-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TZiFqdF/zaDr3ezKpfwcJzTQ86FNt0UhRFNXm9FDgbjXRO3R+I7z2yAMtIP3hnUo SbvKId6aqEH4KPIexFC4/Q== 0000950117-99-001041.txt : 19990517 0000950117-99-001041.hdr.sgml : 19990517 ACCESSION NUMBER: 0000950117-99-001041 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CLARION COMMERCIAL HOLDINGS INC CENTRAL INDEX KEY: 0001056880 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 133988895 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-14167 FILM NUMBER: 99622092 BUSINESS ADDRESS: STREET 1: 335 MADISON AVE CITY: NEW YORK STATE: NY ZIP: 10017 BUSINESS PHONE: 2128832500 10-Q 1 CLARION COMMERCIAL HOLDINGS, INC. 10-Q CLARION COMMERCIAL HOLDINGS, INC. FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 Commission File Number: 1-14167 CLARION COMMERCIAL HOLDINGS, INC. (Exact name of registrant as specified in its charter) Maryland 13-3988895 - ---------------------------------------------------------------------------------------- (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 335 Madison Avenue, New York, New York 10017 - ---------------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code)
(Registrant's telephone number including area code): (212) 883-2500 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 10, 1999, 4,328,050 shares of Class A Common Stock ($.001 par value) were outstanding. 1 CLARION COMMERCIAL HOLDINGS, INC. FORM 10-Q INDEX PART I FINANCIAL INFORMATION.........................................................................3 Item 1: Financial Statements........................................................................3 Consolidated Statements of Financial Condition.....................................................3 Consolidated Statement of Operations...............................................................4 Consolidated Statement of Changes in Stockholders' Equity..........................................5 Consolidated Statement of Cash Flows...............................................................6 NOTES TO FINANCIAL STATEMENTS......................................................................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......11 Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................14 PART II - OTHER INFORMATION............................................................................15 Item 1. Legal Proceedings...........................................................................15 Item 2. Changes in Securities and Use of Proceeds...................................................15 Item 3. Defaults Upon Senior Securities.............................................................15 Item 4. Submission of Matters to a Vote of Security Holders.........................................15 Item 5. Other Information...........................................................................15 Item 6. Exhibits and Reports on Form 8-K............................................................15 SIGNATURES.............................................................................................16
2 PART I FINANCIAL INFORMATION Item 1: Financial Statements Clarion Commercial Holdings, Inc. & Subsidiaries Consolidated Statements of Financial Condition (Unaudited)
Assets: March 31, 1999 December 31, 1998 -------------- ----------------- Cash and cash equivalents $ 1,936,797 $ 565,684 Securities - trading, at fair value 80,163,726 80,731,788 Commercial mortgage loan held for sale, at market value 11,970,887 12,949,224 Other investments 4,856,250 4,856,250 Deposits with brokers as collateral for securities sold short 50,992,665 46,830,041 Accrued interest receivable and other assets 1,341,036 2,089,891 ------------ ------------ Total assets $151,261,361 $148,022,878 ------------ ------------ ------------ ------------ Liabilities and stockholders' equity: Repurchase agreements $ 58,692,000 $ 58,924,000 Government securities sold short 49,777,568 45,578,695 Distributions payable 883,130 689,348 Treasury stock payable 7,126 577,851 Other liabilities 1,301,561 2,336,160 ------------ ------------ Total liabilities 110,661,385 108,106,054 ------------ ------------ Stockholders' equity: Preferred Stock, par value $.01 per share, 25,000,000 shares authorized; no shares issued - - Class A Common Stock, par value $.001 per share 74,000,000 shares authorized; 5,000,750 issued; 4,411,650 and 4,451,050 shares outstanding in 1999 and 1998, respectively 5,001 5,001 Class B Common Stock, par value $.001 per share 1,000,000 shares authorized; 175,000 issued and outstanding 175 175 Additional paid-in capital 98,197,339 98,197,339 Net loss and distributions (51,404,971) (52,303,201) Treasury stock - (589,100 and 549,700 shares in 1999 and 1998 respectively), at cost (6,197,568) (5,982,490) ------------ ------------ Total stockholders' equity 40,599,976 39,916,824 ------------ ------------ Total liabilities and stockholders' equity $151,261,361 $148,022,878 ------------ ------------ ------------ ------------
