SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1994 Commission file number: 1-9977
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HOMEPLEX MORTGAGE INVESTMENTS CORPORATION
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(Exact name of registrant as specified in its charter)
Maryland 86-0611231
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5333 North Seventh Street
Suite 219, Phoenix, Arizona 85014
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (602) 265-8541
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share New York Stock Exchange
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Title of each class Name of each exchange on which
registered
Securities registered pursuant to Section 12(g) of the Act: None
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
As of March 23, 1995, 9,716,517 shares of Homeplex Mortgage Investments
Corporation common stock were outstanding, and the aggregate market value of the
8,291,217 shares held by non-affiliates (based upon the closing price of the
shares on the New York Stock Exchange on March 23, 1995) was approximately
$12,437,000. Shares of Common Stock held by each officer and director and by
each person who owns more than 5% of the outstanding Common Stock of the Company
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily conclusive.
Documents incorporated by reference: None
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TABLE OF CONTENTS
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Page
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PART I
Item 1. Business 1
Item 2. Properties 38
Item 3. Legal Proceedings 38
Item 4. Submission of Matters to a Vote of Security Holders 38
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 39
Item 6. Selected Financial Data 41
Item 7. Management's Discussion and Analysis of Financial Condition, Results of
Operations and Interest Rates and Other Information 42
Item 8. Financial Statements and Supplementary Data 44
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure 44
PART III
Item 10. Directors and Executive Officers of Registrant 45
Item 11. Executive Compensation 47
Item 12. Security Ownership of Certain Beneficial Owners and Management 50
Item 13. Certain Relationships and Related Transactions 52
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 52
SIGNATURES 54
FINANCIAL STATEMENTS F-1
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PART I
ITEM 1. BUSINESS
INTRODUCTION
Homeplex Mortgage Investments Corporation (the "Company") makes short-term
and intermediate-term mortgage loans on improved and unimproved real property
("Real Estate Loans") and owns Mortgage Assets as described herein. In 1993, the
Company decided to shift its focus to making Real Estate Loans from the
ownership of Mortgage Assets consisting of Mortgage Interests (commonly known as
residual interests) and Mortgage Instruments. Mortgage Instruments include
residential mortgage loans ("Mortgage Loans") and mortgage certificates
representing interest in pools of residential mortgage loans ("Mortgage
Certificates"). Mortgage Interests represent the right to receive the net cash
flows ("Net Cash Flows") on Mortgage Instruments. Substantially all of the
Company's Mortgage Instruments and the Mortgage Instruments underlying the
Company's Mortgage Interests currently secure or underlie mortgage-
collateralized bonds ("CMOs" or "Bonds"), mortgage pass-through certificates
("MPCs" or "Pass-Through Certificates") or other mortgage securities
(collectively "Mortgage Securities") issued by various Mortgage Securities
issuers ("Issuers").
The Company does not currently plan to acquire any additional Mortgage
Assets. Instead, the Company plans to utilize its available funds to make or
acquire additional Real Estate Loans. Through December 31, 1994 the Company has
made six Real Estate Loans aggregating $9,930,000 each with a loan term of one
year and an aggregate weighted average interest rate of 19.72% per annum. The
Company plans to emphasize land acquisition and development loans, residential
land development loans, single family residential construction loans, commercial
land development loans, and interim construction and bridge loans. Initially,
the Real Estate Loans can be expected to be concentrated in Arizona.
The Company was incorporated in the State of Maryland in May 1988 and
commenced operations on July 27, 1988. The Company changed its name from Emerald
Mortgage Investments Corporation to Homeplex Mortgage Investments Corporation in
April 1990. Emerald Mortgage Advisors Limited Partnership (the "Manager")
managed the day-to-day operations of the Company subject to the supervision of
the Company's Board of Directors pursuant to the terms of a management agreement
(the "Management Agreement") from the commencement of the Company's operations
through April 30, 1990. On March 1, 1990, the Company gave notice to the Manager
of its intention not to renew the Management Agreement on its termination on
April 30, 1990. Beginning May 1, 1990, management of the Company assumed the
performance of the functions formerly performed for the Company by the Manager.
The Company has elected to be taxed as a real estate investment trust
("REIT") pursuant to Sections 856 through 860 of the Internal Revenue Code of
1986, as amended (the "Code"). The Company generally will not be subject to tax
on its income to the extent that it distributes its earnings to stockholders and
maintains its qualification as a REIT. See "Business -- Federal Income Tax
Considerations." The Company may consider electing to discontinue its
qualification as a REIT for tax purposes as a result of its substantial tax-loss
carryforward. If such a determination were made, the Company would be taxed as a
regular domestic corporation and, among other consequences, any distributions to
the Company's stockholders will not be deductible by the Company in computing
its taxable income.
The Company's Common Stock is listed on the New York Stock Exchange. Unless
the context otherwise requires, the term the Company means Homeplex Mortgage
Investments Corporation and its subsidiaries.
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for certain recent information with respect
to the the Company.
BUSINESS
REAL ESTATE LOANS
General
The Company intends to make or acquire short-term and intermediate-term Real
Estate Loans. A short-term loan generally has a maturity of one year or less and
an intermediate-term loan generally has a maturity of not more than three years.
Such loans are expected to consist primarily of first mortgage loans,
development loans, interim construction loans, bridge loans, and to a much
lesser extent, junior mortgage loans and wrap-around mortgage loans.
The Company plans to make or acquire development or interim construction
loans on unimproved real properties which are either expected to be developed
within a reasonable period of time, generally less than one year, into
income-producing properties, are being subdivided into lots for resale, or are
being held for resale by the borrowers. Certain of the other loans to be made by
the Company are expected to be made, on a first mortgage basis, on the security
of apartment complexes, shopping centers, warehouses, office buildings and other
commercial and industrial properties, and as bridge loans on completed
income-producing projects during leasing activities. The Company also may make
or acquire junior mortgage loans and wrap-around mortgage loans, although such
Real Estate Loans are not expected to represent a significant portion of the
Company's Real Estate Loan portfolio.
The Company's Real Estate Loans may be made on both large and small
properties and in various combinations and may incorporate a variety of
financing techniques. The Company intends to make or acquire such loans on
properties located primarily in Arizona and other southwestern states, with
primary emphasis on the Phoenix and Tucson metropolitan areas. There are no
limitations on the types of properties on which the Company may make or acquire
loans. It is intended that the Company's Real Estate Loans will provide for
regular debt service payments, normally consisting of interest only with
repayment of principal on maturity or earlier as the result of contractual
provisions requiring balloon payments of principal. The Company also may make or
acquire loans on the security of apartments or office buildings with repayment
to be derived from the conversion of the properties to condominiums and the sale
of units.
The Company will require that the borrower obtain a mortgagee's or owner's
title insurance policy insuring the priority of a mortgage or the condition of
title in connection with each of its Real Estate Loans. In certain cases, the
Company will receive an independent appraisal for a property on which it plans
to make or acquire a loan, the cost of which usually will be paid by the
borrower. It should be noted that appraisals are estimates of value and should
not be relied upon as measures of true worth or realizable value. The Company,
however, generally will rely on its own independent analysis and not on
appraisals in determining whether or not to make or acquire a particular loan.
In general, the amount of each Real Estate Loan made by the Company will not
exceed at the date the loan is funded, when added to the amount of any existing
senior indebtedness, (i) 95% of the Company's assessment of the value of the
property in the case of improved income-producing property or unimproved real
property and (ii) 90% of the Company's assessment of the value of the property
on the assumption that construction or development, as the case may be, is
completed substantially in accordance with the plans and specifications as of
the date the loan commitment is provided, in the case of construction or
development loans. Such loan-to-value ratio may be increased in the case of a
specific Real Estate Loan if, in the judgment of the Company, the Real Estate
Loan is supported by credit or collateral adequate to justify a higher ratio.
The Company may make Real Estate Loans to borrowers that acquire properties for
prices below their appraised values. Thus, the loan-to- cost ratios of certain
of the Company's Real Estate Loans may exceed the loan-to-value ratios described
above. As a result, loans by the Company may not be limited to the purchase
price of a property.
The Company's Real Estate Loans generally will provide for fixed interest
rates although it may make or acquire loans which float with changes in the
prime rate or other benchmark interest rates. Interest rates on Real Estate
Loans will be determined by taking into account a variety of factors including
the prevailing interest rate in the area for the type of loan being considered,
the proposed term of the loan, the loan-to-value ratio, and the creditworthiness
of the borrower and any guarantors.
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Current Real Estate Loans
The following table sets forth information relating to the Company's
outstanding Real Estate Loans at December 31, 1994.
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PRINCIPAL
AMOUNT DATE FUNDED MATURITY AMORTIZATION SECURITY
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$2,280,000 January 31, 1994 January 31, 1995 Interest only at 24% per First Deed of Trust on a 321-unit
annum payable monthly with garden apartment complex in
principal due upon maturity metropolitan Tucson, Arizona, with
(1) recourse to corporate borrower and
the personal guarantee of an
officer of borrower
$2,348,000 April 15, 1994 April 15, 1995 Interest only at 24% per First Deed of Trust on 128-unit
annum payable monthly with garden apartment complex in Sierra
principal due upon maturity Vista, Arizona, with recourse to
(2) corporate borrower and the
personal guarantee of an officer
of borrower
$2,360,000 October 31, 1994 October 31, 1995 Interest only at 16% per First Deed of Trust on 33 acres of
annum payable monthly with land located in Scottsdale,
principal due upon Arizona, with no recourse to
maturity, may be renewed borrower and no personal guarantee
for one year under certain
terms and conditions(3)
$2,272,000 November 21, 1994 November 21, 1995 Interest only at 16% per First Deed of Trust on 33 acres of
annum payable monthly with land located in Tempe, Arizona,
principal due upon maturity with no recourse to borrower and
(3) no personal guarantee
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(1) Extended to April 30, 1995 upon payment of 1/2% extension fee.
(2) Prepayment penalty of 2% of outstanding balance if property is sold prior
to maturity. No extension provisions.
(3) Borrower paid a 2% loan fee at close of loan and pays all direct costs
associated with the loan.
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Types of Real Estate Loans
In furtherance of its objectives, the Company may make and acquire a wide
variety of Real Estate Loans. In connection with certain of the Company's Real
Estate Loans, a portion of the Company's return could be in the form of deferred
interest payments, accruing in each year of the loan but payable only on
repayment of the loan. Such deferred interest may accrue at a fixed rate over
the term of a loan or may accrue at a faster rate in the later period of a loan.
In either case, the present value of deferred interest is less than it would be
if received currently.
The types of Real Estate Loans which the Company expects to make and acquire
include the following.
First Mortgage Loans. First mortgage loans will be secured by first
mortgages on the fee or a leasehold interest in improved income-producing real
property and generally will provide for repayment in full prior to the end of
the amortization period. Such loans will be in an amount which generally will
not exceed 95% of the Company's assessment of value of the property.
Land Loans. Land loans are first or junior mortgage loans on unimproved real
property normally providing only for interest payments prior to maturity. Such
loans are made on properties held by borrowers for inventory, investment or
development purposes and generally are expected to be repaid from the proceeds
of the resale of the properties. As a result and due in addition to the absence
of cash flow, such loans normally are considered more risky than loans on
improved property. The maximum loan-to-value ratio will generally not exceed 90%
of the Company's assessment of the value of the property.
Development Loans. Development loans are mortgage loans made to finance or
refinance the acquisition of unimproved land and the costs of developing such
land into finished sites, including the installation of utilities, drainage,
sewerage and road systems. Such loans are expected to be repaid from the
proceeds of construction loans or the sale of the developed sites. The Company
will not normally require the borrower to have a commitment for a construction
or long-term mortgage loan on the developed property. In some instances, the
Company may receive an equity participation or other interest in connection with
the property being developed. The original term of any development loan made by
the Company generally will not exceed three years, and the maximum loan-to-value
ratio generally will not exceed 90% of the Company's assessment of the value of
the property on the assumption that development is completed substantially in
accordance with the plans and specifications as of the date the loan commitment
is provided.
Construction Loans. Construction loans are mortgage loans made to finance
the acquisition of land and the erection of improvements thereon, such as
residential subdivisions, apartment complexes, shopping centers, office
buildings, and commercial and industrial buildings. Such loans generally have
maturities of less than three years and usually provide for higher yields than
those prevailing on long-term mortgage loans on comparable properties.
Disbursements by the Company under construction loan commitments will be related
to actual construction progress. Before a construction loan is made or acquired,
the Company, in most cases, will either require that the borrower have a
commitment from a responsible financial institution for financing upon
completion or will itself have made the determination that such a loan is
readily available or unnecessary. In some cases, the Company may receive an
equity participation or other interest in connection with the property being
constructed. Construction loans will be in amount which generally will not
exceed 90% of the Company's assessment of value of the property on the
assumption that construction is completed substantially in accordance with the
plans and specifications as of the date the loan commitment is provided.
Construction loans made to finance single family tract developments or
condominiums generally will be repaid from proceeds of the sale of completed
residential units.
Junior Mortgage Loans. Junior mortgage loans will be secured by mortgages
which are subordinate to one or more prior liens on the fee or a leasehold
interest in real property and generally, but not in all cases, will provide for
repayment in full prior to the end of the amortization period. Such loans will
be in an amount which, when added to the amount of prior liens, generally will
not exceed 90% of the Company's assessment of the value of the property.
Wrap-Around Mortgage Loans. Wrap-around mortgage loans are expected to be
made or acquired by the Company on real property which is already subject to
prior mortgage indebtedness in an amount which, when added to the amount of
prior indebtedness, generally will not exceed 90% of the Company's assessment of
the value of the property. A wrap-around loan is a junior mortgage loan having a
principal amount equal to the sum of the outstanding balance under the existing
mortgage loans plus the amount actually advanced under the wrap-around mortgage
loan. Under a wrap-around mortgage loan, the Company would make principal and
interest payments to the holders of the prior mortgage loans but ordinarily only
to the extent that payments are received from the borrower. The Company expects
to negotiate all wrap-around mortgage loans so that the borrowers' payments to
be made to the Company will equal or exceed the amount of the Company's
principal and interest payments on the underlying loans.
The Company also is permitted to invest in agreements for sale, which for
the most part are governed by contract law but generally provide a statutory
method for foreclosure. In addition, the Company is permitted to acquire Real
Estate Loans secured by other comparable security devices as permitted by
applicable state law.
In those types of loans described above, the Company generally will receive
as security for its loan a deed of trust or mortgage on the property financed.
Loans generally will be made on a nonrecourse basis by which recourse will be
limited to the real properties on which the loans have been made so that in the
event of default the Company would be required to rely on the value of such real
property to protect its interests. In other instances, the Company's Real Estate
Loans will be made on a full recourse basis so that the borrower will be liable
for any deficiency in the event that proceeds of a foreclosure or trustee's sale
were insufficient to repay the loan. In connection with any loans to a
corporation or other non-individual borrower, the Company may require that the
loan be personally guaranteed by the borrower's principal individual owners. In
addition, the Company may purchase or otherwise acquire participations or
fractional interests in Real Estate Loans which are originated by parties that
are not affiliated with the Company or may retain participations or fractional
interests in such loans which the Company has originated and a portion of which
have been acquired by parties that are not affiliated with the Company. In such
cases, the Company may not have control over the loan or the unrestricted right
to institute foreclosure proceedings. Except for the personal guarantees of a
borrower's owners, it is not intended that any loan will be guaranteed or
insured.
Standards for Real Estate Loans
In making or acquiring a Real Estate Loan, the Company will consider various
relevant real property and financial factors including the value of the property
underlying the loan as security, the location and other aspects of the property,
the potential for development of the property within one to three years, the
income-producing capacity and quality of the property, the rate and terms of the
loan (including the discount from the face amount of the note that can be
obtained giving consideration to current interest rates and the Company's
overall portfolio) and the quality, experience and creditworthiness of the
borrower. The Company will calculate internal rates of return in reviewing the
terms and purchase discount that can be obtained.
Although the Company generally will receive a deed of trust or mortgage on
the financed property as security for each Real Estate Loan, it may use other
security devices from time to time. In most cases, recourse for a Real Estate
Loan will be limited to the real property servicing the loan.
The Company will not make or acquire a Real Estate Loan on any one property
if the aggregate amount of all senior mortgage loans outstanding on the property
plus the loan of the Company would exceed an amount equal to 95% of the value of
the property as determined by the Company. The Company may lend additional funds
to the borrower if the outstanding principal amount plus any outstanding senior
indebtedness encumbering the property and additional advances does not exceed
95% of the value of the underlying property at the time the Real Estate Loan is
made or at the time of any new appraisal.
In general, the Company will make or acquire Real Estate Loans in amounts
ranging from a minimum of $300,000 to a maximum of $5,000,000.
The Company may obtain a current independent appraisal for a property on
which it plans to make or acquire a Real Estate Loan. The Company also may
require, among other things, a survey and an aerial photograph of the property
underlying each Real Estate Loan. The Company, however, generally will rely on
its own analysis and not on appraisals and other documents in determining
whether to make or acquire a particular loan. It should be noted that appraisals
are estimates of value and should not be relied upon as measures of true worth
or realizable value. The Company will require that a mortgagee's or owner's
title insurance policy or commitment as to the priority of a mortgage or the
condition of title be obtained in connection with each Real Estate Loan. The
Company also will require public liability insurance naming the Company as an
additional insured for claims arising on or about each underlying property when
making a Real Estate Loan and, to the extent permitted by the existing loan
documents, when acquiring a Real Estate Loan. Such liability insurance will be
for suitable amounts as determined by the Company, but to the extent that a
borrower incurs uninsured liabilities or liabilities in excess of the applicable
coverage, such liabilities may adversely affect the borrower's ability to repay
the Real Estate Loan.
In some cases, the Company may attempt to obtain equity participations in
connection with making Real Estate Loans. Participations are designed to provide
the potential for a higher return when such equity participations are deemed by
management to be in the best interests of the Company. Such a participation is
expected to be in the form of additional interest based upon items such as gross
receipts from the property securing the loan in excess of certain levels or
appreciation in the value of the property on whose security the Company has made
the Real Estate Loan based upon either sales price or increases in value. There
can be no assurance, however, that any Real Estate Loans will be structured in
this manner or that any such loans will provide enhanced yields.
In determining whether to make or acquire a Real Estate Loan, the Company
also will review the borrower's ability to repay the loan. Despite such review,
the ability of a borrower to repay the principal amount of a loan will depend
primarily upon the borrower's ability to obtain sufficient funds to pay the
outstanding principal balance of the Real Estate Loan by refinancing, sale or
other disposition of the property underlying the Real Estate Loan. See "Business
-- Special Considerations."
The Company will invest in agreements for sale or real estate contracts of
sale only if such contracts are in recordable form and are appropriately
recorded in the chain of title.
Maturity of Loans
The Company expects that its Real Estate Loans generally will provide for
payment of interest only during their term and for repayment of principal in
full at maturity, generally within one to two years after funding. The Company
plans to reinvest the proceeds which are received by it upon loan repayments.
The Company believes its policy of making and acquiring short-term and
intermediate-term Real Estate Loans will enable it to reinvest loan repayment
proceeds in new loans and thus to vary its portfolio more quickly in response to
changing economic, financial and investment conditions than would be the case if
the Company were to make long-term Real Estate Loans.
Borrowing Policies
The Company may seek a line of credit or other financing from a financial
institution primarily to increase the amount of the Real Estate Loans that it is
able to make or acquire and to increase its potential returns. The Company also
may incur indebtedness in order to meet expenses of holding any property on
which the Company has theretofore made a Real Estate Loan and has subsequently
taken over the operation of the underlying property as a result of default or to
protect a Real Estate Loan. In addition, the Company may incur indebtedness in
order to complete development of a property on which the Company has theretofore
made a development or land loan and has subsequently taken over the operation of
the underlying property as a result of default. The Company also may utilize a
line of credit in order to prevent default under senior loans or to discharge
them entirely if this becomes necessary to protect the Company's Real Estate
Loans. Such borrowing may be required if foreclosure proceedings are instituted
by the holder of a mortgage loan that is senior to that held by the Company.
The Company has not as yet obtained the commitment of any financial
institution to fund a line of credit. There can be no assurance that the Company
will obtain a line of credit or that the terms of any line of credit that it
obtains will be favorable to it. In addition, any such line of credit in all
likelihood will require periodic renewals, and no assurance can be given that
such renewals will always be approved. In the event that any portion of an
outstanding line of credit is not renewed, the Company will be required to
reevaluate its reserve requirements and review its portfolio for possible
disposition of Real Estate Loans.
The amount and terms and conditions of any line of credit will affect the
profitability of the Company and the funds that will be available to satisfy its
obligations. Interest will be payable on a line of credit regardless of the
profitability of the Company. The Company's ability to increase its return
through borrowings will depend in part upon the Company's ability to generate
income from its borrowed funds based upon the difference between the Company's
return on investment from such borrowed funds and the interest rate charged by
its lender for the funds. Adverse economic conditions could increase defaults by
borrowers on the Real Estate Loans and could impact the Company's ability to
make its loan payments to its lenders. Adverse economic conditions could also
increase the Company's borrowing costs and cause the terms on which funds become
available to be unfavorable. In such circumstances, the Company could be
required to liquidate some of its loans at a significant loss.
The Company may pledge Real Estate Loans as security for any borrowing. In
addition, any property acquired by the Company upon default and foreclosure of
any Real Estate Loan may be pledged as collateral for a line of credit.
Remedies Upon Default by Borrower
Real Estate Loans are subject to the risk of default, in which event the
Company would have the added responsibility of foreclosing and protecting its
loans. In the state of Arizona, where the Company intends to make or acquire a
significant portion of its Real Estate Loans, the Company will have a choice of
two alternative and mutually exclusive remedies in the event of default by a
borrower with respect to a Real Estate Loan secured by a deed of trust. In such
case, the Company either can proceed to cause the trustee under the deed of
trust to exercise its power of sale under the deed of trust and sell the
collateral at a non-judicial sale or it can choose to have the deed of trust
judicially foreclosed as if it were a mortgage. In the event of default by a
borrower with respect to a Real Estate Loan secured by a mortgage, the Company
will have no election of remedies and will be required to foreclose the mortgage
judicially. Remedies in other states in which the Company may acquire or make
Real Estate Loans could vary significantly from those available in Arizona.
In Arizona, mortgages must be foreclosed judicially. A judicial foreclosure
is usually a time consuming and potentially expensive undertaking. Under
judicial foreclosure proceedings, the borrower does not have a right to
reinstate the loan and can only cure its default by either paying the entire
accelerated sum owing under the note before the judicial sale or by redeeming
the property within six months after the date of the judicial sale.
The major advantage of a deed of trust is that Arizona law permits the
beneficiary of a deed of trust to foreclose the deed of trust as a mortgage
through judicial proceedings or by a non-judicial trustee's sale. A non-judicial
trustee's sale conducted under the power of sale provided to the trustee usually
is more expedient and less expensive than a judicial foreclosure and may be held
any time after 90 days from the date of recording of the trustee's notice of
sale. Furthermore, unlike a judicial foreclosure, there is no redemption period
following a non-judicial sale. The major disadvantage of a deed of trust is the
significantly greater reinstatement rights granted to a borrower. Before a
trustee's sale, the borrower under a deed of trust has a right to reinstate the
contract and deed of trust as if no breach or default had occurred by payment of
the entire amount then due, plus costs and expenses, reasonable attorney's fees
actually incurred, the recording fee for a cancellation of notice of sale and
the trustee's fee. The accelerated portion of the loan balance need not be paid
in order to reinstate. As a result, a borrower could repeatedly be in default
under a deed of trust and use its right to reinstate the loan under successive
non-judicial sale proceedings. Nonetheless, the borrower's right to reinstate a
deed of trust without payment of the accelerated portion of the loan balance can
be cut off upon the filing of an action to judicially foreclose the deed of
trust as a mortgage.
In the case of both judicial and non-judicial foreclosure, if a proceeding
under the Bankruptcy Code is commenced by or against a person or other entity
having an interest in the real property that secures payment of the loan, then
the foreclosure will be prevented from going forward until authorization to
foreclose is obtained from the Bankruptcy Court. During the period when the
foreclosure is stayed by the Bankruptcy Court, it is possible that payments,
including payments from any interest reserve account, may not be made on the
loan if so ordered by the Bankruptcy Court. The length of time during which the
foreclosure is delayed as a result of the bankruptcy, and during which the
payments may not be made, is indefinite. In addition, under the Bankruptcy Code,
the Bankruptcy Court may render a portion of the loan unsecured if it determines
that the value of the real property that secures payment of the loan is less
than the balance of the loan and, under other circumstances, may modify or
otherwise impair the lien of the lender in connection with the defaulted
mortgage or deed of trust.
The Company will have the right to bid on and purchase the property
underlying a Real Estate Loan at a foreclosure or trustee's sale following a
default by the borrower. If the Company is the successful bidder and purchases a
property underlying a Real Estate Loan, the Company's return on such Real Estate
Loan will depend upon the amount of cash or other funds that can be realized by
selling or otherwise disposing of the property. There can be no assurance that
the Company will be able to sell such a property on terms favorable to the
Company particularly as the result of real estate market conditions. Recent
conditions in real estate loan markets have affected the availability and cost
of real estate loans, thereby making real estate financing difficult and costly
to obtain and impeding the ability of real estate owners to sell their
properties at favorable prices. Such conditions may adversely affect the ability
of the Company to sell the property securing a Real Estate Loan in the event
that the Company deems it in the best interests of the Company to foreclose upon
and purchase the property. To the extent that the funds generated by such
actions are less than the amounts advanced by the Company for such Real Estate
Loan, the Company may realize a loss of all or part of the principal and
interest on the loan. Thus, there can be no assurance that the Company will not
experience financial loss upon a default by a borrower.
Transactions with Affiliates and Joint Venture Investments
The Company does not intend to make Real Estate Loans to affiliates.
The Company may enter into joint ventures, general partnerships and loan
participations with third parties for the purpose of acquiring or making Real
Estate Loans in accordance with the Company's investment policies. Any such
investments will be made consistently with the then existing Securities and
Exchange Commission interpretations and case law respecting the applicability of
the Investment Company Act.
The Company generally will not enter into joint ventures, general
partnerships or loan participations with non-affiliates without acquiring a
"controlling interest" except for arrangements entered into with banks, savings
institutions, insurance companies or other institutional lenders having assets
in excess of $100 million. In the event the Company enters into such
arrangements with banks, savings institutions, insurance companies or other
institutional lenders having assets in excess of $100 million but does not
obtain a controlling interest therein, (a) the investment of each investor must
be on substantially the same terms and conditions; (b) the loan being made by
the joint venture may not be made to an affiliate of the controlling party of
the joint venture; (c) no duplicate mortgage servicing or similar fees may be
paid; and (d) each investor must have a right of first refusal to buy the
other's interest in the investment except when the desired transfer is to an
affiliate of the joint venture partner.
Other Policies
The Company intends to operate in such a manner as not to be within the
definition of investment company under the Investment Company Act of 1940. The
Company may not invest in public entities similar to the Company and may not
invest in securities of other issuers for the purpose of exercising control.
