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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, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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.)
1521 Locust Street
Suite 400
Philadelphia, PA 19102
(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:
Title of each class
Common Stock, par value $.01 per share
Name of each exchange on which registered: The Company's Common Stock trades on
the Nasdaq Stock Market under the symbol "REXI."
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. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant, based upon the closing price of such stock on November 30, 1997, was
$200,277,600.
The number of outstanding shares of the registrant's Common Stock on November
30, 1997 was 4,749,463.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for registrant's 1998 Annual Meeting of
Shareholders to be held on February 17, 1998 are incorporated by reference in
Part III of this Form 10-K.
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RESOURCE AMERICA, INC. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT
ON FORM 10-K
Page
PART I
Item 1: Business....................................................................... 4
Item 2: Properties..................................................................... 38
Item 3: Legal Proceedings.............................................................. 38
Item 4: Submission of Matters to a Vote of Security
Holders............................................................. 38
PART II
Item 5: Market for the Registrant's Common Equity and
Related Stockholder Matters......................................... 39
Item 6: Selected Financial Data........................................................ 40
Item 7: Management's Discussion and Analysis of
Financial Condition and Results of
Operations.......................................................... 40
Item 8: Financial Statements and Supplementary Data.................................... 51
Item 9: Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.............................. 85
PART III
Item 10: Directors, Executive Officers, Promoters and
Control Persons of the Registrant................................... 86
Item 11: Executive Compensation................................................ 86
Item 12: Security Ownership of Certain Beneficial Owners
and Management...................................................... 86
Item 13: Certain Relationships and Related Transactions........................ 86
PART IV
Item 14: Exhibits, Financial Statement Schedules and
Reports on Form 8-K................................................. 87
SIGNATURES
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PART I
ITEM 1. BUSINESS
General
The Company is a specialty finance company engaged primarily in real
estate finance and equipment leasing. For approximately 25 years prior to 1991,
the Company was principally involved in the energy industry and it continues to
have energy industry operations, including natural gas and oil production. Since
1991, the Company's business strategy has focused on locating and developing
niche finance businesses in which the Company can realize attractive returns by
targeting well-defined financial services markets and by developing specialized
skills to service those markets on a cost-effective basis. To date, the Company
has developed two main businesses: real estate finance and equipment leasing.
Within its real estate finance business, the Company has developed a commercial
mortgage loan acquisition and resolution business and a non-conforming
residential mortgage lending business. Within its equipment leasing business,
the Company focuses primarily on small ticket equipment lease financing,
although it also manages six publicly-owned equipment leasing partnerships and
has a lease finance placement and advisory business.
The Company's commercial mortgage loan acquisition and resolution
business involves the purchase at a discount of troubled commercial real estate
mortgage loans at prices generally ranging from $1 million to $10 million and
the restructuring and refinancing of those loans. These loans are generally
acquired from private market sellers, primarily financial institutions. Loans
acquired by the Company typically involve legal and other disputes among the
lender, the borrower and/or other parties in interest, and generally are secured
by properties which are unable to produce sufficient cash flow to fully service
the loans in accordance with the original lender's loan terms. Since fiscal 1991
(when it entered this business), and through September 30, 1997, the Company's
aggregate commercial mortgage loan portfolio has grown to 38 loans with an
outstanding loan balance (excluding discounts) of $233.7 million, acquired at an
investment cost (including subsequent advances, which had been anticipated by
the Company at the time of acquisition and were included in its analysis of loan
costs and yields) of $120.4 million. During the fiscal years ended September 30,
1997, 1996 and 1995, the Company's yield on its net investment in commercial
mortgage loans (including gains on sale of senior lien interests in, and gains,
if any, resulting from refinancings of commercial mortgage loans) equalled
34.7%, 36.2% and 34.6%, respectively, while its gross profit (that is, revenues
from loan activities minus costs attributable thereto, including interest and
provision for possible losses, and less depreciation and amortization, without
allocation of corporate overhead) from its commercial mortgage loan activities
for fiscal years 1997, 1996 and 1995 were $16.5 million, $6.3 million and $5.3
million, respectively.
The Company seeks to reduce the amount of its own capital invested in
commercial mortgage loans after their acquisition, and to enhance its returns,
through sale at a profit of senior lien interests in its loans (typically on a
recourse basis) or through borrower refinancing of the
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properties underlying its loans. At September 30, 1997, senior lenders held
outstanding obligations of $55.5 million, secured by properties with an
aggregate appraised value of $125.4 million, resulting in a ratio of senior lien
obligations-to-appraised value of property of 44%. For the three months ended
September 30, 1997, the operating cash flow coverage on the required debt
service on senior lien interests averaged 202%. Such calculation excludes (i)
proceeds from the sale of senior lien interests or from refinancings and (ii)
cash flows from and senior lien interests with respect to nine loans acquired
during the fourth quarter of fiscal 1997 as to which the Company had less than
three months' cash flow experience at September 30, 1997 (see "Commercial
Mortgage Loan Acquisition and Resolution: Loan Status"). If such nine loans had
been included (utilizing for this purpose their cash flows for periods
subsequent to September 30, 1997 as set forth in "- Real Estate Finance
- -Commercial Mortgage Loan Acquisition and Resolution: Loan Status"), the
operating cash flow coverage would have averaged 273%. The excess of operating
cash flow over required debt service on senior lien obligations is, pursuant to
agreements with the borrowers, retained by the Company as debt service on the
outstanding balance of the Company's loans.
The Company has sponsored a real estate investment trust (the "REIT")
and has undertaken to sell 10 loans to the REIT (including one loan consisting
of four related obligations). The Company will not retain a junior lien interest
in any of these loans. In addition, the Company has undertaken to sell a senior
participation in another of its loans to the REIT. The aggregate price to be
paid by the REIT for the loans and the senior participation will be $27.7
million. The Company's carried cost of investment in these loans was $22.2
million at September 30, 1997. The Company anticipates selling further loans to
the REIT. See "Sponsorship of Real Estate Investment Trust."
The Company's residential mortgage lending business provides first and
second mortgage loans on one- to four-family residences to borrowers who do not
conform to guidelines established by Fannie Mae because of past credit
impairment or other reasons. Through its subsidiaries, Fidelity Mortgage
Funding, Inc. ("FMF") and Tri-Star Financial Services, Inc. ("Tri-Star") (which
was acquired in November 1997 and which, following regulatory approvals, the
Company anticipates merging into FMF), the Company is licensed as a residential
mortgage lender in 19 states and is currently originating loans in eleven states
(Connecticut, Delaware, Indiana, Kentucky, Maryland, Mississippi, New Jersey,
North Carolina, Ohio, Pennsylvania and Virginia). The Company began its
residential mortgage lending business during fiscal 1997 and commenced
originating loans in the first quarter of fiscal 1998. The Company's operational
strategy is to concentrate on mid-size residential mortgage loans with targeted
average loan of approximately $75,000. The Company markets its services directly
to consumers and anticipates establishing "private label" lending programs (that
is, programs where the Company will process, fund and service loans originated
by an institution, under the institution's name) for institutions which, because
of a lack of expertise in the area or for other reasons, do not otherwise make
non-conforming loans.
The Company's equipment leasing business commenced in September 1995
with the acquisition of an equipment leasing subsidiary of a regional insurance
company. Through this
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acquisition, the Company assumed the management of six publicly-held equipment
leasing partnerships involving $55.2 million (original equipment cost) in leased
assets at September 30, 1997. More importantly, through this acquisition the
Company acquired an infrastructure of operating systems, computer hardware and
proprietary software (generally referred to as a "platform"), as well as
personnel, which the Company utilized in fiscal 1996 as a basis for the
development of an equipment leasing business for its own account. As part of its
development of this business, in early 1996 the Company hired a team of four
experienced leasing executives, including the former chief executive officer of
the U.S. leasing subsidiary of Tokai Bank, a major Japanese banking institution.
The Company's operational strategy for equipment leasing is to focus on leases
with equipment costs of between $5,000 to $100,000 ("small ticket" leasing),
with a targeted average transaction of approximately $10,000 per lease. The
Company markets its equipment leasing products through vendor programs with
equipment manufacturers, distributors and other vendors such as Minolta
Corporation and Lucent Technologies, Inc. The Company believes that the small
ticket leasing market is under-served by equipment lessors, banks and other
financial institutions, affording the Company a niche market with significant
growth potential. During fiscal 1997, the Company received 8,344 lease proposals
involving equipment with an aggregate cost of $113.4 million, approved 5,054
such proposals involving equipment with an aggregate cost of $67.2 million and
entered into 3,214 transactions involving equipment with an aggregate cost of
$34.6 million. During fiscal 1997, the Company sold, on a servicing retained
basis, equipment leases with an aggregate net book value of approximately $30.2
million to third parties. The Company anticipates similar equipment lease sales
in the future. The Company's income from retained servicing was not material
during fiscal 1997.
The Company produces natural gas and, to a lesser extent, oil from
locations principally in Ohio, Pennsylvania and New York. At September 30, 1997,
the Company had a net investment of $11.4 million in its energy operations,
including interests in 1,129 individual wells (including overriding interests)
owned directly by the Company or through 64 partnerships and joint ventures
managed by the Company. While the Company has focused its business development
efforts on its specialty finance operations over the past several years, its
energy operations historically have provided a steady source of cash flow and
tax benefits.
Real Estate Finance
Commercial Mortgage Loan Acquisition and Resolution Strategy
Identification and Acquisition of Troubled Commercial Mortgage Loans.
The Company believes that the success to date of its commercial mortgage loan
acquisition and resolution business has been due in large part to its ability to
identify and acquire troubled commercial mortgage loans which, due to
operational difficulties at the underlying properties, legal or factual
disputes, or other problems, are unable to fully meet debt service requirements
under the original loan terms and can be acquired at a discount from the unpaid
principal and interest amounts of the loan and the estimated value of the
underlying property. A principal part of this strategy is the Company's focus on
commercial mortgage loans with purchase prices generally ranging from $1 million
to $10 million held by large private sector financial institutions. Due to the
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comparatively small size of these loans relative to a large institution's total
portfolio, the lender is often not able, or willing, to devote the managerial
and other resources necessary to resolve the problems to which the loans are
subject, and thus is sometimes willing to dispose of these loans at prices
favorable to the Company. The Company, which offers to acquire a loan quickly
and for immediate cash, provides a convenient way for an institution to dispose
of these loans and to eliminate future work-out costs. The Company believes that
the trend of consolidation in the banking industry, and the implementation of
risk-based capital rules in the insurance industry, may cause an increase in the
amount of smaller loans available for sale and provide the Company significant
opportunities for growth.
