UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File No. 001-14043
OCWEN ASSET INVESTMENT CORP.
----------------------------
(Exact name of registrant as specified in its charter)
Virginia 65-0736120
- -------- ----------
(State or other jurisdiction (I.R.S.Employer
of incorporation or organization) Identification No.)
The Forum, Suite 1000
---------------------
1675 Palm Beach Lakes Boulevard, West Palm Beach, Florida 33401
---------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(561) 682-8000
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ].
Number of shares of Common Stock, $.01 par value, outstanding at the close of
business on November 13, 1998: 18,965,000 shares.
<PAGE>
OCWEN ASSET INVESTMENT CORP.
FORM 10-Q/A
I N D E X
================================================================================
Page
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PART I - FINANCIAL INFORMATION
Item 1. Interim Consolidated Financial Statements........................ 3
Consolidated Statements of Financial Condition................... 3
Consolidated Statements of Operations............................ 4
Consolidated Statements of Changes in Shareholders' Equity....... 5
Consolidated Statements of Cash Flows............................ 6
Notes to Consolidated Financial Statements....................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 38
PART II - OTHER INFORMATION
Item 2. Changes in Securities............................................ 41
Item 6. Exhibits and Reports on Form 8-K................................. 41
Signature................................................................. 42
2
<PAGE>
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
OCWEN ASSET INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31,
1998 1997
(Unaudited) (Audited)
------------- -------------
<S> <C> <C>
ASSETS:
Cash and amounts due from depository institutions ...................... $ 3,135,888 $ 331,047
Interest earning deposits .............................................. 15,193,815 48,346,076
Securities available for sale, at market value ......................... 395,495,423 146,026,907
Commercial and multifamily loan portfolio, net ......................... 55,116,284 9,481,436
Residential loan portfolio, net ........................................ 197,495,230 6,350,043
Discount loan portfolio, net ........................................... 8,589,370 26,978,888
Investment in real estate, net ......................................... 209,851,125 45,430,039
Principal and interest receivable ...................................... 5,967,421 2,518,272
Deposits on pending asset acquisitions ................................. -- 1,000,000
Other assets ........................................................... 19,553,108 1,540,633
------------- -------------
Total assets ........................................ $ 910,397,664 $ 288,003,341
============= =============
LIABILITIES:
Securities sold under agreements to repurchase ..................... $ 143,058,656 $ --
Obligation outstanding under line of credit ........................ 189,136,665 --
Obligation outstanding under line of credit - secured by real estate 142,444,500 --
11.5% Notes due 2005 ............................................... 143,000,000 --
Dividends and distributions payable ................................ 9,140,443 7,458,750
Accrued expenses, payables and other liabilities ................... 12,267,243 6,344,783
------------- -------------
Total liabilities ................................... 639,047,507 13,803,533
------------- -------------
Minority interest ...................................................... 28,369,583 2,941,541
------------- -------------
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;
18,965,000 shares issued and outstanding ........................ 189,650 189,650
Additional paid-in capital ......................................... 294,461,433 280,503,838
Distributions in excess of earnings ................................ (35,982,904) (2,107,331)
Accumulated other comprehensive income:
Net unrealized loss on securities available for sale .......... (13,719,114) (7,327,890)
Accumulative translation adjustments .......................... (1,968,491) --
------------- -------------
Total other comprehensive income .............................. (15,687,605) (7,357,890)
------------- -------------
Total shareholders' equity .............................. 242,980,574 271,258,267
------------- -------------
Total liabilities and shareholders' equity .......... $ 910,397,664 $ 288,003,341
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
3
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
OCWEN ASSET INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three For the Three For the Nine For the Period
Months ended Months ended Months ended May 14, 1997 to
September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Interest income:
Repurchase agreements and interest bearing deposits $ 713,966 $ 2,753,729 $ 1,009,614 $ 4,150,857
Securities held for trading ........................ -- -- 106,892 --
Securities available for sale ...................... 13,806,940 2,492,172 29,990,157 3,497,356
Commercial and multifamily loans ................... 1,512,508 -- 3,786,210 --
Residential loans .................................. 3,862,725 5,565 6,475,756 5,565
Discount loans ..................................... 393,132 260,471 1,719,330 340,966
------------ ------------ ------------ ------------
20,289,271 5,511,937 43,087,959 7,994,744
------------ ------------ ------------ ------------
Interest expense:
Securities sold under agreements to repurchase ..... 3,082,025 -- 7,048,840 --
Obligations outstanding under lines of credit ...... 3,828,297 -- 6,102,066 --
11.5% Notes due 2005 ............................... 3,687,347 -- 3,687,347 --
------------ ------------ ------------ ------------
10,597,669 -- 16,838,253 --
------------ ------------ ------------ ------------
Net interest income before provision for loan losses 9,691,602 5,511,937 26,249,706 7,994,744
Provision for loan losses ............................ 350,682 -- 556,731 --
------------ ------------ ------------ ------------
Net interest income after provision for loan losses. 9,340,920 5,511,937 25,692,975 7,994,744
------------ ------------ ------------ ------------
Real estate-operating income:
Rental income ...................................... 8,035,170 107,668 14,584,661 107,668
Other .............................................. 1,508 7,298 28,343 7,298
------------ ------------ ------------ ------------
8,036,678 114,966 14,613,004 114,966
------------ ------------ ------------ ------------
Real estate-operating expenses:
Rental operation ................................... 3,626,054 29,039 6,901,905 29,039
Depreciation & amortization ........................ 1,159,652 21,386 2,222,573 21,386
Interest ........................................... 2,707,478 -- 4,396,581 --
------------ ------------ ------------ ------------
7,493,184 50,425 13,521,059 50,425
------------ ------------ ------------ ------------
Real estate income, net .............................. 543,494 64,541 1,091,945 64,541
------------ ------------ ------------ ------------
Other expenses (income):
Management fees .................................... 1,576,379 719,914 4,110,011 1,060,914
Due diligence expenses ............................. 567,981 237,891 935,625 285,812
Foreign currency gain .............................. -- (2,497) (116,953) (2,497)
Other .............................................. 1,067,996 270,898 1,644,090 304,562
------------ ------------ ------------ ------------
3,212,356 1,226,206 6,572,773 1,648,791
------------ ------------ ------------ ------------
Net losses on securities and derivatives ............. 15,646,384 -- 32,723,429 --
------------ ------------ ------------ ------------
(Loss) income before minority interest ............. (8,974,326) 4,350,272 (12,511,282) 6,410,494
Minority interest in net loss of
consolidated subsidiary............................. 720,513 -- 399,359 --
------------ ------------ ------------ ------------
Net (loss) income before extraordinary items ....... (8,253,813) 4,350,272 (12,111,923) 6,410,494
Extraordinary gain on repurchase of debt ............. 615,047 -- 615,047 --
------------ ------------ ------------ ------------
Net (loss) income ............................... $ (7,638,766) $ 4,350,272 $(11,496,876) $ 6,410,494
============ ============ ============ ============
Basic (loss) earnings per share:
(Loss) income before extraordinary item ......... $ (0.43) $ 0.23 $ (0.64) $ 0.34
Extraordinary item .............................. 0.03 -- 0.03 --
------------ ------------ ------------ ------------
Net (loss) income ............................... $ (0.40) $ 0.23 $ (0.61) $ 0.34
============ ============ ============ ============
Diluted (loss) earnings per share:
(Loss) income before extraordinary item ......... $ (0.43) $ 0.22 $ (0.64) $ 0.33
Extraordinary item .............................. 0.03 -- 0.03 --
------------ ------------ ------------ ------------
Net (loss) income ............................... $ (0.40) $ 0.22 $ (0.61) $ 0.33
============ ============ ============ ============
Weighted average shares outstanding:
Basic ........................................... 18,965,000 19,125,000 18,965,000 19,125,000
Diluted ......................................... 18,965,000 19,715,712 18,965,000 19,620,046
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
4
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
OCWEN ASSET INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
AND FOR THE PERIOD MAY 14, 1997 TO DECEMBER 31, 1997
Net unrealized
loss on
Common stock Distributions securities Cumulative
---------------------- Additional in excess available translation
Shares Amount Paid-in-capital of earnings for sale adjustment Total
----------- --------- --------------- ------------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock ....... 19,125,000 $ 191,250 $ 283,496,750 $ -- $ -- $ -- $ 283,688,000
Retirement of common stock ..... (160,000) (1,600) (2,992,912) -- -- -- (2,994,512)
Net income ..................... -- -- -- 11,791,518 -- -- 11,791,518
Dividends ...................... -- -- -- (13,898,849) -- -- (13,898,849)
Change in unrealized loss ...... -- -- -- -- (7,327,890) -- (7,327,890)
----------- --------- ------------- ------------ ------------ ----------- -------------
Balances at December 31, 1997 .. 18,965,000 189,650 280,503,838 (2,107,331) (7,327,890) -- 271,258,267
Capital contribution ........... -- -- 13,957,595 -- -- -- 13,957,595
Net loss ....................... -- -- -- (11,496,876) -- -- (11,496,876)
Dividends ...................... -- -- -- (22,378,697) -- -- (22,378,697)
Change in unrealized loss ...... -- -- -- -- (6,391,224) -- (6,391,224)
Change in cumulative translation
adjustment ................... -- -- -- -- -- (1,968,491) (1,968,491)
----------- --------- ------------- ------------ ------------ ----------- -------------
Balances at September 30, 1998 18,965,000 $ 189,650 $ 294,461,433 $(35,982,904) $(13,719,114) $(1,968,491) $ 242,980,574
=========== ========= ============= ============ ============ =========== =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
5
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION
OCWEN ASSET INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the For the Period
Nine Months May 14, 1997
ended to
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income ......................................................... $ (11,496,876) $ 6,410,494
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Premium amortization, net ............................................. 7,992,956 1,422,847
Depreciation .......................................................... 2,222,573 21,386
Foreign exchange gain ................................................. (116,953) --
Cumulative translation adjustment ..................................... (1,968,491) --
Extraordinary gain on extinguishment of debt .......................... (615,047) --
Provision for loan losses ............................................. 556,731 --
Proceeds received on sale of securities held for trading .............. 39,408,287 --
Net losses on securities and derivatives .............................. 32,723,429 --
Increase in interest receivable ....................................... (3,449,149) (1,897,189)
Increase in other assets .............................................. (20,108,845) (535,106)
Decrease in accrued expenses, payables and other liabilities .......... (1,071,622) 2,039,437
Minority interest in net loss of operating partnership ................ (399,359) --
------------- -------------
Net cash provided by operating activities .................................... 43,677,634 7,461,869
------------- -------------
Cash flows from investing activities:
Purchases of securities available for sale ................................ (357,494,324) (92,295,129)
Maturities and principal payments received on securities available for sale 30,388,130 2,957,402
Principal payments received from discount loans ........................... 973,325 6,915
Principal payments received from loans .................................... 20,344,923 --
Purchase of loans ......................................................... (257,818,817) (3,773,321)
Purchase of discount loans ................................................ (10,031) (25,191,206)
Payment received from sale of loans ....................................... 111,109 --
Investment in real estate ................................................. (149,017,946) (26,285,103)
Deposits on pending asset acquisitions .................................... 996,500 (6,184,300)
------------- -------------
Net cash (used) by investing activities ...................................... (711,527,131) (150,764,742)
------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of offering costs ............. -- 283,688,000
Dividend payments on common stock ......................................... (22,378,697) (1,912,500)
Proceeds received from sale of securities to affiliates
in excess of market value ............................................... 13,957,595 --
Proceeds from issuance of Notes ........................................... 150,000,000 --
Repurchase of Notes ....................................................... (6,309,944) --
Proceeds from sale of operating partnership units ......................... 27,593,302 --
Increase in securities sold under agreements to repurchase ................ 143,058,656 --
Increase in obligations outstanding under lines of credit ................. 331,581,165 --
------------- -------------
Net cash provided by financing activities .................................... 637,502,077 281,775,500
------------- -------------
Net (decrease) increase in cash and cash equivalents ......................... (30,347,420) 138,472,627
Cash and cash equivalents at beginning of period ............................. 48,677,123 --
------------- -------------
Cash and cash equivalents at end of period ................................... $ 18,329,703 $ 138,472,627
============= =============
Reconciliation of cash and cash equivalents at end of period:
Cash and amounts due from depository institutions ......................... 3,135,888 10,850
Interest bearing deposits ................................................. 15,193,815 8,461,777
Repurchase agreements ..................................................... -- 130,000,000
------------- -------------
Total ................................................................... $ 18,329,703 $ 138,472,627
============= =============
Supplemental schedule of non-cash financing activities:
Interest paid .............................................................. $ 16,204,823 $ --
Non-cash activities:
Loans transferred through the foreclosure of a related
Mortgage loan to real estate owned ......................................... 17,625,713 --
Change in unrealized (loss) gain on securities available for sale .......... (6,391,224) 1,605,820
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS
6
</TABLE>
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
================================================================================
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of
Regulation S-X for interim financial statements. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles ("GAAP") for complete financial statements. The
consolidated financial statements include the accounts of Ocwen Asset Investment
Corp. ("OAC" or the "Company") and its subsidiaries. The interim financial
information should be read in conjunction with the Company's 1997 Annual Report
on Form 10-K.
OAC directly owns two qualified real estate investment trust ("REIT")
subsidiaries, Ocwen General, Inc. ("General Partner") and Ocwen Limited, Inc.
("Limited Partner"), among others. At September 30, 1998, the General Partner
and the Limited Partner owned 0.9% and 90.4%, respectively of Ocwen Partnership,
L.P. ("Operating Partnership"). The minority interest at September 30, 1998
represents an 8.7% interest (1,808,733 units) in the Operating Partnership held
by Investors Mortgage Insurance Holding Company ("IMI"), a wholly-owned
subsidiary of Ocwen Financial Corporation ("OCN"). IMI also owns 1,540,000
shares, or 8.12 percent, of the Company's outstanding common stock.
