Exhibit 99 (b)
CONSOLIDATED FINANCIAL STATEMENTS
ARCap Investors, L.L.C. and Subsidiaries
YEAR ENDED DECEMBER 31, 2003
ARCap Investors, L.L.C. and Subsidiaries
Consolidated Financial Statements
Year ended December 31, 2003
CONTENTS
Report of Independent Auditors.................................................1
Audited Consolidated Financial Statements
Consolidated Balance Sheet.................. ..................................2
Consolidated Statement of Operations...........................................3
Consolidated Statement of Members' Equity.... .................................4
Consolidated Statement of Cash Flows.......... ................................5
Notes to Consolidated Financial Statements.....................................6
Report of Independent Auditors
The Board of Managers
ARCap Investors, L.L.C.
We have audited the accompanying consolidated balance sheet of ARCap Investors,
L.L.C. and subsidiaries (the Company) as of December 31, 2003, and the related
consolidated statements of operations, 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. 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, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of ARCap Investors,
L.L.C. and subsidiaries at December 31, 2003, and the consolidated results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
February 6, 2004
ARCap Investors, L.L.C. and Subsidiaries
Consolidated Balance Sheet
December 31, 2003
ASSETS
Investment securities - available-for-sale, net (NOTE 3) $ 739,048,867
Investment securities - trading, net (NOTE 3) 282,157,427
Accrued interest receivable 11,433,408
Deferred borrowing costs, net (NOTE 5) 9,331,954
Restricted cash - CBO swap (NOTE 5) 4,376,111
Cash and cash equivalents 2,657,131
Other assets 1,207,425
--------------
Total assets $1,050,212,323
==============
LIABILITIES AND MEMBERS' EQUITY
Liabilities:
Long-term debt (NOTE 5) $ 461,800,000
Repurchase agreements (NOTE 6) 163,011,000
CBO swap liability (NOTE 5) 4,125,000
Accrued interest payable 2,839,836
Deferred compensation (NOTE 10) 3,140,244
Borrowed investment securities and interest rate swap, net (NOTE 4) 2,155,215
Accrued expenses 985,520
--------------
Total liabilities 638,056,815
Commitments and contingencies
Minority interest in consolidated entities 202,589,352
Members' equity:
Series A preferred members 67,367,415
Common members 142,198,741
--------------
Total members' equity 209,566,156
--------------
Total liabilities and members' equity $1,050,212,323
==============
SEE ACCOMPANYING NOTES.
2
ARCap Investors, L.L.C. and Subsidiaries
Consolidated Statement of Operations
Year ended December 31, 2003
Revenues:
Interest income - CMBS $ 100,309,513
Other income 4,602,285
-------------
Total revenues 104,911,798
Expenses:
Interest - long-term debt and repurchase agreements 28,314,158
Interest - borrowed investment securities and interest rate swap, net 8,372,835
Salaries and employee benefits 8,831,993
General and administrative 4,398,268
Financing fee 1,180,000
-------------
Total expenses 51,097,254
-------------
Net margin on CMBS and other income 53,814,544
Other revenue (expense):
Accretion of purchase discount 9,753,013
Loss on investment securities, net (NOTE 7) (37,655,565)
-------------
Deferred compensation expense (NOTE 10) (3,140,244)
-------------
(31,042,796)
Income before minority interest 22,771,748
Minority interest (6,630,611)
-------------
Net income 16,141,137
Other comprehensive income:
Unrealized gain on available-for-sale securities, net of minority
interest of $4,620,290 2,240,385
-------------
Comprehensive income $ 18,381,522
=============
SEE ACCOMPANYING NOTES.
3
ARCap Investors, L.L.C. and Subsidiaries
Consolidated Statement of Members' Equity
SERIES A
COMMON PREFERRED
MEMBERS MEMBERS TOTAL
------------- ------------- -------------
BALANCE AT JANUARY 1, 2003 $ 77,779,421 $ 147,340,254 $ 225,119,675
Distributions (10,867,864) (18,135,326) (29,003,190)
Net income -- 16,141,137 16,141,137
Surrender of common units (31,851) -- (31,851)
Costs to raise capital (8,487) 8,487 --
Redemption of preferred units 100,000 (5,000,000) (4,900,000)
Other comprehensive income:
Unrealized gain on available
for - sale securities 396,196 1,844,189 2,240,385
------------- ------------- -------------
BALANCE AT DECEMBER 31, 2003 $ 67,367,415 $ 142,198,741 $ 209,566,156
SEE ACCOMPANYING NOTES.
