<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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
Securities registered pursuant to Section 12(b) of the Act:
NONE
(Title of class)
Securities registered pursuant to Section 12(g) of the Act:
COMMON SHARES OF BENEFICIAL INTEREST, $0.01 PAR VALUE PER SHARE
PREFERRED SHARE PURCHASE RIGHTS
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
As of March 1, 1999, 10,006,111 shares of the registrant's common stock, par
value $.01 per share, were outstanding. As of that date, the aggregate market
value of the shares of common stock held by non-affiliates of the registrant
(based upon the closing price of $9.00 per share on March 1, 1999 as reported
on The Nasdaq Stock Market(R)) was approximately $75.0 million. Shares of
common stock held by each executive officer and trust manager have been
excluded in that such persons may be deemed to be affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed for the
Annual Meeting of Shareholders to be held on May 11, 1999 are incorporated by
reference in Part III of this report.
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AMRESCO CAPITAL TRUST
INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I
Item 1. Business .................................................................. 3
Item 2. Properties ................................................................ 11
Item 3. Legal Proceedings ......................................................... 11
Item 4. Submission of Matters to a Vote of Security Holders ....................... 11
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder
Matters ................................................................ 12
Item 6. Selected Financial Data ................................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations .................................................. 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ................ 25
Item 8. Financial Statements and Supplementary Data ............................... 28
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ................................................... 28
PART III
Item 10. Trust Managers and Executive Officers of the Company ...................... 28
Item 11. Executive Compensation .................................................... 28
Item 12. Security Ownership of Certain Beneficial Owners and Management ............ 28
Item 13. Certain Relationships and Related Transactions ............................ 28
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K .......... 29
SIGNATURES ........................................................................... 31
</TABLE>
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PART I
ITEM 1. BUSINESS
OVERVIEW
AMRESCO Capital Trust (the "Company") was organized on January 6, 1998 as a
real estate investment trust 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
through the sale of 100 of its common shares of beneficial interest, par value
$.01 per share (the "Common Shares"), to AMRESCO, INC. ("AMRESCO") on February
2, 1998 for $1,000. The Company 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 (the
"Private Placement") at $15.00 per share. The net proceeds from the IPO and the
Private Placement, after the underwriters' discount and offering expenses
attributable to the IPO, aggregated approximately $139.7 million. Immediately
after the closing of the IPO, the Company began originating and acquiring
investments. As of September 30, 1998, the Company had fully invested the
proceeds from the IPO and the Private Placement and had begun to leverage its
investments. At December 31, 1998, the Company had debt outstanding, excluding
non-recourse debt on real estate, of $39.3 million.
The Company believes it has operated and it intends to continue to operate in a
manner so as to continue to qualify as a real estate investment trust ("REIT")
under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended
(the "Code"). As a result, the Company will generally not be subject to federal
income tax on that portion of its ordinary income or capital gain that is
currently distributed to its shareholders if it distributes at least 95% of its
annual REIT taxable income and it complies with a number of other
organizational and operational requirements including, among others, those
concerning the ownership of its outstanding Common Shares, the nature of its
assets and the sources of its income.
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 and investment activities are managed by AMREIT
Managers, L.P. (the "Manager"), an affiliate of AMRESCO (together with its
affiliated entities, the "AMRESCO Group") which was formed in March 1998. 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 and
0.5% per annum of the Company's average invested investment grade assets. 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. In addition to
the fees described above, the Manager is entitled to receive reimbursement for
its costs of providing certain due diligence and professional services 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 (the "IPO Price") and the remaining 30%
of the options are exercisable at an option price of $18.75 per share. The
options vest ratably over a four-year period commencing on the first
anniversary of the date of grant.
AMREIT Holdings, Inc. ("Holdings"), a wholly-owned subsidiary of AMRESCO,
currently owns 1,500,011 shares, or approximately 15% of the Company's
outstanding common stock. Holdings acquired 1,000,011 shares at the IPO Price
pursuant to the Private Placement; the remaining 500,000 shares were acquired
through the IPO. AMRESCO owns 100 shares of the Company's outstanding common
shares; as described above, these shares were acquired on February 2, 1998 in
connection with the initial capitalization of the Company.
Subject to certain limited exceptions, AMRESCO has granted to the Company a
right of first refusal with respect to the first $100 million of targeted
mortgage loan investments which are identified by or to any member of the
AMRESCO Group during any calendar quarter and all mortgage-backed securities
(other than mortgage-backed securities issued in securitizations sponsored in
whole or in part by any member of the AMRESCO Group). Additionally, the Company
has entered into a Correspondent Agreement with Holliday Fenoglio Fowler, L.P.
("HFF"), a member of the AMRESCO Group, pursuant to which HFF presents to the
Company (on a non-exclusive basis) investment opportunities identified by HFF
which meet the investment criteria and objectives of the Company.
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EMPLOYEES
The Company has no employees nor does it maintain a separate office. Instead,
the Company relies on the facilities and resources of the Manager and its
executive officers, each of whom is employed by AMRESCO. The Company is not a
party to any collective bargaining agreements. AMRESCO is a publicly-traded,
diversified financial services company specializing in real estate lending,
asset management services and commercial finance. AMRESCO is headquartered in
Dallas, Texas and has offices located throughout the United States, as well as
internationally in Canada, the United Kingdom, Mexico and Japan. AMRESCO, which
began operating in 1987, employs approximately 3,700 people.
BUSINESS STRATEGY
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 Company intends to achieve this objective
by making opportunistic investments while maintaining a conservative leverage
position. Specifically, the Company's strategy is to:
o Invest in senior mortgage loans, mezzanine loans, CMBS, commercial real
estate (either directly or through investments in joint ventures and/or
partnerships) and certain other opportunistic investments including,
without limitation, foreign real estate and loans to borrowers in foreign
countries or secured by foreign real estate (principally in the markets in
which the AMRESCO Group conducts business) and distressed loans and/or
real estate. The Company invests opportunistically, pursuing those
investments which it believes will generate the highest risk-adjusted
returns on capital invested, after considering all material relevant
factors including, but not limited to, any limitations imposed by the Code
as a result of its status as a REIT.
o Take advantage of expertise existing within, and investment and
co-investment opportunities arising from the business and operations of,
the AMRESCO Group. During 1998, the Company acquired 10 loans from the
AMRESCO Group at an aggregate purchase price of $39.7 million.
o Utilize the expertise and resources of HFF to monitor trends and demands
in the mortgage loan and real estate markets and to adjust its mortgage
loan products in response thereto in order to increase its ability to
successfully compete for investments.
o Through the Manager, capitalize upon the market research capabilities of
the AMRESCO Group to analyze the Company's investment opportunities and
the economic conditions in the Company's proposed geographic markets to
assist the Company in selecting investments which satisfy the Company's
investment criteria and targeted returns.
o Through the Manager, utilize the expertise of the AMRESCO Group in the
underwriting, origination and closing of mortgage loans and in the
acquisition, management and servicing of mortgage loans, mortgage loan
portfolios and CMBS.
o Borrow against or leverage its investments (through its existing credit
facilities and any new sources of debt financing which the Company may be
able to secure), to the extent consistent with the Company's leverage
policies, in order to increase the size of its portfolio and increase
potential returns to the Company's shareholders. Currently, the Company
intends to maintain a debt to equity ratio of no more than 2.5 to 1,
excluding non-recourse debt on real estate. At December 31, 1998, the
Company's debt to equity ratio, excluding non-recourse debt on real
estate, was 0.3 to 1. Including non-recourse debt on real estate, the
Company's debt to equity ratio was 0.4 to 1 at December 31, 1998.
o Implement various hedging strategies, including, but not limited to,
interest rate swaps and interest rate collars, caps or floors (to the
extent permitted by the REIT provisions of the Code) to minimize the
effects of interest rate fluctuations on its investments and its
borrowings if, given the cost of such hedges and the Company's desire not
to jeopardize its status as a REIT, the Manager determines that such
strategies are in the best interest of the Company's shareholders.
o Manage the credit risk of its assets by (i) extensively underwriting its
investments utilizing the processes developed and utilized by the AMRESCO
Group, (ii) selectively choosing its investments for origination or
acquisition in compliance with the Company's investment policies, (iii)
actively monitoring (through the servicing and asset
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management capabilities of the AMRESCO Group) the credit quality of its
assets, and (iv) maintaining appropriate capital levels and allowances for
credit losses.
INVESTMENT ACTIVITIES
General
The Manager is authorized in accordance with the terms of the Management
Agreement to make the day-to-day investment decisions of the Company based on
guidelines in effect and approved from time to time by the Company's Board of
Trust Managers. The Trust Managers review all transactions of the Company on a
quarterly basis to determine compliance with the guidelines. Due to the
typically higher risk nature of its investments, the Manager selectively and
extensively underwrites the Company's targeted investments utilizing the
expertise, processes and procedures developed by the AMRESCO Group.
The Company operates exclusively as an investor in real estate related assets.
Its asset allocation decisions and investment strategies are influenced by
changing market factors and conditions. The Company has no policy requiring
that any specific percentage of its assets be invested in any particular type
or form of real estate investment nor does it limit any particular type or form
of real estate investment (other than CMBS) to a specific percentage. CMBS
investments, by policy, cannot exceed 40% of the Company's total consolidated
assets. From time to time, the percentage of the Company's investments that
will be invested in a particular category of real estate assets will vary.
Future investment opportunities that may be available to the Company will
depend upon many factors including, but not limited to, regional, national and
international economic conditions.
To date, the Company's investment activities have been focused in three primary
areas: loan investments, CMBS and equity investments in real estate. Each of
these investment categories is more fully described below. During the period
from May 12, 1998 (inception of operations) through December 31, 1998, revenues
derived from each of these categories were as follows (dollars in thousands):
<TABLE>
<CAPTION>
Amount % of Total
------ ----------
<S> <C> <C>
Loan investments $4,834 55%
Investments in CMBS 1,563 18
Equity investments in real estate 181 2
Other 2,167 25
------ ---
$8,745 100%
====== ===
</TABLE>
Revenues derived from loan investments are included in the Company's
consolidated statement of income as follows: interest income on mortgage loans
- - $4,278,000; operating income from real estate - $211,000; and equity in
earnings of other real estate ventures - $345,000. The Company provides
financing through certain real estate loan arrangements that, because of their
nature, qualify as either real estate or joint venture investments for
financial reporting purposes. Such determination by the Company affects the
balance sheet classification of these investments and the recognition of
revenues derived therefrom. For a discussion of these loan arrangements as well
as operating profit and information regarding the Company's assets, reference
is made to the audited consolidated financial statements and notes thereto
included in Item 8 of this report. Other is comprised principally of interest
income which was derived from the temporary investment of the Company's IPO and
Private Placement proceeds prior to their deployment in real estate related
investments and, to a lesser extent, of income from its unconsolidated taxable
subsidiary.
The Company does not have, nor does it rely upon, any major customers.
Consistent with its investments to date, the Company currently expects that a
substantial portion of its new investments will be made in the form of senior
mortgage loans. To date, the Company has made no investments outside of the
United States nor has it made any investments in distressed loans and/or real
estate, although it may do so in the future.
Loan Investments
The Company specializes in providing mid- to high-yield senior and mezzanine
financing to real estate owners and developers on a participating and
non-participating basis. Mezzanine loans, the repayment of which is
subordinated to senior mortgage loans, are secured by a second lien mortgage
and/or a pledge of the ownership interests of the borrower. Mezzanine loans
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generally afford a relatively higher yield and entail greater risks than senior
mortgage loans. Senior mortgage loans and mezzanine loans comprised 83% and
17%, respectively, of the Company's loan investment portfolio at December 31,
1998 (based on committed amount). The Company's existing mortgage loan
commitments range in size from $0.5 million to $45 million; currently, the
Manager, on behalf of the Company, is targeting loans ranging in size from $5
million to $20 million.
The Company believes that its relationship with the AMRESCO Group and, in
particular, HFF, one of the largest commercial mortgage bankers in the United
States in 1998 (based on origination volume), provide the Company with a
competitive advantage in sourcing loan and equity investment opportunities.
During 1998, HFF sourced 45% of the Company's loan and equity real estate
commitments (based on commitment amount). In addition to the product sourcing
capabilities of HFF, the Manager relies upon its numerous business
relationships, referral business and repeat customers in generating investment
opportunities for consideration by the Company.
Loan structures vary as they are usually customized to fit the characteristics
and purpose of the loans. Generally, the Company's loans have terms ranging
from one to three years. Many of the Company's loans, particularly construction
and rehabilitation loans, provide for initial investments followed by
subsequent advances as costs are incurred by the borrower. Typically, loans
provide for a fixed pay rate and fixed accrual rate of interest and, in some
cases, may also provide for profit participation above the contractual accrual
rate. The incremental interest earned at the accrual rate is often times not
payable by the borrower until maturity of the loan. At December 31, 1998, the
Company had 21 loan investments which accrue interest at accrual rates ranging
from 10.5% to 16% per annum; four of the 21 loan investments provide the
Company with the opportunity for profit participation in excess of the
contractual accrual rates.
The following table sets forth information regarding the location of the
properties securing the Company's loan investments at December 31, 1998
(dollars in millions):
<TABLE>
<CAPTION>
% of Total
Committed Loan Amount Committed
Amount Outstanding Amount
--------- ----------- ----------
<S> <C> <C> <C>
Texas $118 $ 70 56%
Massachusetts 54 33 26
California 24 21 12
Ohio 7 7 3
Washington, D.C. 7 6 3
---- ---- ----
$210 $137 100%
==== ==== ====
</TABLE>
At December 31, 1998, the Company's loan investments were collateralized by the
following product types (dollars in millions):
<TABLE>
<CAPTION>
% of Total
Committed Loan Amount Committed
Amount Outstanding Amount
--------- ----------- ----------
<S> <C> <C> <C>
Office $132 $ 81 63%
Mixed Use 26 24 12
Apartment 23 13 11
Other 29 19 14
---- ---- ----
$210 $137 100%
==== ==== ====
</TABLE>
The Company is obligated to fund its loan 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 upon and therefore the total
commitment amounts do not necessarily represent future cash requirements. Until
the investment portfolio becomes larger, geographic and product type
concentrations are expected. As the Company's loan portfolio grows, further
geographic and product type diversification will be sought by the Manager.
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The Company typically originates its loan investments; however, it may also
purchase mortgage loans from other parties, including members of the AMRESCO
Group. To the extent the Company acquires mortgage loans from the AMRESCO
Group, such acquisitions are made in strict conformance with the Company's
policies regarding transactions with the AMRESCO Group. During the period from
May 12, 1998 (inception of operations) through December 31, 1998, the Company
acquired 10 loans from the AMRESCO Group for an aggregate purchase price of
$39.7 million. Currently, any proposed acquisition or sale of assets involving
a member of the AMRESCO Group requires the prior approval of a majority of the
Independent Trust Managers of the Investment Committee of the Board of Trust
Managers.
The underwriting process for loans takes into account special risks associated
with mid- to high-yield lending, including an in-depth assessment of the
character, experience (including operating history) and financial capacity of
the borrower or the borrowers' principal(s), a detailed analysis of the
property or project being financed and an analysis of the market in which the
borrower operates, including competition, market share data, comparable
properties, absorption rates and market rental rates as well as general
information such as population, employment trends, median income and
demographic data. Prior to closing, the Manager will either obtain a Phase I
environmental assessment or review a recently obtained Phase I environmental
assessment and at least one of the Manager's representatives will perform a
site inspection. Sources of information which may be examined (if available)
during the due diligence process include: (a) current and historical operating
statements; (b) existing or new appraisals; (c) sales comparables; (d) industry
statistics and reports regarding operating expenses; (e) existing leases and
market rates for comparable leases; and (f) deferred maintenance observed
during site inspections and described in structural and engineering reports.
