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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, 1998
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. [X]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant, based upon the closing price of such stock on December 9, 1998, was
approximately $232,358,000.
The number of outstanding shares of the registrant's Common Stock on December 9,
1998 was 21,859,924.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for registrant's Annual Meeting of Stockholders
to be held on March 16, 1999 are incorporated by reference in Part III of this
Form 10-K.
2
RESOURCE AMERICA, INC. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT
ON FORM 10-K
PART I Page
Item 1: Business............................................... 4
Item 2: Properties............................................. 43
Item 3: Legal Proceedings...................................... 43
Item 4: Submission of Matters to a Vote of Security
Holders............................................ 44
PART II
Item 5: Market for Registrant's Common Equity and
Related Stockholder Matters........................ 44
Item 6: Selected Financial Data................................ 45
Item 7: Management's Discussion and Analysis of
Financial Condition and Results of
Operations......................................... 45
Item 7A: Quantitative and Qualitative Disclosures
About Market Risk.................................. 62
Item 8: Financial Statements and Supplementary Data............ 66
Item 9: Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure............. 107
PART III
Item 10: Directors, Executive Officers, Promoters and
Control Persons of the Registrant.................. 107
Item 11: Executive Compensation................................. 107
Item 12: Security Ownership of Certain Beneficial Owners
and Management..................................... 107
Item 13: Certain Relationships and Related Transactions......... 107
PART IV
Item 14: Exhibits, Financial Statement Schedules and
Reports on Form 8-K................................ 107
SIGNATURES
3
PART I
ITEM 1 BUSINESS
General
The Company was organized as a Delaware corporation in 1966 and, until
1991, was principally involved in the energy industry. Since 1991, the Company
has expanded its business strategy to focus 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 finance 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 residential mortgage
lending business. The Company has also sponsored Resource Asset Investment Trust
("RAIT"), a real estate investment trust, and currently owns 14% of RAIT's
common shares of beneficial interest. Within its equipment leasing business, the
Company focuses primarily on small ticket equipment lease financing, although it
also manages five publicly-owned equipment leasing partnerships and has a small
lease finance placement and advisory business. In its energy business, the
Company produces natural gas and oil. In September 1998, the Company acquired
The Atlas Group, Inc. ("Atlas"), a company primarily involved in energy finance
through the syndication of oil and gas properties.
Amounts of revenue, operating profit or loss and identifiable assets
attributable to each of the Company's industry segments for fiscal 1996 through
fiscal 1998 are shown in note 13 of the Consolidated Financial Statements.
During the past three fiscal years, the Company's revenues were distributed
across its industry segments as follows:
Year ended September 30,
------------------------
(Dollars in Thousands)
1998 1997 1996
---- ---- ----
Segment % $ % $ % $
- - ------- --- --- --- --- --- ---
Real estate finance 72 62,856 58 19,144 42 7,171
Equipment leasing 16 13,561 22 7,162 26 4,466
Energy 8 6,734 17 5,608 30 5,157
Real Estate Finance
Commercial Mortgage Loan Acquisition and Resolution Strategy
Identification and Acquisition of 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, on favorable terms, commercial mortgage loans held by
large private sector financial institutions and other entities. Due to the
complexity of issues relating to these loans (including under-performance and
past or present defaults), their comparatively small size relative to a large
4
institution's total portfolio, their lack of conformity to an institution's then
existing lending criteria and/or other factors, the lender is often not able, or
willing, to devote the necessary managerial and other resources to the loans.
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.
Efficient Resolution of Loans. The Company believes that a further
aspect of its success to date has been its ability to resolve issues 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 identify
and resolve any existing operational, financial or other issues at the property
or to manage the non-conforming aspects of the loan or its underlying 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 issues
to which commercial properties may be subject and who have, in the past,
provided effective services to the Company.
Refinancings and Sales of Senior Lien Interests in Portfolio Loans. The
Company seeks to reduce its invested cash and enhance its returns from its
commercial loan portfolio through refinancing by borrowers of the properties
underlying its loans, financing by the Company of the loans held by it, or the
sale of senior lien interests or loan participations in loans held by it. 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 cash (and in some
cases has obtained returns of amounts in excess of its invested cash), which it
will typically seek to reinvest in further loans, while maintaining a
significant continuing position in the original loan. See "Business - Real
Estate Finance - Commercial Mortgage Loan Acquisition and Resolution:
Refinancings and Sales of Senior Lien Interests in Portfolio Loans." In
addition, the Company has sold and anticipates further sales of whole loans,
senior lien interests and loan participations to RAIT (see "Business - Real
Estate Finance - Sponsorship of Real Estate Investment Trust").
Disposition of Loans. In the event a borrower does not repay a loan
when due, or upon expiration of applicable forbearance periods (See "Business -
Real Estate Finance - Commercial Mortgage Loan Acquisition and Resolution:
Forbearance Agreements"), 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 (or further
forbear) from the exercise of remedies available to it.
Market for Commercial Mortgage Loan Acquisition and Resolution Services
Loans acquired by the Company are, at the time of acquisition, secured
by commercial properties (generally multi-family housing, office buildings,
hotels or single-user retail properties) which, while income producing, are
typically unable fully to meet the debt service requirements of the original
loan terms or otherwise do not conform to the holder's then-established lending
criteria. The loans are usually acquired from banks, insurance companies,
investment banks, mortgage banks, pension funds or other similar financial
organizations.
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 the creation of this market was the sale of
packages of under-performing and non-performing loans by government agencies,
5
which has declined in recent years. The Company believes, however, that a
permanent market for these services has emerged in the private sector as
financial institutions and other entities realize that outside specialists may
be able to address issues surrounding under-performing, defaulted,
non-conforming or similar loans more cost-efficiently than their internal staff.
Additionally, the Company believes that Japanese banks are continuing to dispose
of non-performing, under-performing and non-conforming commercial mortgages
secured by properties located in the United States in response to Japanese
domestic market and banking conditions. The sale of loans provides selling
institutions with a means of disposing of these assets, thereby obtaining
liquidity and improving their balance sheets. The trend has been reinforced,
management believes, by consolidation within the banking 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 loan, 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 purchase offer for any loan is based upon
the foregoing evaluations and analyses.
The Company has established the following guidelines in connection with
its loan acquisitions: (i) cash flow from the property securing the loan should
be sufficient to yield an initial cash return on the Company's cash investment
of not less than 10% per annum; (ii) the ratio of the Company's initial
investment to the appraised value of the property underlying the loan (generally
utilizing an appraisal dated within one year of acquisition) should be less than
80%; (iii) there is the possibility of either prompt refinancing of the loan by
the borrower after acquisition, refinancing of the loan by the Company 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; 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. The Company is not,
however, bound by these guidelines and 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. While the Company
has met the initial cash return on net investment guideline in acquiring its
loans, as of September 30, 1998, the Company had in its portfolio 10 loans (57%
of the Company's commercial loan portfolio by book value, including four loans
acquired in 1998 constituting 47% of the Company's commercial loan portfolio by
book value) in which the ratio of the cost of investment to the appraised value
of the underlying property (both at the time of acquisition and at the date of
6
the most recent appraisal) exceeded 80%. While the Company has historically
acquired loans in the $1.0 million to $15.0 million range, it has expanded its
focus to also include larger loans which meet its investment objectives. The
Company currently has seven loans in its portfolio which had initial acquisition
costs in excess of $15.0 million. After borrower refinancings or sales of senior
lien interests in six of these loans, the Company had an investment in two loans
that exceeded $15.0 million, one of which has not been refinanced. 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), or as to the amount it may invest in any one loan,
the ratio of initial investment cost-to-appraised value of the underlying
property or the cash yield on the Company's remaining investment. See "Business
- - - Real Estate Finance - Commercial Mortgage Loan Acquisition and Resolution:
Sale of Senior Lien Interests and Refinancings" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Results of
Operations: Real Estate Finance."
