<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, 2000
Commission File Number: 1-14167
CLARION COMMERCIAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
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)
(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 11, 2000, 4,063,155 shares of Class A Common Stock ($.001 par
value) were outstanding.
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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 Statements of Operations..............................................................4
Consolidated Statement of Changes in Stockholders' Equity..........................................5
Consolidated Statements 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.............................................................................16
Item 1. Legal Proceedings............................................................................16
Item 2. Changes in Securities and Use of Proceeds....................................................16
Item 3. Defaults Upon Senior Securities..............................................................16
Item 4. Submission of Matters to a Vote of Security Holders..........................................16
Item 5. Other Information............................................................................16
Item 6. Exhibits and Reports on Form 8-K.............................................................16
SIGNATURES..............................................................................................16
</TABLE>
2
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PART I FINANCIAL INFORMATION
Item 1: Financial Statements
CLARION COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
---- ----
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 1,215,687 $ 1,143,182
Securities-trading, at fair value 65,139,193 100,893,785
Other investments 3,954,638 4,106,250
Deposits with brokers as collateral for securities sold short 25,272,876 25,191,059
Accrued interest receivable and other assets 904,290 735,775
------------- -------------
Total assets $ 96,486,684 $ 132,070,051
============= =============
LIABILITIES
Repurchase agreements $ 30,755,000 $ 64,691,000
Government securities sold short 25,495,841 24,518,159
Dividends payable 812,396 839,356
Treasury stock payable -- 184,123
Other liabilities 814,468 1,242,614
------------- -------------
Total liabilities 57,877,705 91,475,252
------------- -------------
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;
4,061,979 and 4,173,380 shares issued and outstanding on June 30, 2000
and December 31, 1999, respectively 4,062 4,173
Class B Common Stock, par value $.001 per share, 1,000,000 shares authorized;
175,000 shares issued and outstanding on December 31, 1999;
converted to Class A shares January 1, 2000 -- 175
Additional paid-in capital 88,063,118 90,307,988
Net loss and distributions (49,458,201) (49,717,537)
------------- -------------
Total stockholders' equity 38,608,979 40,594,799
------------- -------------
Total liabilities and stockholders' equity $ 96,486,684 $ 132,070,051
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
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CLARION COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Income:
Interest income from securities-trading $ 2,340,470 $ 2,978,661 $ 5,147,270 $ 5,693,703
Interest income from commercial mortgage loan -- 236,810 -- 472,050
Income from other investments 90,898 134,937 225,301 268,620
Interest income from cash and cash equivalents 71,945 14,701 79,279 28,075
----------- ----------- ----------- -----------
Total income 2,503,313 3,365,109 5,451,850 6,462,448
----------- ----------- ----------- -----------
Expenses:
Interest 1,032,235 1,818,148 2,359,648 3,406,276
Management fee 127,617 150,570 256,481 295,462
Other expenses 389,822 216,344 556,283 394,287
----------- ----------- ----------- -----------
Total expenses 1,549,674 2,185,062 3,172,412 4,096,025
----------- ----------- ----------- -----------
Other operating gains and losses:
Gain/(loss) from securities-trading (759,666) 1,306,807 (395,502) 2,826,791
Provision to adjust commercial mortgage loan
to market value -- (575,633) -- (1,500,633)
----------- ----------- ----------- -----------
Total other operating gains (losses) (759,666) 731,174 (395,502) 1,326,158
----------- ----------- ----------- -----------
Net Income $ 193,973 $ 1,911,221 $ 1,883,936 $ 3,692,581
=========== =========== =========== ===========
Net Income per share:
Basic $ 0.05 $ 0.42 $ 0.46 $ 0.81
=========== =========== =========== ===========
Diluted $ 0.05 $ 0.42 $ 0.46 $ 0.81
=========== =========== =========== ===========
Weighted average shares
Basic 4,061,968 4,548,694 4,071,920 4,582,645
=========== =========== =========== ===========
Diluted 4,061,968 4,548,694 4,071,920 4,582,645
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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CLARION COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2000
(UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL NET INCOME AND TOTAL
PAID-IN DISTRIBUTIONS
CAPITAL
CLASS A CLASS B
------- ------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 2000 $ 4,173 $ 175 $ 90,307,988 $(49,717,537) $ 40,594,799
Common stock conversion 175 (175) -- -- --