Using all of the information obtained during the due diligence process, the
Manager then develops projections of net operating income and cash flows to
determine current and expected exit values, as well as appropriate lending
limits and pricing given the risks inherent in each transaction.
As of December 31, 1998, the Company had no realized losses on its portfolio of
outstanding loans and had established loan loss reserves of $1.3 million or 1%
of its aggregate loan balances. One mezzanine loan, representing 5% of the
Company's outstanding loan portfolio, was over 30 days past due as of December
31, 1998. On February 25, 1999, the Company's unconsolidated taxable subsidiary
assumed control of the borrower (a partnership) through foreclosure of the
partnership interests. Currently, the Company does not expect that the ultimate
resolution of this investment will have a material adverse impact on its
financial position or results of operations.
Commercial Mortgage-backed Securities
The Company acquires primarily non-investment grade classes of CMBS from
various sources. In most commercial mortgage securitizations, a series of CMBS
is issued in multiple classes in order to obtain investment-grade credit
ratings for the senior classes (i.e., those with credit ratings of "BBB", "A",
"AA" or "AAA") in order to increase their marketability. The non-investment
grade, or subordinated classes, typically include classes with ratings below
investment grade "BBB". Such subordinated classes also typically include an
unrated higher-yield, credit-support class (which generally is required to
absorb the first losses on the underlying mortgage loans). Each class of CMBS
may be issued with a specific fixed rate or variable coupon rate and has a
stated maturity or final scheduled distribution date. As the subordinated
classes provide credit protection to the senior classes by absorbing losses
from underlying mortgage loan defaults or foreclosures, they carry more credit
risk than the senior classes. Subordinated classes are generally issued at a
discount to their outstanding face value and therefore generally afford a
higher yield than the senior classes.
The Company's investments in CMBS are classified as available for sale and are
carried at estimated fair value as determined by quoted market rates when
available, otherwise by discounting estimated cash flows at current market
rates. Any unrealized gains or losses are excluded from earnings and reported
as a component of accumulated other comprehensive income (loss) in
shareholders' equity.
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During the period from May 12, 1998 (inception of operations) through December
31, 1998, the Company acquired five commercial mortgage-backed securities at an
aggregate purchase price of $34.5 million. At December 31, 1998, the aggregate
amortized cost and estimated fair value of CMBS, by underlying credit rating,
were as follows (dollars in thousands):
<TABLE>
<CAPTION>
Percentage of
Security Aggregate Aggregate Aggregate Total Based
Rating Amortized Cost Unrealized Loss Fair Value on Fair Value
------ -------------- --------------- ---------- -------------
<S> <C> <C> <C> <C>
BB- $ 4,233 $ (618) $ 3,615 13%
B 19,489 (2,952) 16,537 57%
B- 11,277 (2,675) 8,602 30%
------- -------- -------- --------
$ 34,999 $ (6,245) $ 28,754 100%
======== ======== ======== ========
</TABLE>
The Company has recorded an unrealized loss of $230,000, net of tax effects,
related to one commercial mortgage-backed security owned by its unconsolidated
taxable subsidiary. The unconsolidated taxable subsidiary acquired the security
at a purchase price of $3.5 million.
The unrealized loss on securities available for sale had no impact on the
Company's taxable income or cash flow during 1998. 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.
To date, the Company has not directly acquired any unrated CMBS although it may
do so in the future. In early 1999, the Company (through a minority-owned
partnership) acquired a 5% interest in certain unrated CMBS which were
purchased by the partnership for $830,000. Although the Company is not
prohibited from investing in residential mortgage-backed securities, it has no
present intention to do so. The Company may also invest in other mortgage
derivative products (such as interest only and principal only securities);
although it does not currently intend to acquire any of these securities
directly, the Company (through a minority-owned partnership) acquired a 5%
interest in certain interest only securities in early 1999. The interest only
securities were acquired by the partnership at a total cost of $625,000.
Because there are numerous characteristics to consider when evaluating CMBS for
purchase, each CMBS is analyzed individually, taking into consideration both
objective data as well as subjective analysis. The Manager's due diligence may
include an analysis of (i) the underlying collateral pool, (ii) the prepayment
and default history of the mortgage loans previously originated by the
originator, (iii) cash flow analyses under various prepayment and interest rate
scenarios (including sensitivity analyses) and (iv) an analysis of various
default scenarios. However, which of these characteristics (if any) are
important and how important each characteristic may be to the evaluation of a
particular CMBS depends on the individual circumstances. The Manager uses
sampling and other analytical techniques to determine on a loan-by-loan basis
which mortgage loans will undergo a full-scope review and which mortgage loans
will undergo a more streamlined review process. Although the choice is a
subjective one, considerations that influence the choice for scope of review
often include mortgage loan size, debt service coverage ratio, loan-to-value
ratio, mortgage loan maturity, 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 reports, and a
review of prices paid for similar CMBS by bona fide 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 will be performed.
Equity Investments in Real Estate
The Company has made and intends to continue to make equity investments in real
estate. Such investments may be made directly by the Company or through
partnerships and/or joint ventures. The Company expects to acquire real estate
or interests therein on a leveraged basis that will provide sufficient cash
flow to provide a return on its investment after debt service within the
Company's target parameters. The tax depreciation associated with these
investments is used to offset the non-cash accrual of interest on certain loan
investments and original issue discount generally associated with CMBS.
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During the period from May 12, 1998 (inception of operations) through December
31, 1998, the Company entered into a partnership that will ultimately acquire
interests in five newly constructed, grocery-anchored shopping centers in the
Dallas/Fort Worth (Texas) area. The Company holds a 99.5% interest in the
partnership. In October 1998, the Company (through the partnership) acquired
the first of these five centers, an 82,730 square foot facility in Arlington,
Texas, for approximately $10.3 million. In connection with this acquisition,
the title-holding partnership obtained a $7.5 million non-recourse loan from an
unaffiliated third party. Immediately prior to the closing, the Company
contributed $3.4 million of capital to the partnership. The proceeds from this
contribution were used, in part, to fund the balance of the purchase price and
to pay partnership formation expenses and costs associated with the
non-recourse financing. The remaining four centers, initially comprising
approximately 320,000 net rentable square feet, are expected to be acquired at
an aggregate purchase price of approximately $39.6 million. In anticipation of
these acquisitions, the partnership has secured permanent, non-recourse
financing commitments from an unaffiliated third party aggregating $27.1
million. The balance of the acquisition costs, totaling approximately $12.5
million, will be funded by the Company (via equity contributions to the
partnership). The Company anticipates that the remaining four centers will be
acquired during the second and third quarters of 1999 after the completion of
construction and satisfaction of certain other closing conditions. After the
acquisitions are completed, the Company expects to construct an additional
62,000 square feet of space. 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 does not operate the real estate owned by the partnership, but
rather it relies upon a qualified and experienced real estate operator
unaffiliated with the Company. Future investments will be similarly managed by
experienced third party operators.
In considering potential equity investments in real estate, the Manager
performs due diligence substantially similar to that described above in
connection with the acquisition or origination of loan investments.
COMPETITION
The Company competes in the acquisition and origination of investments with a
significant number of other REITs, investment banking firms, savings and loan
associations, banks, mortgage bankers, insurance companies, mutual funds,
credit companies and other entities, some of which have greater financial
resources than the Company. In addition, there are several REITs similar to the
Company, and others may be organized in the future. The effect of the existence
of such additional investors may be to increase competition for the available
supply of targeted investments. The availability of targeted investments is
dependent upon, among other things, the size of and level of activity in the
commercial real estate lending market, which depend on various factors,
including the level of interest rates, regional and national economic
conditions and inflation and deflation in commercial real estate values. To the
extent the Company is unable to acquire and maintain a sufficient volume of
investments, the Company's income and the Company's ability to make
distributions to its shareholders will be adversely affected.
In addition, the Company (to the extent the Company owns commercial real estate
directly or through investments in joint ventures and/or partnerships) and the
owners of real properties securing the Company's mortgage loans compete with
numerous other owners and operators of similar properties, including commercial
developers, real estate companies and REITs, many of which may have greater
financial and other resources and more operating experience than the Company or
the owners of real properties securing the Company's mortgage loans, as
applicable. The Company expects that many of the real properties which may be
owned by it and those owned and operated by borrowers under its mortgage loans
will be located in markets or submarkets in which significant construction or
rehabilitation of properties may occur, which could result in overbuilding in
such markets or submarkets. Any such overbuilding could adversely impact the
ability of the Company to lease its properties and the ability of the borrowers
under the Company's mortgage loans to lease their respective properties and
repay their mortgage loans, which could, in turn, adversely impact the
Company's income and its ability to make distributions to its shareholders.
ENVIRONMENTAL MATTERS
The value and operating costs of real estate acquired by the Company may be
affected by the obligation to pay for the cost of complying with existing and
future environmental legislation under which a current or previous owner or
operator of real estate may be liable for the remediation of hazardous or toxic
substances on, under or in such real estate. As a part of the Manager's due
diligence activities, Phase I environmental assessments are obtained on all
real estate to be acquired by
9
<PAGE> 10
the Company and on the real estate collateralizing its loan investments. The
purpose of Phase I environmental assessments is to identify potential
environmental contamination that is made apparent from historical reviews of
the real estate, reviews of certain public records, preliminary (non-invasive)
investigations of the sites and surrounding real estate, and screening of
relevant records for the presence of hazardous substances, toxic substances and
underground storage tanks. There can be no assurance that such assessments will
reveal all existing or potential environmental risks and liabilities, nor that
there will be no unknown or material environmental obligations or liabilities.
Based on these assessments, the Company believes that its real estate
investments and the real estate underlying its loan investments are in
compliance, in all material respects, with all federal, state and local
ordinances and regulations regarding hazardous or toxic substances and other
environmental matters, the violation of which could have a material adverse
effect on the Company or the borrowers, as applicable. The Company has not been
notified by any governmental authority of any material noncompliance, liability
or claim relating to hazardous or toxic substances or other environmental
matters in connection with any of its owned properties nor is it aware of any
such noncompliance with respect to the real estate collateralizing its loan
investments.
INDUSTRY TRENDS
Although it began on a positive note, 1998 was an extremely difficult year for
REITs in general and mortgage REITs in particular. Even though real estate
fundamentals generally remain strong in most markets, the poor price
performance of REIT stocks appears to have begun early in the year with the
departure of many growth and momentum investors from this market sector.
Downward pressure on REIT stock prices adversely affected the ability of REITs
to access the capital markets for new equity. REITs are limited in their
ability to grow through retained earnings because they are required to
distribute at least 95% of their REIT taxable income annually. In order to
continue to grow its asset base, a REIT must raise new capital either in the
form of equity or debt. Although seven initial public offerings for mortgage
REITs were conducted in 1998, the last offering occurred on May 28, 1998, only
16 days after the completion of the Company's IPO. The last capital markets
transaction involving a mortgage REIT was completed on June 29, 1998. Mortgage
REIT stock prices were further jolted in August 1998 by Russia's default on its
debt payments and in October 1998 by the Chapter 11 bankruptcy filing of CRIIMI
MAE Inc., a mortgage REIT principally focused on subordinated CMBS.
In addition to limitations on access to additional equity, the Office of the
Comptroller of Currency warned federally regulated lenders about its concern
over the amount of debt, particularly unsecured debt, being extended to REITs.
This appears to have caused banks to reduce their level of lending to the REIT
industry and other lenders followed suit. The ability to raise new capital
through the issuance of public debt or preferred stock has also been limited
due to many of the factors affecting new equity issues, but was further
impacted by a flight on the part of bond investors to U.S. Treasury bonds which
was triggered by Russia's debt default. The result was a large increase in the
premium over U.S. Treasury bonds required by investors on other types of bonds
through all ratings classifications. This bond spread widening not only
increased the cost of borrowing, but had a severe negative impact on commercial
mortgage REITs that were holding large portfolios of commercial mortgage-backed
securities because the value of those securities declined significantly and in
some cases precipitated large margin calls.
The Company expects that the capital markets for additional equity will re-open
at some point in the future, but that the current conditions will prevail for
an indeterminate time. This limited access to new equity has been predicted to
lead to an increase in merger and acquisition activity within the REIT sector.
The Company has also noted that a number of companies within the commercial
mortgage REIT sector have begun to liquidate some of their assets. In the
interim, the Company's growth will be limited by the availability under its
credit facilities and to the borrowing restrictions imposed by its lenders. For
additional discussion regarding these trends and the Company's response
thereto, reference is made to the Liquidity and Capital Resources section of
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 of this report.
RECENT DEVELOPMENTS
Given the capital constraints currently limiting the Company's growth, it has
sought to form alliances with third parties who have similar investment
objectives. To that end, the Company recently entered into a partnership with
Olympus Real Estate Corporation ("Olympus") for the purpose of making
investments similar to those made by the Company. The Company, through certain
of its subsidiaries, holds a 5% minority interest in the partnership with
Olympus and could further benefit through a disproportionate percentage of cash
flow to the extent that certain return thresholds are met. The Company has
committed to invest $5 million in the partnership and it has an option (which
expires on August 2, 1999) to
10
<PAGE> 11
invest an additional $5 million. Olympus has committed to invest $95 million in
the partnership subject to adjustment in the event that the Company exercises
its option. The Company made its initial capital contribution to the
partnership, totaling $657,000, on February 12, 1999.
On February 25, 1999, the Company's Board of Trust Managers adopted a
shareholder rights plan (the "Plan"). The Plan was adopted in response to the
consolidation trend in the REIT industry rather than in response to any
specific proposals or communications. The Plan is designed to provide the
Company's Board of Trust Managers with negotiating leverage in dealing with a
potential acquirer, to protect the Company from unfair and abusive takeover
tactics and to prevent an acquirer from gaining control of the Company without
offering a full and fair price to all shareholders. The Plan is not intended to
prevent an acquisition beneficial to all of the Company's shareholders. In
connection with the adoption of the Plan, the Board of Trust Managers declared
a dividend of one preferred share purchase right (a "Right") for each
outstanding Common Share of the Company. The dividend was paid on March 11,
1999 to shareholders of record on March 11, 1999. Each Right entitles the
registered holder to purchase from the Company one one-hundredth of a newly
created Series A Junior Participating Preferred Share ("Preferred Share") for
$37.50 per one one-hundredth of a Preferred Share. The Rights trade with the
Company's Common Shares and are not exercisable until a triggering event, as
defined, occurs.
ITEM 2. PROPERTIES
The Company does not maintain a separate office. It relies exclusively on the
facilities of its manager, AMREIT Managers, L.P. (the "Manager"), an affiliate
of AMRESCO, INC. The executive offices of the Company, the Manager and AMRESCO,
INC. are located at 700 North Pearl Street, Suite 2400, Dallas, Texas 75201.
The Company (through a majority-owned partnership) holds an interest in an
82,730 square foot grocery-anchored shopping center in Arlington, Texas. The
property, which is held subject to a $7.5 million non-recourse loan, was 100%
leased as of March 1, 1999. See sub-heading "Investment Activities/Equity
Investments in Real Estate" in "Item 1. Business".
