-----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, Jnfu0J6lRq0ad1tlAujZWfgjixGFv89/yHPD0S2WNDZiAHZ5zvxG/s7PniMuOUYB fo7fjkqE5puH7SmbavyOKg== 0000950134-96-006031.txt : 19961115 0000950134-96-006031.hdr.sgml : 19961115 ACCESSION NUMBER: 0000950134-96-006031 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961113 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONTINENTAL MORTGAGE & EQUITY TRUST CENTRAL INDEX KEY: 0000319416 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 942738844 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-10503 FILM NUMBER: 96660646 BUSINESS ADDRESS: STREET 1: 10670 N CENTRAL EXPWY STE 300 CITY: DALLAS STATE: TX ZIP: 75231 BUSINESS PHONE: 2146924700 FORMER COMPANY: FORMER CONFORMED NAME: CONSOLIDATED CAPITAL SPECIAL TRUST DATE OF NAME CHANGE: 19901122 10-Q 1 FORM 10-Q PERIOD END SEPTEMBER 30, 1996 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 1996 ------------------ Commission File Number 0-10503 ------- CONTINENTAL MORTGAGE AND EQUITY TRUST ------------------------------------------------------ (Exact Name of Registrant as Specified in Its Charter) California 94-2738844 -------------------------------- ---------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.)
10670 North Central Expressway, Suite 300, Dallas, TX 75231 ----------------------------------------------------------------- (Address of Principal Executive Offices) (Zip Code)
(214) 692-4700 (Registrant's Telephone Number, Including Area Code) 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 ___ Shares of Beneficial Interest, no par value 4,144,762 - ------------------------------ ------------------------------------ (Class) (Outstanding at November 1, 1996)
1 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS The accompanying Consolidated Financial Statements have not been audited by independent certified public accountants, but in the opinion of the management of Continental Mortgage and Equity Trust (the "Trust"), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of consolidated results of operations, consolidated financial position and consolidated cash flows at the dates and for the periods indicated, have been included. CONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED BALANCE SHEETS
September 30, December 31, 1996 1995 ------------- ------------ (dollars in thousands) Assets ------ Notes and interest receivable Performing........................................ $ 6,119 $ 4,240 Nonperforming, nonaccruing........................ 2,287 2,299 ---------- --------- 8,406 6,539 Less - allowance for estimated losses................. (1,188) (1,188) ---------- --------- 7,218 5,351 Foreclosed real estate held for sale, net of accumulated depreciation ($725 in 1996 and $738 in 1995).......................................... 10,657 11,553 Real estate under contract for sale, net of accumulated depreciation ($602 in 1995)........... - 1,268 Less - allowance for estimated losses................. (4,941) (5,117) ---------- --------- 5,716 7,704 Real estate held for investment, net of accumulated depreciation ($15,459 in 1996 and $16,395 in 1995) 182,724 174,713 Investment in marketable equity securities, at market (including $5,550 in 1996 and $3,812 in 1995 of affiliates)............................... 6,676 4,753 Investments in partnerships........................... 2,265 12,970 Cash and cash equivalents............................. 16,537 6,386 Other assets (including $680 in 1996 and $469 in 1995 from affiliates)............................. 11,254 6,691 ---------- --------- $ 232,390 $ 218,568 ========== =========
The accompanying notes are an integral part of these Consolidated Financial Statements. 2 3 CONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED BALANCE SHEETS - Continued
September 30, December 31, 1996 1995 ------------- ------------ (dollars in thousands) Liabilities and Shareholders' Equity Liabilities Notes and interest payable.......................... $ 142,516 $ 135,590 Other liabilities (including $938 in 1995 to affiliates)....................................... 7,462 6,993 ---------- --------- 149,978 142,583 Commitments and contingencies Shareholders' equity Shares of Beneficial Interest, no par value; authorized shares, unlimited; issued and out- standing, 4,182,030 in 1996 and 4,377,141 shares in 1995........................................... 8,379 8,766 Paid-in capital..................................... 258,545 260,060 Accumulated distributions in excess of accumulated earnings.......................................... (189,468) (195,870) Net unrealized gains on marketable equity securities 4,956 3,029 ---------- --------- 82,412 75,985 ---------- --------- $ 232,390 $ 218,568 ========== =========
The accompanying notes are an integral part of these Consolidated Financial Statements. 3 4 CONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months For the Nine Months Ended September 30, Ended September 30, -------------------- ------------------- 1996 1995 1996 1995 ------ ------ ------ ------ (dollars in thousands, except per share) Revenue Rentals..................... $ 11,435 $ 9,612 $ 33,205 $ 27,318 Interest.................... 268 196 821 600 --------- --------- ---------- --------- 11,703 9,808 34,026 27,918 Expenses Property operations......... 7,188 5,896 20,091 16,456 Interest.................... 3,254 2,481 9,317 6,998 Depreciation................ 1,271 1,103 3,565 3,133 Provision for losses........ (884) - (884) 541 Advisory fee to affiliate... 449 394 1,300 1,139 General and administrative.. 461 299 1,400 928 --------- --------- ---------- --------- 11,739 10,173 34,789 29,195 --------- --------- ---------- --------- Loss from operations.......... (36) (365) (763) (1,227) Equity in income of partnerships................ 21 28 197 213 Gain on sale of real estate... 3,598 - 9,397 - --------- --------- ---------- --------- Income (loss) before extraordinary gain.......... 3,583 (337) 8,831 (1,064) Extraordinary gain............ 149 - 812 - --------- --------- ---------- --------- Net income (loss)............. $ 3,732 $ (337) $ 9,643 $ (1,064) ========= ========= ========== ========= Earnings per share Income (loss) before extra- ordinary gain............. $ .86 $ (.08) $ 2.08 $ (.24) Extraordinary gain.......... .04 - .20 - --------- --------- ---------- --------- Net income (loss)........... $ .90 $ (.08) $ 2.28 $ (.24) ========= ========= ========== ========= Weighted average shares of beneficial interest used in computing earnings per share 4,184,086 4,377,156 4,243,754 4,377,171 ========= ========= ========== =========
The accompanying notes are an integral part of these Consolidated Financial Statements. 4 5 CONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Unrealized Shares of Distributions Gains on Beneficial Interest in Excess of Marketable ----------------------- Paid-in Accumulated Equity Shareholders' Shares Amount Capital Earnings Securities Equity -------- -------- ------- ------------- ---------- ------------ (dollars in thousands) Balance, January 1, 1996............ 4,377,141 $ 8,766 $ 260,060 $ (195,870) $ 3,029 $ 75,985 Repurchase of shares of beneficial interest.......... (195,111) (387) (1,515) - - (1,902) Distributions ($.76 per share)........ - - - (3,241) - (3,241) Unrealized gains on marketable equity securities........ - - - - 1,927 1,927 Net income.......... - - - 9,643 - 9,643 --------- -------- --------- ----------- -------- --------- Balance, September 30, 1996............... 4,182,030 $ 8,379 $ 258,545 $ (189,468) $ 4,956 $ 82,412 ========= ======== ========= =========== ======== =========
