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CLARION COMMERCIAL HOLDINGS, INC. 10-Q
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
Commission File Number: 1-14167
CLARION COMMERCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
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<S> <C>
Maryland 13-3988895
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
335 Madison Avenue, 10017
New York, New York
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
</TABLE>
(Registrant's telephone number including area code): (212) 883-2500
NOT APPLICABLE
(Former name, former address, and former fiscal year if
changed since last report)
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
As of November 12, 1998, 4,636,750 shares of voting common stock ($.001 par
value) were outstanding.
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CLARION COMMERCIAL HOLDINGS, INC.
FORM 10-Q
INDEX
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<S> <C>
PART I FINANCIAL INFORMATION.......................................................3
Item 1: Financial Statements......................................................3
Consolidated Statement of Financial Condition....................................3
Consolidated Statements of Operations............................................4
Consolidated Statement of Changes in Stockholders' Equity........................5
Consolidated Statement of Cash Flows.............................................6
NOTES TO FINANCIAL STATEMENTS....................................................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..............................................13
PART II - OTHER INFORMATION..........................................................17
Item 1. Legal Proceedings.........................................................17
Item 2. Changes in Securities and Use of Proceeds.................................17
Item 3. Defaults Upon Senior Securities...........................................17
Item 4. Submission of Matters to a Vote of Security Holders.......................17
Item 5. Other Information.........................................................17
Item 6. Exhibits and Reports on Form 8-K..........................................17
SIGNATURES...........................................................................18
</TABLE>
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PART I..FINANCIAL INFORMATION
Item 1: Financial Statements
Clarion Commercial Holdings, Inc. & Subsidiaries
Consolidated Statement of Financial Condition
September 30, 1998
(Unaudited)
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<S> <C>
Assets:
Cash and cash equivalents $ 466,367
Securities - trading 188,205,975
Commercial mortgage loan receivable 12,987,397
Other investments 7,309,167
Accrued interest receivable 1,857,415
Other assets 133,653
-----------
Total assets $210,959,974
============
Liabilities and Stockholders' Equity:
Liabilities:
Repurchase agreements $159,903,000
Distributions payable 2,165,288
Other liabilities 6,337,450
---------
Total liabilities 168,405,738
-----------
Stockholders' equity:
Preferred Stock, par value $.01 per share,
25,000,000 shares authorized; no shares issued -
Class A Common Stock, par value $.001 per share,
74,000,000 shares authorized; 5,000,750 issued;
4,636,750 shares outstanding 5,001
Class B Common Stock, par value $.001 per share,
1,000,000 shares authorized; 175,000 issued
and outstanding 175
Additional paid-in capital 98,085,797
Accumulated deficit (50,304,032)
Treasury stock -- (364,000 shares), at cost (5,232,705)
------------
Total stockholders' equity 42,554,236
----------
Total liabilities and stockholders' equity $210,959,974
============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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Clarion Commercial Holdings, Inc. & Subsidiaries
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
For the period June 2, 1998
For the three months (commencement of operations)
ended September 30, 1998 through September 30, 1998
------------------------ --------------------------
<S> <C> <C>
Income:
Interest income from securities - trading $7,358,168 $8,992,934
Realized losses from securities - trading (1,099,396) (1,309,897)
Unrealized losses from securities - trading (48,041,149) (47,906,440)
Income from commercial mortgage loan 231,599 304,389
Income from other investments 150,776 181,634
Interest income from cash and cash equivalents 16,372 30,826
------ ------
Total income (loss) (41,383,630) (39,706,554)
------------ ------------
Expenses:
Interest 5,544,220 6,364,944
Management fee 241,326 320,686
Other expenses 1,001,661 1,021,956
--------- ---------
Total expenses 6,787,207 7,707,586
--------- ---------
Net Loss $ (48,170,837) $(47,414,140)
============== =============
Net loss per share data:
Basic $ (9.80) $ (9.52)
======== ========
Diluted $ (9.80) $ (9.52)
======== ========
Weighted average number of shares outstanding:
Basic 4,916,584 4,978,336
========= =========
Diluted 4,916,584 4,978,336
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
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Clarion Commercial Holdings, Inc. & Subsidiaries
Consolidated Statement of Changes in Stockholders' Equity