Efficient Resolution of Loans. The Company believes that a further
aspect of its success to date has been its ability to resolve problems
surrounding loans it has identified for acquisition. The principal element of
this strategy is the cost-effective use of management and third-party resources
to negotiate and resolve disputes concerning a troubled loan or the property
securing it, and to identify and resolve any existing operational or other
problems at the property. To implement this strategy, the Company has taken
advantage of the background and expertise of its management and has identified
third-party subcontractors (such as property managers and legal counsel)
familiar with the types of problems to which smaller commercial properties may
be subject and who have, in the past, provided effective services to the
Company.
Refinancing or Sale of Senior Lien Interests in Portfolio Loans. The
Company seeks to reduce its invested capital and enhance its returns through
sale, at a profit, of senior lien interests in its loans or through refinancing
of the properties underlying its loans by borrowers. In so doing, the Company
has in the past obtained, and in the future anticipates obtaining, a return of a
substantial portion of its invested capital (and in some cases has obtained
returns of amounts in excess of its invested capital), which it will typically
seek to reinvest in further loans, while maintaining a significant continuing
position in the original loan. See "- Commercial Mortgage Loan Acquisition and
Resolution: Sale of Senior Lien Interests and Refinancings." The Company also
anticipates sales of whole loans to the REIT (see "- Sponsorship of Real Estate
Investment Trust"). The Company's strategic plan contemplates continued growth
in its commercial mortgage loan portfolio, in part through the liquidity
provided by such sales or refinancings.
Disposition of Loans. In the event a borrower does not repay a loan
when due, the Company will seek to foreclose upon and sell the underlying
property or otherwise liquidate the loan. In appropriate cases and for
appropriate consideration, the Company may agree to forbear from the exercise of
remedies available to it. See "- Commercial Mortgage Loan Acquisition and
Resolution: Forbearance Agreements" and "- Loan Status."
Market for Commercial Mortgage Loan Acquisition and Resolution Services
The discounted loans acquired by the Company to date are secured by
commercial properties (generally multi-family housing, small office buildings,
hotels or single-user retail properties) which, while income producing, are
unable to meet fully debt service requirements of the original loan under its
then current terms. The loans are usually acquired from banks,
-7-
insurance companies, investment bankers, mortgage bankers or other similar
financial organizations. Typically, the loans identified by the Company for
acquisition (and the properties securing them) have been the subject of complex
and/or contentious legal and other disputes, operational difficulties or other
problems demanding commitments of managerial and other resources that are
perceived by the selling institutions to be inordinate relative to the
comparatively small asset value of these loans in the institution's total
portfolio.
The market for commercial mortgage loan acquisition and resolution
services of the type provided by the Company is, the Company believes,
relatively new. A major impetus to this market has been the sale of packages of
under-performing and non-performing loans by government agencies, in particular
the Resolution Trust Corporation ("RTC") and Federal Deposit Insurance
Corporation ("FDIC"). While the need for loan acquisition and resolution
services by governmental agencies has declined in recent years (the RTC
terminated its loan pool packaging and sales operations on December 31, 1995,
and any RTC assets remaining to be sold at that time were transferred to the
FDIC for sale), the Company believes that a permanent market for these services
is emerging in the private sector as financial institutions and other
organizations realize that outside specialists may be able to resolve troubled
loans more cost-efficiently than their internal staff. Moreover, the sale of
loans provides selling institutions with a means of disposing of
under-performing assets, thereby obtaining liquidity and improving their balance
sheets. The trend has been reinforced, management believes, by consolidation
within the banking industry, the implementation of risk-based capital rules
within the insurance industry, and by the standardization of financing criteria
by real estate conduits and other "securitization" outlets.
Acquisition and Administration Procedures for Commercial Mortgage Loan
Acquisition and Resolution Operations
Prior to acquiring any commercial mortgage loans, the Company conducts
an acquisition review. This review includes an evaluation of the adequacy of the
loan documentation (for example, the existence and adequacy of notes, mortgages,
collateral assignments of rents and leases, and title policies ensuring first or
other lien positions) and other available information (such as credit and
collateral files). The value of the property securing the loan is estimated by
the Company based upon a recent independent appraisal obtained by the borrower
or seller of the loan, an independent appraisal obtained by the Company, or upon
valuation information obtained by the Company and thereafter confirmed by an
independent appraisal. One or more members of the Company's management makes an
on-site inspection of the property and, where appropriate, the Company will
require further inspections by engineers, architects or property management
consultants. The Company may also retain environmental consultants to review
potential environmental issues. The Company obtains and reviews available
rental, expense, maintenance and other operational information regarding the
property, prepares cash flow and debt service analyses and reviews all pertinent
information relating to any legal or other disputes to which the property is
subject. The amount of the Company's offer to purchase any such loan is based
upon the foregoing evaluations and analyses. The Company generally will not
acquire a loan unless (i) current net cash flow from the property securing the
loan is sufficient to yield an immediate cash return on the Company's investment
of not less than 10% per annum, (ii) the
-8-
ratio of the Company's initial investment to the appraised value of the property
underlying the loan (utilizing an appraisal dated within one year of
acquisition) is less than 80%, (iii) there is the possibility of either prompt
refinancing of the loan by the borrower after acquisition, or sale by the
Company of a senior lien interest, that will result in an enhanced yield to the
Company on its (reduced) funds still outstanding (see "- Commercial Mortgage
Loan Acquisition and Resolution: Sale of Senior Lien Interests and
Refinancings"), and (iv) there is the possibility of a substantial increase in
the value of the property underlying the loan over its appraised value,
increasing the potential amount of the loan discount recoverable by the Company
at loan termination. On occasion, the Company will acquire a loan that does not
meet one or more of the criteria specified above if, in the Company's judgment,
other factors make the loan an appropriate investment opportunity. The Company
currently has in its portfolio eight loans in which the ratio of the cost of
investment to the appraised value (both at the time of acquisition and at the
date of the most recent appraisal) of the underlying property exceeds 80%. The
Company has a policy that appraisals of properties underlying loans be updated
no less often than every three years. Also, the Company has acquired loans
outside of its targeted investment cost range of $1 million to $10 million and,
as opportunities arise, may do so in the future. Five of the Company's portfolio
loans were acquired at a lesser investment cost, while two loans were acquired
at a greater cost ($10.6 million and $19.2 million, respectively). The Company
is not limited by regulation or contractual obligation as to the types of
properties that secure the loans it may seek to acquire or the nature or
priority of any lien or other encumbrance it may accept with respect to a
property. The Company also does not have restrictions regarding whether, after
sale of a senior lien interest or a refinancing, its interest in a particular
loan must continue to be secured (although the Company will typically retain a
subordinated lien position), the amount it may invest in any one loan, or the
ratio of initial investment cost-to-appraised value of the underlying property.
As part of the acquisition process, the Company typically resolves
disputes relating to the loans or the underlying properties. Through
negotiations with the borrower and, as appropriate or necessary, with other
creditors or parties in interest, the Company seeks to arrive at arrangements
that reflect more closely the current operating conditions of the property and
the present strategic position of the various interested parties. Where
appropriate, the Company will offer concessions to assure that the Company's
future control of the property's cash flow is free from dispute. These
arrangements are normally reflected in an agreement (a "Forbearance Agreement")
pursuant to which foreclosure or other action on the mortgage is deferred so
long as the arrangements reflected in the Forbearance Agreement are met. The
Company also seeks to resolve operational problems of the properties by
appointment of a property manager acceptable to it (see "- Commercial Mortgage
Loan Acquisition and Resolution: Forbearance Agreements") and may advance funds
for purposes of paying property improvement costs, unpaid taxes and similar
items. Prior to loan acquisition, the Company includes in its pre-acquisition
analysis of loan costs and yields an estimate of such advances. See "Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations: Results of Operations: Commercial Mortgage Loan Acquisition and
Resolution."
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Upon acquisition of a loan, the Company typically requires that all
revenues from the property underlying the loan be paid into an operating account
on which the Company or its managing agent is the sole signatory. All
expenditures with respect to a property (including debt service, taxes,
operational expenses and maintenance costs) are paid from the Company's account
and are reviewed and approved by a senior officer of the Company prior to
payment. The Company further requires that its approval be obtained before any
material contract or commercial lease with respect to the property is executed.
To assist it in monitoring the loan, the Company requires that the borrower
prepare a budget for the property not less than sixty days prior to the
beginning of a year, which must be reviewed and approved by the Company, and
submit both a monthly cash flow statement and a monthly occupancy report. The
Company analyzes these reports in comparison with each other and with account
activity in the operating account referred to above.
The Company may alter the foregoing procedures in appropriate
circumstances. Where a borrower has refinanced a loan held by the Company (or
where the Company has acquired a loan subject to existing senior debt), the
Company may agree that the revenues be paid to an account controlled by the
senior lienor, with the excess over amounts payable to the senior lienor being
paid directly to the Company. As of September 30, 1997, one of the Company's
loans (loan 17; see "- Commercial Mortgage Loan Acquisition and Resolution: Loan
Status") is subject to such a provision. Where the property is being managed by
Brandywine Construction & Management, Inc. ("BCMI"), a property manager
affiliated with the Company (see "- Commercial Mortgage Loan Acquisition and
Resolution: Forbearance Agreements"), the Company may direct that property
revenues be paid to BCMI, as the Company's managing agent. As of September 30,
1997, revenues are being paid to BCMI with respect to two loans (loans 25 and
30). Where the Company believes that operating problems with respect to an
underlying property have been substantially resolved, the Company may permit the
borrower to retain revenues and pay property expenses directly. The Company
currently permits borrowers with respect to three loans (loans 24, 27 and 37) to
do so.