The accompanying notes are an integral part of these Consolidated Financial Statements. 5 6 CONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, ------------------- 1996 1995 ---- ---- (dollars in thousands) Cash Flows from Operating Activities Rents collected.................................. $ 32,925 $ 27,306 Interest collected............................... 462 527 Interest paid.................................... (8,270) (6,359) Payments for property operations................. (18,666) (16,149) General and administrative expenses paid......... (1,282) (1,201) Advisory fee paid to affiliate................... (1,300) (1,139) Distributions from partnerships' operating cash flow........................................... 844 745 Other............................................ 2,581 833 -------- -------- Net cash provided by operating activities...... 7,294 4,563 Cash Flows from Investing Activities Acquisition of real estate....................... (18,996) (6,593) Real estate improvements......................... (667) (696) Funding of capital improvement escrow............ (1,500) (252) Proceeds from sale of real estate................ 14,673 - Funding of notes receivable...................... (1,870) - Collections on notes receivable.................. 1,117 1,059 Distributions from partnerships' investing activities..................................... 10,720 - Deferred financing costs......................... (1,961) (365) -------- -------- Net cash provided by (used in) investing activities.................................. 1,516 (6,847) Cash Flows from Financing Activities Distributions to shareholders.................... (3,241) (1,313) Proceeds from notes payable...................... 28,427 4,829 Payments on notes payable........................ (21,943) (2,781) Distributions from partnerships' financing activities..................................... - 1,025 Repurchase of shares of beneficial interest...... (1,902) - -------- -------- Net cash provided by financing activities...... 1,341 1,760 -------- -------- Net increase (decrease) in cash and cash equivalents...................................... 10,151 (524) Cash and cash equivalents, beginning of period..... 6,386 7,478 -------- -------- Cash and cash equivalents, end of period........... $ 16,537 $ 6,954 ======== ========
The accompanying notes are an integral part of these Consolidated Financial Statements. 6 7 CONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
For the Nine Months Ended September 30, ------------------- 1996 1995 -------- -------- (dollars in thousands) Reconciliation of net income (loss) to net cash provided by operating activities Net income (loss)................................. $ 9,643 $ (1,064) Adjustments to reconcile net income (loss) to net cash provided by operating activities Depreciation and amortization.................... 3,565 3,012 Provision for losses............................. (884) 541 Gain on sale of real estate...................... (9,397) - Extraordinary gain............................... (812) - (Increase) decrease in interest receivable....... (44) 46 Decrease in other assets......................... 4,801 703 Increase (decrease) in other liabilities......... 299 (80) (Decrease) increase in interest payable.......... (524) 508 Distributions from partnerships' operating cash flow........................................... 844 745 Equity in (income) loss of partnerships.......... (197) (213) -------- -------- Net cash provided by operating activities...... $ 7,294 $ 4,198 ======== ======== Noncash investing and financing activities Notes payable from acquisition of real estate.... $ 3,200 $ 20,790 Unrealized gain on marketable equity securities.. 1,927 483 Note receivable from sale of real estate......... 750 - Carrying value of real estate acquired through foreclosure (in satisfaction of notes receivable with a carrying value of $891)...... - 891
The accompanying notes are an integral part of these Consolidated Financial Statements. 7 8 CONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The accompanying Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Operating results for the nine month period ended September 30, 1996 are not necessarily indicative of the results that may be expected for the year ending December 31, 1996. Dollar amounts in tables are in thousands. For further information, refer to the Consolidated Financial Statements and Notes thereto included in the Trust's Annual Report on Form 10-K for the year ended December 31, 1995 ("1995 Form 10-K"). Certain balances for 1995 have been reclassified to conform to the 1996 presentation. Shares and per share data have been restated for the three for two forward share split effected February 15, 1996. NOTE 2. INVESTMENTS IN PARTNERSHIPS The Trust's investments in partnerships accounted for using the equity method consisted of the following at September 30, 1996: Sacramento Nine....................... $ 103 Indcon, L.P........................... 2,162 ------- $ 2,265 =======
The Trust and National Income Realty Trust ("NIRT") are partners in Sacramento Nine, the Trust having a 30% interest in the partnership's earnings, losses and distributions. The Trust and NIRT are also partners in Income Special Associates ("ISA"), a joint venture partnership in which the Trust has a 60% interest in earnings, losses and distributions. ISA in turn owns a 100% interest in Indcon, L.P. The partnership agreements require the consent of both the Trust and NIRT for any material changes in the operations of the partnerships' properties, including sales, refinancings and changes in property management. The Trust, as a noncontrolling partner, accounts for its investment in the partnerships using the equity method. In February and March 1996, Indcon sold 25 of its industrial warehouses for a total of $36.2 million in cash. Indcon received net cash of $14.2 million, of which the Trust's equity share was $8.5 million, after the payoff of existing mortgage debt with a principal balance of $23.4 million. Indcon recognized a gain of $617,000 on the sale, of which the Trust's equity share was $370,000. Indcon paid a real estate sales commission of $585,000 to Carmel Realty, Inc. ("Carmel Realty"), an affiliate of Basic Capital Management, Inc. ("BCM"), the Trust's advisor, based upon the $36.2 million sales price of the properties. In March 1996, Indcon reached a settlement with an insurance company on the fire loss of one of its industrial warehouses. Indcon received a 8 9 CONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 2. INVESTMENTS IN PARTNERSHIPS (Continued) total of $2.2 million in cash. Indcon does not intend to rebuild the destroyed warehouse and accordingly has recognized an extraordinary gain of $1.2 million, of which the Trust's equity share was $663,000. In April 1996, Indcon sold two additional industrial warehouses for $1.8 million in cash, of which the Trust's equity share was $1.1 million. Indcon paid a real estate sales commission of $16,000 to Carmel Realty based upon the $1.8 million sales price of the properties. Set forth below is summarized results of operations for the partnerships the Trust accounts for using the equity method for the nine months ended September 30, 1996: Rents................................... $ 2,133 Depreciation............................ (411) Property operations..................... (1,520) Interest expense........................ (856) ------- Loss before gain on sale of real estate and extraordinary gain................ (654) Gain on sale of real estate............. 617 Extraordinary gain...................... 1,208 ------- Net income.............................. $ 1,171 =======
