-----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, I/aBw5ODy86HpUcUoZ4gLJ6n7oWzrwR+clNOLefsb64tbiav2xcmSubbJJsNSGUd KTAxXXfIih+pM0/7kU7qCg== 0001215811-04-000021.txt : 20040315 0001215811-04-000021.hdr.sgml : 20040315 20040315125001 ACCESSION NUMBER: 0001215811-04-000021 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN MORTGAGE ACCEPTANCE CO CENTRAL INDEX KEY: 0000878774 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 136972380 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-14583 FILM NUMBER: 04668567 BUSINESS ADDRESS: STREET 1: 625 MADISON AVE CITY: NEW YORK STATE: NY ZIP: 10022 BUSINESS PHONE: 2124215333 MAIL ADDRESS: STREET 1: 625 MADISON AVENUE CITY: NEW YORK STATE: NY ZIP: 10022 FORMER COMPANY: FORMER CONFORMED NAME: AMERICAN MORTGAGE INVESTORS TRUST DATE OF NAME CHANGE: 19931013 10-K 1 f10k_dec2003-amac2.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (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, 2003 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES - ----- EXCHANGE ACT OF 1934 Commission File Number 0-23972 AMERICAN MORTGAGE ACCEPTANCE COMPANY (Formerly American Mortgage Investors Trust) -------------------------------------------- (Exact name of registrant as specified in its charter) Massachusetts 13-6972380 - ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 625 Madison Avenue, New York, New York 10022 - ---------------------------------------- ---------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 421-5333 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Shares of Beneficial Interest, par value $.10 per share 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] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes X No ----- ----- The approximate aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant as of June 30, 2003 was $142,280,303, based on a price of $17.36 per share, the closing sales price for the Registrant's shares of beneficial interest or the American Stock Exchange on that date. As of March 15, 2004 there were 8,338,180 outstanding shares of the Registrant's shares of beneficial interest. DOCUMENTS INCORPORATED BY REFERENCE Part III: Those portions of the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on June 9, 2004, which are incorporated into Items 10, 11, 12 and 13. Index to exhibits may be found on page 60 Page 1 of 106 CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 WHEN USED IN THIS ANNUAL REPORT ON FORM 10-K, THE WORDS "BELIEVES", "ANTICIPATES", "EXPECTS" AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. STATEMENTS LOOKING FORWARD IN TIME ARE INCLUDED IN THIS ANNUAL REPORT ON FORM 10-K PURSUANT TO THE "SAFE HARBOR" PROVISION OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY, INCLUDING, BUT NOT LIMITED TO, THOSE SET FORTH IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS". READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE HEREOF. 2 PART I Item 1. Business. General - ------- American Mortgage Acceptance Company (the "Company") was formed on June 11, 1991 as a Massachusetts business trust. The Company elected to be treated as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). The Company's business plan focuses on originating and acquiring mortgages secured by multifamily properties, which may take the form of government insured first mortgages, insured mortgage pass-through certificates or insured mortgage backed securities, and uninsured mezzanine loans, construction loans, and bridge loans. Additionally, the Company has indirectly invested in subordinate commercial mortgage-backed securities and may invest in other real estate assets, including non-multifamily mortgages. The Company also issues guarantees of construction and permanent financing and makes standby loan commitments. The Company is governed by a board of trustees comprised of three independent trustees and two non-independent trustees who are affiliated with CharterMac, an American Stock Exchange listed company. The Company has engaged Related AMI Associates, Inc. (the "Advisor"), an affiliate of CharterMac, to manage its day-to-day affairs. The Advisor has subcontracted with Related Capital Company ("Related"), a subsidiary of CharterMac, to provide the services contemplated. Through the Advisor, Related offers the Company a core group of experienced staff and executive management providing the Company with services on both a full and part-time basis. These services include, among other things, acquisition, financial, accounting, tax, capital markets, asset monitoring, portfolio management, investor relations and public relations services. Effective November 17, 2003, CharterMac, an affiliate of the Advisor, acquired Related, which included the Advisor. This acquisition did not affect the Company's day-to-day operations or the services provided to the Company by the Advisor. Ownership of the Advisor was transferred to CharterMac, but management of the Advisor remained unchanged as the principals of Related who managed the Advisor became executive officers of CharterMac and remain executive officers of the Advisor. As a result of CharterMac's acquisition of Related, two of the Company's independent trustees, Mr. Arthur P. Fisch and Mr. Peter T. Allen, who are also on CharterMac's board of trustees, were no longer considered to be independent. Due to a provision in the Company's trust agreement which requires the Company to have a majority of "independent" trustees, Mr. Fisch and Mr. Allen resigned from the board and were replaced by Stanley R. Perla and Richard M. Rosan as independent trustees on the Company's board. The consolidated financial statements include the accounts of the Company and three wholly-owned subsidiaries which it controls: AMAC Repo Seller, LLC, AMAC/FM Corporation ("AMAC/FM") and AMAC Credit Facility, LLC. All intercompany accounts and transactions have been eliminated in consolidation. Unless otherwise indicated, the "Company" as hereinafter used, refers to American Mortgage Acceptance Company and its subsidiaries. Effective October 2003, the Company dissolved AMAC/FM due to the assignment of all rights and obligations under the Fannie Mae loan program to PW Funding. AMAC/FM was formed to manage this program. Investment Strategy - ------------------- Since the Company's 1999 listing on the American Stock Exchange, the Company's goal has been to attempt to maximize the return on the Company's asset base by investing in higher yielding assets while managing risk by maintaining a portion of its investments in government agency guaranteed or insured assets and by maintaining a conservative capital structure. The Company seeks asset diversification, capital appreciation and income for distribution to its shareholders primarily through the acquisition and origination of mortgages secured by multifamily properties. These investments may take the form of first mortgages, mezzanine loans, construction loans and bridge loans. The Company also indirectly invests in subordinate commercial mortgage-backed securities and may invest in other real estate assets. The Company invests in the following types of assets: GOVERNMENT INSURED AND GUARANTEED INVESTMENTS Generally, the Company seeks to maintain a minimum of 40% of its investments in government insured or guaranteed investments, primarily through the acquisition of Government National Mortgage Association ("GNMA") and Federal National Mortgage Association ("FNMA") mortgage-backed securities and pass-through certificates. The Company believes that government agency insured lending offers safety, liquidity and moderate yields, while also providing a strong asset base for collateralized borrowing on favorable terms. 3 MEZZANINE LOANS Mezzanine loans are subordinate to senior mortgages and may include a participating component, such as a right to a portion of the cash flow and proceeds generated from the refinancing and sale of the underlying properties. The Company seeks to capitalize on attractive yields available through the funding of mezzanine debt in combination with the origination of government insured, multifamily first mortgages. The Company's mezzanine loans typically finance newly constructed or rehabilitated market-rate multifamily properties and generally have terms of 40 years with an option to call the loan on 12 months notice at any time after the tenth anniversary of the completion of the construction or rehabilitation. These loans are typically in a subordinated mortgage position, are also secured by equity interests in the borrower and have limited recourse to the borrower for the three years from the date of loan. The Company seeks properties in growing real estate markets with well capitalized developers or guarantors. The Company leverages the expertise of its Advisor and its affiliates in both the initial underwriting of the property, as well as in the ongoing monitoring of the property through construction, lease-up and stabilization. BRIDGE LOANS The Company has two bridge loan programs. In the first, the Company's bridge loans are typically funded in connection with the development of multifamily properties which benefit from the Low Income Housing Tax Credit program under Section 42 of the Internal Revenue Code ("LIHTC program"). Due to the equity payment schedule typically associated with the LIHTC program, there can be periods in a construction cycle where a developer needs short-term capital. To capitalize on this demand, the Company will offer bridge loans to developers with typical terms of approximately 12 months and which are collateralized by the equity interests in the property owner. In the second program, the Company provides bridge loans for properties undergoing rehabilitation by new owners when the rehabilitation process will add significant value to the property and reduce the effective loan-to-value ratio and risk of loss. The Company's loans may finance the initial purchase and/or the subsequent rehabilitation of a property. During October 2002, the Company entered into a mortgage warehouse line of credit with Fleet National Bank (the "Fleet Warehouse Facility"), in the amount of up to $40 million. Under the terms of the Fleet Warehouse Facility, Fleet will advance up to 83% of the total loan package, to be used to fund notes receivable, which the Company will make to its customers for the acquisition/refinancing and minor renovation of existing, lender-approved multifamily properties. From time to time, the Company will use this facility to finance real estate owned. COMMERCIAL MORTGAGE-BACKED SECURITIES ("CMBS") The Company may invest in subordinated CMBS, which offer the advantage of significantly higher yields than government insured and guaranteed investments. The market values of subordinated interest in CMBS and other subordinated securities tend to be more sensitive to changes in economic conditions than senior, rated classes. As a result of these and other factors, subordinated interest generally are not actively traded and may not provide holders with liquidity of investment. The Company currently invests indirectly in CMBS through a convertible preferred equity investment in ARCap Investors, LLC ("ARCap"). ARCap specializes in, and is a recognized industry leader in investing in, non-investment grade and unrated subordinated CMBS. The CMBS which comprise ARCap's portfolio are collateralized by a diverse range of underlying properties including multifamily, retail, office and hotel. REAL ESTATE OWNED From time to time, in order to protect its investments, the Company may foreclose on certain properties that have collateralized loans where the borrower has defaulted on interest and/or principal payments that were due to the Company. Once the property is in the Company's possession, the Company will take the necessary steps to improve the performance of the property and protect the value of its investment. STANDBY LOAN COMMITMENTS The Company issues standby bridge loan and permanent loan commitments for projects involved with the construction or rehabilitation of multifamily apartment complexes in various locations. In return, the Company receives a fee for issuing these commitments. STABILIZATION GUARANTEES The Company has entered into an agreement with Wachovia Bank, National Association ("Wachovia"), to provide stabilization guarantees for new construction of multifamily properties under the LIHTC program. Wachovia already provides construction and stabilization guarantees to Fannie Mae, for loans Wachovia originates under the Fannie Mae LIHTC forward commitment loan program, but only for loans within regions of the country Wachovia has designated to be within its territory. For loans outside Wachovia's territory, the Company has agreed to issue a stabilization guarantee, for the benefit of Wachovia. Under this program, the Company guarantees that properties which have completed construction will stabilize and the associated construction loans will convert to permanent Fannie Mae loans. The Company receives origination and guarantee fees from the developers for providing the guarantees. If the properties do not stabilize with enough net operating income for Fannie Mae to fully fund its commitment for a permanent loan, AMAC may be required to purchase the 4 construction loan from Wachovia or to fund the difference between the construction loan amount and the reduced Fannie Mae permanent loan amount. TAXABLE REVENUE BONDS During 2003, the Company invested in taxable revenue bonds, each of which is pari-passu with a first mortgage position held by CharterMac, the owner of each related tax-exempt revenue bond. The Company will seek to make additional investments in these types of bonds in the future. OTHER INVESTMENTS From time to time, the Company may invest in assets outside of the Company's investment strategy if it believes that making such an investment is advantageous in maximizing the Company's return on its asset base. Portfolio - --------- At December 31, 2003, the Company had total assets of approximately $327.1 million. At December 31, 2003, the Company owned approximately $167.3 million in GNMA and FNMA certificates, or approximately 51.1% of the Company's assets. The Company generally seeks to maintain at least 40% of its investments in government insured or guaranteed investments. At December 31, 2003, the Company owned approximately $11.1 million in mezzanine loans, approximately $2.8 million in mortgage loans, and approximately $35.9 million in total bridge loans (approximately $26.3 million in floating rate bridge loans and approximately $9.6 million in fixed rate bridge loans) funded in connection with the development of multifamily properties which benefit from the LIHTC program. The Company also owned approximately $77.4 million in real estate that was foreclosed upon, $7.6 million in taxable revenue bonds and owned an indirect investment in CMBS through the Company's $20.2 million preferred equity interest in ARCap. DEBT SECURITIES - AVAILABLE FOR SALE As of December 31, 2003, the Company's portfolio included ten GNMA and fifteen FNMA DUS certificates. GNMA is a wholly owned United States government corporation within the Department of Housing and Urban Development ("HUD") created to support a secondary market in government-insured and guaranteed mortgage loans. GNMA guarantees the timely payment of principal and interest on its securities, which are backed by pools of FHA and other government agency insured or guaranteed mortgages. GNMA certificates are backed by the full faith and credits of the United States government. Fannie Mae is a private, shareholder-owned company that is the largest private-sector provider of multifamily financing for affordable and market-rate rental housing in America. Fannie Mae pools loans and converts them into single-class mortgage-backed securities known as Fannie Mae MBS, which is then guaranteed as to timely payment of principal and interest. GNMA and FNMA DUS certificates are widely held and traded mortgage-backed securities and therefore provide a high degree of liquidity. The yield on the GNMA and FNMA DUS certificates will depend, in part, upon the rate and timing of principal prepayments on the underlying mortgages. Generally, as market interest rates decrease, mortgage prepayment rates increase and the market value of interest rate sensitive obligations like the GNMA FNMA DUS certificates increases. As market interest rates increase, mortgage prepayment rates tend to decrease and the market value of interest rate sensitive obligations like the GNMA and FNMA DUS certificates tend to decrease. The effect of prepayments on yield is greater the earlier a prepayment of principal is received. Certain of the Company's GNMA and FNMA DUS certificates are collateralized by mortgage loans on multifamily properties. 5 Investments in Debt Securities - Available for Sale - --------------------------------------------------- Information relating to debt securities owned by the Company as of December 31, 2003 is as follows: (Dollars in thousands)
Date Purchased/ Amortized Certificate Final Stated Cost at Name Number Payment Date Interest Rate December 31, 2003 - ---------------- ----------- -------------- ------------- ----------------- GNMA CERTIFICATES Western Manor (1) 355540 7/27/94 7.125% $ 2,457 3/15/29 Copper Commons (2) 382486 7/28/94 8.500% -- 8/15/29 SunCoast Capital Group, Ltd. (1) G002412 6/23/97 7.000% 232 4/20/27 Elmhurst Village (1) 549391 6/28/01 7.745% 21,594 1/15/42 Reserve at Autumn Creek (1)(3) 448748 6/28/01 7.745% 15,962 1/15/42 Casitas at Montecito (4) 519289 3/11/02 7.300% -- 10/15/42 Village at Marshfield (1) 519281 3/11/02 7.475% 21,371 1/15/42 Cantera Crossing (1) 532663 3/28/02 6.500% 6,419 6/1/29 Filmore Park (1) 536740 3/28/02 6.700% 1,432 10/15/42 Northbrooke (1) 548972 5/24/02 7.080% 14,018 8/1/43 Ellington Plaza (1) 585494 7/26/02 6.835% 27,447 6/1/44 Burlington (1) 595515 11/1/02 5.900% 6,814 4/15/31 FNMA DUS CERTIFICATES Cambridge (1) 385971 4/11/03 5.560% 3,665 3/1/33 Bayforest (1) 381974 4/21/03 7.430% 4,305 10/1/28 Coventry Place (1) 384920 5/9/03 6.480% 791 3/1/32 Rancho de Cieto (1) 385229 5/13/03 6.330% 2,608 9/1/17 Elmwood Gardens (1) 386113 5/15/03 5.350% 5,545 5/1/33 30 West (1) 380751 5/27/03 6.080% 1,362 10/1/16 Jackson Park (1) 386139 5/30/03 5.150% 2,777 6/1/18 Interest Income Unrealized Earned Applicable Gain (Loss)at Balance at to the Year Ended Name December 31,2003 December 31, 2003 December 31, 2003 - ---------- ---------------- ----------------- ----------------- GNMA CERTIFICATES Western Manor (1) $ (22) $ 2,435 $ 193 Copper Commons (2) -- -- 17 SunCoastCapital Group, Ltd. (1) 11 243 25 Elmhurst Village (1) 3,329 24,923 1,675 Reserve at Autumn Creek (1)(3) -- 15,962 1,238 Casitas at Montecito (4) -- -- 70 Village at Marshfield (1) 1,082 22,453 1,439 Cantera Crossing (1) 747 7,166 395 Filmore Park (1) 152 1,584 85 Northbrooke (1) 1,824 15,842 905 Ellington Plaza (1) 2,420 29,867 1,175 Burlington (1) 288 7,102 397 FNMA DUS CERTIFICATES Cambridge (1) (83) 3,582 142 Bayforest (1) (61) 4,244 178 Coventry Place (1) (24) 767 28 Rancho de Cieto (1) (78) 2,530 79 Elmwood Gardens (1) (145) 5,400 182 30 West (1) (89) 1,273 37 Jackson Park (1) (44) 2,733 82
6
Date Purchased/ Amortized Certificate Final Stated Cost at Name Number Payment Date Interest Rate December 31, 2003 - ---------------- ----------- --------------- ------------- ----------------- Courtwood (1) 386274 6/26/03 4.690% 1,765 6/1/33 Sultana (1) 386259 6/30/03 4.650% 4,104 6/1/23 Buena (1) 386273 6/30/03 4.825% 3,053 6/1/33 Allegro (1) 386324 6/30/03 5.380% 2,574 6/1/33 Village West (1) 386243 6/30/03 4.910% 786 6/1/21 Westwood/Monterey (1) 386421 9/15/03 5.090% 2,720 8/1/33 Euclid (1) 386446 9/15/03 5.310% 2,374 8/1/33 Edgewood (1) 386458 9/15/03 5.370% 2,358 9/1/33 ----------------- Total $158,533 ================= Interest Income Unrealized Earned Applicable Gain (Loss)at Balance at to the Year Ended Name December 31,2003 December 31, 2003 December 31, 2003 - ---------- ---------------- ----------------- ----------------- Courtwood (1) (147) 1,618 42 Sultana (1) (293) 3,811 96 Buena (1) (245) 2,808 71 Allegro (1) (42) 2,532 69 Village West (1) (41) 745 19 Westwood/Monterey (1) 80 2,800 46 Euclid (1) 55 2,429 40 Edgewood (1) 53 2,411 40 ----------------------------------------------------------- Total $8,727 $167,260 $8,765 ===========================================================
(1) These GNMA and FNMA DUS certificates are partially or wholly-pledged as collateral for borrowings under the repurchase facility (see Note 9). (2) This GNMA certificate was repaid in April 2003 at par. There was no gain or loss recognized. (3) In January 2004, the Company received proceeds in the approximate amount of $14.5 million from HUD in relation to the paydown of the Reserve at Autumn Creek GNMA certificate. This paydown approximated 90% of the total outstanding balance of the underlying mortgage loan, which was the initial payment pursuant to the FHA insurance claim made by the Company when the borrower missed debt service payments. The remaining balance of approximately $1.5 million is expected to be received in the second quarter 2004, from the remaining amounts of the insurance and potentially the guarantee from GNMA. (4) This GNMA certificate was repaid in March 2003 at par. As a result of the repayment, the Company realized a loss of approximately $391,000 due to the unamortized balance of the premium that was recorded when the GNMA certificate had been purchased. 7
(Dollars in thousands) Remaining Outstanding Committed Principal Unamortized Carrying Balance to Interest Property Location Balance Fees Amount Fund (1) Rate Maturity - ------------------------------------------------------------------------------------------------------------------------------- Parwood (2) Long Beach, CA $ 2,683 $ 2 $ 2,681 $ 567 11.00% January 2004 Noble Towers (2)(3) Oakland, CA 3,581 30 3,551 3,719 9.75% July 2005 Clarks Crossing (2) Laredo, TX 1,074 -- 1,074 -- 12.00% April 2004 Desert View (2) Coolidge, AZ 20 -- 20 -- 11.00% May 2004 Valley View (2) North Little Rock, AR 400 -- 400 -- 12.00% July 2004 Georgia King (2) Newark, NJ 1,495 25 1,470 5 11.50% May 2004 Reserve at Thornton (2) Thornton, CO 260 9 251 690 11.00% August 2006 Concord at Gessner Land Houston, TX 188 -- 188 -- 8.00% December 2008 LIBOR + 4.625% Del Mar Villas (4) Dallas, TX 5,554 8 5,546 -- (5) April 2004 LIBOR + 4.750% Mountain Valley (4) Dallas, TX 6,306 30 6,276 -- (5) November 2004 LIBOR + 4.000% Baywoods (4) Antioch, CA 10,990 40 10,950 -- (5) March 2005 LIBOR + 4.500% Oaks of Baytown (4) Baytown, TX 2,337 16 2,321 1,488 (5) August 2005 LIBOR + 3.600% Quay Point (4) Houston, TX 1,223 5 1,218 -- (5) August 2005 --------------------------------------------------- Total $36,111 $165 $35,946 $6,469 ===================================================
(1) Funded on an as needed basis. (2) These loans are to limited partnerships who are affiliated with the Advisor. (3) Affiliate of the Advisor has provided a full guarantee on the payment of principal and interest due on this note. (4) Pledged as collateral in connection with warehouse facility with Fleet National Bank. (5) 30-day LIBOR at December 31, 2003 was 1.12%. 8 INVESTMENTS IN MORTGAGE LOANS Information relating to the Company's investments in mortgage loans as December 31, 2003 is as follows: (Dollars in thousands)
Final Maturity Lifetime Property Description Date Call Date(A) Interest Rate Interest Cap(C) - -------- ----------- -------- ----------- ------------- --------------- FIRST MORTGAGE LOANS: Stony Brook II East Haven, CT 125 Units 6/37 12/06 7.625% N/A Sunset Gardens Eagle Pass, TX 60 Units 6/04 N/A 11.50% N/A Alexandrine (H) Detroit, MI 30 Units 12/03 N/A 11.00% N/A Desert View (I) Coolidge, AZ 45 Units 5/04 N/A 11.00% N/A Subtotal First Mortgage Loans MEZZANINE LOANS (J): Stabilized Properties - --------------------- Stony Brook II East Haven, CT 125 Units 6/37 12/06 15.33%(B) 16% Plaza at San Jacinto (K) Houston, TX 132 Units 1/43 6/11 11.40%(B) 16% Subtotal Stabilized Mezzanine Loans Properties in Lease-Up - ---------------------- The Hollows (L) Greenville, NC 184 Units 1/42 1/12 10.00%(B) 16% Elmhurst Village (M)(N) Oveido, FL 313 Units 1/42 3/19 10.00%(B) 16% The Reserve at Autumn Creek (K)(M)(N) Friendswood, TX 212 Units 1/42 9/14 10.00%(B) 16% Club at Brazos (L)(O) Rosenberg, TX 200 Units 5/43 4/13 10.00%(B) 14% Northbrooke (M)(N) Harris County, TX 240 Units 8/43 7/13 11.50%(B) 14% Subtotal Properties in Lease-Up Properties in Construction/Rehabilitation - ----------------------------------------- Del Mar Villas Dallas, TX 260 Units 4/04 N/A LIBOR+4.625% (P) Mountain Valley Dallas, TX 312 Units 11/04 N/A LIBOR+4.750% (P) Villas at Highpoint Lewisville, TX 304 Units 4/33 TBD 14.57% N/A Subtotal Properties in Construction/Rehabilitation Subtotal Mezzanine Loans Total Mortgage Loans Share of Share of Excess Sale or Excess Operating Refinancing Periodic Property Cash Flows Proceeds Payment Terms Prior Liens - -------- ---------------- -------------- ------------- ----------- FIRST MORTGAGE LOANS: Stony Brook II East Haven, CT N/A N/A (F) -- Sunset Gardens Eagle Pass, TX N/A N/A (G) -- Alexandrine (H) Detroit, MI N/A N/A (G) -- Desert View (I) Coolidge, AZ N/A N/A (G) -- Subtotal First Mortgage Loans MEZZANINE LOANS (J): Stabilized Properties - --------------------- Stony Brook II East Haven, CT 40% 35% (F) -- Plaza at San Jacinto (K) Houston, TX 50% 50% (G) -- Subtotal Stabilized Mezzanine Loans Properties in Lease-Up - ---------------------- The Hollows (L) Greenville, NC 50% 25% (G) $ 8,880 Elmhurst Village (M)(N) Oveido, FL 50% 25% (G) 21,594 The Reserve at Autumn Creek (K)(M)(N) Friendswood, TX 50% 25% (G) 15,993 Club at Brazos (L)(O) Rosenberg, TX 50% 25% (G) 14,343 Northbrooke (M)(N) Harris County, TX 50% 50% (G) 13,871 Subtotal Properties in Lease-Up Properties in Construction/Rehabilitation - ----------------------------------------- Del Mar Villas Dallas, TX N/A N/A (G) 5,554 Mountain Valley Dallas, TX N/A N/A (G) 6,306 Villas at Highpoint Lewisville, TX N/A N/A (G) 18,800 Subtotal Properties in Construction/Rehabilitation Subtotal Mezzanine Loans Total Mortgage Loans Interest Outstanding Carrying Earned Applicable Face Amount of Unamortized Amount of to the Year Ended Property Mortgages(D) Costs and Fees Mortgages(E) December 31, 2003 - -------- -------------- -------------- ------------ ----------------- FIRST MORTGAGE LOANS: Stony Brook II East Haven, CT $ -- $ -- $ -- $ 497 Sunset Gardens Eagle Pass, TX 1,479 -- 1,479 182 Alexandrine (H) Detroit, MI 342 -- 342 38 Desert View (I) Coolidge, AZ 960 -- 960 69 ----------------------------------------------------------- Subtotal First Mortgage Loans 2,781 -- 2,781 786 ----------------------------------------------------------- MEZZANINE LOANS (J): Stabilized Properties - --------------------- Stony Brook II East Haven, CT -- -- -- 527 Plaza at San Jacinto (K) Houston, TX -- -- -- 39 ----------------------------------------------------------- Subtotal Stabilized Mezzanine Loans -- -- -- 566 ----------------------------------------------------------- Properties in Lease-Up - ---------------------- The Hollows (L) Greenville, NC 1,549 (133) 1,416 174 Elmhurst Village (M)(N) Oveido, FL 2,874 (391) 2,483 320 The Reserve at Autumn Creek (K)(M)(N) Friendswood, TX -- -- -- 36 Club at Brazos (L)(O) Rosenberg, TX 1,962 (75) 1,887 200 Northbrooke (M)(N) Harris County, TX 1,500 (133) 1,367 177 ----------------------------------------------------------- Subtotal Properties in Lease-Up 7,885 (732) 7,153 907 ----------------------------------------------------------- Properties in Construction/Rehabilitation - ----------------------------------------- Del Mar Villas Dallas, TX 765 -- 765 46 Mountain Valley Dallas, TX 776 -- 776 47 Villas at Highpoint Lewisville, TX 2,574 (185) 2,389 245 ----------------------------------------------------------- Subtotal Properties in Construction/Rehabilitation 4,115 (185) 3,930 338 ----------------------------------------------------------- Subtotal Mezzanine Loans 12,000 (917) 11,083 1,811 ----------------------------------------------------------- Total Mortgage Loans $14,781 $ (917) $13,864 $ 2,597 ===========================================================
9 (A) Loans are subject to mandatory prepayment at the option of the Company ten years after construction completion, with one year's notice. Loans with a call date of "TBD" are still under construction. (B) Interest on the mezzanine loans is based on a fixed percentage of the unpaid principal balance of the related first mortgage loans. The amount shown is the approximate effective rate earned on the balance of the mezzanine loan. The mezzanine loans also provide for payments of additional interest based on a percentage of cash flow remaining after debt service and participation in sale or refinancing proceeds and certain provisions that cap the Company's total yield, including additional interest and participations, over the term of the loan. (C) Lifetime interest cap represents the maximum annual return, including interest, fees and participations, that can be earned by the Company over the life of the mezzanine loan, computed as a percentage of the balance of the first mortgage loan plus the mezzanine loan. (D) As of December 31, 2003, all interest payments on the mortgage loans are current, except as noted. (E) Carrying amounts of the loans are net of unamortized origination costs and fees and loan discounts. (F) The Stonybrook II first mortgage loan and mezzanine loan were repaid in January 2003. (G) Interest only payments are due monthly, with loan balance due at maturity. (H) The first mortgage loan, which matured in December 2003, did not pay off the outstanding balance at the maturity date, which caused the loan to be in default. The Company is currently in the process of determining the necessary steps needed to be taken to protect its investment. The Company has obtained an independent appraisal for the property underlying the mortgage. The appraisal indicates that the value of the property exceeds the carrying amount of the first mortgage loan on the property. Accordingly, the Company has not recorded an allowance for probable losses on this loan. (I) Loan purchased in April 2003 in connection with the performance under a guarantee made by the Company. (J) The principal balance of the mezzanine loans is secured by the partnership interests of the entity that owns the underlying property and a third mortgage deed of trust. Interest payments on the mezzanine loans are secured by a second mortgage deed of trust and are guaranteed for the first 36 months after construction completion by an entity related to the general partner of the entity that owns the underlying property. (K) These mezzanine loans have been reclassified to real estate owned -- see Note 7. (L) The Company does not have an interest in the first lien position relating to this mezzanine loan. (M) The Company has an interest in the first lien position relating to this mezzanine loan. (N) The first mortgage loans related to these properties were converted from participations in FHA loans to ownership of the GNMA certificates and are held by the Company - see Note 3. (O) The funding of this mezzanine loan is based on property level operational achievements. (P) Interest cap on these loans is the maximum rate permitted by law. 10 Investment in ARCap - ------------------- The Company owns 800,000 preferred equity units of ARCap, with a face amount of $25 per unit, representing a 7.41% ownership and voting interest. The preferred equity units are convertible, at the Company's option, into ARCap common units. If converted into common units, the conversion price is equivalent to $25 per unit, subject to certain adjustments. Also, if not already converted, for a period of sixty days following the fifth anniversary of the first closing date, which will be August 4, 2005, the preferred equity units are convertible, at the Company's option, into a three-year note bearing interest at 12% that would be junior to all of ARCap's then existing indebtedness. The preferred equity units are also redeemable, at the option of ARCap, up until the fifth anniversary of the first closing date. Through the Company's convertible preferred membership interests in ARCap, it has a substantial indirect investment in CMBS owned by ARCap. ARCap was formed in January 1999 by REMICap, an experienced CMBS investment manager, and Apollo Real Estate Investors, the real estate arm of one of the country's largest private equity investors. In conjunction with a preferred equity offering, REMICap and ARCap merged, making ARCap the only internally managed investment vehicle exclusively investing in subordinated CMBS. As of December 31, 2003, ARCap had approximately $1.1 billion in assets, including investments of approximately $1.0 billion of CMBS. Multifamily properties underlie approximately one-third of ARCap's CMBS. The Company's equity in the earnings of ARCap will generally be equal to the preferred equity rate of 12% , unless ARCap does not have earnings and cash flows adequate to meet this distribution requirement. ARCap has met its distribution requirements to the Company to date. Yields on CMBS depend, among other things, on the rate and timing of principal payments, the pass-through rate, interest rate fluctuations and defaults on the underlying mortgages. The Company's interest in ARCap is illiquid and the Company would need to obtain the consent of the board of managers of ARCap before it could transfer its interest in ARCap to any party other than a current member. The carrying amount of the investment in ARCap is not necessarily representative of the amount the Company would receive upon a sale of the interest. ARCap has shifted its focus to CMBS fund management, whereby ARCap manages CMBS investment funds raised from third-party investors. ARCap is generally a minority investor in these funds. ARCap thereby diversifies its revenue base by increasing its proportion of revenue derived from fees as opposed to interest income. Loan Origination Program with Fannie Mae - ---------------------------------------- In the first quarter of 2003, the Company discontinued its loan program with Fannie Mae, under which Fannie Mae had agreed to fully fund the origination of $250 million of Delegated Underwriter and Servicer loans ("DUS") for apartment properties that qualify for low income housing tax credits ("LIHTC") under Section 42 of the Internal Revenue Code. Under the loan program, the Company originated and contracted for individual loans of up to $6 million each. The Company guaranteed a first loss position of the aggregate principal amount of these loans and also guaranteed construction loans for which it had issued a forward commitment to originate under this program. Accordingly, the Company wrote off approximately $358,000 of unamortized deferred costs relating to this program, which is included in other expenses on the consolidated statement of income. In September 2003, the Company entered into a letter of agreement with PW Funding Inc. ("PWF"), a subsidiary of CharterMac, each of which are affiliates of the Advisor, under which the Company transferred and assigned all of its rights and obligations to the two loans it originated under this program to PWF. There was no payment made or received by the Company in connection with this transfer. CharterMac has agreed to guarantee PWF's performance with regard to this program, which in turn, allowed for the release of approximately $8.3 million in collateral pledged by the Company to secure its obligations under the loan program. In turn, the Company indemnified PWF against any losses to Fannie Mae on the loans and indemnified CharterMac against any obligations under its guaranty. The maximum aggregate exposure to the Company under this agreement is approximately $7.5 million. However, the Company believes that it will not be called upon to fund any of these guarantees and, accordingly, that the fair value of the guarantees is insignificant. Effective October 2003, as a result of the release of the collateral due to the assignment of all rights and obligations under this program to PW Funding, the Company as dissolved AMAC/FM, which was formed for the purpose of managing this program. Competition - ----------- The Company competes with various financial institutions in each of its lines of business. The Company competes with banks and quasi-governmental agencies such as Fannie Mae, Freddie Mac and HUD, as well as their designated mortgagees, for multifamily loan product. For CMBS investments, competitors include major financial institutions that sponsor CMBS conduits, pension funds, REITs and finance companies that specialize in CMBS investment management. The Company's business is also affected by competition to the extent that underlying properties from which it derives interest and, ultimately, principal payments may be subject to rental rates and relative levels of amenities from comparable neighboring properties. Additional information about the Company is also available at www.americanmortgageco.com. We have made available, free of charge on or through our website, our annual report on Form 10-K, our quarterly reports in Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably 11 practicable after such material was electronically filed with, or furnished to the Securities and Exchange Commission ("SEC"). Materials we filed with the SEC may be read and copies at the SEC's Public Reference Room at 450 Fifth Street, NY, Washington D.C. 20549. This information may also be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. We will provide a copy of any of the foregoing documents to shareholders upon request. Employees and Management - ------------------------ The Company does not directly employ anyone. All services are performed for the Company by the Advisor and its affiliates. The Advisor receives compensation in connection with such activities as set forth in Item 8, Financial Statements and Supplementary Data, Item 11, Executive Compensation and Item 13, Certain Relationships and Related Transactions. In addition, the Company reimburses the Advisor and certain of its affiliates for expenses incurred in connection with the performance by their employees of services for the Company in accordance with the Declaration of Trust. 12 Item 2. Properties. During 2003, the Company had three bridge loans and two mezzanine loans on which required debt service payments were not received, causing the notes to be in default. In all five of these instances, the Company has foreclosed on the property securing the note receivable and taken possession of the property. The Company sold three of the properties in 2003 and is currently managing the other two properties in an attempt to stabilize the properties for future marketing attempts. Item 3. Legal Proceedings. On October 27, 2003, prior to taking possession of the real estate collateral supporting the Gulfgate loan, the Company was named in a lawsuit, Concord Gulfgate, Ltd. vs. Robert Parker, Sunrise Housing Ltd., and American Mortgage Acceptance Company, Cause No. 2003-59290 in the State District Court of Harris County, Texas. The suit claims, among other causes of action against the respective defendants, that the Company conducted wrongful foreclosure in that the Guarantor did not derive any benefit from the Company's loan and that the limited partners of the Guarantor did not authorize the loan transaction. The suit seeks, among other relief, actual, consequential, exemplary, and punitive damages, a declaration that the loan made by the Company is unenforceable, and that the Company was involved in a conspiracy to defraud the Guarantor. The suit is currently in the discovery phase. Item 4. Submission of Matters to a Vote of Shareholders. None. 13 PART II Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters. As of March 12, 2004, there were 242 registered shareholders owning 8,338,180 Shares. The Company's Shares have been listed on the American Stock Exchange since July 1, 1999, under the symbol "AMC". Prior to July 1, 1999, there was no established public trading market for the Company's Shares. The high and low common share prices for each quarterly period in the past two fiscal years in which the Shares were traded is as follows:
2003 2003 2002 2002 Quarter Ended Low High Low High - ------------- ------ ------ ------ ------ March 31 $13.60 $16.06 $12.60 $14.70 June 30 $14.93 $17.99 $12.70 $14.09 September 30 $13.50 $17.94 $10.05 $13.60 December 31 $15.40 $16.97 $11.50 $14.09
The last reported sale price of Shares on the American Stock Exchange on March 12, 2004 was $17.69. On February 25, 2002, the Company completed a public offering 2,500,000 common shares at a price of $13.50 per share. The net proceeds from this offering, approximately $30.9 million, net of underwriters' discount and expenses, were used to fund investments. On April 23, 2003, the Company completed a public offering of 1,955,000 common shares at a price of $15.00 per share resulting in proceeds, net of underwriters' discount and expenses, of approximately $27.5 million. The net proceeds from this offering have been used to fund investment activity. Incentive Share Option Plan - --------------------------- The Company adopted an incentive share option plan (the "Incentive Share Option Plan") to attract and retain qualified persons as trustees and officers and to provide incentive to and more closely align the financial interests of the Advisor and its employees and officers with the interests of the Company's shareholders by providing the Advisor with substantial financial interest in the Company's success. The compensation committee (the "Compensation Committee"), which is comprised of Messrs. Scott M. Mannes and Richard M. Rosan, administers the Incentive Share Option Plan. Pursuant to the Incentive Share Option Plan, if the Company's distributions per share in the immediately preceding calendar year exceed $1.45 per share, the Compensation Committee has the authority to issue options to purchase, in the aggregate, that number of shares which is equal to three percent of the shares outstanding as of December 31 of the immediately preceding calendar year (or in the initial year, as of December 31, 1999), provided that the Compensation Committee may only issue, in the aggregate, options to purchase a maximum number of shares over the life of the Incentive Share Option Plan equal to 383,863 shares (i.e. 10% of the shares outstanding on December 31, 2001). If the Compensation Committee does not grant the maximum number of options in any year, then the excess of the number of authorized options over the number of options granted in such year will be added to the number of authorized options in the succeeding year and will be available for grant by the Compensation Committee in such succeeding year. All options granted by the Compensation Committee will have an exercise price equal to or grater than the fair market value of the share on the date of the grant. The maximum option term is ten years from the date of grant. All share options granted pursuant to the Incentive Share Option Plan may vest immediately upon issuance or in accordance with the determination of the Compensation Committee. In April 2003, in accordance with the Incentive Share Option Plan, the Company's Compensation Committee granted 190,000 options to employees of Related at an exercise price of $15.03, which was the market price of the Company's common shares at the grant date. These options vest equally, in thirds, in April 2004, 2005 and 2006 and expire in 10 years. Share Repurchase Program - ------------------------ In August 2003, the Company's Board of Trustees approved a share repurchase plan for the Company. The plan enables the Company to repurchase, from time to time, up to 1,000,000 common shares. The repurchases will be made in the open market, and the timing will be dependent on the availability of shares and other market conditions. No repurchases have been made at December 31, 2003. 14 Distribution Information - ------------------------ Cash distributions per share for the years ended December 31, 2003 and 2002 are as set forth in the following table:
(Dollars in thousands, except per share amounts) Cash Distribution Total Amount for Quarter Ended Date Paid Per Share Distributed - ----------------- --------- --------- ------------ March 31, 2003 5/15/03 $ .4000 $ 2,546 June 30, 2003 8/14/03 .4000 3,335 September 30, 2003 11/14/03 .4000 3,335 December 31, 2003 2/14/04 .4000 3,335 ------- ------- Total for 2003 $1.6000 $12,551 ======= ======= March 31, 2002 5/15/02 $ .3625 $ 2,308 June 30, 2002 8/14/02 .3750 2,386 September 30, 2002 11/14/02 .3750 2,386 December 31, 2002 2/14/03 .4000 2,545 ------- ------- Total for 2002 $1.5125 $ 9,625 ======= =======
There are no material legal restrictions upon the Company's present or future ability to make distributions in accordance with the provisions of the Declaration of Trust. Future distributions paid by the Company will be at the discretion of the Trustees and will depend on the actual cash flow of the Company, its financial condition, capital requirements and such other factors as the Trustees deem relevant. In order to qualify as a REIT under the Internal Revenue Code, as amended, the Company must, among other things, distribute at least 90% of its taxable income to shareholders. The Company believes that it is in compliance with the REIT-related provisions of the Code. During 2003, for federal income tax purposes, the Company's per share distribution totaled $1.60, all of which was reported as ordinary income to shareholders for 2003. During 2002, for federal income tax purposes, the Company's per share distribution totaled $1.47, of which $1.42 and $.05 were reported as ordinary income and capital gain, respectively, to shareholders for 2002. 15 Item 6. Selected Financial Data. The information set forth below presents selected financial data of the Company. Additional financial information is set forth in the audited financial statements and footnotes thereto contained in Item 8, Financial Statements and Supplementary Data. (Dollars in thousands except per share amounts)
Year ended December 31, -------------------------------------------------------------- OPERATIONS 2003 2002 2001 2000 1999 - ---------- ---------- ---------- ---------- ---------- ---------- Total revenues $ 15,510 $ 10,458 $ 5,698 $ 7,910 $ 5,507 Total expenses 5,653 3,812 2,660 4,766 2,301 ---------- ---------- ---------- ---------- ---------- Income before other income 9,857 6,646 3,038 3,144 3,206 Total other income 2,027 3,014 2,149 174 3,054 ---------- ---------- ---------- ---------- ---------- Net income $ 11,884 $ 9,660 $ 5,187 $ 3,318 $ 6,260 ========== ========== ========== ========== ========== Net income per share basic and diluted $ 1.52 $ 1.61 $ 1.35 $ .86 $ 1.63 ========== ========== ========== ========== ========== Weighted average shares outstanding Basic 7,802,957 6,017,740 3,838,630 3,838,630 3,841,831 ========== ========== ========== ========== ========== Diluted 7,814,810 6,017,740 3,838,630 3,838,630 3,841,931 ========== ========== ========== ========== ========== December 31, -------------------------------------------------------------- FINANCIAL POSITION 2003 2002 2001 2000 1999 - ------------------ ---------- ---------- ---------- ---------- ---------- Total assets $ 327,107 $ 195,063 $ 101,982 $ 70,438 $ 115,565 ========== ========== ========== ========== ========== Repurchase facility payable $ 149,529 $ 87,880 $ 43,610 $ 12,656 $ 19,127 ========== ========== ========== ========== ========== Warehouse facility payable $ 34,935 $ 8,788 $ -- $ -- $ -- ========== ========== ========== ========== ========== Mortgage payable on real estate owned $ 15,993 $ -- $ -- $ -- $ -- ========== ========== ========== ========== ========== Total liabilities $ 206,212 $ 100,725 $ 46,703 $ 15,362 $ 58,474 ========== ========== ========== ========== ========== Total shareholders' equity $ 120,895 $ 94,338 $ 55,279 $ 55,076 $ 57,091 ========== ========== ========== ========== ========== DISTRIBUTIONS - ------------ Distributions to shareholders $ 12,551 $ 9,625 $ 5,566 $ 5,566 $ 5,544 ========== ========== ========== ========== ========== Distribution per share $ 1.600 $ 1.513 $ 1.450 $ 1.450 $ 1.444 ========== ========== ========== ========== ==========
16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Overview - -------- The Company is a real estate investment trust specializing in multi-family housing finance. The Company originates and acquires mezzanine loans, bridge loans, and government-insured first mortgages secured by multi-family housing properties throughout the United States. The Company seeks to increase the return on its asset base by investing in higher yielding assets while balancing risk by maintaining a portion of its investments in government-insured or agency-guaranteed loans. The Company primarily generates revenue from the collection of interest income from mezzanine loans, bridge loans, and debt securities. The Company also earns fees on standby loan commitments and stabilization guarantees that it makes. The Company is managed by an affiliate of CharterMac, who provides services including, among other things, acquisition, financial, accounting, tax, capital markets, asset monitoring, portfolio management, investor relations, and public relation services. A significant amount of the expenditures made by the Company are in the form of fees paid to the Advisor for these services rendered. The Company also incurs costs relating to interest expense on debt. Results of Operations - --------------------- 2003 was a challenging year for the Company as several of its loans went into default and the Company took aggressive steps to protect its investments. In certain instances this required the Company to invest additional capital to acquire senior mortgage positions and subsequently foreclose its position to acquire the real estate securing the loans. While the Company believes that to date it has been successful in protecting its investments and over time it will recover all its invested capital, some of the steps taken resulted in capital being invested at returns lower than the Company's targeted returns for a period of time. This, combined with the lost interest due to defaulted loans, is the primary driver of the decrease in the Company's net income per share from 2002 to 2003. As a result of the foreclosures, the Company now has a significant amount of real estate owned on its balance sheet. The Company is focused on increasing the occupancy level and operating income of the properties to projected stabilization levels. As property level operations improve, the Company will seek to sell or refinance the properties with third parties such that the Company can redeploy the capital invested in higher yielding investments. COMPARISON OF YEARS ENDED DECEMBER 31, 2003 AND 2002 Interest income from debt securities increased approximately $2,996,000 for the year ended December 31, 2003, as compared to 2002, primarily due to the purchase of an additional three GNMA certificates in the latter part of 2002 (approximately $1,907,000) and the purchase of fifteen FNMA DUS certificates during 2003 at an average interest rate yield of 5.49% (approximately $1,150,000). Interest income from mortgage loans increased approximately $547,000 for the year ended December 31, 2003, as compared to 2002, primarily due to the additional interest and prepayment penalties received (approximately $330,000), as well as the recognition of deferred loan origination fees from the repayment of the Stonybrook II first mortgage and mezzanine loans in 2003 (approximately $113,000). Interest income from notes receivable increased approximately $896,000 for the year ended December 31, 2003, as compared to 2002, due to the initial funding of ten notes receivable during 2003 (approximately $1,404,000), partially offset by the default of required debt service payments from the Concord at Gessner, Concord at Little York, and Concord at Gulfgate notes (approximately $680,000). Interest income from revenue bonds in the approximate amount of $151,000, relating to the purchase of nine taxable revenue bonds in October 2003, was recorded for the year ended December 31, 2003. The nine taxable revenue bonds carry a weighted average interest rate of 8.69%. Other income increased approximately $457,000 for the year ended December 31, 2003, as compared to 2002, primarily due to the increase in net operating income picked up from the operations of foreclosed property. General and administrative increased approximately $232,000 for the year ended December 31, 2003, as compared to 2002 primarily due to increased legal fees on foreclosed properties (approximately $107,000) and an increase in excise taxes paid by the company due to untimely dividend distributions (approximately $99,000). Interest expense increased approximately $1,320,000 for the year ended December 31, 2003, as compared to 2002, due to the increased borrowings on the Fleet Warehouse Facility and additional borrowings under the repurchase facility (approximately $755,000), as well as the addition of an interest rate swap agreement (approximately $537,000), put into place in March 2003 to mitigate the impact of interest rate fluctuations on the Company's cash flows and earnings. Fees to Advisor increased approximately $292,000 for the year ended December 31, 2003, as compared to 2002, primarily due to an increase in asset management fees payable to the Advisor due to an increase in the assets (approximately $265,000) and an increase in the overhead reimbursement paid by the Company to the Advisor (approximately $272,000), offset by a decrease in incentive management fees paid to the Advisor (approximately $235,000). 17 A loss on the repayment of debt securities in the amount of approximately $391,000, relating to the write-off of a purchase premium due to the repayment of one GNMA certificate and a gain of approximately $18,000 for the sale of Concord at Gessner vacant lot, were recorded for the year ended December 31, 2003. During 2002, the Company had a gain of approximately $614,000, resulting from the sale of one GNMA certificate. COMPARISON OF YEARS ENDED DECEMBER 31, 2002 AND 2001 Interest income from mortgage loans decreased approximately $723,000 for the year ended December 31, 2002, as compared to 2001, primarily due to the sale of the Columbiana mortgage during 2001 (approximately $602,000) offset by additional construction period interest received from the Club at Brazos and Northbrooke (approximately $320,000). The decrease can also be attributed to the conversion of the Hollows, Elmhurst Village and Autumn Creek mortgages to GNMA certificates (approximately $712,000); the interest income on these assets was included in interest income from mortgage loans prior to conversion and in interest income from GNMA certificates after the conversion. Conversely, interest income from GNMA certificates increased approximately $3.5 million for the year ended December 31, 2002 as compared to 2001 primarily due to the conversion of these three mortgage loans to GNMA certificates (approximately $1,215,000) and the purchase of an additional six GNMA certificates in 2002 (approximately $2,288,000) offset by the loss of interest income from the Hollows GNMA certificate (approximately $216,000) which was sold in March of 2002. The increase in interest income from GNMA certificates and the decrease in interest income from mortgage loans were, in part, a result of the interest income earned by these loans converted to GNMA certificates subsequent to the conversion. No gains or losses resulted from the conversion. Interest income from notes receivable increased approximately $1,819,000, for the year ended December 31, 2002, as compared to 2001, primarily due to the addition of nine notes receivable during 2001 and 2002. Other income increased approximately $212,000, for the year ended December 31, 2002, as compared to 2001, primarily due to the collection of loan extension fees from Autumn Creek during 2002. Interest expense decreased approximately $178,000, for the year ended December 31, 2002, as compared to 2001, primarily due to the net effect of lower interest rates on repurchase facility borrowings and increased leverage. General and administrative expenses increased approximately $24,000, for the year ended December 31, 2002, as compared to 2001, primarily due to an increase in accounting fees and legal expenses (approximately $102,000) offset by a decrease in unused Nomura Asset Capital Corporation fees and amortization (approximately $76,000). Fees to Advisor increased approximately $927,000, for the year ended December 31, 2002, as compared to 2001, due to an increase in the Company's assets and an increase in the reimbursements of certain administrative and other costs incurred by the Advisor on behalf of the Company. The Company also paid to the Advisor an incentive management fee of approximately $235,000 for 2002; no such fee was paid in 2001. Amortization and other expenses increased by approximately $379,000, for the year ended December 31, 2002, as compared to 2001, primarily due to the fact that during the year ended December 31, 2002, the Company recognized approximately $358,000 in Fannie Mae loan program expenses associated with the write-off of the unamortized deferred costs related to this program, which is being discontinued. The Company has not recognized significant fee income from this program. Except for the write-off of the program costs, this program has not, and its discontinuance is not anticipated to have a significant impact on the Company's financial position or results of operation. A gain on the sale or repayment of GNMAs and mortgage loans increased approximately $865,000, for the year ended December 31, 2002 as compared to 2001, due to the sale of the Hollows GNMA in March of 2002 (approximately $614,000) and the repayment of the Columbiana loans in 2001 (approximately $251,000). Although the Company intends to hold its GNMA certificates until maturity, it elected "available for sale" designation under SFAS 115 to give it the flexibility to liquidate those assets if business conditions require. The Company decided to sell the Hollows GNMA when it received an unsolicited offer at an extremely favorable price. 18 Acquisitions - ------------ During the year ended December 31, 2003, the Company made the following investments:
(Dollars in thousands) Acquisitions for the Year Ended December 31, 2003 ------------------------------------------------- Loan/Note Property Name Closing Date Amount (1) Interest Rate Maturity Date - ----------------------------------------- -------------- --------------- ----------------- -------------- Mortgage Loans --------------------------------------- Desert View 4/4/03 $ 1,011 11.00% 5/31/04 -------------- ----------------- Total Mortgage Loans $ 1,011 11.00% ============== ================= Mezzanine Loans --------------------------------------- Villas at Highpoint 4/22/03 $ 2,600 14.57% 4/22/33 Villas at Highpoint 4/22/03 693 23.76% 4/22/33 -------------- ----------------- Total Mezzanine Loans $ 3,293 16.50% (4) ============== ================= Bridge Loans/Notes Receivable --------------------------------------- Noble Towers 2/19/03 $ 7,300 12.00% 7/31/05 Clark's Crossing 3/6/03 1,649 12.00% 4/1/04 Concord at Gessner (2) 3/11/03 1,700 12.00% N/A Desert View 4/1/03 20 11.00% 5/31/04 Valley View 5/1/03 400 12.00% 7/1/04 Related Capital Guaranteed Corporate Partners II (3) 10/15/03 1,300 N/A N/A Georgia King Village 11/3/03 1,500 11.50% 5/3/04 Reserve at Thornton 12/1/03 950 11.00% 8/1/06 Concord at Gessner - Land Parcel 12/29/03 188 8.00% 12/29/08 -------------- ----------------- Total Bridge Loans/Notes Receivable $ 15,007 11.82% (4) ============== ================= Variable Rate Bridge Loans --------------------------------------- Baywoods 3/7/03 $ 10,990 LIBOR + 4.00% 3/7/05 Oaks of Baytown 8/28/03 3,826 LIBOR + 4.50% 8/28/05 Quay Point 8/28/03 1,223 LIBOR + 3.60% 8/28/05 -------------- ----------------- Total Variable Rate Bridge Loans $ 16,039 LIBOR + 4.09% (4) ============== =================
19
(Dollars in thousands) Acquisitions for the Year Ended December 31, 2003 Face Purchase Maturity Property Name Closing Date Amount Price Interest Rate Date - ------------------------------------ -------------- ----------- ----------- -------------- ----------- FNMA DUS Certificates ---------------------------------- Cambridge 4/11/03 $ 3,600 $ 3,699 5.56% 3/1/33 Bay Forest 4/21/03 3,771 4,347 7.43% 10/1/28 Coventry Place 5/9/03 719 797 6.48% 3/1/32 Rancho De Cieto 5/13/03 2,329 2,633 6.33% 9/1/17 Elmwood Gardens 5/15/03 5,500 5,584 5.35% 5/1/33 30 West Apartments 5/27/03 1,226 1,379 6.08% 10/1/16 Jackson Park 5/30/03 2,750 2,795 5.15% 6/1/18 Courtwood 6/26/03 1,750 1,777 4.69% 6/1/33 Buena 6/30/03 3,000 3,075 4.83% 6/1/33 Sultana 6/30/03 4,120 4,132 4.65% 6/1/23 Village West 6/30/03 779 792 4.91% 6/1/21 Allegro 6/30/03 2,567 2,587 5.38% 7/1/33 Edgewood 9/15/03 2,454 2,365 5.37% 9/1/33 Euclid 9/15/03 2,485 2,381 5.31% 8/1/33 Westwood/Monterey 9/15/03 2,910 2,731 5.09% 8/1/33 ----------- ----------- ------------- Total FNMA DUS Certificates $ 39,960 $ 41,074 5.48% (4) =========== =========== ============= Taxable Revenue Bonds ---------------------------------- Clearwood Villas 10/10/03 $ 125 $ 124 9.00% 1/1/06 Colonial Park 10/10/03 375 371 8.75% 3/1/12 Johnston Mill 10/10/03 500 495 8.00% 9/1/12 Lake Park 10/10/03 302 299 9.00% 9/15/35 Magnolia Arbors 10/10/03 1,000 990 8.95% 7/1/18 Meridian 10/10/03 375 371 8.75% 12/1/13 Oaks at Brandlewood 10/10/03 1,200 1,188 8.75% 3/1/17 Ocean Ridge 10/10/03 2,325 2,302 8.75% 9/1/23 Pleasant Valley Villas 10/10/03 1,470 1,456 8.50% 9/1/42 ----------- ----------- ------------- Total Taxable Revenue Bonds $ 7,672 $ 7,596 8.69% (4) =========== =========== =============
(1) Amount represents total funding commitment. (2) This loan balance was reclassified to real estate owned in May 2003. (3) This loan balance was fully repaid October 31, 2003. (4) Weighted average interest rate. 20 Liquidity and Capital Resources - ------------------------------- During 2003, the Company had three bridge loans and two mezzanine loans on which required debt service payments were not received, causing the notes to be in default. In all five of these instances, the Company has foreclosed on the property securing the note receivable and taken possession of the property. The Company goes through an extensive underwriting process prior to making its investments, and the Company believes that these recent events of default are part of the risks and nature of making certain types of mezzanine investments. While the Company is working to preserve its invested capital, the defaults have had a negative impact on the Company's cash flows in the short term, as required interest payments on the notes have not been received. Through recent independent appraisals on each of the properties, the Company believes that it will be able to liquidate each of the properties at amounts greater than that of their carrying amounts. The Company sold three of the properties in 2003 and is currently managing the other two properties in an attempt to stabilize the properties for future marketing attempts. During the year ended December 31, 2003, cash and cash equivalents decreased approximately $8,376,000 primarily due to funding of notes receivable of approximately $23,906,000, purchase of mortgage loans of approximately $46,627,000, investments in debt securities of approximately $62,290,000, funding of first mortgage loans of approximately $3,866,000, and repayments of repurchase facility payable of approximately $54,169,000, partially offset by repayments of mortgage loans of approximately $9,463,000, proceeds from repurchase facility payable of approximately $115,818,000, proceeds from the issuance of common shares of approximately $27,455,000, proceeds from the warehouse facility payable of approximately $26,147,000, principal repayments of debt securities of approximately $8,539,000 and a repayment of a notes receivable of approximately $5,746,000. The Company finances the acquisition of its assets primarily through borrowing at short-term rates using demand repurchase agreements and the mortgage warehouse line of credit (see below). Under the Company's declaration of trust, the Company may incur permanent indebtedness of up to 50% of total market value calculated at the time the debt is incurred. Permanent indebtedness and working capital indebtedness may not, in the aggregate, exceed 100% of the Company's total market value. On April 23, 2003, the Company completed a public offering of 1,955,000 common shares, at a price of $15.00 per share, resulting in proceeds, net of underwriters discount and expenses, of approximately $27.5 million. The net proceeds from the public offering were used to fund investments. The Company has the capacity to raise an additional approximate amount of $170 million in either common or preferred shares remaining under a shelf registration statement filed with the Securities and Exchange Commission during 2002. If market conditions warrant, the Company may seek to raise additional funds up to this amount for investment through further common and/or preferred offerings in the future, although the timing and amount of such offerings cannot be determined at this time. Effective February 15, 2000, the Company entered into a repurchase facility with Nomura Securities International Inc. ("Nomura"). This facility enables the Company to borrow up to 97% of the fair market value of GNMA and FNMA DUS certificates owned by the Company, which are pledged as collateral for the borrowings. Interest on borrowings are at 30-day LIBOR plus 0.02%. As of December 31, 2003 and December 31, 2002, the amount outstanding under this facility was approximately $149.5 and $87.9 million, respectively, and weighted average interest rates were 1.56% and 1.47%, respectively. All borrowings under this facility typically have 30-day settlement terms. In January 2004, Nomura notified the Company that it intended to terminate the repurchase facility. Nomura agreed to allow the Company time to find a replacement repurchase facility, while reducing the amount the Company could borrow under the existing facility to 93% of the fair market value of the collateral certificates. In February 2004, the Company executed repurchase agreements with three counterparties, Greenwich Capital, Bear Stearns, and RBC Capital Markets, which provides the Company with the capacity to completely terminate the facility with Nomura. Terms of the three newly executed agreements offer advance rates between 94% and 97% and borrowing rates between the LIBOR plus 2 basis points and LIBOR plus 10 basis points. In the first week of March 2004, the Company executed multiple transactions whereby the repurchase transactions outstanding with Nomura were transferred to the three new trading partners. Of the Company's portfolio of debt securities, 13 are in an unrealized loss position, totaling approximately $1,313,000, at December 31, 2003. All of these securities have been in an unrealized position for less than one year. These unrealized losses are as a result of increases in interest rates subsequent to the acquisition of these securities. All of the debt securities are performing according to their terms. Accordingly, the Company has concluded that these impairments are not other than temporary. In October 2002, the Company entered into the Fleet Warehouse Facility with Fleet National Bank in the amount of $40 million. Advances under the warehouse facility, up to 83% of the total loan package, will be used to fund notes receivable, which the Company will make to its customers for the acquisition/refinancing and minor renovation of existing, lender-approved multifamily properties located in stable sub-markets. The warehouse facility, which matures April 2006, bears interest at a rate of 30, 60, 90 or 180-day LIBOR + 200 basis points, at the discretion of the Company, payable monthly on advances. Principal is due upon the earlier of refinance or sale of the underlying property or upon maturity. The Company pays a fee of 12.5 basis points, paid quarterly, on any unused portion of the facility. From time to time, the Company will use this facility to finance real estate owned. As of December 31, 2003 and December 31, 2002, the Company had approximately $34.9 million and $8.8 million, respectively, in loans outstanding under this program. In order to qualify as a REIT under the Code, as amended, the Company must, among other things, distribute at least 90% of its taxable income. The Company believes that it is in compliance with the REIT-related provisions of the Code. 21 The Company expects that cash generated from the Company's investments, as well as cash generated from additional borrowings from the new repurchase facilities and Fleet Warehouse Facility, will meet its needs for short-term liquidity, and will be sufficient to pay all of the Company's expenses and to make distributions to its shareholders in amounts sufficient to retain the Company's REIT status in the foreseeable future. In February 2004, a distribution of $3,335,272 ($.40 per share), which was declared in December 2003, was paid to the shareholders for the quarter ended December 31, 2003. Management is not aware of any trends or events, commitments or uncertainties, which have not otherwise been disclosed that will or are likely to impact liquidity in a material way. Critical Accounting Policies - ---------------------------- In preparing the consolidated financial statements, management must make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Some of these estimates and assumptions require application of difficult, subjective, complex judgment, often about the effect of matters that are uncertain and that may change in later periods. Set forth below is a summary of the accounting policies that management believes involve the most significant estimates and assumptions. The Company's portfolio of mortgage loans and notes is periodically evaluated for possible impairment to establish appropriate loan loss reserves, if necessary. The Company's Advisor has a credit review committee which meets each month. This committee reviews the status of each of the Company's loans and notes, and maintains a "watch list" of loans (including loans for which the Company has issued guarantees) for which the underlying property may be experiencing construction cost overruns, delays in construction completion, occupancy shortfalls, lower than expected debt service coverage ratios, or other matters which might cause the borrower to be unable to make the interest and principal payments as scheduled in the loan agreement. If a loan is experiencing difficulties, members of this credit committee work with the borrower to try to resolve the issues, which could include extending the loan term, making additional advances, or reducing required payments. If, in the judgment of Company management, it is determined that is probable that the Company will not receive all contractually required payments when they are due, the loan or note would be deemed impaired, and a loan loss reserve established. As of December 31, 2003, management has determined that no loan loss reserve is necessary. The Company's GNMA and FNMA DUS certificates are carried at estimated fair values. Changes in these valuations do not impact the Company's income or cash flows, but affect shareholders' equity. GNMA and FNMA DUS certificates are relatively liquid investments. The Company uses third party quoted market prices as its primary source of valuation information. The Company's mezzanine investments of approximately $11.1 million at December 31, 2003 bear interest at fixed or variable rates, but some also include provisions that allow the Company to participate in a percentage of the underlying property's excess cash flows from operations and excess proceeds from a sale or refinancing. At the inception of each such investment, Company management must determine whether such investment should be accounted for as a loan, joint venture or as real estate, using the guidance contained in the Third Notice to Practitioners issued by the AICPA. Although the accounting methodology does not affect the Company's cash flows from these investments, this determination affects the balance sheet classification of the investments as well as the classification, timing and amounts of reported earnings. Accounting for the investment as real estate is required if the Company expects that the amount of profit, whether called interest or another name, such as an equity kicker, that it expects to receive above a reasonable amount of interest and fees, is over 50 percent of the property's total expected residual profit. If a mezzanine investment were to be accounted for as an investment in real estate, the Company's balance sheet would show the underlying property and its related senior debt (if such debt were not also held by the Company), and the income statement would include the property's rental revenues, operating expenses and depreciation. If the Company expects that it will receive less than 50 percent of the property's residual profit, then loan or joint venture accounting is applied. Loan accounting is appropriate if the borrower has a substantial equity investment in the property, if the Company has recourse to substantial assets of the borrower, if the property is generating sufficient cash flow to service normal loan amortization, or if certain other conditions are met. Under loan accounting, the Company recognizes interest income as earned and additional interest from participations as received. Joint venture accounting would require that the Company only record its share of the net income from the underlying property. The Company's management must exercise judgment in making the required accounting determinations. For each mezzanine arrangement, the Company projects total cash flows over the loan's term and the Company's share in those cash flows, and considers the borrower's equity, the contractual cap, if any, on total yield to the Company over the term of the loan, market yields on comparable loans, borrower guarantees, and other factors in making its assessment of the proper accounting. To date, the Company has determined that all mezzanine investments are properly accounted for as loans. During 2003, the Company guaranteed certain loans related to the construction of affordable multifamily apartment complexes in various locations. The loan guarantees provide credit support for the properties after construction 22 completion, up until the date in which permanent financing takes place. For each guarantee, the Company monitors the status of the underlying properties and evaluates its exposure under the guarantees. To date, the Company has concluded that no accrual for probable losses is required under SFAS 5. During 2003, the Company entered into a five-year interest rate swap, which is accounted for under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". At the inception, the Company designated this interest rate swap as a cash flow hedge on the variable interest payments on its floating rate financing. Accordingly, the interest rate swap is recorded at fair market value each accounting period, with changes in market value being recorded in other comprehensive income to the extent the hedge is effective in achieving offsetting cash flows. This hedge has been highly effective, so there has been no ineffectiveness included in earnings. Net amounts receivable or payable under the swap agreements are recorded as adjustments to interest expense. During 2003, the Company exercised its rights under subordinated promissory notes and other documents to take possession of certain real estate collateral. The Company has also purchased the first mortgage loans on the properties and acquired the real estate at foreclosure auctions. When a loan is in the process of foreclosure, it is the Company's policy to reclassify the balance of the loan into real estate owned at the lower of fair value of the real estate, less estimated disposal costs or the carrying amount of the loan, and to cease accrual of interest. The Company obtains independent appraisals of all foreclosed real estate to assist management in evaluating property values. To date, no losses have been recorded upon foreclosure. During 2003, in accordance with the Incentive Share Option Plan, the Company's Compensation Committee granted 190,000 options to employees of Related. The Company has adopted the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" for its share options issued to non-employees. Accordingly, compensation cost is accrued based on the estimated fair value of the options issued, and amortized over the vesting period. Because vesting of the options is contingent upon the recipient continuing to provide services to the Company until the vesting date, the Company estimates the fair value of the non-employee options at each period-end up to the vesting date, and adjusts expensed amounts accordingly. The fair value of each option grant is estimated using the Black-Scholes option-pricing model. Commitments and Contingencies - ----------------------------- In the first quarter of 2003, the Company discontinued its loan program with Fannie Mae, under which Fannie Mae had agreed to fully fund the origination of $250 million of Delegated Underwriter and Servicer loans ("DUS") for apartment properties that qualify for low income housing tax credits ("LIHTC") under Section 42 of the Internal Revenue Code. Under the loan program, the Company originated and contracted for individual loans of up to $6 million each. The Company guaranteed a first loss position of the aggregate principal amount of these loans and also guaranteed construction loans for which it had issued a forward commitment to originate under this program. Accordingly, the Company wrote off approximately $358,000 of unamortized deferred costs relating to this program, which is included in other expenses on the consolidated statement of income. In September 2003, the Company entered into a letter of agreement with PW Funding Inc. ("PWF"), a subsidiary of CharterMac, each of which are affiliates of the Advisor, under which the Company transferred and assigned all of its rights and obligations to the two loans it originated under this program to PWF. There was no payment made or received by the Company in connection with this transfer. CharterMac has agreed to guarantee PWF's performance with regard to this program, which in turn, allowed for the release of approximately $8.3 million in collateral pledged by the Company to secure its obligations under the loan program. In turn, the Company indemnified PWF against any losses to Fannie Mae on the loans and indemnified CharterMac against any obligation under its guaranty. The maximum aggregate exposure to the Company under this agreement is approximately $7.5 million. However, the Company believes that it will not be called upon to fund any of these guarantees and, accordingly, that the fair value of the guarantees is insignificant. Off-Balance Sheet Arrangements - ------------------------------ The Company has no unconsolidated subsidiaries, special purpose off-balance sheet financing entities, or other off-balance sheet arrangements. 23 Contractual Obligations - ----------------------- In conducting business, the Company enters into various contractual obligations. Detail of these obligations, including expected settlement periods, is contained below.