The Company will make or acquire Real Estate Loans for investment or make or
acquire Real Estate Loans primarily for sale or other disposition in the
ordinary course of business. The Company may be required to engage in real
estate operations if, among other things, the Company forecloses on a property
on which it has made or acquired a Real Estate Loan and takes over management of
the property. Since the ownership of equity interests in real estate is not an
objective of the Company, such operations would only be conducted for a limited
period pending sale of the properties so acquired.
OWNERSHIP OF MORTGAGE ASSETS
The Company owns Mortgage Assets as described herein consisting of Mortgage
Interests (commonly known as "residuals") and Mortgage Instruments. Mortgage
Instruments include residential mortgage loans ("Mortgage Loans") and mortgage
certificates representing interests in pools of residential mortgage loans
("Mortgage Certificates"). Mortgage Interests represent the right to receive the
cash flows on Mortgage Instruments. Mortgage Interests are created through the
purchase of interests (which may include interests in REMICs as described
herein) in or from entities ("Mortgage Finance Companies") which own or finance
Mortgage Instruments. Substantially all of the Company's Mortgage Instruments
and the Mortgage Instruments underlying the Company's Mortgage Interests
currently secure or underlie mortgage-collateralized bonds ("CMOs" or "Bonds"),
mortgage pass-through certificates ("MPCs" or "Pass-Through Certificates") or
other mortgage securities (collectively "Mortgage Securities").
The Company's Mortgage Assets generate net cash flows ("Net Cash Flows")
which result primarily from the difference between (i) the cash flows on
Mortgage Instruments (including those securing or underlying various series of
Mortgage Securities as described herein) together with reinvestment income
thereon and (ii) the amount required for debt service payments on such Mortgage
Securities, the costs of issuance and administration of such Mortgage Securities
and other borrowing and financing costs of the Company. The revenues received by
the Company are derived from the Net Cash Flows received directly by the Company
as well as any Net Cash Flows received by subsidiaries of the Company and paid
to the Company as dividends and any Net Cash Flows received by trusts in which
the Company has a beneficial interest to the extent of distributions to the
Company as the owner of such beneficial interest. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Mortgage Loans consist of Conforming Mortgage Loans and Nonconforming
Mortgage Loans. Conforming Mortgage Loans consist of conventional mortgage loans
(i.e. not guaranteed or insured by the United States Government or any agency or
instrumentality thereof), mortgage loans ("FHA Loans") insured by the Federal
Housing Administration ("FHA") and mortgage loans ("VA Loans") partially
guaranteed by the Department of Veterans Affairs ("VA"), all of which are
secured by first mortgages or deeds of trust on single-family (one to four
units) residences. FHA Loans and VA Loans comply with requirements for inclusion
in a pool of mortgage loans guaranteed by the Government National Mortgage
Association ("GNMA"), and conventional Conforming Mortgage Loans comply with
requirements for inclusion in certain programs sponsored by the Federal Home
Loan Mortgage Corporation ("FHLMC") or the Federal National Mortgage Association
("FNMA"). Nonconforming Mortgage Loans generally would comply with the
requirements for participation in FHLMC and FNMA programs except that
Nonconforming Mortgage Loans generally have original principal balances which
exceed the requirements for such programs and may vary in certain other respects
from the requirements of such programs.
Mortgage Certificates consist of fully-modified pass-through mortgage-backed
certificates guaranteed by GNMA ("GNMA Certificates"), mortgage participation
certificates issued by FHLMC ("FHLMC Certificates"), guaranteed mortgage
pass-through certificates issued by FNMA ("FNMA Certificates") and certain other
types of mortgage certificates and mortgage-collateralized obligations ("Other
Mortgage Certificates").
Mortgage Interests entitle the Company to receive Net Cash Flows on Mortgage
Instruments securing or underlying Mortgage Securities. Mortgage Interests are
created through the purchase of interests in or from entities ("Mortgage Finance
Companies") which own or finance such Mortgage Instruments. Mortgage Interests
include interests which are treated for federal income tax purposes as interests
in real estate mortgage investments conduits ("REMICs") under the Code.
Mortgage Securities consisting of CMOs and MPCs typically are issued in
series. Each such series generally consists of several serially maturing classes
secured by or representing interests in Mortgage Instruments. Generally,
payments of principal and interest received on the Mortgage Instruments
(including prepayments on such Mortgage Instruments) are applied to principal
and interest payments on one or more classes of the CMOs or MPCs. Scheduled
payments of principal and interest on the Mortgage Instruments and other
collateral are intended to be sufficient to make timely payments of interest on
such CMOs or MPCs and to retire each class of such CMOs or MPCs by its stated
maturity or final payment date. The Company also finances its Mortgage Assets in
long-term structured obligations involving borrowings or other credit
arrangements secured by Mortgage Instruments or Mortgage Interests owned by the
Company.
Current Mortgage Assets
As of December 31, 1994, the Company owned approximately $62,360,000 in
principal amount of Mortgage Instruments which have been pledged in a long-term
financing transaction. As of December 31, 1994, the Company also owned Mortgage
Interests with respect to seven separate series of Mortgage Securities with a
net amortized cost balance of approximately $7,622,000 (representing the
aggregate purchase price paid for such Mortgage Interests less the amount of
distributions on such Mortgage Interests received by the Company representing a
return of investment).
The Company owns Mortgage Interests which entitle it to receive the Net Cash
Flows on the Mortgage Instruments pledged to secure the following four series of
Bonds: (i) the Series 1 Mortgage-Collateralized Bonds issued by Westam Mortgage
Financial Corporation ("Westam") (the "Series 1 Bonds" or "Westam 1"), (ii) the
Series 3 Mortgage-Collateralized Bonds issued by Westam (the "Series 3 Bonds" or
"Westam 3"), (iii) the Series 65 MortgageCollateralized Bonds issued by American
Southwest Financial Corporation ("ASW") (the "Series 65 Bonds" or "ASW 65") and
(iv) the Series 5 MortgageCollateralized Bonds issued by Westam (the "Series 5
Bonds" or "Westam 5"). Each of these series of Bonds are CMOs, and an election
has been made to treat the Mortgage Instruments and other collateral securing
such series of Bonds as REMICs.
The Company also owns the residual interest in the REMIC with respect to the
Series 17 Multi-Class Mortgage Participation Certificates (Guaranteed) ("FHLMC
17") issued by the Federal Home Loan Mortgage Corporation ("FHLMC") and 20.2%
and 45.07%, respectively, of the residual interests in the REMICs with respect
to the FNMA REMIC Trust 1988-24 Guaranteed REMIC Pass-Through Certificates
("FNMA 24") and the FNMA REMIC Trust 1988-25 Guaranteed REMIC Pass-Through
Certificates ("FNMA 25") issued by the Federal National Mortgage Association
("FNMA"). An election has been made to treat the Mortgage Instruments and other
collateral underlying each of the above series of Mortgage Securities as REMICs.
The Company has not purchased any Mortgage Interests since October 26, 1988.
All of the series described above collectively are referred to herein as the
"Outstanding Mortgage Securities." For purposes of the remainder of this section
only, "Bonds," "Pass-Through Certificates," "Mortgage Securities," "Net Cash
Flows" and "Mortgage Instruments" refer to the Bonds issued by ASW and Westam,
the Pass-Through Certificates issued by FHLMC and FNMA, the Outstanding Mortgage
Securities, the Net Cash Flows generated by the Mortgage Instruments securing or
underlying the Specified Mortgage Securities, and the Mortgage Instruments
securing or underlying the Outstanding Mortgage Securities, respectively. Unless
otherwise specified, information as to the Outstanding Mortgage Securities is as
of their respective closing dates.
The Outstanding Mortgage Securities were issued during the period from April
29, 1988 through October 26, 1988 in an aggregate original principal amount of
$2,700,200,000, and all are collateralized by or represent interests in Mortgage
Instruments.
The Mortgage Instruments Securing or Underlying the Outstanding Mortgage
Securities
The Mortgage Instruments pledged as collateral for the Bonds are
beneficially owned by the Issuers of such Bonds, and the Company owns the
residual interests in the REMICs with respect to the Bonds. The Mortgage
Instruments contained in the pools underlying the Pass-Through Certificates are
beneficially owned by the holders of the Pass-Through Certificates (including
the holders of the residual interests relating thereto), and the Company owns
100%, 20.2% and 45.07% of the residual interest in the REMICs with respect to
FHLMC 17, FNMA 24 and FNMA 25, respectively. The Mortgage Instruments securing
or underlying the Mortgage Securities consist of mortgage-backed certificates
guaranteed by GNMA ("GNMA Certificates"), mortgage participation certificates
issued by FHLMC ("FHLMC Certificates") and guaranteed mortgage pass-through
certificates issued by FNMA ("FNMA Certificates"). As of December 31, 1994, the
GNMA Certificates had an aggregate principal balance of $231,746,000, the FHLMC
Certificates had an aggregate principal balance of $71,026,000 and the FNMA
Certificates had an aggregate principal balance of $167,593,000.
<TABLE>
The following table sets forth the remaining principal balances, the
weighted average pass-through rates, the weighted average mortgage coupon rates
and the weighted average remaining terms to maturity of the Mortgage Instruments
pledged as collateral for each series of Bonds or contained in the pool
underlying each series of Pass-Through Certificates. The information presented
in the table was provided to the Company by the respective Issuer of each series
of Mortgage Securities. The Company did not issue such Mortgage Securities and
is relying on the respective Issuers regarding the accuracy of the information
provided.
SUMMARY OF MORTGAGE INSTRUMENT CHARACTERISTICS
<CAPTION>
WEIGHTED AVERAGE
SERIES OF TYPE OF REMAINING WEIGHTED AVERAGE WEIGHTED AVERAGE REMAINING TERM
MORTGAGE MORTGAGE PRINCIPAL BALANCE PASS-THROUGH MORTGAGE COUPON TO MATURITY
SECURITIES INSTRUMENT (1) RATE RATE (YEARS)(1)
---------------- --------------- ------------------ -------------------- -------------------- ---------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Westam 1 GNMA $45,201 10.50% 11.00% 21.8
Westam 3 GNMA 52,855 9.50 10.00 22.8
ASW 65 GNMA 54,432 10.00 10.50 22.7
Westam 5 GNMA 79,258 9.00 9.50 22.2
FHLMC 17 FHLMC 71,026 10.00 10.57 22.5
FNMA 24 FNMA 70,035(2) 10.00 10.65 23.2
FNMA 25 FNMA 97,558(3) 9.50 10.14 23.2
--------------
(1) As of December 31, 1994.
(2) The Company owns a 20.2% interest in the residual interest in the REMIC with
respect to FNMA 24.
(3) The Company owns a 45.07% interest in the residual interest in the REMIC
with respect to FNMA 25.
</TABLE>
The prepayment experience on the Mortgage Instruments securing or underlying
the Mortgage Securities will significantly affect the average life of such
Mortgage Securities because all or a portion of such prepayments will be paid to
the holders of the related Mortgage Securities as principal payments on such
Mortgage Securities. Prepayments on mortgage loans commonly are measured by a
prepayment standard or model. The model used herein (the "Prepayment Assumption
Model") is based on an assumed rate of prepayment each month of the unpaid
principal amount of a pool of new mortgage loans expressed on an annual basis.
100% of the Prepayment Assumption Model assumes that each mortgage loan
underlying a Mortgage Certificate and each Mortgage Loan (regardless of interest
rate, principal amount, original term to maturity or geographic location)
prepays at an annual compounded rate of 0.2% per annum of its outstanding
principal balance in the first month after origination, that this rate increases
by an additional 0.2% per annum in each month thereafter until the thirtieth
month after origination and in the thirtieth month and in each month thereafter
prepays at a constant prepayment rate of 6% per annum.
The Prepayment Assumption Model does not purport to be either a historical
description of the prepayment experience of any pool of mortgage loans or a
prediction of the anticipated rate of prepayment of any pool of mortgage loans,
including the mortgage loans underlying the Mortgage Certificates, and there is
no assurance that the prepayment of the mortgage loans underlying the Mortgage
Certificates or the Mortgage Loans will conform to any of the assumed prepayment
rates. The rate of principal payments on pools of mortgage loans is influenced
by a variety of economic, geographic, social and other factors. In general,
however, Mortgage Instruments are likely to be subject to higher prepayment
rates if prevailing interest rates fall significantly below the interest rates
on the mortgage loans underlying the Mortgage Certificates or the Mortgage
Loans. Conversely, the rate of prepayment would be expected to decrease if
interest rates rise above the interest rate on the mortgage loans underlying the
Mortgage Certificates or the Mortgage Loans. Other factors affecting prepayment
of mortgage loans include changes in mortgagors' housing needs, job transfers,
unemployment, mortgagors' net equity in the mortgaged properties, assumability
of mortgage loans and servicing decisions.
Description of the Outstanding Mortgage Securities
Each series of Bonds constitutes a nonrecourse obligation of the Issuer of
such series of Bonds payable solely from the Mortgage Instruments and any other
collateral pledged to secure such series of Bonds. All of the Bonds are rated
"AAA" by Standard & Poor's Corporation. All of the Bonds have been issued in
series pursuant to indentures (the "Indenture") between the Issuer and a bank
trustee (the "Trustee") which holds the underlying Mortgage Instruments and
other collateral pledged to secure the related series of Bonds.
Each series of the Bonds is structured so that the monthly payments on the
Mortgage Instruments pledged as collateral for such series of Bonds, together
(in certain cases) with reinvestment income on such monthly payments at the
rates required to be assumed by the rating agencies rating such Bonds or at the
rates provided pursuant to a guaranteed investment contract, will be sufficient
to make timely payments of interest on each class of Bonds of such series (each
a "Bond Class"), to begin payment of principal on each Bond Class not later than
its "first mandatory principal payment date" or "first mandatory redemption
date" (as defined in the related Indenture) and to retire each Bond Class no
later than its "stated maturity" (as defined in the related Indenture).
Each series of Pass-Through Certificates represents beneficial ownership
interests in a pool ("Mortgage Pool") of Mortgage Instruments formed by the
Issuer thereof and evidences the right of the holders of such Pass-Through
Certificates to receive payments of principal and interest at the pass-through
rate with respect to the related Mortgage Pool. Pass-Through Certificates issued
by FHLMC or FNMA generally are not rated by any rating agency. The Pass-Through
Certificates issued by FHLMC have been issued pursuant to an agreement ("Pooling
Agreement") which generally provides for the formation of the Mortgage Pool and
the performance of administrative and servicing functions. The Pass-Through
Certificates issued by FNMA have been issued pursuant to a trust agreement
("Trust Agreement") between FNMA in its corporate capacity and in its capacity
as trustee which generally provides for the formation of the Mortgage Pool and
the performance of administrative and servicing functions. The Pass-Through
Certificates are not obligations of the Issuers thereof.
Each series of Pass-Through Certificates is structured so that the monthly
payments of principal and interest on the Mortgage Instruments in the Mortgage
Pool underlying such series of Pass-Through Certificates are passed through on
monthly payment dates to the holders of each class of Pass-Through Certificates
of such series (each a "Pass-Through Class") as payments of principal and
interest, respectively, and each Pass-Through Class is retired no later than its
"final payment date" or "final distribution date" (as defined in the related
Pooling Agreement or Trust Agreement, respectively).
With respect to FHLMC 17, FHLMC guarantees to each holder of a Pass-Through
Certificate that bears interest the timely payment of interest at the applicable
interest rate on such Pass-Through Certificates. FHLMC also guarantees to each
holder of a Pass-Through Certificate the payment of the principal amount of such
holder's Pass-Through Certificates as payments are made on the underlying FHLMC
Certificates. Such guarantees, however, do not assure the Company any particular
return on its Mortgage Interests with respect to these Mortgage Securities. The
FHLMC 17 Pass-Through Certificates have been issued pursuant to agreements
between the holders of the Pass-Through Certificates and FHLMC, which holds and
administers, or supervises the administration of, the pool of Mortgage
Instruments underlying the Pass-Through Certificates.
With respect to FNMA 24 and FNMA 25, FNMA is obligated to distribute on a
timely basis to the holders of the Pass-Through Certificates required
installments of principal and interest and to distribute the principal balance
of each Class of Pass-Through Certificate in full no later than its applicable
"final distribution date," whether or not sufficient funds are available in the
"certificate account" (as defined in the offering circular). The guarantee of
FNMA is not backed by the full faith and credit of the United States. The FNMA
24 and FNMA 25 Pass-Through Certificates represent beneficial ownership
interests in trusts created pursuant to a Trust Agreement. FNMA is responsible
for the administration and servicing of the mortgage loans underlying the FNMA
Certificates, including the supervision of the servicing activities of lenders,
if appropriate, the collection and receipt of payments from lenders, and the
remittance of distributions and certain reports to holders of the Pass-Through
Certificates.
Interest payments on the Bond Classes and the Pass-Through Classes (together
"Classes") are due and payable on specified payment dates, except with respect
to principal only or zero coupon Classes ("Principal Only Classes") which do not
bear interest and with respect to compound interest Classes ("Compound Interest
Classes") as to which interest accrues but generally is not paid until other
designated Classes in the same series of Mortgage Securities are paid in full.
The payment dates for the Mortgage Securities are monthly. Each Class of
Mortgage Securities, except the Principal Only Classes, provides for the payment
of interest either at a fixed rate, or at an interest rate which resets
periodically based on a specified spread from (i) the arithmetic mean of
quotations of the London interbank offered rates ("LIBOR") for one-month
Eurodollar deposits, subject to a specified maximum interest rate, (ii) the
Monthly Weighted Average Cost of Funds Index for Eleventh District Savings
Institutions (the "COF Index"), as published by the Federal Home Loan Bank of
San Francisco (the "FHLB/SF"), subject to a specified maximum interest rate or
(iii) other indices specified in the prospectus supplement or offering circular
for a series of Mortgage Securities.
According to information furnished by the FHLB/SF, the COF Index is based on
financial reports submitted monthly to the FHLB/SF by Eleventh District savings
institutions and is computed by the FHLB/SF for each month by dividing the cost
of funds (interest paid during the month by Eleventh District savings
institutions on savings, advances and other borrowings) by the average of the
total amount of those funds outstanding at the end of that month and at the end
of the prior month, subject to certain adjustments. According to such FHLB/SF
information, the COF Index reflects the interest cost paid on all types of funds
held by Eleventh District savings institutions, and is weighted to reflect the
relative amount of each type of funds held at the end of the particular month.
The COF Index has been reported each month since August 1981.
Unlike most other interest rate measures, the COF Index does not necessarily
reflect current market rates. A number of factors affect the performance of the
COF Index which may cause the COF Index to move in a manner different from
indices tied to specific interest rates, such as United States Treasury Bills or
LIBOR. Because of the various maturities of the liabilities upon which the COF
Index is based (which may be more or less sensitive to market interest rates),
the COF Index may not necessarily reflect the average prevailing market interest
rates on new liabilities of similar maturities. Additionally, the COF Index may
not necessarily move in the same direction as market interest rates, because as
longer term deposits or borrowings mature and are renewed at prevailing market
interest rates, the COF Index is influenced by the differential between the
prior rates on such deposits or borrowings and the cost of new deposits or
borrowings. Moreover, the COF Index represents the weighted average cost of
funds for Eleventh District savings institutions for the month prior to the
month in which the COF Index is customarily published, and therefore lags
current rates. Movement of the COF Index, as compared to other indices tied to
specific interest rates, also may be affected by changes instituted by the
FHLB/SF in the method used to calculate the COF Index.
Principal payments on each Class of the Mortgage Securities are made on
monthly payment dates. Payments of principal generally are allocated to the
earlier maturing Classes until such Classes are paid in full. However, in
certain series of Mortgage Securities, principal payments on certain Classes are
made concurrently with principal payments on other Classes of such series of
Mortgage Securities in certain specified percentages (as described in the
prospectus supplement or offering circular for such series of Mortgage
Securities). In addition, payments of principal on certain Classes (referred to
as "SAY," "PAC," "SMRT" or "SPPR" Classes) occur pursuant to a specified
repayment schedule to the extent funds are available therefor, regardless of
which other Classes of the same series of Mortgage Securities remain
outstanding. Each of the Principal Only Classes has been issued at a substantial
discount from par value and receives only principal payments. Certain Classes of
the Mortgage Securities will be subject to redemption at the option of the
Issuer of such series (in the case of FHLMC 17) or upon the instruction of the
Company (as the holder of the residual interest in the REMICs with respect to
the other Mortgage Securities Classes subject to redemption) on the dates
specified herein in accordance with the specific terms of the related Indenture,
Pooling Agreement or Trust Agreement, as applicable. Certain Classes which
represent the residual interest in the REMIC with respect to a series of
Mortgage Securities (referred to as "Residual Interest Classes") generally also
are entitled to additional amounts, such as the remaining assets in the REMIC
after the payment in full of the other Classes of the same series of Mortgage
Securities and any amount remaining on each payment date in the account in which
distributions on the Mortgage Instruments securing or underlying the Mortgage
Securities are invested after the payment of principal and interest on the
related Mortgage Securities and the payment of expenses.
<PAGE>
<TABLE>
The table below sets forth certain information regarding the Mortgage
Securities with respect to which the Company owns all or a part of the Mortgage
Interest.
SUMMARY OF THE MORTGAGE SECURITIES
<CAPTION>
REMAINING WEIGHTED
PRINCIPAL AVERAGE PASS-
BALANCE OF THE THROUGH RATE OF
MORTGAGE THE MORTGAGE FIRST
INSTRUMENTS INSTRUMENTS STATED OPTIONAL
COLLATERALIZING COLLATERALIZING REMAINING MATURITY REDEMPTION
OR UNDERLYING OR UNDERLYING INITIAL PRINCIPAL OR FINAL OR
THE MORTGAGE THE MORTGAGE ISSUE PRINCIPAL BALANCE PAYMENT TERMINATION
SERIES(1) SECURITIES(2) SECURITIES CLASS DATE BALANCE (2) COUPON DATE DATE
--------- --------------- --------------- ----------- -------- -------- --------- ---------------- -------- -----------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Westam 1 $45,201 10.50% 1-A 4/29/88 $109,228 $ 11,331 Variable Rate(3) 9/1/12 6/1/98
1-B 4/29/88 85,142 0 8.55 1/1/09 6/1/98
1-C 4/29/88 44,380 13,436 8.55 9/1/12 6/1/98
1-Z(4) 4/29/88 11,250 21,542 9.90 5/1/18 6/1/98
Westam 3 $52,855 9.50% 3-A 6/30/88 $ 80,960 $ 4,450 Variable Rate(5) 6/1/07 8/1/98
3-B 6/30/88 54,000 0 6.00 10/1/02 8/1/98
3-C 6/30/88 16,000 0 6.00 10/1/04 8/1/98
3-D 6/30/88 25,040 5,224 6.00 6/1/07 8/1/98
3-E(4) 6/30/88 24,000 43,918 9.45 7/1/18 8/1/98
ASW 65 $54,432 10.00% 65-A 6/29/88 $ 41,181 $ 0 9.00% 5/1/14 8/1/98
65-B 6/29/88 7,746 0 Variable Rate(6) 9/1/14 8/1/98
65-C(7) 6/29/88 11,872 0 8.25 10/1/18 8/1/98
65-D(7) 6/29/88 21,169 0 7.25 10/1/18 8/1/98
65-E(7) 6/29/88 6,965 0 7.50 10/1/18 8/1/98
65-F(7) 6/29/88 19,977 15,656 7.50 10/1/18 8/1/98
65-G(7) 6/29/88 12,540 12,540 7.50 10/1/18 8/1/98
65-H(7) 6/29/88 60,344 27,089 Variable Rate(6) 10/1/18 8/1/98
65-I(7) 6/29/88 32,230 0 7.00 10/1/18 8/1/98
65-J(7) 6/29/88 23,476 0 Variable Rate(6) 10/1/18 8/1/98
65-Z(4) 6/29/88 12,500 0 7.75 10/1/18 8/1/98
Westam 5 $79,258 9.00% 5-A 7/28/88 $ 70,488 $ 1,455 Variable Rate(8) 8/1/18 (9)
5-B(10) 7/28/88 39,784 821 Zero Coupon 8/1/18 (9)
5-Y(7) 7/28/88 139,728 78,120 8.95 8/1/18 (9)
FHLMC 17 $71,026 10.00% 17-A(7) 9/30/88 $ 26,000 $ 0 9.35% 5/15/02 (14)
17-B(7) 9/30/88 98,850 0 9.00 9/15/19 (14)
17-C 9/30/88 92,400 0 Variable Rate 10/15/19 (14)
(12)
17-D(10) 9/30/88 27,750 0 Zero Coupon 10/15/19 (14)
17-E(7) 9/30/88 75,400 0 9.30 2/15/12 (14)
17-F(7) 9/30/88 26,700 0 9.35 12/15/13 (14)
17-G(7) 9/30/88 67,400 0 9.55 3/15/17 (14)
17-H(7) 9/30/88 34,700 27,316 9.70 6/15/18 (14)
17-I(7) 9/30/88 43,696 43,696 9.90 10/15/19 (14)
17-J(7) 9/30/88 7,104 0 9.00 10/15/19 (14)
17-R(11) 9/30/88 100 14 Residual(13) 10/15/19 (14)
FNMA 24(15) $70,035 10.00% 24-A(7) 10/26/88 $13,300 $ 0 7.00% 3/25/02 (19)
24-B(7) 10/26/88 33,400 0 7.00 3/25/11 (19)
24-C(7) 10/26/88 13,200 0 7.00 2/25/13 (19)
24-D(7) 10/26/88 29,100 0 7.00 3/25/16 (19)
24-E(7) 10/26/88 16,600 12,952 7.00 7/25/17 (19)
24-F(16) 10/26/88 217,350 38,170 Variable Rate 10/25/18 (19)
(17)
24-G(7) 10/26/88 18,899 18,899 7.00 10/25/18 (19)
24-H(7) 10/26/88 36,100 0 9.50 7/25/16 (19)
24-J(7) 10/26/88 32,850 0 9.50 4/25/17 (19)
24-K(7) 10/26/88 72,151 0 9.50 10/25/18 (19)
24-L 10/26/88 17,050 0 Zero Coupon 10/25/18 (19)
24-R(11) 10/26/88 100 14 Residual(18) 10/25/18 (19)
FNMA 25(20) $97,558 9.50% 25-A(7)(21) 10/25/88 $165,000 $ 0 9.00% 6/25/08 (19)
25-B(7) 10/25/88 270,823 85,627 9.25 10/25/18 (19)
25-C(16) 10/25/88 37,500 11,856 Variable Rate 10/25/18 (19)
(22)
25-D 10/25/88 70,912 0 Variable Rate 10/25/18 (19)
(23)
25-E 10/25/88 139,575 0 Variable Rate 10/25/18 (19)
(24)
25-G(25) 10/25/88 66,115 0 Zero Coupon 10/25/18 (19)
25-R(11) 10/25/88 75 75 Residual(26) 10/25/18 (19)
--------------
(1) Unless otherwise specified, the Company owns 100% of the residual interest
with respect to each series of Mortgage Securities.