NOTE 3. MORTGAGE NOTES RECEIVABLE In February 1996, the Trust funded a $1.5 million second lien mortgage secured by the Signature Athletic Club Building in Dallas, Texas. The note bears interest at 12% per annum and requires monthly interest only payments to the extent of available cash flow. Any accrued but unpaid interest is added to the principal balance of the note annually. In addition, the note requires quarterly principal payments equal to the excess property cash flow for the quarter. The note matures in October 1998 with an option to extend the note to December 2000. The Trust has also guaranteed the underlying $3.0 million first mortgage secured by the property which is current. The Trust has an option to purchase a 50% interest in the partnership which owns the Signature Athletic Club Building. The option expires in December 2005. The Club has had no available cash flow during 1996, therefore the Trust ceased recognizing interest income effective June 1996. In July 1996, the Trust agreed to fund a $500,000 promissory note secured by a contract to purchase land in Frisco, Texas. Through September 30, 1996, the Trust has funded $300,000. The note bears interest at 13% per annum and all interest and principal is payable at the December 31, 1996 maturity date. 9 10 CONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 4. REAL ESTATE In February 1996, the Trust sold the Rivertree Apartments in Hurst, Texas for $1.8 million, a property under contract for sale at December 31, 1995. In conjunction with the sale, the Trust provided $750,000 of purchase money financing which was paid in full in August 1996. The Trust received net cash of $959,000 after the payment of various closing costs associated with the sale. The Trust paid a real estate sales commission of $70,000 to Carmel Realty based on the $1.8 million sales price of the property. The Trust recognized a gain of $378,000 on the sale. In September 1996, the Trust received an insurance reimbursement for hail damage that had occurred in 1995 and recognized an extraordinary gain of $149,000. In March 1996, the Trust purchased the Hampton Court Office Building, a 104,001 square foot office building in Dallas, Texas, for $7.7 million. The Trust paid $1.4 million in cash and obtained new mortgage financing of $6.3 million. The first mortgage bears interest at 8.0% per annum, requires monthly payments of principal and interest of $42,000 and matures in March 2001. In conjunction with the financing, the Trust established various escrow accounts in the amount of $1.5 million. The Trust paid a real estate brokerage commission of $205,000 to Carmel Realty and an acquisition fee of $77,000 to BCM based on the $7.7 million purchase price of the property. In April 1996, the Trust purchased the Amoco Building, a 378,244 square foot office building in New Orleans, Louisiana, for $5.9 million in cash. The Trust paid a real estate brokerage commission of $188,000 to Carmel Realty and an acquisition fee of $59,000 to BCM based on the $5.9 million purchase price of the property. Also in April 1996, the Trust purchased the Central Storage Warehouse, a 216,035 square foot warehouse in Dallas, Texas, for $2.2 million in cash. The Trust paid a real estate brokerage commission of $86,000 to Carmel Realty and an acquisition fee of $22,000 to BCM based on the $2.2 million purchase price of the property. In May 1996, the Trust sold the Sunset Towers Apartments in San Francisco, California for $24.1 million in cash. The Trust received $9.7 million after the payoff of $14.0 million in existing mortgage debt and the payment of various closing costs associated with the sale. The Trust paid a real estate sales commission of $482,000 to Carmel Realty based on the $24.1 million sales price of the property. The Trust recognized a gain of $5.4 million on the sale. In June 1996, the Trust purchased the Grove Park Apartments, a 188 unit apartment complex in Plano, Texas for $4.4 million. The Trust paid $1.2 million in cash and assumed the existing first lien mortgage of $3.2 million. The mortgage bears interest at a rate of 8.9% per annum, requires monthly payments of principal and interest of $26,315 and matures in March 1998. The Trust paid a $153,000 real estate brokerage 10 11 CONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 4. REAL ESTATE (Continued) commission to Carmel Realty and a $44,000 acquisition commission to BCM based on the $4.4 million purchase price of the property. Also in June 1996, the Trust sold the Crystal Court Apartments, a foreclosed property held for sale, in Detroit, Michigan for $700,000. The Trust paid a real estate sales commission of $28,000 to Carmel Realty based on the $700,000 sales price of the property. The Trust recognized no loss on the property beyond that which had already been provided. In July 1996, the Trust purchased the Promenade Shopping Center, a 133,558 square foot shopping center in Highlands Ranch, Colorado for $8.1 million. The Trust paid $1.8 million in cash and obtained new mortgage financing for the remaining $6.3 million of the purchase price. The first lien mortgage bears interest at 9.0% per annum, requires monthly payments of principal and interest of $50,385 and matures July 1, 1999. The second lien mortgage bears interest at 9.0% per annum and matures June 30, 1997, at which time all principal and interest is due. The Trust paid a $232,000 real estate brokerage commission to Carmel Realty and a $81,000 acquisition commission to BCM based on the $8.1 million purchase price of the property. Also in July 1996, the Trust purchased the Park at Colonnade Apartments, a 211 unit apartment complex in San Antonio, Texas for $4.2 million. The Trust paid $700,000 in cash and obtained new mortgage financing for the remaining $3.5 million of the purchase price. The mortgage bears interest at 10.0% per annum, through July 1997, increasing to 10.5% per annum thereafter, requires monthly payments of interest only, and matures January 1, 1998. The Trust paid a $146,000 real estate brokerage commission to Carmel Realty and a $42,000 acquisition commission to BCM based on the $4.2 million purchase price of the property. Also in July 1996, the Trust purchased the 3400 Carlisle Building, a 74,000 square foot office building in Dallas, Texas for $5.3 million. The Trust paid $800,000 in cash and obtained new mortgage financing for the remaining $4.5 million of the purchase price. The mortgage bears interest at 8.93% per annum, requires monthly payments of principal and interest of $33,488 through July 31, 1998, increasing to $38,457 through maturity and matures March 31, 2001. The Trust paid a $177,000 real estate brokerage commission to