<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 1996
------------------
Commission File Number 0-10503
-------
CONTINENTAL MORTGAGE AND EQUITY TRUST
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C>
California 94-2738844
-------------------------------- ----------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
</TABLE>
<TABLE>
<S> <C>
10670 North Central Expressway, Suite 300, Dallas, TX 75231
-----------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
</TABLE>
(214) 692-4700
(Registrant's Telephone Number,
Including Area Code)
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 ___
<TABLE>
<S> <C>
Shares of Beneficial Interest,
no par value 4,144,762
- ------------------------------ ------------------------------------
(Class) (Outstanding at November 1, 1996)
</TABLE>
1
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements have not been audited by
independent certified public accountants, but in the opinion of the management
of Continental Mortgage and Equity Trust (the "Trust"), all adjustments
(consisting of normal recurring accruals) necessary for a fair presentation of
consolidated results of operations, consolidated financial position and
consolidated cash flows at the dates and for the periods indicated, have been
included.
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
(dollars in thousands)
Assets
------
<S> <C> <C>
Notes and interest receivable
Performing........................................ $ 6,119 $ 4,240
Nonperforming, nonaccruing........................ 2,287 2,299
---------- ---------
8,406 6,539
Less - allowance for estimated losses................. (1,188) (1,188)
---------- ---------
7,218 5,351
Foreclosed real estate held for sale, net of
accumulated depreciation ($725 in 1996 and $738
in 1995).......................................... 10,657 11,553
Real estate under contract for sale, net of
accumulated depreciation ($602 in 1995)........... - 1,268
Less - allowance for estimated losses................. (4,941) (5,117)
---------- ---------
5,716 7,704
Real estate held for investment, net of accumulated
depreciation ($15,459 in 1996 and $16,395 in 1995) 182,724 174,713
Investment in marketable equity securities, at
market (including $5,550 in 1996 and $3,812 in
1995 of affiliates)............................... 6,676 4,753
Investments in partnerships........................... 2,265 12,970
Cash and cash equivalents............................. 16,537 6,386
Other assets (including $680 in 1996 and $469 in
1995 from affiliates)............................. 11,254 6,691
---------- ---------
$ 232,390 $ 218,568
========== =========
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
2
<PAGE> 3
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED BALANCE SHEETS - Continued
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
(dollars in thousands)
Liabilities and Shareholders' Equity
<S> <C> <C>
Liabilities
Notes and interest payable.......................... $ 142,516 $ 135,590
Other liabilities (including $938 in 1995 to
affiliates)....................................... 7,462 6,993
---------- ---------
149,978 142,583
Commitments and contingencies
Shareholders' equity
Shares of Beneficial Interest, no par value;
authorized shares, unlimited; issued and out-
standing, 4,182,030 in 1996 and 4,377,141 shares
in 1995........................................... 8,379 8,766
Paid-in capital..................................... 258,545 260,060
Accumulated distributions in excess of accumulated
earnings.......................................... (189,468) (195,870)
Net unrealized gains on marketable equity securities 4,956 3,029
---------- ---------
82,412 75,985
---------- ---------
$ 232,390 $ 218,568
========== =========
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
3
<PAGE> 4
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------
1996 1995 1996 1995
------ ------ ------ ------
(dollars in thousands, except per share)
<S> <C> <C> <C> <C>
Revenue
Rentals..................... $ 11,435 $ 9,612 $ 33,205 $ 27,318
Interest.................... 268 196 821 600
--------- --------- ---------- ---------
11,703 9,808 34,026 27,918
Expenses
Property operations......... 7,188 5,896 20,091 16,456
Interest.................... 3,254 2,481 9,317 6,998
Depreciation................ 1,271 1,103 3,565 3,133
Provision for losses........ (884) - (884) 541
Advisory fee to affiliate... 449 394 1,300 1,139
General and administrative.. 461 299 1,400 928
--------- --------- ---------- ---------
11,739 10,173 34,789 29,195
--------- --------- ---------- ---------
Loss from operations.......... (36) (365) (763) (1,227)
Equity in income of
partnerships................ 21 28 197 213
Gain on sale of real estate... 3,598 - 9,397 -
--------- --------- ---------- ---------
Income (loss) before
extraordinary gain.......... 3,583 (337) 8,831 (1,064)
Extraordinary gain............ 149 - 812 -
--------- --------- ---------- ---------
Net income (loss)............. $ 3,732 $ (337) $ 9,643 $ (1,064)
========= ========= ========== =========
Earnings per share
Income (loss) before extra-
ordinary gain............. $ .86 $ (.08) $ 2.08 $ (.24)
Extraordinary gain.......... .04 - .20 -
--------- --------- ---------- ---------
Net income (loss)........... $ .90 $ (.08) $ 2.28 $ (.24)
========= ========= ========== =========
Weighted average shares of
beneficial interest used in
computing earnings per share 4,184,086 4,377,156 4,243,754 4,377,171
========= ========= ========== =========
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
4
<PAGE> 5
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated Unrealized
Shares of Distributions Gains on
Beneficial Interest in Excess of Marketable
----------------------- Paid-in Accumulated Equity Shareholders'
Shares Amount Capital Earnings Securities Equity
-------- -------- ------- ------------- ---------- ------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1996............ 4,377,141 $ 8,766 $ 260,060 $ (195,870) $ 3,029 $ 75,985
Repurchase of shares
of beneficial
interest.......... (195,111) (387) (1,515) - - (1,902)
Distributions ($.76
per share)........ - - - (3,241) - (3,241)
Unrealized gains on
marketable equity
securities........ - - - - 1,927 1,927
Net income.......... - - - 9,643 - 9,643
--------- -------- --------- ----------- -------- ---------
Balance, September 30,
1996............... 4,182,030 $ 8,379 $ 258,545 $ (189,468) $ 4,956 $ 82,412
========= ======== ========= =========== ======== =========
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
5
<PAGE> 6
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
-------------------
1996 1995
---- ----
(dollars in thousands)
<S> <C> <C>
Cash Flows from Operating Activities
Rents collected.................................. $ 32,925 $ 27,306
Interest collected............................... 462 527
Interest paid.................................... (8,270) (6,359)
Payments for property operations................. (18,666) (16,149)
General and administrative expenses paid......... (1,282) (1,201)
Advisory fee paid to affiliate................... (1,300) (1,139)
Distributions from partnerships' operating cash
flow........................................... 844 745
Other............................................ 2,581 833
-------- --------
Net cash provided by operating activities...... 7,294 4,563
Cash Flows from Investing Activities
Acquisition of real estate....................... (18,996) (6,593)
Real estate improvements......................... (667) (696)
Funding of capital improvement escrow............ (1,500) (252)
