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UNITED STATES
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 September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number: 0-4408
RESOURCE AMERICA, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 72-0654145
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1845 Walnut Street
Suite 1000
Philadelphia, PA 19103
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (215) 546-5005
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the voting common equity held by non-affiliates of
the registrant, based upon the closing price of such stock on December 20, 2002,
was approximately $136.3 million.
The number of outstanding shares of the registrant's common stock on December
20, 2002 was 17,382,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for registrant's 2003 Annual Meeting of
Stockholders are incorporated by reference in Part III of this Form 10-K.
[THIS PAGE INTENTIONALLY LEFT BLANK]
RESOURCE AMERICA, INC. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT
ON FORM 10-K
PART I Page
----
Item 1: Business.................................................................................. 3 - 27
Item 2: Properties................................................................................ 28 - 31
Item 3: Legal Proceedings......................................................................... 32
Item 4: Submission of Matters to a Vote of Security Holders....................................... 32
PART II
Item 5: Market for Registrant's Common Equity and Related Stockholder Matters..................... 33
Item 6: Selected Financial Data................................................................... 34 - 35
Item 7: Management's Discussion and Analysis of Financial Condition
and Results of Operation.............................................................. 36 - 53
Item 7A: Quantitative and Qualitative Disclosures about Market Risk................................ 54 - 59
Item 8: Financial Statements and Supplementary Data............................................... 60 - 98
Item 9: Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................................................ 98
PART III
Item 10: Directors and Executive Officers of the Registrant........................................ 99
Item 11: Executive Compensation.................................................................... 99
Item 12: Security Ownership of Certain Beneficial Owners and Management............................ 99
Item 13: Certain Relationships and Related Transactions............................................ 99
Item 14: Controls and Procedures................................................................... 100
PART IV
Item 15: Exhibits, Financial Statement Schedules and Reports on Form 8-K........................... 100 - 102
SIGNATURES................................................................................................ 103
CERTIFICATIONS............................................................................................ 104 - 105
2
PART I
ITEM 1. BUSINESS
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS REGARDING EVENTS
AND FINANCIAL TRENDS WHICH MAY AFFECT THE REGISTRANT'S FUTURE OPERATING RESULTS
AND FINANCIAL POSITION. SUCH STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES
THAT COULD CAUSE THE REGISTRANT'S ACTUAL RESULTS AND FINANCIAL POSITION TO
DIFFER MATERIALLY FROM THOSE ANTICIPATED IN FORWARD-LOOKING STATEMENTS. IN OUR
ENERGY BUSINESS, THESE FACTORS INCLUDE, BUT ARE NOT LIMITED TO, LACK OF
REVENUES, COMPETITION, NEED FOR ADDITIONAL CAPITAL, RISKS ASSOCIATED WITH
EXPLORING, DEVELOPING, AND OPERATING OIL AND NATURAL GAS WELLS, AND FLUCTUATIONS
IN THE MARKET FOR NATURAL GAS AND OIL. IN REAL ESTATE, THESE FACTORS INCLUDE,
BUT ARE NOT LIMITED TO, RISKS OF LOAN DEFAULTS, ADEQUACY OF OUR PROVISION FOR
LOSSES AND ILLIQUIDITY OF OUR PORTFOLIO.
General
We are a proprietary asset management company that uses industry
specific expertise to generate and administer investment opportunities for our
own account and for outside investors in the energy, real estate and financial
services sectors. As a proprietary asset manager, we seek to develop investment
entities in which outside investors invest along with us and for which we manage
the assets acquired, pursuant to long-term management and operating agreements.
We limit our investment vehicles to investment areas where we own existing
operating companies or have specific expertise. We believe this strategy
enhances our return on investment as well as that of our third party investors.
We typically receive an interest in the investment entity in addition to the
interest resulting from our investments. We managed approximately $1.2 billion
in assets in these sectors at the end of fiscal 2002, as follows:
o $360 million of energy assets (31%)(1),
o $628 million of real estate assets (54%)(2) and
o $169 million of financial service assets (15%)(3).
During fiscal 2002, we continued developing our energy operations,
which account for approximately 81% of our total revenues and 39% of our total
assets. We increased our average financial interests in wells we drilled. As a
result, the number of gross wells we drilled decreased 2% and the number of net
wells increased 5% in fiscal 2002 as compared to fiscal 2001. Moreover, our
production for our account of natural gas increased by 12% and the revenues from
our drilling activities increased by 28%. We have undertaken new initiatives in
real estate finance and financial services by sponsoring a private real estate
investment partnership, a public equipment leasing partnership and two
investment partnerships formed to acquire the trust preferred securities of
small to mid-size regional banks and bank holding companies. These new
investment entities are in their offering stages (except for one of the trust
preferred securities entities which completed its offering in the first quarter
of fiscal 2003). We intend to develop similar programs in the future.
Energy. Our energy operations focus on the development, production and
transportation of natural gas and, to a lesser extent, oil in the Appalachian
Basin. While we have been involved in the energy industry since 1976, we began
to expand our energy operations during fiscal 1999. We have funded our
development and production operations primarily by sponsoring drilling
investment partnerships. Since the beginning of fiscal 1999 through September
30, 2002, we have raised approximately $149.0 million in 13 separate drilling
investment partnerships. During that period, we drilled 815 gross wells in the
Appalachian Basin and completed approximately 99% as producing wells. We, and
our drilling investment partnerships, own interests in approximately 5,000
wells, 85% of which we operate. At September 30, 2002, proved reserves net to
our interest were approximately 134.5 Bcfe (4) with a PV-10 value (5) of $132.5
million. Of these reserves, 92% were natural gas and 71% were classified as
proved developed reserves. At September 30, 2002, we managed an additional 182.6
Bcfe of proved reserves with a PV-10 value of $199.9 million for our drilling
partnerships and others. Of these reserves, 88% are natural gas, substantially
all of which are classified as proved developed reserves. As of September 30,
2002, we had an acreage position of approximately 488,000 gross (407,000 net)
acres, of which 223,000 gross (213,000 net) acres were undeveloped. We have
identified over 400 potential drilling locations on our acreage, of which 276
are classified as proved undeveloped locations.
3
We own 51% of Atlas Pipeline Partners, a publicly held master limited
partnership which trades on the American Stock Exchange. At September 30, 2002,
Atlas Pipeline Partners owned approximately 1,400 miles of intrastate gathering
systems located in eastern Ohio, western New York and western Pennsylvania, to
which approximately 4,100 natural gas wells were connected.
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(1) We value our managed energy assets as the sum of the PV-10 value, as of
September 30, 2002, of the proved reserves owned by us and the
investment partnerships and other entities whose assets we manage, plus
the book value, as of September 30, 2002, of the totals assets of Atlas
Pipeline Partners, L.P., a publicly traded (AMEX: APL) natural gas
pipeline master limited partnership of which we are the general partner
and principal owner.
(2) We value our managed real estate assets as the sum of the amount of our
outstanding loan receivables plus the book value of our interests in
real estate ventures as of September 30, 2002.
(3) We value our financial services assets as the sum of book values of
equipment held by equipment leasing investment partnerships we managed
as of September 30, 2002, and the cost of securities acquired by a
venture which we co-manage that acquired trust preferred securities of
regional banks and bank holding companies.
(4) "Mcfe," "Mmcfe" and "Bcfe" mean thousand cubic feet equivalent, million
cubic feet equivalent and billion cubic feet equivalent, respectively.
Natural gas volumes are converted to barrels or "Bbls", of oil
equivalent using the ratio of six thousand cubic feet, or "Mcf" of
natural gas to one Bbl of oil and are stated as the official
temperature and pressure bases of the area in which the reserves are
located.
(5) "PV-10 value" means, in accordance with SEC guidelines, the estimated
future net cash flow to be generated from the production of proved
reserves discounted to present value using an annual discount rate of
10%. These amounts are calculated net of estimated production costs and
future development costs, using prices and costs in effect as of a
certain date, without escalation and without giving effect to
non-property or non-production related expenses such as general
administrative expenses, debt service or future income tax expense, or
to depreciation, depletion and amortization.
Real Estate Finance. We manage for our own account a portfolio of
commercial real estate loans and interests in real properties from which we
receive interest payments and cash distributions. In addition, we sponsored and
are the largest shareholder of RAIT Investment Trust, a publicly-traded real
estate investment trust (NYSE: RAS) that originates or acquires real estate
loans and, to a lesser extent, interests in real properties. As of September 30,
2002, RAIT had a market capitalization and stockholders' equity of $373.6
million and $266.5 million, respectively.
From fiscal 1991 through fiscal 1999, we focused on loan acquisition
and resolution. We have not acquired any new loans since fiscal 1999 although,
as part of our portfolio management activities, we have purchased senior lien
interests relating to properties in which we hold junior lien interests and have
invested in three partnerships involving properties adjacent to a property in
which we have an interest. In fiscal 2002, we decided to pursue development of
our real estate operations through the sponsorship of real estate investment
partnerships. We currently are a sponsor of one private real estate partnership,
which is in the offering stage. This partnership is focused on the purchase of
multifamily apartment buildings. We will provide real estate management and
advisory services to the partnership. We anticipate this fund closing in March
2003.
Financial Services. Our financial services operations currently focus
on managing investment partners that invest in equipment leasing and entities
that invest in trust preferred securities of small to mid-size regional banks
and their holding companies.
We manage equipment leasing assets through a company we acquired in
1995 that acts as the general partner and manager of four public equipment
leasing partnerships. We intend to develop our equipment leasing operations
through the sponsorship of new equipment leasing partnerships. We have sponsored
one public equipment leasing partnership which is currently in the offering
stage. Previously, in 1996, we had started a proprietary equipment leasing
business which, by 2000, held over $600 million in equipment leasing assets. On
August 1, 2000, we sold this business to European American Bank, a subsidiary of
ABN AMRO Bank, N.V., for $583 million, including assumption of debt of $431
million, subject to certain indemnification obligations. For information on the
status of these obligations, refer to "Obligations Relating to Discontinued
Operations.
4
We manage trust preferred securities assets through a limited liability
company of which we are a 50% owner. The limited liability company manages a
trust preferred securities portfolio owned by another limited liability company
that issues collateralized debt obligations secured by that portfolio, as the
"CDO issuer." We also are the 50% owner of the general partner of, and have
invested $2.8 million in a limited partnership that acquired the equity interest
of the CDO issuer. We have co-sponsored, with a third party, a second trust
preferred securities investment similar to the first, which is currently in the
offering stage.