Carmel Realty and a $53,000 acquisition commission to BCM based on the $5.3 million purchase price of the property. In August 1996, the Trust sold the Southgate Square Apartments in Round Rock, Texas for $6.1 million in cash. The Trust received net cash of $3.0 million after the payoff of $2.9 million in existing mortgage debt and the payment of various closing costs associated with the sale. The Trust paid a real estate sales commission of $192,000 to Carmel Realty based on the $6.1 million sales price. The Trust recognized a gain of $3.6 million on the sale. 11 12 CONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 4. REAL ESTATE (Continued) In September 1996, the Trust purchased the Shady Trail Warehouse, a 42,900 square foot warehouse in Dallas, Texas for $681,000. The Trust paid $131,000 in cash and obtained new mortgage financing for the remaining $550,000 of the purchase price. The mortgage bears interest at 8.5% per annum, requires monthly payments of principal and interest of $4,429 and matures October 1, 2001. The Trust paid a $27,000 real estate brokerage commission to Carmel Realty and a $7,000 acquisition commission to BCM based on the $681,000 purchase price of the property. Also in September 1996, the Trust sold the Ravenswood Apartments in Stratford, New Jersey for $1.2 million in cash. The Trust paid a real estate sales commission of $49,600 to Carmel Realty based on the $1.2 million sales price. The Trust recognized no gain or loss on the sale. NOTE 5. NOTES PAYABLE In February 1995, after determining that further investment in Genesee Towers Office Building in Flint, Michigan, could not be justified without a substantial modification of the mortgage debt, the Trust ceased making debt service payments on the $8.8 million nonrecourse mortgage secured by the property. Accordingly, as of December 31, 1994, the Trust wrote down the carrying value of the property by $1.2 million, which is included in the 1994 provision for losses, to the amount of the nonrecourse mortgage. In February 1996, the Trust and the lender entered into a forbearance agreement that provided, among other things, that until August 20, 1996, the Trust make monthly payments of the greater of regular scheduled principal and interest or cash flow from the property. The deed to the property was placed in escrow during the term of the forbearance agreement. The Trust transferred the property to the lender in September 1996. The Trust had written down the carrying value of the property to the amount of the nonrecourse mortgage debt, which approximated fair value of the property. During the pendency of the foreclosure negotiations, the Trust continued to accrue and expense its interest obligations on such note. The Trust recorded a negative provision for loss with the elimination of its obligation for such accrued interest on the transfer of the property to the lender. In April 1996, the Trust refinanced the mortgage debt secured by the Edgewood Apartments in Lansing, Illinois in the amount of $8.1 million. The Trust received net cash of $1.3 million after the payoff of $6.7 million in existing mortgage debt, including a $60,000 prepayment penalty. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. The new mortgage bears interest at the rate of 8.65% per annum, requires monthly payments of principal and interest of $66,000 and matures in May 2006. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $81,000 based upon the new $8.1 million mortgage. Also in April 1996, the Trust refinanced the mortgage debt secured by the In the Pines Apartments in Gainesville, Florida in the amount of 12 13 CONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 5. NOTES PAYABLE (Continued) $6.0 million. The Trust received net cash of $415,000 after the payoff of $5.3 million in existing mortgage debt. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. The new mortgage bears interest at the rate of 8.65% per annum, requires monthly payments of principal and interest of $49,000 and matures in May 2006. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $60,000 based upon the new $6.0 million mortgage. Also in April 1996, the Trust refinanced the mortgage debt secured by the Quail Oaks Apartments in Balch Springs, Texas in the amount of $1.3 million. The Trust received net cash of $413,000 after the payoff of $753,000 in existing mortgage debt. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. The new mortgage bears interest at 8.875% per annum, requires monthly payments of principal and interest of $10,798 and matures in May 2006. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $13,000 based on the new $1.3 million mortgage. In May 1996, the Trust obtained mortgage financing for the previously unencumbered Applecreek Apartments in Dallas, Texas in the amount of $1.8 million. The Trust received net cash of $1.6 million after payment of various closing costs associated with the financing. The mortgage bears interest at 8.875% per annum, requires monthly payments of principal and interest of $15,076 and matures June 1, 2006. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $18,000 based on the new $1.8 million mortgage. In June 1996, the Trust refinanced the mortgage debt secured by the Fairways Apartments in Longview, Texas in the amount of $2.0 million. The Trust received net cash of $210,000 after the payoff of $1.7 million in existing mortgage debt. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. The new mortgage bears interest at 8.9375% per annum, requires monthly payments of principal and interest of $16,003 and matures in July 2006. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $20,000 based on the new $2.0 million mortgage. In July 1996, the Trust refinanced the mortgage debt secured by the Woodbridge Apartments in Denver, Colorado in the amount of $3.0 million. The Trust received net cash of $2.0 million after the payoff of $903,000 in existing mortgage debt. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. The new mortgage bears interest at 9.125% per annum, requires monthly payments of principal and interest of $25,433 and matures August 1, 2006. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $30,000 based on the new $3.0 million mortgage. Also in July 1996, the Trust obtained mortgage financing for the previously unencumbered Forest Ridge Apartments in Denton, Texas in the 13 14 CONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 5. NOTES PAYABLE (Continued) amount of $1.2 million. The Trust received net cash of $1.1 million after payment of various closing costs associated with the financing. The mortgage bears interest at 8.875% per annum, requires monthly payments of principal and interest of $10,175 and matures August 1, 2006. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $12,000 based on the $1.2 million mortgage. In August 1996, the Trust obtained mortgage financing for the previously unencumbered Central Storage Warehouse in Dallas, Texas in the amount of $1.4 million. The Trust received net cash of $1.4 million after the payment of various closing costs associated with the financing. The mortgage bears interest at 8.5% through July 30, 1999 and at variable rate thereafter, requires monthly payments of principal and interest of $13,786 through July 30, 1999 adjusted thereafter based on the interest rate and matures July 31, 2011. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $14,000 based on the new $1.4 million mortgage. Also in August 1996, the Trust refinanced the mortgage debt secured by the McCallum Glen Apartments in Dallas, Texas for $5.2 million. The Trust received net cash of $761,000 after the payoff of the existing first mortgage of $4.2 million and the payment of various closing costs. The new mortgage bears interest at 8.5%, requires monthly payments of principal and interest of $40,176 and matures September 1, 2006. The Trust paid BCM a mortgage brokerage and equity refinancing fee of $52,250 based on the new $5.2 million mortgage. NOTE 6. COMMITMENTS AND CONTINGENCIES The Trust is involved in various lawsuits arising in the ordinary course of business. Management of the Trust is of the opinion that the outcome of these lawsuits would have no material impact on the Trust's financial condition, results of operations or liquidity. NOTE 7. SUBSEQUENT EVENTS In October 1996, the Trust purchased 236 acres of undeveloped land on State Highway 121 in Collin County, Texas for $3.9 million in cash. The Trust paid a real estate brokerage commission of $136,000 to Carmel Realty and a $39,000 acquisition commission to BCM based on the $3.9 million purchase price of the property. Also in October 1996, the Trust sold a .60 acre parcel of the 6 acre tract of Northwest Crossing land in Houston, Texas for $290,000 in cash. The Trust recorded the sale under the cost recovery method and therefore recognized no gain or loss on the sale. In November 1996, the Trust purchased the Glenwood Apartments in Addison, Texas for $4.2 million. The Trust paid $1.3 million in cash and assumed the existing first lien mortgage of $2.9 million. The 14 15 CONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE 7. SUBSEQUENT EVENTS (Continued) mortgage bears interest at 9.25% per annum, requires monthly payments of principal and interest of $27,476 and matures in November 2004. The Trust paid a real estate brokerage commission of $145,000 to Carmel Realty and a $42,000 acquisition commission to BCM based on the $4.2 million purchase price of the property. ------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction Continental Mortgage and Equity Trust (the "Trust") was formed to invest in real estate through acquisitions, leases and partnerships and in mortgage loans on real estate, including first, wraparound and junior mortgage loans. The Trust was organized on August 27, 1980 and commenced operations on December 3, 1980. Liquidity and Capital Resources Cash and cash equivalents aggregated $16.3 million at September 30, 1996, compared with $6.4 million at December 31, 1995. The principal reasons for the increase in cash are discussed in the paragraphs below. The Trust's principal sources of cash have been and will continue to be property operations, proceeds from property sales, collections of mortgage notes receivable and borrowings. The Trust expects that net cash provided by operating activities and from anticipated external sources, such as property sales and refinancings, will be sufficient to meet the Trust's various cash needs, including, but not limited to, property acquisitions, debt service obligations, shareholder distributions and property maintenance and improvements. The Trust's cash flow from property operations (rents collected less payments for expenses applicable to rental income) increased from $11.2 million in the first nine months of 1995 to $13.9 million in the first nine months of 1996. Of this net increase, $2.6 million is the result of the Trust acquiring fifteen additional income producing properties during 1995 and 1996. The remainder of the increase is due to increased rental and occupancy rates and lower operating expenses at the Trust's commercial properties and apartment complexes. These increases are partially offset by a decrease of $713,000 due to four properties being sold in 1996. The Trust's management believes that the Trust's cash flow from property operations will continue to increase as the Trust continues to benefit from the properties acquired in 1995 and first nine months of 1996. 15 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) In February 1996, the Trust funded a $1.5 million second lien mortgage secured by the Signature Athletic Club Building in Dallas, Texas. See NOTE 3. "MORTGAGE NOTES RECEIVABLE." In February 1996, the Trust sold the Rivertree Apartments in Hurst, Texas for $1.8 million. The Trust received net cash of $959,000 after the payment of various closing costs associated with the sale. In conjunction with the sale, the Trust provided $750,000 of purchase money financing which was paid in full in August 1996. In February and March 1996, Indcon, L.P. ("Indcon"), a joint venture partnership in which the Trust has a 60% interest, sold 25 of its industrial warehouses for a total of $36.2 million in cash. Indcon received net cash of $14.2 million, of which the Trust's equity share was $8.5 million, after the payoff of existing mortgage debt with a principal balance of $23.4 million. In March 1996, Indcon reached a settlement with an insurance company on the fire loss of one of its industrial warehouses. Indcon received a total of $2.2 million, of which the Trust's equity share was $1.3 million. In March 1996, the Trust purchased the Hampton Court Office Building, a 104,001 square foot office building in Dallas, Texas, for $7.7 million. The Trust paid $1.4 million in cash and obtained new mortgage financing of $6.3 million. In conjunction with the financing, the Trust established various escrow accounts in the amount of $1.5 million. In April 1996, the Trust purchased the Amoco Building, a 378,244 square foot office building in New Orleans, Louisiana, for $5.9 million in cash. Also in April 1996, the Trust purchased the Central Storage Warehouse, a 216,035 square foot warehouse in Dallas, Texas, for $2.2 million in cash. In April 1996, the Trust refinanced the mortgage debt secured by the Edgewood Apartments in Lansing, Illinois in the amount of $8.1 million. The Trust received net cash of $1.3 million after the payoff of $6.7 million in existing mortgage debt, including a $60,000 prepayment penalty. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. Also in April 1996, the Trust refinanced the mortgage debt secured by the In the Pines Apartments in Gainesville, Florida in the amount of $6.0 million. The Trust received net cash of $415,000 after the payoff of $5.3 million in existing mortgage debt. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. 16 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) Also in April 1996, the Trust refinanced the mortgage debt secured by the Quail Oaks Apartments in Balch Springs, Texas in the amount of $1.3 million. The Trust received net cash of $413,000 after the payoff of $753,000 in existing mortgage debt. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. In April 1996, Indcon sold two additional industrial warehouses for $1.8 million in cash, of which the Trust's equity share was $1.1 million. In May 1996, the Trust sold the Sunset Towers Apartments in San Francisco, California for $24.1 million in cash. The Trust received net cash of $9.7 million after payoff of $14.0 million in existing mortgage debt and the payment of various closing costs associated with the sale. In June 1996, the Trust purchased the Grove Park Apartments, a 188 unit apartment complex in Plano, Texas for $4.4 million. The Trust paid $1.2 million in cash and obtained the property subject to the existing first lien mortgage of $3.2 million. Also in June 1996, the Trust sold the Crystal Court Apartments in Detroit, Michigan for $700,000 in cash. Also in June 1996, the Trust refinanced the mortgage debt secured by the Fairways Apartments in Longview, Texas in the amount of $2.0 million. The Trust received net cash of $210,000 after the payoff of $1.7 million in existing mortgage debt. The remainder of the refinancing proceeds were used to pay various closing costs associated with the refinancing. In July 1996, the Trust purchased the Promenade Shopping Center, a 133,558 square foot shopping center in Highlands Ranch, Colorado for $8.1 million. The Trust paid $2.5 million in cash and obtained new mortgage financing of $5.6 million. Also in July 1996, the Trust refinanced the mortgage debt secured by the Woodbridge Court Apartments in Westminster, Colorado in the amount of $3.0 million. The Trust received net cash of $2.0 million after the payoff of $903,000 in existing mortgage debt and the payment of various closing costs associated with the refinancing. Also in July 1996, the Trust purchased the Park at Colonnade Apartments, a 211 unit apartment complex in San Antonio, Texas for $4.2 million. The Trust paid $700,000 cash and obtained new mortgage financing of $3.5 million. Also in July 1996, the Trust obtained mortgage financing of $1.2 million secured by the previously unencumbered Forest Ridge Apartments in Denton, Texas. The Trust received net cash of $1.1 million after the payment of various closing costs associated with the financing. 17 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) Also in July 1996, the Trust purchased the 3400 Carlisle Office Building, a 76,727 square foot office building in Dallas, Texas for $5.3 million. The Trust paid $800,000 in cash and obtained new mortgage financing of $4.5 million. In August 1996, the Trust obtained mortgage financing of $1.4 million secured by the previously unencumbered Central Storage Warehouse in Dallas, Texas. The Trust received net cash of $1.4 million after the payment of various closing costs associated with the financing. Also in August 1996, the Trust sold the Southgate Square Apartments in Round Rock, Texas for $6.1 million. The Trust received net cash of $3.0 million after the payoff of $2.9 million in existing mortgage debt and the payment of various closing costs associated with the sale. Also in August 1996, the Trust refinanced the mortgage debt secured by the McCallum Glen Apartments in Dallas, Texas for $5.2 million. The Trust received net cash of $761,000 after the payoff of $4.2 million in existing mortgage debt and the payment of various closing costs. In September 1996, the Trust purchased the Shady Trail Warehouse in Dallas, Texas for $681,000. The Trust paid $131,000 in cash and obtained new mortgage financing of $550,000. Also in September 1996, the Trust sold the Ravenswood Apartments in Stratford, New Jersey for $1.2 million in cash. Through September 30, 1996, the Trust has funded $300,000 of a $500,000 note receivable secured by a contract to purchase land in Frisco, Texas. In October 1996, the Trust purchased 236 acres of undeveloped land on State Highway 121 in Collin County, Texas for $3.9 million in cash. Also in October 1996, the Trust sold a .60 acre parcel of the 6 acre tract of Northwest Crossing land in Houston, Texas for $290,000 in cash. In November 1996, the Trust purchased the Glenwood Apartments in Addison, Texas for $4.2 million. The Trust paid $1.3 million in cash and assumed the existing first lien mortgage of $2.9 million. The Trust has deposited $778,000 as earnest money toward the purchase of three apartment complexes and one office building in separate transactions during the fourth quarter. The Trust estimates it will expend $10.5 million of its cash balance to close these transactions. The Trust's Board of Trustees has authorized the Trust to repurchase a total of 1,465,000 of its shares of beneficial interest, of which 92,164 shares remain to be purchased as of September 30, 1996. Through 18 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (Continued) September 30, 1996, the Trust had repurchased 1,372,836 of its shares at a total cost to the Trust of $6.9 million, of which 195,111 shares were repurchased in 1996 at a total cost of $1.9 million. In August 1996, the Trust announced an offer to buy back its shares of beneficial interest from shareholders owning 99 or fewer shares. The Trust paid a premium of $.50 per share over the average closing price of its shares as reported from August 8, 1996 through September 30, 1996, the expiration date of the offer. On October 17, 1996, the Trust repurchased 82,967 shares pursuant to such offer, at a total cost of $913,000. In the first nine months of 1996, the Trust paid quarterly and special distributions of $.76 per share or a total of $3.2 million. On a quarterly basis, the Trust's management reviews the carrying value of the Trust's mortgage notes receivable and properties held for sale and periodically, but no less than annually, its properties held for investment. Generally accepted accounting principles require that the carrying value of such assets cannot exceed the lower of their respective carrying amounts or estimated net realizable value. In the initial instance when estimated net realizable value of a mortgage note receivable or a property held for sale is less than the carrying amount at the time of evaluation, a reserve is established and a corresponding provision for loss is recorded by a charge against earnings. A subsequent revision to estimated net realizable value either increases or decreases such reserve with a corresponding charge against or credit to earnings. In the case of properties held for investment the carrying value of the property is written down and a provision for loss is recorded. The estimate of net realizable value of the Trust's mortgage notes receivable is based on management's review and evaluation of the collateral property securing the mortgage note. The property review generally includes selective property inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of maintenance requirements, discussions with the manager of the property and a review of the surrounding area. See "Recent Accounting Pronouncement," below. Results of Operations For the three and nine months ended September 30, 1996, the Trust had net income of $3.7 million and $9.6 million, compared to a net loss of $337,000 and $1.1 million for the three and nine months ended September 30, 1995. The primary factors contributing to the Trust's net income in 1996 are discussed in the following paragraphs. Rents increased from $9.6 million and $27.3 million for the three and nine months ended September 30, 1995 to $11.4 million and $33.2 million for the three and nine months ended September 30, 1996. Of these increases $2.6 million and $6.6 million are attributable to the 19 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations Continued acquisition of six apartment complexes and nine commercial properties during 1995 and 1996. These increases