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 June 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.)
3600 South Yosemite Street, Suite 350 80237
Denver, Colorado (Zip Code)
(Address of Principal Executive Offices)
(303) 773-1221
(Registrant's telephone number, including area code)
Not Applicable
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___.
As of August 1, 1997, 10,342,009 shares of Commercial Assets, Inc.
Common Stock were outstanding.
<PAGE>
COMMERCIAL ASSETS, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION:
Item 1. Condensed Financial Statements:
Balance Sheets as of June 30, 1997 (Unaudited)
and December 31, 1996.................................. 1
Statements of Income for the three and six months
ended June 30, 1997 and 1996 (Unaudited)............... 2
Statements of Cash Flows for the six months ended
June 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.......... 8
PART II. OTHER INFORMATION:
Item 4. Submission of Matters to a Vote of Security Holders...... 17
Item 6. Exhibits and Reports on Form 8-K......................... 17
(i)
<PAGE>
<TABLE>
<CAPTION>
COMMERCIAL ASSETS, INC.
CONDENSED BALANCE SHEETS
(Dollar amounts in thousands)
June 30, December 31,
1997 1996
---- ----
Assets (Unaudited)
<S> <C> <C>
Cash and cash equivalents $ 3,082 $ 8,277
Accrued interest receivable 613 597
Restricted cash 2,209 1,982
CMBS bonds 68,460 61,460
Other assets, net 176 90
---------- ----------
Total Assets $ 74,540 $ 72,406
========== ==========
Liabilities
Accounts payable and accrued liabilities $ 153 $ 189
Management fees payable 311 298
---------- ----------
Total Liabilities 464 487
---------- ----------
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 (23,807) (20,295)
Cumulative net income 22,486 18,941
---------- ----------
Dividends in excess of net income (1,321) (1,354)
---------- ----------
Net unrealized holding losses on CMBS bonds (1,431) (3,389)
---------- ----------
Total Stockholders' Equity 74,076 71,919
---------- ----------
Total Liabilities and Stockholders' Equity $ 74,540 $ 72,406
========== ==========
</TABLE>
See Notes to Condensed Financial Statements.
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<PAGE>
<TABLE>
<CAPTION>
COMMERCIAL ASSETS, INC.
CONDENSED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- -----------------------
1997 1996 1997 1996
--------- --------- --------- ------
Revenues
<S> <C> <C> <C> <C>
CMBS bonds $ 2,193 $ 3,462 $ 4,237 $ 5,773
Interest 49 64 160 71
-------- -------- -------- -------
Total Revenues 2,242 3,526 4,397 5,844
-------- -------- -------- -------
Expenses
Management fees 311 452 608 830
General and administrative 121 114 244 444
Elimination of DERs -- 966 -- 966
Interest -- 2 -- 5
-------- -------- -------- -------
Total Expenses 432 1,534 852 2,245
-------- -------- -------- --------
Net Income $ 1,810 $ 1,992 $ 3,545 $ 3,599
======== ======== ======== ========
Net income per share $ .17 $ .19 $ .34 $ .35
Weighted-average shares outstanding 10,326 10,214 10,321 10,178
Dividends per share $ .17 $ .17 $ .34 $ .34
</TABLE>
See Notes to Condensed Financial Statements.
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<PAGE>
<TABLE>
<CAPTION>
COMMERCIAL ASSETS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended
June 30,
--------------------
1997 1996
---- ----
Cash Flows From Operating Activities
<S> <C> <C>
Net income $ 3,545 $ 3,599
Adjustments to reconcile net income to net cash flows from operating
activities:
Amortization of discount on CMBS bonds and other assets (460) (1,775)
Issuance of Common Stock for elimination of DERs -- 941
(Increase) decrease in accrued interest receivable (16) 78
Decrease (increase) in other assets 19 (14)
(Decrease) increase in accounts payable and accrued liabilities (1) 173
------- ---------
Net Cash Provided By Operating Activities 3,087 3,002
------- ---------
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 (3,512) (1,724)
Repayments of short-term notes payable -- (700)
Issuance of Common Stock 31 --
-------- ---------
Net Cash Used In Financing Activities (3,481) (2,424)
-------- ---------
Cash and Cash Equivalents
(Decrease) increase (5,195) 10,435
Beginning of period 8,277 598
------- ---------
End of period $ 3,082 $ 11,033
======== =========
</TABLE>
See Notes to Condensed Financial Statements.