As part of the acquisition process, the Company typically resolves
existing issues 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. With
respect to non-conforming loans or their related properties, or where a property
underlying a loan has operational problems, the Company will typically require
appointment of a property manager acceptable to it (see "Business - Real Estate
Finance - 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.
Upon acquisition of a loan, the Company typically requires that all
revenues from the property underlying the loan be paid into an operating account
which the Company or its managing agent control. 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 60 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.
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
7
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, 1998, revenues were being paid
directly to senior lienholders with respect to two loans (loans 7 and 40). Where
the property is being managed by Brandywine Construction & Management, Inc.
("BCMI"), a property manager affiliated with the Company (see "Business - Real
Estate Finance - 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, 1998, 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. As of September 30, 1998, the
Company permitted borrowers with respect to six loans (loans 24, 27, 31, 32, 37
and 41) to do so.
Commercial Mortgage Loan Acquisition and Resolution: Refinancings
and Sales of Senior Lien Interests
In evaluating a potential commercial mortgage loan, the Company places
significant emphasis on the likelihood of its being able to finance its interest
or 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 refinancing or sale of a senior lien interest,
the Company will typically retain an interest in the loan, which is subordinated
to the interest of the refinance lender or senior lienholder.
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 typically less than the interest rate on the Company's retained
interest.
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 interest.
Typically, the interest rate on the senior lien interest is less than the stated
rate on the Company's loan.
As of September 30, 1998, senior lien interests with an aggregate
balance of $12.0 million relating to seven 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 (one in 1999, five in 2000 and one in
2001). Five other senior lien interests obligate the Company, upon their
respective maturities (all in fiscal 2003), 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 (which will aggregate
$2.1 million, $11.9 million, $2.5 million, $10.7 million and $2.8 million,
8
respectively, assuming all debt service payments have been made). See "Business
- - - Real Estate Finance - Commercial Mortgage Loan Acquisition and Resolution:
Loan Status."
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 two loans aggregating $2.8 million
and constituting 1.5%, by book value, of the Company's loans as of September 30,
1998), 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, a
pledge of the borrower's equity and/or a similar device.
Commercial Mortgage Loan Acquisition and Resolution: Forbearance Agreements
Commercial mortgage loans acquired by the Company that are in default
typically 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 "Business - Real Estate Finance - 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 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 owned by the Company as of September 30, 1998. In eight
instances, the President of BCMI (or an entity affiliated with him) has also
acted as the general partner, president 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 "Business - Real Estate Finance - Commercial Mortgage Loan
Acquisition and Resolution: Accounting for Discounted Loans") are not recognized
as revenue to the Company until actually paid.
When a loan is refinanced by the Company or the borrower, or the
Company sells a senior lien interest in the loan, the Forbearance Agreement
typically will remain in effect, subject to such modifications as may be
required by the refinance lender or senior lien holder.
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
depend 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
9
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.
Commercial Mortgage Loan Acquisition and Resolution: Loan Status
At September 30, 1998, the Company's loan portfolio consisted of 41
loans of which 32 loans were acquired as first mortgage liens and nine loans
were acquired as junior lien obligations. The Company's strategy has been to
acquire loans in anticipation of financing the loan by the Company, selling a
senior lien interest in the loan or in anticipation of the borrower's
refinancing of the loan. As of September 30, 1998, the Company had sold senior
lien interests in 21 loans in its portfolio (including senior interests in five
loans initially acquired by the Company as junior lien loans) and borrowers with
respect to 10 of the Company's loans had obtained refinancing. After such sales
and refinancings, the Company held subordinated interests in 35 loans of which
two interests, constituting approximately 1.5% of the book value of the
Company's loan portfolio, are not collateralized by recorded mortgages (see
"Business - Real Estate Finance - Commercial Mortgage Loan Acquisition and
Resolution: Sale of Senior Lien Interests and Refinancings").
The following table sets forth certain information relating to the
Company's investments in commercial mortgage loans, grouped by the type of
property underlying the loans, as of September 30, 1998. Loans 2, 4, 6, 8, 9,
10, 12, 19, 23, and 38 are not included in the table because they were sold to
RAIT during the 1998 fiscal year.
Loan Outstanding
Loan Type of Acquired Loan
Number Property Location Seller/Originator (Fiscal Year) Receivable(1)
- - ------ -------- -------- ----------------- ------------- -------------
005 Office Pennsylvania Shawmut Bank(10) 1993 $ 6,871,095
011(32) Office Washington, D.C. First Union Bank(10) 1995 1,496,017
014 Office Washington, D.C. Nomura/Cargill/Eastdil Realty(13) 1995 16,981,029
020 Office New Jersey Cargill/Eastdil Realty(13) 1996 7,537,780
026(32) Office Pennsylvania FirsTrust FSB/The Metropolitan Fund 1997 8,900,194
027(22) Office Pennsylvania Lehman Brothers Holdings, Inc. 1997 57,103,389
029(24)(32) Office Pennsylvania Castine Associates, L.P. 1997 7,655,240
035(26) Office Pennsylvania Jefferson Bank 1997 2,434,553
036 Office North Carolina Union Labor Life Insurance Co. 1997 4,626,269
044(31) Office Washington, DC Dai-Ichi Kangyo Bank 1998 100,725,247
046 Office Pennsylvania CoreStates Bank, N.A. 1998 6,014,713
048(33) Office Pennsylvania Institutional Property Assets 1998 65,665,695
049(37) Office Maryland BRE/Maryland 1998 98,856,915
------------
Office Totals $384,868,136
------------
001 Multifamily Pennsylvania Alpha Petroleum Pension Fund 1991 $ 8,852,591
003 Multifamily New Jersey RAM Enterprises/Glenn Industries 1993 2,860,838
Pension Plan
015 Condo/ North Carolina First Bank/South Trust Bank(14) 1995/1997 3,564,318
Multifamily
021(18) Multifamily Pennsylvania Bruin Holdings/Berkeley Federal 1996/1997 9,821,038
Savings Bank
022 Multifamily Pennsylvania FirsTrust FSB 1996 5,257,097
024 Multifamily Pennsylvania U.S. Dept. of Housing & Urban
Development 1996 3,404,809
028 Condo/ North Carolina First Bank/SouthTrust Bank(23) 1997 1,724,363
Multifamily
031 Multifamily Connecticut John Hancock Mutual Life 1997 10,121,734
Insurance Company
032 Multifamily New Jersey John Hancock Mutual Life 1997 12,532,447
Insurance Company
034(25) Multifamily Pennsylvania Resource America, Inc. 1997 404,537
[TABLE RESTUBBED FROM ABOVE]
Value of
Property
Loan Securing Cost of
Number Loan(2) Investment(3)
- - ------ ---------- -------------
005 $ 1,700,000 $ 1,246,629
011(32) 1,500,000 1,187,419
014 14,000,000 11,995,336
020 4,600,000 3,358,762
026(32) 5,000,000 2,485,078
027(22) 34,000,000 19,252,051
029(24)(32) 4,025,000 3,057,928
035(26) 2,550,000 1,695,498
036 4,150,000 3,077,343
044(31) 98,000,000 79,192,515
046 5,300,000 3,737,114
048(33) 65,000,000 58,657,176
049(37) 99,000,000 88,511,074
----------- -----------
Office Totals $338,825,000 $277,453,923
----------- -----------
001 $ 5,300,000 $ 4,742,767
003 1,350,000 1,334,167
015 3,702,000 2,792,309
021(18) 4,222,000 2,498,065
022 4,110,000 2,461,114
024
3,250,000 2,740,159
028 1,773,000 1,028,143
031 7,500,000 4,777,959
032 13,278,000 7,397,888
034(25) 450,000 401,500
11
(Continued)
Loan Outstanding
Loan Type of Acquired Loan
Number Property Location Seller/Originator (Fiscal Year) Receivable(1)
- - ------ -------- -------- ----------------- ------------- -------------
037 Multifamily Florida Howe, Soloman & Hall 1997 $ 7,421,526
Financial, Inc.