4
ARCap Investors, L.L.C. and Subsidiaries
Consolidated Statement of Cash Flows
Year ended December 31, 2003
OPERATING ACTIVITIES
Net income $ 16,141,137
Adjustments to reconcile net income to net cash
used in operating activities:
Loss on investment securities, net 37,655,565
Accretion of purchase discount (9,753,013)
Amortization of deferred borrowing costs 1,045,824
Minority interest 6,630,611
Deferred compensation 3,140,244
Changes in operating assets and liabilities:
Investment securities - trading, net (151,017,303)
Accrued interest receivable (2,190,366)
Restricted cash - CBO swap (50,263)
Other assets (517,015)
Accrued interest payable (2,013,921)
Borrowed investment securities and interest
rate swap, net (6,218,328)
Accrued expenses 641,739
-------------
Net cash used in operating activities (106,505,089)
INVESTING ACTIVITIES
Purchases of investment securities - available-for-sale (88,488,096)
FINANCING ACTIVITIES
Distributions to members (28,867,864)
Contributions from minority interest members, net of
capital returned 16,821,400
Operating distributions to minority interest members (17,820,580)
Redemption of preferred units (4,900,000)
Proceeds from repurchase agreements 7,588,000
Proceeds from the issuance of long-term debt 225,800,000
Payment for deferred borrowing costs (5,924,028)
-------------
Net cash provided by financing activities 192,696,928
-------------
Net change in cash and cash equivalents (2,296,257)
Cash and cash equivalents, beginning of year 4,953,388
-------------
Cash and cash equivalents, end of year $ 2,657,131
=============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash payments for interest on long-term debt and
repurchase agreements $ 26,062,747
=============
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Surrender of common units in exchange for other assets $ 31,851
=============
Accrued distribution on preferred units redemption $ 135,326
=============
SEE ACCOMPANYING NOTES.
5
ARCap Investors, L.L.C. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING AND REPORTING 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.
- ARCap REIT, Inc. (ARCap REIT), a majority-owned subsidiary of the
Company.
- ARCap Resecuritization Corporation (ARCap Resecuritization), a wholly
owned subsidiary of ARCap REIT. ARCap Resecuritization owns all the
residual interest in Commercial Resecuritization Trust 2001 ABC-2 (the
Trust) and Commercial Resecuritization Trust 2003-ABC3 (2003-ABC3
Trust).
- ARCap High Yield CMBS Fund, L.L.C. (the High Yield Fund), of which
ARCap REIT owned an approximate 23% controlling interest as of
December 31, 2003. The High Yield Fund owns approximately 60% of ARCap
CMBS Fund REIT, Inc. (the Fund REIT). ARCap 2003-1 Resecuritization,
Inc. (2003-1 Resecuritization), a wholly owned subsidiary of the Fund
REIT, owns all of the equity interest in ARCap 2003-1 Resecuritization
Trust (the 2003-1 Trust).
- ARCap Diversified Risk CMBS Fund, L.L.C. (the Diversified Risk Fund),
of which ARCap REIT owned an approximate 1% controlling interest as of
December 31, 2003. The Diversified Risk Fund owns approximately 40% of
the Fund REIT.
- ARCap Servicing, Inc., a taxable REIT subsidiary wholly owned by ARCap
REIT.
Minority interests primarily represent outside members' approximate 77%
ownership in the High Yield Fund and outside members' approximate 99% ownership
in the Diversified Risk Fund. The Company has consolidated the High Yield Fund
and Diversified Risk Fund as it exercises control (through ARCap REIT, which
acts as the Managing Member of both Funds in accordance with the terms of the
respective LLC agreements) over the operations of these Funds. The Company
records minority interest expense (income) that reflects the portion of the
earnings (losses) of the operations which is applicable to the minority interest
members. As the Managing Member of both the High Yield Fund and the Diversified
Risk Fund, ARCap REIT is entitled to a 20% promote in the event the Funds
achieve a specified investment return. Accordingly, minority interest expense
may not equal the earnings of each of the Funds times the respective outside
members' ownership percentages. Separate books of accounts are maintained for
ARCap REIT, ARCap Resecuritization, the Trust, the High Yield Fund, the Fund
REIT, 2003-1 Resecuritization, the 2003-1 Trust, the Diversified Risk Fund, and
ARCap Servicing, Inc. and are reflected in the accompanying consolidated
financial statements of the Company. 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
for existing securities and the settlement date for to-be-issued securities. In
October 2003, the Trust reclassified CMBS with a fair value of approximately
$386,000,000 from trading to available-for-sale in connection with the creation
of 2003-ABC3 Trust (see Note 5). The reclassification effectively established a
new basis for financial reporting for the CMBS at the date of transfer. In
August 2003, the Fund REIT reclassified CMBS with a fair value of approximately
$260,000,000 from trading to available-for-sale in connection with the
resecuritization of 64 CMBS securities and the issuance of a collateralized debt
obligation (CDO) (see Note 5). The reclassification effectively established a
new basis for financial reporting for the CMBS at the date of transfer. CMBS
classified as available-for-sale are securities that the Company considers for
possible sales or other dispositions prior to the maturity of the securities.