For financial information about our operating segments, see Note 16,
"Operating Segments and Major Customers," to our "Consolidated Financial
Statements". We do not separately report financial information for our financial
services operating segment because it does not represent at least 10% of our
assets, revenues, profits or losses.
Energy
General. We concentrate our energy operations in the Western New York,
Eastern Ohio and Western Pennsylvania region of the Appalachian Basin. As of
September 30, 2002, we owned proved reserves of approximately 134.5 Bcfe as
compared to 93.3 Bcfe at the beginning of fiscal 1999. As of September 30, 2002:
o We had, either directly or through investment partnerships managed by
us, interests in approximately 5,000 gross wells, including royalty
or overriding royalty interests in 600 wells. We operate 85% of these
wells.
o Wells in which we have an interest produced, net to our interest,
approximately 19,500 Mcf of natural gas and 473 Bbls of oil per day.
o We had an acreage position of approximately 488,000 gross (407,000
net) acres, of which 223,000 gross (213,000 net) acres were
undeveloped.
o We owned and operated, directly or through our Atlas Pipeline
Partners subsidiary, approximately 1,600 miles of gas gathering
systems and pipelines.
Since 1976, we or our predecessors have funded our development and
production operations through private and, since 1992, public drilling
investment partnerships. We act as the managing general partner of each of these
partnerships, contribute the leases on which the partnership drills, and
contribute a proportionate share of the partnership's capital. We receive an
interest in a partnership proportionate to the capital and leases we contribute,
generally 25% to 27%, plus 7% carried interest. We typically subordinate a
portion of our partnership interest to a preferred return to the limited
partners for the first five years of distributions, and receive monthly
operating and administrative fees. In addition, we typically act as the drilling
contractor and operator of the wells drilled by the partnership on a fee basis.
In fiscal 2002, our drilling partnerships invested $75.5 million in drilling and
completing wells, of which we contributed $19.7 million. In fiscal 2001, our
drilling partnerships invested $55.1 million in drilling and completing wells,
of which we contributed $11.7 million.
We transport the natural gas produced from wells we operate through the
gas gathering pipeline systems owned and operated by Atlas Pipeline Partners.
See "Energy- Pipeline Operations." The gathering systems transport the natural
gas to public utility pipelines for delivery to our customers. We sell the
natural gas we produce to customers such as gas brokers and local utilities
under a variety of contractual arrangements. We sell the oil we produce to
regional oil refining companies at the prevailing spot price for Appalachian
crude oil.
5
Appalachian Basin Overview. Natural gas is the second largest energy
source in the United States, after liquid petroleum. The 22.5 trillion cubic
feet, or "Tcf" of natural gas consumed in 2000 represented approximately 23% of
the total energy used in the United States. The Appalachian Basin, in which
substantially all of our wells are located accounted for 3.5% of total 2000
domestic natural gas production, or 658 billion cubic feet, or "Bcf".
Furthermore, according to the Energy Information Administration of the U.S.
Department of Energy, the Appalachian Basin holds 7.9 Tcf of economically
recoverable reserves representing approximately 4.5% of total domestic reserves
as of December 31, 2000. Although the potential to find recoverable quantities
of oil and gas exists at depths below 6,500 feet, the vast majority of wells in
Appalachia produce from depths between 1,000 and 6,500 feet. Companies drilling
at these depths, including us, have historically realized well completion rates
of greater than 90% and well production periods that last longer than 20 years.
The Appalachian Basin is strategically located near the energy consuming
population centers in the Mid-Atlantic and Northeastern United States, which
generally allows Appalachian producers to sell their natural gas at a premium to
the benchmark price for natural gas on the New York Mercantile Exchange.
Natural Gas and Oil Properties. For information concerning our natural
gas and oil properties including the number of wells in which we have a working
interest, production, reserve information and acreage, see Item 2,
"Properties-Energy."
Natural Gas Hedging. Pricing for gas and oil production has been
volatile and unpredictable for many years. To hedge exposure to changing natural
gas prices we use both non-financial and financial hedges. Through our hedges,
we seek to provide a measure of stability in the volatile environment of natural
gas prices. Our risk management objective is to lock in a range of pricing for
expected production volumes. This allows us to forecast future earnings within a
predictable range. For the fiscal year ended September 30, 2002, approximately
49% of produced volumes were sold in this manner. For the fiscal year ending
September 30, 2003, we estimate that in excess of 65% of our produced natural
gas volumes will be sold in this manner, leaving the remaining 35% of our
produced volumes to be sold at contract prices in the month produced at spot
market prices. For information concerning our natural gas hedging, see Item 7A,
"Quantitative and Qualitative Disclosures about Market Risk - Energy - Commodity
Price Risk."
Financing Our Drilling Activities. We derive a substantial portion of
our capital resources for drilling operations from our sponsored drilling
partnerships. Accordingly, the amount of development activities we undertake
depends upon our ability to obtain investor subscriptions to the partnerships.
During fiscal 2002, 2001 and 2000 our drilling partnerships invested $75.5
million, $55.1 million and $39.9 million, respectively, in drilling and
completing wells, of which we contributed $19.7 million, $11.7 million and $9.6
million, respectively.
We generally structure our drilling partnership so that, upon formation
of a partnership, we contribute leaseholds to it, enter into a drilling and well
operating agreement with it and become its general or managing partner.
6
As general partner, we typically receive an interest in the
partnership's net revenues proportionate to our contributed capital, including
the costs of leases contributed, plus a 7% carried interest. Our interests in
partnerships formed during the past three fiscal years generally range from 25%
to 27% plus the 7% carried interest, a portion of which we subordinate to a
preferred return to our partnership investors for the first five years of
distributions. We also receive monthly operating fees of approximately $275 per
well and monthly administrative fees of $75 per well.
Pipeline Operations. In February 2000, we sold substantially all of our
gathering systems to Atlas Pipeline Partners for $16.6 million in cash and
1,641,026 subordinated units of the newly-formed limited partnership. As of
September 30, 2002, our subordinated units constituted a 49% interest in Atlas
Pipeline Partners. Atlas Pipeline Partners GP, LLC, our indirect wholly-owned
subsidiary, is the general partner of Atlas Pipeline Partners and, on a
consolidated basis, has a 2% interest in Atlas Pipeline Partners. Atlas Pipeline
Partners GP manages the activities of Atlas Pipeline Partners using Atlas
America personnel who act as its officers and employees. At September 30, 2002,
Atlas Pipeline Partners owned approximately 1,400 miles of intrastate gathering
systems located in Eastern Ohio, Western New York and Western Pennsylvania, to
which approximately 4,100 natural gas wells were connected.
Our subordinated units in Atlas Pipeline Partners are a special class
of interest under which our right to receive distributions is subordinated to
those of the publicly held common units. The subordination period extends until
December 31, 2004 and will continue beyond that date if financial tests
specified in the partnership agreement are not met. Our interest also includes a
right to receive incentive distributions if the partnership meets or exceeds its
minimum quarterly distribution obligations to the common and subordinated units
as follows:
o of the first $.10 per unit available for distribution in excess of
the $.42 minimum quarterly distribution, 85% goes to all unit holders
(including to us as a subordinated unit holder) and 15% goes to us as
a general partner;
o of the next $.08 per unit available for distribution, 75% goes to all
unit holders and 25% goes to us as a general partner, and
o after that, 50% goes to all unit holders and 50% goes to us as a
general partner.
In connection with our sale of the gathering systems to Atlas Pipeline
Partners, we entered into agreements that require us to do the following:
o Connect wells owned or controlled by us that are within specified
distances of Atlas Pipeline Partners' gathering systems to those
gathering systems.
o Provide stand-by construction financing to Atlas Pipeline Partners
for gathering system extensions and additions, to a maximum of $1.5
million per year, until 2005.
o Pay gathering fees to Atlas Pipeline Partners for natural gas
gathered by the gathering systems equal to the greater of $.35 per
Mcf ($.40 per Mcf in certain instances) or 16% of the gross sales
price of the natural gas transported. For the year ended September
30, 2002, these gathering fees averaged $.57 per Mcf.
o Support a minimum quarterly distribution by Atlas Pipeline Partners
to holders of the common units of $.42 per unit, an aggregate of
$1.68 per fiscal year until February 2003. We established a letter of
credit administered by Wachovia Bank to support our obligation. The
face amount of the letter of credit as of September 30, 2002 was
$630,000.
We believe that we comply with all the requirements of these
agreements. We have not been required to provide any construction financing. For
Atlas Pipeline Partner's initial quarter of operations, ending March 31, 2000,
we provided $443,000 of distribution support due to the timing of its cash
receipts. This amount was subsequently repaid by Atlas Pipeline Partners as
provided in its partnership agreement. No distribution support has been required
in any subsequent quarter.
Availability of Oil Field Services. We contract for drilling rigs and
purchase goods and services necessary for the drilling and completion of wells
from a substantial number of drillers and suppliers, none of which supplies a
significant portion of our annual needs. During fiscal 2002, we faced no
shortage of these goods and services. We cannot predict the duration of the
current supply and demand situation for drilling rigs and other goods and
services with any certainty due to numerous factors affecting the energy
industry and the demand for natural gas and oil.
7
Major Customers. During fiscal 2002 and 2001, gas sales to one
purchaser accounted for 13% and 14%, respectively, of total revenues.
Competition. The energy industry is intensely competitive in all of its
aspects. Competition arises not only from numerous domestic and foreign sources
of natural gas and oil but also from other industries that supply alternative
sources of energy. Competition is intense for the acquisition of leases
considered favorable for the development of natural gas and oil in commercial
quantities. Product availability and price are the principal means of
competition in selling oil and natural gas. Many of our competitors possess
greater financial and other resources than ours which may enable them to
identify and acquire desirable properties and market their natural gas and oil
production more effectively than we do. While it is impossible for us to
accurately determine our comparative industry position, we do not consider our
operations to be a significant factor in the industry. Moreover, we also compete
with a number of other companies that offer interests in drilling partnerships.
As a result, competition for investment capital to fund drilling partnerships is
intense.
Markets. The availability of a ready market for natural gas and oil
produced by us, and the price obtained, depends upon numerous factors beyond our
control, including the extent of domestic production, import of foreign natural
gas and oil, political instability in oil and gas producing countries and
regions, market demand, the effect of federal regulation on the sale of natural
gas and oil in interstate commerce, other governmental regulation of the
production and transportation of natural gas and oil and the proximity,
availability and capacity of pipelines and other required facilities. During
fiscal 2002 and 2001, we experienced no problems in selling our natural gas and
oil, although prices have varied significantly during and after the period.