For the Period June 2, 1998 (Commencement of Operations)
Through September 30, 1998
(Unaudited)
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<CAPTION>
Common Stock
Shares Class Class Additional Retained Treasury Total
A B Paid-In Earnings Stock
Capital
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<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 2, 1998 750 $ 1 $ -- $ 14,999 $ -- $ -- $ 15,000
Issuance of common stock:
Class A 5,000,000 5,000 -- 94,570,973 -- -- 94,575,973
Class B 175,000 -- 175 3,499,825 -- -- 3,500,000
Distributions:
Class A common stock -- -- -- -- (2,786,642) -- (2,786,642)
Class B common stock -- -- -- -- (103,250) -- (103,250)
Net Loss -- -- -- -- (47,414,140) -- (47,414,140)
Treasury Stock (364,000) -- -- -- -- (5,232,705) (5,232,705)
---------------------------------------------------------------------------------
Balance at September 30, 1998 4,811,750 5,001 175 98,085,797 (50,304,032) (5,232,705) 42,554,236
=================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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Clarion Commercial Holdings, Inc. & Subsidiaries
Consolidated Statement of Cash Flows
For the Period June 2, 1998 (Commencement of Operations)
Through September 30, 1998
(Unaudited)
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<S> <C>
Cash flows from operating activities:
Net loss $ (47,414,140)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Discount accretion, net (100,935)
Unrealized loss on investment in commercial mortgage-
backed securities 35,684,823
Unrealized loss on investment in government securities 12,221,618
Increase in accrued interest receivable & other assets (1,991,068)
Increase in other liabilities 6,337,450
---------
Net cash provided by operating activities 4,737,748
---------
Cash flows from investing activities:
Purchase of investments:
Investment in commercial mortgage-backed securities (222,576,009)
Investment in government securities -- net (42,167,874)
Commercial mortgage loan receivable (13,014,690)
Investment in other investments (3,809,168)
Net cash used in investing activities (281,567,741)
-------------
Cash flows from financing activities:
Proceeds from repurchase agreements 159,903,000
Proceeds from sale of government securities 28,759,697
Proceeds from issuance of common stock, net of offering costs 94,590,973
Distributions paid (724,605)
Investment in treasury stock, at cost (5,232,705)
-----------
Net cash flows provided by financing activities 277,296,360
-----------
Net increase in cash and cash equivalents
and balance at September 30, 1998 $ 466,367
=========
Supplemental information:
Interest paid $ 3,563,575
==========
</TABLE>
Supplemental disclosures of cash flow information:
* Distributions in the amount of $2,165,288 were declared on September 23, 1998
and paid on October 15, 1998.
* The Company exchanged 175,000 class B shares of common stock valued at
$3,500,000 for a 10% interest in a Limited Liability Company.
The accompanying notes are an integral part of these consolidated financial
statements.
6
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NOTES TO FINANCIAL STATEMENTS
NOTE 1 BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of
Regulation S-X for interim financial statements. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles ("GAAP") for complete financial statements. The
consolidated financial statements include the accounts of Clarion Commercial
Holdings, Inc. ("Clarion") and its consolidated subsidiaries (together with
Clarion, the "Company"). Clarion directly owns two subsidiaries, CCHI General,
Inc. ("General Partner") and CLARCOMM Limited, Inc. ("Limited Partner"). General
Partner and Limited Partner own 1% and 99% respectively of CLARCOMM Holdings,
L.P. ("Operating Partnership"). All intercompany transactions and balances are
eliminated in consolidation.
In the opinion of management, the accompanying consolidated financial statements
contain all adjustments, consisting of normal and recurring accruals, necessary
for a fair presentation of the consolidated financial condition of the Company
at September 30, 1998, the results of its operations for the three months ended
September 30, 1998 and for the period from June 2, 1998 (commencement of
operations) through September 30, 1998, the changes in its stockholders' equity
and its cash flows for the period June 2, 1998 (commencement of operations)
through September 30, 1998. Operating results for the period ended September 30,
1998 are not necessarily indicative of the results that may be expected for any
other interim periods or the period ending December 31, 1998.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the consolidated statement of financial condition and
revenues and expenses for the period covered. Actual results could differ from
those estimates and assumptions.
NOTE 2 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Clarion was incorporated in Maryland in February 1998 and commenced its
operations on June 2, 1998. The Company is a specialty finance company organized
to invest in commercial mortgage-backed securities (primarily subordinate
securities), commercial mortgage loans, mezzanine investments, equity
investments and other real estate related investments.
