1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-14029
AMRESCO CAPITAL TRUST
(Exact name of Registrant as specified in its charter)
TEXAS 75-2744858
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
700 N. PEARL STREET, SUITE 2400, LB 342,
DALLAS, TEXAS 75201-7424
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 953-7700
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 [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
10,006,111 shares of common stock, $.01 par value per share, as of May 1, 1999.
2
AMRESCO CAPITAL TRUST
INDEX
Page No.
-----------------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - March 31, 1999 and December 31, 1998 ..................................... 3
Consolidated Statements of Income - For the Three Months Ended March 31, 1999 and the Period from
February 2, 1998 (Date of Initial Capitalization) through March 31, 1998.............................. 4
Consolidated Statement of Changes in Shareholders' Equity - For the Three Months Ended
March 31, 1999........................................................................................ 5
Consolidated Statements of Cash Flows - For the Three Months Ended March 31, 1999 and the Period
from February 2, 1998 (Date of Initial Capitalization) through March 31, 1998......................... 6
Notes to Consolidated Financial Statements.............................................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................... 21
PART II. OTHER INFORMATION
Item 5. Other Information................................................................................ 22
Item 6. Exhibits and Reports on Form 8-K................................................................. 22
SIGNATURE ................................................................................................ 24
2
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMRESCO CAPITAL TRUST
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
March 31,
1999 December 31,
(unaudited) 1998
-------------- --------------
ASSETS
Mortgage loans, net ................................................................ $ 97,782 $ 96,976
Acquisition, development and construction loan arrangements accounted for as real
estate or investments in joint ventures ......................................... 28,730 39,550
-------------- --------------
Total loan investments ............................................................. 126,512 136,526
Allowance for loan losses .......................................................... (1,610) (1,368)
-------------- --------------
Total loan investments, net of allowance for losses ................................ 124,902 135,158
Commercial mortgage-backed securities - available for sale (at fair value) ......... 27,842 28,754
Real estate, net of accumulated depreciation of $122 and $56, respectively ......... 10,207 10,273
Investments in unconsolidated partnerships and subsidiary .......................... 11,528 3,271
Receivables and other assets ....................................................... 3,716 3,681
Cash and cash equivalents .......................................................... 6,846 9,789
-------------- --------------
TOTAL ASSETS .................................................................... $ 185,041 $ 190,926
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Accounts payable and other liabilities .............................................. $ 1,001 $ 941
Amounts due to affiliates ........................................................... 4,805 6,268
Line of credit ...................................................................... 39,338 39,338
Non-recourse debt on real estate .................................................... 7,500 7,500
Dividends payable ................................................................... -- 4,002
-------------- --------------
TOTAL LIABILITIES ............................................................... 52,644 58,049
-------------- --------------
Minority interests .................................................................. 500 2,611
-------------- --------------
COMMITMENTS AND CONTINGENCIES (NOTE 3)
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value, 50,000,000 shares authorized, no shares issued ..... -- --
Common stock, $.01 par value, 200,000,000 shares authorized, 10,006,111 shares
issued and outstanding .......................................................... 100 100
Additional paid-in capital .......................................................... 140,941 140,941
Unearned stock compensation ......................................................... (658) (848)
Accumulated other comprehensive income (loss) ....................................... (7,378) (6,475)
Distributions in excess of accumulated earnings ..................................... (1,108) (3,452)
-------------- --------------
TOTAL SHAREHOLDERS' EQUITY ...................................................... 131,897 130,266
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ...................................... $ 185,041 $ 190,926
============== ==============
See notes to consolidated financial statements.
3
4
AMRESCO CAPITAL TRUST
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED; IN THOUSANDS, EXCEPT SHARE DATA)
Period from
February 2,
Three Months 1998
Ended through
March 31, 1999 March 31, 1998
-------------- --------------
REVENUES:
Interest income on mortgage loans ............................................................ $ 3,057 $ --
Income from commercial mortgage-backed securities ............................................ 914 --
Operating income from real estate ............................................................ 346 --
Equity in earnings of unconsolidated subsidiary, partnerships and other real estate venture .. 70 --
Interest income from short-term investments .................................................. 86 --
-------------- --------------
TOTAL REVENUES ............................................................................. 4,473 --
-------------- --------------
EXPENSES:
Interest expense ............................................................................. 589 --
Management fees .............................................................................. 588 --
General and administrative ................................................................... 523 --
Depreciation ................................................................................. 86 --
Participating interest in mortgage loans ..................................................... 185 --
Provision for loan losses .................................................................... 742 --
-------------- --------------
TOTAL EXPENSES ............................................................................. 2,713 --
-------------- --------------
INCOME BEFORE GAINS ............................................................................ 1,760 --
Gain associated with repayment of ADC loan arrangement ...................................... 584 --
-------------- --------------
NET INCOME ..................................................................................... $ 2,344 $ --
============== ==============
EARNINGS PER COMMON SHARE:
Basic ....................................................................................... $ 0.23 $ --
============== ==============
Diluted ..................................................................................... $ 0.23 $ --
============== ==============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic ....................................................................................... 10,000,111 100
============== ==============
Diluted ..................................................................................... 10,006,960 100
============== ==============
See notes to consolidated financial statements.
4
5
AMRESCO CAPITAL TRUST
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(UNAUDITED; IN THOUSANDS, EXCEPT SHARE DATA)
Common Stock
$.01 Par Value Accumulated Distributions
------------------ Additional Unearned Other in Excess of Total
Number of Paid-in Stock Comprehensive Accumulated Shareholders'
Shares Amount Capital Compensation Income (Loss) Earnings Equity
--------- ------ ------- ------------ ------------- ------------- -------------
Balance at January 1, 1999..... 10,006,111 $100 $140,941 $(848) $(6,475) $ (3,452) $ 130,266
Net income..................... 2,344 2,344
Unrealized loss on securities
available for sale........... (903) (903)
Amortization of unearned trust
manager compensation ........ 22 22
Amortization of compensatory
options ..................... 168 168
---------- ---- -------- ----- ------- -------- ---------
Balance at March 31, 1999...... 10,006,111 $100 $140,941 $(658) $(7,378) $ (1,108) $ 131,897
========== ==== ======== ===== ======= ======== =========
See notes to consolidated financial statements.
5
6
AMRESCO CAPITAL TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
Period from
February 2,
Three Months 1998
Ended through
March 31, 1999 March 31, 1998
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................................. $ 2,344 $ --
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses ........................................................... 742 --
Depreciation ........................................................................ 86 --
Gain associated with repayment of ADC loan arrangement .............................. (584) --
Amortization of prepaid assets ...................................................... 59 --
Discount amortization on commercial mortgage-backed securities ...................... (76) --
Amortization of compensatory stock options and unearned trust manager compensation .. 190 --
Amortization of loan commitment fees ................................................ (138) --
Receipt of loan commitment fees ..................................................... 34 --
Increase in receivables and other assets ............................................ (374) --
Decrease in interest receivable related to commercial mortgage-backed securities .... 82 --
Increase in accounts payable and other liabilities .................................. 60 --
Increase in amounts due to affiliates ............................................... 234 --
Equity in undistributed earnings of unconsolidated subsidiary, partnerships and
other real estate venture ........................................................ (70) --
Distributions from unconsolidated subsidiary ........................................ 79 --
-------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES ...................................... 2,668 --
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments in mortgage loans .......................................................... (8,276) --
Investments in ADC loan arrangements ................................................... (8,899) --
Sale of mortgage loan to affiliate ..................................................... 4,585 --
Principal collected on mortgage loans .................................................. 1,260 --
Principal and interest collected on ADC loan arrangement ............................... 11,513 --
Investments in unconsolidated partnerships and subsidiary .............................. (2,104) --
-------------- --------------
NET CASH USED IN INVESTING ACTIVITIES .......................................... (1,921) --
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock ............................................. -- 26
Proceeds from financing provided by affiliate .......................................... 312 --
Dividends paid to common shareholders .................................................. (4,002) --
-------------- --------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ............................ (3,690) 26
-------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ...................................... (2,943) 26
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............................................ 9,789 --
-------------- --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD .................................................. $ 6,846 $ 26
============== ==============
SUPPLEMENTAL INFORMATION:
Interest paid, net of amount capitalized ............................................... $ 588 $ --
============== ==============
Income taxes paid ...................................................................... $ 25 $ --
============== ==============
Minority interest distribution associated with ADC loan arrangement .................... $ 2,111 $ --
============== ==============
Receivables transferred in satisfaction of amounts due to affiliate .................... $ 280 $ --
============== ==============
Amounts due to affiliate discharged in connection with sale of mortgage loan ........... $ 1,729 $ --
============== ==============
See notes to consolidated financial statements
6
7
AMRESCO CAPITAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
1. ORGANIZATION AND RELATIONSHIPS
AMRESCO Capital Trust (the "Company"), a real estate investment trust ("REIT"),
was organized under the laws of the State of Texas. The Company was formed to
take advantage of certain mid- to high-yield lending and investment
opportunities in real estate related assets, including various types of
commercial mortgage loans (including, among others, participating loans,
mezzanine loans, acquisition loans, construction loans, rehabilitation loans and
bridge loans), commercial mortgage-backed securities ("CMBS"), commercial real
estate, equity investments in joint ventures and/or partnerships, and certain
other real estate related assets. The Company was initially capitalized on
February 2, 1998 and commenced operations on May 12, 1998, concurrent with the
completion of its initial public offering ("IPO") of 9,000,000 common shares and
private placement of 1,000,011 common shares.
