<PAGE> 1
UNITED STATES
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 September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-14029
AMRESCO CAPITAL TRUST
(Exact name of Registrant as specified in its charter)
TEXAS 75-2744858
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
700 N. PEARL STREET, SUITE 2400, LB 342,
DALLAS, TEXAS 75201-7424
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (214) 953-7700
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:
10,015,111 shares of common stock, $.01 par value per share,
as of November 1, 1999.
<PAGE> 2
AMRESCO CAPITAL TRUST
INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - September 30, 1999 and December 31, 1998 ................................. 3
Consolidated Statements of Income - For the Three and Nine Months Ended September 30, 1999, the Three
Months Ended September 30, 1998 and the Period from February 2, 1998 (Date of Initial Capitalization)
through September 30, 1998............................................................................ 4
Consolidated Statement of Changes in Shareholders' Equity - For the Nine Months Ended
September 30, 1999.................................................................................... 5
Consolidated Statements of Cash Flows - For the Nine Months Ended September 30, 1999 and the
Period from February 2, 1998 (Date of Initial Capitalization) through September 30, 1998.............. 6
Notes to Consolidated Financial Statements.............................................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................... 29
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................................. 31
SIGNATURE ................................................................................................ 32
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMRESCO CAPITAL TRUST
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
September 30,
1999 December 31,
(unaudited) 1998
------------ ------------
<S> <C> <C>
ASSETS
Mortgage loans held for investment, net ........................................... $ 124,080 $ 96,976
Acquisition, development and construction loan arrangements accounted for as real
estate or investments in joint ventures ........................................ 42,144 39,550
------------ ------------
Total loan investments ............................................................ 166,224 136,526
Allowance for loan losses ......................................................... (2,690) (1,368)
------------ ------------
Total loan investments, net of allowance for losses ............................... 163,534 135,158
Commercial mortgage-backed securities - available for sale (at fair value) ........ 26,027 28,754
Real estate, net of accumulated depreciation of $572 and $56, respectively ........ 50,650 10,273
Investments in unconsolidated partnerships and subsidiary ......................... 11,773 3,271
Receivables and other assets ...................................................... 5,435 3,681
Cash and cash equivalents ......................................................... 3,794 9,789
------------ ------------
TOTAL ASSETS ................................................................... $ 261,213 $ 190,926
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Accounts payable and other liabilities ............................................. $ 2,696 $ 941
Amounts due to affiliates .......................................................... 6,383 6,268
Repurchase agreement ............................................................... 10,701 --
Line of credit ..................................................................... 78,500 39,338
Non-recourse debt on real estate ................................................... 34,600 7,500
Dividends payable .................................................................. -- 4,002
------------ ------------
TOTAL LIABILITIES .............................................................. 132,880 58,049
------------ ------------
Minority interests ................................................................. 500 2,611
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 3)
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value, 49,650,000 shares authorized, no shares issued .... -- --
Series A junior participating preferred stock, $.01 par value, 350,000 shares
authorized, no shares issued ................................................... -- --
Common stock, $.01 par value, 200,000,000 shares authorized, 10,015,111 and
10,006,111 shares issued and outstanding, respectively ......................... 100 100
Additional paid-in capital ......................................................... 140,998 140,941
Unearned stock compensation ........................................................ (359) (848)
Accumulated other comprehensive income (loss) ...................................... (9,341) (6,475)
Distributions in excess of accumulated earnings .................................... (3,565) (3,452)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY ..................................................... 127,833 130,266
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ..................................... $ 261,213 $ 190,926
============ ============
</TABLE>
See notes to consolidated financial statements
3
<PAGE> 4
AMRESCO CAPITAL TRUST
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Period from
February 2,
Three Months Ended Nine Months 1998
September 30, Ended through
----------------------- September 30, September 30,
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Interest income on mortgage loans ................................... $ 3,841 $ 1,188 $ 10,776 $ 1,328
Income from commercial mortgage-backed securities ................... 905 560 2,753 597
Operating income from real estate ................................... 1,416 91 2,593 108
Equity in earnings of unconsolidated subsidiary, partnerships and
other real estate ventures ........................................ 63 326 197 486
Interest income from short-term investments ......................... 76 827 198 1,734
---------- ---------- ---------- ----------
Total revenues .................................................... 6,301 2,992 16,517 4,253
---------- ---------- ---------- ----------
Expenses:
Interest expense .................................................... 1,769 1 3,427 1
Management fees ..................................................... 610 439 1,613 632
General and administrative .......................................... 338 755 1,120 953
Depreciation ........................................................ 408 21 705 24
Participating interest in mortgage loans ............................ 190 3 1,019 3
Provision for loan losses ........................................... 642 501 1,822 611
---------- ---------- ---------- ----------
Total expenses .................................................... 3,957 1,720 9,706 2,224
---------- ---------- ---------- ----------
Income before gains ................................................... 2,344 1,272 6,811 2,029
Gain associated with repayment of ADC loan arrangement ............. -- -- 584 --
---------- ---------- ---------- ----------
Net income ............................................................ $ 2,344 $ 1,272 $ 7,395 $ 2,029
========== ========== ========== ==========
Earnings per common share:
Basic .............................................................. $ 0.24 $ 0.12 $ 0.74 $ 0.34
========== ========== ========== ==========
Diluted ............................................................ $ 0.24 $ 0.12 $ 0.74 $ 0.34
========== ========== ========== ==========
Weighted average number of common shares outstanding:
Basic .............................................................. 10,000 10,000 10,000 5,892
========== ========== ========== ==========
Diluted ............................................................ 10,016 10,006 10,011 5,896
========== ========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
AMRESCO CAPITAL TRUST
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(UNAUDITED; IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Common Stock
$.01 Par Value Accumulated Distributions
------------------- Additional Unearned Other in Excess of Total
Number of Paid-in Stock Comprehensive Accumulated Shareholders'
Shares Amount Capital Compensation Income (Loss) Earnings Equity
----------- ------ --------- ------------ ------------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1999....... 10,006,111 $ 100 $ 140,941 $ (848) $ (6,475) $ (3,452) $ 130,266
Issuance of trust managers'
restricted shares.............. 9,000 -- 91 (91) --
Issuance of warrants............. 400 400
Decrease in fair value of
compensatory options .......... (434) 434 --
Amortization of unearned trust
manager compensation........... 68 68
Amortization of compensatory
options ....................... 78 78
Dividends declared
($0.75 per common share)....... (7,508) (7,508)
Unrealized loss on securities
available for sale............. (2,866) (2,866)
Net income....................... 7,395 7,395
----------- ------ --------- ------- --------- --------- ----------
Balance at September 30, 1999.... 10,015,111 $ 100 $ 140,998 $ (359) $ (9,341) $ (3,565) $ 127,833
=========== ====== ========= ======= ========= ========= ==========
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
AMRESCO CAPITAL TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
Period from
February 2,
Nine Months 1998
Ended through
September 30, September 30,
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................................................................... $ 7,395 $ 2,029
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses .................................................................. 1,822 611
Depreciation ............................................................................... 705 24
Gain associated with repayment of ADC loan arrangement ..................................... (584) --
Loss on sale of interest rate cap .......................................................... 5 --
Amortization of prepaid assets ............................................................. 176 104
Discount amortization on commercial mortgage-backed securities ............................. (231) (54)
Amortization of compensatory stock options and unearned trust manager compensation ......... 146 285
Amortization of loan commitment fees ....................................................... (555) (74)
Receipt of loan commitment fees ............................................................ 428 1,220
Increase in receivables and other assets ................................................... (1,020) (1,766)
Increase in interest receivable related to commercial mortgage-backed securities ........... -- (377)
Increase in accounts payable and other liabilities ......................................... 1,755 1,008
Increase in amounts due to affiliates ...................................................... 1,217 388
Equity in undistributed earnings of unconsolidated subsidiary, partnerships and other real
estate ventures ......................................................................... (197) (486)
Distributions from unconsolidated subsidiary, partnerships and other real estate venture ... 294 380
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES ............................................. 11,356 3,292
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of mortgage loans ................................................................. -- (25,807)
Investments in mortgage loans ................................................................. (41,676) (55,607)
Investments in ADC loan arrangements .......................................................... (22,482) (29,004)
Sale of mortgage loan to affiliate ............................................................ 4,585 --
Principal collected on mortgage loans ......................................................... 8,385 --
Principal and interest collected on ADC loan arrangement ...................................... 11,513 --
Investments in real estate .................................................................... (40,894) --
Investments in unconsolidated partnerships and subsidiary ..................................... (2,374) (3,501)
Distributions from unconsolidated partnerships and other real estate ventures ................. 26 133
Purchase of commercial mortgage-backed securities ............................................. -- (34,480)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES ................................................. (82,917) (148,266)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings under line of credit ................................................. 39,162 --
Proceeds from borrowings under repurchase agreement ........................................... 12,103 5,123
Repayment of borrowings under repurchase agreement ............................................ (1,402) --
Proceeds from financing provided by affiliate ................................................. 907 5,020
Proceeds from non-recourse debt on real estate ................................................ 27,100 --
Purchase of interest rate cap ................................................................. (110) --
Proceeds from sale of interest rate cap ....................................................... 30 --
Deferred financing costs associated with line of credit ....................................... (120) --
Deferred financing costs associated with non-recourse debt on real estate ..................... (594) --
Net proceeds from issuance of common stock .................................................... -- 139,717
Dividends paid to common shareholders ......................................................... (11,510) (1,001)
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES ............................................. 65,566 148,859
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ............................................. (5,995) 3,885
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................................................... 9,789 --
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ......................................................... $ 3,794 $ 3,885
============ ============
SUPPLEMENTAL INFORMATION:
Interest paid, net of amount capitalized ...................................................... $ 2,783 $ --
============ ============
Income taxes paid ............................................................................. $ 25 $ --
============ ============
Minority interest contributions associated with ADC loan arrangements ......................... $ -- $ 2,611
============ ============
Minority interest distribution associated with ADC loan arrangement ........................... $ 2,111 $ --
============ ============
Receivables transferred in satisfaction of amounts due to affiliate ........................... $ 280 $ --
============ ============
Amounts due to affiliate discharged in connection with sale of mortgage loan .................. $ 1,729 $ --
============ ============
Issuance of warrants in connection with line of credit ........................................ $ 400 $ --
============ ============
</TABLE>
See notes to consolidated financial statements.
6
<PAGE> 7
AMRESCO CAPITAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
1. ORGANIZATION AND RELATIONSHIPS
AMRESCO Capital Trust (the "Company"), a real estate investment trust ("REIT"),
was organized under the laws of the State of Texas. The Company was formed to
take advantage of certain mid- to high-yield lending and investment
opportunities in real estate related assets, including various types of
commercial mortgage loans (including, among others, participating loans,
mezzanine loans, acquisition loans, construction loans, rehabilitation loans and
bridge loans), commercial mortgage-backed securities ("CMBS"), commercial real
estate, equity investments in joint ventures and/or partnerships, and certain
other real estate related assets. The Company was initially capitalized on
February 2, 1998 and commenced operations on May 12, 1998, concurrent with the
completion of its initial public offering ("IPO") of 9,000,000 common shares and
private placement of 1,000,011 common shares.
Pursuant to the terms of a Management Agreement dated as of May 12, 1998 and
subject to the direction and oversight of the Board of Trust Managers, the
Company's day-to-day operations are managed by AMREIT Managers, L.P. (the
"Manager"), an affiliate of AMRESCO, INC. (together with its affiliated
entities, the "AMRESCO Group"). For its services, the Manager is entitled to
receive a base management fee equal to 1% per annum of the Company's Average
Invested Non-Investment Grade Assets, as defined, and 0.5% per annum of the
Company's Average Invested Investment Grade Assets, as defined. In addition to
the base management fee, the Manager is entitled to receive incentive
compensation in an amount equal to 25% of the dollar amount by which Funds From
Operations (as defined by the National Association of Real Estate Investment
Trusts), as adjusted, exceeds a certain threshold. The Manager is also entitled
to receive reimbursement for its costs of providing certain services to the
Company. The base management fee, reimbursable expenses and incentive fee, if
any, are payable quarterly in arrears. During the three and nine months ended
September 30, 1999, base management fees charged to the Company totaled $563,000
and $1,521,000, respectively. Reimbursable expenses charged to the Company
during these periods totaled $66,000 and $170,000, respectively. During the
three months ended September 30, 1998 and the period from February 2, 1998 (date
of initial capitalization) through September 30, 1998, base management fees
charged to the Company totaled $298,000 and $421,000, respectively; reimbursable
expenses charged to the Company during these periods totaled $80,000 and
$96,000, respectively. Since its inception, no incentive fees have been charged
to the Company. Immediately after the closing of the IPO, the Manager was
granted options to purchase 1,000,011 common shares; 70% of the options are
exercisable at an option price of $15.00 per share and the remaining 30% of the
options are exercisable at an option price of $18.75 per share. During the three
and nine months ended September 30, 1999, management fees included compensatory
option charges totaling $47,000 and $92,000, respectively. During the three
months ended September 30, 1998 and the period from February 2, 1998 (date of
initial capitalization) through September 30, 1998, management fees included
compensatory option charges totaling $141,000 and $211,000, respectively.
2. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10,
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and disclosures required by generally accepted accounting principles
for complete financial statements. The consolidated financial statements include
the accounts of the Company, its wholly-owned subsidiaries and a majority-owned
partnership. The Company accounts for its investment in AMREIT II, Inc., a
taxable subsidiary, using the equity method of accounting, and thus reports its
share of income or loss based on its ownership interest. The Company uses the
equity method of accounting due to the non-voting nature of its ownership
interest and because the Company is entitled to substantially all of the
economic benefits of ownership of AMREIT II, Inc. The Company owns
non-controlling interests in two partnerships; the Company accounts for these
investments using the equity method of accounting and thus reports its share of
income or loss based on its ownership interests. The accompanying financial
statements should be read in conjunction with the Company's consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1998 (the "10-K"). The notes to the
financial statements included herein highlight significant changes to the notes
included in the 10-K.
7
<PAGE> 8
In the opinion of management, the accompanying consolidated financial statements
include all adjustments (consisting of normal and recurring accruals) necessary
for a fair presentation of the interim financial statements. Operating results
for the periods presented are not necessarily indicative of the results that may
be expected for the entire fiscal year or any other interim period.
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 certain assets and liabilities at the date of the
financial statements and revenues and expenses for the reporting period.
Significant estimates include the valuation of commercial mortgage-backed
securities, the allowance for loan losses and the determination of the fair
value of certain share option awards and warrants. Actual results may differ
from those estimates.
Certain prior period amounts have been reclassified to conform with the current
period's presentation.
3. LOAN INVESTMENTS
During the three months ended September 30, 1999, the Company originated two
loans. During the nine months ended September 30, 1999, four of the Company's
loans were fully repaid, three loan originations were closed and one loan was
sold to AMRESCO Commercial Finance, Inc. ("ACFI"), a member of the AMRESCO
Group; additionally, one loan was reclassified, net of a $500,000 charge-off, to
investment in unconsolidated subsidiary following the subsidiary's acquisition
(through foreclosure on February 25, 1999) of the partnership interests of one
of the Company's borrowers. As of September 30, 1999, the Company's loan
investments are summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
Date of Initial Scheduled Collateral
Investment Maturity Location Property Type Position
- ------------------------ ------------------- ---------------- -------------- ---------------
<S> <C> <C> <C> <C>
May 12, 1998 March 31, 2001 Richardson, TX Office Second Lien
June 1, 1998 June 1, 2001 Houston, TX Office First Lien
June 12, 1998 June 30, 2000 Pearland, TX Apartment First Lien
June 17, 1998 June 30, 2000 San Diego, CA R&D/Bio-Tech First Lien
June 19, 1998 June 18, 2000 Houston, TX Office First Lien
June 22, 1998 June 19, 2000 Wayland, MA Office First Lien
July 1, 1998 July 1, 2001 Dallas, TX Office Ptrshp Interests
July 2, 1998 June 30, 2000 Washington, D.C. Office First Lien
July 10, 1998 July 31, 2000 Pasadena, TX Apartment First Lien
September 1, 1998 February 28, 2001 Los Angeles, CA Mixed Use First Lien
September 30, 1998 Various San Antonio, TX/ Residential Lots First Lien
Sunnyvale, TX
September 30, 1998 October 7, 1999 Ft. Worth, TX Apartment Ptrshp Interests
September 30, 1998 December 31, 1999 Dallas, TX Medical Office First Lien
September 30, 1998 September 22, 1999 Norwood, MA Industrial/Office First Lien
October 1, 1998 December 31, 1999 Richardson, TX Office First Lien
May 18, 1999 May 19, 2001 Irvine, CA Office First Lien
July 29, 1999 July 28, 2001 Lexington, MA R&D/Bio-Tech First Lien
August 19, 1999 August 15, 2001 San Diego, CA Medical Office First Lien
</TABLE>
<TABLE>
<CAPTION>
Amount
Outstanding at Interest Interest
Date of Initial Scheduled Commitment September 30, Pay Accrual
Investment Maturity Amount 1999 Rate Rate
- ------------------------ ------------------- ----------- --------------- -------- --------
<S> <C> <C> <C> <C> <C>
May 12, 1998 March 31, 2001 $ 14,700 $ 13,368 10.0% 12.0%
June 1, 1998 June 1, 2001 11,800 10,531 12.0% 12.0%
June 12, 1998 June 30, 2000 12,827 12,291 10.0% 11.5%
June 17, 1998 June 30, 2000 5,560 4,587 10.0% 13.5%
June 19, 1998 June 18, 2000 24,000 20,281 12.0% 12.0%
June 22, 1998 June 19, 2000 45,000 38,688 10.5% 10.5%
July 1, 1998 July 1, 2001 10,068 7,197 10.0% 15.0%
July 2, 1998 June 30, 2000 7,000 6,165 10.5% 10.5%
July 10, 1998 July 31, 2000 3,350 2,993 10.0% 14.0%
September 1, 1998 February 28, 2001 18,419 17,418 10.0% 12.0%
September 30, 1998 Various 8,400 3,233 10.0% 14.0%
September 30, 1998 October 7, 1999 2,650 2,649 10.5% 16.0%
September 30, 1998 December 31, 1999 3,015 2,638 10.0% 13.0%
September 30, 1998 September 22, 1999 8,765 8,335 10.0% 12.5%
October 1, 1998 December 31, 1999 567 300 9.7% 15.0%
May 18, 1999 May 19, 2001 15,260 12,924 10.0% 12.0%
July 29, 1999 July 28, 2001 5,213 2,623 10.4% 13.4%
August 19, 1999 August 15, 2001 5,745 3,415 10.4% 10.4%
--------- ----------
$ 202,339 $ 169,636
========= ==========
</TABLE>
As more fully described in Note 13, the following loans were sold to ACFI on
November 1, 1999 (dollars in thousands):
<TABLE>
<CAPTION>
Amount
Outstanding at
Commitment September 30, Scheduled
Amount 1999 Maturity
----------------- ---------------- -------------------
<S> <C> <C>
$ 2,650 $ 2,649 October 7, 1999
3,015 2,638 December 31, 1999
8,765 8,335 September 22, 1999
------- --------
$14,430 $ 13,622
======= ========
</TABLE>
At September 30, 1999, amounts outstanding under construction loans,
acquisition/rehabilitation loans, acquisition loans, land development loans and
bridge loans totaled $48,589,000, $54,944,000, $54,235,000, $3,533,000 and
$8,335,000, respectively.
8
<PAGE> 9
Three of the 18 loan investments provide the Company with the opportunity for
profit participation in excess of the contractual interest accrual rates. The
loan investments are classified as follows (in thousands):
<TABLE>
<CAPTION>
Loan Amount Balance Sheet
Outstanding at Amount at
September 30, 1999 September 30, 1999
------------------ ------------------
<S> <C> <C>
Mortgage loans held for investment, net ............... $ 125,280 $ 124,080
Real estate, net ...................................... 37,159 35,897
Investment in real estate venture ..................... 7,197 6,247
------------------ ------------------
Total ADC loan arrangements ........................ 44,356 42,144
------------------ ------------------
Total loan investments ................................ $ 169,636 166,224
==================
Allowance for loan losses ............................. (2,690)
------------------
Total loan investments, net of allowance for losses ... $ 163,534
==================
</TABLE>
The differences between the outstanding loan amounts and the balance sheet
amounts are due primarily to loan commitment fees, interest fundings, minority
interests, capitalized interest and accumulated depreciation.
ADC loan arrangements accounted for as real estate consisted of the following at
September 30, 1999 (in thousands):
<TABLE>
<S> <C>
Land ................................... $ 4,648
Buildings and improvements ............. 14,514
Construction in progress ............... 16,968
------------
Total ............................... 36,130
Less: Accumulated depreciation ......... (233)
------------
$ 35,897
============
</TABLE>
On October 1, 1999, amounts classified as construction in progress were
transferred to buildings and improvements.
A summary of activity for mortgage loans and ADC loan arrangements accounted for
as real estate or investments in joint ventures is as follows (in thousands):
<TABLE>
<S> <C>
Balance at December 31, 1998 ........... $ 136,791
Investments in loans ................... 65,741
Collections of principal ............... (19,743)
Cost of mortgage sold .................. (6,314)
Foreclosure (partnership interests) .... (6,839)
------------
Balance at September 30, 1999 .......... $ 169,636
============
</TABLE>
The activity in the allowance for loan losses was as follows (in thousands):
<TABLE>
<S> <C>
Balance at December 31, 1998 ........... $ 1,368
Provision for losses ................... 1,822
Charge-offs ............................ (500)
Recoveries ............................. --
------------
Balance at September 30, 1999 .......... $ 2,690
============
</TABLE>
As of September 30, 1999, the Company had outstanding commitments to fund
approximately $32,703,000 under 18 loans, of which $808,000 was reimbursable by
ACFI. The Company is obligated to fund these commitments to the extent that the
borrowers are not in violation of any of the conditions established in the loan
agreements. Commitments generally have fixed expiration dates or other
termination clauses and may require the payment of a fee if amounts are repaid
to the Company during certain prepayment lock-out periods. A portion of the
commitments could expire without being drawn
9
<PAGE> 10
upon and therefore the total commitment amounts do not necessarily represent
future cash requirements. ACFI's reimbursement obligations were discharged in
connection with the loan sale described in Note 13.
4. REAL ESTATE
On April 30, 1999, the Company (through a majority-owned partnership) acquired
interests in three newly constructed, grocery-anchored shopping centers in the
Dallas/Fort Worth (Texas) area. These properties, which were acquired by
subsidiary partnerships at an aggregate purchase price of $30.2 million, include
an 86,516 square foot facility in Flower Mound, Texas, a 61,440 square foot
facility in Fort Worth, Texas and an 85,611 square foot facility in Grapevine,
Texas. Through the majority-owned partnership, the Company acquired an interest
in an additional grocery-anchored shopping center on August 25, 1999. The newly
constructed property, an 87,540 square foot facility in Richardson, Texas, was
acquired by a subsidiary partnership at a purchase price of $10.7 million. In
connection with these acquisitions, the subsidiary partnerships which hold title
to these assets obtained non-recourse financing aggregating $19.5 million and
$7.6 million, respectively, from an unaffiliated third party (Note 5).
Immediately prior to the closings, the Company contributed $11.4 million and
$3.4 million, respectively, of capital to the partnership. The proceeds from
these contributions were used, in part, to fund the balance of the acquisition
costs, to pay costs associated with the financing and to provide initial working
capital to the title-holding partnerships. The majority-owned partnership owns,
directly or indirectly, all of the equity interests in the title-holding
subsidiary partnerships.
Real estate, which is comprised entirely of amounts derived from the Company's
partnership investment, consisted of the following at September 30, 1999 and
December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ ------------------
<S> <C> <C>
Land ................................... $ 14,385 $ 2,353
Buildings and improvements ............. 36,837 7,976
------------------ ------------------
Total ............................... 51,222 10,329
Less: Accumulated depreciation ......... (572) (56)
------------------ ------------------
$ 50,650 $ 10,273
================== ==================
</TABLE>
In connection with the partnership's procurement of third party financing, the
Company was required to post two irrevocable standby letters of credit totaling
$1,084,000. The letters of credit, which were cancelled on May 4, 1999, were
collateralized by certificates of deposit in a like amount; the certificates of
deposit matured on August 31, 1999. Concurrent with the cancellation and as a
replacement for a portion thereof related to the financing associated with the
Richardson property, the Company posted an irrevocable standby letter of credit
in the amount of $304,000. This letter of credit, which was cancelled on August
30, 1999, was collateralized by a $304,000 certificate of deposit that matured
on September 30, 1999.
