-----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, AnoPvimKXxlsL0Shajaw2gJHfHbt3GzUK16TjyHjzKbRVUE7fF5rAthbdKDZ9qRV 7iJEunmB9gVUdKOMwkyWXw== 0000929624-99-000680.txt : 19990505 0000929624-99-000680.hdr.sgml : 19990505 ACCESSION NUMBER: 0000929624-99-000680 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990415 DATE AS OF CHANGE: 19990504 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TIS MORTGAGE INVESTMENT CO CENTRAL INDEX KEY: 0000833088 STANDARD INDUSTRIAL CLASSIFICATION: 6798 IRS NUMBER: 943067889 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-10004 FILM NUMBER: 99595384 BUSINESS ADDRESS: STREET 1: 655 MONTGOMERY ST STE 800 CITY: SAN FRANCISCO STATE: CA ZIP: 94111 BUSINESS PHONE: 4153938000 10-K405 1 FORM 10-K405 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 1-10004 TIS MORTGAGE INVESTMENT COMPANY (Exact name of registrant as specified in its charter) MARYLAND 94-3067889 (State of incorporation) (I.R.S. Employer Identification No.) 655 MONTGOMERY STREET, SUITE 800 SAN FRANCISCO, CALIFORNIA 94111 (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (415) 393-8000 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- COMMON STOCK, PACIFIC EXCHANGE PAR VALUE $.001 PER SHARE Securities registered pursuant to Section 12 (g) of the Act: None ------------------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ ------ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes X ------ As of April 13, 1999, the aggregate market value of the Registrant's voting stock held by non-affiliates (based upon the closing price on that date of the shares on the Pacific Exchange) was approximately $9,787,000. As of April 13, 1999, there were 8,893,250 shares of Common Stock outstanding. Documents Incorporated by Reference Specifically identified portions of the Registrant's 1999 definitive proxy statement to be filed with the Securities and Exchange Commission are incorporated by reference to Part III of this Annual Report on Form 10-K. TIS MORTGAGE INVESTMENT COMPANY INDEX TO ANNUAL REPORT ON FORM 10-K
PART I Page Item 1: Business 3 Item 2: Properties 21 Item 3: Legal Proceedings 22 Item 4: Submission of Matters to a Vote of Security Holders 22 PART II Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters 23 Item 6: Selected Financial Data 24 Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations 26 Item 7A: Quantitative and Qualitative Disclosures About Market Risk 36 Item 8: Financial Statements and Supplementary Data 36 Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 36 PART III Item 10: Directors and Executive Officers of the Registrant 37 Item 11: Executive Compensation 37 Item 12: Security Ownership of Certain Beneficial Owners and Management 37 Item 13: Certain Relationships and Related Transactions 37 PART IV Item 14: Exhibits, Financial Statements and Reports on Form 8-K 38
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF THE COMPANY'S PLANS, BELIEFS, EXPECTATIONS AND INTENTIONS. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THE SECTION ENTITLED "RISK FACTORS." THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT ARISE AFTER THE DATE HEREOF. READERS SHOULD CAREFULLY REVIEW THE RISK FACTORS DESCRIBED IN OTHER DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE QUARTERLY REPORTS ON FORM 10-Q TO BE FILED BY THE COMPANY IN 1999 AND ANY CURRENT REPORTS ON FORM 8-K FILED BY THE COMPANY. PART I ITEM 1. BUSINESS. INTRODUCTION GENERAL TIS Mortgage Investment Company, a Maryland corporation (the "Company" or the "Registrant") which, unless otherwise indicated, refers to the Company and its interests in certain real estate partnerships, and its subsidiaries, TIS Mortgage Acceptance Corporation, a Delaware corporation ("TISMAC"), incorporated on May 11, 1988, and TIS Property Acquisition Company ("TISPAC"), a Maryland corporation, incorporated on September 8, 1995. TISPAC is a wholly-owned subsidiary of the Company for the purpose of owning and financing real property. In March 1997, as part of the refinancing of two of the Company's multifamily residential properties and a portion of the Four Creeks property, title to those properties was vested in TISPAC. Simultaneously, in March 1997, TISPAC entered into notes secured by mortgages on those properties. TISPAC is a wholly owned subsidiary of TISMIC and as such is a Qualified REIT Subsidiary. Accordingly, the accounts of TISPAC are consolidated with those of the Company. On February 2, 1999 the Company acquired Novato Markets, Inc., ("Novato") and made it a wholly owned subsidiary of the Company. Novato was incorporated on July 26, 1956, and it has a wholly owned subsidiary P-SUB I, Inc., ("P-SUB I") which was incorporated on June 4, 1997. Until 1994, the Company sought to generate income for distribution to its shareholders primarily through acquisition of Structured Securities (as hereinafter defined). "Structured Securities" include (i) residual interests ("Residual Interests"), principal only bonds ("PO Bonds") and interest only bonds ("IO Bonds") in collateralized mortgage obligations ("CMOs"), which entitle the Company to certain cash flows from collateral pledged to secure such securities; (ii) Mortgage Certificates ("Mortgage Certificates"), which include securities collateralized by or representing equity interests in Mortgage Loans secured by first liens on single family residences, multiple family residences or commercial real estate ("Mortgage Loans"); (iii) CMOs; and (iv) Commercial Securitizations ("Commercial Securitizations"), which include debt obligations that are issued in multiple classes and are funded as to the payment of interest and principal by a specific group of Mortgage Loans on multiple family or commercial real estate, accounts and other collateral. Beginning in 1994, the Company changed its investment focus from investments in Structured Securities to multifamily real estate located in California's Central Valley. Accordingly, during 1995, the Company sold the majority of its investments in Structured Securities and acquired during 1995 3 a portfolio of four income-producing residential real estate properties of which one was sold in 1998. The Company expects that the majority of its ongoing assets and operating results will be related to its investments in real estate and selective development opportunities. On February 2, 1999, the Company acquired all the shares of Novato from Pacific Securitization, Inc., ("Pacific") in exchange for 1,613,070 shares of Common Stock (the "Shares") of the Company pursuant to an Agreement and Plan of Reorganization dated as of February 1, 1999, between the Company and Pacific. Through its wholly-owned subsidiary, P-SUB I, Inc., Novato owns a shopping center located in Rohnert Park, California, named Mountain Shadows Plaza, and owns a shopping center subject to a ground lease in Petaluma, California, named Midtown Center. See Note 20 to the Financial Statement. Subsequent to year end, the Company sold one of its Structured Securities for a sales price of $783,000 for a gain of approximately $8,000. Additionally, as discussed in Note 20 to the Company's consolidated financial statements, in February 1999, the Company repurchased 825,700 shares of common stock for approximately $2 million in cash and entered into an exchange transaction resulting in the issuance of common stock for Novato Markets. The Company's investment policy is controlled by its Board of Directors. The By-Laws of the Company require that a majority of the members of the Board of Directors must be persons who are not employed by, or receiving any compensation (except for serving as a director) from, the Company ("Unaffiliated Directors"). On July 1, 1996, the Company became a self-administered Real Estate Investment Trust ("REIT"). Prior to that date, the Company operated under an agreement (the "Management Agreement") with TIS Financial Services, Inc., a Delaware corporation (the "Former Manager"), to manage the Company's day-to-day operations, subject to the supervision of the Board of Directors. The Company intends, for all taxable years since inception, to qualify for the tax treatment accorded to REITs under the Internal Revenue Code of 1986, as amended, (the "Code") and to make quarterly distributions to its shareholders which, in the aggregate, annually will equal at least 95% of its real estate investment trust taxable income (as defined in Section 857(b)(2) of the Code) (hereafter "REIT Taxable Income"). As a result, the Company expects that, with limited exceptions, its REIT Taxable Income distributed to its shareholders will not be subject to Federal income tax at the corporate level. See "Federal Income Tax Considerations" below. See Item 7 below, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional information on the general development of the Company's business. See "Risk Factors" below for a discussion of certain risks to which holders of the Company's Common Stock may be subject. The Company normally borrows funds to purchase and carry assets expecting that the cost of such borrowings will be less than the net cash flow on the assets purchased with such funds. 4 PRIMARY BUSINESS ACTIVITY The Company intends to make a substantial portion of its future investments in multifamily real properties, family shopping centers and potential development projects. The investment strategy of the Company is to identify communities with an expanding employment base and demographics which will continue to provide economic growth. After identifying communities with strong potential economic growth, the Company attempts to seek out those areas within a chosen community which are most likely to be positively affected by the economic growth of the community. Finally, the property sought for purchase within a given area is chosen because it is considered to be among the highest quality properties in that area and can be purchased below estimated replacement cost. Management believes that this strategy will allow income from each of the properties to rise before the properties encounter significant competition from new construction. Real property acquisitions will be opportunistic and will occur from time to time if and when sufficient liquid assets are available. In 1995, the Company acquired four multifamily residential properties in California's Central Valley. These properties consist of 539 units together with 9.75 acres of unimproved land slated for the development of an additional 126 units. The aggregate purchase price for the properties was approximately $29.3 million, including existing debt assumed by the Company. In the fourth quarter of 1998, the Company sold its investment in one of these residential properties for a sale price of $8.3 million including the assumption of approximately $6.3 million of mortgage related debt. On February 2, 1999, the Company acquired all the shares of Novato Markets and through its subsidiary acquired a shopping center located in Rohnert Park, California, named Mountain Shadows Plaza and a shopping center in Petaluma, California, named Midtown Center. The shopping centers have a combined commerical and retail space totaling approximately 80,000 square feet. Mountain Shadows Plaza consists of three buildings and is anchored by a large grocery store. Midtown Center consists of a single building. As of the date of acquisition, the shopping centers only had one vacancy. The Company intends to continue operating the shopping centers. The Company has, in years before 1994, primarily invested in the Residual Interests of single-family CMOs, which are a series of fixed rate or variable rate bonds with a wide range of maturities. CMOs are typically issued in series, which generally consist of serially maturing classes ratably secured by a single pool of mortgage instruments. Generally, principal payments received on the mortgage instruments securing a series of CMOs, including prepayments on such mortgage instruments, are applied to principal payments on one or more classes of the CMOs of such series on each principal payment date for such CMOs. Scheduled payments of principal and interest on the collateral securing a series of CMOs are intended to be sufficient to make timely payments of interest on such CMOs and to retire each class of such CMO by its stated maturity. In most CMOs, there are excess cash flows after bond payments and administrative expenses. The excess cash flows, called residuals, arise primarily from the difference between the interest received from the mortgage obligations and the interest paid on the bonds. Prior to 1994, these CMO residuals were the primary focus of the Company's Structured Securities business. However, the Company has invested in other parts of the CMO such as IO Bonds and inverse IO Bonds. Single-family CMOs are collateralized by residential mortgages, most often in the form of mortgage-backed securities or certificates, and the bond interest and principal payments, as well as administrative costs, are covered by the interest and principal payments of the underlying mortgages. The mortgage collateral underlying the single-family CMOs in the Company's portfolio of Residual Interests and some of the IO Bonds are mortgage-backed certificates issued by the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). Some of the IO Bonds are backed by single-family loans which are not included in mortgage-backed certificates issued by these agencies. Monthly cash flows on the Company's mortgage assets have two components: income from the investment and a partial return of investment principal. The investment income forms the basis for payment of expenses and any distributions paid to shareholders. In most cases cash flows and income tend to be higher in early periods of ownership and lower in the later periods. The principal which is repaid is 5 used to reduce debt or to acquire new assets. During 1998, the Company sold its interest in its only CMO. As of December 31, 1998, the Company's investment portfolio consists primarily of residual interests and IO Bonds. LIMITATION ON USE OF NET OPERATING LOSS CARRYFORWARDS. As of December 31, 1998, the Company had a consolidated net operating loss carryforward of approximately $57.1 million for Federal income tax purposes. This number is based upon actual Federal consolidated income tax filings for the periods through December 31, 1997 and an estimate of the 1998 taxable loss. Some or all of the carryforward may be available to the Company to offset, for Federal income tax purposes, the future taxable income, if any, of the Company and its wholly-owned subsidiaries, subject to the limitations and risks discussed below. The future ability to use these NOLs may be limited under Internal Revenue Code (the "Code") Section 382 which provides that if a corporation undergoes an "ownership change," its ability to use its NOLs in the future may be limited. An ownership change occurs when the aggregate cumulative increase in the percentage ownership of a corporation's capital stock owned by "5-percent shareholders" within any three-year testing period is more than 50 percentage points. A "5-percent shareholder" is defined as any person holding 5 percent or more of the fair market value of the corporation's stock at any time during the three-year testing period. All shareholders who are not 5-percent shareholders individually are aggregated into one or more public groups, each of which is considered to be a 5-percent shareholder. If an ownership change occurs within the meaning of Section 382, the amount of NOLs the Company may use to offset income in any future taxable year would be limited, in general, to an amount determined by multiplying the fair market value of the Company's outstanding capital stock on the ownership change date by the long-term tax-exempt rate which is published monthly by the Internal Revenue Service. There could be circumstances under which an issuance by the Company of a significant number of new shares of Common Stock or other new class of equity security having certain characteristics (for example, the right to vote or to convert into Common Stock) might result in an ownership change under the Code. The Company believes that it has not undergone an ownership change in prior years. However, the Company as of April 13, 1999, does have two 5-percent or more shareholders who acquired their stock in the last three-year period. There is no assurance that these shareholders will not make additional changes in their holdings in any potential future three-year testing period which could, when combined with other changes, cause an ownership change to have occurred. In addition, if any additional shareholders become 5-percent shareholders in the future, this could cause an ownership change to occur and limit the Company's use of its NOLs. The Company also has capital loss carryforwards of approximately $5.6 million at December 31, 1998. These loss carryforwards expire in the year 2000. 6 RISK FACTORS 1. Insufficient Cash and Liquidity Sources to Fund Ongoing Operations - - ---------------------------------------------------------------------- The Company's financial statements have been presented on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. In April 1999, the Company obtained a $1,000,000 revolving line of credit from TIS Financial Services, Inc., the former manager of the Company for working capital purposes (the "TIS Line"). In addition to the TIS Line, management is currently evaluating the Company's alternatives to fund its fiscal 1999 cash requirements. Such alternatives include, among other things, consideration of (i) the sale of real property, (ii) the sale of Structured Securities, (iii) reducing general and administrative expenses, (iv) refinancing existing debt, and (v) entering into joint venture arrangements with third parties. Management can provide no assurances as to the timing or ultimate closure of any of these alternatives. These strategies are dependant on the economic operating environment including volatility of interest rates and the ability for the California Central Valley apartment rental market to absorb rental increases. The Company believes that the proceeds from the TIS Line, together with its on-going real estate operations and mortgage related investment portfolio will provide sufficient liquidity for it to continue as a going concern throughout 1999, however, management can provide no assurance with regard thereto. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities or any other adjustments that might result from these uncertainties. 2. Risks Associated with Investments in Real Estate - - ---------------------------------------------------- The yields available from equity investments in real estate depend on the amount of income earned and capital appreciation generated by the related properties as well as the expenses incurred. Income from the properties may be adversely affected by, among other things, increasing unemployment rates, oversupply of competing properties, reduction in demand for properties in the area, increasing affordability of single family homes, and adverse real estate, zoning and tax laws. Certain significant expenditures associated with an investment in real estate (such as mortgage payments, real estate taxes and maintenance costs) constitute fixed costs and do not decrease when circumstances cause a reduction in income from the investment. Furthermore, real estate investments are relatively illiquid and therefore, will tend to limit the Company's ability to vary its portfolio promptly in response to changes in economic or other conditions. Potential Environmental Liability - - --------------------------------- The Company could be held liable for the costs of removal or remediation of any hazardous or toxic substances located on or in its properties. These laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of the hazardous or toxic substances. The presence of such substances, or the failure to remediate such substances properly, may adversely affect the owner's ability to sell or rent the property or to borrow using the property as collateral. Other Federal and state laws require the removal of damaged material containing asbestos in the event of remodeling or renovation. Uninsured Loss - - -------------- The Company carries several types of insurance. There are, however, certain types of extraordinary losses (such as losses resulting from earthquakes) that may be either uninsurable or not economically insurable. Should an uninsured loss occur, the Company could lose its investment in and anticipated profits and cash flow from a property and would continue to be obligated on any mortgage indebtedness on the property. 7 Americans with Disabilities Act - - ------------------------------- The Company's properties must comply with Title III of the Americans with Disabilities Act (the "ADA") to the extent that the properties are "public accommodations" and/or "commercial facilities" as defined by the ADA. Compliance with the ADA requirements could require removal of structural barriers to handicapped access in certain public access areas of the Company's properties, where such removal is readily achievable. The ADA does not, however, consider residential properties, such as apartment communities, to be public accommodation or commercial facilities, except portions of such facilities, such as a leasing office which is open to the public. Noncompliance with the ADA could result in imposition of fines or an award of damages to private litigants. If required changes involve a greater expenditure than the Company currently anticipates or if the changes must be made on a more accelerated basis than it anticipates, the Company's operations could be adversely affected. Fair Housing Amendments Act of 1988 - - ----------------------------------- The Fair Housing Amendments Act of 1988 (the "FHA") requires multifamily residential properties first occupied after March 13, 1991 to be accessible to the handicapped. Noncompliance with the FHA could result in the imposition of fines or an award of damages to private litigants. If required changes involve a greater expenditure than the Company currently anticipates or if the changes must be made on a more accelerated basis than it anticipates, the Company's operations could be adversely affected. Risk of Real Estate Development - - ------------------------------- The Company plans to seek selective opportunities for development. The real estate development business involves significant risks in addition to those involved in the acquisition, ownership and operation of established apartment communities and shopping centers. The development risks include, among other things, lack of construction financing on favorable terms and adverse changes in rental rates and occupancy rates in the market. 3. Market Risks Relating to Mortgage Assets - - -------------------------------------------- The results of the Company's operations depend, among other things, on the level of net cash flows generated by the Company's mortgage assets. The net cash flows vary primarily as a result of changes in mortgage prepayment rates, interest rates, reinvestment income and borrowing costs, all of which involve various risks and uncertainties as set forth below. Prepayment rates, interest rates, reinvestment income and borrowing costs depend upon the nature and terms of the mortgage assets, the geographic location of the properties securing the Mortgage Loans included in or underlying the mortgage assets, conditions in financial markets, the fiscal and monetary policies of the United States Government and the Board of Governors of the Federal Reserve System, international economic and financial conditions, competition and other factors, none of which can be predicted with any certainty. Prepayment Risks - - ---------------- Mortgage prepayments shorten the life of the mortgage instruments underlying the Company's mortgage assets, thereby reducing the overall net cash flows in the long term and causing an inherent decline in the Company's income. Prepayments of mortgage instruments generally increase when then current mortgage interest rates fall below the interest rates on the fixed-rate Mortgage Loans included in such mortgage instruments. Conversely, prepayments decrease when then current mortgage interest rates exceed the interest rates on the Mortgage Loans included in such mortgage instruments. Prepayment experience also may be affected by the geographic location of the Mortgage Loans included in mortgage instruments, the types (whether fixed or adjustable rate) and assumability of such Mortgage Loans, conditions in the Mortgage Loan, housing and financial markets, and general economic conditions. 8 Interest Rate Fluctuation Risks - - ------------------------------- Changes in interest rates affect the performance of the Company and its mortgage assets. Risks of Decline in Net Cash Flows and Income from Mortgage Assets - - ------------------------------------------------------------------ The Company's income from mortgage assets derives primarily from the net cash flows received on its mortgage assets which decline over time. For both tax and accounting purposes, the Company's net cash flows consist of two components - one representing return of a portion of the purchase price of the mortgage asset (the "Cost Component") and one representing income on the investment (the "Income Component"). The Income Component is highest in years immediately following the purchase of the mortgage asset and declines over time. In addition, to the extent that actual mortgage prepayments or variable interest rates experienced exceed those assumed, this inherent decline in net cash flows and income is accelerated. Inability to Predict Effects of Market Risks - - -------------------------------------------- Because none of the above factors, including changes in prepayment rates, interest rates, reinvestment income and expenses are susceptible to accurate projection, the net cash flows generated by the Company's mortgage assets, and thus distributions to the Company's shareholders, cannot be predicted. The Company's borrowings may bear fixed or variable interest rates, may require additional collateral if the value of existing collateral declines on a market value basis and may be due on demand or upon the occurrence of certain events. To the extent that the Company's borrowings bear variable interest rates, changes in short term interest rates will significantly influence the cost of such borrowings and can result in losses in certain circumstances. The Company also may increase the amount of its available funds through the issuance of debt securities. 