Governmental Regulation. Our energy business and the energy industry in
general are heavily regulated by federal and state authorities, including
regulation of production, environmental quality and pollution control, and
pipeline construction and operation. The intent of federal and state regulations
generally is to prevent waste, protect rights to produce natural gas and oil
between owners in a common reservoir and control contamination of the
environment. Failure to comply with regulatory requirements can result in
substantial fines and other penalties. We believe that we substantially comply
with applicable regulatory requirements. The following discussion of the
regulations of the United States energy industry does not intend to constitute a
complete discussion of the various statutes, rules, regulations and
environmental orders to which our operations may be subject.
Regulation of Exploration and Production. Many states require permits
for drilling operations, drilling bonds and reports concerning operations, and
impose requirements concerning the location of wells, the method of drilling and
casing wells, the surface use and restoration of properties on which wells are
drilled, the plugging and abandoning of wells and the disposal of fluids used in
connection with operations. Many states also impose conservation requirements,
principally regulating the density of wells which may be drilled and the
unitization or pooling of properties. In this regard, some states allow the
forced pooling or integration of tracts to facilitate exploration while other
states rely primarily or exclusively on voluntary pooling of lands and leases.
In areas where pooling is voluntary, it may be more difficult to form units and,
therefore, more difficult to develop a project if the operator owns less than
100% of the leasehold. In addition, some state conservation laws establish
requirements regarding production rates and related matters. The effect of these
regulations may be to limit the amount we can produce and may limit the number
of wells or the locations at which we can drill. The regulatory burden on the
energy industry increases our costs of doing business and, consequently, affects
our profitability. Since these laws and regulations are frequently expanded,
amended and reinterpreted, we are unable to predict the future cost or impact of
complying with such regulations.
8
Regulation of Pipelines. While natural gas pipelines generally are
subject to regulation by the Federal Energy Regulatory Commission ("FERC") under
the Natural Gas Act of 1938, because Atlas Pipeline Partners' individual
gathering systems perform primarily a gathering function, as opposed to the
transportation of natural gas in interstate commerce, Atlas Pipeline Partners
believes that it is not subject to regulation under the Natural Gas Act.
However, Atlas Pipeline Partners delivers a significant portion of the natural
gas it transports to interstate pipelines subject to FERC regulation. The
regulation principally involves transportation rates and service conditions
which affect revenues we receive for our natural gas production. Through a
series of initiatives by FERC, the interstate natural gas transportation and
marketing system has been substantially restructured to increase competition. In
particular, in Order No. 636, FERC required that interstate pipelines provide
transportation separate, or "unbundled," from their sales activities, and
required that interstate pipelines provide transportation on an open access
basis that is equal for all natural gas suppliers. Although Order No. 636 does
not directly regulate our production and marketing activities, it does affect
how buyers and sellers gain access to the necessary transportation facilities
and how we and our competitors sell natural gas in the marketplace. Courts have
largely affirmed the significant features of Order No. 636 and the numerous
related orders pertaining to individual pipelines, although some appeals remain
pending and FERC continues to review and modify its regulations regarding the
transportation of natural gas. We cannot predict what actions FERC will take in
the future. However, we do not believe that any action taken will affect us in a
way that materially differs from the way it affects other natural gas producers,
gatherers and marketers.
State-level regulation for pipeline operations, similar to that of
Atlas Pipeline Partners', is through the Public Utility Commission of Ohio, the
New York Public Service Commission and the Pennsylvania Public Utilities
Commission. Atlas Pipeline Partners has been granted an exemption from
regulation by the Public Utility Commission of Ohio, and believes that it is not
subject to New York or Pennsylvania regulation since it does not generally
provide service to the public.
Environmental and Safety Regulation. Under the Comprehensive
Environmental Response, Compensation and Liability Act, the Toxic Substances
Control Act, the Resource Conservation and Recovery Act, the Oil Pollution Act
of 1990, the Clean Air Act, and other federal and state laws relating to the
environment, owners and operators of wells producing natural gas or oil, and
pipelines, can be liable for fines, penalties and clean-up costs for pollution
caused by the wells or the pipelines. Moreover, the owners' or operators'
liability can extend to pollution costs from situations that occurred prior to
their acquisition of the assets. Natural gas pipelines are also subject to
safety regulation under the Natural Gas Pipeline Safety Act of 1968 and the
Pipeline Safety Act of 1992 which, among other things, dictate the type of
pipeline, quality of pipeline, depth, methods of welding and other
construction-related standards. State public utility regulators in New York,
Ohio and Pennsylvania have either adopted federal standards or promulgated their
own safety requirements consistent with the federal regulations.
We do not anticipate that we will be required in the near future to
expend amounts that are material in relation to our revenues by reason of
environmental laws and regulations, but since as these laws and regulations
change frequently, we cannot predict the ultimate cost of compliance. We cannot
assure you that more stringent laws and regulations protecting the environment
will not be adopted or that we will not otherwise incur material expenses in
connection with environmental laws and regulations in the future.
Real Estate Finance
General. From fiscal 1991 through fiscal 1999, we sought to purchase
commercial real estate loans at discounts to their outstanding loan balances and
the appraised value of their underlying properties. Since 1999, we have focused
our real estate finance activities on managing our existing loan portfolio and
have not originated or acquired any new significant real estate loans. As part
of our portfolio management activities, however, we purchased senior lien
interests relating to properties in which we hold junior lien interests and
invested in three partnerships that own properties adjacent to a property in
which we have an interest. As part of the management process or as opportunities
arise, we may sell, purchase or originate portfolio loans or real property
investments in the future. In fiscal 2002, we decided to expand our real estate
operations through the sponsorship of investment partnerships. We sponsored one
such program, which is currently in the offering stage.
9
At September 30, 2002, our loan portfolio consisted of 30 loans with
aggregate outstanding loan balances of $610.0 million. These loans were acquired
at an investment cost of $386.3 million, including subsequent advances. During
each of fiscal 2002, 2001 and 2000, the yield on our loan portfolio investment
was 9%, including gains on the sale of senior lien interests in, and gains, if
any, resulting from proceeds received by us when property owners refinanced
their loans. Gross profit from our real estate finance activities for the same
periods was $10.7 million, $11.8 million and $11.8 million, respectively. For
these purposes, we calculate gross profit as revenues from loan activities minus
costs, including interest, provision for possible losses and less depreciation
and amortization, without allocation of corporate overhead.
We seek to reduce the amount of our capital invested in portfolio
loans, and to enhance our returns, through borrower refinancing of the
properties underlying our loans. Before January 1, 1999, we also sought to sell
senior lien interests; since that date, we have sought to structure our senior
lien transactions as financings rather than sales. At September 30, 2002, senior
lien holders held outstanding obligations of $260.7 million. Pursuant to
agreements with most borrowers, we generally retain the excess of operating cash
flow after required debt service on senior lien obligations as debt service on
the outstanding balance of our loans.
Because our loans typically were not performing in accordance with the
original terms when we acquired them, they generally are subject to forbearance
agreements that defer foreclosure or other action so long as the borrower meets
the terms of the forebearance agreement. Generally, our forbearance agreements
require:
o payment of all revenues from the property into an operating account
controlled by us or our managing agent;
o payment of all property expenses, including debt service, taxes,
operational expenses and maintenance costs, from the operating
account, after our review and approval;
o receipt by us of specified minimum monthly payments;
o retention by us of all cash flow above the minimum monthly payment
and application to accrued but unpaid debt service;
o appointment of a property manager acceptable to us;
o receipt of our approval before concluding any material contract or
commercial lease; and
o submission of monthly cash flow statements and occupancy reports.
We may alter these arrangements in appropriate circumstances. Where a
borrower refinances a portfolio loan or where we acquired a loan subject to
existing senior debt, we may agree that the revenues be paid to an account
controlled by the senior lien holder, with the excess over amounts payable to
the senior lien holder being paid directly to us. As of September 30, 2002,
revenues were being paid directly to senior lien holders with respect to loan 7
in the table under "Loan Status." Where Brandywine Construction & Management,
Inc., a property manager affiliated with us manages the property, we may direct
that property revenues be paid to Brandywine Construction & Management as our
managing agent. As of September 30, 2002, revenues were being paid to Brandywine
Construction & Management with respect to loans 25 and 30 in the table under
"Loan Status." Where we believe that operating problems with respect to an
underlying property have been substantially resolved, we may permit the borrower
to retain revenues and pay property expenses directly. As of September 30, 2002,
we permitted borrowers with respect to loans 24, 31, 32, 41 and 50 in the table
under "Loan Status" to do so.
As a result of the requirement that borrowers retain a property
management firm acceptable to us, Brandywine has assumed responsibility for
supervisory and, in many cases, day-to-day management of the underlying
properties with respect to substantially all of our portfolio loans as of
September 30, 2002. In seven instances, the president of Brandywine Construction
& Management, or an entity affiliated with him, has also acted as the general
partner, president or trustee of the borrower.
10
The minimum payments required under a forbearance agreement are
normally materially less than the debt service payments called for by the
original terms of the loan. The difference between the minimum required payments
under the forbearance agreement and the payments called for by the original loan
terms continues to accrue. However, except for amounts we recognize as accretion
of discount, we do not recognize the accrued but unpaid amounts as revenue until
actually paid. For a discussion of how we account for accretion of discount, you
should read "Real Estate Finance-Accounting for Discounted Loans."
When we refinance or sell a senior lien interest, the forbearance
agreement typically will remain in effect, subject to any modifications required
by the refinance lender or senior lien holder.
At the end of a forbearance agreement, the borrower must pay the loan
in full. The borrower's ability to do so, however, will depend upon a number of
factors, including prevailing conditions at the underlying property, the state
of real estate and financial markets generally and as they pertain to the
particular property, and general economic conditions. If the borrower does not
or cannot repay the loan, we anticipate it will seek to sell the property
underlying the loan or otherwise liquidate the loan. Alternatively, where we
already control all of the cash flow and other economic benefits from the
property, or where we believe that the cost of foreclosure is more than any
benefit we could obtain from foreclosure, we may continue our forbearance.
Refinancings. In borrower refinancings, we reduce the amount
outstanding on our loan by the amount of the net refinancing proceeds received
by us and either convert the outstanding balance of the original note into the
stated principal amount of an amended note on the same terms as the original
note, or retain the original loan obligation as paid down by the amount of
refinance proceeds we receive. The interest rate on the refinancing is typically
less than the interest rate on our retained interest.