5. DEBT AND FINANCING FACILITIES
Effective as of July 1, 1998, the Company (and certain of its subsidiaries)
entered into a $400 million Interim Warehouse and Security Agreement (the "Line
of Credit") with Prudential Securities Credit Corporation ("PSCC"). Subject to
certain limitations, borrowings under the facility can be used to finance the
Company's structured loan and equity real estate investments. Prior to the
modifications discussed below, borrowings under the Line of Credit bore interest
at rates ranging from LIBOR plus 1% per annum to LIBOR plus 2% per annum
depending upon the type of asset, its loan-to-value ratio and the advance rate
selected by the Company. Advance rates on eligible assets ranged from 50% to 95%
depending upon the asset's characteristics.
Effective as of May 4, 1999, the Company (and certain of its subsidiaries)
entered into an Amended and Restated Interim Warehouse and Security Agreement
(the "Amended Line of Credit") with PSCC; the agreement amended the Company's
existing Line of Credit. The Amended Line of Credit includes the following
modifications: (1) a reduction in the size of the committed facility from $400
million to $300 million; (2) the elimination of the requirement that assets
financed with proceeds from the facility must be securitizable; (3) a reduction
in the amount of capital the Company must fund with respect to construction and
rehabilitation loans before PSCC is required to begin advancing funds; (4) an
extension of the maturity date from July 1, 2000 to November 3, 2000; and (5)
the modification to, and addition of, certain sublimits on specified types of
loans and assets. Under the Amended Line of Credit, borrowings bear interest at
LIBOR plus 1.25% per
10
<PAGE> 11
annum to the extent such borrowings do not exceed the Company's Tangible Net
Worth, as defined; borrowings in excess of the Company's Tangible Net Worth bear
interest at LIBOR plus 3%. At September 30, 1999, the weighted average interest
rate under this facility was 6.63% per annum.
As compensation for entering into the Amended Line of Credit and extending the
maturity date, the Company granted warrants to Prudential Securities
Incorporated, an affiliate of PSCC, to purchase 250,002 common shares of
beneficial interest at $9.83 per share. The exercise price represents the
average closing market price of the Company's common shares for the ten-day
period ending on May 3, 1999. The warrants were issued in lieu of a commitment
fee or other cash compensation. The estimated fair value of the warrants,
totaling $400,000, was measured at the grant date and is being amortized to
interest expense over the 18-month term of the facility using the straight-line
method.
Borrowings under the facility are secured by a first lien security interest on
all assets funded with proceeds from the Amended Line of Credit. The Amended
Line of Credit contains several covenants; among others, the more significant
covenants include the maintenance of a $100 million consolidated Tangible Net
Worth, subject to adjustment in connection with any future equity offerings;
maintenance of a Coverage Ratio, as defined, of not less than 1.4 to 1; and
limitation of Total Indebtedness, as defined, to no more than 400% of
shareholders' equity.
On July 2, 1999, the Company terminated its existing $33.6 million (notional)
interest rate cap agreement at a loss of $5,000. Concurrently, the Company
entered into a new cap agreement to reduce the impact that rising interest rates
would have on its floating rate indebtedness. The new agreement, which became
effective on August 1, 1999, has a notional amount of $59.0 million. Until its
expiration on November 1, 2000, the agreement entitles the Company to receive
from the counterparty the amounts, if any, by which one month LIBOR exceeds
6.25%. The premium paid for this cap, totaling $110,000, is being amortized on a
straight-line basis over the life of the agreement as an adjustment of interest
incurred.
Five consolidated title-holding partnerships are indebted under the terms of
five non-recourse loan agreements with Jackson National Life Insurance Company.
All five loans bear interest at 6.83% per annum. The interest rates on the first
four loans were adjusted in connection with the placement of the fifth loan on
August 25, 1999. Prior to that time, a $7.5 million loan bore interest at 7.28%
per annum while three loans aggregating $19.5 million bore interest at 6.68% per
annum. The loans require interest only payments through January 1, 2002;
thereafter, interest and principal payments are due based upon 25-year
amortization schedules. The loans, which mature on January 1, 2014, prohibit any
prepayment of the outstanding principal prior to January 1, 2006. Thereafter,
prepayment is permitted at any time, in whole or in part, upon payment of a
yield maintenance premium of at least 1% of the then outstanding principal
balance.
Obligations under various financing arrangements were as follows at September
30, 1999 and December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ ------------------
<S> <C> <C>
Repurchase agreement ................... $ 10,701 $ --
Line of credit ......................... 78,500 39,338
Non-recourse debt on real estate ....... 34,600 7,500
------------------ ------------------
$ 123,801 $ 46,838
================== ==================
</TABLE>
Future scheduled principal repayments on debt and financing facilities at
September 30, 1999 are as follows (in thousands):
<TABLE>
<S> <C>
Remainder of 1999 ........................ $ --
2000 ..................................... 89,201
2001 ..................................... --
2002 ..................................... 499
2003 ..................................... 581
2004 and thereafter ...................... 33,520
------------
$ 123,801
============
</TABLE>
11
<PAGE> 12
6. STOCK-BASED COMPENSATION
As of September 30, 1999, the estimated fair value of the options granted to the
Manager and certain employees of the AMRESCO Group approximated $0.71 per share.
The fair value of the options granted was estimated using the
Cox-Ross-Rubinstein option pricing model with the following assumptions: risk
free interest rates ranging from 5.97% to 6.17%; expected lives ranging from
four to seven years; expected volatility of 35%; and dividend yield of 12%.
During the three months ended June 30, 1999, compensation cost associated with
these options was adjusted to reflect the decline in fair value (from March 31,
1999) of approximately $0.39 per share. During the three and nine months ended
September 30, 1999, the three months ended September 30, 1998 and the period
from February 2, 1998 (date of initial capitalization) through September 30,
1998, management fees and general and administrative expenses included the
following compensatory option charges (in thousands):
<TABLE>
<CAPTION>
Period from
February 2,
Three Months Ended Nine Months 1998
September 30, Ended through
--------------------- September 30, September 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Management fees ........................ $ 47 $ 141 $ 92 $ 211
General and administrative expenses .... 6 27 (14) 41
-------- -------- -------- --------
$ 53 $ 168 $ 78 $ 252
======== ======== ======== ========
</TABLE>
In lieu of cash compensation for their services and participation at regularly
scheduled meetings of the Board of Trust Managers, the Company granted 2,250
restricted common shares to each of its four independent trust managers on May
11, 1999. The associated compensation cost is being recognized over the one-year
service period.
At September 30, 1999, 519,006 shares were available for grant in the form of
restricted common shares or options to purchase common shares.
7. EARNINGS PER SHARE
A reconciliation of the numerator and denominator used in computing basic
earnings per share and diluted earnings per share for the three and nine months
ended September 30, 1999, the three months ended September 30, 1998 and the
period from February 2, 1998 (date of initial capitalization) through September
30, 1998, is as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
Period from
February 2,
Three Months Ended Nine Months 1998
September 30, Ended through
----------------------------- September 30, September 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net income available to common shareholders ........... $ 2,344 $ 1,272 $ 7,395 $ 2,029
============ ============ ============ ============
Weighted average common shares outstanding ............ 10,000 10,000 10,000 5,892
============ ============ ============ ============
Basic earnings per common share ....................... $ 0.24 $ 0.12 $ 0.74 $ 0.34
============ ============ ============ ============
Weighted average common shares outstanding ............ 10,000 10,000 10,000 5,892
Effect of dilutive securities:
Restricted shares ................................. 15 6 11 4
Net effect of assumed exercise of stock options ... 1 -- -- --
------------ ------------ ------------ ------------
Adjusted weighted average shares outstanding .......... 10,016 10,006 10,011 5,896
============ ============ ============ ============
Diluted earnings per common share ..................... $ 0.24 $ 0.12 $ 0.74 $ 0.34
============ ============ ============ ============
</TABLE>
12
<PAGE> 13
Options and warrants to purchase 1,466,011 and 250,002 shares, respectively, of
common stock were outstanding at September 30, 1999. For the three and nine
months ended September 30, 1999, options related to 1,460,011 shares and the
warrants were not included in the computation of diluted earnings per share
because the exercise prices related thereto were greater than the average market
price of the Company's common shares. The Company was initially capitalized on
February 2, 1998 with the sale of 100 shares to AMRESCO, INC. The Company had no
earnings prior to the commencement of its operations on May 12, 1998. No options
or warrants were outstanding during the period from February 2, 1998 through May
11, 1998. When calculated for the period from May 12, 1998 (inception of
operations) through September 30, 1998, the Company's basic and diluted earnings
were $0.20 per common share.
8. LEASING ACTIVITIES
As of September 30, 1999, the future minimum lease payments to be received by
the Company (through a majority-owned partnership) under noncancellable
operating leases, which expire on various dates through 2024, are as follows (in
thousands):
<TABLE>
<S> <C>
Remainder of 1999 ........................ $ 1,158
2000 ..................................... 4,613
2001 ..................................... 4,630
2002 ..................................... 4,657
2003 ..................................... 4,630
2004 and thereafter ...................... 71,979
------------
$ 91,667
============
</TABLE>
Approximately 86% of the future minimum lease payments disclosed above are due
from a regional grocer.
9. COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances except
those resulting from investments by, and distributions to, its owners. Other
comprehensive income includes unrealized gains and losses on marketable
securities classified as available-for-sale. Comprehensive income during the
three and nine months ended September 30, 1999, the three months ended September
30, 1998 and the period from February 2, 1998 (date of initial capitalization)
through September 30, 1998, is as follows (in thousands):
<TABLE>
<CAPTION>
Period from
February 2,
Three Months Ended Nine Months 1998
September 30, Ended through
---------------------- September 30, September 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income ........................................... $ 2,344 $ 1,272 $ 7,395 $ 2,029
Unrealized losses on securities available for sale ... (45) (4,301) (2,866) (4,301)
-------- -------- -------- --------
Comprehensive income (loss) .......................... $ 2,299 $ (3,029) $ 4,529 $ (2,272)
======== ======== ======== ========
</TABLE>
The unrealized losses on securities available for sale had no impact on the
Company's taxable income or cash flow.
10. SEGMENT INFORMATION
The Company, as an investor in real estate related assets, operates in only one
reportable segment. Within this segment, the Company makes asset allocation
decisions based upon its diversification strategies and changes in market
conditions. The Company does not have, nor does it rely upon, any major
customers. All of the Company's investments are secured directly or indirectly
by real estate properties located in the United States; accordingly, all of its
revenues were derived from U.S. operations.
13
<PAGE> 14
11. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires that
an entity recognize all derivatives as either assets or liabilities in its
balance sheet and that it measure those instruments at fair value. The
accounting for changes in the fair value of a derivative (that is, gains and
losses) is dependent upon the intended use of the derivative and the resulting
designation. SFAS No. 133 generally provides for matching the timing of gain or
loss recognition on the hedging instrument with the recognition of (1) the
changes in the fair value of the hedged asset or liability that are attributable
to the hedged risk or (2) the earnings effect of the hedged forecasted
transaction. In June 1999, the FASB issued Statement of Financial Accounting
Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities
- - Deferral of the Effective Date of FASB Statement No. 133" ("SFAS No. 137").
SFAS No. 137 deferred the effective date of SFAS No. 133 such that it is now
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000, although earlier application is encouraged. The Company has not yet
assessed the impact that SFAS No. 133 will have on its financial condition or
results of operations.
12. MERGER WITH IMPAC COMMERCIAL HOLDINGS, INC.
Effective as of August 4, 1999, the Company entered into an Agreement and Plan
of Merger (the "Merger Agreement") with Impac Commercial Holdings, Inc. ("ICH").
Pursuant to the Merger Agreement, ICH will be merged with and into the Company,
with the Company as the surviving entity (the "Merger"), and each outstanding
share of common stock of ICH will be converted into 0.66094 of a common share of
the Company. Also pursuant to this agreement, the holder of the outstanding
shares of Series B 8.5% Cumulative Convertible Preferred Stock of ICH ("ICH
Preferred Stock") will convert all of such shares into 1,683,635 shares of
common stock of ICH or, if such conversion does not occur prior to the effective
time of the Merger, all of the shares of ICH Preferred Stock will be converted
into 1,112,782 common shares of the Company. The Merger will be accounted for
under the purchase method of accounting. After the Merger, the Company will have
approximately 16.7 million common shares outstanding. The parties anticipate
that the Merger will be completed late in the fourth quarter of 1999. The
transactions contemplated by the Merger Agreement are subject to approval by the
shareholders of the Company and ICH.
On September 8, 1999, AMRESCO, INC., AMREIT Managers, L.P., AMREIT Holdings,
Inc. and MLM Holdings, Inc. (all of which are members of the AMRESCO Group) and
FIC Management, Inc. (ICH's external manager) entered into a purchase agreement
(the "Purchase Agreement"). Pursuant to the Purchase Agreement, FIC Management,
Inc. (or one of its affiliates) agreed to acquire certain assets from the
AMRESCO Group concurrent with and as a condition to the closing of the Merger.
These assets include, among others, the Company's existing management agreement
and 1,500,111 common shares of the Company (representing approximately 15% of
the Company's outstanding common shares).
13. SUBSEQUENT EVENTS
On October 21, 1999, the Company declared a dividend of $0.40 per share; the
dividend is payable on November 15, 1999 to shareholders of record on October
31, 1999.
On November 1, 1999, the Company sold three loans to ACFI. The proceeds from
this transaction totaled $8,755,000. In connection with the sale, amounts due to
ACFI were fully extinguished; at November 1, 1999 and September 30, 1999,
amounts due to ACFI totaled $5,825,000 and $5,754,000, respectively. The sale
was recorded as follows (dollars in thousands):
<TABLE>
<S> <C>
Cash ................................... $ 8,755
Mortgage loans ......................... (13,622)
Receivables and other assets ........... (958)
Amounts due to affiliates .............. 5,825
------------
Gain (loss) ............................ $ --
============
</TABLE>
14
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
AMRESCO Capital Trust (the "Company") is a real estate investment trust ("REIT")
which was formed in early 1998 to take advantage of certain mid- to high-yield
lending and investment opportunities in real estate related assets, including
various types of commercial mortgage loans (including, among others,
participating loans, mezzanine loans, acquisition loans, construction loans,
rehabilitation loans and bridge loans), commercial mortgage-backed securities
("CMBS"), commercial real estate, equity investments in joint ventures and/or
partnerships, and certain other real estate related assets. Subject to the
direction and oversight of the Board of Trust Managers, the Company's day-to-day
operations are managed by AMREIT Managers, L.P. (the "Manager"), an affiliate of
AMRESCO, INC. (together with its affiliated entities, the "AMRESCO Group").
The Company commenced operations on May 12, 1998 concurrent with the completion
of its initial public offering of 9,000,000 common shares and private placement
of 1,000,011 common shares with AMREIT Holdings, Inc., a wholly-owned subsidiary
of AMRESCO, INC. To date, the Company's investment activities have been focused
in three primary areas: loan investments, CMBS and equity investments in real
estate. The Company expects that its mid- to high-yield loan investments and, to
a lesser extent, equity investments in real estate, will continue to comprise a
substantial portion of its investment portfolio. Similarly, the Company expects
to continue to have 15% to 20% of its invested capital (comprising equity and
proceeds from its two credit facilities) allocated to CMBS.
In general, the Company's investment activities were limited early in the year
as the mortgage REIT market continued to be affected by the aftermath of the
dislocation in the capital markets which occurred in mid to late 1998. Following
the completion (in early May) of modifications to its line of credit facility,
the Company's investment activities increased in the second and third quarters
of 1999, albeit at a slower rate than was achieved in the second and third
quarters of 1998. Currently, the Company does not expect to make any new
investments prior to the completion of its anticipated merger with Impac
Commercial Holdings, Inc. The merger is described below under the heading
"Recent Developments". The Company's year-to-date investment activities are more
fully described below under the heading "Results of Operations".
The Company believes it has operated and it intends to continue to operate in a
manner so as to continue to qualify as a REIT under the Internal Revenue Code of
1986, as amended (the "Code"). As such, the Company has distributed and it
intends to continue to distribute at least 95% of its REIT taxable income
annually.
The Company may experience high volatility in financial statement net income and
tax basis income from quarter to quarter and year to year, primarily as a result
of fluctuations in interest rates, borrowing costs, reinvestment opportunities,
prepayment rates and favorable and unfavorable credit related events (e.g.,
profit participations or credit losses). Additionally, the Company's accounting
for certain real estate loan arrangements as either real estate or joint venture
investments may contribute to volatility in financial statement net income. The
operating results of the Company will depend, in large part, upon the ability of
the Company to manage its interest rate, prepayment and credit risks, while
maintaining its status as a REIT.
RECENT DEVELOPMENTS
Effective as of August 4, 1999, the Company entered into an Agreement and Plan
of Merger (the "Merger Agreement") with Impac Commercial Holdings, Inc. ("ICH").
Pursuant to the Merger Agreement, ICH will be merged with and into the Company,
with the Company as the surviving entity (the "Merger"), and each outstanding
share of common stock of ICH will be converted into 0.66094 of a common share of
the Company. Also pursuant to the Merger Agreement, the holder of the
outstanding shares of Series B 8.5% Cumulative Convertible Preferred Stock of
ICH ("ICH Preferred Stock") will convert all of such shares into 1,683,635
shares of common stock of ICH or, if such conversion does not occur prior to the
effective time of the Merger, all of the shares of ICH Preferred Stock will be
converted into 1,112,782 common shares of the Company. After the Merger, the
Company will have approximately 16.7 million common shares outstanding. The
parties anticipate that the Merger will be completed late in the fourth quarter
of 1999. The transactions contemplated by the Merger Agreement are subject to
approval by the shareholders of the Company and ICH.
On September 8, 1999, AMRESCO, INC., AMREIT Managers, L.P., AMREIT Holdings,
Inc. and MLM Holdings, Inc. (all of which are members of the AMRESCO Group) and
FIC Management, Inc. (ICH's external manager) entered into a purchase
15
<PAGE> 16
agreement (the "Purchase Agreement"). Pursuant to the Purchase Agreement, FIC
Management, Inc. (or one of its affiliates) agreed to acquire certain assets
from the AMRESCO Group concurrent with and as a condition to the closing of the
Merger. These assets include, among others, the Company's existing management
agreement and 1,500,111 common shares of the Company (representing approximately
15% of the Company's outstanding common shares).
RESULTS OF OPERATIONS
The following discussion of results of operations should be read in conjunction
with the consolidated financial statements and notes thereto included in
"Item 1. Financial Statements".
Under generally accepted accounting principles, net income for the three and
nine months ended September 30, 1999 was $2,344,000 and $7,395,000,
respectively, or $0.24 and $0.74 per common share, respectively. The Company's
sources of revenue for the three and nine months ended September 30, 1999,
totaling $6,301,000 and $16,517,000, respectively, are set forth below.
o $4,282,000 and $11,442,000, respectively, from loan investments. As certain
of the Company's loan investments are accounted for as either real estate
or joint venture investments for financial reporting purposes, these
revenues are included in the consolidated statement of income for the three
and nine months ended September 30, 1999 as follows: interest income on
mortgage loans - $3,841,000 and $10,776,000, respectively; and operating
income from real estate - $441,000 and $666,000, respectively. The loan
investments earn interest at accrual rates ranging from 10.4% to 16% per
annum as of September 30, 1999.
o $905,000 and $2,753,000, respectively, from investments in CMBS.
o $975,000 and $1,927,000, respectively, of operating income from real estate
owned by the Company (through a majority-owned partnership).
o $63,000 and $197,000, respectively, of equity in earnings from its
unconsolidated subsidiary, partnerships and other real estate ventures.
o $76,000 and $198,000, respectively, of interest income from short-term
investments.
Additionally, the Company realized a gain of $584,000 during the three months
ended March 31, 1999 in connection with the repayment of an ADC loan
arrangement. The gain was comprised principally of interest income earned at the
accrual rate over the life of the loan investment. No gains were realized during
the three month periods ended June 30, 1999 or September 30, 1999.
The Company incurred expenses of $3,957,000 and $9,706,000, respectively, during
the three and nine months ended September 30, 1999. These expenses are set forth
below.
o $610,000 and $1,613,000, respectively, of management fees, including
$563,000 and $1,521,000, respectively, of base management fees payable to
the Manager pursuant to the Management Agreement and $47,000 and $92,000,
respectively, of expense associated with compensatory options granted to
the Manager. Costs associated with the compensatory options decreased
during the three months ended June 30, 1999 primarily as a result of a
decrease in the expected volatility of the Company's stock. No incentive
fees were incurred during either period.
o $338,000 and $1,120,000, respectively, of general and administrative costs,
including $0 and $200,000, respectively, of resolution costs associated
with a non-performing loan, $71,000 and $270,000, respectively, for
professional services, $59,000 and $176,000, respectively, for directors
and officers' insurance, $66,000 and $170,000, respectively, of
reimbursable costs pursuant to the Management Agreement, $6,000 and
$(14,000), respectively, related to compensatory options granted to certain
members of the AMRESCO Group, $87,000 and $87,000, respectively, of
dividend equivalent costs, $19,000 and $19,000, respectively, of fees paid
to the Company's Independent Trust Managers for their participation at
special meetings of the Board of Trust Managers and $23,000 and $68,000,
respectively, related to restricted stock awards to the Company's
Independent Trust Managers. Costs associated with the compensatory options
decreased during the three months ended June 30, 1999 primarily as a result
of a decrease in the expected volatility of the Company's stock. These
categories do not represent all general and administrative expenses.
16
<PAGE> 17
o $1,769,000 and $3,427,000, respectively, of interest expense (net of
capitalized interest totaling $207,000 and $593,000, respectively)
associated with the Company's credit facilities and five non-recourse loans
secured by real estate.
o $190,000 and $1,019,000, respectively, of participating interest associated
with amounts due to an affiliate.
o $408,000 and $705,000, respectively, of depreciation expense, including
$275,000 and $516,000, respectively, related to five grocery-anchored
shopping centers and $133,000 and $189,000, respectively, related to loan
investments accounted for as real estate.
o $642,000 and $1,822,000, respectively, of provision for loan losses. During
the three months ended March 31, 1999, the Company charged-off $500,000
against an existing allowance for losses related to the non-performing loan
referred to above. This loan is discussed further in this section of
Management's Discussion and Analysis of Financial Condition and Results of
Operations under the sub-heading "Loan Investments".
The Company's policy is to distribute at least 95% of its REIT taxable income to
shareholders each year; to that end, dividends are paid quarterly. Tax basis
income differs from income reported for financial reporting purposes due
primarily to differences in methods of accounting for ADC loan arrangements and
stock-based compensation awards and the nondeductibility, for tax purposes, of
the Company's loan loss reserve (for a discussion of ADC loan arrangements, see
the notes to the consolidated financial statements included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998). As a result of
these accounting differences, net income under generally accepted accounting
principles is not necessarily an indicator of distributions to be made by the
Company. The following dividends have been declared in 1999:
<TABLE>
<CAPTION>
Dividend per
Declaration Record Payment Common
Date Date Date Share
---------------- ---------------- ----------------- -------
<S> <C> <C> <C> <C>
First Quarter April 22, 1999 April 30, 1999 May 17, 1999 $ 0.36
Second Quarter July 22, 1999 July 31, 1999 August 16, 1999 0.39
Third Quarter October 21, 1999 October 31, 1999 November 15, 1999 0.40
-------
$ 1.15
=======
</TABLE>
For federal income tax purposes, all dividends declared to date should be
treated as ordinary income to the Company's shareholders.
