<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
Amendment No. 1
(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.
<PAGE> 2
This Form 10-K/A is being filed to amend and restate Items 1, 7 and 14 in
their entirety.
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.
2
<PAGE> 3
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. The Company has
used, and it expects that in the future it will use, repurchase agreements
to finance a portion of its CMBS portfolio. These agreements often involve
financing with a shorter term than the underlying assets being financed. In
addition, repurchase agreements require margin calls if there is a
dimunition of asset value due to spread widening or interest rate changes.
Both of these risks result in a need for liquidity to either pay down or
pay off repurchase agreement financing. The Company would be required to
increase its leverage from its line of credit or sell assets in the event
that repurchase agreement financing could not be obtained at maturity.
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
3
<PAGE> 4
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 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.
4
<PAGE> 5
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 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.
As of December 31, 1998, the Company's loan investments are summarized as
follows (dollars in thousands):
<TABLE>
<CAPTION>
Date of Initial Scheduled Collateral
Investment Maturity Location Property Type Position
- ----------------- -------------- ------------ --------------- -------------
<S> <C> <C> <C> <C>
May 12, 1998 March 31, 2001 Columbus, OH Mixed Use Second Lien (a)
May 12, 1998 March 31, 2001 Richardson, TX Office Second Lien
June 1, 1998 June 1, 2001 Houston, TX Office First Lien
June 12, 1998 June 30, 2000 Pearland, TX Apartment First Lien
June 17, 1998 June 30, 2000 San Diego, CA R&D/Bio-Tech First Lien
June 19, 1998 June 18, 2000 Houston, TX Office First Lien
June 22, 1998 June 19, 2000 Wayland, MA Office First Lien
July 1, 1998 July 1, 2001 Dallas, TX Office Ptrshp Interests
July 2, 1998 June 30, 2000 Washington, D.C. Office First Lien
July 10, 1998 July 31, 2000 Pasadena, TX Apartment First Lien
September 1, 1998 February 28, 2001 Los Angeles, CA Mixed Use First Lien
September 30, 1998 October 30,1999 (b) Richardson, TX Office First Lien
September 30, 1998 May 1, 2001 San Antonio, TX Residential Lots First Lien
September 30, 1998 Various San Antonio, TX Residential Lots First Lien
September 30, 1998 July 15, 1999 Galveston, TX Apartment First Lien
September 30, 1998 June 8, 1999 Ft. Worth, TX Apartment Ptrshp Interests
September 30, 1998 April 18, 1999 (c) Austin, TX Office First Lien
September 30, 1998 June 30, 1999 Dallas, TX Medical Office First Lien
September 30, 1998 July 22, 1999 Norwood, MA Industrial/Office First Lien
October 1, 1998 April 30, 1999 Richardson, TX Office First Lien
December 29, 1998 December 9, 1999 (d) San Antonio, TX Residential Lots First Lien
AMRESCO Commercial Finance, Inc's Economic Interest
<CAPTION>
Amount
Outstanding
at Interest Interest
Date of Initial Commitment December 31, Pay Accrual
Investment Amount 1998(g) Rate Rate
--------------- ----------- ------------ -------- -------
<S> <C> <C> <C> <C>
May 12, 1998 $ 7,000 $ 6,839(e) 15.0% 15.0%
May 12, 1998 14,700 10,811 10.0% 12.0%
June 1, 1998 11,800 10,034 12.0% 12.0%
June 12, 1998 12,827 4,237(f) 10.0% 11.5%
June 17, 1998 5,560 3,994(f) 10.0% 13.5%
June 19, 1998 24,000 6,682(f) 12.0% 12.0%
June 22, 1998 45,000 24,962 10.5% 10.5%
July 1, 1998 10,068 6,459(e) 10.0% 15.0%
July 2, 1998 7,000 5,489 10.5% 10.5%
July 10, 1998 3,350 2,614 10.0% 14.0%
September 1, 1998 18,419 17,418 10.0% 12.0%
September 30, 1998 13,001 10,277(f) 10.0% 14.0%
September 30, 1998 3,266 2,059 16.0% 16.0%
September 30, 1998 8,400 1,637 10.0% 14.0%
September 30, 1998 3,664 3,664 10.0% 15.0%
September 30, 1998 2,650 2,649 10.5% 16.0%
September 30, 1998 6,325 6,314 10.0% 16.0%
September 30, 1998 3,015 2,364 10.0% 13.0%
September 30, 1998 8,765 7,733 10.0% 12.5%
October 1, 1998 567 300 9.97% 15.0%
December 29, 1998 255 255 16.0% 16.0%
-------- --------
209,632 136,791
AMRESCO Commercial Finance, Inc's Economic Interest (6,552) (4,857)
-------- --------
$203,080 $131,934
======== ========
</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.
5
<PAGE> 6
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 $38,488,000 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".
AMRESCO Commercial Finance, Inc.'s economic interest and the loan referred to in
note (a) accompanying the table above are more fully described in Management's
Discussion and Analysis of Financial Condition and Results of Operations (Item
7) and in the notes to the audited consolidated financial statements (Item 8).
At December 31, 1998, the Company's loan investments were geographically
dispersed as follows (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.
6
<PAGE> 7
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.
7
<PAGE> 8
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. Investments in CMBS comprised
approximately 16.7% of the Company's investment portfolio at December 31, 1998.