A summary of the Company's significant accounting policies follows:
SECURITIES - TRADING
The Company's government securities and commercial mortgage-backed securities
("CMBS") are designated as trading assets because the Company is evaluating its
current portfolio of securities for possible sales or other dispositions in the
near term. Such securities are carried at their estimated fair value, with the
net unrealized gains or losses included in earnings. For a description of the
methodology used in determining fair value of the Company's CMBS investments,
refer to Note 3 to the Financial Statements. Interest income is recognized as it
becomes receivable, and includes amortization of premiums and accretion of
discounts, computed using the effective yield method.
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The Company may, in the future, determine that certain of these assets will be
held for longer periods of time, and will therefore, not be held principally for
the purpose of selling them in the near term. In this case, such assets would be
classified as "Available-For-Sale" and any future unrealized gains and losses on
the assets would be reported in a separate component of stockholder's equity as
dictated by SFAS 115.
COMMERCIAL MORTGAGE LOAN
The Company's investment in a commercial mortgage loan is carried at amortized
cost, with interest income recognized as it becomes receivable. The Company
periodically evaluates the collectibility of both interest and principal on its
loan to determine whether such loan is impaired. A loan is considered to be
impaired when, based on current information and events, it is probable that the
Company will be unable to collect all amounts due according to the existing
contractual terms. If a loan is determined to be impaired, a loss accrual is
recorded through income, determined by discounting the expected future cash
flows at the loan's effective interest rate or, for practical purposes, from the
estimated fair value of the collateral.
OTHER INVESTMENTS
The Company's 10% interest in Clarion Capital, LLC (the "Manager") and the
preferred interest in a limited partnership are accounted for at cost, with
income from distributions recognized as distributions are declared. The Company
periodically reviews these investments for other-than-temporary impairment. Any
such impairment would be recognized in income by reducing the investment to its
estimated fair value.
COMPREHENSIVE INCOME
The Company had no items of comprehensive income during the period ended
September 30, 1998.
NET LOSS PER SHARE
Net loss per share is computed in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 128, Earnings Per Share, and is calculated on
the basis of the weighted average number of common shares outstanding during the
period plus the additional dilutive effect of common stock equivalents. The
dilutive effect of outstanding stock options is calculated using the treasury
stock method.
For the period ending September 30, 1998, diluted net loss per share was the
same as basic net loss per share, because the exercise price of the Company's
outstanding stock options was in excess of the average trading price of the
Company's common stock during the period.
8
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DISTRIBUTIONS
On July 15, 1998, the Company made a distribution of $0.14 per share to
stockholders of record at the close of business on June 30, 1998. On October 15,
1998, the Company made a distribution of $0.45 per share to stockholders of
record at the close of business on September 30, 1998. No portion of these
distributions is expected to be either a return of capital or a capital gain.
INCOME TAXES
The Company intends to elect to be taxed as a Real Estate Investment Trust
("REIT") and comply with the provisions of the Internal Revenue Code of 1986, as
amended (the "Code"), with respect thereto. Accordingly, the Company will not be
subjected to federal income tax to the extent of its distributions to
stockholders and as long as certain asset, income and stock ownership tests are
met.
NOTE 3 SECURITIES - TRADING
The Company's securities - trading are carried at estimated fair value and were
comprised of the following at September 30, 1998:
Securities - trading
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<CAPTION>
Amortized Unrealized Fair
Cost Loss Value
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Commercial Mortgage Backed Securities
Investment grade $ 32,187,110 $ (1,372,892) $ 30,814,218
Non-investment grade 190,517,135 (34,311,930) 156,205,205
U.S. Government Treasury Securities - net 1,186,552
- ----------------------------------------------------------------------------------------------
$ 188,205,975
=============
</TABLE>
The aggregate estimated fair value by underlying credit rating of the Company's
CMBS at September 30, 1998 is as follows:
<TABLE>
<CAPTION>
Security Rating Estimated Fair Value % of Total
- ----------------------------------------------------------
<S> <C> <C>
BBB $ 17,352,344 9.3%
BBB- 13,461,874 7.2
BB 103,191,040 55.2
BB- 4,415,316 2.3
B 27,410,660 14.7
B- 16,900,492 9.0
NR 4,287,697 2.3
- ----------------------------------------------------------
$ 187,019,423 100.0%
</TABLE>
The fair value of the Company's portfolio of commercial mortgage backed
securities and government securities is generally estimated by management based
on market prices provided by certain dealers who make a market in these
financial instruments. In order to provide an estimate of fair value for the
Company's investment in CMBS as of September 30, 1998, the Company
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used the following valuation methodology: CMBS that were disposed of by the
Company subsequent to September 30, and prior to October 22, 1998 were valued at
September 30 by applying the spread used in determining the value of the CMBS at
the time of sale. Those securities not sold by the Company prior to October 22,
1998 were valued at September 30 by applying the spreads used by the
counterparty to the Company's repurchase agreements in assessing the value of
the securities for collateral. The market for the Company's CMBS is currently
suffering from a lack of liquidity and large value swings, accordingly, the fair
values reported reflect estimates and may not necessarily be indicative of the
amounts the Company could realize in a current market exchange.