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<PAGE>
COMMERCIAL ASSETS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
A. Organization
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. ("AMEX") under the symbol "CAX."
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 June 30, 1997 and for
the three and six months then ended and 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 overnight
cash investments are considered to be cash and cash equivalents for purposes of
reporting cash flows. The Company paid interest expense in cash of $7,000 for
the six months ended June 30, 1996.
Non-cash investing and financing activities for the six months
ended June 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 $ 227 $ 996
Unrealized holding gains on CMBS bonds $ 1,958 $ 381
Distributions of Common Stock $ 135 $ 96
Distributions of Common Stock as consideration for the elimination of DERs $ -- $ 941
Dividends declared but not yet paid $ -- $ 1,754
</TABLE>
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<PAGE>
D. CMBS Bonds
The Company owns subordinate classes of Commercial Mortgage Backed
Securities ("CMBS bonds"). As of June 30, 1997 and December 31, 1996, the
outstanding balances of the Company's CMBS bonds were $94,806,000 and
$89,297,000, respectively, while unamortized purchase discounts, acquisition
costs and allowance for credit losses totaled $24,915,000 and $24,448,000,
respectively. Additionally, unrealized holding losses on the CMBS bonds as of
June 30, 1997 and December 31, 1996 were $1,431,000 and $3,389,000,
respectively.
In May 1996, two CMBS bonds (Aspen MHC, Series 1994-1 Class C and
D-1) 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 three and six months ended June
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.
At June 30, 1997, the outstanding balance of the mortgage loans
collateralizing the CMBS bonds was $864,555,000 and the outstanding principal
balance of the CMBS bonds that are senior to the Company's CMBS bonds was
$766,458,000. The aggregate allowance for credit losses on the Company's CMBS
bonds was $12,720,000 at both June 30, 1997 and December 31, 1996. As of June
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. There have been no credit losses charged to operations or
write-downs charged against the allowance for credit losses.
Pursuant to the provisions of certain of the Company's CMBS bonds,
principal payments which would otherwise be attributable to the Company's
interests are required to be set aside in reserve accounts to support the
eventual payment of more senior classes of CMBS bonds. At June 30, 1997 and
December 31, 1996, $2,209,000 and $1,982,000, respectively, were set aside in
reserve accounts and are shown as restricted cash on the balance sheet.
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) expires
on November 29, 1997. No borrowings were outstanding on this line at June 30,
1997 or December 31, 1996. Advances bear interest based upon a spread over the
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<PAGE>
London Interbank Offered Rate on Eurodollar Deposits ("LIBOR"). The Loan and
Security Agreement contains certain covenants with which the Company was in
compliance at June 30, 1997. The amount the Company will be able to borrow under
the Loan and Security Agreement is subject to lender approval and will vary
depending on the value of the collateral pledged to secure such facility.
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."
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 six months ended June 30, 1997 and 1996, the Company's
total management fees pursuant to the Management Agreement were $631,000 and
$830,000, respectively. Management fees during the six months ended June 30,
1997 and 1996 included: (i) Base Fees of $341,000 and $335,000, respectively;
(ii) Administrative Fees of $30,000 and $32,000, respectively; (iii) Incentive
Fees of $237,000 and $463,000, 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.
In February 1997, the Board of Directors of Asset Investors formed
a special committee to consider of Asset Investors' acquisition of the Manager.
If the acquisition is consummated, it would result in Asset Investors assuming
the operations of the Manager and its obligations under the Management
Agreement.
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,
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<PAGE>
1996, stock options granted under the Stock Option Plan automatically accrued
dividend equivalent rights ("DERs"). During the six months ended June 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 three and six
months ended June 30, 1996.
- 7 -
<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 also manages Asset
Investors. 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 Company owns, and the Manager administers on the Company's
behalf, subordinate debt interests in CMBS bonds issued in securitizations of
mortgage loans on multifamily properties. The Company owns 12 CMBS bonds from
five commercial mortgage loan securitizations acquired at a cost of $70,146,000.