The Company was initially capitalized through the sale of 100 common shares to
AMRESCO, INC. on February 2, 1998 and it commenced operations on May 12, 1998
concurrent with the completion of its initial public offering of 9,000,000
common shares and private placement of 1,000,011 common shares with AMREIT
Holdings, Inc., a wholly-owned subsidiary of AMRESCO, INC. At September 30,
1998, $149.0 million had been invested in structured finance arrangements and
commercial mortgage-backed securities. As of September 30, 1998, the Company had
advanced $111.1 million under 19 commercial mortgage loan commitments. During
its initial 142-day period of operations, the Company, either directly or
through its unconsolidated taxable subsidiary, acquired six commercial
mortgage-backed securities at an aggregate purchase price of $37.9 million. The
following comparisons are reflective of the fact that during the entire three
and nine months ended September 30, 1999, the Company's net proceeds from the
issuance of its common shares were fully invested and it (and its consolidated
partnerships) had outstanding borrowings under several credit facilities. By
contrast, during the three months ended September 30, 1998 and the period from
February 2, 1998 (date of initial capitalization) through September 30, 1998,
the Company was actively investing the $139.7 million of net proceeds received
from the issuance of its common shares; such proceeds were not fully invested
until September 30, 1998. Additionally, the Company did not begin to borrow
under its credit facilities until September 30, 1998. During the period from
February 2, 1998 (date of initial capitalization) through September 30, 1998,
the Company had operations for only 142 days (from May 12, 1998 through
September 30, 1998); the Company had no income or expenses during the period
from February 2, 1998 through May 11, 1998.
17
<PAGE> 18
Three Months Ended September 30, 1999 Compared to Three Months Ended
September 30, 1998
The Company's revenues increased 111%, from $2,992,000 to $6,301,000, due
primarily to increases in interest income derived from mortgage loan
investments, income from commercial mortgage-backed securities, and operating
income from real estate; as of September 30, 1998, the Company had not made any
equity investments in real estate. More specifically, the higher revenues were
attributable to the following:
o additional fundings (made after September 30, 1998) under commitments which
were closed during the Company's initial 142-day period of operations;
o certain loans which contributed to third quarter 1999 revenues were
acquired on September 30, 1998 (as a result, such loans did not contribute
significantly to the prior period's revenues);
o acquisitions of real estate which occurred subsequent to September 30, 1998
(October 23, 1998, April 30, 1999 and August 25, 1999);
o three of the six commercial mortgage-backed securities held by the Company
were not acquired until September 1, 1998 (as a result, only one month of
revenue was generated from these securities during the comparable period in
1998); and,
o to a lesser extent, new loan originations in the fourth quarter of 1998 and
the second and third quarters of 1999.
During the three months ended September 30, 1999, the average book value of the
Company's assets, excluding cash and cash equivalents, approximated $244
million. During the three months ended September 30, 1998, the average book
value of the Company's assets, excluding cash and cash equivalents, approximated
$100 million. Equity in earnings of unconsolidated subsidiary, partnerships and
other real estate ventures declined by $263,000 from the comparable period in
1998. For the most part, this decline was attributable to the non-performing
loan referred to above. This loan was performing until late in the fourth
quarter of 1998. Prior to its reclassification (described below), this loan was
accounted for as a joint venture investment for financial reporting purposes.
Interest income on short-term investments declined by $751,000 from the
comparable period in 1998 as the uninvested portion of the net proceeds received
from the issuance of the Company's common shares were temporarily invested
during such period in short-term investments.
The Company's expenses increased 130%, from $1,720,000 to $3,957,000, due
primarily to the fact that the Company incurred borrowing costs, including
participating interest in mortgage loans, of $1,959,000 (net of amounts
capitalized of $207,000) during the three months ended September 30, 1999;
during the comparable period in 1998, the Company incurred only $4,000 of
borrowing costs (including participating interest in mortgage loans) as it did
not begin to leverage its assets until September 30, 1998. Additionally, base
management fees increased by $265,000, from $298,000 to $563,000, as a result of
the Company's larger asset base upon which the fee is calculated. The Company's
loan loss provision increased by $141,000, from $501,000 to $642,000, as a
result of significantly higher loan balances. Finally, depreciation expense
increased by $387,000, from $21,000 to $408,000, primarily as a result of
several real estate acquisitions which were closed in October 1998, April 1999
and August 1999. These higher costs were offset by a $417,000 decrease in
general and administrative expenses. The reduction in general and administrative
expenses was due primarily to the fact that the Company incurred approximately
$400,000 of due diligence costs (in connection with an abandoned transaction)
during the three months ended September 30, 1998. No such costs were incurred by
the Company during the three months ended September 30, 1999.
For the reasons cited above, income before gains and net income increased 84%,
from $1,272,000 to $2,344,000.
18
<PAGE> 19
Nine Months Ended September 30, 1999 Compared to Period from February 2, 1998
(Date of Initial Capitalization) through September 30, 1998
For the reasons described above, the Company's revenues increased by $12,264,000
(or 288%), from $4,253,000 to $16,517,000, and its expenses increased by
$7,482,000 (or 336%), from $2,224,000 to $9,706,000. The changes in the
component revenues and expenses were as follows (dollars in thousands):
<TABLE>
<CAPTION>
Increase /
(Decrease)
------------
<S> <C>
Interest income on mortgage loans .......................... $ 9,448
Income from commercial mortgage-backed securities .......... 2,156
Operating income from real estate .......................... 2,485
Equity in earnings of unconsolidated subsidiary,
partnerships and other real estate ventures ............ (289)
Interest income from short-term investments ................ (1,536)
------------
Total revenues ......................................... $ 12,264
============
Interest expense .......................................... $ 3,426
Management fees ........................................... 981
General and administrative ................................ 167
Depreciation .............................................. 681
Participating interest in mortgage loans .................. 1,016
Provision for loan losses ................................. 1,211
------------
Total expenses ......................................... $ 7,482
============
</TABLE>
Income before gains increased 236%, from $2,029,000 to $6,811,000, and net
income increased 264%, from $2,029,000 to $7,395,000. In addition to the factors
cited above, net income increased partially as a result of a $584,000 gain
realized in connection with the repayment of an ADC loan arrangement.
Loan Investments
During the three months ended September 30, 1999, the Company originated two
first lien loans aggregating $11.0 million in commitments; the initial advances
under these loans totaled approximately $5.9 million. During the nine months
ended September 30, 1999, four of the Company's loans were fully repaid, three
loan originations were closed and one loan was sold to AMRESCO Commercial
Finance, Inc. ("ACFI"), a member of the AMRESCO Group; additionally, one loan
was reclassified, net of a $500,000 charge-off, to investment in unconsolidated
subsidiary following the subsidiary's acquisition (through foreclosure on
February 25, 1999) of the partnership interests of one of the Company's
borrowers. In connection with the loan sale, amounts due to ACFI were reduced by
$2.0 million; as of September 30, 1999, amounts due to ACFI totaled $5.8
million. The proceeds from the four loan repayments and the loan sale totaled
$22.3 million, including accrued interest, a profit participation and a
prepayment fee aggregating $1.0 million. Principal collections on certain of the
Company's other loan investments totaled $0.3 million and $3.0 million during
the three and nine months ended September 30, 1999, respectively. During the
three and nine months ended September 30, 1999, the Company advanced a total of
$17.7 million and $65.7 million, respectively, under its loan commitments.
Excluding the loan classified as an investment in unconsolidated subsidiary, the
Company had 18 loans representing $202.3 million in aggregate commitments as of
September 30, 1999; $169.6 million had been advanced under these facilities at
September 30, 1999. A portion of the commitments may expire without being drawn
upon and therefore the total commitment amounts do not necessarily represent
future cash requirements. After giving effect to ACFI's economic interest (as
described in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998), commitments and amounts outstanding totaled approximately
$196.6 million and $164.7 million, respectively, at September 30, 1999. At
September 30, 1999, ACFI's contingent obligation for additional advances which
might have been
19
<PAGE> 20
required to be made under certain of the Company's loans approximated $0.8
million. On November 1, 1999, the Company sold the following loans to ACFI:
<TABLE>
<CAPTION>
Amount
Outstanding at
Commitment September 30, Scheduled
Amount 1999 Maturity
----------------- ---------------- ----------------------
<S> <C> <C>
$ 2,650 $ 2,649 October 7, 1999
3,015 2,638 December 31, 1999
8,765 8,335 September 22, 1999
------- -------
$14,430 $13,622
======= =======
</TABLE>
These investments were the last remaining loans subject to the ACFI economic
interest. Comprised initially of five loans, one loan was sold to ACFI in
January 1999 and the other was fully repaid by the borrower in May 1999. In
connection with this most recent sale, amounts due to ACFI totaling $5.8 million
were fully extinguished; additionally, ACFI's contingent reimbursement
obligations were discharged. The proceeds from this transaction, which produced
no gain or loss for the Company, totaled approximately $8.8 million. Following
this sale, the Company has 15 loans representing $187.9 million in aggregate
commitments; at September 30, 1999, $156.0 million had been advanced under these
15 facilities.
Based upon the amounts outstanding under these facilities and after giving
effect to the contractual right sold to ACFI, the Company's portfolio of
commercial mortgage loans had a weighted average interest pay rate of 10.6% and
a weighted average interest accrual rate of 11.8% as of September 30, 1999.
Three of the 18 loans provide the Company with the opportunity for profit
participation above the contractual accrual rate. The Company's loan investments
as of September 30, 1999 are summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
Date of Initial Scheduled Collateral
Investment Maturity Location Property Type Position
- --------------------- ---------------------- ------------------- ---------------- ---------------
<S> <C> <C> <C> <C>
May 12, 1998 March 31, 2001 Richardson, TX Office Second Lien
June 1, 1998 June 1, 2001 Houston, TX Office First Lien
June 12, 1998 June 30, 2000 Pearland, TX Apartment First Lien
June 17, 1998 June 30, 2000 San Diego, CA R&D/Bio-Tech First Lien
June 19, 1998 June 18, 2000 Houston, TX Office First Lien
June 22, 1998 June 19, 2000 Wayland, MA Office First Lien
July 1, 1998 July 1, 2001 Dallas, TX Office Ptrshp Interests
July 2, 1998 June 30, 2000 Washington, D.C. Office First Lien
July 10, 1998 July 31, 2000 Pasadena, TX Apartment First Lien
September 1, 1998 February 28, 2001 Los Angeles, CA Mixed Use First Lien
September 30, 1998 Various San Antonio, TX/ Residential Lots First Lien
Sunnyvale, TX
September 30, 1998 October 7, 1999 Ft. Worth, TX Apartment Ptrshp Interests
September 30, 1998 December 31, 1999 Dallas, TX Medical Office First Lien
September 30, 1998 September 22, 1999 Norwood, MA Industrial/Office First Lien
October 1, 1998 December 31, 1999 Richardson, TX Office First Lien
May 18, 1999 May 19, 2001 Irvine, CA Office First Lien
July 29, 1999 July 28, 2001 Lexington, MA R&D/Bio-Tech First Lien
August 19, 1999 August 15, 2001 San Diego, CA Medical Office First Lien
</TABLE>
<TABLE>
<CAPTION>
Amount
Outstanding
at Interest Interest
Date of Initial Scheduled Commitment September 30, Pay Accrual
Investment Maturity Amount 1999(c) Rate Rate
- --------------------- ---------------------- ------------ ------------- ------ --------
<S> <C> <C> <C> <C> <C>
May 12, 1998 March 31, 2001 $14,700 $13,368 10.0% 12.0%
June 1, 1998 June 1, 2001 11,800 10,531 12.0% 12.0%
June 12, 1998 June 30, 2000 12,827 12,291(b) 10.0% 11.5%
June 17, 1998 June 30, 2000 5,560 4,587(b) 10.0% 13.5%
June 19, 1998 June 18, 2000 24,000 20,281(b) 12.0% 12.0%
June 22, 1998 June 19, 2000 45,000 38,688 10.5% 10.5%
July 1, 1998 July 1, 2001 10,068 7,197(a) 10.0% 15.0%
July 2, 1998 June 30, 2000 7,000 6,165 10.5% 10.5%
July 10, 1998 July 31, 2000 3,350 2,993 10.0% 14.0%
September 1, 1998 February 28, 2001 18,419 17,418 10.0% 12.0%
September 30, 1998 Various 8,400 3,233 10.0% 14.0%
September 30, 1998 October 7, 1999 2,650 2,649 10.5% 16.0%
September 30, 1998 December 31, 1999 3,015 2,638 10.0% 13.0%
September 30, 1998 September 22, 1999 8,765 8,335 10.0% 12.5%
October 1, 1998 December 31, 1999 567 300 9.7% 15.0%
May 18, 1999 May 19, 2001 15,260 12,924 10.0% 12.0%
July 29, 1999 July 28, 2001 5,213 2,623 10.4% 13.4%
August 19, 1999 August 15, 2001 5,745 3,415 10.4% 10.4%
-------- --------
202,339 169,636
(5,765) (4,958)
-------- --------
ACFI's Economic Interest $196,574(d) $164,678(d)
======== ========
</TABLE>
(a) Accounted for as investment in joint venture for financial reporting
purposes.
(b) Accounted for as real estate for financial reporting purposes.
(c) For all loan investments, payments of interest only are due monthly at the
interest pay rate. All principal and all remaining accrued and unpaid
interest are due at the scheduled maturities of the loans.
(d) Amounts exclude the loan which was reclassified to investment in
unconsolidated subsidiary during the three months ended March 31, 1999.
20
<PAGE> 21
The Company provides financing through certain real estate loan arrangements
that, because of their nature, qualify either as real estate or joint venture
investments for financial reporting purposes (see notes [a] and [b] accompanying
the table above). As of September 30, 1999, loan investments representing
approximately $52,455,000 in aggregate commitments were accounted for as either
real estate or joint venture interests; approximately $44,356,000 had been
advanced to borrowers under the related agreements. For a discussion of these
loan arrangements, see the Company's consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998.
A mezzanine (second lien) loan with an outstanding balance of $6,839,000 and a
recorded investment of $6,659,000 was over 30 days past due as of December 31,
1998. The allowance for loan losses related to this investment totaled $500,000
at December 31, 1998. On February 25, 1999, an unconsolidated taxable subsidiary
of the Company assumed control of the borrower (a partnership) through
foreclosure of the partnership interests. In addition to the second lien
mortgage, the property is encumbered by a $17 million first lien mortgage
provided by an unaffiliated third party. The first lien mortgage, which matures
on March 1, 2001, requires interest only payments throughout its term. To date,
all interest payments have been made in accordance with the terms of the first
lien mortgage. However, on March 11, 1999, the first lien lender notified the
Company that it considered the first lien loan to be in default because of
defaults under the Company's mezzanine loan. The first lien lender has not given
the Company any notice of an intention to accelerate the balance of the first
lien loan. During the first quarter of 1999, the Company charged-off $500,000
against the allowance for losses related to this investment which amount
represented management's estimate at that time of the amount of the expected
loss which could result upon a disposition of the collateral. If the Company
incurs an actual loss on this investment, tax basis income would be reduced at
the time the loss is realized. On September 21, 1999, a subsidiary of the
Company entered into a non-binding letter agreement with a prospective investor
who intends to make a substantial equity commitment to the project. Under the
terms of the agreement, the Company would continue to have an interest in the
project as an equity owner. If the proposed transaction is consummated, the
Company currently believes that it will fully recover its original investment.
At September 30, 1999, the Company's commercial mortgage loan commitments were
geographically dispersed in three states and the District of Columbia: Texas
(46%); Massachusetts (28%); California (23%); and Washington, D.C. (3%). The
underlying collateral for these loans was comprised of the following property
types: office (65%); mixed use (10%); multifamily (9%); R&D/Bio-Tech (6%);
residential (4%); medical office (4%); and industrial (2%).
Acquisition/rehabilitation loans, acquisition loans, construction loans,
single-family lot development loans and bridge loans comprised 34%, 32%, 27%, 4%
and 3% of the portfolio, respectively. All of the properties securing the
Company's construction loans are now complete. Eighty-six percent of the
portfolio is comprised of first lien loans while the balance of the portfolio
(14%) is secured by second liens and/or partnership interests. The percentages
reflected above are based upon committed loan amounts and give effect to ACFI's
economic interest. Additionally, the percentages exclude the loan which was
reclassified to investment in unconsolidated subsidiary during the first quarter
of 1999.
Until the loan investment portfolio becomes larger, geographic and product type
concentrations are expected. The Company expects to see more diversification
both geographically and by product type as the loan portfolio grows. Geographic
and product type concentrations present additional risks, particularly if there
is a deterioration in the general condition of the real estate market or in the
sub-market in which the loan collateral is located, or if demand for a
particular product type does not meet expectations due to adverse market
conditions that are different from those projected by the Company. In an effort
to reduce concentration risks, the Company is targeting transactions which will
more broadly diversify its loan investment portfolio.
Commercial Mortgage-backed Securities
As of September 30, 1999, the Company holds five commercial mortgage-backed
securities ("CMBS") which were acquired at an aggregate purchase price of $34.5
million. All of these securities were acquired on or before September 1, 1998.
Due to an increase in comparable-term U.S. Treasury rates and increasing spreads
in the CMBS market during the six months ended June 30, 1999, the value of the
Company's CMBS holdings declined by $2,822,000. During the three months ended
September 30, 1999, the value of the Company's CMBS holdings declined by
$137,000 as an increase in comparable-term U.S. Treasury rates was largely
offset by a decline in spreads for certain of its bonds. As a result, during the
three and nine months ended September 30, 1999, the Company recorded an
unrealized loss of $137,000 and $2,959,000, respectively, on its CMBS portfolio.
Additionally, during the three and nine months ended September 30, 1999, the
Company recorded an unrealized gain of $92,000 and $93,000, respectively, net of
tax effects, related to one commercial mortgage-backed
21
<PAGE> 22
security owned by its unconsolidated taxable subsidiary; the security held by
this subsidiary has an investment rating of "B-". As these securities are
classified as available for sale, the aggregate unrealized loss was reported as
a component of accumulated other comprehensive income (loss) in shareholders'
equity for financial reporting purposes. The cumulative unrealized losses
(totaling $9.3 million) have had no impact on the Company's taxable income or
cash flow. Management intends to retain these investments for the foreseeable
future. Excluding the potential tax effects associated with the security held by
the Company's unconsolidated taxable subsidiary, the weighted average
unleveraged yield over the expected life of these investments is expected to
approximate 11.4%. The Company's direct CMBS investments are summarized as
follows (dollars in thousands):
<TABLE>
<CAPTION>
Percentage of
Security Aggregate Aggregate Total Based
Rating Amortized Cost Fair Value on Fair Value
------------- ------------------ ----------------- ----------------
<S> <C> <C> <C>
BB- $ 4,259 $ 3,341 13%
B 19,608 15,746 60%
B- 11,364 6,940 27%
------- ------- ----
$35,231 $26,027 100%
======= ======= ====
</TABLE>
The Company's estimated returns on its CMBS investments are based upon a number
of assumptions that are subject to certain business and economic risks and
uncertainties including, but not limited to, the timing and magnitude of
prepayments and credit losses on the underlying mortgage loans that may result
from general and/or localized real estate market factors. These risks and
uncertainties are in many ways similar to those affecting the Company's
commercial mortgage loans. These risks and uncertainties may cause the actual
yields to differ materially from expected yields.
In February 1999, the Company contributed $0.7 million to a newly formed
investment partnership with Olympus Real Estate Corporation. The partnership,
which is 5% owned by the Company, acquired several classes of subordinated CMBS
at an aggregate purchase price of $12.7 million. Currently, the Company does
not expect to make any additional investments in the partnership.
Equity Investments in Real Estate
On March 2, 1999, the Company acquired a 49% limited partner interest in a
partnership which owns a 116,000 square foot office building in Richardson,
Texas. In connection with this acquisition, the Company contributed $1.4 million
of capital to the partnership. The property is encumbered by a first lien
mortgage with a current outstanding balance of approximately $13.8 million. The
non-recourse mortgage loan, which is provided by an unaffiliated third party,
bears interest at 6.75% per annum and requires interest and principal payments
based upon a 25-year amortization schedule. The loan matures on March 5, 2019.
On the tenth anniversary of the loan, the lender has the option, upon 60 days
prior written notice, to increase the interest rate to the then current market
rate. No prepayment of principal (other than scheduled amortization) is
permitted during years 1-5 and years 11-15. The loan can be prepaid during years
6 and 16 upon payment of a penalty equal to 3% of the amount prepaid.
Thereafter, the prepayment penalty decreases by 1% per year. In years 9, 10, 19
and 20 the loan can be prepaid without penalty.
On April 30, 1999, the Company (through a majority-owned partnership) acquired
interests in three newly constructed, grocery-anchored shopping centers in the
Dallas/Fort Worth (Texas) area. These properties, which were acquired by
subsidiary partnerships at an aggregate purchase price of $30.2 million, include
an 86,516 square foot facility in Flower Mound, Texas, a 61,440 square foot
facility in Fort Worth, Texas and an 85,611 square foot facility in Grapevine,
Texas. Through the majority-owned partnership, the Company acquired an interest
in an additional grocery-anchored shopping center on August 25, 1999. The newly
constructed property, an 87,540 square foot facility in Richardson, Texas, was
acquired by a subsidiary partnership at a purchase price of $10.7 million. In
connection with these acquisitions, the subsidiary partnerships which hold title
to these assets obtained non-recourse financing aggregating $19.5 million and
$7.6 million, respectively, from an unaffiliated third party. Immediately prior
to the closings, the Company contributed $11.4 million and $3.4 million,
respectively, of capital to the partnership. The proceeds from these
contributions were used, in part, to fund the balance of the acquisition costs,
to pay costs associated with the financing and to provide initial working
capital to the title-holding partnerships.
With the transactions described above, the Company now owns interests in five
grocery-anchored shopping centers in the Dallas/Fort Worth (Texas) area. The
first center was acquired in October 1998. The Company holds a 99.5% interest in
the majority-owned (or master) partnership. The master partnership owns,
directly or indirectly, 100% of the equity
22
<PAGE> 23
interests in each of the five title-holding subsidiary partnerships. To date,
the Company has contributed a total of $18.2 million of capital to the
partnerships.
The five consolidated title-holding partnerships are indebted under the terms of
five non-recourse loan agreements with Jackson National Life Insurance Company.
All five loans, aggregating $34.6 million, bear interest at 6.83% per annum. The
interest rates on the first four loans were adjusted in connection with the
placement of the fifth loan on August 25, 1999. Prior to that time, a $7.5
million loan bore interest at 7.28% per annum and three loans aggregating $19.5
million bore interest at 6.68% per annum. The loans require interest only
payments through January 1, 2002; thereafter, interest and principal payments
are due based upon 25-year amortization schedules. The loans, which mature on
January 1, 2014, prohibit any prepayment of the outstanding principal prior to
January 1, 2006. Thereafter, prepayment is permitted at any time, in whole or in
part, upon payment of a yield maintenance premium of at least 1% of the then
outstanding principal balance.
Ultimately, the Company expects to construct an additional 62,000 square feet of
side-store space. This development is expected to occur at the four most
recently acquired centers. It is currently anticipated that the development
costs will be financed with an additional $1 million equity contribution from
the Company and $3.8 million of third party financing proceeds.
The Company's unconsolidated taxable subsidiary holds interests (indirectly) in
a partnership which owns a 909,000 square foot mixed-use property in Columbus,
Ohio. This investment is described above under the sub-heading "Loan
Investments".
LIQUIDITY AND CAPITAL RESOURCES
The following discussion of liquidity and capital resources should be read in
conjunction with the consolidated financial statements and notes thereto
included in "Item 1. Financial Statements".
The Company's ability to execute its business strategy, particularly the growth
of its investment and loan portfolio, depends to a significant degree on its
ability to obtain additional capital. The Company's principal demands for
liquidity are cash for operations, including funds for its lending activities
and other investments, interest expense associated with its indebtedness, debt
repayments and distributions to its shareholders. In the near term, the
Company's principal sources of liquidity are the funds available to it under its
financing facilities described below.