4. General Risks - - ----------------- Competition - - ----------- There are numerous real estate companies, insurance companies, financial institutions, pension funds and other property owners that compete with the Company in seeking properties for acquisition and in attracting and retaining tenants. Market Price of Common Stock - - ---------------------------- The market price of the Company's Common Stock has been very volatile due to a wide variety of factors including the Company's operating results, distributions (if any), actual or perceived changes in short-term and mortgage interest rates and their relationship to each other, actual or perceived changes in mortgage prepayment rates, and any variation between the net yield on the Company's assets and prevailing market interest rates. Additionally, the performance of the Company's income-producing properties has an effect on the market price of the Company's Common Stock. Any actual or perceived unfavorable changes in the real estate market and other factors may adversely affect the market price of the Company's Common Stock. Future Offerings of Common Stock - - -------------------------------- The Company in the future may increase its capital resources by making additional offerings of its Common Stock or securities convertible into its Common Stock. The actual or perceived effect of such offerings may be the dilution of the book value or earnings per share of the Company's Common Stock which may result in a reduction of the market price of the Company's Common Stock. The Company is unable to estimate the amount, timing or nature of future sales of its Common Stock, as such sales will depend upon market conditions and other factors such as the Company's need for additional equity. 9 Certain Consequences of and Failure to Maintain REIT Status - - ----------------------------------------------------------- In order to maintain its qualification as a REIT for Federal income tax purposes, the Company must continually satisfy certain tests with respect to the sources of its income, the nature and diversification of its assets and the amount of its distributions to shareholders. See "Business -- Federal Income Tax Considerations -- Qualification of the Company as a REIT." Among other things, these restrictions may limit the Company's ability to acquire certain types of assets that it otherwise would consider desirable, limit the ability of the Company to dispose of assets that it has held for less than four years if the disposition would result in gains exceeding specified amounts, limit the ability of the Company to engage in hedging transactions that could result in income exceeding specified amounts and require the Company to make distributions to its shareholders at times that the Company may deem it more advantageous to utilize the funds available for distribution for other corporate purposes (such as the purchase of additional assets or the repayment of debt) or at times that the Company may not have funds readily available for distribution. The Company's operations from time to time may generate taxable income in excess of its net income for financial reporting purposes. The Company also may experience a situation in which its taxable income is in excess of the actual cash receipts. See "Business -- Federal Income Tax Considerations." To the extent that the Company does not otherwise have funds available, either situation may result in the Company's inability to distribute substantially all of its taxable income as required to maintain its REIT status. Alternatively, the Company may be required to borrow funds to make the required distributions which could have the effect of reducing the yield to its shareholders, to sell a portion of its assets at times or for amounts that are not advantageous, or to distribute amounts that represent a return of capital which would reduce the equity of the Company. In evaluating assets for acquisition, the Company considers the anticipated tax effects of the acquisition, including the possibility of any excess of taxable income over projected cash receipts. If the Company should not qualify as a REIT in any tax year, it would be taxed as a regular domestic corporation and, among other consequences, distributions to the Company's shareholders would not be deductible by the Company in computing its taxable income. Any such tax liability could be substantial and would reduce the amount of cash available for distributions to the Company's shareholders. See "Business -- Federal Income Tax Considerations." In addition, the unremedied failure of the Company to be treated as a REIT for any one year would disqualify the Company from being treated as a REIT for the four subsequent years. Excess Inclusion Income - - ----------------------- A portion of the distributions paid by the Company constitutes unrelated business taxable income to certain otherwise tax-exempt shareholders which will constitute a floor for the taxable income of shareholders not exempt from tax and will not be eligible for any reduction (by treaty or otherwise) in the rate of income tax withholding in the case of nonresident alien shareholders. Marketability of Shares of Common Stock and Restrictions on Ownership - - --------------------------------------------------------------------- The Company's Articles of Incorporation prohibit ownership of its Common Stock by tax-exempt entities that are not subject to tax on unrelated business taxable income and by certain other persons (collectively "Disqualified Organizations"). Such restrictions on ownership exist so as to avoid imposition of a tax on a portion of the Company's income from excess inclusions. 10 Provisions of the Company's Articles of Incorporation also are designed to prevent concentrated ownership of the Company which might jeopardize its qualification as a REIT under the Code. Among other things, these provisions provide (i) that any acquisition of shares that would result in the disqualification of the Company as a REIT under the Code will be void, and (ii) that in the event any person acquires, owns or is deemed by operation of certain attribution rules set out in the Code, to own a number of shares in excess of 9.8% of the outstanding shares of the Company's Common Stock ("Excess Shares"), the Board of Directors, at its discretion, may redeem the Excess Shares. In addition, the Company may refuse to effectuate any transfer of Excess Shares, and certain shareholders and proposed transferees of shares may be required to file an affidavit with the Company setting forth certain information relating generally to their ownership of the Company's Common Stock. These provisions may inhibit market activity and the resulting opportunity for the Company's shareholders to receive a premium for their shares that might otherwise exist if any person were to attempt to assemble a block of shares of the Company's Common Stock in excess of the number of shares permitted under the Articles of Incorporation. Such provisions also may make the Company an unsuitable investment vehicle for any person seeking to obtain (either alone or with others as a group) ownership of more than 9.8% of the outstanding shares of Common Stock. Investors seeking to acquire substantial holdings in the Company should be aware that this ownership limitation may be exceeded by a shareholder without any action on such shareholder's part in the event of a reduction in the number of outstanding shares of the Company's Common Stock. ACQUISITION AND DISPOSITION OF STRUCTURED SECURITIES The Company is not in the business of trading its Structured Securities. However, from time to time the Company may dispose of Structured Securities and therefore they have been classified as available-for-sale. In 1996 the Company sold its equity residual interest in TMAC CMO Trust 1986-1 and in 1997 its interests in TMAC CMO Trust 1986-2 and TMAC CMO Trust 1987-3 Under the Financial Accounting Standards Board method of accounting for Residual Interests in CMOs, residual interests are required to be classified either as "equity" (and be accounted for under the Equity Method) or as "nonequity" (and be accounted for under a level yield method referred to as the Prospective Method). The Company has adopted these methods for accounting for its residual interests and the accounting method for impairment of mortgage- backed derivative investments prescribed by Statement of Financial Accounting Standards No. 115 and presents its financial statements in accordance therewith. During 1998, the Company's interest in the Bear Stearns Mortgage Securities, Series 1992-1 IO Bond was redeemed and the Company sold its interest in its only remaining CMO instrument, CMOT-28. These transactions resulted in net proceeds of $1,888,000 and realized losses of $198,000 and $216,000 respectively. Subsequent to year end, in February, 1999, the Company sold its interest in FNMA Series 1992-123, Class S IO Bond resulting in proceeds of $783,000 and a realized gain of $8,000. 11 FAIR VALUE OF RESIDUAL INTERESTS AND IO BONDS Historically, a significant portion of the Company's revenue has been derived from the cash flows on the Company's Residual Interests and IO Bonds. The fair value of Residual Interests and IO Bonds is the net present value of the projected future cash flows. The amount of cash flows that may be generated from these assets is uncertain and may be subject to wide variations depending primarily upon the rate and timing of prepayments on the underlying mortgage collateral and, for Residual Interests with variable rate bond classes and IO Bonds with variable interest rates, changes in LIBOR. Information regarding the fair value of Residual Interests and IO Bonds is presented in the notes to the consolidated financial statements. CAPITAL RESOURCES When feasible, the Company may seek to increase the amount of funds available for its activities through various types of debt financing. The Company may seek to obtain lines of credit from independent financial institutions. The Company may also seek to raise funds through agreements pursuant to which the Company would sell Structured Securities for cash and simultaneously agree to repurchase them at a specified date for the same amount of cash plus an interest component ("Reverse Repurchase Agreements"), and through the issuance of commercial paper and other debt securities, other forms of borrowings and the issuance of additional equity securities. Short-term indebtedness would be expected to bear interest at variable rates. There can be no assurance that the Company will be able to finance assets that it wishes to acquire. In connection with the 1995 acquisition of four multifamily residential properties in California's Central Valley, the Company assumed and incurred mortgage obligations totaling $20,490,000 secured by such properties. After giving effect to the sale of one of the properties, as of December 31, 1998, the Company had mortgage obligations of approximately $13,794,000 secured by the three remaining properties. At December 31, 1997, the Company had mortgage obligation balances of $59,008,000 related to its interest in CMOT-28 which was sold during 1998. 12 At December 31, 1998 and 1997, the Company had short-term borrowings of $667,000 and $2,009,500, respectively, in the form of repurchase agreements with Bear Stearns & Co. and Paine Webber. The weighted average interest rates on these instruments as of these dates were 7.2189% and 7.4335%, respectively. This debt is securitized by certain of the Company's mortgage related assets. Subsequent to December 31, 1998, the short-term indebtedness was paid in full in conjunction with the sale of one of the Company's mortgage related assets. The Company's By-Laws provide that it may not incur indebtedness if, after giving effect to the incurrence thereof, the Company's aggregate indebtedness (other than liability represented by Structured Securities and any loans between the Company and its trusts or corporate subsidiaries), secured and unsecured, would exceed 100% of the Company's average invested assets in the preceding calendar quarter, as calculated in accordance with generally accepted accounting principles, unless approved by a majority of the Unaffiliated Directors. In April of 1999, the Company entered into a financing agreement with The Former Manager whereby The Former Manager extended a revolving line of credit of $1,000,000 to the Company. This line is to provide working capital to the Company. The Former Manager and the Company have common ownership and executive officers and as such are related parties. Credit support to the Former Manager includes guaranteed loans by a bank and a board member of the Company in support of the TIS Line to the Company. Additionally, certain of the Company's mortgage assest are pledged as collateral for the TIS Line. This revolving line of credit is for a term of one year, is at the rate of prime plus one and one half percent and is secured by the Company's ownership in Bankers Trust series 1988-1 Residual Interest Certificate. The Company has 100,000,000 authorized shares of Common Stock. The Company may increase its capital resources by making additional offerings of Common Stock. Such offerings may result in a reduction of the net tangible book value per outstanding share and a reduction in the market price of the Company's Common Stock. The Company is unable to estimate the amount, timing or nature of such future sales of its Common Stock, as any such sales would depend on general market conditions and other factors. The Company has a Dividend Reinvestment and Share Purchase Plan (the "Plan"). The Plan provides, at the Company's option, for shares purchased under the Plan to either be issued by the Company, or be purchased on the open market. The Plan prospectus provides for up to 1,000,000 new shares to be issued. To the extent new shares are issued, the Company's capital will be increased. During 1992, 5,780 shares were issued under the Plan resulting in an increase to capital of $39,000. No new shares were issued under the Plan thereafter, as all required shares have been purchased in the open market. OPERATING RESTRICTIONS The Company intends to conduct its business so as not to become regulated as an investment company under the Investment Company Act of 1940 (the "1940 Act"). Accordingly, the Company does not expect to be subject to the provisions of the 1940 Act, including those that prohibit certain transactions among affiliated parties. The 1940 Act exempts entities that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. Under current interpretations of the staff of the Securities and Exchange Commission, in order to qualify for this exemption, the Company must maintain at least 55% of its assets directly in Mortgage Loans, certain Mortgage Certificates and certain other qualifying interests in real estate. The Company's ownership of Residual Interests may therefore be limited by the 1940 Act. In addition, certain Mortgage Certificates may be treated as securities separate from the underlying Mortgage Loans and, thus, may not qualify as "mortgages and other liens on and interests in real estate" for purposes of the 55% requirement, unless such Mortgage Certificates represent all the certificates issued with respect to an underlying pool of mortgages. The Company's investment policies prohibit it from making any investments that would cause the Company to be an investment company within the meaning of the 1940 Act. 13 Although the Company has no present intention to seek modification of its operating policies described herein, a majority of the Unaffiliated Directors may in the future conclude that it would be advantageous for the Company to do so and may modify such operating policies accordingly, without the consent of the shareholders. SUBSIDIARIES TISPAC is a wholly-owned subsidiary of the Company incorporated on September 8, 1995, for the purpose of owning and financing real property. In March 1997, as part of the refinancing of two of the Company's multifamily residential properties and a portion of the Four Creeks property, title to those properties was vested in TISPAC. Simultaneously, TISPAC entered into notes secured by mortgages on those properties. TISPAC is a Qualified REIT Subsidiary. Accordingly, the accounts of TISPAC are consolidated with those of the Company. Novato Markets, Inc., is a wholly-owned subsidiary of the Company, incorporated on July 26, 1956, and acquired on February 2, 1999. It has one wholly-owned subsidiary, P-SUB I Inc., incorporated on June 4, 1997. P-SUB I owns a shopping center located in Rohnert Park, California, named Mountain Shadows Plaza, and owns a shopping center subject to a ground lease in Petaluma, California, named Midtown Center. COMPETITION The Company's real estate properties face the normal competitive pressure of most rental real estate projects. However, the Company's real property acquisitions have been and will continue to be opportunistic and may occur from time to time only when sufficient liquid assets are available. EMPLOYEES Until July 1, 1996, the Company had no full-time salaried employees. On that date, the Company became a self-administered REIT. As a result, the Company now directly employs three individuals, two of whom receive only a portion of their total compensation from the Company. The balance of their compensation is paid by the Company's Former Manager. In addition, the Company reimburses the Former Manager for employment expenses of personnel performing certain functions which are deemed applicable to the affairs of the Company. MANAGEMENT OF OPERATIONS SELF MANAGEMENT JULY 1, 1996 AND THEREAFTER - - --------------------------- At a special meeting of the Board of Directors on June 27, 1996, the Board resolved to let the Management Agreement expire on June 30, 1996 and to have the Company become a self-administered REIT. In connection therewith, the Company entered into a Facilities and Expense Sharing Agreement ("Expense Sharing Agreement") with the Former Manager providing for the sharing of office space, office equipment and the expenses of certain administrative and other personnel and ancillary services. In addition, the Board approved employment contracts with Lorraine O. Legg, Chairman and President of the Company, for a term of three years and John E. Castello, as Executive Vice President and Chief Financial Officer, for a term of two years. 14 The Company and the Former Manager entered into the Expense Sharing Agreement on July 1, 1996. The Expense Sharing Agreement provides for certain office space and expense sharing arrangements, whereby the Company and the Former Manager share on a prorata basis all fees and expenses incurred in connection with rent, telephone charges, utilities and other office expenses, bookkeeping fees and expenses and miscellaneous administrative and other expenses, including certain personnel expenses, as described in the Expense Sharing Agreement. The prorata sharing of such expenses is determined based upon the relative benefit received by each party in accordance with the amount of space utilized or the relative amount of time each such resource is used, or such other allocation method as may be reasonable and agreed to by the parties. The Expense Sharing Agreement continues in effect until terminated by either party on 30 days' prior written notice by either party or at such time as the parties no longer continue to share office space or other resources. Prior to July 1, 1996 - - --------------------- Prior to July 1, 1996, the Company operated under a Management Agreement with the Former Manager which was renewable annually. In June 1995, the Board of Directors of the Company and the Former Manager entered into a new Management Agreement through June 30, 1996. In March 1995, the Board of Directors authorized a committee composed of four Unaffiliated Directors to consider proposed revisions to the Management Agreement in light of the Company's acquisition of multifamily residential properties and recent waivers by the Unaffiliated Directors of the requirement in the Management Agreement that the Former Manager reimburse the Company for Excess Expenses (as defined). As a result, the Management Agreement approved in June 1995 increased the base management fee from .375% per annum of average invested assets to .65% thereof, changed the incentive compensation, eliminated an expense reimbursement provision, and discontinued the payment of a Residual Interest Administration Fee. These changes in the management fee became effective October 1, 1995. However, the Former Manager voluntarily waived the increase in base management fee for the fourth quarter of 1995 and first two quarters of 1996. Prior to becoming self managed on July 1, 1996, the Company reimbursed the Former Manager for certain expenses incurred by the Former Manager on the Company's behalf, including rent, telephone, utilities, office furniture, equipment and machinery, computers, and computer services, as well as expenses relating to accounting, bookkeeping and related administrative functions (including the employment expenses of any persons performing these functions), and fees and expenses of agents and employees employed directly by the Former Manager at the Company's expense. Except as set forth above, the Former Manager was required to pay employment expenses of its personnel, rent, telephone, utilities, other office expenses, certain travel and miscellaneous administrative expenses of the Former Manager and, if the Former Manager or an affiliate of the Former Manager served as bond administrator for a series of Structured Securities issued by or on behalf of the Company, all expenses incurred by the Former Manager in performing administrative services in connection with the issuance and administration of such series of Structured Securities. 15 FEDERAL INCOME TAX CONSIDERATIONS GENERAL If the Company satisfies certain tests with respect to the nature of its income, assets, management, share ownership and the amount of its distributions, and elects to be so treated, it will qualify as a real estate investment trust ("REIT") for Federal income tax purposes. The Company satisfied such tests and elected to be treated as a REIT on its tax return for the year ended December 31, 1988. The Company has satisfied such tests in all subsequent years. As a REIT, the Company generally will not be subject to tax at the corporate level on its taxable income to the extent that it distributes at lease 95% of such taxable income to its shareholders. See "Taxation of the Company." Generally, those distributions will constitute distributions to the shareholders and will be taxable as ordinary income to the extent of the Company's earnings and profits. It is expected that distributions made by the Company will be made out of earnings and profits. The failure of the Company to be treated as a REIT for any taxable year could materially and adversely affect the shareholders, since the Company would be taxed as a corporation. Accordingly, the taxable income of the Company (computed without any deduction for distributions to shareholders) would be taxed to the Company at corporate rates (currently up to 35% for Federal purposes), and the Company would be subject to any applicable minimum tax. However, the Company has $57 million of net operating loss carryforwards to offset taxable income. Additionally, distributions to the shareholders would be treated as ordinary income to the extent of the Company's earnings and profits. As a result of the "double taxation" (i.e. taxation at the corporate level and subsequently at the shareholder level when earnings are distributed) the distributions to the shareholders would decrease substantially, because a large portion of the cash otherwise available for distribution to shareholders would be used to pay taxes. Further, the failure of the Company to be treated as a REIT for any one year would disqualify the Company from being treated as a REIT for four subsequent years. QUALIFICATION OF THE COMPANY AS A REIT General In order to qualify as a REIT for Federal income tax purposes, the Company must elect to be so treated and must satisfy certain tests with respect to the sources of its income, the nature and diversification of its assets, the amount of its distributions, and the ownership of the Company. The following is a discussion of those tests. Sources of Income The Company must satisfy three separate income tests for each taxable year with respect to which it intends to qualify as a REIT: (i) the 75% income test, and (ii) the 95% income test. Under the first test, at least 75% of the Company's gross income for the taxable year must be derived from certain qualifying real estate related sources. Income that qualifies under the 75% test includes (a) interest on obligations secured by mortgages on real property or on interests in real property (including, generally, income from regular and residual interests in REMICs), (b) rents from real property, (c) distributions from other REITs, (d) gain from the sale or other disposition of real property (including interests in real property and interests in mortgages on real property) that is not "dealer property" (i.e. property that is stock in trade, inventory, or property held primarily for sale to customers in the ordinary course of business), (e) income from the operation, and gain from the sale, of property acquired at or in lieu of a foreclosure of a mortgage ("foreclosure property") , (f) commitment fees related to Mortgage Loans, and (g) income attributable to the temporary investment of the Company's capital proceeds (excluding amounts received pursuant to a 16 dividend reinvestment program) in stock or debt instruments, if such income is received or accrued during the one-year period beginning on the date of receipt of the capital proceeds ("qualified temporary investment income"). In addition to meeting the 75% income test, at least 95% of the Company's gross income for the taxable year must be derived from items of income that either qualify under the 75% test or are from certain other types of passive investments. This is referred to as the 95% income test. Income that satisfies the 95% income test includes income from distributions, interest and gains from the sale or disposition of stock or other securities, other than stock or other securities that are dealer property. If the Company inadvertently fails to satisfy either the 75% income test or the 95% income test, or both, and if the Company's failure to satisfy either or both tests is due to reasonable cause and not willful neglect, the Company may avoid loss of REIT status by satisfying certain reporting requirements and paying a tax generally equal to 100% of any excess nonqualifying income. The Company anticipates that its gross income will continue to include a component from interest and gains on mortgage assets and income from short- term reinvestments, but will consist principally of rents from its