-----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, P19Pftmgy8bPIfgQ7oq9hJX0fiEVz7X8g+Z5x81CyemOlAqgy9BA7OZtgXI2fYgr dh3YpFltKP7OAlX24kgUUw== 0000950134-00-003863.txt : 20000504 0000950134-00-003863.hdr.sgml : 20000504 ACCESSION NUMBER: 0000950134-00-003863 CONFORMED SUBMISSION TYPE: 10-K405/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 20000503 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMRESCO CAPITAL TRUST CENTRAL INDEX KEY: 0001054337 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 752744858 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405/A SEC ACT: SEC FILE NUMBER: 001-14029 FILM NUMBER: 617455 BUSINESS ADDRESS: STREET 1: 700 NORTH PEARL STREET STREET 2: SUITE 1900 CITY: DALLAS STATE: TX ZIP: 75201 BUSINESS PHONE: 2149537700 MAIL ADDRESS: STREET 1: 700 NORTH PEARL STREET STREET 2: SUITE 2400 LB 342 CITY: DALLAS STATE: TX ZIP: 75201 10-K405/A 1 AMENDMENT NO. 1 TO FORM 10-K - FISCAL END 12/31/98 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A Amendment No. 1 (Mark One) [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 1-14029 AMRESCO CAPITAL TRUST (Exact name of Registrant as specified in its charter) TEXAS 75-2744858 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 700 N. PEARL STREET, SUITE 2400, LB 342, DALLAS, TEXAS 75201-7424 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (214) 953-7700 Securities registered pursuant to Section 12(b) of the Act: NONE (Title of class) Securities registered pursuant to Section 12(g) of the Act: COMMON SHARES OF BENEFICIAL INTEREST, $0.01 PAR VALUE PER SHARE PREFERRED SHARE PURCHASE RIGHTS (Title of class) 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. [X] As of March 1, 1999, 10,006,111 shares of the registrant's common stock, par value $.01 per share, were outstanding. As of that date, the aggregate market value of the shares of common stock held by non-affiliates of the registrant (based upon the closing price of $9.00 per share on March 1, 1999 as reported on The Nasdaq Stock Market(R)) was approximately $75.0 million. Shares of common stock held by each executive officer and trust manager have been excluded in that such persons may be deemed to be affiliates. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement to be filed for the Annual Meeting of Shareholders to be held on May 11, 1999 are incorporated by reference in Part III of this report. 2 This Form 10-K/A is being filed to amend and restate Items 1, 7 and 14 in their entirety. PART I ITEM 1. BUSINESS OVERVIEW AMRESCO Capital Trust (the "Company") was organized on January 6, 1998 as a real estate investment trust under the laws of the State of Texas. The Company was formed to take advantage of certain mid- to high-yield lending and investment opportunities in real estate related assets, including various types of commercial mortgage loans (including, among others, participating loans, mezzanine loans, acquisition loans, construction loans, rehabilitation loans and bridge loans), commercial mortgage-backed securities ("CMBS"), commercial real estate, equity investments in joint ventures and/or partnerships, and certain other real estate related assets. The Company was initially capitalized through the sale of 100 of its common shares of beneficial interest, par value $.01 per share (the "Common Shares"), to AMRESCO, INC. ("AMRESCO") on February 2, 1998 for $1,000. The Company commenced operations on May 12, 1998, concurrent with the completion of its initial public offering ("IPO") of 9,000,000 Common Shares and private placement of 1,000,011 Common Shares (the "Private Placement") at $15.00 per share. The net proceeds from the IPO and the Private Placement, after the underwriters' discount and offering expenses attributable to the IPO, aggregated approximately $139.7 million. Immediately after the closing of the IPO, the Company began originating and acquiring investments. As of September 30, 1998, the Company had fully invested the proceeds from the IPO and the Private Placement and had begun to leverage its investments. At December 31, 1998, the Company had debt outstanding, excluding non-recourse debt on real estate, of $39.3 million. The Company believes it has operated and it intends to continue to operate in a manner so as to continue to qualify as a real estate investment trust ("REIT") under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"). As a result, the Company will generally not be subject to federal income tax on that portion of its ordinary income or capital gain that is currently distributed to its shareholders if it distributes at least 95% of its annual REIT taxable income and it complies with a number of other organizational and operational requirements including, among others, those concerning the ownership of its outstanding Common Shares, the nature of its assets and the sources of its income. Pursuant to the terms of a Management Agreement dated as of May 12, 1998 and subject to the direction and oversight of the Board of Trust Managers, the Company's day-to-day operations and investment activities are managed by AMREIT Managers, L.P. (the "Manager"), an affiliate of AMRESCO (together with its affiliated entities, the "AMRESCO Group") which was formed in March 1998. For its services, the Manager is entitled to receive a base management fee equal to 1% per annum of the Company's average invested non-investment grade assets and 0.5% per annum of the Company's average invested investment grade assets. In addition to the base management fee, the Manager is entitled to receive incentive compensation in an amount equal to 25% of the dollar amount by which Funds From Operations (as defined by the National Association of Real Estate Investment Trusts), as adjusted, exceeds a certain threshold. In addition to the fees described above, the Manager is entitled to receive reimbursement for its costs of providing certain due diligence and professional services to the Company. Immediately after the closing of the IPO, the Manager was granted options to purchase 1,000,011 Common Shares; 70% of the options are exercisable at an option price of $15.00 per share (the "IPO Price") and the remaining 30% of the options are exercisable at an option price of $18.75 per share. The options vest ratably over a four-year period commencing on the first anniversary of the date of grant. AMREIT Holdings, Inc. ("Holdings"), a wholly-owned subsidiary of AMRESCO, currently owns 1,500,011 shares, or approximately 15% of the Company's outstanding common stock. Holdings acquired 1,000,011 shares at the IPO Price pursuant to the Private Placement; the remaining 500,000 shares were acquired through the IPO. AMRESCO owns 100 shares of the Company's outstanding common shares; as described above, these shares were acquired on February 2, 1998 in connection with the initial capitalization of the Company. Subject to certain limited exceptions, AMRESCO has granted to the Company a right of first refusal with respect to the first $100 million of targeted mortgage loan investments which are identified by or to any member of the AMRESCO Group during any calendar quarter and all mortgage-backed securities (other than mortgage-backed securities issued in securitizations sponsored in whole or in part by any member of the AMRESCO Group). Additionally, the Company has entered into a Correspondent Agreement with Holliday Fenoglio Fowler, L.P. ("HFF"), a member of the AMRESCO Group, pursuant to which HFF presents to the Company (on a non-exclusive basis) investment opportunities identified by HFF which meet the investment criteria and objectives of the Company. 2 3 EMPLOYEES The Company has no employees nor does it maintain a separate office. Instead, the Company relies on the facilities and resources of the Manager and its executive officers, each of whom is employed by AMRESCO. The Company is not a party to any collective bargaining agreements. AMRESCO is a publicly-traded, diversified financial services company specializing in real estate lending, asset management services and commercial finance. AMRESCO is headquartered in Dallas, Texas and has offices located throughout the United States, as well as internationally in Canada, the United Kingdom, Mexico and Japan. AMRESCO, which began operating in 1987, employs approximately 3,700 people. BUSINESS STRATEGY The Company's principal business objective is to maximize shareholder value by producing cash flow for distribution to its shareholders through investment in mid- to high-yield real estate related assets which earn an attractive spread over the Company's cost of funds. The Company intends to achieve this objective by making opportunistic investments while maintaining a conservative leverage position. Specifically, the Company's strategy is to: o Invest in senior mortgage loans, mezzanine loans, CMBS, commercial real estate (either directly or through investments in joint ventures and/or partnerships) and certain other opportunistic investments including, without limitation, foreign real estate and loans to borrowers in foreign countries or secured by foreign real estate (principally in the markets in which the AMRESCO Group conducts business) and distressed loans and/or real estate. The Company invests opportunistically, pursuing those investments which it believes will generate the highest risk-adjusted returns on capital invested, after considering all material relevant factors including, but not limited to, any limitations imposed by the Code as a result of its status as a REIT. o Take advantage of expertise existing within, and investment and co-investment opportunities arising from the business and operations of, the AMRESCO Group. During 1998, the Company acquired 10 loans from the AMRESCO Group at an aggregate purchase price of $39.7 million. o Utilize the expertise and resources of HFF to monitor trends and demands in the mortgage loan and real estate markets and to adjust its mortgage loan products in response thereto in order to increase its ability to successfully compete for investments. o Through the Manager, capitalize upon the market research capabilities of the AMRESCO Group to analyze the Company's investment opportunities and the economic conditions in the Company's proposed geographic markets to assist the Company in selecting investments which satisfy the Company's investment criteria and targeted returns. o Through the Manager, utilize the expertise of the AMRESCO Group in the underwriting, origination and closing of mortgage loans and in the acquisition, management and servicing of mortgage loans, mortgage loan portfolios and CMBS. o Borrow against or leverage its investments (through its existing credit facilities and any new sources of debt financing which the Company may be able to secure), to the extent consistent with the Company's leverage policies, in order to increase the size of its portfolio and increase potential returns to the Company's shareholders. Currently, the Company intends to maintain a debt to equity ratio of no more than 2.5 to 1, excluding non-recourse debt on real estate. At December 31, 1998, the Company's debt to equity ratio, excluding non-recourse debt on real estate, was 0.3 to 1. Including non-recourse debt on real estate, the Company's debt to equity ratio was 0.4 to 1 at December 31, 1998. The Company has used, and it expects that in the future it will use, repurchase agreements to finance a portion of its CMBS portfolio. These agreements often involve financing with a shorter term than the underlying assets being financed. In addition, repurchase agreements require margin calls if there is a dimunition of asset value due to spread widening or interest rate changes. Both of these risks result in a need for liquidity to either pay down or pay off repurchase agreement financing. The Company would be required to increase its leverage from its line of credit or sell assets in the event that repurchase agreement financing could not be obtained at maturity. o Implement various hedging strategies, including, but not limited to, interest rate swaps and interest rate collars, caps or floors (to the extent permitted by the REIT provisions of the Code) to minimize the effects of interest rate fluctuations 3 4 on its investments and its borrowings if, given the cost of such hedges and the Company's desire not to jeopardize its status as a REIT, the Manager determines that such strategies are in the best interest of the Company's shareholders. o Manage the credit risk of its assets by (i) extensively underwriting its investments