================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from: __________________ to ____________________
Commission File No. 1-14043
OCWEN ASSET INVESTMENT CORP.
-----------------------------------------------------
(Exact name of Registrant as specified in its charter)
VIRGINIA 65-0736120
- ----------------------------------------- ----------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
THE FORUM, SUITE 1000
1675 PALM BEACH LAKES BOULEVARD
WEST PALM BEACH, FLORIDA 33401
- ----------------------------------------- ----------------------------
(Address of principal executive office) (Zip Code)
- --------------------------------------------------------------------------------
(561) 682-8000
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.01 par value New York Stock Exchange
(Title of each class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: Not applicable.
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 by check mark if disclosure of delinquent filers pursuant to
item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the this Form 10-K or any
amendment to this Form 10-K [ ]
Aggregate market value of the Common Stock, $.01 par value, held by
nonaffiliates of the registrant, computed by reference to the closing price as
reported by NASDAQ as of the close of business on February 27, 1998:
$337,132,688 (for purposes of this calculation affiliates include only Ocwen
Financial Corporation, directors and executive officers of the Company).
Number of shares of Common Stock, $.01 par value, outstanding as of
February 27, 1998: 18,965,000 shares.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Annual Report to
Stockholders are incorporated by reference into Part III, Items 5-8. Portions of
the definitive Proxy Statement for the annual meeting of stockholders to be held
on May 14, 1998 are incorporated by reference into Part III, Items 10-13 and
Part IV, Item 14 of this Form 10K.
================================================================================
<PAGE>
OCWEN ASSET INVESTMENT CORP.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
PAGE
PART I
Item 1. Business........................................................... 4
General.......................................................... 4
Initial Stock Offering........................................... 4
The Manager...................................................... 5
Investment Activities............................................ 6
Commercial Real Estate Activities................................ 18
Discount Loan Acquisition and Resolution Activities.............. 22
Lending Activities .............................................. 24
Federal Taxation................................................. 25
Item 2. Properties......................................................... 32
Item 3. Legal Proceedings.................................................. 32
Item 4. Submission of Matters to a Vote of Security Holders................ 32
PART II
Item 5. Market for the Registrant's Common Equity and
Related Shareholder Matters....................................... 33
Item 6. Selected Consolidated Financial Data............................... 33
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................... 33
Item 7a. Quantitative and Qualitative Disclosures About Market Risk......... 33
Item 8. Financial Statements............................................... 34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................... 34
PART III
Item 10. Directors and Executive Officers of Registrant.................... 34
Item 11. Executive Compensation............................................ 34
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 34
Item 13. Certain Relationships and Related Transactions.................... 34
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.............................................. 35
Signatures........................................................ 37
2
<PAGE>
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED HEREIN ARE NOT, AND CERTAIN STATEMENTS
CONTAINED IN FUTURE FILINGS BY THE COMPANY WITH THE SECURITIES AND EXCHANGE
COMMISSION, IN THE COMPANY'S PRESS RELEASES OR IN THE COMPANY'S OTHER PUBLIC OR
SHAREHOLDER COMMUNICATIONS, MAY NOT BE BASED ON HISTORICAL FACTS AND ARE
"FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,
AS AMENDED, INCLUDING THE CONSUMMATION AND EXPECTED BENEFITS OF THE IDENTIFIED
TRANSACTIONS. THESE FORWARD-LOOKING STATEMENTS MAY BE IDENTIFIED BY REFERENCE TO
FUTURE PERIODS, OR BY THE USE OF FORWARD-LOOKING TERMINOLOGY, SUCH AS "MAY,"
"WILL," "BELIEVE," "ESTIMATE," "EXPECT," "ANTICIPATE," "CONSIDER," "CONTINUE,"
"ENCOURAGE," "INTENDS," "PLANS," "PRESENTS," "PROPOSE," "PROSPECT," FUTURE OR
CONDITIONAL VERB TENSES, OR SIMILAR TERMS, VARIATIONS OF THOSE TERMS, OR
NEGATIVES OF ANY SUCH TERMINOLOGY. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE SET FORTH IN FORWARD-LOOKING STATEMENTS DUE TO A VARIETY OF FACTORS,
INCLUDING, BUT NOT LIMITED TO, THOSE RELATED TO THE INTERNATIONAL, NATIONAL,
REGIONAL OR LOCAL ECONOMIC ENVIRONMENTS, PARTICULARLY IN THE MARKET AREAS IN
WHICH THE COMPANY OPERATES, COMPETITIVE PRODUCTS AND PRICING, FISCAL AND
MONETARY POLICIES OF THE U.S., CANADIAN OR OTHER GOVERNMENTS, CHANGES IN
GOVERNMENT REGULATIONS AFFECTING REAL ESTATE INVESTMENT TRUSTS, CHANGES IN
PREVAILING INTEREST AND CURRENCY EXCHANGE RATES, CHANGES IN FACTORS INHERENT TO
THE VALUATION AND PRICING OF VARIOUS SECURITIES INCLUDING THE IMPACT OF CHANGES
IN PREPAYMENT SPEEDS ON MORTGAGE LOANS, THE EFFECTIVENESS OF THE SERVICING OF
LOANS UNDERLYING VARIOUS SECURITIES, THE COURSE OF NEGOTIATIONS WITH RESPECT TO
VARIOUS TRANSACTIONS, THE ABILITY OF PARTIES TO AGREE TO MATERIAL TERMS OF A
TRANSACTION, THE ABILITY TO SATISFY OR FULFILL AGREED UPON TERMS AND CONDITIONS
OF CLOSING OR PERFORMANCE (INCLUDING BOARD APPROVALS, AS NECESSARY OR AGREED
UPON), THE OCCURRENCE OF MATERIAL ADVERSE CHANGES IN THE BUSINESS OF ANY PARTY
TO A TRANSACTION, THE TIMING OF TRANSACTION CLOSINGS, UNSATISFACTORY DUE
DILIGENCE RESULTS, BORROWER FAILURE TO SATISFY CLOSING CONDITIONS, THE ABILITY
TO SECURITIZE MORTGAGE LOANS ON MUTUALLY ACCEPTABLE TERMS, ACQUISITIONS AND THE
INTEGRATION OF ACQUIRED BUSINESSES, CREDIT RISK MANAGEMENT, ASSET/LIABILITY
MANAGEMENT, THE FINANCIAL AND SECURITIES MARKETS, THE AVAILABILITY OF AND COSTS
ASSOCIATED WITH TIMELY SOURCES OF LIQUIDITY ON MUTUALLY ACCEPTABLE TERMS AND
OTHER FACTORS GENERALLY UNDERSTOOD TO AFFECT THE REAL ESTATE ACQUISITION,
MORTGAGE AND LEASING MARKETS AND SECURITY INVESTMENTS. THE COMPANY DOES NOT
UNDERTAKE, AND SPECIFICALLY DISCLAIMS ANY OBLIGATION, TO PUBLICLY RELEASE THE
RESULTS OF ANY REVISIONS WHICH MAY BE MADE TO ANY FORWARD-LOOKING STATEMENTS TO
REFLECT THE OCCURRENCE OF ANTICIPATED OR UNANTICIPATED EVENTS OR CIRCUMSTANCES
AFTER THE DATE OF SUCH STATEMENTS.
3
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
Ocwen Asset Investment Corp. ("OAIC" or the "Company") is a newly
formed corporation that has elected to be taxed as a Real Estate Investment
Trust ("REIT") under Sections 856 through 860 of the Internal Revenue Code of
1986, as amended (the "Code"). As such, OAIC will generally not be subject to
federal income taxation on that portion of its income that it distributes to its
shareholders if it distributes at least 95% of its taxable income to its
shareholders annually and meets certain other income and asset tests.
The Company was incorporated in the Commonwealth of Virginia on January
22, 1997, and on May 14, 1997, the Company was capitalized with the sale of
19,125,000 shares of common stock, par value $.01 per share, at a price of
$16.00 per share (before underwriting and offering expenses).
The Company's business and investment affairs are managed by Ocwen
Capital Corporation ("OCC" or the "Manager"), a Florida corporation wholly-owned
by Ocwen Financial Corporation ("Ocwen"). Ocwen is a diversified financial
services company that is primarily engaged in the acquisition and resolution of
troubled loans and in diverse mortgage lending activities.
The Company seeks to enhance the value of its common stock by pursuing
advantageous investments that capitalize on inefficiencies in the real estate
and mortgage markets. Pursuant to that strategy, the Company has invested in
several categories of real estate and real estate related assets. Such
investments consist primarily of: (i) subordinate interests in commercial and
residential mortgage-backed securities; and (ii) distressed commercial and
multi-family real property, including properties acquired by a mortgage lender
at foreclosure (or deed in lieu of foreclosure). The Company believes that these
investment activities complement each other from both a cash flow and a tax
planning perspective in the early years after an acquisition real property tends
to generate more cash flow than taxable income as a result of depreciation
deductions while subordinate and residual securities during the same period tend
to generate more taxable income than cash flow. The relationship between taxable
income and cash flow will, with respect to each type of investment, generally
reverse in later years.
The Company also has invested, by way of purchase and origination, in:
(i) commercial, multi-family and single-family residential mortgage loans,
including construction and rehabilitation loans and mezzanine loans; (ii)
interest-only and inverse interest-only mortgage-related securities supported by
residential and commercial mortgage loans; and (iii) mortgage loans that are in
default or for which default is likely or imminent or for which the borrower is
currently making monthly payments in accordance with a forbearance plan
(collectively, "discount loans"). The Company also may acquire real property or
mortgage loans secured by such real property and other real property interests
that: (i) may be environmentally distressed; or (ii) is located outside the
United States.
The following table sets forth the composition of the Company's
principal assets at December 31, 1997.
December 31, 1997
----------------------------------
Amount % of Total Assets
------ -----------------
(Dollars in Thousands)
Securities available for sale $146,027 50.7%
Loan portfolio, net 15,831 14.9
Discount loan portfolio, net 26,979 9.4
Investment in real estate, net 45,430 15.8
-------- ----
$234,267 90.8%
INITIAL STOCK OFFERING
On May 19, 1997 the Company completed an initial public offering
("IPO") which consisted of the sale of 19,125,000 shares of its common stock at
a price of $16 per share (before underwriting discount of $1.12 per share),
including 1,875,000 shares of common stock sold to Investors Mortgage Insurance
Holding Company ("IMI"), a wholly-owned subsidiary of Ocwen. Total proceeds to
4
<PAGE>
the Company, net of underwriting discount and offering expenses, were $283.7
million. The Company incorporated and capitalized two qualified REIT
subsidiaries, Ocwen General, Inc. ("General Partner") and Ocwen Limited, Inc.
("Limited Partner") which, in turn, organized and capitalized Ocwen Partnership,
L.P. (the "Operating Partnership"). The Company, through the General Partner and
the Limited Partner, contributed all of the net proceeds from the IPO to the
Operating Partnership. The General Partner and Limited partner initially had a
1% and a 99% ownership interest in the Operating Partnership, respectively.
On December 9, 1997, the Company repurchased 160,000 shares of stock
from IMI at the weighted average price of the stock on the day of the
repurchase. IMI immediately acquired 160,000 units in the Operating Partnership,
representing a 0.8% ownership interest. The shares were repurchased in order to
comply with the stock ownership restrictions imposed on REITs. The shares
redeemed by the Company are presented as treasury stock in the Company's
consolidated financial statements, whereas the units acquired by IMI gave rise
to a minority interest in the Operating Partnership.
THE MANAGER
The Company's business and investment affairs are managed by OCC. The
Company has entered into a management agreement with OCC pursuant to which OCC,
subject to the supervision of the Company's Board of Directors, formulates
operating strategies for the Company, arranges for the acquisition of assets by
the Company and arranges for various types of financing for the Company,
including repurchase agreements and secured lines of credit. In addition, OCC
monitors the performance of the Company's assets and provides certain
administrative and managerial services in connection with the operation of the
Company. In consideration for performance of these services, OCC receives: (i) a
base management fee in an amount equal to 1% per annum, calculated and paid
quarterly based upon the average invested assets of the Company for such
quarter, which is intended to cover OCC's costs of providing management services
to the Company; and (ii) a quarterly incentive fee in an amount equal to the
product of (A) 25% of the dollar amount by which (1) (a) funds from operations
("FFO") (before the incentive fee) of the Company per share of common stock
(based on the weighted average number of shares outstanding) plus (b) gains (or
minus losses) from debt restructuring or sales of property per share of common
stock (based on the weighted average number of shares outstanding), exceed (2)
an amount equal to (a) the weighted average of the price per share at initial
offering and the prices per share at any secondary offerings by the Company
multiplied by (b) the Ten-Year U.S. Treasury Rate plus five percent per annum
multiplied by (B) the weighted average number of shares of common stock
outstanding.
In addition to the management fees described above, OCC is reimbursed
for its costs for performing due diligence on assets purchased by the Company or
considered for purchase by the Company, as well as for out-of-pocket expenses
incurred on behalf of the Company.
Under a non-qualified stock option plan (the "Option Plan") adopted by
the Company, the Manager was granted, at the IPO, options representing the right
to purchase 1,912,500 shares of the Company's common stock or, at the Company's
election, an equal amount of units in the operating partnership at an exercise
price per share equal to the initial offering price of $16 per share. One
quarter of these options will vest and become exercisable on each of the first
four anniversaries of the closing date of the IPO. The purpose of the Option
Plan is to provide a means of performance-based compensation in order to provide
incentive for the Manager to enhance the value of OAIC's stock.
OAIC does not maintain an office and does not employ full-time
personnel. Instead, OAIC relies on the facilities and resources of Ocwen
(through OCC). Ocwen has been actively involved since its formation in 1988 in
the real estate and mortgage markets and brings significant expertise to OAIC in
acquiring and managing distressed real estate assets. The Company's relationship
with Ocwen provides a number of advantages. First, Ocwen's primary operating
subsidiary, Ocwen Federal Bank FSB (the "Bank"), is one of only six firms in the
United States to be rated as a "Strong" Special Servicer for commercial loans by
Standard & Poor's, its highest rating category, and is the only firm to be
designated as a Special Servicer for residential mortgage loans. Further, Ocwen
5
<PAGE>
has a proven track record in managing subperforming and nonperforming
residential and commercial real estate loans and distressed real estate. As a
result, OAIC has bid on many subordinate securities because Ocwen has been able
to be named as Special Servicer on a majority of those investments. Second, the
Company benefits from Ocwen's proprietary software applications, which include
acquisition modeling and resolution management systems. Third, the Company's
relationship with Ocwen has provided it with access to markets, as well as
instant and positive name recognition; OAIC may also benefit by being able to
co-bid on transactions jointly with Ocwen.
Pursuant to the Company's management agreement with OCC, neither Ocwen
nor any of its affiliates is permitted to purchase non-investment grade
subordinate securities or distressed commercial real estate without first
obtaining the approval of OAIC's independent directors.
INVESTMENT ACTIVITIES
At December 31, 1997, the Company's investment in mortgage-backed
securities ("MBS") totaled $146.0 million or 50.7% of total assets. The
following table sets forth the fair value of the Company's MBS available for
sale at December 31, 1997:
Single family residential:
FHLMC interest-only................................. $ 21,177,964
FNMA interest-only.................................. 22,573,132
AAA-rated interest-only............................. 729,372
Subordinates........................................ 9,444,067
--------------
Total............................................. 53,924,535
--------------
Multi-family residential and commercial:
AAA-rated interest-only............................. 865,747
A-rated interest-only............................... 480,188
Non-rated interest-only............................. 4,802,873
Subordinates........................................ 85,953,564
--------------
Total............................................. 92,102,372
--------------
Total............................................ $ 146,026,907
==============
6
<PAGE>
The following tables set forth the Company's residential
mortgage-backed securities portfolio as of December 31, 1997:
SUBORDINATES
<TABLE>
<CAPTION>
($ Thousands)
Collateral Credit
Rating Balance at: Enhancements Product Type at:
Deal Name Security Issue Date Rating Agencies Issuance 12/31/97 12/31/97 12/31/97
-------- ---------- ------ -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
SBMS 1997-HUD1 (1) B5 Apr-97 B2, n.a. Moody's, DCR 9,785 9,666 5.58% 97% Fixed, 3% ARM
SBMS 1997-HUD1 (1) B6 Apr-97 UR 16,998 16,706 n.a.
GECMS 1994-12 (2) B4 Mar-94 UR Moody's, Fitch, S&P 2,069 1,708 n.a. 100% Fixed
Weighted Weighted Actual Actual ($ Thousands) Yield to
Average Average Delinquency Life to Date Actual Life to Maturity
Coupon at: LTV at: at: CPR at: Date Losses at: at:
Deal Name Security 12/31/97 12/31/97 12/31/97 12/31/97 12/31/97 Purchase 12/31/97
-------- -------- -------- -------- ------------ -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
SBMS 1997-HUD1(1) B5 9.78% 111.91% 8.98% 8.52% 214 16.27% 16.41%
SBMS 1997-HUD1(1) B6 22.86% 22.95%
GECMS 1994-12(2) B4 6.84% 53.20% 0.24% 5.00% 0 19.37% 20.81%
</TABLE>
<TABLE>
<CAPTION>
ISSUERS: GLOSSARY OF TERMS:
<S> <C> <C>
(1) Solomon Brothers Mortgage Securities Deal Name Series description of the transaction
(2) GE Capital Mortgage Services, Inc. Security Specific certificate(s) of the transaction owned by OAIC
Issue Date Date at which the trust issued the certificates
Rating Rating, if any, of the certificate(s)
Rating Agencies Rating agencies of the transaction
Class balance Outstanding bond balance at the respective date
Weighted Average Coupon Weighted average interest rate of the underlying collateral
at the respective date
Weighted Average LTV Weighted average loan-to-value ratio at the respective date.
Loan is represented by the unpaid principal balance
("UPB") and the value is represented by the last recorded
appraisal value/broker's price opinion
Actual Delinquency Total UPB of loans more than 30 days delinquent at the
respective date as a percentage of the collateral UPB at the
respective date
Actual Life-to-Date CPR Life-to-Date prepayment rate as of the respective date
Actual Life-to-Date Losses Cumulative losses expressed as a percentage of original
collateral UPB at the respective date
Credit Enhancement Percentage of securities outstanding at the respective date
junior to the security owned intended to cover realized losses
</TABLE>
7
<PAGE>
The following tables set forth the Company's commercial mortgage-backed
securities as of December 31, 1997:
<TABLE>
<CAPTION>
Subordination
Level at:
Securitization Security Issue Date Rating Rating Agencies Issuance 12/30/97
- -------------- -------- ---------- ------ --------------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
MRAC 1996-C2(1) K Dec-96 B Fitch, Moody's 2.50% 2.56%
MRAC 1996-C2(1) L-1 NR-PO 0.00% 0.00%
MRAC 1996-C2(1) L-2 NR-10 0.00% 0.00%
BTC 1997-S1(2) E, F Dec-97 BB/B S&P, Fitch 19.00% 19.89%
BTC 1997-S1(2) Equity NR 0.00% 0.00%
DLJ 1993-MF17(3) B-2 Nov-93 BB Moody's, Duff 4.59% 5.15%
DLJ 1993-MF17(3) B-3 B 1.28% 1.44%
DLJ 1993-MF17(3) C-1 NR 0.00% 0.00%
DLJ 1993-MF17(3) S-1 AAA-IO 32.18% 36.13%
DLJ 1993-MF17(3) S-2 A-IO 18.02% 20.24%
MLMCI 1993-M1(4) B Sep-93 NR Moody's, S&P 2.00% 6.17%
ISSUERS: GLOSSARY OF TERMS:
DSCR: Debt Service Coverage Ratio is calculated as cash flow
available for Debt Service divided by Debt service.
Subordination Level: Represents the percentage of outstanding bonds whose
right to receive payments is subordinated to
a particular class.
(1) Midland Realty Acceptance Corp. Class Size: Represents the percentage size of a particular class
relative to the total outstanding balance of all classes.
(2) BTC Mortgage Investors Trust 1997-S1
(3) DLJ Mortgage Acceptance Corp.
(4) Merrill Lynch Mortgage Capital, Inc.
</TABLE>
COMMERCIAL MORTGAGE BACKED SECURITIES:
<TABLE>
<CAPTION>
Actual Actual
Weighted Weighted Annual Life to
Average Average Actual CPR Date Class Size% Yield to
DSCR at LTV at Delinquency Life to: Losses at: of Total as of: Maturity at
Securitization Security Issuance Issuance 12/31/97 12/31/97 12/31/97 Issuance 12/31/97 Purchase 12/31/97
- -------------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
MRAC 1996-C2(1) K 1.36 69.1% 0.0% 1.0% $0 1.50% 1.54% 12.10% 12.02%
MRAC 1996-C2(1) L-1 2.50% 2.56% 12.31% 12.86%
MRAC 1996-C2(1) L-2 2.50% 2.56% 12.82% 13.67%
BTC 1997-S1(2) E, F 1.27 106.0% 20.7% 53.15% $0 14.50% 15.18% 8.36% 8.37%
BTC 1997-S1(2) Equity 19.00% 19.89% 21.19% 21.19%
DLJ 1993-MF17(3) B-2 1.36 73.7% 0.0% 0.0% $0 9.41% 10.57% 12.29% 12.33%
DLJ 1993-MF17(3) B-3 3.31% 3.71% 11.39% 12.60%
DLJ 1993-MF17(3) C-1 1.28% 1.44% -29.82% -13.80%
DLJ 1993-MF17(3) S-1 67.82% 63.87% 16.69% 16.85%
DLJ 1993-MF17(3) S-2 14.15% 15.90% 14.46% 14.46%
MLMCI 1993-M1(4) B 1.51 56.0% 9.0% 61.9% $0 9.00% 26.80% 13.65% 12.06%
</TABLE>
8
<PAGE>
The following table sets forth information regarding the geographic
location underlying the Company's securities portfolio at December 31, 1997,
based upon the notional amount of the residual and par amount of the class of
subordinate securities held.
<TABLE>
<CAPTION>
Description California Florida Texas Maryland Illinois Other (1)
---------- ---------- --------- -------- -------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Single-family residential...... $ 127,104 $ 21,787 $ 54,582 $ 39,842 $ 37,972 $ 61,970
Multi-family and commercial.... 162,758 89,638 145,739 10,500 2,214 621,060
--------- ---------- --------- -------- -------- ---------
Total.......................... $ 289,862 $ 111,425 $ 200,321 $ 50,342 $ 40,186 $ 683,030
========= ========== ========= ======== ======== =========
Percentage (2)................. 21.1% 8.1% 14.6% 3.7% 2.9% 49.6%
========= ========== ========= ======== ======== =========
</TABLE>
(1) No other individual state makes up more than 5% of total.
(2) Based on a percentage of the total unpaid principal balance of the
underlying loans.
