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CHASTAIN CAPITAL CORPORATION
3424 PEACHTREE ROAD, N.E., SUITE 800
ATLANTA, GEORGIA 30326
(404) 848-8850
To our Shareholders:
Enclosed are the materials that constitute the 1998 Annual Report to
Shareholders of Chastain Capital Corporation (the "Company"). Included herein
are the Company's Annual Report on Form 10-K for the year ended December 31,
1998, and the Amendment No. 1 to such Annual Report on Form 10-K/A. These
reports contain the Company's financial results for 1998. In addition, these
reports are supplemented by the Company's Quarterly Reports on Form 10-Q for the
first two quarters of 1999. These materials are being distributed to
shareholders together with the Proxy Statement for the 1999 Annual Meeting of
Shareholders to be held on October 1, 1999.
In response to the adverse credit market conditions of the third quarter of
1998, the Company's Board of Directors commenced a review of the strategic
alternatives available to the Company. On May 14, 1999, the Company announced
that it intended to liquidate, either through a sale of the Company or pursuant
to a plan of liquidation. On August 2, 1999, the Company announced the sale of
assets to Insignia Opportunity Partners and the adoption of a Plan of
Liquidation and Dissolution. On August 17, 1999, the Company announced the sale
of another asset to BankBoston, N.A. Information relating to the asset sales and
the proposed dissolution of the Company is included in the Proxy Statement
delivered to shareholders together with the enclosed materials. Shareholders are
urged to read all of the enclosed information.
We look forward to meeting any of you who elect to attend the annual
meeting on October 1, 1999 in Atlanta, Georgia.
Sincerely,
/s/ Steven G. Grubenhoff
STEVEN G. GRUBENHOFF
Chief Financial Officer
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
</TABLE>
COMMISSION FILE NUMBER 0-23917
CHASTAIN CAPITAL CORPORATION
(Exact name of registrant as specified in its governing instrument)
<TABLE>
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GEORGIA 58-2354416
(State of Organization) (I.R.S. Employer
Identification No.)
3424 PEACHTREE ROAD N.E., SUITE 800,
ATLANTA, GEORGIA 30326
(Address of principal executive office) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (404) 848-8871
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate the aggregate market value of the voting and non-voting common
equity held by non-affiliates. $27,613,436 as of March 30, 1999.
Indicate the number of shares outstanding of each of issuer's classes of
common stock, as of the latest practicable date. 7,346,778 shares of common
stock outstanding as of March 30, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE REGISTRANT'S PROXY STATEMENT FOR ITS 1999 ANNUAL MEETING OF
SHAREHOLDERS ARE INCORPORATED BY REFERENCE IN PART III.
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CHASTAIN CAPITAL CORPORATION
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PART I
Item 1. Business.................................................... 1
General..................................................... 1
Initial Public Offering..................................... 2
Business of the Company..................................... 2
Investment Guidelines....................................... 2
Purchases of Assets......................................... 6
Debt Agreements............................................. 6
Repurchase of Common Stock.................................. 7
Restructuring............................................... 7
Sales of Assets............................................. 8
Competition................................................. 8
Conflicts of Interest....................................... 8
Management Agreement........................................ 9
Option Plan................................................. 11
Limits of Responsibility.................................... 12
Employees................................................... 13
REIT Status................................................. 13
Investment Portfolio........................................ 13
Commercial Mortgage-Backed Securities....................... 14
Mezzanine Investments....................................... 14
Mortgage Loans.............................................. 15
Real Properties............................................. 15
Item 2. Properties.................................................. 16
Item 3. Legal Proceedings........................................... 16
Item 4. Submission of Matters to a Vote of Security Holders......... 16
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 16
Item 6. Selected Financial Data..................................... 17
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 17
Capital Resources and Liquidity............................. 17
Working Capital Reserves.................................... 18
Financial Condition......................................... 18
Results from Operations..................................... 20
Recent Developments......................................... 20
REIT Status................................................. 21
Quantitative and Qualitative Disclosures about Market
Risk........................................................ 21
Year 2000................................................... 22
Item 8. Financial Statements and Supplementary Data................. 23
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 46
Signatures.......................................................... 48
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PART I
ITEM 1. BUSINESS.
Certain statements contained in this Annual Report on Form 10-K constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995, Section 27A of the Securities Exchange Act of
1933, as amended, 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 "may", "will",
"intend", "should", "expect", "anticipate", "estimate", or "continue" or the
negatives thereof or other comparable terminology. The Company's (as hereinafter
defined) actual results could differ materially from those anticipated in such
forward-looking statements due to a variety of factors, including, but not
limited to, changes in national, regional or local economic environments,
competitive products and pricing, government fiscal and monetary policies,
changes in prevailing interest rates, the course of negotiations, the
fulfillment of contractual conditions, factors inherent to the valuation and
pricing of interests in commercial mortgage-backed securities, credit risk
management, asset/liability management, the financial and securities markets,
the availability of and costs associated with the sources of liquidity, other
factors generally understood to affect the real estate acquisition, mortgage and
leasing markets and security investments, and other risks detailed in the
Company's registration statement on Form S-11 (File No. 333-42629), as amended,
filed with the Securities and Exchange Commission (the "SEC"), and declared
effective on April 23, 1998, the Company's quarterly reports on Form 10-Q filed
with the SEC, and other filings made by the Company with the SEC. The Company
does not undertake, and specifically disclaims any obligation, to publicly
release the results of any revisions which may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
GENERAL
Chastain Capital Corporation (the "Company") is a Georgia corporation that
was organized on December 16, 1997 and that plans to make an election to be
taxed as a real estate investment trust ("REIT") under the Internal Revenue Code
of 1986, as amended (the "Code") commencing with its first REIT taxable year
ended on December 31, 1998. As a REIT, the Company generally is not subject to
federal income taxation on that portion of its income that it distributes
currently to its shareholders, provided that it distributes at least 95% of its
taxable income (excluding net capital gains) to its shareholders annually and
meets certain other REIT tests for qualification as a REIT under the Code. The
Company was initially capitalized on December 16, 1997 through the sale of 100
shares of common stock, par value $.01 per share ("Common Stock") for an
aggregate purchase price of $1,000.
The Company incorporated and capitalized two wholly owned subsidiaries,
Chastain GP Holdings, Inc. (the "General Partner") and Chastain LP Holdings,
Inc. (the "Initial Limited Partner") which organized and capitalized Chastain
Investments, L.P. (the "Operating Partnership"), a Georgia limited partnership
through which the business of the Company is conducted. Because the Company
indirectly owns 100% of the partnership interests in the Operating Partnership,
the Operating Partnership is disregarded as a separate entity from the Company
for federal income tax purposes unless a third party other than either (i) the
Company or (ii) a qualified REIT subsidiary of the Company is admitted as a
partner in the Operating Partnership. The Company organized the Operating
Partnership to provide potential sellers of assets with the opportunity to
transfer those assets to the Company in a tax-deferred exchange.
The General Partner engaged ERE Yarmouth, Inc. ("ERE Yarmouth"), a
wholly-owned indirect subsidiary of Lend Lease Corporation Limited ("Lend Lease
Corporation") to manage and advise the Company's business and investment
affairs. On July 13, 1998, Lend Lease Corporation changed the name of ERE
Yarmouth to Lend Lease Real Estate Investments, Inc. ("Lend Lease" or the
"Manager"). Lend Lease continues to manage and advise the Company.
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INITIAL PUBLIC OFFERING
The Company offered to the public 7,380,000 shares of Common Stock at
$15.00 per share in an initial public offering (the "Offering") which commenced
in April 1998. Gross proceeds from the Offering were $110,700,000 and net
proceeds to the Company were $102,951,000. Additional public offering costs of
$1,215,750 were incurred in connection with the Offering.
The Company also issued, pursuant to two separate private placements, an
aggregate of 897,678 shares of Common Stock to Lend Lease Investment Holdings,
Inc. ("LLIH"), (formerly ERE Yarmouth Investment Holdings, Inc.), an indirect,
wholly-owned subsidiary of Lend Lease, and 700,000 shares of Common Stock to FBR
Asset Investment Corporation, an affiliate of Friedman, Billings, Ramsey & Co.,
Inc. (lead underwriter of the Company's Offering), each of which closed
concurrently with the closing of the Offering, at $13.95 per share, with total
proceeds to the Company of $22,287,608.
BUSINESS OF THE COMPANY
The Company was organized to originate commercial and multifamily Mortgage
Loans ("Mortgage Loans") for the purpose of securitizing the loans by issuing
collateralized mortgage obligations ("CMOs") and retaining residual interests in
the Mortgage Loans subject to the CMO debt. The Company also was organized to
acquire subordinated interests in commercial mortgage-backed securities
("CMBS"), originate and acquire loans on real property that are subordinated to
first lien Mortgage Loans ("Mezzanine Investments") and acquire real property
and other real estate related assets.
Mortgage Loans consist of whole loan originations collateralized by real
estate assets to which an investor has first priority to cash flow.
Commercial mortgage-backed securities represent an ownership interest in a
securitized pool of commercial Mortgage Loans. The most basic mortgage-backed
securities ("MBS"), known as "Pass-Through Certificates," or participation
certificates, represent a direct ownership interest in a trust comprised of a
pool of Mortgage Loans. The trusts are typically organized to issue CMOs or
certificates of Real Estate Mortgage Investment Conduits ("REMICs").
CMOs and REMICs are similar types of securities that allow cash flows to be
split so that different classes of securities with different maturities, coupons
and risk profiles may be created. They may be collateralized by a single
Mortgage Loan or a pool of loans. The key feature is the prioritization of the
cash flows among several different classes of bondholders. This mechanism
creates a series of bonds with varying maturities, interest coupons and risk
profiles that appeal to different investors. Holders of the first tranche
receive all principal paid on the mortgages until that tranche is fully retired,
at which point the holders of the second tranche begin to receive principal
payments. Holders of the last tranche receive principal only when the previous
classes have been fully retired.
Mezzanine Investments are investments that are subordinated to first lien
Mortgage Loans on commercial and multifamily real estate. Mezzanine Mortgage
Loans generally provide the right to receive a stated interest rate on the loan
balance and may also include a percentage of gross revenues from the property,
payable on an ongoing basis, and/or a percentage of any increase in value of the
property, payable upon maturity or refinancing of the loan, or otherwise would
allow an investor to charge an interest rate that would provide an attractive
risk-adjusted return. Mezzanine Investments may also take the form of preferred
equity, which will have a claim against both the operating cash flow and
liquidation proceeds from the specific real estate assets.
INVESTMENT GUIDELINES
The Company announced in October 1998 that it would cease acquiring any
additional assets or funding any additional loans in order to focus on
stabilizing its existing assets and improving its liquidity position. The Board
of Directors is currently reviewing the strategic alternatives available to the
Company with respect to its remaining assets. The discussion below describes the
principal categories of assets that the Company was authorized to acquire under
its investment guidelines up until October 1998. While the investment guidelines
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are currently suspended, they are presented below to describe the environment
the Manager was operating in and might operate in if the suspension is
terminated. All investment guidelines may be amended from time to time by the
Board of Directors.
The Manager is authorized to commit the Company contractually to aggregate
investments in any calendar quarter up to $250,000,000 without the approval of
the Board of Directors. In addition, in any calendar quarter the Manager may
contractually commit the Company to purchase up to a specified aggregate amount
in each category of Real Estate Related Assets, as set forth below. Commencing
on April 28, 1999, the Manager must have approval by the Board of Directors to
invest more than 45% of the Company's aggregate assets in any single region of
the United States, or in any individual property type. In addition, after such
date the Manager will need Board of Directors approval to invest in excess of
45% of the total assets of the Company in any single category of assets
described below.
Subordinated Interests. The Company has the authority to originate
commercial whole loans for the purpose of securitizing such pools of such loans
and retaining non-investment grade subordinated interests. Mortgage-backed
securities ("MBS") typically are divided into two or more classes, sometimes
called "tranches." The senior classes are higher "rated" securities, which would
be rated by independent agencies from low investment grade "BBB" to higher
investment grade "AA" or "AAA." The junior, subordinated classes typically would
include a lower rated, non-investment grade "BB" and "B" class, and an unrated,
higher-yielding, credit support class (the "Subordinated Interest," which
generally is required to absorb the first losses on the underlying mortgage
loans). The Manager may contractually commit the Company to aggregate Mortgage
Loans up to $150 million, or $30 million for any individual transaction, in any
calendar quarter. Any investments outside of these guidelines must be approved
in advance by the Board of Directors.
MBS generally are issued either as CMOs or Pass-Through Certificates. CMOs
are debt obligations of special purpose corporations, owner trusts or other
special purpose entities secured by commercial mortgage loans or MBS. CMOs and
Pass-Through Certificates may be issued or sponsored by private originators of,
or investors in, mortgage loans, including savings and loan associations,
mortgage bankers, commercial banks, investment banks and other entities. MBS are
not guaranteed by an entity having the credit status of a governmental agency or
instrumentality and generally are structured with one or more of the types of
credit enhancement described below. In addition, MBS may be illiquid.
In most mortgage loan securitizations, a series of MBS is issued in
multiple classes in order to obtain investment-grade ratings for the senior
classes and thus increase their marketability. Each class of MBS may be issued
with a specific fixed or variable coupon rate and has a stated maturity or final
scheduled distribution date. Principal prepayments on the mortgage loans
comprising the collateral may cause the MBS to be retired substantially earlier
than their stated maturities or final scheduled distribution dates although,
with respect to commercial mortgage loans, there generally are penalties for or
limitations on the ability of the borrower to prepay the loan. Interest is paid
or accrued on MBS on a periodic basis, typically monthly.
The credit quality of MBS depends on the credit quality of the underlying
mortgage collateral. Among the factors determining the credit quality of the
underlying Mortgage Loans will be the ratio of the Mortgage Loan balances to the
value of the properties securing the Mortgage Loans, the purpose of the Mortgage
Loans (e.g., refinancing or new purchase), the amount and terms of the Mortgage
Loans, the geographic diversification of the location of the properties and, in
the case of commercial Mortgage Loans, the credit-worthiness of tenants.
Moreover, the principal of and interest on the underlying mortgage loans
may be allocated among the several classes of a MBS in many ways, and the credit
quality of a particular class results primarily from the order and timing of the
receipt of cash flow generated from the underlying Mortgage Loans. Subordinated
Interests carry significant credit risks. Typically, in a "senior-subordinated"
structure, the Subordinated Interests provide credit protection to the senior
classes by absorbing losses from loan defaults or foreclosures before such
losses are allocated to senior classes. Moreover, typically, as long as the more
senior tranches of securities are outstanding, all prepayments on the Mortgage
Loans generally are paid to those senior tranches. In some instances,
particularly with respect to Subordinated Interests in commercial
securitizations, the holders of Subordinated Interests are not entitled to
receive scheduled payments of principal until the more
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senior tranches are paid in full. Because of this structuring, Subordinated
Interests in a typical securitization are subject to a substantially greater
risk of non-payment than are those more senior tranches. Accordingly, the
Subordinated Interests are assigned lower credit ratings, or no ratings at all.
Neither the Subordinated Interests nor the underlying Mortgage Loans are
guaranteed by agencies or instrumentalities of the U.S. government or by other
governmental entities and, accordingly, are subject to credit risks.
As a result of the typical "senior-subordinated" structure, the
Subordinated Interest will be extremely sensitive to losses on the underlying
Mortgage Loans. For example, if the Company owns a $10 million Subordinated
Interest in an MBS consisting of $100 million of underlying mortgage loans, a 7%
loss on the underlying mortgage loans will result in a 70% loss on the
Subordinated Interest. Accordingly, the holder of the Subordinated Interest is
particularly interested in minimizing the loss frequency (the percentage of the
loan balances that default over the life of the Mortgage Collateral) and the
loss severity (the amount of loss on a defaulted mortgage loan, i.e., the
principal amount of the mortgage loan unrecovered after applying any recovery to
the expenses of foreclosure and accrued interest) on the underlying Mortgage
Loans.
The loss frequency on a pool of mortgage loans will depend upon a number of
factors, most of which will be beyond the control of the Company or the
applicable servicer. Among other things, the default frequency will reflect
broad conditions in the economy generally and real estate particularly, economic
conditions in the local area in which the underlying property is located, the
loan-to-value ratio of the mortgage loan, the purpose of the loan, and the debt
service coverage ratio. The loss severity will depend upon many of the same
factors described above, and will also be influenced by the servicer's ability
to foreclose on the defaulted mortgage loan and sell the underlying mortgaged
property.
The underwriting standards used by the Company in evaluating Mortgage Loans
include a review of (i) the underlying collateral of each Mortgage Loan,
including property characteristics, location and credit-worthiness of tenants,
(ii) the borrower and manager's ability to manage the property and make debt
service payments, (iii) the relative principal amounts of the loan, including
the loan-to-value and debt service coverage ratios and (iv) the Mortgage Loan's
purpose and documentation. Such evaluation includes engaging third party
appraisal, environmental and engineering firms to prepare independent reports.
The Company's Mortgage Loans have consisted primarily of assets backed by first
liens on commercial property.
Commercial Mortgage-Backed Securities. The Manager is authorized to
contractually commit the Company to aggregate CMBS up to $75 million, or $75
million for any individual transaction, in any calendar quarter. Any investments
outside of these guidelines must be approved in advance by the Board of
Directors. CMBS are backed generally by a more limited number of commercial or
multifamily Mortgage Loans with larger principal balances than those of single
family residential Mortgage Loans. As a result, a loss on a single Mortgage Loan
underlying a CMBS will have a greater negative effect on the yield of such CMBS,
especially the Subordinated Interests in such CMBS.
Before acquiring Subordinated Interests, the Company performs certain
credit underwriting and stress testing to attempt to evaluate future performance
of the Mortgage Collateral supporting the CMBS which will include (i) a review
of the underwriting criteria used in making Mortgage Loans comprising the
Mortgage Collateral for CMBS, (ii) a review of the relative principal amounts of
the loans, their loan-to-value and debt service coverage ratios as well as the
Mortgage Loans' purpose and documentation, (iii) where available, a review of
the historical performance of the loans originated by the particular originator,
(iv) in the case of the CMBS, some level of reunderwriting the underlying
Mortgage Loans, as well as selected site visits and (v) a review of independent
third party appraisal, environmental and engineering reports.
Real Properties. The Company's policy is to conduct an investigation and
evaluation of real property before purchasing such property. Evaluations of
potential properties are conducted primarily by the Manager's employees who
specialize in the analysis of underperforming or distressed assets, often with
further specialization based on geographic or collateral-specific factors. It is
expected that the Manager's employees will use third parties, such as brokers
who are familiar with the property's type and location, to assist them in
conducting an evaluation of the value of the property, and depending on the
circumstances, may use subcontractors, such as local counsel and engineering and
environmental experts, to assist in the evaluation and verification of
information and the gathering of other information not previously made available
by the
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potential seller. The amount offered by the Company generally is the price that
the Manager estimates is sufficient to generate an acceptable risk-adjusted
return on the Company's investment. The Manager may contractually commit the
Company to aggregate real properties up to $75 million, or $25 million for any
individual transaction, in any calendar quarter. Any investments outside of
these guidelines must be approved in advance by the Board of Directors.
Mezzanine Investments. The Company is authorized to make investments that
are subordinated to first lien Mortgage Loans on commercial and multifamily real
estate. For example, on a commercial property subject to a first lien Mortgage
Loan with a principal balance equal to 70% of the value of the property, the
Company could lend the owner of the property (typically a partnership) an
additional 15% to 20% of the value of the property. Typically the loan would be
secured, either by the property subject to the first lien (giving the Company a
second lien position) or a partnership interest in the owner. If a partnership
interest is pledged, the Company would be in a position to take over the
operation of the property in the event of a default on the loan. These Mezzanine
Investments generally provide the Company with the right to receive a stated
interest rate on the loan balance and may also include a percentage of gross
revenues from the property, payable to the Company on an ongoing basis, and/or a
percentage of any increase in value of the property, payable upon maturity or
refinancing of the loan, or otherwise would allow the Company to charge an
interest rate that would provide an attractive risk-adjusted return. Mezzanine
Investments may also take the form of preferred equity, which will have a claim
against both the operating cash flow and liquidation proceeds from the specific
real estate assets. The Manager may contractually commit the Company to
aggregate Mezzanine Investments up to $75 million, or $20 million for any
individual transaction, in any calendar quarter. Any investments outside of
these guidelines must be approved in advance by the Board of Directors.
Before originating Mezzanine Investments, the Company performs certain
credit underwriting to attempt to evaluate future performance of the collateral
supporting such investment, which will include a review of (i) the underlying
collateral of each Mortgage Loan, including property characteristics, location,
credit-worthiness of tenants and economics, (ii) the relative principal amounts
of the loan, including the loan-to-value and debt service coverage ratios, (iii)
the borrower and manager's ability to manage the property and make debt service
payments, and (iv) the Mortgage Loan's purpose and documentation.
Other Real Estate Related Assets. The Manager may contractually commit the
Company to aggregate other real estate related assets up to $50 million, or $20
million for any individual transaction, in any calendar quarter. Any investments
outside of these guidelines must be approved in advance by the Board of
Directors. The Company's policy is to conduct an investigation and evaluation of
real estate related assets before purchasing such assets. Evaluation of
potential properties will be conducted primarily by the Manager's employees who
specialize in the analysis of such assets, often with further specialization
based on geographic or collateral-specific factors. The Company expects the
Manager to use third parties, such as brokers who are familiar with the
property's type and location, to assist it in conducting an evaluation of the
value of the property, and, depending on the circumstances, to use
subcontractors, such as local counsel and engineering and environmental experts,
to assist in the evaluation and verification of information and the gathering of
other information not previously made available by the potential seller. Other
real estate related assets may include the following.
Construction Loans. The Company is authorized to provide construction
loans on commercial property, taking a first lien mortgage to secure the debt.
Agricultural Loans. The Company is authorized to originate or acquire
agricultural loans for use in securitization pools and may acquire agricultural
underperforming real estate assets. Agricultural loans are secured by first
liens on a parcel or parcels of land, which may be improved by buildings,
fixtures, and equipment or other structures permanently affixed to the parcel or
parcels, that are used for the production of one or more agricultural
commodities or products. Loans are secured by a first lien mortgage with
principal amortization based upon the nature of depreciable assets and commodity
types. Lower percentage (longer duration) amortizations are associated with
productive agricultural real estate with limited or no depreciable buildings or
structures. Typically, as the value of depreciable structures becomes a larger
percentage of the security, the amortization percentage is higher (shorter
duration). Agricultural real estate may also be
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improved with permanent plantings (orange groves, vineyards, etc.) which produce
crops for multiple years and the loan amortizations are structured to reflect
the economic life of the productive assets. The loans are payable monthly,
quarterly or semi-annually depending upon the nature of the commodity produced.
Foreign Real Properties. In addition to purchasing real properties, the
Company is authorized to originate or acquire Mortgage Loans secured by real
estate located outside the United States or purchase such real estate. The
Company has not imposed any limits with respect to the amounts that it could
invest in foreign real properties in the aggregate, any particular type of
foreign real property, or properties located in any particular country.
Other MBS. The Company may create or acquire interest-only MBS that have
characteristics of Subordinated Interests, known as "Sub IOs." A Sub IO is
entitled to no payments of principal; moreover, interest on a Sub IO often is
withheld in a reserve fund or spread account and is used to fund required
payments of principal and interest on the more senior tranches. Once the balance
in the spread account reaches a certain level, interest on the Sub IO is paid to
the holders of the Sub IO. These Sub IOs provide credit support to the senior
classes, and thus bear substantial credit risk. Moreover, because a Sub IO
receives only interest payments, its yield is extremely sensitive to changes in
the weighted average life of the class, which in turn is dictated by the rate of
prepayments (including as a result of defaults) on the underlying loans.
Real Estate Companies. The Company is authorized to invest in private
placements of common stock or other securities convertible into common stock.
PURCHASES OF ASSETS
During the second quarter of 1998, commencing on the completion of the
Offering on April 23, 1998 and ending June 30, 1998, the Company purchased five
CMBS for $73.6 million and one real estate property for $3.7 million. The
Company also made two Mezzanine Investments for $25.8 million.
During the third quarter ended September 30, 1998, the Company purchased
two CMBS for $29.1 million and one real estate property for $3.2 million. The
Company also made two Mezzanine Investments for $22.4 million and two Mortgage
Loans for $29.5 million.
During October, 1998, the Company made one Mezzanine Investment for $4.6
million and originated six Mortgage Loans for $60.6 million.
DEBT AGREEMENTS
On May 15, 1998, the Company entered into two Master Loan and Security
Agreements with Morgan Stanley Mortgage Capital Inc. ("Morgan Stanley") and
Morgan Guaranty Trust Company of New York ("Morgan Guaranty Trust"),
respectively, to provide financing for the Company's investments. On October 26,
1998, the Company terminated the agreement with Morgan Stanley at no cost to the
Company. The Company made no borrowings under the Morgan Stanley agreement. As
of December 31, 1998, there were $52,412,238 in borrowings outstanding under the
Morgan Guaranty Trust agreement, secured by the Company's assets with an
aggregate carrying value of $70,745,575 at December 31, 1998. All borrowings
under the Morgan Guaranty Trust agreement were paid off on March 31, 1999, and
the facility was terminated.
On August 21, 1998, the Company entered into a Master Assignment Agreement
with Merrill Lynch Mortgage Capital, Inc. and Merrill Lynch Capital Services,
Inc. (the "Merrill Lynch Agreement"), to provide financing for the Company's
investments. The facility required assets to be pledged as collateral. As of
December 31, 1998, there were $9,505,918 in borrowings outstanding under the
Merrill Lynch Agreement, secured solely by a Mezzanine Investment which had a
carrying value of $16,764,264 at December 31, 1998. All borrowings under the
Merrill Lynch Agreement were paid off on March 25, 1999, and the facility was
terminated.
On August 25, 1998, the Company entered into a Master Repurchase Agreement
with Deutsche Bank Securities, Inc. (the "Deutsche Bank Agreement"), which
provided financing for the Company's investments.
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<PAGE> 10
As of December 31, 1998, there were $7,926,375 in borrowings outstanding under
the Deutsche Bank Agreement, secured solely by one of the Company's BBB- rated
CMBS. On February 19, 1999, the CMBS was sold, and the remaining borrowings
under the Deutsche Bank Agreement were repaid.
On November 13, 1998 LLIH agreed to provide the Company with up to $40
million of unsecured subordinated indebtedness (the "LLIH Agreement"). As of
December 31, 1998 borrowings outstanding under the LLIH Agreement were
$9,000,000. All outstanding borrowings under the LLIH Agreement were due on
March 31, 1999. On March 30, 1999, LLIH granted the Company an extension until
April 5, 1999.
REPURCHASE OF COMMON STOCK
The Company began repurchasing shares of its Common Stock on August 6, 1998
and in total, as of December 31, 1998, had repurchased a total of 1,634,000
shares at an average price of $9.91 per share, for a total price of $16,191,994.
The shares repurchased by the Company have been retired and are presented as a
reduction of Common Stock and additional paid-in capital in the Company's
consolidated financial statements.
RESTRUCTURING
During the third quarter of 1998, turmoil in credit markets caused a
significant and unexpected widening of interest rate spreads as market interest
rates for mortgage-related debt instruments increased dramatically relative to
the interest rates of U.S. Treasury securities. As a result, the Company
incurred substantial losses in the market value of its assets. On October 23,
1998, the Company announced that it had experienced estimated losses in its
investment portfolio of $32.0 million. For the three months ended September 30,
1998, the Company recorded non-cash charges of approximately $24.0 million from
marking the value of its investment portfolio to market. In addition, the
Company reported losses of approximately $15.7 million for the third quarter as
a result of the termination of the Company's interest rate hedges. For the three
months ended December 31, 1998, the Company recorded approximately $7.6 million
in losses realized upon the sale of assets and approximately $2.0 million in
mark-to-market charges and changes in valuation allowances on its remaining
assets.
In response, on October 21, 1998, the Board of Directors formed a special
committee (the "Special Committee") to (i) review and evaluate the short term
and long term strategic alternatives available to the Company and report its
recommendations to the full Board of Directors and (ii) negotiate the terms of
and approve any action that the Special Committee determines involves a conflict
of interest with Lend Lease Corporation. Since its formation, the Special
Committee has discussed and approved the restructuring of the credit facilities
with Morgan Guaranty Trust and Merrill Lynch, the terms of the unsecured
subordinated debt provided by LLIH and the sale of assets to repay the Company's
indebtedness.
On October 23, 1998 the Company announced it was necessary to obtain
temporary waivers from Morgan Guaranty Trust and Merrill Lynch to avoid being in
default of tangible net worth covenants under the Company's credit facilities.
The facilities were amended to provide for new credit limits, debt covenants,
interest rates and maturity dates, as further discussed in "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations", and
in "Item 8. Financial Statements and Supplementary Data".
The Company announced on November 13, 1998 that it had reached an agreement
with its lenders to restructure its credit facilities, dispose of certain assets
and that it would cease acquiring new investments. The Board of Directors then
commenced a review of the strategic alternatives available with respect to the
Company's remaining assets. In connection with the credit facility
restructurings, LLIH agreed to provide the Company with up to $40 million of
unsecured subordinated indebtedness.
The dramatic increase in interest rates spreads on mortgage-related debt
instruments also meant that fulfilling the Company's existing whole Mortgage
Loan commitments would be impracticable. The resale value of the Mortgage Loans
underlying such commitments had fallen significantly, rendering any subsequent
resale or securitization of such loans unprofitable. In October, the Company
began discussions with borrowers
7
<PAGE> 11
that had Mortgage Loans from the Company under commitment. The Company was able
to negotiate terminations of several commitments. These terminations required
the Company to pay third party costs, legal costs and in many cases, a fee to
the borrower. As a result of these terminations, the Company realized losses of
$1,116,400 on the termination of $59,315,000 in Mortgage Loan commitments during
the fourth quarter.
SALES OF ASSETS
During the fourth quarter ended December 31, 1998, the Company sold two
CMBS for $13.8 million resulting in a loss of $1.1 million and seven Mortgage
Loans for $68.8 million resulting in a loss of $5.3 million. Subsequent to
December 31, 1998, the Company accepted a discounted payoff of its remaining
Mortgage Loan for $15.1 million resulting in a realized loss of $798,000, all of
which was recognized in 1998.
In February, 1999 the Company sold a CMBS for $8.8 million resulting in a
realized loss of $0.6 million, of which $0.5 million was recognized in 1998. The
proceeds were used to repay borrowings under the Deutsche Bank Agreement.
The amended credit facilities and LLIH Agreement provided the Company with
the necessary liquidity in the short term to fund its Mortgage Loan commitments,
meet margin calls and hold investments. In order to meet the Company's
restructured debt maturities and hedging liabilities, the Company began
marketing a package of investments in early March 1999. On March 31, 1999 the
sale of a package of CMBS was completed. The total proceeds were $39.0 million,
resulting in a realized loss of $13.6 million, of which $11.2 million was
recognized in 1998. The Company used the proceeds to repay in full its
borrowings from Morgan Guaranty Trust. In connection with its sale of
investments on March 31, 1999, the Company entered into an agreement to sell a
Mezzanine Investment to GMAC Commercial Mortgage Corporation ("GMAC"). The
agreement allows the Company to repurchase the investment no later than April 1,
2000 (transaction referred to hereafter as the "GMAC Repo"). The GMAC Repo is
expected to close no later than April 5, 1999, and will generate proceeds of
$10.5 million. The Company paid a fee of $105,000 in connection with the GMAC
Repo. The repurchase price of the GMAC Repo will be adjusted such that GMAC will
receive an 8% annualized yield on its investment if the Company repurchases the
investment prior to October 1, 1999. After October 1, 1999, the repurchase price
is fixed at $9.6 million. The Company will use the proceeds of the GMAC Repo to
repay borrowings from LLIH and to meet its remaining corporate obligations,
which primarily consist of hedging liabilities.
On March 25, 1999, the Company sold a 51,388 square foot office complex
located in Atlanta, Georgia. Proceeds of the sale were $3.8 million, resulting
in a realized loss of approximately $258,000, all of which was recognized in
1998.
COMPETITION
The Company is engaged in a business that has become increasingly
competitive as more companies enter the market. In acquiring real estate related
assets generally, the Company competes with other REITs, investment banking
firms, savings and loan associations, banks, mortgage bankers, insurance
companies, mutual funds and other lenders and other entities purchasing similar
assets, many of which have established operating histories and procedures, may
have access to greater capital and other resources and may have other advantages
over the Company in conducting certain businesses and providing certain
services.
CONFLICTS OF INTEREST
The Company is subject to conflicts of interest involving the Manager. In
addition to the Management Agreement, the Company has a number of relationships
with the Manager and its affiliates, some of which may give rise to conflicts of
interest. Transactions that may give rise to a conflict of interest between the
Company's shareholders and the Manager include, but are not limited to,
borrowings under the LLIH Agreement and the sale of assets to repay such
indebtedness the re-negotiation of the Management Agreement between the Company
and the Manager, the Company's origination of a Mortgage Loan for a client of
the Manager, the Company's investment in a joint venture with a client of the
Manager, the hiring of
8
<PAGE> 12
an affiliate of the Manager to manage or develop a property owned by the
Company, and the Company's purchase or sale of assets from the Manager or its
affiliates.
The market in which the Company purchases assets is characterized by rapid
evolution of products and services and, as a result, there may, currently or in
the future, be relationships between the Company, the Manager, and affiliates of
the Manager in addition to those described herein.
Officers and Directors. The executive officers of the Company are officers
and employees of the Manager. A majority of the Company's directors have no
business affiliations with the Manager ("Independent Directors"), but were
initially selected by the Manager. Matthew L. Banks, the Chairman of the Board,
is Chief Executive Officer of the Manager. Kurt L. Wright, the President and
Chief Executive Officer and a Director of the Company, is an Executive Vice
President of the Manager.
Role of Independent Directors. The relationships between the Company, on
the one hand, and the Manager and its affiliates, on the other, is governed by
policy guidelines that have been approved by a majority of the Independent
Directors. The guidelines establish certain parameters for the operations of the
Company, including quantitative and qualitative limitations on the Company's
assets that may be acquired. The guidelines are intended to assist and instruct
the Manager and to establish restrictions applicable to transactions with
affiliates of the Manager. Transactions with affiliates of the Manager must be
approved by a majority of the Independent Directors. The Independent Directors
will, however, review the Company's transactions on a quarterly basis to ensure
compliance with the guidelines.
In addition, the Special Committee, which is made up solely of Independent
Directors, was established to negotiate the terms of and approve any action by
the Company that the Special Committee determines involves a conflict of
interest with Lender Lease Corporation. Harald R. Hansen, Elizabeth Kennan and
W. J. Smith were appointed to serve on the Special Committee. The Special
Committee has engaged Alston & Bird LLP as its independent counsel and Chase
Securities, Inc. as its independent financial advisor. Each of the members of
the Special Committee was paid $4,500 in additional Board fees in 1998 for
service on the Special Committee.
Although the Independent Directors review the guidelines periodically and
monitor compliance with those guidelines, investors should be aware that, in
conducting this review, the Independent Directors rely primarily on information
provided to them by the Manager.
If the Independent Directors determine in their periodic review of
transactions that a particular transaction does not comply with the guidelines,
then the Independent Directors will consider what corrective action, if any, can
be taken. Moreover, if transactions are consummated that deviate from the
guidelines, then the Independent Directors will have the option, under the terms
of the Management Agreement, to terminate the Manager. In such event, a
termination fee will be owed to the Manager unless the Manager's actions
demonstrate bad faith, willful misconduct, gross negligence or reckless
disregard of its duties.