utilizing the processes developed and utilized by the AMRESCO Group, (ii) selectively choosing its investments for origination or acquisition in compliance with the Company's investment policies, (iii) actively monitoring (through the servicing and asset management capabilities of the AMRESCO Group) the credit quality of its assets, and (iv) maintaining appropriate capital levels and allowances for credit losses. INVESTMENT ACTIVITIES General The Manager is authorized in accordance with the terms of the Management Agreement to make the day-to-day investment decisions of the Company based on guidelines in effect and approved from time to time by the Company's Board of Trust Managers. The Trust Managers review all transactions of the Company on a quarterly basis to determine compliance with the guidelines. Due to the typically higher risk nature of its investments, the Manager selectively and extensively underwrites the Company's targeted investments utilizing the expertise, processes and procedures developed by the AMRESCO Group. The Company operates exclusively as an investor in real estate related assets. Its asset allocation decisions and investment strategies are influenced by changing market factors and conditions. The Company has no policy requiring that any specific percentage of its assets be invested in any particular type or form of real estate investment nor does it limit any particular type or form of real estate investment (other than CMBS) to a specific percentage. CMBS investments, by policy, cannot exceed 40% of the Company's total consolidated assets. From time to time, the percentage of the Company's investments that will be invested in a particular category of real estate assets will vary. Future investment opportunities that may be available to the Company will depend upon many factors including, but not limited to, regional, national and international economic conditions. To date, the Company's investment activities have been focused in three primary areas: loan investments, CMBS and equity investments in real estate. Each of these investment categories is more fully described below. During the period from May 12, 1998 (inception of operations) through December 31, 1998, revenues derived from each of these categories were as follows (dollars in thousands):
Amount % of Total ------ ---------- Loan investments $4,834 55% Investments in CMBS 1,563 18 Equity investments in real estate 181 2 Other 2,167 25 ------ ------ $8,745 100% ====== ======
Revenues derived from loan investments are included in the Company's consolidated statement of income as follows: interest income on mortgage loans - $4,278,000; operating income from real estate - $211,000; and equity in earnings of other real estate ventures - $345,000. The Company provides financing through certain real estate loan arrangements that, because of their nature, qualify as either real estate or joint venture investments for financial reporting purposes. Such determination by the Company affects the balance sheet classification of these investments and the recognition of revenues derived therefrom. For a discussion of these loan arrangements as well as operating profit and information regarding the Company's assets, reference is made to the audited consolidated financial statements and notes thereto included in Item 8 of this report. Other is comprised principally of interest income which was derived from the temporary investment of the Company's IPO and Private Placement proceeds prior to their deployment in real estate related investments and, to a lesser extent, of income from its unconsolidated taxable subsidiary. The Company does not have, nor does it rely upon, any major customers. Consistent with its investments to date, the Company currently expects that a substantial portion of its new investments will be made in the form of senior mortgage loans. To date, the Company has made no investments outside of the United States nor has it made any investments in distressed loans and/or real estate, although it may do so in the future. 4 5 Loan Investments The Company specializes in providing mid- to high-yield senior and mezzanine financing to real estate owners and developers on a participating and non-participating basis. Mezzanine loans, the repayment of which is subordinated to senior mortgage loans, are secured by a second lien mortgage and/or a pledge of the ownership interests of the borrower. Mezzanine loans generally afford a relatively higher yield and entail greater risks than senior mortgage loans. Senior mortgage loans and mezzanine loans comprised 83% and 17%, respectively, of the Company's loan investment portfolio at December 31, 1998 (based on committed amount). The Company's existing mortgage loan commitments range in size from $0.5 million to $45 million; currently, the Manager, on behalf of the Company, is targeting loans ranging in size from $5 million to $20 million. The Company believes that its relationship with the AMRESCO Group and, in particular, HFF, one of the largest commercial mortgage bankers in the United States in 1998 (based on origination volume), provide the Company with a competitive advantage in sourcing loan and equity investment opportunities. During 1998, HFF sourced 45% of the Company's loan and equity real estate commitments (based on commitment amount). In addition to the product sourcing capabilities of HFF, the Manager relies upon its numerous business relationships, referral business and repeat customers in generating investment opportunities for consideration by the Company. Loan structures vary as they are usually customized to fit the characteristics and purpose of the loans. Generally, the Company's loans have terms ranging from one to three years. Many of the Company's loans, particularly construction and rehabilitation loans, provide for initial investments followed by subsequent advances as costs are incurred by the borrower. Typically, loans provide for a fixed pay rate and fixed accrual rate of interest and, in some cases, may also provide for profit participation above the contractual accrual rate. The incremental interest earned at the accrual rate is often times not payable by the borrower until maturity of the loan. At December 31, 1998, the Company had 21 loan investments which accrue interest at accrual rates ranging from 10.5% to 16% per annum; four of the 21 loan investments provide the Company with the opportunity for profit participation in excess of the contractual accrual rates. As of December 31, 1998, the Company's loan investments are summarized as follows (dollars in thousands):
Date of Initial Scheduled Collateral Investment Maturity Location Property Type Position - ----------------- -------------- ------------ --------------- ------------- May 12, 1998 March 31, 2001 Columbus, OH Mixed Use Second Lien (a) May 12, 1998 March 31, 2001 Richardson, TX Office Second Lien June 1, 1998 June 1, 2001 Houston, TX Office First Lien June 12, 1998 June 30, 2000 Pearland, TX Apartment First Lien June 17, 1998 June 30, 2000 San Diego, CA R&D/Bio-Tech First Lien June 19, 1998 June 18, 2000 Houston, TX Office First Lien June 22, 1998 June 19, 2000 Wayland, MA Office First Lien July 1, 1998 July 1, 2001 Dallas, TX Office Ptrshp Interests July 2, 1998 June 30, 2000 Washington, D.C. Office First Lien July 10, 1998 July 31, 2000 Pasadena, TX Apartment First Lien September 1, 1998 February 28, 2001 Los Angeles, CA Mixed Use First Lien September 30, 1998 October 30,1999 (b) Richardson, TX Office First Lien September 30, 1998 May 1, 2001 San Antonio, TX Residential Lots First Lien September 30, 1998 Various San Antonio, TX Residential Lots First Lien September 30, 1998 July 15, 1999 Galveston, TX Apartment First Lien September 30, 1998 June 8, 1999 Ft. Worth, TX Apartment Ptrshp Interests September 30, 1998 April 18, 1999 (c) Austin, TX Office First Lien September 30, 1998 June 30, 1999 Dallas, TX Medical Office First Lien September 30, 1998 July 22, 1999 Norwood, MA Industrial/Office First Lien October 1, 1998 April 30, 1999 Richardson, TX Office First Lien December 29, 1998 December 9, 1999 (d) San Antonio, TX Residential Lots First Lien AMRESCO Commercial Finance, Inc's Economic Interest Amount Outstanding at Interest Interest Date of Initial Commitment December 31, Pay Accrual Investment Amount 1998(g) Rate Rate --------------- ----------- ------------ -------- ------- May 12, 1998 $ 7,000 $ 6,839(e) 15.0% 15.0% May 12, 1998 14,700 10,811 10.0% 12.0% June 1, 1998 11,800 10,034 12.0% 12.0% June 12, 1998 12,827 4,237(f) 10.0% 11.5% June 17, 1998 5,560 3,994(f) 10.0% 13.5% June 19, 1998 24,000 6,682(f) 12.0% 12.0% June 22, 1998 45,000 24,962 10.5% 10.5% July 1, 1998 10,068 6,459(e) 10.0% 15.0% July 2, 1998 7,000 5,489 10.5% 10.5% July 10, 1998 3,350 2,614 10.0% 14.0% September 1, 1998 18,419 17,418 10.0% 12.0% September 30, 1998 13,001 10,277(f) 10.0% 14.0% September 30, 1998 3,266 2,059 16.0% 16.0% September 30, 1998 8,400 1,637 10.0% 14.0% September 30, 1998 3,664 3,664 10.0% 15.0% September 30, 1998 2,650 2,649 10.5% 16.0% September 30, 1998 6,325 6,314 10.0% 16.0% September 30, 1998 3,015 2,364 10.0% 13.0% September 30, 1998 8,765 7,733 10.0% 12.5% October 1, 1998 567 300 9.97% 15.0% December 29, 1998 255 255 16.0% 16.0% -------- -------- 209,632 136,791 AMRESCO Commercial Finance, Inc's Economic Interest (6,552) (4,857) -------- -------- $203,080 $131,934 ======== ========
(a) Loan was over 30 days past due as of December 31, 1998; on February 25, 1999, the Company's unconsolidated taxable subsidiary assumed control of the borrower (a partnership) through foreclosure of the partnership interests. (b) Loan was fully repaid on March 1, 1999. (c) Loan was purchased by a member of the AMRESCO Group on January 14, 1999. (d) Loan was fully repaid on February 3, 1999. (e) Accounted for as investment in joint venture for financial reporting purposes. (f) Accounted for as real estate for financial reporting purposes. (g) For all loan investments, payments of interest only are due monthly at the interest pay rate. All principal and all remaining accrued and unpaid interest are due at the scheduled maturities of the loans. 5 6 The Company provides financing through certain real estate loan arrangements that, because of their nature, qualify either as real estate or joint venture investments for financial reporting purposes (see notes [e] and [f] accompanying the table above). As of December 31, 1998, loan investments representing approximately $72,456,000 in aggregate commitments were accounted for as either real estate or joint venture interests; approximately $38,488,000 had been advanced to borrowers under the related agreements. For a discussion of these loan arrangements, see the notes to the audited consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data". AMRESCO Commercial Finance, Inc.'s economic interest and the loan referred to in note (a) accompanying the table above are more fully described in Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 7) and in the notes to the audited consolidated financial statements (Item 8). At December 31, 1998, the Company's loan investments were geographically dispersed as follows (dollars in millions):
% of Total Committed Loan Amount Committed Amount Outstanding Amount ----------- ----------- ----------- Texas $ 118 $ 70 56% Massachusetts 54 33 26 California 24 21 12 Ohio 7 7 3 Washington, D.C 7 6 3 ----------- ----------- ----------- $ 210 $ 137 100% =========== =========== ===========
At December 31, 1998, the Company's loan investments were collateralized by the following product types (dollars in millions):
% of Total Committed Loan Amount Committed Amount Outstanding Amount ----------- ----------- ----------- Office $ 132 $ 81 63% Mixed Use 26 24 12 Apartment 23 13 11 Other 29 19 14 ----------- ----------- ----------- $ 210 $ 137 100% =========== =========== ===========