Before January 1, 1999, we sought to sell senior lien interests in our
loans. Although we made a strategic decision to structure our transactions after
such date as financings, we retain the right to sell a senior interest in a loan
where it is economically advantageous to do so. When we sell a senior lien
interest, the outstanding balance of our loan at the time of sale remains
outstanding including, as a part of that balance, the amount of the senior lien
interest. Thus, our remaining interest effectively "wraps around" the senior
lien interest.
As of September 30, 2002, senior lien interests with an aggregate
balance of $10.6 million relating to six portfolio loans obligate us, in the
event of a default on a loan, to replace the loan with a performing loan.
After a refinancing or sale of a senior lien interest, our retained
interest will usually be secured by a subordinate lien on the property. In some
situations, however, our retained interest may not be formally secured by a
mortgage because of conditions imposed by the senior lender. In these
situations, we may be protected by a judgment lien, an unrecorded deed-in-lieu
of foreclosure, the borrower's covenant not to further encumber the property
without our consent, a pledge of the borrower's equity or a similar device. As
of September 30, 2002, we have six retained interests aggregating $31.3 million
and constituting 17%, by carried cost of investment, of our loan portfolio, that
are not secured by a lien on the underlying property.
Loan Status. The following table sets forth information about our
portfolio loans, grouped by the type of property underlying the loans, as of
September 30, 2002.
11
Fiscal Value
Year Outstanding of Property
Loan Type of Loan Loan Underlying
Number Property Location Seller/Originator Acquired Receivable(1) Loan (2)
------ -------- -------- ----------------- -------- ------------- ----------
Office Properties
005 Office Pennsylvania Shawmut Bank (9) 1993 $ 10,549,861 $ 1,700,000
014 Office Washington,
D.C. Nomura/Cargill/Eastdil Realty (10) 1995 21,811,605 14,300,000
020 Office New Jersey Cargill/Eastdil Realty (10) 1996 8,543,846 4,700,000
026 (12) Office Pennsylvania The Metropolitan Fund/First Trust Bank 1997 10,897,041 4,700,000
029 (12) Office Pennsylvania Castine Associates, L.P. (13) 1997 9,685,101 4,075,000
035 (12) (14) Office Pennsylvania Hudson United Bank (9) 1997 2,798,354 2,900,000
036 Office North Carolina Union Labor Life Insurance Co. 1997 5,786,070 4,150,000
044 (16) Office Washington,
D.C. Dai-Ichi Kangyo Bank 1998 112,068,860 98,500,000
046 Office Pennsylvania First Union Bank (9) 1998 6,000,000 5,300,000
049 (17) Office Maryland Bre/Maryland 1998 110,406,241 99,000,000
053 (18) Office Washington,
D.C. Sumitomo Bank, Limited 1999 132,211,326 86,700,000
------------ ------------
Office Totals $430,758,305 $326,025,000
------------ ------------
Multifamily Properties
001 (19) Multifamily Pennsylvania Alpha Petroleum Pension Fund 1991&99 $ 10,817,964 $ 5,500,000
015 Condo/Multifamily North Carolina First Bank/ SouthTrust Bank 1995&97 5,859,330 5,917,000
022 Multifamily Pennsylvania FirsTrust FSB 1996 6,311,117 5,200,000
024 Multifamily Pennsylvania U.S. Dept. of Housing and Urban Development 1996 3,242,364 3,800,000
028 Condo/Multifamily North Carolina First Bank/South Trust Bank 1997 585,454 498,500
031 Multifamily Connecticut John Hancock Mutual Life Ins. Co. 1997 12,145,530 12,500,000
032 Multifamily New Jersey John Hancock Mutual Life Ins. Co. 1997 14,029,158 14,300,000
034 Multifamily Pennsylvania Resource America, Inc. 1997 477,148 650,000
037 (20) Multifamily Florida Howe, Soloman & Hall Financial, Inc. 1997 7,754,166 3,550,000
041 Multifamily Connecticut J.E. Roberts Companies 1998 20,974,000 22,600,000
050 Multifamily Illinois J.E. Roberts Companies 1998 55,327,984 24,000,000
------------ ------------
Multifamily Totals $137,524,215 $ 98,515,500
------------ ------------
Commercial Properties
007 Single User/Retail Minnesota Prudential Insurance, Alpha Petroleum
Pension Fund 1993 $ 5,772,632 $ 2,300,000
013 (12)(21) Single
User/Commercial California California Federal Bank 1994 2,627,761 2,700,000
017 (12)(22) Single User/Retail West Virginia Triester Investments (9)
Emigrant Savings Bank/Walter R. 1996 1,628,955 1,900,000
018 Single User/Retail California Samuels & Jay Furman 1996 3,207,264 6,800,000
033 Single User/Retail Virginia Brambilla, LTD 1997&99 5,068,593 2,700,000
------------ ------------
Commercial Totals $ 18,305,205 $ 16,400,000
------------ ------------
Hotel Properties
025 Hotel/Commercial Georgia Bankers Trust Co. 1997 $ 8,475,535 $ 10,172,500
030 Hotel Nebraska CNA Insurance 1997 13,962,666 6,300,000
------------ ------------
Hotel Totals $ 22,438,201 $ 16,472,500
------------ ------------
Other Loan Receivable (24)
Condo/Multifamily Pennsylvania Resource America, Inc. 2001 $ 1,009,600 $ N/A
------------ ------------
Other Loan Receivables Total $ 1,009,600 $ N/A
------------ ------------
Balance as of September 30, 2002 $610,035,526 $457,413,000
============ =============
12
Maturity
Resource America's of Loan/
Ratio of Cost Net Interest in Expiration of
Cost of of Investment to Third Party Net Carried Cost Outstanding Loan Forbearance
Investment(3) Appraised Value Liens(4) Investment(5) of Investment(6) Receivables (7) Agreement(8)
- ------------- --------------- ------------ ------------- ---------------- ------------------ --------------
$ 1,746,910 103% $ - $ 1,746,910 $ 1,909,093 $ 10,549,861 10/07/02
12,577,052 88% 6,142,737 6,090,052 8,223,645 15,668,868 11/30/98(11)
3,329,628 71% 2,284,683 767,628 2,321,920 6,259,163 02/07/01(11)
2,879,651 61% 2,021,829 647,958 2,539,253 8,875,213 09/30/03
3,109,074 76% - 484,074 3,898,569 9,685,101 07/01/02(11)
1,845,970 64% 1,687,372(15) 95,970 979,880 1,110,982 09/25/02(11)
3,089,740 74% 1,684,057(15) 1,339,740 2,337,719 4,102,013 12/31/11
95,589,983 97% 66,530,920 21,472,128 36,062,577 45,537,940 08/01/08
4,093,597 77% - 4,093,597 4,172,509 6,000,000 09/30/14
90,576,248 91% 58,416,000 30,576,248 38,655,862 51,990,241 04/01/11
80,236,411 93% 63,923,149 15,236,411 23,014,794 68,288,176 01/15/06
------------ ------------ ------------ ------------ ------------
$299,074,264 $202,690,747 $ 82,550,716 $124,115,821 $228,067,558
------------ ------------ ------------ ------------ ------------
$ 5,841,392 106% $ - $ 5,841,392 $ 6,056,579 $ 10,817,964 08/01/21
2,275,408 38% 2,861,608 (724,592) 2,712,999 2,997,722 03/23/09
2,471,782 48% 3,343,363 (963,218) 974,815 2,967,754 05/03/29
2,743,296 72% 2,373,444 424,546 775,554 868,920 11/01/22
451,511 91% - 451,511 484,345 585,454 03/23/09
4,788,642 38% 8,977,893 (4,586,358) 1,384,044 3,167,637 10/14/14
7,404,156 52% - 1,404,156 12,291,391 14,029,158 09/01/05
415,700 64% - 415,700 471,179 477,148 10/01/02
2,868,614 81% - 2,868,614 3,346,231 7,754,166 06/01/10
14,736,584 65% 13,655,075 636,584 7,289,442 7,318,925 01/01/09
19,916,397 83% 14,987,960 4,566,397 9,572,492 40,340,024 09/30/09
------------ ------------ ------------ ------------ ------------
$ 63,913,482 $ 46,199,343 $ 10,334,732 $ 45,359,071 $ 91,324,872
------------ ------------ ------------ ------------ ------------
$ 1,544,709 67% $ 1,796,036 $ (554,291) $ 1,044,472 $ 3,976,596 12/31/14
1,704,549 63% 2,273,000(15) (543,451) 130,415 354,761 12/21/04
906,542 48% 960,958(15) (93,458) 643,087 667,997 12/31/16
2,584,498 38% 1,969,000 615,498 1,135,780 1,238,264 12/01/00(11)
2,478,353 92% 1,571,279(15) 678,353 1,161,072 3,497,314 02/01/21
------------ ------------ ------------ ------------ ------------
$ 9,218,651 $ 8,570,273 $ 102,651 $ 4,114,826 $ 9,734,932
------------ ------------ ------------ ------------ ------------
$ 7,263,020 71% $ 875,000(23) $ 6,388,020 $ 8,425,668 $ 7,600,535 12/31/15
5,845,737 93% 2,400,000(15) 3,445,737 4,516,621 11,562,666 09/30/02(11)
------------ ------------ ------------ ------------ ------------
$ 13,108,757 $ 3,275,000 $ 9,833,757 $ 12,942,289 $ 19,163,201
------------ ------------ ------------ ------------ ------------
$ 1,009,600 N/A $ N/A $ 1,009,600 $ 1,009,600 $ 1,009,600 09/28/06
------------ ------------ ------------ ------------ ------------
$ 1,009,600 $ N/A $ 1,009,600 $ 1,009,600 $ 1,009,600
------------ ------------ ------------ ------------ ------------
$386,324,754 $260,735,363 $103,831,456 $187,541,607 $349,300,163
============ ============ ============ ============ ============
13
(1) Consists of the original stated or face value of the obligation plus
interest and the amount of the senior lien interest at September 30,
2002.
(2) We generally obtain appraisals on each of the properties underlying our
portfolio loans at least once every three years. Accordingly, except
with respect to loan 35, appraisal dates range from 1999 through 2002.
(3) Consists of the original cost of our investment, including the amount
of any senior lien obligation to which the property remains subject,
plus subsequent advances, but excludes the proceeds to us from the sale
of senior lien interests or borrower refinancings.
(4) Represents the amount of the senior lien interests at September 30,
2002.