Pursuant to the terms of a Management Agreement dated as of May 12, 1998 and
subject to the direction and oversight of the Board of Trust Managers, the
Company's day-to-day operations are managed by AMREIT Managers, L.P. (the
"Manager"), an affiliate of AMRESCO, INC. (together with its affiliated
entities, the "AMRESCO Group"). For its services, the Manager is entitled to
receive a base management fee equal to 1% per annum of the Company's Average
Invested Non-Investment Grade Assets, as defined, and 0.5% per annum of the
Company's Average Invested Investment Grade Assets, as defined. In addition to
the base management fee, the Manager is entitled to receive incentive
compensation in an amount equal to 25% of the dollar amount by which Funds From
Operations (as defined by the National Association of Real Estate Investment
Trusts), as adjusted, exceeds a certain threshold. The Manager is also entitled
to receive reimbursement for its costs of providing certain services to the
Company. The base management fee, reimbursable expenses and incentive fee, if
any, are payable quarterly in arrears. During the three months ended March 31,
1999, base management fees and reimbursable expenses charged to the Company
totaled $447,000 and $34,000, respectively. No incentive fees were charged to
the Company during this period. Immediately after the closing of the IPO, the
Manager was granted options to purchase 1,000,011 common shares; 70% of the
options are exercisable at an option price of $15.00 per share and the remaining
30% of the options are exercisable at an option price of $18.75 per share.
During the three months ended March 31, 1999, management fees included
compensatory option charges totaling $141,000.
2. BASIS OF PRESENTATION
The accompanying unaudited 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,
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and disclosures required by generally accepted accounting principles
for complete financial statements. The consolidated financial statements include
the accounts of the Company, its wholly-owned subsidiaries and a majority-owned
partnership. The Company accounts for its investment in AMREIT II, Inc., a
taxable subsidiary, using the equity method of accounting, and thus reports its
share of income or loss based on its ownership interest. The Company uses the
equity method of accounting due to the non-voting nature of its ownership
interest and because the Company is entitled to substantially all of the
economic benefits of ownership of AMREIT II, Inc. The Company owns
non-controlling interests in two partnerships; the Company accounts for these
investments using the equity method of accounting and thus reports its share of
income or loss based on its ownership interests. The accompanying financial
statements should be read in conjunction with the Company's consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1998 (the "10-K"). The notes to the
financial statements included herein highlight significant changes to the notes
included in the 10-K.
In the opinion of management, the accompanying consolidated financial statements
include all adjustments (consisting of normal and recurring accruals) necessary
for a fair presentation of the interim financial statements. Operating results
for the three months ended March 31, 1999 are not necessarily indicative of the
results that may be expected for the entire fiscal year or any other interim
period.
7
8
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of certain assets and liabilities at the date of the
financial statements and revenues and expenses for the reporting period.
Significant estimates include the valuation of commercial mortgage-backed
securities, the allowance for loan losses and the determination of the fair
value of certain share option awards. Actual results may differ from those
estimates.
3. LOAN INVESTMENTS
During the three months ended March 31, 1999, two of the Company's loans were
fully repaid and one loan was sold to AMRESCO Commercial Finance, Inc. ("ACFI"),
a member of the AMRESCO Group. Additionally, a fourth loan was reclassified, net
of a $500,000 charge-off, to investment in unconsolidated subsidiary following
the subsidiary's acquisition (through foreclosure on February 25, 1999) of the
partnership interests of one of the Company's borrowers. As of March 31, 1999,
the Company's loan investments are summarized as follows (dollars in thousands):
Amount
Date of Initial Scheduled Collateral Commitment Outstanding at
Investment Maturity Location Property Type Position Amount March 31, 1999
- ---------- -------- -------- ------------- -------- ------ --------------
May 12, 1998 March 31, 2001 Richardson, TX Office Second Lien $ 14,700 $ 12,705
June 1, 1998 June 1, 2001 Houston, TX Office First Lien 11,800 10,248
June 12, 1998 June 30, 2000 Pearland, TX Apartment First Lien 12,827 7,696
June 17, 1998 June 30, 2000 San Diego, CA R&D/Bio-Tech First Lien 5,560 4,492
June 19, 1998 June 18, 2000 Houston, TX Office First Lien 24,000 10,957
June 22, 1998 June 19, 2000 Wayland, MA Office First Lien 45,000 28,541
July 1, 1998 July 1, 2001 Dallas, TX Office Ptrshp Interests 10,068 6,674
July 2, 1998 June 30, 2000 Washington, D.C. Office First Lien 7,000 5,774
July 10, 1998 July 31, 2000 Pasadena, TX Apartment First Lien 3,350 2,791
September 1, 1998 February 28, 2001 Los Angeles, CA Mixed Use First Lien 18,419 17,418
September 30, 1998 May 1, 2001 San Antonio, TX Residential Lots First Lien 2,952 2,291
September 30, 1998 Various San Antonio, TX/ Residential Lots First Lien 8,400 2,246
Sunnyvale, TX
September 30, 1998 July 15, 1999 Galveston, TX Apartment First Lien 3,664 3,664
September 30, 1998 June 8, 1999 Ft. Worth, TX Apartment Ptrshp Interests 2,650 2,649
September 30, 1998 June 30, 1999 Dallas, TX Medical Office First Lien 3,015 2,450
September 30, 1998 July 22, 1999 Norwood, MA Industrial/Office First Lien 8,765 7,928
October 1, 1998 July 31, 1999 Richardson, TX Office First Lien 567 300
-------- --------
$182,737 $128,824
======== ========
Interest Interest
Date of Initial Pay Accrual
Investment Rate Rate
- ---------- ---- ----
May 12, 1998 10.0% 12.0%
June 1, 1998 12.0% 12.0%
June 12, 1998 10.0% 11.5%
June 17, 1998 10.0% 13.5%
June 19, 1998 12.0% 12.0%
June 22, 1998 10.5% 10.5%
July 1, 1998 10.0% 15.0%
July 2, 1998 10.5% 10.5%
July 10, 1998 10.0% 14.0%
September 1, 1998 10.0% 12.0%
September 30, 1998 16.0% 16.0%
September 30, 1998 10.0% 14.0%
September 30, 1998 10.0% 15.0%
September 30, 1998 10.5% 16.0%
September 30, 1998 10.0% 13.0%
September 30, 1998 10.0% 12.5%
October 1, 1998 9.3% 15.0%
At March 31, 1999, amounts outstanding under construction loans,
acquisition/rehabilitation loans, acquisition loans, land development loans and
bridge loans totaled $34,007,000, $41,938,000, $40,114,000, $4,837,000 and
$7,928,000, respectively.
Three of the 17 loan investments provide the Company with the opportunity for
profit participation in excess of the contractual interest accrual rates. The
loan investments are classified as follows (in thousands):
Loan Amount Balance Sheet Amount
Outstanding at at
March 31, 1999 March 31, 1999
------------------------------------------
Mortgage loans, net..................... $ 99,005 $ 97,782
Real estate, net........................ 23,145 22,712
Investment in real estate venture....... 6,674 6,018
--------- ---------
Total ADC loan arrangements.......... 29,819 28,730
--------- ---------
Total loan investments.................. $ 128,824 126,512
=========
Allowance for loan losses.................................... (1,610)
---------
Total loan investments, net of allowance for losses.......... $ 124,902
=========
The differences between the outstanding loan amounts and the balance sheet
amounts are due primarily to loan commitment fees, minority interests and
accumulated depreciation.