The following table sets forth the property types of the Company's
commercial mortgage-backed securities at December 31, 1997.
Percentage
Property type Invested
------------------------------- ----------
Multi-family................... 48.8%
Retail......................... 21.5
Hotel.......................... 2.7
Office......................... 14.8
Industrial..................... 6.9
Mixed use...................... 3.8
Other.......................... 1.5
-----
Total.......................... 100.0%
At December 31, 1997 the carrying value of the Company's investment in
subordinate interests amounted to $95.4 million or 65.3% of total securities
available for sale and supported senior classes of securities having an
outstanding principal balance of $1.53 billion. As discussed below, because of
their subordinate position, subordinate classes of mortgage-related securities
involve more risk than the other classes.
The Company marks its securities portfolio to fair value at the end of
each month based upon broker/dealer marks, subject to an internal review
process. For those securities which do not have an available market quotation,
the Company requests market values and underlying assumptions from the various
broker/dealers that underwrote, are currently financing the securities, or have
had prior experience with the type of securities. Because the Company's
subordinate and residual securities are not readily marketable, trades can be
infrequent (and under some market conditions, non-existent) and most
broker/dealers do not have the securities modeled and the market value is
typically available from only a small group of broker/dealers, and in most cases
only one broker/dealer. When valuations are obtained from two or more
broker/dealers, the average dealer mark will be utilized. As of each reporting
period, the Company evaluates whether and to what extent any unrealized loss is
to be recognized as other than temporary.
9
<PAGE>
In December, 1997, after its successful bid for an equity interest in a
$320.0 million securitization of real estate owned assets and performing,
subperforming and nonperforming commercial loans, (BTC Trust Mortgage Investors
Trust 1997-S1), the Company effectively acquired 100% of the BB tranche as well
as 25% of the unrated tranche for $47.2 million. This subordinate interest,
which had an amortized cost and carrying value of $47.2 million at December 31,
1997, constitutes the Company's single largest security investment for the
reported period and represents 32.3% of the total carrying value of securities
available for sale at December 31, 1997.
At December 31, 1997, the carrying value of the Company's investment in
interest only securities amounted to $50.6 million or 34.7% of total securities
available for sale. As discussed below, interest only securities exhibit
considerably more price volatility than mortgages or ordinary mortgage
pass-through securities, due in part to the uncertain cash flows that result
from changes in the prepayment rates of the underlying mortgage collateral.
Increased prepayments of the underlying mortgage collateral resulting from a
decrease in market interest rates or other factors can result in a loss of all
or part of the purchase price of such security. At December 31, 1997, all of the
Company's interest only securities were either issued by FHLMC or FNMA or were
rated AAA by national rating agencies, with the exception of one commercial
security with a carrying value of $480,000, which was rated A, and two non-rated
commercial securities with an aggregate carrying value of $4.8 million.
During January and February 1998, the Company recorded charges of $2.5
million against its interest only securities portfolio. The charges resulted
from increases in projected prepayment speeds during this period and a resulting
shortening of the weighted average lives of certain individual securities in the
portfolio. As a result, a determination was ade to write down the recorded
investment in those securities where the reduction in fair value was considered
to be other than temporary. The Company believes that the current low levels of
interest rates, and the inverted shape of the yield curve, are relatively
short-term phenomena. To the extent that longer term interest rates increase or
the relationship between short-term and long-term rates revert to their
historical spreads, the value of the portfolio should recover. To the extent
that the current environment persists, or that rates decrease further,
additional impairment losses may be recognized.
SUBORDINATE INTERESTS. The Company has acquired subordinate interests
in multi-family residential, commercial and single family residential
mortgage-backed securitizations. MBS typically are divided into two or more
classes, sometimes called "tranches." The senior classes are higher "rated"
securities, which would be rated from low investment grade "BBB" to higher
investment grade "AA" or "AAA." The junior, subordinate classes typically
includes one or more lower rated, non-investment grade classes, and an unrated,
higher-yielding, credit support class (which generally is required to absorb the
first losses on the underlying mortgage loans).
MBS generally are issued either as collateralized mortgage obligations
("CMOs" or "CMO Bonds") or as pass-through certificates ("Pass-Through
Certificates"). CMO Bonds are debt obligations of special purpose corporations,
owner trusts or other special purpose entities secured by commercial mortgage
loans or MBS. Pass-Through Certificates evidence interests in trusts, the
primary assets of which are mortgage loans. CMO Bonds and Pass-Through
Certificates may be issued or sponsored by private originators of, or investors
in, mortgage loans, including savings and loan associations, mortgage bankers,
commercial banks, investment banks and other entities.
10
<PAGE>
In most mortgage loan securitizations, a series of MBS is issued in
multiple classes in order to obtain investment-grade ratings for the senior
classes and thus increase their marketability. Each class of MBS may be issued
with a specific fixed or variable coupon rate and a stated maturity or final
scheduled distribution date. Principal prepayments on the mortgage loans
comprising the mortgage collateral may cause the MBS to be retired substantially
earlier than their stated maturities or final scheduled distribution dates,
although, with respect to commercial mortgage loans and certain subprime
residential mortgage loans, there generally are penalties for or limitations on
the ability of the borrower to prepay the loan. Interest is paid or accrued on
MBS on a periodic basis, typically monthly.
The credit quality of MBS depends on the credit quality of the
underlying mortgage collateral. Among the factors determining the credit quality
of the underlying mortgage loans will be the ratio of the mortgage loan balances
to the value of the properties securing the mortgage loans, the purpose of the
mortgage loans (e.g., refinancing or new purchase), the amount of the mortgage
loans, their terms, the geographic diversification of the properties, and, in
the case of commercial mortgage loans, the credit-worthiness of tenants.
Additionally, the principal of and interest on the underlying mortgage
loans may be allocated among the several classes of a MBS in many ways, and the
credit quality of a particular class depends in part on the order and timing of
the receipt of cash flow generated from the underlying mortgage loans.
Subordinate interests carry significant credit risks. Typically, in a
"senior-subordinate" structure, the subordinate interests provide credit
protection to the senior classes by absorbing losses from loan defaults or
foreclosures before such losses are allocated to senior classes. Moreover,
typically, as long as the more senior tranches of securities are outstanding,
all prepayments on the mortgage loans generally are paid to those senior
tranches, at least until the end of a specified period, which typically is five
years or more. In some instances, particularly with respect to subordinate
interests in commercial securitizations, the holders of subordinate interests
are not entitled to receive scheduled payments of principal until the more
senior tranches are paid in full or until the end of a specified period. Because
of this structuring of the cash flows from the underlying mortgage loans,
subordinate interests in a typical securitization are subject to a substantially
greater risk of non-payment than are those more senior tranches. Accordingly,
the subordinate interests are assigned lower credit ratings or no ratings at
all. Neither the subordinate interests nor the underlying mortgage loans are
guaranteed by agencies or instrumentalities of the United States government or
by other governmental entities and, accordingly, are subject, among other
things, to credit risks.
As a result of the typical "senior-subordinate" structure, the
subordinate interest is extremely sensitive to losses on the underlying mortgage
loans. Accordingly, the holder of the subordinate interest is particularly
interested in minimizing the loss frequency (the percentage of the loan balances
that default over the life of the mortgage collateral) and the loss severity
(the amount of loss on a defaulted mortgage loan, i.e., the principal amount of
the mortgage loan unrecovered after applying any recovery to the expenses of
foreclosure and accrued interest) on the underlying mortgage loans.
11
<PAGE>
The loss frequency on a pool of mortgage loans will depend upon a
number of factors, many of which will be beyond the control of the Company or
the applicable servicer. Among other things, the loss frequency will reflect
broad conditions in the economy generally and real estate particularly, economic
conditions in the local area in which the underlying mortgaged property is
located, the loan-to-value ratio of the mortgage loan, the purpose of the loan
and the debt service coverage ratio (with respect to commercial mortgage loans).
The loss serverity will depend upon many of the same factors described above and
will also be influenced by the servicer's ability to efficiently foreclose on
the defaulted mortgage loan and sell the underlying mortgaged property.
The Company determines the present value of anticipated cash flows of
its mortgage-related securities utilizing valuation assumptions appropriate at
the time of each acquisition or securitization transaction. The significant
valuation assumptions include the anticipated prepayment speeds and the
anticipated credit losses related to the underlying mortgages. In order to
determine the present value of this estimated excess cash flow, the Company
currently applies a discount rate of 18% to the projected cash flows on the
unrated classes of securities. The annual prepayment rate of the securitized
loans is a function of full and partial prepayments and defaults. The Company
makes assumptions as to the prepayment rates of the underlying loans, which the
Company believes are reasonable, in estimating fair values of the subordinate
securities and residual securities retained. During 1997, the Company utilized
proprietary prepayment curves generated by the Company (reaching an approximate
range of annualized rates of 30%-40%). In its estimates of annual loss rates,
the Company utilizes assumptions that it believes are reasonable. The Company
estimates annual losses of between 0.22% and 2.06% of the underlying loans.
OTHER MBS. The Company also invests in interest-only and inverse
interest-only securities (together, "IOs"), which are entitled to no (or only
nominal) payments of principal, but only to payments of interest. The holder of
an IO may be entitled to receive a stated rate of interest on a notional
principal balance equal to the principal balance of the mortgage collateral,
that portion that bears interest in excess of a certain rate, or one or more
classes of that MBS. Alternatively, the holder of an IO may be entitled to a
variable rate of interest on a nominal principal balance that adjusts based upon
adjustment in the interest rate of the underlying mortgage collateral.
Because IOs often pay at a relatively small rate of interest on a large
notional principal balance, an accelerated reduction of that principal balance
will have an adverse effect on the anticipated yield to maturity of such IO.
Accordingly, if the underlying mortgage collateral prepays (including
prepayments as a result of default and repurchases by the seller) at a rate
faster than anticipated, the weighted average life of the IO will be reduced,
and the yield to maturity will be adversely affected. Conversely, if the
underlying mortgage collateral prepays at a rate slower than anticipated, the
weighted average life of the IO will be extended, and the anticipated yield to
maturity will be increased.
The yield curve is derived by calculating the term structure of
interest rates based on the yield to maturity of the most recently-issued U.S.
Treasury bills, notes and bonds where the y-axis is yield and the x-axis is
maturity. IOs are sensitive to prepayments, which increase as rates (yields)
decrease and refinance opportunities increase. Inverse IOs also are sensitive to
prepayments but have a coupon that floats inversely to LIBOR. If LIBOR decreases
with rates (yields) then the coupon on the Inverse IOs increases and if LIBOR
increases with rates (yields) then the coupon will decrease.
Residential mortgage loans typically do not have prepayment penalties.
As a result, prepayments tend to increase during periods of falling interest
rates and decrease during periods of rising interest rates. However, prepayments
are dependent upon a number of other factors as well (such as the number of jobs
available in the area, general economic conditions and the borrower's need for
additional cash). Commercial loans often carry prepayment restrictions or
require that the borrower pay a prepayment penalty (which generally is not for
the benefit of the holder of the IO). In any event, it is very difficult to
predict the prepayment pattern for any particular mortgage collateral, which
makes it difficult to predict the actual yield with respect to an IO.
Inverse interest-only securities bear interest at a floating rate that
varies inversely with (and often at a multiple of) changes in a specified index.
The yield to maturity of such a class of IOs is not only very sensitive to the
rate of prepayments on the underlying mortgage collateral, but also to changes
in the related index.
12
<PAGE>
At December 31, 1997, the Company's single family residential IO
portfolio consisted of the following securities:
<TABLE>
<CAPTION>
December 31, Weighted
Purchase Amortized Purchase 1997 Average Market
Broker Issue Class Type Date Cost Coupon Yield Yield Life (2) Value
- -------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CORESTATES FHLMC 1308 K I/O 05/21/97 670 8.50% 11.65% 6.63% 1.59 587
DLJ FHLMC 1977 IA I/O 08/05/97 798 7.00% 13.69% 10.06% 2.10 767
COASTAL FNMA 97-45 JD I/O 06/30/97 933 7.00% 7.39% -6.72% 3.28 396
MORGAN STANLEY HS 92-EB B7 I/O 09/23/97 1,090 n/a (1) 16.22% 15.05% 4.85 729
BEAR STEARNS FHLMC 1933 SO INV I/O 12/04/97 5,193 2.50% 28.33% 29.11% 2.72 4,185
IBS FHLMC 1943 S INV I/O 09/16/97 2,258 2.80% 28.33% 15.75% 3.20 1,813
PAINE WEBBER FHLMC 1946 SE INV I/O 05/20/97 1,078 2.25% 32.47% 23.27% 2.93 1,294
DEUTSCHE FHLMC 1948 S INV I/O 12/17/97 2,316 2.37% 28.33% 26.15% 3.74 2,278
IBS FHLMC 1967 S INV I/O 09/09/97 1,595 2.25% 33.12% 19.83% 4.49 1,133
DLJ FHLMC 1967 SA INV I/O 06/30/97 2,409 2.85% 31.63% 19.62% 2.47 2,177
MORGAN STANLEY FHLMC 1969 SJ INV I/O 07/30/97 461 4.87% 33.45% -13.73% 1.74 428
NOMURA FHLMC 1979 SA INV I/O 12/24/97 1,778 2.32% 28.33% 70.32% 1.38 1,682
SALOMON FHLMC 1983 SA INV I/O 08/29/97 5,919 2.65% 34.56% 13.55% 2.27 3,474
COASTAL FHLMC 1988 SH INV I/O 09/30/97 386 0.20% 15.68% 5.88% 4.47 287
GREENWICH FNMA 96-51 SB INV I/O 12/11/97 4,985 2.75% 28.33% 21.53% 2.89 4,690
PAINE WEBBER FNMA 97-19 SK INV I/O 06/03/97 707 2.28% 32.80% 15.01% 2.96 891
COASTAL FNMA 97-43 SC INV I/O 06/30/97 2,322 2.70% 33.11% 10.40% 1.68 1,632
SALOMON FNMA 97-44 SG INV I/O 09/09/97 3,536 2.75% 34.21% 22.49% 5.34 3,005
SMITH BARNEY FNMA 97-58 S INV I/O 08/29/97 2,020 2.75% 30.57% 13.06% 2.94 1,680
SALOMON FNMA 97-61 SA INV I/O 08/29/97 876 2.85% 32.29% 20.34% 2.94 770
NOMURA FNMA 97-62 S INV I/O 09/23/97 1,045 3.35% 22.59% 18.56% 3.67 959
NOMURA FNMA 97-65 SH INV I/O 09/30/97 8,980 2.25% 34.38% 17.40% 3.26 7,306
NOMURA FHLMC 1979 SC TTIB 12/17/97 1,150 0.65% 0.00% 41.37% 1.75 1,073
SALOMON FNMA 97-30 SL TTIB 05/19/97 1,885 1.00% 17.45% -12.89% 1.55 1,244
---------------------------------------------------------------
54,390 1.51% 21.18% 11.05% 2.26 44,480
</TABLE>
(1) The coupon rate for this instrument is not meaningful because the principal
is based on a notional amount.
(2) Weighted average life is represented in years.
13
<PAGE>
At February 28, 1998, the Company continued to hold a portfolio of
single family residential IOs having an amortized cost of $54.3 million and a
market value of $46.4 million on such date. The portfolio had a gross weighted
average mortgage coupon of 8.30% at February 28, 1998 and 8.34% at December 31,
1997, as follows:
<TABLE>
<CAPTION>
February 28, 1998 December 31, 1997
Gross Weighted Average -------------------------------- ---------------------------------
Mortgage Coupon Amortized Cost Market Value Amortized Cost Market Value
- ---------------------------------- -------------- ------------ -------------- ------------
(Dollars in Thousands) (Dollars in Thousands)
<S> <C> <C> <C> <C>
9.00% to 10.25%................ $ 578 $ 567 $ 667 $ 587
8.25% to 8.99%................ 32,880 26,182 37,156 28,962
7.75% to 8.24%................ 13,661 12,623 11,116 9,585
7.25% to 7.74%................ 7,166 7,015 5,451 5,346
--------- --------- --------- ---------
54,285 46,387 54,390 44,480
</TABLE>
In addition, the portfolio was comprised of a diverse bond structure as
follows:
<TABLE>
<CAPTION>
February 28, 1998 December 31, 1997
--------------------------------- ---------------------------------
Bond Structure Amortized Cost Market Value Amortized Cost Market Value
- ----------------------------------- -------------- ------------ -------------- ------------
(Dollars in Thousands) (Dollars in Thousands)
<S> <C> <C> <C> <C>
Prorata Strip................... $ 14,180 $ 13,177 $ 13,081 $ 11,768
Planned Amortization Class...... 3,005 2,968 386 286
Targeted Amortization Class..... 23,153 18,257 28,276 22,373
Scheduled Pay................... 929 835 1,809 1,166
Sequential Pay.................. 9,634 8,498 7,224 6,074
Support......................... 3,384 2,652 3,614 2,813
--------- --------- --------- ---------
54,285 46,387 54,390 44,480
</TABLE>
Additionally, OAIC has modeled the portfolio at February 28, 1998 in an
interest rate environment which assumes: (i) an instantaneous and sustained
parallel shift in interest rates for the remaining duration of the portfolio;
(ii) a 50 basis point decrease in LIBOR to steepen the yield curve and an
instantaneous and sustained parallel shift in interest rates for the remaining
duration of the portfolio; and (iii) a 50 basis point increase in the 10 year
treasury rate to steepen the yield curve and then an instantaneous and sustained
parallel shift in interest rates for the remaining duration of the portfolio.
OAIC's model is based on median Wall Street prepayment assumptions. The yields
resulting from this analysis are presented below:
<TABLE>
<CAPTION>
LIBOR 10 Year Treasury
Shift in Basis Points Parallel Shift Decreases Increases
- -------------------------------------- -------------- --------- ----------------
<S> <C> <C> <C>
+200............................. 7.0% 28.6% 9.4%
+100............................. 19.5 42.8 28.6
+50.............................. 19.9 44.2 36.5
0.............................. 15.2 35.3 42.8
- -50.............................. (6.7) 15.2 44.2
- -100............................. (19.1) (1.6) 35.3
- -200............................. (28.5) (15.3) (1.6)
</TABLE>
In the above parallel shift scenario, a 50 basis point instantaneous
and sustained decline in current interest rates is estimated to result in a
yield of (6.7)% on a portfolio which would have a weighted average life of 1.26
years, for a loss of $4.6 million on the amortized cost of the IOs. On the other
hand, should the Company experience a 50 basis point parallel, instantaneous and
sustained increase in current interest rates, the portfolio is expected to yield
19.9% with a weighted average life of 3.0 years, for income of $32.4 million
over the remaining life of the portfolio.
14
<PAGE>
OAIC believes that the assumptions used by it to evaluate the
vulnerability of OAIC's operations to changes in interest rates approximate
OAIC's and its affiliates actual experiences and considers them reasonable;
however, the interest rate sensitivity of the IO portfolio and the estimated
effects of changes in interest rates thereon could vary substantially if
different assumptions are used or if actual experience differs from the
historical experience on which they are based. Accordingly, no assurance can be
given that the assumptions used in creating OAIC's model will correspond to
actual results, including, in particular, prepayment speeds in any interest rate
environment.
MARKET RISK. Market risk is the exposure to loss resulting from changes
in interest rates, foreign currency exchange rates, commodity prices and equity
prices. The primary market risk to which the Company is exposed is interest rate
risk, which is highly sensitive to many factors, including governmental monetary
and tax policies, domestic and international economic and political
considerations and other factors beyond the control of the Company. Changes in
the general level of interest rates can affect the Company's net interest
income, which is the difference between the interest income earned on
interest-earning assets and the interest expense incurred in connection with its
interest-bearing liabilities, by affecting the spread between the Company's
interest-earning assets and interest-bearing liabilities. Changes in the level
of interest rates also can affect, among other things, the ability of the
Company to originate and acquire loans, the value of the Company's
mortgage-related securities and other interest-earning assets and its ability to
realize gains from the sale of such assets.
The Company may utilize a variety of financial instruments, including
interest rate swaps, caps, floors and other interest rate exchange contracts, in
order to limit the effects of interest rates on its operations. The use of these
types of derivatives to hedge interest-earning assets and/or interest-bearing
liabilities carries certain risks, including the risk that losses on a hedge
position will reduce the funds available for payments to holders of securities
and, indeed, that such losses may exceed the amount invested in such
instruments. A hedge may not perform its intended purpose of offsetting losses
or increased costs. Moreover, with respect to certain of the instruments used as
hedges, the Company is exposed to the risk that the counterparties with which
the Company trades may cease making markets and quoting prices in such
instruments, which may render the Company unable to enter into an offsetting
transaction with respect to an open position. If the Company anticipates that
the income from any such hedging transaction will not be qualifying income for
REIT income test purposes, the Company may conduct part or all of its hedging
activities through a to-be-formed corporate subsidiary that is fully subject to
federal corporate income taxation. The profitability of the Company may be
adversely affected during any period as a result of changing interest rates.
The following table quantifies the potential changes in net interest
income and net portfolio value should interest rates go up or down (shocked) 400
basis points, assuming the yield curves of the rate shocks will be parallel to
each other. Net portfolio value is defined as interest-earning assets net of
interest-bearing liabilities. All changes in income and value are measured as
percentage changes from the projected net interest income and net portfolio
value at the base interest rate scenario. The base interest rate scenario
assumes interest rates at December 31, 1997 and various estimates regarding
prepayment and all activities are made at each level of rate shock. Actual
results could differ significantly from these estimates.
Projected Percentage Change In
- --------------------------------------------------------------------------------
Change in Interest Rate Net Interest Income (1) Net Portfolio Value
================================================================================
-400 Basis Points -43.47% -0.19%
-300 Basis Points -36.93 -2.69
-200 Basis Points -30.39 -4.88
-100 Basis Points -15.66 -5.13
Base Interest Rate 0 0
+100 Basis Points 9.57 1.36
+200 Basis Points 18.88 -1.10
+300 Basis Points 21.41 -4.93
+400 Basis Points 23.94 -8.66
(1) Represents the estimated percentage change in net interest income over the
next twelve months. For purposes of this calculation, net interest income
includes as a deduction interest expense associated with real estate.
15
<PAGE>
ASSET AND LIABILITY MANAGEMENT. Asset and liability management is
concerned with the timing and magnitude of the repricing of assets and
liabilities. It is the objective of the Company to attempt to control risks
associated with interest rate movements. In general, management's strategy is to
match asset and liability balances within maturity categories to limit the
Company's exposure to earnings variations and variations in the value of assets
and liabilities as interest rates change over time.
The Company may utilize off-balance sheet financing techniques to
assist it in the management of interest rate risk. These techniques may include
interest rate exchange agreements, pursuant to which the parties exchange the
difference between fixed-rate and floating-rate interest payments on a specified
principal amount (referred to as the "notional amount") for a specified period
without the exchange of the underlying principal amount. At December 31, 1997,
the Company had not utilized off-balance sheet financing techniques.