real estate assets. The composition and sources of the Company's income allowed the Company to satisfy the income tests for all fiscal years through December 31, 1998 and should allow the Company to satisfy the income tests during each year of its existence. If, however, the Company causes issuances of interests in real estate mortgage investment conduits ("REMICs") or issuances of certificates representing certain equity interests in mortgage instruments (such as pass- through certificates), the Company could recognize income or gain that, if from transactions in which the Company is deemed to be a dealer, could be subject to the 100% tax on prohibited transactions. See "Taxation of the Company" below. This effectively limits both the Company's ability to issue REMIC securities directly or through wholly owned subsidiaries and its ability to issue such securities indirectly through issuance of funding notes to affiliated issuers. Further, certain short-term reinvestments may generate qualifying income for purposes of the 95% income test but nonqualifying income for purposes of the 75% income test. In addition, income from Structured Securities which do not represent equity interests in Mortgage Loans and with respect to which a REMIC election has not been made (e.g. CMOs) may not qualify under the 75% income test. The Company intends to monitor its reinvestments and hedging transactions closely to avoid disqualification as a REIT. Nature and Diversification of Assets At the end of each quarter of the Company's taxable year, at least 75% of the value of the Company's assets must be cash and cash items (including receivables), "government securities" and "real estate assets." Real estate assets include real property, Mortgage Loans, Mortgage Certificates, equity interest in other REITs, any stock or debt instrument for so long as the income therefrom is qualified temporary investment income and, subject to certain limitations, interests in REMICs. Structured Securities that do not represent equity interests in Mortgage Loans and with respect to which a REMIC election has not been made may not qualify as real estate assets. The balance of the Company's assets may be invested without restriction, except that holdings of the securities of any non-governmental issuer (other than a REIT or qualified REIT subsidiary) may not exceed 5% of the value of the Company's assets or 10% of the outstanding voting securities of that issuer. Securities that are qualifying assets for purposes of the 75% asset test will not be treated as securities for purposes of the 5% and 10% asset tests. If a REIT receives "new capital," stock or debt instruments purchased with such new capital are treated as real estate assets for purposes of the 75% asset test (described above) during the one-year period 17 beginning on the date the REIT receives such new capital. New capital is defined as any amount received by a REIT in exchange for its stock (other than amounts received pursuant to a dividend reinvestment plan) or received in a public offering of its debt obligations having maturities of at least five years. The Company anticipates that its assets will consist of (i) ownership interests in mortgage assets (including undivided ownership interests in mortgage instruments), (ii) interests in REMICs, (iii) interests in real estate, (iv) interests in other REITs, (v) stock or debt instruments that generate qualified temporary investment income, (vi) cash and (vii) certain short-term investments and reinvestments. The Company believes that such asset holdings will allow it to satisfy the assets tests necessary to qualify as a REIT, and the Company intends to monitor its activities to attempt to assure satisfaction of such tests. If the Company fails to satisfy the 75% asset test at the end of any quarter of its taxable year as a result of its acquisition of securities or other property during that quarter, the failure can be cured by a disposition of sufficient nonqualifying assets within 30 days after the close of that quarter. The Company intends to maintain adequate records of the value of its assets and take such action as may be required to cure any failure to satisfy the 75% asset test within 30 days after the close of any quarter. The Company may not be able to cure any failure to satisfy the 75% asset test, however, if assets that the Company believes are qualifying assets for purposes of the 75% asset test are later determined to be nonqualifying assets. REITs are permitted to hold assets in wholly owned subsidiaries ("Qualified REIT Subsidiaries"). A subsidiary of a REIT is a Qualified REIT Subsidiary if 100% of its stock is owned by the REIT at all times during the period such subsidiary is in existence. A Qualified REIT Subsidiary is not treated as a separate corporate entity for Federal income tax purposes, but rather, together with its parent REIT, is treated as a single taxpayer. Accordingly, all of the assets, liabilities and items of income, deduction and credit of a Qualified REIT Subsidiary are treated as the assets, liabilities, and items of income, deduction and credit of the parent REIT for Federal income tax purposes and, in particular, for purposes of satisfying the applicable Code provisions for qualification as a REIT. The Company's wholly owned subsidiaries, TISPAC and TISMAC, are Qualified REIT Subsidiaries. Distributions The Company must distribute as distributions to its shareholders for each taxable year an amount at least equal to (i) 95% of its "REIT taxable income" as defined below (determined before the deduction of dividends paid and excluding any net capital gain) plus (ii) 95% of the excess of its net income from foreclosure property over the tax imposed on such income by the Code, less (iii) any excess non-cash income (as determined under the Code). Generally, a distribution must be made in the taxable year to which it relates. A portion of the required distribution, however, may be made in the following year (i) if the distribution is declared in October, November or December of any year, is payable to shareholders of record on a specified date in such a month, and is actually paid before February 1 of the following year; or (ii) if the distribution is declared before the date on which the Company's tax return for the taxable year is due to be filed (including extensions) and is paid on or before the first regular distribution payment date after such declaration. Further, if the Company fails to meet the 95% distribution requirement as a result of an adjustment to the Company's tax returns by the Internal Revenue Service (the "IRS"), the Company may, if the deficiency is not due to fraud with intent to evade tax or a willful failure to file a timely tax return, retroactively cure the failure by paying a deficiency dividend (plus interest). 18 The Code imposes a non-deductible 4% excise tax on REITs to the extent that the "distributed amount" with respect to a particular calendar year is less than the sum of (i) 85% of the REIT's taxable income (computed pursuant to Section 857(b)(2) of the Code, but before the dividends paid deduction and excluding capital gain or loss) for such calendar year, (ii) 95% of the REIT's capital gain net income (i.e. the excess of capital gains over capital losses) for such calendar year, and (iii) the excess, if any, of the "grossed up required distribution" (as defined in Section 4981(b)(3) of the Code) for the preceding calendar year over the distributed amount for such preceding year. For purposes of the excise tax provision, the "distributed amount" with respect to any calendar year is the sum of (i) the deduction for dividends paid during such calendar year (excluding dividends paid after the close of the taxable year under Section 858 of the Code but including distributions declared in October, November or December and paid in January, as described above), (ii) amounts on which the REIT is required to pay corporate tax and (iii) the excess, if any, of the distributed amount for the preceding year over the "grossed up required distribution" for such preceding taxable year. The Company intends to make distributions to its shareholders on a basis that will allow the Company to satisfy both the 95% distribution requirement and the excise tax distribution requirement. Certain factors inherent in the structure of certain mortgage-backed securities (particularly CMOs) and the Federal income tax rules for calculating income of Mortgage assets may cause the Company to realize taxable income in excess of net cash flows in certain years. The Company intends to monitor closely the interrelationship between its pre-distribution taxable income and its cash flow and intends to borrow funds or liquidate investments in order to overcome any cash flow shortfalls if necessary to satisfy the distribution requirements. Ownership of the Company Shares of the Company's Common Stock must be beneficially owned by a minimum of 100 persons for at least 335 days in each full taxable year (or a proportionate part of any short taxable year) after the Company's first taxable year. Further, at no time during the second half of any taxable year after the Company's first taxable year may more than 50% of the Company's shares be owned, actually or constructively, by five or fewer individuals (including pension funds except under certain circumstances, and certain other types of tax exempt entities). The Company's Articles of Incorporation contain repurchase provisions and transfer restrictions designed to prevent violation of the latter requirement. To evidence compliance with these requirements, the Company is required to maintain records that disclose the actual ownership of its outstanding shares. Each year, in order to satisfy that requirement, the Company will demand written statements from record holders owning designated percentages of Common Stock disclosing, among other things, the identities of the actual owners of such shares. TAXATION OF THE COMPANY For any taxable year in which the Company qualifies and elects to be treated as a REIT under the Code, the Company will be taxed at regular corporate rates (or, if less, at alternative rates in any taxable year in which the Company has an undistributed net capital gain) on its real estate investment trust taxable income ("REIT Taxable Income"). REIT Taxable Income is computed by making certain adjustments to a REIT's taxable income as computed for regular corporations. Significantly, distributions paid by a REIT to its shareholders with respect to a taxable year are deducted to the extent such distributions are not attributable to net income from foreclosure property. Thus, in any year in which the Company qualifies and elects to be treated as a REIT, it generally will not be subject to Federal income tax on that portion of its taxable income that is distributed to its shareholders in or with respect to that year. In computing REIT Taxable Income, taxable income also is adjusted by (i) disallowing any corporate deduction for dividends 19 received, (ii) disregarding any tax otherwise applicable as a result of a change of accounting period, (iii) excluding the net income from foreclosure property, (iv) deducting any tax resulting from the REIT's failure to satisfy either of the 75% or 95% income tests, and (v) excluding net income from prohibited transactions. Regardless of distributions to shareholders, the Company will be subject to a tax at the highest corporate rate on its net income from foreclosure property, a 100% tax on its net income from prohibited transactions, and a 100% tax on the greater of the amount by which it fails either the 75% income test or the 95% income test, less associated expenses, if the failure to satisfy either or both of such tests does not cause the REIT to fail to qualify as such. In addition, as described above, the Company will be subject to a 4% excise tax for any taxable year in which, and on the amount by which, distributions made by the Company fail to equal or exceed a certain amount determined with reference to its REIT Taxable Income. The Company is also subject to the alternative minimum tax, which is determined for REITs with reference to REIT Taxable Income as increased by tax preferences. The Company does not expect to have significant amounts of tax preference items. Accordingly, the Company anticipates that its Federal tax liabilities, if any, will be minimal. On August 5, 1997, the Taxpayer Relief Act of 1997 was enacted. This Act changed a number of federal income tax provisions that affect REITs. These changes include, but are not limited to, the repeal of the 30% income test, the enactment of a "de minimis" rule for tenant services income, and the liberalization of the consequences for failing to comply with the federal regulations regarding determination actual ownership of a REIT's outstanding shares. California Franchise tax regulations regarding REIT qualification currently conform to Federal income tax regulations. There is no assurance that this will continue in the future and, if state regulations do not conform to Federal regulations in the future, there is a possibility that the Company might be liable for state income taxes. The Company uses the calendar year both for tax and financial reporting purposes. Due to the differences between tax accounting rules and generally accepted accounting principles, the Company's REIT Taxable Income may vary from its net income for financial reporting purposes. 20 ITEM 2. PROPERTIES. At December 31, 1997, the Company's operating real estate assets consisted of four multifamily apartment complexes located in California's Central Valley. During the fourth quarter of 1998, the Company sold the River Oaks property and now owns the three properties shown in the following table. All of these properties were acquired in 1995 either in the form of direct ownership of the real property or in the form of an interest in a partnership that directly owns the real property. As part of a refinancing, title to Villa San Marcos and a portion of the Four Creeks Property were vested in TISPAC. The multifamily residential properties, Shady Lane, and Four Creeks Phase I are held directly by the Company at December 31, 1998. Information regarding these properties is shown in the table below:
VILLA FOUR CREEKS Shady Lane SAN MARCOS VILLAGE - - --------------------------------------------------------------------------------------------- Location Visalia, CA Fresno, CA Visalia, CA Date of Construction 1985 1991 1986-1991 Purchase Price $2,105,000 $9,000,000* $9,000,000 Purchase Price per Square Foot $ 40.44 $ 62.44 $ 48.27 Notes Payable Secured by Real Estate at December 31, 1998 $1,292,145 $6,825,984 $5,675,526 Number of Units 54 120 146 Rentable Square Feet 52,056 144,140 186,439 Average Monthly Rent per Unit in 1998 $ 411 $ 826 $ 730 Monthly Rent per Square Foot in 1998 $ 0.43 $ 0.69 $ 0.57 Improved Land Area 2.77 acres 9.77 acres 13.34 acres Unimproved Land Area -- 9.75 acres -- Occupancy at December 31, 1998 94% 96% 100%
* In addition to acquiring the currently existing building, the Company purchased the adjoining 9.75 acres of unimproved land for $1,000,000. An additional 126 rentable units are expected to be constructed on this parcel. At the time of purchase, all requisite entitlements were in place. On February 2, 1999, the Company acquired Novato Markets and through its subsidiary acquired a shopping center located in Rohnert Park, California, named Mountain Shadows Plaza and a shopping center in Petaluma, California, named Midtown Center. The shopping centers have a combined commerical and retail space totaling approximately 80,000 square feet. Mountain Shadows Plaza consists of three buildings and is anchored by a large grocery store. Midtown Center consists of a single building. As of the date of acquisition, the shopping centers only had one vacancy. The principal executive offices of the Company and the Former Manager are located at 655 Montgomery Street, Suite 800, San Francisco, California 94111, telephone (415) 393-8000. The Company leases its office space under a lease expiring February 28, 2002 and subleases space to the Former Manager. 21 ITEM 3. LEGAL PROCEEDINGS. On March 11, 1999, The Bank of New York ("BNY") filed an action in the United States District Court for the Northern District of California, Case No. C.99-1130 MJJ, against the Company for alleged breach of contract, common count and conversion. The complaint alleges that BNY erroneously paid $1.2 million to the Company under the terms of a mortgage-backed security of which the Company is one of the holders, and that the Company has failed to repay approximately $600,000 of those monies despite demand. The complaint requests repayment, prejudgment interest, attorneys fees' and costs. The Company acknowledges that it is required to repay the remaining $600,000, but denies that it is liable to BNY, a trustee to the Company, for any other amounts or that it ever breached any contract, converted monies, or otherwise acted improperly. On March 23, 1999, BNY filed an application for a writ of attachment, requesting expedited hearing thereon. The Company opposed the expedited hearing and the Court denied BNY's request. On April 1, 1999, BNY filed an amended complaint adding a request for a constructive trust, and also set the attachment application for regular hearing on May 11, 1999. The parties have engaged in informal settlement discussions, both before and after the filing of the original complaint. Those discussions continue. If a settlement agreement cannot be reached, the Company intends to oppose the application for an attachment and vigorously defend the action. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of the security holders of the Company during the fourth quarter of the fiscal year covered by this report. 22 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's Common Stock is listed on the Pacific Exchange under the symbol "TIS." The Company was also listed on the New York Stock Exchange until August 19, 1998, when the stock was delisted from that exchange. The high and low closing sales prices of shares of the Common Stock on the Pacific Exchange or the New York Stock Exchange for the periods indicated were as follows:
HIGH LOW ----------------- ----------------- 1997 First Quarter $ 1-3/8 $1-1/16 Second Quarter 1-1/4 1 Third Quarter 1-5/8 1 Fourth Quarter 1-7/8 1-3/8 1998 First Quarter 2-3/8 1-3/16 Second Quarter 2-3/16 1-9/16 Third Quarter 1-7/8 9/16 Fourth Quarter 7/8 3/8 1999 First Quarter 1-7/16 1/2
- - -------------------------------------------------------------------------------- On April 13, 1999, the closing sales price of the shares of Common Stock on the Pacific Exchange was $1.375. On that date the Company had outstanding 8,893,250 shares of Common Stock which were held by approximately 500 shareholders of record and the total number of shareholders was approximately 4,000. The following table details distributions paid during the Company's three most recent fiscal years. No distributions were paid in 1997.
- - ------------------------------------------------------------------------------------------------------------ Date Amount Record Payment Quarter Ended Declared Declared Date Date - - ------------------------------------------------------------------------------------------------------------ December 31, 1998 September 15, 1998 $0.002 December 1, 1998 December 18, 1998 December 31, 1996 September 10, 1996 $ 0.02 December 13, 1996 December 31, 1996 - - ------------------------------------------------------------------------------------------------------------
The actual amount and timing of any future dividend payments will be at the discretion of the Board of Directors and will depend upon the financial condition of the Company in addition to the requirements of the Code. Subject to the distribution requirements to maintain REIT qualification, the Company intends, to the extent practicable, to use substantially all of the interest payments and sales of the Company's Structured Securities to reduce debt and short-term obligations of the Company. The Company may, 23 however, under extraordinary circumstances, make a distribution of principal. Such distributions, if any, will be made at the discretion of the Company's Board of Directors. It is anticipated that distributions generally will be taxable as ordinary income to shareholders of the Company (including, in some cases, shareholders that would otherwise be exempt from tax under the Code), although a portion of such distributions may be designated by the Company as capital gain or may constitute a return of capital. Such distributions received by shareholders of the Company will not be eligible for the dividends-received deduction so long as the Company qualifies as a REIT. The Company furnishes annually to each of its shareholders a statement setting forth distributions paid during the preceding year and their characterization as ordinary income, return of capital or capital gain. A significant portion of the REIT Taxable Income of the Company has been derived from the Company's Structured Securities although, in future years, it is anticipated that increasing portions of the taxable income of the Company will be derived from its operating real estate assets. Taxable income is increased by non-cash credits from, among other things, the accretion of market discount on the Mortgage Certificates pledged as collateral for bonds and is decreased by non-cash expenses, including, among other things, the amortization of the issuance costs of bonds, market premium on the Mortgage Certificates pledged as collateral for bonds and the accretion of original issue discount on certain bond classes. In certain instances, the REIT Taxable Income of the Company for Federal income tax purposes may differ from its net income for financial reporting purposes principally as a result of the different methods used to determine the effect and timing of recognition of such non-cash credits and expenses. As a result of the requirement that the Company distribute to its shareholders an amount equal to substantially all of its REIT Taxable Income in order to qualify as a REIT, the Company may be required to distribute a portion of its working capital to its shareholders or borrow funds to make required distributions in years in which on a tax basis the "non-cash" items of income (such as those resulting from the accretion of market discount on the assets owned by the Company) exceed the Company's "non-cash" expenses. If the Company is unable to pay distributions equal to substantially all of its REIT Taxable Income, it will not continue to qualify as a REIT. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data are qualified in their entirety by, and should be read in conjunction with, the financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. The data as of and for the years ended December 31, 1998, 1997 and 1996 have been derived from the Company's financial statements which are included elsewhere in this Annual Report on Form 10-K. 24 (IN THOUSANDS, EXCEPT PER SHARE DATA) - - --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, -------------------------------------------------------------------------- STATEMENT OF OPERATIONS DATA 1998 1997 1996 1995 1994 -------------------------------------------------------------------------- Income Interest Income on Mortgage Certificates $ 2,602 $6,059 $ 7,748 $ 13,735 $18,298 Interest Income on Residual Interests 22 39 52 1,483 3,650 Income from IO Bonds 171 360 455 1,128 2,208 Income from Commercial Securitizations -- -- -- 89 51 Interest on Short-term Investments 8 2 16 115 126 Gain (Loss) on Sales of Mortgage Related Assets (216) 442 450 (2,385) 0 Loss on Redemption of Investment Asset (198) -- -- -- -- Loss on Sales of Real Property (157) -- -- -- -- Valuation Reserve Reduction (Provision) 210 1,474 651 541 (398) Loss from Real Estate Operations (269) (261) (171) (289) 0 Other Income 4 11 21 30 60 -------- ------ ------- -------- ------- Total Income 2,177 8,126 9,222 14,447 23,995 Expenses Interest Expense on CMOs 3,010 6,549 8,317 14,749 18,987 Interest Expense on Short-term Debt 125 174 159 429 509 Loss on other than temporary impairment of assets 2,073 -- -- -- -- Amortization of Deferred Bond Issuance Costs 80 101 146 276 351 Administrative and Management Expenses 1,323 1,511 1,503 1,572 1,611 -------- ------ ------- -------- ------- Total Expenses 6,611 8,335 10,125 17,026 21,458 Minority Interest Share of Loss (298) -- -- -- -- -------- ------ ------- -------- ------- Net Income (Loss) ($ 4,136) ($ 209) ($ 903) ($ 2,579) $ 2,537 Basic Net Income (Loss) Per Share ($ 0.51) ($ 0.03) ($ 0.11) ($ 0.32) $ 0.31 ======= ======= ======== ========= ======= Distributions Declared per Share $ 0.002 $ 0.00 $ 0.02 $ 0.00 $ 0.02 Weighted Average Shares Outstanding 8,106 8,106 8,106 8,106 8,106 - - --------------------------------------------------------------------------------------------------------------------------
25 SELECTED FINANCIAL DATA (CONTINUED)
(IN THOUSANDS) DECEMBER 31 ------------------------------------------------------------------------ 1998 1997 1996 1995 1994 ------------------------------------------------------------------------ BALANCE SHEET DATA Mortgage Certificates, net $ -- $60,433 $ 72,703 $109,752 $163,817 Residual Interests 284 384 436 725 8,675 IO Bonds 840 1,875 2,695 3,150 9,794 Commercial Securitizations 184 184 183 191 1,194 Reserve for Loss on Investments -- (1,523) (2,997) (4,277) (4,818) Operating Real Estate Assets, Net 20,172 28,697 28,945 29,384 395 Total Assets 25,056 93,754 105,573 145,247 188,957 Accounts Payable and Accrued Liabilities 1,807 870 448 561 252 Notes Payable on Real Estate 13,794 20,350 20,373 20,362 0 Short-term Debt 667 2,010 2,418 2,118 8,325 Total Liabilities 16,268 83,125 94,555 133,266 172,864 Total Shareholders' Equity 8,788 10,629 11,018 11,981 16,093 - - ---------------------------------------------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company commenced operations on August 26, 1988 in connection with its initial public offering of 8,100,000 shares of Common Stock. Subsequent to 1994, the Company has sold the majority of its investments in Structured Securities and, during 1995, acquired a portfolio of four income-producing residential real estate properties of which one was sold during 1998. In February of 1999, the Company acquired two shopping centers in Northern California. The Company expects that the majority of its ongoing assets and selective development opportunities. Additionally, the Company plans to seek selective opportunities for development. However, there can be no assurance that this will occur. 26 The following table illustrates the Company's cash receipts, disbursements and reinvestments for the last three years.