041 Multifamily Connecticut J.E. Roberts Companies 1998 26,767,078
042 Multifamily Pennsylvania Fannie Mae(28) 1998 5,540,485
043(29) Multifamily Pennsylvania Downingtown National Bank 1998 2,049,150
045(16) Multifamily Maryland Lennar Partners 1998 19,900,000
047(32) Multifamily New Jersey Credit Suisse First Boston
Mortgage Capital, Inc. 1998 3,336,500
050 Multifamily Illinois J.E. Roberts Companies 1998 47,144,118
051 Multifamily Illinois J.E. Roberts Companies 1998 24,987,898
----------
Multifamily Totals $195,690,527
-----------
007 Single User Minnesota Prudential Insurance, Alpha 1993 $ 5,363,557
(Retail) Petroleum Pension Fund
013(32)(36) Single User California California Federal Bank, FSB 1994 2,929,469
(Commercial)
016 Single User California Mass Mutual/Alpha Petroleum 1995/1996 7,226,604
(Retail) Pension Fund
017(15)(32) Single User West Virginia Triester Investments(10) 1996 1,506,191
(Retail)
018 Single User California Emigrant Savings Bank/Walter 1996 2,933,741
(Retail) R. Samuels and Jay Furman(17)
033 Single User Virginia Brambilla, Ltd. 1997 4,191,328
(Retail)
040 Retail Virginia Lehman Brothers Holdings 1998 45,365,832
----------
Commercial Retail Totals $ 69,516,722
----------
025 Hotel/Commercial Georgia Bankers Trust Co. 1997 $ 6,304,855
030 Hotel Nebraska CNA Insurance 1997 7,940,171
039(25)(27) Hotel Georgia Resource America, Inc. 1997 1,476,527
-----------
Hotel Totals $ 15,721,553
-----------
Balance as of September 30, 1998 $665,796,938
============
[TABLE RESTUBBED FROM ABOVE]
Appraised
Value of
Property
Loan Securing Cost of
Number Loan(2) Investment(3)
- - ------ --------- -------------
037 $ 3,500,000 $ 2,760,380
041 21,000,000 14,724,961
042 5,740,000 4,234,556
043(30) 2,275,000 1,563,215
045(16) 19,500,000 1,300,000
047(32)
3,375,000 2,515,513
050 23,400,000 18,114,910
051 21,000,000 17,320,143
---------- ----------
Multifamily Totals $144,725,000 $92,707,749
----------- ----------
007 $ 2,515,000 $ 1,356,507
013(32)(36) 2,600,000 1,701,049
016 3,000,000 2,157,238
017(15)(32) 1,900,000 895,334
018 4,555,000 2,267,232
033 2,650,000 2,108,028
040 47,000,000 43,156,561
---------- ----------
Commercial Retail Totals $ 64,220,000 $53,641,949
---------- ----------
025 $ 8,500,000 $ 5,945,373
030 5,100,000 3,872,589
039(25)(27) 4,100,000 1,438,146
------------ -----------
Hotel Totals $ 17,700,000 $11,256,108
------------ -----------
$565,470,000 $435,059,729
============ ============
12
(Continued)
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 Book Value Outstanding Loan Forbearance
Number Appraised Value Lien Interests Investment(4) of Investment(5) Receivables(6) Agreement(7)
- - ------ ---------------- -------------- ------------- ---------------- ----------------- -----------------
005 73% $ 940,000(12) $ 306,629 $ 817,001 $ 6,031,095 02/07/01
011 79% 660,000(12) 527,419 748,554 811,017 06/01/00
014 86% 6,487,000 5,508,336 6,888,741 10,432,874 11/30/98(34)
020 73% 2,562,000 796,762 2,243,582 5,150,563 02/07/01
026 50% 2,231,693 253,385 1,312,215 6,687,291 09/30/03
027 57% 17,900,000(9)(21) 1,352,051 13,576,057 39,318,931 01/01/02
029 76% 2,625,000(20) 432,928 1,299,182 5,044,263 07/01/02
035 66% 1,750,000(38) (54,502) 570,282 684,553 09/25/02
036 74% 1,750,000(38) 1,327,343 1,800,246 2,876,269 12/31/11
044 81% 71,500,000(9) 7,692,515 20,040,925 19,342,588(31) 08/01/08
046 71% 0 3,737,114 3,753,934 6,014,713 09/30/14
048 90% 44,000,000 14,657,176 16,378,129 21,740,202 08/01/08
049 89% 60,000,000 28,511,074 35,081,713 38,856,915 10/01/03
---------- ---------- ---------- ----------
Office Totals $212,405,923 $65,048,230 $ 104,510,561 $162,991,274
----------- ---------- ----------- -----------
001 89% $ 2,570,000(8) $ 2,172,767 $ 2,632,828 $ 6,282,591 12/31/02
003 99% 627,000 707,167 735,102 2,235,969 01/01/03
015 75% 2,558,000(8) 234,309 3,564,320 1,303,246 08/25/00
021 59% 2,860,000(12)(38) (361,935) 1,081,033 6,961,038 07/01/16
022 60% 3,125,000(19)(20) (663,886) 981,399 2,144,117 10/31/98(35)
024 84% 2,318,750 421,409 809,139 926,349 11/01/22
028 58% 0 1,028,143 1,724,363 1,724,363 03/31/02
031 64% 1,800,000(38) 2,977,959 3,917,915 8,321,734 09/01/05
032 56% 6,000,000(9) 1,397,888 4,499,371 6,570,245 09/01/05
034 89% 0 401,500 402,414 404,537 10/01/02
13
(Continued)
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 Book Value Outstanding Loan Forbearance
Number Appraised Value Lien Interests Investment(4) of Investment(5) Receivables(6) Agreement(7)
- - ------ ---------------- -------------- ------------- ---------------- ----------------- -----------------
037 79% $ 2,096,000(11)(12) $ 664,380 $ 1,213,994 $ 5,325,526 07/01/00
041 70% 12,000,000(21) 2,724,961 6,600,194 14,825,089 07/01/03
042 74% 3,000,000(20) 1,234,556 1,760,228 2,543,278 12/31/02
043 69% 1,000,000(30) 563,215 879,702 1,049,150 07/01/02
045 7% 0 1,300,000 1,374,064 3,900,000 06/30/08
047 75% 1,800,000(38) 715,513 1,200,136 1,536,500 10/31/08
050 77% 10,000,000(9) 8,114,910 10,579,556 37,144,118 04/30/03
051 82% 0 17,320,143 17,333,232 24,987,898 09/30/02
---------- ---------- ---------- ------------
Multifamily Totals $ 51,754,750 $ 40,952,999 $ 61,288,990 $128,185,748
---------- ---------- ---------- -----------
007 54% $ 2,099,000 $ (742,493) $ 602,472 $ 3,275,960 12/31/14
013 65% 1,975,000(12) (273,951) 338,112 929,469 05/01/01
016 72% 2,375,000(12) (217,762) 538,238 4,826,604 12/31/00
017 47% 1,000,000(38) (104,666) 488,382 512,399 12/31/16
018 50% 1,969,000(12) 298,232 942,374 964,741 12/01/00
033 80% 1,383,705(8) 724,323 670,556 2,778,697 02/01/21
040 92% 35,250,000(8) $ 7,906,561 8,358,238 10,405,563 12/01/02
---------- --------- ---------- ----------
Commercial Retail Totals $ 46,051,705 $ 7,590,244 $ 11,938,372 $ 23,693,433
------------ ------------- ----------- -----------
025 70% $ 0 $ 5,945,373 $ 6,283,987 $ 6,304,855 12/31/15
030 76% 0 3,872,589 4,082,083 7,940,171 09/30/02
039 35% 0 1,438,146 1,452,527 1,476,527 11/01/02
------------ ------------- ----------- -----------
Hotel Totals $ 0 $ 11,256,108 $ 11,818,597 $ 15,721,553
------------ ------------- ----------- -----------
Balance as of September 30, 1998 $310,212,148 $124,847,581 $189,556,520 $330,592,008
============ ============ ============ ============
14
(1) Consists of the original stated or face value of the obligation plus
accrued interest and the amount of the senior secured interest at
September 30, 1998.