One CMBS was sold subsequent to October 22, 1998, and valued at September 30,
1998 by using the spread used by the counterparty to the Company's repurchase
agreements in assessing the value of the CMBS for collateral, rather than the
spread used in valuing the CMBS upon its sale. The difference between these
two valuation methodologies was not significant.
Subsequent to September 30, 1998, the Company disposed of 14 classes of
commercial mortgage-backed securities in open market transactions for
approximately $105.3 million. The sale of these securities, together with the
closing of short positions in government securities used to hedge these
securities from changes in interest rates, resulted in a realized loss of
approximately $26.2 million. The ratings classes of the CMBS sold subsequent to
September 30, 1998, expressed as a percentage of estimated fair market value of
the total CMBS sold are as follows: BBB: 17.7%, BBB-: 13.7%, BB: 45.2%, BB-:
4.5%, B: 12.1%, B-: 6.8% and Not rated: 0%. The interest income recognized on
the securities that were sold was approximately $2.5 million for the three
months ended September 30, 1998, and approximately $3.2 million for the period
June 2, 1998 to September 30, 1998.
The yield to maturity on the Company's CMBS interests depends on, among other
things, the rate and timing of principal payments, the pass-through rate and
interest rate fluctuations. The subordinated CMBS interests owned by the Company
provide credit support to the more senior interests of the related commercial
securitization. Cash flow from the mortgages underlying the CMBS interests
generally is allocated first to the senior interests, with the most senior
interest having a priority entitlement to cash flow. Remaining cash flow is
allocated generally among the other CMBS interests in order of their relative
seniority. To the extent that there are defaults and unrecoverable losses on the
underlying mortgages, resulting in reduced cash flows, the most subordinate CMBS
interest will bear this loss first. To the extent there are losses in excess of
the most subordinated interest's stated entitlement to principal and interest,
then the remaining CMBS interests will bear such losses in order of their
relative subordination.
During the three months ended September 30, 1998, the Company entered into
contracts to sell securities that it did not own at the time of the sale, at a
specified price at a specified time (short sales). The Company utilizes these
contracts as a means of mitigating ("hedging") the potential financial statement
impact of changes in the fair value of its portfolio of CMBS due to changes in
interest rates. These contracts involve the short sale of U.S. Treasury
securities. Risks in these contracts arise from the possible inability of
counterparties to meet the terms of their contracts and from movements in
securities values and interest rates. If the market value of the securities
involved in the short sale increases, the Company may be required to meet a
"margin call".
At September 30, 1998, the Company had open contracts to sell U.S. Treasury
securities with face amounts totaling $158.3 million. Although the Company
generally does not settle these contracts at expiration, but instead rolls them
over into new contracts, if the Company had settled its open contracts at
September 30, 1998, the counterparty would have been required to pay the Company
$1,186,552.
10
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The Company accounts for its short sales contracts at their market values, with
unrealized gains or losses recorded in earnings. The estimated unrealized loss
on these contracts at September 30, 1998 was $12,221,618, which is included in
unrealized losses from securities-trading in the statement of operations. During
the three months ended September 30, 1998, the Company recorded realized losses
of $1,099,396 from settled contracts.
The composition of the portfolio of securities shown above should not be
considered indicative of the composition of the portfolio that might be expected
in the future.