Proceeds from sale of real estate................ 14,673 -
Funding of notes receivable...................... (1,870) -
Collections on notes receivable.................. 1,117 1,059
Distributions from partnerships' investing
activities..................................... 10,720 -
Deferred financing costs......................... (1,961) (365)
-------- --------
Net cash provided by (used in) investing
activities.................................. 1,516 (6,847)
Cash Flows from Financing Activities
Distributions to shareholders.................... (3,241) (1,313)
Proceeds from notes payable...................... 28,427 4,829
Payments on notes payable........................ (21,943) (2,781)
Distributions from partnerships' financing
activities..................................... - 1,025
Repurchase of shares of beneficial interest...... (1,902) -
-------- --------
Net cash provided by financing activities...... 1,341 1,760
-------- --------
Net increase (decrease) in cash and cash
equivalents...................................... 10,151 (524)
Cash and cash equivalents, beginning of period..... 6,386 7,478
-------- --------
Cash and cash equivalents, end of period........... $ 16,537 $ 6,954
======== ========
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
6
<PAGE> 7
CONTINENTAL MORTGAGE AND EQUITY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
-------------------
1996 1995
-------- --------
(dollars in thousands)
<S> <C> <C>
Reconciliation of net income (loss) to net cash
provided by operating activities
Net income (loss)................................. $ 9,643 $ (1,064)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities
Depreciation and amortization.................... 3,565 3,012
Provision for losses............................. (884) 541
Gain on sale of real estate...................... (9,397) -
Extraordinary gain............................... (812) -
(Increase) decrease in interest receivable....... (44) 46
Decrease in other assets......................... 4,801 703
Increase (decrease) in other liabilities......... 299 (80)
(Decrease) increase in interest payable.......... (524) 508
Distributions from partnerships' operating cash
flow........................................... 844 745
Equity in (income) loss of partnerships.......... (197) (213)
-------- --------
Net cash provided by operating activities...... $ 7,294 $ 4,198
======== ========
Noncash investing and financing activities
Notes payable from acquisition of real estate.... $ 3,200 $ 20,790
Unrealized gain on marketable equity securities.. 1,927 483
Note receivable from sale of real estate......... 750 -
Carrying value of real estate acquired through
foreclosure (in satisfaction of notes
receivable with a carrying value of $891)...... - 891
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
7
<PAGE> 8
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying Consolidated Financial Statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. Operating results for the nine month period ended September 30,
1996 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1996. Dollar amounts in tables are in thousands. For
further information, refer to the Consolidated Financial Statements and Notes
thereto included in the Trust's Annual Report on Form 10-K for the year ended
December 31, 1995 ("1995 Form 10-K").
Certain balances for 1995 have been reclassified to conform to the 1996
presentation. Shares and per share data have been restated for the three for
two forward share split effected February 15, 1996.
NOTE 2. INVESTMENTS IN PARTNERSHIPS
The Trust's investments in partnerships accounted for using the equity method
consisted of the following at September 30, 1996:
<TABLE>
<S> <C>
Sacramento Nine....................... $ 103
Indcon, L.P........................... 2,162
-------
$ 2,265
=======
</TABLE>
The Trust and National Income Realty Trust ("NIRT") are partners in Sacramento
Nine, the Trust having a 30% interest in the partnership's earnings, losses and
distributions. The Trust and NIRT are also partners in Income Special
Associates ("ISA"), a joint venture partnership in which the Trust has a 60%
interest in earnings, losses and distributions. ISA in turn owns a 100%
interest in Indcon, L.P. The partnership agreements require the consent of
both the Trust and NIRT for any material changes in the operations of the
partnerships' properties, including sales, refinancings and changes in property
management. The Trust, as a noncontrolling partner, accounts for its
investment in the partnerships using the equity method.
In February and March 1996, Indcon sold 25 of its industrial warehouses for a
total of $36.2 million in cash. Indcon received net cash of $14.2 million, of
which the Trust's equity share was $8.5 million, after the payoff of existing
mortgage debt with a principal balance of $23.4 million. Indcon recognized a
gain of $617,000 on the sale, of which the Trust's equity share was $370,000.
Indcon paid a real estate sales commission of $585,000 to Carmel Realty, Inc.
("Carmel Realty"), an affiliate of Basic Capital Management, Inc. ("BCM"), the
Trust's advisor, based upon the $36.2 million sales price of the properties.
In March 1996, Indcon reached a settlement with an insurance company on the
fire loss of one of its industrial warehouses. Indcon received a
8
<PAGE> 9
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 2. INVESTMENTS IN PARTNERSHIPS (Continued)
total of $2.2 million in cash. Indcon does not intend to rebuild the destroyed
warehouse and accordingly has recognized an extraordinary gain of $1.2 million,
of which the Trust's equity share was $663,000.
In April 1996, Indcon sold two additional industrial warehouses for $1.8
million in cash, of which the Trust's equity share was $1.1 million. Indcon
paid a real estate sales commission of $16,000 to Carmel Realty based upon the
$1.8 million sales price of the properties.
Set forth below is summarized results of operations for the partnerships the
Trust accounts for using the equity method for the nine months ended September
30, 1996:
<TABLE>
<S> <C>
Rents................................... $ 2,133
Depreciation............................ (411)
Property operations..................... (1,520)
Interest expense........................ (856)
-------
Loss before gain on sale of real estate
and extraordinary gain................ (654)
Gain on sale of real estate............. 617
Extraordinary gain...................... 1,208
-------
Net income.............................. $ 1,171
=======
</TABLE>
NOTE 3. MORTGAGE NOTES RECEIVABLE
In February 1996, the Trust funded a $1.5 million second lien mortgage secured
by the Signature Athletic Club Building in Dallas, Texas. The note bears
interest at 12% per annum and requires monthly interest only payments to the
extent of available cash flow. Any accrued but unpaid interest is added to the
principal balance of the note annually. In addition, the note requires
quarterly principal payments equal to the excess property cash flow for the
quarter. The note matures in October 1998 with an option to extend the note to
December 2000. The Trust has also guaranteed the underlying $3.0 million first
mortgage secured by the property which is current. The Trust has an option to
purchase a 50% interest in the partnership which owns the Signature Athletic
Club Building. The option expires in December 2005. The Club has had no
available cash flow during 1996, therefore the Trust ceased recognizing
interest income effective June 1996.
