<PAGE>
CLARION COMMERCIAL HOLDINGS, INC.
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 June 30, 1999
Commission File Number: 1-14167
CLARION COMMERCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Maryland 13-3988895
- --------------------------------------------------------------------------------------
(State or other jurisdiction of
incorporation or organization) (I.R.S. Employer Identification No.)
335 Madison Avenue,
New York, New York 10017
- --------------------------------------------------------------------------------------
(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 August 6, 1999, 4,327,329 shares of Class A Common Stock ($.001 par value)
were outstanding.
1
<PAGE>
CLARION COMMERCIAL HOLDINGS, INC.
FORM 10-Q
INDEX
<TABLE>
<S> <C>
PART I FINANCIAL INFORMATION........................................................................3
Item 1: Financial Statements......................................................................3
Consolidated Statements of Financial Condition.....................................................3
Consolidated Statement 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.......11
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................14
PART II - OTHER INFORMATION.............................................................................15
Item 1. Legal Proceedings............................................................................15
Item 2. Changes in Securities and Use of Proceeds....................................................15
Item 3. Defaults Upon Senior Securities..............................................................15
Item 4. Submission of Matters to a Vote of Security Holders..........................................15
Item 5. Other Information............................................................................15
Item 6. Exhibits and Reports on Form 8-K.............................................................15
SIGNATURES..............................................................................................16
</TABLE>
2
<PAGE>
PART I FINANCIAL INFORMATION
Item 1: .Financial Statements
Clarion Commercial Holdings, Inc. & Subsidiaries
Statement Of Financial Condition
(Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------------------------------------
<S> <C> <C>
Assets:
Cash and cash equivalents $ 1,803,408 $ 565,684
Securities - trading, at fair value 95,617,740 80,731,788
Commercial mortgage loan held for sale, at market value 11,346,168 12,949,224
Other investments 4,856,250 4,856,250
Deposits with brokers as collateral for securities sold short 61,681,330 46,830,041
Accrued interest receivable and other assets 1,206,462 2,089,891
----------------------------------------
Total assets $ 176,511,358 $ 148,022,878
========================================
Liabilities And Stockholders' Equity:
Repurchase agreements $ 71,697,000 $ 58,924,000
Government securities sold short 60,531,004 45,578,695
Distributions payable 865,669 689,348
Treasury stock payable - 577,851
Other liabilities 2,328,511 2,336,160
----------------------------------------
Total liabilities 135,422,184 108,106,054
----------------------------------------
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;
4,328,346 and 4,451,050 shares outstanding, respectively 5,001 5,001
Class B Common Stock, par value $.001 per share
1,000,000 shares authorized; 175,000 issued and outstanding 175 175
Additional paid-in capital 98,197,339 98,197,339
Net loss and distributions (50,359,419) (52,303,201)
Treasury stock - (672,404 and 549,700 shares, respectively), at cost (6,753,922) (5,982,490)
----------------------------------------
Total stockholders' equity 41,089,174 39,916,824
----------------------------------------
Total liabilities and stockholders' equity $ 176,511,358 $ 148,022,878
========================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
Clarion Commercial Holdings, Inc. & Subsidiaries
Consolidated Statement Of Operations
(Unaudited)
<TABLE>
<CAPTION>
For the period
June 2, 1998
For the three For the six (commencement of
months ended months ended operations) through
June 30, 1999 June 30, 1999 June 30, 1998
-----------------------------------------------------------------
<S> <C> <C> <C>
Income:
Interest income from securities - trading $ 2,978,661 $ 5,693,703 $ 1,634,769
Income from commercial mortgage loan 236,810 472,050 72,790
Income from other investments 134,937 268,620 30,858
Interest income from cash and cash equivalents 14,701 28,075 14,454
-----------------------------------------------------------------
Total income 3,365,109 6,462,448 1,752,871
-----------------------------------------------------------------
Expenses:
Interest 1,818,148 3,406,276 820,724
Management fee 150,570 295,462 79,360
Other expenses 216,344 394,287 20,295
-----------------------------------------------------------------
Total expenses 2,185,062 4,096,025 920,379
-----------------------------------------------------------------
Other operating gains and losses:
Unrealized gains from securities - trading 1,306,807 2,826,791 134,709
Realized (loss) from securities - trading - - (210,504)
Provision to adjust commercial mortgage loan to market value (575,633) (1,500,633) -
-----------------------------------------------------------------
Total other operating gains 731,174 1,326,158 (75,795)
-----------------------------------------------------------------
Net Income $ 1,911,221 $ 3,692,581 $ 756,697
=================================================================
Net Income per share:
Basic $ 0.42 $ 0.81 $ 0.15
=================================================================
Diluted $ 0.42 $ 0.81 $ 0.15
=================================================================
Weighted average shares
Basic 4,548,694 4,582,645 5,172,109
=================================================================
Diluted 4,548,694 4,582,645 5,172,109
=================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
Clarion Commercial Holdings, Inc. & Subsidiaries
Consolidated Statement Of Changes In Stockholders' Equity
For the six months ended June 30, 1999
(Unaudited)
<TABLE>
<CAPTION>
Common Stock Additional Net Income and Treasury
Class A Class B Paid-in Capital Distributions Stock Total
------- ------- --------------- ------------- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1999 $ 5,001 $ 175 $ 98,197,339 $ (52,303,201) $ (5,982,490) $ 39,916,824
Dividend declared:
Class A common stock - - - (1,748,799) - (1,748,799)
Net income (loss)
- - - 3,692,581 - 3,692,581
Treasury Stock - - - - (771,432) (771,432)
---------- --------- ------------ ------------- ------------ ------------
Balance at June 30, 1999 $ 5,001 $ 175 $ 98,197,339 $ (50,359,419) $ (6,753,922) $ 41,089,174
========== ========= ============ ============= ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
Clarion Commercial Holdings, Inc. & Subsidiaries
Consolidated Statement of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the period
June 2, 1998
For the six (commencement of
months ended operations) through
June 30, 1999 June 30, 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 3,692,581 $ 756,697
Adjustments to reconcile net income to net cash used by
Operating activities:
Discount accretion, net (236,972) (110,047)
Unrealized loss (gain) on investment in commercial mortgage-backed securities 963,254 (1,320,908)
Provision to adjust commercial mortgage loan to market value 1,500,633 -
Unrealized (gain) loss on short sales of government securities (3,790,045) 1,186,199
Decrease (increase) in accrued interest receivable and other assets 883,429 (1,798,407)
(Decrease) increase in other liabilities (409,179) 1,851,235
Increase in deposits with broker as collateral for securities sold short (14,851,289) (195,826,078)
Increase in government securities sold short 18,742,354 194,454,325
--------------- --------------
Net cash provided in operating activities 6,494,766 (806,984)
--------------- --------------
Cash flows from investing activities:
Investment in commercial mortgage-backed securities (15,592,314) (222,675,089)
Principal payments received on (investment in) commercial mortgage loan 82,503 (13,059,465)
Investment in other assets - (3,809,168)
--------------- --------------
Net cash provided by investing activities (15,509,811) (239,543,722)
--------------- --------------
Cash flows from financing activities:
Proceeds from reverse repurchase agreements, net 12,773,000 147,678,000
Proceeds from issuance of common stock, net of offering costs - 94,598,045
Distributions paid (1,748,799) -
Purchases of treasury stock (771,432) -
--------------- --------------
Net cash provided by financing activities 10,252,769 242,276,045
--------------- --------------
Net increase in cash and cash equivalents 1,237,724 1,925,339
Cash and cash equivalents at beginning of period 565,684 -
--------------- --------------
Cash and cash equivalents at end of period $ 1,803,408 $ 1,925,339
=============== ==============
Supplemental information:
Interest paid $ 2,949,920 $ -
=============== ==============
Supplemental disclosures of cash flow information:
* Distributions in the amount of $724,605 were declared
on June 17, 1998 and paid on July 15, 1998.
* Treasury stock in the amount of $1,640,100 purchased
on June 30, 1998 was paid for on July 6, 1998.
* Distributions in the amount of $865,669 were declared
on June 15, 1999 and paid on July 15, 1999.
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
NOTES TO FINANCIAL STATEMENTS
6
<PAGE>
NOTE 1 ORGANIZATION AND 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 for complete financial statements and should be read in
conjunction with the annual financial statements and notes thereto included in
the Company's annual report on Form 10-K filed with the Securities and Exchange
Commission. The consolidated financial statements include the accounts of
Clarion Commercial Holdings, Inc. ("Clarion") and its consolidated subsidiaries
(together with Clarion, the "Company"). All intercompany transactions and
balances are eliminated in consolidation.