NOTE 4 COMMON STOCK
Clarion common stock was sold through several transactions as follows:
Clarion was initially capitalized with the sale of 750 shares of Class A Common
Stock, par value $0.001 per share (the "Class A Common Stock") on February 18,
1998, for a total of $15,000. Clarion received commitments on March 11, 1998 for
the purchase, in private placements, of 1,000,000 shares of Class A Common Stock
at $20 per share for a total of $20,000,000. The sale of these shares was
consummated at the time of the closing of Clarion's initial public offering on
June 2, 1998 (the "IPO").
In the IPO, Clarion issued 4,000,000 shares of Class A Common Stock at a price
of $20 per share and received proceeds of $76,025,000, net of underwriting
discounts and commissions. Offering costs in connection with the IPO amounting
to approximately $1,454,000 have been charged against the proceeds of the IPO.
Concurrent with the IPO, Clarion issued 175,000 shares of Class B common stock,
par value $0.001 per share (the "Class B Common Stock") in exchange for a 10%
interest in the Manager and an option to purchase the remaining 90% interest (or
all of the assets of) the Manager for 90% of fair market value. The option may
be exercised between January 2, 2000 and March 31, 2001 only with the approval
of the Independent Directors, as defined in the Company's prospectus.
On June 30, 1998, the Board of Directors of Clarion authorized a program to
repurchase up to 400,000 shares of Class A Common Stock (the "Stock Repurchase
Program"). Pursuant to the Stock Repurchase Program, purchases of Class A Common
Stock have been and will be made at the sole discretion of management in the
open market or in privately negotiated transactions until the earlier to occur
of (i) the date on which the Company acquires, in the aggregate, 400,000 shares
of Class A Common Stock, or (ii) June 30, 1999. On September 8, 1998, the Board
of Directors authorized management to repurchase an additional 400,000 shares
prior to September 30, 1999, at a price not to exceed $13.60.
On June 30, 1998, the Company acquired 105,600 shares of Class A Common Stock in
the open market at a purchase price of $1,646,436. Subsequent to June 30 and
through September 30, 1998, the Company acquired an additional 258,400 shares of
Class A Common Stock in the open market for an aggregate cost of $3,586,269. The
Company has not acquired any additional shares since September 30, 1998.
11
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NOTE 5 TRANSACTIONS WITH AFFILIATES
Clarion has entered into a Management Agreement (the "Management Agreement")
with the Manager, under which the Manager manages the Company's day-to-day
operations, subject to the direction and oversight of Clarion's Board of
Directors. The Company will pay the Manager an annual base management fee equal
to 1% of the average stockholders' equity as further defined in the Company's
Registration Statement No. 333-47887 on form S-11 filed on May 15, 1998 (the
"Registration Statement").
The Company will also pay the Manager, as incentive compensation, an amount
equal to 25% of the Adjusted Net Income of Clarion, before incentive
compensation, in excess of the amount that would produce an annualized return on
equity equal to 2.5% over the Ten-Year U.S. Treasury Rate as further defined in
the Registration Statement. For purposes of the incentive compensation
calculation, equity is generally defined as proceeds from issuance of common
stock before underwriting discounts and commissions and other costs of issuance.
On June 2, 1998, the Company acquired 22 classes of CMBS, one commercial
mortgage loan and a preferred interest in a limited partnership from related
parties.
In accordance with the terms of the Management Agreement, an accrual of $241,326
in base management fees was made for the three months ended September 30, 1998.
The Company has not accrued for, or paid, the Manager any incentive compensation
since inception.
NOTE 6 STOCK INCENTIVE PLAN
Clarion has adopted a stock incentive plan (the "1998 Stock Incentive Plan")
that provides for the grant of both non-qualified stock options, incentive stock
options that meet the requirements of Section 422 of the Code, stock awards,
deferred stock awards, dividend equivalents or other awards. Stock incentive
awards may be granted to the directors, officers, consultants and key employees
of Clarion, the Manager or affiliates of the Manager. Subject to anti-dilution
provisions for stock splits, stock dividends and similar events, the 1998 Stock
Incentive Plan authorizes the grant of awards in the aggregate of up to 590,900
shares of Class A Common Stock.
The exercise price for any stock option granted under the 1998 Stock Incentive
Plan may not be less than 100% of the fair market value of the shares of Class A
Common Stock at the time the option is granted. Each option must terminate no
more than ten years from the date it is granted.
