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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-22262
COMMERCIAL ASSETS, INC.
(Exact name of registrant as specified in its charter)
Maryland 84-1240911
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
3410 South Galena Street, Suite 210 80231
Denver, Colorado (Zip Code)
(Address of Principal Executive Offices)
(303) 614-9410
(Registrant's telephone number, including area code)
3600 South Yosemite Street, Suite 350
Denver, Colorado 80237
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___.
As of November 3, 1997, 10,342,009 shares of Commercial Assets,
Inc. Common Stock were outstanding.
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<PAGE>
COMMERCIAL ASSETS, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION:
Item 1. Condensed Financial Statements:
Balance Sheets as of September 30, 1997 (Unaudited)
and December 31, 1996................................ 1
Statements of Income for the three and nine months
ended September 30, 1997 and 1996 (Unaudited)........ 2
Statements of Cash Flows for the nine months ended
September 30, 1997 and 1996 (Unaudited).............. 3
Notes to Financial Statements (Unaudited).............. 4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations........ 9
PART II. OTHER INFORMATION:
Item 6. Exhibits and Reports on Form 8-K....................... 15
(i)
<PAGE>
<TABLE>
<CAPTION>
COMMERCIAL ASSETS, INC.
CONDENSED BALANCE SHEETS
(Dollar amounts in thousands)
September 30, December 31,
1997 1996
---- ----
Assets (Unaudited)
<S> <C> <C>
Cash and cash equivalents $ 3,335 $ 8,277
Accrued interest receivable 590 597
Restricted cash 8,174 1,982
CMBS bonds 70,012 61,460
Other assets, net 118 90
---------- ----------
Total Assets $ 82,229 $ 72,406
========== ==========
Liabilities
Accounts payable and accrued liabilities $ 111 $ 189
Management fees payable 885 298
---------- ----------
Total Liabilities 996 487
---------- ----------
Stockholders' Equity
Preferred Stock, par value $.01 per share, 25,000,000 shares authorized; no
shares issued or outstanding -- --
Common Stock, par value $.01 per share, 75,000,000 shares authorized;
10,342,009 and 10,315,809 shares issued and outstanding, respectively 104 103
Additional paid-in capital 76,724 76,559
Cumulative dividends declared (25,565) (20,295)
Cumulative net income 24,970 18,941
---------- ----------
Dividends in excess of net income (595) (1,354)
---------- ----------
Net unrealized holding gains (losses) on CMBS bonds 5,000 (3,389)
---------- ----------
Total Stockholders' Equity 81,233 71,919
---------- ----------
Total Liabilities and Stockholders' Equity $ 82,229 $ 72,406
========== ==========
</TABLE>
See Notes to Condensed Financial Statements.
- 1 -
<PAGE>
COMMERCIAL ASSETS, INC.
CONDENSED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- -----------------------
1997 1996 1997 1996
--------- --------- -------- ------
Revenues
<S> <C> <C> <C> <C>
CMBS bonds $ 3,423 $ 2,038 $ 7,660 $ 7,811
Interest 51 129 211 200
-------- -------- -------- -------
Total Revenues 3,474 2,167 7,871 8,011
-------- -------- -------- -------
Expenses
Management fees 886 297 1,494 1,127
General and administrative 104 105 348 549
Elimination of DERs -- -- -- 966
Interest -- -- -- 5
-------- -------- -------- -------
Total Expenses 990 402 1,842 2,647
-------- -------- -------- --------
Net Income $ 2,484 $ 1,765 $ 6,029 $ 5,364
======== ======== ======== ========
Net income per share $ .24 $ .17 $ .58 $ .52
Weighted-average shares outstanding 10,342 10,316 10,328 10,224
Dividends per share:
Regular dividends $ .17 $ .17 $ .51 $ .51
Special dividends -- .04 -- .04
-------- -------- -------- --------
$ .17 $ .21 $ .51 $ .55
======== ======== ======== ========
</TABLE>
See Notes to Condensed Financial Statements.
- 2 -
<PAGE>
COMMERCIAL ASSETS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1997 1996
---- ----
Cash Flows From Operating Activities
<S> <C> <C>
Net income $ 6,029 $ 5,364
Adjustments to reconcile net income to net cash flows from operating
activities:
Amortization of discount on CMBS bonds and other assets (1,542) (1,970)
Issuance of Common Stock for elimination of DERs -- 941
Decrease in accrued interest receivable 7 78
Decrease (increase) in other assets 39 (9)
Increase (decrease) in accounts payable and accrued liabilities (22) 16
Increase (decrease) in management fees payable 587 (290)
------- ---------
Net Cash Provided By Operating Activities 5,098 4,130
------- ---------
Cash Flows From Investing Activities
Acquisition of CMBS bonds (4,801) --
Principal collections from CMBS bonds -- 9,857
------- ---------
Net Cash (Used In) Provided By Investing Activities (4,801) 9,857
------- ---------
Cash Flows From Financing Activities
Dividends paid (5,270) (3,478)
Repayments of short-term notes payable -- (700)
Issuance of Common Stock 31 --
-------- ---------
Net Cash Used In Financing Activities (5,239) (4,178)
-------- ---------
Cash and Cash Equivalents
(Decrease) increase (4,942) 9,809
Beginning of period 8,277 598
------- ---------
End of period $ 3,335 $ 10,407
======== =========
</TABLE>
See Notes to Condensed Financial Statements.