An unconsolidated taxable subsidiary of the Company holds interests
(indirectly) in a partnership which owns a 909,000 square foot mixed-use
property in Columbus, Ohio. The partnership interests were acquired through
foreclosure on February 25, 1999. The property is held subject to a $17 million
first lien mortgage provided by an unaffiliated third party and a $6.8 million
second lien mortgage provided by one of the Company's wholly-owned
subsidiaries. As of March 1, 1999, the property was 76% leased.
Effective 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. The property is encumbered by a first lien mortgage in the amount of
$13.9 million. As of March 1, 1999, the property was 93% leased.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the fourth quarter of 1998, through the solicitation of proxies or otherwise.
11
<PAGE> 12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
MARKET INFORMATION
The Company's common shares of beneficial interest, par value $.01 per share
(the "Common Shares"), are traded on The Nasdaq Stock Market(R) ("Nasdaq")
under the symbol "AMCT". The following table sets forth for the indicated
periods the high and low sale prices for the Common Shares, as reported by
Nasdaq.
<TABLE>
<CAPTION>
High Low
-------- --------
<S> <C> <C>
1998
Second Quarter (commencing May 7, 1998)...... $ 15.063 $ 12.375
Third Quarter ............................... 13.500 8.688
Fourth Quarter .............................. 10.438 5.875
1999
First Quarter (through March 1, 1999)........ 9.938 8.313
</TABLE>
SHAREHOLDER INFORMATION
At March 1, 1999, the Company had approximately 29 holders of record of its
Common Shares. It is estimated that there were approximately 3,100 beneficial
owners of the Common Shares at that date.
Because the Board of Trust Managers believes it is essential for the Company to
continue to qualify as a REIT, the Company's Declaration of Trust, subject to
certain exceptions, limits the number of Common Shares that may be owned by any
single person or affiliated group to 9.8% (the "Aggregate Share Ownership
Limit") of the total outstanding Common Shares. The Trust Managers may waive
the Aggregate Share Ownership Limit and have waived such Aggregate Share
Ownership Limit with respect to AMRESCO, INC. and its affiliates (for whom
there is no fixed Aggregate Share Ownership Limit) and FMR Corp. (for whom the
Aggregate Share Ownership Limit is 15%). The Aggregate Share Ownership Limit
was also waived for Prudential Securities, Inc. ("PSI") (for whom the Aggregate
Share Ownership Limit was 15%); such waiver expired on December 31, 1998 by
which time PSI's ownership was below 9.8%.
DISTRIBUTION INFORMATION
The Company has adopted a policy of paying quarterly dividends on its Common
Shares. The following table sets forth information regarding the declaration
and payment of dividends by the Company since its commencement of operations on
May 12, 1998 (dollars in thousands, except per share amounts).
<TABLE>
<CAPTION>
Dividend per
Declaration Record Payment Dividend Common
Date Date Date Paid Share
----------------- ----------------- ----------------- --------- ------------
<S> <C> <C> <C>
Period from May 12, 1998
through June 30, 1998 July 23, 1998 July 31, 1998 August 17, 1998 $ 1,001 $ 0.10
Third Quarter October 22, 1998 October 31, 1998 November 16, 1998 2,401 0.24
Fourth Quarter December 15, 1998 December 31, 1998 January 27, 1999 4,002 0.40
--------- ------------
$ 7,404 $ 0.74
========= ============
</TABLE>
For federal income tax purposes, all 1998 dividends were reported as ordinary
income to the Company's shareholders; no portion of the Company's distributions
were a return of capital. In order to maintain its qualification as a REIT, the
Company must make annual distributions to its shareholders of at least 95% of
its taxable income (excluding net capital gains). For its initial taxable year
ended December 31, 1998, the Company declared dividends totaling $0.74 per
share which satisfied the 95% distribution requirement. Under certain
circumstances, the Company may be required to make
12
<PAGE> 13
distributions in excess of cash available for distribution in order to meet the
REIT distribution requirements. In such event, the Company presently would
expect to borrow funds, or to sell assets for cash, to the extent necessary to
obtain cash sufficient to make the distributions required to retain its
qualification as a REIT for federal income tax purposes.
The Company's policy is to distribute at least 95 percent of its REIT taxable
income to shareholders each year. Future distributions, if any, paid by the
Company will be at the discretion of the Board of Trust Managers and will be
dependent upon the Company's tax basis income, its financial condition, capital
requirements, the annual distribution requirements under the REIT provisions of
the Internal Revenue Code of 1986, as amended, and such other factors as the
Board of Trust Managers deems relevant.
SALES OF UNREGISTERED SECURITIES
The Company was initially capitalized through the sale of 100 of its Common
Shares to AMRESCO, INC. (AMRESCO) on February 2, 1998 for $1,000. On February
11, 1998, AMRESCO contributed additional capital of $25,000 to the Company; no
additional shares were issued to AMRESCO in connection with this contribution.
On May 12, 1998, concurrent with the completion of its initial public offering
of 9,000,000 Common Shares, the Company sold 1,000,011 Common Shares to AMREIT
Holdings, Inc., a wholly-owned subsidiary of AMRESCO, at the initial public
offering price of $15.00 per share, or $15,000,165 in aggregate cash
consideration, pursuant to a private placement (the "Private Placement"). The
Common Shares sold in the Private Placement and those sold in connection with
the Company's initial capitalization were sold without registration under the
Securities Act of 1933 in reliance on the exemption provided by Section 4(2)
thereof.
13
<PAGE> 14
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below for the period from February 2,
1998 (date of initial capitalization) through December 31, 1998 has been
derived from the Company's audited consolidated financial statements. This
information should be read in conjunction with "Item 1. Business" and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations", as well as the audited consolidated financial statements and notes
thereto included in "Item 8. Financial Statements and Supplementary Data".
<TABLE>
<CAPTION>
Period from
February 2, 1998
through
(In thousands, except per share and ratio data) December 31, 1998
-----------------
<S> <C>
Revenues ........................................................... $ 8,745
Net income ......................................................... $ 3,952
Earnings per common share:
Basic .......................................................... $ 0.56
Diluted ........................................................ $ 0.56
Dividends declared per common share ................................ $ 0.74
Total assets ....................................................... $ 190,926
Long-term debt ..................................................... $ 46,838
Total shareholders' equity ......................................... $ 130,266
Debt to equity ratio ............................................... 0.4 to 1
Debt to equity ratio (excluding non-recourse debt on real estate)... 0.3 to 1
</TABLE>
The Company believes that the following additional financial data is also
meaningful to users of its financial reports. Such information should also be
read in conjunction with "Item 1. Business" and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations", as
well as the audited consolidated financial statements and notes thereto
included in "Item 8. Financial Statements and Supplementary Data". Although the
Company was initially capitalized on February 2, 1998 (with $1,000), it did not
commence operations until its initial public offering was completed on May 12,
1998. As a result, the Company had no earnings prior to the commencement of its
operations. Accordingly, the data set forth below reflects operations, earnings
per common share and other relevant information for the period from May 12,
1998 (inception of operations) through December 31, 1998.
<TABLE>
<CAPTION>
Period from
May 12, 1998
through
(In thousands, except per share and yield data) December 31, 1998
-----------------
<S> <C>
Dividends declared per common share ................................ $ 0.74
Dividend yield (annualized) ........................................ 12.2%(a)
Operating Results under Generally Accepted Accounting Principles:
Revenues ....................................................... $ 8,745
Net income ..................................................... $ 3,952
Earnings per common share:
Basic ...................................................... $ 0.39
Diluted .................................................... $ 0.39
Tax Basis Operating Results:
Tax basis income ............................................... $ 7,495
Tax basis income per common share:
Basic ...................................................... $ 0.75
Diluted .................................................... $ 0.75
</TABLE>
(a) To derive the dividend yield, dividends declared per common share
during the period from May 12, 1998 (inception of operations)
through December 31, 1998 were annualized; the result was then
divided by the Company's closing stock price on December 31, 1998
($9.50 per share).
14
<PAGE> 15
ITEM 7. 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 ("IPO") 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. (the "Private Placement"). As of September 30,
1998, the Company had fully invested the net proceeds from the IPO and the
Private Placement totaling $139.7 million and had begun to leverage its
investments. At December 31, 1998, the Company had debt outstanding, excluding
non-recourse debt on real estate, of $39.3 million. 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. Additionally, the Company expects to make
several of these investments through one or more partnerships in which it holds
a minority ownership interest (i.e., 5% to 10%). In early 1999, one such
partnership was formed.
Due to the dislocation in the capital markets which occurred in mid to late
1998, the Company's investment activities slowed dramatically during the fourth
quarter. After closing a total of 26 investments during the period from May 12,
1998 through September 30, 1998, the Company closed just two new loan
investments totaling $0.8 million in the fourth quarter. This reduction in new
investments was not due to a lack of investment opportunities but rather was in
response to the capital constraints imposed upon the Company. Despite the lack
of new investment activity during the fourth quarter, the Company advanced $25
million under structured loan commitments it had closed on or prior to
September 30, 1998. The capital markets' upheaval and the Company's response
thereto are discussed further in the Liquidity and Capital Resources section
below.
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. Because changes in interest rates may significantly
affect the Company's activities, 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.
The following discussion of results of operations and liquidity and capital
resources should be read in conjunction with the audited consolidated financial
statements and notes thereto included in "Item 8. Financial Statements and
Supplementary Data". In particular, reference is made to Note 13 concerning the
reconciliation of financial statement net income to tax basis income.
15
<PAGE> 16
RESULTS OF OPERATIONS
General
The Company commenced operations on May 12, 1998. Under generally accepted
accounting principles, net income for the period from May 12, 1998 (inception
of operations) through December 31, 1998 was $3,952,000, or $0.39 per common
share. The Company had no income during the period from February 2, 1998 (date
of initial capitalization) through May 11, 1998. The Company's primary sources
of revenue for the period from May 12, 1998 through December 31, 1998, totaling
$8,745,000, were as follows:
o $4,834,000 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 as follows: interest income on
mortgage loans - $4,278,000; operating income from real estate -
$211,000; and equity in earnings of other real estate ventures -
$345,000. The loan investments earn interest at accrual rates ranging
from 10.5% to 16% per annum as of December 31, 1998.
o $1,924,000 of other interest income generated primarily from the
temporary investment of proceeds from the IPO and Private Placement.
o $1,563,000 from investments in commercial mortgage-backed securities.
o $181,000 of operating income from real estate owned by the Company
(through a majority-owned partnership).
Revenue increased during the period from May 12, 1998 through December 31, 1998
as funds from the IPO and the Private Placement were invested in real estate
related assets and the Company began to utilize its financing facilities.
The Company incurred expenses of $4,793,000 for the period from May 12, 1998
through December 31, 1998, consisting primarily of the following:
o $1,187,000 of management fees, including $835,000 of base management fees
payable to the Manager pursuant to the Management Agreement and $352,000
of expense associated with compensatory options granted to the Manager. No
incentive fees were incurred during the period.
o $1,294,000 of general and administrative costs, including approximately
$330,000 of due diligence costs associated with an abandoned transaction,
$396,000 for professional services, $162,000 for directors and officers'
insurance, $140,000 of reimbursable costs pursuant to the Management
Agreement, $68,000 related to compensatory options granted to certain
members of the AMRESCO Group and $56,000 related to restricted stock
awards to the Company's Independent Trust Managers.
o $567,000 of interest expense (net of capitalized interest totaling
$57,000) associated with the Company's credit facilities and a
non-recourse loan secured by real estate. Substantially all of this
interest expense was incurred during the fourth quarter of 1998 as the
Company began to leverage its investments on September 30, 1998.
o $1,368,000 of provision for loan losses. No realized loan losses were
incurred by the Company during the period. One loan, representing 5% of
the Company's outstanding loan portfolio, was over 30 days past due as of
December 31, 1998; 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".
16
<PAGE> 17
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 and
a reconciliation of financial statement net income to tax basis income, see the
notes to the audited consolidated financial statements included in Item 8 of
this report). 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. To date, the following dividends have
been declared (dollars in thousands, except per share amounts):
<TABLE>
<CAPTION>
Dividend per
Declaration Record Payment Dividend Common
Date Date Date Paid Share
----------------- ----------------- ----------------- --------- ------------
<S> <C> <C> <C> <C> <C>
Period from May 12, 1998
through June 30, 1998 July 23, 1998 July 31, 1998 August 17, 1998 $ 1,001 $ 0.10
Third Quarter October 22, 1998 October 31, 1998 November 16, 1998 2,401 0.24
Fourth Quarter December 15, 1998 December 31, 1998 January 27, 1999 4,002 0.40
--------- ------------
$ 7,404 $ 0.74
========= ============
</TABLE>
For federal income tax purposes, all 1998 dividends were reported as ordinary
income to the Company's shareholders. The Company has announced its 1999
dividend payment schedule as follows (dates are subject to change):
<TABLE>
<CAPTION>
Expected Expected Expected
Declaration Record Payable
Date Date Date
----------------- ----------------- -----------------
<S> <C> <C> <C>
First Quarter April 22, 1999 April 30, 1999 May 17, 1999
Second Quarter July 22, 1999 July 31, 1999 August 16, 1999
Third Quarter October 21, 1999 October 31, 1999 November 15, 1999
Fourth Quarter December 15, 1999 December 31, 1999 January 27, 2000
</TABLE>
Loan Investments
During the period from May 12, 1998 through December 31, 1998, the Company
assembled a portfolio of 21 loans, representing $209.6 million in aggregate
commitments; eleven of these loans were originated by the Company while two of
the loans were acquired from AMRESCO Funding Corporation ("AFC") and eight of
the loans were acquired from AMRESCO Commercial Finance, Inc. ("ACFI"), both of
whom are members of the AMRESCO Group. As of December 31, 1998, $136.8 million
had been advanced under these facilities. 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 further described below), commitments and amounts
outstanding totaled approximately $203 million and $132 million, respectively,
at December 31, 1998.
The two loans were acquired from AFC immediately after the closing of the IPO
at an aggregate cash purchase price of $5,433,000, including accrued interest
and as adjusted for unamortized loan commitment fees.
The eight loans were acquired from ACFI on September 30, 1998 pursuant to two
separate agreements. The first agreement provided for the purchase of three
loans at an aggregate cash purchase price of $11,314,000, including accrued
interest of $137,000. The second agreement provided for the purchase of five
loans at an aggregate cash purchase price of $22,978,000, including accrued
interest of $675,000. Immediately following the purchase of the five loans, the
Company sold to ACFI a contractual right to collect from the Company an amount
equal to the economic equivalent of all amounts collected from the five loans in
excess of (i) $17,958,000 and (ii) a return on this amount, or so much of it as
is outstanding from time to time, equal to 12% per annum. The aggregate cash
sales price of $5,020,000 had the effect of reducing the Company's credit
exposure with respect to such loans. The sales price was comprised of $4,345,000
which had the effect of reducing the Company's net investment in such loans; the
balance of the sales price, or $675,000, equated to the amount of interest which
was accrued under the five loan agreements as of September 30, 1998. As
additional consideration, ACFI agreed to
17
<PAGE> 18
immediately reimburse the Company for any additional advances which are
required to be made under the five loan agreements. At December 31, 1998,
ACFI's contingent obligation for these additional advances approximated
$1,695,000.