Effective as of July 1, 1998, the Company (and certain of its subsidiaries)
entered into a $400 million credit facility (the "Line of Credit") with
Prudential Securities Credit Corporation ("PSCC"). Subject to PSCC's approval on
an asset by asset basis, borrowings under the facility can be used to finance
the Company's structured loan and equity real estate investments. As a result of
the dislocation in the capital markets in mid to late 1998, PSCC became more
restrictive in the application of its approval rights with respect to financing
for new investments sought by the Company; accordingly, very few new investments
were consummated during the fourth quarter of 1998 and the first quarter of
1999. Prior to the modifications discussed below, borrowings under the Line of
Credit bore interest at rates ranging from LIBOR plus 1% per annum to LIBOR plus
2% per annum. At December 31, 1998, $39,338,000 had been borrowed under the Line
of Credit. To reduce the impact that rising interest rates would have on this
floating rate indebtedness, the Company entered into an interest rate cap
agreement which became effective on January 1, 1999; the agreement had a
notional amount of $33,600,000 and was scheduled to expire on July 1, 2000. The
agreement entitled the Company to receive from a counterparty the amounts, if
any, by which one month LIBOR exceeded 6.0%. Prior to its termination (as
described below), no payments were due from the counterparty as one month LIBOR
had not exceeded 6.0%. On July 2, 1999, the agreement was terminated and
replaced with an interest rate cap agreement which became effective on August 1,
1999. The new agreement, which was entered into to more closely match the then
outstanding borrowings, has a notional amount of $59,000,000. Until its
expiration on November 1, 2000, the agreement entitles the Company to receive
from a counterparty the amounts, if any, by which one month LIBOR exceeds 6.25%.
To date, one month LIBOR has not exceeded 6.25%. There are no margin
requirements associated with interest rate caps and therefore there is no
liquidity risk associated with this particular hedging instrument.
23
<PAGE> 24
Effective as of May 4, 1999, the Company (and certain of its subsidiaries)
entered into an Amended and Restated Interim Warehouse and Security Agreement
(the "Amended Line of Credit") with PSCC; the agreement amended the Company's
existing line of credit. The Amended Line of Credit includes the following
modifications:
o a reduction in the size of the committed facility from $400 million to $300
million;
o the elimination of the requirement that assets financed with proceeds from
the facility must be securitizable;
o a reduction in the amount of capital the Company must fund with respect to
construction and rehabilitation loans before PSCC is required to begin
advancing funds;
o an extension of the maturity date from July 1, 2000 to November 3, 2000;
and
o the modification to, and addition of, sublimits on specified types of loans
and assets, including:
o a new $40 million sublimit on mezzanine loans and equity investments;
and
o a reduction in the sublimit on construction loans from $150 million to
$115 million, with the addition of a new $50 million sublimit within
this category for construction loans that are less than 70% pre-leased
at the time the initial advance is to be made under the Amended Line
of Credit with respect to a construction loan fitting this category.
Under the Amended Line of Credit, borrowings bear interest at LIBOR plus 1.25%
per annum to the extent such borrowings do not exceed the Company's Tangible Net
Worth, as defined; borrowings in excess of the Company's Tangible Net Worth bear
interest at LIBOR plus 3%. Borrowings are secured by a first lien security
interest in all assets funded with proceeds from the Amended Line of Credit. At
September 30, 1999, $78,500,000 had been borrowed under the Amended Line of
Credit. All of these borrowings bear interest at LIBOR plus 1.25% per annum. The
weighted average interest rate at September 30, 1999 was 6.63%.
Effective as of July 1, 1998, the Company (and certain of its subsidiaries)
entered into a $100 million Master Repurchase Agreement (the "Repurchase
Agreement") with PSCC; subsequently, PSCC was replaced by Prudential-Bache
International, Ltd. ("PBI"), an affiliate of PSCC, as lender. Borrowings under
the Repurchase Agreement can be used to finance a portion of the Company's
portfolio of mortgage-backed securities. The Repurchase Agreement provides that
the Company may borrow a varying percentage of the market value of the purchased
mortgage-backed securities, depending on the credit quality of such securities.
Borrowings under the Repurchase Agreement bear interest at rates ranging from
LIBOR plus 0.20% per annum to LIBOR plus 1.5% per annum depending upon the
advance rate and the credit quality of the securities being financed. Borrowings
under the facility are secured by an assignment to PBI of all mortgage-backed
securities funded with proceeds from the Repurchase Agreement. The Repurchase
Agreement matures on June 30, 2000. At September 30, 1999, $10,701,000 was
outstanding under the Repurchase Agreement. At December 31, 1998, there were no
outstanding borrowings under this facility. The weighted average interest rate
at September 30, 1999 was 6.52%.
Under the terms of the Amended Line of Credit and the Repurchase Agreement, PSCC
and PBI, respectively, retain the right to mark the underlying collateral to
market value. A reduction in the value of its pledged assets may require the
Company to provide additional collateral or fund margin calls. From time to
time, the Company may be required to provide such additional collateral or fund
margin calls.
The Company believes that the funds available under its two credit facilities
will be sufficient to meet the Company's liquidity and capital requirements
through the maturity date of the Amended Line of Credit. The Company believes
that the Amended Line of Credit provides it with more flexibility, which in turn
will allow it to utilize favorable financing terms in connection with the
origination of investments. The Company, however, remains subject to capital
constraints. In particular, the Company's ability to raise additional capital
through the public equity and debt markets continues to be severely limited.
Furthermore, the Company's ability to obtain additional secured debt beyond its
existing credit facilities (or to replace its existing credit facilities) has
not yet been fully explored. Currently, the Company does not expect to originate
or acquire any new investments prior to the completion of its merger with ICH.
24
<PAGE> 25
In the near term, the Company believes it will be constrained from accessing the
public equity markets. In addition, new issues of long-term public unsecured
debt would be difficult to obtain and, in any event, would likely not be
available to the Company at a reasonable cost. Additional secured debt beyond
the Company's Amended Line of Credit would also be difficult to obtain and may
not be offered at a reasonable cost. Aside from limiting the Company's access to
additional capital in the near term to fund growth, the Company has been
relatively insulated from the effects of the dislocation in the capital markets.
While the market value of the Company's CMBS holdings has declined, the Company
invested in these bonds for the long term yields that they are expected to
produce. Management believes that the fundamental value of the real estate
mortgages underlying its bonds has been largely unaffected to date, although
general economic conditions could adversely impact real estate values in the
future.
REIT STATUS
Management believes that the Company is operated in a manner that will enable it
to continue to qualify as a REIT for federal income tax purposes. As a REIT, the
Company will not pay income taxes at the trust level on any taxable income which
is distributed to its shareholders, although AMREIT II, Inc., its "Non-Qualified
REIT Subsidiary", may be subject to tax at the corporate level. Qualification
for treatment as a REIT requires the Company to meet certain criteria, including
certain requirements regarding the nature of its ownership, assets, income and
distributions of taxable income. The Company may, however, be subject to tax at
normal corporate rates on any ordinary income or capital gains not distributed.
YEAR 2000 ISSUE
General
Many of the world's computers, software programs and other equipment using
microprocessors or embedded chips currently have date fields that use two digits
rather than four digits to define the applicable year. These computers, programs
and chips may be unable to properly interpret dates beyond the year 1999. For
example, computer software that has date sensitive programming using a two-digit
format may recognize a date using "00" as the year 1900 rather than the year
2000. This inability to properly process dates is commonly referred to as the
"Year 2000 issue", the "Year 2000 problem" or the "Millennium Bug." These errors
could potentially result in a system failure or miscalculation causing
disruptions of operations, including, among other things, a temporary inability
to process transactions or engage in similar normal business activities, which,
in turn, could lead to disruptions in the Company's operations or performance.
All of the Company's information technology infrastructure is provided by the
Manager. The Manager's systems are supplied by AMRESCO, INC. The Company's
assessments of the cost and timeliness of completion of Year 2000 modifications
set forth below are based on representations made to the Company and the best
estimates of the individuals within or engaged by AMRESCO, INC. charged with
handling the Year 2000 issue. These estimates were derived using numerous
assumptions relating to future events, including, without limitation, the
continued availability of certain internal and external resources and third
party readiness plans. Furthermore, as the AMRESCO, INC. Year 2000 initiative
(described below) progresses, AMRESCO, INC., the Manager and the Company
continue to revise estimates of the likely problems and costs associated with
the Year 2000 issue and to adapt contingency plans. However, there can be no
assurance that any estimate or assumption will prove to be accurate.
The AMRESCO, INC. Year 2000 Initiative
AMRESCO, INC. is conducting a comprehensive Year 2000 initiative with respect to
its internal business-critical systems, including those upon which the Company
depends. This initiative encompasses information technology ("IT") systems and
applications, as well as non-IT systems and equipment with embedded technology,
such as fax machines and telephone systems, which may be impacted by the Year
2000 issue. Business-critical systems encompass internal accounting systems,
including general ledger, accounts payable and financial reporting applications;
cash management systems; loan servicing systems; and decision support systems;
as well as the underlying technology required to support the software. The
initiative includes assessing, remediating or replacing, testing and upgrading
the business-critical IT systems of AMRESCO, INC. with the assistance of a
consulting firm that specializes in Year 2000 readiness. Based upon a review of
the completed and planned stages of the initiative, and the testing done to
date, AMRESCO, INC. does not anticipate any material difficulties in achieving
Year 2000 readiness with respect to its internal business-critical systems used
in connection with the operations of the Manager or the Company. The Company has
received a written representation from AMRESCO, INC. that Year 2000 readiness
was achieved by December 1998 with respect to all its internal business-critical
systems used in connection with the operations of the Manager or the Company.
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<PAGE> 26
In addition to the internal IT systems and non-IT systems of AMRESCO, INC., the
Company may be at risk from Year 2000 failures caused by or occurring to third
parties. These third parties can be classified into two groups. The first group
includes borrowers, significant business partners, lenders, vendors and other
service providers with whom the Company, the Manager or AMRESCO, INC. has a
direct contractual relationship. The second group, while encompassing certain
members of the first group, is comprised of third parties providing services or
functions to large segments of society, both domestically and internationally,
such as airlines, utilities and national stock exchanges.
As is the case with most other companies, the actions the Company, the Manager
and AMRESCO, INC. can take to avoid any adverse effects from the failure of
companies, particularly those in the second group, to become Year 2000 ready is
extremely limited. However, AMRESCO, INC. has communicated with those companies
that have significant business relationships with AMRESCO, INC., the Manager or
the Company, particularly those in the first group, to determine their Year 2000
readiness status and the extent to which AMRESCO, INC., the Manager or the
Company could be affected by any of their Year 2000 readiness issues. In
connection with this process, AMRESCO, INC. has sought to obtain written
representations and other independent confirmations of Year 2000 readiness from
the third parties with whom AMRESCO, INC., the Manager or the Company has
material contracts regarding the internal business-critical operations of the
Company. AMRESCO, INC. and the Company have received written responses
certifying Year 2000 readiness and/or have conducted testing from all but three
of the vendors and other third parties providing goods and services supporting
the internal business-critical functions identified in the initiative of the
Company, the Manager and AMRESCO, INC. With respect to the three vendors who
have not responded, alternative vendors have been identified or a contingency
plan has been developed to address a business interruption arising from the Year
2000 issue. To date, eight of sixteen borrowers to which letters were sent have
represented in writing that they are Year 2000 ready. Based on responses
received and testing to date, it is not currently anticipated that AMRESCO,
INC., the Manager or the Company will be materially affected by any third party
Year 2000 readiness issues in connection with the operations of the Company or
the Manager.
For all business-critical systems interfaces used in connection with the
operations of the Manager and the Company, AMRESCO, INC. advised the Company
that readiness was achieved by December 31, 1998. Replacement providers believed
to be compliant have been identified for significant third party providers that
did not complete their Year 2000 initiatives.
There can be no assurance that the systems of AMRESCO, INC. or those of third
parties will not experience adverse effects after December 31, 1999.
Furthermore, there can be no assurance that a failure to convert by another
company, or a conversion that is not compatible with the systems of AMRESCO,
INC. or those of other companies on which the systems of AMRESCO, INC. rely,
would not have a material adverse effect on the Company.
Under the terms of the Company's Management Agreement with the Manager, all of
the costs associated with addressing the Company's Year 2000 issue are to be
borne by the Manager. Therefore, the Company does not anticipate that it will
incur any expenditures in connection with any modifications necessary to achieve
Year 2000 readiness.
Potential Risks
In addition to the internal systems of AMRESCO, INC. and the systems and
embedded technology of third parties with whom AMRESCO, INC., the Manager and
the Company do business, there is a general uncertainty regarding the overall
success of global remediation efforts relating to the Year 2000 issue, including
those efforts of providers of services to large segments of society, as
described above in the second group. Due to the interrelationships on a global
scale that may be impacted by the Year 2000 issue, there could be short-term
disruptions in the capital or real estate markets or longer-term disruptions
that would affect the overall economy.
26
<PAGE> 27
Due to the general uncertainty with respect to how this issue will affect
businesses and governments, it is not possible to list all potential problems or
risks associated with the Year 2000 issue. However, some examples of problems or
risks to the Company that could result from the failure by third parties to
adequately deal with the Year 2000 issue include:
o in the case of lenders, the potential for liquidity stress due to
disruptions in funding flows;
o in the case of exchanges and clearing agents, the potential for funding
disruptions and settlement failures;
o in the case of counterparties, accounting and financial difficulties to
those parties that may expose the Company to increased credit risk; and
o in the case of vendors or providers, service failures or interruptions,
such as failures of power, telecommunications and the embedded technology
in building systems (such as HVAC, sprinkler and fire suppression,
elevators, alarm monitoring and security, and building and parking garage
access).
With respect to the Company's loan portfolio, risks due to the potential failure
of third parties to be ready to deal with the Year 2000 issue include:
o potential borrower defaults resulting from increased expenses or legal
claims related to failures of embedded technology in building systems, such
as HVAC, sprinkler and fire suppression, elevators, alarm monitoring and
security, and building and parking garage access;
o potential reductions in collateral value due to failure of one or more of
the building systems;
o interruptions in cash flow due to borrowers being unable to obtain timely
lease payments from tenants or incomplete or inaccurate accounting of
rents;
o potential borrower defaults resulting from computer failures of retail
systems of major tenants in retail commercial real estate properties such
as shopping malls and strip shopping centers;
o construction delays resulting from contractors' failure to be Year 2000
ready and increased costs of construction associated with upgrading
building systems to be Year 2000 compliant; and
o delays in reaching projected occupancy levels due to construction delays,
interruptions in service or other market factors.
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
also could be adversely affected.
Additionally, the Company has made equity investments in a partnership that owns
interests in five grocery-anchored shopping centers and in a partnership which
owns a suburban office building. Furthermore, the Company's unconsolidated
taxable subsidiary holds interests (indirectly) in a partnership which owns a
mixed-use property. These operations will be subject to many of the risks set
forth above. Although the Company intends to monitor Year 2000 readiness, there
can be no guarantee that all building systems will be Year 2000 compliant.
The Company believes that the risks most likely to affect the Company adversely
relate to the failure of third parties, including its borrowers and sources of
capital, to achieve Year 2000 readiness. If its borrowers' systems fail, the
result could be a delay in making payments to the Company or the complete
business failure of such borrowers. The failure, although believed to be
unlikely, of the Company's sources of capital to achieve Year 2000 readiness
could result in the Company being unable to obtain the funds necessary to
continue its normal business operations.
27
<PAGE> 28
Reasonably Likely Worst Case Scenario / Business Continuity / Disaster Recovery
Plan
The failure to correct a material Year 2000 problem could result in systems
failures leading to a disruption in or failure of some normal business
activities or operations. The most reasonably likely worst case scenario would
involve a failure of the Manager's and the Company's accounting and management
systems. In this case, the Company would temporarily convert its systems to a
manual system.
AMRESCO, INC. currently has a business continuity/disaster recovery plan that
includes business resumption processes that do not rely on computer systems and
the maintenance of hard copy files, where appropriate. The business
continuity/disaster recovery plan is monitored and updated as potential Year
2000 readiness issues of AMRESCO, INC. and third parties are specifically
identified. Due to the inability to predict all of the potential problems that
may arise in connection with the Year 2000 issue, there can be no assurance that
all contingencies will be adequately addressed by this contingency plan.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q are not based on historical facts
and are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. The Company intends that
forward-looking statements be subject to such Act and any similar state or
federal laws. Forward-looking statements, which are based on various
assumptions, include statements regarding the intent, belief or current
expectations of the Company, its Manager, and their respective Trustees or
directors and officers, and may be identified by reference to a future period or
periods or by use of forward-looking terminology such as "intends," "may,"
"could," "will," "believe," "expect," "anticipate," "plan," or similar terms or
variations of those terms or the negative of those terms. Actual results could
differ materially from those set forth in forward-looking statements due to
risks, uncertainties and changes with respect to a variety of factors,
including, but not limited to, changes in international, national, regional or
local economic environments, changes in prevailing interest rates, credit and
prepayment risks, basis and asset/liability risks, spread risk, event risk,
conditions which may affect public securities and debt markets generally or the
markets in which the Company operates, the Year 2000 issue, the availability of
and costs associated with obtaining adequate and timely sources of liquidity,
dependence on existing sources of funding, the size and liquidity of the
secondary market for commercial mortgage-backed securities, geographic or
product type concentrations of assets (temporary or otherwise), hedge mismatches
with liabilities, other factors generally understood to affect the real estate
acquisition, mortgage and leasing markets and securities investments, changes in
federal income tax laws and regulations, and other risks described from time to
time in the Company's SEC reports and filings, including its registration
statement on Form S-11 and periodic reports on Form 10-Q, Form 8-K and Form
10-K.
28
<PAGE> 29
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is a party to various financial instruments which are subject to
market risk. These instruments include mortgage loan investments, investments in
commercial mortgage-backed securities ("CMBS") and certain of the Company's
borrowing facilities. The Company is also a party to an interest rate cap
agreement which it entered into in order to mitigate the market risk exposure
associated with its credit facilities. The Company's financial instruments
involve, to varying degrees, elements of interest rate risk. Additionally, the
Company's investment portfolio, which is comprised of both financial instruments
(mortgage loans and CMBS) and equity investments in real estate, is subject to
real estate market risk. The Company is a party to certain other financial
instruments, including trade receivables and payables and amounts due to
affiliates which, due to their short-term nature, are not subject to market
risk. For a full discussion of market risk exposures, reference is made to Item
7A. "Quantitative and Qualitative Disclosures About Market Risk" in the
Company's Annual Report on Form 10-K for the year ended December 31, 1998. The
market risk exposures described below are intended to supplement the disclosures
included in the Company's Form 10-K.
Commercial Mortgage-backed Securities
The fair values of the Company's investments in non-investment grade CMBS are
subject to both interest rate risk and spread risk. The non-investment grade, or
subordinated classes, of CMBS typically include classes with credit ratings
below investment grade "BBB". As the subordinated classes provide credit
protection to the senior classes by absorbing losses from underlying mortgage
loan defaults or foreclosures, they also carry more credit risk than the senior
classes. Among other factors, the fair value of the Company's interests in CMBS
is dependent upon, and is sensitive to changes in, comparable-term U.S. Treasury
rates and the spreads over such U.S. Treasury rates in effect from time to time.
Spreads over comparable-term U.S. Treasury rates, which are based upon supply
and demand factors, typically vary across different classes of CMBS and are
generally greater for each successively lower rated class of CMBS. Spreads are
influenced by a number of factors including, but not limited to, investor
expectations with respect to future economic conditions, interest rates and real
estate market factors, all or any of which can impact the ability of borrowers
to perform under the terms of the mortgage loans underlying CMBS. As a result,
even in an environment characterized by relatively constant U.S. Treasury rates
and low commercial mortgage default rates, the value of the Company's CMBS
holdings can be adversely impacted simply by increasing spreads. This situation
occurred during the latter half of 1998 and was the primary reason for the
decline in the value of the Company's CMBS holdings. Notwithstanding this
decline in value, the cash flows from the Company's CMBS were unaffected by this
spread widening.
As of September 30, 1999, the Company held five commercial mortgage-backed
securities with credit ratings ranging from "BB-" to "B-". The weighted average
duration of these bonds approximated 5.8 years as of that date. The estimated
fair value of the Company's CMBS holdings was $26.0 million at September 30,
1999. All other things being equal, a 100 basis point increase or decrease in
comparable-term U.S. Treasury rates (from those in effect as of September 30,
1999) would be expected to cause the value of the Company's CMBS to decline or
increase, respectively, by approximately $1.5 million. Similarly, if
comparable-term U.S. Treasury rates remained constant but spreads over such U.S.
Treasury rates increased by 100 basis points (from those quoted as of September
30, 1999) for each of the classes of CMBS owned by the Company, the fair value
of its securities portfolio would also be expected to decline by approximately
$1.5 million. Conversely, a 100 basis point decline in spreads across all
classes of CMBS (all other things being equal) would be expected to increase the
value of the portfolio by a like amount.
The Company's unconsolidated taxable subsidiary holds one commercial
mortgage-backed security that has a credit rating of "B-". The estimated fair
value of this bond and its duration at September 30, 1999 were $3.3 million and
2.5 years, respectively. All other things being equal, a 100 basis point
increase or decrease in comparable-term U.S. Treasury rates (from those in
effect as of September 30, 1999) would be expected to cause the value of this
security to decline or increase, respectively, by approximately $82,000.
Similarly, if comparable-term U.S. Treasury rates remained constant but spreads
over such U.S. Treasury rates (for this security) increased or decreased by 100
basis points (from those quoted as of September 30, 1999), then the value of
the bond would also be expected to decline or increase, respectively, by
approximately $82,000. These amounts exclude the tax effects associated with
reporting unrealized gains and losses.
As these securities are classified as available for sale, unrealized gains and
losses are excluded from earnings and reported as a component of accumulated
other comprehensive income (loss) in shareholders' equity. In the absence of a
sale or a
29
<PAGE> 30
decline in fair value that is deemed to be other than temporary, the Company's
earnings would not be impacted by the changes in fair value described above.
Borrowing Facilities
The Company is a party to two credit facilities, each of which bears interest at
floating rates. Specifically, both facilities bear interest at varying spreads
over one month LIBOR. One of the facilities can be used to finance the Company's
structured loan and equity real estate investments (the "Amended Line of
Credit") while the other facility can be used to finance the Company's CMBS (the
"Repurchase Agreement"). As of September 30, 1999, amounts outstanding under the
Amended Line of Credit and the Repurchase Agreement totaled $78.5 million and
$10.7 million, respectively. To reduce the impact of changes in interest rates
on these floating rate debt facilities, the Company purchased an interest rate
cap agreement. As described below, this agreement reduces (but does not
eliminate) the Company's risk of incurring higher interest costs due to rising
interest rates.
If the one-month LIBOR on September 30, 1999 increased by 100 basis points on
that date (from 5.40% to 6.40%) and then remained constant at the higher rate
for twelve consecutive months, the Company's interest costs on its outstanding
borrowings ($89.2 million), in the absence of the interest rate cap agreement
described below, would increase by approximately $892,000 for the twelve month
period ending September 30, 2000. In order to reduce the impact that rising
interest rates would have on this floating rate indebtedness, the Company
entered into an interest rate cap agreement effective August 1, 1999. The cap
agreement has a notional amount of $59.0 million. Until its expiration on
November 1, 2000, the agreement entitles the Company to receive from the
counterparty the amounts, if any, by which one-month LIBOR exceeds 6.25%
multiplied by the notional amount. If the one-month LIBOR increased as described
above, the Company would receive approximately $89,000 from the counterparty
under the terms of the cap agreement. Under this scenario, earnings and cash
flows for the twelve month period ending September 30, 2000 would be reduced by
a net amount of approximately $803,000. Any further increase in one-month LIBOR
would effect only that portion of the Company's indebtedness in excess of the
cap agreement's notional amount ($30.2 million). As the Company paid an
up-front, one-time premium of $110,000 for the cap, there is no liquidity risk
to the Company associated with holding this derivative financial instrument.
Conversely, a sustained 100 basis point reduction in the one-month LIBOR (if it
occurred on September 30, 1999) would increase earnings and cash flows for the
twelve month period ending September 30, 2000 by approximately $892,000. Under
this scenario, no payments would be received from the counterparty under the cap
agreement.
The Company (through a majority-owned partnership) is indebted under the terms
of five non-recourse loans aggregating $34.6 million. As the loans bear interest
at a fixed rate, the Company's future earnings and cash flows would not be
reduced in the event of rising interest rates.
30
<PAGE> 31
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits and Exhibit Index
Exhibit No.