8
9
ADC loan arrangements accounted for as real estate consisted of the following at
March 31, 1999 (in thousands):
Land .................................. $ 4,648
Buildings and improvements ............ 3,691
Construction in progress .............. 14,438
--------
Total .............................. 22,777
Less: Accumulated depreciation ........ (65)
--------
$ 22,712
========
A summary of activity for mortgage loans and ADC loan arrangements accounted for
as real estate or investments in joint ventures is as follows (in thousands):
Balance at December 31, 1998 ......... $ 136,791
Investments in loans ................. 17,779
Collections of principal ............. (12,593)
Cost of mortgage sold ................ (6,314)
Foreclosure (partnership interests) .. (6,839)
---------
Balance at March 31, 1999 ............ $ 128,824
=========
The activity in the allowance for loan losses was as follows (in thousands):
Balance at December 31, 1998 ........... $ 1,368
Provision for losses ................... 742
Charge-offs ............................ (500)
Recoveries ............................. --
-------
Balance at March 31, 1999 .............. $ 1,610
=======
As of March 31, 1999, the Company had outstanding commitments to fund
approximately $53,913,000 under 17 loans, of which $1,403,000 is reimbursable by
ACFI. The Company is obligated to fund these commitments to the extent that the
borrowers are not in violation of any of the conditions established in the loan
agreements. Commitments generally have fixed expiration dates or other
termination clauses and may require the payment of a fee if amounts are repaid
to the Company during certain prepayment lock-out periods. A portion of the
commitments could expire without being drawn upon and therefore the total
commitment amounts do not necessarily represent future cash requirements.
4. DEBT AND FINANCING FACILITIES
Effective as of July 1, 1998, the Company (and certain of its subsidiaries)
entered into a $400 million Interim Warehouse and Security Agreement (the "Line
of Credit") with Prudential Securities Credit Corporation ("PSCC"). Subject to
certain limitations, borrowings under the facility can be used to finance the
Company's structured loan and equity real estate investments. Prior to the
modifications discussed below, borrowings under the Line of Credit bore interest
at rates ranging from LIBOR plus 1% per annum to LIBOR plus 2% per annum
depending upon the type of asset, its loan-to-value ratio and the advance rate
selected by the Company. Advance rates on eligible assets ranged from 50% to 95%
depending upon the asset's characteristics. The weighted average interest rate
at March 31, 1999 was 5.98%.
Effective as of May 4, 1999, the Company (and certain of its subsidiaries)
entered into an Amended and Restated Interim Warehouse and Security Agreement
(the "Amended Line of Credit") with PSCC; the agreement amended the Company's
existing Line of Credit. The Amended Line of Credit provides for the following
modifications: (1) a reduction in the size of the committed facility from $400
million to $300 million; (2) the elimination of the requirement that assets
financed with proceeds from the facility must be securitizable; (3) a reduction
in the amount of capital the Company must fund with respect to construction and
rehabilitation loans before PSCC is required to begin advancing funds; (4) an
extension of the maturity date from July 1, 2000 to November 3, 2000; and (5)
the modification to, and addition of, certain sublimits on certain types of
loans and assets. Under the Amended Line of Credit, borrowings bear interest at
LIBOR plus 1.25% per annum to the extent such borrowings do not exceed the
Company's Tangible Net Worth, as defined; borrowings in excess of the Company's
Tangible Net Worth bear interest at LIBOR plus 3%.
9
10
As compensation for amending the existing line of credit and extending the
maturity date, the Company granted warrants to Prudential Securities
Incorporated, an affiliate of PSCC, to purchase 250,002 common shares of
beneficial interest at $9.83 per share. The exercise price represents the
average closing market price of the Company's common shares for the ten-day
period ending on May 3, 1999. The warrants were issued in lieu of a commitment
fee or other cash compensation.
Borrowings under the facility are secured by a first lien security interest on
all assets funded with proceeds from the Amended Line of Credit. The Amended
Line of Credit contains several covenants; among others, the more significant
covenants include the maintenance of a $100 million consolidated Tangible Net
Worth, subject to adjustment in connection with any future equity offerings;
maintenance of a Coverage Ratio, as defined, of not less than 1.4 to 1; and
limitation of Total Indebtedness, as defined, to no more than 400% of
shareholders' equity.
5. EARNINGS PER SHARE
A reconciliation of the numerator and denominator used in computing basic
earnings per share and diluted earnings per share for the three months ended
March 31, 1999 and the period from February 2, 1998 (date of initial
capitalization) through March 31, 1998, is as follows (in thousands, except
share data):
Period from
February 2,
Three Months 1998
Ended through
March 31, 1999 March 31, 1998
------------- -------------
Net income available to common shareholders $ 2,344 $ --
============= =============
Weighted average common shares outstanding 10,000,111 100
============= =============
Basic earnings per common share $ 0.23 $ --
============= =============
Weighted average common shares outstanding 10,000,111 100
Effect of dilutive securities:
Restricted shares 6,000 --
Net effect of assumed exercise of stock options 849 --
------------- -------------
Adjusted weighted average shares outstanding 10,006,960 100
============= =============
Diluted earnings per common share $ 0.23 $ --
============= =============
Options to purchase 1,478,011 shares of common stock were outstanding at March
31, 1999. Options related to 1,472,011 shares were not included in the
computation of diluted earnings per share because the options' exercise price
was greater than the average market price of the Company's common shares. The
Company was initially capitalized on February 2, 1998 with the sale of 100
shares to AMRESCO, INC. The Company had no earnings prior to the commencement of
its operations on May 12, 1998. No options were outstanding during the period
from February 2, 1998 through March 31, 1998.
6. COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances except
those resulting from investments by, and distributions to, its owners. Other
comprehensive income includes unrealized gains and losses on marketable
securities classified as available-for-sale. During the three months ended March
31, 1999, total nonowner changes in equity aggregated $1,441,000 and were
comprised of net income of $2,344,000 and an unrealized loss on securities
available for sale of $903,000. The unrealized loss on securities available for
sale had no impact on the Company's taxable income or cash flow.
7. SEGMENT INFORMATION
The Company, as an investor in real estate related assets, operates in only one
reportable segment. Within this segment, the Company makes asset allocation
decisions based upon its diversification strategies and changes in market
conditions. The Company does not have, nor does it rely upon, any major
customers. All of the Company's investments are secured
10
11
directly or indirectly by real estate properties located in the United States;
accordingly, all of its revenues were derived from U.S. operations.
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires that an entity
recognize all derivatives as either assets or liabilities in its balance sheet
and that it measure those instruments at fair value. The accounting for changes
in the fair value of a derivative (that is, gains and losses) is dependent upon
the intended use of the derivative and the resulting designation. SFAS No. 133
generally provides for matching the timing of gain or loss recognition on the
hedging instrument with the recognition of (1) the changes in the fair value of
the hedged asset or liability that are attributable to the hedged risk or (2)
the earnings effect of the hedged forecasted transaction. SFAS No. 133 is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999,
although earlier application is encouraged. The Company has not yet assessed the
impact that SFAS No. 133 will have on its financial condition or results of
operations.
9. SUBSEQUENT EVENTS
On April 22, 1999, the Company declared a dividend of $0.36 per share; the
dividend is payable on May 17, 1999 to shareholders of record on April 30, 1999.
On April 30, 1999, the Company (through a majority-owned partnership) acquired
interests in three newly constructed, grocery-anchored shopping centers in the
Dallas/Fort Worth (Texas) area. These properties, which were acquired by
subsidiary partnerships at an aggregate purchase price of $30.7 million, include
an 86,516 square foot facility in Flower Mound, Texas, a 61,440 square foot
facility in Fort Worth, Texas and an 85,611 square foot facility in Grapevine,
Texas. In connection with these acquisitions, the title-holding partnerships
obtained non-recourse financing aggregating $19.5 million from an unaffiliated
third party. Immediately prior to the closing, the Company contributed $11.4
million of capital to the partnership. The proceeds from this contribution were
used to fund the balance of the purchase price and to provide initial working
capital to the title-holding partnerships. The non-recourse loans bear interest
at 6.68% per annum and require interest only payments through December 31, 2001;
thereafter, interest and principal payments are due based upon 25-year
amortization schedules. The loans mature on January 1, 2014.
As further described in Note 4, the Company's Line of Credit was modified
effective as of May 4, 1999.