MANAGEMENT AGREEMENT
The Company entered into the Management Agreement with the Manager for an
initial two-year term expiring on April 28, 2000. Thereafter, successive
extensions, each for a period not to exceed 24 months, may be made by agreement
between the Company and the Manager, subject to the affirmative vote of a
majority of the Independent Directors. The Company may terminate, or decline to
extend the term of, the Management Agreement without cause at any time after the
initial term upon 60 days written notice by a majority vote of the Independent
Directors; provided that the Company shall pay the Manager a termination fee
equal to the sum of the base management fee and incentive management fee, if
any, earned with respect to the immediately preceding four fiscal quarters. This
requirement may adversely affect the Company's ability to terminate the Manager
without cause. In addition, Independent Directors of the Company may terminate
the Management Agreement upon the occurrence of certain specified events,
including a material breach by the Manager of any provision contained in the
Management Agreement, without the payment of any termination fee. If the
Management Agreement is terminated for any reason, LLIH will have certain
registration rights with respect to its Common Stock.
9
<PAGE> 13
The Manager at all times is subject to the supervision of the Company's
Board of Directors and has only such functions and authority as the Company may
delegate to it. The Company relies on the Manager's expertise in six principal
areas: (i) portfolio management; (ii) equity acquisition and loan origination;
(iii) equity asset management; (iv) interim servicing; (v) special servicing;
and (vi) monitoring servicing. The Manager is responsible for the day-to-day
operations of the Company and performs (or causes to be performed) such services
and activities relating to the assets and operations of the Company as may be
appropriate.
Asset Management Fee. The following table presents all compensation, fees
and other benefits (including reimbursement of certain out-of-pocket expenses)
that the Manager may earn or receive under the terms of the Management
Agreement. There are no caps on any category of such compensation, fees or
benefits payable under the Management Agreement.
<TABLE>
<CAPTION>
FEE RECIPIENT PAYOR
- --- --------- -------
<S> <C> <C>
Quarterly base management fee(1) equal to the following:
For the first four fiscal quarters commencing with the
fiscal quarter ended June 30, 1998
1.00% per annum of the Average Invested Assets(2) of
the Company........................................... Manager Company
During each fiscal quarter thereafter
0.85% per annum of the Average Invested Assets up to $1
billion............................................... Manager Company
0.75% per annum of the Average Invested Assets from $1
billion to $1.25 billion.............................. Manager Company
0.50% per annum of the Average Invested Assets in
excess of $1.25 billion............................... Manager Company
Quarterly non-cumulative incentive management fee based on
the amount, if any, by which the Company's Funds From
Operations(3) and certain net gains exceed a hurdle
rate(4)................................................ Manager Company
Termination fee equal to the sum of the base management
fee and incentive management fee, if any, earned during
the immediately preceding four fiscal quarters......... Manager Company
Reimbursement of out-of-pocket expenses of the Manager
paid to third parties(5)............................... Manager Company
</TABLE>
- ---------------
(1) Intended to cover the Manager's costs in providing management services to
the Company. In connection with renewal and re-negotiation of the Management
Agreement, the Board of Directors of the Company may adjust the base
management fee in the future to align it more closely with the Manager's
actual costs of providing such services. The Manager will pay a portion of
this fee to Lend Lease Hyperion Capital Advisors, LLC for sub-management
services performed on behalf of the Company.
(2) The term "Average Invested Assets" for any period means the average of the
aggregate book value of the assets of the Company, including a proportionate
amount of the assets of all of its direct and indirect subsidiaries, before
reserves for depreciation or bad debts or other similar non-cash reserves
less (i) un-invested cash balances and (ii) the book value of the Company's
CMO liabilities, computed by dividing (a) the sum of such values for each of
the three months during such quarter (based on the book value of such assets
as of the last day of each month) by (b) three.
(3) The term "Funds From Operations" as defined by the National Association of
Real Estate Investment Trusts ("NAREIT") means net income (computed in
accordance with GAAP) excluding gains (or losses) from debt restructuring
and sales of property, plus depreciation and amortization on real estate
assets, and after deduction of preferred stock dividends, if any, and
similar adjustments for unconsolidated partnerships and joint ventures.
Funds From Operations does not represent cash generated from operating
activities in accordance with GAAP and should not be considered as an
alternative to net income as an indication of the Company's performance or
to cash flows as a measure of liquidity or ability to make distributions.
(4) The quarterly incentive management fee is equal to the product of (A) 25% of
the dollar amount by which (1) (a) Funds From Operations (before the
incentive fee) of the Company for the applicable
10
<PAGE> 14
quarter per weighted average number of shares of Common Stock outstanding
plus (b) gains (or minus losses) from debt restructuring or sales of assets
not included in Funds From Operations of the Company for such quarter per
weighted average number of shares of Common Stock outstanding, exceed (2) an
amount equal to (a) the weighted average of the price per share at the
initial offering and the prices per share at any secondary offerings by the
Company multiplied by (b) 25% of the sum of the Ten-Year U.S. Treasury Rate
plus four percent, and (B) the weighted average number of shares of Common
Stock outstanding. Because this amount is based on the income of the
Company, it is not currently determinable. The quarterly incentive fee is
non-cumulative. As used in calculating the Manager's compensation, the term
"Ten-Year U.S. Treasury Rate" means the arithmetic average of the weekly
average yield to maturity for actively traded current coupon U.S. Treasury
fixed interest rate securities (adjusted to constant maturities of ten
years) published by the Federal Reserve Board during a quarter, or, if such
rate is not published by the Federal Reserve Board, any Federal Reserve Bank
or agency or department of the federal government selected by the Company.
If the Company determines in good faith that the Ten-Year U.S. Treasury Rate
cannot be calculated as provided above, then the rate shall be the
arithmetic average of the per annum average yields to maturities, based upon
closing asked prices on each business day during a quarter, for each
actively traded marketable U.S. Treasury fixed interest rate security with a
final maturity date not less than eight nor more than twelve years from the
date of the closing asked prices as chosen and quoted for each business day
in each such quarter in New York City by at least three recognized dealers
in U.S. government securities selected by the Company.
(5) There is no cap on the reimbursement of out-of-pocket expenses.
The ability of the Company to generate Funds from Operations in excess of
the Ten-Year U.S. Treasury Rate, and of the Manager to earn the incentive
compensation described in the above table, is dependent upon the level and
volatility of interest rates, the Company's ability to react to changes in
interest rates and to utilize successfully the operating strategies described
herein, and other factors, many of which are not within the Company's control.
The management fees are payable in arrears. The Manager's base and
incentive fees will be calculated by the Manager within 45 days after the end of
each quarter, and such calculation will be promptly delivered to the Company.
The Company is obligated to pay such fees and expenses within 60 days after the
end of each fiscal quarter.
The Manager is expected to use the proceeds from its base management fee
and incentive compensation in part to pay compensation to its officers who,
although they also are officers of the Company, will receive no cash
compensation directly from the Company. During 1998, the Manager earned
$1,096,562 in base management fees and no incentive fees. There were no
out-of-pocket expenses that the Company had to reimburse the Manager.
OPTION PLAN
Eligibility and Awards. All employees (including officers), directors and
others providing services to the Company, as well as the Manager and employees
(including officers) and directors of the Manager (collectively, the "Eligible
Recipients"), will be eligible to receive stock options at the discretion of the
Compensation Committee of the Board of Directors. In addition, 80% of the
options remaining in the option plan following the initial grant of options to
the Manager have been set aside for future option grants to the Manager. Such
reserve does not guarantee that the Manager will be granted such options. The
Compensation Committee will be authorized to determine which Eligible Recipients
shall receive options, and the terms and conditions on which options shall be
granted. The Compensation Committee may grant options to employees of the
Manager, subject to certain limits described in the option plan. Options granted
pursuant to the option plan will be nonqualified stock options. Options granted
to individuals pursuant to the option plan generally are not transferable except
by will or by the applicable laws of descent and distribution. The Manager may
transfer its options to any other Eligible Recipient. Grants of options under
the option plan to persons or entities other than employees and directors of the
Company may result in a charge against the Company's earnings for financial
reporting purposes under GAAP. Any such charge to earnings will be recognized
over the period during which such options become exercisable.
11
<PAGE> 15
The Company has a stock option plan for the Company's executive officers
and the Manager, which provides for the issuance of up to 2,500,000 shares of
Common Stock. At the closing of the Offering, the Company granted the Manager a
fully vested option to purchase 1,166,667 shares of Common Stock exercisable at
the Offering price of $15.00 per share. The Manager received the stock option as
compensation for its efforts in completing the Offering. The Manager granted a
portion of its options to the individual officers of the Company. One-fourth of
the Manager's options become exercisable on each of the first four anniversaries
of the Offering. Unless exercised, these options expire in 2008.
The underwriters sold in the Offering 79,586 shares of Common Stock to
directors and officers of the Company and the Manager for $15.00 per share.
Pursuant to the Company's Directed Share Program, such individuals were granted
an option to purchase one share of Common Stock for each share purchased in the
Offering at an exercise price of $15.00 per share. One-fifth of the options
became exercisable immediately, and one-fifth of the options become exercisable
on each of the first four anniversaries of the Offering. Unless exercised, these
options expire in 2008.
Exercise Price and Exercisability. The exercise price of all options will
be not less than 100% of the fair market value of the Common Stock subject to
the options on the date of grant. All options will become exercisable as
determined by the Compensation Committee at the time of the award. Options
granted under the plan generally will be exercisable in five equal installments
on the date of grant and each of the four anniversaries of the date of grant.
The exercise price of an option may be paid by any one or more of the following:
(i) cash or certified check, (ii) shares of Common Stock held more than six
months, (iii) cancellation of any indebtedness owed by the Company, (iv) a
full-recourse promissory note, if approved by the Committee or (v) a "cashless"
exercise pursuant to a sale through a broker of all or a portion of the shares
covered by the option.
Termination of Employment. If an Eligible Recipient's affiliation with the
Company is terminated for cause or if such Eligible Recipient terminates his
affiliation voluntarily, all of such Eligible Recipient's unexercised options
will terminate immediately upon such termination. Except as otherwise determined
by the Compensation Committee, if an Eligible Recipient has a termination of
affiliation because of death or total and permanent disability or for any other
reason (other than a voluntary termination or a termination for cause), all of
such Eligible Recipient's unexercised options may be exercised by the Eligible
Recipient or his beneficiary or legal representative to the extent such options
are or become exercisable in accordance with their terms during the shorter of
(i) the one-year period following the Eligible Recipient's death or total and
permanent disability or, if longer, a period to be determined by the Board
acting in its absolute discretion or (ii) the period of the remaining life of
the option. If an Eligible Recipient has a termination of affiliation for any
reason other than death, total and permanent disability, a voluntary termination
or a termination for cause, all of such Eligible Recipient's unexercised options
may be exercised by the Eligible Recipient on the date of such termination or
during the 90 day period immediately following such termination or, if less,
during the remaining life of the option. Upon termination of the Manager, all
options granted to employees of the Manager will become immediately exercisable
for a period of 90 days from such termination.
Amendment and Termination. The Board of Directors generally may amend the
option plan at any time, except that approval by the Company's shareholders will
be required for any amendment that increases the aggregate number of shares of
Common Stock that may be issued pursuant to the option plan, that materially
changes the class of persons eligible to receive such options, that extends the
maximum option term or that decreases the exercise price of any option to less
than the fair market value of the Common Stock on the date of grant. Shares of
Common Stock subject to options that expire, are terminated or otherwise are
surrendered to the Company will be available for issuance in connection with
future awards under the option plan. No option term may exceed ten years from
the date of grant, and no option grant may be made under the option plan after
the tenth anniversary of the date the option plan was adopted by the Board of
Directors.
LIMITS OF RESPONSIBILITY
Pursuant to the Management Agreement, the Manager does not assume any
responsibility other than to render the services called for thereunder and is
not responsible for any action of the Company's Board of
12
<PAGE> 16
Directors in following or declining to follow its advice or recommendations. In
addition, the Manager does not owe any fiduciary duties to the Company and its
shareholders. The Manager, its directors and its officers are not liable to the
Company, any subsidiary of the Company, the Independent Directors, the Company's
shareholders or any subsidiary's shareholders for acts performed in accordance
with and pursuant to the Management Agreement, except by reason of acts
constituting bad faith, willful misconduct, gross negligence or reckless
disregard of their duties under the Management Agreement. The Company has agreed
to indemnify the Manager, its directors and its officers with respect to all
expenses, losses, damages, liabilities, demands, charges and claims arising from
acts of the Manager not constituting bad faith, willful misconduct, gross
negligence or reckless disregard of duties, performed in good faith in
accordance with and pursuant to the Management Agreement.
The Management Agreement does not limit or restrict the right of the
Manager or any of its officers, directors, employees or affiliates from engaging
in any business or rendering services of any kind to any other person, including
the purchase of, or rendering advice to others purchasing, assets that meet the
Company's policies and criteria.
EMPLOYEES
As of December 31, 1998, the Company had no employees. The Company is
managed by the Manager. The Company is not party to any collective bargaining
agreement.
REIT STATUS
The Company plans to make an election to be taxed as a REIT under the Code,
commencing with its first REIT taxable year ended on December 31, 1998. The
Company believes that it qualifies for taxation as a REIT and therefore will not
be subject to federal corporate income tax on net income that it distributes
currently.
To qualify as a REIT under the Code, the Company must meet several
requirements regarding, among other things, the ownership of its outstanding
stock, the sources of its gross income, the nature of its assets, and the levels
of distributions to the shareholders. These requirements are highly technical
and complex, and the Company's determination that it qualifies as a REIT
requires an analysis of various factual matters and circumstances that may not
be entirely within the Company's control. Accordingly, there can be no assurance
that the Company has qualified or will remain qualified as a REIT.
If the Company fails to qualify for taxation as a REIT in any taxable year,
and certain relief provisions of the Code do not apply, the Company will be
subject to tax (including any applicable alternative minimum tax) on its taxable
income at regular corporate rates. Distributions to the Company's shareholders
in any year in which the Company fails to qualify will not be deductible by the
Company nor will they be required to be made. In such event, to the extent of
the Company's current and accumulated earnings and profits, all distributions to
shareholders will be taxable as ordinary income and, subject to certain
limitations of the Code, corporate distributees may be eligible for the
dividends received deduction. Unless entitled to relief under specific statutory
provisions, the Company also will be disqualified from taxation as a REIT for
the four taxable years following the year during which the Company ceased to
qualify as a REIT. It is impossible to predict whether the Company would be
entitled to such statutory relief.
INVESTMENT PORTFOLIO
The Company was organized to invest in commercial and multifamily mortgage
and real estate related assets sourced, managed and actively serviced through
the Manager's offices located in major metropolitan markets throughout the
United States. As of December 31, 1998, the Company's real estate related
investments included $71,567,475 of CMBS, $44,374,346 of Mezzanine Investments,
a $15,150,400 Mortgage Loan and $7,294,583 of real estate investments. The CMBS
and Mezzanine Investments were recorded at the lower of cost or fair value in
order to recognize impairment losses. The Mortgage Loan and real estate
investments were also recorded at the lower of cost or fair value since they
were held for sale at December 31, 1998. During the year, the Company acquired
$18,423,411 in additional CMBS and $68,826,722 in additional
13
<PAGE> 17
Mortgage Loans. These investments were sold before year-end and resulted in
realized losses of $1,124,753 on the sale of CMBS, and $5,325,524 on the sale of
Mortgage Loans. In addition, the Company incurred a loss of $1,116,400 on the
termination of Mortgage Loan commitments.
COMMERCIAL MORTGAGE-BACKED SECURITIES
During 1998, the Company acquired $127,077,975 in CMBS investments. Prior
to December 31, 1998, the Company sold $18,928,000 of its CMBS resulting in a
realized loss of $1,167,179. The Company recorded impairment losses on the
remainder of its CMBS in the amount of $16,676,570 at December 31, 1998.
The following table shows the Company's CMBS portfolio as of December 31,
1998:
<TABLE>
<CAPTION>
WEIGHTED ESTIMATED
AVERAGE AMORTIZED IMPAIRMENT AMORTIZED COST FAIR
SECURITY RATING LIFE COST LOSSES ADJUSTED VALUE
- --------------- -------- ----------- ----------- -------------- -----------
<S> <C> <C> <C> <C> <C>
CMBS:
BBB-.................... 7/7/12 $ 9,452,762 $ 541,562 $ 8,911,200 $ 8,911,200
BB...................... 2/6/13 15,861,815 2,922,753 12,939,062 12,939,062
BB...................... 6/30/12 20,658,847 3,490,551 17,168,296 17,168,296
BB-..................... 4/26/13 4,368,958 951,933 3,417,025 3,417,025
B....................... 7/7/11 32,282,831 6,815,014 25,467,817 25,467,817
B-...................... 4/26/13 2,808,723 674,162 2,134,561 2,134,561
Unrated................. 4/26/13 2,810,109 1,280,595 1,529,514 1,529,514
----------- ----------- ----------- -----------
Total........... $88,244,045 $16,676,570 $71,567,475 $71,567,475
=========== =========== =========== ===========
</TABLE>
The Company's investments in CMBS are supported by mortgage loans on the
following property types and are located in the following regions:
<TABLE>
<CAPTION>
PROPERTY TYPE % REGION %
- ------------- --- ------ ---
<S> <C> <C> <C>
Hotel................................ 28 Northeast............................ 34
Retail............................... 21 West................................. 30
Other................................ 21 Southeast............................ 24
Office............................... 13 Midwest.............................. 12
Multifamily.......................... 11
Industrial........................... 6
</TABLE>
From January 1, 1999 to March 31, 1999 the Company has sold certain of its
CMBS investments. The total proceeds from the sales were $47.8 million resulting
in a realized loss of $14.2 million, of which $11.7 million was recognized in
1998.
MEZZANINE INVESTMENTS
As of December 31, 1998, the Company's Mezzanine Investments consisted of
the following:
<TABLE>
<CAPTION>
ESTIMATED
UNDERLYING INTEREST MATURITY AMORTIZATION FACE AMORTIZED IMPAIRMENT CARRYING FAIR
SECURITY RATE DATE PERIOD VALUE COST LOSS VALUE VALUE
- ---------- -------- ---------- ------------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Office............... 12.00% 05/01/2007 Interest Only $21,000,000 $24,635,473 $4,260,059 $20,375,414 $21,000,000
Hotel................ 11.77* 06/30/2003 Interest Only 19,647,200 19,722,940 2,958,676 16,764,264 16,764,264
Multi-family......... 10.63** 08/01/2008 10 years 2,800,000 2,746,565 372,308 2,374,257 2,374,257
Retail............... 9.69* 05/01/2005 7.5 years 4,570,896 4,488,901 459,590 4,029,311 4,029,311
Other................ 10.57** 07/01/2008 10 years 1,000,000 975,958 144,858 831,100 831,100
----------- ----------- ---------- ----------- -----------
Total........ $49,018,096 $52,569,837 $8,195,491 $44,374,346 $44,998,932
=========== =========== ========== =========== ===========
</TABLE>
- ---------------
* Interest rates are for year ended December 31, 1998 however, these interest
rates are adjustable from period to period.
14
<PAGE> 18
** Interest rates represent the stated coupon rates written into the contract.
The yield to maturities for the multi-family and other underlying security
are 12% and 11.82% respectively.
The Company's $19,647,200 Mezzanine Investment is a British pounds Sterling
loan. The Company purchased the investment for L.11.98 million. Interest on the
loan is based on Sterling Libor ("Base Rate") plus 4.00%. The exchange rate at
the date of investment was 1.64 dollars per pound. In order to reduce the risk
of foreign currency exchange rate fluctuations, the Company entered into a
foreign currency swap arrangement with Merrill Lynch Capital Services, Inc. The
swap arrangement provides the Company with an exchange rate of $1.64 per pound
on the return of its principal regardless of exchange rate fluctuation. The swap
arrangement also converts the Base Rate to US$ Libor minus 0.06% regardless of
movements in the Sterling Libor. The Company is subject to foreign currency risk
on the spread portion (4.00%) of the quarterly interest payments. The market
value of the currency swap at December 31, 1998 was a liability of $242,000. The
foreign currency swap arrangement expires on the maturity date of the related
loan.
MORTGAGE LOANS
As of December 31, 1998, the Company's investment in Mortgage Loans
consisted of White Station Tower, first Mortgage Loan in the amount of
$16,000,000 that closed in July 1998. The loan is a 10-year loan on which
principal and interest are paid monthly at an annual interest rate of 7.11%. The
collateral is a 278,000 square foot office building in Memphis, Tennessee. As of
December 31, 1998, the loan was recorded at its negotiated payoff amount. A
discounted pay off was accepted on January 4, 1999 for $15,150,400, resulting in
a realized loss of $797,810.
REAL PROPERTIES
As of December 31, 1998, the Company's investment in real property
consisted of the following:
Lakeside Plaza. In June 1998, the Company acquired a 72,829 square
foot, specialty retail and commercial center located in Stockton,
California for $3,675,000. The property was originally built in 1981. The
property consists of one single tenant store anchored by a 26,000 square
foot Marshall's and a multi-tenant strip retail building. The multi-tenant
building contains one level of storefronts on the north side and two levels
of storefronts on the south side containing an additional 46,829 square
feet. The total site is 4.39 acres.
Bryarwood 85. In September 1998, the Company acquired a 51,388 square
foot office complex located in Atlanta, Georgia for $4,058,500. The
property has two buildings, each occupied by one tenant. The largest
building is 44,974 square feet and is occupied by BellSouth. The second
building is 6,414 square feet and is occupied by MCG Communications. The
property was originally built in 1969. In 1998 the property underwent
improvements to complete an ADA ramp and restroom, exterior stucco was
repainted and repaired, a new built-up roof system was completed and the
electrical supply to the property was upgraded. The property was sold on
March 25, 1999 for $3.8 million, resulting in a realized loss of $258,000,
all of which was recognized in 1998.
At December 31, 1998, the Company's investments in real estate are held for
sale. Accordingly, the Company wrote down its investments in real estate to
estimated fair value and recognized an impairment loss of $447,505. The
Company's ability to hold its real estate investments has been negatively
affected by the recent turmoil in the financial markets and its effect on the
value of the property, along with the restructuring of its debt agreements.
15
<PAGE> 19
Minimum future rentals to be received on real estate properties under
leases in effect as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
PROPERTY 1999 2000 2001 2002 2003 THEREAFTER TOTAL
- -------- ------ ------ ---- ---- ---- ---------- ------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Lakeside Plaza................. $ 415 $ 398 $234 $ 66 $ 58 $ 41 $1,212
Bryarwood 85................... 697 718 739 761 432 339 3,686
------ ------ ---- ---- ---- ---- ------
Totals............... $1,112 $1,116 $973 $827 $490 $380 $4,898
====== ====== ==== ==== ==== ==== ======
</TABLE>
The major tenants occupying more than ten percent of leasable space at each
of the Company's real estate properties are as follows:
<TABLE>
<CAPTION>
PERCENTAGE OF
LEASABLE
PROPERTY MAJOR TENANTS SPACE
- -------- ------------- -------------
<S> <C> <C>
Lakeside Plaza.............................. Marshall's 35.7%
California Fitness 12.4
Bryarwood 85................................ BellSouth 87.5
MGC Communications 12.5
</TABLE>
ITEM 2. PROPERTIES.
The Company does not maintain any offices. It relies on the facilities of
the Manager. In addition, reference is made to the section captioned
"Business -- Real Properties" in Item 1, which is incorporated by reference
herein.
ITEM 3. LEGAL PROCEEDINGS.
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded under the symbol "CHAS" on the Nasdaq
Stock Market. Below is a table of the high and low sale prices for the Common
Stock during the three quarters of 1998 after the Offering on April 23, 1998.
<TABLE>
<CAPTION>
QUARTER HIGH LOW
- ------- ------ ------
<S> <C> <C>
2nd qtr. 98................................................. $15.50 $12.88
3rd qtr. 98................................................. 13.38 7.75
4th qtr. 98................................................. 10.88 2.53
</TABLE>
On March 30, 1999, the Company's Common Stock closed at $5.38 per share. As
of March 30, 1999 there were approximately 10 shareholders of record (including
holders who were nominees for a number of beneficial shareholders) of the
Company's Common Stock.
During 1998, the Company paid total dividends of $0.41 per share. A $0.09
per share dividend was declared for shareholders of record on June 30, 1998 and
paid on July 15, 1998. A $0.32 per share dividend was declared for shareholders
of record on September 30, 1998 and paid on October 15, 1998. On November 13,
1998, the Company announced that the fourth quarter dividend had been suspended.
Under its borrowing arrangements with Morgan Guaranty Trust and LLIH, the
Company is allowed to pay distributions
16
<PAGE> 20
only to meet the requirements of a REIT. The Company was not required to pay any
dividends in the fourth quarter of 1998 due to net taxable losses incurred for
the year.
ITEM 6. SELECTED FINANCIAL DATA.
The following sets forth selected financial data for the entire year ended
December 31, 1998 and selected quarterly financial data for the year ended
December 31, 1998:
<TABLE>
<CAPTION>
YEAR ENDED QTR ENDED QTR ENDED QTR ENDED QTR ENDED
31-DEC-98 31-DEC-98 30-SEP-98 30-JUN-98 31-MAR-98
------------ ------------ ------------ ------------ ---------
<S> <C> <C> <C> <C> <C>
Total revenue................. $ 9,374,394 $ 4,406,914 $ 3,595,081 $ 1,372,399
Net income (loss)............. (45,671,695) (7,605,299) (38,169,032) 102,636
Net income (loss) per common
share....................... (5.54) (1.03) (4.46) .01
Total assets.................. 154,512,426 154,512,427 182,752,533 127,455,082 1,000
Cash distributions per
share....................... $ .41 $ -- $ .32 $ .09 $ --
</TABLE>
The above selected financial data for the 1998 should be read in
conjunction with the consolidated financial statements and the related notes
appearing elsewhere in this annual report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion of the Company's consolidated financial condition,
results from operations, and capital resources and liquidity should be read in
conjunction with the Financial Statements and related Notes included in Item 8.
CAPITAL RESOURCES AND LIQUIDITY
Liquidity is the ability for the Company to meet its cash requirements
including any ongoing commitments, borrowings, shareholder distributions,
lending and general business activities. The Company's source of liquidity
during the period ended December 31, 1998 consisted of net proceeds from the
Offering, borrowings under the Master Loan and Security agreement with Morgan
Guaranty Trust (the "Morgan Guaranty Trust Agreement"), borrowings under the
Merrill Lynch Agreement, borrowings under the LLIH Agreement and repurchase
financing from the Deutsche Bank Agreement. The net proceeds from the Offering
were $102,951,000.
From the date of the Offering until the funds were invested in real estate
assets, the Offering proceeds were held in a short-term investment account
earning an annualized yield of 6.15%. Once the Offering proceeds were fully
invested, the Company began to utilize the Master Loan and Security Agreement
that was established with Morgan Guaranty Trust in the amount of $450,000,000,
the Merrill Lynch Agreement in the amount of $35,000,000 and the Deutsche Bank
Agreement, with unlimited transactions subject to the approval of both Deutsche
Bank and the Company. After the Company's disclosure in October 1998 that it
would need to restructure its debt in order to avoid default status under the
debt covenants with Merrill Lynch and Morgan Guaranty Trust, the Company
negotiated amendments to both lines. The Morgan Guaranty Trust debt had two
amendments dated November 13, 1998 and January 29, 1999, respectively. The first
amendment reduced the available line of credit to $90,000,000 until January 31,
1999 and $50,000,000 thereafter. The interest rate was increased to 150 basis
points over Libor until December 31, 1998 and 200 basis points over Libor until
March 31, 1999, the new termination date. The second amendment reduced the
required cash on hand by the Company from $10,000,000 to $5,000,000. On February
8, 1999, Morgan Guaranty Trust agreed to a waiver of the Maintenance of Interest
Coverage Ratio, one of its debt covenants, for the fourth quarter of 1998. The
Merrill Lynch Agreement has been amended three times, first on October 23, 1998,
second on January 27, 1999 and third on February 25, 1999. The first amendment
granted an extension for repayment until January 31, 1999. The second amendment
increased the borrowing rate to 500 basis points over Libor, reduced the line to
$8,005,918 and extended the maturity date until February 26, 1999. The third
amendment extended the maturity date until March 25, 1999. As a result of a
cross-default clause in the Merrill Lynch
17
<PAGE> 21
Agreement, the Company obtained a waiver from Merrill Lynch of its failure to
meet the Maintenance of Interest Coverage Ratio in the Morgan Guaranty Trust
Agreement.
During the fourth quarter, the Company also entered into a unsecured
subordinated debt agreement in the amount of $40,000,000 with LLIH. The debt
originally matured on March 31, 1999, but has been extended to April 5, 1999,
and has an annual interest rate of 14% until January 31, 1999 and 16%
thereafter. As a result of a cross-default clause in the LLIH Agreement, the
Company obtained a waiver from LLIH of its failure to meet the Maintenance of
Interest Coverage Ratio in the Morgan Guaranty Trust Agreement. As of December
31, 1998, the Company had an outstanding balance of $9,000,000 under the LLIH
Agreement.
As a result of the turmoil in the credit markets during the third and
fourth quarter 1999, the Company cancelled its treasury lock positions and
incurred a liability of $13,070,685.
In order to meet the Company's liquidity needs in early 1999, the Board of
Directors, on January 25, 1999, approved a plan of action to sell a portion of
the Company's assets in order to meet the Company's outstanding obligations. On
February 19, 1999, the Company sold a CMBS for total proceeds of $8.8 million.
The proceeds were used to repay the Company's indebtedness under the Deutsche
Bank Agreement. On March 31, 1999, the Company completed the sale of the package
of CMBS. The total proceeds from the sale were $39.0 million. The Company used
the proceeds to repay its borrowings from Morgan Guaranty Trust. In connection
with its sale of investments on March 31, 1999, the Company entered into an
agreement to sell a Mezzanine Investment to GMAC. The agreement allows the
Company to repurchase the investment no later than April 1, 2000. The GMAC Repo
is expected to close no later than April 5, 1999, and will generate proceeds of
$10.5 million. The repurchase price of the GMAC Repo will be adjusted such that
GMAC will receive an 8% annualized yield on its investment if the Company
repurchases the investment prior to October 1, 1999. After October 1, 1999, the
repurchase price is fixed at $9.6 million. The Company will use the proceeds of
the GMAC Repo to repay borrowings from LLIH and to meet its remaining corporate
obligations, which primarily consist of hedging liabilities.
The Company has paid off and terminated all of its existing credit
facilities with the exception of $8.5 million outstanding to LLIH, which is
expected to be repaid on April 5, 1999 with the proceeds of the GMAC Repo. The
Company's remaining material liability is $10.9 million of accrued losses on
terminated forward Treasury locks. $5.9 million of this liability is due on
April 30, 1999, and $5.0 million is due on July 2, 1999. The Company believes
its net working capital and net operating cash flow will be sufficient to meet
all of the Company's remaining hedging liabilities.
WORKING CAPITAL RESERVES
At December 31, 1998 the Company had $11,957,616 in cash and short-term
investments. Included in the November 1998 debt restructuring were covenants
requiring the Company to maintain a minimum cash balance of $10,000,000. These
covenants were included in its borrowing agreements with Morgan Guaranty Trust
and Merrill Lynch. As of January 31, 1999, the covenants were amended requiring
the Company to maintain a minimum balance of $5,000,000. The excess cash was
used to reduce its outstanding debt. As of March 31, 1999, the minimum cash
requirements were terminated with the termination of the Morgan Guaranty Trust
Agreement.
FINANCIAL CONDITION
Securities available-for-sale. Due to uncertainty of the Company's ability
to hold its CMBS investments until the cost of the CMBS could be recovered, the
Company determined that the decline in the market value of its CMBS below
amortized cost for the year ended December 31, 1998 was other than temporary.
Accordingly, the Company wrote down its investment in CMBS to fair value and
recognized an impairment loss of $16,676,570 for the year ended December 31,
1998. The Company sold two CMBS holdings during the fourth quarter for
$13,823,912, resulting in a realized loss of $1,167,179. On March 31, 1999, the
Company sold $39.0 million of CMBS in order to repay its obligations under its
borrowing agreements.
18
<PAGE> 22
Mezzanine Investment Portfolio. Due to the uncertainty of the Company's
ability to hold the Mezzanine Investments until the cost of the loans could be
recovered, the Company determined that the decline in the market value of the
loans below amortized cost was other than temporary. Accordingly, the Company
wrote down its investments in Mezzanine Investments by $8,195,491 for the year
ended December 31, 1998. In connection with its sale of CMBS on March 31, 1999,
the Company entered into an agreement to sell a Mezzanine Investment to GMAC.
The agreement allows the Company to repurchase the investment no later than
April 1, 2000. The GMAC Repo is expected to close no later than April 5, 1999,
and will generate proceeds of $10.5 million. The repurchase price of the GMAC
Repo will be adjusted such that GMAC will receive an 8% annualized yield on its
investment if the Company repurchases the investment prior to October 1, 1999.
After October 1, 1999, the repurchase price is fixed at $9.6 million. The
Company will use the proceeds of the GMAC Repo to repay borrowings from LLIH and
to meet its remaining corporate obligations, which primarily consist of hedging
liabilities.
Mortgage Loan Portfolio. Due to the uncertainty of the Company's ability
to hold its Mortgage Loans until the cost of the loans could be recovered and
due to the restructuring of its debt agreements, the Company focused on selling
or terminating its Mortgage Loans and Mortgage Loan commitments during the
fourth quarter of 1998. As a result, the Company was able to sell or terminate
all of its loan commitments and all but one of its Mortgage Loans. The activity
resulted in realized losses of $6,441,924 for the year ended December 31, 1998.
The one remaining Mortgage Loan was sold on January 4, 1999 at a loss of
$797,810. This loss was recognized by the Company as an operating loss for the
year ended December 31, 1998.
Real Estate Investments. At December 31, 1998, the Company's two real
estate investments were considered held for sale. Preliminary offers determined
that the values of the properties were less than book value. Thus, the
properties were written down by $447,505 as of December 31, 1998. The Company's
ability to hold its real estate investments had been negatively affected by the
turmoil in the financial markets and its effect on the value of the property and
the Company's cost of capital, along with the restructuring of its debt
agreements. On March 25, 1999 the Company sold one real estate investment for
$3.8 million in order to meet its debt obligations.
Short-term borrowings. During the fourth quarter of 1998, the Company
obtained additional financing from LLIH and restructured its credit facilities
with Morgan Guaranty Trust and Merrill Lynch, as further discussed in "Liquidity
and Capital Resources" and in the footnotes to the Company's consolidated
financial statements as of and for the year ended December 31, 1998 included
herein. The Company used its short-term borrowing arrangements to finance its
investments in certain CMBS, Mortgage Loans and Mezzanine Investments. As of
December 31, 1998, the Company had short-term borrowings totaling $78,844,531.
The total amount was comprised of:
<TABLE>
<CAPTION>
LOAN FACILITY AMOUNT BORROWED ASSETS PLEDGED
- ------------- --------------- --------------
<S> <C> <C>
Morgan Guaranty....... $52,412,238 Bear Stearns, GSMS 1998-GLII G,
ASC 1996-MD6B1 bonds
Merrill Lynch......... 9,505,918 Savoy Mezzanine Investment
Deutsche Bank......... 7,926,375 GMAC 1998-C1 F
LLIH.................. 9,000,000 Unsecured
</TABLE>
19
<PAGE> 23
Treasury locks payable. As a result of the turmoil in the credit market
during the fourth quarter of 1998 and the Company's failure to comply with its
debt agreements, the Company determined that its ability to obtain long-term
fixed rate financing is not probable. The turmoil also created uncertainty as to
the Company's ability to hold its investments. Accordingly, the Company
discontinued hedge accounting for its Treasury locks and incurred a loss of
$13,070,685 on these agreements. As part of its debt restructuring on November
13, 1998, the Company paid $2,390,000 to settle its Treasury locks payable with
Merrill Lynch. The remaining amounts payable and dates due are provided in the
table below. On January 27, 1999, the Company canceled an interest rate collar
at a cost of $265,000.