In the opinion of management, the accompanying financial statements contain all
adjustments, consisting of normal and recurring accruals, necessary for a fair
presentation of the Company's:
o financial condition at September 30, 1998 and December 31, 1997,
o the results of its operations for the three and nine months ended
September 30, 1998; and for the quarter ended September 30, 1997 and the
period May 14, 1997 to September 30, 1997,
o the changes in shareholders' equity for the nine month period ended
September 30, 1998 and for the period May 14, 1997 to December 31, 1997,
and
o cash flows for the nine months ended September 30, 1998 and for the period
May 14, 1997 to September 30, 1997.
Operating results for the period ended September 30, 1998 are not necessarily
indicative of the results that may be expected for any other interim period or
the entire year ending December 31, 1998.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities at the dates of the statements of financial condition and revenues
and expenses for the periods covered. Actual results could differ from those
estimates and assumptions.
NOTE 2 ORGANIZATION AND RELATIONSHIPS
OAC 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 has entered into a management agreement with Ocwen Capital
Corporation ("OCC" or the "Manager"), a wholly-owned subsidiary of OCN, 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 quarterly base management fee of
0.25% per quarter
7
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
================================================================================
on average invested assets except for residential mortgage loans. Effective
January 1, 1998, the base management fee for residential loans, was reduced to
0.25% per quarter of average net equity invested. In addition, OCC is entitled
to receive an annual incentive fee in an amount equal to 25% of the dollar
amount by which funds from operations, as adjusted, exceeds certain defined
levels per the management agreement.
OCC has 1,912,500 options (478,125 of which vested in May 1998 and an additional
25% of which vest each year over the next three 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 also has entered into servicing agreements with Ocwen Federal Bank
FSB ("OFB" or the "Bank"), a wholly-owned subsidiary of OCN, for the servicing
of all of the Company's mortgage loans. In addition, the Bank in its capacity as
servicer or special servicer receives fees from certain mortgage-backed
securities in which the Company owns a subordinate or residual interest. As a
Special Servicer, the Bank provides asset management and resolution services
with respect to defaulted mortgage loans subject to the Company's right to
direct the foreclosure, the management and disposal of foreclosed properties and
all other actions that a servicer may take in connection with a defaulted loan.
On May 7, 1998, the Operating Partnership issued 1,473,733 additional limited
partnership units to IMI in exchange for a capital contribution of $24.5
million. At September 30, 1998, IMI's minority interest in the Operating
Partnership was 8.7 percent.
Also on May 7, 1998, the Company sold its entire portfolio of AAA-rated interest
only ("IO") and inverse floating rate interest only ("Inverse IO") classes of
mortgage related securities backed by single-family residential loans (the "IO
Portfolio") to affiliates of the Company, the Manager and OCN, for a cash price
of $54.6 million, which represents the IO Portfolio's amortized cost plus
accrued interest and exceeded the IO Portfolio's market value by approximately
$14.0 million. Because the IOs were being sold to a principal shareholder and
another related party, the $14.0 million by which amortized cost exceeded market
value was recorded as a charge to earnings and has been reflected on the
Company's books as a capital contribution.
NOTE 3 RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", which
amends FASB Statements No. 52 and 107, and supersedes FASB Statements No. 80,
105 and 119. SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. SFAS No. 133 requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. SFAS No. 133 is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
Initial application of SFAS No. 133 should be as of the beginning of an entity's
fiscal quarter; on that date, hedging relationships must be designated anew and
documented pursuant to the provisions of SFAS No. 133. Earlier application of
SFAS No. 133 is encouraged but is permitted only as of the beginning of any
fiscal quarter that begins after issuance of SFAS No. 133. The Company has not
yet determined the impact on its results of operations, financial position or
cash flows as a result of implementing SFAS No. 133.
In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise", an amendment of FASB Statement No. 65. This
statement is effective for the first fiscal quarter beginning after December 15,
1998. This Statement standardizes how mortgage banking firms account for certain
securities and other interests they retain after securitizing mortgage loans
that were held for sale. Adoption of this pronouncement is not expected to have
a material impact on the Company's consolidated financial statements.
8
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
================================================================================
NOTE 4 INCOME TAXES
The Company qualifies as a REIT under Sections 856 through 860 of the Internal
Revenue Code of 1986, as amended (the "Code"). 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
for the year 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.
NOTE 5 COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a business enterprise
during a period as a result of transactions and other events and circumstances
during such period, excluding those resulting from investments by and
distributions to owners. SFAS No. 130 requires that comprehensive income be
presented beginning with net income and adding the elements of comprehensive
income not included in the determination of net income in order to arrive at
comprehensive income.
The following table computes comprehensive income for the periods indicated.
<TABLE>
<CAPTION>
For the For the For the For the Period
Three Months Three Months Nine Months May 14, 1997
Ended Ended Ended to
September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Net (loss) income before extraordinary item.. $ (8,253,813) $ 4,350,272 $(12,111,923) $ 6,410,494
Other comprehensive (loss) income:
Foreign currency translation adjustment... (916,525) -- (1,968,491) --
Unrealized losses on securities:
Unrealized (losses) gains arising
during the period ....................... (27,376,733) (177,989) (37,044,667) 1,605,820
Adjustment for losses included in
net income .............................. 13,576,398 -- 30,653,443 --
------------ ------------ ------------ ------------
Net unrealized (losses) gains ........ (13,800,335) (177,989) (6,391,224) 1,605,820
Other comprehensive (loss) income .... (14,716,860) (177,989) (8,359,715) 1,605,820
------------ ------------ ------------ ------------
Comprehensive (loss) income before
extraordinary item ..................... $(22,970,673) $ 4,172,283 $(20,471,638) $ 8,016,314
Extraordinary item .......................... 615,047 -- 615,047 --
------------ ------------ ------------ ------------
Comprehensive (loss) income ................. $(22,355,626) $ 4,172,283 $(19,856,591) $ 8,016,314
============ ============ ============ ============
</TABLE>
NOTE 6 RISK MANAGEMENT INSTRUMENTS
The Company enters into derivatives, particularly interest rate swaps, to hedge
interest rate exposures arising from mismatches between assets and liabilities.
Under interest rate swaps, the Company agrees with other parties to exchange, at
specified intervals, the difference between fixed-rate and floating-rate
interest amounts calculated by reference to an agreed notional principal amount
and the London Interbank Offered Rate ("LIBOR"). The terms of these swaps allow
the Company to receive a floating rate of interest equal to LIBOR and to pay
fixed interest rates.
The swaps are used to hedge current LIBOR rate debt incurred to fund the
Company's acquisitions of real estate and subordinate and residual securities.
None of the Company's swaps are held for trading
9
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
================================================================================
purposes. As of September 30, 1998 the Company held swaps with a notional amount
of approximately $200.8 million.
The cost of derivatives that qualify for hedge accounting are amortized over the
term of the agreement. To qualify for hedge accounting, an interest rate
protection agreement must meet two criteria:
o the Company is exposed to interest rate risk as the result of a debt it has
incurred; and
o the interest rate protection agreement reduces the Company's exposure to
such risk.
If an interest rate protection agreement does not qualify as a hedge, it is
accounted for as an investment at fair value, with any gain or loss included as
a component of current income.
The Company is exposed to credit loss in the event of nonperformance by the
counterparties to the interest rate agreements should the floating interest
rates received by the Company exceed the fixed interest rates paid by it. All of
the counterparties have long-term debt ratings of A+ or above by Standard and
Poor's and A1 or above by Moody's. Although a swap generally may not be sold or
transferred without the consent of the counterparty, management does not believe
that this consent would be withheld. Although none of the Company's swaps are
exchange-traded, there are a number of financial institutions which enter into
these types of transactions as part of their day-to-day activities.
The following table indicates the interest rate swaps outstanding at September
30, 1998:
<TABLE>
<CAPTION>
Notional LIBOR Floating Rate at
Maturity Amount Index Fixed Rate End of Period Fair Value
-------- ------ ----- ---------- ------------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
2003 $ 100,000 1-month 5.75% 5.59% $ (3,273)
2001 17,000 1-month 6.00 5.66 (492)
2001 75,000 1-month 6.00 5.64 (2,158)
2002 8,780 1-month 6.04 5.66 (341)
---------- ----------
$ 200,780 $ (6,264)
========= =========
</TABLE>
The Company has a foreign currency swap contract to hedge currency exposure in
connection with its investment in residual interests backed by residential
mortgage loans originated in the United Kingdom ("U.K."), currently held by
OAIC-UK, a wholly owned subsidiary of the Company. The purpose of the Company's
foreign currency hedging activities is to protect the Company from the risk that
the eventual dollar net cash inflows will be adversely affected by changes in
exchange rates. Under the terms of the agreement, the Company will settle in
U.S. dollars on January 29, 1999 on the difference between the exchange rate on
the effective date of the contract and the exchange rate on January 29, 1999, on
a notional amount of 14.7 million British Pounds Sterling. At September 30,
1998, the fair value of the foreign currency contract was ($1.4) million. Gains
and losses on foreign currency translation from operations for which the
functional currency is other than the U.S. dollar, together with related hedged
item, are reported in Shareholders' equity.
The Company also enters into U.S. Treasury interest rate futures contracts as
part of its overall interest rate risk management activity. Interest rate
futures contracts are commitments to either purchase or sell designated
financial instruments at a future date for a specified price and may be settled
in cash or through delivery. U.S. Treasury futures have been sold by the Company
to hedge the risk of a reduction in the market value of fixed-rate mortgage
loans and certain fixed-rate mortgage-backed and related securities available
for sale in a rising interest rate environment.
Terms and other information on interest rate futures contracts sold short were
as follows at the dates indicated:
Maturity Notional Principal Fair Value
-------- ------------------ ----------
(Dollars in Thousands)
SEPTEMBER 30, 1998:
U.S. Treasury futures...... Dec 1998 $ 13,400 $ 345
10
<PAGE>
OCWEN ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
================================================================================
The fair value of the interest rate swaps, the foreign currency swap, and
interest rate futures contracts represent the estimated amount that the Company
would receive or pay to terminate these agreements taking into account current
interest and exchange rates. Market quotes are available for these agreements.
The fair values are recorded in the Consolidated Statements of Financial
Condition offsetting the item being hedged.
NOTE 7 SECURITIES AVAILABLE FOR SALE
Securities are classified as available for sale when in management's judgement
they may be sold in response to or in anticipation of changes in interest rates
and resulting prepayment risk, or other factors. Available for sale securities
are carried at fair value. Unrealized gains and losses on these securities,
along with any unrealized gains and losses on related derivatives, are reported
in shareholders' equity. Securities that the Company has the positive intent and
ability to hold to maturity are classified as held-to-maturity and are carried
at amortized cost. At September 30, 1998, the Company had no securities
classified as held-to-maturity. Interest and dividend income on securities,
including amortization of premiums and accretion of discounts, are reported in
earnings. Interest income is recognized using the interest method. The specific
identification method is used to determine realized gains and losses on sales of
securities, which are reported in earnings. The carrying value of individual
securities is reduced through write-downs in earnings to reflect
other-than-temporary impairments in value.
NOTE 8 LOANS
Loans are generally reported at the principal amount outstanding, net of the
allowance for loan losses, purchase premium or discount, and any net deferred
loan fees. Interest income is recognized using the interest method or on a basis
approximating a level yield over the term of the loan. Loans are placed on
nonaccrual status when the loan is past due 90 days or more. Interest accrued
but not collected at the date a loan is placed on nonaccrual status is reversed
against interest income. In addition, the amortization of net deferred loan fees
is suspended when a loan is placed on nonaccrual status. Interest income on
nonaccrual loans is recognized only to the extent received in cash. However,
where there is doubt regarding the ultimate collectibility of the loan
principal, cash receipts, whether designated as principal or interest, are
thereafter applied to reduce the carrying value of the loan. Loans are restored
to accrual status only when interest and principal payments are brought current
and future payments are reasonably assured.
NOTE 9 COMMITMENTS
As of November 16, 1998, OAC had no outstanding commitments. All other
previously announced commitments or negotiations have been closed, discontinued,
or failed to close. The unfunded balances on the commercial and multi-family
loan portfolio amounted to $65.3 million as of October 31, 1998 and are expected
to be funded through working capital and/or a $200.0 million line of credit
secured by certain of the Company's investments in real estate and commercial
and multi-family loans.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
General
The Company is a Virginia corporation, formed in the first quarter of 1997, that
has elected to be taxed as a REIT under Sections 856 through 860 of the Code.
The Company's primary investments include:
o commercial and residential subordinate and residual interests in
collateralized mortgage obligations and other mortgage-related securities
(collectively, "mortgage-related securities"); and
o underperforming or otherwise distressed commercial and multi-family real
property, including properties acquired by mortgage lenders at foreclosure
or through deed-in-lieu thereof.
The Company also has invested, by way of purchase or origination, in other real
estate related assets including:
o commercial, multifamily and single-family mortgage loans, including
construction and renovation loans and mezzanine loans, which comprise the
Company's loan portfolio, and
o nonperforming and subperforming mortgage loans, which generally are
purchased at a discount to their aggregate unpaid principal amount and
comprise the Company's discount loan portfolio.
RECENT OPERATING LOSSES; DISCONTINUANCE OF INVESTMENT ACTIVITIES
The Company reported a loss of $7.6 million or ($0.40) per fully diluted share
for the three months ended September 30, 1998 and a loss of $11.5 million or
($0.61) per fully diluted share for the nine months ended September 30, 1998.
These losses were primarily attributable to: (i) an aggregate of $17.1 million
of losses incurred in connection with the Company's portfolio of AAA-rated
interest-only ("IO") and inverse interest-only ("Inverse IO") securities backed
by single-family residential loans (the "IO Portfolio"), which was adversely
affected in the first quarter of 1998 by an increase in prepayments of the
underlying mortgages in response to a decrease in market interest rates; and
(ii) $15.6 million of losses on subordinate and residual interests in
mortgage-related securities and derivatives (consisting of a $13.6 million loss
on securities and a $2.0 million loss on derivatives), which were adversely
affected by increased prepayments of the underlying mortgage loans and the
substantial volatility in U.S. and foreign securities markets which has resulted
in widening mortgage spreads and declining market liquidity. Moreover, as a
result of these conditions, in recent months there has been a general "flight to
quality" by investors, with the result that the market or demand for subordinate
and residual interests in mortgage-related securities has been substantially
reduced or eliminated. These factors have adversely affected the operations and
financial condition of numerous companies in the financial service, REIT and
mortgage-backed security sectors, including the Company.