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<PAGE>
COMMERCIAL ASSETS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
A. The Company
Commercial Assets, Inc. (the "Company") was incorporated under the
laws of Maryland on August 11, 1993, as a wholly owned subsidiary of Asset
Investors Corporation, a Maryland corporation, which is listed on the New York
Stock Exchange, Inc. under the symbol "AIC" ("Asset Investors"). Pursuant to the
agreement dated August 20, 1993, between Asset Investors and the Company, Asset
Investors contributed $75,000,000 to the initial capital of the Company,
including $200,000 in cash. On October 12, 1993, Asset Investors distributed
approximately 70% of the outstanding common stock, par value of $.01 per share,
of the Company ("Common Stock") as a taxable dividend to Asset Investors'
stockholders. Prior to the distribution, the Company had not engaged in any
activities other than those related to its formation. Asset Investors currently
owns approximately 27% of the outstanding Common Stock. The Common Stock is
listed on the American Stock Exchange, Inc. under the symbol "CAX."
The Company has historically owned subordinate class of Commercial
Mortgage Backed Securities ("CMBS bonds"). On November 3, 1997, the Company
announced that it has restructured its portfolio of CMBS bonds. The Company sold
nine CMBS bonds, resecuritized two CMBS bonds and the related restricted cash,
and redeemed the remaining CMBS bond. See Subsequent Events below.
B. Presentation of Financial Statements
The Condensed Financial Statements of the Company have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. These Condensed Financial Statements
reflect all adjustments, consisting of only normal recurring accruals, which, in
the opinion of management, are necessary to present fairly the financial
position and results of operations of the Company as of September 30, 1997, for
the three and nine months then ended, and for all prior periods presented. These
statements are condensed and do not include all the information required by
generally accepted accounting principles ("GAAP") in a full set of financial
statements. These statements should be read in conjunction with the Company's
Financial Statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1996.
C. Statements of Cash Flows
Cash maintained in bank accounts, money market funds and highly-
liquid investments with an initial maturity of three months or less are
considered to be cash and cash equivalents for purposes of reporting cash flows.
The Company paid interest expense in cash of $5,000 for the nine months ended
September 30, 1996.
Non-cash investing and financing activities for the nine months
ended September 30, 1997 and 1996 were as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Principal collections on CMBS bonds transferred to restricted cash $ 6,192 $ 1,104
Unrealized holding gains on CMBS bonds $ 8,389 $ 943
Distributions of Common Stock $ 135 $ 96
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Distributions of Common Stock as consideration for the elimination of DERs $ -- $ 941
Dividends declared but not yet paid $ -- $ 2,166
</TABLE>
D. CMBS Bonds
As of September 30, 1997 and December 31, 1996, the outstanding
balances of the Company's CMBS bonds were $88,841,000 and $89,297,000,
respectively, while unamortized purchase discounts, acquisition costs and
allowance for credit losses totaled $23,829,000 and $24,448,000, respectively.
Additionally, the Company recorded unrealized holding gains of $5,000,000 and
unrealized holding losses of $3,389,000 on the CMBS bonds as of September 30,
1997 and December 31, 1996, respectively.
In May 1996, two CMBS bonds with an outstanding principal balance
of $9,664,000 and net carrying value of $8,723,000 were redeemed, eight years
earlier than anticipated. The bonds were acquired on March 8, 1994, for
$9,088,000, or 84.25% of their outstanding principal balance. Since the bonds
were redeemed at par, $1,426,000 of discount amortization was included in
earnings during the nine months ended September 30, 1996.
In March 1997, the Company contributed its ownership interest in
two CMBS bonds (Lehman Capital Corporation Trust Certificate, Series 1994-2 and
Series 1994-3) into a newly created trust (Blaylock Mortgage Capital Corporation
Multifamily Trust). Interests in bond classes within the same CMBS issuance
which were owned by another party were also contributed into the trust. The
trust then issued seven classes of CMBS bonds collateralized by the CMBS bond
classes contributed into the trust. The Company received an interest in five of
the new bond classes which corresponded to the Company's ownership interests in
the two bonds contributed to the trust. The Company also acquired the remaining
$5,737,000 principal balance of two of the new bond classes rated "BB" and "B"
at a cost of $4,801,000, which resulted in the Company having 100% ownership in
the five new subordinate classes.
