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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 March 31, 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 May 1, 1997, 10,315,809 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 MARCH 31, 1997
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION: PAGE
Item 1. Condensed Financial Statements:
Balance Sheets as of March 31, 1997 (Unaudited)
and December 31, 1996........................ 1
Statements of Income for the three months
ended March 31, 1997 and 1996 (Unaudited).... 2
Statements of Cash Flows for the three months
ended March 31, 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 6. Exhibits and Reports on Form 8-K.............. 16
(i)
<PAGE>
<TABLE>
<CAPTION>
COMMERCIAL ASSETS, INC.
CONDENSED BALANCE SHEETS
(Dollar amounts in thousands)
March 31, December 31,
1997 1996
---- ----
Assets (Unaudited)
<S> <C> <C>
Cash and cash equivalents $ 3,288 $ 8,277
Accrued interest receivable 612 597
Restricted cash 2,094 1,982
CMBS bonds 67,368 61,460
Other assets, net 82 90
---------- ----------
Total Assets $ 73,444 $ 72,406
========== ==========
Liabilities
Accounts payable and accrued liabilities $ 209 $ 189
Management fees payable 320 298
---------- ----------
Total Liabilities 529 487
---------- ----------
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;
10,315,809 shares issued and outstanding 103 103
Additional paid-in capital 76,559 76,559
Cumulative dividends declared (22,049) (20,295)
Cumulative net income 20,676 18,941
---------- ----------
Dividends in excess of net income (1,373) (1,354)
---------- ----------
Net unrealized holding losses on CMBS bonds (2,374) (3,389)
---------- ----------
Total Stockholders' Equity 72,915 71,919
---------- ----------
Total Liabilities and Stockholders' Equity $ 73,444 $ 72,406
========== ==========
</TABLE>
See Notes to Condensed Financial Statements.
- 1 -
<PAGE>
<TABLE>
<CAPTION>
COMMERCIAL ASSETS, INC.
CONDENSED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
Three Months Ended
March 31,
1997 1996
---- ----
Revenues
<S> <C> <C>
CMBS bonds $ 2,044 $ 2,311
Interest 111 7
-------- --------
Total Revenues 2,155 2,318
-------- --------
Expenses
Management fees 297 378
General and administrative 123 330
Interest -- 3
-------- --------
Total Expenses 420 711
-------- --------
Net Income $ 1,735 $ 1,607
======== ========
Net income per share $ .17 $ .16
Weighted-average shares outstanding 10,316 10,142
Dividends per share $ .17 $ .17
</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)
Three Months Ended
March 31,
1997 1996
---- ----
Cash Flows From Operating Activities
<S> <C> <C>
Net income $ 1,735 $ 1,607
Adjustments to reconcile net income to net cash flows from operating
activities:
Amortization of discount on CMBS bonds and other assets (200) (238)
(Increase) decrease in accrued interest receivable (15) 3
Decrease in other assets 4 --
Increase in accounts payable and accrued liabilities 42 164
------- -------
Net Cash Provided By Operating Activities 1,566 1,536
------- -------
Cash Flows From Investing Activities
Acquisition of CMBS bonds (4,801) --
Principal collections from CMBS bonds -- 144
------- -------
Net Cash (Used In) Provided By Investing Activities (4,801) 144
------- -------
Cash Flows From Financing Activities
Dividends paid (1,754) (1,724)
Repayments of short-term notes payable -- (300)
-------- --------
Net Cash Used In Financing Activities (1,754) (2,024)
-------- --------
Cash and Cash Equivalents
Decrease (4,989) (344)
Beginning of period 8,277 598
------- -------
End of period $ 3,288 $ 254
======== ========
</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 (the
"Contribution Agreement"), 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 March 31, 1997 and for the three
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 $5,000 for
the three months ended March 31, 1996.