(2) As of December 31, 1994.
(3) Determined monthly, and generally equal to 0.65% above the arithmetic mean
of LIBOR, subject to a maximum rate of 12.75%.
(4) Compound Interest Class.
(5) Determined monthly, and generally equal to 0.70% above the arithmetic mean
of LIBOR, subject to a maximum rate of 13.00%.
(6) Determined monthly, and generally equal to 0.80%, 0.70% and 0.95%,
respectively, above the arithmetic mean of LIBOR, subject to a maximum rate
of 13.50%, 12.50% and 14.00%, respectively.
(7) SAY, PAC, SMRT, SPPR or other Class which receives a preferential allocation
of principal payments during a designated period.
(8) Determined monthly, and generally equal to 0.85% above the arithmetic mean
of LIBOR, subject to a maximum rate of 14.00%.
(9) The Westam 5 Bonds may be redeemed at any time after the aggregate principal
amount of such Bonds then outstanding is less than 10% of their original
aggregate principal amount.
(10) Principal Only Class.
(11) Residual Interest Class. This class represents the "residual interest" in
the REMIC with respect to such Series.
(12) Determined monthly, and generally equal to 0.90% above the arithmetic mean
of LIBOR, subject to a maximum rate of 13.00%.
(13) The Class of Pass-Through Certificates will bear interest on each payment
date in an amount equal to the amounts received as interest payments on the
FHLMC Certificates in the Mortgage Pool on such payment date, less the
aggregate amount of interest payable on the FHLMC 17 Pass-Through
Certificates (other than the Residual Interest Class) on such payment date.
(14) The FHLMC 17 Pass-Through Certificates may be redeemed in whole, but not in
part, on any payment date if the aggregate principal amount of such
Pass-Through Certificates outstanding is less than 1% of the initial
principal amount of such Pass-Through Certificates.
(15) The Company owns a 20.20% interest in the residual interest in the REMIC
with respect to FNMA 24.
(16) Paid principal in the manner of a SAY, PAC, SMRT or SPPR Class with respect
to a portion of its principal balance.
(17) Determined monthly, and generally equal to 2.10% below the product of 1.15
and the arithmetic mean of LIBOR, subject to a maximum rate of 12.50%.
(18) On each payment date, the Class of Pass-Through Certificates will receive
the excess of the sum of all distributions payable on the FNMA Certificates
underlying the Pass-Through Certificates on such payment date over all
amounts distributable on such payment date as principal and interest on
each Class of the Pass-Through Certificates (including amounts
distributable as principal on this Class of Pass-Through Certificates).
(19) Not subject to optional redemption.
(20) The Company owns a 45.07% interest in the residual interest in the REMIC
with respect to FNMA 25.
(21) On any payment date on which the principal distributions from the FNMA
Certificates underlying the FNMA 25 Pass-Through Certificates are not
sufficient to reduce the principal balance of this Class of such
PassThrough Certificates to a designated amount, the amount of interest
distributed from the FNMA Certificates underlying such Pass-Through
Certificates not required to be paid out as interest on such Pass-Through
Certificates on such payment date ("Excess Interest") will be applied to
reduce the principal balance of this Class to the designated amount for
that payment date.
(22) Determined monthly, and generally equal to .7586% above the product of
.9632 and the COF Index, subject to a maximum rate of 11.3054%.
(23) Determined monthly, and generally equal to 1.5229% below the product of
.9247 and the COF Index, subject to a maximum rate of 9.50%.
(24) Determined monthly, and generally equal to 1.25% above the COF Index,
subject to a maximum rate of 14.00%.
(25) On any payment date on which this Class of Pass-Through Certificates
receives principal payments, 30% of the Excess Interest will be applied to
reduce the principal balance of this Class.
(26) When Excess Interest is used to pay principal on Classes 25-A and 25-G, the
amount of Excess Interest so applied will be added to the principal balance
of this Class of Pass-Through Certificates. In addition, on each Payment
Date, this Class of Pass-Through Certificates will receive the excess of
the sum of all distributions payable on the FNMA Certificates underlying
the FNMA 25 Pass-Through Certificates on such payment date over all amounts
distributable on such payment date as principal and interest (including
amounts distributable as principal on this Class of Pass-Through
Certificates).
</TABLE>
Net Cash Flows
The Net Cash Flows available from the Company's Mortgage Assets are derived
principally from three sources: (i) the favorable spread between the interest or
pass-through rates on the Mortgage Instruments securing or underlying the
Mortgage Securities and the interest or pass-through rates of the Mortgage
Securities Classes, (ii) reinvestment income in excess of the amount thereof
required to be applied to pay the principal of and interest on the Mortgage
Securities, and (iii) any amounts available from prepayments on the Mortgage
Instruments securing or underlying the Mortgage Securities that are not
necessary for the payments on the Mortgage Securities. The amount of Net Cash
Flows generally decreases over time as the Classes are retired. Distributions of
Net Cash Flows represent both the return on and the return of the investment on
the Mortgage Assets purchased. In addition, the Company may exercise its rights
in accordance with the terms of a series of Mortgage Securities to redeem all or
a part of such series prior to maturity and sell the related Mortgage
Instruments, in which case the net payment (after payment of the Mortgage
Securities and related costs) will be remitted to the Company.
The principal factors which influence Net Cash Flows are as follows:
(1) Other factors being equal, Net Cash Flows in each payment period tend to
decline over the life of a series of Mortgage Securities, because (a) as normal
amortization of principal and principal prepayments occur on the Mortgage
Instruments securing or underlying such Mortgage Securities, the principal
balances of earlier, lower-yielding Classes of such Mortgage Securities are
reduced, thereby resulting in a reduction of the favorable spread between the
weighted average interest or pass-through rate on outstanding Classes and the
interest or pass-through rates on the Mortgage Instruments securing or
underlying such Mortgage Securities and (b) the higher coupon Mortgage
Instruments are likely to be prepaid faster, reinforcing the same effect.
(2) The rate of prepayments on the Mortgage Instruments securing or
underlying a series of Mortgage Securities significantly affects the Net Cash
Flows. Because prepayments shorten the life of the mortgage loans underlying the
Mortgage Instruments securing or underlying a series of Mortgage Securities, a
higher rate of prepayments normally reduces overall Net Cash Flows. The rate of
prepayments may be expected to vary over the life of a series of Mortgage
Securities, and the timing of prepayments will further affect their
significance. The rate of prepayments is affected by mortgage interest rates and
other factors. Generally, increases in mortgage interest rates reduce prepayment
rates, while decreases in mortgage interest rates increase prepayment rates.
Because an important component of Net Cash Flows derives from the spread between
the weighted average interest or pass-through rate on the Mortgage Instruments
securing or underlying a series of Mortgage Securities and the weighted average
interest or pass-through rate on the outstanding classes of such Mortgage
Securities Classes, a higher than expected level of prepayments concentrated
during the early life of such Mortgage Securities (thereby reducing the weighted
average life of the earlier, lower-yielding Classes) has a more negative effect
on Net Cash Flows than the same volume of prepayments have at a constant rate
over the life of such Mortgage Securities or at a later date.
(3) With respect to Variable Rate Classes of Mortgage Securities, increases
in the level of the index on which the interest rate for such Variable Rate
Classes are based increase the interest or pass-through rate payable on Variable
Rate Classes and thus reduce or, in some instances, eliminate Net Cash Flows,
while decreases in the level of the relevant index decrease the interest or
pass-through rate payable on Variable Rate Classes and thus increase Net Cash
Flows.
(4) The interest rate at which the monthly cash flow from the Mortgage
Instruments securing or underlying a series of Mortgage Securities may be
reinvested until payment dates for such Mortgage Securities influences the
amount of reinvestment income contributing to the Net Cash Flows unless such
reinvestment income is not paid to the owner of the related Mortgage Asset.
(5) The administrative expenses of a series of Mortgage Securities (if any)
may increase as a percentage of Net Cash Flows as the outstanding balances of
the Mortgage Instruments securing or underlying such Mortgage Securities
decline, if some of such administrative expenses are fixed. In later years, it
can be expected that fixed expenses will exceed the available cash flow.
Although reserve funds generally are established to cover such shortfalls, there
can be no assurance that such reserves will be sufficient to cover such
shortfalls. In addition, although each series of Mortgage Securities (other than
FNMA 24 or FNMA 25) generally has an optional redemption provision that allows
the Issuer thereof (in the case of FHLMC 17) or the Company (as the holder of
the residual interest in the REMICs with respect to the other series of Mortgage
Securities) to retire the remaining Classes that are subject to redemption or
retirement after a certain date, there can be no assurance that the Issuer or
the Company will exercise such options and, in any event, in a high interest
rate environment the market value of the remaining Mortgage Instruments securing
or underlying the Mortgage Securities may be less than the amount required to
retire the remaining outstanding Classes. The Company may be liable for, or its
return subject to, administrative expenses relating to a series of Mortgage
Securities if reserves prove to be insufficient. Moreover, any unanticipated
liability or expenses with respect to the Mortgage Securities could adversely
affect Net Cash Flows.
Hedging
The Company from time to time hedges its Mortgage Assets and indebtedness in
whole or in part so as to provide protection from interest rate fluctuations or
other market movements. With respect to assets, hedging can be used either to
increase the liquidity or decrease the risk of holding an asset by guaranteeing,
in whole or in part, the price at which such asset may be disposed of prior to
its maturity. With respect to indebtedness, hedging can be used to limit, fix or
cap the interest rate on variable interest rate indebtedness. The Company's
hedging activities may include the purchase of interest rate cap agreements, the
consummation of interest rate swaps, the purchase of Stripped Mortgage
Securities, the maintenance of short positions in financial futures contracts,
the purchase of put options on such contracts and the trading of forward
contracts. For a description of the Company's current hedging activities and the
costs associated therewith, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Certain of the federal income
tax requirements that the Company has been required to satisfy to qualify as a
REIT have limited its ability to hedge. See "Business -- Federal Income Tax
Considerations -- Qualification of the Company as a REIT."
CAPITAL RESOURCES
Subject to the terms of the Company's Bylaws, the availability and cost of
borrowings, various market conditions and restrictions that may be contained in
the Company's financing arrangements from time to time and other factors as
described herein, the Company may increase the amount of funds available for its
activities with the proceeds of borrowings including borrowings under lines of
credit, loan agreements, repurchase agreements and other credit facilities.
Subject to the foregoing, the Company's borrowings may bear fixed or
variable interest rates, may require additional collateral in the event that the
value of existing collateral declines on a market value basis and may be due on
demand or upon the occurrence of certain events. Repurchase agreements are
agreements pursuant to which the Company sells Mortgage Assets for cash and
simultaneously agrees to repurchase such Mortgage Assets on a specified date for
the same amount of cash plus an interest component. The Company also may
increase the amount of funds available for investment through the issuance of
debt securities (including Mortgage Securities). In general, the Company may
make use of short-term borrowings to provide additional funds when it is able to
borrow at interest rates lower than the yields expected to be earned on such
funds. If borrowing costs are higher than the yields generated by such funds,
the Company's ability to utilize borrowed funds may be substantially reduced and
it may experience losses.
A substantial portion of the assets of the Company are pledged to secure
indebtedness incurred by the Company. Accordingly, such assets will not be
available for distribution to the stockholders of the Company in the event of
the Company's liquidation except to the extent that the value of such assets
exceeds the amount of such indebtedness.
On December 17, 1992, a wholly owned, limited-purpose subsidiary of the
Company issued $31,000,000 of Secured Notes under an Indenture to several
institutional investors. The Secured Notes bear interest at 7.81% per annum
which is payable quarterly. Scheduled principal repayments are $1,532,000 per
quarter during the first four quarters, $991,000 per quarter for the next 12
quarters, $901,000 per quarter for the next eight quarters and $721,000 per
quarter thereafter through February 15, 2001.
The Secured Notes are secured by the Company's Mortgage Assets with respect
to Westam 1, Westam 3, Westam 5, ASW 65, FNMA 1988-24 and FNMA 1988-25 and by a
reserve fund in an initial amount of $3,100,000 with a specified maximum amount
of $7,750,000. The reserve fund will be used to make the scheduled principal and
interest payments on the Secured Notes if the cash flow available from the
pledged Mortgage Assets is not sufficient to make the scheduled payments.
Under the Indenture, the cash flow from the Mortgage Assets pledged to
secure the Secured Notes is used to make payments of interest and scheduled
principal on the Secured Notes and to pay expenses in connection therewith. Any
excess cash flow will be applied to prepay the Secured Notes at par or to
increase the reserve fund up to its $7,750,000 maximum amount or will be
remitted to the Company, in each case depending on the level of certain
specified financial ratios set forth in the Indenture.
The Company used the proceeds from the issuance of the Secured Notes to
repay a term loan, to repay its short-term borrowings under a repurchase
agreement, to establish the reserve fund and for working capital.
The Company's Bylaws provide that it may not incur indebtedness if, after
giving effect to the incurrence thereof, aggregate indebtedness (other than
Mortgage Securities and any loans between the Company and its trusts or
corporate subsidiaries), secured and unsecured, would exceed 300% of the
Company's net assets, on a consolidated basis, unless approved by a majority of
the Unaffiliated Directors. For this purpose, the term "net assets" means the
total assets (less intangibles) of the Company at cost, before deducting
depreciation or other non-cash reserves, less total liabilities, as calculated
at the end of each quarter in accordance with generally accepted accounting
principles.
The Company in the future may increase its capital resources by making
additional offerings of its Common Stock or securities convertible into Common
Stock. The effect of such offerings may be the dilution of the equity of
stockholders of the Company or the reduction of the market price of shares of
the Company's Common Stock, or both. The Company is unable to estimate the
amount, timing or nature of future sales of its Common Stock as such sales will
depend upon the Company's need for additional funds, market conditions and other
factors.
EMPLOYEES
The Company currently has four full time salaried employees.
THE SUBCONTRACT AGREEMENT
The Company and American Southwest Financial Services, Inc. ("ASFS") are
parties to the Subcontract Agreement pursuant to which ASFS performs certain
services for the Company in connection with the structuring, issuance and
administration of Mortgage Securities issued by the Company or by any Issuer
affiliated with ASFS with respect to which the Company acquires Mortgage
Interests. Under the Subcontract Agreement, ASFS charges for any series of CMOs
an issuance fee of .1% of the principal amount for such series, generally
subject to a minimum fee of $10,000 and a maximum fee of $100,000, and for any
series of Pass-Through Certificates an issuance fee not to exceed .125% of the
principal amount of such series. In addition, ASFS charges the Company or such
Issuer an administration fee for each series of CMOs equal to a maximum of
$20,000 per year and for any series of Pass-Through Certificates an
administration fee equal to up to .025% of the amount of the series outstanding
at the beginning of each year.
The Subcontract Agreement had an initial term expiring on December 31, 1989
and continuing from year to year thereafter until terminated by the parties. The
Subcontract Agreement may be terminated by either party upon six months prior
written notice. In addition, the Company has the right to terminate the
Subcontract Agreement upon the happening of certain specified events, including
a breach by ASFS of any provision contained in the Subcontract Agreement. ASFS
is a privately held Arizona corporation which is indirectly beneficially owned
by the Class A shareholders of American Southwest Holdings, Inc.
Based on reports received by the Company from ASFS, ASFS received
administration fees of $286,000 for the year ended December 31, 1990, $235,000
for the year ended December 31, 1991, $227,000 for the year ended December 31,
1992, and $201,000 for the year ended December 31, 1993 and $165,000 for the
year ended December 31, 1994.
Pursuant to the Subcontract Agreement, ASFS will not assume any
responsibility other than to render the services called for therein. ASFS and
its directors, officers, stockholders and employees will not be liable to the
Company or any of its directors or stockholders for any acts or omissions by
ASFS, its directors, officers, stockholders or employees under or in connection
with the Subcontract Agreement, except by reason of acts constituting bad faith,
willful misconduct, gross negligence or reckless disregard of their duties under
the Subcontract Agreement.
SPECIAL CONSIDERATIONS
REAL ESTATE LOAN CONSIDERATIONS
New Business Activity
The Company has been involved in making and acquiring Real Estate Loans for
a brief period. Although officers of the Company have substantial real estate
investment and real estate loan experience, they have no prior experience in the
management or operation of a company engaged primarily in making and acquiring
such loans. The Company will be competing for acceptable Real Estate Loans with
numerous other companies, many of which will have greater resources and
experience than the Company and its officers.
Real Estate Market Conditions
The Company will be subject to the risks generally incident to the ownership
of and investment in real estate because of the impact of such risks on the
ability of its borrowers' to repay their Real Estate Loans and the ability of
the Company to resell, refinance or dispose of property following a foreclosure
for an amount at least equal to its loan. These risks include general and local
economic conditions; the investment climate for real estate investments; the
demand for and supply of competing properties; local market conditions and
neighborhood characteristics; unanticipated holding costs; the availability and
cost of necessary utilities and services; real estate tax rates and other
operating expenses; governmental rules and fiscal policies, including rent, wage
and price controls; zoning and other land use regulations; environmental
controls; acts of God (which may result in uninsured losses); the treatment for
federal and state income tax purposes of income derived from real estate; the
levels of interest rates; the availability and cost of financing in connection
with the purchase, sale or refinancing of properties; and other factors beyond
the control of the Company. In recent years, the presence of hazardous
substances or toxic waste has adversely affected real estate values in various
areas of the country and resulted in the imposition of costs and damages to real
estate owners and lenders. In addition, certain expenses related to properties,
such as property taxes and insurance, tend to increase over time. These and
other factors could result in an increase in the Company's cost of holding any
real estate it acquires as a result of a foreclosure or adversely affect the
terms and conditions upon which the Company may sell or refinance any properties
held by it. In addition, all Real Estate Loans, including the Company's Real
Estate Loans, are subject to loss resulting from the priority of real estate tax
liens, mechanic's liens and materialman's liens. Therefore, the success of the
Company will depend in part upon events beyond its control.
Lack of Geographic Diversification
Through December 31, 1994, the Company has made Real Estate Loans on real
estate located only in Arizona. As a result of this geographic concentration,
unfavorable economic conditions in Arizona could increase the likelihood of
defaults on the Company's Real Estate Loans and affect the Company's ability to
protect the principal of and interest on such loans following foreclosures upon
the real properties securing such loans. The Company intends to continue to
actively pursue real estate lending operations in Arizona and other parts of the
Southwest.
Concentration of Loan Amounts
The Company can be expected to make Real Estate Loans to a relatively small
number of borrowers as a result of the amount of its funds available for lending
activities which currently approximates $15.9 million. Therefore, the Company
may be subject to increased risk to the extent that a single borrower defaults
with respect to a loan constituting significant percentage of the Company's
total Real Estate Loan portfolio.
Loans Secured by Unimproved Properties
Many of the Company's Real Estate Loans will be secured by deeds of trust,
mortgages or other similar instruments on unimproved real property. A Real
Estate Loan secured by unimproved real property involves a particularly high
degree of risk since such property generally does not generate income other than
as the result of a sale or refinancing, and the borrower's loan payments
generally will be the Company's only source of cash flow on the property until a
sale or refinancing. Accordingly, the Company will be subject to a greater risk
of loss in the event of delinquency or default by a borrower on a Real Estate
Loan secured by a deed of trust, mortgage or similar instrument on unimproved
real property than if such Real Estate Loan were secured by a deed of trust,
mortgage or similar instrument on improved real property.
Balloon Payments
The Company will make or acquire a significant number of Real Estate Loans
that do not provide for the payment of all or any part of principal prior to
maturity. The ability of a borrower to repay the outstanding principal amount of
such a Real Estate Loan at maturity will depend primarily upon the borrower's
ability to obtain, by refinancing, sale or other disposition of the property or
otherwise, sufficient funds to pay the outstanding principal balance at a time
when such funds may be difficult to obtain, with the result that the borrower
may default on its obligation to repay the amount of the Real Estate Loan in
accordance with the terms of the deed of trust, mortgage or other security
instrument. In addition, a substantial reduction in the value of the property
securing a Real Estate Loan could precipitate or otherwise result in the
borrower's default. Any such default could result in a loss to the Company of
all or part of the principal of or interest on such a Real Estate Loan.
Development and Construction Loans
The development and interim construction loans which the Company intends to
make generally are expected to generate higher rates of return than other types
of Real Estate Loans, but generally will entail greater risks. Such a loan will
be subject to substantial risk because the ability of the borrower to complete
or dispose of the project being developed or constructed on the underlying real
estate and repay the loan may be affected by various factors including adverse
changes in general economic conditions, interest rates, the availability of
permanent mortgage funds, local conditions, such as excessive building resulting
in an excess supply of real estate, a decrease in employment reducing the demand
for real estate in the area, and the borrower's ability to control costs and to
conform to plans, specifications and time schedules, which will depend upon the
borrower's management and financial capabilities and which may also be affected
by strikes, adverse weather and other conditions beyond the borrower's control.
Such contingencies and adverse factors could deplete the borrower's borrowed
funds and working capital and could result in substantial deficiencies
precluding compliance with specified conditions of commitments for permanent
mortgage funds relied on as a primary source of repayment of the loan. In
addition, in some jurisdictions, construction and development lenders, such as
the Company, in certain circumstances, may be liable for defective construction.
The possibility of such liability may be increased if, in addition to its loan,
the Company is deemed to have an equity position in the developer or contractor
or in the property being developed or improved. This, however, is not likely to
be the case since the Company does not plan to make construction and development
loans to affiliates.
Risk of Joint Ventures
The Company may enter into joint ventures, general partnerships and loan
participations with third parties for the purpose of making or acquiring Real
Estate Loans. Any such investments will be made consistently with the then
existing Securities and Exchange Commission interpretations and case law
respecting the applicability of the Investment Company Act of 1940, as amended
(the "Investment Company Act"). Any such Real Estate Loans also will be subject
to certain additional restrictions. See "Business -- Transactions with
Affiliates and Joint Venture Investments." Joint ventures, general partnerships
and loan participations involve the potential risk of impass on decision making
in situations in which no single party fully controls the Real Estate Loan with
the result that neither the Company nor any other party will be able to exercise
full authority with respect to the protection of the investment in the loan. In
addition, although the Company or another party to the transaction often will
have the right to purchase the interest of any other party in the Real Estate
Loan, the party seeking to acquire the interest of another party may not have
sufficient funds to do so.
Junior Loans
Although not currently contemplated, the Company in the future may make or
acquire junior mortgage loans or wrap-around mortgage loans. A junior mortgage
loan or a wrap-around mortgage loan generally entails greater risks than a first
mortgage loan on the same property. In the event of default under a senior loan,
the holder of a junior loan may be forced to cure the default on the senior loan
in order to prevent the sale of the underlying property or to discharge the
senior loan entirely by paying the entire amount of principal and interest then
outstanding in the event of the acceleration of the senior loan. There can be no
assurance that the Company will have sufficient funds to pay amounts owing on
the related first loan to prevent default or to discharge the first loan
entirely. If the Company decides to cure a default under a senior mortgage loan
or purchases an underlying property at a foreclosure or trustee's sale, the
Company will be subject to the risks of ownership of real property.
Sufficiency of Collateral
Many of the Company's Real Estate Loans will be made on a nonrecourse basis.
In such a case, the Company will be required to rely for its security solely on
the value of the underlying real property and will not have any right to make
any claims for repayment personally against the borrower. Other Real Estate
Loans may be full recourse loans, may be secured by personal guarantees or may
be secured by one or more items of real or personal property in addition to the
property constituting the primary security for the Real Estate Loan.
Nevertheless, the property constituting the primary security for a Real Estate
Loan in most cases will be the primary source for repayment of the loan upon
maturity or in the event of a default. The ability of the borrower to pay the
outstanding balance of a Real Estate Loan (particularly a non-amortizing Real
Estate Loan) on maturity will depend primarily upon the borrower's ability to
obtain sufficient funds by refinancing, sale or other disposition of the
property.
The risk of a Real Estate Loan will increase as the ratio of the amount of
the loan to the value of the property securing such loan increases because the
real property will possess less protective equity in the event of a default by
the borrower. The principal amount of each Real Estate Loan, when added to the
aggregate amount of any senior indebtedness outstanding on the property,
generally will not exceed 95% of the Company's assessment of the value of the
property at the time the loan is made or acquired. The Company will make an
assessment of the loan-to-value ratio prior to making a Real Estate Loan. In
making its assessment of the value of the real estate to secure a Real Estate
Loan, the Company will review any available appraisals of the property by
qualified appraisers, the purchase price of the property, recent sales of
comparable properties, and other factors. The Company generally will rely on its
own assessment of the value of a property rather than requiring a current
appraisal. Although appraisals are estimates of value which should not be relied
upon as measures of true worth or realizable value, neither the Company nor any
of its officers are qualified real estate appraisers and the absence of an
independent appraisal removes an independent estimate of value. There can be no
assurance that the Company's estimated values will be comparable or bear any
relation to the actual market value of a property or the amount that could be
realized upon the refinancing, sale or other disposition of the property. As a
result, the amount realized in connection with the refinancing, sale or other
disposition of the property by the buyer in the ordinary course of business by
the Company or at or following a foreclosure sale may not equal the then
outstanding balance of the related Real Estate Loan.
Remedies Upon Default by Borrower
Real Estate Loans are subject to the risk of default, in which event the
Company would have the added responsibility of foreclosing and protecting its
loans. In the state of Arizona, where the Company intends to make or acquire a
significant portion of its Real Estate Loans, the Company will have a choice of
two alternative and mutually exclusive remedies in the event of default by a
borrower with respect to a Real Estate Loan secured by a deed of trust. In such
case, the Company either can proceed to cause the trustee under the deed of
trust to exercise its power of sale under the deed of trust and sell the
collateral at a non-judicial sale or it can choose to have the deed of trust
judicially foreclosed as if it were a mortgage. In the event of default by a
borrower with respect to a Real Estate Loan secured by a mortgage, the Company
will have no election of remedies and will be required to foreclose the mortgage
judicially. Remedies in other states in which the Company may acquire or make
Real Estate Loans could vary significantly from those available in Arizona.
A judicial foreclosure usually is a time consuming and potentially expensive
undertaking. Under judicial foreclosure proceedings, the borrower does not have
a right to reinstate the loan, but can cure its default by either paying the
entire accelerated sum owing under the note before the judicial sale or by
redeeming the property within six months after the date of the judicial sale.
A non-judicial trustee's sale conducted under the power of sale provided to
the trustee may not take place until 90 days after notice of default has been
given to the borrower and a notice of sale has been recorded. Before a trustee's
sale, the borrower under a deed of trust has a right to reinstate the contract
and deed of trust as if no breach or default had occurred by payment of the
entire amount then due, plus costs and expenses, reasonable attorney's fees
actually incurred, the recording fee for a cancellation of notice of sale and
the trustee's fee. The accelerated portion of the loan balance need not be paid
in order to reinstate. As a result, a borrower could repeatedly be in default
under a deed of trust and use its right to reinstate the loan under successive
non-judicial sale proceedings. Nonetheless, the borrower's right to reinstate a
deed of trust without payment of the accelerated portion of the loan balance can
be cut off upon the filing of an action to judicially foreclose the deed of
trust as a mortgage.