In August 1997, three mortgages backing one of the Company's CMBS
bonds were prepaid. As a result of the prepayment, during the three and nine
months ended September 30, 1997, the Company recognized $482,000 of income from
a prepayment penalty received and $2,305,000 of income from accelerated discount
amortization. The $5,853,000 of principal collections from the repaid mortgages
was transferred to restricted cash pursuant to the terms of the indenture to
support the eventual payment of more senior classes of CMBS bonds. At September
30, 1997 and December 31, 1996, $8,174,000 and $1,982,000, respectively, were
set aside in reserve accounts and are shown as restricted cash on the balance
sheet.
At September 30, 1997, the outstanding balance of the mortgage
loans collateralizing the CMBS bonds was $842,174,000 and the outstanding
principal balance of the CMBS bonds that are senior to the Company's CMBS bonds
was $750,042,000. The aggregate allowance for credit losses on the Company's
CMBS bonds was $12,720,000 at both September 30, 1997 and December 31, 1996. As
of September 30, 1997, one mortgage loan with an outstanding balance of
$788,000, which collateralized two of the Company's CMBS bonds, has been
foreclosed. The Company estimates that the loss from this mortgage loan may
range from $0 to $425,000, depending upon the recovery of indemnification claims
made against the bond underwriter.
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<PAGE>
E. Short-Term Notes Payable
The Company's Loan and Security Agreement collateralized by four
CMBS bonds (FNMA 94-M2C, FNMA 94-M2D, Kidder 94-M1C and Kidder 94-M1D) was
cancelled in November 1997 upon the sale and resecuritization of these bonds. No
borrowings were outstanding on this line at September 30, 1997 or December 31,
1996.
The Company also has an unsecured line of credit with a bank for
$1,000,000. Advances under this line bear interest at prime. Two of the
Company's Independent Directors are members of the Advisory Board of the bank.
At September 30, 1997 and December 31, 1996, no advances were outstanding on
this line of credit.
F. Management Fees
The Company's day-to-day operations are performed by Financial
Asset Management LLC (the "Manager") pursuant to a management agreement (the
"Management Agreement") which is subject to the annual approval of a majority of
the Independent Directors. The Company's By-laws, as amended, require that a
specified number of the Board of Directors and each committee thereof be
comprised of persons constituting Independent Directors. Pursuant to the
Company's By-laws, an Independent Director is a person "who is not affiliated,
directly or indirectly, with the person or entity responsible for directing or
performing the day-to-day business affairs of the corporation (the "advisor"),
including a person or entity to which the advisor subcontracts substantially all
of such functions, whether by ownership of, ownership interest in, employment
by, any material business or professional relationship with, or by serving as an
officer of the advisor or an affiliated business entity of the advisor."
On September 9, 1997, Asset Investors announced a plan to acquire
the assets and operations of the Manager. The acquisition has been approved by
Asset Investors' Board of Directors (including its Independent Directors) and is
subject to a vote of Asset Investors' stockholders at its annual meeting on
November 21, 1997. If the acquisition were consummated, it would result in Asset
Investors assuming the operations of the Manager and its obligations under the
Management Agreement.
Pursuant to the Management Agreement, the Manager receives a Base
Fee, an Incentive Fee, an Acquisition Fee and an Administrative Fee. The Base
Fee is payable quarterly in an amount equal to 1% per annum of the "average
invested assets" of the Company. The Incentive Fee is based on the Company's
profitability and is intended to align compensation paid to the Manager with the
interests of the Company's stockholders. The Manager is entitled to the
Incentive Fee only after the Company's stockholders first have received a
threshold return on the Company's "average net worth" equal to the "Ten-Year
United States Treasury rate" plus 1%. Twenty percent of the Company's REIT
income in excess of this threshold return is paid to the Manager as the
Incentive Fee. The Manager receives an Acquisition Fee of 1/2 of 1% of the
initial cost of each asset which the Manager assists the Company in acquiring.
The Acquisition Fee compensates the Manager for performing due diligence
procedures on portfolio assets acquired by the Company. The Manager also
performs certain bond administration and other related services for the Company
pursuant to the Management Agreement and receives an Administrative Fee for such
services of up to $10,000 per annum for each of the Company's CMBS bonds. If the
Company owns more than one class of a commercial securitization, the Manager is
entitled to receive an additional fee of up to $2,500 per annum for each
additional class.