<TABLE>
<CAPTION>
AMOUNT DUE DUE DATE
---------- --------------
<S> <C> <C>
Salomon Brothers Holding Co., Inc........................... $4,771,187 April 30, 1999
Morgan Guaranty Trust....................................... 1,149,570 May 3, 1999
Morgan Guaranty Trust....................................... 5,034,953 July 2, 1999
</TABLE>
Shareholders' Equity. Shareholders' equity increased by $124,022,858 as a
result of the Offering on April 23, 1998. The increase was primarily offset by
1,634,000 shares of Common Stock repurchased by the Company and retired during
1998, totaling $16,191,994, and net losses of $45,671,695. Also included in the
change were dividends paid of $3,255,239, the value of stock options issued of
$888,773 and shares issued to the Independent Directors in the amount of
$45,000.
RESULTS FROM OPERATIONS
Revenue. Revenue totaled $9,374,394 for the year ended December 31, 1998.
Revenue is comprised primarily of interest income on CMBS investments, Mezzanine
Investments, Mortgage Loans and from the cash proceeds from the Offering before
they were fully invested. The Offering proceeds were fully invested on July 8,
1998. At December 31, 1998, rental income consisted of two real estate
investments. The real estate investments include one retail property located in
Stockton, California and one office building located in Atlanta, Georgia.
Operating Expenses. Operating expenses consist of expenses incurred in
operating the Company, property and investment operations, and totaled
$47,479,412 for the year ended December 31, 1998. Included in the amount were
impairment losses totaling $26,117,376 and losses on forward interest rate
Treasury lock agreements of $13,070,685. These losses are due to financial
market conditions and the widening of credit spreads. As a result of the
Company's restructuring in November 1998, the Company incurred fees of
$1,842,174, $800,000 of which are classified as additional interest expense.
During the year the Company recorded a one-time charge of $877,917 for stock
options issued to the Manager as part of the Offering. Management fees were
calculated at 1% per annum of the Average Invested Assets per quarter and
totaled $1,096,562 for year ended December 31, 1998. The Company also recorded
general and administrative expenses of $745,285 for the year ended December 31,
1998. These costs consist of professional fees, insurance costs and other
miscellaneous expenses.
Loss on Sale of CMBS. The loss on sale of CMBS was a result of the
disposition of two CMBS investments during the fourth quarter for $13,823,912.
The losses totaled $1,167,179. The losses were offset by a second quarter gain
of $42,426 on the sale of CMBS.
Loss on Sale and Settlement of Mortgage Loans. The loss was a result of
the Company's disposition of its Mortgage Loans and Mortgage Loan commitments.
During the fourth quarter of 1998, all of the commitments were sold or
terminated and all but one of its Mortgage Loans were sold. The Company realized
losses of $5,325,524 on the sale of $68,826,722 in Mortgage Loans and incurred
expenses of $1,116,400 on the termination of $59,315,000 of loan commitments,
resulting in a total loss of $6,441,924.
RECENT DEVELOPMENTS
On January 4, 1999 the Company negotiated a discounted payoff of its last
Mortgage Loan, White Station Tower. The Company's current portfolio thereafter
has been primarily comprised of Mezzanine
20
<PAGE> 24
Investments and CMBS. The Company has used the proceeds from the payoff to
continue to reduce its debt obligations.
On January 27, 1999, the Company terminated an interest rate collar at a
cost to the Company of $265,000.
On February 19, 1999 the Company sold a CMBS investment. The total proceeds
from the sale, including accrued interest were $8,862,813. The sale resulted in
a loss of $626,917, $541,561 of which was recognized in 1998. The Company used
$7,955,605 to pay off the amount borrowed from Deutsche Bank and accrued
interest through the date of sale.
On March 25, 1999, the Company borrowed $8,000,000 under its borrowing
agreement with LLIH to pay of its remaining obligation under the Merrill Lynch
Agreement.
On March 31, 1999, the Company sold a package of CMBS for $39.0 million,
resulting in realized losses of $13.6 million, of which $11.2 million was
recognized in 1998. On March 31, 1999, the Company used the proceeds to repay
its borrowings. In connection with its sale of CMBS on March 31, 1999, the
Company entered into the GMAC Repo.
REIT STATUS
The Company plans to make an election to be taxed as a REIT under the Code,
commencing with its first REIT taxable year ending on December 31, 1998. The
Company believes that it qualifies for taxation as a REIT and therefore will not
be subject to federal corporate income tax on its net income that is distributed
currently to its shareholders.
To qualify as a REIT under the Code, the Company must meet several
requirements regarding, among other things, the ownership of its outstanding
stock, the sources of its gross income, the nature of its assets, and the levels
of distributions to its shareholders. These requirements are highly technical
and complex, and the Company's determination that it qualifies as a REIT
requires an analysis of various factual matters and circumstances that may not
be entirely within the Company's control. Accordingly, there can be no assurance
that the Company has qualified or will remain qualified as a REIT.
If the Company fails to qualify for taxation as a REIT in any taxable year,
and certain relief provisions of the Code do not apply, the Company will be
subject to tax (including any applicable alternative minimum tax) on its taxable
income at regular corporate rates. Distributions to the Company's shareholders
in any year in which the Company fails to qualify will not be deductible by the
Company nor will they be required to be made. In such event, to the extent of
the Company's current and accumulated earnings and profits, all distributions to
shareholders will be taxable as ordinary income and, subject to certain
limitations of the Code, corporate distributees may be eligible for the
dividends received deduction. Unless entitled to relief under specific statutory
provisions, the Company also will be disqualified from taxation as a REIT for
the four taxable years following the year during which the Company ceased to
qualify as a REIT. It is impossible to predict whether the Company would be
entitled to such statutory relief.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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
Company is primarily exposed to interest rate and spread risk. Interest rates
and spreads are sensitive to many external forces including, but not limited to,
governmental monetary and tax policies and domestic and international economic
and political factors. These forces are beyond the control of the Manager and
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.
21
<PAGE> 25
The Company may utilize a variety of financial instruments, including
interest rate swaps, caps, floors, and other interest rate 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.
The following table quantifies the potential changes in net interest income
and net asset value should interest rates rise or fall. Due to the restructuring
of the Company's portfolio during the first quarter of 1999, certain assets were
sold and the Company's borrowings were repaid. Thus, the table below calculates
the changes in the assets owned by the Company as of March 31, 1999, over the
calendar year 1999. The results assume that yield curves of the rate changes
will be parallel to each other. Net asset value is calculated as the sum of the
present value of cash in-flows generated from interest-earning assets net of
cash outflows in respect of interest-bearing liabilities. The base interest rate
scenario assumes interest rates at December 31, 1998. All changes in the net
asset value are a result of valuing assets based on changes in interest rates.
These changes do not include the effects of income or dividends. The net
interest income is interest income (excluding interest income on cash) netted
with interest expense. All changes are measured by percentage changes from the
base interest rate. Actual results could differ significantly from these
estimates.
<TABLE>
<CAPTION>
NET
CHANGE IN INTEREST RATE NET INTEREST INCOME ASSET VALUE
- ----------------------- ------------------- -----------
<S> <C> <C>
+400................................................. 15.6% (16.5)%
+300................................................. 11.7 (12.9)
+200................................................. 7.8 (9.0)
+100................................................. 3.9 (4.7)
Base................................................. 0.0 0.0
-100................................................. (3.9) 5.2
-200................................................. (7.8) 10.9
-300................................................. (11.7) 17.2
-400................................................. (15.6) 24.1
</TABLE>
YEAR 2000
The inability of computers, software and other equipment to recognize and
properly process data fields containing a two-digit year is commonly referred to
as the Year 2000 compliance issue ("Y2K"). As the year 2000 approaches, such
systems may be unable to accurately process certain date-based information.
Y2K exposures of the Company are currently being assessed. Potential
critical exposures include reliance on third party vendors and building systems
that are not Y2K compliant. The Company has begun to communicate with third
party service vendors such as the Manager and property managers in an effort to
assess their Y2K compliance status and the adequacy of their Y2K efforts.
The Manager has made Year 2000 compliance a high priority for replacement
applications and is in the process of updating and replacing other applications
that are not Year 2000 compliant. The Manager expects to complete the updating
of its critical systems no later than March 31, 1999, which will allow for nine
months of systems testing to resolve any remaining Year 2000 compliance issues.
However, if any of the vendors of the Manager's Year 2000 compliant software
fail to perform pursuant to their contracts with the Manager, the Manager's Year
2000 compliance could be jeopardized, and could materially adversely affect the
Company. The Manager does not believe that the costs to remediate any Year 2000
issues will materially affect its business, operations or financial condition,
or will have an adverse affect on its clients, including the Company.
Each property owned by the Company is being individually assessed in an
effort to identify critical Y2K issues specific to each property. Required
remediation strategies will depend on the outcome of the
22
<PAGE> 26
assessments and therefore will not be developed until the property assessments
are complete. The Manager expects the majority of critical property assessments
to be completed and remediation efforts to be underway by the end of the first
quarter of 1999.
The Company has not incurred any material costs to date relating to Y2K.
Total property assessment costs to the Company are expected to total
approximately $5,700. These costs were not incurred and therefore not accrued as
of December 31, 1998. Remediation efforts may vary significantly from one
building to the next. Therefore remediation costs can not be reasonably
estimated until the assessments are complete and remediation strategies
determined. The failure to adequately address the Year 2000 issue may result in
the closure of buildings owned by the Company. In order to reduce the potential
impact on the operations of the Company, contingency plans will be developed
once Y2K exposures have been assessed.
Building contingency plans will be developed on a property-by-property
basis once assessments have been completed. This will allow the efficient
development of contingency plans that take into account individual circumstances
surrounding each property. Contingency plans may involve the engagement of
additional security services, implementation of temporary systems modifications,
and the identification and engagement of alternate service vendors. Additional
contingency plans may be developed as circumstances warrant.
With respect to the Company's Mortgage Loans and Mezzanine Investments, the
primary Year 2000 issue relates to potential borrower defaults caused by:
- increased expenses or legal claims related to failures of embedded
technology in building systems,
- reductions in collateral value due to failure of one or more building
systems,
- interruptions in building cash flows due to tenant's inability to make
timely lease payments, inaccurate or incomplete accounting of rents, or
decreases in building occupancy levels,
- the borrower's inability to address all material Y2K issues that may
potentially impact the borrower's operations.
These risks are also applicable to the Company's portfolio of CMBS as these
securities are dependent upon the pool of Mortgage Loans underlying them. If the
investors in these types of securities demand higher returns in recognition of
these potential risks, the market value of the CMBS portfolio of the Company
could also be adversely affected.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
23
<PAGE> 27
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Chastain Capital Corporation
We have audited the accompanying consolidated balance sheets of Chastain
Capital Corporation and its subsidiaries (the "Company") as of December 31, 1998
and 1997 and the related statements of operations, shareholders' equity, and
cash flows for the year ended December 31, 1998 and for the period December 16,
1997 to December 31, 1997. Our audits also included the financial statement
schedules listed in the index at Item 14. These financial statements and
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company at December 31,
1998 and 1997, and the results of its operations and its cash flows for the year
ended December 31, 1998 and for the period December 16, 1997 to December 31,
1997 in conformity with generally accepted accounting principles. Also, in our
opinion, such financial statements schedules, when considered in relation to the
basic consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
/s/ Deloitte & Touche LLP
Atlanta, Georgia
February 5, 1999 (March 31, 1999 as to Notes 1, 10, 15)
24
<PAGE> 28
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Commercial mortgage-backed securities (CMBS) available for
sale, at fair value....................................... $ 71,567,475
Mezzanine loan investments.................................. 44,374,346
Mortgage loan investments................................... 15,150,400
Real estate investments held for sale, net.................. 7,294,583
Cash and short-term investments............................. 11,957,616 $1,000
Escrow cash................................................. 2,138,011
Accrued interest receivable................................. 1,153,989
Other assets................................................ 876,006
------------ ------
Total assets...................................... $154,512,426 $1,000
============ ======
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Short-term borrowings....................................... $ 61,918,156
Subordinated debt to related party.......................... 9,000,000
Borrowings under repurchase agreement....................... 7,926,375
Treasury locks payable...................................... 10,887,660
Accrued management fees..................................... 438,842
Accrued interest expense.................................... 374,759
Accrued expenses and other liabilities...................... 4,127,931
------------ ------
Total liabilities................................. 94,673,723 --
------------ ------
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value. Authorized 25,000,000
shares, no shares issued
Common stock, $.01 par value. Authorized 200,000,000 shares,
7,346,778 and 100 shares issued and outstanding at
December 31, 1998 and 1997, respectively.................. 73,468 $ 1
Additional paid-in capital.................................. 108,692,169 999
Distributions in excess of earnings:
Accumulated losses from operations........................ (38,105,018)
Accumulated losses from sale of assets.................... (7,566,677)
Dividends paid............................................ (3,255,239)
------------ ------
Total distributions in excess of earnings......... (48,926,934) --
------------ ------
Total shareholders' equity........................ 59,838,703 1,000
------------ ------
Total liabilities and shareholders' equity........ $154,512,426 $1,000
============ ======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
25
<PAGE> 29
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEAR
ENDED
DECEMBER 31, 1998
-----------------
<S> <C>
REVENUE:
Interest income on CMBS..................................... $ 4,547,413
Interest income on mezzanine loan investments............... 2,151,517
Interest income on mortgage loan investments................ 851,949
Rental income............................................... 492,995
Other income................................................ 28,648
Other interest income....................................... 1,301,872
------------
Total revenue..................................... 9,374,394
------------
OPERATING EXPENSES:
Impairment loss on CMBS..................................... 16,676,570
Impairment loss on mezzanine loan investments............... 8,195,491
Impairment loss on real estate investments.................. 447,505
Impairment loss on mortgage loan investments................ 797,810
Losses on forward interest rate treasury lock agreements.... 13,119,685
Loss on interest rate collar................................ 216,000
Interest expense............................................ 3,321,327
Management fees............................................. 1,096,562
Restructuring fees.......................................... 1,042,174
Stock compensation to Manager............................... 877,917
General and administrative expense.......................... 745,285
Forfeited deposit on real estate and termination expenses... 669,913
Real estate operating expenses.............................. 154,422
Depreciation and amortization............................... 118,751
------------
Total operating expenses.......................... 47,479,412
------------
OPERATING LOSS BEFORE ASSET SALES........................... (38,105,018)
REALIZED LOSSES ON SALE OF ASSETS
Losses on sale and settlement of mortgage loan investments
and Commitments........................................... (6,441,924)
Net loss on sale of CMBS.................................... (1,124,753)
------------
NET LOSS.......................................... $(45,671,695)
============
NET LOSS PER COMMON SHARE:
Basic and Diluted........................................... $ (5.54)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic and Diluted........................................... 8,237,032
</TABLE>
Chastain Capital Corporation was incorporated on December 16, 1997 and
commenced operations on April 23, 1998 (see Note 1).
See accompanying Notes to Consolidated Financial Statements.
26
<PAGE> 30
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
DISTRIBUTIONS IN EXCESS OF EARNINGS
----------------------------------------------
NUMBER OF ADDITIONAL LOSSES FROM TOTAL
SHARES COMMON PAID-IN ACCUMULATED SALE OF DIVIDENDS SHAREHOLDERS'
OUTSTANDING STOCK CAPITAL OPERATIONS ASSETS PAID EQUITY
----------- -------- ------------ ------------ -------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Initial Contribution
on December 16,
1997............... 100 $ 1 $ 999 $ 1,000
---------- -------- ------------ ------------ ----------- ----------- ------------
Balance at December
31, 1997........... 100 1 999 1,000
Net proceeds from
initial public
offering and
private placement
on April 23, 1998.. 8,977,678 89,777 123,933,081 124,022,858
Shares issued to
Board of
Directors.......... 3,000 30 44,970 45,000
Purchase and
retirement of
common stock....... (1,634,000) (16,340) (16,175,654) (16,191,994)
Value of stock
options issued..... 888,773 888,773
Net loss............. $(38,105,018) $(7,566,677) (45,671,695)
Dividends paid ($0.41
per share)......... $(3,255,239) $ (3,255,239)
========== ======== ============ ============ =========== =========== ============
Balance at December
31, 1998........... 7,346,778 $ 73,468 $108,692,169 $(38,105,018) $(7,566,677) $(3,255,239) $ 59,838,703
========== ======== ============ ============ =========== =========== ============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
27
<PAGE> 31
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE YEAR DECEMBER 16,
ENDED 1997 TO
DECEMBER 31, DECEMBER 31,
1998 1997
------------ --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(45,671,695)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Impairment loss on investments.......................... 26,117,376
Losses on forward interest rate lock agreements......... 13,119,685
Loss on interest rate collar............................ 216,000
Loss on sale of mortgage loan investments............... 5,325,524
Net loss on sale of CMBS................................ 1,124,753
Depreciation and amortization........................... 118,751
Amortization of discount/premium on CMBS
available-for-sale..................................... (396,249)
Amortization of premium on mezzanine loan investment.... 144,526
Stock options issued.................................... 888,773
Shares issued for Directors fees........................ 45,000
Net increase in assets:
Accrued interest receivable........................... (1,153,989)
Other assets.......................................... (930,689)
Net increase in liabilities:
Accrued interest expense.............................. 374,759
Accrued management fees............................... 438,842
Accrued expenses and other liabilities................ 762,207
------------ ------
Net cash provided by operating activities.......... 523,574
------------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of CMBS available-for-sale...................... (106,273,063)
Proceeds from sale of CMBS available-for-sale............. 17,295,745
Purchases of mezzanine loan investments................... (52,873,836)
Purchases of mortgage loan investments.................... (90,110,000)
Proceeds from sale of mortgage loan investments........... 68,756,166
Purchase of real estate investments....................... (6,854,807)
Repayments on loans....................................... 244,342
Capital additions to real estate.......................... (44,290)
------------ ------
Net cash used by investing activities.............. (169,859,743)
------------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering..................... 124,364,120
Proceeds from initial stock purchase...................... -- $1,000
Deferred financing costs incurred......................... (78,633)
Proceeds from loan facilities............................. 159,869,418
Repayments of loan facilities............................. (81,024,887)
Purchase and retirement of common stock................... (16,191,994)
Repayment of treasury lock liability...................... (2,390,000)
Dividends paid............................................ (3,255,239)
------------ ------
Net cash provided by financing activities.......... 181,292,785 1,000
------------ ------
NET INCREASE IN CASH AND CASH EQUIVALENTS:.................. 11,956,616 1,000
Cash and cash equivalents at beginning of period.......... 1,000 0
------------ ------
Cash and cash equivalents at end of period................ $ 11,957,616 $1,000
============ ======
Cash paid for interest.................................... $ 2,946,568 $ --
============ ======
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES:
Accrued public offering costs............................. $ 341,262 $ --
============ ======
Accrued tenant liabilities................................ $ 890,794 $ --
============ ======
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
28
<PAGE> 32
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION
Chastain Capital Corporation (the "Company") was incorporated in Georgia on
December 16, 1997 and was initially capitalized on such date through the sale of
100 shares of common stock, par value $0.01 per share ("Common Stock") for an
aggregate purchase price of $1,000. On April 23, 1998, the Company commenced
operations through the consummation of an initial public offering ("IPO") of
7,380,000 shares of its Common Stock, with gross proceeds of $110,700,000 and
net proceeds to the Company of $102,951,000. Additional public offering costs of
$1,215,750 were incurred in connection with the IPO.
The Company also issued, pursuant to two separate private placements, an
aggregate of 897,678 shares of Common Stock to Lend Lease Investments Holdings,
Inc. ("LLIH", formerly ERE Yarmouth Holdings, Inc.), an indirect wholly-owned
subsidiary of Lend Lease Corporation Limited ("Lend Lease Corporation"), and
700,000 shares of Common Stock to FBR Asset Investment Corporation, an affiliate
of Friedman, Billings, Ramsey & Co., Inc. (lead underwriter of the Company's
IPO). The two private placements closed concurrently with the closing of the
IPO, at $13.95 per share, with total proceeds to the Company of $22,287,608.
Pursuant to the Company's Directors Stock Plan, each of the Company's three
independent directors received, as of the consummation of the IPO, $15,000 worth
of Common Stock equal to 1,000 shares as part of their annual director's fee.
The Company was organized to originate first lien commercial and
multifamily mortgage loans for the purpose of issuing collateralized mortgage
obligations ("CMOs") collateralized by its mortgage loans and retaining the
mortgage loans subject to the CMO debt. The Company also was organized to
acquire subordinated interests in commercial mortgage-backed securities
("CMBS"), originate and acquire loans on real property that are subordinated to
first lien mortgage loans and acquire real property and other real estate
related assets.
On October 23, 1998, the Company announced that due to turmoil in the
credit markets, it was necessary to obtain temporary waivers from Morgan
Guaranty Trust Company of New York ("Morgan Guaranty Trust") and Merrill Lynch
Mortgage Capital, Inc. ("Merrill Lynch") to avoid being in default of tangible
net worth covenants under the Company's credit facilities. The Board of
Directors decided to discontinue new investment activity and concluded that the
Company needed to be restructured. On November 13, 1998, the Company reached an
agreement with Morgan Guaranty Trust and Merrill Lynch to restructure its credit
facilities and to dispose of certain assets to reduce the size and stabilize the
volatility of the overall portfolio. Proceeds from the asset sales were used to
reduce outstanding indebtedness on both credit facilities. Through the asset
sales and indebtedness reduction, the Company was able to satisfy its immediate
liquidity needs. The remaining portfolio consists primarily of CMBS, mezzanine
loan investments and real estate.
In connection with the credit facility amendments, LLIH agreed to provide
the Company with up to $40 million of unsecured subordinated debt. An initial
advance of $17 million was drawn on November 13, 1998 and the remaining funds
can be drawn from time to time by the Company through maturity on March 31,
1999. The advances incur interest at the rate of 14% per annum through January
31, 1999 and 16% thereafter. The advances are pre-payable at any time, subject
to certain notice requirements. The terms of the subordinated debt were reviewed
and approved by a special committee of the Board of Directors consisting of
independent directors not affiliated with Lend Lease. The special committee
obtained the advice of independent financial advisors and legal counsel in
negotiating the terms of the loan.
The amended credit facilities and new subordinated debt agreement provided
the Company with the necessary liquidity in the short term to fund its mortgage
loan commitments, meet margin calls and hold investments. The Merrill Lynch
amendment required the $19 million in outstanding borrowings be repaid on or
before January 31, 1999. On January 27, 1999, the Merrill Lynch Agreement was
further amended, requiring the borrowings to be repaid on or before February 26,
1999. On February 25, 1999, the Merrill
29
<PAGE> 33
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Lynch agreement was again amended, extending the maturity date to March 25,
1999. All outstanding indebtedness under the Merrill Lynch agreement was repaid
on March 25, 1999, and the facility was terminated. All indebtedness under the
Morgan Guaranty Trust agreement was repaid on March 31, 1999. The LLIH
subordinated debt agreement matures on April 5, 1999. The Company continues to
evaluate various strategic alternatives available to maximize shareholder value
and to repay its indebtedness, including additional asset sales, refinancing or
further restructuring of its capital base.
On January 25, 1999, the Board of Directors approved a plan of action to
sell existing assets to meet the debt maturities. From January 25, to March 31,
1999, the Company sold certain CMBS for total proceeds of $47.8 million,
resulting in a realized loss of $14.2 million, of which $11.7 million was
recognized in 1998. On March 25, 1999, the Company sold a real estate asset for
total proceeds of $3.8 million, resulting in a realized loss of $258,000, all of
which was recognized in 1998.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Company include the accounts
of the Company and its wholly owned subsidiaries. All intercompany accounts and
transactions have been eliminated in consolidation.
CASH AND SHORT-TERM INVESTMENTS
All highly liquid investments with maturities of three months or less when
purchased are considered to be short-term investments.
COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a business
during a period from transactions and other events and circumstances, excluding
those resulting from investments by and distributions to owners. For the year
ended December 31, 1998, there is no difference between net loss and
comprehensive net loss.
CMBS
The Company classifies its CMBS as available-for-sale. Available-for-sale
securities are reported at fair value with net unrealized gains and losses
reported in comprehensive income (loss) as a separate component of shareholders'
equity. The Company recognizes income from CMBS under the effective interest
method, using the anticipated yield over the projected life of the investment.
The Company recognizes impairment on its CMBS when it determines that the
decline in the estimated fair value of its CMBS below cost is other than
temporary. Impairment losses are determined by comparing the estimated fair
value of a CMBS to its current carrying amount, the difference being recognized
as a loss. The Company uses specific identification in determining realized
gains/losses on its CMBS.
MEZZANINE LOAN INVESTMENTS
The Company purchased and originated certain mezzanine loans to be held as
long-term investments. Loans held for investment are recorded at cost at the
date of purchase. Premiums and discounts related to these loans are amortized
over their estimated lives using the effective interest method. Any origination
fee income, application fee income and direct costs associated with originating
or purchasing mezzanine investments have been deferred and the net amount is
added to the basis of the loans on the balance sheet. The Company recognizes
impairment on the loans when it is probable that the Company will not be able to
collect all amounts due according to the contractual terms of the loan
agreement, or when the fair value of the loans is below amortized cost and the
Company determines that it may not be able to hold the loans until
30
<PAGE> 34
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amortized cost is recovered. As a result of the Company's November restructuring
and the Board's decision to discontinue new investment activity and to sell
assets to repay the Company's indebtedness, it is currently unlikely that the
Company will hold its mezzanine loan investments until maturity. At December 31,
1998, mezzanine loans are recorded at lower of amortized cost or estimated fair
value. The Company measures impairment based on the present value of expected
future cash flows discounted at the loan's effective interest rate or
management's estimates of the fair value of the loan.
MORTGAGE LOAN INVESTMENTS
The Company originated mortgage loans to be held as long-term investments.
Interest income was recognized using the effective interest rate method. Due to
the turmoil in the credit markets in October 1998, and the Company's revised
credit facility terms, the Company changed its strategy and is now holding its
mortgage loans for resale. Loans held for resale are accounted for at the lower
of cost or estimated fair value. Fair value is determined based upon the
Company's estimate of market value. Subsequent to December 31, 1998, the Company
sold its remaining mortgage loan investment.
REAL ESTATE INVESTMENTS
Real estate assets are stated at cost when purchased and are subsequently
reduced by depreciation charges using the straight-line method over the
estimated useful lives of the assets. At December 31, 1998, the Company's
investment in real estate is classified as held for sale and is carried at the
lower of cost or estimated fair value less estimated selling costs.
Rental income was being recognized over the life of the tenant leases using
the straight-line method. The Company eliminated the effect of the straight-line
adjustment when the properties were reclassified as held for sale.
INTEREST RATE PROTECTION AGREEMENTS
The Company acquired interest rate protection agreements, in the form of
forward treasury locks, to reduce its exposure to interest rate risk on
anticipated long-term borrowings. At the time the treasury locks were acquired
it was anticipated that they would hedge the Company's exposure to future
financing costs and thus qualify for hedge accounting. Under hedge accounting,
any gain or loss on the treasury lock settlements would be amortized over the
term of the anticipated financing agreement. To qualify for hedge accounting,
these interest rate protection agreements must meet certain criteria including:
(1) the debt to be hedged exposes the Company to interest rate risk, (2) the
interest rate protection agreement reduces the Company's exposure to interest
rate risk, and (3) it is probable that the anticipated financing will occur. In
the event these interest rate protection agreements do not qualify as hedges,
such agreements are reclassified to be investments accounted for at fair value,
with any gain or loss included as a component of income or loss in the statement
of operations.
As a result of the turmoil in the credit markets in October 1998, the
Company determined that its ability to obtain long-term, fixed-rate financing
was no longer probable. On October 23, 1998 the Company terminated all of its
treasury locks and incurred a realized loss of $13.3 million.
On July 13, 1998 the Company entered into a Libor collar in the notional
amount of $89 million to mature on July 1, 1999, in order to hedge against
rising short term borrowing costs. The collar contract effectively locked in the
Company's Libor base rate between a floor of 5.51% and a ceiling of 5.80% during
the term. At December 31, 1998, the Company no longer considered the interest
rate collar as a hedge, and accordingly recorded the fair value of the collar as
a liability through a charge to income. The Company terminated the collar
contract on January 27, 1999 and realized a loss of $265,000.
31
<PAGE> 35
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ESCROW CASH
Good faith deposits received from borrowers for mortgage loans to which the
Company is committed are included in escrow cash with a corresponding escrow
liability.
INCOME TAXES
The Company plans to make an election to be taxed as a REIT under the
Internal Revenue Code of 1986, as amended, commencing with its first REIT
taxable year ended on December 31, 1998. As a REIT, the Company generally is not
subject to federal corporate income taxes on net income that it distributes to
shareholders, provided that the Company meets certain other requirements for
qualification as a REIT under the Code. Because the Company believes that it
qualified as a REIT with respect to its taxable year ended December 31, 1998,
and because the Company is reporting net losses for such year, no provision has
been made for federal income taxes for the Company and its subsidiaries in the
accompanying consolidated financial statements.
All dividends declared and paid during 1998 represent a return of capital.
NET LOSS PER SHARE
Basic net loss per share is computed on the basis of the weighted average
number of shares outstanding for the period. Diluted net loss per share is
computed on the basis of the weighted average number of shares and dilutive
common equivalent shares outstanding for the period. The computation for the
year ended December 31, 1998 assumes the year began on April 23, 1998, when the
Company commenced operations. For the year ending December 31, 1998, all
outstanding options to purchase 1,246,253 shares of Common Stock were
anti-dilutive. Accordingly, there is no difference between basic and diluted net
loss per common share.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the reporting
period. Actual results could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial and Accounting Standards Board issued Statement
of Financial Accounting Standard 133 "Accounting for Derivative Instruments and
for Hedging Activities" ("FAS 133"). FAS 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as a hedge. The accounting for changes in the fair value of a
derivative depends on the intended use of the derivative and the resulting
designation. FAS 133 is effective for the Company beginning January 1, 2000. The
Company is evaluating the eventual impact of FAS 133 on its financial
statements.
NOTE 3. SEGMENT DISCLOSURE
The Company has one reportable segment, real estate investments. At
December 31, 1998, the Company's real estate investments included CMBS,
mezzanine real estate loans, commercial mortgage loans and commercial real
estate properties. The Company uses net income (loss) to measure profit or loss.
The Company separately discloses assets, revenue and capital expenditures by
type of real estate investment in the consolidated financial statements.
32
<PAGE> 36
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Except for interest income earned on the Company's investment in a British
pounds Sterling mezzanine loan, discussed in Note 6, all of the Company's
revenue is attributed to investments located in the United States. Revenue
information by country is summarized below:
<TABLE>
<CAPTION>
1998
----------
<S> <C>
United States............................................... $8,703,530
United Kingdom.............................................. 670,864
----------
Total............................................. $9,374,394
==========
</TABLE>
At December 31, 1998, the carrying amount of the Company's British pounds
Sterling loan was $16,764,264.
At December 31, 1998, the Company's investment in a mezzanine loan on an
office building in New York (Note 6) accounted for more than 10% of revenue.
NOTE 4. MANAGEMENT FEES
The Company entered into a Management Agreement (the "Management
Agreement") with ERE Yarmouth, Inc., an indirect wholly-owned subsidiary of Lend
Lease Corporation Limited, under which ERE Yarmouth, Inc. 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. On July 13, 1998, the name
of ERE Yarmouth, Inc. was changed to Lend Lease Real Estate Investments, Inc.
("Lend Lease" or the "Manager" or "Management"). Lend Lease continues as the
advisor to the Company.
Pursuant to the Management Agreement, the Company will pay the Manager a
quarterly base management fee equal to the following:
<TABLE>
<S> <C>
For the first four fiscal quarters
commencing with the fiscal
quarter ended June 30, 1998...... 1.00% per annum of the Average
Invested Assets(1) of the Company
During each fiscal quarter
thereafter....................... 0.85% per annum of the Average
Invested Assets up to $1 billion
0.75% per annum of the Average
Invested Assets from $1 billion to
$1.25 billion
0.50% per annum of the Average
Invested Assets in excess of $1.25
billion
</TABLE>
- ---------------
(1) The term "Average Invested Assets" for any period means the average of the
aggregate book value of the assets of the Company, including a proportionate
amount of the assets of all of its direct and indirect subsidiaries, before
reserves for depreciation or bad debts or other similar non-cash reserves
less (i) un-invested cash balances and (ii) the book value of the Company's
CMO liabilities, computed by dividing (a) the sum of such values for each of
the three months during such quarter (based on the book value of such assets
as of the last day of each month) by (b) three.
The Company incurred base management fees in 1998 of $1,096,562.
33
<PAGE> 37
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Management Agreement also provides for a quarterly incentive management
fee equal to the product of (A) 25% of the dollar amount by which (1)(a) Funds
From Operations(2) (before the incentive fee) of the Company for the applicable
quarter per weighted average number of shares of Common Stock outstanding plus
(b) gains (or minus losses) from debt restructuring or sales of assets not
included in Funds From Operations of the Company for such quarter per weighted
average number of shares of Common Stock outstanding, exceed (2) an amount equal
to (a) the weighted average of the price per share at initial offering and the
prices per share at any secondary offerings by the Company multiplied by (b) 25%
of the sum of the Ten-Year U.S. Treasury Rate plus four percent, and (B) the
weighted average number of shares of Common Stock outstanding. No incentive
management fees were earned during 1998.
The Management Agreement is for an initial term of two years, and can be
successively extended for two year periods subject to an affirmative vote of a
majority of the Independent Directors. In addition, the Management Agreement
provides for a termination fee equal to the sum of the base management fee and
incentive management fee, if any, earned during the immediately preceding four
fiscal quarters.
NOTE 5. INVESTMENT IN CMBS
The amortized cost and estimated fair value of commercial mortgage-backed
securities classified as available-for-sale securities at December 31, 1998 are
summarized below. The face value of CMBS was $108,149,975 at December 31, 1998.
<TABLE>
<CAPTION>
WEIGHTED ESTIMATED
AVERAGE AMORTIZED IMPAIRMENT AMORTIZED COST FAIR
SECURITY RATING LIFE COST LOSSES ADJUSTED VALUE
- --------------- -------- ----------- ----------- -------------- -----------
<S> <C> <C> <C> <C> <C>
BBB-.............................. 7/7/12 $ 9,452,762 $ 541,562 $ 8,911,200 $ 8,911,200
BB+............................... 2/6/13 15,861,815 2,922,753 12,939,062 12,939,062
BB................................ 6/30/12 20,658,847 3,490,551 17,168,296 17,168,296
BB-............................... 4/26/13 4,368,958 951,933 3,417,025 3,417,025
B................................. 7/7/11 32,282,831 6,815,014 25,467,817 25,467,817
B-................................ 4/26/13 2,808,723 674,162 2,134,561 2,134,561
Unrated........................... 4/26/13 2,810,109 1,280,595 1,529,514 1,529,514
----------- ----------- ----------- -----------
Total................... $88,244,045 $16,676,570 $71,567,475 $71,567,475
=========== =========== =========== ===========
</TABLE>
The estimated fair value of the CMBS is based on either i) the price
obtained from the investment banking institutions, which sold the CMBS to the
Company, or ii) an average of at least three quotes received on similarly
structured and rated CMBS. The use of different market assumptions, valuation
methodologies, changing interest rates, interest rate spreads for CMBS over the
U.S. Treasury yields and the timing and magnitude of credit losses may have a
material effect on the estimates of fair value. The fair value estimates
presented herein are based on pertinent information available as of December 31,
1998.
The CMBS tranches owned by the Company provide credit support to the more
senior tranches of the related commercial securitization. Cash flow from the
underlying mortgages is generally allocated first to the
- ---------------
(2) The term "Funds From Operations" as defined by the National Association
of Real Estate Investment Trusts, Inc. means net income (computed in accordance
with GAAP) excluding gains (or losses) from debt restructuring, sales of
property and any unusual or non-recurring transactions, plus depreciation and
amortization on real estate assets, and after deduction of preferred stock
dividends, if any, and similar adjustments for unconsolidated partnerships and
joint ventures. Funds From Operations does not represent cash generated from
operating activities in accordance with GAAP and should not be considered as an
alternative to net income as an indication of the Company's performance or to
cash flows as a measure of liquidity or ability to make distributions.