Available-for-sale securities are carried at their estimated fair value with
unrealized gains and losses reported in other comprehensive income (loss) as a
separate component of members' equity. The Company evaluates unrealized losses
on its available-for-sale CMBS securities to determine if such declines in fair
value are "other than temporary." In the event a decline in the fair value of an
available-for-sale CMBS security is deemed "other than temporary," the decline
in fair value would be recorded as an impairment to the security and charged
through earnings rather than as a component of other comprehensive income.
Approximately $6,598,000 of "other than temporary" impairments has been
recognized for the year ended December 31, 2003.
The Company's CMBS that are designated as trading assets represent securities
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 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
6
ARCap Investors, L.L.C. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003
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 that result 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.
Revenue Recognition
- -------------------
Interest income and servicing fees are recognized as earned. Accretion of
discounts is computed using the effective-interest method over the expected life
of the securities based on management's estimates regarding the timing and
amount of cash flows from the underlying collateral.
Derivative Financial Instruments
- --------------------------------
Derivative financial instruments are utilized by the Company to reduce interest
rate risk. The Company utilizes interest rate swaps and cap and floor agreements
as a means of hedging the potential financial statement impact of changes in the
fair value of its portfolio of CMBS and variable rate long-term debt due to
changes in interest rates. 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 its derivative financial
instruments at fair value with any unrealized gain or loss included in earnings,
in accordance with the provisions of SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES.
Resale and Repurchase 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
maturity when purchased of three months or less.
Restricted Cash
- ---------------
Restricted cash represents amounts required to be pledged under interest rate
cap and floor agreements (see Note 5).
Deferred Borrowing Costs
- ------------------------
Deferred borrowing costs represent costs incurred in connection with the
issuance of long-term debt. Such amounts are amortized using the
effective-interest method over the term of the related debt (see Note 5). During
2003, the Company paid approximately $228,000 in connection with the issuance of
a long-term repurchase agreement, approximately $4,825,000 in connection with
the High Yield Fund's CDO offering, and approximately $871,000 in connection
with the creation of 2003-ABC3 Trust.
Financing Fee
- -------------
The Company pays an annual rate of 0.50% on $236,000,000 of its existing
long-term debt to a financier to provide credit enhancement of such debt.
Income Taxes
- ------------
The Company has elected to be taxed as a partnership, whereby all income is
taxed at the member level, with the exception of ARCap Servicing, Inc., which is
taxed at the entity level. ARCap REIT has elected to be taxed as a real estate
investment trust for federal income tax purposes. No provision for income taxes
has been made for ARCap Servicing, Inc. for the year ended December 31, 2003, as
ARCap Servicing, Inc. did not generate any taxable income.
7
ARCap Investors, L.L.C. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003
Use of Estimates
- ----------------
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect reported amounts of
certain assets, liabilities, revenues, and expenses. Actual results could 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 could have a material effect on the estimated fair
value amounts.
The Company's portfolio of CMBS and securities borrowed is carried at their
estimated fair values. The Company's management believes that the fair values of
its cash and cash equivalents, restricted cash, long-term debt, and repurchase
agreements approximate their carrying values due to the nature of the
instruments or the fact that their terms approximate current market terms. The
Fixed Rate Notes (see Note 5) with a carrying value of $98,500,000 have an
estimated fair value of approximately $107,313,000 at December 31, 2003. Fair
value was estimated using a discounted cash flow analysis, based on an interest
rate of 5% which management believes is currently available for the issuance of
similarly rated debt.