During the period from its inception of operations through December 31, 1998,
the Company's investments in CMBS comprised an average of approximately 8.4% of
the Company's investment portfolio. 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.
As of December 31, 1998, the Company's CMBS holdings and their anticipated
maturity date were as follows:
<TABLE>
<CAPTION>
Expected
Class Security Name Maturity Date
- ----- ------------------------------------------------------ -------------
<S> <C> <C>
G Merrill Lynch Mortgage Investors, Inc. Series 1998-C2 March 2013
H Merrill Lynch Mortgage Investors, Inc. Series 1998-C2 March 2013
J Merrill Lynch Mortgage Investors, Inc. Series 1998-C2 March 2014
G2 Morgan Stanley Capital I Series 1997 RR November 2022
B-2A Nomura Depositor Trust Series 1998-ST1A February 2003
B-3A Nomura Depositor Trust Series 1998-ST1A February 2003
</TABLE>
The B-3A bond is owned by the Company's unconsolidated taxable subsidiary.
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
8
<PAGE> 9
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.
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
9
<PAGE> 10
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.
There are an estimated 25 to 40 significant competitive structured finance
lenders competing against the Company. The Company ranks on the lower end on
volume and on the upper end on return on assets in this group of lenders. The
Company believes it is competitive as a finance company due to its ability and
willingness to customize financing structures. The Company may be less
competitive at times due to its relatively small capitalization and lack of low
cost capital.
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 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.
10
<PAGE> 11
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 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.
11
<PAGE> 12
PART II
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.
12
<PAGE> 13
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".
13
<PAGE> 14
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
14
<PAGE> 15
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.
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. To date, all
interest payments have been made in accordance with the terms of the first lien
mortgage. During 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 allowance for loan losses related to this
investment totaled $500,000 at December 31, 1998, which amount represented
management's estimate at that time of the amount of the expected loss which
could result upon a disposition of the collateral. 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):
15
<PAGE> 16
<TABLE>
<CAPTION>
Percentage of
Security Aggregate Aggregate Total Based
Rating Amortized Cost Fair Value on Fair Value
- -------- -------------- ---------- -------------
<S> <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.
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").
16
<PAGE> 17
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.
17
<PAGE> 18
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
its 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, including banks and other financial institutions which lend to
entities that
18
<PAGE> 19
originate commercial mortgage loans and/or acquire CMBS. Management is actively
exploring the availability of capital from these 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 used
in connection with the
19
<PAGE> 20
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. has sent
written requests seeking written representations and other independent
confirmations of Year 2000 readiness from all of the third parties with whom
AMRESCO, INC., the Manager or the Company have contracts regarding the material
business- critical operations of the Company. By December 31, 1998, written
responses had been received from approximately 20% (by number) of these third
parties stating that they had achieved, or that, by September 30, 1999, they
expected to achieve Year 2000 readiness. 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, particularly that of AMRESCO, INC., and testing done through
the date of this report, 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.
20
<PAGE> 21
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.
21
<PAGE> 22
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.
22
<PAGE> 23
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:
Exhibit No.
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.
23
<PAGE> 24
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.
10.3 Management Agreement, dated as of May 12, 1998, by and
between AMRESCO Capital Trust and AMREIT Managers, L.P.,
which exhibit is incorporated herein by reference.
11 Computation of Per Share Earnings. (Previously filed)
21 Subsidiaries of the Registrant. (Previously filed)
24 Power of Attorney (included on the signature page hereto)
27 Financial Data Schedule. (Previously filed)
(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.
24
<PAGE> 25
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/ Thomas R. Lewis II
--------------------------
Thomas R. Lewis II
Senior Vice President, Chief Financial and Accounting Officer & Controller
Date: April 25, 2000
POWER OF ATTORNEY
KNOWN ALL MEN BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Robert L. Adair III and Jonathan S.
Pettee, and each of them, his true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him, and on his behalf and in
his name, place and stead, in any and all capacities, to sign, execute and file
this Amendment to Annual Report on Form 10K under the Securities Exchange Act of
1934, as amended, and any or all future amendments, with all exhibits and any
and all documents required to be filed with respect thereto, with the Securities
and Exchange Commission or any regulatory authority, granting unto such
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises in order to effectuate the same, as fully to all intents
and purposes as he himself might or could do if personally present, hereby
ratifying and confirming all that such attorneys-in-fact and agents, or any of
them, or their substitute or substitutes, may lawfully do or cause to be done.
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>
April 25, 2000 /s/ Robert L. Adair III
-----------------------------------
Robert L. Adair III
Chairman of the Board of Trust Managers
and Chief Executive Officer
(Principal Executive Officer)
April 25, 2000 /s/ Thomas R. Lewis II
-----------------------------------
Thomas R. Lewis II
Senior Vice President, Chief Financial
And Accounting Officer & Controller
(Principal Financial and Accounting Officer)
April 25, 2000 /s/ John C. Deterding
-----------------------------------
John C. Deterding
Independent Trust Manager
April 25, 2000
-----------------------------------
Bruce W. Duncan
Independent Trust Manager
April 25, 2000
-----------------------------------
Christopher B. Leinberger
Independent Trust Manager
April 25, 2000 /s/ James C. Leslie
-----------------------------------
James C. Leslie
Independent Trust Manager
April 25, 2000 /s/ Robert H. Lutz, Jr.
-----------------------------------
Robert H. Lutz, Jr.
Trust Manager
</TABLE>
25