Payments Due by Period (Dollars in thousands) Less than More than Total 1 Year 1 - 3 Years 3 - 5 Years 5 Years ------------ ----------- ------------ ------------ ------------- Debt: Lines of credit: Repurchase facility $149,529 $149,529 $ -- $ -- $ -- Fleet warehouse facility 34,935 23,853 11,082 -- -- Mortgage loan 15,993 -- -- -- 15,993 (1) Contingent liabilities: Standby and forward bridge loan commitments 6,469 2,750 3,719 -- -- Standby and forward mezzanine loan commitments 719 26 693 -- -- Forward GNMA commitments 10,255 10,255 -- -- -- Stabilization loan guarantees 19,205 12,290 6,915 -- -- ------------ ----------- ------------ ------------ ------------- Total $237,105 $198,703 $ 22,409 $ -- $15,993 ============ =========== ============ ============ =============
(1) Represents contractual maturity of mortgage loan on real estate owned. However, it is the Company's intention to find a buyer who will assume this obligation in the near term. 24 Distributions - ------------- Of the total distributions of $12,551,268 and $9,624,992 for the years ended December 31, 2003 and 2002, respectively, $666,885 ($.08 per share or 5.31%) represented a return of capital for the year ended December 31, 2003, determined in accordance with generally accepted accounting principles. There was no return of capital for the year ended December 31, 2002. As of December 31, 2003, the aggregate amount of the distributions made since the commencement of the initial public offering representing a return of capital, in accordance with generally accepted accounting principles, totaled $15,137,780. The portion of the distributions which constituted a return of capital was made in order to maintain level distributions to shareholders. Recently Issued Accounting Standards - ------------------------------------ There are no new accounting pronouncements pending adoption that would have a significant impact on the Company's consolidated financial statements. The adoption of the following pronouncements during 2003 did not have a significant impact on the consolidated financial statements: o FASB Statement No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections". o FASB Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". o FASB Interpretation No. 45, "Guarantors' Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". The Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure provisions of this Interpretation are included in Note 14. o FASB Statement SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123". o FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46") as amended and interpreted by FIN 46 (R). o FASB Statement SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". o FASB Statement SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity". Forward-Looking Statements - -------------------------- Certain statements made in this report may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include statements regarding the intent, belief or current expectations of the Company and its management and involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, the following: general economic and business conditions, which will, among other things, affect the availability and creditworthiness of prospective tenants, lease rents and the terms and availability of financing; adverse changes in the real estate markets including, among other things, competition with other companies; risks of real estate development and acquisition; governmental actions and initiatives; and environment/safety requirements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Inflation - --------- Inflation did not have a material effect on the Company's results for the periods presented. Item 7. Quantitative and Qualitative Disclosures About Market Risk Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risk to which the investments of the Company are exposed is interest rate risk, which is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the control of the Company. INTEREST RATE RISK Interest rate fluctuations can adversely affect the Company's income and value of its common shares in many ways and present a variety of risks, including the risk of mismatch between asset yields and borrowing rates. 25 The Company's operating results will depend in large part on differences between the income from its assets (net of credit losses) and its borrowing costs. Most of the Company's assets generate fixed returns and have terms in excess of five years. The Company funds the origination and acquisition of a significant portion of these assets with borrowings which have interest rates that reset relatively rapidly, such as monthly or quarterly. In most cases, the income from assets will respond more slowly to interest rate fluctuations than the cost of borrowings, creating a mismatch between asset yields and borrowing rates. Consequently, changes in interest rates, particularly short-term interest rates, may influence the Company's net income. The Company's borrowings under repurchase and warehouse agreements bear interest at rates that fluctuate with LIBOR. Various financial vehicles exist which would allow Company management to mitigate the impact of interest rate fluctuations on the Company's cash flows and earnings. During March 2003, upon management's analysis of the interest rate environment and the costs and risks of such strategies, the Company entered into an interest rate swap in order to hedge against increases in the floating interest rate on its repurchase facility. On March 25, 2003, the Company entered into a five-year interest rate swap agreement with Fleet National Bank ("Fleet") whereby the Company has agreed to pay Fleet a fixed 3.48% on a notional amount of $30 million. In return, Fleet will pay the Company a floating rate equivalent to the 30-day LIBOR rate on the same notional amount. This effectively fixes $30 million of the Company's secured borrowings at 3.48%, protecting the Company in the event the 30-day LIBOR rate rises. A possible risk of such swap agreements is the possible inability of Fleet to meet the terms of the contracts with the Company; however, there is no current indication of such an inability. Based on the $154.5 million unhedged portion of $184.5 million of borrowings outstanding under these facilities at December 31, 2003, a 1% change in LIBOR would impact the Company's annual net income and cash flows by approximately $1.6 million. However, due to the fact that the interest income from loans made under the Fleet Warehouse Facility are also based on LIBOR, a 1% increase in LIBOR would increase the Company's annual net income and cash flows from such loans by approximately $349,000. Increases in these rates will decrease the net income and market value of the Company's net assets. Interest rate fluctuations that result in interest expense exceeding interest income would result in operating losses. The value of the Company's assets may be affected by prepayment rates on investments. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond the Company's control, and consequently, such prepayment rates cannot be predicted with certainty. When the Company originates mortgage loans, it expects that such mortgage loans will have a measure of protection from prepayment in the form of prepayment lock-out periods or prepayment penalties. However, such protection may not be available with respect to investments which the Company acquires, but does not originate. In periods of declining mortgage interest rates, prepayments on mortgages generally increase. If general interest rates decline as well, the proceeds of such prepayments received during such periods are likely to be reinvested by the Company in assets yielding less than the yields on the investments that were prepaid. In addition, the market value of mortgage investments may, because of the risk of prepayment, benefit less from declining interest rates than from other fixed-income securities. Conversely, in periods of rising interest rates, prepayments on mortgages generally decrease, in which case the Company would not have the prepayment proceeds available to invest in assets with higher yields. Under certain interest rate and prepayment scenarios the Company may fail to recoup fully its cost of acquisition of certain investments. REAL ESTATE RISK Multifamily and commercial property values and net operating income derived from such properties are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as an oversupply of housing, retail, industrial, office or other commercial space); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; and increases in operating expenses (such as energy costs). In the event net operating income decreases, a borrower may have difficulty paying the Company's mortgage loan, which could result in losses to the Company. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the Company's mortgage loans, which could also cause the Company to suffer losses. RISK IN OWNING SUBORDINATED INTERESTS The Company has invested indirectly in subordinated CMBS through its ownership of a $20.2 million preferred membership interest in ARCap. Subordinated CMBS of the type in which ARCap invests include "first loss" and non-investment grade subordinated interests. A first loss security is the most subordinate class in a structure and accordingly is the first to bear the loss upon a default on restructuring or liquidation of the underlying collateral and the last to receive payment of interest and principal. Such classes are subject to special risks, including a greater risk of loss of principal and non-payment of interest than more senior, rated classes. The market values of subordinated interests in CMBS and other subordinated securities tend to be more sensitive to changes in economic conditions than more senior, rated classes. As a result of these and other factors, subordinated interests generally are not actively traded and may not provide holders with liquidity of investment. With respect to the Company's investment in ARCap, the ability to transfer the membership interest in ARCap is further limited by the terms of ARCap's operating agreement. PARTICIPATING INTEREST In connection with the acquisition and origination of mortgages, the Company has, on occasion, obtained and may continue to obtain participating interests that may entitle it to payments based upon a development's cash flow, profits or any increase in the value of the development that would be realized upon a refinancing or sale of the development. Competition for participating interests is dependent to a large degree upon market conditions. Participating interests are more difficult to obtain when mortgage financing is available at relatively low interest rates. In the current interest rate environment, the Company may have greater difficulty obtaining participating interest. Participating 26 interests are not government insured or guaranteed and are therefore subject to the general risks inherent in real estate investments. Therefore, even if the Company is successful in investing in mortgage investments which provide for participating interests, there can be no assurance that such interests will result in additional payments. REPURCHASE FACILITY COLLATERAL RISK Repurchase agreements involve the risk that the market value of the securities sold by the Company may decline and that the Company will be required to post additional collateral, reduce the amount borrowed or suffer forced sales of the collateral. If forced sales were made at prices lower than the carrying value of the collateral, the Company would experience additional losses. If the Company is forced to liquidate these assets to repay borrowings, there can be no assurance that the Company will be able to maintain compliance with the REIT asset and source of income requirements. BRIDGE AND MEZZANINE LOAN RISK The Company has originated and expects to continue to originate bridge and mezzanine loans. These types of mortgage loans are considered to involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property due to a variety of factors, including the loan becoming unsecured as a result of foreclosure by the senior lender. The Company may not recover some or all of its investment in such loans. In addition, bridge loans and mezzanine loans may have higher loan to value ratios than conventional mortgage loans resulting in less equity in the property and increasing the risk of loss of principal. 27 Item 8. Financial Statements and Supplementary Data. Page -------- (a) 1. Financial Statements -------------------- Independent Auditors' Report 29 Consolidated Balance Sheets as of December 31, 2003 and 2002 30 Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001 31 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2003, 2002 and 2001 32 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 33 Notes to Consolidated Financial Statements 35 (a) 2. Financial Statement Schedules ----------------------------- All schedules have been omitted because they are not required or because the required information is contained in the financial statements or notes thereto. 28 INDEPENDENT AUDITORS' REPORT To the Board of Trustees And Shareholders of American Mortgage Acceptance Company New York, New York We have audited the accompanying consolidated balance sheets of American Mortgage Acceptance Company and subsidiaries (the "Company") as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of American Mortgage Acceptance Company and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP New York, New York March 15, 2004 29 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
ASSETS December 31, ---------------------- 2003 2002 --------- --------- Investments in debt securities - available for sale $ 167,260 $ 114,034 Real estate owned - subject to sales contracts 51,616 -- Real estate owned - held for sale 25,802 -- Notes receivable, net 35,946 25,997 Investment in ARCap 20,240 20,240 Investments in mortgage loans, net 13,864 22,384 Revenue bonds - available for sale 7,586 -- Cash and cash equivalents 2,028 10,404 Other assets 2,765 2,004 --------- --------- Total assets $ 327,107 $ 195,063 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Repurchase facilities payable $ 149,529 $ 87,880 Warehouse facility payable 34,935 8,788 Mortgage payable on real estate owned 15,993 -- Interest rate derivatives 278 -- Accounts payable and accrued expenses 1,552 822 Due to Advisor and affiliates 590 690 Distributions payable 3,335 2,545 --------- --------- Total liabilities 206,212 100,725 --------- --------- Commitments and contingencies Shareholders' equity: Shares of beneficial interest; $.10 par value; 25,000,000 shares authorized; 8,713,376 issued and 8,338,180 outstanding in 2003 and 6,738,826 issued and 6,363,630 outstanding in 2002 871 674 Treasury shares of beneficial interest; 375,196 shares (38) (38) Additional paid-in capital 126,779 99,470 Deferred compensation - stock options (29) -- Distributions in excess of net income (15,138) (14,471) Accumulated other comprehensive income 8,450 8,703 --------- --------- Total shareholders' equity 120,895 94,338 --------- --------- Total liabilities and shareholders' equity $ 327,107 $ 195,063 ========= =========
See accompanying notes to consolidated financial statements. 30 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands except per share amounts)
Years Ended December 31, ---------------------------------------- 2003 2002 2001 ----------- ----------- ----------- Revenues: Interest income: Debt securities $ 8,765 $ 5,769 $ 2,294 Mortgage loans 2,597 2,050 2,773 Notes receivable 3,166 2,270 451 Revenue bonds 151 -- -- Temporary investments 55 50 73 Other income 776 319 107 ----------- ----------- ----------- Total revenues 15,510 10,458 5,698 ----------- ----------- ----------- Expenses: Interest 2,548 1,228 1,406 General and administrative 917 685 661 Fees to Advisor 1,812 1,520 593 Amortization and other 376 379 -- ----------- ----------- ----------- Total expenses 5,653 3,812 2,660 ----------- ----------- ----------- Other income: Equity in earnings of ARCap 2,400 2,400 2,400 Net gain (loss) on sale or repayment of debt securities and land parcel (373) 614 (251) ----------- ----------- ----------- Total other income 2,027 3,014 2,149 ----------- ----------- ----------- Net income $ 11,884 $ 9,660 $ 5,187 =========== =========== =========== Net income per share (basic and diluted) $ 1.52 $ 1.61 $ 1.35 =========== =========== =========== Weighted average shares outstanding Basic 7,802,957 6,017,740 3,838,630 =========== =========== =========== Diluted 7,814,810 6,017,740 3,838,630 =========== =========== ===========
See accompanying notes to consolidated financial statements. 31 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 (Dollars in thousands)
TREASURY SHARES OF DEFERRED SHARES OF BENEFICIAL INTEREST BENEFICIAL INTEREST ADDITIONAL COMPENSATION ----------------------------- ------------------- PAID-IN STOCK SHARES AMOUNT SHARES AMOUNT CAPITAL OPTIONS ----------- ------------ -------- -------- -------------- ------------ Balance at January 2001 4,213,826 $ 421 (375,196) $ (38) $ 68,841 Comprehensive income: Net income Other comprehensive income: Net unrealized holding gain arising during the period Comprehensive income Distributions --------------------------------------------------------------------------------------- Balance at December 31, 2001 4,213,826 421 (375,196) (38) 68,841 Comprehensive income: Net income Other comprehensive income: Unrealized holding gain arising during the period Less: reclassification adjustment for gain included in net income Total other comprehensive gain Comprehensive income Issuance of common shares 2,525,000 253 30,629 Distributions --------------------------------------------------------------------------------------- Balance at December 31, 2002 6,738,826 674 (375,196) (38) 99,470 Comprehensive income: Net income Other comprehensive income: Net unrealized loss on interest rate derivatives Unrealized holding gain arising during the period Plus: reclassification adjustment for loss included in net income Total other comprehensive income Comprehensive income Issuance of stock options 51 (51) Deferred compensation costs 22 Common shares issued 1,974,550 197 27,258 Distributions --------------------------------------------------------------------------------------- Balance at December 31, 2003 8,713,376 $ 871 (375,196) $ (38) $ 126,779 $(29) ======================================================================================= ACCUMULATED DISTRIBUTIONS OTHER IN EXCESS COMPREHENSIVE COMPREHENSIVE OF NET INCOME INCOME INCOME TOTAL ------------- ------------- ------------- ---------- Balance at January 2001 $ (14,126) $ (22) $ 55,076 Comprehensive income: Net income 5,187 $ 5,187 5,187 Other comprehensive income: Net unrealized holding gain arising during the period 582 582 582 --------- Comprehensive income $ 5,769 ========= Distributions (5,566) (5,566) ----------- ------------------------ Balance at December 31, 2001 (14,505) 560 55,279 Comprehensive income: Net income 9,660 $ 9,660 9,660 Other comprehensive income: Unrealized holding gain arising during the period 8,757 Less: reclassification adjustment for gain included in net income (614) --------- Total other comprehensive gain 8,143 8,143 8,143 --------- Comprehensive income $ 17,803 ========= Issuance of common shares 30,882 Distributions (9,626) (9,626) ----------- ------------------------ Balance at December 31, 2002 (14,471) 8,703 94,338 Comprehensive income: Net income 11,884 $ 11,884 11,884 --------- Other comprehensive income: Net unrealized loss on interest rate derivatives (278) Unrealized holding gain arising during the period (348) Plus: reclassification adjustment for loss included in net income 373 --------- Total other comprehensive income (253) (253) (253) --------- Comprehensive income $ 11,631 ========= Issuance of stock options Deferred compensation costs 22 Common shares issued 27,455 Distributions (12,551) (12,551) ------------------------------------------------------------ Balance at December 31, 2003 $ (15,138) $ 8,450 $120,895 =========== ========================
See accompanying notes to consolidated financial statements. 32 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Years Ended December 31, ------------------------------------ 2003 2002 2001 --------- --------- --------- Cash flows from operating activities: Net income $ 11,884 $ 9,660 $ 5,187 Adjustments to reconcile net income to net cash provided by operating activities: Net loss (gain) on sale or repayment of debt securities and land parcel 373 (614) 251 Equity in earnings of ARCap, in excess of distributions received -- 6 (204) Amortization - deferred financing costs 170 6 113 Amortization - deferred compensation costs 22 -- -- Amortization - loan premium and origination costs and fees (518) (89) 40 Accretion of discount on debt securities 157 23 (22) Changes in operating assets and liabilities: Accrued interest receivable (936) (599) 111 Other assets 8 743 (410) Due to (from) Advisor and affiliates (100) 359 (638) Accounts payable and accrued expenses 91 (586) 1,069 Accrued interest payable 639 39 (6) --------- --------- --------- Net cash provided by operating activities 11,790 8,948 5,491 --------- --------- --------- Cash flows from investing activities: Net proceeds from sale of land 37 -- -- Funding of mortgage loans (4,053) (4,711) (24,813) Repayment of mortgage loans 9,463 -- 9,245 Purchase of mortgage loans (46,627) 46 85 Funding of notes receivable (23,906) (22,307) (9,959) Loan orgination fees on mortgage loans net of acquisition expenses) 187 169 152 Repayment of notes receivable 5,746 7,683 -- Principal repayments of debt securities 8,539 526 346 Investment in debt securities (62,290) (55,768) (6,506) Additions to real estate owned (3,166) -- -- Investment in revenue bonds (7,586) -- -- --------- --------- --------- Net cash used in investing activities (123,656) (74,362) (31,450) --------- --------- --------- (continued)
33 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (continued)
Years Ended December 31, ------------------------------------ 2003 2002 2001 --------- --------- --------- Cash flows from financing activities: Proceeds from repurchase facilities payable 115,818 100,750 62,030 Proceeds from warehouse facility payable 26,147 8,788 -- Repayments of repurchase facilities payable (54,169) (56,480) (31,076) Increase in deferred financing costs -- (669) (43) Distributions paid to shareholders (11,761) (8,471) (5,566) Issuance of common shares 27,455 30,882 -- --------- --------- --------- Net cash provided by financing activities 103,490 74,800 25,345 --------- --------- --------- Net increase (decrease) in cash and cash equivalents (8,376) 9,386 (614) Cash and cash equivalents at the beginning of the year 10,404 1,018 1,632 --------- --------- --------- Cash and cash equivalents at the end of the year $ 2,028 $ 10,404 $ 1,018 ========= ========= ========= Supplemental information: Interest paid $ 2,546 $ 1,163 $ 1,412 ========= ========= ========= Conversion of mortgage loans to debt securities Increases in debt securities $ 37,444 Decrease in mortgage loans (37,444) --------- $ -- --------- Conversion of mortgage loans to real estate owned: Increase in real estate owned $ 72,748 Decrease in mortgage loans (49,808) Decrease in notes receivable (6,947) Increase in mortgage loan on real estate (15,993) --------- $ -- =========
See accompanying notes to consolidated financial statements. 34 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - General American Mortgage Acceptance Company (the "Company") was formed on June 11, 1991 as a Massachusetts business trust. The Company elected to be treated as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). The Company's business plan focuses on originating and acquiring mortgages secured by multifamily properties, which may take the form of government insured first mortgages, insured mortgage pass-through certificates or insured mortgage backed securities, and uninsured mezzanine loans, construction loans, and bridge loans. Additionally, the Company has indirectly invested in subordinate commercial mortgage-backed securities and may invest in other real estate assets, including non-multifamily mortgages. The Company also issues guarantees of construction and permanent financing and makes standby loan commitments. The Company is governed by a board of trustees comprised of three independent trustees and two non-independent trustees who are affiliated with CharterMac, an American Stock Exchange listed company. The Company has engaged Related AMI Associates, Inc. (the "Advisor"), an affiliate of CharterMac, to manage its day-to-day affairs. The Advisor has subcontracted with Related Capital Company ("Related"), a subsidiary of CharterMac, to provide the services contemplated. Through the Advisor, Related offers the Company a core group of experienced staff and executive management providing the Company with services on both a full and part-time basis. These services include, among other things, acquisition, financial, accounting, tax, capital markets, asset monitoring, portfolio management, investor relations and public relations services. Effective November 17, 2003, CharterMac, an affiliate of the Advisor, acquired Related, which included the Advisor. This acquisition did not affect the Company's day-to-day operations or the services provided to the Company by the Advisor. Ownership of the Advisor was transferred to CharterMac, but management of the Advisor remained unchanged as the principals of Related who managed the Advisor became executive officers of CharterMac and remain executive officers of the Advisor. The consolidated financial statements include the accounts of the Company and three wholly-owned subsidiaries which it controls: AMAC Repo Seller, LLC, AMAC/FM Corporation ("AMAC/FM") and AMAC Credit Facility, LLC. All intercompany accounts and transactions have been eliminated in consolidation. Unless otherwise indicated, the "Company" as hereinafter used, refers to American Mortgage Acceptance Company and its subsidiaries. Effective October 2003, the Company dissolved AMAC/FM due to the assignment of all rights and obligations under the Fannie Mae loan program to PW Funding Inc. (see Note 15). AMAC/FM was formed to manage this program. NOTE 2 - Significant Accounting Policies a) Basis of Presentation The consolidated financial statements of the Company are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. b) Investments in Mortgage Loans and Notes Receivable Mortgage loans and notes receivable are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized loan origination costs and fees. The Company's mezzanine investments bear interest at fixed or variable rates, but certain of these investments also include provisions that allow the Company to participate in a percentage of the underlying property's excess cash flows from operations and excess proceeds from a sale or refinancing. At the inception of each such investment, Company management must determine whether such investment should be accounted for as a loan, joint venture or as real estate, using the guidance contained in the Third Notice to Practitioners issued by the American Institute of Certified Public Accountants ("AICPA"). Although the accounting methodology does not affect the Company's cash flows from these investments, this determination affects the balance sheet classification of the investments as well as the classification, timing and amounts of reported earnings. Accounting for the investment as real estate is required if the Company expects that the amount of profit, whether called interest or another name, such as an equity kicker, that it expects to receive above a reasonable amount of interest and fees, is over 50 percent of the property's total expected residual profit. If a mezzanine investment were to be accounted for as an investment in real estate, the Company's balance sheet would show the underlying property and its related senior debt (if such debt was not also held by the Company), and the income statement would include the property's rental revenues, operating expenses and depreciation. If the Company expects that it will receive less than 50 percent of the property's residual profit, then loan or joint venture accounting is applied. Loan accounting is appropriate if the borrower has a substantial equity investment in the property, if the Company has recourse to substantial assets of the borrower, if the property is generating sufficient cash flow to service normal loan amortization, or if certain other conditions are met. Under loan 35 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS accounting, the Company recognizes interest income as earned and additional interest from participations as received. Joint venture accounting would require that the Company only record its share of the net income from the underlying property. Company management must exercise judgment in making the required accounting determinations. For each mezzanine arrangement, the Company projects total cash flows over the loan's term and the Company's share in those cash flows, and considers the borrower's equity, the contractual cap, if any, on total yield to the Company over the term of the loan, market yields on comparable loans, borrower guarantees, and other factors in making its assessment of the proper accounting. To date, the Company has determined that all mezzanine investments are properly accounted for as loans. The Company accounts for its investments in mortgage loans and notes receivable under the provisions of Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS 114"). Under SFAS 114, a loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. SFAS No. 114 requires lenders to measure impaired loans based on: (i) the present value of expected future cash flows discounted at the loans' effective interest rate; (ii) the loan's observable market price; or (iii) the fair value of the collateral if the loan is collateral-dependent. The Company's portfolio of mortgage loans and notes is periodically evaluated for possible impairment to establish appropriate loan loss reserves, if necessary. If, in the judgment of Company management, it is determined that is probable that the Company will not receive all contractually required payments when they are due, the loan or note would be deemed impaired, and a loan loss reserve established. c) Investments in Debt Securities The Company accounts for its investments in GNMA and FNMA DUS certificates under the provisions of SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities". At the date of acquisition, the Company elected to designate its GNMA and FNMA DUS certificates as available-for-sale debt securities. Available-for-sale securities are carried at fair value with net unrealized gain (loss) reported as a separate component of other comprehensive income until realized. The Company uses third party quoted market prices as its primary source of valuation information. A decline in the market value of any available-for-sale security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to interest income using the effective yield method. Realized gains and losses on securities are included in earnings and are recorded on the trade date and calculated as the difference between the amount of cash received and the amortized cost of the specific GNMA and FNMA DUS certificate, including unamortized discounts or premiums. d) Investments in Revenue Bonds The Company accounts for its investments in revenue bonds as available-for-sale debt securities under the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Accordingly, the revenue bonds are carried at their estimated fair values, with unrealized gains and losses reported in other comprehensive income. In most cases, the Company has a right to require redemption of the revenue bonds prior to their maturity, although it can and may elect to hold them up to their maturity dates unless otherwise modified. As such, SFAS 115 requires the Company to classify these investments as "available-for-sale." Accordingly, investments in revenue bonds are carried at their estimated fair values, with unrealized gains and losses reported in other comprehensive income. If, in the judgment of the Advisor, it is determined probable that the Company will not receive all contractual payments required, when they are due, the bond is deemed impaired and is written down to its then estimated fair value, with the amount of the write-down accounted for as a realized loss. Because Revenue Bonds have a limited market, the Company estimates fair value for each bond as the present value of its expected cash flows using a discount rate for comparable investments. This process is based upon projections of future economic events affecting the real estate collateralizing the bonds, such as property occupancy rates, rental rates, operating cost inflation, market capitalization rates and upon determination of an appropriate market rate of interest, all of which are based on good faith estimates and assumptions developed by the Advisor. Changes in market conditions and circumstances may occur which would cause these estimates and assumptions to change; therefore, actual results may vary from the estimates and the variance may be material. e) Real Estate Owned Real estate owned consists of properties that the Company took possession of by exercising its rights under subordinated promissory notes and other documents. In some cases, the Company also purchased the first mortgage loans on the properties before foreclosing on the real estate collateral. The Company records these properties at the lower of fair value of the real estate, less estimated 36 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS disposal costs, or the carrying amount of the loan. The determination of fair value of the real estate is based on independent appraisals. When the foreclosure process is complete and the property is owned by the Company, the net income or loss from operations of the property is included in other income. It is the Company's intent to sell those properties in the near term. Accordingly, real estate owned is not depreciated. f) Investment in ARCap The Company's preferred equity investment in ARCap Investors, LLC ("ARCap") is accounted for using the