Non-cash investing and financing activities for the three months ended
March 31, 1997 and 1996 were as follows (in thousands):
Three Months Ended
March 31,
-------------------
1997 1996
---- ----
Principal collections on CMBS bonds transferred to
restricted cash $ 112 $ 442
Unrealized holding gains on CMBS bonds $ 1,015 $ 24
Distributions of Common Stock pursuant to dividend
equivalent rights ("DERs") $ -- $ 96
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<PAGE>
D. CMBS Bonds
The Company owns subordinate classes of Commercial Mortgage Backed
Securities ("CMBS bonds"). As of March 31, 1997 and December 31, 1996, the
outstanding balances of the Company's CMBS bonds were $94,921,000 and
$89,297,000, respectively, while unamortized purchase discounts, acquisition
costs and allowance for credit losses totaled $25,179,000 and $24,448,000,
respectively. Additionally, unrealized holding losses on the CMBS bonds as of
March 31, 1997 and December 31, 1996 were $2,374,000 and $3,389,000,
respectively.
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 to 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 100% ownership in the five subordinate
new classes.
At March 31, 1997, the outstanding balance of the mortgage loans
collateralizing the CMBS bonds was $894,072,000 and the outstanding principal
balance of the CMBS bonds that are senior to the Company's CMBS bonds was
$795,859,000. The aggregate allowance for credit losses on the Company's CMBS
bonds was $12,720,000 at both March 31, 1997 and December 31, 1996. As of March
31, 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,
dependent 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 March 31, 1997 and
December 31, 1996, $2,094,000 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 March 31, 1997 or
December 31, 1996 and $21,616,000 was available to be borrowed, subject to
lender approval. Advances bear interest based upon a spread over the London
Interbank Offered Rate on Eurodollar Deposits ("LIBOR"). The Loan and Security
Agreement contains certain covenants with which the Company was in compliance at
March 31, 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.
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<PAGE>
The Company has a one-year, unsecured line of credit with a bank for
$1,000,000 which expires on July 19, 1997. 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 March 31, 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."
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 three months ended March 31, 1997 and 1996, the Company's total
management fees pursuant to the Management Agreement were $320,000 and $378,000,
respectively. Management fees during the three months ended March 31, 1997 and
1996 included: (i) Base Fees of $166,000 and $171,000, respectively; (ii)
Administrative Fees of $13,000 and $16,000, respectively; (iii) Incentive Fees
of $118,000 and $191,000, 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 adopted a
multi-step plan which includes consideration of Asset Investors acquisition of
the Manager. A special committee of Asset Investors' Independent Directors has
been established to evaluate the acquisition. If the acquisition is consummated,
it would result in Asset Investors assuming the operations of the Manager and
its obligations under the Management Agreement.
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<PAGE>
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 three months ended March 31, 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.
- 7 -
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Commercial Assets, Inc. (the "Company") 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
($74,800,000 pursuant to the Contribution Agreement plus $200,000 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 5
commercial mortgage loan securitizations acquired at a cost of $70,146,000. The
CMBS bonds had an outstanding principal balance of $94,921,000 at March 31,
1997, and an estimated weighted-average yield-to-maturity before credit losses
of 13.3%. At March 31, 1997, approximately 66% of the outstanding principal
balance of the Company's CMBS bonds is unrated, and the remaining 34% 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%, 12% and 8% in Texas, Arizona and
Georgia, 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 the 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
March 31, 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) 3/31/97 12/31/96
- ----------------------------------------------- ------ -------- ---------- ------ ----------- -----------------------
Fannie Mae Multifamily REMIC Trust 1994-M2