Methods for evaluating interest rate risk include an analysis of the
Company's interest rate sensitivity "gap", which is defined as the difference
between interest-earning assets and interest-bearing liabilities maturing or
repricing within a given time period. A gap is considered positive when the
amount of interest-rate sensitive assets exceeds the amount of interest-rate
sensitive liabilities. A gap is considered negative when the amount of
interest-rate sensitive liabilities exceeds interest-rate sensitive assets.
During a period of rising interest rates, a negative gap would tend to adversely
affect net interest income, while a positive gap would tend to result in an
increase in net interest income. During a period of falling interest rates, a
negative gap would tend to result in an increase in net interest income, while a
positive gap would tend to affect net interest income adversely. Because
different types of assets and liabilities with the same or similar maturities
may react differently to changes in overall market rates or conditions, changes
in interest rates may affect net interest income positively or negatively even
if an institution were perfectly matched in each maturity category.
The following table sets forth the estimated maturity or repricing of
the Company's interest-earning assets and interest-bearing liabilities at
December 31, 1997. The amounts of assets and liabilities shown within a
particular period were determined in accordance with the contractual terms of
the assets and liabilities, except (i) adjustable-rate loans, and securities are
included in the period in which their interest rates are first scheduled to
adjust and not in the period in which they mature, (ii) fixed-rate
mortgage-related securities reflect estimated prepayments, which were estimated
based on analyses of broker estimates, the results of a prepayment model
utilized by the Company and empirical data, (iii) non-performing discount loans
reflect the estimated timing of resolutions which result in repayment to the
Company and (iv) fixed-rate loans reflect scheduled contractual amortization,
with no estimated prepayment. Management believes that these assumptions
approximate actual experience and considers them reasonable; however, the
interest rate sensitivity of the Company's assets and liabilities in the table
could vary substantially if different assumptions were used or actual experience
differs from the historical experience on which the assumptions are based.
<TABLE>
<CAPTION>
December 31, 1997
---------------------------------------------------------------------------
More than 1
Within 4 to 12 Year to 3 Years
3 Months Months 3 Years and Over Total
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Rate-Sensitive Assets: (In Thousands)
Interest-earning cash........................ $ 48,346 $ -- $ -- $ -- $ 48,346
Securities available for sale................ 6,365 20,347 42,688 76,627 146,027
Loan portfolio, net (1)...................... 1,888 4,925 3,222 5,796 15,831
Discount loan portfolio, net (1)............. 4,192 5,225 7,220 10,342 26,979
------------ ------------ ------------ ------------ ------------
Total rate-sensitive assets................ 60,791 30,497 53,130 92,765 237,183
------------ ------------ ------------ ------------ ------------
Rate-Sensitive Liabilities:..................... -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Total rate-sensitive liabilities........... -- -- -- -- --
Interest rate sensitivity gap................... 60,791 30,497 53,130 92,765 $ 237,183
------------ ------------ ------------ ------------ ------------
Cumulative interest rate sensitivity gap........ $ 60,791 $ 91,288 $ 144,418 $ 237,183
============ ============ ============ ============
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets.... 25.63% 38.49% 60.89% 100.00%
</TABLE>
(1) Balances have not been reduced for non-performing loans.
16
<PAGE>
SERVICING. The Company intends generally to acquire servicing rights
with respect to the mortgage loans underlying subordinated interests it
purchases. Acquiring these rights will give the Company control of the
underlying mortgage loans within certain parameters.
The terms of servicing agreements vary considerably, and the Company
cannot predict with certainty the precise terms of the servicing agreements into
which it will enter. In general, the Company will attempt to negotiate servicing
agreements that will permit the Company to service, or to direct the servicing
of, mortgage loans that are more than 60 to 90-days delinquent. At that point,
the Company would have the right (and the obligation) to decide whether to begin
foreclosure proceedings or to seek alternatives to foreclosure, such as
forbearance agreements, partial payment forgiveness, repayment plans, loan
modification plans, loan sales and loan assumption plans. Thus, the Company will
have within its control, subject to obligations to the related senior classes,
some ability to minimize losses on mortgage loans underlying subordinated
interests owned by the Company.
The Company intends to assign to the Bank, all of its servicing rights
and obligations (other than the right to direct foreclosure and related
decisions). It is expected that most or all of the servicing compensation will
be paid to the Bank, and thus, the Company may benefit from the ability to
direct certain of the special servicing activities, as a result of the Bank's
expertise in servicing loans, particularly nonperforming and subperforming
loans, as discussed under "The Manager" above, but not from receipt of material
amounts of servicing fees.
The Bank has experience in servicing distressed loans, has been
approved as a servicer by HUD, FHLMC and FNMA and has been rated in the second
highest applicable category, "above average," by Fitch Investors Service, Inc.,
as a special servicer of commercial mortgage loans. Moreover, Moody's recognizes
the Bank as a "highly capable" servicer of single-family residential loans,
while Standard & Poors includes the Bank on an approved servicers list.
Because the acquisition and servicing of distressed real estate is one
of the Bank's business focuses, the Bank has an established network of real
estate professionals throughout the United States to assist its asset management
activities. The Bank maintains working relationships with approved engineers,
environmental consultants and real estate brokers nationwide, and calls upon
these local advisors for assistance when appropriate.
The Company has acquired subordinate residual interests in several
pools of mortgage loans and has assumed responsibility for the special servicing
of nonperforming loans underlying such subordinate residual interests. The
Company has assigned to the Bank the servicing rights related to these
acquisitions.
For a general description of the Bank's approach to resolving troubled
loans, see "Discount Loan Acquisition and Resolution Activities - Resolution of
Discount Loans."
17
<PAGE>
COMMERCIAL REAL ESTATE ACTIVITIES
The Company believes that, under appropriate circumstances, the
acquisition of commercial and multifamily real estate acquired by a mortgage
lender at foreclosure, or by receipt of a deed in lieu of foreclosure, and other
underperforming and otherwise distressed commercial and multifamily real estate
("Distressed Real Properties") offers significant opportunities to the Company.
Distressed Real Property generally is real estate that, because of insufficient
income production or inadequate management, is in foreclosure or impending
foreclosure or which suffers significant physical or structural deficiencies.
Distressed Real Property generally is not performing to its potential because of
any one or a combination of the following: adverse market conditions, over
leverage or management neglect. OAIC focuses on the acquisition of Distressed
Real Properties that it can reposition or rehabilitate in order to increase the
underlying value.
The Company's $45.4 million net investment in real estate at December
31, 1997 is the result of the acquisition of two office buildings in California
and one shopping center in Florida, as follows:
<TABLE>
<CAPTION>
Date Acquired Property Location Square Feet Property Type Acquisition Cost
- ----------------- ----------------- ----------------- ----------- ------------- ----------------
<S> <C> <C> <C> <C> <C>
09/03/97 10 U.N. Plaza (1) San Francisco, CA 68,560 Office Bldg. $ 9,095,341
09/23/97 450 Sansome St.(2) San Francisco, CA 123,099 Office Bldg. 17,246,713
11/10/97 Cortez Plaza (3) Bradenton, FL 289,686 Shopping Ctr. 19,267,073
--------------
$ 45,609,127
==============
</TABLE>
- --------------------
(1) The leases, 90% of which mature over the next several months, are at below
market rate. OAIC intends to reposition the office building to offer large
blocks of contiguous space and full floor identity, both of which are
presently in demand in the San Francisco market.
(2) OAIC intends to reposition the office building with renovations and
upgrades to common areas to support increasing market rents. The property
has been 83% leased and a substantial number of leases mature over the
next few years.
(3) The shopping center has been 97% leased. In a separate simultaneous
transaction, the Company purchased fee simple title to a large portion of
the shopping center that had been subject to a ground lease. National and
regional tenants comprise over 86% of the center.
Set forth below is a brief description of each of the investments in
real estate at December 31, 1997.
CORTEZ PLAZA. In November 1997, the Company purchased Cortez Plaza, a
289,686 square foot shopping center located in Bradenton, Florida, a suburb of
Tampa Bay. The Company purchased this property, which was built in 1956 and
renovated in 1988, for $18.4 million. In a separate transaction, the fee simple
title to a large portion of the shopping center that had been subject to a
ground lease was purchased simultaneously for $650,000, which resulted in a
total investment in this property of $19.1 million. By simultaneously acquiring
fee simple title to a ground lease that encumbered a large part of the shopping
center's parking lot, the Company believes that it immediately improved the
value and marketability of the project. As of December 31, 1997, the shopping
center was 97% leased, and national and regional tenants, including Publix,
PetSmart, Circuit City and Montgomery Ward, which currently is in bankruptcy,
comprised a majority of the complex. Below market leases covering approximately
17% of the center expire during 1998, 1999 and 2000.
18
<PAGE>
450 SANSOME STREET. In September 1997, the Company acquired a 130,437
square foot, 16- story, Class B office building located at 450 Sansome Street in
the financial district of San Francisco, California. The Company purchased this
property for $17.2 million. The building was 83% leased as of December 31, 1997.
The property was built in 1967 and upgraded in certain respects in 1989 and
1990. The property was acquired from a lender who had taken title through
foreclosure. Subsequent to the foreclosure, the property was suboptimally
managed by the institutional owner. As a result, average rent per square foot
amounted to approximately $18.00 at the date of acquisition. During the next
five years, 86% of the leased space in the property expires. The Company plans
to invest approximately $6.7 million in this property to renovate the entrance
lobby, elevator cabs, bathrooms and hallways, install a sprinkler system,
install various upgrades to enhance compliance with the Americans with
Disabilities Act of 1990 (the "ADA"), fund deferred maintenance and various
tenant improvements and pay leasing commissions. Since acquiring the property,
the Company has commenced its repositioning strategy.
10 UNITED NATIONS PLAZA. In September 1997, the Company acquired a
71,636 square foot, six-story, Class B office building located at 10 United
Nations Plaza in the civic center district of San Francisco. The Company
purchased this property, which was built in 1982, for $9.1 million. At the date
of acquisition, the property was substantially leased and the average rent per
square foot was a below market $13.76. The building was 100% leased as of
December 31, 1997, and over 93% of total rentable space will become available by
August 1998. The property is currently being marketed for lease to tenants with
full floor or full building space requirements and the Company is under active
negotiation with several companies for rents in the upper $20 per square foot
range. The Company plans to invest approximately $3.0 million in this property
to fund cosmetic improvements to enhance the lobby and hallways, install ADA
upgrades, fund deferred maintenance and tenant improvements and pay leasing
commissions.
The Company maintains comprehensive insurance coverage on its real
estate, including coverage against events of a catastrophic nature, such as
earthquakes, hurricanes and other natural disasters. There can be no assurance
that insurance against such events will continue to be obtainable on terms which
are acceptable to the Company or at all. Moreover, changes in building codes and
ordinances, environmental considerations and other factors also might make it
not feasible to use insurance proceeds to replace a property if it is damaged or
destroyed. Under such circumstances, the insurance proceeds received by the
Company might not be adequate to restore its economic position with respect to
the affected distressed real property.
The Company's current overall strategy, with respect to its properties
is to renovate and reposition the facilities and target full floor tenants with
five to ten year lease terms. The Company estimates that over the next twelve
months, the Company will spend approximately $4.4 million in capital
improvements, tenant improvements and leasing commissions to renovate and
reposition the above properties. Repositioning is intended to result in rents,
upon re-leasing, that are greater than the current rents at the sites.
The Company intends to acquire Distressed Real Properties solely for
its own portfolio. From time to time, however, the Company and a co-investor may
submit a joint bid to acquire a pool of Distressed Real Property in order to
enhance the prospects of submitting a successful bid. It may be beneficial to
submit a bid with a co-investor depending on the size and make-up of a
particular portfolio, which are often quite diverse in terms of the asset type,
quality, performance and location. If the size is determined to be too large, or
if there is a concentration of assets in the pool within a particular
geographical location, or of a particular type which the Company deems
undesirable, either because of its preference for asset type, quality, location
or portfolio concentration issues, it may choose to bid with a co-investor and
split the portfolio, keeping the desirable assets for itself. Conversely,
another investor may ask that the Company submit a joint bid because of the
Company's special expertise in evaluating and managing specific asset types. Any
co-investor with the Company must (i) be adequately capitalized and (ii) have
significant expertise in the analysis, management or operation of the assets
being acquired. If a joint bid is successful, the Company and the co-investor
generally would split up the acquired assets in an agreed-upon manner, although
in certain instances the Company and the co-investor may continue to have a
joint interest in the acquired assets.
19
<PAGE>
The Company's policy is to conduct an investigation and evaluation of
the properties in a portfolio of Distressed Real Property before purchasing such
a portfolio. Prior to purchasing assets, the Manager will generally identify and
contact real estate brokers and/or appraisers in the market area of the subject
properties in order to obtain rent and sale comparables and broker price
opinions ("BPOs") for each asset in a portfolio. This information is used to
supplement due diligence that is performed by the Manager's employees.
The Company's due diligence generally includes the review of market
studies for each market within a portfolio. The studies typically include area
economic data, employment trends, absorption rates and market rental rates. Due
diligence also includes site inspections by the Manager's employees or agents of
most properties in a portfolio and a review of all available asset files and
documentation. To the extent possible, those include examinations of available
legal documents, litigation files, correspondence, title reports, operating
statements, appraisals and engineering and environmental reports. The
information compiled is then analyzed in order to value each property.
The property valuation process utilizes a variety of tools which may
include various proprietary financial models that have been developed by Ocwen
and are available to the Company through its management agreement with Ocwen.
Sources of information examined to determine value may include: (a) current and
historical operating statements; (b) existing appraisals: (c) BPOs; (d) rent and
sales comparables; (e) industry statistics and reports regarding operating
expenses such as those compiled by the Institute of Real Estate Management; (f)
leases; and (g) deferred maintenance observed during site inspections or
described in structural reports, and correspondence found in the loan files.
The Manager develops projections of net operating income and cash flows
taking into account lease rollovers, tenant improvement costs and leasing
commissions. The Manager compares its estimates of revenue and expenses to
historical operating statements and estimates provided in BPOs, appraisals and
general industry and regional statistics. Market capitalization rates and
discount rates are then applied to the cash flow projections to estimate values.
Market capitalization rates generally are calculated by dividing the stabilized
projected net operating income by the total investment and increase as the level
of risk in a property increases. Determining the appropriate capitalization rate
to apply to a particular property is subjective, but generally is a function of
comparing capitalization rates of similar properties that have sold and making
adjustments based on various risk factors, including market, tenancy and
physical asset factors. These values obtained from these analyses are then
compared to available appraisals, BPOs and market sale comparables to determine
recommended bid prices for each asset. The bids take into account projected
holding periods, capital costs and projected profit expectations. Recommended
bid prices are then reviewed with senior management and a decision whether to
bid is made. The amount offered by the Company generally will be the price that
the Manager estimates is sufficient to generate an acceptable risk-adjusted
return on the Company's investment.
After the Company acquires Distressed Real Property, the Company's
strategy is to improve management of the property so as to increase the cash
flow from the property. If cash flows can be increased and the property
stabilized, the Company may begin to seek an opportunity to sell the property.
Although the period during which the Company holds Distressed Real Properties
varies considerably from asset to asset, the Company believes that most such
properties will be held in its portfolio more than four years and generally
fewer than ten years.
If the Company is offered the opportunity to purchase a Distressed Real
Property that is likely to be held for fewer than four years, the Company
anticipates establishing a corporation in which the Operating Partnership will
hold a 95% non-voting ownership interest to make the purchase. Such a
corporation will not be eligible for taxation as a qualified REIT subsidiary,
and any profits that it earns on its activities will be subject to federal
corporate income tax before they are distributable to the Company. If the
Company purchases a Distressed Real Property with the intent to hold it in the
Operating Partnership for more than four years, but an opportunity arises to
sell the property sooner, the Company will consider certain strategies, such as
a like-kind exchange, to reduce any negative tax consequences relating to the
sale.
Although the Company believes that a permanent market for the
acquisition of Distressed Real Property has emerged in recent years within the
private sector, there can be no assurance that the Company will be able to
acquire the
20
<PAGE>
desired amount and type of Distressed Real Property in future periods or that
there will not be significant inter-period variations in the amount of such
acquisitions. Moreover, there can be no assurance that the Company will be
effective in making any asset acquired more valuable than the price paid to
acquire it.
The following table sets forth the cost of improvements for each
investment in real estate during 1997.
<TABLE>
<CAPTION>
Actual
Budgeted Cost of Carrying Value Rents due and
Initial Cost Cost of Improvements at December Accumulated Accrued at Total
Property to Company Improvements(1) to Date 31, 1997 Depreciation end of Period Rental Income
--------------------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
450 Sansome St......... $ 17,205 $ 3,401 $ 42 $ 17,247 $ 90 $ - $ 506
10 United Nations Plaza. 9,080 3,153 15 9,095 49 12 466
Cortez Plaza........... 19,244 212 23 19,267 40 - 348
--------- -------- -------- --------- ------- ------- -------
Total ...... $ 45,529 $ 6,766 $ 80 $ 45,609 $ 179 $ 12 $ 1,320
========= ======== ======== ========= ======= ======= =======
</TABLE>
(1) Projected through December 31, 1998
The following table sets forth a summary schedule of the total lease
expirations for the Company's investments in real estate for leases in place as
of December 31, 1997, assuming that none of the tenants exercise renewal options
or termination rights, if any, at or prior to the scheduled expirations.
<TABLE>
<CAPTION>
Percentage of Average Base Percentage of
Aggregate Annualized Rent per Aggregate
Number of Square Footage Portfolio Base Rent of Square Foot of Portfolio
Year of Lease Leases of Expiring Leased Square Expiring Expiring Annualized Base
Expiration(1) Expiring Leases Feet Leases(2) Leases(3) Rent
- ---------------- ---------- -------------- -------------- ------------ -------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
1998 7 23,373 6.07% $ 213,068 $9.12 8.64%
1999 11 35,686 9.27 338,827 9.49 13.74
2000 8 28,854 7.50 361,700 12.54 14.67
2001 12 41,898 10.89 390,955 9.33 15.85
2002 8 34,232 8.90 165,371 4.83 6.71
2003 - - - - - -
2004 - - - - - -
2005 1 8,768 2.28 36,533 4.17 1.48
2006 3 6,730 1.75 43,053 6.40 1.75
2007 & beyond 6 205,243 53.34 916,780 4.47 37.16
-- ------- ------- ------- ------
56 384,784 100.00% $2,466,287 100.00%
== ======= ======= ========== ======
</TABLE>
- ---------
(1) Lease year runs from January 1 to December 31 for all years.
(2) Annualized base rent is calculated based on the amount of rent
scheduled from January 1 of the listed year to the lease expiration.
(3) Average base rent per square foot is calculated using the annualized
base rent divided by the square footage.
The operating costs and the value of real property acquired by the
Company may be affected by the obligation to pay for the cost of complying with
existing environmental laws, ordinances and regulations, as well as the cost of
future legislation. Under various federal, state and local environmental laws,
ordinances and regulations, a current or previous owner or operator of real
property may be liable for the costs of removal or remediation of hazardous or
toxic substances on, under or in such property. Such laws often impose liability
whether or not the owner or operator knew of, or was responsible for, the
presence of such hazardous or toxic substances. Therefore, an environmental
liability could have a material adverse effect on the underlying value of a real
property, and the revenue therefrom. Although the Company is not aware that any
of its real estate has any known material environmental concerns and believes
that such real estate is in material compliance with environmental laws and
regulations, there can be no assurance that this will continue to be the case in
the future.
21
<PAGE>
DISCOUNT LOAN ACQUISITION AND RESOLUTION ACTIVITIES
The Company believes that under appropriate circumstances the
acquisition of nonperforming and underperforming mortgage loans at a discount
offers significant opportunities to the Company. Discount loans generally have
collateral coverage (which refers to the purchase price of a particular loan
relative to the value of the collateral securing the loan) which is sufficiently
in excess of the purchase price of the loan, such that successful resolutions
can produce total returns which are in excess of an equivalent investment in
performing mortgage loans.
COMPOSITION OF THE DISCOUNT LOAN PORTFOLIO. At December 31, 1997, the
Company's net discount loan portfolio amounted to $27.0 million or 9.4% of the
Company's total assets. All of the Company's discount loan portfolio is secured
by mortgage liens on real estate.
The following table sets forth the composition of the Company's discount
loan portfolio by type of loan at December 31, 1997:
Commercial real estate loans:
Office..................................................... $ 11,892,814
Retail..................................................... 30,635,968
-------------
Total discount loans..................................... 42,528,782
Discount................................................. (15,549,894)
Allowance for loan losses.................................... --
-------------
Discount loans, net.......................................... $ 26,978,888
=============
(1) Discount generally represents the difference between the purchase price
of discounted loans and their aggregate book value at the date of
acquisition which has not been accreted into income in accordance with
generally accepted accounting principles. See "- Accounting for
Discounted Loans" below.
The properties which secure the Company's discount loans are located in
the United States and Canada. At December 31, 1997, discount loans with unpaid
principal balance of $26.8 million, $9.2 million, $3.9 million and $2.6 million
were secured by properties located in Nova Scotia (Canada), New York, Montana
and Ohio, respectively. At December 31, 1997, the discount loan portfolio
included one loan with a carrying value greater than $16.0 million and four
loans with a carrying value of more than $1.1 million and less than $5.4
million.
At December 31, 1997, the Company's discount loans primarily consisted of the
following loans:
o A 13.83% participation interest in a loan pool purchased from a large
commercial bank, which interest had an outstanding balance of $7.6
million. The collateral for the loans consists primarily of three
office buildings located in midtown Manhattan, New York. The loans are
serviced by the Bank, which was the other successful joint bidder on
the loan pool. At December 31, 1997, all but $277,000 of these loans
were performing in accordance with their terms.
o A loan secured by a shopping center located in Havre, Montana with a
book value of $1.8 million. At December 31, 1997, this loan was not
performing in accordance with its terms.
o A loan secured by a shopping center located in Halifax, Nova Scotia
with a book value of $16.1 million. At December 31, 1997, this loan was
not performing in accordance with its terms.
o A loan secured by an office building located in Dayton, Ohio with a
book value of $1.5 million. At December 31, 1997, this loan was not
performing in accordance with its terms.
22
<PAGE>
Nonperforming and subperforming mortgage loans may presently be in
default or may have a greater than normal risk of future defaults and
delinquencies, as compared to newly-originated, high-quality loans of comparable
type, size and geographic concentration. Returns on an investment of this type
depend on the borrower's ability to make required payments or, in the event of
default, the ability of the loan's servicer to foreclose and liquidate the
mortgage loan. There can be no assurance that the Company will be able to
liquidate a defaulted mortgage loan successfully (through sale of the security
property or otherwise) or in a timely fashion.