As a result of the foregoing developments, particularly as they relate to the
Company's subordinate and residual interests in mortgage-related securities, the
Company has received requests from its lenders to pledge additional collateral
or repay certain portions of its debt pursuant to the terms of its indebtedness,
which it has been able to meet as of the date hereof. See "Capital Resources and
Liquidity." In anticipation of a possible economic downturn and in order to
enhance its ability to meet the obligations under its indebtedness, the Company
has decided that, for the foreseeable future, it does not plan to acquire any
additional assets or fund any additional loans (beyond those which are currently
committed), and it will work to accelerate the stabilization of its existing
assets and increase its overall liquidity position. As a result, the Company has
currently curtailed each of its business lines, which include the acquisition of
subordinate and residual interests in residential and commercial
mortgage-related securities, underperforming real estate and commercial real
estate loans, including construction and renovation loans.
At September 30, 1998, the Company's shareholders' equity amounted to $243.0
million or $12.81 per fully diluted share. This amount was comprised of $295.0
million of stated capital and additional paid-in capital related to the
Company's Common Stock, less distributions in excess of earnings of $36.0
million, unrealized losses on securities available for sale of $13.7 million and
accumulative translation adjustments of $2.0 million.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
The future success of the Company will be primarily dependent on its ability to
continue to be able to meet its obligations under its indebtedness. This ability
will depend largely on the Company's future performance, which, in turn, is
subject to prevailing economic conditions and to financial, business and other
factors beyond its control, including levels of interest rates, and its
dependence on its existing assets. There can be no assurance that the Company's
existing assets will be sufficient to ensure future profitable operations or
enable the Company to meet its indebtedness obligations, or that such assets
will not be further significantly adversely affected by changes in market and
economic conditions and other factors.
OTHER SIGNIFICANT EVENTS FOR THE QUARTER ENDED SEPTEMBER 30, 1998
For the quarter ended September 30, 1998, the Company closed transactions
totaling approximately $114.6 million, all of which were funded. This activity
brings the Company's total closed transactions since its initial public
offering, net of repayments, to $917.1 million as of September 30, 1998. Of this
amount, $866.5 million has been funded and the remaining $50.6 million is to be
funded over the construction and renovation periods, which range from two to 18
months.
On July 14, 1998, OAC issued $150.0 million of 11 1/2% Notes due 2005 (the
"Notes") under Rule 144A of the Securities Act of 1933, as amended (the
"Securities Act").
On July 22, 1998, the Company acquired the Prudential Building, an existing
488,080 square foot, 22-story office building located in the central business
district of Jacksonville, Florida, for $36.0 million in cash plus closing costs.
The purchase price was funded with cash on hand and advances from the Company's
line of credit. Simultaneous with the closing, the Company also leased 97% of
the building back to the Prudential Insurance Co. of America and sold two
parcels of adjacent parking areas to an adjacent hospital for approximately $4.1
million. See "Changes in Financial Condition - Investments in Real Estate."
On August 28, 1998, the Company purchased for $19.8 million from Nomura Asset
Securities Corp., a single B-rated subordinate interest collateralized by a pool
of ten first lien conduit quality commercial loans secured by 108 properties.
The purchase price was funded with cash on hand and a reverse repurchase
agreement in the amount of $14.7 million, which matures in August, 1999. OFB is
the special servicer for these loans. See "Changes in Financial Condition -
Securities Available for Sale."
On September 22, 1998, the Company declared a cash dividend of $0.44 per share
for the third quarter of 1998, which was payable to shareholders of record on
September 30, 1998, and paid on October 15, 1998.
Also on September 22, 1998, the Company announced that its Board of Directors
authorized a program to repurchase up to $10 million of its issued and
outstanding shares of common stock. Any such repurchases will be at times, at
prices per share, in amounts and through solicited or unsolicited transactions
in the open market, on the New York Stock Exchange or in privately negotiated
transactions, in each case as the Company deems appropriate depending on market
conditions, corporate requirements, and applicable securities laws. The Company
has no plans to repurchase any common stock at this time.
On September 23, 1998, the Company filed a registration statement with the
Securities and Exchange Commission (the "SEC") as the first step in effecting
its planned exchange offer for the Notes whereby the holders of the Notes will
receive new Notes with substantially the same terms which have been registered
with the SEC.
On September 30, 1998, the Company filed with the SEC a shelf registration
statement allowing for the issuance of up to $250 million of common and
preferred stock, senior and subordinated debt and other securities. The Company
has no plans to conduct a registered offering of securities in the foreseeable
future.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
RECENT DEVELOPMENTS
During October of 1998, the Company closed an existing commitment to finance a
hotel construction loan in the amount of $17.7 million, of which $1.2 million
has been funded.
On November 13, 1998, OAC completed the securitization of 1,808 first and second
single family residential mortgage loans having an aggregate unpaid principal
balance of $182.2 million. The mortgage loans were acquired by the Operating
Partnership during 1997 and 1998. After the payment in full of all transaction
expenses and the repayment in full of the approximately $136.0 million warehouse
facility secured by such mortgage loans, the securitization will net OAC
approximately $35.0 million in cash. OAC will retain an approximately $10.1
million non-investment grade equity certificate which will entitle OAC to the
available excess cashflow, and OFB will continue to service the mortgage loans.
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 Interim Consolidated Financial Statements and related Notes
included in Item 1 above.
GENERAL. The Company reported a net loss of $7.6 million for the quarter ended
September 30, 1998, or ($0.40) per diluted share, compared to net income of $4.4
million, or $0.22 per diluted share, for that same period a year ago. During the
third quarter of 1998, the Company recognized a charge of $15.6 million, or
($0.75) per diluted share after minority interest, related primarily to its
commercial and residential mortgage-backed securities. For the nine months ended
September 30, 1998, the Company reported a net loss of $11.5 million, or ($0.61)
per diluted share.
INTEREST INCOME. Interest income increased by $14.8 million from $5.5 million in
the third quarter of 1997 to $20.3 million for the three months ended September
30, 1998. This increase was primarily the result of a $346.6 million increase in
the average balance of securities available for sale during the quarter ended
September 30, 1998 as compared to the quarter ended September 30, 1997 and a
$231.6 million increase in the average balances of the loan portfolios during
the third quarter of 1998 as compared to the third quarter of 1997. Likewise,
interest income increased $35.1 million to $43.1 million for the nine months
ended September 30, 1998, compared to $8.0 million for the same period a year
ago. This increase was primarily attributable to a $223.8 million increase in
the average balance of securities available for sale during the nine months
ended September 30, 1998 as compared to the same period in 1997, and a $146.6
million increase in the average balance of loan portfolios during the same
respective periods.
INTEREST EXPENSE. The Company had no interest expense during the three months or
nine months ended September 30, 1997 compared to $10.6 million and $16.8 million
during the three months and nine months ended September 30, 1998, respectively.
This increase was the result of the Company being newly formed and unleveraged
during the three and nine months ended September 30, 1997. For purposes of these
financial statements, interest expense does not include the expense associated
with the borrowings secured by investments in real estate which is included in
determining the operations of the Company's real estate. See "Real Estate
Income, net" below.
NET INTEREST INCOME. Net interest income before provision for loan losses
increased by $4.2 million to $9.7 million in the third quarter of 1998 versus
the same period a year ago. This increase was largely due to an $11.3 million
increase in interest income from securities available for sale and a $3.9
million increase in interest income from residential loans, which were partially
offset by a $2.0 million decrease in interest income from repurchase agreements
and interest earning deposits and a $10.6 million increase in interest expense.
These increases in interest income and interest expense versus the same period a
year ago were largely the result of OAC being newly formed, only partially
invested and not levered in the third quarter of 1997. Net interest income
before provision for loan losses increased $18.3 million to $26.2 million for
the nine months ended September 30, 1998, versus the same period a year ago.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
Net interest income represents the difference between income on interest-earning
assets and expense on interest-bearing liabilities. Net interest income depends
upon the relative amount of interest-earning assets and interest-bearing
liabilities and the interest rate earned or paid on them. The following table
sets forth certain information relating to the Company's consolidated statements
of financial condition and consolidated statements of operations for the three
and nine months ended September 30, 1998, for the three months ended September
30, 1997 and for the period May 14, 1997 to September 30, 1997, and reflects the
average yield on assets and average cost of liabilities for the periods
indicated. Such yields and costs are derived by dividing income or expense by
the average balance of assets or liabilities, respectively, for the periods
shown. Average balances are derived from average daily balances. The yields
include amortization of fees which are considered adjustments to yields.
<TABLE>
<CAPTION>
For the three months ended September 30,
-------------------------------------------------------------------------
1998 1997
(Dollars in Thousands) ----------------------------------- ----------------------------------
Average Annualized Average Annualized
Balance Interest Yield/Rates Balance Interest Yield/Rates
-------- -------- ----------- ------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Repurchase agreements and
interest-bearing deposits .................. $ 54,861 $ 714 5.16% $193,385 $ 2,754 5.70%
Securities available for sale ................ 412,265 13,807 13.29 65,699 2,492 15.17
Commercial and multifamily loan portfolio, net 50,323 1,512 11.92 -- -- --
Residential loan portfolio, net ............. 181,545 3,863 8.44 294 6 7.58
Discount loans, net ......................... 8,527 393 18.29 11,480 260 9.08
----------------------------------- ----------------------------------
Total interest-earning assets ........... 707,521 20,289 11.38 270,858 5,512 8.14
----------------------------------- ----------------------------------
Interest-bearing liabilities:
Securities sold under agreements to repurchase 163,253 3,082 7.49 -- -- --
Obligations outstanding under lines of credit 189,414 3,828 8.02 -- -- --
11.5% Notes due 2005 ......................... 128,255 3,687 11.50 -- -- --
----------------------------------- ----------------------------------
Total interest-bearing liabilities ...... 480,922 10,597 8.74 -- -- --
----------------------------------- ----------------------------------
Net interest income/spread (1) .................. 9,692 2.64% 5,512 8.14%
Net interest margin (2) ......................... 5.43% 8.14%
<CAPTION>
For the nine months ended For the period May 14, 1997 to
(Dollars in Thousands) September 30, 1998 September 30, 1997
----------------------------------- ----------------------------------
Average Annualized Average Annualized
Balance Interest Yield/Rates Balance Interest Yield/Rates
-------- -------- ----------- ------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Repurchase agreements and interest-bearing
deposits..................................... $ 26,375 $ 1,010 5.12% $203,527 $ 4,151 5.58%
Securities available for trading ............. 28,702 107 0.50 -- -- --
Securities available for sale ................ 285,298 29,990 14.05 61,525 3,497 15.55
Commercial and multifamily loan portfolio, net 38,815 3,786 13.04 -- -- --
Residential loan portfolio, net .............. 108,017 6,476 8.02 201 6 7.58
Discount loans, net .......................... 14,845 1,719 15.48 9,632 341 9.68
----------------------------------- ----------------------------------
Total interest-earning assets ........... 502,052 43,088 11.47 274,885 7,995 7.96
----------------------------------- ----------------------------------
Interest-bearing liabilities:
Securities sold under agreements to repurchase 126,071 7,049 7.48 -- -- --
Obligations outstanding under lines of credit 108,514 6,102 7.52 -- -- --
11.5% Notes due 2005 ......................... 42,752 3,687 11.50 -- -- --
----------------------------------- ----------------------------------
Total interest-bearing liabilities ...... 277,337 16,838 8.12 -- -- --
----------------------------------- ----------------------------------
Net interest income/spread (1) .................. 26,250 3.35% 7,995 7.96%
Net interest margin (2) ......................... 6.99% 7.96%
</TABLE>
- --------------
(1) Interest rate spread represents the difference between the average rate on
interest-earning assets and the average cost of interest-bearing
liabilities.
(2) Net interest income divided by average interest-earning assets.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
PROVISION FOR LOAN LOSSES. The allowance for loan losses was established in
1998. The provision for loan losses amounted to $351,000 during the three months
ended September 30, 1998, which reflects the Company's evaluation of current
economic conditions, a credit review of loans, an analysis of specific loan
situations and the size and composition of the commercial and multi-family loan
portfolio. At September 30, 1998, the allowance for loan losses amounted to $0.6
million or 1.0% of the net commercial and multifamily loan portfolio. At the
same date, the Company had not established an allowance for loan losses on the
single-family residential loan portfolio or the discount loan portfolio.
REAL ESTATE INCOME, NET. Real estate income, net increased $479,000 to $543,000
for the three months ended September 30, 1998, versus the same period a year
ago. This increase was largely due to a $7.9 million increase in rental income
offset by a $3.6 million increase in rental operation expense, a $1.1 million
increase in depreciation and amortization expense and a $2.7 million increase in
interest expense. These increases in real estate operating income and expenses
versus the same period a year ago were largely the result of an increase in
OAC's investment in real estate, net of $209.8 million at September 30, 1998,
versus $26.3 million at September 30, 1997. For the same reason, real estate
income, net increased $1.0 million to $1.1 million for the nine months ended
September 30, 1998, versus the same period a year ago.
OTHER EXPENSES. Other expenses increased $2.0 million to $3.2 million for the
three months ended September 30, 1998, versus the same period a year ago. This
increase was largely due to a $0.9 million increase in management fees and a
$0.8 million increase in other expenses (which consisted generally of servicing,
legal, and accounting expenses). These increases in other expenses versus the
same period a year ago are largely the result of OAC becoming fully invested and
leveraging its assets in 1998. Other expenses increased $4.9 million to $6.6
million for the nine months ended September 30, 1998, versus the same period a
year ago. The management fees payable by OAC to OCC totaled $1.6 million for the
quarter ended September 30, 1998 and $4.1 million for nine months ended
September 30, 1998. 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 2 to the Interim Consolidated Financial
Statements included in Item 1 above. In addition, OAC reimbursed OCC for due
diligence expenses of $568,000 and $936,000 in connection with its asset
acquisitions during the three and nine months ended September 30, 1998 (which
amounts are likely to be substantially reduced or eliminated to the extent OAC
does not review or acquire assets in the future).