CASH FLOW ANALYSIS (IN THOUSANDS) 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------ Beginning Cash Balance $ 185 $ 82 $ 198 Cash Received: Mortgage Related Assets 1,124 1,633 2,758 Sale of Mortgage Related Assets 1,888 442 450 Sale of Real Estate Assets 1,584 -- -- Deposit from Trustee 1,218 -- -- Increase in Short-term Debt -- 0 300 Increase in Real Estate Notes -- 17,400 11 Decrease in Other Assets -- 115 -- Cash Disbursements: Cash Expenses (1,191) (1,173) (2,483) Additions to Real Estate Assets (426) (483) (258) Increase in Other Assets -- -- (732) Distributions (16) -- (162) Decrease to Short-term Debt (1,343) (408) -- Decrease in Real Estate Notes (256) (17,423) -- - - ------------------------------------------------------------------------------------------------------------ Ending Cash Balance $ 2,767 $ 185 $ 82 ============================================================================================================
RESULTS OF OPERATIONS The Company had a net loss of $4,136,000, or $0.51 per share, for the year ended December 31, 1998. For the year ended December 31, 1997 it had a net loss of $209,000, or $0.03 per share. For the year ended December 31, 1996, it had a net loss of $903,000, or $0.11 per share. The Company declared distributions totaling $16,000, or $.002 per share, and $162,000, or $0.02 per share, for the years 1998 and 1996, respectively. No distributions were declared for 1997. 1998 COMPARED TO 1997 1998 was the third full year of the Company's real estate operations. River Oaks was sold in the fourth quarter of 1998 to increase the Company's liquidity. The income from operations before depreciation and amortization decreased from $479,000 in 1997 to $360,000 in 1998. The decline in 1998 income is due to a $157,000 loss on the sale of the River Oaks property. Rental and other income increased $64,000 or 1.6% from $3,987,000 in 1997 to $4,051,000 in 1998. Operating and Maintenance Expenses increased $109,000 or 8.12% from $1,342,000 in 1997 to $1,451,000 in 1998. Occupancy at the Company's properties improved from 96% in 1997 to 97.5% in 1998. Net interest margin (interest income from Mortgage Certificates net of interest expense on CMOs) increased in 1998 to a net interest expense of $408,000 from net interest expense of $490,000 in 1997. This decrease in net interest income and expense is due primarily to the principal reductions in the Company's investment in CMOT 28 that was ultimately sold in 1998. 27 Below is a summary of net interest margin for the years ended December 31, 1998 and 1997.
(In thousands) 1998 1997 Change -------------------- -------------------- -------------------- Interest Income from Mortgage Certificates $ 1,547 $ 5,845 ($4,298) Amortization of Market Discount 1,055 214 841 -------------------- -------------------- -------------------- Net Interest Income 2,602 6,059 ($3,457) -------------------- -------------------- -------------------- Interest Expense on CMOs (713) 5,793 (6,506) Amortization of Original Issue Discount 3,723 756 2,967 -------------------- -------------------- -------------------- Net Interest Expense 3,010 6,549 (3,539) -------------------- -------------------- -------------------- Net Interest Margin (Deficit) ($ 408) ($ 490) $ 82 ==================== ==================== ====================
The reserve for loss on investments was reduced by $1,523,000 in 1997 as a result of the sale of CMOT 28. General and Administrative expense decreased from $1,443,000 in 1997 to $1,289,000 in 1998. This decrease was due primarily to decreased expenses related to the omission of the 1998 annual meeting of stockholders. During 1998, the Company determined that the yield on two of its mortgage related assets was less than the risk free rate versus the amortized cost basis of the assets. Therefore the Company recognized a loss of $2,073,000 in the income statement to bring amortized cost down to fair value. In addition, one of the Company's mortgage investments was retired prior to its maturity as part of an optional redemption of the entire bond series. This retirement resulted in a loss of $198,000 which was recorded in 1998. Additionally, the Company sold its interest in CMOT-28 during 1998 which also resulted in the Company taking a non-cash writedown of $567,000 for recognition of previously unrealized losses. 1997 COMPARED TO 1996 1997 was the second full year of the Company's real estate operations. The performance of the real estate properties was virtually flat from 1996 to 1997 with the exception of the amortization of loan costs related to the refinancing of properties accomplished during 1997. The income from operations before depreciation and amortization declined from $534,000 in 1996 to $479,000 in 1997 The decrease is a result of the loan amortization expense related to the 1997 refinancing. Rental and other income declined from $3,990,000 in 1996 to $ 3,987,000 in 1997. while Operating and Maintenance Expenses declined from $1,388,000 in 1996 to $1,342,000 in 1997. Occupancy at the Company's properties was improved in 1996 over 1995 to approximately 96% and remained constant at approximately 96% during 1997. Net interest margin (interest income from Mortgage Certificates net of interest expense on CMOs) increased in 1997 to a net interest expense of $490,000 from net interest expense of $569,000 in 1996. This decrease in net interest expense is due primarily to the principal reductions in the Company's investment in CMOT 28. 28 Below is a summary of net interest margin for the years ended December 31, 1997 and 1996.
(In thousands) 1997 1996 Change -------------------- -------------------- ------------------- Interest Income from Mortgage Certificates $ 5,845 $ 7,433 $(1,588) Amortization of Market Discount 214 315 (101) Net Interest Income 6,059 7,748 (1,689) -------------------- -------------------- ------------------- Interest Expense on CMOs 5,793 7,343 (1,550) Amortization of Original Issue Discount 756 974 (218) Net Interest Expense 6,549 8,317 (1,768) -------------------- -------------------- ------------------- Net Interest Margin ($ 490) ($ 569) $ 79 ==================== ==================== ===================
The reserve for loss on investments was reduced by $1,474,000 in 1997. This decrease in reserve primarily reflects an increase in the fair value of the Company's investment in CMOT 28, the Company's remaining consolidated equity residual interest. General and Administrative expense increased from $1,356,000 in 1996 to $1,443,000 in 1997. This increase was due primarily to increased legal and other expenses related to the 1997 annual meeting of shareholders. NET INTEREST INCOME ANALYSIS
1998 1997 1996 ----------------------------------------------------------------------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE (IN THOUSANDS) INTEREST BALANCE RATE INTEREST BALANCE RATE INTEREST BALANCE RATE - - ----------------------------------------------------------------------------------------------------------------------- Interest Income Mortgage Certificates $2,602 27,263 9.54% $6,059 $66,568 9.10% $ 7,748 $74,316 10.43% Residual Interests 22 365 29.32% 39 410 9.51% 52 575 9.03% Interest Only Bonds 171 1,197 14.29% 360 2,285 15.75% 455 2,998 15.19% Other 8 2,106 0.3% 2 1,853 0.11% 16 2,645 0.61% - - ----------------------------------------------------------------------------------------------------------------------- Interest Income 2,803 30,931 9.34% 6,460 71,116 9.08% 8,271 80,534 10.27% Interest Expense Collateralized Mort- gage Obligations 3,010 23,038 10.71% 6,549 64,634 10.13% 8,317 86,473 9.62% Short-term Debt 125 1,181 10.58% 174 2,214 7,86% 159 2,145 7.44% - - ----------------------------------------------------------------------------------------------------------------------- Interest Expense 3,135 24,219 12.94% 6,723 66,848 10.06% 8,476 88,618 9.56% Net Interest Loss (332) (0.82%) ($ 263) (0.37%) ($ 205) (0.25%) - - -----------------------------------------------------------------------------------------------------------------------
The table above summarizes the amount of interest expense, the average amounts outstanding of interest-bearing assets and liabilities, and the average effective interest rates. 29 The table below summarizes the amount of change in interest income and interest expense due to changes in interest rates versus changes in volume.
1998- 1997 1997 - 1996 1996 - 1995 ------------------- --------------------------- ---------------------------- (In thousands) Rate VOLUME TOTAL RATE VOLUME TOTAL RATE VOLUME TOTAL - - -------------------------------------------------------------------------------------------------------------- Interest Income Mortgage Certificates (780) (2,676) (3,456) ($ 881) ($ 808) ($1,689) $ 1,849 ($7,836) ($5,987) Residual Interests (12) (5) (17) 2 (15) (13) (644) (787) (1,431) Interest Only Bonds (51) (139) (190) 13 (108) (95) (90) (582) (672) Other 6 0 6 (9) (5) (14) (135) (54) (189) - - ------------------------------------------------------------------------------------------------------------- Interest Income (837) (2,820) (3,657) (875) (936) (1,811) 980 (9,259) (8,279) Interest Expense CMOs (625) (2,915) (3,540) (763) (5,669) (6,432) 1,430 (5,668) (4,238) Short-term Debt 36 (85) (49) (7) (263) (270) (715) 635 (80) - - ------------------------------------------------------------------------------------------------------------- Interest Expense (589) (3,000) (3,589) (770) (5,932) (6,702) (307) (5,033) (4,318) Net Interest Income $(248) $ 180 $ (68) $1,750 ($3,327) ($1,577) ($ 1,375) ($2,090) ($3,465) - - -------------------------------------------------------------------------------------------------------------
OUTLOOK The Company has determined that it will direct its future investments principally to multifamily residential properties, family shopping centers and development opportunities. With regard to real estate investments, the acquisition strategy of the Company is to identify communities with an expanding employment base and demographics which will continue to provide economic growth. After identifying communities with a strong potential economic growth, the Company attempts to seek out those areas within a chosen community which are most likely to be positively affected by the economic growth of the community. Finally, the property sought for purchase within a given area is chosen because it is considered to be among the highest quality properties in that area and can be purchased below replacement cost. Management believes that this strategy will allow income from each of the properties to rise before the properties encounter significant competition from new construction, however, there can be no assurance that this will happen. The Company has generated significant tax loss carryforwards from losses experienced over the last several years. Should the Company's real estate acquisitions be successful, the Company would be in a tax position to have the right, but not the obligation, to continue to use cash flows to rebuild its investment portfolio prior to resuming taxable dividend payments. SUBSEQUENT EVENTS EXCHANGE OF SHARES FOR NOVATO MARKETS. On February 2, 1999, the Company acquired all the shares of Novato Markets, Inc. ("Novato") from Pacific Securitization, Inc., ("Pacific") in exchange for 1,613,070 shares of Common Stock of the Company pursuant to an Agreement and Plan of Reorganization dated as of February 1, 1999, between the Company and Pacific. Pacific is indirectly principally owned by Lorraine O. Legg, the President and Chief Executive Officer and a director of the Company, and Patricia M. Howe, a director of the Company. The Company's acquisition of Novato was approved by the Company's Board of Directors. Through a wholly-owned subsidiary, Novato owns a shopping center located in Rohnert Park, California, named Mountain Shadows Plaza, and a shopping center subject to a ground lease in Petaluma, California, named Midtown Center. The shopping centers have a combined 30 commercial and retail space totaling approximately 80,000 square feet. Mountain Shadows Plaza consists of three buildings and is anchored by a large grocery store. Midtown Center consists of a single building. The Company intends to continue operating the shopping centers. The Shares were issued to Pacific under an exemption to the registration requirements of the Securities Act of 1933, as amended. Accordingly, the Shares are "restricted securities," as defined in Rule 144 of the Securities Act, and are not freely transferable. The Company granted Pacific one-time demand registration rights with respect to the Shares for the period beginning June 30, 1999 and ending February 2, 2001. It also granted Pacific piggy-back registration rights in the event that the Company files a registration statement under the Securities Act in connection with the proposed offer and sale for cash of shares of Common Stock by it or by any of its shareholders. The share exchange is intended to be a tax free reorganization within the meaning of Section 368(a)(1) of the Internal Revenue Code of 1986, as amended. Prior to the closing of the share exchange, Novato caused its wholly-owned subsidiary to transfer to Pacific all its rights under a lease, with option to purchase, with Ignacio Properties, LLC, relating to the Ignacio Center in Novato, California, and Pacific agreed to assume all the obligations of the subsidiary under the lease and option. The Company, Novato, Novato's wholly-owned subsidiary and Pacific then entered into an agreement dated as of February 1, 1999, whereby the parties clarified their respective rights and obligations relating to the Ignacio Property and the Company's rights to an escrow established when Pacific originally acquired Novato. SHARE PURCHASE FROM TURKEY VULTURE FUND XIII, LTD. On February 2, 1999, the Company acquired 793,700 shares of its Common Stock from Turkey Vulture Fund XIII, Ltd. for $1,984,250, 20,000 shares of its Common Stock from Christopher L. Jarratt for $40,000 and 12,000 shares of its Common Stock from James G. Lewis for $24,000, pursuant to an Agreement dated as of February 1, 1999, among the Company, Turkey Vulture Fund, Richard M. Osborne, Third Capital, LLC, Mr. Jarratt and Mr. Lewis. Turkey Vulture Fund, Third Capital and Messrs. Osborne, Jarratt and Lewis agreed that, for a period of seven years, they will not directly or indirectly, among other things, (i) effect or participate in or in any way assist any other person in effecting or participating in (a) any acquisition of securities or rights to acquire securities or assets of the Company or its subsidiaries, (b) any tender or exchange offer, merger or other business combination involving the Company or its subsidiaries, (c) any liquidation or other extraordinary transaction with respect to the Company or its subsidiaries, or (d) any solicitation of proxies or consents to vote any voting securities of the Company; (ii) form or in anyway participate in a "group" with respect to the Company; (iii) otherwise act, alone or in concert with others, to seek to control or influence the management, Board of Directors or policies of the Company or its subsidiaries; (iv) take any action to compel the holding of an annual or special meeting of stockholders; or (v) enter into any discussions or arrangements with any person relating to the foregoing. The parties also agreed to a mutual general release of all claims arising out of or relating to the business or affairs of the Company or the ownership of its stock. Messrs. Osborne, Jarratt and Lewis resigned from the Company's Board of Directors, effective February 2, 1999. This share purchase and the acquisition of Novato were approved by the Company's Board of Directors and, specifically, by directors with no financial interest in either transaction. The disinterested directors required that the share exchange transaction be closed as a condition to closing the share purchase transaction. 31 APPOINTMENT OF NEW DIRECTORS. On February 5, 1999, the Company's Board of Directors appointed Anthony H. Barash and J. David Schemel to fill two vacancies on the Board. Mr. Barash is the Senior Vice President, Corporate Affairs, and General Counsel of Bowater Incorporated, a paper and forest products company. He is responsible for Bowater's legal matters, corporate communications and governmental affairs. Prior to joining Bowater in April 1996, Mr. Barash was a partner in the Los Angeles office of Seyfarth, Shaw, Fairweather & Geraldson, a national law firm, where he was a member of the firm's Business Law and Real Estate Group. Mr. Schemel has been the Managing Member of Vista Marin, LLC, the owner and manager of an office building in Redwood City, California since 1998, the Managing Member of David Schemel Development and Investments, LLC, an owner of apartment buildings in San Francisco and on the San Francisco Peninsula since 1988, and a Managing Member of Oxford Associates, LLC, a residential home developer, since 1996. From 1988 to 1994, Mr. Schemel was also a Vice President of TRI Commercial Real Estate, for which he managed various workout transactions. SALE OF FNMA SERIES 92-123 S. On March 4, 1999, the Company sold its interest in its IO Bond, FNMA Series 1992-123 S for $782,879. In conjunction with this sale, the Company retired short term debt of approximately $616,000. LIQUIDITY AND CAPITAL RESOURCES The Company's financial statements have been presented on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. In April 1999, the Company obtained a $1,000,000 revolving line of credit from the Former Manager of the Company for working capital purposes. In addition to the TIS Line, management is currently evaluating the Company's alternatives to fund its fiscal 1999 cash requirements. Such alternatives include, among other things, consideration of (i) the sale of real property, (ii) the sale of Structured Securities, (iii) reducing general and administrative expenses, (iv) refinancing existing debt, and (v) entering into joint venture arrangements with third parties. Management can provide no assurances as to the timing or ultimate closure of any of these alternatives. These strategies are dependant on the economic operating environment including volatility of interest rates and the ability for the California Central Valley apartment rental market to absorb rental increases. The Company believes that the proceeds from the TIS Line, together with its on-going real estate operations and mortgage related investment portfolio will provide sufficient liquidity for it to continue as a going concern throughout 1999, however, management can provide no assurance with regard thereto. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities or any other adjustments that might result from these uncertainties. At December 31, 1998, the Company had cash and cash equivalents of $2,767,000 and current liabilities excluding debt principal maturities of approximately $2,474,000. In addition the Company incurred a net loss during 1998 of $4,136,000. Included in the Company's unrestricted cash and cash equivalents at December 31, 1998, is $1.2 million relating to a deposit inadvertently made by the trustee of one of the Company's Structured Securities. In March 1999, the Company repaid $600,000 of such amount to the Trustee. On March 11, 1999, the Trustee filed an action against the Company for alledged breach of contract, common count and conversion. The Company has opposed the action and the parties have engaged informal settlement discussions. See Item 3 Legal Proceedings. Subsequent to year end, the Company sold one of its Structured Securities for a sales price of $782,879 and a gain of approximately $8,000. After related debt repayments, the Company realized net cash proceeds of approximately $167,000 from this sale. Additionally, as discussed in Note 20 to the Company's financial statements, in February 1999, the Company repurchased 825,700 shares of common stock for approximately $2 million in cash and entered into an exchange transaction resulting in the issuance of common stock for Novato Markets. On an unaudited pro forma basis, after these transactions, the Company has cash and cash equivalents of approximately $392,000 and current liabilities of $1,398,000. In April of 1999, the Company entered into a financing agreement with the Former Manager whereby The Former Manager extended a revolving line of 32 credit of $1,000,000 to the Company. The Former Manager and the Company have common ownership and executive officers and as such are related parties. Credit support to the Former Manager includes guaranteed loans by a bank and a board member of the Company in support of the TIS Line to the Company. Additionally, certain of the Company's mortgage assets are pledged as collateral for the TIS Line. This line is to provide working capital to the Company. This revolving line of credit is for a term of one year, is at the rate of prime plus one and one half percent and is secured by the Company's ownership in Bankers Trust series 1988-1 Residual Interest Certificate The Company uses its cash flow to provide working capital to pay its expenses and debt service, acquire other assets and, at the discretion of the Board of Directors, to pay distributions to its shareholders. In 1998 the Company's cash flows (in thousands) were used as follows: Used in by operating activities ($ 1,037) Provided by investing activities 13,635 Used in financing activities (10,016) --------- Net increase in cash and cash equivalents $ 2,582 =========