During the nine months ended September 30, 1997 and 1996, the
Company's total management fees pursuant to the Management Agreement were
$1,517,000 and $1,127,000, respectively. Management fees during the nine months
ended September 30, 1997 and 1996 included: (i) Base Fees of $527,000 and
- 6 -
<PAGE>
$494,000, respectively; (ii) Administrative Fees of $46,000 and $45,000,
respectively; (iii) Incentive Fees of $921,000 and $588,000, respectively; and
(iv) Acquisition Fees of $23,000 and $0, respectively. Acquisition Fees are
capitalized as part of the cost of the acquired CMBS bonds.
G. Stock Option Plan
The Company has a Stock Option Plan for the issuance of
non-qualified stock options to its directors and officers. Prior to May 30,
1996, stock options granted under the Stock Option Plan automatically accrued
dividend equivalent rights ("DERs"). During the nine months ended September 30,
1996, the Company incurred $96,000 of non-cash general and administrative
expenses from DERs covering 16,362 shares of Common Stock which were subject to
issuance pursuant to options granted under the Stock Option Plan.
On May 30, 1996, the Company's stockholders approved an amendment
to the Stock Option Plan which provided for the issuance of Common Stock in
exchange for the elimination of the accrual of DERs for options granted under
the Stock Option Plan. Pursuant to the amendment, the Company incurred a
$966,000 charge (a $941,000 non-cash charge from the issuance of 157,413 shares
of Common Stock plus $25,000 of transaction costs) during the nine months ended
September 30, 1996.
H. Subsequent Events
In November 1997, the Company sold nine CMBS bonds, resecuritized
two CMBS bonds and the related restricted cash, and had the remaining CMBS bond
redeemed by the issuer. Total proceeds from these transactions were
approximately $77,000,000 of cash and the Company retained a small residual
interest in the resecuritized CMBS bonds. The combined gain from these
transactions calculated in accordance with GAAP is approximately $5,000,000,
which will be included in results of operations during the fourth quarter of
1997.
The following unaudited pro-forma information has been prepared
assuming the restructuring of the CMBS bonds had been completed at the beginning
of the periods presented. The pro-forma information is presented for information
purposes only and is not necessarily indicative of what would have occurred if
the restructuring had been completed as of those dates. In addition, the
pro-forma information is not intended to be a projection of future results. The
unaudited, pro-forma results of operations for the nine months ended September
30, 1997 and 1996 are as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Revenues $ 3,147 $ 4,934
========== ==========
Net income (loss) from continuing operations $ 2,843 $ 3,419
Gain on restructuring of CMBS bonds, net of management fees
6,492 6,417
---------- ----------
Net income $ 9,335 $ 9,836
========== ==========
Net income per share $ .90 $ .96
========== ==========
</TABLE>
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<PAGE>
Also in November 1997, the Company declared a fourth quarter
dividend consisting of a regular dividend of $.17 per share, a special dividend
of $.26 per share and a capital gain distribution of $.17 per share for a total
distribution of $.60 per share. The dividend is payable on December 30, 1997, to
stockholders of record on December 15, 1997.
- 8 -
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
Commercial Assets, Inc. was incorporated under Maryland law on
August 11, 1993 by Asset Investors. The Company commenced operations on October
12, 1993, the date on which Asset Investors contributed $75,000,000, including
$200,000 in cash to the capital of the Company and distributed approximately 70%
of the shares of Common Stock of the Company to Asset Investors' stockholders.
The Company's Common Stock is listed on the American Stock Exchange under the
symbol "CAX".
Since its inception, the Company has operated in a manner that
permitted it to qualify for the income tax treatment afforded to a real estate
investment trust ("REIT") as defined in the Internal Revenue Code of 1986, as
amended, (the "Code"). If it so qualifies, the Company's taxable income ("REIT
income"), with certain limited exceptions, will not be subject to federal or
state income tax at the corporate level. To qualify as a REIT under the Code,
the Company is required, among other things, to distribute annually to its
stockholders at least 95% of its REIT income and to meet certain asset, income
and stock ownership tests.
The Company's day-to-day operations are performed by the Manager,
pursuant to the Management Agreement, which is subject to the annual approval of
a majority of the Independent Directors. The Manager is subject to the
supervision of the Board of Directors of the Company. As part of its duties, the
Manager presents the Company with asset acquisition opportunities and furnishes
the Board of Directors with information concerning the acquisition, performance
and disposition of assets. The Company has no employees. Certain employees of
the Manager have been designated officers of the Company. The Manager also
currently manages Asset Investors, but on September 9, 1997, Asset Investors
announced a plan to acquire the assets and operations of the Manager. The
acquisition is subject to a vote of Asset Investors' stockholders at its annual
meeting on November 21, 1997. If the acquisition were consummated, it would
result in Asset Investors assuming the operations of the Manager and its
obligations under the Management Agreement.