2. MEMBERS' EQUITY
The Limited Liability Company Agreement (LLC Agreement) establishes two classes
of membership: Series A Preferred members and Common members.
Cash Flows are distributed in the following order of priority:
- - 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 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 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 members.
- 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.
8
ARCap Investors, L.L.C. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003
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 the effective date of the First Amendment to
the LLC Agreement (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.
In December 2003, a Series A Preferred unit holder accepted a redemption of its
200,000 units for consideration of $4,900,000, plus accrued distributions
through the date of redemption. Accrued distributions in connection with the
redemption in the amount of $135,326 are included in accrued expenses in the
accompanying consolidated balance sheet.
At December 31, 2003, there were a total of 5,800,000 Series A Preferred Units
and 4,997,917 Common Units issued and outstanding.
The LLC Agreement contains certain restrictive covenants regarding the amount of
variable rate debt, total debt, and certain financial ratios. Failure to meet
the covenants in successive quarters can result in the Chief Executive Officer
and Chief Operating Officer being removed from the Board of Managers until such
time as the covenants are cured for successive quarters. Management believes
that the Company has not violated the covenants in successive quarters.
3. INVESTMENT SECURITIES
The Company's available-for-sale securities are carried at estimated fair value
and are comprised of the following at December 31, 2003:
FACE ACCRETED COST FAIR VALUE PERCENTAGE
-------------------------------------------------------------------
Subordinated CMBS: Security rating:
BB+ $ 115,969,711 $100,476,507 $100,989,593 13.66%
BB 187,510,690 151,286,305 152,973,681 20.70%
BB- 141,923,565 103,046,413 102,883,384 13.92%
B+ 207,933,210 129,402,233 129,725,184 17.55%
B 239,353,347 130,807,073 126,630,338 17.13%
B- 160,278,326 72,779,789 74,040,639 10.02%
NR 211,411,772 50,987,832 51,806,048 7.02%
-------------------------------------------------------------------
$ 1,264,380,621 $738,786,152 $739,048,867 100.00%
===================================================================
The Company's trading securities are carried at estimated fair value and are
comprised of the following at December 31, 2003:
FACE ACCRETED COST FAIR VALUE PERCENTAGE
-------------------------------------------------------------------
Subordinated CMBS: Security rating:
BB+ $ 83,615,000 $ 67,653,304 $ 69,376,540 24.59%
BB 63,340,512 48,069,924 47,647,477 16.89%
BB- 41,236,511 27,084,333 29,403,288 10.42%
B+ 65,740,512 38,821,364 42,978,057 15.23%
B 45,104,511 23,655,960 25,634,761 9.09%
B- 17,561,512 7,276,006 4,982,478 1.77%
NR 282,727,504 72,543,757 62,134,826 22.01%
-------------------------------------------------------------------
$599,326,062 $285,104,648 $282,157,427 100.00%
===================================================================
At December 31, 2003, the accumulated accretion of purchase discounts on
available-for sale and trading securities, was approximately $2,932,000 and
$6,245,000, respectively.
9
ARCap Investors, L.L.C. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003
The gross cumulative unrealized gains and losses on the Company's
available-for-sale investment securities were approximately $12,064,000 and
$(5,203,000), respectively, at December 31, 2003 for a total accumulated other
comprehensive income on available for-sale securities of approximately
$6,861,000.
The gross cumulative unrealized gains and losses on the Company's trading
investment securities at December 31, 2003, were approximately $10,941,000 and
$(20,133,000), respectively.
4. BORROWED INVESTMENT SECURITIES AND INTEREST RATE SWAP, NET
The Company's borrowed investment securities and interest rate swap are carried
at estimated fair value and are comprised of the following at December 31, 2003:
COUPON FAIR UNREALIZED
SECURITY DESCRIPTION RATE FACE BASIS VALUE GAIN (LOSS)
- --------------------------------------------------------------------------------------------------------------
U.S. Treasury (08-15-09) 6.000% $ (4,791,000) $ (4,675,342) $ (5,429,550) $ (754,208)
U.S. Treasury (02-15-11) 5.000% (14,850,000) (14,587,658) (15,956,789) (1,369,131)
U.S. Treasury (08-15-11) 5.000% (12,501,000) (12,546,518) (13,385,835) (839,317)
U.S. Treasury (02-15-12) 4.875% (10,845,000) (11,647,608) (11,494,006) 153,602
U.S. Treasury (11-15-12) 4.000% (3,603,000) (3,579,918) (3,570,912) 9,006
-----------------------------------------------------------------------
$ (46,590,000) $ (47,037,044) (49,837,092) $ (2,800,048)
Reverse repurchase agreements 50,945,341
-------------
Borrowed investment securities, net 1,108,249
Interest rate swap (3,263,464)
-------------
Borrowed investment securities and interest rate swap, net $ (2,155,215)
=============
The borrowed 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 value of the borrowed securities, and any
unrealized gains (losses) are included in earnings.