In the opinion of management, the accompanying unaudited 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 June 30, 1999 and December 31, 1998, the results of its operations
for the three months and six months ended June 30, 1999 and for the period from
commencement of operations (June 2, 1998) to June 30, 1998, the changes in its
stockholders' equity for the six months ended June 30, 1999 and its cash flows
for the six months ended June 30, 1999 and for the period from commencement of
operations (June 2, 1998) to June 30, 1998. Operating results for the period
ended June 30, 1999 are not necessarily indicative of the results that may be
expected for any other interim periods or the year ending December 31, 1999.
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.
NOTE 2 SIGNIFICANT ACCOUNTING POLICIES
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated statement of financial condition and revenues and expenses for
the periods covered. Actual results could differ from those estimates and
assumptions.
A summary of the Company's significant accounting policies follows:
SECURITIES - TRADING
At the date of acquisition, the Company elected to designate its government
securities and commercial mortgage-backed securities ("CMBS") as trading assets.
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. Interest income is recognized as it becomes receivable, and
includes amortization of premiums and accretion of discounts, computed using the
effective yield method, after considering estimated prepayments and credit
losses. Actual credit loss and prepayment experience is reviewed periodically
and effective yields adjusted if necessary.
The Company may, in the future, acquire similar assets that 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, the Company may elect to
designate these assets as "Available-For-Sale" and any subsequent unrealized
gains and losses on the assets would be reported in other comprehensive income.
SHORT SALES
The Company enters into contracts to sell securities that it does 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
sale of U.S. Treasury securities borrowed from a broker. The broker retains the
proceeds from the sale until the Company replaces the borrowed securities. Risks
in these contracts arise from the
7
<PAGE>
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". The Company accounts for its liability to return the
borrowed securities under short sales contracts at their market values, with
unrealized gains or losses recorded in earnings. Income earned on the proceeds
on deposit with brokers is included in interest income from securities - trading
and interest due under the short sales is included in interest expense.
COMMERCIAL MORTGAGE LOAN
In 1998, the Company carried its investment in a commercial mortgage loan at
amortized cost, with interest income recognized as it became receivable. In the
first quarter of 1999, the Company decided that it would dispose of this
investment as soon as practicable, and is marketing it for sale. Accordingly,
the Company has reclassified this loan as held for sale, and at June 30, 1999
has recorded an allowance of $1,500,633, to reduce its carrying value to the
lower of cost or market, based on preliminary pricing indications received from
potential buyers.
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
SFAS No. 130, "Reporting Comprehensive Income" defines comprehensive income as
the change in equity of a business enterprise during a period from transactions
and other events and circumstances, excluding those resulting from investments
by and distributions to owners. The Company had no items of other comprehensive
income during the three months or six months ended June 30, 1999 or the period
ended June 30, 1998.
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 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 on January 1, 2001. 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.
NET INCOME PER SHARE
Net income 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 three months and six months ending June 30, 1999 and the period ended
June 30, 1998, diluted net income per share was the same as basic net income per
share, because all outstanding stock options were antidilutive.
8
<PAGE>
DISTRIBUTIONS
On July 15, 1999, the Company made a distribution of $0.20 per share to
stockholders of record at the close of business on June 30, 1999. No portion of
these distributions is expected to be either a return of capital or a capital
gain for income tax purposes.
INCOME TAXES
The Company currently 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
would not be subjected to federal income tax to the extent of its distributions
to stockholders as long as certain asset, income and stock ownership tests are
met.
NOTE 3 SECURITIES - TRADING AND SHORT SALES
The Company's securities - trading consist of CMBS with an estimated fair value
of $95,617,740 and an amortized cost of $115,518,797 at June 30, 1999, resulting
in an unrealized loss of $19,901,057 at that date. At December 31, 1998, the
Company's securities trading consisted of CMBS with an estimated fair value of
$80,731,788 and an amortized cost of $99,669,591, resulting in an unrealized
loss of $18,937,803 at that date.