In July 1996, the Trust agreed to fund a $500,000 promissory note secured by a
contract to purchase land in Frisco, Texas. Through September 30, 1996, the
Trust has funded $300,000. The note bears interest at 13% per annum and all
interest and principal is payable at the December 31, 1996 maturity date.
9
<PAGE> 10
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 4. REAL ESTATE
In February 1996, the Trust sold the Rivertree Apartments in Hurst, Texas for
$1.8 million, a property under contract for sale at December 31, 1995. In
conjunction with the sale, the Trust provided $750,000 of purchase money
financing which was paid in full in August 1996. The Trust received net cash
of $959,000 after the payment of various closing costs associated with the
sale. The Trust paid a real estate sales commission of $70,000 to Carmel
Realty based on the $1.8 million sales price of the property. The Trust
recognized a gain of $378,000 on the sale. In September 1996, the Trust
received an insurance reimbursement for hail damage that had occurred in 1995
and recognized an extraordinary gain of $149,000.
In March 1996, the Trust purchased the Hampton Court Office Building, a 104,001
square foot office building in Dallas, Texas, for $7.7 million. The Trust paid
$1.4 million in cash and obtained new mortgage financing of $6.3 million. The
first mortgage bears interest at 8.0% per annum, requires monthly payments of
principal and interest of $42,000 and matures in March 2001. In conjunction
with the financing, the Trust established various escrow accounts in the amount
of $1.5 million. The Trust paid a real estate brokerage commission of $205,000
to Carmel Realty and an acquisition fee of $77,000 to BCM based on the $7.7
million purchase price of the property.
In April 1996, the Trust purchased the Amoco Building, a 378,244 square foot
office building in New Orleans, Louisiana, for $5.9 million in cash. The Trust
paid a real estate brokerage commission of $188,000 to Carmel Realty and an
acquisition fee of $59,000 to BCM based on the $5.9 million purchase price of
the property.
Also in April 1996, the Trust purchased the Central Storage Warehouse, a
216,035 square foot warehouse in Dallas, Texas, for $2.2 million in cash. The
Trust paid a real estate brokerage commission of $86,000 to Carmel Realty and
an acquisition fee of $22,000 to BCM based on the $2.2 million purchase price
of the property.
In May 1996, the Trust sold the Sunset Towers Apartments in San Francisco,
California for $24.1 million in cash. The Trust received $9.7 million after
the payoff of $14.0 million in existing mortgage debt and the payment of
various closing costs associated with the sale. The Trust paid a real estate
sales commission of $482,000 to Carmel Realty based on the $24.1 million sales
price of the property. The Trust recognized a gain of $5.4 million on the
sale.
In June 1996, the Trust purchased the Grove Park Apartments, a 188 unit
apartment complex in Plano, Texas for $4.4 million. The Trust paid $1.2
million in cash and assumed the existing first lien mortgage of $3.2 million.
The mortgage bears interest at a rate of 8.9% per annum, requires monthly
payments of principal and interest of $26,315 and matures in March 1998. The
Trust paid a $153,000 real estate brokerage
10
<PAGE> 11
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 4. REAL ESTATE (Continued)
commission to Carmel Realty and a $44,000 acquisition commission to BCM based
on the $4.4 million purchase price of the property.
Also in June 1996, the Trust sold the Crystal Court Apartments, a foreclosed
property held for sale, in Detroit, Michigan for $700,000. The Trust paid a
real estate sales commission of $28,000 to Carmel Realty based on the $700,000
sales price of the property. The Trust recognized no loss on the property
beyond that which had already been provided.
In July 1996, the Trust purchased the Promenade Shopping Center, a 133,558
square foot shopping center in Highlands Ranch, Colorado for $8.1 million. The
Trust paid $1.8 million in cash and obtained new mortgage financing for the
remaining $6.3 million of the purchase price. The first lien mortgage bears
interest at 9.0% per annum, requires monthly payments of principal and interest
of $50,385 and matures July 1, 1999. The second lien mortgage bears interest
at 9.0% per annum and matures June 30, 1997, at which time all principal and
interest is due. The Trust paid a $232,000 real estate brokerage commission to
Carmel Realty and a $81,000 acquisition commission to BCM based on the $8.1
million purchase price of the property.
Also in July 1996, the Trust purchased the Park at Colonnade Apartments, a 211
unit apartment complex in San Antonio, Texas for $4.2 million. The Trust paid
$700,000 in cash and obtained new mortgage financing for the remaining $3.5
million of the purchase price. The mortgage bears interest at 10.0% per annum,
through July 1997, increasing to 10.5% per annum thereafter, requires monthly
payments of interest only, and matures January 1, 1998. The Trust paid a
$146,000 real estate brokerage commission to Carmel Realty and a $42,000
acquisition commission to BCM based on the $4.2 million purchase price of the
property.
Also in July 1996, the Trust purchased the 3400 Carlisle Building, a 74,000
square foot office building in Dallas, Texas for $5.3 million. The Trust paid
$800,000 in cash and obtained new mortgage financing for the remaining $4.5
million of the purchase price. The mortgage bears interest at 8.93% per annum,
requires monthly payments of principal and interest of $33,488 through July 31,
1998, increasing to $38,457 through maturity and matures March 31, 2001. The
Trust paid a $177,000 real estate brokerage commission to Carmel Realty and a
$53,000 acquisition commission to BCM based on the $5.3 million purchase price
of the property.
In August 1996, the Trust sold the Southgate Square Apartments in Round Rock,
Texas for $6.1 million in cash. The Trust received net cash of $3.0 million
after the payoff of $2.9 million in existing mortgage debt and the payment of
various closing costs associated with the sale. The Trust paid a real estate
sales commission of $192,000 to Carmel Realty based on the $6.1 million sales
price. The Trust recognized a gain of $3.6 million on the sale.
11
<PAGE> 12
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 4. REAL ESTATE (Continued)
In September 1996, the Trust purchased the Shady Trail Warehouse, a 42,900
square foot warehouse in Dallas, Texas for $681,000. The Trust paid $131,000
in cash and obtained new mortgage financing for the remaining $550,000 of the
purchase price. The mortgage bears interest at 8.5% per annum, requires
monthly payments of principal and interest of $4,429 and matures October 1,
2001. The Trust paid a $27,000 real estate brokerage commission to Carmel
Realty and a $7,000 acquisition commission to BCM based on the $681,000
purchase price of the property.
Also in September 1996, the Trust sold the Ravenswood Apartments in Stratford,
New Jersey for $1.2 million in cash. The Trust paid a real estate sales
commission of $49,600 to Carmel Realty based on the $1.2 million sales price.
The Trust recognized no gain or loss on the sale.