On June 2, 1998, pursuant to the 1998 Stock Incentive Plan, options to purchase
350,000 shares of Class A Common Stock were granted. 178,250 shares were granted
to certain officers and directors of the Company, and 171,750 shares were
granted to certain officers and employees of the Manager and its affiliates who
are not officers and directors of the Company. The exercise price of these
options is $20 per share. The remaining contractual life of each option is
approximately ten years. One third of the options vested on June 30, 1998. The
remaining options vest in equal installments on June 30, 1999 and June 30, 2000.
No other options have been granted, and no options have been exercised or
forfeited through September 30, 1998.
12
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NOTE 7 REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements to finance a portion of its
investments. As of September 30, 1998, the Company had entered into repurchase
agreements in the amount of $159,903,000. The weighted average maturity of the
agreements as of September 30, 1998, was 16 days, with no agreement with
maturities greater than 30 days, and the weighted average interest rate was
6.1565%. The repurchase agreements were collateralized by the Company's
portfolio of CMBS investments.
Subsequent to September 30, 1998, the Company reduced its borrowings under
repurchase agreements by $94,970,000, using the proceeds from the sales of
certain CMBS described in Note 3.
NOTE 8 FAIR VALUE OF FINANCIAL INSTRUMENTS
As discussed above, the Company's portfolio of CMBS securities is carried at its
estimated fair value. Company management believes that the fair value of its
government securities, cash and cash equivalents, and repurchase agreements
approximates their carrying values, due to the short-term nature of the
instruments or the fact that their terms approximate current market terms. Given
the lack of liquidity in the market for CMBS on September 30, 1998, the Company
used the following methodology to value its investment in CMBS: CMBS that were
disposed of by the Company subsequent to September 30, and prior to October 22,
1998 were valued at September 30 by applying the spread used in determining the
value of the CMBS at the time of sale. Those securities not sold by the Company
prior to October 22, 1998 were valued at September 30 by applying the spreads
used by the counterparty to the Company's repurchase agreements in assessing the
value of the securities for collateral. These values reflect estimates and may
not necessarily be indicative of the amounts the Company could realize in a
current market exchange.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
GENERAL: Clarion was organized in February 1998 to invest in commercial
mortgage-backed securities (primarily subordinate securities), commercial
mortgage loans, mezzanine investments, equity investments, and other real estate
related investments. Substantially all of the $94.6 million of net proceeds
received from the sale of 5,000,000 shares of its Class A Common Stock in June
1998 together with the net proceeds of other financing arrangements has been
used to acquire the Company's current portfolio of investments.
The following discussion of the Company's financial condition, results of
operations, and capital resources and liquidity should be read in conjunction
with the Interim Financial Statements and related Notes included in Item 1
hereof.
MARKET CONDITIONS: The three months ended September 30, 1998 were difficult for
the Company as its portfolio of CMBS suffered substantial unrealized losses. In
the month of August, new CMBS issuance and credit concerns across other markets
led to the limited
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widening of spreads on CMBS. The price of a fixed income security is often
determined by adding an interest rate spread to a benchmark interest rate, such
as the U.S. Treasury rate. As the spread on a security widens (or increases),
the price (or value) of the security falls.
In September, the restructuring of several prominent hedge funds led to
extensive spread widening in CMBS and other fixed income markets as well as a
rally in the market for government securities. Continued credit concerns led to
a tightening of credit markets. In the three months ended September 30, 1998,
the Company met all obligations under financing arrangements. Subsequent to
September 30, 1998, the Company disposed of 14 classes of CMBS to reduce
leverage and the Company's exposure to continued spread widening. The sale of
these securities resulted in realized losses of approximately $26.2 million.
With regard to the underlying credit, the CMBS that remain in the Company's
portfolio continue to perform as anticipated when acquired. The interest income
recognized on the securities that were sold was approximately $2.5 million for
the three months ended September 30, 1998, and approximately $3.2 million for
the period June 2, 1998 to September 30, 1998.
In the three months ended September 30, 1998, the liquidity in the CMBS market
diminished significantly, with much of the diminution occurring in the month of
September. This loss of liquidity continued into the month of October and made
the valuation of the Company's CMBS portfolio difficult. For the three months
ended September 30, 1998, the Company valued its portfolio of CMBS as described
in the notes to the financial statements.
The Company is currently evaluating a number of alternatives, including the sale
of equity and obtaining additional financing lines, that will reduce the
Company's exposure to further market volatility and enable the Company to
continue to execute its business plan.