The aggregate estimated fair value by underlying credit rating of the Company's
CMBS at June 30, 1999 and December 31, 1998 are as follows:
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
------------- -----------------
Security Rating Estimated Fair Value % of Total Estimated Fair Value % of Total
--------------- -------------------- ---------- -------------------- ----------
<S> <C> <C> <C> <C>
BBB $18,593,322 19.4% $ - -
BBB- 15,615,518 16.3 - -
BB 40,303,391 42.2 58,252,658 72.2%
B 14,718,793 15.4 15,695,359 19.4
B- 2,545,011 2.7 2,819,988 3.5
NR 3,841,705 4.0 3,963,783 4.9
----------- -------- ----------- ------
$95,617,740 100.00% $80,731,788 100.0%
=========== ======== =========== ======
</TABLE>
As of June 30, 1999, the mortgage loans underlying the CMBS interests held by
the Company were secured by properties of the types and in the states identified
below:
<TABLE>
<CAPTION>
Property Type Percentage (1) State Percentage (1)
---------------------------------------- ------------------------------------
<S> <C> <C> <C>
Retail 37.2% CA 24.4%
Multifamily 21.2 TX 10.5
Hotel 17.1 FL 8.1
Office 14.8 MO 6.1
Other 9.7 NJ 5.9
All others (2) 45.0
</TABLE>
(1) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(2) No other state comprises more than 5% of the total.
As of June 30, 1999, the weighted average unpaid principal balance of loans that
are (1) underlying the CMBS investments of the Company and (2) more than 60 days
delinquent is 0.34% of the unpaid principal balance of the total collateral as
of that date.
The fair value of the Company's portfolio of CMBS is generally estimated by
management based on market prices provided by third party market participants.
The market for the Company's CMBS periodically suffers from a lack of liquidity,
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.
9
<PAGE>
At June 30, 1999, the un-leveraged, un-hedged, weighted average yield to
maturity of the Company's CMBS portfolio was 11.59%.
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. There is, therefore no assurance that the yield to
maturity discussed above will be achieved.
At June 30, 1999, the Company had open contracts to sell U.S. Treasury
securities with face amounts totaling $57,028,000 and a fair value of
$60,531,004. 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 June 30, 1999, the Company would have been
required to pay the counterparty $571,280.
The unrealized gain on these contracts for the three months and six months ended
June 30, 1999 was $1,592,892 and $3,790,045, respectively, which is included in
unrealized gains from securities-trading in the consolidated statement of
operations. The Company earned $634,445 and $1,171,970 on short sale proceeds
held by brokers and incurred interest of $871,349 and $1,614,255 on the short
sales contracts for the three months and six months ending June 30, 1999,
respectively.
NOTE 4 COMMON STOCK
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.
As of January 1, 1999, the Company had acquired a total of 549,700 shares of
Class A Common Stock in the open market at a cost of $5,982,490. In the six
months ended June 30, 1999, the Company acquired an additional 123,000 shares of
Class A Common Stock in the open market at a cost of $771,432.
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 pays the Manager an annual base management fee equal to
1% of the average stockholders' equity in the company, excluding any mark to
market adjustments to the Company's assets.
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.
In accordance with the terms of the Management Agreement, the Company paid
$150,570 and $295,462 in base management fees for the three months and six
months ended June 30, 1999, respectively. The Company has not accrued for, or
paid, the Manager any incentive compensation since inception.
10
<PAGE>
NOTE 6 REPURCHASE AGREEMENTS
As of June 30, 1999, the Company had entered into repurchase agreements in the
amount of $71,697,000 to finance a portion of its investments. The weighted
average maturity of the agreements as of June 30, 1999 was 19.23 days, with no
agreement having a maturity greater than 30 days, and the weighted average
interest rate was 5.85%, based on one-month LIBOR plus a weighted average spread
of 0.79%. The repurchase agreements were collateralized by the Company's
portfolio of CMBS investments.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company 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 $94.7 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 Company's financial statements and related notes.
MARKET CONDITIONS:
The three months ended June 30, 1999 were relatively calm for the Company as
spreads on subordinate classes of CMBS experienced some tightening. The price of
a fixed income security (such as a CMBS) or a commercial loan 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 tightens (or decreases),
the price (or value) of the security rises.