The accompanying notes are an integral part of these consolidated financial statements. 3 Clarion Commercial Holdings, Inc. & Subsidiaries Consolidated Statement of Operations For The Three Months Ended March 31, 1999 (Unaudited) Income: Interest income from securities - trading $ 2,715,042 Income from commercial mortgage loan 235,240 Income from other investments 133,683 Interest income from cash and cash equivalents 13,374 ------------ Total income 3,097,339 ------------ Expenses: Interest 1,588,128 Management fee 144,892 Other expenses 177,943 ------------ Total expenses 1 ,910,963 ------------ Other operating gains and losses: Unrealized gains from securities - trading 1,519,984 Provision to adjust commercial mortgage loan to market value (925,000) ------------ Total other operating gains 594,984 ------------ Net Income $ 1,781,360 ------------ ------------ Net Income per share: Basic $ 0.39 -------- -------- Diluted $ 0.39 -------- -------- Weighted average shares Basic 4,620,069 ---------- ---------- Diluted 4,620,069 ---------- ----------
The accompanying notes are an integral part of these consolidated financial statements. 4 Clarion Commercial Holdings, Inc. & Subsidiaries Consolidated Statement of Changes in Stockholders' Equity For The Three Months Ended March 31, 1999 (Unaudited)
Common Stock ------------ Additional Net Income and Treasury Class A Class B Paid-in Capital Distributions Stock Total ------- ------- --------------- ------------- ----- ----- Balance at January 1 , 1999 $5,001 $175 $98,197,339 $(52,303,201) $(5,982,490) $39,916,824 Distributions declared: Class A common stock - - - (883,130) - (883,130) Net income - - - 1,781,360 - 1,781,360 Treasury stock purchases - - - - (215,078) (215,078) ------- ----- ----------- ------------ ----------- ----------- Balance at March 31, 1999 $5,001 $175 $98,197,339 $(51,404,971) $(6,197,568) $40,599,976 ------- ----- ----------- ------------ ----------- ----------- ------- ----- ----------- ------------ ----------- -----------
The accompanying notes are an integral part of these consolidated financial statements. 5 Clarion Commercial Holdings, Inc. & Subsidiaries Consolidated Statement of Cash Flows For The Three Months Ended March 31, 1999 (Unaudited) Cash flows from operating activities: Net income $ 1,781,360 Adjustments to reconcile net income to net cash provided by Operating activities: Premium amortization (discount accretion), net (99,292) Unrealized loss on investment in commercial mortgage-backed securities 677,169 Provision to adjust commercial mortgage loan to market value 925,000 Unrealized gain on short sales of government securities (2,197,153) Decrease in accrued interest receivable and other assets 748,855 Decrease in other liabilities (1,034,599) Increase in deposits with broker as collateral for securities sold short (4,162,624) Increase in government securities sold short 6,396,026 ----------- Net cash provided in operating activities 3 ,034,742 ----------- Cash flows from investing activities: Principal payments received on commercial mortgage loan 43,522 ----------- Cash flows from financing activities: Repayments of reverse repurchase agreements, net (232,000) Distributions paid (689,348) Purchases of treasury stock (785,803) ----------- Net cash used by financing activities (1,707,151) ----------- Net increase in cash and cash equivalents 1,371,113 Cash and cash equivalents at beginning of period 565,684 ----------- Cash and cash equivalents at end of period $1,936,797 ----------- ----------- Supplemental information: Interest paid $2,155,301 ----------- ----------- Supplemental disclosures of cash flow information: Distributions in the amount of $883,130 were declared on March 11, 1999 and paid on April 15, 1999. Treasury stock in the amount of $7,126 purchased on March 29, 1999 was paid for on April 1, 1999.