Based upon the amounts committed 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 10.9% and a weighted
average interest accrual rate of 12.2% as of December 31, 1998. In cases where
the Company has originated loans, the borrowers paid a commitment fee to the
Company that is in addition to interest payments due under the terms of the
loan agreements. Commitment fees are deferred and recognized over the life of
the loan as an adjustment of yield or, in those cases where loan investments
are classified as either real estate or joint ventures for financial reporting
purposes, such fees are deferred and recognized upon the disposition of the
investment. Eight of the 21 loans provide for profit participation above the
contractual accrual rate; four of these eight facilities are included in the
pool of loans in which ACFI has a contractual right to collect certain excess
proceeds, as described above. The Company's loan investments are summarized as
follows (dollars in thousands):
<TABLE>
<CAPTION>
Amount
Outstanding at
Date of Initial Scheduled Collateral Commitment December 31,
Investment Maturity Location Property Type Position Amount 1998 (g)
- ------------------ -------------------- ---------------- ----------------- ---------------- -------- --------------
<S> <C> <C> <C> <C> <C> <C>
May 12, 1998 March 31, 2001 Columbus, OH Mixed Use Second Lien (a) $ 7,000 $ 6,839 (e)
May 12, 1998 March 31, 2001 Richardson, TX Office Second Lien 14,700 10,811
June 1, 1998 June 1, 2001 Houston, TX Office First Lien 11,800 10,033
June 12, 1998 June 30, 2000 Pearland, TX Apartment First Lien 12,827 4,238 (f)
June 17, 1998 June 30, 2000 San Diego, CA R&D/Bio-Tech First Lien 5,560 3,994 (f)
June 19, 1998 June 18, 2000 Houston, TX Office First Lien 24,000 6,682 (f)
June 22, 1998 June 19, 2000 Wayland, MA Office First Lien 45,000 24,962
July 1, 1998 July 1, 2001 Dallas, TX Office Ptrshp Interests 10,068 6,459 (e)
July 2, 1998 June 30, 2000 Washington, D.C. Office First Lien 7,000 5,489
July 10, 1998 July 31, 2000 Pasadena, TX Apartment First Lien 3,350 2,614
September 1, 1998 February 28, 2001 Los Angeles, CA Mixed Use First Lien 18,419 17,418
September 30, 1998 October 30, 1999 (b) Richardson, TX Office First Lien 13,001 10,277 (f)
September 30, 1998 May 1, 2001 San Antonio, TX Residential Lots First Lien 3,266 2,059
September 30, 1998 Various San Antonio, TX Residential Lots First Lien 8,400 1,637
September 30, 1998 July 15, 1999 Galveston, TX Apartment First Lien 3,664 3,664
September 30, 1998 June 8, 1999 Ft. Worth, TX Apartment Ptrshp Interests 2,650 2,649
September 30, 1998 April 18, 1999 (c) Austin, TX Office First Lien 6,325 6,314
September 30, 1998 June 30, 1999 Dallas, TX Medical Office First Lien 3,015 2,364
September 30, 1998 July 22, 1999 Norwood, MA Industrial/Office First Lien 8,765 7,733
October 1, 1998 April 30, 1999 Richardson, TX Office First Lien 567 300
December 29, 1998 December 9, 1999 (d) San Antonio, TX Residential Lots First Lien 255 255
-------- ---------
209,632 136,791
ACFI's Economic Interest (6,552) (4,857)
-------- ---------
$203,080 $ 131,934
======== =========
<CAPTION>
Interest Interest
Date of Initial Pay Accrual
Investment Rate Rate
- ------------------ -------- --------
<S> <C> <C>
May 12, 1998 15.0% 15.0%
May 12, 1998 10.0% 12.0%
June 1, 1998 12.0% 12.0%
June 12, 1998 10.0% 11.5%
June 17, 1998 10.0% 13.5%
June 19, 1998 12.0% 12.0%
June 22, 1998 10.5% 10.5%
July 1, 1998 10.0% 15.0%
July 2, 1998 10.5% 10.5%
July 10, 1998 10.0% 14.0%
September 1, 1998 10.0% 12.0%
September 30, 1998 10.0% 14.0%
September 30, 1998 16.0% 16.0%
September 30, 1998 10.0% 14.0%
September 30, 1998 10.0% 15.0%
September 30, 1998 10.5% 16.0%
September 30, 1998 10.0% 16.0%
September 30, 1998 10.0% 13.0%
September 30, 1998 10.0% 12.5%
October 1, 1998 9.97% 15.0%
December 29, 1998 16.0% 16.0%
</TABLE>
(a) Loan was over 30 days past due as of December 31, 1998; on February 25,
1999, the Company's unconsolidated taxable subsidiary assumed control of
the borrower (a partnership) through foreclosure of the partnership
interests.
(b) Loan was fully repaid on March 1, 1999.
(c) Loan was purchased by a member of the AMRESCO Group on January 14, 1999.
(d) Loan was fully repaid on February 3, 1999.
(e) Accounted for as investment in joint venture for financial reporting
purposes.
(f) Accounted for as real estate for financial reporting purposes.
(g) 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.
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 [e] and [f]
accompanying the table above). As of December 31, 1998, loan investments
representing approximately $72,456,000 in aggregate commitments were accounted
for as either real estate or joint venture interests; approximately $38,489,000
had been advanced to borrowers under the related agreements. For a discussion
of these loan arrangements, see the notes to the audited consolidated financial
statements included in "Item 8. Financial Statements and Supplementary Data".
A mezzanine (second lien) loan with an outstanding balance of $6,839,000 (or 5%
of the Company's outstanding loan portfolio) was over 30 days past due as of
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.
During
18
<PAGE> 19
the period from May 12, 1998 through December 31, 1998, this loan investment
generated financial statement and tax basis revenues of $345,000 and $621,000,
respectively. The Company believes that it has adequate loan loss reserves to
absorb any financial statement losses that it might incur with respect to this
investment. However, should the Company incur an actual loss on this
investment, tax basis income would be adversely affected. Management does not
currently believe that this investment, when ultimately resolved, will have a
material impact on the Company's financial position or results of operations.
At December 31, 1998, the Company's commercial mortgage loan commitments were
geographically dispersed in four states and the District of Columbia: Texas
(56%); Massachusetts (26%); California (12%); Ohio (3%); and Washington, D.C.
(3%). The underlying collateral for these loans was comprised of the following
property types: office (63%); mixed use (12%); multifamily (11%); residential
(6%); industrial (4%); R&D/Bio-Tech (3%); and medical office (1%). Construction
loans, acquisition/rehabilitation loans, acquisition loans, single-family lot
development loans and bridge loans comprised 33%, 31%, 27%, 6% and 3% of the
portfolio, respectively. Eighty-three percent of the portfolio is comprised of
first lien loans while the balance of the portfolio (17%) 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.
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 December 31, 1998, 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 the significant widening of spreads in the CMBS market, the value of the
Company's CMBS holdings declined by $6.245 million; accordingly, the Company
recorded an unrealized loss of $6.245 million on its CMBS portfolio as of
December 31, 1998. Additionally, the Company recorded an unrealized loss of
$230,000, net of tax effects, related to one commercial mortgage-backed
security owned by its unconsolidated taxable subsidiary; the security held by
this subsidiary has a rating of "B-". As these securities are classified as
available for sale, the unrealized loss was reported as a component of
accumulated other comprehensive income (loss) in shareholders' equity for
financial reporting purposes. The unrealized loss had no impact on the
Company's taxable income or cash flow. Management intends to retain these
investments for the foreseeable future. Furthermore, these investments were not
leveraged as of December 31, 1998. 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> <C>
BB- $ 4,233 $ 3,615 13%
B 19,489 16,537 57%
B- 11,277 8,602 30%
------- ------- ----
$34,999 $28,754 100%
======= ======= ====
</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.
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<PAGE> 20
Equity Investments in Real Estate
During the period from May 12, 1998 (inception of operations) through December
31, 1998, the Company entered into a partnership that will ultimately acquire
interests in five newly constructed, grocery-anchored shopping centers in the
Dallas/Fort Worth (Texas) area. The Company holds a 99.5% interest in the
partnership. In October 1998, the Company (through the partnership) acquired
the first of these five centers, an 82,730 square foot facility in Arlington,
Texas, for approximately $10.3 million. In connection with this acquisition,
the title-holding partnership obtained a $7.5 million non-recourse loan from an
unaffiliated third party. Immediately prior to the closing, the Company
contributed $3.4 million of capital to the partnership. The proceeds from this
contribution were used, in part, to fund the balance of the purchase price and
to pay partnership formation expenses and costs associated with the
non-recourse financing. The remaining four centers, initially comprising
approximately 320,000 net rentable square feet, are expected to be acquired at
an aggregate purchase price of approximately $39.6 million. In anticipation of
these acquisitions, the partnership has secured permanent, non-recourse
financing commitments from an unaffiliated third party aggregating $27.1
million. The balance of the acquisition costs, totaling approximately $12.5
million, will be funded by the Company (via equity contributions to the
partnership). The Company anticipates that the remaining four centers will be
acquired during the second and third quarters of 1999 after the completion of
construction and satisfaction of certain other closing conditions. After the
acquisitions are completed, the Company expects to construct an additional
62,000 square feet of space. 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.
LIQUIDITY AND CAPITAL RESOURCES
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 capital market trends discussed below, 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. Borrowings
under the Line of Credit bear interest at rates ranging from LIBOR plus 1% per
annum to LIBOR plus 2% per annum and are secured by a first lien security
interest in all assets funded with proceeds from the Line of Credit. The Line
of Credit matures on July 1, 2000. At December 31, 1998, $39,338,000 had been
borrowed under the Line of Credit. The weighted average interest rate at
December 31, 1998 was 6.65%. 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 January 1, 1999. The agreement, which
expires on July 1, 2000, has a notional amount of $33,600,000. The agreement
entitles the Company to receive from a counterparty the amounts, if any, by
which one month LIBOR exceeds 6.0%. There are no margin requirements associated
with interest rate caps and therefore there is no liquidity risk associated
with this particular hedging instrument (see Item 7A.
"Quantitative and Qualitative Disclosures About Market Risk").
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. The Company borrowed $5.1
million under this facility on September 30, 1998; these borrowings were repaid
on October 23, 1998 with proceeds from the Line of Credit described above. No
additional amounts have since been drawn on the Repurchase Agreement.
20
<PAGE> 21
Under the terms of the 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,
without modification, will be sufficient to meet the Company's liquidity and
committed capital requirements in 1999. However, in order to fund growth beyond
it existing commitments, the Company will need to modify its existing Line of
Credit and/or raise additional funds for operations through future public or
private equity and debt offerings and/or by leveraging its investments through
additional secured and unsecured financings and other borrowing arrangements.
In the absence of more flexible credit terms or additional sources of
financing, the Company will be limited from making any significant commitments
to new loan and/or equity transactions until existing loan investments are
repaid by borrowers. As a result, financial statement net income and tax basis
income will temporarily be adversely affected until repayment proceeds can be
redeployed in real estate related assets.
The Company intends to renew the Line of Credit and the Repurchase Agreement or
enter into similar or additional secured lending arrangements with
institutional lenders in the future, although there can be no assurances that
the Company will be able to obtain renewed or additional financing on
acceptable terms.
The capital market fluctuations that began during the third quarter of 1998
(and which continued into the fourth quarter) have, at least in the near term,
diminished the Company's access to additional capital and have restricted its
ability to expand its asset base. These capital market fluctuations resulted in
a global investor flight to low risk investments. During the latter part of the
year, spreads on high yield and mortgage-backed bonds widened significantly
resulting in a marked decline in the market value of CMBS and a general
lessening of liquidity for the lower rated classes of CMBS. Substantial margin
calls related to certain hedge positions were brought on by steep declines in
U.S. Treasury rates. The combination of spread widening and hedge losses
created severe liquidity problems for some companies, including many companies
within the mortgage REIT sector. The Company's emphasis on structured finance
transactions (as opposed to CMBS) and its conservative use of leverage and
avoidance of hedge positions which would subject it to liquidity risk have all
contributed to the Company's ability to avoid the liquidity problems faced by
many of these companies.
Management currently believes that the dislocation in the capital markets will
not extend long-term; however, its duration is impossible to predict at this
time. 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 will be difficult to obtain and, in any event, will
likely not be available to the Company at a reasonable cost. Additional secured
debt beyond the Company's existing Line of Credit will 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 current market
dislocation presents significant investment opportunities for selective
acquisitions of CMBS and that the fundamental value of the real estate
mortgages underlying these bonds has been largely unaffected to date, although
general economic conditions could adversely impact real estate values in the
future.
In order to address its capital constraints and certain concerns expressed by
PSCC with respect to the Line of Credit, the Company has initiated discussions
with PSCC. These discussions are intended to increase the flexibility of the
Line of Credit. While discussions are on-going, there can be no assurances that
an agreement will eventually be reached.
In the event that modifications to the Line of Credit can be successfully
concluded, management believes that the Company's growth will continue, albeit
at a slower rate than was achieved in 1998. However, in view of the
uncertainties in the capital markets, management believes that it is prudent to
maintain low leverage and greater liquidity. Therefore, it is unlikely that the
Company will add additional assets if such addition were to result in a debt to
equity ratio exceeding 2.5 to 1, excluding non-recourse debt on real estate. As
of December 31, 1998, the Company's debt to equity ratio, excluding
non-recourse debt on real estate, was 0.3 to 1. The Company also intends to
closely monitor any financing that it may place on the Company's existing CMBS
portfolio in an effort to minimize the risk of margin calls.
Despite the uncertainties in the public debt and equity markets, management
believes that there are other potential sources of capital available to
entities like the Company. Management is actively exploring the availability of
capital from these
21
<PAGE> 22
other sources and the costs associated therewith. However, there can be no
assurances that such capital will become available at a reasonable cost.
Given the capital constraints currently limiting the Company's growth, it has
sought to form alliances with third parties who have similar investment
objectives. To that end, the Company recently entered into a partnership with
Olympus Real Estate Corporation ("Olympus") for the purpose of making
investments similar to those made by the Company. The Company, through certain
of its subsidiaries, holds a 5% minority interest in the partnership with
Olympus and could further benefit through a disproportionate percentage of cash
flow to the extent that certain return thresholds are met. The Company has
committed to invest $5 million in the partnership and it has an option (which
expires on August 2, 1999) to invest an additional $5 million. Olympus has
committed to invest $95 million in the partnership subject to adjustment in the
event that the Company exercises its option.
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 "Millennium Bug." Such
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, and 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, which 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
22
<PAGE> 23
used in connection with the operations of the Manager or the Company, and 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.
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. is in the process of communicating
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. is seeking 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. Responses from all third parties having
material contracts with AMRESCO, INC., the Manager or the Company have not been
received, nor is it likely that responses will be received from all such third
parties. In addition to contacting these third parties, where there are direct
interfaces between the systems of AMRESCO, INC. and the systems of these third
parties in the first group, AMRESCO, INC. plans to conduct testing in the
second quarter of 1999 in conformance with the Guidelines of the Federal
Financial Institutions Examination Council. 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 Manager or the
Company.
For all business-critical systems interfaces used in connection with the
operations of the Manager and the Company, AMRESCO, INC. has advised the
Company that readiness was achieved by December 31, 1998. Significant third
party service providers that have not completed their Year 2000 initiative by
March 31, 1999 are scheduled to be replaced with comparable firms that are
believed to be compliant. AMRESCO, INC. anticipates that this portion of its
Year 2000 initiative will be completed within the scheduled time periods.
There can be no assurance that the systems of AMRESCO, INC. or those of third
parties will be timely converted. 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 material 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.