The Company is obligated to fund its loan commitments to the extent that the borrowers are not in violation of any of the conditions established in the loan agreements. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee if amounts are repaid to the Company during certain prepayment lock-out periods. A portion of the commitments could expire without being drawn upon and therefore the total commitment amounts do not necessarily represent future cash requirements. Until the investment portfolio becomes larger, geographic and product type concentrations are expected. As the Company's loan portfolio grows, further geographic and product type diversification will be sought by the Manager. 6 7 The Company typically originates its loan investments; however, it may also purchase mortgage loans from other parties, including members of the AMRESCO Group. To the extent the Company acquires mortgage loans from the AMRESCO Group, such acquisitions are made in strict conformance with the Company's policies regarding transactions with the AMRESCO Group. During the period from May 12, 1998 (inception of operations) through December 31, 1998, the Company acquired 10 loans from the AMRESCO Group for an aggregate purchase price of $39.7 million. Currently, any proposed acquisition or sale of assets involving a member of the AMRESCO Group requires the prior approval of a majority of the Independent Trust Managers of the Investment Committee of the Board of Trust Managers. The underwriting process for loans takes into account special risks associated with mid- to high-yield lending, including an in-depth assessment of the character, experience (including operating history) and financial capacity of the borrower or the borrowers' principal(s), a detailed analysis of the property or project being financed and an analysis of the market in which the borrower operates, including competition, market share data, comparable properties, absorption rates and market rental rates as well as general information such as population, employment trends, median income and demographic data. Prior to closing, the Manager will either obtain a Phase I environmental assessment or review a recently obtained Phase I environmental assessment and at least one of the Manager's representatives will perform a site inspection. Sources of information which may be examined (if available) during the due diligence process include: (a) current and historical operating statements; (b) existing or new appraisals; (c) sales comparables; (d) industry statistics and reports regarding operating expenses; (e) existing leases and market rates for comparable leases; and (f) deferred maintenance observed during site inspections and described in structural and engineering reports. Using all of the information obtained during the due diligence process, the Manager then develops projections of net operating income and cash flows to determine current and expected exit values, as well as appropriate lending limits and pricing given the risks inherent in each transaction. As of December 31, 1998, the Company had no realized losses on its portfolio of outstanding loans and had established loan loss reserves of $1.3 million or 1% of its aggregate loan balances. One mezzanine loan, representing 5% of the Company's outstanding loan portfolio, was over 30 days past due as of December 31, 1998. On February 25, 1999, the Company's unconsolidated taxable subsidiary assumed control of the borrower (a partnership) through foreclosure of the partnership interests. Currently, the Company does not expect that the ultimate resolution of this investment will have a material adverse impact on its financial position or results of operations. Commercial Mortgage-backed Securities The Company acquires primarily non-investment grade classes of CMBS from various sources. In most commercial mortgage securitizations, a series of CMBS is issued in multiple classes in order to obtain investment-grade credit ratings for the senior classes (i.e., those with credit ratings of "BBB", "A", "AA" or "AAA") in order to increase their marketability. The non-investment grade, or subordinated classes, typically include classes with ratings below investment grade "BBB". Such subordinated classes also typically include an unrated higher-yield, credit-support class (which generally is required to absorb the first losses on the underlying mortgage loans). Each class of CMBS may be issued with a specific fixed rate or variable coupon rate and has a stated maturity or final scheduled distribution date. As the subordinated classes provide credit protection to the senior classes by absorbing losses from underlying mortgage loan defaults or foreclosures, they carry more credit risk than the senior classes. Subordinated classes are generally issued at a discount to their outstanding face value and therefore generally afford a higher yield than the senior classes. The Company's investments in CMBS are classified as available for sale and are carried at estimated fair value as determined by quoted market rates when available, otherwise by discounting estimated cash flows at current market rates. Any unrealized gains or losses are excluded from earnings and reported as a component of accumulated other comprehensive income (loss) in shareholders' equity. 7 8 During the period from May 12, 1998 (inception of operations) through December 31, 1998, the Company acquired five commercial mortgage-backed securities at an aggregate purchase price of $34.5 million. At December 31, 1998, the aggregate amortized cost and estimated fair value of CMBS, by underlying credit rating, were as follows (dollars in thousands):
Percentage of Security Aggregate Aggregate Aggregate Total Based Rating Amortized Cost Unrealized Loss Fair Value on Fair Value -------- -------------- --------------- ---------- -------------- BB- $ 4,233 $ (618) $ 3,615 13% B 19,489 (2,952) 16,537 57% B- 11,277 (2,675) 8,602 30% -------------- --------------- ---------- -------------- $ 34,999 $ (6,245) $ 28,754 100% ============== =============== ========== ==============
The Company has recorded an unrealized loss of $230,000, net of tax effects, related to one commercial mortgage-backed security owned by its unconsolidated taxable subsidiary. The unconsolidated taxable subsidiary acquired the security at a purchase price of $3.5 million. The unrealized loss on securities available for sale had no impact on the Company's taxable income or cash flow during 1998. Investments in CMBS comprised approximately 16.7% of the Company's investment portfolio at December 31, 1998. During the period from its inception of operations through December 31, 1998, the Company's investments in CMBS comprised an average of approximately 8.4% of the Company's investment portfolio. The Company expects to continue to have 15% to 20% of its invested capital (comprising equity and proceeds from its two credit facilities) allocated to CMBS. As of December 31, 1998, the Company's CMBS holdings and their anticipated maturity date were as follows:
Expected Class Security Name Maturity Date - ----- ------------------------------------------------------ ------------- G Merrill Lynch Mortgage Investors, Inc. Series 1998-C2 March 2013 H Merrill Lynch Mortgage Investors, Inc. Series 1998-C2 March 2013 J Merrill Lynch Mortgage Investors, Inc. Series 1998-C2 March 2014 G2 Morgan Stanley Capital I Series 1997 RR November 2022 B-2A Nomura Depositor Trust Series 1998-ST1A February 2003 B-3A Nomura Depositor Trust Series 1998-ST1A February 2003
The B-3A bond is owned by the Company's unconsolidated taxable subsidiary. To date, the Company has not directly acquired any unrated CMBS although it may do so in the future. In early 1999, the Company (through a minority-owned partnership) acquired a 5% interest in certain unrated CMBS which were purchased by the partnership for $830,000. Although the Company is not prohibited from investing in residential mortgage-backed securities, it has no present intention to do so. The Company may also invest in other mortgage derivative products (such as interest only and principal only securities); although it does not currently intend to acquire any of these securities directly, the Company (through a minority-owned partnership) acquired a 5% interest in certain interest only securities in early 1999. The interest only securities were acquired by the partnership at a total cost of $625,000. Because there are numerous characteristics to consider when evaluating CMBS for purchase, each CMBS is analyzed individually, taking into consideration both objective data as well as subjective analysis. The Manager's due diligence may include an analysis of (i) the underlying collateral pool, (ii) the prepayment and default history of the mortgage loans previously originated by the originator, (iii) cash flow analyses under various prepayment and interest rate scenarios (including sensitivity analyses) and (iv) an analysis of various default scenarios. However, which of these characteristics (if any) are important and how important each characteristic may be to the evaluation of a particular CMBS depends on the individual circumstances. The Manager uses sampling and other analytical techniques to determine on a loan-by-loan basis which mortgage loans will undergo a full-scope review and which mortgage loans will undergo a more streamlined review process. Although the choice is a subjective one, considerations that influence the choice for scope of review often include mortgage loan size, debt service coverage ratio, loan-to-value ratio, mortgage loan maturity, lease rollover, property type and geographic location. A full-scope review may include, among other factors, a site inspection, tenant-by-tenant rent roll analysis, review of historical income and expenses for each property securing the mortgage loan, a review of major leases for each property (if available); recent appraisals (if available), engineering and environmental reports (if available), and the 8 9 price paid for similar CMBS by unrelated third parties in arm's length purchases and sales (if available) or a review of broker price opinions (if the price paid by a bona fide third party for similar CMBS is not available and such price opinions are available). For those mortgage loans that are selected for the more streamlined review process, the Manager's evaluation may include a review of the property operating statements, summary loan level data, third party reports, and a review of prices paid for similar CMBS by bona fide third parties or broker price opinions, each as available. If the Manager's review of such information does not reveal any unusual or unexpected characteristics or factors, no further due diligence will be performed. Equity Investments in Real Estate The Company has made and intends to continue to make equity investments in real estate. Such investments may be made directly by the Company or through partnerships and/or joint ventures. The Company expects to acquire real estate or interests therein on a leveraged basis that will provide sufficient cash flow to provide a return on its investment after debt service within the Company's target parameters. The tax depreciation associated with these investments is used to offset the non-cash accrual of interest on certain loan investments and original issue discount generally associated with CMBS. During the period from May 12, 1998 (inception of operations) through December 31, 1998, the Company entered into a partnership that will ultimately acquire interests in five newly constructed, grocery-anchored shopping centers in the Dallas/Fort Worth (Texas) area. The Company holds a 99.5% interest in the partnership. In October 1998, the Company (through the partnership) acquired the first of these five centers, an 82,730 square foot facility in Arlington, Texas, for approximately $10.3 million. In connection with this acquisition, the title-holding partnership obtained a $7.5 million non-recourse loan from an unaffiliated third party. Immediately prior to the closing, the Company contributed $3.4 million of capital to the partnership. The proceeds from this contribution were used, in part, to fund the balance of the purchase price and to pay partnership formation expenses and costs associated with the non-recourse financing. The remaining four centers, initially comprising approximately 320,000 net rentable square feet, are expected to be acquired at an aggregate purchase price of approximately $39.6 million. In anticipation of these acquisitions, the partnership has secured permanent, non-recourse financing commitments from an unaffiliated third party aggregating $27.1 million. The balance of the acquisition costs, totaling approximately $12.5 million, will be funded by the Company (via equity contributions to the partnership). The Company anticipates that the remaining four centers will be acquired during the second and third quarters of 1999 after the completion of construction and satisfaction of certain other closing conditions. After the acquisitions are completed, the Company expects to construct an additional 62,000 square feet of space. It is