ACQUISITION OF DISCOUNT LOANS. Commercial discount real estate loans
generally are acquired individually. The Company believes that it has a
competitive advantage relative to many of its competitors as a result of the
Manager's experience in managing and resolving discount loans, the Manager's
large investment in the computer systems, technology and other resources which
are necessary to conduct this business, the Manager's national reputation and
the strategic relationships and contacts developed by the Manager in connection
with these activities.
Prior to making an offer to purchase discount loans, the Manager
conducts an extensive investigation and evaluation of the loan. Evaluations of
potential discount loans are conducted primarily by the Manager's employees who
specialize in the analysis of nonperforming loans, often with further
specialization based on geographic or collateral specific factors. The Manager's
employees regularly use third parties, such as brokers, who are familiar with
the property's type and location, to assist them in conducting an evaluation of
the collateral property, and depending on the circumstances, particularly in the
case of commercial real estate loans, may use subcontractors, such as local
counsel and engineering and environmental experts, to assist in the evaluation
and verification of information and the gathering of other information not
previously made available by the potential seller.
The Company determines the amount to offer to acquire potential
discount loans by using the Manager's proprietary modeling system and loan
information database which focuses on the anticipated recovery amount, timing
and cost of the resolution of the loan. The amount offered by the Company
generally is at a discount from both the stated value of the loan and the value
of the underlying collateral and is sufficient to generate an acceptable return
on the Company's investment. Upon acquisition, the servicing of the loan is
transferred to the Manager.
RESOLUTION OF DISCOUNT LOANS. After a discount loan is acquired, the
Manager utilizes its computer software system to resolve the loan as
expeditiously as possible in accordance with specified procedures. The various
resolution alternatives generally include the following: (i) the borrower brings
the loan current in accordance with original or modified terms, (ii) the
borrower repays the loan or a negotiated amount of the loan, (iii) the borrower
agrees to deed the property to the Company in lieu of foreclosure, in which case
it is classified as real estate, or (iv) the Company forecloses on the loan and
the property is acquired at the foreclosure sale either by a third party or by
the Company, in which case it is classified as real estate.
ACTIVITY IN THE DISCOUNT LOAN PORTFOLIO. The following table sets forth
the activity in the Company's gross discount loan portfolio during the period
from May 19, 1997 to December 31, 1997:
Balance at beginning of period.............................. $ --
Acquisitions (1)............................................ 44,686,413
Resolutions and repayments (2).............................. (1,281,846)
Foreign exchange loss (3)................................... (875,785)
-------------
Balance at end of period.................................... $ 42,528,782
=============
- -------------------
(1) Acquisitions consisted of $31.6 million of commercial real estate loans
secured by retail buildings and $13.1 million of commercial real estate
loans secured by office buildings.
(2) Resolutions and repayments consists of loans which were resolved in a
manner which resulted in partial or full repayment of the loan to the
Company and consisted of $1.3 million of negotiated settlements and
$16,000 of partial repayments.
(3) Amount represents the gross foreign currency loss related to the unpaid
principal balance which, net of $307,220 related to the discount on the
loans, resulted in a net foreign currency loss of $568,565 for the period
from May 14, 1997 to December 31, 1997.
23
<PAGE>
PAYMENT STATUS OF DISCOUNT LOANS. The following table sets forth
certain information relating to the payment status of loans in the Company's
discount loan portfolio at December 31, 1997:
Loan status:
Current................................................... $ 7,964,105
Past due 31 days to 89 days............................... --
Past due 90 days or more.................................. 34,564,677
-------------
$ 42,528,782
=============
ACCOUNTING FOR DISCOUNT LOANS. The acquisition cost for a pool of
discount loans is allocated to each individual loan within the pool based upon
the Company's pricing methodology. The discount which is associated with
commercial real estate loans which are current, and which the Company believes
will remain current, is accreted into interest income as a yield adjustment
using the interest method over the contractual maturity of the loan. For all
other loans interest is earned as cash is received. Gains on the repayment and
discharge of loans are reported as interest income.
LENDING ACTIVITIES
COMPOSITION OF LOAN PORTFOLIO. At December 31, 1997, the Company's loan
portfolio, net amounted to $15.8 million or 5.5% of the Company's total assets.
Loans held for investment in the Company's loan portfolio are carried at
amortized cost, less any allowance for loan losses.
The following table sets forth the composition of the Company's loan
portfolio by type of loan at December 31, 1997:
Single-family residential................................ $ 6,465,080
Multi-family residential................................. 3,455,000
Commercial real estate:
Office................................................. 33,058,000
Hotel.................................................. 20,952,000
-------------
Total loans........................................... 63,930,080
Undisbursed loan proceeds................................ (47,639,676)
Deferred origination fees................................ (458,925)
Allowance for loan losses................................ --
-------------
Loans, net............................................. $ 15,831,479
=============
At December 31, 1997, the five states in which the largest amount of
properties securing loans in the Company's loan portfolio were located were
Massachusetts, Delaware, South Carolina, New York and Georgia, which had $40.7
million, $13.3 million, $3.5 million, $3.5 million and $2.0 million of principal
amount of loans, respectively.
During the reported period, the Company acquired 48 single family
residential loans with an aggregate unpaid principal balance of $6.5 million
with the intent of accumulating such loans, executing a securitization and
effectively retaining a subordinate interest. In addition, the Company
originated one multi-family residential loan in the amount of $3.5 million, of
which $1.4 million had been funded at December 31, 1997, two hotel acquisition
and renovation loans in the aggregate amount of $21.0 million, of which $8.4
million had been funded at December 31, 1997, and one office building renovation
and construction loan in the amount of $33.0 million which had not been funded
at December 31, 1997. At December 31, 1997 all loans were current with the
exception of four single family residential loans having an unpaid principal
balance of approximately $269,000 which were greater than 89 days past due.
24
<PAGE>
COMPETITION
GENERAL. The Company's competition varies by business line and
geographic market. In many cases, the acquisition of mortgage-related
securities, real estate and commercial and multi-family loans is based on
competitive bidding, which involves the risk that the Company may bid too low
(which generates no business) or too high (which could result in an acquisition
at an economically unattractive price). Many of the Company's competitors are
larger and have greater financial resources than the Company, and thus may be
better able than the Company to pursue business opportunities or to survive
periods of industry consolidation.
MORTGAGE-RELATED SECURITIES. The competition for subordinate and
residual interests in mortgage-related securities is intense and dominated by a
relatively few large entities, including Criimi Mae, Inc. in the case of
subordinate interests in commercial mortgage-related securities. Other
significant purchasers of these securities from time to time include General
Electric Capital Corporation, First Chicago Commercial Assets, Wilshire Real
Estate Investment Trust, Amresco, Inc., Clarion Capital Corp. and Anthracite
Capital, Inc.
REAL ESTATE. The markets in which the Company invests in commercial and
multi-family real estate are located nationwide and characterized by competitive
factors that vary based upon the type of real estate and geographic region. In
general, in periods of increasing real estate values the market for commercial
and multifamily real estate is highly competitive. The Company's competitors for
investments in real estate include Goldman Sach's Whitehall Street Real Estate
Funds, Cargill Financial Services, Colony Capital Management, Lone Star
Financial and other real estate investment trusts, insurance companies and
institutional lenders.
COMMERCIAL AND MULTIFAMILY LENDING ACTIVITIES. The markets in which the
Company conducts commercial and multifamily lending activities are located
nationwide and characterized by competitive factors that vary based upon the
type of loan product and geographic region. The Company's competitors for
commercial and multifamily loans include commercial banks, thrift institutions,
finance companies, asset-based lenders and other real estate investment trusts.
FEDERAL TAXATION
OAIC operates in a manner so as to qualify as a REIT for federal income
tax purposes under sections 856 through 860 of the Code. Generally, a REIT that
complies with the Code and distributes at least 95% of its taxable income to its
stockholders does not pay federal income tax on its distributed income.
Qualification as a REIT involves the application of highly technical rules for
which there are only limited judicial or administrative interpretations. The
determination of various factual matters and circumstances not entirely within
OAIC's control, may affect its ability to qualify as a REIT. In addition, new
legislation, regulations, administrative interpretations, or court decisions
could have a substantial adverse impact on OAIC's qualification as a REIT or the
federal income tax consequences of such qualification. If OAIC were to fail to
qualify as a REIT in any taxable year, OAIC would not be allowed a deduction for
distributions to stockholders in computing its taxable income and would be
subject to federal income tax (including any applicable alternative minimum tax)
on its taxable income at regular corporate rates. Unless entitled to relief
under certain Code provisions, OAIC also would be disqualified from treatment as
a REIT for the four taxable years following the year during which qualification
was lost. As a result, the cash available for distribution to stockholders would
be reduced for each of the years involved. Although OAIC currently intends to
operate in a manner designed to qualify as a REIT, it is possible that future
economic, market, legal, tax, or other considerations could cause the Board of
Directors, with appropriate shareholder consent, to revoke OAIC's REIT election.
25
<PAGE>
OAIC generally will not be subject to federal corporate income tax on
its net income that is distributed currently to its stockholders. That treatment
substantially eliminates the "double taxation" (i.e., taxation at both the
corporate and stockholder levels) that generally results from an investment in a
corporation. However, OAIC will be subject to federal income tax in certain
circumstances. First, OAIC will be taxed at regular corporate rates on any
undistributed REIT taxable income, including undistributed net capital gains.
Second, under certain circumstances, OAIC may be subject to the "alternative
minimum tax" on its undistributed items of tax preference, if any. Third, if
OAIC has (i) net income from the sale or other disposition of "foreclosure
property" that is held primarily for sale to customers in the ordinary course of
business or (ii) other nonqualifying income from foreclosure property, it will
be subject to tax at the highest corporate rate on such income. Fourth, if OAIC
has net income from prohibited transactions (which are, in general, certain
sales or other dispositions of property (other than foreclosure property) held
primarily for sale to customers in the ordinary course of business), such income
will be subject to a 100% tax. Fifth, if OAIC should fail to satisfy the 75%
gross income test or the 95% gross income test (as discussed below), and
nonetheless has maintained its qualification as a REIT because certain other
requirements have been met, it will be subject to a 100% tax on the net income
attributable to the greater of the amount by which OAIC fails the 75% or 95%
gross income test. Sixth, if OAIC should fail to distribute during each calendar
year at least the sum of (i) 85% of its REIT ordinary income for such year, (ii)
95% of its REIT capital gain net income for such year, and (iii) any
undistributed taxable income from prior periods, OAIC would be subject to a 4%
excise tax on the excess of such required distribution over the amounts actually
distributed. Seventh, if OAIC acquires any asset from a C corporation (i.e., a
corporation generally subject to full corporate-level tax) in a merger or other
transaction in which the basis of the asset in OAIC's hands is determined by
reference to the basis of the asset (or any other asset) in the hands of the C
corporation and OAIC recognizes gain on the disposition of such asset during the
10-year period beginning on the date on which it acquired such asset, then to
the extent of such asset's "built-in-gain" (i.e., the excess of the fair market
value of such asset at the time of acquisition by OAIC over the adjusted basis
in such asset at such time), OAIC will be subject to tax at the highest regular
corporate rate applicable. The results described above with respect to the tax
on "built-in-gain" assume that OAIC will elect pursuant to IRS Notice 88-19 to
be subject to the rules described in the preceding sentence if it were to make
any such acquisition. Finally, OAIC will be subject to tax at the highest
marginal corporate rate on the portion of any excess inclusion derived by OAIC
from REMIC residual interests equal to the percentage of the stock of OAIC held
by the United States, any state or political subdivision thereof, any foreign
government, any international organization, any agency or instrumentality of any
of the foregoing, any other tax-exempt organization (other than a farmer's
cooperative described in section 521 of the Code) that is exempt from taxation
under the unrelated business taxable income provisions of the Code, or any rural
electrical or telephone cooperative (each, a "Disqualified Organization"). Any
such tax on the portion of any excess inclusion allocable to stock of OAIC held
by a Disqualified Organization will reduce the cash available for distribution
from OAIC to all stockholders.
REQUIREMENTS FOR QUALIFICATION
The Code defines a REIT as a corporation, trust, or association (i)
that is managed by one or more trustees or directors; (ii) the beneficial
ownership of which is evidenced by transferable shares, or by transferable
certificates of beneficial interest; (iii) that would be taxable as a domestic
corporation, but for sections 856 through 860 of the Code; (iv) that is neither
a financial institution nor an insurance company subject to certain provisions
of the Code; (v) the beneficial ownership of which is held by 100 or more
persons; (vi) not more than 50% in value of the outstanding shares of which is
owned, directly or indirectly, by five or fewer individuals (as defined in the
Code to include certain entities) during the last half of each taxable year (the
"5/50 Rule"); (vii) that makes an election to be a REIT (or has made such
election for a previous taxable year) and satisfies all relevant filing and
other administrative requirements established by the IRS that must be met in
order to elect and maintain REIT status; (viii) that uses a calendar year for
federal income tax purposes and complies with the record keeping requirements of
the Code and regulations promulgated thereunder ("Treasury Regulations"); and
(ix) that meets certain other tests, described below, regarding the nature of
its income and assets. The Code provides that conditions (i) to (iv), inclusive,
must be met during the entire taxable year and that condition (v) must be met
during at least 335 days of a taxable year of 12 months, or during a
proportionate part of a taxable year of less than 12 months. Conditions (v) and
(vi) will not apply until after the first taxable year for which an election is
made to be taxed as a REIT. For purposes of determining stock ownership under
the 5/50 Rule, a supplemental unemployment compensation benefits plan, a private
foundation, or a portion of a trust permanently set aside or used exclusively
for charitable purposes generally is considered an individual. A trust that is a
qualified trust under Code section 401(a), however, generally is not
26
<PAGE>
considered an individual and beneficiaries of such trust are treated as holding
shares of a REIT for purposes of the 5/50 Rule in proportion to their actuarial
interests in such trust.
OAIC directly owns two qualified REIT two subsidiaries, the General
Partner and the Limited Partner, and may have additional subsidiaries in the
future. Code section 856(i) provides that a corporation that is a "qualified
REIT subsidiary" shall not be treated as a separate corporation, and all assets,
liabilities, and items of income, deduction, and credit of a "qualified REIT
subsidiary" shall be treated as assets, liabilities, and items of income,
deduction, and credit of the REIT. A "qualified REIT subsidiary" is a
corporation, all of the capital stock of which has been held by the REIT at all
times during the period such corporation was in existence. Effective for tax
years beginning after August 5, 1997, the definition of a "qualified REIT
subsidiary" was changed to require only that the REIT own 100% of such
corporation. Thus, in applying the requirements described herein, any "qualified
REIT subsidiaries" of OAIC will be ignored, and all assets, liabilities, and
items of income, deduction, and credit of such subsidiaries will be treated as
assets, liabilities, and items of income, deduction, and credit of OAIC. The
General Partner and the Limited Partner are "qualified REIT subsidiaries."
Accordingly, neither the General Partner nor the Limited Partner will be subject
to federal corporate income taxation, although each may be subject to state and
local taxation.
Treasury Regulations provide that a REIT will be deemed to own its
proportionate share of the assets of a partnership in which it is a partner, and
will be deemed to be entitled to the gross income of the partnership
attributable to such share. In addition, the assets and gross income of the
partnership will retain the same character in the hands of the REIT for purposes
of section 856 of the Code, including satisfying the gross income and asset
tests described below. On December 9, 1997, IMI acquired 160,000 units in the
operating partnership. Accordingly, OAIC's proportionate share of the assets and
gross income of the Operating Partnership are treated as assets and gross income
of OAIC for purposes of applying the requirements described herein.
INCOME TESTS
In order for OAIC to qualify and to maintain its qualification as a
REIT, three requirements relating to OAIC's gross income must be satisfied
annually. First, at least 75% of OAIC's gross income (excluding gross income
from prohibited transactions) for each taxable year must consist of defined
types of income derived directly or indirectly from investments relating to real
property or mortgages on real property (including "rents from real property" and
interest on obligations secured by mortgages on real property or on interests in
real property) or temporary investment income. Second, at least 95% of OAIC's
gross income (excluding gross income from prohibited transactions) for each
taxable year must be derived from such real property, mortgages on real
property, or temporary investments, and from dividends, other types of interest,
and gain from the sale or disposition of stock or securities. Third, not more
than 30% of OAIC's gross income (including gross income from prohibited
transactions) for each taxable year may be gain from the sale or other
disposition of (i) stock or securities held for less than one year, (ii) dealer
property that is not foreclosure property, and (iii) certain real property held
for less than four years (apart from involuntary conversions and sales of
foreclosure property). This third requirement no longer exists as of the 1998
tax year. The specific application of these tests to OAIC is discussed below.
The term "interest," as defined for purposes of the 75% and 95% gross
income tests, generally does not include any amount received or accrued
(directly or indirectly) if the determination of such amount depends in whole or
in part on the income or profits of any person. However, an amount received or
accrued generally will not be excluded from the term "interest" solely by reason
of being based on a fixed percentage or percentages of receipts or sales. In
addition, an amount received or accrued generally will not be excluded from the
term "interest" solely by reason of being based on the income or profits of a
debtor if the debtor derives substantially all of its gross income from the
related property through the leasing of substantially all of its interests in
the property, to the extent the amounts received by the debtor would be
characterized as rents from real property if received by a REIT. Furthermore, to
the extent that interest from a loan that is based on the cash proceeds from the
sale of the property securing the loan constitutes a "shared appreciation
provision" (as defined in the Code), income attributable to such participation
feature will be treated as gain from the sale of the secured property, which
generally is qualifying income for purposes of the 75% and 95% gross income
tests.
Interest on obligations secured by mortgages on real property or on
interests in real property is qualifying income for purposes of the 75% gross
27
<PAGE>
income test. Any amount includible in gross income with respect to a regular or
residual interest in a REMIC generally is treated as interest on an obligation
secured by a mortgage on real property. If, however, less than 95% of the assets
of a REMIC consists of real estate assets (determined as if OAIC held such
assets), OAIC will be treated as receiving directly its proportionate share of
the income of the REMIC. In addition, if OAIC receives interest income with
respect to a mortgage loan that is secured by both real property and other
property and the highest principal amount of the loan outstanding during a
taxable year exceeds the fair market value of the real property on the date OAIC
purchased the mortgage loan, the interest income will be apportioned between the
real property and the other property, which apportionment may cause OAIC to
recognize income that is not qualifying income for purposes of the 75% gross
income test.
Interest, original issue discount, and market discount income that OAIC
derives from its investments in subordinate interests, IOs, and Inverse IOs
generally will be qualifying interest income for purposes of both the 75% and
the 95% gross income tests, except to the extent that less than 95% of the
assets of a REMIC in which OAIC holds an interest consists of real estate assets
(determined as if OAIC held such assets), and OAIC's proportionate share of the
income of the REMIC includes income that is not qualifying income for purposes
of the 75% and 95% gross income tests. Most of the income that OAIC recognizes
with respect to its investments in loans will be qualifying income for purposes
of both gross income tests. In some cases, however, the loan amount may exceed
the value of the real property securing the loan, which will result in a portion
of the income from the loan being classified as qualifying income for purposes
of the 95% gross income test, but not for purposes of the 75% gross income test.
It is also possible that, in some instances, the interest income from a loan may
be based in part on the borrower's profits or net income, which generally will
disqualify the income from the loan for purposes of both the 75% and the 95%
gross income tests.
OAIC may originate or acquire construction or mezzanine loans that have
shared appreciation provisions. OAIC generally will be required to recognize
income from a shared appreciation provision over the term of the related loan
using the constant yield method pursuant to certain Treasury Regulations.
OAIC may originate or acquire and securitize loans through the issuance
of non-REMIC CMOs. As a result of such transactions, OAIC will retain an equity
ownership interest in the loans that, after considering the notes issued in the
securitization, has economic characteristics similar to those of a subordinate
interest. In addition, OAIC may resecuritize MBS (or non-REMIC CMOs) through the
issuance of non-REMIC CMOs, retaining an equity interest in the MBS used as
collateral in the resecuritization transaction. Such transactions will not cause
OAIC to fail to satisfy the gross income tests or the asset tests described
herein.
OAIC may receive income that is not qualifying income for purposes of
the 75% and 95% gross income tests. For example, certain fees for services
rendered by the Operating Partnership will not be qualifying income for purposes
of the gross income tests. It is not anticipated that the Operating Partnership
will receive a significant amount of such fees. Such fees include, without
limitation, (i) fees for servicing loans, (ii) fees for performing underwriting
or appraisal services for others and (iii) fees for managing property owned by
others. OAIC will monitor the amount of nonqualifying income produced by its
assets and has represented that it will manage its portfolio in order to comply
at all times with the three gross income tests.
The rent received by OAIC from the tenants of its real property
("Rent") will qualify as "rents from real property" in satisfying the gross
income tests for a REIT described above only if several conditions are met.
First, the amount of Rent must not be based, in whole or in part, on the income
or profits of any person. However, an amount received or accrued generally will
not be excluded from the term "rents from real property" solely by reason of
being based on a fixed percentage or percentages of receipts or sales. Second,
the Code provides that the Rent received from a tenant will not qualify as
"rents from real property" in satisfying the gross income tests if OAIC, or a
direct or indirect owner of 10% or more of OAIC, owns 10% or more of such
tenant, taking into account both direct and constructive ownership (a "Related
Party Tenant"). Third, if Rent attributable to personal property, leased in
connection with a lease of Real Property, is greater than 15% of the total Rent
received under the lease, then the portion of Rent attributable to such personal
28
<PAGE>
property will not qualify as "rents from real property." Finally, for the Rent
to qualify as "rents from real property," OAIC generally must not operate or
manage the Real Property or furnish or render services to the tenants of such
real property, other than through an "independent contractor" who is adequately
compensated and from whom OAIC derives no revenue. (An "independent
contractor" for this purpose generally means a service provider that is not (i)
an employee of the Company or (ii) in general, an entity which owns 35% or more
of the Company or an entity of which the persons owning a greater than 35%
equity interest also own 35% or more of the Company.) The "independent
contractor" requirement, however, does not apply to the extent the services
provided by OAIC are "usually or customarily rendered" in connection with the
rental of space for occupancy only and are not otherwise considered "rendered to
the occupant." Pursuant to a DE MINIMIS expection, OAIC may provide
non-customary services to its tenants other than through an independent
contractor without disqualifying the income from the property as long as the
amount OAIC receives for the impermissible services does not exceed 1% of OAIC's
gross income from the property. The amount that OAIC receives that is
attributable to impermissible services cannot be valued at less than 150% of the
direct cost to OAIC of providing the services.