Class A common stock dividend declared -- -- -- (1,624,600) (1,624,600)
Net income -- -- -- 1,883,936 1,883,936
Common stock repurchase (296) -- (2,321,860) -- (2,322,156)
Issuance of common stock 10 -- 76,990 -- 77,000
------- ---- ------------ ------------ ------------
Balance at June 30, 2000 $ 4,062 $ -- $ 88,063,118 $(49,458,201) $ 38,608,979
======= ==== ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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<PAGE>
CLARION COMMERCIAL HOLDINGS, INC. & SUBSIDIARIES
STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30 JUNE 30,
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,883,936 $ 3,692,581
Adjustments to reconcile net income to net cash used by
Operating activities:
Amortization and accretion, net (259,419) (236,972)
Issuance of shares - fees and compensation 77,000 --
Change in unrealized (gain) loss on securities-trading (414,890) 963,254
Change in unrealized (gain) loss on government securities sold short 1,224,265 (3,790,045)
Provision to adjust commercial mortgage loan to market value -- 1,500,633
Decrease (increase) in accrued interest receivable & other assets (168,515) 883,429
(Decrease) increase in other liabilities (428,146) (409,179)
Purchase of securities-trading (30,458,810) (15,592,314)
Sale of and principal payments on securities-trading 66,995,987 --
Decrease (increase) in deposits with broker as collateral for securities sold short (81,817) (14,851,289)
(Decrease) increase in government securities sold short (246,583) 18,742,354
------------ ------------
Net cash provided by (used in) in operating activities 38,123,008 (9,097,548)
------------ ------------
Cash flows from investing activities:
Principal payments received on mezzanine investment 43,333 --
Principal payments received on commercial mortgage loan -- 82,503
------------ ------------
Net cash provided by investing activities 43,333 82,503
------------ ------------
Cash flows from financing activities:
(Repayments) borrowings under reverse repurchase agreements, net (33,936,000) 12,773,000
Dividends paid (1,651,560) (1,748,799)
Repurchases of common stock (2,506,276) (771,432)
------------ ------------
Net cash provided by (used in) financing activities (38,093,836) 10,252,769
------------ ------------
Net increase in cash and cash equivalents 72,505 1,237,724
Cash and cash equivalents at beginning of period 1,143,182 565,684
------------ ------------
Cash and cash equivalents at end of period $ 1,215,687 $ 1,803,408
============ ============
Supplemental information:
Interest paid $ 1,834,196 $ 2,949,920
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
6
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NOTES TO FINANCIAL STATEMENTS
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, 2000 and December 31, 1999 and the results of its operations
and its cash flows for the three months and six months ended June 30, 2000 and
1999. Operating results for the period ended June 30, 2000 are not necessarily
indicative of the results that may be expected for any other interim periods or
the year ending December 31, 2000.
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 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
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proceeds from the sale until the Company replaces the borrowed 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". 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 September 1999 the Company sold its investment in the commercial mortgage
loan. The Company recorded a reserve for loan impairment in the amount of
$1,500,633 during the six months ended June 30, 1999 based on its estimated
valuation.
OTHER INVESTMENTS
The Company's 10% interest in Clarion Capital, LLC (the "Manager") and the
preferred interest in a limited partnership are accounted for on a cost basis,
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 any of the periods presented, so its comprehensive income was the
same as its net income.
NEW ACCOUNTING PRONOUNCEMENT
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") 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 through comprehensive income) depends on
the intended use of the derivative and the resulting designation.
The Company is required to implement SFAS 133, as amended by SFAS 137 and SFAS
138, on January 1, 2001. Based on the Company's current hedging strategies,
management believes that implementation of SFAS 133 will have no impact 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, 2000 and 1999, diluted net
income per share was the same as basic net income per share, because all
outstanding stock options were antidilutive.
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DISTRIBUTIONS
On July 17, 2000, the Company made a distribution of $0.20 per share to
stockholders of record at the close of business on June 30, 2000. The character
of the distribution to the stockholders for income tax purposes has not been
determined at this time.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment Trust ("REIT")
and has complied with the provisions of the Internal Revenue Code of 1986, as
amended (the "Code"), with respect thereto. Accordingly, the Company is not
subject to federal income tax to the extent of its distributions to stockholders
as long as certain asset, income and stock ownership tests are met.
