<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-10004
TIS MORTGAGE INVESTMENT COMPANY
(Exact name of registrant as specified in its charter)
MARYLAND 94-3067889
(State of incorporation) (I.R.S. Employer Identification No.)
655 MONTGOMERY STREET, SUITE 800
SAN FRANCISCO, CALIFORNIA 94111
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (415) 393-8000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
COMMON STOCK, PACIFIC EXCHANGE
PAR VALUE $.001 PER SHARE
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 ____
------
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. Yes X
------
As of April 13, 1999, the aggregate market value of the Registrant's voting
stock held by non-affiliates (based upon the closing price on that date of the
shares on the Pacific Exchange) was approximately $9,787,000.
As of April 13, 1999, there were 8,893,250 shares of Common Stock outstanding.
Documents Incorporated by Reference
Specifically identified portions of the Registrant's 1999 definitive proxy
statement to be filed with the Securities and Exchange Commission are
incorporated by reference to Part III of this Annual Report on Form 10-K.
<PAGE>
TIS MORTGAGE INVESTMENT COMPANY
INDEX TO ANNUAL REPORT
ON FORM 10-K
<TABLE>
<CAPTION>
PART I Page
<S> <C>
Item 1: Business 3
Item 2: Properties 21
Item 3: Legal Proceedings 22
Item 4: Submission of Matters to a Vote of Security Holders 22
PART II
Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters 23
Item 6: Selected Financial Data 24
Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations 26
Item 7A: Quantitative and Qualitative Disclosures About Market Risk 36
Item 8: Financial Statements and Supplementary Data 36
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 36
PART III
Item 10: Directors and Executive Officers of the Registrant 37
Item 11: Executive Compensation 37
Item 12: Security Ownership of Certain Beneficial Owners and Management 37
Item 13: Certain Relationships and Related Transactions 37
PART IV
Item 14: Exhibits, Financial Statements and Reports on Form 8-K 38
</TABLE>
<PAGE>
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS
CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF THE COMPANY'S PLANS, BELIEFS, EXPECTATIONS AND INTENTIONS. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN
THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THE SECTION
ENTITLED "RISK FACTORS." THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY
REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT
ARISE AFTER THE DATE HEREOF. READERS SHOULD CAREFULLY REVIEW THE RISK FACTORS
DESCRIBED IN OTHER DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE
SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE QUARTERLY REPORTS ON FORM 10-Q
TO BE FILED BY THE COMPANY IN 1999 AND ANY CURRENT REPORTS ON FORM 8-K FILED BY
THE COMPANY.
PART I
ITEM 1. BUSINESS.
INTRODUCTION
GENERAL
TIS Mortgage Investment Company, a Maryland corporation (the "Company"
or the "Registrant") which, unless otherwise indicated, refers to the Company
and its interests in certain real estate partnerships, and its subsidiaries, TIS
Mortgage Acceptance Corporation, a Delaware corporation ("TISMAC"), incorporated
on May 11, 1988, and TIS Property Acquisition Company ("TISPAC"), a Maryland
corporation, incorporated on September 8, 1995. TISPAC is a wholly-owned
subsidiary of the Company for the purpose of owning and financing real property.
In March 1997, as part of the refinancing of two of the Company's multifamily
residential properties and a portion of the Four Creeks property, title to those
properties was vested in TISPAC. Simultaneously, in March 1997, TISPAC entered
into notes secured by mortgages on those properties. TISPAC is a wholly owned
subsidiary of TISMIC and as such is a Qualified REIT Subsidiary. Accordingly,
the accounts of TISPAC are consolidated with those of the Company. On February
2, 1999 the Company acquired Novato Markets, Inc., ("Novato") and made it a
wholly owned subsidiary of the Company. Novato was incorporated on July 26,
1956, and it has a wholly owned subsidiary P-SUB I, Inc., ("P-SUB I") which was
incorporated on June 4, 1997.
Until 1994, the Company sought to generate income for distribution to
its shareholders primarily through acquisition of Structured Securities (as
hereinafter defined). "Structured Securities" include (i) residual interests
("Residual Interests"), principal only bonds ("PO Bonds") and interest only
bonds ("IO Bonds") in collateralized mortgage obligations ("CMOs"), which
entitle the Company to certain cash flows from collateral pledged to secure such
securities; (ii) Mortgage Certificates ("Mortgage Certificates"), which include
securities collateralized by or representing equity interests in Mortgage Loans
secured by first liens on single family residences, multiple family residences
or commercial real estate ("Mortgage Loans"); (iii) CMOs; and (iv) Commercial
Securitizations ("Commercial Securitizations"), which include debt obligations
that are issued in multiple classes and are funded as to the payment of interest
and principal by a specific group of Mortgage Loans on multiple family or
commercial real estate, accounts and other collateral. Beginning in 1994, the
Company changed its investment focus from investments in Structured Securities
to multifamily real estate located in California's Central Valley. Accordingly,
during 1995, the Company sold the majority of its investments in Structured
Securities and acquired during 1995
3
<PAGE>
a portfolio of four income-producing residential real estate properties of which
one was sold in 1998. The Company expects that the majority of its ongoing
assets and operating results will be related to its investments in real estate
and selective development opportunities.
On February 2, 1999, the Company acquired all the shares of Novato
from Pacific Securitization, Inc., ("Pacific") in exchange for 1,613,070 shares
of Common Stock (the "Shares") of the Company pursuant to an Agreement and Plan
of Reorganization dated as of February 1, 1999, between the Company and Pacific.
Through its wholly-owned subsidiary, P-SUB I, Inc., Novato owns a shopping
center located in Rohnert Park, California, named Mountain Shadows Plaza, and
owns a shopping center subject to a ground lease in Petaluma, California, named
Midtown Center. See Note 20 to the Financial Statement.
Subsequent to year end, the Company sold one of its Structured
Securities for a sales price of $783,000 for a gain of approximately $8,000.
Additionally, as discussed in Note 20 to the Company's consolidated financial
statements, in February 1999, the Company repurchased 825,700 shares of common
stock for approximately $2 million in cash and entered into an exchange
transaction resulting in the issuance of common stock for Novato Markets.
The Company's investment policy is controlled by its Board of
Directors. The By-Laws of the Company require that a majority of the members of
the Board of Directors must be persons who are not employed by, or receiving any
compensation (except for serving as a director) from, the Company ("Unaffiliated
Directors").
On July 1, 1996, the Company became a self-administered Real Estate
Investment Trust ("REIT"). Prior to that date, the Company operated under an
agreement (the "Management Agreement") with TIS Financial Services, Inc., a
Delaware corporation (the "Former Manager"), to manage the Company's day-to-day
operations, subject to the supervision of the Board of Directors.
The Company intends, for all taxable years since inception, to qualify
for the tax treatment accorded to REITs under the Internal Revenue Code of 1986,
as amended, (the "Code") and to make quarterly distributions to its shareholders
which, in the aggregate, annually will equal at least 95% of its real estate
investment trust taxable income (as defined in Section 857(b)(2) of the Code)
(hereafter "REIT Taxable Income"). As a result, the Company expects that, with
limited exceptions, its REIT Taxable Income distributed to its shareholders will
not be subject to Federal income tax at the corporate level. See "Federal
Income Tax Considerations" below.
See Item 7 below, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for additional information on the general
development of the Company's business. See "Risk Factors" below for a
discussion of certain risks to which holders of the Company's Common Stock may
be subject.
The Company normally borrows funds to purchase and carry assets
expecting that the cost of such borrowings will be less than the net cash flow
on the assets purchased with such funds.
4
<PAGE>
PRIMARY BUSINESS ACTIVITY
The Company intends to make a substantial portion of its future
investments in multifamily real properties, family shopping centers and
potential development projects. The investment strategy of the Company is to
identify communities with an expanding employment base and demographics which
will continue to provide economic growth. After identifying communities with
strong potential economic growth, the Company attempts to seek out those areas
within a chosen community which are most likely to be positively affected by the
economic growth of the community. Finally, the property sought for purchase
within a given area is chosen because it is considered to be among the highest
quality properties in that area and can be purchased below estimated replacement
cost. Management believes that this strategy will allow income from each of the
properties to rise before the properties encounter significant competition from
new construction. Real property acquisitions will be opportunistic and will
occur from time to time if and when sufficient liquid assets are available.
In 1995, the Company acquired four multifamily residential properties
in California's Central Valley. These properties consist of 539 units together
with 9.75 acres of unimproved land slated for the development of an additional
126 units. The aggregate purchase price for the properties was approximately
$29.3 million, including existing debt assumed by the Company. In the fourth
quarter of 1998, the Company sold its investment in one of these residential
properties for a sale price of $8.3 million including the assumption of
approximately $6.3 million of mortgage related debt.
On February 2, 1999, the Company acquired all the shares of Novato
Markets and through its subsidiary acquired a shopping center located in Rohnert
Park, California, named Mountain Shadows Plaza and a shopping center in
Petaluma, California, named Midtown Center. The shopping centers have a
combined commerical and retail space totaling approximately 80,000 square feet.
Mountain Shadows Plaza consists of three buildings and is anchored by a large
grocery store. Midtown Center consists of a single building. As of the date of
acquisition, the shopping centers only had one vacancy. The Company intends to
continue operating the shopping centers.
The Company has, in years before 1994, primarily invested in the
Residual Interests of single-family CMOs, which are a series of fixed rate or
variable rate bonds with a wide range of maturities. CMOs are typically issued
in series, which generally consist of serially maturing classes ratably secured
by a single pool of mortgage instruments. Generally, principal payments
received on the mortgage instruments securing a series of CMOs, including
prepayments on such mortgage instruments, are applied to principal payments on
one or more classes of the CMOs of such series on each principal payment date
for such CMOs. Scheduled payments of principal and interest on the collateral
securing a series of CMOs are intended to be sufficient to make timely payments
of interest on such CMOs and to retire each class of such CMO by its stated
maturity.
In most CMOs, there are excess cash flows after bond payments and
administrative expenses. The excess cash flows, called residuals, arise
primarily from the difference between the interest received from the mortgage
obligations and the interest paid on the bonds. Prior to 1994, these CMO
residuals were the primary focus of the Company's Structured Securities
business. However, the Company has invested in other parts of the CMO such as
IO Bonds and inverse IO Bonds. Single-family CMOs are collateralized by
residential mortgages, most often in the form of mortgage-backed securities or
certificates, and the bond interest and principal payments, as well as
administrative costs, are covered by the interest and principal payments of the
underlying mortgages. The mortgage collateral underlying the single-family CMOs
in the Company's portfolio of Residual Interests and some of the IO Bonds are
mortgage-backed certificates issued by the Government National Mortgage
Association (GNMA), the Federal National Mortgage Association (FNMA) and the
Federal Home Loan Mortgage Corporation (FHLMC). Some of the IO Bonds are backed
by single-family loans which are not included in mortgage-backed certificates
issued by these agencies.
Monthly cash flows on the Company's mortgage assets have two
components: income from the investment and a partial return of investment
principal. The investment income forms the basis for payment of expenses and
any distributions paid to shareholders. In most cases cash flows and income
tend to be higher in early periods of ownership and lower in the later periods.
The principal which is repaid is
5
<PAGE>
used to reduce debt or to acquire new assets. During 1998, the Company sold its
interest in its only CMO. As of December 31, 1998, the Company's investment
portfolio consists primarily of residual interests and IO Bonds.
LIMITATION ON USE OF NET OPERATING LOSS CARRYFORWARDS.
As of December 31, 1998, the Company had a consolidated net operating
loss carryforward of approximately $57.1 million for Federal income tax
purposes. This number is based upon actual Federal consolidated income tax
filings for the periods through December 31, 1997 and an estimate of the 1998
taxable loss. Some or all of the carryforward may be available to the Company
to offset, for Federal income tax purposes, the future taxable income, if any,
of the Company and its wholly-owned subsidiaries, subject to the limitations and
risks discussed below.
The future ability to use these NOLs may be limited under Internal
Revenue Code (the "Code") Section 382 which provides that if a corporation
undergoes an "ownership change," its ability to use its NOLs in the future may
be limited. An ownership change occurs when the aggregate cumulative increase
in the percentage ownership of a corporation's capital stock owned by "5-percent
shareholders" within any three-year testing period is more than 50 percentage
points. A "5-percent shareholder" is defined as any person holding 5 percent
or more of the fair market value of the corporation's stock at any time during
the three-year testing period. All shareholders who are not 5-percent
shareholders individually are aggregated into one or more public groups, each
of which is considered to be a 5-percent shareholder.
If an ownership change occurs within the meaning of Section 382, the
amount of NOLs the Company may use to offset income in any future taxable year
would be limited, in general, to an amount determined by multiplying the fair
market value of the Company's outstanding capital stock on the ownership change
date by the long-term tax-exempt rate which is published monthly by the Internal
Revenue Service.
There could be circumstances under which an issuance by the Company of
a significant number of new shares of Common Stock or other new class of equity
security having certain characteristics (for example, the right to vote or to
convert into Common Stock) might result in an ownership change under the Code.
The Company believes that it has not undergone an ownership change in
prior years. However, the Company as of April 13, 1999, does have two 5-percent
or more shareholders who acquired their stock in the last three-year period.
There is no assurance that these shareholders will not make additional changes
in their holdings in any potential future three-year testing period which could,
when combined with other changes, cause an ownership change to have occurred.
In addition, if any additional shareholders become 5-percent shareholders in the
future, this could cause an ownership change to occur and limit the Company's
use of its NOLs.
The Company also has capital loss carryforwards of approximately $5.6
million at December 31, 1998. These loss carryforwards expire in the year 2000.
6
<PAGE>
RISK FACTORS
1. Insufficient Cash and Liquidity Sources to Fund Ongoing Operations
- - ----------------------------------------------------------------------
The Company's financial statements have been presented on the going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. In April 1999, the Company
obtained a $1,000,000 revolving line of credit from TIS Financial Services,
Inc., the former manager of the Company for working capital purposes (the "TIS
Line"). In addition to the TIS Line, management is currently evaluating the
Company's alternatives to fund its fiscal 1999 cash requirements. Such
alternatives include, among other things, consideration of (i) the sale of real
property, (ii) the sale of Structured Securities, (iii) reducing general and
administrative expenses, (iv) refinancing existing debt, and (v) entering into
joint venture arrangements with third parties. Management can provide no
assurances as to the timing or ultimate closure of any of these alternatives.
These strategies are dependant on the economic operating environment including
volatility of interest rates and the ability for the California Central Valley
apartment rental market to absorb rental increases. The Company believes that
the proceeds from the TIS Line, together with its on-going real estate
operations and mortgage related investment portfolio will provide sufficient
liquidity for it to continue as a going concern throughout 1999, however,
management can provide no assurance with regard thereto. The accompanying
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities or any other adjustments that might result from
these uncertainties.
2. Risks Associated with Investments in Real Estate
- - ----------------------------------------------------
The yields available from equity investments in real estate depend on
the amount of income earned and capital appreciation generated by the related
properties as well as the expenses incurred. Income from the properties may be
adversely affected by, among other things, increasing unemployment rates,
oversupply of competing properties, reduction in demand for properties in the
area, increasing affordability of single family homes, and adverse real estate,
zoning and tax laws. Certain significant expenditures associated with an
investment in real estate (such as mortgage payments, real estate taxes and
maintenance costs) constitute fixed costs and do not decrease when circumstances
cause a reduction in income from the investment. Furthermore, real estate
investments are relatively illiquid and therefore, will tend to limit the
Company's ability to vary its portfolio promptly in response to changes in
economic or other conditions.
Potential Environmental Liability
- - ---------------------------------
The Company could be held liable for the costs of removal or
remediation of any hazardous or toxic substances located on or in its
properties. These laws often impose such liability without regard to whether
the owner knew of, or was responsible for, the presence of the hazardous or
toxic substances. The presence of such substances, or the failure to remediate
such substances properly, may adversely affect the owner's ability to sell or
rent the property or to borrow using the property as collateral. Other Federal
and state laws require the removal of damaged material containing asbestos in
the event of remodeling or renovation.
Uninsured Loss
- - --------------
The Company carries several types of insurance. There are, however,
certain types of extraordinary losses (such as losses resulting from
earthquakes) that may be either uninsurable or not economically insurable.
Should an uninsured loss occur, the Company could lose its investment in and
anticipated profits and cash flow from a property and would continue to be
obligated on any mortgage indebtedness on the property.
7
<PAGE>
Americans with Disabilities Act
- - -------------------------------
The Company's properties must comply with Title III of the Americans
with Disabilities Act (the "ADA") to the extent that the properties are "public
accommodations" and/or "commercial facilities" as defined by the ADA.
Compliance with the ADA requirements could require removal of structural
barriers to handicapped access in certain public access areas of the Company's
properties, where such removal is readily achievable. The ADA does not,
however, consider residential properties, such as apartment communities, to be
public accommodation or commercial facilities, except portions of such
facilities, such as a leasing office which is open to the public. Noncompliance
with the ADA could result in imposition of fines or an award of damages to
private litigants. If required changes involve a greater expenditure than the
Company currently anticipates or if the changes must be made on a more
accelerated basis than it anticipates, the Company's operations could be
adversely affected.
Fair Housing Amendments Act of 1988
- - -----------------------------------
The Fair Housing Amendments Act of 1988 (the "FHA") requires
multifamily residential properties first occupied after March 13, 1991 to be
accessible to the handicapped. Noncompliance with the FHA could result in the
imposition of fines or an award of damages to private litigants. If required
changes involve a greater expenditure than the Company currently anticipates or
if the changes must be made on a more accelerated basis than it anticipates, the
Company's operations could be adversely affected.
Risk of Real Estate Development
- - -------------------------------
The Company plans to seek selective opportunities for development.
The real estate development business involves significant risks in addition to
those involved in the acquisition, ownership and operation of established
apartment communities and shopping centers. The development risks include, among
other things, lack of construction financing on favorable terms and adverse
changes in rental rates and occupancy rates in the market.
3. Market Risks Relating to Mortgage Assets
- - --------------------------------------------
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
net cash flows vary primarily as a result of changes in mortgage prepayment
rates, 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.
Prepayment Risks
- - ----------------
Mortgage prepayments shorten the life of the mortgage instruments
underlying the Company's mortgage assets, thereby reducing the overall net cash
flows in the long term and causing an inherent decline in the Company's income.
Prepayments of mortgage instruments generally increase when then current
mortgage interest rates fall below the interest rates on the fixed-rate Mortgage
Loans included in such mortgage instruments. Conversely, prepayments decrease
when then current mortgage interest rates exceed the interest rates on the
Mortgage Loans included in such mortgage instruments. Prepayment experience
also may be affected by the geographic location of the Mortgage Loans included
in 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.
8
<PAGE>
Interest Rate Fluctuation Risks
- - -------------------------------
Changes in interest rates affect the performance of the Company and
its mortgage assets.
Risks of Decline in Net Cash Flows and Income from Mortgage Assets
- - ------------------------------------------------------------------
The Company's income from mortgage assets derives primarily from the
net cash flows received on its mortgage assets which decline over time. For
both tax and accounting purposes, the Company's net cash flows consist of two
components - one representing return of a portion of the purchase price of the
mortgage asset (the "Cost Component") and one representing income on the
investment (the "Income Component"). The Income Component is highest in years
immediately following the purchase of the mortgage asset and declines over time.
In addition, to the extent that actual mortgage prepayments or variable interest
rates experienced exceed those assumed, this inherent decline in net cash flows
and income is accelerated.
Inability to Predict Effects of Market Risks
- - --------------------------------------------
Because none of the above factors, including changes in prepayment
rates, interest rates, reinvestment income and expenses are susceptible to
accurate projection, the net cash flows generated by the Company's mortgage
assets, and thus distributions to the Company's shareholders, cannot be
predicted. The Company's borrowings may bear fixed or variable interest rates,
may require additional collateral if 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 the Company's borrowings bear variable
interest rates, changes in short term interest rates will significantly
influence the cost of such borrowings and can result in losses in certain
circumstances. The Company also may increase the amount of its available funds
through the issuance of debt securities.