34
<PAGE> 38
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
senior tranches, with the most senior tranches having a priority right to cash
flow. Any remaining cash flow is generally allocated among the other tranches
based on their seniority. To the extent there are defaults and unrecoverable
losses on the underlying mortgages, resulting in reduced cash flows, the
subordinate tranches will bear those losses first. To the extent there are
losses in excess of the most subordinate tranches stated right to principal and
interest, the remaining tranches will bear such losses in order of their
relative subordination.
At December 31, 1998, the amortized cost of the Company's investments in
CMBS exceeded estimated fair value by $16,676,570. Due to uncertainty of the
Company's ability to hold its CMBS investments until the cost of the CMBS is
recovered, the Company determined that the decline in the fair value of its CMBS
below amortized cost at December 31, 1998 was other than temporary. Accordingly,
the Company carries its investment in CMBS at estimated fair value at December
31, 1998. During the third and fourth quarters of 1998, the Company recognized
impairment losses of $16,676,570. The Company's ability to hold its CMBS has
been negatively affected by the recent turmoil in the financial markets and its
effect on the value of CMBS securities along with the restructuring of the
Company's debt agreements (see Note 10). During the fourth quarter of 1998, the
Company sold certain of its investment in BBB- CMBS securities for $13,826,912
and realized a loss of $1,167,179.
NOTE 6. MEZZANINE LOAN INVESTMENTS
As of December 31, 1998, the Company's investment in mezzanine loans
consisted of the following:
<TABLE>
<CAPTION>
ESTIMATED
UNDERLYING INTEREST MATURITY FACE AMORTIZED IMPAIRMENT CARRYING FAIR
SECURITY RATE DATE VALUE COST LOSS VALUE VALUE
- ----------------------- -------- ---------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Commercial real estate:
Office............... 12.00% 05/01/2007 $21,000,000 $24,635,473 $4,260,059 $20,375,414 $21,000,000
Hotel................ 11.77 06/30/2003 19,647,200 19,722,940 2,958,676 16,764,264 16,764,264
Multi-family......... 10.63 08/01/2008 2,800,000 2,746,565 372,308 2,374,257 2,374,257
Retail............... 9.69 05/01/2005 4,570,896 4,488,901 459,590 4,029,311 4,029,311
Other................ 10.57 07/01/2008 1,000,000 975,958 144,858 831,100 831,100
----------- ----------- ---------- ----------- -----------
Total......... $49,018,096 $52,569,837 $8,195,491 $44,374,346 $44,998,932
=========== =========== ========== =========== ===========
</TABLE>
At December 31, 1998, the amortized cost of the Company's investments in
mezzanine loans exceeded their aggregate carrying value by $8,195,491. Due to
the uncertainty of the Company's ability to hold the mezzanine loans until the
cost of the loans can be recovered, the Company determined that the decline in
the fair value of the loans below amortized cost at December 31, 1998 was other
than temporary. Accordingly, the Company carries its investments in mezzanine
loans at the lower of amortized cost after impairment losses or fair value.
During the year ended December 31, 1998, the Company recognized impairment
losses of $8,195,491. The estimated fair value of mezzanine loan investments is
based on Management's best estimate of market conditions at December 31, 1998.
The use of different market assumptions, valuation methodologies, changing
interest rates, interest rate spreads and the timing and magnitude of credit
losses may have a material effect on the estimates of fair value. The Company's
ability to hold its mezzanine loans to maturity has been negatively affected by
the recent turmoil in the financial markets and its effect on the value of the
loans, along with the restructuring of its debt agreements (See Note 10).
The Company's $19,647,200 face value mezzanine loan investment is a British
pounds Sterling loan. The Company purchased the investment for 11.98 million in
British pounds Sterling. Interest on the loan is based on Sterling Libor ("Base
Rate") plus 4.00%. The exchange rate at the date of investment was $1.64 dollars
per pound. In order to reduce the risk of foreign currency exchange rate
fluctuations, the Company entered into a foreign currency swap arrangement with
Merrill Lynch Capital Services, Inc. The swap arrangement provides the Company
with an exchange rate of $1.64 per pound on the return of its principal
regardless of exchange rate fluctuation. The swap arrangement also converts the
Base Rate to US$ Libor minus 0.06% regardless of movements in the Sterling
Libor. The Company is subject to foreign currency risk on the spread
35
<PAGE> 39
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
portion (4.00%) of the quarterly interest payments. The market value of the
currency swap at December 31, 1998 was a liability of $242,000. The foreign
currency swap arrangement expires on the maturity date of the related loan. The
Company is exposed to credit loss in the event of nonperformance by the
counterparty to the currency swap agreement. However, the Company does not
anticipate nonperformance by the counterparty.
NOTE 7. MORTGAGE LOAN INVESTMENTS
As of December 31, 1998, the Company's investment in mortgage loans
consisted of the following:
<TABLE>
<CAPTION>
ESTIMATED
UNDERLYING INTEREST MATURITY FACE AMORTIZED IMPAIRMENT CARRYING FAIR
SECURITY RATE DATE VALUE COST LOSS VALUE VALUE
---------- -------- ---------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Commercial real estate:
Office............... 7.11% 08/01/2008 $16,000,000 $15,948,210 $797,810 $15,150,400 $15,150,400
----------- ----------- -------- ----------- -----------
Total......... $16,000,000 $15,948,210 $797,810 $15,150,400 $15,150,400
=========== =========== ======== =========== ===========
</TABLE>
At December 31, 1998, the amortized cost of the Company's investment in the
mortgage loan exceeded estimated fair value by $797,810 which is reflected in
the December 31, 1998 financial statements as an impairment loss. A discounted
payoff of the loan was accepted on January 4, 1999 for $15,150,400.
In connection with the Company's initial investment strategy of originating
commercial and multi-family loans for the purpose of issuing collateralized
mortgage obligations, the Company through September 30, 1998 had originated
approximately $29,525,000 in mortgage loans and had entered commitments to fund
an additional $119,900,000 in mortgage loans. Because of the financial turmoil
in the credit markets in October 1998 and the related restructuring of the
Company's credit facilities, the Company discontinued this investment strategy
and began selling its loans and terminating its commitments. During the fourth
quarter of 1998, the Company funded and sold $60,585,000 of these commitments
and terminated the remaining $59,315,000 in commitments. The Company recognized
losses of $5,325,524 on the sale of $68,826,722 in mortgage loans and incurred
expenses of $1,116,400 on the termination of the loan commitments.
NOTE 8. REAL ESTATE INVESTMENTS HELD FOR SALE
As of December 31, 1998, the Company's investments in real estate consisted
of the following:
<TABLE>
<CAPTION>
DATE ACQUIRED PROPERTY LOCATION PROPERTY TYPE
- ------------- -------------- ------------ -------------
<S> <C> <C> <C>
6/26/98............................................. Lakeside Plaza Stockton, CA Retail
9/24/98............................................. Bryarwood 85 Atlanta, GA Office
</TABLE>
The carrying value of real estate investments held for sale at December 31,
1998 is summarized below:
<TABLE>
<S> <C>
Real estate investments held for sale -- at cost
Land...................................................... $2,470,000
Buildings................................................. 4,388,263
Tenant Improvements....................................... 891,945
Capitalized Costs......................................... 39,683
Less accumulated depreciation and amortization.............. (47,803)
Less impairment charge...................................... (447,505)
----------
Real estate investments held for sale -- net................ $7,294,583
==========
</TABLE>
In connection with the Company's decision to discontinue its initial
investment strategies, the Company also decided to sell its real estate
investments and accordingly, at December 31, 1998, the Company classified its
real estate investments as held for sale. The Company expects to dispose of the
real estate in 1999. The real estate investments have been written down to
market value less estimated selling costs, resulting in an
36
<PAGE> 40
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
impairment charge of $447,505. Rental income and expenses approximated $493,000
and $602,000, including depreciation expense of $47,803 and the impairment
charge of $447,505, for the year ended December 31, 1998.
NOTE 9. MINIMUM RENTS
Minimum future rentals to be received on real estate properties under
leases in effect as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- ------------------------
<S> <C>
1999........................................................ $1,111,743
2000........................................................ 1,115,674
2001........................................................ 973,565
2002........................................................ 827,445
2003........................................................ 489,957
Thereafter.................................................. 379,582
----------
Total............................................. $4,897,966
==========
</TABLE>
NOTE 10. BORROWING ARRANGEMENTS
On May 15, 1998, the Company entered into two Master Loan and Security
Agreements, to provide financing for the Company's investments. The facilities
require assets to be pledged as collateral. The first loan agreement, which was
with Morgan Stanley Mortgage Capital, Inc. (the "Morgan Stanley Agreement")
permitted the Company to borrow up to $250,000,000 and was scheduled to
terminate on May 14, 1999. The facility was intended to finance first-mortgage
loans originated by the Company. On October 26, 1998, the Company terminated the
agreement with Morgan Stanley at no cost to the Company. There were no
borrowings outstanding under the Morgan Stanley Agreement. The second agreement,
which is with Morgan Guaranty Trust (the "Morgan Guaranty Trust Agreement"),
permitted the company to borrow up to $450,000,000 and was scheduled to
terminate on May 14, 1999. As discussed below, all outstanding indebtedness
under the Morgan Guaranty Agreement was repaid, and the agreement was terminated
on March 31, 1999. As of December 31, 1998, there were $52,412,238 in borrowings
outstanding under the Morgan Guaranty Agreement, secured by the Company's assets
with an aggregate carrying value of $70,745,575 at December 31, 1998. The
annualized interest rate on these borrowings at December 31, 1998 was 6.60%.
On August 21, 1998, the Company entered into a Master Assignment Agreement
with Merrill Lynch Mortgage Capital, Inc. and Merrill Lynch Capital Services,
Inc. (the "Merrill Lynch Agreement"), to provide financing for the Company's
investments. The facility requires assets to be pledged as collateral. The
Merrill Lynch Agreement permitted the Company to borrow up to $35,000,000 and
was scheduled to terminate on August 20, 1999. As discussed below, all
indebtedness outstanding under the Merrill Lynch Agreement was repaid and the
agreement was terminated on March 25, 1999. Outstanding borrowings against this
line of credit bear interest based on the Libor rate plus 1.25%. The Merrill
Lynch Agreement allows the lender to establish a margin requirement on each
borrowing, and to request payments from the Company, at any time, if the market
value of the collateral falls below the applicable margin requirement. As of
December 31, 1998, there were $9,505,918 in borrowings outstanding under the
Merrill Lynch Agreement, secured solely by the Company's Savoy Hotel mezzanine
loan which has a carrying value of $16,764,264 at December 31, 1998. The
annualized interest rate on these borrowings at December 31, 1998 was 6.52%.
As a result of the financial turmoil in the credit markets in October 1998
and the related widening of spreads between rates on mortgage investments and
treasury securities, the Company experienced significant losses in its
investment portfolio. Because of these losses, on October 23, 1998 the Company
announced it was
37
<PAGE> 41
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
necessary to obtain temporary waivers from Morgan Guaranty Trust and Merrill
Lynch to avoid being in default of tangible net worth covenants under the
Company's credit facilities. On November 13, 1998 the Company reached an
agreement with Morgan Guaranty Trust and Merrill Lynch to restructure its credit
facilities and terminated the Morgan Stanley Agreement.
Under its amended agreement with Morgan Guaranty Trust, the Company's
credit facility has been reduced to $90 million. The facility reduces to $50
million on January 31, 1999. The interest rate is Libor plus 1.5% from November
13, 1998 to December 31, 1998 and Libor plus 2.0% from January 1, 1999 until the
facility matures on March 31, 1999. As part of the amended agreement, the
Company sold $19.6 million of mortgage loans to Morgan Guaranty Trust and paid
fees of $800,000.
Under the amended agreement with Merrill Lynch, the Company agreed to pay
down the outstanding borrowings to $19.0 million, and further agreed that no
additional borrowings would be permitted under the agreement through its
maturity on January 31, 1999. On January 27, 1999, this agreement was further
amended, extending the maturity to February 26, 1999. On February 25, 1999, the
Merrill Lynch Agreement was again amended, extending the maturity date to March
25, 1999. The amended agreements with Morgan Guaranty Trust and Merrill Lynch
contain covenants that appropriately reflect the reduced size of the Company's
portfolio.
In connection with the credit facility restructurings, on November 13,
1998, LLIH agreed to provide the Company with up to $40 million of unsecured
subordinated indebtedness ("LLIH Agreement"). An initial advance of $17 million
was drawn on November 13, 1998 and the remaining funds can be drawn from time to
time by the Company through maturity at April 5, 1999. The advances incur
interest at the rate of 14% per annum through January 31, 1999 and 16%
thereafter. The advances are prepayable at any time subject to certain notice
requirements. As of December 31, 1998, borrowings outstanding under the LLIH
Agreement were $9,000,000. The annualized interest rate on these borrowings at
December 31, 1998 was 14.00%.
In addition to the $800,000 in fees paid to Morgan Guaranty Trust, the
Company incurred $1,042,174 in restructuring fees. The Company expensed all of
these fees during 1998.
The annualized weighted average rate of interest on all of the Company's
borrowings, including the Deutsche Bank repurchase agreement (see Note 11), for
the year ended December 31, 1998 was 6.91%.
The Company is required to meet certain debt covenants on its borrowings to
avoid default on its obligations. The Morgan Guaranty Trust Agreement has three
debt covenants. Maintenance of Tangible Net Worth requires that the Company's
Tangible Net Worth, as defined, be at least $100,000,000. The first amendment to
the Morgan Guaranty Trust Agreement reduced the threshold to $65,000,000 for the
period from November 13, 1998 to January 1, 1999 and to $50,000,000 thereafter.
The Company was in compliance with this covenant as of December 31, 1998.
Maintenance of Ratio of Indebtedness to Tangible Net Worth requires that the
ratio of the Company's total debt to its Tangible Net Worth not exceed 5 to 1.
This covenant is still in full effect as of December 31, 1998. Maintenance of
Interest Coverage Ratio requires that the ratio of the Company's interest
expense to Earnings Before Interest, Taxes, Depreciation and Amortization
("EBITDA"), as defined, shall not be less than 1.45 to 1. The Company failed to
meet the Interest Coverage Ratio covenant for the fourth quarter of 1998, and
received a waiver from Morgan Guaranty Trust in February 1999. The first
amendment to the Morgan Guaranty Trust Agreement also provides that the Company
must maintain a cash position on its balance sheet of a minimum of $10,000,000,
free and clear of all encumbrances. This covenant was in effect until January
29, 1999, when the second amendment to the agreement reduced the requirement to
$5,000,000.
The original Merrill Lynch Agreement includes three debt covenants. Book
Net Worth requires that, in any given period, the Company's ending Book Net
Worth, as defined, shall not be less than 80% of beginning Book Net Worth, and
that total Book Net Worth shall be at least $100,000,000. The first amendment to
the
38
<PAGE> 42
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Merrill Lynch Agreement reduced the threshold to $50,000,000 for the period from
October 23, 1998 to November 13, 1998, and to $65,000,000 thereafter. The second
amendment to the Merrill Lynch Agreement reduces the threshold back to
$50,000,000. The Maximum Debt to Equity Ratio requires that the ratio of the
Company's total debt to total equity shall not exceed 8 to 1. This covenant is
still in full effect as of December 31, 1998. Merrill Lynch also has a
cross-default covenant which provides that if the Company fails to meet any of
its covenants under its other borrowing arrangements, that it is also in default
under the Merrill Lynch agreement. The Company received a waiver in March 1999
from Merrill Lynch for the fourth quarter of 1998 when it defaulted on the
Morgan Guaranty Trust Agreement by failing to meet the Maintenance of Interest
Coverage Ratio. The first amendment to the Merrill Lynch Agreement also provides
that the Company must maintain a cash position on its balance sheet of a minimum
of $10,000,000, free and clear of all encumbrances. This covenant was in effect
until January 27, 1999, when the second amendment to the agreement reduced the
requirement to $5,000,000.
The LLIH agreement contains a cross-default covenant which provides that if
the Company fails to meet any of its covenants under its other borrowing
arrangements, that it is also in default under the LLIH Agreement. The Company
received a waiver from LLIH in March 1999 for the fourth quarter of 1998 when it
defaulted on the Morgan Guaranty Trust Agreement by failing to meet the
Maintenance of Interest Coverage Ratio. The LLIH agreement has no other covenant
requirements.
Under its borrowing arrangements with Morgan Guaranty Trust and LLIH, the
Company is allowed to pay distributions only to meet the requirements of a REIT.
The Company was not required to pay any dividends in the fourth quarter of 1998
due to net taxable losses incurred for the year.
NOTE 11. REPURCHASE AGREEMENT
On August 25, 1998, the Company entered into a Master Repurchase Agreement
with Deutsche Bank Securities, Inc. (the "Deutsche Bank Agreement"), which
provides financing for the Company's investments. The Deutsche Bank Agreement
permits the Company to enter into an unlimited number of transactions, subject
to the approval of both Deutsche Bank and the Company. The Deutsche Bank
Agreement is a 30-day revolving facility, which may be terminated by either
party upon giving written notice to the other, except that the agreement shall
remain applicable to any transactions then outstanding. Transactions bear
interest at a rate negotiated between Deutsche Bank and the Company at the
inception of a transaction. The Deutsche Bank Agreement allows Deutsche Bank to
establish a margin requirement on each transaction, and to request payment from
the Company at any time, if the market value of the underlying assets or
securities falls below the applicable margin requirement. As of December 31,
1998, there were $7,926,375 in borrowings outstanding under the Deutsche Bank
Agreement, secured solely by one of the Company's BBB- rated CMBS with an
estimated fair value of $8,911,200 at December 31, 1998. The annualized interest
rate on this borrowing was 5.93% at December 31, 1998. Subsequent to year-end,
the related CMBS was sold, and the remaining borrowings under the agreement were
paid (See Note 15).
NOTE 12. STOCK OPTION PLAN
The Company has a stock option plan for the Company's executive officers
and the Manager, which provides for the issuance of up to 2,500,000 shares of
Common Stock. At the closing of the IPO, the Company granted the Manager a fully
vested option to purchase 1,166,667 shares of Common Stock exercisable at the
IPO price of $15.00 per share. The Manager received the stock option as
compensation for its efforts in completing the IPO. One-fourth of the Manager's
options become exercisable on each of the first four anniversaries of the IPO.
Unless exercised, these options expire in 2008.
The underwriters sold in the IPO 79,586 shares of Common Stock to directors
and officers of the Company and the Manager for $15.00 per share. Pursuant to
the Company's Directed Share Program, such
39
<PAGE> 43
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
individuals were granted an option to purchase one share of Common Stock for
each share purchased in the IPO at an exercise price of $15.00 per share.
One-fifth of the options became exercisable immediately, and one-fifth of the
options become exercisable on each of the first four anniversaries of the IPO.
Unless exercised, these options expire in 2008.
The Company accounts for stock options in accordance with FAS 123,
"Accounting for Stock-Based Compensation". FAS 123 applies a market value based
approach to valuing the options. The Company estimated the market value of the
options granted using the Black-Scholes option-pricing model, with the following
assumptions:
<TABLE>
<S> <C>
Risk-free rate of interest.................................. 5.62%
Expected life of options.................................... 2.42 years
Volatility.................................................. 24.05%
Dividend rate............................................... 12.76%
</TABLE>
The estimated weighted average grant date market value of stock options
granted by the Company in 1998 was approximately $0.75 per share or $932,196.
The Company expensed the $877,197 value of the fully vested options granted to
the Manager upon completion of the IPO. The remaining $54,279 of value related
to the options granted under the Company's Directed Share Program is being
amortized over the vesting period. Total compensation cost related to stock
options recognized in income during 1998 totaled $888,773.
The following table summarizes the status of the Company's stock options at
December 31, 1998:
<TABLE>
<CAPTION>
GRANTED PER SHARE REMAINING
AND EXERCISE CONTRACTUAL
OUTSTANDING PRICE EXERCISABLE LIFE
----------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Manager..................................... 1,166,667 $15.00 None 9.25 years
Others...................................... 79,586 15.00 15,917 9.25 years
Total............................. 1,246,253 15.00 15,917 9.25 years
</TABLE>
NOTE 13. INTEREST RATE PROTECTION AGREEMENTS
In order to hedge the risk of a material change in interest rates that
would affect the Company's borrowing rate on its lines of credit and on
anticipated future long-term borrowings secured by the Company's investments,
the Company entered into forward treasury lock agreements, an interest rate
collar and an interest rate cap. None of these agreements were held for trading
purposes. The Company's policy was to purchase a forward treasury lock whenever
a fixed rate mortgage loan closed or when a borrower requested a rate lock under
an executed loan application. Depending on the size of fixed rate mortgage
loans, the Company in some cases aggregated loans and purchased a single
treasury lock for a pool of small loans. The Company also entered into forward
treasury locks in anticipation of long-term financing of its CMBS and mezzanine
investments that were expected to close in 1999.
As a result of the financial turmoil in the credit markets in October 1998,
and the Company's failure to comply with its debt agreements, the Company
determined that its ability to obtain long-term, fixed-rate financing was not
probable. The turmoil also created uncertainty as to the Company's ability to
hold the investments, and thus the treasury locks no longer qualified for hedge
accounting. On October 23, 1998 the Company terminated all of its treasury locks
and incurred a realized loss of $13.3 million, which was recognized as a
component of income. The interest rate cap was terminated in July 1998.
40
<PAGE> 44
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Below is a summary of the Company's interest rate protection agreements,
which consisted of an interest rate collar at December 31, 1998.
<TABLE>
<CAPTION>
NOTIONAL FLOATING MARKET
PURCHASE MATURITY AMOUNT INDEX STRIKE VALUE
- -------- -------- ----------- ----------- ---------- ---------
<S> <C> <C> <C> <C> <C>
7/13/98 7/01/99 $89,131,070 1 mo. LIBOR 5.8%-5.51% $(216,000)
</TABLE>
At December 31, 1998, the Company no longer considered the interest rate
collar a hedge and, accordingly recorded the value of the collar as a liability
through a charge to income. Subsequent to December 31, 1998, the Company
terminated the collar contract at a loss of $265,000.
NOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of the Company's financial instruments at December
31, 1998 are as follows:
<TABLE>
<CAPTION>
CARRYING AMOUNT FAIR VALUE
--------------- -----------
<S> <C> <C>
ASSETS
Cash and short-term investments........................... $11,957,616 $11,957,616
Commercial mortgage-backed securities..................... 71,567,475 71,567,475
Mezzanine loan investment................................. 44,374,346 44,998,932
Mortgage loan investment.................................. 15,150,400 15,150,400
Escrow cash............................................... 2,138,011 2,138,011
Accrued interest receivable............................... 1,153,989 1,153,989
LIABILITIES
Short-term borrowings..................................... 61,918,156 61,918,156
Subordinated debt to related party........................ 9,000,000 9,000,000
Borrowings under repurchase agreement..................... 7,926,375 7,926,375
Treasury locks payable.................................... 10,887,660 10,887,660
Accrued interest expense.................................. 374,759 374,759
Interest rate collar...................................... 216,000 216,000
Currency swap............................................. 242,000 242,000
</TABLE>
The carrying amounts of cash and short-term investments, escrow cash,
accrued interest receivable, treasury locks payable and accrued interest expense
approximate their fair values because of the short maturity of those
instruments.
See Note 1 for fair value assumptions with respect to CMBS, mezzanine loan
investments and mortgage loan investments.
Based on their short-term maturities, the carrying amounts of short-term
borrowings, subordinated debt to related party and borrowings under repurchase
agreement approximate their fair values.
The fair values of the interest rate collar and currency swap are the
estimated amounts the Company would pay to terminate the agreements at December
31, 1998, based on quotes received from the counterparties. The currency swap
carrying amount is included in the related mezzanine loan balance.
NOTE 15. SUBSEQUENT EVENTS
On January 4, 1999, the Company accepted a discounted payoff of its
remaining $15,948,210 whole mortgage loan for $15,150,400, resulting in a loss
of $797,810, which had been recorded as an impairment loss as of December 31,
1998.
41
<PAGE> 45
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On January 23, 1999, the Company cancelled its interest rate collar
agreement with Merrill Lynch. As a result the Company realized a loss of
$265,000.
On February 19, 1999, the Company sold a BBB- bond for $8,827,344 resulting
in a loss of $85,356 since December 31, 1998. Total losses realized on this sale
were $626,917. The proceeds from this sale were used to repay $7,929,250 in
borrowings from Deutsche Bank.
On February 25, 1999, the third amendment was made to the Merrill Lynch
Agreement to extend the maturity date to March 25, 1999.
On March 25, 1999, the Company sold its Bryarwood 85 real estate investment
for $3,800,000, resulting in a realized loss of approximately $258,000 which was
recognized in 1998.
On March 25, 1999, the Company borrowed $8,000,000 under the LLIH Agreement
to repay its remaining borrowings under the Merrill Lynch Agreement.
On March 30, 1999, an amendment was made to the LLIH Agreement to extend
the maturity date to April 5, 1999.
On March 31, 1999, the Company sold CMBS for $39.0 million, resulting in a
realized loss of $13.6 million, of which $11.2 million was recognized in 1998.
On March 31, 1999, the Company used proceeds from the sale of CMBS to repay
in full its borrowings from Morgan Guaranty Trust.
In connection with its sale of CMBS on March 31, 1999, the Company entered
into an agreement to sell a mezzanine loan to GMAC Commercial Mortgage
Corporation ("GMAC"). The agreement allows the Company to repurchase the loan no
later than April 1, 2000 (transaction referred to hereafter as the "GMAC Repo").
The GMAC Repo is expected to close no later than April 5, 1999, and will
generate proceeds of $10.5 million. The repurchase price of the GMAC Repo will
be adjusted such that GMAC will receive an 8% annualized yield on its investment
if the Company repurchases the investment prior to October 1, 1999. After
October 1, 1999, the repurchase price is fixed at $9.6 million. The Company will
use the proceeds of the GMAC Repo to repay borrowings from LLIH and to meet its
remaining corporate obligations, which primarily consist of terminated treasury
lock agreements.
42
<PAGE> 46
SCHEDULE III
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION
AS OF DECEMBER 31, 1998
<TABLE>
<CAPTION>
COSTS GROSS COST
INITIAL COST TO COMPANY CAPITALIZED AT WHICH CARRIED AT END OF THE YEAR(1)
------------------------- SUBSEQUENT TO --------------------------------------
BUILDINGS ACQUISITION BUILDINGS
AND ------------- AND
DESCRIPTION LAND IMPROVEMENTS IMPROVEMENTS LAND IMPROVEMENTS TOTAL
- ----------- ---------- ------------ ------------- ---------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
RETAIL
Lakeside Plaza,
Stockton,
California...... $1,470,000 $2,222,413 $24,158 $1,470,000 $2,056,863 $3,526,863
OFFICE
Bryarwood 85,
Atlanta,
Georgia......... 1,000,000 3,053,188 20,132 1,000,000 2,815,523 3,815,523
---------- ---------- ------- ---------- ---------- ----------
$2,470,000 $5,275,601 $44,290 $2,470,000 $4,872,386 $7,342,386
========== ========== ======= ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED DATE OF DATE
DESCRIPTION DEPRECIATION CONSTRUCTION ACQUIRED
- ----------- ------------ ------------ --------
<S> <C> <C> <C>
RETAIL
Lakeside Plaza, Stockton, California...................... $32,280 1981 6/26/98
OFFICE
Bryarwood 85, Atlanta, Georgia............................ 15,523 1969 9/24/98
-------
$47,803
=======
</TABLE>
<TABLE>
<CAPTION>
RECONCILIATION OF BEGINNING AND ENDING BALANCES 1998
- ----------------------------------------------- ----------
<S> <C>
Rental Properties:
Balance at beginning of year.............................. $ 0
Lakeside Plaza Acquisition................................ 3,692,413
Bryarwood 85 Acquisition.................................. 4,053,188
Improvements.............................................. 44,290
Impairment Losses(1)...................................... (447,505)
----------
Balance at end of year...................................... $7,342,386
==========
Accumulated Depreciation:
Balance at beginning of year.............................. $ 0
Depreciation for year..................................... 47,803
----------
Balance at end of year...................................... $ 47,803
==========
</TABLE>
- ---------------
(1) All real estate properties are held for sale as of December 31, 1998, and
are accounted for at lower of cost or market value less costs to sell,
resulting in impairment losses on Lakeside Plaza and Bryarwood 85 of
$189,708 and $257,797, respectively.
43
<PAGE> 47
SCHEDULE IV
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED SCHEDULE OF MORTGAGE AND MEZZANINE LOANS ON REAL ESTATE
AS OF DECEMBER 31, 1998
<TABLE>
<CAPTION>
INTEREST/ FINAL PERIODIC FACE CARRYING BALLOON
COUPON MATURITY PAYMENT AMOUNT OF AMOUNT OF PAYMENT AT
DESCRIPTION RATE DATE TERMS MORTGAGES MORTGAGES MATURITY
- ------------------------- ------- ---------- ---------------------------------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Mortgage Loans:
First mortgage loan on
office building in
Tennessee.............. 7.11% 08/01/2008 Principal and interest amortizing
at stated interest rate.
Prepayment penalty: defeasance. $16,000,000 $15,150,400
Mezzanine Loans:
Mezzanine loan on an
office building in New
York................... 12.00 05/01/2007 Interest only. Prepayment lockout
until April 30, 2002, yield
maintenance thereafter through
April 30, 2006. 21,000,000 20,375,414 $21,000,000
Mezzanine loan on
apartment complex in
Texas.................. 10.63** 08/01/2008 Principal and interest amortizing
at stated interest rate.
Prepayment prohibited for first 12
months of loan term. 2,800,000 2,374,257
Mezzanine loan on retail
properties in various
states................. 9.69* 05/01/2005 Interest only; variable interest
rate 400 basis points over one-
month Libor rate. No prepayment
penalties. 4,570,896 4,029,311 5,000,000
Mezzanine loan on a hotel
in England............. 11.77* 06/30/2003 Interest only quarterly; variable
interest rate based on 400 basis
points over 90 day sterling Libor
rate. No prepayment penalty. 19,647,200 16,764,264
Mezzanine loan on a
retail property in
Florida................ 10.57** 07/01/2008 Principal and interest amortizing
at stated interest rate.
Prepayment lockout for 12 months,
yield maintenance thereafter
through August, 2004, penalty to
realize of IRR of 10 year Treasury
plus spread thereafter. 1,000,000 831,100 --
----------- ----------- -----------
$65,018,096 $59,524,746 $26,000,000
=========== =========== ===========
</TABLE>
- ---------------
* Interest rates are for year ended December 31, 1998 however, these interest
rates are adjustable from period to period.
** Interest rates represent stated coupon rates written into the contract. The
yield to maturities for the apartment complex and retail property are 12% and
11.82% respectively.
44
<PAGE> 48
<TABLE>
<CAPTION>
RECONCILIATION OF BEGINNING AND ENDING BALANCES 1998
- ----------------------------------------------- ------------
<S> <C>
Balance at beginning of year................................ $ 0
Additions during year:
New mortgage loans................................... 90,110,000
New mezzanine loans.................................. 52,798,096
Capitalized costs.................................... 75,740
------------
142,983,836
------------
Deductions during year
Collections of principal............................. (244,342)
Cost of mortgages sold............................... (74,076,921)
Amortization of premium/discount..................... (144,526)
Impairment write-downs............................... (8,993,301)
------------
Balance at end of year...................................... $ 59,524,746
============
</TABLE>
45
<PAGE> 49
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
<TABLE>
<CAPTION>
PAGE IN THIS
ANNUAL REPORT
ON FORM 10-K
-------------
<S> <C>
(a)1. Financial Statements:
Independent Auditors' Report........................... 24
Consolidated Balance Sheets............................ 25
Consolidated Statements of Operations.................. 26
Consolidated Statements of Changes in Shareholders'
Equity................................................ 27
Consolidated Statements of Cash Flows.................. 28
Notes to Consolidated Financial Statements............. 29
</TABLE>
(a)2. Financial Statement Schedules:
Schedule III. Real Estate and Accumulated Depreciation
Schedule IV. Mortgage Loans on Real Estate
(a)3. Exhibits
(Asterisk indicates exhibit previously filed with the Securities and
Exchange Commission as indicated in parentheses and incorporated herein by
reference.)
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NUMBER DESCRIPTION
- ------- ------------------
<C> <C> <S>
3.1* -- Form of Amended and Restated Articles of Incorporation of
the Company (Exhibit 3.1 to Company's Registration Statement
on Form S-11 (Reg. No. 333-42629) ("S-11")).
3.2* -- Bylaws of the Company (Exhibit 3.2 to the S-11).
10.1* -- Form of Management Agreement (Exhibit 10.1 to the S-11).
10.2* -- Form of Registration Rights Agreement between the Company
and Yarmouth Lend Lease Holdings, Inc. (Exhibit 10.2 to the
S-11).
10.3* -- Form of Registration Rights Agreement between the Company
and FBR Asset Investment Corporation (Exhibit 10.3 to the
S-11).
10.4* -- Chastain Capital Corporation 1998 Non-Incentive Stock Option
Plan (Exhibit 10.4 to the S-11).
10.5* -- Chastain Capital Corporation Directors Stock Incentive Plan
(Exhibit 10.5 to the S-11).
10.6* -- Form of Agreement of Limited Partnership of Chastain Capital
Investments, L.P. (Exhibit 10.6 to the S-11).
10.7* -- Master Loan and Security Agreement between Chastain Capital
Corporation and Morgan Guaranty Trust Company of New York
dated May 15, 1998 (Exhibit 10.1 to Company's Quarterly
Report on Form 10-Q for the Quarter ended June 30, 1998
("June 30, 1998 10-Q").
10.8* -- Master Loan and Security Agreement between Chastain Capital
Corporation and Morgan Stanley Mortgage Capital dated May
15, 1998 (Exhibit 10.2 to the June 30, 1998 10-Q).
10.9 -- Waiver, dated as of October 22, 1998, to the Master Loan and
Security Agreement, dated as of May 15, 1998, between
Chastain Capital Corporation and Morgan Guaranty Trust
Company of New York.
10.10* -- Master Assignment Agreement among Chastain Capital
Corporation, Merrill Lynch Mortgage Capital, Inc., and
Merrill Lynch Capital Services, Inc. (Exhibit 10.3 to
Company's Quarterly report on Form 10-Q for the Quarter
ended September 30, 1998 ("September 30, 1998 10-Q").
10.11* -- Amendment No. 1, dated as of October 23, 1998, to Master
Assignment Agreement among Chastain Capital Corporation,
Merrill Lynch Mortgage Capital, Inc., and Merrill Lynch
Capital Services, Inc. (Exhibit 10.4 to September 30, 1998
10-Q).
</TABLE>
46
<PAGE> 50
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NUMBER DESCRIPTION
- ------- ------------------
<C> <C> <S>
10.12 -- Waiver, dated as of November 5, 1998, to the Master Loan and
Security Agreement, dated as of May 15, 1998 (as amended,
supplemented or otherwise modified prior to the date
thereof), between Chastain Capital Corporation and Morgan
Guaranty Trust Company of New York.
10.13 -- Waiver, dated as of November 6, 1998, to the Master Loan and
Security Agreement, dated as of May 15, 1998 (as amended,
supplemented or otherwise modified prior to the date
thereof), between Chastain Capital Corporation and Morgan
Guaranty Trust Company of New York.
10.14* -- Subordinated Loan Agreement dated as of November 13, 1998
between Chastain Capital Corporation and Lend Lease
Investments Holdings, Inc. (Exhibit 10.1 to September 30,
1998 10-Q).
10.15* -- Amendment and Agreement, dated as of November 13, 1998, to
and in respect of the Master Loan and Security Agreement,
dated as of May 15, 1998, between Chastain Capital
Corporation and Morgan Guaranty Trust Company of New York
(Exhibit 10.2 to September 30, 1998 10-Q).
