EXHIBIT 99
INDEPENDENT AUDITORS' REPORT
To the Members of ARCap Investors, L.L.C.:
We have audited the accompanying consolidated balance sheet of ARCap Investors,
L.L.C. and subsidiary (the "Company") as of December 31, 2000, and the related
consolidated statements of income and comprehensive income, members' equity and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company and subsidiary as of
December 31, 2000, and the results of their operations and their cash flows for
the year then ended in conformity with accounting principles generally accepted
in the United States of America.
/s/ DELOITTE & TOUCHE LLP
Dallas, Texas
January 22, 2001
ARCap Investors, L.L.C.
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2000
Assets
Investment securities - trading $214,000,516
Investment securuties - available-for-sale 76,092,175
Cash and cash equivalents 2,675,475
Restricted cash 683,520
Receivable for security sold 13,372,667
Accrued interest receivable 3,165,177
Other assets 352,373
--------------
Total $310,341,903
===========
Liabilities and Members' Equity
Liabilities:
Accrued expenses $ 546,712
Accrued interest payable 3,203,432
Securities sold under agreement to repurchase-
repurchase agreements 123,483,443
Borrowed investment security - liability, net 6,078,876
-------------
Total liabilities 133,312,463
Commitments and Contingencies (Note 7)
Minority interests 2,221
Members' Equity 177,027,219
-----------
Total $310,341,903
===========
The accompanying notes are an integral part of these consolidated financial
statements.
ARCap INVESTORS, L.L.C.
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
YEAR ENDED DECEMBER 31, 2000
REVENUES:
Interest and other investment income $26,873,191
Loss on trading securities, net (6,942,136)
------------
Total revenues 19,931,055
EXPENSES:
General and administrative 2,232,077
Interest 5,044,681
Management fee 825,142
Minority interest 3,365
-------------
Total expenses 8,105,265
-----------
NET INCOME 11,825,790
OTHER COMPREHENSIVE INCOME - Unrealized holding
gain (loss) on investment securities - available-for-sale 4,400,901
-----------
COMPREHENSIVE INCOME $16,226,691
==========
The accompanying notes are an integral part of these consolidated financial
statements.
ARCap INVESTORS, L.L.C.
CONSOLIDATED STATEMENT OF MEMBERS' EQUITY
YEAR ENDED DECEMBER 31, 2000
Accumulated
Series A Other Com- Total
Common Preferred Preferred prehensive Members'
Members Members Members Income Equity
BALANCE, JANUARY 1, 2000 $60,904,584 $34,966,975 $ - $(1,297,056)$ 94,574,503
Proceeds from issuance of
membership units - - 81,750,000 - 81,750,000
Costs to raise capital - - (4,173,592) - (4,173,592)
Distributions (7,426,558) (3,277,183) (646,642) (11,350,383)
Net income 6,721,605 2,334,498 2,769,687 - 11,825,790
Other comprehensive
income - unrealized gain
on investment securities -
available-for-sale - - - 4,400,901 4,400,901
Contributions of REMICap
(Note 2)
Recapitalization 28,019,990 (34,024,290) 6,004,300 - -
---------- ----------- -------------------------------------------------
BALANCE, DECEMBER 31, 2000 $88,219,621 $ - $85,703,753$3,103,845 $177,027,219
========== =================== ========== ========= ===========
The accompanying notes are an integral part of these consolidated financial
statements.
ARCap INVESTORS, L.L.C.
CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2000
Operating activities:
Net income $11,825,790
Adjustments to reconcile net income to net cash
used in operating activities:
Loss on trading securities 6,942,136
Accretion of interest income (3,332,291)
Minority interest 3,365
(Increase) decrease in cash for changes in
operating assets and liabilities:
Restricted cash (57,100)
Investment securities - trading (100,674,955)
Securities purchased under agreement to resell and
proceeds from borrowed security, net (5,664,448)
Receivable for security sold (13,372,667)
Accrued interest receivable (1,247,297)
Other assets 106,468
Accrued expenses and interest payable 3,264,334
------------
Net cash used in operating activities (102,206,665)
------------
Investing activities - Purchase of investment securities-
available-for-sale (11,985,869)
---------------
Financing activities:
Contributions from members 81,750,000
Distributions to members (11,350,383)
Payment of issuance costs (4,173,592)
Distributions to minority interest members (1,154)
Proceeds from other borrowings and securities
sold under agreement to repurchase, net 46,194,085
------------
Net cash provided by financing activities 112,418,956
-----------
Net decrease in cash and cash equivalents (1,773,578)
Cash and cash equivalents, beginning of year 4,449,053
-------------
Cash and cash equivalents, end of year $ 2,675,475
=============
Supplemental disclosure of cash flow information -
Cash payments for interest $ 4,652,352
=============
The accompanying notes are an integral part of these consolidated financial
statements.
ARCap INVESTORS, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATMENTS
YEAR ENDED DECEMBER 31, 2000
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization - ARCap Investors, L.L.C. (the "Company") was incorporated in
January 1999 and commenced its operations on March 17, 1999. The Company was
organized to invest primarily in subordinated commercial mortgage-backed
securities ("CMBS").
Principles of Consolidation - The consolidated financial statements include the
accounts of the Company and ARCap REIT, Inc., its majority-owned subsidiary. All
material intercompany transactions and account balances have been eliminated in
consolidation.
Investment Securities - The Company's investment security transactions are
recorded on the trade date. CMBS that are designated as trading assets are
securities that the Company is holding for possible sales or other dispositions
in the near term. Such securities are carried at their estimated fair value,
with unrealized gains or losses included in earnings.
The Company's CMBS that are designated as available-for-sale are securities that
the Company considers for possible sales or other dispositions prior to the
maturity of the bond and are generally of a nonrated class. Any unrealized gains
and losses on securities available-for-sale are reported in other comprehensive
income, a separate component of members' equity.
Interest income is recognized as earned and includes amortization of premiums
and accretion of discounts, computed using the effective yield method over the
expected life of these mortgage assets.
Derivative Financial Instruments - Derivative financial instruments are utilized
by the Company to reduce interest rate risk. Derivative financial instruments
include interest rate swaps. The Company utilizes interest rate swap agreements
as a means of hedging the potential financial statement impact of changes in the
fair value of its portfolio of CMBS due to changes in interest rates. These
contracts involve the agreement between two parties to make periodic payments to
each other for an agreed-upon period of time based upon a notional amount of
principal. Under this agreement, a fixed rate of interest on the notional amount
is exchanged for a stream of payments similarly calculated but using a floating
rate of interest. Risks in these contracts arise from the movements in interest
rates and from the possible inability of counterparties to meet the terms of
their contracts. The Company carries interest rate swaps at market value, and
any unrealized gain (loss) is included in earnings.
Resale and Repurchase Agreements and Securities Lending Agreements -
Transactions involving purchases of securities under agreements to resell
(reverse repurchase agreements or reverse repos) or sales of securities under
agreements to repurchase (repurchase agreements or repos) are accounted for as
collateralized financings, except where the Company does not have an agreement
to sell (or purchase) the same or substantially the same securities before
maturity at a fixed or determinable price.
Cash and Cash Equivalents - Cash and cash equivalents include all highly liquid
investments with original maturities of three months or less.
Restricted Cash - Restricted cash represents amounts required to be pledged
under an interest rate swap agreement (see Note 3).
Income Taxes - The Company has elected to be taxed similar to a partnership,
whereby all income is taxed at the member level.
Use of Estimates - The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
reported amounts of certain assets, liabilities, revenues and expenses. Actual
results may differ from those estimates.
Fair Value of Financial Instruments - The estimated fair value amounts herein
have been determined by the Company using available market information and
appropriate valuation methodologies. However, considerable judgment is required
to interpret market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the amounts
that the Company could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair value amounts.