The accompanying notes are an integral part of these consolidated financial statements. 6 NOTES TO FINANCIAL STATEMENTS NOTE 1 ORGANIZATION AND BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The consolidated financial statements include the accounts of Clarion Commercial Holdings, Inc. ("Clarion") and its consolidated subsidiaries (together with Clarion, the "Company"). All intercompany transactions and balances are eliminated in consolidation. In the opinion of management, the accompanying consolidated financial statements contain all adjustments, consisting of normal and recurring accruals, necessary for a fair presentation of the consolidated financial condition of the Company at March 31, 1999 and December 31, 1998, the results of its operations and the changes in its stockholders' equity and its cash flows for the three months ended March 31, 1999. Operating results for the period ended March 31, 1999 are not necessarily indicative of the results that may be expected for any other interim periods or the year ending December 31, 1999. Clarion was incorporated in Maryland in February 1998 and commenced its operations on June 2, 1998. The Company is a specialty finance company organized to invest in commercial mortgage-backed securities (primarily subordinate securities) commercial mortgage loans, mezzanine investments, equity investments and other real estate related investments. NOTE 2 SIGNIFICANT ACCOUNTING POLICIES In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated statement of financial condition and revenues and expenses for the period covered. Actual results could differ from those estimates and assumptions. A summary of the Company's significant accounting policies follows: SECURITIES - TRADING At the date of acquisition, the Company elected to designate its government securities and commercial mortgage-backed securities ("CMBS") as trading assets. Such securities are carried at their estimated fair value, with the net unrealized gains or losses included in earnings. For a description of the methodology used in determining fair value of the Company's CMBS investments, refer to Note 3. Interest income is recognized as it becomes receivable, and includes amortization of premiums and accretion of discounts, computed using the effective yield method, after considering estimated prepayments and credit losses. Actual credit loss and prepayment experience is reviewed periodically and effective yields adjusted if necessary. The Company may, in the future, acquire similar assets that will be held for longer periods of time, and will therefore, not be held principally for the purpose of selling them in the near term. In this case, the Company may elect to designate these assets as "Available-For-Sale" and any subsequent unrealized gains and losses on the assets would be reported in other comprehensive income. SHORT SALES The Company enters into contracts to sell securities that it does not own at the time of the sale, at a specified price at a specified time (short sales). The Company utilizes these contracts as a means of mitigating ("hedging") the potential financial statement impact of changes in the fair value of its portfolio of CMBS due to changes in interest rates. These contracts involve the sale of U.S. Treasury securities borrowed from a broker. The broker retains the proceeds from the sale until the Company replaces the borrowed securities. Risks in these contracts arise from the possible inability of counterparties to meet the terms of their contracts and from movements in securities values and interest rates. If the market value of the securities involved in the short sale increases, the Company may be required to meet a "margin call". The Company accounts for its liability to return the borrowed securities under 7 short sales contracts at their market values, with unrealized gains or losses recorded in earnings. Income earned on the proceeds on deposit with brokers is included in interest income from securities - trading and interest due under the short sales in included in interest expense. COMMERCIAL MORTGAGE LOAN In 1998, the Company carried its investment in a commercial mortgage loan at amortized cost, with interest income recognized as it became receivable. In the first quarter of 1999, the Company decided that it would dispose of this investment as soon as practicable, and is marketing it for sale. Accordingly, effective March 31, 1999, the Company has reclassified this loan as held for sale, and recorded an allowance of $925,000 to reduce its carrying value to the lower of cost or market, based on preliminary pricing indications received from potential buyers. OTHER INVESTMENTS The Company's 10% interest in Clarion Capital, LLC (the "Manager") and the preferred interest in a limited partnership are accounted for at cost, with income from distributions recognized as distributions are declared. The Company periodically reviews these investments for other-than-temporary impairment. Any such impairment would be recognized in income by reducing the investment to its estimated fair value. COMPREHENSIVE INCOME SFAS No. 130, "Reporting Comprehensive Income" defines comprehensive income as the change in equity of a business