11
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
AMRESCO Capital Trust (the "Company") is a real estate investment trust ("REIT")
which was formed in early 1998 to take advantage of certain mid- to high-yield
lending and investment opportunities in real estate related assets, including
various types of commercial mortgage loans (including, among others,
participating loans, mezzanine loans, acquisition loans, construction loans,
rehabilitation loans and bridge loans), commercial mortgage-backed securities
("CMBS"), commercial real estate, equity investments in joint ventures and/or
partnerships, and certain other real estate related assets. Subject to the
direction and oversight of the Board of Trust Managers, the Company's day-to-day
operations are managed by AMREIT Managers, L.P. (the "Manager"), an affiliate of
AMRESCO, INC. (together with its affiliated entities, the "AMRESCO Group").
The Company commenced operations on May 12, 1998 concurrent with the completion
of its initial public offering of 9,000,000 common shares and private placement
of 1,000,011 common shares with AMREIT Holdings, Inc., a wholly-owned
subsidiary of AMRESCO, INC. To date, the Company's investment activities have
been focused in three primary areas: loan investments, CMBS and equity
investments in real estate. The Company expects that its mid- to high-yield
loan investments and, to a lesser extent, equity investments in real estate,
will continue to comprise a substantial portion of its investment portfolio.
Similarly, the Company expects to continue to have 15% to 20% of its invested
capital (comprising equity and proceeds from its two credit facilities)
allocated to CMBS. Additionally, the Company expects to make several of these
investments through one or more partnerships in which it holds a minority
ownership interest (i.e., 5% to 10%). During the three months ended March 31,
1999, one such partnership was formed.
The Company's investment activities remained slow during the first quarter of
1999 as the mortgage REIT market continued to be affected by the aftermath of
the dislocation in the capital markets which occurred in mid to late 1998. The
Company closed no new loan investments during the first quarter. This was not
due to a lack of investment opportunities but rather was in response to the
capital market constraints which impacted the Company. Notwithstanding the lack
of new investment activity during the first quarter, the Company advanced $17.8
million under structured loan commitments it had closed on or prior to December
31, 1998; a substantial portion of these funds were provided by the repayment of
two loan investments and the sale of one mortgage loan during the quarter.
Additionally, the Company's equity investments in real estate increased to $4.8
million as a result of the acquisition of a 49% limited partner interest in a
partnership which owns a 116,000 square foot suburban office building. Finally,
the Company contributed $0.7 million to a recently formed investment partnership
with Olympus Real Estate Corporation. The partnership, which is 5% owned by the
Company, acquired several classes of subordinated CMBS at an aggregate purchase
price of $12.7 million.
The Company believes it has operated and it intends to continue to operate in a
manner so as to continue to qualify as a REIT under the Internal Revenue Code of
1986, as amended (the "Code"). As such, the Company has distributed and it
intends to continue to distribute at least 95% of its REIT taxable income
annually.
The Company may experience high volatility in financial statement net income and
tax basis income from quarter to quarter and year to year, primarily as a result
of fluctuations in interest rates, borrowing costs, reinvestment opportunities,
prepayment rates and favorable and unfavorable credit related events (e.g.,
profit participations or credit losses). Additionally, the Company's accounting
for certain real estate loan arrangements as either real estate or joint venture
investments may contribute to volatility in financial statement net income.
Because changes in interest rates may significantly affect the Company's
activities, the operating results of the Company will depend, in large part,
upon the ability of the Company to manage its interest rate, prepayment and
credit risks, while maintaining its status as a REIT.
The following discussion of results of operations and liquidity and capital
resources should be read in conjunction with the consolidated financial
statements and notes thereto included in "Item 1. Financial Statements".
12
13
RESULTS OF OPERATIONS
General
Under generally accepted accounting principles, net income for the three months
ended March 31, 1999 was $2,344,000, or $0.23 per common share. The Company
commenced operations on May 12, 1998; as a result, comparisons to the prior
year's first quarter are not available. The Company's primary sources of revenue
for the three months ended March 31, 1999, totaling $4,473,000, were as follows:
o $3,164,000 from loan investments. As certain of the Company's loan
investments are accounted for as either real estate or joint venture
investments for financial reporting purposes, these revenues are included
in the consolidated statement of income as follows: interest income on
mortgage loans - $3,057,000; and operating income from real estate -
$107,000. The loan investments earn interest at accrual rates ranging from
10.5% to 16% per annum as of March 31, 1999.
o $914,000 from investments in CMBS.
o $239,000 of operating income from real estate owned by the Company (through
a majority-owned partnership).
Additionally, the Company realized a gain of $584,000 in connection with the
repayment of an ADC loan arrangement. The gain was comprised principally of
interest income earned at the accrual rate over the life of the loan investment.
The Company incurred expenses of $2,713,000 during the three months ended March
31, 1999, consisting primarily of the following:
o $588,000 of management fees, including $447,000 of base management fees
payable to the Manager pursuant to the Management Agreement and $141,000 of
expense associated with compensatory options granted to the Manager. No
incentive fees were incurred during the period.
o $523,000 of general and administrative costs, including $200,000 of
resolution costs associated with a non-performing loan, $96,000 for
professional services, $59,000 for directors and officers' insurance,
$34,000 of reimbursable costs pursuant to the Management Agreement, $27,000
related to compensatory options granted to certain members of the AMRESCO
Group and $22,000 related to restricted stock awards to the Company's
Independent Trust Managers.
o $589,000 of interest expense (net of capitalized interest totaling
$151,000) associated with the Company's credit facilities and a
non-recourse loan secured by real estate.
o $742,000 of provision for loan losses. During the period, the Company
charged-off $500,000 against an existing allowance for losses related to
the non-performing loan referred to above. This loan is discussed further
in this section of Management's Discussion and Analysis of Financial
Condition and Results of Operations under the sub-heading "Loan
Investments".
The Company's policy is to distribute at least 95% of its REIT taxable income to
shareholders each year; to that end, dividends are paid quarterly. Tax basis
income differs from income reported for financial reporting purposes due
primarily to differences in methods of accounting for ADC loan arrangements and
stock-based compensation awards and the nondeductibility, for tax purposes, of
the Company's loan loss reserve (for a discussion of ADC loan arrangements, see
the notes to the consolidated financial statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998). As a result of
these accounting differences, net income under generally accepted accounting
principles is not necessarily an indicator of distributions to be made by the
Company. On April 22, 1999, the Company declared its first quarter dividend; the
dividend, totaling $0.36 per share, is payable on May 17, 1999 to shareholders
of record on April 30, 1999. For federal income tax purposes, this dividend
should be treated as ordinary income to the Company's shareholders.
13
14
Loan Investments
During the three months ended March 31, 1999, two of the Company's loans were
fully repaid prior to their scheduled maturities and one loan was sold to
AMRESCO Commercial Finance, Inc. ("ACFI"), a member of the AMRESCO Group. The
proceeds from these transactions totaled $16,353,000, including accrued interest
and a prepayment fee aggregating $180,000. In connection with the loan sale,
amounts due to ACFI were reduced by $2,009,000; as of March 31, 1999, amounts
due to ACFI totaled $4,324,000. Additionally, a fourth loan was reclassified,
net of a $500,000 charge-off, to investment in unconsolidated subsidiary
following the subsidiary's acquisition (through foreclosure on February 25,
1999) of the partnership interests of one of the Company's borrowers. Principal
collections on certain of the Company's other loan investments totaled
$1,005,000 during the quarter ended March 31, 1999. During the quarter, the
Company advanced $17,779,000 under its loan commitments. No new loan commitments
were closed during the first quarter.
Excluding the loan classified as an investment in unconsolidated subsidiary, the
Company has 17 loans representing $182.7 million in aggregate commitments; as of
March 31, 1999, $128.8 million had been advanced under these facilities. A
portion of the commitments may expire without being drawn upon and therefore the
total commitment amounts do not necessarily represent future cash requirements.
After giving effect to ACFI's economic interest (as described in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998), commitments
and amounts outstanding totaled approximately $177.9 million and $125.4 million,
respectively, at March 31, 1999. At March 31, 1999, ACFI's contingent obligation
for additional advances which may be required to be made under certain of the
Company's loans approximated $1,403,000.