NOTE 5. NOTES PAYABLE
In February 1995, after determining that further investment in Genesee Towers
Office Building in Flint, Michigan, could not be justified without a
substantial modification of the mortgage debt, the Trust ceased making debt
service payments on the $8.8 million nonrecourse mortgage secured by the
property. Accordingly, as of December 31, 1994, the Trust wrote down the
carrying value of the property by $1.2 million, which is included in the 1994
provision for losses, to the amount of the nonrecourse mortgage. In February
1996, the Trust and the lender entered into a forbearance agreement that
provided, among other things, that until August 20, 1996, the Trust make
monthly payments of the greater of regular scheduled principal and interest or
cash flow from the property. The deed to the property was placed in escrow
during the term of the forbearance agreement. The Trust transferred the
property to the lender in September 1996. The Trust had written down the
carrying value of the property to the amount of the nonrecourse mortgage debt,
which approximated fair value of the property. During the pendency of the
foreclosure negotiations, the Trust continued to accrue and expense its
interest obligations on such note. The Trust recorded a negative provision for
loss with the elimination of its obligation for such accrued interest on the
transfer of the property to the lender.
In April 1996, the Trust refinanced the mortgage debt secured by the Edgewood
Apartments in Lansing, Illinois in the amount of $8.1 million. The Trust
received net cash of $1.3 million after the payoff of $6.7 million in existing
mortgage debt, including a $60,000 prepayment penalty. The remainder of the
refinancing proceeds were used to pay various closing costs associated with the
refinancing. The new mortgage bears interest at the rate of 8.65% per annum,
requires monthly payments of principal and interest of $66,000 and matures in
May 2006. The Trust paid BCM a mortgage brokerage and equity refinancing fee
of $81,000 based upon the new $8.1 million mortgage.
Also in April 1996, the Trust refinanced the mortgage debt secured by the In
the Pines Apartments in Gainesville, Florida in the amount of
12
<PAGE> 13
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 5. NOTES PAYABLE (Continued)
$6.0 million. The Trust received net cash of $415,000 after the payoff of $5.3
million in existing mortgage debt. The remainder of the refinancing proceeds
were used to pay various closing costs associated with the refinancing. The
new mortgage bears interest at the rate of 8.65% per annum, requires monthly
payments of principal and interest of $49,000 and matures in May 2006. The
Trust paid BCM a mortgage brokerage and equity refinancing fee of $60,000 based
upon the new $6.0 million mortgage.
Also in April 1996, the Trust refinanced the mortgage debt secured by the Quail
Oaks Apartments in Balch Springs, Texas in the amount of $1.3 million. The
Trust received net cash of $413,000 after the payoff of $753,000 in existing
mortgage debt. The remainder of the refinancing proceeds were used to pay
various closing costs associated with the refinancing. The new mortgage bears
interest at 8.875% per annum, requires monthly payments of principal and
interest of $10,798 and matures in May 2006. The Trust paid BCM a mortgage
brokerage and equity refinancing fee of $13,000 based on the new $1.3 million
mortgage.
In May 1996, the Trust obtained mortgage financing for the previously
unencumbered Applecreek Apartments in Dallas, Texas in the amount of $1.8
million. The Trust received net cash of $1.6 million after payment of various
closing costs associated with the financing. The mortgage bears interest at
8.875% per annum, requires monthly payments of principal and interest of
$15,076 and matures June 1, 2006. The Trust paid BCM a mortgage brokerage and
equity refinancing fee of $18,000 based on the new $1.8 million mortgage.
In June 1996, the Trust refinanced the mortgage debt secured by the Fairways
Apartments in Longview, Texas in the amount of $2.0 million. The Trust
received net cash of $210,000 after the payoff of $1.7 million in existing
mortgage debt. The remainder of the refinancing proceeds were used to pay
various closing costs associated with the refinancing. The new mortgage bears
interest at 8.9375% per annum, requires monthly payments of principal and
interest of $16,003 and matures in July 2006. The Trust paid BCM a mortgage
brokerage and equity refinancing fee of $20,000 based on the new $2.0 million
mortgage.
In July 1996, the Trust refinanced the mortgage debt secured by the Woodbridge
Apartments in Denver, Colorado in the amount of $3.0 million. The Trust
received net cash of $2.0 million after the payoff of $903,000 in existing
mortgage debt. The remainder of the refinancing proceeds were used to pay
various closing costs associated with the refinancing. The new mortgage bears
interest at 9.125% per annum, requires monthly payments of principal and
interest of $25,433 and matures August 1, 2006. The Trust paid BCM a mortgage
brokerage and equity refinancing fee of $30,000 based on the new $3.0 million
mortgage.
Also in July 1996, the Trust obtained mortgage financing for the previously
unencumbered Forest Ridge Apartments in Denton, Texas in the
13
<PAGE> 14
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 5. NOTES PAYABLE (Continued)
amount of $1.2 million. The Trust received net cash of $1.1 million after
payment of various closing costs associated with the financing. The mortgage
bears interest at 8.875% per annum, requires monthly payments of principal and
interest of $10,175 and matures August 1, 2006. The Trust paid BCM a mortgage
brokerage and equity refinancing fee of $12,000 based on the $1.2 million
mortgage.
In August 1996, the Trust obtained mortgage financing for the previously
unencumbered Central Storage Warehouse in Dallas, Texas in the amount of $1.4
million. The Trust received net cash of $1.4 million after the payment of
various closing costs associated with the financing. The mortgage bears
interest at 8.5% through July 30, 1999 and at variable rate thereafter,
requires monthly payments of principal and interest of $13,786 through July 30,
1999 adjusted thereafter based on the interest rate and matures July 31, 2011.
The Trust paid BCM a mortgage brokerage and equity refinancing fee of $14,000
based on the new $1.4 million mortgage.
Also in August 1996, the Trust refinanced the mortgage debt secured by the
McCallum Glen Apartments in Dallas, Texas for $5.2 million. The Trust received
net cash of $761,000 after the payoff of the existing first mortgage of $4.2
million and the payment of various closing costs. The new mortgage bears
interest at 8.5%, requires monthly payments of principal and interest of
$40,176 and matures September 1, 2006. The Trust paid BCM a mortgage brokerage
and equity refinancing fee of $52,250 based on the new $5.2 million mortgage.
NOTE 6. COMMITMENTS AND CONTINGENCIES
The Trust is involved in various lawsuits arising in the ordinary course of
business. Management of the Trust is of the opinion that the outcome of these
lawsuits would have no material impact on the Trust's financial condition,
results of operations or liquidity.