While spreads on the subordinate classes of CMBS tightened a little in the three
months ended June 30, 1999, interest rates increased. The ten-year U.S Treasury
rate rose approximately 0.55% in the three months ended June 30, 1999. In the
same way that a widening (increasing) spread for CMBS and commercial loans
causes their value to fall, increasing interest rates also causes their value to
decline. In order to offset this potential loss in CMBS and commercial loan
value due to increasing interest rates, the Company "sells short" U.S. Treasury
securities that increase in value as interest rates rise. In the three months
ended June 30, 1999, the Company's short positions in U.S. Treasury securities
effectively offset the decline in value of the Company's CMBS and commercial
loan positions due to the increase in interest rates.
RESULTS OF OPERATIONS
General:
Net income for the three months and six months ending June 30, 1999 amounted to
$1,911,221 or $0.42 per share, basic and diluted and $3,692,581 or $0.81 per
share, basic and diluted, respectively. Net income for the period from
commencement of operations (June 2, 1998) through June 30, 1998 amounted to
$756,697 or $0.15 per share, basic and diluted. The net income for the three
months ending June 30, 1999 was attributable primarily to income from
investments of $3.4 million and net unrealized gains of $1.3 million and was
offset by interest expense of $1.8 million, other expenses of $0.4 million, and
a $0.6 million provision recorded to reduce the carrying value of the Company's
investment in a commercial mortgage loan to its estimated market value. The net
income for the six months ending June 30, 1999 was attributable primarily to
income from investments of $6.5 million and net unrealized gains of $2.8 million
and was offset by interest expense of $3.4 million, other expenses of $0.7
million, and a $1.5 million provision recorded to reduce the carrying value of
the Company's investment in a commercial mortgage loan to its estimated market
value. The net income for the period ending June 30, 1998 consisted of income
from investments of $1.8 million offset by interest expense of $0.8 million. The
results of operations realized during the period ending June 30, 1999 are not
necessarily indicative of the results that may be expected for future periods.
11
<PAGE>
Investment Income:
For the three months and six months ending June 30, 1999 and the period ending
June 30, 1998, the Company earned income of $3,365,109, $6,462,448 and
$1,752,871 from investments, respectively, as follows:
<TABLE>
<CAPTION>
Investment Income for the three months and six months ending June 30, 1999 and the period ending June 30, 1998
- ------------------------------------------------------------------------------------------------------------------
Three Months Six Months Period
ending June 30, ending June ending June
Investment 1999 30, 1999 30, 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CMBS $ 2,344,216 $ 4,521,733 $ 1,479,925
Deposits with brokers as collateral for securities sold short 634,445 1,171,970 154,844
Commercial mortgage loan 236,810 472,050 72,790
Mezzanine investment 134,937 268,620 30,858
Cash and cash equivalents 14,701 28,075 14,454
------ ------ ------
TOTAL $ 3,365,109 $ 6,462,448 $ 1,752,871
=========== =========== ===========
</TABLE>
Interest Expense:
For the three months and six months ending June 30, 1999, the Company incurred
interest expense of $946,799 and $1,792,021 from repurchase agreements and
$871,349 and $1,614,255 from government securities sold short, respectively. For
the period ending June 30, 1998, the Company incurred interest expense of
$650,119 from repurchase agreements and $170,605 from government securities sold
short.
As of June 30, 1999, the Company had entered into repurchase agreements in the
amount of $71,697,000. The weighted average interest rate was 5.85%, and is a
variable rate, based on one-month LIBOR plus a weighted average spread 0.79%.
As of June 30, 1999, the Company had the following open short positions in U.S.
Treasury securities: $3,881,000 (face) of U.S. Treasury 6.50%, 11/15/2026 and
$53,147,000 (face) of U.S. Treasury 7.00%, 07/15/2006.
Other Expenses:
In accordance with the terms of the Management Agreement, an expense of $150,570
and $295,462 in base management fees was incurred for the three months and six
months ending June 30, 1999, respectively. The base management fees for the
period ending June 30, 1998 was $79,360. The Company has not accrued for or paid
any incentive compensation to the Manager since inception.
Other Operating Gains & Losses
For the three months and six months ended June 30, 1999, the Company recognized
unrealized gains of $1,306,807 and $2,826,791, respectively, on their securities
portfolio. Management's decision to market the commercial whole loan for sale
required an adjustment of the loan to the lower of the cost or market value.