The Company has elected mark-to-market valuation treatment for its investment
portfolio under Internal Revenue Code Section 475. Under this election the
Company must treat all unrealized trading gains and losses as realized for
income tax purposes as well as treating all trading transactions as operating
gains and losses.
NOTE 3 SECURITIES -- TRADING AND SHORT SALES
The Company's securities-trading consist of CMBS with an estimated fair value of
$65,139,193 and an amortized cost of $79,989,710 at June 30, 2000, resulting in
an unrealized loss of $14,850,517 at that date. At December 31, 1999, the
Company's securities-trading consisted of CMBS with an estimated fair value of
$100,893,785 and an amortized cost of $116,159,192, resulting in an unrealized
loss of $15,265,407 at that date.
The aggregate estimated fair values by underlying credit rating of the Company's
CMBS at June 30, 2000 and December 31, 1999 are as follows:
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
Security Rating Estimated Fair Value % of Total Estimated Fair Value % of Total
--------------- -------------------- ---------- -------------------- ----------
<S> <C> <C> <C> <C>
AAA $ 3,992,209 6.1% $ 24,993,295 24.8%
A 4,988,740 7.7% -- --
BBB 15,902,872 24.4% 37,538,397 37.2%
BB 18,590,121 28.5% 17,547,932 17.4%
B 16,239,106 24.9% 14,365,174 14.2%
B- 1,883,099 2.9% 2,461,145 2.4%
NR 3,543,046 5.4% 3,987,849 4.0%
----------- ------ ------------ -----
$65,139,193 100.0% $100,893,792 100.0%
=========== ====== ============ =====
</TABLE>
As of June 30, 2000, 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> <C>
Retail 44.3% CA 27.9%
Office 18.1 MO 8.7
Hotel 15.5 TX 8.6
Multifamily 12.6 NY 8.0
Other 9.5 NJ 6.7
All others (2) 40.1
</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.
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As of June 30, 2000, 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 0.12% 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 level
exchange.
At June 30, 2000, the un-leveraged, un-hedged, weighted average yield to
maturity (excluding default and prepayment estimates) of the Company's CMBS
portfolio was 12.74%.
The yield to maturity on the Company's CMBS interests depends on, among other
things, the amount 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. The Company typically invests in the most subordinate
securities. There is, therefore no assurance that the yield to maturity
discussed above will be achieved.
At June 30, 2000, the Company had open contracts to sell U.S. Treasury
securities with face amounts totaling $26,307,000 and a fair value of
$25,495,841. 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, 2000, the Company would have been
required to pay the counterparty $226,106.
The unrealized gain (loss) on these contracts for the three months and six
months ending June 30, 2000 was $526,398 and ($1,224,265), respectively, which
is included in gain (loss) from securities-trading in the consolidated statement
of operations. 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 gain (loss) from securities-trading in the consolidated
statement of operations. The realized gain (loss) on these contracts for the
three months and six months ended June 30, 2000 was ($550,332) and $375,500,
respectively, which is included in gain (loss) from securities-trading in the
consolidated statement of operations.
The Company earned $390,637 and $715,790 on short sale proceeds held by brokers
and incurred interest of $358,230 and $713,838 on the short sales contracts for
the three months and six months ending June 30, 2000, respectively. 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 Company's Board of Directors 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 November 17,
1999, the Board of Directors authorized management to repurchase an additional
400,000 shares and extended the program to September 30, 2000, at a price not to
exceed $8.75. Through June 30, 2000, the Company acquired a total of 1,128,200
shares in the open market at a cost of $10,254,825. In accordance with Maryland
law, all repurchased shares of common stock are retired.
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During the six months ended June 30, 2000 the independent members of the Board
of Directors received 1,899 shares of Class A Common Stock as compensation for
their service to the Company.
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 a base management fee, payable monthly,
at an annual rate of 1.0% of the Company's average stockholders' equity,
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 incurred
$127,617 and $256,481 in base management fees for the three months and six
months ended June 30, 2000, respectively. The Company incurred $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.