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.
In October 2003, ARCap REIT repurchased approximately $20,300,000 of its U.S.
Treasury securities held against its CMBS for delivery to the lender and sold
all offsetting reverse repurchase agreements, consistent with ARCap REIT's
practice of settling its borrowed investment transactions on a net basis.
Settlement of the transactions resulted in an approximate $1,207,000 realized
loss to ARCap REIT.
In July 2003, the High Yield Fund repurchased approximately $260,000,000 of its
U.S. Treasury securities and, in November 2003, it repurchased the remaining
$19,000,000 of the U.S. Treasury securities held against its CMBS for delivery
to the lender. The High Yield Fund sold all offsetting reverse repurchase
agreements, consistent with the High Yield Fund's practice of settling its
borrowed investment transactions on a net basis. Settlement of the transactions
resulted in an approximate $17,000,000 realized loss to the High Yield Fund, of
which approximately $6,000,000 was attributable to current year earnings.
In June 2003, the Diversified Risk Fund repurchased approximately $18,000,000 of
its U.S. Treasury securities. The Diversified Risk Fund realized a loss of
approximately $600,000 in connection with the transaction.
The Company entered into an interest rate swap agreement with Bear Stearns
Capital Markets (Bear Stearns) with a notional amount at December 31, 2003, of
$27,000,000, on which the Company pays a fixed rate of 6.015% and receives a
variable rate based on six month LIBOR for a term of 10 years ending April 27,
2011. 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 collateral valued at 1% of the
notional amount of the swap to ensure its performance in the event that the swap
declines in value. At December 31, 2003, the Company pledged CMBS valued at
approximately $9,112,000 as additional collateral against the interest rate
swap.
10
ARCap Investors, L.L.C. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003
5. LONG-TERM DEBT
During August 2003, the Fund REIT contributed 64 CMBS certificates with an
approximate fair value of $260,000,000 to its subsidiary, 2003-1
Resecuritization, for pass-through to the 2003-1 Trust. The 2003-1 Trust
resecuritized the pooled certificates and offered $220,800,000 in senior notes
of Classes A through G with fixed rate coupons ranging from 4.97% to 8.74%. The
Classes A through G notes mature in increments from September 2011 through March
2013. The notes are secured by 64 CMBS certificates which have a carrying value
of approximately $269,000,000 at December 31, 2003. Accrued interest payable at
December 31, 2003, was approximately $1,019,000.
At December 31, 2003, $220,800,000 of the Class A through G senior notes is
issued and outstanding, of which ARCap REIT holds $25,000,000 of Class G senior
notes with a fixed rate coupon of 8.74% as a security, which has been eliminated
in consolidation.
The High Yield Fund capitalized approximately $4,825,000 of deferred borrowing
costs related to the issuance of the collateralized debt obligation notes. The
costs are being amortized using the effective-interest method over the earliest
of the expected lives of the debt, which is eight years (through September
2011). The High Yield Fund amortized approximately $256,000 of deferred
borrowing costs for the year ended December 31, 2003.
During fiscal year 2001, the Company entered into an agreement to sell its
interests in 50 CMBS pass-through certificates (the Pooled Certificates) to its
subsidiary, the Trust. The Trust resecuritized the Pooled Certificates and
offered $98,500,000 Class A-1 Senior Notes with a fixed coupon rate of 7.17%
(Fixed Rate Notes) and $137,500,000 Class A-2 Senior Notes with a variable
coupon rate based on one-month LIBOR plus 115 basis points (Variable Rate Notes)
(together, the Notes). The Notes mature on February 17, 2008.