This adjustment resulted in an unrealized loss of $575,633 and $1,500,633 for
the three months and six months ended June 30, 1999, respectively.
CHANGES IN FINANCIAL CONDITION
General: Total assets as of June 30, 1999 amounted to $176.5 million and were
comprised primarily of $95.6 million of CMBS, $61.7 million of deposits with
brokers as collateral for securities sold short, an investment of $11.3 million
in a commercial mortgage loan, and a mezzanine investment of $3.9 million. Total
liabilities of the Company as of June 30, 1999 amounted to $135.4 million and
were comprised primarily of repurchase agreements in the amount of $71.7 million
and government securities sold short in the amount of $60.5 million. During the
three months ended June 30, 1999, the Company purchased a CMBS investment for
$15.6 million. There was a corresponding increase in repurchase agreements of
$13.0 million to finance the new acquisition. Deposits with brokers as
collateral for securities sold short increased by $14.9 million, mirroring the
increase in government securities sold short. The Company increased its short
positions to hedge against changes in interest rates.
12
<PAGE>
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 Company's operating activities generated cash flows of $6.5 million during
the six months ending June 30, 1999. This was due primarily to an excess of
interest income on investments over financing costs of approximately $3.1
million and cash generated from decreased collateral requirements on the
government securities sold short of approximately $3.8 million. This compares
with the Company's operating activities during the period from commencement of
operations (June 2, 1998) through June 30, 1998 which used cash flows of $0.8
million. This was primarily due to increased collateral requirements on the
government securities sold short of $1.4 million.
The Company's investing activities used cash flows totaling $15.5 million during
the six months ending June 30, 1999 primarily through the purchase of a new CMBS
investment for $15.6 million and was offset by principal payments from the
commercial mortgage loan in the amount of $0.08 million. This compares with cash
flows used for investing activities of $239.5 million for the period from
commencement of operations (June 2, 1998) through June 30, 1998. These funds
were used to purchase the Company's initial portfolio of investments.
The Company's financing activities generated $10.3 million during the six months
ending June 30, 1999 and consisted primarily of proceeds from repurchase
agreements, purchases of treasury stock and distributions to shareholders. The
Company's financing activities for the period from commencement of operations
(June 2, 1998) through June 30, 1998 generated $242.3 million through proceeds
from issuance of common stock of $94.6 million and proceeds from repurchase
agreements of $147.7 million.
The Manager is currently evaluating investment opportunities on behalf of the
Company. In the event that the Manager identifies an investment opportunity
consistent with the Company's investment objectives, the Company may seek
sources of additional capital, including various third-party borrowings or the
issuance of preferred equity. The Company may also elect to increase its
borrowings under repurchase agreements or may elect to dispose of an existing
asset. The Company intends to dispose of its investment in a commercial mortgage
loan as soon as practicable.
The Company, in order to avoid corporate income taxation of the earnings that it
distributes, is required to distribute annually at least 95% if its taxable
income to stockholders. It is possible that the Company may experience timing
differences between the actual receipt of income and the inclusion of that
income in the calculation of taxable income. In the event that the cash
generated by the Company's investments is insufficient to fund the distributions
to stockholders that are required to maintain the Company status as a REIT, the
Company may access cash reserves or seek sources of additional capital in order
to fund the distributions.
Except as discussed herein, management is not aware of any other trends, events,
commitments or uncertainties that may have a significant effect on liquidity.
STOCKHOLDERS' EQUITY:
Stockholders' equity as of June 30, 1999 was $41.1 million. In the six months
ending June 30, 1999, stockholders' equity increased by $1.2 million due to net
income of $3.7 million, a decrease of $0.8 million due to the repurchase of
stock and a decrease of $1.7 million due to distributions of $0.20 per share to
stockholders of record on June 30, 1999 and March 31, 1999.
YEAR 2000 COMPLIANCE:
Substantially all of the Company's computer systems are supplied by the Manager.
In 1998, an affiliate of the Manager formed an internal team ("the team") of
information technology professionals to identify the risks to the business
operations of the Manager, and the Company, that may arise from the transition
to the Year 2000 and beyond. The team also assumed responsibility for increasing
awareness of the potential risks to the business operations through
presentations to employees and management of the Manager. The team has also
completed a written plan that identifies corrective steps to mitigate these
risks.