enterprise during a period from transactions and other events and circumstances, excluding those resulting from investments by and distributions to owners. The Company had no items of other comprehensive income during the three months ended March 31, 1999. NEW ACCOUNTING PRONOUNCEMENT In June of 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that the Company recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge of the exposure to changes in the fair value of a recognized asset or liability or a hedge exposure to variable cash flows of a forecasted transaction. The accounting for changes in the fair value of a derivative (e.g. through earnings or outside earnings, through comprehensive income) depends on the intended use of the derivative and the resulting designation. The Company is required to implement SFAS 133 on January 1, 2000. Company management is evaluating the impact that this statement will have on its hedging strategies and use of derivative instruments and is currently unable to predict the effect, if any, it will have on the Company's financial statements. NET INCOME PER SHARE Net income per share is computed in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share, and is calculated on the basis of the weighted average number of common shares outstanding during the period plus the additional dilutive effect of common stock equivalents. The dilutive effect of outstanding stock options is calculated using the treasury stock method. For the period ending March 31, 1999, diluted net income per share was the same as basic net income per share, because all outstanding stock options as of March 31, 1999, were antidilutive. DISTRIBUTIONS On April 15, 1999, the Company made a distribution of $0.20 per share to stockholders of record at the close of business on March 31, 1999. No portion of these distributions is expected to be either a return of capital or a capital gain for income tax purposes. 8 INCOME TAXES The Company intends to elect to be taxed as a Real Estate Investment Trust ("REIT") and comply with the provisions of the Internal Revenue Code of 1986, as amended (the "Code"), with respect thereto. Accordingly, the Company will not be subjected to federal income tax to the extent of its distributions to stockholders and as long as certain asset, income and stock ownership tests are met. NOTE 3 SECURITIES - TRADING AND SHORT SALES The Company's securities - trading consist of CMBS with an estimated fair value of $80,163,726 and an amortized cost of $99,778,699 at March 31, 1999, resulting in an unrealized loss of $19,614,973 at that date. At December 31, 1998, the Company's securities - trading consisted of CMBS with an estimated fair value of $80,731,788 and an amortized cost of $99,669,591, resulting in an unrealized loss of $18,937,803 at that date. The aggregate estimated fair value by underlying credit rating of the Company's CMBS at March 31, 1999 and December 31, 1998 are as follows:
March 31, 1999 December 31, 1998 -------------- ----------------- Security Rating Estimated Fair Value % of Total Estimated Fair Value % of Total --------------- -------------------- ---------- -------------------- ---------- BBB* $18,667,500 23.3% $ - - BB 39,938,648 49.8 58,252,658 72.2% B 15,107,963 18.8 15,695,359 19.4 B- 2,616,025 3.3 2,819,988 3.5 NR 3,833,590 4.8 3,963,783 4.9 ----------- ------ ----------- ----- $80,163,726 100.00% $80,731,788 100.0% ----------- ------ ----------- ----- ----------- ------ ----------- -----
*On March 9, 1999, the rating on the BTR 1998-S1A, Class F security was upgraded by Moody's from Ba2 (BB) to Baa2 (BBB). As of March 31, 1999, the mortgage loans underlying the CMBS interests held by the Company were secured by properties of the types and in the states identified below:
Property Type Percentage (1) State Percentage (1) ---------------------------------- ------------------------------- Retail 24.9% CA 17.5% Office 24.8 TX 13.1 Multifamily 19.4 FL 9.0 Hotel 19.1 NJ 6.6 Other 11.8 NY 5.6 All others(2) 48.2
(1) Based on a percentage of the total unpaid principal balance of the underlying loans. (2) No other state comprises more than 5% of the total. As of March 31, 1999, the weighted average unpaid principal balance of loans that are (1) underlying the CMBS investments of the Company and (2) more than 60 days delinquent is 0.52% of the unpaid principal balance of the collateral as of that date. The fair value of the Company's portfolio of CMBS is generally estimated by management based on market prices provided by certain dealers who make a market in these financial instruments. The market for the Company's CMBS periodically suffers from a lack of liquidity, accordingly, the fair values reported reflect estimates and may not necessarily be indicative of the amounts the Company could realize in a current market exchange. At March 31, 1999, the un-leveraged, un-hedged, weighted average yield to maturity of the Company's CMBS portfolio was 12.08%. The yield to maturity on the Company's CMBS interests depends on, among other things, the rate and timing of principal payments, the pass-through rate and interest rate fluctuations. The subordinated CMBS interests owned by 9 the Company provide credit