LOSSES ON SECURITIES AND DERIVATIVES. Due to accelerated prepayment speeds,
widening mortgage spreads and declining market liquidity, OAC recognized a $15.6
million charge to earnings during the third quarter of 1998. This charge was
comprised of a $13.6 million writedown of the securities available for sale
portfolio (which is comprised of residential and commercial subordinate and
residual mortgage-backed securities) and a $2.0 million charge on futures losses
incurred on short positions in U.S. Treasury futures used to hedge the
residential loan portfolio. Total losses on securities and derivatives for the
nine months ended September 30, 1998, were $32.7 million.
MINORITY INTEREST IN NET LOSS OF CONSOLIDATED SUBSIDIARY. Minority interest in
net loss of $0.7 million and $0.4 million for the three and nine months ended
September 30, 1998, respectively, arose from the investment by IMI in the
Operating Partnership which conducts the majority of OAC's business activities.
OAC has a 91.3% ownership interest in the Operating Partnership.
EXTRAORDINARY GAIN ON REPURCHASE OF DEBT. On September 30, 1998, OAC repurchased
in the open market $7.0 million of its $150.0 million outstanding Notes. This
resulted in OAC realizing an extraordinary gain of $615,000 during the third
quarter of 1998. At September 30, 1998, the outstanding balance of the Notes was
$143.0 million.
16
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
NET INCOME/LOSS AND OTHER COMPREHENSIVE INCOME/LOSS. The Company's net loss
before extraordinary item amounted to $8.3 million and $12.1 million during the
three and nine months ended September 30, 1998, respectively, as compared to a
comprehensive loss before extraordinary item during the same periods of $22.4
million and $19.9 million, respectively. The comprehensive loss exceeded the
Company's net loss during the three and nine months ended September 30, 1998
primarily because of $13.8 million and $6.4 million of unrealized losses on
securities which were not included in the Company's net loss during the
respective periods, and to a lesser extent $917,000 and $2.0 million of foreign
currency translation losses which were not included in the Company's net loss
during the respective periods. For further information, see Note 5 to the
Interim Consolidated Financial Statements included in Item 1 above.
CHANGES IN FINANCIAL CONDITION
GENERAL. From December 31, 1997 to September 30, 1998, total assets increased
$622.4 million or 216.1% to $910.4 million. This increase was primarily due to a
$55.1 million increase in the commercial and multi-family loan portfolio, a
$191.1 million increase in the residential loan portfolio, a $164.4 million
increase in investments in real estate and a $249.5 million increase in
securities available for sale, which were offset in part by a $18.4 million
decrease in the discount loan portfolio. Total liabilities increased $625.2
million during the period, primarily as a result of $143.1 million increase in
securities sold under agreements to repurchase, $189.1 million of obligations
outstanding under lines of credit, $142.4 million of obligations outstanding
under lines of credit secured by real estate and a $143.0 million obligation
with respect to the Notes.
CASH AND INTEREST-EARNING DEPOSITS. At September 30, 1998 cash and
interest-earning deposits amounted to $18.3 million or 2.0% of total assets and
were comprised of deposits at various banks. Interest-bearing deposits declined
by $30.4 million or 62% from December 31, 1997 to September 30, 1998 due to the
reinvestment of cash and cash equivalents into long-term assets. Although the
Company had no repurchase agreements at September 30, 1998 or 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 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. At October 31, 1998, OAC had cash and cash
equivalents of approximately $26.6 million.
SECURITIES AVAILABLE FOR SALE. The Company's investment in securities available
for sale at September 30, 1998 increased by $249.5 million to $395.5 million
from $146.0 million at December 31, 1997. At September 30, 1998, the Company's
securities available for sale portfolio of $395.5 million consisted of:
o Non-investment grade and unrated subordinate commercial mortgage-backed
securities having a book value of $134.1 million and a market value of
$129.6 million;
o Unrated residential subprime residuals having a book value of $254.7
million and a market value of $245.2 million; and
o Unrated subordinate residential mortgage-backed securities having a book
value of $20.4 million and a market value of $20.7 million.
At September 30, 1998, the Company's unrated subprime residual portfolio of
$245.2 million consisted of:
o $112.8 million of seasoned residuals (i.e., securitized between 1994 and
1997) with overcollateralization reserves funded at approximately $125.3
million.
o $132.4 million of unseasoned residuals (i.e., securitized in 1998) with
overcollateralization reserves funded at approximately $23.3 million.
17
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
At October 31, 1998, the market value and book value of OAC's securities
available for sale was approximately $362.1 million and $397.2, which consisted
of the following:
o Non-investment grade and unrated subordinate commercial mortgage-backed
securities having a book value of $133.4 million and a market value of
$120.3 million;
o Unrated residential subprime residuals having a book value of $243.6
million and a market value of $222.0 million; and
o Unrated subordinate residential mortgage-backed securities having a book
value of $20.2 million and a market value of $19.8 million.
At October 31, 1998, the Company's unrated subprime residual portfolio of $222.0
million consisted of:
o $107.3 million of seasoned residuals (i.e., securitized between 1994 and
1997) with overcollateralization reserves funded at approximately $120.9
million.
o $114.7 million of unseasoned residuals (i.e., securitized in 1998) with
overcollateralization reserves funded at approximately $24.8 million.
The following table describes the composition of the securities available for
sale at the dates indicated.
September 30, December 31,
1998 1997
-------- --------
(In Thousands)
Single family residential:
FHLMC interest-only ................. $ -- $ 21,178
FNMA interest-only .................. -- 22,573
AAA-rated interest-only ............. -- 729
Subordinates ........................ 20,743 9,444
Subprime residuals .................. 245,181 --
-------- --------
265,924 53,924
-------- --------
Multi-family residential and commercial:
AAA-rated interest-only ............. 508 866
A-rated interest-only ............... 265 480
Non-rated interest-only ............. 3,951 4,803
Non-rated principal-only ............ 608 960
Subordinates ........................ 124,239 84,994
-------- --------
129,571 92,103
-------- --------
Total ............................. $395,495 $146,027
======== ========
Yield to maturity represents a measure of the average rate of return that is
earned on a security if held to maturity. The following table details the
Company's securities available for sale portfolio at September 30, 1998, and its
estimates of expected yields on such securities, taking into consideration
expected prepayment and loss rates together with other factors:
<TABLE>
<CAPTION>
Anticipated
Original Anticipated Unleveraged
Unleveraged Yield to Maturity
Issuer Issue Yield to Maturity at September 30, 1998(1)
- ------------------------------------------------------------ -------------------------------------------------
<S> <C> <C> <C>
Single-family Residential:
Unrated residuals:
Structured Asset Securities Corp. Series 1998-2 16.00% 5.66%
Structured Asset Securities Corp. Series 1998-3 16.00 5.60
18
</TABLE>
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
<TABLE>
<CAPTION>
Yield to Maturity Yield to Maturity
Issuer Issue at purchase at September 30, 1998(1)
- ------------------------------------------------------------ -------------------------------------------------
<S> <C> <C> <C>
Pan American Bank, FSB Series 1997-1 22.76 26.97
Access Financial Series 1996-1 18.00 35.11
Access Financial Series 1996-2 18.00 22.87
Access Financial Series 1996-3 18.00 20.15
Access Financial Series 1996-4 18.00 17.44
Access Financial Series 1997-1 18.00 15.08
Access Financial Series 1997-2 18.00 9.67
Access Financial Series 1997-3 18.00 15.32
Access Financial Series 1994-2 18.00 20.06
Access Financial Series 1995-1 18.00 22.04
Access Financial Series 1995-2 18.00 31.91
City Mortgage Receivables 1 PLC 18.00 27.80
City Mortgage Receivables 2 PLC 18.00 16.60
City Mortgage Receivables 3 PLC 18.00 12.80
City Mortgage Receivables 4 PLC 18.00 11.90
City Mortgage Receivables 6 PLC 18.00 15.70
Merrill Lynch & Co. Inc. Series 1998-FF1 18.57 9.95
Lehman ABS Corp. Series 1998-2 18.55 17.59
B-rated residential subordinates:
Solomon Brothers, Inc. Series 1997-HUD1 16.87 18.82
Unrated Subordinates:
GE Capital Mtg. Services, Inc. Series 1994-12. 19.37 20.50
Union Bank of Switzerland Series 1998-R1 13.75 8.58
Salomon Brothers, Inc. Series 1997-HUD1 22.86 24.75
Multi-family and Commercial:
BB-rated subordinates:
Credit Suisse First Boston Series 1995-AEW 1 7.93 7.75
DLJ Securities Corporation Series 1993-MF17 12.29 12.29
Bankers Trust Series 1997-S1 8.36 8.36
B-rated subordinates:
Credit Suisse First Boston Series 1995-AEW 1 9.75 9.65
DLJ Securities Corporation Series 1993-MF17 11.39 14.93
Midland Realty Acceptance Corp. Series 1996-C2 12.10 12.14
Nomura Asset Securities Corp. Series 1996-MD V 9.99 9.78
Unrated Subordinates:
Credit Suisse First Boston Series 1995-AEW 1 13.92 13.75
DLJ Securities Corporation Series 1993-MF17 (29.82) 29.25
Bankers Trust Series 1997-S1 21.19 27.19
Merrill Lynch & Co. Inc. Series 1993-M1 13.65 6.85
AAA-Rated IOs:
DLJ Securities Corporation Series 1993-MF17 16.69 (3.67)
A-Rated IOs:
DLJ Securities Corporation Series 1993-MF17 14.46 (8.84)
Unrated IOs (2):
Midland Realty Acceptance Corp. Series 1996-C2 12.82 16.25
Unrated POs (2):
Midland Realty Acceptance Corp. Series 1996 C2 12.31 14.32
</TABLE>
- --------------
(1) Represents the Company's anticipated yield to maturity at September 30,
1998, taking into consideration management's estimates of the timing and
amount of future credit losses and prepayments..
(2) These securities relate to the same mortgage-related security, thus giving
the Company both the principal -- and interest components to the particular
class.
19
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
The following table summarizes information relating to the Company's
mortgage-related securities available for sale at September 30, 1998.
<TABLE>
<CAPTION>
Original Anticipated Anticipated
Anticipated Unleveraged Weighted
Unleveraged Yield to Average
Amortized Fair Percent Yield to Maturity at Remaining
Rating/Description Cost Value Owned Maturity 9/30/98 Coupon Life
- ------------------ --------- ----- ------- ----------- ------------ ------ ----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Single-family Residential:
Unrated residuals................ $254,652 $245,181 100% 17.90% 13.48% 0.00% 2.57(3)
B-rated subordinates............. 5,143 5,143 100 16.87 18.82 7.75 7.11
Unrated subordinates............. 15,205 15,600 41 15.16 11.19 7.03 6.27
-------- --------
275,000 265,924
-------- --------
Multi-family and
Commercial:
BB-rated subordinates............ 66,070 66,567 68 8.67 8.62 7.86 4.38
B-rated subordinates............. 33,460 32,308 80 10.42 10.65 8.39 10.09
Unrated subordinates............. 27,984 25,364 89 14.04 15.80 9.97 5.56
AAA-Rated IOs.................... 508 508 100 16.69 (3.67) 0.34 6.11
A-Rated IOs...................... 265 265 100 14.46 (8.84) 0.65 2.22
Unrated IOs (1).................. 4,811 3,951 100 12.82 16.25 7.23 11.18
Unrated principal only ("POs")(1) 1,117 608 100 12.31 14.32 0.00 11.21
-------- --------
134,215 129,571
-------- --------
Total...................... $409,215 $395,495
======== ========
</TABLE>
- ---------------
(1) These securities relate to the same mortgage-related security, thus giving
the Company both the principal and interest components to the particular
class.
(2) Changes in the September 30, 1998 anticipated yield to maturity from that
originally anticipated are primarily the result of changes in prepayment
assumptions and to a lesser extent loss assumptions.
(3) Equals the weighted average duration based off of September 30, 1998 book
value.
The following table sets forth information regarding the geographic location
underlying the Company's securities portfolio at September 30, 1998, based upon
the notional amount of the residual and par amount of the class of subordinate
securities held.
<TABLE>
<CAPTION>
Description California Florida Texas New York Ohio Other (1)
- ----------- ---------- ------- -------- -------- -------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Single-family residential..... $244,511 $283,801 $179,629 $101,726 $122,276 $2,655,499
Multi-family and commercial... 209,663 131,793 166,496 112,286 54,303 1,024,357
-------- -------- -------- -------- -------- ----------
Total......................... $454,174 $415,594 $346,125 $214,012 $176,579 $3,679,856
======== ======== ======== ======== ======== ==========
Percentage (2)................ 8.6% 7.9% 6.5% 4.1% 3.3% 69.6%
======== ======== ======== ======== ======== ==========
</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 September 30, 1998.
Percentage
Property type Invested
----------------------------- --------
Multi-family................. 27.4%
Retail....................... 25.7
Hotel........................ 20.6
Office....................... 16.5
Industrial................... 5.3
Mixed use.................... 2.8
Other........................ 1.7
-------
Total........................ 100.0%
Subordinate and residual interests in mortgage-related securities provide credit
support to the more senior classes of the mortgage-related securities. Principal
from the underlying mortgage loans generally is allocated first to the senior
classes, with the most senior class having a priority right to the cash flow
from the mortgage loans until its payment requirements are satisfied. To the
20
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
extent that there are defaults and unrecoverable losses on the underlying
mortgage loans, resulting in reduced cash flows, the most subordinate security
will be the first to bear this loss. Because subordinate and residual interests
generally have no credit support, to the extent there are realized losses on the
mortgage loans comprising the mortgage collateral for such securities, the
Company may not recover the full amount or, indeed, any of its initial
investment in such subordinate and residual interests The Company generally owns
the most subordinate classes of the securities in which it invests and therefore
will be the first to bear any credit losses.
The credit risk of mortgage related securities is affected by the nature of the
underlying mortgage loans. In this regard, the risk of loss on securities backed
by commercial and multifamily loans and single-family residential loans made to
borrowers who, because of prior credit problems, the absence of a credit history
or other factors, are unable or unwilling to qualify as borrowers under
guidelines established by the Federal Home Loan Mortgage Corporation ("FHLMC")
and the Federal National Mortgage Association ("FNMA") for purchases of loans by
such agencies, generally involve more risk than securities backed by
single-family residential loans which conform to the requirements established by
FHLMC and FNMA for their purchase by such agencies.