4. General Risks
- - -----------------
Competition
- - -----------
There are numerous real estate companies, insurance companies,
financial institutions, pension funds and other property owners that compete
with the Company in seeking properties for acquisition and in attracting and
retaining tenants.
Market Price of Common Stock
- - ----------------------------
The market price of the Company's Common Stock has been very volatile
due to a wide variety of factors including the Company's operating results,
distributions (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 assets and prevailing market interest rates. Additionally, the
performance of the Company's income-producing properties has an effect on the
market price of the Company's Common Stock. Any actual or perceived unfavorable
changes in the real estate market and other factors 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 a 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 the Company's need for additional equity.
9
<PAGE>
Certain Consequences of and Failure to Maintain 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 and the
amount of its distributions to shareholders. See "Business -- Federal Income
Tax Considerations -- 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 shareholders 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 may 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 cash receipts. See "Business -- Federal Income Tax Considerations."
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. 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 shareholders, 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 acquisition, the Company
considers the anticipated tax effects of the acquisition, 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 shareholders 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 shareholders. 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 Inclusion Income
- - -----------------------
A portion of the distributions paid by the Company constitutes
unrelated business taxable income to certain otherwise tax-exempt shareholders
which will constitute a floor for the taxable income of shareholders 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
shareholders.
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.
10
<PAGE>
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 shareholders 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
shareholders 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 shareholder without
any action on such shareholder's part in the event of a reduction in the number
of outstanding shares of the Company's Common Stock.
ACQUISITION AND DISPOSITION OF STRUCTURED SECURITIES
The Company is not in the business of trading its Structured
Securities. However, from time to time the Company may dispose of Structured
Securities and therefore they have been classified as available-for-sale. In
1996 the Company sold its equity residual interest in TMAC CMO Trust 1986-1 and
in 1997 its interests in TMAC CMO Trust 1986-2 and TMAC CMO Trust 1987-3
Under the Financial Accounting Standards Board method of accounting
for Residual Interests in CMOs, residual interests are required to be classified
either as "equity" (and be accounted for under the Equity Method) or as
"nonequity" (and be accounted for under a level yield method referred to as the
Prospective Method). The Company has adopted these methods for accounting for
its residual interests and the accounting method for impairment of mortgage-
backed derivative investments prescribed by Statement of Financial Accounting
Standards No. 115 and presents its financial statements in accordance therewith.
During 1998, the Company's interest in the Bear Stearns Mortgage
Securities, Series 1992-1 IO Bond was redeemed and the Company sold its interest
in its only remaining CMO instrument, CMOT-28. These transactions resulted in
net proceeds of $1,888,000 and realized losses of $198,000 and $216,000
respectively. Subsequent to year end, in February, 1999, the Company sold its
interest in FNMA Series 1992-123, Class S IO Bond resulting in proceeds of
$783,000 and a realized gain of $8,000.
11
<PAGE>
FAIR VALUE OF RESIDUAL INTERESTS AND IO BONDS
Historically, a significant portion of the Company's revenue has been
derived from the cash flows on the Company's Residual Interests and IO Bonds.
The fair value of Residual Interests and IO Bonds is the net present value of
the projected future cash flows. The amount of cash flows that may be generated
from these assets is uncertain and may be subject to wide variations depending
primarily upon the rate and timing of prepayments on the underlying mortgage
collateral and, for Residual Interests with variable rate bond classes and IO
Bonds with variable interest rates, changes in LIBOR. Information regarding the
fair value of Residual Interests and IO Bonds is presented in the notes to the
consolidated financial statements.
CAPITAL RESOURCES
When feasible, the Company may seek to increase the amount of funds
available for its activities through various types of debt financing. The
Company may seek to obtain lines of credit from independent financial
institutions. The Company may also seek to raise funds through agreements
pursuant to which the Company would sell Structured Securities for cash and
simultaneously agree to repurchase them at a specified date for the same amount
of cash plus an interest component ("Reverse Repurchase Agreements"), and
through the issuance of commercial paper and other debt securities, other forms
of borrowings and the issuance of additional equity securities. Short-term
indebtedness would be expected to bear interest at variable rates. There can be
no assurance that the Company will be able to finance assets that it wishes to
acquire.
In connection with the 1995 acquisition of four multifamily
residential properties in California's Central Valley, the Company assumed and
incurred mortgage obligations totaling $20,490,000 secured by such properties.
After giving effect to the sale of one of the properties, as of December 31,
1998, the Company had mortgage obligations of approximately $13,794,000 secured
by the three remaining properties. At December 31, 1997, the Company had
mortgage obligation balances of $59,008,000 related to its interest in CMOT-28
which was sold during 1998.
12
<PAGE>
At December 31, 1998 and 1997, the Company had short-term borrowings
of $667,000 and $2,009,500, respectively, in the form of repurchase agreements
with Bear Stearns & Co. and Paine Webber. The weighted average interest rates
on these instruments as of these dates were 7.2189% and 7.4335%, respectively.
This debt is securitized by certain of the Company's mortgage related assets.
Subsequent to December 31, 1998, the short-term indebtedness was paid in full in
conjunction with the sale of one of the Company's mortgage related assets. The
Company's By-Laws provide that it may not incur indebtedness if, after giving
effect to the incurrence thereof, the Company's aggregate indebtedness (other
than liability represented by Structured Securities and any loans between the
Company and its trusts or corporate subsidiaries), secured and unsecured, would
exceed 100% of the Company's average invested assets in the preceding calendar
quarter, as calculated in accordance with generally accepted accounting
principles, unless approved by a majority of the Unaffiliated Directors.
In April of 1999, the Company entered into a financing agreement with
The Former Manager whereby The Former Manager extended a revolving line of
credit of $1,000,000 to the Company. This line is to provide working capital
to the Company. The Former Manager and the Company have common ownership and
executive officers and as such are related parties. Credit support to the Former
Manager includes guaranteed loans by a bank and a board member of the Company in
support of the TIS Line to the Company. Additionally, certain of the Company's
mortgage assest are pledged as collateral for the TIS Line. This revolving line
of credit is for a term of one year, is at the rate of prime plus one and one
half percent and is secured by the Company's ownership in Bankers Trust series
1988-1 Residual Interest Certificate.
The Company has 100,000,000 authorized shares of Common Stock. The
Company may increase its capital resources by making additional offerings of
Common Stock. Such offerings may result in a reduction of the net tangible book
value per outstanding share and a reduction in the market price of the Company's
Common Stock. The Company is unable to estimate the amount, timing or nature of
such future sales of its Common Stock, as any such sales would depend on general
market conditions and other factors.
The Company has a Dividend Reinvestment and Share Purchase Plan (the
"Plan"). The Plan provides, at the Company's option, for shares purchased under
the Plan to either be issued by the Company, or be purchased on the open market.
The Plan prospectus provides for up to 1,000,000 new shares to be issued. To
the extent new shares are issued, the Company's capital will be increased.
During 1992, 5,780 shares were issued under the Plan resulting in an increase to
capital of $39,000. No new shares were issued under the Plan thereafter, as all
required shares have been purchased in the open market.
OPERATING RESTRICTIONS
The Company intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940 (the
"1940 Act"). Accordingly, the Company does not expect to be subject to the
provisions of the 1940 Act, including those that prohibit certain transactions
among affiliated parties. The 1940 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
Mortgage Loans, certain Mortgage Certificates and certain other qualifying
interests in real estate. The Company's ownership of Residual Interests may
therefore be limited by the 1940 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. The Company's investment policies prohibit it from making
any investments that would cause the Company to be an investment company within
the meaning of the 1940 Act.
13
<PAGE>
Although the Company has no present intention to seek modification of
its operating policies described herein, a majority of the Unaffiliated
Directors may in the future conclude that it would be advantageous for the
Company to do so and may modify such operating policies accordingly, without the
consent of the shareholders.
SUBSIDIARIES
TISPAC is a wholly-owned subsidiary of the Company incorporated on
September 8, 1995, for the purpose of owning and financing real property. In
March 1997, as part of the refinancing of two of the Company's multifamily
residential properties and a portion of the Four Creeks property, title to those
properties was vested in TISPAC. Simultaneously, TISPAC entered into notes
secured by mortgages on those properties. TISPAC is a Qualified REIT
Subsidiary. Accordingly, the accounts of TISPAC are consolidated with those of
the Company.
Novato Markets, Inc., is a wholly-owned subsidiary of the Company,
incorporated on July 26, 1956, and acquired on February 2, 1999. It has one
wholly-owned subsidiary, P-SUB I Inc., incorporated on June 4, 1997. P-SUB I
owns a shopping center located in Rohnert Park, California, named Mountain
Shadows Plaza, and owns a shopping center subject to a ground lease in Petaluma,
California, named Midtown Center.
COMPETITION
The Company's real estate properties face the normal competitive
pressure of most rental real estate projects. However, the Company's real
property acquisitions have been and will continue to be opportunistic and may
occur from time to time only when sufficient liquid assets are available.
EMPLOYEES
Until July 1, 1996, the Company had no full-time salaried employees.
On that date, the Company became a self-administered REIT. As a result, the
Company now directly employs three individuals, two of whom receive only a
portion of their total compensation from the Company. The balance of their
compensation is paid by the Company's Former Manager. In addition, the Company
reimburses the Former Manager for employment expenses of personnel performing
certain functions which are deemed applicable to the affairs of the Company.
MANAGEMENT OF OPERATIONS
SELF MANAGEMENT
JULY 1, 1996 AND THEREAFTER
- - ---------------------------
At a special meeting of the Board of Directors on June 27, 1996, the
Board resolved to let the Management Agreement expire on June 30, 1996 and to
have the Company become a self-administered REIT. In connection therewith, the
Company entered into a Facilities and Expense Sharing Agreement ("Expense
Sharing Agreement") with the Former Manager providing for the sharing of office
space, office equipment and the expenses of certain administrative and other
personnel and ancillary services. In addition, the Board approved employment
contracts with Lorraine O. Legg, Chairman and President of the Company, for a
term of three years and John E. Castello, as Executive Vice President and Chief
Financial Officer, for a term of two years.
14
<PAGE>
The Company and the Former Manager entered into the Expense Sharing
Agreement on July 1, 1996. The Expense Sharing Agreement provides for certain
office space and expense sharing arrangements, whereby the Company and the
Former Manager share on a prorata basis all fees and expenses incurred in
connection with rent, telephone charges, utilities and other office expenses,
bookkeeping fees and expenses and miscellaneous administrative and other
expenses, including certain personnel expenses, as described in the Expense
Sharing Agreement. The prorata sharing of such expenses is determined based
upon the relative benefit received by each party in accordance with the amount
of space utilized or the relative amount of time each such resource is used, or
such other allocation method as may be reasonable and agreed to by the parties.
The Expense Sharing Agreement continues in effect until terminated by either
party on 30 days' prior written notice by either party or at such time as the
parties no longer continue to share office space or other resources.
Prior to July 1, 1996
- - ---------------------
Prior to July 1, 1996, the Company operated under a Management
Agreement with the Former Manager which was renewable annually. In June 1995,
the Board of Directors of the Company and the Former Manager entered into a new
Management Agreement through June 30, 1996. In March 1995, the Board of
Directors authorized a committee composed of four Unaffiliated Directors to
consider proposed revisions to the Management Agreement in light of the
Company's acquisition of multifamily residential properties and recent waivers
by the Unaffiliated Directors of the requirement in the Management Agreement
that the Former Manager reimburse the Company for Excess Expenses (as defined).
As a result, the Management Agreement approved in June 1995 increased the base
management fee from .375% per annum of average invested assets to .65% thereof,
changed the incentive compensation, eliminated an expense reimbursement
provision, and discontinued the payment of a Residual Interest Administration
Fee. These changes in the management fee became effective October 1, 1995.
However, the Former Manager voluntarily waived the increase in base management
fee for the fourth quarter of 1995 and first two quarters of 1996.
Prior to becoming self managed on July 1, 1996, the Company reimbursed
the Former Manager for certain expenses incurred by the Former Manager on the
Company's behalf, including rent, telephone, utilities, office furniture,
equipment and machinery, computers, and computer services, as well as expenses
relating to accounting, bookkeeping and related administrative functions
(including the employment expenses of any persons performing these functions),
and fees and expenses of agents and employees employed directly by the Former
Manager at the Company's expense.
Except as set forth above, the Former Manager was required to pay
employment expenses of its personnel, rent, telephone, utilities, other office
expenses, certain travel and miscellaneous administrative expenses of the Former
Manager and, if the Former Manager or an affiliate of the Former Manager served
as bond administrator for a series of Structured Securities issued by or on
behalf of the Company, all expenses incurred by the Former Manager in performing
administrative services in connection with the issuance and administration of
such series of Structured Securities.
15
<PAGE>
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
If the Company satisfies certain tests with respect to the nature of
its income, assets, management, share ownership and the amount of its
distributions, and elects to be so treated, it will qualify as a real estate
investment trust ("REIT") for Federal income tax purposes. The Company
satisfied such tests and elected to be treated as a REIT on its tax return for
the year ended December 31, 1988. The Company has satisfied such tests in all
subsequent years. As a REIT, the Company generally will not be subject to tax at
the corporate level on its taxable income to the extent that it distributes at
lease 95% of such taxable income to its shareholders. See "Taxation of the
Company." Generally, those distributions will constitute distributions to the
shareholders and will be taxable as ordinary income to the extent of the
Company's earnings and profits. It is expected that distributions made by the
Company will be made out of earnings and profits.
The failure of the Company to be treated as a REIT for any taxable
year could materially and adversely affect the shareholders, since the Company
would be taxed as a corporation. Accordingly, the taxable income of the Company
(computed without any deduction for distributions to shareholders) would be
taxed to the Company at corporate rates (currently up to 35% for Federal
purposes), and the Company would be subject to any applicable minimum tax.
However, the Company has $57 million of net operating loss carryforwards to
offset taxable income. Additionally, distributions to the shareholders would
be treated as ordinary income to the extent of the Company's earnings and
profits. As a result of the "double taxation" (i.e. taxation at the corporate
level and subsequently at the shareholder level when earnings are distributed)
the distributions to the shareholders would decrease substantially, because a
large portion of the cash otherwise available for distribution to shareholders
would be used to pay taxes. Further, the 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 four subsequent years.
QUALIFICATION OF THE COMPANY AS A REIT
General
In order to qualify as a REIT for Federal income tax purposes, the
Company must elect to be so treated and must 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 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, and (ii) the 95% 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. Income that qualifies under the 75%
test includes (a) interest on obligations secured by mortgages on real property
or on interests in real property (including, generally, income from regular and
residual interests in REMICs), (b) rents from real property, (c) distributions
from other REITs, (d) gain from the sale or other disposition of real property
(including interests in real property and interests in mortgages on real
property) that is not "dealer property" (i.e. property that is stock in trade,
inventory, or property held primarily for sale to customers in the ordinary
course of business), (e) income from the operation, and gain from the sale, of
property acquired at or in lieu of a foreclosure of a mortgage ("foreclosure
property") , (f) commitment fees related to Mortgage Loans, and (g) income
attributable to the temporary investment of the Company's capital proceeds
(excluding amounts received pursuant to a
16
<PAGE>
dividend reinvestment program) in stock or debt instruments, if such income is
received or accrued during the one-year period beginning on the date of receipt
of the capital proceeds ("qualified temporary investment income").
In addition to meeting the 75% income test, at least 95% of the
Company's gross income for the taxable year must be derived from items of income
that either qualify under the 75% test or are from certain other types of
passive investments. This is referred to as the 95% income test. Income that
satisfies the 95% income test includes income from distributions, interest and
gains from the sale or disposition of stock or other securities, other than
stock or other securities that are dealer property.
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 generally equal to 100% of any excess
nonqualifying income.
The Company anticipates that its gross income will continue to include
a component from interest and gains on mortgage assets and income from short-
term reinvestments, but will consist principally of rents from its real estate
assets. The composition and sources of the Company's income allowed the Company
to satisfy the income tests for all fiscal years through December 31, 1998 and
should allow the Company to satisfy the income tests during each year of its
existence. If, however, the Company causes issuances of interests in real
estate mortgage investment conduits ("REMICs") or issuances of certificates
representing certain equity interests in mortgage instruments (such as pass-
through certificates), the Company could recognize income or gain that, if from
transactions in which the Company is deemed to be a dealer, could be subject to
the 100% tax on prohibited transactions. See "Taxation of the Company" below.
This effectively limits both the Company's ability to issue REMIC securities
directly or through wholly owned subsidiaries and its ability to issue such
securities indirectly through issuance of funding notes to affiliated issuers.
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. In addition, income from Structured Securities which do not
represent equity interests in Mortgage Loans and with respect to which a REMIC
election has not been made (e.g. CMOs) may not qualify under the 75% income
test. The Company intends to monitor its reinvestments and hedging transactions
closely 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), "government securities" and "real estate assets." Real estate
assets include real property, Mortgage Loans, Mortgage Certificates, equity
interest 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. Structured Securities that do not represent
equity interests in Mortgage Loans and with respect to which a REMIC election
has not been made may not qualify as real estate assets. The balance of the
Company's assets may be invested without restriction, except that holdings of
the securities of any non-governmental issuer (other than a REIT or qualified
REIT subsidiary) 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 for purposes of the 5% and 10% asset tests.
If a REIT receives "new capital," stock or debt instruments purchased
with such new capital are treated as real estate assets for purposes of the 75%
asset test (described above) during the one-year period
17
<PAGE>
beginning on the date the REIT receives such new capital. New capital is defined
as any amount received by a REIT in exchange for its stock (other than amounts
received pursuant to a dividend reinvestment plan) or received in a public
offering of its debt obligations having maturities of at least five years.
The Company anticipates that its assets will consist of (i) ownership
interests in mortgage assets (including undivided ownership interests in
mortgage instruments), (ii) interests in REMICs, (iii) interests in real estate,
(iv) interests in other REITs, (v) stock or debt instruments that generate
qualified temporary investment income, (vi) cash and (vii) certain short-term
investments and reinvestments. The Company believes that such asset holdings
will allow it to satisfy the assets tests necessary to qualify as a REIT, and
the Company intends to monitor its activities to attempt to assure satisfaction
of such 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 intends to 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.
REITs are permitted to hold assets in wholly owned subsidiaries
("Qualified REIT Subsidiaries"). A subsidiary of a REIT is a Qualified REIT
Subsidiary if 100% of its stock is owned by the REIT at all times during the
period such subsidiary is in existence. A Qualified REIT Subsidiary is not
treated as a separate corporate entity for Federal income tax purposes, but
rather, together with its parent REIT, is treated as a single taxpayer.
Accordingly, all of the assets, liabilities and items of income, deduction and
credit of a Qualified REIT Subsidiary are treated as the assets, liabilities,
and items of income, deduction and credit of the parent REIT for Federal income
tax purposes and, in particular, for purposes of satisfying the applicable Code
provisions for qualification as a REIT. The Company's wholly owned
subsidiaries, TISPAC and TISMAC, are Qualified REIT Subsidiaries.
Distributions
The Company must distribute as distributions to its shareholders for
each taxable year an amount at least equal to (i) 95% of its "REIT taxable
income" as defined below (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).
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 (i) if the distribution is declared in October, November or
December of any year, is payable to shareholders of record on a specified date
in such a month, and is actually paid before February 1 of the following year;
or (ii) if the distribution is declared before the date on which the Company's
tax return for the taxable year is due to be filed (including extensions) and is
paid on or before the first regular distribution 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
Internal Revenue Service (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 (plus
interest).