NOTE 7. SUBSEQUENT EVENTS
In October 1996, the Trust purchased 236 acres of undeveloped land on State
Highway 121 in Collin County, Texas for $3.9 million in cash. The Trust paid a
real estate brokerage commission of $136,000 to Carmel Realty and a $39,000
acquisition commission to BCM based on the $3.9 million purchase price of the
property.
Also in October 1996, the Trust sold a .60 acre parcel of the 6 acre tract of
Northwest Crossing land in Houston, Texas for $290,000 in cash. The Trust
recorded the sale under the cost recovery method and therefore recognized no
gain or loss on the sale.
In November 1996, the Trust purchased the Glenwood Apartments in Addison, Texas
for $4.2 million. The Trust paid $1.3 million in cash and assumed the existing
first lien mortgage of $2.9 million. The
14
<PAGE> 15
CONTINENTAL MORTGAGE AND EQUITY TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 7. SUBSEQUENT EVENTS (Continued)
mortgage bears interest at 9.25% per annum, requires monthly payments of
principal and interest of $27,476 and matures in November 2004. The Trust paid
a real estate brokerage commission of $145,000 to Carmel Realty and a $42,000
acquisition commission to BCM based on the $4.2 million purchase price of the
property.
-------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
Continental Mortgage and Equity Trust (the "Trust") was formed to invest in
real estate through acquisitions, leases and partnerships and in mortgage loans
on real estate, including first, wraparound and junior mortgage loans. The
Trust was organized on August 27, 1980 and commenced operations on December 3,
1980.
Liquidity and Capital Resources
Cash and cash equivalents aggregated $16.3 million at September 30, 1996,
compared with $6.4 million at December 31, 1995. The principal reasons for the
increase in cash are discussed in the paragraphs below.
The Trust's principal sources of cash have been and will continue to be
property operations, proceeds from property sales, collections of mortgage
notes receivable and borrowings. The Trust expects that net cash provided by
operating activities and from anticipated external sources, such as property
sales and refinancings, will be sufficient to meet the Trust's various cash
needs, including, but not limited to, property acquisitions, debt service
obligations, shareholder distributions and property maintenance and
improvements.
The Trust's cash flow from property operations (rents collected less payments
for expenses applicable to rental income) increased from $11.2 million in the
first nine months of 1995 to $13.9 million in the first nine months of 1996.
Of this net increase, $2.6 million is the result of the Trust acquiring fifteen
additional income producing properties during 1995 and 1996. The remainder of
the increase is due to increased rental and occupancy rates and lower operating
expenses at the Trust's commercial properties and apartment complexes. These
increases are partially offset by a decrease of $713,000 due to four properties
being sold in 1996. The Trust's management believes that the Trust's cash flow
from property operations will continue to increase as the Trust continues to
benefit from the properties acquired in 1995 and first nine months of 1996.
15
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
In February 1996, the Trust funded a $1.5 million second lien mortgage secured
by the Signature Athletic Club Building in Dallas, Texas. See NOTE 3.
"MORTGAGE NOTES RECEIVABLE."
In February 1996, the Trust sold the Rivertree Apartments in Hurst, Texas for
$1.8 million. The Trust received net cash of $959,000 after the payment of
various closing costs associated with the sale. In conjunction with the sale,
the Trust provided $750,000 of purchase money financing which was paid in full
in August 1996.
In February and March 1996, Indcon, L.P. ("Indcon"), a joint venture
partnership in which the Trust has a 60% interest, sold 25 of its industrial
warehouses for a total of $36.2 million in cash. Indcon received net cash of
$14.2 million, of which the Trust's equity share was $8.5 million, after the
payoff of existing mortgage debt with a principal balance of $23.4 million.
In March 1996, Indcon reached a settlement with an insurance company on the
fire loss of one of its industrial warehouses. Indcon received a total of $2.2
million, of which the Trust's equity share was $1.3 million.
In March 1996, the Trust purchased the Hampton Court Office Building, a 104,001
square foot office building in Dallas, Texas, for $7.7 million. The Trust paid
$1.4 million in cash and obtained new mortgage financing of $6.3 million. In
conjunction with the financing, the Trust established various escrow accounts
in the amount of $1.5 million.
In April 1996, the Trust purchased the Amoco Building, a 378,244 square foot
office building in New Orleans, Louisiana, for $5.9 million in cash.
Also in April 1996, the Trust purchased the Central Storage Warehouse, a
216,035 square foot warehouse in Dallas, Texas, for $2.2 million in cash.
In April 1996, the Trust refinanced the mortgage debt secured by the Edgewood
Apartments in Lansing, Illinois in the amount of $8.1 million. The Trust
received net cash of $1.3 million after the payoff of $6.7 million in existing
mortgage debt, including a $60,000 prepayment penalty. The remainder of the
refinancing proceeds were used to pay various closing costs associated with the
refinancing.
Also in April 1996, the Trust refinanced the mortgage debt secured by the In
the Pines Apartments in Gainesville, Florida in the amount of $6.0 million.
The Trust received net cash of $415,000 after the payoff of $5.3 million in
existing mortgage debt. The remainder of the refinancing proceeds were used to
pay various closing costs associated with the refinancing.
16
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
Also in April 1996, the Trust refinanced the mortgage debt secured by the Quail
Oaks Apartments in Balch Springs, Texas in the amount of $1.3 million. The
Trust received net cash of $413,000 after the payoff of $753,000 in existing
mortgage debt. The remainder of the refinancing proceeds were used to pay
various closing costs associated with the refinancing.
In April 1996, Indcon sold two additional industrial warehouses for $1.8
million in cash, of which the Trust's equity share was $1.1 million.
In May 1996, the Trust sold the Sunset Towers Apartments in San Francisco,
California for $24.1 million in cash. The Trust received net cash of $9.7
million after payoff of $14.0 million in existing mortgage debt and the payment
of various closing costs associated with the sale.
In June 1996, the Trust purchased the Grove Park Apartments, a 188 unit
apartment complex in Plano, Texas for $4.4 million. The Trust paid $1.2
million in cash and obtained the property subject to the existing first lien
mortgage of $3.2 million.
Also in June 1996, the Trust sold the Crystal Court Apartments in Detroit,
Michigan for $700,000 in cash.
Also in June 1996, the Trust refinanced the mortgage debt secured by the
Fairways Apartments in Longview, Texas in the amount of $2.0 million. The
Trust received net cash of $210,000 after the payoff of $1.7 million in
existing mortgage debt. The remainder of the refinancing proceeds were used to
pay various closing costs associated with the refinancing.