support to the more senior interests of the related commercial securitization. Cash flow from the mortgages underlying the CMBS interests generally is allocated first to the senior interests, with the most senior interest having a priority entitlement to cash flow. Remaining cash flow is allocated generally among the other CMBS interests in order of their relative seniority. To the extent that there are defaults and unrecoverable losses on the underlying mortgages, resulting in reduced cash flows, the most subordinate CMBS interest will bear this loss first. To the extent there are losses in excess of the most subordinated interest's stated entitlement to principal and interest, then the remaining CMBS interests will bear such losses in order of their relative subordination. There is, therefore no assurance that the yield to maturity discussed above will be achieved. At March 31, 1999, the Company had open contracts to sell U.S. Treasury securities with face amounts totaling $45,528,000 and a fair value of $49,777,568. Although the Company generally does not settle these contracts at expiration, but instead rolls them over into new contracts, if the Company had settled its open contracts at March 31, 1999, the counterparty would have been required to pay the Company $607,193. The unrealized gain on these contracts for the three months ended March 31, 1999 was $2,197,153, which is included in unrealized gains from securities-trading in the consolidated statement of operations. The Company earned $537,524 on short sale proceeds held by brokers and incurred interest of $742,906 on the short sales contracts during the period. NOTE 4 COMMON STOCK On June 30, 1998, the Board of Directors of Clarion authorized a program to repurchase up to 400,000 shares of Class A Common Stock (the "Stock Repurchase Program"). Pursuant to the Stock Repurchase Program, purchases of Class A Common Stock have been and will be made at the sole discretion of management in the open market or in privately negotiated transactions until the earlier to occur of (i) the date on which the Company acquires, in the aggregate, 400,000 shares of Class A Common Stock, or (ii) June 30, 1999. On September 8, 1998, the Board of Directors authorized management to repurchase an additional 400,000 shares prior to September 30, 1999, at a price not to exceed $13.60. As of January 1, 1999, the Company had acquired a total of 549,700 shares of Class A Common Stock in the open market at a cost of $5,982,490. In the three months ending March 31, 1999, the Company acquired an additional 39,400 shares of Class A Common Stock in the open market at a cost of $232,050. Subsequent to March 31, 1999 through May 10, 1999 the Company acquired an additional 83,600 shares of Class A Common Stock in the open market at a cost of $534,950. NOTE 5 TRANSACTIONS WITH AFFILIATES Clarion has entered into a Management Agreement (the "Management Agreement") with the Manager, under which the Manager manages the Company's day-to-day operations, subject to the direction and oversight of Clarion's Board of Directors. The Company will pay the Manager an annual base management fee equal to 1% of the average stockholders' equity. The Company will also pay the Manager, as incentive compensation, an amount equal to 25% of the Adjusted Net Income of Clarion, before incentive compensation, in excess of the amount that would produce an annualized return on equity equal to 2.5% over the Ten-Year U.S. Treasury. In accordance with the terms of the Management Agreement, the Company paid $144,892 in base management fees for the three months ended March 31, 1999. The Company has not accrued for, or paid, the Manager any incentive compensation since inception. 10 NOTE 6 REPURCHASE AGREEMENTS As of March 31, 1999, the Company had entered into repurchase agreements in the amount of $58,692,000 to finance a portion of its investments. The weighted average maturity of the agreements as of March 31, 1999 was 15.02 days, with no agreement having a maturity greater than 30 days, and the weighted average interest rate was 5.74%, based on one-month LIBOR plus a weighted average spread of 0.80%. The repurchase agreements were collateralized by the Company's portfolio of CMBS investments. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company was organized in February 1998 to invest in commercial mortgage-backed securities (primarily subordinate securities), commercial mortgage loans, mezzanine investments, equity investments, and other real estate related investments. Substantially all of the $94.7 million of net proceeds received from the sale of 5,000,000 shares of its Class A Common Stock in June 1998 together with the net proceeds of other financing arrangements has been used to acquire the Company's current portfolio of investments. The following discussion of the Company's financial condition, results of operations, and capital resources and liquidity should be read in conjunction with the Company's financial statements and related notes. MARKET CONDITIONS: The first three months of 1999 were relatively calm for the Company as spreads on subordinate classes of CMBS experienced little movement. The price of a fixed income security (such as a