18
<PAGE>
The Code imposes a non-deductible 4% excise tax on REITs to the extent
that the "distributed amount" with respect to a particular calendar year is less
than the sum of (i) 85% of the REIT's taxable income (computed pursuant to
Section 857(b)(2) of the Code, but before the dividends paid deduction and
excluding capital gain or loss) for such calendar year, (ii) 95% of the REIT's
capital gain net income (i.e. the excess of capital gains over capital losses)
for such calendar year, and (iii) the excess, if any, of the "grossed up
required distribution" (as defined in Section 4981(b)(3) of the Code) for the
preceding calendar year over the distributed amount for such preceding year.
For purposes of the excise tax provision, the "distributed amount" with respect
to any calendar year is the sum of (i) the deduction for dividends paid during
such calendar year (excluding dividends paid after the close of the taxable year
under Section 858 of the Code but including distributions declared in October,
November or December and paid in January, as described above), (ii) amounts on
which the REIT is required to pay corporate tax and (iii) the excess, if any, of
the distributed amount for the preceding year over the "grossed up required
distribution" for such preceding taxable year.
The Company intends to make distributions to its shareholders on a
basis that will allow the Company to satisfy both the 95% distribution
requirement and the excise tax distribution requirement. Certain factors
inherent in the structure of certain mortgage-backed securities (particularly
CMOs) and the Federal income tax rules for calculating income of Mortgage assets
may cause the Company to realize taxable income in excess of net cash flows in
certain years. The Company intends to monitor closely the interrelationship
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 requirements.
Ownership of the Company
Shares of the Company's Common Stock must be beneficially owned by a
minimum of 100 persons for at least 335 days in each full taxable year (or a
proportionate part of any short 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 except under certain circumstances, and certain other types of tax exempt
entities). The Company's Articles of Incorporation contain repurchase
provisions and transfer restrictions designed to prevent violation of the latter
requirement. To evidence compliance with these requirements, the Company is
required to maintain records that disclose the actual ownership of its
outstanding shares. Each year, in order to satisfy that requirement, the
Company will demand written statements from record holders owning designated
percentages of Common Stock disclosing, among other things, the identities of
the actual owners of such shares.
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. Significantly, distributions paid by a REIT to its shareholders
with respect to a taxable year are deducted to the extent such distributions are
not attributable to net income from foreclosure property. Thus, in any year in
which the Company qualifies and elects to be treated 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 shareholders in or with respect to that year. In
computing REIT Taxable Income, taxable income also is adjusted by (i)
disallowing any corporate deduction for dividends
19
<PAGE>
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.
Regardless of distributions to shareholders, the Company will be
subject to a tax at the highest corporate rate 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 does not cause the REIT to fail to qualify
as such. In addition, as described above, the Company will be subject to a 4%
excise tax for any taxable year in which, and on the amount by which,
distributions made by the Company fail to equal or exceed a certain amount
determined with reference to its REIT Taxable Income. The Company is also
subject to the alternative minimum tax, which is determined for REITs with
reference to REIT Taxable Income as increased by tax preferences. The Company
does not expect to have significant amounts of tax preference items.
Accordingly, the Company anticipates that its Federal tax liabilities, if any,
will be minimal.
On August 5, 1997, the Taxpayer Relief Act of 1997 was enacted. This
Act changed a number of federal income tax provisions that affect REITs. These
changes include, but are not limited to, the repeal of the 30% income test, the
enactment of a "de minimis" rule for tenant services income, and the
liberalization of the consequences for failing to comply with the federal
regulations regarding determination actual ownership of a REIT's outstanding
shares.
California Franchise tax regulations regarding REIT qualification
currently conform to Federal income tax regulations. There is no assurance that
this will continue in the future and, if state regulations do not conform to
Federal regulations in the future, there is a possibility that the Company might
be liable for state income taxes.
The Company uses the calendar year both for tax and financial
reporting purposes. Due to the differences between tax accounting rules and
generally accepted accounting principles, the Company's REIT Taxable Income may
vary from its net income for financial reporting purposes.
20
<PAGE>
ITEM 2. PROPERTIES.
At December 31, 1997, the Company's operating real estate assets
consisted of four multifamily apartment complexes located in California's
Central Valley. During the fourth quarter of 1998, the Company sold the River
Oaks property and now owns the three properties shown in the following table.
All of these properties were acquired in 1995 either in the form of direct
ownership of the real property or in the form of an interest in a partnership
that directly owns the real property. As part of a refinancing, title to Villa
San Marcos and a portion of the Four Creeks Property were vested in TISPAC. The
multifamily residential properties, Shady Lane, and Four Creeks Phase I are held
directly by the Company at December 31, 1998. Information regarding these
properties is shown in the table below:
<TABLE>
<CAPTION>
VILLA FOUR CREEKS
Shady Lane SAN MARCOS VILLAGE
- - ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Location Visalia, CA Fresno, CA Visalia, CA
Date of Construction 1985 1991 1986-1991
Purchase Price $2,105,000 $9,000,000* $9,000,000
Purchase Price per Square Foot $ 40.44 $ 62.44 $ 48.27
Notes Payable Secured by
Real Estate at December 31, 1998 $1,292,145 $6,825,984 $5,675,526
Number of Units 54 120 146
Rentable Square Feet 52,056 144,140 186,439
Average Monthly Rent per Unit in 1998 $ 411 $ 826 $ 730
Monthly Rent per Square Foot in 1998 $ 0.43 $ 0.69 $ 0.57
Improved Land Area 2.77 acres 9.77 acres 13.34 acres
Unimproved Land Area -- 9.75 acres --
Occupancy at December 31, 1998 94% 96% 100%
</TABLE>
* In addition to acquiring the currently existing building, the Company
purchased the adjoining 9.75 acres of unimproved land for $1,000,000. An
additional 126 rentable units are expected to be constructed on this parcel. At
the time of purchase, all requisite entitlements were in place.
On February 2, 1999, the Company acquired Novato Markets and through its
subsidiary acquired a shopping center located in Rohnert Park, California, named
Mountain Shadows Plaza and a shopping center in Petaluma, California, named
Midtown Center. The shopping centers have a combined commerical and retail
space totaling approximately 80,000 square feet. Mountain Shadows Plaza
consists of three buildings and is anchored by a large grocery store. Midtown
Center consists of a single building. As of the date of acquisition, the
shopping centers only had one vacancy.
The principal executive offices of the Company and the Former Manager
are located at 655 Montgomery Street, Suite 800, San Francisco, California
94111, telephone (415) 393-8000. The Company leases its office space under a
lease expiring February 28, 2002 and subleases space to the Former Manager.
21
<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
On March 11, 1999, The Bank of New York ("BNY") filed an action in the
United States District Court for the Northern District of California, Case No.
C.99-1130 MJJ, against the Company for alleged breach of contract, common count
and conversion. The complaint alleges that BNY erroneously paid $1.2 million to
the Company under the terms of a mortgage-backed security of which the Company
is one of the holders, and that the Company has failed to repay approximately
$600,000 of those monies despite demand. The complaint requests repayment,
prejudgment interest, attorneys fees' and costs. The Company acknowledges that
it is required to repay the remaining $600,000, but denies that it is liable to
BNY, a trustee to the Company, for any other amounts or that it ever breached
any contract, converted monies, or otherwise acted improperly. On March 23,
1999, BNY filed an application for a writ of attachment, requesting expedited
hearing thereon. The Company opposed the expedited hearing and the Court denied
BNY's request. On April 1, 1999, BNY filed an amended complaint adding a
request for a constructive trust, and also set the attachment application for
regular hearing on May 11, 1999. The parties have engaged in informal
settlement discussions, both before and after the filing of the original
complaint. Those discussions continue. If a settlement agreement cannot be
reached, the Company intends to oppose the application for an attachment and
vigorously defend the action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the security holders of the
Company during the fourth quarter of the fiscal year covered by this report.
22
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is listed on the Pacific Exchange under the
symbol "TIS." The Company was also listed on the New York Stock Exchange until
August 19, 1998, when the stock was delisted from that exchange. The high and
low closing sales prices of shares of the Common Stock on the Pacific Exchange
or the New York Stock Exchange for the periods indicated were as follows:
<TABLE>
<CAPTION>
HIGH LOW
----------------- -----------------
<S> <C> <C>
1997
First Quarter $ 1-3/8 $1-1/16
Second Quarter 1-1/4 1
Third Quarter 1-5/8 1
Fourth Quarter 1-7/8 1-3/8
1998
First Quarter 2-3/8 1-3/16
Second Quarter 2-3/16 1-9/16
Third Quarter 1-7/8 9/16
Fourth Quarter 7/8 3/8
1999
First Quarter 1-7/16 1/2
</TABLE>
- - --------------------------------------------------------------------------------
On April 13, 1999, the closing sales price of the shares of Common
Stock on the Pacific Exchange was $1.375. On that date the Company had
outstanding 8,893,250 shares of Common Stock which were held by approximately
500 shareholders of record and the total number of shareholders was
approximately 4,000.
The following table details distributions paid during the Company's
three most recent fiscal years. No distributions were paid in 1997.
<TABLE>
<CAPTION>
- - ------------------------------------------------------------------------------------------------------------
Date Amount Record Payment
Quarter Ended Declared Declared Date Date
- - ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 31, 1998 September 15, 1998 $0.002 December 1, 1998 December 18, 1998
December 31, 1996 September 10, 1996 $ 0.02 December 13, 1996 December 31, 1996
- - ------------------------------------------------------------------------------------------------------------
</TABLE>
The actual amount and timing of any future dividend payments 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.
Subject to the distribution requirements to maintain REIT
qualification, the Company intends, to the extent practicable, to use
substantially all of the interest payments and sales of the Company's Structured
Securities to reduce debt and short-term obligations of the Company. The
Company may,
23
<PAGE>
however, under extraordinary circumstances, make a distribution of principal.
Such distributions, if any, will be made at the discretion of the Company's
Board of Directors.
It is anticipated that distributions generally will be taxable as
ordinary income to shareholders of the Company (including, in some cases,
shareholders that would otherwise be exempt from tax under the Code), although a
portion of such distributions may be designated by the Company as capital gain
or may constitute a return of capital. Such distributions received by
shareholders of the Company 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 shareholders a statement setting forth distributions
paid during the preceding year and their characterization as ordinary income,
return of capital or capital gain.
A significant portion of the REIT Taxable Income of the Company has
been derived from the Company's Structured Securities although, in future years,
it is anticipated that increasing portions of the taxable income of the Company
will be derived from its operating real estate assets. Taxable income is
increased by non-cash credits from, among other things, the accretion of market
discount on the Mortgage Certificates pledged as collateral for bonds and is
decreased by non-cash expenses, including, among other things, the amortization
of the issuance costs of bonds, market premium on the Mortgage Certificates
pledged as collateral for bonds and the accretion of original issue discount on
certain bond classes. In certain instances, the REIT Taxable Income of the
Company for Federal income tax purposes may differ from its net income for
financial reporting purposes principally as a result of the different methods
used to determine the effect and timing of recognition of such non-cash credits
and expenses.
As a result of the requirement that the Company distribute to its
shareholders an amount equal to substantially all of its REIT Taxable Income in
order to qualify as a REIT, the Company may be required to distribute a portion
of its working capital to its shareholders or borrow funds to make required
distributions in years in which on a tax basis the "non-cash" items of income
(such as those resulting from the accretion of market discount on the assets
owned by the Company) exceed the Company's "non-cash" expenses. If the Company
is unable to pay distributions equal to substantially all of its REIT Taxable
Income, it will not continue to qualify as a REIT.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are qualified in their entirety
by, and should be read in conjunction with, the financial statements and notes
thereto appearing elsewhere in this Annual Report on Form 10-K. The data as of
and for the years ended December 31, 1998, 1997 and 1996 have been derived from
the Company's financial statements which are included elsewhere in this Annual
Report on Form 10-K.
24
<PAGE>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA 1998 1997 1996 1995 1994
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income
Interest Income on Mortgage Certificates $ 2,602 $6,059 $ 7,748 $ 13,735 $18,298
Interest Income on Residual Interests 22 39 52 1,483 3,650
Income from IO Bonds 171 360 455 1,128 2,208
Income from Commercial
Securitizations -- -- -- 89 51
Interest on Short-term Investments 8 2 16 115 126
Gain (Loss) on Sales of
Mortgage Related Assets (216) 442 450 (2,385) 0
Loss on Redemption of Investment Asset (198) -- -- -- --
Loss on Sales of Real Property (157) -- -- -- --
Valuation Reserve Reduction (Provision) 210 1,474 651 541 (398)
Loss from Real Estate Operations (269) (261) (171) (289) 0
Other Income 4 11 21 30 60
-------- ------ ------- -------- -------
Total Income 2,177 8,126 9,222 14,447 23,995
Expenses
Interest Expense on CMOs 3,010 6,549 8,317 14,749 18,987
Interest Expense on Short-term Debt 125 174 159 429 509
Loss on other than temporary
impairment of assets 2,073 -- -- -- --
Amortization of Deferred Bond
Issuance Costs 80 101 146 276 351
Administrative and
Management Expenses 1,323 1,511 1,503 1,572 1,611
-------- ------ ------- -------- -------
Total Expenses 6,611 8,335 10,125 17,026 21,458
Minority Interest Share of Loss (298) -- -- -- --
-------- ------ ------- -------- -------
Net Income (Loss) ($ 4,136) ($ 209) ($ 903) ($ 2,579) $ 2,537
Basic Net Income (Loss) Per Share ($ 0.51) ($ 0.03) ($ 0.11) ($ 0.32) $ 0.31
======= ======= ======== ========= =======
Distributions Declared per Share $ 0.002 $ 0.00 $ 0.02 $ 0.00 $ 0.02
Weighted Average Shares Outstanding 8,106 8,106 8,106 8,106 8,106
- - --------------------------------------------------------------------------------------------------------------------------
</TABLE>
25
<PAGE>
SELECTED FINANCIAL DATA (CONTINUED)
<TABLE>
<CAPTION>
(IN THOUSANDS) DECEMBER 31
------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Mortgage Certificates, net $ -- $60,433 $ 72,703 $109,752 $163,817
Residual Interests 284 384 436 725 8,675
IO Bonds 840 1,875 2,695 3,150 9,794
Commercial Securitizations 184 184 183 191 1,194
Reserve for Loss on Investments -- (1,523) (2,997) (4,277) (4,818)
Operating Real Estate Assets, Net 20,172 28,697 28,945 29,384 395
Total Assets 25,056 93,754 105,573 145,247 188,957
Accounts Payable and Accrued
Liabilities 1,807 870 448 561 252
Notes Payable on Real Estate 13,794 20,350 20,373 20,362 0
Short-term Debt 667 2,010 2,418 2,118 8,325
Total Liabilities 16,268 83,125 94,555 133,266 172,864
Total Shareholders' Equity 8,788 10,629 11,018 11,981 16,093
- - ---------------------------------------------------------------------------------------------------------------------
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company commenced operations on August 26, 1988 in connection with
its initial public offering of 8,100,000 shares of Common Stock.
Subsequent to 1994, the Company has sold the majority of its
investments in Structured Securities and, during 1995, acquired a portfolio of
four income-producing residential real estate properties of which one was sold
during 1998. In February of 1999, the Company acquired two shopping centers in
Northern California. The Company expects that the majority of its ongoing
assets and selective development opportunities. Additionally, the Company
plans to seek selective opportunities for development. However, there can be
no assurance that this will occur.
26
<PAGE>
The following table illustrates the Company's cash receipts, disbursements
and reinvestments for the last three years.
<TABLE>
<CAPTION>
CASH FLOW ANALYSIS
(IN THOUSANDS) 1998 1997 1996
- - ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Beginning Cash Balance $ 185 $ 82 $ 198
Cash Received:
Mortgage Related Assets 1,124 1,633 2,758
Sale of Mortgage Related Assets 1,888 442 450
Sale of Real Estate Assets 1,584 -- --
Deposit from Trustee 1,218 -- --
Increase in Short-term Debt -- 0 300
Increase in Real Estate Notes -- 17,400 11
Decrease in Other Assets -- 115 --
Cash Disbursements:
Cash Expenses (1,191) (1,173) (2,483)
Additions to Real Estate Assets (426) (483) (258)
Increase in Other Assets -- -- (732)
Distributions (16) -- (162)
Decrease to Short-term Debt (1,343) (408) --
Decrease in Real Estate Notes (256) (17,423) --
- - ------------------------------------------------------------------------------------------------------------
Ending Cash Balance $ 2,767 $ 185 $ 82
============================================================================================================
</TABLE>
RESULTS OF OPERATIONS
The Company had a net loss of $4,136,000, or $0.51 per share, for the
year ended December 31, 1998. For the year ended December 31, 1997 it had a net
loss of $209,000, or $0.03 per share. For the year ended December 31, 1996, it
had a net loss of $903,000, or $0.11 per share. The Company declared
distributions totaling $16,000, or $.002 per share, and $162,000, or $0.02 per
share, for the years 1998 and 1996, respectively. No distributions were declared
for 1997.
1998 COMPARED TO 1997
1998 was the third full year of the Company's real estate operations. River
Oaks was sold in the fourth quarter of 1998 to increase the Company's liquidity.
The income from operations before depreciation and amortization decreased from
$479,000 in 1997 to $360,000 in 1998. The decline in 1998 income is due to a
$157,000 loss on the sale of the River Oaks property. Rental and other income
increased $64,000 or 1.6% from $3,987,000 in 1997 to $4,051,000 in 1998.
Operating and Maintenance Expenses increased $109,000 or 8.12% from $1,342,000
in 1997 to $1,451,000 in 1998. Occupancy at the Company's properties improved
from 96% in 1997 to 97.5% in 1998.
Net interest margin (interest income from Mortgage Certificates net of
interest expense on CMOs) increased in 1998 to a net interest expense of
$408,000 from net interest expense of $490,000 in 1997. This decrease in net
interest income and expense is due primarily to the principal reductions in the
Company's investment in CMOT 28 that was ultimately sold in 1998.
27
<PAGE>
Below is a summary of net interest margin for the years ended December 31,
1998 and 1997.
<TABLE>
<CAPTION>
(In thousands) 1998 1997 Change
-------------------- -------------------- --------------------
<S> <C> <C> <C>
Interest Income from Mortgage Certificates $ 1,547 $ 5,845 ($4,298)
Amortization of Market Discount 1,055 214 841
-------------------- -------------------- --------------------
Net Interest Income 2,602 6,059 ($3,457)
-------------------- -------------------- --------------------
Interest Expense on CMOs (713) 5,793 (6,506)
Amortization of Original Issue Discount 3,723 756 2,967
-------------------- -------------------- --------------------
Net Interest Expense 3,010 6,549 (3,539)
-------------------- -------------------- --------------------
Net Interest Margin (Deficit) ($ 408) ($ 490) $ 82
==================== ==================== ====================
</TABLE>
The reserve for loss on investments was reduced by $1,523,000 in 1997 as
a result of the sale of CMOT 28.
General and Administrative expense decreased from $1,443,000 in 1997 to
$1,289,000 in 1998. This decrease was due primarily to decreased expenses
related to the omission of the 1998 annual meeting of stockholders.
During 1998, the Company determined that the yield on two of its
mortgage related assets was less than the risk free rate versus the amortized
cost basis of the assets. Therefore the Company recognized a loss of $2,073,000
in the income statement to bring amortized cost down to fair value. In
addition, one of the Company's mortgage investments was retired prior to its
maturity as part of an optional redemption of the entire bond series. This
retirement resulted in a loss of $198,000 which was recorded in 1998.
Additionally, the Company sold its interest in CMOT-28 during 1998 which also
resulted in the Company taking a non-cash writedown of $567,000 for recognition
of previously unrealized losses.
1997 COMPARED TO 1996
1997 was the second full year of the Company's real estate operations.