equity method because the Company has the ability to exercise significant influence, but not control, over ARCap's operating and financial policies. g) Cash and Cash Equivalents Cash and cash equivalents include cash in banks and temporary investments in short-term instruments with original maturity dates equal to or less than three months. h) Loan Origination Costs and Fees Acquisition fees and other direct expenses incurred for activities performed to originate mortgage loans have been capitalized and are included in Investment in Mortgage Loans in the balance sheets, net of any fees received from borrowers for loan originations. Loan origination costs and fees are being amortized to interest income using the effective yield method over the lives of the respective mortgages. i) Revenue Recognition The Company derives its revenues from a variety of investments and guarantees, summarized as follows: o INTEREST INCOME FROM MORTGAGE LOANS AND NOTES RECEIVABLE - Interest on mortgage loans and notes receivable is recognized on the accrual basis as it becomes due. Deferred loan origination costs and fees are amortized over the life of the applicable loan as an adjustment to interest income, using the interest method. Interest which was accrued is reversed out of income if deemed to be uncollectible. Certain mortgage loans (mezzanine investments) contain provisions that allow the Company to participate in a percentage of the underlying property's excess cash flows from operations and excess proceeds from a sale or refinancing. This income is recognized when received. o INTEREST INCOME ON DEBT SECURITIES - Interest on GNMA and FNMA DUS certificates is recognized on the accrual basis as it becomes due. Interest income also includes the amortization or accretion of premiums and discounts arising at the purchase date, using the effective yield method. o INTEREST INCOME ON TEMPORARY INVESTMENTS - Interest income from temporary investments, such as cash in banks and short-term instruments, is recognized on the accrual basis as it becomes due. o INTEREST INCOME ON REVENUE BONDS - Interest income from revenue bonds is recognized on the accrual basis as it becomes due. o EQUITY IN EARNINGS OF ARCAP - The Company's equity in the earnings of ARCap Investors, LLC ("ARCap") is accrued at the Company's preferred dividend rate of 12%, unless ARCap does not have earnings and cash flows adequate to meet this dividend requirement. o INCOME FROM REAL ESTATE OWNED - Income or loss from the operations of real estate owned is accrued monthly and included, net, in other income. o STANDBY LOAN COMMITMENT FEES - The Company receives fees for issuing standby loan commitments. If the Company does not expect to fund the commitment, the commitment fee is recognized, in other income, ratably over the commitment period. If it is determined that it is possible or probable that a commitment will be exercised, such fees are deferred and, if the commitment is exercised, amortized over the life of the loan as an adjustment to interest income or, if the commitment expires unexercised, recognized as other income upon expiration of the commitment. o STABILIZATION GUARANTEE AND LOAN ADMINISTRATION FEES - The Company receives fees from borrowers for guaranteeing construction loans made by third-party lenders. The Company guarantees the loan during the period between construction completion and funding of the permanent loan. These fees are received in advance and are deferred and amortized into other income over the guarantee period. The Company also receives loan administration fees on these guaranteed loans, on a monthly basis during the guarantee period. These fees are recognized in other income as they become due. 37 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS o LOSS SHARING/GUARANTEE FEES - The Company received loss sharing/guarantee fees related to the FNMA DUS program (see Note 14). These fees were received monthly and recognized in other income as they become due. j) Repurchase Facilities Payable The Company finances its investments in GNMA and FNMA DUS certificates using repurchase facilities. Under such facilities, the certificates are sold to a counterparty under an agreement requiring the Company to repurchase such certificates for a fixed price on a fixed date, generally 30 days from sale date. These transactions are accounted for as collateralized borrowings. Accordingly, the certificates remain on the Company's consolidated balance sheet, with the proceeds from the sales included on the consolidated balance sheet as "Repurchase Facilities Payable". The difference between the sales proceeds and the fixed repurchase price is recorded as interest expense ratably over the period between the sale and repurchase. k) Fair Value of Financial Instruments As described above, the Company's debt securities, revenue bonds, and interest rate derivatives are carried at estimated fair values. The Company has determined that the fair value of its remaining financial instruments, including its mortgage loans and cash and cash equivalents, notes receivable, and secured borrowings approximate their carrying values at December 31, 2003 and 2002. The fair value of investments in mortgage loans, revenue bonds, notes receivable, and GNMA and FNMA DUS certificates are based on actual market price quotes or by determining the present value of the projected future cash flows using appropriate discount rates, credit losses and prepayment assumptions. Other financial instruments carry interest rates which are deemed to approximate market rates. l) Interest Rate Derivative The Company accounts for its interest rate swap agreement under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Standards No. 133". At the inception, the Company designated this interest rate swap as a cash flow hedge on the variable interest payments in its floating rate financing. Accordingly, the interest rate swap is recorded at fair market value each accounting period, with changes in market value being recorded in other comprehensive income to the extent the hedge is effective in achieving offsetting cash flows. This hedge has been highly effective, so there has been no ineffectiveness included in earnings. Net amounts receivable or payable under the swap agreement are recorded as adjustments to interest expense. m) Income Taxes The Company has qualified as a REIT under the Code. A REIT is generally not subject to federal income tax on that portion of its REIT taxable income ("Taxable Income") which is distributed to its shareholders provided that at least 90% of Taxable Income is distributed and provided that such income meets certain other conditions. Accordingly, no provision for federal income taxes is required. The Company may be subject to state taxes in certain jurisdictions. During 2003, the Company declared distributions of $1.60 per share. For federal income tax purposes, the Company's distribution totaled $1.60, all of which was reported as ordinary income to shareholders for 2003. n) Comprehensive Income SFAS No. 130, "Reporting Comprehensive Income," requires the Company to classify items of "other comprehensive income", such as unrealized gains and losses on its investment in GNMA and FNMA DUS certificates, revenue bonds and interest rate derivatives by their nature in the financial statements and display the accumulated balance of other comprehensive income (loss) separately from shareholders' equity in the shareholders' equity section of the balance sheets. In accordance with SFAS No. 130, cumulative unrealized gains and losses on such instruments are classified as accumulated other comprehensive income in shareholders' equity and current period unrealized gains and losses are included as a component of comprehensive income. o) Segment Information SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information", requires enterprises to report certain financial and descriptive information about their reportable operating segments, and certain enterprise-wide disclosures regarding products and services, geographic areas and major customers. The Company is an investor in mortgage products and operates in only one reportable segment. The Company's chief operating decision maker, its president and chief executive officer makes asset allocation decisions between various real estate lending activities as opportunities are brought to the Company through its relationship with the Advisor. Each potential investment is evaluated for its potential return on investment and risks. The Company does not have or rely upon any major customers. All of the Company's investments are secured by real estate properties located in the United States; accordingly, all of its revenues were derived from U.S. operations. 38 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS p) New Accounting Pronouncements In April 2002, the FASB issued Statement No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections". SFAS No. 145 among other things, rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt", and accordingly, the reporting of gains and losses from the early extinguishments of debt as extraordinary items will only be required if they meet the specific criteria for extraordinary items included in Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations". The rescission of SFAS No. 4 became effective January 1, 2003. The implementation of this statement did not have an impact on the Company's consolidated financial statements. In July 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 replaces current accounting literature and requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 became effective January 1, 2003. The implementation of this statement did not have an impact on the Company's consolidated financial statements. In November 2002, the FASB issued Interpretation No. 45, "Guarantors' Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". The Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The disclosure provisions of this Interpretation are included in Note 14. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123". This statement amends SFAS No. 123, "Accounting for Stock-Based Compensation" to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Because the Company accounts for its share options using the fair value method, implementation of this statement did not have an impact on the Company's consolidated financial statements. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which was amended and interpreted through issuance of FIN 46 (R) in December of 2003. This Interpretation clarifies the application of existing accounting pronouncements to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The Company has determined that it has no variable interests in variable interest entities requiring consolidation under FIN 46 or FIN 46 (R). In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS 149 amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS 149 is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The implementation of this statement did not have an impact on the Company's consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity". SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that certain financial instruments be classified as liabilities that were previously considered equity. The implementation of this statement on July 1, 2003 did not have an impact on the Company's consolidated financial statements. q) Reclassifications Certain amounts in the 2002 and 2001 financial statements have been reclassified to conform to the 2003 presentation. 39 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3 - Investments in Debt Securities - Available for Sale Information relating to debt securities owned by the Company as of December 31, 2003 is as follows: (Dollars in thousands)
Date Purchased/ Amortized Certificate Final Stated Cost at Name Number Payment Date Interest Rate December 31, 2003 - ------------------- ----------- --------------- ------------- ----------------- GNMA CERTIFICATES Western Manor (1) 355540 7/27/94 7.125% $ 2,457 3/15/29 Copper Commons (2) 382486 7/28/94 8.500% -- 8/15/29 SunCoast Capital Group,Ltd. (1) G002412 6/23/97 7.000% 232 4/20/27 Elmhurst Village (1) 549391 6/28/01 7.745% 21,594 1/15/42 Reserve at Autumn Creek (1)(3) 448748 6/28/01 7.745% 15,962 1/15/42 Casitas at Montecito (4) 519289 3/11/02 7.300% -- 10/15/42 Village at Marshfield (1) 519281 3/11/02 7.475% 21,371 1/15/42 Cantera Crossing (1) 532663 3/28/02 6.500% 6,419 6/1/29 Filmore Park (1) 536740 3/28/02 6.700% 1,432 10/15/42 Northbrooke (1) 548972 5/24/02 7.080% 14,018 8/1/43 Ellington Plaza (1) 585494 7/26/02 6.835% 27,447 6/1/44 Burlington (1) 595515 11/1/02 5.900% 6,814 4/15/31 FNMA DUS CERTIFICATES Cambridge (1) 385971 4/11/03 5.560% 3,665 3/1/33 Bayforest (1) 381974 4/21/03 7.430% 4,305 10/1/28 Coventry Place (1) 384920 5/9/03 6.480% 791 3/1/32 Rancho de Cieto (1) 385229 5/13/03 6.330% 2,608 9/1/17 Elmwood Gardens (1) 386113 5/15/03 5.350% 5,545 5/1/33 30 West (1) 380751 5/27/03 6.080% 1,362 10/1/16 Jackson Park (1) 386139 5/30/03 5.150% 2,777 6/1/18 Unrealized Earned Applicable Gain (Loss) at Balance at to the Year Ended Name December 31, 2003 December 31, 2003 December 31, 2003 - ------------------- ----------------- ----------------- ----------------- GNMA CERTIFICATES Western Manor (1) $ (22) $ 2,435 $ 193 Copper Commons (2) -- -- 17 SunCoast Capital Group,Ltd. (1) 11 243 25 Elmhurst Village (1) 3,329 24,923 1,675 Reserve at Autumn Creek (1)(3) -- 15,962 1,238 Casitas at Montecito (4) -- -- 70 Village at Marshfield (1) 1,082 22,453 1,439 Cantera Crossing (1) 747 7,166 395 Filmore Park (1) 152 1,584 85 Northbrooke (1) 1,824 15,842 905 Ellington Plaza (1) 2,420 29,867 1,175 Burlington (1) 288 7,102 397 FNMA DUS CERTIFICATES Cambridge (1) (83) 3,582 142 Bayforest (1) (61) 4,244 178 Coventry Place (1) (24) 767 28 Rancho de Cieto (1) (78) 2,530 79 Elmwood Gardens (1) (145) 5,400 182 30 West (1) (89) 1,273 37 Jackson Park (1) (44) 2,733 82
40 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Date Purchased/ Amortized Certificate Final Stated Cost at Name Number Payment Date Interest Rate December 31, 2003 - ------------------- ----------- --------------- ------------- ----------------- Courtwood (1) 386274 6/26/03 4.690% 1,765 6/1/33 Sultana (1) 386259 6/30/03 4.650% 4,104 6/1/23 Buena (1) 386273 6/30/03 4.825% 3,053 6/1/33 Allegro (1) 386324 6/30/03 5.380% 2,574 7/1/33 Village West (1) 386243 6/30/03 4.910% 786 6/1/21 Westwood/Monterey (1) 386421 9/15/03 5.090% 2,720 8/1/33 Euclid (1) 386446 9/15/03 5.310% 2,374 8/1/33 Edgewood (1) 386458 9/15/03 5.370% 2,358 9/1/33 -------- Total $158,533 ======== Unrealized Earned Applicable Gain (Loss) at Balance at to the Year Ended Name December 31, 2003 December 31, 2003 December 31, 2003 - ------------------- ----------------- ----------------- ----------------- Courtwood (1) (147) 1,618 42 Sultana (1) (293) 3,811 96 Buena (1) (245) 2,808 71 Allegro (1) (42) 2,532 69 Village West (1) (41) 745 19 Westwood/Monterey (1) 80 2,800 46 Euclid (1) 55 2,429 40 Edgewood (1) 53 2,411 40 --------------------------------------------------- Total $ 8,727 $167,260 $8,765 ===================================================
(1) These GNMA and FNMA DUS certificates are partially or wholly-pledged as collateral for borrowings under the repurchase facility (see Note 9). (2) This GNMA certificate was repaid in April 2003 at par. There was no gain or loss recognized. (3) In January 2004, the Company received proceeds in the approximate amount of $14.5 million from HUD in relation to the paydown of the Reserve at Autumn Creek GNMA certificate. This paydown approximated 90% of the total outstanding balance of the underlying mortgage loan, which was the initial payment pursuant to the FHA insurance claim made by the Company when the borrower missed debt service payments. The remaining balance of approximately $1.5 million is expected to be received in the second quarter 2004, from the remaining amounts of the insurance and potentially the guarantee from GNMA. (4) This GNMA certificate was repaid in March 2003 at par. As a result of the repayment, the Company realized a loss of approximately $391,000 due to the unamortized balance of the premium that was recorded when the GNMA certificate had been purchased. 41 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amortized cost, unrealized gain and fair value for the investment in debt securities at December 31, 2003 and 2002 were as follows:
(Dollars in thousands) December 31, ------------------- 2003 2002 -------- -------- Amortized cost $158,533 $105,331 Net unrealized gain 8,727 8,703 -------- -------- Fair value $167,260 $114,034 ======== ========
For the year ended December 31, 2003, there were gross unrealized gains and losses of approximately $10,040,000 and approximately $1,313,000 respectively, on debt securities. For the year ended December 31, 2002, there were gross unrealized gains and losses of approximately $8,730,000 and approximately $27,000, respectively, on debt securities. Due to the complexity of the GNMA and FNMA DUS structure and the uncertainty of future economic events and other factors that affect interest rates and mortgage prepayments, it is not possible to predict the effect of future events upon the yield to maturity or the market value of the debt securities upon any sale or other disposition or whether the Company, if it chose to, would be able to reinvest proceeds from prepayments at favorable rates relative to the coupon rate. The fair value and gross unrealized losses of the Company's debt securities aggregated by length of time that individual debt securities have been in a continuous unrealized loss position, at December 31, 2003, is summarized in the table below:
(Dollars in thousands) Less than 12 Months 12 Months or More Total - ------------------------------------------------------------------------------- Fair value $34,480 -- $34,480 Gross unrealized loss $ 1,313 -- $ 1,313
Of the Company's portfolio of debt securities, 13 are in an unrealized loss position at December 31, 2003. All of these securities have been in an unrealized position for less than one year. These unrealized losses are as a result of increases in interest rates subsequent to the acquisition of these securities. All of the debt securities are performing according to their terms. Accordingly, the Company has concluded that these impairments are not other than temporary. 42 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4 - Investments in Mortgage Loans Information relating to the Company's investments in mortgage loans as December 31, 2003 is as follows: (Dollars in thousands)
Final Maturity Lifetime Property Description Date Call Date (A) Interest Rate Interest Cap (C) - ------- ----------- -------- ------------ ------------- --------------- FIRST MORTGAGE LOANS: Stony Brook II East Haven, CT 125 Units 6/37 12/06 7.625% N/A Sunset Gardens Eagle Pass, TX 60 Units 6/04 N/A 11.50% N/A Alexandrine (H) Detroit, MI 30 Units 12/03 N/A 11.00% N/A Desert View (I) Coolidge, AZ 45 Units 5/04 N/A 11.00% N/A Subtotal First Mortgage Loans MEZZANINE LOANS (J): Stabilized Properties - --------------------- Stony Brook II East Haven, CT 125 Units 6/37 12/06 15.33%(B) 16% Plaza at San Jacinto (K) Houston, TX 132 Units 1/43 6/11 11.40%(B) 16% Subtotal Stabilized Mezzanine Loans Properties in Lease-Up - ---------------------- The Hollows (L) Greenville, NC 184 Units 1/42 1/12 10.00%(B) 16% Elmhurst Village (M)(N) Oveido, FL 313 Units 1/42 3/19 10.00%(B) 16% The Reserve at Autumn Creek (K)(M)(N) Friendswood, TX 212 Units 1/42 9/14 10.00%(B) 16% Club at Brazos (L)(O) Rosenberg, TX 200 Units 5/43 4/13 10.00%(B) 14% Northbrooke (M)(N) Harris County, TX 240 Units 8/43 7/13 11.50%(B) 14% Subtotal Properties in Lease-Up Properties in Construction/Rehabilitation - ----------------------------------------- Del Mar Villas Dallas, TX 260 Units 4/04 N/A LIBOR+4.625% (P) Mountain Valley Dallas, TX 312 Units 11/04 N/A LIBOR+4.750% (P) Villas at Highpoint Lewisville, TX 304 Units 4/33 TBD 14.57% N/A Subtotal Properties in Construction/Rehabilitation Subtotal Mezzanine Loans Total Mortgage Loans Share of Share of Excess Sale or Excess Operating Refinancing Periodic Property Cash Flows Proceeds Payment Terms Prior Liens - ------- ----------------- -------------- ------------- ------------- FIRST MORTGAGE LOANS: Stony Brook II East Haven, CT N/A N/A (F) -- Sunset Gardens Eagle Pass, TX N/A N/A (G) -- Alexandrine (H) Detroit, MI N/A N/A (G) -- Desert View (I) Coolidge, AZ N/A N/A (G) -- Subtotal First Mortgage Loans MEZZANINE LOANS (J): Stabilized Properties - --------------------- Stony Brook II East Haven, CT 40% 35% (F) -- Plaza at San Jacinto (K) Houston, TX 50% 50% (G) -- Subtotal Stabilized Mezzanine Loans Properties in Lease-Up - ---------------------- The Hollows (L) Greenville, NC 50% 25% (G) $ 8,880 Elmhurst Village (M)(N) Oveido, FL 50% 25% (G) 21,594 The Reserve at Autumn Creek (K)(M)(N) Friendswood, TX 50% 25% (G) 15,993 Club at Brazos (L)(O) Rosenberg, TX 50% 25% (G) 13,342 Northbrooke (M)(N) Harris County, TX 50% 50% (G) 13,871 Subtotal Properties in Lease-Up Properties in Construction/Rehabilitation - ----------------------------------------- Del Mar Villas Dallas, TX N/A N/A (G) 5,554 Mountain Valley Dallas, TX N/A N/A (G) 6,306 Villas at Highpoint Lewisville, TX N/A N/A (G) 18,800 Subtotal Properties in Construction/Rehabilitation Subtotal Mezzanine Loans Total Mortgage Loans Interest Outstanding Carrying Earned Applicable Face Amounts of Unamortized Amount of to the Year Ended Property Mortgages (D) Costs and Fees Mortgages (E) December 31, 2003 - ------- ---------------- -------------- ------------ ----------------- FIRST MORTGAGE LOANS: Stony Brook II East Haven, CT $ -- $ -- $ -- $ 497 Sunset Gardens Eagle Pass, TX 1,479 -- 1,479 182 Alexandrine (H) Detroit, MI 342 -- 342 38 Desert View (I) Coolidge, AZ 960 -- 960 69 --------------------------------------------------------------- Subtotal First Mortgage Loans 2,781 -- 2,781 786 --------------------------------------------------------------- MEZZANINE LOANS (J): Stabilized Properties - --------------------- Stony Brook II East Haven, CT -- -- -- 527 Plaza at San Jacinto (K) Houston, TX -- -- -- 39 --------------------------------------------------------------- Subtotal Stabilized Mezzanine Loans -- -- -- 566 --------------------------------------------------------------- Properties in Lease-Up - ---------------------- The Hollows (L) Greenville, NC 1,549 (133) 1,416 174 Elmhurst Village (M)(N) Oveido, FL 2,784 (391) 2,483 320 The Reserve at Autumn Creek (K)(M)(N) Friendswood, TX -- -- -- 36 Club at Brazos (L)(O) Rosenberg, TX 1,962 (75) 1,887 200 Northbrooke (M)(N) Harris County, TX 1,500 (133) 1,367 177 --------------------------------------------------------------- Subtotal Properties in Lease-Up 7,885 (732) 7,153 907 --------------------------------------------------------------- Properties in Construction/Rehabilitation - ----------------------------------------- Del Mar Villas Dallas, TX 765 -- 765 46 Mountain Valley Dallas, TX 776 -- 776 47 Villas at Highpoint Lewisville, TX 2,574 (185) 2,389 245 --------------------------------------------------------------- Subtotal Properties in Construction/Rehabilitation 4,115 (185) 3,930 338 --------------------------------------------------------------- Subtotal Mezzanine Loans 12,000 (917) 11,083 1,811 --------------------------------------------------------------- Total Mortgage Loans $14,781 $ (917) $13,864 $ 2,597 ===============================================================
43 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (A) Loans are subject to mandatory prepayment at the option of the Company ten years after construction completion, with one year's notice. Loans with a call date of "TBD" are still under construction. (B) Interest on the mezzanine loans is based on a fixed percentage of the unpaid principal balance of the related first mortgage loans. The amount shown is the approximate effective rate earned on the balance of the mezzanine loan. The mezzanine loans also provide for payments of additional interest based on a percentage of cash flow remaining after debt service and participation in sale or refinancing proceeds and certain provisions that cap the Company's total yield, including additional interest and participations, over the term of the loan. (C) Lifetime interest cap represents the maximum annual return, including interest, fees and participations, that can be earned by the Company over the life of the mezzanine loan, computed as a percentage of the balance of the first mortgage loan plus the mezzanine loan. (D) As of December 31, 2003, all interest payments on the mortgage loans are current, except as noted. (E) Carrying amounts of the loans are net of unamortized origination costs and fees and loan discounts. (F) The Stonybrook II first mortgage loan and mezzanine loan were repaid in January 2003. (G) Interest only payments are due monthly, with loan balance due at maturity. (H) The first mortgage loan, which matured in December 2003, did not pay off the outstanding balance at the maturity date, which caused the loan to be in default. The Company is currently in the process of determining the necessary steps needed to be taken to protect its investment. The Company has obtained an independent appraisal for the property underlying the mortgage. The appraisal indicates that the value of the property exceeds the carrying amount of the first mortgage loan on the property. Accordingly, the Company has not recorded an allowance for probable losses on this loan. (I) Loan purchased in April 2003 in connection with the performance under a guarantee made by the Company. (J) The principal balance of the mezzanine loans is secured by the partnership interests of the entity that owns the underlying property and a third mortgage deed of trust. Interest payments on the mezzanine loans are secured by a second mortgage deed of trust and are guaranteed for the first 36 months after construction completion by an entity related to the general partner of the entity that owns the underlying property. (K) These mezzanine loans have been reclassified to real estate owned -- see Note 7. (L) The Company does not have an interest in the first lien position relating to this mezzanine loan. (M) The Company has an interest in the first lien position relating to this mezzanine loan. (N) The first mortgage loans related to these properties were converted from participations in FHA loans to ownership of the GNMA certificates and are held by the Company - see Note 3. (O) The funding of this mezzanine loan is based on property level operational achievements. (P) Interest cap on these loans is the maximum rate permitted by law. 44 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Further information relating to investments in mortgage loans for the years ended December 31, 2003, 2002 and 2001 is as follows: (Dollars in thousands)
2003 2002 2001 -------- -------- -------- Reconciliation of mortgage loans: Balance at beginning of period $ 22,384 $ 17,799 $ 31,829 Advances made during the period 4,053 4,711 24,813 Conversion of mortgage loans to GNMA certificates -- -- (37,444) Conversion of mortgage loans to real estate owned (3,181) -- -- Loan origination fees (net of acquisition expenses) (187) (169) (152) Proceeds from repayment of mortgage loans (9,463) -- (9,245) Periodic principal payments of mortgage loans -- (46) (85) Consolidation of previously unconsolidated subsidiary -- -- 8,374 Excess(deficiency) of proceeds over carrying value of mortgage loans -- -- (251) Amortization and accretion -- net 258 89 (40) -------- -------- -------- Investments in mortgage loans - December 31, $ 13,864 $ 22,384 $ 17,799 ======== ======== ========
45 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 - Investment in ARCap The Company owns 800,000 preferred equity units of ARCap, with a face amount of $25 per unit, representing a 7.41% ownership and voting interest. The preferred equity units are convertible, at the Company's option, into ARCap common units. If converted into common units, the conversion price is equivalent to $25 per unit, subject to certain adjustments. Also, if not already converted, for a period of sixty days following the fifth anniversary of the first closing date, which will be August 4, 2005, the preferred equity units are convertible, at the Company's option, into a three-year note bearing interest at 12% that would be junior to all of ARCap's then existing indebtedness. The preferred equity units are also redeemable, at the option of ARCap, up until the fifth anniversary of the first closing date. Through the Company's convertible preferred membership interests in ARCap, it has a substantial indirect investment in commercial mortgage backed securities ("CMBS") owned by ARCap. ARCap was formed in January 1999 by REMICap, an experienced CMBS investment manager, and Apollo Real Estate Investors, the real estate arm of one of the country's largest private equity investors. As of December 31, 2003, ARCap had approximately $1.1 billion in assets, including investments of approximately $1.0 billion of CMBS. Multifamily properties underlie approximately one-third of ARCap's CMBS. The Company's equity in the earnings of ARCap will generally be equal to the preferred equity rate of 12% , unless ARCap does not have earnings and cash flows adequate to meet this distribution requirement. ARCap has met its distribution requirements to the Company to date. Yields on CMBS depend, among other things, on the rate and timing of principal payments, the pass-through rate, interest rate fluctuations and defaults on the underlying mortgages. The Company's interest in ARCap is illiquid and the Company would need to obtain the consent of the board of managers of ARCap before it could transfer its interest in ARCap to any party other than a current member. The carrying amount of the investment in ARCap is not necessarily representative of the amount the Company would receive upon a sale of the interest. ARCap has shifted its focus to CMBS fund management, whereby ARCap manages CMBS investment funds raised from third-party investors. ARCap is generally a minority investor in these funds. ARCap thereby diversifies its revenue base by increasing its proportion of revenue derived from fees as opposed to interest income. Summarized information for ARCap as of December 31, 2003 and 2002, and the years then ended is as follows:
2003 2002 ----------------- ----------------- ($'s in millions) ($'s in millions) Investment securities - available for sale $ 739 $ -- Investment securities - trading 282 799 Other assets 29 24 ------ ------ Total assets $1,050 $ 823 ====== ====== Repurchase agreements and long-term debt $ 625 $ 392 Other liabilities 215 206 Members' equity 210 225 ------ ------ Total liabilities and equity $1,050 $ 823 ====== ====== Total revenues $ 115 $ 96 Total expenses 99 65 ------ ------ Net income $ 16 $ 31 ====== ======
46 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 - Bridge Loans/Notes Receivable The Company's notes receivable are collateralized by equity interests in the owner of the underlying property and consist of the following as of December 31, 2003:
(Dollars in thousands) Remaining Outstanding Committed Principal Unamortized Carrying Balance to Interest Property Location Balance Fees Amount Fund (1) Rate Maturity - ---------------------------------------------------------------------------------------------------------------------------------- Parwood (2) Long Beach, CA $ 2,683 $ 2 $ 2,681 $ 567 11.00% January 2004 Noble Towers (2)(3) Oakland, CA 3,581 30 3,551 3,719 9.75% July 2005 Clarks Crossing (2) Laredo, TX 1,074 -- 1,074 -- 12.00% April 2004 Desert View (2) Coolidge, AZ 20 -- 20 -- 11.00% May 2004 Valley View (2) North LittleRock, AR 400 -- 400 -- 12.00% July 2004 Georgia King (2) Newark, NJ 1,495 25 1,470 5 11.50% May 2004 Reserve at Thornton (2) Thornton, CO 260 9 251 690 11.00% August 2006 Concord at Gessner Land Houston, TX 188 -- 188 -- 8.00% December 2008 Del Mar Villas (4) Dallas, TX 5,554 8 5,546 -- LIBOR + 4.625%(5) April 2004 Mountain Valley (4) Dallas, TX 6,306 30 6,276 -- LIBOR + 4.750%(5) November 2004 Baywoods (4) Antioch, CA 10,990 40 10,950 -- LIBOR + 4.000%(5) March 2005 Oaks of Baytown (4) Baytown, TX 2,337 16 2,321 1,488 LIBOR + 4.500%(5) August 2005 Quay Point (4) Houston, TX 1,223 5 1,218 -- LIBOR + 3.600%(5) August 2005 =============================================== Total $36,111 $165 $35,946 $6,469 ===============================================
(1) Funded on an as needed basis. (2) These loans are to limited partnerships who are affiliated with the Advisor (see Note 11). (3) Affiliate of the Advisor has provided a full guarantee on the payment of principal and interest due on this note. (4) Pledged as collateral in connection with warehouse facility with Fleet National Bank (see Note 10). (5) 30-day LIBOR at December 31, 2003 was 1.12%. 47 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7- Real Estate Owned The Company foreclosed on several mortgage loans and notes receivable during 2003. The Company's real estate owned at December 31, 2003 consisted of the following:
(Dollars in thousands) Carrying Value as of Number of December 31, Units Location 2003 --------- --------------- --------------- Real estate owned -- subject to sales contracts - ----------------------------------------------- Concord at Little York (1) 276 Houston, TX $16,274 Concord at Gessner (2) 288 Houston, TX 17,194 Concord at Gulfgate (3) 288 Houston, TX 18,148 ------ ------- Total real estate owned - subject to sales contracts 852 $51,616 ====== ======= Real estate owned -- held for sale - ---------------------------------- Reserve at Autumn Creek (5) 212 Friendswood, TX $17,924 Plaza at San Jacinto (4) 132 La Porte, TX 7,878 ------ ------- Total real estate owned - held for sale 344 $25,802 ====== =======