On November 3, 1997, the Company sold nine CMBS bonds,
resecuritized two CMBS bonds and redeemed the remaining CMBS bond. Total
proceeds from these transactions were approximately $77,000,000 of cash and the
Company retained a small residual interest in the resecuritized CMBS bonds. The
combined gain from these transactions is approximately $5,000,000 for GAAP
income purposes and approximately $2,000,000 for REIT income purposes and will
be included in the Company's fourth quarter 1997 earnings.
The Company is currently evaluating its investment opportunities
for the proceeds from restructuring its portfolio. Its plans are to acquire
equity interests in real estate, but the specific class of real estate has not
yet been determined. The Company believes that even though the cash on cash
returns to be earned from equity interests in real estate may be less than the
returns earned on the portfolio of subordinate classes of CMBS bonds, the change
in portfolio assets will reduce the Company's exposure to credit risks and may,
under certain circumstances, result in increased opportunities for capital
appreciation of the real estate assets acquired.
Presented below is a schedule of the CMBS bonds previously owned by
the Company as of September 30, 1997 and December 31, 1996 (dollar amounts in
thousands).
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<PAGE>
<TABLE>
<CAPTION>
Weighted-
Maturity Average Senior Outstanding Balance at
Description Coupon Date Life (1) Rating CMBS Bonds(2) 9/30/97 12/31/96
- ----------------------------------------------------- ------ -------- ---------- ------ ----------- ----------------------
Fannie Mae Multifamily REMIC Trust 1994-M2
<S> <C> <C> <C> <C> <C> <C> <C>
Class C(4) 7.99% 1/2001 3.3 yrs. Unrated $ 293,184 $ 10,627 $ 10,704
Class D(4) 8.18% 1/2004 6.1 Unrated 32,269 38,384
DLJ Mortgage Acceptance Corporation
Series 1994-MF4, Class B-3 8.50% 4/2001 3.5 B 89,296 3,136 3,136
Series 1994-MF4, Class C 8.50% 4/2001 3.5 Unrated 4,183 4,183
Kidder, Peabody Acceptance Corporation I
Series 1993-M2, Class E(5) 8.88% 8/2021 2.9 BB 79,744 10,000 10,000
Kidder, Peabody Acceptance Corporation I
Series 1994-M1, Class C 8.25% 11/2002 3.8 B 166,900 8,930 8,930
Series 1994-M1, Class D 8.25% 11/2002 4.1 Unrated 7,655 7,655
Lehman Capital Corporation Trust Certificate
Series 1994-2(3) -- 2,143
Series 1994-3(3) -- 4,162
Blaylock Mortgage Capital Corporation Multifamily Trust
Series 1997-A Class B-3 (3) 6.42% 10/2003 6.1 BB 120,918 5,352 --
Series 1997-A Class B-4 (3) 6.42% 10/2003 6.1 B 3,345 --
Series 1997-A Class B-5 (3) 6.42% 10/2003 6.1 B- 1,003 --
Series 1997-A Class B-6 (3) 6.42% 10/2003 6.1 CCC 1,003 --
Series 1997-A Class B-7 (3) 6.42% 10/2003 6.1 Unrated 1,338 --
---- --- ----------- -------- --------
Total outstanding balance 8.04% 4.8 yrs. $ 750,042 88,841 89,297
==== === ===========
Unamortized discount (6) (11,499) (12,077)
Allowance for credit losses (6) (12,720) (12,720)
Unamortized acquisition costs (6) 390 349
-------- --------
Amortized cost 65,012 64,849
Net unrealized holding losses (6) 5,000 (3,389)
-------- --------
Total net book value $ 70,012 $ 61,460
======== ========
- ------------------------------------------------------------------
<FN>
1 Remaining weighted-average life at September 30, 1997.
2 The outstanding principal balance at September 30, 1997, of the CMBS bonds
senior to the Company's subordinate CMBS bond classes. The amount is
aggregated for classes from a single issuance.
3 In March 1997, the Company contributed Lehman Series 1994-2 and 1994-3 to a
trust and in turn received Blaylock Classes B-5, B-6 and B-7 and a partial
interest in Classes B-3 and B-4. At the same time, the Company acquired the
remaining interests in Blaylock Classes B-3 and B-4.
4 Payment of principal and interest is not guaranteed by FNMA. The Company
owns the trust receipt, which has an interest in these two bonds.