(5) Represents the unrecovered costs of our investment, calculated as the
cash investment made in acquiring the loan plus subsequent advances,
less cash received from the sale of a senior lien interest in or
borrower refinancing of the loan. Negative amounts represent our
receipt of proceeds from the sale of senior lien interests or borrower
refinancings in excess of our investment.
(6) Represents the book cost of our investment, including subsequent
advances, after accretion of discount and allocation of gains from the
sale of a senior lien interest in, or borrower refinancing of, the
loan, but excludes an allowance for possible losses of $3.5 million.
(7) Consists of the amount set forth in the column "Outstanding Loan
Receivable" less senior lien interests at September 30, 2002.
(8) With respect to loans 5, 13, 18, 20, 26, 29 and 35, the date given is
the expiration date of the related forbearance agreement. For the
remaining loans, the date given is for the maturity of our interest in
the loan.
(9) Successor by merger to the seller.
(10) Seller was a partnership of these entities.
(11) Although these forbearance agreements have expired by their term, we
continue to forbear from exercising our remedies since we believe we
receive all of the economic benefit from the properties without having
to incur the expense of foreclosure.
(12) With respect to loans 13, 17 and 26, the president of Brandywine
Construction & Management is the general partner of the borrower and
with respect to loan 29, he is the general partner for the sole limited
partner of the borrower. With respect to loan 35, he is the president
of the general partner of the borrower.
(13) From 1993 to 1997, one of our former executive officers who is also a
former director served as the general partner of the seller.
(14) The borrower is a limited partnership formed in 1991. The general
partner is the president of Brandywine Construction & Management; our
chairman and his wife beneficially own a 49% limited partnership
interest in the partnership and a former director beneficially owns a
1% limited partnership interest.
(15) Senior lien interest sold subject to the right of the holder to require
us to substitute a performing loan, upon default.
(16) The borrower is a limited partnership whose general partner, a former
director, is the president and a director.
(17) The borrower is a limited liability company whose manager is a
corporation of which a former director is the sole shareholder, officer
and director. Our chairman, two of our former directors and the
president of Brandywine Construction & Management are equal limited
partners of an entity that owns approximately 30% of the borrower.
(18) One of our subsidiaries is the manager of the borrower.
(19) We acquired a first mortgage loan at face value from RAIT. The loan is
secured by property in which we have held a subordinate interest since
1991.
(20) The borrower is a limited partnership of which a former director is the
president of the general partner and our chairman, two of our former
directors and the president of Brandywine Construction & Management are
equal limited partners.
(21) Our chairman and his wife beneficially own a 40% limited partnership
interest in the borrower.
14
(22) Consists of a series of notes becoming due yearly through December 31,
2016.
(23) In May 1999, we borrowed $875,000 from a limited partnership in which
our chairman and a former director beneficially own a 22% limited
partnership interest. The loan is secured by a first priority lien on
loan 25. Accordingly, the debt is included in the cost of investment
carried on our books.
(24) In September 2001, we sold a wholly-owned subsidiary to Brandywine
Construction & Management for $4.0 million. Of the $4.0 million we
received, $3.0 million consisted of cash and $1.0 million was in the
form of a non-recourse note, bearing interest at 8% per year and due in
September 2006.
15
The following table sets forth average monthly cash flow (deficit) from
the properties underlying our portfolio loans, average monthly debt service
payable to senior lienholders and refinance lenders, average monthly cash flow
(deficit) with respect to our retained interest and cash flow coverage (the
ratio of cash flow from the properties to debt service payable on senior lien
interests) for the three months ended September 30, 2002. The loans are grouped
by the type of property underlying the loans.
Average Monthly Average Monthly
Interest Principal
Payment on Debt Payment on Debt Average Monthly
Average Monthly Service on Service on Cash Flow
Loan Cash Flow Refinancing or Refinancing or (Deficit) after Cash Flow
Number from Property(1) Senior Lien Interests Senior Lien Interests Debt Service Coverage
------ ---------------- --------------------- --------------------- --------------- ---------
Office
- ------
005 $ 1,337 $ - $ - $ 1,337 N/A
014 88,881 44,510 18,223 26,148 1.42
020 42,254 17,903 1,624 22,727 2.16
026 31,666 17,694 3,906 10,066 1.47
029 26,459 - - 26,459 N/A
035 24,176 14,408 1,494 8,274 1.52
036 32,182 14,396 1,506 16,280 2.02
044 605,007 389,013 67,088 148,906 1.33
046 40,810 - - 40,810 N/A
049 504,639 378,000 72,000 54,639 1.12
053 822,568 662,671 37,923 121,974 1.17
---------- ---------- -------- --------
Office Totals $2,219,979 $1,538,595 $203,764 $477,620 1.27
========== ========== ======== ========
Multifamily
- -----------
001 $ 30,040 $ - $ - $ 30,040 N/A
015&028(2) 23,336 19,995 3,680 (339) 0.99
022 32,134 22,045 2,623 7,466 1.30
024 25,926 15,804 2,158 7,964 1.44
031 81,517 60,034 10,901 10,582 1.15
032 84,583 - - 84,583 N/A
034 3,932 - - 3,932 N/A
037 28,430 - - 28,430 N/A
041 136,667 86,115 13,490 37,062 1.37
050 155,385 100,854 11,137 43,394 1.39
---------- ---------- -------- --------
Multifamily Totals $ 601,950 $ 304,847 $ 43,989 $253,114 1.73
========== ========== ======== ========
Commercial
- ----------
007 $ 20,400 $ 14,423 $ 5,977 $ - 1.00
013 34,271 11,365 - 22,906 3.02
017 10,690 8,142 945 1,603 1.18
018(3) 26,443 13,034 - 13,409 2.03
033 21,940 14,258 5,084 2,598 1.13
---------- ---------- -------- --------
Commercial Totals $ 113,744 $ 61,222 $ 12,006 $ 40,516 1.55
========== ========== ======== ========
Hotel
- -----
025 $ 76,494 $ 7,292 $ - $ 69,202 10.49
030 - 12,300 - (12,300) N/A
---------- ---------- -------- --------
Hotel Totals $ 76,494 $ 19,592 $ - $ 56,902 3.90
========== ========== ======== ========
Other Loan Receivables
- ----------------------
$ 20,641 $ - $ - $ 20,641 N/A
---------- ---------- -------- --------
Other Totals $ 20,641 $ - $ - $ 20,641
========== ========== ======== ========
Totals $3,032,808 $1,924,256 $259,759 $848,793 1.39
========== ========== ======== ========
16
- --------------
(1) "Cash flow" as used in this table is that amount equal to the revenues
from property operations less operating expenses, including real estate
and other taxes pertaining to the property and its operations, and
before depreciation, amortization and capital expenditures.
(2) The properties underlying loans 15 and 28 are different condominium
units in the same building and, accordingly, are combined for cash flow
purposes.
(3) Includes one-twelfth of an annual payment of $120,000 received in
December of each year.
Investments in Real Estate Ventures. In fiscal 1999, we became the
owner of a hotel property in Savannah, Georgia as a result of receiving a
deed-in-lieu of foreclosure. Our carrying cost in this property was $4.3 million
at September 30, 2002. Also in fiscal 1999, the borrower with respect to an
office property and parking garage in Philadelphia, Pennsylvania in which we
have our executive offices, exercised its right to satisfy its loan by paying us
$29.6 million in cash and giving us 50% equity interests in the two properties.
Our carrying cost in these properties was $10.1 million at September 30, 2002.
In fiscal 2002, we invested in three limited partnerships which purchased
properties adjacent to these properties. Our carrying cost for the partnership
interests was $2.7 million at September 30, 2002.
Accounting for Discounted Loans. We accrete the difference between our
cost basis in a portfolio loan and the sum of projected cash flows from the loan
into interest income over the estimated life of the loan using the interest
method, which results in a level rate of interest over the life of the loan. We
review projected cash flow, which include amounts realizable from the underlying
property, on a quarterly basis. Changes to projected cash flow reduce or
increase the amounts accreted into interest income over the remaining life of
the loan.
We record our investments in real estate loans at cost, which is
discounted significantly from the stated principal amount plus accrued interest
and penalties on the loans. We refer to the stated principal, accrued interest
and penalties as the face value of the loan. The discount from face value, as
adjusted to give effect to refinancings and sales of senior lien interests,
totaled $165.2 million, $150.7 million and $156.5 million at September 30, 2002,
2001 and 2000, respectively. We review the carrying value of each of our loans
quarterly to determine whether it is greater than the sum of the future
projected cash flows. If we determine that carrying value is greater, we provide
an appropriate allowance through a charge to operations. In establishing our
allowance for possible losses, we also consider the historic performance of our
loan portfolio, characteristics of the loans and their underlying properties,
industry statistics and experience regarding losses in similar loans, payment
history on specific loans as well as general economic conditions in the United
States, in the borrower's geographic area or in the borrower's or its tenants'
specific industries.
Allowance for Possible Losses. For the year ended September 30, 2002,
we recorded a provision for possible losses of $1.5 million, a write-down of
$559,000 on one loan, which was subsequently sold, increasing our allowance for
possible losses at September 30, 2002 to $3.5 million.
Depending on the structure of the transaction, we can recognize a gain
or loss on the sale of a senior lien interest in a loan. We calculate the gain
or loss by allocating our cost basis between the portion of the loan sold and
the portion retained based upon fair values on the date of sale. Gains resulting
from the refinancing of a property by its owners arise only when the financing
proceeds exceed the carried cost of our investment in the loan. We credit to
income any gain recognized on a sale of a senior lien interest, or a refinancing
at the time of the sale or refinancing.
Sponsorship of Real Estate Investment Trust. We are the sponsor and a
7.9% shareholder, as of September 30, 2002, of RAIT, a real estate investment
trust that began operations in January 1998. RAIT acquires or originates
commercial real estate loans in situations that generally do not conform to the
underwriting standards of institutional lenders or sources that provide
financing through securitization. To a lesser extent, RAIT acquires interests in
real properties. For a description of certain relationships between RAIT and us,
you should read Part III, Item 13, of this report and Note 4, "Certain
Relationships and Related Party Transactions-Relationship with RAIT" in the
Notes to Consolidated Financial Statements. Following the end of fiscal 2002, we
have reduced our interest in RAIT to 7.0%.
17
Financial Services
Our financial services operations currently focus on managing equipment
leasing investment partnerships and entities that invest in the trust preferred
securities of small to mid-size regional banks and bank holding companies and
debt securities collateralized by these trust preferred securities..