currently anticipated that the development costs will be financed with an additional $1 million equity contribution from the Company and $3.8 million of third party financing proceeds. The Company does not operate the real estate owned by the partnership, but rather it relies upon a qualified and experienced real estate operator unaffiliated with the Company. Future investments will be similarly managed by experienced third party operators. In considering potential equity investments in real estate, the Manager performs due diligence substantially similar to that described above in connection with the acquisition or origination of loan investments. COMPETITION The Company competes in the acquisition and origination of investments with a significant number of other REITs, investment banking firms, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, credit companies and other entities, some of which have greater financial resources than the Company. In addition, there are several REITs similar to the Company, and others may be organized in the future. The effect of the existence of such additional investors may be to increase competition for the available supply of targeted investments. The availability of targeted investments is dependent upon, among other things, the size of and level of activity in the commercial real estate lending market, which depend on various factors, including the level of interest rates, regional and national economic conditions and inflation and deflation in commercial real estate values. To the extent the Company is unable to acquire and maintain a sufficient volume of investments, the Company's income and the Company's ability to make distributions to its shareholders will be adversely affected. In addition, the Company (to the extent the Company owns commercial real estate directly or through investments in joint ventures and/or partnerships) and the owners of real properties securing the Company's mortgage loans compete with numerous other owners and operators of similar properties, including commercial developers, real estate companies and REITs, many of which may have greater financial and other resources and more operating experience than the Company or the owners of real properties securing the Company's mortgage loans, as applicable. The Company expects that many of 9 10 the real properties which may be owned by it and those owned and operated by borrowers under its mortgage loans will be located in markets or submarkets in which significant construction or rehabilitation of properties may occur, which could result in overbuilding in such markets or submarkets. Any such overbuilding could adversely impact the ability of the Company to lease its properties and the ability of the borrowers under the Company's mortgage loans to lease their respective properties and repay their mortgage loans, which could, in turn, adversely impact the Company's income and its ability to make distributions to its shareholders. There are an estimated 25 to 40 significant competitive structured finance lenders competing against the Company. The Company ranks on the lower end on volume and on the upper end on return on assets in this group of lenders. The Company believes it is competitive as a finance company due to its ability and willingness to customize financing structures. The Company may be less competitive at times due to its relatively small capitalization and lack of low cost capital. ENVIRONMENTAL MATTERS The value and operating costs of real estate acquired by the Company may be affected by the obligation to pay for the cost of complying with existing and future environmental legislation under which a current or previous owner or operator of real estate may be liable for the remediation of hazardous or toxic substances on, under or in such real estate. As a part of the Manager's due diligence activities, Phase I environmental assessments are obtained on all real estate to be acquired by the Company and on the real estate collateralizing its loan investments. The purpose of Phase I environmental assessments is to identify potential environmental contamination that is made apparent from historical reviews of the real estate, reviews of certain public records, preliminary (non-invasive) investigations of the sites and surrounding real estate, and screening of relevant records for the presence of hazardous substances, toxic substances and underground storage tanks. There can be no assurance that such assessments will reveal all existing or potential environmental risks and liabilities, nor that there will be no unknown or material environmental obligations or liabilities. Based on these assessments, the Company believes that its real estate investments and the real estate underlying its loan investments are in compliance, in all material respects, with all federal, state and local ordinances and regulations regarding hazardous or toxic substances and other environmental matters, the violation of which could have a material adverse effect on the Company or the borrowers, as applicable. The Company has not been notified by any governmental authority of any material noncompliance, liability or claim relating to hazardous or toxic substances or other environmental matters in connection with any of its owned properties nor is it aware of any such noncompliance with respect to the real estate collateralizing its loan investments. INDUSTRY TRENDS Although it began on a positive note, 1998 was an extremely difficult year for REITs in general and mortgage REITs in particular. Even though real estate fundamentals generally remain strong in most markets, the poor price performance of REIT stocks appears to have begun early in the year with the departure of many growth and momentum investors from this market sector. Downward pressure on REIT stock prices adversely affected the ability of REITs to access the capital markets for new equity. REITs are limited in their ability to grow through retained earnings because they are required to distribute at least 95% of their REIT taxable income annually. In order to continue to grow its asset base, a REIT must raise new capital either in the form of equity or debt. Although seven initial public offerings for mortgage REITs were conducted in 1998, the last offering occurred on May 28, 1998, only 16 days after the completion of the Company's IPO. The last capital markets transaction involving a mortgage REIT was completed on June 29, 1998. Mortgage REIT stock prices were further jolted in August 1998 by Russia's default on its debt payments and in October 1998 by the Chapter 11 bankruptcy filing of CRIIMI MAE Inc., a mortgage REIT principally focused on subordinated CMBS. In addition to limitations on access to additional equity, the Office of the Comptroller of Currency warned federally regulated lenders about its concern over the amount of debt, particularly unsecured debt, being extended to REITs. This appears to have caused banks to reduce their level of lending to the REIT industry and other lenders followed suit. The ability to raise new capital through the issuance of public debt or preferred stock has also been limited due to many of the factors affecting new equity issues, but was further impacted by a flight on the part of bond investors to U.S. Treasury bonds which was triggered by Russia's debt default. The result was a large increase in the premium over U.S. Treasury bonds required by investors on other types of bonds through all ratings classifications. This bond spread widening not only increased the cost of borrowing, but had a severe negative impact on commercial mortgage REITs that were holding large portfolios of commercial mortgage-backed securities because the value of those securities declined significantly and in some cases precipitated large margin calls. 10 11 The Company expects that the capital markets for additional equity will re-open at some point in the future, but that the current conditions will prevail for an indeterminate time. This limited access to new equity has been predicted to lead to an increase in merger and acquisition activity within the REIT sector. The Company has also noted that a number of companies within the commercial mortgage REIT sector have begun to liquidate some of their assets. In the interim, the Company's growth will be limited by the availability under its credit facilities and to the borrowing restrictions imposed by its lenders. For additional discussion regarding these trends and the Company's response thereto, reference is made to the Liquidity and Capital Resources section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of this report. RECENT DEVELOPMENTS Given the capital constraints currently limiting the Company's growth, it has sought to form alliances with third parties who have similar investment objectives. To that end, the Company recently entered into a partnership with Olympus Real Estate Corporation ("Olympus") for the purpose of making investments similar to those made by the Company. The Company, through certain of its subsidiaries, holds a 5% minority interest in the partnership with Olympus and could further benefit through a disproportionate percentage of cash flow to the extent that certain return thresholds are met. The Company has committed to invest $5 million in the partnership and it has an option (which expires on August 2, 1999) to invest an additional $5 million. Olympus has committed to invest $95 million in the partnership subject to adjustment in the event that the Company exercises its option. The Company made its initial capital contribution to the partnership, totaling $657,000, on February 12, 1999. On February 25, 1999, the Company's Board of Trust Managers adopted a shareholder rights plan (the "Plan"). The Plan was adopted in response to the consolidation trend in the REIT industry rather than in response to any specific proposals or communications. The Plan is designed to provide the Company's Board of Trust Managers with negotiating leverage in dealing with a potential acquirer, to protect the Company from unfair and abusive takeover tactics and to prevent an acquirer from gaining control of the Company without offering a full and fair price to all shareholders. The Plan is not intended to prevent an acquisition beneficial to all of the Company's shareholders. In connection with the adoption of the Plan, the Board of Trust Managers declared a dividend of one preferred share purchase right (a "Right") for each outstanding Common Share of the Company. The dividend was paid on March 11, 1999 to shareholders of record on March 11, 1999. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a newly created Series A Junior Participating Preferred Share ("Preferred Share") for $37.50 per one one-hundredth of a Preferred Share. The Rights trade with the Company's Common Shares and are not exercisable until a triggering event, as defined, occurs. 