The CMBS bonds had an outstanding principal balance of $94,806,000 at June 30,
1997, and an estimated weighted-average yield-to-maturity before credit losses
of 13.3%. At June 30, 1997, approximately 65% of the outstanding principal
balance of the Company's CMBS bonds is unrated, and the remaining 35% is rated
"BB" through "CCC" by national credit rating agencies. The mortgages which
comprise the collateral for the Company's CMBS bonds are secured by apartment
communities in 36 states, including 25%, 13% and 8% in Texas, Arizona and
Florida, respectively.
The multifamily mortgage loans that collateralize the Company's
CMBS bonds were primarily originated during 1993 and 1994. Capital for mortgage
financing during 1993 and 1994 was generally less available than in 1995 and
1996 because of, among other things, the reduced funding of such loans by
traditional real estate lenders (e.g. banks, thrifts, pension funds, etc.) in
response to significant losses which resulted from falling real estate values in
the late 1980s and early 1990s. Accordingly, the Company believes the mortgage
loan underwriting procedures applied to mortgage loans originated in 1993 and
1994 were more stringent than underwriting procedures applied to multifamily
mortgage loans originated in 1995 and 1996. The Company may benefit from these
more stringent underwriting procedures on the mortgage loans that collateralize
its CMBS bonds through reduced credit losses in the future. See "FORWARD LOOKING
INFORMATION" below.
Presented below is a schedule of the CMBS bonds owned by the
Company as of June 30, 1997 and December 31, 1996 (dollar amounts in thousands).
- 8 -
<PAGE>
<TABLE>
<CAPTION>
Weighted- Outstanding
Maturity Agerage Senior Balance at
Description Coupon Date Life (1) Rating CMBS Bonds(2) 6/30/97 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 3.4 yrs. Unrated $298,756 $ 10,653 $ 10,704
Class D(4) 8.18% 1/2004 6.2 Unrated 38,208 38,384
DLJ Mortgage Acceptance Corporation
Series 1994-MF4, Class B-3 8.50% 4/2001 3.8 B 89,959 3,136 3,136
Series 1994-MF4, Class C 8.50% 4/2001 3.8 Unrated 4,183 4,183
Kidder, Peabody Acceptance Corporation I
Series 1993-M2, Class E(5) 8.88% 8/2021 3.1 BB 79,745 10,000 10,000
Kidder, Peabody Acceptance Corporation I
Series 1994-M1, Class C 8.25% 11/2002 4.1 B 176,665 8,930 8,930
Series 1994-M1, Class D 8.25% 11/2002 4.3 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 6.3 BB 121,333 5,352 --
Series 1997-A Class B-4 (3) 6.42% 10/2003 6.3 B 3,345 --
Series 1997-A Class B-5 (3) 6.42% 10/2003 6.3 B- 1,003 --
Series 1997-A Class B-6 (3) 6.42% 10/2003 6.3 CCC 1,003 --
Series 1997-A Class B-7 (3) 6.42% 10/2003 6.3 Unrated 1,338 --
---- --- -------- -------- --------
Total outstanding balance 8.05% 5.0 yrs. $766,458 94,806 89,297
==== === ========
Unamortized discount (6) (12,605) (12,077)
Allowance for credit losses (6) (12,720) (12,720)
Unamortized acquisition costs (6) 410 349
-------- --------
Amortized cost 69,891 64,849
Net unrealized holding losses (6) (1,431) (3,389)
-------- --------
Total net book value $ 68,460 $ 61,460
======== ========
<FN>
- ------------------------------------------------------------------
1 Remaining weighted-average life at June 30, 1997.
2 The outstanding principal balance at June 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.
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
SIX MONTHS ENDED JUNE 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 six months ended June 30, 1997, was $1,954,000 ($.19 per share) and
$3,866,000 ($.38 per share), respectively, compared with $2,546,000 ($.25 per
share) and $4,605,000 ($.45 per share), respectively, for the same periods in
1996. The primary reason for the decrease was lower income from CMBS bonds
partially offset by reduced management fees and expenses incurred only in 1996
for the elimination of DERs.
REIT income from CMBS bonds for the three and six months ended June
30, 1997, was $2,337,000 ($.22 per share) and $4,559,000 ($.44 per share),
respectively, compared with $4,022,000 ($.39 per share) and $6,847,000 ($.67 per
share), respectively, for the same periods in 1996. The decrease in REIT income
from CMBS bonds was due to the May 1996 redemption of two CMBS bonds, and
prepayments on one other CMBS bond during the first half of 1996, partially
offset by earnings on CMBS bonds acquired in March 1997.