In July 1996, the Trust purchased the Promenade Shopping Center, a 133,558
square foot shopping center in Highlands Ranch, Colorado for $8.1 million. The
Trust paid $2.5 million in cash and obtained new mortgage financing of $5.6
million.
Also in July 1996, the Trust refinanced the mortgage debt secured by the
Woodbridge Court Apartments in Westminster, Colorado in the amount of $3.0
million. The Trust received net cash of $2.0 million after the payoff of
$903,000 in existing mortgage debt and the payment of various closing costs
associated with the refinancing.
Also in July 1996, the Trust purchased the Park at Colonnade Apartments, a 211
unit apartment complex in San Antonio, Texas for $4.2 million. The Trust paid
$700,000 cash and obtained new mortgage financing of $3.5 million.
Also in July 1996, the Trust obtained mortgage financing of $1.2 million
secured by the previously unencumbered Forest Ridge Apartments in Denton,
Texas. The Trust received net cash of $1.1 million after the payment of
various closing costs associated with the financing.
17
<PAGE> 18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
Also in July 1996, the Trust purchased the 3400 Carlisle Office Building, a
76,727 square foot office building in Dallas, Texas for $5.3 million. The
Trust paid $800,000 in cash and obtained new mortgage financing of $4.5
million.
In August 1996, the Trust obtained mortgage financing of $1.4 million secured
by the previously unencumbered Central Storage Warehouse in Dallas, Texas. The
Trust received net cash of $1.4 million after the payment of various closing
costs associated with the financing.
Also in August 1996, the Trust sold the Southgate Square Apartments in Round
Rock, Texas for $6.1 million. The Trust received net cash of $3.0 million
after the payoff of $2.9 million in existing mortgage debt and the payment of
various closing costs associated with the sale.
Also in August 1996, the Trust refinanced the mortgage debt secured by the
McCallum Glen Apartments in Dallas, Texas for $5.2 million. The Trust received
net cash of $761,000 after the payoff of $4.2 million in existing mortgage debt
and the payment of various closing costs.
In September 1996, the Trust purchased the Shady Trail Warehouse in Dallas,
Texas for $681,000. The Trust paid $131,000 in cash and obtained new mortgage
financing of $550,000.
Also in September 1996, the Trust sold the Ravenswood Apartments in Stratford,
New Jersey for $1.2 million in cash.
Through September 30, 1996, the Trust has funded $300,000 of a $500,000 note
receivable secured by a contract to purchase land in Frisco, Texas.
In October 1996, the Trust purchased 236 acres of undeveloped land on State
Highway 121 in Collin County, Texas for $3.9 million in cash.
Also in October 1996, the Trust sold a .60 acre parcel of the 6 acre tract of
Northwest Crossing land in Houston, Texas for $290,000 in cash.
In November 1996, the Trust purchased the Glenwood Apartments in Addison, Texas
for $4.2 million. The Trust paid $1.3 million in cash and assumed the existing
first lien mortgage of $2.9 million.
The Trust has deposited $778,000 as earnest money toward the purchase of three
apartment complexes and one office building in separate transactions during the
fourth quarter. The Trust estimates it will expend $10.5 million of its cash
balance to close these transactions.
The Trust's Board of Trustees has authorized the Trust to repurchase a total of
1,465,000 of its shares of beneficial interest, of which 92,164 shares remain
to be purchased as of September 30, 1996. Through
18
<PAGE> 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
September 30, 1996, the Trust had repurchased 1,372,836 of its shares at a
total cost to the Trust of $6.9 million, of which 195,111 shares were
repurchased in 1996 at a total cost of $1.9 million.
In August 1996, the Trust announced an offer to buy back its shares of
beneficial interest from shareholders owning 99 or fewer shares. The Trust
paid a premium of $.50 per share over the average closing price of its shares
as reported from August 8, 1996 through September 30, 1996, the expiration date
of the offer. On October 17, 1996, the Trust repurchased 82,967 shares
pursuant to such offer, at a total cost of $913,000.
In the first nine months of 1996, the Trust paid quarterly and special
distributions of $.76 per share or a total of $3.2 million.
On a quarterly basis, the Trust's management reviews the carrying value of the
Trust's mortgage notes receivable and properties held for sale and
periodically, but no less than annually, its properties held for investment.
Generally accepted accounting principles require that the carrying value of
such assets cannot exceed the lower of their respective carrying amounts or
estimated net realizable value. In the initial instance when estimated net
realizable value of a mortgage note receivable or a property held for sale is
less than the carrying amount at the time of evaluation, a reserve is
established and a corresponding provision for loss is recorded by a charge
against earnings. A subsequent revision to estimated net realizable value
either increases or decreases such reserve with a corresponding charge against
or credit to earnings. In the case of properties held for investment the
carrying value of the property is written down and a provision for loss is
recorded. The estimate of net realizable value of the Trust's mortgage notes
receivable is based on management's review and evaluation of the collateral
property securing the mortgage note. The property review generally includes
selective property inspections, a review of the property's current rents
compared to market rents, a review of the property's expenses, a review of
maintenance requirements, discussions with the manager of the property and a
review of the surrounding area. See "Recent Accounting Pronouncement," below.
Results of Operations
For the three and nine months ended September 30, 1996, the Trust had net
income of $3.7 million and $9.6 million, compared to a net loss of $337,000 and
$1.1 million for the three and nine months ended September 30, 1995. The
primary factors contributing to the Trust's net income in 1996 are discussed in
the following paragraphs.
Rents increased from $9.6 million and $27.3 million for the three and nine
months ended September 30, 1995 to $11.4 million and $33.2 million for the
three and nine months ended September 30, 1996. Of these increases $2.6
million and $6.6 million are attributable to the
19
<PAGE> 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Results of Operations Continued
acquisition of six apartment complexes and nine commercial properties during
1995 and 1996. These increases are partially offset by decreases of $1.2
million and $1.6 million attributable to four properties sold in 1996.
Interest income was $196,000 and $600,000 for the three and nine months ended
September 30, 1995 compared to $268,000 and $821,000 for the three and nine
months ended September 30, 1996. Of these increases $16,000 and $100,000 for
the three and nine months are due to the funding of a $1.5 million second lien
mortgage in February 1996, $370,000 of a $500,000 note in July 1996 and a
$750,000 purchase money note accepted in February 1996 in conjunction with the
sale of Rivertree Apartments. Additional increases of $138,000 and $248,000
for the three and nine months are due to increased dividend and short-term
investment income. Interest income for the remainder of 1996 is expected to
approximate that of the third quarter of 1996.