23
<PAGE> 24
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 counter parties, 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 portfolios, 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 an equity investment in a partnership that
will ultimately own interests in five grocery-anchored shopping centers. 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.
24
<PAGE> 25
Some of the risks associated with the Year 2000 issue may be mitigated through
insurance maintained or purchased by the Company, its affiliates, its business
partners, borrowers and vendors. However, the scope of insurance coverage in
addressing these potential issues under existing policies has yet to be tested,
and the economic impact on the solvency of the insurers has not been explored.
Therefore, no assurance can be given that insurance coverage will be available
or, if it is available, that it will be available on a cost-effective basis or
that it will cover all or a significant portion of any potential loss.
Business Continuity/Disaster Recovery Plan
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 such plan.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-K 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.
ITEM 7A. 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; accordingly, no discussion of these instruments is provided herein.
All of the Company's financial instruments, including its derivative financial
instruments, are entered into for purposes other than trading. The Company has
not entered into, nor does it intend to enter into, any financial instruments
for trading or speculative purposes. As the Company has no investments outside
of the United States, it is not currently subject to foreign currency exchange
rate risk.
25
<PAGE> 26
The Company generally intends to hold its investments over relatively long
periods of time and therefore does not attempt to hedge its exposure to changes
in the fair value of those investments through the use of derivative
instruments. Instead, these exposures are managed by the Company through its
diversification efforts and strict underwriting of its investments.
Furthermore, as a real estate investment trust, the Company is subject to
certain limitations imposed by the Internal Revenue Code of 1986, as amended,
as it relates to the use of derivative instruments, particularly with regard to
hedging fair value exposures. The Company generally intends to hold its
mortgage loan investments to maturity; these loans typically have terms ranging
from one to three years. The Company's investments in CMBS are acquired for the
yield that they offer rather than with an intent to sell. It is expected that
CMBS investments, when made, will generally be held for periods ranging from
three years to maturity although certain of these investments may be held for
shorter periods of time depending upon a number of factors.
In the following discussion of market risk exposures, the Company has employed
sensitivity analyses, where practicable to do so, in quantifying the potential
loss in future earnings, fair values or cash flows resulting from one or more
selected hypothetical changes in relevant market rates.
Mortgage Loans
The Company provides mid- to high-yield senior and mezzanine financing to real
estate owners and developers. Mezzanine loans, the repayment of which is
subordinated to senior mortgage loans, are secured by a second lien mortgage
and/or a pledge of the ownership interests of the borrower. Typically, the
Company's loans provide for a fixed pay rate and fixed accrual rate of interest
and, in some cases, may also provide for profit participation above the
contractual accrual rate. The incremental interest earned at the accrual rate
is often times not payable by the borrower until maturity of the loan.
Generally, the Company's loans provide for higher loan-to-value ratios than
most conventional loans.
The fair values of the Company's mortgage loans are less sensitive (than are the
values of more conventional loans) to changes in interest rates due to their
comparatively shorter duration and higher yield, equity-like characteristics.
For example, the Company does not believe that a 10% increase or decrease in
general interest rates (from those prevailing at December 31, 1998) would have a
significant impact on the fair value of its predominately fixed rate mortgage
loan portfolio. However, a general real estate market decline could have a
material adverse impact on the Company. If rental rates were to decline and/or
vacant space was not able to be leased as a result of declining demand, cash
flows from the properties securing the Company's loans might be inadequate to
service the loans. In the event of shortfalls, borrowers may or may not be
willing to supplement property cash flows to pay the Company all amounts due
under the terms of its mortgage loans. If real estate values were to decline,
borrowers may find it difficult, if not impossible, to repay some or all of the
principal and accrued interest in connection with a sale or refinancing of the
underlying properties. With the exception of certain limited guarantees, most of
the Company's loans are without recourse and therefore borrowers may have little
or no incentive to retain ownership of their properties if real estate values
decline sharply. A number of factors could lead to a real estate market decline
including, but not limited to, a slowdown in the growth of the economy,
increasing commercial mortgage interest rates and supply and demand factors. In
the event of a decline, some real estate markets may be adversely impacted more
than others. Despite generally high loan-to-value ratios, the Company's
borrowers have varying amounts of equity at risk; this equity, which is
subordinate to the Company's investment, serves to protect the Company in the
event of a declining real estate market. As a result of these factors and the
unique characteristics of the Company's mortgage loan investments, it is not
possible for the Company to quantify the potential loss in earnings or cash
flows that might result from a real estate market decline.
The Company attempts to mitigate these risk exposures by carefully underwriting
its investments and by diversifying its mortgage loan portfolio. The
underwriting process for loans includes, among other things, an in-depth
assessment of the character, experience (including operating history) and
financial capacity of the borrower. In the event of a real estate market
decline, the borrower's motivations and financial capacity could, to some
extent, limit the potential loss to the Company. While the Company attempts to
mitigate these risk exposures, there can be no assurance that these efforts
will be successful.
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.
26
<PAGE> 27
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 December 31, 1998, the Company held five commercial mortgage-backed
securities with credit ratings ranging from "BB-" to "B-". The weighted average
duration of these bonds approximated 6.3 years as of that date. The estimated
fair value of the Company's CMBS holdings was $28.8 million at December 31,
1998. 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 December 31,
1998) would be expected to cause the value of the Company's CMBS to decline or
increase, respectively, by approximately $1.8 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
December 31, 1998) 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 $1.8 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.
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 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.
Although impossible to quantify, declines in rental rates and/or real estate
values could adversely impact the ability of borrowers to fully repay or
otherwise satisfy their loan obligations which in turn could lead to losses
which would be absorbed initially by the holders of subordinated classes of
CMBS (in many cases, an unrated higher-yield, credit support class absorbs the
first losses). The Company attempts to mitigate its exposure to these types of
risks by investing in various classes of subordinated CMBS which are backed by
mortgage loans secured by a diversified mix of commercial real estate assets
(both by property type and location). Additionally, the Company performs
extensive due diligence in its underwriting process in order to identify loans
which may be more likely to default. The Company then attempts to quantify the
risks and projected losses from the pool of mortgage loans which is then
factored into the price that the Company is willing to pay for the securities.
However, there can be no assurances that such strategies will enable the
Company to avoid adverse consequences in the future even if such bonds are held
to maturity.
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 "Line of Credit") while
the other facility can be used to finance the Company's CMBS (the "Repurchase
Agreement"). As of December 31, 1998, amounts outstanding under the Line of
Credit totaled $39.3 million. There were no borrowings under the Repurchase
Agreement at December 31, 1998. To reduce the impact of changes in interest
rates on these floating rate debt facilities, the Company may purchase interest
rate swap and/or cap agreements. These agreements effectively convert its
variable-rate debt to fixed-rate debt and therefore reduce the Company's risk of
incurring higher interest costs due to rising interest rates.
If the one-month LIBOR on December 31, 1998 increased by 100 basis points on
that date (from 5.06% to 6.06%) and then remained constant at the higher rate
throughout 1999, the Company's interest costs on its outstanding borrowings
($39.3 million), in the absence of the interest rate cap agreement described
below, would increase by approximately $393,000 for the year ending December
31, 1999. 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 January 1, 1999. The cap agreement has a notional
amount of $33.6 million. Until its expiration on July 1, 2000, the agreement
entitles the Company to receive from the counterparty the amounts, if any, by
which one-month LIBOR exceeds 6% multiplied by the
27
<PAGE> 28
notional amount. If the one-month LIBOR increased as described above, the
Company would receive approximately $20,000 from the counterparty under the
terms of the cap agreement. Under this scenario, earnings and cash flows for
the year ending December 31, 1999 would be reduced by a net amount of
approximately $373,000. 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. As the Company paid an up-front, one-time premium
of $52,000 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 December 31, 1998) would increase earnings and cash flows for the
year ending December 31, 1999 by approximately $393,000. 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 a $7.5 million non-recourse loan. As the loan bears interest at a fixed
rate, the Company's future earnings and cash flows would not be reduced in the
event of rising interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Included herein at pages F-1 through F-19.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. TRUST MANAGERS AND EXECUTIVE OFFICERS OF THE COMPANY
The information required by this Item is incorporated by reference from the
Company's definitive proxy statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A under the Securities Exchange
Act of 1934.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from the
Company's definitive proxy statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A under the Securities Exchange
Act of 1934.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from the
Company's definitive proxy statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A under the Securities Exchange
Act of 1934.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference from the
Company's definitive proxy statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A under the Securities Exchange
Act of 1934.
28
<PAGE> 29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Included herein at pages F-1 through F-19.
2. Financial Statement Schedules
All schedules for which provision is made in Regulation S-X
are either not required to be included herein under the
related instructions or are inapplicable or the related
information is included in the audited financial statements
or notes thereto.
3. Exhibits
The following exhibits are filed as part of this Annual Report on Form 10-K:
<TABLE>
<CAPTION>
Exhibit No.
<S> <C>
2.1 Sale and Assignment Agreement by and between AMRESCO
Commercial Finance, Inc. and AMREIT I, Inc. dated
effective as of September 30, 1998 relating to three
loans (filed as Exhibit 2.1 to the Registrant's
Current Report on Form 8-K dated September 30, 1998,
which exhibit is incorporated herein by reference).
2.2 Sale and Assignment Agreement by and between AMRESCO
Commercial Finance, Inc. and AMREIT I, Inc. dated
effective as of September 30, 1998 relating to five
loans (filed as Exhibit 2.2 to the Registrant's
Current Report on Form 8-K dated September 30, 1998,
which exhibit is incorporated herein by reference).
2.3 Economics Equivalents and Funding Agreement by and
between AMRESCO Commercial Finance, Inc. and AMREIT
I, Inc. dated effective as of September 30, 1998
(filed as Exhibit 2.3 to the Registrant's Current
Report on Form 8-K dated September 30, 1998, which
exhibit is incorporated herein by reference).
3.1 Amended and Restated Declaration of Trust of the
Registrant (filed as Exhibit 3.1 to the Registrant's
Registration Statement on Form S-11 (Registration No.
333-45543), which exhibit is incorporated herein by
reference).
3.2 First Amendment to Amended and Restated Declaration
of Trust of the Registrant (filed as Exhibit 3.1 to
the Registrant's Current Report on Form 8-K dated May
12, 1998, which exhibit is incorporated herein by
reference).
3.3 Second Amendment to Amended and Restated Declaration
of Trust of the Registrant (filed as Exhibit 3.2 to
the Registrant's Current Report on Form 8-K dated May
12, 1998, which exhibit is incorporated herein by
reference).
3.4 Form of Bylaws of the Registrant (filed as Exhibit
3.2 to the Registrant's Registration Statement on
Form S-11 (Registration No. 333-45543), which exhibit
is incorporated herein by reference).
10.1 Interim Warehouse and Security Agreement dated as of
July 1, 1998 by and among Prudential Securities
Credit Corporation and AMRESCO Capital Trust, AMREIT
I, Inc. and AMREIT II, Inc., which exhibit is
incorporated herein by reference.
</TABLE>
29
<PAGE> 30
<TABLE>
<S> <C>
10.2 Master Repurchase Agreement dated as of July 1, 1998
between Prudential-Bache International, Ltd. and
AMRESCO Capital Trust, AMREIT CMBS I, Inc., AMREIT
RMBS I, Inc. and AMREIT II, Inc., which exhibit is
incorporated herein by reference.
11 Computation of Per Share Earnings.
21 Subsidiaries of the Registrant.
27 Financial Data Schedule.
</TABLE>
(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 September 30, 1998 and filed with the
Commission on October 15, 1998, reporting (a) under
Item 2 of such form, the acquisition from an
affiliate of the Registrant of (i) a package of loans
for a purchase price of approximately $11,313,916 and
(ii) another package of loans for a purchase price of
approximately $ 22,978,251 and (b) under Item 5 of
such form, the origination of four other loans. No
financial statements were required to be included in
this Form 8-K.
30
<PAGE> 31
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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
By: /s/ Michael L. McCoy
---------------------
Michael L. McCoy
Senior Vice President, General Counsel & Secretary
Date: March 23, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Date Signature
---- ---------
<S> <C>
March 23, 1999 /s/ Robert L. Adair III
-----------------------------------
Robert L. Adair III
Chairman of the Board of Trust Managers
and Chief Executive Officer
(Principal Executive Officer)
March 23, 1999 /s/ Thomas J. Andrus
-----------------------------------
Thomas J. Andrus
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
March 23, 1999 /s/ Thomas R. Lewis II
-----------------------------------
Thomas R. Lewis II
Vice President & Controller
(Principal Accounting Officer)
March 23, 1999 /s/ John C. Deterding
-----------------------------------
John C. Deterding
Independent Trust Manager
March 23, 1999 /s/ Bruce W. Duncan
-----------------------------------
Bruce W. Duncan
Independent Trust Manager
March 23, 1999 /s/ Mark D. Gibson
-----------------------------------
Mark D. Gibson
Trust Manager
March 23, 1999 /s/ Christopher B. Leinberger
-----------------------------------
Christopher B. Leinberger
Independent Trust Manager
March 23, 1999 /s/ James C. Leslie
-----------------------------------
James C. Leslie
Independent Trust Manager
March 23, 1999 /s/ Robert H. Lutz, Jr.
-----------------------------------
Robert H. Lutz, Jr.