It is OAIC's policy that it will not charge Rent for any portion of any
real property that is based, in whole or in part, on the income or profits of
any person (except by reason of being based on a fixed percentage or percentages
of receipts or sales, as described above) to the extent that the receipt of such
Rent would jeopardize OAIC's status as a REIT. In addition, it is OAIC's
intention that, to the extent that it receives Rent from a related party tenant,
such Rent will not cause OAIC to fail to satisfy either the 75% or 95% gross
income test. It is also OAIC's intention that it will not allow the Rent
attributable to personal property leased in connection with any lease of real
property to exceed 15% of the total Rent received under the lease, if the
receipt of such Rent would cause OAIC to fail to satisfy either the 75% or 95%
gross income test. Finally, OAIC intends that it will not operate or manage its
real property or furnish or render noncustomary services to the tenants of its
real property other than through an "independent contractor," to the extent that
such operation or the provision of such services would jeopardize OAIC's status
as a REIT.
REITs generally are subject to tax at the maximum corporate rate on any
income from foreclosure property (other than income that would be qualifying
income for purposes of the 75% gross income test), less expenses directly
connected with the production of such income. "Foreclosure property" is defined
as any real property (including interests in real property) and any personal
property incident to such real property (i) that is acquired by a REIT as the
result of such REIT having bid in such property at foreclosure, or having
otherwise reduced such property to ownership or possession by agreement or
process of law, after there was a default (or default was imminent) on a lease
of such property or on an indebtedness owed to the REIT that such property
secured, (ii) for which the related loan was acquired by the REIT at a time when
default was not imminent or anticipated, and (iii) for which such REIT makes a
proper election to treat such property as foreclosure property. OAIC does not
anticipate that it will receive any income from foreclosure property that is not
qualifying income for purposes of the 75% gross income test, but, if OAIC does
receive any such income, OAIC will make an election to treat the related
property as foreclosure property.
If property is not eligible for the election to be treated as
foreclosure property ("Ineligible Property") because the related loan was
acquired by the REIT at a time when default was imminent or anticipated, income
received with respect to such Ineligible Property may not be qualifying income
for purposes of the 75% or 95% gross income test. OAIC anticipates that any
income it receives with respect to Ineligible Property will be qualifying income
for purposes of the 75% and 95% gross income tests.
Net income derived from a prohibited transaction is subject to a 100%
tax. The term "prohibited transaction" generally includes a sale or other
disposition of property (other than foreclosure property) that is held primarily
for sale to customers in the ordinary course of a trade or business. The Company
believes that no asset owned by OAIC or the Operating Partnership will be held
for sale to customers and that a sale of any such asset will not be in the
ordinary course of OAIC's or the Operating Partnership's business. Whether
property is held "primarily for sale to customers in the ordinary course of a
trade or business" depends, however, on the facts and circumstances in effect
from time to time, including those related to a particular property.
Nevertheless, OAIC will attempt to comply with the terms of safe-harbor
provisions in the Code prescribing when asset sales will not be characterized as
prohibited transactions. Complete assurance cannot be given, however, that OAIC
can comply with the safe-harbor provisions of the Code or avoid owning property
that may be characterized as property held "primarily for sale to customers in
the ordinary course of a trade or business."
29
<PAGE>
OAIC will from time to time, enter into hedging transactions with
respect to one or more of its assets or liabilities. Any such hedging
transactions could take a variety of forms, including interest rate swap
contracts, interest rate cap or floor contracts, futures or forward contracts,
and options. To the extent that OAIC enters into an interest rate swap or cap
contract, option, future contract, forward rate agreement, or any similar
financial instrument to reduce its interest rate risk with respect to debt
incurred or to be incurred to acquire or carry real estate assets, any periodic
income or gain from the disposition of such contract should be qualifying income
for purposes of the 95% gross income test, but not the 75% gross income test. To
the extent that OAIC hedges with other types of financial instruments or in
other situations, it may not be entirely clear how the income from those
transactions will be treated for purposes of the various income tests that apply
to REITs under the Code. OAIC intends to structure any hedging transactions in a
manner that does not jeopardize its status as a REIT.
Accordingly, OAIC may conduct some or all of its hedging activities
through a corporate subsidiary that is fully subject to federal corporate income
tax.
If OAIC fails to satisfy one or both of the 75% and 95% gross income
tests for any taxable year, it nevertheless may qualify as a REIT for such year
if it is entitled to relief under certain provisions of the Code. Those relief
provisions generally will be available if OAIC's failure to meet such tests is
due to reasonable cause and not due to willful neglect, OAIC attaches a schedule
of the sources of its income to its return, and any incorrect information on the
schedule was not due to fraud with intent to evade tax. It is not possible,
however, to state whether in all circumstances OAIC would be entitled to the
benefit of those relief provisions. As discussed above, even if those relief
provisions apply, a 100% tax would be imposed on the net income attributable to
the greater of the amount by which OAIC fails the 75% or 95% gross income test.
ASSET TESTS
OAIC, at the close of each quarter of each taxable year, also must
satisfy two tests relating to the nature of its assets. First, at least 75% of
the value of OAIC's total assets must be represented by cash or cash items
(including certain receivables), government securities, "real estate assets,"
or, in cases where OAIC raises new capital through stock or long-term (at least
five-year) debt offerings, temporary investments in stock or debt instruments
during the one-year period following OAIC's receipt of such capital. The term
"real estate assets" includes interests in real property, interests in mortgages
on real property to the extent the principal balance of a mortgage does not
exceed the fair market value of the associated real property, regular or
residual interests in a REMIC (except that, if less than 95% of the assets of a
REMIC consists of "real estate assets" (determined as if OAIC held such assets),
OAIC will be treated as holding directly its proportionate share of the assets
of such REMIC), and shares of other REITs. For purposes of the 75% asset test,
the term "interest in real property" includes an interest in mortgage loans on
land and improvements thereon, such as buildings or other inherently permanent
structures (including items that are structural components of such buildings on
structures), a leasehold of real property, and an option to acquire real
property (or a leasehold of real property). An "interest" in real property also
generally includes an interest in mortgage loans secured by controlling equity
interests in entities treated as partnerships for federal income tax purposes
that own real property, to the extent that the principal balance of the mortgage
does not exceed the fair market value of the real property that is allocable to
the equity interest. Second, of the investments not included in the 75% asset
class, the value of any one issuer's securities owned by OAIC may not exceed 5%
of the value of OAIC's total assets, and OAIC may not own more than 10% of any
one issuer's outstanding voting securities (except for its interests in the
Operating Partnership, the General Partner, the Limited Partner, any other
qualified REIT subsidiary, partnership or any other REIT).
OAIC expects that any distressed real properties, subordinate
interests, IOs and temporary investments that it acquires generally will be
qualifying assets for purposes of the 75% asset test, except to the extent that
less than 95% of the assets of a REMIC in which OAIC owns an interest consists
of "real estate assets" and OAIC's proportionate share of those assets includes
assets that are nonqualifying assets for purposes of the 75% asset test. Loans
also will be qualifying assets for purposes of the 75% asset test to the extent
that the principal balance of each mortgage loan does not exceed the value of
the associated real property. OAIC will monitor the status of the assets that it
acquires for purposes of the various asset tests and has represented that it
will manage its portfolio in order to comply at all times with such tests.
30
<PAGE>
If OAIC should fail to satisfy the asset tests at the end of a calendar
quarter, such a failure would not cause it to lose its REIT status if (i) it
satisfied the asset tests at the close of the preceding calendar quarter and
(ii) the discrepancy between the value of OAIC's assets and the asset test
requirements arose from changes in the market values of its assets and was not
wholly or partly caused by the acquisition of one or more non-qualifying assets.
If the condition described in clause (ii) of the preceding sentence were not
satisfied, OAIC still could avoid disqualification by eliminating any
discrepancy within 30 days after the close of the calendar quarter in which it
arose.
DISTRIBUTION REQUIREMENTS
OAIC, in order to avoid corporate income taxation of the earnings that
it distributes, is required to distribute with respect to each taxable year
dividends (other than capital gain dividends) to its stockholders in an
aggregate amount at least equal to (i) the sum of (A) 95% of its "REIT taxable
income" (computed without regard to the dividends paid deduction and its net
capital gain) and (B) 95% of the net income (after tax), if any, from
foreclosure property, minus (ii) the sum of certain items of noncash income.
Such distributions must be paid in the taxable year to which they relate, or in
the following taxable year if declared before OAIC timely files its federal
income tax return for such year and if paid on or before the first regular
dividend payment date after such declaration. To the extent that OAIC does not
distribute all of its net capital gain or distributes at least 95%, but less
than 100%, of its "REIT taxable income," as adjusted, it will be subject to tax
thereon at regular ordinary and capital gains corporate tax rates. Furthermore,
if OAIC should fail to distribute during each calendar year (or, in the case of
distributions with declaration and record dates falling in the last three months
of the calendar year, by the end of the January immediately following such year)
at least the sum of (i) 85% of its REIT ordinary income for such year, (ii) 95%
of its REIT capital gain income for such year, and (iii) any undistributed
taxable income from prior periods, OAIC would be subject to a 4% nondeductible
excise tax on the excess of such required distribution over the amounts actually
distributed. OAIC intends to make timely distributions sufficient to satisfy the
annual distribution requirements.
It is possible that, from time to time, OAIC may experience timing
differences between (i) the actual receipt of income and actual payment of
deductible expenses and (ii) the inclusion of that income and deduction of such
expenses in arriving at its REIT taxable income. For example, OAIC will
recognize taxable income in excess of its cash receipts when, as generally
happens, original issue discount ("OID") accrues with respect to its subordinate
interests. Furthermore, some loans and IOs may be deemed to have OID, in which
case OAIC will be required to recognize taxable income in advance of the related
cash flow. In addition, pursuant to certain Treasury Regulations, OAIC may be
required to recognize the projected amount of any payment to be made pursuant to
a shared appreciation provision over the term of the related loan using the
constant yield method. OID generally will be accrued using a methodology that
does not allow credit losses to be reflected until they are actually incurred.
In addition, OAIC may recognize taxable market discount income upon the receipt
of proceeds from the disposition of, or principal payments on, subordinate
interests and loans that are "market discount bonds" (i.e., obligations with a
stated redemption price at maturity that is greater than OAIC's tax basis in
such obligations), although such proceeds often will be used to make
non-deductible principal payments on related borrowings. OAIC also may recognize
excess inclusion or other "phantom" taxable income from REMIC residual
interests. It also is possible that, from time to time, OAIC may recognize net
capital gain attributable to the sale of depreciated property that exceeds its
cash receipts from the sale. Finally, OAIC may recognize taxable income without
receiving a corresponding cash distribution if it forecloses on or makes a
"significant modification" (as defined in Regulations section 1.1001-3(e)) to a
loan, to the extent that the fair market value of the underlying property or the
principal amount of the modified loan, as applicable, exceeds OAIC's basis in
the original loan. Therefore, OAIC may have less cash than is necessary to meet
its annual 95% distribution requirement or to avoid corporate income tax or the
excise tax imposed on certain undistributed income. In such a situation, OAIC
may find it necessary to arrange for short-term (or possibly long-term)
borrowings or to raise funds through the issuance of preferred stock or
additional common stock.
31
<PAGE>
Under certain circumstances, OAIC may be able to rectify a failure to
meet the distribution requirements for a year by paying "deficiency dividends"
to its stockholders in a later year, which may be included in OAIC's deduction
for dividends paid for the earlier year. Although OAIC may be able to avoid
being taxed on amounts distributed as deficiency dividends, it will be required
to pay to the IRS interest based upon the amount of any deduction taken for
deficiency dividends.
RECORDKEEPING REQUIREMENTS
Pursuant to applicable Treasury Regulations, in order to be able to
elect to be taxed as a REIT, OAIC must maintain certain records and request on
an annual basis certain information from its stockholders designed to disclose
the actual ownership of its outstanding stock. OAIC intends to comply with such
requirements.
FAILURE TO QUALIFY
If OAIC fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, OAIC will be subject to tax (including
any applicable alternative minimum tax) on its taxable income at regular
corporate rates. Distributions to OAIC's stockholders in any year in which OAIC
fails to qualify will not be deductible by OAIC nor will they be required to be
made. In such event, to the extent of OAIC's current and accumulated earnings
and profits, all distributions to stockholders will be taxable as ordinary
income and, subject to certain limitations of the Code, corporate distributees
may be eligible for the dividends received deduction. Unless entitled to relief
under specific statutory provisions, OAIC also will be disqualified from
taxation as a REIT for the four taxable years following the year during which
OAIC ceased to qualify as a REIT. It is not possible to state whether in all
circumstances OAIC would be entitled to such statutory relief.
ITEM 2. PROPERTIES
OFFICES
The Company does not maintain an office. It relies on the facilities
provided by its manager, OCC. In addition, reference is made to the section
entitled "Business-Distressed Commercial Real Estate Activities" which is
incorporated herein by reference.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
32
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
Information required by this Item appears under the caption
"Shareholder Information" on page 29 of the Annual Report to Shareholders and is
incorporated herein by reference.
The following table sets forth the amount of cash dividends declared on
the common stock during the periods indicated.
Cash Dividends
1997 Per Share
--------------------------------- ----------------------
Second quarter (from May 14) $ 0.10
Third quarter 0.24
Fourth quarter 0.39
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION
Information required by this Item appears under the caption "Selected
Consolidated Financial Information" on page 1 of the Annual Report to
Shareholders and is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Information required by this Item appears under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 2 to 9 of the Annual Report to Shareholders and is
incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this Item appears under the caption "Business -
Investment Activities" under Item 1 hereto and is incorporated herein by
reference.
33
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
Information required by this Item appears in the Annual Report to
Shareholders on pages 12 to 26 and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information contained in the Company's 1998 Proxy Statement, dated
April 15, 1998, for the 1998 Annual Meeting of Shareholders under the captions
"Election of Directors" on pages 2 to 4, "Ownership of the Company's Common
Stock -- Has There Been Compliance with Section 16(a) Beneficial Ownership
Reporting Requirements?" on page 7 and "Management of the Company--Who are the
Executive Officers of the Company?" on pages 8 to 9 is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in the Company's 1998 Proxy Statement for the
1998 Annual Meeting of Shareholders under the captions "Executive
Compensation--What Compensation does the Company Pay to its Executive Officers?
" on page 11 and "Management of the Company -- What is the Compensation Paid to
Directors?" and "What Committees has the Board Established? - Compensation
Committee" on page 9 other than under the sub-caption "Report of the Nominating
and Compensation Committee," and "Board of Directors Compensation" is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained in the Company's 1998 Proxy Statement for the
1998 Annual Meeting of Shareholders under the caption "Ownership of the
Company's Common Stock" on pages 6 to 7 is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the Company's 1998 Proxy Statement for the
1998 Annual Meeting of Shareholders under the caption "Certain Relationships and
Related Transactions" on pages 10 to 11 is incorporated herein by reference.
34
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Amended and Restated Articles of Incorporation (1)
3.2 Bylaws(1)
4.1 Form of Common Stock Certificate (1).
10.1 Form of Management Agreement (1).
10.2 Form of Registration Rights Agreement (1).
10.3 Second Amended and Restated Agreement of Limited
Partnership of Ocwen Partnership L.P.*
10.4 Form of Stock Option Plan (1)
11.1 Computation of earnings per share.*
13.1 Annual Report to Shareholders for the Period Ended
December 31, 1997
21.0 List of subsidiaries.*
27.1 Financial Data Schedule - For the period ended
December 31, 1997*
27.2 Financial Data Schedule - For the period ended June
30, 1997*
27.3 Financial Data Schedule - For the period ended
September 30, 1997*
----------------
* Previously filed.
(1) Incorporated by reference to the similarly
described exhibit filed in connection with the
Company's Registration Statement on Form S-11 (File
No. 333-21965), as amended, declared effective by the
Commission on May 14, 1997.
(2) Computation of earnings per share appears on page
25 in the Annual Report to Shareholders and is
incorporated herein by reference.
(b) Financial Statements and Schedules
The following Consolidated Financial Statements of Ocwen Asset
Investment Corp. and Report of Price Waterhouse LLP, Independent
Certified Public Accountants, are incorporated herein by reference to
pages 11 to 26 of the Company's Annual Report to Shareholders:
(1) Report of Independent Certified Public Accountants
(2) Consolidated Statement of Financial Condition at
December 31, 1997
(3) Consolidated Statement of Operations for the period
from May 14, 1997 to December 31, 1997
35
<PAGE>
(4) Consolidated Statement of Changes in Stockholders'
Equity for the period from May 14, 1997 to December
31, 1997
(5) Consolidated Statement of Cash Flows for the period
from May 14, 1997 to December 31, 1997
(6) Notes to Consolidated Financial Statements
Financial statement schedules have been omitted because they
are not applicable or the required information is shown in the
Consolidated Financial Statements or notes thereto.
(c) Reports on Form 8-K filed during the quarter ended December 31,
1997
(1) A Form 8-K was filed by the Company on October 31,
1997 which contained a news release announcing the
Company's financial results for the three months
ended September 30, 1997 and for the period May 19,
1997 to September 30, 1997.
(2) A Form 8-K was filed by the Company on December 9,
1997 which contained a news release announcing the
Company's November 1997 investments of $35.4 million
and $164.9 million in outstanding commitments.
36
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this amended
report to be signed on its behalf by the undersigned, thereunto duly authorized.
OCWEN ASSET INVESTMENT CORP.
By: /s/ MARK S. ZEIDMAN
-----------------------------------------------------
Mark S. Zeidman
Senior Vice President and Chief Financial Officer
(duly authorized representative of the registrant)
Date: December 21, 1998
37
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following table presents selected consolidated financial data of
Ocwen Asset Investment Corp. and its subsidiaries ("OAIC" or the "Company") at
the date and for the period indicated.
The selected balance sheet data at December 31, 1997 and operations data
for the period from May 14, 1997 to December 31, 1997 have been derived from the
financial statements audited by Price Waterhouse LLP, independent certified
public accountants. The selected consolidated financial data should be read in
conjunction with, and is qualified in its entirety by reference to, the
information in the consolidated Financial Statements and related notes set forth
elsewhere herein.
For the Period
May 14, 1997
to
December 31, 1997
-----------------
OPERATIONS DATA:
Interest income ........................................... $ 13,461,715
Income on investments in real estate, net ................. 1,481,633
Other operating income .................................... 12,665
-------------
Total income ........................................... 14,956,013
Operating expenses ........................................ 3,155,065
-------------
Income before minority interest ........................... 11,800,948
Minority interest in net income of operating partnership .. (9,430)
-------------
Net income ............................................. $ 11,791,518
=============
Earnings per share:
Basic .................................................. $ 0.62
=============
Diluted ................................................ $ 0.60
=============
Weighted average common shares outstanding:
Basic .................................................. 19,108,789
=============
Diluted ................................................ 19,564,770
=============
BALANCE SHEET DATA:
Total assets ............................................ $ 288,003,341
Cash and cash equivalents ............................... 48,677,123
Securities available for sale, at market value .......... 146,026,907
Loan portfolio .......................................... 15,831,479
Discount loan portfolio ................................. 26,978,888
Investment in real estate ............................... 45,430,039
Minority interest ....................................... 2,941,541
Shareholders' equity .................................... 271,258,267
OTHER DATA:
Average assets .......................................... $ 289,215,300
Average equity .......................................... 284,260,200
Return on average assets ................................ 6.56%
Return on average equity ................................ 6.67%
Average equity to average assets ........................ 98.29%
Dividend payment ratio .................................. 117.70%
1
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of the Company's consolidated financial
condition, results from operations, and capital resources and liquidity should
be read in conjunction with the Consolidated Financial Information and the
Consolidated Financial Statements and related notes included elsewhere herein.
GENERAL
The Company is a newly formed corporation that has elected to be taxed
as a real estate investment trust ("REIT") under the Internal Revenue Code of
1986, as amended (the "Code"), and that specializes in opportunistic real estate
investments. At December 31, 1997, the Company had invested $234.3 million or
83% of the $283.7 million of net proceeds received from the sale of 19,125,000
shares of its common stock in May 1997. Of this amount, $146 million or 62% was
invested in mortgage-related securities, $45.4 million or 19% was invested in
real estate, $27 million or 12% was invested in commercial discount mortgage
loans and $15.9 million or 7% was invested in other mortgage loans.
RECENT TRANSACTIONS
During the months of January and February 1998, the Company completed
the acquisition of five pools of residential loans with an aggregate unpaid
principal balance of approximately $10.9 million. The loans have a weighted
average coupon rate of 8.13%.
On January 12, 1998, the Company closed an $11.6 million mezzanine
construction loan, which had an initial draw of $1.6 million, for a 160 unit
apartment rental project located in San Francisco, California with on-site
parking and commercial space on the first floor.
On January 15, 1998, in order to match-fund the Company's asset base
with anticipated borrowings and thereby minimize the impact on the Company from
changes in net interest income due to changes in 1-month London InterBank
Offered Rate ("LIBOR"), the Company placed a 5 year, $100.0 million notional
swap. The terms of the swap call for the Company to pay a fixed rate of 5.75%
and receive 1-month LIBOR on $100.0 million.
On January 23, 1998, the Company purchased for $13.7 million, a
16-story, 124,688 square foot office property located at 690 Market Street, San
Francisco, California. The building is 83% leased with 41% of the building
becoming available by the end of 1998. The Company anticipates investing an
additional $4.3 million to reposition the building for re-leasing.
On January 30, 1998, the Company purchased a $51.6 million investment
in a subordinate interest-only strip supported by a pool of 6,309 subprime
mortgage loans. Ocwen Federal Bank FSB (the "Bank") will special service any
loans that become 60 days delinquent. The average balance of the loan is
approximately $95,000 and the geographical concentration is mainly in
California, Florida, Illinois, Massachusetts and Washington.
On February 17, 1998, the Company sold 175,000 shares of common stock
for cash in an aggregate amount of approximately $3.1 million to certain
officers and directors of the Company and Ocwen Financial Corporation ("Ocwen").
In connection with this stock issuance, a subsidiary of Ocwen sold a like number
of shares of the Company's common stock and invested in a like number of limited
partnership units in the Company's operating partnership in order to comply with
the stock ownership restrictions imposed on REITs under the Code.
On February 27, 1998, the Company closed a $30.3 million commercial
real estate construction loan which had an initial draw of $13.2 million. The
loan facilitated the acquisition of a 12-story, 155,000 gross square foot,
office building located in the Tribeca area of Manhattan, New York, and will
finance its conversion to contain 52 large luxury loft-style residential
condominiums with a parking garage. The loan has a five year term. The Company
also receives prepaid interest upon closing of the loan, and a fixed exit fee
when the loan is repaid in full.