Property operating expenses increased from $5.9 million and $16.5 million for
the three and nine months ended September 30, 1995 to $7.2 million and $20.1
million for the three and nine months ended September 30, 1996. Increases of
$1.5 million and $3.6 million are due to the acquisition of six apartment
complexes and nine commercial properties during 1995 and 1996. The remainder
of the increase is primarily due to increased repair and maintenance and
personnel expenses in an effort to maintain the Trust's increased rental and
occupancy rates. These increases are partially offset by decreases of $551,000
and $841,000 due to properties sold in 1996.
Interest expense increased from $2.5 million and $7.0 million for the three and
nine months ended September 30, 1995 to $3.3 million and $9.3 million for the
three and nine months ended September 30, 1996. Of these increases, $806,000
and $1.9 million for the three and nine months, respectively, are due to
interest expense recorded on mortgages secured by nine properties, encumbered
by debt, acquired during 1996 and 1995. An additional $210,000 and $708,000
for the three and nine months, respectively, is due to interest expense
recorded on borrowings during 1996 and 1995, secured by mortgages on three
previously unencumbered apartment complexes and one industrial property and the
refinancing of five existing mortgages. These increases are partially offset
by decreases of $245,000 and $336,000 for the three and nine months,
respectively, due to two properties sold in 1996. Interest expense is expected
to increase in the remainder of 1996, as a result of the Trust's acquisition of
other properties and refinancings during the remainder of 1996.
Depreciation expense increased from $1.1 million and $3.1 million for the three
and nine months ended September 30, 1995 to $1.3 million and $3.6 million for
the three and nine months ended September 30, 1996. Of these increases,
$356,000 and $600,000 for the three and nine months, respectively, are due to
the acquisition of six apartment complexes and nine commercial properties
during 1996 and 1995. These increases are
20
<PAGE> 21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Results of Operations Continued
partially offset by decreases of $151,000 and $237,000 due to properties sold
in 1996. Depreciation is expected to increase in the remainder of 1996, as a
result of the Trust's acquisition of six commercial properties and two
apartment complexes in 1996, as well as acquisitions subsequent to September
30, 1996.
A provision for losses of $541,000 was recognized in the nine months ended
September 30, 1995 to provide for the loss on the discounted payoff of the
mortgage note receivable secured by Alderwood Apartments. A negative provision
for losses of $884,000 was recognized in the three and nine months ended
September 30, 1996. Such negative provisions represents accrued interest
recorded on a mortgage between February 1995, the date the Trust stopped making
payments on the mortgage, and September 1996 when the property was transferred
to the lender. See NOTE 5. "NOTES PAYABLE."
Advisory fee to affiliate increased from $394,000 and $1.1 million for the
three and nine months ended September 30, 1995 to $449,000 and $1.3 million for
the three and nine months ended September 30, 1996. These increases are due to
an increase in the Trust's gross assets, the basis for the advisory fee, as a
result of property acquisitions during 1995 and 1996. The advisory fee is
expected to continue to increase as the Trust makes additional property
acquisitions.
General and administrative expenses increased from $299,000 and $928,000 for
the three and nine months ended September 30, 1995 to $461,000 and $1.4 million
for the three and nine months ended September 30, 1996. These increases are
primarily attributable to an increase in legal fees and Advisor cost
reimbursements.
The Trust's equity in earnings of partnerships was $21,000 and $197,000 for the
three and nine months ended September 30, 1996 compared to $28,000 and $213,000
for the three and nine months ended September 30, 1995. Included in equity
earnings of partnerships for the nine months ended September 30, 1996 is a gain
on sale of real estate of $370,000, the Trust's equity share of the gain
recognized by Indcon, L.P. ("Indcon"), a joint venture partnership, on the sale
of its 27 warehouse facilities. See NOTE 2. "INVESTMENTS IN PARTNERSHIPS."
Without such gain the Trust's equity in earnings of partnerships would have
been a loss of $173,000. Such decrease is primarily due to the sale of
Indcon's 27 warehouse facilities in the first quarter of 1996. In addition,
interest expense for Sacramento Nine ("SAC 9"), also a joint venture
partnership, increased as a result of new mortgage financing secured on a
previously unencumbered office building. See NOTE 2. "INVESTMENTS IN
PARTNERSHIPS." Equity in earnings of partnerships is expected to be minimal
for the remainder of 1996.
For the three and nine months ended September 30, 1996, the Trust recognized
gains on the sale of real estate of $378,000 on the sale of Rivertree
Apartments in February 1996, $5.4 million on the sale of
21
<PAGE> 22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Results of Operations Continued
Sunset Towers Apartments in May 1996, $3.6 million on the sale of Southgate
Apartments in August 1996. See NOTE 4. "REAL ESTATE."
In the three months ended September 30, 1996, the Trust recognized an
extraordinary gain of $149,000 representing an insurance settlement at the
Rivertree Apartments which the Trust had sold in February 1996. See NOTE 4.
"REAL ESTATE." In the nine months ended September 30, 1996, the Trust also
recognized an extraordinary gain of $663,000, its equity share of an insurance
settlement from a fire loss on an industrial warehouse owned by Indcon. See
NOTE 2. "INVESTMENTS IN PARTNERSHIPS." The Trust recognized no extraordinary
gains in 1995.
Tax Matters
As more fully discussed in the Trust's 1995 Form 10-K, the Trust has elected
and in the opinion of the Trust's management, qualified to be taxed as a Real
Estate Investment Trust ("REIT") as defined under Sections 856 through 860 of
the Internal Revenue Code of 1986, as amended, (the "Code"). To continue to
qualify for federal taxation as a REIT under the Code, the Trust is required to
hold at least 75% of the value of its total assets in real estate assets,
government securities and cash and cash equivalents at the close of each
quarter of each taxable year. The Code also requires a REIT to distribute at
least 95% of its REIT taxable income plus 95% of its net income from
foreclosure property, as defined in Section 857 of the Code, on an annual basis
to shareholders.
Inflation
The effects of inflation on the Trust's operations are not quantifiable.
Revenues from property operations fluctuate proportionately with increases and
decreases in housing costs. Fluctuations in the rate of inflation also affect
the sales values of properties and, correspondingly, the ultimate gains to be
realized by the Trust from property sales. To the extent that inflation
affects interest rates, the Trust's earnings from short-term investments and
the cost of new borrowings as well as its existing variable rate borrowings
will be affected.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and
regulations, the Trust may be potentially liable for removal or remediation
costs, as well as certain other potential costs relating to hazardous or toxic
substances (including governmental fines and injuries to persons and property)
where property-level managers have arranged for the removal, disposal or
treatment of hazardous or toxic substances. In addition, certain environmental
laws impose liability for release of asbestos-containing materials into the
air, and third parties may seek recovery from the Trust for personal injury
associated with such materials.