In the case of both judicial and non-judicial foreclosure, if a proceeding
under the Bankruptcy Code is commenced by or against a person or other entity
having an interest in the real property that secures payment of the loan, then
the foreclosure will be prevented from proceeding until authorization to
foreclose is obtained from the Bankruptcy Court. During the period when the
foreclosure is stayed by the Bankruptcy Court, it is possible that payments,
including payments from any interest reserve account, may not be made on the
loan if so ordered by the Bankruptcy Court. The length of time during which the
foreclosure is delayed as a result of the bankruptcy, and during which the
payments may not be made, is indefinite. In addition, under the Bankruptcy Code,
the Bankruptcy Court may render a portion of the loan unsecured if it determines
that the value of the real property that secures payment of the loan is less
than the balance of the loan and, under other circumstances, may modify or
otherwise impair the lien of the lender in connection with the defaulted
mortgage or deed of trust. In addition, in certain areas, lenders can lose
priority of liens to mechanics' liens, materialmen's liens and real estate tax
liens.
The Company will have the right to bid on and purchase the property
underlying a Real Estate Loan at a foreclosure or trustee's sale following a
default by the borrower. If the Company is the successful bidder and purchases a
property underlying a Real Estate Loan, the Company's return on such Real Estate
Loan will depend upon the amount of cash or other funds that can be realized by
selling or otherwise disposing of the property. There can be no assurance that
the Company will be able to sell such a property on terms favorable to the
Company particularly in the event of unfavorable real estate market conditions.
Recent conditions in real estate loan markets also have affected the
availability and cost of real estate loans, thereby making real estate financing
difficult and costly to obtain and impeding the ability of real estate owners to
sell their properties at favorable prices. Such conditions may adversely affect
the ability of the Company to sell the property securing a Real Estate Loan in
the event that the Company deems it in the best interests of the Company to
foreclose upon and purchase the property. To the extent that the funds generated
by such actions are less than the amounts advanced by the Company for such Real
Estate Loan, the Company may realize a loss of all or part of the principal and
interest on the loan. Thus, there can be no assurance that the Company will not
experience financial loss upon a default by a borrower.
Effect of Interest Rate Fluctuations; Length of Maturity and Prepayment
Provisions
The Company's Real Estate Loans generally will be fixed-rate debt
instruments of specified maturities. The economic value of an investment in the
Company's shares may fluctuate to the extent that market rates of interest for
similar Real Estate Loans of similar maturities exceed or fall below the
Company's anticipated rate of return on investment on its Real Estate Loans.
Certain Real Estate Loans may be variable or adjustable-rate Real Estate
Loans under which the interest rate will be based on the prime or other
benchmark rate published by a designated institutional lender, and will be
periodically adjusted as such prime or other benchmark rate is adjusted. The
adjustability of the interest rate with respect to such Real Estate Loans
generally will reduce the risk that the economic value of an investment in the
Company's shares will decline in the event that market rates of interest for
similar Real Estate Loans of similar maturities exceed the Company's initial
return on investment. However, in the event of a general decline in such market
rates of interest, such adjustability will result in a lowering of the the
Company's return on investment, thereby lowering the economic value of an
investment in the Company's shares.
The economic value of an investment in the Company's shares also may
fluctuate as a result of the length of maturity and prepayment terms of its Real
Estate Loans, depending in part upon whether funds to be received by the Company
upon maturity of a Real Estate Loan or prepayment of all or a portion of the
principal amount of a Real Estate Loan may be reinvested at interest rates
higher or lower than the return on the original Real Estate Loan. A substantial
number of the Real Estate Loans comprising the Company's portfolio can be
expected to allow the borrower to prepay all or a portion of the principal
amount at any time without penalty.
In some cases, the Company may attempt to obtain equity participations in
connection with making Real Estate Loans designed to provide an increased return
when such equity participations are deemed by management to be in the best
interests of the Company. Such a participation can be expected to be in the form
of additional interest based upon items such as gross receipts from the property
securing the loan in excess of certain levels or appreciation in the value of
the property on whose security the Company has made the Real Estate Loan based
upon either sales price or increases in appraised value. There can be no
assurance, however, that any Real Estate Loans will be structured in this manner
or that any such loans will provide enhanced returns.
Interest Ceilings Under Usury Statutes
Interest on Real Estate Loans may be subject to state usury laws imposing
maximum interest charges and possible penalties for violation, including
restitution of excess interest and unenforceability of the debt. Uncertainty may
exist in determining what constitutes interest, including, among other things,
the treatment of loan commitment fees or other fees payable by the borrower
under a Real Estate Loan. The Company does not intend to make Real Estate Loans
with terms that may violate applicable state usury provisions. Nevertheless,
uncertainties in determining the legality of rates of interest and other
borrowing charges under some statutes may result in inadvertent violations.
Environmental Considerations
Real estate in general is subject to certain environmental risks arising
from the location or site on which a project is built or from materials used in
construction or stored on the property. Although the Company will use
commercially reasonable efforts to become aware of any environmental problem
with regard to any property before it makes a loan secured by that property, the
occurrence of health problems or other dangerous conditions caused by work on
the property may only become apparent after a lengthy period of time. Thus,
there can be no assurance that environmental problems will not develop with
respect to any property securing a Real Estate Loan. If hazardous substances are
discovered on such properties or discovered to be emanating from any such
properties, the owner of the property (including the Company) may be held
strictly liable for all costs and liabilities relating to such hazardous
substances. This could negatively affect the Company's security in the Real
Estate Loan.
In addition, the construction of improvements on such property may be
adversely affected by regulatory, administrative or other procedures or by
requirements by local, state or federal environmental agencies including matters
relating to the clean up of hazardous or toxic substances. Such factors could
impede the ability of the borrower to obtain permits and approvals for a project
or result in the inability to develop or use the property.
Risks of Leverage
The Company may utilize a line of credit or other financing from a financial
institution to increase the amount of the Real Estate Loans that it is able to
make or acquire and to increase its potential returns. The Company also may
incur indebtedness in order to meet expenses of holding any property on which
the Company has theretofore made a Real Estate Loan and has subsequently taken
over the operation of the underlying property as a result of default or to
protect a Real Estate Loan. In addition, the Company may incur indebtedness in
order to complete development of a property on which the Company has theretofore
made a development or land loan and has subsequently taken over the operation of
the underlying property as a result of default. The Company also may utilize a
line of credit in order to prevent default under senior loans or to discharge
them entirely if this becomes necessary to protect the Company's Real Estate
Loans. Such borrowing may be required if foreclosure proceedings are instituted
by the holder of a mortgage loan that is senior to that held by the Company.
The Company has not as yet, however, obtained the commitment of any
financial institution to fund a line of credit. There can be no assurance that
the Company will obtain a line of credit or that the terms of any line of credit
that is obtained will be favorable to the Company. In addition, any such line of
credit in all likelihood will require periodic renewals, and no assurance can be
given that such renewals will always be approved. In the event that any portion
of an outstanding line of credit is not renewed, the Company will be required to
reevaluate its reserve requirements and review its portfolio for possible
disposition of Real Estate Loans.
The amount and terms and conditions of any line of credit will affect the
profitability of the Company and the funds that will be available to satisfy its
obligations. Interest will be payable on a line of credit regardless of the
profitability of the Company. The Company's ability to increase its return
through borrowings will depend in part upon the Company's ability to generate
income from its borrowed funds based upon the difference between the Company's
return on investment from such borrowed funds and the interest rate charged by
its lender for the funds. Adverse economic conditions could increase defaults by
borrowers on the Real Estate Loans and could impact the Company's ability to
make its loan payments to its lenders. Adverse economic conditions also could
increase the Company's borrowing costs and cause the terms on which funds become
available to be unfavorable. In such circumstances, the Company could be
required to liquidate some of its loans at a significant loss.
The Company's Bylaws limit borrowings, excluding the liability represented
by CMOs, to no more than 300% of the amount of its Average Invested Assets (as
described herein) unless borrowings in excess of that amount are approved by a
majority of the Unaffiliated Directors (as defined herein). See "Business
-Capital Resources."
Competition for Real Estate Loans
The Company may encounter significant competition in making or acquiring
Real Estate Loans from banks, insurance companies, savings and loan
associations, mortgage bankers, pension funds, real estate investment trusts,
investment partnerships, investment bankers and other investors that have been
or may be formed with objectives similar to those of the Company. An increase in
the availability of mortgage funds may increase competition for making and
acquiring Real Estate Loans and may reduce the yields available thereon.
Lack of Suitable Loans
The Company will attempt to make or acquire Real Estate Loans which will
produce returns sufficient to allow the Company to satisfy its objectives.
However, there is no assurance that interest rates will be such that the Company
will be able to make or acquire Real Estate Loans that will provide a
satisfactory return on investment or that any Real Estate Loans will be
available which meet all of the Company's investment criteria.
Uninsured Losses
Some, but likely not all, of the Real Estate Loans made or acquired by the
Company will require that the borrower carry general public liability insurance
for claims arising on or about the real property in suitable amounts as
determined by the Company. To the extent that a borrower incurs uninsured
liabilities or liabilities in excess of the applicable coverage, such
liabilities may adversely affect the borrower's ability to repay the Real Estate
Loan.
Enforceability Of Loan Documents
The Company will attempt to determine that the instruments relating to each
Real Estate Loan and the underlying real property will be legal, valid, binding
and enforceable. However, there can be no assurance of such enforceability in
all instances, and the unenforceability of any such instruments could result in
a complete or partial loss of the principal of or interest on a Real Estate
Loan. The Company will have the power to waive certain fees and penalties in
connection with a default or late payments with respect to a Real Estate Loan
should the Company be advised that provisions governing such fees and penalties
may not be enforceable.
MORTGAGE ASSET CONSIDERATIONS
General
The results of the Company's operations depend, among other things, on the
level of Net Cash Flows generated by the Company's Mortgage Assets. The
Company's Net Cash Flows vary primarily as a result of changes in mortgage
prepayment rates, short-term interest rates, reinvestment income and borrowing
costs, all of which involve various risks and uncertainties as set forth below.
Prepayment rates, interest rates, reinvestment income and borrowing costs depend
upon the nature and terms of the Mortgage Assets, the geographic location of the
properties securing the mortgage loans included in or underlying the Mortgage
Assets, conditions in financial markets, the fiscal and monetary policies of the
United States Government and the Board of Governors of the Federal Reserve
System, international economic and financial conditions, competition and other
factors, none of which can be predicted with any certainty.
The rates of return to the Company on its Mortgage Assets will be based upon
the levels of prepayments on the mortgage loans included in or underlying such
Mortgage Instruments, the rates of interest or pass-through rates on such
Mortgage Securities that bear variable interest or pass-through rates, and rates
of reinvestment income and expenses with respect to such Mortgage Securities.
Prepayment Risks
Mortgage prepayment rates vary from time to time and may cause declines in
the amount and duration of the Company's Net Cash Flows. Prepayments of
fixed-rate mortgage loans included in or underlying Mortgage Instruments
generally increase when then current mortgage interest rates fall below the
interest rates on the fixed-rate mortgage loans included in or underlying such
Mortgage Instruments. Conversely, prepayments of such mortgage loans generally
decrease when then current mortgage interest rates exceed the interest rates on
the mortgage loans included in or underlying such Mortgage Instruments. See
"Business -- Special Considerations -- Mortgage Asset Considerations -Interest
Rate Fluctuation Risks." Prepayment experience also may be affected by the
geographic location of the mortgage loans included in or underlying Mortgage
Instruments, the types (whether fixed or adjustable rate) and assumability of
such mortgage loans, conditions in the mortgage loan, housing and financial
markets, and general economic conditions.
In general, without regard to the interest or pass-through rates payable on
classes of a series of Mortgage Securities, prepayments on Mortgage Instruments
bearing a net interest rate higher than or equal to the highest interest rate on
the series of Mortgage Securities secured by or representing interests in such
Mortgage Instruments ("Premium Mortgage Instruments") will have a negative
impact on the Net Cash Flows of the Company because such principal payments
eliminate or reduce the principal balance of the Premium Mortgage Instruments
upon which premium interest was earned.
Net Cash Flows on Mortgage Instruments securing or underlying a series of
Mortgage Securities also tend to decline over the life of such Mortgage
Securities because the classes of such Mortgage Securities with earlier stated
maturities or final payment dates tend to have lower interest rates. In
addition, because an important component of the Net Cash Flows on Mortgage
Instruments securing or underlying a series of Mortgage Securities derives from
the spread between the weighted average interest rate on such Mortgage
Instruments and the weighted average interest or pass-through rate on the
outstanding amount of such Mortgage Securities, a given volume of prepayments
concentrated during the early life of a series of Mortgage Securities reduces
the weighted average lives of the earlier maturing classes of such Mortgage
Securities bearing lower interest or pass-through rates. Thus, an early
concentration of prepayments generally has a greater negative impact on the Net
Cash Flows of the Company than the same volume of prepayments at a later date.
Mortgage prepayments also shorten the life of the Mortgage Instruments
securing or underlying Mortgage Securities, thereby generally reducing overall
Net Cash Flows as described under "Business -- Special Considerations -Mortgage
Asset Considerations -- Decline in Net Cash Flows from Mortgage Assets."
No assurance can be given as to the actual prepayment rate of mortgage loans
included in or underlying the Mortgage Instruments in which the Company has an
interest.
Interest Rate Fluctuation Risks
Changes in interest rates affect the performance of the Company and its
Mortgage Assets. A portion of the Mortgage Securities secured by the Company's
Mortgage Instruments and a portion of the Mortgage Securities with respect to
which the Company holds Mortgage Interests bear variable interest or
pass-through rates based on short-term interest rates (primarily LIBOR). As of
December 31, 1994, $57,378,000 of the $364,723,000 of the Company's
proportionate share of Outstanding Mortgage Securities associated with the
Company's Mortgage Assets consisted of variable interest rate Mortgage
Securities. Consequently, changes in short-term interest rates significantly
influence the Company's Net Cash Flows.
Increases in short-term interest rates increase the interest cost on
variable rate Mortgage Securities and, thus, tend to decrease the Company's Net
Cash Flows. Conversely, decreases in short-term interest rates decrease the
interest cost on the variable rate Mortgage Securities and, thus, tend to
increase the Company's Net Cash Flows. As stated above, increases in mortgage
interest rates generally tend to increase the Company's Net Cash Flows by
reducing mortgage prepayments, and decreases in mortgage interest rates
generally tend to decrease the Company's Net Cash Flows by increasing mortgage
prepayments. Therefore, the negative impact on the Company's Net Cash Flows of
an increase in short-term interest rates generally will be offset in whole or in
part by a corresponding increase in mortgage interest rates while the positive
impact on the Company's Net Cash Flows of a decrease in short-term interest
rates generally will be offset in whole or in part by a corresponding decrease
in mortgage interest rates. See "Business -- Special Considerations -- Mortgage
Asset Considerations -- Prepayment Risks." However, although short-term interest
rates and mortgage interest rates normally change in the same direction and
therefore generally offset each other as described above, they may not change
proportionally or may even change in opposite directions during a given period
of time (as occurred during portions of 1989) with the result that the adverse
effect from an increase in short-term interest rates may not be offset to a
significant extent by a favorable effect on prepayment experience and visa
versa. Thus, the net effect of changes in short-term and mortgage interest rates
may vary significantly between periods resulting in significant fluctuations in
Net Cash Flows.
Changes in interest rates also affect the Company's reinvestment income. See
"Business -- Special Considerations -- Mortgage Asset Considerations
-Reinvestment Income and Expense Risks." Changes in interest rates after the
Company acquires Mortgage Assets can result in a reduction in the value of such
Mortgage Assets and could result in losses in the event of a sale.
The Company from time to time utilizes hedging techniques to mitigate
against fluctuations in market interest rates. However, no hedging strategy can
completely insulate the Company from such risks, and certain of the federal
income tax requirements that the Company has been required to satisfy to qualify
as a REIT have severely limited the Company's ability to hedge. Even hedging
strategies permitted by the federal income tax laws could result in hedging
income which, if excessive, could result in the Company's disqualification as a
REIT for failing to satisfy certain REIT income tests. See "Business -- Federal
Income Tax Considerations -- Qualification of the Company as a REIT." In
addition, hedging involves transaction costs, and such costs increase
dramatically as the period covered by the hedging protection increases.
Therefore, the Company may be prevented from effectively hedging its
investments. See "Business -- Hedging."
No assurances can be given as to the amount or timing of changes in interest
rates or their effect on the Company's Mortgage Assets or income therefrom.
Reinvestment Income and Expense Risks
In the event that actual reinvestment rates decrease over the term of a
series of Mortgage Securities, reinvestment income will be reduced, which in
turn will adversely affect the Company's Net Cash Flows. The Company also may be
liable for or its return may be subject to the expenses relating to such
Mortgage Securities including administrative, trustee, legal and accounting
costs and, in certain cases, for any liabilities under indemnifications granted
to the underwriters, trustees or other Issuers. These expenses are used in
projecting Net Cash Flows; however, to the extent that these expenses are
greater than those assumed, such Net Cash Flows will be adversely affected.
Moreover, in later years, Mortgage Instruments securing or underlying a series
of Mortgage Securities may not generate sufficient cash flows to pay all of the
expenses incident to such Mortgage Securities. Although reserve funds generally
are established to cover such future expenses, there can be no assurance that
such reserves will be sufficient.
No assurance can be given as to the actual reinvestment rates or the actual
expenses incurred with respect to such Mortgage Securities.
Borrowing Risks
Subject to the terms of the Company's Bylaws, the availability and cost of
borrowings, various market conditions, restrictions that may be contained in the
Company's financing arrangements from time to time and other factors, the
Company may, but does not currently intend to, increase the amount of funds
available to acquire Mortgage Assets with funds from borrowings including
borrowings under loan agreements, repurchase agreements and other credit
facilities. The Company's borrowings to date generally have been secured by
Mortgage Assets owned by the Company. Any borrowings may bear fixed or variable
interest rates, may require additional collateral in the event that the value of
existing collateral declines on a market value basis and may be due on demand or
upon the occurrence of certain events. To the extent that borrowings bear
variable interest rates, changes in short-term interest rates will significantly
influence the cost of such borrowings and could result in losses in certain
circumstances. See "Business -- Special Considerations -Mortgage Asset
Considerations -- Interest Rate Fluctuation Risks." The Company also may
increase the amount of its available funds through the issuance of debt
securities.
The Company's Net Cash Flows would be increased by using borrowings to
purchase Mortgage Assets if the costs of such borrowings were less than the Net
Cash Flows on such Mortgage Assets. The Company's Bylaws limit borrowings,
excluding the liability represented by CMOs, to no more than 300% of the amount
of its Average Invested Assets (as described herein) unless borrowings in excess
of that amount are approved by a majority of the Unaffiliated Directors (as
defined herein). See "Business -- Capital Resources." If the Company purchases
Mortgage Assets utilizing borrowed funds and the cost of such borrowings
increases to the extent that such cost exceeds the Net Cash Flows on such
Mortgage Assets, such an increase would reduce Net Cash Flows and could result
in losses in certain circumstances. No assurance can be given as to the cost or
availability of any such borrowings which the Company may determine to incur. As
of December 31, 1994, the Company's long-term debt represented by its Secured
Notes (as described herein) totalled $11,783,000 or 66.79% of stockholders'
equity.
No assurance can be given as to the actual effect of borrowings by the
Company.
Inability to Predict Effects of Market Risks
Because none of the above factors including changes in prepayment rates,
interest rates, reinvestment income, expenses and borrowing costs are
susceptible to accurate projection, the Net Cash Flows generated by the
Company's Mortgage Assets cannot be predicted.
Decline in Net Cash Flows from Mortgage Assets
The Company derives income from the Net Cash Flows received on its Mortgage
Assets. The rights to receive such Net Cash Flows ("Net Cash Flow Interests")
result from the Company's ownership of Mortgage Instruments and Mortgage
Interests with respect to Mortgage Instruments. Because the Company's Net Cash
Flows derive principally from the difference between the cash flows on the
Mortgage Instruments underlying Mortgage Securities and the required cash
payments on the Mortgage Securities, Net Cash Flows are the greatest in the
years immediately following the purchase of Mortgage Assets and decline over
time unless the Company reinvests its Net Cash Flows in additional Mortgage
Assets which it currently does not contemplate. This decline in Net Cash Flows
over time occurs as (i) interest rates on Mortgage Securities classes receiving
principal payments first generally are lower than those on later classes thus
effectively increasing the relative interest cost of the Mortgage Securities
over time and (ii) mortgage prepayments on Mortgage Instruments with higher
interest rates tend to be higher than on those with lower interest rates thus
effectively lowering the relative interest income on the Mortgage Instruments
over time.
PLEDGED ASSETS
Substantially all of the Company's Mortgage Assets and the Net Cash Flows
therefrom currently are and in the future can be expected to be pledged to
secure or underlie Mortgage Securities, bank borrowings, repurchase agreements
or other credit arrangements. Therefore, such Mortgage Assets and Net Cash Flows
will not be available to the stockholders in the event of the liquidation of the
Company except to the extent that the market value thereof exceeds the amounts
due to the senior creditors. However, the market value of the Mortgage Assets is
uncertain because the market for Mortgage Assets of the type owned by the
Company is not well developed and fluctuates rapidly as the result of numerous
market factors (including interest rates and prepayment rates) as well as the
supply of and demand for such assets. In addition, the Company may pledge its
Real Estate Loans in the future to secure any indebtedness that it may incur.
MARKET PRICE OF COMMON STOCK
The market price of the Company's Common Stock has been and may be expected
to continue to be extremely sensitive to a wide variety of factors including the
Company's operating results, dividend payments (if any), actual or perceived
changes in short-term and mortgage interest rates and their relationship to each
other, actual or perceived changes in mortgage prepayment rates, and any
variation between the net yield on the Company's Mortgage Assets and prevailing
market interest rates. It can be anticipated that the results of the Company's
Real Estate Loans will have an increasingly important effect on the market price
of the Company's Common Stock. Any actual or perceived unfavorable changes in
the Company's operating results including those related to its Real Estate Loan
activities, or other factors resulting from the circumstances described herein
or other circumstances, may adversely affect the market price of the Company's
Common Stock.
FUTURE OFFERINGS OF COMMON STOCK
The Company in the future may increase its capital resources by making
additional offerings of its Common Stock or securities convertible into its
Common Stock. The actual or perceived effect of such offerings may be the
dilution of the book value or earnings per share of the Company's Common Stock
which may result in the reduction of the market price of the Company's Common
Stock. The Company is unable to estimate the amount, timing or nature of future
sales of its Common Stock as such sales will depend upon market conditions and
other factors such as its need for additional equity, its ability to apply or
invest the proceeds of such sales of its Common Stock, the terms upon which its
Common Stock could be sold, and any restrictions on its ability to sell its
Common Stock contained in any credit facility or other agreements.
POTENTIAL CONFLICTS OF INTEREST
The Company's Articles of Incorporation limit the liability of its directors
and officers to the Company and its stockholders to the fullest extent permitted
by Maryland law, and both the Company's Articles and Bylaws provide for
indemnification of the directors and officers to such extent. See "Directors and
Executive Officers of Registrant." In addition, the Subcontract Agreement limits
the responsibilities of ASFS and provides for the indemnification of ASFS, its
affiliates and their directors and officers against various liabilities. See
"Business -- The Subcontract Agreement."
CERTAIN CONSEQUENCES OF REIT STATUS
In order to maintain its qualification as a REIT for federal income tax
purposes, the Company must continually satisfy certain tests with respect to the
sources of its income, the nature and diversification of its assets, the amount
of its distributions to stockholders and the ownership of its stock. See
"Business -- Federal Income Tax Considerations -- Status of the Company as a
REIT" and "Qualification of the Company as a REIT." Among other things, these
restrictions may limit the Company's ability to acquire certain types of assets
that it otherwise would consider desirable, limit the ability of the Company to
dispose of assets that it has held for less than four years if the disposition
would result in gains exceeding specified amounts, limit the ability of the
Company to engage in hedging transactions that could result in income exceeding
specified amounts, and require the Company to make distributions to its
stockholders at times that the Company may deem it more advantageous to utilize
the funds available for distribution for other corporate purposes (such as the
purchase of additional assets or the repayment of debt) or at times that the
Company may not have funds readily available for distribution.
The Company's operations from time to time generate taxable income in excess
of its net income for financial reporting purposes. The Company also may
experience a situation in which its taxable income is in excess of the actual
receipt of Net Cash Flows. See "Business -- Federal Income Tax Considerations --
Activities of the Company." To the extent that the Company does not otherwise
have funds available, either situation may result in the Company's inability to
distribute substantially all of its taxable income as required to maintain its
REIT status. See "Business -- Federal Income Tax Considerations." Alternatively,
the Company may be required to borrow funds to make the required distributions
which could have the effect of reducing the yield to its stockholders, to sell a
portion of its assets at times or for amounts that are not advantageous, or to
distribute amounts that represent a return of capital which would reduce the
equity of the Company. In evaluating assets for purchase, the Company considers
the anticipated tax effects of the purchase including the possibility of any
excess of taxable income over projected cash receipts.
If the Company should not qualify as a REIT in any tax year, it would be
taxed as a regular domestic corporation and, among other consequences,
distributions to the Company's stockholders would not be deductible by the
Company in computing its taxable income. Any such tax liability could be
substantial and would reduce the amount of cash available for distributions to
the Company's stockholders. See "Business -- Federal Income Tax Considerations."
In addition, the unremedied failure of the Company to be treated as a REIT for
any one year would disqualify the Company from being treated as a REIT for the
four subsequent years.
EXCESS INCLUSIONS
A portion of the dividends paid by the Company constitutes unrelated
business taxable income to certain otherwise tax-exempt stockholders, will
constitute a floor for the taxable income of stockholders not exempt from tax,
and will not be eligible for any reduction (by treaty or otherwise) in the rate
of income tax withholding in the case of nonresident alien stockholders. The
portion of the Company's dividends subject to such treatment is the
stockholder's allocable share of that portion of the Company's "excess
inclusions" that exceeds the Company's REIT Taxable Income as described herein
(excluding net capital gain). Generally, excess inclusions are the excess of the
quarterly net income from a residual interest in a REMIC over the product of the
adjusted issue price of the residual interest and 120% of the applicable
long-term federal rate. In addition, to the extent provided in Treasury
Regulations, all the income from a residual interest in a REMIC may constitute
excess inclusions if that residual interest does not have significant value. The
portion of the Company's dividends that constitutes excess inclusions typically
will rise as the degree of leveraging of the Company's activities increases.
Additionally, excess inclusion income cannot be offset by net operating losses
generated by the Company and therefore may set a minimum taxable income amount
for the Company. This amount would be subject to the same REIT distribution
requirements, even if cash was unavailable. See "Business -- Federal Income Tax
Considerations -- Tax Consequences of Common Stock Ownership -- Excess Inclusion
Rule."