11 12 PART II ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW AMRESCO Capital Trust (the "Company") is a real estate investment trust ("REIT") which was formed in early 1998 to take advantage of certain mid- to high-yield lending and investment opportunities in real estate related assets, including various types of commercial mortgage loans (including, among others, participating loans, mezzanine loans, acquisition loans, construction loans, rehabilitation loans and bridge loans), commercial mortgage-backed securities ("CMBS"), commercial real estate, equity investments in joint ventures and/or partnerships, and certain other real estate related assets. Subject to the direction and oversight of the Board of Trust Managers, the Company's day-to-day operations are managed by AMREIT Managers, L.P. (the "Manager"), an affiliate of AMRESCO, INC. (together with its affiliated entities, the "AMRESCO Group"). The Company commenced operations on May 12, 1998 concurrent with the completion of its initial public offering ("IPO") of 9,000,000 common shares and private placement of 1,000,011 common shares with AMREIT Holdings, Inc., a wholly-owned subsidiary of AMRESCO, INC. (the "Private Placement"). As of September 30, 1998, the Company had fully invested the net proceeds from the IPO and the Private Placement totaling $139.7 million and had begun to leverage its investments. At December 31, 1998, the Company had debt outstanding, excluding non-recourse debt on real estate, of $39.3 million. To date, the Company's investment activities have been focused in three primary areas: loan investments, CMBS and equity investments in real estate. The Company expects that its mid- to high-yield loan investments and, to a lesser extent, equity investments in real estate, will continue to comprise a substantial portion of its investment portfolio. Similarly, the Company expects to continue to have 15% to 20% of its invested capital (comprising equity and proceeds from its two credit facilities) allocated to CMBS. Additionally, the Company expects to make several of these investments through one or more partnerships in which it holds a minority ownership interest (i.e., 5% to 10%). In early 1999, one such partnership was formed. Due to the dislocation in the capital markets which occurred in mid to late 1998, the Company's investment activities slowed dramatically during the fourth quarter. After closing a total of 26 investments during the period from May 12, 1998 through September 30, 1998, the Company closed just two new loan investments totaling $0.8 million in the fourth quarter. This reduction in new investments was not due to a lack of investment opportunities but rather was in response to the capital constraints imposed upon the Company. Despite the lack of new investment activity during the fourth quarter, the Company advanced $25 million under structured loan commitments it had closed on or prior to September 30, 1998. The capital markets' upheaval and the Company's response thereto are discussed further in the Liquidity and Capital Resources section below. The Company believes it has operated and it intends to continue to operate in a manner so as to continue to qualify as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"). As such, the Company has distributed and it intends to continue to distribute at least 95% of its REIT taxable income annually. The Company may experience high volatility in financial statement net income and tax basis income from quarter to quarter and year to year, primarily as a result of fluctuations in interest rates, borrowing costs, reinvestment opportunities, prepayment rates and favorable and unfavorable credit related events (e.g., profit participations or credit losses). Additionally, the Company's accounting for certain real estate loan arrangements as either real estate or joint venture investments may contribute to volatility in financial statement net income. Because changes in interest rates may significantly affect the Company's activities, the operating results of the Company will depend, in large part, upon the ability of the Company to manage its interest rate, prepayment and credit risks, while maintaining its status as a REIT. The following discussion of results of operations and liquidity and capital resources should be read in conjunction with the audited consolidated financial statements and notes thereto included in "Item 8. Financial Statements and Supplementary Data". In particular, reference is made to Note 13 concerning the reconciliation of financial statement net income to tax basis income. 12 13 RESULTS OF OPERATIONS General The Company commenced operations on May 12, 1998. Under generally accepted accounting principles, net income for the period from May 12, 1998 (inception of operations) through December 31, 1998 was $3,952,000, or $0.39 per common share. The Company had no income during the period from February 2, 1998 (date of initial capitalization) through May 11, 1998. The Company's primary sources of revenue for the period from May 12, 1998 through December 31, 1998, totaling $8,745,000, were as follows: o $4,834,000 from loan investments. As certain of the Company's loan investments are accounted for as either real estate or joint venture investments for financial reporting purposes, these revenues are included in the consolidated statement of income as follows: interest income on mortgage loans - $4,278,000; operating income from real estate - $211,000; and equity in earnings of other real estate ventures - $345,000. The loan investments earn interest at accrual rates ranging from 10.5% to 16% per annum as of December 31, 1998. o $1,924,000 of other interest income generated primarily from the temporary investment of proceeds from the IPO and Private Placement. o $1,563,000 from investments in commercial mortgage-backed securities. o $181,000 of operating income from real estate owned by the Company (through a majority-owned partnership). Revenue increased during the period from May 12, 1998 through December 31, 1998 as funds from the IPO and the Private Placement were invested in real estate related assets and the Company began to utilize its financing facilities. The Company incurred expenses of $4,793,000 for the period from May 12, 1998 through December 31, 1998, consisting primarily of the following: o $1,187,000 of management fees, including $835,000 of base management fees payable to the Manager pursuant to the Management Agreement and $352,000 of expense associated with compensatory options granted to the Manager. No incentive fees were incurred during the period. o $1,294,000 of general and administrative costs, including approximately $330,000 of due diligence costs associated with an abandoned transaction, $396,000 for professional services, $162,000 for directors and officers' insurance, $140,000 of reimbursable costs pursuant to the Management Agreement, $68,000 related to compensatory options granted to certain members of the AMRESCO Group and $56,000 related to restricted stock awards to the Company's Independent Trust Managers. o $567,000 of interest expense (net of capitalized interest totaling $57,000) associated with the Company's credit facilities and a non-recourse loan secured by real estate. Substantially all of this interest expense was incurred during the fourth quarter of 1998 as the Company began to leverage its investments on September 30, 1998. o $1,368,000 of provision for loan losses. No realized loan losses were incurred by the Company during the period. One loan, representing 5% of the Company's outstanding loan portfolio, was over 30 days past due as of December 31, 1998; this loan is discussed further in this section of Management's Discussion and Analysis of Financial Condition and Results of Operations under the sub-heading "Loan Investments". 13 14 The Company's policy is to distribute at least 95% of its REIT taxable income to shareholders each year; to that end, dividends are paid quarterly. Tax basis income differs from income reported for financial reporting purposes due primarily to differences in methods of accounting for ADC loan arrangements and stock-based compensation awards and the nondeductibility, for tax purposes, of the Company's loan loss reserve (for a discussion of ADC loan arrangements and a reconciliation of financial statement net income to tax basis income, see the notes to the audited consolidated financial statements included in Item 8 of this report). As a result of these accounting differences, net income under generally accepted accounting principles is not necessarily an indicator of distributions to be made by the Company. To date, the following dividends have been declared (dollars in thousands, except per share amounts):
Dividend per Declaration Record Payment Dividend Common Date Date Date Paid Share ----------------- ---------------- ---------------- -------- ------------ Period from May 12, 1998 through June 30, 1998 July 23, 1998 July 31, 1998 August 17, 1998 $ 1,001 $ 0.10 Third Quarter October 22, 1998 October 31, 1998 November 16, 1998 2,401 0.24 Fourth Quarter December 15, 1998 December 31, 1998 January 27, 1999 4,002 0.40 -------- ------------ $ 7,404 $ 0.74 ======== ============
For federal income tax purposes, all 1998 dividends were reported as ordinary income to the Company's shareholders. The Company has announced its 1999 dividend payment schedule as follows (dates are subject to change):
Expected Expected Expected Declaration Record Payable Date Date Date ----------------- ----------------- ----------------- First Quarter April 22, 1999 April 30, 1999 May 17, 1999 Second Quarter July 22, 1999 July 31, 1999 August 16, 1999 Third Quarter October 21, 1999 October 31, 1999 November 15, 1999 Fourth Quarter December 15, 1999 December 31, 1999 January 27, 2000
Loan Investments During the period from May 12, 1998 through December 31, 1998, the Company assembled a portfolio of 21 loans, representing $209.6 million in aggregate commitments; eleven of these loans were originated by the Company while two of the loans were acquired from AMRESCO Funding Corporation ("AFC") and eight of the loans were acquired from AMRESCO Commercial Finance, Inc. ("ACFI"), both of whom are members of the AMRESCO Group. As of December 31, 1998, $136.8 million had been advanced under these facilities. A portion of the commitments may expire without being drawn upon and therefore the total commitment amounts do not necessarily represent future cash requirements. After giving effect to ACFI's economic interest (as further described below), commitments and amounts outstanding totaled approximately $203 million and $132 million, respectively, at December 31, 1998. The two loans were acquired from AFC immediately after the closing of the IPO at an aggregate cash purchase price of $5,433,000, including accrued interest and as adjusted for unamortized loan commitment fees. The eight loans were acquired from ACFI on September 30, 1998 pursuant to two separate agreements. The first agreement provided for the purchase of three loans at an aggregate cash purchase price of $11,314,000, including accrued interest of $137,000. The second agreement provided for the purchase of five loans at an aggregate cash purchase price of $22,978,000, including accrued interest of $675,000. Immediately following the purchase of the five loans, the Company sold to ACFI a contractual right to collect from the Company an amount equal to the economic equivalent of all amounts collected from the five loans in excess of (i) $17,958,000 and (ii) a return on this amount, or so much of it as is outstanding from time to time, equal to 12% per annum. The aggregate cash sales price of $5,020,000 had the effect of reducing the Company's credit exposure with respect to such loans. The sales price was comprised of $4,345,000 which had the effect of reducing the Company's net investment in such loans; the balance of the sales price, or $675,000, equated to the amount of interest which was accrued under the five loan agreements as of September 30, 1998. As additional consideration, ACFI agreed to 14 15 immediately reimburse the Company for any additional advances which are required to be made under the five loan agreements. At December 31, 1998, ACFI's contingent obligation for these additional advances approximated $1,695,000. Based upon the amounts committed under these facilities and after giving effect to the contractual right sold to ACFI, the Company's portfolio of commercial mortgage loans had a weighted average interest pay rate of 10.9% and a weighted average interest accrual rate of 12.2% as of December 31, 1998. In cases where the Company has originated loans, the borrowers paid a commitment fee to the Company that is in addition to interest payments due under the terms of the loan agreements. Commitment fees are deferred and recognized over the life of the loan as an adjustment of yield or, in those cases where loan investments are classified as either real estate or joint ventures for financial reporting purposes, such fees are deferred and recognized upon the disposition of the investment. Eight of the 21 loans provide for profit participation above the contractual accrual rate; four of these eight facilities are included in the pool of loans in which ACFI has a contractual right to collect certain excess proceeds, as described above. A mezzanine (second lien) loan with an outstanding balance of $6,839,000 (or 5% of the Company's outstanding loan portfolio) was over 30 days past due as of December 31, 1998. On February 25, 1999, an unconsolidated taxable subsidiary of the Company assumed control of the borrower (a partnership) through foreclosure of the partnership interests. In addition to the second lien mortgage, the property is encumbered by a $17 million first lien mortgage. To date, all interest payments have been made in accordance with the terms of the first lien mortgage. During the period from May 12, 1998 through December 31, 1998, this loan investment generated financial statement and tax basis revenues of $345,000 and $621,000, respectively. The allowance for loan losses