At December 31, 1998, the Company had outstanding short-term borrowings totaling $667,000 which consisted of a repurchase agreement with an investment banking firm. The repurchase agreement borrowings had a weighted average interest rate of 7.2189%. The repurchase agreement had an initial term of one month, is renewed on a month-to-month basis, is collateralized by one of the Company's Residual Interests and one of the Company's IO Bonds whose fair values approximate $840,000 and have a floating rate of interest which is tied to the one-month LIBOR rate. In February 1999, the Company sold its investment in FNMA Series 1992-123, Series S. Proceeds from the sale were used to repay the short- term borrowings in full. After giving effect to the repayment of the debt, the sale resulted in net cash proceeds to the Company of $167,000 and a realized gain of approximately $36,000. At December 31, 1998, the Company had outstanding borrowings secured by multifamily real estate totaling $13,793,655. Approximately 91% of this debt had a fixed rate of interest and 9% of the debt bears a variable rate of interest. The weighted average interest rate at December 31, 1998 was 8.3%. Over the twelve months ending December 31, 1999, scheduled principal maturities on the notes payable on real estate amount to $175,684, excluding the Shady Lane variable note, on which $145,186 is due in principal and interest in 1999. The notes are expected to be funded by cash flows from the Company's multifamily residential properties. In conjunction with the acquisition of all of the shares of Novato Markets, Inc. in February 1999, the Company acquired two family shopping centers in Rohnert Park, California and Petaluma, California. The properties are currently subject to temporary financing as a result of the previous owner acquisition and serve collateral for such financing. The notes currently bear interest at 15% of which 10% is paid currently and 5% is added to the principal of the note. The notes do not have scheduled principal payments. Note payments are expected to be funded by cash flows from the underlying properties. The Company intends to continue operating the shopping centers and is in the process of obtaining permanent financing. The Company has no significant commitments for capital expenditures relating to the real estate operations over the twelve months ended December 31, 1999 and anticipates that any capital expenditures or repair and maintenance activities would be funded from cash generated from real estate activities. The Company expects to commence construction on 126 units of apartments to be built on the ten acres of land adjacent to the Villa San Marcos Apartments in Fresno, California. This construction is expected to be funded by a construction loan. YEAR 2000 COMPLIANCE 33 STATE OF READINESS. The Company utilizes a number of computer software programs and operating systems across its entire organization, including applications used in financial business systems and various administrative functions. To the extent that the Company's software applications contain source code that is unable to appropriately interpret the upcoming calendar year "2000" and beyond, some level of modification, or replacement of such application will be necessary. The Company is in the process of identifying applications that are not yet "Year 2000" compliant. COSTS OF ADDRESSING THE COMPANY'S YEAR 2000 ISSUES. Given information known at this time about the Company's systems that are non-compliant, coupled with the Company's ongoing, normal course-of-business efforts to upgrade or replace critical systems as necessary, management does not expect Year 2000 compliance costs to have any material adverse impact on the Company's liquidity or ongoing results of operations. RISKS OF THE COMPANY'S YEAR 2000 ISSUES. No assurance can be given, however, that all the Company's systems will be Year 2000 compliant or that compliance costs or the impact of the Company's failure to achieve substantial Year 2000 compliance will not have a material adverse impact on the Company's future liquidity or results of operations. THE COMPANY'S CONTINGENCY PLAN. Management has identified manual operating procedures for critical operations to address the most reasonably likely worst case scenarios regarding Year 2000 compliance. FACTORS THAT MAY AFFECT FUTURE RESULTS Ownership of shares of the Company's Common Stock is subject to certain risks. The Company's earnings from its multifamily residential properties and shopping centers will depend upon maintaining rental income that exceeds the Company's interest and other costs. Rental income, in turn, will depend upon the rental market and rates of occupancy. Long-term profits will depend upon an appreciation in the value of the residential properties. The ability of the Company to generate income from the cash flows relating to Structured Securities, or to minimize losses, depends, in large part, upon whether the Company is able to respond to fluctuations in market interest rates and utilize appropriate strategies. The amount of income that may be generated from Structured Securities is dependent upon the rate of principal prepayments on the underlying mortgages. Lower rates of prepayments means a longer life for Residual Interests and IO Bonds and thus higher income. Similarly, faster rates of prepayments mean a shorter life and lower income. The rate of prepayments on mortgages is influenced by a variety of economic, geographic, social and other factors, but probably the most important factor is the level of prevailing mortgage rates. In general, prepayments of Mortgage Loans are faster during periods of substantially declining interest rates and slower during periods of substantially increasing interest rates. During 1998, the rate of prepayments was generally increased thereby decreasing the estimated fair value of the Company's investment in IO Bonds and increasing the fair value of residual interests. 34 The income from Residual Interests in CMOs which include one or more bond classes which bear interest based on specified margins in relation to either the London Interbank Offered Rate for Eurodollars on U.S. dollar deposits ("LIBOR") and income on Inverse IO Bonds which bear an interest rate which is inversely related to LIBOR, may fluctuate widely depending upon changes in LIBOR which affect the amount of interest payable on such LIBOR bonds and on Inverse IO Bonds. In general, income on these Residual Interests and Inverse IO Bonds will decrease when LIBOR increases, and will increase when LIBOR rates decrease. Income on these Residual Interests and Inverse IO Bonds will also be affected by the relationship between changes in these rates and prepayments on mortgages. Under certain extended high interest rate periods or in the event of extremely high prepayment rates on mortgages, the return on a Residual Interest on an IO Bond or on an Inverse IO Bond could be zero or negative and may require the Company to effect significant reductions in the carrying value of these assets. Such reductions are recorded as operating losses in the year in which the reduction is taken. The Company has purchased Residual Interests, IO Bonds and PO Bonds of CMOs only if the Structured Securities relating to such CMOs were rated in one of the two highest categories by a nationally recognized rating agency. Certain Residual Interests, IO and PO Bonds themselves are rated. The risks of ownership of such assets, however, are substantially the same as those associated with ownership of unrated Residual Interests and IO and PO Bonds because the rating would not address the possibility that the Company might have a lower than anticipated yield or, in the case of Residual Interests and IO Bonds, fail to recover its initial investment. There are varying degrees of risk incident to the ownership of real estate. There are many factors which can impact the performance of real estate including economic and demographic trends or governmental regulations which are out of the control of the Company. In order to maintain its status as a REIT, the Company is required to comply with certain restrictions imposed by the Code with respect to the nature of its assets and income, which could prevent it from making investments or from making dispositions of investments otherwise considered desirable. The REIT provisions of the Code require the Company to distribute substantially all of its net taxable income on an annual basis. If the Company should not qualify as a REIT in any tax year, it would be taxed as a regular domestic corporation, and distributions to the Company's shareholders would not be deductible by the Company in computing its taxable income. Any resulting tax liability could be substantial and would reduce the amount of cash available for distributions to shareholders. Further, the failure of the Company to be treated as a REIT for any one year would disqualify the Company from being treated as a REIT for four subsequent years. The Company's ability to use its net operating tax loss carryforwards could be substantially reduced if the Company were to undergo an "ownership change" within the meaning of Section 382(g)(1) of the Internal Revenue Code. Because of these and other factors, future distributions to shareholders cannot be predicted. The Company has the right, but not the obligation, to refrain from making distributions to shareholders until the tax loss carryforward is fully used. It is likely that the market price of the shares of the Company's Common Stock would be affected by any decline in the spread between the Company's net yield on its assets and prevailing interest rates. 35 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary market risk exposure is to changes in interest rates obtainable on its secured and unsecured mortgage borrowings and to changes in market which impact the fair value of its Structured Securities as discussed in Note 6 to the consolidated financial statements. The Company manages its exposure to fluctuations in market interest rates for its borrowings by obtaining fixed rate debt to the extent that rates available on such arrangements are favorable to the Company. At December 31, 1998 and 1997, 9% and 7% of the Company's outstanding debt was subject to variable rates respectively. For information about the Company's debt instruments that are sensitive to changes in interest rates, see Note 10 to the consolidated financial statements for detail of the fair value at December 31, 1998, related maturity dates and interest rates. The rates disclosed in Note 10 to the consolidated financial statements are based on rates in effect as of December 31, 1998. The Company does not undertake any specific actions to cover its exposure to interest rate risk and the Company is not party to any interest rate risk management transactions. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The response to this item is submitted as a separate section of this Form 10-K. See Item 14. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 36 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this Item is incorporated by reference to the Company's definitive Proxy Statement for its Annual Meeting of Stockholders to be held in 1999, to be filed with the Commission within 120 days after the end of the Company's fiscal year pursuant to General Instruction G(3) to Form 10-K. ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference to the Company's definitive Proxy Statement for its Annual Meeting of Stockholders to be held in 1999, to be filed with the Commission within 120 days after the end of the Company's fiscal year pursuant to General Instruction G(3) to Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this Item is incorporated by reference to the Company's definitive Proxy Statement for its Annual Meeting of Stockholders to be held in 1999, to be filed with the Commission within 120 days after the end of the Company's fiscal year pursuant to General Instruction G(3) to Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference to the Company's definitive Proxy Statement for its Annual Meeting of Stockholders to be held in 1999, to be filed with the Commission within 120 days after the end of the Company's fiscal year pursuant to General Instruction G(3) to Form 10-K. 37 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K. (A) 1. FINANCIAL STATEMENTS AND REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS Report of Independent Public Accountants................... 41 Consolidated Balance Sheets - December 31, 1998 and 1997... 42 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996.................. 43 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996...... 44 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996.................. 45 Notes to the Consolidated Financial Statements............. 46 2. FINANCIAL STATEMENT SCHEDULES Schedule III - Real Estate and Accumulated Depreciation as of December 31, 1998....................................... 66 All other schedules are omitted because they are not required or the required information is shown in the financial statements or notes thereto. 38 3. EXHIBITS The following exhibits in the accompanying index to exhibits are filed herewith or are incorporated by reference to exhibits previously filed. NUMBER EXHIBIT - - ------ ------- 3(a) Amended Articles of Incorporation of the Registrant (1) 3(b) Amended and Restated Bylaws of the Registrant (7) 4(a) Specimen Certificate representing $.001 par value Common Stock (1) 4(b) Dividend Reinvestment and Share Purchase Plan (2) 10(c) Custody Agreement between Registrant and Mellon Bank N.A. (3) 10(d) Transfer Agency Agreement between Registrant and Mellon Securities Trust Company (3) 10(e) Reverse Repurchase Agreement between Registrant and Bear, Stearns Securities Corp.(4) 10(f) Loan and Security Agreement dated July 19, 1995 between TIS Mortgage Investment Company and Paine Webber Real Estate Securities, Inc. (5) 10(g) Nonqualified Stock Option Agreement with John D. Boyce and Schedule of Omitted Contracts (5) 10(h) Nonqualified Stock Option Agreement with John E. Castello and Schedule Omitted Contracts (5) 10(i) Employment Agreement between TIS and Lorraine O. Legg. (6) 10(j) Employment Agreement between TIS and John E. Castello. (6) 10(k) Facilities and Expense Sharing Agreement (6) 10(l) Agreement and Plan of Reorganization dated as of February 1, 1999, between TIS Mortgage Investment Company and Pacific Securitization, Inc. (8) 10(m) Agreement dated February 1, 1999, among TIS Mortgage Investment Company, Novato Markets, Inc., P-SUB I, Inc. and Pacific Securitization, Inc. (8) 10(n) Agreement dated as of February 1, 1999, among TIS Mortgage Investment Company, Turkey Vulture Fund XIII, Ltd., Richard M. Osborne, Third Capital, LLC, Christopher L. Jarratt and James G. Lewis. (8) 21 Subsidiaries of the Registrant 24 Consent of Arthur Andersen LLP ___________________________________ (1) Incorporated herein by reference to Registrant's Registration Statement on Form S-11 (No. 33-22182) declared effective August 19, 1988. (2) Incorporated herein by reference to Pre-Effective Amendment No. 1 to Registrant's Registration Statement on Form S-3 (No. 33-44526) filed with the Securities and Exchange Commission on December 30, 1991. (3) Incorporated herein by reference to Registrant's Annual Report on Form 10-K (File No. 1-10004) filed with the Securities and Exchange Commission on March 30, 1992. 39 (4) Incorporated herein by reference to Registrant's Annual Report on Form 10-K (File No. 1-10004) filed with the Securities and Exchange Commission on March 30, 1993. (5) Incorporated herein by reference to Registrant's Annual Report on Form 10-K (File No. 1-10004) filed with the Securities and Exchange Commission on April 1, 1996. (6) Incorporated herein by reference to Registrant's Current Report on Form 8-K (File No. 1-10004) filed with the Securities and Exchange Commission on July 9, 1996. (7) Incorporated herein by reference to Registrant's Current Report on Form 8-K (File No. 1-10004) filed with the Securities and Exchange Commission on May 29, 1997. (8) Incorporated herein by reference to Registrant's Current Report on Form 8-K (File No. 1-10004) filed with the Securities and Exchange Commission on February 17, 1999. (B) REPORTS ON FORM 8-K: During the first quarter of 1999, the Company filed a Current Report on Form 8-K, on February 17, 1999, covering the Company's issuance of shares of common stock to Pacific Securitization, Inc., under Item 2 of Form 8-K, and the Company's repurchase of shares of common stock from Turkey Vulture Fund XIII, Ltd. and its affiliates, and the appointment of new directors, under Item 5 of Form 8-K. The Company filed an amendment to this Report, on April 5, 1999, stating that it had determined that financial statements and pro forma financial information on the Pacific Securitization transaction did not need to be filed under Item 7 of Form 8-K. 40 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of TIS Mortgage Investment Company: We have audited the accompanying consolidated balance sheets of TIS Mortgage Investment Company (a Maryland corporation) and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of TIS Mortgage Investment Company and Subsidiaries as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Our audit was made for purposes of forming an opinion on the basic consolidated financial statements taken as a whole. The accompanying Schedule III - Real Estate and Accumulated Depreciation as of December 31, 1998 - is presented for the purpose of complying with the Securities and Exchange Commission rules and is not part of the basic consolidated financial statements. This information has been subjected to the audit procedures applied in our audit of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole. /s/ARTHUR ANDERSEN LLP San Francisco, California, April 15, 1999 41 TIS Mortgage Investment Company and Subsidiaries CONSOLIDATED BALANCE SHEETS
- - -------------------------------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT SHARE DATA) DECEMBER 31, 1998 DECEMBER 31, 1997 - - -------------------------------------------------------------------------------------------------------- ASSETS Mortgage Related Assets Mortgage Certificates, net $ -- $ 60,433 Residual Interests 284 384 Interest Only (IO) Bonds 840 1,875 Commercial Securitizations 184 184 Reserve for Loss on Investments -- (1,523) ----------- ----------- Total Mortgage Related Assets 1,308 61,353 ----------- ----------- Operating Real Estate Assets, net 20,172 28,697 ----------- ----------- Other Assets Cash and Cash Equivalents (Note 9) 2,767 185 Restricted Cash 140 1,800 Accrued Interest and Accounts Receivable, Net 33 484 Deferred Bond Issuance Costs, Net -- 497 Amortizable Costs, Net 351 594 Prepaid Expenses 285 144 ----------- ----------- Total Other Assets 3,576 3,704 ----------- ----------- Total Assets $ 25,056 $ 93,754 =========== =========== - - -------------------------------------------------------------------------------------------------------- LIABILITIES Collateralized Mortgage Obligations, net $ -- $ 59,008 Accounts Payable and Accrued Liabilities 473 870 Due to Trustee 1,218 -- Accrued Interest Payable 116 887 Notes Payable on Real Estate 13,794 20,350 Short-term Debt 667 2,010 ----------- ----------- Total Liabilities 16,268 83,125 ----------- ----------- SHAREHOLDERS' EQUITY Common Stock, par value $.001 per share; 100,000,000 shares authorized; 8,105,880 shares issued and outstanding 8 8 Additional Paid-in Capital 74,696 74,696 Accumulated Other Comprehensive Loss (11) (2,322) Retained Deficit (65,905) (61,753) ----------- ----------- Total Shareholders' Equity 8,788 10,629 ----------- ----------- Total Liabilities and Shareholders' Equity $ 25,056 $ 93,754 =========== =========== - - --------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 42 TIS Mortgage Investment Company and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, -------------------------------------------------------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) 1998 1997 1996 - - --------------------------------------------------------------------------------------------------------------------- MORTGAGE RELATED ASSETS Interest $ 2,803 $ 6,460 $ 8,271 Valuation Reserve Reduction 210 1,474 651 Loss on Redemption of Investment (198) -- -- Loss due to other than temporary impairment of assets (2,073) -- -- Gain (Loss) on Sales of Mortgage Related Assets (216) 442 450 Other 4 11 21 --------- ------- ------- Income from Mortgage Related Assets 530 8,387 9,393 --------- ------- ------- INTEREST AND CMO RELATED EXPENSES Collateralized Mortgage Obligations Interest 3,010 6,549 8,317 Administration Fees 34 68 70 Amortization of Deferred Bond Issuance Costs 80 101 146 Interest on Short-term Debt 125 174 159 --------- ------- ------- Total Interest and CMO Related Expenses 3,249 6,892 8,692 --------- ------- ------- REAL ESTATE OPERATIONS Rental and Other Income 4,051 3,987 3,990 Operating and Maintenance Expenses (1,451) (1,342) (1,388) Interest on Real Estate Notes Payable (1,750) (1,820) (1,718) Property Taxes (333) (346) (350) Depreciation and Amortization (786) (740) (705) Loss on Sale of Property (157) -- -- --------- ------- ------- Loss from Real Estate Operations (426) (261) (171) --------- ------- ------- OTHER EXPENSES Management Fee to a related party -- -- 77 General and Administrative, including amounts paid to a related party of $28,980, $37,806 and $391,198, respectively 1,289 1,443 1,356 --------- ------- ------- Loss Before Minority Interest (4,434) (209) (903) Minority Interest Share of Loss (298) -- -- --------- ------- ------- Net Loss ($ 4,136) ($ 209) ($ 903) ========= ======= ======= - - --------------------------------------------------------------------------------------------------------------------- Net Loss per Share ($ 0.51) ($ 0.03) ($ 0.11) Distributions Declared per Share $ 0.002 $ 0.000 $ 0.020 Weighted Average Number of Shares Outstanding 8,106 8,106 8,106 - - ---------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 43
TIS Mortgage Investment Company and Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - - -------------------------------------------------------------------------------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 - - -------------------------------------------------------------------------------------------------------- (IN THOUSANDS) ACCUMU- LATED COMPRE- COMPRE- COMMON STOCK PAID-IN RETAINED HENSIVE HENSIVE SHARES AMOUNT CAPITAL DEFICIT INCOME TOTAL INCOME - - ------------------------------------------------------------------------------------------- ----------- Balance - December 31, 1995 8,106 8 74,696 (60,479) (2,244) (11,981) Net Loss -- -- -- (903) -- (903) ($903) Other Comprehensive Income: Net unrealized gain on available for sale securities, net of reclassification adjustment -- -- -- -- 102 102 102 ----------- Comprehensive Income ($ 801) =========== Distributions Declared - -- -- (162) -- (162) - - ------------------------------------------------------------------------------------------- Balance - December 31, 1996 8,106 8 74,696 (61,544) (2142) 11,018 Net Loss -- -- -- (209) -- (209) $ (209) Other Comprehensive Income: Net unrealized gain on available for sale securities, net of reclassification adjustment -- -- -- -- (180) (180) (180) ----------- Comprehensive Income ($389) - - ------------------------------------------------------------------------------------------- =========== Balance - December 31, 1997 8,106 8 74,696 (61,753) (2,322) 10,629 Net Loss -- -- -- (4,136) -- (4,136) ($4,136) Other Comprehensive Income: Net unrealized gain on available for sale securities, net of reclassification adjustment -- -- -- -- 2,311 2,311 2,311 ----------- Comprehensive Income ($ 1,825) =========== Distributions Declared -- -- -- (16) -- (16) - - ------------------------------------------------------------------------------------------- Balance - December 31, 1998 8,106 8 74,696 (65,905) (11) 8,788 ===========================================================================================
The accompanying notes are an integral part of these consolidated financial statements. 44 TIS Mortgage Investment Company and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