In May 1996, two CMBS bonds (Aspen MHC, Series 1994-1 Class C and
D-1), 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 six months ended
June 30, 1996, the Company's earnings for these bonds were $1,837,000.
Additionally, during the first half of 1996, the Company received
principal prepayments on one of its CMBS bonds. For this particular bond, 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 six months ended June 30, 1996, there were
$755,000 of principal prepayments from a mortgage collateralizing this bond. As
a result of the election, amortization during the first six months of 1996 was
$633,000 higher than the same period in 1997 due to prepayments.
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 $95,000 during the six
months ended June 30, 1997, as compared to the same period in 1996.
The CMBS bonds have coupon interest rates ranging from 6.4% to 8.9%
and a weighted-average yield-to-maturity before credit losses for REIT purposes
of 13.3%. The yield from CMBS bonds exceeds the coupon interest rate because the
subordinate CMBS bonds were sold to the Company with original issue discount or
market discount (i.e., the acquisition prices of the CMBS bonds were less than
their par values). Accordingly, the Company amortizes a portion of the discount
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<PAGE>
(the excess of the outstanding par amount over the net cost), as interest
income, on a constant effective yield under the interest method over the life of
the CMBS bond. Amortization of the discount into REIT income from certain CMBS
bonds is limited to principal received.
Through June 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. Otherwise, there have been no delinquencies.
As of June 30, 1997, there have been no credit losses charged to operations or
write-downs charged against the allowance for credit losses. For REIT purposes,
credit losses are reflected in income only when they are realized. In future
periods, the Company likely will be allocated credit losses on its CMBS bonds,
and as a result, REIT income may be adversely impacted. See "FORWARD LOOKING
INFORMATION" below.
Interest income during the three and six months ended June 30,
1997, was $49,000 ($.01 per share) and $160,000 ($.02 per share), respectively,
compared with $64,000 ($.01 per share) and $71,000 ($.01 per share),
respectively, for the same periods in 1996. The increase in interest income
during the six months ended June 30, 1997, as compared to the same period in
1996 is due to investing the proceeds from the May 1996 redemption of two CMBS
bonds into highly liquid, short-term investments. Interest income during the
three months ended June 30, 1997, was lower than that of the preceding quarter
and the same quarter 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's management fees were $311,000 ($.03 per share) and
$608,000 ($.06 per share), respectively, for the three and six months ended June
30, 1997, compared with $452,000 ($.04 per share) and $830,000 ($.08 per share),
respectively, for the same periods in 1996. Specifically, Incentive Fees
declined by $153,000 and $226,000, respectively, Administrative Fees increased
by $1,000 and decreased by $2,000, respectively, and Base Fees increased by
$11,000 and $6,000, respectively. The decreases in Incentive Fees were primarily
due to decreases in REIT income of $592,000 and $739,000, respectively. In
addition, the average Ten-Year U.S. Treasury Rate was 33 basis points higher
during the six months ended June 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 six
months ended June 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 six
months ended June 30, 1996.
In February 1997, the Board of Directors of Asset Investors formed
a special committee for the consideration of Asset Investors' acquisition of the
Manager. If the acquisition is consummated, it would result in Asset Investors
assuming the operations of the Manager and its obligations under the Management
Agreement.
General and administrative expenses of the Company were $121,000
($.01 per share) and $245,000 ($.02 per share), respectively, for the three and
six months ended June 30, 1997, compared with $120,000 ($.01 per share) and
$512,000 ($.05 per share), respectively, for the same periods in 1996. General
and administrative expenses decreased during the six months ended June 30, 1997,
compared with the same period in 1996, due to lower shareholder relations
expenses and the elimination of DER expense pursuant to the May 1996 amendment
to the Stock Option Plan.
- 11 -
<PAGE>
On May 30, 1996, the Company's shareowners 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 six months ended June 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 six months ended June 30, 1997. The decrease is the
result of repayment of short-term borrowings during the first half of 1996.
Dividend Distributions
In May 1997, the Company declared a second quarter dividend of $.17
per share which was paid on June 30, 1997, to stockholders of record on June 16,
1997. This was the eleventh consecutive regular quarterly dividend of $.17 per
share.