The performance of the real estate properties was virtually flat from 1996 to
1997 with the exception of the amortization of loan costs related to the
refinancing of properties accomplished during 1997. The income from operations
before depreciation and amortization declined from $534,000 in 1996 to $479,000
in 1997 The decrease is a result of the loan amortization expense related to
the 1997 refinancing. Rental and other income declined from $3,990,000 in 1996
to $ 3,987,000 in 1997. while Operating and Maintenance Expenses declined from
$1,388,000 in 1996 to $1,342,000 in 1997. Occupancy at the Company's properties
was improved in 1996 over 1995 to approximately 96% and remained constant at
approximately 96% during 1997.
Net interest margin (interest income from Mortgage Certificates net of
interest expense on CMOs) increased in 1997 to a net interest expense of
$490,000 from net interest expense of $569,000 in 1996. This decrease in net
interest expense is due primarily to the principal reductions in the Company's
investment in CMOT 28.
28
<PAGE>
Below is a summary of net interest margin for the years ended December 31,
1997 and 1996.
<TABLE>
<CAPTION>
(In thousands) 1997 1996 Change
-------------------- -------------------- -------------------
<S> <C> <C> <C>
Interest Income from Mortgage Certificates $ 5,845 $ 7,433 $(1,588)
Amortization of Market Discount 214 315 (101)
Net Interest Income 6,059 7,748 (1,689)
-------------------- -------------------- -------------------
Interest Expense on CMOs 5,793 7,343 (1,550)
Amortization of Original Issue Discount 756 974 (218)
Net Interest Expense 6,549 8,317 (1,768)
-------------------- -------------------- -------------------
Net Interest Margin ($ 490) ($ 569) $ 79
==================== ==================== ===================
</TABLE>
The reserve for loss on investments was reduced by $1,474,000 in 1997.
This decrease in reserve primarily reflects an increase in the fair value of the
Company's investment in CMOT 28, the Company's remaining consolidated equity
residual interest.
General and Administrative expense increased from $1,356,000 in 1996 to
$1,443,000 in 1997. This increase was due primarily to increased legal and
other expenses related to the 1997 annual meeting of shareholders.
NET INTEREST INCOME ANALYSIS
<TABLE>
<CAPTION>
1998 1997 1996
-----------------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
(IN THOUSANDS) INTEREST BALANCE RATE INTEREST BALANCE RATE INTEREST BALANCE RATE
- - -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income
Mortgage Certificates $2,602 27,263 9.54% $6,059 $66,568 9.10% $ 7,748 $74,316 10.43%
Residual Interests 22 365 29.32% 39 410 9.51% 52 575 9.03%
Interest Only Bonds 171 1,197 14.29% 360 2,285 15.75% 455 2,998 15.19%
Other 8 2,106 0.3% 2 1,853 0.11% 16 2,645 0.61%
- - -----------------------------------------------------------------------------------------------------------------------
Interest Income 2,803 30,931 9.34% 6,460 71,116 9.08% 8,271 80,534 10.27%
Interest Expense
Collateralized Mort-
gage Obligations 3,010 23,038 10.71% 6,549 64,634 10.13% 8,317 86,473 9.62%
Short-term Debt 125 1,181 10.58% 174 2,214 7,86% 159 2,145 7.44%
- - -----------------------------------------------------------------------------------------------------------------------
Interest Expense 3,135 24,219 12.94% 6,723 66,848 10.06% 8,476 88,618 9.56%
Net Interest Loss (332) (0.82%) ($ 263) (0.37%) ($ 205) (0.25%)
- - -----------------------------------------------------------------------------------------------------------------------
</TABLE>
The table above summarizes the amount of interest expense, the average amounts
outstanding of interest-bearing assets and liabilities, and the average
effective interest rates.
29
<PAGE>
The table below summarizes the amount of change in interest income and interest
expense due to changes in interest rates versus changes in volume.
<TABLE>
<CAPTION>
1998- 1997 1997 - 1996 1996 - 1995
------------------- --------------------------- ----------------------------
(In thousands) Rate VOLUME TOTAL RATE VOLUME TOTAL RATE VOLUME TOTAL
- - --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income
Mortgage Certificates (780) (2,676) (3,456) ($ 881) ($ 808) ($1,689) $ 1,849 ($7,836) ($5,987)
Residual Interests (12) (5) (17) 2 (15) (13) (644) (787) (1,431)
Interest Only Bonds (51) (139) (190) 13 (108) (95) (90) (582) (672)
Other 6 0 6 (9) (5) (14) (135) (54) (189)
- - -------------------------------------------------------------------------------------------------------------
Interest Income (837) (2,820) (3,657) (875) (936) (1,811) 980 (9,259) (8,279)
Interest Expense
CMOs (625) (2,915) (3,540) (763) (5,669) (6,432) 1,430 (5,668) (4,238)
Short-term Debt 36 (85) (49) (7) (263) (270) (715) 635 (80)
- - -------------------------------------------------------------------------------------------------------------
Interest Expense (589) (3,000) (3,589) (770) (5,932) (6,702) (307) (5,033) (4,318)
Net Interest Income $(248) $ 180 $ (68) $1,750 ($3,327) ($1,577) ($ 1,375) ($2,090) ($3,465)
- - -------------------------------------------------------------------------------------------------------------
</TABLE>
OUTLOOK
The Company has determined that it will direct its future investments
principally to multifamily residential properties, family shopping centers and
development opportunities. With regard to real estate investments, the
acquisition strategy of the Company is to identify communities with an expanding
employment base and demographics which will continue to provide economic growth.
After identifying communities with a strong potential economic growth, the
Company attempts to seek out those areas within a chosen community which are
most likely to be positively affected by the economic growth of the community.
Finally, the property sought for purchase within a given area is chosen because
it is considered to be among the highest quality properties in that area and can
be purchased below replacement cost. Management believes that this strategy
will allow income from each of the properties to rise before the properties
encounter significant competition from new construction, however, there can be
no assurance that this will happen.
The Company has generated significant tax loss carryforwards from losses
experienced over the last several years. Should the Company's real estate
acquisitions be successful, the Company would be in a tax position to have the
right, but not the obligation, to continue to use cash flows to rebuild its
investment portfolio prior to resuming taxable dividend payments.
SUBSEQUENT EVENTS
EXCHANGE OF SHARES FOR NOVATO MARKETS. On February 2, 1999, the Company
acquired all the shares of Novato Markets, Inc. ("Novato") from Pacific
Securitization, Inc., ("Pacific") in exchange for 1,613,070 shares of Common
Stock of the Company pursuant to an Agreement and Plan of Reorganization dated
as of February 1, 1999, between the Company and Pacific. Pacific is indirectly
principally owned by Lorraine O. Legg, the President and Chief Executive Officer
and a director of the Company, and Patricia M. Howe, a director of the Company.
The Company's acquisition of Novato was approved by the Company's Board of
Directors. Through a wholly-owned subsidiary, Novato owns a shopping center
located in Rohnert Park, California, named Mountain Shadows Plaza, and a
shopping center subject to a ground lease in Petaluma, California, named Midtown
Center. The shopping centers have a combined
30
<PAGE>
commercial and retail space totaling approximately 80,000 square feet. Mountain
Shadows Plaza consists of three buildings and is anchored by a large grocery
store. Midtown Center consists of a single building. The Company intends to
continue operating the shopping centers.
The Shares were issued to Pacific under an exemption to the registration
requirements of the Securities Act of 1933, as amended. Accordingly, the Shares
are "restricted securities," as defined in Rule 144 of the Securities Act, and
are not freely transferable. The Company granted Pacific one-time demand
registration rights with respect to the Shares for the period beginning June 30,
1999 and ending February 2, 2001. It also granted Pacific piggy-back
registration rights in the event that the Company files a registration statement
under the Securities Act in connection with the proposed offer and sale for cash
of shares of Common Stock by it or by any of its shareholders. The share
exchange is intended to be a tax free reorganization within the meaning of
Section 368(a)(1) of the Internal Revenue Code of 1986, as amended. Prior to
the closing of the share exchange, Novato caused its wholly-owned subsidiary to
transfer to Pacific all its rights under a lease, with option to purchase, with
Ignacio Properties, LLC, relating to the Ignacio Center in Novato, California,
and Pacific agreed to assume all the obligations of the subsidiary under the
lease and option. The Company, Novato, Novato's wholly-owned subsidiary and
Pacific then entered into an agreement dated as of February 1, 1999, whereby the
parties clarified their respective rights and obligations relating to the
Ignacio Property and the Company's rights to an escrow established when Pacific
originally acquired Novato.
SHARE PURCHASE FROM TURKEY VULTURE FUND XIII, LTD. On February 2, 1999,
the Company acquired 793,700 shares of its Common Stock from Turkey Vulture Fund
XIII, Ltd. for $1,984,250, 20,000 shares of its Common Stock from Christopher L.
Jarratt for $40,000 and 12,000 shares of its Common Stock from James G. Lewis
for $24,000, pursuant to an Agreement dated as of February 1, 1999, among the
Company, Turkey Vulture Fund, Richard M. Osborne, Third Capital, LLC, Mr.
Jarratt and Mr. Lewis. Turkey Vulture Fund, Third Capital and Messrs. Osborne,
Jarratt and Lewis agreed that, for a period of seven years, they will not
directly or indirectly, among other things, (i) effect or participate in or in
any way assist any other person in effecting or participating in (a) any
acquisition of securities or rights to acquire securities or assets of the
Company or its subsidiaries, (b) any tender or exchange offer, merger or other
business combination involving the Company or its subsidiaries, (c) any
liquidation or other extraordinary transaction with respect to the Company or
its subsidiaries, or (d) any solicitation of proxies or consents to vote any
voting securities of the Company; (ii) form or in anyway participate in a
"group" with respect to the Company; (iii) otherwise act, alone or in concert
with others, to seek to control or influence the management, Board of Directors
or policies of the Company or its subsidiaries; (iv) take any action to compel
the holding of an annual or special meeting of stockholders; or (v) enter into
any discussions or arrangements with any person relating to the foregoing. The
parties also agreed to a mutual general release of all claims arising out of or
relating to the business or affairs of the Company or the ownership of its
stock. Messrs. Osborne, Jarratt and Lewis resigned from the Company's Board of
Directors, effective February 2, 1999. This share purchase and the acquisition
of Novato were approved by the Company's Board of Directors and, specifically,
by directors with no financial interest in either transaction. The disinterested
directors required that the share exchange transaction be closed as a condition
to closing the share purchase transaction.
31
<PAGE>
APPOINTMENT OF NEW DIRECTORS. On February 5, 1999, the Company's Board of
Directors appointed Anthony H. Barash and J. David Schemel to fill two vacancies
on the Board. Mr. Barash is the Senior Vice President, Corporate Affairs, and
General Counsel of Bowater Incorporated, a paper and forest products company. He
is responsible for Bowater's legal matters, corporate communications and
governmental affairs. Prior to joining Bowater in April 1996, Mr. Barash was a
partner in the Los Angeles office of Seyfarth, Shaw, Fairweather & Geraldson, a
national law firm, where he was a member of the firm's Business Law and Real
Estate Group. Mr. Schemel has been the Managing Member of Vista Marin, LLC, the
owner and manager of an office building in Redwood City, California since 1998,
the Managing Member of David Schemel Development and Investments, LLC, an owner
of apartment buildings in San Francisco and on the San Francisco Peninsula since
1988, and a Managing Member of Oxford Associates, LLC, a residential home
developer, since 1996. From 1988 to 1994, Mr. Schemel was also a Vice President
of TRI Commercial Real Estate, for which he managed various workout
transactions.
SALE OF FNMA SERIES 92-123 S. On March 4, 1999, the Company sold its
interest in its IO Bond, FNMA Series 1992-123 S for $782,879. In conjunction
with this sale, the Company retired short term debt of approximately $616,000.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financial statements have been presented on the going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. In April 1999, the Company
obtained a $1,000,000 revolving line of credit from the Former Manager of the
Company for working capital purposes. In addition to the TIS Line, management
is currently evaluating the Company's alternatives to fund its fiscal 1999 cash
requirements. Such alternatives include, among other things, consideration of
(i) the sale of real property, (ii) the sale of Structured Securities, (iii)
reducing general and administrative expenses, (iv) refinancing existing debt,
and (v) entering into joint venture arrangements with third parties. Management
can provide no assurances as to the timing or ultimate closure of any of these
alternatives. These strategies are dependant on the economic operating
environment including volatility of interest rates and the ability for the
California Central Valley apartment rental market to absorb rental increases.
The Company believes that the proceeds from the TIS Line, together with its
on-going real estate operations and mortgage related investment portfolio will
provide sufficient liquidity for it to continue as a going concern throughout
1999, however, management can provide no assurance with regard thereto. The
accompanying financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities or any other adjustments that might result from
these uncertainties.
At December 31, 1998, the Company had cash and cash equivalents of
$2,767,000 and current liabilities excluding debt principal maturities of
approximately $2,474,000. In addition the Company incurred a net loss during
1998 of $4,136,000. Included in the Company's unrestricted cash and cash
equivalents at December 31, 1998, is $1.2 million relating to a deposit
inadvertently made by the trustee of one of the Company's Structured Securities.
In March 1999, the Company repaid $600,000 of such amount to the Trustee. On
March 11, 1999, the Trustee filed an action against the Company for alledged
breach of contract, common count and conversion. The Company has opposed the
action and the parties have engaged informal settlement discussions. See Item 3
Legal Proceedings.
Subsequent to year end, the Company sold one of its Structured Securities
for a sales price of $782,879 and a gain of approximately $8,000. After related
debt repayments, the Company realized net cash proceeds of approximately
$167,000 from this sale. Additionally, as discussed in Note 20 to the Company's
financial statements, in February 1999, the Company repurchased 825,700 shares
of common stock for approximately $2 million in cash and entered into an
exchange transaction resulting in the issuance of common stock for Novato
Markets. On an unaudited pro forma basis, after these transactions, the Company
has cash and cash equivalents of approximately $392,000 and current liabilities
of $1,398,000.
In April of 1999, the Company entered into a financing agreement with the
Former Manager whereby The Former Manager extended a revolving line of
32
<PAGE>
credit of $1,000,000 to the Company. The Former Manager and the Company have
common ownership and executive officers and as such are related parties. Credit
support to the Former Manager includes guaranteed loans by a bank and a board
member of the Company in support of the TIS Line to the Company. Additionally,
certain of the Company's mortgage assets are pledged as collateral for the TIS
Line. This line is to provide working capital to the Company. This revolving
line of credit is for a term of one year, is at the rate of prime plus one and
one half percent and is secured by the Company's ownership in Bankers Trust
series 1988-1 Residual Interest Certificate
The Company uses its cash flow to provide working capital to pay its
expenses and debt service, acquire other assets and, at the discretion of the
Board of Directors, to pay distributions to its shareholders. In 1998 the
Company's cash flows (in thousands) were used as follows:
<TABLE>
<S> <C>
Used in by operating activities ($ 1,037)
Provided by investing activities 13,635
Used in financing activities (10,016)
---------
Net increase in cash and cash equivalents $ 2,582
=========
</TABLE>
At December 31, 1998, the Company had outstanding short-term borrowings
totaling $667,000 which consisted of a repurchase agreement with an investment
banking firm. The repurchase agreement borrowings had a weighted average
interest rate of 7.2189%. The repurchase agreement had an initial term of one
month, is renewed on a month-to-month basis, is collateralized by one of the
Company's Residual Interests and one of the Company's IO Bonds whose fair values
approximate $840,000 and have a floating rate of interest which is tied to the
one-month LIBOR rate. In February 1999, the Company sold its investment in FNMA
Series 1992-123, Series S. Proceeds from the sale were used to repay the short-
term borrowings in full. After giving effect to the repayment of the debt, the
sale resulted in net cash proceeds to the Company of $167,000 and a realized
gain of approximately $36,000.
At December 31, 1998, the Company had outstanding borrowings secured by
multifamily real estate totaling $13,793,655. Approximately 91% of this debt had
a fixed rate of interest and 9% of the debt bears a variable rate of interest.
The weighted average interest rate at December 31, 1998 was 8.3%.
Over the twelve months ending December 31, 1999, scheduled principal
maturities on the notes payable on real estate amount to $175,684, excluding the
Shady Lane variable note, on which $145,186 is due in principal and interest in
1999. The notes are expected to be funded by cash flows from the Company's
multifamily residential properties. In conjunction with the acquisition of all
of the shares of Novato Markets, Inc. in February 1999, the Company acquired two
family shopping centers in Rohnert Park, California and Petaluma, California.
The properties are currently subject to temporary financing as a result of the
previous owner acquisition and serve collateral for such financing. The notes
currently bear interest at 15% of which 10% is paid currently and 5% is added to
the principal of the note. The notes do not have scheduled principal payments.
Note payments are expected to be funded by cash flows from the underlying
properties. The Company intends to continue operating the shopping centers and
is in the process of obtaining permanent financing.
The Company has no significant commitments for capital expenditures
relating to the real estate operations over the twelve months ended December 31,
1999 and anticipates that any capital expenditures or repair and maintenance
activities would be funded from cash generated from real estate activities. The
Company expects to commence construction on 126 units of apartments to be built
on the ten acres of land adjacent to the Villa San Marcos Apartments in Fresno,
California. This construction is expected to be funded by a construction loan.
YEAR 2000 COMPLIANCE
33
<PAGE>
STATE OF READINESS. The Company utilizes a number of computer software
programs and operating systems across its entire organization, including
applications used in financial business systems and various administrative
functions. To the extent that the Company's software applications contain source
code that is unable to appropriately interpret the upcoming calendar year "2000"
and beyond, some level of modification, or replacement of such application will
be necessary. The Company is in the process of identifying applications that are
not yet "Year 2000" compliant.
COSTS OF ADDRESSING THE COMPANY'S YEAR 2000 ISSUES. Given information known
at this time about the Company's systems that are non-compliant, coupled with
the Company's ongoing, normal course-of-business efforts to upgrade or replace
critical systems as necessary, management does not expect Year 2000 compliance
costs to have any material adverse impact on the Company's liquidity or ongoing
results of operations.
RISKS OF THE COMPANY'S YEAR 2000 ISSUES. No assurance can be given,
however, that all the Company's systems will be Year 2000 compliant or that
compliance costs or the impact of the Company's failure to achieve substantial
Year 2000 compliance will not have a material adverse impact on the Company's
future liquidity or results of operations.
THE COMPANY'S CONTINGENCY PLAN. Management has identified manual operating
procedures for critical operations to address the most reasonably likely worst
case scenarios regarding Year 2000 compliance.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Ownership of shares of the Company's Common Stock is subject to certain
risks. The Company's earnings from its multifamily residential properties and
shopping centers will depend upon maintaining rental income that exceeds the
Company's interest and other costs. Rental income, in turn, will depend upon the
rental market and rates of occupancy. Long-term profits will depend upon an
appreciation in the value of the residential properties. The ability of the
Company to generate income from the cash flows relating to Structured
Securities, or to minimize losses, depends, in large part, upon whether the
Company is able to respond to fluctuations in market interest rates and utilize
appropriate strategies.
The amount of income that may be generated from Structured Securities is
dependent upon the rate of principal prepayments on the underlying mortgages.
Lower rates of prepayments means a longer life for Residual Interests and IO
Bonds and thus higher income. Similarly, faster rates of prepayments mean a
shorter life and lower income. The rate of prepayments on mortgages is
influenced by a variety of economic, geographic, social and other factors, but
probably the most important factor is the level of prevailing mortgage rates. In
general, prepayments of Mortgage Loans are faster during periods of
substantially declining interest rates and slower during periods of
substantially increasing interest rates. During 1998, the rate of prepayments
was generally increased thereby decreasing the estimated fair value of the
Company's investment in IO Bonds and increasing the fair value of residual
interests.