- - ----------------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, -------------------------------------------------------- (IN THOUSANDS) 1998 1997 1996 - - ----------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net Loss ($ 4,136) ($ 209) ($ 903) Adjustments to Reconcile Net Loss to Net Cash Provided by Operating Activities: Depreciation and Amortization 1,503 1,476 1,488 (Gain) Loss on Sales of Mortgage Related Assets 216 (442) (450) Loss on Redemption 198 -- -- Loss due to Other than Temporary Impairment 2,073 -- -- Loss on Sales of Real Estate 157 -- -- Minority interest share in net loss (298) -- -- Valuation Reserve Reduction (1,523) (1,474) (651) Decrease (Increase) in Accrued Interest Receivable -- 88 (207) Decrease (Increase) in Accounts Receivable 85 96 (49) Decrease (Increase) in Prepaid Expenses (141) 19 47 Decrease (Increase) in Other Assets -- 115 (732) Increase (Decrease) in Accounts Payable And Accrued Liabilities 950 421 (128) Decrease in Accrued Interest Payable (121) (169) (303) --------- -------- -------- Net Cash Provided by (Used in) Operating Activities (1,037) (79) (1,888) --------- -------- -------- - - ----------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Net Decrease (Increase) in Restricted Cash (154) (528) 899 Acquisition of Real Estate Assets -- -- -- Additions to Real Estate Assets (426) (483) (258) Proceeds from Sale of Real Estate Assets 1,584 -- -- Principal Reduction in Mortgage Certificates 9,888 12,485 17,452 Proceeds from Sales of Mortgage Related Assets 1,888 442 450 Principal Reduction in Residual Interests 90 41 59 Principal (Increase) Reduction in Commercial Securities -- (1) 8 Principal Reduction in IO Bonds 765 652 788 --------- -------- -------- Net Cash Provided by Investing Activities 13,635 12,608 19,398 --------- -------- -------- - - ----------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Deposit from Trustee 1,218 -- -- Increase (Decrease) in Short-term Debt (1,343) (408) 300 Principal Payments on CMOs (9,619) (11,995) (17,775) Proceeds from Notes Payable on Real Estate -- 17,400 170 Principal Payments on Notes Payable on Real Estate (256) (17,423) (159) Cash Distributions Paid on Common Stock (16) -- (162) --------- -------- -------- Net Cash Used in Financing Activities (10,016) (12,426) (17,626) --------- -------- -------- - - ----------------------------------------------------------------------------------------------------------------- Net Change in Cash and Cash Equivalents 2,582 103 (116) Cash and Cash Equivalents at Beginning of Year 185 82 198 --------- -------- -------- Cash and Cash Equivalents at End of Year $ 2,767 $ 185 $ 82 ========= ======== ======== - - ----------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW Cash Paid for CMO Interest Expense $ 3,893 $ 6,718 $ 7,638 Cash Paid for Other Interest Expense $ 1,763 $ 1,889 $ 1,886 - - -----------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 45 TIS MORTGAGE INVESTMENT COMPANY AND SUBSIDIARY NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 AND 1997 1. THE COMPANY TIS Mortgage Investment Company (the "Company") was incorporated on May 11, 1988. The Company operates as a real estate investment trust (REIT) and has, in years prior to 1995, primarily invested in structured securities (mortgage related assets) including residual interests, principal only bonds (PO Bonds), interest only bonds (IO Bonds) and collateralized mortgage obligations (CMOs). Beginning in 1994, the Company changed its investment focus from investments in structured securities to multifamily real estate located in California's Central Valley. Accordingly, subsequent to 1994, the Company has sold the majority of its investments in structured securities and acquired a portfolio of four income-producing residential real estate properties (as of December 31, 1998, three such properties remain). The Company expects that the majority of its ongoing assets and operating results will be related to investments in real estate and development related activities. At December 31, 1998, the Company had cash and cash equivalents of $2,767,000 and current liabilities excluding debt principal maturities of approximately $2,474,000. In addition the Company incurred a net loss during 1998 of approximately $4,136,000. As discussed in Note 9, included in the Company's unrestricted cash and cash equivalents at December 31, 1998, is $1.2 million relating to a deposit inadvertently made by the trustee of one of the Company's Structured Securities. In March 1999, the Company repaid $600,000 of such amount to the Trustee. On March 11, 1999, the Trustee filed an action against the Company for alleged breach of contract, common count and conversion. The Company has opposed the action and the parties have engaged in informal settlement discussions. (See Note 9.) Subsequent to year end, the Company sold one of its Structured Securities for a sales price of $782,879 and a gain of approximately $8,000. After related debt repayments, the Company realized net cash proceeds of approximately $167,000 from these sales. Additionally, as discussed in Note 20, in February 1999, the Company repurchased 825,700 shares of common stock for approximately $2 million in cash and entered into an exchange transaction resulting in the issuance of common stock for Novato Markets. On an unaudited pro forma basis, after these transactions, the Company has cash and cash equivalents of approximately $392,000 and current liabilities of $1,398,000. Additionally, subsequent to year-end, the Company has obtained a $1,000,000 revolving line of credit from the former manager (the "Former Manager") for working capital purposes (the "TIS Line"). The Former Manager and the Company have common ownership and executive officers and as such are related parties. Credit support to the Former Manager includes guaranteed loans by a bank and a board member of the Company in support of the TIS Line to the Company. Additionally, certain of the Company's mortgage assets are pledged as collateral for the TIS Line. (See Note 20.) The Company's financial statements have been presented on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. In addition to the TIS Line, Management is currently evaluating the Company's alternatives to fund its fiscal 1999 cash requirements. Such alternatives include, among other things, consideration of (i) the sale of real property, (ii) the sale of Structured Securities, (iii) reducing general and administrative expenses, (iv) refinancing existing debt, and (v) entering into joint venture arrangements with third parties. Management can provide no assurances as to the timing or ultimate closure of any of these alternatives. These strategies are dependent on the economic operating environment including the volatility of interest rates and the ability for the California Central Valley apartment rental market to absorb rental increases. The Company believes that the proceeds from the TIS Line, together with its on-going real estate operations and mortgage related investment portfolio will provide sufficient liquidity for it to continue as a going concern throughout 1999, however, management can provide no assurance with regard thereto. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities or any other adjustments that might result from these uncertainties. 46 OVERALL METHODS OF ACCOUNTING - Emerging Issues Task Force Issue 89-4, subsequently modified by issue 93-18, specifies the method of accounting for Residual Interests in collateralized mortgage obligations ("CMOs"). Issue 89-4, among other things, required Residual Interests to be classified either as "equity" (and be accounted for under the Equity Method) or as "nonequity" (and be accounted for under a level yield method referred to as the Prospective Method). The methods described in Issue 89-4 are essentially the same as those used by the Company. The Company has classified all of its investments in mortgage related assets as available-for-sale investments, carried at fair value in the financial statements. Unrealized holding gains and losses, excluding unrealized losses considered to be other than temporary, for available-for-sale investments are excluded from earnings and reported as a net amount in shareholders' equity until realized. All of the Company's investments in mortgage related assets are subject to write down whenever the yield on the projected cash flows is less than a risk free rate. If the yield on the projected cash flows is less than a risk free rate, the decline in value is considered to be "other than temporary" and the investment is written down to its fair value as the new cost basis. The amount of the write down is included in the Company's current earnings (i.e. accounted for as a realized loss). For purposes of evaluating impairment the Company considers its investment in each of its equity residuals to be a net cash flow investment (net of CMO bond interest payments and related CMO bond administrative expenses). The Company measures other than temporary impairment by comparing the yield on the projected net cash flows from the equity residual, (i.e. Mortgage Certificates net of discounts and CMO bond liabilities) to a risk free rate. If the yield on the projected cash flows from the equity residual is less than a risk free rate, the Company records a reserve to reduce the carrying value to fair value. The fair value is calculated using the forecasted net cash flows discounted at a risk adjusted rate. The risk adjusted rate is determined by the Company using established market transactions for securities having similar characteristics and backed by collateral of similar rate and term. For investments in mortgage assets which do not meet the definition of other than temporary impairment, the Company has recorded cumulative net unrealized losses of $11,559 and 2,322,000 as of December 31, 1998 and 1997, respectively, directly to equity. FAIR VALUE OF FINANCIAL INSTRUMENTS - Based on the borrowing rates currently available to the Company, the carrying amount of its debt approximates fair value. The carrying amount of cash and cash equivalents approximates fair value. PRINCIPLES OF CONSOLIDATION - The Company's consolidated financial statements present the results of operations of the Company, its wholly-owned subsidiary, TIS Property Acquisition Company ("TISPAC"), a Maryland corporation, incorporated on September 8, 1995 for the purpose of owning and financing real property, and the accounts underlying the Company's interest in real estate partnerships for the years ended December 31, 1995 and thereafter. In March 1997, as part of the refinancing of two of the Company's multifamily residential properties and a portion of the Four Creeks property, title to those properties was vested in TISPAC. Simultaneously, in March 1997, TISPAC entered into notes secured by mortgages on those properties. TISPAC is a Qualified REIT Subsidiary. 47 In 1996, the Company sold its economic interest in TMAC CMO Trust 1986-1 through the sale of the residual interest certificate and optional redemption rights in the underlying trust. As a result, the accounts of TMAC CMO Trust 1986-1 are not included in the consolidated balance sheets at December 31, 1996 and 1997 and the results of operations of the trust are included in the 1996 consolidated statement of operations only through the date of sale. In 1998, the Company sold its economic interest in CMOT-28 through the sale of the residual interest certificate and optional redemption rights in the underlying trust. As a result, the accounts of CMOT-28 are not included in the consolidated balance sheets at December 31, 1998 and the results of operations of the trust are included in the 1998 consolidated statement of operations only through the date of sale. MORTGAGE CERTIFICATES AND CMOS - Mortgage certificates and CMO bonds of consolidated Owner Trusts are carried at their outstanding principal balance plus or minus any premium or discount, respectively. AMORTIZATION OF PREMIUMS AND DISCOUNTS - Premiums and discounts related to mortgage certificates and CMOs are amortized to income using the interest method over the stated maturity of the mortgage certificates or CMOs. Residual Interests held in bond form and Corporate Real Estate Mortgage Investment Conduit ("REMIC") Residual Interests, regardless of percentage ownership, are Nonequity Residual Interests and, along with IO Bonds, are accounted for under the Prospective Method. Under this method, assets are carried at book value and income is amortized over their estimated lives based on a method which provides a constant yield. At the end of each quarter, the yield over the remaining life of the asset is recalculated based on expected future cash flows using current interest rates and mortgage prepayment speeds. This new yield is then used to calculate the subsequent quarter's financial statement income. CAPITALIZED LOAN FEES - Capitalized loan fees are amortized as interest expense over the term of the related debt. OPERATING REAL ESTATE ASSETS - The Company values operating real estate assets at cost unless circumstances indicate that cost cannot be recovered, in which case carrying value is reduced to estimated fair value. In management's opinion, as of December 31, 1998, the carrying value of real estate assets did not exceed their estimated fair value. Operating real estate assets are depreciated using the straight-line method over the estimated useful lives of the real estate assets. The Company uses a 40 year estimated life for buildings and improvements and either a 5 or 12 year life for personal property depending on the nature of the asset. Significant expenditures that improve or extend the useful life of the asset are capitalized and depreciated over their estimated useful lives. All leases of real estate assets are classified as operating leases. Rental income is recognized when contractually due based on the terms of signed lease agreements which range in duration from month-to-month to one year. 48 RESTRICTED CASH - Restricted cash as of December 31, 1998 and 1997 includes cash balances totaling $0 and $1,608,558, respectively, of CMOs in which the Company holds a Residual Interest and whose assets and liabilities are consolidated with those of the Company. This cash is not available to the Company or its creditors. Additionally, restricted cash as of December 31, 1998 and 1997 includes $140,000 and $191,538 respectively, in property tax and insurance impound accounts required under the terms of certain notes payable on real estate. INCOME TAXES - The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended. As a REIT, the Company must distribute at least 95% of its taxable income to its shareholders. No provision has been made for income taxes in the accompanying consolidated financial statements as the Company is not subject to Federal income taxes. The loss reported in the accompanying consolidated financial statements may be greater or less than the taxable loss because some income and expense items are reported in different periods for income tax purposes. Over the life of a Residual Interest or IO Bond, total taxable income will equal total financial statement income. However, the timing of income recognition may differ between the two from year to year. BASIC NET LOSS PER SHARE - Basic net loss per share is based upon the weighted average number of shares of Common Stock outstanding for 1998, 1997, and 1996, 8,105,880 shares each year, respectively. The potential common shares related to the 1995 Stock Option Plan (see Note 15) are antidilutive in 1998, 1997 and 1996, and therefore are not included in the weighted average number of shares outstanding. The number of antidilutive potential common share amounts in 1998, 1997 and 1996 were 342,000, 347,000 and 342,000 respectively. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 128 - Earnings Per Share, effective January 1, 1977. The adoption of SFAS No. 128 resulted in no change to the Company's historical manner of calculating earnings per share. STATEMENT OF CASH FLOWS - For purposes of the statement of cash flows, the Company considers only highly liquid instruments with original maturities of three months or less to be cash equivalents. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Examples of such estimates include prepayment speeds on principal payments of Mortgage Loans and interest rates. Actual results could differ from those estimates. Refer to Note 6 regarding assumptions related to the determination of fair value of certain Structured Securities. NEW ACCOUNTING PRONOUNCEMENT - Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" is expected to be adopted by the Company effective January 1, 2000. This statement establishes standards for accounting for derivative instruments and requires that an entity recognize derivatives as assets or liabilities in the statement of financial position and measure those assets and liabilities at fair value. Management has not fully assessed the impact of adoption of the statement but does not anticipate it will have a significant impact on the presentation of the Company's statements of financial position. 49 The Company paid distributions of $0.002 per share and $0.02 per share in the years ended December 31, 1998 and 1996, respectively. There were no distributions paid by the Company in 1997. Of the 1998 distribution, 40.28% was taxable and considered "excess inclusion" income. Of the 1996 distribution, 47.19% was taxable and was also considered "excess inclusion" income Excess inclusion income is attributable to Residual Interests for which an election has been made to be treated as a REMIC for Federal income tax purposes. The portion of the Company's distributions determined to be excess inclusion income is taxable to certain otherwise tax-exempt shareholders as unrelated business income. Except for certain entities such as savings and loan associations, the portion of the distribution considered excess inclusion income may not be offset by any deductions or losses, including net operating losses. 4. RESIDUAL INTERESTS General - Each CMO in which the Company has purchased a Residual Interest was rated at the time of its issuance "AAA" by Standard & Poor's Corporation or "Aaa" by Moody's Investors Service, Inc. Each such CMO was comprised of one or more classes of bonds (each, a "Bond Class") and was issued pursuant to an Indenture between the CMO issuer and a specified trustee. Each CMO was structured so that the principal and interest payments received from the collateral pledged to secure such CMO, together with reinvestment income thereon, would be sufficient, irrespective of the rate of prepayments on the collateral, to make timely payments of interest on each Bond Class, to begin the payment of principal on each Bond Class not later than its "first mandatory principal date" and to retire each Bond Class not later than its "stated maturity." Residual Interests are classified as either equity or nonequity. Presented in the following table is a schedule of the Nonequity Residual Interests and the Prospective Method yield at December 31, 1998. NONEQUITY RESIDUAL INTERESTS - - ---------------------------- (DOLLARS IN THOUSANDS)
Book Value Prospective Residual Purchase December 31, Method -------------------------------------- Series Price 1998 1997 Yield - - --------------------------------------------------------------------------------------------------------------- Nonequity Residual Interests - - ----------------------------------- BT 88-1 $1,537 $ 176 $ 179 14.0% LFR-9 2,589 89 94 14.0% CMSC I 8,642 14 104 14.0% FHLMC 25 4,934 3 4 14.0% FHLMC 21 5,361 2 3 14.0% - - --------------------------------------------------------------------------------------------------------------- $ 284 $ 384 - - ---------------------------------------------------------------------------------------------------------------
During 1998, the Company recorded a loss due to other than temporary impairment of its investment in Nonequity Residual Interest of $90, triggered by the decline in the yield on certain investments below the risk-free rate. 50 SECURITIZED RESIDUALS AND CORPORATE REMIC RESIDUAL INTERESTS - Both Residual Interests held in bond form and Corporate REMIC Residual Certificates are Nonequity Residual Interests and are accounted for under the Prospective Method as described in Note 2. Certain characteristics of the CMO Bonds in the Company's Residual Interests held in these forms are on the following tables:
FIXED RATE RESIDUALS - - ------------------------------------------------------------------------------------------------------------------------------ CMO BOND DATA (100% OF ISSUE) ---------------------------------------------------------------------- NAME OF ISSUER TIS INITIAL DEC. 31, 1998 AND SERIES/ TIS PURCHASE PRINCIPAL PRINCIPAL CMO ISSUE PURCHASE TIS % PRICE BOND BALANCE BALANCE BOND STATED DATE DATE OWNERSHIP ($000) CLASS ($000) ($000) COUPON MATURITY - - ------------------------------------------------------------------------------------------------------------------------------ 1) Bankers Trust May 29, 1991 99.990% $1,537 1-A $ 9,722 $ 0 7.35% Jan 1, 2013 Series 1988-1 1-B 8,017 0 8.50% Apr 1, 2014 (BT 88-1) 1-C 34,769 10,205 8.75% Apr 1, 2018 Feb 16, 1988 1-D 47,492 5,238 8.63% Apr 1, 2018 ---------------------------- $ 100,000 $15,443 - - ------------------------------------------------------------------------------------------------------------------------------ 2) L F Rothschild Nov 7, 1990 100.000% $2,589 A $ 11,000 $ 0 Zero Coupon Jan 1, 2019 Trust 9 B 22,000 0 Zero Coupon Jan 1, 2019 (LFR-9) C 54,000 5,849 Zero Coupon Jan 1, 2019 Dec 2, 1988 D 32,850 405 Zero Coupon Jan 1, 2019 E 30,000 0 Zero Coupon Jan 1, 2019 R 150 150 Residual Bond Jan 1, 2019 ---------------------------- $ 150,000 $ 6,404 - - ------------------------------------------------------------------------------------------------------------------------------ 3) Collateralized Dec 21, 1988 44.000% $4,462 I-1 $ 291,000 $ 0 7.95% Feb 1, 2009 Mortgage Mar 23, 1989 44.000% 4,180 I-2 194,000 0 9.45% May 1, 2013 --------- -------- Securities Corp. Subtotal 88.000% $8,642 I-3(Z) 15,000 23,469 9.45% Feb 1, 2017 ========= ======== ---------------------------- Series I (CMSC I) $ 500,000 $23,469 Jan 28, 1987 - - ------------------------------------------------------------------------------------------------------------------------------ 4) Federal Home Jun 22, 1989 55.000% $4,934 25-A $ 105,923 $ 0 9.00% Nov 15, 2018 Loan Mortgage 25-B 51,002 0 9.50% Nov 15, 2005 Corporation 25-C 53,028 0 9.50% Mar 15, 2011 Series 25 25-D 46,414 0 9.50% Feb 15, 2014 (FHLMC 25) 25-E 50,936 0 9.50% May 15, 2016 Dec 1, 1988 25-F 76,167 0 9.50% Dec 15, 2018 25-G 43,940 24,254 9.50% Feb 15, 2020 25-H 72,490 0 7.90% Feb 15, 2020 R 100 5 Residual Bond Feb 15, 2020 ---------------------------- $ 500,000 $24,259 - - ------------------------------------------------------------------------------------------------------------------------------ 5) Federal Home Jan 5, 1989 62.500% $5,361 21-A $ 140,645 $ 0 8.90% Jan 15, 1998 Loan Mortgage 21-B 216,267 0 8.90% Feb 15, 2004 Corporation 21-C 101,503 0 9.10% Jan 15, 2006 Series 21 21-D 93,376 0 9.25% Jun 15, 2007 (FHLMC 21) 21-E 122,951 0 9.35% Feb 15, 2009 Nov 30, 1988 21-F 240,408 0 9.45% Sep 15, 2011 21-Z 84,750 43,624 9.50% Jan 15, 2020 R 100 4 Residual Bond Jan 15, 2020 ---------------------------- $1,000,000 $43,628 ==============================================================================================================================
51 EQUITY RESIDUAL INTERESTS - As of December 31, 1998, the Company does not hold interest in any Owner Trust Residuals. As of December 31, 1997, the Company owned one equity residual interest, CMOT 28 REMIC Residual Interest. On January 30, 1998, the Company sold 49% of its ownership in CMOT 28 and on July 1, 1998, the Company sold the remaining 51% of its ownership. Income and loss related to the operations of CMOT 28 during the period February 1 to July 1, 1998 attributed to the 49% interest sold has been reflected as "minority interest" in the consolidated statement of operations. Although the underlying CMOs in this Residual Interest was not a liability of the Company, under the requirements of generally accepted accounting principles, the Company consolidated the assets and liabilities of the Owner Trust Residuals when over 50% equity interest in the trust was held by the Company. As discussed above, on January 30, 1998, the Company sold 49% of its interest in CMOT 28 for $764,400 and on July 1, 1998 the Company sold its remaining 51% interest in CMOT 28 for $1,120,000. These combined sales produced a realized loss of approximately $216,000 reported in the consolidated statement of operations. The net effect on shareholders equity, however, was an increase of approximately $351,000 as a result of recognizing unrealized losses of $567,000 previously recorded on this investment. As a result of these sales, the assets and liabilities of CMOT 28 of $53,340,560 and $53,831,734, respectively, are no longer reported in the consolidated financial statements. On June 30, 1997, the Company sold its interests in TMAC CMO Trust 1986-2 and TMAC CMO Trust 1987-3 for $128,222 and $313,367 respectively, all of which was treated as a gain on sale in the period. On April 22, 1996, the Company sold its 100% equity residual interest in TMAC CMO Trust 1986-1 for $450,000. This investment had been carried at zero so that the entire amount of the sales proceeds is reflected as a gain on disposition of investments and the assets and liabilities of this Owner Trust Residual are no longer included in the consolidated financial statements. The net assets of TMAC 1986-1 (in thousands) at the date of sale were: Mortgage Certificates, net $ 19,913 Reserve for Loss on Investments (629) Other Assets 2,486 Collateralized Mortgage Obligations, net (21,358) Other Liabilities (412) -------- Net Assets $ 0 ======== CMO COLLATERAL - The table below sets forth certain characteristics of the mortgage collateral pledged to secure each CMO in which the Company holds a Residual Interest.