We manage equipment leasing partnerships through LEAF Financial
Corporation, formerly F.L. Partnership Management, a wholly-owned subsidiary. At
September 30, 2002, LEAF managed, and acted as the general partner of four
public equipment leasing partnerships that had a net investment of approximately
$22.1 million in equipment leasing assets, principally computer systems and
related peripheral equipment. LEAF receives management fees, expense
reimbursements and, as general partner, an interest in cash distributions from
the partnerships. These partnerships commenced their liquidation periods at
various times between December 1995 and December 1998. LEAF intends to sponsor
new equipment leasing partnerships and currently is the sponsor of one such
public partnership which is in its offering stage.
We own a 50% interest in Trapeza Funding, LLC, an entity that acts as
the general partner of Trapeza Partners L.P., ("Trapeza Partners"), which
sponsored and invested in the equity interests of Trapeza CDO I, LLC, an issuer
of collateralized debt obligations. The collateralized debt obligations are
supported by a pool of trust preferred securities issued by trusts affiliated
with, and whose preferred securities are guaranteed by, banks and other
financial institutions. We also own a 50% interest in Trapeza Capital
Management, LLC, the collateral manager of Trapeza CDO. We will receive
collateral management fees from Trapeza CDO and administrative fees for managing
Trapeza Partners, in addition to the return on our limited partner investment.
We will also receive a 20% carried interest in the limited partnership. In June
2002, Trapeza Partners raised $27.4 million from investors, including $2.8
million from us and a like amount from the other owner of Trapeza Funding. In
November 2002, Trapeza CDO sold $330.0 million of its collateralized debt
obligations. In addition to making an equity investment in the limited
partnership, we provided it with a $5.0 million bridge loan to facilitate the
CDO issuer's purchase of trust preferred securities. We have developed a second
investment partnership to sponsor and purchase equity interests in another
newly-created CDO issuer, which is in its offering stage. We may develop similar
investment partnerships in the future.
Obligations Relating to Discontinued Operations
On August 1, 2000, we sold our small ticket equipment leasing
subsidiary, Fidelity Leasing, to European American Bank and AEL Leasing Co.,
Inc., subsidiaries of ABN AMRO Bank, N.V. We received total consideration of
$152.2 million, including repayment of indebtedness of Fidelity Leasing to us;
the purchasers also assumed approximately $431.0 million in debt payable to
third parties and other liabilities. Of the $152.2 million consideration, $16.0
million was paid by a non-interest bearing promissory note. The promissory note
is payable to the extent that payments are made on a pool of Fidelity Leasing
lease receivables and refunds are received with respect to certain tax
receivables. In addition, $10.0 million was placed in escrow until March 31,
2004 as security for our indemnification obligations to the purchasers.
The successor in interest to the purchaser, has made a series of claims
totaling $19.0 million with respect to our indemnification obligations and
representations. In addition, the successor has indicated it will have
significant additional claims with respect to future credit losses that are
covered by the indemnification. While we have disputed these claims, in the
first quarter of fiscal 2003 we entered into substantive settlement negotiations
with the successor. In December 2002, we agreed in principle to the monetary
terms of a non-executed "Term Sheet for Proposed Settlement Agreement" with the
successor. The ultimate settlement is subject to negotiation of a definitive
settlement agreement, which the Company and the successor will seek to complete
on or before December 31, 2002. The Company believes that the terms of any
ultimate settlement will not be materially different from the most recent
proposed agreement as further described.
18
The terms of the proposed agreement would release us and the successor
from certain terms and obligations of the original purchase agreements,
including many of the terms of our non-competition agreement, and claims arising
from circumstances known at the settlement date. In addition, we would (i)
release to the successor the $10.0 million in escrow, previously referred to;
(ii) pay the successor $6.0 million; (iii) guarantee that the successor will
receive payments of $1.2 million from a note, secured by FLI lease receivables,
delivered to us at the close of the FLI sale previously referred to; and (iv)
deliver two promissory notes to the successor, each in the principal amount of
$1.75 million, bearing interest at the two-year treasury rate plus 500 basis
points, and due on December 31, 2003 and 2004, respectively. The liability
relating to the cash payment and the notes is recorded in our consolidated
financial statements as liabilities on assets held for disposal. We recorded a
loss from discontinued operations, net of taxes, of $9.4 million in connection
with this settlement.
Credit Facilities and Senior Notes
Credit Facilities. We and certain of our real estate subsidiaries are
the obligors under a $6.8 million term note to Hudson United Bank. At September
30, 2002, $6.4 million was outstanding on this note which matures on April 1,
2004. The note bears interest at the prime rate reported in The Wall Street
Journal, minus one percent, and is secured by certain portfolio loans.
Through our real estate subsidiaries, we have an $18.0 million line of
credit with Sovereign Bank. The facility bears interest at the prime rate
reported in The Wall Street Journal and expires in July 2004. Advances under
this facility must be used to acquire real property, loans on real property or
to reduce indebtedness on property loans. The facility is secured by the
interest of our subsidiaries in assets they acquire using advances under the
lines of credit. Credit availability is based on the value of the assets pledged
as security and was $18.0 million as of September 30, 2002, all of which had
been drawn at that date. The facility imposes limitations on the incurrence of
future indebtedness by our subsidiaries whose assets were pledged, and on sales,
transfers or leases of their assets, and requires the subsidiaries to maintain
both a specified level of equity and a specified debt service coverage ratio.
We have a second line of credit with Sovereign Bank for $5.0 million
that is similar to the $18.0 million line of credit. This facility bears
interest at the same rate as the $18.0 million line of credit and also expires
in July 2004. Advances under this facility must be used to acquire real
property, loans on real property or to reduce indebtedness on property or loans.
The facility is secured by a pledge of approximately 500,000 of our RAIT common
shares and by a guaranty from the subsidiaries holding the assets securing the
$18.0 million line of credit. Credit availability is based on the value of the
pledged RAIT shares and was $5.0 million as of September 30, 2002, all of which
had been drawn at that date. The facility restricts us from making loans to our
affiliates other than:
o existing loans,
o loans in connection with lease transactions in an aggregate not to
exceed $50,000 in any fiscal year,
o loans to RAIT made in the ordinary course of business, and
o loans to our subsidiaries.
We have a line of credit with Commerce Bank for $5.0 million, none of
which has been drawn. The facility is secured by our pledge of 520,000 of our
RAIT common shares. Credit availability is 50% of the value of those shares, and
was $5.0 million at September 30, 2002. Loans bear interest, at our election, at
either the prime rate reported in The Wall Street Journal or specified London
Interbank Offered Rates, or LIBOR, plus 250 basis points, in either case with a
minimum rate of 5.5% and a maximum rate of 9.0%. The facility terminates in May
2004, subject to extension. The facility requires us to maintain a specified net
worth and ratio of liabilities to tangible net worth, and prohibits our transfer
of the collateral.
Through our real estate subsidiaries, we have a $10.0 million term loan
with The Marshall Group, formerly Miller and Schroeder Investment Corp. The loan
bears interest at the three month LIBOR rate plus 350 basis points (5.6% at
September 30, 2002), adjusted annually. Principal and interest are payable
monthly based on a five-year amortization schedule maturing on October 31, 2006.
The loan is secured by our interest in the capital stock of 11 real estate
subsidiaries and the portfolio loans and real estate held by those subsidiaries.
The loan prohibits mergers by the subsidiaries and prohibits the subsidiaries,
other than Resource Properties, Inc., our principal real estate subsidiary, from
incurring additional recourse debt. We are required to maintain a specified net
worth, a ratio of recourse debt to net worth and a ratio of cash flow from
pledged collateral to participations under the loan. At September 30, 2002, $7.9
million is outstanding under this loan.
19
In July 2002, our principal energy subsidiary, Atlas America, entered
into a $75.0 million credit facility administered by Wachovia Bank. The
revolving credit facility is guaranteed by Atlas America's subsidiaries and by
us. Credit availability, which is principally based on the value of Atlas
America's assets, was $45.0 million at September 30, 2002. Up to $10.0 million
of the borrowings under the facility may be in the form of standby letters of
credit. A letter of credit in the original amount of $1.3 million was issued to
Atlas Pipeline Partners under this facility to replace a prior letter of credit
securing our obligation to support, through February 2003, minimum quarterly
distributions by Atlas Pipeline Partners to holders of its common units. The
letter of credit, which has reduced, by its terms, to $630,000, expires in
February 2003. Borrowings under the facility are secured by the assets of Atlas
America and its subsidiaries, including the stock of Atlas America's
subsidiaries and interests in Atlas Pipeline Partners and its general partner.
Loans under the facility bear interest at one of the following two
rates, at the borrower's election:
o the base rate plus the applicable margin; or
o the adjusted LIBOR plus the applicable margin.
The base rate for any day equals the higher of the federal funds rate
plus 1/2 of 1% or the Wachovia Bank prime rate. Adjusted LIBOR is LIBOR divided
by 1.00 minus the percentage prescribed by the Federal Reserve Board for
determining the reserve requirement for euro currency funding. The applicable
margin is as follows:
o where utilization of the borrowing base is equal to or less than 50%,
the applicable margin is 0.25% for base rate loans and 1.75% for
LIBOR loans;
o where utilization of the borrowing base is greater than 50%, but
equal to or less than 75%, the applicable margin is 0.50% for base
rate loans and 2.00% for LIBOR loans; and
o where utilization of the borrowing base is greater than 75%, the
applicable margin is 0.75% for base rate loans and 2.25% for LIBOR
loans.
At September 30, 2002, borrowings under the Wachovia credit facility
bore interest at rates ranging from 3.54% to 5.0%.
The Wachovia credit facility requires Atlas America to maintain a
specified net worth and specified ratios of current assets to current
liabilities and debt to EBITDA, and requires us to maintain a specified interest
coverage ratio. In addition, the facility limits sales, leases or transfers of
assets and the incurrence of additional indebtedness. The facility limits the
dividends payable by Atlas America to us, on a cumulative basis, to 50% of the
Atlas America's net income from and after April 1, 2002 plus federal income
taxes, amounts necessary to pay interest on our Senior Notes and $5.0 million.
The facility terminates in July 2005, when all outstanding borrowings must be
repaid. We used this credit facility to pay off our previous revolving credit
facility at PNC Bank ("PNC"). At September 30, 2002, $45.0 million was
outstanding under this facility.
