv) the property's cash flow.
Results of Operations
The Trust reported a net loss of $1.8 million and net income of $667,000 for the
three and nine months ended September 30, 1998, which includes gains on sale of
real estate of $454,000 and $5.9 million. For the three months ended September
30, 1997, the Trust reported a net loss of $1.2 million including a $245,000
loss on the sale of real estate. The Trust reported net income of $3.5 million
for the nine months ended September 30, 1997, which included gains on sale of
real estate of $6.8 million. Fluctuations in these and other components of the
Trust's revenues and expenses between the 1997 and 1998 periods are discussed
below.
Rents increased from $14.4 million and $40.6 million for the three and nine
months ended September 30, 1997, to $16.5 million and $47.3 million for the
three and nine months ended September 30, 1998. Of these increases, $692,000 and
$4.6 million is attributable to the acquisition of 4 apartment complexes and 8
commercial properties in 1997, and $1.5 million and $3.2 million is attributable
to the acquisition of one apartment complex and two commercial properties in
1998. Increases of $883,000 and $3.4 million are due to increased rental and
occupancy rates at the Trust's apartment complexes and commercial properties.
These increases are partially offset by decreases of $429,000 and $2.7 million
due to the sale of 4 commercial properties in 1997 and decreases of $743,000 and
$2.0 million due to the sale of an apartment complex and three commercial
properties during 1998. Rents are expected to continue to increase due to
revenues from properties acquired in 1998 and higher rental and occupancy rates.
Interest income was $263,000 and $729,000 for the three and nine months ended
September 30, 1997, compared to $168,000 and $539,000 for the three and nine
months ended September 30, 1998. These decreases are due to the sale of five
mortgage notes receivable in 1998 and the payoff of five mortgage notes
receivable in 1997, partially offset by an increase in short-term investment
income. Interest income in the fourth quarter of 1998 is expected to approximate
that of the third quarter of 1998.
Property operating expenses increased from $8.4 million and $23.6 million for
the three and nine months ended September 30, 1997, to $10.0 million and $27.4
million for the three and nine months ended September 30, 1998. Of these
increases, $632,000 and $2.7 million is due to the acquisition of 4 apartment
complexes and 8 commercial properties in 1997 and $1.4 million and $2.7 million
is due to the acquisitions of one apartment complex and two commercial
properties in 1998. These increases are partially offset by decreases of
$308,000 and $1.7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
million due to the sale of four commercial properties in 1997 and decreases of
$482,000 and $1.0 million due to the sale of an apartment complex and three
commercial properties during 1998. Property operating expenses are expected to
continue to increase due to properties acquired in 1998.
Interest expense increased from $4.4 million and $12.2 million for the three and
nine months ended September 30, 1997 to $6.0 million and $16.1 million for the
three and nine months ended September 30, 1998. Of these increases, $1.1 million
and $3.8 million is due to interest expense recorded on mortgages secured by
fifteen properties, encumbered by debt, acquired in 1997 and six properties,
encumbered by debt, acquired in 1998. An additional $740,000 and $1.1 million is
due to interest expense recorded on borrowings in 1997 and 1998, secured by
mortgages on one previously unencumbered commercial property and a note
receivable in 1997 and three parcels of undeveloped land in 1998 and the
refinancing of six existing mortgages in 1997 and four existing mortgages in
1998 where the loan balance was increased. These increases are partially offset
by decreases of $294,000 and $1.5 million due to the sale of four commercial
properties in 1997 and an apartment complex and three commercial properties in
1998. Interest expense in the fourth quarter of 1998 is expected to approximate
that of the third quarter of 1998.
Depreciation expense increased from $1.6 million and $4.6 million for the three
and nine months ended September 30, 1997 to $2.0 million and $6.1 million for
the three and nine months ended September 30, 1998. These increases are due to
the acquisition of 4 apartment complexes and 8 commercial properties in 1997 and
one apartment complex and two commercial properties in 1998, partially offset by
the sale of four commercial properties in 1997 and an apartment complex and
three commercial properties in 1998. Depreciation is expected to increase during
the fourth quarter of 1998, as a result of depreciation on the properties
acquired in the fourth quarter of 1997 and the properties acquired in the first
nine months of 1998.