are partially offset by decreases of $1.2 million and $1.6 million attributable to four properties sold in 1996. Interest income was $196,000 and $600,000 for the three and nine months ended September 30, 1995 compared to $268,000 and $821,000 for the three and nine months ended September 30, 1996. Of these increases $16,000 and $100,000 for the three and nine months are due to the funding of a $1.5 million second lien mortgage in February 1996, $370,000 of a $500,000 note in July 1996 and a $750,000 purchase money note accepted in February 1996 in conjunction with the sale of Rivertree Apartments. Additional increases of $138,000 and $248,000 for the three and nine months are due to increased dividend and short-term investment income. Interest income for the remainder of 1996 is expected to approximate that of the third quarter of 1996. Property operating expenses increased from $5.9 million and $16.5 million for the three and nine months ended September 30, 1995 to $7.2 million and $20.1 million for the three and nine months ended September 30, 1996. Increases of $1.5 million and $3.6 million are due to the acquisition of six apartment complexes and nine commercial properties during 1995 and 1996. The remainder of the increase is primarily due to increased repair and maintenance and personnel expenses in an effort to maintain the Trust's increased rental and occupancy rates. These increases are partially offset by decreases of $551,000 and $841,000 due to properties sold in 1996. Interest expense increased from $2.5 million and $7.0 million for the three and nine months ended September 30, 1995 to $3.3 million and $9.3 million for the three and nine months ended September 30, 1996. Of these increases, $806,000 and $1.9 million for the three and nine months, respectively, are due to interest expense recorded on mortgages secured by nine properties, encumbered by debt, acquired during 1996 and 1995. An additional $210,000 and $708,000 for the three and nine months, respectively, is due to interest expense recorded on borrowings during 1996 and 1995, secured by mortgages on three previously unencumbered apartment complexes and one industrial property and the refinancing of five existing mortgages. These increases are partially offset by decreases of $245,000 and $336,000 for the three and nine months, respectively, due to two properties sold in 1996. Interest expense is expected to increase in the remainder of 1996, as a result of the Trust's acquisition of other properties and refinancings during the remainder of 1996. Depreciation expense increased from $1.1 million and $3.1 million for the three and nine months ended September 30, 1995 to $1.3 million and $3.6 million for the three and nine months ended September 30, 1996. Of these increases, $356,000 and $600,000 for the three and nine months, respectively, are due to the acquisition of six apartment complexes and nine commercial properties during 1996 and 1995. These increases are 20 21 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations Continued partially offset by decreases of $151,000 and $237,000 due to properties sold in 1996. Depreciation is expected to increase in the remainder of 1996, as a result of the Trust's acquisition of six commercial properties and two apartment complexes in 1996, as well as acquisitions subsequent to September 30, 1996. A provision for losses of $541,000 was recognized in the nine months ended September 30, 1995 to provide for the loss on the discounted payoff of the mortgage note receivable secured by Alderwood Apartments. A negative provision for losses of $884,000 was recognized in the three and nine months ended September 30, 1996. Such negative provisions represents accrued interest recorded on a mortgage between February 1995, the date the Trust stopped making payments on the mortgage, and September 1996 when the property was transferred to the lender. See NOTE 5. "NOTES PAYABLE." Advisory fee to affiliate increased from $394,000 and $1.1 million for the three and nine months ended September 30, 1995 to $449,000 and $1.3 million for the three and nine months ended September 30, 1996. These increases are due to an increase in the Trust's gross assets, the basis for the advisory fee, as a result of property acquisitions during 1995 and 1996. The advisory fee is expected to continue to increase as the Trust makes additional property acquisitions. General and administrative expenses increased from $299,000 and $928,000 for the three and nine months ended September 30, 1995 to $461,000 and $1.4 million for the three and nine months ended September 30, 1996. These increases are primarily attributable to an increase in legal fees and Advisor cost reimbursements. The Trust's equity in earnings of partnerships was $21,000 and $197,000 for the three and nine months ended September 30, 1996 compared to $28,000 and $213,000 for the three and nine months ended September 30, 1995. Included in equity earnings of partnerships for the nine months ended September 30, 1996 is a gain on sale of real estate of $370,000, the Trust's equity share of the gain recognized by Indcon, L.P. ("Indcon"), a joint venture partnership, on the sale of its 27 warehouse facilities. See NOTE 2. "INVESTMENTS IN PARTNERSHIPS." Without such gain the Trust's equity in earnings of partnerships would have been a loss of $173,000. Such decrease is primarily due to the sale of Indcon's 27 warehouse facilities in the first quarter of 1996. In addition, interest expense for Sacramento Nine ("SAC 9"), also a joint venture partnership, increased as a result of new mortgage financing secured on a previously unencumbered office building. See NOTE 2. "INVESTMENTS IN PARTNERSHIPS." Equity in earnings of partnerships is expected to be minimal for the remainder of 1996. For the three and nine months ended September 30, 1996, the Trust recognized gains on the sale of real estate of $378,000 on the sale of Rivertree Apartments in February 1996, $5.4 million on the sale of 21 22 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations Continued Sunset Towers Apartments in May 1996, $3.6 million on the sale of Southgate Apartments in August 1996. See NOTE 4. "REAL ESTATE." In the three months ended September 30, 1996, the Trust recognized an extraordinary gain of $149,000 representing an insurance settlement at the Rivertree Apartments which the Trust had sold in February 1996. See NOTE 4. "REAL ESTATE." In the nine months ended September 30, 1996, the Trust also recognized an extraordinary gain of $663,000, its equity share of an insurance settlement from a fire loss on an industrial warehouse owned by Indcon. See NOTE 2. "INVESTMENTS IN PARTNERSHIPS." The Trust recognized no extraordinary gains in 1995. Tax Matters As more fully discussed in the Trust's 1995 Form 10-K, the Trust has elected and in the opinion of the Trust's management, qualified to be taxed as a Real Estate Investment Trust ("REIT") as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, (the "Code"). To continue to qualify for federal taxation as a REIT under the Code, the Trust is required to hold at least 75% of the value of its total assets in real estate assets, government securities and cash and cash equivalents at the close of each quarter of each taxable year. The Code also requires a REIT to distribute at least 95% of its REIT taxable income plus 95% of its net income from foreclosure property, as defined in Section 857 of the Code, on an annual basis to shareholders. Inflation The effects of inflation on the Trust's operations are not quantifiable. Revenues from property operations fluctuate proportionately with increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and, correspondingly, the ultimate gains to be realized by the Trust from property sales. To the extent that inflation affects interest rates, the Trust's earnings from short-term investments and the cost of new borrowings as well as its existing variable rate borrowings will be affected. Environmental Matters Under various federal, state and local environmental laws, ordinances and regulations, the Trust may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery from the Trust for personal injury associated with such materials. 