The Company generally owns the most subordinate classes of the securities in
which it invests and therefore will be the first to bear any credit losses.
Subordinate and residual interests are affected by the rate and timing of
payments of principal (including prepayments, repurchase, defaults and
liquidations) on the mortgage loans underlying a series of mortgage-related
securities. The rate of principal payments may vary significantly over time
depending on a variety of factors, such as the level of prevailing mortgage loan
interest rates and economic, demographic, tax, legal and other factors.
Prepayments on the mortgage loans underlying a series of mortgage-related
securities are generally allocated to the more senior classes of
mortgage-related securities. Although in the absence of defaults or interest
shortfalls all subordinates receive interest, amounts otherwise allocable to
residuals generally are used to make payments on more senior classes or to fund
a reserve account for the protection of senior classes until
overcollateralization or the balance in the reserve account reaches a specified
level. In periods of declining interest rates, rates of prepayments on mortgage
loans generally increase, and if the rate of prepayments is faster than
anticipated, then the yield on subordinates will be positively affected and the
yield on residuals will be negatively affected. Accelerated prepayment speeds
were a significant factor in the $15.6 million loss on securities and
derivatives recorded by the Company during the three months ended September 30,
1998.
Accelerated prepayment speeds also significantly affected the IO portfolio in
the first half of 1998 at which time the portfolio was sold. The IO portfolio
represents classes of mortgage-related securities that are entitled to payments
of interest but no (or only nominal) payments of principal, and Inverse IOs,
which bear interest at a floating rate that varies inversely with (and often at
a multiple of) changes in a specified index. As a result of an increase in
prepayment speeds due to declining interest rates in the first quarter of 1998,
the Company incurred $17.1 million of losses on its IO Portfolio and, following
the sale of the IO Portfolio to affiliates of the Company in May 1998 at a price
equal to its amortized cost plus accrued interest, the Company discontinued
investing in the IO portfolio.
The Company marks its securities portfolio to market 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.
During the third quarter of 1998, the Company valued its securities available
for sale portfolio and net unrealized losses thereon at the end of each month
as follows:
21
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
<TABLE>
<CAPTION>
July 31, 1998 August 31, 1998 September 30, 1998
-----------------------------------------------------------------------------
Unrealized Unrealized Unrealized
Value Loss(Gain) Value Loss(Gain) Value Loss(Gain)
----- ---------- ----- ---------- ----- ----------
<S> <C> <C> <C> <C> <C>
Single family residential:
Subordinates........................... $ 20,331 $ 8,508 $ 21,413 $ 720 $ 20,743 $ (396)
Residuals.............................. 260,197 1,901 253,160 16,026 245,181 9,569
--------- -------- -------- ------- -------- -------
Total single family.................... 280,528 10,409 274,573 16,746 265,924 9,173
--------- -------- -------- ------- -------- -------
Commercial:
AAA-rated interest-only................ 584 255 534 299 508 --
A-rated interest-only.................. 296 175 271 198 265 --
Non-rated interest-only................ 5,023 (218) 4,427 381 3,951 859
Non-rated principal-only............... 1,248 (163) 864 236 608 509
Subordinates........................... 114,349 (2,643) 131,578 (2,354) 124,239 3,178
--------- -------- -------- ------- -------- -------
Total commercial....................... $ 121,500 (2,594) 137,674 (1,240) 129,571 4,546
--------- -------- -------- ------- -------- -------
Total................................. $ 402,028 $ 7,815 $412,247 $15,506 $395,495 $13,719
========= ======== ======== ======= ======== =======
</TABLE>
COMMERCIAL AND MULTI-FAMILY LOAN PORTFOLIO. The Company's investment in
commercial and multi-family loans amounted to $55.1 million at September 30,
1998, a $45.6 million increase over the $9.5 million investment at December 31,
1997. The Company's commercial lending activities focuses on real estate lending
opportunities in selected major metropolitan markets throughout the United
States where the Company believes there are significant supply constraints and
where employment and/or population growth and other demand generators are
expected to remain strong. The Company's general approach to commercial lending
is to capitalize on the core capabilities of the Manager and its affiliates,
which include an ability to assess the value creation potential of underutilized
real estate and to oversee and manage the conversion, rehabilitation and/or
construction process. The Company seeks to make loans to borrowers who have a
proven ability to acquire such assets and enhance value through a process of
repositioning or development. Loans are usually structured to provide current
income along with either exit fees or gross revenue participation features.
Loans may be originated as first mortgage loans or structured as subordinated
debt or mezzanine financing.
The following table sets forth the composition of the Company's commercial and
multi-family loan portfolio by type of loan at the dates indicated:
September 30, December 31,
1998 1997
----------- -----------
(In Thousands)
Multi-family ............................... $ 45,285 $ 3,455
Commercial real estate:
Office................................... 33,058 33,058
Hotel.................................... 28,581 20,952
----------- -----------
Total loans............................. 106,924 57,465
Deferred origination fees, net.............. (665) (344)
Loans in progress (1)...................... (50,586) (47,640)
Allowance for loan losses.................. (557) --
------------ -----------
Commercial and multi-family loans, net.... $ 55,116 $ 9,481
=========== ===========
- ------------
(1) Represents the unfunded balance of closed loan agreements.
The Company maintains an allowance for loan losses at a level which management
considers adequate to provide for potential losses based upon an evaluation of
known and inherent risks. At September 30, 1998, the Company had an allowance
for loan losses in the amount of $0.6 million on the commercial and multi-family
loan portfolio. At December 31, 1997, no allowance for loan losses had been
provided.
22
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
The following table sets forth certain information regarding the loans in the
Company's commercial and multi-family loan portfolio at September 30, 1998.
<TABLE>
<CAPTION>
Loan Amount Loan per Stabilized
Outstanding Ratio of Unit/ Debt/
Loan At September 30, Type of Loan to Square Coverage Coupon
Loan Location Amount 1998 Loan Cost Foot Ratio Rate Size
---- -------- ------ ---- ---- ---- ---- ----- ---- ----
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Multi-family residential:
Fourth & Harrison... San Francisco, CA $ 11,550 $ 3,228 Construction 85% $ 201 1.22 9.630% 160 units
241 Church Street... New York, NY 30,280 13,684 Conversion 88 582 N/A 9.000 52 units
459 Washington
Street............. New York, NY 3,455 2,026 Conversion 61 314 N/A 10.500 11 units
Commercial:
Doubletree Hotel.... Lowell, MA 7,652 7,447 Renovation 85 31 1.90 10.000 249 rooms
Hawthorn Suites Hotel. Schaumburg, IL 7,629 -- Construction 65 56 1.59 8.750 136 suites
Wyndham Garden
Hotel.............. Wilmington, DE 13,300 10,555 Renovation 67 61 2.20 8.650 219 rooms
Landmark III-GTE...... Burlington, MA 33,058 19,281 Renovation 85 114 1.18 9.250 291,077
-------- -------
$106,924 $56,221
======== =======
</TABLE>
- ------------
(1) Represents the net income of the stabilized property divided by debt service
required by the loan.
The following table sets forth the activity in the Company's gross commercial
and multi-family loan portfolio during the periods indicated.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 1998 September 30, 1998
----------------------------- -----------------------------
Balance No. of Loans Balance No. of Loans
----------- -------- ----------- ------------
(In Thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period.......... $ 106,924 7 $ 57,465 4
Originations:
Multi-family loans................... -- -- 41,830 2
Hotel loan........................... -- -- 7,629 1
----------- -------- ----------- ------
Net (decrease) increase in loans..... -- -- 49,459 3
----------- -------- ----------- ------
Balance at end of period................ $ 106,924 7 $ 106,924 7
=========== ======== =========== ======
</TABLE>
During October 1998, the Company closed a commitment to finance a hotel
construction loan in New York, NY in the amount of $17.7 million, of which $1.2
million has been funded.
The following table sets forth certain information relating to the payment
status of funded loans in the Company's commercial and multi-family loan
portfolio at the dates indicated.
23
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
September 30, December 31,
1998 1997
------- -------
(In Thousands)
Past due less than 31 days................ $ 56,221 $ 9,825
Past due 31 days to 89 days............... -- --
Past due 90 days or more.................. -- --
-------- -------
$ 56,221 $ 9,825
======== =======
RESIDENTIAL LOAN PORTFOLIO. The Company's investment in residential loans
amounted to $197.5 million at September 30, 1998, a $191.1 million increase over
the $6.4 million investment at December 31, 1997.
The following table sets forth the composition of the Company's residential loan
portfolio at the dates indicated:
September 30, December 31,
1998 1997
----------- ------------
(In Thousands)
Single-family residential.................... $ 196,111 $ 6,465
Premium (discount), net...................... 1,039 (115)
Deferred hedge loss.......................... 345 --
--------- --------
Residential loans, net..................... $ 197,495 $ 6,350
========= ========
On November 13, 1998, the Company securitized approximately $182.2 million of
its single-family residential loans through a special purpose entity which
issued mortgage-related securities backed by such loans. The senior classes in
this securitization were acquired by third parties, and the Company retained the
subordinate or residual interests in such securitization. The securitization
provided the Company with additional funds for general corporate purposes.
The following table sets forth the geographic location of the residential loan
portfolio at September 30, 1998.
Geographic Location Balance Percentage
- ------------------- ------- ----------
(In Thousands)
Michigan.............................. $ 50,282 26.2%
California............................ 19,710 10.3
Florida............................... 10,032 5.2
Ohio.................................. 9,387 4.9
Texas................................. 9,259 4.8
Other................................. 97,441 48.6
---------- -------
$ 196,111 100.0%
========== =======
The following table sets forth the activity in the Company's gross residential
loan portfolio during the periods indicated.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 1998 September 30, 1998
----------------------------- ---------------------------
Balance No. of Loans Balance No. of Loans
--------- ------------ --------- ------------
(In Thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period.. $ 137,462 1,392 $ 6,465 50
Purchases....................... 70,644 673 210,524 2,041
Sales........................... (131) (5) (131) (5)
Principal repayments............ (11,864) (128) (20,747) (154)
----------- ------- ----------- -------
Net increase in loans........ 58,649 540 189,646 1,882
----------- ------- ----------- -------
Balance at end of period........ $ 196,111 1,932 $ 196,111 1,932
=========== ======= =========== =======
24
</TABLE>
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
The following table sets forth certain information relating to the payment
status of loans in the Company's residential loan portfolio at the dates
indicated.
September 30, December 31,
1998 1997
---------- -----------
(In Thousands)
Current to past due 30 days................ $ 183,253 $ 6,196
Past due 31 days to 89 days................ 6,080 --
Past due 90 days or more................... 6,778 269
---------- -----------
$ 196,111 $ 6,465
=========== ===========
DISCOUNT LOAN PORTFOLIO. The discount loan portfolio consists of nonperforming
and subperforming 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, which generally are purchased at
a discount to both the unpaid principal amount of the loan and the estimated
value of the security property. At September 30, 1998, the Company's gross
discount loan portfolio amounted to $12.1 million, exclusive of $3.5 million of
discount recorded in connection with the acquisition of discount loans.
The following table sets forth the composition of the Company's discount loan
portfolio by type of loan at the dates indicated.
September 30, December 31,
1998 1997
----------- -----------
(In Thousands)
Commercial real estate loans:
Office..................................... $ 8,246 $ 11,893
Retail..................................... 3,873 30,636
----------- -----------
Total unpaid principal balance........... 12,119 42,529
Discount...................................... (3,530) (15,550)
----------- -----------
Discount loans, net........................ $ 8,589 $ 26,979
=========== ===========
During the nine months ended September 30, 1998, the Company acquired through
foreclosure a shopping center located in Halifax, Nova Scotia and an office
building located in Dayton, Ohio, which secured discount loans with a balance of
$15.4 million and $1.5 million, respectively. These foreclosures were the
primary reason for the decrease in the discount loan portfolio during the nine
months ended September 30, 1998.
At September 30, 1998, the Company's discount loans included:
o a 13.83% interest in two loans, which interest had an aggregate
outstanding principal balance of $8.2 million. The collateral for the
loans consist of two office buildings located in Manhattan, New York. In
September 1998, the maturity date of one of these loans were extended to
June 1st, 1999. As of September 30, 1998, these loans were performing in
accordance with their terms.
o a loan secured by a shopping center located in Havre, Montana with an
unpaid principal amount of $3.9 million. The shopping center has 195,445
gross rentable square feet. As of September 30, 1998, the loan was
nonperforming and foreclosure proceedings were in process. During the
month of October 1998, this property was acquired by the Company through
foreclosure sale.
25
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
The following table sets forth certain information relating to the payment
status of loans in the Company's discount loan portfolio at the dates indicated.
September 30, December 31,
1998 1997
--------- ---------
(In Thousands)
Current to past due 30 days.................... $ 8,246 $ 7,964
Past due 31 days to 89 days.................... -- --
Past due 90 days or more....................... 3,873 34,565
--------- ---------
$ 12,119 $ 42,529
========= =========
INVESTMENTS IN REAL ESTATE. The Company's real estate investment approach had
sought value creation opportunities that can be realized through increased
management focus and capital investment. The Company generally sought
underperforming properties that can be acquired and renovated at discounts to
replacement cost. In evaluating opportunities, the Company has focused on a
series of key investment criteria. These include analysis of the level of
proposed new supply and development constraints in the markets where it is
considering investing. An underlying premise of the Company's real estate
investment philosophy is that, while demand for real estate has remained
relatively constant over time, sudden and dramatic increases in supply have
driven boom and bust real estate cycles.
At September 30, 1998, the Company's investments in real estate consisted of
eight properties which had an aggregate carrying value of $209.9 million. A
total of four of the properties currently owned by the Company with an aggregate
carrying value of approximately $143.4 million are located in San Francisco,
California. Three of these properties are located in the financial district of
San Francisco, and one property is located in the adjacent civic center district
of San Francisco. The Company believes that the office market in San Francisco,
particularly the financial district, satisfies its general real estate
investment philosophy because in management's view it is characterized by
limited new supply and significant barriers to entry. Low vacancy rates, coupled
with lack of new construction, currently are increasing rental rates. Government
regulation of development in conjunction with local construction costs and a
lack of developable land provide significant barriers to entry to this area. The
Company believes that its investments in real estate in San Francisco are well
located and benefit from their proximity to the majority of the city's office,
retail and hotel accommodations.