RESULTS OF OPERATIONS: Clarion began operations on June 2, 1998. Net losses for
the period from June 2, 1998 to September 30, 1998 amounted to $47,414,140 or
$9.52 per share. The total loss for the period from June 2, 1998 to September
30, 1998 was attributable primarily to unrealized losses on securities held for
trade of $47,906,440, losses from the closing of short positions in government
securities of $1,309,897 and offset by interest income from securities - trading
of $8,992,934. Total expense for the period of $7,707,586 was due primarily to
interest expense of $6,364,944.
The results of operations, including the interest yields on investments,
realized during the period ended September 30, 1998 are not necessarily
indicative of the results that may be expected for future periods.
CHANGES IN FINANCIAL CONDITION
GENERAL: In the three months ended September 30, 1998 total assets decreased by
approximately $37.4 million and total liabilities increased by approximately
$16.5 million. These changes were due primarily to unrealized losses of
approximately $48.0 million in securities - trading and increases in repurchase
agreements by $12.2 million. At September 30, 1998, accrued expenses, payables
and other liabilities of $6,337,450 were primarily comprised of accrued interest
payable, unpaid costs incurred in connection with the organization and
capitalization of the Company and unpaid due diligence expenses incurred in the
evaluation of investments for the Company.
14
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<PAGE>
In accordance with the terms of the Management Agreement, an accrual of $241,326
in base management fees was made for the three months ended September 30, 1998.
Clarion did not accrue for, or pay, the Manager any incentive compensation for
the period June 2, 1998 through September 30, 1998.
STOCKHOLDERS' EQUITY: Stockholders' equity decreased by $53.9 million in the
three months ended September 30, 1998. The decrease in stockholders' equity
during this period was attributable primarily to unrealized losses in securities
- - trading of $48.0 million, and a decrease of $3.6 million due to the repurchase
of stock. See the Statement of Changes in Stockholders' Equity in the Interim
Financial Statements included in Item 1 hereof.
CAPITAL RESOURCES AND LIQUIDITY: Liquidity is a measurement of the Company's
ability to meet potential cash requirements, including ongoing commitments to
repay borrowings, fund investments, loan acquisition and lending activities and
for other general business purposes. The Company's primary sources of funds for
liquidity consist of repurchase agreements and maturities and principal payments
on securities and loans, and proceeds from sales thereof.
The tightening of credit markets and the widening of yield spreads on CMBS in
the three months ended September 30, 1998 adversely affected the liquidity
position of the Company. While the Company met all obligations under its
financing agreements, it was required to post additional collateral in order to
meet margin calls from its lenders. In addition, subsequent to September 30,
1998, the Company sold 14 classes of CMBS in order to improve its liquidity. If
credit and/or fixed income markets worsen, the Company may not be able to meet
its obligations under its financing agreements.
The Company's operating activities provided cash flows of $4.7 million during
period June 2, 1998 through September 30, 1998.
The Company's investing activities used cash flows totaling $281.6 million
during the period June 2, 1998 through September 30, 1998.
The Company's financing activities provided $277.3 million during the period
June 2, 1998 through September 30, 1998 and consisted primarily of proceeds from
repurchase agreements and the issuance of Class A Common Stock.
The Company is currently engaged in discussions with respect to obtaining
additional capital either through various third-party borrowings or other
sources. To the extent that either of these two activities comes to fruition,
the Company's liquidity and capital resources could be materially affected.
Except as discussed herein, management is not aware of any other trends, events,
commitments or uncertainties that may have a significant effect on liquidity.
NEW ACCOUNTING PRONOUNCEMENT: In June of 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS 133"). This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that the Company
15
<PAGE>
<PAGE>
recognize all derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as a hedge of
the exposure to changes in the fair value of a recognized asset or liability or
a hedge exposure to variable cash flows of a forecasted transaction. The
accounting for changes in the fair value of a derivative (e.g. through earnings
or outside earnings, through comprehensive income) depends on the intended use
of the derivative and the resulting designation.
The Company is required to implement SFAS 133 by the end of the first quarter of
the year ending December 31, 2000. Company management is evaluating the impact
that this statement will have on its hedging strategies and use of derivative
instruments and is currently unable to predict the effect, if any, it will have
on the Company's financial statements.