The Company's portfolio of CMBS and securities borrowed are carried at their
estimated fair values. The Company's management believes that the fair values of
its cash and cash equivalents, restricted cash and repurchase agreements
approximate their carrying values due to the nature of the instruments or the
fact that their terms approximate current market terms.
Change in Accounting Standard - Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended, was adopted by the Company on January 1, 2001. This
standard requires that all derivative financial instruments be recognized as
either assets or liabilities on the balance sheet at their fair values and that
accounting for the changes in fair values is dependent upon the intended use of
the derivatives and their resulting designations. The adoption of this standard
did not have a material effect on the Company's consolidated financial
statements.
2. MEMBERS' EQUITY
Prior to August 4, 2000, interests in the Company were available in units
requiring commitments of $1 million. There was an aggregate of 100 units each of
common and preferred interests available for subscription. Each member was
required to subscribe for a minimum of five units. However, the Managing Member
may have, at its sole discretion, permitted subscription for a lesser amount.
Member contributions were made upon calls of the required capital commitments.
Prior to August 4, 2000, distributions of Taxable Cash Flows were made as
follows:
- To the preferred members in an amount equal to the accrued Annual
Return.
- To the common members in an amount equal to the accrued Annual Return.
- The remaining Taxable Cash Flows were distributed 20% to the
preferred members and 80% to the common members.
Prior to August 4, 2000, distributions of Nontaxable Cash Flows were made
as follows:
- - To the preferred members until they had received an amount equal to their
aggregate capital contributions plus the Excess Income previously allocated to
them.
- - To the common members until they had received an amount equal to their
aggregate capital contributions plus the Excess Income previously allocated to
them.
Prior to August 4, 2000, net income of the Company was allocated first to the
members in the amount of Taxable Cash Flow distributed or distributable to them.
Excess income was allocated 20% to the preferred members and 80% to the common
members.
Reorganization - On August 4, 2000, the Company amended and restated its
Limited Liability Company Agreement (the "LLC Agreement"). The LLC
Agreement established two classes of membership: Series A Preferred
members and Common members. Subscriptions for Series A Preferred Units
shall be made for no less than 400,000 units ($10,000,000) unless the
Board of Managers, in its sole discretion, permits subscription for some
lesser number of units.
The LLC Agreement gave the existing members holding Preferred Units the
option of converting their Preferred Units into either Series A Preferred
Units at a conversion rate of $25.00 per Series A Preferred Unit or new
Common Units at a conversion rate of $21.74 per new Common Unit. The
existing members' Common Units were converted into new Common Units at a
conversion rate of $21.74 per Common Unit.
The LLC Agreement calls for distributions of Cash Flows as follows:
- To the Series A Preferred members in an amount equal to the accrued and
unpaid Preferred Distributions (12% per annum of the $25.00 price per
Unit).
- To the Common members in an amount equal to (a) during the 18-month
period following the First Closing Date, the amount determined by the
Board of Managers, but no more than a cumulative return on the Common
Units at the rate of 10% per annum, and (b) subsequent to such 18-month
period, the amount determined by the Board of Managers, provided that if
the amount distributable to the Common members shall exceed a cumulative
annual return on the Common Units of 12% per annum, the Board of Managers
shall notify the Series A Preferred members 30 days in advance of the
record date for distribution of Cash Flow.
- To the extent that any remaining Cash Flow received during such tax
period is not includable in the income of the Company, to members that
have been allocated Net Profits in excess of amounts actually distributed
to such members, in proportion to such amounts.
Net Profits of the Company are allocated as follows:
- To the Series A Preferred members to the extent of amounts distributed
or distributable to them in such taxable year.
- To the Series A Preferred members to the extent Net Losses previously
allocated to such members exceed undistributed Net Profits previously
allocated to them.
- To the Common members to the extent of amounts distributed or
distributable to them in such taxable year.