2.1 Agreement and Plan of Merger, dated as of August
4, 1999, by and between the Company and Impac
Commercial Holdings, Inc. (filed as Exhibit 2.1 to
the Registrant's Quarterly Report on Form 10-Q for
the quarterly period ended June 30, 1999, which
exhibit is incorporated herein by reference).
4.1 Rights Agreement, dated as of February 25, 1999,
between the Company and The Bank of New York, as
Rights Agent, which includes: as Exhibit A
thereto, the Form of Statement of Designation of
Series A Junior Participating Preferred Shares,
par value $.01 per share, of the Company; as
Exhibit B thereto, the Form of Right Certificate;
and as Exhibit C thereto, the Summary of Rights to
Purchase Preferred Shares (filed as Exhibit 1 to
the Registrant's Current Report on Form 8-K dated
February 25, 1999, which exhibit is incorporated
herein by reference).
10.1 Amended and Restated Interim Warehouse and
Security Agreement dated as of May 4, 1999, by and
among Prudential Securities Credit Corporation and
AMRESCO Capital Trust, AMREIT I, Inc., AMREIT II,
Inc., ACT Equities, Inc. and ACT Holdings, Inc.
(filed as Exhibit 10.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1999, which exhibit is
incorporated herein by reference).
10.2 Warrant Agreement dated as of May 4, 1999 between
AMRESCO Capital Trust and Prudential Securities
Incorporated (filed as Exhibit 10.2 to the
Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1999, which
exhibit is incorporated herein by reference).
10.3 Management Agreement, dated as of May 12, 1998, by
and between AMRESCO Capital Trust and AMREIT
Managers, L.P.
27 Financial Data Schedule.
(b) Reports on Form 8-K. The following reports on Form 8-K were
filed with respect to events occurring during the quarterly
period for which this report is filed:
(i) Form 8-K dated August 5, 1999 and filed with the
Commission on August 9, 1999, reporting the
announcement that AMRESCO Capital Trust and Impac
Commercial Holdings, Inc. had entered into a
merger agreement, under Item 5 of such form.
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<PAGE> 32
SIGNATURE
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.
AMRESCO CAPITAL TRUST
Registrant
Date: November 12, 1999 By: /s/ Thomas R. Lewis II
----------------------
Thomas R. Lewis II
Vice President and Controller
(Chief Accounting Officer)
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<PAGE> 33
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
2.1 Agreement and Plan of Merger, dated as of August
4, 1999, by and between the Company and Impac
Commercial Holdings, Inc. (filed as Exhibit 2.1 to
the Registrant's Quarterly Report on Form 10-Q for
the quarterly period ended June 30, 1999, which
exhibit is incorporated herein by reference).
4.1 Rights Agreement, dated as of February 25, 1999,
between the Company and The Bank of New York, as
Rights Agent, which includes: as Exhibit A
thereto, the Form of Statement of Designation of
Series A Junior Participating Preferred Shares,
par value $.01 per share, of the Company; as
Exhibit B thereto, the Form of Right Certificate;
and as Exhibit C thereto, the Summary of Rights to
Purchase Preferred Shares (filed as Exhibit 1 to
the Registrant's Current Report on Form 8-K dated
February 25, 1999, which exhibit is incorporated
herein by reference).
10.1 Amended and Restated Interim Warehouse and
Security Agreement dated as of May 4, 1999, by and
among Prudential Securities Credit Corporation and
AMRESCO Capital Trust, AMREIT I, Inc., AMREIT II,
Inc., ACT Equities, Inc. and ACT Holdings, Inc.
(filed as Exhibit 10.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1999, which exhibit is
incorporated herein by reference).
10.2 Warrant Agreement dated as of May 4, 1999 between
AMRESCO Capital Trust and Prudential Securities
Incorporated (filed as Exhibit 10.2 to the
Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1999, which
exhibit is incorporated herein by reference).
10.3 Management Agreement, dated as of May 12, 1998, by
and between AMRESCO Capital Trust and AMREIT
Managers, L.P.
27 Financial Data Schedule.
</TABLE>
<PAGE> 1
EXHIBIT 10.3
MANAGEMENT AGREEMENT
THIS MANAGEMENT AGREEMENT (this "Agreement"), dated as of May 12, 1998,
is by and between AMRESCO CAPITAL TRUST, a Texas real estate investment trust
(the "Company"), and AMREIT MANAGERS, L.P., a Delaware limited partnership (the
"Manager").
WHEREAS, the Company intends to invest in various types of real estate
related assets and to qualify as a "real estate investment trust" under the
Internal Revenue Code of 1986, as amended (the "Code"); and
WHEREAS, the Company desires to retain the Manager to undertake, on the
Company's behalf, the duties and responsibilities set forth in this Agreement,
subject to the direction and oversight of the Board of Trust Managers of the
Company (the "Board of Trust Managers"), on the terms and conditions set forth
in this Agreement; and
WHEREAS, the Manager desires to undertake, on the Company's behalf, the
duties and responsibilities set forth in this Agreement, subject to the
direction and oversight of the Board of Trust Managers, on the terms and
conditions set forth in this Agreement.
NOW THEREFORE, in consideration of the mutual agreements herein set
forth, the parties hereto agree as follows:
SECTION 1 Definitions. Capitalized terms used herein and not otherwise
defined herein shall have the respective meanings assigned to them below:
(a) "AMRESCO Group" means AMRESCO, Inc. together with its
affiliated entities.
(b) "Average Invested Investment Grade Assets" means, for any
quarter, the average of the aggregate book value of the assets of the
Company on a consolidated basis (as reflected on the Company's balance
sheet) and of all of the Company's nonconsolidated taxable subsidiaries
(but excluding the Company's investment in such subsidiaries), which
either (i) have received an Investment Grade Rating from all Rating
Agencies which have rated such asset or (ii) are unrated but are
guaranteed by the U.S. government or any agency or instrumentality
thereof, before reserves for depreciation or bad debts or other similar
noncash reserves, 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.
(c) "Average Invested Non-Investment Grade Assets" means, for
any quarter, the average of the aggregate book value of the assets of
the Company on a consolidated basis (as reflected on the Company's
balance sheet) and of all of the Company's nonconsolidated taxable
subsidiaries (but excluding the Company's investment in such
subsidiaries), other than Average Invested Investment Grade
<PAGE> 2
Assets, before reserves for depreciation or bad debts or other similar
noncash reserves, 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.
(d) "Chief Investment Officer" means the Chief Investment
Officer of the Company.
(e) "Closing Date" means the date of closing of the Company's
initial public offering of its Common Shares.
(f) "Common Shares" means the Company's common shares of
beneficial interest, $.01 par value per share.
(g) "Confidential Information" means all information of the
Company not generally known in the Company's industry or in the
financial markets which is obtained by the Manager from the Company or
directly as a result of the performance by the Manager of its services
to the Company pursuant to this Agreement.
(h) "Exchange Act" means the Securities Exchange Act of 1934,
as amended.
(i) "Funds From Operations" or "FFO" 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 adjustments for unconsolidated partnerships and joint ventures.
(j) "Governing Instruments" means (i) with respect to the
Company, its Declaration of Trust and Bylaws, (ii) with respect to any
Subsidiary which is a corporation, the articles or certificate of
incorporation and bylaws of such corporation, (iii) with respect to any
Subsidiary which is a partnership, the partnership agreement of such
partnership and (iv) with respect to any Subsidiary which is a limited
liability company the articles of organization and the regulations of
such limited liability company, in each case, as the same may be
amended from time to time.
(k) "Guidelines" means the operating policies and general
guidelines for the Company's investments, borrowings and operations, as
approved by the Board of Trust Managers of the Company and in effect
from time to time. The Guidelines, as initially approved by the Board
of Trust Managers of the Company, are attached hereto as Exhibit "A.".
MANAGEMENT AGREEMENT - PAGE 2
<PAGE> 3
(l) "Investment Grade Rating" means a rating equal to or
higher than (i) "BBB-" by Standard & Poor's Rating Services, a division
of the McGraw-Hill Companies, (ii) "Baa3" by Moody's Investors
Services, Inc., (iii) "2" by National Association of Insurance
Commissioners, (iv) "BBB-" by Duff and Phelps Credit Rating Co. or (v)
"BBB-" by Fitch IBCA, Inc.
(m) "Master Servicing" means providing administrative and
reporting services to securitized pools of MBS.
(n) "MBS" means mortgage-backed securities (including
commercial or multifamily mortgage backed securities and residential
mortgage backed securities).
(o) "Mezzanine Loan" means a commercial real estate loan the
repayment of which is subordinated to a senior Mortgage Loan and which
is secured either by a second lien mortgage or a pledge of the
ownership interests of the borrower. Such loans can also take the form
of a preferred equity investment in the borrower.
(p) "Mortgage Loans" means, collectively, loans secured by
real property and Mezzanine Loans.
(q) "Nasdaq" means the Nasdaq National Market.
(r) "Nonperforming Mortgage Loans" means Mortgage Loans for
which the payment of principal and/or interest is more than 90 days
delinquent.
(s) "NYSE" means the New York Stock Exchange.
(t) "REIT" means a real estate investment trust, as defined
under Section 856 of the Code.
(u) "REIT Provisions of the Code" means Sections 856 through
860 of the Code.
(v) "Securities Act" means the Securities Act of 1933, as
amended.
(w) "Special Servicer" means an entity which services
delinquent and/or defaulted Mortgage Loans, including the oversight and
management of the resolution of such Mortgage Loans by modification,
foreclosure, deed in lieu of foreclosure or otherwise.
(x) "Special Servicing" means the oversight and management of
the resolution of Mortgage Loans by workout or modification of loan
provisions, foreclosure, deed in lieu of foreclosure or otherwise, and
the control of decisions
MANAGEMENT AGREEMENT - PAGE 3
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with respect to the preservation of the collateral generally, including
property management and maintenance decisions.
(y) "Special Servicing Rights" means rights to control the
oversight and management of the resolution of Mortgage Loans by workout
or modification of loan provisions, foreclosure, deed in lieu of
foreclosure or otherwise, and to control decisions with respect to the
preservation of the collateral generally, including property management
and maintenance decisions.
(z) "Subperforming Mortgage Loans" means Mortgage Loans for
which default is likely or imminent or for which the borrower is making
payments in accordance with a forbearance plan.
(aa) "Subsidiary" means any corporation, partnership, limited
liability company or other entity formed and controlled by the Company.
(bb) "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 a constant maturity 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.
(cc) "Trust Manager" means a member of the Board of Trust
Managers.
SECTION 2 Duties of the Manager.
(a) Subject to the direction and oversight of the Board of
Trust Managers and in accordance with the Governing Instruments, the
Manager shall be responsible for the day-to-day operations of the
Company and perform (or cause to be performed as permitted herein)
services and activities relating to the assets and operations of the
Company, including, without limitation, the following:
(i) providing a complete program of investing and
reinvesting the capital and assets of the Company in pursuit
of its investment objectives and in accordance with the
Guidelines and policies adopted by the Board of Trust Managers
from time to time;
MANAGEMENT AGREEMENT - PAGE 4
<PAGE> 5
(ii) serving as the Company's consultant with respect
to formulation of investment criteria and policies and
preparation of the Guidelines by the Board of Trust Managers;
(iii) assisting the Company in developing criteria for
asset purchase commitments that are specifically tailored to
the Company's investment objectives and making available to
the Company its knowledge and experience with respect to
Mortgage Loans, MBS, real estate and other real estate related
assets;
(iv) representing and making recommendations to the
Company in connection with the origination of Mortgage Loans,
the purchase of and commitment to purchase Mortgage Loans,
MBS, real estate and other real estate related assets, the
financing of Mortgage Loans, MBS, real estate and other real
estate related assets, and the sale and commitment to sell
Mortgage Loans, MBS, real estate and other real estate related
assets (including, without limitation, the underwriting of
Mortgage Loans, the accumulation of Mortgage Loans for
securitization and arrangement for the issuance of MBS from
pools of Mortgage Loans owned by the Company);
(v) furnishing reports and statistical and economic
research to the Company regarding market conditions in the
areas in which the Company proposes to invest as well as the
Company's activities and the services performed for the
Company by the Manager;
(vi) monitoring and providing to the Board of Trust
Managers on an ongoing basis price information and other data,
obtained from certain nationally recognized brokers or dealers
identified by the Board of Trust Managers from time to time,
and providing data and recommendations to the Board of Trust
Managers in connection with the identification of such brokers
or dealers;
(vii) providing the executive and administrative
personnel and office space and office and administrative
services required in rendering services to the Company;
(viii) monitoring the operating performance of the
Company's investments and providing periodic reports with
respect thereto to the Board of Trust Managers, including
comparative information with respect to such operating
performance and budgeted or projected operating results;
(ix) administering the day-to-day operations of the
Company and performing and supervising the performance of such
other administrative functions necessary for the management of
the Company and its assets as
MANAGEMENT AGREEMENT - PAGE 5
<PAGE> 6
may be agreed upon by the Manager and the Board of Trust
Managers, including the collection of revenues and the payment
of the Company's debts and obligations;
(x) communicating on behalf of the Company with the
holders of any equity or debt securities of the Company as
required to satisfy the reporting and other requirements of
any governmental bodies or agencies and to maintain effective
relations with such holders;
(xi) counseling the Company in connection with policy
decisions made or to be made by the Board of Trust Managers,
including, without limitation, policy decisions with respect
to investments, leveraging of the Company's assets, management
of the credit risk of the Company's assets, management of the
interest rate risks of the Company's assets, including
decisions with respect to hedging of the assets and compliance
with certain legal requirements;
(xii) advising the Company regarding its status as a
REIT, consulting with legal counsel as appropriate regarding
the application of the REIT Provisions of the Code to the
proposed investments and operations of the Company and
monitoring compliance by the Company with the REIT Provisions
of the Code;
(xiii) advising the Company regarding the status of its
exemption from the Investment Company Act of 1940, as amended,
consulting with legal counsel as appropriate regarding the
nature of its proposed investments and the impact of such
proposed investments on the Company's exemption from
registration under such Act and monitoring the Company's
continuing exemption from registration;
(xiv) evaluating and recommending hedging strategies
to the Board of Trust Managers and, upon approval by the Board
of Trust Managers, engaging in hedging activities on behalf of
the Company, consistent with the Company's status as a REIT
and with the Guidelines;
(xv) upon request by and in accordance with the
directions of the Board of Trust Managers, investing or
reinvesting any money of the Company, and advising the Company
as to its capital structure and capital raising;
(xvi) causing the Company to retain qualified
accountants and/or legal counsel to assist in developing
appropriate accounting procedures, compliance procedures and
testing systems with respect to financial reporting
obligations and compliance with the REIT Provisions of the
Code and to conduct quarterly compliance reviews with respect
thereto;
MANAGEMENT AGREEMENT - PAGE 6
<PAGE> 7
(xvii) causing the Company to qualify to do business
in all applicable jurisdictions;
(xviii) assisting the Company in complying with all
federal, state and local regulatory requirements applicable to
the Company in respect of its business activities, including,
without limitation, preparing or causing to be prepared all
financial statements required under applicable regulations and
contractual undertakings and all reports and documents, if
any, required under the Exchange Act;
(xix) taking all necessary actions to enable the
Company to make required federal, state and local tax filings
and reports, including, without limitation, soliciting
shareholders for required information to the extent provided
by the REIT Provisions of the Code;
(xx) handling and resolving all claims, disputes or
controversies (including all litigation, arbitration,
settlement or other proceedings or negotiation) in which the
Company may be involved or to which the Company may be subject
arising out of the Company's day-to-day operations, subject to
such limitation or parameters as may be imposed from time to
time by the Board of Trust Managers;
(xxi) using commercially reasonable efforts to cause
expenses incurred by or on behalf of the Company to be
reasonable or customary and within any budgeted parameters or
Guidelines set by the Board of Trust Managers from time to
time;
(xxii) performing such other services as may be
required from time to time for management or other activities
relating to the assets of the Company in furtherance of the
Manager's obligations hereunder, as the Board of Trust
Managers shall reasonably request or the Manager shall deem
appropriate under the particular circumstances; and
(xxiii) using commercially reasonable efforts to cause
the Company to comply with all applicable laws.
(b) The Manager will perform portfolio management services on
behalf of the Company with respect to the Company's investments. Such
services will include, but not be limited to, consulting the Company on
purchase, sale and other opportunities, collection of information and
submission of reports pertaining to the Company's assets, interest
rates, and general economic conditions, periodic review and evaluation
of the performance of the Company's portfolio of assets, acting as
liaison between the Company and banking, mortgage banking, investment
banking and other parties with respect to the purchase, financing and
disposition of assets,
MANAGEMENT AGREEMENT - PAGE 7
<PAGE> 8
and other customary functions related to portfolio management. The
Manager may enter into subcontracts with other parties, including
AMRESCO, Inc. and its affiliates, to provide any such services to the
Company.
(c) The Manager will monitor and administer the loan servicing
activities provided by servicers of the Company's Mortgage Loans, other
than loans pooled to collateralize MBS or pledged to secure MBS. Such
monitoring and administrative services will include, but not be limited
to, the following activities: serving as the Company's consultant with
respect to the servicing of loans; collection of information and
submission of reports pertaining to the Mortgage Loan and the moneys
remitted to the Manager or the Company by servicers; periodic review
and evaluation of the performance of each servicer to determine its
compliance with the terms and conditions of the servicing agreement
and, if deemed appropriate, recommending to the Company the termination
of such servicing agreement; acting as a liaison between servicers and
the Company and working with servicers to the extent necessary to
improve their servicing performance; review of and recommendations as
to fire losses, easement problems and condemnation, delinquency and
foreclosure procedures with regard to the Mortgage Loans; review of
servicers' delinquency, foreclosing and other reports on Mortgage
Loans; advising as to and supervising claims filed under any mortgage
insurance policies; and enforcing the obligation of any servicer to
repurchase Mortgage Loans from the Company.
(d) The Manager will perform monitoring services on behalf of
the Company with respect to loan servicing activities provided by third
parties and with respect to the Company's portfolio of Special
Servicing Rights. Such monitoring services will include, but not be
limited to: negotiating Special Servicing agreements; acting as liaison
between the servicers of the Mortgage Loans and the Company; review of
servicer's delinquency, foreclosures and other reports on Mortgage
Loans; supervising claims filed under any mortgage insurance policies;
and enforcing the obligation of any servicer to repurchase Mortgage
Loans.
(e) The Manager agrees to use its commercially reasonable
efforts at all times in performing services for the Company hereunder
and in accordance with the Guidelines and policies of the Company in
effect from time to time.
SECTION 3. Obligations of the Manager and the Company.
(a) The Manager shall use commercially reasonable efforts to
determine, in good faith, whether each Mortgage Loan, MBS, real estate
or other real estate asset proposed to be acquired by the Company
conforms to the investment criteria and Guidelines of the Company
approved from time to time by the Board of Trust Managers.
MANAGEMENT AGREEMENT - PAGE 8
<PAGE> 9
(b) The Manager shall require each seller or transferor of
assets to the Company to make such representations and warranties
regarding such assets as are customarily made in similar transactions
and as may, in the judgment of the Manager, be necessary and/or
appropriate. With respect to Mortgage Loans acquired by the Company,
and to the extent consistent with prevailing industry practices, the
Manager shall use commercially reasonable efforts to require the seller
or transferor of any Mortgage Loan to the Company to agree to
repurchase any such Mortgage Loan with respect to which there is fraud
or misrepresentation. In addition, the Manager shall take all such
other action as it deems reasonably necessary or appropriate with
regard to the protection of the Company's investments.
(c) The Manager shall refrain from any action which, in its
sole judgment made in good faith, (i) would adversely affect the status
of the Company as a REIT under the Code, (ii) would violate any law,
rule or regulation of any governmental body or agency having
jurisdiction over the Company which violation could have a material
adverse effect on the Company, its business or assets or results of
operations or (iii) would otherwise not be permitted by the Governing
Instruments, the Guidelines, any operating policies adopted from time
to time by the Company or any agreements of the Company which have
previously been provided to the Manager. If the Manager is ordered to
take any such action by the Board of Trust Managers, the Manager shall
promptly notify the Board of Trust Managers of the Manager's judgment
that such action would adversely affect such status or violate any such
law, rule or regulation or the Governing Instruments, the Guidelines,
the operating policies adopted from time to time by the Company or any
agreements which have previously been provided to the Manager.
(d) The Manager shall cause Deloitte & Touche LLP, or another
independent accounting firm having the requisite expertise and
reputation, to review the Company's assets and operations on a
quarterly basis to determine whether the Company has complied with the
REIT Provisions of the Code. The Manager shall cause such accounting
firm to deliver to the Board of Trust Managers no later than March 31
of each year an annual report regarding compliance by the Company with
the REIT Provisions of the Code for the preceding fiscal year.
(e) The Manager shall prepare regular reports for the Board of
Trust Managers that will review the Company's acquisitions of assets,
portfolio composition and characteristics, credit quality and
compliance with the Guidelines and the operating performance of such
assets (including comparative information with respect to such
operating performance and budgeted or projected operating results).
(f) In purchasing assets for the Company, the Manager shall
endeavor to obtain on behalf of the Company terms no less favorable
than commercially reasonable terms. In assessing commercially
reasonable terms for any transaction,
MANAGEMENT AGREEMENT - PAGE 9
<PAGE> 10
the Manager shall consider all factors which it, in good faith, deems
relevant, including the breadth of the market in the asset, the price
of the asset, the reasonableness of any broker commissions both for the
specific transaction and on a continuing basis and the market terms
determined in comparable arm's length transactions.
(g) The Company agrees to take all actions reasonably required
to permit the Manager to carry out its duties and obligations under
this Agreement. The Company further agrees to make available to the
Manager all materials reasonably requested by the Manager to enable the
Manager to satisfy its obligations to deliver financial statements and
other information or reports with respect to the Company.
(h) The Manager agrees, at all times during which it is
serving as Manager to the Company, to (i) maintain a tangible net worth
of at least $250,000 and (ii) maintain "errors and omissions" insurance
coverage (which may be provided by a policy or policies maintained
through, and providing coverage for, other members of the AMRESCO
Group) in an amount which is comparable to that customarily maintained
by other managers or servicers of assets similar to those held by the
Company.
SECTION 4. Additional Activities of Manager.
(a) Except as expressly provided below, this Agreement shall
not prevent or restrict the Manager or any other member of the AMRESCO
Group, or any of their respective officers, directors, partners,
officers, stockholders, employees or Affiliates from engaging in other
businesses or from rendering services of any kind to any other Person,
including investment in, or advisory service to others investing in,
any type of real estate related assets, including assets which meet the
principal investment objectives of the Company; provided, however, that
during the term of this Agreement, neither the Manager, nor any other
member of the AMRESCO Group, nor any of their respective directors,
partners, officers, employees or affiliates (while acting in such
capacity only) will (i) sponsor, (ii) act as manager to or (iii) make
any significant equity investment in, any other REIT with investment
objectives substantially similar to those of the Company, without the
prior approval of a majority of the Independent Trust Managers.
(b) Directors, partners, officers, stockholders, employees and
Affiliates of the Manager or any other member of the AMRESCO Group may
serve as directors, partners, officers, stockholders, employees or
signatories for the Company or any Subsidiary of the Company, to the
extent permitted by their Governing Instruments, as from time to time
amended, or by any resolutions duly adopted by the Board of Trust
Managers pursuant to the Company's Governing Instruments. When
executing documents or otherwise acting in such capacities for the
Company, such persons shall use their respective titles in the Company.
MANAGEMENT AGREEMENT - PAGE 10
<PAGE> 11
(c) Nothing in this Agreement shall prevent the Manager or any
other member of the AMRESCO Group from selling assets to, or engaging
in any other transaction with, the Company; provided, that any such
transactions must be effected in accordance with the Guidelines or
shall otherwise be approved in advance by a majority of the Independent
Trust Managers.
SECTION 5. Bank Accounts. At the direction of the Board of Trust
Managers, the Manager may establish and maintain one or more bank accounts in
the name of the Company, and may collect and deposit into any such account or
accounts, and disburse funds from any such account or accounts, under such terms
and conditions as the Board of Trust Managers may approve. The Manager shall
from time to time (or at any time upon the request of a majority of the
Independent Trust Managers) render appropriate accounting of such collections
and payments to the Board of Trust Managers and, upon request, to the auditors
of the Company.