On March 6, 1998, OAIC executed a definitive purchase agreement for the
acquisition of an existing 536,000 square foot, 22 story Class A- office
building located at 225 Bush Street in the financial district of San Francisco,
California for $100.2 million. OAIC expects to make an additional investment of
approximately $10.5 million to fund closing costs and commissions, construction
costs associated with mechanical systems and cosmetic upgrades, and tenant
2
<PAGE>
improvements and leasing commissions. Current rents in the building average
$18.30 per square foot, and OAIC estimates the average current market rent to
approximate $32 to $35 per square foot. As a result of the nearly 60% turnover
of the rental space in 1998 and 1999, OAIC expects its funds from operations
during 1998 will provide a modest return on this investment. As is typical of
many of OAIC's commercial real estate investments, future releasing of this
property at market rates is anticipated to provide stronger contributions to
funds from operations thereafter and to meet OAIC's desired return parameters
over the expected holding period of the investment. This transaction is subject
to various terms and conditions of closing and performance, and as a result,
there can be no assurance that this transaction will be consummated.
On March 17, 1998, OAIC executed a definitive agreement with a Wall
Street firm concerning the acquisition of subordinate interest only securities
("Sub IO") for approximately $14.3 million plus closing costs (such transaction
constitutes the result of negotiations pursuant to the letter of intent
announced by OAIC and Aames Financial Corporation in January 1998). The
transaction is subject to various terms and conditions of closing and
performance, and as a result, there can be no assurance that this transaction
will be consummated.
On March 19, 1998, the Company announced the declaration of its first
quarter 1998 cash dividend of $0.25 per share, payable to shareholders of record
on March 30, 1998 with payment on April 16, 1998.
On March 26, 1998, the Company closed the acquisition of $8.3 million
of Sub IOs issued from a securitization of sub-prime residential mortgage loans.
RESULTS OF OPERATIONS
The Company completed an initial public offering on May 14, 1997 and
commenced operations thereon. Net income for the period from May 14, 1997 to
December 31, 1997 amounted to $11.8 million. Diluted earnings per weighted
average common share were $0.60 for the period.
The Company is engaged in a variety of real estate and mortgage-related
investment activities, investing primarily in mortgage-related securities,
commercial real estate, commercial discount loans and commercial and residential
loans. The following table presents the contribution by investment activity to
the Company's net income before minority interest for the period from May 14,
1997 to December 31, 1997.
<TABLE>
<CAPTION>
Amount %
----------- -----------
<S> <C> <C>
Mortgage-related securities and other short-term investments.. $ 9,948,788 84%
Commercial real estate ....................................... 1,375,733 12
Commercial discount loans .................................... 394,391 3
Commercial and residential loans ............................. 82,036 1
----------- ---
$11,800,948 100%
=========== ===
</TABLE>
INTEREST INCOME. Interest income for the period from May 14, 1997 to
December 31, 1997 amounted to $13.5 million. The following table sets forth the
total amount of interest income generated from interest-earning assets and the
resultant annualized yields. The average balance is based on average daily
balances for the reported period.
<TABLE>
<CAPTION>
For the Period from May 14, 1997 to December 31, 1997
-----------------------------------------------------
Average Interest Annualized
Balance Income Yield
-------------- --------------- ----------------
<S> <C> <C> <C>
Repurchase agreements and interest-earning
deposits ................................. $ 155,756,900 $ 5,538,946 5.72%
Securities available for sale............... 76,423,400 6,362,909 13.39
Loans....................................... 4,294,000 311,157 11.65
Discount loans.............................. 16,453,200 1,248,703 12.20
-------------- --------------
Total.................................... $ 252,927,500 $ 13,461,715 8.56%
============== ===============
</TABLE>
OPERATING INCOME. Operating income is comprised primarily of $1.5
million in income earned on investments in real estate during the period from
May 14, 1997 to December 31, 1997. Such income represents rental income, net of
operating expenses and depreciation, and $890,000 of income realized from the
early termination of a lease by a tenant, generated from the Company's
investment in two office buildings located in California and a retail shopping
center located in Florida.
3
<PAGE>
OPERATING EXPENSES. The following table sets forth the principal
components of the Company's operating expenses during the period from May 14,
1997 to December 31, 1997.
Management fees.......................................... $ 1,796,311
Due diligence............................................ 326,025
Foreign currency loss.................................... 568,565
Other .................................................. 464,164
--------------
Total................................................. $ 3,155,065
==============
Management fees totaling $1.8 million for the period from May 14, 1997
to December 31, 1997 were comprised solely of a base management fee (1% per
annum of average invested assets) earned by Ocwen Capital Corporation ("OCC"), a
wholly-owned subsidiary of Ocwen, pursuant to the terms of a management
agreement entered into between the Company and Ocwen. OCC advises the Company on
various facets of its business and manages its day-to-day operations, subject to
the supervision of the Company's Board of Directors. See Note 1 to the
Consolidated Financial Statements. In addition, the Company incurred due
diligence expense in connection with its asset acquisitions. Foreign currency
loss for the period is a result of the strengthening U.S. dollar versus the
Canadian dollar and relates to the Company's investment in a Canadian commercial
discount loan. See "Discount Loan Portfolio" and Notes 1 and 6 to the
Consolidated Financial Statements. Other expenses were comprised of auditing
fees, insurance premiums and other miscellaneous expenses.
4
<PAGE>
CHANGES IN FINANCIAL CONDITION
The following table sets forth information relating to certain of the
Company's assets and liabilities at December 31, 1997.
ASSETS:
Interest earning deposits................................. $ 48,346,076
Securities available for sale, at market value............ 146,026,907
Loan portfolio............................................ 15,831,479
Discount loan portfolio, net.............................. 26,978,888
Investment in real estate, net............................ 45,430,039
Total assets.............................................. 288,003,341
LIABILITIES AND SHAREHOLDERS' EQUITY:
Dividends and distributions payable...................... 7,458,750
Total liabilities......................................... 13,803,533
Minority interest......................................... 2,941,541
Shareholders' equity...................................... 271,258,267
GENERAL. Total assets amounted to $288.0 million at December 31, 1997
and consisted primarily of $48.3 million of interest earning deposits, $146.0
million of securities available for sale, $15.8 million of loans held in
portfolio, $27.0 million of discount loans and $45.4 million of investments in
real estate. These assets are the result of the Company's investment of the
$283.7 million of proceeds received from its initial public offering in May
1997. Total liabilities amounted to $13.8 million at December 31, 1997 and were
primarily comprised of declared but unpaid dividends of $7.5 million, $2.8
million payable in connection with the acquisition of a pool of single family
loans and unpaid management fees due OCC of $728,000.
REPURCHASE AGREEMENTS AND INTEREST EARNING DEPOSITS. At December 31,
1997 total interest earning deposits amounted to $48.3 million or 17% of total
assets and were comprised of deposits at various banks, including $16,000 on
deposit in an account at the Bank.
Although the Company had no repurchase agreements at December 31, 1997,
it enters into such agreements from time to time. In these transactions, the
Company purchases securities from a counterparty and agrees to sell the
securities back to the counterparty at a specified future date. Repurchase
agreements are carried at the amounts at which the securities will be
subsequently resold to the counterparty plus accrued interest, as specified in
the respective agreements. The securities purchased are held in custody for the
benefit of the Company. All of the transactions are in United States agency or
investment grade securities. The Company's exposure to credit risks associated
with the non-performance of counterparties in fulfilling their contractual
obligations can be directly impacted by market fluctuations, which may impair
the counterparties' ability to satisfy their obligations. The Company monitors
the market value of the underlying securities relative to the amounts due under
the agreements and, when necessary, requires prompt additional collateral or
reduction in loan balance to ensure that the market value remains sufficient to
protect itself in the event of default by the counterparty.
The Company earned interest income of $5.5 million during the period
May 14, 1997 to December 31, 1997 from its investment in interest earning
deposits and repurchase agreements. Of this amount, $5.1 million was earned from
investments in repurchase agreements. Given the Company's investment of cash and
cash equivalents received in connection with its initial public offering in
other types of assets over the course of the reporting period, operating results
for the period presented are unlikely to be indicative of the results that may
be expected for future periods.
5
<PAGE>
SECURITIES AVAILABLE FOR SALE. The Company's investment in
mortgage-related securities available for sale of $146.0 million at December 31,
1997 is net of $7.3 million of net unrealized losses which was included in
shareholders' equity. The Company's securities available for sale were comprised
of the following at December 31, 1997:
Mortgage-related securities:
Single-family residential:
FHLMC interest only................................ $ 21,177,964
FNMA interest only................................. 22,573,132
AAA-rated interest only............................ 729,372
Subordinates....................................... 9,444,067
---------------
Total............................................ 53,924,535
---------------
Multi-family residential and commercial:
AAA-rated interest only............................ 865,747
A-rated interest only.............................. 480,188
Non-rated interest only............................ 4,802,873
Subordinates....................................... 85,953,564
---------------
Total............................................ 92,102,372
---------------
Total.......................................... $ 146,026,907
===============
The $146.0 million of securities available for sale at December 31,
1997 is the result of purchases of $166.3 million, offset in part by $6.7
million of principal payments and maturities, $6.3 million of net premium
amortization and net unrealized losses of $7.3 million.
The Company's investments in interest only and inverse interest-only
securities (together, "IOs"), which had an aggregate amortized cost and fair
value of $60.8 million and $50.6 million at December 31, 1997, respectively,
exhibit considerably more price volatility than mortgages or ordinary mortgage
pass-through securities, due in part to the uncertain cash flows that result
from changes in the prepayment rates of the underlying mortgages. In the case of
IOs, increased prepayments of the underlying mortgages as a result of a decrease
in market interest rates or other factors can result in loss of all or part of
the purchase price of such security. During January and February 1998, the
Company recorded a charge of $2.5 million against its interest only securities
portfolio. The charge resulted from increases in projected prepayment speeds
during this period and a resulting shortening of the weighted average lives of
certain individual securities in the portfolio. As a result, a determination was
made to write down the recorded investment in those securities where the
reduction in fair value was considered to be other than temporary. The Company
believes that the current low levels of interest rates, and the inverted shape
of the yield curve, are relatively short-term phenomena. To the extent that
longer term interest rates increase or the relationship between short-term and
long-term rates revert to their historical spreads, the value of the portfolio
should recover. To the extent that the current environment persists, or that
rates decrease further, additional impairment losses may be recognized. See Note
4 to the Consolidated Financial Statements.
LOAN PORTFOLIO. The Company's investment in loans amounted to $15.8
million at December 31, 1997 as follows:
Single-family residential............................ $ 6,465,080
Multi-family residential............................. 3,455,000
Commercial real estate:
Office............................................ 33,058,000
Hotel............................................. 20,952,000
--------------
Total loans...................................... 63,930,080
Deferred origination fees............................ (458,925)
Undisbursed loan proceeds........................... (47,639,676)
Allowance for loan losses............................ --
--------------
Loans, net......................................... $ 15,831,479
==============
During the reporting period, the Company acquired 48 single family
residential loans with an aggregate unpaid principal balance of $6.8 million
with the intent of accumulating such loans, executing a securitization, and
effectively retaining a subordinate interest. In addition, the Company
originated one multi-family residential loan in the amount of $3.5 million, of
which $1.4 million had been funded at December 31, 1997, two hotel acquisition
and renovation loans in
6
<PAGE>
the aggregate amount of $21.0 million, of which $8.4 million had been funded at
December 31, 1997, and one office building renovation and construction loan in
the amount of $33.0 million which had not been funded at December 31, 1997. At
December 31, 1997 all loans were current with the exception of four single
family residential loans having an unpaid principal balance of approximately
$269,000 which were greater than 89 days past due. Substantially all of the
above loans are serviced by the Bank. See Note 5 to the Consolidated Financial
Statements.
DISCOUNT LOAN PORTFOLIO. The following table sets forth the composition
of the Company's $27.0 million investment in discount loans at December 31,
1997.
Commercial real estate loans:
Office ........................................... $ 11,892,814
Retail............................................ 30,635,968
------------
Total unpaid principal balance................. 42,528,782
Allowance for loan losses......................... --
Unaccreted discount............................... (15,549,894)
------------
Discount loans, net............................ $ 26,978,888
============
The $27.0 million of discount loans at December 31, 1997 is the result
of three acquisitions. During June 1997 the Company acquired a 13.83% pari passu
interest in four subperforming commercial loans with an aggregate unpaid
principal balance of $10.5 million. The loans are collateralized by three office
buildings located in New York, New York and one shopping center in Yorktown, New
York. The Bank acquired the remaining interest in these loans. During September
1997 the Company acquired a Canadian commercial loan with an unpaid principal
balance of $27.6 million, ($38.3 million Canadian). The loan is collateralized
by a 395,000 square foot shopping center located in Halifax, Nova Scotia,
Canada. During November 1997 the Company acquired two loans secured by a 195,445
square foot shopping center in Havre, Montana and a 43,205 square foot Dayton,
Ohio office building with an aggregate unpaid principal balance of $6.6 million.
All of the Company's discount loans are serviced by the Bank. See Note 6 to the
Consolidated Financial Statements.
The following table sets forth certain information relating to the
payment status of loans in the Company's discount loan portfolio at December 31,
1997.
Past due less than 31 days............................ $ 7,964,105
Past due 31 days to 89 days........................... --
Past due 90 days or more.............................. 34,564,677
--------------
$ 42,528,782
==============
ALLOWANCE FOR LOAN LOSSES. The Company's policy is to maintain an
allowance for loan losses on its loan and discount loan portfolios at a level
which management considers adequate to provide for potential losses based upon
an evaluation of known and inherent risks. At December 31, 1997, no allowance
for loan losses had been provided because all loans held by the Company were
recent acquisitions and were performing in accordance with management's
expectations at the date of origination or acquisition.
INVESTMENT IN REAL ESTATE. The Company's $45.4 million net investment
in real estate at December 31, 1997 is net of $179,088 of accumulated
depreciation and is the result of the acquisition of two office buildings in
California and one shopping center in Florida, as follows:
<TABLE>
<CAPTION>
Date Acquired Property Location Square Feet Acquisition Cost
------------- --------------- ----------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
09/03/97 10 U.N. Plaza San Francisco, CA 68,560 $ 9,095,341
09/23/97 450 Sansome St. San Francisco, CA 123,099 17,246,713
11/10/97 Cortez Plaza Bradenton, FL 289,686 19,267,073
--------------
$ 45,609,127
==============
</TABLE>
The Company's strategy is to renovate and reposition the facilities and
target full floor tenants with five to ten year lease terms. The Company
estimates that over the next twelve months approximately $4.4 million in capital
improvements, tenant improvements and leasing commissions will be spent to
renovate and reposition the above properties. Repositioning is intended to
result in rents that are considerably greater than the current rents being
achieved at the sites. See Note 7 to the Consolidated Financial Statements.
7
<PAGE>
DIVIDENDS AND DISTRIBUTIONS PAYABLE. At December 31, 1997, dividends
payable totaled $7.5 million and represents declared but unpaid dividends on
common stock.
MINORITY INTEREST. At December 31, 1997, minority interest totaled $2.9
million and represents Ocwen's ownership of 160,000 units in the Ocwen
Partnership, L.P. ("Operating Partnership"). See Note 1 to the Consolidated
Financial Statements.
SHAREHOLDERS' EQUITY. Shareholders' equity increased to $271.3 million
from May 14, 1997 to December 31, 1997. The increase in shareholders' equity
during this period was attributable to net proceeds of $283.7 million from the
issuance of 19,125,000 shares of common stock in May 1997 and net income of
$11.8 million earned during the period, offset in part by net unrealized losses
on securities available for sale of $7.3 million, the repurchase of 160,000
shares of the Company's common stock for $3.0 million and dividends declared on
common stock of $13.9 million.
FUNDS FROM OPERATIONS
The Company generally considers Funds From Operations ("FFO") to be a
useful financial performance measure of the operating performance of a REIT
because such measure does not recognize (i) depreciation and amortization of
real estate assets as operating expenses, which management believes are not
meaningful in evaluating income-producing real estate because such real estate
historically has not depreciated and (ii) gains/losses from debt restructuring
and sales of property. In addition, FFO together with net income and cash flow,
provides investors with an additional basis to evaluate the ability of a REIT to
incur and service debt and to fund acquisitions and other capital expenditures.
FFO does not represent cash provided by operating activities in accordance with
GAAP and should not be considered an alternative to net income as an indication
of the results of the Company's performance or to cash flows as a measure of
liquidity. For a discussion of the Company's operating, investing and financing
activities under GAAP, see "-Capital Resources and Liquidity" below. In 1995,
the National Association of Real Estate Investment Trusts ("NAREIT") established
new guidelines clarifying its definition of FFO and requested that REITs adopt
this new definition beginning in 1996. FFO consists of net income applicable to
common shareholders (computed in accordance with GAAP) excluding gains (losses)
from debt restructuring and sales of property (including furniture and
equipment) plus real estate related depreciation and amortization (excluding
amortization of deferred financing costs) and after adjustments for
unconsolidated partnerships and joint ventures. Because other REITs may
calculate FFO in a different manner, however, there can be no assurance that the
Company's FFO is comparable with the FFO reported by other entities.
The following table reconciles funds from operations and net income:
Net income............................................... $ 11,791,518
Add: Real estate related depreciation.................... 179,088
-------------
FFO ..................................................... $ 11,970,606
=============
Diluted weighted average shares outstanding.............. 19,564,770
=============
CAPITAL RESOURCES AND LIQUIDITY
Liquidity is a measurement of the Company's ability to meet potential
cash requirements, including ongoing commitments to repay borrowings, fund
investments, engage in loan acquisition and lending activities and for other
general business purposes. Additionally, to maintain its status as a REIT under
the Code, the Company must distribute annually at least 95% of its taxable
income. The primary sources of funds for liquidity consist of the proceeds from
the Company's initial public offering, net income, reverse repurchase agreements
and other secured borrowings, maturities and principal payments on loans and
securities and proceeds from loan resolutions thereof.
Cash and cash equivalents were $48.7 million at December 31, 1997. The
Company's operating activities provided cash flows of $21.1 million during the
period from May 14, 1997 to December 31, 1997. During the foregoing period, cash
resources from operating activities were provided primarily by net income. The
Company's investing activities used cash flows of $249.6 million during the
period from May 14, 1997 to December 31, 1997. During the foregoing period, cash
flows from investing activities were used primarily to purchase securities
available for sale, discount loans, loans and investments in real estate. The
Company's financing activities provided cash flows of $277.2 million during the
period from May 14, 1997 to December 31, 1997 and consisted of $283.7 million
net proceeds from the issuance of common stock, net of $6.5 million of dividends
paid during the period.
The Company expects to meet its short-term liquidity requirements
(which include approximately $4.4 million of capital improvements, tenant
improvements and leasing commissions to renovate and reposition its investments
in real estate during the next 12 months) generally through its working capital
and net cash provided by operating and financing activities. In addition, the
Company has contractual relationships with five brokerage firms pursuant to
which it could obtain funds from reverse repurchase agreements and has $146.0
million of unencumbered mortgage-related securities which could be pledged to
secure such borrowings. The Company also believes that its net cash provided by
operating activities will be sufficient to allow the Company to make the
distributions necessary for continued benefit from qualification as a REIT.
At December 31, 1997, the Company had $ 74.3 million of outstanding
commitments. In addition, the Company has subsequently engaged in additional
acquisition activities, including the performance of due diligence with respect
to a variety of other investment opportunities. See Note 11 to the Consolidated
Financial Statements. At December 31, 1997, the Company had invested
approximately 83% of the net proceeds received from its initial public offering.
The Company expects to meet certain long-term liquidity requirements such as
property and security acquisitions and loan originations by obtaining various
third-party borrowings and has entered into discussions with respect to
obtaining such borrowings. Additionally, as discussed above, the Company intends
to execute a securitization of its loan portfolio and use the proceeds for
further acquisitions. The Company believes that such new, as well as its
existing, sources of liquidity, including third-party borrowings currently being
pursued, will be adequate to fund planned activities for the foreseeable future,
although there can be no assurances in this regard. In the event the Company was
unable to effect such third-party borrowings or securitization, its liquidity
could be constrained and the impact on its results of operations, financial
condition and FFO could be significant.
MARKET CONDITIONS
Recently, the competitive conditions of some of the markets in which
the Company operates have changed due to the significant amount of capital made
available in the marketplace. This competition is particularly notable in the
subordinated commercial mortgage-backed securities ("CMBS") market for new
issuances. New issuances have reduced
8
<PAGE>
subordination levels with spreads declining by approximately 200 basis points in
the noninvestment grade and unrated tranches. The Company believes that
investment in a new issue CMBS at this time does not meet its return objectives.
Therefore, the Company is focusing on seasoned or special situation subordinates
which meet its return objectives, taking advantage of Ocwen's special servicing
capabilities. In addition, the Company has purchased pools of residential loans
for securitization, and is pursuing investments in Sub IOs in CMBS backed by
subprime residential mortgage loans.
INFLATION
Inflation has remained relatively low during the past few years and has
had a minimal impact on the operating performance of the properties.
Nonetheless, certain of the tenants' leases contain provisions designed to
lessen the impact of inflation. Such provisions include clauses enabling the
Company to receive percentage rentals based on tenants' gross sales, which
generally increase as prices rise, and/or escalation clauses, which generally
increase rental rates during the terms of the leases. In addition, many of the
leases are for terms of less than ten years, which may enable the Company to
replace existing leases with new leases at higher base and/or percentage rentals
if rents of the existing leases are below the then-existing market rate. Office
and retail space in the properties is generally leased to tenants under lease
terms which provide for the tenants to pay for increases in operating expenses
in excess of specified amounts. See Note 11 to the Consolidated Financial
Statements.
However, inflation may have a negative impact on some of the Company's
other operating items. Interest and general and administrative expenses may be
adversely affected by inflation as these specified costs could increase at a
rate higher than rents. Also, for tenant leases with stated rent increases,
inflation may have a negative effect as the stated rent increases in these
leases could be lower than the increase in inflation at any given time.
RECENT ACCOUNTING DEVELOPMENTS
For information relating to the effects on the Company of the adoption
of recent accounting standards, see Note 1 to the Consolidated Financial
Statements.
REIT STATUS
The Company has qualified and intends to continue to qualify as a REIT
under Sections 856 through 860 of the Internal Revenue Code. 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. A REIT will generally not be subject to federal
income taxation on that portion of its income that is distributed to its
shareholders if it distributes at least 95 percent of its taxable income and
meets certain other income and asset tests. The Company has until the filing of
its tax return to satisfy the distribution requirement. Since the Company plans
to distribute 100% of its taxable income, no provision has been made for federal
income taxes for the Company and its subsidiaries in the accompanying
consolidated financial statements. As taxable income is finalized and the tax
return is filed, an additional distribution may be required which may be
significant. The Company may be subject to tax at normal corporate rates on net
income or capital gains not distributed.