NOTE 6 REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements with Bear Stearns to finance
a portion of its investments. As of June 30, 2000 and December 31,1999, the
Company had entered into repurchase agreements in the amount of $30,755,000 and
$64,691,000, respectively. All of the repurchase agreements outstanding at June
30, 2000 matured in 31 days, and the weighted average interest rate was 7.31%,
based on one-month LIBOR plus a weighted average spread of 0.67%. The weighted
average maturity of the agreements as of December 31, 1999 was 19.4 days, with
no agreement having a maturity greater than 30 days, and the weighted average
interest rate was 6.98%, based on one-month LIBOR plus a weighted average spread
of 0.60%. The repurchase agreements are 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 were used to
acquire the Company's 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 ending June 30, 2000, were relatively calm for the Company, as
spreads on subordinate classes of CMBS did not move dramatically in either
direction. 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.
Spreads on the subordinate classes of CMBS held steady in the three months
ending June 30, 2000 and interest rates also held firm. The ten-year U.S
Treasury rate increased approximately 0.01% in the three months ending June 30,
2000. This compares to a rise of 0.55% in the three months ending June 30, 1999.
In the same way that a widening
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<PAGE>
(increasing) spread for CMBS causes their value to fall, increasing interest
rates also causes their value to fall. In order to offset a potential loss in
CMBS 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, 2000 and 1999, respectively, the Company's short positions
in U.S. Treasury securities effectively offset the change in value of the
Company's CMBS due to changes in interest rates.
RESULTS OF OPERATIONS
General:
Net income for the three months and six months ending June 30, 2000 amounted to
$193,793 or $0.05 per share, basic and diluted, and $1,883,936 or $0.46 per
share, basic and diluted, respectively. The net income for the three months
ending June 30, 2000 was attributable primarily to income from investments of
$2.5 million. This was offset by interest expense of $1.0 million, net loss
(realized and unrealized) from securities-trading of $0.8 million and other
expenses of $0.5 million. The net income for the six months ending June 30,
2000 was attributable primarily to income from investments of $5.5 million and
was offset by interest expense of $2.4 million, other expenses of $0.8 million,
and a $0.4 million loss (realized and unrealized) from securities-trading.
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. The net income for the three months
ending June 30, 1999 was attributable primarily to income from investments of
$3.4 million and gains (realized and unrealized) from securities-trading 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 gains
(realized and unrealized) from securities-trading 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 results of operations realized during the periods ending June 30, 2000 are
not necessarily indicative of the results that may be expected for future
periods.
Investment Income:
For the three months and six months ending June 30, 2000 and for the three
months and six months ending June 30,1999, the Company earned income of
$2,503,313, $5,451,850, $3,365,109 and $6,462,448 from investments,
respectively, as follows:
<TABLE>
<CAPTION>
Three Months Six Months Three Months Six Months
Ending Ending Ending Ending
Investment June 30, 2000 June 30, 2000 June 30, 1999 June 30, 1999
---------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
CMBS $ 1,949,833 $ 4,431,480 $ 2,344,216 $ 4,521,733
Deposits with brokers as collateral
for securities sold short 390,637 715,790 634,445 1,171,970
Commercial mortgage loan - - 236,810 472,050
Mezzanine investment 90,898 225,301 134,937 268,620
Cash and cash equivalents 71,945 79,279 14,701 28,075
----------- ----------- ----------- -----------
TOTAL $ 2,503,313 $ 5,451,850 $ 3,365,109 $ 6,462,448
=========== =========== =========== ===========
</TABLE>
12
<PAGE>
Interest Expense:
For the three months and six months ending June 30, 2000, the Company incurred
interest expense of $674,005 and $1,645,811 from repurchase agreements and
$358,230 and $713,837 from government securities sold short, respectively. 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.
As of June 30, 2000 and December 31, 1999, the Company had entered into
repurchase agreements in the amount of $30,755,000 and $64,691,000,
respectively. The weighted average interest rates were 7.31% and 6.98%,
respectively, and were based on a variable rate, one-month LIBOR plus a weighted
average spread of 0.67% and 0.60%, respectively. All of the Company's repurchase
agreements are with Bear Stearns.