The Company's net investment in real estate increased to $209.9 million at
September 30, 1998 from $45.4 million at December 31, 1997 and is comprised of
the following properties:
<TABLE>
<CAPTION>
Date Book Value at
Acquired Property Location Square Feet Property Type September 30, 1998
- -------- -------- -------- ----------- ------------- ------------------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C>
04/08/98 225 Bush Street San Francisco, CA 536,382 Office Bldg. 102,870
09/23/97 450 Sansome St. San Francisco, CA 130,437 Office Bldg. 17,588
01/23/98 690 Market St. San Francisco, CA 124,692 Office Bldg. 13,772
09/03/97 10 U.N. Plaza San Francisco, CA 71,636 Office Bldg. 9,155
07/22/98 841 Prudential Drive Jacksonville, FL 488,080 Office Bldg. 32,827
11/10/97 Cortez Plaza Bradenton, FL 289,686 Shopping Ctr. 19,288
04/09/98 7075 Bayers Rd. Halifax, Nova Scotia 402,529 Shopping Ctr. 15,219
04/03/98 Park Center I Dayton, OH 44,000 Office Bldg. 1,534
Accumulated depreciation (2,402)
----------
$ 209,851
=========
</TABLE>
The Company's current overall strategy with respect to these properties is to
reposition the facilities and target larger or full floor tenants with five to
ten year lease terms. Repositioning is intended to result in rents, upon
re-leasing, that are greater than the current rents at the sites.
26
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
The following table sets forth the cost of improvements for each investment in
real estate during the nine months ended September 30, 1998
<TABLE>
<CAPTION>
Actual
Budgeted Cost of Carrying Value Rents due and
Initial Cost Cost of Improvements at September Accumulated Accrued at Total Rental
Property to Company Improvements(1) to Date 30, 1998 Depreciation end of Period Income
-------- ---------- --------------- ------- -------- ------------ ------------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
(In Thousands)
225 Bush Street......... 101,632 3,701 1,238 102,870 890 530 4,787
450 Sansome St.......... 17,205 496 383 17,588 361 179 1,783
690 Market St........... 13,707 4,072 65 13,772 189 45 1,419
10 United Nations plaza. 9,080 2,417 75 9,155 196 66 999
Prudential Building..... 32,827 465 -- 32,827 190 71 1,586
Cortez Plaza............ 19,244 197 44 19,288 398 345 2,173
Bayers Road............. 15,219 609 -- 15,219 162 1,208 1,838
Park Center I........... 1,534 -- -- 1,534 16 -- --
--------- -------- ------- --------- ------- ------- --------
Total.............. $ 210,448 $ 11,957 $ 1,805 $ 212,253 $ 2,402 $ 2,444 $ 14,585
========= ======== ======= ========= ======= ======= ========
</TABLE>
(1) Projected through December 1999
Set forth below is a brief description of each of the Company's investments in
real estate at September 30, 1998.
BUSH STREET. In April 1998, the Company acquired an existing 536,382 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. Bush Street
was originally constructed in 1923, expanded in 1994 and brought up to 1992
building code seismic standards during 1992-94. Originally built as the world
headquarters of Chevron of USA, Inc. ("Chevron"), it was sold in 1994 as Chevron
sought to relocate its executive offices. The Company is projecting to make an
additional investment of approximately $11.1 million to pay tenants improvements
and leasing commissions and to install a sprinkler system, life/safety systems,
ADA upgrades and cosmetic improvements to the entrance lobby. As of September
30, 1998, the Bush Street Property was 89% leased and the average rent per
square foot amounted to approximately $18.30. A new 25,000 square foot lease has
been executed and is projected for occupancy in October 1998, with an effective
rate of $38 per square foot.
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 77% leased as of September 30,
1998. 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. 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.
690 MARKET STREET. In January 1998, the Company acquired a 124,692 square foot,
16-story, Class C office building located at 690 Market Street in the financial
district of San Francisco, California. The property was purchased for $13.7
million. The property was originally constructed in 1888 and has undergone
numerous renovations. At the date of acquisition, approximately 41% of the
building was available for re-leasing by the end of 1998 and existing rents
averaged $14.06 per square foot. The building was 72% leased as of September 30,
1998. The Company is investing approximately $4.3 million
27
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
to install structural upgrades, a sprinkler system and ADA upgrades, fund
deferred maintenance and tenant improvements and pay leasing commissions. The
Company is currently implementing a new leasing program at the property to
coincide with the renovation schedule and has executed nine new leases totaling
approximately 13,800 square feet.
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
$13.76. The building was 9% leased as of September 30, 1998, which is consistent
with the acquisition strategy to retenant the building. The property is
currently being marketed for lease to tenants with full floor or full building
space requirements. The Company is investing approximately $3.5 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.
PRUDENTIAL BUILDING. On July 22, 1998, the Company purchased the Prudential
Building, a 488,080 square foot, 22 story office building in the central
business district of Jacksonville, Florida for an aggregate purchase price of
$36.0 million, plus closing costs. The purchase price was funded with cash on
hand and advances from the Company's line of credit. Simultaneously with this
closing, the Company also leased 97% of the building back to the Prudential
Insurance Co. of America, and sold two adjacent parking areas to a neighboring
hospital for approximately $4.1 million. The Prudential lease has a term of four
years with options to vacate the premises during the term of the lease, as well
as three subsequent five year extension options. The Company also entered into
an agreement with the hospital pursuant to which the hospital is to lease up to
150,000 square feet in the Prudential Building for a nine-year period should
Prudential exercise its termination option.
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.
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 September 30, 1998, 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 14% of the
center expire during 1998, 1999 and 2000.
BAYERS ROAD SHOPPING CENTRE. In April 1998, the Company acquired the Bayers Road
Shopping Centre, which is located at 7075 Bayers Road in Halifax, Nova Scotia.
The property was acquired by foreclosure on the loans secured by the property,
which were acquired by the Company at a discount in September 1997. The property
contains 402,529 square feet of space, which consists primarily of retail space
but also includes some office space and storage space. The original buildings
were built in 1956 and were enclosed and expanded in several phases between 1971
and 1987. Major tenants of the property currently consist of Zellers, Lawton's
and Mark's Work Wearhouse. The property was approximately 81% leased at
September 30, 1998. The Company currently is implementing an operating plan for
this investment that will include the relocation of existing major tenants to
higher visibility areas in order to improve pedestrian traffic flow.
PARK CENTER I. In April 1998, the Company acquired Park Center I, a suburban
office building located on a frontage road to Interstate 75 in Dayton, Ohio. The
building was constructed in 1981 and has four stories and approximately 44,000
square feet of rentable space. The property was acquired by foreclosure on the
loan secured by the property, which was acquired by the Company at a discount in
September 1997. The building is currently vacant and configured for single
tenant use, but may be converted to multi-tenant use.
28
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
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 September
30, 1998, 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>
1998 36 75,627 4.39% $ 320,170 $ 4.23 1.69%
1999 45 166,888 9.68 1,996,059 11.96 10.52
2000 37 110,400 6.41 1,644,278 14.89 8.67
2001 44 160,075 9.29 2,038,016 12.73 10.74
2002 43 585,294 33.96 7,981,246 13.64 42.08
2003 9 37,496 2.18 737,511 19.67 3.89
2004 5 48,770 2.83 640,189 13.13 3.38
2005 5 32,960 1.91 128,563 3.90 0.68
2006 5 127,804 7.42 677,470 5.30 3.57
2007 5 113,492 6.59 1,359,321 11.98 7.17
2008 & beyond 12 264,496 15.35 1,445,298 5.46 7.62
--- --------- ------ ----------- ------
246 1,723,302 100.00% $18,968,121 100.00%
=== ========= ====== =========== ======
</TABLE>
- -----------
(1) Lease year runs from January 1 to December 31 for all years except for
1998, in which the lease year is October 1 to December 31, 1998.
(2) Annualized base rent is calculated based on the amount of rent scheduled
from January 1 of the listed year to the lease expiration, except for 1998
in which the amount is based on the amount of rent scheduled from October 1
to lease expiration.
(3) Average base rent per square foot is calculated using the annualized base
rent divided by the square footage.
As part of its initial repositioning of a property after an acquisition, the
Company generally pursues a policy of replacing some existing tenants with
tenants which have higher lease payments and/or a higher probability of
expansion and renewal. This policy, which is in accordance with the Company's
philosophy of investing in distressed real estate, may affect a number of
existing tenants at acquired properties. Although the Company's repositioning
strategy may adversely affect tenant retention rates in the early years of
ownership of a property, management believes that the strategy will be
beneficial to the Company in the long term. There can be no assurance, however,
that the Company's tenant retention rate will increase as each property is
repositioned or stabilized or that the net present value of new or renewed
leases will substantially exceed the net present value of leases with existing
tenants.
The Company's leases generally contain provisions designed to mitigate the
adverse impact of inflation on net income. These provisions include clauses
enabling the Company to pass through to tenants certain operating costs,
including real estate taxes, common area maintenance, utilities and insurance,
thereby reducing the Company's exposure to increases in costs and operating
expense resulting from inflation. In addition, many of the Company's leases are
for terms of less than ten years, which permits the Company to seek increased
rents upon re-leasing at higher market rates.
INDEBTEDNESS-GENERAL. The Company's investments in real estate, subordinate and
residual interests in mortgage-related securities and other assets, such as
single-family residential loans, generally depend upon short-term borrowings
such as repurchase agreements and warehouse facilities/lines of credit with
financial institutions or institutional lenders to finance the Company's
acquisition of such assets on a short-term basis in the case of repurchase
agreements and on a one to three-year basis in the case of warehouse
facilities/lines of credit. There can be no assurance that such financing will
continue to be available on terms reasonably satisfactory to the Company. The
inability of the Company to arrange additional borrowings such as repurchase
agreements and warehouse facilities/lines of credit or to repay, extend or
replace existing borrowings when they expire would have a material adverse
effect on the
29
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
Company's business, financial condition and results of operations and on the
Company's outstanding securities.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE. Securities sold under agreements
to repurchase were $143.1 million at September 30, 1998, a decrease from $223.8
million at June 30, 1998. These obligations are secured by certain of the
Company's investments in subordinated interests in commercial mortgage-backed
securities and residual interests in subprime residential loan securitizations.
The following table summarizes the maturity dates of the Company's repurchase
agreements and the market value of the related collateral securities as of
September 30, 1998:
<TABLE>
<CAPTION>
Outstanding Commercial Securities Residential Securities
Maturity Date Borrowing Collateral Value Collateral Value
------------- --------- ---------------- ----------------
(Dollars in Millions)
<S> <C> <C> <C>
0-30 days $ 17.8 $ 20.9 $ --
6-12 months 73.9 60.5 58.0
18 months and over 51.4 -- 104.7
------- ------- -------
Total $ 143.1 $ 81.4 $ 162.7
======= ======= ========
</TABLE>
At September 30, 1998, interest payments with respect to these obligations were
approximately $0.6 million per month (which assumes that the repurchase
agreements which mature within 30 days are renewed at approximately the same
rate of interest).
The following table summarizes the maturity dates of the Company's repurchase
agreements and the market value of the related collateral securities as of
October 31, 1998:
<TABLE>
<CAPTION>
Outstanding Commercial Securities Residential Securities
Maturity Date Borrowing Collateral Value Collateral Value
------------- --------- ---------------- ----------------
(Dollars in Millions)
<S> <C> <C> <C>
0-30 days $ 28.2 $ 34.6 $ 15.1
31-180 days 53.7 40.9 51.9
6-12 months 13.7 18.3 --
18 months and over 42.5 -- 88.5
------- ------- --------
Total $ 138.1 $ 93.8 $ 155.5
======= ======= ========
</TABLE>
At October 31, 1998, interest payments with respect to these obligations were
approximately $0.56 million per month (which assumes that the repurchase
agreements which mature within 30 days are renewed at approximately the same
rate of interest).
OBLIGATIONS OUTSTANDING UNDER LINES OF CREDIT. Obligations outstanding under
lines of credit amounted to $189.1 million at September 30, 1998, as compared to
$154.2 million at June 30, 1998. These borrowings at September 30, 1998,
include:
o $28.9 million pursuant to a three year agreement which matures in July
2001, which is collateralized by commercial loans, with respect to which,
the monthly interest payments were $0.18 million and which is described
below under "Obligations Outstanding Under Lines of Credit - Real Estate";
o the U.S. dollar equivalent of $24.2 million pursuant to a three year
agreement which matures in June 2001, which is denominated in Pounds
Sterling with respect to which the monthly interest payments were $0.20
million and collateralized by certain U.K. mortgage loan residual
securities; and
o $136.0 million pursuant to an agreement which matures in April 1999, and
on which monthly interest payments were $0.67 million. The obligation was
collateralized by single family residential mortgages but was repaid on
November 13, 1998, in conjunction with the securitization of 1,808 first
and second single family residential mortgage loans (as discussed above).
30
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
At October 31, 1998, the outstanding balances with respect to these borrowings
were $34.5 million, $22.3 million, and $136.0 million and the monthly interest
payments with respect to these borrowings were approximately $0.17 million,
$0.20 million, and $0.67 million.
OBLIGATIONS OUTSTANDING UNDER LINES OF CREDIT - REAL ESTATE. Obligations
outstanding under lines of credit secured by real estate amounted to $142.4
million at September 30, 1998, as compared to $115.2 million at June 30, 1998.
These borrowings have a three-year term and an interest rate that floats in
accordance with LIBOR. Set forth below is information regarding OAC's mortgage
indebtedness relating to its investment in real estate at September 30, 1998:
<TABLE>
<CAPTION>
Principal Interest Maturity Annual
Property Amount Rate Date Payments
- -------- ------ ---- ---- --------
(Dollars in Millions)
<S> <C> <C> <C> <C>
Bush Street $ 75.0 (1) LIBOR plus 1.75% April 2001 (3) $5.5 (4)
Other.................. 67.4 (2) LIBOR plus 1.75% June 2001 (3) $5.0 (4)
------
$142.4
======
</TABLE>
(1) Plus up to $5.0 million of additional advances for capital improvements to
Bush Street.