10.16 -- Mortgage Loan Purchase Agreement, dated as of November 16,
1998, between Chastain Capital Corporation and Morgan
Guaranty Trust Company of New York.
10.17 -- Amendment No. 2, dated as of January 27, 1999, to Master
Assignment Agreement among Chastain Capital Corporation,
Merrill Lynch Mortgage Capital, Inc. and Merrill Lynch
Capital Services, Inc.
10.18 -- Amendment, dated as of January 29, 1999, to the Master Loan
and Security Agreement, dated as of May 15, 1998 (as
amended, supplemented and otherwise modified prior to the
date thereof), between Chastain Capital Corporation and
Morgan Guaranty Trust Company of New York.
10.19 -- Amendment No. 3, dated as of February 25, 1999, to Master
Assignment Agreement among Chastain Capital Corporation,
Merrill Lynch Mortgage Capital, Inc. and Merrill Lynch
Capital Services, Inc.
10.20 -- Extension Amendment, dated as of March 29, 1999, to and in
respect of the Master Loan and Security Agreement, dated as
of May 15, 1998 (as amended, supplemented or otherwise
modified prior to the date thereof), between Chastain
Capital Corporation and Morgan Guaranty Trust Company of New
York.
10.21 -- Extension Amendment, dated as of March 30, 1999, to and in
respect of the Subordinated Loan Agreement, dated as of
November 13, 1998 (as amended, supplemented or otherwise
modified prior to the date thereto), between Chastain
Capital Corporation and Lend Lease Investments Holdings,
Inc.
21.1* -- List of Subsidiaries of the Company (Exhibit 21.1 to the
S-11).
27.1 -- Financial Data Schedule (for SEC filing purposes only).
</TABLE>
(b) Reports on Form 8-K
The Company did not file any Form 8-K's for the period covered by this
report.
(c) Exhibits
See Item 14(a)(3) above.
47
<PAGE> 51
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized on the
31st day of March, 1999.
CHASTAIN CAPITAL CORPORATION
By: /s/ KURT L. WRIGHT
-------------------------------------
Kurt L. Wright
Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 31, 1998.
/s/ MATTHEW BANKS
------------------------------------
Matthew Banks
Chairman of the Board
/s/ KURT L. WRIGHT
------------------------------------
Kurt L. Wright
Chief Executive Officer and Director
(Principal Executive Officer)
/s/ STEVEN G. GRUBENHOFF
------------------------------------
Steven G. Grubenhoff
Chief Financial Officer (Principal
Financial and Accounting Officer)
/s/ HARALD R. HANSEN
------------------------------------
Harald R. Hansen
Director
-------------------------------------
Elizabeth Kennan
Director
-------------------------------------
W.J. Smith
Director
48
<PAGE> 52
EXHIBIT INDEX
(Asterisk indicates exhibit previously filed with the Securities and
Exchange Commission as indicated in parentheses and incorporated herein by
reference.)
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S>
3.1* -- Form of Amended and Restated Articles of Incorporation of
the Company (Exhibit 3.1 to Company's Registration Statement
on Form S-11 (Reg. No. 333-42629) ("S-11")).
3.2* -- Bylaws of the Company (Exhibit 3.2 to the S-11).
10.1* -- Form of Management Agreement (Exhibit 10.1 to the S-11).
10.2* -- Form of Registration Rights Agreement between the Company
and Yarmouth Lend Lease Holdings, Inc. (Exhibit 10.2 to the
S-11).
10.3* -- Form of Registration Rights Agreement between the Company
and FBR Asset Investment Corporation (Exhibit 10.3 to the
S-11).
10.4* -- Chastain Capital Corporation 1998 Non-Incentive Stock Option
Plan (Exhibit 10.4 to the S-11).
10.5* -- Chastain Capital Corporation Directors Stock Incentive Plan
(Exhibit 10.5 to the S-11).
10.6* -- Form of Agreement of Limited Partnership of Chastain Capital
Investments, L.P. (Exhibit 10.6 to the S-11).
10.7* -- Master Loan and Security Agreement between Chastain Capital
Corporation and Morgan Guaranty Trust Company of New York
dated May 15, 1998 (Exhibit 10.1 to Company's Quarterly
Report on Form 10-Q for the Quarter ended June 30, 1998
("June 30, 1998 10-Q").
10.8* -- Master Loan and Security Agreement between Chastain Capital
Corporation and Morgan Stanley Mortgage Capital dated May
15, 1998 (Exhibit 10.2 to the June 30, 1998 10-Q).
10.9 -- Waiver, dated as of October 22, 1998, to the Master Loan and
Security Agreement, dated as of May 15, 1998, between
Chastain Capital Corporation and Morgan Guaranty Trust
Company of New York.
10.10* -- Master Assignment Agreement among Chastain Capital
Corporation, Merrill Lynch Mortgage Capital, Inc., and
Merrill Lynch Capital Services, Inc. (Exhibit 10.3 to
Company's Quarterly report on Form 10-Q for the Quarter
ended September 30, 1998 ("September 30, 1998 10-Q").
10.11* -- Amendment No. 1, dated as of October 23, 1998, to Master
Assignment Agreement among Chastain Capital Corporation,
Merrill Lynch Mortgage Capital, Inc., and Merrill Lynch
Capital Services, Inc. (Exhibit 10.4 to September 30, 1998
10-Q).
10.12 -- Waiver, dated as of November 5, 1998, to the Master Loan and
Security Agreement, dated as of May 15, 1998 (as amended,
supplemented or otherwise modified prior to the date
thereof), between Chastain Capital Corporation and Morgan
Guaranty Trust Company of New York.
10.13 -- Waiver, dated as of November 6, 1998, to the Master Loan and
Security Agreement, dated as of May 15, 1998 (as amended
supplemented or otherwise modified prior to the date
thereof), between Chastain Capital Corporation and Morgan
Guaranty Trust Company of New York.
10.14* -- Subordinated Loan Agreement dated as of November 13, 1998
between Chastain Capital Corporation and Lend Lease
Investments Holdings, Inc. (Exhibit 10.1 to September 30,
1998 10-Q).
10.15* -- Amendment and Agreement, dated as of November 13, 1998, to
and in respect of the Master Loan and Security Agreement,
dated as of May 15, 1998, between Chastain Capital
Corporation and Morgan Guaranty Trust Company of New York
(Exhibit 10.2 to September 30, 1998 10-Q).
10.16 -- Mortgage Loan Purchase Agreement, dated as of November 16,
1998, between Chastain Capital Corporation and Morgan
Guaranty Trust Company of New York.
10.17 -- Amendment No. 2, dated as of January 27, 1999, to Master
Assignment Agreement among Chastain Capital Corporation,
Merrill Lynch Mortgage Capital, Inc. and Merrill Lynch
Capital Services, Inc.
10.18 -- Amendment, dated as of January 29, 1999, to the Master Loan
and Security Agreement, dated as of May 15, 1998 (as
amended, supplemented and otherwise modified prior to the
date thereof), between Chastain Capital Corporation and
Morgan Guaranty Trust Company of New York.
</TABLE>
49
<PAGE> 53
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S>
10.19 -- Amendment No. 3, dated as of February 25, 1999, to Master
Assignment Agreement among Chastain Capital Corporation,
Merrill Lynch Mortgage Capital, Inc. and Merrill Lynch
Capital Services, Inc.
10.20 -- Extension Amendment, dated as of March 29, 1999, to and in
respect of the Master Loan and Security Agreement, dated as
of May 15, 1998 (as amended, supplemented or otherwise
modified prior to the date thereof), between Chastain
Capital Corporation and Morgan Guaranty Trust Company of New
York.
10.21 -- Extension Amendment, dated as of March 30, 1999, to and in
respect of the Subordinated Loan Agreement, dated as of
November 13, 1998 (as amended, supplemented or otherwise
modified prior to the date thereto), between Chastain
Capital Corporation and Lend Lease Investments Holdings,
Inc.
21.1* -- List of Subsidiaries of the Company (Exhibit 21.1 to the
S-11).
27.1 -- Financial Data Schedule (for SEC filing purposes only).
</TABLE>
50
<PAGE> 54
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-K/A
AMENDMENT NO. 1
---------------------
<TABLE>
<C> <S>
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
</TABLE>
COMMISSION FILE NUMBER 0-23917
CHASTAIN CAPITAL CORPORATION
(Exact name of registrant as specified in its governing instrument)
<TABLE>
<S> <C>
GEORGIA 58-2354416
(State of Organization) (I.R.S. Employer
Identification No.)
3424 PEACHTREE ROAD N.E., SUITE 800,
ATLANTA, GEORGIA 30326
(Address of principal executive office) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (404) 848-8871
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate the aggregate market value of the voting and non-voting common
equity held by non-affiliates. $27,613,436 as of March 31, 1999.
Indicate the number of shares outstanding of each of issuer's classes of
common stock, as of the latest practicable date. 7,346,778 shares of common
stock outstanding as of March 31, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
NONE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 55
EXPLANATORY NOTE
Pursuant to Rule 12b-5 under the Securities Exchange Act of 1934, as
amended, Chastain Capital Corporation (the "Company") hereby amends the
Company's Annual Report on Form 10-K as filed with the Securities and Exchange
Commission on March 31, 1999 (the "Annual Report"). This Amendment No. 1 to the
Annual Report adds the information required by Part III of Form 10-K in
accordance with General Instruction G to Form 10-K.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
BOARD OF DIRECTORS
Matthew Banks, 37, has served as Chairman of the Board since the Company's
inception in December 1997. Mr. Banks has been Chief Executive Officer of Lend
Lease since June 1997, responsible for its overall management as well as Lend
Lease's worldwide real estate investment management and advisory business. From
1995 to June 1997, he served as Chief Executive Officer of Lend Lease Property
Investment Services Group in Australia. From 1992 to 1995, he served in various
positions within Lend Lease, including Senior Project Manager, Branch Manager,
Development Manager, and General Manager.
Kurt L. Wright, 39, has served as a director and Chief Executive Officer of
the Company since its inception in December 1997 and as President of the Company
since March 1999. Mr. Wright has been Executive Vice President of Lend Lease
since April 1997 and currently heads Lend Lease's Mortgage Debt and Public
Markets Group, which is responsible for all CMBS and REIT share management, loan
originations and securitization and high-yield investing. From 1995 to 1997, he
was Senior Vice President responsible for portfolio management for the Buckhead
Strategic Fund series and ERE Hyperion Capital Advisors. From 1993 to 1995, Mr.
Wright was a Vice President responsible for mortgage research, product
development and marketing activities within the Mortgage Investors Group.
Harald R. Hansen, 67, has served as a director of the Company since
February 1998. He served as chairman of First Union National Bank of Georgia
from January 1989 until his retirement in September 1996. From January 1989 to
April 1996, he also served as Chief Executive Officer of First Union National
Bank of Georgia and prior to that he was executive vice president in charge of
the General Banking Group of First Union National Bank of Georgia.
Elizabeth T. Kennan, 61, has served as a director of the Company since
February 1998. She has been President Emeritus of Mount Holyoke College since
1995. She was President and Professor of History of Mount Holyoke College from
1978 until 1995. Dr. Kennan is a director of Talbots Inc., the Putnam Funds,
Northeast Utilities, and Bell Atlantic Corporation.
W.J. Smith, 66, has served as a director of the Company since February
1998. Mr. Smith has been President of W.J.S. & Associates, a company that
provides real estate consultant services to public pension funds and real estate
advisors to pension funds, since December 1991. Mr. Smith currently serves on
the board of directors of Shurgard Storage Centers and Franchise Finance
Corporation of America.
MEETINGS OF THE BOARD OF DIRECTORS
During 1998, the Board of Directors held a total of 18 meetings. All of the
directors attended at least 75% of all Board and committee meetings in 1998.
COMPENSATION OF DIRECTORS
The Company pays each director who is not an employee of Lend Lease (each
an "Independent Director") an annual director's fee equal to $30,000 per annum,
consisting of $15,000 in cash and $15,000 in shares of Common Stock. In April
1998, Messrs. Hansen and Smith and Dr. Kennan each received 1,000 shares of
Common Stock. The number of shares of Common Stock to be awarded to each
Independent
1
<PAGE> 56
Director will be determined annually on the date of the Annual Meeting of
Shareholders by dividing $15,000 by the average closing price of the Common
Stock for the preceding ten business days. The shares of Common Stock are vested
when issued. Each Independent Director was also paid a fee of $1,000 for each
meeting of the Board of Directors over four attended in person by such
Independent Director. All directors are reimbursed for their costs and expenses
in attending all meetings of the Board of Directors and its committees. Messrs.
Banks and Wright are not separately compensated by the Company for their service
on the Board of Directors. In addition, each of the members of the Special
Committee (as defined below) was paid $4,500 in additional fees for service on
the committee.
COMMITTEES OF THE BOARD OF DIRECTORS
Audit Committee. The Board of Directors has established an Audit Committee
that consists of Mr. Hansen and Dr. Kennan. Mr. Hansen serves as the chairman of
the Audit Committee. The Audit Committee is responsible for recommending to the
Board the firm to be employed as independent auditors of the Company, reviewing
with the independent auditor the Company's financial statements and internal
accounting controls and the plans and results of the audit engagement, approving
the professional services provided by the independent auditor, reviewing the
independence of the independent auditor, considering the range of audit and
non-audit fees and reviewing the adequacy of the Company's internal accounting
controls. During 1998, the Audit Committee held 0 meetings.
Compensation Committee. The Board of Directors has established a
Compensation Committee that consists of Messrs. Smith and Hansen and Dr. Kennan.
Mr. Smith serves as the chairman of the Compensation Committee. The Compensation
Committee is responsible for making recommendations, at least annually, to the
Board of Directors regarding the policies of the Company relating to, and the
amounts and terms of, all compensation of executive officers of the Company and
administering and discharging in full the authority of the Board with respect to
the Company's Stock Option Plan. During 1998, the Compensation Committee held 1
meeting.
Special Committee. During the third and fourth quarter of 1998,
developments in the debt and equity markets resulted in a significant impact in
the value of the Company's portfolio and credit available. As a result, on
October 21, 1998, the Board of Directors formed a special committee of
Independent Directors (the "Special Committee") to (i) review and evaluate the
short term and long term strategic alternatives available to the Company and
report its recommendations to the full Board of Directors and (ii) negotiate the
terms of and approve any action that the Special Committee determines involves a
conflict of interest with Lend Lease. Harald R. Hansen, Elizabeth Kennan and
W.J. Smith, the Independent Directors of the Board, were appointed to serve on
the Special Committee. The Special Committee has engaged Alston & Bird LLP as
its independent counsel and Chase Securities, Inc. as its independent financial
advisor. Since its formation, the Special Committee has discussed and approved
the restructuring of the credit facilities with Morgan Guaranty Trust and
Merrill Lynch and the terms of the unsecured subordinated debt provided by an
affiliate of Lend Lease. During 1998, the Special Committee held 10 meetings.
The Company does not have a nominating committee.
EXECUTIVE OFFICERS
The executive officers of the Company and their positions are described
below, together with a biographical summary of the experience of such officers
for the past five years. The executive officers serve at the discretion of the
Board of Directors.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
- ---- --- -------------------------
<S> <C> <C>
Kurt L. Wright....................................... 39 President and Chief Executive Officer
D. Michael Jett...................................... 49 Chief Operating Officer
Steven G. Grubenhoff................................. 35 Chief Financial Officer
Samuel F. Hatcher.................................... 53 Secretary
</TABLE>
2
<PAGE> 57
D. Michael Jett has served as Chief Operating Officer of the Company since
its inception. He has been Senior Vice President of Lend Lease since 1992. Since
1995, Mr. Jett has been responsible for coordinating new equity acquisitions for
three Lend Lease division offices.
Steven G. Grubenhoff has served as Chief Financial Officer of the Company
since its inception. He was a Vice President of Lend Lease from 1995 to 1998 and
has been a Senior Vice President of Lend Lease since 1998. In addition, Mr.
Grubenhoff has served as chief financial officer for two commingled
opportunistic real estate limited partnerships since 1995. Mr. Grubenhoff's
responsibilities have included all financial reporting requirements, developing
portfolio financial strategies, ensuring that optimum tax and legal structures
are being utilized; performing financial due diligence on new investments and
managing interest rate exposures.
Samuel F. Hatcher has served as Secretary of the Company since its
inception. He has been Senior Executive Vice President and General Counsel for
Lend Lease since June 1997 and, prior thereto, was Executive Vice President and
General Counsel of Equitable Real Estate Investment Management, Inc. ("ERE")
since 1989.
ITEM 11. EXECUTIVE COMPENSATION
The Company has not paid, and does not intend to pay, any annual
compensation to the Company's executive officers for their services as executive
officers. However, the Company has established a Compensation Committee, which
is responsible for making recommendations, at least annually, to the Board of
Directors regarding the policies of the Company relating to, and the amounts and
terms of, all compensation of executive officers of the Company and
administering and discharging in full the authority of the Board with respect to
the Company's Stock Option Plan.
ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table and notes thereto set forth information, as of March
31, 1999 (unless otherwise indicated), with respect to the beneficial ownership
of shares of Common Stock (i) by persons known by the Company to own more than
5% of the outstanding shares of Common Stock, (ii) by each director and (iii) by
the directors and executive officers of the Company as a group, based upon
information furnished to the Company by such persons. The executive officers of
the Company, other than the Chief Executive Officer, are not included
individually because they receive no compensation from the Company. Except as
otherwise indicated, each person included in the table exercises sole voting and
dispositive power over such shares.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENT OF
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED CLASS(1)
- ------------------------ ------------------ ----------
<S> <C> <C>
DIRECTORS AND CHIEF EXECUTIVE OFFICER
Matthew Banks(2)............................................ 469 *
Harald R. Hansen(3)......................................... 3,800 *
Samuel F. Hatcher(4)........................................ 469 *
Elizabeth Kennan(5)......................................... 2,400 *
W.J. Smith(6)............................................... 2,400 *
Kurt L. Wright(7)........................................... 9,332 *
All executive officers and directors as a group (8
persons)(8)............................................... 22,870 *
OTHER FIVE PERCENT HOLDERS
Friedman, Billings, Ramsey Group, Inc.(9)................... 968,847 13.2%
Capital Guardian Trust Company(10).......................... 943,000 12.8%
Putnam Investments, Inc.(11)................................ 507,900 6.9%
Lend Lease Investment Holdings, Inc.(12).................... 1,254,481 17.0%
</TABLE>
- ---------------
* Less than 1%
(1) Based on an aggregate of 7,346,778 shares of Common Stock issued and
outstanding as of April 24, 1999. Assumes that all options beneficially
owned by the person are exercised. The total number of
3
<PAGE> 58
shares outstanding used in calculating this percentage assumes that none of
the options beneficially owned by other persons are exercised.
(2) Includes 134 shares of Common Stock issuable upon the exercise of
outstanding options.
(3) Includes 800 shares of Common Stock issuable upon the exercise of
outstanding options.
(4) Includes 134 shares of Common Stock issuable upon the exercise of
outstanding options.
(5) Includes 400 shares of Common Stock issuable upon the exercise of
outstanding options.
(6) Includes 400 shares of Common Stock issuable upon the exercise of
outstanding options.
(7) Includes 2,666 shares of Common Stock issuable upon the exercise of
outstanding options.
(8) Includes 4,534 shares of Common Stock issuable upon the exercise of
outstanding options.
(9) Represents shares owned by Friedman, Billings, Ramsey Group, Inc. ("FBR")
and certain affiliates of FBR. FBR has sole voting power over 968,847
shares of Common Stock and sole dispositive power over 968,847 shares of
Common Stock. This information is included in reliance on a Schedule 13G
filed by FBR with the Securities and Exchange Commission ("the SEC") on
February 16, 1999. FBR's address is 1001 19th Street North, Arlington, VA
22209-1710.
(10) This information is included in reliance on a Schedule 13G filed by Capital
Guardian Trust Company ("CGT") with the SEC on February 16, 1999. CGT has
sole voting power over 668,000 shares of Common Stock and sole dispositive
power over 943,000 shares of Common Stock. CGT's address is 11100 Santa
Monica Boulevard, Los Angeles, CA 90025-3384.
(11) Represents shares beneficially owned by Putnam Investments, Inc. ("PI"),
Marsh & McLennan Companies, Inc. and certain subsidiaries of PI. PI has
sole voting power over 0 shares of Common Stock, sole dispositive power
over 0 shares of Common Stock and shared dispositive power over 507,900
shares of Common Stock. This information is included in reliance on a
Schedule 13G filed by PI with the SEC on February 12, 1999. PI's address is
One Post Office Square, Boston, Massachusetts 02109.
(12) This information is included in reliance on a Schedule 13D filed by Lend
Lease Investment Holdings, Inc. ("LLIH") (formerly ERE Yarmouth Holdings,
Inc.) with the SEC on May 8, 1998. LLIH has sole voting power over
1,254,481 shares of Common Stock and sole dispositive power over 1,254,481
shares of Common Stock. LLIH's address is 3424 Peachtree Road, Suite 800,
Atlanta, GA 30326.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
MANAGEMENT AGREEMENT
The Manager, subject to the supervision of the Board of Directors of the
Company, manages the Company pursuant to a management agreement. The management
agreement provides for an annual base management fee, calculated and paid
quarterly based upon 1% of the "Average Invested Assets" (as defined below) of
the Company for such quarter for the first four fiscal quarters commencing with
the fiscal quarter ended June 30, 1998. In subsequent fiscal quarters, the
annual base management fee is equal to 0.85% of the Average Invested Assets up
to $1 billion, 0.75% of the Average Invested Assets from $1 billion to $1.25
billion and 0.50% of the Average Invested Assets in excess of $1.25 billion. The
term "Average Invested Assets" for any period means the average of the aggregate
book value of the assets of the Company, including a proportionate amount of the
assets of all of its direct and indirect subsidiaries, before reserves for
depreciation or bad debts or other similar non-cash reserves, less (i)
uninvested cash balances and (ii) the book value of the Company's CMO
liabilities, computed by dividing (a) the sum of such values for each of the
three months during such quarter (based on the book value of such assets as of
the last day of each month) by (b) three.
The Manager is also entitled to receive incentive compensation for each
fiscal quarter in an amount equal to the product of (A) 25% of the dollar amount
by which (1) (a) "Funds From Operations" (as defined below) before the incentive
fee of the Company for the applicable quarter per weighted average number of
shares of Common Stock outstanding plus (or minus) (b) gains (or losses) from
debt restructuring or sales of assets not included in Funds From Operations of
the Company for such quarter per weighted average number of shares of Common
Stock outstanding, exceeds (2) an amount equal to (a) the weighted average of
the price per share at the initial public offering and the prices per share at
any secondary offerings by the Company multiplied by (b) 25% of the sum of the
Ten-Year U.S. Treasury Rate plus four percent, and (B) the
4
<PAGE> 59
weighted average number of shares of Common Stock outstanding. The quarterly
incentive fee is non-cumulative. "Funds from Operations" as defined by the
National Association of Real Estate Investment Trusts means net income (computed
in accordance with generally accepted accounting principles) excluding gains (or
losses) from debt restructuring and sales of property, plus depreciation and
amortization on real estate assets, and after deduction of preferred stock
dividends, if any, and similar adjustments for unconsolidated partnerships and
joint ventures. Funds from Operations does not represent cash generated from
operating activities in accordance with GAAP and should not be considered as an
alternative to net income as an indication of the Company's performance or to
cash flows as a measure of liquidity or ability to make distributions.
The Manager is reimbursed for (or charges the Company directly for) the
Manager's out-of-pocket costs incurred in performing its duties under the
management agreement. There is no cap on the reimbursement of out-of-pocket
expenses.
The ability of the Company to generate Funds from Operations in excess of
the Ten-Year U.S. Treasury Rate, and of the Manager to earn the incentive
compensation described in the above table, is dependent upon the level and
volatility of interest rates, the Company's ability to react to changes in
interest rates and other factors, many of which are not within the Company's
control.
The management fees are payable in arrears. The Manager's base and
incentive fees are calculated by the Manager within 45 days after the end of
each quarter, and such calculation is delivered to the Company. The Company is
obligated to pay such fees and expenses within 60 days after the end of each
fiscal quarter.
The Manager is expected to use the proceeds from its base management fee
and incentive compensation in part to pay compensation to its officers who,
although they also are officers of the Company, receive no cash compensation
directly from the Company. During 1998, the Manager earned $1,096,562 in base
management fees and no incentive fees. There were approximately $671,000
expenses for which the Company reimbursed the Manager.
TRANSACTIONS WITH THE MANAGER AND ITS AFFILIATES
On April 28, 1998, concurrently with the completion of its initial public
offering, the Company issued and sold 897,678 shares of Common Stock to Lend
Lease Investment Holdings, Inc. ("LLIH"), an indirect wholly owned subsidiary of
the Manager. The purchase price was $13.95 per share, for an aggregate purchase
price of approximately $12.5 million.
On November 13, 1998, the Company entered into a subordinated loan
agreement with LLIH (the "LLIH Agreement"). The agreement provided for a $40
million line of credit for the Company. The Company made an initial draw of $17
million under the LLIH Agreement. As of December 31, 1998, borrowings under the
LLIH Agreement were $9 million. Amounts borrowed under the LLIH Agreement
accrued interest at a rate of 14% per annum through January 31, 1999, and 16%
thereafter. The Company accrued a total of approximately $141,000 in interest
expenses with respect to borrowings under the LLIH Agreement in 1998. The
Company repaid all of the outstanding indebtedness under the LLIH Agreement on
April 5, 1999, and the agreement was terminated. Reference is also made to the
disclosure under the caption "Option Plan" in Item 1 to the Company's Annual
Report on Form 10-K filed on March 31, 1999, which is incorporated herein by
this reference.
EXECUTIVE OFFICERS AND DIRECTORS
In addition to being Chairman of the Board of Directors, Matthew Banks is
Chief Executive Officer of the Manager. Kurt L. Wright, the Company's President
and Chief Executive Officer, is Executive Vice President of the Manager.
Similarly, each of the executive officers of the Company is employed by the
Manager.
5
<PAGE> 60
TRANSACTIONS WITH SIGNIFICANT SHAREHOLDERS
An affiliate of FBR, listed above as a holder of more than 5% of the Common
Stock, acted as a managing underwriter for the Company's initial public offering
in April 1997. Concurrently with the initial public offering, the Company issued
in a private placement 700,000 shares of Common Stock to an affiliate of FBR at
a purchase price of $13.95 per share, with total proceeds to the Company of
$22,287,608.
6
<PAGE> 61
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this amendment
to be signed on its behalf by the undersigned, thereunto duly authorized on the
30th day of April, 1999.
CHASTAIN CAPITAL CORPORATION
By: /s/ KURT L. WRIGHT
--------------------------------------
Kurt L. Wright
Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
amendment has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on April 30, 1999.
/s/ MATTHEW BANKS
-------------------------------------
Matthew Banks
Chairman of the Board
/s/ KURT L. WRIGHT
-------------------------------------
Kurt L. Wright
Chief Executive Officer and Director
(Principal Executive Officer)
/s/ STEVEN G. GRUBENHOFF
-------------------------------------
Steven G. Grubenhoff
Chief Financial Officer (Principal
Financial and Accounting Officer)
/s/ HARALD R. HANSEN
-------------------------------------
Harald R. Hansen
Director
--------------------------------------
Elizabeth Kennan
Director
--------------------------------------
W.J. Smith
Director
7
<PAGE> 62
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
<TABLE>
<C> <S>
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM ____________TO ____________
</TABLE>
COMMISSION FILE NO. 0-23917
CHASTAIN CAPITAL CORPORATION
(Exact name of registrant as specified in its governing instrument)
<TABLE>
<S> <C>
GEORGIA 58-2354416
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3424 PEACHTREE ROAD N.E., SUITE 80
ATLANTA, GEORGIA 30326
(Address of principal executive office) (Zip Code)
</TABLE>
(Registrant's telephone number, include area code)(404) 848-8850
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 7,346,778 shares of common
stock outstanding as of May 10, 1999.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 63
CHASTAIN CAPITAL CORPORATION
CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements:
1
Consolidated Balance Sheets as of March 31, 1999 (Unaudited)
and December 31, 1998 (Audited)...........................
2
Consolidated Statement of Operations for the three months
ended March 31, 1999 (Unaudited)..........................
3
Consolidated Statement of Changes in Shareholders' Equity
for the three months ended March 31, 1999 (Unaudited).....
4
Consolidated Statement of Cash Flows for the three months
ended March 31, 1999 (Unaudited)..........................
5
Notes to Consolidated Financial Statements..................
Item 2. Management's Discussion and Analysis of Financial Condition 17
and Results of Operations.................................
Item 3. Quantitative and Qualitative Disclosure about Market Risk... 21
PART II -- OTHER INFORMATION
Items 1 through 6.................................................... 23
Signatures........................................................... 24
</TABLE>
i
<PAGE> 64
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1999 (UNAUDITED)
DECEMBER 31, 1998 (AUDITED)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Commercial mortgage-backed securities (CMBS)
available-for-sale, at fair value......................... $ 20,973,395 $ 71,567,475
Mezzanine loan investments.................................. 44,115,499 44,374,346
Mortgage loan investments................................... -- 15,150,400
Real estate investment held for sale, net................... 3,496,460 7,294,583
Cash and short-term investments............................. 8,875,695 11,957,616
Escrow cash................................................. -- 2,138,011
Accrued interest receivable................................. 277,214 1,153,989
Other assets................................................ 440,245 876,006
------------ ------------
Total assets...................................... $ 78,178,508 $154,512,426
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Short-term borrowings....................................... $ -- $ 61,918,156
Subordinated debt to related party.......................... 8,500,000 9,000,000
Borrowings under repurchase agreement....................... -- 7,926,375
Treasury locks payable...................................... 10,845,075 10,887,660
Accrued management fees..................................... 279,469 438,842
Accrued interest expense.................................... 28,713 374,759
Accrued expenses and other liabilities...................... 281,348 4,127,931
------------ ------------
Total liabilities................................. 19,934,605 94,673,723
------------ ------------
SHAREHOLDERS' EQUITY:
Preferred stock, $0.01 par value. Authorized 25,000,000
shares, no shares issued
Common stock, $.01 par value. Authorized 200,000,000 shares,
7,346,778 issued and outstanding at March 31, 1999 and
December 31, 1998......................................... 73,468 73,468
Additional paid-in capital.................................. 108,692,169 108,692,169
Distributions in excess of earnings:
Accumulated losses from operations........................ (37,036,193) (38,105,018)
Accumulated losses from sale of assets.................... (10,230,302) (7,566,677)
Dividends paid............................................ (3,255,239) (3,255,239)
------------ ------------
Total distributions in excess of earnings......... (50,521,734) (48,926,934)
------------ ------------
Total shareholders' equity........................ 58,243,903 59,838,703
------------ ------------
Total liabilities and shareholders' equity........ $ 78,178,508 $154,512,426
============ ============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
1
<PAGE> 65
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE
MONTHS ENDED
MARCH 31, 1999
--------------
<S> <C>
REVENUE:
Interest income on CMBS..................................... $ 1,833,192
Interest income on mezzanine loan investments............... 1,208,003
Interest income on mortgage loan investments................ 9,739
Rental income............................................... 297,005
Other income................................................ 11,497
Other interest income....................................... 90,906
-----------
Total revenue..................................... 3,450,342
-----------
OPERATING EXPENSES:
Interest expense............................................ 1,236,354
Management fees............................................. 279,469
General and administrative expense.......................... 99,326
Real estate operating expenses.............................. 110,914
Depreciation and amortization............................... 135,926
Impairment loss on CMBS..................................... 470,528
Loss on termination of interest rate collar................. 49,000
-----------
Total operating expenses.......................... 2,381,517
-----------
OPERATING INCOME BEFORE ASSET SALES......................... 1,068,825
REALIZED LOSSES ON SALE OF ASSETS
Loss on sale of CMBS........................................ 2,561,102
Loss on sale and settlement of mortgage loans............... 97,929
Loss on sale of real estate................................. 4,594
-----------
NET LOSS.......................................... $(1,594,800)
===========
NET LOSS PER COMMON SHARE:
Basic and Diluted........................................... $ (0.22)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic and Diluted........................................... 7,346,778
</TABLE>
Chastain Capital Corporation was incorporated on December 16, 1997 and
commenced operations on April 23, 1998 (see Note 1).
See accompanying Notes to Consolidated Financial Statements.
2
<PAGE> 66
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
DISTRIBUTIONS IN EXCESS OF EARNINGS
-----------------------------------------
NUMBER OF ADDITIONAL LOSSES FROM TOTAL
SHARES COMMON PAID-IN ACCUMULATED SALE OF DIVIDENDS SHAREHOLDERS'
OUTSTANDING STOCK CAPITAL OPERATIONS ASSETS PAID EQUITY
----------- ------- ------------ ------------ ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December
31, 1998........... 7,346,778 $73,468 $108,692,169 $(38,105,018) $ (7,566,677) $(3,255,239) 59,838,703
Net loss............. 1,068,825 (2,663,625) (1,594,800)
========= ======= ============ ============ ============ =========== ===========
Balance at March 31,
1999............... 7,346,778 $73,468 $108,692,169 $(37,036,193) $(10,230,302) $(3,255,239) $58,243,903
========= ======= ============ ============ ============ =========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE> 67
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE
MONTHS ENDED
MARCH 31, 1999
--------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $ (1,594,800)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Impairment loss on investments......................... 470,528
Loss on sale of CMBS................................... 2,561,102
Losses on termination of interest rate collar.......... 49,000
Non-cash interest expense on rate lock agreements...... 173,415
Loss on sale and settlement of mortgage loan
investments........................................... 97,929
Loss on sale of real estate............................ 4,594
Depreciation and amortization.......................... 135,926
Amortization of discount/premium on CMBS
available-for-sale.................................... (210,342)
Amortization of premium on mezzanine loan investment... 75,141
Net decrease in assets:
Accrued interest receivable.......................... 876,775
Other assets......................................... 2,437,846
Net decrease in liabilities:
Accrued interest expense............................. (346,047)
Accrued management fees.............................. (159,373)
Accrued expenses and other liabilities............... (2,955,788)
------------
Net cash provided by operating activities......... 1,615,906
------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of CMBS available-for-sale............. 47,772,792
Proceeds from sale of mortgage loan investment............ 15,052,470
Proceeds from sale of real estate investment.............. 2,904,612
Repayments on loans....................................... 183,707
Capital additions to real estate.......................... (1,877)
------------
Net cash provided by investing activities......... 65,911,704
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of loan facilities............................. (78,344,531)
Proceeds from loan facilities............................. 8,000,000
Repayments of interest rate collar........................ (265,000)
------------
Net cash used by financing activities............. (70,609,531)
------------
NET DECREASE IN CASH AND CASH EQUIVALENTS................... (3,081,921)
Cash and cash equivalents at beginning of period.......... 11,957,616
------------
Cash and cash equivalents at end of period................ $ 8,875,695
============
Cash paid for interest.................................... $ 1,408,985
============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE> 68
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION
Chastain Capital Corporation (the "Company") was incorporated in Georgia on
December 16, 1997 and was initially capitalized on such date through the sale of
100 shares of common stock, par value $0.01 per share ("Common Stock") for an
aggregate purchase price of $1,000. On April 23, 1998, the Company commenced
operations through the consummation of an initial public offering ("IPO") of
7,380,000 shares of its Common Stock, with gross proceeds of $110,700,000 and
net proceeds to the Company of $102,951,000. Additional public offering costs of
$1,215,750 were incurred in connection with the IPO.