(2) The Company generally obtains appraisals on each of its properties at
least once every three years. Accordingly, appraisal dates range from
1995 to 1998.
(3) Consists of the original cost of the investment to the Company (including
acquisition costs and the amount of any senior lien obligation 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 $905,000. 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 senior lien interests at September 30, 1998 (excluding
one senior lien interest of $2.3 million which is included in the cost of
investment carried on the books of the Company relating to loan 15).
(7) With respect to loans 7, 14, 17, 25, 27, 30, 31, 32, 34, 39,40,42,44, 45,
46, 47,48 and 49, the date given is for the maturity of the Company's
interest in the loan. For loan 43, the date given is the expiration date
of the Forbearance Agreement with respect to the loan in the original
principal amount of $404,026 (see note (29) below). 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 the date of
acquisition, except that, with respect to loan 40, it represents the
amount of a refinancing of the loan by the Company contemporaneously with
the Company's investment.
(9) A senior lien interest was sold to RAIT. See "Business - Real Estate
Finance - Sponsorship of Real Estate Investment Trust."
(10) Successor by merger to the seller.
(11) Senior lien interests in sold loans 2, 4 and 10 were transferred to loan
37.
(12) 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.
(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, 2016.
(16) The Company's interest is subordinate to a $4,000,000 senior lien held by
RAIT and a $12,000,000 senior lien held by an unaffiliated third party.
15
(17) Amounts advanced by the Company were used in part to directly repay the
loan of Emigrant Savings Bank; the balance was applied to purchase a note
held by Messrs. Samuels and Furman.
(18) 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, 18 are due January 1, 2015, one is due October 1, 2007, one is
due March 1, 2001 and two are due October 9, 2001. The president of BCMI
and his wife own general and limited partnership interests in the
borrowers of some of these loans. The borrower with respect to other
loans is a trust, the trustee of which is the president of BCMI and the
beneficiary of which is a limited partnership for which a director of the
Company is general partner.
(19) Includes a junior lien interest sold to Crafts House Apartments Partners,
L.P., a limited partnership in which the Chairman and Vice Chairman of
the Company beneficially own a 21.3% interest.
(20) Three senior lien interests sold to Crusader Bank, Philadelphia,
Pennsylvania. At the time of sale the Company paid off the original
senior lien interests pertaining to two of these loans. The Company has
the obligation to repurchase these senior lien interests, at Crusader's
option, on or after March 31, 2003 (loans 22 and 29) and June 25, 2003
(loan 42).
(21) Two senior lien interests were sold to Commerce Bank, N.A. ("Commerce"),
Philadelphia, Pennsylvania. The Company has the obligation to repurchase
the senior lien interest associated with loan 27, at Commerce's option,
on or after March 5, 2003, if the senior lien interest is not repaid in
accordance with its terms by the borrower.
(22) The property securing the loan is owned by two partnerships, the
"Building Partnership" and the "Garage Partnership." Pursuant to a loan
restructuring agreement which pre-dates the Company's interest in the
loan, an affiliate of the holder of the loan is required to hold the
general partnership interests in both the Building Partnership and the
Garage Partnership as additional security for the loan. The partnership
interest in the Building Partnership was assigned to a limited
partnership for which a subsidiary of the Company is general partner and
RPI Partnership, an entity for which the Vice Chairman of the Company is
the general partner and the Chairman and President of the Company are
limited partners, is a limited partner. Similarly, the Garage Partnership
interest was assigned to a limited partnership for which a subsidiary of
the Company is general partner and RPI Partnership is a limited partner.
RPI Partnership has agreed that any economic benefit distributed to it as
a result of its limited partnership interests described above will be
assigned and transferred to the Company.
(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.
(24) From 1993 to October 1997, an officer of the Company served as the
general partner of the seller.
(25) Loan originated by the Company.
(26) The borrower is a limited partnership formed in 1991. The general partner
of the partnership is owned by the president of BCMI; the Chairman of the
Company and his wife beneficially own a 49% limited partnership interest
in the partnership and the Vice Chairman beneficially owns a 1% limited
partnership interest.
(27) Construction loan with a maximum borrowing of $3,625,000.
(28) Original lending institution.
(29) Consists of two related loans to one borrower secured by a single
property in the original principal amounts of $1,600,000 and $404,026,
(30) Senior lien interest sold to Washsquare Properties Partners, L.P., a
limited partnership in which the Chairman and Vice Chairman of the
Company beneficially own a 14.4% limited partnership interest.
16
(31) The Company and RAIT jointly purchased this loan, with RAIT contributing
$10,000,000 of the purchase price. Pursuant to an order of the United
States Bankruptcy Court for the District of Columbia that was in effect
at the time the Company acquired the loan, legal title to the underlying
property had to be transferred on or before June 30, 1998. In order to
comply with that order and to maintain the control of the property that
the Company deemed necessary to protect its loan interest, Evening Star
Associates took legal title on June 19, 1998. A subsidiary of the Company
is the general partner and owns a 1% interest in Evening Star Associates;
the Chairman, Vice Chairman and President of the Company own a 94%
limited partnership interest. The latter have agreed to list their
interests in Evening Star Associates for sale through a qualified real
estate broker until December 31, 1999. Any amounts received by the
limited partners for their interests in excess of their original capital
contributions plus a 6% return will be paid to Evening Star Associates.
If no such sale occurs by December 31, 1999, the limited partners may
retain their interests.
(32) With respect to loans 13, 17 and 26, the president of BCMI is the general
partner of the borrower; with respect to loan 29, he is the general
partner for the sole limited partner of the borrower; and with respect to
loan 11, he is the president of the borrower. With respect to loan 47,
the president of the borrower is an employee of BCMI.
(33) The borrower for this loan is a partnership of which BCMI owns an 11%
interest and RAIT owns a 89% interest.
(34) The Company is negotiating an extension of the forbearance agreement with
the borrower.