As of June 30, 2000, 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,
$22,135,000 (face) of U.S. Treasury 5.50%, 05/15/2009 and $291,000 (face) of
U.S. Treasury 5.25%, 02/15/2029. As of December 31, 1999, the Company had the
following open short positions in U.S. Treasury securities: $291,000 (face) of
U.S. Treasury 5.25%, 02/15/2029, $21,151,000 (face) of U.S. Treasury 6.00%
08/15/2009 and $3,881,000 (face) of U.S. Treasury 6.50% 11/15/2026.
Other Expenses:
In accordance with the terms of the Management Agreement, an expense of $127,617
and $256,481 in base management fees was incurred for the three months and six
months ending June 30, 2000, respectively. The Company incurred $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 any incentive
compensation to the Manager since inception.
Other Operating Gains & Losses
For the three months and six months ending June 30, 2000, the Company recognized
losses of $759,666 and $395,502 respectively, on its securities portfolio. For
the three months and six months ended June 30, 1999, the Company recognized
gains of $731,174 and $1,326,158, respectively, on its securities portfolio.
In the three months ending June 30, 2000 the Company sold four of its CMBS
investments for total proceeds of $24,876,611. These transactions resulted in
realized gains of $9,314.
CHANGES IN FINANCIAL CONDITION
General: Total assets as of June 30, 2000, amounted to $96.5 million and were
comprised primarily of $65.1 million of CMBS, $25.3 million of deposits with
brokers as collateral for securities sold short, cash and cash equivalents of
$1.2 million and a mezzanine investment of $3.7 million. Total liabilities of
the Company as of June 30, 2000 amounted to $57.8 million and were comprised
primarily of repurchase agreements in the amount of $30.8 million and government
securities sold short in the amount of $25.5 million. During the three months
ended June 30, 2000, the Company reduced its cash position by $16.2 million,
sold four CMBS investment for $24.9 million and purchased three CMBS investments
for $14.9 million. There was a corresponding decrease in repurchase agreements
of $25.2 million.
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. 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.
13
<PAGE>
The Company's operating activities generated cash flows of $38.1 million during
the six months ending June 30, 2000. This was due primarily to an excess of
interest income on investments over financing costs of approximately $2.3
million and net proceeds from trading in commercial mortgage backed securities
of $36.5 million. This compares with the Company's operating activities during
the six months ended June 30, 1999 which used cash flows of $9.1 million. This
was due primarily to an excess of interest income on investments over financing
costs of approximately $2.7 million and cash generated from decreased collateral
requirements on the government securities sold short of approximately $3.9
million offset by securities purchases of $15.6 million.
The Company's financing activities used cash of $38.1 million during the six
months ending June 30, 2000 and consisted primarily of payments made on
repurchase agreements of $33.9 million, purchases of treasury stock of $2.5
million and distributions to shareholders of $1.7 million. The Company's
financing activities generated cash of $10.3 million for the six months ended
June 30, 1999 and consisted of borrowings made from repurchase agreements of
$12.8 million offset by purchases of treasury stock of $0.8 million and
distributions to shareholders of $1.7 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, 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. If 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 financing in order to fund
the distributions.
Except as discussed herein, management is not aware of any other trends, events
or commitments that may have a significant effect on liquidity.
STOCKHOLDERS' EQUITY:
Stockholders' equity as of June 30, 2000 was $38.6 million. In the six months
ending June 30, 2000, stockholders' equity decreased by $2.0 million. This
decrease was due to the repurchase of stock in the amount of $2.3 million and
the payment of $1.6 million in distributions and was offset by net income from
operations of $1.9 million.
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.
14
<PAGE>
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, real estate cash flows and
values, mortgage defaults, foreign currency exchange rates, commodity prices and
equity prices. The primary market risks to which the investments of the Company
are exposed are lending environments, interest rate risk, real estate cash flows
and CMBS spread risk, which are highly sensitive to many factors, including
governmental monetary and tax policies, domestic and international economic and
political considerations and other factors beyond the control of the Company.
Changes in the general level of interest rates can also 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 or liquidity concerns in CMBS markets or 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 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. Furthermore, if the
market value of the securities involved in the short sale increases, the Company
may be required to meet a "margin call".
15
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
At June 30, 2000 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
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Bylaws of the Company, as amended by Resolution of the Board
of Directors dated May 24, 2000.
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None
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 11, 2000 By: /s/ Fredrick D. Arenstein
---------------------------------
Name: Fredrick D. Arenstein
Title: Treasurer
16