- To the Common members to the extent Net Losses previously allocated to
such members exceed undistributed Net Profits previously allocated to
them.
- To the members in proportion to their Percentage Interests.
Net Losses of the Company are allocated as follows:
- To the members in an amount equal to undistributed Net Profits allocated
to such member.
- To the Common members pro rata to the extent of their Capital Accounts.
- To the Series A Preferred members pro rata to the extent of their
Capital Accounts.
Contribution of REMICap, L.L.C. - The Company received select nonmonetary
intangible assets, primarily employees, business processes and the
Company's management agreement, from REMICap, L.L.C. ("REMICap"), an
affiliate and sponsor of the Company, on August 4, 2000. In exchange for
these nonmonetary assets, the Company issued 459,982 of Common Units, with
an agreed-upon value of $21.74 per unit, to the members of REMICap. Since
the Company did not receive any tangible assets, the $10,000,000 value of
the Common Units granted to the members of REMICap has been recorded as
the issuance of equity and a distribution to REMICap with no net impact in
the members' equity section of the accompanying consolidated financial
statements.
Series A Preferred Units - Series A Preferred Units are convertible into
Common Units at the Conversion Price in effect on the Conversion Date. If
the Series A Preferred Units have not been converted within five years of
August 4, 2000, Series A Preferred Units may, at the holder's option, be
converted to a note equal to $25.00 per Unit, plus accrued and unpaid
Preferred Distributions.
Eighteen months after the First Closing Date (February 4, 2002), but no
later than the fifth anniversary of the First Closing Date (August 4,
2005), the Company may redeem the Series A Preferred Units for $25.00 per
Unit, plus accrued and unpaid Preferred Distributions, plus a premium that
will provide the Series A Preferred members with a total pretax internal
rate of return of 17.50%.
In addition, upon either a change in control or sale or transfer of all or
substantially all of the assets of the Company, Series A Preferred Units
may, at the holder's option, be redeemed at $25.00 per Unit, plus accrued
and unpaid Preferred Distributions.
Subsequent to the Company's amendment and restatement of its LLC
Agreement, the Company circulated an amended Private Placement Memorandum
(the "PPM") for 5,739,741 Units of Series A Preferred Membership Interests
representing the balance of such interests available for subscription in
the Company's offering. As of December 31, 2000, 3,270,000 Units have been
issued pursuant to the Company's offering for total capital contributions
of $81,750,000.
At December 31, 2000, there were a total of 3,530,259 and 5,008,292 Series
A Preferred Units and Common Units, respectively, issued and outstanding.
3. INVESTMENT SECURITIES
The Company's trading securities are carried at estimated fair value and
comprise the following at December 31, 2000:
Fair Value Percentage
---------- ----------
Subordinated CMBS:
Security rating:
BB $ 29,242,773 13.66%
BB- 33,079,593 15.46
B+ 55,017,330 25.71
B 59,213,811 27.67
B- 37,101,774 17.34
Interest rate swap 345,235 0.16
------------ -------
$214,000,516 100.00%
===========
The fair value of the Company's portfolio of CMBS is generally estimated
by management based on market prices provided by certain dealers who make
a market in these financial instruments. The market for the Company's CMBS
may lack liquidity and have limited market volume. Accordingly, the fair
values reported reflect estimates and may not necessarily be indicative of
the amounts that the Company could realize in a current market exchange.
The yield to maturity on the Company's CMBS depends on, among other
things, the rate and timing of principal payments, the pass-through rate
and interest rate fluctuations. The subordinated CMBS interests owned by
the Company provide credit support to the more senior interests of the
related commercial securitization. Cash flow from the mortgages underlying
the CMBS interests generally is allocated first to the senior interests,
with the most senior interest having a priority entitlement to cash flow.
Remaining cash flow is allocated generally among the other CMBS interests
in order of their relative seniority. To the extent that there are
defaults and unrecoverable losses on the underlying mortgages, resulting
in reduced cash flows, the most subordinated CMBS interest will bear this
loss first. To the extent that there are losses in excess of the most
subordinated interest's stated entitlement to principal and interest, then
the remaining CMBS interests will bear such losses in order of their
relative subordination.