(1) The property underlying the note receivable secured by the Concord at Little York partnership interests missed required debt service payments beginning with the May 2003 payment, causing the note to be in default. The Company stopped accruing interest on the note receivable. During July 2003, the Company exercised its rights under the subordinated promissory note and other documents to take possession of the real estate collateral of the Concord at Little York property. The Company had provided a $3.5 million mezzanine loan to the owner of the property in February 2002. The Company paid an additional approximate amount of $11.7 million to purchase the first mortgage loan on the property. On August 4, 2003, the Company acquired the real estate of the property at a foreclosure auction. Based on an independent appraisal, the Company concluded that the fair value of the property, less expected disposal costs, was in excess of the carrying amounts of the loans. As such, the Company believes that no reserve for impairment is necessary at this time. On October 27, 2003, the Company sold the property for approximately $16.4 million to a qualified 501(c)(3) entity, which qualifies for a real estate tax abatement. In order to expedite the closings and ensure the 501(c)(3) entity would receive the real estate tax abatement prior to January 1, 2004, the Company provided 100% financing to the 501(c)(3) entity via a bridge loan, which matures in April 2005. The 501(c)(3) entity will pay the Company 100% of the property's cash flow until the property is fully leased, stabilized, and permanent financing is in place. The Company is working with the 501(c)(3) entity to obtain third party permanent financing for the property. If there is a gap between the permanent mortgage amount and the bridge loan, the Company intends to provide mezzanine financing. Due to the fact that the Company provided 100% financing to the buyer, this transaction did not constitute a sale in accordance with GAAP. Therefore, the Company continues to classify the property as real estate owned on the consolidated balance sheet. Income from operations of the property in the approximate amount of $162,000 is recorded in other income on the 2003 consolidated statement of income. (2) The property underlying the note receivable secured by the Concord at Gessner partnership interests missed required debt service payments beginning with the May 2003 payment, causing the note to be in default. The Company stopped accruing interest on the note receivable. During July 2003, the Company exercised its rights under the subordinated promissory note and other documents to take possession of the real estate collateral of the Concord at Gessner property. The Company had provided a $1.5 million mezzanine loan to the owner of the property in March 2003. The Company paid an additional approximate amount of $14.2 million to purchase the first mortgage loan on the property. On August 4, 2003, the Company acquired the real estate of the property at a foreclosure auction. Based on an independent appraisal, the Company concluded that the fair value of the property, less expected disposal costs, was in excess of the carrying amounts of the loans. As such, the Company believes that no reserve for impairment is necessary at this time. On October 27, 2003, the Company sold the property for approximately $17.5 million to a qualified 501(c)(3) entity, which qualifies for a real estate tax abatement. In order to expedite the closings and ensure the 501(c)(3) entity would receive the real estate tax abatement prior to January 1, 2004, the Company provided 100% financing to the 501(c)(3) entity via a bridge loan, which matures in April 2005. The 501(c)(3) entity will pay the Company 100% of the property's cash flow until the property is fully leased, stabilized, and permanent financing is in place. The Company is working with the 501(c)(3) entity to obtain third party permanent financing for the property. If there is a gap between the permanent mortgage amount and the bridge loan, the Company intends to provide mezzanine financing. Due to the fact that the Company 48 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS provided 100% financing to the buyer, this transaction did not constitute a sale in accordance with GAAP. Therefore, the Company continues to classify the property as real estate owned on the consolidated balance sheet. Income from operations of the property in the approximate amount of $111,000 is recorded in other income on the 2003 consolidated statement of income. The Company is funding additional costs to complete the construction of the property. These costs, estimated to be approximately $1.5 million, of which approximately $1.4 million has been funded through December 31, 2003, are capitalized to real estate owned. In connection with the foreclosure of the Concord at Gessner property, the Company acquired a land parcel which it subsequently sold to an unrelated third party. The sales price of the land was approximately $224,000, net of closing costs. The Company provided seller financing, in the form of a bridge note, to the buyer, in the approximate amount of $187,000. The Company allocated approximately $206,000 of cost basis to the land parcel resulting from the Concord at Gessner foreclosure and recognized a gain on the sale of approximately $18,000. (3) The property underlying the note receivable secured by the Concord at Gulfgate partnership interests missed required debt service payments beginning with the May 2003 payment, causing the note to be in default. The Company stopped accruing interest on the note receivable. During December 2003, the Company exercised its rights under the subordinated promissory note and other documents to take possession of the real estate collateral of the Concord at Gulfgate property. The Company had provided a $3.5 million mezzanine loan to the owner of the property in May 2002. The Company paid an additional approximate amount of $14.1 million to purchase the first mortgage loan on the property. On December 2, 2003, the Company acquired the real estate of the property at a foreclosure auction. Based on independent appraisal, the Company concluded that the fair value of the property, less expected disposal costs, was in excess of the carrying amounts of the loans. As such, the Company believes that no reserve for impairment is necessary at this time. On December 9, 2003, the Company sold the property for approximately $18.1 million to a qualified 501(c)(3) entity, which qualifies for a real estate tax abatement. In order to expedite the closings and ensure the 501(c)(3) entity would receive the real estate tax abatement prior to January 1, 2004, the Company provided 100% financing to the 501(c)(3) entity via a bridge loan, which matures in April 2005. The 501(c)(3) entity will pay the Company 100% of the property's' cash flow until the property is fully leased, stabilized, and permanent financing is in place. The Company is working with the 501(c)(3) entity to obtain third party permanent financing for the property. If there is a gap between the permanent mortgage amount and the bridge loan, the Company intends to provide mezzanine financing. Due to the fact that the Company provided 100% financing to buyer, this transaction did not constitute a sale in accordance with GAAP. Therefore, the Company continues to classify the property as real estate owned on the consolidated balance sheet. Income from operations of the property in the approximate amount of $187,000 is recorded in other income on the 2003 consolidated statement of income. (4) On March 7, 2003, the Company exercised its rights under the subordinated promissory note and other documents to take possession of the real estate collateral of the Plaza at San Jacinto. The Company had provided a $1.2 million mezzanine loan to the owner of the Plaza at San Jacinto on May 24, 2001; this loan was in default. The Company paid an additional approximate amount of $6.7 million to purchase the first mortgage loan on the property. On May 6, 2003, the Company acquired the real estate at a foreclosure auction. Based on an independent appraisal, the Company concluded that the value of the property, less estimated disposal costs, exceeds the amount paid for the first mortgage loan and the carrying amount of the mezzanine loan. As such, the Company believes that no reserve for impairment is necessary at this time. However, there can be no assurance that the Company will be able to sell this property for an amount greater than or equal to its appraised value. The Company has reclassified its investment in the Plaza at San Jacinto mezzanine loan, as well as the balance of the first mortgage, purchased during the first quarter, to real estate owned on the consolidated balance sheet and ceased accrual of interest. Income from operations of the property, in the approximate amount of $152,000, is recorded as other income on the 2003 consolidated statement of income. The property is held for sale and is not being depreciated. The Company also incurred approximately $88,000 of costs to effect this foreclosure, which are included in amortization and other expenses. The Company is currently focused on increasing the occupancy and the operating income generated from the property. As operations begin to improve, the property will be marketed for sale. (5) Certain required debt service payments have been missed, causing the Reserve at Autumn Creek mezzanine loan to be in default. As of May 2003, the Company stopped accruing income on the mezzanine loan. During October 2003, the Company exercised its rights under the subordinated promissory note and other documents to take possession of the real estate collateral of the Reserve at Autumn Creek property, subject to the first mortgage loan. The first mortgage loan, in the approximate amount of $15,993,000, bears interest at a fixed rate of 8% per annum and matures January 2042. The Company has obtained an independent appraisal for the property underlying the mezzanine loan. The appraisal indicates that the value of the property, less estimated disposal costs, exceeds the value of the first mortgage outstanding on the property and the Company's mezzanine loan outstanding. As such, the Company believes that no reserve for impairment is necessary at this time. The Company has reclassified its investment in the Reserve at Autumn Creek to real estate owned on the consolidated balance sheet. The Company has incurred approximately $56,000 of costs to effect this foreclosure, which are included in amortization and other expenses. NOTE 8- Taxable Revenue Bonds During October 2003, the Company purchased nine taxable revenue bonds at a discount (99% of par) from CharterMac in the amount of $7.6 million. The nine taxable revenue bonds, each of which is secured by a first mortgage position, held by CharterMac, on a multifamily property, carry a weighted average interest rate of 8.69%. The price paid was determined by an independent third party valuation of the taxable revenue bonds. This transaction was approved by the 49 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Company's Board of Trustees. The Company's estimate of each revenue bond's fair value was equal to its amortized cost of December 31, 2003. NOTE 9- Repurchase Facilities The Company has a repurchase facility with Nomura Securities International Inc. ("Nomura"), which enables the Company to borrow up to 97% of the fair market value of GNMA and FNMA DUS Certificates owned by the Company. Interest on borrowings are at 30-day LIBOR plus 0.02%. As of December 31, 2003 and December 31, 2002, the amounts outstanding under this facility were $149.5 and $87.9 million, respectively, and weighted average interest rates were 1.56% and 1.47%, respectively. Deferred costs relating to the Nomura facility have been fully amortized. All amounts outstanding at December 31, 2003, had 30-day settlement terms. During March 2003, upon management's analysis of the interest rate environment and the costs and risks of such strategies, the Company entered into an interest rate swap in order to hedge against increases in the floating interest rate on its repurchase facility. On March 25, 2003, the Company entered into a five-year interest rate swap agreement with Fleet National Bank ("Fleet") whereby the Company has agreed to pay Fleet a fixed 3.48% on a notional amount of $30 million. In return, Fleet will pay the Company a floating rate equivalent to the 30-day LIBOR rate on the same notional amount. This effectively fixes $30 million of the Company's secured borrowings at 3.48%, protecting the Company in the event the 30-day LIBOR rate rises. In January 2004, Nomura notified the Company that it intended to terminate the repurchase facility. Nomura agreed to allow the Company time to find a replacement repurchase facility, while reducing the amount the Company could borrow under the existing facility to 93% of the fair market value of the collateral certificates. In February 2004, the Company executed repurchase agreements with three counterparties, Greenwich Capital, Bear Stearns, and RBC Capital Markets, which provides the Company with the capacity to completely terminate the facility with Nomura. Terms of the three newly executed agreements offer advance rates between 94% and 97% and borrowing rates between the LIBOR plus 2 basis points and LIBOR plus 10 basis points. The borrowings are subject to 30-day settlement terms. In the first week of March 2004, the Company executed multiple transactions whereby the repurchase transactions outstanding with Nomura were transferred to the three new trading partners. NOTE 10- Warehouse Facilities In October 2002, the Company entered into a mortgage warehouse line of credit with Fleet National Bank (the "Fleet Warehouse Facility") in the amount of up to $40 million. Under the terms of the Fleet Warehouse Facility, Fleet will advance up to 83% of the total loan package, to be used to fund notes receivable, which the Company will make to its customers for the acquisition/refinancing and minor renovation of existing, lender-approved multifamily properties. This facility, which matures April 2006, bears interest at a rate of 30, 60, 90 or 180-day LIBOR + 200 basis points, or prime, at the discretion of the Company, payable monthly on the total amounts advanced. Principal is due upon the earlier of refinance or sale of the underlying project or upon maturity. The Company pays a fee of 12.5 basis points, paid quarterly, on any unused portion of the facility. From time to time, the Company will use this facility to finance real estate owned. As of December 31, 2003 and December 31, 2002, the Company had approximately $34.9 and $8.8 million, respectively, in borrowings outstanding under this program. Included in the $34.9 million of outstanding borrowings under this program at December 31, 2003 was $14 million borrowed by the Company to repay an intercompany loan from CharterMac (see Note 11). 50 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 11- Related Party Transactions Pursuant to the amended Advisory Agreement between the Company and the Advisor, the Advisor receives certain fees, in addition to reimbursements of certain administrative and other costs incurred by the Advisor on behalf of the Company, for its ongoing management and operations of the Company: Fees/Compensation Annual Amount ----------------- ------------- I. Asset management .355% for investments in mortgage loans fees .355% for certain investment grade investments .750% for certain non-investment grade investments 1.000% for unrated investments .625% for investments held prior to the adoption of the amended Advisory Agreement between the Company and the Advisor dated April 6, 1999. II. Annual A) 25% of the dollar amount by which incentive fees (1) (a) funds from operations (before the annual incentive fee) per share based on the weighted average number of shares outstanding), plus (b) gains (or minus losses) from debt restructuring and sales of property per share (based on the weighted average number of shares outstand- ing), exceed (2) an amount equal to the greater of: (a) (i) the weighted average of (x) $20 (the price per share in the Company's initial public offer- ing) and (y) the prices per share of any secondary offerings by the Company multiplied by (ii) the ten year U.S.Treasury Rate plus 2% per annum; and; (b) $1.45 multiplied by the weighted average number of shares out- standing during such year. During September 2003, the Company and its Advisor have agreed to amend its management agreement regarding the payment of an incentive management fee to the Advisor. Under the terms of the amended agreement, there is no change to the calculation of the incentive management fee. However, the incentive management fee is only earned by the Advisor if the Company attains $1.60 in GAAP earnings per share for the calendar year. Based on the amendment to the agreement and the Company's 2003 earnings per share of $1.52, the Company has not incurred an incentive management fee in 2003. In addition, with respect to new mortgage loans acquired by the Company, the Advisor will receive origination points paid by borrowers equal to up to 1% of the principal amount of each mortgage loan and the Company will receive origination points paid by borrowers in excess of 1%. During 2002, the Company made an agreement with the Advisor, whereby the Advisor waived approximately $71,000 in net fees and expense reimbursements, in light of higher than usual expenses related to the origination of investments that were never completed. During 2003, the Advisor agreed to waive approximately $67,000 in asset management fees relating to additional work the Advisor performed on certain properties owned by the Company which were acquired as the result of the Company foreclosing on troubled loans. As the Advisor was paid a fee at the time the loans were originated, the Advisor agreed to waive certain additional fees to which it was entitled. 51 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The costs incurred to related parties for the years ended December 31, 2003, 2002 and 2001 were as follows:
(Dollars in thousands) Years Ended December 31, ------------------------ 2003 2002 2001 ------ ------ ------ Expense reimbursement $ 725 $ 447 $ 345 Asset management fees 1,087 838 248 Incentive management fee -- 235 -- ------ ------ ------ $1,812 $1,520 $ 593 ====== ====== ======
Some of the Company's notes receivable (see Note 6), the stabilization loan guarantees and standby loan commitments (Note 15) are to limited partnerships in which the general partner is an unaffiliated third party and the limited partner is itself a limited partnership in which an affiliate of Related is the general partner. The Noble Towers notes receivable is guaranteed by an affiliate of the Advisor (see Note 6). In September 2003, the Company entered into a letter of agreement with PW Funding Inc. ("PWF"), a subsidiary of CharterMac, each of which are affiliates of the Advisor, under which the Company transferred and assigned all of its rights and obligations to the two loans it originated under this program to PWF. There was no payment made or received by the Company in connection with this transfer. CharterMac has agreed to guarantee PWF's performance with regard to this program, which in turn, allowed for the release of approximately $8.3 million in collateral pledged by the Company to secure its obligations under the loan program. In turn, the Company indemnified PWF against any losses to Fannie Mae on the loans and indemnified CharterMac against any obligation under its guaranty. The maximum aggregate exposure to the Company under this agreement is approximately $7.5 million. However, the Company believes that it will not be called upon to fund any of these guarantees and, accordingly, that the fair value of the guarantees is insignificant. During October 2003, the Company purchased nine taxable revenue bonds from CharterMac (see Note 8). On October 15, 2003, the Company funded a bridge loan to Related Capital Guaranteed Corporate Partners II, L.P. Series A, an affiliate of the Advisor, in the approximate amount of $1.3 million. The Company received a fee of $10,000 for funding the loan. The loan was repaid on October 31, 2003. In December 2003, the Company borrowed approximately $11.3 million from CharterMac in order to aid in the purchase of the Concord at Gulfgate first mortgage in the total amount of $14.1 million. CharterMac charged the Company interest at an annual rate of 3.17% on the borrowings, which was based on LIBOR plus 2%, which is the same rate paid by the Company on its Fleet Warehouse Facility. Shortly thereafter, the Company received a loan from Fleet on the warehouse facility in the amount of $14 million, the proceeds of which were used to repay the loan to CharterMac. NOTE 12 - Earnings Per Share Basic net income per share in the amount of $1.52, $1.61 and $1.35 for the years ended December 31, 2003, 2002 and 2001, respectively, equals net income for the periods ($11,884,383, $9,659,362 and $5,187,064, respectively), divided by the weighted average number of shares outstanding for the periods (7,802,957, 6,017,740 and 3,838,630, respectively). Diluted net income per share is calculated using the weighted average number of shares outstanding during the period plus the additional dilutive effect of common share equivalents. The dilutive effect of outstanding share options is calculated using the treasury stock method. Diluted net income per share in the amount of $1.52, $1.61 and $1.35 for the years ended December 31, 2003, 2002 and 2001, respectively, equals net income for the periods ($11,884,383, $9,659,362 and $5,187,064, respectively), divided by the weighted average number of shares outstanding for the periods (7,814,810, 6,017,740 and 3,838,630, respectively). NOTE 13 - Capital Shares On February 25, 2002, the Company completed a public offering of 2.5 million common shares at a price of $13.00 per share. The net proceeds from this offering, approximately $30.9 million, net of underwriter's discount and expenses, were used to fund investments. 52 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On April 23, 2003, the Company completed a public offering of 1,955,000 common shares at a price of $15.00 per share, resulting in proceeds, net of underwriters' discount and expenses, of approximately $27.5 million. The net proceeds from this offering have been used to fund investment activity. The Company applies the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" for its share options issued to non-employees. Accordingly, compensation cost is accrued based on the estimated fair value of the options issued, and amortized over the vesting period. Because vesting of the options is contingent upon the recipient continuing to provide services to the Company until the vesting date, the Company estimates the fair value of the non-employee options at each period-end up to the vesting date, and adjusts expensed amounts accordingly. The fair value of each option grant is estimated using the Black-Scholes option-pricing model. In April 2003, in accordance with the Incentive Share Option Plan, the Company's Compensation Committee granted 190,000 options to employees of Related at an exercise price of $15.03, which was the market price of the Company's common shares at the grant date. These options vest equally, in thirds, in April 2004, 2005 and 2006 and expire in 10 years. These options were dilutive for the year ended December 31, 2003, and were taken into account in the calculation of diluted earnings per share. At December 31, 2003, these options had a fair value of $51,300 based on the Black-Scholes pricing model, using the following assumptions: dividend yield of 9.63%, estimated volatility of 16%, risk free interest rate of 4.27% and expected lives of 9.41 years. The Company recorded compensation cost of $22,675, reflected in general and administrative expenses for the year ended December 31, 2003, relating to these options. No options were excercised or forfeited during 2003. In August 2003, the Company's Board of Trustees approved a share repurchase plan for the Company. The plan enables the Company to repurchase, from time to time, up to 1,000,000 common shares. The repurchases will be made in the open market, and the timing will be dependent on the availability of shares and other market conditions. No repurchases have been made at December 31, 2003. 53 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 14 - Selected Quarterly Financial Data
2003 Quarter Ended ------------------------------------------------------- (Dollars in thousands except per share amounts) (unaudited) March 31 June 30 September 30 December 31 ----------- ----------- ------------ ----------- Revenues: Interest income: Debt securities $ 1,872 $ 1,980 $ 2,364 $ 2,549 Mortgage loans 1,407 356 418 416 Notes receivable 918 878 721 649 Revenue bonds -- -- -- 151 Temporary investments 8 7 37 3 Other income 28 82 70 596 ----------- ----------- ----------- ----------- Total revenues 4,233 3,303 3,610 4,364 ----------- ----------- ----------- ----------- Expenses: Interest 407 643 693 805 General and administrative 243 182 152 340 Fees to Advisor 443 456 468 445 Amortization and other 157 49 121 49 ----------- ----------- ----------- ----------- Total expenses 1,250 1,330 1,434 1,639 ----------- ----------- ----------- ----------- Other income: Equity in earnings of ARCap 600 600 600 600 Net gain (loss) on sale or repayment of debt securities and land parcel (391) -- -- 18 ----------- ----------- ----------- ----------- Total other income 209 600 600 618 ----------- ----------- ----------- ----------- Net income $ 3,192 $ 2,573 $ 2,776 $ 3,343 =========== =========== =========== =========== Net income per share (basic and diluted) $ 0.50 $ 0.32 $ 0.33 $ 0.40 =========== =========== =========== =========== Weighted average shares outstanding Basic 6,363,630 8,144,259 8,338,180 8,338,180 =========== =========== =========== =========== Diluted 6,363,630 8,158,524 8,346,866 8,350,807 =========== =========== =========== ===========
54 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2002 Quarter Ended ----------------------------------------------------- (Dollars in thousands except per share amounts) (unaudited) March 31 June 30 September 30 December 31 ----------- ----------- ------------ ----------- Revenues: Interest income: Debt securities $ 1,084 $ 1,370 $ 1,548 $ 1,767 Mortgage loans 401 609 536 504 Notes receivable 487 627 548 608 Temporary investments 11 13 16 10 Other income 60 76 67 116 ---------- ---------- ---------- ---------- Total revenues 2,043 2,695 2,715 3,005 ---------- ---------- ---------- ---------- Expenses: Interest 272 307 290 359 General and administrative 121 164 119 281 Fees to Advisor 357 371 318 474 Amortization and other 360 3 -- 16 ---------- ---------- ---------- ---------- Total expenses 1,110 845 727 1,130 ---------- ---------- ---------- ---------- Other income: Equity in earnings of ARCap 592 608 600 600 Net gain on repayment of debt securities 614 -- -- -- ---------- ---------- ---------- ---------- Total other income 1,206 608 600 600 ---------- ---------- ---------- ---------- Net income $ 2,139 $ 2,458 $ 2,588 $ 2,475 ========== ========== ========== ========== Net income per share (basic and diluted) $ 0.43 $ 0.39 $ 0.41 $ 0.39 ========== ========== ========== ========== Weighted average shares outstanding Basic 4,960,852 6,363,630 6,363,630 6,363,630 ========== ========== ========== ========== Diluted 4,960,852 6,363,630 6,363,630 6,363,630 ========== ========== ========== ==========
NOTE 15 - Commitments and Contingencies Upon taking possession of the real estate collateral supporting the Concord at Gulfgate loan, the Company has been named in a lawsuit filed by the limited partners of partnership that owned the property. Subsequently, the Company has filed a countersuit against the limited partners seeking to recover unpaid taxes and misappropriated property receipts. The Company is currently unable to determine the possible outcome of the litigation, but does not believe it will have a material impact on the consolidated financial statements. In the first quarter of 2003, the Company discontinued its loan program with Fannie Mae, under which Fannie Mae had agreed to fully fund the origination of $250 million of Delegated Underwriter and Servicer loans ("DUS") for apartment properties that qualify for low income housing tax credits ("LIHTC") under Section 42 of the Internal Revenue Code. Under the loan program, the Company originated and contracted for individual loans of up to $6 million each. The Company guaranteed a first loss position of the aggregate principal amount of these loans and also guaranteed construction loans for which it had issued a forward commitment to originate under this program. Accordingly, the Company wrote off approximately $358,000 of unamortized deferred costs relating to this program, which is included in other expenses on the consolidated statement of income. In September 2003, the Company entered into a letter of agreement with PW Funding Inc. ("PWF"), a subsidiary of CharterMac, each of which are affiliates of the Advisor, under which the Company transferred and assigned all of its rights and obligations to the two loans it originated under this program to PWF. There was no payment made or received by the Company in connection with this transfer. CharterMac has agreed to guarantee PWF's performance with regard to this program, which in turn, allowed for the release of approximately $8.3 million in collateral pledged by the Company to secure its obligations under the loan program. In turn, the Company indemnified PWF against any losses to Fannie 55 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Mae on the loans and indemnified CharterMac against any obligation under its guaranty. The maximum aggregate exposure to the Company under the agreement is approximately $7.5 million. However, the Company believes that it will not be called upon to fund any of these guarantees and, accordingly, that the fair value of the guarantees is insignificant. 56 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Standby and Forward Loan and GNMA Commitments - --------------------------------------------- The Company has issued the following standby and forward bridge and permanent loan commitments for the purpose of constructing/rehabilitating certain multifamily apartment complexes in various locations.
(Dollars in thousands) STANDBY AND FORWARD BRIDGE LOAN COMMITMENTS - --------------------------------------- MAXIMUM AMOUNT OF COMMITMENTS ---------------------------------------------------- ISSUE DATE PROJECT LOCATION NO. OF APT. UNITS LESS THAN 1 YEAR 1-3 YEARS - ------------------------------------------------------------------------------------------------------------------------------------ Jan-02 Parwood Long Beach, CA 528 $ 567 (1) $ -- Feb-03 Noble Towers Oakland, CA 195 -- 3,719 (2) Aug-03 Oaks of Baytown Baytown, TX 248 1,488 -- Nov-03 Georgia King Newark, NJ 422 5 -- Dec-03 Reserve at Thornton Thornton, CO 216 690 -- -------------------------------------------------------------------------- TOTAL STANDBY AND FORWARD BRIDGE LOAN COMMITMENTS 1,609 $2,750 $ 3,719 ========================================================================== STANDBY AND FORWARD MEZZANINE LOAN COM- MITMENTS - ---------------------------------------- MAXIMUM AMOUNT OF COMMITMENTS ---------------------------------------------------- ISSUE DATE PROJECT LOCATION NO. OF APT. UNITS LESS THAN 1 YEAR 1-3 YEARS - ------------------------------------------------------------------------------------------------------------------------------------ April-03 Villas at Highpoint Lewisville, TX 304 $ 26 (3) $ -- April-03 Villas at Highpoint Lewisville, TX -- -- 693 -------------------------------------------------------------------------- TOTAL STANDBY AND FORWARD MEZZANINE LOAN COMMITMENTS 304 $ 26 $ 693 ==========================================================================
57 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FORWARD GNMA COMMITMENTS - ------------------------ MAXIMUM AMOUNT OF COMMITMENTS ------------------------------------------------------------- DATE PURCHASED PROJECT LOCATION LESS THAN 1 YEAR 1-3 YEARS - ------------------------------------------------------------------------------------------------------------------------- May-02 Ellington Plaza Washington, DC $10,255 (3) $ -- ------------------------------------------------------------- TOTAL FORWARD GNMA COMMITMENTS $10,255 -- ------------------------------------------------------------- TOTAL STANDBY AND FORWARD LOAN AND GNMA COMMITMENTS $13,031 $ 4,412 =============================================================
(1) Funding has already begun. Remaining amount of commitment is not expected to be funded. (2) Fundings will be on an as needed basis to complete rehabilitation of the property. (3) Funding has already begun. Amount represents remaining commitment expected to be funded. 58 AMERICAN MORTGAGE ACCEPTANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Stabilization Loan Guarantees During 2002, the Company guaranteed the following loans in relation to the construction of affordable multifamily apartment complexes in various locations. The stabilization loan guarantees will provide credit support for the properties after construction completion, up until the date in which permanent financing takes place. During October 2002, the Company entered into an agreement with Wachovia Bank, National Association ("Wachovia") to provide stabilization guarantees for new construction of multifamily properties under the LIHTC program. Wachovia already provides construction and stabilization guarantees to Fannie Mae, for loans Wachovia originates under the Fannie Mae LIHTC forward commitment loan program, but only for loans within regions of the country Wachovia has designated to be within its territory. For loans outside Wachovia's territory, the Company has agreed to issue a stabilization guarantee, for the benefit of Wachovia. The Company is guarantying that properties which have completed construction will stabilize and the associated construction loans will convert to permanent Fannie Mae loans. The Company receives origination and guarantee fees from the developers for providing the guarantees. If the properties do not stabilize with enough net operating income for Fannie Mae to fully fund its commitment for a permanent loan, AMAC may be required to purchase the construction loan from Wachovia or to fund the difference between the construction loan amount and the reduced Fannie Mae permanent loan amount.