34
<PAGE>
The income from Residual Interests in CMOs which include one or more bond
classes which bear interest based on specified margins in relation to either the
London Interbank Offered Rate for Eurodollars on U.S. dollar deposits ("LIBOR")
and income on Inverse IO Bonds which bear an interest rate which is inversely
related to LIBOR, may fluctuate widely depending upon changes in LIBOR which
affect the amount of interest payable on such LIBOR bonds and on Inverse IO
Bonds. In general, income on these Residual Interests and Inverse IO Bonds will
decrease when LIBOR increases, and will increase when LIBOR rates decrease.
Income on these Residual Interests and Inverse IO Bonds will also be affected by
the relationship between changes in these rates and prepayments on mortgages.
Under certain extended high interest rate periods or in the event of extremely
high prepayment rates on mortgages, the return on a Residual Interest on an IO
Bond or on an Inverse IO Bond could be zero or negative and may require the
Company to effect significant reductions in the carrying value of these assets.
Such reductions are recorded as operating losses in the year in which the
reduction is taken.
The Company has purchased Residual Interests, IO Bonds and PO Bonds of CMOs
only if the Structured Securities relating to such CMOs were rated in one of the
two highest categories by a nationally recognized rating agency. Certain
Residual Interests, IO and PO Bonds themselves are rated. The risks of ownership
of such assets, however, are substantially the same as those associated with
ownership of unrated Residual Interests and IO and PO Bonds because the rating
would not address the possibility that the Company might have a lower than
anticipated yield or, in the case of Residual Interests and IO Bonds, fail to
recover its initial investment.
There are varying degrees of risk incident to the ownership of real
estate. There are many factors which can impact the performance of real estate
including economic and demographic trends or governmental regulations which are
out of the control of the Company.
In order to maintain its status as a REIT, the Company is required to
comply with certain restrictions imposed by the Code with respect to the nature
of its assets and income, which could prevent it from making investments or from
making dispositions of investments otherwise considered desirable. The REIT
provisions of the Code require the Company to distribute substantially all of
its net taxable income on an annual basis. If the Company should not qualify as
a REIT in any tax year, it would be taxed as a regular domestic corporation, and
distributions to the Company's shareholders would not be deductible by the
Company in computing its taxable income. Any resulting tax liability could be
substantial and would reduce the amount of cash available for distributions to
shareholders. Further, the 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 four
subsequent years.
The Company's ability to use its net operating tax loss carryforwards could
be substantially reduced if the Company were to undergo an "ownership change"
within the meaning of Section 382(g)(1) of the Internal Revenue Code.
Because of these and other factors, future distributions to shareholders
cannot be predicted. The Company has the right, but not the obligation, to
refrain from making distributions to shareholders until the tax loss
carryforward is fully used. It is likely that the market price of the shares of
the Company's Common Stock would be affected by any decline in the spread
between the Company's net yield on its assets and prevailing interest rates.
35
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposure is to changes in interest rates
obtainable on its secured and unsecured mortgage borrowings and to changes in
market which impact the fair value of its Structured Securities as discussed in
Note 6 to the consolidated financial statements.
The Company manages its exposure to fluctuations in market interest rates for
its borrowings by obtaining fixed rate debt to the extent that rates available
on such arrangements are favorable to the Company. At December 31, 1998 and
1997, 9% and 7% of the Company's outstanding debt was subject to variable rates
respectively. For information about the Company's debt instruments that are
sensitive to changes in interest rates, see Note 10 to the consolidated
financial statements for detail of the fair value at December 31, 1998, related
maturity dates and interest rates. The rates disclosed in Note 10 to the
consolidated financial statements are based on rates in effect as of December
31, 1998.
The Company does not undertake any specific actions to cover its exposure to
interest rate risk and the Company is not party to any interest rate risk
management transactions.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this
Form 10-K. See Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
36
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item is incorporated by reference to the
Company's definitive Proxy Statement for its Annual Meeting of Stockholders to
be held in 1999, to be filed with the Commission within 120 days after the end
of the Company's fiscal year pursuant to General Instruction G(3) to Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to the
Company's definitive Proxy Statement for its Annual Meeting of Stockholders to
be held in 1999, to be filed with the Commission within 120 days after the end
of the Company's fiscal year pursuant to General Instruction G(3) to Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to the
Company's definitive Proxy Statement for its Annual Meeting of Stockholders to
be held in 1999, to be filed with the Commission within 120 days after the end
of the Company's fiscal year pursuant to General Instruction G(3) to Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to the
Company's definitive Proxy Statement for its Annual Meeting of Stockholders to
be held in 1999, to be filed with the Commission within 120 days after the end
of the Company's fiscal year pursuant to General Instruction G(3) to Form 10-K.
37
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K.
(A) 1. FINANCIAL STATEMENTS AND REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT
PUBLIC ACCOUNTANTS
Report of Independent Public Accountants................... 41
Consolidated Balance Sheets - December 31, 1998 and 1997... 42
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996.................. 43
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1998, 1997 and 1996...... 44
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.................. 45
Notes to the Consolidated Financial Statements............. 46
2. FINANCIAL STATEMENT SCHEDULES
Schedule III - Real Estate and Accumulated Depreciation as of
December 31, 1998....................................... 66
All other schedules are omitted because they are not required or
the required information is shown in the financial statements or
notes thereto.
38
<PAGE>
3. EXHIBITS
The following exhibits in the accompanying index to exhibits are filed
herewith or are incorporated by reference to exhibits previously
filed.
NUMBER EXHIBIT
- - ------ -------
3(a) Amended Articles of Incorporation of the Registrant (1)
3(b) Amended and Restated Bylaws of the Registrant (7)
4(a) Specimen Certificate representing $.001 par value Common Stock (1)
4(b) Dividend Reinvestment and Share Purchase Plan (2)
10(c) Custody Agreement between Registrant and Mellon Bank N.A. (3)
10(d) Transfer Agency Agreement between Registrant and Mellon Securities
Trust Company (3)
10(e) Reverse Repurchase Agreement between Registrant and Bear, Stearns
Securities Corp.(4)
10(f) Loan and Security Agreement dated July 19, 1995 between TIS Mortgage
Investment Company and Paine Webber Real Estate Securities, Inc.
(5)
10(g) Nonqualified Stock Option Agreement with John D. Boyce and Schedule of
Omitted Contracts (5)
10(h) Nonqualified Stock Option Agreement with John E. Castello and Schedule
Omitted Contracts (5)
10(i) Employment Agreement between TIS and Lorraine O. Legg. (6)
10(j) Employment Agreement between TIS and John E. Castello. (6)
10(k) Facilities and Expense Sharing Agreement (6)
10(l) Agreement and Plan of Reorganization dated as of February 1, 1999,
between TIS Mortgage Investment Company and Pacific Securitization,
Inc. (8)
10(m) Agreement dated February 1, 1999, among TIS Mortgage Investment
Company, Novato Markets, Inc., P-SUB I, Inc. and Pacific
Securitization, Inc. (8)
10(n) Agreement dated as of February 1, 1999, among TIS Mortgage Investment
Company, Turkey Vulture Fund XIII, Ltd., Richard M. Osborne, Third
Capital, LLC, Christopher L. Jarratt and James G. Lewis. (8)
21 Subsidiaries of the Registrant
24 Consent of Arthur Andersen LLP
___________________________________
(1) Incorporated herein by reference to Registrant's Registration Statement on
Form S-11 (No. 33-22182) declared effective August 19, 1988.
(2) Incorporated herein by reference to Pre-Effective Amendment No. 1 to
Registrant's Registration Statement on Form S-3 (No. 33-44526) filed with the
Securities and Exchange Commission on December 30, 1991.
(3) Incorporated herein by reference to Registrant's Annual Report on Form 10-K
(File No. 1-10004) filed with the Securities and Exchange Commission on March
30, 1992.
39
<PAGE>
(4) Incorporated herein by reference to Registrant's Annual Report on Form 10-K
(File No. 1-10004) filed with the Securities and Exchange Commission on March
30, 1993.
(5) Incorporated herein by reference to Registrant's Annual Report on Form 10-K
(File No. 1-10004) filed with the Securities and Exchange Commission on April 1,
1996.
(6) Incorporated herein by reference to Registrant's Current Report on Form 8-K
(File No. 1-10004) filed with the Securities and Exchange Commission on
July 9, 1996.
(7) Incorporated herein by reference to Registrant's Current Report on Form 8-K
(File No. 1-10004) filed with the Securities and Exchange Commission on May 29,
1997.
(8) Incorporated herein by reference to Registrant's Current Report on Form 8-K
(File No. 1-10004) filed with the Securities and Exchange Commission on February
17, 1999.
(B) REPORTS ON FORM 8-K:
During the first quarter of 1999, the Company filed a Current Report
on Form 8-K, on February 17, 1999, covering the Company's issuance of shares of
common stock to Pacific Securitization, Inc., under Item 2 of Form 8-K, and the
Company's repurchase of shares of common stock from Turkey Vulture Fund XIII,
Ltd. and its affiliates, and the appointment of new directors, under Item 5 of
Form 8-K. The Company filed an amendment to this Report, on April 5, 1999,
stating that it had determined that financial statements and pro forma financial
information on the Pacific Securitization transaction did not need to be filed
under Item 7 of Form 8-K.
40
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
TIS Mortgage Investment Company:
We have audited the accompanying consolidated balance sheets of TIS
Mortgage Investment Company (a Maryland corporation) and Subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. These consolidated financial statements and
the schedule referred to below are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and the schedule 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 financial statements referred to above present
fairly, in all material respects, the financial position of TIS Mortgage
Investment Company and Subsidiaries as of December 31, 1998 and 1997, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
Our audit was made for purposes of forming an opinion on the basic
consolidated financial statements taken as a whole. The accompanying Schedule
III - Real Estate and Accumulated Depreciation as of December 31, 1998 - is
presented for the purpose of complying with the Securities and Exchange
Commission rules and is not part of the basic consolidated financial statements.
This information has been subjected to the audit procedures applied in our audit
of the basic consolidated financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic consolidated financial
statements taken as a whole.
/s/ARTHUR ANDERSEN LLP
San Francisco, California,
April 15, 1999
41
<PAGE>
TIS Mortgage Investment Company and Subsidiaries
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
- - --------------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE DATA) DECEMBER 31, 1998 DECEMBER 31, 1997
- - --------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Mortgage Related Assets
Mortgage Certificates, net $ -- $ 60,433
Residual Interests 284 384
Interest Only (IO) Bonds 840 1,875
Commercial Securitizations 184 184
Reserve for Loss on Investments -- (1,523)
----------- -----------
Total Mortgage Related Assets 1,308 61,353
----------- -----------
Operating Real Estate Assets, net 20,172 28,697
----------- -----------
Other Assets
Cash and Cash Equivalents (Note 9) 2,767 185
Restricted Cash 140 1,800
Accrued Interest and Accounts Receivable, Net 33 484
Deferred Bond Issuance Costs, Net -- 497
Amortizable Costs, Net 351 594
Prepaid Expenses 285 144
----------- -----------
Total Other Assets 3,576 3,704
----------- -----------
Total Assets $ 25,056 $ 93,754
=========== ===========
- - --------------------------------------------------------------------------------------------------------
LIABILITIES
Collateralized Mortgage Obligations, net $ -- $ 59,008
Accounts Payable and Accrued Liabilities 473 870
Due to Trustee 1,218 --
Accrued Interest Payable 116 887
Notes Payable on Real Estate 13,794 20,350
Short-term Debt 667 2,010
----------- -----------
Total Liabilities 16,268 83,125
----------- -----------
SHAREHOLDERS' EQUITY
Common Stock, par value $.001 per share;
100,000,000 shares authorized; 8,105,880
shares issued and outstanding 8 8
Additional Paid-in Capital 74,696 74,696
Accumulated Other Comprehensive Loss (11) (2,322)
Retained Deficit (65,905) (61,753)
----------- -----------
Total Shareholders' Equity 8,788 10,629
----------- -----------
Total Liabilities and Shareholders' Equity $ 25,056 $ 93,754
=========== ===========
- - --------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
42
<PAGE>
TIS Mortgage Investment Company and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1998 1997 1996
- - ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
MORTGAGE RELATED ASSETS
Interest $ 2,803 $ 6,460 $ 8,271
Valuation Reserve Reduction 210 1,474 651
Loss on Redemption of Investment (198) -- --
Loss due to other than temporary impairment of assets (2,073) -- --
Gain (Loss) on Sales of Mortgage Related Assets (216) 442 450
Other 4 11 21
--------- ------- -------
Income from Mortgage Related Assets 530 8,387 9,393
--------- ------- -------
INTEREST AND CMO RELATED EXPENSES
Collateralized Mortgage Obligations
Interest 3,010 6,549 8,317
Administration Fees 34 68 70
Amortization of Deferred Bond Issuance Costs 80 101 146
Interest on Short-term Debt 125 174 159
--------- ------- -------
Total Interest and CMO Related Expenses 3,249 6,892 8,692
--------- ------- -------
REAL ESTATE OPERATIONS
Rental and Other Income 4,051 3,987 3,990
Operating and Maintenance Expenses (1,451) (1,342) (1,388)
Interest on Real Estate Notes Payable (1,750) (1,820) (1,718)
Property Taxes (333) (346) (350)
Depreciation and Amortization (786) (740) (705)
Loss on Sale of Property (157) -- --
--------- ------- -------
Loss from Real Estate Operations (426) (261) (171)
--------- ------- -------
OTHER EXPENSES
Management Fee to a related party -- -- 77
General and Administrative, including amounts paid
to a related party of $28,980, $37,806
and $391,198, respectively 1,289 1,443 1,356
--------- ------- -------
Loss Before Minority Interest (4,434) (209) (903)
Minority Interest Share of Loss (298) -- --
--------- ------- -------
Net Loss ($ 4,136) ($ 209) ($ 903)
========= ======= =======
- - ---------------------------------------------------------------------------------------------------------------------
Net Loss per Share ($ 0.51) ($ 0.03) ($ 0.11)
Distributions Declared per Share $ 0.002 $ 0.000 $ 0.020
Weighted Average Number of Shares Outstanding 8,106 8,106 8,106
- - ---------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
43
<PAGE>
<TABLE>
<CAPTION>
TIS Mortgage Investment Company and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- - --------------------------------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- - --------------------------------------------------------------------------------------------------------
(IN THOUSANDS) ACCUMU-
LATED
COMPRE- COMPRE-
COMMON STOCK PAID-IN RETAINED HENSIVE HENSIVE
SHARES AMOUNT CAPITAL DEFICIT INCOME TOTAL INCOME
- - ------------------------------------------------------------------------------------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance - December 31, 1995 8,106 8 74,696 (60,479) (2,244) (11,981)
Net Loss -- -- -- (903) -- (903) ($903)
Other Comprehensive Income:
Net unrealized gain on available
for sale securities, net of
reclassification adjustment -- -- -- -- 102 102 102
-----------
Comprehensive Income ($ 801)
===========
Distributions Declared - -- -- (162) -- (162)
- - -------------------------------------------------------------------------------------------
Balance - December 31, 1996 8,106 8 74,696 (61,544) (2142) 11,018
Net Loss -- -- -- (209) -- (209) $ (209)
Other Comprehensive Income:
Net unrealized gain on available
for sale securities, net of
reclassification adjustment -- -- -- -- (180) (180) (180)
-----------
Comprehensive Income ($389)
- - ------------------------------------------------------------------------------------------- ===========
Balance - December 31, 1997 8,106 8 74,696 (61,753) (2,322) 10,629
Net Loss -- -- -- (4,136) -- (4,136) ($4,136)
Other Comprehensive Income:
Net unrealized gain on available
for sale securities, net of
reclassification adjustment -- -- -- -- 2,311 2,311 2,311
-----------
Comprehensive Income ($ 1,825)
===========
Distributions Declared -- -- -- (16) -- (16)
- - -------------------------------------------------------------------------------------------
Balance - December 31, 1998 8,106 8 74,696 (65,905) (11) 8,788
===========================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
44
<PAGE>
TIS Mortgage Investment Company and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- - -----------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
--------------------------------------------------------
(IN THOUSANDS) 1998 1997 1996
- - -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss ($ 4,136) ($ 209) ($ 903)
Adjustments to Reconcile Net Loss to Net Cash
Provided by Operating Activities:
Depreciation and Amortization 1,503 1,476 1,488
(Gain) Loss on Sales of Mortgage Related Assets 216 (442) (450)
Loss on Redemption 198 -- --
Loss due to Other than Temporary Impairment 2,073 -- --
Loss on Sales of Real Estate 157 -- --
Minority interest share in net loss (298) -- --
Valuation Reserve Reduction (1,523) (1,474) (651)
Decrease (Increase) in Accrued Interest Receivable -- 88 (207)
Decrease (Increase) in Accounts Receivable 85 96 (49)
Decrease (Increase) in Prepaid Expenses (141) 19 47
Decrease (Increase) in Other Assets -- 115 (732)
Increase (Decrease) in Accounts Payable
And Accrued Liabilities 950 421 (128)
Decrease in Accrued Interest Payable (121) (169) (303)
--------- -------- --------
Net Cash Provided by (Used in) Operating Activities (1,037) (79) (1,888)
--------- -------- --------
- - -----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net Decrease (Increase) in Restricted Cash (154) (528) 899
Acquisition of Real Estate Assets -- -- --
Additions to Real Estate Assets (426) (483) (258)
Proceeds from Sale of Real Estate Assets 1,584 -- --
Principal Reduction in Mortgage Certificates 9,888 12,485 17,452
Proceeds from Sales of Mortgage Related Assets 1,888 442 450
Principal Reduction in Residual Interests 90 41 59
Principal (Increase) Reduction in Commercial Securities -- (1) 8
Principal Reduction in IO Bonds 765 652 788
--------- -------- --------
Net Cash Provided by Investing Activities 13,635 12,608 19,398
--------- -------- --------
- - -----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposit from Trustee 1,218 -- --
Increase (Decrease) in Short-term Debt (1,343) (408) 300
Principal Payments on CMOs (9,619) (11,995) (17,775)
Proceeds from Notes Payable on Real Estate -- 17,400 170
Principal Payments on Notes Payable on Real Estate (256) (17,423) (159)
Cash Distributions Paid on Common Stock (16) -- (162)
--------- -------- --------
Net Cash Used in Financing Activities (10,016) (12,426) (17,626)
--------- -------- --------
- - -----------------------------------------------------------------------------------------------------------------
Net Change in Cash and Cash Equivalents 2,582 103 (116)
Cash and Cash Equivalents at Beginning of Year 185 82 198
--------- -------- --------
Cash and Cash Equivalents at End of Year $ 2,767 $ 185 $ 82
========= ======== ========
- - -----------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
Cash Paid for CMO Interest Expense $ 3,893 $ 6,718 $ 7,638
Cash Paid for Other Interest Expense $ 1,763 $ 1,889 $ 1,886
- - -----------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
45
<PAGE>
TIS MORTGAGE INVESTMENT COMPANY AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
1. THE COMPANY
TIS Mortgage Investment Company (the "Company") was incorporated on May
11, 1988. The Company operates as a real estate investment trust (REIT) and
has, in years prior to 1995, primarily invested in structured securities
(mortgage related assets) including residual interests, principal only bonds (PO
Bonds), interest only bonds (IO Bonds) and collateralized mortgage obligations
(CMOs). Beginning in 1994, the Company changed its investment focus from
investments in structured securities to multifamily real estate located in
California's Central Valley. Accordingly, subsequent to 1994, the Company has
sold the majority of its investments in structured securities and acquired a
portfolio of four income-producing residential real estate properties (as of
December 31, 1998, three such properties remain). The Company expects that the
majority of its ongoing assets and operating results will be related to
investments in real estate and development related activities.