(2) Represents the portion of the outstanding balance under a $200 million loan
that is secured by real estate. As of September 30, 1998, OAC's investments
in Cortez Plaza, 450 Sansome Street, 10 U.N. Plaza, Prudential Plaza and 690
Market Street secured this loan, and an additional $28.9 million was
borrowed and secured by commercial mortgage loans under this line of credit.
(3) Subject to certain conditions, OAC may extend the maturity date by one year.
(4) Based on the interest rate in effect as of September 30, 1998.
At October 31, 1998, the obligations under lines of credit - real estate had not
changed materially.
DERIVATIVE AND FOREIGN EXCHANGE FINANCIAL INSTRUMENTS. Derivative and foreign
exchange transactions involve credit and market risk. Because of changing market
environments, the monitoring and managing of these risks is a continual process.
For a further discussion of market risk, see Item 3, "Quantitative and
Qualitative Disclosures about Market Risk." The Company believes the true
measure of credit risk is the replacement cost of the derivative or foreign
exchange contract. This is also referred to as repayment risk or the
mark-to-market exposure amount. While notional amount is the most commonly used
volume measure in the derivative and foreign exchange markets, it is not a
measure of credit or market risk. The notional amount typically does not change
hands, but is simply a quantity upon which interest and other payments are
calculated. The notional amounts of the Company's derivative and foreign
exchange products exceed the possible credit and market loss that could arise
from such transactions. For a further discussion of the Company's derivative and
foreign exchange instruments, see Note 6 to the Interim Consolidated Financial
Statements included in Item 1 above.
The following table indicates the interest rate swaps outstanding at October 31,
1998:
<TABLE>
<CAPTION>
Notional LIBOR Floating Rate at
Maturity Amount Index Fixed Rate End of Period Fair Value
-------- ------ ----- ---------- ------------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
2003 $ 100,000 1-month 5.75% 5.22% $ (3,327)
2001 17,000 1-month 6.00 5.34 (522)
2001 75,000 1-month 6.00 5.38 (2,292)
2002 8,780 1-month 6.04 5.34 (349)
--------- ---------
$ 200,780 $ (6,491)
========= =========
At October 31, 1998, there were no future contracts outstanding.
</TABLE>
31
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
MINORITY INTEREST. At September 30, 1998, minority interest totaled $28.4
million and represented OCN's ownership through IMI of 1,808,733 units in the
Operating Partnership. On May 7, 1998, the Company sold 1,473,733 units in the
Operating Partnership to IMI for $24.5 million. 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
OCN. In connection with this stock issuance, IMI sold a like number of shares of
the Company's common stock to the Company and invested in a like number of units
in the Operating Partnership in order to comply with the stock ownership
restrictions imposed on REITs under the Code. See Notes 1 and 2 to the Interim
Consolidated Financial Statements included in Item 1 above.
SHAREHOLDERS' EQUITY. Shareholders' equity decreased by $28.3 million from
December 31, 1997 to September 30, 1998. The decrease was due to a $6.4 million
increase in unrealized losses on securities available for sale, a net loss of
$11.5 million, a cumulative currency translation adjustment of $2.0 million,
$22.4 million in cash dividends paid during 1998, which were offset by a $14.0
million capital contribution in connection with the sale of the IO Portfolio.
See the Consolidated Statement of Changes in Shareholders' Equity in the
Consolidated Financial Statements included in Item 1 above.
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.
FFO for the three months ended September 30, 1998 was ($7.1) million compared to
$4.4 million for the same period a year ago. FFO for the nine months ended
September 30, 1998, was $4.1 million as compared to $6.4 million for the period
May 14, 1997, to September 30, 1997, which began on the date the Company
completed the IPO.
FFO differs from cash made available to holders of the Company's common stock,
which is based on the Company's net taxable income. Distributions of dividends
to shareholders amounted to $6.5 million or $0.34 per share for the period May
14, 1997 to September 30, 1997 and $22.4 million or $1.10 per share for the nine
months ended September 30, 1998.
The following table reconciles funds from operations and net income.
32
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
<TABLE>
<CAPTION>
For the For the For the For the Period
Three Months Three Months Nine Months May 14, 1997
Ended Ended Ended to
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
--------- -------- --------- --------
(In Thousands)
<S> <C> <C> <C> <C>
Net income................................... $ (7,639) $ 4,350 $ (11,497) $ 6,410
Depreciation and amortization................ 1,160 22 2,223 22
Loss on sale of IO portfolio................. -- -- 13,957 --
Extraordinary gain on repurchase of (615) -- (615) --
--------- -------- --------- --------
debt
FFO $ (7,094) $ 4,372 $ 4,068 $ 6,432
========= ======== ========= ========
</TABLE>
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 during the first nine months
of 1998 consisted of net cash provided by operating activities, reverse
repurchase agreements, proceeds from issuance of the Notes, other secured
borrowings, maturities and principal payments on loans and securities and
proceeds from the sale of Operating Partnership units to IMI.
The Company's operating activities provided cash flows of $43.7 million and
$344,000 during the nine months and three months ended September 30, 1998,
respectively. The Company's investing activities used cash flows of $711.5
million and $110.2 million during the nine months and three months ended
September 30, 1998, respectively. During both of the foregoing periods, cash
flows from investing activities were used primarily to purchase securities
available for sale, originate or purchase loans, and purchase commercial real
estate. The Company's financing activities provided cash flows of $637.5 million
and $129.0 million during the nine months and three months ended September 30,
1998, respectively, and primarily consisted of proceeds from lines of credit and
repurchase agreements of $474.6 million and proceeds from the issuance of the
Notes of $150.0 million.
Fluctuations in interest rates will continue to impact the Company's net
interest income to the extent the Company's fixed rate assets are funded by
variable rate debt or the Company's variable rate asset reprice on a different
schedule or in relation to a different index than its floating rate debt which
in turn could impact potential returns to shareholders. At September 30, 1998,
the Company had interest rate swap agreements with a notional amount of
approximately $200.8 million and a fair value of ($6.3) million, in order to
partially limit the adverse effects of rising interest rates on the remaining
floating-rate debt. When the Company's swap agreements expire, the Company will
have interest rate risk to the extent interest rates increase on any
floating-rate borrowings unless the swaps are replaced or other steps are taken
to mitigate this risk. The flexibility in the Company's leverage is dependent
upon, among other things, the levels of unencumbered assets, which are
inherently linked to prevailing interest rates and changes in the credit of the
underlying asset. At September 30, 1998, the Company had unencumbered
residential loans and securities having a market value totaling approximately
$167.6 million ($57.9 million of subordinate and residual mortgage-backed
securities, $48.2 million of commercial mortgage-backed securities, and $61.5
million of residential loans). In certain circumstances, including, among other
things, increases in interest rates, changes in market spreads, or decreases in
credit quality of underlying assets, the Company would be required to provide
additional collateral in connection with its short-term, floating-rate borrowing
facilities. During the third quarter of 1998, the Company was required to and
did fund requests by its lenders for additional collateral calls on outstanding
reverse repurchase agreements collateralized by securities available for sale
which aggregated $2.3 million in July 1998, $1.4 million in August 1998, and
$3.9 million in September 1998, and $13.7 million in October 1998. The Company
funded requests for additional margin deposits in connection with its swaps and
future positions which aggregated $0.7 million in July 1998, $1.0 million in
August 1998, $4.6 million in September 1998, and $3.3 million in October 1998.
At October 31, 1998, OAC had unencumbered securities having a market value
totaling approximately $67.0 million which comprised of $40.5 million of
subordinate and residual mortgage-backed securities and $26.5 million of
commercial mortage-backed securities.
33
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
For additional information with respect to the Company's monthly mark-to-market
of its securities available for sale portfolio, see "Changes in Financial
Condition - Securities Available for Sale." The Company has significant debt
service obligations, as discussed above. At September 30, 1998, the Company had
total consolidated indebtedness of $617.6 million, of which all but the $143.0
million of outstanding Notes was secured indebtedness, as well as $21.4 million
of other liabilities. This consolidated indebtedness consisted of (i) $143.1
million of repurchase agreements, (ii) lines of credit aggregating $331.6
million which mature in 1999 and 2002 and are secured by real estate, loans and
securities and (iii) $143.0 million of outstanding Notes. The monthly interest
payments on the Company's total consolidated indebtedness were $4.1 million,
$5.2 million and $4.0 million for the months of July, August, and September
1998, respectively. One line of credit which amounted to $136.0 million at
September 30, 1998 was repaid on November 13, 1998 (in connection with the
securitization of the residential mortgage loans which secured this line of
credit, and which resulted in $173.4 million of net proceeds to the Company
prior to repayment of this line of credit).
Mortgage-related securities which are subject to repurchase agreements, as well
as loans and real estate which secure other indebtedness, periodically are
revalued by the lender, and a decline in such value may result in the lender
requiring the Company to provide additional collateral to secure the
indebtedness. Although to date the Company has had adequate cash, cash
equivalents and other unencumbered assets to meet calls for additional
collateral, to repay a portion of the related indebtedness or to meet its other
operating and financing requirements, including its current capital expenditure
plans, there can be no assurance that sufficient levels of such assets will
continue to be available.
If the Company is unable to fund additional collateral needs or to repay, renew
or replace maturing indebtedness on terms reasonably satisfactory to the
Company, the Company would be required to sell, under adverse market conditions,
a portion of its assets, and could incur losses as a result. Furthermore, an
extremely limited market for subordinate and residual interests in
mortgage-related securities exists and there can be no assurance that one will
fully develop, thereby limiting the Company's ability to dispose of such
securities promptly for fair value in such situations.
In addition to payment and, in the case of the Company's secured indebtedness,
collateralization requirements, the Company is subject to various other
covenants in the agreements evidencing its indebtedness, including the
maintenance of specified amounts of equity. At September 30, 1998, the Company
was in compliance with all obligations under the agreements evidencing its
indebtedness with respect to the Company's equity and the Operating
Partnership's equity, as defined in the applicable agreement. As of October 31,
1998, the Company exceeded the highest applicable requirement by in excess of
$19.7 million. There can be no assurance that additional operating losses will
not result in the Company's violation of its financial covenants in the future.
In the event of a default in such covenants, the lender generally would be able
to accelerate repayment of the subject indebtedness and pursue other available
remedies, which could result in defaults on other indebtedness of the Company,
unless the applicable lender or lenders allowed the Company to remain in
violation of the agreements. Were a default to be declared, the Company would
not be able to continue to operate without the consent of its lenders. The
Company currently is considering various alternatives to enhance its ability to
meet its payment and other obligations under its indebtedness and the funding
requirements discussed below, including the sale of certain assets and the
potential tax and other consequences associated therewith. There can be no
assurance that the Company will have sufficient liquidity to meet these
obligations on a short-term or long-term basis.
For the quarter ended September 30, 1998, OAC closed transactions totaling
approximately $114.6 million, all of which were funded. This activity brings
OAC's total closed transactions since its initial public offering, net of
repayment, to $917.1 million as of September 30, 1998. Of this amount, $866.5
million has been funded and the remaining $50.6 million is to be funded over the
construction and renovation periods, which range from two to 18 months. In
addition, at September 30, 1998, the Company had budgeted $11.9 million of
capital expenditures on its investments in real estate in order to
34
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
improve such properties for reposition in the market, of which $4.8 million is
anticipated to be spent in the fourth quarter of 1998 and $7.1 million is
anticipated to be spent in 1999.
Based on its monthly interest and other expenses, monthly cash receipts,
existing commitments, capital expenditure plans and rate of collateral calls
through October 31, 1998, the Company believes that its existing sources of
funds will be adequate for purposes of meeting its short-term (one year or less)
and long-term liquidity needs. There can be no assurance that this will be the
case, however. Material increases in monthly interest expense or in collateral
calls, or material decreases in monthly cash receipts, generally would
negatively impact the Company's liquidity. On the other hand, material decreases
in monthly interest expense or in collateral calls generally would positively
affect the Company's liquidity.
Year 2000
As the year 2000 approaches, a critical business issue has emerged regarding how
existing application software programs and operating systems can accommodate
this date value. Many existing application software products in the marketplace
were designed to accommodate only two-digit date entries. Beginning in the year
2000, these systems and products will need to be able to accept four-digit
entries to distinguish years beginning with 2000 from prior years. As a result,
computer systems and software used by many companies may need to be upgraded to
comply with such Year 2000 requirements.
The Company is dependent upon data processing systems and software to conduct
its business. The data processing systems and software include those developed,
purchased and maintained by OCC, as well as OCN and its other subsidiaries,
which provide management services to the Company. The Company does not own nor
maintain computer equipment or software.
OCN has established a project plan to achieve year 2000 readiness of its mission
critical and non-mission critical systems, including hardware infrastructure and
software applications. The project plan is divided into six phases:
identification, evaluation, remediation, validation, risk assessment and
contingency planning. As of September 30, 1998, the systems identification and
evaluation phases of the project were completed. OCN expects to have
substantially completed the remediation and validation phases of the project by
the end of 1998.
As part of the identification and evaluation phases of the project, the Company
has documented critical operating functions within each business unit, as well
as strategic third-party and vendor relationships. OCN has retained a business
continuity expert to prepare contingency plans and assist with the testing and
validation of these plans. OCN expects to complete its year 2000 risks
assessment and contingency planning efforts during the first quarter of 1999.
The cost of OCN's year 2000 project, which is budgeted at $2.0 million, will be
borne by OCN. The Company does not expect to incur any costs in connection with
achieving year 2000 compliance.
REIT Status
The Company has qualified and intends to continue to qualify a REIT under
Sections 856 through 860 of the 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 Interim Consolidated
Financial Statements. As taxable income is finalized and the tax return is
filed, and 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.