(35) The borrower is currently seeking to refinance the Company's loan. The
Company has not initiated any action with respect to the expiration of
the forbearance agreement.
(36) The Chairman of the Company and his wife beneficially own a 40% limited
partnership interest in the borrower.
(37) In connection with the acquisition of this loan, the Company acquired the
right to transfer the equity interest in the borrower. Currently, a
subsidiary of the Company is the general partner of the borrower. Pending
transfer of the limited partnership interests, the Vice Chairman of the
Company holds legal title to these interests.
(38) Senior lien interest sold to Peoples Thrift Savings Bank which has the
right, upon a default by borrower, to require the Company to substitute a
performing loan.
17
The following table sets forth certain information, grouped by the type
of property underlying the loans, with respect to average monthly cash flow from
the properties underlying the Company's commercial mortgage loans, average
monthly debt service payable to senior lienholders and refinance lenders,
average monthly payments with respect to the Company's retained interest and the
ratio of cash flow from the properties to debt service payable on senior lien
interests.
Average Average Monthly Debt Average Monthly
Monthly Cash Service on Refinancing Payment to
Loan Flow from or Senior Lien the Company's Cash Flow
Number Property(1)(2) Interests(3) Interest Coverage
- - ------ --------------- ---------------------- --------------- ---------
005 $ 9,841 $ 6,825 $ 3,016 1.44
011 7,813 5,566 2,247 1.40
014 92,620(4) 58,551 34,069 1.58
020 27,016 19,527 7,489 1.38
026 30,283 21,600 8,683 1.40
027 175,515 161,704 13,811 1.09
029 23,667 22,254 1,413 1.06
035 23,173 14,583 8,590 1.59
036 36,719 14,583 22,136 2.52
044 815,883 456,101 359,782 1.79
046 35,141 0 35,141 N/A
048(9) 425,000 288,314 136,686 1.47
049(9) 620,000(5) 450,000(6) 170,000 1.38
---------- ---------- ----------
Office Totals $2,322,671 $1,519,608 $ 803,063 1.53
---------- ---------- ----------
001 $ 39,197 $ 26,425 $ 12,772 1.48
003 8,052 6,058 1,994 1.33
015 & 028(7) 30,297 26,113 4,184 1.16
021 26,689 22,789 3,900 1.17
022 27,537 26,997 540 1.02
024 25,926 17,962 7,964 1.44
031 72,001 15,000 57,001 4.80
032 90,712 78,805 11,907 1.15
034 5,104 0 5,104 N/A
037 25,000 17,030 7,970 1.47
041 160,346 109,192 51,154 1.50
042 32,166 25,176 6,990 1.47
043 15,851 8,343 7,508 1.90
045 12,998 0 12,998 N/A
047 15,165 15,000(8) 165 1.01
050 92,773(5) 83,333(8) 9,440 1.11
051 67,731(5) 0 67,731 N/A
---------- ---------- ----------
Multifamily Totals $ 747,545 $ 478,223 $ 269,322 1.56
---------- ---------- ----------
007 $ 20,400 $ 20,400 $ 0 1.00
013 23,503 15,833 7,670 1.48
016 23,917 19,500 4,417 1.23
017 10,690 9,087 1,603 1.18
018 25,493(9) 15,998 9,495 1.59
033 21,940 14,985 6,955 1.46
040 375,000 249,497 125,503 1.50
---------- ---------- ----------
Commercial Retail
Totals $ 500,943 $ 345,300 $ 155,643 1.45
---------- ---------- ----------
025 $ 50,205 $ 0 $ 50,205 N/A
030 77,667 0 77,667 N/A
039 12,148(10) 0 12,148 N/A
---------- ---------- ---------- -----
Hotel Totals $ 140,020 $ 0 $ 140,020 N/A
---------- ---------- ----------
Total Properties $3,711,179 $2,343,131 $1,368,048 1.58
========== ========== ==========
18
(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 notes (4) and (5), monthly cash flow from each of
the properties has been calculated as the average monthly amount during
the three month period ended September 30, 1998.
(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 participation.
(4) Average monthly cash flow from the property represents stabilized rents
for the two months ending December 31, 1998 for leases executed for which
total rental payments commence in November 1998.
(5) Estimate based on an historical analysis of the property's cash flow
prior to the Company's purchase of the loan.
(6) The Company sold a senior lien interest in the loan on September 25,
1998. The debt service is the monthly payment commencing November 1998.
(7) Loans 15 and 28 represent different condominium units in the same
property and are, accordingly, combined for cash flow purposes.
(8) The Company sold a senior lien interest in the loan on September 30,
1998. The debt service is the monthly payment commencing November 1998.
(9) Includes one-twelfth of an annual payment of $118,000 received in
December of each year.
(10) Loan 39 is a construction loan and, as such, loan payments are based upon
outstanding advances.
Commercial Mortgage Loan Acquisition and Resolution:
Accounting for Discounted Loans
The difference between the Company's cost basis in a commercial morgage
loan and the sum of projected cash flows therefrom is accreted into interest
income over the estimated life of the loan using a method which approximates the
level interest method. Projected cash flows, which include amounts realizable
from the underlying properties, are reviewed on a regular basis, as are property
appraisals. Changes to projected cash flows reduce or increase the amounts
accreted into interest income over the remaining life of the loan.
The Company records the investments in its commercial mortgage loan
portfolio at cost, which is significantly discounted from the face value of, and
accrued interest and penalties on, the loans. This discount to face value and
accrued interest and penalties (as adjusted to give effect to refinancings and
sales of senior lien interests) totaled $139.7 million, $86.3 million and $40.0
million at September 30, 1998, 1997 and 1996, respectively. The carrying value
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 carrying value were found to be greater, the
Company would provide, through a charge to operations, an appropriate allowance.
In establishing the Company's allowance for possible losses, the Company also
considers the historic performance of the Company's loan portfolio,
characteristics of the loans in the portfolio and the properties underlying
those loans, industry statistics and experience regarding losses in similar
loans, payment history on specific loans as well as general economic conditions
in the United States, in the borrower's geographic area or in the borrower's (or
its tenant's) specific industries.
19
For the year ended September 30, 1998, the Company recorded a provision
for possible losses of $505,000 to reflect the increase in size of its
commercial mortgage loan portfolio, thereby increasing its allowance for
possible losses to $905,000.
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
The commercial mortgage loan acquisition and resolution business is
competitive in virtually all of its aspects. 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. This
competition has in the past caused, and may in the future cause, the Company's
loan acquisition costs to increase, thus reducing both the amount of loan
discount the Company can obtain and the yield of the investment to the Company.
In addition, the Company's ability to add to its loan portfolio will depend on
its success in obtaining funding for the acquisition of additional mortgages.
Subject to general market conditions and investor receptivity to the investment
potential of specialty finance companies in general and real estate and
equipment leasing companies in particular, 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. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources."
Residential Mortgage Loans
During fiscal 1998, the Company's residential mortgage lending business
emphasized providing first and second mortgage loans on one-to-four family
residences to borrowers who typically do not conform to guidelines established
by the Federal Home Loan Mortgage Corporation ("Freddie Mac") because of past
credit impairment or other reasons. The Company originated approximately $74.8
million of such loans in fiscal 1998. Subsequent to the fiscal year end, and as
a result of conditions in the capital markets (which affected the Company's
ability to obtain warehouse lines of credit and to resell residential mortgage
loans it originated), the Company determined to focus more heavily on
establishing private label programs for institutions. Under these programs the
Company operates the residential lending function of an institution for its
account, under its name and funded by the institution. No private label programs
had been established at September 30, 1998. In addition, with respect to loans
originated for its own account for resale, the Company has determined to place
more emphasis on originating conforming loans and has become a Freddie Mac
qualified lender. During fiscal 1998, approximately 7% of the Company's
residential mortgage loans conformed to Freddie Mac guidelines. The Company
currently is licensed as a residential mortgage lender in 25 states and is
originating loans in 18 states.