In October 2003, ARCap REIT sold 10 CMBS securities to ARCap Resecuritization,
which in turn contributed the 10 CMBS securities to the Trust. ARCap
Resecuritization then created a new trust, 2003-ABC3 Trust, for the purpose of
resecuritizing the Trust's pooled certificates. 2003-ABC3 Trust issued
$80,000,000 of Class A Notes (the Class A Notes) bearing interest at 8.6%, and
$15,000,000 of Class B Notes bearing interest at 6% (the Class B Notes)
(together, the CRC3-ABC3 Notes). The CRC3-ABC3 Notes, which mature on February
22, 2008, were then distributed to ARCap REIT through ARCap Resecuritization. On
October 9, 2003, ARCap REIT sold $30,000,000 of the Class A Notes and used the
net proceeds to settle approximately $29,000,000 of repurchase agreements. ARCap
REIT has retained the balances of the Class A Notes and the Class B Notes. The
Notes and the CRC3-ABC3 Notes are secured by the investment securities of the
Company with a carrying value of approximately $382,000,000 at December 31,
2003.
Interest on the Notes and the CRC3-ABC3 Notes is paid monthly. Interest expense
on the Notes and the CRC3-ABC3 Notes was approximately $17,900,000 for the year
ended December 31, 2003, and the related accrued interest payable was
approximately $695,000.
The Company capitalized approximately $5,668,000 of deferred borrowing costs
related to the issuance of the Notes. The deferred borrowing costs are being
amortized using the effective-interest method over the life of the debt, which
is seven years (through February 22, 2008). The Company amortized approximately
$734,000 of deferred costs for the year ended December 31, 2003. Total
accumulated amortization of deferred borrowing costs at December 31, 2003, was
approximately $1,948,000.
The Company capitalized approximately $871,000 of deferred borrowing costs
related to the creation of the 2003-ABC3 Trust. The deferred borrowing costs are
being amortized using the effective-interest method over the life of the debt
through February 22, 2008. The Company amortized approximately $31,000 of
deferred borrowing costs for the year ended December 31, 2003.
In conjunction with the issuance of the Variable Rate Notes, the Company entered
into an interest rate cap agreement and an interest rate floor agreement with
Bear Stearns (CBO Swap) to effectively fix the interest rate on its variable
rate debt at 7.435%. The notional amount for the CBO Swap is $137,500,000. The
agreements call for interest to be paid monthly. The Company carries the CBO
Swap at its estimated fair value, with all periodic changes in estimated fair
value recognized in earnings.
The Company originally deposited $4,125,000 of cash to ensure its performance in
the event that the CBO Swap declines in value. If the market value of the CBO
Swap falls below defined thresholds, the Company may be required to deposit
additional restricted cash. Amounts in excess of the minimum requirements may be
withdrawn by the Company.
6. REPURCHASE AGREEMENTS
The Fund REIT and the Diversified Risk Fund each entered into a credit facility
with Liquid Funding, Ltd., an affiliate of Bear Stearns & Co., to finance a
portion of its CMBS purchases through both short-term variable rate and
long-term fixed rate repurchase agreements.
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ARCap Investors, L.L.C. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003
At December 31, 2003, the Diversified Risk Fund has short-term variable rate
repurchase agreements outstanding of $5,031,000, with an interest rate of 2.154%
and a maturity of 32 days. The balance was collateralized by CMBS investments
with a fair value of approximately $8,962,000 at December 31, 2003.
The Diversified Risk Fund has a long-term repurchase agreement outstanding at
December 31, 2003 of $25,367,000, which carries a 4.135% fixed interest rate
from the initial purchase date of June 2003 until final repurchase in June 2008.
The balance was collateralized by CMBS investments with a fair value of
approximately $36,509,000 at December 31, 2003.
The Diversified Risk Fund's combined accrued interest payable under the facility
at December 31, 2003 was approximately $55,000.
The Fund REIT's repurchase agreements outstanding of $65,577,000 have a weighted
average interest rate as of December 31, 2003 of 2.185%, and the average
maturity of the agreements was 32 days. The repurchase agreements are
collateralized by a portion of the Company's portfolio of CMBS investments with
a fair value of approximately $102,773,000 at December 31, 2003. Accrued
interest payable at December 31, 2003 was approximately $56,000.
ARCap REIT entered into short-term repurchase agreements with Bear Stearns & Co.
and its affiliates to finance a portion of its CMBS purchases. The
weighted-average interest rate on $67,036,000 of such borrowings as of December
31, 2003, was 2.269%, and the average maturity of the agreements was 30 days.