At December 31, 1998, the Company had cash and cash equivalents of
$2,767,000 and current liabilities excluding debt principal maturities of
approximately $2,474,000. In addition the Company incurred a net loss during
1998 of approximately $4,136,000. As discussed in Note 9, included in the
Company's unrestricted cash and cash equivalents at December 31, 1998, is $1.2
million relating to a deposit inadvertently made by the trustee of one of the
Company's Structured Securities. In March 1999, the Company repaid $600,000 of
such amount to the Trustee. On March 11, 1999, the Trustee filed an action
against the Company for alleged breach of contract, common count and conversion.
The Company has opposed the action and the parties have engaged in informal
settlement discussions. (See Note 9.)
Subsequent to year end, the Company sold one of its Structured Securities
for a sales price of $782,879 and a gain of approximately $8,000. After related
debt repayments, the Company realized net cash proceeds of approximately
$167,000 from these sales. Additionally, as discussed in Note 20, in February
1999, the Company repurchased 825,700 shares of common stock for approximately
$2 million in cash and entered into an exchange transaction resulting in the
issuance of common stock for Novato Markets. On an unaudited pro forma basis,
after these transactions, the Company has cash and cash equivalents of
approximately $392,000 and current liabilities of $1,398,000.
Additionally, subsequent to year-end, the Company has obtained a
$1,000,000 revolving line of credit from the former manager (the "Former
Manager") for working capital purposes (the "TIS Line"). The Former Manager and
the Company have common ownership and executive officers and as such are related
parties. Credit support to the Former Manager includes guaranteed loans by a
bank and a board member of the Company in support of the TIS Line to the
Company. Additionally, certain of the Company's mortgage assets are pledged as
collateral for the TIS Line. (See Note 20.)
The Company's financial statements have been presented on the going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. In addition to the TIS Line,
Management is currently evaluating the Company's alternatives to fund its fiscal
1999 cash requirements. Such alternatives include, among other things,
consideration of (i) the sale of real property, (ii) the sale of Structured
Securities, (iii) reducing general and administrative expenses, (iv) refinancing
existing debt, and (v) entering into joint venture arrangements with third
parties. Management can provide no assurances as to the timing or ultimate
closure of any of these alternatives. These strategies are dependent on the
economic operating environment including the volatility of interest rates and
the ability for the California Central Valley apartment rental market to absorb
rental increases. The Company believes that the proceeds from the TIS Line,
together with its on-going real estate operations and mortgage related
investment portfolio will provide sufficient liquidity for it to continue as a
going concern throughout 1999, however, management can provide no assurance with
regard thereto. The accompanying financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amounts and classification of liabilities or any other
adjustments that might result from these uncertainties.
46
<PAGE>
OVERALL METHODS OF ACCOUNTING - Emerging Issues Task Force Issue 89-4,
subsequently modified by issue 93-18, specifies the method of accounting for
Residual Interests in collateralized mortgage obligations ("CMOs"). Issue 89-4,
among other things, required Residual Interests to be classified either as
"equity" (and be accounted for under the Equity Method) or as "nonequity" (and
be accounted for under a level yield method referred to as the Prospective
Method). The methods described in Issue 89-4 are essentially the same as those
used by the Company.
The Company has classified all of its investments in mortgage related
assets as available-for-sale investments, carried at fair value in the financial
statements. Unrealized holding gains and losses, excluding unrealized losses
considered to be other than temporary, for available-for-sale investments are
excluded from earnings and reported as a net amount in shareholders' equity
until realized.
All of the Company's investments in mortgage related assets are subject
to write down whenever the yield on the projected cash flows is less than a risk
free rate. If the yield on the projected cash flows is less than a risk free
rate, the decline in value is considered to be "other than temporary" and the
investment is written down to its fair value as the new cost basis. The amount
of the write down is included in the Company's current earnings (i.e. accounted
for as a realized loss).
For purposes of evaluating impairment the Company considers its
investment in each of its equity residuals to be a net cash flow investment (net
of CMO bond interest payments and related CMO bond administrative expenses).
The Company measures other than temporary impairment by comparing the yield on
the projected net cash flows from the equity residual, (i.e. Mortgage
Certificates net of discounts and CMO bond liabilities) to a risk free rate. If
the yield on the projected cash flows from the equity residual is less than a
risk free rate, the Company records a reserve to reduce the carrying value to
fair value. The fair value is calculated using the forecasted net cash flows
discounted at a risk adjusted rate. The risk adjusted rate is determined by the
Company using established market transactions for securities having similar
characteristics and backed by collateral of similar rate and term.
For investments in mortgage assets which do not meet the definition of
other than temporary impairment, the Company has recorded cumulative net
unrealized losses of $11,559 and 2,322,000 as of December 31, 1998 and 1997,
respectively, directly to equity.
FAIR VALUE OF FINANCIAL INSTRUMENTS - Based on the borrowing rates
currently available to the Company, the carrying amount of its debt approximates
fair value. The carrying amount of cash and cash equivalents approximates fair
value.
PRINCIPLES OF CONSOLIDATION - The Company's consolidated financial
statements present the results of operations of the Company, its wholly-owned
subsidiary, TIS Property Acquisition Company ("TISPAC"), a Maryland corporation,
incorporated on September 8, 1995 for the purpose of owning and financing real
property, and the accounts underlying the Company's interest in real estate
partnerships for the years ended December 31, 1995 and thereafter. In March
1997, as part of the refinancing of two of the Company's multifamily residential
properties and a portion of the Four Creeks property, title to those properties
was vested in TISPAC. Simultaneously, in March 1997, TISPAC entered into notes
secured by mortgages on those properties. TISPAC is a Qualified REIT
Subsidiary.
47
<PAGE>
In 1996, the Company sold its economic interest in TMAC CMO Trust 1986-1
through the sale of the residual interest certificate and optional redemption
rights in the underlying trust. As a result, the accounts of TMAC CMO Trust
1986-1 are not included in the consolidated balance sheets at December 31, 1996
and 1997 and the results of operations of the trust are included in the 1996
consolidated statement of operations only through the date of sale.
In 1998, the Company sold its economic interest in CMOT-28 through the
sale of the residual interest certificate and optional redemption rights in the
underlying trust. As a result, the accounts of CMOT-28 are not included in the
consolidated balance sheets at December 31, 1998 and the results of operations
of the trust are included in the 1998 consolidated statement of operations only
through the date of sale.
MORTGAGE CERTIFICATES AND CMOS - Mortgage certificates and CMO bonds of
consolidated Owner Trusts are carried at their outstanding principal balance
plus or minus any premium or discount, respectively.
AMORTIZATION OF PREMIUMS AND DISCOUNTS - Premiums and discounts related
to mortgage certificates and CMOs are amortized to income using the interest
method over the stated maturity of the mortgage certificates or CMOs. Residual
Interests held in bond form and Corporate Real Estate Mortgage Investment
Conduit ("REMIC") Residual Interests, regardless of percentage ownership, are
Nonequity Residual Interests and, along with IO Bonds, are accounted for under
the Prospective Method. Under this method, assets are carried at book value and
income is amortized over their estimated lives based on a method which provides
a constant yield. At the end of each quarter, the yield over the remaining life
of the asset is recalculated based on expected future cash flows using current
interest rates and mortgage prepayment speeds. This new yield is then used to
calculate the subsequent quarter's financial statement income.
CAPITALIZED LOAN FEES - Capitalized loan fees are amortized as interest
expense over the term of the related debt.
OPERATING REAL ESTATE ASSETS - The Company values operating real estate
assets at cost unless circumstances indicate that cost cannot be recovered, in
which case carrying value is reduced to estimated fair value. In management's
opinion, as of December 31, 1998, the carrying value of real estate assets did
not exceed their estimated fair value.
Operating real estate assets are depreciated using the straight-line
method over the estimated useful lives of the real estate assets. The Company
uses a 40 year estimated life for buildings and improvements and either a 5 or
12 year life for personal property depending on the nature of the asset.
Significant expenditures that improve or extend the useful life of the asset are
capitalized and depreciated over their estimated useful lives.
All leases of real estate assets are classified as operating leases.
Rental income is recognized when contractually due based on the terms of signed
lease agreements which range in duration from month-to-month to one year.
48
<PAGE>
RESTRICTED CASH - Restricted cash as of December 31, 1998 and 1997
includes cash balances totaling $0 and $1,608,558, respectively, of CMOs in
which the Company holds a Residual Interest and whose assets and liabilities are
consolidated with those of the Company. This cash is not available to the
Company or its creditors. Additionally, restricted cash as of December 31, 1998
and 1997 includes $140,000 and $191,538 respectively, in property tax and
insurance impound accounts required under the terms of certain notes payable on
real estate.
INCOME TAXES - The Company has elected to be taxed as a REIT under the
Internal Revenue Code of 1986, as amended. As a REIT, the Company must
distribute at least 95% of its taxable income to its shareholders. No provision
has been made for income taxes in the accompanying consolidated financial
statements as the Company is not subject to Federal income taxes. The loss
reported in the accompanying consolidated financial statements may be greater or
less than the taxable loss because some income and expense items are reported in
different periods for income tax purposes. Over the life of a Residual Interest
or IO Bond, total taxable income will equal total financial statement income.
However, the timing of income recognition may differ between the two from year
to year.
BASIC NET LOSS PER SHARE - Basic net loss per share is based upon the
weighted average number of shares of Common Stock outstanding for 1998, 1997,
and 1996, 8,105,880 shares each year, respectively. The potential common shares
related to the 1995 Stock Option Plan (see Note 15) are antidilutive in 1998,
1997 and 1996, and therefore are not included in the weighted average number of
shares outstanding. The number of antidilutive potential common share amounts
in 1998, 1997 and 1996 were 342,000, 347,000 and 342,000 respectively. The
Company adopted Statement of Financial Accounting Standards (SFAS) No. 128 -
Earnings Per Share, effective January 1, 1977. The adoption of SFAS No. 128
resulted in no change to the Company's historical manner of calculating earnings
per share.
STATEMENT OF CASH FLOWS - For purposes of the statement of cash flows,
the Company considers only highly liquid instruments with original maturities of
three months or less to be cash equivalents.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS - The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Examples of such
estimates include prepayment speeds on principal payments of Mortgage Loans and
interest rates. Actual results could differ from those estimates. Refer to
Note 6 regarding assumptions related to the determination of fair value of
certain Structured Securities.
NEW ACCOUNTING PRONOUNCEMENT - Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" is expected to be adopted by the Company effective January 1, 2000.
This statement establishes standards for accounting for derivative instruments
and requires that an entity recognize derivatives as assets or liabilities in
the statement of financial position and measure those assets and liabilities at
fair value. Management has not fully assessed the impact of adoption of the
statement but does not anticipate it will have a significant impact on the
presentation of the Company's statements of financial position.
49
<PAGE>
The Company paid distributions of $0.002 per share and $0.02 per share in
the years ended December 31, 1998 and 1996, respectively. There were no
distributions paid by the Company in 1997. Of the 1998 distribution, 40.28% was
taxable and considered "excess inclusion" income. Of the 1996 distribution,
47.19% was taxable and was also considered "excess inclusion" income
Excess inclusion income is attributable to Residual Interests for which
an election has been made to be treated as a REMIC for Federal income tax
purposes. The portion of the Company's distributions determined to be excess
inclusion income is taxable to certain otherwise tax-exempt shareholders as
unrelated business income. Except for certain entities such as savings and loan
associations, the portion of the distribution considered excess inclusion income
may not be offset by any deductions or losses, including net operating losses.
4. RESIDUAL INTERESTS
General - Each CMO in which the Company has purchased a Residual Interest
was rated at the time of its issuance "AAA" by Standard & Poor's Corporation or
"Aaa" by Moody's Investors Service, Inc. Each such CMO was comprised of one or
more classes of bonds (each, a "Bond Class") and was issued pursuant to an
Indenture between the CMO issuer and a specified trustee. Each CMO was
structured so that the principal and interest payments received from the
collateral pledged to secure such CMO, together with reinvestment income
thereon, would be sufficient, irrespective of the rate of prepayments on the
collateral, to make timely payments of interest on each Bond Class, to begin the
payment of principal on each Bond Class not later than its "first mandatory
principal date" and to retire each Bond Class not later than its "stated
maturity."
Residual Interests are classified as either equity or nonequity.
Presented in the following table is a schedule of the Nonequity Residual
Interests and the Prospective Method yield at December 31, 1998.
NONEQUITY RESIDUAL INTERESTS
- - ----------------------------
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Book Value Prospective
Residual Purchase December 31, Method
--------------------------------------
Series Price 1998 1997 Yield
- - ---------------------------------------------------------------------------------------------------------------
Nonequity Residual Interests
- - -----------------------------------
<S> <C> <C> <C> <C>
BT 88-1 $1,537 $ 176 $ 179 14.0%
LFR-9 2,589 89 94 14.0%
CMSC I 8,642 14 104 14.0%
FHLMC 25 4,934 3 4 14.0%
FHLMC 21 5,361 2 3 14.0%
- - ---------------------------------------------------------------------------------------------------------------
$ 284 $ 384
- - ---------------------------------------------------------------------------------------------------------------
</TABLE>
During 1998, the Company recorded a loss due to other than temporary
impairment of its investment in Nonequity Residual Interest of $90, triggered by
the decline in the yield on certain investments below the risk-free rate.
50
<PAGE>
SECURITIZED RESIDUALS AND CORPORATE REMIC RESIDUAL INTERESTS - Both Residual
Interests held in bond form and Corporate REMIC Residual Certificates are
Nonequity Residual Interests and are accounted for under the Prospective Method
as described in Note 2. Certain characteristics of the CMO Bonds in the
Company's Residual Interests held in these forms are on the following tables:
<TABLE>
<CAPTION>
FIXED RATE RESIDUALS
- - ------------------------------------------------------------------------------------------------------------------------------
CMO BOND DATA (100% OF ISSUE)
----------------------------------------------------------------------
NAME OF ISSUER TIS INITIAL DEC. 31, 1998
AND SERIES/ TIS PURCHASE PRINCIPAL PRINCIPAL
CMO ISSUE PURCHASE TIS % PRICE BOND BALANCE BALANCE BOND STATED
DATE DATE OWNERSHIP ($000) CLASS ($000) ($000) COUPON MATURITY
- - ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1) Bankers Trust May 29, 1991 99.990% $1,537 1-A $ 9,722 $ 0 7.35% Jan 1, 2013
Series 1988-1 1-B 8,017 0 8.50% Apr 1, 2014
(BT 88-1) 1-C 34,769 10,205 8.75% Apr 1, 2018
Feb 16, 1988 1-D 47,492 5,238 8.63% Apr 1, 2018
----------------------------
$ 100,000 $15,443
- - ------------------------------------------------------------------------------------------------------------------------------
2) L F Rothschild Nov 7, 1990 100.000% $2,589 A $ 11,000 $ 0 Zero Coupon Jan 1, 2019
Trust 9 B 22,000 0 Zero Coupon Jan 1, 2019
(LFR-9) C 54,000 5,849 Zero Coupon Jan 1, 2019
Dec 2, 1988 D 32,850 405 Zero Coupon Jan 1, 2019
E 30,000 0 Zero Coupon Jan 1, 2019
R 150 150 Residual Bond Jan 1, 2019
----------------------------
$ 150,000 $ 6,404
- - ------------------------------------------------------------------------------------------------------------------------------
3) Collateralized Dec 21, 1988 44.000% $4,462 I-1 $ 291,000 $ 0 7.95% Feb 1, 2009
Mortgage Mar 23, 1989 44.000% 4,180 I-2 194,000 0 9.45% May 1, 2013
--------- --------
Securities Corp. Subtotal 88.000% $8,642 I-3(Z) 15,000 23,469 9.45% Feb 1, 2017
========= ======== ----------------------------
Series I (CMSC I) $ 500,000 $23,469
Jan 28, 1987
- - ------------------------------------------------------------------------------------------------------------------------------
4) Federal Home Jun 22, 1989 55.000% $4,934 25-A $ 105,923 $ 0 9.00% Nov 15, 2018
Loan Mortgage 25-B 51,002 0 9.50% Nov 15, 2005
Corporation 25-C 53,028 0 9.50% Mar 15, 2011
Series 25 25-D 46,414 0 9.50% Feb 15, 2014
(FHLMC 25) 25-E 50,936 0 9.50% May 15, 2016
Dec 1, 1988 25-F 76,167 0 9.50% Dec 15, 2018
25-G 43,940 24,254 9.50% Feb 15, 2020
25-H 72,490 0 7.90% Feb 15, 2020
R 100 5 Residual Bond Feb 15, 2020
----------------------------
$ 500,000 $24,259
- - ------------------------------------------------------------------------------------------------------------------------------
5) Federal Home Jan 5, 1989 62.500% $5,361 21-A $ 140,645 $ 0 8.90% Jan 15, 1998
Loan Mortgage 21-B 216,267 0 8.90% Feb 15, 2004
Corporation 21-C 101,503 0 9.10% Jan 15, 2006
Series 21 21-D 93,376 0 9.25% Jun 15, 2007
(FHLMC 21) 21-E 122,951 0 9.35% Feb 15, 2009
Nov 30, 1988 21-F 240,408 0 9.45% Sep 15, 2011
21-Z 84,750 43,624 9.50% Jan 15, 2020
R 100 4 Residual Bond Jan 15, 2020
----------------------------
$1,000,000 $43,628
==============================================================================================================================
</TABLE>
51
<PAGE>
EQUITY RESIDUAL INTERESTS - As of December 31, 1998, the Company does not
hold interest in any Owner Trust Residuals. As of December 31, 1997, the
Company owned one equity residual interest, CMOT 28 REMIC Residual Interest. On
January 30, 1998, the Company sold 49% of its ownership in CMOT 28 and on July
1, 1998, the Company sold the remaining 51% of its ownership. Income and loss
related to the operations of CMOT 28 during the period February 1 to July 1,
1998 attributed to the 49% interest sold has been reflected as "minority
interest" in the consolidated statement of operations. Although the underlying
CMOs in this Residual Interest was not a liability of the Company, under the
requirements of generally accepted accounting principles, the Company
consolidated the assets and liabilities of the Owner Trust Residuals when over
50% equity interest in the trust was held by the Company.
As discussed above, on January 30, 1998, the Company sold 49% of its
interest in CMOT 28 for $764,400 and on July 1, 1998 the Company sold its
remaining 51% interest in CMOT 28 for $1,120,000. These combined sales produced
a realized loss of approximately $216,000 reported in the consolidated statement
of operations. The net effect on shareholders equity, however, was an increase
of approximately $351,000 as a result of recognizing unrealized losses of
$567,000 previously recorded on this investment. As a result of these sales,
the assets and liabilities of CMOT 28 of $53,340,560 and $53,831,734,
respectively, are no longer reported in the consolidated financial statements.
On June 30, 1997, the Company sold its interests in TMAC CMO Trust 1986-2
and TMAC CMO Trust 1987-3 for $128,222 and $313,367 respectively, all of which
was treated as a gain on sale in the period.
On April 22, 1996, the Company sold its 100% equity residual interest in
TMAC CMO Trust 1986-1 for $450,000. This investment had been carried at zero so
that the entire amount of the sales proceeds is reflected as a gain on
disposition of investments and the assets and liabilities of this Owner Trust
Residual are no longer included in the consolidated financial statements. The
net assets of TMAC 1986-1 (in thousands) at the date of sale were:
Mortgage Certificates, net $ 19,913
Reserve for Loss on Investments (629)
Other Assets 2,486
Collateralized Mortgage Obligations, net (21,358)
Other Liabilities (412)
--------
Net Assets $ 0
========
CMO COLLATERAL - The table below sets forth certain characteristics of the
mortgage collateral pledged to secure each CMO in which the Company holds a
Residual Interest.