Book Income
For the three and six months ended June 30, 1997, the Company
earned book income computed in accordance with GAAP of $1,810,000 ($.17 per
share) and $3,545,000 ($.34 per share), respectively, compared with $1,992,000
($.19 per share) and $3,599,000 ($.35 per share), respectively, for the same
periods in 1996. The $54,000 ($.01 per share) decrease in book income for the
six months was due to reasons previously discussed: lower revenues from the
early redemption of the two CMBS bonds partially offset by income on newly
acquired bonds, increased interest income, lower management fees and general and
administrative expenses and no DER elimination expense. The election regarding
the amortization of the pricing discount on the bond with the $755,000 principal
prepayment was for REIT income purposes only. The prepayment did not have an
impact on book income during the six months ended June 30, 1996.
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 six months ended June 30, 1997, REIT income
exceeded book income by $144,000 ($.01 per share) and $321,000 ($.03 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 June 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.
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<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 six months ended
June 30, 1997 and 1996, cash flows provided by operating activities were
$3,087,000 and $3,002,000, respectively. As of June 30, 1997, the Company had
$3,082,000 in cash and cash equivalents, which the Company currently intends to
use to pay its expenses, make dividend distributions to stockholders and acquire
portfolio assets. See "FORWARD LOOKING INFORMATION" below.
During March 1997, the Company acquired interests in Blaylock
Mortgage Capital Corporation Multifamily Trust Classes B-3 and B-4 for
$4,703,000 plus acquisition and transaction costs of $98,000. The acquired
interests in the new bond classes are rated "BB" and "B", had a principal
balance of $5,737,000 at acquisition, and pay a coupon of 6.4% per annum. The
estimated weighted-average yield-to-maturity before credit losses of the
acquired CMBS bonds is 10.0% per annum.
The Company's Loan and Security Agreement collateralized by four
CMBS bonds expires on November 29, 1997. No borrowings were outstanding on this
line at June 30, 1997 or December 31, 1996. Advances bear interest based upon a
spread over LIBOR. The Loan and Security Agreement contains certain covenants
with which the Company was in compliance at June 30, 1997. The amount the
Company will be able to borrow under the Loan and Security Agreement is subject
to lender approval and will vary depending on the value of the collateral
pledged to secure such facility.
The indentures of the commercial securitizations in which the
Company has acquired CMBS bonds generally provide for substantial penalties if
the mortgage loans underlying the commercial securitization are prepaid, and the
prepayments generally are allocated to the senior bond classes before the
subordinate bond classes which the Company generally owns. Significant principal
distributions to subordinate CMBS bonds generally are not anticipated before the
scheduled principal distributions.
The Company's ability to acquire additional assets will depend on,
among other things, unanticipated principal prepayments such as the $9,664,000
of CMBS bonds redeemed in May 1996, obtaining new debt or equity capital, or
liquidating the existing portfolio of CMBS bonds. There is no assurance the
Company will be able to identify new asset acquisition opportunities that meet
the Company's acquisition criteria or that the Company will be able to raise
additional funds, whether from principal prepayments, borrowings, issuances of
debt or equity securities, liquidation of the current portfolio or other
sources. See "FORWARD LOOKING INFORMATION" below.
As a REIT, the Company is required, among other things, to
distribute annually to its stockholders at least 95% of its REIT income, 85% of
which must be declared during the tax year and distributed by January 31 of the
subsequent year. The remainder is required to be distributed prior to filing the
tax return for the year. At June 30, 1997, the Company had cumulative REIT
income in excess of distributions of $1,629,000. 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 be required to pay
income tax at the corporate level. See "FORWARD LOOKING INFORMATION" below.
The Company anticipates its REIT income from CMBS bonds will exceed
the related cash flow due to the inherent structure and pricing of the
subordinate CMBS bonds. The subordinate classes of CMBS bonds purchased by the
Company were issued at a significant discount to their par value. In accordance
- 13 -
<PAGE>
with the Code, this discount generally is amortized into income over the life of
the CMBS bond (a non-cash source of REIT income).
Under the Code, the Company has elected an income recognition
methodology for certain of its CMBS bonds that computes income attributable to
the amortization of market discount as the lesser of: (i) the amount of
principal received from the CMBS bond during the year; or (ii) the computed
discount amortization. The effect of this election is to defer a portion of the
amount of the Company's REIT income from non-cash discount amortization from the
early years in the life of the applicable bonds to later years when significant
repayments of principal are expected to be received. The Company was able to
make this election on seven CMBS bonds which had an outstanding principal
balance of $60,902,000 at June 30, 1997.