13
<PAGE>
The Manager's plan for Year 2000 compliance covers mission-critical systems,
physical facilities and communications systems. It also addresses external
interfaces with third-party computer systems that communicate with the systems
of the Manager. The Manager has allocated approximately $50,000 to cover
expenses associated with the assessment of potential Year 2000 issues. The
Company has not allocated any funds to cover Year 2000 compliance; however, the
Company may bear a portion of the costs incurred by the Manager in this regard.
Mission Critical Systems:
The Manager advised the Company that, as of June 30, 1999, the team had
completed an inventory of all systems, and had identified all mission-critical
systems that were not Year 2000 compliant. The team had also developed
remediation and testing plans to address Year 2000 issues. As of June 30, 1999,
the team advised the Company that it had completed remediation and testing of
substantially all internal mission-critical systems.
Assessment of Year 2000 Readiness of Third Parties:
On June 30, 1999, the Manager advised the Company that it had identified and had
contact with all third parties upon which the Manager relies for
mission-critical and non-mission-critical systems. All of the third parties
contacted by the team had documented their plans for addressing Year 2000 issues
and their progress in achieving Year 2000 compliance.
Development of Contingency Plan:
On June 30, 1999, the team advised the Company that it had created a written
disaster recovery plan that addresses contingency plans for the Manager in the
event of internal and external computer failures.
Risks Associated with Achieving Year 2000 Compliance:
Based upon the Manager's representations regarding the team's efforts and
responses from third parties, the Company believes that the Manager is
substantially Year 2000 compliant. There can be no assurance that the
assessments or remediation measures made by the Manager or significant third
parties with whom the Manager's systems interface have been or will be accurate.
There is a risk that failure by the Manager or those significant third parties
to achieve Year 2000 compliance will have an adverse effect on the business
operations of the Company.
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 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the exposure to loss resulting from changes in interest rates,
lending environments, changes in spreads on CMBS, foreign currency exchange
rates, commodity prices and equity prices. The primary market risks to which the
investments of the Company are exposed are interest rate risk and CMBS spread
risk, which are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and
14
<PAGE>
political considerations and other factors beyond the control of the Company.
Changes in the general level of interest rates can affect the net interest
income of the Company.
The Company is further exposed to interest rate risk through its short term
financing through repurchase agreements at rates that are based on 30-day LIBOR.
The repurchase agreements into which the Company has entered are for terms of
less than, or equal to 30 days. Changes in interest rates may increase the
Company's cost of financing its investments. Furthermore, if the company were
unable to replace its short term financing, it may be forced to sell its assets
in order to pay down its repurchase agreements at a time when the market for the
sale of such assets is unfavorable. If this were to occur, the company could
realize substantial losses.
The investments of the Company are also exposed to spread risk. The price of a
fixed income security is generally 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. As
spreads on CMBS widen, the fair value of the Company's portfolio falls. Spread
widening in the market for CMBS can occur as a result of market concerns over
the stability of the commercial real estate market, excess supply of CMBS, or
general credit concerns in other markets.
The Company enters into contracts to sell securities that it does 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. As the value of the
Company's CMBS declines (increases) with increases (decreases) in interest
rates, the value of the contracts increases (decreases). There can be no
guarantee, however, that the change in value of the contract will completely
offset the change in value of the fixed-rate interest-earning asset. 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".
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
At June 30, 1999 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
(b) Reports on Form 8-K
None
15
<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: August 12, 1999 By: /s/ Daniel Heflin
--------------------------------------------
Name: Daniel Heflin
Title: President and Chief Executive Officer
16
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM JUNE 30,
1999 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 1,803,408
<SECURITIES> 111,820,158<F1>
<RECEIVABLES> 1,134,041
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 176,511,358
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 98,202,515
<OTHER-SE> (57,113,341)
<TOTAL-LIABILITY-AND-EQUITY> 176,511,358
<SALES> 0
<TOTAL-REVENUES> 3,365,109
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2,185,062
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,818,148
<INCOME-PRETAX> 1,911,221
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,911,221
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,911,221
<EPS-BASIC> 0.42
<EPS-DILUTED> 0.42
<FN>
<F1>Includes commercial mortgage loans receivable of $11,346,168 and $4,856,250
</FN>
</TABLE>