related to this investment totaled $500,000 at December 31, 1998, which amount represented management's estimate at that time of the amount of the expected loss which could result upon a disposition of the collateral. Should the Company incur an actual loss on this investment, tax basis income would be adversely affected. Management does not currently believe that this investment, when ultimately resolved, will have a material impact on the Company's financial position or results of operations. At December 31, 1998, the Company's commercial mortgage loan commitments were geographically dispersed in four states and the District of Columbia: Texas (56%); Massachusetts (26%); California (12%); Ohio (3%); and Washington, D.C. (3%). The underlying collateral for these loans was comprised of the following property types: office (63%); mixed use (12%); multifamily (11%); residential (6%); industrial (4%); R&D/Bio-Tech (3%); and medical office (1%). Construction loans, acquisition/rehabilitation loans, acquisition loans, single-family lot development loans and bridge loans comprised 33%, 31%, 27%, 6% and 3% of the portfolio, respectively. Eighty-three percent of the portfolio is comprised of first lien loans while the balance of the portfolio (17%) is secured by second liens and/or partnership interests. The percentages reflected above are based upon committed loan amounts and give effect to ACFI's economic interest. Until the loan investment portfolio becomes larger, geographic and product type concentrations are expected. The Company expects to see more diversification both geographically and by product type as the loan portfolio grows. Geographic and product type concentrations present additional risks, particularly if there is a deterioration in the general condition of the real estate market or in the sub-market in which the loan collateral is located, or if demand for a particular product type does not meet expectations due to adverse market conditions that are different from those projected by the Company. In an effort to reduce concentration risks, the Company is targeting transactions which will more broadly diversify its loan investment portfolio. Commercial Mortgage-backed Securities As of December 31, 1998, the Company holds five commercial mortgage-backed securities ("CMBS") which were acquired at an aggregate purchase price of $34.5 million. All of these securities were acquired on or before September 1, 1998. Due to the significant widening of spreads in the CMBS market, the value of the Company's CMBS holdings declined by $6.245 million; accordingly, the Company recorded an unrealized loss of $6.245 million on its CMBS portfolio as of December 31, 1998. Additionally, the Company recorded an unrealized loss of $230,000, net of tax effects, related to one commercial mortgage-backed security owned by its unconsolidated taxable subsidiary; the security held by this subsidiary has a rating of "B-". As these securities are classified as available for sale, the unrealized loss was reported as a component of accumulated other comprehensive income (loss) in shareholders' equity for financial reporting purposes. The unrealized loss had no impact on the Company's taxable income or cash flow. Management intends to retain these investments for the foreseeable future. Furthermore, these investments were not leveraged as of December 31, 1998. Excluding the potential tax effects associated with the security held by the Company's unconsolidated taxable subsidiary, the weighted average unleveraged yield over the expected life of these investments is expected to approximate 11.4%. The Company's direct CMBS investments are summarized as follows (dollars in thousands): 15 16
Percentage of Security Aggregate Aggregate Total Based Rating Amortized Cost Fair Value on Fair Value - -------- -------------- ---------- ------------- BB- $ 4,233 $ 3,615 13% B 19,489 16,537 57% B- 11,277 8,602 30% ------- ------- ------- $34,999 $28,754 100% ======= ======= =======
The Company's estimated returns on its CMBS investments are based upon a number of assumptions that are subject to certain business and economic risks and uncertainties including, but not limited to, the timing and magnitude of prepayments and credit losses on the underlying mortgage loans that may result from general and/or localized real estate market factors. These risks and uncertainties are in many ways similar to those affecting the Company's commercial mortgage loans. These risks and uncertainties may cause the actual yields to differ materially from expected yields. Equity Investments in Real Estate During the period from May 12, 1998 (inception of operations) through December 31, 1998, the Company entered into a partnership that will ultimately acquire interests in five newly constructed, grocery-anchored shopping centers in the Dallas/Fort Worth (Texas) area. The Company holds a 99.5% interest in the partnership. In October 1998, the Company (through the partnership) acquired the first of these five centers, an 82,730 square foot facility in Arlington, Texas, for approximately $10.3 million. In connection with this acquisition, the title-holding partnership obtained a $7.5 million non-recourse loan from an unaffiliated third party. Immediately prior to the closing, the Company contributed $3.4 million of capital to the partnership. The proceeds from this contribution were used, in part, to fund the balance of the purchase price and to pay partnership formation expenses and costs associated with the non-recourse financing. The remaining four centers, initially comprising approximately 320,000 net rentable square feet, are expected to be acquired at an aggregate purchase price of approximately $39.6 million. In anticipation of these acquisitions, the partnership has secured permanent, non-recourse financing commitments from an unaffiliated third party aggregating $27.1 million. The balance of the acquisition costs, totaling approximately $12.5 million, will be funded by the Company (via equity contributions to the partnership). The Company anticipates that the remaining four centers will be acquired during the second and third quarters of 1999 after the completion of construction and satisfaction of certain other closing conditions. After the acquisitions are completed, the Company expects to construct an additional 62,000 square feet of space. It is currently anticipated that the development costs will be financed with an additional $1 million equity contribution from the Company and $3.8 million of third party financing proceeds. LIQUIDITY AND CAPITAL RESOURCES The Company's ability to execute its business strategy, particularly the growth of its investment and loan portfolio, depends to a significant degree on its ability to obtain additional capital. The Company's principal demands for liquidity are cash for operations, including funds for its lending activities and other investments, interest expense associated with its indebtedness, debt repayments and distributions to its shareholders. In the near term, the Company's principal sources of liquidity are the funds available to it under its financing facilities described below. Effective as of July 1, 1998, the Company (and certain of its subsidiaries) entered into a $400 million credit facility (the "Line of Credit") with Prudential Securities Credit Corporation ("PSCC"). Subject to PSCC's approval on an asset by asset basis, borrowings under the facility can be used to finance the Company's structured loan and equity real estate investments. As a result of the capital market trends discussed below, PSCC became more restrictive in the application of its approval rights with respect to financing for new investments sought by the Company; accordingly, very few new investments were consummated during the fourth quarter of 1998. Borrowings under the Line of Credit bear interest at rates ranging from LIBOR plus 1% per annum to LIBOR plus 2% per annum and are secured by a first lien security interest in all assets funded with proceeds from the Line of Credit. The Line of Credit matures on July 1, 2000. At December 31, 1998, $39,338,000 had been borrowed under the Line of Credit. The weighted average interest rate at December 31, 1998 was 6.65%. To reduce the impact that rising interest rates would have on this floating rate indebtedness, the Company entered into an interest rate cap agreement effective January 1, 1999. The agreement, which expires on July 1, 2000, has a notional amount of $33,600,000. The agreement entitles the Company to receive from a counterparty the amounts, if any, by which one month LIBOR exceeds 6.0%. There are no margin requirements associated with interest rate caps and therefore there is no liquidity risk associated with this particular hedging instrument (see Item 7A. "Quantitative and Qualitative Disclosures About Market Risk"). 16 17 Effective as of July 1, 1998, the Company (and certain of its subsidiaries) entered into a $100 million Master Repurchase Agreement (the "Repurchase Agreement") with PSCC; subsequently, PSCC was replaced by Prudential-Bache International, Ltd. ("PBI"), an affiliate of PSCC, as lender. Borrowings under the Repurchase Agreement can be used to finance a portion of the Company's portfolio of mortgage-backed securities. The Repurchase Agreement provides that the Company may borrow a varying percentage of the market value of the purchased mortgage-backed securities, depending on the credit quality of such securities. Borrowings under the Repurchase Agreement bear interest at rates ranging from LIBOR plus 0.20% per annum to LIBOR plus 1.5% per annum depending upon the advance rate and the credit quality of the securities being financed. Borrowings under the facility are secured by an assignment to PBI of all mortgage-backed securities funded with proceeds from the Repurchase Agreement. The Repurchase Agreement matures on June 30, 2000. The Company borrowed $5.1 million under this facility on September 30, 1998; these borrowings were repaid on October 23, 1998 with proceeds from the Line of Credit described above. No additional amounts have since been drawn on the Repurchase Agreement. 17 18 Under the terms of the Line of Credit and the Repurchase Agreement, PSCC and PBI, respectively, retain the right to mark the underlying collateral to market value. A reduction in the value of its pledged assets may require the Company to provide additional collateral or fund margin calls. From time to time, the Company may be required to provide such additional collateral or fund margin calls. The Company believes that the funds available under its two credit facilities, without modification, will be sufficient to meet the Company's liquidity and committed capital requirements in 1999. However, in order to fund growth beyond its existing commitments, the Company will need to modify its existing Line of Credit and/or raise additional funds for operations through future public or private equity and debt offerings and/or by leveraging its investments through additional secured and unsecured financings and other borrowing arrangements. In the absence of more flexible credit terms or additional sources of financing, the Company will be limited from making any significant commitments to new loan and/or equity transactions until existing loan investments are repaid by borrowers. As a result, financial statement net income and tax basis income will temporarily be adversely affected until repayment proceeds can be redeployed in real estate related assets. The Company intends to renew the Line of Credit and the Repurchase Agreement or enter into similar or additional secured lending arrangements with institutional lenders in the future, although there can be no assurances that the Company will be able to obtain renewed or additional financing on acceptable terms. The capital market fluctuations that began during the third quarter of 1998 (and which continued into the fourth quarter) have, at least in the near term, diminished the Company's access to additional capital and have restricted its ability to expand its asset base. These capital market fluctuations resulted in a global investor flight to low risk investments. During the latter part of the year, spreads on high yield and mortgage-backed bonds widened significantly resulting in a marked decline in the market value of CMBS and a general lessening of liquidity for the lower rated classes of CMBS. Substantial margin calls related to certain hedge positions were brought on by steep declines in