22 23 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Environmental Matters (Continued) The Trust's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Trust's business, assets or results of operations. Recent Accounting Pronouncement In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 121 - "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of". The statement requires that long-lived assets be considered impaired "...if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset." If impairment exists, an impairment loss shall be recognized, by a charge against earnings, equal to "...the amount by which the carrying amount of the asset exceeds the fair value of the asset." If impairment of a long-lived asset is recognized, the carrying amount of the asset shall be reduced by the amount of the impairment, shall be accounted for as the asset's "new cost" and such new cost shall be depreciated over the asset's remaining useful life. SFAS No. 121 further requires that long-lived assets held for sale "...be reported at the lower of carrying amount or fair value less cost to sell." If a reduction in a held for sale asset's carrying amount to fair value less cost to sell is required, a provision for loss shall be recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale asset's fair value less cost to sell shall be recorded as an adjustment to the asset's carrying amount, but not in excess of the asset's carrying amount when originally classified as held for sale. A corresponding charge or credit to earnings is to be recognized. Long-lived assets held for sale are not to be depreciated. The Trust adopted SFAS No. 121 effective January 1, 1996. The effect of adopting SFAS No. 121 was the discontinuance of depreciation on the Trust's properties held for sale of $26,000 and $75,000 in the three and nine months ended September 30, 1996, and a corresponding increase in its reported net income. ------------------------------- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Olive Litigation. In February 1990, the Trust, together with Income Opportunity Realty Investors, Inc., National Income Realty Trust and Transcontinental Realty Investors, Inc., three real estate entities with, at the time, the same officers, directors or trustees and advisor 23 24 ITEM 1. LEGAL PROCEEDINGS (Continued) as the Trust, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al. pending before the United States District Court for the Northern District of California and relating to the operation and management of each of the entities (the "Olive Litigation"). On April 23, 1990, the court granted final approval of the terms of a Stipulation of Settlement. On May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the "Olive Modification") that settled subsequent claims of breaches of the settlement that were asserted by the plaintiffs and that modified certain provisions of the April 1990 settlement. The Olive Modification was preliminarily approved by the court on July 1, 1994, and final court approval was entered on December 12, 1994. The effective date of the Olive Modification was January 11, 1995. During August and September 1996, the court held evidentiary hearings to assess compliance with the terms of the Olive Modification by the various parties. The court has not issued any ruling or order with respect to the matters addressed at the hearings. Separately, in 1996, legal counsel for the plaintiffs notified the Trust's Board of Trustees that he intends to assert that certain actions taken by the Board of Trustees during 1994, 1995 and 1996 breached the terms of the Olive Modification. Plaintiffs' counsel has not made a petition to the court on any of these claims. ITEM 5. OTHER INFORMATION The Trust's management has recommended that the Trust's Board of Trustees approval a proposal to convert the Trust to a Nevada Corporation. On October 25, 1996, the Trust's Board of Trustees approved such recommendation. The Board of Trustees believes the change from a California business trust to a Nevada corporation will afford the Trust greater legal certainty in matters of corporate grievance and indemnification and greater predictability in the conduct of its business as a corporation under Nevada law. The Trust has filed a Proxy Statement/Prospectus with the Securities and Exchange Commission providing for a special meeting of the Trust's shareholders. At such meeting shareholders will be presented with a proposal to approve the conversion of the Trust to a corporation by way of merger of the Trust into a wholly-owned subsidiary of the Trust. This proposal will require the approval of shareholders holding a majority of the Trust's outstanding shares of beneficial interest. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a)Exhibits: Exhibit Number Description - ------- ---------------------------------------------------- 27.0 Financial Data Schedule 24 25 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (Continued) (b) Reports on Form 8-K as follows: A Current Report on Form 8-K, dated July 9, 1996, was filed with respect to Item 2. "Acquisition or Disposition of Assets," and Item 7. "Financial Statements and Exhibits," which reports the acquisition of the Hampton Court Office Building, the Central Storage Warehouse, the Amoco Office Building, the Grove Park Apartments, the Promenade Shopping Center and the Park at Colonnade Apartments, which was amended on Form 8-K/A, filed September 9, 1996. 25 26 SIGNATURE PAGE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CONTINENTAL MORTGAGE AND EQUITY TRUST Date: November 13, 1996 By: /s/ RANDALL M. PAULSON ------------------------- ------------------------------ Randall M. Paulson President Date: November 13, 1996 By: /s/ THOMAS A. HOLLAND ------------------------ ------------------------- Thomas A. Holland Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 26 27 CONTINENTAL MORTGAGE AND EQUITY TRUST EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q For the Nine Months Ended September 30, 1996 Exhibit Page Number Description Number - ------- ---------------------------------------------------- ------ 27.0 Financial Data Schedule. 28 27 EX-27 2 FINANCIAL DATA SCHEDULE
5 1000 9-MOS DEC-31-1996 JAN-1-1996 SEP-30-1996 16,537 6,676 8,406 6,129 0 0 209,565 16,184 232,390 0 142,516 0 0 0 82,412 232,390 0 33,205 0 20,091 3,565 0 9,317 (763) 0 (763) 0 812 0 9,643 2.28 2.28
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