OTHER: The Company is currently in the process of evaluating its information
technology infrastructure for Year 2000 compliance. Substantially all of the
Company's systems are supplied by the Manager. The Manager has advised the
Company that it is currently evaluating whether such systems are Year 2000
compliant and the costs of any necessary modifications or replacements to
achieve Year 2000 compliance. To date, the Company and the Manager have incurred
no expenses related to achieving Year 2000 compliance. The Manager has advised
the Company that it does not expect that the cost to modify the Manager's
systems to be Year 2000 compliant will be material. However, the Company would
bear a portion of the costs, if any incurred by the Manager in this regard. The
Manager has advised the Company that it does not anticipate any material
disruption in the operations of the Company as a result of any failure by the
Manager to achieve Year 2000 compliance. There can be no assurance that the
costs will be immaterial or that the Company will not experience a disruption in
operations. The Manager has advised the Company that it anticipates completing
its evaluation by the end of 1998.
The Manager has advised the Company that it is currently evaluating the Year
2000 compliance of various third parties with which the Company and the Manager
do business. The Manager has advised the Company that it intends to communicate
with such third parties to determine their Year 2000 compliance status and the
extent to which the Manager or the Company could be affected by any third party
Year 2000 compliance issues. To date, however, the Manager has received no
written confirmations of Year 2000 compliance from such third parties, and there
can be no assurance that the systems of such third parties, who are beyond the
Company's control, will be Year 2000 compliant. In the event that significant
third parties with whom the Company does business do not successfully and timely
achieve Year 2000 compliance, the Company's business operations could be
adversely affected.
FORWARD-LOOKING STATEMENTS: Certain statements contained herein are not, and
certain statements contained in future filings by the Company with the SEC, in
the Company's press releases or in the Company's other public or shareholder
communications may not be, based on historical facts and are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Forward-looking statements which are based on various assumptions (some
of which are beyond the Company's control), may be identified by reference to a
future period or periods, or by the use of forward-looking terminology, such as
"may," "will," "believe," "expect," "anticipate," "continue," or similar terms
or variations on those terms, or the negative of those terms. Actual results
could differ materially from those set forth in forward-looking statements due
to a variety of factors, including, but not limited to, those related to the
economic environment, particularly in the market areas in which the
16
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<PAGE>
Company operates, competitive products and pricing, fiscal and monetary policies
of the U.S. Government, changes in prevailing interest rates, acquisitions and
the integration of acquired businesses, credit risk management, asset/liability
management, the financial and securities markets and the availability of and
costs associated with sources of liquidity. The Company does not undertake, and
specifically disclaims any obligation, to publicly release the result of any
revisions, which may be made to any forward-looking statements to reflect the
occurrence of anticipated or unanticipated events or circumstances after the
date of such statements.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
At September 30, 1998 there were no legal proceedings to which the Company
was a party or of which any of its property was subject.
Item 2. Changes in Securities and Use of Proceeds
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27.1 - Financial Data Schedule (incorporated herein by reference to
the Exhibits to Form 10-Q filed by the registrant on August 14, 1998)
(b) Reports on Form 8-K
17
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<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CLARION COMMERCIAL HOLDINGS, INC,
Dated: November 13, 1998 By: /s/ Daniel Heflin
--------------------------------------------
Name: Daniel Heflin
Title: President and Chief Executive Officer
18
<PAGE>
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
SEPTEMBER 30, 1998 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUN-02-1998
<PERIOD-END> SEP-30-1998
<CASH> 466,367
<SECURITIES> 208,502,539 <F1>
<RECEIVABLES> 1,857,415
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 133,653
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 210,959,974
<CURRENT-LIABILITIES> 168,405,738
<BONDS> 0
0
0
<COMMON> 98,090,973
<OTHER-SE> (55,536,737)
<TOTAL-LIABILITY-AND-EQUITY> 210,959,974
<SALES> 0
<TOTAL-REVENUES> (39,706,554)
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1,342,642
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,364,944
<INCOME-PRETAX> (47,414,140)
<INCOME-TAX> 0
<INCOME-CONTINUING> (47,414,140)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (47,414,140)
<EPS-PRIMARY> (9.52)
<EPS-DILUTED> (9.52)
<FN>
<F1>Includes commercial mortgage loans receivable of $12,987,397 and $7,309,167
in other investments.
</FN>
</TABLE>