5 The Company has a 75.2% ownership interest in this CMBS bond.
6 The amounts are specifically identified to individual CMBS bonds.
</FN>
</TABLE>
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<PAGE>
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
REIT Income
REIT income is taxable income computed as prescribed for REITs
prior to the dividends paid deduction. The Company's REIT income for the three
and nine months ended September 30, 1997, was $4,124,000 ($.40 per share) and
$7,990,000 ($.77 per share), respectively, compared with $1,986,000 ($.19 per
share) and $6,591,000 ($.64 per share), respectively, for the same periods in
1996. The primary reason for the increase was higher income from CMBS bonds and
expenses incurred for the elimination of DERs in 1996 partially offset by
increased management fees.
REIT income from CMBS bonds for the three and nine months ended
September 30, 1997, was $5,062,000 ($.49 per share) and $9,621,000 ($.93 per
share), respectively, compared with $2,259,000 ($.22 per share) and $9,106,000
($.89 per share), respectively, for the same periods in 1996. The increase in
REIT income from CMBS bonds was due to August 1997 prepayments on one of the
CMBS bonds and earnings on CMBS bonds acquired in March 1997 offset by the May
1996 redemption of two CMBS bonds and prepayments on one other CMBS bond during
the first half of 1996.
In May 1996, two CMBS bonds with an outstanding principal balance
of $9,664,000 were redeemed eight years earlier than anticipated. As a result,
the yield on the bonds increased to 18.1% from an originally expected yield of
11.8%. During the nine months ended September 30, 1996, the Company's earnings
for these bonds were $1,837,000.
In 1997 and 1996, the Company received principal prepayments on
mortgages backing two of its CMBS bonds. For these particular bonds, the Company
previously had elected, under the Code, to limit the amount of amortization of
the market discount to the lesser of principal received or computed
amortization. During the nine months ended September 30, 1997, there were
$5,853,000 of principal prepayments compared to $755,000 of principal
prepayments for the same period in 1996. Primarily, as a result of the elections
and prepayments, amortization during the three and nine months ended September
30, 1997, was $2,257,000 and $1,639,000, respectively, higher than the same
periods in 1996. In addition, a prepayment penalty fee of $482,000 was received
during the three and nine months ended September 30, 1997.
In March 1997, the Company contributed its ownership interest in
two CMBS bonds (Lehman Capital Corporation Trust Certificate, Series 1994-2 and
Series 1994-3) into a newly created trust (Blaylock Mortgage Capital Corporation
Multifamily Trust). Interests in bond classes within the same CMBS issuance
which were owned by another party were also contributed into the trust. The
trust then issued seven classes of CMBS bonds collateralized by the CMBS bond
classes contributed into the trust. The Company received an interest in five of
the new bond classes, which corresponded to the Company's ownership interests in
the two bonds contributed to the trust. The Company also acquired the remaining
$5,737,000 principal balance of two of the new bond classes rated "BB" and "B"
at a cost of $4,801,000, which resulted in the Company having 100% ownership in
the five new subordinate classes. As a result of the restructuring and
acquisition, revenues from these CMBS bonds increased by $73,000 and $168,000,
respectively, during the three and nine months ended September 30, 1997, as
compared to the same periods in 1996.
Interest income during the three and nine months ended September
30, 1997, was $51,000 ($.00 per share) and $211,000 ($.02 per share),
- 11 -
<PAGE>
respectively, compared with $129,000 ($.01 per share) and $200,000 ($.02 per
share), respectively, for the same periods in 1996. Interest income during the
three months ended September 30, 1997, was lower than the same period in 1996
because of the $4,801,000 of short-term investments used to acquire interests in
Blaylock Classes B-3 and B-4 in March 1997. The Company anticipates that
interest income will increase while the proceeds from the restructuring of the
CMBS bond portfolio are invested in cash equivalents. See "FORWARD LOOKING
INFORMATION" below.
The Company's management fees were $886,000 ($.09 per share) and
$1,494,000 ($.14 per share), respectively, for the three and nine months ended
September 30, 1997, compared with $297,000 ($.03 per share) and $1,127,000 ($.11
per share), respectively, for the same periods in 1996. Specifically, Incentive
Fees increased by $559,000 and $333,000, respectively, Administrative Fees
increased by $3,000 and $1,000, respectively, and Base Fees increased by $27,000
and $33,000, respectively. The increases in Incentive Fees were primarily due to
increases in REIT income of $2,138,000 and $1,399,000, respectively. The impact
of the increase in REIT income was partially offset by an increase in the
average Ten-Year U.S. Treasury Rate during the nine months ended September 30,
1997, as compared to the same period in 1996 which had the effect of raising the
threshold above which Incentive Fees are paid. The increase in Base Fees was
primarily due to the $4,801,000 acquisition of Blaylock bonds in March 1997 and
unrealized holding gains on the CMBS bonds causing the net carrying value of the
bonds to increase.