The short-term repurchase agreements are collateralized by a portion of the
Company's portfolio of CMBS investments with a fair value of approximately
$125,550,000 at December 31, 2003. Accrued interest payable at December 31,
2003, was approximately $68,000.
7. LOSS ON INVESTMENT SECURITIES, NET
The composition of the Company's gain (loss) on investment securities, net for
the year ended December 31, 2003, is as follows:
DECEMBER 31,
2003
------------
Unrealized gain - borrowed investment securities $ 14,553,693
Unrealized gain - interest rate swap 805,831
Unrealized loss - CMBS (14,825,322)
Realized loss - CMBS, net (12,346,305)
Realized loss - borrowed investment securities, net (19,245,505)
Realized loss - "other than temporary" losses on available-for-sale CMBS (6,597,957)
------------
Loss on investment securities, net $(37,655,565)
============
8. OPERATING LEASES
The Company leases its office space and certain equipment under operating leases
that expire between April 2004 and May 2008. The office leases, as amended,
provide for an annual basic rental of approximately $332,000 during the initial
lease term and contain an option to extend the term of one of the leases 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:
2004 $ 547,000
2005 492,000
2006 278,000
2007 66,000
2008 24,000
----------
Total $1,407,000
==========
Lease expense for the year ended December 31, 2003, was approximately $552,000.
9. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES
At times, the Company purchases investment securities at fair value from members
of the Company or their affiliates. These purchases represent transactions that
are in the normal course of business of the Company and the members. During the
year ended December 31, 2003, the Company purchased from such members CMBS with
an approximate face of $325,177,000 at an approximate purchase price of
$168,227,000.
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ARCap Investors, L.L.C. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2003
The Company has loaned approximately $231,000 to key executives for funding of
tax liabilities associated with units granted under an incentive compensation
arrangement. In June 2003, approximately $32,000 of such loans was satisfied
through the surrender of 1,465 Common Units to the Company. As of December 31,
2003, there is approximately $137,000 outstanding.
These loans 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. The
loans become due upon termination of the executives' employment with the
Company, and recourse is limited to the Common Units securing the loans.
10. EMPLOYEE BENEFITS
The Company holds a contributory defined contribution 401(k) plan that covers
substantially all full-time employees. The Company matches participant
contributions up to 3% of each participant's total compensation. Matching
contributions totaled approximately $153,000 for the year ended December 31,
2003.
The Company has a deferred compensation plan for key employees. The Board of
Managers approved the availability of approximately 690,000 phantom appreciation
units and 296,000 phantom grant units for awards to employees, all of which have
been granted.
Grant units granted each have a vesting period, which generally is ratable over
a period of three years. Once vested, employees are entitled to receive
additional compensation in an amount equal to the per Unit amount distributed on
account of the Common Units times the number of grant units vested in the
employee. The employee is entitled to this compensation regardless of whether
the distribution to the holders of Common Units is an ordinary distribution or
an extraordinary distribution. Thus, if the Company is sold or liquidated, the
employee would be entitled to share in the proceeds of the sale or liquidation
on the same basis as the holders of Common Units with respect to vested grant
units.
Appreciation units granted also have a vesting period, which is generally spread
ratably over a three-year period. Once vested, employees begin to "earn" the
right to receive compensation on account of each vested appreciation unit by
being credited with an amount equal to the per Unit distributions made to
holders of Common Units until the amount credited equals the Initial Value
(i.e., the price at which a vested employee could obtain the appreciation unit)
established by the Compensation Committee. Vested employees are entitled to
compensation on account of each vested appreciation unit in an amount equal to
the per Unit distributions made to holders of Common Units only after they have
"earned" credits equal to the Initial Value. In the event of a liquidation or
sale, employees with vested appreciation units are entitled to compensation in
an amount equal to the per Unit proceeds in excess of the Initial Value plus the
credits which have been earned.
The Company accrues the estimated value of deferred compensation under this plan
over the service period, which ends when the units are fully vested. Subsequent
to the final vesting date, changes in the estimated amount of deferred
compensation will be recorded as an increase or decrease to net income in the
period in which such change occurs. For the year ended December 31, 2003, the
Company expensed approximately $3,140,000 of deferred compensation and paid
approximately $359,000 for the year ended December 31, 2003, related to the
vested grant units.
11. SUBSEQUENT EVENT
On January 23, 2004, the Company issued a special distribution in the amount of
$1,443,000 to the Common Unit holders, along with its regular quarterly
distribution.
13