Commercial Mortgage Loan Acquisition and Resolution: Sale of Senior Lien
Interests and Refinancings
In evaluating a potential mortgage loan, the Company places significant
emphasis on the likelihood of its being able to sell a senior lien interest on
favorable terms after the acquisition and/or the borrower's likely ability, with
or without the Company's assistance, to secure favorable refinancing. When a
loan is refinanced, or a senior lien interest sold, the Company will obtain net
sale or refinance proceeds in an amount representing a major portion of (and
sometimes exceeding) the amount of its investment in the loan. After sale of a
senior lien interest or refinancing, the Company will typically retain an
interest in the loan, which is usually subordinated to the interest of the
senior lienholder or refinance lender.
Where a senior lien interest is sold, the outstanding balance of the
Company's loan at the time of sale remains outstanding, including as a part of
that balance the amount of the senior lien interest. Thus, the Company's
remaining interest effectively "wraps around" the senior lien
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interest. Typically, the interest rate on the senior lien interest is less than
the stated rate on the Company's loan. Senior lien interests with an aggregate
balance of $12.0 million at September 30, 1997, relating to nine of the
Company's loans, obligate the Company, in the event of a default on a loan, to
replace such loan with a performing loan. These senior lien interests become due
upon the expiration of their respective Forbearance Agreements (two each in
1998, 1999, 2000 and 2001 and one in 2016). Three other senior lien interests,
with an aggregate balance of $10.3 million at September 30, 1997, obligate the
Company, upon their respective maturities, all in fiscal 2002, to repurchase the
senior lien interest (if not theretofore paid off) at a price equal to the
outstanding balance of the senior lien interest plus accrued interest. See
"Commercial Mortgage Loan Acquisition and Resolution: Loan Status."
Where a refinancing is effectuated, the Company reduces the amount
outstanding on its loan by the amount of net refinancing proceeds received by it
and either converts the outstanding balance of the original note (both principal
and accrued interest, as well as accrued penalties) into the stated principal
amount of an amended note on the same terms as the original note, or retains the
original loan obligation as paid down by the amount of refinance proceeds
received by the Company. As with senior lien interests, the interest rate on the
refinancing is less than the interest rate on the Company's retained interest.
After sale of a senior lien interest or a refinancing, the Company's
retained interest will usually be secured by a subordinate lien on the property.
In certain situations, however, (including seven loans constituting 8.3%, by
book value, of the Company's loans), the Company's retained interest may not be
formally secured by a mortgage because of conditions imposed by the senior
lender, although it 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 the Company's consent, and/or a similar device.
Commercial Mortgage Loan Acquisition and Resolution: Forbearance Agreements
Substantially all of the commercial mortgage loans acquired by the
Company are subject to Forbearance Agreements with borrowers pursuant to which
the holder of the loan (the Company, upon loan acquisition) (i) agrees, subject
to receipt of specified minimum monthly payments, to defer the exercise of
existing rights to proceed on the defaulted loan (including the right to
foreclose), (ii) receives the rents from the underlying property (either
directly or through a managing agent approved by the Company, subject to certain
exceptions; see "- Acquisition and Administration Procedures for Commercial Loan
Acquisition and Resolution Operations") and (iii) requires the borrower to
retain a property management firm acceptable to the holder. The Forbearance
Agreements also provide that any cash flow from the property (after payment of
Company-approved expenses and debt service on senior lien interests) above the
minimum payments will be retained by the Company and applied to accrued but
unpaid debt service on the loan. As a result of provision (iii), BCMI, an
affiliated property management company, has assumed responsibility for
supervisory and, in many cases, day to day management of the underlying
properties with respect to substantially all of the loans the Company currently
owns. In ten instances, the President of BCMI (or an entity affiliated with him)
has also acted as the
-11-
general partner or trustee of the borrower. The minimum payments required under
a Forbearance Agreement (generally related to anticipated cash flow from the
property after operating expenses) 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, but (except
for amounts recognized as an accretion of discount; see "- Commercial Mortgage
Loan Acquisition and Resolution: Accounting for Discounted Loans") are not
recognized as revenue to the Company until actually paid.
At the end of the term of a Forbearance Agreement, the borrower is
required to pay the loan in full. The borrower's ability to do so, however, will
be dependent upon a number of factors, including prevailing conditions at the
underlying property, the state of real estate and financial markets (generally
and as regards the particular property), and general economic conditions. In the
event the borrower does not or cannot do so, the Company anticipates that it
will seek to sell the property underlying the loan or otherwise liquidate the
loan. Alternatively, the Company anticipates that it might, in appropriate
cases, and for appropriate additional consideration, agree to further
forbearance.
An existing Forbearance Agreement remains in effect with no
modifications when the Company sells a senior lien interest in a loan. In such
instance, the purchaser's interest is in the loan subject to the terms of the
Forbearance Agreement. However, when a borrower refinances a loan, the
Forbearance Agreement is thereby amended to (i) reflect the pay down of the loan
balance, (ii) acknowledge the existence of the refinancing and (iii) provide for
the continued effectiveness of all provisions of the Forbearance Agreement for
the term specified therein, except that where specific provisions of the
Forbearance Agreement are inconsistent with the terms of the refinancing, the
terms of the refinancing have priority. In some refinancings, the refinance
lender may require that the borrower issue an amended note (a "retained interest
note") to reflect the reduction of the borrower's indebtedness to the Company
and, where applicable, any other revised terms.
Commercial Mortgage Loan Acquisition and Resolution: Loan Status
At September 30, 1997, the Company's loan portfolio consisted of 38
loans of which 28 loans were acquired as first mortgage liens and 10 loans were
acquired as junior lien obligations. The Company's strategy has been to acquire
loans in anticipation of selling a senior lien interest in the loan or in
anticipation of the borrower's refinancing of the loan. At September 30, 1997,
the Company had sold a senior lien interest in 14 loans in its portfolio,
(including senior interests in five loans acquired by the Company as junior lien
loans) and borrowers with respect to 12 of the Company's loans have obtained
refinancing (including a refinancing of one loan acquired by the Company as a
junior lien loan). After such sales and refinancings, the Company holds
subordinated interests in 30 loans of which seven interests, constituting
approximately 8.3% of the book value of the Company's loan portfolio, are not
collateralized by recorded mortgages (see "- Commercial Mortgage Loan
Acquisition and Resolution: Sale of Senior Lien Interests and Refinancings").
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The Company anticipates that 10 of its loans, and a senior lien
interest in an eleventh loan will be sold to the REIT. See "- Sponsorship of
Real Estate Investment Trust" and Note 9 to the following table.
-13-
The following table sets forth certain information relating to the
Company's investments in real estate loans at September 30, 1997.
Loan Outstanding
Loan Type of Acquired Loan
Number Property Location Seller/Originator (Fiscal Year) Receivable(1)
- ------ -------- -------- ----------------- ------------- -------------
001 Multifamily Pennsylvania Alpha Petroleum Pension Fund 1991 $ 8,471,635
002(9) Multifamily Pennsylvania CoreStates Bank(10) 1992 1,555,120
003 Multifamily New Jersey RAM Enterprises/Glenn Industries 1993 2,695,748
Pension Plan
004(9) Multifamily Pennsylvania St. Paul Federal Bank for Savings(12) 1993 1,481,638
005 Office Pennsylvania Shawmut Bank(10) 1993 6,273,329
006(9) Office/Retail Virginia Nationsbank(10) 1993 5,761,455
007 Single User Minnesota Prudential Insurance, Alpha 1993 4,441,379
(Retail) Petroleum Pension Fund
008(9) Multifamily Pennsylvania Nomura/Cargill/Eastdil Realty(13) 1994 5,389,823
009(9) Multifamily Pennsylvania Mellon Bank(10) 1995 1,638,263
010(9) Multifamily Pennsylvania RIVA Financial 1994 1,579,540
011 Office Washington, D.C. First Union Bank(10) 1995 1,410,289
012(9) Multifamily Pennsylvania CoreStates Bank(10)(12) 1995 3,036,879
013 Single User California California Federal Bank, FSB 1995 2,985,207
(Commercial)
014 Office Washington, D.C. Nomura/Cargill/Eastdil Realty(13) 1995/1997 14,786,192
015 Condo/ North Carolina First Bank, South Trust Bank(14) 1997 3,572,780
Multifamily
016 Single User California Mass Mutual, Alpha Petroleum 1995/1996 6,924,661
(Retail) Pension Fund
017 Single User West Virginia Triester Investments(10)(15) 1996 1,786,434