The Company also issued, pursuant to two separate private placements, an
aggregate of 897,678 shares of Common Stock to Lend Lease Investments Holdings,
Inc. ("LLIH", formerly ERE Yarmouth Holdings, Inc.), an indirect wholly-owned
subsidiary of Lend Lease Corporation Limited ("Lend Lease"), and 700,000 shares
of Common Stock to FBR Asset Investment Corporation, an affiliate of Friedman,
Billings, Ramsey & Co., Inc. (lead underwriter of the Company's IPO). The two
private placements closed concurrently with the closing of the IPO, at $13.95
per share, with total proceeds to the Company of $22,287,608.
Pursuant to the Company's Directors Stock Plan, each of the Company's three
independent directors received, as of the consummation of the IPO, $15,000 worth
of Common Stock equal to 1,000 shares as part of their annual director's fee.
The Company was organized to originate first lien commercial and
multifamily mortgage loans for the purpose of issuing collateralized mortgage
obligations ("CMOs") collateralized by its mortgage loans and retaining the
mortgage loans subject to the CMO debt. The Company also was organized to
acquire subordinated interests in commercial mortgage-backed securities
("CMBS"), originate and acquire loans on real property that are subordinated to
first lien mortgage loans and acquire real property and other real estate
related assets.
On October 23, 1998, the Company announced that due to turmoil in the
credit markets, it was necessary to obtain temporary waivers from Morgan
Guaranty Trust Company of New York ("Morgan Guaranty Trust") and Merrill Lynch
Mortgage Capital, Inc. ("Merrill Lynch") to avoid being in default of tangible
net worth covenants under the Company's credit facilities. The Board of
Directors decided to discontinue new investment activity and concluded that the
Company needed to be restructured. On November 13, 1998, the Company reached an
agreement with Morgan Guaranty Trust and Merrill Lynch to restructure its credit
facilities and to dispose of certain assets to reduce the size and stabilize the
volatility of the overall portfolio. Proceeds from the asset sales were used to
reduce outstanding indebtedness on both credit facilities. Through the asset
sales and indebtedness reduction, the Company was able to satisfy its immediate
liquidity needs. The remaining portfolio consists primarily of CMBS, mezzanine
loan investments and real estate.
In connection with the credit facility amendments, LLIH agreed to provide
the Company with up to $40 million of unsecured subordinated debt. An initial
advance of $17 million was drawn on November 13, 1998 and the remaining funds
were available to be drawn from time to time by the Company through maturity on
April 5, 1999. The advances incured interest at the rate of 14% per annum
through January 31, 1999 and 16% thereafter. The terms of the subordinated debt
were reviewed and approved by a special committee of the Board of Directors
consisting of independent directors not affiliated with Lend Lease. The special
committee obtained the advice of independent financial advisors and legal
counsel in negotiating the terms of the loan.
The amended credit facilities and new subordinated debt agreement provided
the Company with the necessary liquidity in the short term to fund its mortgage
loan commitments, meet margin calls and hold investments. The Merrill Lynch
amendment required the $19 million in outstanding borrowings be repaid on or
before January 31, 1999. On January 27, 1999, the Merrill Lynch Agreement was
further amended, requiring the borrowings to be repaid on or before February 26,
1999. On February 25, 1999, the Merrill Lynch agreement was again amended,
extending the maturity date to March 25, 1999. All outstanding indebtedness
under the Merrill Lynch agreement was repaid on March 25, 1999, and the facility
was
5
<PAGE> 69
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
terminated. All indebtedness under the Morgan Guaranty Trust agreement was
repaid on March 31, 1999. The LLIH subordinated debt agreement was repaid and
terminated on April 5, 1999. The Company continues to evaluate various strategic
alternatives available to maximize shareholder value.
On January 25, 1999, the Board of Directors approved a plan of action to
sell off existing assets to meet the debt maturities. From January 25, 1999 to
March 31, 1999, the Company sold certain CMBS for total proceeds of $47.8
million, resulting in a realized loss of $14.2 million, of which $11.7 million
was recognized in 1998. On March 25, 1999, the Company sold a real estate asset
for $3.8 million, resulting in a realized loss of $262,392, of which $257,797
was recognized in 1998.
On April 5, 1999, the Company consummated an agreement (the "GMAC Repo") to
sell an office mezzanine loan with a face value of $21 million to General Motors
Acceptance Corporation ("GMAC"). The agreement allows the Company to repurchase
the investment no later than April 1, 2000. The GMAC Repo generated proceeds of
$10.5 million. The repurchase price of the GMAC Repo will be adjusted such that
GMAC will receive an 8% annualized yield on its investment prior to October 1,
1999. After October 1, 1999, the repurchase price is fixed at $9.6 million. The
Company used $8.5 million of the proceeds of the GMAC Repo to repay borrowings
from LLIH and will use the remaining proceeds to meet its remaining corporate
obligations, which primarily consist of hedging liabilities. The Company is
accounting for the GMAC Repo as a financing transaction.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Company include the accounts
of the Company and its wholly owned subsidiaries. All intercompany accounts and
transactions have been eliminated in consolidation.
CASH AND SHORT-TERM INVESTMENTS
All highly liquid investments with maturities of three months or less when
purchased are considered to be short-term investments.
COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a business
during a period from transactions and other events and circumstances, excluding
those resulting from investments by and distributions to owners. For the period
ended March 31, 1999, there is no difference between net loss and comprehensive
net loss.
CMBS
The Company classifies its CMBS as available-for-sale. Available-for-sale
securities are reported at fair value with net unrealized gains and losses
reported in comprehensive income (loss) as a separate component of shareholders'
equity. The Company recognizes income from CMBS under the effective interest
method, using the anticipated yield over the projected life of the investment.
The Company recognizes impairment on its CMBS when it determines that the
decline in the estimated fair value of its CMBS below cost is other than
temporary. Impairment losses are determined by comparing the estimated fair
value of a CMBS to its current carrying amount, the difference being recognized
as a loss. The Company uses specific identification in determining realized
gains/losses on its CMBS.
6
<PAGE> 70
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MEZZANINE LOAN INVESTMENTS
The Company purchased and originated certain mezzanine loans to be held as
long-term investments. Loans held for investment are recorded at cost at the
date of purchase. Premiums and discounts related to these loans are amortized
over their estimated lives using the effective interest method. Any origination
fee income, application fee income and direct costs associated with originating
or purchasing mezzanine investments have been deferred and the net amount is
added to the basis of the loans on the balance sheet. The Company recognizes
impairment on the loans when it is probable that the Company will not be able to
collect all amounts due according to the contractual terms of the loan
agreement, or when the fair value of the loans is below amortized cost and the
Company determines that it may not be able to hold the loans until amortized
cost is recovered. As a result of the Company's November restructuring and the
Board's decision to discontinue new investment activity and to sell assets to
repay the Company's indebtedness, it is currently unlikely that the Company will
hold its mezzanine loan investments until maturity. The Company measures
impairment based on the present value of expected future cash flows discounted
at the loan's effective interest rate or Management's estimate of the fair value
of the loan.
REAL ESTATE INVESTMENTS
Real estate assets are stated at cost when purchased and are subsequently
reduced by depreciation charges using the straight-line method over the
estimated useful lives of the assets. At March 31, 1999, the Company's
investment in real estate is classified as held for sale and is carried at the
lower of cost or fair value less estimated selling costs.
Rental income was being recognized over the life of the tenant leases using
the straight-line method. The Company eliminated the effect of the straight-line
adjustment when the properties were reclassified as held for sale.
INTEREST RATE PROTECTION AGREEMENTS
The Company acquired interest rate protection agreements, in the form of
forward treasury locks, to reduce its exposure to interest rate risk on
anticipated long-term borrowings. At the time the treasury locks were acquired
it was anticipated that they would hedge the Company's exposure to future
financing costs and thus qualify for hedge accounting. Under hedge accounting,
any gain or loss on the treasury lock settlements would be amortized over the
term of the anticipated financing agreement. To qualify for hedge accounting,
these interest rate protection agreements must meet certain criteria including:
(1) the debt to be hedged exposes the Company to interest rate risk, (2) the
interest rate protection agreement reduces the Company's exposure to interest
rate risk, and (3) it is probable that the anticipated financing will occur. In
the event these interest rate protection agreements do not qualify as hedges,
such agreements are reclassified to be investments accounted for at fair value,
with any gain or loss included as a component of income or loss in the statement
of operations.
As a result of the turmoil in the credit markets in October 1998, the
Company determined that its ability to obtain long-term, fixed-rate financing
was no longer probable. On October 23, 1998 the Company terminated all of its
treasury locks and incurred a realized loss of $13.3 million in 1998.
On July 13, 1998 the Company entered into a Libor collar in the notional
amount of $89 million to mature on July 1, 1999, in order to hedge against
rising short term borrowing costs. The collar contract effectively locked in the
Company's Libor base rate between a floor of 5.51% and a ceiling of 5.80% during
the term. The Company terminated the collar contract on January 27, 1999 and
realized a loss of $265,000, of which $216,000 was recognized in 1998.
7
<PAGE> 71
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INCOME TAXES
The Company elected to be taxed as a REIT under the Internal Revenue Code
of 1986 (the "Code"), as amended, commencing with its first REIT taxable year
ended on December 31, 1998. As a REIT, the Company generally is not subject to
federal corporate income taxes on net income that it distributes to
shareholders, provided that the Company meets certain other requirements for
qualification as a REIT under the Code. Because the Company qualifies as a REIT
and because the Company is reporting net losses year to date for 1999, no
provision has been made for federal income taxes for the Company and its
subsidiaries in the accompanying consolidated financial statements.
NET LOSS PER SHARE
Basic net loss per share is computed on the basis of the weighted average
number of shares outstanding for the period. Diluted net loss per share is
computed on the basis of the weighted average number of shares and dilutive
common equivalent shares outstanding for the period. For the three months ending
March 31, 1999, all outstanding options to purchase 1,246,253 shares of Common
Stock were anti-dilutive. Accordingly, there is no difference between basic and
diluted net loss per common share.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the reporting
period. Actual results could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 133 "Accounting for Derivative Instruments and for
Hedging Activities" ("FAS 133"). FAS 133 establishes accounting and reporting
standards for derivative instruments and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as a
hedge. The accounting for changes in the fair value of a derivative depends on
the intended use of the derivative and the resulting designation. FAS 133 is
effective for the Company beginning January 1, 2000. The Company is evaluating
the eventual impact of FAS 133 on its financial statements.
NOTE 3. SEGMENT DISCLOSURE
The Company has one reportable segment, real estate investments. At March
31, 1999, the Company's real estate investments included CMBS, mezzanine real
estate loans, and a commercial real estate property. The Company uses net income
(loss) to measure profit or loss. The Company separately discloses assets,
revenue and capital expenditures by type of real estate investment in the
consolidated financial statements.
Except for interest income earned on the Company's investment in a British
pounds Sterling mezzanine loan, discussed in Note 6, all of the Company's
revenue is attributed to investments located in the United States. Revenue
information by country is summarized below:
<TABLE>
<CAPTION>
MARCH 31,
1999
----------
<S> <C>
United States............................................... $3,001,393
United Kingdom.............................................. 448,949
Total............................................. 3,450,342
</TABLE>
8
<PAGE> 72
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At March 31, 1999, the carrying amount of the Company's British pounds
Sterling loan was $16,764,264.
During the three months ending March 31, 1999, the following Company
investments accounted for more than 10% of revenue:
<TABLE>
<S> <C>
Mezzanine loan on an office building in New York............ 18%
Mezzanine loan on multiple hotels in London, England........ 13
B rated CMBS sold in March 1999............................. 14
</TABLE>
NOTE 4. MANAGEMENT FEES
The Company entered into a Management Agreement (the "Management
Agreement") with ERE Yarmouth, Inc., an indirect wholly-owned subsidiary of Lend
Lease Corporation Limited, under which ERE Yarmouth, Inc. 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. On July 13, 1998, the name
of ERE Yarmouth, Inc. was changed to Lend Lease Real Estate Investments, Inc.
("Lend Lease" or the "Manager" or "Management"). Lend Lease continues as the
advisor to the Company.
Pursuant to the Management Agreement, the Company will pay the Manager a
quarterly base management fee equal to the following:
<TABLE>
<S> <C>
For the first four fiscal quarters
commencing with the fiscal Quarter
ended June 30, 1998................. 1.00% per annum of the Average
Invested Assets(1) of the Company
</TABLE>
<TABLE>
<S> <C>
During each fiscal quarter
thereafter....................... 0.85% per annum of the Average
Invested Assets up to $1 billion
0.75% per annum of the Average
Invested Assets from $1 billion to
$1.25 billion
0.50% per annum of the Average
Invested Assets in excess of $1.25
billion
</TABLE>
The Company incurred base management fees of $279,469 for the three months
ended March 31, 1999.
The Management Agreement also provides for a quarterly incentive management
fee equal to the product of (A) 25% of the dollar amount by which (1) (a) Funds
From Operations(2) (before the incentive fee) of the Company for the applicable
quarter per weighted average number of shares of Common Stock outstanding plus
(b) gains (or minus losses) from debt restructuring or sales of assets not
included in Funds From Operations of the Company for such quarter per weighted
average number of shares of Common Stock
- ---------------
(1) The term "Average Invested Assets" for any period means the average of
the aggregate book value of the assets of the Company, including a proportionate
amount of the assets of all of its direct and indirect subsidiaries, before
reserves for depreciation or bad debts or other similar non-cash reserves less
(i) uninvested cash balances and (ii) the book value of the Company's CMO
liabilities, computed by dividing (a) the sum of such values for each of the
three months during such quarter (based on the book value of such assets as of
the last day of each month) by (b) three.
(2) The term "Funds From Operations" as defined by the National Association
of Real Estate Investment Trusts, Inc. means net income (computed in accordance
with GAAP) excluding gains (or losses) from debt restructuring, sales of
property and any unusual or non-recurring transactions, plus depreciation and
amortization on real estate assets, and after deduction of preferred stock
dividends, if any, and similar adjustments for unconsolidated partnerships and
joint ventures. Funds From Operations does not represent cash generated from
operating activities in accordance with GAAP and should not be considered as an
alternative to net income as an indication of the Company's performance or to
cash flows as a measure of liquidity or ability to make distributions.
9
<PAGE> 73
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
outstanding, exceed (2) an amount equal to (a) the weighted average of the
price per share at initial offering and the prices per share at any secondary
offerings by the Company multiplied by (b) 25% of the sum of the Ten-Year U.S.
Treasury Rate plus four percent, and (B) the weighted average number of shares
of Common Stock outstanding. No incentive management fees have been earned for
the three months ended March 31, 1999.
The Management Agreement is for an initial term of two years, and can be
successively extended for two year periods subject to an affirmative vote of a
majority of the Independent Directors. In addition, the Management Agreement
provides for a termination fee equal to the sum of the base management fee and
incentive management fee, if any, earned during the immediately preceding four
fiscal quarters.
NOTE 5. INVESTMENT IN CMBS
The amortized cost and estimated fair value of commercial mortgage-backed
securities classified as available-for-sale securities at March 31, 1999 are
summarized below. The face value of CMBS was $31,015,870 at March 31, 1999.
<TABLE>
<CAPTION>
WEIGHTED ESTIMATED
AVERAGE LIFE AMORTIZED IMPAIRMENT AMORTIZED COST FAIR
SECURITY RATING (IN YEARS) COST LOSSES ADJUSTED VALUE
- --------------- ------------ ----------- ---------- -------------- -----------
<S> <C> <C> <C> <C> <C>
CMBS:
BB+............................ 14.2 $15,884,875 $3,257,525 $12,627,350 $12,627,350
BB............................. 14.9 10,517,695 2,171,650 8,346,045 8,346,045
----------- ---------- ----------- -----------
Total.................. $26,402,570 $5,429,175 $20,973,395 $20,973,395
=========== ========== =========== ===========
</TABLE>
The estimated fair value of the CMBS is based on either i) the price
obtained from the investment banking institutions, which sold the CMBS to the
Company, or ii) an average of at least three quotes received on similarly
structured and rated CMBS. The use of different market assumptions, valuation
methodologies, changing interest rates, interest rate spreads for CMBS over the
U.S. Treasury yields and the timing and magnitude of credit losses may have a
material effect on the estimates of fair value. The fair value estimates
presented herein are based on pertinent information available as of March 31,
1999.
The CMBS tranches owned by the Company provide credit support to the more
senior tranches of the related commercial securitization. Cash flow from the
underlying mortgages is generally allocated first to the senior tranches, with
the most senior tranches having a priority right to cash flow. Any remaining
cash flow is generally allocated among the other tranches based on their
seniority. To the extent there are defaults and unrecoverable losses on the
underlying mortgages, resulting in reduced cash flows, the subordinate tranches
will bear those losses first. To the extent there are losses in excess of the
most subordinate tranches stated right to principal and interest, the remaining
tranches will bear such losses in order of their relative subordination.
At March 31, 1999, the amortized cost of the Company's investments in CMBS
exceeded estimated fair value by $5,429,175. Impairment losses of $4,958,647 on
these investments were recognized in 1998. Due to the uncertainty of the
Company's ability to hold its CMBS investments until the cost of the CMBS is
recovered, the Company determined that the decline in the fair value of its CMBS
below amortized cost at March 31, 1999 was other than temporary. Accordingly,
the Company carries its investment in CMBS at estimated fair value at March 31,
1999. During the first quarter, the Company sold seven of its investment in CMBS
securities for $47.8 million, resulting in a realized loss of $14.2 million of
which $11.7 million was recognized in 1998. The proceeds from the sale of CMBS
were used to repay the Company's obligations under its debt agreements. (See
Note 9)
10
<PAGE> 74
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6. MEZZANINE LOAN INVESTMENTS
As of March 31, 1999, the Company's investment in mezzanine loans consisted
of the following:
<TABLE>
<CAPTION>
ESTIMATED
UNDERLYING INTEREST MATURITY FACE AMORTIZED IMPAIRMENT CARRYING FAIR
SECURITY RATE DATE VALUE COST LOSS VALUE VALUE
---------- -------- ---------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Commercial real estate:
Office............... 12.00% 05/01/2007 $21,000,000 $24,560,333 $4,260,059 $20,300,274 $21,000,000
Hotel................ 11.77 06/30/2003 19,647,200 19,722,940 2,958,676 16,764,264 16,881,936
Multi-family......... 10.63 08/01/2008 2,800,000 2,705,233 372,308 2,332,925 2,394,087
Retail............... 9.69 05/01/2005 4,570,896 4,361,465 459,590 3,901,875 3,901,875
Other................ 10.57 07/01/2008 1,000,000 961,019 144,858 816,161 830,473
----------- ----------- ---------- ----------- -----------
Total......... $49,018,096 $52,310,990 $8,195,491 $44,115,499 $45,008,371
=========== =========== ========== =========== ===========
</TABLE>
At March 31, 1999, the amortized cost of the Company's investments in
mezzanine loans exceeds their aggregate carrying value. The Company carries its
investments in mezzanine loans at the lower of amortized cost after impairment
losses or fair value. The fair value of mezzanine loan investments is based on
Management's best estimate of market conditions at March 31, 1999. The use of
different market assumptions, valuation methodologies, changing interest rates,
interest rate spreads and the timing and magnitude of credit losses may have a
material effect on the estimates of fair value. The Company's ability to hold
its mezzanine loans to maturity has been negatively affected by the recent
turmoil in the financial markets and its effect on the value of the loans, along
with the restructuring of its debt agreements (See Note 9). The $8,195,491
impairment loss on mezzanine loan investments was recognized in 1998.
The Company's $19,647,200 face value mezzanine loan investment is a British
pounds Sterling loan. The Company purchased the investment for 11.98 million in
British pounds Sterling. Interest on the loan is based on Sterling Libor ("Base
Rate") plus 4.00%. The exchange rate at the date of investment was $1.64 dollars
per pound. In order to reduce the risk of foreign currency exchange rate
fluctuations, the Company entered into a foreign currency swap arrangement with
Merrill Lynch Capital Services, Inc. The swap arrangement provides the Company
with an exchange rate of $1.64 per pound on the return of its principal
regardless of exchange rate fluctuation. The swap arrangement also converts the
Base Rate to US$ Libor minus 0.06% regardless of movements in the Sterling
Libor. The Company is subject to foreign currency risk on the spread portion
(4.00%) of the quarterly interest payments. The market value of the currency
swap at March 31, 1999 was an asset of $269,998. The foreign currency swap
arrangement expires on the maturity date of the related loan. The Company is
exposed to credit loss in the event of nonperformance by the counterparty to the
currency swap agreement. However, the Company does not anticipate nonperformance
by the counterparty.
On April 5, 1999, the Company consummated the GMAC Repo to sell an office
mezzanine loan with a face value of $21 million to GMAC. The agreement allows
the Company to repurchase the investment no later than April 1, 2000. The GMAC
Repo generated proceeds of $10.5 million. The repurchase price of the GMAC Repo
will be adjusted such that GMAC will receive an 8% annualized yield on its
investment if the Company repurchases the investment prior to October 1, 1999.
After October 1, 1999, the repurchase price is fixed at $9.6 million. The
Company used $8.5 million of the proceeds of the GMAC Repo to repay borrowings
from LLIH and will use the remaining proceeds to meet its remaining corporate
obligations, which primarily consist of hedging liabilities. The Company is
accounting for the GMAC Repo as a financing transaction.
NOTE 7. MORTGAGE LOAN INVESTMENTS
On January 4, 1999, the Company accepted a discounted payoff of its one
remaining mortgage loan for $15,150,400, resulting in a realized loss of
$797,810, which was recognized in 1998.
11
<PAGE> 75
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8. REAL ESTATE INVESTMENT HELD FOR SALE
As of March 31, 1999, the Company's investment in real estate consisted of
the following:
<TABLE>
<CAPTION>
DATE ACQUIRED PROPERTY LOCATION PROPERTY TYPE
- ------------- -------------- ------------ -------------
<S> <C> <C> <C>
6/26/98............................................. Lakeside Plaza Stockton, CA Retail
</TABLE>
The carrying value of real estate investment held for sale at March 31,
1999 is summarized below:
<TABLE>
<S> <C>
Real estate investment held for sale -- at cost
Land...................................................... $1,470,000
Buildings................................................. 2,225,869
Tenant Improvements....................................... 1,909
Capitalized Costs......................................... 20,670
Less accumulated depreciation and amortization.............. (32,280)
Less impairment charge...................................... (189,708)
----------
Real estate investment held for sale -- net................. $3,496,460
==========
</TABLE>
In connection with the Company's decision to discontinue its initial
investment strategies, the Company also decided to sell its real estate
investments and accordingly, at March 31, 1999, the Company's real estate
investment is classified as held for sale. The Company expects to dispose of the
real estate in 1999. The real estate investment was written down to market value
less estimated selling costs in 1998.
On March 25, 1999, the Company sold its Bryarwood 85 real estate investment
for $3.8 million. Primarily due to the buyer's assumption of tenant improvement
liabilities, net cash proceeds were $2,881,543, resulting in a realized loss of
$262,392 of which $257,797 was recognized in 1998.
NOTE 9. BORROWING ARRANGEMENTS
On May 15, 1998, the Company entered into two Master Loan and Security
Agreements, to provide financing for the Company's investments. The facilities
required assets to be pledged as collateral. The first loan agreement, which was
with Morgan Stanley Mortgage Capital, Inc. (the "Morgan Stanley Agreement")
permitted the Company to borrow up to $250,000,000 and was scheduled to
terminate on May 14, 1999. The facility was intended to finance first-mortgage
loans originated by the Company. On October 26, 1998, the Company terminated the
agreement with Morgan Stanley at no cost to the Company. There were no
borrowings outstanding under the Morgan Stanley Agreement. The second agreement,
which is with Morgan Guaranty Trust Company of New York (the "Morgan Guaranty
Agreement"), permitted the Company to borrow up to $450,000,000 and was
scheduled to terminate on May 14, 1999. As discussed below, this agreement has
been amended and on March 31, 1999, all amounts were repaid and the agreement
terminated. As of December 31, 1998, there were $52,412,238 in borrowings
outstanding under the Morgan Guaranty Agreement secured by the Company's assets
with an aggregate value of $70,745,575 at December 31, 1998.
On August 21, 1998, the Company entered into a Master Assignment Agreement
with Merrill Lynch Mortgage Capital, Inc. and Merrill Lynch Capital Services,
Inc. (the "Merrill Lynch Agreement"), to provide financing for the Company's
investments. The facility required assets to be pledged as collateral. The
Merrill Lynch Agreement permitted the Company to borrow up to $35,000,000 and
was scheduled to terminate on August 20, 1999. As discussed below, this
agreement has been amended and terminated on March 25, 1999. Outstanding
borrowings against this line of credit accrued interest based on the Libor rate
plus 1.25%. The Merrill Lynch Agreement allowed the lender to establish a margin
requirement on each borrowing, and to request payments from the Company, at any
time, if the market value of the collateral fell below the applicable margin
requirement. As of December 31, 1998, there were $9,505,918 in borrowings
12
<PAGE> 76
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
outstanding under the Merrill Lynch Agreement, secured solely by the Company's
hotel mezzanine investment which had a carrying value of $16,764,264 at December
31, 1998.
As a result of the financial turmoil in the credit markets in October 1998
and the related widening of spreads between rates on mortgage investments and
treasury securities, the Company experienced significant losses in its
investment portfolio. Because of these losses, on October 23, 1998 the Company
announced it was necessary to obtain temporary waivers from Morgan Guaranty
Trust and Merrill Lynch to avoid being in default of tangible net worth
covenants under the Company's credit facilities. On November 13, 1998 the
Company reached an agreement with Morgan Guaranty Trust and Merrill Lynch to
restructure its credit facilities and terminated the Morgan Stanley Agreement.
Under its amended agreement with Morgan Guaranty Trust, the Company's
credit facility was reduced to $90 million. The facility reduced to $50 million
on January 31, 1999. The interest rate was Libor plus 1.5% from November 13,
1998 to December 31, 1998 and Libor plus 2.0% from January 1, 1999 until the
facility matured on March 31, 1999.
Under the amended agreement with Merrill Lynch, the Company agreed to pay
down the outstanding borrowings to $19.0 million, and further agreed that no
additional borrowings would be permitted under the agreement through its
maturity on January 31, 1999. On January 27, 1999, this agreement was further
amended, extending the maturity to February 26, 1999. On February 25, 1999, the
Merrill Lynch agreement was again amended, extending the maturity date to March
25, 1999.
In connection with the credit facility restructurings, on November 13,
1998, LLIH agreed to provide the Company with up to $40 million of unsecured
subordinated indebtedness ("LLIH Agreement") through March 31, 1999. An initial
advance of $17 million was drawn on November 13, 1998. On March 30, 1999, the
agreement was amended extending the maturity date to April 5, 1999. The advances
incurred interest at the rate of 14% per annum through January 31, 1999 and 16%
thereafter. As of March 31, 1999 and December 31, 1998, borrowings outstanding
under the LLIH Agreement were $8,500,000 and $9,000,000 respectively. Interest
expense for the three months ending March 31, 1999 under the LLIH Agreement was
$132,658, an annualized interest rate of 15.4%. Interest expense from April 1,
1999 through April 5, 1999 was $14,904.
The Company was required to meet certain debt covenants on its borrowings
to avoid default on its obligations. The Morgan Guaranty Trust agreement had
three debt covenants. Maintenance of Tangible Net Worth required that the
Company's Tangible Net Worth, as defined, be at least $100,000,000. The first
amendment to the Morgan Guaranty Trust agreement reduced the threshold to
$65,000,000 for the period from November 13, 1998 to January 1, 1999 and to
$50,000,000 thereafter. The Company was in compliance with this covenant for the
three months ended March 31, 1999. Maintenance of Ratio of Indebtedness to
Tangible Net Worth required that the ratio of the Company's total debt to its
Tangible Net Worth not exceed 5 to 1. This covenant was met for the three months
ended March 31, 1999. Maintenance of Interest Coverage Ratio required that the
ratio of the Company's interest expense to Earnings Before Interest, Taxes,
Depreciation and Amortization ("EBITDA"), as defined, shall not be less than
1.45 to 1. The Company met the Interest Coverage Ratio covenant for the three
months ended March 31, 1999. The first amendment to the Morgan Guaranty Trust
agreement also provided that the Company must maintain a cash position on its
balance sheet of a minimum of $10,000,000, free and clear of all encumbrances.
This covenant was in effect until January 29, 1999, when the second amendment to
the agreement reduced the requirement to $5,000,000.
The original Merrill Lynch agreement included three debt covenants. Book
Net Worth required that, in any given period, the Company's ending Book Net
Worth, as defined, shall not be less than 80% of beginning Book Net Worth, and
that total Book Net Worth shall be at least $100,000,000. The first amendment to
the Merrill Lynch agreement reduced the threshold to $50,000,000 for the period
from October 23, 1998 to November 13, 1998, and to $65,000,000 thereafter. The
second amendment to the Merrill Lynch agreement reduced the threshold back to
$50,000,000. Maximum Debt to Equity Ratio required that the ratio of the
13
<PAGE> 77
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company's total debt to total equity shall not exceed 8 to 1. Merrill Lynch also
had a cross-default covenant which provided that if the Company failed to meet
any of its covenants under its other borrowing arrangements, that it was also in
default under the Merrill Lynch agreement. The first amendment to the Merrill
Lynch agreement also provided that the Company must maintain a cash position on
its balance sheet of a minimum of $10,000,000, free and clear of all
encumbrances. This covenant was in effect until January 27, 1999, when the
second amendment to the agreement reduced the requirement to $5,000,000. The
company was in compliance with these covenants for the three months ended March
31, 1999.
The LLIH agreement contained a cross-default covenant which provided that
if the Company fails to meet any of its covenants under its other borrowing
arrangements, that it was also in default under the LLIH Agreement. The LLIH
agreement had no other covenant requirements. On April 5, 1999, the Company
repaid all its outstanding borrowing under the LLIH Agreement with proceeds from
the GMAC Repo (See Note 10).
Under its borrowing arrangements with Morgan Guaranty Trust and LLIH, the
Company was allowed to pay distributions to meet the requirements of a REIT. The
Company was not required to pay any dividends in the first quarter of 1999 due
to net taxable losses incurred for the quarter.
NOTE 10. REPURCHASE AGREEMENTS
On August 25, 1998, the Company entered into a Master Repurchase Agreement
with Deutsche Bank Securities, Inc. (the "Deutsche Bank Agreement"), which
provided financing for the Company's investments. The Deutsche Bank Agreement
allowed Deutsche Bank to establish a margin requirement on each transaction, and
to request payment from the Company at any time, if the market value of the
underlying assets or securities fell below the applicable margin requirement. On
February 19, 1999, the CMBS collateralizing the borrowing was sold, and the
remaining borrowings under the agreement were paid. As of December 31, 1998,
there were $7,926,375 in borrowings outstanding under the Deutsche Bank
Agreement, secured solely by one of the Company's BBB- rated CMBS with an
estimated fair value of $8,911,200 at December 31, 1998. On February 19, 1999,
the Company sold the BBB- CMBS for $8.8 million and repaid all amounts owed
under the Deutsche Bank Agreement.
On April 5, 1999, the Company consummated the GMAC Repo agreement to sell
an office mezzanine loan with a face value of $21 million to GMAC. The agreement
allows the Company to repurchase the investment no later than April 1, 2000. The
GMAC Repo generated proceeds of $10.5 million. The repurchase price of the GMAC
Repo will be adjusted such that GMAC will receive an 8% annualized yield on its
investment if the Company repurchases the investment prior to October 1, 1999.
After October 1, 1999, the repurchase price is fixed at $9.6 million. The
Company used $8.5 million of the proceeds of the GMAC Repo to repay borrowings
from LLIH and will use the remaining proceeds to meet its remaining corporate
obligations, which primarily consist of hedging liabilities. The Company
accounted for the GMAC Repo as a financing transaction.
NOTE 11. STOCK OPTION PLAN
The Company has a stock option plan for the Company's executive officers
and the Manager, which provides for the issuance of up to 2,500,000 shares of
Common Stock. At the closing of the IPO, the Company granted the Manager a fully
vested option to purchase 1,166,667 shares of Common Stock exercisable at the
IPO price of $15.00 per share. The Manager received the stock option as
compensation for its efforts in completing the IPO. One-fourth of the Manager's
options become exercisable on each of the first four anniversaries of the IPO.
Unless exercised, these options expire in 2008.
The underwriters sold in the IPO 79,586 shares of Common Stock to directors
and officers of the Company and the Manager for $15.00 per share. Pursuant to
the Company's Directed Share Program, such
14
<PAGE> 78
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
individuals were granted an option to purchase one share of Common Stock for
each share purchased in the IPO at an exercise price of $15.00 per share.
One-fifth of the options became exercisable immediately, and one-fifth of the
options become exercisable on each of the first four anniversaries of the IPO.
Unless exercised, these options expire in 2008.
The Company accounts for stock options in accordance with FAS 123,
"Accounting for Stock-Based Compensation". FAS 123 applies a market value based
approach to valuing the options. The Company estimated the market value of the
options granted using the Black-Scholes option-pricing model, with the following
assumptions:
<TABLE>
<S> <C>
Risk-free rate of interest.................................. 5.62%
Expected life of options.................................... 2.42 years
Volatility.................................................. 24.05%
Dividend rate............................................... 12.76%
</TABLE>
The estimated weighted average grant date market value of stock options
granted by the Company in 1998 was approximately $0.75 per share or $932,196.
The Company expensed the $877,197 value of the fully vested options granted to
the Manager upon completion of the IPO.
The following table summarizes the status of the Company's stock options at
March 31, 1999:
<TABLE>
<CAPTION>
GRANTED PER SHARE REMAINING
AND EXERCISE CONTRACTUAL
OUTSTANDING PRICE EXERCISABLE LIFE
----------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Manager.............................................. 1,166,667 $15.00 None 9 years
Others............................................... 79,586 $15.00 15,917 9 years
Total...................................... 1,246,253 $15.00 15,917 9 years
</TABLE>
NOTE 12. INTEREST RATE PROTECTION AGREEMENTS
In order to hedge the risk of a material change in interest rates that
would affect the Company's borrowing rate on its lines of credit and on
anticipated future long-term borrowings secured by the Company's investments,
the Company entered into forward treasury lock agreements and an interest rate
collar. None of these agreements were held for trading purposes. The Company's
policy was to purchase a forward treasury lock whenever a fixed rate mortgage
loan closed or when a borrower requested a rate lock under an executed loan
application. Depending on the size of fixed rate mortgage loans, the Company in
some cases aggregated loans and purchased a single treasury lock for a pool of
small loans. The Company also entered into forward treasury locks in
anticipation of long-term financing of its CMBS and mezzanine investments that
were expected to close in 1999.
As a result of the financial turmoil in the credit markets in October 1998,
and the Company's failure to comply with its debt agreements, the Company
determined that its ability to obtain long-term, fixed-rate financing was not
probable. The turmoil also created uncertainty as to the Company's ability to
hold the investments, and thus the treasury locks no longer qualified for hedge
accounting. On October 23, 1998 the Company terminated all of its treasury locks
and incurred a realized loss of $13.3 million, which was recognized as a
component of income.
On January 23, 1999 the Company terminated its interest rate collar
contract at a loss of $265,000, of which $216,000 was recognized in 1998.
On March 31, 1999, the Company had no exposures to interest rate protection
agreements.
15
<PAGE> 79
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13. SUBSEQUENT EVENTS
On April 5, 1999, the Company consummated the GMAC Repo to sell an office
mezzanine loan with a face value of $21 million to GMAC. The agreement allows
the Company to repurchase the investment no later than April 1, 2000. The GMAC
Repo generated proceeds of $10.5 million. The repurchase price of the GMAC Repo
will be adjusted such that GMAC will receive an 8% annualized yield on its
investment if the Company repurchases the investment prior to October 1, 1999.
After October 1, 1999, the repurchase price is fixed at $9.6 million. The
Company used $8.5 million of the proceeds of the GMAC Repo to repay borrowings
from LLIH and will use the remaining proceeds to meet its remaining corporate
obligations, which primarily consist of hedging liabilities. The Company is
accounting for the GMAC Repo as a financing transaction.