Advisory fee to affiliate increased from $548,000 and $1.6 million for the three
and nine months ended September 30, 1997 to $632,000 and $1.8 million for the
three and nine months ended September 30, 1998. This increase is due to an
increase in the Trust's gross assets, the basis for the advisory fee, as a
result of property acquisitions in 1997 and in 1998 partially offset by the sale
of four commercial properties in 1997 and an apartment complex and three
commercial properties in 1998. The advisory fee is expected to continue to
increase as the Trust makes additional property acquisitions.
For the three months ended September 30, 1998, the Trust recorded a net income
fee credit of $140,000 and for the nine months ended September 30, 1998, the
Trust recorded a net income fee of $58,000. A net income
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
fee credit of $99,000 and a net income fee of $287,000 were recorded for the
three and nine months ended September 30, 1997. The net income fee is 7.5% of
the Trust's net income.
General and administrative expenses decreased from $817,000 and $2.2 million for
the three and nine months ended September 30, 1997, to $504,000 and $1.6 million
for the three and nine months ended September 30, 1998. These decreases are
primarily attributable to a decrease in legal fees related to the Olive
litigation, partially offset by an increase in Advisor cost reimbursements.
The Trust's equity in earnings of partnerships was a loss of $17,000 and income
of $56,000 for the three and nine months ended September 30, 1997, as compared
to income of $38,000 and $108,000 for the three and nine months ended September
30, 1998. The increase is due primarily to a loss recorded in 1997 on the sale
of an industrial property by one of the equity partnerships.
For the nine months ended September 30, 1998, the Trust recognized a net gain on
the sale of real estate of $5.9 million, $5.6 million of such gain being from
the sale of the Edgewood Apartments in January 1998, a loss of $154,000 on the
sale of the Pinemont Professional Building in May 1998 and a gain of $454,000 on
the sale of the Rio Pinar Shopping Center in September 1998. See NOTE 3. "REAL
ESTATE." For the three months ended September 30, 1997, the Trust recognized a
loss of $245,000 on the sale of Builders Square Shopping Center. For the nine
months ended September 30, 1997, the Trust also recognized gains on the sale of
real estate totaling $6.8 million, $5.4 million on the sale of Tollhill West
Office Building in April 1997 and $1.4 million on the sale of 2626 Cole Office
Building in May 1997.
Tax Matters
As more fully discussed in the Trust's 1997 Form 10-K, the Trust has elected and
in the opinion of the Trust's management, qualified to be taxed as a Real Estate
Investment Trust ("REIT") as defined under Sections 856 through 860 of the
Internal Revenue Code of 1986, as amended, (the "Code"). To continue to qualify
for federal taxation as a REIT under the Code, the Trust is required to hold at
least 75% of the value of its total assets in real estate assets, government
securities and cash and cash equivalents at the close of each quarter of each
taxable year. The Code also requires a REIT to distribute at least 95% of its
REIT taxable income plus 95% of its net income from foreclosure property, as
defined in Section 857 of the Code, on an annual basis to shareholders.
Inflation
The effects of inflation on the Trust's operations are not quantifiable.
Revenues from property operations fluctuate proportionately with
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Inflation (Continued)
increases and decreases in housing costs. Fluctuations in the rate of inflation
also affect the sales values of properties and, correspondingly, the ultimate
gains to be realized by the Trust from property sales. To the extent that
inflation affects interest rates, the Trust's earnings from short-term
investments and the cost of new borrowings as well as its existing variable rate
borrowings will be affected.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and
regulations, the Trust may be potentially liable for removal or remediation
costs, as well as certain other potential costs relating to hazardous or toxic
substances (including governmental fines and injuries to persons and property)
where property-level managers have arranged for the removal, disposal or
treatment of hazardous or toxic substances. In addition, certain environmental
laws impose liability for release of asbestos-containing materials into the air,
and third parties may seek recovery from the Trust for personal injury
associated with such materials.