(Retail)
018 Single User California Emigrant Savings Bank, Walter 1996 2,933,154
(Retail) R. Samuels and Jay Furman(16)
019(9) Multifamily Pennsylvania Summit Bancorp(10) 1996 4,724,376
020 Office New Jersey Cargill/Eastdil Realty(13) 1996 7,026,381
021 Multifamily Pennsylvania Bruin Holdings/Berkeley Federal 1996/1997 9,743,475
Savings Bank
022 Multifamily Pennsylvania FirsTrust FSB 1996/1997 4,465,421
023(9) Multifamily Pennsylvania Jefferson Bank 1996 711,924 (20)
024 Multifamily Pennsylvania U.S. Dept. of Housing & Urban
Development 1996 3,427,673
025 Hotel/Commercial Georgia Bankers Trust Co. 1997 6,029,552
026 Office Pennsylvania FirsTrust FSB 1997 7,983,948
RESTUBBED FROM TABLE ABOVE
Appraised Value
Loan Type of of Property Cost of
Number Property Location Seller/Originator Securing Loan(2) Investment(3)
- ------ -------- -------- ----------------- ----------------- -------------
001 Multifamily Pennsylvania Alpha Petroleum Pension Fund $ 5,300,000 $ 4,628,323
002(9) Multifamily Pennsylvania CoreStates Bank(10) 900,000 547,813
003 Multifamily New Jersey RAM Enterprises/Glenn Industries 1,350,000 1,324,780
Pension Plan
004(9) Multifamily Pennsylvania St. Paul Federal Bank for Savings(12) 1,200,000 862,356
005 Office Pennsylvania Shawmut Bank(10) 1,700,000 1,242,218
006(9) Office/Retail Virginia Nationsbank(10) 2,800,000 2,388,018
007 Single User Minnesota Prudential Insurance, Alpha 2,515,000 1,354,382
(Retail) Petroleum Pension Fund
008(9) Multifamily Pennsylvania Nomura/Cargill/Eastdil Realty(13) 3,200,000 1,614,174
009(9) Multifamily Pennsylvania Mellon Bank(10) 2,700,000 1,362,884
010(9) Multifamily Pennsylvania RIVA Financial 800,000 456,356
011 Office Washington, D.C. First Union Bank(10) 2,000,000 1,180,030
012(9) Multifamily Pennsylvania CoreStates Bank(10)(12) 2,200,000 1,296,565
013 Single User California California Federal Bank, FSB 2,400,000 1,694,799
(Commercial)
014 Office Washington, D.C. Nomura/Cargill/Eastdil Realty(13) 11,000,000 10,566,013
015 Condo/ North Carolina First Bank, South Trust Bank(14) 3,702,000 2,787,774
Multifamily
016 Single User California Mass Mutual, Alpha Petroleum 3,000,000 2,083,399
(Retail) Pension Fund
017 Single User West Virginia Triester Investments(10)(15) 1,900,000 1,070,597
(Retail)
018 Single User California Emigrant Savings Bank, Walter 4,555,000 2,224,658
(Retail) R. Samuels and Jay Furman(16)
019(9) Multifamily Pennsylvania Summit Bancorp(10) 5,725,000 3,758,685
020 Office New Jersey Cargill/Eastdil Realty(13) 4,600,000 2,981,599
021 Multifamily Pennsylvania Bruin Holdings/Berkeley Federal 4,222,000 2,453,501
Savings Bank
022 Multifamily Pennsylvania FirsTrust FSB 4,110,000 2,409,598
023(9) Multifamily Pennsylvania Jefferson Bank 600,000 427,474
024 Multifamily Pennsylvania U.S. Dept. of Housing & Urban
Development 3,250,000 2,730,183
025 Hotel/Commercial Georgia Bankers Trust Co. 8,500,000 5,877,058
026 Office Pennsylvania FirsTrust FSB 5,000,000 3,581,137
-14-
Loan Outstanding
Loan Type of Acquired Loan
Number Property Location Seller/Originator (Fiscal Year) Receivable(1)
- ------ -------- -------- ----------------- ------------- -------------
027(9) Office Pennsylvania Lehman Brothers Holdings, Inc. 1997 $ 52,644,228
028 Condo/ North Carolina First Bank, SouthTrust Bank(23) 1997 1,678,680
Multifamily
029 Commercial/ Pennsylvania Castine Associates, L.P.(24) 1997 6,962,930
Retail
030 Hotel Nebraska CNA Insurance 1997 6,456,907
031 Multifamily Connecticut John Hancock Mutual Life 1997 6,251,307
Insurance Company
032 Multifamily New Jersey John Hancock Mutual Life 1997 12,210,777
Insurance Company
033 Single User/ Virginia Brambilla, Ltd. 1997 3,970,564
Retail
034 Multifamily Pennsylvania Resource America, Inc.(26) 1997 400,622
035 Office Pennsylvania Jefferson Bank 1997 2,321,627
036 Office North Carolina Union Labor Life Insurance Co. 1997 4,475,257
037 Multifamily Florida Howe, Soloman & Hall 1997 6,876,566
Financial, Inc.
038(9) Office/Retail Pennsylvania Resource Asset Investment Trust(26) 1997 8,580,000
-------------
Balance as of September 30, 1997 $233,665,613
============
RESTUBBED FROM TABLE ABOVE
Appraised Value
Loan Type of of Property Cost of
Number Property Location Seller/Originator Securing Loan(2) Investment(3)
- ------ -------- -------- ----------------- ----------------- -------------
027(9) Office Pennsylvania Lehman Brothers Holdings, Inc. $ 34,000,000 $ 19,240,747
028 Condo/ North Carolina First Bank, SouthTrust Bank(23) 1,773,000 1,028,143
Multifamily
029 Commercial/ Pennsylvania Castine Associates, L.P.(24) 4,000,000 2,978,752
Retail
030 Hotel Nebraska CNA Insurance 4,000,000 3,740,922
031 Multifamily Connecticut John Hancock Mutual Life 7,500,000 4,678,000
Insurance Company
032 Multifamily New Jersey John Hancock Mutual Life 12,425,000 7,410,218
Insurance Company
033 Single User/ Virginia Brambilla, Ltd. 2,650,000 1,995,705
Retail
034 Multifamily Pennsylvania Resource America, Inc.(26) 450,000 400,000
035 Office Pennsylvania Jefferson Bank 2,550,000 1,582,088
036 Office North Carolina Union Labor Life Insurance Co. 4,150,000 3,050,200
037 Multifamily Florida Howe, Soloman & Hall 3,500,000 2,796,393
Financial, Inc.
038(9) Office/Retail Pennsylvania Resource Asset Investment Trust(26) 10,600,000 8,580,000
------------- -------------
Balance as of September 30, 1997 $176,827,000 $120,385,542
============ ============
-15-
Proceeds from Company's Net Maturity of Loan/
Ratio of Cost Refinancing or Interest In Expiration of
Loan of Investment to Sale of Senior Net Carried Cost Outstanding Loan Forbearance
Number Appraised Value Lien Interests Investment(4) of Investment(5) Receivables(6) Agreement(7)
- ------ --------------- -------------- ------------- ---------------- -------------- ------------
001 87% $ 2,570,000 (8) $ 2,058,323 $ 2,503,108 $ 5,945,935 12/31/02
002 61% 575,000 (11) (27,187) 185,295 955,120 10/31/98
003 98% 627,000 697,780 725,350 2,058,198 01/01/03
004 72% 871,000 (11) (8,644) 238,958 585,638 10/31/98
005 73% 940,000 (11) 302,218 785,814 5,433,329 02/07/01
006 85% 840,000 1,548,018 1,670,669 4,881,874 07/31/98
007 54% 2,099,000 (744,618) 555,149 2,295,519 12/31/14
008 50% 934,300 679,874 1,058,457 4,287,524 07/31/98
009 50% 654,600 708,284 579,159 750,691 11/01/99
010 57% 575,000 (11) (118,644) 133,073 979,540 09/02/99
011 59% 660,000 (11) 520,030 670,564 725,289 09/30/99
012 59% 1,079,000 217,565 747,650 1,778,063 12/02/99
013 71% 1,975,000 (11) (280,201) 328,767 985,207 05/01/01
014 96% 6,487,000 4,079,013 5,297,790 8,041,969 11/30/98
015 75% 2,558,000 (8) 229,774 3,572,780 1,211,780 08/25/00
016 69% 2,375,000 (11) (291,601) 469,130 4,524,661 12/31/00
017 56% 693,000 (8) 377,597 965,512 1,116,845 12/31/18
018 49% 1,969,000 (11) 255,658 886,261 964,154 12/01/00
019 66% 3,020,000 738,685 956,429 1,539,656 12/29/00
020 65% 2,562,000 419,599 1,856,859 4,623,458 02/07/01
021 60% 2,010,000 (11) 443,501 1,496,972 7,733,475 07/01/16 (17)
022 59% 2,636,000 (18)(19) (226,402) 862,459 1,795,337 10/31/98
023 71% 450,000 (21) (22,526) 128,641 263,041 03/28/01
024 84% 2,318,750 411,433 804,390 927,673 11/01/22
025 69% - 5,877,058 6,102,725 6,029,552 12/31/15
026 72% 2,240,000 (22) 1,341,137 2,312,620 5,738,258 09/30/03
-16-
Proceeds from Company's Net Maturity of Loan/
Ratio of Cost Refinancing or Interest In Expiration of
Loan of Investment to Sale of Senior Net Carried Cost Outstanding Loan Forbearance
Number Appraised Value Lien Interests Investment(4) of Investment(5) Receivables(6) Agreement(7)
- ------ --------------- -------------- ------------- ---------------- -------------- ------------
027 57% $7,920,000 (18) $11,320,747 $16,615,724 $44,644,228 01/01/02
028 58% - 1,028,143 1,678,680 1,678,680 03/31/02
029 75% 750,000 (25) 2,228,752 2,464,174 6,212,930 07/01/02
030 94% - 3,740,922 3,816,425 6,456,907 09/30/02
031 62% - 4,678,000 4,704,270 6,251,307 09/01/05
032 60% - 7,410,218 7,451,074 12,210,777 09/01/05
033 80% - 1,995,705 628,671 2,595,241 02/01/21
034 89% - 400,000 400,000 400,622 10/01/02
035 63% 750,000 (25) 832,088 1,081,234 1,571,627 09/25/02
036 76% - 3,050,200 3,074,544 4,475,257 12/31/11
037 80% - 2,796,393 2,826,741 6,876,566 07/01/00
038 81% - 8,580,000 8,580,000 8,580,000 03/31/02
----------- ------------ ------------ -------------
Balance as of September 30, 1997 $53,138,650 $67,246,892 $89,216,118 $178,125,928
=========== =========== =========== ============
-17-
(1) Consists of the stated, or face value of the obligation plus accrued
interest and penalties and the outstanding balance of the senior lien
interest at September 30, 1997.
(2) The Company's policy is to obtain an appraisal of a property underlying a
loan at least once every three years. Accordingly, appraisal dates range
from 1994 to 1997.
(3) Consists of the original cost of the investment to the Company (including
acquisition costs and the amount of any senior lien interest to which the
property remained subject) plus subsequent advances, but excludes the
proceeds to the Company from the sale of senior lien interests or
borrower refinancings.
(4) Represents the unrecovered costs of the Company's investment, calculated
as the cash investment made in acquiring the loan plus subsequent
advances less cash received from sale of a senior lien interest in or
borrower refinancing of the loan. Negative amounts represent the receipt
by the Company of proceeds from the sale of senior lien interests or
borrower refinancings in excess of the Company's investment.
(5) Represents the cost of the investment carried on the books of the Company
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 $400,000. For a discussion of
accretion on discount and allocation of gains, see "- Commercial Mortgage
Loan Acquisition and Resolution: Accounting for Discounted Loans."