On April 30, 1999 and May 3, 1999, the Company paid $4,771,187 and
$1,149,570 respectively, toward its Treasury locks liability.
16
<PAGE> 80
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the Company's consolidated financial condition,
results from operations, and capital resources and liquidity should be read in
conjunction with the Financial Statements and related Notes included in Item 1.
CAPITAL RESOURCES AND LIQUIDITY
Liquidity is the ability for the Company to meet its cash requirements
including any ongoing commitments, borrowings, shareholder distributions,
lending and general business activities. The Company's source of liquidity
during the period ended March 31, 1999 consisted of net proceeds from the
Offering, borrowings under the Master Loan and Security Agreement with Morgan
Guaranty Trust (the "Morgan Guaranty Trust Agreement"), borrowings under the
Merrill Lynch Agreement, borrowings under the LLIH Agreement and repurchase
financing from the Deutsche Bank Agreement and the GMAC Repo. The net proceeds
from the Offering were $102,951,000.
From the date of the Offering until the funds were invested in real estate
assets, the Offering proceeds were held in a short-term investment account
earning an annualized yield of 6.15%. Once the Offering proceeds were fully
invested, the Company began to utilize the Master Loan and Security Agreement
that was established with Morgan Guaranty Trust in the amount of $450,000,000,
the Merrill Lynch Agreement in the amount of $35,000,000 and the Deutsche Bank
Agreement with unlimited transactions subject to the approval of both Deutsche
Bank and the Company. After the Company's disclosure in October 1998 that it
would need to restructure its debt in order to avoid default status under the
debt covenants with Merrill Lynch and Morgan Guaranty Trust, the Company
negotiated amendments to both lines and a new subordinated debt agreement with
LLIH. The Morgan Guaranty Trust debt had two amendments dated November 13, 1998
and January 29, 1999, respectively. The first amendment reduced the available
line of credit to $90,000,000 until January 31, 1999 and $50,000,000 thereafter.
The interest rate was increased to 150 basis points over Libor until December
31, 1998 and 200 basis points over Libor until March 31, 1999, the new
termination date. The second amendment reduced the required cash on hand by the
Company from $10,000,000 to $5,000,000. On February 8, 1999, Morgan Guaranty
Trust agreed to a waiver of the Maintenance of Interest Coverage Ratio, one of
its debt covenants, for the fourth quarter of 1998. The Merrill Lynch Agreement
has been amended three times, first on October 23, 1998, second on January 27,
1999 and third on February 25, 1999. The first amendment granted an extension
for repayment until January 31, 1999. The second amendment increased the
borrowing rate to 500 basis points over Libor, reduced the line to $8,005,918
and extended the maturity date until February 26, 1999. The third amendment
extended the maturity date until March 25, 1999. The LLIH subordinated debt
agreement was in the amount of $40,000,000. The debt originally matured on March
31, 1999, but was extended to April 5, 1999, and has an annual interest rate of
14% until January 31, 1999 and 16% thereafter. The balance outstanding at March
31, 1999 was $8.5 million and on April 5, 1999 the subordinated debt was
completely paid off.
In order to meet the Company's liquidity needs in early 1999, the Board of
Directors, on January 25, 1999, approved a plan of action to sell a portion of
the Company's assets in order to meet the Company's outstanding obligations. On
February 19, 1999, the Company sold a CMBS for total proceeds of $8.8 million.
The proceeds were used to repay the Company's indebtedness under the Deutsche
Bank Agreement. On March 31, 1999, the Company completed the sale of a package
of CMBS. The total proceeds from the sale were $39.0 million. The Company used
the proceeds to repay its borrowings from Morgan Guaranty Trust. In connection
with its sale of investments on March 31, 1999, the Company entered into an
agreement to sell a Mezzanine Investment with a face value of $21 million to
GMAC. The agreement allows the Company to repurchase the investment no later
than April 1, 2000. The GMAC Repo was closed on April 5, 1999 and generated
proceeds of $10.5 million. The repurchase price of the GMAC Repo will be
adjusted such that GMAC will receive an 8% annualized yield on its investment if
the Company repurchases the investment prior to October 1, 1999. After October
1, 1999, the repurchase price is fixed at $9.6 million. The Company used $8.5
million of the proceeds of the GMAC Repo to repay borrowings from LLIH and the
remaining monies will be used to meet its remaining corporate obligations, which
primarily consist of hedging liabilities.
17
<PAGE> 81
The Company has paid off and terminated all of its existing credit
facilities as of April 5, 1999. The Company's remaining material liability is
$10.5 million for the GMAC Repo and $10.9 million of accrued losses on
terminated forward Treasury locks. $4.8 million and $1.1 million of the forward
Treasury lock liability was due and paid on April 30, 1999 and May 3, 1999,
respectively. The remaining $5 million of the forward Treasury lock liability is
due on July 2, 1999. The Company believes its net working capital and net
operating cash flow will be sufficient to meet the Company's remaining
liabilities.
WORKING CAPITAL RESERVES
At March 31, 1999 the Company had $8,875,695 in cash and short-term
investments. Included in the November 1998 debt restructuring were covenants
requiring the Company to maintain a minimum cash balance of $10,000,000. These
covenants were included in its borrowing agreements with Morgan Guaranty Trust
and Merrill Lynch. As of January 31, 1999, the covenants were amended requiring
the Company to maintain a minimum balance of $5,000,000. The excess cash was
used to reduce its outstanding debt. As of March 31, 1999, the minimum cash
requirements were terminated with the termination of the Morgan Guaranty Trust
Agreement.
FINANCIAL CONDITION
Securities available-for-sale. Due to uncertainty of the Company's ability
to hold its CMBS investments until the cost of the CMBS could be recovered, the
Company determined that the decline in the market value of its CMBS below
amortized cost for the period ended March 31, 1999 was other than temporary.
Accordingly, the Company wrote down its investment in CMBS to fair value and
recognized an impairment loss of $470,528 for the period ended March 31, 1999.
The company sold a CMBS on February 19, 1999 for $8,827,344 resulting in a
realized loss of $627,488, of which $541,562 was recognized at December 31,
1998. On March 31, 1999, the Company sold $38,962,296 million of CMBS in order
to repay its obligations under its borrowing agreements resulting in a realized
loss of $13,592,790 of which $11,176,359 was recognized at December 31, 1999.
Mezzanine Investment Portfolio. In connection with its sale of CMBS on
March 31, 1999, the Company entered into a repurchase agreement to sell an
office Mezzanine loan with a face value of $21 million to GMAC. The agreement
allows the Company to repurchase the investment no later than April 1, 2000. The
GMAC Repo closed on April 5, 1999, and generated proceeds of $10.5 million. The
repurchase price of the GMAC Repo will be adjusted such that GMAC will receive
an 8% annualized yield on its investment if the Company repurchases the
investment prior to October 1, 1999. After October 1, 1999, the repurchase price
is fixed at $9.6 million. The Company used $8.5 million of the proceeds of the
GMAC Repo to repay borrowings from LLIH and will use the remaining monies to
meet its remaining corporate obligations, which primarily consist of hedging
liabilities.
Mortgage Loan Portfolio. The Company accepted a discounted pay off of the
remaining Mortgage Loan on January 4, 1999 at a loss of $797,810. This loss was
recognized by the Company as an operating loss for the year ended December 31,
1998. The loss on sale and settlement of mortgage loans in the amount of $97,929
resulted from changes in estimates that were used to accrue for third party
costs relating to the sale and settlement of previously committed loans.
Real Estate Investments. At March 31, 1999, the Company's real estate
investment was classified as held for sale. Preliminary offers determined that
the value of the property was less than book value. Impairment losses of
$447,505 were recognized in 1998. On March 25, 1999 the Company sold one real
estate investment for $3.8 million in order to meet its debt obligations.
Short-term borrowings. During the first quarter of 1999, the Company
repaid its borrowings with Morgan Guaranty Trust and Merrill Lynch and extended
the maturity date of its agreement with LLIH, as further discussed in "Liquidity
and Capital Resources" and in the footnotes to the Company's consolidated
financial statements as of and for the period ended March 31, 1999 included
herein. The Company used its short-term borrowing arrangements to finance its
investments in certain CMBS, Mortgage Loans and
18
<PAGE> 82
Mezzanine Investments. As of March 31, 1999, the Company had short-term
borrowings totaling $8,500,000. The total amount was comprised of:
<TABLE>
<CAPTION>
LOAN FACILITY AMOUNT BORROWED ASSETS PLEDGED
- ------------- --------------- --------------
<S> <C> <C>
LLIH..................................................... 8,500,000 Unsecured
</TABLE>
Treasury locks payable. As a result of the turmoil in the credit market
during the fourth quarter of 1998 and the Company's failure to comply with its
debt agreements, the Company determined that its ability to obtain long-term
fixed rate financing was not probable. The turmoil also created uncertainty as
to the Company's ability to hold its investments. Accordingly, the Company
discontinued hedge accounting for its Treasury locks and incurred a loss of
$13,070,685 on these agreements. As part of its debt restructuring on November
13, 1998, the Company paid $2,390,000 to settle its Treasury locks payable with
Merrill Lynch. The remaining amounts payable and dates due are provided in the
table below. On January 27, 1999, the Company canceled an interest rate collar
at a cost of $265,000.
<TABLE>
<CAPTION>
AMOUNT DUE DUE DATE
- ---------- --------------
<S> <C>
$4,771,187................................................ April 30, 1999
1,149,570................................................ May 3, 1999
5,034,953................................................ July 2, 1999
</TABLE>
The hedging liabilities due on April 30, 1999 and on May 3, 1999 were paid
on their respective due dates.
Shareholders' Equity. Shareholder's equity decreased by $1,594,800 from
December 31, 1998 due entirely to net losses for the period ended March 31,
1999.
RESULTS FROM OPERATIONS
Revenue. Revenue totaled $3,450,342 for the period ended March 31, 1999.
Revenue is comprised primarily of interest income on CMBS investments and
Mezzanine Investments and rental income from real estate. For the three months
ended March 31, 1999, rental income consisted of two real estate investments.
The real estate investments include a retail property in Stockton, California
and an office building in Atlanta, Georgia. The office building was sold on
March 25, 1999.
Operating Expenses. Operating expenses consist of expenses incurred in
operating the Company, property and investment operations, and totaled
$2,381,517 for the period ended March 31, 1999. Included in the amount were
impairment losses totaling $470,528 and losses on the termination of interest
rate collar of $49,000. These losses are due to financial market conditions and
the increase in Treasury rates for the three months ended March 31, 1999.
Management fees were calculated at 1% per annum of the Average Invested Assets
per quarter and totaled $279,469 for period ended March 31, 1999. The Company
also recorded general and administrative expenses of $99,326 for the period
ended March 31, 1999. These costs consist of professional fees, insurance costs
and other miscellaneous expenses.
Loss on Sale of CMBS. The loss on sale of CMBS was a result of the
disposal of CMBS during first quarter for $47,789,640. The losses totaled
$14,219,707 of which $11,717,920 was recognized in 1998.
REIT STATUS
The Company made an election to be taxed as a REIT under the Code,
commencing with its first REIT taxable year ending on December 31, 1998. The
Company qualifies for taxation as a REIT and therefore will not be subject to
federal corporate income tax on its net income that is distributed currently to
its shareholders.
To qualify as a REIT under the Code, the Company must meet several
requirements regarding, among other things, the ownership of its outstanding
stock, the sources of its gross income, the nature of its assets, and the levels
of distributions to its shareholders. These requirements are highly technical
and complex, and the Company's determination that it qualifies as a REIT
requires an analysis of various factual matters and
19
<PAGE> 83
circumstances that may not be entirely within the Company's control.
Accordingly, there can be no assurance that the Company will remain qualified as
a REIT.
If the Company fails to qualify for taxation as a REIT in any taxable year,
and certain relief provisions of the Code do not apply, the Company will be
subject to tax (including any applicable alternative minimum tax) on its taxable
income at regular corporate rates. Distributions to the Company's shareholders
in any year in which the Company fails to qualify will not be deductible by the
Company nor will they be required to be made. In such event, to the extent of
the Company's current and accumulated earnings and profits, all distributions to
shareholders will be taxable as ordinary income and, subject to certain
limitations of the Code, corporate distributees may be eligible for the
dividends received deduction. Unless entitled to relief under specific statutory
provisions, the Company also will be disqualified from taxation as a REIT for
the four taxable years following the year during which the Company ceased to
qualify as a REIT. It is impossible to predict whether the Company would be
entitled to such statutory relief.
YEAR 2000
The inability of computers, software and other equipment to recognize and
properly process data fields containing a two-digit year is commonly referred to
as the Year 2000 compliance issue ("Y2K"). As the year 2000 approaches, such
systems may be unable to accurately process certain date-based information.
Y2K exposures of the Company are currently being assessed. Potential
critical exposures include reliance on third party vendors and building systems
that are not Y2K compliant. The Company has begun to communicate with third
party service vendors such as the Manager and property managers in an effort to
assess their Y2K compliance status and the adequacy of their Y2K efforts.
The Manager has made Y2K compliance a high priority for replacement
applications and is in the process of updating and replacing other applications
that are not Y2K compliant. The Manager expects to materially complete all
mission critical system projects by the modified date of July 31, 1999, which
will allow for Y2K systems testing to resolve any remaining Y2K compliance
issues. However, if any of the vendors of the Manager's Y2K compliant software
fail to perform pursuant to their contracts with the Manager, the Manager's Y2K
compliance could be jeopardized, and could materially adversely affect the
Company. The Manager does not believe that the costs to remediate any Y2K issues
will materially affect its business, operations or financial condition, or will
have an adverse affect on its clients, including the Company.
Each property owned by the Company is being individually assessed in an
effort to identify critical Y2K issues specific to each property. Required
remediation strategies will depend on the outcome of the assessments and
therefore will not be developed until the property assessments are complete. The
inventory survey for Lakeside Plaza, the only real property owned by the
Company, is expected to be complete by May 31, 1999. The assessment process will
follow, with the expected completion date for any remediation by July 31, 1999.
The Company has not incurred any material costs to date relating to Y2K.
Total property assessment costs to the Company are expected to total
approximately $4,300 and the total cost for quality assurance for third party
engineers and consultants is expected to be approximately $1,000. Remediation
efforts may vary significantly from one building to the next. Therefore
remediation costs can not be reasonably estimated until the assessments are
complete and remediation strategies determined.
The failure to adequately address the Y2K issue may result in the closure
of buildings owned by the Company. In order to reduce the potential impact on
the operations of the Company, contingency plans will be developed by July 31,
1999.
Building contingency plans will be developed by July 31, 1999, once
assessments have been completed. This will allow the efficient development of
contingency plans that take into account individual circumstances surrounding
each property. Contingency plans may involve the engagement of additional
security services, implementation of temporary systems modifications, and the
identification and engagement of alternate service vendors. Additional
contingency plans may be developed as circumstances warrant.
20
<PAGE> 84
With respect to the Company's Mezzanine Investments, the primary Year 2000
issue relates to potential borrower defaults caused by:
- increased expenses or legal claims related to failures of embedded
technology in building systems,
- reductions in collateral value due to failure of one or more building
systems,
- interruptions in building cash flows due to tenant's inability to make
timely lease payments, inaccurate or incomplete accounting of rents, or
decreases in building occupancy levels,
- the borrower's inability to address all material Y2K issues that may
potentially impact the borrower's operations.
These risks are also applicable to the Company's portfolio of CMBS as these
securities are dependent upon the pool of Mortgage Loans underlying them. If the
investors in these types of securities demand higher returns in recognition of
these potential risks, the market value of the CMBS portfolio of the Company
could also be adversely affected.
FORWARD LOOKING STATEMENTS
Certain statements contained herein are "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A
of the Securities Act of 1933, as amended, 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 "may", "will", "intend", "should", "expect", "anticipate", "estimate",
or "continue" or the negatives thereof or other comparable terminology. The
Company's actual results could differ materially from those anticipated in such
forward-looking statements due to a variety of factors, including, but not
limited to, changes in national, regional or local economic environments,
competitive products and pricing, government fiscal and monetary policies,
changes in prevailing interest rates, the course of negotiations, the
fulfillment of contractual conditions, factors inherent to the valuation and
pricing of interests in commercial mortgage-backed securities, credit risk
management, asset/liability management, the financial and securities markets,
the availability of and costs associated with the sources of liquidity, other
factors generally understood to affect the real estate acquisition, mortgage and
leasing markets and security investments, and other risks detailed in the
Company's registration statement on Form S-11, as amended, filed with the SEC,
the Company's annual report on Form 10-K and quarterly reports on Form 10-Q
filed with the SEC, and other filings made by the Company with the SEC. The
Company does not undertake, and specifically disclaims any obligation, to
publicly release the results of any revisions which may be made to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT 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
Company is primarily exposed to interest rate and spread risk. Interest rates
and spreads are sensitive to many external forces including, but not limited to,
governmental monetary and tax policies and domestic and international economic
and political factors. These forces are beyond the control of the Manager and
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 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
21
<PAGE> 85
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.
The following table quantifies the potential changes in net interest income
and net asset value should interest rates rise or fall. The table below
calculates the changes in the assets owned by the Company as of March 31, 1999
and includes the adjustment to payoff LLIH debt with proceeds from the GMAC
Repo. The table represents the effect over the next four quarters. The results
assume that yield curves of the rate changes will be parallel to each other. Net
asset value is calculated as the sum of the present value of cash in-flows
generated from interest-earning assets net of cash outflows in respect of
interest-bearing liabilities. The base interest rate scenario assumes interest
rates at March 31, 1999. All changes in the net asset value are a result of
valuing assets based on changes in interest rates. These changes do not include
the effects of income or dividends. The net interest income is interest income
(excluding interest income on cash) netted with interest expense. All changes
are measured by percentage changes from the base interest rate. Actual results
could differ significantly from these estimates.
<TABLE>
<CAPTION>
NET
CHANGE IN INTEREST RATE NET INTEREST INCOME ASSET VALUE
- ----------------------- ------------------- -----------
<S> <C> <C>
+400..................................................... 1 5.6% (16.5)
+300................................................... 11.7 (12.9)
+200................................................... 7.8 (9.0)
+100................................................... 3.9 (4.7)
Base..................................................... 0.0 0.0
-100................................................... (3.9) 5.2
-200................................................... (7.8) 10.9
-300................................................... (11.7) 17.2
-400................................................... (15.6) 24.1
</TABLE>
22
<PAGE> 86
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule (for SEC filing purposes only)
(b) Reports
None
23
<PAGE> 87
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CHASTAIN CAPITAL CORPORATION
By: /s/ STEVE GRUBENHOFF
------------------------------------
Steve Grubenhoff
Chief Financial Officer
Date: May 7, 1999
24
<PAGE> 88
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
---------------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999__________
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 0-23917
CHASTAIN CAPITAL CORPORATION
(Exact name of registrant as specified in its governing instrument)
<TABLE>
<S> <C>
GEORGIA 58-2354416
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
3424 PEACHTREE ROAD N.E., SUITE 800,
ATLANTA, GEORGIA 30326
(Address of principal executive office) (Zip Code)
</TABLE>
(Registrant's telephone number, including area code)
(404) 848-8850
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 7,346,778 shares of common
stock outstanding as of August 13, 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 89
CHASTAIN CAPITAL CORPORATION
CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of June 30, 1999 and December
31, 1998 (Unaudited)...................................... 1
Consolidated Statements of Operations for the three and six
months ended June 30, 1999 and 1998 (Unaudited)........... 2
Consolidated Statement of Changes in Shareholders' Equity
for the six months ended
June 30, 1999 and December 31, 1998 (Unaudited)........... 3
Consolidated Statements of Cash Flows for the six months
ended June 30, 1999 and 1998 (Unaudited).................. 4
Notes to Consolidated Financial Statements (Unaudited)...... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 14
Item 3. Quantitative and Qualitative Disclosure about Market Risk... 18
PART II -- OTHER INFORMATION
Items 1 through 6................................................... 20
Signatures.......................................................... 21
</TABLE>
i
<PAGE> 90
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1999 AND DECEMBER 31, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------- ------------
<S> <C> <C>
ASSETS
Commercial mortgage-backed securities (CMBS)
available-for-sale, at fair value......................... $18,946,951 $ 71,567,475
Mezzanine loan investments.................................. 44,990,786 44,374,346
Mortgage loan investments................................... -- 15,150,400
Real estate investment held for sale, net................... 3,496,460 7,294,583
Cash and short-term investments............................. 5,991,187 11,957,616
Escrow cash................................................. -- 2,138,011
Accrued interest receivable................................. 279,079 1,153,989
Other assets................................................ 294,481 876,006
----------- ------------
Total assets...................................... $73,998,944 $154,512,426
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Short-term borrowings..................................... $ -- $ 61,918,156
Subordinated debt to related party........................ -- 9,000,000
Borrowings under repurchase agreement..................... 10,069,000 7,926,375
Treasury locks payable.................................... 5,034,951 10,887,660
Accrued management fees................................... 436,911 438,842
Accrued interest expense.................................. -- 374,759
Accrued expenses and other liabilities.................... 761,792 4,127,931
----------- ------------
Total liabilities................................. 16,302,654 94,673,723
----------- ------------
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value. Authorized 25,000,000
shares, no shares issued Common stock, $.01 par value.
Authorized 200,000,000 shares, 7,346,778 issued and
outstanding at June 30, 1999 and December 31, 1998..... 73,468 73,468
Additional paid-in capital................................ 108,692,169 108,692,169
Distributions in excess of earnings:
Accumulated losses from operations..................... (37,583,806) (38,105,018)
Accumulated losses from sale of assets................. (10,230,302) (7,566,677)
Dividends paid......................................... (3,255,239) (3,255,239)
----------- ------------
Total distributions in excess of earnings......... (51,069,347) (48,926,934)
----------- ------------
Total shareholders' equity........................ 57,696,290 59,838,703
----------- ------------
Total liabilities and shareholders' equity........ $73,998,944 $154,512,426
=========== ============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
1
<PAGE> 91
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ------------------------
1999 1998 1999 1998
------------ ----------- ----------- ----------
<S> <C> <C> <C> <C>
REVENUE:
Interest income on CMBS..................... $ 530,617 $ 317,095 $ 2,363,809 $ 317,095
Interest income on mezzanine loan
investments.............................. 1,201,265 11,602 2,409,268 11,602
Interest income on mortgage loan
investments.............................. -- -- 9,739 --
Rental income............................... 163,711 7,979 460,716 7,979
Other income................................ 10,815 -- 22,312 --
Other interest income....................... 92,279 1,009,314 183,185 1,009,314
----------- ---------- ----------- ----------
Total revenue....................... 1,998,687 1,345,990 5,449,029 1,345,990
----------- ---------- ----------- ----------
OPERATING EXPENSES:
Stock compensation to Manager............... -- 877,917 -- 877,917
Impairment loss on CMBS..................... 2,079,322 -- 2,549,850 --
Asset selling costs......................... 750,000 -- 750,000 --
Decrease in impairment on mezzanine loans... (1,136,107) -- (1,136,107) --
Interest expense............................ 408,535 -- 1,644,889 --
Management fees............................. 157,442 220,986 436,911 220,986
General and administrative expense.......... 245,968 179,198 345,294 179,198
Real estate operating expenses.............. 41,140 2,366 152,054 2,366
Depreciation and amortization............... -- 5,313 135,926 5,313
Loss on termination of interest rate
collar................................... -- -- 49,000 --
----------- ---------- ----------- ----------
Total operating expenses............ 2,546,300 1,285,780 4,927,817 1,285,780
----------- ---------- ----------- ----------
OPERATING INCOME (LOSS) BEFORE ASSET SALES.... (547,613) 60,210 521,212 60,210
REALIZED GAINS (LOSSES) ON SALE OF ASSETS:
Gain (Loss) on sale of CMBS................. -- 42,426 (2,561,102) 42,426
Loss on sale and settlement of mortgage
loans.................................... -- -- (97,929) --
Loss on sale of real estate................. -- -- (4,594) --
----------- ---------- ----------- ----------
NET INCOME (LOSS)................... $ (547,613) $ 102,636 $(2,142,413) $ 102,636
=========== ========== =========== ==========
NET INCOME (LOSS) PER COMMON SHARE:
Basic and Diluted........................... $ (0.07) $ 0.01 $ (0.29) $ 0.01
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic and Diluted........................... 7,346,728 8,980,778 7,346,728 8,980,778
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
2
<PAGE> 92
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
DISTRIBUTIONS IN EXCESS OF EARNINGS
NUMBER OF ADDITIONAL ---------------------------------------------- TOTAL
SHARES COMMON PAID-IN ACCUMULATED LOSSES FROM SHAREHOLDERS'
OUTSTANDING STOCK CAPITAL OPERATIONS SALE OF ASSETS DIVIDENDS PAID EQUITY
----------- ------- ------------ ------------ -------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1998................... 7,346,778 $73,468 $108,692,169 $(38,105,018) $ (7,566,677) $(3,255,239) 59,838,703
Net loss................. -- -- -- 521,212 (2,663,625) -- (2,142,413)
--------- ------- ------------ ------------ ------------ ----------- -----------
Balance at June 30,
1999................... 7,346,778 $73,468 $108,692,169 $(37,583,806) $(10,230,302) $(3,255,239) $57,696,290
========= ======= ============ ============ ============ =========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE> 93
CHASTAIN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30,
---------------------------
1999 1998
----------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $(2,142,413) $ 102,636
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Impairment loss on investments......................... 1,413,743 --
Loss (Gain) on sale of CMBS............................ 2,561,102 (42,426)
Losses on termination of interest rate collar.......... 49,000 --
Non-cash interest expense on rate lock agreements...... 284,047 --
Loss on sale and settlement of mortgage loan
investments........................................... 97,929 --
Loss on sale of real estate............................ 4,594 --
Depreciation and amortization.......................... 135,926 5,313
Amortization of discount/premium on CMBS
available-for-sale.................................... (263,220) (11,849)
Amortization of premium on mezzanine loan investment... 149,890 1,462
Stock options issued................................... -- 888,773
Shares issued for directors fees....................... 45,000
Net (increase) decrease in assets:
Accrued interest receivable.......................... 874,910 (655,057)
Other assets......................................... 2,583,610 (457,805)
Net increase (decrease) in liabilities:
Accrued interest expense............................. (374,759) --
Accrued management fees.............................. (1,931) 220,986
Accrued expenses and other liabilities............... (2,475,344) 598,277
----------- -------------
Net cash provided by operating activities......... 2,897,084 695,310
----------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of CMBS available-for-sale....................... -- (77,084,208)
Proceeds from sale of CMBS available-for-sale............. 47,772,792 3,477,500
Purchase of mezzanine loan investments.................... -- (25,780,000)
Proceeds from sale of mortgage loan investment............ 15,052,470 --
Purchase of real estate investment........................ -- (3,678,346)
Proceeds from sale of real estate investment.............. 2,904,612 --
Repayments on investment borrowings....................... 369,778 --
Capital additions to real estate.......................... (1,877) --
----------- -------------
Net cash provided by (used in) investing
activities..................................... 66,097,775 (103,065,054)
----------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering..................... -- 124,937,334
Deferred financing costs incurred......................... -- (52,650)
Repayments of loan facilities............................. (87,275,531) --
Proceeds from loan facilities............................. 18,500,000 --
Repayments of treasury lock liability..................... (5,920,757)
Repayments of interest rate collar........................ (265,000) --
----------- -------------
Net cash provided by (used in) financing
activities..................................... (74,961,288) 124,884,684
----------- -------------
NET INCREASE (DECREASE) IN CASH AND SHORT-TERM
INVESTMENTS............................................... (5,966,429) 22,514,940
Cash and cash equivalents at beginning of period.......... 11,957,616 1,000
----------- -------------
Cash and cash equivalents at end of period................ $ 5,991,187 $ 22,515,940
=========== =============
Cash paid for interest.................................... $ 1,630,601 $ --
=========== =============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE> 94
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION
Chastain Capital Corporation (the "Company") was incorporated in Georgia on
December 16, 1997 and was initially capitalized on such date through the sale of
100 shares of common stock, par value $0.01 per share ("Common Stock"), for an
aggregate purchase price of $1,000. On April 23, 1998, the Company commenced
operations through the consummation of an initial public offering ("IPO") of
7,380,000 shares of its Common Stock, with gross proceeds of $110,700,000 and
net proceeds to the Company of $102,951,000. Additional public offering costs of
$1,215,750 were incurred in connection with the IPO.
The Company also issued, pursuant to two separate private placements, an
aggregate of 897,678 shares of Common Stock to Lend Lease Investments Holdings,
Inc. ("LLIH", formerly ERE Yarmouth Holdings, Inc.), an indirect wholly-owned
subsidiary of Lend Lease Corporation Limited ("Lend Lease"), and 700,000 shares
of Common Stock to FBR Asset Investment Corporation, an affiliate of Friedman,
Billings, Ramsey & Co., Inc. (lead underwriter of the Company's IPO). The two
private placements closed concurrently with the closing of the IPO, at $13.95
per share, with total proceeds to the Company of $22,287,608.
Pursuant to the Company's Directors Stock Plan, each of the Company's three
independent directors received, as of the consummation of the IPO, $15,000 worth
of Common Stock equal to 1,000 shares as part of their annual director's fee.
The Company was organized to originate first lien commercial and
multifamily mortgage loans for the purpose of issuing collateralized mortgage
obligations ("CMOs") collateralized by its mortgage loans and retaining the
mortgage loans subject to the CMO debt. The Company also was organized to
acquire subordinated interests in commercial mortgage-backed securities
("CMBS"), originate and acquire loans on real property that are subordinated to
first lien mortgage loans and acquire real property and other real estate
related assets.
On October 23, 1998, the Company announced that due to turmoil in the
credit markets, it was necessary to obtain temporary waivers from Morgan
Guaranty Trust Company of New York ("Morgan Guaranty Trust") and Merrill Lynch
Mortgage Capital, Inc. ("Merrill Lynch") to avoid being in default of tangible
net worth covenants under the Company's credit facilities. The Board of
Directors decided to discontinue new investment activity and concluded that the
Company needed to be restructured. On November 13, 1998, the Company reached an
agreement with Morgan Guaranty Trust and Merrill Lynch to restructure its credit
facilities and to dispose of certain assets to reduce the size and stabilize the
volatility of the overall portfolio. Proceeds from the asset sales were used to
reduce outstanding indebtedness on both credit facilities. Through the asset
sales and indebtedness reduction, the Company was able to satisfy its immediate
liquidity needs. The remaining portfolio consists primarily of CMBS, mezzanine
loan investments and real estate.
In connection with the credit facility amendments, LLIH agreed to provide
the Company with up to $40 million of unsecured subordinated debt. An initial
advance of $17 million was drawn on November 13, 1998 and the remaining funds
were available to be drawn from time to time by the Company through maturity on
March 31, 1999. The advances incurred interest at the rate of 14% per annum
through January 31, 1999 and 16% thereafter. The terms of the subordinated debt
were reviewed and approved by a special committee of the Board of Directors
consisting of independent directors not affiliated with Lend Lease. The special
committee obtained the advice of independent financial advisors and legal
counsel in negotiating the terms of the loan.
The amended credit facilities and new subordinated debt agreement provided
the Company with the necessary liquidity in the short term to fund its mortgage
loan commitments, meet margin calls and hold investments. The Merrill Lynch
amendment required the $19 million in outstanding borrowings be repaid on or
before January 31, 1999. On January 27, 1999, the Merrill Lynch Agreement was
further amended, requiring the borrowings to be repaid on or before February 26,
1999. On February 25, 1999, the Merrill Lynch agreement was again amended,
extending the maturity date to March 25, 1999. All outstanding indebtedness
under the Merrill Lynch agreement was repaid on March 25, 1999, and the facility
was
5
<PAGE> 95
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
terminated. All indebtedness under the Morgan Guaranty Trust agreement was
repaid on March 31, 1999. The LLIH subordinated debt agreement was repaid and
terminated on April 5, 1999.
On January 25, 1999, the Board of Directors approved a plan of action to
sell off existing assets to meet the debt maturities. From January 25, 1999 to
March 31, 1999, the Company sold certain CMBS for total proceeds of $47.8
million, resulting in a realized loss of $14.2 million, of which $11.7 million
was recognized in 1998. On March 25, 1999, the Company sold a real estate asset
for $3.8 million, resulting in a realized loss of $262,392, of which $257,797
was recognized in 1998.
On April 5, 1999, the Company consummated an agreement (the "GMAC Repo") to
sell an office mezzanine loan with a face value of $21 million to General Motors
Acceptance Corporation ("GMAC"). The agreement allows the Company to repurchase
the investment no later than April 1, 2000. The GMAC Repo generated proceeds of
$10.5 million. The repurchase price of the GMAC Repo will be adjusted such that
GMAC will receive an 8% annualized yield on its investment prior to October 1,
1999. After October 1, 1999, the repurchase price is fixed at $9.6 million. The
Company used $8.5 million of the proceeds of the GMAC Repo to repay borrowings
from LLIH and used the remaining proceeds to meet its remaining corporate
obligations, which primarily consist of hedging liabilities. The Company is
accounting for the GMAC Repo as a financing transaction.
On May 14, 1999, the Company announced that its Board of Directors had
voted to sell all of the Company's assets, either through a plan of liquidation
or through a sale of the Company, with proceeds to be distributed to
shareholders.
On August 2, 1999, the Company entered into an agreement to sell all of its
remaining CMBS investments and three of its mezzanine loan investments to
Insignia Opportunity Partners. The aggregate purchase price for the transaction
is $24.4 million. The purchase price is fixed subject to a closing prior to
December 15, 1999, thus movements in interest rates and credit spreads should
not impact the Company's net proceeds. In addition, the Company's Board of
Directors has adopted a Plan of Liquidation and Dissolution (the "Plan"), which
provides for the complete liquidation of the Company's remaining assets and the
dissolution of the Company in accordance with the Georgia Business Corporation
Code. Both the asset sales and the Plan are subject to the approval of holders
of a majority of the outstanding shares of common stock of the Company. The
Company expects to submit these matters to its shareholders at its Annual
Meeting of Shareholders during the fourth quarter of 1999. Prior to the meeting,
the Company may enter into additional agreements for the sale of its assets,
which would also be submitted to shareholders at the meeting. Assuming the Plan
is approved by the shareholders, the Company intends to sell the remaining
assets of the Company in the fourth quarter of 1999 or the first quarter of
2000. The Company expects to distribute the proceeds of such asset sales to
shareholders as the properties are sold, with appropriate reserves for the
Company's liabilities and expenses.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Company include the accounts
of the Company and its wholly owned subsidiaries. All intercompany accounts and
transactions have been eliminated in consolidation.
CASH AND SHORT-TERM INVESTMENTS
All highly liquid investments with maturities of three months or less when
purchased are considered to be short-term investments.
6
<PAGE> 96
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
COMPREHENSIVE INCOME (LOSS).
Comprehensive income is defined as the change in equity of a business
during a period from transactions and other events and circumstances, excluding
those resulting from investments by and distributions to owners. For the period
ended June 30, 1999 there is no difference between net income (loss) and
comprehensive net income (loss). For the period ending June 30, 1998
comprehensive net income was 763,712.
CMBS
The Company classifies its CMBS as available-for-sale. Available-for-sale
securities are reported at fair value with net unrealized gains and losses
reported in comprehensive income (loss) as a separate component of shareholders'
equity. The Company recognizes income from CMBS under the effective interest
method, using the anticipated yield over the projected life of the investment.
The Company recognizes impairment on its CMBS when it determines that the
decline in the estimated fair value of its CMBS below cost is other than
temporary. Impairment losses are determined by comparing the estimated fair
value of a CMBS to its current carrying amount, the difference being recognized
as a loss. The Company uses specific identification in determining realized
gains/losses on its CMBS.