Our equipment leasing subsidiary has a $10.0 million warehouse line of
credit with National City Bank of Pennsylvania. We are the guarantor of that
facility. The facility is secured by a pledge of our subsidiary's assets and by
the equipment, equipment leases and proceeds thereof financed by the facility,
and terminates in June 2003. Loans under the facility bear interest, at our
election, at either the National City Bank prime rate plus 1.0% or adjusted
LIBOR plus 3.0%, with the LIBOR adjustment being similar to that in the Wachovia
Bank facility. The facility requires our subsidiary to maintain a specified net
worth and specified interest coverage and debt to net worth ratios. The facility
limits dividends our subsidiary may pay, mergers, sales of assets by our
subsidiary and the terms of equipment leases that may be financed under the
facility. At September 30, 2002, $2.4 million had been drawn under the facility
at an average rate of 4.81%.
Atlas Pipeline Partners has a $10.0 million revolving credit facility
administered by PNC Bank. Up to $3.0 million of the facility may be used for
standby letters of credit. Borrowings under the facility are secured by a lien
on all the property of Atlas Pipeline Partners' assets, including its
subsidiaries. The facility has a term ending in October 2003 and bears interest,
at Atlas Pipeline Partners' election, at the base rate plus the applicable
margin or the euro rate plus the applicable margin.
20
As used in the facility agreement, the base rate is the higher of:
o PNC Bank's prime rate or
o the sum of the federal funds rate plus 50 basis points.
The euro rate is the average of specified LIBORs divided by 1.00 minus
the percentage prescribed by the Federal Reserve Board for determining the
reserve requirement for euro currency funding. The applicable margin varies with
Atlas Pipeline Partners' leverage ratio from between 150 to 200 basis points,
for the euro rate option, or 0 to 50 basis points, for the base rate option.
Draws under any letter of credit bear interest as specified under the first
bullet point above. The credit facility requires Atlas Pipeline Partners to
maintain a specified net worth, ratio of debt to tangible assets and an interest
coverage ratio. In addition, the facility limits sales, leases or transfers of
assets, incurrence of other indebtedness and guarantees, and certain
investments. As of September 30, 2002, $5.6 million was outstanding under this
facility at an average interest rate of 3.27%.
Senior Notes Our 12% senior notes are unsecured general obligations
with interest payable only until maturity on August 1, 2004. The senior notes
are not subject to mandatory redemption except upon a change in control, as
defined in the indenture governing the senior notes, when the noteholders have
the right to require us to redeem the senior notes at 101% of their principal
amount plus accrued interest. There is no sinking fund for the senior notes. At
our option, we may redeem the senior notes in whole or in part on or after
August 1, 2002 at a price of 106% of principal amount (through July 31, 2003)
and 103% of principal amount (through July 31, 2004), plus accrued interest to
the date of redemption. At September 30, 2002, $65.3 million of these notes were
outstanding.
The indenture governing the senior notes contains covenants that, among
other things, require us to maintain certain levels of net worth (generally, an
amount equal to $200.0 million plus a cumulative 25% of our consolidated net
income less an adjustment based upon the principal amount of senior notes we
repurchase) and liquid assets (generally, an amount equal to 100% of required
interest payments for the next succeeding interest payment date); and limit our
ability to:
o incur indebtedness, but excluding secured indebtedness used to
acquire assets or refinance acquisitions;
o pay dividends or make other distributions in excess of 25% of our
aggregate consolidated net income, offset by 100% of any consolidated
losses, on a cumulative basis;
o engage in specified transactions with affiliates;
o dispose of subsidiaries;
o create liens and guarantees with respect to pari passu or junior
indebtedness;
o enter into any arrangement that would restrict our subsidiaries to
make dividend and other payments to us except in connection with
specified indebtedness;
o merge, consolidate or sell all or substantially all of our assets;
o incur additional indebtedness if our "leverage ratio" exceeds 2.0 to
1.0; or
o incur pari passu or junior indebtedness with a maturity date prior to
that of the senior notes.
As defined by the indenture, the leverage ratio is the ratio of all
indebtedness to our consolidated net worth. The indenture excludes from
indebtedness considered in calculating the leverage ratio debt used to acquire
assets, obligations to repurchase loans or other financial assets sold by us,
guarantees of either of the foregoing, non-recourse debt and certain securities
issued by securitization entities, as defined in the indenture. At September 30,
2002, we believe that we comply with the indenture covenants.
Employees
As of September 30, 2002, we employed 249 persons: 25 in general
corporate, 193 in energy, 24 in equipment leasing partnership management and
seven in real estate finance.
21
Where you can find more information
The periodic reports we file with the SEC are available on our website
at www.resourceamerica.com promptly after we file them with the SEC. In
addition, we will provide you with copies of any of these reports, without
charge, upon request made to:
Michael S. Yecies
Chief Legal Officer
Resource America, Inc.
1845 Walnut St., Suite 1000
Philadelphia, PA 19103
(215) 546-5005
Risk Factors
Statements made by us in written or oral form to various persons,
including statements made in filings with the SEC, that are not strictly
historical facts are "forward-looking" statements that are based on current
expectations about our business and assumptions made by management. These
statements are subject to risks and uncertainties that exist in our operations
and business environment that could result in actual outcomes and results that
are materially different than predicted. The following includes some, but not
all, of those factors or uncertainties:
General
Interest rate increases will increase our interest costs under our
eight credit facilities as well as interest costs relating to some of the senior
lien interests encumbering our portfolio loans. This could have material adverse
effects, including reduction of net revenues for both our energy and real
estate finance operations.
Risks Relating to Our Energy Business
Our future financial condition, results of operations and the value of
our natural gas and oil properties will depend upon market prices for natural
gas and oil. Natural gas and oil prices historically have been volatile and will
likely continue to be volatile in the future. Natural gas and oil prices we
received in fiscal 2002 were significantly lower than the average prices we
received during fiscal 2001 while prices we have received thus far in fiscal
2003 have been higher than the average prices we received in fiscal 2002. Prices
for natural gas and oil are affected by many factors over which we have no
control, including:
o political instability or armed conflict in oil producing regions or
other market uncertainties;
o worldwide and domestic supplies of oil and gas;
o weather conditions;
o the level of consumer demand;
o the price and availability of alternative fuels;
o the availability of pipeline capacity;
o the price and level of foreign imports;
o domestic and foreign governmental regulations and taxes;
o the ability of the members of the Organization of Petroleum Exporting
Countries to agree to and maintain oil prices and production
controls; and
o the overall economic environment.
22
The volatility of the energy markets caused by these and other factors
make it extremely difficult for us to predict future oil and gas price movements
with any certainty. Price fluctuations can materially adversely affect us
because:
o price decreases will reduce our energy revenues;
o price decreases may make it more difficult to obtain financing for
our drilling and development operations through sponsored investment
partnerships, borrowings or otherwise;
o price decreases may make some reserves uneconomic to produce,
reducing our reserves and cash flow;
o price decreases may cause the lenders under our energy credit
facility to reduce our borrowing base because of lower revenues or
reserve values, reducing our liquidity and, possibly, requiring
mandatory loan repayment;
o price increases may make it more difficult, or more expensive, to
drill and complete wells if they lead to increased competition for
drilling rigs and related materials;
o price increases may make it more difficult, or more expensive, to
execute our business strategy of acquiring additional natural gas
properties and energy companies.
Further, oil and gas prices do not necessarily move in tandem. Because
approximately 92% of our proved reserves are natural gas reserves, we are more
susceptible to movements in natural gas prices.
The energy business involves operating hazards such as well blowouts,
cratering, explosions, uncontrollable flows of oil, natural gas or well fluids,
fires, formations with abnormal pressures, pipeline ruptures or spills,
pollution, releases of toxic gas and other environmental hazards and risks, any
of which could result in substantial losses to us. In addition, we may be liable
for environmental damage caused by previous owners of properties purchased or
leased by us. As a result, we may incur substantial liabilities to third parties
or governmental entities. In accordance with customary industry practices, we
maintain insurance against some, but not all, of such risks and losses.
Moreover, pollution and environmental risks generally are not fully insurable.
We may elect to self-insure if we believe that insurance, although available, is
excessively costly relative to the risks presented. The occurrence of an event
that is not covered, or not fully covered, by insurance could reduce our income,
the value of our assets or otherwise have a material adverse effect on our
business, financial condition and results of operations.
Although wells we drill are generally to formations that have a high
probability of resulting in commercially productive natural gas and oil
reservoirs, the amount of recoverable reserves may vary significantly from well
to well. We may drill wells that, while productive, do not produce sufficient
net revenues to return a profit after drilling, operating and other costs. The
geologic data and technologies we use do not allow us to know conclusively prior
to drilling a well that natural gas or oil is present or may be produced
economically. The cost of drilling, completing and operating a well is often
uncertain, and cost factors can adversely affect the economics of a project.
Further, our drilling operations may be curtailed, delayed or cancelled as a
result of many factors, including:
o unexpected drilling conditions;
o title problems;
o pressure or irregularities in formations;
o equipment failures or accidents;
o adverse weather conditions;
o environmental or other regulatory concerns; and
o costs of, or shortages or delays in the availability of, drilling
rigs and equipment.
23
The estimates of our proved natural gas and oil reserves and future net
revenues from those reserves are based upon analyses that rely upon various
assumptions, including those required by the SEC, as to natural gas and oil
prices, drilling and operating expenses, capital expenditures, taxes and
availability of funds. Any significant variance in these assumptions could
materially affect the estimated quantity of our reserves. As a result, our
estimates of our proved natural gas and oil reserves are inherently imprecise.
Actual future production, natural gas and oil prices, revenues, taxes,
development expenditures, operating expenses and quantities of recoverable
natural gas and oil reserves may vary substantially from our estimates or
estimates contained in the reserve reports. Our properties also may be
susceptible to hydrocarbon drainage from production by other operators on
adjacent properties. In addition, our proved reserves may be subject to downward
or upward revision based upon production history, results of future exploration
and development, prevailing natural gas and oil prices, mechanical difficulties,
governmental regulation and other factors, many of which are beyond our control.
You should not assume that the PV-10 values referred to in this report
represent the current market value of our estimated natural gas and oil
reserves. In accordance with SEC requirements, the estimates are based on prices
and costs as of the date of the estimates. Moreover, the 10% discount factor,
which the SEC requires in calculating future net cash flows for reporting
purposes, is not necessarily the most appropriate discount factor to calculate
risk-based value. The effective interest rate at various times and the risks
associated with the oil and gas industry generally will affect the
appropriateness of the 10% discount factor.