SECTION 6. Records; Confidentiality. The Manager shall maintain
appropriate books of accounts and records relating to the assets of the Company
and the services performed hereunder, and such books of account and records
shall be accessible for inspection by representatives of the Company at any time
during normal business hours. Except in the ordinary course of business or as
required by the Securities Act, the Exchange Act, NYSE, Nasdaq or any statute,
rule, regulation, order or decree of any governmental entity, the Manager agrees
not to disclose any Confidential Information to third parties who are not
Affiliates of the Manager, except with the prior approval of a majority of
Independent Trust Managers.
SECTION 7. Compensation.
(a) For services rendered under this Agreement, the Company
shall pay to the Manager a base management fee calculated and payable
quarterly in an amount equal to (i) 1% per annum of the Average
Invested Non-Investment Grade Assets of the Company and (ii) 0.50% per
annum of the Average Invested Investment Grade Assets of the Company.
(b) In addition to the base management fee, the Manager shall
be 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 (before the incentive fee) of the
Company for such quarter per Common Share (based on the weighted
average number of shares outstanding during such quarter) (b) plus
gains (or minus losses) from debt restructuring and sales of property
per Common Share (based on the weighted average number of shares
outstanding during such quarter), exceed (2) an amount equal to (a) the
weighted average of the price per Common Share at the initial offering
and the prices per Common Share for any subsequent issuances of Common
Shares by the Company, multiplied by (b) the Ten-Year U.S. Treasury
Rate for the respective quarter plus
MANAGEMENT AGREEMENT - PAGE 11
<PAGE> 12
3.5% multiplied by (B) the weighted average number of Common Shares
outstanding during such period.
(c) The Manager shall compute the compensation payable under
Sections 7(a) and 7(b) within 45 days after the end of each fiscal
quarter. A copy of the computations made by the Manager to calculate
its compensation shall thereafter promptly be delivered to the Board of
Trust Managers and payment of the compensation earned under Sections
7(a) and 7(b) of this Agreement shown therein shall be due and payable
within 60 days after the end of such fiscal quarter.
SECTION 8. Expenses.
(a) Without regard to the compensation received under this
Agreement by the Manager and subject to Sections 8(b) and 8(c), the
Manager shall bear the following expenses:
(i) employment expenses of the personnel employed by
the Manager (including, but not limited to, officers of the
Company employed by the Manager) including, but not limited
to, salaries, wages, payroll taxes and the cost of the
employee benefit plans of such personnel;
(ii) rent, telephone, utilities, office furniture,
equipment, machinery, and other office expenses of the Manager
and/or its Affiliates required for the Company's day-to-day
operations, including costs associated with accounting,
clerical, primary or Master Servicing (including all expenses
customarily paid by primary loan servicers or Master Servicers
in performing primary loan servicing or Master Servicing for
third parties) and back-office services provided by the
Manager or its affiliates;
(iii) computer hardware and software costs (including
costs associated with determining whether its systems are
"Year 2000" compliant and with modifying or replacing source
codes to bring its systems into "Year 2000" compliance),
except for any such expenses that relate solely to the
computer hardware or software used solely for the business and
operations of the Company; and
(iv) all premiums and other expenses required in
connection with "errors and omissions" insurance policies
covering officers and employees of the Manager.
(b) The Company shall pay all of its expenses except those
that are the responsibility of the Manager pursuant to Section 8(a) and
without limiting the generality of the foregoing, it is specifically
agreed that the following expenses actually incurred by or on behalf of
the Company shall be paid by the Company and shall not be paid by the
Manager or any other member of the AMRESCO Group:
MANAGEMENT AGREEMENT - PAGE 12
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(i) the cost of money borrowed by the Company,
including interest, commitment fees and other charges;
(ii) all taxes and license fees applicable to the
Company, including interest and penalties thereon;
(iii) legal, audit, accounting, underwriting,
brokerage, listing, filing, rating agency, registration and
other fees, printing, engraving and other expenses and taxes
incurred in connection with the issuance, distribution,
transfer, registration and stock exchange listing of any
securities of the Company (including, without limitation, debt
or equity securities, options or warrants to purchase debt or
equity securities, convertible securities, etc.);
(iv) fees and expenses paid to advisors and
independent contractors, consultants, managers and other
agents (including the Manager or any other member of the
AMRESCO Group) engaged directly by the Company upon its
written request or by the Manager at the Company's written
request for the account of the Company;
(v) due diligence costs and related costs (including
legal fees, accounting and auditing fees, environmental and
engineering reviews) associated with the acquisition or
proposed acquisition or the disposition or proposed
disposition of any of the Company's assets; provided that with
respect to any proposed acquisition of assets, such asset(s)
shall have been preliminarily approved in writing for
investment by the Chief Investment Officer or the Board of
Trust Managers, and further provided that any extraordinary
costs (in excess of $500,000 with respect to any single
transaction or asset) shall be required to be approved in
advance by the Board of Trust Managers;
(vi) other expenses connected with the acquisition,
disposition, financing and ownership of the Company's assets,
including, but not limited to, commitment fees, brokerage
fees, guaranty fees, ad valorem taxes, costs of foreclosure,
maintenance, repair and improvement of property and premiums
for insurance on property owned by the Company;
(vii) costs related to hedging transactions
(including losses);
(viii) the expenses of organizing, modifying or
dissolving the Company;
(ix) costs related to advertising and marketing of
the Company's assets or services;
MANAGEMENT AGREEMENT - PAGE 13
<PAGE> 14
(x) expenses connected with payments of dividends or
interest or distributions in any other form made or caused to
be made by the Board of Trust Managers to holders of the
securities of the Company;
(xi) expenses connected with the structuring,
issuance and administration of MBS by the Company, including,
but not limited to, legal, audit, accounting, underwriting,
listing, filing, rating agency and trustee's fees, insurance
premiums and costs of required credit enhancements;
(xii) all expenses of third parties connected with
communications to holders of equity securities or debt
securities issued by the Company and the other bookkeeping and
clerical work necessary in maintaining relations with holders
of such securities and in complying with the continuous
reporting and other requirements of governmental bodies or
agencies, including any costs of computer services in
connection with this function, the cost of printing and
mailing certificates for such securities and proxy
solicitation materials and reports to holders of the Company's
securities and reports to third parties required under any
indenture to which the Company is a party;
(xiii) custodian's, transfer agent's and registrar's
fees and charges;
(xiv) compensation, fees and expenses paid to the
Independent Trust Managers, the cost of director and officer
liability insurance and premiums for any errors and omissions
insurance coverage maintained for the Company and its
employees (solely in their capacity as employees of the
Company and not in their capacity as employees of the Manager
or any other member of the AMRESCO Group);
(xv) legal, accounting, tax and auditing fees and
expenses paid to third parties relating to the Company's
operations;
(xvi) legal, expert and other fees and expenses paid
to third parties relating to any actions, proceedings,
lawsuits, demands, causes of action and claims, whether actual
or threatened, made by or against the Company, or which the
Company is authorized or obligated to pay under applicable law
or the Governing Instruments or by the Board of Trust
Managers;
(xvii) any judgment rendered against the Company, or
against any Trust Manager, director or officer of the Company
in his capacity as such for which the Company is required to
indemnify such Trust Manager, director, or officer by any
court or governmental agency, or settlement of pending or
threatened litigation; provided that such settlement is
approved or authorized by the Board of Trust Managers or is
entered into by the Manager pursuant
MANAGEMENT AGREEMENT - PAGE 14
<PAGE> 15
to the discretionary authority granted to the Manager by the
Board of Trust Managers;
(xviii) expenses relating to any office or office
facilities maintained solely for the use or benefit of the
Company exclusive of the office of the Manager;
(xix) expenses related to the accumulation and
Special Servicing of Mortgage Loans;
(xx) travel and related expenses of directors,
officers and employees of the Manager or other members of the
AMRESCO Group, and of Trust Managers, directors, officers and
employees of the Company who are also directors, officers or
employees of the Manager or other members of the AMRESCO
Group, incurred in connection with attending meetings of the
Board of Trust Managers or holders of securities of the
Company or performing other business activities that relate to
the Company, including, where applicable, a proportionate
share of such expenses as reasonably determined by the Manager
where such expenses were not incurred solely for the benefit
of the Company;
(xxi) costs associated with computer hardware and
software, third party information services and office expenses
that relate solely to the business activities of the Company
(including the costs of bringing any systems into "Year 2000"
compliance, if such systems relate solely to the business
activities of the Company);
(xxii) any extraordinary or non-recurring costs or
charges incurred by the Company; and
(xxiii) other expenses of the Company that are not
expenses of the Manager under Section 8(a).
(c) Any due diligence investigations, underwriting and other
services typically performed by third-party consultants or service
providers (including, without limitation, legal review and
documentation) may be provided to the Company by the Manager or any
other member of the AMRESCO Group if the Manager determines in good
faith that (i) the requisite expertise is available through the Manager
or the other members of the AMRESCO Group and that (ii) either (a) such
services provided by the Manager or other members of the AMRESCO Group
are superior in quality to those available from third parties or (b)
costs savings or other efficiencies will arise from the use of such
services. The Manager will, and will cause each other member of the
AMRESCO Group to, document the time spent by its employees on such
services on behalf of the Company and will be
MANAGEMENT AGREEMENT - PAGE 15
<PAGE> 16
entitled to reimbursement for the allocable portion of salary and
benefits for such employees.
(d) Notwithstanding the foregoing provisions of this Section
8, if the Company (or the Manager on behalf of the Company) incurs due
diligence and related costs with respect to a proposed acquisition of
one or more assets and all or any portion of such assets are not
acquired by the Company but are instead acquired by a member of the
AMRESCO Group, then AMRESCO or the appropriate member of the AMRESCO
Group shall, within 30 days of its receipt of an itemized statement
from the Manager reflecting the costs incurred by or on behalf of the
Company, pay or reimburse the Company for all such costs (or the
appropriate portion thereof allocable to the portion of the asset(s)
acquired).
SECTION 9. Calculations of Expenses. The Manager shall prepare a
statement documenting the expenses of the Company and those incurred by the
Manager on behalf of the Company during each quarter and shall deliver such
statement to the Company within 45 days after the end of each quarter. Expenses
incurred by the Manager on behalf of the Company shall be reimbursed quarterly
to the Manager within 60 days after the end of each quarter. All expenses
incurred by the Manager and submitted to the Company for reimbursement shall be
reviewed by the Independent Trust Managers on a quarterly basis.
SECTION 10. Limits of Manager Responsibility. The Manager assumes no
responsibility under this Agreement other than to render the services called for
hereunder in good faith and shall not be responsible for any action of the Board
of Trust Managers in following or declining to follow any advice or
recommendations of the Manager, including as set forth in Section 3(b). Neither
the Manager, nor any other member of the AMRESCO Group will be liable to the
Company, the Independent Trust Managers, the Company's shareholders or partners,
any issuer of MBS or any other party for any acts or omissions by the Manager,
any other member of the AMRESCO Group or any of their respective partners,
directors, officers, stockholders or employees under or in connection with this
Agreement, except by reason of acts constituting bad faith, willful misconduct,
gross negligence or reckless disregard of their duties. The Company shall
reimburse, indemnify and hold harmless the Manager and the members of the
AMRESCO Group and their respective stockholders, directors, partners, officers
and employees (collectively, the "Indemnified Parties") for, from and against
any and all expenses, losses, damages, liabilities, demands, charges and claims
of any nature whatsoever, (including attorneys' fees) in respect of or arising
from any acts or omissions of the Manager, its stockholders, directors,
partners, officers and employees made in good faith in the performance of the
Manager's duties under this Agreement and not constituting bad faith, willful
misconduct, gross negligence or reckless disregard of its duties. WITHOUT
LIMITING ANY OTHER PROVISION OF THIS AGREEMENT, IT IS THE EXPRESS INTENTION OF
THE COMPANY AND THE MANAGER THAT THE COMPANY'S OBLIGATION TO INDEMNIFY THE
INDEMNIFIED PARTIES PURSUANT TO THIS SECTION 10 INCLUDES INDEMNIFICATION FOR
EXPENSES, LOSSES, DAMAGES, LIABILITIES,
MANAGEMENT AGREEMENT - PAGE 16
<PAGE> 17
DEMANDS AND CHARGES AND CLAIMS OF ANY NATURE WHATSOEVER (INCLUDING ATTORNEYS'
FEES) ARISING DIRECTLY OR INDIRECTLY FROM THE SOLE OR CONTRIBUTORY NEGLIGENCE OF
ANY OF SUCH INDEMNIFIED PARTIES.
SECTION 11. No Joint Venture. The Company and the Manager are not
partners or joint venturers with each other and nothing herein shall be
construed to make them such partners or joint venturers or impose any liability
as such on either of them.
SECTION 12. Term; Termination.
(a) This Agreement shall commence on the date set forth above
and shall continue in force until the second anniversary of such date,
and thereafter, it shall be subject to successive one-year renewal
periods upon the review and approval of the Independent Trust Managers.
If the Independent Trust Managers do not resolve to renew or terminate
this Agreement within at least 90 days prior to the end of the
then-current period of this Agreement, this Agreement shall be
automatically extended for a one-year period. The Manager shall have
the right, following the initial term of this Agreement, to terminate
this Agreement at any time upon not less than 180 days prior written
notice. The Company shall have the right, following the initial term of
this Agreement and subject to Section 12(b), to terminate this
Agreement at any time upon not less than 90 days prior written notice.
(b) In addition to such further liability or obligation of
either party to the other provided in Sections 15 and 16, if this
Agreement is terminated by the Company without cause (as "cause" is
defined in Section 14) by delivery of a notice of non-renewal or
termination pursuant to Section 12(a), the Company, in addition to its
obligations under Section 15, shall pay the Manager a termination fee
in an amount equal to the sum of the Manager's base management fee and
incentive compensation earned pursuant to Sections 7(a) and 7(b) during
the four calendar quarters immediately preceding such termination. Such
termination fee shall be paid no later than 30 days following receipt
of the accounting contemplated by Section 15(b).
SECTION 13. Assignments.
(a) Except as set forth in Section 13(b), this Agreement shall
terminate automatically in the event of its assignment, in whole or in
part, by the Manager, unless such assignment is consented to in writing
by the Company with the consent of a majority of the Independent Trust
Managers. Any such assignment approved by the Independent Trust
Managers, in their sole discretion, shall bind the assignee hereunder
in the same manner as the Manager is bound. In addition, the assignee
shall execute and deliver to the Company an amendment to this Agreement
naming such assignee as Manager. This Agreement shall not be assigned
by the Company without the prior written consent of the Manager, except
in the case of assignment by the Company to another REIT or other
organization which (i) is a successor to
MANAGEMENT AGREEMENT - PAGE 17
<PAGE> 18
the Company (by merger, consolidation or otherwise by operation of law)
or (ii) is the purchaser of all or substantially all of the assets of
the Company, in which case such successor organization shall be bound
hereunder and by the terms of such assignment in the same manner as the
Company is bound hereunder.
(b) Notwithstanding any provision of this Agreement, the
Manager may subcontract any or assign all of its responsibilities under
this Agreement to any of its qualified Affiliates, and the Company
hereby consents to any such assignment and subcontracting; provided
that no such subcontract or assignment shall relieve the Manager of its
duties and obligations hereunder. The Manager agrees to send copies of
any subcontract or assignment to the Company promptly following its
agreement to the same.
SECTION 14. Termination by the Company for Cause. This Agreement may be
terminated by the Company for "cause" upon 60 days' prior written notice of
termination from the Board of Trust Managers to the Manager, without payment of
any termination fee, if any of the following events shall occur:
(a) if a majority of the Independent Trust Managers shall
determine that the Manager has breached any provision of this Agreement
in any material respect and, within 30 days after receipt of written
notice of such violation, the Manager shall not have cured such
violation, provided that, if such breach is not capable of cure within
such 30-day period, the Manager shall have failed to commence to cure
such breach within such 30-day period and thereafter to diligently and
in good faith prosecute the cure of such breach and further provided,
that if such breach is not capable of cure within any period of time, a
majority of the Independent Trust Managers shall have also determined
that such breach may have a material adverse effect on the business,
operations or financial condition of the Company; or
(b) there is entered an order for relief or similar decree or
order with respect to the Manager by a court having competent
jurisdiction in an involuntary case under the federal bankruptcy laws
as now or hereafter constituted or under any applicable federal or
state bankruptcy, insolvency or other similar laws; or the Manager (i)
ceases, or admits in writing its inability to pay its debts as they
become due and payable, or makes a general assignment for the benefit
of, or enters into any composition or arrangement with, creditors; (ii)
applies for, or consents (by admission of material allegations of a
petition or otherwise) to the appointment of a receiver, trustee,
assignee, custodian, liquidator or sequestrator (or other similar
official) of the Manager or of any substantial part of its properties
or assets, or authorizes such an application or consent, or proceedings
seeking such appointment are commenced without such authorization,
consent or application against the Manager and continue undismissed for
30 days; (iii) authorizes or files a voluntary petition in bankruptcy,
or applies for or consents (by admission of material allegations of a
petition or otherwise) to the application of any bankruptcy,
MANAGEMENT AGREEMENT - PAGE 18
<PAGE> 19
reorganization, arrangement, readjustment of debt, insolvency,
dissolution, liquidation or other similar law of any jurisdiction, or
authorizes such application or consent, or proceedings to such end are
instituted against the Manager without such authorization, application
or consent and are approved as properly instituted and remain
undismissed for 30 days or result in adjudication of bankruptcy or
insolvency; or (iv) permits or suffers all or any substantial part of
its properties or assets to be sequestered or attached by court order
and the order remains undismissed for 30 days. If any of the events
specified in this Section 14(b) shall occur, the Manager shall give
prompt written notice thereof to the Board of Trust Managers.
SECTION 15. Action Upon Termination. From and after the effective date
of termination of this Agreement, the Manager shall not be entitled to
compensation for further services hereunder, but shall be paid all compensation
accruing to the date of termination and, if terminated for any reason other than
for "cause" under Section 14, the applicable termination fee. Upon such
termination, the Manager shall forthwith:
(a) after deducting any accrued compensation, any applicable
termination fee and reimbursement for its expenses permitted hereunder
to which it is then entitled, promptly pay over to the Company all
money collected and held for the account of the Company pursuant to
this Agreement;
(b) deliver to the Board of Trust Managers a full accounting,
including a statement showing all payments collected by it, all
expenses incurred by it and a statement of all money held by it,
covering the period following the date of the last accounting furnished
to the Board of Trust Managers with respect to the Company; and
(c) deliver to the Board of Trust Managers all property,
documents, records and reports of the Company or pertaining to the
Company's assets or operations then in the custody of the Manager.
SECTION 16. Release of Money or Other Property Upon Written Request.
The Manager agrees that any money or other property of the Company held by the
Manager under this Agreement shall be held by the Manager as custodian for the
Company, and the Manager's records shall be appropriately marked clearly to
reflect the ownership of such money or other property by the Company. Upon the
receipt by the Manager of a written request signed by a duly authorized officer
of the Company requesting the Manager to release to the Company any money or
other property then held by the Manager for the account of the Company under
this Agreement, the Manager shall release such money or other property to the
Company within a reasonable period of time, but in no event later than 60 days
following such request. Subject to Section 10, the Manager shall not be liable
to the Company, the Independent Trust Managers, or the Company's shareholders or
partners for any acts performed or omissions to act by the Company in connection
with the money or other property released to the Company in accordance with this
Section 16. The Company shall indemnify the Manager, its directors, officers,
stockholders, partners
MANAGEMENT AGREEMENT - PAGE 19
<PAGE> 20
and employees against any and all expenses, losses, damages, liabilities,
demands, charges and claims of any nature whatsoever, which arise in connection
with the Manager's release of such money or other property to the Company upon
written request of the Company in accordance with the terms of this Section 16.
Indemnification pursuant to this provision shall be in addition to any right of
the Manager to indemnification under Section 10.
SECTION 17. Representations and Warranties.
(a) The Company hereby represents and warrants to the Manager
as follows:
(i) The Company is duly organized and validly
existing under the laws of the jurisdiction of its
incorporation, has the power to own its assets and to transact
the business in which it is now engaged and is duly qualified
as a foreign corporation and in good standing under the laws
of each jurisdiction where its ownership or lease of property
or the conduct of its business requires such qualification,
except for failures to be so qualified, authorized or licensed
that could not in the aggregate have a material adverse effect
on the business operations, assets or financial condition of
the Company. the Company does not do business under any
fictitious business name.
(ii) The Company has the power and authority to
execute, deliver and perform this Agreement and all
obligations required hereunder and has taken all necessary
action to authorize this Agreement on the terms and conditions
hereof and the execution, delivery and performance of this
Agreement and all obligations required hereunder. No consent
of any other person, including, without limitation,
shareholders and creditors of the Company, and no license,
permit, approval or authorization of, exemption by, notice or
report to, or registration, filing or declaration with, any
governmental authority is required by the Company in
connection with this Agreement or the execution, delivery,
performance, validity or enforceability of this Agreement and
all obligations required hereunder. This Agreement has been,
and each instrument or document required hereunder will be,
executed and delivered by a duly authorized officer of the
Company, and this Agreement constitutes, and each instrument
or document required hereunder when executed and delivered
hereunder will constitute, the legally valid and binding
obligation of the Company enforceable against the Company in
accordance with its terms.
(iii) The execution, delivery and performance of this
Agreement and the documents or instruments required hereunder
will not violate any provision of any existing law or
regulation binding on the Company, or any order, judgment,
award or decree of any court, arbitrator or governmental
MANAGEMENT AGREEMENT - PAGE 20
<PAGE> 21
authority binding on the Company, or the Governing Instruments
of the Company or of any mortgage, indenture, lease, contract
or other agreement, instrument or undertaking to which the
Company is a party or by which the Company or any of its
assets may be bound, the violation of which would have a
material adverse effect on the business operations, assets or
financial condition of the Company, and will not result in, or
require, the creation or imposition of any lien on any of its
property, assets or revenues pursuant to the provisions of any
such mortgage, indenture, lease, contract or other agreement,
instrument or undertaking.
(b) The Manager hereby represents and warrants to the Company
as follows:
(i) The Manager is duly organized, validly existing
and in good standing under the laws of the jurisdiction of its
formation, has the power to own its assets and to transact the
business in which it is now engaged and is duly qualified to
do business and is in good standing under the laws of each
jurisdiction where its ownership or lease of property or the
conduct of its business requires such qualification, except
for failures to be so qualified, authorized or licensed that
could not in the aggregate have a material adverse effect on
the business operations, assets or financial condition of the
Manager and its subsidiaries, taken as a whole. The Manager
does not do business under any fictitious business name.
(ii) The Manager has the power and authority to
execute, deliver and perform this Agreement and all
obligations required hereunder and has taken all necessary
action to authorize this Agreement on the terms and conditions
hereof and the execution, delivery and performance of this
Agreement and all obligations required hereunder. No consent
of any other person including, without limitation, partners
and creditors of the Manager, and no license, permit, approval
or authorization of, exemption by, notice or report to, or
registration, filing or declaration with, any governmental
authority is required by the Manager in connection with this
Agreement or the execution, delivery, performance, validity or
enforceability of this Agreement and all obligations required
hereunder. This Agreement has been, and each instrument or
document required hereunder will be, executed and delivered by
a duly authorized agent of the Manager, and this Agreement
constitutes, and each instrument or document required
hereunder when executed and delivered hereunder will
constitute, the legally valid and binding obligation of the
Manager enforceable against the Manager in accordance with its
terms.
(iii) The execution, delivery and performance of this
Agreement and the documents or instruments required hereunder,
will not violate any provision of any existing law or
regulation binding on the Manager, or any
MANAGEMENT AGREEMENT - PAGE 21
<PAGE> 22
order, judgment, award or decree of any court, arbitrator or
governmental authority binding on the Manager, or the
partnership agreement of the Manager or of any mortgage,
indenture, lease, contract or other agreement, instrument or
undertaking to which the Manager is a party or by which the
Manager or any of its assets may be bound, the violation of
which would have a material adverse effect on the business
operations, assets or financial condition of the Manager and
its subsidiaries, taken as a whole, and will not result in, or
require, the creation or imposition of any lien on any of its
property, assets or revenues pursuant to the provisions of any
such mortgage, indenture, lease, contract or other agreement,
instrument or undertaking.