(6) Consists of the amount set forth in the column "Outstanding Loan
Receivable" less the outstanding balance of senior lien interests at
September 30, 1997.
(7) With respect to loans 6, 7, 8, 14, 25, 27, 30, 31, 32, 34, 35 and 38, the
date given is for the maturity of the subordinate note for the residual
loan balance received by the Company in connection with the refinancing.
For the remaining loans, the date given is the expiration date of the
related Forbearance Agreement.
(8) Represents the amount of the senior lien interest in place on date of
acquisition.
(9) It is anticipated that these loans will be sold to the REIT. See "-
Sponsorship of Real Estate Investment Trust."
(10) Successor by merger to the Seller.
(11) Senior lien interest sold subject to the right of the holder (Citation
Insurance Company, a subsidiary of Physicians Insurance Company of Ohio),
upon default, to require the Company to substitute a performing loan.
(12) Seller was a wholly-owned subsidiary of this institution.
-18-
(13) Seller was a partnership of these entities.
(14) Original lending institutions. In March 1997, as a result of agreements
among the borrower, the Company and a third party, Concord Investment,
L.P. ("Concord"), the borrower's partnership interests were transferred
to the Company which resold them to Concord for a mortgage note (which
wrapped around certain senior indebtedness), and cash.
(15) The loan acquired consists of a series of notes becoming due yearly
through December 31, 2018. The notes are being paid in accordance with
their terms and, accordingly, a Forbearance Agreement was not required.
(16) Amounts advanced by the Company were used in part to repay the loan of
Emigrant Savings Bank; the balance was applied to purchase a note held by
Messrs. Samuels and Furman.
(17) The loan acquired consists of 31 separate mortgage loans on 49 individual
condominium units in a single building. Nine of such loans are due July
1, 2016, eighteen are due January 1, 2015, one is due October 1, 2007,
one is due March 1, 2001 and two are due October 9, 2001.
(18) Two senior lien interests were sold to Commerce Bank, N.A. ("Commerce").
The Company has the obligation to repurchase these senior lien interests,
at Commerce's option, on or after June 27, 2002 (loan 22) and September
29, 2002 (loan 27), if the senior lien interest is not repaid in
accordance with its terms by the borrower.
(19) Junior lien interest sold to Crafts House Apartments Partners, L.P., a
limited partnership in which officers and directors of the Company
beneficially own a 21.3% interest.
(20) Includes a note for $14,948 which is payable to the Company on demand.
(21) Senior lien interest sold to Crusader Bank. If not repaid at its maturity
date, the Company is required to repurchase the interest at a price equal
to its unpaid principal balance plus accrued interest.
(22) Senior lien interest sold to CRC-Axewood Partners, L.P., a limited
partnership in which officers and directors of the Company beneficially
own an 18.3% interest.
(23) Original lending institutions. In connection with the transactions
referred to in Note (14), Concord acquired other condominium units in the
same building. These units secured a loan in the original principal
amount of $910,000 held by the Company. As part of that acquisition, the
Company made an additional mortgage loan to Concord of $797,675.
(24) From 1993 to October 1997 an officer of the Company served as the General
Partner.
-19-
(25) Senior lien interest sold to Peoples Thrift Savings Bank.
(26) Consists of four related loans to one borrower secured by two properties.
-20-
The following table sets forth the average monthly cash flow from the
properties underlying loans 1 through 29, the average monthly debt service
payable to senior lienholders and refinance lenders and the average monthly
payment with respect to the Company's retained interest, based on three months
ended September 30, 1997:
Average Average Monthly Debt Average Monthly
Monthly Cash Service on Payment to
Loan Flow from Refinancing or the Company's
Number Property (1)(2) Senior Lien Interests(3) Interest (2)
------- --------------- ------------------------ ----------------
001 $ 37,581 $ 26,425 $ 11,156
002 7,646 4,875 2,771
003 6,629 6,058 571
004 10,718 7,280 3,438
005 12,262 6,825 5,437
006 24,964 8,021 16,943
007 21,300 20,400 900
008 27,839 10,670 17,169
009 21,646 7,359 14,287
010 8,467 4,875 3,592
011 11,843 5,566 6,277
012 19,517 10,317 9,200
013 27,821 15,833 11,988
014 156,369 58,551 97,818
015 & 028 (4) 33,834 26,113 7,721
016 23,917 19,500 4,417
017 10,690 9,190 1,500
018 24,827 (5) 15,998 8,829
019 58,364 25,300 33,064
020 41,732 19,527 22,205
021 19,204 16,331 2,873
022 30,731 24,365 6,366
023 6,065 3,932 2,133
024 28,066 17,474 10,592
025 45,967 - 45,967
026 26,537 10,800 15,737
027 224,958 102,713 122,245
029 20,997 6,250 (6) 14,747
---------- -------- --------
$ 990,491 (7) $490,548 (7) $499,943 (7)
========== ======== ========
-21-
(1) "Cash Flow" as used in this table is that amount equal to the operating
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) Except as set forth in Note (4), monthly cash flow from each of the
properties has been calculated as the average monthly amount during the
three-month period ended September 30, 1997.
(3) Monthly debt service consists of required payments of principal, interest
and other regularly recurring charges payable to the holder of the
refinancing loan or senior lien interest.
(4) Loans 15 and 28 are secured by different condominium units in the same
property and are, accordingly combined for cash flow purposes.
(5) Includes one twelfth of an annual payment of $110,000 received in
December of each year.
(6) Prior to September 29, 1997, this note was subordinate to a senior lien
interest of approximately $952,000 with monthly debt service of $8,990.
On September 29, 1997, the senior lien interest was repaid through sale
of a senior lien interest to another institution.
(7) Excludes amounts attributable to loans 30 through 38, which are referred
to in the table below. For certain information regarding the combined
results for all loans (including estimated results) see Note (4) to the
table below.
The loans in the following table have been recently acquired by the
Company and, accordingly, the table sets forth monthly cash flow, debt service
and payment to the Company's interest based upon the Company's experience with
such loans for periods after September 30, 1997, as noted. Except as set forth
in Note (3) below, "cash flow" and "monthly debt service" are as defined in
notes (1) and (3) to the previous table.
Monthly Debt Monthly
Monthly Cash Service on Payment to
Loan Flow from Refinancing or the Company's
Number Property Senior Lien Interests Interest
------ -------- --------------------- --------
030 $ 60,194 (1) $ - $ 60,194
031 41,445 (1) - 41,445
032 76,056 (1) - 76,056
033 21,940 (2) - 21,940
034 5,577 (1) - 5,577
035 25,131 (1) 6,250 18,881
036 31,598 (1) - 31,598
037 25,000 (1) - 25,000
038 77,400 (3) - 77,400 (3)
-------- ------ --------
$364,341 (4) $6,250 (4) $358,091 (4)
======== ====== ========
-22-
(1) Based upon cash flow for the three months ended November 30, 1997.
(2) Based upon cash flow for the two months ended November 30, 1997.
(3) Loan was originated by, and it is anticipated will be sold to, the REIT
and is a non- discounted loan. Accordingly "cash flow" consists of
required payments of principal and interest on the loan.
(4) Combined with the prior table, total monthly cash flow would be
$1,354,832 total monthly debt service on refinancings or senior lien
interests would be $496,798 and total monthly payment to the Company's
interest would be $858,034.
All of the Company's portfolio loans are currently performing in
accordance with their respective repayment terms under Forbearance Agreements or
retained interest notes.
Commercial Mortgage Loan Acquisition and Resolution: Accounting for Discounted
Loans
The difference between the Company's cost basis in a loan and the sum
of projected cash flows from, and the appraised value of, the underlying
property (up to the amount of the loan) is accreted into interest income over
the estimated life of the loan using a method which approximates the level yield
method. The projected cash flows from the property are reviewed on a quarterly
basis and changes to the projected amounts reduce or increase the amounts
accreted into interest income over the remaining life of the loan on a method
approximating the level yield method.
The Company records the investments in its loan portfolio at cost,
which is significantly discounted from the face value of, and accrued interest
and penalties on, the notes. This discount (as adjusted to give effect to
refinancings and sales of senior lien interests) totaled $86.3 million, $40.0
million and $16.1 million at September 30, 1997, 1996 and 1995, respectively.
The cost basis in the various loans is periodically reviewed to determine that
it is not greater than the sum of the projected cash flows and the appraised
value of the underlying properties. If the cost basis were found to be greater,
the Company would provide, through a charge to operations, an appropriate
allowance. For the year ended September 30, 1997, the Company recorded a
provision for possible losses of $400,000 to reflect the increase in size of its
commercial loan portfolio. For the years ended September 30, 1996 and 1995, no
such provision was required.
Gains on the sale of a senior lien interest in a loan (or gains, if
any, from the refinancing of a loan) are allocated between the portion of the
loan sold or refinanced and the portion retained based upon the fair value of
those respective portions on the date of such sale or refinancing. Any gain
recognized on a sale of a senior lien interest or a refinancing is brought into
income on the date of such sale or refinancing.
Commercial Mortgage Loan Acquisition and Resolution: Competition
-23-
Although the commercial mortgage loan acquisition and resolution
business is intensely competitive in virtually all of its aspects, the Company's
focus on the acquisition of relatively small troubled commercial mortgage loans
subject to complex and/or contentious situations is a niche in which the Company
believes there are relatively few, specialized investors. In the overall market
for the acquisition of real estate obligations, however, there are a substantial
number of competitors (including investment partnerships, financial
institutions, investment companies, public and private mortgage funds and other
entities), many of which possess far greater financial resources than the
Company. The Company's ability to add to its loan portfolio will depend on its
success in obtaining funding for the acquisition of additional mortgages. In
raising such funds in the financial capital markets, the Company will have to
compete for capital based largely on the Company's overall financial performance
and, more specifically, the performance of the Company's loan portfolio.