RISK OF LOSS OF INVESTMENT COMPANY ACT EXEMPTION
The Company believes that it is not, and intends to conduct its operations so as
not to become, regulated as an investment company under the Investment Company
Act of 1940, as amended (the "Investment
35
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
Company Act"). Under the Investment Company Act, an investment company is
required to register with the Commission and is subject to extensive,
restrictive and potentially adverse regulations. The Investment Company Act
exempts entities, however, that 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 interpretations by the
staff of the Commission, qualifying for this exemption requires the Company,
among other things, to maintain at least 55% of its assets in Qualifying
Interests and to maintain an additional 25% in Qualifying Interests or other
real estate-related assets. The Company's investments in real estate and
mortgage loans generally constitute Qualifying Interests, and the Company
believes that subordinate and residual interests in mortgage-related securities
constitute Qualifying Interests when the Company acquires the right to direct
the foreclosure upon any defaulted loan which backs such securities and to take
all other actions that a servicer generally may take in connection with a
defaulted loan.
At September 30, 1998, the Company believes that its Qualifying Interests,
including subordinate and residual interests, comprised over 86% of the
Company's total assets and over 95% when combined with other real-estate related
assets. As a result, the Company believes that it was and is not required to
register as an investment company under the Investment Company Act. The Company
does not intend, however, to seek an exemptive order, no-action letter or other
form of interpretive guidance from the Commission on this position, and if the
Commission were to take a different position, the Company could be required
either (a) to change the manner in which it conducts its operations in order to
avoid investment company registration or (b) to register as an investment
company, either of which could have a material adverse effect on the Company and
its securities, could subject the Company to monetary penalties and injunctive
relief in an action brought by the Commission, could cause the Company to be
unable to enforce contracts with third parties and could cause third parties to
seek recession of relevant transactions.
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS CONTAINED HEREIN ARE NOT BASED ON HISTORICAL FACTS AND ARE
"FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT AND SECTION 21E OF THE SECURITIES ACT OF 1934, AS AMENDED. THESE
FORWARD-LOOKING STATEMENTS MAY BE IDENTIFIED BY REFERENCE TO A FUTURE PERIOD(S)
OR BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "COMMITMENT," "CONTINUE,"
"EXPECT," "FORESEE," "MAY," "PLAN," "WILL," FUTURE OR CONDITIONAL VERB TENSES,
SIMILAR TERMS, VARIATIONS ON SUCH TERMS OR NEGATIVES OF SUCH TERMS. ALTHOUGH OAC
BELIEVES THE ANTICIPATED RESULTS OR OTHER EXPECTATIONS REFLECTED IN SUCH
FORWARD-LOOKING STATEMENTS ARE BASED ON REASONABLE ASSUMPTIONS, ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE INDICATED IN SUCH STATEMENTS DUE TO RISKS,
UNCERTAINTIES AND CHANGES WITH RESPECT TO A VARIETY OF FACTORS, INCLUDING, BUT
NOT LIMITED TO, INTERNATIONAL, NATIONAL, REGIONAL OR LOCAL ECONOMIC
ENVIRONMENTS, GOVERNMENT FISCAL AND MONETARY, PREVAILING INTEREST OR CURRENCY
EXCHANGE RATES, EFFECTIVENESS OF INTEREST RATE, CURRENCY EXCHANGE RATE AND OTHER
HEDGING STRATEGIES, LAWS AND REGULATIONS AFFECTING REAL ESTATE INVESTMENT
TRUSTS, INVESTMENT COMPANIES AND REAL ESTATE (INCLUDING CAPITAL REQUIREMENTS,
INCOME AND PROPERTY TAXATION, ACCESS FOR DISABLED PERSONS AND ENVIRONMENTAL
COMPLIANCE), UNCERTAINTY OF FOREIGN LAWS, COMPETITIVE PRODUCTS, PRICING AND
CONDITIONS (INCLUDING FROM COMPETITORS THAT HAVE SIGNIFICANTLY GREATER RESOURCES
THAN OAC), CREDIT, PREPAYMENT, BASIS, DEFAULT, SUBORDINATION AND ASSET/LIABILITY
RISKS, LOAN SERVICING EFFECTIVENESS, SATISFACTORY DUE DILIGENCE RESULTS,
SATISFACTION OR FULFILLMENT OF AGREED UPON TERMS AND CONDITIONS OF CLOSING OR
PERFORMANCE, TIMING OF TRANSACTION CLOSINGS, AVAILABILITY OF AND COSTS
ASSOCIATED WITH OBTAINING ADEQUATE AND TIMELY SOURCES OF LIQUIDITY, DEPENDENCE
ON EXISTING SOURCES OF FUNDING, ABILITY TO REPAY OR REFINANCE INDEBTEDNESS (AT
MATURITY OR UPON ACCELERATION), TO MEET COLLATERAL CALLS BY LENDERS (UPON
RE-VALUATION OF THE UNDERLYING ASSETS OR OTHERWISE), TO GENERATE REVENUES
SUFFICIENT TO MEET DEBT SERVICE PAYMENTS AND OTHER OPERATING EXPENSES AND TO
SECURITIZE WHOLE LOANS, TAXABLE INCOME EXCEEDING CASH FLOW, SIZE OF, NATURE OF
AND YIELDS AVAILABLE WITH RESPECT TO THE SECONDARY MARKET FOR MORTGAGE LOANS AND
FINANCIAL, SECURITIES AND SECURITIZATION MARKETS IN GENERAL, ALLOWANCES FOR LOAN
LOSSES, GEOGRAPHIC CONCENTRATIONS OF ASSETS (TEMPORARY OR OTHERWISE), TIMELY
LEASING OF UNOCCUPIED SQUARE FOOTAGE (GENERALLY AND UPON LEASE EXPIRATION),
CHANGES IN REAL ESTATE MARKET CONDITIONS (INCLUDING LIQUIDITY, VALUATION,
REVENUES, RENTAL RATES, OCCUPANCY LEVELS AND COMPETING PROPERTIES), ADEQUACY OF
INSURANCE COVERAGE IN THE EVENT OF A LOSS, KNOWN OR UNKNOWN ENVIRONMENTAL
CONDITIONS, EXTERNAL MANAGEMENT, CONFLICTS OF INTEREST, YEAR 2000 COMPLIANCE,
OTHER
36
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
FACTORS GENERALLY UNDERSTOOD TO AFFECT THE REAL ESTATE ACQUISITION, MORTGAGE AND
LEASING MARKETS, SECURITIES INVESTMENTS AND RAPID GROWTH COMPANIES, AND OTHER
RISKS DETAILED FROM TIME TO TIME IN OAC'S REPORTS AND FILINGS WITH THE SEC,
INCLUDING ITS REGISTRATION STATEMENTS ON FORMS S-3, S-4 AND S-11 AND ITS
PERIODIC REPORTS ON FORMS 10-Q, 8-K AND 10-K. GIVEN THESE UNCERTAINTIES, READERS
ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH STATEMENTS.
37
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
================================================================================
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 September 30, 1998 and various estimates regarding
prepayment and all activities are made at each level of rate shock. Actual
results could differ significantly from these estimates.
<TABLE>
<CAPTION>
Projected Percentage Change In
- -------------------------------------------------------------------------------------------------------
Change in Interest Rate Net Interest Income(1) Net Portfolio Value
=======================================================================================================
<S> <C> <C>
-400 Basis Points 38.53 % 25.00 %
-300 Basis Points 28.90 17.60
-200 Basis Points 19.26 10.26
-100 Basis Points 9.63 3.67
Base Interest Rate 0 0
+100 Basis Points -9.63 -4.26
+200 Basis Points -19.26 -8.52
+300 Basis Points -28.90 -15.05
+400 Basis Points -38.53 -21.68
</TABLE>
(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.
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
38
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
================================================================================
Company's exposure to earnings variations and variations in the value of assets
and liabilities as interest rates change over time.
The Company utilizes a variety of off-balance sheet financial techniques to
assist it in the management of interest rate risk. These techniques 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. Interest rate exchange
agreements are utilized by the Company to protect against the increase in
borrowing cost from floating rate debt or a short-term, fixed-rate liability,
such as reverse repurchase agreements, in an increasing interest-rate
environment. At September 30, 1998, the Company had entered into interest rate
exchange agreements with an aggregate notional amount of $200.8 million. See
Note 6 to the Interim Consolidated Financial Statements included in Item 1
above.
The Company currently has a foreign currency swap with a counterparty to hedge
currency exposure in connection with its investment in residual interests
originated in the U.K. The purpose of the Company's foreign currency hedging
activities is to protect the Company from the risk that the eventual dollar net
cash inflows will be adversely affected by changes in exchange rates. Under the
terms of the agreement, the Company will settle in U.S. dollars on January 29,
1999 on the difference between the exchange rate on the effective date of the
contract and the exchange rate on January 29, 1999, on a notional amount of 14.7
million British Pounds Sterling. See Note 6 to the Interim Consolidated
Financial Statements included in Item 1 hereof.
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 September
30, 1998. 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.
39
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
================================================================================
<TABLE>
<CAPTION>
September 30, 1998
--------------------------------------------------------------------------
More than 1
Within 4 to 12 Year to 3 Years
3 Months Months 3 Years and Over Total
---------- ---------- ---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Rate-Sensitive Assets:
Interest-earning cash and repurchase
agreements................................ $ 15,194 $ -- $ -- $ -- $ 15,194
Securities available for sale............... 15,116 44,512 99,345 236,522 395,495
Loan portfolio, net (1)..................... 23,316 63,418 98,910 66,968 252,612
Discount loan portfolio, net (1)............ 1,201 1,770 5,618 -- 8,589
---------- ---------- ---------- ---------- ----------
Total rate-sensitive assets............... 54,827 109,700 203,873 303,490 671,890
---------- ---------- ---------- ---------- ----------
Rate-Sensitive Liabilities:
Securities sold under agreements
to repurchase............................. 143,059 -- -- -- 143,059
Obligations outstanding under lines of
credit.................................. 331,581 -- -- -- 331,581
Notes, debentures and other interest-
bearing obligations..................... -- -- -- 143,000 143,000
------------ ------------ ------------ ---------- ----------
Total rate-sensitive liabilities.......... 474,640 -- -- 143,000 617,640
Interest rate sensitivity gap before
off-balance sheet financial instruments... (419,813) 109,700 203,873 160,490 54,250
Off-Balance Sheet Financial Instruments:
Futures contracts and interest rate swaps... 200,780 -- (92,000) (108,780) --
------------ ------------ ------------- ------------- ----------
Interest rate sensitivity gap.................. (219,033) 109,700 111,873 51,710 $ 54,250
------------- ------------ ------------ ------------ ==========
Cumulative interest rate sensitivity gap....... $ (219,033) $ (109,333) $ 2,540 $ 54,250
============ ============ ============ ============
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets .. (32.60%) (16.27%) 0.38% 8.07%
</TABLE>
- ------------
(1) Balances have not been reduced for non-performing loans.
40
<PAGE>
PART II OTHER INFORMATION
================================================================================
Item 2. Changes in Securities
On July 14, 1998 the Company issued $150,000,000 principal amount of
Notes under Rule 144A of the Securities Act of 1933. Interest on the
Notes is payable in cash semi-annually in arrears on each January 1 and
July 1 commencing on January 1, 1999. The Notes will mature on July 1,
2005 and are redeemable, at the option of the Company, in whole or
part, on or after July 1, 2002. During the first 36 months, the Company
may, on any one or more occasions, use the net proceeds of one or more
offerings of its Common Stock to redeem up to 25% of the aggregate
principal amount of the Notes, provided that, after any such
redemption, the aggregate principal amount of the Notes outstanding
must equal at least $112.5 million. Upon the occurrence of a change of
control, the Company is required, subject to certain conditions, to
offer to purchase all of the Notes. The Indenture relating to the Notes
contains certain covenants of the Company, including a covenant that
restricts its ability to declare or pay dividends or make payments or
distributions on its outstanding Common Stock unless certain
requirements are met. This covenant does not affect the ability of the
Company to make distributions which are necessary to preserve its
status as a REIT under the Code. On September 30, 1998, the Company
repurchased $7.0 million principal amount of the Notes in the open
market.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule - For the quarter ended September
30, 1998 (filed herewith)
(b) Reports on Form 8-K filed during the quarter ended September
30, 1998
(1) A Form 8-K filed on July 14, 1998, announcing the
Company's issuance of $150.0 million principal amount of
11 1/2 % Notes due 2005.
(2) A Form 8-K filed on July 24, 1998, which contained a news
release announcing the Company's financial results for the
three months ended June 30, 1998.
(3) A Form 8-K filed on August 6, 1998, announcing the
Company's purchase of the Prudential Building.
(4) A Form 8-K filed on September 15, 1998, which contained
financial information for the Prudential Building and
certain additional other properties acquired by the
Company.
(5) A Form 8-K filed on September 17, 1998, which contained a
news release responding to the New York Stock Exchange and
investor inquiries regarding its common stock price.
(6) A Form 8-K filed on of September 22, 1998, which contained
a news release announcing the Company's third quarter
dividend and a stock repurchase program.
(7) A Form 8-K filed on October 27, 1998, which contained a
news release announcing the Company's financial results
for the three months ended September 30, 1998.
41
<PAGE>
SIGNATURE
================================================================================
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 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
(On behalf of the Registrant and as its principal
financial officer)
Date: November 20, 1998
42
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Statement of Financial Condition at September 30, 1998 (Unaudited)
and the Consolidated Statement of Operations for the Nine Months Ended September
30, 1998 (Unaudited) and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<CIK> 0001033643
<NAME> OCWEN ASSET INVESTMENT CORP.
<MULTIPLIER> 1,000
<CURRENCY> USD
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 18,330
<SECURITIES> 395,495
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 910,398
<CURRENT-LIABILITIES> 21,408
<BONDS> 617,640
190
0
<COMMON> 0
<OTHER-SE> 242,791
<TOTAL-LIABILITY-AND-EQUITY> 910,398
<SALES> 0
<TOTAL-REVENUES> 57,701
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 15,697
<LOSS-PROVISION> 557
<INTEREST-EXPENSE> 21,235
<INCOME-PRETAX> (12,112)
<INCOME-TAX> 0
<INCOME-CONTINUING> (12,112)
<DISCONTINUED> 0
<EXTRAORDINARY> 615
<CHANGES> 0
<NET-INCOME> (11,497)
<EPS-PRIMARY> (0.61)
<EPS-DILUTED> (0.61)
<FN>
</FN>
</TABLE>