MARKETABILITY OF SHARES OF COMMON STOCK AND RESTRICTIONS ON OWNERSHIP
The Company's Articles of Incorporation prohibit ownership of its Common
Stock by tax-exempt entities that are not subject to tax on unrelated business
taxable income and by certain other persons (collectively "Disqualified
Organizations"). Such restrictions on ownership exist so as to avoid imposition
of a tax on a portion of the Company's income from excess inclusions.
Provisions of the Company's Articles of Incorporation also are designed to
prevent concentrated ownership of the Company which might jeopardize its
qualification as a REIT under the Code if the Company continues its REIT
election as well as its tax loss carryforward. Among other things, these
provisions provide (i) that any acquisition of shares that would result in the
disqualification of the Company as a REIT under the Code will be void, and (ii)
that in the event any person acquires, owns or is deemed, by operation of
certain attribution rules set out in the Code, to own a number of shares in
excess of 9.8% of the outstanding shares of the Company's Common Stock ("Excess
Shares"), the Board of Directors, at its discretion, may redeem the Excess
Shares. In addition, the Company may refuse to effectuate any transfer of Excess
Shares and certain stockholders, and proposed transferees of shares, may be
required to file an affidavit with the Company setting forth certain information
relating, generally, to their ownership of the Company's Common Stock. These
provisions may inhibit market activity and the resulting opportunity for the
Company's stockholders to receive a premium for their shares that might
otherwise exist if any person were to attempt to assemble a block of shares of
the Company's Common Stock in excess of the number of shares permitted under the
Articles of Incorporation. Such provisions also may make the Company an
unsuitable investment vehicle for any person seeking to obtain (either alone or
with others as a group) ownership of more than 9.8% of the outstanding shares of
Common Stock. Investors seeking to acquire substantial holdings in the Company
should be aware that this ownership limitation may be exceeded by a stockholder
without any action on such stockholder's part in the event of a reduction in the
number of outstanding shares of the Company's Common Stock.
On December 13, 1993, the Board of Directors approved the adoption of a
program to repurchase up to 2,000,000 shares of the Company's Common Stock in
open market conditions. The decision to repurchase shares pursuant to the
program, and the timing and amount of such purchases, will be based upon market
conditions then in effect and other corporate considerations. Through December
31, 1994, 15,200 shares of Common Stock have been repurchased under such
program.
INVESTMENT CONSEQUENCES OF EXEMPTION FROM INVESTMENT COMPANY ACT
The Company conducts its business so as not to become regulated as an
investment company under the Investment Company Act of 1940, as amended (the
"Investment Company Act"). Accordingly, the Company does not expect to be
subject to the restrictive provisions of the Investment Company Act. The
Investment Company Act exempts entities that are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate." Under current interpretations of the staff of the
Securities and Exchange Commission, in order to qualify for this exemption, the
Company must maintain at least 55% of its assets directly in Real Estate Loans,
Mortgage Loans, certain Mortgage Certificates and certain other qualifying
interests in real estate. The Company's ownership of certain Mortgage Assets
therefore may be limited by the Investment Company Act. In addition, certain
Mortgage Certificates may be treated as securities separate from the underlying
Mortgage Loans and, thus, may not qualify as "mortgages and other liens on and
interests in real estate" for purposes of the 55% requirement, unless such
Mortgage Certificates represent all the certificates issued with respect to an
underlying pool of mortgages. If the Company failed to qualify for exemption
from registration as an investment company, its ability to use investment
leverage would be substantially reduced, it would be prohibited from engaging in
certain transactions with affiliates, and it would be unable to conduct its
business as described herein. Such a failure to qualify could have a material
adverse effect on the Company.
FEDERAL INCOME TAX CONSIDERATIONS
STATUS OF THE COMPANY AS A REIT
The Company has made an election to be treated as a real estate investment
trust ("REIT"). Thus, if the Company satisfies certain tests in each taxable
year with respect to the nature of its income, assets, share ownership and the
amount of its distributions, among other things, it generally should not be
subject to tax at the corporate level on its income to the extent that it
distributes cash in the amount of such income to its stockholders.
QUALIFICATION OF THE COMPANY AS A REIT
General
In order to qualify as a REIT for federal income tax purposes and to
maintain such qualification, the Company must elect to be so treated and must
continually satisfy certain tests with respect to the sources of its income, the
nature and diversification of its assets, the amount of its distributions, and
the ownership of the Company. The following is a discussion of those various
tests.
Sources of Income
The Company must satisfy three separate income tests for each taxable year
with respect to which it intends to qualify as a REIT: (i) the 75% income test,
(ii) the 95% income test, and (iii) the 30% income test.
Under the first test, at least 75% of the Company's gross income for the
taxable year must be derived from certain qualifying real estate related
sources. Under the 95% test, 95% of the Company's gross income for the taxable
year must be derived from the items of income that either qualify under the 75%
test or are from certain other types of passive investments. Finally, the 30%
income test requires the Company to derive less than 30% of its gross income for
the taxable year from the sale or other disposition of (1) real property,
including interests in real property and interests in mortgages on real
property, held for less than four years, other than foreclosure property or
property involuntarily converted through destruction, condemnation or similar
events, (2) stock, securities, or swap agreements held for less than one year,
and (3) property in "prohibited transactions." A prohibited transaction is a
sale or disposition of dealer property that is not foreclosure property or,
under certain circumstances, a real estate asset held for at least four years.
If the Company inadvertently fails to satisfy either the 75% income test or
the 95% income test, or both, and if the Company's failure to satisfy either or
both tests is due to reasonable cause and not willful neglect, the Company may
avoid loss of REIT status by satisfying certain reporting requirements and
paying a tax equal to 100% of any excess nonqualifying income. See "Business --
Federal Income Tax Considerations -- Taxation of the Company." There is no
comparable safeguard that could protect against REIT disqualification as a
result of the Company's failure to satisfy the 30% income test.
The composition and sources of the Company's income should allow the Company
to satisfy the income tests during each year of its existence. Further, certain
short-term reinvestments may generate qualifying income for purposes of the 95%
income test but nonqualifying income for purposes of the 75% income test, and
certain hedging transactions could give rise to income that, if excessive, could
result in the Company's disqualification as a REIT for failing to satisfy the
30% income test, the 75% income test, and/or the 95% income test. The Company
intends to monitor its reinvestments and hedging transactions closely to attempt
to avoid disqualification as a REIT.
Nature and Diversification of Assets
At the end of each quarter of the Company's taxable year, at least 75% of
the value of the Company's assets must be cash and cash items (including
receivables), federal government securities and qualifying real estate assets.
Qualifying real estate assets include interests in real property and mortgages,
equity interests in other REITs, any stock or debt instrument for so long as the
income therefrom is qualified temporary investment income and, subject to
certain limitations, interests in REMICs. The balance of the Company's assets
may be invested without restriction, except that holdings of the securities of
any one non-governmental issuer may not exceed 5% of the value of the Company's
assets or 10% of the outstanding voting securities of that issuer. Securities
that are qualifying assets for purposes of the 75% asset test will not be
treated as securities of a non-governmental issuer for purposes of the 5% and
10% asset tests. Although the Company believes that such anticipated asset
holdings will allow it to satisfy the asset tests necessary to qualify as a
REIT, the Company intends to monitor its activities to assure satisfaction of
the asset tests.
If the Company fails to satisfy the 75% asset test at the end of any quarter
of its taxable year as a result of its acquisition of securities or other
property during that quarter, the failure can be cured by a disposition of
sufficient nonqualifying assets within 30 days after the close of that quarter.
The Company has represented that it will maintain adequate records of the value
of its assets and take such action as may be required to cure any failure to
satisfy the 75% asset test within 30 days after the close of any quarter. The
Company may not be able to cure any failure to satisfy the 75% asset test,
however, if assets that the Company believes are qualifying assets for purposes
of the 75% asset test are later determined to be nonqualifying assets.
Distributions
Each taxable year, the Company must distribute as dividends to its
stockholders an amount at least equal to (i) 95% of its REIT taxable income
(determined before the deduction of dividends paid and excluding any net capital
gain) plus (ii) 95% of the excess of its net income from foreclosure property
over the tax imposed on such income by the Code less (iii) any excess noncash
income (as determined under the Code).
Generally, a distribution must be made in the taxable year to which it
relates. A portion of the required distribution, however, may be made in the
following year if (i) a dividend is declared in October, November or December of
any year, is payable to stockholders of record on a specified date in October,
November or December and is actually paid in January of the following year or
(ii) a dividend is declared before the Company timely files its tax return for
the taxable year to which the distribution relates and is paid on or before the
first regular dividend payment date after such declaration. Further, if the
Company fails to meet the 95% distribution requirement as a result of an
adjustment to the Company's tax returns by the IRS, the Company may, if the
deficiency is not due to fraud with intent to evade tax or a willful failure to
file a timely tax return, retroactively cure the failure by paying a deficiency
dividend to stockholders and certain interest and penalties to the IRS.
The Company intends to make distributions to its stockholders on a basis
that will allow the Company to satisfy the distribution requirement. In certain
instances, however, the Company's pre-distribution taxable income may exceed its
cash flow and the Company may have difficulty satisfying the distribution
requirement. See "Business -- Federal Income Tax Considerations -- Activities of
the Company." The Company intends to monitor closely the relationship between
its pre-distribution taxable income and its cash flow and intends to borrow
funds or liquidate investments in order to overcome any cash flow shortfalls if
necessary to satisfy the distribution requirement. It is possible, although
unlikely, that the Company may decide to terminate its REIT status as a result
of any such cash shortfall. Such a termination would have adverse consequences
to the stockholders. See "Business -- Federal Income Tax Considerations --
Status of the Company as a REIT."
Ownership of the Company
Shares of the Company's Common Stock must be held by a minimum of 100
persons for at least 335 days in each taxable year after the Company's first
taxable year. Further, at no time during the second half of any taxable year
after the Company's first taxable year may more than 50% of the Company's shares
be owned, actually or constructively, by five or fewer individuals (including
pension funds and certain other types of tax-exempt entities). To evidence
compliance with these requirements, the Company is required to maintain records
that disclose the actual ownership of its outstanding shares. In order to
satisfy that requirement, the Company demands written statements from record
holders owning designated percentages of Common Stock disclosing, among other
things, the identities of the actual owners of such shares. The Company's
Articles of Incorporation contain repurchase provisions and transfer
restrictions designed to prevent violation of the latter requirement. Therefore,
the Company believes that its shares of Common Stock currently are owned by a
sufficient number of unrelated persons to allow the Company to satisfy the
ownership requirements for REIT qualification.
ACTIVITIES OF THE COMPANY
The Company expects to continue to generate income from the Net Cash Flows
on Mortgage Instruments and Mortgage Interests (i.e., interests in or from
Mortgage Finance Companies which own and finance Mortgage Instruments) and to
generate income from its Real Estate Loans. As discussed below, it is possible
that in any particular year the reportable taxable income associated with Net
Cash Flows may exceed the cash received in that year, making it difficult for
the Company to satisfy the dividend requirements. The Company also expects to
generate income by (i) making commitments to acquire Mortgage Assets, (ii)
earning interest on qualified temporary investments and (iii) earning interest
on short-term reinvestments and entering into hedging transactions. As explained
below, there are holding period requirements with respect to qualifying real
estate assets held by the Company as well as certain federal income tax risks
associated with hedging transactions and with the generation of income from Net
Cash Flows on Mortgage Instruments securing or underlying Mortgage Securities.
The Company expects that a substantial portion of its income from Net Cash
Flows will continue to come through its ownership of "residual" interests in
REMICs. A REMIC is a tax entity through which multiple classes of Mortgage
Securities are issued. A REMIC generally is considered a pass-through entity
(similar in some respects to a partnership) for federal income tax purposes.
Interests in a REMIC consist of a single class of residual interests and one or
more classes of "regular" interests. A regular interest resembles, though it
need not be in the form of, debt. A residual interest in a REMIC is any interest
in the REMIC that is not a regular interest and that is designated as a residual
interest by the REMIC. For purposes of maintaining its status as a REIT, the
Company anticipates that its ownership of residual interests in REMICs generally
will be qualifying real estate assets for purposes of the 75% asset test and
that its income with respect to such residual interests generally will be
qualifying income for purposes of the 75% income test.
The Company has obtained residual interests in REMICs by purchasing those
residual interests from other entities. The Code does not provide a method for
the Company to amortize any premium paid for a residual interest in excess of
its initial issue price. The lack of such an adjustment could reduce the
Company's yield on REMIC residual interests purchased at a premium. Although the
legislative history of the REMIC provisions recognizes this problem and notes
that certain modifications of the rules governing taxation of holders of
residual interests may be appropriate, no further guidance is provided.
The Company also has purchased Mortgage Instruments, transferred those
Mortgages Instruments to an entity that has made a REMIC election, and caused
that entity to issue Mortgage Securities backed by those Mortgage Instruments.
In that instance, the issuance of regular interests in that REMIC was treated,
for federal income tax purposes, as a sale of those Mortgage Instruments by the
Company.
Ownership by the Company of rights to Net Cash Flows in the forms of REMIC
residual interests pose certain risks to the Company. The failure of an entity
for which a REMIC election has been made to qualify as a REMIC could result in
treatment of the entity as a corporation for federal income tax purposes. If the
Company owns an interest in an entity that is taxed as a corporation, the
Company's REIT status could be jeopardized under the 75% income test and certain
of the asset tests. With respect to its interest in any REMIC the Company's
income under certain circumstances may exceed its cash receipts and thus make it
difficult for the Company to satisfy the cash distribution test. Distributions
received by the Company from any REMIC in excess of the Company's basis in its
interest in that REMIC could result in recognition by the Company of
nonqualifying income under the 30% prohibited income test.
The Company also has engaged in certain hedging transactions, and may engage
in future hedging transactions. See "Business -- Hedging"; "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note 8 to the Company's Consolidated Financial Statements. Hedging transactions,
including those transactions into which the Company has already entered, pose
risks to the Company. For example, the income from hedging transactions could
result in the Company violating the 95% income test, the 75% income test, and/or
the 30% income test. Also, certain losses incurred in connection with hedging
transactions could be characterized as capital losses, which cannot offset
ordinary REIT income, resulting in "phantom" income (income without cash) on
which dividends must be paid.
TAXATION OF THE COMPANY
For any taxable year in which the Company qualifies and elects to be treated
as a REIT under the Code, the Company will be taxed at regular corporate rates
(or, if less, at alternative rates in any taxable year in which the Company has
an undistributed net capital gain) on its real estate investment trust taxable
income ("REIT Taxable Income"). REIT Taxable Income is computed by making
certain adjustments to a REIT's taxable income as computed for regular
corporations. Dividends paid by a REIT to its stockholders with respect to a
taxable year are deducted to the extent those dividends are not attributable to
net income from foreclosure property. In computing REIT Taxable Income, taxable
income also is adjusted by (i) disallowing the deduction for dividends received,
(ii) disregarding any tax otherwise applicable as a result of a change of
accounting period, (iii) excluding the net income from foreclosure property,
(iv) deducting any tax resulting from the REIT's failure to satisfy either of
the 75% or 95% income tests, and (v) excluding net income from prohibited
transactions. Thus, in any year in which the Company qualifies as a REIT, it
generally will not be subject to federal income tax on that portion of its
taxable income that is distributed to its stockholders in or with respect to
that year.
Regardless of distributions to stockholders, the Company will be subject to
a tax at the highest corporate rate (currently 34%) on its net income from
foreclosure property, a 100% tax on its net income from prohibited transactions,
and a 100% tax on the greater of the amount by which it fails either the 75%
income test or the 95% income test, less associated expenses, if the failure to
satisfy either or both of such tests is due to reasonable cause and not willful
neglect and if certain other requirements are satisfied. In addition, the
Company will be subject to an excise tax (currently at the rate of 4%) for any
taxable year in which, and on the amount by which, distributions actually made
by the Company in that taxable year fail to exceed a certain amount determined
with reference to its REIT Taxable Income. Finally, although the minimum tax on
items of tax preference will apply to the Company, the Company does not expect
to have any significant amounts of tax preference items.
The Company uses the calendar year both for tax purposes and for financial
reporting purposes. Due to the differences between tax accounting rules and
generally accepted accounting principles, the Company's REIT Taxable Income will
vary from its net income for financial reporting purposes.
TAX CONSEQUENCES OF COMMON STOCK OWNERSHIP
Dividend Income
Distributions to stockholders out of the Company's current or accumulated
earnings and profits will constitute dividends to the stockholders generally
taxable as ordinary income. Generally, distributions by the Company will be out
of current or accumulated earnings and profits and, therefore, will be taxable.
Generally, dividends are taxable to stockholders in the year received. With
respect to any dividend declared by the Company in October, November or December
of any calendar year and payable to stockholders of record as of a specified
date in October, November or December, however, that dividend will be deemed to
have been paid by the Company and received by the stockholder on December 31 if
the dividend is actually paid in January of the following calendar year.
The Company's dividends will not be eligible for the dividends-received
deduction for corporations. If the Company's total distributions for a taxable
year exceed its current and accumulated earnings and profits, a portion of each
distribution will be treated first as a return of capital, reducing a
stockholder's basis in his shares (but not below zero), and then as capital gain
in the event such distributions are in excess of a stockholder's adjusted basis
in his shares.
Distributions properly designated by the Company as "capital gain dividends"
will be taxable to the stockholders as long-term capital gain, to the extent
those dividends do not exceed the Company's actual net capital gain for the
taxable year, without regard to the stockholder's holding period for his shares.
A REIT is not required to offset its net capital gain for any taxable year with
its net operating loss for that year or from a prior year in determining the
maximum amount of capital gain dividends that it can pay for that year. Any loss
on the sale or exchange of shares of Common Stock held by a stockholder for one
year or less will be treated as long-term capital loss to the extent of any
capital gain dividends received on that Common Stock by that stockholder. The
Company will notify stockholders after the close of its taxable year regarding
the portions of the distributions that constitute ordinary income, return of
capital and capital gain. Stockholders may not deduct any net operating losses
or capital losses of the Company. The Company will also notify stockholders
regarding their reportable share of excess inclusion income. See "Excess
Inclusion Rule" below.
Dividends As Portfolio Income
Dividends paid by the Company will be "portfolio income" to stockholders.
Therefore, a stockholder subject to the passive activity limitations will not be
able to offset income earned with respect to his or her investment in the
Company with passive activity losses or deductions, except to the extent that
suspended passive activity losses or deductions have been made available by
taxable dispositions of interests in the passive activities that generated those
losses or deductions.
Excess Inclusion Rule
Ownership by the Company of residual interests in REMICs may adversely
affect the federal income taxation of the Company and of certain stockholders to
the extent those residual interests generate "excess inclusion income." The
Company's excess inclusion income during a calendar quarter generally will equal
the excess of its taxable income from residual interests in REMICs over its
"daily accruals" with respect to those residual interests for the calendar
quarter. The daily accruals are calculated by multiplying the adjusted issue
price of the residual interest by 120% of the long-term federal interest rate in
effect on the REMIC's startup date. It is possible that the Company will have
excess inclusion income without associated cash. In taxable years in which the
Company has both a net operating loss and excess inclusion income, it will still
have to report a minimum amount of taxable income equal to its excess inclusion
income. In order to maintain its REIT status, the Company will be required to
distribute at least 95% of its taxable income, even if its taxable income is
comprised exclusively of excess inclusion income and otherwise has a net
operating loss.
In general, each stockholder is required to treat the stockholder's
allocable share of the portion of the Company's excess inclusions that is not
taxable to the Company as an excess inclusion received by such stockholder. The
portion of the Company's dividends that constitute excess inclusions typically
will rise as the degree of leveraging of the Company's activities increase.
Therefore, all or a portion of the dividends received by the stockholders may be
excess inclusion income. Excess inclusion income will constitute unrelated
business taxable income for tax-exempt entities and may not be used to offset
deductions or net operating losses from other sources for most other taxpayers.
TAX-EXEMPT ORGANIZATIONS AS STOCKHOLDERS
The Code requires a tax-exempt stockholder of the Company to treat as
unrelated business taxable income its allocable share of the Company's excess
inclusions. The Company is likely to receive excess inclusion income. See
"Federal Income Tax Considerations -- Tax Consequences of Common Stock Ownership
-- Excess Inclusion Rule." The Common Stock of the Company may not be held by
tax-exempt entities which are not subject to tax on unrelated business taxable
income.
TAXATION OF FOREIGN STOCKHOLDERS
Gain from the sale of the Company's shares by a nonresident alien individual
or foreign corporation ("foreign persons") generally will not be subject to
United States taxation unless that gain is effectively connected with that
foreign person's United States trade or business or, in the case of an
individual foreign person, that person is present within the United States for
more than 182 days in the taxable year in question or otherwise is considered a
resident alien. If a foreign person holds more than 5% of the shares of the
Company, however, gain from the sale of that person's shares could be subject to
full United States taxation if the Company ever held any real property interests
and was not a domestically controlled REIT.
Distributions of cash generated by the Company's operations that are paid to
foreign persons generally will be subject to United States withholding tax at a
rate of 30% or at a lower rate if a foreign person can claim the benefits of a
tax treaty. Notwithstanding the foregoing, distributions made to foreign
stockholders will not be subject to treaty withholding reductions to the extent
of their allocable shares of the portion of the Company's excess inclusion that
is not taxable to the Company for the period under review. It is expected that
the Company will have excess inclusions. See "Federal Income Tax Considerations
-- Tax Consequences of Common Stock Ownership -- Excess Inclusion Rule."
Distributions to foreign persons of cash attributable to gain on the Company's
sale or exchange of real properties, if any, generally will be subject to full
United States taxation and withholding.
The federal income taxation of foreign persons is a highly complex matter
that may be affected by many considerations. Accordingly, foreign investors in
the Company should consult their own tax advisors regarding the income and
withholding tax considerations with respect to their investments in the Company.
Foreign governments and organizations, and their instrumentalities, may not
invest in the Company.
BACKUP WITHHOLDING
The Company is required by the Code to withhold from dividends 20% of the
amount paid to stockholders, unless the stockholder (i) files a correct taxpayer
identification number with the Company, (ii) certifies as to no loss of
exemption from backup withholding and (iii) otherwise complies with the
applicable requirements of the backup withholding rules. The Company will report
to its stockholders and the IRS the amount of dividends paid during each
calendar year and the amount of tax withheld, if any. Stockholders should
consult their tax advisors as to the procedure for insuring that the Company
dividends to them will not be subject to backup withholding.
STATE AND LOCAL TAXES
The discussion herein concerns only the federal income tax treatment likely
to be accorded the Company and its stockholders. No discussion has been provided
regarding the state or local tax treatment of the Company and its stockholders.
The state and local tax treatment may not conform to the federal income tax
treatment described above and each stockholder should discuss such treatment
with his state and local tax adviser.
ITEM 2. PROPERTIES
The principal executive offices of the Company are located at 5333 North
Seventh Street, Suite 219, Phoenix, Arizona 85014, telephone (602) 265-8541.
ITEM 3. LEGAL PROCEEDINGS
None
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
(a) The Company's 1994 Annual Meeting of Stockholders was held on November
29, 1994.
(b) The names of each director elected at the meeting are designated below.
There are no other directors whose terms of office as directors
continued after the meeting.
Alan D. Hamberlin
Mike Marusich
Mark A. McKinley
Gregory K. Norris
(c) (i) A vote was cast with respect to the election of the nominated
slate of directors to hold office until the annual meeting of
stockholders in 1995 and until their successors are elected and
qualified.
The following votes were cast for, against and withheld in this
matter:
For Against Withheld
--------- -------- ----------
Alan D. Hamberlin 7,388,713 0 511,694
Mike Marusich .... 7,391,288 0 509,119
Mark A. McKinley . 7,402,013 0 498,394
Gregory K. Norris 7,400,213 0 500,194
(ii) A vote was cast with respect to the ratification of the appointment
of Kenneth Leventhal & Company as the independent auditors of the
Company for the fiscal year ending December 31, 1994.
The following votes were cast for, against and withheld in this
matter:
For Against Withheld
--------- -------- ----------
7,643,529 163,989 92,889
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock is listed on the New York Stock Exchange under
the symbol "HPX." The high and low sales prices of shares of the Common Stock on
the New York Stock Exchange and the dividends per share paid by the Company for
the periods indicated were as follows:
DIVIDENDS
HIGH LOW PER SHARE
-------- ------- -----------
1993
First quarter ................... $ 2-5/8 $ 1-5/8 $0
Second quarter .................. 2 1-1/2 0
Third quarter ................... 1-5/8 1 0
Fourth quarter .................. 1-1/2 3/4 .03
1994
First quarter ................... 1-1/2 1 0
Second quarter .................. 1-1/2 1 0
Third quarter ................... 1-1/2 1 0
Fourth quarter .................. 1-3/8 1 .02
On March 23, 1995, the closing sales price of the Common Stock of the
Company on the New York Stock Exchange was $1 1/2. On December 31, 1994, the
Company had outstanding 9,716,517 shares of Common Stock which were held by
approximately 850 stockholders of record. Based upon information available to
the Company, the Company believes that there are approximately 6,000 beneficial
owners of its Common Stock.
In order to maintain its qualification as a REIT under the Code for any
taxable year, the Company, among other things, must distribute as dividends to
its stockholders an amount at least equal to (i) 95% of its REIT taxable income
(determined before the deduction of dividends paid and excluding any net capital
gain) plus (ii) 95% of the excess of its net income from foreclosure property
over the tax imposed on such income by the Code less (iii) any excess non-cash
income (as determined under the Code). The Company generally intends that the
cash dividends paid each year to its stockholders will equal or exceed the
Company's taxable income. The actual amount and timing of dividend payments,
however, will be at the discretion of the Board of Directors and will depend
upon the financial condition of the Company in addition to the requirements of
the Code.
The Company has accumulated a net operating loss carryforward, for income
tax purposes, of approximately $58,000,000 as of December 31, 1994. This tax
loss may be carried forward, with certain restrictions, for up to 15 years to
offset future taxable income, if any. Until the tax loss carryforward is fully
utilized, the Company will not be required to distribute dividends to its
stockholders except to the extent of its "excess inclusion income." See
"Business -- Federal Income Tax Considerations -- Taxation of Common Stock
Ownership -- Excess Inclusion Income."
The Company may apply the principal from repayments, sales and refinancings
of the Company's Mortgage Assets to reduce the unpaid principal balance of its
Secured Notes. The Company also may, under certain circumstances, and subject to
the distribution requirements referred to above, make distributions of
principal. Such distributions of principal, if any, will be made at the
discretion of the Board of Directors and only to the extent permitted by the
Company's Indenture with respect to the Secured Notes.
Although a portion of the dividends may be designated by the Company as
capital gain or may constitute a return of capital, it is anticipated that
dividends generally will be taxable as ordinary income to taxpaying stockholders
of the Company. With respect to tax-exempt organizations, it is likely that a
significant portion of the dividends will be treated as unrelated business
taxable income ("UBTI"). Dividends received by a corporation will not be
eligible for the dividends-received deduction so long as the Company qualifies
as a REIT. The Company furnishes annually to each of its stockholders a
statement setting forth distributions paid during the preceding year and their
characterization as ordinary income, return of capital or capital gains. For a
discussion of the federal income tax treatment of distributions by the Company,
see "Business -- Federal Income Tax Considerations -- Taxation of the Company,
-- Tax Consequences of Common Stock Ownership, and -- Tax-Exempt Organizations
as Stockholders."