CMBS) is often determined by adding an interest rate spread to a benchmark interest rate, such as the U.S. Treasury rate. As the spread on a security widens (or increases), the price (or value) of the security falls. While spreads on thw subordinate classes of CMBS changed little in the first three months of 1999, interest rates increased. The ten-year U.S Treasury rate rose approximately 0.60% in the first three months of 1999. In the same way that a widening (increasing) spread for CMBS causes their value to fall, increasing interest rates cause their value to decline. In order to offset this potential loss in CMBS value due to increasing interest rates, the Company "sells short" U.S. Treasury securities that increase in value as interest rates rise. In the first three months of 1999, the Company's short positions in U.S. Treasury securities effectively offset the decline in value of the Company's CMBS positions due to the increase in interest rates. On March 9, 1999, the rating of one of the Company's assets, BTC Commercial Mortgage Pass-Through Certificates, Series BTR Trust 1998-S1, Class F, was upgraded by Moody's Investors Service from Ba2 to Baa2. RESULTS OF OPERATIONS General: Net income for the three months ending March 31, 1999 amounted to $1,781,360 or $0.39 per share, basic and diluted . The total income for the three months ending March 31, 1999 was attributable primarily to income from investments of $3.1 million and net unrealized gains of $1.5 million and was offset by interest expense of $1.6 million, other expenses of $0.3 million, and a $0.9 million provision recorded to reduce the carrying value of the Company's investment in a commercial mortgage loan to its estimated market value. The results of operations realized during the three months ending March 31, 1999 are not necessarily indicative of the results that may be expected for future periods. 11 Investment Income: For the three months ending March 31, 1999, the Company earned income of $3,096,979 from investments as follows:
Investment Income for the three months ending March 31, 1999 ------------------------------------------------------------ Investment Income Earned - -------------------------------------------------------------------------------- CMBS $ 2,177,518 Deposits with brokers as collateral for securities sold short 537,524 Commercial mortgage loan 235,240 Mezzanine investment 133,683 Cash and cash equivalents 13.014 --------------------- TOTAL $ 3,096,979 --------------------- ---------------------
Interest Expense: For the three months ending March 31, 1999, the Company incurred interest expense of $845,222 from repurchase agreements and $742,906 from government securities sold short. As of March 31, 1998, the Company had entered into repurchase agreements in the amount of $58,692,000. The weighted average interest rate was 5.74%, and is a variable rate, based on one-month LIBOR plus a weighted average spread 0.80%. As of March 31, 1999, the Company had the following open short positions in U.S. Treasury securities: $3,881,000 (face) of U.S. Treasury 7.00%, 07/15/2006 and $41,647,000 (face) of U.S. Treasury 6.50%, 11/15/2026. Other Expenses: In accordance with the terms of the Management Agreement, an accrual of $144,892 in base management fees was made for the three months ending March 31, 1999. The Company has not accrued for or paid any incentive compensation to the Manager since inception. Other Operating Gains & Losses For the three months ended March 31, 1999, the Company recognized unrealized gains of $1,519,984 on their securities portfolio. Management's decision to market the commercial whole loan for sale required an adjustment of the loan to the lower of the cost or market value. This adjustment resulted in an unrealized loss of $925,000. CHANGES IN FINANCIAL CONDITION General: Total assets as of March 31, 1999 amounted to $151.3 million and were comprised primarily of $80.2 million of CMBS, $51.0 million of deposits with brokers as collateral for securities sold short, an investment of $12.0 million in a commercial mortgage loan, and a mezzanine investment of $3.9 million. Total liabilities of the Company as of March 31, 1999 amounted to $110.7 million and were comprised primarily of repurchase agreements in the amount of $58.7 million and government securities sold short in the amount of $49.8 million. The Company's investment portfolio and financing did not change significantly during the three months ended March 31, 1999. Deposits with brokers as collateral for securities sold short increased by $4.2 million, mirroring the increase in government securities sold short, as the Company increased its overall short positions. CAPITAL RESOURCES AND LIQUIDITY: Liquidity is a measurement of the Company's ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund investments, loan acquisition and lending activities and for other general business purposes. The Company's primary sources of funds for liquidity consist of repurchase agreements and maturities and principal payments on securities and loans, and proceeds from sales thereof. 