CMO COLLATERAL - - -------------------------------------------------------------------------------------------------------------- CMO COLLATERAL DATA (100% OF ISSUE) ------------------------------------------------ WEIGHTED DEC 31, 1998 CURRENT WEIGHTED AVERAGE COLLATERAL WEIGHTED AVERAGE RESIDUAL PASS- PRINCIPAL AVERAGE REMAINING RESIDUAL INTEREST TYPE OF THROUGH BALANCE COUPON MONTHS TO SERIES TYPE COLLATERAL RATE ($000) RATE MATURITY - - -------------------------------------------------------------------------------------------------------------- Nonequity Residual Interests - - ---------------------------- BT 88-1 Fixed GNMA 9.00% $13,982 9.50% 199 LFR-9 Fixed FNMA 9.50% 6,210 10.22% 220 CMSC I Fixed FNMA 9.50% 21,873 10.13% 192 FHLMC 25 Fixed FHLMC 9.50% 23,546 10.33% 217 FHLMC 21 Fixed FHLMC 9.50% 42,715 10.22% 220 ==============================================================================================================
52 5. INTEREST ONLY (IO) BONDS IO Bonds include both regular IO Bonds and Inverse IO Bonds. Presented below is a schedule of the Company's IO Bonds and the Prospective Method yield at December 31, 1998. INTEREST ONLY (IO) BONDS - - ------------------------ (Dollars in thousands)
Book Value Prospective Purchase December 31, Method ---------------------------------- Interest Only Bond Price 1998 1997 Yield - - ------------------------------------------------------------------------------------------------------------- FNMA Series 1992-123 Class S $8,203 $ 809 $1,303 30.00% Pru Home Mtg Corp Series 1992-7 4,776 31 426 14.00% Bear Stearns Mtg Sec Series 1992-1 2,720 -- 146 N/A - - ------------------------------------------------------------------------------------------------------------- $ 840 $1,875 =============================================================================================================
During 1998, the Company recorded a loss due to other than temporary impairment of its investment in IO Bonds of $1,983,000 triggered by the decline in yield on certain investments below the risk-free rate. Certain characteristics of the Company's IO Bonds held at December 31, 1997 are on the following table:
INTEREST ONLY BONDS - - ------------------------------------------------------------------------------------------------------------ COLLATERAL DATA (% OF IO HELD BY TIS) ---------------------------------------------------------------- WEIGHTED DEC. 31, 1998 CURRENT WEIGHTED NAME OF ISSUER TIS AVERAGE COLLATERAL WEIGHTED AVERAGE AND SERIES/ TIS PURCHASE PASS PRINCIPAL AVERAGE REMAINING CMO ISSUE PURCHASE PRICE TYPE OF THROUGH BALANCE COUPON MONTHS TO DATE DATE ($000) COLLATERAL RATE TO IO ($000) RATE MATURITY - - ------------------------------------------------------------------------------------------------------------ 1) FNMA July 30, 1992 $8,203 FNMA 49.58 - $ 2,381 8.94% 268 Series 1992-123 (5.67 x Class S LIBOR) July 25, 1992 - - ------------------------------------------------------------------------------------------------------------ 2) Prudential Mar 27, 1992 $4,776 NON- 0.5652% 23,594 8.81% 267 Home Mortgage AGENCY Corporation Series 1992-7 March 1, 1992 ============================================================================================================
6. FAIR VALUE OF NONEQUITY RESIDUAL INTERESTS AND IO BONDS GENERAL - The fair value of a Residual Interest and an IO Bond is the net present value of the projected future cash flows. The amount of cash flows that may be generated from the Company's Residual Interests and IO Bonds are uncertain and may be subject to wide variations depending primarily upon the rate and timing of prepayments on the mortgage collateral and Inverse IO Bonds and changes in LIBOR. The following information sets forth assumptions used to calculate the projected cash flows on the Company's Residual Interests and IO Bonds, and the present value of these assets at December 31, 1998 and 1997 based on various assumptions and discount factors. ASSUMPTIONS - For purposes of the presentations below, the Nonequity Residual Interests are shown as a group and the IO Bonds have been separated into two groups: regular IO Bonds and Inverse IO Bonds. For purposes of projecting future cash flows, the one month LIBOR rate at December 31, 1998 and 1997 of 5.00156% and 5.65625% is used. 53 Principal payments on Mortgage Loans may be in the form of scheduled amortization or prepayments (for this purpose, "prepayments" includes principal prepayments and liquidations due to default or other dispositions). The prepayment assumptions used herein are based on an assumed rate of prepayment each month of the unpaid principal balance on a pool of Mortgage Loans. The prepayment assumptions used to estimate the fair value of the Company's Nonequity Residual Interests and IO Bonds are the Bloomberg Financial Markets ("Bloomberg") Dealer Prepayment Estimates Average as estimated by several dealers in mortgage-related assets and compiled by Bloomberg as of December 31, 1998 and 1997. Bloomberg has obtained this information from sources it believes to be reliable but has not verified such information and assumes no responsibility for the accuracy of such information. The following are the prepayment assumptions used to project cash flows in order to calculate the present value of Nonequity Residual Interests and IO Bonds:
PREPAYMENT ASSUMPTIONS 1997 -------------------------------------------------------------------------------- Percent Prepayment Mortgage Collateral Pass-Through Rate Assumption -------------------------------------------------------------------------------- GNMA Certificates 9.0% 241% FNMA/FHLMC Certificates 8.5% 286% FNMA/FHLMC Certificates 9.0% 330% FNMA/FHLMC Certificates 9.5% 339% - - --------------------------------------------------------------------------------------
PREPAYMENT ASSUMPTIONS 1998 -------------------------------------------------------------------------------- Percent Prepayment Mortgage Collateral Pass-Through Rate Assumption -------------------------------------------------------------------------------- GNMA Certificates 9.0% 346% FNMA Certificates 9.5% 401% FHLMC Certificates 9.5% 361% - - --------------------------------------------------------------------------------------
NEITHER THE INTEREST RATES NOR THE PREPAYMENT ASSUMPTIONS USED HEREIN PURPORTS TO BE A HISTORICAL DESCRIPTION OF INTEREST RATES OR PREPAYMENT EXPERIENCES OR A PREDICTION OF FUTURE INTEREST RATES OR PREPAYMENTS OF ANY POOL OF MORTGAGE LOANS. THE FAIR VALUE OF THESE ASSETS CAN VARY DRAMATICALLY DEPENDING ON FUTURE INTEREST RATES, PREPAYMENT SPEEDS AND THE DISCOUNT FACTOR USED. PRESENT VALUE OF PROJECTED CASH FLOWS - The tables which follow set forth the present value at December 31, 1998 and December 31, 1997of the projected cash flows discounted at the indicated discount rates subject to the assumptions described above. For example, if cash flows are projected using the Bloomberg Financial Markets ("Bloomberg") Dealer Prepayment Estimates Average, as estimated by several dealers in mortgage-related assets and compiled by Bloomberg as of December 31, 1998 and 1997, and Nonequity Residual Interests in CMOs with fixed rate Bond Classes are discounted at 14%, the present value of the projected cash flows of the Company's Nonequity Residual Interests would equal approximately $284,000 and $384,000 respectively. This is the Company's estimate of the fair value of these assets. Similarly, if cash flows on the Company's regular IO Bonds are discounted at 14% and the cash flows on its Inverse IO Bonds are discounted at 30%, the present value of the projected cash flows on the IO Bonds and inverse IO Bonds would equal $840,000 and $1,875,000 at December 31, 1998 and 1997. The book value is the Company's estimate of the fair value of these IO Bonds. There will be differences between the projected cash flows used to calculate the present value of these assets and the actual cash flows received by the Company, and such differences may be material. 54
PRESENT VALUE OF NONEQUITY RESIDUAL INTERESTS AS OF DECEMBER 31, 1997 - - -------------------------------------------------------------------------------------------------------------------- (In thousands) Residual Interests in CMOs with Fixed Rate Bond Classes ----------------------------------------------------------------------------------------- Discount Rate 10% 12% 14% 16% 18% Present Value $559 $458 $384 $330 $290 - - --------------------------------------------------------------------------------------------------------------------
PRESENT VALUE OF IO BONDS AS OF DECEMBER 31, 1997 - - -------------------------------------------------------------------------------------------------------------------- (In thousands) Regular Interest Only Bonds ----------------------------------------------------------------------------------------- Discount Rate 10% 12% 14% 16% 18% Present Value $611 $591 $572 $553 $537 Inverse Interest Only Bonds ----------------------------------------------------------------------------------------- Discount Rate 22% 26% 30% 34% 38% Present Value $1,542 $1,413 $1,303 $1,209 $1,127 - - --------------------------------------------------------------------------------------------------------------------
PRESENT VALUE OF NONEQUITY RESIDUAL INTERESTS AS OF DECEMBER 31, 1998 - - -------------------------------------------------------------------------------------------------------------------- (In thousands) Residual Interests in CMOs with Fixed Rate Bond Classes ----------------------------------------------------------------------------------------- Discount Rate 10% 12% 14% 16% 18% Present Value $359 $318 $284 $258 $235 - - --------------------------------------------------------------------------------------------------------------------
PRESENT VALUE OF IO BONDS AS OF DECEMBER 31, 1998 - - -------------------------------------------------------------------------------------------------------------------- (In thousands) Regular Interest Only Bonds ----------------------------------------------------------------------------------------- Discount Rate 10% 12% 14% 16% 18% Present Value $31 $31 $31 $31 $31 Inverse Interest Only Bonds ----------------------------------------------------------------------------------------- Discount Rate 22% 26% 30% 34% 38% Present Value $928 $865 $809 $761 $717 - - --------------------------------------------------------------------------------------------------------------------
During the second quarter of 1998, the Bear Stearns Mortgage Securities Series 1992-7 Interest Only Bond was retired prior to its maturity as part of an optional redemption of the entire bond series. This redemption resulted in a loss on redemption of investment of $198,000. 55 7. COMMERCIAL SECURITIZATIONS Commercial Securitizations which include debt obligations that are issued in multiple classes and are funded as to the payment of interest and principal by a specific group of Mortgage Loans on multiple family or commercial real estate, accounts and other collateral. Presented below is a schedule of Commercial Securitizations owned by the Company:
(In thousands) Book Value ----------------------------------------- Purchase December 31, December 31, Issuer and Series Price 1998 1997 - - ------------------------------------------------------------------------------------------------------------ Prudential Securities Series 1993-6 $250 $ 184 $ 184 ============================================================================================================
8. OPERATING REAL ESTATE ASSETS During the year ended December 31, 1995, the Company acquired four multifamily housing properties in California's Central Valley. The properties were purchased either in the form of direct ownership of the real property or in the form of an interest in a partnership that directly owns the real property. Capitalized costs differ from the purchase price due to capitalization of acquisition costs. During 1998, one property was sold. The carrying value of operating real estate assets at December 31, 1998 and 1997 is presented in the following table:
December 31, (in thousands) 1998 1997 -------------------------------------------------------------------------- Land $ 4,120 $ 5,024 Buildings and improvements 16,920 24,186 Personal property 899 1,300 ---------------------------------- Total 21,939 30,510 Less accumulated depreciation and amortization (1,767) (1,813) ---------------------------------- Net $20,172 $28,697 ==================================
At December 31, 1998, the Company's three multifamily properties had an overall occupancy of 97.5%. In December 1998, the Company divested the River Oaks apartment complex in Hanford, California for a selling price of $8,060,000. After closing costs and prorated items, the Company recorded a loss on sale of approximately $157,000 and net proceeds of approximately $1.5 million. In conjunction with the sale, the purchaser assumed the $6.3 million of mortgage obligation related to the property 9. FUNDS DUE TO TRUSTEE During the fourth quarter of 1998, the trustee for Bankers Trust Series 1988-1 (the "Trustee"), a nonequity residual interest investment of the Company, inadvertently deposited approximately $1.2 million in the Company's accounts. Such amount is reflected within cash and cash equivalents and due to trustee on the accompanying consolidated balance sheet at December 31, 1998. In March 1999, the Company repaid $600,000 of such amount to the Trustee. On March 11, 1999, The Trustee filed an action in the United States District against the Company for alleged breach of contract, common count and conversion. The complaint alleges that the Trustee erroneously paid $1.2 million to the Company under the terms of a mortgage-backed security of which the Company is one of the holders, and that the Company has failed to repay approximately $600,000 of those monies despite demand. The complaint requests payment, prejudgment interest, attorneys fees' and costs. The Company acknowledges that it is required to repay the remaining $600,000, but denies that it is liable to the Trustee for any other amounts or that it ever breached any contract, converted monies, or otherwise acted improperly. On March 23, 1999, the Trustee filed an application for a writ of attachment, requesting expedited hearing thereon. The Company opposed the expedited hearing and the Court denied the Trustee's request. On April 1, 1999, the Trustee filed an amended complaint adding a request for a constructive trust, and also set the attachment application for regular hearing on May 11, 1999. The parties have engaged in informal settlement discussions, both before and after the filing of the original complaint. Those discussions continue. If a settlement agreement cannot be reached, the Company intends to oppose the application for an attachment and vigorously defend the action. 56 10. NOTES PAYABLE ON REAL ESTATE As part of the 1995 acquisition of multifamily residential properties, existing secured debt totaling $18,675,000 was assumed. In addition, new secured debt of $1,815,000 was obtained in 1995. In August 1996, the River Oaks and Four Creeks - II mortgage notes payable matured and were retired using the proceeds from a new mortgage note in the principal amount of $11,235,000 (the "Interim Note"). On March 24, 1997, the Company obtained permanent financing with an insurance company (the "Permanent Financing"). The total loan proceeds from the Permanent Financing amounted to $17,400,000 and, after certain costs and fees, were used to retire the then-outstanding principal and interest on the Interim Note of $11,235,000 and the mortgage note on Villa San Marcos of $5,965,884. The Permanent Financing comprises three deeds of trust and an assignment of rents on Four Creeks - II, River Oaks and Villa San Marcos. The term of each of the underlying Mortgage Loans is ten years with a fixed annual interest rate of 8.36% for River Oaks and 8.31% for the others The mortgages comprising the Permanent Financing may not be retired during the first five years and are subject to a prepayment penalty if prepaid after the fifth year. On December 23, 1998 the Company sold its interest in River Oaks. (See Note 8) The following table summarizes the debt outstanding on the properties as of December 31, 1998 and 1997, respectively. The Shady Lane loan remains in the name of the seller of the property and will continue to remain so until refinanced. The Company is servicing the debt and receives all of the economic benefits from Shady Lane. The weighted average interest rate at December 31, 1998 was 8.30%.
Interest Monthly Principal Balance Basis of Rate Principal December 31, Interest Dec. 31, Due and Interest ----------------- Property 1998 1997 Rate 1998 Date Payment - - --------------------------------------------------------------------------------------------------------------------------- Shady Lane $ 1,292,145 $ 1,327,859 Floating Rate 8.394% 12/1/04 12,063 River Oaks -- 6,372,237 -- -- -- -- Villa San Marcos 6,825,984 6,910,481 Fixed 8.31% 4/1/07 70,597 Four Creeks - I 1,767,100 1,782,994 Fixed 8.16% 12/1/05 13,521 Four Creeks - II 3,908,426 3,956,808 Fixed 8.31% 4/1/07 31,649 - - --------------------------------------------------------------------------------------------------------------------------- Total $13,793,655 $20,350,379 $127,830 ===========================================================================================================================
The scheduled principal payments to be made on notes payable on real estate outstanding at December 31, 1998 are as follows (in thousands), except for the Shady Lane property note payable, as discussed below: YEAR Amount ---------------------------------- 1999 $ 175,684 2000 190,822 2001 207,265 2002 225,124 2003 244,523 Thereafter 11,458,092 ---------------------------------- Total $12,501,510 ================================== The variable rate loan for the Shady Lane property is payable in monthly installments of $12,063. The floating rate of interest is adjusted every six months, in July and December. Since the principal payments vary each month, the scheduled principal payments are not included in the schedule above. 57 11. SHORT-TERM DEBT At December 31, 1998 and 1997, the Company's short-term borrowings totaled $667,000 and $2,009,500 respectively. Short-term borrowing consisted of repurchase agreements with Bear Stearns & Co. and Paine Webber. The repurchase agreement borrowings had a weighted average interest rates of 7.129% and 7.272% at December 31, 1998 and 1997, respectively. The repurchase agreements had initial terms of one month, are renewed on a month-to-month basis, are collateralized by some of the Company's nonequity Residual Interests and IO Bonds whose fair values at December 31, 1998 and 1997 approximated $840,000 and $2,000,000 respectively and have a floating rate of interest which is tied to the one month LIBOR rate. The Company has no committed lines of credit. 12. SEGMENT DATA The Company's operations consist of investments in structured securities and a portfolio of multifamily residential housing. Each activity represents an operating segment as defined by Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information and financial results of each are reported and monitored by the Company. The investments in structured securities are comprised primarily of mortgage related assets consisting of both equity and non-equity residual interest instruments and bond and REMIC based interest only strips. The real estate portfolio consists of multifamily apartment buildings located in the California Central Valley region. Units of each of the buildings are rented to residential tenants on either a month-to-month basis or for terms of one year or less. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. Details of the financial results of the Company's real estate operations are segregated in the accompanying income statement, real estate operations results for the twelve months in each of the periods ending December 31, 1998, 1997, and 1996 amounted to a net loss of $426,000, $261,000 and $171,000 respectively. Details of the financial results of the Company's investments in Structured Securities are segregated in the accompanying balance sheet. Net operating results of the investment portfolio for the years ended December 31, 1998, 1997 and 1995 were a net loss of $2,642,000 and net income of $1,495,000 and $701,000 respectively as reflected in the following table:
Financial Instruments Portfolio ($000) 1998 1997 1996 - - -------------------------------------- ---- ---- ---- Income from Mortgage $ 530 $ 8,387 $ 9,393 Total Interest and CMO Related Expenses (3,249) (6,892) (8,692) ------------------------------ Net Income (Loss) from Financial Instruments ($2,719) $ 1,495 $ 701
The Company does not allocate overhead expenses to its segments nor does management consider such costs in its evaluation of the results of each segment. 58 13. SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS The following items were non-cash transactions with regard to the sale of CMOT-28 and the River Oaks Property for the year ended December 31, 1998.