The taxable income of the Company from its Mortgage Assets is increased by
non-cash income from, among other things, the accretion of market discount on
the Mortgage Instruments securing or underlying Mortgage Securities and is
decreased by non-cash expenses, including, among other things, the amortization
of the issuance costs of Mortgage Securities and the accretion of original issue
discount on certain Classes of Mortgage Securities. The taxable income of the
Company will differ from its net income for financial reporting purposes
principally as a result of the different method used to determine the effect and
timing of recognition of such non-cash income and expenses.
Because the Company must distribute to its stockholders an amount equal to
substantially all of its net taxable income (computed after taking into account
any net operating loss carryforwards that are available) in order to qualify as
a REIT, the Company may be required to distribute a portion of its working
capital to its stockholders, borrow funds or sell assets to make required
distributions in years in which the non-cash items of taxable income exceed the
Company's non-cash expenses. In the event that the Company is unable to pay
dividends equal to substantially all of its taxable income, it will not continue
to qualify as a REIT.
The Company's Articles of Incorporation, as amended to date (the "Articles
of Incorporation"), prohibit ownership of its Common Stock by tax-exempt
entities that are not subject to tax on unrelated business taxable income and by
certain other persons (collectively "Disqualified Organizations"). Such
restriction on ownership exists so as to avoid imposition of a tax on a portion
of the Company's income from excess inclusions.
Provisions of the Company's Articles of Incorporation also are designed to
prevent concentrated ownership of the Company which might jeopardize its
qualification as a REIT under the Code. Among other things, these provisions
provide (i) that any acquisition of shares that would result in the
disqualification of the Company as a REIT under the Code will be void, and (ii)
that in the event any person acquires, owns or is deemed, by operation of
certain attribution rules set out in the Code, to own a number of shares in
excess of 9.8% of the outstanding shares of the Company's Common Stock ("Excess
Shares"), the Board of Directors, at its discretion, may redeem the Excess
Shares. In addition, the Company may refuse to effectuate any transfer of Excess
Shares and certain stockholders and proposed transferees of shares may be
required to file an affidavit with the Company setting forth certain information
relating, generally, to their ownership of the Company's Common Stock. These
provisions may inhibit market activity and the resulting opportunity for the
Company's stockholders to receive a premium for their shares that might
otherwise exist if any person were to attempt to assemble a block of shares of
the Company's Common Stock in excess of the number of shares permitted under the
Articles of Incorporation. Such provisions also may make the Company an
unsuitable investment vehicle for any person seeking to obtain (either alone or
with others as a group) ownership of more than 9.8% of the outstanding shares of
Common Stock. Investors seeking to acquire substantial holdings in the Company
should be aware that this ownership limitation may be exceeded by a stockholder
without any action on such stockholder's part if the number of outstanding
shares of the Company's Common Stock is reduced. On December 13, 1993, the Board
of Directors approved the adoption of a program to repurchase up to 2,000,000
shares of the Company's Common Stock in open market conditions. The decision to
repurchase shares pursuant to the program, and the timing and amount of such
purchases, will be based upon market conditions then in effect and other
corporate considerations. As of December 31, 1994, 15,200 shares of common stock
have been repurchased under such program.
<TABLE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is qualified in its entirety by, and
should be read in conjunction with, the financial statements and notes thereto
appearing elsewhere herein. The data has been derived from the financial
statements of the Company audited by Kenneth Leventhal & Company, independent
certified public accountants, as indicated by their report thereon as specified
therein which also appears elsewhere herein.
<CAPTION>
Years Ended December 31
-----------------------------------------------------------------------
1994 1993 1992 1991 1990
------------- ------------- ------------- ------------ ------------
(In Thousands Except Per Share Data)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME (LOSS) DATA:
Income (Loss) From Mortgage Assets....... $ (1,203) $ (21,814) $ (14,068) $ 15,507 $ 20,271
Interest Expense......................... 1,383 2,274 2,750 4,535 6,012
Other Expense (Hedging, Management,
General and Administrative)............ 1,938 1,822 2,315 2,945 3,438
------------- ------------- ------------- ------------ ------------
Income (Loss) Before Cumulative Effect of
Accounting Change...................... (4,524) (25,910) (19,133) 8,027 10,821
Cumulative Effect of Accounting Change... -- (6,078) -- -- --
------------- ------------- ------------- ------------ ------------
Net Income (Loss)........................ $ (4,524) $ (31,988) $ (19,133) $ 8,027 $ 10,821
============= ============= ============= ============ ============
Income (Loss) Per Share Before Cumulative
Effect of Accounting Change............ $ (.47) $ (2.66) $ (1.93) $ .81 $ 1.11
Cumulative Effect of Accounting Change
Per Share.............................. -- (.63) -- -- --
------------- ------------- ------------- ------------ ------------
Net Income (Loss) Per Share.............. $ (.47) $ (3.29) $ (1.93) $ .81 $ 1.11
============= ============= ============= ============ ============
Dividends Per Share (1).................. $ .02 $ .03 $ .40 $ 1.70 $ 1.05
============= ============= ============= ============ ============
</TABLE>
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------
1994 1993 1992 1991 1990
------------- ------------- ------------ ------------ ------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
$ $ $
Real Estate Loans......................... $ 9,260 $ 320 -- -- --
Residual Interest Certificates............ 4,853 14,025 48,081 70,278 74,637
Interests Relating Mortgage Participation
Certificates............................ 2,801 3,710 18,687 42,710 56,726
Total Assets.............................. 31,150 43,882 87,063 121,502 138,980
Long-Term Debt............................ 11,783 19,926 31,000 16,450 20,000
Total Liabilities......................... 13,508 21,505 32,357 43,462 52,822
Total Stockholders' Equity................ 17,642 22,377 54,706 78,040 86,158
--------------
(1) On January 30, 1991, the Company paid a dividend of $1.05 per share for the
year ended December 31, 1990. On April 15, 1991, the Company paid a dividend
of $.50 per share consisting of $.40 per share for the first quarter of 1991
and a special dividend of $.10 per share representing the remainder of
undistributed taxable income for 1990. On July 15, 1991, October 14, 1991
and January 15, 1992, the Company paid a dividend of $.40 per share for the
quarters ended June 30, 1991, September 30, 1991 and December 31, 1991,
respectively. On April 15, 1992, the Company paid a dividend of $.25 per
share for the quarter ended March 31, 1992 and on July 15, 1992, the Company
paid a dividend of $.15 per share for the quarter ended June 30, 1992. The
Company paid a dividend of $.03 per share on January 14, 1994 for 1993. The
Company paid a dividend of $.02 per share on January 17, 1995 for 1994.
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION, RESULTS
OF OPERATIONS AND INTEREST RATES AND OTHER INFORMATION
RESULTS OF OPERATIONS -- 1994 COMPARED TO 1993
The Company incurred a net loss of $4,524,000 or $.47 per share in 1994
compared to a net loss of $31,988,000 or $3.29 per share in 1993.
The Company's loss from Mortgage Assets was $1,203,000 in 1994 compared to a
loss of $21,814,000 in 1993. The above amounts include net charges of $3,343,000
in 1994 and $22,312,000 in 1993 to writedown the Company's investments in
several of its Mortgage Interests. Writedowns of Mortgage Interests declined in
1994 as compared to 1993 because of a decrease in the average balance of
Mortgage Interests owned by the Company and a decline in projected prepayment
rates. See "Interest Rates and Prepayments."
Interest income on real estate loans increased from $29,000 in 1993 to
$1,113,000 in 1994 due to the expansion of the Company's real estate lending
program. See "Liquidity, Capital Resources and Commitments."
The Company's interest expense declined from $2,274,000 in 1993 to
$1,383,000 in 1994 due to a reduction of the average aggregate long-term debt.
General and administrative expenses in 1994 include $340,000 of legal and
investment banking expenses related to merger negotiations with a privately held
company which were subsequently terminated.
RESULTS OF OPERATIONS -- 1993 COMPARED TO 1992
The Company incurred a net loss of $31,988,000 or $3.29 per share in 1993
compared to a net loss of $19,133,000 or $1.93 per share in 1992. The 1993 loss
included a charge of $6,078,000 or $.63 per share from the cumulative effect of
an accounting change. See Note 10 to the financial statements.
The Company's loss from Mortgage Assets increased from $14,068,000 in 1992
to $21,814,000 in 1993 primarily due to continuing increases in both actual and
projected mortgage prepayment rates. The above amounts include net charges of
$22,312,000 in 1993 and $20,933,000 in 1992 to writedown the Company's
investments in several of its Mortgage Interests. The negative impact on income
of increased mortgage prepayments rates more than offset the positive effect on
income from lower LIBOR rates on floating rate CMO classes and lower LIBOR and
COFI rates on floating rate MPC classes related to the Company's Mortgage
Interests. See "Interest Rates and Prepayments."
The Company's interest expense declined from $2,750,000 in 1992 to
$2,274,000 in 1993 due to a reduction of the average aggregate long-term debt
and short-term borrowings outstanding.
General and administrative expenses declined from $2,246,000 in 1992 to
$1,684,000 in 1993 primarily as a result of a reduction in payroll and payroll
related expenses that are tied to the level of the Company's net income and
dividends.
LIQUIDITY, CAPITAL RESOURCES AND COMMITMENTS
The Company raised $80,593,000 in connection with its initial public
offering on July 27, 1988. The proceeds were immediately utilized to purchase
Mortgage Interests. Subsequently, through October 1988, the Company purchased an
additional $59,958,000 of Mortgage Interests which were initially financed using
a combination of borrowings under repurchase agreements and the Company's bank
line of credit.
The Company has not purchased any Mortgage Interests since October 1988.
Since December 1993, the Company has originated several Real Estate Loans
secured by various first deeds of trust on real properties located in Arizona.
The Company's loan program seeks higher returns by targeting loan opportunities
to which the Company can respond on a more timely basis than traditional real
estate lenders. At December 31, 1994, all of the Company's loans are secured by
properties located in Arizona. As a result of this geographic concentration,
unfavorable economic conditions in Arizona could increase the likelihood of
defaults on these loans and affect the Company's ability to protect the
principal and interest on such loans following foreclosures upon the real
properties securing such loans. The Company may, in the future, make loans on
properties located outside of Arizona. At December 31, 1994 the Company's Real
Estate Loans outstanding total $9,260,000 and bear interest at between 16% and
24%, payable monthly, with all principal due within one year. All loans are
current as of December 31, 1994.
On December 17, 1992, a wholly owned limited-purpose subsidiary of the
Company issued $31,000,000 of Secured Notes under an Indenture to a group of
institutional investors. The Notes bear interest at 7.81% and require quarterly
payments of principal and interest with the balance due on February 15, 2001.
The Notes are secured by the Company's residual interests in Westam 1, Westam 3,
Westam 5, Westam 6 and ASW 65 (see Note 4 to the December 31, 1993 financial
statements), by the Company's Mortgage Interests relating to mortgage
participation certificates FNMA 1988-24 and FNMA 1988-25 (see Note 5 to the
December 31, 1993 financial statements), and by funds held by Trustee. The
Company used $3,100,000 of the proceeds to establish a reserve fund. The reserve
fund has a specified maximum balance of $7,750,000, and is to be used to make
the scheduled principal and interest payments on the Notes if the cash flow
available from the collateral is not sufficient to make the scheduled payments.
Depending on the level of certain specified financial ratios relating to the
collateral, the cash flow from the collateral is required to either repay the
Notes at par, increase the reserve fund up to its $7,750,000 maximum or is
remitted to the Company. At December 31, 1994, $6,720,000 is held by Trustee in
the reserve fund under the Indenture.
At December 31, 1994, the Company does not have any used or unused
short-term debt or line of credit facilities.
As a real estate investment trust (REIT), the Company is not subject to
income tax at the corporate level as long as it distributes 95% of its taxable
income to its shareholders. The Company has, in the past, distributed 100% of
its taxable income to its shareholders. However, primarily as a result of the
significant mortgage refinancing activity in both 1992 and 1993 (see "Interest
Rates and Prepayments"), the Company has accumulated a net operating loss
carryforward, for income tax purposes, of approximately $58,000,000 as of
December 31, 1994. This tax loss may be carried forward, with certain
restrictions, for up to 15 years to offset future taxable income, if any. Until
the tax loss carryforward is fully utilized, the Company will not be required to
distribute dividends to its stockholders except for income that is deemed to be
excess inclusion income. The Company anticipates that future cash flow from
operations will be used for payment of operating expenses and debt service with
the remainder, if any, available for investment in mortgage or real estate
related assets. At December 31, 1994, the Company has $6,666,000 of cash and
cash equivalents available for investment purposes.
INTEREST RATES AND PREPAYMENTS
One of the Company's major sources of income is its income from Mortgage
Interests which consists of the Company's net investment in eight real estate
mortgage investment conduits ("REMICs") as described in Notes 4, 5 and 10 to the
financial statements. The Company's cash flow and return on investment from its
Mortgage Interests are highly sensitive to the prepayment rate on the related
Mortgage Certificates and the variable interest rates on variable rate CMOs and
MPCs.
At December 31, 1994, the Company's proportionate share of floating-rate
CMOs and MPCs in the eight REMICs is $52,034,000 in principal amount that pays
interest based on LIBOR and $5,344,000 in principal amount that pays interest
based on COFI. Consequently, absent any changes in prepayment rates on the
related Mortgage Certificates, increases in LIBOR and COFI will decrease the
Company's net income, and decreases in LIBOR and COFI will increase the
Company's net income. The average LIBOR and COFI rates were as follows:
1994 1993 1992
--------- --------- ---------
LIBOR .................... 4.33% 3.22% 3.86%
COFI ..................... 3.83% 4.16% 5.45%
The LIBOR and COFI rates as of December 31, 1994, were 6.00% and 4.37%,
respectively.
On May 12, 1992, the Company entered into a LIBOR ceiling rate agreement
with a bank for a fee of $245,000. The agreement, which had a term of two years
beginning July 1, 1992, required the bank to pay a monthly amount to the Company
equal to the product of $175,000,000 multiplied by the percentage, if any, by
which actual one-month LIBOR (measured on the first business day of each month)
exceeds 9.0%. Through the expiration of the agreement on July 1, 1994, LIBOR has
remained under 9.0% and, accordingly, no amounts were paid under the agreement.
The Company's cash flow and return on investment from Mortgage Interests
also is sensitive to prepayment rates on the Mortgage Certificates securing the
CMOs and underlying the MPCs. In general, slower prepayment rates will tend to
increase the cash flow and return on investment from Mortgage Interests and
faster prepayment rates will tend to decrease the cash flow and return on
investment from Mortgage Interests. The rate of principal prepayments on
Mortgage Certificates is influenced by a variety of economic, geographic, social
and other factors. In general, prepayments of the Mortgage Certificates should
increase when the current mortgage interest rates fall below the interest rates
on the fixed rate mortgage loans underlying the Mortgage Certificates.
Conversely, to the extent that then current mortgage interest rates exceed the
interest rates on the mortgage loans underlying the Mortgage Certificates,
prepayments of such Mortgage Certificates should decrease. Prepayment rates also
may be affected by the geographic location of the mortgage loans underlying the
Mortgage Certificates, conditions in mortgage loan, housing and financial
markets, the assumability of the mortgage loans and general economic conditions.
The national average contract interest rate for major lenders on purchase of
previously occupied homes, as published by the Federal Housing Finance Board,
decreased from an average of 9.04% in 1991 to an average of 7.84% in 1992 to an
average of 6.96% in 1993. This resulted in a significant increase in refinancing
activity beginning in the fourth quarter of 1991 and continuing throughout 1992
and 1993. As a result, the Company incurred net charges of $22,312,000 in 1993
and $20,933,000 in 1992 to writedown its Mortgage Interests. This mortgage
interest rate has subsequently risen from 6.65% in December 1993 to 7.75% in
December 1994 and projected prepayment rates have declined. However, actual
prepayments have been declining slower than projected and, as a result, the
Company incurred an additional net charge of $3,343,000 in 1994 to writedown its
Mortgage Interests.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the report thereon and the
notes thereto commencing at page F-1 of this report, which financial statements,
report and notes are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
<TABLE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
<CAPTION>
NAME AGE POSITION(S) HELD
---- --- ----------------
<S> <C> <C>
Alan D. Hamberlin 46 Chairman of the Board of Directors, Director, President and
Chief Executive Officer
Jay R. Hoffman 40 Vice President, Secretary, Treasurer and Chief Financial and
Accounting Officer
Mike Marusich 69 Director
Mark A. McKinley 48 Director
Gregory K. Norris 44 Director
</TABLE>
Alan D. Hamberlin has been a Director and the President and Chief Executive
Officer of the Company since its organization and Chairman of the Board of
Directors of the Company since January 1990. Mr. Hamberlin also served as the
President and Chief Executive Officer of the managing general partner of the
Company's former Manager. Mr. Hamberlin has been President of Courtland Homes,
Inc. since July 1983. Mr. Hamberlin has served as a Director of American
Southwest Financial Corporation and American Southwest Finance Co., Inc. since
their organization in September 1982. Mr. Hamberlin also has served as a
Director of American Southwest Affiliated Companies since its organization in
March 1985 and of American Southwest Holdings, Inc. since August 1994.
Jay R. Hoffman has been a Vice President and the Secretary, Treasurer and
Chief Financial and Accounting Officer of the Company since July 1988. Mr.
Hoffman, a certified public accountant, engaged in the practice of public
accounting with Kenneth Leventhal & Company from March 1987 through June 1988
and with Arthur Andersen & Co. from June 1976 through March 1987.
Mike Marusich has been a Director of the Company since June 1990. Mr.
Marusich has been a business consultant since 1980. Mr. Marusich, a certified
public accountant for 38 years, engaged in the practice of public accounting
with Ernst & Whinney (now Ernst & Young) for 15 years and was partner-in-charge
of that firm's Phoenix, Arizona office from 1976 until his retirement in 1980.
Mark A. McKinley has been a Director of the Company since May 1988. Mr.
McKinley is currently Senior Vice President of NationsBanc Mortgage Corporation.
Prior to that, he was the Co-Founder, President and Director of Cypress
Financial Corporation organized in 1983 and Managing Director of Rancho Santa
Margarita Mortgage Corporation, organized in 1990. From 1968 through 1983, Mr.
McKinley served as Senior Vice President of The Colwell Company, a publicly held
mortgage banking corporation and was responsible for administration of secondary
marketing, hedging operations and loan sales.
Gregory K. Norris has been a Director of the Company since June 1990. Mr.
Norris has been the President of Norris & Benedict Associates P.C., certified
public accountants, or its predecessor firms since November 1979. Mr. Norris
previously was engaged in the practice of public accounting with Bolan, Vassar
and Borrows, certified public accountants, from December 1978 until November
1979 and with Ernst & Whinney (now Ernst & Young) from July 1974 until December
1978.
Messrs. Marusich, McKinley and Norris are members of the Company's Audit
Committee and the Company's Special Committee.
The Special Committee was formed in May 1994 for the purpose of evaluating
and negotiating a proposed merger transaction between American Southwest
Holdings, Inc. and the Company. In February 1995, the Board of Directors of
American Southwest Holdings, Inc. notified the Company that they were ending
negotiations with respect to such merger transaction.
The Board of Directors held a total of three meetings during the fiscal year
ended December 31, 1994. One director was absent for one of the three meetings.
The Audit Committee met separately at one formal meeting during the year ended
December 31, 1994. One director was absent for such Audit Committee meeting. The
Special Committee held a total of eight meetings during the fiscal year ended
December 31, 1994. One director was absent for one of the eight meetings.
All directors are elected at each annual meeting of the Company's
stockholders for a term of one year, and hold office until their successors are
elected and qualified. All officers serve at the discretion of the Board of
Directors.
The Bylaws of the Company provide that, if the Company elects to be treated
as a REIT, the majority of the members of the Board of Directors and of any
committee of the Board of Directors will at all times be persons who are not
"Affiliates" of "Advisors of the Company," except in the case of a vacancy. An
Advisor is defined in the Bylaws as a person or entity responsible for directing
or performing the day to day business affairs of the Company, including a person
or entity to which an Advisor subcontracts substantially all such functions. An
"Affiliate" of another person is defined in the Bylaws to mean any person
directly or indirectly owning, controlling or holding the power to vote 5% or
more of the outstanding voting securities of such other person or of any person
directly or indirectly controlling, controlled by or under common control with
such other person; 5% or more of whose outstanding voting securities are
directly or indirectly owned, controlled or held with power to vote by such
other person; any person directly or indirectly controlling, controlled by or
under common control with such other person; and any officer, director, partner
or employee of such other person. The term "person" includes a natural person, a
corporation, partnership, trust company or other entity.
Vacancies occurring on the Board of Directors among the Unaffiliated
Directors may be filled by the vote of a majority of the directors, including a
majority of the Unaffiliated Directors, on nominees selected by the Unaffiliated
Directors. All transactions involving the Company in which an Advisor has an
interest must be approved by a majority of the Unaffiliated Directors.
The Articles of Incorporation and Bylaws of the Company provide for the
indemnification of the directors and officers of the Company to the fullest
extent permitted by Maryland law. Maryland law generally permits indemnification
of directors and officers against certain costs, liabilities and expenses which
such persons may incur by reason of serving in such positions unless it is
proved that: (i) the act or omission of the director or officer was material to
the cause of action adjudicated in the proceeding and was committed in bad faith
or was the result of active and deliberate dishonesty; (ii) the director or
officer actually received an improper personal benefit in money, property or
services; or (iii) in the case of criminal proceedings, the director or officer
had reasonable cause to believe that the act or omission was unlawful. Insofar
as indemnification for liabilities arising under the Securities Act of 1933 may
be permitted to directors, officers or persons controlling the Company pursuant
to the foregoing provisions, the Company has been informed that in the opinion
of the Securities and Exchange Commission, such indemnification is against
public policy as expressed in the Securities Act of 1933 and is therefore
unenforceable.
The Articles of Incorporation of the Company provide that the personal
liability of any director or officer of the Company to the Company or its
stockholders for money damages is limited to the fullest extent allowed by the
statutory or decisional law of the State of Maryland as amended or interpreted.
Maryland law authorizes the limitation of liability of directors and officers to
corporations and their stockholders for money damages except (a) to the extent
that it is proved that the person actually received an improper benefit in
money, property, or services for the amount of the benefit or profit in money,
property or services actually received; or (b) to the extent that a judgment or
other final adjudication adverse to the person is entered in a proceeding based
on a finding that the person's action, or failure to act, was the result of
active and deliberate dishonesty and was material to the cause of action
adjudicated. The Maryland statute permitting limitation of the liability of
directors and officers for money damages as described above was enacted on
February 18, 1988, and applies only to acts occurring on or after that date, and
has not been interpreted in any judicial proceeding. Maryland law does not
affect the potential liability of directors and officers to third parties, such
as creditors of the Company.
<TABLE>
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF OFFICERS
The following table sets forth compensation received by the Company's Chief
Executive Officer and its other executive officer for the Company's last three
fiscal years ending December 31, 1994.
SUMMARY COMPENSATION TABLE
<CAPTION>
Annual Compensation Long-Term Compensation
------------------------------------------------------ ---------------------------
Restricted
Name and Principal Other Annual Stock Stock All Other
Position Salary Bonus Compensation Awards Options Compensation
------------------------- ------------ ------------ ---------------- -------------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Alan D. Hamberlin 1994 $250,000 $ 2,100 $ -- -- 4,642 $ --
Chairman, President and 1993 250,000 4,100 -- -- 5,439 --
Chief Executive Officer 1992 250,000 47,500 -- -- 25,280 243,861(1)
Jay R. Hoffman, Vice 1994 $175,000 $ 15,000 $ -- -- 1,216 $ --
President, Secretary, 1993 175,000 -- -- -- 1,425 --
Treasurer and Chief 1992 175,000 -- -- -- 4,091 12,975(1)
Accounting and
Financial Officer
--------------
(1) During 1992 the Company purchased 64,818 shares of Common Stock from Mr.
Hamberlin and 9,793 shares of Common Stock from Mr. Hoffman pursuant to the
purchase provisions of the Company's stock option plan. The net value
realized (purchase price of stock on date of purchase by the Company less
fair market value on such date) equaled $243,861 for Mr. Hamberlin and
$12,975 for Mr. Hoffman. Such shares had originally been purchased in 1991
and 1990 by Mr. Hamberlin and in 1991 by Mr. Hoffman through the exercise of
stock options. At the time Mr. Hamberlin exercised his options to acquire
the 64,818 shares of Common Stock, such shares of Common Stock had a fair
market value in excess of the exercise price paid of $291,422. At the time
Mr. Hoffman exercised his options to acquire the 9,793 shares of Common
Stock, such shares of Common Stock had a fair market value in excess of the
exercise price paid of $57,716. Such amounts were previously disclosed in
the Company's Form 10-Ks for the years ended December 31, 1991 and December
31, 1990, as applicable. A portion of these amounts, for Federal income tax
purposes, were reported as compensation to Mr. Hamberlin and Mr. Hoffman in
the years the stock options were exercised.
</TABLE>
Officers and key personnel of the Company are eligible to receive stock
options under the Company's stock option plan. Officers serve at the discretion
of the Board of Directors.
COMPENSATION OF DIRECTORS
The Company pays an annual director's fee to each Unaffiliated Director
equal to $20,000, a fee of $1,000 for each meeting of the Board of Directors
attended by each Unaffiliated Director and reimbursement of costs and expenses
for attending such meetings. During 1994, the Unaffiliated Directors also
accrued dividend equivalent rights, in the amounts of 913 with respect to Mr.
McKinley, 224 with respect to Mr. Norris, and 672 with respect to Mr. Marusich.
The dividend equivalent rights accrued to Messrs. Hamberlin and Hoffman during
1994 are included in the table on options granted to the Company's executive
officers below. In addition, the Company's Directors are eligible to participate
in the Company's stock option plan described below.
EMPLOYMENT AGREEMENTS
On November 1, 1992, the Company entered into an employment agreement with
Alan D. Hamberlin which superseded the previous employment agreement that was to
expire on April 30, 1993. The term of the employment agreement is for the period
from November 1, 1992 through April 30, 1996. The employment agreement provides
for the employment of Mr. Hamberlin as the President and Chief Executive Officer
of the Company and for Mr. Hamberlin to perform such duties and services as are
customary for such a position. The employment agreement provides for Mr.
Hamberlin to receive an annual base salary of $250,000 and an annual performance
bonus in an amount equal to $1,500 for each $.01 per share of taxable income
(computed in accordance with the Code) distributed to the Company's stockholders
with respect to each calendar year beginning with 1992. A corporation owned by
Mr. Hamberlin also is entitled to the payment of $15,000 annually as
reimbursement for expenses incurred by such company in providing support to Mr.
Hamberlin in connection with the performance of his duties.