The Company originates residential mortgage loans with a targeted
average loan size of approximately $50,000. As of September 30, 1998, the
average loan size was approximately $44,000. Depending upon the credit
qualification of a borrower, the Company may originate loans for its portfolio
20
with a loan-to-value ratio of up to 60% (for the least qualified borrowers) to
90% (for the most qualified borrowers). During fiscal 1998, the Company also had
a program for originating "125 loans" (that is, loans with a cumulative
loan-to-value ratio of up to 125%). Approximately 29% of the Company's
residential mortgage loans originated in fiscal 1998 were 125 loans. Subsequent
to fiscal year end, the Company terminated its 125 loan program due to
conditions in the capital markets and the consequent withdrawal of entities to
whom the Company sold its 125 loans. As of September 30, 1998, the Company held
$3.9 million of 125 loans, all of which are held for sale.
During fiscal 1998, the Company utilized two warehouse lines of credit,
which have since expired, to fund its residential lending operations. The
Company is currently in the process of obtaining a new warehouse line of credit;
pending the establishment of a new line of credit, lending operations for the
Company's account are being internally funded. See "Business - Sources of
Funds."
The Company's policy is to sell loans originated for its own account
for cash. During the first quarter of fiscal 1998, however, the Company engaged
in a sale of a pool of loans for a note. The Company's policy is generally to
sell loans on a servicing-released basis; however, with respect to the sale of a
group of originated and acquired loans, the sale was on a servicing-retained
basis. The Company has subcontracted the servicing of these loans to Jefferson
Bank.
As an originator of residential mortgage loans, the Company faces
intense competition, primarily from mortgage banking companies, commercial
banks, credit unions, thrift institutions and finance companies. This
competition is particularly intense in the area of conforming loan originations
and results in loan yields and fees that are less than in the non-conforming
loan market.
Sponsorship of Real Estate Investment Trust
The Company has sponsored RAIT, a publicly-held real estate investment
trust whose common shares of beneficial interest are listed on the American
Stock Exchange. RAIT's primary business is to acquire or originate commercial
mortgage loans in situations that, generally, do not conform to the underwriting
standards of institutional lenders or sources that provide financing through
securitization. Although RAIT may acquire commercial mortgage loans at a
discount, it seeks to acquire such loans where the workout process has been
initiated and where, unlike the commercial mortgage loans acquired by the
Company, there is no need for RAIT's active intervention. RAIT commenced
operations on January 14, 1998.
As the sponsor of RAIT, the Company has acquired 14% of RAIT's common
shares at a cost of approximately $12.0 million. So long as the Company owns 5%
or more of RAIT's common shares, the Company will have the right to nominate one
person to RAIT's board of trustees (the "Board of Trustees"). In connection with
RAIT's initial public offering, the Company sold 10 of its mortgage loans and
senior lien interests in two other loans (representing a net investment by the
Company at December 31, 1997 of $17.1 million, including $2.1 million of senior
lien interests acquired by the Company in connection with the sale) to RAIT, as
part of RAIT's initial investments, for $20.1 million. The Company subsequently
sold the balance of its interest in one of the loans in which RAIT had acquired
a senior lien interest to RAIT at the carrying value of such interest to the
Company. In addition, RAIT separately acquired a $6.0 million participation in
loan 32, a $12.0 million participation in loan 44, a $4.0 million participation
in loan 45 and a $10.0 million participation in loan 50, each of which is senior
21
to the Company's interest. RAIT also purchased an 89% interest in a partnership
that owns the property securing a portion of loan 48. The Company may sell
further loans to RAIT, to a maximum of 30% of RAIT's investments (on a cost
basis), excluding the initial investments. Betsy Z. Cohen, spouse of the
Company's Chairman and Chief Executive Officer, Edward E. Cohen, and mother of
Daniel G. Cohen, President and director of the Company, is the Chairman and
Chief Executive Officer of RAIT. Jonathan Z. Cohen, a son of Mr. and Mrs. Cohen
and a Vice President of the Company, is the Company's nominee to the Board of
Trustees and is the Secretary of RAIT.
To limit conflicts between RAIT and the Company, it has been agreed
that, until January 14, 2000, (i) the Company will not sponsor another real
estate investment trust with investment objectives and policies which are the
same as, or substantially similar to, those of RAIT; (ii) if the Company
originates a proposal to provide wraparound or other junior lien or subordinated
financing (as opposed to acquiring existing financing) with respect to
multifamily, office or other commercial properties to a borrower (other than to
a borrower with an existing loan from the Company), the Company must first offer
the opportunity to RAIT; and (iii) if the Company desires to sell any loan it
has acquired that conforms to RAIT's investment objectives and policies with
respect to acquired loans, it must first offer to sell it to RAIT. The Company
believes that complying with these restrictions has not materially affected the
Company's current operations, nor does it anticipate that it will do so in the
future. The Company has also agreed that if, following January 14, 2000, the
Company sponsors a real estate investment trust with investment objectives
similar to those of RAIT, the Company's representative on the Board of Trustees
(should the Company have a representative on the Board at that time) will recuse
himself or herself from considering or voting upon matters relating to
financings which may be deemed to be within the lending guidelines of both RAIT
and the real estate investment trust then being sponsored by the Company.
Equipment Leasing
General
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 acquisition, the Company assumed the management of five
publicly-held equipment leasing partnerships involving $50.1 million (original
equipment cost) in leased assets at September 30, 1998. 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 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 five 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 August
1996. FLPM's operations will continue to be reduced over the next several years
22
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
that costs between $5,000 and $100,000 ("small ticket" leasing). 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 businesses thereby affording the Company a niche market with
significant growth potential (see "Business - Equipment Leasing - Strategy:
Focus on Leasing to Small Businesses"). 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 actively pursues 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 currently has
programs established with 10 manufacturers or distributors of equipment in a
variety of equipment categories, including Lucent Technologies
(telecommunications) and Minolta (office automation). In addition, in fiscal
1998 the Company became the exclusive lessor for Tech Data Corporation, the
world's second largest distributor of information technology equipment. Two of
the Company's vendor programs (for Minolta Corporation and for Lucent
Technologies) accounted for 16% and 10%, respectively, of the equipment (by
cost) leased by the Company during fiscal 1998. In 1998, the Company also
pursued a marketing strategy of providing leasing on a private label basis to
the small business customers of commercial banks. Through September 30, 1998,
program agreements had been signed with three banks, including Huntington Bank,
a $40.0 billion (total assets) bank based in Columbus, Ohio.
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 employees). The Company has acquired and developed
credit evaluation and scoring systems (based upon credit evaluation services
provided by Dun & Bradstreet) which it believes significantly increases its
ability to evaluate the credit risk in dealing with small business end-users
(see "Business - Equipment Leasing 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.
23
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. 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. To the extent possible, the Company seeks to 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 four hours after receipt of a request.