CMOT-28 (in thousands) 1998 ---------------------------------------------------------------------------- Reduction of Mortgage Certificates $ 51,600 Reduction of Unamortized Discount on Mortgage Certificates (885) Reduction of Mortgage Certificate Reserve for Loss (567) Reduction of Restricted Cash on Mortgage Certificates 1,814 Reduction of Accrued Interest on CMOs 365 Reduction of CMOs (53,103) Reduction of Unamortized Discount on CMOs 3,125 Reduction of Accrued Interest Payable on CMOs (745) Reduction of Minority Interest (1,352) RIVER OAKS (in dollars) 1998 ---------------------------------------------------------------------------- Reduction of Land ($904,244) Reduction of Building (7,266,026) Reduction of Plant, Property and Equipment (691,230) Reduction of Accumulated Depreciation 848,829 Reduction of Accounts Receivable (5,462) Reduction of Prepaid Assets (6,148) Reduction of Amortizable Costs (180,280) Reduction of Accounts Payable 79,133 Reduction of Notes Payable 6,294,917
14. COMPREHENSIVE INCOME As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130 ("SFAS 130") Reporting Comprehensive Income. This statement established standards for the reporting and disclosure of comprehensive income and its components in the financial statements. For the Company, comprehensive income includes the net loss as reported on the consolidated statements of operations, and the unrealized gain (loss) due to changes in the fair value of its available-for-sale investments that are reported as a component of shareholders' equity. The following table presents net loss adjusted by the change in unrealized gains or losses on available-for- sale investments as a component of comprehensive income.
1998 1997 1996 ---- ---- ---- Unrealized gain (loss) arising during the year: ($176) $ 262 $ 552 Reclassification adjustments for net realized (gains) losses on securities available for sale included in net income during the year: 2,487 (442) (450) -------------------------- $2,311 ($180) $ 102
59 15. STOCK OPTIONS During 1995, the shareholders approved the 1995 Stock Option Plan (the "Plan") covering shares of the Company's Common Stock. The plan provides for the granting of non-qualified stock options to officers and unaffiliated directors of the Company. Under the terms of the Plan, the purchase price of the shares subject to each option granted to officers will not be less than 100% and options granted to unaffiliated directors will not be less than 110% of their fair market value at the date of the grant reduced by the aggregate amount of distributions declared. Options granted are exercisable for no more than 10 years from the date of grant. Statement of Financial Accounting Standards No. 123 ("SFAS 123") Accounting for Stock-Based Compensation, is effective for transactions entered into for fiscal years beginning after December 15, 1995. This statement defines a fair- value-based method of account for stock-based compensation. As permitted by SFAS 123, the Company accounts for stock options under APB Opinion. 25, under which no compensation cost has been recognized. The Company has provided the following pro forma net income and earnings per share data as if compensation cost for the Plan had been provided for consistent with SFAS 123. The potential common shares related to the 1995 Stock Option Plan are antidilutive in 1998, 1997 and 1996.
1998 1997 1996 ---- ---- ---- Net Loss (in thousands): As reported ($4,136) ($209) ($903) Pro forma (4,136) (214) (904) Earnings per share As reported ($0.51) ($0.03) ($0.11) Pro forma ($0.51) ($0.03) ($0.11)
The following table summarizes the stock option activity for the years ended December 31, 1998, 1997 and 1996, respectively.
Number of Share Options Outstanding --------------- Balance, December 31, 1995 336,000 Granted to officers 6,000 Expired -- --------------- Balance, December 31, 1996 342,000 Granted to officers 6,000 Expired (1,000) --------------- Balance, December 31, 1997 347,000 Granted -- Expired (5,000) --------------- Balance, December 31, 1998 342,000 ===============
During 1998, 5,000 options expired relating to two unaffiliated directors who were replaced in 1997. During 1997, 1,000 options expired relating to an unaffiliated director who retired in 1996. No other options were exercised, forfeited, or expired during 1998, 1997 or 1996. As of December 31, 1998 and 1997, respectively, 342,000 and 347,000 of the options were exercisable. As of December 31, 1998, 58,000 shares were available under the Plan for granting further options. The weighted average fair value of options granted in 1997and 1996 were $1.02 and $0.18 respectively. No options were granted in 1998. The options outstanding at December 31, 1998 have exercise prices of $1.25, $1.22, $2.25 and $2.26 with a weighted average exercise price of $2.23 and a weighted average remaining contractual life of 6.3 years. 60 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. Management made the following average assumptions for grants in 1997: risk-free interest rate of 6.43%, expected distribution yield of 0%, expected life of 10 years, and expected volatility of 97%. 16. RELATED PARTY TRANSACTIONS Prior to July 1, 1996, the Company had entered into a Management Agreement (the "Management Agreement") with TIS Financial Services Inc., (the "Former Manager") which was renewable annually. At a special meeting of the Board of Directors on June 27, 1996, the Board resolved to let the Management Agreement expire on June 30, 1996 and to have the Company become a self-administered REIT. No management fees were paid in 1998 or 1997; management fees of $77,000 were paid for the first half of 1996. In addition, the Company reimbursed the Former Manager in the amount of $ 28,980, $37,806 and $391,198, respectively for 1998, 1997 and 1996 related to certain general and administrative expenses incurred by the Former Manager on the Company's behalf (see further discussion below). PRIOR TO JULY 1, 1996 - - --------------------- Prior to July 1, 1996, the Company operated under the Management Agreement with the Former Manager. In June 1995, the Board of Directors of the Company and the Former Manager entered into a new Management Agreement through June 30, 1996. In March 1995, the Board of Directors authorized a committee composed of four Unaffiliated Directors to consider proposed revisions to the Management Agreement in light of the Company's acquisition of multifamily residential properties and recent waivers by the Unaffiliated Directors of the requirement in the Management Agreement that the Former Manager reimburse the Company for Excess Expenses. As a result, the Management Agreement approved in June 1995 increased the base management fee from .375% per annum of average invested assets to .65% thereof, changed the incentive compensation, eliminated an expense reimbursement provision, and discontinued the payment of a Residual Interest Administration Fee. These changes in the management fee became effective October 1, 1995. However, the Former Manager voluntarily waived the increase in base management fee for the fourth quarter of 1995 and first two quarters of 1996. Prior to becoming self-managed on July 1, 1996, the Company reimbursed the Former Manager for certain expenses incurred by the Former Manager on the Company's behalf, including rent, telephone, utilities, office furniture, equipment and machinery, computers, and computer services, as well as expenses relating to accounting, bookkeeping and related administrative functions (including the employment expenses of any persons performing these functions), and fees and expenses of agents and employees employed directly by the Former Manager at the Company's expense. July 1, 1996 and Thereafter - - --------------------------- In connection with becoming self-managed on July 1, 1996, the Company entered into a Facilities and Expense Sharing Agreement ("Expense Sharing Agreement") with the Former Manager providing for the sharing of office space, office equipment and the expenses of certain administrative and other personnel and ancillary services. In addition, the Board approved employment contracts with Lorraine O. Legg, Chairman and President of the Company, for a term of three years and John E. Castello, as Executive Vice President and Chief Financial Officer, for a term of two years. The Expense Sharing Agreement provides for certain office space and expense sharing arrangements, whereby the Company and the Former Manager share on a prorata basis all fees and expenses incurred in connection with rent, telephone charges, utilities and other office expenses, bookkeeping fees and expenses and miscellaneous administrative and other expenses, including certain personnel expenses, as described in the Expense Sharing Agreement. The prorata sharing of such expenses is determined based upon the relative benefit received by each party in accordance with the amount of space utilized or the relative amount of time each such resource is used, or such other allocation method as may be reasonable and agreed to by the parties. The Expense Sharing Agreement continues in effect until terminated by either party on 30 days prior written notice or at such time as the parties no longer continue to share office space. 61 In April of 1999, the Company entered into a financing agreement with the Former Manager whereby the Former Manager extended a revolving line of credit of $1,000,000 to the Company. (See Note 20) 17. INTEREST INCOME Interest income from Mortgage Related Assets consisted of:
YEARS ENDED DECEMBER 31, --------------------------------- (IN THOUSANDS) 1998 1997 1996 - - --------------------------------------------------------------- Mortgage Certificates, net $ 2,602 $ 6,059 $ 7,748 Short-term Investments -- 2 16 Residual Interests 22 39 52 Interest Only (IO) Bonds 171 360 455 Commercial Securitizations 8 0 0 - - --------------------------------------------------------------- Total $ 2,803 $ 6,460 $ 8,271 ===============================================================
- - -------------------------------------------------------------------------------------------------------- (IN THOUSANDS, FIRST SECOND THIRD FOURTH EXCEPT PER SHARE DATA) QUARTER QUARTER QUARTER QUARTER TOTAL - - -------------------------------------------------------------------------------------------------------- 1998 Income from Mortgage Related Assets $ 1,528 $ 1,296 ($ 224) ($ 2,070) $ 530 Income (Loss) from Real Estate Operations (38) (54) (45) (289) (426) Net Income (Loss) (269) (609) (541) (2,718) (4,136) Basic Net Income (Loss) per Share ($0.03) $ 0.08 ($ 0.07) ($ 0.49) ($ 0.51) 1997 Income (Loss) from Mortgage Related Assets $ 1,788 $ 2,225 $1,676 $ 2,698 $ 8,387 Loss from Real Estate Operations (97) (65) (43) (56) (261) Net Income (Loss) (417) (103) (307) 618 (209) Basic Net Income (Loss) per Share ($0.04) $ 0.01 ($ 0.04) $ 0.08 ($ 0.03)
62 18. DIVIDEND REINVESTMENT AND SHARE PURCHASE PLAN The Company has a Dividend Reinvestment and Share Purchase. The Plan provides, at the Company's option, for shares purchased under the Plan to either be issued by the Company, or be purchased on the open market. The Plan prospectus provides for up to 1,000,000 new shares to be issued. To the extent new shares are issued, the Company's capital will be increased. During 1992, 5,780 shares were issued under the Plan resulting in an increase to capital of $39,000. No new shares were issued under the Plan thereafter, as all required shares have been purchased in the open market. 19. CONTINGENCIES RISK OF UNINSURED LOSSES The Company's real estate properties are located in an area that is subject to earthquake activity. The Company's comprehensive liability, fire, flood, extended coverage and rental loss insurance does not cover damage resulting from an earthquake and certain other losses. Accordingly, should the Company sustain damage resulting from an earthquake or other uninsured loss, the Company could lose its investment in, and anticipated profits and cash flows from the properties. The accompany financial statements do not reflect any adjustments for these uncertainties. LITIGATION The Company is involved from time to time in legal actions relating to the ownership and operations of its properties. In management's opinion, the liabilities, if any, that may ultimately result from such legal actions are not expected to have a materially adverse effect on the consolidated financial position, results of operations or cash flows of the Company. ENVIRONMENTAL MATTERS The Company follows a policy of monitoring its properties for the presence of hazardous or toxic substances. The Company is not aware of any environmental liability with respect to the properties that would have a material adverse effect on the Company's business, assets or results of operations. There can be no assurance that such a material environmental liability does not exist. The existence of any such environmental liability could have an adverse effect on the Company's results of operations and cash flow 20. SUBSEQUENT EVENTS EXCHANGE OF SHARES FOR NOVATO MARKETS On February 2, 1999, the Company acquired all the shares of Novato Markets, Inc. ("Novato") from Pacific Securitization, Inc., ("Pacific") in exchange for 1,613,070 shares of Common Stock (the "Shares") of the Company pursuant to an Agreement and Plan of Reorganization dated as of February 1, 1999, between the Company and Pacific. Pacific is indirectly principally owned by Lorraine O. Legg, the President and Chief Executive Officer and a director of the Company, and Patricia M. Howe, a director of the Company. The Company's acquisition of Novato was approved by the Company's Board of Directors. Through a wholly-owned subsidiary, Novato owns a shopping center located in Rohnert Park, California, named Mountain Shadows Plaza, and owns a shopping center subject to a ground lease in Petaluma, California, named Midtown Center. The shopping centers have a combined commercial and retail space totaling approximately 80,000 square feet. Mountain Shadows Plaza consists of three buildings and is anchored by a large grocery store. Midtown Center consists of a single building. The Company intends to continue operating the shopping centers. The Shares were issued to Pacific under an exemption to the registration requirements of the Securities Act of 1933, as amended. Accordingly, the Shares are "restricted securities," as defined in Rule 144 of the Securities Act, and are not freely transferable. The Company granted Pacific one-time demand registration rights with respect to the Shares for the period beginning June 30, 1999 and ending February 2, 2001. It also granted Pacific piggy-back registration rights in the event that the Company files a registration statement under the Securities Act in connection with the proposed offer and sale for cash of shares of 63 Common Stock by it or by any of its shareholders. The share exchange is intended to be a tax free reorganization within the meaning of Section 368(a)(1) of the Internal Revenue Code of 1986, as amended. Prior to the closing of the share exchange, Novato caused its wholly-owned subsidiary to transfer to Pacific all its rights under a lease, with option to purchase, with Ignacio Properties, LLC, relating to the Ignacio Center in Novato, California, and Pacific agreed to assume all the obligations of the subsidiary under the lease and option. The Company, Novato, Novato's wholly-owned subsidiary and Pacific then entered into an agreement dated as of February 1, 1999, whereby the parties clarified their respective rights and obligations relating to the Ignacio Property and the Company's rights to an escrow established when Pacific originally acquired Novato. SHARE PURCHASE FROM TURKEY VULTURE FUND XIII, LTD. On February 2, 1999, the Company acquired 793,700 shares of its Common Stock from Turkey Vulture Fund XIII, Ltd. for $1,984,250, 20,000 shares of its Common Stock from Christopher L. Jarratt for $40,000 and 12,000 shares of its Common Stock from James G. Lewis for $24,000, pursuant to an Agreement dated as of February 1, 1999, among the Company, Turkey Vulture Fund, Richard M. Osborne, Third Capital, LLC, Mr. Jarratt and Mr. Lewis. Turkey Vulture Fund, Third Capital and Messrs. Osborne, Jarratt and Lewis agreed that, for a period of seven years, they will not directly or indirectly, among other things, (i) effect or participate in or in any way assist any other person in effecting or participating in (a) any acquisition of securities or rights to acquire securities or assets of the Company or its subsidiaries, (b) any tender or exchange offer, merger or other business combination involving the Company or its subsidiaries, (c) any liquidation or other extraordinary transaction with respect to the Company or its subsidiaries, or (d) any solicitation of proxies or consents to vote any voting securities of the Company; (ii) form or in anyway participate in a "group" with respect to the Company; (iii) otherwise act, alone or in concert with others, to seek to control or influence the management, Board of Directors or policies of the Company or its subsidiaries; (iv) take any action to compel the holding of an annual or special meeting of stockholders; or (v) enter into any discussions or arrangements with any person relating to the foregoing. The parties also agreed to a mutual general release of all claims arising out of or relating to the business or affairs of the Company or the ownership of its stock. Messrs. Osborne, Jarratt and Lewis resigned from the Company's Board of Directors, effective February 2, 1999. This share purchase and the acquisition of Novato were approved by the Company's Board of Directors and, specifically, by directors with no financial interest in either transaction. The disinterested directors required that the share exchange transaction be closed as a condition to closing the share purchase transaction. SALE OF FNMA SERIES 92-123 S On March 4, 1999, the Company sold its interest in its IO Bond, FNMA Series 1992-123 S for $782,879. In conjunction with this sale, the Company retired short-term debt of approximately $616,000. REVOLVING LINE OF CREDIT In April of 1999, the Company entered into a financing agreement with The Former Manager whereby The Former Manager extended a revolving line of credit of $1,000,000 to the Company. The Former Manager and the Company have common ownership and executive officers and as such are related parties. Credit support to the Former Manager includes guaranteed loans by a bank and a board member of the Company in support of the TIS Line to the Company. Additionally, certain of the Company's mortgage assets are pledged as collateral for the TIS Line. This line is to provide working capital to the Company. This revolving line of credit is for a term of one year, is at the rate of prime plus one and one half percent and is secured by the Company's ownership in Bankers Trust series 1988-1 Residual Interest Certificate. 64 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TIS MORTGAGE INVESTMENT COMPANY Date: April 15, 1999 By: /s/ Lorraine O. Legg ----------------------- Lorraine O. Legg, Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date - - --------- ----- ---- /s/ Lorraine O. Legg Director, President and April 15, 1999 - - -------------------------- Lorraine O. Legg Principal Executive Officer /s/ John E. Castello Executive Vice President (Principal April 15, 1999 - - -------------------------- John E. Castello Financial Officer) /s/ Douglas B. Fletcher Director, Chairman of the Board April 15, 1999 - - -------------------------- Douglas B. Fletcher Director - - -------------------------- Anthony H. Barash /s/ Patricia M. Howe Director April 15, 1999 - - -------------------------- Patricia M. Howe /s/ Robert W. Ledoux Director April 15, 1999 - - -------------------------- Robert W. Ledoux Director - - -------------------------- J. David Schemel 65 SCHEDULE III TIS MORTGAGE INVESTMENT COMPANY REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1998 (DOLLARS IN THOUSANDS)
Column A Column B Column C Column D Column E -------- -------- -------- -------- -------- Costs Subsequently Gross Amount at which Carried Initial Cost to Company Capitalized at Close of Year ----------------------- ------------ ----------------------------- Buildings Buildings and and Description Encumbrances Land Improvements Improvements Land Improvements Total ----------- ------------ ---- ------------ ------------ ---- ------------ ----- Shady Lane Village Visalia, CA $1,292 $379 $1,725 $38 $379 $1,763 $2,142 Villa San Marcos Fresno, CA 6,826 2,549 7,459 35 2,584 7,459 10,043 Four Creeks Village Visalia, CA 5,676 1,157 7,698 -- 1,157 7,698 8,855 --------------------------------------------------------------------------------------------- $13,794 $4,989 $16,882 $73 $4,120 $16,920 $21,040 =============================================================================================
Column A Column F Column G Column H Column I -------- -------- -------- -------- -------- Life on which Accumulated Year of Year Depreciation Description Depreciation Construction Acquired is Computed ----------- ------------ ------------ -------- -------------- Shady Lane Village Visalia, CA $220 1985 1995 40 years Villa San Marcos Fresno, CA 736 1991 1995 40 years Four Creeks Village Visalia, CA 811 1986-91 1995 40 years ------ $1,767 ======
1998 1997 1996 ---- ---- ---- Accumulated Accumulated Accumulated Cost Depreciation Cost Depreciation Cost Depreciation --------------------- -------------------- --------------------- Balance at Beginning of Year $29,210 $1,537 $29,026 $938 $29,026 $339 Additions (sales) during period Purchases Sales (8,170) (503) Capital Improvements 184 Depreciation 733 599 599 --------------------- --------------------- --------------------- Balance at End of Year $21,040 $1,767 $29,210 $1,537 $29,026 $938 ==================== ==================== =====================
66 EX-21 2 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 TIS MORTGAGE INVESTMENT COMPANY SUBSIDIARIES OF THE REGISTRANT TIS Mortgage Acceptance Corporation TIS Property Acquisition Company Novato Markets Inc. P-Sub I, Inc. EX-24 3 CONSENT OF ARTHUR ANDERSEN LLP EXHIBIT 24 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included on this Form 10-K, into the Company's previously filed Registration Statements on Form S-8 (file number 333-96960) and Form S-3 (file number 333-44526). /s/ Arthur Andersen LLP San Francisco, California April 15, 1999 EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 2,907 1,308 33 0 0 0 0 0 25,056 2,474 0 0 0 8 8,780 25,056 0 4,581 0 0 4,016 0 4,999 (4,136) 0 (4,136) 0 0 0 (4,136) (.51) (.51)
-----END PRIVACY-ENHANCED MESSAGE-----