Subordinate CMBS bonds acquired by the Company are relatively
non-liquid and, as a result, the Company's ability to change its portfolio
quickly in response to changes in economic and other conditions may be limited.
In addition, REIT rules applicable to the Company may restrict the Company's
ability to sell assets within four years of their acquisition. Under the Code, a
redemption or prepayment does not constitute a "sale."
As the holder of subordinate CMBS bonds (which generally are
allocated all losses on the underlying mortgage loans until the principal
balance of the bond is exhausted), the Company has significant credit risk.
These bonds are subject to a greater risk of loss of principal and non-payment
of interest than the more senior bonds secured by the same assets. If a borrower
defaults on a commercial mortgage loan that is pledged as collateral for a
commercial mortgage loan securitization, and the proceeds of the foreclosure of
the property are less than the unpaid balance of the mortgage plus foreclosure
costs (principal and interest advances through foreclosure sale, repair and
maintenance costs during the foreclosure, brokerage fees, legal fees, taxes,
insurance, etc.), the Company, as the holder in most cases of the subordinate
class, will suffer a loss.
The Company believes that cash generated by current and future
operations and additional capital-raising activities, including borrowings, will
enable the Company to meet its current and anticipated future liquidity
requirements, including the payment of dividends to its stockholders in an
amount equal to at least 95% of the Company's REIT income. See "FORWARD LOOKING
INFORMATION" below.
The management and the Board of Directors of the Company are
continuously evaluating the Company's existing investments, structure and
strategy and considering whether changes are warranted. The goal of management
and the Board of Directors is to invest in assets with the greatest
risk-adjusted rates of return. A change in the Company's existing portfolio may
impact the nature of the Company's assets, future REIT income and resulting
dividends of the Company. See "FORWARD LOOKING INFORMATION" below.
CMBS BOND YIELD CONSIDERATIONS
Defaults
The yields on the CMBS bonds acquired by the Company are extremely
sensitive to the amount and timing of defaults and the severity of losses on the
mortgage loans collateralizing such CMBS bonds. The Company's right, as a holder
of subordinate CMBS bonds, to distributions of principal and interest is
subordinate to the more senior classes of CMBS bonds. Actual losses on the loans
take place after default on the loan, when the proceeds from the foreclosure
sale of the real estate are less than the unpaid balance of the mortgage loan
- 14 -
<PAGE>
plus interest advances and foreclosure costs. Such losses will be allocated
first to the subordinate first-loss CMBS bonds prior to being allocated to the
more senior CMBS bond classes. As of June 30, 1997, one of the mortgages with an
outstanding balance of $788,000 that 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. Otherwise, there have
been no delinquencies. The CMBS bonds the Company owns are more speculative than
the senior CMBS bond classes and may be subject to special risks, including a
substantially greater risk of loss of principal and non-payment of interest.
If the CMBS bonds acquired by the Company have an actual default
rate and severity of loss on the mortgage collateral that are higher than those
anticipated by the Company when the bonds were acquired, their yield will be
lower than the Company initially anticipated and, in the event of substantial
losses, the Company may not recover its acquisition cost. The timing of actual
losses also will affect the Company's yield on CMBS bonds, even if the rate of
default and severity of loss are consistent with the Company's projections. In
general, the earlier a loss occurs, the greater the adverse effect on the
Company's yield.
The Company's yield on CMBS bonds also will be affected by interest
rate levels during the periods in which the mortgage loans collateralizing the
CMBS bonds mature. For example, if at the maturity date of a mortgage loan,
prevailing mortgage interest rates are much higher than the original interest
rate on the mortgage loan, the operating cash flows from the commercial property
may not be sufficient to meet the higher debt service costs of replacement
financing, and the owner of the commercial property, unable to obtain
replacement financing, may default on the mortgage. If the property is not sold
for more than the amount of the mortgage plus foreclosure costs, the Company may
incur credit losses. Similar losses may occur if financing of the commercial
properties cannot be arranged at the maturity date of the current outstanding
mortgage due to poor property performance. These potential losses are referred
to as "balloon losses."
There can be no assurance as to the future rate of delinquency,
severity of loss or the timing of any such losses on the mortgage loans
collateralizing the CMBS bonds and, thus, no assurance as to the actual yield
received by the Company. See "FORWARD LOOKING INFORMATION" below.