12 The Company's operating activities generated cash flows of $3.0 million during the three months ending March 31, 1999. This was due primarily to an excess of interest income on investments in excess of financing costs of approximately $1.5 million and cash generated from decreased collateral requirements on the government securities sold short of approximately $2.2 million. The Company's investing activities provided cash flows totaling $.04 million during the three months ending March 31, 1999 through principal payments from the commercial mortgage loan receivable. The Company's financing activities used $1.7 million during the three months ending March 31, 1999 and consisted primarily of purchases of treasury stock and distributions to shareholders. The Manager is currently evaluating investment opportunities on behalf of the Company. In the event that the Manager identifies an investment opportunity consistent with the Company's investment objectives, the Company may seek sources of additional capital, including various third-party borrowings or the issuance of preferred equity. The Company may also elect to increase its borrowings under repurchase agreements or may elect to dispose of an existing asset. The Company intends to dispose of its investment in a commercial mortgage loan as soon as practicable. The Company, in order to avoid corporate income taxation of the earnings that it distributes, is required to distribute annually at least 95% if its taxable income to stockholders. It is possible that the Company may experience timing differences between the actual receipt of income and the inclusion of that income in the calculation of taxable income. In the event that the cash generated by the Company's investments is insufficient to fund the distributions to stockholders that are required to maintain the Company status as a REIT, the Company may access cash reserves or seek sources of additional capital in order to fund the distributions. Except as discussed herein, management is not aware of any other trends, events, commitments or uncertainties that may have a significant effect on liquidity. STOCKHOLDERS' EQUITY: Stockholders' equity as of March 31, 1999 was $40.6 million. In the three months ending March 31, 1999, stockholders' equity increased by $0.7 million due to net income of $1.8 million, a decrease of $0.2 million due to the repurchase of stock and a decrease of $0.9 million due to a distribution of $0.20 per share to stockholders of record on March 31, 1999. YEAR 2000 COMPLIANCE: Substantially all of the Company's computer systems are supplied by the Manager. In 1998, the Manager formed an internal team of information technology professionals to identify the risks to the business operations of the Manager, and the Company, that may arise from the transition to the Year 2000 and beyond. The team also assumed responsibility for increasing awareness of the potential risks to the business operations through presentations to employees and management of the Manager. The team has also completed a written plan that identifies corrective steps to mitigate these risks. The Manager's plan for Year 2000 compliance covers mission-critical systems, physical facilities and communications systems. It also addresses external interfaces with third-party computer systems that communicate with the systems of the Manager. The Manager has allocated approximately $50,000 to cover expenses associated with the assessment of potential Year 2000 issues. The Company has not allocated any funds to cover Year 2000 compliance; however, the Company may bear a portion of the costs incurred by the Manager in this regard. Mission Critical Systems: The Manager advised the Company that, as of March 31, 1999, it had completed an inventory of all systems, and had identified all mission-critical systems that were not Year 2000 compliant. The Manager had also developed remediation and testing plans to address Year 2000 issues. As of March 31, 1999, the Manager advised the Company that it had completed remediation and testing of substantially all internal mission-critical systems. The Manager advised the Company that it expects to complete remediation and testing by June 30, 1999. Assessment of Year 2000 Readiness of Third Parties: 13 On March 31, 1999, the Manager advised the Company that it had identified all third-parties upon whom the Manager relies for mission-critical and non-mission-critical systems. The Manager also notified the Company that it had contacted approximately one-half of the identified third parties. All of the third-parties contacted by the Manager had documented their plans for addressing Year 2000 issues and their progress in achieving Year 2000 compliance. The Manager advised the Company that it expects to contact all remaining third parties upon whom the Manager relies for mission-critical and non-mission-critical systems by June 30, 1999. Development of Contingency Plan: On March 31, 1999, the Manager advised the Company that it had yet to create a written contingency plan for systems it uses if, after December 31, 1999, it has computer problems caused by the Year 2000. The Manager has reported that it is in the process of preparing a written contingency plan and that it expects the contingency plan to be complete by June 30, 1999. Risks Associated with Achieving Year 