SECTION 18. Notices. Unless expressly provided otherwise herein, all
notices, requests, demands and other communications required or permitted under
this Agreement shall be in writing and shall be deemed to have been duly given,
made and received when delivered against receipt or upon actual receipt of
registered or certified mail, postage prepaid, return receipt requested,
addressed as set forth below:
(a) If to the Company:
AMRESCO Capital Trust
700 North Pearl Street
Suite 2400
Dallas, Texas 75201
Attention: President and General Counsel
MANAGEMENT AGREEMENT - PAGE 22
<PAGE> 23
(b) If to the Manager:
AMREIT Managers, L.P.
700 North Pearl Street
Suite 2400
Dallas, Texas 75201
Attention: President and General Counsel
Either party may alter the address to which communications or copies
are to be sent by giving notice of such change of address in conformity with the
provisions of this Section 18 for the giving of notice.
SECTION 19. Binding Nature of Agreement; Successors and Assigns. This
Agreement shall be binding upon and inure to the benefit of the parties hereto
and their respective heirs, personal representatives, successors and assigns as
provided herein.
SECTION 20. Entire Agreement. This Agreement contains the entire
agreement and understanding among the parties hereto with respect to the subject
matter hereof, and supersedes all prior and contemporaneous agreements,
understandings, inducements and conditions, express or implied, oral or written,
of any nature whatsoever with respect to the subject matter hereof. The express
terms hereof control and supersede any course of performance and/or usage of the
trade inconsistent with any of the terms hereof.
SECTION 21. Amendment. This Agreement may not be modified or amended
other than by an agreement in writing signed by the Manager and the Company,
provided that the amendment of any provision of this Agreement requiring consent
or approval of any matter by a majority of the Independent Trust Managers may
not be amended without the approval of a majority of the Independent Trust
Managers.
SECTION 22. CONTROLLING LAW. THIS AGREEMENT AND ALL QUESTIONS RELATING
TO ITS VALIDITY, INTERPRETATION, PERFORMANCE AND ENFORCEMENT SHALL BE GOVERNED
BY AND CONSTRUED, INTERPRETED AND ENFORCED IN ACCORDANCE WITH THE LAWS OF THE
STATE OF TEXAS.
SECTION 23. Indulgences, Not Waivers. Neither the failure nor any delay
on the part of a party to exercise any right, remedy, power or privilege under
this Agreement shall operate as a waiver thereof, nor shall any single or
partial exercise of any right, remedy, power or privilege preclude any other or
further exercise of the same or of any other right, remedy, power or privilege,
nor shall any waiver of any right, remedy, power or privilege with respect to
any occurrence be construed as a waiver of such right, remedy, power or
privilege with respect to any other occurrence. No waiver shall be effective
unless it is in writing and is signed by the party asserted to have granted such
waiver.
MANAGEMENT AGREEMENT - PAGE 23
<PAGE> 24
SECTION 24. Titles Not to Affect Interpretation. The titles of
paragraphs and subparagraphs contained in this Agreement are for convenience
only, and they neither form a part of this Agreement nor are they to be used in
the construction or interpretation hereof.
SECTION 25. Execution in Counterparts. This Agreement may be executed
in any number of counterparts, each of which shall be deemed to be an original
as against any party whose signature appears thereon, and all of which shall
together constitute one and the same instrument. This Agreement shall become
binding when one or more counterparts hereof, individually or taken together,
shall bear the signatures of all of the parties reflected hereon as the
signatories.
SECTION 26. Provisions Separable. The provisions of this Agreement are
independent of and separable from each other, and no provision shall be affected
or rendered invalid or unenforceable by virtue of the fact that for any reason
any other or others of them may be invalid or unenforceable in whole or in part.
SECTION 27. Attorneys' Fees. Should any action or other proceeding be
necessary to enforce any of the provisions of this Agreement or the various
transactions contemplated hereby, the prevailing party will be entitled to
recover its actual reasonable attorneys' fees and expenses from the
non-prevailing party.
SECTION 28. Gender. Words used herein regardless of the number and
gender specifically used, shall be deemed and construed to include any other
number, singular or plural, and any other gender, masculine, feminine or neuter,
as the context requires.
MANAGEMENT AGREEMENT - PAGE 24
<PAGE> 25
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first written above.
"COMPANY"
AMRESCO CAPITAL TRUST
By: /s/ Michael L. McCoy
------------------------------
Name: Michael L. McCoy
------------------------------
Title: Senior Vice President
------------------------------
"MANAGER"
AMREIT MANAGERS, L.P.
By: AMREIT MANAGERS G.P., INC.
its general partner
By: /s/ Thomas J. Andrus
------------------------------
Name: Thomas J. Andrus
------------------------------
Title: Executive Vice President
------------------------------
MANAGEMENT AGREEMENT - PAGE 25
<PAGE> 26
EXHIBIT "A"
TO MANAGEMENT AGREEMENT
AMRESCO CAPITAL TRUST
OPERATING POLICIES
PRELIMINARY STATEMENT
I. INVESTMENT POLICIES
II. CAPITAL AND LEVERAGE POLICIES
III. CREDIT RISK MANAGEMENT POLICIES
IV. FINANCIAL RISK MANAGEMENT POLICIES
V. POLICIES REGARDING TRANSACTIONS WITH THE AMRESCO GROUP
VI. REIT COMPLIANCE POLICIES
VII. POLICY REGARDING INVESTMENT COMPANY ACT
SCHEDULE I - DEFINITIONS
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 1
<PAGE> 27
PRELIMINARY STATEMENT
The following operating policies of AMRESCO Capital Trust (the
"Company") are intended to be guidelines for the business and operations of the
Company. Such policies are intended to be reviewed from time to time and may be
changed from time to time by the Board of Trust Managers, in their sole
discretion without shareholder approval. As used in these policies, the term
"Company" means either AMRESCO Capital Trust, a Texas real estate investment
trust ("AMCT") or AMCT collectively with its affiliates, as the context
requires, the term "AMRESCO Group" means AMRESCO, INC. and its affiliated
entities (other than the Manager) and the term "Manager" means AMREIT Managers,
L.P., an affiliate of AMRESCO. Other capitalized terms used in these policies
have the meanings set forth on Schedule I attached.
SECTION 1. INVESTMENT POLICIES
A. General
1. Principal Business Objective. The Company's principal
business objective is to maximize shareholder value by producing cash flow for
distribution to its shareholders through investment in mid- to high-yield real
estate related assets which earn an attractive spread over the Company's cost of
funds. The investment policies set forth below are intended to enable the
Company to achieve its principal business objective.
2. Role of the Manager. The Manager is authorized in
accordance with the terms of the Management Agreement to make all day-to-day
investment decisions of the Company based on the policies and guidelines set
forth below. The Manager should use all commercially reasonable efforts to
determine, in good faith, whether each investment proposed to be made by the
Company conforms to the policies and guidelines set forth below. All proposed
investments shall be reviewed and approved by the Investment Committee prior to
investment.
3. Review by the Board. The Board will review the investments
of the Company on a quarterly basis to determine general compliance with the
policies and guidelines set forth below.
B. Investment Objectives
1. General. The Company will invest in those real estate
related assets which it believes are likely to generate attractive risk-adjusted
returns on capital invested, after considering all material relevant factors.
Initially the Company intends to invest in a diversified portfolio of commercial
and multifamily Mortgage Loans (including, among others, Participating Loans,
Mezzanine Loans, Construction Loans and Bridge Loans), MBS, and commercial real
estate (including, but not limited to, Net Leased Real Estate, real estate
acquired at foreclosure or by deed-in-lieu of foreclosure or other
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 2
<PAGE> 28
underperforming or Distressed Real Estate). Investments in real estate may also
take the form of equity investments in partnerships and joint ventures, but not
in corporations in which more than 10% of the voting shares would be owned by
the Company or which would represent more than 5% of the value of the Company's
total consolidated assets (unless such corporation is a Qualified REIT
Subsidiary), and shall otherwise be structured in compliance with the REIT
Provisions of the Code.
2. Types of Investments. The Company shall invest principally
in the following types of investments:
(a) Mortgage Loans. The Company may invest in various
types of commercial and multifamily Mortgage Loans, including without
limitation Permanent Mortgage Loans, Participating Loans, Construction
Loans, Mezzanine Loans, Bridge Loans or any combination thereof. The
Company may not invest directly nor originate residential Mortgage
Loans secured by single family (one-to-four unit) residential property.
(i) Limits on Investments. The Manager's
loan underwriters will be afforded flexibility and latitude
with respect to the size of any single Mortgage Loan, but
shall generally target loans ranging from $10 million to $40
million. However, without the prior approval of the Board, the
Company's investment in any one Mortgage Loan may not exceed
the greater of (A) $75 million in principal amount outstanding
or (B) 10.0% of the Company's total consolidated assets.
(ii) Coinvestment. The Company may invest in
any Mortgage Loan alone or may coinvest with others. If the
Company coinvests in any Mortgage Loan with any member of the
AMRESCO Group, such investment must be made in accordance with
the Company's policies regarding transactions with members of
the AMRESCO Group.
(iii) Concentration Limits. The Manager
shall seek to achieve diversification in the Company's assets
to avoid undue geographic, borrower, issuer, product type,
industry and certain other types of concentrations. The
Company may, in the future, in consultation with the Manager
and the Investment Committee, establish specified limitations
or parameters as to the foregoing concentrations. The Manager
shall seek to invest, on the Company's behalf, primarily in
Mortgage Loans secured by property located in the United
States and in foreign countries in which the AMRESCO Group has
previously conducted business.
(iv) Sources of Loans. Mortgage Loans in
which the Company invests may be either originated or
purchased by the Company. Purchased loans may be purchased
individually, through loan participations or syndications or
in pools and may include Distressed Mortgage Loans. Loans
purchased from any member of the AMRESCO Group must be
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 3
<PAGE> 29
purchased in accordance with the Company's policies regarding
transactions with members of the AMRESCO Group.
(v) Pricing. In determining the rate at
which an originated Mortgage Loan will bear interest, or the
price at which a purchased Mortgage Loan will be acquired, the
Manager should consider the following factors, in addition to
the Company's targeted rate of return on such investment:
market conditions, market interest rates, the availability of
mortgage credit and other economic factors, the term of the
Mortgage Loan, the liquidity of the Mortgage Loan, the
limitations on the obligations of the borrower and/or seller
with respect to the Mortgage Loan, the rate and timing of
payments to be made with respect to the Mortgage Loan, the
mortgaged property underlying the Mortgage Loan, the existence
and quality of any credit enhancement related to such Mortgage
Loan, the risk of adverse fluctuations in the market values of
that mortgaged property as a result of economic events or
governmental regulations, the historical performance and other
attributes of the property manager responsible for managing
the mortgaged property, relevant laws limiting actions that
may be taken with respect to Mortgage Loans and limitations on
recourse against the borrower following realization on the
collateral through various means, risks of timing with respect
to Mortgage Loan prepayments, risks associated with geographic
concentration of mortgaged property, environmental risks,
pending and threatened litigation, junior liens and other
issues relating to title, a prior history of real estate
mortgage and other contractual defaults by affiliated parties
on similar and dissimilar obligations, and other factors
deemed relevant by the Manager.
(vi) Due Diligence. In considering whether
to originate or acquire any Mortgage Loan, the Manager should
perform certain due diligence tasks on behalf of the Company
that reasonably may be expected to provide relevant and
material information as to the value of such Mortgage Loan and
whether the Company should originate or acquire that Mortgage
Loan, including all such information described above as
necessary to be considered in connection with the pricing of a
Mortgage Loan or as may be required by any warehouse lender.
(vii) Credit Risk Management. Each Mortgage
Loan investment must be in accordance with the Company's
credit risk management policies and underwriting criteria,
including its policies or criteria, to the extent applicable,
regarding loan-to-value ratios or loan-to-cost ratios,
borrower and tenant credit quality, credit enhancement,
collateral requirements, etc.
(viii) Compliance With Other Policies. Each
Mortgage Loan investment shall comply with Company policies,
including, without limitation,
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 4
<PAGE> 30
its policies regarding compliance with the REIT Provisions of
the Code and exclusions from regulation under the Investment
Company Act.
(b) MBS. The Company may invest in all types of MBS,
including, without limitation, all types of investment grade and
non-investment grade CMBS and RMBS (except that the Company does not
currently intend to invest in RMBS secured by lower credit quality
Mortgage Loans known as "B," "C" and "D" Mortgage Loans).
(i) Limits on Investments. Without the prior
approval of the Board, the percentage of the Company's total
consolidated assets which may be invested in MBS at any time
may not exceed 40%. The Company may, in the future, in
consultation with the Manager and Investment Committee,
establish specified limitations or parameters on the
percentage of the Company's total consolidated assets invested
in MBS that may be related to any one issuer.
(ii) Coinvestment. The Company may invest in
any MBS alone or may coinvest with others. If the Company
coinvests in any MBS with any member of the AMRESCO Group,
such investment must be made in accordance with the Company's
policies regarding transactions with members of the AMRESCO
Group.
(iii) Sources of MBS. MBS may be purchased
by the Company from any source. MBS purchased from any member
of the AMRESCO Group must be purchased in accordance with the
Company's policies regarding transactions with members of the
AMRESCO Group.
(iv) Pricing. In determining the price at
which to acquire any MBS, the Manager should consider, in
addition to the Company's targeted rate of return on such
investment, the following factors: (A) the quality of the
underlying collateral pool, (B) the prepayment and default
history of the underlying Mortgage Loans, (C) cash flow
analyses under various prepayment and interest rate scenarios
(including sensitivity analyses), (D) an analysis of various
default scenarios and (E) prices paid for similar MBS by bona
fide third parties or broker price opinions. Because there are
so many characteristics to consider, each MBS should be
analyzed individually, taking into consideration both
objective data as well as subjective analysis.
(v) Due Diligence. The Company shall, in
consultation with the Manager, determine the scope of review
to be performed before the Company acquires MBS, which will be
designed to provide sufficient information regarding the MBS
to enable the Company to make a decision regarding the
acquisition and pricing of the MBS. The due diligence should
include an analysis of the information described above as
necessary to be
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 5
<PAGE> 31
considered in connection with the pricing of MBS. With respect
to CMBS, the Manager will use sampling and other appropriate
analytical techniques to determine which Mortgage Loans will
undergo a full-scope review or a more streamlined review
process. Considerations that should influence the choice for
scope of review should generally include size of the loan,
debt service coverage ratio, loan-to-value ratio, maturity of
the loan, lease rollover, property type and geographic
location. A full-scope review may include, among other
factors, a site inspection, tenant-by-tenant rent roll
analysis, review of historical income and expenses for each
property securing the Mortgage Loan, a review of major leases
for each property (if available); recent appraisals (if
available), engineering and environmental reports (if
available), and the price paid for similar CMBS by unrelated
third parties in arm's length purchases and sales (if
available) or a review of broker price opinions (if the price
paid by a bona fide third party for similar CMBS is not
available and such price opinions are available). For those
Mortgage Loans that are selected for the more streamlined
review process, the Manager's evaluation may include a review
of the property operating statements, summary loan level data,
third party report and a review of prices paid for similar
CMBS by bonafide third parties or broker price opinions, each
as available. If the Manager's review of such information does
not reveal any unusual or unexpected characteristics or
factors, no further due diligence need be performed.
(vi) Compliance With Other Policies. Each
MBS investment must be in accordance with all Company
policies, including, without limitation, its policies
regarding compliance with the REIT Provisions of the Code and
exclusion from regulation under the Investment Company Act and
the Investment Advisors Act.
(c) Real Estate. The Company intends to invest in
various types of commercial real estate, including, but not limited to,
Net Leased Real Estate, REO Properties and other Distressed Real
Estate.
(i) Coinvestment; Manner of Investment. The
Company may invest in any real estate project alone or may
coinvest with others. Investments may be made directly by the
Company or through partnerships or other entities formed with
other parties, including members of the AMRESCO Group. If the
Company coinvests in any real estate project with any member
of the AMRESCO Group, such investment must be made in
accordance with the Company's policies regarding transactions
with members of the AMRESCO Group.
(ii) Concentration Limits. The Manager shall
seek to avoid undue geographic and product type concentrations
with respect to the Company's commercial real estate, when
considered together with the Company's other invested assets.
The Manager will seek to invest, on the
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 6
<PAGE> 32
Company's behalf, primarily in commercial real estate located
in the United States and in other foreign countries in which
the AMRESCO Group has previously conducted business.
(iii) Sources. Real estate may be purchased
by the Company from any source. Real estate purchased from any
member of the AMRESCO Group must be purchased in accordance
with the Company's policies regarding transactions with
members of the AMRESCO Group.
(iv) Pricing. The Company's policy is to
determine the fair market value of real estate utilizing those
procedures that the Company and the Manager deem relevant for
the specific real estate being evaluated, which procedures
need not be the same for each property being evaluated.
Information that may be examined in determining the fair
market value of a property includes the following: (A) the
Company's projected rate of return on such investment; (B)
current and historical operating statements; (C) existing or
new appraisals; (D) sales comparables; (E) industry statistics
and reports regarding operating expenses; (F) existing leases
and market rates for comparable leases; (G) deferred
maintenance observed during site inspections or described in
structural and engineering reports; and (H) correspondence and
other documents and memoranda found in the files of the seller
of that real estate or other relevant parties. The Manager is
expected to develop projections of net operating income and
cash flows taking into account lease rollovers, tenant
improvement costs and leasing commissions. The Manager should
compare its estimates of revenue and expenses to historical
operating statements and estimates provided in appraisals and
general industry and regional statistics. Market
capitalization rates and discount rates should then be applied
to the cash flow projections to estimate values. These values
should then be compared to available appraisals and market
sale comparables to determine recommended bid prices for each
property. The amount offered by the Company generally should
take into account projected holding periods, capital costs and
projected profit expectations.
(v) Due Diligence. The Manager should
conduct an investigation and evaluation of all real estate
proposed to be purchased. The Manager should include within
its due diligence review and analysis of the real estate
contemplated to be acquired a review of market studies for
each geographic market in which the real estate proposed to be
purchased is concentrated, including area economic data,
employment trends, absorption rates and market rental rates.
Such due diligence analyses generally also should include (A)
site inspections of properties, (B) a review of all property
files and documentation that are made available to the Company
or the Manager, (C) a Phase I environmental assessment for
each property, and (D) all other information necessary to
determine a fair price for such property. The Manager's review
should include, to the extent possible,
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 7
<PAGE> 33
examinations of available legal documents, litigation files,
correspondence, title reports, operating statements,
appraisals, engineering reports and environmental reports,
among other due diligence items.
(vi) Credit Risk Management. Each real
estate investment must be in accordance with the Company's
credit risk management policies, including its policies
regarding tenant credit quality.
(vii) Compliance With Other Policies. Each
real estate investment must be in accordance with all Company
policies including without limitation its policies regarding
compliance with the REIT Provisions of the Code and exclusion
from regulation under the Investment Company Act.
(d) Other Investments. The Company may also pursue a
variety of complementary commercial real estate and finance-related
businesses and investments in furtherance of its business objective.
Such activities may include, but are not limited to, foreign real
estate-related asset investments, equity interests or other investments
in other REITs, registered investment companies, partnerships and other
investment funds and real estate operating companies to the extent
permitted by the REIT Provisions of the Code. Any such investments may
be made by the Company in accordance with the operating policies of the
Company upon approval of the Investment Committee.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 8
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SECTION 2. CAPITAL AND LEVERAGE POLICIES
A. General. The Company intends to increase its invested assets through
the use of leverage in order to create yields commensurate with its investment
objectives. The Company intends to utilize leverage in a manner that is prudent
and consistent with maintaining an acceptable level of risk.
B. Limitations on Indebtedness. The Company's Leverage Ratio (i.e.,
ratio of (i) indebtedness with respect to which the Company is the obligor to
(ii) the Company's total outstanding equity) shall not exceed (at the time any
debt is incurred) 3:1, without the prior approval of the Board of Trust
Managers.
C. Sources of Financing. The Company may utilize a variety of debt
vehicles, including warehouse lending arrangements, reverse repurchase
agreements, securitizations of mortgage loans or other secured or unsecured
financing sources, as deemed appropriate by the Manager, considering the
availability of financing sources and existing rates and market conditions at
any given time.
D. Securitizations. The Company may obtain secured financing through
the securitization of all or any portion of its Mortgage Loans. Securitizations
may be accomplished through the issuance of structured debt, with the Company
retaining an equity interest in the collateral or through a "sale" of the
underlying Mortgage Loans, if the Manager reasonably determines there are
structural or other advantages to such form of securitization. Any
securitizations conducted by the Company under which a "sale" of an interest in
Mortgage Loans occurs shall be conducted, to the extent permitted by the REIT
Provisions of the Code, through one or more taxable subsidiaries of the Company,
unless otherwise approved by the Board of Trust Managers or the Company's
investment or tax compliance officer. In addition, any such securitizations
shall be structured, to the extent practicable, to minimize the attribution of
any Excess Inclusion income to the Company's shareholders.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 9
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SECTION 3. CREDIT RISK MANAGEMENT POLICIES
A. General. The Company is expected to be exposed to various levels of
credit and special hazard risks depending on the nature of its investments. The
Company's policy is to manage such risk by originating or otherwise acquiring
only those assets which satisfy the Company's underwriting criteria and credit
quality standards and, through the activities of the Manager, by closely
monitoring the quality and performance of its invested assets.
B. Investment Committee. The Manager will establish one or more
Investment Committees (an "Investment Committee") which will meet regularly to
consider whether the Company should invest in specific Targeted Investments.
Subject to the following conditions, the voting members of an Investment
Committee may vary depending on the type of Targeted Investment under
consideration. At least two-thirds of the members of the Investment Committee
present and voting, must vote in favor of a particular Targeted Investment
before the Targeted Investment may be purchased, acquired or originated by the
Company. A quorum must be present for any meeting of the Investment Committee. A
quorum shall consist of a minimum of four of the members of the Investment
Committee and must include at least two of the following officers of the
Company: the President, the Chief Investment Officer and the Chief Operating
Officer. The Board of Trust Managers will monitor the Invested Portfolio and the
credit risk associated therewith.
C. Portfolio Review Program. The Manager shall implement a Portfolio
Review Program to provide for periodic review of the Invested Portfolio so that
potential credit problems can be recognized and addressed at the earliest
opportunity.
D. Underwriting Criteria and Credit Quality. The Company shall, from
time to time, in consultation with the Manager and the Investment Committee,
establish underwriting criteria and credit quality standards for the various
types of assets in which the Company intends to invest. Such underwriting
criteria shall include, without limitation, the following:
1. Loan to Value Ratios. The Company will typically not loan
in excess of 90% of the "stabilized" value of the property or in excess
of 100% of the cost of a property (which may include budgeted
construction period interest in the case of a Construction Loan).
2. Return Requirements. In underwriting a Mortgage Loan, the
Manager will model the economic return to the Company and the borrower
to determine whether the loan is economically feasible. The Manager is
not required to establish minimum debt service coverage ratios, but
shall underwrite to a "market" debt service coverage ratio in
evaluating the viability of refinancing of a loan. With respect to MBS,
the Manager shall utilize bond models (including those of AMRESCO,
Charter Research and dealers), as appropriate, to project potentials
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 10
<PAGE> 36
for delinquency, prepayment and extension and to project losses and
returns prior to pricing of transactions.
3. Concentrations of Credit. The Manager shall seek to
diversify and balance the Company's portfolio to minimize risk and
potential losses. To the extent applicable, the Manager shall monitor
the Company's Mortgage Loan concentrations from the perspectives of (i)
the size of any single loan, (ii) the total size of the transaction if
the Company is in a subordinate loan position, (iii) the aggregate
amount of loans to one borrower, (iv) geographic concentrations, (v)
property type concentrations. The Company may, in the future (in
consultation with the Investment Committee and the Manager), establish
specified limitations or parameters as to the foregoing concentrations.