Prepayments
The aggregate amount of distributions on the Company's CMBS bonds
and their yields also will be affected by the amount and timing of principal
prepayments on the mortgage loans. Generally, all payments of principal,
including prepayments, on the mortgage loans will be paid to the holders of any
more senior classes of CMBS bonds before principal payments are paid to the
subordinate bond classes held by the Company. Because of this, when computing
yields-to-maturity on its CMBS bonds, the Company generally does not consider
prepayments from the underlying mortgage loans collateralizing its CMBS bonds.
However, because the Company acquires the CMBS bonds at a significant discount
from their outstanding principal balance, prepayments of principal on the
Company's CMBS bonds may increase the Company's yield on its CMBS bonds.
Because the rate and timing of principal payments on mortgage loans
will depend on future events and on a variety of factors over which the Company
has no control, no assurances can be given as to the rate or timing of principal
payments, if any, on the CMBS bonds the Company owns. See "FORWARD LOOKING
INFORMATION" below.
- 15 -
<PAGE>
Loss Severity
While the rate and timing of defaults and prepayments on the
mortgage collateral are important in determining the anticipated yield on
subordinate CMBS bonds, the anticipated severity of the loss on the mortgage
loans (i.e., the total loss on any foreclosure sale as a percentage of the
remaining outstanding principal balance of a mortgage loan) is significantly
more important in determining the anticipated yield on a subordinate CMBS bond.
Losses on defaulted mortgage collateral are realized after the foreclosure sale
of the property which generally is the only security for the mortgage loan. The
severity of these losses is extremely important because such losses generally
will be allocated to, and will reduce the remaining principal balance of, the
Company's subordinate CMBS bonds. The severity of loss takes into account the
property owner's equity in the mortgaged real estate, the anticipated decline in
market value of the property, accrued and unpaid interest through the
foreclosure process and foreclosure costs. The higher the coupon rate of the
mortgage loan, the higher are the costs of interest advances from the date of
default through foreclosure sale.
INFLATION, INTEREST RATES, MORTGAGE PREPAYMENTS AND OTHER FACTORS
The Company, its assets and its Common Stock will be affected by
prevailing market interest rates, including: (i) the effects of interest rates
on the values of long-term, fixed-rate debt securities; (ii) the possibility
that, in periods of high interest rates, the Common Stock may be less attractive
than alternative investments of equal or lower risk; (iii) possible mismatches
between the Company's borrowing costs and the Company's cash flow requirements
which could have a negative effect on the Company's income; (iv) the negative
effect of high interest rates on the properties underlying the Company's CMBS
bonds (including a negative impact on the owner's ability to refinance debt
secured by such properties); and (v) the effects of interest rates on the
Company's borrowing costs. Interest rates are determined in large part by market
conditions and government policies which are beyond the control of the Company
and which are difficult to predict.
FORWARD LOOKING INFORMATION
Certain statements made by the Company's officers included in, but
not limited to, this Form 10-Q Quarterly Report, periodic press releases, oral
statements about the Company, and conference calls following quarterly earnings
releases, constitute "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors that
may cause the actual results, performance or achievements of the Company to be
materially different from any future results, performance or achievements
expressed or implied by the forward-looking statements. Such factors include the
following: general economic and business conditions; investment opportunities;
interest rate changes; competition; the availability of financing with terms and
prices acceptable to the Company; the Company's ability to maintain or reduce
expense levels; and losses on CMBS bonds.
- 16 -
<PAGE>
PART II
OTHER INFORMATION
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's 1997 Annual Meeting of Stockholders was held on
May 20, 1997. At the meeting, Messrs. Thomas L. Rhodes,
Raymond T. Baker, and Thomas C. Fries were elected as Class I
Directors to terms expiring in 2000; Mr. Terry Considine was
elected as a Class III Director to a term expiring in 1999;
and Mr. Bruce D. Benson was elected as a Class II Director to
a term expiring in 1998. There were 8,939,364, 8,964,945,
8,940,320, 8,961,163, and 8,941,946 votes cast "for" the
election of Messrs. Rhodes, Baker, Fries, Considine and
Benson, respectively; and 130,035, 104,454, 129,079, 108,236,
and 127,453, respectively, votes cast "abstain."