(Dollars in thousands) MAXIMUM AMOUNT OF GUARANTEE LOAN ADMINIS- STABILIZATION NO. OF LESS THAN TRATION FEE (1) GUARANTEE DATE CLOSED PROJECT LOCATION UNITS 1 YEAR 1-3 YEARS (ANNUAL PERCENTAGE) FEE (2) - ------------------------------------------------------------------------------------------------------------------------------------ Jul-02 Clark's Crossing Laredo, TX 160 $ 4,790 $ -- 0.500% 0.625% Sept-02 Creekside Apts. Colorado Springs, CO 144 7,500 -- 0.375% -- Oct-02 Village at Meadowbend (3) Temple, TX 138 -- 3,675 0.500% 0.750% Nov-02 Mapleview Apartments (3) Saginaw, MI 104 -- 3,240 0.625% 0.247% ------------------------------------------------------------------ Total Stabilization Loan Guarantees 546 $ 12,290 $ 6,915 -- -- ==================================================================
(1) Loan Administration Fee is paid on a quarterly basis during the guarantee period. (2) Stabilization Guarantee Fee is an up-front fee - paid at closing and amortized over the guarantee period. (3) Guarantee was made under Wachovia Bank, National Association Guarantee Agreement. For each of these guarantees, and for the guarantees issued under the Fannie Mae program discussed in the first paragraph of this Note 14, the Company monitors the status of the underlying properties and evaluates its exposure under the guarantees. To date, the Company has concluded that no accrual for probable losses is required under SFAS 5. 59 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. Item 9A. Disclosure Controls and Procedures (a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rule 15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, such officers have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective. (b) INTERNAL CONTROL OVER FINANCIAL REPORTING. There have not been any significant changes in the Company's internal control over financial reporting during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART III Item 10. Directors and Executive Officers of the Company. Incorporated by reference to the Company's definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Item 11. Executive Compensation. Incorporated by reference to the Company's definitive proxy statement to be filed pursuant to Regulation 14A under the Exchange Act. Item 12. Security Ownership of Certain Beneficial Owners and Management. Incorporated by reference to the Company's definitive proxy statement to be filed pursuant to Regulation 14A under the Exchange Act. Item 13. Certain Relationships and Related Transactions. Incorporated by reference to the Company's definitive proxy statement to be filed pursuant to Regulation 14A under the Exchange Act. Item 14. Principal Accounting Fees and Services Incorporated by reference to the Company's definitive proxy statement to be filed pursuant to Regulation 14A under the Exchange Act. Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. Sequential Page ---------- (a) 1. Filed Documents --------------- The following documents are filed as part of this report: American Mortgage Acceptance Company ------------------------------------ Independent Auditors' Report 29 Consolidated Balance Sheets as of December 31, 2003 and 2002 30 Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001 31 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2003, 2002 and 2001 32 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 33 Notes to Consolidated Financial Statements 35 60 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (continued) Sequential Page ---------- ARCap Investors, LLC -------------------- Consolidated 2003 financial statements for ARCap Investors, LLC (see Exhibit 99 (a)) 71 Consolidated 2002 financial statements for ARCap Investors, LLC (see Exhibit 99 (b)) 84 Consolidated 2001 financial statements for ARCap Investors, LLC (see Exhibit 99 (c)) 96 (a) 2. Financial Statement Schedules All schedules have been omitted because they are not required or because the required information is contained in the financial statements or notes thereto. (a) 3. Exhibits 3.4 Second Amended and Restated Declaration of Trust, dated as of April 6, 1999 (incorporated by reference to Exhibit 3.4(c) in the Company's March 31, 1999 Quarterly Report on Form 10-Q). 10(a) Amended and Restated Advisory Services Agreement, effective as of April 6, 1999 (incorporated herein by reference to Exhibit 10(z) to Form 10-Q dated September 30, 1999 filed with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 (Commission File No. 0-23972)). 10(b) First Amendment to Amended and Restated Advisory Services Agreement between Related AMI Associates, Inc. and the Company dated November 29, 2001 (incorporated by reference to Exhibit 10-6 to the Company's Registration Statement on Form S-2, file number 333-74288 as filed on November 30, 2001). 10(c) Third Amendment to Amended and Restated Advisory Services Agreement between Related AMI Associates, Inc. and the Company dated November 12, 2003. 23(a) Consent of Deloitte & Touche LLP with respect to incorporation by reference of its report in the Company's Registration Statement on Form S-3 (filed herewith). 68 23(b) Consent of Deloitte & Touche LLP with respect to incorporation by reference of its report relating to the financial statements of ARCap Investors, LLC in the Company's Registration Statement on Form S-3 (filed herewith). 69 23(c) Consent of Ernst & Young LLP with respect to incorporation by reference of its report relating to the financial statements of ARCap Investors, LLC in the Company's Registration Statement on form S-3 (filed herewith). 70 24.1 Power of Attorney (Included on signature page hereto) 31.1 Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 64 31.2 Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 65 32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 66 32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 67 99. Additional Exhibits ------------------- 99(a) The 2003 Financial Statements of ARCap Investors, LLC which invests primarily in subordinated commercial mortgage-backed securities, as required by Regulation S-X, Rule 3-09 (filed herewith). 71 99(b) The 2002 Financial Statements of ARCap Investors, LLC which invests primarily in subordinated commercial mortgage-backed securities, as required by Regulation S-X, Rule 3-09 (filed herewith). 84 99(c) The 2001 Financial Statements of ARCap Investors, LLC which invests primarily in subordinated commercial mortgage-backed securities, as required by Regulation S-X, Rule 3-09 (filed herewith). 96 (b) Reports on Form 8-K None. 61 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. AMERICAN MORTGAGE ACCEPTANCE COMPANY (Registrant) Date: March 15, 2004 By: /s/ Stuart J. Boesky -------------------- Stuart J. Boesky Trustee, Chairman of the Board, President and Chief Executive Officer Date: March 15, 2004 By: /s/ Stuart A. Rothstein ----------------------- Stuart A. Rothstein Chief Financial Officer 62 POWER OF ATTORNEY Each person whose signature appears below hereby constitutes and appoints Stuart J. Boesky, Alan P. Hirmes and Stuart A. Rothstein, and each or either of them, his true and lawful attorney-in-fact with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report, and to cause the same to be filed, with all exhibits thereto and other documents in connection therewith, with the Securities Exchange Commission, hereby granting to said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing whatsoever requisite or desirable to be done in and about the premises, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all acts and things that said attorneys-in-fact and agents, or either of them, or their substitutes or substitute, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated: Signature Title Date - ---------------------- -------------------------------------- -------------- /s/ Stuart J. Boesky - -------------------- Trustee, Chairman of the Board, Stuart J. Boesky President and Chief Executive Officer March 15, 2004 /s/ Stanley R. Perla - -------------------- Stanley R. Perla Trustee March 15, 2004 /s/ Richard M. Rosan - -------------------- Richard M. Rosan Trustee March 15, 2004 /s/ Alan P. Hirmes - ------------------ Alan P. Hirmes Trustee March 15, 2004 /s/ Scott M. Mannes - ------------------- Scott M. Mannes Trustee March 15, 2004 /s/ Stuart A. Rothstein - ----------------------- Stuart A. Rothstein Chief Financial Officer March 15, 2004 63 Exhibit 31.1 CERTIFICATION I, Stuart J. Boesky, hereby certify that: 1. I have reviewed this annual report on Form 10-K of American Mortgage Acceptance Company; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 and 15d-15) for the registrant and we have: a) designed such disclosure controls and procedures to ensure the material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of December 31, 2003 (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors or persons performing the equivalent functions: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 15, 2004 By: /s/ Stuart J. Boesky -------------- -------------------- Stuart J. Boesky Chief Executive Officer 64 Exhibit 31.2 CERTIFICATION I, Stuart A. Rothstein, hereby certify that: 1. I have reviewed this annual report on Form 10-K of American Mortgage Acceptance Company; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15 and 15d-15) for the registrant and we have: a) designed such disclosure controls and procedures to ensure the material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of December 31, 2003 (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors or persons performing the equivalent functions: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 15, 2004 By: /s/ Stuart A. Rothstein -------------- ----------------------- Stuart A. Rothstein Chief Financial Officer 65 Exhibit 32.1 CERTIFICATION PURSUANT TO 18.U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of American Mortgage Acceptance Company (the "Company") on Form 10-K for the year ending December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Stuart J. Boesky, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. By: /s/ Stuart J. Boesky -------------------- Stuart J. Boesky Chief Executive Officer March 15, 2004 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. 66 Exhibit 32.2 CERTIFICATION PURSUANT TO 18.U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of American Mortgage Acceptance Company (the "Company") on Form 10-K for the year ending December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Stuart J. Boesky, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. By: /s/ Stuart A. Rothstein ----------------------- Stuart A. Rothstein Chief Financial Officer March 15, 2004 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. 67 EXHIBIT 23(a) INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 33-42481 of American Mortgage Acceptance Company on Form S-3 of our report relating to the financial statements of American Mortgage Acceptance Company as of December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003, dated March 15, 2004, appearing in this Annual Report on Form 10-K of American Mortgage Acceptance Company for the year ended December 31, 2003. /s/ DELOITTE & TOUCHE LLP New York, New York March 15, 2004 68 EXHIBIT 23(b) INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 33-42481 of American Mortgage Acceptance Company on Form S-3 of our report relating to the consolidated financial statements of ARCap Investors, L.L.C. as of December 31, 2001 and for the year then ended, dated January 31, 2002, appearing in this Annual Report on Form 10-K of American Mortgage Acceptance Company for the year ended December 31, 2003. /s/ DELOITTE & TOUCHE LLP Dallas, Texas March 12, 2004 69 EXHIBIT 23 (c) INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement (Form S-3 No. 33-42481) of American Mortgage Acceptance Company and in the related Prospectus of our report dated February 6, 2004 and February 4, 2003 on the consolidated financial statements of ARCap Investors, L.L.C. included in this Annual Report (Form 10-K) for the year ended December 31, 2003. /s/ Ernst & Young LLP Dallas, Texas March 5, 2004 70 Exhibit 99 (a) Report of Independent Auditors The Board of Managers ARCap Investors, L.L.C. We have audited the accompanying consolidated balance sheet of ARCap Investors, L.L.C. and subsidiaries (the Company) as of December 31, 2003, and the related consolidated statements of operations, members' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ARCap Investors, L.L.C. and subsidiaries at December 31, 2003, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP February 6, 2004 71 ARCap Investors, L.L.C. and Subsidiaries Consolidated Balance Sheet December 31, 2003
ASSETS Investment securities - available-for-sale, net (NOTE 3) $ 739,048,867 Investment securities - trading, net (NOTE 3) 282,157,427 Accrued interest receivable 11,433,408 Deferred borrowing costs, net (NOTE 5) 9,331,954 Restricted cash - CBO swap (NOTE 5) 4,376,111 Cash and cash equivalents 2,657,131 Other assets 1,207,425 -------------- Total assets $1,050,212,323 ============== LIABILITIES AND MEMBERS' EQUITY Liabilities: Long-term debt (NOTE 5) $ 461,800,000 Repurchase agreements (NOTE 6) 163,011,000 CBO swap liability (NOTE 5) 4,125,000 Accrued interest payable 2,839,836 Deferred compensation (NOTE 10) 3,140,244 Borrowed investment securities and interest rate swap, net (NOTE 4) 2,155,215 Accrued expenses 985,520 -------------- Total liabilities 638,056,815 Commitments and contingencies Minority interest in consolidated entities 202,589,352 Members' equity: Series A preferred members 67,367,415 Common members 142,198,741 -------------- Total members' equity 209,566,156 -------------- Total liabilities and members' equity $1,050,212,323 ==============
SEE ACCOMPANYING NOTES. 72 ARCap Investors, L.L.C. and Subsidiaries Consolidated Statement of Operations Year ended December 31, 2003
Revenues: Interest income - CMBS $ 100,309,513 Other income 4,602,285 ------------- Total revenues 104,911,798 Expenses: Interest - long-term debt and repurchase agreements 28,314,158 Interest - borrowed investment securities and interest rate swap, net 8,372,835 Salaries and employee benefits 8,831,993 General and administrative 4,398,268 Financing fee 1,180,000 ------------- Total expenses 51,097,254 ------------- Net margin on CMBS and other income 53,814,544 Other revenue (expense): Accretion of purchase discount 9,753,013 Loss on investment securities, net (NOTE 7) (37,655,565) ------------- Deferred compensation expense (NOTE 10) (3,140,244) ------------- (31,042,796) Income before minority interest 22,771,748 Minority interest (6,630,611) ------------- Net income 16,141,137 Other comprehensive income: Unrealized gain on available-for-sale securities, net of minority interest of $4,620,290 2,240,385 ------------- Comprehensive income $ 18,381,522 =============
SEE ACCOMPANYING NOTES. 73 ARCap Investors, L.L.C. and Subsidiaries Consolidated Statement of Members' Equity
SERIES A COMMON PREFERRED MEMBERS MEMBERS TOTAL ------------- ------------- ------------- BALANCE AT JANUARY 1, 2003 $ 77,779,421 $ 147,340,254 $ 225,119,675 Distributions (10,867,864) (18,135,326) (29,003,190) Net income -- 16,141,137 16,141,137 Surrender of common units (31,851) -- (31,851) Costs to raise capital (8,487) 8,487 -- Redemption of preferred units 100,000 (5,000,000) (4,900,000) Other comprehensive income: Unrealized gain on available for - sale securities 396,196 1,844,189 2,240,385 ------------- ------------- ------------- BALANCE AT DECEMBER 31, 2003 $ 67,367,415 $ 142,198,741 $ 209,566,156
SEE ACCOMPANYING NOTES. 74 ARCap Investors, L.L.C. and Subsidiaries Consolidated Statement of Cash Flows Year ended December 31, 2003
OPERATING ACTIVITIES Net income $ 16,141,137 Adjustments to reconcile net income to net cash used in operating activities: Loss on investment securities, net 37,655,565 Accretion of purchase discount (9,753,013) Amortization of deferred borrowing costs 1,045,824 Minority interest 6,630,611 Deferred compensation 3,140,244 Changes in operating assets and liabilities: Investment securities - trading, net (151,017,303) Accrued interest receivable (2,190,366) Restricted cash - CBO swap (50,263) Other assets (517,015) Accrued interest payable (2,013,921) Borrowed investment securities and interest rate swap, net (6,218,328) Accrued expenses 641,739 ------------- Net cash used in operating activities (106,505,089) INVESTING ACTIVITIES Purchases of investment securities - available-for-sale (88,488,096) FINANCING ACTIVITIES Distributions to members (28,867,864) Contributions from minority interest members, net of capital returned 16,821,400 Operating distributions to minority interest members (17,820,580) Redemption of preferred units (4,900,000) Proceeds from repurchase agreements 7,588,000 Proceeds from the issuance of long-term debt 225,800,000 Payment for deferred borrowing costs (5,924,028) ------------- Net cash provided by financing activities 192,696,928 ------------- Net change in cash and cash equivalents (2,296,257) Cash and cash equivalents, beginning of year 4,953,388 ------------- Cash and cash equivalents, end of year $ 2,657,131 ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash payments for interest on long-term debt and repurchase agreements $ 26,062,747 ============= SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES Surrender of common units in exchange for other assets $ 31,851 ============= Accrued distribution on preferred units redemption $ 135,326 =============
SEE ACCOMPANYING NOTES. 75 ARCap Investors, L.L.C. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES Organization - ------------ ARCap Investors, L.L.C. (the Company) was incorporated in January 1999 and commenced its operations on March 17, 1999. The Company was organized to invest primarily in subordinated commercial mortgage-backed securities (CMBS). Principles of Consolidation - --------------------------- The consolidated financial statements include the accounts of: - The Company. - ARCap REIT, Inc. (ARCap REIT), a majority-owned subsidiary of the Company. - ARCap Resecuritization Corporation (ARCap Resecuritization), a wholly owned subsidiary of ARCap REIT. ARCap Resecuritization owns all the residual interest in Commercial Resecuritization Trust 2001 ABC-2 (the Trust) and Commercial Resecuritization Trust 2003-ABC3 (2003-ABC3 Trust). - ARCap High Yield CMBS Fund, L.L.C. (the High Yield Fund), of which ARCap REIT owned an approximate 23% controlling interest as of December 31, 2003. The High Yield Fund owns approximately 60% of ARCap CMBS Fund REIT, Inc. (the Fund REIT). ARCap 2003-1 Resecuritization, Inc. (2003-1 Resecuritization), a wholly owned subsidiary of the Fund REIT, owns all of the equity interest in ARCap 2003-1 Resecuritization Trust (the 2003-1 Trust). - ARCap Diversified Risk CMBS Fund, L.L.C. (the Diversified Risk Fund), of which ARCap REIT owned an approximate 1% controlling interest as of December 31, 2003. The Diversified Risk Fund owns approximately 40% of the Fund REIT. - ARCap Servicing, Inc., a taxable REIT subsidiary wholly owned by ARCap REIT. Minority interests primarily represent outside members' approximate 77% ownership in the High Yield Fund and outside members' approximate 99% ownership in the Diversified Risk Fund. The Company has consolidated the High Yield Fund and Diversified Risk Fund as it exercises control (through ARCap REIT, which acts as the Managing Member of both Funds in accordance with the terms of the respective LLC agreements) over the operations of these Funds. The Company records minority interest expense (income) that reflects the portion of the earnings (losses) of the operations which is applicable to the minority interest members. As the Managing Member of both the High Yield Fund and the Diversified Risk Fund, ARCap REIT is entitled to a 20% promote in the event the Funds achieve a specified investment return. Accordingly, minority interest expense may not equal the earnings of each of the Funds times the respective outside members' ownership percentages. Separate books of accounts are maintained for ARCap REIT, ARCap Resecuritization, the Trust, the High Yield Fund, the Fund REIT, 2003-1 Resecuritization, the 2003-1 Trust, the Diversified Risk Fund, and ARCap Servicing, Inc. and are reflected in the accompanying consolidated financial statements of the Company. All material intercompany transactions and account balances have been eliminated in consolidation. Investment Securities - --------------------- The Company's investment security transactions are recorded on the trade date for existing securities and the settlement date for to-be-issued securities. In October 2003, the Trust reclassified CMBS with a fair value of approximately $386,000,000 from trading to available-for-sale in connection with the creation of 2003-ABC3 Trust (see Note 5). The reclassification effectively established a new basis for financial reporting for the CMBS at the date of transfer. In August 2003, the Fund REIT reclassified CMBS with a fair value of approximately $260,000,000 from trading to available-for-sale in connection with the resecuritization of 64 CMBS securities and the issuance of a collateralized debt obligation (CDO) (see Note 5). The reclassification effectively established a new basis for financial reporting for the CMBS at the date of transfer. CMBS classified as available-for-sale are securities that the Company considers for possible sales or other dispositions prior to the maturity of the securities. Available-for-sale securities are carried at their estimated fair value with unrealized gains and losses reported in other comprehensive income (loss) as a separate component of members' equity. The Company evaluates unrealized losses on its available-for-sale CMBS securities to determine if such declines in fair value are "other than temporary." In the event a decline in the fair value of an available-for-sale CMBS security is deemed "other than temporary," the decline in fair value would be recorded as an impairment to the security and charged through earnings rather than as a component of other comprehensive income. Approximately $6,598,000 of "other than temporary" impairments has been recognized for the year ended December 31, 2003. The Company's CMBS that are designated as trading assets represent securities the Company is holding for possible sales or other dispositions in the near term. Such securities are carried at their estimated fair value, with unrealized gains or losses included in earnings. The fair value of the Company's portfolio of CMBS is generally estimated by management based on market prices provided by certain dealers who make a market in these financial instruments. The market for the Company's CMBS may lack 76 ARCap Investors, L.L.C. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 liquidity and have limited market volume. Accordingly, the fair values reported reflect estimates and may not necessarily be indicative of the amounts that the Company could realize in a current market exchange. The yield to maturity on the Company's CMBS depends on, among other things, the rate and timing of principal payments, the pass-through rate, and interest rate fluctuations. The subordinated CMBS interests owned by the Company provide credit support to the more senior interests of the related commercial securitization. Cash flow from the mortgages underlying the CMBS interests generally is allocated first to the senior interests, with the most senior interest having a priority entitlement to cash flow. Remaining cash flow is allocated generally among the other CMBS interests in order of their relative seniority. To the extent that there are defaults and unrecoverable losses on the underlying mortgages that result in reduced cash flows, the most subordinated CMBS interest will bear this loss first. To the extent that there are losses in excess of the most subordinated interest's stated entitlement to principal and interest, then the remaining CMBS interests will bear such losses in order of their relative subordination. Revenue Recognition - ------------------- Interest income and servicing fees are recognized as earned. Accretion of discounts is computed using the effective-interest method over the expected life of the securities based on management's estimates regarding the timing and amount of cash flows from the underlying collateral. Derivative Financial Instruments - -------------------------------- Derivative financial instruments are utilized by the Company to reduce interest rate risk. The Company utilizes interest rate swaps and cap and floor agreements as a means of hedging the potential financial statement impact of changes in the fair value of its portfolio of CMBS and variable rate long-term debt due to changes in interest rates. Risks in these contracts arise from the movements in interest rates and from the possible inability of counterparties to meet the terms of their contracts. The Company carries its derivative financial instruments at fair value with any unrealized gain or loss included in earnings, in accordance with the provisions of SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. Resale and Repurchase Agreements - -------------------------------- Transactions involving purchases of securities under agreements to resell (reverse repurchase agreements or reverse repos) or sales of securities under agreements to repurchase (repurchase agreements or repos) are accounted for as collateralized financings, except where the Company does not have an agreement to sell (or purchase) the same or substantially the same securities before maturity at a fixed or determinable price. Cash and Cash Equivalents - ------------------------- Cash and cash equivalents include all highly liquid investments with original maturity when purchased of three months or less. Restricted Cash - --------------- Restricted cash represents amounts required to be pledged under interest rate cap and floor agreements (see Note 5). Deferred Borrowing Costs - ------------------------ Deferred borrowing costs represent costs incurred in connection with the issuance of long-term debt. Such amounts are amortized using the effective-interest method over the term of the related debt (see Note 5). During 2003, the Company paid approximately $228,000 in connection with the issuance of a long-term repurchase agreement, approximately $4,825,000 in connection with the High Yield Fund's CDO offering, and approximately $871,000 in connection with the creation of 2003-ABC3 Trust. Financing Fee - ------------- The Company pays an annual rate of 0.50% on $236,000,000 of its existing long-term debt to a financier to provide credit enhancement of such debt. Income Taxes - ------------ The Company has elected to be taxed as a partnership, whereby all income is taxed at the member level, with the exception of ARCap Servicing, Inc., which is taxed at the entity level. ARCap REIT has elected to be taxed as a real estate investment trust for federal income tax purposes. No provision for income taxes has been made for ARCap Servicing, Inc. for the year ended December 31, 2003, as ARCap Servicing, Inc. did not generate any taxable income. 77 ARCap Investors, L.L.C. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 Use of Estimates - ---------------- The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect reported amounts of certain assets, liabilities, revenues, and expenses. Actual results could differ from those estimates. Fair Value of Financial Instruments - ----------------------------------- The estimated fair value amounts herein have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies could have a material effect on the estimated fair value amounts. The Company's portfolio of CMBS and securities borrowed is carried at their estimated fair values. The Company's management believes that the fair values of its cash and cash equivalents, restricted cash, long-term debt, and repurchase agreements approximate their carrying values due to the nature of the instruments or the fact that their terms approximate current market terms. The Fixed Rate Notes (see Note 5) with a carrying value of $98,500,000 have an estimated fair value of approximately $107,313,000 at December 31, 2003. Fair value was estimated using a discounted cash flow analysis, based on an interest rate of 5% which management believes is currently available for the issuance of similarly rated debt. 2. MEMBERS' EQUITY The Limited Liability Company Agreement (LLC Agreement) establishes two classes of membership: Series A Preferred members and Common members. Cash Flows are distributed in the following order of priority: - - To the Series A Preferred members in an amount equal to the accrued and unpaid Preferred Distributions (12% per annum of the $25.00 price per Unit). - To the Common members in an amount equal to the amount determined by the Board of Managers, provided that if the amount distributable to the Common members shall exceed a cumulative annual return on the Common Units of 12% per annum, the Board of Managers shall notify the Series A Preferred members 30 days in advance of the record date for distribution of Cash Flow. - To the extent that any remaining Cash Flow received during such tax period is not includable in the income of the Company, to members that have been allocated Net Profits in excess of amounts actually distributed to such members, in proportion to such amounts. Net Profits of the Company are allocated as follows: - To the Series A Preferred members to the extent of amounts distributed or distributable to them in such taxable year. - To the Series A Preferred members to the extent Net Losses previously allocated to such members exceed undistributed Net Profits previously allocated to them. - To the Common members to the extent of amounts distributed or distributable to them in such taxable year. - To the Common members to the extent of amounts distributed or distributable to them in such taxable year. - To the Common members to the extent Net Losses previously allocated to such members exceed undistributed Net Profits previously allocated to them. - To the members in proportion to their Percentage Interests. Net Losses of the Company are allocated as follows: - To the members in an amount equal to undistributed Net Profits allocated to such members. - To the Common members pro rata to the extent of their Capital Accounts. - To the Series A Preferred members pro rata to the extent of their Capital Accounts. 78 ARCap Investors, L.L.C. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 Series A Preferred Units - ------------------------ Series A Preferred Units are convertible into Common Units at the Conversion Price in effect on the Conversion Date. If the Series A Preferred Units have not been converted within five years of the effective date of the First Amendment to the LLC Agreement (August 4, 2000), Series A Preferred Units may, at the holder's option, be converted to a note equal to $25.00 per Unit, plus accrued and unpaid Preferred Distributions. Eighteen months after the First Closing Date (February 4, 2002), but no later than the fifth anniversary of the First Closing Date (August 4, 2005), the Company may redeem the Series A Preferred Units for $25.00 per unit, plus accrued and unpaid Preferred Distributions, plus a premium that will provide the Series A Preferred members with a total pretax internal rate of return of 17.50%. In addition, upon either a change in control or sale or transfer of all or substantially all of the assets of the Company, Series A Preferred Units may, at the holder's option, be redeemed at $25.00 per unit, plus accrued and unpaid Preferred Distributions. In December 2003, a Series A Preferred unit holder accepted a redemption of its 200,000 units for consideration of $4,900,000, plus accrued distributions through the date of redemption. Accrued distributions in connection with the redemption in the amount of $135,326 are included in accrued expenses in the accompanying consolidated balance sheet. At December 31, 2003, there were a total of 5,800,000 Series A Preferred Units and 4,997,917 Common Units issued and outstanding. The LLC Agreement contains certain restrictive covenants regarding the amount of variable rate debt, total debt, and certain financial ratios. Failure to meet the covenants in successive quarters can result in the Chief Executive Officer and Chief Operating Officer being removed from the Board of Managers until such time as the covenants are cured for successive quarters. Management believes that the Company has not violated the covenants in successive quarters. 3. INVESTMENT SECURITIES The Company's available-for-sale securities are carried at estimated fair value and are comprised of the following at December 31, 2003:
FACE ACCRETED COST FAIR VALUE PERCENTAGE ------------------------------------------------------------------- Subordinated CMBS: Security rating: BB+ $ 115,969,711 $100,476,507 $100,989,593 13.66% BB 187,510,690 151,286,305 152,973,681 20.70% BB- 141,923,565 103,046,413 102,883,384 13.92% B+ 207,933,210 129,402,233 129,725,184 17.55% B 239,353,347 130,807,073 126,630,338 17.13% B- 160,278,326 72,779,789 74,040,639 10.02% NR 211,411,772 50,987,832 51,806,048 7.02% ------------------------------------------------------------------- $ 1,264,380,621 $738,786,152 $739,048,867 100.00% =================================================================== The Company's trading securities are carried at estimated fair value and are comprised of the following at December 31, 2003: FACE ACCRETED COST FAIR VALUE PERCENTAGE ------------------------------------------------------------------- Subordinated CMBS: Security rating: BB+ $ 83,615,000 $ 67,653,304 $ 69,376,540 24.59% BB 63,340,512 48,069,924 47,647,477 16.89% BB- 41,236,511 27,084,333 29,403,288 10.42% B+ 65,740,512 38,821,364 42,978,057 15.23% B 45,104,511 23,655,960 25,634,761 9.09% B- 17,561,512 7,276,006 4,982,478 1.77% NR 282,727,504 72,543,757 62,134,826 22.01% ------------------------------------------------------------------- $599,326,062 $285,104,648 $282,157,427 100.00% ===================================================================
At December 31, 2003, the accumulated accretion of purchase discounts on available-for sale and trading securities, was approximately $2,932,000 and $6,245,000, respectively. 79 ARCap Investors, L.L.C. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 The gross cumulative unrealized gains and losses on the Company's available-for-sale investment securities were approximately $12,064,000 and $(5,203,000), respectively, at December 31, 2003 for a total accumulated other comprehensive income on available for-sale securities of approximately $6,861,000. The gross cumulative unrealized gains and losses on the Company's trading investment securities at December 31, 2003, were approximately $10,941,000 and $(20,133,000), respectively. 4. BORROWED INVESTMENT SECURITIES AND INTEREST RATE SWAP, NET The Company's borrowed investment securities and interest rate swap are carried at estimated fair value and are comprised of the following at December 31, 2003:
COUPON FAIR UNREALIZED SECURITY DESCRIPTION RATE FACE BASIS VALUE GAIN (LOSS) - -------------------------------------------------------------------------------------------------------------- U.S. Treasury (08-15-09) 6.000% $ (4,791,000) $ (4,675,342) $ (5,429,550) $ (754,208) U.S. Treasury (02-15-11) 5.000% (14,850,000) (14,587,658) (15,956,789) (1,369,131) U.S. Treasury (08-15-11) 5.000% (12,501,000) (12,546,518) (13,385,835) (839,317) U.S. Treasury (02-15-12) 4.875% (10,845,000) (11,647,608) (11,494,006) 153,602 U.S. Treasury (11-15-12) 4.000% (3,603,000) (3,579,918) (3,570,912) 9,006 ----------------------------------------------------------------------- $ (46,590,000) $ (47,037,044) (49,837,092) $ (2,800,048) Reverse repurchase agreements 50,945,341 ------------- Borrowed investment securities, net 1,108,249 Interest rate swap (3,263,464) ------------- Borrowed investment securities and interest rate swap, net $ (2,155,215) =============