The employment agreement provides for Mr. Hamberlin to receive his fixed and
bonus compensation to the date of the termination of his employment by reason of
his death, disability or resignation and for Mr. Hamberlin to receive his fixed
compensation to the date of the termination of his employment by reason of the
termination of his employment for cause as defined in the agreement. The
employment agreement also provides for Mr. Hamberlin to receive his fixed
compensation in a lump sum and bonus payments that would have been payable
through the term of the agreement as if his employment had not been terminated
in the event that Mr. Hamberlin or the Company terminates Mr. Hamberlin's
employment following any "change in control" of the Company as defined in the
agreement. Section 280G of the Code may limit the deductibility of such payments
for federal income tax purposes. A change in control would include a merger or
consolidation of the Company, a sale of all or substantially all of the assets
of the Company, changes in the identity of a majority of the members of the
Board of Directors of the Company or acquisitions of more than 9.8% of the
Company's Common Stock subject to certain limitations. The employment agreement
also restricts the Company from entering into a separate management agreement or
arrangement without Mr. Hamberlin's consent.
EMPLOYEE BENEFIT PLANS
Stock Option Plan
In May 1988, the Company's Board of Directors adopted a stock option plan
(the "Plan") which was amended on July 18, 1990 to limit the redemption price
available to optionholders as described below. Under the terms of the Plan, both
qualified incentive stock options ("ISOs"), which are intended to meet the
requirements of Section 422A of the Code, and non-qualified stock options may be
granted. ISOs may be granted to the officers and key personnel of the Company.
Non-qualified stock options may be granted to the Company's directors and key
personnel, and to the key personnel of the Manager. The purpose of the Plan is
to provide a means of performance-based compensation in order to attract and
retain qualified personnel and to provide an incentive to others whose job
performance affects the Company.
Under the Plan, options to purchase shares of the Company's Common Stock may
be granted to the Company's directors, officers and key personnel, as well as to
the key personnel of the Manager. The maximum number of shares of the Company's
Common Stock which may be covered by options granted under the Plan is limited
to 5% of the number of shares outstanding. An option granted under the Plan may
be exercised in full or in part at any time or from time to time during the term
of the option, or provide for its exercise in stated installments at stated
times during the term of the option. The exercise price for any option granted
under the Plan may not be less than 100% of the fair market value of the shares
of Common Stock at the time the option is granted. The optionholder may pay the
exercise price in cash, bank cashier's check, or by delivery of previously
acquired shares of Common Stock of the Company. No option may be granted under
the Plan to any person who, assuming exercise of all options held by such
person, would own directly or indirectly more than 9.8% of the total outstanding
shares of Common Stock of the Company.
An optionholder also will receive at no additional cost "dividend equivalent
rights" to the extent that dividends are declared on the outstanding shares of
Common Stock of the Company on the record dates during the period between the
date an option is granted and the date such option is exercised. The number of
dividend equivalent rights which an optionholder receives on any dividend
declaration date is determined by application of a formula whereby the number of
shares subject to the option is multiplied by the dividend per share and divided
by the fair market value per share (as determined in accordance with the Plan)
to arrive at the total number of dividend equivalent rights to which the
optionholder is entitled.
The dividend equivalent rights earned will be distributed to the
optionholder (or his successor in interest) in the form of shares of the
Company's Common Stock when the option is exercised. Dividend equivalent rights
will be computed both with respect to the number of shares under the option and
with respect to the number of dividend equivalent rights previously earned by
the optionholder (or his successor in interest) and not issued during the period
prior to the dividend record date. Shares of the Company's Common Stock issued
pursuant to the exchange of dividend equivalent rights will not qualify for the
favored tax treatment afforded shares issued upon exercise of an ISO,
notwithstanding the character of the underlying option with respect to which the
dividend equivalent rights were earned. The number of shares issuable upon
exchange of dividend equivalent rights is not subject to the limit of the number
of shares which are issuable upon exercise of options granted under the Plan.
Under the Plan, an exercising optionholder has the right to require the
Company to purchase some or all of the optionholder's shares of the Company's
Common Stock. That redemption right is exercisable by the optionholder only with
respect to shares (including the related dividend equivalent rights) that he has
acquired by exercise of an option under the Plan. Furthermore, the optionholder
can only exercise his redemption rights within six months from the last to
expire of (i) the two year period commencing with the grant date of an option,
(ii) the one year period commencing with the exercise date of an option, or
(iii) any restriction period on the optionholder's transfer of the shares of
Common Stock he acquires through exercise of his option. The price for any
shares repurchased as a result of an optionholder's exercise of his redemption
right is the lesser of the book value of those shares at the time of redemption
or the fair market value of the shares on the date the options were exercised.
The Plan is administered by the Board of Directors which will determine
whether such options will be granted, whether such options will be ISOs or
non-qualified stock options, which directors, officers and key personnel will be
granted options, and the number of options to be granted, subject to the
aggregate maximum amount of shares issuable under the Plan set forth above. Each
option granted must terminate no more than 10 years from the date it is granted.
Under current law, ISOs cannot be granted to directors who are not also
employees of the Company, or to directors or employees of entities unrelated to
the Company.
The Board of Directors may amend the Plan at any time, except that approval
by the Company's stockholders is required for any amendment that increases the
aggregate number of shares of Common Stock that may be issued pursuant to the
Plan, increases the maximum number of shares of Common Stock that may be issued
to any person, changes the class of persons eligible to receive such options,
modifies the period within which the options may be granted, modifies the period
within which the options may be exercised or the terms upon which options may be
exercised, or increases the material benefits accruing to the participants under
the Plan. Unless previously terminated by the Board of Directors, the Plan will
terminate in May 1998.
<TABLE>
The following table provides information on options granted to the Company's
executive officers during 1994.
OPTION GRANTS IN LAST FISCAL YEAR
<CAPTION>
Percentage of
Total Stock
Granted to Grant Date
Options Employees Exercise Price Expiration Market Price
Name Granted(#)(1) in 1994 (per share) Date(3) Of Stock Valuation(4)
---- ----------------- ----------------- ------------------ -------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Alan D. Hamberlin 4,642 59.67% (2) (2) $1.00 $4,642
Jay R. Hoffman 1,216 15.63% (2) (2) $1.00 $1,216
--------------
(1) All of such options are currently exercisable.
(2) Represent dividend equivalent rights earned in 1994. Such rights expire at
the same time as the options on which they were earned which expire at
various dates between July 26, 1999 and February 6, 2002.
(3) Options are subject to earlier expiration upon an optionee's termination for
cause or three months after any other termination of employment.
(4) This column presents the Black-Scholes option valuation method calculation
of the options' present value. The Black-Scholes computation is based upon
certain assumptions, including hypothetical stock price volatility and
market interest rate calculations. In addition, the Black-Scholes valuation
method does not reflect the effects upon option valuation of the options'
nontransferability and conditional exercisability.
</TABLE>
<TABLE>
The following table provides information on options exercised in 1994 by the
Company's executive officers and the value of such officer's unexercised options
at December 31, 1994.
FISCAL YEAR END OPTION VALUES
<CAPTION>
Number of Value of Unexercised
Unexercised Options In-The-Money Options at
At December 31, 1994 December 31, 1994($)(1)
Shares Acquired Value At ---------------------------------- ----------------------------------
Name on Exercise (#) Exercise($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------------- --------------- --------------- ----------------- --------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Alan D. Hamberlin -- $-- 236,709 -- -- --
Jay R. Hoffman -- $-- 62,029 -- -- --
--------------
(1) Calculated based on the closing price at December 31, 1994 of $1.00
multiplied by the number of applicable shares in the money (including
dividend equivalent rights), less the total exercise price per share.
</TABLE>
SEP-IRA
On June 27, 1991, the Company established a simplified employee
pensionindividual retirement account pursuant to Section 408(k) of the Code (the
"SEP-IRA"). Annual contributions may be made by the Company under the SEP-IRA to
employees. Such contributions will be excluded from each employee's gross income
and will not exceed the lesser of 15% of such employee's compensation or
$30,000. The Company did not make any contributions to the SEP-IRA during 1994.
<TABLE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
At March 23, 1995, there were 9,716,517 shares of Common Stock outstanding.
The table below sets forth, as of March 23, 1995, those persons known by the
Company to own beneficially five percent or more of the outstanding shares of
Common Stock, the number of shares of Common Stock beneficially owned by each
director and executive officer of the Company and the number of shares
beneficially owned by all of the Company's executive officers and directors as a
group, which information as to beneficial ownership is based upon statements
furnished to the Company by such persons.
<CAPTION>
NUMBER OF
NAME AND ADDRESS OF SHARES BENEFICIALLY PERCENT OF
BENEFICIAL OWNER OWNED (1) COMMON STOCK(2)
--------------------- ----------------------- --------------------
<S> <C> <C>
Alan D. Hamberlin* 274,609(3) 2.71%
Jay R. Hoffman* 77,029(4) **
Mark A. McKinley* 46,575(5) **
Mike Marusich* 34,273(5) **
Gregory K. Norris* 11,423(5) **
All directors and executive officers
as a group (five persons) 443,909(6) 4.31%
5% Stockholders:
Ira Sochet
5701 Sunset Drive, Suite 315
South Miami, Florida 33143 513,400 5.28%
The Intergroup Corporation
and Mr. John V. Winfield
2121 Avenue of the Stars, Suite 2020
Los Angeles, California 90067 859,000(7) 8.84%
--------------
* Each director and executive officer of the Company may be reached through the
Company at 5333 North Seventh Street, Suite 219, Phoenix, Arizona
85014.
** Less than 1% of the outstanding shares of Common Stock.
(1) Includes, where applicable, shares of Common Stock owned of record by such
person's minor children and spouse and by other related individuals and
entities over whose shares of Common Stock such person has custody, voting
control or the power of disposition.
(2) The percentages shown include the shares of Common Stock actually owned as
of March 23, 1995 and the shares of Common Stock which the person or group
had the right to acquire within 60 days of such date. In calculating the
percentage of ownership, all shares of Common Stock which the identified
person or group had the right to acquire within 60 days of March 23, 1995
upon the exercise of options are deemed to be outstanding for the purpose of
computing the percentage of the shares of Common Stock owned by such person
or group, but are not deemed to be outstanding for the purpose of computing
the percentage of the shares of Common Stock owned by any other person.
(3) Includes 37,900 shares of Common Stock indirectly beneficially owned by Mr.
Hamberlin through a partnership and 236,709 shares of Common Stock which Mr.
Hamberlin had the right to acquire within 60 days of March 23, 1995 by the
exercise of stock options (including dividend equivalent rights).
(4) Includes 15,000 shares of Common Stock owned by Mr. Hoffman and 62,029
shares of Common Stock which Mr. Hoffman had the right to acquire within 60
days of March 23, 1995 by the exercise of stock options (including dividend
equivalent rights).
(5) All of such shares of Common Stock are shares which Mr. McKinley, Mr.
Marusich and Mr. Norris had the right to acquire within 60 days of March 23,
1995 by the exercise of stock options (including dividend equivalent
rights).
(6) Includes 391,009 shares of Common Stock which such persons had the right to
acquire within 60 days of March 23, 1995 by the exercise of stock options
(including dividend equivalent rights).
(7) The nature of beneficial ownership of the 859,000 shares is 459,000 shares
are owned by the InterGroup Corporation and 400,000 shares are owned by
John V. Winfield. Mr. Winfield is Chairman of the Board and President of
The InterGroup Corporation. As of February 7, 1995, 427,406 shares of
InterGroup common stock, constituting 46% of the outstanding InterGroup
shares, were owned directly or beneficially by Mr. Winfield.
</TABLE>
Other than options and dividend equivalent rights granted under the
Company's stock option plan, there are no outstanding warrants, options or
rights to purchase any shares of Common Stock of the Company, and no outstanding
securities convertible into Common Stock of the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
POTENTIAL CONFLICTS OF INTEREST
The Bylaws of the Company provide that, if the Company elects to be treated
as a REIT, a majority of the Board of Directors (and a majority of each
committee of the Board of Directors) must not be "Affiliates" of "Advisors," as
these terms are defined in the Bylaws, and that the investment policies of the
Company must be reviewed annually by these directors (the "Unaffiliated
Directors").
Counsel to the Company has furnished, and in the future may furnish, legal
services to ASFS, certain Issuers (including American Southwest Financial
Corporation, American Southwest Finance Co., Inc. and Westam Mortgage Financial
Corporation), certain Mortgage Suppliers and certain Mortgage Finance Companies.
There is a possibility that in the future the interests of certain of such
parties may become adverse, and counsel may be precluded from representing one
or all of such parties. If any situation arises in which the interests of the
Company appear to be in conflict with those of ASFS, any Issuer, Mortgage
Supplier or Mortgage Finance Company, additional counsel may be retained by one
or more of the parties.
CERTAIN RELATIONSHIPS
Alan D. Hamberlin, the Chairman of the Board of Directors, President and
Chief Executive Officer of the Company, also is a director of American Southwest
Financial Corporation, American Southwest Finance Co., Inc., American Southwest
Affiliated Companies and American Southwest Holdings, Inc.
Mr. Hamberlin directly and indirectly owns a total of 6.7% of the voting
stock of American Southwest Holdings, Inc. American Southwest Holdings, Inc.
directly or indirectly owns 100% of the voting stock of, among other entities,
ASFS, American Southwest Financial Corporation and Westam Mortgage Financial
Corporation. See "Business -- The Subcontract Agreement."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER EXHIBIT
------ -------
3(a) Amended and Restated Articles of Incorporation of the
Registrant*
3(b) Bylaws of the Registrant*
4 Specimen Certificate representing $.01 par value Common
Stock*
10(a) Subcontract Agreement between the Registrant and American
Southwest Financial Services, Inc.*
10(b) Form of Master Servicing Agreement*
10(c) Form of Servicing Agreement*
10(d) Stock Option Plan*
10(e) Amendment to Stock Option Plan**
10(g) Employment Agreement between the Registrant and Alan D.
Hamberlin****
10(h) Indenture dated as of December 1, 1992 between EMIC Finance
Corporation, as Note Issuer of the Secured Notes, and State
Street Bank & Trust Company, as Note Trustee****
10(i) Agreement and Certificate dated as of December 1, 1992 by
Registrant for the benefit of the Note Trustee****
22 Subsidiaries of the Registrant***
23 Consent of Kenneth Leventhal & Company
27 Financial Data Schedule
--------------
* Incorporated herein by reference to the Registrant's Registration Statement
on Form S-11 (No. 33-22092) filed July 19, 1988 and declared effective on
July 20, 1988.
** Incorporated herein by reference to Registrant's Form 10-K for the fiscal
year ended December 31, 1990 filed March 31, 1991.
*** Incorporated herein by reference to Registrant's Form 10-K for the fiscal
year ended December 31, 1991 filed March 31, 1992.
**** Incorporated herein by reference to Registrant's Form 10-K for the fiscal
year ended December 31, 1992 filed March 30, 1993.
(b) Financial Statements and Financial Statement Schedules filed as part of
this report:
1. Financial Statements -- as listed in the "Index to Financial
Statements" on page F-1 of this Annual Report on Form 10-K.
2. Financial Statement Schedules -- no schedules are required because
of the absense of conditions under which they are required or
because the information is given in the financial statements and
notes beginning on page F-1 of this Annual Report on Form 10-K.
(c) Reports on Form 8-K:
No Current Reports on Form 8-K were filed by the Company during the fourth
quarter of 1994.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HOMEPLEX MORTGAGE
INVESTMENTS CORPORATION
Date: March 30, 1995
By: /s/ Alan D. Hamberlin
---------------------------------------
Alan D. Hamberlin,
Chairman of the Board
of Directors and President
<TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Alan D. Hamberlin Chairman of the Board of Directors, March 30, 1995
--------------------------------------- President, Chief Executive Officer and
Alan D. Hamberlin Director (Principal Executive Officer)
/s/ Jay R. Hoffman Vice President, Secretary, Treasurer and March 30, 1995
--------------------------------------- Chief Financial and Accounting Officer
Jay R. Hoffman
/s/ Mike Marusich Director March 30, 1995
---------------------------------------
Mike Marusich
/s/ Mark A. McKinley Director March 30, 1995
---------------------------------------
Mark A. McKinley
/s/ Gregory K. Norris Director March 30, 1995
---------------------------------------
Gregory K. Norris
</TABLE>
<TABLE>
HOMEPLEX MORTGAGE INVESTMENTS CORPORATION
INDEX TO FINANCIAL STATEMENTS
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report...................................................... F-2
Consolidated Balance Sheets As Of December 31, 1994 And 1993...................... F-3
Consolidated Statements Of Net Income (Loss) For The Years Ended December 31,
1994, 1993
And 1992........................................................................ F-4
Consolidated Statements Of Stockholders' Equity For The Years Ended December 31,
1994, 1993 And 1992............................................................. F-5
Consolidated Statements Of Cash Flows For The Years Ended December 31, 1994, 1993
And 1992........................................................................ F-6
Notes To Consolidated Financial Statements........................................ F-7
</TABLE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Homeplex Mortgage Investments Corporation
We have audited the accompanying consolidated balance sheets of Homeplex
Mortgage Investments Corporation and subsidiaries as of December 31, 1994 and
1993, and the related consolidated statements of net income (loss),
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1994. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Homeplex
Mortgage Investments Corporation and subsidiaries as of December 31, 1994 and
1993, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1994, in conformity with generally
accepted accounting principles.
As discussed in Note 10 to the consolidated financial statements, the
Company changed its method for accounting for mortgage interests as of December
31, 1993.
KENNETH LEVENTHAL & COMPANY
Phoenix, Arizona
March 10, 1995
<PAGE>
HOMEPLEX MORTGAGE INVESTMENTS CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1994 AND DECEMBER 31, 1993
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
1994 1993
--------- ---------
ASSETS
Real estate loans (Note 3).............................. $ 9,260 $ 320
Funds held by Trustee (Note 6).......................... 6,720 8,761
Cash and cash equivalents............................... 6,666 16,247
Residual interest certificates (Note 4 and 10).......... 4,853 14,025
Interests relating to mortgage participation
certificates (Note 5 and 10).......................... 2,801 3,710
Other assets (Note 6)................................... 695 819
Accrued interest receivable............................. 155 --
--------- ---------
Total Assets............................................ $ 31,150 $ 43,882
========= =========
LIABILITIES
Long-term debt (Note 6)................................. $ 11,783 $ 19,926
Accounts payable and other liabilities (Note 9)......... 1,416 1,093
Dividend payable........................................ 194 292
Accrued interest payable................................ 115 194
--------- ---------
Total Liabilities....................................... 13,508 21,505
--------- ---------
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share; 50,000,000
shares authorized; issued and
outstanding -- 9,875,655
shares (Note 9)....................................... 99 99
Additional paid-in-capital.............................. 84,046 84,046
Cumulative net loss..................................... (24,854) (20,330)
Cumulative dividends.................................... (41,239) (41,045)
Treasury stock -- 159,138 shares in 1994 and 143,938
shares in 1993........................................ (410) (393)
--------- ---------
Total Stockholders' Equity.............................. 17,642 22,377
--------- ---------
Total Liabilities and Stockholders' Equity.............. $ 31,150 $ 43,882
========= =========
See notes to consolidated financial statements.
<PAGE>
HOMEPLEX MORTGAGE INVESTMENTS CORPORATION
CONSOLIDATED STATEMENTS OF NET INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
1994 1993 1992
---------- ---------- ----------
INCOME (LOSS) FROM MORTGAGE ASSETS
Interest income on real estate loans...... $ 1,113 $ 29 $ --
Income (loss) from residual interest
certificates (Notes 4 and 10)........... (3,337) (14,367) (876)
Income (loss) from interests relating to
mortgage participation certificates
(Notes 5 and 10)........................ 673 (7,945) (13,374)
Other income.............................. 348 469 182
---------- ---------- ----------
(1,203) (21,814) (14,068)
---------- ---------- ----------
INTEREST EXPENSE
Long-term borrowings...................... 1,383 2,274 1,720
Short-term borrowings..................... -- -- 1,030
---------- ---------- ----------
1,383 2,274 2,750
---------- ---------- ----------
Loss Before Other Expenses and Cumulative
Effect of Accounting Change............. (2,586) (24,088) (16,818)
---------- ---------- ----------
OTHER EXPENSES
General and administrative (Notes 2 and 9) 1,842 1,684 2,246
Hedging expense........................... 96 138 69
---------- ---------- ----------
Total Other Expenses...................... 1,938 1,822 2,315
---------- ---------- ----------
Net Income (Loss) Before Cumulative Effect
of Accounting Change.................... (4,524) (25,910) (19,133)
Cumulative Effect of Accounting Change
(Note 10)............................... -- (6,078) --
---------- ---------- ----------
Net Income (Loss)......................... $ (4,524) $ (31,988) $ (19,133)
========== ========== ==========
PER SHARE DATA
Net Income (Loss) Per Share Before
Cumulative Effect of Accounting Change.. $ (.47) $ (2.66) $ (1.93)
Cumulative Effect of Accounting Change Per
Share................................... -- (.63) --
---------- ---------- ----------
Net Income (Loss) Per Share............... $ (.47) $ (3.29) $ (1.93)
========== ========== ==========
Dividends Declared Per Share.............. $ .02 $ .03 $ .40
========== ========== ==========
Weighted Average Number Of Shares Of
Common Stock And Common Stock
Equivalents Outstanding................. 9,720,612 9,732,056 9,897,406
========== ========== ==========
See notes to consolidated financial statements.
<PAGE>
<TABLE>
HOMEPLEX MORTGAGE INVESTMENTS CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
(DOLLARS IN THOUSANDS)
<CAPTION>
Additional Cumulative
Number Par Paid-In Net Income Cumulative Treasury
Of Shares Value Capital (Loss) Dividends Stock Total
------------- --------- -------------- -------------- -------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1991................... 9,855,287 $ 99 $ 83,954 $ 30,791 $ (36,804) $ -- $ 78,040
Exercise of stock options
(Note 9)............... 20,368 -- 92 -- -- -- 92
Treasury stock acquired
123,570 shares (Note 9) -- -- -- -- -- (344) (344)
Net loss................. -- -- -- (19,133) -- -- (19,133)
Dividends declared....... -- -- -- -- (3,949) -- (3,949)
------------- -------- ------------- ------------- ------------- ----------- -------------
Balance at December 31,
1992................... 9,875,655 99 84,046 11,658 (40,753) (344) 54,706
Net loss................. -- -- -- (31,988) -- -- (31,988)
Dividend declared........ -- -- -- -- (292) -- (292)
------------- -------- ------------- ------------- ------------- ----------- -------------
Balance at December 31,
1993................... 9,875,655 99 84,046 (20,330) (41,045) (393) 22,377
Treasury stock acquired
-- 15,200 shares (Note
9)..................... -- -- -- -- -- (17) (17)
Net loss................. -- -- -- (4,524) -- -- (4,524)
Dividend declared........ -- -- -- -- (194) -- (194)
------------- -------- ------------- ------------- ------------- ----------- -------------
Balance at December 31,
1994................... 9,875,655 $ 99 $ 84,046 $ (24,854) $ (41,239) $ (410) $ 17,642
============= ======== ============= ============= ============= =========== =============
See notes to consolidated financial statements.
</TABLE>
<PAGE>
HOMEPLEX MORTGAGE INVESTMENTS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
INCREASE (DECREASE) IN CASH
(DOLLARS IN THOUSANDS)
1994 1993 1992
-------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss...................................... $(4,524) $(31,988) $(19,133)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Net write-downs and non-cash losses on
residual interest certificates.......... 3,343 14,367 5,876
Increase (decrease) in accounts payable
and other liabilities................... 323 (129) 246
Amortization of debt costs................ 216 230 1,053
(Increase) decrease in other assets....... (188) (169) 466
Increase in accrued interest receivable... (155) -- --
Amortization of hedging costs............. 96 138 69
Increase (decrease) in accrued interest
payable................................. (79) 59 41
Net write-downs on interests relating to
mortgage participation certificates..... -- 7,945 15,057
Cumulative effect of accounting change.... -- 6,078 --
-------- --------- ---------
Net Cash Provided By (Used In) Operating
Activities.................................. (968) (3,469) 3,675
-------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Real estate loans funded...................... (9,610) (320) --
Amortization of residual interest certificates 5,829 15,319 16,320
(Increase) decrease in funds held by Trustee.. 2,041 (3,631) (5,130)
Amortization of interests relating to mortgage
participation certificates.................. 909 5,324 8,966
Principal payments received on real estate
loans....................................... 670 -- --
-------- --------- ---------
Net Cash Provided By (Used In) Investing
Activities.................................. (161) 16,692 20,156
-------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments made on long-term debt..... (8,143) (11,074) (16,450)
Dividends paid................................ (292) -- (7,891)
Repurchases of common stock, net of common
stock issuances............................. (17) (49) (252)
Capitalized debt costs........................ -- (25) (610)
Proceeds from long-term debt.................. -- -- 31,000
Net decrease in short-term borrowings......... -- -- (22,000)
Purchase of hedging instruments............... -- -- (245)
-------- --------- ---------
Net Cash Used In Financing Activities......... (8,452) (11,148) (16,448)
-------- --------- ---------
Net Increase (Decrease) In Cash And Cash
Equivalents................................. (9,581) 2,075 7,383
Cash And Cash Equivalents At Beginning Of
Period...................................... 16,247 14,172 6,789
-------- --------- ---------
Cash And Cash Equivalents At End Of Period.... $ 6,666 $ 16,247 $ 14,172
======== ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Cash paid for interest........................ $ 1,246 $ 2,103 $ 1,738
======== ========= =========
See notes to consolidated financial statements.
<PAGE>
HOMEPLEX MORTGAGE INVESTMENTS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994
NOTE 1 -- ORGANIZATION
Homeplex Mortgage Investments Corporation, a Maryland corporation, (the
Company) commenced operations in July 1988. As described in Notes 4 and 5, the
Company has purchased interests in mortgage certificates securing collateralized
mortgage obligations (CMOs) and interests relating to mortgage participation
certificates (MPCs) (collectively Mortgage Interests). Since December 1993 the
Company has originated various loans secured by real estate (see Note 3).
NOTE 2 -- GENERAL AND SUMMARY OF ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of Homeplex
Mortgage Investments Corporation and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation.
Income Taxes
The Company has elected to be taxed as a real estate investment trust (REIT)
under the Internal Revenue Code. As a REIT, the Company must distribute annually
at least 95% of its taxable income to its stockholders. The $.40 dividend
declared in 1992 consisted of $.3166 of ordinary income and $.0834 of return of
capital, the $.03 dividend declared in 1993 consisted of $.0276 of ordinary
income and $.0024 of return of capital and the $.02 dividend declared in 1994
consisted of $.0142 of ordinary income and $.0058 of return of capital to the
recipients for federal income tax purposes.
At December 31, 1994, the Company has available, for income tax purposes, a
net operating loss carryforward of approximately $58,000,000. Such loss may be
carried forward, with certain restrictions, for up to 15 years to offset future
taxable income, if any. Until the tax loss carryforward is fully utilized the
Company will not be required to pay dividends to its stockholders except for
income that is deemed to be excess inclusion income.