The rate of production from natural gas and oil properties declines as
reserves are depleted. Our proved reserves will decline as reserves are produced
unless we acquire additional properties containing proved reserves, successfully
develop new or existing properties or identify additional formations with
primary or secondary reserve opportunities on our properties. If we are not
successful in expanding our reserve base, our future natural gas and oil
production and drilling activities, the primary source of our energy revenues,
will decrease. Our ability to find and acquire additional reserves depends on
our generating sufficient cash flow from operations and other sources of
capital, principally our sponsored drilling partnerships, all of which are
subject to risks discussed elsewhere in this section. We cannot assure you that
we will have sufficient cash flow or cash available from other sources to expand
our reserve base.
The growth of our energy operations has resulted from both our
acquisition of energy companies and assets and from our ability to obtain
capital funds through our sponsored drilling partnerships. If we are unable to
identify acquisitions on acceptable terms, or if our ability to obtain capital
funds through sponsored partnerships is impaired, we may be unable to increase
or maintain our inventory of properties and reserve base, or may be forced to
curtail drilling, production or other activities. This would likely result in a
decline in our revenues from our energy operations.
Under current federal tax laws, there are tax benefits to investing in
drilling partnerships such as ours, including deductions for intangible drilling
costs and depletion deductions. If changes to federal tax laws reduce or
eliminate these benefits, our ability to raise capital funds through our
drilling partnerships could be materially impaired.
We operate in a highly competitive environment, competing with major
integrated and independent energy companies for desirable oil and gas
properties, as well as for the equipment, labor and materials required to
develop and operate such properties. Many of our competitors have financial and
technological resources substantially greater than ours and, as a result, we may
lack technological information or expertise available to other bidders. We may
incur higher costs or be unable to acquire and develop desirable properties at
costs we consider reasonable because of this competition.
Under our agreements with Atlas Pipeline Partners, we are required to
pay transportation fees for natural gas produced by our drilling partnerships
equal to the greater of $0.35 per Mcf ($0.40 per Mcf in certain instances) or
16% of the purchase price of the natural gas transported. Many of our
transportation arrangements with our existing drilling partnerships require them
to pay us lesser fees. For the years ended September 30, 2002, 2001 and 2000,
the differences between the amount we paid to Atlas Pipeline and the amount we
received from our drilling programs were $10.8 million, $13.1 million and $5.2
million, respectively.
24
We currently serve as the managing general partner of 84 energy
partnerships. As general partner, we are contingently liable for the obligations
of these partnerships to the extent that these obligations cannot be repaid from
program assets or insurance proceeds.
Federal, state and local authorities extensively regulate drilling and
production activities, including the drilling of wells, the spacing of wells,
the use of pooling of oil and gas properties, environmental matters, safety
standards, production limitations, plugging and abandonment, and restoration.
Laws affecting the industry are under constant review, raising the possibility
of changes that may affect, among other things, the pricing or marketing of oil
and gas production. If we do not comply with these laws, we may incur
substantial penalties. The overall regulatory burden on the industry increases
the cost of doing business and, in turn, decreases profitability.
Our operations are subject to complex and constantly changing
environmental laws adopted by federal, state and local governmental authorities.
We could face significant liabilities to the government and third parties for
discharges of natural gas, oil or other pollutants into the air, soil or water,
and we could have to spend substantial amounts on investigation, litigation and
remediation.
Risks Relating to Our Real Estate and Financial Services Businesses
The primary or sole source of recovery for our real estate loans is
typically the real property underlying these loans. Accordingly, the value of
our loans depends upon the value of that real property. Many of the properties
underlying our portfolio loans, while income producing, do not generate
sufficient revenues to pay the full amount of debt service required under the
original loan terms or have other problems. Although we generally control cash
flow from the properties underlying our loans and, where appropriate, have made
financial accommodations to take into account the operating conditions of the
underlying properties, there may be a higher risk of default with these loans as
compared to conventional loans. Loan defaults will reduce our current return on
investment and may require us to become involved in expensive and time-consuming
proceedings, including, bankruptcy, reorganization or foreclosure proceedings.
Our loans typically provide payment structures other than equal
periodic payments that retire a loan over its specified term, including
structures that defer payment of some portion of accruing interest, or defer
repayment of principal, until loan maturity. Where a borrower must pay a loan
balance in a large lump sum payment, its ability to satisfy this obligation may
depend upon its ability to obtain suitable refinancing or otherwise to raise a
substantial cash amount, which we do not control. In addition, lenders can lose
their lien priority in many jurisdictions, including those in which our existing
loans are located, to persons who supply labor or materials to property. For
these and other reasons, the total amount which we may recover from one of our
loans may be less than the total amount of the loan or our cost of acquisition.
Declines in real property values generally and/or in those specific
markets where the properties underlying our portfolio loans are located could
affect the value of and default rates under those loans. Properties underlying
our loans may be affected by general and local economic conditions, neighborhood
values, competitive overbuilding, casualty losses and other factors beyond our
control. The value of real properties may also be affected by factors such as
the cost of compliance with regulations and liability under applicable
environmental laws, changes in interest rates and the availability of financing.
Income from a property will be reduced if a significant number of tenants are
unable to pay rent or if available space cannot be rented on favorable terms.
Operating and other expenses of properties, particularly significant expenses
such as real estate taxes and maintenance costs, generally do not decrease when
revenues decrease and, even if revenues increase, operating and other expenses
may increase faster than revenues.
Many of our portfolio loans were, acquired as junior lien obligations
or were converted from senior lien obligations to junior lien obligations, as a
result of borrower or senior lien refinancing. Subordinate loans carry a greater
credit risk, including a substantially greater risk of nonpayment of interest or
principal, than senior lien financing. In the event a loan is foreclosed, we
will be entitled to share only in the net foreclosure proceeds after the payment
to all senior lenders. It is therefore possible that we will not recover the
full amount of a foreclosed loan or of our unrecovered investment in the loan.
25
At September 30, 2002, our allowance for possible losses was $3.5
million (1.7%) of the book value of our real estate loans and ventures. You
should not assume that this allowance will prove to be sufficient to cover
future losses, or that future provisions for loan losses will not be materially
greater than our allowance for losses. Losses in excess of our allowance for
losses, or an increase in our provision for losses, could materially reduce our
earnings.
Our loans typically do not conform to standard loan underwriting
criteria. Many of our loans are subordinate loans. As a result, our loans are
relatively illiquid investments. We may be unable to vary our portfolio in
response to changing economic, financial and investment conditions.
The existence of hazardous or toxic substances on a property will
reduce its value and our ability to sell the property in the event of a default
in the loan it underlies. Contamination of a real property by hazardous
substances or toxic wastes not only may give rise to a lien on that property to
assure payment of the cost of remediation, but also can result in liability to
us as lender or, if we assume ownership or management, as an owner or operator.
Many environmental laws impose liability regardless of whether we know of, or
are responsible for, the contamination. In addition, if we arrange for the
disposal of hazardous or toxic substances at another site, we may be liable for
the costs of cleaning up and removing those substances from the site, even if we
neither own nor operate the disposal site. Environmental laws may require us to
incur substantial expenses and may materially limit use of contaminated
properties. In addition, future laws or more stringent interpretations or
enforcement policies with respect to existing environmental requirements may
increase our exposure to environmental liability.
Our income from our real estate operations includes accretion of
discount, which is a non-cash item. For a discussion of accretion of discount,
see "Business - Real Estate Finance - Accounting for Discounted Loans." For the
years ended September 30, 2002, 2001 and 2000, accretion of discount was $3.2
million, $5.9 million, and $5.8 million, respectively. Under generally accepted
accounting principles, the amount of income we accrete on a loan equals the
difference between our cost basis in the loan and the sum of the projected cash
flows from the property underlying the loan, net to our interest. If the actual
cash flows from the property are less than our estimates, or if we reduce our
estimates of cash flows, our earnings may be adversely affected. Moreover, if we
sell a loan, or foreclose upon and sell the underlying property, and the amount
we receive is less than the amount of our investment plus the amount of the
accreted discount, we will recognize an immediate charge to our allowance for
losses or, if that amount is insufficient, our statement of operations.
Before fiscal 2000, we entered into a series of standby commitments
with some participants in our loans which obligate us to repurchase their
participations or substitute a performing loan if the borrower defaults. At
September 30, 2002, the participations as to which we had standby commitments
had aggregate outstanding balances of $10.6 million. At September 30, 2002, we
also were contingently liable under guarantees of $2.2 million in mortgage loan
receivables connected with a discontinued operation and contingently liable
under guarantees of $905,000 in standby letters of credit issued in connection
with Atlas Pipeline Partners and our lease of office space in New York City.
In addition, we obtained senior lien financing with respect to loans
15, 22, 44, 49, and 53 in the table under "Loan Status". The senior loans are
with recourse only to the properties securing them subject to certain standard
exceptions, which we have guaranteed. These exceptions relate principally to the
following:
o fraud or intentional misrepresentation in connection with the loan
documents;
o misapplication or misappropriation of rents, insurance proceeds or
condemnation awards during continuance of an event of default or, at
any time, of tenant security deposits or advance rents;
o payments of fees or commissions to various persons related to the
borrower or to us during an event of default, except as permitted by
the loan documents;
o failure to pay taxes, insurance premiums or specific other expenses,
failure to use property revenues to pay property expenses, and
commission of criminal acts or waste with respect to the property;
o environmental violations; and
o the undismissed or unstayed bankruptcy or insolvency of borrower.
26
We believe that none of the foregoing standby commitments or guarantees
must be included in our consolidated financial statements based on our
assessment that the likelihood of our being required to pay any claims under any
of them is remote under the facts and circumstances pertaining to each of them.
An adverse change in these facts and circumstances could cause us to determine
that the likelihood that a particular contingency may occur is no longer remote.
In that event, we may be required to include all or a portion of the contingency
as a liability in our financial statements, which could result in:
o violations of restrictions on incurring debt contained in our senior
notes or in agreements governing our other outstanding debt;
o defaults under and acceleration of the maturity of our senior notes
or our other indebtedness; and
o prohibitions on additional borrowings under our credit lines.
In addition, if we become liable under one or more of the foregoing
commitments or contingencies, we may not have sufficient funds to pay them and,
in order to meet our obligations, may have to sell assets at times and for
prices that are disadvantageous to us.
We are involved in a dispute with the purchaser of our former
proprietary equipment leasing subsidiary, as discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Obligations Relating to Discontinued Operations." We are in discussions with the
purchaser to settle that dispute. The amount of the final settlement, if any,
may significantly exceed the amount we have reserved. If the settlement does
exceed the reserve amount, the excess will be a charge against our earnings.
We currently serve a