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit No. Description
10.4(b)* Second Amendment to Commercial Assets, Inc. 1993 Stock Option
Plan
27 Financial Data Schedule.
- --------------------
* Management contract or compensatory plan or arrangement.
(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.
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: August 7, 1997 By /s/ Kevin J. Nystrom
----------------------
Kevin J. Nystrom
Chief Financial Officer
- 17 -
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<NAME> COMMERCIAL ASSETS, INC.
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<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 3,082
<SECURITIES> 0
<RECEIVABLES> 613
<ALLOWANCES> 0
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COMMERCIAL ASSETS INC.
SECOND AMENDMENT TO
1993 STOCK OPTION PLAN
MAY 20, 1997
This Second Amendment to the Commercial Assets, Inc. 1993 Stock Option
Plan, adopted as of August 19, 1993 as amended March 6, 1996 (the "Plan") was
approved by the Board of Directors of the Corporation on May 20, 1997.
Capitalized terms used herein shall have the meanings given to them in the Plan
unless otherwise defined in this Second Amendment.
1. Section 16 of the Plan ("Nontransferability") is amended and
restated to read as follows:
16. Limited Transferability of Awards. Options, Stock
Appreciation Rights and Limited Rights granted under the Plan shall not
be transferable other than (i) by will or by the laws of descent and
distribution, (ii) pursuant to a qualified domestic relations order as
defined by the Code or Title I of the Employee Retirement Income
Security Act, or the rules thereunder, (iii) with the consent of the
Committee and without payment of consideration, to immediate family
members of the Recipient or to trusts of partnerships for such family
members, or (iv) with the consent of the Committee and solely to the
extent such Options, Stock Appreciation Rights and Limited Rights are
then exercisable (or will become exercisable solely with the lapse of
time), to another officer, director or employee of the Corporation.
Awards may be exercised or otherwise realized only by the Recipient or
by his guardian or legal representative or permitted transferee.
2. A new Section 24 is added to the Plan to read as follows:
24. Meeting Fees.
(a) Election to Receive Common Stock. Commencing with
the Corporation's 1997 Annual Meeting of Shareowners, each Independent
Director of the Corporation, as defined in the Corporation's bylaws (an
"Independent Director"), may elect to receive all or any portion of any
Meeting Fees in cash, in shares of Common Stock, or in a combination
thereof. "Meeting Fees" shall mean all annual retainers and other fees
paid for attendance at each regular or special meeting of the Board or
any committees attended by an Independent Director. Such election shall
be irrevocable, shall be made in writing and delivered to the
1
<PAGE>
Corporation's Secretary on or prior to each Annual Meeting of the
Corporation's Shareowners (the "Election Date"), and shall apply to the
period commencing on the Election Date and terminating on the Annual
Meeting of Shareowners for the year following the Election Date (the
"Election Period"). If no such election is timely received, an
Independent Director shall receive any Meeting Fees during such
Election Period in cash.
(b) Cash Meeting Fees. Meeting Fees paid in cash
shall be paid on or as soon as practicable after any regular or special
meeting attended by an Independent Director.
(c) Shares in lieu of Cash Meeting Fees. Meeting fees
paid in shares of Common Stock shall be evidenced by certificates for
such shares, delivered to the Independent Directors as soon as
practicable following the determination of the number of shares to be
paid in connection with any Election Period. Such certificates shall be
registered in the name of the Independent Director, and all shares so
issued shall be fully paid and nonassessable. The Corporation will pay
any issuance or transfer taxes with respect to the issuance of such
shares. Any fractions of shares otherwise issuable under this Section
24 shall be paid in cash, or, if an Independent Director has elected to
receive shares for the next Election Period, added to the amount to the
number of shares to be issued in connection with the next Election
Period. Notwithstanding any provision of the Plan to the contrary, no
Independent Director may receive more than 50,000 shares of Common
Stock in lieu of Meeting Fees in any year.
(d) Administration. Notwithstanding any provision of
the Plan to the contrary, the members of the Board other than the
Independent Directors shall administer this Section 24 and have all
authority of the Committee provided in Section 3 of this Plan or
otherwise with respect to this Section 24. Such authority shall
include, without limitation, the authority to set the amount of Meeting
Fees and the cash, shares of Common Stock and combinations thereof to
be paid pursuant to this Section 24.
2