The income (loss) reported in the accompanying financial statements is
different than taxable income (loss) because some income and expense items are
reported in different periods for income tax purposes. The principal differences
relate to reserves on and the amortization of Mortgage Interests and the
treatment of stock option expense.
Interests Relating To Mortgage Participation Certificates and Residual
Interest Certificates
Interests relating to mortgage participation certificates and residual
interest certificates are accounted for as described in Notes 4, 5 and 10.
Cash and Cash Equivalents
Cash and cash equivalents include demand deposits and certificates of
deposit with maturities of less than three months.
Amortization of Hedging
The cost of the Company's LIBOR ceiling rate agreements (see Note 8) is
amortized using the straight-line method over the lives of the agreements.
Net Income (Loss) Per Share
Primary net income (loss) per share is calculated using the weighted average
shares of common stock outstanding and common stock equivalents. Common stock
equivalents consist of dilutive stock options. Net income (loss) per share is
the same for both primary and fully diluted calculations.
General and Administrative Expenses
General and administrative expenses in 1994 include $340,000 of legal and
investment banking expenses related to merger negotiations with a privately held
company which were subsequently terminated.
<TABLE>
NOTE 3 -- REAL ESTATE LOANS
The following is a summary of real estate loans at December 31, 1994:
<CAPTION>
INTEREST PAYMENT PRINCIPAL AND
DESCRIPTION RATE TERMS CARRYING AMOUNT (1)
----------- ------------ --------------------------------- -----------------------
<S> <C> <C> <C>
First Deed of Trust on 321 24% Interest only monthly, principal $2,280,000
unit apartment in Tucson, due January 31, 1995; extended to
Arizona, with recourse to April 30, 1995 upon payment of 1/2%
corporate borrower and the extension fee.
personal guarantee of an
officer of borrower.
First Deed of Trust on 128 24% Interest only monthly, principal 2,348,000
unit apartment in Sierra due April 15, 1995.
Vista, Arizona, with
recourse to corporate borrower
and the personal guarantee
of an officer of borrower.
First Deed of Trust on 33 16% Interest only monthly, principal 2,360,000
acres of land in Scottsdale, due October 31, 1995; may be
Arizona. extended for one year under
certain terms and conditions.
First Deed of Trust on 33 16% Interest only monthly, principal 2,272,000
acres of land in Tempe, due November 21, 1995.
Arizona.
----------
$9,260,000
==========
--------------
(1) Also represents cost for federal income tax purposes.
</TABLE>
At December 31, 1994, all of the Company's loans are secured by properties
located in Arizona. As a result of this geographic concentration, unfavorable
economic conditions in Arizona could increase the likelihood of defaults on
these loans and affect the Company's ability to protect the principal and
interest on such loans following foreclosures upon the real properties securing
such loans.
Each of the preceding loans was current as of December 31, 1994. The
following summarizes real estate loan activity for 1994:
Balance at December 31, 1993 ........................... $ 320,000
Real estate loans funded ............................... 9,610,000
Principal repayments ................................... (670,000)
-----------
Balance at December 31, 1994 ........................... $ 9,260,000
===========
NOTE 4 -- RESIDUAL INTEREST CERTIFICATES
The Company owns 100% of the residual interest certificates in five real
estate mortgage investment conduits (REMICs). The assets of these five REMICs
consist of mortgage certificates, accrued interest thereon and cash funds held
by a Trustee. The liabilities consist of collateralized mortgage obligations
(CMOs), accrued interest thereon and administrative expenses payable. The CMOs
have been issued through Westam Mortgage Financial Corporation (Westam) or
American Southwest Financial Corporation (ASW). The mortgage certificates
securing the CMOs all have fixed interest rates. Certain of the classes of CMOs
have fixed interest rates and certain have interest rates that are determined
monthly based on the London Interbank Offered Rates (LIBOR) for one month
Eurodollar deposits, subject to specified maximum interest rates.
Each series of CMOs consists of several serially maturing classes
collateralized by mortgage certificates. Generally, principal payments received
on the mortgage certificates, including prepayments on such mortgage
certificates, are applied to principal payments on the classes of CMOs in
accordance with the respective indentures. Scheduled payments of principal and
interest on the mortgage certificates securing each series of CMOs and
reinvestment earnings thereon are intended to be sufficient to make timely
payments of interest on such series and to retire each class of such series by
its stated maturity. Certain series of CMOs are subject to redemption according
to the specific terms of the respective indentures.
The following summarizes the Company's investment at December 31, 1994:
COMPANY'S AMORTIZED
CMO SERIES COST (SEE NOTE 10)
------- -------------------
(IN THOUSANDS)
Westam 1 ............................................... $1,208
Westam 3 ............................................... 144
Westam 5 ............................................... 310
Westam 6 ............................................... 32
ASW 65 ................................................. 3,159
------
$4,853
======
<TABLE>
The following summarizes the combined assets and liabilities of the five
REMICs at December 31, 1994 (in thousands):
<S> <C> <C>
Assets:
Outstanding Principal Balance of Mortgage Certificates $294,107
Funds Held By Trustee ........... 8,691
Accrued Interest Receivable ..... 2,356
--------
$305,154
========
Range of Stated Coupon Rate of Mortgage Certificates................... 9.0%-10.5%
Liabilities:
Outstanding Principal Balance of CMOs:
Fixed Rate................................................. $ 254,407
Floating Rate -- LIBOR Based............................... 44,324
------------
Total CMO Principal Balance................................ $ 298,731
Accrued Interest Payable..................................... 2,851
------------
$ 301,582
============
Range of Stated Interest Rates on CMOs....................................... 0% to 9.45%
</TABLE>
The Company's 100% residual interests entitle the Company to receive the
excess, if any, of payments received from the pledged mortgage certificates
together with reinvestment income thereon over amounts required to make debt
service payments on the related CMOs and to pay related administrative expenses
of the REMICs. The Company also has the right, under certain conditions, to
cause an early redemption of the CMOs. Under the early redemption feature, the
mortgage certificates are sold at the then current market price and the CMOs
repaid at par value. The Company is entitled to any excess cash flow from such
early redemptions. The conditions under which such early redemptions may be
elected vary but generally cannot be done until the remaining outstanding CMO
balance is less than 10% of the original balance.
Effective December 31, 1993, the Company adopted the prospective net level
yield method with respect to these investments (see Note 10). The cumulative
effect of the change was recorded as of December 31, 1993. Income for the year
ended December 31, 1994 has been determined using the prospective net level
yield method.
Prior to December 31, 1993 (see Note 10), the Company accounted for its
investment in these five REMICs using the equity method of accounting.
Accordingly, the Company consolidated the financial statements of the REMICs in
its financial statements and included the respective REMICs income or loss in
its consolidated statement of net income (loss). In the event the undiscounted
estimated future net cash flows from the residual interest were less than the
Company's financial reporting basis, the residual interest was considered to be
impaired and the Company established a reserve for the difference. The reserves
were then amortized to income as the loss actually occurred. Because of the
continuing low interest rate environment, beginning in the quarter ended
September 30, 1993, the Company incorporated redemption proceeds into the
undiscounted cash flow estimates used to establish reserves. The estimated
redemption proceeds were adjusted each quarter as part of the Company's
undiscounted cash flow estimates. These redemption proceeds estimates were
calculated assuming that the current interest rate environment exists at the
time redemptions are possible.
<TABLE>
The following summarizes the Company's combined loss from these REMICs for
the years ended December 31, 1993 and 1992 (in thousands) prior to the
cumulative effect of the change in accounting principle described in Note 10:
<CAPTION>
1993 1992
------------- -------------
<S> <C> <C>
Interest income, including amortization of mortgage premium or
discount, and reinvestment income from mortgage collateral..... $ 57,029 $ 79,238
CMO interest, including amortization of debt discount, and
administration expense.......................................... (69,076) (74,940)
Writedown of investment to estimated undiscounted cash flows, net
of amortization................................................. (2,320) (5,174)
------------- -------------
Loss from residual interest certificates.......................... $ (14,367) $ (876)
============= =============
</TABLE>
The average LIBOR-reset rates on the floating rate CMO classes were 4.33%,
3.22% and 3.86%, respectively, for the years ended December 31, 1994, 1993 and
1992. At December 31, 1994, LIBOR was 6.00%.
NOTE 5 -- INTERESTS RELATING TO MORTGAGE PARTICIPATION CERTIFICATES
The Company owns interests in REMICs with respect to three separate series
of Mortgage Participation Certificates (MPCs) issued by the Federal Home Loan
Mortgage Corporation (FHLMC) or by the Federal National Mortgage Association
(FNMA). The certificates entitle the Company to receive its proportionate share
of the excess (if any) of payments received from the mortgage certificates
underlying the MPCs over amounts required to make principal and interest
payments on such MPCs. The Company is not entitled to reinvestment income earned
on the underlying mortgage certificates, is not required to pay any
administrative expenses of the MPCs and does not have the right to elect early
redemption of any of the MPC classes. The mortgage certificates underlying the
MPCs all have fixed interest rates. Certain of the classes of the MPCs have
fixed interest rates and certain have interest rates that are determined monthly
based on LIBOR or based on the Monthly Weighted Average Cost of Funds (COFI) for
Eleventh District Savings Institutions as published by the Federal Home Loan
Bank of San Francisco, subject to specified maximum interest rates.
The Company accounts for its interests relating to these mortgage
participation certificates using the prospective net level yield method as
described in Note 10. In the event the undiscounted estimated future net cash
flows from the MPC series is less than the Company's financial reporting basis,
the Company reduces its financial reporting basis. The Company has taken net
charges of $7,945,000 and $15,057,000, respectively, for the years ended
December 31, 1993 and 1992 to reduce the MPC series to their undiscounted
estimated future net cash flows. Effective December 31, 1993 the Company changed
its method of accounting for impairment on these investments to the method
described in Note 10. The following summarizes the Company's investment at
December 31, 1994:
COMPANY'S AMORTIZED COST COMPANY'S PERCENTAGE OWNERSHIP
MPC SERIES AT DEC. 31, 1994 OF INTERESTS RELATING TO MPCS
--------------------- ------------------------ -------------------------------
(IN THOUSANDS)
FHLMC 17 ............ $ 219 100.00%
FNMA 1988-24 ........ 1,768 20.20%
FNMA 1988-25 ........ 814 45.07%
------
2,801
======
The following summarizes the Company's proportionate interest in the
aggregate mortgage certificates and MPCs at December 31, 1994 (in thousands):
Mortgage Certificates Underlying MPCs:
Outstanding Principal Balance...................... $129,143
Range of Stated Coupon Rates....................... 9.5%-10.0%
MPCs:
Outstanding Principal Balance:
Fixed Rate....................................... $116,089
Floating Rate -- LIBOR Based..................... 7,710
Floating Rate -- COFI Based...................... 5,344
------------
Total MPCs Principal Balance..................... $129,143
============
Range of Stated Interest Rates on MPCs............. 4.76%-9.9%
The average LIBOR and COFI rates used to determine income from the interests
relating to the above MPCs were as follows:
1994 1993 1992
---- ----- ----
LIBOR .................... 4.33% 3.22% 3.86%
COFI ..................... 3.83% 4.16% 5.45%
The LIBOR and COFI rates as of December 31, 1994 were 6.00% and 4.37%,
respectively.
NOTE 6 -- LONG-TERM DEBT
In December 1990, the Company borrowed $20,000,000 under a three-year term
loan agreement with a bank. The agreement required monthly principal
amortization and interest payments at LIBOR plus .75%. In connection with the
agreement, the Company paid fees of $375,000 which were amortized to interest
expense over the term of the agreement. Additionally, the Company paid a fee of
$1,160,000 to obtain a three year letter of credit from other financial
institutions, which upon certain conditions, could be drawn upon to repay the
term loan. Such fee was amortized to interest expense over the life of the
agreement. The Company's residual interests in Westam 1, Westam 5 and ASW 65
(see Note 4) were pledged as collateral under the agreement. The balance
outstanding under the agreement was repaid and the agreement terminated on
December 17, 1992.
On December 17, 1992, a wholly owned limited-purpose subsidiary of the
Company issued $31,000,000 of Secured Notes under an Indenture to a group of
institutional investors. The Notes bear interest at 7.81% and require quarterly
payments of principal and interest with the balance due on February 15, 1998. In
connection with the agreement the Company paid fees of $635,000 which are
included in other assets in the accompanying consolidated balance sheets and are
being amortized to interest expense over the life of the agreement. The Notes
are secured by the Company's residual interests in Westam 1, Westam 3, Westam 5,
Westam 6 and ASW 65 (see Note 4), by the Company's Interests relating to
mortgage participation certificates FNMA 1988-24 and FNMA 1988-25 (see Note 5),
and by Funds held by Trustee. The Company used $3,100,000 of the proceeds to
establish a reserve fund which is included in Funds held by Trustee in the
accompanying consolidated balance sheets. The reserve fund, which has a
specified maximum balance of $7,750,000, is to be used to make the scheduled
principal and interest payments on the Notes if the cash flow available from the
collateral is not sufficient to make the scheduled payments. Depending on the
level of certain specified financial ratios relating to the collateral, the cash
flow from the collateral is required to either prepay the Notes at par, increase
the reserve fund up to its $7,750,000 maximum or is remitted to the Company. At
December 31, 1994, Funds held by Trustee consist of $5,954,000 in the Reserve
Fund and $766,000 of other funds pledged under the Indenture.
At December 31, 1994, scheduled principal payments are as follows
(thousands):
1995 ................................... 3,964
1996 ................................... 3,964
1997 ................................... 3,694
1998 ................................... 161
-------
11,783
=======
NOTE 7 -- SHORT-TERM BORROWINGS
The Company's short-term borrowings have consisted primarily of repurchase
agreements. Such agreements were at both fixed and floating rates, were secured
by various Mortgage Interests and required the maintenance of certain collateral
levels. At December 31, 1994 and 1993, there were no borrowings outstanding
under repurchase agreements.
<TABLE>
Interest rates and balances related to the Company's short term borrowings,
in the aggregate, were as follows:
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
--------------------------------
1994 1993 1992
-------- -------- ------------
<S> <C> <C> <C>
Weighted Average Balance Outstanding (In Thousands)................ $ -- $ -- $ 14,876
Maximum Amount Outstanding At Any Month-End (In Thousands)......... $ -- $ -- $ 22,000
Weighted Average Effective Interest Rate........................... --% --% 6.92%
</TABLE>
NOTE 8 -- HEDGING
On May 12, 1992, the Company entered into a LIBOR ceiling rate agreement
with a bank for a fee of $245,000. The agreement, which had a term of two years
beginning July 1, 1992, required the bank to pay a monthly amount to the Company
equal to the product of $175,000,000 multiplied by the percentage, if any, by
which actual one-month LIBOR (measured on the first business day of each month)
exceeded 9.0%. Through the expiration of the agreement on July 1, 1994 LIBOR
remained under 9.0% and, accordingly, no amounts were paid under the agreement.
NOTE 9 -- COMMON STOCK AND STOCK OPTIONS
The Company has a Stock Option Plan which is administered by the Board of
Directors. The plan provides for qualified stock options which may be granted to
key personnel of the Company and non-qualified stock options which may be
granted to the Directors and key personnel of the Company. The purpose of the
plan is to provide a means of performance-based compensation in order to attract
and retain qualified personnel whose job performance affects the Company.
Options to acquire a maximum (excluding dividend equivalent rights) of
437,500 shares of the Company's common stock may be granted under the plan. The
exercise price may not be less than the fair market value of the common stock at
the date of grant. The options expire ten years after date of grant.
Optionholders also receive, at no additional cost, dividend equivalent
rights which entitle them to receive, upon exercise of the options, additional
shares calculated based on the dividends declared during the period from the
grant date to the exercise date. For the year ended December 31, 1992
approximately $182,000 of non-cash expense related to dividend equivalent rights
is included in general and administrative expenses in the accompanying
consolidated statements of net income (loss). There was no expense related to
dividend equivalent rights in 1994 or 1993. At December 31, 1994 and 1993,
accounts payable and other liabilities in the accompanying consolidated balance
sheets, include approximately $940,000 related to the Company's granting of
dividend equivalent rights. This liability will remain in the accompanying
consolidated balance sheets until the options to which the dividend equivalent
rights relate are exercised, cancelled or expire.
Under the plan, an exercising optionholder also has the right to require the
Company to purchase some or all of the optionholder's shares of the Company's
common stock. That redemption right is exercisable by the optionholder only with
respect to shares (including the related dividend equivalent rights) that the
optionholder has acquired by exercise of an option under the Plan. Furthermore,
the optionholder can only exercise his redemption rights within six months from
the last to expire of (i) the two year period commencing with the grant date of
an option, (ii) the one year period commencing with the exercise date of an
option, or (iii) any restriction period on the optionholder's transfer of the
shares of common stock he acquires through exercise of his option. The price for
any shares repurchased as a result of an optionholder's exercise of his
redemption right is the lesser of the book value of those shares at the time of
redemption or the fair market value of the shares on the original date the
options were exercised. During 1993 and 1992, 20,368 and 123,570 shares,
respectively, were repurchased by the Company in connection with this provision
of the plan. For the years ended December 31, 1993 and 1992, approximately
$66,000 and $441,000, respectively, related to the repurchase of the shares is
included in general and administrative expenses in the accompanying consolidated
statements of net income (loss).
<TABLE>
The following summarizes stock option activity:
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, 1994 1993 1992
-------------------------------- ---------- ---------- -----------
<S> <C> <C> <C>
Options granted................................................. -- -- 9,662
Exercise price per share of options granted..................... $ -- $ -- $ 5.125
Dividend equivalent rights granted.............................. 7,779 9,115 26,174
Options cancelled (including dividend equivalent rights)........ -- -- 10,184
Options exercised (including dividend equivalent rights)........ -- -- 20,368
Exercise price per share of options exercised (excluding
dividend equivalent rights)................................... $ -- $ -- $ 3.75
</TABLE>
AT DECEMBER 31, 1994 1993
--------------- -------- --------
Options outstanding....................................... 231,769 231,769
Dividend equivalent rights outstanding.................... 164,953 157,174
-------- --------
Total options and dividend equivalent rights outstanding.. 396,722 388,943
======== ========
At December 31, 1994, all of the options, including dividend equivalent
rights, are exercisable. At December 31, 1994 and 1993, 54,357 common shares are
reserved for future grants.
In December 1993, the Board of Directors approved a program to purchase up
to 2,000,000 shares of the Company's common stock in open market transactions.
The decision to repurchase shares pursuant to the program, and the timing and
amount of such purchases, will be based upon market conditions then in effect
and other corporate considerations. During 1994, the Company purchased 15,200
shares in the open market at an aggregate cost of $17,000.
NOTE 10 -- ACCOUNTING MATTERS
Accounting principles and disclosure practices for Mortgage Interests have
historically varied throughout the industry. At the May 1990 meeting, the
Emerging Issues Task Force (EITF) reached a consensus (Issue Number 89-4) that
certain Mortgage Interests should be accounted for using a prospective net level
yield method.
Under this method, a Mortgage Interest would be recorded at cost and
amortized over the life of the related CMO issuance. The total expected cash
flow would be allocated between principal and interest as follows:
1. An effective yield is calculated as of the date of purchase based on the
purchase price and anticipated future cash flows.
2. In the initial accounting period, interest income is accrued on the
investment balance using the effective yield calculated as of the date of
purchase.
3. Cash received on the investment is first applied to accrued interest with
any excess reducing the recorded principal balance of the investment.
4. At each reporting date, the effective yield is recalculated based on the
amortized cost of the investment and the then-current estimate of the
remaining future cash flows.
5. The recalculated effective yield is then used to accrue interest income
on the investment balance in the subsequent accounting period.
6. The above procedure continues until all cash flows from the investment
have been received.
At the end of each period, the amortized balance of the investment should
equal the present value of the estimated cash flows discounted at the
newly-calculated effective yield. In the event that the yield is negative, the
investment is to be written down to an amount equal to the undiscounted
estimated future cash flows.
As described in Note 5, the Company's investments in the REMICs relating to
three separate series of MPCs (FHLMC 17, FNMA 24 and FNMA 25) entitle the
Company to receive its proportionate share of the excess (if any) of payments
received from the mortgage certificates underlying MPCs over amounts required to
pass through principal and interest to the holders of such MPCs. The Company is
not entitled to reinvestment income earned on the underlying mortgage
certificates, is not required to pay administrative expenses of the MPCs and
does not have the right to elect early termination of any of the MPC classes.
The Company's investments in FHLMC 17, FNMA 24 and FNMA 25 are accounted for
using the prospective net level yield method.
As described in Note 4, the Company's residual interest certificates with
respect to five separate series of CMOs (Westam 1, 3, 5, 6 and ASW 65) entitle
the Company to receive 100% of the excess of payments received from the pledged
mortgage certificates together with reinvestment income thereon over amounts
required to make debt service payments on such CMOs and to pay related
administrative expenses relating to such CMOs. The Company also has the right,
under certain conditions, to cause an early redemption of the CMOs. The Company
previously used the equity method of accounting for its investments in Westam 1,
3, 5, 6 and ASW 65 and consolidated the accounts of these REMICs in the
Company's consolidated financial statements. Effective December 31, 1993, the
Company has adopted the prospective net level yield method with respect to these
investments to be consistent with the change in accounting for impaired assets
as described below. The related balances in the 1992 financial statements have
been reclassified to conform with this net presentation.
In May 1993 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". SFAS No. 115 is applicable
to debt securities including investments in REMICs and requires all investments
to be classified into one of three categories: held to maturity, available for
sale, or trading. The Company acquired its residual interest certificates and
interests relating to mortgage participation certificates without the intention
to resell the assets. The Company has both the intent and ability to hold these
investments to maturity and believes these investments meet the "held to
maturity" criteria of SFAS No. 115.
The primary difference between SFAS No. 115 and the method of accounting
previously used by the Company relates to accounting for impairment of both
residual interest certificates (Note 4) and interests relating to mortgage
participation certificates (Note 5) (collectively Mortgage Interests).
Previously, if the undiscounted estimated future net cash flows from these
Mortgage Interests were less than the Company's financial reporting basis, the
Mortgage Interest was considered to be impaired and the Company would establish
a reserve for the difference so that the Mortgage Interest's projected yield
would be 0%. Under SFAS No. 115, if a security is determined to have other than
temporary impairment, the security is to be written down to fair value. The
Company reviewed all of its impaired Mortgage Interests and recorded a charge of
$6,078,000 to record impaired Mortgage Interests at their fair value at December
31, 1993 in accordance with SFAS No. 115. Prior years financial statements were
not restated to apply the provisions of SFAS No. 115. The 1994 financial
statements include net charges of $3,343,000 to record impaired Mortgage
Interests at fair market value.
<TABLE>
In determining fair value the Company considers that the market for Mortgage
Interests is volatile and thinly traded. Moreover, the Company acquired its
Mortgage Interests without intention to resell those assets. Generally, Mortgage
Interests are priced by discounting projected net cash flows from the Mortgage
Interests at an assumed internal rate of return. Projected net cash flows have
been estimated using projected prepayment speeds based on projections by various
investment banks for particular collateral and using current short-term interest
rates in effect for floating rate CMO or MPC classes and assuming such
short-term rates will stay in effect over the lives of the floating rate
classes. A comparison of the amortized cost and estimated fair value of the
Company's Mortgage Interests at December 31, 1994 and 1993, is as follows (in
thousands):
<CAPTION>
AT DECEMBER 31,
-----------------------
1994 1993
---------- -----------
<S> <C> <C>
Amortized Cost:
Residual Interest Certificates..................................... $ 4,853 $ 14,025
Interests Relating to Mortgage Certificates........................ 2,801 3,710
---------- -----------
$ 7,654 $ 17,735
========== ===========
Estimated Fair Value................................................. $ 7,160 $ 17,012
========== ===========
</TABLE>
The estimated prospective net level yield at December 31, 1994 of the
Company's Mortgage Interests based on the amortized cost balance of $7,654,000,
in the aggregate, is 27% without early redemptions being considered and 35% if
early redemptions are considered. The timing and amount of redemption cash flows
is highly uncertain because it is dependent upon levels of prepayments, interest
rates and other factors.
The assumptions used in calculating the above net cash flows and the
prospective net level yield were the December 31, 1994 LIBOR and COFI rates of
6.00% and 4.37%, respectively, and prepayment speeds for particular collateral
as follows:
PREPAYMENT ASSUMPTIONS
------------------------------------------------------------
MORTGAGE INTEREST COLLATERAL COUPON PSA %
------------------------- ---------- ---------- ---------
Westam 1 GNMA I 10.5% 273
Westam 3 GNMA I 9.5% 222
Westam 5 GNMA I 9.0% 183
Westam 6 GNMA 1 9.5% 222
ASW 65 GNMA I 10.0% 254
FHLMC 17 FHLMC 10.0% 335
FNMA 24 FNMA 10.0% 335
FNMA 25 FNMA 9.5% 297
The projected yield and discounted present values of projected net cash
flows are based on the assumptions at December 31, 1994 as described above.
There will be differences, which may be material, between the projected yields
and the actual yields and between the present values of projected net cash flows
and the present values of actual net cash flows.
NOTE 11 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
NET INCOME
NET INCOME (LOSS) PER DIVIDENDS PER
1992 (LOSS) SHARE SHARE
--- ------------- -------------- ------------
First ..................... $ 2,555 $ .25 $ .25
Second .................... (3,248) (.33) .15
Third ..................... (15,368) (1.56) --
Fourth .................... (3,072) (.31) --
1993
----
First ..................... $(10,824) $ (1.11) $ --
Second .................... (8,148) (.84) --
Third ..................... (4,050) (.42) --
Fourth (1) ................ (8,966) (.93) .03
1994
----
First ..................... $ (675) $ (.07) $ --
Second .................... (1,094) (.11) --
Third ..................... 409 .04 --
Fourth (2) ................ (3,164) (.33) .02
--------
(1) Net loss in the fourth quarter of 1993 includes a charge of $6,078,000, or
$.63 per share, for the cumulative effect of an accounting change.
(2) Net loss in the fourth quarter of 1994 includes a charge of $3,212,000, or
$.33 per share, to record impaired Mortgage Interests at fair market value.
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statement
on Form S-8 of our report dated March 10, 1995 appearing on page F-2 of the
Annual Report on Form 10-K, on the consolidated financial statements of Homeplex
Mortgage Investments Corporation appearing on pages F-3 through F-17 of the
Annual Report on Form 10-K for the year ended December 31, 1994.
KENNETH LEVENTHAL & COMPANY
Phoenix, Arizona
March 28, 1995
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1994
<PERIOD-START> JAN-01-1994
<PERIOD-END> DEC-31-1994
<EXCHANGE-RATE> 1
<CASH> 6,666
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 31,150
<CURRENT-LIABILITIES> 0
<BONDS> 11,783
<COMMON> 99
0
0
<OTHER-SE> 17,543
<TOTAL-LIABILITY-AND-EQUITY> 31,150
<SALES> 0
<TOTAL-REVENUES> (1,203)
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1,938
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,383
<INCOME-PRETAX> (4,524)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,524)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,524)
<EPS-PRIMARY> (.47)
<EPS-DILUTED> (.47)
</TABLE>