<TABLE>
<CAPTION>
CMO COLLATERAL
- - --------------------------------------------------------------------------------------------------------------
CMO COLLATERAL DATA (100% OF ISSUE)
------------------------------------------------
WEIGHTED DEC 31, 1998 CURRENT WEIGHTED
AVERAGE COLLATERAL WEIGHTED AVERAGE
RESIDUAL PASS- PRINCIPAL AVERAGE REMAINING
RESIDUAL INTEREST TYPE OF THROUGH BALANCE COUPON MONTHS TO
SERIES TYPE COLLATERAL RATE ($000) RATE MATURITY
- - --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Nonequity Residual Interests
- - ----------------------------
BT 88-1 Fixed GNMA 9.00% $13,982 9.50% 199
LFR-9 Fixed FNMA 9.50% 6,210 10.22% 220
CMSC I Fixed FNMA 9.50% 21,873 10.13% 192
FHLMC 25 Fixed FHLMC 9.50% 23,546 10.33% 217
FHLMC 21 Fixed FHLMC 9.50% 42,715 10.22% 220
==============================================================================================================
</TABLE>
52
<PAGE>
5. INTEREST ONLY (IO) BONDS
IO Bonds include both regular IO Bonds and Inverse IO Bonds.
Presented below is a schedule of the Company's IO Bonds and the Prospective
Method yield at December 31, 1998.
INTEREST ONLY (IO) BONDS
- - ------------------------
(Dollars in thousands)
<TABLE>
<CAPTION>
Book Value Prospective
Purchase December 31, Method
----------------------------------
Interest Only Bond Price 1998 1997 Yield
- - -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FNMA Series 1992-123 Class S $8,203 $ 809 $1,303 30.00%
Pru Home Mtg Corp Series 1992-7 4,776 31 426 14.00%
Bear Stearns Mtg Sec Series 1992-1 2,720 -- 146 N/A
- - -------------------------------------------------------------------------------------------------------------
$ 840 $1,875
=============================================================================================================
</TABLE>
During 1998, the Company recorded a loss due to other than temporary impairment
of its investment in IO Bonds of $1,983,000 triggered by the decline in yield
on certain investments below the risk-free rate.
Certain characteristics of the Company's IO Bonds held at December 31, 1997 are
on the following table:
<TABLE>
<CAPTION>
INTEREST ONLY BONDS
- - ------------------------------------------------------------------------------------------------------------
COLLATERAL DATA (% OF IO HELD BY TIS)
----------------------------------------------------------------
WEIGHTED DEC. 31, 1998 CURRENT WEIGHTED
NAME OF ISSUER TIS AVERAGE COLLATERAL WEIGHTED AVERAGE
AND SERIES/ TIS PURCHASE PASS PRINCIPAL AVERAGE REMAINING
CMO ISSUE PURCHASE PRICE TYPE OF THROUGH BALANCE COUPON MONTHS TO
DATE DATE ($000) COLLATERAL RATE TO IO ($000) RATE MATURITY
- - ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1) FNMA July 30, 1992 $8,203 FNMA 49.58 - $ 2,381 8.94% 268
Series 1992-123 (5.67 x
Class S LIBOR)
July 25, 1992
- - ------------------------------------------------------------------------------------------------------------
2) Prudential Mar 27, 1992 $4,776 NON- 0.5652% 23,594 8.81% 267
Home Mortgage AGENCY
Corporation
Series 1992-7
March 1, 1992
============================================================================================================
</TABLE>
6. FAIR VALUE OF NONEQUITY RESIDUAL INTERESTS AND IO BONDS
GENERAL - The fair value of a Residual Interest and an IO Bond is the net
present value of the projected future cash flows. The amount of cash flows that
may be generated from the Company's Residual Interests and IO Bonds are
uncertain and may be subject to wide variations depending primarily upon the
rate and timing of prepayments on the mortgage collateral and Inverse IO Bonds
and changes in LIBOR. The following information sets forth assumptions used to
calculate the projected cash flows on the Company's Residual Interests and IO
Bonds, and the present value of these assets at December 31, 1998 and 1997 based
on various assumptions and discount factors.
ASSUMPTIONS - For purposes of the presentations below, the Nonequity
Residual Interests are shown as a group and the IO Bonds have been separated
into two groups: regular IO Bonds and Inverse IO Bonds. For purposes of
projecting future cash flows, the one month LIBOR rate at December 31, 1998 and
1997 of 5.00156% and 5.65625% is used.
53
<PAGE>
Principal payments on Mortgage Loans may be in the form of scheduled
amortization or prepayments (for this purpose, "prepayments" includes principal
prepayments and liquidations due to default or other dispositions). The
prepayment assumptions used herein are based on an assumed rate of prepayment
each month of the unpaid principal balance on a pool of Mortgage Loans.
The prepayment assumptions used to estimate the fair value of the
Company's Nonequity Residual Interests and IO Bonds are the Bloomberg Financial
Markets ("Bloomberg") Dealer Prepayment Estimates Average as estimated by
several dealers in mortgage-related assets and compiled by Bloomberg as of
December 31, 1998 and 1997. Bloomberg has obtained this information from
sources it believes to be reliable but has not verified such information and
assumes no responsibility for the accuracy of such information. The following
are the prepayment assumptions used to project cash flows in order to calculate
the present value of Nonequity Residual Interests and IO Bonds:
<TABLE>
<CAPTION>
PREPAYMENT ASSUMPTIONS 1997
--------------------------------------------------------------------------------
Percent
Prepayment
Mortgage Collateral Pass-Through Rate Assumption
--------------------------------------------------------------------------------
<S> <C> <C> <C>
GNMA Certificates 9.0% 241%
FNMA/FHLMC Certificates 8.5% 286%
FNMA/FHLMC Certificates 9.0% 330%
FNMA/FHLMC Certificates 9.5% 339%
- - --------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
PREPAYMENT ASSUMPTIONS 1998
--------------------------------------------------------------------------------
Percent
Prepayment
Mortgage Collateral Pass-Through Rate Assumption
--------------------------------------------------------------------------------
<S> <C> <C> <C>
GNMA Certificates 9.0% 346%
FNMA Certificates 9.5% 401%
FHLMC Certificates 9.5% 361%
- - --------------------------------------------------------------------------------------
</TABLE>
NEITHER THE INTEREST RATES NOR THE PREPAYMENT ASSUMPTIONS USED HEREIN
PURPORTS TO BE A HISTORICAL DESCRIPTION OF INTEREST RATES OR PREPAYMENT
EXPERIENCES OR A PREDICTION OF FUTURE INTEREST RATES OR PREPAYMENTS OF ANY POOL
OF MORTGAGE LOANS. THE FAIR VALUE OF THESE ASSETS CAN VARY DRAMATICALLY
DEPENDING ON FUTURE INTEREST RATES, PREPAYMENT SPEEDS AND THE DISCOUNT FACTOR
USED.
PRESENT VALUE OF PROJECTED CASH FLOWS - The tables which follow set
forth the present value at December 31, 1998 and December 31, 1997of the
projected cash flows discounted at the indicated discount rates subject to the
assumptions described above. For example, if cash flows are projected using the
Bloomberg Financial Markets ("Bloomberg") Dealer Prepayment Estimates Average,
as estimated by several dealers in mortgage-related assets and compiled by
Bloomberg as of December 31, 1998 and 1997, and Nonequity Residual Interests in
CMOs with fixed rate Bond Classes are discounted at 14%, the present value of
the projected cash flows of the Company's Nonequity Residual Interests would
equal approximately $284,000 and $384,000 respectively. This is the Company's
estimate of the fair value of these assets. Similarly, if cash flows on the
Company's regular IO Bonds are discounted at 14% and the cash flows on its
Inverse IO Bonds are discounted at 30%, the present value of the projected cash
flows on the IO Bonds and inverse IO Bonds would equal $840,000 and $1,875,000
at December 31, 1998 and 1997. The book value is the Company's estimate of the
fair value of these IO Bonds. There will be differences between the projected
cash flows used to calculate the present value of these assets and the actual
cash flows received by the Company, and such differences may be material.
54
<PAGE>
<TABLE>
<CAPTION>
PRESENT VALUE OF NONEQUITY RESIDUAL INTERESTS
AS OF DECEMBER 31, 1997
- - --------------------------------------------------------------------------------------------------------------------
(In thousands)
Residual Interests in CMOs with Fixed Rate Bond Classes
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Discount Rate 10% 12% 14% 16% 18%
Present Value $559 $458 $384 $330 $290
- - --------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
PRESENT VALUE OF IO BONDS
AS OF DECEMBER 31, 1997
- - --------------------------------------------------------------------------------------------------------------------
(In thousands)
Regular Interest Only Bonds
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Discount Rate 10% 12% 14% 16% 18%
Present Value $611 $591 $572 $553 $537
Inverse Interest Only Bonds
-----------------------------------------------------------------------------------------
Discount Rate 22% 26% 30% 34% 38%
Present Value $1,542 $1,413 $1,303 $1,209 $1,127
- - --------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
PRESENT VALUE OF NONEQUITY RESIDUAL INTERESTS
AS OF DECEMBER 31, 1998
- - --------------------------------------------------------------------------------------------------------------------
(In thousands)
Residual Interests in CMOs with Fixed Rate Bond Classes
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Discount Rate 10% 12% 14% 16% 18%
Present Value $359 $318 $284 $258 $235
- - --------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
PRESENT VALUE OF IO BONDS
AS OF DECEMBER 31, 1998
- - --------------------------------------------------------------------------------------------------------------------
(In thousands)
Regular Interest Only Bonds
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Discount Rate 10% 12% 14% 16% 18%
Present Value $31 $31 $31 $31 $31
<CAPTION>
Inverse Interest Only Bonds
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Discount Rate 22% 26% 30% 34% 38%
Present Value $928 $865 $809 $761 $717
- - --------------------------------------------------------------------------------------------------------------------
</TABLE>
During the second quarter of 1998, the Bear Stearns Mortgage Securities Series
1992-7 Interest Only Bond was retired prior to its maturity as part of an
optional redemption of the entire bond series. This redemption resulted in a
loss on redemption of investment of $198,000.
55
<PAGE>
7. COMMERCIAL SECURITIZATIONS
Commercial Securitizations which include debt obligations that are
issued in multiple classes and are funded as to the payment of interest and
principal by a specific group of Mortgage Loans on multiple family or commercial
real estate, accounts and other collateral. Presented below is a schedule of
Commercial Securitizations owned by the Company:
<TABLE>
<CAPTION>
(In thousands) Book Value
-----------------------------------------
Purchase December 31, December 31,
Issuer and Series Price 1998 1997
- - ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Prudential Securities Series 1993-6 $250 $ 184 $ 184
============================================================================================================
</TABLE>
8. OPERATING REAL ESTATE ASSETS
During the year ended December 31, 1995, the Company acquired four
multifamily housing properties in California's Central Valley. The properties
were purchased either in the form of direct ownership of the real property or in
the form of an interest in a partnership that directly owns the real property.
Capitalized costs differ from the purchase price due to capitalization of
acquisition costs. During 1998, one property was sold. The carrying value of
operating real estate assets at December 31, 1998 and 1997 is presented in the
following table:
<TABLE>
<CAPTION>
December 31,
(in thousands) 1998 1997
--------------------------------------------------------------------------
<S> <C> <C>
Land $ 4,120 $ 5,024
Buildings and improvements 16,920 24,186
Personal property 899 1,300
----------------------------------
Total 21,939 30,510
Less accumulated depreciation
and amortization (1,767) (1,813)
----------------------------------
Net $20,172 $28,697
==================================
</TABLE>
At December 31, 1998, the Company's three multifamily properties had an
overall occupancy of 97.5%.
In December 1998, the Company divested the River Oaks apartment complex
in Hanford, California for a selling price of $8,060,000. After closing costs
and prorated items, the Company recorded a loss on sale of approximately
$157,000 and net proceeds of approximately $1.5 million. In conjunction with
the sale, the purchaser assumed the $6.3 million of mortgage obligation related
to the property
9. FUNDS DUE TO TRUSTEE
During the fourth quarter of 1998, the trustee for Bankers Trust Series
1988-1 (the "Trustee"), a nonequity residual interest investment of the Company,
inadvertently deposited approximately $1.2 million in the Company's accounts.
Such amount is reflected within cash and cash equivalents and due to trustee on
the accompanying consolidated balance sheet at December 31, 1998. In March
1999, the Company repaid $600,000 of such amount to the Trustee.
On March 11, 1999, The Trustee filed an action in the United States
District against the Company for alleged breach of contract, common count and
conversion. The complaint alleges that the Trustee erroneously paid $1.2
million to the Company under the terms of a mortgage-backed security of which
the Company is one of the holders, and that the Company has failed to repay
approximately $600,000 of those monies despite demand. The complaint requests
payment, prejudgment interest, attorneys fees' and costs. The Company
acknowledges that it is required to repay the remaining $600,000, but denies
that it is liable to the Trustee for any other amounts or that it ever breached
any contract, converted monies, or otherwise acted improperly. On March 23,
1999, the Trustee filed an application for a writ of attachment, requesting
expedited hearing thereon. The Company opposed the expedited hearing and the
Court denied the Trustee's request. On April 1, 1999, the Trustee filed an
amended complaint adding a request for a constructive trust, and also set the
attachment application for regular hearing on May 11, 1999. The parties have
engaged in informal settlement discussions, both before and after the filing of
the original complaint. Those discussions continue. If a settlement agreement
cannot be reached, the Company intends to oppose the application for an
attachment and vigorously defend the action.
56
<PAGE>
10. NOTES PAYABLE ON REAL ESTATE
As part of the 1995 acquisition of multifamily residential properties,
existing secured debt totaling $18,675,000 was assumed. In addition, new
secured debt of $1,815,000 was obtained in 1995. In August 1996, the River Oaks
and Four Creeks - II mortgage notes payable matured and were retired using the
proceeds from a new mortgage note in the principal amount of $11,235,000 (the
"Interim Note"). On March 24, 1997, the Company obtained permanent financing
with an insurance company (the "Permanent Financing"). The total loan proceeds
from the Permanent Financing amounted to $17,400,000 and, after certain costs
and fees, were used to retire the then-outstanding principal and interest on the
Interim Note of $11,235,000 and the mortgage note on Villa San Marcos of
$5,965,884. The Permanent Financing comprises three deeds of trust and an
assignment of rents on Four Creeks - II, River Oaks and Villa San Marcos. The
term of each of the underlying Mortgage Loans is ten years with a fixed annual
interest rate of 8.36% for River Oaks and 8.31% for the others The mortgages
comprising the Permanent Financing may not be retired during the first five
years and are subject to a prepayment penalty if prepaid after the fifth year.
On December 23, 1998 the Company sold its interest in River Oaks. (See Note 8)
The following table summarizes the debt outstanding on the properties as of
December 31, 1998 and 1997, respectively. The Shady Lane loan remains in the
name of the seller of the property and will continue to remain so until
refinanced. The Company is servicing the debt and receives all of the economic
benefits from Shady Lane. The weighted average interest rate at December 31,
1998 was 8.30%.
<TABLE>
<CAPTION>
Interest Monthly
Principal Balance Basis of Rate Principal
December 31, Interest Dec. 31, Due and Interest
-----------------
Property 1998 1997 Rate 1998 Date Payment
- - ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Shady Lane $ 1,292,145 $ 1,327,859 Floating Rate 8.394% 12/1/04 12,063
River Oaks -- 6,372,237 -- -- -- --
Villa San Marcos 6,825,984 6,910,481 Fixed 8.31% 4/1/07 70,597
Four Creeks - I 1,767,100 1,782,994 Fixed 8.16% 12/1/05 13,521
Four Creeks - II 3,908,426 3,956,808 Fixed 8.31% 4/1/07 31,649
- - ---------------------------------------------------------------------------------------------------------------------------
Total $13,793,655 $20,350,379 $127,830
===========================================================================================================================
</TABLE>
The scheduled principal payments to be made on notes payable on real estate
outstanding at December 31, 1998 are as follows (in thousands), except for the
Shady Lane property note payable, as discussed below:
YEAR Amount
----------------------------------
1999 $ 175,684
2000 190,822
2001 207,265
2002 225,124
2003 244,523
Thereafter 11,458,092
----------------------------------
Total $12,501,510
==================================
The variable rate loan for the Shady Lane property is payable in monthly
installments of $12,063. The floating rate of interest is adjusted every six
months, in July and December. Since the principal payments vary each month, the
scheduled principal payments are not included in the schedule above.
57
<PAGE>
11. SHORT-TERM DEBT
At December 31, 1998 and 1997, the Company's short-term borrowings
totaled $667,000 and $2,009,500 respectively. Short-term borrowing consisted of
repurchase agreements with Bear Stearns & Co. and Paine Webber. The repurchase
agreement borrowings had a weighted average interest rates of 7.129% and 7.272%
at December 31, 1998 and 1997, respectively. The repurchase agreements had
initial terms of one month, are renewed on a month-to-month basis, are
collateralized by some of the Company's nonequity Residual Interests and IO
Bonds whose fair values at December 31, 1998 and 1997 approximated $840,000 and
$2,000,000 respectively and have a floating rate of interest which is tied to
the one month LIBOR rate. The Company has no committed lines of credit.
12. SEGMENT DATA
The Company's operations consist of investments in structured
securities and a portfolio of multifamily residential housing. Each activity
represents an operating segment as defined by Statement of Financial Accounting
Standards No. 131, Disclosures about Segments of an Enterprise and Related
Information and financial results of each are reported and monitored by the
Company. The investments in structured securities are comprised primarily of
mortgage related assets consisting of both equity and non-equity residual
interest instruments and bond and REMIC based interest only strips. The real
estate portfolio consists of multifamily apartment buildings located in the
California Central Valley region. Units of each of the buildings are rented to
residential tenants on either a month-to-month basis or for terms of one year or
less.
The accounting policies of the operating segments are the same as
those described in the summary of significant accounting policies. Details of
the financial results of the Company's real estate operations are segregated in
the accompanying income statement, real estate operations results for the twelve
months in each of the periods ending December 31, 1998, 1997, and 1996 amounted
to a net loss of $426,000, $261,000 and $171,000 respectively. Details of the
financial results of the Company's investments in Structured Securities are
segregated in the accompanying balance sheet. Net operating results of the
investment portfolio for the years ended December 31, 1998, 1997 and 1995 were a
net loss of $2,642,000 and net income of $1,495,000 and $701,000 respectively as
reflected in the following table:
<TABLE>
<CAPTION>
Financial Instruments Portfolio ($000) 1998 1997 1996
- - -------------------------------------- ---- ---- ----
<S> <C> <C> <C>
Income from Mortgage $ 530 $ 8,387 $ 9,393
Total Interest and CMO Related Expenses (3,249) (6,892) (8,692)
------------------------------
Net Income (Loss) from Financial Instruments ($2,719) $ 1,495 $ 701
</TABLE>
The Company does not allocate overhead expenses to its segments nor does
management consider such costs in its evaluation of the results of each segment.
58
<PAGE>
13. SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS
The following items were non-cash transactions with regard to the sale
of CMOT-28 and the River Oaks Property for the year ended December 31, 1998.