Residential Mortgage Loans
The Company's residential mortgage loan business focuses upon loans to
individuals secured by one- to four-family residences. Depending upon the credit
qualification of a borrower, the Company may originate loans for its portfolio
with a loan-to-value ratio of up to 60% (for the least qualified borrowers) to
90% (for the most qualified borrowers). In addition, the Company originates "125
Loans" (that is, loans with a cumulative loan-to-value ratio of up to 125%)
provided that such loans are approved for acquisition by third-party purchasers
prior to funding. On November 5, 1997, the Company acquired Tri-Star, an
originator of non-conforming residential mortgage loans, which operates in six
states (Delaware, Maryland, New Jersey, Pennsylvania, Ohio and Virginia).
Tri-Star originated $46 million in mortgage loans in calendar year 1996 and, for
the first ten months of 1997, originated $51 million of residential mortgage
loans. FMF and Tri-Star, through which the Company conducts its residential
mortgage lending operations, are currently separate subsidiaries of the Company
which the Company anticipates merging upon completion of regulatory requirements
relating to transfer of residential mortgage lending licenses.
The Company originates residential mortgage loans directly with
consumers rather than acquiring such loans in bulk from other originators. The
Company primarily originates its loans through retail/consumer direct channels
(principally direct mail) under the trade name USDirect Mortgage. Potential
customers are identified using statistical models predicting consumer need and
capacity for a mortgage loan. The Company also anticipates entering into
"private label" arrangements with financial institutions and other entities to
originate loans by providing loan underwriting, processing and other services to
these institutions for their non-conforming borrowers. The Company reduces the
time and costs related to underwriting, processing and funding residential
mortgage loans, and attempts to increase the consistency of its loan
underwriting, through an automated underwriting and processing system which
incorporates a proprietary credit evaluation system developed from industry data
and parameters established by FMF's management. Although to date the Company has
funded substantially all of its loans through internally available resources,
the Company (through FMF) has arranged two warehouse
-24-
lines of credit, with an aggregate credit amount of $20 million, to fund its
lending operations. See "- Sources of Funds."
The Company anticipates that, in the first quarter of fiscal 1998, it
will commence sales or securitizations of residential mortgage loans held in its
portfolio. The Company (through FMF) is approved as a loan seller to six
investors (Unicor Mortgage, Inc., Industry Mortgage Company, Key Home Equity,
Delta Funding Corporation, Cityscape Corporation and The Money Store). The
Company anticipates that, initially, all loan sales will be on a
service-released basis. However, as FMF and Tri-Star develop their operations
and increase staffing, they may sell loans on a service-retained basis and may
retain certain loans for their portfolios.
Sponsorship of Real Estate Investment Trust
The Company is the sponsor of the REIT which has filed a registration
statement with the Securities and Exchange Commission for the public offer and
sale of its common shares of beneficial interest. The REIT's primary business
will be to acquire or originate mortgage loans in situations that, generally, do
not conform to the underwriting standards of institutional lenders or sources
that provide financing through securitization. Although the REIT may acquire
mortgage loans at a discount, it seeks to acquire such loans where the workout
process has been initiated and where, unlike the mortgage loans acquired by the
Company, there is no need for the REIT's active intervention. It is anticipated
that the REIT will commence operations in December, 1997.
As sponsor of the REIT, the Company will acquire 9.8% of the REIT's
common shares of beneficial interest upon completion of the REIT offering, at an
anticipated cost of approximately $11.4 million, and have the right to purchase
up to 15% of the REIT's common shares. So long as the Company owns 5% or more of
the REIT's common shares, the Company will have the right to nominate one person
to the REIT's board of trustees. The Company will sell 10 of its mortgage loans
and a senior lien interest in an eleventh loan (representing a net investment by
the Company at September 30, 1997 of $22.2 million) to the REIT, as part of the
REIT's initial investments, for $27.7 million. The Company may sell further
loans to the REIT, to a maximum of 30% of the REIT's investments (on a cost
basis), excluding the initial investments. Betsy Z. Cohen, spouse of the
Company's Chairman and Chief Executive Officer, is the Chairman and Chief
Executive Officer of the REIT. Jonathan Z. Cohen, the son of Mrs. Cohen and
Edward E. Cohen, Chairman and Chief Executive Officer of the Company, is the
Company's nominee to the REIT's board of trustees. To mitigate potential
conflicts of interest, the Company has agreed to certain restrictions for a
period of two years following completion of the REIT's offering of common
shares, including agreements not to sponsor another mortgage REIT and to provide
certain rights of first refusal on originated mortgage loans (but not mortgage
loans acquired from third parties) and on mortgage loans that the Company seeks
to sell.
-25-
Equipment Leasing
General
The Company conducts its leasing operations through three corporate
divisions: Fidelity Leasing, Inc. ("FLI"), which conducts the Company's small
ticket leasing operations; F.L. Partnership Management, Inc. ("FLPM"), which
manages six public leasing partnerships; and FL Financial Services, Inc.
("FLFS"), which provides lease finance placement and advisory services. The
Company's primary focus in its equipment leasing operations is on the
development of FLI, which commenced small ticket leasing operations in June
1996. FLPM's operations will be reduced over the next several years as
partnership assets are sold and cash is distributed back to the investors. FLPM
does not anticipate forming new limited partnerships in the future. FLFS will
continue to operate its lease finance placement and advisory business which,
while profitable, is not expected to constitute a material source of revenues
for the Company.
Strategy
Focus on Small Ticket Leasing. The Company focuses on leasing equipment
costing between $5,000 and $100,000. By so doing, the Company takes advantage
not only of the background and expertise of its leasing management team, but
also of the servicing platform the Company has acquired and developed, which has
the capacity to monitor the large amounts of equipment and related assets
involved in a small-ticket leasing operation. In addition, small ticket items
represent a substantial portion of the equipment sought by small business, a
segment of the end-user market the Company believes is under-served by equipment
lessors, banks and other financial institutions, thereby affording the Company a
niche market with significant growth potential (see "Strategy - Focus on Leasing
to Small Businesses," below). Moreover, the small size of a typical transaction
relative to the Company's total lease portfolio reduces the Company's credit
risk exposure from any particular transaction.
Focus on Vendor Programs. The significant majority of equipment leased
to end-user customers by the Company will be purchased from manufacturers or
regional distributors with whom the Company is establishing vendor programs. In
so doing, the Company utilizes the manufacturer's or distributor's sales
organization to gain access to the manufacturer's end-user base without
incurring the costs of establishing independent customer relationships. The
Company is actively pursuing the establishment of multiple vendor programs in an
effort to reduce its reliance on any one vendor and, thus, to reduce the risk of
tying the success of the Company's leasing operations to the continuation of a
relationship with one (or a small group) of vendors. The Company has currently
established programs with ten manufacturers or distributors. Two of such
manufacturers (Minolta Corporation and Lucent Technologies, Inc.) accounted for
23% and 6.6%, respectively, of the equipment (by cost) leased by the Company
during fiscal 1997.
Focus on Leasing to Small Businesses. The Company focuses its marketing
programs and resources on lease programs for small business end-users (generally
those with 500 or fewer
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employees). The Company has acquired and developed credit evaluation and scoring
systems (based upon credit evaluation services provided by Dunn & Bradstreet)
which it believes significantly reduce the credit risk in dealing with small
business end-users (see "- Small Ticket Leasing"). The Company also believes
that small business end-users, while sensitive to the size of a monthly lease
payment, are less sensitive than large end-users to the interest rate structure
of a lease, allowing the Company to increase its yield by lengthening lease
terms to lower monthly rent. The Company currently offers lease terms from one
to five years to meet the needs of its end-users and will consider other lease
terms in appropriate circumstances.
Focus on Full-Payout Leases. The Company seeks to reduce the financial
risk associated with the lease transactions it originates through the use of
full-payout leases. The principal benefit from this lease format is the
repayment to the Company during the lease term of its invested capital plus an
amount sufficient to cover its transaction costs and, typically, a minimum
return on its invested capital. To the extent possible, the Company seeks to
substantially increase this return through amounts received upon remarketing the
equipment or through continued leasing of the equipment after expiration of the
initial lease term.
Focus on Providing Service. The Company provides service and support to
its small business customers and vendors by seeking to minimize the time
required to respond to customer applications for lease financing and by
providing sales training programs to its vendors and their sales staff (which it
customizes to their particular needs) regarding the use of lease financing for
marketing purposes to increase a vendor's equipment sales and market share. The
Company has acquired and developed proprietary management systems to assist it
in providing lease quotes and application decisions to its customers, generally
within 4 hours after receipt of a request.
Small Ticket Leasing
The Company offers full-payout leases with options, exercisable by the
lessee at the end of the lease term, either to purchase the equipment at fair
market value, to purchase the equipment for a fixed price negotiated at the time
the lease is signed, or to continue as a lessee on a month-to-month basis. A
"full-payout lease" is a lease under which the non-cancelable rental payments
due during the initial lease term are at least sufficient to recover the
purchase price of the equipment under the lease, related acquisition fees and,
typically, a minimum return on the Company's invested capital. The Company's
leases have a provision which requires the lessee to make all lease payments
under all circumstances. The leases are also net leases, requiring the lessee to
pay (in addition to rent) any other expenses associated with the use of
equipment, such as maintenance, casualty and liability insurance, sales or use
taxes and personal property taxes. The Company offers lease terms from one to
five years and will consider other lease terms in appropriate circumstances.
The equipment that the Company presently purchases for lease includes
document processing and storage equipment, telecommunications systems, computer
equipment, small manufacturing machines and office furniture. The table below
sets forth the distribution of
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equipment purchased by the Company, by product type and percentage of dollar
volume of equipment purchased, during fiscal years 1997 and 1996.
Equipment Volume by Product Type
(% by dollar volume of equipment purchased)
Fiscal Year Ended September 30,
1997 1996
---- ----
Document processing and storage......... 49% 73%
Telecommunications...................... 37% 21%
Computer systems........................ 8% 6%
Other................................... 6% -
---- ---
Total................................. 100% 100%
==== ====
The Company has developed a credit evaluation system, known as the
"Small Business Credit Scoring System," which is intended to respond to the
inability of small businesses to supply standardized financial information for
credit analysis (for example, audited financial statements). The system operates
by assigning point amounts, or "scores," to various factors (such as business
longevity, type of business, payment history, bank account balances and credit
ratings) deemed relevant by the Company in determining whether an end-user is a
creditworthy lessee. The scoring system declines approval of end-users with low
scores, approves end-users with high scores and refers mid-range scores to
credit analysts for further consideration and decision. Information is obtained
from the end-user, from reports by standard credit reporting firms and from
reports provided by consumer credit bureaus. The credit scoring system is also
based upon industry data and the past experience of the Company and will be
reviewed and modified as required in response to actual portfolio performance.