Trust Manager
</TABLE>
31
<PAGE> 32
AMRESCO CAPITAL TRUST
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
FINANCIAL STATEMENTS
Independent Auditors' Report ....................................................... F-2
Consolidated Balance Sheet - December 31, 1998...................................... F-3
Consolidated Statement of Income - For the Period from February 2, 1998 (Date of
Initial Capitalization) through December 31, 1998................................. F-4
Consolidated Statement of Changes in Shareholders' Equity - For the Period
from February 2, 1998 (Date of Initial Capitalization) through December 31,
1998.............................................................................. F-5
Consolidated Statement of Cash Flows - For the Period from February 2, 1998 (Date
of Initial Capitalization) through December 31, 1998.............................. F-6
Notes to Consolidated Financial Statements.......................................... F-7
</TABLE>
F-1
<PAGE> 33
INDEPENDENT AUDITORS' REPORT
To the Board of Trust Managers and Shareholders
of AMRESCO Capital Trust
We have audited the accompanying consolidated balance sheet of AMRESCO Capital
Trust (the Company) and its subsidiaries as of December 31, 1998 and the
related consolidated statements of income, changes in shareholders' equity and
cash flows for the period from February 2, 1998 (date of initial
capitalization) through December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of AMRESCO Capital Trust and its
subsidiaries as of December 31, 1998, and the results of their operations and
their cash flows for the period from February 2, 1998 through December 31,
1998, in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
Dallas, Texas
February 4, 1999
F-2
<PAGE> 34
AMRESCO CAPITAL TRUST
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<S> <C>
ASSETS
Mortgage loans, net ............................................................. $ 96,976
Acquisition, development and construction loan arrangements accounted for as real
estate or investments in joint ventures ....................................... 39,550
----------
Total loan investments .......................................................... 136,526
Allowance for loan losses ....................................................... (1,368)
----------
Total loan investments, net of allowance for losses ............................. 135,158
Commercial mortgage-backed securities - available for sale (at fair value) ...... 28,754
Real estate, net of accumulated depreciation of $56 ............................. 10,273
Investment in unconsolidated subsidiary ......................................... 3,271
Receivables and other assets .................................................... 3,681
Cash and cash equivalents ....................................................... 9,789
----------
TOTAL ASSETS ................................................................. $ 190,926
==========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Accounts payable and other liabilities ........................................... $ 941
Amounts due to affiliates ........................................................ 6,268
Line of credit ................................................................... 39,338
Non-recourse debt on real estate ................................................. 7,500
Dividends payable ................................................................ 4,002
----------
TOTAL LIABILITIES ............................................................ 58,049
----------
Minority interests ............................................................... 2,611
----------
COMMITMENTS AND CONTINGENCIES (NOTE 3)
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value, 50,000,000 shares authorized, no shares issued .. --
Common stock, $.01 par value, 200,000,000 shares authorized, 10,006,111 shares
issued and outstanding ....................................................... 100
Additional paid-in capital ....................................................... 140,941
Unearned stock compensation ...................................................... (848)
Accumulated other comprehensive income (loss) .................................... (6,475)
Distributions in excess of accumulated earnings .................................. (3,452)
----------
TOTAL SHAREHOLDERS' EQUITY ................................................... 130,266
----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................................... $ 190,926
==========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 35
AMRESCO CAPITAL TRUST
CONSOLIDATED STATEMENT OF INCOME
FOR THE PERIOD FROM FEBRUARY 2, 1998 (DATE OF INITIAL CAPITALIZATION)
THROUGH DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<S> <C>
REVENUES:
Interest income on mortgage loans ................................................ $ 4,278
Income from commercial mortgage-backed securities ................................ 1,563
Operating income from real estate ................................................ 392
Equity in earnings of unconsolidated subsidiary and other real estate ventures.... 588
Interest income from short-term investments ...................................... 1,924
----------
TOTAL REVENUES ................................................................. 8,745
----------
EXPENSES:
Interest expense ................................................................. 567
Management fees .................................................................. 1,187
General and administrative ....................................................... 1,294
Depreciation ..................................................................... 100
Participating interest in mortgage loans ......................................... 277
Provision for loan losses ........................................................ 1,368
----------
TOTAL EXPENSES ................................................................. 4,793
----------
NET INCOME ......................................................................... $ 3,952
==========
EARNINGS PER COMMON SHARE:
Basic ........................................................................... $ 0.56
==========
Diluted ......................................................................... $ 0.56
==========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic ........................................................................... 7,027
==========
Diluted ......................................................................... 7,031
==========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 36
AMRESCO CAPITAL TRUST
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE PERIOD FROM FEBRUARY 2, 1998 (DATE OF INITIAL CAPITALIZATION)
THROUGH DECEMBER 31, 1998 (IN THOUSANDS,
EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
Common Stock
$.01 Par Value Accumulated Distributions Total
---------------- Additional Unearned Other in Excess of Nonowner Total
Number of Paid-in Stock Comprehensive Accumulated Changes Shareholders'
Shares Amount Capital Compensation Income (Loss) Earnings in Equity Equity
--------- ------ ---------- ------------ ------------- ------------ --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Initial capitalization,
February 2, 1998.............. 100 -- $ 1 $ 1
Additional paid-in capital,
February 11, 1998............. -- -- 25 25
Issuance of common shares
through IPO, net of
offering expenses, May 12,
1998.......................... 9,000,000 $ 90 124,601 124,691
Issuance of common shares
through Private Placement,
May 12, 1998.................. 1,000,011 10 14,990 15,000
Issuance of trust managers'
restricted shares............. 6,000 -- 90 $ (90) --
Total nonowner changes in
equity
Net income................ $ 3,952 $ 3,952 3,952
Unrealized losses on
securities available
for sale................ $ (6,475) (6,475) (6,475)
-------
Comprehensive loss............. $(2,523)
=======
Compensatory options
granted....................... 1,234 (1,234) --
Amortization of unearned
trust manager
compensation ................. 56 56
Amortization of
compensatory options ......... 420 420
Dividends declared
($0.74 per common share)...... (7,404) (7,404)
--------- ----- -------- ------ -------- -------- --------
Balance at December 31,
1998.......................... 10,006,111 $ 100 $140,941 $ (848) $ (6,475) $ (3,452) $130,266
========== ===== ======== ====== ======== ======== ========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 37
AMRESCO CAPITAL TRUST
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM FEBRUARY 2, 1998 (DATE OF INITIAL CAPITALIZATION)
THROUGH DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .......................................................................... $ 3,952
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses ........................................................ 1,368
Depreciation ..................................................................... 100
Amortization of prepaid assets ................................................... 162
Discount amortization on commercial mortgage-backed securities ................... (173)
Amortization of compensatory stock options and unearned trust manager compensation 476
Amortization of loan commitment fees ............................................. (180)
Receipt of loan commitment fees .................................................. 1,507
Increase in receivables and other assets ......................................... (3,659)
Increase in interest receivable related to commercial mortgage-backed securities . (345)
Increase in accounts payable and other liabilities ............................... 941
Increase in amounts due to affiliates ............................................ 736
---------
NET CASH PROVIDED BY OPERATING ACTIVITIES ................................... 4,885
---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of mortgage loans ....................................................... (25,807)
Investments in mortgage loans ....................................................... (73,059)
Investments in ADC loan arrangements ................................................ (37,269)
Principal collected on mortgage loans ............................................... 563
Purchase of commercial mortgage-backed securities ................................... (34,480)
Investment in real estate ........................................................... (10,329)
Investment in unconsolidated subsidiary ............................................. (3,501)
Distributions from ADC joint ventures ............................................... 285
---------
NET CASH USED IN INVESTING ACTIVITIES ....................................... (183,597)
---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock .......................................... 139,717
Proceeds from borrowings under repurchase agreement ................................. 5,123
Repayment of borrowings under repurchase agreement .................................. (5,123)
Proceeds from borrowings under line of credit ....................................... 39,338
Proceeds from non-recourse debt on real estate ...................................... 7,500
Deferred financing costs associated with non-recourse debt on real estate ........... (184)
Proceeds from other financing provided by affiliate ................................. 5,532
Dividends paid to common shareholders ............................................... (3,402)
---------
NET CASH PROVIDED BY FINANCING ACTIVITIES ................................... 188,501
---------
NET INCREASE IN CASH AND CASH EQUIVALENTS .............................................. 9,789
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ......................................... --
---------
CASH AND CASH EQUIVALENTS, END OF PERIOD ............................................... $ 9,789
=========
SUPPLEMENTAL INFORMATION:
Interest paid, net of amount capitalized ............................................ $ 365
=========
Minority interest contributions associated with ADC loan arrangements ............... $ 2,611
=========
Dividends declared, paid in 1999 .................................................... $ 4,002
=========
</TABLE>
See notes to consolidated financial statements
F-6
<PAGE> 38
AMRESCO CAPITAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
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, 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 (the "Private Placement").
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. ("AMRESCO") (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. 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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
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 in AMREIT II, Inc. All
significant intercompany balances and transactions have been eliminated in
consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of 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 provision for loan losses and the determination of the fair
value of certain share option awards. Actual results may differ from those
estimates.
ACQUISITION, DEVELOPMENT AND CONSTRUCTION (ADC) LOAN ARRANGEMENTS
The Company provides financing through certain real estate loan arrangements
that, because of their nature, qualify as either real estate or joint venture
investments for financial reporting purposes. Using the guidance set forth in
the Third Notice to Practitioners issued by the AICPA in February 1986 entitled
"ADC Arrangements" (the "Third Notice"), the Company evaluates each investment
to determine whether loan, joint venture or real estate accounting is
appropriate; such determination affects the Company's balance sheet
classification of these investments and the recognition of revenues derived
therefrom. The Third Notice was issued to address those real estate
acquisition, development and construction arrangements where a lender has
virtually the same risks and potential rewards as those of real estate owners
or joint venturers. EITF 86-21, "Application of the AICPA Notice to
Practitioners regarding Acquisition, Development, and
F-7
<PAGE> 39
Construction Arrangements to Acquisition of an Operating Property" expanded the
applicability of the Third Notice to loans on operating real estate.
The Company accounts for its loan investments classified as real estate in
accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 67, "Accounting for Costs and Initial Rental Operations of Real
Estate Projects" and SFAS No. 66, "Accounting for Sales of Real Estate",
consistent with its accounting for direct real estate investments. Depreciation
on buildings and improvements is provided under the straight-line method over
an estimated useful life of 39 years for office and industrial buildings and
27.5 years for multi-family projects.
The Company accounts for its loan investments classified as joint ventures in
accordance with the provisions of Statement of Position 78-9, "Accounting for
Investments in Real Estate Ventures" and thus reports its share of income or
loss under the equity method of accounting based on its preferential ownership
interest.
MORTGAGE LOANS
Mortgage loans are stated at face value, net of deferred origination and
commitment fees and associated direct costs, if any. Loan origination and
commitment fees and incremental direct costs, if any, are deferred and
recognized over the life of the loan as an adjustment of yield using the
interest method.
PROVISION FOR LOAN LOSSES
The Company provides for estimated loan losses by establishing an allowance for
losses through a charge to earnings. Management performs a periodic evaluation
of the allowance with consideration given to economic conditions and trends,
collateral values and other relevant factors. ADC loan arrangements are
considered in the allowance for loan losses.
Impairment on a loan-by-loan basis is determined by assessing the probability
that a borrower will not be able to fulfill the contractual terms of its loan
agreement. If a loan is determined to be impaired, the amount of the impairment
is measured based on the present value of expected future cash flows discounted
at the loan's effective interest rate or by the fair value of the collateral
less estimated costs to sell if those costs are expected to reduce the cash
flows available to repay or otherwise satisfy the loan. The allowance for loan
losses is adjusted accordingly. The recognition of income on impaired loans is
dependent upon their classification as either mortgage loans, real estate or
joint venture investments. Interest income on impaired mortgage loans is
recognized using a cash-basis method while income recognition related to ADC
loan arrangements is dependent upon the facts and circumstances specific to
each investment.
REAL ESTATE
Real estate is stated at cost, net of accumulated depreciation. Costs
associated with the acquisition, development and construction of a real estate
project are capitalized as a cost of that project during its construction
period. In accordance with SFAS No. 34, "Capitalization of Interest Cost",
interest on the Company's borrowings is capitalized to the extent such asset
qualifies for capitalization. When a real estate project is substantially
completed and held available for occupancy, rental revenues and operating costs
are recognized as they accrue. Depreciation on buildings and improvements is
provided under the straight-line method over an estimated useful life of 39
years. Depreciation on land improvements is provided using the 150%
declining-balance method over an estimated useful life of 15 years. Maintenance
and repair costs are charged to operations as incurred, while significant
capital improvements and replacements are capitalized. Leasing commissions and
leasehold improvements are deferred and amortized on a straight-line basis over
the terms of the related leases. Other deferred charges are amortized over
terms applicable to the expenditure.
The Company will record impairment losses on direct real estate investments
when events and circumstances indicate that the assets might be impaired and
the estimated undiscounted cash flows to be generated by those assets are less
than the carrying amounts of those assets. The Company periodically reviews its
real estate holdings to determine if its carrying costs will be recovered from
future operating cash flows. In cases where the Company does not expect to
recover its carrying costs, the Company recognizes an impairment loss. No such
impairment losses have been recognized to date.
LEASES
The Company, having retained substantially all of the risks and benefits of
ownership, accounts for its leases as operating leases. Rental income is
recognized over the terms of the leases as it is earned.
F-8
<PAGE> 40
COMMERCIAL MORTGAGE-BACKED SECURITIES
The Company's investments in commercial mortgage-backed securities ("CMBS") are
classified as available for sale and are carried at estimated fair value as
determined by quoted market rates when available, otherwise by discounting
estimated cash flows at current market rates. Any unrealized gains or losses
are excluded from earnings and reported as a component of accumulated other
comprehensive income (loss) in shareholders' equity. If a decline in fair value
is deemed to be other than temporary, it is charged to earnings during the
period such determination is made. Income from CMBS is recognized based on the
effective interest method using the anticipated yield over the expected life of
the investments.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consists of cash on hand and highly liquid
investments with maturities of three months or less at the date of purchase.
STOCK-BASED COMPENSATION
The Company applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related Interpretations in accounting for stock option awards
granted to its officers and trust managers. Pro forma disclosures of net income
and earnings per common share as if the fair value based method of accounting
had been applied are included in Note 8.
Stock options awarded to the Manager and certain other members of the AMRESCO
Group are accounted for under the fair value method prescribed by SFAS No. 123,
"Accounting for Stock-Based Compensation" and related Interpretations.
EARNINGS PER COMMON SHARE
Basic earnings per common share ("EPS") excludes dilution and is computed by
dividing income available to common shareholders by the weighted-average number
of common shares outstanding for the period. Diluted EPS gives effect to all
dilutive potential common shares that were outstanding during the period.
INCOME TAXES AND DISTRIBUTIONS
The Company intends to qualify and will elect to be taxed as a REIT under
Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the
"Code"), commencing with its initial taxable year ended December 31, 1998. As a
result, the Company will generally not be subject to federal income tax on that
portion of its ordinary income or capital gain that is currently distributed to
its shareholders if it distributes at least 95% of its annual REIT taxable
income and it complies with a number of other organizational and operational
requirements. AMREIT II, Inc. is subject to federal income tax on its taxable
income at regular corporate rates.
The Company pays quarterly dividends to its shareholders which are designed to
allow the Company to qualify as a REIT under the Code. Earnings and profits,
which will determine the taxability of distributions to shareholders, 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. As a result, net income under generally accepted
accounting principles is not necessarily an indicator of distributions to be
made by the Company.