Based upon the amounts outstanding under these facilities and after giving
effect to the contractual right sold to ACFI, the Company's portfolio of
commercial mortgage loans had a weighted average interest pay rate of 10.8% and
a weighted average interest accrual rate of 11.9% as of March 31, 1999. Six of
the 17 loans provide for profit participation above the contractual accrual
rate; three of these six facilities are included in the pool of loans in which
ACFI has a contractual right to collect certain excess proceeds. The Company's
loan investments are summarized as follows (dollars in thousands):
Amount
Outstanding at
Date of Initial Scheduled Collateral Commitment March 31,
Investment Maturity Location Property Type Position Amount 1999 (c)
---------- -------- -------- ------------- -------- ------ --------
May 12, 1998 March 31, 2001 Richardson, TX Office Second Lien $14,700 $12,705
June 1, 1998 June 1, 2001 Houston, TX Office First Lien 11,800 10,248
June 12, 1998 June 30, 2000 Pearland, TX Apartment First Lien 12,827 7,696 (b)
June 17, 1998 June 30, 2000 San Diego, CA R&D/Bio-Tech First Lien 5,560 4,492 (b)
June 19, 1998 June 18, 2000 Houston, TX Office First Lien 24,000 10,957 (b)
June 22, 1998 June 19, 2000 Wayland, MA Office First Lien 45,000 28,541
July 1, 1998 July 1, 2001 Dallas, TX Office Ptrshp 10,068 6,674 (a)
Interests
July 2, 1998 June 30, 2000 Washington, D.C. Office First Lien 7,000 5,774
July 10, 1998 July 31, 2000 Pasadena, TX Apartment First Lien 3,350 2,791
September 1, 1998 February 28, 2001 Los Angeles, CA Mixed Use First Lien 18,419 17,418
September 30, 1998 May 1, 2001 San Antonio, TX Residential Lots First Lien 2,952 2,291
September 30, 1998 Various San Antonio, TX/ Residential Lots First Lien 8,400 2,246
Sunnyvale, TX
September 30, 1998 July 15, 1999 Galveston, TX Apartment First Lien 3,664 3,664
September 30, 1998 June 8, 1999 Ft. Worth, TX Apartment Ptrshp 2,650 2,649
Interests
September 30, 1998 June 30, 1999 Dallas, TX Medical Office First Lien 3,015 2,450
September 30, 1998 July 22, 1999 Norwood, MA Industrial/Office First Lien 8,765 7,928
October 1, 1998 July 31, 1999 Richardson, TX Office First Lien 567 300
-------- --------
182,737 128,824
ACFI's Economic Interest (4,869) (3,466)
-------- --------
$177,868 (d) $125,358 (d)
======== ========
Interest Interest
Date of Initial Pay Accrual
Investment Rate Rate
---------- ---- ----
May 12, 1998 10.0% 12.0%
June 1, 1998 12.0% 12.0%
June 12, 1998 10.0% 11.5%
June 17, 1998 10.0% 13.5%
June 19, 1998 12.0% 12.0%
June 22, 1998 10.5% 10.5%
July 1, 1998 10.0% 15.0%
July 2, 1998 10.5% 10.5%
July 10, 1998 10.0% 14.0%
September 1, 1998 10.0% 12.0%
September 30, 1998 16.0% 16.0%
September 30, 1998 10.0% 14.0%
September 30, 1998 10.0% 15.0%
September 30, 1998 10.5% 16.0%
September 30, 1998 10.0% 13.0%
September 30, 1998 10.0% 12.5%
October 1, 1998 9.3% 15.0%
(a) Accounted for as investment in joint venture for financial reporting
purposes.
(b) Accounted for as real estate for financial reporting purposes.
(c) For all loan investments, payments of interest only are due monthly at the
interest pay rate. All principal and all remaining accrued and unpaid
interest are due at the scheduled maturities of the loans.
(d) Amounts exclude the loan which was reclassified to investment in
unconsolidated subsidiary during the three months ended March 31, 1999.
The Company provides financing through certain real estate loan arrangements
that, because of their nature, qualify either as real estate or joint venture
investments for financial reporting purposes (see notes [a] and [b] accompanying
the table
14
15
above). As of March 31, 1999, loan investments representing approximately
$52,455,000 in aggregate commitments were accounted for as either real estate or
joint venture interests; approximately $29,819,000 had been advanced to
borrowers under the related agreements. For a discussion of these loan
arrangements, see the Company's consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
A mezzanine (second lien) loan with an outstanding balance of $6,839,000 and a
recorded investment of $6,659,000 was over 30 days past due as of December 31,
1998. The allowance for loan losses related to this investment totaled $500,000
at December 31, 1998. On February 25, 1999, an unconsolidated taxable subsidiary
of the Company assumed control of the borrower (a partnership) through
foreclosure of the partnership interests. In addition to the second lien
mortgage, the property is encumbered by a $17 million first lien mortgage
provided by an unaffiliated third party. During the first quarter, the Company
charged-off $500,000 against the allowance for losses related to this
investment. Should the Company incur an actual loss on this investment, tax
basis income would be adversely affected.
At March 31, 1999, the Company's commercial mortgage loan commitments were
geographically dispersed in three states and the District of Columbia: Texas
(54%); Massachusetts (29%); California (13%); and Washington, D.C. (4%). The
underlying collateral for these loans was comprised of the following property
types: office (64%); multifamily (12%); mixed use (10%); residential (6%);
industrial (4%); R&D/Bio-Tech (3%); and medical office (1%). Construction loans,
acquisition/rehabilitation loans, acquisition loans, single-family lot
development loans and bridge loans comprised 30%, 33%, 27%, 7% and 3% of the
portfolio, respectively. Eighty-five percent of the portfolio is comprised of
first lien loans while the balance of the portfolio (15%) is secured by second
liens and/or partnership interests. The percentages reflected above are based
upon committed loan amounts and give effect to ACFI's economic interest.
Additionally, the percentages exclude the loan which was reclassified to
investment in unconsolidated subsidiary during the first quarter.
Until the loan investment portfolio becomes larger, geographic and product type
concentrations are expected. The Company expects to see more diversification
both geographically and by product type as the loan portfolio grows. Geographic
and product type concentrations present additional risks, particularly if there
is a deterioration in the general condition of the real estate market or in the
sub-market in which the loan collateral is located, or if demand for a
particular product type does not meet expectations due to adverse market
conditions that are different from those projected by the Company. In an effort
to reduce concentration risks, the Company is targeting transactions which will
more broadly diversify its loan investment portfolio.
Commercial Mortgage-backed Securities
As of March 31, 1999, the Company holds five commercial mortgage-backed
securities ("CMBS") which were acquired at an aggregate purchase price of $34.5
million. All of these securities were acquired on or before September 1, 1998.
Due to the continued widening of spreads in the CMBS market during the first
quarter, the value of the Company's CMBS holdings declined by $907,000 during
the three months ended March 31, 1999; accordingly, the Company recorded an
unrealized loss of $907,000 on its CMBS portfolio during the quarter ended March
31, 1999. Additionally, the Company recorded an unrealized gain of $4,000, net
of tax effects, related to one commercial mortgage-backed security owned by its
unconsolidated taxable subsidiary; the security held by this subsidiary has an
investment rating of "B-". As these securities are classified as available for
sale, the aggregate unrealized loss was reported as a component of accumulated
other comprehensive income (loss) in shareholders' equity for financial
reporting purposes. The cumulative unrealized losses (totaling $7.4 million)
have had no impact on the Company's taxable income or cash flow. Management
intends to retain these investments for the foreseeable future. Excluding the
potential tax effects associated with the security held by the Company's
unconsolidated taxable subsidiary, the weighted average unleveraged yield over
the expected life of these investments is expected to approximate 11.4%. The
Company's direct CMBS investments are summarized as follows (dollars in
thousands):
Percentage of
Security Aggregate Aggregate Total Based
Rating Amortized Cost Fair Value on Fair Value
------------- ------------------ ----------------- ----------------
BB- $4,239 $3,482 12%
B 19,530 16,095 58%
B- 11,225 8,265 30%
------- ------- ---
$34,994 $27,842 100%
======= ======= ===
15
16
The Company's estimated returns on its CMBS investments are based upon a number
of assumptions that are subject to certain business and economic risks and
uncertainties including, but not limited to, the timing and magnitude of
prepayments and credit losses on the underlying mortgage loans that may result
from general and/or localized real estate market factors. These risks and
uncertainties are in many ways similar to those affecting the Company's
commercial mortgage loans. These risks and uncertainties may cause the actual
yields to differ materially from expected yields.