Financial statements may be required for larger transactions (in the $30,000 to
$100,000 range) as a complement to the scoring system.
The Company oversees its leasing program through lease administration
and management systems which control invoicing, collection, sales and property
taxes and financial and other reporting to management (including reports
regarding regular payments, payment shortages, advance payments, security
deposits, insurance payments and late or finance charges). The Company has
supplemented the system with an internal audit department (which evaluates the
safeguarding of assets, reliability of financial information and compliance with
the Company's credit policies) and a collection department.
The Company is marketing its leasing services primarily through the
establishment of vendor programs. See "- Strategy: Focus on Vendor Programs."
The Company has currently entered into vendor program relationships with nine
vendors: Minolta Corporation (copiers), Celsis Incorporated (microbial testing
systems), American Marbacom Communications (Teleco) (telephone systems), CSi
(test equipment), Telrad Communications (telephone systems), CT
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Solutions (computer telephony), ATI Communications (telephone systems), the
National Association of College Stores (affinity program) and Millipore Corp.
(test equipment). In addition, Lucent Technologies (telecommunications
equipment) has designated the Company as an authorized lessor for its dealer
distribution channel. Under a typical vendor program, the Company will work with
the vendor and the lessee to structure the lease, finance the lease, purchase
the related equipment and administer the lease, including providing all billing
and collection services (except for private-label leasing, referred to below).
At the end of the initial lease term, the Company and the vendor will typically
coordinate the re-marketing of the equipment. The Company seeks to establish
vendor relationships by (i) obtaining manufacturers' endorsements of the
Company's finance programs, (ii) offering inventory financing credit lines to a
manufacturer's vendors, (iii) developing customized sales training programs to
offer to vendors and (iv) assisting the manufacturers and their vendors in
establishing a sales package including the lease financing provided by the
Company. The Company also competes by establishing private-label leasing
programs with its vendors. Private-label leasing involves the lease by a vendor
of its own equipment on a lease form bearing the vendor's name as lessor (but
otherwise identical to the Company's lease form), the sale of the lease and
equipment to the Company, and the provision of basic administrative services by
the vendor (such as billing and collecting rent). The Company will provide
assistance, particularized rental payment structures and other customized lease
terms, remarketing, customized invoicing and management information reports. The
Company also seeks to develop programs marketing directly to end-user groups,
primarily through small business affinity groups or associations, participations
in trade shows and conventions, and media advertising.
Although there can be no assurance, it is anticipated that a
significant portion of the Company's revenues from leasing operations will be
derived from residuals. The Company anticipates that residuals will principally
involve the original end-users; however, equipment not sold or re-leased to
end-users will be disposed of in the secondary market. While residual
realization is generally higher with original end-users than in the secondary
market, the secondary market (essentially, networks of distributors and dealers
in various equipment categories) is well developed in the product categories the
Company currently pursues and transactions in these product categories have
historically resulted in residual recoveries, on average, equal to the book
value of the equipment. Equipment reacquired by the Company prior to lease
termination (through lease default or otherwise) will be sold in the secondary
market.
Partnership Management
The Company acts as the general partner and manager of six public
limited partnerships formed between 1985 and 1990 with total assets at September
30, 1997 of $36.1 million, including $19.5 million (book value) of equipment
with an original cost of $55.2 million. The partnerships primarily lease
computers and related peripheral equipment to investment grade, middle market,
capital intensive companies. The principal stated objective of each of the
limited partnerships is to generate leasing revenues for distribution to the
investors in the partnerships.
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For its services as general partner, the Company receives management
fees, an interest in partnership cash distributions and a reimbursement of
specified expenses related to administration of the partnerships (including
costs of non-executive personnel, legal, accounting and third-party contractor
fees and costs, and costs of equipment used in a partnership's behalf).
Management fees range from 3% to 6% of gross rents except that, if leases are
full payout leases, management fees range from 1% to 3% of gross rents. In four
of the partnerships, management fees are subordinated to the receipt by limited
partners of a cumulative annual cash distribution of 11% (two partnerships) or
12% (two partnerships) of the limited partners' aggregate investment. The
Company's interest, as general partner, in cash distributions from the
partnerships is 5% (one partnership), 3.5% (one partnership) and 1% (four
partnerships).
Lease Finance Placement and Advisory Business
The Company also operates a lease finance placement and advisory
business which focuses on two related types of leasing transactions: the
origination of leases by others and the identification of third-party lease
funding sources. Lease transactions generated by the division are typically full
payout leases. The Company generally receives between 1% and 4% of the equipment
cost at the time the transaction is closed for its services in arranging a
transaction. In some of the transactions it generates, the Company also enters
into a remarketing agreement that entitles it to fees upon residual sale. Lease
finance placement and advisory services generated revenues of $657,000 and
$650,000 during fiscal years 1997 and 1996, respectively.
Competition
The Company believes that, although the small ticket leasing business
has experienced substantial consolidation in the past few years, the business of
equipment leasing remains highly competitive. The Company believes, however,
that small ticket leasing, to be viable, requires the financing and monitoring
of large amounts of equipment and related assets. Because of the complexity and
cost of developing and maintaining the platforms and vendor programs to handle
such high volumes, the Company believes that there are substantial barriers to
others entering into this business. Accordingly, the Company believes that its
principal competitors are and will be primarily major financial institutions and
their affiliates. The Company also believes that the scale on which these
competitors generally operate inhibits their attention to the needs of the
Company's targeted market of small manufacturers and regional distributors and
provides the Company with an under-served market niche.
Energy Operations
General
The Company produces natural gas and, to a lesser extent, oil from
locations principally in Ohio, Pennsylvania and New York. At September 30, 1997,
the Company had (either directly or through partnerships and joint ventures
managed by it) interests in 1,129 wells, including overriding interests (of
which the Company operates 799 wells), 530 miles of natural gas
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pipelines and 81,000 acres of mineral rights, including the Company's
acquisition in June 1997 from a third party of wells, pipelines and acreage.
Natural gas produced from wells operated by the Company is collected in gas
gathering pipeline systems owned by partnerships managed by the Company (and in
which the Company also has an interest) and by systems directly owned by the
Company, and is sold to a number of customers, such as gas brokers and local
utilities, under a variety of contractual arrangements. Oil produced from wells
operated by the Company is sold at the well site to regional oil refining
companies at the prevailing spot price for Appalachian crude oil.
Well Operations
The following table sets forth information as of September 30, 1997
regarding productive oil and gas wells in which the Company has a working
interest:
Number of Productive Wells
--------------------------
Gross(1) Net(1)
---------- --------
Oil Wells......................... 157 60
Gas Wells......................... 810 526
--- ---
Total.......................... 967 586
=== ===
- ----------
(1) Includes the Company's equity interest in wells owned by 64
partnerships and joint ventures. Does not include royalty or overriding
interests with respect to 162 wells held by the Company.
The following table sets forth net quantities of oil and natural gas
produced, average sales prices, and average production (lifting) costs per
equivalent unit of production, for the periods indicated, including the
Company's equity interests in the production of 64 partnerships and joint
ventures, for the periods indicated.
Average
Lifting
Production Average Sales Price Cost per
------------------------- ------------------------ Equivalent
Fiscal Year Oil(bbls) Gas(mcf) per bbl per mcf mcf(1)
----------- --------- -------- ------- ------- ------
1997 35,811 1,227,887 $19.68 $2.59 $1.13
1996 33,862 1,165,477 $18.53 $2.34 $1.04
1995 36,420 1,198,245 $16.74 $2.31 $1.06
- ----------
(1) Oil production is converted to mcf equivalents at the rate of six
mcf per barrel.
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Neither the Company nor the partnerships and joint ventures it manages
are obligated to provide any fixed quantities of oil or gas in the future under
existing contracts.
Exploration and Development
The following table sets forth information with respect to the number
of wells completed in Ohio and New York (the only areas in which Company
drilling activities occurred) at any time during fiscal years 1997, 1996 and
1995, regardless of when drilling was initiated.
Exploratory Wells Development Wells
----------------- -----------------
Productive Dry Productive Dry
Fiscal ---------------- --------------- -------------- -------------
Year Gross Net Gross Net Gross Net Gross Net
---- ----- --- ----- --- ----- --- ----- ---
1997 1.0 .50 - - - - - -
1996 3.0 .52 1.0 .29 2.0 1.50 - -
1995 3.0 .36 2.0 .36 1.0 .87 2.0 1.75
All drilling has been on acreage held by the Company. The Company does
not own its own drilling equipment; rather, it acts as a general contractor for
well operations and subcontracts drilling and certain other work to third
parties.
Oil and Gas Reserve Information
An evaluation of the Company's estimated proved developed oil and gas
reserves as of September 30, 1997, was verified by E.E. Templeton & Associates,
Inc., an independent petroleum engineering firm. Such study showed, subject to
the qualifications and reservations therein set forth, reserves of 15.2 million
mcf of gas and 358,000 barrels of oil at September 30, 1997. See Note 13 to the
Consolidated Financial Statements.
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The following table sets forth information with respect to the
Company's developed and undeveloped oil and gas acreage as of September 30,
1997. The information in this table includes the Company's equity interest in
acreage owned by 64 partnerships and joint ventures.
Developed Acreage Undeveloped Acreage
--------------------- ------------------------
Gross Net Gross Net
----- --- ----- ---
Arkansas........................... 2,560 403 - -
Kansas............................. 160 20 - -
Louisiana.......................... 1,819 206 - -
Mississippi........................ 40 3 - -
New York........................... 12,772 10,649 14,498 13,457
Ohio............................... 61,224 36,652 18,489 17,450
Oklahoma........................... 4,243 635 - -
Pennsylvania....................... 2,271 1,679 - -
Texas.............................. 4,520 209 - -
------ ------ ------ ----
89,609 50,456 32,987 30,907
====== ====== ====== ======
The terms of the oil and gas leases held by the Company's managed
partnerships and by the Company for its own account vary, depending upon the
location of the leased premises and the minimum remaining terms of undeveloped
leases, from less than one year to five years. Rentals of approximately $27,600
were paid in fiscal 1997 to maintain leases on such acreage in force.