U.S. Treasury rates. The combination of spread widening and hedge losses created severe liquidity problems for some companies, including many companies within the mortgage REIT sector. The Company's emphasis on structured finance transactions (as opposed to CMBS) and its conservative use of leverage and avoidance of hedge positions which would subject it to liquidity risk have all contributed to the Company's ability to avoid the liquidity problems faced by many of these companies. Management currently believes that the dislocation in the capital markets will not extend long-term; however, its duration is impossible to predict at this time. In the near term, the Company believes it will be constrained from accessing the public equity markets. In addition, new issues of long-term public unsecured debt will be difficult to obtain and, in any event, will likely not be available to the Company at a reasonable cost. Additional secured debt beyond the Company's existing Line of Credit will also be difficult to obtain and may not be offered at a reasonable cost. Aside from limiting the Company's access to additional capital in the near term to fund growth, the Company has been relatively insulated from the effects of the dislocation in the capital markets. While the market value of the Company's CMBS holdings has declined, the Company invested in these bonds for the long term yields that they are expected to produce. Management believes that the current market dislocation presents significant investment opportunities for selective acquisitions of CMBS and that the fundamental value of the real estate mortgages underlying these bonds has been largely unaffected to date, although general economic conditions could adversely impact real estate values in the future. In order to address its capital constraints and certain concerns expressed by PSCC with respect to the Line of Credit, the Company has initiated discussions with PSCC. These discussions are intended to increase the flexibility of the Line of Credit. While discussions are on-going, there can be no assurances that an agreement will eventually be reached. In the event that modifications to the Line of Credit can be successfully concluded, management believes that the Company's growth will continue, albeit at a slower rate than was achieved in 1998. However, in view of the uncertainties in the capital markets, management believes that it is prudent to maintain low leverage and greater liquidity. Therefore, it is unlikely that the Company will add additional assets if such addition were to result in a debt to equity ratio exceeding 2.5 to 1, excluding non-recourse debt on real estate. As of December 31, 1998, the Company's debt to equity ratio, excluding non-recourse debt on real estate, was 0.3 to 1. The Company also intends to closely monitor any financing that it may place on the Company's existing CMBS portfolio in an effort to minimize the risk of margin calls. Despite the uncertainties in the public debt and equity markets, management believes that there are other potential sources of capital available to entities like the Company, including banks and other financial institutions which lend to entities that 18 19 originate commercial mortgage loans and/or acquire CMBS. Management is actively exploring the availability of capital from these other sources and the costs associated therewith. However, there can be no assurances that such capital will become available at a reasonable cost. Given the capital constraints currently limiting the Company's growth, it has sought to form alliances with third parties who have similar investment objectives. To that end, the Company recently entered into a partnership with Olympus Real Estate Corporation ("Olympus") for the purpose of making investments similar to those made by the Company. The Company, through certain of its subsidiaries, holds a 5% minority interest in the partnership with Olympus and could further benefit through a disproportionate percentage of cash flow to the extent that certain return thresholds are met. The Company has committed to invest $5 million in the partnership and it has an option (which expires on August 2, 1999) to invest an additional $5 million. Olympus has committed to invest $95 million in the partnership subject to adjustment in the event that the Company exercises its option. REIT STATUS Management believes that the Company is operated in a manner that will enable it to continue to qualify as a REIT for federal income tax purposes. As a REIT, the Company will not pay income taxes at the trust level on any taxable income which is distributed to its shareholders, although AMREIT II, Inc., its "Non-Qualified REIT Subsidiary", may be subject to tax at the corporate level. Qualification for treatment as a REIT requires the Company to meet certain criteria, including certain requirements regarding the nature of its ownership, assets, income and distributions of taxable income. The Company may, however, be subject to tax at normal corporate rates on any ordinary income or capital gains not distributed. YEAR 2000 ISSUE General Many of the world's computers, software programs and other equipment using microprocessors or embedded chips currently have date fields that use two digits rather than four digits to define the applicable year. These computers, programs and chips may be unable to properly interpret dates beyond the year 1999; for example, computer software that has date sensitive programming using a two-digit format may recognize a date using "00" as the year 1900 rather than the year 2000. This inability to properly process dates is commonly referred to as the "Year 2000 issue", the "Year 2000 problem" or "Millennium Bug." Such errors could potentially result in a system failure or miscalculation causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in similar normal business activities, which, in turn, could lead to disruptions in the Company's operations or performance. All of the Company's information technology infrastructure is provided by the Manager, and the Manager's systems are supplied by AMRESCO, INC. The Company's assessments of the cost and timeliness of completion of Year 2000 modifications set forth below are based on representations made to the Company and the best estimates of the individuals within or engaged by AMRESCO, INC. charged with handling the Year 2000 issue, which estimates were derived using numerous assumptions relating to future events, including, without limitation, the continued availability of certain internal and external resources and third party readiness plans. Furthermore, as the AMRESCO, INC. Year 2000 initiative (described below) progresses, AMRESCO, INC., the Manager and the Company continue to revise estimates of the likely problems and costs associated with the Year 2000 issue and to adapt contingency plans. However, there can be no assurance that any estimate or assumption will prove to be accurate. The AMRESCO, INC. Year 2000 Initiative AMRESCO, INC. is conducting a comprehensive Year 2000 initiative with respect to its internal business-critical systems, including those upon which the Company depends. This initiative encompasses information technology ("IT") systems and applications, as well as non-IT systems and equipment with embedded technology, such as fax machines and telephone systems, which may be impacted by the Year 2000 issue. Business-critical systems encompass internal accounting systems, including general ledger, accounts payable and financial reporting applications; cash management systems; loan servicing systems; and decision support systems; as well as the underlying technology required to support the software. The initiative includes assessing, remediating or replacing, testing and upgrading the business-critical IT systems of AMRESCO, INC. with the assistance of a consulting firm that specializes in Year 2000 readiness. Based upon a review of the completed and planned stages of the initiative, and the testing done to date, AMRESCO, INC. does not anticipate any material difficulties in achieving Year 2000 readiness with respect to its internal business-critical systems used in connection with the 19 20 operations of the Manager or the Company, and the Company has received a written representation from AMRESCO, INC. that Year 2000 readiness was achieved by December 1998 with respect to all its internal business-critical systems used in connection with the operations of the Manager or the Company. In addition to the internal IT systems and non-IT systems of AMRESCO, INC., the Company may be at risk from Year 2000 failures caused by or occurring to third parties. These third parties can be classified into two groups. The first group includes borrowers, significant business partners, lenders, vendors and other service providers with whom the Company, the Manager or AMRESCO, INC. has a direct contractual relationship. The second group, while encompassing certain members of the first group, is comprised of third parties providing services or functions to large segments of society, both domestically and internationally, such as airlines, utilities and national stock exchanges. As is the case with most other companies, the actions the Company, the Manager and AMRESCO, INC. can take to avoid any adverse effects from the failure of companies, particularly those in the second group, to become Year 2000 ready is extremely limited. However, AMRESCO, INC. is in the process of communicating with those companies that have significant business relationships with AMRESCO, INC., the Manager or the Company, particularly those in the first group, to determine their Year 2000 readiness status and the extent to which AMRESCO, INC., the Manager or the Company could be affected by any of their Year 2000 readiness issues. In connection with this process, AMRESCO, INC. has sent written requests seeking written representations and other independent confirmations of Year 2000 readiness from all of the third parties with whom AMRESCO, INC., the Manager or the Company have contracts regarding the material business- critical operations of the Company. By December 31, 1998, written responses had been received from approximately 20% (by number) of these third parties stating that they had achieved, or that, by September 30, 1999, they expected to achieve Year 2000 readiness. In addition to contacting these third parties, where there are direct interfaces between the systems of AMRESCO, INC. and the systems of these third parties in the first group, AMRESCO, INC. plans to conduct testing in the second quarter of 1999 in conformance with the Guidelines of the Federal Financial Institutions Examination Council. Based on responses received, particularly that of AMRESCO, INC., and testing done through the date of this report, it is not currently anticipated that AMRESCO, INC., the Manager or the Company will be materially affected by any third party Year 2000 readiness issues in connection with the operations of the Manager or the Company. For all business-critical systems interfaces used in connection with the operations of the Manager and the Company, AMRESCO, INC. has advised the Company that readiness was achieved by December 31, 1998. Significant third party service providers that have not completed their Year 2000 initiative by March 31, 1999 are scheduled to be replaced with comparable firms that are believed to be compliant. AMRESCO, INC. anticipates that this portion of its Year 2000 initiative will be completed within the scheduled time periods. There can be no assurance that the systems of AMRESCO, INC. or those of third parties will be timely converted. Furthermore, there can be no assurance that a failure to convert by another company, or a conversion that is not compatible with the systems of AMRESCO, INC. or those of other companies on which the systems of AMRESCO, INC. rely, would not have a material adverse effect on the Company. Under the terms of the Company's Management Agreement with the Manager, all of the costs associated with addressing the Company's Year 2000 issue are to be borne by the Manager. Therefore, the Company does not anticipate that it will incur material expenditures in connection with any modifications necessary to achieve Year 2000 readiness. Potential Risks In addition to the internal systems of AMRESCO, INC. and the systems and embedded technology of third parties with whom AMRESCO, INC., the Manager and the Company do business, there is a general uncertainty regarding the overall success of global remediation efforts relating to the Year 2000 issue, including those efforts of providers of services to large segments of society, as described above in the second group. Due to the interrelationships on a global scale that may be impacted by the Year 2000 issue, there could be short-term disruptions in the capital or real estate markets or longer-term disruptions that would affect the overall economy. 