The Company incurred $23,000 of Acquisition Fees during the nine
months ended September 30, 1997, relating to the purchase of interests in
Blaylock Classes B-3 and B-4. These Acquisition Fees are capitalized and
amortized over the life of the related bonds. No Acquisition Fees were incurred
during the nine months ended September 30, 1996.
General and administrative expenses of the Company were $103,000
($.01 per share) and $348,000 ($.03 per share), respectively, for the three and
nine months ended September 30, 1997, compared with $105,000 ($.01 per share)
and $617,000 ($.06 per share), respectively, for the same periods in 1996.
General and administrative expenses decreased during the nine months ended
September 30, 1997, compared with the same period in 1996, due to lower
shareholder relations expenses, lower consulting and accounting expenses and the
elimination of DER expense pursuant to the May 1996 amendment to the Stock
Option Plan.
On May 30, 1996, the Company's stockholders approved an amendment
to the Stock Option Plan at their annual meeting permitting the Company to issue
shares of Common Stock in the second quarter of 1996 to the holders of stock
options who voluntarily gave up their DERs. The amendment also eliminated
provisions in the Stock Option Plan that would have permitted the issuance of
DERs in connection with stock options granted in the future. The issuance of
Common Stock in exchange for the right to receive DERs resulted in a one-time,
non-cash charge to income of $966,000 ($941,000 for the issuance of 157,413
shares of Common Stock plus $25,000 of transaction costs) during the second
quarter of 1996.
During the nine months ended September 30, 1996, interest expense
on the Company's short-term notes payable was $5,000 ($.00 per share). There was
no interest expense during the nine months ended September 30, 1997. The
decrease is the result of repayment of short-term borrowings during the first
half of 1996.
- 12 -
<PAGE>
Dividend Distributions
In September 1997, the Company declared a third quarter dividend of
$.17 per share which was paid on September 30, 1997, to stockholders of record
on September 18, 1997. This was the twelfth consecutive regular quarterly
dividend of $.17 per share.
As a result of the restructuring of the CMBS bonds and other
transactions, in November 1997, the Company announced that its regular fourth
quarter 1997 dividend will be $.17 per share plus a $.26 per share special
dividend. Additionally, the Company will pay a $.17 per share capital gain
distribution subject to tax on the stockholders at their applicable capital gain
tax rates. These distributions add to a total fourth quarter 1997 dividend of
$.60 per share, which will be paid on December 30, 1997, to stockholders of
record on December 15, 1997.
The Company plans to invest the proceeds from restructuring its
CMBS bond portfolio in cash equivalents until equity investments in real estate
are acquired. The returns from such interim investments are expected to be less
than the Company's historical returns from its CMBS bonds. Accordingly, the
Company's quarterly dividends are expected to decline to $.13 per share in 1998,
assuming no reinvestment of the proceeds in real estate and consistent levels of
operating expenses and interim investment returns. However, if the Company is
able to invest the proceeds in classes of real estate that generate higher
returns than those earned from the interim investments, future quarterly
dividends may improve from these projected levels. See "FORWARD LOOKING
INFORMATION" below.
Reconciliation of REIT Income and Book Income
The Company computes its income in accordance with the Code (REIT
income) and in accordance with GAAP (book income). As a REIT, the Company's REIT
income is the basis upon which the Code requires the Company to make
distributions to its stockholders. However, because the Company's Common Stock
is registered with the Securities and Exchange Commission, the Company is also
required to report its financial position and income in accordance with GAAP.
During the three and nine months ended September 30, 1997, REIT
income exceeded book income by $1,640,000 ($.16 per share) and $1,961,000 ($.19
per share), respectively. Substantially all of this difference is due to: (i)
the method of recording credit losses, which for REIT income purposes are not
deducted until they occur (as of September 30, 1997, no credit losses had been
realized) and which for book income purposes are estimated and reflected as a
reduction of revenues in the form of lower discount amortization included in
interest income from CMBS bonds; and (ii) the method of amortizing purchase
price discounts, which for REIT income purposes is subject to certain
limitations not applicable for book income purposes.
For the three and nine months ended September 30, 1997, the Company
earned book income computed in accordance with GAAP of $2,484,000 ($.24 per
share) and $6,029,000 ($.58 per share), respectively, compared with $1,765,000
($.17 per share) and $5,364,000 ($.52 per share), respectively, for the same
periods in 1996. The variances in book income between 1997 and 1996 are due to
reasons previously discussed. However, because of the different methods of
amortizing purchase price discounts for GAAP and REIT purposes, the redemptions,
prepayments and purchases of CMBS bonds noted above caused GAAP revenues from
CMBS bonds for the three and nine months ended September 30, 1997, to increase
by $887,000 and decrease by $428,000, respectively, as compared to the same
periods in 1996.