3. LOAN INVESTMENTS
Concurrent with the commencement of its operations on May 12, 1998, the Company
acquired two loans from AMRESCO Funding Corporation, a member of the AMRESCO
Group. Additionally, the Company originated eleven loans during the period from
May 12, 1998 through December 31, 1998. On September 30, 1998, the Company
acquired eight loans from AMRESCO Commercial Finance, Inc. ("ACFI"), a member
of the AMRESCO Group, at an aggregate cash purchase price of $34,292,000,
including accrued interest of $812,000. Immediately following the purchase, the
Company sold to ACFI a contractual right to collect from the Company an amount
equal to the economic equivalent of all amounts collected from five of the
loans in excess of (i) $17,958,000 and (ii) a return on this amount, or so much
of it as is outstanding from time to time, equal to 12% per annum. The
aggregate cash sales price of $5,020,000 had the effect of reducing the
Company's credit exposure with respect to such loans. As additional
consideration, ACFI agreed to immediately reimburse the Company for any
F-9
<PAGE> 41
additional advances which are required to be made under the five loan
agreements. At December 31, 1998, ACFI's contingent obligation for these
additional advances approximated $1,695,000. The proceeds received from ACFI
are accounted for as a financing. As of December 31, 1998, amounts due to ACFI
totaled 5,809,000 and are included in amounts due to affiliates in the
consolidated balance sheet. The Company's loan investments are summarized as
follows (dollars in thousands):
<TABLE>
<CAPTION>
Amount
Outstanding at
Date of Initial Scheduled Collateral Commitment December 31,
Investment Maturity Location Property Type Position Amount 1998
---------- -------- -------- ------------- -------- ------ ----
<S> <C> <C> <C> <C> <C> <C>
May 12, 1998 March 31, 2001 Columbus, OH Mixed Use Second Lien $ 7,000 $ 6,839
May 12, 1998 March 31, 2001 Richardson, TX Office Second Lien 14,700 10,811
June 1, 1998 June 1, 2001 Houston, TX Office First Lien 11,800 10,033
June 12, 1998 June 30, 2000 Pearland, TX Apartment First Lien 12,827 4,238
June 17, 1998 June 30, 2000 San Diego, CA R&D/Bio-Tech First Lien 5,560 3,994
June 19, 1998 June 18, 2000 Houston, TX Office First Lien 24,000 6,682
June 22, 1998 June 19, 2000 Wayland, MA Office First Lien 45,000 24,962
July 1, 1998 July 1, 2001 Dallas, TX Office Ptrshp Interests 10,068 6,459
July 2, 1998 June 30, 2000 Washington, D.C. Office First Lien 7,000 5,489
July 10, 1998 July 31, 2000 Pasadena, TX Apartment First Lien 3,350 2,614
September 1, 1998 February 28, 2001 Los Angeles, CA Mixed Use First Lien 18,419 17,418
September 30, 1998 October 30, 1999 Richardson, TX Office First Lien 13,001 10,277
September 30, 1998 May 1, 2001 San Antonio, TX Residential Lots First Lien 3,266 2,059
September 30, 1998 Various San Antonio, TX Residential Lots First Lien 8,400 1,637
September 30, 1998 July 15, 1999 Galveston, TX Apartment First Lien 3,664 3,664
September 30, 1998 June 8, 1999 Ft. Worth, TX Apartment Ptrshp Interests 2,650 2,649
September 30, 1998 April 18, 1999 Austin, TX Office First Lien 6,325 6,314
September 30, 1998 June 30, 1999 Dallas, TX Medical Office First Lien 3,015 2,364
September 30, 1998 July 22, 1999 Norwood, MA Industrial/Office First Lien 8,765 7,733
October 1, 1998 April 30, 1999 Richardson, TX Office First Lien 567 300
December 29, 1998 December 9, 1999 San Antonio, TX Residential Lots First Lien 255 255
-------- --------
$209,632 $136,791
======== ========
<CAPTION>
Interest Interest
Date of Initial Pay Accrual
Investment Rate Rate
---------- ---- ----
<S> <C> <C>
May 12, 1998 15.0% 15.0%
May 12, 1998 10.0% 12.0%
June 1, 1998 12.0% 12.0%
June 12, 1998 10.0% 11.5%
June 17, 1998 10.0% 13.5%
June 19, 1998 12.0% 12.0%
June 22, 1998 10.5% 10.5%
July 1, 1998 10.0% 15.0%
July 2, 1998 10.5% 10.5%
July 10, 1998 10.0% 14.0%
September 1, 1998 10.0% 12.0%
September 30, 1998 10.0% 14.0%
September 30, 1998 16.0% 16.0%
September 30, 1998 10.0% 14.0%
September 30, 1998 10.0% 15.0%
September 30, 1998 10.5% 16.0%
September 30, 1998 10.0% 16.0%
September 30, 1998 10.0% 13.0%
September 30, 1998 10.0% 12.5%
October 1, 1998 9.97% 15.0%
December 29, 1998 16.0% 16.0%
</TABLE>
At December 31, 1998, amounts outstanding under construction loans,
acquisition/rehabilitation loans, acquisition loans, land development loans and
bridge loans totaled $34,657,000, $43,912,000, $46,238,000, $4,251,000 and
$7,733,000, respectively. 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.
Eight of the 21 loans provide for profit participation above the contractual
interest accrual rate; four of these eight facilities are included in the pool
of loans in which ACFI has a contractual right to collect certain excess
proceeds, as described above. The loan investments are classified as follows
(in thousands):
<TABLE>
<CAPTION>
Loan Amount Balance Sheet Amount
Outstanding at at
December 31, 1998 December 31, 1998
----------------- --------------------
<S> <C> <C>
Mortgage loans, net .................................. $ 98,303 $ 96,976
Real estate, net ..................................... 25,191 26,873
Investments in real estate ventures .................. 13,297 12,677
--------- ---------
Total ADC loan arrangements ....................... 38,488 39,550
--------- ---------
Total loan investments ............................ $ 136,791 136,526
=========
Allowance for loan losses ............................ (1,368)
---------
Total loan investments, net of allowance for losses $ 135,158
=========
</TABLE>
The differences between the outstanding loan amounts and the balance sheet
amounts are due primarily to loan commitment fees, minority interests and
accumulated depreciation.
F-10
<PAGE> 42
ADC loan arrangements accounted for as real estate consisted of the following
at December 31, 1998 (in thousands):
<TABLE>
<S> <C>
Land ................................ $ 6,118
Buildings and improvements .......... 3,196
Construction in progress ............ 17,603
---------
Total ............................ 26,917
Less: Accumulated depreciation ...... (44)
---------
$ 26,873
=========
</TABLE>
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 February 2, 1998 ......... $ --
Investments in loans ................ 137,354
Collections of principal ............ (563)
---------
Balance at December 31, 1998 ........ $ 136,791
=========
</TABLE>
The activity in the allowance for loan losses was as follows (in thousands):
<TABLE>
<S> <C>
Balance at February 2, 1998 ......... $ --
Provision for losses ................ 1,368
Charge-offs ......................... --
Recoveries .......................... --
---------
Balance at December 31, 1998 ........ $ 1,368
=========
</TABLE>
An ADC loan arrangement with a recorded investment of $6,659,000 was
non-performing as of December 31, 1998. The allowance for loan losses related
to this investment totaled $500,000 at December 31, 1998. The average recorded
investment in this ADC loan arrangement was $5,970,000 during the period from
May 12, 1998 (inception of operations) through December 31, 1998. At December
31, 1998, the amount outstanding under this loan totaled $6,839,000. No income
was recognized after the loan investment became non-performing.
As of December 31, 1998, the Company had outstanding commitments to fund
approximately $72,841,000 under 21 loans, of which $1,695,000 is 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 upon and therefore the total
commitment amounts do not necessarily represent future cash requirements. At
December 31, 1998, approximately 56% of the Company's committed loan
investments were collateralized by properties located in Texas. Additionally,
approximately 63% of the Company's loan commitments were secured by office
properties.
4. COMMERCIAL MORTGAGE-BACKED SECURITIES
As of December 31, 1998, the Company holds five commercial mortgage-backed
securities ("CMBS") which were acquired at an aggregate purchase price of
$34,480,000. The Company's CMBS available for sale are carried at estimated
fair value. At December 31, 1998, the aggregate amortized cost and estimated
fair value of CMBS, by underlying credit rating, were as follows (in
thousands):
<TABLE>
<CAPTION>
Security Aggregate Aggregate Aggregate
Rating Amortized Cost Unrealized Loss Fair Value
------ -------------- --------------- ----------
<S> <C> <C> <C>
BB- $ 4,233 $ (618) $ 3,615
B 19,489 (2,952) 16,537
B- 11,277 (2,675) 8,602
------- ------- -------
$34,999 $(6,245) $28,754
======= ======= =======
</TABLE>
F-11
<PAGE> 43
Additionally, the Company has recorded an unrealized loss of $230,000, net of
tax effects, related to CMBS owned by AMREIT II, Inc. The mortgage loans
underlying the Company's CMBS are diverse in nature; no particular
concentrations exist by property type or location. At December 31, 1998, the
weighted average maturity and weighted average duration of the Company's CMBS
was 13 years and 6.3 years, respectively.
5. REAL ESTATE
On October 23, 1998, the Company (through a majority-owned partnership)
acquired an interest in the first of five newly constructed, grocery-anchored
shopping centers in the Dallas/Fort Worth (Texas) area, an 82,730 square foot
facility in Arlington, Texas. In connection with this acquisition and other
partnership formation activities, the Company contributed $3,400,000 of capital
to the partnership; the balance of the acquisition price was financed with a
$7,500,000 non-recourse loan (Note 6). Real estate, which is comprised entirely
of amounts derived from the Company's partnership investment, consisted of the
following at December 31, 1998 (in thousands):
<TABLE>
<S> <C>
Land ................................ $ 2,353
Buildings and improvements .......... 7,976
--------
Total ............................ 10,329
Less: Accumulated depreciation ...... (56)
--------
$ 10,273
========
</TABLE>
The acquisitions of the remaining four centers, which are subject to certain
closing conditions, will require an additional equity investment of
approximately $12,500,000. In anticipation of these acquisitions, the
partnership has secured permanent financing commitments aggregating
$27,100,000. In connection with the partnership's procurement of this
financing, the Company was required to post two irrevocable standby letters of
credit totaling $1,084,000. The letters of credit, which expire on July 15,
1999, are collateralized by certificates of deposit in a like amount. The
certificates of deposit, which mature on August 31, 1999, are included in
receivables and other assets in the consolidated balance sheet.
6. 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. Borrowings under
the Line of Credit bear 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 range from 50% to 95% depending upon the asset's characteristics.
Borrowings under the facility are secured by a first lien security interest on
all assets funded with proceeds from the Line of Credit. The Line of Credit
contains several covenants; among others, the more significant covenants
include the maintenance of a $100 million consolidated Tangible Net Worth, as
defined and 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. The Line of Credit matures on July 1, 2000. The weighted
average interest rate at December 31, 1998 was 6.65%. Currently, the Company is
negotiating modifications to the Line of Credit with PSCC in an effort to
lessen the borrowing limitations imposed by PSCC in connection with the
existing facility.
To reduce the impact that rising interest rates would have on its floating rate
Line of Credit indebtedness, the Company entered into an interest rate cap
agreement with a major international financial institution. The cap agreement,
which became effective on January 1, 1999, has a notional amount of
$33,600,000. Until its expiration on July 1, 2000, the agreement entitles the
Company to receive from the counterparty the amounts, if any, by which one
month LIBOR exceeds 6.0%. The premium paid for this cap, totaling $52,000, is
included in receivables and other assets in the consolidated balance sheet. The
premium is being amortized on a straight-line basis over the life of the
agreement as an adjustment of interest incurred.
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
F-12
<PAGE> 44
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 December 31, 1998, there
were no borrowings under the Repurchase Agreement.
Under the terms of the 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.
A consolidated partnership is indebted under the terms of a $7,500,000
non-recourse loan from Jackson National Life Insurance Company. The loan bears
interest at 7.28% per annum. The loan requires interest-only payments through
January 1, 2002; thereafter, interest and principal payments are due based upon
a 25-year amortization schedule. The note, which matures on January 1, 2014,
prohibits 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.
Total interest incurred during the period from May 12, 1998 (inception of
operations) through December 31, 1998, was $624,000, of which $57,000 was
capitalized.
Future scheduled principal repayments on debt and financing facilities at
December 31, 1998 are as follows (in thousands):
<TABLE>
<S> <C>
1999 ...................... $ --
2000 ...................... 39,338
2001 ...................... --
2002 ...................... 100
2003 ...................... 118
2004 and thereafter ....... 7,282
-------
$46,838
=======
</TABLE>
7. RELATED PARTY TRANSACTIONS
The Company's day-to-day operations are managed by the Manager, a member of the
AMRESCO Group. During the period from May 12, 1998 (inception of operations)
through December 31, 1998, base management fees and reimbursable expenses
charged to the Company totaled $835,000 and $140,000, respectively. No
incentive fees were charged to the Company during this period. Reimbursable
expenses are included in general and administrative expenses in the Company's
consolidated statement of income. As of December 31, 1998, base management fees
and reimbursable expenses due to the Manager totaled $415,000 and $44,000,
respectively; these amounts are included in amounts due to affiliates in the
consolidated balance sheet.
Subject to certain limited exceptions, AMRESCO has granted to the Company a
right of first refusal with respect to the first $100 million of targeted
mortgage loan investments which are identified by or to any member of the
AMRESCO Group during any calendar quarter and all MBS (other than MBS issued in
securitizations sponsored in whole or in part by any member of the AMRESCO
Group). Additionally, the Company has entered into a Correspondent Agreement
with Holliday Fenoglio Fowler ("HFF"), a member of the AMRESCO Group, pursuant
to which HFF presents to the Company (on a non-exclusive basis) investment
opportunities identified by HFF which meet the investment criteria and
objectives of the Company.
As described more fully in Note 3, the Company acquired certain loans from
members of the AMRESCO Group during the period from May 12, 1998 (inception of
operations) through December 31, 1998.
F-13
<PAGE> 45
8. STOCK-BASED COMPENSATION
Under the Company's 1998 Share Option and Award Plan, the Company may grant
restricted common shares and options to purchase common shares in amounts up to
an aggregate of 15% of the Company's outstanding common shares (or 1,500,017
common shares).
On May 12, 1998, the Company granted to its trust managers and officers
non-qualified options to purchase 352,000 common shares at an exercise price of
$15.00 per share (the IPO price). The options vest ratably over a four-year
period beginning one year after the date of grant. The Company applies APB
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
Interpretations in accounting for these awards. As the awards had no intrinsic
value at the grant date, no compensation cost has been recognized. Had the
Company determined compensation cost associated with these options consistent
with the fair value methodology of SFAS No. 123, the Company's net income and
earnings per common share for the period from February 2, 1998 (date of initial
capitalization) through December 31, 1998 would have been reduced to the
following pro forma amounts (in thousands, except per share data):
<TABLE>
<S> <C>
Net income:
As reported ................................. $ 3,952
Pro forma ................................... $ 3,831
Basic earnings per common share:
As reported ................................. $ 0.56
Pro forma ................................... $ 0.54
Diluted earnings per common share:
As reported ................................. $ 0.56
Pro forma ................................... $ 0.54
</TABLE>
The estimated fair value of the options granted to the Company's officers and
trust managers, approximating $2.20 per share, was measured at the grant date
using the Cox-Ross-Rubinstein option pricing model with the following
assumptions: risk free interest rate of 5.64%; expected life of four years;
expected volatility of 25%; and dividend yield of 8%. Subsequent to the grant
date, the fair value of the options is not adjusted for changes in these
assumptions nor for changes in the price of the Company's stock.
On May 12, 1998, the Company granted to the Manager and certain employees of
the AMRESCO Group non-qualified options to purchase 1,000,011 and 141,500
common shares, respectively. Seventy percent of the Manager's options and those
options awarded to the other members of the AMRESCO Group are exercisable at
$15.00 per share (the IPO price); the remaining thirty percent of the Manager's
options are exercisable at an option price of $18.75 per share. The options
vest in four equal installments on May 12, 1999, May 12, 2000, May 12, 2001 and
May 12, 2002. The Company accounts for these options under SFAS No. 123 and the
interpretation thereof provided by EITF 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services"; accordingly, compensation cost is
recognized over the four-year vesting period. For purposes of recognizing
compensation costs during the financial reporting periods prior to the
measurement date, the share option awards are measured as of each financial
reporting date at their then-current fair value. Changes in those fair values
between reporting dates are attributed in accordance with the provisions of
FASB Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans". As of December 31, 1998, the estimated
fair value of the options granted to the Manager and certain employees of the
AMRESCO Group approximated $1.10 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 4.54% to
4.59%; expected lives ranging from four to seven years; expected volatility of
40%; and dividend yield of 10%. During the period from May 12, 1998 (inception
of operations) through December 31, 1998, management fees and general and
administrative expenses included compensatory option charges totaling $352,000
and $68,000, respectively.