The borrowed U.S. Treasury securities were sold in the open market (i.e., a "short" security sale). The Company is obligated to return the securities in the future and is, therefore, exposed to price risk until it repurchases the securities for delivery to the lender. Short security sales are used by the Company to modify its interest rate risk. The Company must pay the security lender the interest earned by the underlying security. Short security sales are recorded at the estimated fair value of the borrowed securities, and any unrealized gains (losses) are included in earnings. Proceeds from short security sales are used to purchase reverse repurchase agreements of the same security. The transactions are governed by one master repurchase agreement with rights of offset and, therefore, the values of the short security sales and reverse repurchase agreements have been offset and shown as one line item in the accompanying consolidated financial statements. It has been the Company's practice to settle these transactions on a net basis. In October 2003, ARCap REIT repurchased approximately $20,300,000 of its U.S. Treasury securities held against its CMBS for delivery to the lender and sold all offsetting reverse repurchase agreements, consistent with ARCap REIT's practice of settling its borrowed investment transactions on a net basis. Settlement of the transactions resulted in an approximate $1,207,000 realized loss to ARCap REIT. In July 2003, the High Yield Fund repurchased approximately $260,000,000 of its U.S. Treasury securities and, in November 2003, it repurchased the remaining $19,000,000 of the U.S. Treasury securities held against its CMBS for delivery to the lender. The High Yield Fund sold all offsetting reverse repurchase agreements, consistent with the High Yield Fund's practice of settling its borrowed investment transactions on a net basis. Settlement of the transactions resulted in an approximate $17,000,000 realized loss to the High Yield Fund, of which approximately $6,000,000 was attributable to current year earnings. In June 2003, the Diversified Risk Fund repurchased approximately $18,000,000 of its U.S. Treasury securities. The Diversified Risk Fund realized a loss of approximately $600,000 in connection with the transaction. The Company entered into an interest rate swap agreement with Bear Stearns Capital Markets (Bear Stearns) with a notional amount at December 31, 2003, of $27,000,000, on which the Company pays a fixed rate of 6.015% and receives a variable rate based on six month LIBOR for a term of 10 years ending April 27, 2011. The swap agreement calls for interest to be paid semiannually in arrears. The Company carries the swap agreement at its estimated fair value, with all periodic changes in estimated fair value recognized in earnings. The Company was required under the swap agreement to pledge collateral valued at 1% of the notional amount of the swap to ensure its performance in the event that the swap declines in value. At December 31, 2003, the Company pledged CMBS valued at approximately $9,112,000 as additional collateral against the interest rate swap. 80 ARCap Investors, L.L.C. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 5. LONG-TERM DEBT During August 2003, the Fund REIT contributed 64 CMBS certificates with an approximate fair value of $260,000,000 to its subsidiary, 2003-1 Resecuritization, for pass-through to the 2003-1 Trust. The 2003-1 Trust resecuritized the pooled certificates and offered $220,800,000 in senior notes of Classes A through G with fixed rate coupons ranging from 4.97% to 8.74%. The Classes A through G notes mature in increments from September 2011 through March 2013. The notes are secured by 64 CMBS certificates which have a carrying value of approximately $269,000,000 at December 31, 2003. Accrued interest payable at December 31, 2003, was approximately $1,019,000. At December 31, 2003, $220,800,000 of the Class A through G senior notes is issued and outstanding, of which ARCap REIT holds $25,000,000 of Class G senior notes with a fixed rate coupon of 8.74% as a security, which has been eliminated in consolidation. The High Yield Fund capitalized approximately $4,825,000 of deferred borrowing costs related to the issuance of the collateralized debt obligation notes. The costs are being amortized using the effective-interest method over the earliest of the expected lives of the debt, which is eight years (through September 2011). The High Yield Fund amortized approximately $256,000 of deferred borrowing costs for the year ended December 31, 2003. During fiscal year 2001, the Company entered into an agreement to sell its interests in 50 CMBS pass-through certificates (the Pooled Certificates) to its subsidiary, the Trust. The Trust resecuritized the Pooled Certificates and offered $98,500,000 Class A-1 Senior Notes with a fixed coupon rate of 7.17% (Fixed Rate Notes) and $137,500,000 Class A-2 Senior Notes with a variable coupon rate based on one-month LIBOR plus 115 basis points (Variable Rate Notes) (together, the Notes). The Notes mature on February 17, 2008. In October 2003, ARCap REIT sold 10 CMBS securities to ARCap Resecuritization, which in turn contributed the 10 CMBS securities to the Trust. ARCap Resecuritization then created a new trust, 2003-ABC3 Trust, for the purpose of resecuritizing the Trust's pooled certificates. 2003-ABC3 Trust issued $80,000,000 of Class A Notes (the Class A Notes) bearing interest at 8.6%, and $15,000,000 of Class B Notes bearing interest at 6% (the Class B Notes) (together, the CRC3-ABC3 Notes). The CRC3-ABC3 Notes, which mature on February 22, 2008, were then distributed to ARCap REIT through ARCap Resecuritization. On October 9, 2003, ARCap REIT sold $30,000,000 of the Class A Notes and used the net proceeds to settle approximately $29,000,000 of repurchase agreements. ARCap REIT has retained the balances of the Class A Notes and the Class B Notes. The Notes and the CRC3-ABC3 Notes are secured by the investment securities of the Company with a carrying value of approximately $382,000,000 at December 31, 2003. Interest on the Notes and the CRC3-ABC3 Notes is paid monthly. Interest expense on the Notes and the CRC3-ABC3 Notes was approximately $17,900,000 for the year ended December 31, 2003, and the related accrued interest payable was approximately $695,000. The Company capitalized approximately $5,668,000 of deferred borrowing costs related to the issuance of the Notes. The deferred borrowing costs are being amortized using the effective-interest method over the life of the debt, which is seven years (through February 22, 2008). The Company amortized approximately $734,000 of deferred costs for the year ended December 31, 2003. Total accumulated amortization of deferred borrowing costs at December 31, 2003, was approximately $1,948,000. The Company capitalized approximately $871,000 of deferred borrowing costs related to the creation of the 2003-ABC3 Trust. The deferred borrowing costs are being amortized using the effective-interest method over the life of the debt through February 22, 2008. The Company amortized approximately $31,000 of deferred borrowing costs for the year ended December 31, 2003. In conjunction with the issuance of the Variable Rate Notes, the Company entered into an interest rate cap agreement and an interest rate floor agreement with Bear Stearns (CBO Swap) to effectively fix the interest rate on its variable rate debt at 7.435%. The notional amount for the CBO Swap is $137,500,000. The agreements call for interest to be paid monthly. The Company carries the CBO Swap at its estimated fair value, with all periodic changes in estimated fair value recognized in earnings. The Company originally deposited $4,125,000 of cash to ensure its performance in the event that the CBO Swap declines in value. If the market value of the CBO Swap falls below defined thresholds, the Company may be required to deposit additional restricted cash. Amounts in excess of the minimum requirements may be withdrawn by the Company. 6. REPURCHASE AGREEMENTS The Fund REIT and the Diversified Risk Fund each entered into a credit facility with Liquid Funding, Ltd., an affiliate of Bear Stearns & Co., to finance a portion of its CMBS purchases through both short-term variable rate and long-term fixed rate repurchase agreements. 81 ARCap Investors, L.L.C. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 At December 31, 2003, the Diversified Risk Fund has short-term variable rate repurchase agreements outstanding of $5,031,000, with an interest rate of 2.154% and a maturity of 32 days. The balance was collateralized by CMBS investments with a fair value of approximately $8,962,000 at December 31, 2003. The Diversified Risk Fund has a long-term repurchase agreement outstanding at December 31, 2003 of $25,367,000, which carries a 4.135% fixed interest rate from the initial purchase date of June 2003 until final repurchase in June 2008. The balance was collateralized by CMBS investments with a fair value of approximately $36,509,000 at December 31, 2003. The Diversified Risk Fund's combined accrued interest payable under the facility at December 31, 2003 was approximately $55,000. The Fund REIT's repurchase agreements outstanding of $65,577,000 have a weighted average interest rate as of December 31, 2003 of 2.185%, and the average maturity of the agreements was 32 days. The repurchase agreements are collateralized by a portion of the Company's portfolio of CMBS investments with a fair value of approximately $102,773,000 at December 31, 2003. Accrued interest payable at December 31, 2003 was approximately $56,000. ARCap REIT entered into short-term repurchase agreements with Bear Stearns & Co. and its affiliates to finance a portion of its CMBS purchases. The weighted-average interest rate on $67,036,000 of such borrowings as of December 31, 2003, was 2.269%, and the average maturity of the agreements was 30 days. The short-term repurchase agreements are collateralized by a portion of the Company's portfolio of CMBS investments with a fair value of approximately $125,550,000 at December 31, 2003. Accrued interest payable at December 31, 2003, was approximately $68,000. 7. LOSS ON INVESTMENT SECURITIES, NET The composition of the Company's gain (loss) on investment securities, net for the year ended December 31, 2003, is as follows:
DECEMBER 31, 2003 ------------ Unrealized gain - borrowed investment securities $ 14,553,693 Unrealized gain - interest rate swap 805,831 Unrealized loss - CMBS (14,825,322) Realized loss - CMBS, net (12,346,305) Realized loss - borrowed investment securities, net (19,245,505) Realized loss - "other than temporary" losses on available-for-sale CMBS (6,597,957) ------------ Loss on investment securities, net $(37,655,565) ============
8. OPERATING LEASES The Company leases its office space and certain equipment under operating leases that expire between April 2004 and May 2008. The office leases, as amended, provide for an annual basic rental of approximately $332,000 during the initial lease term and contain an option to extend the term of one of the leases for one extension term of five years, with the basic rental being reset at the then market rate. Future minimum lease payments under these leases are as follows:
2004 $ 547,000 2005 492,000 2006 278,000 2007 66,000 2008 24,000 ---------- Total $1,407,000 ==========
Lease expense for the year ended December 31, 2003, was approximately $552,000. 9. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES At times, the Company purchases investment securities at fair value from members of the Company or their affiliates. These purchases represent transactions that are in the normal course of business of the Company and the members. During the year ended December 31, 2003, the Company purchased from such members CMBS with an approximate face of $325,177,000 at an approximate purchase price of $168,227,000. 82 ARCap Investors, L.L.C. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2003 The Company has loaned approximately $231,000 to key executives for funding of tax liabilities associated with units granted under an incentive compensation arrangement. In June 2003, approximately $32,000 of such loans was satisfied through the surrender of 1,465 Common Units to the Company. As of December 31, 2003, there is approximately $137,000 outstanding. These loans are classified as other assets in the consolidated balance sheet. The loans bear interest at a rate of 7% per annum, and payments are due quarterly on the distribution date for the Common Units. Payments are due only to the extent that the quarterly distribution is sufficient to pay them. The loans become due upon termination of the executives' employment with the Company, and recourse is limited to the Common Units securing the loans. 10. EMPLOYEE BENEFITS The Company holds a contributory defined contribution 401(k) plan that covers substantially all full-time employees. The Company matches participant contributions up to 3% of each participant's total compensation. Matching contributions totaled approximately $153,000 for the year ended December 31, 2003. The Company has a deferred compensation plan for key employees. The Board of Managers approved the availability of approximately 690,000 phantom appreciation units and 296,000 phantom grant units for awards to employees, all of which have been granted. Grant units granted each have a vesting period, which generally is ratable over a period of three years. Once vested, employees are entitled to receive additional compensation in an amount equal to the per Unit amount distributed on account of the Common Units times the number of grant units vested in the employee. The employee is entitled to this compensation regardless of whether the distribution to the holders of Common Units is an ordinary distribution or an extraordinary distribution. Thus, if the Company is sold or liquidated, the employee would be entitled to share in the proceeds of the sale or liquidation on the same basis as the holders of Common Units with respect to vested grant units. Appreciation units granted also have a vesting period, which is generally spread ratably over a three-year period. Once vested, employees begin to "earn" the right to receive compensation on account of each vested appreciation unit by being credited with an amount equal to the per Unit distributions made to holders of Common Units until the amount credited equals the Initial Value (i.e., the price at which a vested employee could obtain the appreciation unit) established by the Compensation Committee. Vested employees are entitled to compensation on account of each vested appreciation unit in an amount equal to the per Unit distributions made to holders of Common Units only after they have "earned" credits equal to the Initial Value. In the event of a liquidation or sale, employees with vested appreciation units are entitled to compensation in an amount equal to the per Unit proceeds in excess of the Initial Value plus the credits which have been earned. The Company accrues the estimated value of deferred compensation under this plan over the service period, which ends when the units are fully vested. Subsequent to the final vesting date, changes in the estimated amount of deferred compensation will be recorded as an increase or decrease to net income in the period in which such change occurs. For the year ended December 31, 2003, the Company expensed approximately $3,140,000 of deferred compensation and paid approximately $359,000 for the year ended December 31, 2003, related to the vested grant units. 11. SUBSEQUENT EVENT On January 23, 2004, the Company issued a special distribution in the amount of $1,443,000 to the Common Unit holders, along with its regular quarterly distribution. 83 EXHIBIT 99 (b) INDEPENDENT AUDITORS' REPORT The Board of Managers ARCap Investors, L.L.C. We have audited the accompanying consolidated balance sheet of ARCap Investors, L.L.C. and subsidiaries (the Company) as of December 31, 2002, and the related consolidated statements of operations, members' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ARCap Investors, L.L.C. and subsidiaries at December 31, 2002, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Dallas, Texas February 4, 2003 84 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET ASSETS
December 31, 2002 ----------------- Investment securities - trading, net (Note 3) $798,856,791 Accrued interest receivable 9,243,042 Cash and cash equivalents 4,953,388 Deferred borrowing costs, net (Note 5) 4,453,750 Restricted cash - CBO swap (Note 5) 4,325,848 Other assets 722,261 ------------ Total assets $822,555,080 ============ LIABILITIES AND MEMBERS' EQUITY Liabilities: Long-term debt (Note 5) $236,000,000 Repurchase agreements (Note 6) 155,423,000 Accrued interest payable 4,853,757 Borrowed investment securities and interest rate swap, net (Note 4) 4,487,562 CBO swap liability (Note 5) 4,125,000 Accrued expenses 208,455 ------------ Total liabilities 405,097,774 ------------ Commitments and contingencies Minority interest in consolidated entities 192,337,631 Members' equity: Series A preferred members 147,340,254 Common members 77,779,421 Total members' equity 225,119,675 ------------ Total liabilities and members' equity $822,555,080 ============
See notes to consolidated financial statements 85 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS
December 31, 2002 ----------------- Revenues: Interest income - CMBS $ 76,306,706 Other investment income 2,175,975 ------------ Total revenues 78,482,681 ------------ Expenses: Interest - long-term debt and repurchase agreements 20,527,438 Interest - borrowed investment securities and interest rate swap, net 7,287,485 Financing fee 1,180,000 Salaries and employee benefits 5,508,718 General and administrative 4,442,601 ------------ Total expenses 38,946,242 ------------ Net margin on CMBS and other investments 39,536,439 Other revenue (expense): Accretion of purchase discount 17,137,362 Loss on trading securities, net (Note 7) (11,068,375) ------------ 6,068,987 Income before minority interest 45,605,426 Minority interest (14,456,330) ------------ Net income $ 31,149,096 ============
See notes to consolidated financial statements 86 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF MEMBERS' EQUITY YEAR EMDED DECEMBER 31, 2002
Series A Common Preferred Members Members Total ------------------------------------------------ Balance at January 1, 2002 $ 78,156,400 $145,827,125 $223,983,525 Costs to raise capital of consolidated subsidiaries (386,470) (863,826) (1,250,296) Distributions (10,890,994) (17,871,656) (28,762,650) Net income 10,900,485 20,248,611 31,149,096 ------------ ------------ ------------ Balance at December 31, 2002 $ 77,779,421 $147,340,254 $225,119,675 ============ ============ ============
See notes to consolidated financial statements 87 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
December 31, 2002 ----------------- OPERATING ACTIVITIES Net income $ 31,149,096 Adjustments to reconcile net income to net cash used in operating activities: Loss on trading securities, net 11,068,375 Accretion of purchase discount (17,137,362) Amortization of deferred borrowing costs 680,930 Minority interest 14,456,330 Changes in operating assets and liabilities: Investment securities - trading, net (205,485,635) Accrued interest receivable (3,410,351) Restricted cash - CBO swap (73,117) Other assets (93,381) Accrued interest payable 1,616,725 Borrowed investment securities and interest rate swap, net (14,765,069) Accrued expenses (190,995) ------------- Net cash used in operating activities (182,184,454) ------------- FINANCING ACTIVITIES Distributions to members (28,762,650) Contributions from minority interest members 148,576,742 Distributions to minority interest members (14,093,989) Costs to raise capital (1,350,296) Proceeds from repurchase agreements 69,321,000 ------------- Net cash provided by financing activities 173,690,807 ------------- NET CHANGE IN CASH AND CASH EQUIVALENTS (8,493,647) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 13,447,035 ------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 4,953,388 ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash payments for interest on repurchase agreements and long-term debt $ 20,489,835 =============
88 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES A) Organization - ARCap Investors, L.L.C. (the Company) was incorporated in January 1999 and commenced its operations on March 17, 1999. The Company was organized to invest primarily in subordinated commercial mortgage-backed securities (CMBS). B) Principles of Consolidation - The consolidated financial statements include the accounts of: - The Company. - ARCap REIT, Inc. (ARCap REIT), a majority-owned subsidiary of the Company. - ARCAP Resecuritization Corporation (ARCap Resecuritization), a wholly owned subsidiary of ARCap REIT. ARCap Resecuritization owns all the residual interest in Commercial Resecuritization Trust 2001 ABC-2 (the Trust). - ARCap High Yield CMBS Fund, L.L.C. (the High Yield Fund), of which ARCap REIT owned an approximate 23% controlling interest as of December 31, 2002. The High Yield Fund owns approximately 60% of ARCap CMBS Fund REIT, Inc. (the Fund REIT). - ARCap Diversified Risk CMBS Fund, L.L.C. (the Diversified Risk Fund), of which ARCap REIT owned an approximate 1% controlling interest as of December 31, 2002. The Diversified Risk Fund owns approximately 40% of the Fund REIT. - ARCap Special Servicing, Inc. (Special Servicing), a taxable REIT subsidiary wholly owned by ARCap REIT. Minority interests primarily represent outside members' approximate 77% ownership in the High Yield Fund and outside members' approximate 99% ownership in the Diversified Risk Fund. The Company has consolidated the High Yield Fund and Diversified Risk Fund as it exercises control (through ARCap REIT, which acts as the Managing Member of both Funds in accordance with the terms of the respective LLC agreements) over the operations of these Funds. The Company records minority interest expense (income) that reflects the portion of the earnings (losses) of the operations which is applicable to the minority interest members. Separate books of accounts are maintained for ARCap REIT, ARCap Resecuritization, the Trust, the High Yield Fund, the Fund REIT, the Diversified Risk Fund, and Special Servicing and are reflected in the accompanying consolidated financial statements of the Company. All material intercompany transactions and account balances have been eliminated in consolidation. C) Investment Securities - The Company's investment security transactions are recorded on the trade date for existing securities and the settlement date for to-be-issued securities. CMBS are designated as trading assets since the Company is holding the securities for possible sales or other dispositions in the near term. Such securities are carried at their estimated fair value, with unrealized gains or losses included in earnings. The fair value of the Company's portfolio of CMBS is generally estimated by management based on market prices provided by certain dealers who make a market in these financial instruments. The market for the Company's CMBS may lack liquidity and have limited market volume. Accordingly, the fair values reported reflect estimates and may not necessarily be indicative of the amounts that the Company could realize in a current market exchange. The yield to maturity on the Company's CMBS depends on, among other things, the rate and timing of principal payments, the pass-through rate and interest rate fluctuations. The subordinated CMBS interests owned by the Company provide credit support to the more senior interests of the related commercial securitization. Cash flow from the mortgages underlying the CMBS interests generally is allocated first to the senior interests, with the most senior interest having a priority entitlement to cash flow. Remaining cash flow is allocated generally among the other CMBS interests in order of their relative seniority. To the extent that there are defaults and unrecoverable losses on the underlying mortgages that result in reduced cash flows, the most subordinated CMBS interest will bear this loss first. To the extent that there are losses in excess of the most subordinated interest's stated entitlement to principal and interest, then the remaining CMBS interests will bear such losses in order of their relative subordination. D) Revenue Recognition - Interest income and special servicing fees are recognized as earned. Accretion of discounts is computed using the effective-yield method over the life of the underlying assets. E) Derivative Financial Instruments - Derivative financial instruments are utilized by the Company to reduce interest rate risk. The Company utilizes interest rate swaps and cap and floor agreements as a means of hedging the potential financial statement impact of changes in the fair value of its portfolio of CMBS and variable rate long-term debt due to changes in interest rates. Risks in these contracts arise from the movements in interest rates and from the possible inability of counterparties to meet the terms of their contracts. The Company carries its derivative financial instruments at fair 89 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 value with any unrealized gain or loss included in earnings, in accordance with the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. F) Resale and Repurchase Agreements - Transactions involving purchases of securities under agreements to resell (reverse repurchase agreements or reverse repos) or sales of securities under agreements to repurchase (repurchase agreements or repos) are accounted for as collateralized financings, except where the Company does not have an agreement to sell (or purchase) the same or substantially the same securities before maturity at a fixed or determinable price. G) Cash and Cash Equivalents - Cash and cash equivalents include all highly liquid investments with original maturities when purchased of three months or less. H) Restricted Cash - Restricted cash represents amounts required to be pledged under interest rate cap and floor agreements (see Note 5). I) Deferred Borrowing Costs - Deferred borrowing costs represent costs incurred in connection with the issuance of long-term debt. Such amounts are amortized using the effective interest method over the term of the related debt (see Note 5). J) Financing Fee - The Company pays an annual rate of 0.50% of the face of its existing long-term debt to a financier to provide credit enhancement of such debt. K) Income Taxes - The Company has elected to be taxed as a partnership, whereby all income is taxed at the member level, with the exception of Special Servicing which is taxed at the entity level. ARCap REIT has elected to be taxed as a real estate investment trust for federal income tax purposes. No provision for income taxes has been made for Special Servicing for the period April 1, 2002 (inception of Special Servicing) through December 31, 2002 as Special Servicing did not generate any taxable income. L) Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect reported amounts of certain assets, liabilities, revenues, and expenses. Actual results could differ from those estimates. M) Fair Value of Financial Instruments - The estimated fair value amounts herein have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies could have a material effect on the estimated fair value amounts. The Company's portfolio of CMBS and securities borrowed is carried at their estimated fair values. The Company's management believes that the fair values of its cash and cash equivalents, restricted cash, and repurchase agreements approximate their carrying values due to the nature of the instruments or the fact that their terms approximate current market terms. NOTE 2. MEMBERS' EQUITY The Limited Liability Company Agreement (LLC Agreement) establishes two classes of membership: Series A Preferred members and Common members. Cash Flows are distributed in the following order of priority: - To the Series A Preferred members in an amount equal to the accrued and unpaid Preferred Distributions (12% per annum of the $25.00 price per Unit). - To the Common members in an amount equal to (a) during the 18-month period that ended February 4, 2002, the amount determined by the Board of Managers, but no more than a cumulative return on the Common Units at the rate of 10% per annum on an established value of $21.74 per unit, and (b) subsequent to such 18-month period, the amount determined by the Board of Managers, provided that if the amount distributable to the Common members shall exceed a cumulative annual return on the Common Units of 12% per annum, the Board of Managers shall notify the Series A Preferred members 30 days in advance of the record date for distribution of Cash Flow. 90 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 - To the extent that any remaining Cash Flow received during such tax period is not includable in the income of the Company, to members that have been allocated Net Profits in excess of amounts actually distributed to such members, in proportion to such amounts. Net Profits of the Company are allocated as follows: - To the Series A Preferred members to the extent of amounts distributed or distributable to them in such taxable year. - To the Series A Preferred members to the extent Net Losses previously allocated to such members exceed undistributed Net Profits previously allocated to them. - To the Common members to the extent of amounts distributed or distributable to them in such taxable year. - To the Common members to the extent Net Losses previously allocated to such members exceed undistributed Net Profits previously allocated to them. - To the members in proportion to their Percentage Interests. Net Losses of the Company are allocated as follows: - To the members in an amount equal to undistributed Net Profits allocated to such member. - To the Common members pro rata to the extent of their Capital Accounts. - To the Series A Preferred members pro rata to the extent of their Capital Accounts. Series A Preferred Units - ------------------------ Series A Preferred Units are convertible into Common Units at the Conversion Price in effect on the Conversion Date. If the Series A Preferred Units have not been converted within five years of the effective date of the First Amendment to the LLC Agreement (August 4, 2000), Series A Preferred Units may, at the holder's option, be converted to a note equal to $25.00 per Unit, plus accrued and unpaid Preferred Distributions. Eighteen months after the First Closing Date (February 4, 2002), but no later than the fifth anniversary of the First Closing Date (August 4, 2005), the Company may redeem the Series A Preferred Units for $25.00 per unit, plus accrued and unpaid Preferred Distributions, plus a premium that will provide the Series A Preferred members with a total pretax internal rate of return of 17.50%. In addition, upon either a change in control or sale or transfer of all or substantially all of the assets of the Company, Series A Preferred Units may, at the holder's option, be redeemed at $25.00 per unit, plus accrued and unpaid Preferred Distributions. At December 31, 2002, there were a total of 6,000,000 Series A Preferred Units and 4,999,382 Common Units issued and outstanding. The LLC Agreement contains certain restrictive covenants regarding the amount of variable rate debt, total debt, and certain financial ratios. Failure to meet the covenants in successive quarters can result in the Chief Executive Officer and Chief Operating Officer being removed from the Board of Managers until such time as the covenants are cured for successive quarters. Management believes that the Company has not violated the covenants in successive quarters. 91 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 NOTE 3. INVESTMENT SECURITIES The Company's trading securities are carried at estimated fair value and are comprised of the following at December 31, 2002:
Face Cost Fair Value Percentage ---------------------------------------------------------- Subordinated CMBS: Security rating: BB+ $ 115,923,711 $ 91,176,800 $103,776,027 12.99% BB 170,077,178 127,903,052 141,264,695 17.68% BB- 134,295,076 90,149,121 99,793,698 12.49% B+ 215,067,722 127,005,619 137,774,880 17.25% B 264,721,814 151,661,428 144,486,471 18.09% B- 161,254,347 79,612,839 70,601,239 8.84% NR 420,501,779 110,757,808 101,159,781 12.66% --------------- ------------- ------------ ------- $ 1,481,841,627 $ 778,266,667 $798,856,791 100.00% =============== ============= ============ =======
The Company accretes purchase discounts using the effective yield method over the life of the CMBS. The accumulated accretion of purchase discounts at December 31, 2002, was approximately $30,627,000. The gross cumulative unrealized gains and losses on the Company's trading investment securities at December 31, 2002, were approximately $41,709,000 and ($51,746,000), respectively. NOTE 4. BORROWED INVESTMENT SECURITIES AND INTEREST RATE SWAP, NET The Company's borrowed investment securities and interest rate swap are carried at estimated fair value and are comprised of the following at December 31, 2002:
Security Coupon Cost Fair Unrealized Description Rate Face Basis Value Gain (Loss) - ------------------------------------------------------------------------------------------------------ U.S. Treasury (08-15-09) 6.000% $ (11,239,000) $ (10,974,728) $( 13,072,362) $ (2,097,634) U.S. Treasury (02-15-11) 5.000% (17,818,000) (17,523,195) (19,591,448) (2,068,253) U.S. Treasury (08-15-11) 5.000% (136,603,000) (138,334,790) (149,900,450) (11,565,660) U.S. Treasury (02-15-12) 4.875% (85,300,000) (91,513,064) (92,697,111) (1,184,047) U.S. Treasury (11-15-12) 4.000% (20,468,000) (20,336,877) (20,775,020) (438,143) -------------- -------------- -------------- ------------ $(271,428,000) $( 278,682,654) (296,036,391) $(17,353,737) ============== =============== ============= Reverse repurchase agreements 295,618,149 ------------- Borrowed investment securities, net (418,242) Interest rate swap (4,069,320) ------------- Borrowed investment securities and interest rate swap, net $ (4,487,562) ==============
The borrowed U.S. Treasury securities were sold in the open market (i.e., a "short" security sale). The Company is obligated to return the securities in the future and is therefore exposed to price risk until it repurchases the securities for delivery to the lender. Short security sales are used by the Company to modify its interest rate risk. The Company must pay the security lender the interest earned by the underlying security. Short security sales are recorded at the estimated fair value of the borrowed securities, and any unrealized gains (losses) are included in earnings. Proceeds from short security sales are used to purchase reverse repurchase agreements of the same security. The transactions are governed by one master repurchase agreement with rights of offset and, therefore, the values of the short security sales and reverse repurchase agreements have been offset and shown as one line item in the accompanying consolidated financial statements. It has been the Company's practice to settle these transactions on a net basis. At December 31, 2002, the Company pledged CMBS valued at approximately $10,363,000 as additional collateral against the borrowed investment securities outstanding as of December 31, 2002. 92 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 The Company entered into an interest rate swap agreement with Bear Stearns Capital Markets (Bear Stearns) with a notional amount at December 31, 2002, of $27,000,000, on which the Company pays a fixed rate of 6.015% and receives a variable rate based upon a six-month LIBOR for a term of 10 years ending April 27, 2011. The swap agreement calls for interest to be paid semiannually in arrears. The Company carries the swap agreement at its estimated fair value, with all periodic changes in estimated fair value recognized in earnings. The Company was required under the swap agreement to pledge collateral valued at 1% of the notional amount of the swap to ensure its performance in the event that the swap declines in value. At December 31, 2002, the Company pledged CMBS valued at approximately $14,611,000 as additional collateral against the interest rate swap outstanding as of December 31, 2002. NOTE 5. LONG-TERM DEBT During fiscal year 2001, the Company entered into an agreement to sell its interests in 50 CMBS pass-through certificates (the Pooled Certificates) to its subsidiary, the Trust. The Trust resecuritized the Pooled Certificates and offered $98,500,000 Class A-1 Senior Notes with a fixed coupon rate of 7.17% (Fixed Rate Notes) and $137,500,000 Class A-2 Senior Notes with a variable coupon rate based on one-month LIBOR plus 115 basis points (Variable Rate Notes) (together, the Notes). The Notes are secured by the investment securities of the Company with a carrying value of approximately $345,512,000 at December 31, 2002. The Company capitalized $5,667,580 of deferred borrowing costs related to the issuance of the Notes. The deferred borrowing costs are being amortized, using the effective-interest method, over the life of the debt, which is seven years (through February 22, 2008). The Company amortized $680,930 of deferred costs for the year ended December 31, 2002. Total accumulated amortization of deferred borrowing costs at December 31, 2002, was $1,213,830. In conjunction with the issuance of the Variable Rate Notes, the Company entered into an interest rate cap agreement and an interest rate floor agreement with Bear Stearns (CBO Swap) to effectively fix the interest rate on its variable rate debt at 7.435%. The notional amount for the CBO Swap is $137,500,000. The agreements call for interest to be paid monthly. The Company carries the CBO Swap at its estimated fair value, with all periodic changes in estimated fair value recognized in earnings. The Company originally deposited $4,125,000 of cash to ensure its performance in the event that the CBO Swap declines in value. If the market value of the CBO Swap falls below defined thresholds, the Company may be required to deposit additional restricted cash. Amounts in excess of the minimum requirements may be withdrawn by the Company. Interest on the Notes is paid monthly. Interest expense on the Notes was approximately $17,238,000 for the year ended December 31, 2002, and the related accrued interest payable at December 31, 2002, was approximately $480,000. NOTE 6. REPURCHASE AGREEMENTS The Company entered into repurchase agreements to finance a portion of its CMBS purchases. The weighted-average interest rate as of December 31, 2002, was 2.73%, and the average maturity of the agreements was 30 days. The repurchase agreements are collateralized by a portion of the Company's portfolio of CMBS investments with a fair value of approximately $284,943,000 at December 31, 2002. Accrued interest payable at December 31, 2002, was approximately $209,000. NOTE 7. LOSS ON TRADING SECURITIES, NET The composition of the Company's gain (loss) on trading securities, net for the year ended December 31, 2002, is as follows:
Unrealized loss - borrowed investment securities $(17,594,455) Unrealized loss - interest rate swap (3,395,007) Unrealized loss - CBO Swap (1,408,400) Unrealized gain - CMBS 12,443,165 Realized loss - CMBS (1,086,698) Realized loss - borrowed investment securities (26,980) ------------- Loss on trading securities, net $(11,068,375) =============
93 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 NOTE 8. OPERATING LEASES The Company leases its office space and certain equipment under operating leases that expire between April 2004 and January 2007. The office lease, as amended, provides for an annual basic rental of $206,244 during the initial lease term and contains an option to extend the term of the lease for one extension term of five years, with the basic rental being reset at the then market rate. Future minimum lease payments under these leases are as follows:
2003 $313,851 2004 243,455 2005 207,384 2006 206,244 2007 17,187 -------- Total $988,121 ========
Lease expense for the year ended December 31, 2002 was approximately $316,000. NOTE 9. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES At times, the Company purchases investment securities from members of the Company or their affiliates. These purchases represent transactions that are in the normal course of business of the Company and the members. During the year ended December 31, 2002, the Company purchased from such members CMBS with an approximate face of $387,327,000 at an approximate purchase price of $210,382,000. The Company has loaned approximately $231,000 to key executives for funding of tax liabilities associated with units granted under an incentive compensation arrangement. As of December 31, 2002, there is approximately $190,000 outstanding. These loans are classified as other assets in the consolidated balance sheet. The loans bear interest at a rate of 7% per annum, and payments are due quarterly on the distribution date for the Common Units. Payments are due only to the extent that the quarterly distribution is sufficient to pay them. The loans become due upon termination of the executives' employment with the Company, and recourse is limited to the Common Units securing the loans. Under a fee arrangement, ARCap REIT paid C.P. Eaton & Associates, Inc. a monthly retainer fee and an incentive fee to assist ARCap REIT in raising capital for fund operations with respect to which ARCap REIT acts as the Managing Member. The total costs incurred under this fee arrangement are allocated proportionately (based on total dollars raised) to all funds for which capital dollars are raised. NOTE 10. EMPLOYEE BENEFITS The Company holds a contributory defined contribution 401(k) plan that covers substantially all full-time employees. The Company matches participant contributions up to 3% of each participant's total compensation. Matching contributions totaled approximately $75,000 for the year ended December 31, 2002. The Company has a deferred compensation plan for key employees. The Board of Managers approved the availability of approximately 690,000 phantom appreciation units and 296,000 phantom grant units for future awards to employees. In order to grant these awards, the Compensation Committee must recommend that they be granted, and the Compensation Committee's recommendation must be approved by the Board of Managers. As of December 31, 2002, the Company has granted approximately 551,000 and 193,000 appreciation units and grant units, respectively. The Board of Managers approved the Compensation Committee's recommendations to grant additional appreciation units and grant units of approximately 138,000 and 95,000, respectively, effective January 1, 2003. Grant units granted each have a vesting period, which generally is ratable over a period of three years. Once vested, employees are entitled to receive a bonus in an amount equal to the per Unit amount distributed on account of the Common Units times the number of grant units vested in the employee. The employee is entitled to this compensation regardless of whether the distribution to the holders of Common Units is an ordinary distribution or an extraordinary distribution. Thus, if the Company is sold or liquidated, the employee would be entitled to share in the proceeds of the sale or liquidation on the same basis as the holders of Common Units with respect to vested grant units. Appreciation units granted also have a vesting period which is generally spread ratably over a three year period. Once vested, employees begin to "earn" the right to receive compensation on account of each vested appreciation unit by being credited with an amount equal to the per Unit distributions made to holders of Common Units until the amount credited equals the Initial Value (i.e. the price at which a vested employee could obtain the appreciation unit) established by the Compensation Committee. Vested employees are entitled to compensation on account of each vested appreciation unit in an amount equal to the per Unit distributions made to holders of Common Units only after they have "earned" credits equal to the Initial Value. In the event of a liquidation or 94 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2002 sale, employees with vested appreciation units are entitled to compensation in an amount equal to the per Unit proceeds in excess of the Initial Value plus the credits which have been earned. The amount actually received by employees on account of the vested grant and appreciation units is compensation. For the year ended December 31, 2002, the Company expensed approximately $157,000 relating to compensation paid on account of vested grant units. 95 Exhibit 99 (c) INDEPENDENT AUDITORS' REPORT To the Members of ARCap Investors, L.L.C.: We have audited the accompanying consolidated balance sheet of ARCap Investors, L.L.C. and subsidiaries (the "Company") as of December 31, 2001, and the related consolidated statements of income, members' equity and cash flows for each of the two years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of ARCap Investors, L.L.C. and subsidiaries as of December 31, 2001, and the results of their operations and their cash flows for each of the two years ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP Dallas, Texas January 31, 2002 96 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET ASSETS
December 31, 2001 ----------------- Investment securities - trading (Notes 3 and 5) $ 564,877,324 Borrowed investment securities and interest rate swap, net (Note 4) 1,763,811 Cash and cash equivalents 13,447,035 Restricted cash - CBO swap (Note 5) 4,252,731 Accrued interest receivable 5,832,691 Deferred borrowing costs, net (Note 5) 5,134,680 Other assets 628,880 ------------- Total $ 595,937,152 ============= LIABILITIES AND MEMBERS' EQUITY Liabilities: Long-term debt (Note 5) $ 236,000,000 Repurchase agreements (Note 6) 86,102,000 CBO swap liability (Note 5) 2,716,600 Accrued interest payable 3,237,032 Accrued expenses 499,447 ------------- Total liabilities 328,555,079 ------------- Commitments and contingencies Minority Interests in consolidated entities 43,398,548 Members' equity 223,983,525 ------------- Total $ 595,937,152 =============
See notes to consolidated financial statements. 97 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME
December 31, 2001 ----------------- Revenues: Interest income - CMBS $ 51,730,450 Accretion of purchase discount 10,172,033 Other investment income 882,160 Gain on sale of real estate 224,482 ------------- Total revenues 63,009,125 ------------- Expenses: Loss on trading securities, net (Note 7) 24,281,841 Interest - long-term debt and repurchase agreements 17,151,723 Interest - borrowed investment securities and interest rate swap, net 2,079,629 Financing fee 1,015,054 General and administrative 3,616,430 Salaries and employee benefits 3,286,376 ------------- Total expenses 51,431,053 ------------- Income before minority interests 11,578,072 Minority interests 1,781,987 ------------- Net income $ 13,360,059 =============
See notes to consolidated financial statements. 98 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF MEMBERS' EQUITY YEAR ENDED DECEMBER 31, 2001
---------------------------------------------------------------- Accumulated Series A Other Common Preferred Comprehensive Members Members Income Total ---------------------------------------------------------------- Balance, January 1, 2001 $ 88,219,621 $ 85,703,753 $ 3,103,845 $ 177,027,219 Proceeds from issuance of membership units -- 61,743,525 -- 61,743,525 Costs to raise capital (71,856) (1,620,153) -- (1,692,009) Distributions (10,873,542) (12,462,367) -- (23,335,909) Repurchase of members' equity (Note 9) (15,515) -- -- (15,515) Net income 897,692 12,462,367 -- 13,360,059 Transfer of available for sale to trading securities (Note 3) -- -- (3,103,845) (3,103,845) ------------- ------------- ------------- ------------- Balance, December 31, 2001 $ 78,156,400 $ 145,827,125 $ -- $ 223,983,525 ============= ============= ============= =============
See notes to consolidated financial statements. 99 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
December 31, 2001 ----------------- OPERATING ACTIVITIES: Net income $ 13,360,059 Adjustments to reconcile net income to net cash used in operating activities: Loss on trading securities, net 24,281,841 Accretion of purchase discount (10,172,033) Gain on sale of real estate (224,482) Amortization of deferred borrowing costs 532,900 Minority interest (1,781,987) Increase (decrease) in cash for changes in operating assets and liabilities: Restricted cash (3,569,211) Investment securities - trading, net (292,096,310) Securities purchased under agreement to resell and proceeds rom borrowed security, net (5,028,069) Accrued interest receivable (2,667,514) Other assets (5,944,087) Accrued expenses (47,259) Accrued interest payable 33,600 Receivable for sold security 13,372,667 ------------- Net cash used in operating activities (269,949,885) ------------- INVESTING ACTIVITIES - Proceeds from sale of real estate and net cash provided by investing activities 224,482 ------------- FINANCING ACTIVITIES: Contributions from members 61,743,525 Distributions to members (23,335,909) Contributions from minority interest members 45,355,985 Distributions to minority interest members (2,721) Repurchase of members' equity (15,515) Payment of issuance costs (1,692,009) Payment of issuance costs by minority interest members (174,950) Proceeds from issuance of long-term debt 236,000,000 Payment of repurchase agreements (37,381,443) ------------- Net cash provided by financing activities 280,496,963 ------------- NET INCREASE IN CASH AND CASH EQUIVALENTS 10,771,560 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 2,675,475 ------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 13,447,035 ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION - Cash payments for interest $ 16,816,163 ============= SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES - Transfer of securities from available for sale to trading $ 76,092,175 =============
See notes to consolidated financial statements. 100 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2001 NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES A) Organization - ARCap Investors, L.L.C. (the "Company") was incorporated in January 1999 and commenced its operations on March 17, 1999. The Company was organized to invest primarily in subordinated commercial mortgage-backed securities ("CMBS"). B) Principles of Consolidation - The consolidated financial statements include the accounts of: - The Company; - ARCap REIT, Inc., its majority-owned subsidiary; - ARCap Resecuritization Corporation ("ARCap Resecuritization"), a wholly owned subsidiary of ARCap REIT, Inc.; - Commercial Resecuritization Trust 2001 ABC-2 (the "Trust"), in which ARCap Resecuritization owns all of the residual interest; and - ARCap High Yield CMBS Fund, L.L.C. (the "Fund"), of which ARCap REIT, Inc. owned approximately 48% as of December 31, 2001. The Fund is the majority-owner of ARCap CMBS Fund REIT, Inc. (the "Fund REIT"). Minority interests primarily represent outside members' approximate 52% ownership in the Fund. The Company has consolidated this entity as it exercises control (through ARCap REIT, Inc.) over the operations of the Fund REIT (subject to provisions of the Fund Limited Liability Company Agreement). The Company records minority interest income (expense) that reflects the portion of the earnings (losses) of the operations which are applicable to the minority interest members. Separate books of accounts are maintained for ARCap REIT, Inc.; ARCap Resecuritization; the Trust; the Fund; and the Fund REIT and are reflected in the accompanying consolidated financial statements of the Company. All material intercompany transactions and account balances have been eliminated in consolidation. C) Investment Securities - The Company's investment security transactions are recorded on the trade date. CMBS are designated as trading assets since the Company is holding the securities for possible sales or other dispositions in the near term. Such securities are carried at their estimated fair value, with unrealized gains or losses included in earnings. Interest income is recognized as earned and includes amortization of premiums and accretion of discounts, computed using the effective yield method over the expected life of the underlying assets. D) Derivative Financial Instruments - Derivative financial instruments are utilized by the Company to reduce interest rate risk. The Company utilizes interest rate swap, cap and floor agreements as a means of hedging the potential financial statement impact of changes in the fair value of its portfolio of CMBS and variable rate long-term debt due to changes in interest rates. Risks in these contracts arise from the movements in interest rates and from the possible inability of counterparties to meet the terms of their contracts. The Company carries its derivative financial instruments at fair value with any unrealized gain or loss included in earnings. E) Resale and Repurchase Agreements and Securities Lending Agreements - Transactions involving purchases of securities under agreements to resell (reverse repurchase agreements or reverse repos) or sales of securities under agreements to repurchase (repurchase agreements or repos) are accounted for as collateralized financings, except where the Company does not have an agreement to sell (or purchase) the same or substantially the same securities before maturity at a fixed or determinable price. F) Cash and Cash Equivalents - Cash and cash equivalents include all highly liquid investments with original maturities of three Months or less. G) Restricted Cash - Restricted cash represents amounts required to be pledged under an interest rate swap agreement and amounts required to be pledged under the interest rate cap and floor agreements (see Notes 4 and 5). H) Deferred Borrowing Costs - Deferred borrowing costs represent costs incurred in connection with the issuance of long-term debt. Such amounts are amortized using the effective interest method over the term of the related debt (see Note 5). I) Financing Fee - The Company pays an annual rate of 0.50% of the face of its existing long-term debt to a financier to provide credit enhancement of such debt. J) Income Taxes - The Company has elected to be taxed as a partnership, whereby all income is taxed at the member level. K) Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of certain assets, liabilities, revenues and expenses. Actual results could differ from those estimates. L) Fair Value of Financial Instruments - The estimated fair value amounts herein have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required 101 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2001 to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies could have a material effect on the estimated fair value amounts. The Company's portfolio of CMBS and securities borrowed are carried at their estimated fair values. The Company's management believes that the fair values of its cash and cash equivalents, restricted cash and repurchase agreements approximate their carrying values due to the nature of the instruments or the fact that their terms approximate current market terms. M) Change in Accounting Standard - Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, was adopted by the Company on January 1, 2001. This standard requires that all derivative financial instruments be recognized as either assets or liabilities on the balance sheet at their fair values and that accounting for the changes in fair values is dependent upon the intended use of the derivatives and their resulting designations. The adoption of this standard did not have a material effect on the Company's consolidated financial statements. N) New Accounting Standards - In September 2000, the Financial Accounting Standards Board ("FASB") issued SFAS No. 140, ("SFAS 140") Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 140 replaces SFAS No. 125 ("SFAS 125") Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS 125's provisions without reconsideration. The statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The Company has made the required disclosures relating to securitization transactions and collateral for the year ended December 31, 2000. The Company adopted the remaining requirements of SFAS 140 on April 1, 2001, as required. During 1999, the FASB issued Emerging Issues Task Force ("EITF") No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets. Effective the second quarter of 2001, EITF No. 99-20 provides guidance on the recognition of interest income from, and measurement of retained beneficial interests. The implementation of EITF No. 99-20 did not have a material effect on the Company's consolidated financial statements. O) Reclassifications - Certain reclassifications have been made to the prior-year amounts to conform to the current-year presentation. NOTE 2. MEMBERS' EQUITY On August 4, 2000, the Company amended and restated its Limited Liability Company Agreement (the "LLC Agreement"). Capitalized terms in this footnote are defined in the LLC Agreement. The LLC Agreement established two classes of membership: Series A Preferred members and Common members. The LLC Agreement calls for distributions of Cash Flows as follows: - - To the Series A Preferred members in an amount equal to the accrued and unpaid Preferred Distributions (12% per annum of the $25.00 price per Unit). - - To the Common members in an amount equal to (a) during the 18-month period that ends February 4, 2002, the amount determined by the Board of Managers, but no more than a cumulative return on the Common Units at the rate of 10% per annum, and (b) subsequent to such 18-month period, the amount determined by the Board of Managers, provided that if the amount distributable to the Common members shall exceed a cumulative annual return on the Common Units of 12% per annum, the Board of Managers shall notify the Series A Preferred members 30 days in advance of the record date for distribution of Cash Flow. - - To the extent that any remaining Cash Flow received during such tax period is not includable in the income of the Company, to members that have been allocated Net Profits in excess of amounts actually distributed to such members, in proportion to such amounts. Net Profits of the Company are allocated as follows: - - To the Series A Preferred members to the extent of amounts distributed or distributable to them in such taxable year. - - To the Series A Preferred members to the extent Net Losses previously allocated to such members exceed undistributed Net Profits previously allocated to them. - - To the Common members to the extent of amounts distributed or distributable to them in such taxable year. 102 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2001 - - To the Common members to the extent Net Losses previously allocated to such members exceed undistributed Net Profits previously allocated to them. - - To the members in proportion to their Percentage Interests. Net Losses of the Company are allocated as follows: - - To the members in an amount equal to undistributed Net Profits allocated to such member. - - To the Common members pro rata to the extent of their Capital Accounts. - - To the Series A Preferred members pro rata to the extent of their Capital Accounts. Series A Preferred Units - ------------------------ Series A Preferred Units are convertible into Common Units at the Conversion Price in effect on the Conversion Date. If the Series A Preferred Units have not been converted within five years of August 4, 2000, Series A Preferred Units may, at the holder's option, be converted to a note equal to $25.00 per Unit, plus accrued and unpaid Preferred Distributions. Eighteen months after the First Closing Date (February 4, 2002), but no later than the fifth anniversary of the First Closing Date (August 4, 2005), the Company may redeem the Series A Preferred Units for $25.00 per unit, plus accrued and unpaid Preferred Distributions, plus a premium that will provide the Series A Preferred members with a total pretax internal rate of return of 17.50%. In addition, upon either a change in control or sale or transfer of all or substantially all of the assets of the Company, Series A Preferred Units may, at the holder's option, be redeemed at $25.00 per unit, plus accrued and unpaid Preferred Distributions. Subsequent to the Company's amendment and restatement of its LLC Agreement, the Company circulated an amended Private Placement Memorandum (the "PPM") for 5,739,741 units of Series A Preferred Membership Interests representing the balance of such interests available for subscription in the Company's offering. As of December 31, 2001, 5,739,741 units have been issued pursuant to the Company's offering for total capital contributions of $143,493,525. At December 31, 2001, there were a total of 6,000,000 and 4,999,382 Series A Preferred Units and Common Units, respectively, issued and outstanding. NOTE 3. INVESTMENT SECURITIES The Company's trading securities are carried at estimated fair value and comprise the following at December 31, 2001:
Face Cost Fair Value Percentage -------------- -------------- -------------- ---------- Subordinated CMBS: Security rating: BB+ $ 70,399,711 $ 54,261,102 $ 55,566,874 9.84% BB 88,938,033 65,393,924 66,145,766 11.71 BB- 99,764,931 67,278,474 67,543,265 11.96 B+ 172,749,308 102,104,976 100,908,791 17.86 B 219,851,296 129,013,634 124,843,334 22.10 B- 141,994,347 71,886,492 66,223,972 11.72 NR 339,813,225 83,926,063 83,645,322 14.81 -------------- -------------- -------------- ---------- $1,133,510,851 $ 573,864,665 $ 564,877,324 100.00% ============== ============== ============== ==========
The fair value of the Company's portfolio of CMBS is generally estimated by management based on market prices provided by certain dealers who make a market in these financial instruments. The market for the Company's CMBS may lack liquidity and have limited market volume. Accordingly, the fair values reported reflect estimates and may not necessarily be indicative of the amounts that the Company could realize in a current market exchange. The Company accretes purchase discounts using the effective yield method over the life of the CMBS. The accumulated accretion of purchase discounts at December 31, 2001, was approximately $13,491,000. The yield to maturity on the Company's CMBS depends on, among other things, the rate and timing of principal payments, the pass-through rate and interest rate fluctuations. The subordinated CMBS interests owned by the Company provide credit support to the more senior interests of the related commercial securitization. Cash flow from the mortgages underlying the CMBS interests generally is allocated first to the senior interests, with the most senior 103 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2001 interest having a priority entitlement to cash flow. Remaining cash flow is allocated generally among the other CMBS interests in order of their relative seniority. To the extent that there are defaults and unrecoverable losses on the underlying mortgages that result in reduced cash flows, the most subordinated CMBS interest will bear this loss first. To the extent that there are losses in excess of the most subordinated interest's stated entitlement to principal and interest, then the remaining CMBS interests will bear such losses in order of their relative subordination. The gross cumulative unrealized gains and losses on the Company's trading investment securities at December 31, 2001, were approximately $6,900,000 and $29,378,000, respectively. On January 1, 2001, the Company transferred all of its available for sale CMBS to the trading category. This resulted in the reclassification of the related $3,103,845 unrealized gain in accumulated other comprehensive income to loss on trading securities, net in the accompanying statement of income. NOTE 4. BORROWED INVESTMENT SECURITIES AND INTEREST RATE SWAP, NET The Company's borrowed investment securities and interest rate swap are carried at estimated fair value and are comprised of the following at December 31, 2001:
Security Coupon Cost Fair Unrealized Description Rate Face Basis Value Gain (Loss) - ------------------------ ------ ------------- ------------- ------------ ------------ U.S. Treasury (08-15-09) 6.000% $ 11,239,000 $ 10,974,728 $ 11,981,828 $ (1,007,100) U.S. Treasury (02-15-11) 5.000 17,818,000 17,523,195 17,765,103 (241,908) U.S. Treasury (08-15-11) 5.000 97,378,000 98,609,087 97,119,363 1,489,724 ------------- ------------- ------------ ------------ $ 126,435,000 $ 127,107,010 126,866,294 $ 240,716 ============= ============= ============ Reverse repurchase agreements 129,304,395 ------------ Borrowed investment securities, net 2,438,101 Interest rate swap (674,290) ------------- Borrowed investment securities and interest rate swap, net $ 1,763,811 =============
As of December 31, 2001, the Company had borrowed agency and U.S. Treasury securities with face amounts totaling $126,435,000. The fair value of these borrowed agency and U.S. Treasury securities at December 31, 2001, was $126,866,294. The U.S. Treasury securities were sold in the open market (i.e., a "short" security sale). The Company is obligated to return the securities in the future and is therefore exposed to price risk until it repurchases the securities for delivery to the lender. Short security sales are used by the Company to modify its interest rate risk. The Company must pay the security lender the interest earned by the underlying security. Short security sales are recorded at the estimated fair value of the borrowed securities, and any unrealized gains (losses) are included in earnings. The cumulative unrealized loss on the short securities at December 31, 2001, was $240,716, which is included in borrowed investment securities and interest rate swap, net, in the accompanying consolidated financial statements. Proceeds from short security sales are used to purchase reverse repurchase agreements of the same security. The transactions are governed by one master repurchase agreement with rights of offset, and therefore, the values of the short security sales and reverse repurchase agreements have been offset and shown as one line item in the accompanying consolidated financial statements. It has been the Company's practice to settle these transactions on a net basis. In April 2001, the Company entered into an interest rate swap agreement with Bear Stearns Capital Markets ("Bear Stearns") with a notional amount of $30,956,000, on which the Company pays a fixed rate of 6.015% and receives a variable rate based upon a six-month LIBOR for a term of 10 years ending April 27, 2011. In December 2001, the Company terminated $3,956,000 of the original notional amount, which resulted in a realized loss of approximately $82,000. The swap agreement with Bear Stearns has a notional amount of $27,000,000 at December 31, 2001. The swap agreement calls for interest to be paid semiannually in arrears. The Company carries the swap agreement at its estimated fair value, with all periodic changes in estimated fair value recognized in earnings. The Company was required under the swap agreement to pledge collateral valued at 1% of the notional amount of the swap to ensure its performance in the event that the swap declines in value. At December 31, 2001, the Company pledged CMBS valued at approximately $1,107,000. The fair value and cumulative unrealized loss on this interest rate swap agreement at December 31, 2001, was $674,290, which is included in borrowed investment securities and interest rate swap, net, in the accompanying consolidated financial statements. In February 2001, the Company terminated an interest rate swap agreement with Bear Stearns with a notional amount of $31,321,000, on which the Company paid a fixed rate of 5.952% and received a variable rate based upon a six-month LIBOR for a term of 10 years ending April 9, 2009. The termination resulted in a realized loss of approximately $145,000. 104 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2001 NOTE 5. LONG-TERM DEBT On February 22, 2001, the Company entered into an agreement to sell its interests in 50 CMBS passthrough certificates (the "Pooled Certificates") to its subsidiary, the Trust. The Trust resecuritized the Pooled Certificates and offered $98,500,000 Class A-1 Senior Notes with a fixed coupon rate of 7.17% ("Fixed Rate Notes") and $137,500,000 Class A-2 Senior Notes with a variable coupon rate based on one-month LIBOR plus 115 basis points ("Variable Rate Notes") (together, the "Notes"). The Notes are secured by the investment securities of the Company with a carrying value of approximately $349,855,000 at December 31, 2001. The Company capitalized $5,667,580 of deferred borrowing costs related to the issuance of the Notes. The deferred borrowing costs are being amortized, using the effective interest method, over the life of the debt, which is seven years (through February 22, 2008). The Company amortized $532,900 of deferred costs in year ended December 31, 2001. In conjunction with the issuance of the Variable Rate Notes, the Company entered into an interest rate cap agreement and an interest rate floor agreement with Bear Stearns ("CBO Swap") to effectively fix the interest on its variable rate debt. The notional amount for the CBO Swap is $137,500,000. With the interest rate cap, the Company receives a variable rate based on one-month LIBOR plus 115 basis points if it is greater than 7.435%. With the interest rate floor, the Company pays a variable rate based on one month LIBOR plus 115 basis points if it is less than 7.435%. The agreements call for interest to be paid monthly. The Company carries the CBO Swap at its estimated fair value, with all periodic changes in estimated fair value recognized in earnings. The Company deposited $4,125,000 of cash to ensure its performance in the event that the CBO Swap declines in value. If the market value of the CBO Swap falls below defined thresholds, the Company may be required to deposit additional restricted cash. Amounts in excess of the minimum requirements may be withdrawn by the Company. Interest on the Notes is to be paid monthly. Interest expense on the Notes was approximately $14,550,000 for the year ended December 31, 2001, and the related accrued interest payable at December 31, 2001, was approximately $528,000. The LLC Agreement contains certain restrictive covenants regarding the amount of variable rate debt, total debt, and certain financial ratios. Management believes that the Company is in compliance with such covenants. NOTE 6. REPURCHASE AGREEMENTS The Company has entered into repurchase agreements to finance a portion of its CMBS purchases. As of December 31, 2001, the Company had entered into repurchase obligations in the amount of $86,102,000. The weighted average maturity of the agreements as of December 31, 2001, was 32 days, and the weighted average interest rate was 3.90%. The repurchase agreements are collateralized by a portion of the Company's portfolio of CMBS investments with a fair value of approximately $206,700,000 at December 31, 2001. Interest expense on the repurchase agreements was approximately $2,599,000 for the year ended December 31, 2001, and the related accrued interest payable at December 31, 2001, was approximately $124,000. NOTE 7. LOSS ON TRADING SECURITIES, NET The composition of the Company's gain (loss) on trading securities, net for the year ended December 31, 2001, follows:
Realized gain - borrowed investment security $ 2,965,698 Realized loss - borrowed investment security (719,668) Realized loss - interest rate swap (227,240) Realized gain - CMBS sold 1,683,516 Realized loss - CMBS sold (1,238,190) Unrealized gain - borrowed investment security 1,124,884 Unrealized loss - interest rate swap (674,290) Unrealized loss - CBO Swap (2,716,600) Unrealized loss - CMBS (27,583,796) Unrealized gain - CMBS, transferred from other comprehensive income 3,103,845 $ (24,281,841)
105 ARCap INVESTORS, L.L.C. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2001 NOTE 8. OPERATING LEASES The Company leases its office space and certain equipment under operating leases that expire between October 2002 and December 2005. The office lease provides for an annual basic rental of $180,504 during the initial lease term and contains an option to extend the term of the lease for one extension term of five years, with the basic rental being reset at the then market rate. Future minimum lease payments under these leases are as follows:
Year ending December 31: 2002 $ 280,977 2003 270,568 2004 199,958 2005 166,602
Lease expense for the year ended December 31, 2001, was approximately $273,000. NOTE 9. TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES At times, the Company purchases investment securities from members of the Company or their affiliates. These purchases and sales represent transactions that are in the normal course of business of the Company and the members. During the year ended December 31, 2001, the Company purchased from such members CMBS with face values totaling approximately $457,200,000 for a purchase price of approximately $229,300,000 and sold CMBS to such members with face values totaling approximately $58,400,000 for proceeds of approximately $25,000,000. The Company has loaned approximately $310,000 to key executives for funding of tax liabilities associated with units granted under an incentive compensation arrangement. As of December 31, 2001, there is approximately $214,000 outstanding, with approximately $77,000 satisfied through the transfer of 3,567 Common Units to the Company and approximately $19,000 repaid by the employees. During the year ended December 31, 2001, the Company purchased 5,343 common units from a key executive for approximately $116,000. The key executive had members' equity of $15,515 at the date of repurchase. These loans are classified as other assets in the consolidated balance sheet. The loans bear interest at a rate of 7% per annum, and payments are due quarterly on the distribution date for the Common Units. Payments are due only to the extent that the quarterly distribution is sufficient to pay them. The loans become due upon termination of the executives' employment with the Company, and recourse is limited to the Common Units securing the loans. NOTE 10. EMPLOYEE BENEFITS During 2001, the Company implemented a contributory defined contribution 401(k) plan that covers substantially all full-time employees. Under the plan, participants may contribute up to 15% of their total compensation. The Company matches up to 3% of each participant's total compensation. Matching contributions totaled $71,000 for year ended December 31, 2001. Effective January 1, 2001, the Company adopted a deferred compensation plan for key employees. The Board of Managers approved the availability of approximately 690,000 phantom appreciation units and 296,000 phantom grant units for future awards to employees. In order to grant these awards, the Compensation Committee must recommend that they be granted, and the Compensation Committee's recommendation must be approved by the Board of Managers. As of December 31, 2001, the Company granted approximately 279,000 and 105,000 of appreciation units and grant units, respectively. Prior to December 31, 2001, the Board of Managers approved the Compensation Committee's recommendations to grant additional appreciation units and grant units of approximately 269,000 and 88,000, respectively, effective January 1, 2002. For the appreciation units, compensation is measured as the amount by which the cumulative per common unit distribution exceeds the value specified under the plan and is expensed over the performance of the related services. For the grant units, compensation is equal to the per common unit distributions times the number of vested grant units. Compensation is measured at the date of declared distribution. As of December 31, 2001, the Company has expensed approximately $57,000 relating to compensation expense for the grant units. 106 -----END PRIVACY-ENHANCED MESSAGE-----