Equity Investments in Real Estate
The Company's equity investments in real estate increased to $4.8 million during
the three months ended March 31, 1999 as a result of the acquisition of a 49%
limited partner interest in a partnership which owns a 116,000 square foot
office building in Richardson, Texas. The property is encumbered by a first lien
mortgage in the amount of $13.9 million. The Company contributed $1.4 million of
capital to the partnership.
On April 30, 1999, the Company (through a majority-owned partnership) acquired
interests in three newly constructed, grocery-anchored shopping centers in the
Dallas/Fort Worth (Texas) area. These properties, which were acquired by
subsidiary partnerships at an aggregate purchase price of $30.7 million, include
an 86,516 square foot facility in Flower Mound, Texas, a 61,440 square foot
facility in Fort Worth, Texas and an 85,611 square foot facility in Grapevine,
Texas. In connection with these acquisitions, the title-holding partnerships
obtained non-recourse financing aggregating $19.5 million from an unaffiliated
third party. Immediately prior to the closing, the Company contributed $11.4
million of capital to the partnership. The proceeds from this contribution were
used to fund the balance of the purchase price and to provide initial working
capital to the title-holding partnerships. The non-recourse loans bear interest
at 6.68% per annum and require interest only payments through December 31, 2001;
thereafter, interest and principal payments are due based upon 25-year
amortization schedules. The loans mature on January 1, 2014.
The partnership expects to acquire a fifth center, an 87,540 square foot
facility in Richardson, Texas, during the third quarter of 1999 following the
completion of construction and satisfaction of certain other closing conditions.
The fifth center is expected to be acquired at a purchase price of approximately
$10.8 million; it is anticipated that this acquisition will be financed with a
$3.2 million equity contribution from the Company and $7.6 million of third
party non-recourse financing.
Ultimately, the Company expects to construct an additional 62,000 square feet of
side-store space; this development is expected to occur at the three recently
acquired properties and at the fifth center (following the acquisition thereof).
It is currently anticipated that the development costs will be financed with an
additional $1 million equity contribution from the Company and $3.8 million of
third party financing proceeds.
LIQUIDITY AND CAPITAL RESOURCES
The Company's ability to execute its business strategy, particularly the growth
of its investment and loan portfolio, depends to a significant degree on its
ability to obtain additional capital. The Company's principal demands for
liquidity are cash for operations, including funds for its lending activities
and other investments, interest expense associated with its indebtedness, debt
repayments and distributions to its shareholders. In the near term, the
Company's principal sources of liquidity are the funds available to it under its
financing facilities described below.
Effective as of July 1, 1998, the Company (and certain of its subsidiaries)
entered into a $400 million credit facility (the "Line of Credit") with
Prudential Securities Credit Corporation ("PSCC"). Subject to PSCC's approval on
an asset by asset basis, borrowings under the facility can be used to finance
the Company's structured loan and equity real estate investments. As a result of
the dislocation in the capital markets in mid to late 1998, PSCC became more
restrictive in the application of its approval rights with respect to financing
for new investments sought by the Company; accordingly, very few new investments
were consummated during the fourth quarter of 1998 and the first quarter of
1999. Prior to the modifications discussed below, borrowings under the Line of
Credit bore interest at rates ranging from LIBOR plus 1% per annum to LIBOR plus
2% per annum. Borrowings are secured by a first lien security interest in all
assets funded with proceeds from the Line of Credit. At March 31, 1999,
$39,338,000 had been borrowed under the Line of Credit. The weighted average
interest rate at March 31, 1999 was 5.98%. To reduce the impact that rising
interest rates would have on this floating rate indebtedness, the Company
entered into an interest rate cap agreement effective January 1, 1999. The
agreement, which expires on July 1, 2000, has a notional amount of $33,600,000.
The agreement entitles the Company to receive from a counterparty the amounts,
if any, by which one month LIBOR exceeds 6.0%. There are no margin requirements
associated with interest rate caps and therefore there is no liquidity risk
associated with this particular hedging
16
17
instrument. As of March 31, 1999, no payments were due from the counterparty as
one month LIBOR had not exceeded 6.0%.
On May 4, 1999, the Company (and certain of its subsidiaries) entered into an
Amended and Restated Interim Warehouse and Security Agreement (the "Amended Line
of Credit"). The terms of the Amended Line of Credit are discussed below in
"Part II, Item 5. Other Information". In anticipation of completing the
modifications to its line of credit, the Company intensified its loan production
efforts during the first quarter.
Effective as of July 1, 1998, the Company (and certain of its subsidiaries)
entered into a $100 million Master Repurchase Agreement (the "Repurchase
Agreement") with PSCC; subsequently, PSCC was replaced by Prudential-Bache
International, Ltd. ("PBI"), an affiliate of PSCC, as lender. Borrowings under
the Repurchase Agreement can be used to finance a portion of the Company's
portfolio of mortgage-backed securities. The Repurchase Agreement provides that
the Company may borrow a varying percentage of the market value of the purchased
mortgage-backed securities, depending on the credit quality of such securities.
Borrowings under the Repurchase Agreement bear interest at rates ranging from
LIBOR plus 0.20% per annum to LIBOR plus 1.5% per annum depending upon the
advance rate and the credit quality of the securities being financed. Borrowings
under the facility are secured by an assignment to PBI of all mortgage-backed
securities funded with proceeds from the Repurchase Agreement. The Repurchase
Agreement matures on June 30, 2000. At March 31, 1999, there were no borrowings
under the Repurchase Agreement. On April 29, 1999, $11,795,000 was borrowed
under this facility in order to provide the funds necessary to complete the
acquisition of the three grocery-anchored shopping centers described above.
Under the terms of the Amended Line of Credit and the Repurchase Agreement, PSCC
and PBI, respectively, retain the right to mark the underlying collateral to
market value. A reduction in the value of its pledged assets may require the
Company to provide additional collateral or fund margin calls. From time to
time, the Company may be required to provide such additional collateral or fund
margin calls.
The Company believes that the funds available under its two credit facilities
will be sufficient to meet the Company's liquidity and capital requirements in
1999. The Company believes that the Amended Line of Credit will provide it with
more flexibility, which in turn will allow it to utilize favorable financing
terms in connection with the origination of investments and enable it to resume
the growth of its assets, albeit at a slower rate than was achieved in the
second and third quarters of 1998. The Company, however, remains subject to
capital constraints. In particular, the Company's ability to raise additional
capital through the public equity and debt markets continues to be severely
limited. The Company is continuing its efforts to obtain additional secured loan
facilities that would better match the duration of its assets. Additionally,
these efforts are designed to provide alternatives to the Amended Line of Credit
and, ultimately, to replace it. However, there can be no assurances that the
Company will be able to obtain renewal or additional financing on acceptable
terms.
Management currently believes that the dislocation in the capital markets will
not extend long-term; however, its duration is impossible to predict at this
time. In the near term, the Company believes it will be constrained from
accessing the public equity markets. In addition, new issues of long-term public
unsecured debt will be difficult to obtain and, in any event, will likely not be
available to the Company at a reasonable cost. Additional secured debt beyond
the Company's Amended Line of Credit will also be difficult to obtain and may
not be offered at a reasonable cost. Aside from limiting the Company's access to
additional capital in the near term to fund growth, the Company has been
relatively insulated from the effects of the dislocation in the capital markets.
While the market value of the Company's CMBS holdings has declined, the Company
invested in these bonds for the long term yields that they are expected to
produce. Management believes that the current market dislocation presents
significant investment opportunities for selective acquisitions of CMBS and that
the fundamental value of the real estate mortgages underlying these bonds has
been largely unaffected to date, although general economic conditions could
adversely impact real estate values in the future.
REIT STATUS
Management believes that the Company is operated in a manner that will enable it
to continue to qualify as a REIT for federal income tax purposes. As a REIT, the
Company will not pay income taxes at the trust level on any taxable income which
is distributed to its shareholders, although AMREIT II, Inc., its "Non-Qualified
REIT Subsidiary", may be subject to tax at the corporate level. Qualification
for treatment as a REIT requires the Company to meet certain criteria, including
certain requirements regarding the nature of its ownership, assets, income and
distributions of taxable income. The Company may, however, be subject to tax at
normal corporate rates on any ordinary income or capital gains not distributed.