22
<PAGE> 23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
Environmental Matters (Continued)
The Trust's management is not aware of any environmental liability relating to
the above matters that would have a material adverse effect on the Trust's
business, assets or results of operations.
Recent Accounting Pronouncement
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 121 - "Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of".
The statement requires that long-lived assets be considered impaired "...if the
sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the asset." If impairment exists,
an impairment loss shall be recognized, by a charge against earnings, equal to
"...the amount by which the carrying amount of the asset exceeds the fair value
of the asset." If impairment of a long-lived asset is recognized, the carrying
amount of the asset shall be reduced by the amount of the impairment, shall be
accounted for as the asset's "new cost" and such new cost shall be depreciated
over the asset's remaining useful life.
SFAS No. 121 further requires that long-lived assets held for sale "...be
reported at the lower of carrying amount or fair value less cost to sell." If
a reduction in a held for sale asset's carrying amount to fair value less cost
to sell is required, a provision for loss shall be recognized by a charge
against earnings. Subsequent revisions, either upward or downward, to a held
for sale asset's fair value less cost to sell shall be recorded as an
adjustment to the asset's carrying amount, but not in excess of the asset's
carrying amount when originally classified as held for sale. A corresponding
charge or credit to earnings is to be recognized. Long-lived assets held for
sale are not to be depreciated. The Trust adopted SFAS No. 121 effective
January 1, 1996.
The effect of adopting SFAS No. 121 was the discontinuance of depreciation on
the Trust's properties held for sale of $26,000 and $75,000 in the three and
nine months ended September 30, 1996, and a corresponding increase in its
reported net income.
-------------------------------
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Olive Litigation. In February 1990, the Trust, together with Income
Opportunity Realty Investors, Inc., National Income Realty Trust and
Transcontinental Realty Investors, Inc., three real estate entities with, at
the time, the same officers, directors or trustees and advisor
23
<PAGE> 24
ITEM 1. LEGAL PROCEEDINGS (Continued)
as the Trust, entered into a settlement of a class and derivative action
entitled Olive et al. v. National Income Realty Trust et al. pending before the
United States District Court for the Northern District of California and
relating to the operation and management of each of the entities (the "Olive
Litigation"). On April 23, 1990, the court granted final approval of the terms
of a Stipulation of Settlement.
On May 4, 1994, the parties entered into a Modification of Stipulation of
Settlement dated April 27, 1994 (the "Olive Modification") that settled
subsequent claims of breaches of the settlement that were asserted by the
plaintiffs and that modified certain provisions of the April 1990 settlement.
The Olive Modification was preliminarily approved by the court on July 1, 1994,
and final court approval was entered on December 12, 1994. The effective date
of the Olive Modification was January 11, 1995.
During August and September 1996, the court held evidentiary hearings to assess
compliance with the terms of the Olive Modification by the various parties.
The court has not issued any ruling or order with respect to the matters
addressed at the hearings. Separately, in 1996, legal counsel for the
plaintiffs notified the Trust's Board of Trustees that he intends to assert
that certain actions taken by the Board of Trustees during 1994, 1995 and 1996
breached the terms of the Olive Modification. Plaintiffs' counsel has not made
a petition to the court on any of these claims.
ITEM 5. OTHER INFORMATION
The Trust's management has recommended that the Trust's Board of Trustees
approval a proposal to convert the Trust to a Nevada Corporation. On October
25, 1996, the Trust's Board of Trustees approved such recommendation. The
Board of Trustees believes the change from a California business trust to a
Nevada corporation will afford the Trust greater legal certainty in matters of
corporate grievance and indemnification and greater predictability in the
conduct of its business as a corporation under Nevada law. The Trust has filed
a Proxy Statement/Prospectus with the Securities and Exchange Commission
providing for a special meeting of the Trust's shareholders. At such meeting
shareholders will be presented with a proposal to approve the conversion of the
Trust to a corporation by way of merger of the Trust into a wholly-owned
subsidiary of the Trust. This proposal will require the approval of
shareholders holding a majority of the Trust's outstanding shares of beneficial
interest.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)Exhibits:
Exhibit
Number Description
- ------- ----------------------------------------------------
27.0 Financial Data Schedule
24
<PAGE> 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (Continued)
(b) Reports on Form 8-K as follows:
A Current Report on Form 8-K, dated July 9, 1996, was filed with respect
to Item 2. "Acquisition or Disposition of Assets," and Item 7.
"Financial Statements and Exhibits," which reports the acquisition of
the Hampton Court Office Building, the Central Storage Warehouse, the
Amoco Office Building, the Grove Park Apartments, the Promenade Shopping
Center and the Park at Colonnade Apartments, which was amended on Form
8-K/A, filed September 9, 1996.
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SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CONTINENTAL MORTGAGE AND EQUITY TRUST
Date: November 13, 1996 By: /s/ RANDALL M. PAULSON
------------------------- ------------------------------
Randall M. Paulson
President
Date: November 13, 1996 By: /s/ THOMAS A. HOLLAND
------------------------ -------------------------
Thomas A. Holland
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
26
<PAGE> 27
CONTINENTAL MORTGAGE AND EQUITY TRUST
EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Nine Months Ended September 30, 1996
Exhibit Page
Number Description Number
- ------- ---------------------------------------------------- ------
27.0 Financial Data Schedule. 28
27
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-1-1996
<PERIOD-END> SEP-30-1996
<CASH> 16,537
<SECURITIES> 6,676
<RECEIVABLES> 8,406
<ALLOWANCES> 6,129
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 209,565
<DEPRECIATION> 16,184
<TOTAL-ASSETS> 232,390
<CURRENT-LIABILITIES> 0
<BONDS> 142,516
0
0
<COMMON> 0
<OTHER-SE> 82,412
<TOTAL-LIABILITY-AND-EQUITY> 232,390
<SALES> 0
<TOTAL-REVENUES> 33,205
<CGS> 0
<TOTAL-COSTS> 20,091
<OTHER-EXPENSES> 3,565
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9,317
<INCOME-PRETAX> (763)
<INCOME-TAX> 0
<INCOME-CONTINUING> (763)
<DISCONTINUED> 0
<EXTRAORDINARY> 812
<CHANGES> 0
<NET-INCOME> 9,643
<EPS-PRIMARY> 2.28
<EPS-DILUTED> 2.28
</TABLE>