The Trust's management is not aware of any environmental liability relating to
the above matters that would have a material adverse effect on the Trust's
business, assets or results of operations.
Year 2000
BCM, the Trust's advisor, has informed the Trust that its computer hardware
operating system and computer software have been certified as year 2000
compliant.
Further, Carmel Realty Services, Ltd. ("Carmel, Ltd."), an affiliate of BCM,
that performs property management services for the Trust's properties, has
informed the Trust that it is currently testing year 2000 compliant property
management computer software for the Trust's commercial properties. Carmel, Ltd.
expects to begin utilizing such software January 1, 1999. With regards to the
Trust's apartment properties, Carmel, Ltd. has informed the Trust that its
subcontractors either have in place or will have in place in the first quarter
of 1999, year 2000 compliant property management computer software.
The Trust has not incurred, nor does it expect to incur, any costs related to
its accounting and property management computer software being modified,
upgraded or replaced in order to make it year 2000 compliant. Such costs have
been or will be borne by either BCM, Carmel, Ltd. or the property management
subcontractors of Carmel, Ltd.
Management has not completed its evaluation of the Trust's computer controlled
building systems, such as security, elevators, heating and
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Year 2000 (Continued)
cooling, etc., to determine what systems are not year 2000 compliant. Management
does not believe that any necessary modifications to such systems will require
significant expenditures or cause interruptions in operations, as such enhanced
operating systems are readily available.
The Trust has or will have in place the year 2000 compliant systems that will
allow it to operate. The risks the Trust faces are that certain of its vendors
will not be able to supply goods or services and that financial institutions and
taxing authorities will not be able to accurately apply payments made to them.
Management believes that other vendors are readily available and that financial
institutions and taxing authorities will, if necessary, apply monies received
manually. The likelihood of the above having a significant impact on the Trust's
operations is negligible.
--------------------------------
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Olive Litigation. In February 1990, the Trust, together with Income Opportunity
Realty Investors, Inc., National Income Realty Trust and Transcontinental Realty
Investors, Inc., three real estate entities with, at the time, the same
officers, directors or trustees and advisor as the Trust, entered into a
settlement of a class and derivative action entitled Olive et al. v. National
Income Realty Trust et al. pending before the United States District Court for
the Northern District of California and relating to the operation and management
of each of the entities (the "Olive Litigation"). On April 23, 1990, the court
granted final approval of the terms of a Settlement.
On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Olive Modification") that settled
subsequent claims of breaches of the settlement that were asserted by the
plaintiffs and that modified certain provisions of the April 1990 settlement.
The Olive Modification was preliminarily approved by the Court on July 1, 1994,
and final Court approval was entered on December 12, 1994. The effective date of
the Olive Modification was January 11, 1995.
The Court retained jurisdiction to enforce the Olive Modification, and during
August and September 1996, the Court held evidentiary hearings to assess
compliance with the terms of the Olive Modification by various parties. The
Court issued no ruling or order with respect to the matters addressed at the
hearings.
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ITEM 1. LEGAL PROCEEDINGS (Continued)
Separately, in 1996, legal counsel for the plaintiffs notified the Trust's Board
of Trustees that he intended to assert that certain actions taken by the Board
of Trustees breached the terms of the Olive Modification. On January 27, 1997,
the parties entered into an Amendment to the Olive Modification, effective
January 9, 1997 (the "Olive Amendment"), which was submitted to the Court for
approval on January 29, 1997. The Olive Amendment provides for the settlement of
all matters raised at the evidentiary hearings and by plaintiffs' counsel in his
notices to the Trust's Board of Trustees. On May 2, 1997, a hearing was held for
the Court to consider approval of the Olive Amendment. As a result of the
hearing, the parties entered into a revised Olive Amendment. The Court issued an
order approving the Olive Amendment on July 3, 1997.