The Company believes that the partnership, joint venture and Company
properties have satisfactory title. The developed oil and gas properties are
subject to customary royalty interests generally contracted for in connection
with the acquisition of the properties, burdens incident to operating
agreements, current taxes and easements and restrictions (collectively,
"Burdens"). Presently, the partnerships, joint ventures and the Company are
current with respect to all such Burdens.
At September 30, 1997, the Company had no individual interests in any
oil and gas property that accounted for more than 10% of the Company's proved
developed oil and gas reserves, including the Company's interest in reserves
owned by 64 partnerships and joint ventures.
Pipeline Operation
The Company operates, on behalf of three limited partnerships of which
it is both a general and limited partner (in which it owns 13%, 46% and 22%
interests), and for its own account, various gas gathering pipeline systems
totaling approximately 530 miles in length. Such pipeline systems are located in
Ohio, New York and Pennsylvania.
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Well Services
The Company provides a variety of well services to wells of which it is
the operator and to wells operated by independent third party operators. These
services include well operations, petroleum engineering, well maintenance and
well workover and are provided at rates in conformity with general industry
standards.
Sources and Availability of Raw Materials
The Company contracts for drilling rigs and purchases tubular goods
necessary for the drilling and completion of wells from a substantial number of
drillers and suppliers, none of which supplies a significant portion of the
Company's annual needs. During fiscal 1997 and 1996, the Company faced no
shortage of such goods and services. The duration of the current supply and
demand situation cannot be predicted with any degree of certainty due to
numerous factors affecting the oil and gas industry, including selling prices,
demand for oil and gas, and governmental regulations.
Major Customers
The Company's natural gas is sold under contract to various purchasers.
For the years ended September 30, 1997 and 1996, gas sales to two purchasers
accounted for 29% and 12%, and 29% and 13%, respectively, of the Company's total
production revenues. Gas sales to one purchaser individually accounted for
approximately 15% of total revenues from energy production for fiscal 1995.
Competition
The oil and gas business is intensely competitive in all of its
aspects. The oil and gas industry also competes with other industries in
supplying the energy and fuel requirements of industrial, commercial and
individual customers. Domestic oil and gas sales are also subject to competition
from foreign sources. Moreover, competition is intense for the acquisition of
leases considered favorable for the development of oil and gas in commercial
quantities. The Company's competitors include other independent oil and gas
companies, individual proprietors and partnerships. Many of these entities
possess greater financial resources than the Company. While it is impossible for
the Company to accurately determine its comparative industry position with
respect to its provision of products and services, the Company does not consider
its oil and gas operations to be a significant factor in the industry.
Markets
The availability of a ready market for oil and gas produced by the
Company, and the price obtained therefor, will depend upon numerous factors
beyond the Company's control including the extent of domestic production, import
of foreign natural gas and/or oil, political instability in oil and gas
producing countries and regions, market demands, the effect of federal
regulation
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on the sale of natural gas and/or oil in interstate commerce, other governmental
regulation of the production and transportation of natural gas and/or oil and
the proximity, availability and capacity of pipelines and other required
facilities. Currently, the supply of both crude oil and natural gas is more than
sufficient to meet projected demand in the United States. These conditions have
had, and may continue to have, a negative impact on the Company through
depressed prices for its oil and gas reserves.
Governmental Regulation
The exploration, production and sale of oil and natural gas are subject
to numerous state and federal laws and regulations. Compliance with the laws and
regulations affecting the oil and gas industry generally increases the Company's
costs of doing business in, and the profitability of its energy operations.
Inasmuch as such regulations are frequently changing, the Company is unable to
predict the future cost or impact of complying with such regulations. The
Company is not aware of any pending or threatened matter involving a claim that
it has violated environmental regulations which would have a material effect on
its operations or financial position.
Sources of Funds
Historically, the Company has relied upon internally generated funds to
finance its growth. Since fiscal 1992, internally generated funds have been
augmented by sales of senior lien interests and refinancings by borrowers of the
Company's portfolio loans (see "- Commercial Mortgage Loan Acquisition and
Resolution: Sale of Senior Lien Interests and Refinancings"), by the issuance,
in May 1994, of an $8 million principal amount 9.5% Senior Note (which has since
been repaid) and, for the acquisition of one loan, purchase money financing of
$13.4 million (which has since been repaid). During fiscal 1997, the Company
entered into an initial $20 million credit facility for its equipment leasing
operations and completed two capital markets transactions: a public offering of
its common stock resulting in $19.5 million in net proceeds to the Company and a
private placement of $115 million of its 12% Senior Notes due 2004 ("Senior
Notes") to a small group of institutional investors, resulting in $110.6 million
of net proceeds to the Company. In addition, in fiscal 1997 the Company sold
equipment leases with an the aggregate book value of $30.2 million for $33.9
million (including notes in aggregate face amount of $13.3 million).
Senior Notes. The Senior Notes are unsecured general obligations of the
Company, payable interest only until maturity on August 1, 2004. The Senior
Notes are not subject to mandatory redemption except upon a Change in Control of
the Company, as defined in the indenture (the "Indenture") pursuant to which the
Senior Notes were issued, when the Noteholders have the right to require the
Company to redeem the Senior Notes at 101% of principal amount plus accrued
interest. No sinking fund has been established for the Senior Notes. At the
Company's option, the Senior Notes may be redeemed 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. The Indenture
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contains covenants that, among other things, (i) require the Company to maintain
certain levels of net worth (generally, an amount equal to $50 million plus a
cumulative 25% of the Company's consolidated net income) and liquid assets
(generally, an amount equal to 100% of required interest payments for the next
succeeding interest payment date); and (ii) limit the ability of the Company and
its subsidiaries to (a) incur indebtedness (not including secured indebtedness
used to acquire or refinance the acquisition of loans, equipment leases or other
assets), (b) pay dividends or make other distributions in excess of 25% of
aggregate consolidated net income (offset by 100% of any deficit) on a
cumulative basis, (c) engage in certain transactions with affiliates, (d)
dispose of certain subsidiaries, (e) create liens and guarantees with respect to
pari passu or junior indebtedness and (f) enter into any arrangement that would
impose restrictions on the ability of subsidiaries to make dividend and other
payments to the Company. The Indenture also restricts the Company's ability to
merge, consolidate or sell all or substantially all of its assets and prohibits
the Company from incurring additional indebtedness if the Company's "Leverage
Ratio" exceeds 2.0 to 1.0. As defined by the Indenture, the Leverage Ratio is
the ratio of all indebtedness (excluding debt used to acquire assets,
obligations of the Company to repurchase loans or other financial assets sold by
the Company, guarantees of either of the foregoing, non-recourse debt and
certain securities issued by Securitization Entities, as defined in the
Indenture), to the consolidated net worth of the Company. The Indenture also
prohibits the Company from incurring pari passu or junior indebtedness with a
maturity date prior to that of the Senior Notes.
Senior Lien Interests. In fiscal years 1994 and 1995, Physicians
Insurance Company of Ohio ("PICO") provided refinancing of $12 million with
respect to the Company's portfolio loans through the purchase of senior lien
interests in such loans. See "- Commercial Mortgage Loan Acquisition and
Resolution: Sale of Senior Lien Interests and Refinancings" and "- Loan Status."
If a borrower defaults in the payment of debt service on any of these senior
lien interests, the Company is required to replace the defaulted obligation with
a performing obligation. The Company receives an annual mortgage servicing fee
of 0.25% of the principal amount of any senior lien interests sold to PICO. In
connection with the sale of these senior lien interests and the issuance of the
9.5% Senior Note, PICO was issued warrants to purchase 983,150 shares of the
Company's common stock. PICO exercised these warrants in July 1997, from which
the Company realized $3.66 million. The 983,150 shares were subsequently resold
by PICO in a separate private placement to a small group of institutional
investors.
In fiscal 1996 and 1997, Commerce Bank, Philadelphia, Pennsylvania,
purchased senior lien interests in four of the Company's loans for $13.8 million
(of which two senior lien interests, for $4.0 million, have since been repaid).
The remaining senior lien interests must be repaid before June 27, 2002 ($1.8
million) and September 29, 2002 ($8 million). If either interest is not repaid
by its maturity date, the Company is required to repurchase it from Commerce for
a price equal to its unpaid principal balance plus accrued interest.
In fiscal 1997, Crusader Bank, Philadelphia, Pennsylvania ("Crusader")
purchased a senior lien interest in one of the Company's loans for $450,000. The
interest must be repaid before
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May 21, 2002. If not repaid by its maturity date, the Company is required to
repurchase the interest for a price equal to its unpaid principal balance plus
accrued interest.
In fiscal 1997, People's Thrift Savings Bank, Norristown, Pennsylvania
("People's Thrift") purchased senior lien interests in two of the Company's
loans, each in the amount of $750,000.
Each interest must be repaid before September 30, 2002.
The Company receives no servicing fees from the Commerce Bank, Crusader
Bank or People's Thrift Savings Bank senior lien interests.
Lease Financing Credit Facility. FLI entered into an initial $20
million revolving credit facility with term loan availability with CoreStates
Bank and First Union Bank for its equipment leasing operations. The facility
has, in addition to customary covenants, the following principal terms: (i)
revolving credit lines will have an interest rate equal to an adjusted London
Interbank Offered Rate ("LIBOR") plus 175 basis points, while term loans will
have an interest rate equal to an adjusted LIBOR plus 225 basis points; (ii) the
loans will be secured by a first lien on the equipment leases being financed
(and on the underlying equipment), a guaranty by the Company and a pledge of the
capital stock of FLI and Resource Leasing, Inc. (the direct parent of FLI and a
wholly-owned subsidiary of the Company); (iii) revolving credit loans may be
converted to term loans (with terms of 1