<TABLE>
<CAPTION>
CMOT-28
(in thousands) 1998
----------------------------------------------------------------------------
<S> <C>
Reduction of Mortgage Certificates $ 51,600
Reduction of Unamortized Discount on Mortgage Certificates (885)
Reduction of Mortgage Certificate Reserve for Loss (567)
Reduction of Restricted Cash on Mortgage Certificates 1,814
Reduction of Accrued Interest on CMOs 365
Reduction of CMOs (53,103)
Reduction of Unamortized Discount on CMOs 3,125
Reduction of Accrued Interest Payable on CMOs (745)
Reduction of Minority Interest (1,352)
RIVER OAKS
(in dollars) 1998
----------------------------------------------------------------------------
Reduction of Land ($904,244)
Reduction of Building (7,266,026)
Reduction of Plant, Property and Equipment (691,230)
Reduction of Accumulated Depreciation 848,829
Reduction of Accounts Receivable (5,462)
Reduction of Prepaid Assets (6,148)
Reduction of Amortizable Costs (180,280)
Reduction of Accounts Payable 79,133
Reduction of Notes Payable 6,294,917
</TABLE>
14. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 ("SFAS 130") Reporting Comprehensive Income. This
statement established standards for the reporting and disclosure of
comprehensive income and its components in the financial statements. For the
Company, comprehensive income includes the net loss as reported on the
consolidated statements of operations, and the unrealized gain (loss) due to
changes in the fair value of its available-for-sale investments that are
reported as a component of shareholders' equity. The following table presents
net loss adjusted by the change in unrealized gains or losses on available-for-
sale investments as a component of comprehensive income.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Unrealized gain (loss) arising during the year: ($176) $ 262 $ 552
Reclassification adjustments for net realized
(gains) losses on securities available for
sale included in net income during the year: 2,487 (442) (450)
--------------------------
$2,311 ($180) $ 102
</TABLE>
59
<PAGE>
15. STOCK OPTIONS
During 1995, the shareholders approved the 1995 Stock Option Plan (the
"Plan") covering shares of the Company's Common Stock. The plan provides for the
granting of non-qualified stock options to officers and unaffiliated directors
of the Company. Under the terms of the Plan, the purchase price of the shares
subject to each option granted to officers will not be less than 100% and
options granted to unaffiliated directors will not be less than 110% of their
fair market value at the date of the grant reduced by the aggregate amount of
distributions declared. Options granted are exercisable for no more than 10
years from the date of grant.
Statement of Financial Accounting Standards No. 123 ("SFAS 123") Accounting
for Stock-Based Compensation, is effective for transactions entered into for
fiscal years beginning after December 15, 1995. This statement defines a fair-
value-based method of account for stock-based compensation. As permitted by SFAS
123, the Company accounts for stock options under APB Opinion. 25, under which
no compensation cost has been recognized. The Company has provided the following
pro forma net income and earnings per share data as if compensation cost for the
Plan had been provided for consistent with SFAS 123. The potential common shares
related to the 1995 Stock Option Plan are antidilutive in 1998, 1997 and 1996.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C> <C>
Net Loss (in thousands): As reported ($4,136) ($209) ($903)
Pro forma (4,136) (214) (904)
Earnings per share As reported ($0.51) ($0.03) ($0.11)
Pro forma ($0.51) ($0.03) ($0.11)
</TABLE>
The following table summarizes the stock option activity for the years ended
December 31, 1998, 1997 and 1996, respectively.
<TABLE>
<CAPTION>
Number of Share
Options
Outstanding
---------------
<S> <C>
Balance, December 31, 1995 336,000
Granted to officers 6,000
Expired --
---------------
Balance, December 31, 1996 342,000
Granted to officers 6,000
Expired (1,000)
---------------
Balance, December 31, 1997 347,000
Granted --
Expired (5,000)
---------------
Balance, December 31, 1998 342,000
===============
</TABLE>
During 1998, 5,000 options expired relating to two unaffiliated directors
who were replaced in 1997. During 1997, 1,000 options expired relating to an
unaffiliated director who retired in 1996. No other options were exercised,
forfeited, or expired during 1998, 1997 or 1996. As of December 31, 1998 and
1997, respectively, 342,000 and 347,000 of the options were exercisable. As of
December 31, 1998, 58,000 shares were available under the Plan for granting
further options. The weighted average fair value of options granted in 1997and
1996 were $1.02 and $0.18 respectively. No options were granted in 1998. The
options outstanding at December 31, 1998 have exercise prices of $1.25, $1.22,
$2.25 and $2.26 with a weighted average exercise price of $2.23 and a weighted
average remaining contractual life of 6.3 years.
60
<PAGE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model. Management made the following average
assumptions for grants in 1997: risk-free interest rate of 6.43%, expected
distribution yield of 0%, expected life of 10 years, and expected volatility of
97%.
16. RELATED PARTY TRANSACTIONS
Prior to July 1, 1996, the Company had entered into a Management Agreement
(the "Management Agreement") with TIS Financial Services Inc., (the "Former
Manager") which was renewable annually. At a special meeting of the Board of
Directors on June 27, 1996, the Board resolved to let the Management Agreement
expire on June 30, 1996 and to have the Company become a self-administered REIT.
No management fees were paid in 1998 or 1997; management fees of $77,000 were
paid for the first half of 1996. In addition, the Company reimbursed the Former
Manager in the amount of $ 28,980, $37,806 and $391,198, respectively for 1998,
1997 and 1996 related to certain general and administrative expenses incurred by
the Former Manager on the Company's behalf (see further discussion below).
PRIOR TO JULY 1, 1996
- - ---------------------
Prior to July 1, 1996, the Company operated under the Management Agreement
with the Former Manager. In June 1995, the Board of Directors of the Company and
the Former Manager entered into a new Management Agreement through June 30,
1996. In March 1995, the Board of Directors authorized a committee composed of
four Unaffiliated Directors to consider proposed revisions to the Management
Agreement in light of the Company's acquisition of multifamily residential
properties and recent waivers by the Unaffiliated Directors of the requirement
in the Management Agreement that the Former Manager reimburse the Company for
Excess Expenses. As a result, the Management Agreement approved in June 1995
increased the base management fee from .375% per annum of average invested
assets to .65% thereof, changed the incentive compensation, eliminated an
expense reimbursement provision, and discontinued the payment of a Residual
Interest Administration Fee. These changes in the management fee became
effective October 1, 1995. However, the Former Manager voluntarily waived the
increase in base management fee for the fourth quarter of 1995 and first two
quarters of 1996. Prior to becoming self-managed on July 1, 1996, the Company
reimbursed the Former Manager for certain expenses incurred by the Former
Manager on the Company's behalf, including rent, telephone, utilities, office
furniture, equipment and machinery, computers, and computer services, as well as
expenses relating to accounting, bookkeeping and related administrative
functions (including the employment expenses of any persons performing these
functions), and fees and expenses of agents and employees employed directly by
the Former Manager at the Company's expense.
July 1, 1996 and Thereafter
- - ---------------------------
In connection with becoming self-managed on July 1, 1996, the Company
entered into a Facilities and Expense Sharing Agreement ("Expense Sharing
Agreement") with the Former Manager providing for the sharing of office space,
office equipment and the expenses of certain administrative and other personnel
and ancillary services. In addition, the Board approved employment contracts
with Lorraine O. Legg, Chairman and President of the Company, for a term of
three years and John E. Castello, as Executive Vice President and Chief
Financial Officer, for a term of two years. The Expense Sharing Agreement
provides for certain office space and expense sharing arrangements, whereby the
Company and the Former Manager share on a prorata basis all fees and expenses
incurred in connection with rent, telephone charges, utilities and other office
expenses, bookkeeping fees and expenses and miscellaneous administrative and
other expenses, including certain personnel expenses, as described in the
Expense Sharing Agreement. The prorata sharing of such expenses is determined
based upon the relative benefit received by each party in accordance with the
amount of space utilized or the relative amount of time each such resource is
used, or such other allocation method as may be reasonable and agreed to by the
parties. The Expense Sharing Agreement continues in effect until terminated by
either party on 30 days prior written notice or at such time as the parties no
longer continue to share office space.
61
<PAGE>
In April of 1999, the Company entered into a financing agreement with the
Former Manager whereby the Former Manager extended a revolving line of credit of
$1,000,000 to the Company. (See Note 20)
17. INTEREST INCOME
Interest income from Mortgage Related Assets consisted of:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
(IN THOUSANDS) 1998 1997 1996
- - ---------------------------------------------------------------
<S> <C> <C> <C>
Mortgage Certificates, net $ 2,602 $ 6,059 $ 7,748
Short-term Investments -- 2 16
Residual Interests 22 39 52
Interest Only (IO) Bonds 171 360 455
Commercial Securitizations 8 0 0
- - ---------------------------------------------------------------
Total $ 2,803 $ 6,460 $ 8,271
===============================================================
</TABLE>
<TABLE>
<CAPTION>
- - --------------------------------------------------------------------------------------------------------
(IN THOUSANDS, FIRST SECOND THIRD FOURTH
EXCEPT PER SHARE DATA) QUARTER QUARTER QUARTER QUARTER TOTAL
- - --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998
Income
from Mortgage Related Assets $ 1,528 $ 1,296 ($ 224) ($ 2,070) $ 530
Income (Loss) from
Real Estate Operations (38) (54) (45) (289) (426)
Net Income (Loss) (269) (609) (541) (2,718) (4,136)
Basic Net Income (Loss) per Share ($0.03) $ 0.08 ($ 0.07) ($ 0.49) ($ 0.51)
1997
Income (Loss)
from Mortgage Related Assets $ 1,788 $ 2,225 $1,676 $ 2,698 $ 8,387
Loss from
Real Estate Operations (97) (65) (43) (56) (261)
Net Income (Loss) (417) (103) (307) 618 (209)
Basic Net Income (Loss) per Share ($0.04) $ 0.01 ($ 0.04) $ 0.08 ($ 0.03)
</TABLE>
62
<PAGE>
18. DIVIDEND REINVESTMENT AND SHARE PURCHASE PLAN
The Company has a Dividend Reinvestment and Share Purchase. The Plan
provides, at the Company's option, for shares purchased under the Plan to either
be issued by the Company, or be purchased on the open market. The Plan
prospectus provides for up to 1,000,000 new shares to be issued. To the extent
new shares are issued, the Company's capital will be increased. During 1992,
5,780 shares were issued under the Plan resulting in an increase to capital of
$39,000. No new shares were issued under the Plan thereafter, as all required
shares have been purchased in the open market.
19. CONTINGENCIES
RISK OF UNINSURED LOSSES The Company's real estate properties are
located in an area that is subject to earthquake activity. The Company's
comprehensive liability, fire, flood, extended coverage and rental loss
insurance does not cover damage resulting from an earthquake and certain other
losses. Accordingly, should the Company sustain damage resulting from an
earthquake or other uninsured loss, the Company could lose its investment in,
and anticipated profits and cash flows from the properties. The accompany
financial statements do not reflect any adjustments for these uncertainties.
LITIGATION The Company is involved from time to time in legal actions
relating to the ownership and operations of its properties. In management's
opinion, the liabilities, if any, that may ultimately result from such legal
actions are not expected to have a materially adverse effect on the consolidated
financial position, results of operations or cash flows of the Company.
ENVIRONMENTAL MATTERS The Company follows a policy of monitoring its
properties for the presence of hazardous or toxic substances. The Company is not
aware of any environmental liability with respect to the properties that would
have a material adverse effect on the Company's business, assets or results of
operations. There can be no assurance that such a material environmental
liability does not exist. The existence of any such environmental liability
could have an adverse effect on the Company's results of operations and cash
flow
20. SUBSEQUENT EVENTS
EXCHANGE OF SHARES FOR NOVATO MARKETS
On February 2, 1999, the Company acquired all the shares of Novato
Markets, Inc. ("Novato") from Pacific Securitization, Inc., ("Pacific") in
exchange for 1,613,070 shares of Common Stock (the "Shares") of the Company
pursuant to an Agreement and Plan of Reorganization dated as of February 1,
1999, between the Company and Pacific. Pacific is indirectly principally owned
by Lorraine O. Legg, the President and Chief Executive Officer and a director of
the Company, and Patricia M. Howe, a director of the Company. The Company's
acquisition of Novato was approved by the Company's Board of Directors. Through
a wholly-owned subsidiary, Novato owns a shopping center located in Rohnert
Park, California, named Mountain Shadows Plaza, and owns a shopping center
subject to a ground lease in Petaluma, California, named Midtown Center. The
shopping centers have a combined commercial and retail space totaling
approximately 80,000 square feet. Mountain Shadows Plaza consists of three
buildings and is anchored by a large grocery store. Midtown Center consists of a
single building. The Company intends to continue operating the shopping centers.
The Shares were issued to Pacific under an exemption to the
registration requirements of the Securities Act of 1933, as amended.
Accordingly, the Shares are "restricted securities," as defined in Rule 144 of
the Securities Act, and are not freely transferable. The Company granted Pacific
one-time demand registration rights with respect to the Shares for the period
beginning June 30, 1999 and ending February 2, 2001. It also granted Pacific
piggy-back registration rights in the event that the Company files a
registration statement under the Securities Act in connection with the proposed
offer and sale for cash of shares of
63
<PAGE>
Common Stock by it or by any of its shareholders. The share exchange is intended
to be a tax free reorganization within the meaning of Section 368(a)(1) of the
Internal Revenue Code of 1986, as amended. Prior to the closing of the share
exchange, Novato caused its wholly-owned subsidiary to transfer to Pacific all
its rights under a lease, with option to purchase, with Ignacio Properties, LLC,
relating to the Ignacio Center in Novato, California, and Pacific agreed to
assume all the obligations of the subsidiary under the lease and option. The
Company, Novato, Novato's wholly-owned subsidiary and Pacific then entered into
an agreement dated as of February 1, 1999, whereby the parties clarified their
respective rights and obligations relating to the Ignacio Property and the
Company's rights to an escrow established when Pacific originally acquired
Novato.
SHARE PURCHASE FROM TURKEY VULTURE FUND XIII, LTD.
On February 2, 1999, the Company acquired 793,700 shares of its Common
Stock from Turkey Vulture Fund XIII, Ltd. for $1,984,250, 20,000 shares of its
Common Stock from Christopher L. Jarratt for $40,000 and 12,000 shares of its
Common Stock from James G. Lewis for $24,000, pursuant to an Agreement dated as
of February 1, 1999, among the Company, Turkey Vulture Fund, Richard M. Osborne,
Third Capital, LLC, Mr. Jarratt and Mr. Lewis. Turkey Vulture Fund, Third
Capital and Messrs. Osborne, Jarratt and Lewis agreed that, for a period of
seven years, they will not directly or indirectly, among other things, (i)
effect or participate in or in any way assist any other person in effecting or
participating in (a) any acquisition of securities or rights to acquire
securities or assets of the Company or its subsidiaries, (b) any tender or
exchange offer, merger or other business combination involving the Company or
its subsidiaries, (c) any liquidation or other extraordinary transaction with
respect to the Company or its subsidiaries, or (d) any solicitation of proxies
or consents to vote any voting securities of the Company; (ii) form or in anyway
participate in a "group" with respect to the Company; (iii) otherwise act, alone
or in concert with others, to seek to control or influence the management, Board
of Directors or policies of the Company or its subsidiaries; (iv) take any
action to compel the holding of an annual or special meeting of stockholders; or
(v) enter into any discussions or arrangements with any person relating to the
foregoing. The parties also agreed to a mutual general release of all claims
arising out of or relating to the business or affairs of the Company or the
ownership of its stock. Messrs. Osborne, Jarratt and Lewis resigned from the
Company's Board of Directors, effective February 2, 1999. This share purchase
and the acquisition of Novato were approved by the Company's Board of Directors
and, specifically, by directors with no financial interest in either
transaction. The disinterested directors required that the share exchange
transaction be closed as a condition to closing the share purchase transaction.
SALE OF FNMA SERIES 92-123 S
On March 4, 1999, the Company sold its interest in its IO Bond, FNMA Series
1992-123 S for $782,879. In conjunction with this sale, the Company retired
short-term debt of approximately $616,000.
REVOLVING LINE OF CREDIT
In April of 1999, the Company entered into a financing agreement with The
Former Manager whereby The Former Manager extended a revolving line of credit of
$1,000,000 to the Company. The Former Manager and the Company have common
ownership and executive officers and as such are related parties. Credit support
to the Former Manager includes guaranteed loans by a bank and a board member of
the Company in support of the TIS Line to the Company. Additionally, certain of
the Company's mortgage assets are pledged as collateral for the TIS Line. This
line is to provide working capital to the Company. This revolving line of credit
is for a term of one year, is at the rate of prime plus one and one half percent
and is secured by the Company's ownership in Bankers Trust series 1988-1
Residual Interest Certificate.
64
<PAGE>
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.
TIS MORTGAGE INVESTMENT COMPANY
Date: April 15, 1999 By: /s/ Lorraine O. Legg
-----------------------
Lorraine O. Legg, Chief
Executive Officer
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.
Signature Title Date
- - --------- ----- ----
/s/ Lorraine O. Legg Director, President and April 15, 1999
- - --------------------------
Lorraine O. Legg Principal Executive Officer
/s/ John E. Castello Executive Vice President (Principal April 15, 1999
- - --------------------------
John E. Castello Financial Officer)
/s/ Douglas B. Fletcher Director, Chairman of the Board April 15, 1999
- - --------------------------
Douglas B. Fletcher
Director
- - --------------------------
Anthony H. Barash
/s/ Patricia M. Howe Director April 15, 1999
- - --------------------------
Patricia M. Howe
/s/ Robert W. Ledoux Director April 15, 1999
- - --------------------------
Robert W. Ledoux
Director
- - --------------------------
J. David Schemel
65
<PAGE>
SCHEDULE III
TIS MORTGAGE INVESTMENT COMPANY
REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Costs
Subsequently Gross Amount at which Carried
Initial Cost to Company Capitalized at Close of Year
----------------------- ------------ -----------------------------
Buildings Buildings
and and
Description Encumbrances Land Improvements Improvements Land Improvements Total
----------- ------------ ---- ------------ ------------ ---- ------------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Shady Lane Village
Visalia, CA $1,292 $379 $1,725 $38 $379 $1,763 $2,142
Villa San Marcos
Fresno, CA 6,826 2,549 7,459 35 2,584 7,459 10,043
Four Creeks Village
Visalia, CA 5,676 1,157 7,698 -- 1,157 7,698 8,855
---------------------------------------------------------------------------------------------
$13,794 $4,989 $16,882 $73 $4,120 $16,920 $21,040
=============================================================================================
</TABLE>
<TABLE>
<CAPTION>
Column A Column F Column G Column H Column I
-------- -------- -------- -------- --------
Life on which
Accumulated Year of Year Depreciation
Description Depreciation Construction Acquired is Computed
----------- ------------ ------------ -------- --------------
<S> <C> <C> <C> <C>
Shady Lane Village
Visalia, CA $220 1985 1995 40 years
Villa San Marcos
Fresno, CA 736 1991 1995 40 years
Four Creeks Village
Visalia, CA 811 1986-91 1995 40 years
------
$1,767
======
</TABLE>
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
Accumulated Accumulated Accumulated
Cost Depreciation Cost Depreciation Cost Depreciation
--------------------- -------------------- ---------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at Beginning of Year $29,210 $1,537 $29,026 $938 $29,026 $339
Additions (sales) during period
Purchases
Sales (8,170) (503)
Capital Improvements 184
Depreciation 733 599 599
--------------------- --------------------- ---------------------
Balance at End of Year $21,040 $1,767 $29,210 $1,537 $29,026 $938
==================== ==================== =====================
</TABLE>
66
<PAGE>
EXHIBIT 21
TIS MORTGAGE INVESTMENT COMPANY
SUBSIDIARIES OF THE REGISTRANT
TIS Mortgage Acceptance Corporation
TIS Property Acquisition Company
Novato Markets Inc.
P-Sub I, Inc.
<PAGE>
EXHIBIT 24
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our report included on this Form 10-K, into the Company's
previously filed Registration Statements on Form S-8 (file number 333-96960) and
Form S-3 (file number 333-44526).
/s/ Arthur Andersen LLP
San Francisco, California
April 15, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,907
<SECURITIES> 1,308
<RECEIVABLES> 33
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 25,056
<CURRENT-LIABILITIES> 2,474
<BONDS> 0
0
0
<COMMON> 8
<OTHER-SE> 8,780
<TOTAL-LIABILITY-AND-EQUITY> 25,056
<SALES> 0
<TOTAL-REVENUES> 4,581
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 4,016
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,999
<INCOME-PRETAX> (4,136)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,136)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,136)
<EPS-PRIMARY> (.51)
<EPS-DILUTED> (.51)
</TABLE>