With respect to the Company's MBS portfolio, the Manager shall employ
the following risk control guidelines: (i) investments should be made
in a manner intended to minimize overweighing of economic concentration
as measured by the quotient of the weighted average loan distribution
(compared to the U.S. as a whole) of the largest states divided by the
size of the state's economy relative to the entire U.S. economy, (ii)
no single property type shall represent more than 50% of the Company's
entire MBS portfolio, (iii) distribution of loan sizes intended to
result in favorable loss distributions (large loans must be
individually analyzed and determined to be secure enough to protect the
Company's position) and (iv) the establishment of a maximum percentage
of the Company's MBS portfolio that may be represented by a single
issuer.
4. Insurance Requirements. The Manager shall require that the
borrower or owner, as applicable, maintain, at all times during the
term of the loan or the investment, liability, hazard, rent loss,
flood, earthquake and/or other insurance coverage as may be applicable,
in such amounts and in accordance with the requirements established
from time to time by the Manager.
5. Borrower or Tenant Credit Quality. The Manager shall review
and analyze the credit history, net worth, liquidity, etc. of each
borrower/guarantor or significant tenant, as applicable.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 11
<PAGE> 37
SECTION 4. FINANCIAL RISK MANAGEMENT POLICY
A. General. The objective of the Company's Financial Risk Management
Policy is to ensure that business exposures to risk are identified, measured,
and are managed in the most effective and efficient methods within established
guidelines. It is the Company's policy to hedge as much of the interest rate
risk as the Manager determines is in the best interest of the Company, given the
cost of and risks involved with such hedges and the Company's desire not to
jeopardize its status as a REIT.
B. Financial Risk Management Committee. The Trust Managers will
establish the Financial Risk Management Committee to assist it in establishing
financial risk management, hedging and derivatives policies and to oversee and
monitor the Company's management of risk and use of derivatives. The Committee
will be composed initially of the Chairman of the Board of Company, Chief
Executive Officer ("CEO"), Chief Operating Officer ("COO"), Chief Investment
Officer ("CIO"), Chief Financial Officer ("CFO"), Treasurer and Chief Accounting
Officer. At least 50% of the members of the Financial Risk Committee are
required to constitute a quorum at any meeting of such Committee and at least
two-thirds of those present and voting at any meeting is required for approval
of any action. The Committee can also designate other persons to act as
nonvoting members who serve in an advisory capacity. To assist the Committee in
operating decisions and implementation of policy and procedures, it may
establish a Financial Risk Steering Committee to handle operational issues.
C. General Objectives for the Use of Derivatives. Derivative
transactions or hedging activities are not to be undertaken for speculative
purposes, but only to lessen risks associated with earnings, credit, interest
rate, foreign currency, and other similar risks. Use of derivatives is not
automatic, nor is it necessarily the only response to managing business risk.
Derivative transactions should only be undertaken after the risks that have been
identified are determined to exceed defined levels established by this Policy
and are considered to be unavoidable because they are necessary or support
normal business activities.
The use of derivatives involves risks such as credit, liquidity, basis,
settlement, legal and systemic. Derivatives should be used only to the extent
that the Manager determines that the expected benefit of such use (after
considering the cost of the derivative transactions) is considered to outweigh
these risks. The Manager should avoid any incremental increase in the Company's
overall market exposure from the use of derivatives.
D. Specific Objectives for Use of Derivatives. Derivatives may be used
to protect foreign activities, including foreign revenue sources, specific
assets and liabilities denominated in foreign currencies, to hedge firm
commitments and forecasted transactions that expose the Company to risk, and to
protect against exchange rate movements between different currencies that impact
revenue and profit expressed in U.S. Dollars. Derivatives may also be used to
protect the value of the Company's investments in
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 12
<PAGE> 38
Mortgage Loans and MBS and to hedge purchase commitments and forecasted
transactions that expose the Company to risk and to protect against interest
rate movements that negatively impact the value and/or intended execution of a
transaction.
E. Prohibitions on Use of Derivatives.
1. General. Derivatives shall not be used for trading,
speculation, or any other purpose in which the objective is to generate
profits. Derivative transactions are considered speculative if they are
perceived (at the time such transaction is entered into) to increase
risk, if their use has no relation to objectives specified by the
Company's policy, or if their use is not intended and expected to
manage business risks that have been identified.
2. Leverage. Derivative transactions are considered to be
highly leveraged if they expose the Company to loss in excess of gains
expected to be generated by positions and transactions they modify.
Unless approved by the Board of Trust Managers, the Manager shall not
utilize highly leveraged derivatives as they generally do not reduce
risk.
3. Valuation. Unless otherwise approved by the Board of Trust
Managers, the Manager shall avoid using any derivative for which a
market quotation cannot be obtained or which cannot be valued reliably
internally by the financial staff using valuation methodologies that
have been approved for use by the Financial Risk Management Committee.
4. GAAP Accounting. Use of derivatives that do not qualify for
hedge accounting or deferral accounting under generally accepted
accounting principles shall not be utilized unless approval is obtained
from the Financial Risk Management Committee.
5. Accounting Motivated Transactions. Derivative transactions
that are primarily motivated by accounting implications and do not
reduce economic or business risk exposure shall not be utilized.
Derivative transactions are considered to be accounting motivated
transactions if they result in the current recognition of revenue or
current reduction of cost as a result of incurring a liability to be
recognized in the future or taking a risk to be determined and settled
in the future.
Use of derivatives solely to manage earnings is prohibited.
Derivative transactions are unauthorized if the intention of the
transaction is to recognize a profit by closing out, modifying,
terminating or offsetting the derivative instrument, even if the
transaction would otherwise meet the requirements for use under this
policy.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 13
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F. Operating Limitations on Use of Derivatives.
1. Forecasted Transactions. Forecasted transactions that are
not expected to occur within one year generally are not considered to
be probable of occurring under this policy. The Manager shall not use
derivatives to hedge such forecasted transactions unless specific
written approval is obtained from the Financial Risk Management
Committee.
2. Derivative Products and Strategies. Use of the following
products and strategies requires specific approval for each transaction
by the Financial Risk Management Committee:
o Written options
o Combination options involving the use of written options
o Written options embedded in swaps and other derivatives
o Selective hedging and partial hedging of exposures outside of
preapproved parameters that have been identified
o Frequent buying and selling or terminating derivatives used in
risk management activities not specifically related to
changing positions of the matched items
3. Types of Contracts Authorized for Use. The Company may use
the following derivative instruments specifically approved by the
Financial Risk Management Committee:
Cash Market Derivatives
o Treasury or Eurodollar securities
o Futures contracts Treasury or Eurodollar securities
o Purchased options on Treasury and Eurodollar features
o MBS forward securities
Mortgage Backed Securities ("MBS") - FNMA, GNMA, FHLMC, and Other Debt
Securities
o Futures contracts on MBS and other debt securities
o Purchase options on MBS and other debt securities
o MBS forward cash securities
Interest Rate Derivatives
o Interest rate swaps
o Interest rate caps, floors and collars
o Options on swaps
Foreign Currency Derivatives
o Currency forwards and futures
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 14
<PAGE> 40
o Purchased currency options
o Combination foreign currency options - where the notional
amount and maturity date exactly match the underlying
transaction being hedged and the cost of the purchased options
is equal to or greater than the proceeds received on the
option sold
o Foreign currency derivatives - authorized for use by business
units exposed to foreign currency risk to the extent
identified by the risk identification and measurement process
Use of any derivative not specifically identified above requires the written
approval of the Financial Risk Management Committee.
G. Counterparty Risk. The Company will only enter into derivative
transactions with counterparties that have a current senior debt rating by
either Standard & Poor's Rating Services, a division of McGraw-Hill Companies,
or Moody's Investors Service, Inc. of A or better or the equivalent rating by
other recognized rating agencies approved by the Financial Risk Management
Committee.
The Company will generally continue in a derivative transaction if the
counterparty's credit rating is downgraded to BBB. Appropriate steps should be
taken by the Manager to minimize risks if the counterparty's credit rating is
downgraded below BBB. Such steps may include obtaining collateral or some other
acceptable form of credit enhancement, or terminating the transactions, if
practicable. The Manager shall notify the Financial Risk Management Committee of
all credit downgrades. The Committee must approve the actions proposed to be
taken with respect to a transaction where the counterparty's credit rating is
downgraded below BBB.
The Company will not enter into a new derivative transaction with a
counterparty if the new transaction will result in credit exposure exceeding
limits specified by the Financial Risk Management Committee. Such limits are
currently set as follows:
(Senior Debt Rating)
o For counterparties rated AAA Unlimited
o For counterparties rated AA Unlimited
o For counterparties rated A 10% of the Company's Equity
For purposes of this paragraph, "credit exposure" means the greater of the
current net market value of all derivative transactions with the counterparty,
or 5% of the total notional value of the derivatives with that counterparty.
H. Authorized Brokers. The Manager is authorized, on behalf of the
Company, to enter into derivative transactions with primary dealers and other
financial institutions as follows:
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 15
<PAGE> 41
o Any "primary" government security dealer as approved from time to time
by the Federal Reserve Bank of New York.
o Any commercial bank which is FDIC insured and maintains a commercial
paper rating in the top two credit categories from a rating service of
national prominence.
o Any SEC-registered broker dealer that meets the voluntary capital
requirements of the Federal Reserve Bank of New York.
o Any federal agency or federally sponsored agency.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 16
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SECTION 5. POLICIES REGARDING TRANSACTIONS WITH THE AMRESCO GROUP
A. General. As a result of the Company's relationship with the AMRESCO
Group (including, particularly, as a result of the Right of First Refusal and
the Correspondent Agreement), the Company expects to benefit from the market
reputation, expertise and relationships developed by the AMRESCO Group and the
potential investment opportunities (including coinvestment opportunities)
expected to be identified through the AMRESCO Group. It is the intention of the
Company that the agreements and transactions, including the sale of or
coinvestment in any asset, between the Company and the AMRESCO Group be fair to
the Company and be on terms at least as favorable as those the Company could
have obtained from unaffiliated third parties. Accordingly, the following
procedures should be implemented to assist the Company in ascertaining that any
transactions and agreements with the AMRESCO Group meet such standard.
B. Acquisitions from Members of the AMRESCO Group.
1. The Company may acquire assets which meet its investment
criteria and objectives (other than CMBS or RMBS issued in
securitizations sponsored by members of the AMRESCO Group) from members
of the AMRESCO Group, without prior approval from the Independent Trust
Managers provided that:
(a) the Chief Investment Officer reasonably
determines in good faith that the price of the asset is no
greater and the terms of the sale are no less favorable than
that which would be available from third parties for similar
investments;
(b) the purchase price of any individual asset or
pool of assets proposed to be purchased at any one time does
not exceed the greater of $75 million or 10.0% of the
Company's total consolidated assets, determined before the
proposed acquisition; and
(c) when possible, the price that the Company will
pay for any asset acquired from the AMRESCO Group shall be
determined by reference to the prices most recently paid to
the AMRESCO Group for similar investments, adjusted for
differences in the terms of such transactions and for changes
in market conditions between the dates of the relevant
transactions. If no previous sales of comparable investments
have occurred, the Manager shall attempt to determine a market
price for the asset by obtaining a broker's price opinion or
an appraisal, if it can do so at a reasonable cost.
2. Assets which do not meet the criteria set forth above may
be purchased from any member of the AMRESCO Group only with the prior
approval of a majority of the Independent Trust Managers (or a majority
of the Independent Trust Managers of any authorized Committee of the
Board).
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 17
<PAGE> 43
3. The Company may purchase CMBS or RMBS issued in
securitizations sponsored by members of the AMRESCO Group only in a
competitive bidding situation and upon prior approval of a majority of
the Independent Trust Managers.
C. Coinvestments with Members of The AMRESCO Group.
1. The Company may coinvest in any asset with any member of
the AMRESCO Group, without prior approval from the Independent Trust
Managers, provided that the terms of the Company's investment is
substantially similar to the terms of the investment of the AMRESCO
Group, except for such differences as may be attributable solely to the
size of the investment.
2. Any potential coinvestments by the Company with any member
of the AMRESCO Group which exceed $15 million (in the aggregate, during
any calendar year) and which contemplate investment terms for the
Company which are different than those proposed for any member of the
AMRESCO Group will require the prior approval of a majority of the
Independent Trust Managers (or a majority of the Independent Trust
Managers of any authorized Committee of the Board).
D. Expense Reimbursement and Allocation Matters.
1. Due diligence and underwriting expenses incurred by the
Manager or any member of the AMRESCO Group may be charged to and
reimbursed by the Company only after an asset has been preliminarily
approved for investment by the Chief Investment Officer or other
authorized officer of the Company.
2. The Manager may incur due diligence, underwriting and other
costs and expenses on behalf of the Company, provided that, in the
event costs and expenses with respect to any one transaction are
expected to exceed $500,000, the incurrence of such costs and expenses
must be approved, in advance, by the Board of Trust Managers (or a
majority of the Independent Trust Managers of any authorized Committee
of the Board).
3. In the event that any member of the AMRESCO Group purchases
or otherwise invests in all or any portion of an asset with respect to
which due diligence, underwriting or other costs of which have been
charged to or reimbursed by the Company, the Company shall recover from
the AMRESCO Group all or the applicable portion of such costs and
expenses allocable to the investment by the AMRESCO Group.
4. To the extent any member of the AMRESCO Group (other than
the Manager) provides services to the Company pursuant to the
Management Agreement or otherwise for which it is entitled to receive
payment or compensation, such payment or compensation shall be
reasonable and no greater than amounts which are charged by third
parties in arms-length transactions.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 18
<PAGE> 44
E. Quarterly Review of Related Party Transactions. The Independent
Trust Managers shall review, on a quarterly basis, all (i) acquisitions of
assets by the Company from members of the AMRESCO Group made during the
preceding calendar quarter (including the prices of and the terms of such
acquisitions) which were not specifically approved for acquisition by the
Independent Trust Managers, (ii) all coinvestments made with any member of the
AMRESCO Group during the preceding calendar quarter, (iii) the reasonableness of
the expenses paid to any member of the AMRESCO Group and (iv) the terms of all
other transactions between the Company and any member of the AMRESCO Group.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 19
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SECTION 6. REIT COMPLIANCE POLICIES
A. General. It is the Company's intention to qualify as a REIT under
the Code beginning with its taxable year ending on December 31, 1998.
Accordingly, the Company shall conduct its business in accordance with the
following procedures so as to meet the (i) organizational requirements, (ii)
income tests, (iii) asset tests and (iv) annual distribution requirements
applicable to REITs.
B. Organizational Requirements. The Company shall enforce the "Excess
Share" provisions of its Declaration of Trust prohibiting ownership of more than
9.8% of the Common Shares by any person, subject to the exceptions provided
therein. In addition, on or before January 30th of each year, the Company shall
send a letter demanding information regarding the amount of shares each such
shareholder constructively owns (the "shareholder demand letters") (i) in the
event the Company has 2,000 or more shareholders of record on any dividend
record date, from each record holder of 5% or more of its shares, (ii) in the
event the Company has less than 2,000 and more than 200 shareholders of record
on any dividend record date, from each record holder of 1% or more of its shares
and (iii) in the event the Company has 200 or less shareholders of record on any
dividend record date, from each shareholder of record of one-half of 1% or more
of its shares.
C. Income Tests. At least 75% of the Company's gross income (excluding
income from prohibited transactions) for each taxable year shall be derived
directly or indirectly from investments relating to real property or mortgages
on real property (including "rents from real property" and interest) or from
certain types of temporary investments. In addition, at least 95% of the
Company's gross income (excluding income from prohibited transactions) for each
taxable year must be derived from such real property investments and from
dividends, interest and gain from the sale or disposition of securities.
1. Acquisition of Assets. Prior to purchasing, originating or
otherwise acquiring any asset (including, without limitation, any
acquisition by foreclosure or deed-in-lieu of foreclosure), such asset
will be reviewed and analyzed by the Company's investment compliance
officer (and, to the extent the investment compliance officer or other
executive officer of the Company determines necessary, by qualified
REIT tax counsel) to ensure that the acquisition and ownership will not
cause the Company to fail to qualify as a REIT for federal income tax
purposes. To the extent that any proposed acquisition includes an
equity investment in real estate or a Mortgage Loan or a pool of
Mortgage Loans secured by real estate, the Company shall require the
owner of the real estate or the borrower, as applicable, to complete a
"checklist," make representations, and/or otherwise supply requisite
information regarding the nature of the income from and the operation
of the property to enable the Company's investment compliance officer
(or REIT tax counsel, as applicable) to determine whether such proposed
investment satisfies the income tests applicable to REITs.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 20
<PAGE> 46
2. Other Income. Prior to entering into any transaction which
may result in the receipt by the Company of income (whether through the
sale or lease of assets, the provision of services, the entering into
of a hedging transaction or otherwise), such transaction will be
reviewed and analyzed by the Company's investment compliance officer
(and, to the extent the investment or tax compliance officer or other
executive officer of the Company determines necessary, by qualified
REIT tax counsel) to ensure that the receipt of income from such
transaction will not cause the Company to fail to qualify as a REIT for
federal income tax purposes. If the investment compliance officer or
qualified REIT tax counsel determines it to be appropriate, the Company
may transfer certain nonqualifying activities to a taxable corporation
from which it may receive dividends, to the extent permitted by the
Code.
D. Asset Tests. At least 75% of the value of the Company's total assets
shall be represented by cash or cash items (including certain receivables),
government securities, "real estate assets" (including loans secured by real
estate interests) or, in certain cases, temporary investments as defined in or
permitted by the Code. In addition to the foregoing requirement, the value of
any one issuer's securities owned by the Company shall not exceed 5% of the
value of the Company's total consolidated assets, and the Company shall not own
more than 10% of any one issuer's outstanding voting securities (except for its
interests in any qualified REIT subsidiary). Prior to any acquisition or
disposition of the Company's assets, the investment compliance officer (or
qualified REIT counsel, as applicable) shall review such proposed acquisition or
disposition to determine that such acquisition or disposition will not cause the
Company to fail to qualify as a REIT for federal income tax purposes as a result
of the foregoing asset tests.
E. Annual Distribution Requirements. The Company shall make quarterly
distributions to its shareholders equal, on an annual basis, to at least 95% of
the Company's REIT taxable income (computed without regard to the dividends paid
deduction and any net capital gains).
F. Review by Independent Accounting Firm. The Company shall cause its
independent accounting firm to review, in connection with its quarterly review
of the financial statements of the Company, the Company's compliance with the
REIT Provisions of the Code. The Company shall cause its independent accounting
firm to review, in connection with its annual audit of the financial statements
of the Company, the Company's compliance with the REIT Provisions of the Code
and, in connection therewith, to prepare and deliver, on an annual basis, a
report of its findings with respect thereto to the Board.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 21
<PAGE> 47
SECTION 7. POLICY REGARDING INVESTMENT COMPANY ACT
A. General. The Company intends to be primarily engaged in the business
of purchasing or otherwise acquiring "mortgages and other liens on and interests
in real estate" and therefore to be excluded from regulation under the
Investment Company Act.
B. Percentage of Assets Constituting Interests in Real Estate. The
Company shall maintain at least 55% of its assets directly in Mortgage Loans,
MBS which represent all of the beneficial interest in the underlying pool of
Mortgage Loans, direct equity investments in real estate and other qualifying
liens on and interests in real estate.
C. Collateral Rights. With respect to any proposed investment in any
MBS which does not represent all of the beneficial interest in the underlying
pool of Mortgage Loans, the Manager shall seek (where appropriate and feasible)
to obtain the right to foreclose on the underlying property, to control the
oversight and management of the resolution of the underlying Mortgage Loans by
workout or modification of loan provisions, foreclosure, deed in lieu of
foreclosure or otherwise and to control decisions with respect to the
preservation of the collateral generally (collectively, the "Collateral
Rights").
D. Maximum Percentage of Partial MBS Interests. Without the prior
approval of the Board of Trust Managers (or any authorized Committee of the
Board), the Company's aggregate investments in MBS shall not exceed, at the time
of such investment, 40% of the Company's total consolidated assets.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 22
<PAGE> 48
SCHEDULE I
DEFINITIONS
Capitalized terms used above have the meanings set forth below, unless
the context indicates otherwise.
"Board" means the Board of Trust Managers of AMCT.
"Bridge Loan" means a Mortgage Loan used for temporary financing.
"CMBS" means commercial or multifamily MBS.
"Code" means the Internal Revenue Code of 1986, as amended.
"Common Shares" means AMCT's common shares of beneficial interest, par
value $.01 per share.
"Construction Loan" means a Mortgage Loan the proceeds of which are to
be used to finance the costs of construction or rehabilitation of real property.
"Correspondent Agreement" means the nonexclusive Correspondent
Agreement between Holliday Fenoglio Fowler and the Company.
"Distressed Mortgage Loans" means Subperforming Mortgage Loans and
Nonperforming Mortgage Loans.
"Distressed Real Estate" means REO Properties and other underperforming
or otherwise distressed real estate.
"Investment Company Act" means the Investment Company Act of 1940, as
amended.
"Investment Committee" means the committee(s) maintained by the Manager
(which committee(s) will include the President and the Chief Investment Officer
of the Company) which must approve the purchase, acquisition or origination by
the Company of any Targeted Investment.
"Management Agreement" means the agreement by and between the Company
and the Manager whereby the Manager agrees to perform certain services to the
Company in exchange for certain compensation.
"MBS" means mortgage-backed securities (including CMBS and RMBS).
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 23
<PAGE> 49
"Mezzanine Loan" means a commercial real estate loan the repayment of
which is subordinated to a senior Mortgage Loan and which is secured either by a
second lien mortgage or a pledge of the ownership interests of the borrower.
Such loans can also take the form of a direct equity investment in a partnership
or joint venture.
"Mortgage Collateral" means mortgage pass-through securities or pools
of whole loans securing or backing a series of CMBS.
"Mortgage Loans" means, collectively, loans secured by real property
and Mezzanine Loans.
"Net Leased Real Estate" means real estate that is net leased on a
long-term basis (ten years or more) to tenants who are typically responsible for
paying a majority of the costs of owning, operating, and maintaining the leased
property during the term of the lease, in addition to the payment of a monthly
rent to the landlord for the use and occupancy of the premises.
"Nonperforming Mortgage Loans" means Mortgage Loans for which the
payment of principal and/or interest is more than 90 days delinquent.
"Participating Loan" means a Mortgage Loan that entitles the lender to
the receipt of interest based on a percentage of the mortgaged property's
revenues or cash flow, and/or any gain on sale of the property which
Participating Loan may be a Mezzanine Loan, Construction Loan, Bridge Loan or
other Mortgage Loan.
"Permanent Mortgage Loans" means long-term senior Mortgage Loans.
"Qualified REIT Subsidiary" means a corporation whose stock is entirely
owned by the Company at all times during such corporation's existence.
"REIT" means a real estate investment trust, as defined under Section
856 of the Code.
"REIT Provisions of the Code" means Sections 856 through 860 of the
Code.
"REO Property" means real estate acquired at foreclosure (or by deed in
lieu of foreclosure).
"Residual Interests" means REMIC Residual Interests and non-REMIC
Residual Interests collectively.
"Right of First Refusal" means the right to be granted by AMRESCO to
the Company with respect to Targeted Mortgage Loans and MBS, pursuant to which
AMRESCO will agree not to permit any member of the AMRESCO Group to invest in
(i) the first $100 million of Targeted Mortgage Loans which are identified by or
to any member of the AMRESCO Group during any calendar quarter, or (ii) any MBS,
other than MBS issued
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 24
<PAGE> 50
in securitizations sponsored in whole or in part by any member of the AMRESCO
Group, unless the Investment Committee shall have first determined, in each
case, that the Company should not invest in such asset or assets, or should
invest in only a portion of such asset or assets.
"RMBS" means a series of one-to four-family residential MBS.
"Subordinated Interests" means classes of MBS that are subordinated in
right of payments of principal and interest to more senior classes.
"Subperforming Mortgage Loans" means Mortgage Loans for which default
is likely or imminent or for which the borrower is making payments in accordance
with a forbearance plan.
"Targeted Investments" means the various types of real estate related
assets targeted to be invested in by the Company.
"Targeted Mortgage Loans" means any Mortgage Loan which (i) meets the
investment criteria and objectives of the Company and (ii) has been
preliminarily reviewed and approved for further consideration by any member of
the AMRESCO Group.
EXHIBIT "A" TO MANAGEMENT AGREEMENT - PAGE 25
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