2000 Compliance: Based upon the Manager's representations regarding its own efforts and responses from third parties, the Company believes that the Manager will be Year 2000 compliant by mid-1999. Until the Manager advises the Company that it has completed further testing and has received confirmations of Year 2000 compliance from additional third parties, the Company cannot assure that the Manager will achieve Year 2000 compliance within its current time and cost estimates. There can be no assurance that the assessments or remediation measures made by the Manager or significant third parties with whom the Manager's systems interface have been or will be accurate. There is a risk that failure by the Manager or those significant third parties to achieve Year 2000 compliance will have an adverse effect on the business operations of the Company. FORWARD-LOOKING STATEMENTS: Certain statements contained herein are not, and certain statements contained in future filings by the Company with the SEC, in the Company's press releases or in the Company's other public or shareholder communications may not be, based on historical facts and are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements which are based on various assumptions (some of which are beyond the Company's control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "anticipate," "continue," or similar terms or variations on those terms, or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity. The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions, which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Item 3. Quantitative and Qualitative Disclosures About Market Risk Market risk is the exposure to loss resulting from changes in interest rates, changes in spreads on CMBS, foreign currency exchange rates, commodity prices and equity prices. The primary market risks to which the investments of the Company are exposed are interest rate risk and CMBS spread risk, which are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the control of the Company. Changes in the general level of interest rates can affect the net interest income of the Company. The Company is further exposed to interest rate risk through its short term financing through repurchase agreements at rates that are based on 30-day LIBOR. The repurchase agreements into which the Company has entered are for terms of less than, or equal to 30 days. Changes in interest rates may increase the Company's cost of financing its investments. 14 The investments of the Company are also exposed to spread risk. The price of a fixed income security is generally determined by adding an interest rate spread to a benchmark interest rate, such as the U.S. Treasury rate. As the spread on a security widens (or increases), the price (or value) of the security falls. As spreads on CMBS widen, the fair value of the Company's portfolio falls. Spread widening in the market for CMBS can occur as a result of market concerns over the stability of the commercial real estate market, excess supply of CMBS, or general credit concerns in other markets. The Company enters into contracts to sell securities that it does not own at the time of the sale, at a specified price at a specified time (short sales). The Company utilizes these contracts as a means of mitigating ("hedging") the potential financial statement impact of changes in the fair value of its portfolio of CMBS due to changes in interest rates. As the value of the Company's CMBS declines (increases) with increases (decreases) in interest rates, the value of the contracts increases (decreases). There can be no guarantee, however, that the change in value of the contract will completely offset the change in value of the fixed-rate interest-earning asset. Risks in these contracts arise from the possible inability of counterparties to meet the terms of their contracts and from movements in securities values and interest rates. If the market value of the securities involved in the short sale increases, the Company may be required to meet a "margin call". PART II - OTHER INFORMATION Item 1. Legal Proceedings At March 31, 1999 there were no legal proceedings to which the Company was a party or of which any of its property was subject. Item 2. Changes in Securities and Use of Proceeds Not applicable Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders Not applicable Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 27.1 - Financial Data Schedule (b) Reports on Form 8-K None 15 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CLARION COMMERCIAL HOLDINGS, INC, Dated: May 12, 1999 By: /s/ Daniel Heflin -------------------------------------------- Name: Daniel Heflin Title: President and Chief Executive Officer 16 EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MARCH 31, 1999 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH. 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 1,936,797 96,990,863 1,341,036 0 0 0 0 0 151,261,361 0 0 0 0 98,202,515 (57,602,539) 151,261,361 0 3,692,323 0 0 1,910,963 0 1,588,128 1,781,360 0 1,781,360 0 0 0 1,781,360 0.39 0.39 Includes commercial mortgage loans receivable of $11,970,887 and $4,856,250
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