The Company intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940 (the
"Investment Company Act"). The Investment Company Act exempts entities that,
directly or through majority-owned subsidiaries, are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate" ("Qualifying Interests"). Under current interpretation
by the staff of the Securities and Exchange Commission ("SEC"), in order to
qualify for this exemption, the Company, among other things, must maintain at
least 55% of its assets in Qualifying Interests and also may be required to
maintain an additional 25% in Qualifying Interests or other real estate-related
assets. Therefore, the type and amount of assets the Company may acquire may be
limited by the Investment Company Act.
YEAR 2000 DATE CONVERSION
OCC, as well as Ocwen and its other subsidiaries which provide
management services to the Company, have begun to coordinate the identification,
evaluation, and implementation of changes to computer systems and applications
necessary to achieve a year 2000 date conversion with no effect on customers or
disruption to business operations. These
9
<PAGE>
actions are necessary to ensure that the systems and applications will recognize
and process the year 2000 and beyond. Major areas of potential business impact
have been identified and dimensioned, and initial conversion efforts are
underway. Ocwen also is communicating with customers, financial institutions and
others with which it does business to identify and coordinate year 2000
conversion issues. Ocwen expects its year 2000 conversion will be completed on a
timely basis, and the cost of achieving year 2000 compliance will be immaterial
and borne by Ocwen. The Company does not expect to incur any costs in connection
with achieving year 2000 compliance.
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED HEREIN ARE NOT, AND CERTAIN STATEMENTS
CONTAINED IN FUTURE FILINGS BY THE COMPANY WITH THE SECURITIES AND EXCHANGE
COMMISSION, IN THE COMPANY'S PRESS RELEASES OR IN THE COMPANY'S OTHER PUBLIC OR
SHAREHOLDER COMMUNICATIONS, MAY NOT BE BASED ON HISTORICAL FACTS AND ARE
"FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,
AS AMENDED, INCLUDING THE CONSUMMATION AND EXPECTED BENEFITS OF THE IDENTIFIED
TRANSACTIONS. THESE FORWARD-LOOKING STATEMENTS MAY BE IDENTIFIED BY REFERENCE TO
A FUTURE PERIOD(S), OR BY THE USE OF FORWARD-LOOKING TERMINOLOGY, SUCH AS "MAY,"
"WILL," "BELIEVE," "ESTIMATE," "EXPECT," "COMMITMENT," "ANTICIPATE," "CONSIDER,"
"CONTINUE," "ENCOURAGE," "INTEND," "PLAN," "PRESENT," "PROPOSE," "PROSPECT," OR
SIMILAR TERMS, VARIATIONS OF THOSE TERMS, OR NEGATIVES OF ANY SUCH TERMINOLOGY.
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE SET FORTH IN FORWARD-LOOKING
STATEMENTS DUE TO A VARIETY OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE
RELATED TO THE INTERNATIONAL, NATIONAL, REGIONAL OR LOCAL ECONOMIC ENVIRONMENT,
PARTICULARLY IN THE MARKET AREAS IN WHICH THE COMPANY OPERATES, COMPETITIVE
PRODUCTS AND PRICING, FISCAL AND MONETARY POLICIES OF THE U.S., CANADIAN OR
OTHER GOVERNMENTS, CHANGES IN GOVERNMENT REGULATIONS AFFECTING REAL ESTATE
INVESTMENT TRUSTS, CHANGES IN PREVAILING INTEREST AND CURRENCY EXCHANGE RATES,
CHANGES IN FACTORS INHERENT TO THE VALUATION AND PRICING OF VARIOUS SECURITIES
INCLUDING THE IMPACT OF CHANGES IN PREPAYMENT SPEEDS ON MORTGAGE LOANS, THE
EFFECTIVENESS OF THE SERVICING OF LOANS UNDERLYING VARIOUS SECURITIES, THE
COURSE OF NEGOTIATIONS WITH RESPECT TO VARIOUS TRANSACTIONS, THE ABILITY OF
PARTIES TO AGREE TO MATERIAL TERMS OF A TRANSACTION, THE ABILITY TO SATISFY OR
FULFILL AGREED UPON TERMS AND CONDITIONS OF CLOSING OR PERFORMANCE (INCLUDING
BOARD APPROVALS, AS NECESSARY OR AGREED UPON), THE OCCURRENCE OF MATERIAL
ADVERSE CHANGES IN THE BUSINESS OF ANY PARTY TO A TRANSACTION, THE TIMING OF
TRANSACTION CLOSINGS, UNSATISFACTORY DUE DILIGENCE RESULTS, BORROWER FAILURE TO
SATISFY CLOSING CONDITIONS, THE ABILITY TO SECURITIZE MORTGAGE LOANS IN MUTUALLY
ACCEPTABLE TERMS, ACQUISITIONS AND THE INTEGRATION OF ACQUIRED BUSINESSES,
CREDIT RISK MANAGEMENT, ASSET/LIABILITY MANAGEMENT, THE FINANCIAL AND SECURITIES
MARKETS, THE AVAILABILITY OF AND COSTS ASSOCIATED WITH TIMELY SOURCES OF
LIQUIDITY ON MUTUALLY ACCEPTABLE TERMS AND OTHER FACTORS GENERALLY UNDERSTOOD TO
AFFECT THE REAL ESTATE ACQUISITION MORTGAGE AND LEASING MARKETS AND SECURITY
INVESTMENTS. THE COMPANY DOES NOT UNDERTAKE, AND SPECIFICALLY DISCLAIMS ANY
OBLIGATION, TO PUBLICLY RELEASE THE RESULTS OF ANY REVISIONS WHICH MAY BE MADE
TO ANY FORWARD-LOOKING STATEMENTS TO REFLECT THE OCCURRENCE OF ANTICIPATED OR
UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH STATEMENTS.
10
<PAGE>
REPORT OF MANAGEMENT
The management of Ocwen Asset Investment Corp. is responsible for the
preparation and fair presentation of the financial statements and other
financial information contained in this annual report. The accompanying
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles applied on a consistent basis
and include amounts based on management's best estimates and judgments.
Nonfinancial information included in this annual report has also been
prepared by management and is consistent with the consolidated
financial statements. In the opinion of management, the consolidated
financial statements fairly reflect the Company's financial position,
results of operations and cash flows.
To assure that financial information is reliable and assets are
safeguarded, management has established and maintains an effective
system of internal accounting controls and procedures that provide
reasonable assurance as to the integrity and reliability of the
financial statements, the protection of assets against loss from
unauthorized use or disposition and the prevention and detection of
errors and irregularities on a timely basis.
Price Waterhouse LLP conducts its audit of the consolidated financial
statements in accordance with generally accepted auditing standards.
Such standards include the evaluation of internal accounting controls
to establish a basis for developing the scope of its examination of the
consolidated financial statements. In addition to the use of
independent certified public accountants, Ocwen maintains a
professional staff of internal auditors who conduct financial,
procedural and special audits of the Company. To ensure their
independence, both Price Waterhouse LLP and the internal auditors have
direct access to the Audit Committee of the Board of Directors.
The Audit Committee, which consists solely of independent directors of
the Company, makes recommendations to the Board of Directors concerning
the appointment of the independent certified public accountants and
meets with Price Waterhouse LLP and the internal auditors to discuss
the results of their audits, the Company's internal accounting controls
and financial reporting matters.
/s/ William C. Erbey /s/ Mark S. Zeidman
---------------------------------------- ----------------------------
William C. Erbey Mark S. Zeidman
Chairman and Chief Executive Officer Senior Vice President and
Chief Financial Officer
11
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Ocwen Asset Investment Corp.
In our opinion, the accompanying consolidated statements of financial condition
and the related consolidated statements of operations, of changes in
shareholders' equity and of cash flows present fairly, in all material respects,
the financial position of Ocwen Asset Investment Corp. (the "Company") and its
subsidiaries at December 31, 1997 and the results of their operations and their
cash flows for the period from May 14, 1997 to December 31, 1997, in conformity
with generally accepted accounting principles. 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 audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatements. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
- --------------------------------
Price Waterhouse LLP
Fort Lauderdale, Florida
January 26, 1998
12
<PAGE>
OCWEN ASSET INVESTMENT CORP.
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
DECEMBER 31, 1997
ASSETS:
Cash and amounts due from depository institutions ............ $ 331,047
Interest earning deposits .................................... 48,346,076
Securities available for sale, at market value ............... 146,026,907
Loan portfolio, net .......................................... 15,831,479
Discount loan portfolio, net ................................. 26,978,888
Investment in real estate, net ............................... 45,430,039
Deposits on pending asset acquisitions ....................... 1,000,000
Principal and interest receivable ............................ 2,518,272
Other assets ................................................. 1,540,633
-------------
$ 288,003,341
=============
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Dividends and distributions payable ........................ $ 7,458,750
Accrued expenses, payables and other liabilities ........... 6,344,783
-------------
Total liabilities ....................................... 13,803,533
-------------
Minority interest ............................................ 2,941,541
-------------
COMMITMENTS AND CONTINGENCIES (NOTE 11)
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value; 25,000,000 shares
authorized; 0 shares issued and outstanding .............. --
Common Stock, $.01 par value; 200,000,000 shares authorized;
19,125,000 shares issued; 18,965,000 shares outstanding .. 191,250
Additional paid-in capital ................................. 283,496,750
Distributions in excess of earnings ........................ (2,107,331)
Unrealized loss on securities available for sale ........... (7,327,890)
Treasury stock at cost (160,000 shares) .................... (2,994,512)
-------------
Total shareholders' equity .............................. 271,258,267
-------------
$ 288,003,341
=============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
13
<PAGE>
OCWEN ASSET INVESTMENT CORP.
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE PERIOD FROM MAY 14, 1997 TO DECEMBER 31, 1997
Interest income:
Repurchase agreements and interest earning deposits ...... $ 5,538,946
Securities available for sale ............................ 6,362,909
Loans .................................................... 311,157
Discount loans ........................................... 1,248,703
------------
13,461,715
------------
Operating income:
Investments in real estate, net .......................... 1,481,633
Other .................................................... 12,665
------------
1,494,298
------------
Operating expenses:
Management fees .......................................... 1,796,311
Due diligence ............................................ 326,025
Foreign currency loss .................................... 568,565
Other .................................................... 464,164
------------
3,155,065
------------
Income before minority interest .............................. 11,800,948
Minority interest in net income of operating partnership ..... (9,430)
------------
Net income ............................................... $ 11,791,518
============
Earnings per share:
Basic .................................................... $ 0.62
============
Diluted .................................................. $ 0.60
============
Weighted average shares outstanding:
Basic .................................................... 19,108,789
============
Diluted .................................................. 19,564,770
============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
14
<PAGE>
<TABLE>
<CAPTION>
OCWEN ASSET INVESTMENT CORP.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE PERIOD FROM MAY 14, 1997 TO DECEMBER 31, 1997
Unrealized
loss on
Common Stock Additional Distributions securities
---------------------- Treasury paid-in- in excess available
Shares Amount stock capital of earnings for sale Total
---------- ---------- ----------- ------------ ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock ........ 19,125,000 $ 191,250 $ -- $283,496,750 $ -- $ -- $283,688,000
Repurchase of common stock ...... (160,000) -- (2,994,512) -- -- -- (2,994,512)
Net income ...................... -- -- -- -- 11,791,518 -- 11,791,518
Dividends ....................... -- -- -- -- (13,898,849) -- (13,898,849)
Change in unrealized loss on
securities available for sale.. -- -- -- -- -- (7,327,890) (7,327,890)
---------- ---------- ----------- ------------ ------------- ----------- -------------
Balance at December 31, 1997 .... 18,965,000 $ 191,250 $(2,994,512) $283,496,750 $ (2,107,331) $(7,327,890) $271,258,267
========== ========== =========== ============ ============= =========== ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
15
</TABLE>
<PAGE>
OCWEN ASSET INVESTMENT CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM MAY 14, 1997 TO DECEMBER 31, 1997
<TABLE>
<CAPTION>
<S> <C>
Cash flows from operating activities:
Net income ....................................................... $ 11,791,518
Adjustments to reconcile net income to net cash provided by
operating activities:
Premium amortization (discount accretion), net ................ 6,236,654
Depreciation .................................................. 179,088
Foreign exchange loss ......................................... 568,565
Increase in interest receivable ............................... (2,518,272)
Increase in other assets ...................................... (1,540,633)
Increase in accrued expenses, payables and other liabilities .. 6,344,783
Minority interest in earnings ................................. 9,430
-------------
Net cash provided by operating activities .......................... 21,071,133
-------------
Cash flows from investing activities:
Purchase of securities available for sale ........................ (166,334,140)
Maturities and principal payments received on securities available
for sale ...................................................... 6,654,881
Purchase of loans ................................................ (16,091,515)
Purchase of discount loans ....................................... (28,465,429)
Principal payments received on discount loans .................... 932,366
Principal payments received on loans ............................. 333,454
Investment in real estate ........................................ (45,609,127)
Deposits on pending asset acquisitions ........................... (1,000,000)
-------------
Net cash used by investing activities .............................. (249,579,510)
-------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of offering costs .... 283,688,000
Dividend payments on common stock ................................ (6,502,500)
Treasury stock acquisition ....................................... (2,994,512)
Proceeds from sale of operating partnership units ............... 2,994,512
-------------
Net cash provided by financing activities .......................... 277,185,500
-------------
Net increase in cash and cash equivalents .......................... 48,677,123
Cash and cash equivalents at beginning of period ................... --
-------------
Cash and cash equivalents at end of period ......................... $ 48,677,123
=============
Reconciliation of cash and cash equivalents at end of period:
Cash and amounts due from depository institutions ................ $ 331,047
Interest earning deposits ........................................ 48,346,076
-------------
$ 48,677,123
=============
Supplemental schedule of non-cash financing activities:
Common stock dividends and distributions declared but not paid ... $ 7,458,750
=============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
16
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1 ORGANIZATION
Ocwen Asset Investment Corp. ("OAIC" or the "Company") is a newly
formed corporation that has elected to be taxed as a Real Estate Investment
Trust ("REIT") under the Internal Revenue Code of 1986 (the "Code"). As such,
OAIC will generally not be subject to federal income taxation on that portion of
its income that is distributed to shareholders if it distributes at least 95% of
its taxable income to its shareholders by the due date of its federal income tax
return and complies with various other requirements.
The Company was incorporated in the Commonwealth of Virginia on January
22, 1997 and was initially capitalized on February 12, 1997 through the sale of
100 shares of common stock for $1,600. On May 14, 1997, the Company completed an
initial public offering ("IPO") with the sale of 19,125,000 shares of common
stock, par value $.01 per share, at a price of $16.00 per share (before
underwriting and offering expenses), and commenced operations thereon.
The Company's consolidated financial statements include the accounts of
OAIC and its subsidiaries. OAIC directly owns two qualified REIT subsidiaries,
Ocwen General Partner, Inc. ("General Partner") and Ocwen Limited, Inc.
("Limited Partner"). General Partner and Limited Partner own 1% and 98.2%,
respectively of Ocwen Partnership, L.P. ("Operating Partnership"). Additionally,
through General Partner and Limited Partner, the Company established additional
partnerships in Florida and California for real estate investment purposes. The
minority interest at December 31, 1997 represents a 0.8% interest (160,000
units) in the Operating Partnership held by Investors Mortgage Insurance Holding
Company ("IMI"), a wholly owned subsidiary of Ocwen Financial Corporation
("Ocwen"). IMI also owns 1,715,000 shares, or 9.0%, of the Company's outstanding
common stock and has 1,912,500 options (25% of which vest each year over the
next four years) to purchase, at the election of the Company, either shares of
the Company or an equivalent number of units in the operating partnership at an
exercise price of $16.00 per share.
The Company has entered into a management agreement with Ocwen Capital
Corporation ("OCC"), a wholly owned subsidiary of Ocwen, under which OCC advises
the Company on various facets of its business and manages its day-to-day
operations, subject to the supervision of the Company's Board of Directors. For
its services, OCC receives a base management fee of 1% per annum of average
invested assets, as defined in the related agreement, payable quarterly. In
addition, OCC is entitled to receive incentive compensation in an amount equal
to 25% of the dollar amount by which Funds From Operations ("FFO"), as adjusted,
exceeds certain defined levels.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The Company's consolidated financial statements include the accounts of
OAIC and its subsidiaries as described in Note 1 above. All significant
intercompany transactions and balances have been eliminated.
SECURITIES AVAILABLE FOR SALE
Securities available for sale are carried at fair value with the net
unrealized gains or losses reported as a separate component of shareholders'
equity. Unrealized losses on securities that reflect a decline in value which is
other than temporary, if any, are charged to earnings. At disposition, the
realized net gain or loss is included in earnings on a specific identification
basis. The amortization of premiums and accretion of discounts are computed
using the interest method after considering actual and estimated prepayment
rates, if applicable. Actual prepayment experience is periodically reviewed and
effective yields
17
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
are recalculated when differences arise between prepayments originally
anticipated and amounts actually received plus anticipated future prepayments.
LOAN PORTFOLIO
Loans held for investment are stated at amortized cost, less any
allowance for loan losses, because the Company has the ability and the intent to
hold them to maturity. Interest income is accrued as it is earned. Loans are
placed on non-accrual status after being delinquent greater than 89 days, or
earlier if the borrower is deemed by management to be unable to continue
performance. When a loan is placed on non-accrual status, interest accrued but
not received is reversed. While a loan is on non-accrual status, interest is
recognized only as cash is received. Loans are returned to accrual status only
when the loan is reinstated and ultimate collectibility of future interest is no
longer in doubt. Loan origination fees and certain direct loan origination costs
are deferred and recognized over the lives of the related loans as a yield
adjustment and included in interest income using the interest method applied on
a loan-by-loan basis. Gains and losses on disposal of such assets are computed
on a specific identification basis.
DISCOUNT LOAN PORTFOLIO
Certain mortgage loans, for which the borrower is not current as to
principal and interest payments or for which there is a reason to believe the
borrower will be unable to continue to make its scheduled principal and interest
payments, are acquired at a discount. The acquisition cost for a pool of loans
is allocated on a relative form value basis to each loan within the pool. The
Company believes that it is able to reasonably estimate the amounts and timing
of collections on all of its discounted loans and believes that the
collectibility of the acquisition amount of the loan and discount is probable.
For those commercial real estate loans which are current and the Company
believes will remain current, the discount is accreted into interest income as a
yield adjustment using the interest method over the contractual maturity of the
loan. For all other loans, in lieu of accretion of purchased discount, interest
is reported as cash is received. Gains on the repayment and discharging of loans
are reported as interest income. In situations where the collateral is
foreclosed upon, the loans are transferred to real estate owned upon receipt of
title to the property and accretion of the related discount is discontinued.
ALLOWANCE FOR LOAN LOSSES
The allowance for estimated loan losses is maintained at a level that
management, based upon evaluation of known and inherent risks in the portfolio,
considers adequate to provide for potential losses. Management's periodic
evaluation of the allowance for estimated loan losses is based upon an analysis
of the portfolio, historical loss experience, economic conditions and trends,
collateral values and other relevant factors. Future adjustments to the
allowance may be necessary if economic conditions and trends, collateral values
and other relevant factors differ substantially from the assumptions used in
making the evaluation.
INVESTMENT IN REAL ESTATE
Investment in real estate is recorded at cost less accumulated
depreciation (which is less than the net realizable value of the property). The
Company reviews its investment in real estate for impairment whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. If changes in events or circumstances indicate that the carrying
amount of an investment may not be recoverable, an impairment loss would be
recorded if the sum of the expected future cash flows (undiscounted and without
interest charges) is less than the carrying amount of the investment.
Depreciation is computed on a straight line basis over the estimated
useful lives of the assets as follows:
Buildings and improvements 39 years
Tenant improvements Lesser of lease term or useful life
Furniture, fixtures and equipment 7 years
18
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
Expenditures for repairs and maintenance are charged to operations as
incurred. Significant renovations are capitalized. Fees and costs incurred in
the successful negotiation of leases are deferred and amortized on a
straight-line basis over the terms of the respective leases. Rental revenue is
reported on a straight-line basis over the terms of the respective leases.
FOREIGN CURRENCY TRANSACTIONS
The Company's investment in foreign assets is translated into U.S.
dollars at current exchange rates, and related revenues and expenses are
translated at average exchange rates for the period. Resulting translation
adjustments are reflected in the results of operations. Transaction gains and
losses that arise from exchange rate fluctuations on transactions denominated in
a currency other than U.S. dollars are included in the results of operations as
incurred.
INCOME TAXES
The Company qualifies as a REIT under Sections 856 through 860 of the
Code of 1986, as amended. A REIT will generally not be subject to federal income
taxation on that portion of its income that is distributed to shareholders if it
distributes at least 95% of its taxable income by the due date of its federal
income tax return and complies with certain other requirements. Accordingly, no
provision has been made for federal income taxes for the Company and its
subsidiaries in the accompanying consolidated financial statements.
CONSOLIDATED STATEMENT OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include
non-interest earning deposits, interest earning deposits and all highly liquid
investments purchased with an original maturity date of three months or less.
BASIC AND DILUTED EARNINGS PER SHARE
Basic earnings per share is calculated based upon the weighted average
number of shares of common stock outstanding during the year. Diluted earnings
per share is calculated based upon the weighted average number of shares of
common stock outstanding and all dilutive potential common shares outstanding
during the year. The computation of diluted earnings per share includes the
impact of the exercise of the outstanding options to purchase common stock and
assumes that the proceeds from such issuance are used to repurchase common
shares at fair value.
RISKS AND UNCERTAINTIES
In the normal course of business, the Company encounters primarily two
significant types of economic risk: credit and market. Credit risk is the risk
of default on the company's loan portfolio that results from a borrowers'
inability or unwillingness to make contractually required payments. Market risk
reflects changes in the value of securities available for sale and investments
in real estate due to changes in interest rates or other market factors,
including the rate of prepayments of principal, the value of the collateral
underlying loans and the valuation of real estate held by the Company.
Additionally, the Company encounters significant tax risks. If OAIC
were to fail to qualify as a REIT in any taxable year, OAIC would be subject to
federal income tax (including any applicable alternative minimum tax) on its
taxable income at regular corporate rates, and distributions to shareholders
would not be deductible by OAIC in computing its taxable income. Any such
corporate tax liability could be substantial and would reduce the amount of cash
available for distribution to shareholders, which in turn could have an adverse
impact on the value of, and trading prices for, the Company's common stock.
19
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
Unless entitled to relief under certain Code provisions, the Company
could also be disqualified from taxation as a REIT for the four taxable years
following the year during which OAIC ceased to qualify as a REIT.
The preparation of financial statements in conformity with generally
accepted accounting principles ("GAAP") requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to significant change in the near or
medium term relate to the determination of the allowance for losses on loans and
discount loans.