17
18
YEAR 2000 ISSUE
General
Many of the world's computers, software programs and other equipment using
microprocessors or embedded chips currently have date fields that use two digits
rather than four digits to define the applicable year. These computers, programs
and chips may be unable to properly interpret dates beyond the year 1999; for
example, computer software that has date sensitive programming using a two-digit
format may recognize a date using "00" as the year 1900 rather than the year
2000. This inability to properly process dates is commonly referred to as the
"Year 2000 issue", the "Year 2000 problem" or "Millennium Bug." Such errors
could potentially result in a system failure or miscalculation causing
disruptions of operations, including, among other things, a temporary inability
to process transactions or engage in similar normal business activities, which,
in turn, could lead to disruptions in the Company's operations or performance.
All of the Company's information technology infrastructure is provided by the
Manager, and the Manager's systems are supplied by AMRESCO, INC. The Company's
assessments of the cost and timeliness of completion of Year 2000 modifications
set forth below are based on representations made to the Company and the best
estimates of the individuals within or engaged by AMRESCO, INC. charged with
handling the Year 2000 issue, which estimates were derived using numerous
assumptions relating to future events, including, without limitation, the
continued availability of certain internal and external resources and third
party readiness plans. Furthermore, as the AMRESCO, INC. Year 2000 initiative
(described below) progresses, AMRESCO, INC., the Manager and the Company
continue to revise estimates of the likely problems and costs associated with
the Year 2000 issue and to adapt contingency plans. However, there can be no
assurance that any estimate or assumption will prove to be accurate.
The AMRESCO, INC. Year 2000 Initiative
AMRESCO, INC. is conducting a comprehensive Year 2000 initiative with respect to
its internal business-critical systems, including those upon which the Company
depends. This initiative encompasses information technology ("IT") systems and
applications, as well as non-IT systems and equipment with embedded technology,
such as fax machines and telephone systems, which may be impacted by the Year
2000 issue. Business-critical systems encompass internal accounting systems,
including general ledger, accounts payable and financial reporting applications;
cash management systems; loan servicing systems; and decision support systems;
as well as the underlying technology required to support the software. The
initiative includes assessing, remediating or replacing, testing and upgrading
the business-critical IT systems of AMRESCO, INC. with the assistance of a
consulting firm that specializes in Year 2000 readiness. Based upon a review of
the completed and planned stages of the initiative, and the testing done to
date, AMRESCO, INC. does not anticipate any material difficulties in achieving
Year 2000 readiness with respect to its internal business-critical systems used
in connection with the operations of the Manager or the Company, and the Company
has received a written representation from AMRESCO, INC. that Year 2000
readiness was achieved by December 1998 with respect to all its internal
business-critical systems used in connection with the operations of the Manager
or the Company.
In addition to the internal IT systems and non-IT systems of AMRESCO, INC., the
Company may be at risk from Year 2000 failures caused by or occurring to third
parties. These third parties can be classified into two groups. The first group
includes borrowers, significant business partners, lenders, vendors and other
service providers with whom the Company, the Manager or AMRESCO, INC. has a
direct contractual relationship. The second group, while encompassing certain
members of the first group, is comprised of third parties providing services or
functions to large segments of society, both domestically and internationally,
such as airlines, utilities and national stock exchanges.
As is the case with most other companies, the actions the Company, the Manager
and AMRESCO, INC. can take to avoid any adverse effects from the failure of
companies, particularly those in the second group, to become Year 2000 ready is
extremely limited. However, AMRESCO, INC. has communicated with those companies
that have significant business relationships with AMRESCO, INC., the Manager or
the Company, particularly those in the first group, to determine their Year 2000
readiness status and the extent to which AMRESCO, INC., the Manager or the
Company could be affected by any of their Year 2000 readiness issues. In
connection with this process, AMRESCO, INC. has sought to obtain written
representations and other independent confirmations of Year 2000 readiness from
the third parties with whom AMRESCO, INC., the Manager or the Company has
material contracts. Responses from all third parties having material contracts
with AMRESCO, INC., the Manager or the Company have not been received, nor is it
likely that responses will be received from all such third parties. In addition
to contacting these third parties, where there are direct interfaces between the
18
19
systems of AMRESCO, INC. and the systems of these third parties in the first
group, AMRESCO, INC. plans to complete testing by the end of the second quarter
of 1999 in conformance with the Guidelines of the Federal Financial Institutions
Examination Council. Based on responses received and testing to date, it is not
currently anticipated that AMRESCO, INC., the Manager or the Company will be
materially affected by any third party Year 2000 readiness issues in connection
with the operations of the Manager or the Company.
For all business-critical systems interfaces used in connection with the
operations of the Manager and the Company, AMRESCO, INC. advised the Company
that readiness was achieved by December 31, 1998. Backup service providers that
have achieved Year 2000 readiness have been put in place for significant third
party providers that did not complete their Year 2000 initiatives by March 31,
1999.
There can be no assurance that the systems of AMRESCO, INC. or those of third
parties will not experience adverse effects after December 31, 1999.
Furthermore, there can be no assurance that a failure to convert by another
company, or a conversion that is not compatible with the systems of AMRESCO,
INC. or those of other companies on which the systems of AMRESCO, INC. rely,
would not have a material adverse effect on the Company.
Under the terms of the Company's Management Agreement with the Manager, all of
the costs associated with addressing the Company's Year 2000 issue are to be
borne by the Manager. Therefore, the Company does not anticipate that it will
incur material expenditures in connection with any modifications necessary to
achieve Year 2000 readiness.
Potential Risks
In addition to the internal systems of AMRESCO, INC. and the systems and
embedded technology of third parties with whom AMRESCO, INC., the Manager and
the Company do business, there is a general uncertainty regarding the overall
success of global remediation efforts relating to the Year 2000 issue, including
those efforts of providers of services to large segments of society, as
described above in the second group. Due to the interrelationships on a global
scale that may be impacted by the Year 2000 issue, there could be short-term
disruptions in the capital or real estate markets or longer-term disruptions
that would affect the overall economy.
Due to the general uncertainty with respect to how this issue will affect
businesses and governments, it is not possible to list all potential problems or
risks associated with the Year 2000 issue. However, some examples of problems or
risks to the Company that could result from the failure by third parties to
adequately deal with the Year 2000 issue include:
o in the case of lenders, the potential for liquidity stress due to
disruptions in funding flows;
o in the case of exchanges and clearing agents, the potential for funding
disruptions and settlement failures;
o in the case of counter parties, accounting and financial difficulties to
those parties that may expose the Company to increased credit risk; and
o in the case of vendors or providers, service failures or interruptions,
such as failures of power, telecommunications and the embedded technology
in building systems (such as HVAC, sprinkler and fire suppression,
elevators, alarm monitoring and security, and building and parking garage
access).
19
20
With respect to the Company's loan portfolios, risks due to the potential
failure of third parties to be ready to deal with the Year 2000 issue include:
o potential borrower defaults resulting from increased expenses or legal
claims related to failures of embedded technology in building systems, such
as HVAC, sprinkler and fire suppression, elevators, alarm monitoring and
security, and building and parking garage access;
o potential reductions in collateral value due to failure of one or more of
the building systems;
o interruptions in cash flow due to borrowers being unable to obtain timely
lease payments from tenants or incomplete or inaccurate accounting of
rents;
o potential borrower defaults resulting from computer failures of retail
systems of major tenants in retail commercial real estate properties such
as shopping malls and strip shopping centers;
o construction delays resulting from contractors' failure to be Year 2000
ready and increased costs of construction associated with upgrading
building systems to be Year 2000 compliant; and
o delays in reaching projected occupancy levels due to construction delays,
interruptions in service or other market factors.
These risks are also applicable to the Company's portfolio of CMBS as these
securities are dependent upon the pool of mortgage loans underlying them. If the
investors in these types of securities demand higher returns in recognition of
these potential risks, the market value of any CMBS portfolio of the Company
also could be adversely affected.
Additionally, the Company has made equity investments in a partnership that will
ultimately own interests in five grocery-anchored shopping centers and in a
partnership which owns a suburban office building. These operations will be
subject to many of the risks set forth above. Although the Company intends to
monitor Year 2000 readiness, there can be no guarantee that all building systems
will be Year 2000 compliant.
The Company believes that the risks most likely to affect the Company adversely
relate to the failure of third parties, including its borrowers and sources of
capital, to achieve Year 2000 readiness. If its borrowers' systems fail, the
result could be a delay in making payments to the Company or the complete
business failure of such borrowers. The failure, although believed to be
unlikely, of the Company's sources of capital to achieve Year 2000 readiness
could result in the Company being unable to obtain the funds necessary to
continue its normal business operations.