20 21 Due to the general uncertainty with respect to how this issue will affect businesses and governments, it is not possible to list all potential problems or risks associated with the Year 2000 issue. However, some examples of problems or risks to the Company that could result from the failure by third parties to adequately deal with the Year 2000 issue include: o in the case of lenders, the potential for liquidity stress due to disruptions in funding flows; o in the case of exchanges and clearing agents, the potential for funding disruptions and settlement failures; o in the case of counter parties, accounting and financial difficulties to those parties that may expose the Company to increased credit risk; and o in the case of vendors or providers, service failures or interruptions, such as failures of power, telecommunications and the embedded technology in building systems (such as HVAC, sprinkler and fire suppression, elevators, alarm monitoring and security, and building and parking garage access). With respect to the Company's loan portfolios, risks due to the potential failure of third parties to be ready to deal with the Year 2000 issue include: o potential borrower defaults resulting from increased expenses or legal claims related to failures of embedded technology in building systems, such as HVAC, sprinkler and fire suppression, elevators, alarm monitoring and security, and building and parking garage access; o potential reductions in collateral value due to failure of one or more of the building systems; o interruptions in cash flow due to borrowers being unable to obtain timely lease payments from tenants or incomplete or inaccurate accounting of rents; o potential borrower defaults resulting from computer failures of retail systems of major tenants in retail commercial real estate properties such as shopping malls and strip shopping centers; o construction delays resulting from contractors' failure to be Year 2000 ready and increased costs of construction associated with upgrading building systems to be Year 2000 compliant; and o delays in reaching projected occupancy levels due to construction delays, interruptions in service or other market factors. These risks are also applicable to the Company's portfolio of CMBS as these securities are dependent upon the pool of mortgage loans underlying them. If the investors in these types of securities demand higher returns in recognition of these potential risks, the market value of any CMBS portfolio of the Company also could be adversely affected. Additionally, the Company has made an equity investment in a partnership that will ultimately own interests in five grocery-anchored shopping centers. These operations will be subject to many of the risks set forth above. Although the Company intends to monitor Year 2000 readiness, there can be no guarantee that all building systems will be Year 2000 compliant. The Company believes that the risks most likely to affect the Company adversely relate to the failure of third parties, including its borrowers and sources of capital, to achieve Year 2000 readiness. If its borrowers' systems fail, the result could be a delay in making payments to the Company or the complete business failure of such borrowers. The failure, although believed to be unlikely, of the Company's sources of capital to achieve Year 2000 readiness could result in the Company being unable to obtain the funds necessary to continue its normal business operations. 21 22 Business Continuity/Disaster Recovery Plan AMRESCO, INC. currently has a business continuity/disaster recovery plan that includes business resumption processes that do not rely on computer systems and the maintenance of hard copy files, where appropriate. The business continuity/disaster recovery plan is monitored and updated as potential Year 2000 readiness issues of AMRESCO, INC. and third parties are specifically identified. Due to the inability to predict all of the potential problems that may arise in connection with the Year 2000 issue, there can be no assurance that all contingencies will be adequately addressed by such plan. FORWARD-LOOKING STATEMENTS Certain statements contained in this Form 10-K are not based on historical facts and are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends that forward-looking statements be subject to such Act and any similar state or federal laws. Forward-looking statements, which are based on various assumptions, include statements regarding the intent, belief or current expectations of the Company, its Manager, and their respective Trustees or directors and officers, and may be identified by reference to a future period or periods or by use of forward-looking terminology such as "intends," "may," "could," "will," "believe," "expect," "anticipate," "plan," or similar terms or variations of those terms or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to risks, uncertainties and changes with respect to a variety of factors, including, but not limited to, changes in international, national, regional or local economic environments, changes in prevailing interest rates, credit and prepayment risks, basis and asset/liability risks, spread risk, event risk, conditions which may affect public securities and debt markets generally or the markets in which the Company operates, the Year 2000 issue, the availability of and costs associated with obtaining adequate and timely sources of liquidity, dependence on existing sources of funding, the size and liquidity of the secondary market for commercial mortgage-backed securities, geographic or product type concentrations of assets (temporary or otherwise), hedge mismatches with liabilities, other factors generally understood to affect the real estate acquisition, mortgage and leasing markets and securities investments, changes in federal income tax laws and regulations, and other risks described from time to time in the Company's SEC reports and filings, including its registration statement on Form S-11 and periodic reports on Form 10-Q, Form 8-K and Form 10-K. 22 23 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Financial Statements Included herein at pages F-1 through F-19. 2. Financial Statement Schedules All schedules for which provision is made in Regulation S-X are either not required to be included herein under the related instructions or are inapplicable or the related information is included in the audited financial statements or notes thereto. 3. Exhibits The following exhibits are filed as part of this Annual Report on Form 10-K: Exhibit No. 2.1 Sale and Assignment Agreement by and between AMRESCO Commercial Finance, Inc. and AMREIT I, Inc. dated effective as of September 30, 1998 relating to three loans (filed as Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated September 30, 1998, which exhibit is incorporated herein by reference). 2.2 Sale and Assignment Agreement by and between AMRESCO Commercial Finance, Inc. and AMREIT I, Inc. dated effective as of September 30, 1998 relating to five loans (filed as Exhibit 2.2 to the Registrant's Current Report on Form 8-K dated September 30, 1998, which exhibit is incorporated herein by reference). 2.3 Economics Equivalents and Funding Agreement by and between AMRESCO Commercial Finance, Inc. and AMREIT I, Inc. dated effective as of September 30, 1998 (filed as Exhibit 2.3 to the Registrant's Current Report on Form 8-K dated September 30, 1998, which exhibit is incorporated herein by reference). 3.1 Amended and Restated Declaration of Trust of the Registrant (filed as Exhibit 3.1 to the Registrant's Registration Statement on Form S-11 (Registration No. 333-45543), which exhibit is incorporated herein by reference). 3.2 First Amendment to Amended and Restated Declaration of Trust of the Registrant (filed as Exhibit 3.1 to the Registrant's Current Report on Form 8-K dated May 12, 1998, which exhibit is incorporated herein by reference). 3.3 Second Amendment to Amended and Restated Declaration of Trust of the Registrant (filed as Exhibit 3.2 to the Registrant's Current Report on Form 8-K dated May 12, 1998, which exhibit is incorporated herein by reference). 3.4 Form of Bylaws of the Registrant (filed as Exhibit 3.2 to the Registrant's Registration Statement on Form S-11 (Registration No. 333-45543), which exhibit is incorporated herein by reference). 10.1 Interim Warehouse and Security Agreement dated as of July 1, 1998 by and among Prudential Securities Credit Corporation and AMRESCO Capital Trust, AMREIT I, Inc. and AMREIT II, Inc., which exhibit is incorporated herein by reference. 23 24 10.2 Master Repurchase Agreement dated as of July 1, 1998 between Prudential-Bache International, Ltd. and AMRESCO Capital Trust, AMREIT CMBS I, Inc., AMREIT RMBS I, Inc. and AMREIT II, Inc., which exhibit is incorporated herein by reference. 10.3 Management Agreement, dated as of May 12, 1998, by and between AMRESCO Capital Trust and AMREIT Managers, L.P., which exhibit is incorporated herein by reference. 11 Computation of Per Share Earnings. (Previously filed) 21 Subsidiaries of the Registrant. (Previously filed) 24 Power of Attorney (included on the signature page hereto) 27 Financial Data Schedule. (Previously filed) (b) Reports on Form 8-K. The following reports on Form 8-K were filed with respect to events occurring during the quarterly period for which this report is filed: (i) Form 8-K dated September 30, 1998 and filed with the Commission on October 15, 1998, reporting (a) under Item 2 of such form, the acquisition from an affiliate of the Registrant of (i) a package of loans for a purchase price of approximately $11,313,916 and (ii) another package of loans for a purchase price of approximately $22,978,251 and (b) under Item 5 of such form, the origination of four other loans. No financial statements were required to be included in this Form 8-K. 24 25 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. AMRESCO CAPITAL TRUST By: /s/ Thomas R. Lewis II -------------------------- Thomas R. Lewis II Senior Vice President, Chief Financial and Accounting Officer & Controller Date: April 25, 2000 POWER OF ATTORNEY KNOWN ALL MEN BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Robert L. Adair III and Jonathan S. Pettee, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him, and on his behalf and in his name, place and stead, in any and all capacities, to sign, execute and file this Amendment to Annual Report on Form 10K under the Securities Exchange Act of 1934, as amended, and any or all future amendments, with all exhibits and any and all documents required to be filed with respect thereto, with the Securities and Exchange Commission or any regulatory authority, granting unto such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises in order to effectuate the same, as fully to all intents and purposes as he himself might or could do if personally present, hereby ratifying and confirming all that such attorneys-in-fact and agents, or any of them, or their substitute or substitutes, may lawfully do or cause to be done. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date Signature ---- --------- April 25, 2000 /s/ Robert L. Adair III ----------------------------------- Robert L. Adair III Chairman of the Board of Trust Managers and Chief Executive Officer (Principal Executive Officer) April 25, 2000 /s/ Thomas R. Lewis II ----------------------------------- Thomas R. Lewis II Senior Vice President, Chief Financial And Accounting Officer & Controller (Principal Financial and Accounting Officer) April 25, 2000 /s/ John C. Deterding ----------------------------------- John C. Deterding Independent Trust Manager April 25, 2000 ----------------------------------- Bruce W. Duncan Independent Trust Manager April 25, 2000 ----------------------------------- Christopher B. Leinberger Independent Trust Manager April 25, 2000 /s/ James C. Leslie ----------------------------------- James C. Leslie Independent Trust Manager April 25, 2000 /s/ Robert H. Lutz, Jr. ----------------------------------- Robert H. Lutz, Jr. Trust Manager
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