The Olive Amendment provided for the addition of four new unaffiliated members
to the Trust's Board of Trustees and set forth new requirements for the approval
of any transactions with certain affiliates until April 28, 1999. In addition,
the Trust, IORI, TCI and their shareholders released the defendants from any
claims relating to the plaintiffs' allegations and matters which were the
subject of the evidentiary hearings. The plaintiffs' allegations of any breaches
of the Modification shall be settled by mutual agreement of the parties or,
lacking such agreement, by an arbitration proceeding.
Under the Olive Amendment, all shares of the Trust owned by Gene E. Phillips or
any of his affiliates shall be voted at all shareholders' meetings held until
April 28, 1999 in favor of all new Board members added under the Olive
Amendment. The Olive Amendment also requires that, until April 28, 1999, all
shares of the Trust owned by Gene E. Phillips or his affiliates in excess of
forty percent (40%) of the Trust's outstanding shares shall be voted pro rata to
the votes cast by all non-affiliated shareholders of the Trust.
In accordance with the Olive Amendment, Richard W. Douglas, Larry E. Harley and
R. Douglas Leonhard were added to the Trust's Board of Trustees in January 1998
and Murray Shaw was added to the Trust's Board of Trustees in February 1998.
ITEM 5. OTHER INFORMATION
On October 25, 1996, the Trust's Board of Trustees approved a proposal to
convert the Trust from a California business trust into a Nevada corporation. On
February 10, 1998, the incorporation proposal was considered by the Trust's
current Board of Trustees and was unanimously approved by such Board members.
However, after evaluating the various alternative methods to accomplish
conversion, the Trust's Board of Trustees approved a proposed merger of the
Trust and Transcontinental Realty Investors, Inc. ("TCI").
Proposed Merger with Transcontinental Realty Investors, Inc.
On September 25, 1998, the Trust and TCI jointly announced the agreement
of their respective Boards for the Trust to be acquired by TCI. Under
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ITEM 5. OTHER INFORMATION (Continued)
Proposed Merger with Transcontinental Realty Investors, Inc. (Continued)
the proposal, TCI would acquire all of the Trust's outstanding shares of
beneficial interest, in a tax free exchange, for shares of its Common Stock. TCI
would issue 1.181 shares of its Common Stock for each outstanding share of
beneficial interest of the Trust. Upon the exchange of shares the Trust would
merge into TCI. The share exchange and merger are subject to the negotiation of
a definitive merger agreement and a vote of the shareholders of both entities.
TCI has the same Board and advisor as the Trust.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
Number Description
10.0 Advisory Agreement dated as of October 15, 1998, between
Continental Mortgage and Equity Trust and Basic Capital
Management, Inc., filed herewith.
27.0 Financial Data Schedule, filed herewith.
(b) Reports on Form 8-K as follows:
A Current Report on Form 8-K, dated September 21, 1998, was
filed September 28, 1998, with respect to Item 5. "Other
Events," which reports the agreement of the respective Boards of
Continental Mortgage and Equity Trust and Transcontinental
Realty Investors, Inc. ("TCI") to form a single consolidated
entity with TCI as its survivor.
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SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONTINENTAL MORTGAGE AND EQUITY TRUST
Date: November 12, 1998 By: /s/ Randall M. Paulson
------------------------- --------------------------
Randall M. Paulson
President
Date: November 12, 1998 By: /s/ Thomas A. Holland
------------------------- -------------------------
Thomas A. Holland
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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CONTINENTAL MORTGAGE AND EQUITY TRUST
EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Nine Months Ended September 30, 1998
Exhibit Page
Number Description Number
- ------ --------------------------------------------------------------------------------------------------- ------
10.0 Advisory Agreement dated as of October 15, 1998 between Continental Mortgage and Equity Trust and 24
Basic Capital Management, Inc.
27.0 Financial Data Schedule. 53
23