The gross unrealized gain and loss on the Company's trading investment
securities at December 31, 2000, were $3,456,361 and $1,297,657,
respectively.
At December 31, 2000, the Company had one open interest rate swap
agreement with Bear Stearns Capital Markets with a notional amount of
$31,321,000, on which the Company pays a fixed rate of 5.952% and receives
a variable rate based upon a six-month LIBOR for a term of 10 years ending
April 9, 2009. The variable rate in effect as of December 31, 2000, was
6.76%. The swap agreement calls for interest to be paid semiannually in
arrears. The Company carries the swap agreement at its estimated fair
value, with all periodic changes in estimated fair value recognized in
earnings. The Company was required under the swap agreement to pledge
$626,420 of cash to ensure its performance in the event that the swap
declines in value. If the market value of the swap decreases, the Company
may be required to deposit additional restricted cash.
The Company's available-for-sale CMBS are carried at estimated fair value.
As of December 31, 2000, the CMBS have an amortized cost of $72,988,330,
gross unrealized gains of $5,046,518, gross unrealized losses of
$1,942,673 and an estimated fair value of $76,092,175. The nonrated CMBS
have maturity dates ranging from March 2009 to September 2029. The Company
reports any unrealized gains and losses on these assets in accumulated
other comprehensive income, a separate component of members' equity.
4. BORROWED INVESTMENT SECURITIES, NET
At December 31, 2000, the Company had borrowed U.S. Treasury securities
with face amounts totaling $203,135,000. The fair value of these borrowed
U.S. Treasury securities at December 31, 2000, was $213,422,545. The U.S.
Treasury securities were sold in the open market (i.e., a "short" security
sale). The Company is obligated to return the securities in the future and
is therefore exposed to price risk until it repurchases the securities for
delivery to the lender. Short security sales are used by the Company to
modify its interest rate risk. The Company must pay the security lender
the interest earned by the underlying security. Short security sales are
recorded at the estimated fair market value of the borrowed securities,
and any unrealized gains (losses) are included in earnings. The unrealized
loss on the short securities at December 31, 2000, was $12,236,377, which
is included in loss on trading securities in the accompanying consolidated
financial statements.
Proceeds from short security sales are used to purchase reverse repurchase
agreements of the same security. The transactions are governed by one
master repurchase agreement with rights of offset, and therefore, the
values of the short security sales and reverse repurchase agreements have
been offset and shown as one line item in the accompanying consolidated
financial statements. It has been the Company's practice to settle these
transactions on a net basis.
5. REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements to finance a portion of
its CMBS purchases. As of December 31, 2000, the Company had entered into
repurchase obligations in the amount of $123,483,443. The weighted average
maturity of the agreements as of December 31, 2000, was 234 days, and the
weighted average interest rate was 8.43%. The repurchase agreements are
collateralized by a portion of the Company's rated portfolio of CMBS
investments.
6. OTHER BORROWINGS
On September 30, 1999, the Company entered into an agreement with American
Mortgage Acceptance Company ("AMAC") regarding the sale of certain CMBS
owned by the Company. The Company sold CMBS with a face value of
$50,399,771 for $35,622,358 to AMAC (the "Bonds"). A portion of the sales
price, $21,310,000, represented a liability that was assumed by AMAC. If
at any time through September 30, 2001, the Company desired to
resecuritize its CMBS, the Company could have notified AMAC of its intent
to repurchase the Bonds. At such time, AMAC could have either:
(a) Resold the Bonds to the Company at a Determination Price as of
the Pricing Date.
(b) Participated and included all of the Bonds in the
resecuritization of the CMBS by the Company on the same terms and
conditions as the Company.
(c) Subscribed for Preferred Membership Interests of the Company in
exchange for all, or a portion of, the Bonds at a Determination Price as
of a Pricing Date.