MEZZANINE LOAN INVESTMENTS
The Company purchased and originated certain mezzanine loans to be held as
long-term investments. Loans held for investment are recorded at cost at the
date of purchase. Premiums and discounts related to these loans are amortized
over their estimated lives using the effective interest method. Any origination
fee income, application fee income and direct costs associated with originating
or purchasing mezzanine investments have been deferred and the net amount is
added to the basis of the loans on the balance sheet. The Company recognizes
impairment on the loans when it is probable that the Company will not be able to
collect all amounts due according to the contractual terms of the loan
agreement, or when the fair value of the loans is below amortized cost and the
Company determines that it may not be able to hold the loans until amortized
cost is recovered. As a result of the Company's November 1998 restructuring and
the Board's decision to sell the remaining assets, it is unlikely that the
Company will hold its mezzanine loan investments until maturity. The Company
measures impairment based on the present value of expected future cash flows
discounted at the loan's effective interest rate or Management's estimate of the
fair value of the loan.
MORTGAGE LOAN INVESTMENTS
The Company originated mortgage loans to be held as long-term investments.
Interest income was recognized using the effective interest rate method. Due to
the turmoil in the credit markets in October 1998, and the Company's revised
credit facility terms, the Company changed its strategy to hold its mortgage
loans for resale. Loans held for resale are accounted for at the lower of cost
or fair value. Fair value is determined based upon the Company's estimate of
market value. Subsequent to December 31, 1998, the Company sold its remaining
mortgage loan investment.
REAL ESTATE INVESTMENTS
Real estate assets are stated at cost when purchased and are subsequently
reduced by depreciation charges using the straight-line method over the
estimated useful lives of the assets. At June 30, 1999, the Company's investment
in real estate is classified as held for sale and is carried at the lower of
cost or fair value less estimated selling costs.
7
<PAGE> 97
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INCOME TAXES
The Company elected to be taxed as a REIT under the Internal Revenue Code
of 1986 (the "Code"), as amended, commencing with its first REIT taxable year
ended on December 31, 1998. As a REIT, the Company generally is not subject to
federal corporate income taxes on net income that it distributes to
shareholders, provided that the Company meets certain other requirements for
qualification as a REIT under the Code. Because the Company believes that it
qualifies as a REIT and because the Company is reporting net losses year to date
for 1999, no provision has been made for federal income taxes for the Company in
the accompanying consolidated financial statements.
NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed on the basis of the weighted
average number of shares outstanding for the period. Diluted net income (loss)
per share is computed on the basis of the weighted average number of shares and
dilutive common equivalent shares outstanding for the period. For all periods
presented, all outstanding options to purchase 1,246,253 shares of Common Stock
were anti-dilutive. Accordingly, there is no difference between basic and
diluted net income (loss) per common share.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the reporting
period. Actual results could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 133 "Accounting for Derivative Instruments and for
Hedging Activities" ("FAS 133"). FAS 133 establishes accounting and reporting
standards for derivative instruments and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as a
hedge. The accounting for changes in the fair value of a derivative depends on
the intended use of the derivative and the resulting designation. FAS 133 is
effective for the Company beginning January 1, 2001. The Company is evaluating
the eventual impact of FAS 133 on its financial statements.
NOTE 3. SEGMENT DISCLOSURE
The Company has one reportable segment, real estate investments. At June
30, 1999, the Company's real estate investments included CMBS, mezzanine real
estate loans, and a commercial real estate property. The Company uses net income
(loss) to measure profit or loss. The Company separately discloses assets,
revenue and capital expenditures by type of real estate investment in the
consolidated financial statements.
8
<PAGE> 98
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Except for interest income earned on the Company's investment in a British
pounds Sterling mezzanine loan, discussed in Note 6, all of the Company's
revenue for the three and six month periods ending June 30, 1999 is attributed
to investments located in the United States. For the period ending June 30, 1998
the company had no revenue attributed to investments located outside the U.S.
Revenue information by country is summarized below:
<TABLE>
<CAPTION>
SIX MONTHS THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1999 1999
-------------- --------------
<S> <C> <C>
United States............................................. $4,515,934 $1,514,561
United Kingdom............................................ $ 933,095 $ 484,146
Total........................................... $5,449,029 $1,998,707
</TABLE>
At June 30, 1999, the carrying amount of the Company's British pounds
Sterling loan was $17,500,000.
During the six months ended June 30, 1999, the following Company
investments accounted for more than 10% of revenue:
<TABLE>
<S> <C>
Mezzanine loan on an office building in New York....... 23%
Mezzanine loan on multiple hotels in London, England... 17%
</TABLE>
NOTE 4. MANAGEMENT FEES
The Company is party to a Management Agreement (the "Management Agreement")
with ERE Yarmouth, Inc., an indirect wholly-owned subsidiary of Lend Lease
Corporation Limited, under which ERE Yarmouth, Inc. 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. On July 13, 1998, the name
of ERE Yarmouth, Inc. was changed to Lend Lease Real Estate Investments, Inc.
("Lend Lease" or the "Manager" or "Management"). Lend Lease continues as the
advisor to the Company.
Pursuant to the Management Agreement, the Company will pay the Manager a
quarterly base management fee equal to the following:
<TABLE>
<S> <C>
For the first four fiscal quarters
commencing with the fiscal
quarter ended June 30, 1998...... 1.00% per annum of the Average
Invested Assets(1) of the Company
During each fiscal quarter
thereafter....................... 0.85% per annum of the Average
Invested Assets up to $1 billion
0.75% per annum of the Average
Invested Assets from $1 billion to
$1.25 billion
0.50% per annum of the Average
Invested Assets in excess of $1.25
billion
</TABLE>
- ---------------
(1) The term "Average Invested Assets" for any period means the average of the
aggregate book value of the assets of the Company, including a proportionate
amount of the assets of all of its direct and indirect subsidiaries, before
reserves for depreciation or bad debts or other similar non-cash reserves
less (i) uninvested cash balances and (ii) the book value of the Company's
CMO liabilities, computed by dividing (a) the sum of such values for each of
the three months during such quarter (based on the book value of such assets
as of the last day of each month) by (b) three.
9
<PAGE> 99
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Management Agreement also provides for a quarterly incentive management
fee equal to the product of (A) 25% of the dollar amount by which (1) (a) Funds
From Operations(2) (before the incentive fee) of the Company for the applicable
quarter per weighted average number of shares of Common Stock outstanding plus
(b) gains (or minus losses) from debt restructuring or sales of assets not
included in Funds From Operations of the Company for such quarter per weighted
average number of shares of Common Stock outstanding, exceed (2) an amount equal
to (a) the weighted average of the price per share at initial offering and the
prices per share at any secondary offerings by the Company multiplied by (b) 25%
of the sum of the Ten-Year U.S. Treasury Rate plus four percent, and (B) the
weighted average number of shares of Common Stock outstanding. No incentive
management fees have been earned since inception.
The Manager is reimbursed for (or charges the Company directly for) the
Manager's out-of-pocket costs incurred in performing its duties under the
management agreement. There is no cap of the reimbursement of out-of-pocket
expenses.
The Management Agreement is for an initial term of two years, and can be
successively extended for two year periods subject to an affirmative vote of a
majority of the directors who are not employees of Lend Lease. In addition, the
Management Agreement provides for a termination fee equal to the sum of the base
management fee and incentive management fee, if any, earned during the
immediately preceding four fiscal quarters.
NOTE 5. INVESTMENT IN CMBS
The amortized cost and estimated fair value of commercial mortgage-backed
securities classified as available-for-sale securities at June 30, 1999 are
summarized below. The face value of CMBS was $31,015,870 at June 30, 1999.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE ESTIMATED
LIFE AMORTIZED IMPAIRMENT AMORTIZED COST FAIR
SECURITY RATING (IN YEARS) COST LOSSES ADJUSTED VALUE
- --------------- ---------- ----------- ---------- -------------- -----------
<S> <C> <C> <C> <C> <C>
CMBS:
BB+.............................. 13.668 $15,915,530 $5,304,209 $10,611,321 $10,611,321
BB............................... 13.900 10,539,920 2,204,290 8,335,630 8,335,630
----------- ---------- ----------- -----------
Total.................... $26,455,450 $7,508,499 $18,946,951 $18,946,951
=========== ========== =========== ===========
</TABLE>
The estimated fair value of the CMBS for this quarter is based on the
purchase price in the agreement with Insignia Opportunity Partners. In prior
periods, the values have been determined by either i) the price obtained from
the investment banking institutions, which sold the CMBS to the Company, or ii)
an average of at least three quotes received on similarly structured and rated
CMBS. The use of different market assumptions, valuation methodologies, changing
interest rates, interest rate spreads for CMBS over the U.S. Treasury yields and
the timing and magnitude of credit losses may have a material effect on the
estimates of
- ---------------
(2) The term "Funds From Operations" as defined by the National Association of
Real Estate Investment Trusts, Inc. means net income (computed in accordance
with GAAP) excluding gains (or losses) from debt restructuring, sales of
property and any unusual or non-recurring transactions, plus depreciation
and amortization on real estate assets, and after deduction of preferred
stock dividends, if any, and similar adjustments for unconsolidated
partnerships and joint ventures. Funds From Operations does not represent
cash generated from operating activities in accordance with GAAP and should
not be considered as an alternative to net income as an indication of the
Company's performance or to cash flows as a measure of liquidity or ability
to make distributions.
10
<PAGE> 100
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
fair value. The fair value estimates presented herein are based on pertinent
information available as of June 30, 1999.
The CMBS tranches owned by the Company provide credit support to the more
senior tranches of the related commercial securitization. Cash flow from the
underlying mortgages is generally allocated first to the senior tranches, with
the most senior tranches having a priority right to cash flow. Any remaining
cash flow is generally allocated among the other tranches based on their
seniority. To the extent there are defaults and unrecoverable losses on the
underlying mortgages, resulting in reduced cash flows, the subordinate tranches
will bear those losses first. To the extent there are losses in excess of the
most subordinate tranches stated right to principal and interest, the remaining
tranches will bear such losses in order of their relative subordination.
At June 30, 1999, the amortized cost of the Company's investments in CMBS
exceeded estimated fair value by $7,508,499. Impairment losses of $4,958,649 on
these investments were recognized in 1998. Due to the Company's inability to
hold its CMBS investments until the cost of the CMBS is recovered, the Company
determined that the decline in the fair value of its CMBS below amortized cost
at June 30, 1999 was other than temporary. Accordingly, the Company carries its
investment in CMBS at estimated fair value at June 30, 1999. During the first
quarter of 1999, the Company sold seven of its investments in CMBS securities
for $47.8 million, resulting in a realized loss of $14.2 million, of which $11.7
million was recognized in 1998. The proceeds from the sale of CMBS were used to
repay the Company's obligations under its debt agreements. (See Note 8)
NOTE 6. MEZZANINE LOAN INVESTMENTS
As of June 30, 1999, the Company's investment in mezzanine loans consisted
of the following:
<TABLE>
<CAPTION>
ESTIMATED
UNDERLYING INTEREST MATURITY FACE AMORTIZED IMPAIRMENT CARRYING FAIR
SECURITY RATE DATE VALUE COST LOSS VALUE VALUE
- ----------------------- -------- ---------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Commercial real estate:
Office............... 12.00% 05/01/2007 $21,000,000 $24,485,585 $2,651,050 $21,834,535 $21,834,535
Hotel................ 11.77% 06/30/2003 19,647,200 19,722,940 2,222,940 17,500,000 17,500,000
Multi-family......... 10.63% 08/01/2008 2,800,000 2,662,793 1,046,515 1,616,278 1,616,278
Retail............... 9.69% 05/01/2005 4,570,896 4,233,172 941,272 3,291,900 3,291,900
Other................ 10.57% 07/01/2008 1,000,000 945,680 197,607 748,073 748,073
----------- ----------- ---------- ----------- -----------
Total......... $49,018,096 $52,050,170 $7,059,384 $44,990,786 $44,990,786
=========== =========== ========== =========== ===========
</TABLE>
At June 30, 1999, the amortized cost of the Company's investments in
mezzanine loans exceeds their aggregate carrying value. The Company carries its
investments in mezzanine loans at the lower of amortized cost after impairment
losses or fair value. The fair value of mezzanine loan investments is based on
the contract with Insignia Opportunity Partners for the loans being sold and
Management's best estimate of market conditions at June 30, 1999. The use of
different market assumptions, valuation methodologies, changing interest rates,
interest rate spreads and the timing and magnitude of credit losses may have a
material effect on the estimates of fair value. The Company's ability to hold
its mezzanine loans to maturity was negatively affected by the 1998 turmoil in
the financial markets and its effect on the value of the loans. An $8,195,491
impairment loss on mezzanine loan investments was recognized in 1998. Based on
information obtained during recent sales negotiations that is perceived to more
accurately reflect the estimated fair value, actual impairment loss on mezzanine
loan investments is $7,059,384 at June 30, 1999, which results in a reduction in
impairment charges of $1,136,107 for the six months ended June 30, 1999.
The Company's $19,647,200 face value mezzanine loan investment is a British
pounds Sterling loan. The Company purchased the investment for 11.98 million in
British pounds Sterling. Interest on the loan is based on Sterling Libor ("Base
Rate") plus 4.00%. The exchange rate at the date of investment was $1.64 per
11
<PAGE> 101
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
pound. In order to reduce the risk of foreign currency exchange rate
fluctuations, the Company entered into a foreign currency swap arrangement with
Merrill Lynch Capital Services, Inc. The swap arrangement provides the Company
with an exchange rate of $1.64 per pound on the return of its principal
regardless of exchange rate fluctuation. The swap arrangement also converts the
Base Rate to US$ Libor minus 0.06% regardless of movements in the Sterling
Libor. The Company is subject to foreign currency risk on the spread portion
(4.00%) of the quarterly interest payments. The market value of the currency
swap at June 30, 1999 was an asset of $666,029. The foreign currency swap
arrangement expires on the maturity date of the related loan. The Company is
exposed to credit loss in the event of nonperformance by the counterparty to the
currency swap agreement. However, the Company does not anticipate nonperformance
by the counterparty.
On April 5, 1999, the Company consummated a sale and repurchase agreement
with respect to a mezzanine loan at a face value of $21 million to GMAC. The
agreement allows the Company to repurchase the investment no later than April 1,
2000. The GMAC Repo generated proceeds of $10.5 million. The repurchase price of
the GMAC Repo will be adjusted such that GMAC will receive an 8% annualized
yield on its investment if the Company repurchases the investment prior to
October 1, 1999. On and after October 1, 1999, the repurchase price is fixed at
$9.6 million. The Company used $8.5 million of the proceeds of the GMAC Repo to
repay borrowings from LLIH and used the remaining proceeds to meet its remaining
corporate obligations, which primarily consist of hedging liabilities. The
Company is accounting for the GMAC Repo as a financing transaction.
NOTE 7. REAL ESTATE INVESTMENT HELD FOR SALE
As of June 30, 1999, the Company's investment in real estate consisted of
the following:
<TABLE>
<CAPTION>
DATE ACQUIRED PROPERTY LOCATION PROPERTY TYPE
- ------------- -------------- --------------- -------------
<S> <C> <C> <C>
6/26/98............................. Lakeside Plaza Stockton, CA Retail
</TABLE>
The carrying value of real estate investment held for sale at June 30, 1999
is summarized below:
<TABLE>
<S> <C>
Real estate investment held for sale -- at cost
Land...................................................... $1,470,000
Buildings................................................. 2,225,869
Tenant Improvements....................................... 1,909
Capitalized Costs......................................... 20,670
Less accumulated depreciation and amortization.............. (32,280)
Less impairment charge...................................... (189,708)
----------
Real estate investment held for sale -- net................. $3,496,460
==========
</TABLE>
In connection with the Company's decision to discontinue its initial
investment strategies, the Company also decided to sell its real estate
investments and accordingly, at June 30, 1999, the Company's real estate
investment is classified as held for sale. The real estate investment was
written down to market value less estimated selling costs in 1998.
On March 25, 1999, the Company sold its Bryarwood 85 real estate investment
for $3.8 million. Primarily due to credits given for tenant improvement
liabilities, sales proceeds were $2,881,543, resulting in a realized loss of
$262,391 of which $257,797 was recognized in 1998.
NOTE 8. BORROWING ARRANGEMENTS
During 1998, the Company entered into certain borrowing arrangements to
provide financing for the Company's investments. The facility with Morgan
Guaranty Trust Company of New York ("Morgan Guaranty Trust") became due and was
repaid and terminated on March 31, 1999. The agreement with Merrill
12
<PAGE> 102
CHASTAIN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Lynch Mortgage Capital, Inc. and Merrill Lynch Capital Services, Inc. ("Merrill
Lynch") became due and was repaid and terminated on March 25, 1999. Total
interest paid to Morgan Guaranty Trust and Merrill Lynch for the six months
ended June 30, 1999 was $868,360.
The Company also entered into an agreement with Lend Lease Investment
Holdings, Inc. ("LLIH") in 1998, to provide unsecured, subordinated financing to
the Company. This facility was terminated on April 5, 1999, and borrowings under
the agreement were completely repaid on that date with proceeds from the GMAC
Repo. (See Note 9) Interest paid to LLIH for the six months ended June 30, 1999
was $147,562.
NOTE 9. INTEREST RATE PROTECTION AGREEMENTS
In order to hedge the risk of a material change in interest rates that
would affect the Company's borrowing rate on its lines of credit and on
anticipated future long-term borrowings secured by the Company's investments,
the Company entered into forward treasury lock agreements, an interest rate
collar and an interest rate cap. None of these agreements were held for trading
purposes.
As a result of the financial turmoil in the credit markets in October 1998,
and the Company's failure to comply with its debt agreements, the Company
determined that its ability to obtain long-term, fixed-rate financing was not
probable. The turmoil also created uncertainty as to the Company's ability to
hold the investments, and thus the treasury locks no longer qualified for hedge
accounting. On October 23, 1998 the Company terminated all of its treasury locks
and incurred a realized loss of $13.3 million, which was recognized as a
component of income. The interest rate cap was terminated in July 1998.
On January 23, 1999 the Company terminated its interest rate collar
contract at a loss of $265,000, of which $216,000 was recognized in 1998.
On April 30, 1999 and May 3, 1999, the Company paid $4,771,187 and
$1,149,570, respectively toward its Treasury locks liability.
NOTE 10. SUBSEQUENT EVENTS
On July 2, 1999, the Company repaid its remaining Treasury lock liability
of $5,034,951.
On August 2, 1999 the Company announced the sale of a portion of the
Company's mezzanine loan investments and all of its remaining CMBS investments
for $24.4 million. The Board of Directors also voted to adopt a Plan of
Liquidation and Dissolution (the "Plan"). Both the asset sale and the Plan are
subject to shareholder approval. The Company expects to submit the Plan to
shareholders at the Company's annual meeting in the fourth quarter of 1999.
13
<PAGE> 103
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the Company's consolidated financial condition,
results from operations, and capital resources and liquidity should be read in
conjunction with the Consolidated Financial Statements and related Notes
included in Item 1.
CAPITAL RESOURCES AND LIQUIDITY
Liquidity is the ability for the Company to meet its cash requirements
including any ongoing commitments, borrowings, shareholder distributions,
lending and general business activities. The Company's source of liquidity
during the period ended December 31, 1998 consisted of net proceeds from the
IPO, borrowings under the Master Loan and Security Agreement with Morgan
Guaranty Trust (the "Morgan Guaranty Trust Agreement"), borrowings under the
Merrill Lynch Agreement, borrowings under the LLIH Agreement and repurchase
financing from the Deutsche Bank Agreement and the GMAC Repo.
In order to meet the Company's liquidity needs in early 1999, the Board of
Directors, on January 25, 1999, approved a plan of action to sell a portion of
the Company's assets in order to meet the Company's outstanding obligations. On
February 19, 1999, the Company sold a CMBS investment for total proceeds of $8.8
million. The proceeds were used to repay the Company's indebtedness under the
Deutsche Bank Agreement. On March 31, 1999, the Company completed the sale of a
package of CMBS. The total proceeds from the sale were $39.0 million. The
Company used the proceeds to repay its borrowings from Morgan Guaranty Trust. In
connection with its sale of investments on March 31, 1999, the Company entered
into the GMAC Repo. The agreement allows the Company to repurchase the pledged
investment no later than April 1, 2000. The GMAC Repo was closed on April 5,
1999 and generated proceeds of $10.5 million. The repurchase price of the GMAC
Repo will be adjusted such that GMAC will receive an 8% annualized yield on its
investment if the Company repurchases the investment prior to October 1, 1999.
On and after October 1, 1999, the repurchase price is fixed at $9.6 million. The
Company used $8.5 million of the proceeds of the GMAC Repo to repay borrowings
from LLIH and the remaining monies were used to meet its remaining corporate
obligations, which primarily consisted of hedging liabilities.
The Company paid off and terminated all of its existing credit facilities
other than the GMAC Repo as of April 5, 1999. The Company's remaining material
liability is $10.1 million for the GMAC Repo. As of July 2, 1999, the Company
had paid all of the forward Treasury lock liabilities that were due. The Company
believes its net working capital and net operating cash flow will be sufficient
to meet the Company's remaining liabilities and that it will pay off the GMAC
repo with proceeds from asset sales.
As discussed in Note 1 to the Consolidated Financial Statements included in
Item 1, the Company has entered into an agreement to sell all of its remaining
CMBS investments and three of its mezzanine loan investments to Insignia
Opportunity Partners. The aggregate purchase price for the transaction is $24.4
million. In addition, the Company's Board of Directors has adopted a Plan of
Liquidation and Dissolution (the "Plan"), which provides for the complete
liquidation of the Company's remaining assets and the dissolution of the Company
in accordance with the Georgia Business Corporation Code. Both the asset sales
and the Plan are subject to the approval of holders of a majority of the
outstanding shares of common stock of the Company. The Company expects to submit
these matters to its shareholders at its Annual Meeting of Shareholders during
the fourth quarter of 1999. Prior to the meeting, the Company may enter into
additional agreements for the sale of its assets, which would also be submitted
to shareholders at the meeting. Assuming the Plan is approved by the
shareholders, the Company intends to sell the remaining assets of the Company in
the fourth quarter of 1999 or the first quarter of 2000. The Company expects to
distribute the proceeds of such asset sales to shareholders as the properties
are sold, with appropriate reserves for the Company's liabilities and expenses.
The discussion above contains forward-looking statements regarding the
Company's plans, goals and expectations, including statements regarding the
Company's estimate of the timing of the sale of the Company's remaining assets,
the distribution of proceeds and the dissolution of the Company. Forward-
looking statements are necessarily speculative, there being certain risks and
uncertainties that could cause actual events or results to differ materially
from those referred to in the forward-looking statements. The
14
<PAGE> 104
Company's current plans are subject to change, including in the event of changes
in general business and economic conditions as well as changes in interest rates
and credit markets. There can be no assurance that shareholder approval of the
asset sales and the Plan will be obtained, if and when proxy solicitation
materials will be mailed to the Company's shareholders, or if and when the
Company's assets will be sold, the proceeds distributed and the Company
dissolved. The timing of any sale of the Company's assets, the distribution of
proceeds, and the dissolution of the Company are subject to various and
significant uncertainties, many of which are beyond the Company's control and
which could delay any sale of the Company's remaining assets, distribution of
proceeds and dissolution of the Company significantly beyond the time periods
estimated above. Among such uncertainties are the date when any proxy
solicitation materials are mailed to the Company's shareholders, the date when
approval of the shareholders of the assets sales and the Plan is obtained
(assuming it is obtained), the demand for the Company's assets by potential
purchasers, the availability of capital for potential purchasers, the actual
dates when assets are sold, and the duration of any installment sales of any of
the assets and the amount of any contingent liabilities or expenses against
which the Company must reserve sales proceeds.
WORKING CAPITAL RESERVES
At June 30, 1999 the Company had $5,991,187 in cash and short-term
investments. The funds were held to pay the Company's final Treasury lock
liability of $5.0 million dollars on July 2, 1999. The remaining funds will be
used to meet the Company's operating needs.
FINANCIAL CONDITION
Securities Available-For-Sale. Due to the Company's pending agreement with
Insignia Opportunity Partners for the sale of its remaining CMBS, the Company
wrote down its investment in CMBS to fair value and recognized an impairment
loss of $2,549,850 for the six months period ended June 30, 1999. The Company
sold a CMBS on February 19, 1999 for $8,827,344 resulting in a realized loss of
$627,488, of which $541,562 was recognized at December 31, 1998. On March 31,
1999, the Company sold $38,962,296 of CMBS in order to repay its obligations
under its borrowing agreements, resulting in a realized loss of $13,592,790, of
which $11,176,359 was recognized at December 31, 1999.
Mezzanine Investment Portfolio. In connection with its sale of CMBS on
March 31, 1999, the Company entered into a sale and repurchase agreement for an
office mezzanine loan with a face value of $21 million to GMAC. The agreement
allows the Company to repurchase the investment no later than April 1, 2000. The
GMAC Repo closed on April 5, 1999, and generated proceeds of $10.5 million. The
Company's liability at June 30,1999 was $10.1 million. The repurchase price of
the GMAC Repo will be adjusted such that GMAC will receive an 8% annualized
yield on its investment if the Company repurchases the investment prior to
October 1, 1999. On and after October 1, 1999, the repurchase price is fixed at
$9.6 million. The Company used $8.5 million of the proceeds of the GMAC Repo to
repay borrowings from LLIH and used the remaining monies to pay its hedging
liabilities. Based on pending negotiations with third parties with respect to
the mezzanine loans, the Company determined that the carrying value of the
mezzanine loans were below market value and reduced the impairment allowance by
$1,136,107 for the six months ended June 30, 1999. This reduction was a result
of the Company's belief that the increased value more fairly reflected the
estimated value of the assets to be sold.
Mortgage Loan Portfolio. The Company accepted a discounted pay off of its
remaining mortgage loan on January 4, 1999 at a loss of $797,810. This loss was
recognized by the Company as an operating loss for the year ended December 31,
1998. The loss on sale and settlement of mortgage loans in the amount of $97,929
resulted from changes in estimates that were used to accrue for third party
costs relating to the sale and settlement of previously committed loans.
Real Estate Investments. At June 30, 1999, the Company's real estate
investment was classified as held for sale. Preliminary offers determined that
the value of the property was less than book value. Impairment losses of
$447,505 were recognized in 1998. On March 25, 1999 the Company sold one real
estate investment for $3.8 million in order to meet its debt obligations.
15
<PAGE> 105
Short-Term Borrowings. During the second quarter of 1999, the Company
repaid its borrowings with LLIH, as further discussed in "Capital Resources and
Liquidity" and in the notes to the Company's consolidated financial statements
as of and for the period ended June 30, 1999 included herein.
Treasury Locks Payable. As a result of the turmoil in the credit market
during the fourth quarter of 1998 and the Company's failure to comply with its
debt agreements, the Company determined that its ability to obtain long-term
fixed rate financing was not probable. The turmoil also created uncertainty as
to the Company's ability to hold its investments. Accordingly, the Company
discontinued hedge accounting for its Treasury locks and incurred a loss of
$13,070,685 on these agreements. As part of its debt restructuring on November
13, 1998, the Company paid $2,390,000 to settle its Treasury locks payable with
Merrill Lynch. On April 30, 1999 and May 3, 1999, the Company paid $4,771,187
and $1,149,570, respectively, to settle outstanding Treasury lock liabilities.
The remaining hedging liability of $5,034,951 to Morgan Guaranty Trust was paid
on July 2, 1999.
Shareholders' Equity. Shareholders' equity decreased by $2,142,413 from
December 31, 1998 due to net losses from the sale of its investments. The losses
were offset by $521,212 from operating income before asset sales.
RESULTS FROM OPERATIONS
Revenue. Revenue totaled $1,998,687 and $5,449,029 for the three and six
months ended June 30, 1999 and $1,345,990 for the period ending June 30, 1998.
Revenue is comprised primarily of interest income on CMBS investments and
Mezzanine Investments and rental income from real estate. The decrease in
revenue during the second quarter was the result of the asset sales that
occurred earlier in the year.
Operating Expenses. Operating expenses consist of expenses incurred in
operating the Company, property and investment operations, and totaled
$2,546,300 and $4,927,817 for the three and six months ended June 30, 1999 and
$1,285,780 for the three and six months ended June 30, 1998. Included in the
1999 amounts were impairment losses on CMBS totaling $2,079,322 and $2,549,850
for the three and six month periods; and reduction in impairment on mezzanine
loans of $1,136,107 for the three and six month periods. Management fees were
calculated at 1% per annum of the Average Invested Assets for the quarter ended
March 31, 1999 and 0.85% per annum of the Average Invested Assets for the
quarter ended June 30, 1999, and totaled $157,442 and $436,911 for the three and
six months ended June 30, 1999, respectively and $220,986 for the period ending
June 30, 1998. The Company also recorded general and administrative expenses of
$245,968 and $345,294 for the three and six months ended June 30, 1999 and
179,198 for the period ending June 30, 1998.
Loss on Sale of CMBS. The loss on sale of CMBS was a result of the
disposal of CMBS during first quarter for $47,789,640. The losses totaled
$14,279,022 of which $11,717,920 was recognized in 1998.
REIT STATUS
The Company made an election to be taxed as a REIT under the Code,
commencing with its first REIT taxable year ending on December 31, 1998. The
Company believes that it qualifies for taxation as a REIT and therefore will not
be subject to federal corporate income tax on its net income that is distributed
currently to its shareholders.
To qualify as a REIT under the Code, the Company must meet several
requirements regarding, among other things, the ownership of its outstanding
stock, the sources of its gross income, the nature of its assets, and the levels
of distributions to its shareholders. These requirements are highly technical
and complex, and the Company's determination that it qualifies as a REIT
requires an analysis of various factual matters and circumstances that may not
be entirely within the Company's control. Accordingly, there can be no assurance
that the Company will remain qualified as a REIT.
If the Company fails to qualify for taxation as a REIT in any taxable year,
and certain relief provisions of the Code do not apply, the Company will be
subject to tax (including any applicable alternative minimum tax) on its taxable
income at regular corporate rates. Distributions to the Company's shareholders
in any year
16
<PAGE> 106
in which the Company fails to qualify will not be deductible by the Company nor
will they be required to be made. In such event, to the extent of the Company's
current and accumulated earnings and profits, all distributions to shareholders
will be taxable as ordinary income and, subject to certain limitations of the
Code, corporate distributees may be eligible for the dividends received
deduction. Unless entitled to relief under specific statutory provisions, the
Company also will be disqualified from taxation as a REIT for the four taxable
years following the year during which the Company ceased to qualify as a REIT.
It is impossible to predict whether the Company would be entitled to such
statutory relief.
YEAR 2000 DISCLOSURES
The inability of computers, software and other equipment to recognize and
properly process data fields containing a two-digit year is commonly referred to
as the Year 2000 compliance issue ("Y2K"). As the year 2000 approaches, such
systems may be unable to accurately process certain date-based information.
Y2K exposures of the Company are currently being assessed. Potential
critical exposures include reliance on third party vendors and building systems
that are not Y2K compliant. The Company continues to communicate with its third
party service vendors to assess Y2K compliance status and the adequacy of their
Y2K efforts
The Manager has made Year 2000 compliance a high priority for replacement
applications and is in the process of updating and replacing other applications
that are not Year 2000 compliant. The Manager materially completed all mission
critical system projects by the modified date of July 31, 1999, which will allow
for systems testing to resolve any remaining Year 2000 compliance issues.
However, if any of the vendors of the Manager's Y2K compliant software fail to
perform pursuant to their contracts with the Manager, the Manager's Y2K
compliance could be jeopardized, and could materially adversely affect the
Company. The Manager does not believe that the costs to remediate any Y2K issues
will materially affect its business, operations or financial condition, or will
have an adverse affect on its clients, including the Company.
Lakeside Plaza is being assessed in an effort to identify critical Y2K
issues. Required remediation strategies will depend on the outcome of the
assessment and therefore, will not be developed until the property assessment is
complete. The inventory survey for the property was halted due to the pending
sale of the property.
The Company has not incurred any material costs to date relating to Y2K.
Total property assessment costs to the Company were expected to total
approximately $4,300 and the total cost for quality assurance for third party
engineers and consultants is expected to be approximately $1,000. Remediation
costs can not be reasonably estimated, until the assessment is complete and
remediation strategies are determined.
The failure to adequately address the Year 2000 issue may result in the
closure of the building owned by the Company. In order to reduce the potential
impact on the operations of the Company, contingency plans are anticipated to be
completed by September 30, 1999.
With respect to the Company's loan portfolios, the primary Year 2000 issue
relates to potential borrower defaults caused by:
- increased expenses or legal claims related to failures of embedded
technology in building systems,
- reductions in collateral value due to failure of one or more building
systems,
- interruptions in building cash flows due to tenants inability to make
timely lease payments inaccurate or incomplete accounting of rents, or
decreases in building occupancy levels,
- the borrower's inability to address all material Y2K issues that may
potentially impact the borrowers operations.
These risks are also applicable to the Company's portfolio of CMBS, as
these securities are dependent upon the pool of mortgage loans underlying them.
If the investors in these types of securities demand higher returns in
recognition of these potential risks, the market value of any CMBS portfolio of
the Company could also be adversely affected.
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FORWARD LOOKING STATEMENTS
Certain statements contained herein are "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A
of the Securities Act of 1933, as amended, 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 "may", "will", "intend", "should", "expect", "anticipate", "estimate",
or "continue" or the negatives thereof or other comparable terminology. The
Company's actual results could differ materially from those anticipated in such
forward-looking statements due to a variety of factors, including, but not
limited to, changes in national, regional or local economic environments,
competitive products and pricing, government fiscal and monetary policies,
changes in prevailing interest rates, the course of negotiations, the
fulfillment of contractual conditions, factors inherent to the valuation and
pricing of interests in commercial mortgage-backed securities, credit risk
management, asset/liability management, the financial and securities markets,
the availability of and costs associated with the sources of liquidity, other
factors generally understood to affect the real estate acquisition, mortgage and
leasing markets and security investments, and other risks detailed in the
Company's registration statement on Form S-11, as amended, filed with the SEC,
the Company's annual report on Form 10-K and quarterly reports on Form 10-Q
filed with the SEC, and other filings made by the Company with the SEC. The
Company does not undertake, and specifically disclaims any obligation, to
publicly release the results of any revisions which may be made to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT 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
Company is primarily exposed to interest rate and spread risk. Interest rates
and spreads are sensitive to many external forces including, but not limited to,
governmental monetary and tax policies and domestic and international economic
and political factors. These forces are beyond the control of the Manager and
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 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.
The following table quantifies the potential changes in net interest income
and net asset value should interest rates rise or fall. The table below
calculates the changes in the assets owned by the Company as of June 30, 1999
and assumes none of the assets are sold. The table represents the effect over
the next four quarters. The results assume that yield curves of the rate changes
will be parallel to each other. Net asset value is calculated as the sum of the
present value of cash in flows generated from interest-earning assets net of
cash outflows in respect of interest-bearing liabilities. The base interest rate
scenario assumes interest rates at June 30, 1999. All changes in the net asset
value are a result of valuing assets based on changes in interest rates. These
changes do not include the effects of income or dividends. The net interest
income is interest
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<PAGE> 108
income (excluding interest income on cash) netted with interest expense. All
changes are measured by percentage changes from the base interest rate. Actual
results could differ significantly from these estimates.
<TABLE>
<CAPTION>
CHANGE IN INTEREST RATE NET INTEREST INCOME NET ASSET VALUE
- ----------------------- ------------------- ----------------
<S> <C> <C>
+400................................................ 15.7 (15.2)
+300................................................ 11.8 (11.9)
+200................................................ 7.8 (8.2)
+100................................................ 3.9 (4.3)
Base.................................................. 0.0 0.0
-100................................................ (3.9) 4.7
-200................................................ (7.8) 9.8
-300................................................ (11.8) 15.5
-400................................................ (15.7) 21.7
</TABLE>
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PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule (for SEC filing purposes only)
(b) Reports
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CHASTAIN CAPITAL CORPORATION
By: /s/ STEVE GRUBENHOFF
------------------------------------
Steve Grubenhoff
Chief Financial Officer
Date: August 13, 1999
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