RECENT ACCOUNTING STANDARDS
The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" during 1997. SFAS No. 125 (i) sets forth the
criteria for (a) determining when to recognize financial and servicing assets
and liabilities; and (b) accounting for transfers of financial assets as sales
or borrowings; and (ii) requires (a) liabilities and derivatives related to a
transfer of financial assets to be recorded at fair value; (b) servicing assets
and retained interests in transferred assets carrying amounts be determined by
allocating carrying amounts based on fair value; (c) amortization of servicing
assets and liabilities be in proportion to net servicing income; (d) impairment
measurement based on fair value; and (e) pledged financial assets to be
classified as collateral. SFAS No. 125 provides implementation guidance for
assessing isolation of transferred assets and for accounting for transfers of
partial interests, servicing of financial assets, securitizations, transfers of
sales-type and direct financing lease receivables, securities lending
transactions, repurchase agreements including "dollar rolls", "wash sales", loan
syndications and participations, risk participations in banker's acceptances,
factoring arrangements, transfers of receivables with recourse and
extinguishments of liabilities. In December 1996, the FASB issued SFAS No. 127,
"Deferral of the Effective Date of FASB Statement No. 125", which delayed
implementation of certain provisions of SFAS No. 125.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share."
SFAS No. 128 simplifies the calculation of earnings per share ("EPS"), and makes
them comparable to international standards. Under SFAS No. 128, the Company is
required to present both basic and diluted EPS on the face of its statements of
operations. Basic EPS, which replaces primary EPS required by APB 15 for
entities with complex capital structures, excludes common stock equivalents and
is computed by dividing income available to common shareholders by the
weighted-average number of common shares outstanding for the period. Diluted EPS
gives effect to all dilutive potential common shares that were outstanding
during the period. SFAS No. 128 is effective for financial statements for both
interim and annual periods ending after December 15, 1997. The Company adopted
SFAS No. 128 effective December 31, 1997.
In February 1997, the FASB also issued SFAS No. 129, "Disclosure of
Financial Information About Capital Structure" ("SFAS No. 129"). SFAS No. 129
supersedes capital structure disclosure requirements found in previous
accounting pronouncements and consolidates them into one statement for ease of
retrieval and greater visibility for non-public entities. These disclosures are
required for financial statements for periods ending after December 15, 1997. As
SFAS No. 129 makes no changes to previous accounting pronouncements as those
pronouncements applied to OAIC, adoption of SFAS No. 129 will have no impact on
the Company's results of operations and financial condition.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 requires the inclusion of comprehensive income, either in
a separate statement for comprehensive income, or as part of a combined
statement of income and comprehensive income in a full-set of general-
20
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
purpose financial statements. Comprehensive income is defined as the change in
equity of a business enterprise during a period from transactions and other
events and circumstances, excluding those resulting from investments by and
distributions to owners. SFAS No. 130 requires that comprehensive income be
presented beginning with net income, adding the elements of comprehensive income
not included in the determination of net income, to arrive at comprehensive
income. SFAS No. 130 also requires that an enterprise display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of a statement of financial
position. SFAS No. 130 is effective for the Company's fiscal year beginning
January 1, 1998. SFAS No. 130 requires the presentation of information already
contained in the Company's financial statements and therefore is not expected to
have an impact on the Company's financial position or results of operation.
In June 1997, the FASB also issued SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
standards for the reporting of information about operating segments by public
business enterprises in their annual and interim financial reports issued to
shareholders. SFAS No. 131 requires that a public business enterprise report
financial and descriptive information, including profit or loss, certain
specific revenue and expense items, and segment assets, about its reportable
operating segments. Operating segments are defined as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision-maker in deciding how to
allocate resources and in assessing performance. SFAS No. 131 is effective for
the Company's financial statements for periods beginning after December 15,
1997. SFAS No. 131 is a disclosure requirement and therefore is not expected to
have an effect on the Company's financial position or results of operations.
NOTE 3 FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Company's assets are considered financial
instruments. For the majority of the Company's financial instruments,
principally loans, fair values are not readily available since there are no
available trading markets as characterized by current exchanges between willing
parties. Accordingly, fair values can only be derived or estimated using various
valuation techniques, such as computing the present value of estimated future
cash flows using discount rates commensurate with the risks involved. However,
the determination of estimated future cash flows is inherently subjective and
imprecise. In addition, for those financial instruments with option-related
features, prepayment assumptions are incorporated into the valuation techniques.
It should be noted that minor changes in assumptions or estimation methodologies
can have a material effect on these derived or estimated fair values.
The fair values reflected below are indicative of the interest rate
environments as of December 31, 1997 and do not take into consideration the
effects of interest rate fluctuations. In different interest rate environments,
fair value results can differ significantly, especially for certain fixed-rate
financial instruments and non-accrual assets. In addition, the fair values
presented do not attempt to estimate the value of the Company's anticipated
future business activities. In other words, they do not represent the Company's
value as a going concern. Furthermore, the differences between the carrying
amounts and the fair values presented may not be realized because, except as
indicated, the Company generally intends to hold these financial instruments to
maturity and realize their recorded values.
Reasonable comparability of fair values among institutions is difficult
due to the wide range of permitted valuation techniques and numerous estimates
that must be made in the absence of secondary market prices. This lack of
objective pricing standards introduces a degree of subjectivity to these derived
or estimated fair values. Therefore, while disclosure of estimated fair values
of financial instruments is required, readers are cautioned in using this data
for purposes of evaluating the financial condition of the Company.
21
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
The carrying amounts and the estimated fair values of the Company's
financial instruments at December 31, 1997 are as follows:
Carrying Fair
Amount Value
------------ ------------
Cash and cash equivalents .................. $ 48,677,123 $ 48,677,123
Securities available for sale .............. 146,026,907 146,026,907
Loan portfolio, net ........................ 15,831,479 15,831,479
Discount loan portfolio .................... 26,978,888 26,978,888
The methodologies used and key assumptions made to estimate fair value,
the estimated fair values determined and recorded carrying values follow:
CASH AND CASH EQUIVALENTS
Cash and cash equivalents have been valued at their carrying amounts as
these are reasonable estimates of fair value given the relatively short period
of time between origination of the instruments and their expected realization.
SECURITIES AVAILABLE FOR SALE
For securities available for sale, fair value equals quoted price, if
available. For securities for which a quoted market price is not available, fair
value is estimated using quoted market prices for similar instruments. At
December 31, 1997, the fair value for all securities available for sale was
based on quoted market prices.
LOANS AND DISCOUNT LOANS
The fair value of performing whole loans is estimated based upon quoted
market prices for similar whole loan pools. The fair value of the discount loan
portfolio is estimated based upon current market yields at which recent pools of
similar mortgages have traded taking into consideration the timing and amount of
expected cash flows.
22
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 4 SECURITIES AVAILABLE FOR SALE
The amortized cost, fair value and gross unrealized gains and losses on
the Company's securities available for sale are as follows at the period ended
December 31, 1997:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Mortgage-related securities:
Single-family residential:
FHLMC interest only ......... $ 26,010,872 $ 215,892 $ (5,048,800) $ 21,177,964
FNMA interest only .......... 27,289,844 183,774 (4,900,486) 22,573,132
Other AAA-rated interest only 1,090,760 -- (361,388) 729,372
Subordinates ................ 8,668,663 806,723 (31,319) 9,444,067
------------- ------------- ------------- -------------
63,060,139 1,206,389 (10,341,993) 53,924,535
------------- ------------- ------------- -------------
Multi-family and commercial:
AAA-rated interest only ..... 913,182 -- (47,435) 865,747
A-rated interest only ....... 503,707 -- (23,519) 480,188
Non-rated interest only ..... 4,975,589 -- (172,716) 4,802,873
Subordinates ................ 83,902,180 2,536,277 (484,893) 85,953,564
------------- ------------- ------------- -------------
90,294,658 2,536,277 (728,563) 92,102,372
------------- ------------- ------------- -------------
$ 153,354,797 $ 3,742,666 $ (11,070,556) $ 146,026,907
============= ============= ============= =============
</TABLE>
A profile of the maturities of securities available for sale at
December 31, 1997 follows. Securities are included based on their
weighted-average maturities, reflecting anticipated future prepayments based on
a consensus of dealers in the market.
Amortized Cost Fair Value
-------------- ------------
Due within one year ................. $ -- $ --
Due after 1 through 5 years ......... 79,455,456 70,323,551
Due after 5 through 10 years ........ 57,361,874 58,753,733
Due after 10 years .................. 16,537,467 16,949,623
------------ ------------
$153,354,797 $146,026,907
============ ============
Premiums amortized against and discounts accreted to income during the
period from May 14, 1997 to December 31, 1997 are as follows:
Premiums amortized against interest income ........... $ 8,033,504
Discounts accreted to interest income ................ (1,709,044)
-----------
Net premium amortization ........................ $ 6,324,460
===========
During January and February 1998, the Company recorded a charge of $2.5
million against its portfolio of interest-only and inverse interest-only
securities (together, "IOs"). The charge results from increases in projected
prepayment speeds during this period and a resulting shortening of the weighted
average lives of certain individual securities in the portfolio. As a result, a
determination was made to write down the recorded investment in those securities
where the reduction in fair value was considered to be other than temporary. The
Company believes that the current low levels of interest rates, and the inverted
shape of the yield curve, are relatively short-term phenomena. To the extent
that longer term interest rates increase or the relationship between short-term
and long-term rates revert to their historical spreads, the value of the
portfolio should recover. To the extent that the current environment persists,
or that rates decrease further, additional impairment losses may be recognized.
23
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 5 LOAN PORTFOLIO
The Company's loan portfolio consisted of the following at December 31,
1997:
Single-family residential ................................. $ 6,465,080
Multi-family residential .................................. 3,455,000
Commercial real estate:
Office ................................................. 33,058,000
Hotel .................................................. 20,952,000
------------
Total loans ........................................... 63,930,080
Deferred origination fees ................................. (458,925)
Loans in process .......................................... (47,639,676)
Allowance for loan losses ................................. --
------------
Loans, net .............................................. $ 15,831,479
============
The following table represents a summary of the Company's
non-performing loans at December 31, 1997.
NON-PERFORMING LOANS:
Single-family residential ............................. $ 268,689
Multi-family .......................................... --
Commercial ............................................ --
------------
$ 268,689
============
If non-accrual loans had been current in accordance with their original
terms, additional interest income of approximately $5,603 for the period from
May 14, 1997 to December 31, 1997 would have been earned. No interest has been
accrued on loans greater than 89 days past due.
At December 31, 1997, the Company had no investment in impaired loans
as defined in accordance with SFAS No. 114, and as amended by SFAS No. 118.
The following table sets forth the geographic distribution of
properties securing the Company's loans at December 31, 1997:
<TABLE>
<CAPTION>
Single-family Multi-family Commercial
Residential Residential Real Estate Total
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Georgia........... 1,954,863 -- -- 1,954,863
New York.......... -- 3,455,000 -- 3,455,000
South Carolina.... 3,520,770 -- -- 3,520,770
Delaware.......... -- -- 13,300,000 13,300,000
Massachusetts..... $ -- $ -- $ 40,710,000 $ 40,710,000
Other............. 989,447 -- -- 989,447
--------------- --------------- --------------- ---------------
Total............. $ 6,465,080 $ 3,455,000 $ 54,010,000 $ 63,930,080
=============== =============== =============== ===============
</TABLE>
24
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 6 DISCOUNT LOAN PORTFOLIO
The Company has acquired, through private sales and auctions, mortgage
loans at a discount. The Company estimates the amounts it will realize through
foreclosure, collection or other resolution efforts and the length of time
required to complete the collection process in determining the amounts it will
bid to acquire such loans.
The resolution alternatives applied to the discount loan portfolio are
(i) the borrower brings the loan current in accordance with original or modified
terms; (ii) the borrower repays the loan or a negotiated amount; (iii) the
borrower agrees to a deed-in-lieu of foreclosure, in which case it is classified
as real estate owned and held for sale by the Company and (iv) the Company
forecloses on the loan and the property is either acquired at the foreclosure
sale by a third party or by the Company, in which case it is classified as real
estate owned and held for sale. The Company periodically reviews the discount
loan portfolio performance to ensure that nonperforming loans are carried at the
lower of amortized cost or net realizable value of the underlying collateral and
the remaining unaccreted discount is adjusted accordingly. Upon receipt of title
to the property, the loans are transferred to real estate owned.
The Company's discount loan portfolio consists of the following at
December 31, 1997:
LOAN TYPE:
Commercial real estate loans:
Office ............................................ $ 11,892,814
Retail ............................................ 30,635,968
------------
Total unpaid principal balance .................. 42,528,782
Discount .......................................... (15,549,894)
Allowance for loan losses ......................... --
------------
Discount loans, net ............................. $ 26,978,888
============
LOAN STATUS:
Current ........................................... $ 7,964,105
Past due 31 to 89 days ............................ --
Past due 90 days or more .......................... 34,564,677
------------
$ 42,528,782
============
The following table sets forth the activity in the Company's gross
discount loan portfolio for the period from May 14, 1997 to December 31, 1997:
Principal balance at beginning of period ............. $ --
Acquisitions ......................................... 44,686,413
Resolutions and repayments (1) ....................... (1,281,846)
Foreign currency loss (2)............................. (875,785)
------------
Principal balance at end of period ................... $ 42,528,782
============
(1) Resolutions and repayments consists of loans which were resolved in a
manner which resulted in full or partial repayment of the loan to the
Company and consisted of $1.3 million of negotiated settlements and
$16,000 of partial repayments.
(2) The $875,785 represents the gross foreign currency loss related to the
unpaid principal balance which, net of $307,220 related to the discount
on loans, resulted in a net foreign currency loss of $568,565 for the
period from May 14, 1997 to December 31, 1997.
25
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
The following table sets forth the geographic distribution of
properties securing the Company's discount loans at December 31, 1997:
Canada ............................................... $26,762,692
New York ............................................. 9,208,805
Montana .............................................. 3,873,276
Ohio ................................................. 2,684,009
-----------
Total ............................................. $42,528,782
===========
NOTE 7 INVESTMENT IN REAL ESTATE
The investments in real estate at December 31, 1997 represent
acquisitions of two commercial office properties in San Francisco, California
and a shopping plaza in Bradenton, Florida. The investments have been recorded
on the books of OAIC California Partnership, L.P. and OAIC Florida Partnership,
L.P, respectively, and include:
Land ................................................. $ 5,250,105
Office buildings ..................................... 21,741,968
Retail ............................................... 18,602,922
Building improvements ................................ 14,132
------------
..................................................... 45,609,127
Accumulated depreciation ............................. (179,088)
------------
Investment in real estate net ..................... $ 45,430,039
============
NOTE 8 SHAREHOLDERS' EQUITY
On May 14, 1997, the Company completed its initial public offering of
17,250,000 shares, including over-allotments, for an initial public offering
price of $16.00 per share, before underwriting discounts and commissions.
Additionally, upon the closing of the offering 1,875,000 shares of common stock
were sold to IMI at the initial public offering price, net of underwriting
discounts and commissions. The total net proceeds from the sale of the above
shares was $283,688,000.
On December 8, 1997 IMI sold to the Company 160,000 shares of the
Company's common stock and invested in an equivalent number of units in the
Operating Partnership. As a result of this sale, IMI's direct ownership interest
in the Company amounted to 9.0% at December 31, 1997. The change in ownership
structure resulted in IMI holding a 0.8% minority interest in the Operating
Partnership.
The Company adopted a non-qualified stock option plan (the "Option
Plan"), which provides options to purchase shares of common stock (or, at the
election of the Company, limited partnership interests ("Units") in the
Operating Partnership that may be redeemed for cash, or, at the election of the
General Partner, shares of common stock on a one-for-one basis). The maximum
aggregate number of shares of Common stock that may be issued pursuant to
options granted under the Option Plan is 5,000,000. The purpose of the Option
Plan is to provide a means of performance-based compensation as an incentive for
OCC to enhance the value of Company's stock.
At the closing of the initial public offering, the Company granted to
OCC 1,912,500 options under the Option Plan at an exercise price per share equal
to the initial offering price of the common stock. The options vest one quarter
each year upon the first four anniversaries of the closing date of the initial
public offering. The options terminate on the tenth anniversary of the closing
date of the initial public offering.
26
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
The Company has recorded $103,578 of compensation expense related to
the stock options granted to OCC. The compensation expense is based on the
estimated fair value of the options which was determined using the Black-Scholes
option-pricing model. The fair value of the options was estimated using the
following assumptions:
Expected dividend yield .............................. 15.625%
Expected stock price volatility ...................... 17.910%
Risk-free interest rate .............................. 5.391%
Expected life of options ............................. 4 years
NOTE 9 BASIC AND DILUTED EARNINGS PER SHARE
The Company is required to present both basic and diluted EPS on the
face of its statement of operations. Basic EPS, which replaced primary EPS
required by APB 15, is calculated by dividing net income by the weighted average
number of common shares outstanding during the year. Diluted EPS is calculated
by dividing net income by the weighted average number of shares of common stock
outstanding and the dilutive potential common shares related to outstanding
stock options. The following is a reconciliation of the calculation of basic EPS
to diluted EPS for the period from May 14, 1997 to December 31, 1997.
Net income ........................................... $11,791,518
===========
BASIC EPS:
Weighted average shares of common stock .............. 19,108,789
===========
Basic EPS ........................................... $ 0.62
===========
DILUTED EPS:
Weighted average shares of common stock .............. 19,108,789
Effect of dilutive securities:
Stock options .................................. 455,981
-----------
19,564,770
===========
Diluted EPS .......................................... $ 0.60
===========
NOTE 10 TAXATION
The Company qualifies as a REIT under Sections 856 through 860 of the
Code, as amended. A REIT will generally not be subject to federal income
taxation on that portion of its income that is distributed to its shareholders
if it distributes at least 95 percent of its taxable income and meets certain
other income and asset tests. The Company has until the filing of its tax return
to satisfy the distribution requirement. Since the Company plans to distribute
100% of its taxable income, no provision has been made for federal income taxes
for the Company and its subsidiaries in the accompanying consolidated financial
statements. As taxable income is finalized and the tax return is filed, an
additional distribution may be required.
27
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 11 COMMITMENTS AND CONTINGENCIES
Noncancelable operating leases with tenants expire on various dates
through 2028. The future minimum rental income (base rent) to be received under
leases existing as of December 31, 1997, are as follows:
1998 ................................................. $ 3,966,128
1999 ................................................. 3,684,755
2000 ................................................. 3,267,164
2001 ................................................. 2,569,014
2002 ................................................. 1,839,674
Thereafter ........................................... 14,747,152
Office and retail space in the properties is generally leased to
tenants under lease terms which provide for the tenants to pay for increases in
operating expenses in excess of specified amounts. The above future minimum
lease payments do not include specified payments for tenant reimbursements of
operating expenses.
At December 31, 1997, outstanding commitments totaled $74.3 million and
included $14.0 million related to the purchase of an office building, $60.3
million related to the origination of three real estate loans with initial
fundings of approximately $10.0 million.
Neither the Company nor the Operating Partnership is currently involved
in any material litigation nor, to the Company's knowledge, is any material
litigation currently threatened against the Company or the Operating
Partnership.
NOTE 12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth the quarterly financial information for
the period from May 14, 1997 to December 31, 1997.
<TABLE>
<CAPTION>
Quarters Ended For the Period
----------------------------- May 14, 1997
December 31, September 30, to
1997 1997 June 30, 1997
----------- ------------- -------------
<S> <C> <C> <C>
Interest income.............................. $ 5,466,971 $ 5,511,937 $2,482,807
Operating income............................. 1,427,260 67,038 --
Operating expenses........................... (1,503,779) (1,228,703) (422,583)
----------- ----------- ----------
Income before minority interest.............. 5,390,452 4,350,272 2,060,224
Minority interest in net income of operating
partnership ................................ (9,430) -- --
----------- ----------- ----------
Net income................................... $ 5,381,022 $ 4,350,272 $2,060,224
=========== =========== ==========
Earnings per share:
Basic....................................... $ 0.28 $ 0.23 $ 0.11
Diluted..................................... $ 0.28 $ 0.22 $ 0.11
</TABLE>
28
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
SHAREHOLDER INFORMATION
PRICE RANGE OF THE COMPANY'S COMMON STOCK
The Company's common stock began trading on The NASDAQ Stock Market's
National Market ("NASDAQ") on May 14, 1997 under the symbol "OAIC". The
following table sets forth for the indicated periods the high and low bid prices
for the common stock, as traded on such market.
1997 HIGH LOW
----------------------------------------------- --------- ---------
Second quarter (from May 14)................... $ 20.1250 $ 17.8750
Third quarter.................................. 24.8750 19.7500
Fourth quarter................................. 24.0000 17.5000
The foregoing market quotations reflect inter-dealer prices, without retail
mark-up, mark-down, or commissions and may not necessarily represent actual
transactions.
At the close of business on February 27, 1998, the Company's common
stock price was $19.94.
The Company currently qualifies as a REIT. To obtain the tax benefits
of a REIT, the Company is required each year to distribute to its shareholders
at least 95% of its taxable income after certain adjustments by the due date of
its federal income tax return. Future distributions paid by the Company will be
at the discretion of the Board of Directors and will depend on the actual cash
flow of the Company, its financial condition, capital requirements, the annual
REIT distribution requirements and such other factors as the Board of Directors
of the Company deem relevant. During the period from May 14, 1997 to December
31, 1997, the Company declared dividends totaling $13.9 million.
NUMBER OF HOLDERS OF COMMON STOCK
At February 27, 1998, 18,965,000 shares of Company common stock were
outstanding and held by approximately 76 holders of record.
29
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
CORPORATE INFORMATION
Corporate Headquarters
Ocwen Asset Investment Corp.
The Forum, Suite 1000
1675 Palm Beach Lakes Blvd.
West Palm Beach, Florida 33401
(561) 681-8000
Annual Meeting
The Annual Meeting of OAIC Shareholders will be held on May 14, 1998 at:
1675 Palm Beach Lakes Blvd.
West Palm Beach, Florida 33401
Investor Relations
All investor inquiries may be directed to or copies of OAIC Form 10-K may be
obtained from:
Investor Relations
Ocwen Asset Investment Corp.
The Forum, Suite 1003
1675 Palm Beach Lakes Blvd.
West Palm Beach, Florida 33401
(561) 681-8400
Listing
The common stock of Ocwen Asset Investment Corp. is listed on the NASDAQ. Its
symbol is "OAIC".
Registrar and Transfer Agent
Transfer Agent for Stock
The Bank of New York
Shareholder Relations Department 11E
P.O. Box 11258
Church Street Station
New York, NY 10286
(800) 524-4458
Send certificates for transfer and address change notices to:
The Bank of New York
Receive and Deliver Department 11W
P.O. Box 11002
Church Street Station
New York, NY 10286
30