Since AMAC was under obligation to return the Bonds to the Company upon
request by the Company, the transaction was recorded as a secured
borrowing in accordance with SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." At the
time of sale, the security was transferred from investment securities -
trading to investment securities - available-for-sale.
On October 27, 2000, the Company repurchased the Bonds from AMAC for
$36,764,227. Simultaneous with this transaction, AMAC contributed
$20,000,000 to the Company in exchange for 800,000 Units of Series A
Preferred Membership Interests.
7. OPERATING LEASES
In conjunction with the Company's receipt of select assets from REMICap
(see Note 2), the Company consented to the assumption of the leases, which
were previously in the name of REMICap. The Company leases its office
space and certain equipment under operating leases that expire between
October 2002 and December 2005. The office lease provides for an annual
basic rental of $180,504 during the initial lease term and contains an
option to extend the term of the lease for one extension term of five
years, with the basic rental being reset at the then market rate. Future
minimum lease payments under these leases are as follows:
Year ending December 31:
2001 $190,692
2002 189,754
2003 185,065
2004 185,065
2005 166,602
-------
Total $917,178
=======
Lease expense for the year ended December 31, 2000, was approximately
$44,000.
8. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES
Prior to August 4, 2000, the Company was managed by ARCap Management,
L.L.C. ("ARCap Management") and had a management agreement (the
"Management Agreement") with APOLLO ARCap, L.L.C. and REMICap (the
"Managers") to provide the Company's day-to-day operations, subject to the
direction and oversight of ARCap Management. The Managers were direct and
indirect members of the Company. The Company paid the Managers an annual
base management fee equal to 1% of the assets of the Company, as further
defined in the Company's PPM dated January 1999. In addition, the Managers
were to perform all due diligence required to make a prudent investment in
CMBS. Fees for such due diligence were $1,650 per asset for desktop
evaluations and $500 per asset for site visits in connection with the
Company's investment in CMBS. During the year ended December 31, 2000,
asset management fees totaling approximately $825,000 under the Management
Agreement were incurred. Due diligence fees totaling approximately
$333,000 under the Management Agreement were incurred and are recorded as
general and administrative expenses in the accompanying consolidated
financial statements. In conjunction with the Company's receipt of select
assets from REMICap (see Note 2), the Management Agreement was effectively
terminated on August 4, 2000.
At times, the Company purchases investment securities from members of the
Company or their affiliates. These purchases and sales represent
transactions that are in the normal course of business of the Company and
the members. During the year ended December 31, 2000, the Company
purchased CMBS with face values totaling $188,698,755 for a purchase price
of $119,279,530 from such members.
The Company granted loans to key executives during the year ended December
31, 2000. The loans allow for the executives to borrow up to $293,000. As
of December 31, 2000, approximately $197,000 had been lent to these
executives. These amounts are classified as other assets in the
consolidated balance sheet. The loans bear interest at a rate of 7% per
annum, and payments are due quarterly on the distribution date for the
Common Units. Payments are due only to the extent that the quarterly
distribution is sufficient to pay them, and recourse is limited to the
Common Units securing the loans. The loans become due upon termination of
the executives' employment with the Company, and recourse is limited to
the Common Units securing the loans.
9. SUBSEQUENT EVENT (UNAUDITED)
On February 22, 2001, the Company entered into an agreement to sell its
interests in 52 CMBS pass-through certificates (the "Pooled Certificates") from
10 different series issued from 10 different trusts. The Pooled Certificates
have a maturity date of February 21, 2013 and have stated rates of interest
between 6.73% and 7.17%.The Company received approximately $236,000,000 in
proceeds in exchange for the Pooled Certificates; the proceeds were used to pay
down the securities sold under agreements to repurchase.
Since the holders of the pooled certificates have a redemption right and
as the transaction allows for the right of substitution, the transaction
is recorded as a secured borrowing.