Some of the risks associated with the Year 2000 issue may be mitigated through
insurance maintained or purchased by the Company, its affiliates, its business
partners, borrowers and vendors. However, the scope of insurance coverage in
addressing these potential issues under existing policies has yet to be tested,
and the economic impact on the solvency of the insurers has not been explored.
Therefore, no assurance can be given that insurance coverage will be available
or, if it is available, that it will be available on a cost-effective basis or
that it will cover all or a significant portion of any potential loss.
Business Continuity/Disaster Recovery Plan
AMRESCO, INC. currently has a business continuity/disaster recovery plan that
includes business resumption processes that do not rely on computer systems and
the maintenance of hard copy files, where appropriate. The business
continuity/disaster recovery plan is monitored and updated as potential Year
2000 readiness issues of AMRESCO, INC. and third parties are specifically
identified. Due to the inability to predict all of the potential problems that
may arise in connection with the Year 2000 issue, there can be no assurance that
all contingencies will be adequately addressed by such plan.
20
21
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q are not based on historical facts
and are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. The Company intends that
forward-looking statements be subject to such Act and any similar state or
federal laws. Forward-looking statements, which are based on various
assumptions, include statements regarding the intent, belief or current
expectations of the Company, its Manager, and their respective Trustees or
directors and officers, and may be identified by reference to a future period or
periods or by use of forward-looking terminology such as "intends," "may,"
"could," "will," "believe," "expect," "anticipate," "plan," or similar terms or
variations of those terms or the negative of those terms. Actual results could
differ materially from those set forth in forward-looking statements due to
risks, uncertainties and changes with respect to a variety of factors,
including, but not limited to, changes in international, national, regional or
local economic environments, changes in prevailing interest rates, credit and
prepayment risks, basis and asset/liability risks, spread risk, event risk,
conditions which may affect public securities and debt markets generally or the
markets in which the Company operates, the Year 2000 issue, the availability of
and costs associated with obtaining adequate and timely sources of liquidity,
dependence on existing sources of funding, the size and liquidity of the
secondary market for commercial mortgage-backed securities, geographic or
product type concentrations of assets (temporary or otherwise), hedge mismatches
with liabilities, other factors generally understood to affect the real estate
acquisition, mortgage and leasing markets and securities investments, changes in
federal income tax laws and regulations, and other risks described from time to
time in the Company's SEC reports and filings, including its registration
statement on Form S-11 and periodic reports on Form 10-Q, Form 8-K and Form
10-K.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is a party to various financial instruments which are subject to
market risk. These instruments include mortgage loan investments, investments in
commercial mortgage-backed securities ("CMBS") and certain of the Company's
borrowing facilities. The Company is also a party to an interest rate cap
agreement which it entered into in order to mitigate the market risk exposure
associated with its credit facilities. The Company's financial instruments
involve, to varying degrees, elements of interest rate risk. Additionally, the
Company's investment portfolio, which is comprised of both financial instruments
(mortgage loans and CMBS) and equity investments in real estate, is subject to
real estate market risk. The Company is a party to certain other financial
instruments, including trade receivables and payables and amounts due to
affiliates which, due to their short-term nature, are not subject to market
risk. For a discussion of market risk exposures, reference is made to Item 7A.
"Quantitative and Qualitative Disclosures About Market Risk" in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998. The market risk
exposures described therein have not materially changed since December 31, 1998;
accordingly, no additional discussion or analysis is provided in this Form 10-Q.
21
22
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
On April 30, 1999, the Company (through a majority-owned partnership) acquired
interests in three newly constructed, grocery-anchored shopping centers in the
Dallas/Fort Worth, Texas area. The properties include an 86,516 square foot
facility in Flower Mound, Texas, a 61,440 square foot facility in Fort Worth,
Texas and an 85,611 square foot facility in Grapevine, Texas. Completion of
construction of the grocery store anchor space and occupancy of such space
occurred less than ninety days prior to the acquisition of the properties by the
Company. Leases with the grocery store anchor tenant were executed effective as
of the closing date.
Acquisition costs for the properties totaled $30.7 million. The acquiring
partnerships financed the acquisitions with $19.5 million of non-recourse loan
proceeds from an unaffiliated third party and $11.4 million in equity
contributions from the Company. Construction and leasing of additional
side-store space is planned to take place in the future and is expected to
require an additional $1.0 million equity investment by the Company.
Effective as of May 4, 1999, the Company (and certain of its subsidiaries)
entered into an Amended and Restated Interim Warehouse and Security Agreement
(the "Amended Line of Credit") with Prudential Securities Credit Corporation
("PSCC"); the agreement amended the Company's existing line of credit with PSCC.
The Amended Line of Credit provides for the following modifications: (1) a
reduction in the size of the committed facility from $400 million to $300
million; (2) the elimination of the requirement that assets financed with
proceeds from the facility must be securitizable; (3) a reduction in the amount
of capital the Company must fund with respect to construction and rehabilitation
loans before PSCC is required to begin advancing funds; (4) an extension of the
maturity date from July 1, 2000 to November 3, 2000; and (5) the modification
to, and addition of, certain sublimits on certain types of loans and assets.
Under the Amended Line of Credit, borrowings bear interest at LIBOR plus 1.25%
per annum to the extent such borrowings do not exceed the Company's Tangible Net
Worth, as defined; borrowings in excess of the Company's Tangible Net Worth bear
interest at LIBOR plus 3%.
As compensation for amending the existing line of credit and extending the
maturity date, the Company granted warrants to Prudential Securities
Incorporated, an affiliate of PSCC, to purchase 250,002 common shares of
beneficial interest at $9.83 per share. The exercise price represents the
average closing market price of the Company's common shares for the ten-day
period ending on May 3, 1999. The warrants were issued in lieu of a commitment
fee or other cash compensation.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits and Exhibit Index
Exhibit No.
4.1 Rights Agreement, dated as of February 25, 1999,
between the Company and The Bank of New York, as
Rights Agent, which includes: as Exhibit A
thereto, the Form of Statement of Designation of
Series A Junior Participating Preferred Shares,
par value $.01 per share, of the Company; as
Exhibit B thereto, the Form of Right Certificate;
and as Exhibit C thereto, the Summary of Rights to
Purchase Preferred Shares (filed as Exhibit 1 to
the Registrant's Current Report on Form 8-K dated
February 25, 1999, which exhibit is incorporated
herein by reference).
10.1 Amended and Restated Interim Warehouse and
Security Agreement dated as of May 4, 1999, by and
among Prudential Securities Credit Corporation and
AMRESCO Capital Trust, AMREIT I, Inc., AMREIT II,
Inc., ACT Equities, Inc. and ACT Holdings, Inc.
10.2 Warrant Agreement dated as of May 4, 1999 between
AMRESCO Capital Trust and Prudential Securities
Incorporated.
27 Financial Data Schedule.
22
23
(b) Reports on Form 8-K. The following reports on Form 8-K were
filed with respect to events occurring during the quarterly
period for which this report is filed:
(i) Form 8-K dated February 25, 1999 and filed with
the Commission on March 4, 1999, reporting the
adoption of a Shareholder Rights Agreement under
Item 5 of such form.
23
24
SIGNATURE
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.
AMRESCO CAPITAL TRUST
Registrant
Date: May 13, 1999 By: /s/Thomas J. Andrus
------------------------
Thomas J. Andrus
Executive Vice President
and Chief Financial Officer
24
25
INDEX TO EXHIBITS
EXHIBIT
No. DESCRIPTION
------- -----------
4.1 Rights Agreement, dated as of February 25, 1999,
between the Company and The Bank of New York, as
Rights Agent, which includes: as Exhibit A
thereto, the Form of Statement of Designation of
Series A Junior Participating Preferred Shares,
par value $.01 per share, of the Company; as
Exhibit B thereto, the Form of Right Certificate;
and as Exhibit C thereto, the Summary of Rights to
Purchase Preferred Shares (filed as Exhibit 1 to
the Registrant's Current Report on Form 8-K dated
February 25, 1999, which exhibit is incorporated
herein by reference).
10.1 Amended and Restated Interim Warehouse and
Security Agreement dated as of May 4, 1999, by and
among Prudential Securities Credit Corporation and
AMRESCO Capital Trust, AMREIT I, Inc., AMREIT II,
Inc., ACT Equities, Inc. and ACT Holdings, Inc.
10.2 Warrant Agreement dated as of May 4, 1999 between
AMRESCO Capital Trust and Prudential Securities
Incorporated.
27 Financial Data Schedule.