F-14
<PAGE> 46
A summary of the status of the Company's stock options as of December 31, 1998
and the changes during the period from May 12, 1998 (inception of operations)
through December 31, 1998 is as follows:
<TABLE>
<CAPTION>
Compensatory Non-compensatory
Options Options
--------------------------- ---------------------------
Weighted Weighted
Number of Average Number of Average
Shares Exercise Price Shares Exercise Price
---------- -------------- ---------- --------------
<S> <C> <C> <C> <C>
Granted on May 12, 1998 1,141,511 $ 15.99 352,000 $ 15.00
Granted on November 3, 1998 4,000 7.88 -- --
Exercised -- -- -- --
Forfeited (21,500) (15.00) -- --
Expired -- -- -- --
---------- -------------- --------- --------------
Options outstanding at December 31, 1998 1,124,011 $ 15.98 352,000 $ 15.00
========== ============== ========= ==============
</TABLE>
As of December 31, 1998, the 1,476,011 options outstanding have a weighted
average exercise price of $15.74 and a weighted average remaining contractual
life of 9.38 years. No options were exercisable as of December 31, 1998.
In lieu of cash compensation, the Company granted 6,000 restricted common
shares to its four independent trust managers on May 12, 1998. The associated
compensation cost is being recognized over the one-year service period.
At December 31, 1998, 18,006 shares were available for grant in the form of
restricted common shares or options to purchase common shares.
9. COMMON STOCK
The Company was initially capitalized through the sale of 100 of its common
shares to AMRESCO on February 2, 1998 for $1,000. On May 12, 1998, the Company
completed its IPO of 9,000,000 shares of common stock. Concurrently, the
Private Placement of 1,000,011 common shares was completed with AMREIT
Holdings, Inc. ("Holdings"), a wholly-owned subsidiary of AMRESCO. The net
proceeds from the IPO and the Private Placement, after the underwriters'
discount and offering expenses, aggregated approximately $139.7 million. The
price to the public and to Holdings was $15.00 per share and the proceeds to
the Company from the IPO and the Private Placement were $14.00 per share (after
the underwriter's discount and advisory fee) and $15.00 per share,
respectively. Holdings currently owns 1,500,011 shares, or approximately 15% of
the Company's outstanding common stock. In addition to the 1,000,011 shares
acquired pursuant to the Private Placement, Holdings purchased 500,000 shares
through the IPO.
10. EARNINGS PER SHARE
A reconciliation of the numerator and denominator used in computing basic
earnings per share and diluted earnings per share for the period from February
2, 1998 (date of initial capitalization) through December 31, 1998, is as
follows (in thousands, except per share data):
<TABLE>
<S> <C>
Net income available to common shareholders $3,952
======
Weighted average common shares outstanding 7,027
======
Basic earnings per common share $ 0.56
======
Weighted average common shares outstanding 7,027
Effect of dilutive securities:
Restricted shares 4
Net effect of assumed exercise of stock options --
======
Adjusted weighted average shares outstanding 7,031
======
Diluted earnings per common share $ 0.56
======
</TABLE>
F-15
<PAGE> 47
Options to purchase 1,172,008 shares of common stock at $15.00 per share,
300,003 shares of common stock at $18.75 per share and 4,000 shares of common
stock at $7.875 per share were outstanding during the period from May 12, 1998
(inception of operations) through December 31, 1998. The options related to the
1,172,008 shares and the 300,003 shares were not included in the computation of
diluted earnings per share because the options' exercise price was greater than
the average market price of the Company's common shares.
The Company had no earnings prior to the commencement of its operations on May
12, 1998. When calculated for the period from May 12, 1998 (inception of
operations) through December 31, 1998, the Company's basic and diluted earnings
were $0.39 per common share.
11. DISTRIBUTIONS
The Company has adopted a policy of paying quarterly dividends on its common
shares. During the period from May 12, 1998 (inception of operations) through
December 31, 1998, the Company declared dividends totaling $7,404,000, or $0.74
per share. For federal income tax purposes, all 1998 dividends were reported as
ordinary income to the Company's shareholders. Information regarding the
declaration and payment of dividends by the Company since its inception of
operations is as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
Dividend per
Declaration Record Payment Dividend Common
Date Date Date Paid Share
----------------- ----------------- ----------------- --------- ------------
<S> <C> <C> <C> <C> <C>
Period from May 12, 1998
through June 30, 1998 July 23, 1998 July 31, 1998 August 17, 1998 $ 1,001 $ 0.10
Third Quarter October 22, 1998 October 31, 1998 November 16, 1998 2,401 0.24
Fourth Quarter December 15, 1998 December 31, 1998 January 27, 1999 4,002 0.40
------- ------------
$ 7,404 $ 0.74
======= ============
</TABLE>
12. LEASING ACTIVITIES
As of December 31, 1998, 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 2023, are as follows
(in thousands):
<TABLE>
<S> <C>
1999 ....................... $ 983
2000 ....................... 983
2001 ....................... 996
2002 ....................... 999
2003 ....................... 966
2004 and thereafter ........ 14,038
--------
$ 18,965
========
</TABLE>
Approximately 83% of the future minimum lease payments disclosed above are due
from a regional grocer.
F-16
<PAGE> 48
13. RECONCILIATION OF FINANCIAL STATEMENT NET INCOME TO TAX BASIS INCOME
A reconciliation of the Company's financial statement net income to its tax
basis income for the period from February 2, 1998 (date of initial
capitalization) through December 31, 1998 is as follows:
<TABLE>
<S> <C>
Consolidated financial statement net income.................................... $ 3,952
Difference attributable to differences in methods of accounting for ADC
loan arrangements............................................................ 1,713
Interest capitalized under SFAS No. 34......................................... (57)
Adjustments for restricted stock and compensatory options...................... 476
Provision for loan losses...................................................... 1,368
Other.......................................................................... 43
-------
Tax basis income............................................................... $ 7,495
=======
</TABLE>
For the period from May 12, 1998 (inception of operations) through December 31,
1998, the Company retained a portion of its REIT taxable income in excess of
the 95% requirement; as a result, such income is subject to tax at regular
corporate rates. These taxes, totaling approximately $20,000 (of which none was
paid in 1998), are included in general and administrative expenses in the
consolidated statement of income.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments" ("SFAS
No. 107"), requires disclosure of the estimated fair values of financial
instruments whether or not such financial instruments are recognizable in the
balance sheet. For purposes of the statement, fair value is defined as the
amount at which the instrument could be exchanged in a current transaction
between willing parties other than in a forced or liquidation sale. With the
exception of real estate, the Company's unconsolidated investment and minority
interests, substantially all of the Company's assets and liabilities are
considered financial instruments for purposes of SFAS No. 107. The estimated
fair value amounts have been determined by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required to interpret market data to develop the
estimates of fair value. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts. The fair value estimates were derived based upon pertinent information
available to management as of December 31, 1998. Although management is not
aware of any factors that would significantly affect the estimated fair value
amounts, such amounts have not been comprehensively revalued for purposes of
these financial statements since that date.
Mortgage loans and ADC loan arrangements accounted for as real estate or
investments in joint ventures have fixed rates which approximate rates that the
Company would quote currently for investments with similar terms and risk
characteristics; accordingly, their estimated fair values approximate their net
carrying values. However, there is not an active secondary trading market for
these types of investments; as a result, the estimates of fair value are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. Furthermore, the Company generally intends to hold these
financial instruments to maturity and realize their recorded values.
Commercial mortgage-backed securities are carried at estimated fair value based
on quoted market prices.
The estimated fair values of cash and cash equivalents, receivables and other
assets, accounts payable and other liabilities, amounts due to affiliates and
dividends payable approximate their carrying values due to the short-term
nature of these financial instruments.
The estimated fair value of the Line of Credit approximates its carrying value
due to the variable rate nature of the facility. The non-recourse loan on real
estate bears interest at a fixed rate which approximates current market rates;
accordingly, its fair value is not materially different from its carrying
value.
F-17
<PAGE> 49
15. SEGMENT INFORMATION
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS No. 131"), requires enterprises to report certain financial
and descriptive information about their reportable operating segments. SFAS No.
131 also requires certain enterprise-wide disclosures regarding products and
services, geographic areas and major customers.
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. During the period from May 12, 1998 (inception of operations)
through December 31, 1998, revenues derived from loan investments, CMBS and
direct investments in real estate totaled $4,834,000, $1,563,000 and $181,000,
respectively. Certain of the revenues derived from the Company's loan
investments are included in operating income from real estate and equity in
earnings of other real estate ventures in the consolidated statement of income.
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.
16. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS 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. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999, 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.
17. SUBSEQUENT EVENTS (UNAUDITED)
On February 25, 1999, the Company's Board of Trust Managers adopted a
shareholder rights plan (the "Plan"). In connection with the adoption of the
Plan, the Board of Trust Managers declared a dividend of one preferred share
purchase right (a "Right") for each outstanding common share of the Company.
The dividend was paid on March 11, 1999 to shareholders of record on March 11,
1999. The Rights trade with the Company's common shares and are not exercisable
until a triggering event, as defined, occurs.
On February 25, 1999, the Company's unconsolidated taxable subsidiary assumed
control of one of the Company's borrowers through foreclosure of certain
partnership interests.
F-18
<PAGE> 50
18. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of unaudited quarterly results of operations for the
period from February 2, 1998 (date of initial capitalization) through December
31, 1998 (in thousands, except per share data):
<TABLE>
Period from
February 2, 1998
through Second Third Fourth
March 31, 1998 Quarter Quarter Quarter
-------------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues ............................ $ -- $ 1,261 $ 2,992 $ 4,492
Net income............................ $ -- $ 757 $ 1,272 $ 1,923
Earnings per common share:
Basic ............................. $ -- $ 0.14 $ 0.12 $ 0.19
Diluted............................ $ -- $ 0.14 $ 0.12 $ 0.19
</TABLE>
The Company had no earnings prior to the commencement of its operations on May
12, 1998. When calculated for the period from May 12, 1998 (inception of
operations) through June 30, 1998, the Company's basic and diluted earnings
were $0.08 per common share during the second quarter.
F-19
<PAGE> 51
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
2.1 Sale and Assignment Agreement by and between AMRESCO
Commercial Finance, Inc. and AMREIT I, Inc. dated
effective as of September 30, 1998 relating to three
loans (filed as Exhibit 2.1 to the Registrant's
Current Report on Form 8-K dated September 30, 1998,
which exhibit is incorporated herein by reference).
2.2 Sale and Assignment Agreement by and between AMRESCO
Commercial Finance, Inc. and AMREIT I, Inc. dated
effective as of September 30, 1998 relating to five
loans (filed as Exhibit 2.2 to the Registrant's
Current Report on Form 8-K dated September 30, 1998,
which exhibit is incorporated herein by reference).
2.3 Economics Equivalents and Funding Agreement by and
between AMRESCO Commercial Finance, Inc. and AMREIT
I, Inc. dated effective as of September 30, 1998
(filed as Exhibit 2.3 to the Registrant's Current
Report on Form 8-K dated September 30, 1998, which
exhibit is incorporated herein by reference).
3.1 Amended and Restated Declaration of Trust of the
Registrant (filed as Exhibit 3.1 to the Registrant's
Registration Statement on Form S-11 (Registration No.
333-45543), which exhibit is incorporated herein by
reference).
3.2 First Amendment to Amended and Restated Declaration
of Trust of the Registrant (filed as Exhibit 3.1 to
the Registrant's Current Report on Form 8-K dated May
12, 1998, which exhibit is incorporated herein by
reference).
3.3 Second Amendment to Amended and Restated Declaration
of Trust of the Registrant (filed as Exhibit 3.2 to
the Registrant's Current Report on Form 8-K dated May
12, 1998, which exhibit is incorporated herein by
reference).
3.4 Form of Bylaws of the Registrant (filed as Exhibit
3.2 to the Registrant's Registration Statement on
Form S-11 (Registration No. 333-45543), which exhibit
is incorporated herein by reference).
10.1 Interim Warehouse and Security Agreement dated as of
July 1, 1998 by and among Prudential Securities
Credit Corporation and AMRESCO Capital Trust, AMREIT
I, Inc. and AMREIT II, Inc., which exhibit is
incorporated herein by reference.
</TABLE>
<PAGE> 52
<TABLE>
<S> <C>
10.2 Master Repurchase Agreement dated as of July 1, 1998
between Prudential-Bache International, Ltd. and
AMRESCO Capital Trust, AMREIT CMBS I, Inc., AMREIT
RMBS I, Inc. and AMREIT II, Inc., which exhibit is
incorporated herein by reference.
11 Computation of Per Share Earnings.
21 Subsidiaries of the Registrant.
27 Financial Data Schedule.
</TABLE>
(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 September 30, 1998 and filed with the
Commission on October 15, 1998, reporting (a) under
Item 2 of such form, the acquisition from an
affiliate of the Registrant of (i) a package of loans
for a purchase price of approximately $11,313,916 and
(ii) another package of loans for a purchase price of
approximately $ 22,978,251 and (b) under Item 5 of
such form, the origination of four other loans. No
financial statements were required to be included in
this Form 8-K.
<PAGE> 1
AMRESCO CAPITAL TRUST
EXHIBIT 11 - COMPUTATION OF PER SHARE EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Period from
February 2, 1998
through
December 31,
1998
---------------
<S> <C>
Basic:
Net income available to common shareholders $ 3,952
============
Weighted average common shares outstanding 7,027
============
Basic earnings per common share $ 0.56
============
Diluted:
Net income available to common shareholders $ 3,952
============
Weighted average common shares outstanding 7,027
Effect of dilutive securities:
Restricted shares 4
Net effect of assumed exercise of stock options --
------------
Adjusted weighted average common shares outstanding 7,031
============
Diluted earnings per common share $ 0.56
============
</TABLE>
<PAGE> 1
AMRESCO CAPITAL TRUST
EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT
AMREIT I, Inc. (a Delaware corporation)
AMREIT II, Inc. (a Nevada corporation)
AMREIT CMBS I, Inc. (a Delaware corporation)
ACT Holdings, Inc. (a Georgia corporation)
ACT Equities, Inc. (a Georgia corporation)
SC/ACT Investors, L.P. (a Georgia limited partnership)
SC/ACT Equities, LLC (a Texas limited liability company)
Arlington-Riverview Village, L.P. (a Texas limited partnership)
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 11-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> FEB-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 9,789
<SECURITIES> 28,754
<RECEIVABLES> 3,681
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 37,146
<DEPRECIATION> 100
<TOTAL-ASSETS> 190,926
<CURRENT-LIABILITIES> 941
<BONDS> 0
0
0
<COMMON> 100
<OTHER-SE> 130,166
<TOTAL-LIABILITY-AND-EQUITY> 190,926
<SALES> 0
<TOTAL-REVENUES> 8,745
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2,858
<LOSS-PROVISION> 1,368
<INTEREST-EXPENSE> 567
<INCOME-PRETAX> 3,952
<INCOME-TAX> 0
<INCOME-CONTINUING> 3,952
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,952
<EPS-PRIMARY> 0.56<F1>
<EPS-DILUTED> 0.56<F1>
<FN>
<F1>EPS-PRIMARY AND EPS-DILUTED ARE CALCULATED FROM FEBRUARY 2, 1998 (DATE OF
INITIAL CAPITALIZATION) THROUGH DECEMBER 31, 1998. THE COMPANY HAD NO EARNINGS
PRIOR TO THE COMMENCEMENT OF ITS OPERATIONS ON MAY 12, 1998. WHEN CALCULATED FOR
THE PERIOD FROM MAY 12, 1998 (INCEPTION OF OPERATIONS) THROUGH DECEMBER 31,
1998, THE COMPANY'S BASIC AND DILUTED EARNINGS WERE $0.39 PER COMMON SHARE.
</FN>
</TABLE>