Focus on Lease Sales. The Company sells substantially all of its
leases. In fiscal 1997, the Company sold four separate pools of leases and the
equipment underlying the leases (including the residual interest) to special
purpose lease financing entities (each, an "Intermediate Purchaser") which then
sold interests in the leases to an institutional buyer. In the first quarter of
fiscal 1998, the Company entered into an arrangement with an unaffiliated
Intermediate Purchaser and a group of institutional buyers to periodically sell
leases (including lease residuals) to a maximum of $50.0 million of leases. The
Company has utilized $27.7 million of availability under this arrangement
through September 30, 1998. In June 1998, the Company entered into a second
lease sale facility with an affiliated Intermediate Purchaser to a maximum of
$100.0 million. Under this latter facility, the Company retains lease residuals
(that is, the proceeds received from the sale or re-leasing of equipment upon
lease termination or from the extension of the lease term beyond its original
expiration date). The Company has utilized $50.2 million of availability under
this facility through September 30, 1998. See "Business - Sources of Funds -
Forward Lease Sale Facilities." To date, the Company has retained the servicing
rights on the leases it sells. Selling the leases allows the Company to recover
a significant amount of its investment in the leased equipment, freeing capital
for further leasing activity.
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. 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 and
computer systems. The table below sets forth the distribution of equipment
purchased by the Company, by principal product type and percentage of dollar
volume of equipment purchased, during the fiscal years 1998, 1997 and 1996.
24
Equipment Volume by Product Type
(% by dollar volume of equipment purchased)
Year Ended
September 30
-------------------------------------
1998 1997 1996
---- ---- ----
Document processing and storage.............. 40% 49% 73%
Telecommunications........................... 32 37 21
Computer systems............................. 15 8 6
Other........................................ 13 6 -
--- --- ---
100% 100% 100%
=== === ===
The Company has developed a credit evaluation system, known as the
"Small Business Credit Scoring System," in order 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 markets its leasing services primarily through the
establishment of vendor programs. See "Business - Equipment Leasing - Strategy -
Focus on Vendor Programs." As of September 30, 1998, the Company had vendor
program relationships with 10 vendors, including Minolta Corporation and Minolta
Business Systems. In addition, three manufacturers, including Lucent
Technologies, Inc. and Tech Data Corporation, have designated the Company as an
authorized lessor for their dealer distribution channels. 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
25
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.
In April 1998, the Company commenced retaining for its own account the
residual interest in leases sold by it and anticipates that it will derive a
significant portion of its leasing profits (if any) from residuals. Currently,
repayment of notes received by the Company from Intermediate Purchasers of the
Company's equipment leases in earlier sales depends, to a significant extent, on
realization of residuals. See "Business - Equipment Leasing - Revenue
Recognition and Lease Accounting." 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.
Revenue Recognition and Lease Accounting
General. The manner in which lease finance transactions are
characterized and reported for accounting purposes has a significant impact upon
the Company's reported revenue, net earnings and the resulting financial
measures. Lease accounting methods significant to the Company's leasing
operations are discussed below.
Direct Financing Leases. The Company classifies its lease transactions,
as required by the Statement of Financial Accounting Standards No. 13,
Accounting for Leases ("FASB No. 13"), as direct financing leases (as
distinguished from sales-type or operating leases). Direct financing leases
transfer substantially all benefits and risks of equipment ownership to the
customer. A lease is a direct financing lease if the creditworthiness of the
customer and the collectibility of lease payments are reasonably certain and the
lease meets one of the following criteria: (i) it transfers ownership of the
equipment to the customer by the end of the lease term; (ii) it contains a
bargain purchase option; (iii) the term at inception is at least 75% of the
estimated economic life of the leased equipment; or (iv) the present value of
the minimum lease payments is at least 90% of the fair market value of the
leased equipment at inception of the lease. The Company's net investment in
direct financing leases consists of the sum of the total future minimum lease
payments receivable and the estimated unguaranteed residual value of leased
equipment, less unearned income. Unearned lease income, which is recognized as
26
revenue over the term of the lease by the effective interest method, represents
the excess of the total future minimum lease payments plus the estimated
unguaranteed residual value expected to be realized at the end of the lease term
over the cost of the related equipment. Initial direct costs incurred in
consummating a lease are capitalized as part of the investment in direct finance
leases and amortized over the lease term as a reduction in the yield.
Residual Values. Unguaranteed residual value represents the estimated
amount to be received at lease termination from lease extensions or disposition
of the leased equipment. The estimates are based upon available industry data
and senior management's prior experience with respect to comparable equipment.
Current estimates of residual values will vary from the original recorded
estimates. Residual values are reviewed periodically to determine if the fair
market value of the equipment is below its recorded estimate. If required,
residual values are adjusted downward to reflect adjusted estimates of fair
market value. Generally accepted accounting principles do not permit upward
adjustments to residual values.
Sales of Leases. The Company sells a large percentage of the leases it
originates (until recently including residuals) through indirect securitization
transactions and other structured finance techniques. In a securitization
transaction, the Company sells and transfers a pool of leases to a bankruptcy
remote Intermediate Purchaser. Typically, the Intermediate Purchaser will have
no material assets apart from the leases sold to it. The Intermediate Purchaser
in turn simultaneously sells and transfers its interest in the leases (excluding
the residual value) to a financial institution in return for cash equal to a
percentage of the aggregate present value of the lease receivables being sold.
The consideration paid to the Company for the lease receivables and the
residuals sold to the Intermediate Purchaser consists of the cash advanced by
the financial institution and an interest bearing note from the Intermediate
Purchaser. (Only cash is received on sales that do not include residuals.)
Gains on the sale of leases are recorded at the date of sale in the
amount by which the sales price exceeds the book value of the underlying leases.
Subsequent to a sale which includes residuals, the Company has no remaining
interest in the pool of leases or equipment except (i) a security interest is
retained in the pool when a note is received as part of the sale proceeds and
(ii) under certain circumstances, the Company is obligated to replace or accept
retransfer of non-performing leases in the pool.
The Company maintains an allowance for possible losses in connection
with payments due under lease contracts held in the Company's portfolio and its
retained interest in leases securitized or sold. The allowance is determined by
management's estimate of future uncollectible lease contracts based on the
Company's historical loss experience, an analysis of delinquencies, economic
conditions and trends and management's expectations of future trends, industry
statistics and lease portfolio characteristics and assumptions of future losses.
The Company's policy is to charge off to the allowance those lease contracts
which are delinquent and for which management has made a determination that the
probability of collection is remote. Recoveries on leases previously charged off
are restored to the allowance. For the fiscal year ended September 30, 1998, the
Company recorded a provision for possible losses of $1.4 million or
27
approximately 1% of lease receivables under management. For the year ended
September 30, 1997, it recorded a provision for possible losses of $253,000.
To the extent that the Company determines to retain residuals for its
own account, the Company's gain on sale from any pool of leases so sold may be
materially reduced, although the Company's revenues in subsequent years from
realization of residuals may be increased.
During fiscal 1998, the Company sold leases with a book value of
approximately $78.4 million to an Intermediate Purchaser in return for cash of
$78.0 million, on a servicing retained basis, and notes with a face value of
$8.0 million, resulting in a gain of $7.6 million. During fiscal 1997, the
Company sold leases with a book value of approximately $30.2 million, on a
servicing retained basis, to Intermediate Purchasers in return for cash of $20.6
million and notes with a total face value of $13.3 million, resulting in a gain
of $3.7 million. During fiscal 1998 and 1997, $8.6 million of principal payments
were made on these notes.