<S> <C> <C> <C> <C> <C> <C> <C>
Class C4 7.99% 1/2001 3.7 yrs. Unrated $ 361,817 $ 10,679 $ 10,704
Class D4 8.18% 1/2004 6.5 Unrated 38,297 38,384
DLJ Mortgage Acceptance Corporation
Series 1994-MF4, Class B-3 8.50% 4/2001 4.0 B 97,928 3,136 3,136
Series 1994-MF4, Class C 8.50% 4/2001 4.0 Unrated 4,183 4,183
Kidder, Peabody Acceptance Corporation I
Series 1993-M2, Class E5 8.88% 8/2021 3.4 BB 93,035 10,000 10,000
Kidder, Peabody Acceptance Corporation I
Series 1994-M1, Class C 8.25% 11/2002 4.3 B 207,503 8,930 8,930
Series 1994-M1, Class D 8.25% 11/2002 4.6 Unrated 7,655 7,655
Lehman Capital Corporation Trust
Certificate
Series 1994-23 -- 2,143
Series 1994-33 -- 4,162
Blaylock Mortgage Capital Corporation
Multifamily Trust
Series 1997-A Class B-3 3 6.42% 10/2003 6.6 BB 133,789 5,352 --
Series 1997-A Class B-4 3 6.42% 10/2003 6.6 B 3,345 --
Series 1997-A Class B-5 3 6.42% 10/2003 6.6 B- 1,003 --
Series 1997-A Class B-6 3 6.42% 10/2003 6.6 CCC 1,003 --
Series 1997-A Class B-7 3 6.42% 10/2003 6.6 Unrated 1,338 --
---- --- ----------- -------- --------
Total outstanding balance 8.05% 5.3 yrs. $ 894,072 94,921 89,297
==== === ===========
Unamortized discount 6 (12,889) (12,077)
Allowance for credit losses 6 (12,720) (12,720)
Unamortized acquisition costs 6 430 349
-------- --------
Amortized cost 69,742 64,849
Net unrealized holding losses 6 (2,374) (3,389)
-------- --------
Total net book value $ 67,368 $ 61,460
======== ========
<FN>
- -----------------------------------------------
1 Remaining weighted-average life at March 31, 1997.
2 The outstanding principal balance at March 31, 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
THREE MONTHS ENDED MARCH 31, 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 months ended
March 31, 1997, was $1,912,000 ($.19 per share) compared with $2,059,000 ($.20
per share) for the same period in 1996. The primary reason for the decrease was
lower income from CMBS bonds partially offset by increased interest income and
reduced management fees and general and administrative expenses.
REIT income from CMBS bonds for the three months ended March 31, 1997, was
$2,222,000 ($.22 per share) compared with $2,825,000 ($.28 per share) for the
same period in 1996. The decrease in REIT income from CMBS bonds was due in part
to the 1996 amortization of the pricing discount on one of the CMBS bonds. For
this particular bond, the Company elected to limit the amount of amortization
for REIT income purposes to the lesser of principal received or computed
amortization. During the three months ended March 31, 1996, a $337,000 principal
prepayment was made on a mortgage collateralizing this bond. As a result of the
election, amortization was increased by the amount of the prepayment; there were
no similar prepayments during the three months ended March 31, 1997. In
addition, during the three months ended March 31, 1996, the Company earned
$300,000 of income from two CMBS bonds (Aspen MHC, Series 1994-1, Class C and
Class D-1) which redeemed in May 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
(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 of the
Company's CMBS bonds is limited to principal received.
Through March 31, 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, dependent upon the recovery of indemnification claims
made against the bond underwriter. Otherwise, there have been no delinquencies.
As of March 31, 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 months ended March 31, 1997, was $111,000
($.01 per share) compared with $7,000 ($.00 per share) for the three months
ended March 31, 1996. The increase in interest income during the three months
ended March 31, 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. It is anticipated that interest income will decrease in
future periods because a portion of the proceeds were used to acquire interests
in Blaylock Classes B-3 and B-4 in March 1997. See "FORWARD LOOKING INFORMATION"
below.
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<PAGE>
The Company's management fees were $297,000 ($.03 per share) for the three
months ended March 31, 1997, compared with $378,000 ($.04 per share) for the
same period in 1996. Specifically, Incentive Fees declined by $73,000,
Administrative Fees by $3,000 and Base Fees by $5,000. The decrease in Incentive
Fees was due to a $147,000 decrease in REIT income and a 65 basis point increase
in the average Ten-Year U.S. Treasury Rate from the first quarter 1996 to the
first quarter 1997. The decrease in Base Fees and Administrative Fees was
primarily due to the May 1996 redemption of the two CMBS bonds.