- 13 -
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company uses its cash flows from operating activities and other
capital resources to provide working capital to support its operations, for
making distributions to its stockholders, for the acquisition of portfolio
assets and for the repayment of short-term borrowings. For the nine months ended
September 30, 1997 and 1996, cash flows provided by operating activities were
$5,098,000 and $4,130,000, respectively. As of September 30, 1997, the Company
had $3,335,000 in cash and cash equivalents.
In November 1997, the Company restructured its portfolio of CMBS
bonds by selling nine CMBS bonds, resecuritizing two CMBS bonds and having
redeeming the remaining CMBS bonds redeemed by the issuer. The net proceeds from
these transactions were approximately $77,000,000.
The Company's Loan and Security Agreement collateralized by four
CMBS bonds (FNMA 94-M2C, FNMA 94-M2D, Kidder 94-M1C and Kidder 94-M1D) was
cancelled in November 1997 upon the sale and resecuritization of these bonds. No
borrowings were outstanding on this line at September 30, 1997 or December 31,
1996.
The Company also has an unsecured line of credit with a bank for
$1,000,000. Advances under this line bear interest at prime. Two of the
Company's Independent Directors are members of the Advisory Board of the bank.
At September 30, 1997 and December 31, 1996, no advances were outstanding on
this line of credit.
The Company is currently evaluating its investment opportunities
for the proceeds from restructuring its portfolio. Its plans are to acquire
equity interests in real estate, but the specific class of real estate has not
yet been determined. The Company believes that even though the cash on cash
returns to be earned from equity interests in real estate may be less than the
returns earned on the portfolio of subordinate classes of CMBS bonds, the change
in portfolio assets will reduce the Company's exposure to credit risks and may,
under certain circumstances, result in increased opportunities for capital
appreciation of the real estate assets acquired. There is no assurance the
Company will be able to identify new asset acquisition opportunities that meet
the Company's acquisition criteria. See "FORWARD LOOKING INFORMATION" below.
Until the Company invests in equity interests in real estate, the
proceeds from the restructuring of the CMBS bond portfolio will be invested in
cash equivalents. As a result, the Company anticipates that earnings and cash
flow will be lower than 1996 and the first nine months of 1997. See "FORWARD
LOOKING INFORMATION" below.
As a REIT, the Company is required, among other things, to
distribute annually to its stockholders at least 85% of ordinary REIT income and
95% of capital gains income. The dividends must be declared during the tax year
and distributed by January 31 of the subsequent year. The remaining REIT and
capital gains income is required to be distributed prior to filing the tax
return for the year. To meet these requirements, in November 1997, the Company
declared a total fourth quarter dividend of $.60 per share comprised of a
regular dividend of $.17 per share, a special dividend of $.26 per share, and a
capital gain distribution of $.17 per share. Undistributed earnings at December
31, 1997, after distribution of the fourth quarter dividend, are expected to be
$1,121,000 or $.11 per share and will be distributed in 1998. By qualifying for
the favorable tax treatment accorded to a REIT and by distributing to its
stockholders 100% of the Company's REIT income, the Company generally will not
- 14 -
<PAGE>
be required to pay income tax at the corporate level. See "FORWARD LOOKING
INFORMATION" below.
FORWARD LOOKING INFORMATION
The statements contained in this Form 10-Q Quarterly Report that are
not historical facts are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These forward-looking statements are based on current
expectations, estimates and projections about the industry and markets in which
the Company operates, management's beliefs and assumptions made by management.
Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks,"
"estimates," variations of such words and similar expressions are intended to
identify such forward-looking statements. These statements are not guarantees of
future performance and involve certain risks, uncertainties and assumptions
which are difficult to predict. Therefore, actual outcomes and results may
differ materially from what is expressed or forecasted in such forward-looking
statements. Operating results depend primarily on income from equity interests
in real estate, cash equivalents and CMBS bonds, which, in turn, are
substantially influenced by the risks inherent on owning real estate or debt
secured by real estate including, among other things: (i) the demand for and
supply of real estate assets, which meet the Company's investment criteria; (ii)
operating expense levels; (iii) interest rate levels; and (iv) the pace and
price at which the Company can acquire or develop real estate assets. Capital
and credit market conditions, which affect the Company's cost of capital, also
influence operating results.
PART II
OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit No. Description
27 Financial Data Schedule.
(b) Reports on Form 8-K:
No Current Reports on Form 8-K were filed by the Registrant
during the period covered by this Quarterly Report on Form
10-Q.
- 15 -
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
COMMERCIAL ASSETS, INC.
(Registrant)
Date: November 10, 1997 By /s/ Diane Schott Armstrong
----------------------------
Diane Schott Armstrong
Controller
- 16 -
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