The Company accounts for the sale and servicing of lease equipment in
accordance with SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities." See Note 2, Notes to
Consolidated Financial Statements. In calculating the gains on sale to
Intermediate Purchasers, the Company assumed that the cash flows on the
underlying leases sold were discounted at rates ranging from 6.1% to 7.8% per
annum during the fiscal year ended September 30, 1998.
Partnership Management
The Company acts as the general partner and manager of five public
limited partnerships formed between 1986 and 1990 with total assets at September
30, 1998 of $34.4 million, including $21.1 million (book value) of equipment
with an original cost of $50.1 million and investments in direct financing
leases of $8.0 million. The partnerships primarily lease computers and related
peripheral equipment to investment grade, middle market and 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. The partnerships commenced their liquidation periods at various
times between December 1995 and December 1998.
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 4% to 6% of gross rents except that, if leases are
full-payout leases, management fees range from 2% 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% (one partnership) or
12% (three partnerships) of the limited partners' aggregate investment. The
Company's interest, as general partner, in cash distributions from the
partnerships is 3.5% (one partnership) and 1% (four partnerships).
28
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
$789,000, $657,000 and $650,000 during fiscal years 1998, 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.
Recent Developments
On December 15, 1998, the Company entered into an agreement to acquire
JLA Credit Corporation ("JLA"). JLA is the small-ticket United States leasing
subsidiary of Japan Leasing Corporation, headquartered in Tokyo, Japan. Like
FLI, JLA underwrites, finances and services non-cancelable, full-payout
equipment leases. JLA originated leases with an aggregate original equipment
purchase price of $151.0 million and $168.0 million during the year ended
December 31, 1997 and during the eleven months ending November 30, 1998,
respectively. As of October 31, 1998, JLA had a net investment in leases of
$324.4 million and total assets of $367.0 million. JLA's equipment leasing
business focuses on small ticket leasing programs from vendors and manufacturers
primarily in the high technology, machine tool, printing and Japanese business
segments. Lease transactions generally range in equipment size from $25,000 to
$500,000 to small and medium size businesses. Key vendor relationships include
Heidelberg, Scitex and Buycomp.
The Company expects to acquire JLA for a combination of cash, including
financing to be arranged by the Company, and assumption of existing JLA debt.
The Company values the transaction at approximately $350.0 million. Subject to a
financing contingency, the Company anticipates that the transaction will close
in January 1999.
29
Energy Operations
General
The Company produces natural gas and, to a lesser extent, oil from
locations principally in Ohio, Pennsylvania and New York. On September 29, 1998,
the Company acquired Atlas by merger. See "Business - Energy Operations -
Acquisition of Atlas." As a result of that acquisition, at September 30, 1998
the Company had (either directly or through partnerships and joint ventures
managed by it) interests in 2,505 wells (including royalty or overriding
interests with respect to 182 wells), of which the Company operates
approximately 2,200 wells, 1,250 miles of natural gas pipelines and 301,000
acres (net) of mineral rights. 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 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.
The Company seeks to increase its reserve base through selective acquisition of
producing properties and assets, through further development of its existing oil
and gas interests and acquisition of energy industry companies. For further
information, see Note 14 to Consolidated Financial Statements.
Acquisition of Atlas
On September 29, 1998, the Company acquired Atlas, a company
principally involved in the energy finance business, by merger with Atlas
America, Inc., a newly-formed, wholly-owned subsidiary of the Company. Atlas
owned interests in, operated or managed more than 1,400 natural gas and oil
wells and 650 miles of gas gathering pipelines, located predominantly in
Pennsylvania and Ohio. Atlas also had undeveloped oil and gas leases covering
more than 155,000 acres and managed more than 25 energy-related partnerships and
joint ventures which it had syndicated through public and private offerings.
Pursuant to the Agreement and Plan of Merger dated July 13, 1998, as
amended, (the "Agreement"), the former shareholders of Atlas received 2,063,496
shares of the Company's Common Stock ("Common Stock"), options to acquire
120,213 shares of Common Stock for nominal consideration and cash of $6.9
million. Atlas shareholders also received certain "piggy-back" registration
rights, effective during the period from September 30, 1999 through September
29, 2000, with respect to the shares of Common Stock received by them. Atlas
shareholders are also eligible to receive incentive compensation should Atlas'
post-acquisition earnings exceed a specified amount during the four years
following the merger. The incentive compensation is equal to 10% of Atlas'
aggregate earnings in excess of that amount equal to an annual (but
uncompounded) return of 15% on $63.0 million. The $63.0 million base amount will
increase by the amounts (if any) the Company pays for any post-merger energy
acquisitions. Incentive compensation is payable, at the Company's option, in
cash or in shares of Common Stock, valued at the average closing price of the
Common Stock for the ten trading days preceding September 30, 2003.
The Agreement requires the Company to indemnify the officers and
directors of Atlas until September 29, 2000 against claims based upon their
service as officers and directors of Atlas (except for claims based upon breach
of the Agreement or upon a failure to disclose information as required by the
Agreement) and against claims alleging wrongdoing by any of them outside the
scope of their employment with Atlas. The Agreement requires the principal Atlas
30
shareholders to indemnify the Company for losses resulting from a breach of any
representation or warranty given by Atlas. The maximum aggregate amount that the
shareholders are required to pay as a result of this indemnification is $10.0
million. The shareholders will have no indemnification obligation until the
aggregate loss (including expenses) exceeds $750,000 and then only to the extent
such loss exceeds $250,000. As security for this indemnification, 698,651 shares
of the Common Stock issued in connection with the merger are being held in
escrow until September 29, 2002.
The merger consideration paid by the Company was based upon the
Company's valuation of Atlas' assets and the price of the Common Stock. There
were no material relationships between the Company, its officers, directors or
affiliates, and Atlas or its officers, directors or affiliates, prior to the
merger. The cash paid in connection with the merger was derived from the
Company's working capital. It is anticipated that any cash required for payment
of incentive compensation will come from the earnings of Atlas from which the
incentive compensation has been derived.
Well Operations
The following table sets forth information as of September 30, 1998
regarding productive oil and gas wells in which the Company has a working
interest, including wells acquired in connection with the acquisition of Atlas:
Number of Productive Wells
--------------------------
(Unaudited)
Gross(1) Net(1)
-------- ------
Oil wells ................... 180 73
Gas wells ................... 2,143 1,015
----- -----
2,323 1,088
===== =====
(1) Includes the Company's equity interest in wells owned by 84
partnerships and joint ventures. Does not include royalty or overriding
interests with respect to 182 wells held by the Company.
31
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 51 partnerships and joint
ventures.
Average
Lifting
Production Average Sales Price Cost per
------------------------- ---------------------- Equivalent
Fiscal Period Oil(bbls) Gas(mcf) per bbl per mcf mcf(1)
- - ------------- --------- -------- ------- ------- ------
1998(2) 48,113 1,485,008 $14.38 $2.66 $1.14
1997 35,811 1,227,887 $19.68 $2.59 $1.13
1996 33,862 1,165,477 $18.53 $2.34 $1.04
(1) Oil production is converted to mcf equivalents at the rate of six mcf per
barrel.
(2) Excludes production relating to Atlas, which was not acquired by the Company
until the end of the 1998 fiscal year.
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 the fiscal years 1998, 1997 and
1996, regardless of when drilling was initiated.
Exploratory Wells Development Wells
--------------------------------------- -------------------------------------
Productive Dry Productive Dry
Fiscal --------------- ---------------- --------------- --------------
Period Gross Net Gross Net Gross Net Gross Net
- - ------ ----- ---