The Company incurred $23,000 of Acquisition Fees during the three months
ended March 31, 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 three months
ended March 31, 1996.
In February 1997, the Board of Directors of Asset Investors adopted a
multi-step plan which includes consideration of Asset Investors acquisition of
the Manager. A special committee of Asset Investors' Independent Directors has
been established to evaluate the acquisition. If the acquisition is consummated,
it would result in Asset Investors assuming the obligations of the Manager under
the Management Agreement.
General and administrative expenses of the Company were $124,000 ($.01 per
share) for the three months ended March 31, 1997, compared with $392,000 ($.04
per share) for the same period in 1996. General and administrative expenses
decreased during the three months ended March 31, 1997, compared with the first
quarter of 1996, due to the timing of shareholder relations and accounting
expenses and the elimination of DER expense pursuant to the May 1996 amendment
to the Stock Option Plan.
During the three months ended March 31, 1996, interest expense on the
Company's short-term notes payable was $3,000 ($.00 per share). There was no
interest expense during the three months ended March 31, 1997. The decrease was
primarily the result of repayment of short-term borrowings during the first half
of 1996.
Dividend Distributions
In March 1997, the Company declared a first quarter dividend of $.17 per
share which was paid on March 31, 1997, to stockholders of record on March 17,
1997. This was the tenth consecutive quarter of a regular dividend of $.17 per
share.
Book Income
For the three months ended March 31, 1997, the Company earned book income
computed in accordance with GAAP of $1,735,000 ($.17 per share) compared with
$1,607,000 ($.16 per share) for the same period in 1996. The $128,000 ($.01 per
share) increase in book income was due to the increased interest income and
lower management fees and general and administrative expenses, partially offset
by lower revenues from the early redemption of the two CMBS bonds as previously
discussed. The election regarding the amortization of the pricing discount on
the bond with the $337,000 principal prepayment was for REIT income purposes
only. The prepayment did not have an impact on book income during the three
months ended March 31, 1996.
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<PAGE>
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 also is required to report
its financial position and income in accordance with GAAP.
During the three months ended March 31, 1997, REIT income exceeded book
income by $177,000 ($.02 per share). 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 March 31, 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.
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 three months ended March 31,
1997 and 1996, cash flows provided by operating activities were $1,566,000 and
$1,536,000, respectively. As of March 31, 1997, the Company had $3,288,000 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
March 31, 1997 or December 31, 1996, and $21,616,000 was available to be
borrowed subject to lender approval. 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 March 31, 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 Company has a one-year, unsecured line of credit with a bank for
$1,000,000 which expires on July 19, 1997. Advances bear interest at prime. At
March 31, 1997 and December 31, 1996, no advances were outstanding on this line
of credit. Two of the Company's Independent Directors are members of the
Advisory Board of the bank.
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
- 12 -
<PAGE>
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 March 31, 1997, the Company had cumulative REIT income in
excess of distributions of $1,433,000. 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 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 $61,017,000 at March 31, 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.
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<PAGE>
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 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
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 March 31, 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, dependent 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 projection. 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."
- 14 -
<PAGE>
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 is acquiring the CMBS bonds at a significant
discount from their outstanding principal balance, prepayments of principal on
the CMBS bonds the Company owns, 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.
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.
- 15 -
<PAGE>
FORWARD LOOKING INFORMATION
Certain statements in this Form 10-Q Quarterly Report, as well as
statements made by the Company in periodic press releases, and oral statements
made by the Company's officials to analysts and stockholders in the course of
presentations 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.
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.
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: May 12, 1997 By /s/ Kevin J. Nystrom
----------------------
Kevin J. Nystrom
Chief Financial Officer
- 16 -
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